As the federal government’s approach toward nursing homes and COVID-19 continues to shift from emergency support to reflection and reform, analysts are increasingly warning that the coronavirus-era gravy train could soon come to an abrupt stop.
In particular, the past week has brought three pieces of news that may signal trouble ahead for operators and investors that banked on an indefinite round of support from Washington and state houses — with two coming from a single Centers for Medicare & Medicaid Services (CMS) proposed rule.
First up, CMS pitched a significantly smaller fiscal 2022 Medicare raise for nursing homes than it has in previous years. If finalized, the updated prospective payment system (PPS) for skilled nursing care would boost rates by a total of $444 million, or an increase of 1.3%, down significantly from the $750 million bump awarded to providers in fiscal 2021.
This more conservative raise was below expectations by about 80 basis points, according to an analyst note from RBC Capital Markets.
The federal government’s fiscal year begins October 1. The 1.3% rate is merely a proposal — CMS must formally finalize the rule in a process that typically wraps up by the end of July — but the lower starting point prompted Mizuho Securities USA managing director Omotayo Okusanya to predict that it could be the first sign of a coming sea change in COVID-era payment policies.
“While this is still a net increase on a YoY basis, it falls below expectations, and could be seen as CMS setting the stage to begin to pull back the meaningful amount of aid that has been provided to SNFs during the COVID-19 pandemic,” Okusanya observed in an analyst note.
Then there’s the potentially bigger question of when, and by how much, CMS plans to recalibrate the Patient-Driven Payment Model (PDPM). The newest system for determining Medicare payments to nursing homes made its debut in October 2019 with a mandate for revenue neutrality — that is, CMS expected to spend the same amount of total Medicare dollars on nursing home care as it did under the old Resource Utilization Group (RUG) system that PDPM replaced.
Reality didn’t match intentions, however, with pre-pandemic analyses showing that PDPM generated far more revenue winners than losers. The pandemic year of 2020 began with intense speculation about CMS’s PDPM intentions, and now that the worst of COVID-19 has passed in nursing homes, the agency was able to make a clear statement about its plans for 2021 and beyond.
“We believe that, based on the data from this initial phase of PDPM, a recalibration of the PDPM parity adjustment is warranted to ensure that the adjustment serves its intended purpose to make the transition between RUG-IV and PDPM budget neutral,” the agency wrote in the proposed payment rule.
CMS estimated a total PDPM-related increase in nursing home spending of $1.7 billion, or 5%. While the agency acknowledged that COVID-19 may have had an impact on the gains for a variety of reasons — particularly waivers that expanded and extended residents’ access to Medicare coverage of SNF care — it also provided compelling evidence that PDPM boosted spending independent of the pandemic.
“Even when removing those using a PHE-related waiver and those with a COVID-19 diagnosis from our dataset, the observed inadvertent increase in SNF payments since PDPM was implemented is approximately the same,” CMS noted,” referring to the federal public health emergency (PHE).
PDPM had consistently been hailed as an improvement over RUGs from both within and without the skilled nursing industry, and analysts have specifically cited the opportunity for expense reductions and reimbursement boosts as reasons for general long-term optimism about the sector.
But the Thursday warning from CMS marked a distinct tonal shift.
“The proposed FY22 rate update is slightly below our expectation (by ~80 bps), but we are more concerned by the potential PDPM recalibration,” RBC observed.
In text of the proposed payment rule, CMS mentioned a hypothetical cut of 5% when discussing its potential strategies for bringing PDPM back down to budget neutrality; such a reduction would drop coverage ratios for skilled nursing facilities owned by real estate investment trusts (REITs) by about 0.10 to 0.15 times, RBC estimated.
The extent of CMS’s movement on PDPM remains an open question: As with the regular Medicare payment increase, the agency must finalize any PDPM changes in a formal rule, and CMS put out a call for comments and critique on its proposal from all industry stakeholders.
The skilled nursing sector has remained a viable — if even enviable — investment bet for a variety of investors through the tragedy of COVID-19 primarily because of the government’s willingness to provide vast financial and regulatory support; in other words, backers looking for long-term returns on their investments have taken the billions in CARES Act funds and other supplemental COVID relief cash as evidence that Washington sees nursing homes as too important to fail.
But the proposed final payment rule, coupled with the Biden administration’s $400 billion plan to expand Medicaid coverage of home- and community-based services, could form a strong counterpoint to that assumption.
“CMS appears ready to pull back starting in FY22,” Mizuho’s Okusanya observed. “Should rent coverage subsequently fall as a result, increased tenant credit risk (which may not have any earnings impact per se) would likely limit and could actually compress valuation multiples.”
State-level regulatory pushes could also start to play a role in investor attitudes toward post-acute and long-term care. The third news item that raised Mizuho’s attention came from New York, where Gov. Andrew Cuomo and the state legislature reached a deal to implement a 5% profit cap on nursing homes, along with new rules requiring operators to spend a set percentage of revenue on direct patient care costs.
“NY’s stance feels aggressive relative to other states that appear poised to increase their Medicaid spending on SNFs this year given the $200B allocated to states in the recent $1.9T federal coronavirus relief bill,” Okusanya observed. “That said, once the pandemic is in the rear-view mirror, the potential for increased regulation of the SNF industry is high in our view, and could have an impact on operating margins going forward.”
Put those factors together, Okusanya concluded, and the outlook for REITs like CareTrust REIT (Nasdaq: CTRE), Sabra Health Care REIT (Nasdaq: SBRA), and Omega Healthcare Investors (NYSE: NHI) could become more complicated over the years to come.
“These developments do not bode well for health care REITs that focus on skilled nursing such as CTRE, SBRA, and OHI,” he wrote. “We don’t expect any earnings impact per se, but these developments could weaken rent coverage in the future, and increased tenant credit risk has typically negatively impacted valuation multiples.”