Hospital revenues depend upon inpatient occupancy levels, the extent to which ancillary services and therapy programs are ordered by physicians and provided to patients, and the volume of outpatient procedures. Reimbursement rates for inpatient routine services vary significantly depending on the type of service (e.g., acute care, intensive care or psychiatric) and the geographic location of the hospital. The Company has maintained increased levels in the percentage of patient revenues attributable to outpatient services in recent years. These increased levels are primarily the result of advances in medical technology (which allow more services to be provided on an outpatient basis) and increased pressures from Medicare, Medicaid and private insurers to reduce hospital stays and provide services, where possible, on a less expensive outpatient basis. The Company’s experience with respect to increased outpatient levels mirror the trend the Company believes is occurring in the hospital industry. Medicare. Most hospitals (including all of the Company’s acute care hospitals) derive a substantial portion of their revenue from the Medicare program, which is a Federal government program designed to reimburse participating health care providers for covered services rendered and items furnished to qualified beneficiaries. The Medicare program is heavily regulated and subject to frequent changes which in recent years have reduced, and in future years could further restrict increases in, Medicare payments to hospitals. In light of its hospitals’ high percentage of Medicare patients, the Company’s ability in the future to operate its business successfully will depend in large measure on its ability to adapt to changes in the Medicare program. The Medicare program is designed primarily to provide health care services to persons aged 65 and over and those who are chronically disabled or who have End Stage Renal Disease (“ESRD”). The Medicare program is governed by the Social Security Act of 1965 and is administered by the Federal government, primarily the Department of Health and Human Services (“DHHS”) and the Centers for Medicare and Medicaid Services (“CMS”), formerly known as the Health Care Financing Administration (“HCFA”). 4
Legislative action and Federal regulatory changes over the years have resulted in significant changes in the Medicare program. Formerly, Medicare provided reimbursement for the reasonable direct and indirect costs of hospital services furnished to beneficiaries, plus an allowed return on equity for proprietary hospitals. Pursuant to the Social Security Amendments of 1983 (“the Amendments”) and subsequent budget reconciliation act modifications, Congress adopted a prospective payment system (“PPS”) to reimburse the routine and ancillary operating costs of most Medicare inpatient hospital services. In November 2000, as described below, a prospective payment system was proposed for rehabilitation hospitals and rehabilitation units that are a distinct part unit of a hospital. Psychiatric, long-term care and pediatric hospitals, as well as psychiatric units that are distinct parts of a hospital, currently are exempt from PPS and continue to be reimbursed on a reasonable cost basis. Effective August 1, 2000, as also further described below, a prospective payment system was implemented for hospital outpatient services. The Company’s two psychiatric hospitals do not participate in the Medicare program. Under PPS, the Secretary of DHHS has established fixed payment amounts per discharge for categories of hospital treatment, commonly known as diagnosis-related groups (“DRGs”). DRG rates have been established for each individual hospital participating in the Medicare program, in part based upon each facility’s geographic location. As a general rule under PPS, if a facility’s costs of providing care for the beneficiary are less than the predetermined DRG rate, the facility retains the difference. Conversely, if the facility’s costs of providing the necessary service are more than the predetermined rate, the facility must absorb the loss. Because DRG rates are based upon a statistically normal distribution of severity, patients falling outside the normal distribution are afforded additional payments and defined as “outliers.” In certain instances, additional payments may be received for outliers. The DRG rates are updated annually to account for projected inflation. For several years the annual updates or percentage increases to the DRG rates have been lower than the actual inflation in the cost of goods and services purchased by general hospitals. The inflation index used by CMS to adjust the DRG rates gives consideration to the cost of goods and services purchased by hospitals as well as non-hospitals (the “market basket”). Pursuant to the Balanced Budget Act of 1997, the net annual updates were set as follows: market basket minus 1.1% for the Federal fiscal year (“FY”) beginning October 1, 2001 (“FY 2001”) and FY 2002; and for FY 2003 and each subsequent FY, the market basket percentage. The Medicare, Medicaid and State Children’s Health Insurance Program (“SCHIP”) Benefits Improvement and Protection Act of 2000 (“BIPA”) further revised the update for FY 2001 to the full market basket and for FY 2002 and FY 2003 to the market basket minus 0.55%. The Company cannot predict how future adjustments by Congress and the CMS will affect the profitability of its health care facilities. The increase in the market basket for FY 2002 and FY 2001 was 3.3% and 3.4%, respectively. On December 21, 2000, BIPA was enacted. BIPA made a number of changes to the Medicare and Medicaid Acts affecting payments to hospitals which total more than $35 billion nationwide and target $2 billion to rural providers over the next six years. Some of the changes made by BIPA that affect the Company’s facilities are as follows: (i) lowering the threshold by which hospitals qualify as rural or small urban disproportionate share hospitals; (ii) decreasing the reductions in payments to disproportionate share hospitals that had been mandated by previous Congressional enactments; (iii) increasing the update factors for inpatient PPS payments to hospitals; (iv) increasing certain payments to non-PPS psychiatric hospitals and units; and (v) increasing Medicare reimbursement for bad debt from 55% to 70%. In addition, BIPA places limits on the amount of co-insurance a Medicare beneficiary must pay for outpatient services. Under BIPA, outpatient service co-payments are capped at a maximum of 57% of the Ambulatory Payment Classification (“APC” rate) for the period April 1, 2001 to December 31, 2001; 55% of the APC for calendar years 2002 and 2003; 50% of the APC rate for calendar year 2004; 45% of the APC rate for calendar year 2005; and, 40% of the APC rate for calendar year 2006 and thereafter. BIPA also directs DHHS to establish categories of items eligible for additional or “pass-through” payments to hospitals for certain outpatient services rendered on or after April 1, 2001 including such items as current cancer therapy drugs, biologicals, brachtherapy, and medical devices. 5
Hospitals currently excluded from the PPS, such as psychiatric and rehabilitation hospitals, receive reimbursement based on their reasonable costs, with limits placed upon the annual rate of increase in operating costs per discharge. Pursuant to the Balanced Budget Act of 1997, the annual update for FY 1998 was set at 0%. For FY 1999 through FY 2002, the annual update factor was and is dependent upon where the hospital’s costs fall in relation to the limits set by the Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”). The annual update factor will range from 0% to the market basket percentage increase, depending upon whether the hospital’s costs are at, below or above the TEFRA target limits. On November 3, 2000, CMS announced plans to implement a PPS system for certain rehabilitation hospitals and rehabilitation units of a hospital currently exempt from the PPS system. The final rules implementing the rehabilitation PPS were issued on August 7, 2001 and became effective on January 2, 2002 for cost reporting periods beginning on or after January 2, 2002. The payment unit under PPS is a discharge, and the payment rate will encompass the inpatient operating costs and capital costs of furnishing the covered rehabilitation services. Payment rates have been calculated using a relative weight system to account for the varying resources used in each patient category. Payments during FY 2001 and 2002, by statute, are to be budget neutral, with the FY 2001 payments equaling 98% of the amount the payments would have been if paid under the old reasonable cost system, and 100% for fiscal year 2002. Although the BBA envisioned a 2-year phase-in period for the new PPS system, beginning on April 1, 2001, because the final rules were promulgated late, the transitional phase-in period will be truncated. For cost reporting periods beginning on or after January 2, 2002 and before October 1, 2002, payment was based on 1/3 of the facility-specific and 2/3 of the FY 2002 Federal prospective payment. For cost reporting periods beginning on or after October 1, 2002, payment is based solely on the Federal prospective payment. Under final rules, a facility has the option to select payment solely based on the Federal prospective rate for periods prior to October 1, 2002. Because of the limited number of rehabilitation beds operated by the Company, changes under the PPS system will not have a material effect on the Company’s financial results. The Company’s two psychiatric-only hospitals are exempt from the PPS system. Prior to October 1, 1990, Medicare payments for outpatient hospital-based services were generally the lower of hospital costs or customary charges. Due to Federal budget restraints, the Omnibus Budget Reconciliation Act of 1993 (“OBRA-1993”) reduced Medicare payments for the majority of outpatient services to the lower of 94.2% of hospital costs, customary charges or a blend of 94.2% of hospital costs and a fee schedule (such fee schedule generally being lower than hospital costs) through FY 1998. The Balanced Budget Act of 1997, and the Balanced Budget Refinement Act of 1999, extended this reduction to the first date that an outpatient PPS was implemented. On August 1, 2000, as required by the Balanced Budget Act of 1997 and the Balanced Budget Refinement Act of 1999, a Medicare PPS went into place for hospital outpatient services. Under the outpatient PPS, all outpatient services are grouped into Ambulatory Payment Classifications (“APCs”). Services in each APC are clinically similar and are similar in terms of the resources they require. A payment rate has been established by CMS for each APC, with adjustments provided for geographic wage differentials. Hospitals may be paid more than one APC per patient and per encounter, depending upon the services required by and provided to the Medicare eligible beneficiary. Significantly, the outpatient PPS revises the way in which beneficiary co-insurance amounts are determined. Initially, co-insurance amounts were based on 20% of the national median charge for the APC. The Balanced Budget Refinement Act of 1999 limits beneficiary liability so that no co-insurance amount can be greater than the Medicare hospital inpatient deductible for a given year. The outpatient PPS provides for a transitional adjustment to limit potential payment reductions experienced as a result of the transition to prospective encounter payments. For the FY 2000 through FY 2003, providers will receive an adjustment if their payment-to-cost ratio for outpatient services furnished during such year is less than a set percentage of their payment-to-cost ratio for those services in their cost reporting period ending in 1996 (the base year). Rural hospitals with 100 or fewer beds and cancer hospitals will be held harmless under this provision. In addition, small rural hospitals, for services furnished before January 1, 2004, will be maintained at the same payment-to-cost ratio as their base year cost report, if their PPS payment-to-cost ratio is less. The outpatient PPS has not had a material impact on reimbursement to the Company. The Company anticipates the Medicare outpatient prospective payment system will continue to be refined and future adjustments may limit or reduce payments from the program. Outpatient laboratory services are paid based on a fee schedule which is substantially lower than customary charges. Certain ambulatory surgery procedures are paid for at a rate based on a blend of hospital costs and the rate paid by Medicare for similar procedures performed in free standing ambulatory surgery centers. Certain radiology and other diagnostic services are paid on a blend of actual cost and prevailing area charge. 6
Payments under the Medicare program for capital related costs, for cost reporting periods prior to October 1, 1991, were made on a reasonable cost basis. Reasonable capital costs generally include depreciation, rent and lease expense, capital interest, property taxes, insurance related to the physical plant, fixed equipment and movable equipment. As a result of changes made to the Social Security Act by the Omnibus Reconciliation Act of 1987 (“OBRA-1987”), hospitals paid under PPS for operating costs must be reimbursed for capital costs on a prospective basis, effective with the cost reporting period beginning October 1, 1991 (i.e., FY 1992). CMS implemented the PPS for capital costs for FY 1992 based upon FY 1989 Medicare inpatient capital costs per discharge updated to FY 1992 by the estimated increase in Medicare capital costs per discharge. A ten year transition period, beginning with FY 1992, was established for the phasing-in of the capital PPS. Under the transition period rules, hospitals with a hospital-specific capital rate below the standard Federal rate are paid on a fully prospective methodology. Hospitals with a hospital-specific rate above the standard Federal rate are paid based on a hold-harmless method or 100% of the standard Federal rate, whichever results in the higher payment. Beginning with cost reporting periods on or after October 1, 2001, at the end of the transition period, all hospitals are to be paid at the standard Federal rate. Pursuant to the Balanced Budget Act of 1997, capital payment rates were rebased in FY 1998 using the actual rates in effect in FY 1995 and the budget neutrality adjustment factor used to determine the Federal capital payment rate on September 30, 1995. In addition, capital rates are reduced by an additional 2.1% by the Balanced Budget Act of 1997. For FY 2002, CMS increased the Federal rate by 2.28%. The increase for FY 2003, was 4.2%. The Company anticipates further adjustments in the future but is unable to predict the amount or impact of future adjustments. The Medicare program reimburses each hospital on a reasonable cost basis for the Medicare program’s pro rata share of the hospital’s allowable capital costs related to outpatient services. Outpatient capital reimbursement was reduced by 15% (i.e., 85% of outpatient capital costs) during FY 1990 and OBRA-1990 extended the 15% reduction through FY 1991. OBRA-1990 and OBRA-1993 further directed that outpatient capital reimbursement be reduced by only 10% beginning FY 1992 through FY 1998. The Balanced Budget Act of 1997 continued the 10% reduction during FY 2000 up to January 1, 2000. The Company anticipates that payments to hospitals could be reduced as a result of future legislation but is unable to predict what the amount of the final reduction will be. On October 1, 2000, as required by the Balanced Budget Act of 1997 and the Balanced Budget Refinement Act of 1999, Medicare began paying all home health agencies under a PPS system. Medicare will pay home health care agencies for each covered 60-day episode of care for each Medicare beneficiary who continues to remain eligible for home health services. The home health care PPS system provides payment at a higher rate for the beneficiaries with greater medical needs, based upon a payment system that relies upon data collected by caregivers on a patient clinical assessment. PPS rates vary depending upon the intensity of care required by each beneficiary, with actual rates adjusted by CMS to reflect the geographic area wage differentials. Home health care agencies will receive less than the full PPS amounts in those instances where they provide only a minimal number of visits to beneficiaries. In addition, the new PPS provides for “outlier” payments in instances where the costs of care are significantly higher than the specified rate. In most other instances, they will be paid the full PPS amount. Currently, there is not a material impact on the Company due to the implementation of this PPS system. However, the Company will continue to monitor the progress of the program and take the necessary steps to minimize any further reductions in payments as a result of this program. The Balanced Budget Act of 1997 mandated numerous other adjustments and reductions to the Medicare system that collectively may impact the Company’s operations. With respect to the valuation of capital assets as a result of a change in hospital ownership, the Balanced Budget Act of 1997 eliminates the allowance for return on equity capital, and bases reimbursement on the book value of the assets, recognizing no gain, loss or recapture of depreciation. In addition, the Balanced Budget Act of 1997 mandated the following changes: i) reimbursement for Medicare enrollee deductible and coinsurance bad debts is reduced 40% for FY 2000 and 45% for FY 2001 and each subsequent year – BIPA further changed the bad debt reimbursement reduction to 30% for FY 2001 and subsequent years; ii) the bonus payments made to hospitals whose costs are below the target amounts is reduced to 2% of the target amount; and, iii) skilled nursing home reimbursement must transition to a prospective payment system, based upon 1995 allowable costs, with a three year transition period beginning on or after July 1, 1998. 7
The Balanced Budget Refinement Act (“BBRA”) was signed into law on November 29, 1999, and provided hospitals some relief from the impact of the Balanced Budget Act of 1997. The provisions enacted by the BBRA did not materially impact the Company. It did, however, indicate the recognition by Congress that further reductions in payments to hospitals were not necessary. Congress continues to evaluate a number of proposals that would give hospitals additional relief from the impact of the Balanced Budget Act of 1997. However, the uncertainty and fiscal pressures placed upon the Federal government as a result of the ongoing War on Terrorism, and the economic recovery stimulus, may affect the funds available to provide such additional relief in the future. Medicaid. The Medicaid program, created by the Social Security Act of 1965, is designed to provide medical assistance to individuals unable to afford care. Medicaid is a joint Federal and state program in which states voluntarily participate. Payment rates and services covered under the Medicaid program are set by each participating state. As a result, Medicaid payment rates and covered services may vary from state to state. Approximately 50% of Medicaid funding comes from the Federal government, with the balance shared by the state and local governments. The Medicaid program is administered by individual state governments, subject to compliance with broadly defined Federal requirements. The Balanced Budget Act of 1997 repealed the Boren Amendment to the Medicaid Act which had been interpreted by the Courts as establishing a Federal minimum standard for Medicaid rates payable to hospitals and nursing homes. Congress repealed the Boren Amendment in order to give states greater flexibility in establishing Medicaid payment methods and rates. The Boren Amendment required states to undertake a finding analysis and then to assure the Federal government that their Medicaid rates were reasonable and adequate to meet the costs that must be incurred by economically and efficiently operated hospitals in providing care to Medicaid recipients. In place of this minimum standard, Congress has mandated that states employ a rate setting process that requires prior publication and an opportunity for provider comment on the rates. This replacement requirement became effective for rates of payment on and after January 1, 1998. State Medicaid payment methodologies vary from state to state. The most common methodologies are state Medicaid prospective payment systems or state programs that negotiate payment rates with individual hospitals. Generally, Medicaid payments are less than Medicare payments and are substantially less than a hospital’s cost of services. In 1991 Congress passed legislation limiting the states’ use of provider-specific taxes and donated funds to bolster the states’ share and obtain increased Federal Medicaid matching funds. Certain states in which the Company operates have adopted broad-based provider taxes to fund their Medicaid programs in response to the 1991 legislation. Congress has also established a national limit on disproportionate share hospital adjustments (which are additional amounts required to be paid to hospitals defined as providing a disproportionate amount of Medicaid and low-income inpatient services). This legislation and the resulting state broad-based provider taxes have adversely affected the Company’s net Medicaid payments, but to date the net impact has not been materially adverse. The Federal government and many states are currently considering additional ways to limit the increase in the level of Medicaid funding, which also could adversely affect future levels of Medicaid payments received by the Company’s hospitals. Because the Company cannot predict precisely what action the Federal government or the states will take as a result of existing and future legislation, the Company is unable to assess the effect of such legislation on its business. Like Medicare funding, Medicaid funding may also be affected by health care reform legislation, and it is impossible to predict the effect such legislation might have on the Company. TRICARE. Some of the Company’s hospitals provide services to retired and certain other military personnel and their families pursuant to the TRICARE program. TRICARE pays for inpatient acute hospital care on the basis of a prospectively determined rate applied on a per discharge basis using DRGs similar to the Medicare system. At this time, inpatient psychiatric hospital services are reimbursed on an individual hospital per diem rate calculated based upon the average charges for these services by all psychiatric hospitals. The Company can make no assurance that the TRICARE program will continue per diem reimbursement for psychiatric hospital services in the future. 8
The Medicare, Medicaid and TRICARE programs are subject to statutory and regulatory changes, administrative rulings, interpretations and determinations, requirements for utilization review and new governmental funding restrictions, all of which may materially increase or decrease program payments as well as affect the cost of providing services and the timing of payments to facilities. The final determination of amounts earned under the programs often requires many years, because of audits by the program representatives, providers’ rights of appeal and the application of numerous technical reimbursement provisions. Management believes that adequate provision has been made for such adjustments. Until final adjustment, however, significant issues remain unresolved and previously determined allowances could become either inadequate or more than ultimately required. Commercial Insurance. The Company’s hospitals provide services to individuals covered by private health care insurance. Private insurance carriers either reimburse their policy holders or make direct payments to the Company’s hospitals based upon the particular hospitals’ established charges and the particular coverage program that provides its subscribers with hospital benefits through independent organizations that vary from state to state. The Company’s hospitals are paid directly by local Blue Cross organizations on the basis agreed to by each hospital and Blue Cross by a written contract. Recently, several commercial insurers have undertaken efforts to limit the costs of hospital services by adopting prospective payment or DRG-based systems. To the extent such efforts are successful, and to the extent that the insurers’ systems fail to reimburse hospitals for the costs of providing services to their beneficiaries, such efforts may have a negative impact on the results of operations of the Company’s hospitals. Health Care Reform, Regulation and Other Factors General.Health care, as one of the largest industries in the United States, continues to attract much legislative interest and public attention. Medicare, Medicaid, mandatory and other public and private hospital cost-containment programs, proposals to limit health care spending, proposals to limit prices and industry competitive factors are highly significant to the health care industry. In addition, the health care industry is governed by a framework of Federal and state laws, rules and regulations that are extremely complex and for which the industry often has the benefit of little or no regulatory or judicial interpretation. Although the Company believes it is in compliance in all material respects with such laws, rules and regulations, if a determination is made that the Company was in material violation of such laws, rules or regulations, its operations and financial results could be materially adversely affected. Licensure, Certification and Accreditation. Health care facility construction and operation is subject to Federal, state and local regulation relating to the adequacy of medical care, equipment, personnel, operating policies and procedures, fire prevention, rate-setting and compliance with building codes and environmental protection laws. Facilities are subject to periodic inspection by governmental and other authorities to assure continued compliance with the various standards necessary for licensing and accreditation. All of the Company’s health care facilities are properly licensed under appropriate state laws and are certified under the Medicare program or are accredited by the Joint Commission on Accreditation of HealthCare Organizations or the American Osteopathic Association (“Accredited”), the effect of which is to permit the facilities to participate in the Medicare/Medicaid programs. Should any Accredited facility lose its accreditation, and then not become certified under the Medicare program, the facility would be unable to receive reimbursement from the Medicare/Medicaid programs. Management believes that the Company’s facilities are in substantial compliance with current applicable Federal, state, local and independent review body regulations and standards. The requirements for licensure, certification and accreditation are subject to change and, in order to remain qualified, it may be necessary for the Company to effect changes in its facilities, equipment, personnel and services. Although the Company intends to continue its qualification, there can be no assurance that its hospitals will be able to comply in the future. Utilization Review. In order to ensure efficient utilization of facilities and services, Federal regulations require that admissions to, and the utilization of, facilities by Medicare and Medicaid patients be reviewed by a Federally funded Peer Review Organization (“PRO”). Pursuant to Federal law, the PRO must review the need for hospitalization and the utilization of services, denying admission of a patient or denying payment for services provided, where appropriate. Each of the Company’s facilities has contracted with a PRO and has had in effect a quality assurance program that provides for retrospective patient care evaluation and utilization review. 9
Certificates of Need. The construction of new facilities, the acquisition of existing facilities, and the addition of new beds or services may be reviewable by state regulatory agencies under a program frequently referred to as Certificate of Need. Except for Arkansas, Oklahoma, Pennsylvania, and Texas, all of the other states in which the Company’s health care facilities are located have Certificate of Need or equivalent laws which generally require appropriate state agency determination of public need and approval prior to beds or services being added, or a related capital amount being spent. Failure to obtain necessary state approval can result in the inability to complete the acquisition, the imposition of civil or, in some cases, criminal sanctions, the inability to receive Medicare or Medicaid reimbursement and/or the revocation of the facility’s license. State Hospital Rate-Setting Activity. The Company currently operates one facility in a state that has some form of mandated hospital rate-setting. The West Virginia Health Care Authority (“HCA”) requires that hospitals seeking an increase in rates must submit requests for increases to hospital charges annually. Requests for rate increases are reviewed by the HCA and are either approved at the amount requested, approved for a lower amount than requested or are rejected. As a result, in West Virginia, the Company’s ability to increase its rates to compensate for increased costs per admission is limited and the Company’s operating margin on its West Virginia facility may be adversely affected. There can be no assurance that other states in which the Company operates hospitals will not enact rate-setting provisions as well. Anti-kickback and Self-Referral Regulations. During 1998, the Federal government announced that reducing health care fraud was a top priority. As a result, the health care industry continues to be subjected to unprecedented scrutiny and a panoply of statutes, regulations and government initiatives intended to prevent those practices deemed fraudulent or abusive by the government, extensive Federal, state and local regulation relating to licensure, conduct of operations, ownership of facilities, addition of facilities and services and prices for services. In particular, Medicare and Medicaid anti-kickback, antifraud and abuse amendments codified under Section 1128B(b) of the Social Security Act (the “Anti-kickback Amendments”) prohibit certain business practices and relationships that might affect the provision and cost of health care services reimbursable under Medicare and Medicaid, including the payment or receipt of remuneration for the referral of patients whose care will be paid for by Medicare or other government programs. Sanctions for violating the Anti-kickback Amendments include criminal penalties and civil sanctions, including fines and possible exclusion from the Medicare and Medicaid programs. Pursuant to the Medicare and Medicaid Patient and Program Protection Act of 1987, the DHHS has issued regulations that describe some of the conduct and business relationships permissible under the Anti-kickback Amendments (“Safe Harbors”). The fact that a given business arrangement does not fall within a Safe Harbor does not render the arrangement per se illegal. Business arrangements of health care service providers that fail to clearly satisfy the applicable Safe Harbor criteria, however, risk increased scrutiny by enforcement authorities. Because the Company may be less willing than some of its competitors to enter into business arrangements that do not clearly satisfy the Safe Harbors, it could be at a competitive disadvantage. In addition, Section 1877 of the Social Security Act, enacted on December 19, 1989, which restricts referrals by physicians of Medicare and other government-program patients to providers of a broad range of designated health services with which they have ownership or certain other financial arrangements, has been amended numerous times since initial enactment, the most recent of which was amended effective January 1, 1995, to significantly broaden the scope of prohibited physician referrals for certain services to entities with which they have financial relationships (the “Stark Law” or the “Self-Referral Prohibitions”). Final rules implementing the Self-Referral Prohibitions were adopted by DHHS on August 14, 1995 (the “Stark I” rules) and January 4, 2001 (the “Stark II” rules). Many states have adopted or are considering similar legislative proposals, some of which extend beyond the Medicaid program to prohibit the payment or receipt of remuneration for the referral of patients and physician self-referrals regardless of the source of the payment for the care. The Company’s participation in and development of joint ventures and other financial relationships with physicians could be adversely affected by these amendments and similar state enactments. The Company systematically reviews all of its operations on an ongoing basis to ensure that it complies with the Social Security Act and similar state statutes. In addition, the Company has in operation a corporate compliance program at all of the Company’s hospitals, which is an ongoing, working program to monitor and promote continuing compliance with these statutory prohibitions and requirements. (See “Compliance Program” below for further discussion) 10
Both Federal and state government agencies have announced heightened and coordinated civil and criminal enforcement efforts in accordance with the requirements of recent Federal statutory enactments including the Health Insurance Portability and Accountability Act of 1996. The Company is unable to predict the future course of Federal, state and local regulation or legislation, including Medicare and Medicaid statutes and regulations. Further changes in the regulatory framework could have a material adverse effect on the Company’s financial condition. Conversion Legislation. Many states have enacted or are considering enacting laws affecting the conversion or sale of not-for-profit hospitals. These laws generally require prior approval from state attorney generals, advance notification and community involvement. In addition, state attorney generals in states without specific conversion legislation may exercise authority over these transactions based upon existing law. States are showing an increased interest in overseeing the sales or conversions of not-for-profit hospitals. The adoption of conversion legislation and the increased review of not-for-profit hospital conversions may make it more difficult for the Company to acquire not-for-profit hospitals, or could increase acquisition costs in the future. See “Business Strategy” in this Item 1. Environmental Regulations.The Company’s health care operations generate medical waste that must be disposed of in compliance with Federal, state and local environmental laws, rules and regulations. The Company’s operations, as well as the Company’s purchases and sales of facilities, are also subject to compliance with various other environmental laws, rules and regulations. Such compliance does not, and the Company anticipates that such compliance will not, materially affect the Company’s capital expenditures, financial position or results of operations. Compliance Program. During 1996 the Company began developing, and in 1997 formally implemented, a Corporate compliance program to supplement and enhance its existing ethics program. The Company believes its current compliance program meets or exceeds all applicable Federal guidelines and industry standards. The program is designed to raise awareness of various regulatory issues among employees and to stress the importance of complying with all governmental laws and regulations. As part of the program, the Company provides ethics and compliance training to every employee. Management encourages all employees to report, without fear of retaliation, any suspected legal or ethical violation to their supervisors, the compliance officer on staff at the hospital or the Company’s corporate compliance officer. In addition, the Company maintains a 24-hour toll-free telephone hotline, which is manned by an independent company, so that employees can report suspected violations anonymously. HIPAA.The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) was enacted on August 21, 1996. HIPAA is an effort to encourage overall administrative simplification and enhance the effectiveness and efficiency of the health care industry. It mandates the adoption of standards for the exchange of electronic health information. The two key factors of HIPAA are accountability and portability. Accountability refers to the attempt of the legislation to ensure privacy and security of patient information and portability refers to the legislation’s intent to ensure that individuals can take their medical and insurance records with them when they change employers. HIPAA mandates new security measures, sets standards for electronic signatures, standardizes a method for identifying providers, employers, health plans and patients, requires that the health care industry utilize the most efficient method to codify data and may significantly change the manner in which hospitals communicate with payors. These are significant and potentially costly changes to the health care industry. Although proposed security rules were issued on August 11, 1998, DHHS has yet to adopt final rules implementing the security and integrity portions of HIPAA. It is anticipated that final security rules will be promulgated and adopted on or about December 27, 2002. On December 28, 2000, DHHS published final privacy rules implementing the privacy portions of HIPAA, which were subsequently amended by CMS on August 14, 2002. The final privacy rules were effective April 14, 2001. The privacy rules give patients greater access to their own medical records and more control over how their personal health information is used and disclosed. The privacy rules address the obligations of health care providers to protect health information. Providers, including the Company, have until April 14, 2003 to comply with the privacy rule’s requirements. Sanctions for failing to comply with HIPAA include criminal penalties and civil sanctions. 11
The Company filed a plan with the Secretary of DHHS as permitted under The Administrative Simplification Compliance Act (the “ASCA”). This law was signed by President Bush on December 27, 2001. The ASCA granted covered entities a one-year extension (until October 16, 2003) to be in compliance with the electronic submission requirements of all HIPAA transactions as defined in the rule. The Company anticipates that it will be in compliance with the transaction standards by October 16, 2003. The Company also anticipates that it will be able to fully comply with the HIPAA requirements and regulations as they have been adopted to date. The Company has initiated a plan which will allow it to comply with the currently adopted regulations. Estimating the cost of such compliance is difficult and no such estimations have been made at this time. Based on its current knowledge, however, the Company believes that the cost of its compliance will not have a material adverse effect on its business, financial condition or results of operations. Employees and Medical Staff As of September 30, 2002, the Company had approximately 23,000 full-time and part-time employees, approximately 600 of whom were covered by three collective bargaining agreements. The Company’s corporate office staff consisted of approximately 100 people at that date. The Company believes that its relations with employees are satisfactory. In general, the staff physicians at the Company’s acute care and psychiatric-only hospitals are not employees of the Company. The physicians may also be staff members of other hospitals. The Company provides physicians with certain services and assistance. The Company does employ approximately 100 physicians, approximately one-half of whom are primary care physicians located at clinics the Company owns and operates. In addition, the Company’s hospitals provide emergency room coverage, radiology, pathology and anesthesiology services by entering into service contracts with physician groups which are generally cancelable on 90 days notice. Liability Insurance Through September 2002, the Company insured for its professional liability risks under a “claims-made” basis policy, whereby each claim is covered up to $1 million per occurrence, subject to a $100,000 deductible (with an annual deductible cap of $6.1 million). Liabilities in excess of these amounts were covered through a combination of limits provided by commercial insurance companies and a self-insurance program. Accruals for self-insured professional liability risks are determined using asserted and unasserted claims identified by the Company’s incident reporting system and actuarially determined estimates based on Company and industry historical loss payment patterns and have been discounted to their present value using a discount rate of 6.0%. Although the ultimate settlement of these accruals may vary from these estimates, management believes that the amounts provided in the Company’s consolidated financial statements are adequate. If actual payments of claims exceed projected estimates of claims, the Company’s insurance accruals could be materially adversely affected. Effective October 1, 2002, in response to difficulty in obtaining primary insurance from commercial companies at reasonable rates, the Company formed a wholly owned insurance subsidiary in order to self-insure a greater portion of its primary professional and general liability risk. The captive subsidiary reinsures risk up to $1 million per claim and $3 million in the aggregate per hospital, and further acts as an excess insurer for all hospitals in combination with three commercial insurance companies. The Company believes that its insurance is adequate in amount and coverage. There can be no assurance that in the future such insurance will be available at a reasonable price or that the Company will not have to increase its levels of self-insurance. Available Information The Company maintains an internet website located atwww.hma-corp.com. The Company makes available through such website its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed pursuant to Section 13(a) or 15(d) of the Securities Exchange Act as soon as reasonably practicable after electronically filing such material with the Securities and Exchange Commission. 12
Item 2. Properties The Company’s acute care hospitals offer a broad range of medical and surgical services, including inpatient care, intensive and cardiac care, diagnostic services and emergency services that are physician-staffed 24 hours a day, seven days a week. The Company also provides outpatient services such as one-day surgery, laboratory, x-ray, respiratory therapy, cardiology and physical therapy. At certain of the Company’s hospitals, specialty services such as oncology, radiation therapy, CT scanning, MRI imaging, lithotripsy and full-service obstetrics are provided. The Company’s psychiatric care operations consist of two psychiatric-only hospitals: one 64-bed and one 70-bed intensive residential treatment hospital. 13
The following table presents certain information with respect to the Company’s facilities as of September 30, 2002. For more information regarding the utilization of the Company’s facilities, see Item 1 “Business — Selected Operating Statistics.” |
