Health care India South Asia,

HEALTHCARE INDIA

Private Healthcare in India is opening up the demand for quality health services has led to the Government to create Private Initiatives to allow the private sector to participate

By Melvin J. Howard

Healthcare is the responsibility of the Indian central and state governments. Until a decade ago healthcare services were provided only by government and charity hospitals. These service providers have been overwhelmed by the cost and demand. The demand for quality services has increased tremendously during this past decade primarily because India's economy has been strong and the middle class (people with more discretionary money) is growing quickly. People with discretionary money are demanding timely and quality services. Private hospitals and clinics have been established to meet the new demand. Rapid growth is being experienced in this exploding market.

The potential

The marginal presence of the government in healthcare leaves the door open for alternative suppliers. India spends about 0.7 per cent of its Gross Domestic Product on public health against an average of 0.9 per cent of GDP for low-income countries. The world average is 3.2 per cent of GDP. Financial distress seems to be the dominant theme in any discussion on the state of government finances, and with dramatic changes unlikely in the foreseeable future, private healthcare organizations are bound to grow. Other than the cold fact of marginal presence in healthcare delivery, government centres are anyway not the people's choice. Whenever possible, patients seem to opt for private healthcare providers. The unmet demand for good healthcare in India coupled with the growing opportunities to raise resources through the capital market set off a few hospital projects in the last decade.

Implication of health insurance

The low level of health coverage in India suggests that insurance companies have enormous potential. The success of insurance companies will hinge on keeping a tight leash on the cost of healthcare delivery. Such a tight check is likely to propel corporate hospitals towards more efficient functioning. By their ability to command or distribute big business, insurance companies are likely to have the clout to nudge hospitals into running a tight operation.

As the experience in the US shows, the growing importance of insurance or Health Maintenance Organizations (HMOs) does not necessarily guarantee a system free from trouble. These organizations seem to create a unique set of problems. But what appears almost certain is that the advent of private health insurance will insure corporate hospitals work towards greater efficiency.

Private initiatives and policy options: recent health system

 

Experience in India

BRIJESH C PUROHIT

Social Service Area, Administrative Staff College of India, Hyderabad, India

In the recent past the impact of structural adjustment in the Indian health care sector has been felt in the reduction in central grants to States for public health and disease control programmes. This falling share of central grants has had a more pronounced impact on the poorer states, which have found it more difficult to raise local resources to compensate for this loss of revenue. With the continued pace of reforms, the like­lihood of increasing State expenditure on the health care sector is limited in the future. As a result, a number of notable trends are appearing in the Indian health care sector. These include an increasing investment by non-resident Indians (NRIs) in the hospital industry, leading to a spurt in corporatization in the States of their original domicile and an increasing participation by multinational companies in diagnostics aiming to capture the potential of the Indian health insurance market. The policy responses to these private initiatives are reflected in measures comprising strategies to attract private sector participation and management inputs into primary health care centres (PHCs), privatization or semi-privatization of public health facilities such as non-clinical services in public hospitals, innovating ways to finance public health facilities through non­budgetary measures, and tax incentives by the State governments to encourage private sector investment in the health sector. Bearing in mind the vital importance of such market forces and policy responses in shaping the future health care scenario in India, this paper examines in detail both of these aspects and their implications for the Indian health care sector. The analysis indicates that despite the promising newly emerg­ing atmosphere, there are limits to market forces; appropriate refinement in the role of government should be attempted to avoid undesirable consequences of rising costs, increasing inequity and consumer exploi­tation. This may require opening the health insurance market to multinational companies, the proper chan­nelling of tax incentives to set up medical institutions in backward areas, and reinforcing appropriate regulatory mechanisms.

Market forces

One of the most significant trends emerging in the wake of liberalization is the new vigour of the entry of corporate hos­pitals and multinationals in the health care scenario. The

reason for this new tempo is the potential that India offers to NRIs and multinationals. With the current ratio of population to all types of beds being 1300: 1, it has been estimated that there is a huge demand–supply gap which may require nearly 3.6 million beds to overcome it.^6,ii Taking into account the requirements of primary and secondary health care, the short­fall is estimated to be around 2.9 million beds. In tertiary health care, the gap may be somewhere around 20% of the above total, which amounts to some 0.58 million. With investment costs per bed per year (including land, building, equipment, support system and medical consumables) ranging from Rs 0.7 million to Rs 3.5 million depending upon the nature of specialty, the resource requirements are enormous. Further, from a survey conducted by the Confederation of Private Sector Initiatives in Health Care, it is estimated that against a requirement of 60 000 super-specialty beds each year, only 3000 multi-specialty beds are being planned in India, which may cost around Rs 7200 million over the next 3 years.

 

Growing NRI investment in the hospital industry

Realizing the need, the potential for profit and from a desire to develop the States of their original domicile, many NRIs from the USA and UK have taken interest in the develop­ment of health care diagnostics or super-specialty hospitals in their hometowns. Between August 1991 and August 1997, the Foreign Investment Promotion Board (FIPB) approved foreign direct investment (FDI) proposals worth US$100 million (about Rs 3600 million) in the Indian health care sector.⁷ The major chunk of this FDI (Rs 1160 million) goes to Delhi,ⁱⁱⁱ helping in the development of a super-specialty hospital and diagnostic centres. Other places in the country to benefit from this NRI investment include Guntur in Andhra Pradesh, Bhuwaneshwar in Orissa (Rs 30 million), Calcutta in West Bengal (Rs 80 million) and Bangalore in Karnataka (Rs 0.6 million).^iv These investments in States other than Delhi are mostly focused on diagnostic centres and bring with them high-tech care, advanced medical technology and trained Indian medical manpower. This is partly halting and revers­ing the brain-drain of medical personnel.

 

Corporatization of the hospital industry

Health care is thus emerging as a blue-chip industry and in recent years has attracted the investment of both domestic and foreign companies. Unlike the earlier image of the private sector, which mainly focused on nursing homes and polyclinics, the new market orientation is towards super­specialty care.⁸ In this regard, although the pioneering efforts were made way back in 1983 by a group known as Apollo,^v a number of other companies have now entered the market. Notable among the latter include successful domestic and foreign companies like CDR, Wockhardt, Medinova, Duncan, Ispat, Escorts, Mediciti, Kamineni, Parkway, Jardine, Nicholas and Sedgwick.^9,10 The entry of so many such companies has added towards corporatization of the health­care industry with a focus on high profit-margin, super­specialty and diagnostic care. Mostly these companies have expanded their network in India’s major metropolitan towns.

Private initiatives and policy options in India                                                                               

Increasing participation by multinationals

Given the rising cost of health care in the last 5 years,vⁱ the foreign companies are aiming to capture the potential of the health insurance market for nearly 135 million people in the upper-middle income segment of the population who can afford private health care. Against an estimated potential health insurance market of between Rs 6500–275 000 million, the present annual health insurance premium market by the General Insurance Corporation and its subsidiaries is merely Rs 1000 million, covering just 1.6 million people. In view of the possible opening of the market to multinationals, many foreign companies have already taken preliminary steps, such as setting up their representative offices or entering into ties with Indian companies.vⁱⁱ These companies aim to devise health insurance schemes suited to the Indian situation, to improve coverage by incorporating payments for general physicians (GP), medical tests and specialist charges, and containing costs through appropriate controlling systems.

 

Besides health insurance, the high-tech, medical, electronic equipment industry has been the other area to attract invest­ment by multinationals following liberalization. This is due to the high-tech nature of modern diagnostics, which is based largely on foreign technology having a high obsolescence rate of around 5 years and thus high replacement needs. In general, a reduction on import duties on individual com­ponents, and high rates of import duties (up to 31–37%) on high-tech finished products (like CT scanners), have together encouraged multinationals to assemble the imported components in India. Consequently, of total imports of medical equipment (Rs 4500 million), more than half (Rs 2800 million) comprise locally assembled medical electronics (like X-ray, ultrasound, CT scanners, patient monitoring equipment, etc.), with the remainder constituting other electronic medical products (like sterilizers, endoscope accessories etc.).

Policy measures

In the last 1 or 2 years a number of State governments have become increasingly aware of the possibility of introducing policy measures that could enhance resource availability to the health care sector either through economic or insti­tutional reforms. These include policy initiatives to attract private sector participation and management inputs into

running PHCs, the privatization or semi-privatization of public sector health facilities, innovative non-tax measures to finance public health facilities, and tax incentive measures to attract private sector investment in health care. Some of the State governments have even initiated moves to reorganize their health directorates into public sector undertakings.vⁱⁱⁱ More often, however, this has been done with the assistance and insistence of the World Bank. In this section we do not intend to go into this aspect of reorganization but rather focus on the other above-mentioned measures.

Measures to attract private sector inputs in PHCs and privatization

Owing to scarcity of resources, the existing public health system has been unable to provide care to all. At present as many as 135 million Indians do not have access to health ser­vices.¹⁵ Despite the Bhore Committee’s recommendations in 1946 of the provision of one health centre for every 20 000 people, the country currently has one PHC per 31 000 popu­lation.^15,16 Even the existing public health facilities run with abysmally low resources; presently, an average Indian PHC has as its budget only Rs 1 per capita for drugs. Thus, appar­ently prompted by the desire to increase access for more people, some of the State governments have recently favoured an increasing participation of the private sector in running the existing public health facilities.^17,18

 

In this regard two distinct strategies with differing impli­cations have been adopted. One strategy has been to attract direct private investment purely on a philanthropic basis while maintaining the bureaucratic management of the exist­ing health care facility. Expenditure by the private companies falls under charitable purposes and can be claimed for exemp­tion from taxation; beyond this, there is no benefit to the private parties. This strategy has been adopted in Tamil Nadu where the State government has called for private sector par­ticipation by inviting private investment in public health-care infrastructure and improvement. To expedite this process a special division has been created in the State’s department of health and family welfare for the promotion of private sector participation in public health. The emphasis has been laid on the adoption by the private sector of PHCs, district and taluk hospitals and other government-run medical facilities to improve the facilities provided. The State has sought private participation in the form of construction work, maintenance and provision of equipment, with the government providing the staff, medicines and management. Tamil Nadu has 1420 PHCs, many of which are not housed in their own buildings, and there is inadequate maintenance even at the level of taluk and district hospitals.^ix The privatization strategy will there­fore help in raising resources for maintenance purposes. As many as 100 PHCs in the State will be maintained through various private companies and industrial houses under the PHC participation scheme.^x

 

Thus the efforts of Tamil Nadu State are geared towards pooling public and private resources for social purposes, and impose more social obligations on industry. The success of such pilot projects depends upon the continual good profit­ability of companies participating in the scheme and good mixing of two different work cultures, namely, public and private.

 

Another strategy has been to increase private sector partici­pation by handing over the management of public sector facil­ities to a private party working on a not-for-profit basis, with core funding coming from the government. Such a move has been made by the State of Maharashtra. The State govern­ment appointed a committee in July 1997 whose recommen­dations were available in October the same year. The committee suggested some 30 guidelines for considering the transfer of a PHC to those registered private NGOs that are capable of providing such services in remote and hilly areas. The emphasis of these guidelines is on the capabilities of the private organizations and the functions to be performed by such parties after the takeover, and the amount and method of grants to be received by these organizations. According to the committee, it should be ascertained that the concerned NGO has the requisite manpower, expertise in providing basic health services in remote and hilly areas, vehicles and capacity to provide specialized extension services and medical aid in cases where patients need to be referred. Generally these private agencies will have the right to retain the existing staff or to effect changes in the workforce while adhering to laid-down government norms. In either case, the agency will receive wage expenses for its employees from the government. The agency taking over the PHCs shall also be responsible for providing residential quarters for its staff, training, miscellaneous repairs and surrounding sanitation. The above-mentioned strategies to increase private sector participation in public health facilities have a common objec­tive: to make the private sector a partner to shoulder social responsibility with the government. However, the success of any of the approaches will depend upon considerations in their implementation. In the first strategy, attracting private investment on a philanthropic basis, the main considerations would be continued profitability of the company, its geo­graphical location, screening of companies based on their past record of social responsibility, the extent of financial responsibility shouldered by the company and applicability of the tax deduction clause for the company expenditure. The incentive for the company would be the tax deduction from its profit taxation. However, this kind of support would depend upon its future profitability. With fluctuations in trading activities, the market situation may sometimes lead a company to retrench its funds from the social responsibility. In anticipation of this, there should be an alternative arrange­ment by which the government can invite further, alternative private sector participation without causing undue delay in providing the requisite care in the local area.

 

In the case of the second strategy, involving private sector management in public health facilities, the crucial consider­ations would be procedures for the effective delegation of powers within the existing bureaucratic framework and mechanisms of coordination between lower level (PHC) and upper level (district) authorities. The performance following the private sector adoption of a PHC would still depend crucially upon the cooperation of bureaucracy in various ways. In the absence of clear autonomy in hiring personnel, wage fixation and rate fixation, while taking into account the affordability of poorer people in the area, the chances for success of such collaboration between public and private sectors may be slim. This kind of autonomy may require modification of rules and procedures, which may be a time­consuming process and political interference may slow it down further.

Innovative non-tax financing

Some Indian States have initiated some innovative financing measures to mobilize private resources for the public health­care delivery system. For instance, Kerala and Rajasthan have set up committees, known as the hospital development committee (Kerala) or medicare relief society (Rajasthan). These are entrusted with all the funds, which include user charges, visiting fees, outpatient fees etc. These committees have their own bank account and can decide upon the allo­cation of funds ^.xiii Another innovative method initiated by Himachal Pradesh is a scheme called ‘Vikas Me Jan Sahyog’ (Peoples’ participation in development). This scheme envis­ages 20% of funds being contributed by the people and the remaining 80% coming from the State government. The scheme covers the construction of hospitals, sub-centres and ayurvedic hospitals in a specific area. Likewise, in Kerala an innovative measure of raising resources for cancer control was initiated by involving the community in a unique way. For instance, it was announced by the State that 25% of the total collections from Indira Vikas Patra would be earmarked for early detection and prevention of cancer. This resulted in an enormous positive response from the public, and instead of a planned collection of Rs 100–120 million under the scheme, Rs 760 million was collected. In fact, 25% of this collection, earmarked for a cancer control and early detection pro­gramme, was equivalent to nearly 10 years of the sanctioned budget.

 

 

Private initiatives and policy options in India                                                                               

Tax incentive measures

A number of tax concessions have been extended to the hos­pital industry in recent years. These include both central and State level measures. At the State level, these concessions are available in the allotment of land and investment allowances for medical equipment. The Rajasthan Government, for instance, has adopted incentive measures such as the allot­ment of land for hospitals at concessional prices and subsidy for investment in medical equipment.²⁰ In order to extend these facilities, the private enterprises have been classified into different categories^xv which could take advantage of a reduction of 25–50% on the market price of agricultural land in rural areas and the residential land price in urban areas, up to a certain land ceiling. However, if the land allotted for medical institutional purposes is not put to use within 2 years from the date of allotment, it may be taken back by the government. Likewise, if the medical institutions were set up before 31 March 1999, the eligible health care institutions are exempted from local levy and State sales tax on medical equipment, plants and machinery imported from abroad or outside the State or purchased within the State.

 

Many of these incentives, as well as financial help from banks, are available to private hospitals in other States, including Andhra Pradesh and New Delhi. In return for these conces­sions, however, these corporate hospitals and diagnostic centres are required to render free outpatient and in-patient services, at least to 40% of their patients who may be identi­fied as poor and either referred by government hospitals or otherwise. The idea behind this is to cross-subsidize the poor partly through the government subsidy and partly through the higher rates charged to high-income patients by these hos­pitals. In practice, however, the hospitals do not follow this agreement. Thus, some of the branches of the Indian Medical Council (e.g. Vijayawada in Andhra Pradesh) have demanded that the government should make it mandatory for these hospitals to display a board on their premises informing patients about the free services clause. Likewise, the Council has suggested that government hospitals should refer patients identified as poor for treatment to these hospitals.

However, there remains a problem of coordination on this aspect between the private hospitals and the concerned State governments. For instance, in Delhi, the Apollo Hospital, which was recently constructed on concessional land by the government (the latter also being a partner holding a 26% share), was required to build a free outpatient ward, provide 200 free beds and free diagnostic and operation theatre facil­ities and free diets to poor patients. Despite this all being carried out by the hospital, there was some confusion; govern­ment administration also insisted on free medicine and con­sumables for poor patients, despite the absence of such a clause in the contract.²² Likewise, under the contract it was agreed that complicated heart and brain surgery would be performed free of charge for the poor by ‘Super Specialists’ at the hospital. But, due to further confusion, the government has been insisting on admitting and treating all road accident victims for free at the hospital, again a condition not men­tioned in the clause. As a consequence the excellent facilities of the outpatient and in-patient wards, operation theatres and other diagnostics have remained unutilized and the dispute remains unresolved.

 

At the central level, these hospitals have the advantage of the concessional duty for imports of medical equipment. At present, the import duties have been reduced to an average level of 15% for medical equipment and there is no duty on life-saving equipment.²⁴ At the aggregate level, in value terms these imports contribute 50% of the total requirements of medical equipment in the country. This kind of import liberal­ization for health care equipment is accelerating the growth in the domestic production of medical supplies, but it is also being spurred by the affluent and consumer-oriented middle­income population, which is demanding quality health care

using hi-tech equipment.

Policy options and welfare implications

Many of the merits and problems associated with recent policy measures and market forces concerning developing countries generally, seem to be equally relevant for the Indian health care sector. The main thrust of policy in the post­liberalization period has been to encourage market forces. However, there are limits to this approach, unless appropri­ate refinement in the role of government is undertaken. In the last few years, many of the recent reforms both in developed and developing countries have been geared towards privati­zation or increasing private sector participation in public health care.²⁶ With increasing private sector participation it is presumed that managed markets, especially in the hospital sector, will increase supply-side efficiency by increasing com­petition among providers and there will be increased trans­parency in trading or hospital business.²⁷ Also, efficient managed markets in welfare services like health presuppose: (1) competition between suppliers; (2) definable outputs for which consumer valuation could be made; and (3) lower transaction costs compared to an existing set of costs.²⁸ In some recent reforms some of these conditions are not satis­fied, one consequence of which has been a rise in costs. Nonetheless, it has been emphasized that the private sector can be a more efficient producer of secondary and tertiary level health care, and therefore the government budget can be balanced.

 

Labor co-exist with Private Medicine

Labour gets into bed with private medicine

Soon NHS patients will have their hernia operations 'outsourced'.

This is one example of co-existence that governments all around the world are experimenting with. There is no one ways on doing Public and Private Partnerships they vary from Country to Country from Municipality from Municipality. Governments have come to realize they cannot fund health care in the same old way. This is a global technological village it takes less then a click of a button to have a video conference with your associates half way around the world. A surgical suite that was built 6 years ago can become obsolete 6 months from now. Technology has vastly changed our society it has completely changed the world and industries. Still most hospitals computers do not talk to each other. Most patients are still transporting their records by hand. Some medications are being given to the wrong patient. IT departments in hospitals are becoming more and more important as an integral part of patient care. I for one am glad that some Governments are recognizing this. Private and Public can co-exist I will go further and even say it must exist. To keep up with the aging population and our changing lifestyles.

By Melvin J. Howard


Two weeks ago a Labour government signed the 'unthinkable'. Smashing 50 years of ideological hostility towards private medicine, Health Minister Alan Milburn agreed a historic 'concordat' with Britain's private health industry.

Milburn reportedly acted on Prime Minister Tony Blair's direct order to cross this Rubicon in a bid to avoid a repetition of last winter's emergency bed crisis sparked by a flu epidemic. Front page news stories featuring sick patients lying on trolleys in corridors seemed to prove the NHS was on the critical list. And this under a Government 'trusted' to run it.

But the five-page concordat goes far deeper than averting a short-term public relations disaster by asking private hospitals to admit winter snivellers. The World Trade Organization is lobbying for national governments to allow the private sector greater involvement in health provision and financing through what is known as Gats - General Agreement on Trade in Services.

'With profits in manufacturing falling, the corporate lobby is targeting the proportion of gross domestic product that governments spend on public services,' said University College of London health finance expert, Professor Allyson Pollock. 'In health and education alone, government spending is in excess of 15 per cent of GDP in many European countries, but much of that goes on voluntary and public sector provision.'

Britain is at the European cutting edge of this liberalization. Last Monday Milburn confirmed this by inviting consortia to bid for 18 controversial new Private Finance Initiative hospitals worth £18 billion. PFI is a financing mechanism which allows private companies to build hospitals and rent them back to the NHS at considerable profit. The advantage for the Treasury is that infrastructure projects are kept off balance sheet.

Most health industry insiders acknowledge that PFI is an expensive way of building new hospitals which means less money is left to spend on patient care. But Milburn said he wants to see PFI extended 'beyond the hospital gates to include GP surgeries, community pharmacies, health centres, intermediate and long-term care facilities'.

However, the significance of the concordat is chiefly in its effect on the direct provision of health care which has so far largely escaped the private sector. The Independent Healthcare Association (IHA) says the amount of elective surgery (operations the patient can survive without) it takes on for the NHS is worth £35 million - less than 5 per cent of the sector's overall revenue, or the equivalent of six hours of the NHS's £40bn annual budget.

Currently the biggest players in private healthcare are Bupa, the provident association; BMI, owned by General Healthcare; Nuffield Hospitals, a charity; Community Hospitals Group, which is the subject of a takeover bid by Bupa; and US-owned HCA. Combined, they turn over £2bn from acute health provision. The majority of this comes from private medical insurance, with 22 per cent self-paid or from overseas patients.

These days private hospitals can treat a wide range of ailments but are known particularly for the five Hs: hips, hernias, hysterectomies, hearts and hemorrhoids. Barry Hassell, IHA's chief executive who helped frame the concordat, believes the UK's 300 private hospitals could undertake 150,000 operations for the NHS each year. This would triple private hospitals' income. Hassell says current meetings of the NHS and private healthcare providers could lead to the building of new private facilities.

But it won't be easy to make this outsourcing work. 'There's still some hostility to contracting out client services but it may well be that the Government will push the NHS and local authorities towards agreeing contracts with the independent sector,' said leading healthcare analyst William Fitzhugh.

It will be in the intermediate sector - or rehabilitation - where the private sector will gain most. Westminster Healthcare, run by Chai Patel - an influential government adviser - will within days be the first group since the concordat to reach agreement with the NHS to take on this work. Patel said the deals involve no more than 15 beds but it is the shape of things to come. 'The private sector can offer long-term care more efficiently, at lower cost and more competently.'

But Steven Weeks of health workers' union Unison disagrees. 'All the evidence suggests that private sector involvement will push up the cost of long-term care. This is the main area where the private sector operates. Staff get worse wages and conditions. Some people in government will say that's not a problem.'

Healthcare isn't always a license to print money for the private sector. In the area of long-term care Nursing Homes Properties, which built hundreds of nursing homes in seven years, is on the verge of financial meltdown having lost £7.1m in the six months to March, because a number of its tenants went to the wall. They got burnt when local authorities scaled down their fees.

But this hasn't diminished the private sector's appetite for medicine. And so critics fear the concordat will lead to more contracted out services, charging for health care and eventually mean that what the Government - and therefore all taxpayers - can achieve with its health budget will diminish because private providers, which have to make profits, will be dearer.

Hassell disagrees: 'What's important is that contracting authorities get value for money,' he said. 'But it's an assumption to say the private sector will be more expensive. The Department of Health won't reveal cost information so nobody knows the true picture.' Perhaps a little forensic analysis should be undertaken before we proceed with this operation.

Sickness and wealth: What countries spend

Country / % of GDP / % through public / % through provision private health insurance

USA / 13.7 / 44.2 / 33.2

Germany / 10.5 / 75.3 / 6.9

France / 9.6 / 76.4 / 12.2

Canada / 9.5 / 69.6 / 1.9

Netherlands / 8.6 / 70.4 / 17.7

Japan / 7.6 / 78.3 / n/a

UK / 7 / 84.2 / 3.5

Source: OECD

Choosing A Prime Broker

 Choosing a Prime Broker for your Hedge Fund

 

As this site is dedicated to Global Health these same points can be used in choosing a prime broker for all Hedge Funds. Funding healthcare globally in a creative way is my main mission there are new financial techniques and instruments that are being discovered every year. Innovation is key some of these techniques maybe used on its own or in a combination the point is to move in a forward progression of completion on your health objectives whatever that might be. As I talk to Physicians and Nurses and other key people in health care around the world it is clear to me that they are dedicated professionals. Who want to do a good job and go beyond the call of duty. Then there is the patient that needs to be treated in the best care possible in the quickest time possible. This is what I have dedicated my professional life to the business of health care.

 

By Melvin J. Howard       

 

Tip 1: Choose a prime broker who understands both the business of prime brokerage and what you do. Prime brokerage is a business that looks much simpler than it is. And, admittedly, at least in concept, the core business is simple. A prime broker clears and settles trades; keeps custody of and lends against assets; and maintains books and records. The trick is that all of this has to work consistently day-in and day out across a broad product range. You need a prime broker who can provide these services without blinking. I can’t stress this enough—glitz and glitter make nice additions, but make sure that the underpinnings are solid. Next, make sure that the prime broker understands what you do—your strategy, how you implement your strategy and any nuances that may exist. If you use foreign exchange, you want to make sure that your prime broker can handle FX, not just the securities transactions. Make sure that your prime broker understands all of the parameters of what you do and is capable of servicing your entire business well. Don’t be the “test case”—choose a prime broker with relevant experience.

 

Tip 2: Choose a prime broker who is separate from its firm’s trading division. Some prime brokers are sub-units of trading divisions, which, no matter what anyone says, changes the dynamics—for the worse. If prime brokerage is not run as a separate and distinct business, you should not count on the confidentiality of your trading activity or positions. The temptation of using your proprietary information to the “benefit” of the trading division is simply too great and “Chinese walls” are notoriously porous. If you doubt this, re-read Roger Lowenstein’s book about Long Term Capital, When Genius Failed, which offers many lessons in how prime brokers incorporated into trading divisions operate. Protect yourself—choose a prime broker whose sole function is prime brokerage.

 

 Tip 3: Choose a prime broker who understands the risk of your strategy and knows how to effectively manage its own exposure. It is important for your prime broker to have a global risk management organization that understands your style and trading strategy. First, this ensures that at the onset of your relationship leverage is set appropriately. Second, as you trade, your prime broker will understand and, one hopes, be comfortable with what you are doing. Both of these are most important when linked with the last point—that the prime broker knows how to manage its exposure. The last thing that you want is for your prime broker to “suddenly” discover that you are a risk arbitrage manager who uses leverage, and that it therefore needs to increase your margin requirement to protect itself. You want your prime broker to understand your style and trading strategy completely, and for your prime broker to have experience in working with hedge funds similar to yours. There have, unfortunately, been several times when some prime brokers have acted precipitously, and forced entire strategies into liquidation. You are dependent not only on your risk controls, but also the risk controls of your prime broker. Don’t depend on the reputation of the parent—make sure that the prime brokerage business has a great risk team and that you understand how they operate.

 

 

Tip 4: Choose a prime broker who is honest about the capital introduction process. If a prime broker promises to “raise” capital for you, it is either lying or violating the law. Let me explain. Hedge funds are sold as private placements and are technically continuously in distribution. This means that they require continuous due diligence by any third party that is raising capital from investors. If a prime broker were to raise capital for a hedge fund, it would be taking on underwriting risk and no major firm would do that without sufficient compensation (remember that equity IPOs are done for something on the order of 7% of the assets raised and the typical hedge fund marketing firm charges “20 and 20”, that is, 20 percent of the management fee and 20 percent of the performance fee so long as the capital raised remains in the fund). What a prime broker will do is introduce you to potential investors—investors with the capacity and interest to invest in hedge funds. It is your job to raise capital and the investor’s job to perform due diligence. Also remember that a prime broker who raises capital for you can violate your regulatory mandated marketing restrictions because you don’t know what the prime broker is saying about you. Raise capital yourself—let your prime broker play a role only by introducing you to qualified investors.

 

Tip 5: Choose a prime broker who offers a variety of solutions to leverage. Whether or not you intend today to use leverage, make sure that your prime broker has the capability to extend leverage. Further, it is important that your prime broker have a variety of leverage products available, both for ordinary leverage and enhanced leverage. We live in a volatile world of rapidly changing regulation. As much as possible, you want to be able to isolate your business from changes in the regulatory framework. A prime broker who understands the current regulatory framework and provides a number of different avenues to achieving your leverage objectives will serve you better in the long run in case regulatory changes affect your current leverage strategy. Give yourself flexibility for the future—make sure your prime broker knows more than one way to extend leverage to both your on-shore and offshore funds.

Tip 6: Choose a prime broker with a strong global securities lending presence. One of the most important services a prime broker can provide is securities lending. Make sure that your prime broker can lend both stocks and bonds, has access to hard-to-borrow securities, and has a strong global presence. You need to work closely with the securities lending desk at your prime broker to build a strong relationship. The desk should be able to provide you with “color” on the market, give you “early warning” about potential buy in, and understand your preferences and style in trading. Your prime broker should also be able to provide you with electronic access to securities lending (at least for easy-to borrow securities). Your success depends on the strength and consistency of securities lending—know your prime broker’s team and rely on their expertise.

 

Tip 7: Choose a prime broker who offers a range of mechanisms for trading. Make sure your prime broker can provide you with multiple ways to trade. Your prime broker should be able to offer you a variety of electronic platforms for trading—not just one. Different trading styles need different platforms. If you already use a third-party trading platform or have developed your own, your prime broker should be connected or be able to connect to your preferred platform. In addition, your prime broker should offer both wholesale execution services and institutional coverage. If you don’t want to trade yourself, your prime broker should provide a desk that will trade for you. You want a prime broker that has flexibility, not one with only one approach.

 

Tip 8: Choose a prime broker with broad product capability. Your prime broker should be able to handle equity, fixed income, and derivative products including new issues, contracts-for-difference and swaps. In addition, your prime broker should be able to assist you with soft dollars and repos. Your prime broker should be able to provide reports that incorporate all of these products and be able to provide margin across products. More flexibility and capability across product lines signal a prime broker who is sophisticated and serious about the business of prime brokerage. Even if you don’t use all of the capabilities of your prime broker today, you want a prime broker with depth and breadth to meet your future needs.

 

Tip 9: Choose a prime broker with strong technological capabilities. Your prime broker should be able to offer you a variety of proprietary applications, including portfolio reporting (for you), transparency reporting (for your investors) and shadow reporting (for any positions held away). For these reports and applications, your prime broker should also be able to offer you a variety of connectivity options—FIX, internet or dedicated circuits. Your prime broker should also be connected to leading third party vendors—order and portfolio management systems (e.g. Advent and Eze Castle); risk systems (e.g. Imagine and Riskmetrics); accountants; offshore administrators; and middle office service providers. You will, no matter what, be dependent on your prime broker’s technology—make sure that you choose a prime broker with demonstrated capabilities.

Tip 10: Choose a prime broker who offers cash management capabilities. You will always have some amount of cash in your account, but today most hedge funds have more cash on hand than at any other time. Your prime broker should be able to offer you dedicated cash management and fixed rate financing capabilities. You want to be able to minimize the cash drag on your fund—your prime broker should be able to provide expertise and bargaining power to obtain better returns for any cash holdings.

 

Tip 11: Choose a prime broker with a strong back office. At the core of everything in prime brokerage is the back office. Make sure that your prime broker has a strong, experienced operations department. The prime broker’s reorg, cage and margin departments must work seamlessly, and the working should appear effortless to you. The measure of a back office isn’t whether it can handle plain vanilla situations—which should be taken for granted—the real measure is how the back office handles difficult situations or problems. The broader the range of activities, the more businesses and the more hedge funds that a prime broker’s back office supports, the more you should be able to trust that it knows how to resolve problems. The only way that a back office becomes really good is through experience. Experience will save you money—choose a prime broker with an experienced back office.

 

Tip 12: Choose a prime broker with a mature, knowledgeable customer service organization. Key to your relationship with your prime broker is the customer service organization. When you first sign up with a prime broker, there should be a dedicated team of people to ease you into the relationship—to train you or your personnel on technology, to introduce you to your primary contacts and to explain policies and procedures that the prime broker may follow. The prime broker should also provide a team of relationship managers or customer service agents who work with you on day-to­day issues. There should be a dedicated training staff to assist your organization with the nuances of any proprietary systems and new systems as they are developed. And, finally, you should have a relationship with the highest levels of your prime broker’s organization. Knowledge, access, experience and responsiveness should be the cornerstones of your prime broker’s commitment to you.

 

Tip 13: Choose a prime broker who is deeply committed to the business of prime brokerage. Some firms are in and out of prime brokerage every few years. Some prime brokers have been sold a number of times. And some prime brokers are brand new to the business. Prime brokerage is a business of consistency, reliability, integrity, service, experience and, most importantly, relationships. Look for a prime broker that has been around for a while—choose a prime broker who has chosen to be in the business of prime brokerage—not someone who thinks that it might be a good sideline or something to try for a while.

 

Credit Enhancers

Credit Enhancers for Hospitals and Major Clinics

By Melvin J. Howard

Credit enhancement refers to the use of bond insurance, letters of credit, guaranties and other devices by which a third-party (the credit enhancer) guarantees the payment of principal and interest on the bonds, providing additional assurances of payment to the bondholders and therefore lowering the interest rate demanded by investors.

Providers. The most common forms of credit enhancers for hospitals and major clinics are:

1. Bond insurers, which provide bond insurance over the life of long-term bond issues in return for a payment of an up--front fee.

2. National and international banks, which provide letters of credit, for a period of 5 to10 years, with annual fees.

3. Local banks, which provide letters of credit, usually in smaller amounts. Local banks are sometimes more flexible than national and international banks in their terms.

Making the selection process. In theory, choosing if and how you use credit enhancement is quite simple: If the interest rate savings exceed the costs of the credit enhancement, the credit enhancement is worth buying. For a letter of credit, the market rates for the unenhanced credit are compared to the gross interest costs of the enhanced transaction, i.e., actual interest rates plus the annual fees for a letter of credit and remarketing if variable rates are used. For bond insurance, since the premium is paid in advance, the comparison is between the present value of debt service on an unenhanced issue with that for an insured issue. This calculation should reflect the fact that the insurance premium is usually paid out of the bond proceeds and therefore increases the principal amount of the bonds. In actuality, the cost benefit analysis is more complicated because of:

Transaction costs. Transaction costs both in terms of delays and increases of such matters as counsel fees.

Timing. If credit enhancement is selected before the marketing of the bonds, it may be impossible to measure accurately whether credit enhancement is cost effective. On the advice of underwriters, hospitals frequently "go into the market" without credit enhancement, obtaining a ruling and circulating the preliminary official statement and then deciding during the actual marketing of the bonds whether to use credit enhancement. This process, however, complicates the role of hospital counsel in negotiating reasonable covenants with the credit enhancer.

Managing the Selection Process. If the hospital has sound credit, it may have the option, particularly in bond insurance, of having proposals from several bond insurers. Bond insurers are increasingly competitive. The hospital should look to the financial advisers and/or underwriters to give it a general analysis of then various bond insurers. All AAA rated credits are not alike in pricing, and all bond insurers are not rated AAA. The hospital and its counsel can also learn from financial advisers and underwriters generally how flexible particular bond insurers are on particular points.

Responding to Proposals. When a hospital receives multiple proposals of insurance, perhaps the only easy comparison between them is in price. The hospital then runs the risk that the low bidder will ultimately prove to be unsatisfactory because of the insurer's insistence on financing and operating covenants that the hospital finds burdensome. While the hospital cannot string along multiple insurers indefinitely, it may wish to keep the second lowest bid "in reserve" until it has a handle on the operating covenants the low bidder will require.

Negotiating With the Low Bidder. Once the hospital has the low bid and believes it has selected an insurer, it should press ahead quickly to negotiate the actual terms and conditions of the commitment, i.e., identify precisely what financing and operating covenants the insurer will require. The insurer sets these conditions out in a commitment letter, but there is frequently room for negotiation. Once the hospital has gone so far down the road with bond insurance that it cannot easily retreat (such as mailing of a preliminary official  statement that names the bond insurer), the hospital essentially has no leverage to negotiate operating covenants with the insurer.

Operating Covenants. While commitment letters generally list required operating covenants, they are frequently subject to negotiations. Upon the recommendation of underwriters and financial advisers, hospitals frequently have their bond counsel produce financing documents that have the "loosest" possible financial and operating covenants. There then follows a negotiation process in which the insurer requests changes in those basic documents and may or may not insist on all of the operating covenants in precisely the form set forth in the commitment letter. The hospital and its counsel should press ahead with this process as quickly as possible after the initial decision on insurers is made. Otherwise its ability to go to another insurer is lessened.

Utilizing Financial Advisers and Underwriters. A financial adviser is frequently important as a mediator between the hospital and a credit enhancer. Hospital and its counsel should look to the financial adviser to provide a realistic understanding of what changes the bond insurer will or will not accept. Similarly, the existence of credit enhancement frequently changes the relationship between the hospital and the underwriter. In a normal transaction, the underwriter will frequently insist on operating covenants that it believes appropriate. With credit enhancement, the underwriter generally become an ally of the hospital in negotiating with the credit enhancers, since the underwriter generally doesn't care what operating covenants exist in a credit enhanced transaction (even though the Securities and Exchange Commission thinks it should).

Particular Types of Covenants. Credit enhancers have a variety of views on the operating and financial covenants that they require. The most common ones include:

Rate Tests. These are standard. It is important to have a flexible "out" that provides the hospital with the ability to avoid "default" if it drops below a required coverage so long as the hospital hires a consultant and follows all of the consultant's advice as to operations. Nonprofit hospitals should also have provisions that recognize that their ability to comply with rate covenants may be affected by tax code requirements for continuation of tax-exempt status.

Restrictions on Debt. These are frequently the most significant restrictions for hospitals in credit-enhanced transactions. In recent years, greater flexibility has become common, and the insurer's willingness to be flexible likely will reflect both the creditworthiness of the particular hospital and the insurer's current appetite for business. The chief financial officer of the hospital should undertake actual calculations as to the amount of debt that the hospital would be able to incur under the debt restrictions proposed by the credit enhancer.

Transfer of Assets. As hospitals engage in increasingly complicated corporate structures and affiliation agreements, insurers (as well as other lenders) are increasingly concerned on restrictions on the amount of asset transfers that hospitals can transfer to other entities. Again, it is prudent for a hospital and its counsel to consider particular expansion and other plans that the hospital may want in the future in light of such tests.

Credit Enhancer Consents. Credit enhancers frequently require that they consent to particular actions by the hospital. The hospital sometimes find that such consents cannot be obtained or obtainable only at some kind of cost. Hospital should insist on a standard of reasonableness in such consents.

Counsel Fees. Hospital and its counsel will want to be specific on whether there will be a separate payment for counsel to the insurer and whether there is a cap on such amount.

TIPS:

1 AFTER THE HOSPITAL RECEIVES THE COVENANTS PROPOSED BY THE INSURER OR OTHER CREDIT ENHANCER AND ITS COMMITMENT LETTER, HOSPITAL PERSONNEL AND COUNSEL, THE FINANCIAL ADVISER AND UNDERWRITER SHOULD MEET TO DETERMINE WHICH OF THE COVENANTS ARE TRULY IMPORTANT TO THE HOSPITAL AND WHICH ARE NOT. DON'T WASTE YOUR TIME AND LEVERAGE FIGHTING OVER RESTRICTIONS THAT WILL NOT PRACTICALLY AFFECT YOUR OPERATION. CONCENTRATE ON WHAT'S IMPORTANT.

2. IF YOU ARE USING A MASTER INDENTURE OR DOING SUPPLEMENTAL BONDS, PUT THE COVENANTS THAT YOU DO NOT LIKE IN THE SUPPLEMENTAL INDENTURE SO THAT THEY WILL DISAPPEAR IF THE ENHANCED BONDS ARE
REFUNDED OR PAID OFF.