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For the CCRC I mentioned (which I’ll call “CCRC ABC”), the total liabilities are 93% of assets, and this breaks down as follows:
60% - Bonds payable
28% - Deferred revenue from entrance fees
1% - Entrance fees refundable upon reoccupancy
4% - All else
In recent years at least, very little of the entrance fees coming into CCRC ABC have been the refundable type.
At best I can figure out the audited financial statements, the refundable entrance fees get separated into two parts: 80% refundable & 20% not refundable. The 80% refundable part ends up in the "refundable upon reoccupancy" liability. The 20% non-refundable part gets lumped in with all the non-refundable entrance fees that go into the "deferred revenue" liability. A portion of the "deferred revenue" liability is then treated as operating revenue each year to offset expense.
You referred to entrance fees as "as yet unamortized into revenue to pay capital expenses". I have been trying to figure out to what extent CCRC ABC uses amortized entrance fee revenue to pay capital expenses, but so far this seems beyond my ability.
A negative net equity of $200 million for Asbury does seem precarious. So far CCRC ABC still has a positive net equity, most recently amounting to 7% of total assets--down from 24% several years ago before the latest physical renovation project commenced.
Mr. Root, you mentioned the following: "In 2018, FASB discontinued the recognition of revenue from refundable entrance fees and instead required including the full amount of such fees as a liability. A new interest-bearing financing fee which residents could pay was authorized. Continuation of some CCRCs charging refundable entrance fees with refunds postponed until receipt of a successor’s fee is noted in the codification. (FASB 954-440-05-7 to 10)"
Would you mind clarifying the following:
Thanks in advance.
August 15, 2021 from Bill Root
Dear Unnamed Commenter on Jack Cummings Comments
I defer to Jack to respond to your comments on his message.
Jack provides much useful information. However, he does not specifically comment on my entrance fee article.
Your comments on Jack's include some information which might be relevant to my article, such as liabilities being 60% of assets represented by bond liabilities and 27% of assets represented by entrance fees. One might deduce from this that liabilities are 87% of assets, leaving 13% as net equity. However, it is unclear whether the 27% is for the total refundable entrance fees, as required by FASB since 2018, or only for those as yet unamortized into revenue to pay capital expenses, as permitted by FASB prior to 2018. Where I used to live in Asbury Methodist Village (AMV), one of multi-site Asbury Communities (ACOMM), liabilities shown in ACOMM financial statements had been increased after the 2018 FASB change to cover the full amount of refundable entrance fees, so that liabilities exceeded assets by about $200 million. This meant a negative net equity of $200 million. This information suggests a poor credit rating unless assets were grossly understated.
Thanks for your efforts to understand these entrance fee issues.
I am a prospective CCRC inhabitant, and in order to better understand both your post and a particular CCRC’s finances, I have been examining its financial information, including its audited financial statement, in the light of what you say, and vice versa.
In your paragraph beginning “This deceptive model” you mention “accounting that rewards early residential cohorts at the expense of later generations.” Are you referring to refundable contracts here—i.e. entrance fees of later cohorts used for refunds to earlier cohorts—or is it something else?
At the end of that same paragraph you point out that under this deceptive model “entrance fees were not ‘reserved’ to meet the contractual obligations to the specific residents who paid those fees.” Do you mean reserving the entrance fee paid by each resident to meet the obligations only to that specific resident?
Concerning the “pure rental property” model described in your paragraph beginning ”To make this clear”: Wouldn’t the insurance company that makes a loan to the provider require some sort of security? Where is that going to come from if the CCRC is a nonprofit?
Possibly I have misunderstood your explanation in some major way.
The particular CCRC I mentioned above is a nonprofit Type A CCRC that was started in the 1960s. In recent years it has been going through a series of physical expansion and renovation projects financed by bonds. At a meeting with residents about the 2020-21 budget, management stated that according to that budget, the year would end with the debt service coverage ratio just barely above the level specified in the bond covenants, and it was important to have at least a specified $ amount of entrance fees coming in over the coming fiscal year.
On the latest financial statement there is a liability for “bonds payable” which amounts to 60% of assets.
A note in the financial statement says “Non-refundable resident entrance fees are recorded as deferred revenue and are amortized on a straight-line basis over the actuarially determined life expectancy of the resident . . . .” I.e. each year only a portion of all entrance fees on hand is made available to cover expenses, and that portion is calculated based on the residents’ life expectancies.
The latest financial statement shows that for that year the portion of entrance fees made available for expenses covered 17% of total operating expense, and the year ended with a remaining entrance fee “balance” (a liability) amounting to 27% of assets.
Morality of Entrance Fees
This is an interesting discussion that goes well beyond “refundable” entrance fees since the moral and ethical issues involved are inherent in all entrance fee funded communities. It is deceptive to imply that entrance fees are a prepayment for lifelong contractual commitments when the provider intends to put them at risk as an equity investment to secure debt providers. That’s the case for the “nonprofit” sector of the senior housing industry generally.
Those nonprofit providers which are not dependent on entrance fees for equity capital have generally aggregate enough profits, despite their nominally nonprofit claims and tax qualification, to have a positive net worth derived from past resident paid-in capital. This use of entrance fees as at-risk equity capital involves the sale of an unregulated blue sky investment security.
We can deduce what’s right and fair from first principles by looking at the history of how today’s questionable practices evolved and by considering the logic of what has transpired and what might have been more ethical sound and just. The general reasoning is something that ordinarily perceptive people should be able to understand. Once armed with that understanding, it’s up to each individual involved in the process to decide what is just and what is the course of integrity for each of them as individuals.
The senior housing industry evolved from church initiatives and churches were used to operating without concern for financial equity since they were inherently charitable in their mission. Churches themselves are nonprofit, and so it was natural for them to adopt nonprofit concepts for the homes they sponsored, organized, and operated. Initially, those “homes” were intended to provide lifetime retirement housing for retired church workers, clergy, and some others who were dependent on the generosity of others. Beneficiaries paid what they could as entrance fees, and charitable giving made up the balance.
In 1972, Revenue Ruling 72-124 extended nonprofit status to otherwise for-profit enterprises that provide housing for the elderly subject to certain nominal requirements reflective of what the ruling termed the “distress” of old age. That led to the expansion of nonprofit housing operators into the more profitable market of housing the affluent.
The providers, thinking as nonprofit operators, required entrance fees as equity capital, i.e. a down payment, to secure the debt (analogous to a home mortgage) needed to get started. The residents were not told that they were making an at risk equity investment, i.e. a blue sky security investment, and those market based entrance fees were treated as partial consideration for continuing care contracts. Initially, that entrance fee equity contribution was transferred to the enterprise over a relatively short period, usually between 36 and 72 months.
This deceptive model (from a consumer’s perspective, i.e. an at risk equity investment couched as a secured investment in lifetime services) was encouraged by investment banking firms who earn their revenues by originating the debt secured by the entrance fees. The accounting profession, which promulgated rules rather than following principles, acceded to the wishes of their corporate clients, the providers, and allowed accounting that rewards early residential cohorts at the expense of latter generations. In short, entrance fees were not “reserved” to meet the contractual obligations to the specific residents who paid those fees.
To make this clear, imagine a pure rental property for which a resident might wish to prepay future rents from current wealth for the rest of the resident’s lifetime. The resident could easily accomplish that by buying a single premium life annuity from a licensed insurance company and assigning the stream of annuity payments to the rental property owner (the provider) to offset rents that come due. The licensed insurance company could then invest those annuity proceeds in the housing project in the form of an interest-bearing debt obligation (technically known as modified coinsurance reinsurance). That is not what the debt originating investment banking firms suggested be done. It would not be to their interest to do so.
The next development came when Joan Arnett, who was a Managing Director of one such investment banking firm, Cain Brothers (an intriguing name Gen. 4:9), devised the notion of the cascading refund. She thought that if the refund were paid by the next resident, then the provider could take the first resident’s entrance fee into income at a rate that would be limited only by the willingness of the accounting firms to allow it. That created a Ponzi scheme in which succeeding residents’ entrance fee investments are hypothecated to provide benefits to the move in cohort, with the cost of that hypothecating cascading from resident cohort to successor ad infinitum, requiring a presumption of perpetual operation. As Bill has pointed out, such a “scheme” (and it is a “scheme” in all senses of that word) is generally considered to be contrary to public policy (Social Security is a major exception because it is assumed that government will be perpetual and government can coerce payments that produce negative value for the payors).
To cut to the chase, we should start with the simple month-to-month rental model since residents are given no ownership and the value of their residency will be received ratably over the time of their occupancy.
That then means that any entrance fees are equivalent to the single premium required to purchase a life annuity from a licensed, regulated insurance company. That’s how they should be viewed.
If the enterprise is established on such a sound financial footing, then it would be reasonable for there to be fundraising to subsidize residence for those who can’t afford the full cost just as universities engage in fundraising to subsidize the cost of educating underprivileged students.
It's that simple. It’s become complex because it has suited the profit interests of investment bankers and accountants to take advantage of the well-intentioned innocence of decision makers who think of a nonprofit senior housing operation as a quasi-charitable venture. Providing luxury rental housing for affluent residents who pay the full cost of their residency is not charitable.
I disagree strongly with your suggestion to change refundable entrance fees to transferable loans.
The contractual responsibility is for the provider to pay the refund, not the successor.
Otherwise I agree with your comments.
Thanks for sharing
Interesting exchange. I am wondering how can a whole industry just ignore the FASB requirements....
I wish something would be done to ensure that CCRC residents can be guaranteed that whatever is stated in the contract will be fulfilled and that one will not wake up one day with no money and no place to be when old and sick. CCRCs are in theory a good potential solution to the problem of aging without support, but it seems that they are very, very risky due to the way they are run and due to the fact that they are very loosely regulated (if at all) and can do whatever they please with one's money and residents have little or no say in the decisions management makes.
Since the money loaned to the provider by the departing resident is paid by the successor resident, a more accurate name for this arrangement would be “transferable” Entrance Loan.
Looking ahead a few years, it would seem to be a smart move for the providers to discontinue or phase out refundable Entrance Fees, and at the same time to accept the liability for paying back the existing obligations (as Mr. Root suggested). From an equity perspective, the repayment liability is indeed on the providers, since they are the sole beneficiaries of the capital available from this aggregate pool of loaned money. If the providers encounter a cash flow issue about paying back the Entrance Loans, they could issue bonds that would provide a stream of funds to help pay back these amounts thus refinancing the Entrance Loans (again as Mr. Root suggested). From the overall economics of the CCRC community, the amount of money in play would not change. But, the successor residents would no longer be making a no-interest, unsecured loan to the provider, and the departing residents (or their estates) would be paid back more promptly.
Interesting thoughts. Thanks for posting.
Ziegler, the nation’s largest arranger of financing for apartments leased to seniors, did us all a big favor recently by publishing the following:
During the past ten years, for-profits with no entrance fees doubled, whereas not-for-profits stagnated, resulting in for-profit market share increasing significantly.
Why did entrance fees make such a difference? The answer requires an examination of Financial Accounting Standards Board (FASB) codifications.
In the 1970s, FASB authorized not-for-profit CCRCs to obtain revenue from non-interest-bearing refundable entrance fees. Revenue was amortized over the 30-year expected life of the facility. Liability for refunds decreased in steps by the amounts amortized each year. Refunds upon resident death or departure were not provided until receipt of a successor resident’s fee. Not-for-profit CCRCs across the country followed this formula to finance construction or upgrades of buildings leasing apartments to seniors.
The results have been disastrous. What must be refunded can never become actual revenue available for another use. Pretending that revenue exists when it really does not eventually leads to insufficient cash, requiring repeated refinancing of bonds to later maturities to pay the bills.
In 2018, FASB discontinued the recognition of revenue from refundable entrance fees and instead required including the full amount of such fees as a liability. A new interest-bearing financing fee which residents could pay was authorized. Continuation of some CCRCs charging refundable entrance fees with refunds postponed until receipt of a successor’s fee is noted in the codification. (FASB 954-440-05-7 to 10)
The new financing fee serves no useful purpose. It must be repaid to the resident and is, therefore, unusable as a means for the resident to pay for his apartment. Paying a predecessor’s refund is the only permissible use of continued refundable entrance fees. This arrangement benefits neither residents nor providers. Indeed, it deprives providers of attracting residents who cannot afford large entrance fees. In the absence of a FASB-approved alternative, providers are ignoring the 2018 discontinuation of revenue recognition from refundable entrance fees.
This practice is in violation not only of FASB requirements but also of the Age Discrimination Act of 1975, which applies to programs receiving Federal financial assistance, including “health care” and “housing.” It is also in violation of other legislation outlawing pyramid schemes, such as Michigan Franchise Investment Law 445 1501 et seq, which states: “A person may not offer or sell any form of participation in a pyramid or chain promotion.”
The nation’s entire not-for-profit apartment leasing to seniors is in serious jeopardy.
But do not despair. Simply discontinue large entrance fees and add to monthly fees an element to pay for capital needs as well as operational costs, exactly the way for-profits do.
Getting rid of the pyramid scheme of postponing refunds until the successor’s fee is paid is not easy. Indeed, once this pyramid has started, I am unaware of any place where it has been stopped. But there is a simple though unprecedented solution. Providers wishing to comply with legislation outlawing pyramid schemes could revise the residency agreements with existing residents to delete postponement of refunds until receipt of a successor’s fee and then borrow sufficient funds to pay refunds immediately on departure, such loans to be used for no other purpose. This sounds drastic. It is drastic. But it is not so ridiculous as continuing the current pyramid scheme into perpetuity. The extent of such needed loans would not exceed past use of pretend revenues to pay for expenses.