Hospital Reserves

8/9/2019 Hospital Reserves

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Study of the Reserves, Endowments,and

Surpluses of Hospitals inMassachusetts

Deval L. Patrick, Governor

Commonwealth of Massachusetts

Timothy P. Murray

Lieutenant Governor

JudyAnn Bigby, Secretary

Executive Office of Health and Human Services

David Morales, Commissioner

Division of Health Care Finance and Policy


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Table of Contents

Executive Summary

. Introduction

II. Study Methodology

III. Definition of Hospital Surplus

IV. Why Hospitals Need to Accumulate Financial Resources

V. Massachusetts Hospital Market Overview

VI. Financial Status of Massachusetts Hospitals

VII. Hospital Systems

VIII. Comparison of Hospital Financial Regulation to Other States

Hospital Community Benefits

Recommendations

Appendix 1: Glossary of Terms

Appendix 2: Public Input Session

Appendix 3: Hospital Subgroup Classifications

Appendix 4: Hospital Financial Data

Appendix 5: Hospital System Maps

Appendix 6: System Structure Examples

Acknowledgements


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Executive Summary

Section 35 of Chapter 305 of the Acts of 2008,An Act to Promote CostContainment, Transparency, and Efficiency in the Delivery of Quality HealthCare, requires that the Division of Health Care Finance and Policy (DHCFP), inconjunction with the Division of Insurance (DOI), conduct a study of thereserves, endowments, and surpluses of health insurers and hospitals. Perstatute, the goal of the study is to provide information to assist both DHCFPand DOI with the examination of options and alternatives available to theCommonwealth to provide regulation, oversight and disposition of thereserves, endowments and surpluses of health insurers and hospitals.

DHCFP selected the firm Hinckley, Allen & Tringale to perform analyses andprepare draft reports to assist the agency in responding to the requirementsof Section 35. This report examines the reserves, endowments, and

surpluses of hospitals. Analysis and review of the reserves and surpluses ofhealth insurers is provided in a separate report, which is available atwww.mass.gov/dhcfp.

Definition of Hospital Surplus

While relatively clear standards for insurer surplus have been developed, it ismore complicated to analyze hospital surplus for several reasons, whichinclude, but are not limited to, the following:

Definitional: The terms surplus and reserves do not have entirelyclear meanings in the context of hospitals. Surplus could refer tooperating or total profits, accumulated profits, the difference betweentotal assets and total liabilities, the amount of unrestricted net assets,or accumulated cash and marketable securities in excess of workingcapital needs. Hospitals do not generally designate assets asreserves except for certain liquid assets set aside to meet debtservice requirements.

Regulatory environment: While hospitals are required to reportfinancial information to state regulatory agencies, there are nostandards, federal or state, for hospitals regarding necessary orappropriate levels of surplus.

Complexity: Hospitals need financial resources for a larger variety ofpurposes than insurers, whose major need for accumulated financialresources is solvency protection in the event of unanticipated medicalclaims payments or investment losses.

Diversity of hospitals: The sixty-six acute care hospitals inMassachusetts are a varied group across multiple dimensions, such assize, range of services, teaching status, payer mix, geographic
http://www.mass.gov/dhcfphttp://www.mass.gov/dhcfp


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location, and market dominance. Such factors make it more difficult todefine and measure surplus across hospitals. In contrast, for insurancecompanies, the primary financial requirement beyond meetingoperating expenses is setting aside sufficient reserves to meet orexceed specific regulatory requirements addressing the level of

insurance risk undertaken by the insurer. Organizational structure: More than half of the Commonwealths sixty-

six acute care hospitals are part of larger health systems. Any detailedassessment of the financial resources of these hospitals must considerthe resources and obligations of the larger parent system. However,such analysis would be extensive and uniform systems data is notmaintained or analyzed in any one state agency at this time.

Restrictions on use of assets: Some hospital assets may not beavailable to hospital management or boards to use at their discretionbecause of restrictions imposed by donors, or by contractualobligations (such as those imposed by bondholders or those necessary

for self insurance requirements). Some restrictions are permanent andcan be changed only by the donor or through a formal processinvolving the Office of the Attorney General. Other limits on the use ofassets may be changed with the consent of the Board of Directors.

Form of assets: Many hospital assets are in the form of physical plantand equipment, which can not be easily disposed of or liquidated.

In this report, DHCFP examines the financial resources of hospitals andassesses whether any hospitals may have considerable accumulatedfinancial resources. (This approach is analogous to the analysis performedby DHCFP for health plans, which examined health insurer reserves in the

context of various commonly accepted measures of financial performanceand financial solvency.) This analysis is intended to provide a baselinereview of hospital financial resources and to provide contextual financialinformation on hospitals related systems. For the purposes of this report,DHCFP did not examine specific spending strategies by hospital or allocationof resources among system entities.

Why Hospitals Need to Accumulate Financial Resources

Hospitals cannot remain financially viable without earning and maintainingadequate financial resources. Hospitals need to accumulate some level of

financial resources in order to maintain operations, withstand unanticipatedfinancial events, and make investments in new services, infrastructure, andtechnology that are necessary to provide high-quality patient care andcompete effectively. Significant changes in the external environment canalso require hospitals to maintain reserves or make new investments. Forexample, the recent passage of federal health reform is an external changewhich may require some hospitals to accumulate more financial resourcesfor specific uses, such as investments in information technology, or


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experience significant decreases in reimbursement given anticipatedchanges to Medicare payments.

However, the ongoing accumulation of financial resources may lead to higherthan necessary prices and higher than necessary health care costs. Thus, a

careful balance must be struck between adequate and excess accumulatedfinancial resources for hospitals. In addition, most hospitals in Massachusettsare organized as non-profit organizations and public charities. Theseaffiliations render a number of special benefits, including exemption frommost taxes, and impose special obligations to operate solely for thepromotion of health and to engage in community benefit programs. As such,there is an opportunity cost in hospitals accumulating financial resources atthe expense of utilizing these resources for other important purposes.

Study Methodology

This report utilized a three-pronged study methodology, consisting of: A literature review of hospital financial indicators; Collection and analysis of financial information for Massachusetts acute

care hospitals from 2003 to 2008; and A review of laws, regulations, and regulatory practices in

Massachusetts and five peer states1 impacting hospital surplus.

Initially, a literature review was conducted to assist with defining hospitalsurplus, interpreting financial ratios, and understanding the various financialratios considered when determining if a hospital is in sound financialcondition. In its report to Congress in June 2004, the Medicare Payment

Advisory Commission (MedPAC) proposed a set of financial ratios comparableacross all hospitals that would accurately portray a hospitals financialsoundness. The report did not identify a single line item in a financialstatement that would serve as an appropriate indicator of financialsoundness. Rather, MedPAC suggested that by examining a broad set offinancial measures over several years, analysts could gain a more completepicture of providers financial performance.2 Such measures include totalprofit margin, cash flow generated from operations, changes in net assets,and level of cash and other liquid assets.3 The MedPAC report did not, andwas not intended to, develop indicators for policymakers to makedeterminations on the adequacy or reasonableness of accumulated surplus

levels.

For the purpose of this report, a methodology similar to the one proposed byMedPAC was adopted in order to accurately portray hospital financial

1 Connecticut, Maryland, New York, Pennsylvania, and Rhode Island2 MedPAC, Report to the Congress, Sources of Financial Data on Medicare Providers, June,2004, Executive Summary.3 Ibid.


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performance over time. The study also examines payer mix and utilizationfor each hospital to facilitate a more complete understanding of theirfinancial condition. Such an approach allows for the identification ofhospitals in the Commonwealth that may have the greatest amount ofaccumulated financial resources.

Massachusetts collects and maintains standardized hospital financial datawith the Division of Health Care Finance and Policy. Hospital 403 cost reports(DHCFP-403) were utilized for payer mix data and utilization statistics. The403 data has been used by DHCFP and its predecessor to collect hospitaldata for more than twenty years, and as such is the best source ofcomparative data available. Data was analyzed from 2003, 2004, 2005,2006, 2007, and 2008 filings. Since the 2009 DHCFP-403 hospital financialdataset has recently become available, the tables in this report have beenupdated, where possible, to include this information. However, the writtenanalysis does not reflect information filed for 2009.

Other financial data used in this report was based upon annual financialsubmissions provided to DHCFP by hospitals. In the case of the hospitalsystems, consolidated financial statements were utilized for analysis. IRSForm 990s4 were also reviewed for a number of institutions, as well as PublicCharities filings obtained from the Massachusetts Office of the AttorneyGeneral website.

Lastly, several peer states were surveyed in comparison to Massachusetts toassess prior efforts and current practices regarding hospital surplus.Connecticut, Maryland, New York, Pennsylvania, and Rhode Island were

selected for comparison due to their large number of non-profit and teachinghospitals.

Factors to Consider In Identifying Hospital Accumulated FinancialResources

In determining whether a particular hospital potentially has considerableaccumulated financial resources, the following should be taken intoconsideration:

Financial Performance Indicators

Profitability -This includes operating margin (the excess of revenuesover expenses for patient care and patient care related activities), andtotal margin (the excess of revenues over expenses, including non-operating revenues such as research grants and donations and non-operating expenses).

Liquidity -This includes days of cash on hand and other measures ofthe ability of a hospital to pay current liabilities with current assets.

4 An IRS form required of non-profit organizations.


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Solvency -This includes both the amount of existing debt financing, asmeasured by equity financing or long-term debt to equity ratios andthe ability to cover current debt obligations with current operating andnon-operating activity, as measured by the debt service coverageratio.

Other Measures The total amount of unrestricted net assets -These are assets of the

hospital that are not needed to meet obligations or restricted forspecific purposes.

The mix of restricted net assets and Board-designated assets - It iscritical to distinguish between those assets which are permanentlyrestricted because of legal conditions imposed by donors and thosethat are limited by Board decision, which can be altered.

Amount and volatility of investment income - A number of hospitalshave large investments that generate interest income. When

investment income becomes central to a hospitals meeting itsprofitability goals, the hospital may be subject to financial risk ifinterest income falls short of expectations.5

Age of plant - Hospitals with younger buildings potentially have lessneed to make new investments and may require lower levels offinancial resources.

The size of the hospital - Smaller facilities may potentially be less ableto withstand financial fluctuations and therefore have a greater needfor reserves.

Payer mix - Hospitals that are more reliant on public payers may needto maintain more reserves because public payers are less likely to

cover the full cost of services provided. Trends in utilization - Utilization of services is the major source of

hospital operating revenues. Rising utilization may be absorbed byexisting capacity or require increased capacity. Declining utilizationcan increase unit costs if fixed costs cannot be reduced at acomparable rate.

Restrictions imposed by outside parties, including bond holders -Hospitals are generally required by lenders to maintain certainfinancial ratios. Bond markets also require a hospital to meet certainratios in order to qualify for preferred bond rates.

Organizational structure - For institutions that are part of multi-hospital

systems, any assessment of the financial status of an individualhospital, and particularly an assessment of whether there areconsiderable financial resources, must consider the financialarrangements between the hospital and its parent system.

5 Given the recent economic downturn, there have been significant fluctuations in the valueof investment portfolios at most institutions.


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Specifically, the report selected eleven measures that when collectivelyevaluated could identify hospitals that may have considerable accumulatedfinancial resources:

A positive operating margin for at least three of the past four years A positive total margin for at least three of the past four years

Unrestricted net assets of more than $100 million for the past twoyears Net patient service revenues (NPSR)6 of more than $100 million for the

past two years No more than 15% of NPSR from non-managed Medicaid business No more than 50% of NPSR from Medicare and Medicaid business

combined More than $50 million in Board-designated assets More than $5 million gained or lost in investment income A plant that is younger than eight years old Debt service coverage of at least three for at least two of the past four

years More than 15 days of cash on hand for the past two years

Of these eleven, the first four measures were identified as critical indicatorsof long-term positive financial performance. The remaining seven measureswere regarded as supplemental considerations of positive financialperformance. Therefore, a hospital had to meet all of the first four criteria,not just a majority of the eleven measures. This approach to identifyinghospitals that may have considerable accumulated financial resources is notbased on any existing legal or regulatory standards but presented merely asone approach to evaluate these institutions.

Major Findings

Based on the financial performance of hospitals against the identified elevenparameters, there are ten hospitals in the state that may have considerableaccumulated financial resources through 2008 (see Section VI):

Berkshire Medical Center Beth Israel Deaconess Medical Center Brigham and Womens Hospital Childrens Hospital Boston Massachusetts General Hospital

Mount Auburn Hospital Northeast Hospital South Shore Hospital Sturdy Memorial Hospital Winchester Hospital

6 Net patient service revenue is the total amount received by the hospital for providingpatient care, taking into account actual rates of payment and unreimbursed bad debt andfree care.


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Hospitals whose performance may indicate considerable accumulatedfinancial resources despite over 15% NPSR from Medicaid or over 50% NPSRfrom Medicaid and Medicare through 2008 (see Section VI):

Baystate Medical Center

Boston Medical Center Lahey Clinic Southcoast Hospitals Group University of Massachusetts Memorial Medical Center

The financial performance of Massachusetts hospitals varies widely.7 The topquartile of hospitals had strong performance on both an operating and totalmargin basis from 2003-2008, while the bottom quartile of hospitals hadnegative performance during almost all of this period. Some hospitals hadconsistently strong financial performance; thirty-two of the sixty-six hospitalsin the state had positive financial margins in each of the last four years.

Only a handful of hospitals had consistently negative financial results, butsome hospitals have had financial results that are consistently weakcompared to median hospital performance. In addition, the financialperformance at some hospitals has been volatile, with significant variationsin financial performance over the four-year-period examined in the report.

Median hospital margins in Massachusetts have historically been lower thanthose in the U.S. but similar to those in the northeast, on both an operatingand total margin basis.8 Massachusetts hospitals have a history of lowertotal margins than hospitals nationwide but similar performance to otherhospitals in the northeast. The trend in financial performance is similar for

Massachusetts hospitals and those in the northeast and nationwide. Forexample, total and operating margins, on average, declined significantly in2008.

Some hospital characteristics are generally associated with better or worsefinancial performance.9 Although the performance of individual hospitalsvaries widely, certain factors appear to be associated with hospital financialperformance:

Teaching hospitals had far stronger financial performance than didnon-teaching hospitals. The medians of the operating and totalmargins of teaching hospitals were approximately 4% during the study

period, compared to less than 1% for non-teaching hospitals. Size of hospital was positively associated with strong financial results.10

7 See Appendix 4, Tables 1-3.8 See Section V, Figure A.9 See Section V, Figure C.10 This is explained by the higher margins of teaching hospitals, which are the largesthospitals.


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Hospitals that are part of multi-hospital systems had somewhatstronger financial performance than did hospitals that are not part oflarger systems.

Disproportionate share hospitals11 (DSH) had worse financialperformance than non-DSH hospitals.

As a group, the four hospitals that are for-profit entities12

had weakerfinancial performance than the median results for the not-for-profithospitals.

The four specialty hospitals13 in the state, as a group, had weakerfinancial performance, but the actual financial status of two isconsiderably stronger, due to large foundations and/or endowments.

Some Massachusetts hospitals have very strong liquidity and solvencypositions, while others are much weaker. As noted above, understanding thefinancial status of an individual hospital requires a closer analysis and reviewof institutional decisions regarding cash management, transfers of money to

parent corporations, and other operations.

Restricted net assets of Massachusetts hospitals totaled $3.6 billion as offiscal year end 2008.14

The amount of accumulated financial resources--as measured by totalunrestricted net assets--varies widely among hospitals.15 The Massachusettshospitals with the greatest total unrestricted net assets in 2008 wereChildrens Hospital with $951 million and Massachusetts General Hospitalwith $710 million. The hospitals with the least were Caritas Carney Hospitalwith -$20 million and Merrimack Valley Hospital with -$8 million.16

Assets whose use was limited by Board decisions totaled $3.6 billion in 2008.From existing public filings, it is difficult to identify the purposes for whichBoard limitations have been imposed. Unlike assets whose use is restrictedby a donor, Board-designated assets could be released for general operatingpurposes by another Board vote. Some limitations may be less discretionarythan others (e.g., restrictions imposed on assets to meet bond covenants).Without knowing the intended reasons for, or intended uses of Board-designated assets, it is difficult to assess if these assets are necessary aspart of the hospitals essential mission.

11

The Division of Health Care Finance and Policy defines disproportionate share hospitals(DSH) as hospitals where 63% or more of gross patient service charges are from Medicare,Medicaid, other government payers, and Health Safety Net.12 The four for-profit hospitals are: Merrimack Valley Hospital, MetroWest Medical Center,Nashoba Valley Medical Center, and St. Vincent Hospital.13 The four specialty hospitals are: Childrens Hospital, Dana-Farber Cancer Center,Massachusetts Eye and Ear Infirmary, New England Baptist Hospital.14 See Appendix 4, Table 11b.15 See Appendix 4, Table 5.16 Negative assets can occur when total liabilities exceed total assets.


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As of fiscal year end 2008, twenty-four percent of hospitals have a significantlevel of permanently restricted assets.17 While thirty hospitals have morethan $10 million in total restricted assets, only sixteen hospitals have morethan $10 million in net assets that are permanently restricted. However,

these sixteen hospitals account for 89% of the permanently restricted netassets of all Massachusetts hospitals.

Most hospitals added net assets during the past five years, but had somedeterioration in 2008.18 The declines in 2008 were largely the result of poorinvestment performance, but were exacerbated at most hospitals bychanges in accounting requirements for retiree health and pension benefits,and changes in the valuation of malpractice reserves. Unrealizedgains/losses also affected financial performance in 2008. These unrealizedgains/losses are notational until the assets are sold.

In 2008, eleven hospitals experienced significant gains or losses oninvestments.19These hospitals either gained or lost $5 million or more oninvestments.This suggests that certain hospitals may be subject toconsiderable investment risk, which could require additional reporting tobetter understand how hospital portfolios are being managed.

A majority of hospitals are members of systems, making it difficult to assessthe actual level of available financial resources. Low performance on certainfinancial indicators may simply be a reflection of larger cash managementstrategies. Approximately 60% of the states hospitals are members ofmulti-hospital systems. These systems account for approximately 60% of

hospital beds, inpatient admissions and days, and 62% of net patient servicerevenues.20 In 2008, Massachusetts hospital systems total net assetsexceeded $17 billion dollars, $12.9 billion of which were unrestricted netassets.21

Other hospitals that are not members of a multi-institution system havefoundations, outpatient centers, or other affiliated organizations withsignificant financial resources that are reported separately from those of thehospital. These hospitals include Boston Medical Center, Childrens Hospitalof Boston, Dana Farber Cancer Institute, and Tufts Medical Center.

Major Findings of the Review of Hospital Community BenefitPrograms

17 See Appendix 4, Table 10.18 See Appendix 4, Table 6.19 See Appendix 4, Table 12.20 See Section VII, Figure N.21 See Section VII, Figure O.


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The Internal Revenue Service is increasing its review of hospital communitybenefit activities. Until recently, the Internal Revenue Service had fairlygeneral guidelines regarding the types of community benefit activities inwhich tax-exempt hospitals must engage beyond the provision of charitycare. However, since 2009, the IRS has required hospitals to provide much

more detailed information on community benefit programs, which shouldprovide a means of collecting comparable national data to assess whether ahospital is providing sufficient services to its community to warrant itsfederal tax exemption.

In the absence of specific federal guidelines, community benefitrequirements for hospitals differ from state to state. According to a 2008review by the Government Accountability Office, only fifteen states requirecommunity benefit programs. Of these, only five states specify a minimumcommunity benefit contribution level (see Section IX).

The Massachusetts Office of the Attorney General (AGO) has long establisheddetailed community benefit guidelines for hospitals. These guidelines haverecently been revised and strengthened. The AGO first issued communitybenefit guidelines in 1994, and they were then reviewed and updated in2000 and 2002. The AGO recently revised the guidelines, which went intoeffect October 1, 2009.

The Massachusetts community benefit guidelines are voluntary. Hospitalsare not required to comply with the AGO guidelines, although most hospitalssubmit an annual community benefit filing to the Office of the AttorneyGeneral. Massachusetts does not require specific programs but leaves it to

each hospital and its community to conduct a needs assessment todetermine appropriate programs.

The Massachusetts and federal standards differ in terms of what can beclassified as community benefits. Massachusetts permits community benefitexpenditures to include charity care, including a hospitals assessment to theHealth Safety Net (HSN) Trust Fund and the cost of claims billed to the HSNfor which payment has been denied. The state does not recognize bad debt,shortfalls from means-tested government programs like Medicaid, healthprofessions education, or research to be classified as community benefitactivities

A total of $454 million in community benefits was reported by Massachusettshospitals in 2008. This amount includes $149 million in charity care. Theamount of community benefits provided by individual hospitals ranged froma low of $55,000 to a high of $69.9 million.22

Recommendations22 See Appendix 4, Table 36.


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#1: Improve Data Collection and Reporting

The Division of Health Care Finance and Policy collects extremely detailedfinancial information from each hospital in the state and issues quarterly andannual reports which include a number of financial indicators. However, a

majority of Massachusetts hospitals are part of larger holding companies;and hospital holding companies are not required to report holding companylevel data to DHCFP. Thus the individual hospital data compiled by DHCFP isan incomplete picture of a hospitals broader financial situation. A review ofhospital holding company consolidated financial statements indicates that anassessment of holding company finances is necessary for a thoroughunderstanding of hospital finances. For example, while some hospitalsappear to be low on cash, a review of holding company finances can revealthat cash is maintained at the holding company level. The absence of thisinformation may lead to the inaccurate impression that a hospital may haveinadequate or adequate financial resources. Therefore, DHCFP recommends

that the agency be authorized by legislation to collect complete financialdata on individual hospitals and affiliated systems and to provide access tothis data to other government bodies and interested parties.

Transparency is a key regulatory goal. The ready availability of comparativeholding company financial data would greatly increase understanding andanalysis of hospital finances. While consolidated financial statements areavailable on the Attorney Generals website, they are not routinely analyzedand reported by DHCFP. The challenge facing state monitoring agencies isnot necessarily a lack of financial data, but rather a clear directive to oneagency to compile information from disparate sources and analyze the data

to produce useful information for policy makers and the public. This wouldrequire the following concrete steps:

a. All sources of financial disclosure by hospitals and hospitalsystem affiliates should be centrally located, in electronic form,within one agency in the state. Hospitals and hospital systems currentlyreport a variety of financial information to a range of state and quasi-publicstate agencies. Hospitals file quarterly and annual financial statements, andannual cost reports, with DHCFP while the Massachusetts Office of theAttorney General collects annual audited financial statements and annualreports for all non-profit hospitals and hospital systems. Hospital systems

report system-level financial data to a number of state and federalregulatory agencies including municipal repositories (per Securities andExchange regulations), and the Massachusetts Health and EducationalFinancing Authority. Often the system-level audited financial reports includesupplemental information that breaks out various sub-elements of thesystem; sometimes individual hospital performance is broken out, and othertimes it is combined with other sub-elements in the consolidatingsupplements. However, these filings lack uniformity as well as the specifics


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of intra-system cash flow. The SEC filings typically limit disclosure to onlythose entities obligated to repay bondholder debt, which can omit entitieswithin the system.

Today, this information must be compiled and collected from several

agencies in order to develop a consolidated picture of the financial conditionand status of hospitals and hospital systems. Centralized reporting andincreased transparency will lead to a better understanding of both overalland hospital-specific finances.

b. The state should build the analytic capacity to compile,standardize, analyze, and synthesize system financial performancefrom this central data repository. Line of business profitability, overallsystem indebtedness and capacity to repay, inter-affiliate transfers ofresources, system-wide cash, and investment reserves are all useful metricsof the financial health of a system with an embedded hospital. Certain non-

financial metrics routinely disclosed on bond prospectuses such as marketshare, utilization, background and turnover of Board and seniormanagement, payer mix, and profitability by major business lines could alsobe useful.

#2: Increased Oversight of Hospital Accumulated FinancialResources

While hospitals require accumulated financial resources in order toadequately protect patients and providers from unanticipated events and tofulfill their missions, ongoing accumulation of reserves without corresponding

increased value to consumers may lead to higher than necessary prices ofmedical services. Understanding that this is a delicate balance highlights theconcern when hospital resources fluctuate excessively or when regulatorsare unable to assess how hospitals use or dispose of their accumulatedresources.

a. The issue of accumulated financial resources should be furtherexamined to develop guidelines regarding the appropriate amountof accumulated financial resources for hospitals and hospitalsystems. There are currently no standardized methods or guidelinesregarding the appropriate level of hospital accumulated financial resources.

Standardized methods and guidelines are needed to identify when a facilityis under-resourced and may be in danger of failing, as well as when facilitiesare maintaining a considerable level of accumulated financial resources.Regulators have an interest in the solvency of hospitals and ensuring theyare well-capitalized to provide high quality care. However, there are costs toconsumers associated with hospitals accumulating resources in excess ofneed, particularly in Massachusetts where the majority of hospitals are non-profit public charities. The purpose of standard measurement techniques and


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guidelines would be to ensure that Massachusetts hospitals are appropriatelycapitalized, while not excessively accumulating reserves which may increasethe price of medical care.

b. The Commonwealth should require that hospitals report to DHCFP

on an annual basis the purposes and corresponding amounts forwhich Board-designated assets are being reserved. For the sixty-sixacute hospitals studied, over $3.6 billion dollars were labeled Board-designated assets in 2008. However, there is no centralized repository ofinformation delineating the purpose for which these funds have been setaside, making it a challenge to determine if the purposes for which therestrictions are imposed are necessary or discretionary. Bond-holdersfrequently require hospitals to maintain a certain level of available cash;however, the Commonwealth has no information about what proportion ofthe $3.6 billion in Board-designated assets is due to bond covenants. Moredetailed and transparent public reporting about Board-designated assets

would enable policymakers to determine how much of the assets reported asrestricted could actually be released for general operating purposes. Once acomplete picture of Board-designated funds is developed, theCommonwealth may then develop guidelines for reserving funds in thismanner. To the extent that fewer funds are limited in this way, medicalexpenses may be reduced or additional services implemented.


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I. Introduction

Section 35 of Chapter 305 of the Acts of 2008,An Act to Promote CostContainment, Transparency, and Efficiency in the Delivery of Quality HealthCare, requires that the Division of Health Care Finance and Policy (DHCFP), inconjunction with the Division of Insurance (DOI), conduct a study of thereserves, endowments, and surpluses of health insurers and hospitals. Perstatute, the goal of the study is to provide information to assist both DHCFPand DOI with the examination of options and alternatives available to theCommonwealth to provide regulation, oversight and disposition of thereserves, endowments and surpluses of health insurers and hospitals.

Specifically, Section 35 required the study to consist of the followingelements:

(1) an analysis of the laws, regulations and other measures

currently in effect in the commonwealth which regulate theamount, nature and disposition of surpluses held by or for thebenefit of health insurers in excess of amounts reasonablyanticipated to be required to pay claims, taking into account thelevel of such reserves and surpluses necessary to safeguard thesolvency of health insurers against unanticipated events andother circumstances which may cause extraordinary medicallosses;

(2) an analysis of federal and state law, regulations and othermeasures currently in effect which regulate the amount, nature

and disposition of surpluses and endowments held by or for thebenefit of hospitals in excess of amounts reasonably anticipatedto be required to perform and support services provided by thehospital and to guard against unanticipated events and othercircumstances;

(3) a review of recent fiscal practices and financial reporting byhealth insurers relative to reserves and surpluses and of hospitalfiscal practices and financial reporting required by general orspecial law;

(4) a comparison of the commonwealths current statutes and

regulations with those of other states which the commissiondeems to be reasonably comparable to those of thecommonwealth;

(5) a review and assessment of model acts and regulations andany other information which the commission finds to be relevantto its inquiry; and


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(6) a review of the method by which health insurers andhospitals fund community benefit programs including, but notlimited to, the manner by which funding is regulated by otherstates as to the appropriate amount, monitoring and direction ofsuch funding.

DHCFP selected the firm Hinckley, Allen & Tringale to perform analyses andprepare draft reports to assist the agency in responding to the requirementsof Section 35. This report examines the reserves, endowments, andsurpluses of hospitals. Analysis and review of the reserves and surpluses ofhealth insurers is provided in a separate report, which is available atwww.mass.gov/dhcfp.


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II. Study Methodology

This report utilized a three-pronged study methodology, consisting of: A literature review of hospital financial indicators;

Collection and analysis of financial information for Massachusetts acutecare hospitals from 2003 to 2008; and

A review of laws, regulations, and regulatory practices inMassachusetts and five peer states23 impacting hospital surplus.

Initially, a literature review was conducted to assist with defining hospitalsurplus, interpreting financial ratios, and understanding the various financialratios considered when determining if a hospital is in sound financialcondition. In its report to Congress in June 2004, the Medicare PaymentAdvisory Commission (MedPAC) proposed a set of financial ratios comparableacross all hospitals that would accurately portray a hospitals financial

soundness. The report did not identify a single line item in a financialstatement that would serve as an appropriate indicator of financialsoundness. Rather, MedPAC suggested that by examining a broad set offinancial measures over several years, analysts could gain a more completepicture of providers financial performance.24 Such measures include totalprofit margin, cash flow generated from operations, changes in net assets,and level of cash and other liquid assets.25 The MedPAC report did not, andwas not intended to, develop indicators for policymakers to makedeterminations on the adequacy or reasonableness of accumulated surpluslevels.

For the purpose of this report, a methodology similar to the one proposed byMedPAC was adopted in order to accurately portray hospital financialperformance over time. The study also examines payer mix and utilizationfor each hospital to facilitate a more complete understanding of theirfinancial condition. Such an approach allows for the identification ofhospitals in the Commonwealth that may have the greatest amount ofaccumulated financial resources.

Massachusetts collects and maintains standardized hospital financial datawith the Division of Health Care Finance and Policy. Hospital 403 cost reports(DHCFP-403) were utilized for payer mix data and utilization statistics. (The

403 data has been used by DHCFP and its predecessor to collect hospitaldata for more than twenty years, and as such is the best source ofcomparative data available.) Data was analyzed from 2003, 2004, 2005,2006, 2007, and 2008 filings. Since the 2009 DHCFP-403 hospital financial

23 Connecticut, Maryland, New York, Pennsylvania, and Rhode Island24 MedPAC, Report to the Congress, Sources of Financial Data on Medicare Providers, June,2004, Executive Summary.25 Ibid.


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dataset has recently become available, the tables in this report have beenupdated, where possible, to include this information. However, the writtenanalysis does not reflect information filed for 2009.

Other financial data used in this report was based upon annual financial

submissions provided to DHCFP by hospitals. In the case of the hospitalsystems, consolidated financial statements were utilized for analysis. IRSForm 990s26 were also reviewed for a number of institutions, as well as PublicCharities filings obtained from the Massachusetts Office of the AttorneyGeneral website.

Lastly, several peer states were surveyed in comparison to Massachusetts toassess prior efforts or current practices regarding hospital surplus.Connecticut, Maryland, New York, Pennsylvania, and Rhode Island wereselected for comparison due to their large number of non-profit and teachinghospitals.

Public Input Session: DHCFP convened a public input session on April 15,2009. The session provided an opportunity for interested parties to providecomments, ideas, and recommendations regarding the study to DHCFP, DOI,and the consultants. The agencies prepared a project summary for meetingattendees as well as a list of specific questions to be considered. Thesematerials can be found in Appendix 2. Individuals were encouraged to eithersubmit comments orally at the session and/or in writing after the close of thesession.

The following individuals or organizations (in alphabetical order of the

presenter) provided comments: Marylou Buyse, M.D., President and Chief Executive Officer of the

Massachusetts Association of Health Plans (presented by Eric Linzer) Michael Caljouw, Senior Director of Public, Government and Regulatory

Affairs for Blue Cross Blue Shield of Massachusetts Joseph F.X. Casey, Treasurer and Chief Financial Officer for Sturdy

Memorial Hospital John Erwin, Executive Director for the Conference of Boston Teaching

Hospitals Charles R. Goheen, Executive Vice President and Chief Financial Officer

for Fallon Community Health Plan, Inc.

Joe Kirkpatrick, Vice President of Healthcare Finance & Managed Carefor the Massachusetts Hospital Association

Georgia Maheras, Health Care for All Douglas J. McGregor, Director of Healthcare Services for the Boston

Organization of Teaching Hospital Financial Officers Roland Price, Treasurer for Tufts Health Plan, Inc.

26 An IRS form required of non-profit organizations.


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All written comments from the public input session are available in Appendix2.


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III. Definition of Hospital Surplus

Hospital surplus does not fall readily into accepted definitions or concepts.A hospitals surplus is often referred to as a hospitals operating margin or

total margin. A positive margin indicates that revenues are greater thancost; a negative margin indicates that costs exceed revenues.

Evaluation of hospital surplus requires a broader approach than simplyanalyzing operating and total margins. The dollar value of the annualoperating margin and the annual total margin are simply measures of annualoperating and/or total profit or loss. This does not equate to surplus becauseeach year some of a companys profits are put back into the business for thepurpose of maintenance and expansion. In order to be comparable totraditional concepts of capital and surplus, one would want to determine thetotal financial resources available to the hospital less the amount set aside

for future business expenses. To maintain the distinction between traditionalsurplus and usable hospital resources, this concept shall be referred to as ahospitals accumulated financial resources for the purpose of this report.

A number of financial performance ratios are helpful when determining theability of a hospital to generate accumulated financial resources. However,these ratios should not be interpreted alone. These additional ratios and/orfinancial data include:

Days of Cash on Hand: A hospital must have sufficient monies to meetongoing expenses. Days of cash on hand indicates how long a hospital can

meet its financial obligations should revenues cease. This measure iscomparable to days of claims payable in the insurance industry. It isimportant to note that a low number of days of cash on hand does notnecessarily mean that a hospital is in financial difficulty. Hospitalmanagement may have a cash management strategy which results in a lowbut adequate number of days of cash on hand in order to generate additionalinvestment income. Additionally, significant current assets may be held atthe holding company level rather than the hospital level.

Total Net Assets: Total net assets, the difference between total assets andtotal liabilities, represent assets which are owned by the hospital but are not

needed to meet current obligations. However, these assets are notnecessarily available to hospital management to use at its discretion. Totalnet assets are the sum of three elements on the financial statementshospitals report to the Commonwealth: unrestricted net assets, permanentlyrestricted net assets, and temporarily restricted net assets. Since bothpermanently and temporarily restricted net assets are not available fordiscretionary use by hospital management, they should not imply ahospitals access to funds. In addition, other non-discretionary funds such as


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reserve funds for pensions, employee health benefits, or malpractice maycontribute to total net assets.

Unrestricted Net Assets: While the use of these funds is subject to thediscretion of the hospitals management and Board of Directors, these assets

may not be easily liquidated. Examples of such assets include buildings,equipment, and other technology.

Board-Designated Assets: Assets recorded under this category representthose whose use has been limited by the hospitals Board of Directors orTrustees. Unlike restricted net assets, these assets are not restricted bydonors but have been allocated by the hospitals Board of Directors orTrustees for a specific purpose. Use of these funds can be changed by Boardor Trustee vote.It is important to note that if Board designation of either current or non-current assets is to meet the requirements of a bond holder, the Boards

discretionary use of these funds is limited.

Excess of Revenue, Gains, and Other Support Over Expenses: This amount iscalculated as an annual figure and defined by DHCFP as Total Surplus.27

Since it is calculated as an annual figure and not as an accumulated surplusvalue, it is not comparable to traditional capital and surplus, and thus aninadequate measure of a hospitals accumulated financial resources.

Endowments: Many hospitals in Massachusetts have restricted funds, orendowments. A hospitals endowment is an accumulation of funds given tothe hospital for long-term use. These funds are typically raised through

individual donations, and usually come with the stipulation that the donationbe invested, with the principal remaining intact in perpetuity or for a definedperiod of time. The appreciated value and investment income from thedonation is used to finance projects and/or services, but frequently hasrestrictions placed upon its use by the donor. If the donor is available andagrees in writing, endowment funds may be used for a different purposethan originally intended. If, on the other hand, the donor is not available, theinstitution must obtain a release from the appropriate court in order to spendfunds differently from the donor stipulation. The Attorney General is notifiedof all such requests and has the opportunity to be heard. If the restriction isfound to be obsolete, inappropriate, or impracticable, the court may

release the restriction in whole or in part.28 However, to the extent possible,any modification must be done in accordance with the donors probableintent.

Hospital Fundraising: A key source of non-operating income for non-profithospitals is individual donations and fundraising. Both types of funds are

27 Calculated by DHCFP on its Annual Hospital Financial Fact Sheets.28 M.G.L. ch. 180A, 9.


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frequently set aside for specific programs, buildings, and/or services andthus not readily available for expenses other than those specified in thedonation or bequest. Fundraising revenue further complicates the definitionof hospital accumulated surplus. While these funds contribute to the overallfinancial solvency and resources of an institution, in many cases they are

either donor-restricted endowment funds or Board-restricted funds that maybe so-designated to meet bond covenants.

Hospitals accumulated financial resources do not necessarily representliquid financial assets and thus cannot be readily measured by any singlefinancial indicator. Additionally, hospitals accumulated financial resourcesare not generated solely by patient service activities but include funds whoseuse is restricted and funds from investment activity. Further complicatingmatters is a hospitals corporate structure. As will be discussed later,hospitals are often members of larger systems, and an assessment of aninstitutions accumulated financial resources must consider the entitys

related corporations financial resources and obligations in relationship totheir mission, business activities, and business risks.

Please see Appendix 1 for definitions of the hospital financial terms used inthis report.


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IV. Why Hospitals Need to Accumulate Financial Resources

Accumulated financial resources allow a hospital to maintain operations andwithstand unanticipated financial events. These resources allow hospitals tofund major expenses such as the development of information technology

systems, investment in new clinical technologies, and new services inresponse to community needs. In order for a hospital to access bondfinancing at favorable interest rates for such projects, the hospital must be insound financial condition. Additionally, like all businesses, hospitals facerisks which require the maintenance of adequate financial resources in orderto preserve solvency. This section identifies and discusses various risksfaced by hospitals.

Cost and Availability of Labor: Labor is the largest expense category forhospitals. A number of elements of labor costs pose potential challenges forfuture spending levels:

Workforce recruitment and retention: Hospitals depend on highlyskilled medical professionals and must compete with otherMassachusetts and out-of-state medical facilities for these workers.

Labor agreements: Labor costs are predictable if hospitals have a twoor three year agreement with a union. However, as contracts expire,hospitals must predict, and budget, for future labor agreements.

Hospitals frequently bear additional costs when there is a shortage of aparticular provider type in their service area. In addition torecruitment efforts, hospitals in specific regions of the state provideoffice space, staff assistance, and/or higher salary to encouragephysicians to practice in the area. However, once a physician practice

is stabilized, the hospital should benefit from referrals and moreappropriate utilization of the emergency room.

Technology: The medical sector is one area of the economy where thetechnology is changing constantly. Hospitals routinely purchase and upgradeequipment to keep pace with emerging medical technologies. New businessand regulatory requirements for information technology require substantialinvestment for hospitals that do not already have these elements in place.

Current Economic Environment: The downturn in the economy has reducedhospitals ability to earn investment returns, has led to investment losses,

and may negatively impact philanthropic giving. Additionally, asunemployment increases and individuals lose their employer-based healthcoverage, hospitals may experience an increase in uninsured or under-insured patients, loss of service volume as elective procedures arepostponed, and an increase in payment default. During 2008, hospital totalmargins declined materially due in part to a reduction in investment income.


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Competitive Environment: Some hospitals in a competitive environment areat a disadvantage in negotiating adequate rates. In addition, hospitalscompete not only with each other, but with non-hospital providers such asphysicians in private practice, free standing ambulatory surgery centers,laboratories, and imaging suites.

Changing Demographics: Hospitals must adjust the services they provide tomeet local needs. Changing demographics, such as a significant increase inthe elderly, may require a hospital to increase spending to meet these newneeds.

Service Volume (Utilization): Under the current hospital fee-for-servicefinancing system, utilization is a key determinant of hospital operatingrevenues. As utilization increases, revenues increase accordingly.Conversely, as utilization decreases, revenues decrease. In many cases,hospitals may increase utilization without requiring additional buildings,

equipment, or labor. However, significant utilization increases may requireadditional investment in capacity. On the other hand if utilization falls,decreased revenue may prove insufficient to cover fixed costs. Thus, it isimportant to monitor utilization changes in relation to overall capacity andhospital fixed costs.

The size of a hospital affects the resilience of the institution to changes inutilization. Typically, larger hospitals can withstand small variations inutilization more easily than smaller ones. Variations in hospital utilizationmay be due to a variety of factors: absolute increases or decreases acrossthe system, shifts in utilization from one hospital to another, shifts in

utilization from hospitals to alternative sites of care, or changes in averagelength of stay. Additionally, physician affiliations, payment incentives,competition from non-hospital providers, benefit design, changing standardsof care, changing demographics, and the general economic situation maycontribute to utilization pattern changes.

Service Intensity (Case Mix): Service intensity, or case mix, interacts withvolume changes. Changes in case mix are reflected in the provision ofservices for a given utilization level. An increase in case mix intensityrequires additional services per patient, while a decreasing case mix meansa hospital will be providing fewer services for a given patient volume.

Significant increases in either service volume or intensity may requirehospital expansion or the addition of new services.

Insurer and Health Plan Contracting Strategies: Health plan contractingstrategies influence a hospitals need to have additional funds available. Afee-for-service system pays for each unit of care provided while a capitatedor global payment contract typically pays a set amount per person, per


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episode of illness, or per unit of time. In addition, other issues requiringconsideration include health plan interest in limited network products, theimplementation of Centers of Excellence for selected procedures, and atrend toward longer contract terms. Hospital contracts with insurancecompanies and health plans typically run for 3-5 years. The length of these

contracts may place the hospital at risk if unanticipated changes occurduring the life of the contract, or if increases in the cost of labor and/ortechnology are not adequately addressed by the negotiated inflation factors.

Payment Reform: A transition to global payment structures was unanimouslyrecommended by the Special Commission on the Health Care PaymentSystem in 2009. Integrated payment and risk sharing may change thecurrent business model which pays hospitals for production (measured byadmissions, visits, and procedures) to one in which performance and fundsare driven by integrated coordination of a patients health care. To theextent that a hospital successfully manages the transition and invests in the

necessary infrastructure, it will survive and/or flourish. Similarly, the recentpassage of federal health reform will present a challenge for hospitals havingto adjust to new requirements as well as reimbursement changes inMedicare.

Change in Insurance Product Benefit Design: As the cost of health insuranceincreases, employers are increasing the share of total costs borne byemployees. There are two major ways an employer can do this bychanging the employee contribution percentage or by changing the benefitstructure. A change in employee contribution percentage is not likely tohave a significant impact on hospitals; given the individual mandate, most

employees will probably still participate in employer-sponsored coverage.However, as employers offer products with increased deductibles,copayments, and coinsurance levels, hospitals face the prospect ofdecreased revenue if there is considerable benefit buy-down. Patients mayhave increased difficulty making payments at the time of service, thusincreasing accounts receivable and bad debt. Additionally, if patients aresubject to higher out-of-pocket costs, some individuals may choose topostpone care.

Government as a Payer and Regulator: Government impacts hospitals bothas a payer and as a regulator. Hospitals do not have much control over

payment levels for patients who are covered by government programs suchas Medicare, Medicaid, and the Health Safety Net Trust Fund inMassachusetts. Government programs are subject to federal and statebudget pressures, and thus their payment rates are typically lower thanthose negotiated in the private market.

Massachusetts hospitals attempt to balance their revenue needs bynegotiating higher private insurer and health plan rates to offset the lower


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government program rates; this practice is referred to as cost shifting. Themore costs a hospital has to shift and the less privately covered patients ahospital has to shift costs to, the more difficult it is for a hospital to generatesufficient revenue to achieve positive operating margins. Hospitals with ahigh volume of patients financed by public programs have fewer

opportunities to adjust to major changes in the competitive environment ormajor public policy shifts. This dynamic has been recognized by state andfederal authorities through a number of special adjustments, includingdesignation as a Disproportionate Share Hospital (DSH). Due to thedifferences in payment levels, payer mix is a crucial component to assessinga hospitals ability to accumulate additional financial resources.

Investment Risk: A number of hospitals do engage in investment practicesthat generate interest income. When investment income is used as theprimary source for particular activities, a hospital is subject to risk when suchinvestment income falls short of expectations. The hospital may also

experience a higher total margin in good market years, thereby relievingsome pressure on operating margins.


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V. Massachusetts Hospital Market Overview

In 2008, there were sixty-six acute care hospitals in Massachusetts. Thesehospitals provide care for a wide variety of conditions requiring inpatient,

outpatient, laboratory, imaging/radiology services, ancillary services, andtwenty-four hour emergency care services. Massachusetts hospitals are thelargest employer in the state health care sector, and comprise 15.8% ofMassachusetts employment.29

Very few hospitals in the Commonwealth are geographically isolated or meetthe federal definition of critical access institutions, thereby contributing tocompetitive pressure among and between community hospitals andacademic medical centers. This pressure has fostered a dynamic hospitalindustry in Massachusetts in which hospitals are continuously merging,developing clinical affiliations with other hospitals, changing corporate

structures, changing hospital and physician alignments, adding new services,and responding to the changing competitive environment. One such changehas been the significant reduction in the number of independent campusesand bed capacity across the state over the last twenty years. In 1988,Massachusetts had over a hundred short-term acute care hospitals inoperation. Through 2008, sixty-six remain operational.30

The sixty-six acute care hospitals examined in this report vary greatly both insize (in 2008 nine hospitals had under $50 million in net patient servicerevenue (NPSR) while three hospitals had over $1 billion) and in organizationtype (from independent, community hospitals to large, multi-hospital holding

companies).31

Service organizations such as hospitals cannot remain financially viablewithout earning and maintaining adequate reserves. Cash flow (incomeadjusted for non-cash expenses) is generally positive for hospitals even whenmargins are negative due to the substantial non-cash expenses of hospitals(e.g. depreciation). Hospitals must meet normal cash requirements forworking capital, debt principal payment, and investment in capital. It isimportant to note that Massachusetts hospitals have a history of lower totalmargins than hospitals nationwide but similar performance to other hospitalsin the northeast.32 Figure A shows Massachusetts hospitals median total

margin trend below that of the nation but following a similar trajectory. In

29 BLS/DUA Q1 2008 Quarterly Census of Employment & Wages (ES-202); healthcare sectorincludes direct care, medical industry and research.30 In 2009, there were sixty-five acute care hospitals in Massachusetts with the closing ofHubbard Regional Hospital.31 For NPSR data see Appendix 4, Table 21.32 Total Margin = Total Income/Total Revenue


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2008, hospitals across the United States experienced a median total marginof 2.3% compared with the Massachusetts hospital rate of 0.9%.33

33 U.S. and Northeast Region source: 2010 Almanac of Hospital Financial and OperatingIndicators, INGENIX; Massachusetts source: Division of Health Care Finance and PolicyHospital Financial Database


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Figure A: Hospital Total Margins 2003-2008

Hospital Total Margins

2.5%

3.4%

4.2% 4.3% 4.2%

2.3%

1.2%

2.1%

2.9%3.1%

2.8%

0.9%

1.2%

1.6%

3.1% 3.1%3.0%

0.9%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

2003 2004 2005 2006 2007 2008

U.S.

Northeast

Massachuset

Median total and operating margins in 2008 for Massachusetts acute carehospitals were at their lowest during the past five years.34 Total marginranged from -8.5% to 7.4%, with a median of 0.9%. Total surplus rangedfrom a loss of $49.5 million to a gain of $106.6 million, with a median of lessthan one million. Although Figure B shows Massachusetts acute care hospitaloperating margins declined in 2008, the decline is not as steep as totalmargins due to a difficult year with non-operating revenue performance.Median operating margin declined from 1.7% in 2007 to 0.7% in 2008.

34 See 2008 Annual Acute Hospital Financial Report, available at http://www.mass.gov/dhcfp,Reports and Publications. For individual hospital data on total and operating margin seeAppendix 4, Tables 2-3.


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Figure B: Massachusetts Acute Care Hospital Operating Margins 2003-2008

Massachusetts Acute Care Hospital Operating Margins

-2.7%-2.4%

-1.7%

-0.2%0.1% 0.1%

-1.1%

0.0%0.2%

0.8%

1.7%1.9%

1.7%

0.7%

2.1%1.8%

2.9%

3.5% 3.4% 3.4%

2.9%

-4.0%

-2.0%

0.0%

2.0%

4.0%

2002 2003 2004 2005 2006 2007 2008

25th percen

Median

75th percen

Examination of the Massachusetts hospital industry is enhanced byconducting categorical analyses of financial performance measures onhospital subgroups. The subgroups examined in this analysis include system

hospitals, specialty designation, for/non-profit status, teaching status,disproportionate share status, hospital size, and geographic location.Although two of these groups consist of only a few hospitals, it is still usefulto include them in order to provide a fuller picture of the variety found withinthe acute hospital market in Massachusetts. A full list of the hospitalsincluded in each subgroup is available in Appendix 3. Summary data for eachsubgroup is contained in Figure C at the end of this section.

System Hospitals

There are many different types of hospital organizational structures in

Massachusetts ranging from multi-hospital entity systems with otheraffiliated organizations, to single acute care hospitals that may have otheraffiliated organizations such as foundations, real estate management groups,or physician group practices.35 For the purposes of this analysis, systemhospitals are defined as those hospitals that have a parent organizationwhich operates more than one acute care hospital in Massachusetts. In 2008,

35 See Appendix 6 for pictorial examples of systems of varying complexity.


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thirty-seven of the sixty-six acute care hospitals in Massachusetts may beconsidered system hospitals (56%).36

System hospitals reported somewhat stronger total and operating margins

than did non-system hospitals. System hospitals experienced a median totalsurplus that was three times that of hospitals not in systems ($1,099,294versus $364,687, or $4,900 vs. $2,100 per bed), and they also had greatermedian net assets in 2008 ($77,824,265 versus $62,280,622). Systemhospitals had two more days of cash on hand and earned far more netrevenue per adjusted discharge ($7,228 and $4,367) than did non-systemhospitals. It is important to note that the discharge data is not case mixadjusted. Though system hospitals are not necessarily correlated with asicker patient population, this group also contains 60% of the statesteaching hospitals, which tend to treat high acuity patients. System hospitalswere slightly more reliant on Medicare revenue than hospitals not in

systems.

Specialty Hospitals

Most hospitals provide a wide range of health care services to the generalpublic for a number of health-related conditions. Hospitals which specialize inservices for specific populations or conditions are considered specialtyhospitals. Only four of the sixty-six acute care hospitals in Massachusetts arespecialty hospitals: Childrens Hospital, the Dana Farber Cancer Center, theMassachusetts Eye and Ear Infirmary, and New England Baptist Hospital.

Three of the four specialty hospitals in Massachusetts had weaker total andoperating margins than non-specialty hospitals, with Childrens Hospital asthe outlier. Specialty hospitals experienced a 2008 median total surplus of$1,498,736. When Childrens Hospital is removed from the analysis, themedian drops to a deficit of $3,589,528. In comparison, non-specialtyhospitals posted a median surplus of $752,898 in 2008. Median total netassets were also significantly greater at specialty hospitals than at non-specialty hospitals ($510,320,581 versus $58,151,743) due primarily to thefact that some specialty hospitals have large foundations and/orendowments. Specialty hospitals had about one week of cash availablecompared with 19 days for non-specialty hospitals in 2008. Specialty

hospitals earned far greater net patient service revenue per adjusteddischarge than did non-specialty hospitals ($16,425 versus $5,468), and areless dependent on Medicare as a source of revenue. Medicare gross revenueas a proportion of total gross revenue was 26.9%37 at specialty hospitalsversus 40.8% at non-specialty hospitals in 2008.

36 See Appendix 3 for the list of system hospitals.37 This is primarily due to the inclusion of Childrens Hospital which provides very fewservices to Medicare patients.


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For/Non-Profit Status

The vast majority of Massachusetts hospitals are non-profit, 501(c)(3)organizations. Only four hospitals are for-profit: the Hospital of MerrimackValley, Nashoba Valley Hospital, Saint Vincent Hospital, and MetroWest

Medical Center. These four institutions are owned by national for-profithospital chains, the first two by Essent Healthcare and the latter two byVanguard Health Systems.

For-profit hospitals in Massachusetts had weaker total and operating marginsthan non-profit hospitals, with a median total margin of -2.2% whereas for-profit hospitals had a median total margin of 1% in 2008. Net assets of for-profit hospitals were also negative in 2008, meaning that there were moreliabilities than assets on the balance sheets of these hospitals. Since thecash balances are maintained at the parent level, it is not possible tocalculate days cash on hand for the hospital entity alone. Massachusetts for-

profit hospitals earned higher net patient service revenue per adjusteddischarge than did non-profit hospitals ($7,909 versus $5,527), and are moredependent on Medicare as a source of revenue. In 2008, Medicare grossrevenue as a proportion of total gross revenue was 46.1% at for-profithospitals versus 39.6% at non-profit hospitals.

Teaching Status

Teaching hospitals are defined as hospitals that have at least twenty-fivefull-time equivalent medical student residents per one hundred inpatientbeds.38 Based on this definition and using a 2006 base year, fifteen

Massachusetts acute care hospitals are considered teaching hospitals.39

Teaching hospitals had far stronger median total and operating margins thandid non-teaching hospitals. Teaching total and operating margins werearound 4% while non-teaching hospital margins were less than 1 percent.Teaching hospitals had more than three and a half times the net patientservice revenue per adjusted discharge than did non-teaching hospitals($17,783 and $4,873 respectively). Teaching hospitals were also lessdependent on Medicare than non-teaching hospitals. In 2008, Medicare grossrevenue as a proportion of total gross revenue was 34.5% at teachinghospitals versus 41.4% at non teaching hospitals.

Disproportionate Share Status

The Division of Health Care Finance and Policy defines disproportionateshare hospitals (DSH) as hospitals receiving 63% or more of gross patient

38 This is the Medicare Payment Advisory Commissions definition of a major teachinghospital.39 See Appendix 3 for the list of teaching hospitals.


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service charges from Medicare, Medicaid, other government payers, and theHealth Safety Net. Based on this definition and using a 2007 base year,eighteen Massachusetts acute care hospitals may be considereddisproportionate share hospitals.40

Disproportionate share hospitals had lower total and operating margins thandid non-DSH facilities. DSH facilities also reported a total loss versus asurplus, and less than half the total net assets as compared to non-DSHfacilities. DSH facility net patient service revenue per adjusted dischargewas $4,822, nearly one thousand less than the non-DSH facilities at $5,924.DSH facilities were much more likely to be dependent on Medicare than non-DSH facilities. Medicare gross revenue as a proportion of total gross revenuewas 46% for DSH versus 39% for non-DSH facilities in 2008.

Hospital Size

For analyses based on hospital size, hospitals have been assigned to one offour size categories: small, small/medium, medium, and large. The fourcategories were determined using the number of weighted average availablebeds reported in 2008 and looking at the distribution by quartiles. There areseventeen small hospitals with beds ranging from 19 to 103; sixteensmall/medium hospitals with 105 to 181 beds; seventeen medium hospitalswith 197 to 330 beds; and sixteen large hospitals with 335 to 951 beds.41

Total margin ranges from 2.3% to 0% by size category. Operating marginranges from 2.5% for large hospitals to -1.0% for the smallest state hospitals,with the statewide median operating margin at 0.7% in 2008. The largest

hospitals also had the largest total surplus and total net assets, in both casessignificantly greater than the statewide medians. The largest hospitals netpatient service revenue per adjusted discharge was nearly eight times thelevel of the smallest hospitals and three times the statewide median($16,198, $2,138, and $5,527 respectively). Also, at 37.7%, the largesthospitals had the lowest Medicare gross revenue as a proportion of totalgross revenue in 2008 compared to the other three size categories.

Geographic Location

The categorical analysis of hospital geography assigns hospitals to five

different regions in the state. The regions are based on the Massachusettsemergency medical services (EMS) regions. The Massachusetts EMS regionsare defined by grouping the states towns into five state regions: West,Central, Northeast, MetroBoston, and Southeast. The region with the largest

40 See Appendix 3 for the list of disproportionate share hospitals.41 Interestingly, the smallest hospital, Nantucket Cottage Hospital, and the largest hospital,Massachusetts General Hospital, are both members of the same large hospital system Partners Healthcare System, Inc.


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number of hospitals is MetroBoston with twenty-five, followed by the Westand Southeast regions with eleven, the Northeast region with ten, and theCentral region with nine.

Total and operating margin among all the regions are very close to the

statewide medians. Hospitals in the Northeast region experienced thehighest total surplus and hospitals in the MetroBoston region the largest totalnet assets. The hospitals in the West region had nearly half the total netassets as the statewide median total net assets. The hospitals in theSoutheast and West regions had nearly a months worth of cash available,but the hospitals in the Central region had just twelve days. The hospitals inthe MetroBoston region had more than twice the level of net patient servicerevenue per adjusted discharge ($12,466) compared with the statewidemedian ($5,527) and nearly four times as much as the Central region($3,544). Also, among the five regions, the hospitals in the MetroBostonregion had the lowest Medicare gross revenue as a proportion of total gross

revenue in 2008.


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Figure C: Massachusetts Acute Care Hospital Selected Median Measures(2008)

By Hospital Fiscal Year End 2008

Hospital TypeTotal

MarginOperating Margin

TotalSurplus(Loss)

Total NetAssets

DaysCash on

Hand

NetRevenue/Adj

DischargeMedicare/

t GPSR

Hospitals in Systems(n=37) 1.1% 1.0% $1,099,294 $77,824,265 19 7,228 40.8%Hospitals not inSystems(n=29) 0.5% 0.1% $364,687 $62,280,622 17 4,367 39.0%

Specialty Hospitals(n=4) 0.7% -2.3% $1,498,736 $510,320,581 7 16,425 26.9%Non SpecialtyHospitals (n=62) 0.9% 0.7% $752,898 $58,151,743 19 5,468 40.8%

For-Profit Hospitals(n=4) -2.2% -2.3% ($1,851,402) ($1,357,569) -1 7,909 46.1%Non-Profit Hospitals

(n=62) 1.0% 0.7% $802,000 $66,969,188 20 5,527 39.6%

Teaching Hospitals(n=15) 3.9% 4.1% $30,111,095 $423,824,000 13 17,783 34.5%

Non TeachingHospitals (n=51) 0.8% 0.4% $702,734 $45,634,435 20 4,873 41.4%

Disproportionate ShareHospitals (n=18) -0.6% 0.4% ($1,014,326) $33,155,533 22 4,822 46.1%Non DisproportionateShare Hospitals (n=48) 1.0% 0.7% $850,914 $73,617,980 19 5,924 39.1%

Small Hospitals (n=17;19 to 103 beds) 0.1% -1.0% $49,977 $20,009,350 22 2,138 40.8%

Small/MediumHospitals (n=16; 105to 181 beds) 1.0% 0.7% $1,092,782 $54,247,000 21 5,130 40.5%

Medium Hospitals(n=17; 197 to 330beds) 0.0% 0.0% $8,417 $70,738,000 17 5,515 40.8%

Large Hospitals (n=16;335 to 951 beds) 2.3% 2.5% $15,163,164 $194,739,397 17 16,198 37.7%

West Region (n=11) 1.1% 0.5% $702,734 $33,501,660 27 4,130 42.6%

Central Region (n=9) 1.1% 0.7% $720,349 $45,714,800 12 3,544 40.8%

Northeast Region(n=10) 0.9% 1.3% $1,971,752 $57,187,500 18 5,219 42.8%MetroBoston Region(n=25) 0.3% 0.7% $716,924 $91,612,000 17 12,466 36.4%

Southeast Region(n=11) 0.0% 0.0% $8,417 $58,881,486 35 5,515 41.7%All MassachusettsAcute Care

0.9% 0.7% $752,898 $62,740,499 19 5,527 40.1%


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By Hospital Fiscal Year End 2008

Hospital TypeTotal

MarginOperating Margin

TotalSurplus(Loss)

Total NetAssets

DaysCash on

Hand

NetRevenue/Adj

DischargeMedicare/

t GPSR

Hospitals (n=66)

Lowest Value -8.5% -9.4%

($49,469,32

7) ($17,982,819) -5 327 1.6%

Highest Value 7.4% 8.5%$106,649,00

0$1,538,998,0

00 464 248,744 53.9%


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VI. Financial Status of Massachusetts Hospitals

This section presents and analyzes individual financial data for the sixty-sixacute care hospitals in the Commonwealth.

Since the hospital industry is constantly evolving, it is difficult to properlyinterpret trends in financial indicators without an understanding of thecomprehensive hospital environment. Generalizations from and comparisonsacross hospitals using financial data alone must be understood with thislimitation in mind.

The financial data that follows is grouped into five sections profitability andassets, liquidity, solvency and capital structure, payer mix, and utilization.The profitability indicators measure the funds generated above and beyondthose needed to meet the current expenses of running a hospital. Liquidity

ratios demonstrate whether or not the hospital is able to continue togenerate additional cash to meet current expenses. The solvency/capitalstructure ratios indicate the degree of debt or equity financing as a portion ofliabilities, as well as a hospitals ability to meet its debt payments or toobtain additional debt. Payer mix indicates the programs from which ahospital is receiving income and may indicate the volatility of a hospitalsincome stream. Change in utilization is an additional indicator of the stabilityof a hospitals revenue stream.

Each of these financial indicators provides information that contributes toassessing the overall level of a particular hospitals accumulated financial

resources. The tables referred to in each subsection appear in Appendix 4.Where possible, hospital financial data contained in Appendix 4 has beenupdated to include 2009 filing information which was recently madeavailable. However, due to the extensive analysis required in assessinghospital accumulated financial resources, it was not possible to include 2009information in the written analysis.

Table 1a of Appendix 4 provides a 2008 snapshot of the acute care hospitalsthat were reviewed. 2008 is the last year of fully analyzed data, and thusthe annual baseline from which any future changes will be measured. Thefinancial indicators in this chart include many of the key determinants of

hospital accumulated financial resources. Table 1b of Appendix 4 provides2009 snapshot data for comparison.

Profitability and Assets

Margins: Operating margin is defined as the profit or excess of revenuesover expenses that an institution earns from its patient care and patient carerelated activities. Total margin, on the other hand, includes income from


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activities not directly related to patient care (i.e., non-operating income). Asmany hospitals receive revenue from non-operating sources, such as grants,donations, or interest, both operating and total margins were analyzed. Theanalysis indicates that a number of hospitals in the Commonwealth rely onnon-operating revenues to support patient service operations and

presumably may consider these revenues in the development of their annualbudgets.

As Figure D illustrates, six Massachusetts hospitals have had negativeoperating margins every year between 2005 and 2008. On the other hand,twenty-nine hospitals had positive operating margins every year for thatsame time frame.42 Only eleven hospitals did not have positive operatingmargins in at least two of the last four years. In 2008, twenty-six hospitalsreported negative operating margins, and another nine hospitals reportedoperating margins lower than 1%.43

Figure D: Hospitals with Negative Operating Margins 2005-2008

2008 2007 2006 2005

Cambridge Health Alliance -6.77% -0.91% -4.32% -4.58%

Dana-Farber Cancer Institute -5.58% -5.85% -5.97% -6.74%Massachusetts Eye and Ear Infirmary -9.42% -10.88% -7.93% -8.70%

Merrimack Valley Hospital -6.01% -11.46% -3.97% -0.04%

Nantucket Cottage Hospital -8.13% -1.83% -5.95% -13.02%

Quincy Medical Center -2.33% -3.14% -6.43% -5.37%

Hospitals with Four Consecutive Years of Negative Operaing Margins

Hospital Name

Operating Margin

Examination of total margin indicates that thirty-four hospitals had positivetotal margins from 2005 to 2008, and only five hospitals did not achieve atleast two years of positive total margins during this period. Twenty-threehospitals reported negative total margins in 2008, with another elevenhospitals having a positive total margin of less than 1%. Only twelvehospitals had a higher total margin in 2008 than in 2005.44 The weakperformance of the financial markets is reflected in the total marginsreported in 2008. In addition, Chapter 58 of the Acts of 2006 restructuredthe way many low-income individuals access health care, impacting thestates Medicaid program (MassHealth), Commonwealth Care, and the Health

Safety Net. These programs, which tend to concentrate volume in a subsetof institutions, plus the associated changes in free care payment rates andservices have had an impact on hospital financial performance which willevolve over time and will require close examination.

42 See Appendix 4, Table 2c.43 See Appendix 4, Tables 2a and 2b.44 See Appendix 4, Table 3.


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Operating margin ranged from -9.4% to 8.5% in 2008, while total marginranged from -8.5% to 7.4% in that same year. The range was equally greatin 2005, -13.0% to 8.5% for operating margin and -9.1% to 14.6% for totalmargin.

The relative range of operating and total margin performance among thesehospitals is noteworthy. There is not only great variation among hospitals,but also internal fluctuations within individual hospitals of over fivepercentage points from 2005 to 2008.

A hospitals total margin is influenced by many factors in addition tooperating results, such as endowment level, investment strategy, and typeand breadth of ancillary businesses (both clinical and non-clinical) owned andoperated by the hospital. Ancillary services can include associated,community-based clinical services such as home health, hospice, imagingcenters, and physician corporations. The financial performance of these

ancillary services varies significantly across hospitals due to the sameaforementioned factors. In addition, academic medical centers frequentlyhave significant levels of public and private research grants.

It is important to note that long-term debt financing is primarily available tofund capital projects, not operations, although there may be some financingavailable for equipment and information technology. Thus, when looking atthe need for accumulated financial resources in hospitals, it is important howmany hospitals generate positive total margins on a consistent basis overtime.

Assets: One benefit of being a 501(c)(3) non-profit organization is that aninstitution can accept donations which are tax deductible for the donor.These donations, commonly referred to as endowments, may be eitherdesignated towards specific projects or services or may be left to thehospitals discretion. Hospital financial statements report three differentcategories of net assets: permanently restricted net assets, temporarilyrestricted net assets, and unrestricted net assets. For the purpose of thisanalysis, there is no difference between the temporarily restricted andpermanently restricted categories.

There is great variation over time with respect to the level of unrestricted net

assets. Asset valuations were impacted by the Financial AccountingStandards Boards adoption of Statement of Financial Accounting StandardNo. 157 (FAS 157). As a result of FAS 157, most corporations began valuingassets at their current market level (mark to market) for fiscal yearsbeginning after November 15, 2007. The subsequent drop in the stockmarket since 2007 has resulted in decreased asset levels for reportingpurposes based on realized and unrealized losses in institutional investmentportfolios. In addition, changes in accounting requirements for retiree health


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and pension benefits will impact the asset levels of hospitals which provideretiree health benefits and defined benefit pension plans.

Unrestricted net assets do not clearly delineate the level of funds availablefor general use. In order to determine this amount, one must examine the

level of funds that are liquid, and available for cash and spending.

Appendix 4, Tables 4 and 5 list total net assets and total unrestricted netassets. Variability within the industry is notable, with 2008 unrestricted netassets ranging from a deficit of $19,975,522 for Caritas Carney Hospital anddeficit of $8,412,776 for Merrimack Valley Hospital to surpluses of$951,528,000 for Childrens Hospital Boston and $710,281,000 forMassachusetts General Hospital. These hospitals represented the extremesin 2007 and 2006 as well. Most, but not all, hospitals saw a decrease in theirunrestricted net assets from 2007 to 2008. Asset valuation for hospitalswithin systems, however, must be reviewed with an eye toward holding

company impacts as well (see Section VII).

Changes in net assets indicate how much the hospital is adding orsubtracting from its assets from one year to the next. Multiple years ofnegative change in net assets severely hamper a hospitals ability to remainin operation. Appendix 4, Table 6depicts the changes in net assets atMassachusetts hospitals from 2005 to 2008.

While many hospitals appear to have added to net assets from 2005 to 2007,the vast majority of hospitals in the Commonwealth experienced difficultiesin 2008. This was driven in large part by poor investment performance, poor

operating results, accounting policy changes which necessitated fundingdefined benefit plans for pension and retiree health care programs, andchanges in the valuation of malpractice reserves. Nineteen hospitals hadnegative changes to their net asset levels on two or more occasions in thepast four years.

Hospital unrestricted net assets may be used as one indicator of growth indiscretionary net assets. Seventeen hospitals experienced decreases inunrestricted net assets in at least two years from 2005 through 2008.45 Thedegree to which these decreases are short-term depends on the hospitalsoverall situation and cannot be determined from financial data alone.

In addition, hospital Boards may designate funds to be used for specificpurposes. Boards may establish restricted accounts to provide a cushionof operating cash, allow a hospital to withstand a downturn in operatingand/or investment performance, save for a particular project, or protectagainst unforeseen events. Board-designated funds may also be arequirement of a bond covenant. Forty-two hospitals had over $10 million in45 See Appendix 4, Table 7.

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