Viewing liability insurance from the lender's perspective. (NIC On Financing).

This year, liability insurance is taking a larger bite out of operators' profitability. Several reports have indicated how long-term care providers are dealing with this issue, but little has been done to show how lenders are responding.

Recently, the National Investment Center for the Seniors Housing & Care Industries (NIC) polled both providers and financiers on this issue as part of its "Executive Circle," a members-only section of its Web site. Each quarter, leading providers and debt/equity investors are asked to respond to a survey on a hot-topic issue. Results are then discussed at a quarterly conference call in which industry leaders participate, while others listen in and are able to ask questions. Results of our liability insurance poll gave real insight into lenders' responses. Though the bulk of these findings are available on the site to members only, here is a sampling.

Not surprisingly, this issue is of real importance to lenders. Soaring insurance rates can leave owners and operators without cash to pay down debt. So, how do lenders respond when their borrowers' liability insurance comes up for renewal? More specifically, how flexible are they in allowing borrowers to consider different insurance options?

The poll asked whether lenders would permit various "nontraditional" methods of insuring, such as bonded self-insurance, self-insurance, group captives, shared risk pools or paying dollar for dollar, for providers on existing loans when the borrower's current general liability/professional liability policy term expired and was prohibitively costly or impossible to renew.

Responses indicated that holders of existing loans in long-term care generally allowed for a great deal of flexibility in pursuing nontraditional methods. Bonded self-insurance (53%) and shared risk pools (56%) garnered the highest rating preferences from respondents. When borrowers were broken down by property type, however, the number jumped to 89% who were willing to consider bonded self-insurance, shared risk pools and group captives when the loans were for skilled nursing homes. Lenders were most willing to work with skilled nursing borrowers in exploring alternatives to calling the loan. The implication of this is that liability insurance is a bigger--or, at least, higher priority--problem with skilled nursing than with other property types (although the issue is bleeding over to other property types, as well).

John Powell, vice-president of Fannie Mae--the holder of a large number of senior living loans in its portfolio--was not surprised. "When our policies come up for renewal, we're spending a lot of time with individual owners/operators talking through their options, and examining where their deductibles and limits of coverage are headed," he said during the discussion session. "Even though we have overall guidelines for what we'd like to see, we're virtually tailoring a policy or structure for each individual owner/operator when they come in to meet on the situation."

Customization and creativity are key. "Everybody is bringing something to the table," Powell said. "What that probably says from an owner/operator standpoint is that you need a good risk manager or insurance consultant to scour the market on your behalf and be creative in coming up with something that works."

He added that lenders are starting to track the borrower's overall approach to risk management, not just the insurance itself. For example, risk management is being added to underwriting guidelines. Owners/operators might need to submit a quarterly list of all filed and outstanding claims against a property, and report their status and expected payout.

How did lenders respond toward alternative forms of insurance for new loans (or new borrowers) if traditional general liability/professional liability policies were not available or prohibitively expensive? In this case, the numbers of alternatives permitted for all property types went down, although acceptance was still highest for bonded self-insurance (47%) and shared risk pools (38%).

Why did the numbers go down? According to Powell, a lender has an easier decision to make when choosing whether to make a new loan. "If we have someone we haven't done any business with before, and they are telling us they can't get insurance, then the likelihood of our making that loan goes down dramatically," explained Powell. As a comparison, only 9% of lenders said they would decide to no longer do business (i.e., call the loan) with an existing borrower who could not reasonably obtain a traditional policy.

A breakout by property type again showed that lenders had very different attitudes toward skilled nursing than assisted or independent living. "Almost one-third of our lenders said that the majority property type in their portfolio was skilled nursing facilities," reported Harvey N. Singer, NIC research director. "Those who lend to nursing homes were willing to be a lot more creative and consider other things than a traditional policy, probably because they had to." Indeed, proportions of lenders willing to consider alternate insurance methods for new borrowers were highest for skilled nursing: 78% for bonded self-insurance and 89% for both shared risk pools and group captives.

Powell cautioned, however, that many underwriters still do not understand the distinctions among the seniors housing and care property types. Thus, they might not, in fact, be willing to work with owners and operators to customize when their policies come up for renewal. This is another reason, according to John Carrosino, senior vice-president and chief financial officer of Merrill Gardens, LLC, owners and operators need to have a good, long-standing relationship with a lender.

In addition to liability insurance, the NIC poll showed that the other area of most concern for both lenders and providers was facility absorption (or occupancy) rates. Fortunately, indications are that the decline in occupancy rates for skilled nursing facilities might have finally hit bottom, based on NIC's Key Financial Indicators for the fourth quarter of 2001. (Updated quarterly, these indicators are posted at www.NIC.org.) Since hitting a low of 82.4% in the fourth quarter of 2000, average occupancy rates for skilled nursing throughout 2001 stayed at or above that level, suggesting that occupancy for this sector could have stabilized. The average occupancy for skilled nursing in the last two quarters of 2001 remained steady at 83.5%.

The news was not so good for assisted living. After a slight upturn in the third quarter of 2001, the occupancy rate saw further softening in the fourth quarter, to an average of 84.5%. This continues a seven-quarter trend that began in the autumn of 2000, when the average assisted living occupancy rate stood at a reported 88.7%.

Despite these unspectacular occupancy trends, construction showed an increase for these sectors, with 53 new starts reported during the fourth quarter for assisted living and 18 for skilled nursing. The increase in starts for assisted living, coupled with a decline in occupancy, could pose challenges for demand catching up with supply in this sector.

Robert G. Kramer is executive director of the National Investment Center for the Seniors Housing & Care Industries. Further information from this poll, including owner/operator responses to liability insurance needs, can be found on the exclusive Executive Circle section of NIC's site. For more information about NIC's Executive Circle and Key Financial Indicators, its research and annual conference scheduled for October 16-18, visit www.NIC.org or call [phone].