AcSEC Presentation January 26, 2005

1
AcSEC PresentationJanuary 26, 2005

• AICPA Healthcare Organization Expert Panel

2
U.S. Health System

• Industry History and Background
• Disclosure Framework and Analysts
  Interests/Concerns

3
U.S. Health System

• While I can explain
• the meaning of life,
• I dont dare try to
• explain how the U.S
• health system works.

1817110
4
National Health Spending
Components of U.S. GDP 2002 Total Spending 1.6
Trillion
of GDP
Source CMS (2003)
5
National Health Spending
Source GAO (est. 2004)
6
Personal Health Spending
Other DME, public health, dentist
services, over-the-counter drugs, research, etc.
Source GAO (est. 2004)
7
U.S. Hospitals
Source AHA (2004)
8
U.S. Hospitals

• Current operating environment
• Workforce shortages and increased labor costs
• Rapid increase in professional liability premiums
• Medical advances/new tech increase supply costs
• Need to modernize/expand facilities
• Regulatory burden
• Disaster readiness
• Quality and patient safety

Source American Hospital Association (2003)
9
U.S. Physicians

• 888,061 Number of licensed physicians
• 31 Primary care physicians
• 70 Health care spending decisions driven
  by physicians

Source CMS (2004)
10
Insurance Coverage
Source GAO (2003)
11
Government Roles
UNDERWRITER
PROVIDER
REGULATOR
Source Jonas Health Care Delivery in the U.S,
Anthony Kovner Infoworld.com (2000)
12
Federal Role

• SCHIP
• 3.5 billion in funding (FY 02-FY 04)
• 3.9 million children

• MEDICARE
• 274 billion
• 14 of population
• 18.6 of U.S. budget
• MEDICAID
• 280.9 billion
• 14 of population
• 7.4 of U.S. budget
• 14 of state budgets
• FEHBP
• 19.5 billion
• 9 million beneficiaries

• TRICARE
• 29.3 billion
• 9.1 million beneficiaries
• 75 hospitals, 461 clinics

• VA
• 29.1 million (health care)
• 224,724 employees
• 1,266 facilities

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U.S. Health System
How Did We Get Here?
14
Beginnings
1930s The Growing Federal Role

• The Depression sparks federal recognition of
  health care needs
• Employer insurance model (Blue Cross) HMO model
  (Kaiser)
• FDRs Economic Security Plan omits national
  health insurance proposal
• SSA institutionalizes federal policy role

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Beginnings
1940s Access, Coverage and Payment

• Employer-based indemnity insurance becomes
  dominant coverage model
• Physicians and hospitals associate develop
  integrated models of care
• Henry Ford System Geisinger System
• Lovelace Clinic Oschner Medical
  Institutions

16
Beginnings
1940s Access, Coverage and Payment

• Trumans national health insurance plan sparks
  5-year Congressional debate
• McCarren-Ferguson Act recognizes state regulation
  of insurance
• Proposed indigent care subsidy for states
• Hill-Burton accelerates hospital construction

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Medicare / Medicaid
Compromise Social Security Act Amendments July
30, 1965
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Point Counterpoint
1973-9 Cost Containment Rapid Growth

• President Carter advocates rate-setting
• HEW reorganizes establishes HCFA
• NHRPDA Mandates health planning
• HMO Act Fosters market competition
• SSA Amend. Elevate fraud to felony status
• ERISA Regulates self-funded plans

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Changing Focus
1980s Outpatient Alternative Delivery

• OBRA 80 Adds intent requirement to
  Anti-kickback Law
• OBRA 81 Allows Medicaid waivers
• TEFRA Limits Medicare hospital payment
• PPS Creates prospective payment for
  inpatient hospital services

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Changing Focus
1980s Outpatient Alternative Delivery

• COBRA Continues insurance benefits
• HCQIA Creates practitioner data bank
• EMTALA Prohibits patient dumping
• OBRA 89 Establishes RBRVS Stark I

21
Reform Redux
1990s . . . Contraction

• Industry mergers skyrocket 4,000
• Transactions involving physician groups increase
  170
• HMO MAs cause 3.6 billion in assets to change
  hands

22
Reform Redux
1990s . . . Compliance

• HCFA publishes Stark I regulations
• Operation Restore Trust spawns a series of
  federal fraud initiatives
• HIPAA
• Insurance portability
• Fraud
• Privacy

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Balanced Budget Act
MedicareChoice PSOs Fraud Abuse Payment
Freezes Payment Cuts Expansion of PPS DSH
Cuts Medicaid Managed Care Childrens Health
Insurance Program
MEDICAID 13 Billion
MEDICARE 115 Billion
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Balanced Budget Act
Source The Lewin Group analysis of Medicare cost
reports AHA annual survey data. (1999)
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Balanced Budget Act
Source The Lewin Group analysis of Medicare cost
reports AHA annual survey data. (1999)
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New Realities
2002 2003

• Public Company Accounting Reform and Investor
  Act (Sarbanes-Oxley) (2002)
• The Hospital Mortgage Act (2003)
• HHS publishes final HIPAA privacy regulations
  (2002) and security standards (2003)
• Stark II, Phase II
• The Medicare Prescription Drug and
  Modernization Act (MMA) (2003)

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How Accounting, Reporting, and Auditing is
Impacted

• Business/operating environment (mission-based)
• Formation Issues (consolidation)
• Unique payment schemes (revenue recognition)
• Revenue recognition (uninsured, bad debt, etc.)
• Professional liability (cost containment,
  relationship/structure, accounting, etc.)
• Investments (on balance sheet, off balance sheet,
  returns, etc.)

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Consolidation Issues
Health System
NFP
NFP
NFP
NFP
NFP
FP
FP
FP
FP
FP

• Accounting Differences
• Goodwill/intangibles
• Consolidations (FIN 46 (R))
• Taxes
• Etc.

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Consolidation/Framework Issues
Example JOA
50
50
100
100
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Unique Payment Schemes

• Cost reports
• Long settlement process
• Reserves/revenue recognition
• Compliance/regulation
• 100s of payment schemes and prices for same
  service
• Federal mandatory programs (tax)

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Revenue Recognition

• Charity care
• Uninsured
• Bad debts
• Discounting process

32
Professional Liability

• Significant cost
• Different roles
• Captives
• Self-insured
• Claim made / Occurrence
• Related parties

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Whats Needed

• Clarity, Guidance, Consistency, and Transparency

34

• Disclosure Framework
• Analysts Interests/Concerns

35
NFP HCOs Capital Raising

• Relatively few HCOs are SEC registrants
• Yet financial statements of NFP HCOs are widely
  used for capital raising in one of the worlds
  largest securities markets the municipal bond
  market
• Municipal bonds are bought and sold in the
  over-the-counter market rather than on an
  organized exchange

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How Big is the Municipal Bond Market?

• Approximately 1.3 trillion of bonds are
  currently in the hands of investors
• More than 50,000 entities issue municipal
  securities
• 1.5 million separate bond issues outstanding
• In 2004, HCOs issued 28 billion of debt
  securities
• Many were auction-rate deals coupled with
  floating-to-fixed interest rate swaps

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Investor Profile

• An estimated 5.1 million households own municipal
  bonds in some formeither through direct
  ownership of individual bonds or through
  investment in institutional portfolios (mutual
  funds, unit investment trusts, bank trust
  accounts, etc.)
• Commercial banks and insurance companies are also
  major institutional holders of munis

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Regulation

• Congress does not allow SEC to directly regulate
  the muni market
• Regulation through broker-dealers
• Disclosure requirements are fluid and flexible
  (unlike SEC registrants)
• Primary offering documents (Official
  Statements)
• Secondary market disclosure requirements

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Disclosure Framework in Muni Market

• SEC Rule 15c2-12 (Municipal Securities
  Disclosure)
• SEC Rule 10b-5 (Antifraud provisions of 33 and
  34 Acts)
• Industry practice/market demands

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SEC Rule 15c2-12Disclosure Requirements

• Obligors must covenant to disclose financial and
  operating information annually (and material
  event notices as needed) for dealers to be able
  to underwrite their bonds
• Information must be filed with 4
  nationally-recognized municipal securities
  information repositories (NRMSIRs) and, if
  applicable, state information depositories (SIDs)
• Failure to make filings timely must be disclosed
  in subsequent bond issuances omission
  constitutes violation of SEC anti-fraud rules

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What does the SEC Say About Transparency?
"The difference in the quantity, quality, and
availability of ongoing disclosure in the
municipal market can be expected to be noticed
and affect investment decisions. It will be more
important than ever for municipal issuers and
conduit borrowers to establish good disclosure
practices that go beyond the legal minimums of
15c2-12."
Martha Mahan Haines Director, SEC Office of
Municipal Securities
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Best Practices for Health Care and Senior
Housing Credits

• Credits with excellent disclosure "win
  accolades and possibly quicker consideration for
  upgrades"
• Credits with poor disclosure viewed with
  increased skepticism and caution"
• Recommendations for content, format,
  presentation of quarterly/annual disclosure data

http//www.fitchratings.com
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What Does SEC Say About Web-based Disclosure?

• "We encourage the use of web sites for posting
  old and new official statements as well as
  financial and operating data. Issuers in the
  equity market are already disclosing information
  online and investors are going to expect the same
  electronic access to information from the
  fixed-income market. If you don't have that
  information available, you're going to fall
  behind those who do."

Martha Mahan Haines, Chief, SEC Office of
Municipal Securities
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Obligated Group Financing Structures are Common

• Govt agency (issuer) issues bonds and loans
  the proceeds to NFP HCO
• NFP HCO responsible for repayment (obligor)
• Obligation usually secured by security interest
  in gross receipts of HCO/ obligated group and by
  a mortgage
• May be accompanied by credit enhancements
• Reserve fund created to pay a portion of the debt
  service, if necessary

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Obligated Group Model
Created by a Master Trust Indenture

• Members of the obligated group denoted by blue
  shading
• Obligated group members have joint and several
  liability
• Debt covenants imposed

• Typically excludes
• Leased/managed facilities
• Non-healthcare ventures
• For-profit subsidiaries
• Money-losing operations (e.g., physician
  practices)

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Corporate style Unsecured GO Pledge Model

• Involves a promise to pay by a corporate parent
  with no underlying revenue pledge or mortgage
  from individual facilities/operating units
• Frequently used in corporate debt market gaining
  acceptance in healthcare debt market
• Bulk of revenue-producing assets not directly
  obligated on the debt

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Analysts ConcernOff-balance sheet financing

• Nonprofit HCOs increasingly using off-balance
  sheet arrangements to finance certain assets,
  such as
• Sale/leasebacks
• REIT financings
• Operating leases/guarantees
• Contribution agreements to finance jointly-owned
  assets with unrelated parties
• Joint ventures or partnerships