CAPITAL Conundrum.

Ontario's hospital system is facing the largest capital expansion in 30 years. In an era of budgetary constraints and restructuring, the question is how will this be achieved?

Developing New Approaches to Recapitalize Hospitals pending on the physical infrastructure of Ontario's hospital system - the proverbial bricks and mortar - has largely been put off in recent years, due to a variety of fiscal and political uncertainties at both the institutional and system levels. But the bill for more than a decade of neglect is rapidly coming due. That neglect is partly the result of the recession of the late 1980s and early 1990s, and the uncertainty that preceded the restructuring directions of the Health Services Restructuring Commission (HSRC), which was created in 1996.

As the Financial Issues Advisory Group of the Ministry of Health and Long-Term Care and the Ontario Hospital Association observed late last year, hospitals face funding challenges caused by a variety of factors, including voluntary and directed restructuring, growth and aging of the population, and the rising costs of labour and acquisition of new technology. Experts in the hospital field have openly questioned the ability of both hospitals and government to pay for the modernization of Ontario's hospitals.

Many capital initiatives have been deferred by hospitals as a result of budgetary constraints, while others were postponed pending reviews by district health councils and the HSRC. An additional $3.1 billion is required to implement directions made by the HSRC. Hospitals will have to raise more than $1 billion under the 30-70% hospital-government cost-sharing arrangements.

There appears to be consensus between hospitals and government that the capital cost estimates in the OHA study are reasonable. Ministry of Health and Long-Term Care (MOHLTC) estimates for HSRC-related capital now approach $3.4 Billion and HSRC estimates for information technology exceed $1 billion.

Throughout the history of Medicare in Ontario, hospitals and their communities share the funding burden for both hospital operating and capital expenditures. Under current policy related to capital projects, the MOHLTC funds 70% of approved expenditures related to HSRC-directed projects. Ongoing redevelopment capital projects are funded at a 50% level from the Ministry with no government funding provided for information technology projects. The net result of these policies is that the MOHLTC funds 60% of overall new capital costs in hospitals. The MOHLTC does not provide annual funding for depreciation on hospital facilities.

What do the above policies mean for government and hospitals over the next five years? In order to follow current policy, the provincial government must spend an average of $960 Million in each of the next four fiscal years through the end of2003-2004. This is in stark contrast to the government's ten-year average annual contribution to health capital of$170 million, which includes a budgeted capital contribution of $504 million in 1999/2000. Therefore, in an era of balanced budgets, the province must increase annual capital spending six-fold only to cover the capital requirements of hospitals let alone those of other health facilities.

The impact of current MOHLTC capital funding policy on hospitals is equally serious. Factoring in the impact of funding 100% of information technology expenditures, the hospital sector will have to raise a minimum of $2.4 billion. Hospital foundations are working extremely hard to contribute to the capital funding requirements. Fundraising grew by 55% between 1994 and 1998. System-wide, this amounts to only $100 million per year. However, that should be seen as a peak and not a new plateau because it is probably not sustainable over the long term. Furthermore, just 70% of the proceeds from fundraising go to capital funding.

The inadequacy of conventional methods of funding capital projects is a long-standing systemic problem within the health care system. In 1989-90, in the waning days of the Liberal government, the Ministry of Health announced that a review of capital funding had found problems that included:

* A lack of integration in the planning process, which had resulted in approval of individual projects in the absence of an overarching ministry framework;

* Inconsistent application of the limited existing planning guidelines and the absence of overarching Ministry planning guidelines; and

* Absence of a priorities framework.

As a result, the Ministry's new strategy called for government and hospitals to plan in terms of comprehensive health services rather than individual hospital projects. The strategy called for integration of capital funding with implementation of long-term reform; and it was to be phased in community by community.

However, a series of delays in the implementation of long-term reform collided head-on with the recession. Transfer payments from the provincial government to hospitals were frozen in 1992 under the New Democratic Party and reduced in 1995 by the Progressive Conservatives, prompting many hospitals to defer much-needed capital expenditures.

The Ministry-OHA Joint Policy and Planning Committee (JPPC) Financial Issues Advisory Group concluded last year that "a coherent and consistently applied capital budgeting model" that not only focuses on financial outputs, but also balances them against patient outcomes and quality of care," is needed. And further, that "until such a model can be devised and consistently applied across hospitals and within government, consensus on how to handle the impending capital financial pressures cannot be achieved."

As part of the 1999 Ontario Budget, Finance Minister Ernie Eves announced the creation of the SuperBuild Growth Fund to make strategic capital investments in the provincial infrastructure, including the health care system. This fund is envisioned as a five-year, $20-billion partnership between the public and private sectors.

In the fall of 1999, a new Hospital Capital Funding Working Group (HCFWG), Chaired by Hamilton Health Sciences Corporation CEO Scott Rowand, was established to examine whether the capital needs of Ontario hospitals can be accommodated and to develop alternative approaches to capital funding, including partnerships between the public and private sectors. Membership was drawn from hospitals, financial institutions, the Ontario Financing Authority and representatives from the OHA and the Ministry of Health and Long-Term Care.

The goals of the HCFWG are:

* To build a sound and reliable capital funding system that will provide hospitals with access capital funds when they are required;

* To create an environment that is conducive to private-sector investment;

* To identify issues related to taxation that may be barriers to private sector investment; and

* To work with the private sector to build public-private sector partnerships that will allow creative financing models to emerge and fill the gap between capital requirements of hospitals and government funding.

* Identify important roles for the private sector in the future of hospitals in Ontario including providing strengthened management discipline and financial expertise to a hospital system facing the largest capital expansion in 30 years.

The Group's report, including recommendations for each of these key areas, was released in March of this year.

Robert Muir is chief operating officer and vice-president, Hospital Relations at the Ontario Hospital Association. The Ontario Hospital Association is a voluntary association representing about 165 public hospitals in Ontario that provides a wide variety of essential services, such as acute, chronic, rehabilitation and mental health services.

The Cost of Modernization

A study commissioned by the Ontario Hospital Association (OHA) in early 1999 estimated that the province's hospitals require approximately $7.8 billion for capital projects over the next five years. About 40% of that total, or approximately $3.2 billion, is needed for various capital projects, considered normal, ongoing expenditures for general upkeep of hospitals.

The $7.8 billion also includes $1.5 billion, which the OHA study said is needed as an investment in information technology. A recent report prepared for the Ontario government by the HSRC says that the provincial health system does not have the information capabilities needed to function in the age of information, and lags behind other provinces. "We must act now, or catching up will become more and more difficult, and may become impossible," the HSRC report says. The HSRC Report estimates capital needs for information technology in excess of $1 billion.

Investor Turn-Offs

There is no escaping the fact that hospitals will be required to secure funds in the form of debt. Unfortunately, the financial statements for Ontario's hospitals do not reveal a pleasant picture to potential investors. For example, based on audited financial statements for 1996-97, the number of hospitals in deficit positions and the extent of their deficits were greater than projected in their operating plans. This review found 114 of 194 hospitals, or 59%, had deficits with a combined total of $172 million for the previous year. For 1997-98, the audited financial statements of 101 of 185 hospitals examined showed deficits totalling $177 million and for 1998/99, a total of 149 of 165 reporting hospitals showed deficits of $29 million. This decrease is attributable to pre-election spending, which took place late in the 1998/99 fiscal year. In addition, hospital debt load increased from $1.8 billion in 1997/98 to $2.2 billion in 1998/99, representing a 22% increase.