Adventist Health System is sipping from Coca-Cola's can of financial management strategies.
The Winter Park, Fla.-based healthcare system recently began implementing a leading-edge financial management strategy called "economic value added," or EVA for short. Coke is a leader among the handful of companies using EVA analyses to add life to their balance sheets. Adventist hopes to join this trend.
"What is kind of novel about this is trying to do it in not-for-profit healthcare," says Calvin W. Wiese, Adventist's senior vice president for finance.
EVA is similar to the more familiar "discounted cash flow" analyses conducted by healthcare financial managers to assess the value of expected cash flows. But it also includes a charge for capital depletion. EVA is supposed to help an organization measure whether it is adding value from operations.
The particulars get a bit complicated: EVA is measured by taking profits before interest expenses, divided by the organization's weighted average cost of capital, which is a measure of equity plus long-term debt. What it boils down to is a single number, the amount of capital the organization can support without depleting value.
Say a company made a $100 million profit before interest and its weighted average cost of capital is 15%. That tells you it can support $666 million of capital because $100 million is 15% of $666 million. The organization already has $600 million of debt and equity capital on its balance sheet, which means it can allocate an additional $66 million, Wiese explains.
"What you want to guard against is spending capital you shouldn't have spent," and you also should ensure you are spending it in the right places, Wiese says. He says EVA provides a much more rigorous framework for sizing up an organization's capital allocation decisions. "We're prepared to spend capital as long as it creates positive economic value," he adds.
Adventist is stretching EVA's application, using it as a tool for allocating capital to its investment portfolio and to mission-driven activities. Adventist's investment adviser, Birmingham, Ala.-based Highland Associates, developed this application with a healthcare board that had been considering a sale or lease but didn't know the value to the community.
Using EVA, Adventist can compute the positive or negative value of opening, say, a free clinic. If you can divert money to capital market investments that earn amounts exceeding the weighted cost of capital, you can create a subsidy for your mission, Wiese says. But if you're investing and returning less than the weighted average cost of capital, then maybe it would be better to pay off debt and reduce investments in the capital markets, he adds.
Wiese thinks the EVA analysis will lead to investments in what are perceived as riskier asset classes, such as high-yield bonds.
Adventist is no slouch in the money management department. The system is moving from a traditional "rules-based" investment policy to a "risk-based" one. Instead of managing exposure to various asset classes, Wiese establishes how much of its half-billion dollars of assets can be put at risk. He does so on a daily basis, using a statistical value-at-risk measure, and adjusts the system's investments accordingly.
It's how banks and portfolio managers are managing risk in the capital markets. If it sounds like a lot of work, "it is," Wiese confirms. But the payoff can be big.
"Let's say it cost me $1 million a year to do this, but I could increase my yield on my portfolio by (one percentage point). It would be well worth the risk," he says.
Adventist's approach illustrates a broader trend. Investment advisers say top healthcare systems are managing their investments as a single pool instead of segregated buckets of working capital, construction funds and the like.
"They're looking at the appropriate asset allocation for each piece and then trying to integrate the management and have the oversight of the pool of assets at a broader level," explains R. Barry Thomas, managing director of consulting at Rogers-Casey, a Darien, Conn.-based investment consultant.
Minneapolis-based Allina Health System, for example, models its asset allocation decisions in the aggregate. But the 21/2-year-old healthcare system segregates HMO premium income from its $650 million of balance sheet assets before investing. State insurance department rules govern how those dollars may be invested, limiting them mostly to fixed income securities. Of its non-HMO dollars, Allina allocates 35% to equities; the rest goes to global bonds and hedge funds.
"We think what we have here is an evolving, state-of-the-art portfolio," says Larry Kryzaniak, vice president of finance, treasury and consolidations for the system, which posted $2.2 billion in 1996 revenues.
What San Francisco-based Catholic Healthcare West has is an evolving system, and that in itself poses a challenge. In its three years of existence, the system of 35 hospitals and eight medical groups has added 20 facilities, boosting total assets to $4.5 billion from $1.6 billion.
To keep pace with interest-rate fluctuations and boost returns, CHW recently altered its asset and liability mix, shortening liabilities using interest-rate swaps and lengthening maturities by increasing its equity exposure. Overall, about 55% of its $1.5 billion of corporate level funds are allocated to equities.
CHW Treasurer Jesse Bean relies on advice from the system's investment subcommittee, a "kitchen cabinet" of financial experts, including a former executive of California Public Employees Retirement System, a state university retirement system executive and a senior portfolio manager.
"There's so much going on, and there's so much to learn, and we want to stay on top of it as much as we can," Bean says.