“Where are you going?” . . . a very good question to pose to the senior services industry, in general, and to the industry giant Brookdale, in particular.
By Jack Cumming*
Jennifer McCrea, who is scheduled as a keynote speaker for LeadingAge’s forthcoming Annual Conference in New Orleans, asks rhetorically in a recent video, “Where are you going?” That’s both timely and a very good question to pose to the senior services industry, in general, and to the industry giant Brookdale, in particular. The answer in McCrea’s video is, “I’m going home.” Where is home, we may ask, for this important industry and those it serves?
Recently, I was struck by a cautionary note in a Brookdale Senior Living regulatory filing. You know the kind of warnings that are customary: the economy may tank; the government may cut reimbursement rates; interest rates may rise; competitors may overreach; labor markets are tightening, etc. But one flag item stood out. It read: “We have a history of losses and we may not be able to achieve profitability . . .” The text continued, “We have incurred losses in every year since our formation in June 2005 . . .”
Wow, that’s quite an admission. If Brookdale can’t make money in this business, who can?
No other industry has a financial structure like that of the senior housing industry. Roughly, 80% of the businesses providing senior housing are tax exempt. That gives “not-for-profit” enterprises a direct financial advantage over those who pay taxes, in addition to the indirect advantage of lower interest, tax-exempt bond financings. Moreover, many of the 80% have a negative net asset position. Making up the negative difference from resident fees places residents in jeopardy in an industry that is grounded in trust.
These structural factors challenge an industry that relies on integrity at its core. It makes it difficult for an investor-funded, tax-paying enterprise like Brookdale to compete, and not surprisingly, Brookdale has emphasized growing competitive pressure during its most recent quarterly earnings calls with market analysts.
Accounting measures business performance. The ideal is to present the underlying economics of a business entity as fairly and consistently as possible. The accounting profession, though, has evolved from individual professional interpretations of principled fairness toward a complex of codifications governing how business minutiae are to be recorded. Auditors are constrained toward compliance without a requirement to opine on whether financial statements in their entirety are the best overall representation of corporate results.
This movement toward technical compliance has necessitated an academic concentration in accounting, which precludes, for the most part, the principled education offered by more traditional, broadening fields of university study in the humanities. These developments, (1) the move of accounting toward compliance before principle, and (2) the complex compliance focus of accounting education, diminish the value of financial representations made to elderly persons considering entrance fee senior housing.
Balance Sheet Matters
Not-for-profit providers have only abstract ownership. Investing owners, as with publicly traded corporations like Brookdale, require that an enterprise operate profitably and that the net worth of the enterprise be positive. Accountancy has not imposed these constraints on the tax-exempt providers who compete with Brookdale and others.
Accountants have argued that a negative net asset position, i.e., a negative net worth, is of no concern as long as debt covenants are met and cash flow remains positive. Moreover, in the determination of liabilities, the deferred revenue from the advance payment of entrance fees is reserved by a questionable expectancy process (which may not be reflective of the expected mortality of the covered population) and which deprives contracting customers of any return on the entrance fee investment in a continuing care contract.
The Plight of the For-Profits
Consider the challenge that this presents to an accountable organization like Brookdale, which has to report regularly to its investors. Brookdale pays taxes. Tax exempts avoid most taxes. Brookdale has to show a positive net worth. Many tax exempts have a negative net asset position. Brookdale is accountable to owner-investors. Tax exempts only have to meet their debt covenants. It’s no wonder that Brookdale, and its taxpaying peers, are struggling. The playing-field, to use a sports analogy, simply isn’t level.
Is There Hope?
We live in a market-driven economy and people have free choice. Our law requires people of legal competence to assess their own risks in the choices that they make. The question is whether the market alone can factor in underpricing driven by tax exemption, which most people are happy to benefit from, and negative net asset balance sheets. So far, the evidence is that most people choose the tax exempt option, overlooking balance sheet dilution, and often making their choice solely on the basis of location and amenities rather than on financial integrity.
Can the market be adequately informed to offset the tax and net worth challenges that the for-profits face? Is the perception that “not-for-profits” perform better so embedded in the public consciousness that the for-profits will be at a permanent disadvantage? As Brookdale avers “we may not be able to achieve profitability.” Now that’s a sobering concern.
Of course, statutory/regulatory oversight could change these structural factors. Entrance fees could be subjected to the same statutory accounting as applies to life annuities, since entrance fees are, at fundament, a life annuity. That would require action by the National Association of Insurance Commissioners, and so far, the NAIC member commissioners have avoided getting involved. Also, the National Office of the Internal Revenue Service might update the forty-year-old Revenue Ruling 72-124 to better secure the interests of residents and prospective residents. Still, both possibilities for government regulation seem unlikely given the current political environment.
That leaves us with our title question, which we now address to Brookdale and the for-profit industry, “Where are you going?” Do you have a workable plan to bring forth a profitable, financially secure senior housing industry on which Americans can depend?
[* The author is a Brookdale shareholder.]