LTACS face payment freeze

EVEN SO, SOME INDUSTRY REAL ESTATE SOURCES REMAIN OPTIMISTIC

By Sonja Pedersen-Green

On the surface, recent proposals to change the federal payment system for long-term acute care hospitals (LTACS) might seem quite damaging to the operators and owners of such facilities.

That’s because the final rule proposals, announced in recent months by the Centers for Medicare and Medicaid Services (CMS), will include a freeze of the LTAC prospective payment system (PPS) and alterations to the short-stay outlier (SSO) formula.

The goal of the changes, according to CMS, is to curtail the financial incentives of treating short-term cases in LTACs when they should be treated in general acute-care hospitals. CMS says total payments to LTACs for rate year (RY) 2007 are expected to be $5.3 billion – an increase of $2 billion from 2003.

Even so, with 37 percent of all LTAC discharges being for short-term patients, healthcare companies specializing in LTACs say they are expecting losses as a result of the rule changes. 

For example, officials with Louisville, Ky.-based Kindred Healthcare (NYSE:KND), which operates 73 LTACs nationwide, expect the company to see losses in payments of about $46 million annually as a result of the changes to the short stay, high-cost outlier formula.

Kindred’s losses from the elimination of another reimbursement, what is called the market basket adjustment, which usually accounts for a 3 percent to 4 percent change, or $25 million to $30 million annually, should also negatively impact the company’s profits, according to Kindred officials.

Yet, despite reports that LTAC operators will be negatively impacted by the rule changes, some people involved in the real estate aspect of the industry believe things will work out in the long-run. They note that other recent changes in policies affecting LTACs have not hurt the industry, as was originally predicted.

The changes are?

There are three main changes for 2007. First, the PPS federal rate for RY2007 will remain at $38,086.04 – the same as in 2006.

Second, CMS will adopt the rehabilitation, psychiatric and long-term care market basket to replace the excluded hospital with capital market basket as a measure of inflation. This new basket will be used to calculate the annual update to the PPS. There will be no adjustment of inflation this year.

Third, the payment adjustment formula for SSO patients will be revised, changing the portion of the current formula that’s based on costs, and add a fourth component.  According to CMS, the number of patients who are transferred to LTACs from general acute-care hospitals for stays shorter than 25 days has increased significantly since 2003. CMS says because of this trend it is freezing payments for 2007 and changing the SSO formula.

Also, in order for a hospital to be eligible for payments, its estimated costs for treating a case must exceed LTC-DRG payments by an outlier fixed-loss amount. In rate year 2006, that amount was $10,501, but in 2007 the figure will increase by more than $4,000 to $14,887. An earlier proposal suggested an increase to $18,489, which some industry sources say would have been even more damaging to LTACs.

These modifications specifically target short-term stays at LTACs. CMS estimates 37 percent of all LTAC cases come from an acute care hospital and, therefore, many short-term cases might still require acute care that is unavailable at LTACs at the time of admission. 

Impact on profits, development

Following the announcement of CMS’s modifications to the PPS in late January, Kindred’s share price fell by 30 percent. By mid-June, Kindred’s stock had recovered and was trading between $24 and $25 a share, up from $21 or $22 in late January.

There is a great deal of speculation industry-wide as to how the changes will affect reimbursements.

Kindred expects its total reduction in annual reimbursements to be between $125 and $130 million, or almost 13 percent of total reimbursements. Plano, Texas-based Lifecare Hospitals, which operates 18 LTACS, expects its Medicare revenue to be reduced by about 12 percent.

CMS estimates the new regulations will decrease LTAC payments by about 11 percent next year, slightly lower than the companies’ estimates. However, the American Hospital Association (AHA) estimates the net loss from the proposal to be 14.7 percent. The AHA also says the proposal would lower Medicare payments to LTACs to 5 percent below the cost of providing care.

Optimism in some circles

Even with the changes, some folks involved in the industry say LTACs should be able to remain profitable.

One such source is Ray Lewis, executive vice president and chief investment officer of Healthcare Properties for Chicago-based Ventas Inc. (NYSE: VTR), whose primary LTAC tenant is Kindred Healthcare.

“The final rules were much more favorable for the providers, with a net cut of about three, three-point-five percent of total reimbursement,” Mr. Lewis says.

He adds, “Those operators that are flexible in their approach to admitting patients and identifying and targeting prospective patients would potentially be able to mitigate that impact even more. In general, the reimbursements that were finalized by CMS we view as being a fair outcome and at a decent level.” 

John Cobb, senior managing director at GE Healthcare Financial Services, agrees.

“I think the announcement was great for the industry,” says Mr. Cobb. “You saw the Kindred stock improve.”

It is not yet clear whether these changes will impact future investment in LTACs, according to industry sources. Mr. Lewis says the CMS rulings created “a fair amount of turmoil in the industry.”

However, Mr. Lewis adds that following the initial ruling “there was a pretty active educational initiative put on by the industry and others involved in the industry to work with CMS to help them understand what the appropriate reimbursement levels would be for the industry.”

The initiative, Mr. Lewis points out, resulted in a more favorable final ruling for LTAC companies.

At a Feb. 1 panel conference sponsored by New York-based Granite Partners LLC, a firm that includes a medical properties brokerage division, Mr. Lewis told the audience that Ventas makes an effort to keep rents at a level where it can cover short-term reductions in revenue, such as changes in Medicare and Medicaid reimbursements.

Mr. Lewis added that these changes stress the question, “If you’re living in a world where the stroke of a pen can change the fundamental operating business that you’re investing in, how do you deal with that from an investment perspective?”

“These types of facilities are less expensive providers of these services,” said Richard Lerner, managing director of the Fixed Income Division of Credit Suisse First Boston, at the same conference in New York. “So there is not much thought that the government will just let it go away. If there is an adverse change in reimbursements that will put people out of business, you need to make sure that your guy has the staying power to live through it and to wait for the government to correct it, as they have done for the last five years.”

Mr. Lerner reiterated that Credit Suisse lends to operators it believes are more efficient and have higher margins than their competitors. 

LTACs are growing

“The LTAC market is a growing area in the long-term care sector and hospital space, and it fills the much needed niche in the acute care and the intense care hospitalization and the long-term nursing area,” Mr. Lewis says. “There’s been a pretty rapid growth profile in the industry. While it’s a relatively small space, it’s a growing space. It’s a market that we like and we think is a good investment opportunity because of its growth profile and because of the good market fundamentals.”

Mr. Cobb says that he considers the LTAC industry an “exciting” one.

“It’s complicated,” Mr. Cobb adds. “It’s reimbursed; it’s very high-priced. There is a niche in this business for LTACs, (and) I think I foresee them growing. I think they serve a great little niche, but the question is about reimbursement and the security around reimbursement.”

Mr. Cobb likens the LTAC industry – as it now stands — to the skilled nursing industry of a few years ago.

“(In skilled nursing), you’ve seen a lot of stabilization in their reimbursement and when you’ve had three good years of consistent reimbursement, the industry likes that,” he says. “So now you see valuations go up and the market is a lot hotter today in skilled nursing than it was two years ago, where there was a lot of instability. I think from an investment side, LTACs will be a little safer once there’s a little bit more stabilization around the reimbursement.”

Development continues

It appears that Mr. Lewis is correct about LTAC development continuing even after the final CMS ruling – regardless of potential cutbacks in Medicare reimbursements.

An example of an LTAC development taking place can be found in Mesa, Ariz., where Skokie, Ill.-based Alter+Care, the healthcare division of The Alter Group, is in the process of developing a 65,000 square foot, two-story LTAC. The facility is being developed in the Arizona Health & Technology Park and will be operated by Birmingham, Ala.-based Preferred Continuum Care.

The Mesa Specialty Hospital, as it is to be called, is expected to cost $24 million. There are two architects on the project: Phoenix-based Butler Design Group on the exterior and Birmingham, Ala.-based CLA Architects on the interior.

Kurt Rosene, senior vice president of national development for The Alter Group in the transaction, says the LTAC hospital will meet “new, expanding and existing demand,” in the East Valley area of the Phoenix metro.

“Because the need is immediate, we’re delivering a 64-bed facility,” Mr. Rosene says. “On the heels of our delivery is a brand new hospital that is going to be developed, which, from the very nature of that, will (attract) new demand for this LTAC hospital.”

Because its East Valley location is home to a number of retirees, the LTAC is expected to attract a high number of Medicare patients. Mr. Rosene, however, believes the new CMS modifications will not hurt the new facility.

“I’ve been told that, actually, these modifications are going to be helpful,” Mr. Rosene says.

The biggest “con” to having an LTAC within a hospital is that CMS restricts the number of patients that may be admitted to the LTAC from the host hospital, he adds.

Because the Mesa Specialty Hospital will be located on the same campus as an acute-care hospital – but separate from it — the LTAC will not be affected by these regulations.

Mr. Rosene says the LTAC and the hospital will be “operating with two separate ownerships and two separate entities.” He notes that developing an LTAC near, but not within, a hospital, is part of a trend that’s expected to continue.

Moving out of hospitals

At this point, about 150 of the country’s 400 existing LTACs are freestanding. Previously, most LTACs were hospitals within hospitals.

According to Mr. Lewis, “The primary reason that there has been a trend towards free-standing LTACs is that the government has proposed and implemented a hospital on hospital rule that limits the number of admissions you can receive from the host hospital. If you are located in the hospital, no more than 25 percent of your admissions can be from within the hospital, and if you’re a free-standing facility there are no limitations on admissions from any particular referral source.”

After the change was implemented in October 2004, only new hospitals or hospitals in development that did not meet specific CMS criteria were affected. However, CMS did not leave older LTACs out of the mix, as they must also adhere to the rule through a four-year phase-in period that ends in 2008. 

Instead of reducing the number of LTACs being developed, the rule gave developers and operators an impetus to change and to build more freestanding, “satellite” facilities.

A prime example of such a shift in strategy can be found in Machanicsburg, Pa.-based Select Medical Corp. (NYSE: SEM). When the hospital-within-hospital regulations were set in 2004, SEM owned 83 LTACs  — 79 of which were hospitals within hospitals. Of the 14 LTACs that Select Medical has either acquired or developed since that time, 12 are freestanding.

Select Medical now owns 97 LTACs, 85 of which are freestanding facilities.

The company says it will continue to reduce the number of hospital-within-hospital LTACs. In coming weeks, in fact, the company plans to combine two LTACs located within hospitals into one freestanding facility. SEM officials say the trend will continue, as they plan to convert more and more of their LTACs into freestanding facilities. q

Sidebar (Hey, I just thought this part of the story bogged things down, as most people reading it will have some understanding of LTACS. But for those who want more, this would be a good side dish. — JM)

What’s that? An LTAC

 

Long-term acute care hospitals (LTACs) are healthcare facilities that focus on patients with serious medical problems that require intense, long-term care. The average length of stay is about 25 days, while general acute care hospitals have an average length stay of only 5.6 days.

Patients are often transferred into LTACs from the intensive care unit (ICU) of a traditional hospital. An LTAC typically offers more specialized care than a general hospital can provide. 

LTACs are an increasing phenomenon in the healthcare industry. In 1998, there were only 209 LTACs nationwide. By 2005, that number had risen to 365. The Centers for Medicare and Medicaid Services (CMS) reports the prospective payment system (PPS) currently sets payments for about 400 LTAC hospitals.q