Investing in new revenue streams is now standard practice for hospitals facing squeezed operating margins and lower reimbursement rates.
More and more systems are investing in both health and non-health-related sectors, according to James Stanford, managing director and cofounder of Fitzroy Health.
Stanford recently co-authored a study on increasing margins through diversification strategies for non-operating income.
Financial margins, in fact, may depend on investments that have nothing to do with healthcare. "Every health system is making investments like that," Stanford said.
Jeff Blazek, head of Cambridge Associate's Healthcare Practice, added that "if you look at an income statement from a health system for operating margin and see a separate line item for investment income, it's quite conceivable to see the investment line rival or be more than core operations."
One of the main drivers to hospitals seeking funds outside of their core operations is that value-based reimbursement is not returning the higher payment of traditional fee-for-service. Taking reimbursement risk is hard to justify on a tight margin.
"Health systems will tout 50 percent or more in value-based payments," Stanford said. "Ask what percentage of their revenue is at risk, typically it's in the 2-3 percent range."
But the trend toward value is just one factor affecting revenue. Uncompensated care from patients paying a greater share of their bill out-of-pocket is another. Costs, such as labor, are rising.
"The payer-mix is crucial. Patient mix lends itself to profitability," said Blazek, who works with a half dozen health systems and is the former managing director working on investments, for New York-Presbyterian Hospital.
This has traditionally meant having commercial reimbursement counter losses in Medicare and Medicaid payment, but that's not always possible based on a providers' population.
Market conditions and politics play a role in how hospitals fare, as they can affect investment results. Wall Street aided margins in 2017, but degraded margins in 2018 due to stock market volatility, according to Stanford.
When Moody's reported that hospitals had their lowest margins in 10 years, Stanford's reaction was "remarkable," he said. "I've talked to a number of CFOs who were surprised by how bad margins were."
Larger institutions are taking equity risk and the smaller ones are tending to stay liquid and put more of the money in bonds.
There are large institutions in the enviable position of having accumulated a lot of cash, which must be thoughtfully invested.
Many of the larger systems employ an endowment model, investing in private equity, hedge funds and real estate and a less liquid portfolio that can be invested for a 10, 20, to 30-year time horizon, according to Blazek.
The stakes are higher now that core operation revenue is challenged, he said. Hospitals have to be careful not to take too much risk, but being too conservative is also not a good strategy. Health systems must also watch to make sure that their financial risk does not affect their credit rating.
Because there's so much benefit to scale and size, a tremendous amount of merger and acquisition activity has added more gravity to the focus on assets, Blazek said.
The aforementioned diversification report by Partners Healthcare and Fitzroy Health found that health systems have increased operating margin by as much as five points through investment strategies.
The dynamics are different between for-profit and not-for-profit hospitals. Those publicly have fewer degrees of freedom over investing because of the rigor of quarterly profit, Blazek said. Non-profits have a greater degree of freedom.
Not for profits are primarily investing their foundation money, 501C3 businesses are run like foundations that take in a lot of capital. The for-profits, however, are definitely investing in the R&D side of the equation.
INVESTING IN INNOVATION
Some health systems are investing in related businesses and venture capital projects. This gives them a strategic benefit for a good return and gets them on the ground floor on technology and patient-based data to grow more aggressively.
The goal is to create sources of value, according to Stanford. Operationally it has to impact their budgets. From a care model standpoint, it should be innovative. Examples include the University of Colorado Hospital's co-development with RxRevu that has turned a cost center into a profit center; Navicent Health's Flex Health, a workforce management company spin-out; and Children's Hospital of Philadelphia's $35 million investment in Spark Therapeutics to generate royalties from drugs, devices, and diagnostics.
"This is about R&D," Stanford said. "An awful lot is going on in R&D in health systems."
Building businesses that create commercial returns and also improve the way care is delivered is an increasingly common goal for hospital systems. Take Providence St. Joseph Health, for instance. The mission based non-profit has a venture capital arm, Providence Ventures.
"We spun out two companies and are investing in 13 others," said Aaron Martin, chief digital innovation officer for the health system and managing general partner for Providence Ventures.
Wildflower Health, a digital health platform that helps patients navigate benefits and connect to resources, last year acquired Circle Women's Health platform, a startup from Providence St. Joseph Health.
There's a heavy focus on digital health and daily engagement with patients. "They're new revenue streams that come through this, being more digital," Martin said.
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