Integrated risk planning enables healthcare leaders to manage variability and best allocate organizational resources.
Market forces inside and outside of health care continue to generate rapid and disruptive change within the industry. Such change requires healthcare executives and trustees to fundamentally rethink business elements, including service delivery, care models, payment, staffing, technology, and infrastructure. An apt description of the state of affairs facing health care comes from Amos Tversky, a cognitive psychologist and behavioral economist: “Reality is a cloud of possibility, not a point.” a
Extending the Arc of the Planning Process
Many organizations have adopted the good practice of tightly integrating strategy with finance to set a baseline financial plan. Coordinated leadership with this practice ensures the financial foundation of business transformation to advance the organization. Although baseline planning is critical, a trend-based approach is vulnerable to many types of disruption. For instance, hospitals and health systems are seeing new entrants from unrelated markets and once-unrelated industries.
Setting a baseline expectation is only one milestone in the arcing process of strategic financial planning. Amid varied disruptors, organizations that rely solely on a baseline expectation will be unprepared for likely inaccurate future predictions. Once the baseline is determined, leaders should identify their response to potential variability from the plan and take action to address it if it occurs.
Risk Analytics With Purpose
Advancing a dynamic strategic financial plan starts with identifying and quantifying risk (or variability against baseline expectations). Leaders considering responses to possible developments should focus on organizational strengths to promote and weaknesses to address. Framing a risk analysis to generate traction is a powerful way to garner support and prompt action. Under the right risk and resource allocation framework, leaders can govern enterprise risk as crisply as the best-managed leadership functions. b Increasingly rigorous analytic toolsets enable reams of “might-be-helpful” sensitivities, scenarios, and Monte-Carlo simulations to be generated. Unfortunately, they often fail to elicit responses and lack impact. Analytical tools support but do not create strategies. Risk evaluation that determines only whether an organization survives or fails doesn’t fully inform actions.
Valuing Risk and Obligation
Assessing risk requires variability assumptions. Management must use its best judgment because sufficient data often are lacking. Many of today’s stressors are difficult to assess. Ideally, the assessment methodology should fit the risk or obligation it is evaluating. For example, sensitivity analysis is appropriate for payment risk but not for invested asset volatility. The former uses linear logic while the latter must account for portfolio diversification. No single risk analysis model produces reliable results for the entire enterprise. An integrated risk framework usually is indifferent to risk valuation methods for any particular risk pool, but can summon the merits of the output to coordinate in the whole. Management should seek a common denominator—such as cash—to quantify risk across the enterprise.
Mitigating Risk, Protecting Cash Resources
Cash is a required component to almost any growth strategy and the backstop for unmitigated risk. However, each cash outlay diminishes an organization’s ability to address the next unseen obligation or pursue an opportunity. Expending cash should be the risk hedge of last resort.
In addition to valuing the magnitude and likelihood of a downside event, risk analytics should foster a mitigation plan. Mitigation strategies include employing external offsets (e.g., insurance, bank facilities, partnerships), embedded internal capabilities (e.g., introducing optionality to facility plans), and management’s capacity to manage through risk (e.g., cutting cost). An organization should consider all of these alternatives before committing cash.
To the degree an enterprisewide plan is integrated, mitigation strategies coexist at both the business-line and corporate levels. Cross-functional team coordination and full buy-in from the C-suite yield encouraging results. In some cases, both key physicians and operations executives realized, without being told, that their ability to limit downside risk and monitor deviations from baseline had real and significant implications. Repercussions included the system’s ability to lower the cost of capital and seek further investment returns by shifting risk to the balance sheet. Ultimately, a high-quality integrated enterprise risk framework enables efficient resource stewardship. c
Managing Risk Deployment Enterprisewide
A balanced enterprise risk response can be formulated by creating a comparable monetized risk valuation between different areas of the organization. For example, both core operations and capital structure draw on cash for scheduled and contingent cash outlays. Risk-bearing activities in either area should be weighed for highest strategic benefit across the enterprise. After all, cash used to respond to a capital structure crisis will diminish cash capabilities to address operating risk.
The exercise of balancing risk across the enterprise can yield surprising options. In one case, an enterprise resource allocation framework was used to quantify the impact of a health system absorbing the operating commitments of a large physician practice. Although the practice required no capital outlay for acquisition, absorbing its scheduled and contingent exposures would compel the health system to make a risk-deployment rather than a cash-deployment decision. The system could use its risk resources to invest in the physician group or to maintain equity investments, but not both. At the time, the risks and obligations associated with an expanded expense base limited the health system’s ability to seek risk in its investment portfolio.
Managing Amid Variability
A healthcare organization’s integrated planning process requires dynamic capabilities enabled by risk analytics to match the fluid environment. A responsive planning framework has common qualities, including its ability to elicit action, guide resource allocation and decision making, and facilitate organizationwide collaboration. With risk linked tightly to resource allocation, assets are protected against imbalanced variability and remain available when needed. Integrated risk planning not only safeguards against disaster scenarios, but also better positions an organization’s people and resources to succeed under an ever-shifting cloud of possibility.
David Ratliff, CFA, is a senior vice president, Kaufman, Hall & Associates, LLC, and a member of HFMA’s First Illinois Chapter.
Eric A. Jordahl is a managing director, Kaufman, Hall & Associates, LLC, and a member of HFMA’s First Illinois Chapter.
a. As quoted in Lewis, M.: The Undoing Project: A Friendship that Changed Our Minds. New York, NY: W.W. Norton & Company, Inc., 2016.
b. Jordahl, E.A., Ratliff, D.: “Treasury Functions for Strategic Value.” hfm magazine, July 2017.
c. Jordahl, E.A., Ratliff, D.: “Stewarding Cash and Invested Assets to Support Organizational Challenges,” Treasury Insights, Jan. 2018.