Dynamic Financial Planning Provides a Hedge Against Future Disruption

3 minute
Covid financials

The impact of the COVID-19 pandemic has introduced new and potentially long-lasting volatility into traditional financial planning processes at hospitals and health systems. Financial planning remains as important as ever—perhaps even more so as the risk of operating dislocation continues, and new risks appear on the horizon.

The fundamentals of financial planning still apply, including:

  • Understanding the organization’s credit position within capital market expectations
  • Understanding the organization’s capital formation ability
  • Quantifying the organization’s resource position relative to strategic requirements
  • Planning to appropriately integrate and support execution of the organization’s strategy
  • Communicating, implementing, and measuring against plan targets across the organization’s capital management cycle

At the same time, the nature of risks in the new environment and the speed at which they could materialize require that organizational leaders take financial planning to a new level. They should use the financial plan as a dynamic tool to identify and manage risk and build the resiliency needed to absorb the shock of new disruptions.

Identifying Risks in the New Environment

Unlike the credit crisis of 2008 and 2009, the COVID-19 pandemic made a direct hit on hospital and health system operations. The extent to which volumes will recover for non-emergency procedures and emergency department visits—among the areas hardest hit at the height of the pandemic—remains unknown. The rapid shift to digital health in the early months of the pandemic has receded somewhat but remains well above pre-pandemic levels and will likely reshape future care delivery, especially for primary and chronic care services.

COVID-19 has delivered the biggest shock, but other risks—some of which were present before the pandemic began—also pose potential threats to hospital and health system operations and finances. Many of these risks may already have been identified by the organization’s enterprise risk management (ERM) function; the key task in a dynamic financial planning model is to identify those risks that pose a material and plausible threat to the organization’s operations or financial position, separate them out from the potentially hundreds of risks monitored by the ERM function, and quantify their potential impact. Such risks might include:

Payment pressures: With a new administration and Democratic control of Congress, prospects for expansion of Medicaid, changes to the Medicare program (such as lowering the age of eligibility), and the addition of a Medicare-based public option to the Affordable Care Act’s individual insurance exchanges have become more likely. The pandemic has also exposed weaknesses in the fee-for-service payment system and may act as a catalyst for more rapid movement toward value-based payment models. Finally, the new administration has shown little interest in repealing price transparency measures put in place by the former administration, which will, among other things, increase scrutiny of site-of-care payment differentials.

Industry disruption: The rapid shift to digital health further opens the door for industry disruptors who can offer a seamless online patient experience; already, Amazon has expanded its app-based Amazon Care digital health platform to 21 states. Major retailers who were moving into the healthcare space before the pandemic have been designated to offer COVID testing and vaccinations, making them more familiar to consumers as sources for basic healthcare needs. The financial impact of COVID on smaller hospitals and physician practices will likely accelerate industry consolidation, as well as the formation of new partnerships between payers and providers. All these trends threaten to disrupt hospital and health system referral patterns and increase risk for organizations that have not focused on a consumer-driven strategy for patient experience and pricing.

Economic change: Early in the pandemic, the fear was that widespread business closures would result in a recession. Federal stimulus spending has eased recessionary fears but has raised new fears of inflation. After years of historically low interest rates, significant inflationary pressures could have a material impact on the cost of capital under new or existing debt instruments.

Other risks: Hospitals and health systems face other significant risks, including cybersecurity and ransomware threats, data breaches and HIPAA exposure, environmental risks (e.g., flooding, wildfires, or storm damage), and technological advances that further the ongoing movement of inpatient care to outpatient settings. They also face risks in talent recruitment, as healthcare becomes more digital and must compete for talent against sophisticated and established tech companies that also represent a competitive threat for legacy healthcare organizations.

Dynamic Risk Management and Resiliency

It is our position that organizations should adopt a strategic resource allocation framework to build resiliency and enable an agile and fluid response to risks that might undermine an organization’s operating or financial strength. A dynamic financial planning model forms a bridge between the organization’s ERM function and the strategic resource allocation framework, identifying and quantifying the potential impact of material risks as discussed above, and identifying resources within the strategic resource allocation framework to hedge against these risks. For those organizations that do not have an ERM infrastructure in place, the financial planning model can be used to help identify a targeted pool of key operating and financial risks.

A strategic resource allocation framework focuses on integrating risks and resources across the three primary components (described here as “companies”) of all health systems:

  1. An operating company that grows and manages the clinical and strategic initiatives that drive cash flow and define the organization’s mission
  2. A finance company that leverages enterprise resources to secure the liquidity and capital (internal and external) needed to fund the operating company
  3. An investment company that warehouses and deploys accumulated liquidity resources to support credit, drive return, fund capital, stabilize risk, or respond to any combination of a range of sometimes competing and shifting priorities

Figure 1: The Strategic Resource Allocation Framework

Pyramid Chart of Strategic Resource Allocation Framework

The strategic resource allocation framework brings these companies together in a resiliency hub where existing resource claims arising from the operating company and its initiatives can be matched against resources to establish a baseline resiliency profile, and also where investment company resources can be identified to hedge against potential risk exposures of both the operating and the finance companies (Figure 1).

Traditional financial planning contributes to establishment of the baseline resiliency profile by defining the resources required to fund and implement identified operating company initiatives. Dynamic financial planning contributes to building resiliency against future disruptions through the process of risk identification and quantification. A dynamic financial planning model defines not only the claims on resources from known strategic requirements, but also the potential resource claims of risks to the operating company and the finance company. It identifies resources that can be used to respond if these risks materialize, which in turn informs an investment strategy that prioritizes, first, the need to hedge against operating company and finance company risks, and second, the pursuit of independent returns (Figure 2).

Figure 2: Dynamic Financial Planning’s Integration with Strategic Resource Allocation

Workflow of Dynamic Financial Planning Integration with Strategic Resource Allocation

By identifying and drawing attention to material risks and ensuring that planning is in place to hedge against them if they become reality, dynamic financial planning’s integration with strategic resource allocation also contributes to more dynamic, enterprise-wide conversations around resources and risk response. The shock of future disruptions is inevitable, but the resiliency needed to absorb those shocks and move forward is not. Dynamic financial planning is a key element in building that resiliency.

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