United States General Accounting Office

GAO Report to Congressional Committees

February 1996 FHA HOSPITAL

MORTGAGE INSURANCE

PROGRAM

Health Care Trends and

Portfolio Concentration

Could Affect Program

Stability

GAO/HEHS-96-29

GAO United States

General Accounting Office

Washington, D.C. 20548

Health, Education, and

Human Services Division

B-258517 

February 27, 1996

The Honorable Alfonse M. D’Amato

Chairman

The Honorable Paul S. Sarbanes

Ranking Minority Member

Committee on Banking,

 Housing, and Urban Affairs

United States Senate

The Honorable Jim Leach

Chairman

The Honorable Henry B. Gonzalez

Ranking Minority Member

Committee on Banking and

 Financial Services

House of Representatives

The Department of Housing and Urban Development (HUD), through the

Federal Housing Administration’s (FHA) Hospital Mortgage Insurance

Program, insures loans to finance the renovation or construction of

hospitals that meet certain criteria. FHA mortgage insurance protects

lenders against losses they might incur if hospitals fail to make their

mortgage payments. As of August 1995, FHA insured about $5 billion in

outstanding mortgages.

The Multifamily Housing Property Disposition Reform Act of 1994 (P.L.

103-233, Apr. 11, 1994), required that we report on three FHA insurance

programs—hospital, nursing home, and retirement service center—in

FHA’s multifamily loan insurance portfolio. This report provides the results

of our evaluation of the Hospital Mortgage Insurance Program.1

 As agreed

with your staff, we (1) identified factors, including those related to health

care market trends, that could affect the stability of the program’s

portfolio and obtained information on the program’s financial

performance; (2) evaluated the methodology that FHA used to estimate the

program’s fiscal year 1994 loan loss reserve; (3) evaluated the relationship

between the purpose of the Hospital Mortgage Insurance Program and

HUD’s mission; and (4) determined whether FHA has the expertise to

manage the program.

1

The results of our other studies on the nursing home and retirement service center insurance

programs are provided in a separate report: HUD Management: Greater Oversight Needed of FHA’s

Nursing Home Insurance Program (GAO/RCED-95-214, Aug. 25, 1995).

Page 1 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
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To develop our information, we (1) interviewed officials from FHA, the

Health Resources and Services Administration (HRSA) within the

Department of Health and Human Services (HHS), hospitals, health care

and hospital associations, and mortgage and investment banking firms;

(2) analyzed health care data; (3) reviewed program financial data;

(4) reviewed FHA’s documentation regarding its 1994 loan loss reserve

methodology; and (5) reviewed applicable program laws, regulations, and

policy statements. Our review did not include an evaluation of

underwriting criteria, the premium structure of the program, or whether

the program is needed. (See app. IV for a detailed description of our

objectives, scope, and methodology.) Our work was performed between

August 1994 and December 1995, in accordance with generally accepted

government auditing standards.

Results in Brief Since its inception, the program has made a net positive cash contribution

to HUD’s General Insurance Fund,2

 according to FHA. However, the program

is currently faced with potential financial risks that could affect the future

stability of the portfolio. For example, more than $4 billion or about 87

percent of the FHA-insured hospital mortgages’ unpaid principal balance is

concentrated in New York state with many New York hospitals having the

largest individual unpaid principal balances. In addition, state actions,

such as the recent decision in New York to reduce hospital Medicaid

spending by about $140 million in one year, could further strain the

financial condition of many of the already financially weak program

hospitals. Future health care policy changes and trends, like managed

care, that challenge hospitals to control costs and restructure the way they

deliver health care can also threaten program hospitals’ ability to remain

solvent.

Although FHA had a loan loss reserve estimate of $458.25 million as of

September 30, 1994, this estimate is not a reliable measure of program

losses because of methodology limitations. In estimating the reserve, FHA

used questionable assumptions regarding default probabilities and loss

rates. For example, FHA had no justifiable basis for the loss rates it applied

to hospitals with a lower than 50-percent probability of default. In

2

The Hospital Mortgage Insurance Program is part of HUD’s General Insurance Fund, which obtains

revenues from insurance premiums and the proceeds of sales of mortgages and foreclosed properties.

It incurs expenses for administration, payments of insurance claims, and costs of maintaining and

selling foreclosed properties. In addition to the hospital insurance program, this fund’s insurance

portfolio supports a variety of multifamily and single-family insured loans. These include rental

apartments, cooperatives, condominiums, housing for the elderly, nursing homes, manufactured

housing, home improvement loans, and disaster loans.

Page 2 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
B-258517 

addition, FHA’s methodology did not incorporate health care market trends,

a risk factor that can affect the future viability of program hospitals.

Our evaluation of the relationship between the purpose of the Hospital

Mortgage Insurance Program and HUD’s mission found that HUD’s mission is

broad enough to encompass the purpose of the program. However, the

extent to which the program contributes to HUD’s mission is unclear

because HUD does not measure program outcomes. Further, FHA’s staff has

limited expertise in health care to independently manage key program

functions. FHA relies on HHS’ staff expertise in health care and hospital

finance and management to assess projects’ feasibility and monitor

hospitals’ financial performance. We also learned that some program users

have raised concern with the length of the mortgage insurance application

process. Applications can take more than 1-1/2 years to be approved.

Background In 1968, the Congress added Section 242 to the National Housing Act

establishing the Hospital Mortgage Insurance Program. In considering this

amendment to the National Housing Act, the House Committee on

Banking and Currency3

 cited a serious shortage of hospitals and the need

for existing hospitals to expand and renovate. Private lenders seemed

reluctant to provide capital financing at reasonable terms. The purpose of

the program is to “assist the provision of urgently needed hospitals for the

care and treatment of persons who are acutely ill . . ..” Consequently,

Section 242 authorized HUD to provide insurance for hospital mortgages

secured from lenders to finance the construction and renovation of

hospitals.4

Many hospitals need to borrow money from lenders to finance

construction and renovation projects. Lenders often raise capital by selling

bonds to investors and use the hospitals’ mortgage payments to pay

bondholders. Mortgage insurance, like private bond insurance, guarantees

that bondholders will be paid if the hospital stops making payments on its

loan. According to the Health Care Financing Study Group,5

 about

60 percent of hospitals that seek financing require insurance to enhance

3

Currently the Committee on Banking and Financial Services.

4

The Hospital Mortgage Insurance Program supplemented the Hill-Burton Program. Under Hill-Burton,

HHS, formerly the Department of Health, Education, and Welfare, made loan guarantees and direct

loans to hospitals for construction and modernization projects.

5

The Health Care Financing Study Group is comprised of investment and mortgage banking firms

actively involved in financing health care facilities throughout the United States, both conventionally

and on a government-supported basis.

Page 3 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
B-258517 

their credit because they cannot get a loan on their own financial strength.

Eighty-three percent of these hospitals can get private bond insurance but

about 17 percent cannot because private insurers consider them too risky.

Some hospitals that cannot get private mortgage insurance apply to FHA’s

hospital insurance program.

FHA’s Hospital Mortgage Insurance Program staff and HHS’ Division of

Facilities Loans staff jointly manage the hospital program. The Congress

gave HUD statutory responsibility for the program. The House Committee

on Banking and Currency, in recommending that HUD be given this

responsibility, cited FHA’s more than 35 years of experience with

promoting housing construction through its housing insurance programs.

The Committee was concerned, however, that HUD’s staff did not have

specialized knowledge of health care needed to administer this program.

As a result, the Committee recommended and the Congress enacted the

requirement that a state agency must certify that a hospital is needed

before it can participate in the program. Also, the Committee expected HUD

to draw upon HHS’ hospital expertise to devise standards for insuring

hospitals’ mortgages. Through a memorandum of agreement, HUD formally

delegated authority to HHS to review and approve proposals for hospitals’

mortgage insurance. HUD retained authority to make the final insurance

commitment and endorse the mortgage note.

The Hospital Mortgage Insurance Program requires hospitals to have the

state certify the need for the proposed projects and then meet

underwriting criteria before insurance applications can be approved. Since

1988, hospitals have obtained FHA insurance approval to construct acute

care facilities, ambulatory care centers, and operating rooms and to

renovate maternity and emergency departments and surgical suites. In

addition, hospitals have obtained approval to purchase equipment, install

new computer and fire alarm systems, and build parking facilities.

The use of hospital inpatient services, however, has declined over time.

Current trends indicate a greater focus on cost containment and delivering

health care on an outpatient basis.

Page 4 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
B-258517 

Potential Financial

Risks on the Stability

of the Hospital

Program

Overall, the financial performance of the hospital program has reflected a

net positive cash flow from operations over the past 25 years, according to

HUD data. However, in several years, the program has experienced

financial losses. The bulk of the losses occurred between 1989 and 1991,

when HUD had to pay lenders about $147 million because of hospital

defaults.6

 The current composition of the program’s portfolio with the

concentration of insured loans in New York, changes in state policies,

trends in the health care market, and the probability of future changes in

federal health care policies pose risks that may threaten the future

stability of the program. Two reasons given in a 1992 HUD study7

 for why

some hospitals defaulted on their loans were changes in the policies and

practices of state and local governments and changes in Medicare and

Medicaid reimbursement.

The Hospital Program

Portfolio and Its Financial

Performance

The hospital program has made a positive net contribution of $221 million

to HUD’s General Insurance Fund, even though there have been years with

negative cash flows (see fig. 1). Information obtained from FHA shows that

from fiscal year 1969 through 1994, FHA collected $370 million in premiums

and fees and paid $200 million in insurance claims and $13 million in

salaries and other administrative expenses. FHA recovered about

$64 million of claim payments from mortgage payments and the sale of the

mortgages or properties. As of September 30, 1994, 19 hospitals had

defaulted;8 FHA disposed of 10 and retained loan management

responsibility for the remaining 9 hospitals. For these 9 hospitals, the total

unpaid principal balance is $108 million and accrued delinquent interest is

$44 million. (See app. I for a description of the hospital program’s financial

performance from fiscal year 1969 through 1994.)

6

A default occurs when a hospital has at least one payment outstanding, the loan is assigned to HUD,

and HUD pays a claim.

7

Organizational Review of the Hospital Mortgage Insurance Program, Office of Management and

Planning (OMAP), HUD (Washington, D.C.: 1992), pp. 23-24.

8

One of the 19 hospitals also defaulted on an insured loan obtained to cover a 2-year operating loss.

Page 5 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
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Figure 1: FHA’s Hospital Mortgage Insurance Program Cash Flow From Operations, Fiscal Years 1969-94

-70

1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994

-60

-50

-40

-30

-20

-10

0

10

20

30

40

50

60 300

250

200

150

100

50

-50

-100

-150

-200

-250

-300

-350

0

Net Cash Flow (in millions) Cumulative (in millions)

Cumulative Net Cash Flow

From Operations

Net Cash Flow From Operations

(Figure notes on next page)

Page 6 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
B-258517 

Source: FHA Hospital Mortgage Insurance Program staff.

As of August 1995, the hospital program portfolio was comprised of 100

projects in 18 states and Puerto Rico (see fig. 2). The portfolio has an

aggregate unpaid principal balance of about $5 billion. (See app. II for

individual unpaid principal balances of FHA-insured hospital projects, by

state.)

Page 7 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
B-258517 

Figure 2: Distribution of Hospital Projects and Unpaid Principal Balances, by State, in the FHA Hospital Mortgage

Insurance Portfolio, August 1995

1

2

1

1

1

1

1

5

1

1

1

2

2

4

4

63

7

1

1

Arkansas

California

Florida

Illinois

Kentucky

Louisiana

Maryland

Massachusetts

Michigan

Missouri

New Hampshire

New Jersey

New York

Oklahoma

Pennsylvania

Puerto Rico

Texas

Washington

Wisconsin

2,600,490

1,809,901

11,362,651

6,063,326

9,285,024

2,493,799

9,099,451

221,070,490

23,112,498

4,305,135

2,537,862

233,335,878

4,184,837,396

387,472

63,359,725

15,782,102

12,286,708

220,096

15,555,484

State

Unpaid Principal Balance

(in dollars) State

Unpaid Principal Balance

(in dollars)

(Figure notes on next page)

Page 8 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
B-258517 

Note: Numbers within states reflect the number of hospital projects insured.

Source: FHA Hospital Mortgage Insurance Program staff.

The majority of the hospital program projects, 63 percent, are in New

York. The unpaid principal balance on mortgages for these projects is

about $4.2 billion or 87 percent of the portfolio’s aggregate unpaid

principal balance. Also, 9 of the 10 largest hospital mortgages are in New

York. These mortgages account for about $2.4 billion or 50 percent of the

portfolio’s total unpaid principal balance. Included in these mortgages is a

$591 million loan, the largest single loan amount FHA has insured in the

history of the program. Since 1988, 17 of the 20 projects that FHA insured

have been for New York hospitals. In addition, as of August 1995, 6 of the

10 mortgage insurance applications under review by HHS and FHA were for

projects in New York.

New York’s

Reimbursement System Is

a Factor in Hospitals’

Reliance on FHA Program

The hospital program has become a major financing vehicle for many New

York hospitals. Several officials stated that New York hospitals rely on FHA

mortgage insurance, in part, because the state’s reimbursement system

hinders hospitals’ ability to access capital in the private market. “New

York’s restrictive reimbursement system makes it the most regulated

nationwide,” according to a Moody’s Investors Service report.9

 Except for

Medicare, New York utilizes an all-payer fixed rate system to reimburse

hospitals. The state controls all third-party payers’ rates of payments by

setting a fixed payment for each hospital based on patient diagnoses. The

rate-setting system is a regulatory method of budgeting for hospitals. The

goals of the rate-setting system are cost containment and access to

hospital care. However, New York state officials said that this system

constrains hospitals’ profitability, which weakens their creditworthiness.

According to a Moody’s Investors Service report, New York hospitals’

credit ratings are the weakest in the nation.10

In other states, hospitals’ credit ratings are generally stronger, which

enables many of them to access capital in the private market. These

hospitals primarily rely on bond financing backed by their revenues and

projected ability to make loan payments or by commercial bond insurance

9

Health Care Finance: Hospital Revenue Bonds, State of New York, Moody’s Investors Service HC71-14

(New York: 1994), p. 3.

10Health Care Finance: Hospital Revenue Bonds, State of New York, Moody’s Investors Service, p. 1.

Page 9 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
B-258517 

instead of FHA’s Hospital Mortgage Insurance Program. In contrast, private

insurers are reluctant to back bond sales to finance some New York

hospital projects because the hospitals are considered too risky.

Concentration of Insured

Projects in New York

Poses Program Risks

The lack of portfolio geographic diversification and the large individual

unpaid loan balances in New York pose a risk to the program. The

concentration of the portfolio in New York makes the program susceptible

to New York policies and other factors specific to the state. The strength

of a portfolio lies in its diversity because portfolio diversification

decreases the risk from losses. In addition, a single default of a large loan

could lead to insurance claims that could significantly burden the

program. A 1992 HUD report stated that the concentration of FHA-insured

projects in a single state and large loan amounts are major controllable

risks to the program that should be avoided or minimized.11

FHA does not limit the number of projects in a particular state nor does it

cap individual loan amounts it insures as a means of controlling risks to

the program. The legislation authorizes the Secretary of HUD to set the

terms and conditions under which HUD will insure projects, but the law

does not specifically authorize FHA to limit the number of projects

accepted into the program from a geographic area or to limit the loan

amounts it insures. In fact, in 1974, the Congress removed existing caps on

loan amounts.

FHA officials stated that they are taking action to diversify the portfolio by

marketing the program to attract hospitals from other states. For example,

FHA officials reported working with mortgage bankers to increase program

awareness to hospitals outside New York. They reported that, as of

August 1995, they had received four applications from hospitals in Illinois,

New Jersey, Pennsylvania, and Puerto Rico. By expanding the portfolio,

FHA also increases the program’s total outstanding mortgage amount.

Officials involved in the financing of hospital projects told us that

hospitals in other states may not be interested in the FHA program for

several reasons, including the program’s high premiums, lengthy

application process, and a lack of program awareness.

For some future hospital projects, FHA is considering ways to reduce the

risk of financial losses. For example, FHA is considering a proposal to

establish risk-sharing arrangements with the public and private sector.

According to FHA officials, the risk-sharing partner would assume

11Organizational Review of the Hospital Mortgage Insurance Program, OMAP, p. 27.

Page 10 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
B-258517 

underwriting responsibilities, have an equity position in the hospital, and

share in any losses that result from defaults. In an October 1993 report, we

noted that HUD terminated FHA’s multifamily housing coinsurance program

in January 1990. The program enabled FHA to share the risk of insuring a

multifamily mortgage with participating lenders. However, problems with

the program resulted from deficient conceptual design and failures in

administration.12

New York’s Health Care

Policy and Future Federal

Policy Changes Increase

Risks to the Program

Changes in state health care policies that reduce hospitals’ revenues can

negatively affect the financial stability of hospitals, particularly the

financially weaker hospitals in FHA’s hospital program. Recent changes in

New York’s Medicaid policy would reduce hospitals’ patient revenues and

could increase program hospitals’ risk of default. The New York state

fiscal year 1996 budget contains health care cost-cutting measures that are

estimated to reduce state Medicaid hospital spending by $138 million,

resulting in an estimated total hospital revenue loss of $553 million.13 State

analyses of the reduction in Medicaid spending for individual hospitals

estimate that FHA-insured hospitals will lose $170 million in Medicaid

revenue. Also, individual program hospitals may lose between 0.31 percent

and 4.25 percent of total revenues.

Some New York hospitals’ already marginal operating margins14 may

deteriorate further as a result of the loss in Medicaid revenue. Our analysis

of 1994 Health Care Financing Administration data for 52 program

hospitals in New York indicates that 49 had negative operating margins.

The average operating margin for the 52 hospitals was –5.6 percent. Our

analysis shows that, on average, operating margins for the 52 hospitals

would deteriorate by 26 percent in 1 year because of the state’s reduction

in Medicaid spending. Thus, the ability of some of these hospitals to

absorb the cuts and possible future state Medicaid spending reductions

without defaulting on their FHA-insured loans is questionable.

In the past, state policy changes have precipitated hospital defaults. For

example, three hospital defaults in Illinois resulted in a $27 million loss to

the program. According to a 1992 HUD report, two of these defaults were

12Housing Finance: Expanding Capital for Affordable Multifamily Housing (GAO/RCED-94-3, Oct. 27,

1993).

13The total provider loss includes federal, state, and county Medicaid contributions.

14The operating margin is a commonly used measure of hospitals’ profitability. It is used to measure

profitability on all patient care operations and is net patient revenue minus operating expenses,

divided by net patient revenue. Because for many hospitals net patient revenue does not include all

operating revenue, this measure tends to understate operating profitability.

Page 11 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
B-258517 

caused, in part, by the state setting a Medicaid reimbursement rate that

was too low to cover the hospital’s cost of treating Medicaid patients or

the state delaying Medicaid reimbursement to hospitals.15

The extent to which New York hospitals are able to reduce expenses will

affect their ability to withstand revenue losses. According to FHA, HHS, and

New York health care officials, hospitals are expected to reduce expenses

and implement revenue enhancers to mitigate Medicaid revenue losses

and remain viable. Hospitals with large Medicaid caseloads are

particularly vulnerable to reductions in Medicaid spending. Our analysis of

1994 data from 52 New York program hospitals shows that for about

one-third of the hospitals, their Medicaid inpatient days were greater than

25 percent.16 Plans developed by New York program hospitals to respond

to the state’s Medicaid cuts include cost-containment measures, such as

reducing staff, salaries, and benefits and revenue enhancement measures,

such as decreasing the length of stay and increasing admissions. Hospital

and hospital organization officials reported that some hospitals had

already begun taking cost-cutting measures before the budget decision

was made. In reaction to the cuts, FHA required New York hospitals

awaiting application approval to submit sensitivity analyses on the impact

of the cuts. In addition, HHS required New York program hospitals to

submit an action plan for responding to the cuts. After evaluating the

hospitals’ responses, FHA and HHS increased their monitoring efforts for

those hospitals identified as most vulnerable to the cuts.

In addition to changes in state policies, future changes in federal health

care policies can also restrict hospitals’ revenues. For example, the Fiscal

Year 1996 Congressional Budget Resolution proposes cumulative Medicare

reductions of $270 billion, from current law projections, over the next 7

years. In addition, the Budget Resolution proposes reducing Medicaid

outlays by about $180 billion. As the congressional debate on deficit

reduction continues, other proposals for containing the cost of federal

health care spending on Medicare and Medicaid could surface.

To Remain Viable, Program

Hospitals Must Respond to

Health Care Delivery

Trends

Changes in the delivery of health care can adversely affect the viability of

hospitals that do not take action to successfully control costs and compete

in the marketplace. One major shift in the way health care is delivered is

the change from a focus on hospital inpatient care to outpatient care.

From 1983 through 1993, there were 5.4 million or 15 percent fewer

15Organizational Review of the Hospital Mortgage Insurance Program, OMAP, pp. 23 and 30.

16Our analysis also shows that one-half of program hospitals had Medicare inpatient days of 50 percent.

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community hospital admissions nationwide.17 Over the same period, the

average length of stay for patients admitted to hospitals declined from 7.6

to 7.0 days. American Hospital Association (AHA) data show for the same

10-year period that hospital occupancy rates declined by 10 percent and

522 community hospitals closed—a decline of 9 percent.18 In contrast,

more dramatic than the decline in inpatient hospital use was the increase

in hospital outpatient visits. Community outpatient visits increased about

75 percent over the 10-year period. This change in outpatient volume

reflects an overall restructuring of the health care delivery system.

Some of the factors driving the trends in health care include advances in

technology that allow more care to be delivered in outpatient settings;

changes in reimbursement incentives, such as the introduction of

diagnostic related groups under the prospective payment system in the

early 1980s; and the growth of enrollment in managed care health plans.

As these trends continue, the need for hospital acute care beds will

continue to decline. Health care association representatives cite managed

care as a significant trend facing some hospitals. Because of the increased

enrollment in managed care plans, hospitals that cannot become a part of

a managed care network or compete in this environment stand to suffer

financially from a loss of market share.

Understanding the overall impact of these health care trends on the future

need of the program would require further analysis which was beyond the

scope of this review. Any such analysis should have to consider, at a

minimum, (1) the characteristics of program hospitals compared with

nonprogram hospitals accessing capital, (2) the ability of program

hospitals to obtain financing on the private market without FHA mortgage

insurance, (3) the costs and benefits of the program including the public

good that the program serves, and (4) the program’s underwriting criteria

and premium structure.

Managed Care Penetration

in New York Could Affect

Viability of Program

Hospitals

The growth of managed care in New York can negatively affect some

FHA-insured hospitals’ financial condition and, as a result, increase the risk

of financial loss to the insurance program. In 1993, the penetration of

managed care plans in New York was more than 24 percent. Also, there is

17Community hospitals include institutions that are nonfederal, short-term, general, and other special

hospitals whose facilities are open to the public. Not included in this category are hospital units of

institutions, long-term hospitals, psychiatric hospitals, and alcoholism and chemical dependency

facilities.

18According to an AHA report, the decline in the number of community hospitals was especially rapid

between 1985 and 1990, however, the number of hospital closures has since slowed. See 94/5 Hospital

Statistics: The AHA Profile of United States Hospitals, American Hospital Association.

Page 13 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
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a push in the state for the adoption of mandatory Medicaid managed care.

Managed care emphasizes health care cost control, which includes

avoiding unnecessary admissions and lengthy stays.

Managed care also focuses on cost and utilization control measures.

However, few New York hospitals have experienced managed care pricing

and utilization controls. New York hospitals may be at a disadvantage in a

managed care market because they generally have high lengths of stay. In

addition, according to a Moody’s Investors Service report, “in a managed

care market where the key variable is cost, the generally high-cost urban

teaching facilities which are disproportionately located in New York, will

definitely be at a disadvantage.”19

In addition, these hospitals have large teaching and research costs and

significant fixed costs tied to their large physical plants and debt loads.

The potential effect on teaching hospitals can be important to the program

because, according to FHA data, the program insures 44 teaching hospitals

of which 34, or 77 percent, are in New York.

Hospitals that reduce costs and develop cooperative relationships with

other health care providers may be able to mitigate the negative financial

impact of managed care. Some program hospitals in New York and other

states are affiliating and forming networks with other health care

providers to reduce costs and increase service area. For example, one

hospital reduced costs by establishing an affiliate in which financial and

support services were consolidated and shared within its provider

network. In addition, several hospitals reported affiliating with community

hospitals and physician groups, as well as developing satellite clinics to

broaden their patient base.

An HHS official stated that, in reviewing hospitals’ applications, HHS

considers whether the hospitals are preparing for managed care and

addressing other health care trends. In addition, according to an HHS

official, HHS examines affiliate contracts and insures that the contracts are

not a drain on the hospitals’ finances. Also, program hospitals are required

to obtain FHA approval for some mergers and affiliate transactions. FHA

officials also reported that FHA consultants consider health care trends in

their review of hospitals’ applications.

19Health Care Finance: Hospital Revenue Bonds, State of New York, Moody’s Investors Service, p. 2.

Page 14 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
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Methodological Flaws

Limit the Reliability of

the Loan Loss Reserve

Estimate

FHA’s loan loss reserve estimate of $458.25 million, as of September 30,

1994, is not reliable because of weaknesses in the methodology that FHA

used to calculate the estimated loan losses.20 The assumptions that FHA

used to estimate key variables such as default probabilities and the actual

loss rates were not directly linked to or justified by a detailed documented

analysis of loss exposure in the hospital mortgage insurance portfolio. In

an October 1994 report we discuss this principle as it applies to depositary

institutions.21 Further, FHA’s methodology did not incorporate some health

care market trends that are likely to impact the future financial

performance of program hospitals. The net effect of the methodological

flaws on the reserve estimate is unclear because FHA’s default assumptions

and their exclusion of market trends could overstate or understate the

loan loss reserve estimate.

In estimating loan loss reserves, FHA—which is subject to the Government

Corporation Control Act—is required to follow generally accepted

accounting principles (GAAP) for financial statement reporting purposes.

However, in our October 1994 report, we stated that this authoritative

accounting guidance, established for private sector institutions, does not

provide sufficiently detailed direction for establishing loan loss reserves.

As a result, our evaluation of the methodology used by FHA is based on this

general GAAP principle for loss recognition and our experience in applying

other principles in other situations involving the estimation of loan loss

reserves.22

Assumptions Not Based on

Detailed Analysis of Loss

Exposure in the Portfolio

FHA’s assumptions regarding default probabilities and loss rates were not

supported by analysis of the loss exposure of each individual insured loan

or other evidence that justified the estimates used. Specifically, FHA

computed the probability of each program hospital appearing on HHS’

Credit Watch List23 and then used these probabilities as proxies to

20This estimate, calculated on a present value basis, represents the amount that FHA expects to lose

from defaults through 2002 on hospital loans insured as of September 30, 1994. The estimate is about

11 percent of the unpaid principal balance of FHA’s insured hospital portfolio as of this date.

21The report discussed inconsistencies in the use of individual loan assessments and loss history in

establishing loss reserves and the need to link the loan loss reserve to a detailed documented analysis

of current loss exposure in the loan portfolio. Depositary Institutions: Divergent Loan Loss Methods

Undermine Usefulness of Financial Reports (GAO/AIMD-95-8, Oct. 31, 1994).

22We also considered Statement of Federal Financial Accounting Standard No. 1, Accounting for

Selected Assets and Liabilities, which provides more detailed guidance on loss reserves than GAAP.

23The Credit Watch List is a listing of hospitals that are in financial difficulty. HHS develops the list

based on its monitoring of change in hospitals’ financial condition. The list does not include hospitals

that have defaulted on their loans.

Page 15 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
B-258517 

measure the default probability of each hospital in the portfolio.24 The

probability of a hospital being on the Credit Watch List, however, is not a

valid proxy for estimating the default probabilities for the entire portfolio

because a hospital appearing on this list is a more common occurrence

than a hospital defaulting. HHS’ data show that from 1984 to 1994 there

were on average 167 hospitals in FHA’s portfolio. During this period, 16

hospitals (or 9.6 percent) defaulted on their loans and there were 82

hospitals on the Credit Watch List (49 percent). HHS data indicate that the

majority of the default probabilities that FHA used to calculate the loan loss

reserve were higher than the actual default rate of hospitals in the

program. FHA’s approach for measuring default probabilities resulted in

estimates of program hospitals’ default probabilities that ranged from

about 3 to 80 percent with the majority of the default probabilities in the

10 to 40 percent range. However, FHA’s approach may have underreserved

for loans that have high default probabilities because FHA did not consider

the full unpaid principle balance when applying the loss percentages.25

Moreover, FHA’s use of the Credit Watch List overstates the hospitals’

default probabilities for loans less likely to default. FHA officials reported

that they preferred to use the Credit Watch List as an indicator of the

probability of default because, in their view, the Credit Watch List

provides a prospective approach to estimating defaults.

Regarding the loss rates, FHA applied percentages that were in some

instances arbitrarily set and not linked to documented evidence of the

individual insured loan’s likely losses. For example, FHA assigned the

historical average loss rate of 70 percent to the hospitals it predicted were

most likely to default on their mortgages26 (that is, hospitals with

estimated default probabilities of 50 percent or more) and graduated

downward the loss rate for hospitals that had estimated default

24FHA used regression analysis to estimate the probability of a hospital appearing on the Credit Watch

List. The analysis was based on six financial indicators: liquidity, profitability, capital structure, liquid

assets to liabilities, trends of these indicators, and a combination of trends and financial indicators.

FHA averaged the predicted probabilities resulting from these six indicators. In effect, the average

predicted probability for the hospitals in the portfolio is the same as the percentage of hospitals on the

Credit Watch List. FHA assumed that a hospital’s average on these probabilities was a good estimate of

the hospital’s probability of default.

25GAAP generally requires that 100 percent of the principle balance be considered for reserving

purposes when default is more likely than not to occur (that is, defaults that are considered probable).

FHA’s analysis shows that it considered less than 100 percent of the principle balance in applying

reserve percentages for the loans FHA identified as having high default probabilities. This practice

understates reserves for loans more likely than not to default.

26According to FHA, losses have averaged 70 percent from the sale at foreclosure or property

disposition of eight of the nine hospital mortgages taken into inventory and sold since 1974. Loss data

were not available for the ninth hospital.

Page 16 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
B-258517 

probabilities lower than 50 percent.27 The 70-percent loss rate was based

on losses HUD experienced from the sale at foreclosure or property

disposition of eight of the nine hospital mortgages taken into inventory

and sold since 1974. However, a better method for estimating the loan loss

reserve would be to do a comprehensive analysis of the individual loss

exposure for defaults considered probable—hospital loans with 50 percent

or higher default probabilities. This entails not only reviewing the financial

condition of the hospital, which FHA did, but considering other factors

such as the likelihood of foreclosure versus FHA continuing to carry the

loan. Further, FHA had no justifiable basis for the loss rate percentages

applied to the hospitals that had default probabilities lower than

50 percent. FHA’s rationale was that in the future it could recover more

from disposing of hospitals with default probabilities below 50 percent

because these hospitals are considered to be stronger financially, based on

the hospitals’ financial condition in 1994. FHA arbitrarily assumed that

these hospitals would default later28 and have a higher value at the time of

sale because they would have a broader patient base and higher net

patient revenue. We question the validity of these assumptions because

FHA provided no analysis to support the loss rates applied to hospitals with

a lower than 50 percent probability of default.29 Because FHA had no basis

for the loss rate percentages used for these categories of loans, it may be

misstating the loan loss reserve estimate.

Health Care Market Trends

That Might Affect the

Future Viability of the

Program Were Not

Included in the Analysis

FHA’s loan loss reserve methodology did not incorporate newly developed

events, such as health care market trends, that can affect the future

financial condition of program hospitals. For example, by omitting

analyses of the potential impact of managed care, the loan loss reserve did

not consider developing events that can impact program hospitals’

revenues. A reduction in revenue related to managed care could result in

program losses. Overall, FHA’s exclusion of health care market trends in its

methodology may have understated or overstated the loan loss reserve

estimate depending on the impact that the specific market trend has on the

program hospitals. While FHA officials acknowledged the importance of

27The loss rates were 50 percent for default estimates between 40 and 50 percent, 25 percent for those

between 30 and 40 percent, 10 percent for defaults estimates between 20 and 30 percent, and 2 percent

for default estimates between 0 and 20 percent.

28FHA assumed that hospitals with default likelihoods of over 80 percent would default in 1995; those

between 70-80 percent in 1996; 60-70 percent in 1997; 50-60 percent in 1998; 40-50 percent in 1999;

30-40 percent in 2000; 20-30 percent in 2001; and 2-20 percent in 2002. FHA officials said that they

arbitrarily set the specific years in which the defaults would occur.

29FHA’s underlying assumptions were that some insured loans would have loss rates equal to the

historical average and others would have loss rates below the historical average. However, because

none of the insured loans was assumed to have a loss rate above the historical average, FHA is

assuming that future loss rates would be less than the historical average indicates.

Page 17 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
B-258517 

health care trends, they stated that they had not developed an approach to

incorporate such factors into their analysis.

Program Purpose

Relates to HUD’s

Mission but

Achievement of Goals

Is Not Routinely

Measured

HUD’s mission is broad enough to encompass the purpose of the hospital

program. HUD’s overall mission includes increasing opportunities for

housing and community development and, through FHA, providing

mortgage insurance for construction projects. The purpose of the program

is to assist with providing for urgently needed hospitals. In the report

supporting the establishment of the hospital program, the House

Committee on Banking and Currency cited FHA’s experience with

promoting construction through its insurance programs. Subsequently, the

Congress made providing mortgage insurance for hospital construction a

part of HUD’s mission by giving the department statutory responsibility for

the program.

HUD officials reported that through FHA the program supports the

department’s mission because it (1) provides an opportunity for hospitals

to obtain financing for construction and renovation projects that they may

not otherwise obtain in the private market and (2) promotes one of the

department’s goals of economic lift by increasing employment, economic

development, and neighborhood stabilization. The program also has as one

of its specific goals promoting neighborhood stability and economic lift.30

Although FHA officials believe that the hospital program is consistent with

HUD’s mission, the extent to which the program accomplishes the

department’s goals and thereby supports its mission is not routinely

measured. For example, HUD does not measure the extent to which local

employment increased as a result of the program or the effect an insured

project had on stabilizing a community. Performance measurement data

would be useful for HUD to determine the strategic importance of the

program to its mission and to evaluate the extent to which program

benefits or outcomes outweigh program risks.

Although no legal requirement existed for performance measurement, the

Government Performance Results Act (GPRA) of 1993 requires federal

agencies to submit a strategic plan to the Congress in the fall of 1997 and

30In addition, FHA also established the following five program goals: (1) provide access to capital for

facilities that cannot get conventional financing, (2) make facility modernization and improved patient

care possible, (3) support governmental and market-driven health care reforms, (4) ease health care

costs, and (5) provide technical assistance to help “turn around” troubled facilities.

Page 18 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
B-258517 

an annual performance plan in fiscal year 1999.31 In response to GPRA

requirements, HUD officials stated that HUD established performance

measures for some of its major programs. These measures include

increasing the number of first-time home buyers and increasing benefits to

low- and moderate-income home buyers. However for the hospital

program, HUD officials stated that the agency has not developed

performance measures, in part, because of the program’s relatively small

size and HUD’s lack of data systems to track specific performance

measures.

FHA Program

Management

Responsibilities

Shared With HHS Staff

FHA has limited health care expertise to independently manage the

program. FHA’s headquarters staff has overall responsibility but shares

program responsibilities with HHS staff because of HHS’ experience with

hospitals and health care. Managing the program requires, in part,

(1) familiarity with health care regulations, insurance practices,

reimbursement systems, and trends; (2) an understanding of the indicators

of a hospital’s financial condition; and (3) knowledge of the unique

construction guidelines that apply to hospitals. According to a 1992 HUD

report, HHS has staff with skills and experience in business administration,

financial analysis, and accounting in the health care industry, as well as

architects and engineers who specialize in overseeing the construction of

health care facilities.32 The majority of the tasks related to managing the

initial phases of the program’s loan cycle—loan development and

management—have been delegated to HHS. FHA has primary responsibility

for managing the latter stages of the program’s loan cycle—loan

assignment and property disposition (see app. III for a description of each

agency’s responsibilities during the phases of the loan cycle).

A 1992 HUD report shows that FHA and HHS’ efforts to manage the program

have produced mixed results. The report raised some concern about their

past performance in loan development and management and the

management of assigned loans and disposition of HUD-owned hospitals.

However, the report concluded that, for the most part, HHS staff had done a

good job and HUD’s staff was getting more involved and gaining experience

in working with troubled hospitals.33 As agreed with your staff, our review

31The strategic plan is to contain the agency’s mission, long-term goals and objectives, and strategies

for achieving these goals and objectives. The annual performance plan is to contain annual

performance goals to gauge the agency’s progress toward accomplishing its longer-term strategic goals

and identify the performance measures the agency will use to assess its progress.

32Organizational Review of the Hospital Mortgage Insurance Program, OMAP, pp. 82-83.

33Organizational Review of the Hospital Mortgage Insurance Program, OMAP, pp. 15, 22, 37, 43, 45, 52,

and 83.

Page 19 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
B-258517 

did not include an evaluation of FHA and HHS’ performance in program

management.

Length of Application

Process Criticized

The hospital and finance agency officials we interviewed raised concerns

about the length of time it takes to get mortgage insurance applications

and loan modifications34 approved by HHS and FHA. Our analysis of 12 loan

applications approved since September 1990 shows that the average time

from the date an application was first submitted to HHS to FHA’s final

approval was more than 18 months. In contrast, a Price Waterhouse study

reported that private insurers approve mortgage insurance applications for

health facilities in 2 to 4 weeks.35 In addition, according to HUD’s 1992

report, the median timeframe for selected modification approvals was

more than 9 months.36 Several hospital and finance agency officials said

that the application and loan modification processes are lengthy primarily

because of the number of offices involved in reviewing the applications.

FHA and HHS officials attribute some of the delay to hospitals not

responding to their questions in a timely manner. The lengthy approval

processes may hinder hospitals’ ability to take advantage of favorable

market interest rates, several officials said. One hospital reported that it

had to pay an additional 65 basis points37 on its interest rate because of the

time that elapsed between HHS’ recommendation to approve the

application and FHA’s final approval.

FHA recognizes that the approval processes are lengthy and stated that a

reasonable goal for approving applications is 6 months. FHA and HHS

recently initiated efforts to streamline the application process. These

efforts include using a team approach to analyze applications and

involving FHA’s field staff earlier in the process. However, FHA officials

stated that their approval timeframes will generally never match those of

private sector insurers because the hospitals that FHA insures are

financially weaker and require closer screening and evaluation.

34Loan modifications are modifying or waiving existing loan terms and conditions. These changes

include, but are not limited to, buying or selling equipment, leasing property, and merging or

restructuring the corporation.

35Assessment of Loan Management Procedures to Identify Strategies to Improve Health Care Facilities’

Financial Performance, Price Waterhouse (1994), p. 13.

36Organizational Review of the Hospital Mortgage Insurance Program, OMAP, p. 77.

37A basis point is equal to one one-hundredth of one percentage point, or 0.01 percent.

Page 20 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
B-258517 

Conclusions Although the hospital program had made a positive dollar contribution to

the General Insurance Fund as of fiscal year 1994, the accumulation of

more than $4 billion of insured projects and the large loan amounts in New

York pose risks to the future stability of the program. The continued

buildup in New York may further exacerbate this risk. Further, trends in

health care and changes in state and federal health care policies that

reduce hospitals’ revenues will impact program hospitals.

FHA officials are aware of the risks of concentration and health care

changes associated with the current portfolio. Portfolio concentration is a

controllable program risk for the future. But the law that authorizes the

Secretary of HUD to set the terms and conditions under which HUD will

insure projects does not specifically authorize FHA to use as options for

diversifying the portfolio, limiting the number of projects accepted into the

program from a geographic area, or limiting the amounts it insures. Health

care trends and changes in health care policies are risks beyond FHA’s

control. Hospitals currently in the FHA program must make adjustments to

respond to these changes or they could suffer significant financial losses.

To reduce the potential financial losses associated with future insured

mortgages, FHA is considering risk sharing with the public and private

sectors. However, the risk to the current portfolio remains.

Flaws in FHA’s methodology for estimating loan losses limit the reliability

of FHA’s loan loss reserve estimate. The implications of health care trends

for program hospitals were not factored into FHA’s methodology for

estimating potential loan losses. In addition, the approach that FHA used to

determine default and loss rate assumptions was not reliable. FHA did not

consider the full loss exposure in estimating reserves for hospitals that it

identified as having high default probabilities. As a result of these flaws,

the loan loss reserve estimate could be understated or overstated.

While FHA has developed performance measures for some of its major

programs in response to GPRA, it has not developed performance measures

for the hospital program. Performance measures would help HUD evaluate

the program’s effectiveness.

Page 21 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
B-258517 

Matter for

Congressional

Consideration

Given the risks associated with the portfolio’s geographic concentration

and the possible implications for the program of current health care

trends, the Congress may wish to explore further with HUD officials

options for reducing the program’s risk by, for example, limiting the

program’s risk exposure in a particular state and capping mortgage

insurance amounts.

Recommendations To improve the reliability of FHA’s loan loss reserve estimate, insure future

compliance with federal performance measurement requirements, and

minimize potential financial losses from future projects, we recommend

that the Secretary of HUD

• perform a comprehensive analysis of individual loan loss exposure when

default is considered probable; link the loan loss reserve estimate to

documented analyses that justifiably support loss rates and default

percentages; and consider newly developed events, such as health care

trends and policy changes, that can affect the performance of loans in

estimating loan loss reserves;

• develop performance measures and begin collecting the data needed to

track the performance of the Hospital Mortgage Insurance Program; and

• pursue risk-sharing arrangements in which a private or public entity would

share in potential financial losses from hospital defaults on future

FHA-insured projects only after a thorough evaluation of the benefits and

drawbacks of risk-sharing ventures, taking into account past experiences

of FHA’s multifamily housing programs.

Agency Comments

and Our Evaluation

On November 22, 1995, we provided a draft of this report to HUD and HRSA

for comment. Although HRSA did not provide comments, HUD generally

agreed with the report’s findings and conclusions. In response to our

recommendations, HUD reported that it will (1) incorporate additional data

on market trends and health care policy changes into FHA’s loan loss

reserve methodology as such data become available and can be quantified;

(2) develop and implement performance measures for the program in

fiscal year 1997; and (3) conduct front-end risk analysis and incorporate

multifamily’s risk-sharing experience into its plans for the hospital

risk-sharing program. (See app. V.).

HUD did not, however, concur with our evaluation of its 1994 loan loss

reserve methodology. Contrary to what we concluded, HUD stated that it

(1) used the financial position of the hospitals, not their appearance on the

Page 22 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
B-258517 

Credit Watch List to predict the probability of default, (2) based its loss

rates on a review of all losses incurred in foreclosure or property

disposition sales since the beginning of the program, (3) considered the

full unpaid principal balance in estimating the loan loss reserve, and

(4) included health care market trends through its analysis of the current

financial condition and trends in the financial condition of individual

hospitals.

Predicting the Probability

of Default

HUD’s comment that FHA used the financial condition of the hospitals, not

appearance on the Credit Watch List, to predict probability of default is

inconsistent with the documentation that FHA provided on the method

used for estimating the program’s loan loss reserves. FHA’s documentation

states that financial indicators “were used to predict the probability that a

hospital would appear on HHS’ Watch List.” FHA averaged the probabilities

estimated by these indicators to convert “the predictors of appearance on

the Watch List to a likelihood of default.” Further, as stated in the report,

our review of HHS data showed that the majority of default probabilities

that FHA used were higher than the actual default rate of hospitals in the

program. Clearly, FHA did not adjust the predicted probabilities of default

for this difference.

Determining Loss Rates Regarding the loss rates, HUD commented that FHA’s analysis was based on

all losses incurred in foreclosure and property disposition since the

inception of the program. HUD also stated that the loss rates were adjusted

downward for mortgages with probabilities of default lower than

50 percent based on the assumption that hospitals with a better financial

condition would be worth more at foreclosure.

As discussed in our report, the 70-percent average loss rate that FHA used

for hospitals with high default probabilities was based on actual losses

experienced in the foreclosure or property disposition of only eight

mortgages taken into inventory and sold since 1974. Thus, FHA’s historical

analysis was not statistically significant and was based on information that

was not adjusted for current real estate market trends. We believe that

FHA’s use of this historical analysis to determine loss reserves for loans

where default is considered more likely than not (that is, hospital loans

with 50-percent or higher default probabilities) may overstate or

understate the reserves on these loans. We believe that individual loan

analysis of mortgages in the current portfolio provides for a more accurate

Page 23 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
B-258517 

means to measure loss exposure on loans where default is considered

more likely than not.

Although as a matter of generally accepted practice, using historical data

may under some circumstances be appropriate for groups of loans with a

lower than 50-percent default probability, FHA arbitrarily adjusted a

questionable 70-percent loss rate downward for such loans and provided

no supporting analysis to justify the resultant loss rates. We believe that

this analysis was inappropriate for this group of loans with lower default

probabilities. Therefore, these loss rates do not provide a reliable basis for

estimating FHA’s reserves.

Accounting for the Full

Unpaid Principal Balance

With respect to accounting for the full unpaid principal balance in

estimating potential losses, HUD stated that it “multiplied the full unpaid

principal balance by the probability of default and then by the loss rate—a

standard approach to factoring the probability of default into a loss

estimate.”

However, this approach has the effect of reducing the unpaid principal

balance. Proper application of GAAP requires 100 percent of the unpaid

principle balance for reserving purposes when default is more likely than

not to occur. Including default probabilities in the reserve calculation may

be appropriate for loans where default is not considered more likely than

not, but once that threshold has been determined, the full amount of the

loan balance should be considered in calculating the loss estimate.

Including Health Care

Trends

HUD stated that its methodology reflected current health care market

trends. We agree that some health care market trends may be reflected in

hospitals’ financial statements. However, some rapidly evolving health

care market trends, such as managed care, may not be reflected in the

hospitals’ financial statements that HUD uses because of the time lag in

financial reporting. FHA’s loan loss reserve methodology does not include a

mechanism to identify and adjust for such trends. Historical trends should

be adjusted to reflect changes in economic and business conditions, such

as managed care, in order to provide a reasonable estimate of current loss

exposure. Data on hospitals’ utilization rates may be used in analyzing

health care trends.

HUD also commented on other issues that did not accurately reflect the

information presented in our report. For example, HUD commented that we

Page 24 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
B-258517 

found the program to be “consistent with and contributing towards the

mission of HUD.” However, this is not a conclusion of our report. Our

report cites the statements of HUD officials that the program supports and

is consistent with the Department’s mission. We concluded that HUD’s

mission is broad enough to encompass the purpose of the hospital

program, not that it contributes to the mission of HUD. (See p. 18.)

HUD also commented that it agreed with our concern that the proposed

federal Medicare and Medicaid cuts could have a “significant adverse

impact on the hospital industry, including some hospitals with mortgages

insured by FHA.” Our report does not make a value judgment about the

proposed federal Medicare and Medicaid reductions on the hospital

industry or hospitals in the program. Instead, we report that future

changes in federal health care policies can restrict hospital revenues and

increase risks to the program. (See p. 12.)

While HUD commented that our report noted “many urban community and

teaching hospitals need credit enhancement but cannot meet all of the

standards of the private insurers,” we did not differentiate among which

types of hospitals need credit enhancement.

HUD provided additional reasons for the program’s concentration in New

York other than the state’s reimbursement system. Despite these reasons

and recent actions taken in efforts to address these risks, the program’s

concentration and the large individual unpaid loan balances in New York

continue to pose program risks. Specifically, the concentration of the

portfolio in New York makes the program susceptible to New York

policies and other factors specific to the state. (See p. 10.)

HUD also noted actions that it is initiating to geographically and

economically diversify its portfolio. According to HUD comments, these

actions include increasing program awareness and developing new

products to meet market demands. Although we recommended that HUD

pursue risk-sharing arrangements and suggested that the Congress

consider exploring with HUD options for reducing program risks; for

example, by limiting the program’s risk exposure in a particular state and

capping mortgage insurance amounts, we do not endorse expanding FHA’s

Hospital Mortgage Insurance Program. By expanding the program, FHA

increases the program’s total outstanding mortgage amount. In fact,

because the overall impact of health care trends and policy changes is

unclear, we stated that to understand the overall impact of these changes

Page 25 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
B-258517 

on the future of the program would require further analysis given its

original purpose and the current composition of the portfolio. (See p. 13.)

We are sending copies of this report to appropriate congressional

committees; the Secretary of HUD; the Secretary of HHS; the Director, Office

of Management and Budget; and other interested parties. We also will

make copies available to others on request.

Please contact me at (202) 512-7119 if you or your staff have any questions.

Other major contributors are listed in appendix VI.

Sarah F. Jaggar

Director, Health Financing

 and Public Health Issues

Page 26 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Page 27 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Contents

Letter 1

Appendix I 

Financial

Performance of FHA’s

Hospital Mortgage

Insurance Program,

Fiscal Years 1969-94

30

Appendix II 

FHA-Insured Hospital

Projects’ Unpaid

Principal Balances, by

State, August 1995

31

Appendix III 

HUD’s and HHS’

Responsibilities in

FHA’s Hospital

Mortgage Insurance

Program Loan Cycle

35

Appendix IV 

Objectives, Scope,

and Methodology

37

Appendix V 

Comments From the

Department of

Housing and Urban

Development

39

Page 28 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Contents

Appendix VI 

Major Contributors to

This Report and Staff

Acknowledgments

53

Figures Figure 1: FHA’s Hospital Mortgage Insurance Program Cash Flow

From Operations, Fiscal Years 1969-94

6

Figure 2: Distribution of Hospital Projects and Unpaid Principal

Balances, by State, in the FHA Hospital Mortgage Insurance

Portfolio, August 1995

8

Abbreviations

AHA American Hospital Association

FHA Federal Housing Administration

GAAP generally accepted accounting principles

GPRA Government Performance Results Act

HHS Department of Health and Human Services

HRSA Health Resources and Services Administration

HUD Department of Housing and Urban Development

Page 29 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Appendix I 

Financial Performance of FHA’s Hospital

Mortgage Insurance Program, Fiscal Years

1969-94

Dollars in thousandsa

Fiscal year

Fees and

premium

earned

Claims

paid

Net of

recovery

and holding

costb

Salaries and

administrative

expenses

Net cash

flow from

operations

for the year

1969 $11 $0 $0 ($1) $10

1970 234 0 0 (12) 221

1971 1,255 0 0 (50) 1,205

1972 2,756 0 0 (86) 2,670

1973 4,144 0 0 (133) 4,012

1974 5,028 (26,867) 13 (159) (21,985)

1975 5,356 0 991 (169) 6,178

1976 6,186 0 1,935 (243) 7,878

1977 9,117 0 1,990 (337) 10,770

1978 11,502 0 6,262 (363) 17,401

1979 11,150 0 2,582 (378) 13,354

1980 11,253 (12,105) 2,407 (418) 1,137

1981 13,763 0 2,409 (516) 15,656

1982 15,708 0 1,995 (548) 17,155

1983 18,640 0 12,040 (663) 30,017

1984 20,435 0 298 (673) 20,060

1985 22,369 0 7,061 (869) 28,560

1986 25,373 0 1,317 (876) 25,814

1987 27,385 (5,351) 1,308 (898) 22,443

1988 25,335 0 29 (901) 24,463

1989 22,694 (34,606) 1,432 (844) (11,324)

1990 23,450 (21,240) 6,118 (872) 7,456

1991 24,571 (91,179) 803 (883) (66,687)

1992 22,866 0 6,420 (828) 28,458

1993 20,521 (4,202) 5,897 (773) 21,442

1994 19,008 (4,180) 474 (714) 14,589

Total $370,110 ($199,730) $63,781 ($13,207) $220,953

Source: FHA.

aThese amounts were not adjusted for inflation.

bThis column includes the amount FHA recovers from mortgage payments and the sale of the

mortgages or properties and the amount paid in taxes, rent, insurance, maintenance, and other

holding expenses.

Page 30 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Appendix II 

FHA-Insured Hospital Projects’ Unpaid

Principal Balances, by State, August 1995

Project

Unpaid

principal

balance

Arkansas

1 $1,365,254

2 1,235,236

Subtotal 2,600,490

California

1 1,210,456

2 599,445

Subtotal 1,809,901

Florida

1 11,362,651

Subtotal 11,362,651

Illinois

1 6,063,326

Subtotal 6,063,326

Kentucky

1 9,285,024

Subtotal 9,285,024

Louisiana

1 2,493,799

Subtotal 2,493,799

Maryland

1 9,099,451

Subtotal 9,099,451

Massachusetts

1 151,986,224

2 30,637,783

3 27,398,992

4 6,725,307

5 4,322,184

Subtotal 221,070,490

Michigan

1 15,279,345

2 3,773,294

3 3,137,481

4 922,378

Subtotal 23,112,498

(continued)

Page 31 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Appendix II 

FHA-Insured Hospital Projects’ Unpaid

Principal Balances, by State, August 1995

Project

Unpaid

principal

balance

Missouri

1 4,305,135

Subtotal 4,305,135

New Hampshire

1 2,537,862

Subtotal 2,537,862

New Jersey

1 83,732,411

2 58,311,090

3 31,765,110

4 20,420,021

5 16,987,817

6 16,969,713

7 5,149,716

Subtotal 233,335,878

New York

1 590,797,000

2 380,241,760

3 372,438,614

4 364,192,332

5 204,573,918

6 140,979,861

7 136,555,425

8 131,418,238

9 110,113,928

10 94,763,000

11 91,896,764

12 88,735,802

13 88,678,093

14 87,755,400

15 72,560,788

16 70,722,167

17 64,465,065

18 60,866,708

19 58,959,262

20 52,714,233

21 50,420,949

(continued)

Page 32 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Appendix II 

FHA-Insured Hospital Projects’ Unpaid

Principal Balances, by State, August 1995

Project

Unpaid

principal

balance

22 43,470,870

23 42,298,615

24 40,740,246

25 38,213,163

26 36,501,710

27 36,030,000

28 35,091,398

29 30,720,000

30 30,580,690

31 30,081,568

32 27,242,060

33 26,940,025

34 26,633,787

35 25,750,401

36 25,124,360

37 23,062,692

38 22,089,824

39 21,143,165

40 21,028,658

41 20,430,852

42 19,908,217

43 18,726,104

44 18,223,927

45 17,171,818

46 15,597,580

47 15,593,213

48 15,557,416

49 15,449,366

50 14,857,896

51 14,664,349

52 14,088,396

53 13,929,748

54 11,860,561

55 9,385,082

56 9,318,357

57 8,256,858

58 8,253,678

(continued)

Page 33 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Appendix II 

FHA-Insured Hospital Projects’ Unpaid

Principal Balances, by State, August 1995

Project

Unpaid

principal

balance

59 7,487,455

60 7,368,244

61 5,411,324

62 5,281,195

63 1,423,221

Subtotal 4,184,837,396

Oklahoma

1 387,472

Subtotal 387,472

Pennsylvania

1 28,400,264

2 19,226,647

3 8,154,756

4 7,578,058

Subtotal 63,359,725

Puerto Rico

1 15,782,102

Subtotal 15,782,102

Texas

1 12,286,708

Subtotal 12,286,708

Washington

1 220,096

Subtotal 220,096

Wisconsin

1 8,989,065

2 6,566,419

Subtotal 15,555,484

Total (100 projects) $4,819,505,488

Source: FHA Hospital Mortgage Insurance Program staff.

Page 34 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Appendix III 

HUD’s and HHS’ Responsibilities in FHA’s

Hospital Mortgage Insurance Program Loan

Cycle

HHS HUD

Development

Provide applicant guidance and assistance (including

preapplication conference) x x

Conduct initial site visit to hospital x x

Review and approve construction plans, specifications, and

contracts x

Engage independent feasibility consultant x

Recommend to HUD approval or disapproval of hospital’s

application x

Make final underwriting determinations, conduct any needed

legal reviews, issue firm commitment, close and initially

endorse loan x

Conduct preconstruction conference, monitor construction

work, and process requests for advances of mortgage

proceeds x

Review cost certification, inform lender of maximum insurable

mortgage amount, and process final advance x

Arrange final closing and finally endorse mortgage x

Loan Management

Monitor hospital’s financial performance by reviewing financial

statements and conducting periodic site visits x

Receive, review, and recommend to HUD approval or

disapproval of special requests and loan modifications (for

example, partial release of security, transfer of physical

assets, bond refundings, or major capital projects) x

Approve special requests and loan modifications x

Conduct site visits to troubled hospitals to determine actions

needed to prevent or cure defaults x x

Review quality and condition of insured hospital loan portfolio

and determine amount of loan loss reserve x

Assignment

Receive/process assignment of loan and pay insurance claim x

Review assigned hospital’s operational performance and

financial condition and conduct site visits as needed x x

Receive, review, and recommend to HUD approval or

disapproval of proposed workout agreements or mortgage

modifications x

Bill for and collect mortgage payments x

Disposition

Analyze hospital’s situation, evaluate alternative uses, secure

appraisal, make decision to foreclose, and arrange and hold

foreclosure sale x

(continued)

Page 35 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Appendix III 

HUD’s and HHS’ Responsibilities in FHA’s

Hospital Mortgage Insurance Program Loan

Cycle

HHS HUD

Contract for management services and repairs, as needed, to

protect asset if HUD is mortgagee-in-possession or acquires

hospital through foreclosure or deed-in-lieu x

Develop marketing plan; advertise and sell hospital x

Source: FHA Hospital Mortgage Insurance Program staff.

Page 36 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Appendix IV 

Objectives, Scope, and Methodology

The specific objectives of our review were to (1) identify factors, including

those related to health care market trends, that could affect the stability of

the program’s portfolio and provide information on the program’s financial

performance; (2) evaluate the methodology FHA used to estimate the

program’s fiscal year 1994 loan loss reserve; (3) evaluate the relationship

between the purpose of the hospital mortgage insurance program and

HUD’s mission; and (4) determine whether FHA has the expertise to manage

the program.

To identify factors that could affect the stability of the program’s portfolio,

we (1) researched the literature and used HUD’s 1992 internal report on the

hospital mortgage insurance program; (2) interviewed program officials in

FHA and HHS headquarters and field offices; (3) interviewed senior financial

officers from seven hospitals in New Jersey, New York, Puerto Rico, and

Texas;38 (4) interviewed representatives from the Health Care Financing

Study Group, New Jersey Health Care Facilities Financing Authority, New

York State Medical Care Facilities Finance Agency, Goldman, Sachs & Co.,

Merrill Lynch and Co., AMBAC Indemnity Corp., Municipal Bond Investors

Assurance Insurance Corp., Greater New York Hospital Association,

Healthcare Association of New York State, State of New York Department

of Health, the law firm of Krooth & Altman, and other state health and

hospital organizations that are knowledgeable about or involved with the

program; and (5) convened a panel of investment bankers and hospital

financial officers.

We used the Health Care Financing Administration’s Health Care Provider

Cost Report Information System, the New York State Department of Social

Services Medicaid Provider Ranking List, and the New York State

Department of Health’s estimation of Medicaid cost containment to

demonstrate the effect of New York’s fiscal year 1996 Medicaid spending

reductions on program hospitals. We calculated 1994 operating margins

for 48 of 57 New York program hospitals. Nine hospitals did not have 1994

cost report information available or did not have the state’s estimation of

Medicaid cost containment. We reduced calendar year 1994 net patient

revenues by the New York State Department of Health estimation of

Medicaid cost containment. Two assumptions of our analysis were that

(1) the effects of the proposed changes on net patient revenue would be

the same in each year and (2) the hospitals took no action to reduce

expenses.

38This was a nonrandom, judgmental sample of states. Each state was chosen because it illustrates one

or more of the following: (1) a high proportion of the program’s unpaid principal balance, (2) several

mortgage loans in default, (3) varying health care regulatory environments, and (4) market trends in

diverse geographic areas.

Page 37 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Appendix IV 

Objectives, Scope, and Methodology

To evaluate the methodology FHA used to estimate its 1994 hospital loan

loss reserve, we reviewed the description of the hospital loan loss analysis

and other related documents. We evaluated the methodology and

discussed the statistical estimation model and assumptions FHA used with

FHA and HHS officials. Also, we interviewed investment bankers and bond

insurers to determine conventional approaches private industry uses in

estimating loss reserves. As agreed with Committee staff, we did not

assess the accuracy of the estimated amount of the program’s loan loss

reserve.

To evaluate the relationship between the purpose of the hospital program

and HUD’s mission, we reviewed and analyzed the applicable laws,

regulations, and policy statements related to the Department’s and FHA’s

missions. We reviewed the legislative history to determine the purpose of

the program. We also interviewed FHA officials to discuss how the

program’s purpose supports HUD’s mission.

To determine whether FHA has the expertise to manage the program, we

interviewed agency officials and representatives from hospitals and state

health and hospital organizations, as previously mentioned. Our review of

FHA’s expertise to manage the program did not involve an evaluation of

risks to the program resulting from program management or organization.

Our 1990 report and internal HUD studies have previously addressed

organizational issues.39

The approach to accomplishing the objectives of this review was

discussed with and agreed to by staff from both the Senate and House

Banking Committees.

39Financial Audit: Federal Housing Administration Fund’s 1988 Financial Statements

(GAO/AFMD-90-36, Feb. 9, 1990); Federal Managers’ Financial Integrity Act Report for Fiscal Year

1991, HUD; and Organizational Review of the Hospital Mortgage Insurance Program, Office of

Management and Planning, HUD (1992).

Page 38 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Appendix V 

Comments From the Department of Housing

and Urban Development

Page 39 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Appendix V 

Comments From the Department of Housing

and Urban Development

Page 40 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Appendix V 

Comments From the Department of Housing

and Urban Development

Page 41 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Appendix V 

Comments From the Department of Housing

and Urban Development

Page 42 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Appendix V 

Comments From the Department of Housing

and Urban Development

Page 43 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Appendix V 

Comments From the Department of Housing

and Urban Development

Page 44 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Appendix V 

Comments From the Department of Housing

and Urban Development

Page 45 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Appendix V 

Comments From the Department of Housing

and Urban Development

Page 46 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Appendix V 

Comments From the Department of Housing

and Urban Development

Page 47 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Appendix V 

Comments From the Department of Housing

and Urban Development

Page 48 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Appendix V 

Comments From the Department of Housing

and Urban Development

Page 49 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Appendix V 

Comments From the Department of Housing

and Urban Development

Page 50 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Appendix V 

Comments From the Department of Housing

and Urban Development

Page 51 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Appendix V 

Comments From the Department of Housing

and Urban Development

Page 52 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
Appendix VI 

Major Contributors to This Report and Staff

Acknowledgments

Major Contributors James O. McClyde, Assistant Director, (202) 512-7152

Madeline M. Chulumovich

Janina R. Johnson

Carmen Rivera-Lowitt

Connie Drake Wilson

Acknowledgments In addition to those named above, the following individuals also made

important contributions to this report as advisors and technical assistants:

Linda Calbom, Robert C. DeRoy, Austin J. Kelly, Ann McDermott, Luann

M. Moy, David Patrick Redmon, Mary W. Reich, Daynah K. Shah, and

William J. Carter-Woodbridge.

(108213) Page 53 GAO/HEHS-96-29 FHA Hospital Mortgage Insurance
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