Rewriting the rules.

Prospective payment has hammered some and helped others, but nearly everyone's glad to be through the first tough year

Officially, PPS refers to the prospective payment system for Medicare. But some skilled nursing facility operators say it might as well stand for Please Pay Something. And many of them are Positively Panic Stricken by the effects of the new reimbursement formula, which replaced the cost-based system on July 1.

"Basically, the process has been harder, the learning curve steeper, and the cuts deeper than most people were anticipating," says Tom Burke, a spokesperson for the American Health Care Association. And let's face it: No one was wildly optimistic to begin with.

"PPS has surprised a lot of people in how much money it's taken out of the system," says Burke. "Even a 20 percent drop-off in revenues is monumental if your margins are thin to begin with. And if your Medicare census is low, you still have the expenditures for technology and training."

"It's beyond horrible," adds an analyst who covers the industry. "The only people who are doing well are the consultants, and half of them don't know what they're doing. But people are desperate for advice."

A public spectacle

Among the hardest hit have been the large chains--whom some in the industry blame for the advent of PPS in the first place. "They were the ones that got us into this trouble," says an administrator at a not-for-profit facility. "A lot of them jumped into high acuity and high ancillaries strictly on a cost- and profit-driven basis, and pretty much came out and told their investors they were working the system. Now, as a result of that, we're all being hit."

And the big guys are being walloped. Last year, the stock prices of the eight largest publicly traded subacute and long term care companies fell by an average of 56.7 percent, shedding a total of $5 billion in stock value. (The second-worst year, 1988, saw just a 10 to 15 percent drop-off.) Seven of the top 15 firms absorbed stock-price declines of more than 60 percent. Granted, the health care sector as a whole fell out of favor last year, but overall companies still managed to eke out an average gain of 1.9 percent. Meanwhile, the Dow Jones Industrial Average was up 16.1 percent on the year, the S&P 500 rose 26.7 percent, and the Nasdaq composite index soared 39.6 percent.

Many of the subacute stocks have continued to fall in 1999, with some trading below $2 a share. "PPS has dramatically affected their potential profitability," notes Murray Gunty, principal and chief investment officer at Lazard Freres Real Estate Investors. "It's probably going to be a very ugly year."

"We could see a lot of operators in serious financial jeopardy on their Medicare lines," says Sheryl Skolnick, managing director of BancBoston Robertson Stephens. "And to make matters worse, a lot of states are cutting back on Medicaid and tightening up on managed care.

"These companies need one or two quarters of good numbers under PPS to regain their credibility," she adds. "There are still a lot of implementation issues to be worked out, not only in terms of how well the companies can handle this but how well HCFA can." Some companies aren't even providing quarterly earnings guidance--and a few analysts believe that one or two firms could eventually seek bankruptcy protection.

Scaling back

Smaller providers have problems of their own "Some of them had a Medicare 'cushion' that helped them manage other patients at break-even levels," says Leah Klusch, executive director of the Alliance Training Center. "But what do you do when your operating margins go from 5 or 7 percent--not great to begin with--to 1 percent? And with 120 beds it's hard to get a great service contract."

On the other hand, some small facilities, which have had to be efficient just to stay in business, could have an easier time adjusting to PPS. "For the ones who are getting hit hard, it's a big deal, because even if only 15 to 20 percent of their patients are Medicare, they could account for 40 percent of revenues," says Steve Monroe, a partner at Irving Levin Associates. "But for some of the mom-and-pops and even some of the larger private chains, PPS is fairly neutral--and for some people, especially if they have very low acuity or have good rehab contracts, it could be a net positive. Of course, the guy who owns three well-run nursing homes in Missouri doesn't issue press releases announcing his quarterly results."

"Many of the independent owners may find it very challenging at first," agrees Phyllis Madigan, executive vice president of Navigator Health Group. "But they are actually positioned well because they don't have the overhead and huge fixed costs that larger, more consolidated firms have.

"The providers in Southern California, Oregon, Washington, Arizona, and southern Florida, where there is already a lot of managed care, also could be a little ahead of the game," she adds. "Many of them have already learned to control the major cost centers--nursing, rehab, and pharmacy--while managing patients effectively with quality outcomes."

Contract killings

Firms that rely on SNFs as clients, however, are getting squeezed pretty much across the board. Pharmaceutical, contract therapy, and other ancillary services are reimbursed at significantly lower rates under PPS than they had been in the past--so the use of extenders, trained paraprofessionals, and restorative aides is increasing. "We're 1,000 employees down from where we were six months ago," says Larry Lane, senior vice president of NovaCare. "Most companies are just cutting and shaving, with significant reductions in staff and salaries."

"Therapists used to be in the catbird seat, and now they're being eaten," adds Monroe. "They're being laid off right and left." And the ones that remain have to be a lot more flexible. "They can no longer just walk into someone's room and do an independent evaluation," says Klusch. "They have to become much more integrated into the care planning and delivery team, know how to properly monitor and document the service they provide, and be available on evenings and weekends."

On the pharmacy side, "some of the smaller local and regional pharmacies could start getting more business," Klusch predicts. "Because the big firms have enjoyed cost-based reimbursement for so long, they might have a bigger adjustment than the smaller guys who have been used to containing costs all along."

Acuity adjustments...

Many SNFs are starting to adopt a more actuarial approach to care delivery--not only in terms of their service contracts, but in the kinds of patients they accept. "In this environment, the immediate response is one of risk avoidance, cautious assessment and a reluctance to take certain case profiles such as high non-ancillary respiratory or other chronic or complex patients," says Lane. "There's a movement toward lower acuity levels."

"Some of the SNFs that are struggling with the capped per diem and don't have the volume to renegotiate their ancillary contracts are minimizing their short-term Part A admissions, essentially returning to the long term care emphasis that had been their core," adds Kathleen Griffin, PhD, national director of post-acute services for Health Dimensions. "And some are certifying all of their beds for Medicaid. But those who had developed a large-volume short-term care product line and learned to manage those patients effectively probably will be expanding that."

Some facilities are marketing to specific clinical niches. "People are defining their service patterns much more aggressively, seeking out certain delivery channels," says Klusch. "They're also building or further refining their restorative care programs.

...And management makeovers

Some people aren't sticking around for the dawn of this brave new world, While no one is willing to officially chalk up any high-level personnel shifts to PPS, changes are indeed under way. 'We're seeing a significant spinoff of good talent leaving this field, both at the industry and trade association level, because people feel we're in a cul de sac," says Lane. "A lot of people are retiring early, or getting stressed out and going back to less prestigious middle management jobs. And if there isn't stability in the companies, there won't be stability in the execution of the new system."

"There's a big difference between who is best to lead a company in a growth stage and who can lead it out of the fire," says Monroe. "If there is significant financial disruption and the board is not confident in someone's ability to lead them out of it, probably at least one CEO will find his way our the door. And a leveraged buyout could bring in a whole new management team."

Consolidation remains a very visible specter. "Even the large public firms that still have access to capital will find it more costly or challenging to get hold of" says Charlie Lynch, a long term care analyst at Schroder & Co. "In 1994 there were about 27 nursing homes publicly listed. Today there are about 12--but that number will probably shrink. Some of these firms could end up aligning with their strongest competitors. This will take time to shake out, and then the winners will start emerging next year.