The bull market's recent retreat doesn't frighten 247-bed Riddle Hospital in Media, Pa.
Although the not-for-profit facility risks a hefty 58% of its $9,746 funded-depreciation account on equity investments, investment committee members aren't likely to reduce that exposure when they meet next week, says Robert Sutton, vice president, chief financial officer and treasurer at the suburban Philadelphia hospital.
Riddle is lucky. It doesn't rely on investment income to prop up the bottom line, as many providers do. According to Standard & Poor's, Riddle Health System, the hospital's parent, generated healthy operating and profit margins averaging 6% and 5.6%, respectively, from 1995 to 1997.
Riddle is in the stock market for the long haul, but not every provider dares to be so bold with its allocation to equities. Providers faced with eroding profits from operations are those for whom the stock market's recent rough-and-tumble ride is causing serious indigestion, financial advisers say.
No investor wants to relive the pain inflicted by the market during the third quarter 1998. Take the Dow Jones industrial average as a proxy for market losses. On Sept. 30, blue chip stocks had fallen 1109.40 points, or 12.4%, from June 30, the end of the previous quarter. The Dow reached a record high on July 17, closing at 9337.97. During the same period, Standard & Poor's Index of 500 stocks fell 10.3% to 1017.01.
Hospitals accustomed to posting strong quarterly gains on their investments in stocks and mutual funds suddenly began to see market windfalls shrink or disappear.
"The impact has been pretty significant depending on the equity mix they have adopted," says Terry Bilkey, a principal with Yanni-Bilkey Investment Consulting in Pittsburgh. The company advises 50 healthcare clients in 22 states. Hospitals that were counting on a 7% nonoperating margin, for instance, may see that number slip several percentage points because of losses on investments.
"Generally they have erased a big part of their cushion," Bilkey says. Those losses run through a hospital's income statement, directly affecting the bottom line.
Market volatility also is reflected on the balance sheet. Under accounting rules for not-for-profit organizations issued in November 1995, investments in equity and debt securities must be reported at fair market value, with any gains or losses reported in annual and interim-period financial statements. That means some hospitals will be posting losses from investments for the first time.
It's too early for most hospitals and health systems to be overly concerned with the loss of market value-what a security will sell for-to book value, or what it cost to buy it, Bilkey says. "If we go back to roaring bull markets, it's no big deal."
But if investment portfolio swings begin nipping away at budgeted earnings from operations, some providers are likely to play it safer and reduce their equity exposure.
"I think we are finally into the gut-wrenching time of equity investment," Bilkey says.
Still, many providers easily stomached the latest downturn.
"We got zero panic calls. None," says Bill Mills, a principal with Birmingham, Ala.-based Highland Associates, whose 32 healthcare clients took the market correction in stride. "We haven't changed any asset allocations," Mills says. Highland manages some $6 billion of investment assets on behalf of its healthcare clients.
Having said that, Mills says his firm currently is working with three clients to reassess their investment strategies. But all were prompted by changes in the providers' operating condition and not the market, he says.
As recent analyses by New York-based Moody's Investors Service suggest, the healthcare industry is experiencing some volatility as providers move to create larger integrated systems (Sept. 21, p. 76). The agency has lowered ratings or outlooks on a number of providers that are reporting declining margins on operations.
Recent market upheaval merely creates an opportunity for providers to reassess their risk tolerance, Mills says.
Investment advisers say those decisions should be made in light of a provider's entire balance sheet, not just earnings from investments. For example, one upside is the strong performance of the U.S. dollar. The Federal Reserve Board's recent easing of interest rates sent long-term government bond yields below 5% for the first time in decades.
Harvey Willis, director of institutional business at Diversified Financial Products, a Louisville, Ky.-based unit of Aegon Insurance Group, offers another solution to keep hospitals in the equity markets. His firm sells an insurance product designed to protect hospital investments from the full brunt of a market downturn. The insurance, for which DFP charges up to 35 basis points, allows hospitals to amortize gains and losses over an extended period. Since DFP launched the product in June, three hospitals have signed on for the insurance.
"When the equity market was strong and interest rates were moving downward. . . it was like trying to sell an umbrella on a sunny day," he says.
"Now it's getting a little bit cloudy."