APRIL 23, 2012

U.S. PUBLIC FINANCE

SPECIAL COMMENT

Supreme Decision: Prohibition of Individual Mandate Would Remove Healthcare Reforms Best Feature for Hospitals
Loss of Requirement to Buy Insurance Would Pressure Not-for-Profit Hospitals

Table of Contents: SUMMARY ELIMINATION OF THE INDIVIDUAL MANDATE WOULD ADD TO CREDIT PRESSURE FOR NOT-FOR-PROFIT HOSPITALS CREDIT-POSITIVE FEATURES OF HEALTHCARE REFORM MOST HOSPITAL MANAGEMENT TEAMS ALREADY PREPARING FOR LOWER REIMBURSEMENT LONGER-TERM CHALLENGES LIKELY TO FOLLOW COURT DECISION MOODYS RELATED RESEARCH Analyst Contacts:
CHICAGO +1.312.706.9950

Summary
1

2 3 4 4 5

The prospects for the federal governments landmark healthcare reform law remain uncertain. The constitutionality of the Patient Protection and Affordable Care Act (PPACA, also referred to as healthcare reform) will be decided by the US Supreme Court, with a decision expected in June. In the broadest terms, three outcomes are possible: the Supreme Court rules the entire healthcare law unconstitutional; the court rules the entire law constitutional; or the court rules that the individual mandate to purchase health insurance is unconstitutional while upholding the remaining provisions. For not-for-profit hospitals and health systems, which account for the vast majority of community hospitals in the US, 1 this uncertainty heightens credit risk in an already pressured operating environment, and continues to drive our negative outlook on the sector. 2 This special comment focuses on the potential effects of the last of the three scenarios on hospital performance, specifically the extent to which elimination of the individual mandate would affect not-for-profit hospital credit, and that doing so would be a clear credit negative for the not-for-profit healthcare sector (similarly, this scenario would be a credit negative for the for-profit hospital sector 3). A Supreme Court ruling that strikes down the individual mandate while upholding the rest of healthcare reform would protect some credit positives for hospital providers even though many wonder if the law is viable without the mandate. If the court overturns the individual mandate, the private health insurance market likely would weaken under the unbalanced weight of the PPACAs strict provisions to cover all those who seek insurance without the counterbalancing benefit of a new, largely healthy, population segment that would be provided under the mandate. This would likely lead to a rise in costs for many insurers and hospitals but without a corresponding rise in revenues. Further reforms and changes in funding and regulation would then have to be considered by policymakers and industry professionals.

Mark Pascaris +1.312.706.9963 Vice President-Senior Analyst mark.pascaris@moodys.com NEW YORK +1.212.553.1653

Lisa Goldstein +1.212.553.4431 Associate Managing Director lisa.goldstein@moodys.com John C. Nelson +1.212.553.4096 Managing Director-Public Finance john.nelson@moodys.com

2 3

According to the American Hospital Association, there are 4,985 community hospitals in the US (excluding Veterans Health Administration hospitals, psychiatric hospitals, and other specialty hospitals). Of the 4,985 community hospitals, approximately 80% are private not-for-profit or state/local government owned, while approximately 20% are for-profit. http://www.aha.org/research/rc/stat-studies/fast-facts.shtml U.S. Not-For-Profit Healthcare Outlook Remains Negative for 2012, January 2012 (139377) Repeal of Healthcare Law Would Raise Costs and Squeeze Revenues, Profit Margins, April 2012 (141094)

U.S. PUBLIC FINANCE

Elimination of the Individual Mandate Would Add to Credit Pressure for Not-forProfit Hospitals
In its entirety, the healthcare reform law is a long-term credit negative for not-for-profit hospitals given the hardwired Medicare rate reductions embedded in the law along with new forms of reimbursement models (such as bundled payments) that also lower reimbursement to hospitals. 4 Some aspects of healthcare reform have positive credit implications for hospitals, however. Specifically, the individual mandate is the most credit positive feature of healthcare reform, and its elimination would be a clear credit negative for the not-for-profit healthcare sector. The requirement for individuals to obtain insurance, or pay a fine, would result in a significant reduction in uncompensated care delivered by hospitals. It also would improve efficiency in the healthcare system by reducing utilization of expensive emergency room services. Removing the mandate would make the negative features of reform loom much larger compared to the remaining positive elements: An estimated 16.7% of the US does not have health insurance. 5 Without the individual mandate, this large uninsured share of the patient population would likely continue to grow as employers will be unable or unwilling to bear the growing cost of health benefits. The continued rise in uncompensated care will reduce hospital margins and suppress debt service coverage, creating added credit stress in the sector. Medicare and Medicaid reimbursements are likely to be reduced due to features of the reform law, as well as the systemic pressure to reduce spending on most federal budget programs. Healthcare reform includes more than $150 billion of reduced Medicare reimbursement payments to hospitals and $14 billion of Medicaid disproportionate share funding cuts, spread over 10 years. In addition to provisions in healthcare reform, given the extent of the federal budget deficit and failure of the 2011 Congressional budget super committee, additional Medicare spending reductions are certain (this is true irrespective of the Supreme Courts decision regarding healthcare reform). The most vulnerable not-for-profit hospitals and health systems will be those with the highest reliance on federal government payers (see Figure 1). Hospitals will receive lower reimbursement from commercial insurers as these payers will be under intense pressure to offset the increase in premiums resulting from the absence of the individual mandate, which would have allowed insurers to spread the costs of covering the sick among a broader population, including the healthy.

4 5

Long-term Credit Challenges of Healthcare Reform Outweigh Benefits for Not-for-Profit Hospitals, April 2010 (124233) U.S. Department of Commerce. U.S. Census Bureau. Income, Poverty, and Health Insurance Coverage in the United States: 2009, September 2010. Some estimates indicate an even higher rate of uninsured.

APRIL 23, 2012

SPECIAL COMMENT: SUPREME DECISION: PROHIBITION OF INDIVIDUAL MANDATE WOULD REMOVE HEALTHCARE REFORMS BEST FEATURE FOR HOSPITALS

U.S. PUBLIC FINANCE

FIGURE 1

Top 20 Rated Hospitals and Health Systems with Highest Combined Medicare and Medicaid as % of Gross Revenue
Name Rating Medicare % of Gross Revenue Medicaid % of Gross Revenue Combined Medicare + Medicaid %

Mission Hospital, TX Temple University Health System, PA Leesburg Regional Medical Center, FL Citrus Memorial Hospital, FL Yavapai Regional Medical Center, AZ Munroe Regional Health System, FL Fremont-Rideout Health Group, CA Baxter Regional Medical Center, AR Yuma Regional Medical Center, AZ Eisenhower Medical Center, CA Palisades Medical Center, NJ Kaweah Delta Health Care District, CA Albert Einstein Healthcare Network, PA Touro Infirmary, LA Burdette Tomlin Memorial Hospital, NJ (now known as Cape Regional Medical Center) Washington Township Health Care District, CA Monongahela Valley Hospital, PA FirstHealth of the Carolinas, NC NCH Healthcare System, FL Pikeville Medical Center, KY Source: Hospital reports, Moodys

Baa2 Baa3 Baa1 Ba3 Baa2 A3 A2 Baa2 A2 Baa2 Ba2 A3 Baa1 Ba1 A3 A3 Baa1 Aa3 A2 A3

47.2% 36.0% 69.0% 68.8% 58.7% 61.4% 47.9% 65.0% 48.2% 65.7% 53.9% 47.0% 35.9% 51.1% 56.0% 54.1% 54.6% 57.2% 58.5% 50.0%

32.8% 41.6% 7.8% 6.3% 15.5% 12.1% 25.4% 8.0% 23.2% 5.5% 16.3% 23.0% 33.7% 18.0% 13.0% 14.8% 13.9% 11.2% 9.8% 18.0%

80.0% 77.5% 76.8% 75.1% 74.3% 73.5% 73.3% 73.0% 71.4% 71.2% 70.1% 70.0% 69.5% 69.1% 69.0% 69.0% 68.5% 68.4% 68.3% 68.0%

Credit-Positive Features of Healthcare Reform

If the Supreme Court rules the individual mandate unconstitutional but upholds the rest of PPACA, some of the remaining portions of healthcare reform are credit positives for hospital providers, at least over the medium term. Specifically, PPACA: Extends dependent coverage to children up to 26 years of age Requires most employers with 50 or more employees to offer health insurance, or pay a fee, although many firms are likely to pay the fee rather than provide insurance Creates state health insurance exchanges, which will provide markets for low and middle income individuals to purchase government subsidized health insurance Prevents health insurers from denying coverage to those with pre-existing conditions Prohibits rescissions (the practice of terminating existing coverage)

APRIL 23, 2012

SPECIAL COMMENT: SUPREME DECISION: PROHIBITION OF INDIVIDUAL MANDATE WOULD REMOVE HEALTHCARE REFORMS BEST FEATURE FOR HOSPITALS

U.S. PUBLIC FINANCE

Expands Medicaid eligibility to 133% of poverty level, which would benefit hospitals in states that currently offer the least generous eligibility levels as a percent of the federal poverty level, such as Alabama, Arkansas, Indiana, Louisiana, and Texas. 6

Most Hospital Management Teams Already Preparing for Lower Reimbursement

To prepare for the coming reduction in payments, most not-for-profit hospitals have begun cutting their cost structures aggressively. Beyond the low-hanging fruit expense savings (such as supply contract renegotiations, workforce reductions, and employee benefit restructurings) that were removed in the years immediately following the 2008-09 financial crisis, hospitals are strategically evaluating all aspects of their operating cost structures and redesigning care delivery to make fundamental and permanent changes to expenses to offset the reduction in payments that are inevitable. Many hospitals also have invested heavily in information technology that should translate into better operating efficiency and financial performance, and many are still receiving meaningful use funding under the ARRA stimulus law to offset some of the cost of technology. Finally, many hospitals are pursuing employment of physicians or acquisitions of physician groups, although the credit benefits of these strategies are less certain and may take longer to realize.

Longer-term Challenges Likely to Follow Court Decision

The credit profile of the not-for-profit healthcare sector will change further in the coming years as the sector adjusts to the Supreme Courts individual mandate decision, and the federal government continues to address ongoing budget pressures. If the Supreme Court overturns the individual mandate, the private health insurance market would likely weaken under the unbalanced weight of strict provisions to cover all those who seek insurance without the counterbalancing benefit of a new, largely healthy, population segment that would be provided under the mandate. This scenario could become untenable for many insurers and hospitals, as costs would rise but revenues would not. Policymakers, regulators, and the healthcare industry may face the need for further reforms and changes in funding and regulation that are more significant than the changes already required by PPACA. If the private individual insurance market deteriorates significantly, the government option, under which the federal government offers health insurance policies for the non-Medicare population, could be considered. Additionally, as the population ages, healthcare costs soar and budget pressures rise, the federal government may consider proposals to expand the use of vouchers beyond low income individuals now covered in PPACA, especially to those eligible for Medicare. Under voucher plans, individuals would receive some form of public funding to purchase health insurance, rather than the government making direct reimbursement payments to healthcare providers. Under any voucher scenario, the effects on hospitals would be more complex and hard to foresee. Hospitals could still face high levels of uncompensated care if the voucher payments are not funded adequately or individuals choose not to use them as fully as intended.

Kaiser Family Foundation. www.statehealthfacts.org

APRIL 23, 2012

SPECIAL COMMENT: SUPREME DECISION: PROHIBITION OF INDIVIDUAL MANDATE WOULD REMOVE HEALTHCARE REFORMS BEST FEATURE FOR HOSPITALS

U.S. PUBLIC FINANCE

Moodys Related Research

Rating Methodology:

Rating Methodology: Not-for-Profit Healthcare Rating Methodology, March 2012 (139274) Repeal of Healthcare Law Would Raise Costs and Squeeze Revenues, Profit Margins, April 2012 (141094) Long-term Credit Challenges of Healthcare Reform Outweigh Benefits for Not-for-Profit Hospitals, April 2010 (124233) Outlook: U.S. Not-For-Profit Healthcare Outlook Remains Negative for 2012, January 2012 (139377) Moody's confirms US Aaa Rating, assigns negative outlook, August 2011

Special Comments:

Outlook:

Announcement:

To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of this report and that more recent reports may be available. All research may not be available to all clients.

APRIL 23, 2012

SPECIAL COMMENT: SUPREME DECISION: PROHIBITION OF INDIVIDUAL MANDATE WOULD REMOVE HEALTHCARE REFORMS BEST FEATURE FOR HOSPITALS

U.S. PUBLIC FINANCE

Report Number: 141591

Author Mark Pascaris

Production Specialist Cassina Brooks

2012 Moodys Investors Service, Inc. and/or its licensors and affiliates (collectively, MOODYS). All rights reserved. CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. (MIS) AND ITS AFFILIATES ARE MOODYS CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND CREDIT RATINGS AND RESEARCH PUBLICATIONS PUBLISHED BY MOODYS (MOODYS PUBLICATIONS) MAY INCLUDE MOODYS CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MOODYS DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS AND MOODYS OPINIONS INCLUDED IN MOODYS PUBLICATIONS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. CREDIT RATINGS AND MOODYS PUBLICATIONS DO NOT CONSTITUTE OR PROVIDE INVESTMENT OR FINANCIAL ADVICE, AND CREDIT RATINGS AND MOODYS PUBLICATIONS ARE NOT AND DO NOT PROVIDE RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. NEITHER CREDIT RATINGS NOR MOODYS PUBLICATIONS COMMENT ON THE SUITABILITY OF AN INVESTMENT FOR ANY PARTICULAR INVESTOR. MOODYS ISSUES ITS CREDIT RATINGS AND PUBLISHES MOODYS PUBLICATIONS WITH THE EXPECTATION AND UNDERSTANDING THAT EACH INVESTOR WILL MAKE ITS OWN STUDY AND EVALUATION OF EACH SECURITY THAT IS UNDER CONSIDERATION FOR PURCHASE, HOLDING, OR SALE. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY LAW, INCLUDING BUT NOT LIMITED TO, COPYRIGHT LAW, AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODYS PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODYS from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided AS IS without warranty of any kind. MOODY'S adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources MOODY'S considers to be reliable including, when appropriate, independent third-party sources. However, MOODYS is not an auditor and cannot in every instance independently verify or validate information received in the rating process. Under no circumstances shall MOODYS have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of MOODYS or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if MOODYS is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The ratings, financial reporting analysis, projections, and other observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. Each user of the information contained herein must make its own study and evaluation of each security it may consider purchasing, holding or selling. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODYS IN ANY FORM OR MANNER WHATSOEVER. MIS, a wholly-owned credit rating agency subsidiary of Moodys Corporation (MCO), hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MIS have, prior to assignment of any rating, agreed to pay to MIS for appraisal and rating services rendered by it fees ranging from $1,500 to approximately $2,500,000. MCO and MIS also maintain policies and procedures to address the independence of MISs ratings and rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually at www.moodys.com under the heading Shareholder Relations Corporate Governance Director and Shareholder Affiliation Policy. Any publication into Australia of this document is by MOODYS affiliate, Moodys Investors Service Pty Limited ABN 61 003 399 657, which holds Australian Financial Services License no. 336969. This document is intended to be provided only to wholesale clients within the meaning of section 761G of the Corporations Act 2001. By continuing to access this document from within Australia, you represent to MOODYS that you are, or are accessing the document as a representative of, a wholesale client and that neither you nor the entity you represent will directly or indirectly disseminate this document or its contents to retail clients within the meaning of section 761G of the Corporations Act 2001. Notwithstanding the foregoing, credit ratings assigned on and after October 1, 2010 by Moodys Japan K.K. (MJKK) are MJKKs current opinions of the relative future credit risk of entities, credit commitments, or debt or debt-like securities. In such a case, MIS in the foregoing statements shall be deemed to be replaced with MJKK. MJKK is a wholly-owned credit rating agency subsidiary of Moody's Group Japan G.K., which is wholly owned by Moodys Overseas Holdings Inc., a wholly-owned subsidiary of MCO. This credit rating is an opinion as to the creditworthiness of a debt obligation of the issuer, not on the equity securities of the issuer or any form of security that is available to retail investors. It would be dangerous for retail investors to make any investment decision based on this credit rating. If in doubt you should contact your financial or other professional adviser.

APRIL 23, 2012

SPECIAL COMMENT: SUPREME DECISION: PROHIBITION OF INDIVIDUAL MANDATE WOULD REMOVE HEALTHCARE REFORMS BEST FEATURE FOR HOSPITALS