Sunday, January 22, 2012

Let's move to real-time philanthropy

I want to present here a somewhat radical view of how large non-profit organizations like hospitals might more appropriately use the financial reserves they have accumulated through philanthropy.  In short, I want to suggest that virtually all gifts received by a non-profit of this scale should be considered spendable, to be used -- and used up -- for the strategic priorities for the organization over a short period of time, say five to ten years.*

I offer this thought not in any attempt to be critical of the current policies of hospitals, but in the hope of stimulating some discussion.  If this approach were to be adopted, it would require a different viewpoint by boards of trustees and a different approach with many prospective donors. 

Some background.  Virtually all large non-profit hospitals must engage in fundraising to support their clinical, research, and teaching activities because payments from the government and private insurers are inadequate to cover a portion of those costs.  The preponderance of funds received are from individuals and family foundations, from people who believe in the mission of the organization and want to contribute to its success.  Some gifts are offered for current use, but that is a small portion of those received.  A greater percentage of funds donated are placed in endowment-type accounts, against which the institution applies a payout policy.  That policy is usually very conservative, designed to support the perpetual existence and availability of the gift.

It is the word perpetual that concerns me.  In treating donated funds in this manner, the institution has decided that there is an overly important inter-generational aspect of its fiduciary responsibilities.  I want to question that, both as a matter of philanthropy and as a matter of sound business planning.

Let me first acknowledge that it is a good idea to have some "money in the bank" for untoward circumstances, dips in the economy, and such.  Also, of course, there is a need to accumulate some amounts before committing to specific large capital investments.  But let me suggest that the amount of money reserved by most places greatly exceeds the need to cover those contingencies and those projects.

As noted, I'd like us to think instead of a policy that directs virtually all gifts received by a non-profit to be considered spendable.  Instead of constituting a long-term holding account, the funds would be used -- and used up -- for the strategic priorities for the organization over a short period of time, say five to ten years.

Why?  First of all, I do not believe that most donors, were the question put to them in this way, would want their donations put in a decades-long holding account.  I think that most donors want to see their gifts put to use today and in the near future, to improve patient care now, to expand research now, and to enhance teaching now.

Second -- and this is the controversial part -- the establishment of large, slow-payout endowment funds reduces the accountability of a non-profit to the society it serves.  Non-profits are different in many ways from for-profits, which have to answer regularly to investors and thereby prove their strategic and tactical decisions.  The "shareholders" of non-profits are more diffuse, the citizens of the region served.  The success of the non-profit, too, is not measurable by a simple profit-and-loss calculation.  I think we can all agree that an important measure of the effectiveness and relevance of a non-profit is the degree to which it can persuade people to donate money.

A powerful test of an organization's relevance, therefore, is whether it is able to raise money from each generation.  In contrast, the kind of inter-generational transfer of funds represented by a slow-payout endowment accounts weakens the ability of an institution to assess its relevance to the current generation.

I realize that this approach would put non-profits at greater risk.  I am suggesting that this is a good thing.  It is too easy for the management and board of a hospital to get complacent and comfortable when they have a big bank account and use only a small portion for current expenditures and capital budgets.  It is also too easy for them to respond to a turn-down in revenue in a manner designed to preserve those financial assets rather than, for example, to preserve the jobs of people working in the facility.  How many times have we seen hospitals conduct major personnel lay-offs while their endowment accounts remains strong?  To be blunt, these are often instances of valuing money over people.  These kind of decisions can result from overly conservative boards being more focused on the long-run preservation of assets than on an equally important assertion in support of the organization's human capital.

So, let's cut through all that and decide that each generation should be responsible for the financial health of the hospitals in the community.  Sure, have a bit of money squirreled away for contingencies, but test the proposition of each non-profit's value to society by expecting those living today to provide support for today's programs and services.  If an organization cannot meet that test of relevance, let's not plan to keep it on life-support by using money from previous generations of donors.


* This could apply to large colleges and universities, too.


BenK said...

I disagree with the recommendation for a couple key reasons. First, endowment funds are counter-cyclical. They make universities and hospitals particularly strong just when other sectors are weak. They help society as a buffer.

Endowments also strengthen the institutions by allowing them to make large expansions and construction just when labor is inexpensive and materials are not in demand.

Third, they sometimes allow such institutions to stand against the fad of the day; centers of excellence in anything do not grow up during boom times - they sprout during one boom, put down roots during a bust, and flourish in the next cycle - and so on. When their area of interest is out of vogue, they attract the few excellent devotees; then they are the source of insight and training when the vogue returns. Forcing them to live through each and every cycle in a 'responsive' fashion ... accountability, as you say ... is another version of the quarterly reports that plague corporations today and stilt long term growth.

This argument against accountability, the need for strong, independent non-profits, is also part of an argument against 'payments in lieu of taxes' and related government/community extortion. Strong independent non-profits are important bulwark against market and government forces in our society.

Paul Levy said...

I get your points, but recall that I specified payout periods of five to ten years, a far cry from the quarterly time frame of corporations.

I don't get your point about countercycles. You seem to be saying that it is good for the economy for non-profits to be able to spend money during down business cycles, when other people and businesses are not purchasing. I don't know, first, if it is actually true that they spend more during those downturns. I haven't seen evidence of that. But I also don't know why that should be a concern of people charged with the fiduciary needs of the hospitals.

Nancy Thomas said...

Having been on both sides of philanthropy, as solicitor and donor, I think you made excellent points. That designated or restricted gift, often a donor's wish, is usually not even credited toward a major gifts officer's fundraising goal. It is considered an "extra". The push is always for the undesignated, nonrestricted donation which can be put into long term programs or endowments. Being a donor to my college I was pushed to make a scholarship gift "in perpetuity", which meant funding the principle with only the interest EVER being given out. Not too appealing to me. Another issue of importance is how designated gifts can be changed over generations and "giving shoes to children who come to America from Israel" became "donating to the endowment". Agreed that the original intent may no longer be an active issue, but there was no attempt to go back to determine what was the interest of the donor family originally and let's match that as closely as possible. People of extraordinary wealth who give in the millions do understand the need for long term giving, but perhaps the shorter accountability - such as in our lifetime? - may push universities and hospitals to better plan and better account for their mission and their appeals.

Pam said...

You are right on with this but it is heresy among the Foundation professionals who want to "build a corpus" supposedly to secure the hospital's future, but it's really just security for the Foundation I think. I was involved with a hospital that declared bankruptcy while its Foundation fought to hang onto the millions in endowments it held . . . and while the hospital was having to reorganize (and local vendors taking it on the chin) the Foundation was having a big chunk of its value disappear in the market! Doesn't make sense to me.

Bruce Ramshaw said...

I think this is brilliant. Investing in new models and innovative solutions would be more likely to ensure sustainability than hoarding away money. I think many in leadership positions treat the endowment/investment funds like a score in a game- the higher the score, the more proud they are. But, I would extend this strategy to for-profit companies as well. I think the concept of short-term shareholder profit capitalism is misguided for the same reasons. The conscious capitalism and constructive capitalism movements are examples of for-profit companies with a more long-term and socially responsible strategy.

Lynne said...

I think this is a great idea. I have worked for multiple nonprofits, including a university, a well-funded high profile global nonprofit, and more innovative companies known as social enterprises (which try to address social problems through self-sustaining, market-based methods). I'm currently a consultant for a boutique firm in India that's specialized to serve clients in healthcare delivery.

All of these organizations could have benefited greatly from having an increased portion of their donations coming as unrestricted. The social enterprise and the global nonprofit were practically begging for the ability to direct the course of their spending better, even though it's difficult to have an organization more cost-conscious than a social enterprise (because they often have regular VC investors to answer to as well as donors).

The university remained smug in its long-term plans until a terrible president was hired that brought it to the verge of financial ruin in five short years. The next president struggled with lines of credit and complicated financial maneuvers because he couldn't access the amount of funds needed for performance transformation.

As for what BenK said about endowments being counter-cyclical, I'm not sure it works that way in practice. Universities still rely a lot on revenue from incoming students but the proportion of students who can pay full or nearly full price for their education is pro-cyclical - it rises and falls with the business cycle. Your overall financial health enhances your ability to raise funds. While it's true that endowment driven nonprofits might not have to abandon large expansion projects if a down cycle hits, I do not think their relatively stronger position during down swings actually prompts these expansions. In any case, these expansions are years in the making because the pledges have to be collected in advance, so even if it commences in a downturn, it's because it was planned in a upswing with good conditions for philanthropy.

Also, generally speaking, the nature of endowments is pro-cyclical. The interest earned on a portfolio of invested money would fall during a downturn, as markets tumble. You could mitigate this by hedging but that's a risky strategy generally forbidden for institutional investors.

Tom DeSimone said...

I agree with your overall theory. I have suggested to some of the not-for-profits in which I am involved that their endowments/reserves should at least be considered as sources for "venture capital" for their businesses i.e. undertaking projects that cannot be funded from current operations, but which may lead to positive business process changes, increased revenue or more efficient use of expenses. These uses could include capital improvements for which debt or other capital are not available or affordable.

Adam G. said...


I think you've touched on something important. Hospital systems operate in a middle ground between commercial enterprise and charity. Most 501(c)3 non-profit healthcare systems get the vast majority of funding through operations paid by commercial or government payors. They "plug" holes or build strategic assets like new facilities using philanthropic gifts, but this tension between a commercial enterprise and the non-profit charitable organization is an inefficient structure.

Hospitals should continue to operate as non-profits but have tax exempt 501(c)3 status removed. By removing the tax deduction and direct fundraising it won't reduce their community mission (they would still be non-profits with a chartered mission), just simplify the business model. They would then also have an affiliated 501(c)3 foundation which could become a "payor" to finance charity care. Of course, they would have to pay taxes on income, but the affiliated 501(c)3 philanthropic foundation would have a cleaner mission in financing charity care in a way that is much more transparent than how "community benefit" is measured today.

Splitting the non-profit (but not tax exempt) commercial enterprise from the non-profit 501(c)3 tax exempt charitable financing organization would solve the problem you bring up. The charitable organization would direct funds at specific projects that they could report on to donors (e.g. uncompensated care, grants for junior faculty research, Lean initiatives, new primary care clinic in an underserved area) and more easily report on ROI / impact to donors. The commercial enterprise could then focus on what it should be designed to do - high quality and efficient delivery of health care services.

The current state of mixing philanthropy with operational revenue creates the problem you've identified and incentivizes hospital leadership to build inefficient health care "empires" and piles of cash in reserve.