1 Bad Debt Rising: When to Sell Your Accounts Receivable This project is a collaborative effort by Premium Asset Recovery Corp. and the Healthcare Financial Management Association. They merged their identities, their facilities, and their mission statements. And then they attempted to merge their bad debt. In the case of two large Midwest hospitals that merged in 1997, determining what to do with a combined bad debt of more than $100 million was one of the most difficult decisions hospital administrators had to make. Faced with the challenge of how to address the hospital s unpaid accounts receivable was a team of financial executives from the two hospitals the CFOs, patient accounts directors, and controllers. Debbe Winkle, former interim director of patient accounts for one of the hospitals, was on the team. She recalls that, following the merger, leadership was focused on such things as combining the two hospitals computer systems and determining which accounts were at which collection agencies. The last thing we wanted to be dealing with was bad debt, she says. One option the team explored was moving the accounts from a primary agency to a secondary agency. Not all of us wanted to pursue that option, says Winkle, who owns Outsource Receivable Services in Indianapolis. Once you ve written your A/R off to bad debt and sent it somewhere else, it can be very cumbersome transferring all that data from one agency to another. The hospital s other option was to sell its bad debt. In the 1990s, however, it was rare for hospitals to sell their accounts receivable to a debt buyer, and Winkle and the rest of the team wanted to ensure that the hospital maintained a positive image in the community. Our number one concern was that once we sold the accounts, we would lose all control, Winkle says. We didn t want a bunch of bad public relations in the community, especially right after a merger. JULY 2004
2 Traditional Healthcare Account Flow Strategy In-House EBO/Agency Follow-up Primary Agency Warehouse Discharge Day 0 Initial Billing & Recovery Process Retain/ Outsource Day Insurance Follow-up Appeal Re-billing Charge- Off Day Collection/? Retirement Litigation of Charge-off Day Accounts Winkle is not alone in her fear. In fact, the major concerns expressed by CFOs and other hospital leaders who are considering selling their bad debt are, Will I lose control over my patient accounts? And will this result in bad public relations for my hospital? As Winkle found, choosing a debt buyer carefully can help hospital leaders remain in control throughout the process. I was skeptical at first, admits Winkle. All of us in patient financial services deal with angry patients, and the last thing we wanted was to make them more angry. But when we sold our debt, we maintained control through the entire process. I don t remember hearing any patient complaints during or after the sale. An Industry Perspective According to Dennis Hammond, executive director of the Debt Buyers Association, the sale of bad debt is on the rise. Hammond estimates that approximately $50 billion worth of bad debt is sold each year. Most bad debt sales comprise credit cards (70 percent), followed by auto loans, telecommunications, and the retail business. According to Hammond, healthcare debt currently makes up only a small percentage of sales. Some believe this is a growth area, particularly in light of the rising bad debt in hospitals and the compression of their operating margins. To those without an extensive background in health care, the prospect of purchasing bad debt is daunting. However, although these issues are complicated, they can be and have been resolved by specialists who buy healthcare bad debt. At the same time, the public relations concerns of healthcare providers are significantly different from those of lenders and credit card companies. Although the concept of selling bad debt is attracting the attention of hospital CFOs and financial managers, the recent negative publicity surrounding billing and collection practices has forced closer scrutiny, and compels hospitals to be cautious in choosing a partner for A/R placement. The Wall Street Journal has recently published numerous articles highlighting hospitals use of extreme collection practices. 1 As a result, hospitals throughout the country are reevaluating their billing and collection processes. Concerns about aggressive collection practices and charges paid by the uninsured have led to a formal probe by the U.S. House of Representatives House Energy and Commerce Subcommittee on Oversight and Investigations. Also, in June 2003, the American Hospital Association sent an advisory to its members urging them to review their billing and collection policies and practices, consider revisions, and assess how their policies are actually carried out by staff who work with patients. HFMA s PATIENT FRIENDLY BILLING project also provides tools and guidelines to help improve the situation. 2 1 Hospitals Try Extreme Measures to Collect Their Overdue Debt, The Wall Street Journal, Oct. 30, 2003, p. A1.
3 Many hospital administrators argue that they are struggling to make ends meet because of the increasing number of self-pay accounts and uninsured patients (more than 40 million nationwide). According to Zimmerman & Associates, self-pay accounts result in the highest number of gross days revenue outstanding in hospitals 208 days, compared to a national average for overall gross days revenue outstanding of 64 days. 2 Therefore, more hospitals are looking for new ways to manage their bad debt. If you are a CFO or director of patient financial services and you want to realize some value from all the bad debt you have charged off over the past few years but don t want to create patient complaints or PR problems, what should you do? How do you reconcile these seemingly inconsistent goals? Reasons to Sell Your A/R Most hospitals manage their unpaid self-pay receivables internally for approximately days, during which all third-party payment options are resolved and the remaining balance is determined. At around 120 days, many hospitals charge off their self-pay receivables and refer them to a collection agency. Recovery rates vary greatly, but have been as high as 18 to 20 percent, with an average commission in the same range. Key Terms and Definitions Archived accounts. A large pool of self-pay patient accounts receivable that has accumulated, unpaid, over a period of up to six years or more, typically at a primary collection agency. Buy-back: A provision in which hospitals can, under certain conditions, buy back accounts that may subsequently be identified as sensitive or requiring higher levels of attention. Forward flow: A type of purchase in which the hospital agrees to sell accounts on a periodic schedule at an agreed price, as they reach an agreed age. For example, each month, the hospital may place uncollected accounts that its primary agency has worked for six months. Recourse/nonrecourse: When accounts are sold on a recourse basis, the debt buyer has the opportunity to return accounts to the hospital usually because it fails to collect the account. A nonrecourse arrangement, on the other hand, prevents the buyer from returning any accounts for a refund. Resale: The process by which a debt buyer resells a hospital s accounts to smaller, individual debt buyers who may have a better chance collecting them. For example, some states (e.g., Florida, Massachusetts, Texas), are considered to be more debtor friendly than others. Debt buyers will sometimes resell accounts that originate in these states because they know it will be difficult to collect these accounts. Although this practice is common with accounts originated in the financial services industry, in general, hospitals should avoid debt buyers who resell accounts. Hospitals should make it clear to the buyer that the accounts are not to be resold, and should require the contract to so stipulate. Statute of limitations: State laws that set the time after which a party is effectively precluded from filing suit. The amount of time varies depending on the basis for the suit. In the case of hospital bad debt, the basis is breach of contract, and the statutes of limitation vary from two to 20 years. Although accounts may generally be collected after the applicable statutes of limitation have expired, collection is much more difficult, and hospitals and their agents and debt buyers typically abandon collection efforts at this point. 2 Revenue Cycle Management: Industry Key Performance Indicators 2004, Zimmerman and Associates,
4 In most cases, the hospital does not recall accounts from the primary agent, and unpaid accounts simply remain with the agency until they lapse under the state s statute of limitations; these statutes vary between two and 20 years. Healthcare providers usually fully reserve patient accounts after 180 days from billing. Patient accounts that are fully reserved are left unworked by in-house staff or placed with a collection agency, says Doug Womer, a consultant for Matrix Dynamics, Inc., and a former CFO and regional health system vice president. This process results in zero recoveries or time-induced recovery to capture dollars for which the provider could benefit immediately under a purchase agreement. CFOs are constantly weighing the value of staffing to account type collectibility against costs expended to collect. In-house staff will most likely focus on recently billed accounts for maximum reimbursement versus pursuit of older accounts that require more time and effort to collect lower percentages of billed charges. Selling accounts can be an effective way for hospitals to accelerate cash flow and optimize revenue. When hospitals place their bad debt with a nonrecourse purchaser, they book an immediate gain on accounts that they had otherwise written off to bad debt, and the proceeds drop directly to the bottom line. Selling accounts also produces a steady, predictable cash flow stream versus the uncertainty of cash flow and timing from a traditional contingency placement. From a liquidity standpoint, selling bad debt can increase a hospital s cash on hand. When hospitals refer their bad debt to a primary or secondary collection agency, it can take from 18 to 24 months to recover any money. On the other hand, when hospitals sell their delinquent accounts to a debt buyer, they receive payment immediately. However, these benefits are realized only by carefully managing the process of selling bad debt. What Type of Accounts to Sell And Not to Sell A hospital can sell its accumulated archived accounts going back several years from the date of sale. Hospitals may also agree to sell accounts to a buyer in the future on an ongoing basis by entering a forward-flow agreement, in which the hospital sells certain accounts to the buyer at an agreed-upon price after an agreed-upon period. Typical triggers might be accounts 15 months following the date of service, or nine months after referral to the primary agency. Newer accounts tend to have more value, but accounts with dates of service up to six years or more can be sold. For different reasons, some accounts are not salable, and in other cases, the hospital may choose not to sell. For instance, the buyer will want to exclude accounts in which: The patient has declared bankruptcy The patient is deceased or incarcerated The account meets a hospital s charity guidelines The account has been otherwise closed or recalled by the hospital It is in the best interest of the hospital to retain accounts: When the hospital or its agency has filed a complaint on an account in a court of law When an account is currently on a payment plan at the hospital or agency The provider should sell only those accounts that are not otherwise paying, excluding those that are impossible or inappropriate to collect. Benefits Selling its accounts receivable can accelerate a hospital s cash flow and optimize revenue because the hospital can immediately recover accounts that it had written off as bad debt. This allows the hospital to increase its liquidation rate on bad debt. In addition 4
5 to the cash from the sale, most hospitals report an increase in recovery from their primary agency after they begin to recall accounts to sell. The administrative burden is reduced after the accounts are sold, because the hospital no longer needs to update account information or manage an agency relationship. Also, a hospital that sells its bad debt often learns something valuable about its own A/R management (e.g., weaknesses in control, audit, data management, etc.) and the procedures of its collection agencies during the process. When accounts have been referred to a collection agency, the collector is the agent of the hospital; the hospital then has a duty to supervise the agent. Cases have held, however, that if the agent is too closely supervised, the principal (hospital) may become liable for the acts of the agent. Recent case law indicates that hospitals may actually reduce collection risk by selling the accounts. In the case of Neff v. Capital Acquisitions & Management Co., a creditor sold its bad debt to an unrelated third party. The debtor alleged that the balance was incorrect, and that the creditor was responsible for the error under the Fair Debt Collections Practices Act (FDCPA). The Seventh Circuit Court of Appeals held that once the account was sold and the creditor retained no residual ownership interest, the original creditor was no longer a debt collector under the FDCPA and could not be held liable for the acts of the third-party purchaser. Potential Pitfalls Despite the potential benefits, many financial managers fear losing control after they sell their accounts to a buyer. However, in most instances, selling one s accounts to a buyer generates only a fraction of the calls from patients compared with referring them to a primary agency. Sellers maintain control by contractually prohibiting the resale of accounts, and debt purchasers generally allow sellers to recall accounts under identified circumstances. Healthcare financial managers can avoid potential pitfalls by checking a debt buyer s references and understanding what collection tools the buyer will use. It s important to make sure the buyer s practices are consistent with the hospital s ethics, mission, and values. It s also important to make sure the buyer is licensed to practice business in the state, and that the buyer will comply with all federal and state guidelines. Under HIPAA, all buyers must sign a business associate agreement. Selling bad debt could have a negative effect on bond covenants, because some covenants restrict the sale of a hospital s A/R. Therefore, financial managers may want to consult the hospital s legal department before considering a sale to determine whether there are bond covenants that would restrict the sale. The fact that the bad debt has been zeroed out on the balance sheet usually resolves any concerns about such covenants. Avoiding Potential Pitfalls Two of the most common concerns among healthcare financial managers who are considering selling their bad debt are loss of control and the potential harm to patients through harsh collection practices, which can also result in bad public relations. Here are some ways to avoid potential pitfalls: Check the references of a potential buyer. Choose a buyer with experience in the healthcare industry (e.g., find out what portion of their business is medical versus nonmedical). Make sure the buyer handles accounts sensitively, minimizing patient complaints. Make sure the buyer is licensed to practice in your state (if a license is required), and that it will comply with all federal and state laws and regulations. Ask how the buyer is financed. Make sure the contract grants the hospital the right to recall a certain number of accounts that may subsequently be identified as sensitive or requiring higher levels of attention. Make sure the contract prohibits the resale of accounts. 5
6 Archive Portfolio Estimation Sample Memorial Hospital Annual Gross Revenue $ 250,000,000 Average % Bad Debt (4.0%) $ 10,000,000 Agency Liquidation (20.0%) $ 2,000,000 Other closures (20.0%) $ 2,000,000 Annual Net Bad Debt $ 6,000,000 Total Archive Portfolio (5.0 yrs) $ 30,000,000 Annual Forward Flow Estimate Sample Memorial Hospital Annual Gross Revenue $ 250,000,000 Average % Bad Debt (4.0%) $ 10,000,000 Agency Liquidation (20.0%) $ 2,000,000 Other closures (20.0%) $ 2,000,000 Total Annual Forward Flow $ 6,000,000 Types of Arrangements The two types of debt buying arrangements are the one-time sale of archived accounts and a forward-flow arrangement. With the former, the hospital provides the buyer all the charged-off and uncollected accounts going back a number of years typically back to the statute of limitations and receives a lump sum for those accounts. Under a forward-flow arrangement, the hospital agrees to sell accounts to the buyer on a prospective basis at an agreed price, as those accounts reach an agreed age (typically monthly). Some hospitals enter into an agreement to sell both the archived and forward flow accounts; others choose to do only one or the other, for various reasons. Another key consideration is whether the buyer offers a recourse or nonrecourse sale. With a recourse sale, the buyer is allowed to return accounts to the hospital for a refund of the purchase price (typically, this happens when the buyer is unable to collect the account). On the other hand, a nonrecourse sale is as is (other than accounts that were not meant to be sold, such as the account of a deceased person). This is important in ensuring that the sale qualifies as nonrecourse, permitting the booking of an immediate recovery, and assuring the seller that all risk of collection has passed to the buyer at the time of sale. Choosing a Debt Buyer Hospitals depend on their reputations as caring institutions, and choosing a debt buyer should reflect a hospital s mission, vision, and strategies. It s important to sell to a third-party purchaser who will handle the hospital s bad debt professionally and compassionately, and without generating patient complaints. Finding the right purchaser should involve checking references with other healthcare providers who have used the buyer. You should also ask a purchaser the following questions: Does the purchaser handle accounts sensitively, minimizing patient complaints? Are the purchaser s employees well trained and professional? Does the purchaser specialize in healthcare receivables? Does the purchaser itself service the accounts, or does it resell or outsource accounts to third parties? Will the provider be able to recall accounts that prove particularly problematic? It s important to make sure that the people you sell your accounts to are the same people who are going to be working your accounts, and not some middleman, cautions Womer. This could result in bad public relations. Meet the people who are going to be buying and working your accounts, not just buying them. 6
7 Finally, it s important that the debt buyer maintain a good working relationship with the agency that has previously handled the hospital s accounts. Many hospitals stop updating their records when the account is written off. If so, the purchaser will need to receive the data file of the accounts to be sold from the agency. When you sell to a debt buyer, says Winkle, the agency needs to prepare all the files for the debt buyer. Therefore, the hospital needs to maintain a good relationship with the agency, and so does the debt buyer. Many debt buyers are not in the business of acting as primary collection agents. Therefore they view their services as a logical add-on to the A/R management cycle after the agency has attempted to collect the debt. Obtaining a Proposal from a Debt Buyer Most debt buyers will conduct a comprehensive evaluation of a hospital before they provide the hospital with a proposal. Pricing depends on a number of factors, including account type, age of accounts, payer mix, geographic region and demographics, average account balance, previous agency liquidation, and resale provisions. A typical contract contains provisions including a description of the accounts (age, balances, etc.), whether the sale will be limited to archived accounts or will include forward flow accounts, and how the buyer will respond to questions from patients regarding the accounts. The quality of a purchaser s underwriting process and its contract is an early indicator of its level of professionalism. Before entering into an agreement, hospital leaders would be wise to consider the following collection parameters (to be agreed upon in writing): Collectors will receive thorough training in the FDCPA and in any collection guidelines or ethical practices stipulated by the provider. Collectors will handle accounts with courtesy and professionalism, minimizing patient complaints. Collectors will be adequately monitored to ensure compliance. Collectors will be restricted or prohibited from using body attachments and liens on residences. Provision will be made for the hospital to recall accounts that may subsequently be identified as sensitive or requiring higher levels of attention. Collectors will be trained in and adhere to HIPAA privacy rules. Compliance will be confirmed from time to time. After the Sale Both the seller and the buyer have certain responsibilities following a sale of bad debt. The seller is responsible for providing the buyer with access to patients account records so the buyer can address any patient questions. Generally, this is handled in the same manner a hospital provides access to its primary agency. The seller is also responsible for forwarding any payments that are sent to the hospital on accounts that were sold to the buyer. The buyer s primary responsibility is to collect the accounts as agreed, using collection practices as discussed with the hospital and upholding the hospital s mission by positively managing its patient relationships. At the end of the day, however, selling accounts is an individual decision. At some point all the hassles and the headaches make it tempting to sell, but hospitals need to determine on a case-by-case basis if selling their accounts is the best option for them, Winkle adds. 7
8 This educational supplement sponsored by About HFMA HFMA is the nation s leading membership organization for more than 33,000 healthcare financial management professionals employed by hospitals, integrated delivery systems, managed care organizations, ambulatory and long-term care facilities, physician practices, accounting and consulting firms, and insurance companies. Members positions include chief executive officer, chief financial officer, controller, patient accounts manager, accountant, and consultant. HFMA offers educational and professional development opportunities, information on key issues, technical data, and networking opportunities with the ultimate goal being to create a more supportive environment in which members do their business. For more information, visit HFMA s web site at Premium Asset Recovery Corp. Established in 1998, Premium Asset Recovery Corp. is a financial service organization that has taken a unique approach to the resolution of defaulted self-pay medical receivables. PARC s primary business is the purchase of charged off, non-performing self-pay medical debt portfolios from healthcare providers and the collection of these debts as the new owner. PARC offers accounts receivable valuations at no cost to qualified facilities. For more information, visit PARC s web site at or call toll free , extension 1015.