Hospitals and health systems face numerous challenges in today’s evolving healthcare market, including declining utilization, new payment mechanisms, and an uncertain market environment. As a result, they also face higher organizational risks due to increasing financial complexity and volatility.
Responding to these challenges requires a comprehensive risk management initiative founded on a thorough understanding of risk and risk-bearing resources and how these two factors interact. Continuing to think about risk or resources in isolated silos can produce serious negative effects. Individual risk opportunities should be assessed within the context of a broader risk portfolio that encompasses operations, assets, and liabilities so that total risk expenditures do not exceed risk resources.
One highly effective component of an integrated risk and resource management effort is a process that we refer to as tiered liquidity. This construct builds off a detailed cataloguing of risk and resources, and matches invested assets against risks that are not hedged already by a dedicated resource (such as a bank line or letter of credit). The idea of tiered liquidity derives from the premise that decisions about managing risk require a solid understanding of both the portfolio of risk and the available hedges.
The baseline tiered liquidity process includes five core steps:
- Identify claims on liquidity from operations and liabilities; these claims should be net of designated internal or external hedges.
- Place these claims into “tiers” that reflect the certainty and timing of risk realization; allocate invested assets to hedge the net tiered exposure.
- Establish a global volatility budget and allocate or spend that volatility across the tiers.
- Build a risk-adjusted investment portfolio for each tier with the final tier being a residual pool that is free to spend remaining volatility or otherwise pursue return up to some risk limit.
- Roll the sub-portfolios up to produce a risk-adjusted invested asset portfolio; compare the risk adjusted portfolio against the existing/target portfolio to gauge net risk position.
If this process reveals that volatilities between risk-adjusted and actual portfolios are in line, then the organization likely has struck an acceptable balance between risk and risk resources. If actual volatilities are higher than the risk-adjusted portfolio, then risk may exceed resources and the organization should dig deeper to assess whether to reduce risk or choose to tolerate the imbalance. If actual volatilities are lower than the risk-adjusted portfolio, the organization likely has some level of risk capacity to spend or retain as it chooses.
The tiered liquidity construct can be used to help assess new risk opportunities—such as the costs versus benefits of a particular capital structure action. As future risk opportunities are identified, the tiers should be adjusted, hedging dollars reallocated, and overall return expectations (and volatility) revised accordingly. The increase or decrease in return can be measured against the expected economic performance of the new risk opportunity to provide the organization with a sense of the risk-adjusted return.
The changes and challenges confronting the healthcare industry are significant, and hospitals and health systems likely will face increased volatility for some time. Organizations require a centralized and rigorous risk management process that they can learn from and refine over time and that allows them to make sound decisions about incurring, carrying, and hedging risk. A framework that includes tiered liquidity can be a valuable part of this effort, both now and into the future.
Eric Jordahl is a managing director and director, financial advisory practice, Kaufman, Hall & Associates, Inc., Skokie, Ill.
Publication Date: Tuesday, August 27, 2013