In a gaff as memorable as one committed twelve years earlier, it appears that CMS (Centers for Medicare & Medicaid Services) has again missed the mark when calibrating rates for a new system. As investors in the nursing home space well remember, the move to the Prospective Payment System (NYSE:PPS) back in 1998 was viewed with guarded optimism by the industry. In that year, HCR ManorCare publicly stated that “management believes that PPS will ultimately be a net positive for its skilled nursing business.” By July 2000, nine of the countries top nursing home chains had filed for bankruptcy due to reduced revenues stemming from the implementation of PPS.
I was at Harborside Healthcare then and our new private equity owner saw the value of its shares dive from $25 to nothing in three years. Only after several years of increasing Medicare rates and deep cost cutting did the industry fight its way back to profitability and respect.
So what is it this time? No one has mentioned a problem - not analysts, corporate honchos or even CMS itself.
Things are going swimmingly well for skilled nursing companies. Sun Healthcare, the largest public player had a successful spin off of its real estate operations in the fall. Privately owned HCR ManorCare, sold its real estate to HCP, Inc., the largest health care REIT (until today's announced deal between Ventas and NHP), for $6.1 billion in December. At public skilled nursing companies, share prices have jumped over the past three months: Skilled Nursing (+109%); Sun Healthcare (+46%); and Ensign Group (+47%) – all on the back of rising profitability and earnings expectations.
However, if you peel back the numbers something startling appears. Medicare rates are shooting through the roof at a time when government prudence around funding Medicare and Medicaid is reaching a zenith.
Investors in the senior living space are likely aware of the wrangling over adoption of the new MDS (minimum data set) and RUG (resource utilization groups) systems for calculating Medicare payments to skilled nursing facilities. The planned adoption of these rules was slated for 2010 and in the wake of health reform the timing was modified. Congress finally acted in December 2010 to retroactively square away adoption of both RUG IV and MDS 3.0 effective October 1, 2010.
CMS has stated its intention that the economic impact of implementing these changes would be “budget neutral”. Added to these new systems was an announced market basket adjustment of 1.7% that CMS estimated would increase Medicare Part A payments to skilled nursing facilities by $542 million in 2011. However, with the adoption of concurrent therapy rules it was reasonable to expect an overall increase in Medicare spending of less than 1.7%.
Despite the stated neutrality of the new regulations, it was expected that there would be winners and losers in the new system. But judging from reported earnings coming out of the public long term care space, there are only winners.
|Company||Mcr Part A |
Q on Q
|4th Q |
Part A Revenue
As % of
|Skilled Healthcare||15.5%||$ 63,932||$ 18,718||$ 7,638||40.8%|
|Ensign Group||16.4%||$ 61,194||$ 19,092||$ 7,728||40.5%|
|National Healthcare||19.0%||$ 48,717||$ 16,500||$ 7,082||42.9%|
As can be seen above, companies reporting 4th quarter results are showing 15% to 19% increases in their Medicare Part A (room and board) rates. As compared to the expected overall increase of 1.7% to Part A rates. The excess revenues earned from these Medicare increases are responsible for a huge (40% to 60%) percentage of reported Pretax Operating Income for these companies in the 4th quarter.
Certainly, the Medicare system cannot afford to overpay by a factor of 10 times or $5.4 billion. We can be certain that somebody is going to notice this unanticipated spending and soon. Investors should be aware that CMS will need to recoup these funds.
I expect that CMS must drastically reduce the RUG-IV payment schedule in 2012 in order to return to the expected 1.7% rate increase forecasted for 2011 and also recoup the excess payments made during 2011. MEDPAC, the watchdog organization for Medicare makes its first annual report to Congress in March, so this problem could be reported shortly. The impact of reduced reimbursement and profit expectations should cause skilled nursing companies and related private pay senior living companies, that derive a large portion of their revenue from Medicare, to retrace their gains of the past three months.
While the longer term demographic fundamentals of the industry remain solid, challenges from MEDPAC on SNF operated ancillary businesses such as hospice and homecare; state budget shortfalls leading to lower Medicaid revenues; implementation of proposed generally accepted accounting principals around leases; and, most importantly, reduced Medicare reimbursement are all reasons nursing home investors should be very wary of the frothy market and may want to begin to make their way toward the exits.
Disclosure: I am short ENSG, SKH, SUNH.