Derivative Financial Instruments and the Financial Management of Nonprofit Health Systems

Abstract

This paper examines the impact of derivative financial instruments use on the financial management of US nonprofit health systems. We review the existing literature on interest rate derivative instruments and US hospitals and health systems. There are several published papers have described the design of these derivative financial instruments from a theoretical perspective. Our contribution to the literature is to provide an empirical evaluation of derivative financial instruments usage by US nonprofit health systems. We present five case studies of US hospitals and integrated delivery systems that describe the design and operations of the fixed rate to floating rate swap, the floating rate to fixed rate swap, the basis swap, the interest rate cap, and the swaption. In each case study we examine the impact of derivative use across the dimensions of risk management, cash flow, and reported operating results. We conclude that interest rate swaps; caps, and swaptions are effective risk management tools. However, we also found that while these derivative financial instruments are useful hedges against the risks of issuing long term financing instruments, they also expose derivative users to additional credit and other risks. In conclusion, we find that these financial instruments can also generated negative as well as positive cash flows and have both a positive and negative impact on reported operating results.

Keywords: Derivatives, Financial Management, Nonprofit

JEL Classification: M41, M48, I19