'Affordability' might not be so affordable.

For years, the assisted living industry has used a benchmark of $25,000 in annual income as the cutoff between affordability and nonaffordability of its product. The data, however, show a different picture altogether. What are the implications for the industry?

Since public funding is directed largely to nursing facilities, and since managed care and long-term care insurance are still limited, the private-pay market continues to be the largest source of revenue for assisted living providers. That fact has focused increased attention on the issue of "affordable" assisted living. Students of "affordability" have placed seniors (particularly those in the 75+ age bracket), into one of three categories: those with annual incomes below $12,000; those with incomes between $12,000 and $25,000; and those with incomes above $25,000. Those in the first category are presumed to be eligible for Medicaid, at least in those states with waiver programs. Those in the third category are assumed to comprise the traditional market for assisted living and congregate services. It is the middle group (the so-called "gap group") that some suggest needs access to affordable assisted living.

But let's start with a quick look at the data. In reality, most residents in market-rate assisted living have annual incomes of less than $25,000. Indeed, a crude comparison of assisted living residents' incomes to the average rate charged by the communities in which they reside reveals that half these residents would not have sufficient monthly income to pay the prevailing rates, were the $25,000 benchmark actually valid. Research suggests that estimates of market demand based solely on numbers of households exceeding a specific income level may miss prospects who have under-reported their income or who have access to additional financial resources (either their assets or help from their families).

While the gap group described above does exist, its size might well be considerably smaller than originally thought. Thus, the primary issue facing assisted living might not be affordability as much as it is consumer awareness and the perceived value of the product.

But, the size of the potential market notwithstanding, the focus on affordability continues unabated. Aspiring to affordability is one thing, though; achieving it is quite another. Opening your community to lower-income residents creates a basic challenge common to the development of any pricing structure--the need to strike a balance between the imperatives of the market and the imperatives of the project. On one hand, you want to be seen as customer-oriented in the local community. On the other, you need to cover your total costs, while delivering acceptable financial ratios.

On the market side, affordability is only one of the many factors involved in setting your prices. Perceived value, competition in the marketplace, the need to plan for likely cost escalation, and your reputation as a provider must all be taken into consideration, as well.

On the project side, the realities driven by your business plan are equally compelling. Indeed, each of the two force--market and project--will inevitably impact on the other. You need to cover expenses, including debt. You need to provide for the safety margins required by your lenders. You need cash for unforeseen exigencies. You might even want to make a profit! Thus, project-driven considerations will likely determine just how well you can meet those driven by the market, particularly the consideration of affordability, and the converse is equally true.

Assuming affordability is still a goal in view of all this, even for a smaller gap group than was initially anticipated, how can the community achieve it? There are really only two ways. Either your prices have to be reduced, or approaches need to be found either to subsidize the purchaser of service or to help the purchaser convert nonliquid assets into disposable income.

As for reductions in price, they can be achieved either on the development/financing side or in operations. It stands to reason that there is only a short window of opportunity with respect to the first option. Once the project is under construction, financing arrangements have likely been finalized and building design (except, possibly, for some value engineering) has been set in concrete (pun intended). But all this notwithstanding, the opportunities to extract significant savings in financing and development are limited, since those costs themselves make up such a small portion of a project's monthly fees.

So, let's look at operations.

One approach to reducing operating costs (which must actually be considered during the design phase) is shared occupancy. The use of shared units can, of course, have an appreciable impact on monthly fees, reducing them typically from about $2,500 to approximately $1,650--a fairly substantial reduction. However, fees can usually be reduced by only 30 to 40% because, remember, most of your operating costs are labor and other such costs; sharing a room doesn't decrease the amount of staff time allocated to the delivery of personal care services.

There is a real question, too, whether compatible partners can be easily found without violating the critical goals of resident dignity and privacy. Some have argued that the social stimulation that comes with shared occupancy can itself be therapeutic but, ultimately, the customer has to see it that way and desire it. Otherwise, we have simply replicated some of the problems that beset nursing facilities, where shared occupancy (based on the realities of reimbursement systems) has become a way of life.

Other means of reducing the cost of your services are even less clear-cut. As mentioned, most of those costs lie in personnel, and it is personnel that will determine the quality of your product and its value to the customer. And there are even more compelling risks in focusing on reduced staffing as a way to making your community affordable--it may be affordable only until you experience your first lawsuit or draw the attention of your state's attorney general. Then it becomes pretty expensive, at least to you.

So, if reducing costs (other than through shared occupancy) doesn't offer much in the way of affordability, what does? What affordability really gets down to is finding ways of getting others to subsidize the purchaser or by helping the customer "spend down." The latter scenario involves helping the potential resident (and his family) see the value of using equity, particularly home equity, as a contribution to the cost of care.

In reality, "spend down" has always been a feature of long-term care, but with different connotations, depending on the setting. In nursing homes, the term is a statutory mandate requiring potential Medicaid enrollees to dispose of the bulk of their financial resources to meet state and federal eligibility criteria; in CCRCs, the terminology refers to the method by which many residents come up with the price of a community's entrance fees. The key to this form of "spend down" is disposing of the home, whereas under the Medicaid statute, the home is protected from spend-down requirements.

The lack of barriers in the private sector to transforming the home into disposable income helps in other settings because, after all, the home is an asset that more than 70% of the elderly own free and clear. How to apply the proceeds from the home sale to reduce fees is the question. They could be applied directly to community payments; added to an investment portfolio, with the income earned applied to monthly charges; or given to the community as nonrefundable, declining balances or as fully refundable entrance fees.

What about simply getting someone else to pay for the service? This approach could be used as early as during the development phase. Land, for example, can be donated. Tax-favored financing might be available (at the price of course, of devoting a certain percentage of your units to low income residents). Public funding is also available in some states through the Medicaid program. And, in some states, there have been successful attempts at integrating Medicaid payments for health services with subsidized housing programs administered by the federal Department of Housing and Urban Development--for example, Section 8 housing. The disadvantage of Medicaid, at least from the nursing home experience, is the inadequacy of the rates. Low rates lead, of course, to yet another form of cross-subsidization: resident to resident, wherein the more affluent residents cross-subsidize the poorer.

The most obvious form of subsidization, of course, is by children or other family members. In assisted living, almost 28% of residents receive some form of financial assistance from their children. In nursing homes, of course, such assistance (with the exception of certain amenities such as televisions, telephones, and private rooms) is precluded by law for the 66% of residents whose care is financed by Medicaid.

In the last analysis, affordability might well prove to be more an altruistic aspiration than a viable business option. it's doable, but only through the application of concepts that bring with them their own problematic implications. Shared occupancy has its drawbacks. And with public funding comes a new business partner--the government. Bottom line? It is arguable that, for most operators, the potential costs of affordability make it all but unaffordable.

To offer comments on Dr. Willging's views, as expressed here, please send e-mail to [e-mail].

Paul R. Willging, PhD, was involved in long-term care policy development at the highest levels for more than 20 years. For 16 years as president/CEO of the American Health Care Association, Dr. Willging went on to cofound the successful Johns Hopkins Seniors Housing and Care postgraduate program (cosponsored by the National Investment Center for the Seniors Housing & Care Industries), and later served as president/CEO of the Assisted Living Federation of America. He has enjoyed an equally long-lived reputation for offering outspoken, often provocative views on long-term care.