Why the Median Skilled Nursing Margin Fell Below 0% — and How Operators Can Come Up from Underwater

Earlier this fall, a decades-old annual survey of nursing home finances revealed that for the first time, the median operating margin for the nation’s skilled nursing facilities fell below zero.

While the statistics from consulting firm CLA weren’t necessarily surprising, given the micro- and macro-level challenges facing nursing home operators over the last decade, that number — negative 0.1% — served as a stark illustration of the current state of the skilled nursing landscape.

But according to CLA managing director Cory Rutledge, a co-author of the firm’s most recent annual cost report, there’s still reason to believe that operators can turn these negative numbers around into the next decade.

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“The current economics of skilled nursing — I don’t want to paint a rosy picture and say that they’re fantastic. They aren’t,” Rutledge said on the most recent episode of SNN’s “Rethink” podcast. “And in fact, the last three years, we’ve seen a pretty significant decline. But my view is that the tide is turning.”

Rutledge sat down with “Rethink” to discuss the results, including both that dire margin and the common factors that the top-performing SNFs seem to share. Excerpts from Rutledge’s conversation are presented below, and if you like what you read, be sure to check out the full episode — and also subscribe to “Rethink” on the podcast service of your choice, so you never miss a twice-monthly installment.

Were you surprised about the median operating margin figure?

We’ve been doing this report for a number of years — 34 to be exact — and this is the first year that that median operating margin has dipped below zero. I should caveat and say that for the first number of years that we did the report, we were just using our client base; we didn’t have data on all skilled nursing facilities around the country.

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For the last probably three or four years, we’ve had a full national data set. This is the first year that we’ve seen it below zero. I wouldn’t say that we were surprised by it; we sort of saw the writing on the wall. I mean, over the last few years, it was hovering just above 1% operating margin. And then in 2016, it dropped all the way to 0.6%, and then to 0.1%.

We sort of saw that it likely was not going to be recovering. There was nothing that we saw — neither in the clients we serve, nor the metrics that we look at — that operating margin is going to increase. There are a lot of industry headwinds. So to say that it would be a surprise, it really wasn’t; it was something that we anticipated. We just didn’t know if it would be zero or just slightly below.

There are countless factors you can blame this figure on, but what are some of the most prominent?

One is that, you know, different states have different Medicaid systems, obviously. What we found in our analysis is that health care is local, and that that state Medicaid rate matters a lot. As you go across the country and look at different Medicaid systems, none are flush with cash and looking to spend a whole lot more money on skilled nursing, and so some of the pressures related to the Medicaid rates certainly played a role in it.

Another item that I would point to is: Some of the staffing challenges are definitely playing a role. So that turnover, as you all know, is very costly in the skilled nursing space. Recognizing that those pressures related to workforce are not improving — in fact, likely getting worse for many operators — we anticipated that that would be one of the big headwinds that would generate some of the negative trajectory on margins.

And then the final thing I’d point to is just the proliferation of Medicare Advantage. So as Medicare Advantage expands in different parts of the country, generally, they’re paying something less than Medicare in many instances. There’s just more challenges related to revenue cycle when dealing with Medicare Advantage.

Obviously it wasn’t all bad news — what are some of the key indicators for the buildings that were in that 75th percentile, which had an operating margin of 4.5%? That obviously isn’t huge, but it is above water.

That’s kind of the risk in issuing some of these reports: We’re looking at medians. I think our population was somewhere in the 12,000-facility mark of the 15,000 nationally. You run a risk of painting with a very broad brush, recognizing that there are a lot of organizations that are actually doing quite well.

This is a bit of a broad-brush statement in itself, but some of the multi-facility organizations that have really strong regions — so they have a local geography that they know really, really well, strong relationships within it — those organizations tend to do better.

We also see, and we outline this in the report, that there’s a pretty strong correlation between an organization’s CMS five-star rating and their financial performance. So when we look at the median metrics, and slice by five-star, we see that five-star organizations perform better than four-star organizations, four-star perform better than three, three better than two, and two better than one.

Now there’s a question: What comes first the chicken or the egg? Do well-performing financial organizations have high star ratings, or do high star rating organizations have good financial performance? And I don’t know that there’s a simple answer to that.

I just think they build off of one another. It’s really a matter of momentum: Do you have momentum in which you’re providing good outcomes for your residents, getting good five-star ratings, getting more referrals, having higher occupancy — and that drives your financial performance? Or are you in a situation where you’re sliding back in terms of your five-star rating, which can lead to fewer referrals, lower occupancy and the like? So I can’t say that one produces the other, but certainly there tends to be a relationship between the two.

You predicted my next question, which was going to be about the chicken or the egg thing. It’s not the most analytical explanation, but usually operators tell me that investing in quality care begets financial success.

I definitely think that’s true. While it’s not an analytical answer, that doesn’t make it incorrect. I think it’s important to understand the importance of CMS five-star rating. I would even peel that onion back a little bit and say that it’s wildly important for organizations to understand the cost of a staffing star.

Now, I need to be really careful when I say this, because I’m not suggesting that organizations should be a one-star staff facility, nor am I suggesting that they should be a five-star staff facility. I’m merely recommending that they understand the cost of the staffing star, and the revenue that that gets derived from it. When we do a correlation between median operating margin and the staffing portion of the star rating, there’s actually an inverse relationship. So one-star staffed facilities have higher operating margins than two-star, two have higher than three-star, three have higher than four-star, four have higher than five-star.

But that does not mean that I’m saying that people should only be a one-star staffed facility. So again, there’s a happy medium in there, where you’re providing good outcomes, you’re nailing your survey, you’re getting that high quality metric, and you’re staffed appropriately for your building and recognizing the cost of doing so.

I also think that there’s a lot of power — and part of why strong regional providers tend to do better than than others — in that they have good systems in place to monitor performance. So there’s a fair amount of infrastructure built, which allows those organizations to serve residents and do really well with a different level of staffing at the bedside.

You’re pointing to kind of another truism that has emerged in the skilled nursing space over the last half a decade or so is: regional is better. You’re more able to adapt to changes in the marketplace. Is there a right size for a regional operator? It’s a question I ask a lot and there doesn’t seem to be a consensus answer.

I think there’s risk at giving a very specific answer to that question, because you can easily be proved wrong. I think that somewhere in the 20-to-50 mark seems to be a sweet spot. But I really think it depends on the geographic density. We get a lot of questions related to general and administrative costs within skilled nursing. Really the question is: What’s the appropriate number to get high-quality talent to be able to afford really good regional oversight, and be able to deploy that into a small enough geography where it matters?

So I don’t know that there’s a magic number. I’m not going to pinpoint that it’s 30 or 40. But I think somewhere in that 20-to-50 ballpark, we tend to see that you’re large enough to be able to cover your overhead with a large number of beds or resident days, and that you’re large enough to attract the talent that you need — but also small enough, where like you mentioned, you’re able to be nimble and react to market conditions. But I think, as I mentioned, the importance is really knowing that local market and building relationships within it.

You mentioned Medicare Advantage, and the facts haven’t changed — operators receive less money from these plans and feel a pressure to reduce lengths of stay. How can they get ahead of those factors? Is there any way they can adapt?

If you look at a state like Pennsylvania as an example, the Philadelphia marketplace has very different penetration rates than the Pittsburgh marketplace — Pittsburgh having a lot more, but even within Pittsburgh, there are some counties where it’s really heavily penetrated and others much less so. So it definitely is local, and with different Medicare Advantage plans, they certainly aren’t all built the same.

In terms of what can be done about it, I think the the general consensus that I’m hearing is that there is an importance in taking on risk. Now, obviously, I’ve heard … a lot of conversation around I-SNP, and rightfully so. It’s definitely the hot topic. And we’re doing a lot of work in advising skilled nursing facilities on I-SNPs. That’s one answer, but it certainly isn’t the only answer. Frankly, it probably isn’t the most prevalent answer. My view is that I-SNPs aren’t for everybody. They work very well for some, but not for everybody.

But regardless of the avenue that you take in order to accept risk, this concept of taking on that capitated risk, and getting closer to that premium dollar, is important. I think that skilled nursing facilities have struggled to find that premium dollar unless they’re able to build their own plan, and that’s why we’re seeing more I-SNP activity in the marketplace. But this concept of taking on risk, both upside and downside, I think is important, because unless a skilled nursing operator has that ability to really manage that health care dollar, and manage that resident, and not just have them be kind of a per-day situation, they run the risk of being commoditized..

If facility A won’t take Medicare Advantage for X rate, well, they’ll just go to facility B and get it there. So, in order to prevent that commoditization of skilled nursing, I think that taking on risk in some way, shape, or form is going to be necessary for skilled nursing operators in the future.

You and your colleagues concluded the cost report with a warning that SNFs are going to have to take bold actions to survive. What are some of bold, crazy things that you’re seeing as potential solutions — or is it really just as simple as blocking and tackling within the existing structure?

I think the overall trend that I see is this concept of doing more than just providing a bed and nursing services to people in your skilled nursing facility. Taking ownership of that whole person, really focusing on population health, bending the cost curve — I think those are the concepts that will play well.

I think that as time goes on, a facility’s ability to take on risk, regardless of their size, will continue to increase. If you look at what Seema Verma and others, from a federal perspective, are saying, they want organizations to be able to take on risk, regardless of size. And so while the environment today might not be flush with opportunities for skilled nursing facilities — particularly small- to mid-sized organizations to take on risk — as time goes on in the future, I think those opportunities will continue to increase.

Looking at the nursing homes that are in really dire straits, in the bottom 25th percentile: The median loss is 6.5%. That’s obviously not great. What’s the fate of these facilities moving forward? Is there a way for them to turn that around?

It’s something that doesn’t happen overnight, and it won’t get fixed overnight, and they’re in that position for a reason. That’s not a blame statement. It’s some combination of the operator or perhaps the lease situation they’re in, perhaps the demographics of the community. There are a lot of facilities that are in that that bucket — certainly not all, but many that are — in that that lower quartile that you referenced that just don’t have the market to compete. Or they’re in an area where there’s a lot of competition, and they historically have never been high on the list of referrals, and will continue to not be.

Is it something that they can turn around? Or is it going to be a turnaround artist to do it? I think more often than not, it’s going to be a turnaround artist. Maybe the operator isn’t as strong — or doesn’t have the horsepower, regional oversight, clinical oversight, whatever it is — to make a mark in that environment. My sense is that it’s going to have to be a turnaround artist, or it’s just in a demographic where the facility will continue to struggle. So I guess the short answer is, more often than not, my view is that it is not the current operator that’s going to be turning that around, and turning that negative into a positive.

One of the problems with nursing home financial data is that it tends to lag — for instance, this most recent report reflects 2018 numbers. Do you think last year represented a bottoming out, or will we see more pain ahead?

I know that operators are generally optimistic about PDPM: Every conference you go to, and most of the articles you read, there tends to be a lot of optimism, although the jury’s still out. My advice to the clients that I serve is: If PDPM ends up being a big winner for you as an organization, that’s not money that should be spent right away. This is intended to be budget-neutral, as you know. And if it ends up being something other than budget-neutral, I think that the Medicare rates thereafter will adjust accordingly.

So if I look into the future, I see a lot of of positivity for organizations that have the clinical capacity to care for a different type of population, and a more acute type of resident. If you look at the way that the market is going, we’re seeing a downward trend in hospitalizations. And I think part of that could be associated with skilled nursing facilities increasing their clinical capabilities and skilling residents in place.

So as that world comes to fruition, and we get into a rhythm as skilled nursing providers of getting paid to care for more clinically complex people, I think that there is some optimism — that when we start to get paid for caring for residents like that, we can turn the tide a little bit and have more positive financial results for skilled nursing. So I have more optimism for 2019 and beyond than I see in 2018.

Speaking of that optimism, what’s a stat from this report that people should take away and say: Here’s a good opportunity, or here’s reason to believe that things are going to turn around in the next couple years?

Well, I think that the demographics are on our side. There’s a lot of excitement about that, and frankly, it’s not going to happen overnight. I mean, if you look at baby boomers, they’re turning 75 in 2021; clearly, they’re not going to be your skilled nursing residents. But there’s plenty of demand that’s in the marketplace. And I think as skilled nursing really finds its place as the right solution for frail, older adults, I think that that there’s plenty of reasons for optimism.

There’s a lot of conversation around home health and around assisted living, and other alternatives. Those alternatives aren’t going away — and frankly, they’re great alternatives in some instances — but the bottom line is there are a lot of Americans that are getting older, that are frail, that have multiple co-morbidities, chronic conditions. And in terms of longevity and caring for people with that type of situation. skilled nursing does very well.

The current economics of skilled nursing — I don’t want to paint a rosy picture and say that they’re fantastic. They aren’t. And in fact, the last three years, we’ve seen a pretty significant decline. But my view is that the tide is turning. There are a lot of really good operators, a lot of organizations that are doing really well, being innovative and doing some interesting things. And I think the future is bright for those types of organizations.

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