LeadingAge and other proponents of tax exempt senior housing have been silent about capital adequacy, although it lurks as a weighty unseen presence.

By Jack Cummings

LeadingAge and other proponents of tax exempt senior housing have been silent about capital adequacy, although it lurks as a weighty unseen presence. Entrance fee financed tax exempt Continuing Care Retirement Communities (CCRCs, also called Life Plan Communities by some and Lifecare by others) are particularly conflicted about capital.  

On the one hand, many such CCRCs use entrance fees as at-risk equity capital to secure debt. On the other hand, CCRCs issue contracts promising residents lifetime residency in return for their entrance fees. In accounting lingo, this is double counting. Since residents come to a CCRC in search of peace of mind and ready availability of needed services, it is contrary to the fundamental CCRC premise to place entrance fees at risk while marketing lifetime security.

While taxpaying CCRCs have access to the capital markets to meet standards for capital equity, in the absence of major philanthropy, tax exempt CCRCs have turned to entrance fees to make a go of it. Residents have largely been kept in the dark about the dilution of their entrance fee investments, as providers and accountants rationalize “negative net asset” positions as of no importance as long as the debt providers are satisfied. Such tolerance for balance sheet impairment – negative net assets = impairment – calls into question the value of GAAP accounting altogether. If GAAP soundness is meaningless and immaterial because “cash is king,” then there is no need for GAAP accounting. This is an absurdity that reveals wishful thinking in the extreme.

Capital Adequacy

In recent years, other trust industries have been subjected to increasingly sophisticated capital adequacy standards. Banking has been impacted by the Basel Capital Accords after the 2008 economic crisis showed some banks to be undercapitalized. The insurance industry is implementing Risk Based Capital standards to protect policyholders. But, there is no such standard for the entrance fee for the CCRC industry despite the substantial resident investment required. There is not even a requirement that a CCRC enterprise have an unimpaired balance sheet. Impaired balance sheets are treated as “normal.” Impairment is not normal. It’s imprudent and unconscionable. Moreover, it signals a need for rehabilitation to protect residents’ financial investment.

New Communities

Initiatives to open new CCRCs are always well-intentioned. A donor may provide a property with the proviso that it be used to serve the elderly. A hospital may consider founding a CCRC to be part of its community healthcare mission. A group of church leaders may think that care for the elderly is a worthy faith mission. There are many founding motivations, but the result is the same. CCRCs are almost always financially independent of any founding entities or sponsors.

Expansion plans, too, may be well-intentioned, or they may reflect a bias toward growth. Tax exempt debt originators – investment bankers – encourage expansion at least in part because they benefit from the related debt offering. Management may feel that growth is desirable as a means to justify career advancement. Boards may believe advisors’ representation of growth opportunities without the same critical scrutiny that investors – or their board representatives – in a taxpaying CCRC would bring.

Despite these optimistically positive intentions, CCRCs are businesses serving the elderly with a continuum of services and relying on an excess of revenues over expenses (profit), and on debt financing for continued viability. The use of debt as a financing mechanism requires fees from residents to cover the debt service requirements. Of course, philanthropy can help meet these capital costs – as in the example of the donor who provides the property – but philanthropy on a scale needed to meet capital needs is the exception.  More common is the example in which the founders finance the project with debt and entrance fees. The founders themselves have nothing at stake in the project though they typically retain control and reap benefits.

Financial Viability

As businesses, CCRCs need to demonstrate financial viability. Yet, tax exempt CCRCs are only accountable to their debt providers. Residents, who provide the at-risk capital, have no standing. Most tax exempt CCRCs either have no members or have a single corporate member. Despite their sizable financial investment in entrance fees, residents are not members and have no say in the use and distribution of funds. Since entrance fees are partial consideration for a continuing care contract, the reasonable expectation of a knowledgeable resident would be that there would be contract reserves sufficient to assure fulfillment of the contractual promises. That is not now, however, a requirement.

A Scandal Waiting to Happen

The absence of capital adequacy standards for an industry that relies on the trust and good faith of elderly people is a scandal waiting to be revealed. It’s not too late for the industry to adopt standards to place its members – even not-for-profits – on a sound footing. The clock is ticking and the time for constructive action is now.  

Until then, residents and prospective residents should not be misled by the terms Continuing Care Retirement Community, Lifecare Community, or Life Plan Community. Those terms, in and of themselves, do not connote safe havens as long as impaired balance sheets continue to be tolerated. For now, the elderly, and their families and advisors, must fend for themselves in deciding how best to provide for their aging.