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Senior and Post-Acute Healthcare News and Topics

Five Things Every Healthcare Executive Should Focus On: Updated, Revised

More than two years ago I wrote a post regarding “five” things every SNF administrator should focus on and lo and behold, a reader asked late last week if I would revisit this subject.  She (the reader) is not an SNF administrator so she asked if I could focus more globally; sort of a “best practices” approach.  While each health care industry segment has its nuances, in reviewing my travels, the challenges and successes leaders have, where failures occur, and where careers are made and sustained, I quickly found commonality in approaches and focused competencies.

Healthcare leadership is complex and very dynamic.  The alchemy is nearly one-part inquisitor, one-part psychologist, and one-part theoretician.  Those that do well and thrive, regardless of industry segments, are today “global” thinkers capable of transitioning to tactician seamlessly.  They are outcome oriented and know the pieces of the puzzle well enough to be bull**it proof.  They think and act as if synergism is their main duty and they understand (acutely) the law of unintended consequences.   Bottom line: They see cause and effect and constantly seek ways to shorten the distance between the two.

Industry issues aside regarding changing reimbursement, regulation, etc., the focal core that I find as key and thus, displayed in action by the successful executives is as follows.

  1. Quality: This is an oft used buzzword but very skilled and successful executives can articulate this for their business immediately.  In healthcare, quality is all about tangible outcomes that patients experience.  Going one step deeper, quality today is also about a measurable outcome at a particular cost.  In my economist jargon, this is about utility and warranty.  Utility is maximized in healthcare when the payer and the patient receive a desired, tangible outcome at a market or below market price.  Warranty in healthcare is about the outcome’s sustainable benefit to the patient and the payer.  Technical yes but this theory is a key focal area for healthcare executives.  Think about it tangibly in light of today’s issues.  Hospital executives need to understand this because it impacts re-hospitalizations.  The outcome must match the warranty or in other words, the care must be complete such that avoidable readmissions are low or non-existent.  For SNF executives, the same holds true but with a slight twist.  The SNF executive must deliver excellent care all while minimizing the risk areas that lead to re-hospitalizations such as infections, falls, and medication errors.  As a core competency, the best executives I work with didn’t wait for the government to tell them to reduce their falls, reduce their re-admissions, etc.  They knew these issues years ago and had already understood the relationships between quality or utility and warranty.
  2. An Outside-Inside View: Where I find failings in healthcare leadership it almost always starts with executives that believe their challenges and their industry are utterly unique.  They not only bought the healthcare executive manual but they memorized it.  They seek only peer knowledge or interaction, often I believe to validate that “they” are doing the same thing everyone else is doing.  Alas, the story of the Lemmings on their way to the sea is cogent.  What I see as key competency among the best is that they have an “outside-inside” view competency.  This outside-inside view is characterized by looking beyond their industry at analogous problems or issues and seeking solutions that are applicable.  Yes, healthcare is unique but certainly not so unique that strong parallels in marketing, customer service, project management, systems design, etc. can’t be found via other industries.  Across my career, the best ideas I’ve used came from other industries – not healthcare.  I simply altered the concept to fit the situation.  Philosophically, “the coolest things in life exist in places where their aren’t any roads”; a quote from a former camp counselor to my son.  Developing this competency is all about forcing oneself to explore well beyond the industry noise, rhetoric and ideologies.
  3. Small Spaces and Closet Organizers: As odd as this heading sounds, it makes sense to me when I see it applied.  The industry has run through its hey-day where bigger was better and, “if you build it, they will come”.  Really strong executives today have learned how to creatively adapt and re-adapt and they realize the core competency of “revenue contribution” per square foot is the new reality.  This competency area is all about revenue maximization and in a go-forward universe of revenue stagnation via reimbursement cuts and flat payments, using space efficiently and keeping the closets organized rather than overflowing with stuff not needed nor ever used, is the requirement.  Gone are the days where more is better or additional lines of inventory make sense.  This focus is truly a trend from manufacturing where realities on plant size, productive capacity and just-in-time inventory came to roost many years ago.
  4. The True Meaning of Health Policy: This is about the Paul Harvey requiem; “the rest of the story”.  Health policy impacts are point in-time in terms of regulatory implications and reimbursement implications but woven together, a trend is evident.  This competency area is about knowing what the policy trends are, where Medpac is going and why and how the enterprise led should position accordingly.  I have written repeatedly that regardless of regulation and new laws like the PPACA, core issues about entitlement financing, sustainability of funding, etc. will beget certain and permanent changes in health policy.  Ignoring these realities and the resulting policy trends is akin to committing hara-kiri with a butter  knife; no one blow is fatal but the culmination of all blows leads to a slow, painful death.  Much is trending right now regarding networks, ACOs, bundled payments, pay-for-performance, accountability, fraud, etc.  Knowing not only the implication of each but how the same is directing the future is a core executive competency.
  5. Freakonomist: OK, I’m stealing from a book title here but the point is simple: Healthcare executives need to understand at a certain level, core human behavior and economics.  I’m not talking about finance or reimbursement but behavioral economics.  One of the major problems or arguably, the single most demonic problem with healthcare today lies in the axiom that “what get’s rewarded, get’s done”.  We have lived too long on the native belief that acute, fee-for-service, episodic medicine or care is how the U.S. health system thrives.  Thus, we have overspent and over-taxed the system without regard to a potential breaking point.  We have arrived at such a point.  Today’s healthcare executive must realize this core reality and to survive and thrive, re-define his/her leadership to developing systems and services that prevent utilization or revise utilization to more of a minimalist plane.  Those that embody the philosophy that “better is better” rather than “more is better” will understand this innately.  This competency is about “solving” core problems and not chasing root, flawed ideologies of the past.  Profit and success will come via innovation and system-thinking not from finding new ways to exploit Medicare and Medicaid.
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November 13, 2012 Posted by | Assisted Living, Home Health, Hospice, Senior Housing, Skilled Nursing | , , , , , , , , , | 3 Comments

Know Your Market, Know Your Value Proposition

Last October I wrote a post regarding the development of an Economic Value Analysis and how the same is important for marketing seniors housing and skilled nursing.  A couple of weeks ago, I wrote a post regarding feasibility tests key to project success and targeted feasibility.  Later this year, in October at Leading Age’s annual conference in Denver, I’ll again cover the concepts in a direct, interactive fashion.  Until such time however, I continue to receive dozens upon dozens of inquiries as to how to construct an Economic Value Analysis and a corresponding value proposition.  Last October’s post is instructive and can be found at http://wp.me/ptUlY-7G.  In addition, and in concert with the post prior to this one on financial feasibility methodologies, I’ve provided below some additional “help points”.

Economic Value Analysis is a fairly simple process that centers on determining the ability or capability of a product or service to satisfy the core demands of a given market; the ability to quantify utility.  Utility in this context, simply stated, is satisfaction at a given price.  For seniors housing, the struggle always is “how” to demonstrate value to potential consumers in a way that is logical and meaningful.  This is acutely problematic in a market that is competitive as the “noise” emanating from all the competitors regarding price and services is constant and at times, deafening.  At its core, Economic Value Analysis creates a more tangible constant.

Given that seniors housing has a very elastic demand curve (a great many substitute products provide equal or proximally equal core utility), the devil is creating a comparison basis and this basis is not “stated price or features”.  A place to start is completing a simple analysis that equates a seniors housing unit per square foot cost (cost = fixed costs, variable costs, and margin) to the comparable alternatives in the market.  In this case, comparable alternatives equal rental housing, other competitors, community dwellings (housing units, condominiums, etc).  Ignore your current pricing structure as unless the same is equalized on a square foot basis, this analysis won’t provide a true picture.

Taking the example to the next level, once the cost per square foot is known, determine the relevent market comparables.  This does take some homework but it is fairly easy to complete.  Via simple survey, one can generally gather enough information from realtors, friends, etc. to determine a community housing cost per square foot (utilities, taxes, rent costs, depreciation/maintenance, etc.).  Gaining information from competitors is even easier as typically, they publish the information or a simple “blind shopping” trip gathers all the necessary information.

Once the information is gathered, populate a simple spreadsheet with the data.  If the core cost per square foot for the seniors housing option is higher, and it typically is, the analysis must delve deeper.  Usually, elements that drive costs for seniors housing come in the form of rate or price inclusions such as meals, cable television, maid/cleaning services, etc.  Two approaches to deal with this issue are possible.  First, back these costs out of the seniors housing number and re-analyze the comparables.  Second, and my recommended method, gather data on these services and develop a square foot comparable.  Between competitors, the key is to keep the data as apples to apples as possible so one must be clear that the costs include exactly (or as close as possible) the same features/amenities, etc.

Once all the information is known and “spread” and sorted, the picture should become clear.  I like to look closest and hardest at the comparison between living at a seniors housing complex versus living in a market rate situation whether that is home, condominium or rental.  The age-old belief among seniors is that a seniors housing community is too expensive.  The analysis should detail where the true costs lie.  Expect some price sensitivity issues where the seniors housing is a tad more expensive but the difference should be clearly and easily explained (24 hour services, access to care, transportation, etc.).  The more than can be quantified in the form of dollars, the tighter the analysis becomes and the easier it is to explain where the salient benefits lies.  If the gap between the seniors housing cost and the alternatives is too high, the issue may lie in the structural elements of the equation such as inordinately high fixed costs or variable costs.  Becoming competitive may require changing, if possible, the financial drivers of the seniors housing project equation.

Concluding, the square foot model works exceptionally well in this analysis as it provides flexibility to model and to change any number of variables.  It also is “non-unit” specific so its data and results aren’t skewed by less-than relevant unit pricing schemes.  The difficulty simply lies in taking the time to build the model and to accurately gather solid data from the “universe” of housing alternatives.  Assuming costs mirror most of the market, the value proposition thus becomes a powerful tool that can and should be used in market positioning.

April 3, 2012 Posted by | Assisted Living, Senior Housing | , , , , , , , , | 1 Comment

Financial Tests Before Additions, Renovations or New Construction

A frequent, recurring question that I field, especially for CCRCs and seniors housing providers is “what” financial feasibility tests are most important before a project is started or for that matter, financed.  Given that capital is still relatively tight, project feasibility and key financial tests are today, critically important to assure the best financing terms available plus, project viability.  Below, I’ve broken out the initial “best” feasibility tools/tests to work through once a scope and general cost is known.

  • Revenue Efficiency: This is very simple: How much of the proposed project square footage produces revenue?  The more square feet tied to revenue generating functions, the more revenue efficient the project is.  For seniors housing, the factor or test is very important.  Too often, I see proposed projects that allocate way too much space to commons and other areas that aren’t related to revenue production.  While groups will argue that these spaces are necessary to attract prospective renters/residents, the reality is that smaller, more efficient is better from an operating standpoint and frankly, even from a marketing standpoint.  Too much space can give the project a “vacant” feel while driving up costs related to heating/air conditioning, maintenance, furnishings, etc.  Ratios of revenue producing square feet to  common or non-revenue producing square feet of 70/30 or less, tend to work best from a feasibility standpoint.  I’ll tie this point tighter in subsequent segments.
  • Prospective Rate Test by Square Foot: While rate charged is a function for many providers of market or other perceived and financially tied projections, a first basic test should involve a simple equalization model based on project square feet.  In fact, this test is an easily built model that can be used for many rate setting exercises and revenue pro formas.  First, total the revenue producing square feet in the project.  Next, determine the project’s projected or known, fixed costs, variable costs and desired margin.  Finally, decide at what level, stabilized occupancy will occur (e.g, 85%, 90%, etc.).  Hint: Amounts or levels greater than 95% are not realistic.  Once the aforementioned data is determined, divide the total of fixed, variable and margin (annualized) by the total revenue producing square feet, divided by 12 for a monthly factor or 365 for a daily factor.  Finally, multiply this result by the stabilized occupancy percentage.  The result is the gross revenue per square foot required by the project to cover the fixed and variable costs plus generate the desired margin.  To equate this number to prospective rates, multiply it by the unit square footage for each unit type in the project.  Next, analyze the results compared to market.  Are the rates calculated attainable?  If the rates are ultimately not, can the revenue be picked-up elsewhere via a shift among unit types?  Are the costs too high?  Back to the first point, is too much of the project square footage not tied to revenue production?
  • Occupancy Tests: Knowing what the projected gross revenue is on a square foot basis provides a basis for conducting some simple occupancy tests via adjusting fill-rates, overall occupancy rates, payer mix, etc.  Using the same formula above but varying the occupancy, it become easy to see the relationships between square foot expenses, particularly those that are fixed and the revenue levels required to cover these expenses.  I like to analyze the ratios between each or, how much occupancy do I need to cover fixed expenses (percentage) and where can I massage variable expenses based on occupancy levels or payer mix.  Typically, once a simple spreadsheet with square foot costs and revenues is built, it is fairly easy to do assumptive modeling and analyses.
  • Payback Testing: An important analysis or test too often ignored or, assumed to be tied to a debt service amortization schedule, is payback testing.  Payback should be factored to occur on or before the point in the project’s useful life, when major improvements need to occur.  The point here is that the project ideally is paid-for before major improvements occur, commonly known as the period of re-building.  At this point, one shouldn’t look at a scenario of re-building when the original debt or expenditure (if equity is the source) isn’t already recovered or substantially defeased.  If this doesn’t occur, the capital improvement process is akin to building the project twice (or major portions thereof).  In simple theory, new buildings or new construction provides a window of time where capital infusion for improvements is minimal if almost non-existent.  This period is where incremental cash (assuming proper pricing at sustainable occupancy levels) can accumulate, allocated for payback (either via faster current debt repayment or investment for future repayment when the arbitrage is positive).  My preferred methodology for this analysis is to develop a cash flow analysis where revenue is netted against cash expenses, including debt service.  I set my targeted payoff period as that time in the future where projected improvements via major system, structural, etc. upgrades will occur – typically by years 12 to 14.  I also will net my annual cash flow by anticipated or projected capital improvement expenditures that use “cash”.  For inflation assumptions, or investment assumptions, I try to use actual or historic data and I err on the side of conservatism.  Two methods can be used in this approach.  One that negates principal repayment in “real-time” and one that incorporates incremental principal repayment.  If debt is involved and on an amortization schedule with principal repayment incorporated, its easiest to assume a declining balance for the payback analysis.  If the source of funds is equity or a combination of  debt and equity, I assume equity repayment at a current cost of capital rate and while I may not create an amortization schedule with imputed principal payments (equity repayment), I will assume a “balloon” effect by imputing a cost of capital return assumption on the equity.

Ideally, this type of analysis is done sufficiently ahead of project finalization.  If such is the case, the project can be adjusted to conform to a proper payback period, be optimally efficient, and have a rate/revenue structure that fits within the target market.

March 16, 2012 Posted by | Assisted Living, Senior Housing, Skilled Nursing | , , , , , , , , | Leave a comment

A Rare Post

As much as I have focused on keeping this site free from any of my personal agenda, I have encountered a circumstance that bears a one-time exception to my rule.  Please bear with me as this will be brief.

I have a colleague and true friend who was recently downsized from a deteriorating health system due to their financial and operational mismanagement.  This gentleman was in charge of Marketing and P.R. for this organization.  In spite of his best efforts and gifts, he was hamstrung by the financial condition and continued deterioration of the organization, literally unable to do his job due to the reputation and care problems, staff turnover, poor community reputation and consistent resource shortage.  He became a victim of circumstances beyond his control.

As I said earlier, I rarely attest for anyone and never in writing of this sort.  This is a first.  The reason?  This gentleman is gifted, a true professional and a consummate, stand-up guy.  He became a victim of circumstances because he was too principled to walk when he should have, even in spite of my counsel.  He finishes what he starts, even if not given the tools or support to do so.

This all said, here’s the inside information.  His name is Steve (I’ll withhold further unless requested).  He has thirty years of health care marketing and P.R. executive experience within hospital systems (one being the largest in the state) and in the post-acute environment (seniors housing, assisted living, SNFs, hospice, etc.).  He comes from a journalism background originally; television principally.  He knows media, public and community relations and can market and sell health care.  He is a gifted writer and has worked all angles of health care P.R. and Marketing from spokesperson to damage control to mergers and acquisitions and new product launches.  He’s even overseen philanthropy and fund development.  Aside from me, his references are impeccable and he’s well-known in the health care community in his market areas.  I have recruited him in past positions and would without reservation, hire him again.

To the point, he’s networking and available, including possible relocation.  I know of few other health care marketing people with his breadth of experience and track record of success.  To my readers, all of whom I appreciate, and my professional colleagues whom I equally appreciate, your leads or insights on Steve’s behalf would be deeply appreciated.  If you have any ideas or interests you would like to share and/or learn more about Steve (resume, etc.) or talk directly with him, drop me an e-mail and I will make it happen.  My e-mail is Hislop3@msn.com.

Thanks for indulging my deviation in content and again to all, thanks for reading!

November 2, 2011 Posted by | Assisted Living, Home Health, Hospice, Senior Housing, Skilled Nursing | , , , , , , , , | 2 Comments

Post-Acute Outlook Post Debt Ceiling, Post Medicare Rate Adjustments, Etc.

OK, the title is a bit wordy and trust me, I could have included more “posts” but I think I got the point across.  First, I’ll admit to having a crystal ball however, the picture I see is a bit like the first (and only) television set I remember having as a kid: Not in color, lines running vertically and horizontally, snow, and an antenna that required frequent manipulation and tin foil to get any kind of reception.  And of course, there were only three channels available.  The same today is true about my crystal ball on health policy and what to expect in the post-acute industry. 

My crystal ball’s three channels are Medicare, Medicaid and the Economy.  Reviewing each, here’s the programming I see for the fall lineup or if you prefer, the period post October 1 (fiscal year 2012) through early next year.

The Economy: The debt ceiling discussion and the actions taken by S&P and the Fed in the last couple of weeks are a reminder via a cold slap, of how mired in dysfunction Washington remains and how moribund the economy truly is.  While technically not in a recession, the economy is not really growing either; a growth rate of less than 2% in GDP is like treading water.  For unemployment to change, consumers to return and capital to re-enter the business investment side, GDP growth needs to be above 2% and ideally north of 4% for a sustained period.  Unfortunately, in order for this to occur, fiscal policy in Washington needs to develop some semblance of coherency and consistency.

What I know from my economics training and background and my last twenty-five years plus in the healthcare industry boils down to some fairly simple concepts.  These concepts are I believe, a solid framework for providers to use in terms of planning for the near future and even somewhat beyond.

  • The U.S. debt level is fueled to a great degree by entitlement spending, less so by discretionary spending.  If the prevailing wind is about debt reduction and balance in the federal budget (or getting closer to balance), two things must occur.  First, spending constraint where spending primarily occurs, namely entitlements.  Second, revenue increases in some fashion, namely taxes.  The devil as we know it today, is how and where on both sides of the ledger (revenue and expenses).  Spending reductions alone are insufficient, unless dramatic, to significantly lower the debt level or balance the budget; particularly in a period of near zero economic growth.  Dramatic spending reductions are clearly unwise and potentially, deleterious to an industry sector (healthcare) that continues to provide steady employment.  Similarly, for spending reductions on entitlements to truly have a positive impact and make sense, program reform must be at the forefront of “why” less spending is needed or warranted.  Program reform, ala the health care reform bill which didn’t really reform Medicare or Medicaid but added new layers of entitlements, is far from the answer.  For providers, there is no immediate or for that matter, longer-range future that doesn’t entail less spending on Medicare or Medicaid.  As the only “trick” in Washington’s bag or the bags contained in the statehouses is rate cuts, anticipate and plan for the same.
  • A lackluster, no growth economy with high unemployment levels fuels provider competition wars over paying patients.  As fewer paying patients are available and/or fewer “good” paying patients are available, providers will compete for the same market share within and across the industry levels.  What this means is that providers will seek to acquire market share within industry segments (home health, hospice, SNF, etc.) and across industry levels (hospitals seeking to maintain patient days versus referring to post-acute providers).  The end result is more or similar levels of M&A activity, if capital remains available, and thus, consolidation that is driven primarily by market share motives.
  • According to a recent healthcare expenditure outlook released by CMS, healthcare spending is projected to reach $4.6 trillion by the end of the decade, representing nearly 20% of GDP.  The primary contributor to this projected level of growth is the Affordable Care Act, principally due to the expansion of Medicaid and the requirements for private insurance coverage (Medicaid growth of 20.3%).  While CMS notes that Medicare spending may slow somewhat, this assumption is predicated upon the continuation of spending cuts and a 29.4% reduction in physician payment rates required under the current Sustainable Growth Rate (SGR) formula.  Assuming, as has historically occurred, Congress evacuates the cuts called for under the SGR and as has been discussed, moves to a formula tying payment to the Medicare Economic Index, Medicare spending accelerates to a 6.6% growth rate (1.7% projected for 2012 with continuation of the SGR).  Summarized, health spending is the two ton gorilla in the room and it will continue to have a heavy, significant influence on economic policy discussions at the federal level and beyond.  Though I don’t agree with the recent rating action taken by S&P, it is impossible to ignore the consensus opinions of allof the rating agencies: Entitlement spending, namely driven by healthcare spending, is unsustainable at its present level with the present level of income support (taxation) and as long as the status quo remains fundamentally unchanged, the U.S. economy is not fundamentally stable.
  • Current economic realities and the rating agencies actions and statements foreshadow a stormy, near term future for the healthcare industry.  As is always the case, there will be winners and losers or more on-point, those more directly impacted and those less so. On the post-acute side, excluding reimbursement impacts, I’ve summarized my views on what I see in terms of economic impacts for the near term (below).
    • The credit rating side will remain pessimistic for most of the industry “brick and mortar” providers.  Moody’s, Fitch, et.al. will continue to have negative outlooks on CCRCs, SNFs, etc. primarily due to the economic realities of the housing market, investment markets, and reimbursement outlook.  Within this group of brick and mortar providers, Assisted Living Facilities will fair the best as they are the least impacted by the housing market and for all intents and purposes, minimally impacted by reimbursement issues (save the providers that choose to play in the HCBS/Medicaid-waiver arena).
    • The publicly traded companies (primarily SNFs but home health and LTACHs as well) will continue to see stock price suppression due to the unfavorable outlooks and credit downgrades provided by the rating agencies.  This will occur regardless of the favorable earnings posted by some of the companies.  Reimbursement trends (down) are the primary driver combined with the hard reality that Medicaid is in serious financial trouble, even more so going forward as enrollment jumps due to continued healthcare reform phase-in schedules.
    • Capital market access will continue to be tight to inaccessible for some providers.  Reimbursement, negative rating agency outlooks, lending/banking reform, above historic levels of failures/bankruptcies, etc. all continue and will remain as an overhang to the lending environment.  Problems with potential continued stable to increasing funding levels at Fannie, HUD, etc. create additional credit negativity and tighter funding flow.  Capital access, when available, will continue to have a credit premium attached, in-spite of low base rates.  I expect to see continued development and demand for private equity participation.
    • Given the above, financially driven mergers and acquisitions will remain somewhat higher as organizations seek to use the M&A arena to create financially stable partnerships and bigger or larger platforms from which to derive credit/capital access.

Medicare: The problems with Medicare are too deep and lengthy to rehash here and thus, I’ll move to brevity.  Medicare is, as I have written before, horribly inefficient, bureaucratic, and inadequately funded to remain or be, viable.  As a result, only two real scenarios exist today: Cut outlays or increase revenues.  Arguably, a third that involves portions of each scenario is the most probable solution.  Real reform is light-years away as the current and forseeable political future foretells no scenario that includes a Ryanesque option (Paul Ryan plan from the Republican Congressional Budget and/or Roadmap for America).  Viewed in this light, the Medicare outlook for post-acute providers is as follows.

  • For SNFs and Home Health Agencies, reimbursement levels are on the decline.  The OIG for CMS and MedPac have each weighed-in that providers are being overpaid.  Profit margins as a result of Medicare payments or attributable to Medicare, are deemed too high (mid to upper teens) and as such, the prevailing wind is payment or outlay reductions.  The bright-side if such exists, and as I have written before, this “cutting” trend will impact some providers far more than others.  The providers that have relied heavily and primarily on certain patient types for reimbursement gains will be more negatively impacted than providers with a more “balanced” book – a more diverse clinical case mix.  The movement is toward a more balanced level and thus lower level, of reimbursement theoretically closer aligned with the actual clinical care needs of patients.  Providers with more diverse revenue streams and more overall case-mix balance will not be as adversely impacted although, the Medicare revenue stream will be lower or less profitable.
  • Hospice has remained relatively unharmed, principally due to its lower overall outlay from the program.  It remains a less-costly level of care than other institutional alternatives.  A note of caution here is important.  While rates have not been cut, program reform is occurring on the fringes and I suspect a wholesale re-design of the Medicare Hospice benefit is forthcoming.  In such a fashion, payment reform rather than rate reform or reduction will occur.  The obvious trend is to restructure payments away from a reward for lengthier stays and to require more precise determinations of terminality, tied to a tighter or imminent expectation of death.  OIG and MedPac have issued a number of papers and memos regarding the relationships between Hospice and SNFs that correlate to longer stays for certain diagnoses.  Summarized, payment reductions via rate are less of an issue but utilization reform is forthcoming via additional regulation designed to reduce overall payments to Hospices or as CMS would say, to more closely align payments to the real necessity of care for qualified, terminally ill patients.  Without question, the largest impact (negative) going forward will be on hospices that have sizable revenue flows tied to nursing home patients.
  • LTACHs are in a similar reimbursement boat as hospice; small overall outlay within the program and for the past few years, minimal expenditure growth.  The industry is from a cost perspective, fundamentally flat.  What will be interesting to watch is whether under certain aspects of healthcare reform, this niche’ takes on a growth spurt.  Bundled payments, ACOs (Accountable Care Organizations), and shifts in SNF reimbursement away from higher acuity, rehab patients may lead toward more utilization of the LTACH product.  This being said, the prevailing Medicare reimbursement profile is fundamentally flat.  Given a bit more creativity on the part of the LTACH provider community, this segment may be poised for some growth, although not directly via increasing payments.
  • The most uncertainty lies on the Part B provider side, particularly providers that are reimbursement “connected” to the Physician Fee Schedule (therapy for example).  As of today, the required change to the fee schedule as a result of the Sustainable Growth Rate formula is a fee cut of 29.4%.  It is quite possible, due to the current negative or flat growth trajectory of the economy, and sans any change in the law, for fees to be cut again in 2013, barring Congressional action.  Most acutely impacted in this scenario are physicians and predominantly, primary care physicians.  I have yet to see a Congress that fails to intercede and repair cuts this draconian but the political times and the budget deficit debates are markedly different than during any prior period.  Critical to whether this cut or some level less than this is implemented is the issue of access, already a hot topic for physicians.  Physicians, particularly primary care specialists, are already in short-supply nationally, woefully short in certain markets.  If cuts of this magnitude or perhaps any magnitude roll forward, I suspect many physicians will curtail or close their practice to new Medicare patients.  On the other side represented by non-physician providers, Part B cuts of this magnitude will no doubt limit service and access.  Fixing the formula and the law has been difficult for Congress as the dollar implications are substantial.  I foresee another round of patches, etc., occurring close to the “cut” date, especially since 2012 is an election year.

 Medicaid: For as many reasons as Medicare is a mess, Medicaid is as well, though magnified by a factor of two or more.  Medicaid’s biggest problem now is rapid growing enrollment, primarily due to high unemployment and upcoming federal eligibility changes mandated via the Accountable Care Act (healthcare reform). Given Medicaid’s current funding structure, this issue poses huge problems in flat to negative growth economies.  States simply due not have the revenue to create a higher matching threshold or level, necessary to achieve more federal dollars.  In July, the enhanced federal match provided via the Recovery Act (stimulus) sunsetted leaving states with huge structural deficits and the prospect of deficit growth due to increasing enrollment.  In virtually every state, rate cuts have been discussed and in half-again as many, implemented.  States continue to move to the federal government seeking relief from required or imputed service provision requirements and/or relief from eligibility requirements (waivers).  The inherent difficulty with balancing Medicaid funding is that the same is directly tied to stable to growing state revenues and a clear picture of population risk or need.  Changing (increasing) populations often present adverse-risk scenarios, creating higher than normative utilization.  For obvious reasons, lower than market reimbursement levels, access is a big issue.  Not all providers willingly and openly desire Medicaid patients and those that do are not on the increase. Without additional funding assistance at a level beyond what is called for in the Accountable Care Act, regulatory relief and an improving economy, the reimbursement prospects under Medicaid are all bleak.

  • In the post-acute environment, the biggest impact of this continued ugly Medicaid scenario will fall directly on SNFs.  Matching prospective or real Medicaid cuts with Medicare cuts forthcoming is a true “negative” Perfect Storm.  For most SNFs, Medicaid is the largest payer source and until recent, Medicare was used as a make-up funding source for Medicaid reimbursement shortfalls.  Adding fuel to an already smoldering fire, the suppressed earnings available to seniors, no growth in Social Security payments, and a stock market that presently produces only a flat return trajectory limits the pool of private paying and privately insured patients.  In short, there is no additional room on the revenue side to make-up an SNFs Medicaid losses.  For SNFs, only the few that have limited leverage, high occupancy, an extremely balanced payer mix, and stable staffing will weather the Medicaid near term future; a future of no rate increases or likely cuts.
  • While not a huge segment of the post-acute environment, HCBs providers will feel the Medicaid pinch as well.  As a result of needing to reign in Medicaid spending, states are rapidly curtailing their funding and payment levels for HCBs programs.  While most states still claim that HCBs expansion would help soften their Medicaid deficit, states that bit a big bullet in this arena early on (California for one), now realize that waiver programs produce massive new levels of beneficiaries who want and need access to community support services.  SNF access was already somewhat limited as the industry has truly shrunk but the demand for services in this growing eligibility pool has expanded.  Funding these services is becoming a real problem for states and as such, support payments will remain flat, decline and program growth will be capped.
  • Home Health will also feel a bite from declining Medicaid funding although its Medicaid utilization levels are modest at best.  For Home Health, Medicare is the big dog and Medicaid a minor element.  Staffing costs are on the rise for Home Health as the competition for home health aides in many markets is brutal or getting rough.  Competition, even in a high unemployment environment, for certain categories of employees, raises wages and benefit costs.  Staffing is the largest expense for a home health agency and as such, a scenario with rising employment costs and flat to declining reimbursement negatively impacts margins.  I don’t see this scenario changing any time soon.

Concluding, this may be one of my most depressing posts, if for no other reason than the current external view is dreary and nothing foreshadows improving weather.  For brick and mortar providers, capital access is critical, especially for SNFs who have as a profile, some of the oldest physical plants.  SNFs are capital-intensive operations and without an ability to fluidly and reasonably, access modest cost funds, deferred maintenance (already high) will increase.  With so much revenue tied to reimbursement and a reimbursement outlook that is negative, it is unlikely that capital will flood back to the post-acute industry.  Critically important to the viability of this sector is an improving economy combined with regulatory reform that, if reimbursement remains flat, allows providers to become truly more efficient. In short, increased program revenues under Medicare and Medicaid due to economic growth, will ease a lot of the immediate crunch and perhaps, buy sufficient time for absolutely critical, health policy reform.

August 26, 2011 Posted by | Assisted Living, Home Health, Hospice, Policy and Politics - Federal, Senior Housing, Skilled Nursing | , , , , , , , , , , , , , , , , , , , , | 4 Comments

When and Why Projects Go Bad: Traps and Pitfalls to Avoid

Creeping slowly out of a period of recession where financing was nearly impossible to get, providers, operators and developers are starting to look favorably at new development and refreshment of existing properties and infrastructure.  Though capital is less than free flowing, money is entering back into the long-term care and seniors housing world fluidly enough that projects once parked in the “back of the lot” are edging closer to the front.  Having watched significant failures occur over the past three to four years and/or counseled organizations through some of the rough times, now is an appropriate time to pass along some “learnings” from the failures and struggles that I have seen.  Importantly, as the industry and the methods for financing have fundamentally and permanently changed, so have the markers for assuring project (new, redevelopment and remodeling) success.

As a primer or if you prefer place to start, there are three basic elements critical to project (new construction or renovation) success: Market demand, cash flow margins, and project cost.  Too many new projects failed to meet occupancy projections simply by misunderstanding market demand dynamics (market demand is not demography).  While not universal or sacred to only non-profits, misunderstanding regarding cash flow margins is a common failure item.  For example, I don’t know how many projects I’ve looked at, especially on the substantial remodeling side, that incorporated no expectation of new revenue or improved operating margins (either this element was missed or worse, not present/expected as a result of the project).  Finally, project cost should always be less a function of funds available but more a function of payback.  I’ve seen too many projects that suffer from “scope creep” simply because funds, either via debt or equity, were available.  Being able to afford something doesn’t necessarily make it “affordable”, especially when the long range economics of a project are critically analyzed.

Avoiding the common traps, pitfalls, etc. that lead to project failure or in some cases, poor performance, is a function of being clear and knowledgeable about the core feasibility requirements.  Being clear up front means not just “knowing or providing lip-service to” but actually investigating and working through each element.

  • Market Demand: The presence of age and income qualified individuals is not demand; it is supply.  The supply of potential customers only assures that potentially, a large enough universe of people exists that meet the broadest elements of “potential consumers”.  Recognition that only so many of this universe will be actual consumers of any long-term care or seniors housing product at a given time is critical to developing the initial framework for market demand.  For example, less than 10% of all seniors reside at a nursing home at any given time, whether for short or long-term care purposes.  If occupancy rates within the existing supply of facilities are average to low, building more units within such a market is a big step toward potential failure.  Simply adding units, even if they are different in size, amenities, etc., doesn’t change the core demand for the product.  Success of such a project in such a market is thus fundamentally hinged on “taking existing customers” from an established facility; a risky proposition at best.  Even in markets with good demographics (customer supply) and minimal to average supplies of like products doesn’t guarantee that demand is present.  This is particularly true for seniors housing where demand is very price elastic.  The same is true, though not as directly, for SNFs when demand is correlated to payer source (e.g., a private-pay only facility in a market with primarily a Medicaid demand).  Without factoring in price and overall costs plus location and unit features and benefits, demand cannot be truly gauged or determined.  The mere presence of a suitable supply of age and income qualified individuals doesn’t guarantee any occupancy of a new project, save that the new project at a given price, given location, with given features and benefits fits an unfulfilled need or want within the universe (supply) of qualified customers.  Summarily, no matter how much money someone has or how age appropriate someone is, if that person (or persons) does not possess or find a need for a given product at a given price with desired features and benefits, the mere presence of the product within the market will not promote consumption (or occupancy). 
  • Financial Feasibility: Interconnected with a fundamental understanding of demand is pricing.  Pricing, as I have written before, has two key components.  The first is the derivation of price based on the formula of Fixed Costs + Variable Costs + Margin = Price.  The second component is strategic, tied to market.  In any given market, the supply of like products and programs will dictate the amount of elasticity that exists across the pricing continuum.  No longer is “me too”or matching the market a viable strategy for pricing.  This said, true financial feasibility is mostly tied to the first pricing component.  Where projects tend to struggle is when three core elements are misinterpreted or, over (or in some cases under) estimated.  The first core element is fixed cost.  Feasibility which doesn’t properly capture the key fixed cost elements of debt, debt repayment and depreciation has the potential for quickly turning a project from possible to impractical.  Specifically, I recommend the following approach to structuring the fixed cost portion of the feasibility.
    • Debt assumptions, especially those involving floating rate scenarios, need to be conservative and reflective of the true interest rate risk across as lengthy a horizon as possible.  Fixed rate scenarios are ideal but terms for the fixed period are generally less than the amortization schedule for the debt.
    • Following the point above, debt repayment on a schedule that is more aggressive than the amortization schedule is a must.  New projects or substantial remodeling projects carry the mindset that depreciation is a non-event in the initial years; minimal cash outlays.  While this may be true, depreciation picks-up rather quickly in terms of cash needs by year 5 and becomes more acute by year 10.  By year 15, substantial repairs and upgrades to major elements are a common theme.  Carrying debt across a normative amortization cycle without more aggressive repayment means that by year 10, the project is being substantially replaced by the need for upgrades and repairs, all while the first phase is still being paid for at a premium cost (interest on the original debt).  I have seen all too often, providers struggle with competing cash needs; debt service vs. capital maintenance.  Once maintenance becomes deferred, the ability to compete successfully is hampered.  Cardinal rule here: Work the feasibility numbers in terms of pricing to include a debt repayment plan no longer than fifteen years, regardless of the amortization terms, and incorporate a laddered assumption of cash needed (reserves) to replace equipment, upgrade units, etc. within the fixed costs assumptions (cash funding depreciation).
    • Margin is the devil in the details.  Too much fixed cost and/or too much variable cost eats at needed margins or stresses occupancy assumptions to unrealistic and/or unsustainable levels.  Ideally, a forty percent or higher “top line” margin is the target for Assisted Living and Independent Living (marginally higher for Independent).  When debt and depreciation (cash funded) is added below the line at stabilized occupancy, the project can create sustainable cash earnings/returns on equity.  Lower leverage (debt) levels and lower interest costs can aid in thinning top line margin levels but remember, equity contributions instead of debt still bear a cost in the form of opportunity cost.  Repayment of equity infusions need to be factored with an opportunity cost (interest factor).  Depending on current interest rate environments, the arbitrage on equity cash can be positive (debt cost is higher) or negative (debt cost is lower).  Not always does the provider get to pick the amount of equity participation required as lenders today are far pickier on leverage levels and loan to value relationships.
  • Project Costs:  Project costs should always be built around the assumption of revenue required to substantiate the project.  Renovations that do not incorporate opportunities for new revenue or enhanced revenue (new product/service lines, better payer mix, etc.) will almost exclusively be paid-back through depreciation funding and life cycle cost assumptions.  In short, no new money, the project scope needs to be tight.  Rarely have I ever seen the purported “efficiencies” used in renovation justifications materialize to the extent that the gains justified the project scope.  I also am always wary of renovations that incorporate enhanced or improved occupancy levels.  Again, rarely does the cost justify the outcome and almost always, the adage of “we are not marketable” is more a function of other organizational issues (bad reputation, pricing, average care, etc.) than it is a justification for an expensive renovation project.  In new projects/new development, building efficiency is the key to adequate payback.  Allocating too much space to common areas and non-revenue producing areas increases project costs in terms of building and furnishing (not to mention heating, air conditioning, maintenance, upkeep, etc.) and places more “dead space cost” burden into the pricing equation.  Objectively, a building that maximizes the majority of square footage for revenue production pays back investment far faster.  In an Assisted Living project or Independent Living project, I think a 65% revenue allocation vs. 35% common allocation is reasonable.  Higher allocations to common space strain pricing and definitely, require higher occupancy levels to create break-even and payback targets.  Similarly, more common space consumes more “furnishings”, often minimally used. Good focal space done right and space with a multi-purpose use is preferrable over space with singular use or no real defined use at all (i.e., lounge

April 5, 2011 Posted by | Assisted Living, Senior Housing, Skilled Nursing | , , , , , , , , | Leave a comment

Economic Value Analysis, Value Propositions and Marketing

Recently I gave a presentation on strategic pricing and senior housing (see Reports and Other Documents page on this site for the presentation power-point).  A key theme that I often refer to centers around the “value proposition” or in other words, the concept that pricing is both monetary and non-monetary and as such, the value proposition is about not only the price but also about the functional and psychological value of the service or product.  In short hand, the utility; how the product/service satisfies both functional and psychological needs at or for the given price.  During the presentation and since, I’ve received a fair number of questions regarding “how” a value proposition is determined and thus, how the same is correlated to price.  Knowing how complicated senior housing and all forms of long-term care (SNF, ALF, Senior Housing, etc.) are today to market, understanding the core concepts of pricing, economic value analysis, and value proposition can make a real difference in establishing an effective sales and marketing program.

Initially, the primary concept to understand is demand and how demand and price work together.  Demand, for purposes of this article and simplicity, is the ability and willingness on the part of an individual to buy something.  In general, demand and price have an inverse relationship such that the demand for a particular good or service (the quantity thereof) tends to increase as price decreases.  Of course, a variety of factors impact demand including the actual nature of the product or service.  Funeral services for example have a fairly steady level of demand and in actuality, the demand only changes by a change in supply of dead people (morbid as this thought is).  If for example, a major pandemic began to sharply increase the number of people dying, the demand for funeral services would increase.  Conversely, if a break-through in genetic research produced a series of cures for diseases such as diabetes, heart disease and cancer, the demand for funeral services would gradually decrease.  In the example of funeral services, price is less of an influencer on demand as once an individual has died, few alternatives exist (legally) to disposition of a corpse.  While there may be multiple options for pricing inside the range of possible mortuary services (cremation, caskets, size and style of services such as wakes, etc.), there remains a core price that is basically inelastic; doesn’t really change demand as it rises or falls.

For goods and services such as senior housing and to a lesser extent, other long-term care such as Assisted Living and SNF care, demand is more elastic as price changes.  The simple reason is that alternatives exist to each level of care that are available, supply or provide the same basic utility and range in cost (expressed as price).  In the case of senior living, many options exist at a great many price points.  With SNF care, fewer options exist but still, many providers exist and home care and even in some cases, Assisted Living present alternatives at different prices.  The net result is that demand is influenced by price as well as a host of other factors.

  • The service’s core price is a factor such that all products and or services have a “going rate” calculation.  When demand is highly elastic such as with senior housing, the safest presumption is that the core price is equal to living in one’s existing residence as normally, a move to a senior housing facility is equal to or more expensive per month.  If the costs associated with a senior housing option are rising, demand will taper off.
  • The price of related or alternative goods will impact demand, especially when substitution products or services are widely available.  For example, using the funeral home example, if prices for a particular line of wood caskets drop substantially below the prices of metal caskets, the demand for caskets stays essentially the same but the demand for wood versus metal rises substantially.  For senior housing, the demand can be widely impacted by the cost associated with alternatives such as market rate apartments, condominiums, or staying at home with certain services.
  • The ability of the consumer to buy in terms of economic resources changes demand.  If the consumer’s purchasing power changes as a result of loss of income, lower income or lower overall resource levels, the demand for particular goods and services at current price points declines, perhaps shifting to less expensive substitute products/services.
  • An increase or decrease in desire or preference on the part of a consumer can change demand positively or negatively.  The greatest mover here is consumer confidence.  A consumer with a more positive outlook on the economic condition of his/her situation is simply more motivated to consumer.  Consumer expectations about prices also impacts the decision to buy.  A consumer that believes that prices will rise in the near future is more likely to buy immediately and conversely, an expectation of falling prices triggers a delay in consumption.

Taking the above into account regarding demand, economic value analysis and the determination of a value proposition is fundamentally about determining the monetary value of the product or service as well as the functional and psychological value.  The monetary value is not the product/service price but the value, expressed in dollars, of the total cost of a product or service’s ownership.  In this regard, the monetary costs also produce monetary benefits.  For example, using senior housing, calculating the monetary costs requires an analysis of the following (minimally);

  • Rent or mortgage payment
  • Monthly amortized cost of any entry fee including interest cost and negative amortization costs (loss of refund as applicable)
  • Utilities
  • Taxes
  • Insurance
  • Other fees such as parking, etc.
  • Other cost intangibles such as free health care, reduced cost health care, delivery of medications, meals as part of rent, rent increase guarantees (limits), etc.

Calculating the monetary value thus becomes an exercise in quantifying the above elements over a reasonable period of time such as five years, etc.  Once this is complete, the result is used as a comparison against like or alternative options.  Below is an example for a non-profit, senior housing provider with a fully refundable entry fee compared to a person remaining in their home in the community, with no mortgage payment (a fairly typical situation).  The costs I’ve illustrated are over a five-year period (rent for example is monthly times 60 months).

  Sr. Housing Home          
Rent $72,000 $0.00          
Mortgage $0.00 $0.00          
Prop. Taxes $0.00 $25,000          
Insurance $3,000 $7,000          
Utilities $0.00 $18,000          
Depreciation $0.00 $6,250          
Repairs $0.00 $5,000          
Lawn Service $0.00 $1,200          
Parking $0.00 $0.00          
Meals (1 x day) $0.00 $6,400          
Entertainment $0.00 $2,500          
Healthcare (1) $0.00 $1,500          
Misc. Transport $0.00 $1,000          
Entry Fee (2) $18,924 $0.00          
Home Price +/- (3) $0.00 $5,400          
  $93,924 $79,250.00          
               
(1) Sr. Housing provides free wellness services such as flu shots, blood pressure monitoring,
medication assistance, setting appointments, education, screenings, etc.    
               
(2) Entry fee is fully refundable ($150,000) at no interest.  Interest yield is assumed at
2% compounded monthly            
               
(3) The home price increase or decrease reflects what the resident can safely assume
the home price will be in five years.  A negative number is an increase in value whereas 
a positive number reflects a decrease in selling price.  Price of the home is assumed  
to be $300,000 in current dollars.          

In this example, the monetary value of the senior housing option is greater (negative) than the monetary value of remaining at home or simply, it costs more to receive the same basic utility to move to the senior housing community.  The value essentially becomes negative with the inclusion of the entry fee interest loss or cost.  On the surface, this appears to be a negative value proposition for the senior housing community.  The key to achieving a balance or a higher proposition value for the senior housing option is to monetize the functional and psychological costs between the two options.  Ideally, the spread between the two is worth at least $14,674 or the present negative difference between the senior housing option and remaining at home.

In monetizing the functional and psychological costs and benefits between the two options, the trick or key is to have a clear understanding of the profiled consumer.  This means having a true handle on current customers and seniors living in the community.  For example, a psychological benefit to senior housing versus remaining at home is security.  It is possible to measure the value of security by talking to your current customers and imputing a value for a security service to the remain at home option.  A functional value is transportation and convenience.  If for example, the senior housing option provides shopping trips to local grocery stores or has an in-facility delicatessen and convenience store, the cost between the two options in terms of convenience and transportation is measurable.  Other examples such as activity, access (even at a cost) to prescription drug delivery, on-site medical care, check-in services, laundry, housekeeping, etc. are all items with a potential functional and psychological benefit.  Perhaps the most under-valued is the access to on-site, future health care such as an incorporated Assisted Living or Skilled Nursing Facility, even if such access is nothing more than guaranteed accommodation without a price reduction.  The important point here is that each functional and psychological benefit that is discernible and tangible to current customers has a value that is quantifiable and comparable across each option or living alternative.

The value proposition is the accumulation of the monetized values for the core product or service plus the functional and psychological factors.  Consumption activity incorporates all three elements and effective marketing strategy is grounded in communicating the value proposition of a product/service as compared to all other alternatives. Of course the largest difficulty arises in communicating values ascribed to psychological factors.  The key in doing so is the heavy use and reliance upon, current satisfied customers.  They are the source of input as well as the ground for determining monetary values associated with the related psychological factors.

As senior housing demand is highly elastic, creating and communicating a value proposition is critical in terms of developing potential customers.  I would argue that the same approach is as critical for SNFs that are looking to attract certain types of patients with certain payer sources.  In using the above approach, an SNF would complete its economic analysis against its competitors, again monetizing the core service, the functional and psychological factors.  In many regards, completing the analysis against existing competitors is an easier exercise as quantifiable data is far more plentiful.

Pricing strategy comes into play when the value proposition is imbalanced.  Pricing strategy re-weights variables and allows the value proposition to change favorably against key alternatives or competitors.  For example, in the senior housing analysis above, pricing change involving the entry fee instantly changes (positively or negatively) the initial calculated proposition.  For an SNF, adding amenities within service offerings or adding clinical competence improves the value proposition, even under a fixed-payment scenario such as Medicare.  The objective from a marketing strategy approach is to maximize all elements of the value proposition as compared to the competition or to the alternatives.  Taking this approach and then developing an effective sales and communication strategy dramatically improves the opportunities for successful new customer conversions – sales.

October 27, 2010 Posted by | Assisted Living, Senior Housing, Skilled Nursing | , , , , , , , , | 1 Comment

September E-News

My firm’s E-Newsletter for clients and friends was posted on-line today at http://apexhealthcareconsultants.info/2010/10/01/  In this issue;

  • October 1: SNFs, MDS 3.0 and RUGs
  • Economic Outlook
  • Compliance Updates
  • Fourth Quarter: Trends to Watch

October 1, 2010 Posted by | Assisted Living, Home Health, Policy and Politics - Federal, Senior Housing, Skilled Nursing | , , , | Leave a comment

August E-News

My company’s monthly E-News was published on-line today at http://apexhealthcareconsultants.info/2010/08/

Articles this month include;

  • Economic Outlook
  • The Housing Market and Senior Housing: More Stormy Seas Ahead
  • RUGs III to RUGs IV Transition
  • Reimbursement Update
  • Abuse Prevention: An Apex Clinical Feature 

August 31, 2010 Posted by | Assisted Living, Policy and Politics - Federal, Senior Housing, Skilled Nursing | Leave a comment

Due Diligence and Acquisitions: A Review of Common Pitfalls

A regular, although not necessarily routine, exercise that I go through is a re-evaluation of recent acquisitions in the senior housing/long-term care industry to see “how they are doing or performing” post transaction.  Perhaps the primary reason that I do this is my curiosity regarding the effectiveness of the due diligence process and the accuracy of the valuation or economic value proposition created by the acquirer as translated into purchase price.  In short, I’m always curious as to whether the buyer got what he/she/they expected at the anticipated cost (purchase price plus other investments required over the first year or so) he/she/they expected to pay.  As the mechanics and theory behind valuations and due diligence vary between deal to deal (from what I have observed), it is interesting to look at “how things are turning out” once the feeling of accomplishment and the haze of the deal  have passed.

When things don’t go well or aren’t going well at the one year mark, something I find more common in health care transactions (SNFs, Home Care, Hospice, etc.) and less so in Assisted Living or Senior Housing, it nearly always seems to a be a flawed due diligence process that led to an over-estimation of value.  More succinct: Because the due diligence process missed too many issues the price became over-stated as the costs associated with achieving stable operations were under-estimated or the classic, “he/she/they paid too much for what they got”.  Where I notice the largest number of errors occurring during due diligence is when the due diligence is treated as a justification for the purchase price or, a process of validation rather than a process to quantify the economic risks and benefits that are modifiers to the valuation and ultimately, to the negotiated price.  Proof of a what a friend of mine always says; “It doesn’t take a rocket scientist to overpay”.

Separating the issues a bit, valuation is effectively a financial quantification of the relative worth of the business as it stands today, including business/commercial value (cash flow, revenues, expenses, etc.) and tangible and intangible asset value (bricks and mortar, equipment, trademarks, name, etc).  When Buyers capably test the values against their own business models and the available universe of comparable values, the Buyer has established a range of possible purchase price points.  Ideally, within this range lies a number that the Seller will accept or that matches closely, the Seller’s asking price.  At this stage, I would argue that a Buyer should never impute any assumptions on a go-forward basis about “how much” expenses could be lowered or revenues increased to massage an improved value.  A wise Buyer would best assume that upon acquisition, almost all aspects of the business “as is” are set as constant and these same constants are the financial constraints that place the boundaries on the project’s range of values.  This is not to suggest that a pro forma assumption about “go forward” operations that assumes lower debt costs (if applicable), some efficiencies via scale and some reduction in overhead may not be applicable (if in fact they are real and quantifiable).  It is however, a caution based on too many valuations completed at the behest of or by Buyers, that include unrealistic assumptions of census increases, revenue increases, expense reductions, etc., that are hardly quantifiable or even in fact, justified for the particular transaction.  To illustrate: A few years ago I helped an out-of-state buyer get into a particular nursing home transaction (nursing home was for sale).  The buyer owned nursing homes in other locations so the industry was not totally foreign.  The location of the facility was decent but the plant was old and the facility’s reputation marginal.  The asking price had yet to be set “in stone”.  The buyer, accustomed to paying higher prices in other areas, began talking numbers that were far too high for the project, justifying the price with claims of significant improvements in Medicare census and Medicare revenue per day that were unrealistic for the facility (never happened at this location before) and were beyond the norms of the market area.  While I tried to counsel the buyer to be more judicious, the buyer went ahead and acquired the facility.  Within two years, the buyer abandoned the site, having substantially over-paid, never achieving the projections for revenue and census “touted” for the facility. 

Due diligence encompasses the financial valuation but extends the tasks into a level of greater detail that adds or subtracts (creation of debits and credits) from the range of possible values/prices.  In the best of due diligence processes, the methodology also incorporates a review of risks and assists in quantifying costs associated with these risks.  In reality, due diligence should attempt to paint a complete picture of all elements of the transaction, providing final quantification of the price and qualifications to the transaction that must be accounted for by the buyer.  Thought of or approached this way and using the example I presented above, the buyer would never have paid what they paid for the facility and would have realized that achieving a stable, successfully operating SNF in that location would take them years and significant financial and human capital investments.

While buyers tend to approach due diligence and valuation different, each varying upon a theme and using their own methodology and checklists, I’ve found that the problem transactions that I follow each tend to miss one or more of the following elements.  Some of these elements are absolutely critical if the buyer is out-of-state or out of the area and the acquisition represents his/her/their first foray into a given market area.

  • Economic Location Analysis: Not to be confused with market research principally relying on demographics, this analysis looks deeper into the key economic location elements that are critical to the success or failure of the transaction at the given purchase price.  For example, location analysis would quantify labor resources and costs – key elements for a healthcare provider.  Location analysis would also quantify the strength and depth of referral patterns and the quality of such referrals by desired economic value (payer sources, etc.).  Location analysis also examines the market economy and the up or downward trends that are present.  Too many providers over-estimate the value of a particular location without understanding the economic factors that create or detract from the project’s value.
  • Provider Status Assumption Risks: Buyers that are acquiring healthcare projects with existing Medicare business and expecting to assume the former provider’s Medicare number (most common in acquisitions) need to understand that the assumption of the Medicare number brings the assumption of risk.  While it is true that lawyers will create indemnities and warranties that seek to limit the buyer’s assumption of risk, using these clauses to enforce terms when risks are present or encountered is often an expensive and fruitless exercise.  In other words, the seller may no longer exist or as is often the case, will require the buyer to use an expensive legal process to enforce the indemnity and warranty provisions, all while the compliance requirements are inescapable to the current owner. Preferably, although not an expeditious process, buyers should obtain a new provider number and status for the project from CMS, targeted effective on the change of ownership – for Part A and Part B as applicable.  It can be done as I have done it with each of my “former” acquisitions.  By not assuming an existing provider number, the buyer avoids a whole host of issues and compliance problems that may or may not be disclosed or even known by the seller.  CMS, as one would suspect, will only chase the “owner” of the existing provider number when problems arise or are detected and if that is the new owner, regardless of whether the issues pertained to a former operator/owner, the new owner is expected by CMS to be the sole source of remedy.  CMS does not care about the terms of the deal between private parties.
  • Billing Risks and Revenue Accuracy: This is a problem area that I see all to frequent.  The buyer relies on the seller’s representation of revenues and does no further testing.  I lost count of how many times buyers relied on accountant prepared or audited statements as being “gospel” only to find upon ownership that the revenues were over-stated.  Why?  First, even during an audit, accountants do not devote sufficient time or have often, sufficient expertise to analyze, the accuracy of the Medicare claims submitted by the seller.  The typical tests are for basic paper-trail elements such as RUGs groups in SNFs matching the billing, matching the revenue postings.  What needs to occur is a much more in-depth, technical review to determine if the Medicare claims that correlate to patients are in fact, correct.  Again, I have seen circumstances where the Medicare revenue per day is grossly incorrect as the seller had no idea how to properly bill Medicare claims.  Last, I rarely see buyers benchmark the revenue and occupancy numbers against area comparables.  Payer mix and revenue per day numbers across the industry tend to fit pretty narrow ranges and when, in any transaction, they are out of this normative range, a red flag should rise.
  • Compliance Risks: Another area that I see cause buyers problems time and time again.  Compliance with certification, survey and accreditation standards is a function of past and yet to be.  Acquiring a provider with past problems in these areas requires very careful analysis and discussions with regulatory authorities.  Regulators need to be queried extensively and even, negotiated with when the buyer is acquiring a provider with a record of moderate to serious non-compliance.  Don’t have the discussions or do the additional analysis and assuredly, run into compliance problems that cannot be deemed as “owned” by the prior owner/operator.  Likewise, acquiring a provider with a reasonable or decent history doesn’t mean that the current status of compliance is clean.  Sellers tend to wane on their commitments to compliance the closer the time comes to deal “certainty” or closing.  A fair amount of time may also have passed since the current owner was re-accredited or surveyed.  Complaints may be pending requiring regulatory review.  What is certain is that once the acquisition is complete, regulators/surveyors will descend on the new owner in fairly short order.  Take the time necessary to thoroughly review the past and current status of compliance.
  • Market and Reputation Risks: Simply stated: How is the current provider viewed within the market?  New ownership doesn’t mean new perceptions about the quality of the current operation.  If the current operation is viewed marginally or even negatively, a new owner will have a great deal of work ahead to establish an improved or new reputation.  If the business relies heavily on referrals (and most health care provider organizations do), it pays to check referral sources and other common influencers to understand the “market” perception that is in place.
  • Environment and Infrastructure Risks: Assuming that acquiring an existing provider means that existing brick and mortar and equipment doesn’t require improvements immediately can be a false assumption.  Existing providers may operate under waivers or as in some states, new ownership necessitates that the entirety of the project be brought to current code with the issue of a new license.  Such is the case in Wisconsin.  A thorough review of the environment and the infrastructure tied to building code requirements, completed by qualified individuals/organizations will minimize this risk.
  • Employment Related Risk: Here I am not talking about the legal risks associated with handling employment issues during the closing processes.  The risk that I am talking about occurs when buyers make one of two (or both) assumptions about the quality and stability of existing management personnel and/or, their own management personnel.    The error I see too often made occurs with out-of-state buyers not acquiring sufficient local or area expertise and/or, having enough local support available via contractors (consultants, etc.) to ease the transition.  Each market area and certainly, each state brings forth nuances and issues that require stable management and unique knowledge requirements.  I’ve seen too many new owners underestimate the resources needed and over-estimate the ability of their management to handle new areas and states foreign to them.

August 10, 2010 Posted by | Assisted Living, Home Health, Hospice, Senior Housing, Skilled Nursing | , , , , , , , , , , | 10 Comments