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A Capital Project

November 1, 2007
by Greg Goth
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As reimbursement rates fluctuate, CFOs find a steady hand and some creative financing can keep the bottom line looking good.

Forget studying Adam Smith, Milton Friedman and John Maynard Keynes. Why bother? As the government and private sector reimbursement climate gets "curiouser and curiouser," hospital CFOs, are trying to balance multiple approaches to preserve and grow acute care centers' nest eggs — and they've thrown out the textbooks.

Successful capital management today is a combination of prudent investing, sharp negotiation, and ongoing monitoring of ongoing budgetary conditions and money managers' recommendations, hospital CFOs say. Paramount to keeping a strong balance sheet is using margin to provide high quality services that competitors can't or won't. However, regulations and competitive restrictions often make even that difficult.

"Reimbursement is so politically driven now, it's totally departed from economics," says Doug Klebe, CFO of the 376-bed Torrance Memorial Medical Center, Torrance, Calif. Klebe says Medicare reimbursement rates in some instances have sunk from providing 98 percent of the cost of care to only 85 percent of those costs. Consequently, hospitals have to seek to make up that shortfall by getting higher reimbursements from commercial plans.

But budgeting for rates everybody can live with is getting tougher. Medicare's moves have a huge impact on hospitals' bottom lines and ability to plan for capital needs, because the population it serves uses three to four times the hospital resources the typical commercial policy holder does.

Capital planning, Klebe says, is "really getting tougher, primarily because the changes that happened in the declining reimbursement rates have happened so rapidly the last five years or so."

That five-year timeline of decreased reimbursement dovetails with factors that brought about a more cautious investment approach, according to Bill Cleverley, founder of consulting firm Cleverley & Associates, Worthington, Ohio.

Whereas the recent global credit crisis might have temporarily focused attention on portfolios, Cleverley says more cautious hospital investment policies aren't "a function of what's happened the last few months. They're more a function of what happened five years ago with the equity meltdown. I noticed an increasing move toward better asset allocation models as well as a lower reliance on equities as opposed to fixed income investments."

Regardless of the origins of a more cautious investment climate, Cleverley says CFOs are in the horns of a classic dilemma in shepherding strong balance sheets. While he says industry-wide margins are not at their historic lows, traditional cushions no longer exist.

"When Medicare paid on basis of cost, and many of the others did too, the level of margin you needed to make and the amount of cash you needed to carry were nowhere near as great as what they are now. I could always borrow and be assured that if I had Medicare and Medicaid and maybe even some major commercial carriers paying cost on 80 percent of my business, I knew 80 percent of my debt service was going to be covered. That's no longer true."

Torrance Memorial's Klebe says the center's conservative approach served it well during the recent credit meltdown. Within an overall prudent "plain vanilla" strategy, the TMMC board of directors and finance committee reviews its investment mix on an annual basis, and the center's long-term capital needs and projected cash flow are updated regularly.

"We really focus on our estimated cash flow, and look out five to seven years and, generally speaking, we look at that horizon essentially on a monthly basis," Klebe says.

Klebe concedes the political theater surrounding public sector reimbursement makes figuring those projections "very difficult" the past two years or so, but he also says there are ways to offset some of the resulting uncertainty. For example, TMMC has been able to negotiate some long-term capitated managed care contracts that Klebe says serve as insulation from government fee-for-service fluctuations.

"That helps tremendously, compared to what a lot of other hospitals are experiencing," he says. "When you have a steady income stream coming in from a major portion of your business like that, it can help alleviate some typical problems hospitals without that face."

Creativity on campus

Another hospital CFO, Will de la Peña of the 300-bed St. Francis Hospital, Poughkeepsie, N.Y., commiserates with Klebe regarding the whimsical winds of CMS reimbursement and regulations. However, with the exception of the periodic initiation of "major initiatives" from CMS, he says the swings can be predicted within two to three percentage points.

De la Peña points to other regional macroeconomic factors as affecting his ability to plan. On one hand, he says, the Mid-Hudson Valley is a relatively affluent region — thanks to a large IBM presence in the Poughkeepsie area — which reduces the amount of indigent care and bad debt he needs to include in his capital management scheme.

However, St. Francis's cross-town competitor, Vassar Brothers Medical Center, is even better off. "The standard of living is good here, but we are second string to the strength of Vassar," de la Peña says, "and St. Francis provides services that are historically not well compensated."