Five Predictions for Home Health and Hospice over the Near to Mid-Term

By Dexter W. Braff

As part of an ongoing strategic planning process, management must constantly look towards the future, read the industry economic, political, clinical, and social tea leaves, and consider, if, how, and when, strategies should be changed and /or initiated to adapt to a changing environment. Towards that end, as we enter 2007, we offer our predictions for what to expect in home health and hospice over the near to mid-term.

The reimbursement climate for Medicare home health will remain reasonably stable until at least 2009.
Our optimism notwithstanding, one way or another, given the extraordinary pressure on Congress to enact cuts in spending to reign in the soaring deficit, we expect the streak of no-cuts to Medicare home health reimbursement, that began when the Prospective Payment System was initiated, will inevitably come to an end - but not yet. By the time you read this, the fate of the market basket update scheduled for 2007 will be known. Regardless of the final outcome (and optimism appears to be building that some or all of the update will prevail), we don't expect a direct cut in reimbursement in episodic payment rates in 2007. That's the good news. The bad news is that, budget neutrality requirements notwithstanding, our gut instinct is that the refinements that will likely be proposed by CMS by the end of 2006 will prove, over time, to be a de facto- though manageable - reduction in reimbursement. The good news, part two, is that, with PPS refinement unlikely to be implemented until late 2007 at best (January 1, 2008 is probably more likely), and given that it will take CMS and the industry substantial time to fully assess the financial and clinical impact of these rule changes, if support builds for reduction in episodic rates, it is unlikely that we will see such cuts until 2009. All things considered then, we anticipate a relatively favorable reimbursement outlook for Medicare home health over the near term - a condition that will support continued investment in the sector in 2007.

Private duty will continue to grow, but the real explosion in utilization is still five to ten years out. There is no doubt that an aging population and an increasing willingness of consumers to pay for health care services privately bode extremely well for private duty home care. That said, such a sea change in attitudes toward health care spending take a long time to foment widely. Furthermore, with (a) the leading edge of baby boomers just surpassing 60 years of age, and (b) the entire notion of accumulating the necessary funds to pay for these services through savings, long term care policies, or reverse mortgages still at an early stage, the inevitable explosion of utilization in private duty is nevertheless five to ten years out. Until then, we expect modest, but accelerating annual growth.

Providers will cautiously begin to expand and/or develop Medicaid reimbursed services.
Although reimbursement woes lead many home care providers to steer clear of Medicaid home health services (especially after 2002 when, according to an October 2006 report issued by the Kaiser Commission on Medicaid and the Uninsured, spending surged 12.4% at the same time that state tax revenues declined 7.8%), conditions are far more favorable as we enter 2007. According to Kaiser, growth in Medicaid spending dropped for the fourth year in a row to 2.8% in FY 2006, the lowest increase since 1996 (2.7%). Furthermore, "FY 2006 also marked the first year since 1998 that state revenues grew at a rate faster than total Medicaid spending". Under improving fiscal conditions, while cost containment remains an overall priority, "looking forward to FY 2006, only five states have plans to restrict eligibility, while 26 states have plans to restore cuts from previous years, expand to new populations, or make positive changes to Medicaid application and enrollment procedures". One of the focal areas for expansion is home and community based service (HCBS) waivers. Kaiser reports that while more than half of the states expanded their HCBS programs in FY 2006, 38 states plan expansions in FY 2007. This, in part, reflects provisions in the Deficit Reduction Act that, among other items, gives states greater opportunity and flexibility to develop alternatives to institutionally based care. Together then, improved economic conditions and increased utilization may portend the beginning of an attractive window of opportunity for Medicaid reimbursed home health services.

Hospice reimbursement refinement will be favorable to the industry, but will be delayed.
With (a), a payment system that has gone unchanged since the hospice benefit was initiated 25 years ago, (b) MedPac reporting that hospice spending will reach $9.8 billion in 2006 and will continue to grow at rate of 9% per year through 2014, a rate that "outpaces the growth in spending projected for hospital, physicians, skilled nursing facilit[ies], and home health services", (c) increasing lengths of stays leading to a dramatic increase in providers exceeding cost limits, and (d) real concerns that payment rates do not reflect resource utilization for various different patient populations, there is much discussion regarding potential changes to the system. However, with Medicare PPS refinement on the table, hospice remains on the proverbial "back burner", which is not necessarily a good thing. In this case, although we may see a reduction in reimbursement in the aggregate, we believe hospice refinement will lead to better matching of payments to resource utilization, generating still-favorable margins across a broader array of patients. Furthermore, we expect the benefit to be modified to accommodate longer lengths of stay - both of which will create greater revenue and profit predictability and stability. So unlike PPS refinement, we see more upsides, than downsides, to hospice reimbursement refinement. And with the sector still enjoying substantial goodwill from Congress, the outlook continues to remain extremely favorable for hospice for the foreseeable future.

The top end of the premium valuation range for Medicare home health agencies will begin to slide. While it took a long time for the investment community to recognize the extraordinarily favorable economic risk-return fundamentals of Medicare home health, they made up for lost time with a vengeance in 2005 and 2006 as numerous private equity groups (PEGs) sought large, platform sized acquisitions upon which to layer on additional acquisitions and/or startups. This produced an extraordinary imbalance of demand versus supply of premium acquisition targets which, in turn, drove up valuation multiples. However, with many PEGs having already completed their initial transaction(s) (thereby lessening demand for the largest providers), and more sellers looking to test the market, the demand/supply imbalance is beginning to level off. Furthermore, as suggested above, as each year goes by without a substantial cut in reimbursement, the "overhang" of a potential cut gets greater and greater, increasing the perception of risk. Taken together then, while we expect valuations to remain quite strong in 2007 and 2008, the top end of the premium value range has likely peaked.