Strategies for PPS Survival.

How do you get ancillary costs comfortably under control so that you don't go broke? Consider the PPS Revenue Model

By now, most long-term care facilities with a Medicare Part A program are well along in the transition to the full federal PPS per diem. While problems with PPS have been well documented, it is realistic to conclude that PPS represents the future direction of Medicare payment. And, as many facilities are discovering (to their discomfort), when revenues are controlled by a system such as PPS, there are two principal options for maintaining financial stability:

1. control costs and increase the volume of patients, thereby improving the turn on assets; or

2. shift costs to other payers, thereby subsidizing the program.

Realistically, the only option is controlling costs.

Traditional analysis of PPS typically compared the most recent cost-based per diem with an estimate of the blended PPS per diem, as shown in Table 1 (next page).

Administrators had to address several critical questions as the implications of this became clear:

* Could the facility continue to offer a Medicare Part A program at this reduced level of reimbursement?

* What was the impact on ancillary reimbursement, and could the facility justify paying its ancillary providers any more than this amount? (The same question applied to all cost centers.)

* If the facility continues to offer a Medicare Part A program, how can the facility be sure that its costs will be covered by the reduced reimbursement?

* How can the facility structure a relationship with its vendors that offers a win-win environment under PPS?

To help address these issues, we developed what we call the PPS Revenue Model. The PPS Revenue Model uses the 1995 Medicare Cost Report as the basis for determining the components of a facility's Medicare Part A program. If nothing else, the approach offers an objective basis from which credible options can be evaluated. The benefits derived from this approach will manifest themselves in (1) the development of specific revenue and cost structures and (2) the negotiation of contractual agreements that are fair to both ancillary vendors and facility.

Table 2 provides a matrix illustrating some common methods long-term care facilities have used to contract with their ancillary service providers: Percent Discount, Percent of Revenue, Number of Minutes and the PPS Revenue Model.

There are several reasons why the PPS Revenue Model produces better results. First, it makes vendors (e.g., ancillary rehab and pharmacy) responsible for their utilization. While the facility must create and manage a quality Medicare program, it is not responsible for paying its vendors more than Medicare would pay them. That's the problem with the Percent Discount method, in which vendors are paid without regard for utilization; in such a scenario, the facility often ends up subsidizing the vendor with revenues from other sources of income.

Second, it helps administrators to know the impact PPS is having on specific services such as routine costs, pharmacy, rehab and other ancillaries. The trick is to know how to allocate PPS revenues to the different cost centers for each RUG. Then you can structure contractual arrangements that accommodate the Medicare revenues received. Though this isn't hard to do from a technical standpoint, as the following analysis will show, it is easier to accomplish if your vendors participate with you as members of the clinical (and, now, financial) team.

The PPS Revenue Model takes the two components of the Medicare PPS rate--the facility-specific component and the federal component--and calculates the average blended Medicare per diem, then allocates the per diem to the facility's routine and ancillary services. The following application is an example of the PPS Revenue Model at work.

Based on 1995 cost report data, the facility-specific Medicare per diem is calculated and broken down into the following components: routine, nonrehabilitation ancillary services and rehabilitation ancillary services (PT, OT and Speech Therapy). Table 3 summarizes the facility-specific and federal per diems--and shows that the federal per diem lacks the detail of the facility-specific per diem.

Using a sample of Medicare days by RUGS categories, an average federal per-diem rate is calculated. The federal rate has four components: nursing, therapy, non-case-mix therapy and a non-case-mix component. Three of the components--nursing, non-case-mix therapy and the non-case-mix component--are combined into a single category: routine and nonrehab ancillaries. To fill in these blanks, the facility component data are used to calculate ratios for each of the routine and ancillary services, as shown in Table 4.

Using these ratios, the federal per diem can be allocated into the same revenue categories as the facility-specific per diem (Table 5).

With the federal-specific per diem allocated to each routine and ancillary service, we can quickly calculate the blended rate for the transition years. Table 6 calculates the blended rate for transition year 1, with a comparison to the facility's most recent cost-based Medicare per diem. It clearly indicates a significant reduction (41%) in therapy reimbursement. This is information an administrator can use to negotiate with vendors. Table 7 shows the revenue impact for 2,000 Medicare days.

As shown by this example using therapy services, the PPS Revenue Model analysis now provides us with information that can be used to isolate our ancillary service revenues and expenses. We now know that therapy costs cannot be higher than $98.03 per day. If they are, then Medicare rehab revenue will not cover costs.

With an upper limit established, the next question is "How low can costs go?" It is our belief that a rock-bottom price will be problematic. Quality issues and potential payment-for-referral questions arise with steep Medicare discounts, especially discounts that are not based on any methodology.

The PPS Revenue Model uses the overhead factor for therapy services from the 1995 cost report. In our example, the actual overhead factor was 18%. Therefore, our contract rate of $98.03 is adjusted by 18% for a targeted contract rate of $80.39 per day. We now know that our negotiating corridor is a rate between $80.39 and $98.03 per day. Most importantly, if we can fix our therapy costs at $80.39 per day, we know that the therapy portion of our Part A program is within limits set by Medicare.

Once a contract rate has been established, the model can then be used periodically to analyze Medicare revenues and expenses to determine if changes in case mix have affected Medicare revenues and expenses.

The upshot is this: If under cost-based reimbursement, facilities were able to allocate overhead to ancillary services, the same allocations are now possible with the PPS Revenue Model. Using a simple but logical methodology, the PPS Revenue Model provides information to successfully manage Medicare revenues and expenses. When administrators understand the impact that net PPS revenues have on each component of the Part A program, they can effectively control costs.

Michael Scavotto is president and Scott T. Gima is vice-president, Management Performance Associates, St. Louis, Missouri.