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Capital Formation Considerations for Hospitals

Understanding Risks and Rewards

By Calvin W. Weise CPA; and Staff Writers

All hospital and healthcare-entity capital investments create risk.

Definition of Risk

According to www.HealthDictionarySeries.com, risk is the uncertainty of future events. When hospitals make capital investments, they commit to costs that affect future periods. Those costs are known and relatively fixed. What are unknown are the benefits to be realized by those capital investments.

Capital Investment Risks

For capital investments, risk is the certainty of future costs coupled with the uncertainty of future benefits. In some cases, while the future benefits are uncertain, there is a high degree of certainty that the benefits will exceed the costs. In these cases; risk can be very low. Risk may be better defined as the degree to which the uncertainty of unknown benefits will exceed the known and committed costs.

Burdens and Benefits of Ownership

When capital assets are purchased, both the burdens and the benefits of ownership are transferred to the owner. The burdens are primarily the costs associated with acquisition and installation.

The benefits are primarily the revenues generated by operating the capital assets. Risk of ownership is created to the degree that the benefits are uncertain.

Balancing Act

Hospital managers need to be skilled at balancing and putting hospital assets at risk. Without clear knowledge and understanding of the benefits and the burdens, hospitals can quickly find themselves at unacceptably high levels of risk. Risk must be continually assessed and evaluated in order to successfully put hospital assets at risk. Hospitals and related entities require many varied capital investments; their capital investments represent a risk portfolio. An effective combination of risky assets can often create risk that is less than the sum of the risk of each asset.

Modern Portfolio Theory

Of course, financial managers have know this for years as a basic principle of Modern Portfolio Theory (MPT), first introduced by Harry Markowitz, PhD, with the paper ”Portfolio Selection,” which appeared in the 1952 Journal of Finance. Thirty-eight years later, he shared a Nobel Prize with Merton Miller, PhD, and William Sharpe, PhD, for what has become a broad theory for securities asset selection; and hospital assets may be viewed as little different.

Historical Review

Back in the day, prior to Markowitz’s work, investors focused on assessing the rewards and risks of individual securities in constructing a portfolio. Standard advice was to identify those that offered the best opportunities for gain, with the least risk, and then construct a portfolio from them.

Example:

Following this advice, a hospital administrator might conclude that a positron emission tomography (PET) scanning machine offered good risk-reward characteristics, and pursue a strategy to compile a network of them in a given geographic area.

Intuitively, this would be foolish. Markowitz formalized this intuition. Detailing the mathematics of diversity, he proposed that investors focus on selecting portfolios based on their overall risk-reward characteristics instead of merely compiling portfolios of securities, or capital assets that each individually has attractive risk-reward characteristics.

In a nutshell, just as physician-investors should select portfolios not individual securities, so hospital administrators should select a wide spectrum of radiology services, not merely machines.

Other Strategies

According to Dr. David Edward Marcinko, MBA, CMP™, the Publisher-in-Chief of this portal, some other risk and cost control strategies that will affect hospital ROI include:

  • CDHC and medical HSAs,
  • Universal health insurance,
  • eMRs and HIT investments,
  • P4P, and various
  • Medical quality improvement initiatives.

Assessment

Savvy hospital managers, financial advisors, physician and nurse executives, accountants and healthcare administrators should mitigate ownership risk by constructing their portfolio of risky assets in a manner that lowers overall risk www.HealthcareFinancials.com

Conclusion

Please subscribe and contribute your own thoughts, experiences, questions, knowledge and comments on this topic for the benefit of all our Executive-Post readers.

Related Information Sources:

Practice Management: http://www.springerpub.com/prod.aspx?prod_id=23759

Physician Financial Planning: http://www.jbpub.com/catalog/0763745790

Medical Risk Management: http://www.jbpub.com/catalog/9780763733421

Healthcare Organizations: www.HealthcareFinancials.com

Health Administration Terms: www.HealthDictionarySeries.com

Physician Advisors: www.CertifiedMedicalPlanner.com

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com  or Bio: www.stpub.com/pubs/authors/MARCINKO.htm

Subscribe Now: Did you like this Executive-Post, or find it helpful, interesting and informative? Want to get the latest E-Ps delivered to your email box each morning? Just subscribe using the link below. You can unsubscribe at any time. Security is assured.

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