Editorial note: This blog post has been republished from Reg’s Blog: Senior and Post-Acute Healthcare News and Topics, with permission from the author.
As the title of this post implies, a review of the status of the skilled nursing facility (SNF) industry is as much about current issues brought on by past issues influenced by an outlook that is finally starting to take shape. Writing that sentence was convoluted enough and that is exactly where the bulk of the industry issues lie. To begin, an operative “influences” framework is required:
- Federal Conditions of Participation: After years of work and inaction, a final rule updating the Federal Conditions of Participation was released in October of 2016. These Conditions haven’t been updated (substantively) since the early 90s via implementation of the Omnibus Budget Reconciliation Act of 1987 (OBRA) and the Prospective Payment System (PPS). Suffice to say, the update is sweeping; so much so that implementation of the revisions is in year over year phases. Complying with all of the Conditions will cost SNFs tens of thousands of dollars, if not more. Implementation and survey activity on the new Conditions begins November 2017. Reference posts from this site are here: http://wp.me/ptUlY-kL http://wp.me/ptUlY-kU http://wp.me/ptUlY-lf
- Value-Based Purchasing: Pay for performance is coming (or almost here) as the measurement period for SNFs has occurred and the timeframe for making improvements in performance, particularly on avoidable readmissions, is NOW. For SNFs, this is about reducing or eliminating avoidable hospital readmissions (within 30 days of SNF admission from a hospital). The observation period has already concluded for payment adjustments (negative to positive), beginning in 2018. The initial adjustment is 3% ranging to 8% in 2022.
- IMPACT Act and Quality Reporting Program (QRP): This is all about the reporting of quality data and quality measures across all post-acute settings. The implication for SNFs is the disclosure of these measures, tethered to a benchmark. With performance below the benchmark the SNF is encouraged to improve in order to reach the benchmark. SNFs’ failure to improve nets a 2% reduction in Medicare payments. High performers will receive an incentive payment. Specifics are here: http://wp.me/ptUlY-lx
- Bundled Payments: Elective hip and knee replacement is up and running in 67 metropolitan regions. In bundled payments, acute and post-acute providers are essentially paid based on an episode of care. The episode serves as a benchmark for the region and provider costs are based on billed charges that are matched against the target. Additionally, providers are tasked with quality measurements and satisfaction measurements. The goal is to produce outcomes that are lower in cost than the benchmark and that are at or above the desired quality levels. Providers (hospitals initially) that can do so will receive incentive payments. The implication for SNFs is the need to control costs, provide high quality outcomes and potentially, participate in risk-sharing agreements with the hospital for a piece of the incentive “action.” Cardiac and upper femur fracture bundled payments were set to begin March 1 of this year have been delayed to October 1. More on this subject here: http://wp.me/ptUlY-k2 http://wp.me/ptUlY-kv
- Star Ratings: Because of the issues above, mostly influenced by bundled payments and readmission penalties for hospitals, star ratings calculated by CMS’ Five Star system matter. Providers that have lower star ratings (three or less) are watching referrals for quality paying residents (primarily Medicare) dwindle. In some cases, in markets with ample four- and five-star providers, referrals patterns have shifted by as much as 30% away from three-star and lower facilities.
- Market and Referral Shifts: Without question, there is a distinct movement away from institutional post-acute care. In some markets, an abundance of SNF beds has led to an overall reduction of ten plus points in average occupancy (supply exceeding demand). Home health is the biggest benefactor as patients previously sent to SNFs for lengthy rehab stays have shifted to home health for the entire stay or for the back-half or better of the traditional stay. This has hurt occupancy. Couple this effect with the issues noted before and market and referral pressures are enormous for many SNFs. A five- to seven-point reduction in the quality mix occupancy is enough to erode margins from negative to positive. With increasing cost pressure due to recent revisions, including Conditions of Participation, etc., and limited revenue increases due to rate, the fortune for many SNFs is dim.
- Possible New Payment System for Medicare: Within the past week, CMS floated a proposed rule for comment that would “gut” the current resource utilization groups (RUG) system, replacing it with a resident classification system. The overall theme is to reduce the reward tied to maximizing therapy services and length of stay. The new system would categorize residents based on overall needs, combine reimbursement for physical therapy (PT) and occupational therapy (OT) and enhance payment for nursing related needs. More to come on this topic.
With the above headwinds, none of which are all that new or “newsworthy,” the industry is quaking. Consider the following as reasons:
- Medicaid remains the dominant payer for skilled nursing care. With the likelihood of continued rate pressure state by state for providers (Medicaid structural funding issues), the prospect of enhanced payment now or in the near future is ZERO. Fifty plus percent of the SNFs in the industry have a census that is predominantly Medicaid. The negative net Medicaid margin for most providers is 20%. For higher quality providers, the negative margin is 30%.
- The make-whole relief has come from Medicare and to a lesser extent, private pay. In effect, providers have subsidized their Medicaid losses via Medicare. The loss offset plus margin has come from maximizing Medicare census and Medicare reimbursement via higher therapy utilization and length of stay. The net difference per resident between Medicare and Medicaid (on average) is $275 per day. (This number varies state to state.) For most providers with large Medicaid census, a Medicare day is worth 1.7 Medicaid days (one Medicare is 1.7 times more “revenue” valuable than a Medicaid day). Illustrated further: A 100 bed facility with 50 Medicaid residents needs 29.4 Medicare residents to offset the Medicaid loss. Add a few private pay, and a margin is possible.
- With the value based program (VBP), QRP, bundled payments and census pressure, the ability to attract the Medicare volume to offset the Medicaid losses for a growing number of facilities has eroded. Facilities at or below the three-star level in most major metropolitan markets are seeing referral “shrinkage” and thus, census reductions. The effect is directly on the Medicare census.
- The outlook as a result of revised Conditions of Participation is for steadily rising costs to comply, at least in the short to near term. New regulations drive costs up.
- A future that includes a payment system overhaul focused less on therapy and RUG maximization and more on classifying residents’ needs globally, foretells great peril for the sector of the industry that has relied heavily on maximizing therapy volumes and related RUGs as margin subsidy. These SNFs need a new revenue and business model and time is not on their side.
Given the above and the operative factors, it is no wonder Kindred has decided to abandon the SNF market and potentially explore a sale for their entire business. The Kindred reality is/was¾for their SNF business¾a portfolio heavily occupied by Medicaid, facilities with aged, inefficient and out-scale physical plants, so-so market locations, and virtually all subject to leases to Ventas and other real estate investment trusts (REIT). Combine these factors with an average three-star or lower rating, and the outlook is challenging. There simply was and is no business justification to invest millions upon millions of dollars (literally hundreds of millions likely) to upgrade physical plants that were too old and improperly scaled and to embark on a census development and star improvement strategy, none of which will bear fruit for at least five years, if not more. And of course, the fruit that is produced is insufficient in net margin to justify the original expenditure and meet return on investment (ROI) requirements.
News that Kindred may seek a sale of the entire business is a strategic, preemptive hedge to what has occurred (and is occurring) at Brookdale. The parts of Kindred in certain cases may be worth more than the whole. Overall, with revenue pressure down on the post-acute industry, it is heavy with the heaviest pressure set to bear on institutional providers; particularly those with aged and improperly positioned/scoped assets. Revitalizing these assets is expensive, in some cases more so than rebuilding the asset properly, in its entirety. In short, Kindred is asset wealthy but the cash flow future from the heavy institutional element is marginally poor.
Transitioning to REITs that hold large SNF portfolios, the same or an analogous picture is operative. The bulk of REIT holdings are three star and lower. Quality mix has eroded for these facilities along with census. As cash flow pressure has increased, the need has arisen to restructure lower lease payments. Lower lease payments reduce REIT earnings. Without a large volume of facilities that are four and five star, there simply is no place to shift rate and thus, earnings pressure. Four and five star facilities can, and generally do, have enough cash flow to pay leases with coverage ratios at 1.2 and better. Below the three-star level, the pressure today is for leases to move to 1.1 or 1¾not a good future for a REITs’ earnings.
A concomitant problem for REITs is the value decline of the SNF assets they hold. While industry cap rates have been decent, the deal volume is very small and the cash-flow-focused deals done have been typified by four- and five-star rated providers or newer assets. REIT assets tend to be older buildings, larger buildings, and parts of chain or system organizations such as LifeCare and Manor Care. Simply stated: Without a quality mix, strong cash flow, good market location and solid to better assets (not too large, primarily private room, modern, etc.), the underlying brick and mortar value is minimal. Buyers do not exist today for these types of assets and the operators willing to assume these assets with leases are disappearing as well.
Given all of these issues, challenges, etc., one could surmise an outlook for the SNF industry that is rather bearish. My outlook is a bit divided, however, for a large portion of the industry, it is the former:
- Older physical plant that is larger, not fundamentally all private rooms, inefficient to staff, not having modern dining and therapy space, etc.
- Rated at three stars or less
- Medicaid census at 40% or higher of total bed capacity
- Debt or lease payments greater than 20% of net revenue
- In rural locations, unaffiliated with a larger parent or provider organization (staffing is difficult at best)
For providers that don’t fit this profile, there is a decent future if they stay ahead of the trends. Consider the following:
- Quality referrals are migrating aggressively to four and five star providers
- Payment incentives for strong quality outcomes are forthcoming (next one to three years)
- In good market locations, these providers will be able to negotiate terms in narrow networks and with Medicare Advantage plans as the other providers fall-off
- Properly capitalized with a good capital structure and cash flow sufficient to keep physical plant from aging (depreciating) via proper maintenance and investment
Granted, the number of providers that meet this profile is not large and almost entirely today, non-profit, health system affiliated or regional, and privately held. The real challenge is to be nimble and constantly vigilant on quality. The movement as I have written and publicly stated in speeches and lectures is to pay only for high quality and efficiently determined outcomes. Providers that can deliver this level of care will succeed and win in the new “environment.” Those that aren’t at this level yet have likely run out of time. Three-star or lower ratings take a long time today to convert to four and five stars. By the time the conversion has occurred, the referral patterns in the market will have permanently changed.