Where there's a will: how to finance Medicare receivables - legally - Special Report

Healthcare Financial Management, Oct, 1991 by John B. Reiss, Stephen J. Di Cioccio

With cash flow problems facing many hospitals, nursing homes, and clinics, several companies now offer healthcare organizations the opportunity to factor their accounts receivable.

The Health Care Financing Administration's (HCFA's) general prohibition against reassigning accounts receivable, (a) however, prohibits healthcare organizations from factoring Medicare accounts. Although Medicare regulations do not use the term "factoring," factoring actually was the impetus for HCFA's enacting the prohibition. Because most state Medicaid rules follow Medicare practices, factoring of Medicaid accounts also is prohibited in many states. (b)

Factoring of accounts receivable is a financing technique in which a company buys an organization's accounts receivable at a significant discount from their face value and then renders the full amoung of the accounts for payment, keeping the difference or "spread" for itself.

As this technique was developed by healthcare organizations in the 1970s, Medicare and many state Medicaid programs ended up paying not only the medical costs for which a bill originally was rendered but a significant favoring fee as well. The Medicare Bureau (now the Health Care Financing Administration) and equivalent state authorities cast a jaundiced eye of this practice, saying it led to a significant portion of Medicare and Medicaid portion of Medicare and Medicaid dollars being spent on factoring commissions rather than the medical needs of covered patients.

Legal hurdles

While legal arguments linger about what ownership of an account receivable means, the clearest indicator of ownership is taking title. Many of the factoring plans proposed to healthcare organizations would give factors title as well as other ownership rights to an organization's accounts receivable. These programs clearly are illegal when applied to Medicare accounts receivable and many states' Medicaid accounts receivable.

As a result, many healthcare organizations wanting to convert their accounts receivable into cash face a dilemma. Although they may hold private insurance company and self-pay receivables, a majority of many hospitals' most reliable accounts receivable result from Medicare and Medicaid patients. These accounts cannot be sold to factors.

At the same time, a commercial bank, finance company, or other financial institution (a lender) is not likely to be particularly interested in financing a cash-starved healthcare organization unless it can obtain, by assignment, a valid, first-priority security interest in their accounts receivable.s receivable as security, a lender would be left out to dry if the healthcare organization later developed severe financial problems. Because Medicare and Medicaid accounts receivable typically are paid with reasonable certainty (even if not always in reasonable amounts) and make up a significant portion of most healthcare organizations' accounts receivable, excluding them from a factoring program may make accounts receivable financing an unrewarding activity.

A possible solution lies in establishing a financing program under which a lender finances an acceptable percentage (generally between 65 percent and 80 percent) of certain "eligible" (c) accounts receivable of an organization and takes a security interest in all (or some) of the organization's account receivable.

The value of accounts receivable pledged as collateral beyond the total amount of credit available to a healthcare organization under a financing arrangement provides a cushion in the event that some accounts receivable do not perform as anticipated.

To establish such a financing program, a healthcare organization must arrange to have payments from the account debtors on eligible accounts receivable sent to a designated lockbox held with the lender or some other depository institution. Medicare and Medicaid receivables (which, along with all other accounts receivable intended to secure the financed sum, form the organization's "credit facility") are deposited into the lockbox account daily. At the end of some specified period (preferably each business day), an amount equal to the amount deposited that daily into the lockbox account automatically is swept into another account (the "cash collateral account"), (d) held with the lender or another depository. The lender should have a perfected security interest and complete rights of access to the cash collateral account if a default occurs under the credit facility.

The cash collateral account could be either the healthcare organization's working a capital account or a separate account. For a separate account, the lender may require a certain threshold amount to be held on deposit at all times. The lender may choose for the threshold amount to be a percentage of the loans outstanding or a fixed amount.

Keeping it kosher

The simplicity of the program is matched only by the complexity of the legal documents that go with it. At a minimum, a prudent lender ould require the following: