Clear communication and liquid cash reserves are key for organizations seeking to maintain the strength of their credit ratings while making investments in the transition to value-based care, rating agency experts say.

As they seek to restructure their operations and care delivery for the value-based business model, many hospital and health system leaders are making substantial investments for the long term, such as those related to physician-alignment, risk sharing, and care management. The potential ramifications on an organization’s credit rating and capital access must be considered since credit ratings, which provide access to capital, are assets to be managed.

Three rating agency representatives shared insights during a panel discussion about the credit implications of value-based initiatives. The session featured James LeBuhn of Fitch Ratings, Kevin Holloran of Standard & Poor’s, and Lisa Goldstein of Moody’s Investors Service. The session was moderated by Therese Wareham, CEO of Kaufman, Hall & Associates. Excerpts are offered here.

Wareham: The movement away from volume-based payment to a value-based model is creating for hospitals and health systems an “abyss” period, with declining revenues and disproportionately high operating expenses and capital expenditures. How do you evaluate organizations that are making infrastructure investments and pursuing population health programs that in the short-run may reduce revenue and increase cost?

LeBuhn: Fitch believes that financial performance is a product of the qualitative and strategic factors pursued by the organization. Expectations for future financial performance and, ultimately, the credit rating are informed by assessment of those factors. As long as a borrower’s underlying strategic position remains sound, a certain amount of financial variability should not affect the rating.

We assess the soundness of the business strategy through an analysis of historical performance relative to projections. We have the most confidence in organizations that consistently meet their projections and budgets.

Communication early and often is important. We look at how proactive executives are in communicating potential operating performance variability, and how much detail they provide on why there is variation and on the recovery action plan.

We ask management to articulate the benefits of the plan, key risk factors, timeline, the “guard rails,” and the key personnel and consultants involved. We also ask what the risks are of not making those investments.

Providing detail about the income statement also is critical. Certain expenses really are investments, such as IT, which has software and hardware costs, but also employee training expenses. Allowing us to understand expenses granularly will help preserve a credit rating.

Health care is a very fluid business. To me it’s more about how well an organization can pivot and what levers it can use to maintain or at least preserve profitability.

Wareham: How are you starting to assess insurance risk strategies and the balance sheet in light of health care’s new model?

Goldstein: At Moody’s, we are working closely with our health insurance team that rates health insurance plans across the country to assess risk strategies and metrics. We ask an organization’s executives to answer all of the questions outlined earlier in my presentation (see Winter 2015 Kaufman Hall Report, p. 7).

We also are taking a deep dive into the liquidity and allocations of investments on the balance sheet. For example, if an organization is required by insurance regulations to set aside $10 million as an insurance reserve, this sum likely will not be included in the organization’s unrestricted cash position. We want to know what the reserve requirements are and how the organization will effectively replenish that $10 million.

Wareham: What are the credit implications for health systems that are not moving toward value-based contracts?

Holloran: We would want to know why an organization is not moving toward value arrangements with payers. We do want to see some level of experimenting and practicing in population management. For organizations that are investing a lot in population health management, it’s not going to have a huge impact on credit as long as the investments are measured and strategic. We view this as positive and the right thing to do.

Wareham: How long will you be patient about compression in profitability while an organization is investing for the new era?

Holloran: We don’t expect V-shaped profitability rebounds; U-shaped rebounds are fine. At some point those investments need to start producing. There are going to be some pain points, we get that, but they can’t go on forever. The tolerance is probably about three years.

LeBuhn: The more you can communicate how long you expect to see this compression, the better. However, if you keep coming back and extending those projections—that’s where we’re going to begin to run out of patience. We tend to be a bit more patient with organizations that have solid cash positions.

Goldstein: The changes happening in health care are not cyclical. There will be a new normal. The projections we see from the very forward-looking systems that have been investing heavily in IT, risk, physician integration, etc., are sobering. We likely will need to reset the compass over time as to what the median margins and metrics are for Aa, A, and Baa ratings, among others.

Therese Wareham is CEO, Kaufman, Hall & Associates, Skokie, Ill.

Lisa Goldstein is associate managing director, Public Finance Group, Moody’s Investors Service, Inc.

Kevin Holloran is senior director and U.S. public finance and analytical manager, USPF Healthcare Group, Standard & Poor’s.

James LeBuhn is senior director, healthcare sector head, Fitch Ratings.

Discussion Starters

Forum members: What do you think? Please share your thoughts in the comments section below.  

  • How is your hospital prioritizing investments during the current “abyss” period, as termed by Wareham, with declining revenues and disproportionately high expenditures?
  • What questions do you have for the rating agencies?

Publication Date: Tuesday, May 12, 2015