Go-ahead for cost control: increased operating pressures mean nursing homes need help mitigating liability risks and costs.

Nursing-home liability, a once docile class of casualty risk, has changed significantly over the years into an insurance line which has the attention of both insureds and underwriters. The financial and operating challenges of operating a nursing home have had a direct effect upon the quality of services provided and liabilities generated by this area of health-care services.

CAUSING THE PROBLEM

While the reasons for these changes in nursing homes are many, the major drivers of liability costs are the following:

An Aging Population

In 1990 there were 31.2 million people 65 years of age and older in the United States. By the 2000 census, that same group had grown by more than 12% to 35 million people. Projections over the next 15 to 25 years, at which time the last of the "baby boomers" will have reached a minimum 65 years of age, indicate the following:

* The older population will have increased to more than 71 million people. As a percentage of the total population, that group will have grown from 10.4% to 17.6%.

* As of December 2003, nursing homes across the United States have almost 1.5 million patients. As the population ages and life expectancies increase, this number will continue to grow, putting even more demand on these providers of care.

Nursing-Home Services

For the approximately 15,000 certified nursing homes, 10% to 15% of revenue comes from Medicare, 65% to 70% comes from Medicaid and 10% to 25% comes from private sources. Since the Balanced Budget Act of 1997, payments to nursing homes have been on a prospective payment system, which pays a per resident rate adjusted for resources utilized and geographic location. Treatment costs are determined by classifying each resident into one of 44 categories known as resource utilization groups. Prior to the Act, nursing homes were reimbursed on a cost-plus-profit basis, thereby providing for a profit margin.

Approximately 65% of nursing homes are owned by for-profit entities, the remainder being owned by not-for-profit or government organizations. The for-profit sector has shown poor results with average pre-tax margins of 3.3% of revenue, well below a reasonable risk-adjusted rate of return.

Approximately 28% of nursing homes are not-for-profit entities. Studies by both the Government Accountability Office and the American Association of Homes and Services for the Aging indicate that the profit levels of not-for-profit entities fall below even those of for-profit institutions. Some not-for-profit nursing homes rely upon charitable contributions from other parties to cover their deficiencies in operating results. Those operating results would be unsustainable without those donations.

Major Operating Issues

Both for-profit and not-for-profit nursing homes face major operating issues, including the following:

* The various extensions of the prospective payment system, which were adopted following the Balanced Budget Act, are set to expire Sept. 30, 2005. These "add-on" payments expire when the Centers for Medicare and Medicaid Services releases refinements to the current resource utilization groups later this year. These actions most likely will have the effect of a reduction in the Medicare rates for all long-term-care providers.

* The cost and scarcity of quality staffing for nursing homes have increased, particularly in the areas of skilled nursing at the registered nurse level. Costs associated with employee benefits and workers' compensation insurance also have increased along with payroll expenses.

* Nursing homes have faced growth in the number of Medicare and Medicaid "false" claim audits and the resulting disgorgement of collected and billed fees. These exposures remain with operations that collected reimbursement fees under the previous funding systems, thereby jeopardizing their financials.

* Bad-debt reimbursement amounts for Medicare Part-A have been reduced. This reduction in the amount of bad debts recoverable by nursing homes from the government will be lowered to 30% for the reporting year beginning Oct. 1, 2005.

* Inspections by state and federal authorities regarding the provision of care and services by a nursing home could have adverse outcomes. Failing to meet a standard of service can result in fines and penalties, loss of license and even involuntary withdrawal from the Medicare and Medicaid programs.

* Nursing homes could have an increase in provider taxes, which increases operating expenses.

All of these factors affecting revenue, expenses, operations and liability exposures make the running of a successful nursing home extremely difficult.

DESCRIBING THE EFFECT

Over the past 10 years, the severity and frequency of general and professional liability claims against nursing homes have increased significantly. According to a study conducted by Aon Risk Consultants from 1993 to 2003, the average claim has grown from $66,000 to $149,000. The frequency over that same period of time has changed from six claims per 1,000 occupied beds to 15.3 claims per 1,000 occupied beds.

In reaction to the growth in claims, underwriters have increased premiums, reduced liability limits and limited the scope of coverage offered to risks. Some insurers have completely withdrawn from this line of coverage.

A review of the financial statements of most major nursing homes indicates that the cost of general and professional liability claims has dramatically increased, affecting the cost and availability of insurance along with retained losses for self-insured retentions.

Major Causes of Increased Claims Costs

The causes of increased claims costs are complex; however, major issues are:

* Residents' and their relatives' expectations concerning quality of service and degree of care have increased over the years as society has become more affluent.

* Reactions to egregious examples of nursing home negligence have fueled the willingness to seek legal remedies for perceived wrongs.

* Various rights provided by statute and rule, such as The Nursing Home Reform Act of 1987, and the regulations by the Centers for Medicare and Medicaid Services, provide additional causes of action for residents. These types of laws and regulations have given residents additional basis for legal remedies that had not previously existed.

FINDING THE SOLUTION

Tort Reform

In reaction to the rising costs of claims, several states have passed various tort reforms, most notably Florida and Texas. At this time, it is too early to determine the full effects of these reforms; however, where caps and limitations are effective, total claims costs will be better controlled.

Risk Management for Owners And Underwriters

Good risk management will ultimately affect the frequency and severity of claims, which are the greatest drivers of insurance costs. A good risk management program is obviously beneficial to the nursing-home owner and represents the qualitative risk characteristics that underwriters consider most important. While underwriting criteria vary by insurance company, the following are some fundamentals:

Resident care that addresses:

* Prevention and treatment of pressure ulcers.

* Predetermined treatment for terminal illness.

* Pain management policies.

* Nutrition and hydration policies.

Resident safety practices and procedures that address:

* Prevention of falls.

* Medication errors.

* Use of restraints.

* Wandering.

* Abuse.

* Emergency evacuation.

Staffing issues, including:

* Training and education of employees.

* Background checks of employees.

Operations issues, including:

* Reporting of potential liability occurrences.

* Claim mitigation practices.

* Record and document retention practices.

Key Points

* An aging population and changes in finance procedures have a direct effect on the quality of services and liabilities generated by nursing homes.

* An increase in the severity and frequency of liability claims against nursing homes has made insurance more expensive and more difficult to obtain.

* With effective risk management and tort reform, the cost of risk financing can be better controlled.

Contributor William Redington is senior vice president and chief underwriting officer-Professional and Specialty Lines at American Re-Insurance Co.