By Jack Cumming
Sound finances are the foundation for business trust. For entrance fee CCRCs, trust is even more foundational. Where else do people trust you with a huge investment to start? The obvious expectation is that you will be there for them later when they have nothing more than trust to protect them. Where else does a business ask its customers for such a high trust commitment?
Financial Integrity
Where else? In insurance, of course. People pay insurers large single sums for life annuities to give them an income for life. Those single-sum investments are protected by laws that put consumers first and assure that the annuities, within limits, will be paid even if the insurance company fails.
Residents pay entrance fees thinking it’s similarly a contractual prepayment of a portion of lifetime monthly and care fees. That’s a lot like an annuity: a large payment upfront in return for a lifetime income stream. Providers, though, often think differently. Many, especially “not-for-profits,” require entrance fees thinking of them as equity capital to secure debt and other obligations.
Accountants view entrance fees as contract prepayments to be amortized without interest into income. Actuaries view entrance fees as a stochastic prepayment of future expenses. Wow, those varying interpretations of the same thing are confusing and misleading.
Glaring Inequity
The lack of financial principles and safeguards like those that shield insurance annuity policyholders leaves entrance fee residents at risk. Arguably, too, not only are entrance fees riskier than insured annuities, but residents, who commit to an expectation of lifelong residency, have more at stake than most annuity policyholders. This is an industry and regulatory lapse at the expense of those who need protecting.
Insurance companies employ actuaries to ensure that balance sheets include adequate financial reserves. Funded reserves (above the line) are essential to sound financing. This is equally true for annuities and for entrance fee funded contractual commitments.
Reserving on the Cheap
While actuaries typically make these calculations for annuity insurers, many organizations requiring entrance fees don’t employ actuaries. GAAP (“generally accepted accounting principles”) accounting includes a reserving methodology that ignores the interest earnings on entrance fees. Annuity insurers include interest in their reserving. The accounting rule does not. That tips the scales and undermines balance sheet integrity. GAAP “codifications” (rules) are not always as principled as would be desirable.
Intriguingly, there is a publicly accessible table of conservatively calculated annuity rates that can be used to value entrance fee liabilities. The American Council on Gift Annuities annuity rates can be used as a straightforward, conservative quantification of lifetime obligations. Annuity values are the reciprocals of the promulgated ACGA “return” rates.
The reserve calculation is simple. Calculate the reduction in monthly rates from that charged by an equivalent month-to-month rental property. Multiply the reduction by the relevant unit annuity rate. Be sure to adjust for the difference between monthly and annual payouts. Sum the results up to the corporate total. Enter it as “deferred revenue from entrance fees” or something equivalent. It might replace an accounting euphemism like “amortization of accommodation fees” or some similar labeling.
Actuarial Refinement
To be clear, we recommend that entrance fee CCRCs employ qualified actuaries for these calculations just as they employ certified public accountants for conformance with GAAP rules. Qualified actuaries are able to match actual community mortality with other data to bring greater precision to the projections. ACGA’s charitable gift annuity rates are calculated to be conservative.
Actuaries can also consider other contingencies, like withdrawal rates and refund obligations. Beyond providing more nuanced liability valuation, actuaries can help educate the management team, and resident leaders, on the soundness of the community.
Byproduct Benefits
It may be that there are some residents and prospective residents who find a benefit in the entrance fee business model. If so, charitable gift annuities can be an attractive alternative to the conventional entrance fee approach. It’s limited to 501(c)(3) qualified not-for-profit senior housing businesses. Here’s how it works.
A prospective resident, wanting to prepay future monthly fees, buys a charitable gift annuity with the resulting income used to offset the monthly fee otherwise required. There are advantages if the same 501(c)(3) issues the gift annuity agreement as that which provides tax qualification for the senior housing business.
Now prepayment can be offered as a marketing option to help prospective residents with their financial planning. Just as with an entrance fee, a portion of proceeds from the charitable annuity purchase can be used immediately for the not-for-profit’s charitable purposes. It’s a win-win. It brings discipline to the provider’s balance sheet. It gives reassurance and benefit to the resident. And, it avoids the temptation to weaken the balance sheet by using long-term committed funds for short-term purposes.
Charitable gift annuity regulations vary from state to state, so a qualified attorney should be consulted before initiating any such program. Annuity values with refund and long-term care characteristics are determinable, though that will generally require retaining an actuary for the purpose and ensuring tax and regulatory compliance. An experienced actuary can also help a nonprofit to reinsure the longevity risk. Of course, no regulation prevents the use of ACGA annuity rates to value the existing liability exposure from entrance fee contract payments.
