Health System's troubles hurt U.'s financial rating

and Catherine Lucey Last week's announcement that a major investment banking firm was downgrading the University's bond rating because of the financial instability of the University of Pennsylvania Health System has led to questions about how UPHS fits into the rest of the University and, more importantly, why the Health System's weak financial status caused a downgrade for the entire institution. Moody's Investor Service, a New York-based bond rating firm, said that last week's decrease in the ratings for the University and last year's downgrade for the Health System -- which holds separate bonds but makes up 50 percent of Penn's overall budget and revenue base and exists as a single corporate entity -- are both due to the Health System's difficulties within a "volatile operating environment." According to a report by the company, the downgrade reflects "the continued weak financial margins at UPHS. Moody's believes that pressures in the University's clinical enterprise are likely to result in strains on the University's overall operating performance for at least the next several years." But University officials noted that the immediate impact of the ratings drop on the economic status of the University is minor -- although with the drop comes an unwanted "reputational impact," according to Penn Vice President for Finance Kathy Engebretson. Approximately $350 million in outstanding debt is affected by the rating -- which is a measure of the risk that a bond issue will not be repaid in timely fashion. A lower bond rating means that the University will face higher interest rates and makes it more expensive for Penn to borrow money. The Health System's bonds were lowered last year from an A1 to an A2 rating with a negative outlook, meaning that the bonds are "upper-medium-grade" but may be susceptible to future decreases. The University's bonds remain "high grade," at Aa3, lowered last week from Aa2. But Penn is not alone in its financial woes. All of the Philadelphia area health systems and hospitals are losing money due to problems resulting from managed care and cutbacks in Medicare and Medicaid reimbursements. Existing in such a competitive healthcare market makes it even harder for UPHS to regain financial stability, with officials recording a $33 million operating loss through six months of fiscal year 1999, compared with a $53 million operating loss in the comparable period the year before. The Health System had a total deficit of $90 million in the last fiscal year, revised from $100 million. Health Care Systems Professor Mark Pauly said the drop means interest costs will rise slightly -- overall a "pretty negligible" effect. However, "it's more of an issue if you think it's an omen," he said, warning of possible financial downturns in the future. He explained that the Philadelphia market difficulties are due to the existence of too many hospitals and medical schools in the city. And William Kelley, dean of the Medical School and chief executive officer of the Health System, said that the drop was "definitely" due to the state of the Philadelphia market. "We were told by Moody's that the Philadelphia healthcare market is the most difficult in the country," he said. Moody's analyst Lisa Martin said the competitive market and the Health System's budget difficulties -- the two cited reasons for the ratings drop -- are linked. "It's the market-related pressures that are the primary drivers of the operating loss," she said. Another factor that contributed to the Health System's drop is last year's unexpected market-shaking collapse of the Allegheny Health System after months of financial instability, which brought more scrutiny to the Philadelphia market. The excess of hospital beds in Philadelphia is also an issue, Pauly said. Too many spaces and not enough patients means hospitals will accept lower payments for the same services, furthering competition even more. To deal with the losses, University officials have implemented a plan that they say will bring the Health System -- which includes four Penn-owned hospitals and 12 affiliates, controlling 20 percent of the Philadelphia market -- to profitability by fiscal year 2000, which begins this July. Kelley said the change in the bond rating will not affect this plan. "We laid out a plan in the spring of 1997 of how we were going to deal with the financial future, which we knew was very threatening," he said. "We are right on schedule with implementation of that plan." Overall, the effects of the ratings drop on the University are minor, but the effects on the Health System may be more severe and could lead officials to reconsider its relationship with Penn -- such as holding an academic partnership with a health system but not owning one outright, similar to the arrangement Harvard University has with its affiliated hospital. But officials say that the prime purpose of Penn's Health System is to provide a learning environment for students and residents in the Medical School -- not to pump money into the University's coffers. Still, given the losses in recent years, some are raising questions about the cost of doing so. Pauly said that from a risk protection standpoint, it may be better for UPHS to separate from the University. He noted, though, that this also means the University loses control over the Health System. "If you are confident in the people running the health system and its long-term future, you are probably better off hanging in there," he said. And Kelley said that he wouldn't want to see a separation since the University and the Health System mutually benefit from one another. "The interrelationships between the Health System and the University are immensely important to both parties," he said. "Financially, the Health System is a very big contributor to the University. I think it would be more difficult for the University to continue to be successful without the Health System and vice versa."

Please note All comments are eligible for publication in The Daily Pennsylvanian.