Not-for-Profit Health Care Organizations Have Unique Investing Considerations

Consulting firm Mercer has released a list of ten investment priorities for not-for-profit health care organizations.

Many not-for-profit health systems are currently engaged in or considering strategic actions such as a merger, acquisition, operating agreement, or joint venture, notes Michael Ancell, senior consultant and national segment leader for health care investments at Mercer in St. Louis, Missouri. He explains to PLANSPONSOR that during such actions, organizations prioritize projects, and the number one priority is patient care and getting operations configured. Because of this, organizations often put off decisions about consolidation of retirement plans.

However, strategic actions among not-for-profit health care organizations have been going on for years, and many are now facing retirement plan issues, Ancell says. An organization may end up with multiple defined contribution plans and needs to consolidate and bring best practices into plan governance, design and investment lineup. According to Ancell, Mercer is seeing more requests for proposals (RFPs) as health systems turn to this project and need help.

He adds that part of due diligence before completing mergers and acquisitions is to understand defined benefit plan assumptions used by each entity to calculate future benefit payments. One issue unique to not-for-profit health care organizations is that some may be classified as church plans, not subject to Employee Retirement Income Security Act (ERISA) or Pension Protection Act (PPA) requirements. These plans have more flexibility in the assumptions they can use for benefit calculations, as well as funding schedules. Some health care organizations want to maintain that status and the flexibility it provides for those plans, so consolidating defined benefit plans can be tricky.  

In general, Mercer says some strategic actions may materially alter an organization’s balance sheet and boards may be unwilling to tolerate a significant asset decline post-action. Finance and investment committees should consider how best to integrate investment strategy and whether these factors may necessitate a change in investment risk profile.

Managing endowment assets is important because those assets can be used to fund pension benefits, Ancell notes. If organizations have a defined benefit plan, they fund it with operations revenue, but if they don’t make enough, they will have to pull money out of endowments.

The combination of organizations (and their corresponding committees) warrants revisiting key investment policy questions such as time horizon, risk tolerance, and return objectives, for the new combined entity. Mercer has prepared a survey designed to facilitate this process.

For those organizations looking to de-risk defined benefit plans, Mercer suggests developing a strategy for getting the plan fully funded. Ancell points out that interest rates keep dropping, and if an organization has developed an end-game and puts the plan on a de-risking glide path, lower interest rates will make funded status worse.

Another issue unique to not-for-profit health care entities is the organizational and cost-related changes brought on by Patient Protection and Affordable Care Act (ACA) requirements. Some organizations are not as financially healthy as before, Ancell says, and they may need to look again at the endowment and pension plan risks they can take.

But, Mercer says that in 2014, some not-for-profit health care organizations have seen modest improvement in volumes and operating conditions. Improved operations may have increased their risk tolerance.

For defined contribution plans, organizations that have gone through a merger or acquisition should be aware of the differences between plans and will eventually will need to harmonize the plans so certain employees are not getting a better or worse benefit than others, Ancell says. He adds that retirement plan consolidation should not be taken lightly or quickly. Organizations should take this opportunity to review plan design and the long-term vision for their plans—how they are incentivizing employees to participate in the plans and how they helping plan participants achieve retirement readiness. “Tackle the entire project with a long-term view of what you want the plan to be for your organization, and the outcomes you want for participants,” he suggests.

According to Ancell, Mercer recommends that not-for-profit health care organizations adopt a formal investment policy statement, make a clear committee assignment for defined contribution plans and develop a charter for the committee members outlining their responsibilities.

Mercer suggests organizations clearly define defined contribution plan governance and consider whether this is an HR function or finance/investment committee responsibility. It notes that recent regulatory attention has focused on defined contribution plan fees and is likely to expand to other areas. Boards may wish to reconsider which area of an organization is best equipped to ensure regulatory compliance and recognize that ultimate fiduciary duty resides within the organization, not its plan recordkeeper.

Other investment steps for not-for-profit health care organizations recommended by Mercer include:

Set a risk floor for the system. 

Most not-for-profit health systems are subject to debt covenants that may restrict the amount of investment risk they can take with their investment portfolios. Institutions should quantify their risk floor and address it in the investment policy.

Assess the governance structure of investment portfolios and whether a delegated solution offers potential time and cost savings. 

Transformation in the delivery of care, coupled with existing operating pressures, require health care organizations to reduce costs while increasing the quality of care. Delegating certain elements of an organization's investment function can potentially reduce investment expenses and free up staff and committee time to focus on strategy.

Review the fixed-income allocation and evaluate whether unconstrained bond funds could be a component of a fixed income program. 

Health care operating portfolios have generally been structured more conservatively than traditional endowment portfolios with larger allocations to fixed income. Operating revenue shortfalls may increase reliance on operating portfolio returns; however, historically low fixed-income yields present a challenge. In addition to ensuring that overall allocations are appropriate to support an operating portfolio’s multiple objectives, organizations should determine if the size and composition of fixed-income holdings remain appropriate and understand their sensitivity to a rising rate environment. The fixed income portfolio could even be viewed as a partial hedge to variable rate debt on the balance sheet.

Set an illiquidity budget as part of managing the overall risk profile.  

Some systems are increasing their allocations to private or illiquid assets. Yet rating agencies may count illiquid assets in days-cash-on-hand calculations. The investment committee should determine how illiquid investments are viewed by all constituencies and set an illiquidity budget as part of the overall risk profile.