Fifty years ago, conglomerates were corporations that owned several independent businesses. Some of these independent businesses were acquired as part of the parent-company’s vertical integration strategy. Hospitals have more recently deployed this tactic by creating or acquiring companies that could provide products necessary to deliver care, such as durable medical equipment, or acquiring companies who could care for patients after hospital discharge, like home care agencies. In health care, particularly among hospitals, this strategy of vertical integration became widely known as the continuum of care.
Suppliers of products needed by hospitals to deliver care or providers who cared for patients after hospital discharge were not always owned by hospitals. Over the last few decades, however, hospitals have acquired and operated many such services. For instance, within the past 30 years, hospitals aggressively purchased primary care physician practices that could refer patients, within the provisions of the Stark laws, to the parent-hospital’s emergency room, outpatient department, or other acute care services.
To accommodate patients discharged from acute care, many hospitals acquired nursing homes. Hospital leadership teams thought they could better control patients’ average lengths of stay by discharging them to nursing homes’ short-term stay units. Although the strategy was reasonable, not all of these leadership teams realized that managing a nursing home, despite the fact that nursing homes were originally modeled after hospitals in the early 1960s, was much different than managing a hospital.
According to the American Hospital Association’s most recent annual survey, in 2016, 20.7 percent of hospitals owned skilled nursing facilities (SNFs); by 2020 the percentage of hospitals owning skilled nursing facilities had declined to 17 percent.[1] Over time, some hospital leadership teams realized they had neither the resources nor the expertise to successfully manage and operate nursing homes. In addition, hospital-based SNFs have had substantial negative Medicare margins: -40 percent in 2021; -50 percent in 2020; -68 percent in 2019.[2]
The pandemic’s impact on nursing homes cannot be understated. The American Health Care Association (AHCA) and National Center for Assisted Living (NCAL), using data compiled by the Bureau of Labor Statistics (BLS), discovered the loss of approximately 210,000 nursing home workers since 2020.[3] SNFs have faced ongoing staffing struggles—so many, in fact, nursing homes often cannot accept patient discharges referred by hospitals. AHCA/NCAL’s same breakdown of data suggests it may take until 2027 for nursing homes to employ the same number of workers as they had before the pandemic.
Due to these ongoing challenges, hospitals continue to divest of their nursing homes. For example, AdventHealth announced in June that it had sold ten skilled facilities to a real estate investment trust (REIT).[4] In the past year, Hackensack Meridian Health divested of eight nursing homes and two assisted living communities.[5] Other hospitals have followed suit, and it’s widely known that these mostly not-for-profit nursing homes are being acquired by REITs and long-term care companies.
Why Hospitals Have Decided to Divest of Their Nursing Homes
The main reasons hospitals have divested of their nursing homes are:
- Lack of understanding of nursing home payer and revenue mix
- Hospitals’ administrative and general cost allocations to nursing homes
- Capital commitment
- Employee benefits
- Nursing home star ratings
- Ancillary services provided to nursing homes
Lack of Understanding of Nursing Home Payer and Revenue Mix
Commercial insurers are typically the best payers for hospital patients. Medicaid and Medicare Fee-For-Service (FFS) reimburse hospitals at rates lower than the hospitals’ expenses. In addition, hospital revenue mix has been significantly impacted by the onset of accountable care organizations (ACOs), Medicare Advantage plans (MAPs), bundled payments for care improvement, and other value-based models of care.
In contrast to hospitals, nursing homes’ most desirable payer is Medicare FFS, which reimburses at rates significantly higher than costs. In March of 2022, MedPAC found:
- The aggregate Medicare margin for freestanding SNFs in 2020 was 16.7 percent.
- The aggregate Medicare margin, not including federal relief, for freestanding SNFs in 2021 was 17.2 percent.
- The aggregate Medicare margin for freestanding SNFs in 2023 is projected to be 10 percent.[6]
Medicare FFS enrollees have declined with the onset of MAPs. Medicare FFS and MAPs, however, are still more preferred payers than Medicaid or commercial insurers. This situation is quite different than the hospital payer mix. Hospitals can leverage their size and scale with commercial insurers to optimize nursing home rates. Sub-optimal commercial insurer rates, however, can contribute to declines in financial performance for hospital-owned nursing homes.
Hospitals’ Administrative and General Cost Allocations to Nursing Homes
Hospitals generally allocate administrative and general (A&G) expenses to each department; thus, parent-hospitals generally allocate A&G expenses to their nursing homes. For example, Health Dimensions Group’s (HDG) hospital clients allocate A&G expenses to their nursing homes. These expenses typically constitute six to seven percent of a nursing home’s revenue, and unfortunately, lots of nursing homes cannot absorb these additional costs—they further erode profits.
When long-term care companies acquire nursing homes, A&G expenses are reduced, as their A&G allocations can be one-half of hospitals’.
Capital Commitment
Hospitals usually have a capital budget that is used to replace outdated equipment, purchase new services, maintain curb appeal, etc. Nursing homes that are owned by hospitals are usually included in the capital budget; however, many nursing homes’ funded depreciation can be lower than other hospital assets. Consequently, nursing homes’ age of plant can exceed that of hospitals’ resulting in aged buildings that become undesirable to residents.
Employee Benefits
Most hospitals have a competitive benefit structure, which usually includes medical insurance, dental insurance, vision coverage, etc. In HDG’s experience, hospital benefit expenses as a percentage of wages could range from 20–25 percent. When nursing home employees are employed by a hospital, it is not unusual for the same benefits to be provided to them. Unfortunately, nursing home revenues may not be high enough to support this expense, which can deteriorate financial performance. Conversely, when long-term care companies purchase nursing homes, they provide benefits as a percentage of wages that can be lower than that of hospitals, thus improving nursing home financial performance.
Nursing Home Star Ratings
Nursing home quality is evaluated based on the Centers for Medicare and Medicaid Services (CMS) Five-Star Quality Rating System. The system assigns a star rating, based on a nursing home’s quality measures, staffing levels, and survey results. A lack of hospital resources devoted to nursing home clinical care can create challenges for nursing homes to achieve solid five-star ratings. According to the Assistant Secretary for Planning and Evaluation (ASPE), Office of Health Policy, from January, 2016 to December, 2021 nursing homes with lower star ratings were more likely to be sold.[7]
Ancillary Services Provided to Nursing Homes
Nursing homes use pharmacy, therapy, dietary, environmental, and other ancillary services. If these services are provided by a hospital, they may be expensed at rates that could exceed the rates of community providers for these services. The increased costs for these services can further deteriorate nursing home financial performance.
What Should Hospitals Do with Their Nursing Homes?
Hospitals facing financial challenges operating nursing homes should consider the practices mentioned above. Obviously, nursing home management companies, such as Health Dimensions Group, can be engaged to turn around distressed nursing homes; however, hospitals should be flexible and willing to change practices that have led to increased nursing home operating expenses and have contributed to the homes’ financial decline.
Hospitals that have decided to divest should look for buyers who can turn around a home’s financial performance, achieve sustainability, and demonstrate values similar to theirs. Hospitals should identify buyers willing to partner with them after the sale in areas such as discharge planning, clinical programming, access to short-stay beds, and potential gain sharing arrangements through value-based purchasing contracts.
Hospitals can still maintain vertical integration for discharged patients after a nursing home divestiture by outsourcing post-acute services, but this kind of venture will require an elevated level of cooperation, collaboration, and engagement. Over time, however, this may be the best solution for serving nursing home patients and optimizing nursing home clinical and financial performance.
How HDG Can Help
If you are considering divesting or need assistance turning around your owned senior care assets, Health Dimensions Group is here to help. Our proven track record of success assisting hospitals and health systems in evaluating their senior care portfolios and determining strategic options for partnership, network development, joint venture, management, or divestiture makes us uniquely qualified to support your organization. Contact us at info@hdgi1.com or 763-537-5700 to get started.
[1] McKnight’s Long-Term Care News
