Hospital Reserves3

8/9/2019 Hospital Reserves3

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Study of the Reserves, Endowments, and

Surpluses of Hospitals in Massachusetts

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

I. 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

IX. Hospital Community Benefits

X. 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 Cost Containment, Transparency, and Efficiencyin the Delivery of Quality Health Care, requires that the Division of Health Care Finance and Policy (DHCFP),in conjunction with the Division of Insurance (DOI), conduct a study of the reserves, endowments, andsurpluses of health insurers and hospitals. Per statute, the goal of the study is to provide information toassist both DHCFP and DOI with the examination of options and alternatives available to the

Commonwealth to provide regulation, oversight and disposition of the reserves, endowments andsurpluses of health insurers and hospitals.

DHCFP selected the firm Hinckley, Allen & Tringale to perform analyses and prepare draft reports toassist the agency in responding to the requirements of Section 35. This report examines the reserves,endowments, and surpluses of hospitals. Analysis and review of the reserves and surpluses of healthinsurers 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 is more complicated to analyzehospital surplus for several reasons, which include, but are not limited to, the following:

Definitional:The terms surplus and reserves do not have entirely clear meanings in the contextof hospitals. Surplus could refer to operating or total profits, accumulated profits, the differencebetween total assets and total liabilities, the amount of unrestricted net assets, or accumulated cashand marketable securities in excess of working capital needs. Hospitals do not generally designateassets as reserves except for certain liquid assets set aside to meet debt service requirements.

Regulatory environment: While hospitals are required to report financial information to stateregulatory agencies, there are no standards, federal or state, for hospitals regarding necessary orappropriate levels of surplus.

Complexity: Hospitals need financial resources for a larger variety of purposes than insurers, whosemajor need for accumulated financial resources is solvency protection in the event of unanticipatedmedical claims payments or investment losses.

Diversity of hospitals: The sixty-six acute care hospitals in Massachusetts are a varied group acrossmultiple dimensions, such as size, range of services, teaching status, payer mix, geographic location,and market dominance. Such factors make it more difficult to define and measure surplus acrosshospitals. In contrast, for insurance companies, the primary financial requirement beyond meeting

operating expenses is setting aside sufficient reserves to meet or exceed specific regulatoryrequirements addressing the level of insurance risk undertaken by the insurer.

Organizational structure: More than half of the Commonwealths sixty-six acute care hospitals arepart of larger health systems. Any detailed assessment of the financial resources of these hospitalsmust consider the resources and obligations of the larger parent system. However, such analysis

would be extensive and uniform systems data is not maintained or analyzed in any one state agencyat this time.

Restrictions on use of assets: Some hospital assets may not be available to hospital management orboards to use at their discretion because of restrictions imposed by donors, or by contractualobligations (such as those imposed by bondholders or those necessary for self insurancerequirements). Some restrictions are permanent and can be changed only by the donor or througha formal process involving the Office of the Attorney General. Other limits on the use of assetsmay be changed with the consent of the Board of Directors.

Formatted: Left: 0.58"


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Form of assets: Many hospital assets are in the form of physical plant and equipment, which can not

be easily disposed of or liquidated.

In this report, DHCFP examines the financial resources of hospitals and assesses whether any hospitalsmay have considerable accumulated financial resources. (This approach is analogous to the analysisperformed by DHCFP for health plans, which examined health insurer reserves in the context of variouscommonly accepted measures of financial performance and financial solvency.) This analysis is intendedto provide a baseline review of hospital financial resources and to provide contextual financial informationon hospitals related systems. For the purposes of this report, DHCFP did not examine specific spendingstrategies by hospital or allocation of resources among system entities.

Why Hospitals Need to Accumulate Financial Resources

Hospitals cannot remain financially viable without earning and maintaining adequate financial resources.Hospitals need to accumulate some level of financial resources in order to maintain operations, withstandunanticipated financial events, and make investments in new services, infrastructure, and technology thatare necessary to provide high-quality patient care and compete effectively. Significant changes in theexternal environment can also require hospitals to maintain reserves or make new investments. Forexample, the recent passage of federal health reform is an external change which may require somehospitals to accumulate more financial resources for specific uses, such as investments in informationtechnology, or experience significant decreases in reimbursement given anticipated changes to Medicare

payments.

However, the ongoing accumulation of financial resources may lead to higher than necessary prices andhigher than necessary health care costs. Thus, a careful balance must be struck between adequate andexcess accumulated financial resources for hospitals. In addition, most hospitals in Massachusetts areorganized as non-profit organizations and public charities. These affiliations render a number of specialbenefits, including exemption from most 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 costin hospitals accumulating financial resources at the expense of utilizing these resources for other importantpurposes.

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 hospital surplus, interpreting financialratios, and understanding the various financial ratios considered when determining if a hospital is in soundfinancial condition. In its report to Congress in June 2004, the Medicare Payment Advisory Commission(MedPAC) proposed a set of financial ratios comparable across all hospitals that would accurately portray ahospitals financial soundness. The report did not identify a single line item in a financial statement that

1 Connecticut, Maryland, New York, Pennsylvania, and Rhode Island


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would serve as an appropriate indicator of financial soundness. Rather, MedPAC suggested that byexamining a broad set of financial measures over several years, analysts could gain a more complete pictureof providers financial performance.2 Such measures include total profit margin, cash flow generatedfrom operations, changes in net assets, and level of cash and other liquid assets.3 The MedPAC report didnot, and was not intended to, develop indicators for policymakers to make determinations on the adequacyor reasonableness of accumulated surplus levels.

For the purpose of this report, a methodology similar to the one proposed by MedPAC was adopted inorder to accurately portray hospital financial performance over time. The study also examines payer mixand utilization for each hospital to facilitate a more complete understanding of their financial condition.Such an approach allows for the identification of hospitals in the Commonwealth that may have thegreatest amount of accumulated financial resources.

Massachusetts collects and maintains standardized hospital financial data with the Division of Health CareFinance and Policy. Hospital 403 cost reports (DHCFP-403) were utilized for payer mix data andutilization statistics. The 403 data has been used by DHCFP and its predecessor to collect hospital datafor more than twenty years, and as such is the best source of comparative data available. Data wasanalyzed from 2003, 2004, 2005, 2006, 2007, and 2008 filings. Since the 2009 DHCFP-403 hospitalfinancial dataset has recently become available, the tables in this report have been updated, where possible,to include this information. However, the written analysis does not reflect information filed for 2009.

Other financial data used in this report was based upon annual financial submissions provided to DHCFPby hospitals. In the case of the hospital systems, consolidated financial statements were utilized foranalysis. IRS Form 990s4 were also reviewed for a number of institutions, as well as Public Charities filingsobtained from the Massachusetts Office of the Attorney General website.

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

were selected for comparison due to their large number of non-profit and teaching hospitals.

Factors to Consider In Identifying Hospital Accumulated Financial Resources

In determining whether a particular hospital potentially has considerable accumulated financial resources,the following should be taken into consideration:

Financial Performance Indicators Profitability -This includes operating margin (the excess of revenues over expenses for patient care

and patient care related activities), and total margin (the excess of revenues over expenses,including non-operating revenues such as research grants and donations and non-operatingexpenses).

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

2 MedPAC, Report to the Congress, Sources of Financial Data on Medicare Providers, June, 2004, Executive Summary.3 Ibid.4 An IRS form required of non-profit organizations.


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Solvency -This includes both the amount of existing debt financing, as measured by equity financing

or long-term debt to equity ratios and the ability to cover current debt obligations with currentoperating and non-operating activity, as measured by the debt service coverage ratio.

Other Measures The total amount of unrestricted net assets -These are assets of the hospital that are not needed to meet

obligations or restricted for specific purposes. The mix of restricted net assets and Board-designated assets -It is critical to distinguish between those assets

which are permanently restricted because of legal conditions imposed by donors and those that arelimited by Board decision, which can be altered.

Amount and volatility of investment income -A number of hospitals have large investments that generateinterest income. When investment income becomes central to a hospitals meeting its profitabilitygoals, the hospital may be subject to financial risk if interest income falls short of expectations.5

Age of plant -Hospitals with younger buildings potentially have less need to make new investmentsand may require lower levels of financial resources.

The size of the hospital - Smaller facilities may potentially be less able to withstand financialfluctuations and therefore have a greater need for reserves.

Payer mix -Hospitals that are more reliant on public payers may need to maintain more reservesbecause 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 by existing capacity or require increased capacity. Declining

utilization can increase unit costs if fixed costs cannot be reduced at a comparable rate. Restrictions imposed by outside parties, including bond holders -Hospitals are generally required by lenders

to maintain certain financial ratios. Bond markets also require a hospital to meet certain ratios inorder to qualify for preferred bond rates.

Organizational structure -For institutions that are part of multi-hospital systems, any assessment ofthe financial status of an individual hospital, and particularly an assessment of whether there areconsiderable financial resources, must consider the financial arrangements between the hospitaland its parent system.

Specifically, the report selected eleven measures that when collectively evaluated could identify hospitalsthat may have considerable accumulated financial 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 two years 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

5 Given the recent economic downturn, there have been significant fluctuations in the value of investment portfolios at mostinstitutions.6 Net patient service revenue is the total amount received by the hospital for providing patient care, taking into account actualrates of payment and unreimbursed bad debt and free care.


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Of these eleven, the first four measures were identified as critical indicators of long-term positive financialperformance. The remaining seven measures were regarded as supplemental considerations of positivefinancial performance. Therefore, a hospital had to meet all of the first four criteria, not just a majority ofthe eleven measures. This approach to identifying hospitals that may have considerable accumulatedfinancial resources is not based on any existing legal or regulatory standards but presented merely as oneapproach to evaluate these institutions.

Major Findings

Based on the financial performance of hospitals against the identified eleven parameters, there are tenhospitals in the state that may have considerable accumulated 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

Hospitals whose performance may indicate considerable accumulated financial resources despite over 15%NPSR from Medicaid or over 50% NPSR from 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 top quartile of hospitals hadstrong performance on both an operating and total margin basis from 2003-2008, while the bottomquartile of hospitals had negative performance during almost all of this period. Some hospitals hadconsistently strong financial performance; thirty-two of the sixty-six hospitals in the state had positivefinancial margins in each of the last four years. Only a handful of hospitals had consistently negativefinancial results, but some hospitals have had financial results that are consistently weak compared tomedian hospital performance. In addition, the financial performance at some hospitals has been volatile,

with significant variations in financial performance over the four-year-period examined in the report.

Median hospital margins in Massachusetts have historically been lower than those in the U.S. but similar tothose in the northeast, on both an operating and total margin basis.8 Massachusetts hospitals have ahistory of lower total margins than hospitals nationwide but similar performance to other hospitals in thenortheast. The trend in financial performance is similar for Massachusetts hospitals and those in the

7 See Appendix 4, Tables 1-3.8 See Section V, Figure A.


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northeast and nationwide. For example, total and operating margins, on average, declined significantly in2008.

Some hospital characteristics are generally associated with better or worse financial performance.9Although the performance of individual hospitals varies widely, certain factors appear to be associated withhospital financial performance:

Teaching hospitals had far stronger financial performance than did non-teaching hospitals. Themedians of the operating and total margins of teaching hospitals were approximately 4% during thestudy period, compared to less than 1% for non-teaching hospitals.

Size of hospital was positively associated with strong financial results.10 Hospitals that are part of multi-hospital systems had somewhat stronger financial performance

than did hospitals that are not part of larger systems. Disproportionate share hospitals11 (DSH) had worse financial performance than non-DSH

hospitals. As a group, the four hospitals that are for-profit entities12 had weaker financial performance than

the median results for the not-for-profit hospitals. The four specialty hospitals13 in the state, as a group, had weaker financial performance, but the

actual financial status of two is considerably stronger, due to large foundations and/orendowments.

Some Massachusetts hospitals have very strong liquidity and solvency positions, while others are much

weaker. As noted above, understanding the financial status of an individual hospital requires a closeranalysis and review of institutional decisions regarding cash management, transfers of money to parentcorporations, and other operations.

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

The amount of accumulated financial resources--as measured by total unrestricted net assets--varies widelyamong hospitals.15 The Massachusetts hospitals with the greatest total unrestricted net assets in 2008 wereChildrens Hospital with $951 million and Massachusetts General Hospital with $710 million. Thehospitals with the least were Caritas Carney Hospital with -$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 which Board limitations have been imposed. Unlike assets whoseuse is restricted by a donor, Board-designated assets could be released for general operating purposes byanother Board vote. Some limitations may be less discretionary than others (e.g., restrictions imposed on

9 See Section V, Figure C.10 This is explained by the higher margins of teaching hospitals, which are the largest hospitals.11 The Division of Health Care Finance and Policy defines disproportionate share hospitals (DSH) as hospitals where 63% ormore 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, andSt. Vincent Hospital.13 The four specialty hospitals are: Childrens Hospital, Dana-Farber Cancer Center, Massachusetts Eye and Ear Infirmary, NewEngland 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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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 as part of the hospitals essentialmission.

As of fiscal year end 2008, twenty-four percent of hospitals have a significant level of permanentlyrestricted assets.17 While thirty hospitals have more than $10 million in total restricted assets, only sixteenhospitals have more than $10 million in net assets that are permanently restricted. However, these sixteenhospitals account for 89% of the permanently restricted net assets of all Massachusetts hospitals.

Most hospitals added net assets during the past five years, but had some deterioration in 2008.18 Thedeclines in 2008 were largely the result of poor investment performance, but were exacerbated at mosthospitals by changes in accounting requirements for retiree health and pension benefits, and changes in the

valuation of malpractice reserves. Unrealized gains/losses also affected financial performance in 2008.These unrealized gains/losses are notational until the assets are sold.

In 2008, eleven hospitals experienced significant gains or losses on investments.19These hospitals eithergained or lost $5 million or more on investments.This suggests that certain hospitals may be subject toconsiderable investment risk, which could require additional reporting to better understand how hospitalportfolios are being managed.

A majority of hospitals are members of systems, making it difficult to assess the actual level of available

financial resources. Low performance on certain financial indicators may simply be a reflection of largercash management strategies. Approximately 60% of the states hospitals are members of multi-hospitalsystems. These systems account for approximately 60% of hospital beds, inpatient admissions and days,and 62% of net patient service revenues.20 In 2008, Massachusetts hospital systems total net assetsexceeded $17 billion dollars, $12.9 billion of which were unrestricted net assets.21

Other hospitals that are not members of a multi-institution system have foundations, outpatient centers, orother affiliated organizations with significant financial resources that are reported separately from those ofthe hospital. These hospitals include Boston Medical Center, Childrens Hospital of Boston, Dana FarberCancer Institute, and Tufts Medical Center.

Major Findings of the Review of Hospital Community Benefit Programs

The Internal Revenue Service is increasing its review of hospital community benefit activities. Untilrecently, the Internal Revenue Service had fairly general guidelines regarding the types of communitybenefit activities in which tax-exempt hospitals must engage beyond the provision of charity care.However, since 2009, the IRS has required hospitals to provide much more detailed information oncommunity benefit programs, which should provide a means of collecting comparable national data toassess whether a hospital is providing sufficient services to its community to warrant its federal taxexemption.

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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In the absence of specific federal guidelines, community benefit requirements for hospitals differ fromstate to state. According to a 2008 review by the Government Accountability Office, only fifteen statesrequire community benefit programs. Of these, only five states specify a minimum community benefitcontribution level (see Section IX).

The Massachusetts Office of the Attorney General (AGO) has long established detailed communitybenefit guidelines for hospitals. These guidelines have recently been revised and strengthened. The AGOfirst issued community benefit guidelines in 1994, and they were then reviewed and updated in 2000 and2002. The AGO recently revised the guidelines, which went into effect October 1, 2009.

The Massachusetts community benefit guidelines are voluntary. Hospitals are not required to comply withthe AGO guidelines, although most hospitals submit an annual community benefit filing to the Office ofthe Attorney General. Massachusetts does not require specific programs but leaves it to each hospital andits community to conduct a needs assessment to determine appropriate programs.

The Massachusetts and federal standards differ in terms of what can be classified as community benefits.Massachusetts permits community benefit expenditures to include charity care, including a hospitalsassessment to the Health Safety Net (HSN) Trust Fund and the cost of claims billed to the HSN for whichpayment has been denied. The state does not recognize bad debt, shortfalls from means-testedgovernment programs like Medicaid, health professions education, or research to be classified ascommunity benefit activities

A total of $454 million in community benefits was reported by Massachusetts hospitals in 2008. Thisamount includes $149 million in charity care. The amount of community benefits provided by individualhospitals ranged from a low of $55,000 to a high of $69.9 million.22

Recommendations

#1: Improve Data Collection and Reporting

The Division of Health Care Finance and Policy collects extremely detailed financial information fromeach hospital in the state and issues quarterly and annual reports which include a number of financialindicators. However, a majority of Massachusetts hospitals are part of larger holding companies; andhospital holding companies are not required to report holding company level data to DHCFP. Thus theindividual hospital data compiled by DHCFP is an incomplete picture of a hospitals broader financialsituation. A review of hospital holding company consolidated financial statements indicates that anassessment of holding company finances is necessary for a thorough understanding of hospital finances.For example, while some hospitals appear to be low on cash, a review of holding company finances canreveal that cash is maintained at the holding company level. The absence of this information may lead tothe inaccurate impression that a hospital may have inadequate or adequate financial resources. Therefore,DHCFP recommends that the agency be authorized by legislation to collect complete financial data onindividual hospitals and affiliated systems and to provide access to this data to other government bodiesand interested parties.

Transparency is a key regulatory goal. The ready availability of comparative holding company financialdata would greatly increase understanding and analysis of hospital finances. While consolidated financial

22 See Appendix 4, Table 36.


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statements are available on the Attorney Generals website, they are not routinely analyzed and reported byDHCFP. The challenge facing state monitoring agencies is not necessarily a lack of financial data, butrather a clear directive to one agency to compile information from disparate sources and analyze the datato produce useful information for policy makers and the public. This would require the following concretesteps:

a. All sources of financial disclosure by hospitals and hospital system affiliates should be centrallylocated, 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-public state agencies. Hospitals filequarterly and annual financial statements, and annual cost reports, with DHCFP while the MassachusettsOffice of the Attorney General collects annual audited financial statements and annual reports for all non-profit hospitals and hospital systems. Hospital systems report system-level financial data to a number ofstate and federal regulatory agencies including municipal repositories (per Securities and Exchangeregulations), and the Massachusetts Health and Educational Financing Authority. Often the system-levelaudited financial reports include supplemental information that breaks out various sub-elements of thesystem; sometimes individual hospital performance is broken out, and other times it is combined withother sub-elements in the consolidating supplements. However, these filings lack uniformity as well as thespecifics of intra-system cash flow. The SEC filings typically limit disclosure to only those entities obligatedto repay bondholder debt, which can omit entities within the system.

Today, this information must be compiled and collected from several agencies in order to develop a

consolidated picture of the financial condition and status of hospitals and hospital systems. Centralizedreporting and increased transparency will lead to a better understanding of both overall and hospital-specific finances.

b. The state should build the analytic capacity to compile, standardize, analyze, and synthesizesystem financial performance from this central data repository. Line of business profitability, overallsystem indebtedness and capacity to repay, inter-affiliate transfers of resources, system-wide cash, andinvestment reserves are all useful metrics of the financial health of a system with an embedded hospital.Certain non-financial metrics routinely disclosed on bond prospectuses such as market share, utilization,background and turnover of Board and senior management, payer mix, and profitability by major businesslines could also be useful.

#2: Increased Oversight of Hospital Accumulated Financial Resources

While hospitals require accumulated financial resources in order to adequately protect patients andproviders from unanticipated events and to fulfill their missions, ongoing accumulation of reserves withoutcorresponding increased value to consumers may lead to higher than necessary prices of medical services.Understanding that this is a delicate balance highlights the concern when hospital resources fluctuateexcessively or when regulators are unable to assess how hospitals use or dispose of their accumulatedresources.

a. The issue of accumulated financial resources should be further examined to develop guidelinesregarding the appropriate amount of accumulated financial resources for hospitals and hospitalsystems. There are currently no standardized methods or guidelines regarding the appropriate level ofhospital accumulated financial resources. Standardized methods and guidelines are needed to identify whena facility is under-resourced and may be in danger of failing, as well as when facilities are maintaining aconsiderable level of accumulated financial resources. Regulators have an interest in the solvency of


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hospitals and ensuring they are well-capitalized to provide high quality care. However, there are costs toconsumers associated with hospitals accumulating resources in excess of need, particularly inMassachusetts where the majority of hospitals are non-profit public charities. The purpose of standardmeasurement techniques and guidelines would be to ensure that Massachusetts hospitals are appropriatelycapitalized, while not excessively accumulating reserves which may increase the price of medical care.

b. The Commonwealth should require that hospitals report to DHCFP on an annual basis thepurposes and corresponding amounts for which Board-designated assets are being reserved. Forthe sixty-six acute hospitals studied, over $3.6 billion dollars were labeled Board-designated assets in 2008.However, there is no centralized repository of information delineating the purpose for which these fundshave been set aside, making it a challenge to determine if the purposes for which the restrictions areimposed are necessary or discretionary. Bond-holders frequently require hospitals to maintain a certainlevel of available cash; however, the Commonwealth has no information about what proportion of the $3.6billion in Board-designated assets is due to bond covenants. More detailed and transparent publicreporting about Board-designated assets would enable policymakers to determine how much of the assetsreported as restricted could actually be released for general operating purposes. Once a complete pictureof Board-designated funds is developed, the Commonwealth may then develop guidelines for reservingfunds in this manner. To the extent that fewer funds are limited in this way, medical expenses may bereduced or additional services implemented.


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I. Introduction

Section 35 of Chapter 305 of the Acts of 2008,An Act to Promote Cost Containment, Transparency, and Efficiencyin the Delivery of Quality Health Care, requires that the Division of Health Care Finance and Policy (DHCFP),in conjunction with the Division of Insurance (DOI), conduct a study of the reserves, endowments, andsurpluses of health insurers and hospitals. Per statute, the goal of the study is to provide information toassist both DHCFP and DOI with the examination of options and alternatives available to the

Commonwealth to provide regulation, oversight and disposition of the reserves, endowments andsurpluses of health insurers and hospitals.

Specifically, Section 35 required the study to consist of the following elements:

(1) an analysis of the laws, regulations and other measures currently in effect in thecommonwealth which regulate the amount, nature and disposition of surpluses held by orfor the benefit of health insurers in excess of amounts reasonably anticipated to be requiredto pay claims, taking into account the level of such reserves and surpluses necessary tosafeguard the solvency of health insurers against unanticipated events and othercircumstances which may cause extraordinary medical losses;

(2) an analysis of federal and state law, regulations and other measures currently in effectwhich regulate the amount, nature and disposition of surpluses and endowments held by or

for the benefit of hospitals in excess of amounts reasonably anticipated to be required toperform and support services provided by the hospital and to guard against unanticipatedevents and other circumstances;

(3) a review of recent fiscal practices and financial reporting by health insurers relative toreserves and surpluses and of hospital fiscal practices and financial reporting required bygeneral or special law;

(4) a comparison of the commonwealths current statutes and regulations with those ofother states which the commission deems to be reasonably comparable to those of thecommonwealth;

(5) a review and assessment of model acts and regulations and any other information whichthe commission finds to be relevant to its inquiry; and

(6) a review of the method by which health insurers and hospitals fund community benefit

programs including, but not limited to, the manner by which funding is regulated by otherstates as to the appropriate amount, monitoring and direction of such funding.

DHCFP selected the firm Hinckley, Allen & Tringale to perform analyses and prepare draft reports toassist the agency in responding to the requirements of Section 35. This report examines the reserves,endowments, and surpluses of hospitals. Analysis and review of the reserves and surpluses of healthinsurers 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 acute care hospitals from 2003 to

2008; and A review of laws, regulations, and regulatory practices in Massachusetts and five peer states23

impacting hospital surplus.

Initially, a literature review was conducted to assist with defining hospital surplus, interpreting financialratios, and understanding the various financial ratios considered when determining if a hospital is in soundfinancial condition. In its report to Congress in June 2004, the Medicare Payment Advisory Commission(MedPAC) proposed a set of financial ratios comparable across all hospitals that would accurately portray ahospitals financial soundness. The report did not identify a single line item in a financial statement that

would serve as an appropriate indicator of financial soundness. Rather, MedPAC suggested that byexamining a broad set of financial measures over several years, analysts could gain a more complete pictureof providers financial performance.24 Such measures include total profit margin, cash flow generatedfrom operations, changes in net assets, and level of cash and other liquid assets.25 The MedPAC report didnot, and was not intended to, develop indicators for policymakers to make determinations on the adequacyor reasonableness of accumulated surplus levels.

For the purpose of this report, a methodology similar to the one proposed by MedPAC was adopted inorder to accurately portray hospital financial performance over time. The study also examines payer mixand utilization for each hospital to facilitate a more complete understanding of their financial condition.Such an approach allows for the identification of hospitals in the Commonwealth that may have thegreatest amount of accumulated financial resources.

Massachusetts collects and maintains standardized hospital financial data with the Division of Health CareFinance and Policy. Hospital 403 cost reports (DHCFP-403) were utilized for payer mix data andutilization statistics. (The 403 data has been used by DHCFP and its predecessor to collect hospital datafor more than twenty years, and as such is the best source of comparative data available.) Data wasanalyzed from 2003, 2004, 2005, 2006, 2007, and 2008 filings. Since the 2009 DHCFP-403 hospitalfinancial dataset has recently become available, the tables in this report have been updated, where possible,to include this information. However, the written analysis does not reflect information filed for 2009.

Other financial data used in this report was based upon annual financial submissions provided to DHCFPby hospitals. In the case of the hospital systems, consolidated financial statements were utilized foranalysis. IRS Form 990s26 were also reviewed for a number of institutions, as well as Public Charitiesfilings obtained from the Massachusetts Office of the Attorney General website.

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.26 An IRS form required of non-profit organizations.


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

were selected for comparison due to their large number of non-profit and teaching hospitals.

Public Input Session: DHCFP convened a public input session on April 15, 2009. The session providedan opportunity for interested parties to provide comments, ideas, and recommendations regarding thestudy 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. These materials can be found in Appendix2. Individuals were encouraged to either submit comments orally at the session and/or in writing after theclose of the session.

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 Care for 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.

All written comments from the public input session are available in Appendix 2.


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III. Definition of Hospital Surplus

Hospital surplus does not fall readily into accepted definitions or concepts. A hospitals surplus isoften referred to as a hospitals operating margin or total margin. A positive margin indicates thatrevenues are greater than cost; a negative margin indicates that costs exceed revenues.

Evaluation of hospital surplus requires a broader approach than simply analyzing operating and totalmargins. The dollar value of the annual operating margin and the annual total margin are simply measuresof annual operating and/or total profit or loss. This does not equate to surplus because each year some ofa companys profits are put back into the business for the purpose of maintenance and expansion. In orderto be comparable to traditional concepts of capital and surplus, one would want to determine the totalfinancial resources available to the hospital less the amount set aside for future business expenses. Tomaintain the distinction between traditional surplus and usable hospital resources, this concept shall bereferred to as a hospitals accumulated financial resources for the purpose of this report.

A number of financial performance ratios are helpful when determining the ability of a hospital to generateaccumulated financial resources. However, these ratios should not be interpreted alone. These additionalratios and/or financial data include:

Days of Cash on Hand: A hospital must have sufficient monies to meet ongoing expenses. Days of cash

on hand indicates how long a hospital can meet its financial obligations should revenues cease. Thismeasure is comparable to days of claims payable in the insurance industry. It is important to note that alow number of days of cash on hand does not necessarily mean that a hospital is in financial difficulty.Hospital management may have a cash management strategy which results in a low but adequate numberof days of cash on hand in order to generate additional investment income. Additionally, significantcurrent assets may be held at the holding company level rather than the hospital level.

Total Net Assets: Total net assets, the difference between total assets and total liabilities, represent assetswhich are owned by the hospital but are not needed to meet current obligations. However, these assets arenot necessarily available to hospital management to use at its discretion. Total net assets are the sum ofthree elements on the financial statements hospitals report to the Commonwealth: unrestricted net assets,permanently restricted net assets, and temporarily restricted net assets. Since both permanently andtemporarily restricted net assets are not available for discretionary use by hospital management, theyshould not imply a hospitals access to funds. In addition, other non-discretionary funds such as reservefunds for pensions, employee health benefits, or malpractice may contribute to total net assets.

Unrestricted Net Assets: While the use of these funds is subject to the discretion of the hospitalsmanagement and Board of Directors, these assets may not be easily liquidated. Examples of such assetsinclude buildings, equipment, and other technology.

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


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Excess of Revenue, Gains, and Other Support Over Expenses: This amount is calculated as an annualfigure and defined by DHCFP as Total Surplus.27 Since it is calculated as an annual figure and not as anaccumulated surplus value, it is not comparable to traditional capital and surplus, and thus an inadequatemeasure of a hospitals accumulated financial resources.

Endowments: Many hospitals in Massachusetts have restricted funds, or endowments. A hospitalsendowment is an accumulation of funds given to the hospital for long-term use. These funds are typicallyraised through individual donations, and usually come with the stipulation that the donation be invested,

with the principal remaining intact in perpetuity or for a defined period of time. The appreciated value andinvestment income from the donation is used to finance projects and/or services, but frequently hasrestrictions placed upon its use by the donor. If the donor is available and agrees in writing, endowmentfunds may be used for a different purpose than originally intended. If, on the other hand, the donor is notavailable, the institution must obtain a release from the appropriate court in order to spend fundsdifferently from the donor stipulation. The Attorney General is notified of all such requests and has theopportunity to be heard. If the restriction is found to be obsolete, inappropriate, or impracticable, thecourt may release the restriction in whole or in part.28 However, to the extent possible, any modificationmust be done in accordance with the donors probable intent.

Hospital Fundraising: A key source of non-operating income for non-profit hospitals is individualdonations and fundraising. Both types of funds are frequently set aside for specific programs, buildings,

and/or services and thus not readily available for expenses other than those specified in the donation orbequest. Fundraising revenue further complicates the definition of hospital accumulated surplus. Whilethese funds contribute to the overall financial solvency and resources of an institution, in many cases theyare either donor-restricted endowment funds or Board-restricted funds that may be so-designated to meetbond covenants.

Hospitals accumulated financial resources do not necessarily represent liquid financial assets and thuscannot be readily measured by any single financial indicator. Additionally, hospitals accumulated financialresources are not generated solely by patient service activities but include funds whose use is restricted andfunds from investment activity. Further complicating matters is a hospitals corporate structure. As will bediscussed later, hospitals are often members of larger systems, and an assessment of an institutionsaccumulated financial resources must consider the entitys related corporations financial resources andobligations in relationship to their mission, business activities, and business risks.

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

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


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IV. Why Hospitals Need to Accumulate Financial Resources

Accumulated financial resources allow a hospital to maintain operations and withstand unanticipatedfinancial events. These resources allow hospitals to fund major expenses such as the development ofinformation technology systems, investment in new clinical technologies, and new services in response tocommunity needs. In order for a hospital to access bond financing at favorable interest rates for suchprojects, the hospital must be in sound financial condition. Additionally, like all businesses, hospitals facerisks which require the maintenance of adequate financial resources in order to preserve solvency. Thissection identifies and discusses various risks faced by hospitals.

Cost and Availability of Labor: Labor is the largest expense category for hospitals. A number of elementsof labor costs pose potential challenges for future spending levels:

Workforce recruitment and retention: Hospitals depend on highly skilled medical professionalsand must compete with other Massachusetts and out-of-state medical facilities for these workers.

Labor agreements: Labor costs are predictable if hospitals have a two or three year agreement witha union. However, as contracts expire, hospitals must predict, and budget, for future laboragreements.

Hospitals frequently bear additional costs when there is a shortage of a particular provider type intheir service area. In addition to recruitment efforts, hospitals in specific regions of the stateprovide office space, staff assistance, and/or higher salary to encourage physicians to practice inthe area. However, once a physician practice is stabilized, the hospital should benefit from referrals

and more appropriate utilization of the emergency room.

Technology: The medical sector is one area of the economy where the technology is changing constantly.Hospitals routinely purchase and upgrade equipment to keep pace with emerging medical technologies.New business and regulatory requirements for information technology require substantial investment forhospitals that do not already have these elements in place.

Current Economic Environment: The downturn in the economy has reduced hospitals ability to earninvestment returns, has led to investment losses, and may negatively impact philanthropic giving.

Additionally, as unemployment increases and individuals lose their employer-based health coverage,hospitals may experience an increase in uninsured or under-insured patients, loss of service volume aselective procedures are postponed, and an increase in payment default. During 2008, hospital totalmargins declined materially due in part to a reduction in investment income.

Competitive Environment: Some hospitals in a competitive environment are at a disadvantage innegotiating adequate rates. In addition, hospitals compete not only with each other, but with non-hospitalproviders such as physicians in private practice, free standing ambulatory surgery centers, laboratories, andimaging suites.

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

Service Volume (Utilization): Under the current hospital fee-for-service financing system, utilization is akey determinant of hospital operating revenues. 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


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require additional investment in capacity. On the other hand if utilization falls, decreased revenue mayprove insufficient to cover fixed costs. Thus, it is important to monitor utilization changes in relation tooverall capacity and hospital fixed costs.

The size of a hospital affects the resilience of the institution to changes in utilization. Typically, largerhospitals can withstand small variations in utilization more easily than smaller ones. Variations in hospitalutilization may be due to a variety of factors: absolute increases or decreases across the system, shifts inutilization from one hospital to another, shifts in utilization from hospitals to alternative sites of care, orchanges in average length of stay. Additionally, physician affiliations, payment incentives, competitionfrom non-hospital providers, benefit design, changing standards of care, changing demographics, and thegeneral economic situation may contribute to utilization pattern changes.

Service Intensity (Case Mix): Service intensity, or case mix, interacts with volume changes. Changes incase mix are reflected in the provision of services for a given utilization level. An increase in case mixintensity requires additional services per patient, while a decreasing case mix means a hospital will beproviding fewer services for a given patient volume.

Significant increases in either service volume or intensity may require hospital expansion or the addition ofnew services.

Insurer and Health Plan Contracting Strategies: Health plan contracting strategies influence a hospitals

need to have additional funds available. A fee-for-service system pays for each unit of care provided whilea capitated or global payment contract typically pays a set amount per person, per episode of illness, or perunit of time. In addition, other issues requiring consideration include health plan interest in limitednetwork products, the implementation of Centers of Excellence for selected procedures, and a trendtoward longer contract terms. Hospital contracts with insurance companies and health plans typically runfor 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/or technology are not adequatelyaddressed by the negotiated inflation factors.

Payment Reform: A transition to global payment structures was unanimously recommended by the SpecialCommission on the Health Care Payment System in 2009. Integrated payment and risk sharing maychange the current business model which pays hospitals for production (measured by admissions, visits,and procedures) to one in which performance and funds are driven by integrated coordination of apatients health care. To the extent that a hospital successfully manages the transition and invests in thenecessary infrastructure, it will survive and/or flourish. Similarly, the recent passage of federal healthreform will present a challenge for hospitals having to adjust to new requirements as well asreimbursement changes in Medicare.

Change in Insurance Product Benefit Design: As the cost of health insurance increases, employers areincreasing the share of total costs borne by employees. There are two major ways an employer can do this

by changing the employee contribution percentage or by changing the benefit structure. A change inemployee contribution percentage is not likely to have a significant impact on hospitals; given theindividual 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 of decreased revenue if there is considerable benefit buy-down. Patients mayhave increased difficulty making payments at the time of service, thus increasing accounts receivable and


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bad debt. Additionally, if patients are subject to higher out-of-pocket costs, some individuals may chooseto postpone care.

Government as a Payer and Regulator: Government impacts hospitals both as a payer and as a regulator.Hospitals do not have much control over payment levels for patients who are covered by governmentprograms such as Medicare, Medicaid, and the Health Safety Net Trust Fund in Massachusetts.Government programs are subject to federal and state budget pressures, and thus their payment rates aretypically lower than those negotiated in the private market.

Massachusetts hospitals attempt to balance their revenue needs by negotiating higher private insurer andhealth plan rates to offset the lower government program rates; this practice is referred to as costshifting. The more costs a hospital has to shift and the less privately covered patients a hospital has toshift costs to, the more difficult it is for a hospital to generate sufficient revenue to achieve positiveoperating margins. Hospitals with a high volume of patients financed by public programs have feweropportunities to adjust to major changes in the competitive environment or major public policy shifts.

This dynamic has been recognized by state and federal authorities through a number of specialadjustments, including designation as a Disproportionate Share Hospital (DSH). Due to the differences inpayment levels, payer mix is a crucial component to assessing a hospitals ability to accumulate additionalfinancial resources.

Investment Risk: A number of hospitals do engage in investment practices that generate interest income.

When investment income is used as the primary source for particular activities, a hospital is subject to riskwhen such investment income falls short of expectations. The hospital may also experience a higher totalmargin in good market years, thereby relieving some pressure on operating margins.


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V. Massachusetts Hospital Market Overview

In 2008, there were sixty-six acute care hospitals in Massachusetts. These hospitals provide care for a widevariety of conditions requiring inpatient, outpatient, laboratory, imaging/radiology services, ancillaryservices, and twenty-four hour emergency care services. Massachusetts hospitals are the largest employer inthe state health care sector, and comprise 15.8% of Massachusetts employment.29

Very few hospitals in the Commonwealth are geographically isolated or meet the federal definition ofcritical access institutions, thereby contributing to competitive pressure among and between communityhospitals and academic medical centers. This pressure has fostered a dynamic hospital industry inMassachusetts in which hospitals are continuously merging, developing clinical affiliations with otherhospitals, changing corporate structures, changing hospital and physician alignments, adding new services,and responding to the changing competitive environment. One such change has been the significantreduction in the number of independent campuses and bed capacity across the state over the last twentyyears. In 1988, Massachusetts had over a hundred short-term acute care hospitals in operation. Through2008, sixty-six remain operational.30

The sixty-six acute care hospitals examined in this report vary greatly both in size (in 2008 nine hospitalshad under $50 million in net patient service revenue (NPSR) while three hospitals had over $1 billion) andin organization type (from independent, community hospitals to large, multi-hospital holding companies).31

Service organizations such as hospitals cannot remain financially viable without earning and maintainingadequate reserves. Cash flow (income adjusted for non-cash expenses) is generally positive for hospitalseven when margins are negative due to the substantial non-cash expenses of hospitals (e.g. depreciation).Hospitals must meet normal cash requirements for working capital, debt principal payment, andinvestment in capital. It is important to note that Massachusetts hospitals have a history of lower totalmargins than hospitals nationwide but similar performance to other hospitals in the northeast.32 Figure Ashows Massachusetts hospitals median total margin trend below that of the nation but following a similartrajectory. In 2008, hospitals across the United States experienced a median total margin of 2.3% compared

with the Massachusetts hospital rate of 0.9%.33

29 BLS/DUA Q1 2008 Quarterly Census of Employment & Wages (ES-202); healthcare sector includes direct care, medicalindustry and research.30 In 2009, there were sixty-five acute care hospitals in Massachusetts with the closing of Hubbard Regional Hospital.31 For NPSR data see Appendix 4, Table 21.32 Total Margin = Total Income/Total Revenue33 U.S. and Northeast Region source: 2010 Almanac of Hospital Financial and Operating Indicators, INGENIX; Massachusettssource: Division of Health Care Finance and Policy Hospital 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

Massachusetts

Median total and operating margins in 2008 for Massachusetts acute care hospitals were at their lowest

during the past five years.34

Total margin ranged from -8.5% to 7.4%, with a median of 0.9%. Totalsurplus ranged from a loss of $49.5 million to a gain of $106.6 million, with a median of less than onemillion. Although Figure B shows Massachusetts acute care hospital operating margins declined in 2008,the decline is not as steep as total margins 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. Forindividual hospital data on total and operating margin see Appendix 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 percentile

Median

75th percentile

Examination of the Massachusetts hospital industry is enhanced by conducting categorical analyses offinancial performance measures on hospital subgroups. The subgroups examined in this analysis includesystem 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 isstill useful to include them in order to provide a fuller picture of the variety found within the acute hospitalmarket in Massachusetts. A full list of the hospitals included in each subgroup is available in Appendix 3.Summary data for each subgroup 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 other affiliated organizations, to single acute care hospitals that may have otheraffiliated organizations such as foundations, real estate management groups, or physician group practices.35For the purposes of this analysis, system hospitals are defined as those hospitals that have a parentorganization which operates more than one acute care hospital in Massachusetts. In 2008, thirty-seven ofthe sixty-six acute care hospitals in Massachusetts may be considered system hospitals (56%).36

System hospitals reported somewhat stronger total and operating margins than did non-system hospitals.System hospitals experienced a median total surplus that was three times that of hospitals not in systems

35 See Appendix 6 for pictorial examples of systems of varying complexity.36 See Appendix 3 for the list of system hospitals.


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($1,099,294 versus $364,687, or $4,900 vs. $2,100 per bed), and they also had greater median net assets in2008 ($77,824,265 versus $62,280,622). System hospitals had two more days of cash on hand and earnedfar more net revenue per adjusted discharge ($7,228 and $4,367) than did non-system hospitals. It isimportant to note that the discharge data is not case mix adjusted. Though system hospitals are notnecessarily correlated with a sicker patient population, this group also contains 60% of the states teachinghospitals, which tend to treat high acuity patients. System hospitals were slightly more reliant on Medicarerevenue than hospitals not in systems.

Specialty Hospitals

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

Three of the four specialty hospitals in Massachusetts had weaker total and operating margins than non-specialty hospitals, with Childrens Hospital as the outlier. Specialty hospitals experienced a 2008 mediantotal surplus of $1,498,736. When Childrens Hospital is removed from the analysis, the median drops to adeficit of $3,589,528. In comparison, non-specialty hospitals posted a median surplus of $752,898 in 2008.Median total net assets were also significantly greater at specialty hospitals than at non-specialty hospitals

($510,320,581 versus $58,151,743) due primarily to the fact that some specialty hospitals have largefoundations and/or endowments. Specialty hospitals had about one week of cash available compared with19 days for non-specialty hospitals in 2008. Specialty hospitals earned far greater net patient servicerevenue per adjusted discharge than did non-specialty hospitals ($16,425 versus $5,468), and are lessdependent on Medicare as a source of revenue. Medicare gross revenue as a proportion of total grossrevenue was 26.9%37 at specialty hospitals versus 40.8% at non-specialty hospitals in 2008.

For/Non-Profit Status

The vast majority of Massachusetts hospitals are non-profit, 501(c)(3) organizations. Only four hospitalsare for-profit: the Hospital of Merrimack Valley, Nashoba Valley Hospital, Saint Vincent Hospital, andMetroWest Medical Center. These four institutions are owned by national for-profit hospital chains, thefirst two by Essent Healthcare and the latter two by Vanguard Health Systems.

For-profit hospitals in Massachusetts had weaker total and operating margins than 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 more liabilities thanassets on the balance sheets of these hospitals. Since the cash balances are maintained at the parent level, itis not possible to calculate days cash on hand for the hospital entity alone. Massachusetts for-profithospitals earned higher net patient service revenue per adjusted discharge than did non-profit hospitals($7,909 versus $5,527), and are more dependent on Medicare as a source of revenue. In 2008, Medicaregross revenue as a proportion of total gross revenue was 46.1% at for-profit hospitals versus 39.6% at non-profit hospitals.

37 This is primarily due to the inclusion of Childrens Hospital which provides very few services to Medicare patients.


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Teaching Status

Teaching hospitals are defined as hospitals that have at least twenty-five full-time equivalent medicalstudent residents per one hundred inpatient beds.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 than did non-teaching hospitals.Teaching total and operating margins were around 4% while non-teaching hospital margins were less than1 percent. Teaching hospitals had more than three and a half times the net patient service revenue peradjusted discharge than did non-teaching hospitals ($17,783 and $4,873 respectively). Teaching hospitals

were also less dependent on Medicare than non-teaching hospitals. In 2008, Medicare gross revenue as aproportion of total gross revenue was 34.5% at teaching hospitals versus 41.4% at non teaching hospitals.

Disproportionate Share Status

The Division of Health Care Finance and Policy defines disproportionate share hospitals (DSH) ashospitals receiving 63% or more of gross patient service charges from Medicare, Medicaid, othergovernment payers, and the Health Safety Net. Based on this definition and using a 2007 base year,eighteen Massachusetts acute care hospitals may be considered disproportionate share hospitals.40

Disproportionate share hospitals had lower total and operating margins than did non-DSH facilities. DSH

facilities also reported a total loss versus a surplus, and less than half the total net assets as compared tonon-DSH facilities. DSH facility net patient service revenue per adjusted discharge was $4,822, nearly onethousand less than the non-DSH facilities at $5,924. DSH facilities were much more likely to be dependenton Medicare than non-DSH facilities. Medicare gross revenue as a proportion of total gross revenue was46% for DSH versus 39% for non-DSH facilities in 2008.

Hospital Size

For analyses based on hospital size, hospitals have been assigned to one of four size categories: small,small/medium, medium, and large. The four categories were determined using the number of weightedaverage available beds reported in 2008 and looking at the distribution by quartiles. There are seventeensmall hospitals with beds ranging from 19 to 103; sixteen small/medium hospitals with 105 to 181 beds;seventeen medium hospitals with 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 margin ranges from 2.5% for largehospitals to -1.0% for the smallest state hospitals, with the statewide median operating margin at 0.7% in2008. The largest hospitals also had the largest total surplus and total net assets, in both cases significantlygreater than the statewide medians. The largest hospitals net patient service revenue per adjusted discharge

was nearly eight times the level of the smallest hospitals and three times the statewide median ($16,198,$2,138, and $5,527 respectively). Also, at 37.7%, the largest hospitals had the lowest Medicare grossrevenue as a proportion of total gross revenue in 2008 compared to the other three size categories.

38 This is the Medicare Payment Advisory Commissions definition of a major teaching hospital.39 See Appendix 3 for the list of teaching hospitals.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, areboth members of the same large hospital system Partners Healthcare System, Inc.


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Geographic Location

The categorical analysis of hospital geography assigns hospitals to five different regions in the state. Theregions are based on the Massachusetts emergency medical services (EMS) regions. The MassachusettsEMS regions are defined by grouping the states towns into five state regions: West, Central, Northeast,MetroBoston, and Southeast. The region with the largest number of hospitals is MetroBoston with twenty-five, followed by the West and 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 theNortheast region experienced the highest total surplus and hospitals in the MetroBoston region the largesttotal net assets. The hospitals in the West region had nearly half the total net assets as the statewide mediantotal net assets. The hospitals in the Southeast and West regions had nearly a months worth of cashavailable, but the hospitals in the Central region had just twelve days. The hospitals in the MetroBostonregion had more than twice the level of net patient service revenue per adjusted discharge ($12,466)compared with the statewide median ($5,527) and nearly four times as much as the Central region ($3,544).

Also, among the five regions, the hospitals in the MetroBoston region had the lowest Medicare grossrevenue as a proportion of total gross revenue in 2008.


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

ospital Fiscal Year End 2008

pital TypeTotalMargin

OperatingMargin

Total Surplus(Loss)

Total NetAssets

Days Cashon Hand

NetRevenue/Adj

DischargeMedicare/Tot

GPSR

pitals in Systems (n=37) 1.1% 1.0% $1,099,294 $77,824,265 19 7,228 40.8%

pitals not inms(n=29) 0.5% 0.1% $364,687 $62,280,622 17 4,367 39.0%

alty Hospitals (n=4) 0.7% -2.3% $1,498,736 $510,320,581 7 16,425 26.9%

Specialty Hospitals2) 0.9% 0.7% $752,898 $58,151,743 19 5,468 40.8%

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

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%

Teaching Hospitals1) 0.8% 0.4% $702,734 $45,634,435 20 4,873 41.4%

roportionate Sharepitals (n=18) -0.6% 0.4% ($1,014,326) $33,155,533 22 4,822 46.1%

Disproportionate Sharepitals (n=48) 1.0% 0.7% $850,914 $73,617,980 19 5,924 39.1%

l Hospitals (n=17; 19 tobeds) 0.1% -1.0% $49,977 $20,009,350 22 2,138 40.8%

l/Medium Hospitals6; 105 to 181 beds) 1.0% 0.7% $1,092,782 $54,247,000 21 5,130 40.5%

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

e Hospitals (n=16; 3351 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%

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

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

heast Region (n=11) 0.0% 0.0% $8,417 $58,881,486 35 5,515 41.7%

Massachusetts AcuteHospitals (n=66) 0.9% 0.7% $752,898 $62,740,499 19 5,527 40.1%

est Value -8.5% -9.4% ($49,469,327) ($17,982,819) -5 327 1.6%

est Value 7.4% 8.5% $106,649,000 $1,538,998,000 464 248,744 53.9%


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VI. Financial Status of Massachusetts Hospitals

This section presents and analyzes individual financial data for the sixty-six acute care hospitals in theCommonwealth.

Since the hospital industry is constantly evolving, it is difficult to properly interpret trends in financialindicators without an understanding of the comprehensive hospital environment. Generalizations fromand comparisons across hospitals using financial data alone must be understood with this limitation inmind.

The financial data that follows is grouped into five sections profitability and assets, liquidity, solvencyand capital structure, payer mix, and utilization. The profitability indicators measure the funds generatedabove and beyond those needed to meet the current expenses of running a hospital. Liquidity ratiosdemonstrate whether or not the hospital is able to continue to generate additional cash to meet currentexpenses. The solvency/capital structure ratios indicate the degree of debt or equity financing as a portionof liabilities, as well as a hospitals ability to meet its debt payments or to obtain additional debt. Payer mixindicates the programs from which a hospital is receiving income and may indicate the volatility of ahospitals income stream. Change in utilization is an additional indicator of the stability of a hospitalsrevenue stream.

Each of these financial indicators provides information that contributes to assessing the overall level of aparticular 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 been updated to include2009 filing information which was recently made available. However, due to the extensive analysis requiredin assessing hospital accumulated financial resources, it was not possible to include 2009 information in the

written analysis.

Table 1a of Appendix 4 provides a 2008 snapshot of the acute care hospitals that were reviewed. 2008 isthe last year of fully analyzed data, and thus the annual baseline from which any future changes will bemeasured. The financial indicators in this chart include many of the key determinants of hospitalaccumulated financial resources. Table 1b of Appendix 4 provides 2009 snapshot data for comparison.

Profitability and Assets

Margins: Operating margin is defined as the profit or excess of revenues over expenses that aninstitution earns from its patient care and patient care related activities. Total margin, on the other hand,includes income from activities not directly related to patient care (i.e., non-operating income). As manyhospitals receive revenue from non-operating sources, such as grants, donations, or interest, bothoperating and total margins were analyzed. The analysis indicates that a number of hospitals in theCommonwealth rely on non-operating revenues to support patient service operations and presumably mayconsider these revenues in the development of their annual budgets.

As Figure D illustrates, six Massachusetts hospitals have had negative operating margins every yearbetween 2005 and 2008. On the other hand, twenty-nine hospitals had positive operating margins every


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year for that same time frame.42 Only eleven hospitals did not have positive operating margins in at leasttwo of the last four years. In 2008, twenty-six hospitals reported negative operating margins, and anothernine hospitals reported operating margins lower than 1%.43

Figure D: Hospitals with Negative Operating Margins 2005-2008

2008 2007 2006 2005Cambridge 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%

HospitalswithFourConsecutive YearsofNegativeOperaingMargins

Hospital Name

Operating Margin

Examination of total margin indicates that thirty-four hospitals had positive total margins from 2005 to2008, and only five hospitals did not achieve at least two years of positive total margins during this period.

Twenty-three hospitals reported negative total margins in 2008, with another eleven hospitals having apositive total margin of less than 1%. Only twelve hospitals had a higher total margin in 2008 than in2005.44 The weak performance of the financial markets is reflected in the total margins reported in 2008.

In addition, Chapter 58 of the Acts of 2006 restructured the way many low-income individuals accesshealth care, impacting the states Medicaid program (MassHealth), Commonwealth Care, and the HealthSafety Net. These programs, which tend to concentrate volume in a subset of institutions, plus theassociated changes in free care payment rates and services have had an impact on hospital financialperformance which will evolve over time and will require close examination.

Operating margin ranged from -9.4% to 8.5% in 2008, while total margin ranged from -8.5% to 7.4% inthat same year. The range was equally great in 2005, -13.0% to 8.5% for operating margin and -9.1% to14.6% for total margin.

The relative range of operating and total margin performance among these hospitals is noteworthy. Thereis not only great variation among hospitals, but also internal fluctuations within individual hospitals of overfive percentage points from 2005 to 2008.

A hospitals total margin is influenced by many factors in addition to operating results, such as endowmentlevel, investment strategy, and type and breadth of ancillary businesses (both clinical and non-clinical)owned and operated by the hospital. Ancillary services can include associated, community-based clinicalservices such as home health, hospice, imaging centers, and physician corporations. The financialperformance of these ancillary services varies significantly across hospitals due to the same aforementionedfactors. In addition, academic medical centers frequently have significant levels of public and privateresearch grants.

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


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It is important to note that long-term debt financing is primarily available to fund capital projects, notoperations, although there may be some financing available for equipment and information technology.

Thus, when looking at the need for accumulated financial resources in hospitals, it is important how manyhospitals generate positive total margins on a consistent basis over time.

Assets: One benefit of being a 501(c)(3) non-profit organization is that an institution can accept donationswhich are tax deductible for the donor. These donations, commonly referred to as endowments, may beeither designated towards specific projects or services or may be left to the hospitals discretion. Hospitalfinancial statements report three different categories of net assets: permanently restricted net assets,temporarily restricted net assets, and unrestricted net assets. For the purpose of this analysis, there is nodifference between the temporarily restricted and permanently restricted categories.

There is great variation over time with respect to the level of unrestricted net assets. Asset valuations wereimpacted by the Financial Accounting Standards Boards adoption of Statement of Financial AccountingStandard No. 157 (FAS 157). As a result of FAS 157, most corporations began valuing assets at theircurrent market level (mark to market) for fiscal years beginning after November 15, 2007. The subsequentdrop in the stock market since 2007 has resulted in decreased asset levels for reporting purposes based onrealized and unrealized losses in institutional investment portfolios. In addition, changes in accountingrequirements for retiree health 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 available for general use. In order todetermine this amount, one must examine the level of funds that are liquid, and available for cash andspending.

Appendix 4, Tables 4 and 5 list total net assets and total unrestricted net assets. Variability within theindustry is notable, with 2008 unrestricted net assets ranging from a deficit of $19,975,522 for CaritasCarney Hospital and deficit of $8,412,776 for Merrimack Valley Hospital to surpluses of $951,528,000 forChildrens Hospital Boston and $710,281,000 for Massachusetts General Hospital. These hospitalsrepresented the extremes in 2007 and 2006 as well. Most, but not all, hospitals saw a decrease in theirunrestricted net assets from 2007 to 2008. Asset valuation for hospitals within systems, however, must bereviewed with an eye toward holding company impacts as well (see Section VII).

Changes in net assets indicate how much the hospital is adding or subtracting from its assets from one yearto the next. Multiple years of negative change in net assets severely hamper a hospitals ability to remain inoperation. Appendix 4, Table 6depicts the changes in net assets at Massachusetts hospitals from 2005 to2008.

While many hospitals appear to have added to net assets from 2005 to 2007, the vast majority of hospitalsin the Commonwealth experienced difficulties in 2008. This was driven in large part by poor investmentperformance, poor operating results, accounting policy changes which necessitated funding defined benefitplans for pension and retiree health care programs, and changes in the valuation of malpractice reserves.Nineteen hospitals had negative changes to their net asset levels on two or more occasions in the past fouryears.

Hospital unrestricted net assets may be used as one indicator of growth in discretionary net assets.Seventeen hospitals experienced decreases in unrestricted net assets in at least two years from 2005


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through 2008.45 The degree to which these decreases are short-term depends on the hospitals overallsituation and cannot be determined from financial data alone.

In addition, hospital Boards may designate funds to be used for specific purposes. Boards may establishrestricted accounts to provide a cushion of operating cash, allow a hospital to withstand a downturn inoperating and/or investment performance, save for a particular project, or protect against unforeseenevents. Board-designated funds may also be a requirement of a bond covenant. Forty-two hospitals hadover $10 million in Board-designated non-current assets in 2008.46 Unlike some of the other assetcategories, these assets are typically liquid, although not in the short-term.

The level of permanently restricted assets held by each hospital is collected by DHCFP. Appendix 4,Table 8 depicts temporarily restricted net assets by hospital for the years 2005 through 2008. Appendix 4,Table 9 depicts permanently restricted net assets. Figure E below notes the sixteen hospitals with morethan $10 million in permanently restricted net assets in 2008. In Appendix 4, Table 10, permanently andtemporarily restricted assets for 2008 have been added together to gain an understanding of the level oftotal restricted net assets by hospital. When the permanently restricted and temporarily restricted assets arecombined, restricted assets still total more than $10 million for only thirty hospitals, less than half of thetotal number of hospitals. System-wide, restricted net assets amount to approximately $3.6 billion, equal tothe value of Board-designated assets in that same year.47

45 See Appendix 4, Table 7.46 See Appendix 4, Table 11a.47 See Appendix 4, Table 11a and 11b. Since Board-designated asse

Documents

Hospital Reserves3