HUD Management: Greater Oversight Needed of FHA's Nursing Home Insurance Program
Released: 1995-08-25T00:00:00

Letter

Background

Section 232 of the National Housing Act, as amended, authorizes FHA to insure mortgages made by private lenders to finance the construction or renovation of skilled nursing facilities, intermediate care facilities, board and care homes, and assisted living facilities, as well as combinations of these types of projects. As of September 30, 1994, the insured nursing home portfolio consisted of about 869 loans with an aggregate unpaid principal balance of $3.7 billion.

In 1994, HUD issued regulations implementing legislation that has expanded FHA’s nursing home program to include mortgage insurance for the refinancing of non-FHA-insured projects and for assisted living facilities. HUD had previously revised its regulations to allow for the refinancing of FHA-insured projects. Assisted living facilities offer a combination of housing and personalized health care, including separate living units for residents, common areas, and assistance with activities of daily living, such as bathing, dressing, and eating. According to HUD’s Director of Insured Multifamily Housing Development, assisted living facilities under the nursing home program will generally be unsubsidized, market-rate projects serving the moderate- and upper-income elderly.

FHA’s terminated retirement service center program also served the upper-income elderly, providing unsubsidized rental housing that had more services and amenities, such as meals, than those available in the typical FHA-insured project for the elderly. HUD established this program administratively under section 221(d)(4) of the National Housing Act, which provides for multifamily rental housing for moderate-income families. The retirement service center program was not part of the nursing home program. Because retirement service center loans are included with other market-rate housing loans, HUD’s data systems cannot readily identify retirement service center projects. According to HUD’s July 12, 1995, report on retirement service centers, 85 retirement service center loans with original face amounts of $689 million were in force as of September 30, 1994.

When a default occurs on an insured loan, a lender may assign the mortgage to HUD and receive payment from HUD for an insurance claim. Each year, FHA establishes loan loss reserves to reflect the net amount that the agency expects its insurance funds to lose from future defaults on loans in the existing multifamily portfolio. FHA is also required each year, under the Credit Reform Act of 1990, to estimate credit subsidies—the net costs to the government of insuring new mortgages. The act requires that for credit instruments—including mortgage insurance—budget authority be provided for credit subsidies to cover the government’s cost before such credit is extended. The federal budget shows whether credit programs lose money, break even, or make a “profit.”

Furtherance of HUD’s Mission by Programs Is Uncertain

As an agency of HUD, FHA is to further the Department’s overall mission of enhancing opportunities for housing and community development. HUD officials, including the Deputy Assistant Secretary for Multifamily Housing Programs, believe the nursing home program supports HUD’s mission by serving populations or areas that are not adequately served by the private sector. However, the extent to which FHA’s nursing home program has achieved these objectives is uncertain. The nursing home program has not been targeted to serve specific populations or communities, and HUD does not collect and analyze information on whom the program is serving. When HUD evaluated the market being served by the retirement service center program, it found that the private sector and the FHA program were primarily serving the same market—the upper-income elderly.

Extent to Which the Nursing Home Program Furthers HUD’s Mission Is Unclear

The mortgage insurance program for nursing homes was established by the Congress in 1959 to encourage the construction of nursing homes. At that time, the Congress believed that sponsors of for-profit nursing homes had difficulty in obtaining financing on reasonable terms. According to officials in the Policies and Procedures Division of HUD’s Insured Multifamily Housing Development Office, lenders generally viewed nursing homes as risky ventures prior to the establishment of the Medicaid reimbursement program in 1965. The nursing home program was intended to overcome private lenders’ reluctance to finance nursing homes by drawing on FHA’s experience in credit enhancement programs to minimize the lenders’ risk of financial losses. The passage of the Medicaid program in 1965 provided a more reliable income stream for nursing homes by reimbursing their costs.

Since the program’s inception, FHA has insured over 2,000 nursing home loans totaling about $5.1 billion. By comparison, over 16,000 skilled nursing and intermediate care facilities were in the United States as of March 1994. In addition, the American Association of Retired Persons (AARP) reports that an estimated 32,000 licensed board and care homes are in the United States, some of which are assisted living facilities. Because assisted living facilities can be called by a variety of names, the exact number is difficult to determine; however, the Assisted Living Facilities Association of America represents about 12,000 facilities. These statistics indicate that a relatively small number of nursing homes operating in the United States today were financed with mortgage loans carrying FHA insurance. Nonetheless, the Deputy Assistant Secretary for Multifamily Housing Programs and officials in HUD’s Insured Multifamily Housing Development Office and in the Housing Management Divisions of two of the three field offices we visited believe that the nursing home program furthers HUD’s broad mission of increasing opportunities for housing and community development.

Specifically, HUD officials said that the program supports HUD’s mission by insuring mortgages for nursing homes that may serve populations such as low-income individuals or areas such as small rural communities or inner cities that are not adequately served by the private sector. In addition, HUD officials said the program also supports the Department’s mission by assisting borrowers who might otherwise be unable to obtain financing for nursing homes. Along these lines, a 1993 report indicates that nonprofit, public, and small for-profit entities are most likely to obtain financing from either the FHA or state programs, whereas large for-profit entities generally obtain financing from commercial banks, savings and loan associations, and life insurance companies and through the stock market.

Nonetheless, the extent to which the program actually achieves the purposes cited by the HUD officials is uncertain. For example, the nursing home program is not targeted to specific unmet market needs, such as providing access to nursing homes to underserved locations and populations, nor are borrowers required to demonstrate that they could not obtain financing without FHA mortgage insurance. Current FHA borrowers that we contacted cited various reasons why they used FHA insurance in financing their nursing homes. While some noted the unavailability of other financing, others cited different reasons; for example, the program enabled them to obtain lower interest rates and the program offers “nonrecourse” terms, which protect investors. While FHA does have requirements to determine whether sufficient market demand exists for nursing home projects that it insures, the requirements are not specifically aimed at determining whether a project will meet a need that would not otherwise be met by the private sector. Furthermore, HUD does not collect and analyze information on whom the program is serving, such as the income levels of the patients served by FHA nursing homes, the economic characteristics of the communities in which FHA nursing homes are built, or the borrowers’ ability to obtain financing without FHA insurance.

Available information indicates that participation in FHA’s nursing home program varies widely by state. About 32 percent of FHA’s nursing home loan balances cover facilities located in New York, and another 38 percent of FHA’s nursing home loan balances cover facilities located in seven other states. (See fig. 1.) In contrast, FHA currently insures only a small number of nursing homes in many states. For example, FHA currently insures 2 percent of the nursing homes in California and 1 percent of the nursing homes in Texas. (See app. II.)

Eight States Account for 70 Percent of Total UPB Eight states each have over $150 million in UPB. New York has $1.2 billion in UPB, which is 32 percent of the total. Massachusetts, Ohio, Virginia, New Jersey, Illinois, Rhode Island, and Pennsylvania together account for 38 percent of the total.

The Retirement Service Center Program and the Private Sector Served the Same Market

The retirement service center program did not contribute to HUD’s mission of serving unserved markets. When HUD terminated the retirement service center program in 1991, it reported that the program primarily assisted the upper-income elderly and that the private sector also had been developing a wide variety of similar products for the upper-income elderly.

HUD established this program administratively in 1983 with the urging of developers to provide market-rate rental housing for the elderly with a significant level of services and amenities over and above those found in the typical HUD-insured project for the elderly. However, as the HUD Inspector General has noted, HUD implemented the program without having fully assessed the risks and benefits of the Department’s involvement in underwriting loans for retirement service centers. In particular, HUD did not do an adequate job of analyzing the market for such housing—an error that was also made by some private sector investors in retirement centers in the 1980s who also incurred losses as a result of defaults.

For example, HUD underestimated the reluctance of many seniors to move from their current home to alternative housing. In addition, because retirement service centers had no direct federal rental subsidies, the high rents associated with these projects made them affordable to only the upper-middle-income to upper-income elderly population. As a result of these and other factors, the program incurred a high level of loan defaults.

Because of the defaults, the Secretary placed a moratorium on insuring additional facilities in 1989. HUD terminated the program in 1991, at which time, it reported that approximately 53 percent of the retirement service center projects had either defaulted or were experiencing financial or operational difficulties. In terminating the program, HUD noted that this action would not cause a gap in the types of housing and support services available to serve the lower-income elderly because retirement service centers charged market rate rents and had no direct federal rental subsidies.

Financial Data and HUD’s Analyses Indicate Losses for Programs

Because of data limitations, the financial performance of the nursing home and retirement service center programs can only be estimated. Cost estimates for both programs indicate that they have incurred losses. HUD’s data also indicate that both programs will experience a significant number of loan defaults in the future. Furthermore, HUD’s credit subsidy estimates for the nursing home program, which assume that receipts will exceed costs, may be unreliable.

Both Programs Appear to Have Incurred Losses to Date

HUD has not done any complete assessments of the financial performance of the nursing home and retirement service center programs. For example, “actuarial” studies conducted periodically on these programs focus primarily on the number of defaults and the original loan balances associated with the defaults but do not analyze the full costs of the programs. Therefore, this information does not establish whether the programs operate at a profit or a loss. Furthermore, while HUD’s data systems currently track receipts and expenditure data associated with its individual mortgage insurance programs, cumulative receipts and expenditure data for its insurance programs are not available because historically the data systems have not tracked these data for the Department’s individual programs. Consequently, the actual financial performance of the nursing home and retirement service center programs can only be estimated.

Data from HUD that may be used to approximate the financial performance of the nursing home program from its inception to September 30, 1994, indicate that losses were likely incurred under this program. Specifically, HUD’s data on loan defaults, original loan amounts, premium payment requirements, and recoveries from the sale of notes and properties indicate that the nursing home program has incurred losses of approximately $187 million, adjusted for inflation, since its inception.Primarily because of the data limitations, we excluded some expenses, such as administrative costs, and developed some assumptions, for example, on recovery amounts from the sale of defaulted notes or properties, which tend to understate the cost of the nursing home program. These factors are discussed in more detail in appendix III, which summarizes our methodology for estimating the losses of the nursing home program.

Available data indicate that the terminated retirement service center program has incurred losses as well. For example, in terminating the program in 1991, HUD estimated that net losses to the insurance fund could total about $300 million. Furthermore, HUD’s data show that about 46 percent of the total retirement service center portfolio of about $1.4 billion had defaulted as of September 30, 1994. While HUD has not updated its net loss estimates, HUD’s data indicate that claims have been paid on loans with an original face value of $648 million.

Indicators of Future Performance Project Continuing Defaults

As part of the analysis of the fiscal year 1994 loan loss reserves for its insured multifamily inventory, FHA developed an estimate of future losses expected from defaults on loans insured under the nursing home program. On a net present value basis, FHA estimated that it will sustain approximately $724 million in future losses from loan defaults. This amount includes an offset representing estimated premium receipts for loans evaluated in the analysis as having a low risk of default. The loss reserves represent about 19 percent of the total unpaid principal balance of nursing home loans insured as of September 30, 1994.

FHA’s loan loss reserve estimates are based primarily on analyses of the financial and physical condition of properties with FHA mortgage insurance. They do not specifically consider the potential financial impacts of changes in health care policies on nursing homes. Although the exact nature of future national changes in health care is uncertain at the present time, the health care industry is currently undergoing significant changes as a result of national and state efforts to contain costs and reform the health care system. Industry and government officials with whom we spoke generally do not believe that proposed and ongoing changes in the health care industry will have a negative impact upon FHA’s nursing homes. However, efforts by federal, state, and local governments to control rising health care costs—such as current state and federal actions to reduce Medicaid and Medicare costs—could increase risks and undermine the financial viability of some of these projects. For example, a substantial portion of nursing homes’ revenue is provided from Medicaid reimbursements. (See app. IV.)

In addition to the high number of defaults of retirement service center loans that have occurred to date, more defaults are expected. We conducted a survey of HUD’s loan servicers in November 1994 to determine the extent to which they believed the remaining retirement service center loans were likely to default in the future. (See app. V for the scope and methodology for the survey.) The results of this survey and the recent financial analysis of most of the remaining retirement service center loans by a HUD contractor indicate that additional loan defaults under the program are likely. HUD’s loan servicers indicated that about 18 percent of the remaining retirement service center loans that we identified were likely to default in the future. The unpaid principal balance for these projects was approximately $192 million as of September 30, 1993.

Furthermore, an analysis of the 1993 audited financial statements of 90 retirement service center projects, conducted in 1994 for HUD by a contractor, rated one-half of these projects as “poor” in at least two of the five financial ratios evaluated. In nine of these cases, the auditors’ opinions raised a “going concern issue,” indicating that the auditors seriously question the continued viability of these projects. The unpaid principal balance for the projects with two or more poor ratings was $392 million.

Credit Subsidy Estimates May Not Accurately Reflect Future Losses

HUD’s credit subsidy estimates for nursing home loans to be endorsed in fiscal year 1996 may not accurately reflect the losses that are likely to be incurred as a result of future defaults on such loans. HUD’s fiscal year 1996 credit subsidy estimate for the nursing home program projects a profit—that is, HUD expects that the net present value of receipts on these loans (insurance premiums and recoveries on loan defaults) will exceed losses resulting from default claims. For several reasons, we believe that this estimate may not be reliable. First, according to HUD budget staff, the credit subsidy calculation was based on assumptions about loan performance contained in a 1992 report by Price Waterhouse that HUD applied to a standard credit subsidy model (spreadsheet) used by the Office of Management and Budget. According to the HUD staff, the data used to provide the credit subsidy estimates have not been updated even though the most recent data used in the Price Waterhouse study are from 1990. Furthermore, according to the study, because of the lack of available financial data on nursing home loans, the models used in the study were based on historical trends and economic indicators and did not incorporate project-specific financial indicators. The study noted that the general economic models used in the study cannot explain loan performance as accurately as loan-specific models.

Second, HUD’s fiscal year 1996 credit subsidy estimate assumes a higher recovery rate on defaulted loans than HUD has historically experienced—60 percent as opposed to the 40.2-percent rate supported by HUD’s data. Third, HUD’s credit subsidy estimate does not take into account the differences in default risk that may result from HUD’s insurance of assisted living facilities compared with its insurance of nursing homes. These differences are discussed in the next section of our report. And last, a recent study prepared for the Mortgage Bankers Association indicates that the nursing home program has incurred losses in the last 8 years and requires a small credit subsidy. That study also used the 60-percent recovery rate that HUD uses in its credit subsidy model, which may underestimate the program’s losses.

Program and Agency Changes May Further Strain FHA’s Management Capacity

As discussed in our June 1995 report on FHA’s loan loss reserves and default prevention efforts, HUD is unable to provide adequate oversight and management of its existing multifamily loan inventory, including nursing home and retirement service center loans. While HUD is taking steps to overcome its historical loan management deficiencies, its ability to improve its management may be negatively affected, at least in the short run, by the planned FHA restructuring and staff reductions. Currently, HUD’s loan servicers provide limited oversight of nursing home and retirement service center loans. Moreover, recent legislative changes may result in the growth of the nursing home program and potentially riskier loans, placing additional strains on HUD’s management capacity.

HUD’s Multifamily Loan Portfolio Not Adequately Managed

Numerous studies over the past 2 decades by Price Waterhouse, HUD’s Office of Inspector General, and us have identified weaknesses in FHA’s ability to effectively manage its multifamily portfolio, which includes the nursing home and retirement service center programs. The agency currently insures a number of multifamily properties that are in poor condition and projected losses of $9.5 billion from future defaults of loans in its $45.4 billion insured multifamily portfolio as of September 30, 1994. Although HUD is taking steps to overcome staffing inadequacies, data deficiencies, and poor management controls that have hindered its ability to manage the portfolio for many years, many of the Department’s efforts to improve its management are in the early stages. Some of the corrective actions could take years to accomplish. For example, efforts to overcome the serious data deficiencies in FHA’s multifamily portfolio are only at the strategic planning stage. As such, HUD continues to have only limited ability to oversee these programs, and we cannot determine at this time whether HUD’s initiatives will be successful.

In addition, HUD is proposing organizational changes and staffing cuts that could, at least in the short run, place additional strains on FHA’s portfolio management. In December 1994, HUD issued its “Reinvention Blueprint” proposing broad departmental changes, including restructuring FHA, in an effort to operate more efficiently and effectively. HUD’s fiscal year 1996 budget proposal would streamline HUD’s headquarters and field office operations, reducing staff from the current level of 12,000 to about 7,500 over the next 5 years. Under HUD’s proposal, FHA would be transformed into a “streamlined, business-oriented government entity.” As a new “market-driven corporation,” FHA would consolidate its many existing insurance programs into three broad authorities: single-family homeownership; multifamily rental housing; and health care facilities. These sweeping proposals are likely to change the nature and extent of FHA’s future involvement in managing the multifamily portfolio.

According to the Deputy Assistant Secretary for Multifamily Housing Programs, HUD is studying ways to consolidate its multifamily underwriting and asset management responsibilities in response to the proposed departmental restructuring and downsizing. For example, HUD is planning to assign loan originations for assisted living facility loans for its Region 10 offices in Alaska, Idaho, Oregon, and Washington State to the Seattle, Washington, field office to bring efficiency and specialization to the loan origination process for nursing home loans that are unlike other multifamily loans. The Deputy Assistant Secretary said that concentrating highly experienced staff in a few locations will reduce the risk associated with certain types of loans, such as those of assisted living, board and care, and intermediate care facilities. In addition, the Deputy Assistant Secretary indicated that HUD is currently redesigning its program for nursing homes and other residential health care facilities. The Department is considering changing fees and premiums as well as basic underwriting terms, such as reductions in loan-to-value limits and shorter mortgage terms.

Program’s Expansion May Further Strain HUD’s Oversight Ability

The recent expansion of the nursing home program to include mortgage insurance for assisted living facilities (as well as for refinanced loans covering non-FHA-insured nursing homes) could strain HUD’s already limited capacity to manage nursing home and other multifamily loans. Our work in several HUD field offices, as well as data from FHA’s loan loss reserve analysis, indicates that HUD’s loan servicers provide limited oversight of nursing home and retirement service center loans. For example, of the 142 nursing home loans that HUD sampled in its fiscal year 1994 loan loss reserve analysis, only 36 had received recent management reviews and 87 had current physical inspections. In general, HUD’s loan management staff that we contacted viewed nursing home loans as low-risk and, as a result, generally do not focus attention on nursing home loans unless financial trouble appears imminent or a default occurs.

The new assisted living component of the nursing home program has the potential to further strain HUD’s management capabilities. This additional strain could result not only from the fact that the program could increase the size of FHA’s insured loan portfolio but also because the default risk associated with insuring assisted living facilities could be higher than that for other nursing home loans—particularly if the new program is not effectively managed. In this regard, assisted living facilities differ from nursing homes in fundamental ways that can potentially increase the risk of default. For example, while most states limit the supply of skilled nursing homes through the certificate-of-need process, similar limits are not placed by most states on assisted living facilities. Furthermore, the new assisted living facilities program shares some characteristics with the failed retirement service center program in that both target the moderate- and upper-income elderly. As such, these projects typically do not receive Medicaid financing and require careful analysis to ensure that sufficient market demand exists to support the facilities.

Officials in HUD’s Insured Multifamily Housing Development Office believe that several differences between assisted living facilities and retirement service centers will mitigate the risks associated with their similarities. For instance, unlike retirement service centers, FHA’s assisted living facilities (1) will be licensed and regulated by the states; (2) are expected by FHA to be developed and managed by developers and operators experienced in the delivery of long-term care, although no specific level of experience is required; and (3) are intended for residents who, by virtue of their physical condition, no longer have the option of living independently, resulting in a more need-driven market for these facilities. However, as noted earlier, state monitoring and regulation, which focus on the adequacy of health care, do not address default prevention. Furthermore, the extent to which experienced developers and adequate market analysis are used in this program will depend on the HUD field staff responsible for analyzing and underwriting the insurance.

HUD’s Director of Insured Multifamily Housing Development acknowledged that excessive workloads could limit HUD’s ability to adequately administer the assisted living program. However, she stated that HUD will attempt to minimize the risks of assisted living projects through careful underwriting evolving, in part, from HUD’s plans to provide special training to field staff. Training is critical because, as HUD has recognized, the lack of extensive training in underwriting projects exacerbated the problems that HUD experienced with the failed retirement service center program. Nonetheless, HUD’s plans to have initial training completed in early 1995 were not implemented. However, HUD did provide training for underwriting assisted living facility loans to its field offices via a live broadcast from headquarters on August 16, 1995. In addition, HUD plans advanced valuation training for staff from several field offices in August 1995. The training will emphasize market and marketability issues for nursing homes and board and care and assisted living facilities.

HUD’s ability to effectively oversee the assisted living program may be further constrained, in our view, by the fact that the Department has not conducted a market feasibility study to fully assess the risks and benefits associated with assisted living facilities. According to HUD officials, the Department’s policy is to perform feasibility studies only for new programs. Because HUD views the assisted living program as an expansion of FHA’s nursing home program rather than a new program, it does not believe that the assisted living program warrants a feasibility study. However, as noted earlier, the lack of a full assessment of the risks and benefits in underwriting retirement service center loans was cited by HUD’s Inspector General as contributing to the problems associated with that program.

Officials in HUD’s Insured Multifamily Housing Development Office and field offices also believe that FHA’s experience with board and care projects will help ensure effective management of the loans for the assisted living program. However, according to available data, board and care projects are a small part of the nursing home portfolio, and many of HUD’s field offices have little or no experience with board and care facilities.

In addition, in response to our questions about the default risk of board and care facilities, HUD conducted a preliminary analysis of nursing home default claims since 1986 that indicates that FHA may need to strengthen its underwriting standards for board and care facilities. According to the Deputy Director of the Office of Insured Multifamily Housing Development, the preliminary results indicate that a higher proportion of loans for board and care facilities have defaulted than these facilities’ relative share of the nursing home business. HUD is currently taking steps to begin tracking loans for board and care and assisted living facilities in its data systems, but these efforts have not been fully implemented. Furthermore, the steps that HUD plans to take to monitor the performance of these loans after it starts to track them remain unclear.

Conclusions

HUD has not collected and analyzed information needed for it to effectively manage the nursing home program and for it to assess whether the program’s benefits outweigh its costs. While HUD officials believe that the nursing home program serves populations and geographic areas that are not adequately served by the private sector, the Department has not analyzed the types of communities and individuals that the program actually serves nor has it systematically collected the information needed to perform such an analysis. As a result, the extent to which FHA’s nursing home program has contributed to HUD’s mission is uncertain. In addition, HUD has not performed complete assessments of the nursing home program’s financial performance, although in recent years more complete financial data on the program have been collected. In our view, analyses of whom the program is serving and the costs associated with providing such service are essential elements of managing the program.

FHA’s loan loss reserve estimates and its credit subsidy estimates are intended to reflect, respectively, the potential losses associated with loans in its insured multifamily portfolio as well as loans that FHA plans to insure in the coming fiscal year. However, neither of these estimates, in our view, currently provides a complete assessment of the likelihood of such losses. While FHA has made improvements in its loan loss reserve estimates, estimates of losses related to expected nursing home loan defaults, based on assessments of the nursing homes’ physical and financial condition, do not take into account how changes in health care financing may affect the default potential of these loans. In addition, FHA’s credit subsidy estimates for nursing home loans are based on outdated and questionable data and do not reflect the differences in the default risk of loans insured in the past and those that will be insured in the future.

In our view, HUD has not been able to provide adequate oversight of loans in its insured multifamily portfolio, including loans for nursing homes and retirement service centers. The addition of assisted living facilities to FHA’s nursing home program could place additional strains on HUD at a time when its ability to effectively manage its existing multifamily portfolio is already limited. Furthermore, we are concerned about the potential risk associated with the addition of these loans to FHA’s portfolio, especially since it is unclear how HUD will monitor the loans’ performance.

Recommendations

To better measure the outcomes of FHA’s nursing home program, we recommend that the Secretary of HUD direct the Deputy Assistant Secretary for Multifamily Housing Programs to (1) collect data on the characteristics of patients, locations, and borrowers for all future projects; (2) use the receipts and expenses data now tracked by HUD’s data systems to monitor the program’s financial performance; (3) reformulate credit subsidy estimates for nursing home loans on the basis of data that are up-to-date, are accurate, and, to the extent possible, take into account differences between the potential default risk of loans that are to be insured and loans that have been insured in the past; and (4) establish procedures to carefully monitor the financial performance of assisted living facility loans in the nursing home portfolio in a timely manner so that prompt action may be taken to prevent future loan defaults.

Matters for Congressional Consideration

Given the changes in health care and mortgage financing that have occurred since the nursing home program was established in 1959, the program’s financial performance, HUD’s limited management capabilities, and the Department’s impending reorganization, the Congress may wish to review FHA’s role in insuring loans for nursing homes and assisted living facilities. Among the issues that the Congress may wish to consider are (1) whether the program should be targeted more toward meeting specific needs or serving specific populations, (2) how the resource and management problems that have inhibited effective oversight of the program can be addressed, (3) what impact changes in the financing of Medicaid are likely to have on the default risk associated with FHA’s nursing home portfolio, and (4) whether HUD has the capabilities to effectively underwrite the insurance for and oversee loans for assisted living facilities.

Agency Comments and Our Evaluation

We provided a draft of this report to HUD for comment. Appendix VI contains the complete text of HUD’s comments, which were provided by the Deputy Assistant Secretary for Multifamily Housing Programs. HUD’s comments did not include any substantive disagreements with the facts presented in the report. However, as discussed below, HUD disagreed with the scope of our report and one of our recommendations. HUD also cited actions it was taking to address the other recommendations and provided comments on a number of issues covered in the report.

HUD characterized the scope of the draft report as misleading because it did not, in the Department’s view, appropriately distinguish between the operations or status of the nursing home and retirement service center programs. HUD stated that the programs are different products serving different markets and argued that we should issue separate reports on these two programs. However, throughout the report, we provide information on each program separately. We believe the report clearly distinguishes between the operations and status of HUD’s nursing home and retirement service center programs. While there are clearly differences between the two programs, there are also similarities and instances in which the operation of one program has implications for the other. In addition, many in the housing and medical facility fields see housing and care for the elderly as a “continuum of care.” The continuum starts with facilities that provide the lowest levels of assistance, such as retirement service centers; moves toward increased levels of care provided by board and care and assisted living facilities; moves to the various levels of nursing home facilities; and finally ends with hospital care. For these reasons, we believe it is appropriate to discuss both programs in a single report.

HUD disagreed with our recommendation that the Department collect data on the characteristics of patients, locations, and borrowers for future nursing home projects. The Department suggested additional language to the recommendation to state that the recommendation’s purpose is to ensure that the Department serves the target population and then stated that nothing in the legislation directs the Department to target certain areas or populations. However, our recommendation is directed at HUD’s obtaining a better measure of the outcomes of the program—that is, to have information on whom the program is serving. We believe this information is important for assessing the costs and benefits of the program. In addition, the Department maintained that a major effort at this time to collect such data is overly burdensome. To avoid an undue burden on the Department, our recommendation is prospective in nature.

Accordingly, we do not agree that collecting some additional data on new loans would be unnecessarily burdensome.

HUD also noted actions that it is taking as part of a strategic plan prepared in November 1994 that it believes will address our recommendations. While these actions appear worthwhile, they do not, in our view, affect the validity of our recommendations. For example, HUD states that its credit subsidy estimates are a subject of continuing discussion with the Office of Management and Budget and that as better data are obtained and more experience is gained, credit subsidy estimates will be refined and revised. However, HUD’s comments are unclear about what specific improvements it expects to make in its credit subsidy estimates for the nursing home program and when those improvements will be made. Similarly, HUD states that its strategic plan includes other actions such as redesigning products to ensure a self-sustaining FHA, monitoring the financial performance of FHA programs, and implementing a variety of remedial actions on the basis of lessons learned from past practices. However, it is unclear what all of these actions will involve and how soon some of them will be completed.

HUD also provided comments on other issues in the report. For example, HUD pointed out that (1) the retirement service centers are “demand-driven” because they appeal to a relatively independent and well-off segment of the elderly population that has other options, including staying in their own home, and (2) assisted living facilities and board and care facilities are “need-driven” because they address situations in which the elderly can no longer remain fully independent and need the support and health-related services. Our report reflects these differences. Nonetheless, we note that this distinction does not guarantee a market for these facilities. For example, affordability and location are also likely to be important factors. Private sector experts with whom we spoke indicated that identifying the market for assisted living facilities is a difficult and complex task.

HUD asserted that the nursing home program serves those not served by the private sector. However, HUD acknowledged that it does not have data to substantiate its position. In our view, without such data, it is not clear to what extent FHA-insured facilities serve a need that would not otherwise be met by the private sector.

In our report, we provide information on the number of nursing homes in each state compared with the number of nursing homes currently in FHA’s loan portfolio to show that participation in FHA’s nursing home program varies widely by state. HUD stated that FHA’s share of the market should be computed by comparing what has happened in the market over the last few years. We noted in the draft report that the data presented provide an approximate representation of FHA’s role in providing nursing homes in each state, and we identified the limitations in the data provided. In response to the Department’s comment, we have further clarified that the information we provide is not sufficient to represent a complete analysis of FHA’s share of the nursing home market.

We also note that HUD’s data systems do not provide reliable data on the types of nursing home projects insured, and thus comparisons with market data are limited. In addition, available market data are based on varying definitions of housing and medical care facilities for the elderly, which further limit analysis. Nonetheless, in its comments, HUD reported that the American Seniors Housing Finance Association and AARP estimate that since 1990, the FHA nursing home program has been responsible for 20 to 25 percent of the loans for seniors’ housing for board and care and assisted living facilities. Through discussions with HUD and AARP officials, we understand that this information is based on an undocumented, informal analysis by HUD of incomplete data on the number of FHA-insured facilities and those in the private sector during this time period. On the basis of these data, the Department also expressed the opinion that a similar situation exists for nursing homes but did not provide quantitative support for this assertion.

HUD’s response also asserts that FHA-insured nursing home facilities lower the government’s Medicaid costs. The Department stated that because FHA-insured borrowers have loans with lower interest rates, Medicaid’s capital reimbursement costs are lower. While this may be true, other variables, such as loan term and mortgage insurance premiums, affect total loan costs. Furthermore, while FHA’s program may result in savings to the government from lower Medicaid costs, it also carries with it increased risks of losses resulting from future loan defaults.

HUD also provided us with information on the steps being taken to overcome identified management deficiencies and improve its operations, such as moving to a team approach to underwriting loans, upgrading technology and skills through providing computers and software and training, and designing and implementing new information systems for tracking, monitoring, and evaluation. Our draft report recognized that HUD had a number of initiatives under way, and we have added additional information into the final report on the basis of the Department’s comments. However, we still have concerns about HUD’s ability to effectively manage the nursing home and retirement service center programs in the near future. The actions being undertaken are in the planning or early implementation phase, and it is too early to know if they will be effective. In addition, the Department’s proposed organizational changes and staffing cuts will, at least in the short run, place additional strains on HUD’s management capacity, which is currently inadequate to effectively oversee the multifamily loan portfolio.

We conducted our review from September 1994 through July 1995 in accordance with generally accepted government auditing standards. (See app. V for a discussion of our scope and methodology.) We are sending copies of this report to appropriate congressional committees; the Secretary of HUD; the Director, Office of Management and Budget; and other interested parties. We will also make copies available to others upon request.

Please contact me on (202) 512-7631 if you or your staff have any questions. Major contributors to this report are listed in appendix VII.

Facilities and Loan Categories Included in FHA’s Section 232 Nursing Home Insurance Program

Four types of facilities may be insured by the Federal Housing Administration (FHA) under the section 232 nursing home program. In addition to insurance for the construction or renovation of the four types of facilities provided under the “basic” nursing home loan program, FHA’s section 232 loan program also covers other types of loans, such as supplemental loans for additions and improvements to facilities and for the refinancing of loans. FHA also has established categories for insured loans for nursing home facilities that are located in declining urban neighborhoods, processed under the agency’s delegated processing program, or processed under the coinsurance program that was terminated in 1990.

Section 232 Facilities

Four types of facilities are eligible for FHA mortgage insurance under the section 232 nursing home program.

Skilled Nursing Facilities—For purposes of FHA’s program, a skilled nursing facility is licensed or regulated by the state in which it operates and accommodates convalescents or others who are not acutely ill but who need skilled nursing care and related medical services. The nursing care and medical services provided must be prescribed by or performed under the general direction of licensed personnel.

Intermediate Care Facilities—An intermediate care facility under FHA’s program is licensed or regulated by the state in which it operates and accommodates individuals with certain incapacitating infirmities requiring minimum but continuous care.

Board and Care Homes—A board and care home under FHA’s program is regulated by the state and provides room, board, and continuous protective oversight. Only a limited portion of the facility’s total capacity may be made up of separate independent living units. Board and care homes are generally nonmedical settings that offer a range of services, such as supervision of nutrition and medication, assistance with daily activities such as dressing and eating, continuous responsibility for residents’ welfare, or other services.

Assisted Living Facilities—Under FHA’s program, assisted living facilities are licensed and regulated by the state and offer a combination of housing, including separate living units and personalized health care for residents who need assistance with activities of daily living, such as bathing, dressing, and eating.

Section 232 Loan Categories

Identified below is each of FHA’s loan categories associated with the section 232 nursing home program with loans in force as of September 30, 1994. The number of loans and unpaid principal balances reported for each category are also as of September 30, 1994.

Nursing Homes (Section 232)—FHA’s basic section 232 nursing home portfolio consists of 769 insured loans with an unpaid principal balance of $3.3 billion covering the construction or renovation of the various types of facilities approved for the program.

Supplemental Loans (Section 241/232)—The portfolio comprises 28 supplemental loans to pay for improvements to, additions to, or equipment for nursing home projects that already have FHA-insured mortgages. The unpaid principal balance is $62 million.

Coinsurance on Nursing Homes (Section 244/232)—FHA’s portfolio includes 10 loans insured under the multifamily coinsurance program, which was terminated on November 12, 1990, and 2 formerly coinsured loans that have been converted to full insurance. The unpaid principal balance is $75 million.

Declining Urban Neighborhood (Section 223/232)—FHA’s nursing home portfolio includes 11 loans with an unpaid principal balance of $47 million covering insured mortgages for nursing homes in older, declining urban areas.

Two-Year Operating Loss Loans (Section 223/232)—FHA’s portfolio includes 16 2-year operating loss loans with an unpaid principal balance of $8 million. If an FHA nursing home has an operating loss during the first 2 years after the project is completed, FHA may provide insurance for a loan to cover the loss.

Delegated Processing Authority (Section 232)—FHA’s section 232 portfolio includes 25 loans with an unpaid principal balance of $167 million processed under FHA’s delegated processing program. Under this program, FHA staff work with private mortgage bankers under contract to FHA to process mortgage insurance applications. Delegated processing is intended to streamline the underwriting process while maintaining FHA’s control over final underwriting decisions.

Refinancing (Section 223/232)—The portfolio includes eight loans with an unpaid principal balance of $39 million. FHA insures mortgages to refinance the debt of existing nursing home facilities whether or not the projects were originally financed with FHA insurance.

FHA-Insured Nursing Homes and Total Nursing Homes

The information in table II.1 provides an approximate representation of FHA’s role in providing nursing homes in each state and is not sufficient to represent a complete analysis of FHA’s nursing home market share, such as what has happened in the market over the last few years. The number of FHA’s nursing homes represents the number of FHA-insured mortgage loans (and excludes supplemental and operating loss loans for properties with mortgage loans) for skilled nursing facilities, intermediate care facilities, and board and care homes that were in FHA’s insurance-in-force database as of September 30, 1994. The numbers do not include nursing homes previously insured by FHA. The number of total nursing homes in each state represents long-term care facilities providing skilled and unskilled care during 1993, excluding intermediate care, board and care facilities, and assisted living facilities.

D.C. (continued)

Total U.S. (Table notes on next page)

Methodology Used to Evaluate the Financial Performance of the Section 232 Nursing Home Program

Because of the data limitations discussed below, the financial performance of the nursing home program is subject to uncertainty and can only be approximated. To develop an estimate of the actual financial performance of the nursing home program since its inception, we estimated the program’s net cash flow for each year, on the basis of the Department of Housing and Urban Development’s (HUD) data that can be used to estimate the premium income, claims payments, and recoveries from the sale of either the properties or the properties’ mortgage notes. The cash flows were computed on the basis of a comparison of estimated premium receipts with estimated claims payments net of recoveries. Each year’s net cash flow was then adjusted to 1994 dollars using the Gross Domestic Product Deflator.

Our analysis does not include the interest cost of federal debt associated with the program nor does it include the interest income that HUD received on some of its assigned loans. HUD was unable to provide complete interest income data. In addition, our analysis does not include the general administrative costs relating to the nursing home program borne by HUD.

Our analysis covers the basic section 232 program, which provides most of the insurance under this program. The basic section 232 program covers the new construction and substantial rehabilitation of skilled and intermediate nursing homes, board and care facilities, and assisted living facilities. As of September 30, 1994, these loans represented 89 percent of the program’s unpaid principal balance. Our analysis excludes the other section 232 loans, such as supplemental loans (described in app. I), because they represent a small portion of the portfolio and would be expected to have only a minor impact on the results. Also, our estimates are based on cash flows under the program from 1959 to September 30, 1994, including the estimated recoveries from loan defaults in 1992, 1993, and 1994 that would be received in 1995, 1996, and 1997 according to our cost model. The estimate does not reflect the amounts of expected premium collections or claims payments in the future.

HUD’s Data Used in Our Analysis

HUD provided us with detailed data on estimated premium receipts by year and the face value of mortgages that had resulted in claims for the basic nursing home program. We used the face value of the mortgages as a proxy for claims payments, since HUD could not provide data on all claims payments since the program’s inception. According to officials in HUD’s Office of Mortgage Insurance Accounting and Servicing, the face amount of the original mortgages is the best proxy for claims payments. Furthermore, for the nine nursing home properties that went through foreclosure and sale from 1987 through 1994, the cumulative face amount of the loans and the cumulative amount of claims paid were close—$40.4 million versus $40.2 million. We also note that using the face value of the loan to represent HUD’s expenditures may produce cost estimates that are more likely to be understated than overstated because HUD also incurs costs while the properties are in the HUD-held inventory. For example, for the nine recent cases for which we have data, HUD’s “net investment” in the properties was $43 million, compared with the original loan amount of $40.4 million.

Another data limitation is that HUD does not have historical data on recoveries from the sale of nursing home properties or mortgage notes prior to 1987. We used a weighted average recovery rate of 40.2 percent against total claims of $426 million. (See table III.1.) We assumed 100-percent recovery for $48 million of the claims representing (1) 25 loans totaling $35 million that have been repaid in full and (2) 6 additional loans totaling $13 million in the HUD-held inventory as of September 30, 1994, which had not yet been paid in full but which are classified as operational and current in their payments.

For the balance of the defaulted notes totaling $149 million in the HUD-held inventory as of September 30, 1994, we used the 37-percent recovery rate that HUD used in developing loan loss reserves for its FHA-insured multifamily portfolio as of September 30, 1994, including nursing homes. We used a higher rate than the rate of HUD’s actual recoveries for the nursing home program from 1987 through 1994 because HUD management believes that recoveries will be higher than the historical rate as the Department uses foreclosures and property disposition less and increases its use of note sales at foreclosures and third-party note sales upon loan assignment.

For the cases totaling $229 million for which the note or property sales have been completed, we estimated recoveries on HUD’s actual recovery rate of 30 percent for the nursing home program for fiscal years 1987 through 1994. This recovery rate is a weighted average reflecting recoveries on HUD’s net investment in the properties and mortgages sold during this 8-year period. The 30-percent weighted recovery rate reflects actual recovery rates of 11 percent for property sales and 44 percent for note sales. Using this rate for all completed sales would tend to understate costs, since most of the sales before about 1987 were handled through property sales. According to FHA’s Director of Accounting and Servicing, note sales were rarely used before 1987.

Nursing Homes Will Be Affected by Efforts to Contain Health Costs and Reform the Health Care System

A substantial portion of nursing home revenue is provided from Medicaid reimbursements. FHA’s loan loss reserve estimates do not specifically consider the potential financial impacts of changes in health care policies and reimbursement policies on nursing homes. Although the exact nature of future national changes in health care is uncertain at the present time, the health care industry is currently undergoing significant changes as a result of national and state efforts to contain costs and reform the health care system. Industry and government officials with whom we spoke generally do not believe that proposed and ongoing changes in the health care industry will have a negative impact upon FHA’s nursing homes. However, efforts by federal, state, and local governments to control rising health care costs—such as current state and federal actions to reduce Medicaid and Medicare costs—could increase risks and undermine the financial viability of some of these projects.

The view that health care industry changes will not be detrimental to the nursing home industry is based upon the premise that the market for nursing homes will not be reduced, even if alternative housing for the elderly—such as assisted living facilities—becomes more available. Losses to other types of facilities are expected to be offset by hospitals that move patients to nursing homes rapidly to minimize costs and by the overall increase in the elderly population in the United States. However, while market demand for nursing homes may remain stable or increase in the future, the attempts to control medical costs may make it more difficult for nursing homes to remain financially viable. For example, according to officials at the Department of Health and Human Services, skilled nursing homes could face difficulties in covering costs through Medicare and Medicaid as they admit more patients with greater care needs and lose patients requiring less care to other facilities. Medicare and Medicaid reimbursement policies that do not sufficiently compensate for these structural changes in the health care industry could affect the financial stability of nursing homes.

New York provides a good example of the potential impacts of health care reimbursement policies on FHA’s nursing home portfolio at the state level.

The Governor of New York proposed cuts of up to $1.2 billion in the state’s Medicaid expenditures for the 1995-96 fiscal year, including a cut of $242.8 million from nursing home reimbursements. While the state budget’s final cut in nursing home reimbursements was lowered to $111.5 million, this reduction will increase cost pressures on nursing homes in the state. This issue is pertinent to FHA’s insurance portfolio because it includes 136 loans with an unpaid principal balance of $1.2 billion in the state of New York.

In addition, reductions in spending levels for Medicaid are also being considered at the federal level. For example, the federal budget resolution calls for lowering Medicaid spending for the period 1996 through 2002 by $182 billion.

Objectives, Scope, and Methodology

As mandated by the Multifamily Housing Property Disposition Reform Act of 1994 (P.L. 103-233, Sec. 103(f), Apr. 11, 1994), we reviewed the role and performance of HUD nursing home and retirement service center programs. Specifically, we (1) evaluated the relationship of these programs to FHA’s mission; (2) analyzed information on the programs’ financial performance as of September 30, 1994, and assessed HUD’s estimates of potential losses under these programs; and (3) evaluated FHA’s ability to manage these programs.

To evaluate the relationship of the nursing home program to FHA’s mission, we reviewed the legislative history to determine the Congress’s intent in passing section 232 of the National Housing Act, which provides insurance for skilled nursing, intermediate care, board and care, and assisted living facilities. We reviewed HUD’s regulations and policies to determine how the program was being implemented, and we also discussed the ways in which the nursing home program supports HUD’s mission with (1) officials from HUD’s Office of Multifamily Housing Management and HUD’s Office of Insured Multifamily Housing Development, (2) multifamily staff in three of HUD’s field offices, and (3) staff with the Department of Health and Human Services.

We also contacted industry organizations, such as the National Long-Term Care Resource Center, the Health Care Financing Study Group, the Institute for Health Services Research, the New York Association of Homes and Services for the Aging, the Assisted Living Facilities Association of America, and the Sunrise Assisted Living Retirement Community. In addition, we contacted current FHA nursing home insurance program borrowers and lenders to discuss the reasons why FHA financing was used and reviewed studies on the financing of nursing homes and assisted living facilities. Our work primarily focused on issues relating to the extent to which HUD’s mission is furthered by the nursing home and retirement service center programs and is not sufficient to determine whether the nursing home program is needed to serve unserved markets. We also did not evaluate the validity of the criticisms of FHA’s policies and procedures cited as disincentives to the use of the FHA nursing home insurance program that we received in our contacts and that are also cited in some articles we reviewed.

For the terminated retirement service center program, we reviewed the regulations terminating the program that had been created by HUD as part of an existing multifamily housing program and the 1990 program studies by HUD’s Inspector General and HUD’s Office of Policy Development and Research. We also visited HUD’s Minneapolis, Minnesota; San Francisco, California; and Jacksonville, Florida, field offices to obtain detailed information on FHA’s nursing home and retirement service center programs.

To provide information on the programs’ financial performance as of September 30, 1994, we met with officials from HUD’s Office of Housing-FHA Comptroller in August 1994 and requested cumulative financial performance data (covering program receipts and expenditures) for the nursing home and retirement service center programs. While the Comptroller’s office did provide some information in December 1994 and February 1995, it was not sufficient to determine the financial performance of these programs. Subsequently, on the basis of discussions with HUD’s Director, Multifamily Accounting and Servicing Division, and a staff member from HUD’s Statistical and Actuarial Analysis Staff (Office of Policy, Planning, and Financial Systems Enhancements), we obtained data on the nursing home program that these officials believed could be used to provide an estimate of the financial performance of this program since its inception. We did not verify the reliability of HUD’s nursing home data. The scope and methodology of our analysis are summarized in appendix III.

Because automated data are not available on the retirement service center program, HUD did not provide comparable data that would have enabled us to perform a similar analysis of the retirement service center program’s financial performance as we had done for the nursing home program.Accordingly, our assessment of the program’s financial performance was limited to a review of HUD’s data on the program’s default rate and the related face value of loans that have defaulted. We did not verify the reliability of HUD’s data on the retirement service center program in HUD’s July 12, 1995, report, Retirement Service Centers, by Richard G. Calvert, Thomas N. Herzog, James E. Laverty, and Darrel S. Connelly, Statistical and Actuarial Analysis Staff, HUD. We also reviewed the financial performance data in the HUD Inspector General’s 1990 study of this program and the study conducted by HUD’s Office of Policy Development and Research in 1990.

To assess HUD’s estimates of future potential losses under these programs, we reviewed information from FHA’s fiscal year 1993 and 1994 multifamily loan loss reserve analyses that establish loss reserves for estimated future losses stemming from loan defaults. We also used information from our review of FHA’s fiscal year 1993 loan loss reserve analysis. Because FHA’s loan loss reserve analyses do not provide a separate loss estimate for retirement service center loans and FHA analyzed only eight retirement service center loans as part of the fiscal year 1993 loan loss estimate, we used an alternative approach to estimate potential losses for retirement service centers. This approach was based primarily on estimates of the potential for future defaults from loan servicers in the HUD field offices with responsibility for insured retirement service center projects. Working with HUD staff, we identified 108 retirement service center loans in force as of September 30, 1993. In November 1994, we sent standardized questionnaires to the 32 cognizant HUD field offices for each of the 108 retirement service center projects. Of these 108 projects, respondents told us that at the time of our survey, two loans had been paid off and four projects were not considered to be retirement service centers. We obtained responses for all, or 100 percent, of the remaining 102 retirement service centers. We also reviewed the 1993 financial statement analyses of 90 FHA-insured retirement service centers performed by a contractor for HUD in 1994.

To evaluate FHA’s ability to manage these programs, we reviewed relevant HUD Inspector General, Price Waterhouse, and GAO reports on HUD’s multifamily loan management, including reports on the nursing home and retirement service center programs. We also used our June 5, 1995, report, cited above, to provide us with up-to-date information on HUD’s initiatives to prevent defaults. In addition, we reviewed HUD’s reinvention proposal and budget request and discussed management issues with officials in HUD’s Office of Multifamily Housing Development and in the three field offices visited.

We performed our review at HUD’s headquarters in Washington, D.C., and at HUD’s field offices in Jacksonville, Minneapolis, and San Francisco.

Comments From the Department of Housing and Urban Development

Major Contributors to This Report

Housing and Community Development Issue Area

Jim Wells Richard A. Hale Christine M.B. Fishkin Karen E. Bracey Austin J. Kelly Patrick B. Doerning Mark H. Egger Rose M. Schuville Leigh K. Ward The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. Orders for 100 or more copies to be mailed to a single address are discounted 25 percent.

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