How Might a Reforming U.S. Healthcare Marketplace Threaten Balance Sheet Liquidity for Community Health Systems

On the basis of any conventional methods of evaluating balance sheet liquidity for U.S. health systems1, it might appear that some of the larger systems, as measured by asset base and operating revenue performance, are getting stronger. Even some midsized community health systems seem to be performing better in terms of such liquidity measures as cash-to-debt ratios, days cash on hand, and other related metrics. However, a closer look at the future of strategic investment plans for U.S. community health systems should cause leaders to reconsider perspectives and conventions on balance sheet liquidity sufficiency.According to Jay Sterns, director at Barclays Capital:If the largest, U.S. not-for-profit health systems were to consolidate, forming a unified "firm," this new entity would generate an estimated $77 billion in annual operating revenues and hold an estimated $35 billion in cash and cash equivalents-an estimated 198 days cash on hand (approximately $0.50 of cash on hand for every dollar of operating revenue generated annually). By comparison, a large, U.S. public company, such as Apple, may have an estimated $0.77 of cash on hand for every dollar of annual operating revenue earned.Rating agency medians for days cash on hand for AA-category health systems, as published in 2011 by Moody's and Standard & Poor's, were 226 and 215, respectively. If the governing board of our fictitious consolidated healthcare firm elected to maintain a AA credit rating, it would have little, if any, discretionary cash to invest in the organization without pressuring its liquidity ratios to the point of a potential downgrade.This perspective on liquidity should lead executives of U.S. healthcare systems to question the conventional methods for evaluating financial strength and sufficiency of liquidity positions, especially as health systems encounter market environments that could call for unprecedented levels of liquidity to fund a range of strategies, strategic capital needs, and clinical programming redevelopments.Steve Proeschel, managing director at Piper Jaffray, comments:There is little doubt that many of the likely "reform era" strategies will pressure health system balance sheets. Implementation of [electronic health record] systems, together with other strategic investments, will strain cash positions for many health systems. Balance sheet liquidity will be at risk for a growing number of health systems. While some health systems have experienced improving liquidity positions since 2008, Moody's notes that 18 percent of hospitals it rates experienced operating losses in 2011 (Standard & Poor's, 2013). Moody's also reports that most [chief financial officers] predict future cash flow declines in the new environment.Proeschel also believes that regeneration of cash positions will be challenging in the marketplace ahead, due in part to costs related to transitions from fee-for-service business models to risk-based contracting strategies. This challenge will be especially acute for organizations that lack sufficient knowledge of their total costs of care.2While some portion of the U.S. healthcare system marketplace is experiencing improving liquidity positions, the issue addressed in the rest of this article is the sufficiency of these positions in an uncertain, reforming U.S. healthcare marketplace-a marketplace that could require U.S. health systems, especially not-for-profit, tax-exempt community health systems, to draw down on balance sheet liquidity as they pursue strategies that are not amenable to traditional means of strategic investment financing.A question important to U.S. community health systems is: Are some-or perhaps all-heading toward a "liquidity cliff"?MOVING INTO UNSTABLE MARKETSThe prospect of a U.S. healthcare marketplace in the process of reform presents great potential for economic uncertainty and instability. Market instability can produce unexpected and swift negative effects. …