1. Is Exhibit 1 the best set of numbers to use as a basis for arriving at the fee? If not, what improvements would you suggest?

Northridge The meeting of the Northridge Board of Directors on January 8, 1997, unexpectedly evolved into a heated discussion of what one member called a "philosophical" issue, namcly, the role of surplus in a nonprofit organization. As the meeting ended, the issue was still unresolved. ackground Northridge was a continuing care retirement community (CCRC) located in a small college town. Its impetus came from members of a local church, who persuaded the national headquarters of that denomination to take on the project. The denomination headquarters had built other CCRCS. It supervised design and construction, arranged the initial financing, and selected and trained management personnel. Construction started in 1989, and the first residents moved in on July 1, 1991. Construction and start-up costs were financed by two bond issues totaling $42,990,000. One issue, in the amount of $15,000,000, was redeemcd on October 1, 1994. The other issue had an interest rate of 8 percent, due October 1, 2019, with annual mandatory redemption of $440,000 in FY 1997 (the year ended March 31, 1997), increasing by approximately 10 percent each year thereafter. The bonds were se The 60-acre pronerty consisted of a residential complex of 248 apartments with a health center. The apartments were studio, one bedroom, two bedrooms, and two bedrooms and den. In late 1996, there were 369 residents. The complex included a dining room, cafeteria, auditorium seating 150 people, library, indoor pool, beauty/ barber shop, branch bank, gift shop, and facilities for crafts, woodworking, painting, and other activities. These apartments and facilities were in buildings. The health center was connccted group of the residential complex. There a building connectedt were 76 nursing beds, but one section, consisting of 20 beds, was not open in 1996. It was expected that this section would be opened in 1998 or soon thereafter. The health center included an employee day care centcr, exercise and physical therapy rooms, and a clinic with medical, dental, ophthalmology, padiatry, and laboratory facilities Northridge residents paid an entrance fee and a to $267.300, median of th 5 100: ardouble ccunany the entrance fee was 5 percent higher Monthly fees for single occupancy ranged from $1,581 to $2,802, median of $2,451; for double occupancy, the fee was 40 percent higher. An occupant same monthly fee as he or she paid when in an apartment. The monthly fec covered one meal per day, housekeeping, utilities (including cable TV, but not telephone), and Complete health care. Part of a resident's healthcarc costs was reimbursed by Medicare the health center paid the or Medicaid When it opened, Northridge was the only CCRC in its marketing area, which it defined as an area with a radius of about 60 miles. Since then, three other CCRCs had opencd in the area. Although Northridge had a lengthy waiting list of persons w the per who wanted the tvpe of apartment available list had to be contacted to locate and who was willing to move in the near future. For some prospeetive residents, the problem was the difficulty of sclling their home in order to provide funds for the entrance fee. There were 18 new entrants to apartments (each with one or two persons) in FY 1995 and 25 in FY 1996. Northridge was a nonprofit organization exempt from Federal taxes under Section 501(c) of the Internal Revenue Code, but subject to local property taxes on the resi- dential facilities. It was governed by an unpaid board of directors; 11 members were local residents, twa werc residcnts of Northridge, and onc was a member of the national board of the denomination Grover Porter was the executive director of Northridge. He joined Northridge in January 1996. His previous job had been as executive director of a smaller CCRC. Financial Statements At its quarterly meeting on January 8, the Board discussed the financial statements in Exhibits 1, 2, and 3.1 On the Statement of Revenues and Expenses, the item "Health Center Fees, Resi- dent" was the amount of the residents' monthly fee that was allocated to the health r "Entry Fees Earned" was the amortization of the entranco fces applicable to the year. This amount was obtained by amortizing each resident's entrance fee over his or her expected life on a straight-line basis. "Shared Services Fee" was the amount paid to the denomination headquarters for providing assistance. On the balance shect, the assets under "Trustee Held Funds" were assets held by a trustee as required by the bond indenture. The January 8 Meeting After disposing of a few routine matters, the mecting was devoted to the budget for FY 1998 (year ending March 31, 1998). The budget had been discussed and approved at an earlier meeting of the inance committec. Mr. Porter presented the administra- tion's recommended budget. It called for an increase in the monthly fee of 2.5 percent, with no change in the entrance fee. Several members raised questions about the necd for this increase. A summary of the executive director's comments, made throughout the meeting, fallows Fee History. Monthly fees were increased by 4.3 percent in FY 1993,5.0 percent in 1994, 4.0 percent in 1995, 4.3 percent in 1996, and 3.0 percent in 1997. The proposed increase of 2.5 percent for 1998 was the lowest ever. The same percentagc increases were made in the entrance fee; no increase in the entrance fee was proposd for 1998. Refinancing. Northridge probably could refinance its debt at a net $2.5 million saving in interest (and letter-of-credit fee) through 2019. However, prospective under- writers would be concerned about its heavy reliance on entrance fecs. Thcy would want to see a surplus of $500,000 to $800,.000 annually, this, Northridge's chances of refinancing would be unrealistic. Staffing. The proposed cost-of-living increase for staff was 3.25 percent, the same as for 1997. The full-time-equivalent (FTE) staff in the 1998 budget included an increase of six FTES in the healthcare facility; otherwise the numbers were ap- proximately the same as the projected actual for 1997. the numbers didn't show Relation to Inflation. The fee increase was lower than the inflation rate for expenses assumed in the budget. Budgeting a lower increase for fees would challenge the financial viability of the organization Relation to Long-Range Plan. The long-range plan assumed an annual increase in fees of 3.5 percent. Unless there were compelling reasons to do otherwise, North- ridge should stick with the approved plan. Relation to Cash Flow. Maintaining a positive cash flow was of utmost impor- tance. To generate a positiye cash flow, a reaonable bottom-line surplus had budgeted, and Northridge needed to obtain an be new entrance fees. adequate amount Deficit. Unti FY 1996, Northridge operated at an annual deficit; the sum of these deficits was negative equity of S3.3 million as of the end of 1996. Operating surpluses reduced this deficit thereafter, but $1.5 million remained at the beginning of see a balance sheet with negative equity. FY 1998. Lcnders do not like Desirable Surplos. The budgeted surplus revenues; this was reasonable for a nonprofit organization. was less than 4 percent of operating Capital Expenditures. As its fixed assets aged, Northridge needed to provide increasing amounts for renewals and replacements. Budgeting a surplus, in effect, would provide a "nest egg" to help finance these expenditures Policy. Northridge's strongly recommended tha ent" organization, with many years of experiencc, $800,000 annually No dge plan on a surplus and etween Actuarial Study. A careful actuarial study wass made recently. It extrapolated the revenues of each resident for his or her expected life and the rclated expenditures for the total period from now until the years in which the oldest current resident was expected to liye, The numbers were based on the same estimates of cost of living, fce increases, and other factors included in the FY 1998 budget. It showed that the present value of the revenues exceeded the present value of the expenses and expen ditures by only S1 million. This was a smal margin of safety as a percentage of revenues; total revenues for this period were projected to exceed $100 million. Competition. Three CCRCS had opened in Northridge's marketing area, and more were expected. Their fees were a little lower than Northridge's. Although tion at any time. In anticination cf this p xperieice an unexpectcd reduc- of 96 percent. The surplus would help deal with a situation of operating at less than capacity if it arosc Health Care. As residents aged, Northridge had to anticipate that the demand for hcalth care would increase. It needed to face the need to open additional beds, with a drastic increase in healthcarc costs. The surplus would help cushion the impact of these costs Regulatory Uncertainties. Northridge could not know what the state and federal regulatory agencies would do to it. For example, the state could require that the agency maintain a specified amount of liquid assets. Questions 1, Is Exhibit1 the best set of numbers to use as a basis for arriving at the fee? If not, what improvements would you suggest? 3, What is the desirable ul een f the points made by the Executive Director 4. As a director, what change in the FY 1997 fees do you recommend for FY 1998? 2 EXHIBIT 1 NORTHRIDGE Statement of Revenue and Expense Budgeted Flscal Year 1998 (S000) Change between a8png 98/97 BR13alot FY 100R 7 OPERATING REVENUES Operating Revenucs ees Churity Core Health Center Fees: S 7,291 (38) 7.220 (40) $7.239 (50) 0. 1. 27 1 1.5 Medicare uad Otber Insurance -16.36% Non-Resident 29 3 5" 32 9.38% 3,466 ntry rees Baroed 766 s01 Restricted Assets Released to Operations Other Progr e 45 50 NIA 183 177 1.64% S13.174 $13.614 3234. TOTAL OPERATING REVENUES $13.372 OPERATING EXPENSES Health Services Food Services 2,061 1,546 11 2 295 2,057 10,20% --0.52% 1.455 1 538 istrative Employce Bonefits Utilitics 592 601 633 6,48% g Mintenance Shared Services Fee Real Estate Taxcs 913 733 754 469 469 486 789 3.50% 2,15% 772 752 ation and Amortization Inerest Contingency Expense TOTAL OPERATING EXPENSES 400 2.418 7344 88 125 29.60% $12.775 $12.329 2.53% $13.107 EXCESS (DEFICIENCY) OF ES OVER ORERATINGEXPENSES s 507 1,043 309 21.30% 7 LIOIHX NORTHRIDGE Balance Sheet Comparison FY 1996 thraugh Budget FY 1998 Projected Budgeted 96 Yy 86 40w SLISSV I n Short Term Investrments NORTHRIDGE Statement of Forecasted Cash Flows For Budget FY 1998 QE8 9Zs't O0s's Accouits Recevable SEZ Deposits uppes $9 997 (000 Actual and Prepaid FRI asuadxg Projected d DSLAccount 060 Otrt March 98 paapng 9S0' 96 yu Trustee Held OPERATING ACTIVITIES Excess (Deficit) of Revenues over Expenses unooy dsT $10,025 Total Current Assets S 7,670 $10,789 1,043 S07 Trustee Held Funds Deot anitnl Reserve 3,725 3,062 neenupaarea par LO9' $ 65 966 109 098 Depreciation and Amortization E08 LE8'I Liquid Assct 86L Reserve I83ua US-HION sup no9 Decr (Incr) Accounts Receivable (IL) uorenEA m Tbtai Trustee Held Funds 6,759 $ 7,07 $7,055 autoag nanugv (apu) acT 88 Property Plant and Equipment Decr (Tncr) Prepaid Exp/ven Iner (Decr) Interest Payable 1,155 (26) pu and improvements Eainment 48.034 (91) 2,916 3,244 S52,241 (9,441) Total PP&E $53,045 OPERATING ACTIVITIES INVESTING ACTIVITIES $ 1,948 (7,757 9ST'E S Lass Accumulated Depreciation (E9I11) 541,882 (612) (SS) (7EI Net PP&E $44,296 d Auadod nomsahay :sassy Jaqo Organizatianal and Ljcenscs Net Deferred Financing Costs Net (Z61) NET CASH (USED) BY INVESTING ACTIVITIES 96t S (187) $ 1,097 (8st) (t08) $ s 1,326 560,051 FINANCING ACTIVITIES Change in Long Term debt fotal Other Assets 1,211 (440) TOTAL ASSETS $61,107 $60,323 Change in other 1T liabilities LIABILITIES (7z) ONVIVE CINNA pue conts Paahle Accrued Expenses FINANCING ACTIVITIES (425) (1ZP) (szt) Chz CASH INYESTheE N CASH AND 719 ST E08 AND CASH INVESTMENTS AT CASH BEGINNING OF YEAR +C! Cri Payable Total Current Liabilities Interest B DISZI $13,313 STE'EI 858'SIS 060 1 oco'D g's1 c79'z us91s 33,148 saa. I28'ZE Advance Deposits TOTAL LIABILITIES 02 61,825 02+ coH $62,604 $62,617 FUND BALANCE (0Lz'E) S (2,553) (60S)S snc Current Period TOTAL FUND BALANCE (2,553) $ (1,510) S (1,002) TOTAL LIABILITIES aONYNVINDANV 560,05 $60,823 LOI'19S Northridge The meeting of the Northridge Board of Directors on January 8, 1997, unexpectedly evolved into a heated discussion of what one member called a "philosophical" issue, namcly, the role of surplus in a nonprofit organization. As the meeting ended, the issue was still unresolved. ackground Northridge was a continuing care retirement community (CCRC) located in a small college town. Its impetus came from members of a local church, who persuaded the national headquarters of that denomination to take on the project. The denomination headquarters had built other CCRCS. It supervised design and construction, arranged the initial financing, and selected and trained management personnel. Construction started in 1989, and the first residents moved in on July 1, 1991. Construction and start-up costs were financed by two bond issues totaling $42,990,000. One issue, in the amount of $15,000,000, was redeemcd on October 1, 1994. The other issue had an interest rate of 8 percent, due October 1, 2019, with annual mandatory redemption of $440,000 in FY 1997 (the year ended March 31, 1997), increasing by approximately 10 percent each year thereafter. The bonds were se The 60-acre pronerty consisted of a residential complex of 248 apartments with a health center. The apartments were studio, one bedroom, two bedrooms, and two bedrooms and den. In late 1996, there were 369 residents. The complex included a dining room, cafeteria, auditorium seating 150 people, library, indoor pool, beauty/ barber shop, branch bank, gift shop, and facilities for crafts, woodworking, painting, and other activities. These apartments and facilities were in buildings. The health center was connccted group of the residential complex. There a building connectedt were 76 nursing beds, but one section, consisting of 20 beds, was not open in 1996. It was expected that this section would be opened in 1998 or soon thereafter. The health center included an employee day care centcr, exercise and physical therapy rooms, and a clinic with medical, dental, ophthalmology, padiatry, and laboratory facilities Northridge residents paid an entrance fee and a to $267.300, median of th 5 100: ardouble ccunany the entrance fee was 5 percent higher Monthly fees for single occupancy ranged from $1,581 to $2,802, median of $2,451; for double occupancy, the fee was 40 percent higher. An occupant same monthly fee as he or she paid when in an apartment. The monthly fec covered one meal per day, housekeeping, utilities (including cable TV, but not telephone), and Complete health care. Part of a resident's healthcarc costs was reimbursed by Medicare the health center paid the or Medicaid When it opened, Northridge was the only CCRC in its marketing area, which it defined as an area with a radius of about 60 miles. Since then, three other CCRCs had opencd in the area. Although Northridge had a lengthy waiting list of persons w the per who wanted the tvpe of apartment available list had to be contacted to locate and who was willing to move in the near future. For some prospeetive residents, the problem was the difficulty of sclling their home in order to provide funds for the entrance fee. There were 18 new entrants to apartments (each with one or two persons) in FY 1995 and 25 in FY 1996. Northridge was a nonprofit organization exempt from Federal taxes under Section 501(c) of the Internal Revenue Code, but subject to local property taxes on the resi- dential facilities. It was governed by an unpaid board of directors; 11 members were local residents, twa werc residcnts of Northridge, and onc was a member of the national board of the denomination Grover Porter was the executive director of Northridge. He joined Northridge in January 1996. His previous job had been as executive director of a smaller CCRC. Financial Statements At its quarterly meeting on January 8, the Board discussed the financial statements in Exhibits 1, 2, and 3.1 On the Statement of Revenues and Expenses, the item "Health Center Fees, Resi- dent" was the amount of the residents' monthly fee that was allocated to the health r "Entry Fees Earned" was the amortization of the entranco fces applicable to the year. This amount was obtained by amortizing each resident's entrance fee over his or her expected life on a straight-line basis. "Shared Services Fee" was the amount paid to the denomination headquarters for providing assistance. On the balance shect, the assets under "Trustee Held Funds" were assets held by a trustee as required by the bond indenture. The January 8 Meeting After disposing of a few routine matters, the mecting was devoted to the budget for FY 1998 (year ending March 31, 1998). The budget had been discussed and approved at an earlier meeting of the inance committec. Mr. Porter presented the administra- tion's recommended budget. It called for an increase in the monthly fee of 2.5 percent, with no change in the entrance fee. Several members raised questions about the necd for this increase. A summary of the executive director's comments, made throughout the meeting, fallows Fee History. Monthly fees were increased by 4.3 percent in FY 1993,5.0 percent in 1994, 4.0 percent in 1995, 4.3 percent in 1996, and 3.0 percent in 1997. The proposed increase of 2.5 percent for 1998 was the lowest ever. The same percentagc increases were made in the entrance fee; no increase in the entrance fee was proposd for 1998. Refinancing. Northridge probably could refinance its debt at a net $2.5 million saving in interest (and letter-of-credit fee) through 2019. However, prospective under- writers would be concerned about its heavy reliance on entrance fecs. Thcy would want to see a surplus of $500,000 to $800,.000 annually, this, Northridge's chances of refinancing would be unrealistic. Staffing. The proposed cost-of-living increase for staff was 3.25 percent, the same as for 1997. The full-time-equivalent (FTE) staff in the 1998 budget included an increase of six FTES in the healthcare facility; otherwise the numbers were ap- proximately the same as the projected actual for 1997. the numbers didn't show Relation to Inflation. The fee increase was lower than the inflation rate for expenses assumed in the budget. Budgeting a lower increase for fees would challenge the financial viability of the organization Relation to Long-Range Plan. The long-range plan assumed an annual increase in fees of 3.5 percent. Unless there were compelling reasons to do otherwise, North- ridge should stick with the approved plan. Relation to Cash Flow. Maintaining a positive cash flow was of utmost impor- tance. To generate a positiye cash flow, a reaonable bottom-line surplus had budgeted, and Northridge needed to obtain an be new entrance fees. adequate amount Deficit. Unti FY 1996, Northridge operated at an annual deficit; the sum of these deficits was negative equity of S3.3 million as of the end of 1996. Operating surpluses reduced this deficit thereafter, but $1.5 million remained at the beginning of see a balance sheet with negative equity. FY 1998. Lcnders do not like Desirable Surplos. The budgeted surplus revenues; this was reasonable for a nonprofit organization. was less than 4 percent of operating Capital Expenditures. As its fixed assets aged, Northridge needed to provide increasing amounts for renewals and replacements. Budgeting a surplus, in effect, would provide a "nest egg" to help finance these expenditures Policy. Northridge's strongly recommended tha ent" organization, with many years of experiencc, $800,000 annually No dge plan on a surplus and etween Actuarial Study. A careful actuarial study wass made recently. It extrapolated the revenues of each resident for his or her expected life and the rclated expenditures for the total period from now until the years in which the oldest current resident was expected to liye, The numbers were based on the same estimates of cost of living, fce increases, and other factors included in the FY 1998 budget. It showed that the present value of the revenues exceeded the present value of the expenses and expen ditures by only S1 million. This was a smal margin of safety as a percentage of revenues; total revenues for this period were projected to exceed $100 million. Competition. Three CCRCS had opened in Northridge's marketing area, and more were expected. Their fees were a little lower than Northridge's. Although tion at any time. In anticination cf this p xperieice an unexpectcd reduc- of 96 percent. The surplus would help deal with a situation of operating at less than capacity if it arosc Health Care. As residents aged, Northridge had to anticipate that the demand for hcalth care would increase. It needed to face the need to open additional beds, with a drastic increase in healthcarc costs. The surplus would help cushion the impact of these costs Regulatory Uncertainties. Northridge could not know what the state and federal regulatory agencies would do to it. For example, the state could require that the agency maintain a specified amount of liquid assets. Questions 1, Is Exhibit1 the best set of numbers to use as a basis for arriving at the fee? If not, what improvements would you suggest? 3, What is the desirable ul een f the points made by the Executive Director 4. As a director, what change in the FY 1997 fees do you recommend for FY 1998? 2 EXHIBIT 1 NORTHRIDGE Statement of Revenue and Expense Budgeted Flscal Year 1998 (S000) Change between a8png 98/97 BR13alot FY 100R 7 OPERATING REVENUES Operating Revenucs ees Churity Core Health Center Fees: S 7,291 (38) 7.220 (40) $7.239 (50) 0. 1. 27 1 1.5 Medicare uad Otber Insurance -16.36% Non-Resident 29 3 5" 32 9.38% 3,466 ntry rees Baroed 766 s01 Restricted Assets Released to Operations Other Progr e 45 50 NIA 183 177 1.64% S13.174 $13.614 3234. TOTAL OPERATING REVENUES $13.372 OPERATING EXPENSES Health Services Food Services 2,061 1,546 11 2 295 2,057 10,20% --0.52% 1.455 1 538 istrative Employce Bonefits Utilitics 592 601 633 6,48% g Mintenance Shared Services Fee Real Estate Taxcs 913 733 754 469 469 486 789 3.50% 2,15% 772 752 ation and Amortization Inerest Contingency Expense TOTAL OPERATING EXPENSES 400 2.418 7344 88 125 29.60% $12.775 $12.329 2.53% $13.107 EXCESS (DEFICIENCY) OF ES OVER ORERATINGEXPENSES s 507 1,043 309 21.30% 7 LIOIHX NORTHRIDGE Balance Sheet Comparison FY 1996 thraugh Budget FY 1998 Projected Budgeted 96 Yy 86 40w SLISSV I n Short Term Investrments NORTHRIDGE Statement of Forecasted Cash Flows For Budget FY 1998 QE8 9Zs't O0s's Accouits Recevable SEZ Deposits uppes $9 997 (000 Actual and Prepaid FRI asuadxg Projected d DSLAccount 060 Otrt March 98 paapng 9S0' 96 yu Trustee Held OPERATING ACTIVITIES Excess (Deficit) of Revenues over Expenses unooy dsT $10,025 Total Current Assets S 7,670 $10,789 1,043 S07 Trustee Held Funds Deot anitnl Reserve 3,725 3,062 neenupaarea par LO9' $ 65 966 109 098 Depreciation and Amortization E08 LE8'I Liquid Assct 86L Reserve I83ua US-HION sup no9 Decr (Incr) Accounts Receivable (IL) uorenEA m Tbtai Trustee Held Funds 6,759 $ 7,07 $7,055 autoag nanugv (apu) acT 88 Property Plant and Equipment Decr (Tncr) Prepaid Exp/ven Iner (Decr) Interest Payable 1,155 (26) pu and improvements Eainment 48.034 (91) 2,916 3,244 S52,241 (9,441) Total PP&E $53,045 OPERATING ACTIVITIES INVESTING ACTIVITIES $ 1,948 (7,757 9ST'E S Lass Accumulated Depreciation (E9I11) 541,882 (612) (SS) (7EI Net PP&E $44,296 d Auadod nomsahay :sassy Jaqo Organizatianal and Ljcenscs Net Deferred Financing Costs Net (Z61) NET CASH (USED) BY INVESTING ACTIVITIES 96t S (187) $ 1,097 (8st) (t08) $ s 1,326 560,051 FINANCING ACTIVITIES Change in Long Term debt fotal Other Assets 1,211 (440) TOTAL ASSETS $61,107 $60,323 Change in other 1T liabilities LIABILITIES (7z) ONVIVE CINNA pue conts Paahle Accrued Expenses FINANCING ACTIVITIES (425) (1ZP) (szt) Chz CASH INYESTheE N CASH AND 719 ST E08 AND CASH INVESTMENTS AT CASH BEGINNING OF YEAR +C! Cri Payable Total Current Liabilities Interest B DISZI $13,313 STE'EI 858'SIS 060 1 oco'D g's1 c79'z us91s 33,148 saa. I28'ZE Advance Deposits TOTAL LIABILITIES 02 61,825 02+ coH $62,604 $62,617 FUND BALANCE (0Lz'E) S (2,553) (60S)S snc Current Period TOTAL FUND BALANCE (2,553) $ (1,510) S (1,002) TOTAL LIABILITIES aONYNVINDANV 560,05 $60,823 LOI'19S