CMS Provides Critical Insight into Nursing Facility Companies’ Financial and Market Performance
By: Christopher J. Donovan, Esq., Martin Leinwand and Peter R. Leone
In its second Health Care Industry Market Update, the Centers for Medicare and Medicaid Services (CMS) has provided critical insights into the agency’s thinking about the financial and market performance of nursing facility companies.
CMS Administrator Tom Scully states that the new reports are based upon a review of "the vast array of data available from Wall Street analysts that is not widely reviewed in Washington." This is in light of the administrator’s belief that that the data collected from the industry and used by investors in for-profit companies, and lenders to for-profit and nonprofit entities, can be used by regulators and legislators to assess the adequacy of government program funding of nursing facility services and the need for regulatory reforms. Through its market updates, CMS hopes to provide objective information, in summary form, for use by CMS, the U.S. Department of Health and Human Services (HHS), the U.S. Congress and their respective staffs in developing public policy that affects the administration of the Medicare, Medicaid and S-CHIP programs. The second CMS market update on skilled nursing facilities (SNFs), coupled with HHS Secretary Tommy Thompson’s late April 2002 announcement that the SNF case mix refinements will not be implemented by CMS this year, provides us with a better sense of the current industry outlook for nursing facilities and other post-acute, health-care providers.
Impact of the Sunset of Medicare SNF Add-Ons: The "Medicare Cliff"
The CMS market update summarizes the sunset of financial relief provided to SNFs under the Balanced Budget Refinement Act of 1999 (BBRA) of 1999 and the Benefit Improvement and Patient Protection Act of 2000 (BIPA) of 2000. In those laws, the U.S. Congress provided relief to lessen financial pressures resulting from the Prospective Payment System (PPS) that was implemented for SNFs in the Balanced Budget Act of 1997 (the BBA). (PPS is also called the Resource Utilization Groups or RUGs system.) This relief was in the form of certain temporary add-ons to the federal per diem rates, which skilled nursing facilities receive from CMS for services furnished to Medicare beneficiaries. Within the industry, the expiration of these BBRA and BIPA add-on payments has been referred to as the "Medicare cliff," since it will result in a precipitous and significant reduction in the Medicare (federal) per diem rates.
Under CMS estimates, the per diem effect of the BBRA and BIPA add-ons comes to an average of $56.25 per day. Of the $56.25, $35.42 is from Congress allowance until September 30, 2002, of a 16.66 percent increase in the nursing component of the case-mix adjusted federal per diem rates and a 4 percent across-the-board increase of the adjusted federal per diem payment rate. Absent action by Congress prior to October 1, 2002, to extend these two add-ons, aggregate payment to SNFs will be reduced by approximately $1.4 billion annually when these two add-ons expire on September 30, 2002. The remaining $20.83 of the $56.25 per day is tied to 20 percent increases in 12 non-rehabilitative therapy RUG categories and 6.7 percent increases in 14 rehabilitative therapy RUG categories that were implemented under the BBRA and BIPA, which increases are to remain in effect until CMS implements certain refinements to the current RUG case-mix classification system that better address reimbursement for medically complex patients. The elimination of these specific RUG category rate increases was expected to reduce aggregate payments to SNFs by an estimated $1 billion annually. On April 23rd, however, HHS Secretary Tommy Thompson announced that CMS would leave in place the current RUG classification system because the research is not sufficiently advanced at the present time to implement RUGs refinements this year. As a result, the anticipated $1 billion reduction will not occur this year.
Starting in late 1999, five of the 10 largest nursing home chains filed for Chapter 11 bankruptcy proceedings. Some of these companies have now emerged from bankruptcy. Others expect to come out of bankruptcy once disclosure statements and plans of reorganization allocating the company’s equity among secured and unsecured creditors are approved by the bankruptcy court and relevant stakeholders. A combination of Medicare cutbacks caused by BIPA and BBRA, inadequate Medicaid reimbursements and aggressive leveraged acquisitions brought about these bankruptcies.
As these companies come out of bankruptcy with stronger balance sheets, fewer non-performing assets and a keener focus on operations, they are attempting to develop a business model that will provide quality care to residents and shareholder value for investors. In most cases, this will entail continued strategic acquisitions and dispositions. No one is expecting a reemergence of the go-go days of the late 1990s without the infusion of significant additional equity. The caution of the traditional debt markets alone should cause the reemergence of the post-acute care facility-based sector to be at a controlled and measured pace. The "Medicare Cliff" will also continue to provide a brake on overly leveraged acquisition activity.
The hot IPO market for staffing and home health companies are additional features of today’s environment. In addition, hospice, home infusion and specialty pharmacy are all providing outpatient, in-home and non-institutional services that are in current demand. The emergence of this sector of health care as a Wall Street darling, together with continued interest of federal and state lawmakers in community-based care options for seniors, may ultimately impact occupancy rates at skilled nursing facilities and assisted living facilities by permitting a greater volume of in-home care service. Many of these companies have significant private pay or staffing models. As such, the adverse financial impact of periodic attempts by governmental payor programs to reduce reimbursement for such services can be mitigated by private pay and other non-governmental payor revenues. Companies such as Cross Country, Odyssey Healthcare, and Optioncare are examples of these recent trends.
As facility-based providers attempt to develop a successful business model to meet current regulatory and reimbursement challenges, they may increasingly need to address the demand for and interest in non-facility based alternatives. Favorable demographics on the aging U.S. population and the trend on the part of capital markets to favor asset rich companies with strong revenues and stable earnings should be cause for cautious optimism on the part of facility-based provider companies. Unlike prior cycles, however, higher margin service companies may access capital more readily than fixed asset based companies with marginal profits.