Hospitals Face New Financial Threat of Charity Care Legislation

<p>As tax-exempt hospitals and health care systems
continue to struggle with declining reimbursement, class action
lawsuits, property tax exemption and other financial challenges, the
stakes are being ratcheted up significantly by recent legislative
initiatives at both the federal and state level to impose greater
charity care commitments on tax-exempt hospitals, including
threatening revocation of economically favorable tax-exempt status. In
Illinois and New York, in particular, legislation was recently
introduced to impose mandates on the charity care provided by tax-exempt
hospitals. </p><p>While the Illinois bill has been tabled until a future
legislative session, the New York measure was passed and has been
signed into law. At the same time, federal legislation may be just
around the corner, as Congress continues to scrutinize tax-exempt
hospitals and the IRS prepares to launch its latest initiative
regarding the community benefits being provided by tax-exempt hospitals.
With this as the playing field, hospital leaders, their advisors,
investors and rating agencies understandably may feel greater pressure
on their financial prospects in months and years to come.

</p><p><b>Illinois Legislation</b> </p><p>In late January, Illinois Attorney
General Lisa Madigan proposed legislation that would impose specific
charity care requirements on Illinois hospitals. The Tax-Exempt
Hospital Responsibility Act (TEHRA), H.B. 5000, 94th Gen. Assem., Reg.
Sess. (Ill. 2006), would require that to maintain their tax-exempt
status under Illinois' income, sales and use, service, retailers and
property tax codes, all tax-exempt Illinois hospitals must implement
charity care policies providing free or substantially discounted care
to poor uninsured individuals. Patients having household income up to
150 percent of the federal poverty level would qualify for free care,
and hospitals would be prohibited from issuing bills to patients who
qualify for this full charity care. (In 2005, the federal poverty
level was $9,570 for a single person and $19,350 for a family of four.
Accordingly, under the proposed legislation, hospital services would
be provided free of charge to a single person earning less than
$14,355 in annual income, or to a family of four earning less than
$29,025.) In addition, hospitals would be required to provide patients
with income between 150 percent and 250 percent of the federal poverty
level with deep sliding-scale discounts, such that affected patients
could be asked to pay only between 20 and 35 percent of a hospital's
<i>costs</i> of providing the services; further, a patient's total bill
would be capped at $10,000 per year—thereafter, the patient
would become eligible for full charity care. For those patients unable
to pay their share of a discounted bill in one payment, hospitals also
would be required to offer an interest-free payment plan. Hospitals
would have to screen each patient to determine whether he or she is
uninsured and would be prohibited from issuing bills to such uninsured
individuals until the patient's eligibility for charity care assistance
is established according to criteria to be determined by the attorney
general. These standards would replace the voluntary guidelines
adopted by many Illinois hospitals in 2003, which had provided for
free care up to 100 percent of the federal poverty level, and
discounts between 100 and 200 percent of the federal poverty level;
the voluntary guidelines provided for discounts based on hospital
<i>charges</i>, rather than costs. </p><p>The most eyebrow-raising aspect
of TEHRA, as originally proposed, is a requirement that all tax-exempt
hospitals must provide uncompensated care in an amount equal to at
least <i>8 percent of their total operating costs</i>. For these
purposes, "uncompensated care" would include charity care,
bad debt, Medicaid shortfalls and certain other charitable programs
approved in advance by the state. At the time that she announced the
new legislation, Attorney General Madigan noted that not a single
Illinois hospital would currently meet the 8 percent requirement.
</p><p>The Illinois Hospital Association (IHA) and its constituency
responded to the proposed legislation with the claim that the
financial burdens imposed upon hospitals would be
"staggering." The IHA cited statistics indicating that
Illinois hospitals already provide approximately $1.2 billion in free
care annually, plus substantially more (estimated at $3 billion total)
in uncompensated services and Medicaid shortfalls. Using 2003 data,
the IHA observed that the 133 Illinois hospitals that would be subject
to the bill would have been required to provide $739 million
<i>more</i> in uncompensated care. With one-third of the state's
hospitals already operating at a loss (and 22 having closed in the
past decade), a significant portion of the state's health care providers
could be pushed into bankruptcy, the IHA predicted. The IHA also
predicted that the new requirements could push an additional 45
hospitals, currently operating with a positive margin, into the red.
In hearings before the Heath Care Availability and Access Committee of
the Illinois House of Representatives and in other public statements,
opponents of TEHRA argued that when hospitals lose money, they cannot
simply raise prices. Rather, approximately one-half of all hospital care
is paid by Medicare and Medicaid in amounts that do not even cover
hospitals' costs of providing that care. Thus, hospitals will have to
shift the shortfalls to insured patients and private payers. At a time
when an increasing number of employers are cutting back on
employer-funded health benefits, the already-troubled health care
system may well face a crisis of untold proportion—almost
certainly exacerbating current concerns with lack of access to health
care services—<i>i.e.</i>, exactly the problem sought to be
addressed by the Illinois legislation. </p><p>By late March, TEHRA remained
before the Illinois House Rules Committee. After discussions between
Attorney General Madigan and the IHA, it was agreed that no further
action would be taken on TEHRA during the Spring 2006 legislative
session. Rather, the parties agreed to negotiate further and to
reintroduce a bill in the Spring 2007 session. </p><p><b>New York
Legislation</b></p><p> The New York bill took a different approach, focusing
not on hospitals seeking to maintain tax-exempt status but rather on
New York hospitals receiving funds from the state's indigent care
pool. Citing a need to ensure consistent treatment throughout the
state for patients who are either uninsured or have exhausted their
health insurance, the legislation set forth various additional
conditions for participation in the state pool. </p><p>As of Jan. 1, 2007,
participating hospitals must maintain financial assistance policies
providing free or discounted care for low-income individuals who are
uninsured or for insured individuals who have exhausted their coverage
and are unable to pay full charges. Specifically, individuals with
incomes below 300 percent of the federal poverty level may not be
charged more than the rates that would be paid by the hospital's
largest non-governmental payor for the prior year, or by Medicare or
Medicaid, for the same services (whichever is greater). Beyond that,
patient charges would be further adjusted applying a sliding scale for
discounts, with categories of household income in comparison to the
federal poverty level. Patients with household incomes of under 100
percent of the federal poverty level could be charged "no more
than a nominal payment amount." Patients with household incomes
of between 101 percent and 300 percent of the federal poverty
guidelines would be subject to a sliding scale, with proportionate
increases in this range up to the cap set forth above. The legislation
establishes these broad requirements but acknowledges that exceptions
may be appropriate in certain cases. Hospitals could develop policies to
address exceptions on a case-by-case basis, but such policies must be
presented to the New York Department of Health for prior approval.

</p><p>Unlike the Illinois measure, however, the New York bill <i>did
not</i> include an express amount of charity care required to be
undertaken by hospitals. The bill was approved by the New York
Legislature and signed by Governor George Pataki in April. The New
York legislation includes various "teeth" by requiring
hospitals to report to the Department of Health within 90 days
following the effective date of the legislation (<i>i.e.</i>, by the end
of March 2007) regarding their current financial assistance practices,
and to make additional reports on an ongoing basis. </p><p><b>Federal
Outlook </b></p><p>Over the past two years, no fewer than three
Congressional committees (including the House Ways and Means
Committee, the House Energy and Commerce Committee, and the Senate
Finance Committee) and numerous subcommittees have taken upon
themselves the task of scrutinizing nonprofit organizations and, in
particular, nonprofit health care providers. Congressional leaders
have asserted that these inquiries are warranted, given that the legal
standards for §501(c)(3) tax-exempt status of health care
organizations were established more than 35 years ago. Such standards
(which do<i> not</i> impose an express charity care requirement,
outside of emergency circumstances) remain largely unchanged still
today, although the health care industry has evolved such that today's
provider environment bears little resemblance to that which existed
when the standards were established. </p><p>In testimony before the
congressional committees, a number of individuals called into
question, among other things, the distinction between nonprofit and
for-profit hospitals. At the 40,000-foot level, the common assertion
is that nonprofit and for-profit hospitals today are remarkably
similar in their operations and practices; the seeming absence of
substantial distinctions between the two types has led some civic
leaders and others to conclude that there is little basis for allowing
nonprofit hospitals to enjoy federal income tax exemption (and the
other benefits that flow from §501(c)(3) status, such as the
ability to receive tax-deductible contributions and the opportunity to
utilize tax-exempt bond financing), while for-profit hospitals pay
substantial tax bills. </p><p>Witnesses appearing before the congressional
committees offered statistics to the effect that while nonprofit
hospitals may offer <i>some</i> additional amount of uncompensated
care (defined to include both true "charity care" as well as
amounts written off as uncollectible) in comparison to for-profit
hospitals, the differential is not nearly as large as the public is led
to believe. By comparison, governmental hospitals appear to provide
substantially greater levels of uncompensated care than either
nonprofit or for-profit hospitals. Institutions in all three classes
of hospitals (governmental, nonprofit and for-profit) tend to view
themselves as providing significant "community benefits,"
and all tend to report a wide range of programs and services as
demonstrating their dedication and service to the communities in which
they are located. Critics of nonprofit health care, however, have
suggested that the typical "community benefit" measures used
in today's health care industry are simply what any business would do
to attract customers, enhance its market reputation, or stay in touch
with its customer base. Some critics have launched more personal
charges as well, to the effect that the boards of nonprofit health
care institutions (which by tax law are required to include a majority
of independent community leaders) are predominantly comprised of
largely uninformed and disconnected businessmen who simply rubber-stamp
the decisions of health care executives, including approval of
executive compensation and benefits packages that are exorbitant and
incompatible with a nonprofit mission.

</p><blockquote><blockquote>
<hr>
<big><i><center>
With the number of uninsured Americans currently estimated at more than
45 million, the pressure for state and federal legislators to do
something is tremendous.
</center></i></big>
<hr>
</blockquote></blockquote>

<p>Although generally outnumbered by critics of nonprofit health care,
some representatives of the nonprofit health care sector have come
forward to offer a defense. Witnesses before the congressional
committees pointed to studies suggesting that nonprofit hospitals are
more likely than for-profits to offer certain types of health care
services that, although important or even essential, are unprofitable
(for example, psychiatric emergency services, home health services,
child and adolescent psychiatric care, AIDS treatment, and alcohol and
drug treatment). Other studies show that nonprofit hospitals are less
market-sensitive than for-profits and are more likely to preserve
their facilities and programs during economic downturns. Others
commented that while government authorities may be inclined to impose
rigid formulas defining a required amount of charity care or community
benefit, such standards are intrinsically flawed since "community
benefit" is not susceptible to measurement in sheer dollars; for
example, certain types of programs and services offered by nonprofits
are relatively low-cost, but may have a substantial positive impact on
community health.</p><p> In the wake of these hearings, congressional
leaders have signaled their intention to offer proposed legislative
reforms, including those that are aimed at the nonprofit sector
generally (including, but not limited to, hospitals and health care
institutions), and those that are aimed at nonprofit health care
specifically.</p><p> In the former category, the proposed measures vary
wildly, with some that are quite far-reaching in their approach. Most
proposals, however, consistently focus on enhancing federal and state
enforcement mechanisms, substantially modifying and expanding IRS
reporting and public disclosure provisions, implementing improved
financial oversight, bolstering the quality of governing boards and
improving their processes and accountability, and imposing both
substantive and procedural standards for executive compensation. </p><p>As
to nonprofit health care providers specifically, proposals have been
presented calling for, among other measures, hard and fast charity
care and community-benefit formulas, mandated community-needs
assessments, expanded reporting of charity care and community-benefit
practices, limitations on the amounts that can be charged to uninsured
patients, requirements for medical debt-repayment plans, and
constraints on debt-collection practices. </p><p>As with all legislative
matters, the outlook is necessarily uncertain. In recent months, House
and Senate leaders have focused their efforts on certain limited
reforms in the nonprofit sector generally, rather than health care
institutions specifically. Nonetheless, Senate Finance Committee Chair
Charles Grassley (R-Iowa) heightened health care institutions'
concerns when in May 2005 he contacted 10 large health care systems,
posing extensive inquiries regarding their charity care and community
benefit practices. That was followed by inquiries to the Catholic
Health Association and the American Hospital Association in early 2006,
with those organizations providing responses in April and May,
respectively. All of this congressional digging sets the stage for the
IRS's newest initiative—an inquiry into the community-benefit
practices of tax-exempt hospitals. Specifically, the IRS has indicated
that beginning sometime before the end of the government's 2006 fiscal
year (<i>i.e.</i>, before Sept. 30), it will contact roughly 600
hospitals across the country to learn more about their charity care and
community-benefit practices or, as others have expressed, what
hospitals are doing to "earn" their tax-exempt status.

</p><p><b>Implications for Health Care Financing</b></p><p> The current
legislative and regulatory climate has understandably created anxiety
in the nonprofit health care sector. Under the proposed Illinois TEHRA
legislation and other similar proposals, tax-exempt hospitals would face
increased financial pressures in satisfying requirements that a
certain percentage of operating costs be applied to uncompensated
care, while those entities that were unable to meet the percentage
requirement would face the grave possibility of losing their
tax-exempt status. Among other things, the loss of tax-exempt status
could result in substantial tax liability for hospitals, as well as the
acceleration of tax-exempt bond debt that had suddenly lost its tax
exempt status. In the case of Illinois, the proposed legislation has
already had a tangible impact on health care financing. The IHA
predicted that TEHRA's requirements would push many hospitals toward
financial instability, causing credit ratings to plunge. In February
and March, various investment banks warned that the mandates of the
Illinois legislation could result in hospital bond ratings being
downgraded, and could substantially reduce hospitals' access to
capital. Most notably, Standard and Poor's (S&amp;P) observed that
TEHRA "could potentially lead to lower ratings, more expensive
access to capital and an inability to maintain state-of-the-art
services." S&amp;P warned that hospitals may encounter difficulties
in getting bond insurance, thereby increasing the cost of capital and
putting more pressure on already-strained margins. Hospitals across
the state reported that rating agencies were conducting interviews to
determine the practical implications of the legislation. In addition,
at least two Illinois hospital bond issuances were put on hold, as
insurers expressed concerns regarding the impact of the proposed
legislation on future operations. S&amp;P has also noted that "the
charity care issue is gaining in importance across the nation because
of the growing number of uninsured and underinsured patients, who
threaten the margins of not-for-profit health care
providers."¹ These circumstances led certain industry
advisors to speculate on the prospect of class action lawsuits by
bondholders, presumably upset with the loss in bond values, against
hospital boards of directors for purported violations of fiduciary
duties arising from hospitals' fee structures and their billing and
collection practices. </p><p><b>Conclusion </b></p><p>While hospitals in
Illinois may be breathing a sigh of relief for now, it is virtually
certain that charity care legislation imposing expanded charity care
commitments on hospitals will be back in 2007 in Illinois and other
jurisdictions. With the number of uninsured Americans currently
estimated at more than 45 million, the pressure for state and federal
legislators to do <i>something</i> is tremendous. But as the response
of the capital markets to Illinois' proposed TEHRA legislation
suggests, doing "something" may have serious long-term and
unintended consequences on the ability of tax-exempt hospitals and
health care providers to gain access to the capital that they need.
</p><h3>Footnotes</h3><p> 1 Shields, Yvette, "Midwest Bond-Watch:
Illinois: Charity Bill Warnings," <i>The Bond Buyer</i>, Vol.
355, March 22, 2006.</p>