Investments counteract low margins

When Dignity Health reported its earnings for fiscal 2013, the system highlighted strong operating performance and a more than threefold increase in its operating surplus.

Much of the San Francisco-based health system's growth came from its 2012 acquisition of U.S. HealthWorks, an occupational medicine provider that helped boost its ambulatory care volume.

But that wasn't the strongest part of its balance sheet.

Dignity's overall surplus rose to $811.9 million from $134.9 million the previous year because the value of its investments soared.

The recent runup in stock prices hasn't just been good for investor-owned hospital chains—it also has helped many not-for-profit systems stay in the black.

While ratings agencies acknowledge balance-sheet benefits from the market's recent climb to new heights, they caution that riskier investments may create additional uncertainty for less-stable provider groups.

According to its financial report, Dignity invests in not only equity and debt securities, but also alternative investment vehicles such as private equity, real estate and hedge fund opportunities.

Its investment income helped offset a $17.4 million operating loss in the first quarter, when it still produced an excess of revenue over expenses of $71.8 million.

“Our continued strong investment plan … has helped produce the balance-sheet metrics you see here,” Lisa Zuckerman, senior vice president of treasury services, said during Dignity's most recent bondholder call.

Hospital margins have been shrinking in recent years, according to a Modern Healthcare analysis of earnings reports for about 200 acute-care providers.

In fiscal 2013, the average hospital operating margin was 3.1%, down from 3.6% the previous year.

But many providers are finding that the returns on their investment portfolios are helping make up for operating shortfalls that have resulted from lower patient volumes and reimbursement cuts.

In fiscal 2013, Providence Health & Services in Renton, Wash., reported an operating surplus of $37.7 million on $11.1 billion in revenue. It added another $215.6 million in non-operating gains.

“We've had a relatively conservative investment portfolio,” said Todd Hofheins, Providence's chief financial officer. “But, yes, that has helped from a cash generation standpoint.”

Hospitals and health systems with the highest credit ratings can access the bond market when they need to borrow money.

But other providers need to keep sufficient cash on their balance sheets, whether they earn it through operating activities, fundraising efforts or their investments.

“Investment management is exceptionally important,” said Martin Arrick, a managing director at Standard & Poor's. “If you're not investment grade, your access to capital diminishes really quickly. A lot of the operating flexibility comes from the balance sheet.”

Pittsburgh-based health system UPMC's investment portfolio delivered a 9.6% return in fiscal 2013. The system used 168 external investment managers, including hedge-fund and private-equity managers, according to its annual report.

UPMC also invested in startup companies and realized $53 million when it sold its stake in dbMotion, a health IT interoperability vendor, to Allscripts.

St. Louis-based Ascension Health, the third-largest health system by revenue, operates its own investment group of 22 professionals that is registered with the U.S. Securities and Exchange Commission and has $27.8 billion in assets under their management.

“We need a team of people who think 24/7 about our funds,” said Ascension President and CEO Anthony Tersigni.

The health system reported a surplus of $3.1 billion in fiscal 2013 compared with a surplus of $984 million in fiscal 2012.

About $1.4 billion of the increase came largely from patient care revenue that it gained through new affiliations. But a gain in investment returns added another $873 million, according to its annual report.

While investment income can help buoy a system in the short term, the sustainability of that income is uncertain, particularly given the ups and downs of the economy.

Joe Fifer, president and CEO of the Healthcare Financial Management Association, said he's concerned about the long-term health of hospitals that can't cover their expenses from their operating revenue.

A study in the July/September 2013 issue of Health Care Management Review found that 40% of systems lost money on patient care between 2003 and 2007, but only 25% of those providers were able to make up the shortfall with investment income.

While there is little doubt that nonoperating income is becoming more important to hospitals, its benefit exists primarily for systems that are large enough to invest in the stock and bond markets, said study author Paula Song, an associate professor in the department of health policy and management at the University of North Carolina's Gillings School of Global Public Health.

Health systems can absorb a certain amount of risk if they're otherwise financially stable, and for the most part, equity returns are boosting net income, said Mark Pascaris, an analyst at Moody's Investors Service.

But the ratings agency still wants to be assured that a borrower has enough cash on hand to repay its debt obligations.

Follow Beth Kutscher on Twitter: @MHbkutscher