When speaking with business leaders of not-for-profit (NFP) healthcare systems, the conversation commonly turns to the challenges and headwinds of today’s operating environment – and rightfully so, since many systems are combating margin compression from a combination of limited sources of revenue and increased costs. Hard-earned balance sheet investment assets may provide some comfort in support of credit rating agency metrics. However, is that enough?

In hindsight, the low interest rate environment of the last decade fostered debt issuance at inexpensive levels to support capital plans and provided runway for long-term asset pools to accumulate. Capital markets have changed so rapidly in the last two years, however, and some systems that need to refinance are now facing higher costs. At the same time, there is a renewed level of optimism and excitement around maximizing the use of investment assets. Strategic capital plans include areas such as expansion of ambulatory care, AI-enhanced operational efficiencies and targeted partnerships. Interestingly, how the asset investment strategy is considered relative to the state of the operating business has led to a variety of conversations on ways to develop an optimal approach.

This paper seeks to provide insights into how healthcare organizations are thinking about the alignment of their operating business and investment strategies. While there is no one-size-fits-all solution, the goal is to offer a framework that helps guide organizations toward adapting investment portfolio strategy to land on the appropriate level of liquidity and risk, while considering the current economic and capital market environment.

Healthcare in focus

Asset pools supporting healthcare organizations are a critical resource for navigating the next decade, particularly given challenges exacerbated by COVID. By way of background, the following table shows the year-over-year decline in financial performance and balance sheet metrics of the top 100 NFP healthcare systems over the last two years. Staffing shortages, high wage inflation and reimbursement rates that have not kept pace with inflation negatively impacted top-line growth and profitability. Lower investment returns combined with pressures to fund short-term cash flow needs were common drivers in the reduction of key balance sheet metrics such as DCOH and cash-to-debt. 

On a positive note, while balance sheet metrics have directionally declined, median healthcare systems have had sufficient cash to satisfy all debt obligations with cash left over. Today’s higher yield environment is a cash tailwind, and the prospects for attractive returns¹ across investment asset classes¹ gives healthcare organizations greater flexibility to consider ways to maximize investment strategy for the benefit of broader business objectives. As such, the current market environment is prompting healthcare systems to re-affirm their investment approach.

The first step is to take a closer look at the interplay between the various healthcare asset pools and the outlook of the operating business. Given each organization comes with its own unique situation, we introduce a framework to calibrate investment decisions with respect to operating business priorities.

Linking healthcare business and investment strategy

Not surprisingly, on the back of the rapid changes in capital markets over the last two years, forward-looking risk and return assumptions have also materially changed. Looking out over the next 10-15 years, the projected return of a diversified 60/40 stock/bond portfolio has risen from 5.2% in 2022 to 7.0% in 2024 (refer to J.P. Morgan Asset Management’s 2024 Long-Term Capital Markets Assumptions). Enterprise analysis enables a system to understand the impact of changes in portfolio strategic asset allocations on key balance sheet and liquidity metrics, such as net assets, DCOH and cash-to-debt. Portfolio liquidity and risk can then be calibrated to meet the system’s targeted return objective and risk tolerance.

The operating outlook and balance sheet strength are the first items to review when determining the appropriate investment strategy. A scenario analysis that stress-tests the balance sheet and considers potential calls on cash to combat operating losses is then used to set liquidity and risk targets for the organization’s various asset pools. For example, a healthcare system expecting a cash flow shortfall will generally look to shore up liquidity, while the level of debt on the balance sheet informs risk levels, i.e. more (less) debt translates to less (more) risk. The following illustration summarizes how the operating outlook and balance sheet strength inform the investment strategy.

An enterprise-level risk and liquidity analysis assists in understanding the interplay between the system’s various asset pools. Incorporating the current macro-economic environment is a key factor to successfully link the operating business with investment strategy. Understanding the potential paths of the economy, combined with a qualitative assessment of capital markets, such as the shape of the yield curve, valuation levels and the growth and inflation outlook, can improve the effectiveness of the investment strategy while protecting the system’s ability to operate. For example, in an adverse operating and market environment, it can inform how to adjust portfolio strategy to reduce negative impact. Specifically for a pension plan, further asset-liability modeling quantifies projected required cash contributions under a range of economic outcomes. We dive further into examples in the following sections.

The (uncertain) state of the economy has started to provide more certainty

Depending on who is asked, there are a variety of opinions as to the condition of the economy and what can be expected next. The probability of a recession has fluctuated meaningfully during the last year, as the narrative shifted from “hard landing” to “soft landing,” and economic data prints were mixed but persistently positive. The trajectory of growth, inflation, corporate earnings and the labor market combined with changes to central bank policy are all key drivers when charting the path forward.

What we know today: The following are all factors contributing to the overall resilience of the U.S. economy:

• The Federal Reserve increased rates by 500bps in the last year.
• Core inflation has come down since last year and sits at approximately 3.4% vs. 6.5% a year ago.
• The U.S. labor market continues to be strong by historical standards with the unemployment rate at 3.7% and well below the 50-year historical average of 6.2%.
• The consumer remains strong and makes up for nearly 70% of U.S. GDP.
• Consumers and corporations are less sensitive to interest rate increases in the short term.
• Large spending from Washington has been supportive for economic activity.

Looking forward: The following table outlines the various paths of the U.S. economy and summarizes growth, inflation, Federal Reserve monetary policy and the likelihood of each scenario.

The non-recessionary scenarios each present an interesting dynamic. Sticky inflation expects U.S. growth to remain at trend levels but accompanied by higher interest rates. Rebalancing (soft landing) may have lower interest rates but with lower growth. While the recession probability has continued to edge lower, we do expect some fragilities to present themselves in the economy. The following section summarizes the potential portfolio actions that could be taken with the current environment in mind.

Adapting healthcare portfolios amidst the uncertain economic environment

While healthcare organizations each have unique financial situations, there are some recommended actions to adapt investment portfolios to the current market with a specific focus on liquidity and risk.

Conclusion

In conclusion, it is evident that healthcare organizations are operating in a complex and challenging industry landscape. The framework and strategies outlined in this paper aim to provide a guidepost for organizations to effectively adapt investment portfolios through an enterprise risk lens. These portfolio adaptations are not merely reactive measures but strategic actions to manage levels of risk and liquidity in alignment with broader operating and financial objectives. By doing so, healthcare organizations may have a better chance of increasing financial stability and resilience in changing economic and market conditions to continue their vital role of delivering healthcare services in our communities.

For any questions or if you would like more information, please contact your J.P. Morgan Client Advisor.

¹ J.P. Morgan Asset Management, 2024 Long-Term Capital Market Assumptions, October 2023.