New financing programs especially geared to accounts receivable allow healthcare organizations to convert these assets into cash literally overnight and at costs below the prime interest rate. Certain pooled versions of the financing strategy include non-recourse features that guard against sharing bad debts among the participants. These pooled programs generally allow hospitals to continue managing and billing their own accounts.
For healthcare organizations under pressure to meet payroll, pay bills, or reduce debt, "selling" accounts receivable provides a new source for low-cost, readily available cash.
Asset-backed - or "securitized" - financing recently brought dramatic changes to the way financial institutions use assets (such as credit card receivables, automobile loans, and home equity loans) to reduce debt burdens and improve cash flow.
Now hospitals are following suit with similar results. By converting accounts receivable to cash or its equivalent, they can add muscle to financing day-to-day activities.
The method works like an internal bank and offers an alternate way of reaching traditional sources of capital, such as Wall Street firms, banks, leasing companies, and joint venture partners. The structure also resembles off-balance-sheet financing by removing receivables from the books and selling them on a non-recourse basis for their fair market value.
Source of working capital
Accelerating cash flow has become necessary for hospitals hardest hit by changes in Medicare's periodic interim payment (PIP) program. Previously, the program sent payments to hospitals twice each month, with a final adjustment made at the year's end. To better manage the Federal cash flow, the Health Care Financing Administration (HCFA) has instructed fiscal intermediaries to slow the payment of claims.
Third-party payers, in turn, slowed their payment cycles by using intense retroactive reviews of medical records, among other means. Modified payment methods by health maintenance organizations and preferred provider organizations have brought additional cash flow delays.
One of the most important benefits of selling receivables is that it permits hospitals to build working capital at a time when new sources of funds are limited at best.
Pressure to reduce the national deficit, for instance, could compel the Federal government to take steps toward limiting the use of hospital revenue bonds as tax-exempt investment vehicles. As a result, traditional financing through hospital revenue bonds could be modified to resemble that of Industrial Development Agency revenue bonds.
By selling receivables, hospitals gain welcome flexibility in managing their obligations. The method improves liquidity and cash flow through reduced days outstanding in receivables. Proceeds enable hospitals to retire some debts, thus holding down debt-to-equity ratios and enhancing borrowing power in the marketplace.
Because the method can reduce short-term debt through borrowing at lower interest rates over longer periods of time, it also helps maintain favorable credit ratings. This increases the likelihood of future transactions and enhances debt service coverage ratios.
While most hospitals borrow funds at or above the prime interest rate, selling accounts receivable allows them to reach capital markets at costs below the prime rate.
These savings and improved flexibility give hospitals the ability to pay vendors more quickly, creating an opportunity to negotiate better contracts and prices.
Receivables financing also allows hospitals to use new-found liquid assets to increase yields. For example, assets can be used as a more effective way of funding depreciation costs by investing receivable proceeds for longer than normal periods and at higher rates. If the maturity date on the investment is placed further out, yields are greater than under traditional terms.
By keeping internal banking transactions at arm's length, hospitals can use those funds to make loans to for-profit subsidiaries or joint venture partnership at market or below-market rates, without threatening their tax-exempt status.
A new concept
The concept of financing accounts receivable is relatively new for hospitals. Only recently has a variety of financing programs become available, most of them currently sponsored by banks, financial groups, and through group pooling arrangements.
Traditionally, hospitals had access only to factoring programs, a process that involved pledging their accounts receivable as collateral in exchange for cash. Exercising this option also depended on the hospital's creditworthiness. Covenants of hospital bond issues, however, often prohibited them from pledging those assets and using factoring as a source of capital.
On the other hand, accounts receivable financing, if done on a non-recourse basis, involves the actual sale of these assets in keeping with terms of the Financial Accounting Standards Board Statement 77, which views the transactions as true sales. Now, most hospitals can take advantage of the method without violating the terms of their bond covenants.
Banks have been the traditional source for both accounts receivable financing and factoring programs. Some have provided the service since the early 1960s.
Some banks have only felt safe financing hard-asset receivables and have refused to finance service receivables. Their reluctance is based on the fear that if the customer defaults on the loan, they will be left with nothing as collateral.
In many instances, the banks have financed the amount of the receivables, then assumed responsibility for collecting the accounts. Some have required accounts to be paid in monthly installments with pre-established interest rates, comparable to retail installment rate contracts.
Banks and other lenders use a variety of factors, some of them quite strict, to assess a client's suitability for their receivables financing programs. The criteria may include the size of the company, its credit rating, its total assets (minimum levels of working capital may be required), and the amount of the receivables. Lenders also may require a minimum amount to be financed.
Financial institutions only recently began to target hospitals as clients for receivables financing programs. Plans coming onto the market are geared specifically to hospitals, some with particularly attractive benefits.
One creative financing technique allows hospitals to sell their receivables overnight for cash and without recourse. This represents a major departure from the traditional factoring approach in which a hospital uses its receivables as collateral to obtain a bank loan for working capital and is responsible for repaying principal and interest.
The new non-recourse technique uses receivables to obtain cash by selling short-term commercial paper in the marketplace. By selling directly to investors, issuers of commercial paper eliminate the need to use a bank as an intermediary and can achieve significant savings over traditional financing mechanisms.
Investors like commercial paper programs because they are short term, maturing up to a maximum of 270 days, and are considered highly liquid. Issuers also are virtually assured of available funds, provided they maintain good credit ratings.
The first commercial paper program for financing healthcare receivables was introduced late in 1988 on behalf of a chain of psychiatric facilities.
The pooled approach
Commercial paper programs, which start with anywhere from $50 million to $100 million in assets, generally are not feasible for a single hospital. As a result, the newest programs are focusing on a pooled approach to share upfront and ongoing costs and achieve economies of scale.
These programs pool the value of the hospital's receivables, without combining their individual portfolios. Many hospitals may find pooled approaches, which retain their right to manage and bill their own accounts, the most advantageous.
Pooled approaches also give individual hospitals access to capital regardless of their own credit ratings. Traditional financing vehicles examine a hospital's creditworthiness, viewing accounts receivable financing as debt financing.
Rather than assessing the hospital's creditworthiness, pooling determines the payer's ability to pay and examines the mix of the hospital's portfolio and its collection experience.
Some accounts receivable programs are recourse in nature, meaning the hospital is contingently liable for accounts on which the purchaser cannot collect. This liability is disclosed on the hospital's financial statements.
For many hospitals, programs that include a "no-recourse" feature under which bad debt cannot be returned to them are more attractive.
The programs avoid recourse by establishing reserve funds that are determined by a participating hospital's payer mix, bad debt, and collection experience. In a non-recourse program, the credit enhancer and, ultimately, the commercial paper investor are potentially at risk if bad debts on the receivables are much higher than funds placed in the reserve accounts.
Pooled programs can pose risks to participating hospitals. While a hospital's individual portfolio is maintained separately, some assets may be commingled in reserve accounts. Hospitals looking at pooled programs should assess their risk for other participant's bad debts or collection problems. This risk, however, would never exceed a particular hospital's contribution to the program's reserves.
Hospitals not willing to assume risk should look for pooled programs that do not commingle assets or hold an individual institution responsible for another's bad debt or failure to collect on accounts due.
Collection control
Some receivables programs, particularly traditional ones, shift the burden of collecting accounts away from the hospital. In that case, the bank or financial institution literally takes control of a hospital's business office, from billing and collection to, conceivably, handling the pre-admission process and medical records.
Some of the newer programs, however, encourage the hospital to manage its own accounts, presumably because it is in the best position to service and collect those accounts. After receivables are sold into the program, hospitals continue to bill and collect their accounts receivable in much the same manner.
Hospitals participating in these types of programs should be aware that their patient acounting systems must be able to identify receivables sold into the program because hospitals are required to remit cash received on those accounts back to the program. These receivables generally are flagged by using separate financial classes.
Programs that allow hospitals to maintain control of billing and collecting their accounts have built-in safeguards against failure to do so adequately. Some permit consultants to enter the hospital to improve billing and collection procedures. In the case of hospital failure, a third party will take over the management of the hospital's billing and collection operations.
Well-structured financing programs give hospitals incentives for succeeding at collection. If a hospital's collection experience is better than expected, for example, it may receive a refund from surplus funds available in the reserves. If the hospital fails to perform up to expectations, however, its discount rate may be adjusted to reflect a greater number of charge-offs.
Another twist on receivables financing vehicles is the inclusion of all payers. Until recently, programs assumed only third-party insurance assignables: those certain to be collected. Now, programs have received Federal or state approval for collecting all receivables, including Medicare and Medicaid.
Commercial paper programs
In a typical commercial paper program, the hospital selects an accounts receivable portfolio to be sold, such as Medicare, Medicaid, or commercial insurance. Receivables are sold into the program at a discount, after subtracting contractual fees. The discount often pays for the cost of the program and reflects the collection experience of the individual hospital. The discount rate is determined on a hospital-specific basis and considers historical payer mix, bad debt experience, a factor for creating reserve funds, ongoing program costs, and the interest cost of the commercial paper.
To fund the purchase, commercial paper is issued, and the proceeds are sent to the hospital. The hospital receives the cash, minus financing costs, overnight. It continues to bill and collect on accounts sold, as well as sell additional receivables into the program.
Participating hospitals usually are required to prepare a summary report on receivables sold into the program and the status of collections against those receivables.
Hospitals have unrestricted use of the proceeds as long as the purposes are lawful, such as making up cash shortfalls in operations, replacing existing prime-plus borrowing, creating an interim or bridge financing mechanism, or funding capital equipment purchases.
Restrictions may be placed on the time frame during which hospitals remit cash collected on accounts sold to the financing entity. That cash is subsequently used to retire commercial paper, purchase new accounts receivable, fund hospital reserves, or make up shortfalls.
The method presumes that the hospital will continue to sell receivables into the program after the initial sale.
Maturing commercial paper may either be rolled over or retired, and new commercial paper can be issued as receivable balances rise.
Hospitals subsequently can subtract the amount of receivables sold, along with related provisions for bad debts and contractual allowances, from their books. Cash balances on the balance sheet increase by the net proceeds received.
Other risks to consider
Beyond those already spelled out, receivables financing programs present hazards in pioneering a new, wholly unproven, financing mechanism. Before making a commitment to any program, hospitals should insist on provisions enabling them to opt out if they choose to do so.
In addition, some receivables financing vehicles are tax exempt (those started before tax reform in 1986), but the majority are taxable. Taxable programs may be more costly in early stages. Ultimately, however, analysis may show them to be the most cost effective.
Hospitals seeking to participate in any financing program also may be required to meet minimum levels of participation in receivables to be financed.
Obviously hospitals are at risk if their receivables are determined to have been fraudulently sold into a program or if the receivables were misrepresented. In that event, the receivables will be declared not legally sold and will be returned to the hospital. Under those circumstances, funds paid to the hospital for those receivables would have to be returned.
Accounts receivable financing programs usually require periodic audits of individual program participants to review bad debt experience and ensure continued ability to bill and collect the accounts sold.
When shopping for the best receivables financing program, hospitals should look for those that do not prohibit or limit participation by an institution with any receivables for which periodic interim payments continue to be made.
Mel Spiegel is vice president, finance, at Premier Hospital Alliance, a voluntary association of 42 teaching hospitals and systems based in Westchester, Ill. He is an advanced member of HFMA's First Illinois Chapter.
Source: FindArticles.com
