Healthcare providers occupy a strange financial position. They are rich in receivables yet chronically short on cash. A hospital, skilled nursing operator or physician group can deliver millions of dollars in billable care each month and still struggle with cash crunch, because the money owed to it is trapped somewhere between the date of service and the date a payor finally pays. That lag between care delivery and reimbursement is wide, perhaps even stretching to 120 days or more, and for asset-based lenders and factors it is becoming one of the more compelling opportunities to provide a valuable service.
Although providers cannot control when they get paid, they can finance the receivable to provide some cash relief and maintain their often expensive operations. Cash dominion, lockboxes and cash-control mechanics are essential when collections arrive from dozens of payors on unpredictable timelines. Visibility into the revenue cycle, not just the aging report, is what allows a lender to manage the position dynamically. An aging report tells you where receivables have been – understanding the revenue cycle helps explain where they are going and whether they are likely to arrive at all.
Payor Type Impact
Many lenders apply heavy reserves to account for payor mix (Medicare/Medicaid, commercial, private pay), denials and appeals, bad debt/charity care, slow-pay government payors. Availability is higher on paper, but underwriting is complex which requires lender expertise in healthcare billing cycles and payor behavior to properly structure the BBC.
Healthcare is unique in that a single provider bills dozens of different payors simultaneously, each with different rules, rates and timelines. Unlike most industries where a receivable has a fixed value, a healthcare claim’s value is unknown until all payor types claims for product and services are settled.
Another risk lenders need to define and monitor is the expected lag time of payment by different payor types. Receivables for Government payors, especially Medicaid, are real but slow and often age out of eligibility before they are even paid. A hospital with 60% government payor mix will have a materially smaller and less reliable borrowing base than one with 60% commercial mix even if both have identical gross A/R balances.
NCV: Net Collectible Value
Most healthcare ABL lenders care about NCV because gross A/R is misleading; few concepts in healthcare finance have disappointed more first-time observers than the realization that gross charges and collectible cash can be very different numbers. Net Collectible Value (NCV) is the realistic amount a healthcare provider expects to actually receive for billed services, after all adjustments and anticipated losses.
NCV is impacted by contractual adjustments which is the difference between what a provider bills (gross charges) and what a payor has contractually agreed to pay (allowed amount) and is the single largest reducer of NCV. The provider writes off the difference as it was never real revenue. The hospital’s price list are set artificially high as a starting point for negotiation. Lenders must convert gross A/R to net A/R by applying expected contractual adjustments.
A static pool analysis is utilized by lenders and examiners which can track how much was billed in a given period, how much was actually collected, over what timeframe and what was lost and why. It shows speed of collection and ultimate recovery rate and examiners use this to calculate percentage of NCV. This finance tool is utilized to set the ceiling on advance rates and expected payment lag time for setting the BBC formula like past dues.
Static pool analysis converts a healthcare A/R portfolio from an opaque, difficult-to-value asset into a data-driven, predictable cash flow stream. Without it, a lender is essentially trusting the provider’s NCV estimate. With it, the lender has independent evidence of what that receivable pool is actually worth.
Disproportionate Share Hospital (DSH) Payments and other Government subsidies
Additional Medicare, and Medicaid payments to hospitals that serve a disproportionate share of low-income patients may be taken into account when calculating the NCV as these payments are not reflected in the collections of receivables. Many ABL lenders typically exclude DSH from borrowing base but must understand it as a liquidity source and may take this into account for advance rate calculations.
Inter-Company transactions
Large health systems contain dozens of entities hospitals, physician groups, ambulatory surgery centers, home health agencies, management companies, private equity investors with extensive intercompany transactions like management fees from operating entities to parents, shared service arrangements (IT, HR, revenue cycle), intercompany loans and guarantees, captive insurance premiums and private equity sponsors’ payments etc. The risks to be looking for include cash flow at the entity level (which may be the borrower) is reduced by management fees paid to parents. Transfer pricing for intercompany services may not reflect market rates distorts individual entity financials. ABL lenders must understand which entity they are lending to and whether intercompany arrangements are arms-length.
Capitation Risk
Another unique risk in healthcare finance which require unique insights is Capitation. Capitation is a payment model where a payor (insurer or government) pays a provider a fixed amount per member per month (PMPM) regardless of how much care those members actually use. The provider accepts the insurance risk if members use more services than the PMPM covers, the provider absorbs the loss. Capitation payments are prepaid, not billed. This fundamentally breaks the healthcare ABL model as there is no receivable to pledge as collateral, revenue recognition is time-based, not service-based and A/R-based borrowing base does not capture capitation revenue.
A provider transitioning from fee-for-service to capitation may show declining A/R balances (less to lend against) while simultaneously taking on actuarial risk that could generate large future losses. Borrowing base shrinks while risk profile worsens a dangerous combination.
Conclusion
Healthcare finance due diligence must go well beyond the receivable, it requires understanding the provider as a complex, multi-risk enterprise where the most dangerous exposures may not appear anywhere in the borrowing base. Many contingent liabilities are often not reflected on the balance sheet and can materialize suddenly through many different ways and should be monitored during the field exam. A provider can have pristine receivables and excellent collection performance while simultaneously sitting on contingent liabilities in its malpractice program, a capital call obligation in its joint venture health plan and a billing violation that could unwind years of Medicare billing. Many unusual risks operate entirely outside the A/R framework and a deep understanding of all risks associated with healthcare ABL finances is required by lenders and examiners for oversight.
Standard healthcare ABL focuses on A/R quality, NCV, static pools analyses, payor mix review of subsidies and other risks not seen in traditional ABL. The lenders who win here will be the ones who understand net realizable value, dilution, structure for payor complexity, pair capital with the visibility to manage it and unique risks noted and associated with healthcare providers.
Healthcare financing carries risks that simply don’t exist in conventional ABL or corporate lending. Healthcare is not a niche that the asset-based and factoring community can afford to treat lightly. It is a large, and growing segment of the economy whose core financial problem, the persistent and lengthening gap between delivering care and getting paid is precisely the problem that receivables finance was built to solve. In a way, healthcare may represent one of the purest examples of the asset-based lending value proposition: transforming a delayed payment stream into working capital today. The providers who need this capital are not going away; the payment cycles show no sign of shortening. This provides a great opportunity in the immediate future if executed and monitored properly by both lenders and examiners.
Smita Desai, a senior examiner with Insight Examination Services Inc. since 2014, leads specialty finance field examinations including healthcare and has been performing ABL exams with varying complexity. A CA (equivalent to CPA) her career has spanned multiple continents and countries for over 35 years. Her attention to detail and understanding of ABL and how it relates to a specific industry has allowed her to uncover risks and collateral quality issues.