Medicare Cuts Reimbursement For Home Health Services

On June 17, 2022, the Centers for Medicare & Medicaid Services (CMS) in the U.S. proposed approximately a 4% reduction in the Medicare rate under the Home Health (HH) Prospective Payment System, a framework for reimbursement involving a predetermined schedule of rates. This proposal incorporated approximately a 3% increase to reflect rising costs to provide services (referred to as the Market Basket Update), offset by an approximately 7% rate cut to offset behavioral changes (how providers billing practices have changed) under the Patient Driven Grouping Model (PDGM) reimbursement framework that went into effect Jan. 1, 2020. (For more details on this framework, see Appendix 1).

On Oct. 31, 2022, CMS ultimately finalized the calendar-year 2023 Medicare Rate Update and decided to split the approximately 7% rate cut implementing half of it this year and the other half in 2024. CMS now estimates this adjustment will result in a nominal net increase in Medicare payments to home health agencies in 2023 of 0.7% relative to 2022.

Importantly, Medicare payments relating to hospice services are not affected by this reimbursement rule, even though those services are often provided in the home. Indeed, reimbursement rates for hospice are set to rise 3.8% in 2023. Medicaid reimbursement and Medicare Advantage reimbursement for home health services are also not affected by this rule, though other payors may consider Medicare reimbursement rates in setting their reimbursement rates (see Table 1).

Table 1

This is a material and intensifying headwind to home health providers.  Many U.S health care service companies' margins were pressured in 2022, as labor and other costs had risen without an equal increase in reimbursement from government payors. Indeed, reimbursement increases to address cost inflation typically occur annually, with a lag.

The nominal increase in Medicare reimbursement (of 0.7%) for 2023 is substantially below the pace that costs are increasing, which suggests the margin pressure of 2022 might not only persist in 2023 but increase if labor and other costs continue to rise. Moreover, we expect this margin pressure could worsen in 2024 with the second 3.5% downward adjustment to reimbursement. This is consistent with the consensus expectation for margin compression among publicly traded companies with substantial exposure to home health, such as Amedisys and LHC Group (both unrated).

We view this as a material headwind for some home health companies that we rate, those that have significant exposure to Medicare reimbursement. Moreover, a decline in reimbursement is typically more harmful to profits than a decline in volumes, as there is no inherent reduction in costs (mostly labor in the context of home health) with a reimbursement cut. As a result, the impact of a reduction in reimbursement tends to flow straight through to--and have a disproportionate (on a percentage basis) impact on--profitability. Although some providers might try to mitigate the impact by constraining wage increases, we expect much of the effect will flow through to margins and profitability, especially if labor shortages and inflation persist. Moreover, a few hundred basis points of margin compression is quite significant for these companies given their high leverage and relatively modest EBITDA margins, averaging in the low-teens percentages.

We expect some providers will struggle to maintain a reasonable level of profitability and free cash flow generation, which could lead to defaults among some highly leveraged companies as well as industry consolidation. Although we don't expect this, if distress becomes widespread in the industry, that could limit patient access to home health services, leading to any combination of a rise in hospital readmissions, a public backlash, and a change in CMS's plan for further reimbursement reduction in 2024 and beyond.

The impact on rated home health companies will vary based on their diversification and financial strength.  We rate several companies that provide home health services, and we expect the potential impact on them to vary primarily based on (1) the degree of diversification beyond home health revenues, (2) the payor mix within the home health business, and (3) their financial strength, including profit margins and leverage. More specifically, we expect this to disproportionately hurt companies with lower margins (including smaller companies that don't benefit from economies of scale), high debt leverage, and limited cash-flow generation (see Chart 1).

Chart 1

Rating Impact

Chart 1 shows that two publicly traded companies--LHC and Amedisys--have the highest exposure. These companies are not rated and have only moderate debt leverage. In contrast, the home health companies we rate tend to be owned by private equity investors and are highly leveraged.

We believe the two rated companies with the most material exposure are Pluto Acquisition I Inc. (doing business as AccentCare; B-/Stable/--) and BW Homecare Holdings LLC (doing business as Elara Caring; SD), each with 20%-30% of revenue exposed to this Medicare reimbursement cut. This is followed by FC Compassus LLC (B/Negative/--), which has modest exposure (about 10% of revenues, though Ascension Health has a 50% economic interest in that home health business).

Conversely, most of the rated companies have negligible exposure (less than 5% of revenues), including Aveanna Healthcare LLC (B-/Stable/--), which predominantly provides care for critically ill pediatric patients covered by Medicaid (over 90%), and Phoenix Guarantor Inc. (B/Positive/--), which earns most of its revenues providing pharmacy services. KAH Hospice Co. Inc. (B/Stable/--) primarily offers hospice services (over 80%) and services reimbursed by Medicaid, and it does not have any material exposure to this reimbursement headwind. Similarly, Encompass Health Corp. (BB-/Stable/--) doesn't have material exposure to home health, as it spun off its home health unit, Enhabit, in July 2022.

Our ratings already reflect these headwinds. Indeed, we took several negative rating actions last year because of the margin pressure stemming in part from rising labor costs, the potential for that to persist in 2023 and 2024, and rising interest rates (see Table 2).

Mitigating Factors

There are also a variety of mitigating factors, such as:

• More favorable reimbursement trends among other payors and in other service lines, including the 3.8% Medicare rate increase for hospice services;
• Improving economies of scale; and
• Revenue growth as the disruption from the COVID-19 pandemic eases.

In addition, with higher interest rates expected to slow the economy in 2023, we see potential for improvement in labor costs and an easing of staffing constraints. This could support volume growth for companies that have had staffing shortages. Demand for most health care services is relatively insensitive to economic weakness, which is another important positive consideration given the rising risk of a recession this year.

Chart 2

Appendix 1: Background On The Medicare Reimbursement Framework For Home Health (PDGM)

In the U.S., Medicare is a primary payor for home-based health care services because these services are predominantly provided to the elderly. With PDGM, there are a variety of diagnoses and factors that allow for 432 possible combinations with differing rates paid to home health agencies providing care. This compares with 153 under the prior scheme: the Prospective Payment System.

More specifically, reimbursement under PDGM differs depending on 1) 12 possible primary clinical groupings (diagnoses), 2) three levels of functional impairment, 3) three levels of comorbidity adjustments, 4) whether it's the first or second 30-day period of care, and 5) whether the patient was recently discharged from an acute- or post-acute setting (institutional patients) versus those without that history (community-sourced patients).

Some of the more economically meaningful changes with PDGM include:

• The unit period under PDGM is 30 days of service (down from 60 days). The patient is then re-evaluated for eligibility for a subsequent 30-day period. This significantly reduced provider profits on patients who need fewer than 31 days of care.
• The number of therapy visits would no longer be a factor influencing the reimbursement. The expectation was that home-care providers would reduce the number of therapy hours prescribed while still focusing on quality of care.
• CMS would phase out Requests for Anticipated Payments, a prepayment in which home-health providers historically received 50%-60% of the anticipated episodic payment. This increases working-capital needs, making the industry less attractive, especially for smaller companies with limited access to capital.
• CMS accounted for the likely behavior of providers to select the most lucrative diagnosis (for a patient with multiple diagnoses) as the primary one by offsetting that with a negative behavioral adjustment of 4.36%.
• The Low Utilization Payment Adjustment (LUPA) is a standard applied to episodes of care with four or fewer visits during the 60-day period. Under PDGM, the LUPA minimum would be two to six visits but will vary by Homecare Research Group code and apply to the new shorter 30-day payment period.

This new payment model was designed to be budget neutral, and so reimbursement increased for certain subsets of patients and diagnoses. For more details on PDGM, see "The New PDGM Reimbursement Model Poses Near-Term Operational Risks For The U.S. Home-Health Industry," Feb. 24, 2020.

Appendix 2: Background On The Home Health Industry

The U.S. home health industry has attractive characteristics as a relatively cost-efficient site of care (much less expensive than care in a hospital or skilled nursing facility) and has favorable long-term growth prospects due to the increasing population of people older than 65 (for whom these services are most common). Providers also benefit from limited fixed costs.

On the other hand, the industry is highly fragmented, with low barriers to entry, intense competition, and little differentiation among providers. It also operates in a tight labor market, and it has high employee turnover and below-average profitability compared with the other segments within the health care services industry. Home health also relies heavily on government payors (Medicare and Medicaid), which increases the risk from adverse changes to government reimbursement.

The industry is also believed to be plagued with a disproportionate level of fraud, particularly among smaller providers, and we believe government payors would welcome more consolidation. We also believe the top 10 companies account for about 20%-25% of industry revenues.

Demographic trends have a been a tailwind for the industry, as the population of seniors is growing with the aging of the baby boomers. That said, with over 1 million COVID-19-related deaths in the U.S. over the last few years, we believe the pandemic led to an acceleration in mortality, particularly among seniors with significant health issues, which is the demographic most likely to utilize home health services.

Recent reimbursement developments:  Certain recent reimbursement developments have been favorable, including the Provider Relief Fund and Medicare Advance Payments, which provided financial assistance and liquidity to the industry in the face of COVID-19 pandemic-related challenges in 2020

In 2014, under the Budget Control Act, sequestration reduced Medicare payments to hospice and health care providers by 2%. This sequestration was suspended in May 2020 through the Coronavirus Aid, Relief, and Economic Security (CARES) Act, and the suspension was extended several times. The suspension ended March 31, 2022. As a result, effective April 1, 2022, the sequestration began at 1%, and as of June 30, 2022, it increased to 2%, contributing to the margin pressure.

Related Research

• BW Homecare Holdings LLC (Elara Caring) Downgraded To 'SD' From 'CCC-'; Secured Debt Ratings Lowered To 'D', Dec. 22, 2022
• Phoenix Guarantor Inc. Ratings Affirmed; Off CreditWatch Positive on Public Offering Delays; Outlook Positive, Oct. 19, 2022
• FC Compassus LLC Outlook Revised To Negative On Weaker Credit Metrics Related To Lower Patient Volumes; Ratings Affirmed, Sept. 8, 2022
• Aveanna Healthcare LLC Outlook Revised To Stable From Positive On Weaker-Than-Expected Operating Performance, July 29, 2022
• KAH Hospice Co. Inc. Assigned 'B' Issuer Credit Rating; Outlook Stable; New Debt Rated, July 20, 2022
• Encompass Health Corp. Ratings Affirmed On Spin-Off Of Home Health And Hospice Segment, Outlook Stable, July 5, 2022
• Pluto Acquisition I Inc. Outlook Revised To Stable From Positive On Weaker-Than-Expected Credit Metrics, Feb. 4, 2022
• The New PDGM Reimbursement Model Poses Near-Term Operational Risks For The U.S. Home-Health Industry, Feb. 24, 2020