There is an old joke/riddle that goes like this: “Where does an 800 lb. gorilla sit? Answer: Anywhere it wants to”. For SNFs and REITs today, that gorilla is Medicaid. Sure, there are numerous industry headwinds that SNFs face in terms of financial performance;
- Rising percentage of Medicare Advantage patients as part of the payer mix with implied discounts to fee-for-service of 10% or more.
- Additional regulatory costs stemming primarily from the new Conditions of Participation, released in 2016.
- Value-based purchasing.
- Five Star system savvy referral managers that are steering volumes to certain providers
- Rising labor costs, primarily at the lower end of the labor pool (CNA, food service, housekeepers, etc.) representing the 50th or more percentile of the SNF labor budget
- Bundled payments in certain markets
- Growing diversion of former non-complicated orthopedic patients away from IRFs and SNFs to home health and outpatient
Yet is spite of this list, not one or even a combination is as crippling as the impact of a high percentage of Medicaid patients within an SNF payer mix.
Take Genesis for example. Genesis stock trades at just above $1.00 per share. Genesis’ average payer-mix across its SNFs is 73% Medicaid. This means that 27% of the remaining payers must make-up for a negative break-even margin rate of no less than 30% for each Medicaid patient. In some states, the disparity is greater. In other states, the disparity might be less but the state budget woes delay payments or issue IOUs (Illinois) causing the SNF to finance its own below-cost receivables. Recent news that Genesis may be the next significant REIT holding default is far from fantasy.
The seemingly large, formerly well-capitalized SNF chains are in peril. HCR ManorCare is in default to HCP (its primary REIT) to the extent that HCP is seeking receivership for the HCR holdings. The portfolio has a rent coverage ratio of .76x at the facility level and less than 1x globally. Signature is in the same boat. Both have compliance problems with Signature having so scarce a margin that it cannot adequately staff or provide for residents in certain locations such as Memphis (facility denied payment, residents relocated). HCR faces federal Medicare fraud action(s) that will likely lead to settlement payments, etc. for over-billing in excess of $100 million.
Among these troubled SNF providers, one common thread persists – high average Medicaid census (above 66%) as the primary payer mix in their buildings. With this high mix of Medicaid patients comes staggering facility level losses or revenue shortfalls that must be made-up by other payers. Consider Wisconsin as an example. Wisconsin is a state that maintains a balanced budget and generally, a surplus. It has no issues paying its bills so SNFs do receive timely payment. Wisconsin however, grossly underpays its SNFs for their Medicaid residents to the tune of an average of a daily loss of $60 per day in 2013. Between 2013 and 2015, Wisconsin provided no Medicaid rate increase. All tolled, Wisconsin facilities experienced a Medicaid loss in this period exceeding $300 million. This gap is exceeded only by the states of New York and New Jersey. In Wisconsin, the Medicaid loss for an average SNF patient is made up (if possible) by other payers. That amount today is well over $100 per day, excluding the cost of an imputed bed tax. As the average Medicaid census is 65%, 35% of all other payers must pay $100 more to cover the Medicaid loss, before any other margin is applied.
Doing the math: A 100 bed facility with 100 residents has 65 covered by Medicaid. The State pays $175 per day for each Medicaid resident, on average. The Facility costs are $60 per day higher or $235 per day. In total, the Medicaid loss per month then is $60 x 65 x 30 (30 day month) or $117,000. To break-even for the month, the remaining 35 patients must pay $346.43 per day or $235 per day in facility costs plus and additional $111.43 per day to recoup the loss from the Medicaid census. This of course does not include any additional costs related to a bed tax or account for any margin.
While the example is illustrative, it is not an atypical story state to state, save the unique twists that are part of every state program. For example, Kansas chose to convert its Medicaid program to a “managed” program (in 2014) believing it could run more efficiently, save dollars on administrative costs and still provide adequate reimbursement. As most states, Kansas chose to “bid” its program to various third-party administrators (insurers such as United Healthcare). Unlike most states, Kansas chose to convert its entire Medicaid program rather than take a phased-in approach. For SNFs, this approach has been a disaster. The bulk of Kansas Medicaid recipients are rural. Enrollment has been a nightmare and qualification of eligibility even more so. None of the participating administrators were prepared and had systems in-place to qualify promptly, newly eligible residents. The net is many SNFs face technical payment delays due to having to manage multiple payers plus, difficulty in getting approval for residents that are Medicaid “pending”. Receivables in total and days in receivable have skyrocketed and the state has yet to make many facilities current or whole. And, because rate is an issue as is the state budget, the bed tax was increased by $800 per bed, per year. In doing so, any facility with less than a 50% Medicaid census loses money on the bed tax (additional rate generated by Medicaid less than the bed tax increase).
Where this issue resolves is not apparent. Proposals from Congress to block grant Medicaid to the states almost universally conclude with Medicaid rate reductions for SNFs. For some states such as Kansas and Missouri, the outlook is a nominal reduction of 2 to 3% (though this is hardly nominal for the SNFs) in Medicaid spending/support. The reason? Rates and program expenditures are meager and lean to begin with. In Colorado and New Jersey, overall Medicaid spending would reduce by as much as 20% translating to a crippling rate reduction without any additional state support (added state funding). Both states were Medicaid expansion states under the ACA.
As for the survival and fortune of the SNF industry, the outlook for certain segments and providers is rather bleak. The Medicaid story does not come with additional dollars for rate support or spending – just the opposite. While block grants may give states renewed opportunities for innovation, the costs that drive SNF spending are not within the purview of a state to change – namely regulation, capital and staff. The greatest flexibility a state may have is to infuse additional dollars and spending into SNF diversion programs – namely Home and Community Based Services. These programs are wonderful for certain levels of care needs but for those frail seniors that typify the long-term resident in a SNF today, they offer no hope or savings. Like it or not, SNF care for some is very cost-effective and necessary due to the needs of the resident (multiple chronic health problems, lack of family and social supports, mental/cognitive impairments, etc.).
In a recent call with an investment analyst from a private equity group, I was asked if “all was lost” for the sector. The answer I gave is “no” but for some, the ship is definitely taking on water and it may be too late to avoid sinking. This is definitely true for HCR ManorCare and perhaps for Genesis. The question today is the collateral damage that may inure to REITs and other investors. In brief;
- Facilities with Medicaid census in excess of 50% will find it exceptionally difficult to generate enough revenue via other sources to cover the Medicaid losses. Medicare simply is not sufficient in patient volume or rate to offset the losses.
- Reducing Medicaid occupancy is difficult and not quick. States do not provide a clear-path for this process and federal regulations don’t allow facilities to simply shed residents because of inadequate payments.
- Many of the facilities with large (proportionate) Medicaid census are older and typified by bed counts above 75, semi-private rooms, and to a large degree, deferred cosmetic and maintenance issues. In short: they are below the current market expectation for a paying SNF customer.
- Taking over the operations or acquiring a number of these facilities with high Medicaid census, doesn’t change the fortunes of the same, directly or quickly. While fixed costs in the form of rent payments may reduce, the operational headwinds remain the same. A new operator cannot simply transfer out, Medicaid patients. Even with a bed reduction plan approved by the State, the SNF is responsible for each resident, relocation, etc. This process if not fluid or inexpensive. Changing payer mix is difficult, slow and while occurring, expensive. Frankly, I have never seen the same done to a facility that was predominantly, Medicaid.
- The market for these facilities is minimal at best. For REITs, expect valuation changes (negative) as the holding value current is based on acquisition cost and income valuation tied to higher rent multiples. Clearly, with rent coverage levels below 1, re-basing and re-balancing is next (if not already starting).
Reprinted with permission from Reg's blog