N YAHSA PUBLIC POLICY SERIES

January 2004

Fighting for Survival: The Dire State of Nursing Home Finances in New York State
EXECUTIVE SUMMARY
Analysis of newly released nursing home financial statements shows that more and more nursing homes in New York state are slipping into serious financial distress. Almost all of the negative trends observed in the past several years continued unabated. Some became more severe. Each year, New Yorks nursing homes are required to submit cost reports to the New York State Department of Health (DOH). These reports include each facilitys certified financial statements and other financial data. NYAHSA has analyzed this financial information for 524 facilities (about 77 percent of all nursing homes in the state) that filed calendar year cost reports for 2000, 2001 and 2002, and used it as the basis for this comprehensive report. This is the fourth year that NYAHSA has analyzed nursing home finances in this way. Each year since 1997, we have observed and reported an uninterrupted downward trend in nursing home financial performance. The conclusions have been similar: based on a variety of financial indicators, the fiscal standing of New Yorks nursing homes has declined each year. Not only have the indicators shown a continuous deterioration of nursing home finances, but the financial condition of many individual facilities was disastrously poor, with many on the verge of bankruptcy.1 The financial condition of nursing homes in the state continued to deteriorate in 2002, primarily as a result of severe Medicaid underpayments resulting from an outdated payment methodology and years of Medicaid rate cuts, as well as spiraling costs for items such as insurance and pharmaceuticals. These declines reached several disturbing milestones in 2002. When analyzing nursing home financial statements, the question no longer is whether the analysis will show financial deterioration. Rather, the question is how much worse the financial condition will be than in the previous year, how many more homes will have dropped below any semblance of financial health, and how many more will join the ranks of those on the verge of serious (Continued on next page)
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Among the major findings of this analysis are the following: 1. A majority of the nursing homes in New York state lost money on operations in 2002. 2. 2002 marks the first time that nursing homes collectively lost money from operations. 3. For the first time, the total bottom line for all nursing homes was negative. The number of nursing homes with bottomline losses increased dramatically from 2000 to 2002. 4. Rural nursing homes, often the only providers in their communities, were in worse financial health than their urban counterparts. 5. All public homes in the study lost money, due in part to a reduction in federal Medicaid funding. 6. More than a third of voluntary nursing homes face a heightened risk of bankruptcy or insolvency.

NYAHSA Report, Sounding the Alarm: New Yorks Nursing Homes in Financial Crisis, December 2002. For more insight into the financial status of not-for-profit and public nursing homes, see NYAHSA report, 2002: The Worst Year Yet for Not-for-Profit and Public Nursing Home Finances, February 2003. All NYAHSA reports are available at www.nyahsa.org.

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Executive Summary
(continued from page 1)

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Figure 1 Statewide Versus Sample Nursing Homes

STATEWIDE
Sponsor Voluntary Proprietary Public TOTAL Number 309 322 56 687 Percentage 45.0% 46.9% 8.0% 100.0%

financial disruption or bankruptcy. In 2003, New York lost eight nursing homes, affecting the western and northern parts of the state as well as the Capital Region. The 2002 financial conditions described in this report contributed or led to these closures. The $2 billion in cuts made to nursing home reimbursement since 1995 have helped to cripple many facilities, with inadequate inflation adjustments in the Medicaid system effectively acting as further annual funding cuts. State legislators deserve commendation for rejecting proposed Medicaid cuts in the 2003/04 budget that would have exacerbated the crisis. Additional cuts would have precipitated even more facility bankruptcies and closures, disrupting the lives of residents. We urge lawmakers to reject any additional reductions in nursing home payments in the 2004/05 fiscal year. We applaud recent efforts to address the need to reform the states Medicaid program and long-term care infrastructure. We are hopeful that these efforts will lead the way towards a system that will cover the actual costs of delivering nursing home care, provide seniors in need with the most appropriate services, and do so in a sustainable, coordinated way.

SAMPLE
Number Percentage 236 251 37 524 45.0% 47.9% 7.1% 100.0%

NOTE: Statewide figures are current as of January 1, 2002.

Hospital-based nursing homes are under-represented in the analysis. Most of these facilities report nursing home financials on the hospital cost report, which is not readily comparable to the RHCF-4 report. Because recent analyses suggest that hospital-based nursing homes are in worse financial condition than their freestanding counterparts, their exclusion from this analysis means that statewide nursing home finances may be in even more dire condition than presented here.5 As part of this analysis, NYAHSA examined facilities2000, 2001 and 2002 certified financial statements to detect significant changes in reported dollar amounts (e.g., operating income, net income, etc.). While the dollar amounts that appear in financial statements are significant on their own, they only help somewhat in assessing the relative financial condition of an organization. Financial ratio analysis is a widely accepted analytical tool that pinpoints and isolates significant relationships between the figures found in financial statements. These relationships can occur between various figures in the same accounting period or to values in previous years. Using balance sheets and income statements, we calculated a series of financial ratios and examined them closely for emerging or continuing trends over the three-year period. The ratios we selected are widely accepted and used by investment bankers, mortgage bankers, and debt-rating agencies involved in nursing home financing. For most of the ratios, we calculated median values. The median value represents the midpoint of a series of numbers and is most often the best indicator of central tendency. In a large set of values with few outlier numbers, the median and average are very similar. Although median financial ratios offer insight into the overall condition of the states nursing homes, they do not fully illustrate the financial condition of individual facilities. Therefore, we also examined individual facility ratio values over time, and used them to identify those nursing homes in the sample that are the most vulnerable from a financial perspective.

ABOUT NYAHSAS ANALYSIS

NYAHSAs analysis is based on the 2000, 2001 and 2002 Data Collection Masterfile (DCM) obtained from the DOH. The DCM is a computerized database that contains the Residential Health Care Facility Version 4 (RHCF-4) cost reports that nearly all nursing homes in New York state file each year.2 Among other things, the RHCF-4 report includes complete financial statements, which must be prepared and certified by an accountant.3 NYAHSA constructed a matched sample of nursing homes for the 2000-2002 time period to obtain a more valid picture of nursing home finances over time. To be included in the matched sample, a facility must have filed a complete RHCF-4 report for each of the calendar years 2000, 2001 and 2002. This approach helps to improve the reliability and validity of year-to-year comparisons of financial performance. Our matched database of 524 nursing homes represents 77 percent of the total facilities in New York state, and closely approximates the overall proportions of voluntary, proprietary and public facilities as shown in Figure 1.4
The RHCF-4 report database includes only a subset of hospital-based nursing homes, which make up about 10 percent of all nursing homes in the state. Many of these facilities file a different report, the RHCF-2, which does not provide the financial data necessary for this analysis. 3 The financial statements in the RHCF-4 reflect, in certain instances, financial transactions with owners of proprietary facilities, their families and related companies. Every effort has been made to ensure that the analysis was confined to relevant nursing home financial activities. While we believe these types of transactions would not materially alter the basic conclusions of the analysis, an assessment of their effect on the financial condition of the facilities involved is beyond the scope of this report.
2

4 For ratios involving debt calculations (debt service coverage, long-term debt to total assets, and cushion ratio), medians are calculated using only those facilities that reported debt on designated lines of their cost reports. 5

Hospital-based nursing home data obtained from the Healthcare Association of New York State (HANYS) indicated that the median three-year operating margin for the years 1999 through 2001 for these facilities was negative five percent, significantly worse than the statewide median of negative 0.5 percent.

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KEY FINDINGS
This report highlights eleven key findings from our analysis, which are detailed below:

Figure 3

1. A majority of the nursing homes in New York lost money on operations in 2002.
For the first time since NYAHSA has been analyzing nursing home cost reports in this manner, more nursing homes lost money on operations than gained. The most fundamental gauge of an organizations day-to-day financial health, the operating margin, measures the relationship between expenses and revenues. A negative margin indicates that an organization is generating insufficient revenue to cover its expenses. It is calculated as the ratio of operating revenues minus operating expenses, divided by operating revenues. For the 524 nursing homes in our database, the median operating margin fell from a positive 1.5 percent in 2000 to a moneylosing negative 0.5 percent in 2002, with 52.5 percent of homes suffering an operating loss. The number of nursing homes that lost money on operations grew from 206 in 2000 to 275 in 2002, a 33 percent increase. in 2002. The median operating margin for all public facilities was negative for all three years. For half of these providers, the amount lost on operations exceeded 20 percent of their revenues in 2002. For a 250-bed-bed nursing home, the average size of a public home in the state, this negative 20 percent margin translates to a $4-5 million dollar loss. These deficits are placing extreme financial burdens on the county, municipal and state governments that operate these facilities. A total of 133 nursing homes (25% of the sample) lost money from operations all three years. Of this number, 78 percent were either voluntary or public homes. Growing numbers of nursing homes experienced operating losses mainly because patient care revenues did not keep pace with operating costs. For the median facility, operating expenses increased 3.6 percentage points more than patient care revenues between 2000 and 2002.

Figure 2

2. 2002 also marks the first time that nursing homes collectively lost money from operations.
As troubling as it is that a majority of the states nursing homes lost money in 2002, a more ominous development involves aggregate operating gains and losses. For the first time since NYAHSA began analyzing nursing home finances in a comprehensive way, statewide operating losses have outweighed operating gains. This means that if all of the homes in the state were considered as one nursing home, that nursing home would have been unable to cover its operating expenses with operating revenues. As Figure 4 shows, annually decreasing gains (profits for proprietary facilities and surpluses for voluntary/public facilities) have been surpassed by total operating losses. The net operating result for the matched set of nursing homes fell from a positive $137 million in 2000 to a negative $100 million in 2002. The total operating performance of voluntary nursing homes went from a $21 million net surplus in 2000 to a net loss of $74 million in 2002. Public facilities were already experiencing an aggregate net loss of $46 million in 2000, a figure that more than doubled to a net loss of $108 million in 2002. Figure 5 depicts the average operating loss, by sponsorship group, for nursing homes with negative operating margins. Between 2001 and 2002

We validated this troubling milestone against the operating results for all 594 nursing homes that filed a RHCF-4 cost report for 2002 to ensure that it was not a function of our matched sample. We found that 311 of the 594 homes, or 52.4 percent, reported an operating loss. This was almost identical to the 52.5 percent observed in the matched set. For not-for-profit facilities, hereinafter referred to as voluntary nursing homes, the trend was even worse, as indicated in Figure 3 below. The median operating margin for voluntary facilities plummeted from a positive 0.8 percent in 2000 to negative 1.9 percent in 2002, a precipitous drop of almost 3 percentage points. In other words, half of all voluntary nursing homes experienced an operating loss exceeding 1.9 percent of their operating revenues. In fact, 57 percent of the voluntary facilities in the sample lost money on operations in 2002. County and state operated facilities, commonly called public facilities, fared even worse than voluntary homes. Of the 37 public nursing homes in the sample, all 37 lost money on operations

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Figure 4

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to as total margin, net income or total surplus, is a measure of what remains after all expenses, operating and non-operating, are subtracted from operating and non-operating revenue. Negative values indicate that even when revenues from all non-recurring sources are factored in, they are insufficient to cover expenses. The aggregate bottom line for the facilities in the study fell by almost $300 million from 2000 to 2002, as shown in Figure 6 below. Of the 524 facilities in the sample, 72 percent experienced lower bottom lines in 2002 than in 2000.

Figure 6 Aggregate Bottom Lines of Nursing Homes in Sample: 2000 to 2002 (in $ millions)
2000 TOTAL $281.5 2001 $110.0 2002 $(16.8) $ Change % Change 2000-02 2000-02 $(298.3) -106%

alone, the total operating losses for money-losing facilities increased by 37 percent.

Figure 5

Figure 7 illustrates that the number of nursing homes that suffered bottom-line losses grew by 61 percent from 2000 to 2002. Of the 85 nursing homes that lost money all three years, two thirds were voluntary or public facilities.

Figure 7

Losses from operations are a serious issue, since they indicate a facilitys inability to meet ongoing operating expenses with reliable revenue sources such as patient service revenues. When a nursing home incurs an operating loss, it must try to cover it in one of two ways: (1) with non-operating revenues, which are often non-recurring (e.g., bequests), extraordinary (e.g., gains on sales of assets) or inaccessible for operations (e.g., income on restricted funds); or (2) from existing fund balances/equity sources. Of the 275 facilities in this situation in 2002, 90 percent were unable to cover these operating losses with non-operating revenues. As a result, these nursing homes experienced bottom-line losses during the year.

Figure 8

3. For the first time in recent memory, the total bottom line for all nursing homes was negative. The number of individual nursing homes with bottom-line losses also increased dramatically from 2000 to 2002.
Continuing the series of undesirable precedents, the aggregate bottom lines of all nursing homes in the analysis fell into negative territory for the first time in 2002. The bottom line, also referred

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The trend of falling bottom lines was even more pronounced for voluntary facilities, with more than half of these facilities losing money in 2002. The percentage with bottom line losses increased dramatically from 35 percent in 2000 to 59 percent in 2002, as shown in Figure 8. This means that income from sources such as fund-raising and reserves was insufficient to make up for the large operating losses sustained by the facilities. Additionally, voluntary nursing homes in our study reported net extraordinary losses totaling $41.5 million in 2002. These are one-time losses that are not reflected in the bottom-line figures presented above but can have a significant impact on facilities. Considering that voluntary facilities reported net extraordinary gains totaling $17 million in 2000, the combined effect was the subtraction of an additional $57.5 million from the aggregate bottom line for voluntary nursing homes. Although current national benchmarks are scarce, based on our calculations and 1998 national indicators, the median total margin of New Yorks voluntary nursing homes is lower than that of not-for-profit facilities in the nation.6

2001. This $99.1 million represented 10 percent of the total IGT payments made. Local governments and their nursing homes distribute and account for these revenues in a variety of ways. Many local governments allow their nursing homes to retain approximately 10 percent of the total IGT payment, although this figure ranges from 0 percent to 100 percent in other localities. Local governments often use IGT proceeds to reduce the local taxpayer subsidies that were needed to keep their nursing homes operating. Late in 1999, the federal government made changes to Medicaid laws and regulations that are directly impacting New Yorks nursing home IGT program. Based on current estimates, the federal government is gradually disallowing over $900 million of the $991.5 million IGT program over a multi-year period that started in 2002. Although New York state has been able to use other Medicaid funding sources to recapture most of the federal IGT funding it stands to lose, state policy makers have made no commitments to replace the IGT funds that public nursing homes and local governments are losing. Using information available from nursing home cost reports, we were able to identify the amount of IGT monies booked as revenues by 27 public nursing homes in our sample. Figure 9 illustrates the effect on the bottom lines, showing how the dismal financial picture of public nursing homes in 2002 becomes catastrophic when IGT funding is factored out.7

4. All public homes in the study lost money, due in part to a reduction in federal Medicaid funding.
In yet another troubling first, 2002 marked the first year of a multi-year federal phase-down of a source of revenue crucial to public nursing homes. This funding, known as the inter-governmental transfer (IGT) program, is based on a methodology that maximizes federal Medicaid funds that the state receives. IGT funding declined by nearly 18 percent from 2001 to 2002. By the time the phase-down is complete, the net amount the public homes and their sponsoring local governments receive will likely have dropped by more than $90 million. In 2002, all public homes in our sample had negative operating margins. Given the precarious financial state of public homes and the crucial role they play in the states long term care system, loss of this funding is a substantial threat for those who depend on these safety net providers and a significant hardship to local governments and taxpayers. Medicaid is jointly funded by federal and state governments and administered by the states. A few statesincluding New Yorkrequire county governments to finance a portion of the non-federal share of Medicaid costs through direct matching payments. Under the IGT program, local government funds take the place of the state share of Medicaid funding, thereby generating federal matching payments without incurring a state expense. New Yorks IGT program for public nursing homes began in 1995. In 2001, the 48 participating facilities received Medicaid IGT payments totaling $991.5 million. Under the program, the sponsoring local government provides the state and local shares of the payment (i.e., 50% in total). The remaining 50 percent of the funding comes from the federal government. New York state captures 80 percent of these federal funds, thereby leaving public nursing homes and their sponsoring local governments with a net benefit of 20 percent of the federal dollars, or $99.1 million in
6 HCIA-Sachs, LLC and Arthur Andersen, LLP, The Guide to the Nurs ing Home Industry (HCIA-Sachs, LLP and Arthur Andersen, LLP 2000), p. 6.

Figure 9 Public Nursing Home Finances Without IGT Income (in $ millions)
Financial Indicator Average Facility Net Income/(Loss) Total Margin Percentage of Facilities with Bottom Line Loss 2002 with IGT ($1.13) million -7.9% 85% 2002 no IGT ($2.50) million -19.2% 100%

The IGT program funding has helped public nursing homes to serve the poorest and most vulnerable seniors and disabled persons. Various factorsdifficult caseloads, increased mandates and relatively high payroll costsoften cause these facilities to run significant operating deficits. These funds have been used to modernize badly outdated physical plants, subsidize uncompensated care and address inadequate Medicaid payment rates.

5. Rural nursing homes, often the only providers in their communities, were in worse financial health than their urban counterparts.
Nursing homes located in the 44 counties defined as rural by the New York Rural Development Council were more likely to
7 Figures are based on 27 public nursing homes that reported IGT revenues in a readily identifiable manner. The remaining nine public facilities in the database reported these IGT revenues differently.

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experience losses, and the losses were likely to be larger than those experienced by their urban peers. Of the 126 rural facilities in the study, 75 percent saw their operating margins decrease between 2000 and 2002. The median operating margin for rural facilities in 2002 was a negative 4 percent, over 4 percentage points lower than the median of .01 percent for homes in urban counties.

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6. Liquidity continues to be a significant and growing problem for many nursing homes in New York State.
Four of five commonly used indicators of liquidity, indicators that measure an organizations ability to generate and collect sufficient cash to meet payroll and pay vendors, continued to decline between 2000 and 2002. A nursing homes ability to meet its short-term financial obligations without having to liquidate its long-term assets, or discontinue operations, is a very important factor in how lenders, investors and management define its financial condition. In the extreme, an inability to do so can result in bankruptcy and asset liquidation. More often, a lack of liquidity leads to technical insolvency, which limits a facilitys ability to invest in needed goods/services or to obtain credit. The current ratio measures how well an organization is able to meet short-term liabilities out of the cash value of its current assets. The median current ratio for all facilities in our sample fell from 1.32 in 2000 to 1.25 in 2002 (a 5.3% decrease). The median current ratio for New Yorks nursing homes is below the corresponding national figure for the most recent year available (i.e., 1998).8

Figure 10

In our study, 54 facilities located in rural counties (43% of the total rural facilities) lost money on operations in each of the three years examined (2000-2002). This figure stood at 20 percent for homes in urban counties. Often the only provider in a community, rural homes play a vital role in the long term care system. The closure of a rural facility is likely to result in residents needing to seek nursing home care that is further away from their community, family and friends. This was the case when Community Nursing Home in the St. Lawrence County town of Potsdam closed in 2003 due to unsustainable financial pressures.

A current ratio of less than 1.00 means that a nursing home does not have sufficient current assets to meet obligations coming due in the near future. The number of nursing homes in our sample with current ratios of less than 1.00 grew by 13 percent between 2000 and 2002. The 2002 figure of 193 facilities represents more than one third of all facilities in the sample. Days of cash on hand is a more refined liquidity measure that indicates how many days of operating expenses could be covered out of an organizations cash, cash equivalents, and liquid investments. The median number of days of cash on hand for the 524 sample facilities fell by 23 percent from 2000 to 2002. As shown in Figure 12, over half of the nursing homes in the sample had less than 20 days of cash on hand in 2002. This

Figure 11

Figure 12

When we applied a composite measure called the Index of Risk (described in Section 11) to rural homes, we found that 41 percent of all rural facilities were at an elevated risk of bankruptcy or financial disruption. The rate for rural voluntary providers was even higher, topping 47 percent.

8 HCIA-Sachs, LLC and Arthur Andersen, LLP, The Guide to the Nurs ing Home Industry (HCIA-Sachs, LLP and Arthur Andersen, LLP 2000), p. 24.

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means that these facilities did not have enough cash and cash equivalents to cover three weeks worth of operating expenses. The importance of the twenty-day benchmark is discussed further in Section 10 of this report. Since a facilitys cash flow is largely determined by its net income or loss, bottom-line losses contribute to declines in liquidity. Almost 70 percent of the nursing homes with less than seven days of cash on hand in 2002 also lost money that year. Days in accounts receivable measures the average amount of time, expressed in average daily revenues, that elapses before accounts are paid. It is a useful tool for evaluating the timeliness of reimbursements from third party payers such as Medicaid and Medicare. Although still worse than most recently available national averages, this indicator showed a modest positive trend from 2000 to 2002. The median number of days in accounts receivable for the homes in the analysis declined slightly, from 52.2 days to 50.5 days. According to a recent report, the median days in accounts receivable for New Yorks facilities exceeded the corresponding national averages in every sponsorship group.9 Various factors can increase days in accounts receivable including delays in eligibility determinations, delays by payors in revising rates, changes in billing procedures and less timely payments from patients and/or their representatives. Because the ratio is calculated based on year-end financial data in this case, it is unable to measure variations in receivables during the year. For example, not reflected in the days in accounts receivable ratio for year end 2002 is the lag in recruitment and retention funding payments made to nursing homes. Many facilities increased salaries at the beginning of 2002 pursuant to new union contracts funded in part through recruitment and retention monies authorized in the Health Care Reform Act of 2002. Although these facilities paid the higher wages throughout the year, the need for federal approval of the program delayed disbursement of the funds until December. This issue, coupled with the need to make payments on the six percent gross receipts tax, made managing cash flow especially difficult for many homes in 2002. Days in accounts payable (also known as average payment period) measures the average amount of time, expressed in average

daily operating expenses, that elapses before payables are met. As shown in Figure 13, the statewide median value for this ratio was 17.9 days in 2002, up from 16.5 days in 2000. Stated another way, the median nursing home in New York owes the equivalent of about two and a half weeks worth of operating expenses to its vendors at any given time. Anecdotal information suggests that actual vendor payment periods are ranging between 15 and 150 days, depending on priority level (e.g., utility companies must be paid timely). Since some vendors require accounts to be cleaned up at the end of the year, prevailing delays may be even longer than these values indicate. According to 1998 national data, both voluntary and proprietary facilities in New York had higher median days in accounts payable than their national peers.10 For 2002, 113 of the facilities in our sample (23 percent) had the equivalent of over 30 days of expenses in accounts payable, and 19 of these facilities had values greater than 60 days. While delaying payments to vendors is often good financial practice, it can lead to strained relations with vendors and ultimately higher prices for goods and services, due to unavailability of purchase discounts and the imposition of cash on delivery payment terms in more extreme cases. The operating ratio is another indicator that suggests that many nursing homes are having difficulty generating enough cash to meet operating expenses. The ratio, calculated by dividing cash operating expenses by cash operating revenues, is less than 1.00 if a facility is generating net cash from operations. In 2002, 188 facilities had operating ratios above 1.00, a 53 percent increase over the previous year. During the 2000-2002 period, the operating ratios of 381 facilities (73%) increased, a negative trend for this indicator. The median value in 2002 for all facilities was 0.98, up from 0.95 in 2000.

7. New Yorks nursing homes are having more difficulty covering their borrowing costs.
Whereas liquidity ratios try to measure an organizations ability to pay for day-to-day operating expenses, coverage ratios measure the facilitys ability to repay debt such as a mortgage. They measure a nursing homes relative riskiness as a borrower. Facilities with poor scores on these indicators may have a difficult time making timely payments on their long-term debt. Facilities with unfavorable coverage ratios are likely to find it hard, if not impossible, to borrow money for needed improvements or renovations. The cash flow to total debt ratio is a well-regarded indicator of debt repayment ability and has been shown to predict bankruptcy. It is calculated by dividing cash flow (i.e., net income/loss plus depreciation expense) by current liabilities plus long-term debt. As with other coverage ratios, lower values are associated with greater risk of default on fixed payment obligations. Figure 14 shows the 2000, 2001 and 2002 values for this ratio for all facilities and by sponsorship group.

Figure 13

Ibid, pp. 5, 6, 95.

10 Ibid, pp. 5, 6, 95.

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Figure 14

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value used by lenders. Figure 16 indicates that the number of voluntary facilities with coverage ratios of less than 1.1 rose from 60 to 94 (a 57% increase) from 2000 to 2002.

Figure 16

Overall, the median ratio fell by 51 percent from 2000 to 2002. This drop is not surprising, given that cash flow is largely dependent on total margin, which fell by nearly $300 million from 2000 to 2002 (see Figure 6). Voluntary facilities, which are the most dependent on long-term debt, showed the lowest debt repayment ability during the three-year period examined, although catastrophic bottom line losses experienced by public homes pulled their 2002 median into the negatives. The number of voluntary nursing homes with a ratio value of less than ten percent increased from 135 in 2000 to 175 in 2002, a 30 percent increase. Debt service coverage is a commonly used measure of an organizations ability to repay long-term debt or other fixed payment obligations. It compares the total amount of funds available for debt service to a specific years principal and interest obligations. Lenders frequently require borrowers to maintain minimum debt service coverage ratios through what are known as loan covenants (i.e., conditions in the loan agreement). The median debt service coverage ratio for all nursing homes also fell dramatically from 2000 to 2002, as shown in Figure 15 below. Based on the 2002 figures, the median coverage ratio for voluntary nursing homes stood at 1.2, while the public facility median slid to 0.5.

Another commonly used indicator, the cushion ratio, indicates if a facility has an unsustainable debt level or a cash balance that is too low to meet obligations. It is calculated by dividing the sum of cash, drawings and investments (including board designated funds) by annual debt service. A ratio below 2.5 indicates a lack of cushion to service debt. Of 418 facilities for which we were able to calculate cushion ratios, 241 (58 percent) had a cushion ratio below the 2.5 threshold in 2002. As shown in Figure 17, two thirds of all voluntary facilities lacked the debt service cushion that financial analysts deem appropriate.

Figure 17

Figure 15

8. Voluntary and public sponsors, many of which are experiencing financial difficulties, also have the oldest physical plants on average.
While hands-on care is a critical component of nursing home services, so too are residential services. This means that the physical plant plays a major role in care delivery, and that ongoing investments in fixed assets are vitally important. Since fixed asset investments are necessary and can represent a major use of funds, any analysis of nursing home finances should take inven-

In 2002, 40 percent of all nursing homes reporting debt had debt service coverage ratios of less than 1.1, a standard threshold

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tory of the age of existing fixed assets. The age of the assets can be considered a proxy for the need for investments in property, plant and equipment. Since it is not practical to catalog the age and remaining useful life of all nursing home fixed assets, the average age of plant ratio provides a relevant measure of the accounting age of fixed assets. This ratio is calculated by dividing a facilitys total accumulated depreciation on its physical assets by its annual depreciation expense. Figure 18 identifies the median average age of plant for 2002 by sponsorship group. As shown, proprietary facilities had the lowest median accounting age, followed by voluntaries and publics. Ironically, those facilities that are experiencing financial difficulties and have older physical plants in need of upgrades will also have the most difficulty securing financing and needed equity capital.

Figure 18

9. Most of the financial indicators we examined are showing downward trends for New Yorks nursing homes.
For most of the ratios and financial statement values we examined, we have provided either aggregate numbers or median values by year. We also analyzed these indicators at the facility-level to identify trends or patterns over the three-year period. As shown in Figure 19, the prevailing trends from 2000 to 2002 are decidedly negative for all but one of the indicators.

10. Growing numbers of voluntary nursing homes would not be considered creditworthy.
As previously indicated, many lenders (e.g., commercial banks, mortgage banks, etc.) impose restrictions on borrowers known as loan covenants. When an organization violates any of its loan covenants, it is typically considered to be in technical default on the loan. When this occurs, the borrower should expect its lender to: (1) monitor monthly results closely; (2) often be re-

Figure 19 Facility-Level Trends on Key Financial Indicators: 2000 to 2002

Indicator 1. Operating Income/Loss 2. Total Margin (i.e., net income/loss) 3. Current Ratio 4. Days of Cash on Hand 5. Days in Accounts Receivable 6. Days in Accounts Payable 7. Cash Flow to Total Debt 8. Debt Service Coverage 9. Average Age of Plant 10. Liabilities to Assets Facility-Level Findings 366 of 524 facilities (70%) with lower operating income in 2002 than 2000 375 of 524 facilities (72%) with lower total margin in 2002 than 2000 316 of 524 facilities (60%) with lower current ratio in 2002 than 2000 326 of 523 facilities (62%) with fewer days of cash on hand in 2002 than 2000 222 of 515 facilities (43%) with more days in accounts receivable in 2002 than 2000 261 of 500 facilities (52%) with more days in accounts payable in 2002 than 2000 355 of 524 facilities (68%) with lower cash flow to total debt in 2002 than 2000 291 of 450 reporting facilities (65%) with lower debt service coverage in 2002 than 2000 382 of 509 facilities (75%) with greater average age in 2002 than 2000 325 of 524 reporting facilities (62%) with higher liabilities to assets ratio in 2002 than in 2000 Desired Trend Increasing for most Increasing for most Increasing for most Increasing for most Decreasing for most Decreasing for most Increasing for most Increasing for most Decreasing for most Decreasing for most Actual Trend Unfavorable Unfavorable Unfavorable Unfavorable Favorable Unfavorable Unfavorable Unfavorable Unfavorable Unfavorable

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luctant to extend additional credit; and (3) possibly even require the loans immediate repayment. According to nursing home financing experts, the following three covenants are most commonly found in loan agreements: Typical Nursing Home Loan Covenants 1. Current ratio of 1.00 or greater; 2. At least 20 days of cash on hand in any year, and 45 days over two years; and 3. Debt service coverage of 1.10 or greater in any year, and 1.25 over two years. This portion of the analysis focuses on voluntary nursing homes because facilities in this sponsorship group are the most dependent on long-term financing from external sources. To further illustrate this point, the 2002 median ratio of long-term debt to total assets for voluntary facilities was 0.48, versus 0.09 and 0.18 for proprietary and public facilities, respectively. Figure 20 identifies the growing number of voluntary facilities that failed each of these three tests and all three of them during the period 2000 to 2002.

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11. Many voluntary nursing homes are at risk of bankruptcy or serious financial disruption.
We applied a model called the Index of Risk11 to the nursing homes in our sample for which we had sufficient data to calculate all six indicators to determine which facilities are at the most risk of bankruptcy or severe financial disruption. Individual financial ratios may point in different directions and give the reviewer an unclear picture of the overall level of financial risk of a particular organization. The Index of Risk combines a number of financial ratios, each of which has been shown to have some use in predicting business failures and bankruptcies.

Figure 22 KEY FOR CALCULATING INDEX OF RISK

Indicators and Ranges
1. Operating margin trend over a three-year period (45 possible points): Facilities with positive margins every year and rising margins Positive margins every year by no uniform trend in margins Positive margins every year but declining trend in margins Negative margin during first year followed by positive margins Negative margin in a single year other than first year Negative margin in first and second years, or first and third years Negative margin in all three years or in last two years 2. Operating margin in most recent year (5 possible points) Facilities with a positive margin Facilities with a margin between 0% and -2% Facilities with a margin lower than 2% 3. Days of cash on hand (10 possible points) Facilities with a ratio in the upper quartile of all facilities Second Quartile Third Quartile Fourth Quartile 4. Days in Accounts Receivable (10 possible points) Facilities with a ratio in the lowest quartile of all facilities Second Quartile Third Quartile Fourth Quartile 5. Days in Accounts Payable (10 possible points) Facilities with a ratio in the lowest quartile of all facilities Second Quartile Third Quartile Fourth Quartile 6. Total Liabilities to Total Assets (20 possible points) Facilities with a ratio in the lowest quartile of all facilities Second Quartile Third Quartile Fourth Quartile NOTE: Indicators are refined as discussed in end notes.
11 M. Tamari, Financial ratios: Analysis and Prediction (Paul Elek, Ltd. 1978), p.102-06. 12 For voluntary facilities, depreciation is not subtracted as a non-cash expense in the Days Cash on Hand and Days in Accounts Payable ratios, since depreciation reimbursement must be funded pursuant to DOH regulations. Meeting these regulatory requirements reduces a voluntary facilitys available cash.

12

Points

Figure 20

45 36 27 27 18 9 0 5 3 0 10 6 3 0 10 6 3 0 10 6 3 0 20 12 6 0

Based on 2002 figures, 185 of the voluntary nursing homes would have failed at least one of these three loan covenants. As shown below, this means that an astonishing 78 percent of the voluntary facilities in the sample would have been in technical default on their loans based on widely accepted loan covenants.

Figure 21

FIGHTIN G FOR SURV I VAL:

THE DI RE STATE OF NURSIN G HOME FIN ANC ES IN NE W YORK

11

As originally developed, the Index of Risk relies on a series of ratios that measure equity, cash flow, debt, and operating margin over a three-year period. We have adapted the index concept to measure a variety of ratios most relevant to nursing home performance. The scoring key we used for calculating our index of financial risk appears in Figure 22. The sum of the six individual scores is the Index of Risk score, which can range from 0 to 100. Based on the research underlying the original Index of Risk, firms with index scores of less than 30 points are much more likely to go bankrupt than those with scores greater than 60 points, and a majority of the firms with scores less than 30 points went bankrupt during the study period. In addition, firms with low index scores are more likely to remain in this category than firms with high index scores are to drop to a lower category.13 We found that 147 of the 487 total nursing homes for which we could calculate index values (i.e., 30%) were at greater risk of bankruptcy than other facilities with scores of less than 30 points as of the end of 2002. Of this total, 81 of the facilities were voluntary (representing 36% of all voluntary facilities); 52 facilities were proprietary (23% of all proprietary facilities); and 14 facilities were public (39% of all public facilities). We chose to focus our analysis on voluntary nursing homes because this sector is generally less able to rely on outside funding than other sponsorship groups. Figure 23 profiles the voluntary nursing homes with Index of Risk scores of less than 30. Most of these at risk voluntary facilities would have violated all three of the typical loan covenants discussed above.

makes these facilities highly vulnerable to funding disruptions, places them at risk of default, and leaves them without funds needed for future needs such as asset replacement. Growing numbers of nursing homes have low coverage ratios resulting from poor margins and excessive leverage. These facilities have little or no capacity to borrow additional funds to reconfigure their service delivery. Voluntary and public facilities continue to be hit especially hard by these downward trends. These are the very mission-oriented and safety net providers most likely to provide needed services to the most vulnerable New Yorkers, those whose care is the most difficult and least likely to be accompanied by sufficient reimbursement. Nursing homes in rural counties, including many that are sole providers of service in their communities, are also especially vulnerable. Voluntary and public facilities tend to be older from an accounting perspective than their proprietary peers, and are less capable of replacing or upgrading aging assets due to lower margins and other factors. Most of these facilities were constructed in New York before 1980, and many are now in need of replacement or substantial renovation. In addition, public facilities are very dependent on a Medicaid revenue source that is being phased-out by the federal government. What should be most alarming are the implications to the states elderly and disabled persons that these figures represent. Voluntary nursing homes must use donations and reserves to subsidize ongoing operations, rather than investing them on programs and initiatives that further enhance the quality of life of residents or expand services in their communities. Public nursing homes are forced to rely on subsidies from increasingly strapped local taxpayers. Even the boldest and most innovative providers face a level of financial insecurity that inhibits many innovations that would benefit the lives of elderly and disabled persons. When a home is no longer able to endure the financial strain and slips into bankruptcy, the human costs to frail seniors and disabled individuals whose lives are disrupted can be significant. The stress of leaving a familiar place that is home is stressful for anyone. It is even more stressful for an elderly person with dementia. The difficulties many providers are experiencing are not the result of a bad year or a temporary setback from which they can easily recover. These are symptoms of organizations under severe stress that have seen their financial condition deteriorate year after year. That most New York nursing homes are able to continue providing high quality service while facing such financial challenges is a testament to the dedication and perseverance of providers and their staff. At the core of much of the financial stress among nursing homes are inadequate Medicaid payments due in large part to the antiquated 1983-based reimbursement mechanism used in New York and the continuing effects of previous budget cuts. As Figure 24 shows, median operating margins for homes whose Medicaid reimbursement is based on 1983 costs (those with a 1983 base year) were noticeably worse than for facilities with a more recent base year. In 2000, the typical nursing home in New York lost more than $13 per day on each Medicaid resident they served, a figure that grows each year as Medicaid inflationary adjustments fail to keep up with growth in costs. With 70 percent or more of nursing home residents relying on Medicaid, this is a formula that can only lead to financial ruin.14
14 NYAHSA Report, Medicaid Payments to New Yorks Nursing Homes: Fact vs. Fiction, April 2003.

Figure 23
Profile of Voluntary Nursing Homes with Low Index of Risk Scores 81 voluntary facilities with scores of less than 30 Median score of 17 64 (79 percent) were located outside of New York City 28 percent were in rural counties, versus 22 percent of all voluntaries 55 (68 percent) failed all three loan covenants discussed in Section 10

CONCLUSION
The declines in nursing home finances that began in the 1990s continued in 2002. Along with the continuation of negative trends, 2002 was a year marked by several troubling milestones. For the first time: (1) the majority of the states nursing homes lost money on operations; (2) aggregate operating losses exceeded aggregate operating gains and total bottom line losses exceeded total bottom line gains; and (3) it cost every single public home in our study more to operate than they were able to generate in operating revenues. This included the state-run veterans homes. By any measureprofitability, liquidity, debt financingNew Yorks nursing homes are in financial difficulty. As losses erode a facilitys balance sheet, they limit the homes capacity to borrow for financial needs, particularly long-term needs. Poor liquidity
13

Ibid, p.102-06.

New York Association of Homes and Services for the Aging 150 State Street, Suite 301 Albany, New York 12207-1698 518-449-2707 518-449-8210 (fax) www.nyahsa.org

N YAHSA PUBLIC POLICY SERIES

Fighting For Survival: The Dire State of Nursing Home Finances in New York
Figure 24
With more specific regard to nursing home payments, we support the proposal of the Governors Health Care Reform Working Group to convene a group of key stakeholders to review the current reimbursement system. As important as fundamental reform is, however, the data in this report shows that many providers may not survive long enough for fundamental changes to take place. The state must act to provide immediate assistance to those facilities that are on the brink of financial disruption due to inadequate Medicaid reimbursement. State lawmakers should: (1) immediately update Medicaid reimbursement rates to reflect changes in labor costs since 1993 by adding a 2001 wage equalization factor (WEF) option on a hold harmless basis; (2) provide some immediate financial relief to the most financially disadvantaged nursing homes through a formula-based adjustment; and (3) offer a new amnesty program to allow financially troubled facilities that are behind in their gross receipts assessment tax payments to gradually repay their obligations without penalties and interest. NYAHSA does not believe that a re-basing of the current methodology to a more recent cost basis than 1983 is the answer. What is needed instead is a much more fundamental and comprehensive re-examination of the methodology. In NYAHSAs view, any successor methodology needs to: (1) incorporate adequate payments to providers for services rendered; (2) promote desired incentives, such as high quality of care; (3) reflect todays demands and realities, including the evolving role of the nursing home and changing regulatory oversight; and (4) consider the need for periodic updates to ensure a current, relevant system. More broadly, Medicaid and long-term care reform are essential to ensure that consumers receive the services they need, providers are fairly reimbursed for the services they provide, and state and local taxpayers are not burdened with a long term care system that relies too heavily on Medicaid. We commend the state Senate and the governor for taking steps toward Medicaid reform and look forward to working together on common goals.15
15 In 2003, NYAHSA convened a Medicaid Reform Task Force that examined the ways in which Medicaid funds long term care. The task force report, Preserving Long-Term Care for the Long-Term Future, includes a series of detailed recommendations and can be found on the NYAHSA Web site at www.nyahsa.org.

Making any additional Medicaid cuts or otherwise increasing the financial pressure on nursing homes would only serve to undermine the desired effect of the immediate financial assistance we propose, and diminish the prospects for systemic reform. Such Medicaid cost containment measures, if adopted in the 2004/05 state budget, would cause further harm to nursing homes and the thousands of New Yorkers who rely on them, and must be rejected.

ABOUT NYAHSA
Founded in 1961, the New York Association of Homes and Services for the Aging (NYAHSA) is the only statewide orga nization representing the entire continuum of not-for-profit, mission-driven and public continuing care, including nurs ing homes, senior housing, adult care facilities, continuing care retirement communities, assisted living and community service providers. NYAHSAs more than 650 members serve an estimated 500,000 New Yorkers of all ages annually.