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Understanding Capital Investment Risks for Hospitals

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Capital Investment Risks for Hospitals

By Calvin Weise CPA and Dr. David E. Marcinko MBA CMP®

www.CertifiedMedicalPlanner.org

Capital investments create risk. 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 is unknown are the benefits to be realized by those capital investments.

Capital Investments

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.

Capital Assets

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.

Manager Tasks

Hospital managers need to be skilled at 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 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.

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Hospital with paper MRs

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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.

Prior to Markowitz’s work, investors focused on assessing the rewards and risks of individual securities in constructing a portfolio.

Risk Measure

Standard advice was to identify those that offered the best opportunities for gain with the least risk and then construct a portfolio from them. 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 investors should select portfolios not individual securities, so hospital administrators should select a wide spectrum of radiology services, not merely machines.

Assessment

Savvy hospital managers will mitigate ownership risk by constructing their portfolio of risky assets in a manner that lowers overall risk.

Conclusion

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One Response

  1. What were the top 10 nonprofit hospitals in 2013?

    Top 10 Nonprofit Hospitals Based on Care Provided in 2013

    1. Gundersen Lutheran Med Center – $302.5M
    2. Sutter Medical Center – $271.9M
    3. Stanford Hospital and Clinics – $224.7M
    4. Norton Hospital – $211.2M
    5. Medical City Dallas Hospital – $210.3M
    6. Swedish Medical Center – $192.5M
    7. University of Pennsylvania Hospital – $184.5M
    8. Methodist Hospital – $172.4M
    9. Sacred Heart Med Center/Riverbend – $171.2M
    10. Carle Foundation Hospital – $163.5M

    Source: Hospital Safety Score

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