States still face a long and rocky recovery as 30 states have projected budget shortfalls totaling $49 billion for the next fiscal year, according to the Center on Budget and Policy Priorities. Medicaid is a large component of a state’s expenditures — averaging 13 percent of state budgets nationwide — and it's becoming even larger. Standard & Poor's Healthcare Economic Composite Index indicates that the average per capita cost of healthcare services covered by Medicaid rose 5.28 percent in 2011. As a result, Medicaid is a common target for states' budget balancing efforts, leaving many hospitals with an uncertain future.
Medicare reimbursement rates are susceptible to cuts as well. In March, Congressmen Paul Ryan's budget passed by the U.S. House of Representatives proposes to cut Medicare spending by $205 billion in part by privatizing the system. Although this budget will likely be rejected by the Senate, it at least evidences that Medicare cuts are part of the budget-balancing discussion.
Hospitals are often getting pulled in both directions. Even as reimbursement rates are being cut, Medicaid is becoming more prevalent as a payor source. The Medicaid expansion mandated by the Patient Protection and Affordable Care Act, commonly called the Affordable Care Act, is scheduled to take effect Jan. 1, 2014 and is projected to move an additional 16 million people to Medicaid. Although this increased coverage will “federalize Medicaid,” meaning the federal government will bear a majority of the extra costs, the Congressional Budget Office projects that states will still see a 2.8 percent increase in Medicaid cost due to the expanded enrollment.
Legal challenges are fueling the ambiguity. Several lawsuits have been filed in an attempt to block, or at least delay, scheduled cuts to Medicaid reimbursement. In late February, the U.S. Supreme Court decided to forego a ruling on a lengthy legal battle between California and healthcare providers protesting cuts in Medicaid reimbursement rates. A similar federal lawsuit filed by the Arizona Hospital and Healthcare Association in an attempt to block a 5 percent cut in Medicaid hospital payment was recently dropped. A decision by the Supreme Court on the ACA's constitutionality is expected this summer.
The pursuit of financing
Despite the doubt regarding the future of these two major payor sources, many hospitals do not have the luxury of delaying needed capital projects. When pursuing financing for these capital projects, there are steps that providers can take to mitigate the risk of Medicare and Medicaid reimbursement rate cuts. Additionally, lenders are not ignorant to the risk of potential cuts, so being able to articulate a plan for possible Medicaid cuts will improve the chances of obtaining financing.
First, any lender or government agency providing credit enhancement wants to be convinced that hospital management has a grasp on the state and national legislative landscape. Hospital leadership should be able to discuss how the hospital has been impacted by past changes to the law and what future changes are currently being discussed. Government agencies or investors working with hospitals across the country may not be knowledgeable of the reimbursement outlook for a specific market or state, so they will be looking to the hospital to provide this information. Demonstrating that the hospital has a pulse on the developments impacting reimbursement and has been able to navigate reimbursement changes in the past is a key indicator of the strength of the management team when assessing a hospital’s credit worthiness.
While the traditional underwriting metrics of financial performance, market-population analysis, and local reputation still exist and will need to be examined, lenders and agencies will also expect a sensitivity analysis detailing the impact of possible Medicare or Medicaid rate cuts. If a feasibility study is being completed in conjunction with the proposed financing, it will likely include an examination of sensitivity relative to admission declines, interest rate increases and other major variables. Assuming a project has a Medicaid or Medicare census, a separate sensitivity analysis should be completed detailing the impact of various percentage cuts for reimbursement rates. The results may be surprising. According to Fitch’s sensitivity analysis of all the hospitals it rates, each percentage point cut in Medicare reimbursement rates reduces operating margin by 40 basis points on average.
As with all potential underwriting risks, an obvious mitigation to the risk of reduced reimbursement rates is to decrease the project size and resulting funding request. Project size is often the first topic of discussion with potential investors and agencies. Project costs are commonly compared to benchmarks based on per-square-foot construction costs or to similar hospitals that recently have been constructed. Considering their qualms with the health-care industry, investors have reduced the targeted leverage points and are now seeking lower loan-to-value ratios. Therefore, an organization should expect construction costs to be heavily scrutinized, especially with reimbursement-rate cuts looming on the horizon, when pursuing financing.
The pursuit of consistency
Lenders and agencies will likely ask to review a hospital’s strategic plan to ensure there is a response for industry changes, including reimbursement cuts. A plan that successfully addresses the risk of reimbursement cuts should largely focus on expense-control tactics that a hospital may employ. Be aware that, when compared to the actual financial performance of a hospital’s completed financing, expense projections often are understated in the feasibility study while revenue and cash projections are mostly accurate.
Ross Manson, principal at Eide Bailly, a CPA firm dedicated to audit and consulting services, has observed this trend during his 17 years of working with hospital management teams. According to Ross, a hospital needs to make a concerted effort to keep a sharp eye on expenses post-financing even though its balance sheet may be flush with cash.
"When a hospital is pursuing financing for a planned capital project, expenses are often carefully scrutinized by several parties whether it is the hospital's board of directors, a rating agency or potential lenders and investors," Mr. Manson said. "The true test for hospital management is to maintain the same expense discipline in the post-closing years when there is not quite as much third-party oversight."
While a hospital’s revenue base is at the mercy of many external factors, including the local economy, legislative changes and the patient base, a hospital has more direct control over expenses. If it has a plan in place to continue monitoring expenses on an ongoing basis, the hospital can mitigate one of the few variables that can be controlled. This allows room for more fluctuations in the other assumptions contained in a feasibility study, including reimbursement rates.
This is indeed a challenging time for health-care organizations; however, by focusing on a few select items that can be directly controlled, a hospital may better prepare to brave the storm of reimbursement rate cuts. Understanding the political landscape, performing a sensitivity analysis, sizing the project appropriately and exhibiting expense discipline will lead to a higher rate of success when pursuing financing. In a world of uncertainties, the key is to focus on what is certain.
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