California hospitals have endured countless financial tremors the past decade: HMO penny-pinching, large-scale failures of physician practice management firms and cuts in state Medicaid payments, to name a few.
No relief is in store as the state's healthcare industry enters a new decade. And the worst economic tremor of all could come in an ironic form: new codes to ensure California's hospitals better survive earthquakes. The requirements could cost the state's hospitals in excess of $24 billion in the coming decades.
The impetus is the state Seismic Safety Act. It was passed by the Legislature shortly after the devastating 1994 Northridge earthquake. It mandated that state regulators draft new seismic standards for California's hospitals. By 2008, any hospital structures deemed unsafe can no longer be used for acute-care services. By 2030, all other buildings must comply with the new code or be converted to nonacute-care use, closed or demolished.
Though other kinds of structures in California face strict seismic mandates--such as new regulations on using steel structural beams in high-rise buildings--no other industry is facing such a massive overhaul of its fixed assets.
California's lawmakers were moved to this new legislation by a potential nightmare scenario far worse than that posed by a bankrupt medical group or more Medicaid cuts. The 1971 Sylmar earthquake caused a recently built wing of Olive View Medical Center in the Northern San Fernando Valley to collapse, killing some 40 patients. Though no patient deaths were linked to the Northridge temblor--whose epicenter was just a couple of miles away from Sylmar's--several healthcare facilities in the region still had to be evacuated and eventually rebuilt.
Moreover, a survey of California hospitals taken by state regulators shortly after the 1989 Loma Prieta earthquake in the Bay Area revealed an alarming trend. Most California hospital beds--83% in all--were housed in structures that didn't comply with seismic regulations drafted two years after the Sylmar earthquake. About 26% were in buildings so old they didn't comply with any modern seismic codes. And of the 490 hospitals surveyed, 116 either stood on earthquake faults or were built in areas prone to soil liquefaction, flooding, landslides or being cut off from outside access in the event of an earthquake.
Hospitals supported the legislation, citing how it addressed safety concerns.
"The belief was that it wouldn't be a major burden," says Roger Richter, senior vice president of professional services at the California Healthcare Association, the state's leading hospital lobby. "There were a number of hospitals built throughout the state in the 1960s, and the thought was that these hospitals could be easily brought up to substantial compliance with the act and that a large number of hospitals could (operate) beyond 2030."
But such hopes were dashed when California's hospital regulatory body, the Office of Statewide Health Planning and Development, formally introduced the retrofitting guidelines two years ago. The OSHPD had used existing seismic guidelines from the Federal Emergency Management Agency and adopted them to fit the needs of hospitals, conferring with structural engineers along the way. The CHA's original cost estimates nearly doubled.
"Literally any hospital can be brought into compliance if money is no object," Richter says. "But the question is how much is a hospital willing to spend to retrofit a building by 2008 that may still have to be demolished in 2030? Under those circumstances, is it worth rebuilding earlier than expected rather than just retrofit?"
Richter says it's too difficult to ascertain yet how many hospital buildings would require extensive rebuilds, but the publication Engineering News-Record says that as many as 850 pre-1950s hospital structures may be closed by 2008, and as many as 1,000 more might require large-scale retrofits.
The only money discussed in the Seismic Safety Act was a $318,000 appropriation to help the OSHPD develop the new guidelines. Not a cent was allocated to help hospitals comply.
Picking up the tab. "The question isn't answered as to how we're going to pay for it," says Lori Aldrete, spokeswoman for the state's largest system, Catholic Healthcare West, which says its seismic-related cost will be $450 million to $555 million. The system has an annual capital budget of $350 million.
CHW would like to stretch those capital expenditures over 10 years, says John Petersdorf, the system's vice president of finance .
The system is working on a 10-year plan that will include financing strategies, Petersdorf says.
"If every hospital drives toward that 2008 deadline, it's going to drive up costs because it's going to tie up all the architects and builders at once," he says. CHW, which has incurred two credit-rating downgrades in the past year, might also have an easier time selling its bonds if it can stretch its capital costs and keep its financial ratios, such as debt-to-capitalization, at an even keel. "The investment community would prefer more spaced-out projects," Petersdorf says.
Another issue is that hospitals don't want to throw away money by constructing facilities that won't meet the needs of the healthcare system in 10 years. "Part of what we're trying to figure out is how healthcare is going to be delivered in 2008 or 2010 and design the right types of facilities, and that takes time," Petersdorf adds.
"It is an unfunded mandate that has been foisted on the healthcare system by the state Legislature without any identifiable source of funding," says Larry Ainsworth, president and chief executive officer of 300-bed St. Joseph Hospital in Orange. St. Joseph's seismic compliance bill is estimated to run $125 million to $175 million.
Jim Lott, executive vice president of the Healthcare Association of Southern California, a hospital lobby, says no one will have an easy time. "The cost of retrofitting will not be filled by anybody's reserves or philanthropic funds," he says.
It's easy to see why. California's hospital inventory is valued at about $32 billion, yet it is staring down the barrel of a $24 billion seismic retrofitting tab. And that's the most conservative estimate available, according to the CHA's Richter. It doesn't even include extra costs that come from collisions with existing local, state and federal laws, which may add billions more to the final price tag.
For example, many hospital operators with older infrastructures thought they could convert inpatient buildings that didn't meet seismic-compliance standards into clinic or office space. "But if you change the occupancy purpose of a building, you have to make sure the building meets local seismic codes anyway," Richter says.
Faced with that obstacle, parking structures are the only part of an existing hospital campus where new construction can take place without causing vast disruptions to patient services. But Richter notes that current cost estimates don't address the allotment of new parking spaces or buying additional land if a hospital decides to rebuild elsewhere.
California's interpretation of the federal Americans with Disabilities Act poses yet another burden. In most states, spending to comply with ADA as part of refurbishing or building new facilities is capped at 20% of the construction total, meaning that the most that has to be spent to comply with ADA in a $50 million construction project is another $10 million. In California the cap is 100% of the total. That means hospitals may have to double the costs of their construction projects if that's what it takes to ensure ADA compliance.
Shaky estimates. Those and other variables--such as asbestos removal--make it almost impossible to pin down the true cost of bringing the state's hospitals into seismic compliance. Estimates are fluid because hospitals are continually evaluating whether to retrofit, replace or close their facilities based on their financial circumstances and local market conditions. Kaiser Permanente has reversed earlier decisions to close hospitals in Oakland and Sacramento.
Estimates are also shaky because seismic projects are often rolled into other capital projects.
"You have to make a judgment about your future business growth and the state of the healthcare industry in California. These are very serious and complex decisions that are going on," says Harry Anderson, spokesman for Santa Barbara-based Tenet Healthcare Corp.
A few major systems have disclosed estimates in recent bond documents (See chart, p. 28). But others are staying mum until they're required to submit compliance plans by year-end.
Tenet, the state's No. 2 healthcare system, declined to release an estimate of the cost to upgrade its 41 hospitals in California. Likewise, HCA-The Healthcare Co. won't give a figure to revamp its eight hospitals there.
The immense costs threaten to rattle even the facilities that are on firm financial footing. Those on shaky foundations could be leveled.
Within the past nine months, the cost of seismic compliance was cited in decisions to close at least three hospitals: Mercy Healthcare Sacramento's 352-bed American River Hospital, HCA's 327-bed San Jose Medical Center and University of California San Francisco's 150-bed Mount Zion Medical Center.
The St. Joseph system will eliminate 8.5% of its 2,800-member workforce this year as part of a cost-reduction plan, which CEO Ainsworth says will help to offset the cost to finance seismic upgrades that are slated to run from $125 million to $175 million.
"Quality is put at risk," Ainsworth says. "Is that appropriate? From my viewpoint, the answer is no."
Kaiser Permanente expects to spend between $2 billion and $3 billion by 2008, spokesman Bob Eisenman says. Kaiser's costs could be particularly high because it plans to bring all its facilities into compliance with 2030 standards by the earlier 2008 deadline, which entails rebuilding several hospitals, Eisenman says.
Most systems and hospitals probably will have to borrow to meet the guidelines. It's not an attractive scenario for either lenders or borrowers: 46% of California hospitals are rated A or AA by Standard & Poor's, compared with 54% of hospitals nationally. Major players such as Cedars Sinai Medical Center, Catholic Healthcare West and St. Joseph Health System have experienced downgrades in the past year. The weaker-than-average finance picture could boost debt financing costs for some and preclude others from issuing debt at all. The problem could be compounded if many hospitals glut the municipal bond market at once.
Financial instability. The financial burden of seismic compliance could lead to further instability, say ratings agencies, which are beginning to factor seismic expenses into their risk ratings.
Even without seismic compliance headaches, California hospitals have a hard time with their bottom lines, operating on some of the leanest margins in the nation. In 1998, the overall operating profit for California hospitals was 4.1%, compared with 5.7% for hospitals nationally, according to the latest figures from the American Hospital Association.
Little help is expected from Cal-Mortgage, California's public guarantor of hospital bonds. "If they have to cover a default it comes out of the state's general fund, and the amount of money available to do that is not nearly enough," Richter says.
"The reality is, hospitals need more time to figure out how to afford it," says John Landers, managing director in the San Francisco office of Morgan Stanley Dean Witter. Worried hospital managers now are asking the state Legislature to extend compliance deadlines. They're also asking state and federal legislators to provide financial assistance in the forms of low-interest loans, grants and tax credits.
To that end, the CHA has sponsored four bills, which are working their way through hearings in the Legislature (See chart, p. 30). The bills would buy hospitals more time and help them address the potential logistical nightmares of relocating services during construction.
Hospitals say extending deadlines would lower costs by allowing them to fund more of their seismic overhauls through operations and cause fewer disruptions in patient care. Anderson says even Tenet, which is in "pretty strong" financial condition, is hoping for a deadline extension to enable it to absorb the costs over a longer period.
But that may still not be enough for stand-alone facilities that can't tap the borrowing capacity of a corporate parent. "We think it might be the straw that breaks the camel's back for the smaller hospitals," says Terry Goode, a San Francisco-based associate director of public finance at Standard & Poor's.
County-owned 65-bed Trinity Hospital in the northern mountain town of Weaverville doesn't have the $8 million or more it will cost to bring the hospital up to code by 2008, says Administrator David Yarbrough. He says the hospital, staffed for seven acute-care patients, needs a government grant because it lacks sufficient operating income to make debt payments.
The hospital is exploring a sale or merger; Yarbrough has traveled to Sacramento many times to beg for money for "safety net" hospitals such as his, which are sole community providers.
He says residents of his county need a hospital because transportation to other facilities is rough during bad weather. "It's a strange conundrum to be in because certainly if you're responsible for the safety and wellness of your community, you want to provide them a safe place to get their healthcare," he says. "We're not asking for a free ride, but we're asking for some assistance."
At the other end of the spectrum is 356-bed Hoag Memorial Hospital Presbyterian in Newport Beach, which already has a $355 million capital-improvement project under way, partly financed by a bond issue and partly from reserves. About 10% of the project's cost is due to seismic retrofit compliance, says Peter Foulke, executive vice president in charge of corporate services.
Foulke says the hospital, which is located in an affluent and growing community, submitted its plans to the state and began the approval process about two years ago to avoid a regulatory bottleneck that could delay the project.
"We didn't want to wind up being at the end, when there was not enough (state) staff to review the projects," he says.
Despite its early start, though, Foulke says, "By the time we get it done we'll be pushing the 2008 deadline."
Foulke wonders how his less-fortunate colleagues will find financing and get the state's approval in time. "Getting it all done is physically going to be impossible," he says.