Home Healthcare Industry: Systemic Breakdown

This is the second in a series of articles covering the home healthcare industry. See part 1 here.

As demonstrated in the previous article, demographics have not been, nor will be for several years, a meaningful driver of admissions growth for home healthcare agencies (HHAs). In this article, we will review the systemic changes that have caused about four fifths of this industry’s 6.25% admissions growth from 2001 to 2006 (a figure that certainly increased over 2007 and 2008). We will spend the next article studying how our four publics (AFAM, AMED, GTIV and LHCG) have voraciously devoured more than their fair share of this expanding pie.

When enough payors, providers and/or patients within the healthcare system alter habits, the ripple effects can be mind boggling. Over the past few decades, the primary impetus for these changes has been economic. When acted upon, such shifts in thinking have greatly benefited HHAs. To adequately understand how and why, one must generally understand Medicare and the Prospective Payment System. So let’s have our meat—a quick history lesson—before we have our pudding.

A History of Effects: Medicare and PPS

The Centers for Medicare and Medicaid Services (CMS) describes Medicare as “health insurance for people age 65 or older, under age 65 with certain disabilities, and any age with permanent kidney failure (called ‘End-Stage Renal Disease’).” This entitlement was signed into law in 1965 with great fanfare—and after much debate. In order to get various practitioners and politically connected groups throughout the healthcare industry to buy into the program, Congress imposed minimal administrative oversight and generously paid Medicare providers retrospectively (that is, after services were rendered) using the traditional fee-for-service model. This concession has had lasting effects. By the end of the 1970s (a decade offering plenty of political targets for runaway prices) inflationary healthcare costs became one of the leading domestic policy priorities, as evidenced in President Carter’s shelving his National Health Insurance initiative in deference to his Hospital Cost Containment program.

Retrospective fee-for-service engendered a moral hazard throughout the healthcare system, as unchecked providers (who, being paid extra to do extra, were compelled not to disappoint) and patients (who were too far removed from the nuts and bolts of the remunerative process) opted for more and more intensive forms of care. After years of self-interested providers almost independently calling the payment shots and driving costs higher and higher, it became quite clear that a change was necessary. Our healthcare system was filled with excesses: property, equipment, personnel, salaries and wages. To sidestep the ever increasing bills from Medicare providers that came after services were performed, Congress passed legislation in 1982 instituting a Prospective Payment System (PPS), which designated predetermined reimbursement rates before services were rendered. (As opposed to the teenager coming to the parent time and time again for money to cover this, that and the other, the parent wised up, learned customary adolescent expenses, and gave an allowance, leaving it to the child to figure out how to spend it.)

Broadly speaking, hospitals and physicians were paid the lion’s share of Medicare funds, with outpatient services (rehabilitation facilities, skilled nursing facilities, home healthcare, etc.) aggregating a distant third place. Though the latter could be politically bullied, their sheer numbers and diversity were intimidating, and they did not offer a big enough savings opportunity for our financially desperate Congress in the early 1980s. Physicians also presented an unwanted logistical challenge, but primarily did not offer the best entrée to begin this remuneration experiment due to their political power. As such, Congress exigently initiated PPS with hospitals, refined the experiment throughout the 1980s, and then expanded it slowly through the entire Medicare system. Results have varied.

Shortly after PPS was initiated, hospitals were pleasantly surprised as they netted PPS margins in the mid-teens. Those boom years faded quickly, and by the early 1990s those same margins were negative. Such ups and downs are part of the PPS package. The former head of the Healthcare Financing Administration’s Office of Research, Allen Dobson, admitted, “ProPAC and members of Congress would get the [market basket] number each year and they’d go through these shenanigans about hospital productivity and case mix, yada yada yada, but at the end of the day, what they really looked at were hospitals’ overall margins; if they were too high they would lower the rate of PPS increase, and if they were too low they’d increase PPS payment rates.”

Overall, PPS has forced hospitals to pay attention to costs. However, economically speaking, hospitals are famously inefficient, so before cutting fat many hospitals simply looked to increase volumes of businesses unaffected by PPS, such as in-house home healthcare operations. The following figures from CMS show the rise and fall of hospital-based HHAs:

(As will be discussed in the next article more thoroughly, Congress finally imposed PPS on HHAs with the Balanced Budget Act of 1997.)

According to the American Hospital Association (AHA), inpatient revenue grew by 24.6% from 1983 to 1987, while outpatient revenue grew by 85.3%. Before PPS made its way through the healthcare system, enterprising providers rushed to those silos which were unaffected by it to gain higher profits offered by retrospective fee-for-service.

Since virtually all of Medicare has now been “Prospectivized,” a modified version of this activity now exists across silos driven by inequitable profits inherent in such a complex system. The following passage from Medicare Prospective Payment and the Shaping of U.S. Health Care offers insight into the vagaries of Medicare caused by PPS:

…a patient might undergo a routine colonoscopy in an outpatient department of a hospital, in an ambulatory surgery center, or in a physician’s office. In some ways, given the diversity of health delivery systems across the country, the flexibility to pay on behalf of patients served in different types of facilities makes sense. However, Medicare’s payment methods produce payment levels that are based more on the underlying costs of different provider types than on the costs needed to care for patients with particular health problems.

Further, if changes in technology allow resources to be shifted, for example, out of the hospital and into the community, it will be difficult for the government payer to redistribute the funds from the hospital sector to support the increased financial burden of ambulatory care. The result is that patients may be cared for in ways that suit the purpose of the providers, rather than the needs of the patients, with financial incentives rather than clinical considerations driving decisions about the setting in which care is delivered.

For example, when Robert Berenson was a senior official at CMS, he met with a group of gastroenterologists who came to complain that Medicare was paying too much for performing colonoscopies in physicians’ offices. They argued that the much too generous payment was enticing them to perform the procedures in their offices—exposing their patients to risk—rather than in the safety of ambulatory surgery centers (ASCs). In effect, the physicians were asking CMS to “protect them from themselves” by cutting their payments, which was a fairly unusual request, to say the least.

Only later did the rationale for this not entirely selfless plea become apparent. Some gastroenterologists own ASCs, which were losing the business of gastroenterologists now able to perform the procedure in their own offices rather than provide a facility fee for the ASCs.

Such ripple effects throughout Medicare are an important, albeit complicated, sub-plot of this story. Reimbursement changes within home healthcare incent or deter potential newcomers. When the number of HHAs increases quickly (as it has in recent years), it is quite likely that reimbursements have been too high, compelling various entities (often providers predominantly in other fields) to quickly charge into the profitable fray. This in turn compels Congress to reverse the trend by lowering reimbursements. Over short periods, these cycles can cause great distress to stakeholders in this industry. Over long periods, however, they offer incredible opportunities to investors who love inefficient markets.

The major theme of this story, discussed in detail presently, is much more simply applied: Because of their unassailable position within the healthcare system as the lowest cost providers of acute and sub-acute care, HHAs will benefit from industry-wide trends to cut costs.

Before we leave this section, it is useful to learn the more complete story on hospitals, as their PPS margins recovered to the mid-teens by 1997, then fell back to the 6% range earlier this decade. In fact, throughout the healthcare system, providers affected by PPS seem to tell the same story: Though up or down in any given year, profit margins, taken as a whole, are better than expected. Washington continually demonstrates its preference for more than minimal profits for healthcare providers, evidently to ensure the viability of this most socially critical sector.

Externally Driven Systemic Changes

About 60% of home healthcare admissions are referred by hospitals, about 30% by physicians, and the remainder by various assisted living facilities. Medicare gives hospitals—the most expensive forum for healthcare—incentives to discharge patients sooner than later. John Rother, former staff director of the Senate Special Committee on Aging, coined the phrase “sicker and quicker” to refer to patients expeditiously reentering the community from hospitals. The proof is in the pudding: Hospital stays have dropped significantly over the past 25 years (see here - pdf warning).

Increasingly, Medicare patients are discharged from hospitals and funneled to HHAs. The following data is taken from the Agency for Healthcare Research and Quality’s HCUP query system, showing the number of Medicare hospital discharges per year to HHAs:

Year	Medicare Discharges to HH	% Change
1997	1,438,532
1998	1,345,445	-6.47%
1999	1,429,358	6.24%
2000	1,400,836	-2.00%
2001	1,513,192	8.02%
2002	1,582,226	4.56%
2003	1,693,118	7.01%
2004	2,011,806	18.82%
2005	2,121,501	5.45%
2006	2,225,971	4.92%
Total		54.74%

(Note: From the AHRQ website:

Discharge refers to the hospital stay. The unit of analysis for HCUP data is the hospital discharge, not a person or patient. This means that a person who is admitted to the hospital multiple times in one year will be counted each time as a separate discharge from the hospital.

Hence, “discharges” are distinct from clients or admissions within HHAs. Even so, this data offers a telling perspective regarding systemic trends.)

After BBA ‘97, such discharges actually decreased a total of 2.62% through 2000. The final six years of this sample, therefore, show 59% growth—or 8% CAGR. The significance of these figures in contributing to the 6.25% admissions growth for the home healthcare industry cannot be overstated.

Much of the credit for this externally driven systemic growth comes from frugal payors pressuring competent discharge planners and physicians in hospitals. Jan Hoffman of the New York Times reported on the challenges of discharge planners:

Hospitals must ensure that a patient’s transition is ‘safe and adequate’ to comply with accreditation standards and state health department regulations and to remain eligible for Medicaid and Medicare reimbursements. But increasingly, discharge responsibilities are being assigned to clerical staff members rather than nurses or social workers.

Habit changes, of course, don’t have to involve hospitals. Another example comes from the fervid MedPAC, which found room to save taxpayers money when it reported that “skilled nursing facility care is now substituting for home health care for some patients, most likely at a much higher cost to Medicare” (Report to the Congress: Variation and Innovation in Medicare (June 2003)). It is a slow process with the occasional step backward, but an increasing number of admissions will continue to knock on this industry’s front door, without any sales representative or CEO having to do a damned thing.

Internally Driven Systemic Changes

Recall our famously inefficient hospitals. Relying on untrained clerical staff members to appropriately discharge not-quite-recovered elderly patients is a terribly wrongheaded method to overcome that reputation. At the behest of frugal payors, patients are too often simply and quickly discharged from hospitals with no further help or instruction—frequently a recipe for a return trip, or worse. For at least this reason, we can be quite happy that animal spirits are bountiful in the home healthcare industry.

In addition to ignorant and/or apathetic hospital discharge planners, there is a general unawareness of the value of HHAs by physicians in their own communities. As opposed to waiting for outside forces to push admissions towards HHAs, many within the industry are spawning systemic change by pulling in admissions that would otherwise not exist. Industry representatives seek out such benighted referral sources, teach the benefits of home care, and preach for referrals. For example, to prevent a hospital stay, a physician might normally refer an ailing patient to a rehabilitation center for physical therapy. More and more often, physicians are coming to understand that better outcomes can be had by instead referring that same patient to an HHA—which can provide essentially the same services for a fraction of the cost in the comfort of the patient’s own home. And the surface has only been scratched: According to industry insiders, there is likely a sizable majority of physicians who still do not appreciate the good that HHAs can do for their Medicare patients, practices and communities.

Consider the mouthwatering trend that while all of those hospitals have been rapidly increasing their discharges of Medicare patients to HHAs, the percent of physician-referred patients over the past several years has actually gone up significantly for AMED, AFAM and GTIV. (LHCG is a unique case, to be discussed in a later article.) This is the single most impressive achievement by these industry leaders as there is no financial benefit to physicians referring patients to HHAs. The ultimate incentive is the best outcome for the patient. There is no better testimony for this industry than financially disinterested physicians—who can easily be thought of as the quarterbacks of our healthcare system—utilizing the services offered by HHAs with increasing frequency.

We have now identified, with significant specificity, the real drivers behind this industry’s impressive 6.25% annual admissions growth from 2001 to 2006. While short-term disruptive cycles—dominated by avaricious providers and parsimonious politicians—are certain to recur, systemic admissions growth will continue, if not accelerate, over the long term. Next we’ll discuss how the industry leaders came to maintain such a dominant position.

Disclosure: long AFAM, long AMED

Comments

[tc1:]

Another really fine article you've contributed on this important HHA sector, Daryl.

I noticed that you've never responded to my concern about the SHORT-SELLERS (and naked shorters, according to Buyins.Net) who have so heavily targeted AFAM and AMED (33% and 50% of stock float, respectively), a concern which i outlined in full as a response to your first article, and a concern which makes it so precarious for many of us to buy AFAM or AMED for the longterm "buy and hold/hope."

Do i rightly assume that you see these companies as so strong for the longterm, that they'll survive the short-sellers' attacks and their share-prices will rise over the longterm anyway (and not stay in the dumps like Intel and other dot.coms since Spring 2000)?

Thanks again, Daryl. I appreciate all your work here and look forward to your next article on the topic.

Apr 16 11:08 AM

[nooneimportant:]

Daryl, can you please speed up your article production? I enjoy to the 3%-4% bump in stock price on AFAM with their release.

Apr 16 07:34 PM

[RWCMom:]

We used HHP for a period of several months to provide nighttime respite for my sister who was the daytime provider for my dad at their independent living apt. We now also use the same agency occasionally for my mom, in assisted living. We hired directly because my dad refused to go into a nursing home (he died the day after he was finally admitted). I have shared this experience with many friends and acquaintances who are coming upon the same problems and believe that their will be many more HHP hires directly from families as an intermediate step between level and because so many want to stay at home as long as possible.

May 11 05:50 PM