Continuing Care Retirement Communities: Review the Financial Aspects
September 1, 2006
By Laurie Duncan, CPA, MHCA
Mr. and Mrs. Arthur have been your tax clients for many years. After retiring, they asked you to help them review financial planning documents and understand about withdrawals from their individual retirement accounts (IRA). Recently, they've started looking at retirement communities. Mrs. Arthur wants to move from their home, but her husband thinks it's too expensive. Plus, they are very confused about the contract options shown in marketing materials. How do you properly advise them?
Anyone investigating retirement community options easily understands that making a decision is, in fact, not easy. There is a myriad of housing and health care options available to most retirees. This article focuses on one type: retirement communities that offer independent housing plus health care services, often called continuing care retirement communities, or CCRCs.
Before the advent of assisted living, CCRCs primarily offered one type of contract: a paid-in nonrefundable fee with guaranteed access to health care and a stable monthly cost, no matter the level of care needed. This traditional CCRC contract is a type of long-term care insurance tied to a specific building or community.
Some early CCRCs found themselves in financial difficulty because they did not properly account for the entrance fees, earning the income quickly while keeping the obligation of caring for a resident. In 1989–1990, the American Institute of CPAs (AICPA) developed a Statement of Position (90-8), "Financial Accounting and Reporting by Continuing Care Retirement Communities." The standards have been included in and superseded by the AICPA Audit and Accounting Guide, Health Care Organizations. The guidelines are important to the accountant, but would overwhelm the client. The advisor's role is to evaluate, explain and simplify the CCRC contract options in light of the client's finances.
Recent changes in the industry are confounding both advisors and retirees. In the Washington, DC metropolitan area, at least three communities have stopped offering the traditional contract. Two of the most successful communities only offer Type C contracts (see below,) and the resident pays market-rate fees for different levels of care. Complicating matters further, some communities are beginning to offer a discount on fees if the consumer has long-term care insurance.
Knowing the basic types of contracts is crucial. There are five types of contracts and the definitions are standardized for most states and communities1:
- Type A (Extensive or Traditional) Agreement: An entrance fee covering independent up to unlimited specific health-related services with little or no substantial increase in monthly fees.
- Type B (Modified) Agreement: An entrance fee including independent up to unlimited specific health-related services with relatively stable monthly fees; however, there may be increased fees as health care services are used.
- Type C (Fee-for-Service) Agreement: An entrance fee covering independent and supportive services. Access to health care services is guaranteed, but it is often charged at market rates.
- Type D (Rental) Agreement: Residents pay rent for housing and services, but there is no guarantee for access to health care services. Residents usually have priority for admission to health care facilities, but are not guaranteed care.
- Equity Agreement: A resident purchases real estate as a condominium or a cooperative that may be resold later. Residents usually have priority for admission to health care facilities, but are not guaranteed care.
Working With the Information
To determine which contract is best, it is critical to look at a health care scenario over time, normally 8–10 years. Envisioning periods of ill health is a key part of the planning process. Merely looking at expenses while someone is independent understates future expenses. For the purposes of this article, the illustrations are based upon the following2:
- The two clients are independent and plan to move into a two-bedroom apartment.
- Each person will spend three years in every one of the three levels of care: independent, assisted living and nursing.
- Returns on investments, increases in fees and discounts rates equal 3.5 percent.
The economic risk-benefit for both the community and the consumer are relatively simple. The facility is "betting" the resident does not outlive the entrance fee; the consumer hopes to live long enough and use enough services to reap the benefit of the entrance and annual fees.
In a well-structured CCRC, the contracts should be revenue neutral to the retirement community. To illustrate, the CCRC offers three entrance fees and an associated monthly maintenance fee. The first hurdle for the consumer is to appreciate that the fee is more than rent — it includes prepaying future health care costs. In Table 1, the ending figure is derived by:
Entrance Fee + Accumulated Monthly Fees + "Lost" Investment – PV of Refund = TOTAL COST
The example in Table 1 demonstrates the impact of higher monthly fees paid over time offsetting a lower entrance fee, and shows that the less expensive entrance fee in year one may be more costly by year nine. Understanding this financial dynamic counters a frequent first reaction: "I will not choose the
Type A contract because it is too expensive and I do not get money back!"
Impact of Contract Choice Upon Cash Flow Upon Assets
The prior example does not include the client's income or compare it to the monthly expenses. Assume the couple has $850,000 in assets after they sell a home, and their income is $30,000 per year.
Obviously, the clients will invade their capital, and normal financial planning would caution against this. However, as retirees approach their 80s, the planning paradigm shifts. Clients have saved for a "rainy day" and this may be it.
Can they still afford to move into the community? If the couple chooses the Type A contract (Table 2), the answer is "yes," because they have stabilized future health care expenses at $4,500 for them both. Even though they are invading their capital, they are doing so at a minimal amount each year. When using this method, clients should understand that the "life" of assets is not a financial predictor, but a ratio for comparison. It is one way to contrast options and to assess the relative strength of assets to cover costs of care.
What would happen if they choose the Modified Contract because it seems less expensive (Table 3)? While the couple would probably not run out of money, they could invade their remaining assets by $20,000–$35,000 each year, reducing the number of years their assets could last.
Many clients argue that $850,000 will cover any health care needs, and they prefer to rent (Table 4) or stay at home. If the individuals do not have long-term care insurance, the costs of skilled nursing care can overwhelm their ability to pay.
If both clients required nursing facility care, annual costs could exceed $200,000 per year, consequently reducing income from the assets and shortening the "life" of the assets. (Note: Hiring 24-hour care is NOT less expensive.)
Many accountants, families, financial planers and attorneys speak about "Medicaid planning" as a way to preserve assets for heirs and still obtain care. This topic is well beyond the scope of a short article, but it seems a false hope or even a mirage. The regulations are changing, making it harder to transfer money prior to institutionalization. More importantly, most people do not want to end their days in a Medicaid nursing facility bed.
This is a short introduction to the topic. There are other ways to evaluate a community: quality of care, suitability to personal tastes, organizational stability and sources for unfunded or benevolent care. These may well be beyond the scope of your services, but you will call upon other professionals such as elder law attorneys, financial planners or geriatric care managers.
As an accountant, you are well poised to look at the financial statements presented in the disclosure materials the community gives the resident before contract signing. The CARF-CCAC workbook, Financial Ratios and Trend Analysis for CCRCs, details profitability, liquidity and capital structure ratios for CCRCs. The data is presented by year, contract type and provider type.
What a trusted accountant can do is simplify the financial aspects of the contracts and compare communities and their contracts properly. Initial "sticker shock" should not push a retiree to one make an erroneous decision based on misinterpretation of the options.
1. Source: Financial Ratios and Trend Analysis for CCRCs, CARF-CCAC, Commission on Accreditation of Rehabilitation Facilities-Continuing Care Accreditation Commission, www.carf.org.
2. Source: Fees are generally based on figures from Goodwin House, an accredited CCRC in Northern Virginia.
Laurie Duncan, CPA, MHCA, is president and founder of Choices for Aging, which provides elder care management, retirement community consultation and money management services. A 30-year veteran in the field of aging, Duncan is a former nursing home and retirement community administrator and director of a rehabilitation agency.