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The rising insolvency rate among hospitals and other health care providers in the United States is a dilemma of ever-increasing proportions. While the aggregate number of bankruptcy filings in the United States appears to be decreasing annually, health care-related bankruptcy filings remain on the rise. This growing problem has affected both the not-for-profit and for-profit hospital sectors, with multiple factors contributing to this growing insolvency crisis: reduced reimbursement rates, increased governmental regulation of health care facilities, increased reliance on self-insurance coupled with surging medical malpractice claims, and changing urban demographics. Also contributing significantly to the problem has been a consistent decline in hospital occupancy rates. The trend toward ambulatory care has resulted in a substantial reduction of hospital admissions and in-patient census figures and a growing number of empty beds. Services traditionally provided in hospital settings are now provided by ambulatory care centers and similar freestanding care providers, depriving hospitals of profitable procedures involving insured patients. Occupancy rates have also been reduced by an overall decrease in acute medical admissions. Lower-severity medical admissions now comprise the majority of medical admissions in many financially exposed hospitals. See “Drop in Severity of Illness Further Strains Hospital Finances,” Hospital Watch, June 2005, Vol. 16, No. 1, at 6, www.uhfnyc.org/usr_doc/ hw16_1.pdf. Changing demographics have triggered additional financial pressures for urban hospitals. An ever-increasing indigent and uninsured patient population is more heavily reliant on hospital emergency rooms for primary care. Inner-city hospitals have continued to provide care irrespective of an ability to pay. Much of this goes uncompensated. Medicaid and/or Medicare reimbursement rates have proven increasingly insufficient, and although many states maintain indigent-care pools to help offset resulting losses, the funding hardly covers the hospitals’ cost structure. Left with declining reimbursement rates, increased regulation, uninsured patients and declining occupancy rates, hospitals have faced a perpetual financial drain. Historically, while federal and state governments have provided assistance in addressing some of these problems, mounting pressure to reduce state budgets has imperiled already financially troubled hospitals. While many have attempted to implement cost-cutting strategies such as eliminating unnecessary beds, utilizing more outpatient care and sharing technology with other locally situated hospitals, and some have been successful, others have found closure to be inevitable. New York hospitals have emerged as some of the nation’s worst off financially, having posted losses for the last five years running while some hospitals nationwide have posted profits. See Joshua Brustein, “Hospitals in Crisis,” Gotham Gazette, Sept, 26, 2005, www.gothamgazette.com/print/1600. Several of New York’s hospitals have filed for bankruptcy over the last several years while others have been forced to permanently close their doors after facing insurmountable financial difficulties. Many factors have contributed to the decline of New York’s health care system, including changes in federal and state regulations and health care delivery. State regulations and bond financing restrictions in New York impose certain limitations on the amounts hospitals can invest in infrastructure and other capital projects, undermining many hospitals’ ability to remedy their aging infrastructures. The regulations also prohibit certain types of investors from owning hospitals, severely restricting the number of proprietary hospitals. Underfunding in New York The underfunding of New York’s hospitals, particularly in comparison to hospitals nationwide, has also been a source of considerable economic hardship. A review of the operating margins for hospitals in New York reveals a consistent decline since 1996. The average operating margin of New York hospitals is also approximately 5% below that of the national average. See Testimony of Kenneth E. Raske, Greater New York Hospital Association, On the Executive Budget Proposal for 2005-2006 Before the New York Senate Finance and Assembly Ways and Means Committee, available at www.gnyha.org/testimony/2005/pt20050131.pdf. Underfunding can be attributed, in part, to reduced reimbursement rates and pressure by insurance companies for increased profits, which, in turn, has driven down the ratio of payments to health care providers as a percentage of premium revenue. Most hospitals in the state have demonstrated poor cash flow, limited ability to meet current operating and capital obligations and an overreliance on debt for payment of capital improvements. Id. Profitability ratings for New York hospitals are the second lowest nationwide. New York hospitals also rank among the bottom three nationwide in other critical financial measures, including liquidity and capital structure. Id. The rising costs associated with delivering health care have further burdened hospitals beyond their means. New technologies and diagnostic modalities have increased costs and required treatment-related expenditures. Additional cost pressures have resulted from a nursing shortage that has plagued not only New York hospitals but the country as a whole. Finally, a significant factor contributing to the economic distress of New York hospitals is the dramatic rise in liability insurance costs in recent years. A survey of the hospitals in the downstate New York region conducted by the Greater New York Hospital Association indicates that hospitals have experienced average annual malpractice insurance premium increases of 27% per year from 1999 through 2004. See Raske testimony, supra. Additionally, both Medicare and Medicaid have failed to reimburse New York hospitals adequately for the malpractice components of their costs. In response to the aggregate 27% increase in premiums, Medicare provided an increase of only 6.2% for the malpractice component while Medicaid failed to even consider malpractice premium costs when calculating its hospital rates. Further aggravating the situation is the fact that New York insurers have the fourth-worst loss experience of any state in the country. According to the National Association of Insurance Commissioners, New York insurers, on the average, pay out almost 44% more on claims and expenses than they collect in premiums. Id. Not only has this led to the insolvency of two carriers over the last five years, but other carriers have stopped offering specific types of coverage required by physicians. In order to provide adequate coverage, often the only remaining option for hospitals is to provide the required coverage under self-insured trusts. This has led to New York being listed by the American Medical Association as one of the 20 states experiencing a medical malpractice crisis. Taken together, the foregoing factors have resulted in extensive and, at times, irreversible losses for hospitals in New York. Bankruptcy filings and closures have been on the rise and are expected to continue. The national predicament Of course, New York hospitals are not the only ones facing financial challenges. Similar struggles are occurring in hospitals nationwide. Many of the nonteaching hospitals in Massachusetts have also become the subject of recent closures. Some have attributed the closures, in part, to escalating costs coupled with an overabundance of beds in the state. The Illinois Hospital Association (IHA) has reported the existence of similar financial pressures on Illinois hospitals over the past few years. Approximately one-third of the hospitals in Illinois are operating at a loss, while 22 have been forced to close in the last 10 years. See Harold L. Kaplan and Linda S. Moroney, “Hospitals Face New Financial Threat of Charity Care Legislation,” 25-JUN Am. Bankr. Inst. J. 28 (June 2006). The precarious condition of the hospitals that have managed to remain open may be further undermined by pending legislation that seeks to expand charity care commitments on the part of tax-exempt hospitals in Illinois. If legislation of this nature is passed, the IHA predicts that an additional 45 hospitals could be pushed into insolvency. Although discussions on the legislation have been halted, the bill will be reintroduced in the spring of 2007 and will undoubtedly raise renewed concerns over additional hospital closures. Hospitals in the state of Washington are facing an unarguable financial crisis, possibly their worst in the last two decades. Much like other hospitals in financial distress, Washington hospitals have suffered from increasing costs of administration and reduced reimbursement rates from government and private payers. In addition, like most hospitals nationwide, Washington hospitals consistently are forced to deal with payment shortfalls as a result of discounts and reduced reimbursements from Medicare, Medicaid and private insurers. Washington hospitals are uniquely positioned in that they have already utilized typical turnaround strategies such as eliminating unnecessary beds or reducing the use of in-patient care to increase efficiency and reduce costs. Little, if any, room for further reductions remains. Unless a financial turnaround can be managed for many hospitals in Washington, the Washington State Hospital Association (WSHA) predicts that additional closures will occur over the next few years. This will create serious difficulties for patients seeking care in many areas of the state, especially those in rural areas. In smaller communities, where the hospital is often a leading employer, it can potentially wreak havoc on the entire community. The inner-city dilemma Among the hardest hit in virtually every state appear to be the inner-city hospitals. With limited resources, reduced revenue streams and a patient population consisting primarily of the indigent and uninsured, inner-city hospitals across the nation are struggling. A significant factor underlying their failure to survive is the fact that these institutions have traditionally provided high levels of uncompensated care. Consisting predominantly of privately owned hospitals, inner city hospitals have historically continued to provide care irrespective of the patient’s ability to pay. Additionally, many of the individuals who are serviced by inner city hospitals often rely on hospital emergency rooms as their primary-care facilities, having no other facility or option to turn to for even basic treatment. This causes additional financial stress for the already overburdened hospital. Due to increased competition for commercial contracts, and declining reimbursement rates from Medicare and Medicaid, shortfalls now remain largely unpaid. Additionally, due to efforts by an increasing number of hospitals to obtain greater financial assistance, the funds in the indigent care pools are largely insufficient to reimburse hospitals for uncompensated care. Consequently, many hospitals that were previously able to balance the shortfall through reimbursements are now left with significant financial deficits that often prove to be too difficult to overcome. This will mean-as it has in the past-that many who need care in the low-income areas will simply stop getting it as more and more inner-city hospitals face bankruptcy or closures. While inner-city hospitals have attempted to respond to the changing demands of health care, they simply do not have adequate resources to make the necessary changes in the relatively short time frame required of them to remain competitive with larger, more profitable hospitals. As a result, many of them are finding themselves in dire straits with their future remaining questionable. As health care-related filings continue to rise, many federal and state regulators have been required to participate more actively in the regulation of hospitals and similar facilities. In New York, Governor George Pataki created a special commission to examine the hospital industry and assess the viability of existing hospitals. The primary purpose of the commission is to issue recommendations as to which hospitals should be closed. The commission will make final recommendations on rightsizing New York state’s hospitals and nursing homes by Dec. 1. If the recommendations are approved by the governor and the legislature, they become law, and must be implemented by the commissioner of health. In Washington, the WSHA has been working with the American Hospital Association in an effort to improve the Medicare-related in-patient inflation rate over the long term. The two organizations are also attempting to ensure continued maintenance of federal and state support for many needed programs, including Medicaid disproportionate share programs as well as other supplemental programs. Individual hospitals nationwide are also implementing cost-cutting measures in an attempt to improve their bottom line. Improved strategies for the recruitment of physicians and nurses are being employed by many hospitals. Some hospitals are relying on new and innovative forms of hiring that involve the use of professionals trained in foreign countries such as India, who are then matched with employers in the United States. Preliminary results indicate that use of foreign professionals may assist hospitals in alleviating the existing shortage while simultaneously reducing the high cost otherwise incurred by the use of staffing agencies. The Chapter 11 option Finally, many hospitals have taken a proactive approach and utilized Chapter 11 as a vehicle to implement a business plan that would be difficult, if not impossible, to achieve outside of bankruptcy. Using the protection afforded by the automatic stay of the Bankruptcy Code, many hospitals have been able to stave off creditor pressure and craft a plan of reorganization, which has permitted them to address and resolve many of the factors directly contributing to their insolvency, i.e., excessive vendor debt and mounting medical malpractice liabilities. Through the bankruptcy process, many of these hospitals have emerged as stronger, more financially stable entities that are more capable of withstanding ongoing financial pressures. The uncertainty plaguing the health care industry continues to be a fertile ground for a debate and likely will not be resolved in the near future. However, as is apparent from the steps taken by the federal government and many state governments, some change does appear to be under way. Several states are undertaking global analyses of their prevailing systems, hoping to strip away excess and underperforming facilities, consolidate and improve the efficiency of health care delivery and trim overall costs. Troubled hospitals can no longer rely on the largesse of the government to fund losses and bailouts. In order to win the battle against insolvency, it is clear that the majority of the nation’s hospitals need to improve their own profit margins and implement new means for reducing overhead costs. The environment has changed and will continue to change. Time will tell which will become strong and survive. Burton S. Weston is chairman of the corporate reorganization and bankruptcy practice group in the Great Neck, N.Y., home office of Garfunkel, Wild & Travis. Afsheen A. Shah is an associate in that practice group.

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