Morality of Entrance Fees
This is an interesting discussion that goes well beyond “refundable” entrance fees since the moral and ethical issues involved are inherent in all entrance fee funded communities. It is deceptive to imply that entrance fees are a prepayment for lifelong contractual commitments when the provider intends to put them at risk as an equity investment to secure debt providers. That’s the case for the “nonprofit” sector of the senior housing industry generally.
Those nonprofit providers which are not dependent on entrance fees for equity capital have generally aggregate enough profits, despite their nominally nonprofit claims and tax qualification, to have a positive net worth derived from past resident paid-in capital. This use of entrance fees as at-risk equity capital involves the sale of an unregulated blue sky investment security.
We can deduce what’s right and fair from first principles by looking at the history of how today’s questionable practices evolved and by considering the logic of what has transpired and what might have been more ethical sound and just. The general reasoning is something that ordinarily perceptive people should be able to understand. Once armed with that understanding, it’s up to each individual involved in the process to decide what is just and what is the course of integrity for each of them as individuals.
History.
The senior housing industry evolved from church initiatives and churches were used to operating without concern for financial equity since they were inherently charitable in their mission. Churches themselves are nonprofit, and so it was natural for them to adopt nonprofit concepts for the homes they sponsored, organized, and operated. Initially, those “homes” were intended to provide lifetime retirement housing for retired church workers, clergy, and some others who were dependent on the generosity of others. Beneficiaries paid what they could as entrance fees, and charitable giving made up the balance.
In 1972, Revenue Ruling 72-124 extended nonprofit status to otherwise for-profit enterprises that provide housing for the elderly subject to certain nominal requirements reflective of what the ruling termed the “distress” of old age. That led to the expansion of nonprofit housing operators into the more profitable market of housing the affluent.
The providers, thinking as nonprofit operators, required entrance fees as equity capital, i.e. a down payment, to secure the debt (analogous to a home mortgage) needed to get started. The residents were not told that they were making an at risk equity investment, i.e. a blue sky security investment, and those market based entrance fees were treated as partial consideration for continuing care contracts. Initially, that entrance fee equity contribution was transferred to the enterprise over a relatively short period, usually between 36 and 72 months.
This deceptive model (from a consumer’s perspective, i.e. an at risk equity investment couched as a secured investment in lifetime services) was encouraged by investment banking firms who earn their revenues by originating the debt secured by the entrance fees. The accounting profession, which promulgated rules rather than following principles, acceded to the wishes of their corporate clients, the providers, and allowed accounting that rewards early residential cohorts at the expense of latter generations. In short, entrance fees were not “reserved” to meet the contractual obligations to the specific residents who paid those fees.
To make this clear, imagine a pure rental property for which a resident might wish to prepay future rents from current wealth for the rest of the resident’s lifetime. The resident could easily accomplish that by buying a single premium life annuity from a licensed insurance company and assigning the stream of annuity payments to the rental property owner (the provider) to offset rents that come due. The licensed insurance company could then invest those annuity proceeds in the housing project in the form of an interest-bearing debt obligation (technically known as modified coinsurance reinsurance). That is not what the debt originating investment banking firms suggested be done. It would not be to their interest to do so.
The next development came when Joan Arnett, who was a Managing Director of one such investment banking firm, Cain Brothers (an intriguing name Gen. 4:9), devised the notion of the cascading refund. She thought that if the refund were paid by the next resident, then the provider could take the first resident’s entrance fee into income at a rate that would be limited only by the willingness of the accounting firms to allow it. That created a Ponzi scheme in which succeeding residents’ entrance fee investments are hypothecated to provide benefits to the move in cohort, with the cost of that hypothecating cascading from resident cohort to successor ad infinitum, requiring a presumption of perpetual operation. As Bill has pointed out, such a “scheme” (and it is a “scheme” in all senses of that word) is generally considered to be contrary to public policy (Social Security is a major exception because it is assumed that government will be perpetual and government can coerce payments that produce negative value for the payors).
Logic.
To cut to the chase, we should start with the simple month-to-month rental model since residents are given no ownership and the value of their residency will be received ratably over the time of their occupancy.
That then means that any entrance fees are equivalent to the single premium required to purchase a life annuity from a licensed, regulated insurance company. That’s how they should be viewed.
If the enterprise is established on such a sound financial footing, then it would be reasonable for there to be fundraising to subsidize residence for those who can’t afford the full cost just as universities engage in fundraising to subsidize the cost of educating underprivileged students.
It's that simple. It’s become complex because it has suited the profit interests of investment bankers and accountants to take advantage of the well-intentioned innocence of decision makers who think of a nonprofit senior housing operation as a quasi-charitable venture. Providing luxury rental housing for affluent residents who pay the full cost of their residency is not charitable.