Hospitals and healthcare systems that have come to depend on investment income to compensate for lackluster operating results may need to change their financial habits.
A rating agency said last week that hospitals' overall investment return dropped to 8% last year from 10% in 1997. And with hospitals placing more of their investment portfolios into equities, that dependence is becoming even riskier.
The report, issued by New York-based Fitch, marks a turnaround from a few years ago, when hospitals were drawing criticism for being too fiscally conservative.
Fitch reported a sharp increase in the percentage of hospital investment portfolios devoted to equities to 36% last year from 10% in 1995 (See chart). The percentage of hospitals holding variable-rate debt grew to 40% last year from 31% in 1995.
The analysis was based on audited financial statements of the 140 hospitals rated by Fitch.
Analyst Jordan Melick said the trend to more equities is "dangerous to the extent that (hospitals) don't manage it properly."
He added that with a growing portion of hospital income from investments, "It's something we need to put more emphasis on."
Stock holdings of 50% or more of an unrestricted investment portfolio warrant scrutiny, while holdings of 75% "may be a cause of concern," according to Fitch.
Richard Clarke, president and chief executive officer of the Healthcare Financial Management Association, said the numbers reflect an increased comfort with stocks among hospital boards and executives. Still, he said, the mix "is still fairly conservative by corporate standards."
Clarke said most hospital financial managers are focusing on improving operations, where they have the most control.
In a separate report released in August, Fitch reported that hospitals' median operating profit margin dropped to 1% last year from 3.2% in 1997.
Hospital investment adviser Bill Terry, principal at Birmingham, Ala.-based Highland Associates, said hospital systems have come to view investment portfolios as subsidies, much like a university endowment.
That's partly a result of the availability of cheap debt on the bond market, which has allowed hospitals to sock away extra cash, he said.
"The role of the portfolio has changed from a short-term liquidity vehicle to a long-term capital asset," Terry said. "The longer your time frame for investing, the more equities you can afford to hold."
Most large multihospital systems have shifted 50% or more of their holdings into equities, Melick said. But the strategy didn't pay off in 1999, nor has it done so in 2000, as the vast majority incurred unrealized losses from stocks that lowered their liquidity, Melick said. However, none resulted in a rating downgrade, he said.
Fitch said the use of variable-rate debt needs to be monitored, as well. The agency said the appropriate amount of variable-rate debt depends on a hospital's overall financial health, but 50% or more warrants closer scrutiny.
According to Fitch, the median distribution in variable-rate debt among hospitals is still relatively low, at 20%.