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 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.