As complexity grows in health care, board responsibilities become more challenging
Enron. WorldCom. HealthSouth. Tyco. The names are synonymous with financial disaster. In the aftermath of these scandals, Congress passed the Sarbanes-Oxley Act to put tough new accountability measures in place at publicly traded companies. There’s been a ripple effect to the not-for-profit sector. Boards of trustees are taking a closer look at nearly every aspect of an organization’s operations. Trustees don’t want to be caught flat-footed. After all, they are ultimately responsible for the organization’s performance.
For hospital boards, zealous oversight means taking a hard look at plans for not only accessing, but also spending capital. Hospitals are seemingly in a continuous spend mode: aging facilities need upgrades, if not a total razing and rebuilding; costly information technology is needed to meet patient safety and quality trends; competition demands that the latest and greatest medical devices be bought to keep up with the facility down the street; providing care for a rising uninsured and underinsured population puts added stress on the balance sheet.
The board has to ensure that capital is not just spent wisely, but that spending fulfills the organization’s vision and mission. That’s no small task and it’s becoming even more challenging as credit rating agencies and others increase scrutiny of the board’s role in capital planning and spending.
“Creditors are looking to see if the board is involved and cognizant of capital issues and fund raising. They want to make sure the board members are engaged in the capital planning process, that they challenge it and ultimately own it,” says James Orlikoff, president of Orlikoff & Associates, a Chicago-based consulting firm that specializes in health care governance.
The level of board involvement varies greatly, and is often determined by the scope of the project. The bigger the project, the greater the need for the board’s involvement. “It’s more of an oversight responsibility, rather than a detailed role,” says Jeffrey Alexander, Richard Carl Jelinek professor of health management and policy at the University of Michigan. Board members should ask whether the capital project is consistent with the organization’s long-term goals and whether taking on additional debt would place the organization at risk, he says. Boards should stay at that high level though, rather than get involved in the nitty-gritty. “They don’t have the time or the expertise,” he adds.
With proper board oversight, hospitals will be in a stronger position to access capital at the lowest possible cost.
“The ability to fund the future is absolutely critical,” says Orlikoff. “Even if the organization is not participating in the capital markets now, the board needs a certain level of understanding of the issues.”
Capital financing primer
At most hospitals, board members will have varying degrees of understanding of the capital markets. As a result, establishing an effective education program takes on greater importance. Board members with knowledge of capital financing should assist in developing an education program that helps others participate in a meaningful way. “The whole board—not just the financing committee—needs a basic level of financial literacy,” says James Orlikoff, president of Orlikoff & Associates, Chicago. This primer outlines key issues that boards should know about capital financing, including some of the types of capital available and how ratings impact the ability to access that capital.
Capital Leases
Capital leases help hospitals obtain expensive medical equipment and technology without having to fund the full cost of purchase. Leases provide a level of flexibility to hospitals, allowing them to adjust to rapid changes in health care technology.
Direct Loans
Hospitals have numerous capital financing options from banks and other financial institutions, such as mortgage loans and other financial products.
Philanthropy
As capital becomes more difficult and costly to access, hospitals are ratcheting up philanthropic efforts to fund capital projects such as building new facilities and expansion projects. According to the Association for Healthcare Philanthropy, donations to U.S. health care facilities and organizations totaled $7 billion, a 16 percent increase from fiscal 2004 to fiscal 2005.
Tax-Exempt Bonds
Tax-exempt bonds, generally issued through state governments and municipalities, provide nonprofit hospitals long-term financing via the capital markets. Interest rates are typically lower than taxable debt.
Taxable Bonds
Nonprofit hospitals use taxable bonds for projects that do not qualify for tax-exempt financing. Interest paid to investors in taxable bonds are generally not as favorable as tax-exempt bonds. Taxable bonds are subject to taxes at the local, state and federal level.
Sale of Assets
The sale of noncore assets, such as medical office buildings, can provide a significant, one-time source of capital. Financially struggling hospitals may consider selling the hospital itself to another hospital or a system. However, this may result in a change in the hospital’s nonprofit status. One option for hospitals is to sell property to real estate investment trusts and lease back the property. Hospitals receive an influx of capital from the sale and remove the facility from its balance sheet, but are obligated to lease payments.
Board composition
Rating agencies are taking a closer look at board composition to ensure that it has the correct knowledge-base to help the organization achieve its mission. Collectively, the board should represent relevant stakeholders, such as physicians, nurses and the community. And board members should have different skill sets. “We look to see the involvement of groups that are perceived as critical to the hospital’s success,” says John Wells of Fitch Ratings. “The board has to include representatives of the medical staff and the community. It’s their interest at stake.”
While there’s no formula to determine the appropriate size and composition of the board, board membership should reflect the best interest of the organization. Membership should not be offered as an incentive or reward. The board should include one or two members who have a strong financial background and knowledge of the capital markets, if possible. Board size should be determined based upon the expertise and skills that would be useful to the organization, the anticipated workload for each board member, and what issues the board needs to address. Other factors include the ability and willingness of an individual to participate. “Placing someone on the board because they reflect a market the organization wants to embrace is not sufficient for the provision of good governance. It’s simplistic thinking,” says Jeffrey Alexander, Richard Carl Jelinek professor of health management and policy at the University of Michigan.
Hospital board size (number of members)
| 1 to 5 members |
11%
|
| 6 to 10 members |
31%
|
| 11 to 15 members |
33%
|
| 16 to 20 members |
14%
|
| 21 or more |
11%
|
Source: Hospital Governance: Initial Summary Report of 2005 Survey of CEOs
and Board Chairs, Health Research & Educational Trust
Board meeting frequency (number per year)
| 1 to 5 meetings |
11%
|
| 6 to 7 meetings |
14%
|
| 8 to 11 meetings |
27%
|
| 12 meetings |
42%
|
| More than 12 meetings |
6%
|
Source: Hospital Governance: Initial Summary Report of 2005 Survey of CEOs
and Board Chairs, Health Research & Educational Trust
Top 10 skill sets for new board members
In reviewing potential board members, CEOs and board chairs put the most emphasis on finding people whose values are “consistent” with the board’s. Here are the top 10 skill sets they are looking for:
|
CEO criteria
|
Board member criteria
|
|||
| Financial/business acumen |
56%
|
63%
|
Financial/business acumen | |
| Strategic planning/visioning |
36%
|
49%
|
Strategic planning/visioning | |
| PR skills |
21%
|
33%
|
PR skills | |
| Educational background |
21%
|
31%
|
Educational background | |
| Previous board experience |
21%
|
26%
|
Previous board experience | |
| Clinical practice |
13%
|
26%
|
Quality management | |
| Quality management |
12%
|
19%
|
Safety/quality experience | |
| Safety/quality experience |
11%
|
15%
|
Fund-raising ability | |
| Fund-raising ability |
11%
|
13%
|
Clinical practice | |
| Conflict management skills |
6%
|
11%
|
Conflict management skills | |
Source: Hospital Governance: Initial Summary Report of 2005 Survey of CEOs and Board Chair, Health Research & Educational Trust
What rating agencies want to know about board involvement
Rating agencies are taking a closer look at the board’s involvement in the organization’s capital, financial and strategic planning. “Financial performance is a direct product of a hospital’s governance and management,” says John Wells of Fitch Ratings. “As a result, an evaluation of the effectiveness of the board is key to our process.” Adds Martin Arrick of Standard & Poor’s, “We want to see broader involvement from the board. We want to see the board focus on the future.”
Wells says the rating agency is able to glean the level of board involvement during site visits and conference calls. Hospitals have to use these opportunities to reveal the board’s knowledge and understanding of the organization’s mission and strategic direction and how access to capital will help the organization achieve its long-term goals. Still, there aren’t any hard metrics or benchmarks to compare one hospital against another. “When we do interviews with the credit agencies, we are confident the board’s involvement will come across,” says Rob Lake, CEO of Great Plains Regional Medical Center, Elk City, Okla. “It’s easy to sense when there’s tension in the room. Our board is very comfortable and knowledgeable.”
Here’s what officials at rating agencies say they are looking for in terms of board involvement:
Sources: Fitch Ratings, Moody’s Investors Service, and Standard & Poor’s, 2007
Health care sector outlook
The nonprofit health care sector has done relatively well over the past few years, showing solid improvements in financial and operating performance. Rating agencies expect that to continue for the short term. “The outlook is good through the 2008 election,” says John Wells of Fitch Ratings. “Expenses are increasing, but revenue has continued to offset that growth.” A number of factors, including physician competition, slow growth in volume, and increasing bad debt, continue to place pressure on hospitals. “It’s a complicated time for the sector,” says Standard & Poor’s Martin Arrick. “But, overall, the sector will continue to do well.” Here’s a look at some key indicators for the health care industry:
Acute care hospital and health system rating actions
Source: Public Finance, Standard & Poor’s, 2007
2006 ratings distribution (as of July 28, 2006)
Source: 2006 Median Ratios for Nonprofit Hospitals and Health Care Systems, Fitch Ratings
Acute care hospital and health system rating actions
Source: Not-for-Profit Healthcare Sector: 2007 Industry Outlook, Moody’s Investor Service
Sarbanes-Oxley
Although the Sarbanes-Oxley Act, signed into law in 2002, addresses oversight of publicly traded companies, key provisions are being adopted by nonprofit hospitals to strengthen accountability and financial reporting. “More hospitals are forming audit committees, in addition to finance committees, because of Sarbanes-Oxley,” says Errol Biggs of the University of Colorado at Denver. John Wells of Fitch Ratings says the agency looks at what provisions of Sarbanes-Oxley the hospital has adopted. The agency believes that better financial reporting should lead to better financial decision-making. And adoption of provisions related to the audit process, the certification of financial statements and evaluation of internal controls will improve the organization’s accountability and the credibility of financial reporting.
The questions that Fitch asks the board in relation to Sarbanes-Oxley include:
Source: Sarbanes-Oxley and Not-For-Profit Hospitals, Fitch Ratings, 2005
Resources
Bond ratings
What’s their impact on capital access
Bond rating services are provided by Fitch Ratings, Moody’s Investors Service and Standard & Poor’s. The ratings rank the likelihood of an organization to default, providing investors a sense of the risk associated with investing with the organization. Credit ratings impact an organizations ability to access capital. Hospitals and health systems with high ratings will have broad access to low-cost capital. Hospitals with moderate ratings will have more limited access to capital at a higher cost. And hospitals with low credit ratings will have a difficult, if not impossible, time accessing the capital market.
A number of factors play into an organization’s creditworthiness, including financial performance. The rating agencies are beginning to take a closer look at the organization’s quality performance in light of growing consumerism, government oversight and pay-for-performance initiatives.
Case studies
LifeBridge Health, Baltimore
A two-hospital system with a comprehensive geriatric center and skilled-nursing facility, LifeBridges spends the majority of it’s capital, about $100 million per year, on construction, equipment, information technology and infrastructure. “Every year, in June, we present the health system board with the updated financials and budget,” says Chuck Orlando, senior vice president and chief financial officer. The board reviews the organization’s capital spending plan, capital structure, liquidity target and major projects, among other things. “They are looking to see whether the capital plan is consistent with our strategic plan,” Orlando says. The health system sought credit ratings for the first time in 2004. “Since that time, the board has become more involved and is paying closer attention to capital planning,” Orlando adds.
Great Plains Regional Medical Center, Elk City, Okla.
In the midst of a replacement project, the 66-bed hospital employs 40 physicians in a facility that’s designed for only six or eight. “We have financially astute board members that have been involved in all of the critical decisions,” says CEO Rob Lake. One member, in particular, had experience with bond issues and helped educate the board and executive team on the process. “The rating agencies want to make sure the medical staff, the board and the community are involved in the process,” Lake says. “It’s important that we’re singing from the same hymnal.” Lake says good relations with the board has helped facilitate the process. “We know what we can decide for ourselves and when we need to run something by the board,” he says. “They provide a great deal of expertise, but they aren’t constantly looking over our shoulder. The board sets the strategy. It’s up to me to meet the objectives.”
How We Did It: This gatefold was compiled through interviews with industry experts and through a review of industry and rating agency reports.
Research I Lee Ann Runy I lruny@healthforum.com
Design I Chuck Lazar I clazar@healthforum.com
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