Hospital Mortgage Insurance Program: Program and Risk Management Could Be Enhanced
Released: 2006-02-28T00:00:00

Letter

Background

In 1968, the Congress added Section 242 to the National Housing Act establishing the Hospital Mortgage Insurance Program to address a serious shortage of hospitals and the need for existing hospitals to expand and renovate. Through this program, FHA insures the loans lenders make for the construction and renovation of hospitals. Since the inception of the program, FHA has insured 341 hospital mortgages for $11.9 billion in 42 states and Puerto Rico. As of the end of calendar year 2005, FHA was insuring 74 hospital mortgages totaling nearly $5 billion. The number of loans insured annually has increased in recent years, from 2 in fiscal year 2001 to 11 in fiscal year 2005 (see table 1). According to the House report accompanying the Hospital Mortgage Insurance Act of 2003, which revised the standards for determining the need and feasibility for hospitals, as well as eligibility requirements for small, rural hospitals, hospitals face significant financial challenges when providing care to patients who are covered by Medicare and Medicaid, as well as those that are uninsured. At the same time, improvements in technology and health care knowledge necessitate capital improvements such as additions and renovations to existing buildings.

FHA’s Office of Insured Health Care Facilities and HHS’ Division of Facilities and Loans coordinate to implement the hospital program. HUD has statutory responsibility for the program based on the FHA’s experience with promoting housing construction through housing mortgage insurance programs. As such, HUD is fully responsible for management of the program, including developing and proposing legislation, policy development, strategic planning, and approval of applications and loan documents. The House Committee on Banking and Currency, in recommending that HUD be given this responsibility, expected HUD to draw upon HHS’s hospital expertise to devise standards for insuring hospitals’ mortgages. Through an interagency agreement, HUD formally delegates authority to HHS to assist in the review of applications for mortgage insurance and the monitoring of insured loans. HHS is also given full responsibility for construction monitoring. See appendix II for additional information about FHA and HHS’s loan processing responsibilities.

FHA’s Hospital Mortgage Insurance Program generally serves the segment of the market consisting of hospitals that are too risky to obtain private bond insurance but are strong enough to pass FHA’s underwriting tests. Mortgage insurance, like private bond insurance, guarantees that lenders will be paid if the hospital stops making payments on its loan. In addition, both mortgage insurance and private bond insurance are forms of credit enhancement and improve the credit rating of the underlying debt for the insured entity, resulting in a lower interest rate for the loan. Hospitals with FHA-insured mortgages automatically receive investment-grade ratings (AA or AAA) because the reliability of the cash flows from the mortgage note are rated on the insurer’s, not the hospital’s, ability to repay the debt. Both FHA and HHS officials and private insurers agree that FHA’s Hospital Mortgage Insurance Program serves a different market than private insurers. According to FHA and HHS officials, FHA insures loans that are too risky, too small, or too large for private insurers, or are located in a market not served by private insurers.

For the Hospital Mortgage Insurance Program, if a hospital fails to make any payment due under the mortgage, the mortgage is in default. If a default continues for 30 days, the lender is entitled to receive benefits from FHA. FHA may pay claims in either cash or debentures.

Federal agencies that provide direct loans or loan guarantees are required by the Federal Credit Reform Act of 1990 to estimate the expected cost of programs by estimating or predicting their future performance and reporting the costs to the government in their annual budgets. Such estimates are important in that they more accurately measure the government’s costs of federal loan programs and permit better cost comparisons among different programs. Under credit reform procedures, the cost of loan guarantees, such as mortgage insurance, is the net present value of all expected future cash flows, excluding administrative costs. For guarantees, cash inflows consist primarily of fees and premiums charged to insured borrowers and recoveries on assets, and cash outflows consist mostly of payments to lenders to cover the cost of claims. Agencies discount projected future cash flows to the year in which the guaranteed loan was disbursed. The discounted cash flows are the estimated budgetary cost or gain of the cohort of loans obligated in a given fiscalyear. The net present value of each cohort’s estimated cash flows is expressed as a percentage of the volume of guaranteed loans in the cohort—that is, a subsidy rate. Agency managers are responsible for accumulating relevant, sufficient, and reliable data on which to base their credit subsidy estimates.

OMB has final responsibility for determining subsidy estimates, in consultation with agencies.

FHA’s Selection Process Includes Additional Steps Compared with Private Insurers, but Monitoring Techniques Are Similar

FHA requires hospitals to take certain steps, both before they apply for mortgage insurance and as a part of the application process, that private insurers do not mandate. These additional steps are used because FHA insures mortgages that are generally riskier than those using private bond insurance. For example, before they apply for mortgage insurance, FHA advises hospitals to compare their financial status with the program’s minimum requirements. If they meet these requirements, FHA requires hospitals to submit market and financial information so that FHA can make a preliminary assessment about the project and determine whether to conduct a preapplication meeting with the applicant to discuss the project. None of the private insurers that we met with have similar preapplication processes.

After these preapplication steps are met, FHA’s application process includes additional steps compared with those of private bond insurers. FHA requires hospitals to submit a financial feasibility study containing historic and forecasted financial statements and ratios, a financing plan, and information about market demand, among other things. In addition, FHA hires consultants to evaluate the feasibility of each proposed project as an additional, independent check on the viability of the project. While the private bond insurers that we met with review the types of information included in feasibility studies, they do not require hospitals to submit such studies and do not hire consultants to assess the feasibility of proposed projects.

FHA’s application process also includes a final level of review that is absent from private bond insurer processes. After an application for mortgage insurance has gone through underwriting and been reviewed by an independent consultant, it is considered by the program management group, a group of senior-level FHA and HHS staff. FHA also refers to this group as its “credit committee.” Similarly, private bond insurers also consider applications within a credit committee structure. However, while private bond insurers make final insurance decisions through their credit committees, FHA has an additional layer of review. Based upon input from the program management group, the Director of FHA’s Office of Insured Health Care Facilities makes a recommendation to the FHA Commissioner, who then makes the final decision.

It generally takes FHA longer to process applications than it takes private bond insurers. According to program data, it took FHA an average of 265 days to process the 11 applications for hospital mortgage insurance that it endorsed in fiscal year 2005. According to the FHA, processing times vary with the complexity of the project and may be affected by issues requiring a hospital to rethink or resubmit its application, including issues that are beyond HUD’s control. In contrast, according to the private bond insurers and investment bankers that we interviewed, it generally takes private insurers up to 60 days to process an insurance application, sometimes less. While FHA’s average processing time is higher than private bond insurers, it has decreased from an average of 399 days in fiscal year 1999. According to FHA, processing times have improved as a result of implementing the preliminary review process, which disqualifies hospitals that don’t meet the program’s minimum requirements.

FHA uses many of the same techniques that private insurers use to monitor insured hospitals. Both FHA and private bond insurers identify the riskiest hospitals in their portfolio for closer monitoring. Since November 1999, FHA has placed on a priority watch list hospitals it determines are at risk of having a claim filed within the next 12 months. FHA considers a hospital for inclusion on the priority watch list if certain financial criteria are not met. For example, if the ratio measuring a hospital’s ability to pay its mortgage payments with cash generated from current operations (the debt service coverage ratio) falls below an acceptable level, the hospital may be placed on the watch list. A hospital can also be placed on the list if FHA becomes aware of other conditions at the hospital, such as management or personnel problems. As of December 2005, FHA data showed that 11 of the 59 insured hospitals are on this list, representing an unpaid (insured) principal balance of approximately $762 million. Private insurers also assess the risk of the hospitals that they insure in order to identify those that should be monitored more closely. For example, one private bond insurer explained that they monitor compliance with loan agreements by reviewing financial statements, documentation of payer mix (i.e., proportion of reimbursement from Medicare, Medicaid, private insurance, etc.), and notices of litigation, among other things.

As a part of their monitoring efforts, both FHA and private bond insurers monitor agreements that exist between themselves and the insured hospital. These agreements specify the requirements that the insured hospital must comply with in order to maintain the insurance. Agreements may cover issues such as the debt-service coverage ratio; liquidity, or the ability to convert assets to cash; and activities that a hospital cannot do without approval by the insurer. Both FHA and private insurers require hospitals to request waivers from agreement requirements if they are not going to meet them. FHA and private insurers monitor hospitals’ compliance with these agreements through various means, such as by evaluating changes in indicators of financial performance, as reported in hospitals’ financial statements. For example, one private bond insurer reported that it monitors hospitals’ cash on hand, and FHA monitors hospitals’ debt-service coverage ratios. FHA and private insurers monitor financial statements and other documentation quarterly and annually, respectively, and more frequently for hospitals that are experiencing financial difficulty. Both FHA and private insurers require hospitals that are not in compliance to correct violations within specific time frames.

Both FHA and private insurers can require hospitals experiencing financial difficulties to hire consultants. In some cases, FHA will pay for consultants to identify and suggest solutions to hospitals’ financial difficulties. According to FHA, since fiscal year 2000, it has paid $1.3 million for consultant’s studies of 27 hospitals. However, FHA can also require hospitals to hire and pay for consulting services on their own. Similarly, private insurers can require hospitals to hire consultants to assist them with identifying and addressing problems. The requirement for a hospital to hire a consultant can be triggered if a hospital is not in compliance with its loan agreements, according to both FHA and private bond insurers.

Agencies Coordinate Key Activities, but FHA Does Not Track Most Performance Measures

FHA and HHS coordinate key activities, including screening applicants, underwriting loans, and monitoring insured hospitals. While FHA has established performance measures for both coordinated tasks and tasks delegated to HHS through an interagency agreement, it does not collect data with which to assess most of these measures. FHA’s primary guidance for the program has not been updated in over 20 years and, therefore, does not reflect key changes in eligibility criteria.

FHA and HHS Coordinate Their Client Screening, Application Review, and Loan Monitoring Activities

FHA and HHS coordinate to implement the hospital program based upon FHA’s experience with promoting housing construction through its housing mortgage insurance programs and HHS’s hospital and health care expertise. As previously noted, FHA is responsible for management of the program and formally delegates certain responsibilities to HHS. A Memorandum of Agreement (MOA) between FHA and HHS outlines the duties and responsibilities of each agency in carrying out the Hospital Mortgage Insurance Program, including coordinated activities and tasks that FHA delegates to HHS. In accordance with this agreement, both FHA and HHS staff are involved with the screening of applicants during the preapplication meetings. FHA’s policy is to include senior FHA staff and legal counsel, the account executive and client service team members (both of which can be either FHA or HHS staff), and engineering staff from HHS, among others, in such meetings. This policy helps insure that preapplication discussions with applicants are coordinated between FHA and HHS.

FHA and HHS also coordinate activities during the underwriting review portion of the application process, which is the process used by FHA to assess the risk of a potential loan to the GI/SRI fund. The nature of coordination at this level depends on the staffing of the account executive and client service team positions, since these positions can be filled by either FHA or HHS staff or a combination of both. The account executive and client service team are responsible for underwriting activities, including analysis of the market and financial feasibility of the project. In addition, HHS engineers review all design and construction aspects of the proposed project. Appendix II presents the roles and responsibilities of each agency in more detail.

FHA and HHS use regular meetings of the program management group to coordinate additional activities. This group, composed of senior FHA and HHS staff, meets weekly to assist account executives and client service teams as they review applications for mortgage insurance and monitor insured hospitals. Minutes of program management group meetings that we reviewed show joint FHA and HHS discussion of new applications, as well as issues associated with the existing portfolio. According to investment bankers, hospital associations, consulting firms, and selected hospitals we spoke with, coordination between FHA and HHS is generally seamless.

FHA Has Not Used Performance Measures to Manage the Program

The fiscal years’ 2002-2005 MOA between FHA and HHS provides for FHA to establish performance measures and use them to evaluate tasks. While the MOA between FHA and HHS contains 22 performance measures, FHA has tracked actual performance for only 2 of these measures, 1 for processing complete applications within 120 days, and 1 for processing loan modification requests within 30 days. As a result, it is not possible to evaluate how well the agencies perform in implementing the program. According to FHA officials, the agency never intended to track these measures, or use them as actual measures of performance, but rather to show FHA’s expectations of HHS. Neither HUD’s fiscal year 2005 performance plan nor its performance and accountability report includes other performance measures for this program. Moreover, OMB did not assess this program as a part of its fiscal year 2005 Program Assessment Rating Tool (PART), which is used to assess the performance of federal programs. Appendix III provides more detailed information about the 22 performance measures contained in the MOA between FHA and HHS.

Analysis of the two performance measures for which data is collected shows that FHA is not meeting its performance goals for those measures. Based upon analysis of data from the Hospital Mortgage Insurance Management Information System, we determined that FHA did not meet its goal of processing 75 percent of hospital mortgage insurance applications within 120 days. Although the FHA received no more than 10 applications each year between fiscal years 2002 and 2005, FHA and HHS never processed more than 2 within 120 days (see fig. 1).

In addition, according to FHA, the agency did not meet its goal of processing at least 75 percent of loan modification requests within 30 days. However, analysis of available data shows that FHA and HHS improved from processing 45 percent of loan modification requests received in fiscal year 2002 within 30 days to processing 71 percent in fiscal year 2005.

FHA has not tracked other performance measures related to activities that are coordinated, or can be done, by both FHA and HHS staff. For example, according to one performance measure, hospitals with a weakening financial position should be identified early enough to allow time for the account executive to provide technical assistance and undertake default prevention measures. Since such hospitals are identified through the FHA’s priority watch list system, these data are readily available for measurement. Similarly, another performance measure is designed to capture the soundness of analysis performed by client service teams, which can include both FHA and HHS staff, in assessing insurance applications. FHA has also not tracked this measure.

FHA also does not track performance measures of activities that it delegates to HHS. For example, one measure is designed to capture the number of complaints and compliments about HHS’s timeliness, helpfulness, courtesy, and understanding. According to FHA, the agency has not tracked this or other measures because it has not had enough problems with HHS to warrant establishing a tracking system and that establishment of such a system would be both an administrative burden and a poor use of their resources. However, without collecting appropriate information, FHA cannot quantify the input it receives about HHS. In addition, FHA has not tracked performance measures related to construction design and monitoring, which HHS is responsible for. According to FHA, performance measures exist to indicate FHA’s expectations of HHS’s performance, even though HHS’s performance is not tracked.

Several of the performance measures contained in the agreement between FHA and HHS lack the necessary characteristics of performance measures; that is, they are not measurable or objective. As a result, they do not provide useful information about the performance of the hospital program. For example, the measures related to the number of complaints and compliments about HHS are not measurable in that they do not specify a quantifiable threshold for expected performance. As a result, even if FHA tracked complaints, it is not possible to tell whether performance is meeting expectations. Other goals lack objectivity in that they require subjective judgment to assess program performance. As an example, one performance measure indicates that “plans and specifications do not need major revisions during the construction process because of significant architectural or engineering errors.” Another indicator states that “preconstruction meetings are thorough and do not precipitate delays in application processing.” In both cases, the performance measures require subjective judgment, because they do not make explicit what constitutes “major,” “significant,” or “thorough.” As we have previously reported, useful performance information is based upon measurable and objective performance measures. If useful performance information is collected, managers could use it to identify problems, try to identify the causes of problems, and/or to develop corrective actions. (App. III provides a complete list of the performance measures.)

While FHA does not track most of the performance measures outlined in the MOA, FHA’s Hospital Mortgage Insurance Management Information System captures a significant amount of quantitative and qualitative data about the performance of the program, which could be incorporated into measurable and objective performance measures. This system captures key loan processing dates, financial performance data over time, and documentation of internal meetings and actions performed by both agencies to assist insured hospitals. Incorporation of this readily-available data into meaningful performance measures would enable FHA to better assess its management of the program.

FHA and HHS established a new interagency agreement covering fiscal years 2006 through 2010, which includes many of the same measures as the previous agreement, including those that are not measurable or objective. The new agreement also includes a requirement that HHS provide FHA with an annual report detailing its performance against each of the performance measures in the agreement. However, this interagency agreement does not specify whether and how FHA will track its own performance against the measures.

Program Guidance Is Not Up to Date

FHA’s primary guidance for its hospital mortgage insurance program has not been updated in over 20 years and does not reflect changes to the program over that time. As a result, this document does not contain current eligibility requirements, which may cause confusion for potential applicants. In 1973, FHA published the Mortgage Insurance for Hospitals Handbook and last updated the handbook in 1984. The purpose of the handbook is to provide complete information about the processing of hospital mortgage insurance, including basic program features and requirements, to hospitals, lenders, sponsors, FHA and HHS personnel, and all other interested parties. According to FHA, the Office of Insured Health Care Facilities has not had adequate staff to revise the handbook and is waiting for a proposed regulation to become final before revising it. Since the handbook has not been updated since 1984, it does not contain current eligibility requirements, policies, and processing procedures. As we have previously reported, internal control standards applicable to federal programs provide that information should be recorded and communicated in a timely manner.

The handbook does not reflect key changes that the Hospital Mortgage Insurance Act of 2003 made to the program. This act revised the existing requirement that hospitals applying for FHA mortgage insurance have either a Certificate of Need or a state-commissioned study of market need; specifically, it provided that FHA would establish the means for determining market need and feasibility for hospitals. In addition, the 2003 act exempted Critical Access Hospitals (CAH) from the requirement that at least 50 percent of care must be for general acute-care patients. According to one of the mortgage bankers that we met with, the handbook causes confusion because hospitals are uncertain about requirements applicable to them.

As we have previously reported, internal control standards provide that information, such as changes in eligibility requirements and application processing procedures, should be communicated in a timely manner. While FHA publicly communicates program changes through Mortgagee Letters, updating the Applicant’s Guide, distributing copies of its minimum criteria for consideration, and updating its Web page, it has not incorporated all of this updated information into the program’s handbook. All documentation, including the handbook, should be updated in a timely manner. Maintaining current documentation is an internal control that would benefit both those interested in the program and those that administer the program.

Potential Risks Exist Although FHA Has Mitigation Strategies in Place

The hospital program is a relatively small program within the broader GI/SRI fund and has a record of recovering claims. Despite its small size, both program and market trends show risks that could affect the hospital portfolio. FHA has mitigation strategies in place to address some risks but does not have a formal strategy to geographically diversify the hospital loan portfolio.

The Hospital Program Accounts for a Relatively Small Share of the Broader GI/SRI Fund, and Has Recovered a Majority of All Claims

The Hospital Mortgage Insurance Program comprises a relatively small part of the GI/SRI fund, representing about 2.9 percent of the GI/SRI’s fund’s fiscal year 2006 total commitment authority. Moreover, the approximately $5 billion in loans that FHA currently insures through the program is 6.5 percent of the $77 billion in unpaid principal balance of the fund (see fig. 2). In addition to being a financially small component of the broader GI/SRI fund, the Hospital Mortgage Insurance Program has a record of recovering more than two-thirds of all historical claims, and lenders have not made a claim on an insured loan since 1999. Since the program’s inception in 1968, there have been a total of 22 claims totaling $225 million. Of this amount, FHA recovered 68 percent, or $153 million.

Loan Performance and Market Trends Reveal Sources of Potential Risks

In spite of the hospital program’s relatively small size and the relatively good performance history of insured loans, analysis of both program and market trends shows risks that could affect the future performance of the hospital loan portfolio. For example, the average loan size insured through the program has varied over time but has been increasing from about $26 million in 2002 to over $122 million in 2005. This growth creates financial risk because a claim from one large loan could have a significant impact upon the program.

In addition, the majority of the currently insured loans in FHA’s hospital portfolio are less than 10 years old. According to HUD, 70 percent of claims have historically occurred prior to a loan’s tenth year. Currently, the loans that have been insured for less than 10 years have an aggregate unpaid principal balance of $2.8 billion, representing about 57 percent of the aggregate unpaid principal balance (see fig. 3).

Comparing FHA data on selected financial indicators with the criteria the agency uses to determine the financial health of program applicants shows some favorable trends but also indicates sources of potential financial risk (see fig. 4). Specifically, our analysis of program data for calendar years 2000 to 2004 shows that some insured hospitals increased their ability to meet their monthly and future mortgage payments. For example, the median debt-service coverage ratio, a measure of a hospital’s ability to pay its mortgage with cash generated from current operations, increased from 1.54 to 2.18. While a value of 2.18 for this ratio indicates a low level of risk, according to FHA criteria, other financial indicators indicate medium levels of risk. For example, the median number of days of cash on hand and the median current ratio (which compares a hospital’s current assets to its current liabilities) both improved, yet still indicate a medium level of risk to the program. Finally, the median operating margin, which is indicative of a hospital’s ability to control costs and expenses, improved between 2000 and 2004, yet indicates a medium level of risk based on FHA’s criteria.

Median financial indicators for the 11 hospitals that FHA has placed on its priority watch list show much greater levels of risk when compared with FHA’s underwriting guidelines (see fig. 5). For these hospitals, performance as measured by all four selected indicators declined from 2000 to 2004. Further, in 2004, three indicators showed a high level of risk, based on FHA’s criteria. For example, according to FHA’s criteria, an applicant with an operating margin of less than zero is considered high risk. The hospitals on FHA’s priority watch list had median operating margin of -2.65 in 2004. Similarly, according to FHA’s criteria, an applicant with less than 15 days of cash on hand is also high risk, and hospitals on the priority watch list had a median of 3.3 days of cash on hand in 2004. FHA recognizes that the high risk levels of these selected financial indicators are among the reasons that these hospitals are on its priority watch list and are, therefore, subject to closer monitoring to reduce the risk of a claim.

Analysis of program data further shows that, while loans are increasingly being insured outside of the Northeast, the program is still concentrated in New York (see fig. 6). Though the percentage of the unpaid principal balance concentrated in New York has decreased from 89 percent in 2000, 61 percent of the unpaid principal balance in the program remains concentrated in New York in 2005. Of the 30 hospital loans that FHA has insured since 2000, 21 are outside of New York, and 19 are outside of the Northeast region. Since 2003, 5 of the loans insured were for CAHs.

Further, 24 out of 25 mortgage insurance applications in development at the time of our study are located outside of the Northeast (see fig. 7).

Despite these strides, the high concentration of the program’s unpaid principal balance in New York, as well as concentrations with single borrowers with multiple loans, creates risks. New York hospitals insured through FHA, like hospitals nationwide, rely heavily upon reimbursement through Medicare and Medicaid.Since a portion of Medicaid funding comes from states, any cuts made by the state of New York could have an especially negative impact on the hospital program. Insured hospitals in New York are also vulnerable to other state policies. For example, a task force appointed by the Governor is in the process of identifying New York hospitals for closure or restructuring. The Governor and state legislature have committed state funds to assist in restructuring efforts, and the state has had a history of helping its hospitals avoid defaults. Nevertheless, any recommendations for the closure or restructuring of FHA-insured hospitals may present the risk of an insurance claim. Further, some New York hospitals have multiple loans insured through the program, one with unpaid principal balances totaling approximately $828 million as of December 2005. According to HUD’s comments on the draft of this report, this hospital is a financially sound, well-endowed institution that poses a low risk of default.

Industry Trends Pose Risks to Hospitals, Including Those with FHA Insured Mortgages

The hospital program may also face risks from changes in the health care industry at large. According to industry literature, decreasing revenue streams, increases in the number of uninsured patients, increased competition from specialized facilities, and heightened capital needs are some of the trends that affect all hospitals, including FHA-insured hospitals.

We and others have reported that Medicare and Medicaid spending may not be sustainable at current levels. If program cuts occur in Medicaid, for example, states may take cost containment measures to reduce spending. Such measures may include frozen, or reduced, reimbursement rates to providers and restrictions on eligibility for these programs.In addition, the number of Medicare enrollees is projected to increase as baby-boomers age and become Medicare-eligible.These trends will affect all hospitals, including FHA-insured hospitals, which generally have Medicare and Medicaid patients in their payer mix. On average, Medicare discharges for FHA-insured hospitals represented 29 percent of total discharges per hospital, and Medicaid discharges represented 19 percent of total discharges per FHA-insured hospital. (See fig. 8 for Medicare and Medicaid discharges by state.) Stated another way, nearly 50 percent of the reimbursement that program hospitals receive is through Medicare and Medicaid.

Hospitals, including FHA-insured hospitals, must also contend with the rising number of underinsured and uninsured patients, which place demands on hospitals to provide care with little to no reimbursement. According to the U.S. Census Bureau, the number of uninsured persons rose from under 40 million people in 2000 to approximately 45 million people in 2003. This trend may pose a risk to the program. In addition, hospitals in New York, where the hospital mortgage insurance is concentrated, serve a high proportion of uninsured patients.

Credit rating agencies state that competition is increasing in the health care market as the type of care provided shifts to outpatient and specialty hospitals, which provide profitable services, such as cardiology, surgery, orthopedics, and diagnostic imaging. Specialty facilities providing these services can take patients and revenue from general acute-care hospitals, which supplement revenue shortfalls with profitable services after providing needed, but unprofitable, services to the community. The growth of specialty hospitals, such as ambulatory surgery centers, is strong. The average number of specialty hospital openings has increased from 5 hospital openings in the 1960s to 27 hospital openings in the 2000-present time period.

Hospitals throughout the health care sector face increasing capital demands, yet many have limited access to capital according to hospital industry literature.For example, hospitals face demand for outpatient services, emergency room upgrades, and technological advancements, which have significant up-front and maintenance costs. A reputable credit rating agency estimates that information technology expenditures now range between 20 to 30 percent of a hospital’s capital budget. Financially weaker hospitals have less access to capital, yet often have pent-up capital needs. According to a recent rating agency report, New York hospitals have unmet capital needs as a result of their older infrastructure and because they are generally financially weaker than the average hospital.

FHA Uses Tools to Mitigate Risk

FHA uses a variety of tools to mitigate risk in the hospital program. For example, during its preliminary assessment of a hospital, FHA reviews the hospital’s ability to pay its mortgage by analyzing its debt service coverage ratio and determines if this ratio meets FHA’s minimum requirement. FHA takes other steps when reviewing applications (as discussed previously) designed to keep out excessively risky projects and also imposes requirements on insured hospitals to control risks. These include assessing the viability of projects at preapplication meetings with key using a comprehensive underwriting process that assesses, among other factors, past and projected financial performance and the demand for the hospital’s services; hiring an independent consultant to evaluate the feasibility of the proposed project and its potential risk to the FHA; requiring insured hospitals to establish a cash reserve fund sufficient to cover 2 years of mortgage payments; requiring insured hospitals to maintain compliance with key agreements between the hospital and FHA and monitoring these agreements; and considering insured hospitals that fail to meet certain financial criteria for placement on the priority watch list.

FHA has also made some efforts to address the risks associated with the geographic concentration of the program in New York. Since 1999, FHA has had goals for geographically diversifying the hospital portfolio. Currently, FHA’s goals for diversifying the portfolio include reviewing and processing applications for projects in states other than New York. While the agency does not have a formal strategy for marketing the program outside of New York, it has made some efforts to diversify the hospital portfolio by simplifying its application process for CAHs and providing rural hospital associations with information about the program; hiring an expert in rural hospitals; visiting hospital association conferences to educate members about the educating HUD field attorneys, mortgage bankers, and consultants about the program.

HUD has also cooperated with requests for program information from the trade media and assisted other researchers, which resulted in the publication of articles and reports that provided information about the advantages of the hospital program in financing capital projects. A formal strategy, however, would provide the agency with a tool for comprehensively planning for and executing activities that would lead to the geographic diversification of the hospital portfolio. OMB guidance, for example, requires that agencies include a description of the means and strategies that will be used to achieve goals in their strategic plans. Such strategies could include, for example, the processes, skills, technologies, and various resources that will be used to achieve goals.

HUD’s Model for Estimating Credit Subsidy Costs Excludes Potentially Relevant Factors

HUD uses a model for estimating annual credit subsidies that does not explicitly consider the impacts of some potentially important factors. HUD’s model incorporates factors and assumptions about how loans will perform, including estimated claim and recovery rates, which are consistent with OMB guidance. HUD has generally calculated a negative subsidy rate for the hospital program, meaning that estimated cash inflows have been greater than estimated cash outflows. However, HUD’s model does not explicitly consider the potential impacts of prepayment penalties or restrictions when estimating prepayments, or the debt-service coverage ratios of hospitals at the time of loan origination.

For budgeting purposes, agencies that make loans and provide loan guarantees must estimate the costs to the government over the life of the loans that will be insured, commonly referred to as the subsidy cost. In order to estimate the subsidy cost of the Hospital Mortgage Insurance Program, HUD uses a cash-flow model to project expected net cash flows for all these loans over their entire life. HUD’s model is a computer-based spreadsheet that uses assumptions based upon historical and projected data to estimate the amount and timing of claims, subsequent recoveries from these claims, as well as premiums and fees paid by the borrower. In addition, HUD does not consider prepayment penalties and restrictions when it estimates the level and timing of prepayments, which affect estimates of future claims and premiums.

HUD inputs its estimated cash flows into the OMB’s credit subsidy calculator, which produces the official credit subsidy rate. A positive credit subsidy rate means that the present value of cash outflows is greater than inflows, and a negative credit subsidy rate means that the cash inflows are estimated to exceed cash outflows. For the hospital program, cash inflows include premiums and fees, servicing and repayment income from notes held in inventory, rental income from properties held in inventory, and sale income from notes and properties sold from inventory. Cash outflows include claim payments and expenses related to properties and notes held in inventory.

Since the hospital program’s inception, FHA has paid a total of 22 hospital mortgage insurance claims. The last claim was filed in 1999. Because of the small number of claims, HUD determined that claim rates based solely upon the program’s historical claims experience would not be reliable. As a result, HUD uses a methodology initially developed by OMB to increase its estimated claim rate by assuming that the lenders for some active hospitals would file claims for insurance. HUD refers to this methodology as an artificial default. In determining which loans to artificially default, HUD focuses on hospitals that generally have a higher risk of default, and are therefore on FHA’s priority watch list. According to OMB officials, the use of this artificial default accounts for the risk that exists due to the low number of large size loans insured, potential changes in Medicare or Medicaid reimbursement rates, and the geographic concentration of the program in New York, which make the program vulnerable to regional economic conditions.

In 10 of the 14 years that HUD has been estimating the cost of the Hospital Mortgage Insurance Program under credit reform, HUD has estimated that the present value of cash inflows from fees, premiums, and recoveries from loans and properties sold would exceed the outflows from claim payments and other expenses related to properties and notes held in inventory. As a result, HUD calculated a negative credit subsidy rate for the hospital program for these 10 years. In the other 4 years, HUD estimated positive or no credit subsidy costs for the program. Figure 9 shows changes in the credit subsidy rate from 1992 to 2005.

While HUD’s model includes assumptions that are consistent with OMB guidance, such as assumptions on estimated claim and recovery rates and an artificial default methodology to supplement the claim experience, HUD’s model does not explicitly consider the potential impact of prepayment penalties or restrictions, even though they can influence the timing of prepayments and claims and collection of premiums. Inclusion of initial debt-service coverage ratios, as a factor predictive of defaults and claim rates into HUD’s cash-flow model for the hospital program, could potentially enhance HUD’s estimate of the subsidy cost of the program. According to some economic studies, prepayment penalties, or penalties associated with the payment of a loan before its maturity date, can significantly affect borrowers’ prepayment patterns. In turn, prepayments affect claims because if a loan is prepaid it can no longer go to claim. According to FHA officials, FHA does not place prepayment penalties on FHA-insured hospital loans. However, according to the hospital program’s regulations, a mortgage loan made by a lender that has obtained the funds for the loan through bonds can impose a prepayment penalty charge and place a prepayment restriction on the mortgage’s term, amount, and conditions.

According to FHA officials and mortgage bankers, prepayment restrictions on hospital loans are generally in the form of 10-year restrictions on the prepayment of bonds. While FHA does not maintain data specifically on insured hospitals’ bond-financing terms, prepayment restrictions are specified on the mortgage note, which is available to FHA. Moreover, according to the Mortgage Insurance for Hospitals Handbook, FHA has access to bond-financing terms because, upon completion of bond issues, applicants are required to submit bond-related documents to FHA so that FHA can verify that the fees, charges, and other costs previously approved with respect to debt restructuring. Incorporation of such data into the hospital program’s credit subsidy rate model could refine HUD’s credit subsidy estimate by enhancing the model’s ability to account for estimated changes in cash flows as a result of prepayment restrictions.

According to HUD officials responsible for HUD’s cash-flow model, prepayment penalties and restrictions are not incorporated into the model because HUD does not collect such data. HUD officials added that, even though the cash-flow model does not explicitly account for prepayment penalties and restrictions, its use of historic data implicitly captures trends that may occur as a result of prepayment penalties and restrictions. However, by not explicitly incorporating prepayment penalties or restrictions into the cash-flow model, HUD’s model is less able to estimate the impact of changes in prepayment patterns of current and future cohorts.

HUD’s cash-flow model also does not consider the initial debt-service coverage ratio of hospital loans at the point of loan origination. By initial debt-service coverage ratio, we are referring to the projected debt-service coverage ratio that is considered during loan underwriting. (HUD’s cash- flow model does consider the current debt-service coverage ratio of insured hospitals through its artificial default methodology, which, as previously explained, includes hospitals that are on FHA’s priority watch list. This list may include insured hospitals if, based upon the last available full year of data, their debt-service coverage ratio is below 1.10.)

According to the HUD official responsible for HUD’s cash-flow model, the initial debt-service coverage ratio of a hospital at the point of loan origination is not included as a part of the cash-flow model for the hospital program because it (1) is not a cash flow, (2) does not vary, and (3) has no predictive value. We agree that a debt-service coverage ratio is not a cash flow. However, initial debt-service coverage ratios potentially affect relevant cash flows, as do other factors that are included in HUD’s model but are also not cash flows, such as prepayments. For example, the model considers estimated prepayments because they potentially affect future cash inflows from fees and future cash outflows from claim payments. Initial debt-service coverage ratios are another important factor that may affect cash flows, as loans with lower initial debt-service coverage ratios may be more likely to default and result in a claim payment. They can also be used to assess the financial health of either an applicant or a hospital in the existing portfolio.

According to officials from FHA’s Office of Insured Health Care Facilities, the projected debt-service coverage ratio is most meaningful for the third or fourth year projected, when construction is most likely to be complete. Our analysis of projected debt-service coverage ratios, which include the amount of new debt being insured, shows that these ratios varied from 1.48 to 3.11 during the fourth year projected. All other factors being equal, loans with a debt-service coverage ratio of 3.11 are generally considered to have less risk than a loan with only a 1.48 debt-service coverage ratio.

Finally, we also found that economic studies show mixed results regarding the significance of the impact of debt-service coverage ratios upon commercial mortgage defaults. Some studies find initial debt-service coverage ratios to be statistically insignificant in modeling commercial mortgage defaults. Other studies indicate that initial debt-service coverage ratios are meaningful factors in modeling default risk and are helpful in predicting commercial mortgage terminations. Analysis of initial debt-service coverage ratio information, which is available in underwriting documents, may be used to identify trends or shifts in the overall risk of the portfolios that should be considered when making credit subsidy estimates. Further, current credit reform guidance calls for agencies to use the best available data when preparing their credit subsidy estimates.

Conclusions

The Hospital Mortgage Insurance Program plays an important role by insuring loans for capital improvements at hospitals that, due to their greater financial risks, would otherwise face difficulty in accessing capital. FHA’s process for reviewing applications for mortgage insurance, while somewhat lengthier and involving more steps compared with those of private bond insurers, appears to be a reasonable response to the generally riskier nature of the applicants. Further, the agency’s techniques for monitoring insured hospitals are quite similar to those used by private insurers, and the program has operated for several years without experiencing an insurance claim.

FHA and HHS appear to work together reasonably well in carrying out their respective roles in administering the program. However, it is difficult for us, FHA’s managers, or the Congress to assess how well the agencies perform in implementing the program because FHA has not established a set of meaningful program performance measures or collected the information needed to assess performance. We have previously reported on the importance of agencies’ collecting useful performance information.

If FHA collected useful performance information, such as information based on measurable and objective performance measures, the agency’s managers could use it to identify problems, try to identify the causes of problems, and/or to develop corrective actions. Many program activities, including those delegated to HHS, are recorded in FHA’s Hospital Mortgage Insurance Management Information System, and data from this system could be used to establish and monitor useful performance measures. In addition, because FHA has not updated the program handbook since 1984, hospitals, lenders, investment bankers, health care financing agencies, and other interested parties do not have ready access to a consolidated source of current program eligibility requirements, policies, and procedures. The lack of a consolidated source of current information may cause confusion and delay hospitals’ ability to prepare applications that meet FHA’s criteria. Further, outdated guidance in federal programs is an internal control weakness.

Although it represents a relatively small part of HUD’s GI/SRI fund, the hospital program insures multimillion dollar loans that currently total nearly $5 billion. The continued geographic concentration of insured hospitals in the state of New York poses a source of financial risk to the program. While this concentration has decreased from its high of 89 percent of outstanding insured principal balance in 2000, the current 61 percent represents a continuing concentration of credit risk. As a result, the program is vulnerable to New York State policies, such as the governor’s call to restructure hospitals, as well as regional economic trends. While FHA has taken steps in the right direction, it does not have a formal strategy or plan for geographically diversifying the hospital portfolio, which could enhance current efforts to reach this goal.

HUD’s cash-flow model used to estimate annual credit subsidy rates appears to be consistent with applicable OMB guidance; however, it does not explicitly take into account potentially useful factors such as prepayment penalties and restrictions or the initial debt-service coverage ratio of new loan cohorts. Although the program has not experienced a claim for insurance since 1999, the increasing size of loans insured, geographic concentration in New York and the Northeast, and other factors pose risks to the program. Including additional factors into HUD’s model could potentially enhance the agency’s estimates of the subsidy cost of the program, provide HUD and congressional decision makers with better cost data to assess the program, and help assure that the program adequately addresses financial risks.

Recommendations for Executive Action

To improve management of the Hospital Mortgage Insurance Program and reduce potential risks to the GI/SRI fund, we recommend that the Secretary of Housing and Urban Development direct the FHA Commissioner to take the following three actions: Establish measurable and objective performance measures for the hospital program and collect appropriate information to regularly assess performance against the measures.

Update the program handbook to make publicly available current eligibility requirements, policies, and procedures.

Develop a formal strategy to geographically diversify its portfolio of insured hospitals, including such elements as the processes, skills, technologies, and various resources that will be used to reach diversification goals.

To potentially improve HUD’s estimates of the program’s annual credit subsidy rate, we recommend that the Secretary of Housing and Urban Development explore the value of explicitly factoring additional information, such as prepayment penalties and restrictions, as well as the initial debt-service coverage ratio of hospitals, as they enter the program into its credit subsidy model.

Agency Comments and Our Evaluation

We provided a draft of this report to HUD and HHS for their review and comment. In written comments from HUD’s Assistant Secretary for Housing–Federal Housing Commissioner, which incorporated comments from HHS, HUD concurred with our four recommendations. However, the agency disagreed with our presentation of certain aspects of the program, commenting that the report’s “critique of procedural and technical matters” overshadowed the program’s accomplishments. The Assistant Secretary’s letter appears in appendix IV, and a letter from HHS appears in appendix V.

HUD expressed general agreement with the recommendations and noted actions that it plans to take. Specifically, the agency agreed to develop appropriate performance measures and implement data collection procedures to evaluate both program and contract administration; with the need to consolidate updated eligibility requirements, policies, and procedures into an updated handbook, and stated its intention to have the handbook finalized by the end of 2006; to develop a formal strategy to geographically diversify its portfolio of insured hospitals, including such elements as the processes, skills, technologies, and various resources that will be used to reach diversification goals; and to explore the value of explicitly factoring additional information, such as prepayment penalties and the initial debt-service coverage ratio of hospitals as they enter the program, during its annual review of cash flow modeling techniques for the hospital program.

In disagreeing with our presentation of FHA’s efforts to diversify the hospital portfolio, HUD commented that diversification has been a top program goal for many years. Our draft report acknowledged that FHA has had goals for geographically diversifying the portfolio since 1999 and provided examples of FHA’s diversification efforts. However, in response to the comments, we included additional examples of FHA’s efforts. HUD also commented that the report does not appropriately emphasize the success that HUD and HHS have had in working together to implement the hospital program. Our draft report acknowledged the agencies coordinated involvement with key meetings, underwriting, and monitoring. Further, as the letter from HHS observes, our draft report concluded that the two agencies appear to be working reasonably well together. Because we believe the report accurately characterizes the relationship, we did not change it. Finally, HUD commented that the report infers that (1) it has not maintained current policies and procedures and (2) indicates that current eligibility requirements, policies, and procedures are unavailable to the public. Our draft report stated that the handbook does not contain current eligibility requirements, policies, or processing procedures, and acknowledged that FHA publicly communicates program changes through Mortgagee Letters. Nevertheless, in response to HUD’s comments, we revised the report to include additional examples of FHA’s efforts to communicate changes in eligibility requirements, policies, and procedures. We also continue to emphasize the value of updating all program documentation, including the handbook.

HUD also offered comments regarding the report’s presentation of risks facing the hospital program, including potential cuts in reimbursement from Medicare and Medicaid, the potential for closures of hospitals in New York stemming from a commission appointed by the Governor, and the large size of some loans. We recognize that potential cuts in reimbursement from the Medicare and Medicaid programs are a risk factor for hospitals in all states; however, New York is unique among states in accounting for over half of the hospital program’s insurance portfolio. We revised the report to clarify that, due to this concentration, any cuts that the state of New York makes to its Medicaid program could have an especially negative impact. Regarding the New York Governor’s commission, we are aware that state funds are available to assist in restructuring efforts, and that the Dormitory Authority of the State of New York is committed helping its hospitals avoid defaults. However, since there is no guarantee that FHA-insured hospitals will be protected, we continue to believe that a recommendation for their closure or restructuring may present the risk of an insurance claim. Finally, we revised the report as HUD suggested to note that the largest single exposure of $828 million is for a hospital that, according to HUD, poses a low risk of default.

HUD commented that GAO’s presentation of processing times for applications is misleading because it does not mention that there can be periods of time in which HUD cannot continue to process applications due to factors that applicants must address and are thus beyond HUD’s control. Because HUD’s system for tracking application processing times does not capture such periods of time, it is not possible for GAO to quantify their impact. Further, the report notes that processing times vary with the complexity of the project and may be affected by issues outside of HUD’s control.

HUD took exception with our conclusion that it is difficult for us, FHA’s managers, or the Congress to assess how well the agencies perform in implementing the program because FHA has not established a set of meaningful performance measures and stated a belief that program results indicate that the program is fulfilling its purpose. While our report acknowledges that the program has had a good performance history, the creation and use of performance measures can be used by agency managers to improve a program’s results. As we note in the report, analysis of performance information helps managers identify problems, identify the causes of problems, and develop corrective actions. In addition, performance information can be used to develop strategies, identify priorities, make resource allocation decisions, and identify more effective approaches to program implementation.

HUD disagreed with our suggestion that it include such factors as initial debt-service coverage ratio into its credit subsidy modeling and noted that two of the studies that we cited found this ratio to be statistically insignificant in predicting commercial mortgage defaults. Our draft report in fact stated that economic studies have shown mixed results regarding the significance of the impact of debt-service coverage ratios on commercial mortgage defaults. However, we revised the report to explicitly footnote studies that show initial debt-service coverage ratios to be statistically insignificant and those that indicate that this ratio is a meaningful factor in modeling default risk. We also note that the two studies that found initial debt-service coverage ratios to be statistically insignificant were both based on the same, small data set. We acknowledge that HUD’s cash-flow model considers the current debt-service coverage ratio of insured hospitals through its artificial default methodology. However, our recommendation is to include the debt-service coverage ratios at origination, so that the risk of loans at origination will be reflected in the credit subsidy rates for the cohort.

Finally, our draft report stated that FHA estimates that hospital loans are most likely to experience a claim during their tenth insured year. In its comment, HUD stated that historically 70 percent of claims occurred prior to a loan’s tenth year. The statement in our draft report was based on actual historical conditional claim rate data. HUD subsequently provided additional information, which explained that the conditional claim rate peaked due to a single claim with multiple notes. As a result, we revised the report to reflect additional information.

We are sending copies of this report to the Secretaries of the Departments of Housing and Urban Development (HUD) and Health and Human Services (HHS). We also will make copies available to others upon request. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov.

If you or your staff have any questions about this report or need additional information, please contact me at (202) 512-8678 or woodd@gao.gov. Contact points for our Offices of Congressional Relations or Public Affairs may be found on the last page of this report. GAO staff who made major contributions to the report are listed in appendix VI.

Objectives, Scope, and Methodology

Our objectives were to review (1) the design and management of the program, as compared with private insurance; (2) the nature and management of the relationship between the Department of Housing and Urban Development (HUD) and the Department of Health and Human Services (HHS) in implementing the program; (3) the financial implications of the program to the General Insurance/Special Risk Insurance (GI/SRI) fund, including risk posed by program and market trends; and (4) how HUD estimates the annual credit subsidy for the program, including the factors and assumptions used.

To review the design and management of the Hospital Mortgage Insurance Program we interviewed officials at both the Federal Housing Administration’s (FHA) Office of Insured Health Care Facilities and the Division of Facilities and Loans within HHS’ Health Resources and Services Administration, and reviewed program policies, documentation of application processes, laws, and regulations. To compare the program’s design with that of private insurers, we met with private bond insurers and the Association of Financial Guaranty Insurers, credit rating agencies, mortgage and investment banking firms, hospital associations, and state health care financing agencies in New York and New Jersey.

To describe how FHA and HHS coordinate the implementation of the hospital program, we interviewed FHA and HHS officials about the responsibilities for each agency in implementing the program. We also reviewed the Memorandum of Agreement between FHA and HHS that describes the division of duties and responsibilities between the two agencies and organizational charts that depict FHA’s organization, HHS’s organization, and the FHA-HHS interrelationship in program administration. We analyzed the extent to which performance measures related to interagency coordination were met by obtaining available data from FHA and analyzing time frames for processing applications and loan modification requests from the Hospital Mortgage Insurance Management Information System (HMIMIS). We compared performance measures with our criteria on performance measures and compared performance measures in the 2002-2005 Memorandum of Agreement with the performance measures in the 2006-2010 Interagency Agreement between FHA and HHS to identify any changes.

To identify the financial implications of the program to the GI/SRI fund, we interviewed and obtained documentation from FHA and HHS program officials and analyzed FHA data on program portfolio characteristics, including number and amount of loans by cohort, current insurance-in- force, and geographic concentration of loans, claims, and recoveries. Specifically, To obtain the number and amount of active and terminated loans, we created a report from the HMIMIS database, which is updated monthly. To assess the reliability of the HMIMIS data, we reviewed relevant documentation, interviewed agency officials who worked with this database, and conducted electronic testing of the data, including frequency and distribution analyses. We determined the data to be sufficiently reliable to obtain the number and amount of active loans. We corroborated these data with the FHA’s 2004 report to the Congress. As of December 2005, the administrators provided data from HUD’s F-47 database, a multifamily database, to show (1) that there were 59 active hospitals with 74 active loans in the Hospital Mortgage Insurance portfolio and (2) that there had been 341 loans in the portfolio since the inception of the program. To assess the reliability of data from HUD’s F- 47 database, we reviewed HUD’s Hospital Mortgage Insurance Program Functional Requirements Document, Procedures for Maintaining Group Records, and other relevant documentation, interviewed agency officials who worked with this database, and conducted electronic testing of the data, including frequency and distribution analyses. Our assessment showed that two loan records were lacking state data, and one record was lacking hospital name data but were identified by a unique project number. FHA administrators verified that these loans were endorsed long before electronic loan records were maintained and that they were unable to provide additional information. None of our analyses utilized the missing data elements for the two projects; therefore, there was no impact on this report. We determined the data to be sufficiently reliable to describe the geographic concentration of loans in the program.

To determine the proportion of the Hospital Mortgage Insurance Program to the larger GI/SRI fund, we reviewed a spreadsheet provided by HUD’s Office of Evaluation dated June 2005 on insurance-in-force for the hospital program to that of the GI/SRI fund.

To determine the risk posed by insurance claims to the Hospital Mortgage Insurance Program, we analyzed spreadsheets with historic claims and recoveries data provided by HUD’s Office of Evaluation and dated August 2005.

To determine the geographic concentration of loans and loan prepayment history in the program, we analyzed data current as of December 31, 2005, in an extract of HUD’s F-47 database. While we obtained extracts from HUD’s F-47 database in April 2005, October 2005, and December 2005, all analyses from F-47 data in the report utilize the December 2005 extract only.

We also compared data on four financial ratios including debt service coverage, days cash on hand, current, and operating margin ratios provided from HMIMIS, current as of December 2005, with applicant criteria stated in the Manual of the Hospital Insurance Program.

To determine how FHA manages program risks, we interviewed FHA and HHS program officials and reviewed the Mortgage Insurance for Hospitals Handbook and manual to determine steps taken by the agency during the application and monitoring phases of the insurance process. We analyzed cash inflows to the program from income from notes held in inventory, rental income from properties held in inventory, sales income from notes, and properties sold from inventory. We also reviewed documentation of cash outflows, such as claim payments and expenses related to properties and notes held in inventory. To assess risk based on geographic concentration, we identified the state with the highest unpaid principal balance insured by the program. Finally, to assess risk posed by the geographic concentration of the program’s unpaid principal balance, we extracted 2003 data from the Centers for Medicare & Medicaid Services (CMS) database on Hospital Mortgage Insurance Program hospitals active in 2005. We used CMS data to identify the number of discharged patients whose services were paid for through the Medicare/Medicaid programs from hospitals that have loans insured through the program. More than 90 percent of these data have undergone basic edit checks; however, CMS has not yet determined whether these data require an audit. These data may change as they undergo further review by CMS. In addition, CMS does not enforce dates by which hospitals must report data. Thus, at the time of this report, only 49 of the 59 active FHA hospitals had provided data for 2003.

We conducted a literature review and interviewed numerous officials of rating agencies and hospital associations to obtain information on risks due to health care market trends. We conducted the following academic literature searches: (1) Google’s Scholar search engine using the terms “hospital mortgage insurance,” “nursing home mortgage insurance,” “hospital and default and FHA,” “nursing home and default and FHA”; (2) PubMed Web site using the terms “hospital mortgage insurance” and “nursing home mortgage insurance;” and (3) HUDuser.org Web site using the terms “hospital mortgage insurance,” “nursing home mortgage insurance,” and “Section 242.” We also searched for Inspectors General and agency reports through HUD and HHS Web sites using the terms “Hospital mortgage insurance” and “Section 242.” Finally, we conducted a search on our internal Web site to identify previous work on the Section 242 program. The terms “hospital,” “mortgage insurance,” and “Section 242” were used for the period of January 1995 through March 2005.

To determine how HUD estimates the annual credit subsidy rate for the program, we interviewed program officials from HUD’s Office of Evaluation and program auditors from the Office of Management and Budget (OMB), reviewed documentation of HUD’s credit subsidy estimation procedures, and reviewed the cash-flow model for the program. We also compared the assumptions used in HUD’s cash-flow model with relevant OMB guidance and reviewed economic literature on modeling defaults to identify factors that are important for estimation. Additionally, we analyzed data provided by FHA on program hospitals’ projected debt- service coverage ratios (at the time of their loan application). HUD’s Budget Office provided the program’s annual credit subsidy rates for 1992 and 1993, and we obtained this rate for years 1994-2005 from the Federal Credit Supplement of the United States Budget.

Our review did not include an evaluation of underwriting criteria, construction monitoring, or the need for the program. We conducted our work in Albany, New York; Chicago, Illinois; New York, New York; Paterson, New Jersey; Rockville, Maryland; and Washington, D.C., between February 2005 and January 2006 in accordance with generally accepted government auditing standards.

FHA and HHS’ Responsibilities in FHA’s Hospital Mortgage Insurance Program Loan Cycle

Department of Health and Human Services (HHS)

Administration (FHA)

Conduct preliminary review of hospital proposed for insurance.

Provide applicant guidance and feedback (including preapplication conference).

Review and approve construction plans, specifications, and contracts.

Engage independent feasibility consultant.

Account Executive and review team recommend approval or disapproval to the Program Management Group (PMG).

PMG recommends approval or disapproval to the FHA management.

FHA management recommends approval or disapproval to the FHA Commissioner.

FHA Commissioner makes final decision on whether to insure.

Make final underwriting determinations, conduct any needed legal reviews, issue firm commitment, close, and initially endorse loan.

Conduct preconstruction conference, monitor construction work, and process requests for advances of mortgage proceeds.

Review cost certification, inform lender of maximum insurable mortgage amount, and process final advance.

Arrange final closing and finally endorse mortgage.

Account Executive monitors hospital’s performance by periodically reviewing financial and utilization data.

Account Executive will receive, review, and recommend to FHA management 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)

Approve or disapprove special requests and loan modifications.

Develop and carry out strategies for helping a troubled hospital improve its financial condition and for preventing or curing defaults.

Engage consultant to review finances and operations of a troubled hospital and to make recommendations for a financial turnaround plan.

Review quality and condition of insured hospital loan portfolio.

Determine the amount of liability for loan guarantees and credit subsidy rates.

Receive/process assignment of loan and pay insurance claim.

Review assigned hospital’s operational performance and financial condition and conduct site visits as needed.

Department of Health and Human Services (HHS)

Administration (FHA)

Account Executives receive, review, and recommend to FHA management approval or disapproval of proposed workout agreements, mortgage modifications, or note sales.

Analyze hospital’s situation, evaluate alternative uses, secure appraisal, make decision to foreclose, and arrange and hold foreclosure sale.

Contract for management services and repairs, as needed, to protect asset if FHA is mortgagee-in-possession or acquires hospital through foreclosure or deed-in- lieu.

Develop marketing plan, advertise, and sell hospital.

FHA Assessed Performance Using 2 of 22 Performance Measures Included in the 2002- 2005 Memorandum of Agreement

Services (HHS)

Administration (FHA)?

Number of complaints from customers about the HHS staff's lack of helpfulness, timeliness, courtesy, understanding, etc. Number of compliments received for HHS staff's helpfulness, timeliness, courtesy, understanding, etc.

Preliminary information is provided within 2 business days of inquiry.

Time from receipt of complete application to decision letter. Process 75% of complete applications within 120 days of receipt.

There are no instances of incomplete applications being received because applicant was not informed of application requirements.

Soundness of analysis. HUD may consider the following evidence that the team's analysis was flawed: (1) deterioration, within 2 yrs of the recommendation for approval, of the financial condition of an approved applicant due to conditions that should have been detected in the review, or (2) the ability of a disapproved applicant to subsequently obtain insurance elsewhere on similar terms and conditions within 6 months of the recommendation for disapproval.

Plans and specifications do not need major revisions during the construction process because of significant architectural or engineering errors or omissions made prior to or during the application process.

Problems do not arise during the construction period because of significant inconsistencies between contract documents.

Preconstruction meetings are thorough and do not precipitate delays in application processing for our customers.

Monthly inspection reports support the items and amounts included in monthly draws.

Change orders are documented and recommendations are supportable.

Length of time between the team's receipt of monthly requisition package and submission of the team's analysis and payment recommendation to HUD.

Hospital construction project is completed on time and within budget, unless mitigating factors outside HHS's control prevent this from happening.

Services (HHS)

Administration (FHA)?

Length of time between completion of construction and recommendation for final endorsement. HHS accomplishes all activities in a timely manner and provides assistance and works with the hospital and contractor so as to minimize the length of time between completion of construction and recommendations for final endorsement.

Final recommendation package is complete, documented, and supportable if any issues or challenges are raised in relation to the construction phase of the project.

Customers with a weakening financial position should be identified early enough to allow time for the Account Executive (AE) to provide technical assistance and undertake default prevention measures before a situation becomes an emergency.

Each AE will develop and maintain a file in HHS's office on each customer with all pertinent information needed to evaluate the customer's condition.

AE's should not be "blindsided" by local, state, and national developments that affect the viability of customers.

Each customer meeting the conditions above for inclusion on the Priority Watch List (PWL) should be included on the PWL reports provided to HUD.

HHS's work should assist HUD's goal of zero claim payments.

Time from receipt of request to recommendation to HUD. Performance target is to process at least 75% of complete loan modification requests within 30 days of receipt.

HHS provides effective services to reduce or contain costs to the FHA insurance fund for the following activities: (1) transition into the HUD inventory; (2) stabilization of the hospital including patient, physical, and financial concerns; (3) marketing; and (4) disposition.

Comments from the Department of Housing and Urban Development

Comments from the Department of Health and Human Services

GAO Contact and Staff Acknowledgments

GAO Contact

Staff Acknowledgments

Individuals making key contributions to this report included Alison Martin, Lisa Moore, David Pittman, Minette Richardson, Paul Schmidt, and Julie Trinder.