As the dust settles from the Supreme Court's ruling on the constitutionality of the Affordable Care Act (ACA), the results of the presidential election and, more recently, the sequester cuts, acute care providers are now turning attention to the looming reimbursement cuts.
Although uncertainty remains as to the scope and severity of future cuts, many hospitals do not have the luxury of delaying needed capital projects and need to pursue financing now. 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 as states work to balance their budgets and Medicaid expands as the ACA is implemented.
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. 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.
Lenders and agencies will also likely expect a sensitivity analysis detailing the impact of possible Medicare or Medicaid rate cuts to be completed. 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. Considering their qualms with the healthcare 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.
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 Manson, 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," Manson says. "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."
This is indeed a challenging time for healthcare organizations; however, by focusing on a few select items that can be directly controlled now and in the future, a hospital may better prepare to brave the storm of reimbursement rate cuts.
Kevin Laidlaw is a vice president at Lancaster Pollard, an investment banking and mortgage banking firm in Columbus, Ohio.