As the title of this post implies, a review of the status of the SNF industry is as much about current issues begat by past issues influenced by an outlook that is finally, starting to congeal. Writing that (sentence) was convoluted enough and that is exactly, where the bulk of the industry issues are. 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 September of 2016. These Conditions haven’t updated (substantively) since the early 90s via implementation of OBRA and 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 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. Performance below (the measurement period is past), the SNF is encouraged to improve to the benchmark. 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, providers acute and post-acute are essentially paid based on an episode of care. The episode is a benchmark for the region and provider costs based on billed charges, 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 at or above, 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 set to begin March 1 of this year are 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 (the CMS Five Star system) matter. Providers that have lower Star ratings (3 or less) are watching referrals for quality paying patients (primarily Medicare) dwindle. In some cases, in markets with ample 4 and 5 Star providers, referrals patters have shifted by as much as 30% (away from 3 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 the new Conditions of Participation, et.al., 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 RUGs 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 PT and 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 or trembling or at least fifty plus percent is. 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 (50 plus percent). The net Medicaid margin (negative) for most providers is 20%. For higher quality providers, the margin (negative) 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 patient day between Medicare and Medicaid (on average) is $275 per day (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 a bit more: A 100 bed facility with 50 Medicaid needs 29.4 Medicare residents to offset the Medicaid loss. Add a few private pay, and a margin is possible.
- With 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 3 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 result of new 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 RUGs maximization, 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 for the same is not on their side.
Given the above and the factors operative, 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/was for their SNF business, a 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 REITs. Combine these factors with an average Star rating at 3 or lower (not a lot of 4 and 5 star facilities) 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 (plants that were too old and improperly scaled) and to embark on a census development and Star improvement strategy, none of which will/would bear fruit for at least 5 years if not more. And of course, the fruit that is produced is insufficient in net margin to justify the original expenditure and meet ROI (Return on Investment) requirements.
The Kindred news that it may seek a sale of the entire business is a strategic, preemptive hedge to what has occurred (is occurring) to Brookdale. The parts of Kindred in certain cases may be worth more than the whole. Overall, the revenue pressure (down) on the post-acute industry 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 lease payments (lower). 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 1 – not a good future for a REIT’s 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 deals done, cash flow focused – 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. There are not buyers 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 view is a bit bifurcated. For a large portion of the industry, I am bearish;
- 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 percent 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 year to three)
- 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 in number and almost entirely today, non-profit, health system affiliated or regional, 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.