- CHFFA's distressed hospital loan program
- Rural vs urban healthcare systems
- Addressing energy costs through Energy-as-a-Service (EaaS)
Transcription:
Anna Burnatowski (00:00:11):
Good morning everyone. Are we ready or you need a little bit more minutes for a quick break? I know that the other session went over. Great. Well, thank you all for joining us. I wanted to introduce our expert in healthcare and public finance, but before I do that, I wanted to just briefly think about why we are here and talking about healthcare and why healthcare is so important to you all and to us all here in California, healthcare is a significant part of California economy. It is contributing 7% to GDP. It's also the largest sector in terms of jobs. It's 60% for the state and 40% for the business side, for the state. So certainly this is an important topic today and going forward in the future, and I have a fabulous panel here of experts in healthcare. I will start with Brandon Seibold, our Senior Finance Officer and Treasurer Adventist Health.
(00:01:33):
You had a chance to review the bio. I'm not going to go very deep, but I will put a little bit of fun facts about each of them. Brandon is an avid skier, does some very exciting skiing experiences, and also he is not shy to bike to his office over 30 miles, so certainly has the resilience to make change in healthcare and change the headwinds into tailwinds. He will be a great speaker for us today. We also have Douglas Kilcommons, Managing Director, KBRA. Doug joined us today from New York and the fun fact is that he has worked in all four rating agencies. If you think about anyone that knows the ratings, here is Doug and he will definitely will be our subject matter expert. And last but not least, Gia Calabrese is the Vice President, Public Finance BAM Mutual.
(00:02:46):
And the fact about Gia is that Gia has moved here about two years ago from New York to San Francisco and found her sweetheart and she's getting married, so she will be the happy face on our panel here today. With that we'll start and thank you again for joining us here and we wanted to start with the headwinds and the pandemic. Do we feel that the industry has fully recovered from the pandemic? And perhaps I'll just start with Brandon from the practitioner side and invite Doug and Gia to follow up with some of the perspective on the rating agencies and perception or the investor's perception as well as how the insurance industry is evaluating where they should put their insurance dollars into.
Brandon Seibold (00:03:49):
Thanks, Anna. So as we think about kind of what's happened in healthcare since the pandemic, obviously a lot of pressure in terms of volumes coming out of the pandemic, I'd say that at least for Adventist Health, we've really seen those volumes both on the inpatient and the outpatient side start to stabilize, in fact come back to that pre pandemic level from an inpatient perspective. What we've seen though in that time period is a couple things. One, if you think about what's happened to the volume, we've seen it shift materially from the inpatient to the outpatient setting. And that outpatient reimbursement model looks quite a bit different than the inpatient reimbursement model that many folks live on. And what I think many health systems have kind of wrestled with through that is there's been a focus on efficiency within the inpatient setting and thinking about how to create the staffing structures that work in that environment.
(00:04:50):
Shifting to the outpatient setting, the financial model and the construct around staffing and other things looks a lot different in the outpatient setting. And I think health systems are continuing to evolve in terms of how did they manage that model on a go forward basis in an efficient way. The other challenge that I think many health systems have faced and in particular in California, which we'll probably unpack a little bit later, is the inflation that came out of the pandemic has really disproportionately affected healthcare over other industries. And I think that that has been a challenge really across all aspects of the business, not only on the wage side of the business, but also on supplies, professional fees, kind of really all aspects. So from that perspective, I think that that has really been the headwind that healthcare operators have dealt with, but from a volume perspective, there has been kind of stability coming out of the pandemic.
Douglas Kilcommons (00:05:58):
Yeah, so first I'll just say that my fellow panelists have far better fun facts than I do, so I need to work on that for the next panel here. So I will put that on my list of follow-ups. But all joking aside, I fully agree that to a lot of what Brendan has said, I think from our perspective, the depths of COVID-19 and the impact on healthcare really were felt in the 2122 period. We have seen since then a slow climb back out of those depths. And during that time you saw many of the national health systems even and some of the more profitable academic medical centers generate operating margins that were well below breakeven. You're now seeing more of those creep back to the breakeven level if not come above it. Now obviously we had the benefit of federal stimulus and hospitals of all sizes and shapes received lots of support from the federal government to offset some of the really dark periods, but that money has now largely been exhausted either to reimburse or replenish lost revenue or to use for debt service payments.
(00:07:03):
So we're kind of moving beyond that now and we're seeing a more stabilized overall operating environment. Fully agree with Brandon, the predominance of volume recovery of even now volume growth has been in the outpatient ambulatory setting. So we're seeing those trends really accelerate with some of the hospitals and systems seeing more muted recovery on the inpatient side and that's consistent with industry trends and also what payers are looking for at this stage. What I'll also say is that like many sectors in municipal finance during the pandemic, liquidity was key. And I will say that for the systems that entered the pandemic from a position of strength, even though they may have emerged with some scars, they're emerging in a better position than some of their brethren that entered with much weaker liquidity. And that's one of the reasons why in our methodology we put a lot of credit and strength into balance sheet resources and especially around what's available, what can be accessed.
(00:08:03):
The last thing I will mention, Brandon touched on it, couldn't agree more the looming cost pressures that this industry faces. And I think throughout the muni world, every industry is still grappling with inflation, labor costs, the inability to fill positions that are vacant. I think healthcare is at the forefront of this. And while we've seen some of the horror stories around nursing shortages and the costs associated with traveling nurses come down, what we are seeing replacing that now is hiring staff and hiring back at levels that were way above where they had been historically. So while you're eliminating some of those cost pressures around the ups and downs of bringing in traveling, nursing, you're having to hire at a much higher level now. So your expense base is going up much more so than it would've before the pandemic. Last thing on capital, capital is a pressure point for many.
(00:08:59):
And what we saw during the pandemic, especially for the weaker credits, there was a holdback of certain capital programs, especially projects that could be deferred or delayed that were mission critical. Those projects as well as others are now moving forward in what continues to be an environment where costs are up. And so that's a factor that we look at and we're asking lots of questions around capital improvement plans where there are pockets of contingency built in. And if a project is early in its stages, we'll be asking around, well, how much of this is actually locked in? Do you have the budget for this set? And if not, what's your plan if again, two years from now we're at a 20% increase in terms of the overall cost? So those are some of the questions we're asking on capital and certainly hospitals are in the market now looking to borrow again
Gia Calabrese (00:09:51):
From the kind of insurer perspective. And it's interesting because at BAM, we entered the healthcare sector I think at one of the hardest times coming off the pandemic and then dealing with kind of all the industry-wide challenges. We have seen the operating margins stabilizing, like Doug mentioned, balance sheets generally stabilizing hospitals and health systems generally figuring out how to reduce reliance on contract labor, which was a huge issue in the last few years, but there are definitely still some lingering issues I think that will never really go away and the landscape will need to evolve to deal with them, especially like they mentioned that covid money has dried up and governmental reimbursement is not necessarily improving. These include the broken record things like labor costs, the adequacy of the labor supply, supply chain shortages, inflation, but they also include things that I think are a little bit harder to quantify. And those include cybersecurity threats, seismic risk, hurricane, earthquake, floods, wildfire. A few of those are particularly impactful in the state of California. Those things are becoming increasingly impactful in the sector, but they're really impossible to predict. So I think the preparedness for those things is really becoming super important moving forward for hospitals and health systems,
Anna Burnatowski (00:11:27):
All of the speakers touched on very important issues that are facing California healthcare, but also healthcare nationally in particularly. And I would like to go back to couple ideas here. I will start with the wage inflation. You've seen a huge wave in inflation. You probably just hear on the news every so often about nurses strikes in various parts of the country. So it's not only here in California. I would be curious how from the practitioner standpoint at Adventist Health, those challenges are overcome and become the tailwinds, but also how you reconcile on the insurance side and the rating side with that significant burden to the health systems here in California and particularly with the new staffing ratios.
Brandon Seibold (00:12:34):
Yeah, a couple interesting things on wages and staffing. So as Doug called out two years ago, we had were paying nurses in California for contract nurses, it could be $400 an hour, so a level that wasn't sustainable. So the counter to that was to reinvest in the wages of our existing staff, which NetNet is positive for the hospital. You have better patient experience, better patient outcomes, it's a good thing to retain those folks. But that resulted in very rapid inflation on the nursing wages. So to put it in perspective now our nursing wages are actually equivalent to a contract wage for a full-time nurse. So now we basically have parody between contract or internal, and so obviously we choose internal, but then you create, as this has occurred, we've hired very aggressively to get that staffing level back to what we needed. Well, volume has been flat or slightly variable, which then results in this overstaffing aspect that has to be managed through attrition and other aspects.
(00:13:57):
So that I think has been a challenge on the wage inflation side. What's interesting, if you take a step back and think about it from a global, national, excuse me, national perspective, I was looking at something the other day. So if you look back over the last two decades, productivity, or excuse me, the growth in GDP, 80% of it in the US has been driven by productivity and 20% by workforce growth. If you look across all of the industries, if you look at healthcare data subset of that, it actually has declined productivity and healthcare has actually declined over that same period of time. And so Anna Ray is the part of this question around what does that look like in terms of the regulatory environment and why is it that healthcare productivity is declining, which we can unpack a little bit more, but there are truly regulatory barriers to improving productivity within healthcare.
(00:15:00):
We have mandated staffing ratios. There's other things that really prevent that ability to be adaptive from a productivity perspective. The other thing that has occurred not so much affecting the higher nursing wage positions, but the California minimum wage will have a meaningful impact across the healthcare sector. And it's not only the actual movement of the wage to the minimum, what ends up happening is creates this big compression all the way up and wage compression all the way up the wage structure. So when you move somebody who works for a manager to the minimum wage, now the manager makes the same as the person that moved to the minimum wage and now you have to move the manager. So that wage compression is just starting to trickle in, but will be quite impactful across the organization. And I think it'll force organizations to think about where there is automation and where there is technology and ability to do work in different geographies that'll force the healthcare organizations to evaluate those options. Given that pressure.
Anna Burnatowski (00:16:24):
Doug, any comments from your perspective?
Douglas Kilcommons (00:16:27):
Sure. I think Brenda raises several very interesting points. The biggest takeaway I would say is that this is not going to go away. And so this issue of year over year growth in salaries, wages, and benefits on the P&L is going to perpetuate and it's something that we've already seen. And when you look at the cost categories for most providers, it's the salary piece, it's cost of drugs, purchase services and such. And it's like those are your top three. And if you're not capturing enough revenue to offset that, you wind up in a situation where you're obviously below break even and having to rely on your balance sheet to subsidize that. So what we're looking at obviously first on the revenue side is to make sure that a system or a provider has all of the tools possible to make sure that they're getting in the revenue that they need to.
(00:17:17):
And you would be surprised to hear that even the largest systems systems that have been around in their current form for decades that are viewed as the most sophisticated in the business, some of these entities are still struggling to get electronic medical records systems put in and to better track their revenue over the course of a patient's stay. Those things matter because you wind up, if you don't make those investments, you wind up leaving dollars on the table, not basically getting the reimbursement that you need. And those dollars help to offset some of the cost pressures that Brandon is talking about. So that would be the first thing that I would point out and take away from this. The second piece of it is the systems themselves in trying to deal with regulation mandates from the state or the federal government, there's not really much you can do the expression, you can't fight city hall well, you can't fight city hall in this case and you've got to comply.
(00:18:14):
There's going to be this push to figuring out how to do this without the systems basically bearing all of these costs and just not being able to provide a level of care that the market is demanding. So whether that comes from different approaches to the care, whether that includes more in the way of technology. And we've seen on a number of site visits, the amount of technology that hospitals are pouring in to procedures that used to have far more in the way of human interactions. And now lots of those procedures have elements to them where there are no humans involved. And again, the care is still at the level it needs to be. There'll probably be more investments made that way, again to avoid some of these ongoing pressures. But it is challenging and one of the things that we will continue to look at from a rating perspective is this match between revenue growth and one of the many metrics in our methodology is around the net patient revenue growth over the course of a five-year period that compounded a rate of growth versus operating expenses.
(00:19:22):
And as we see those two things get closer and closer, the concern obviously goes up. So looking to see what is being done to help ensure that revenue is outpacing expense growth and really the reliance for many on procedures that have a high acuity level, which obviously get lots better reimbursement rates, that is something we're going to continue to look at. And that is surprisingly, when you look across in the last several years, not every provider in every state came back at the same time. And I still am reading disclosures particularly for systems here in the west where they were dealing with covid related hospitalizations and beds that were occupied much deeper into let's say 2021 and 2022 versus some of the systems back in the east where they had already begun to restart elective surgeries. And so that piece of it is also something that we look at. And again, to what degree are you generating revenue from those electives and again, the overall payers that are supporting them.
Gia Calabrese (00:20:28):
Yeah, I think you guys both hit the nail on the head with this issue. The last thing I think I'll kind of add as I think everyone feels that governmental reimbursement could be better, needs to improve, but it's kind of one of those things that hasn't changed realistically isn't going to change. I actually talked to Martin Eric front and center right before this and I was like, what do you think is going to happen? What do we think is going to happen depending on the outcome of the election with governmental reimbursement as it relates to Medicare and Medicaid? And he was like, if it's a democratic presidency, probably going to say the same if it's a Republican presidency, probably going to get a little bit worse. But it's always been pretty similar over the course of time. I think we all agree that unless there's some major overhaul of reimbursement, nothing is going to change from that perspective. And that's I think something that every healthcare entity is really grappling with because at the end of the day, not everybody has an extremely high commercial payer mix. Not everybody can offer really high acuity services. And then how do those entities survive and how do they still provide quality care to Medicare and Medicaid patients without improved reimbursement because it's for Medicare, best case one-to-one and Medicaid a huge money loser for everyone.
Brandon Seibold (00:22:11):
To Gia's point centric, it's really interesting because if you look back, just take state of California for example, there's 13 million Medi-Cal lives that are covered in California. If you go back 10 years, that was 17% of the population 10 years ago and today it's 27% of the population is on Medi-Cal. So huge shift just in terms of the population that exists of lower reimbursed folks, and that means that there's few, I mean fundamentally the whole model has worked in that commercial reimbursement covers the cost for Medi-Cal and the shortfall for Medicare. And so that's how all the economics theoretically, theoretically work within healthcare. So if there's this big shift in Medi-Cal and Medicare and that reimbursement structure doesn't support what it was 10 years ago, I think that health systems are really starting to focus on where do we get to a place where we can have kind of a model that will be affordable at Medicare rates and how do you build that model to be successful? If that means thinking about what the footprint is, where you do what's in the inpatient acute setting, what's in the outpatient setting and how do you do things more efficiently? So I think it's an interesting dynamic that all of us are wrestling with.
Anna Burnatowski (00:23:37):
I wanted to go back to that rising wage costs and how the humans are maybe not substituted or helped with technology. Maybe I'll ask actually, Doug this time is when you look at rating a health system that is heavily investing in technology and there is a transition, major transition in systems that they use to eventually be better, how do you perceive the risk associated with that? Maybe Doug and Gia can talk a little bit about the risk of transition and implementing new technologies through the health systems.
Douglas Kilcommons (00:24:18):
Yeah, it's an interesting question, Anna. I think one of the things that you have to as a ratings analyst do is look beyond the cost that's going to be incurred not only for the capital investment but also the cost of consultants and the cost of the ramping up of whatever that technology is. And these can be very steep investments and the consultants related to them can also be very steep. And we've seen evidence when you look at a p and l for a number of years in a system or a provider that has typically been at just above break even all of a sudden starts to go below for a number of years, it's not uncommon when they're in the middle of a capital program that does include these investments in technology for there to be the acknowledgement of we incurred consultant related costs because we're trying to get X, Y, or Z system up and implemented.
(00:25:08):
So you've got to be able to look beyond that to see potentially what the benefit would be over the longer term. So we try to look at the capital investment and the associated costs with that long-term view of not only what it can do from a strategic perspective, and again in this industry competition among systems is increasing. So we want to look to see what that investment will do, but then secondly how the system or the provider plans to manage that over the near term. Again, what are they going to do to deal with a potential loss in the next couple of years, or if they're using their balance sheet resources to make the investments what the long run plan is to build that back up if they possibly, excuse me, possibly can. One other item I'll mention on capital plans in general, we realize that there are lots of efforts made when we see them to find non debt sources as components of the overall funding mix.
(00:26:07):
So we realize that when we go into engagement that the total plan and what's targeted for debt could change. And so we like to hear situations where if there is going to be potentially federal money, a state grant or what have you, that's going to be part of the mix. It's important to get that perspective as well because it helps to put into context some of what typically are very large numbers. And when we're looking at leverage ratios and such, it's helpful to get some of the potential offsets to those metrics, especially right out of the gate when a borrowing takes place.
Gia Calabrese (00:26:44):
And aside from the electronic health record rollouts, we as insurers haven't really kind of seen the investment and then the outcome for a lot of this new technology that a lot of systems and hospitals are investing in. So I think from our perspective in terms of an analysis to be able to quantify, of course it's going to come out of your operations every year, the initial investment, but I think we're really going to need to start to evaluate on a deeper level a modeling out a consultant's kind of report of how these investments are going to pay off. Because like Doug said, I mean these are huge undertakings from a financial standpoint for healthcare entities. So you want to make sure that the benefit is actually there over the next few years and that you're not just initially investing in this technology only to end up with losses in the future where you're not going to make your money back on that investment.
(00:27:46):
So I think for us, since the only thing we've seen so far is the EHR aspect of it and how that has been extremely beneficial and everyone needs to shift to that and it's very expensive to implement in the first place With all these other technologies, we're going to need to do a little bit more of a granular review of exactly how much this is going to cost and what kind of improvement to the bottom line healthcare entities are going to see over the longer term. Because I think at this point in time, because it hasn't been the norm yet for many systems, it's impossible for us to quantify. So we're going to really need to start evaluating those reports like those models and figure out is this worth it or is this actually not going to end up being as beneficial as systems thought in the first place?
Anna Burnatowski (00:28:48):
Thank you. Staying a little bit on the technology side, I wanted also to touch on cybersecurity. Clearly healthcare has been exposed to some cybersecurity incidents. The more technologies implemented, there's a greater risk. How do you prepare for that and how you make sure that you stay safe and secure? And maybe I'll start with Brandon from the practitioner side and then perhaps ask whether that's part of your evaluations on the insurance and the rating side, how deep you go with your clients to talk about that?
Brandon Seibold (00:29:28):
Yeah, happy to share a little bit here. The way we think about it is there's three pathways. One, there's on a prevention basis, a lot of investment in security across all of the platforms in particular the EMR and that investment is really the key to the success of prevention. The second piece is kind of active training. So we do have very robust kind of processes around training folks for fishing, doing exercises, tabletop exercises for cyber events. We actually had one of our hospitals have a cyber event. Fortunately it was, or unfortunately it was a recent affiliation and hadn't been onboarded onto our kind of system-wide platform. And so I think that that demonstrated the value of having that system-wide approach where you have that ability to make that technology investment that maybe a local smaller regional or smaller standalone hospital couldn't make those investments to have those preventative measures in place. Whereas a system, we have the ability to do that. And I think the third aspect is finally the catastrophic event happens. So what do you have from an insurance perspective? So obviously we have a layer of insurance and then we also think about it from, I guess we talk about a financial risk framework model where if these events happen, do you have the liquidity? Do you have lines of credit liquidity in the investment portfolio to make it through those events without having to have catastrophic impact to the balance sheet?
Douglas Kilcommons (00:31:37):
The only thing I'll add from a rating perspective is that it is increasingly difficult as part of rating engagements to get much granularity on cyber efforts simply because again, this is such an issue in the industry that's affecting providers of all shapes and sizes and management teams generally like to keep the strategy below the vest there and not really give you too much. We'll ask questions around do you have certain key positions filled exactly what Brandon said around if something does happen, what are your fail safes to deal with that from a monetary standpoint, but from also just operationally what you can do to make sure that things continue without issue. If something does happen that's a cyber breach. And so we're really trying to assess the ability of that particular rated credit to deal with it. But just again, the practical reality is fewer and fewer systems are more willing to share more today because again, the environment, it's challenging and it always seems that the bar is raised for some of these bad actors, so to speak, to try to disrupt operations and access confidential data. So it's certainly a hot topic and again, from our standpoint, it's really around how well protected and how well insulated a particular credit is. And again, if they've thought about some of these things,
Gia Calabrese (00:32:59):
Yeah, basically everything that Brandon said is what we like to ask management teams. And I think from our perspective, because as a bond insurer we take risk, we're on the hook for the bonds until the final maturity. This is something that we really have to be mindful of because even though it may not happen in one or two years, over the course of 30 years, realistically a cyber event is going to happen, a seismic event is going to happen, things like that are probably going to occur and you never know how they're going to play out until they actually happen. So it is really about preparedness for these types of events. And really aside from that, what kind of insurance a system has, like Brandon said, but also just sheer amount of reserves as well, how well equipped just financially as a system to deal with an interruption in operations.
(00:34:03):
And kind of the other part of it too is when a cyber event happens, it's not just the event, eventually a lot of these systems end up getting sued. So that's another part of it that you also have to consider because it's not just what is the actual interruption, it's how much is this going to cost from a legal standpoint when there's a class action lawsuit about it and what happens then? So those are kind of the two aspects of it. Yes, the cyber event and its impact on the system, but it's also what happens when litigation comes up and how does that play out and how a system can deal with that. So those are the kind of things that we think about, but again, both of them said it's a little bit hard to really know until it actually happens. So it's really just about how prepared you are. And when we do talk to a management team that feels that or that does not seem particularly prepared or that feels that it's never going to happen to them, that's a red flag. So we are mindful of that as well when a system you feel like they're not prepared and you know that realistically it's going to happen to them at some point, so they need to be prepared.
Anna Burnatowski (00:35:34):
Oh, great comments. I would also add that the community and patient impact of cyber event, especially if you are the sole provider in the community, where do those patients go? So with that, it's actually a good segue to talk about roller more remote locations. Do you all feel like that's a business model here in California? Can those survive and if not, what's going to happen with this communities? How can they be served? From the medical perspective, and I'll open it to anyone who wants to start.
Gia Calabrese (00:36:18):
We're all fighting wants to go first.
Brandon Seibold (00:36:19):
I'll say a few words, so maybe I'll put a little context around it. So Adventist Health, we have a very disperse kind of footprint in terms of downtown urban centers and very rural towns in central California or northern California that probably many of us have never heard of the names of the towns or even wouldn't know where to find 'em on the map for sure. So with that backdrop in mind, I think that we have been in a unique position to wrestle with the question of rural healthcare and how do we provide the absolute best care for patients in very rural environments? And it is a very challenging dynamic. The reimbursement model does not support rural healthcare. And what you need from a model perspective typically is enough volume and throughput in a concentrated density where you can have the appropriate overhead structure, the appropriate training for nursing, the appropriate technology investment, the appropriate physical plant to really deliver care.
(00:37:32):
And when you take that into a rural environment and expect the exact same services to be delivered in that rural environment that would be delivered in kind of urban you economically, it's not really supportable. And so I think that we've wrestled with how do you create a network in those environments where you can have that kind of concentrated expertise in a particular community, but then you have disperse outpatient settings, clinics and other things where you can bring those folks into a centralized AS model and have the right specialists and the right folks in that to support that on a say more of a regional basis. And I think that's partly the strategy. And then at some point I think there's needs to be further conversation around what the reimbursement model is for rural healthcare and are there other changes that we can make to the model to make it successful?
Douglas Kilcommons (00:38:36):
Yeah, I fully agree with that. So long as it's a volume-based reimbursement model, sole providers, standalone providers, rural providers, the long-term game is to be affiliated with a larger system. And again, that's a system ideally that is built out the full care continuum. So you can enter the system maybe in one spot, but then have the support of many other players in that system if the patient needs to progress throughout and be able to capture them all in one place. I would say the majority of credits that do seek ratings today that are smaller players have either affiliated or in the process of completing those affiliations. So there are fewer and fewer standalone single site entities that are pursuing bond ratings. And again, it's simply because as Brandon said, the model just doesn't work as you're this out station standalone without any affiliation. So I think that's where it will continue to move if the reimbursement model changes and it's not volume driven at that point.
(00:39:39):
Some of this may change, but I think that we're unfortunately far away from that point right now. And I think what you see right now is what you'll continue to see. The one last thing I will mention, these affiliations and as systems have grown, they've crossed state lines, they're in multiple geographies. The one thing I would just say is that there are different drivers of healthcare and the consumption of healthcare in different parts of the country. So there are things that you see in the eastern half of the country that you don't see in the west and vice versa. So that's an important component of the overall picture and also explains why certain combinations, mergers and such didn't work. And the healthcare industry is full of examples where partners came together and then suddenly broke up and those breakups are costly. So we do ask questions when we hear that, hey, we're system A, B, C, and we're looking to either combine or consolidate with hospital X. We'll ask lots of questions around some of the strategic reasons, also the cultural fit, that's a big piece of it as well. And if that's not in alignment, that also can cause what otherwise seems like a good idea on paper to not work. So those would be some of the additional things we would be interested in delving into.
Gia Calabrese (00:41:00):
Yeah, I mean you guys pretty much hit everything. The last thing I'll kind of add is that as Doug mentioned, I mean a standalone rural hospital at this point in time just I feel like doesn't really have a place in the market they need to be picked up or affiliated with a much more diverse system to survive. But also what's interesting about it is at the federal level, supporting rural healthcare is pennies. So I think that it's such an important thing that needs to happen and it's not that expensive for the federal government to do. So I do think there needs to be kind of a consistent dialogue and more kind of collaboration between state government, federal government and rural healthcare to improve the reimbursement model there because at the end of the day, to finance these things to help improve the business models of rural hospitals, it wouldn't actually cost as much money as people think it would. So they just need to go out and do that. But I don't know, we'll see.
Anna Burnatowski (00:42:17):
Oh, with that, oh, you've heard all about the headwinds, but now we want to look a little bit at the future and talk about the tailwinds. And I would ask Doug to about his thoughts about the healthcare credit ratings and whether we hit the button and we are going up now and what that means from the financing perspective. How is the healthcare sector perceived in the public market?
Douglas Kilcommons (00:42:48):
Sure. Well, I would say that healthcare was probably along with transit, the two sectors that took the longest to recover from the COVID-19 pandemic. So this was ground zero for all of the things that Covid left industries to deal with. Healthcare was again at the forefront along with transit and both of these sectors have kind of stumbled as they've recovered. I would say healthcare is probably ahead of transit now in terms of its recovery. A lot of that is being driven by some of the, as we've all talked about, the elective procedures that came back once the pandemic, the health emergency subsided and some of the reimbursement that is related to those elective surgeries. And certainly if you're a system or a provider that has lots of reimbursement from commercial insurers, you're slowly but surely creeping back to the 2019 level of performance. Although as we've all been talking about the expense pressure continues to keep a lid on things and so you're not quite back to where you were pre pandemic.
(00:43:52):
With all that said, you've had some environments where the stock market's done well, so balance sheets have come back, which is good. You've also seen many systems reactivate capital plans, so that shows you that systems themselves are feeling more confident in the environment. Again, all positive signs. Brandon touched on earlier, some of the trends in patient care and where volume growth is the outpatient piece that's going to continue. So you're seeing a lot more in the way of projects around that component of the delivery model versus hospital towers and inpatient beds, although clearly there are systems where you see projects designed to do that because what's there today is antiquated. It may be double rooms, it may be a product that the market is not really supporting anymore, and so you're seeing investments being made. So I would say at the very moment things seem to be stabilizing and our expectation is they'll remain as such for the time being, I think as we've all touched on the election is going to be something that we need to watch.
(00:44:57):
Nothing appears that will be changing overnight regardless of the outcome, but it's something that you need to see because there will always be policy decisions that are made that could certainly impact not-for-profit healthcare. So that would be something to watch going forward. And the last thing I'll mention is in terms of perception from the market, I would say that healthcare continues to enjoy in muni land the distinction of having the best disclosure. So at all of the conferences that we will go to in terms of this idea of providing more information, more timely data, accessing more about the interim financials or utilization information, healthcare is often cited as the leader in this because again, there is perception around being more risky and so therefore investors have long demanded a level of information to assess and manage that risk. So I would say that's a positive thing and that continues to be perceived very well.
(00:45:57):
I would also say that what you have seen in terms of deal structures and transactions that come to market, even though that investors are saying that things in healthcare tend to be more risky and they're more concerned, you've still seen this evolution in transaction structures in the public markets away from covenants and away from structures that you would think would be in place. And so even, and obviously the top systems, AA systems and high A can command generally what they want in terms of deal structure. You'd be surprised as you go below some of those upper rating levels, there's much more loosening of structure, which is interesting because again, you would think that given the perception of risk and the need for so much information that investors would be still demanding the structures they might've gotten 10, 15 years ago, that's not the case and you still see this kind of loosening of things. So I would say on balance right now, things are stabilizing. There's always the unknowns, and this is a very regulated industry healthcare, so there's always the unknowns, but for the time being and the immediate future, I think we're in a stable situation though certainly there can always be the unknown that comes. And that's one of the reasons why we ask lots of questions around financial preparedness and ability to weather the storm, be it through reserves or other measures that a system or provider may have in place.
Gia Calabrese (00:47:20):
What I've also seen, and this is kind of from my own experience having previously worked with general government Munis to then shifting to an exclusive focus in not-for-profit healthcare is that the high brand awareness of healthcare entities very much improves their perception in the market. And somebody may not know a city in the middle of California, but they do know Venice Health despite the perceived risk of the healthcare sector, you still see because of the high brand awareness of these entities, a 10 times oversubscribed billion dollar deal, completely uninsured, you're not going to see that in most of the other muni sectors. And I think that's kind of something that's very unique to healthcare also to the higher ed space as well. There's just a level of brand awareness there of reputation that I think gives investors a lot more confidence despite the higher risk and some of the weaker legal structures that you see, especially with some of the higher rated entities.
Anna Burnatowski (00:48:35):
Brandon, from the practitioner's perspective, I know you're active in the markets, how do you perceive them and what do you anticipating going forward? And perhaps you can touch also about your thoughts about capital and reaching into some alternative capital structures that diversify your capital for the organization.
Brandon Seibold (00:49:00):
Yeah, so as we think about capital as an organization, I'll kind of break it down into two buckets, how we think about capital and manage it that way, and then kind of alternative financing vehicles, how we think about, we believe that capital is essential and access to capital is essential for Adventist health to continue to provide the mission in the communities that we serve. And so as you think about that, the typical source of capital for healthcare systems has been the debt market. And I think that what we also wrestle with in terms of how we deploy capital and what the levers are in terms of our capital spend, we think a lot about what the free cash flow is of the business and how much of the free cash flow we can invest and reinvest in capital while kind of letting the investment portfolio and balance sheet grow as kind of corpus for the organization to really long-term support the access to capital through the debt market.
(00:50:08):
So that's how we think about capital structure and I think that that importance of the need for access to capital really grounds us in how do we maintain our operating performance at a particular level in order to access capital markets. One thing that we've done and looked a lot at recently is there is just to maintain these assets that exist in California and the cost of construction in California, just to put it in perspective, to build a new hospital in California could be anywhere between seven to five to 10 million a bed to build a hospital in California, which is extremely expensive. And if you think about that from an economic perspective, the payback on that, there is really no payback on that that exists within 50 years or some period of time. So if you think about the need for capital and the sources of capital that exists, it can't only be kind of debt financing, you have to, like I already mentioned cat free cashflow, but there's some unique structures that are out there that we've implemented to really optimize the strategic value of certain parts of our portfolio.
(00:51:31):
As an example, our sensor utility plants, all these hospitals have major sensor utility plants and energy infrastructure. So we executed on a transaction that's kind of referred to as energy as a service where we have the ability to extract equity from those central utility plants, invest in improving the efficiency of them, generate savings from that repays, that investment over the term of the agreement. And we have a third party in there that really supports with expertise the operation of those century utility plants. So net for us, this investment will improve our efficiency of the century utility plants by more than 25% and reduce our carbon footprint by 20% over the time horizon. So it's really kind of a win-win in terms of transferring risk to somebody in that space, investing in an asset and extracting value from an asset and having a strategic expert that's a partner in that space.
Anna Burnatowski (00:52:34):
This is very interesting and I know we're almost at that hour time, we're pretty much at that time. I don't know if we have any questions from the audience that I could open. Any follow up questions, any thoughts, comments about what we've covered today? I don't know if there is a mic somewhere.
Brandon Seibold (00:53:02):
We knew this was going to happen.
Audience Member 1 (00:53:03):
Just a quick question on the California seismic rules, the state government just refused to adjust them. Feels like there's a huge game of chicken being aimed at 2030 interested in anybody's thoughts.
Brandon Seibold (00:53:20):
I'll start, and these guys can add though accurate. The governor did not sign the extension and now we're basically, for all intents and purposes, we're in 2025, so five years to the 2030 deadline. To put this in context, two thirds of the hospitals in California are not seismically compliant. So two thirds and the majority of those are actually in rural markets. So if you think about even if everybody wanted to be seismically compliant by 2030, there would not be enough labor workforce, there would not be enough supply. It is not possible for everybody to be sizably compliant by 2030 at this point. So I think that yes there, to your point, maybe there is this kind of chicken, but the reality is it's not possible today. So I think that what has to kind of occur over the coming election cycles will be a different structure in terms of how we think about seismic compliance and really starting to think through where it makes sense to invest in seismic compliance.
(00:54:43):
As you all know, there's different tiers, so there's inpatient, outpatient, and the capital required in certain spaces is exponentially more than others. And so that is something that I think health systems are legitimately wrestling with is where do we see over the next five, 10 years the shift in care so that then maybe we don't need to update this particular part of the hospital and we can move services to another part of the hospital or we're not going to have the volume that we expect in the inpatient setting and we can do that in a different setting. So I think that those are the next order of questions that health systems are wrestling with. And there's probably another just frank reality that if you think about them being primarily in rural environments, there is a distinct possibility that those services will no longer be provided in that community if there's a decision to kind of move forward with the full seismic compliance as laid out. So there's a lot of conversations with CHA around certain rural exemptions for some of the seismic compliance, critical access exemptions, some of those things. So there's a lot of those ideas that are out there. I think people recognize that could be the outcome. You kind of take away a lot of rural healthcare service if you move forward as aggressively on this as we as it is currently slated.
Douglas Kilcommons (00:56:18):
I think Brandon covered it well. There's no way that many of these providers that need to meet these deadlines can do so in the current form. And I agree, Martin, I think it is a bit of a chicken and egg type of thing. And there are other things like that where you think about carbon neutrality and power systems having being told that by 2030 they need to beat zero carbon emissions and they're still operating with the majority of their fuel mix being fossil fuels. It's just not possible without some other way to get those projects funded. There's just not enough dollars out there in the current form for these things to happen. And so you expect that hopefully cooler heads will prevail and you'll get to some middle ground where either the extensions will happen in terms of the deadlines or it's Brandon's comment. There are different ways that this can be thought about and managed this idea around targeting certain requirements first and basically tiering things makes more sense than just putting this blanket, everything's got to be compliant by X date. It just seems like there's got to be some middle ground that can be met.
Anna Burnatowski (00:57:29):
Anything to add Gia?
Gia Calabrese (00:57:31):
No, I agree with both of them. I was supposed to be the happy one, but I feel like everything I've said has been fairly morbid. But what I was going to say, just one last comment is that, and this is why I kind of threw seismic into my cybersecurity commentary again when I completely agree, I think it would be impossible for this to happen by 2030 in the blanket way that it is expected right now. But I also think that when you talk to management and they say, yeah, it's just not possible, we're not going to do it. We haven't thought about it, and they publicly go out and say that in newspapers and things like that. Again, red flag, because while yes, we agree that is impossible task, to not even be remotely prepared for this in some capacity is slightly outrageous in my opinion.
(00:58:26):
And I think it's really concerning because at the end of the day, while we do think there will be some sort of middle ground and some changes, there will have to be some level of compliance realistically for a lot of these systems and they may have to choose the option of closing at that point. And I think they're just being a little bit unrealistic about the types of exemptions and the level that at which that will occur. I do think it will be tiered similar to what they have said, but to just completely be unprepared for something that has been looming for a long time and is now only five years away, I think is very concerning, especially from an insurer perspective when we see that knowing that this has been out there for so long and when systems choose to spend money on other things and then go out there and say, yeah, we're just completely unprepared for this is just not what we think is the best way to manage the situation.
Anna Burnatowski (00:59:28):
Well with that, I wanted to just ask you one last really quick question as why you are still optimistic and planning to stay in healthcare. So I will start with Gia because she was supposed to be our rep of good news.
Gia Calabrese (00:59:45):
No, again, I think this kind of goes back to my brand awareness comment as well. I think that obviously healthcare is an essential service. Hospitals and health systems are absolutely necessary. The largest ones, even despite dips in their margins, changes in their credit rating, they're always going to be there. And I think we know that and it's really about understanding the fundamentals to these systems and how they can weather these storms. And there are, I mean, most of them out there can weather these storms. We know that. So while I have been a little bit negative, we firmly believe that, I mean there's always been issues in the healthcare sector since the beginning of time, and they always make it out. Not everybody does. And that's why the landscape changes and shifts over time. But at the end of the day, it's a very resilient sector and I think we all believe that.
Anna Burnatowski (01:00:55):
Doug why are you optimistic?
Douglas Kilcommons (01:00:57):
All of the reasons Gia stated essential, resilient. I think the service that these organizations provide look no further beyond what we just went through with the pandemic. And you can see how valuable not-for-profit healthcare is to everyone's life. I mean, this is the most essential service you can touch on in Muni land. So I would say that for those reasons, plus when you think about what systems have done in terms of learning over the course of time, as they've learned from one of the many crisis that the industry has faced, they've built and fortified themselves. And that's why you see today that some of these very large systems, while they sometimes in terms of a credit rating, may ebb and flow, they've gotten stronger, they've gotten smarter. And I think as they look out into the landscape and see what's coming down the pike, they're continuing to innovate to think about ways that they can further protect themselves. And so I think it's, again, it's the essentiality piece will continue to drive very smart decisions. And so for those reasons, I'm positive on healthcare.
Anna Burnatowski (01:01:57):
Brandon, will you close us off with?
Brandon Seibold (01:01:59):
Yeah, sure. So I like to think of this as, and I'm a treasury finance guy, so I'm at the corporate level thinking about all these strategies and how we deploy capital. But if I really get excited about it, I just have to think about the community. The hospitals that we serve, or excuse me, the communities that we serve are pretty much the hospital is the main employer and they are essential. And what we do on a day-to-day basis is truly take care of patients and people in our communities. And that I think is something that will forever be valued and be forever a benefit to those communities. And the model may change, it might look a little different over the next five, 10 years, but I think healthcare is truly essential when you get down to that patient level and you think about what it means to each one of us to have those type of services in our communities.
Anna Burnatowski (01:03:02):
Well, thank you all. Thank you to our panelists and to your audience, and thank you for sticking around with us so long. I hope we gave you some things to think about and be cheerful about the future of.