- On Jan. 1, 2020, the Centers for Medicare and Medicaid Services (CMS) rolled out its new reimbursement scheme, the Patient Driven Grouping Model (PDGM), to the approximately $100 billion U.S. home-health industry. The changes attempt to better align reimbursement with patients' needs by reducing potential over utilization and fraudulent behavior.
- This is the largest overhaul to Medicare reimbursement for home health in 20 years. We expect the new reimbursement model to materially affect providers in the highly fragmented home-care industry, even though it is designed to be revenue neutral for the industry overall.
- We see elevated operational risks for all industry participants in the near term, during the transition, and as companies gain experience with the new reimbursement dynamics.
- We expect there will be winners and losers depending on each company's scale, therapy focus, patient and referral mix, financial strength, and access to capital. We expect the larger providers (with greater efficiency) that are well prepared and have financial strength and flexibility (conservative leverage, good cash flow, liquidity and access to capital), effective information systems, to gain market share through attrition of smaller weaker participants from the industry and/or via mergers and acquisitions (M&A).
- The home-care companies we rate that are affected by this include Gentiva Health Services (dba Kindred at Home), Pluto Acquisition (dba AccentCare), and BW Homecare Holdings (dba Elara Caring). Additionally, we rate Encompass Health Corp., which has a large home health segment. These are among the largest industry participants, but are predominantly owned by private equity and are highly leveraged. Among these, we think Encompass Health Corp. and AccentCare are best positioned to benefit and Gentiva will face the greatest headwinds from the shift to PDGM.
A Home-Health Industry Overview
The home-health industry in the U.S. has favorable growth prospects with support from demographic tailwinds, the aging population, and being a relatively cost-efficient site of care (much cheaper than a hospital or skilled nursing facility). Providers also benefit from limited fixed costs. However, the industry is highly fragmented with low barriers to entry, intense competition, little differentiation, and operates with a tight labor market, high employee turnover, and below-average profitability compared witho the other segments within the health care services industry. The top 10 companies account for about 20% to 25% of the industry market share.
Overview Of PDGM Reimbursement Scheme
Medicare is the primary payor for home-based health care services in the U.S., because these services are predominantly provided to the elderly. With PDGM, the new reimbursement framework for home health by Medicare, there are a variety of diagnoses and factors that allow for 432 possible combinations with varying rates paid to home-health agencies (HHAs) providing care (compared with 153 under the prior Prospective Payment System [PPS] scheme). More specifically, under PDGM reimbursement differs depending on 12 possible primary clinical groupings (diagnoses), three levels of functional impairment, three levels of comorbidity adjustments, whether it's the first or second 30-day period, and whether the patient was recently discharged (institutional patients) from an acute- or post-acute setting than those without that history (community sourced patients).
Some of the more economically meaningful changes from PDGM include:
- The unit period under PDGM is 30 days of service (down from 60 days) and will be re-evaluated for each subsequent 30-day period. This significantly reduces provider profits on patients who need less than 31 days of care.
- Number of therapy visits will no longer be a factor influencing the reimbursement, and as a result home-care providers may reduce the number of therapy hours prescribed, however, quality of care is expected to be the focus for providers.
- CMS will phase out Request for Anticipated Payments (RAPs), a prepayment in which home-health providers historically received between 50% and 60% of the anticipated episodic payment. In 2020, the payment will reduce to 20% and ultimately eliminated by the end of 2021. This will increase working capital needs, making the industry less attractive, especially for smaller companies with limited access to capital.
- CMS incorporated 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 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 will be two to six visits, but will vary by HHRG and apply to the new shorter 30-day payment period.
- The new payment model is designed to be budget neutral, so reimbursement will increase for certain patients.
Rated and other leading home-care companies affected
We rate three home-care companies affected by this change: Gentiva Health Services (dba Kindred at Home; B/Stable/--), Pluto Acquisition I (dba AccentCare; B-/Positive/--), and BW Homecare Holdings (dba Elara Caring; CCC/Negative/--).
Additionally, we rate Encompass Health Corp. (BB-/Stable/--) which generates about 25% of its revenue from home health or hospice and represents a sizeable market share as the fourth-largest provider (or about 3.7% market share) of home-health services in the U.S. However, the company's primary business is inpatient rehabilitation facilities (75% of revenues). Other significant players include publicly traded (not rated) Amedisys and LHC Group.
We also rate pediatric home health provider, Aveanna Healthcare (CCC+/Negative/--), and post-acute care provider, CareCentrix Holdings (B/Negative/--). Although both companies have exposure to home health, we expect limited impact on ratings due to PDGM.
|Home Health Companies|
|Gentiva Health Services (dba Kindred At Home)||Pluto Acquisition I Inc. (dba AccentCare)||BW Homecare Holdings (dba Elara Caring)||Encompas Home Health Segment||Amedisys||LHC Group|
|Ratings as of Feb. 21, 2020||B/Stable/--||B-/Positive/--||CCC/Negative/--||N.A.§||Not rated||Not rated|
|2018A revenue (mil. $)||2,893.3||763.2||857.4 ¶||931.1||1,662.6||1,810.0|
|2019E revenue (mil. $)||~3,100||~900||~1,100||N.A.||N.A.||N.A.|
|2018A gross margins (%)||47.2||39.3||34.4||52.9||40.3||36.1|
|2019E gross margins (%)||~47-48||~40||~33||-|
|2018A adj. EBITDA (%)||11.2||7.4||7.8||N.A.||N.A.||N.A.|
|2019E adj. EBITDA (%)||~13-14||~8-9||~7-8||N.A.||N.A.||N.A.|
|2018A adj. leverage (x)||8.6||7.1||13.3||N.A.||N.A.||N.A.|
|2019E adj. leverage (x)||6.5-7.5||6.5-7||13-14||N.A.||N.A.||N.A.|
|*Includes Medicare Advantage, Medicaid, Commercial, Self-Pay, and other.¶BW Homecare’s 2018A revenue represents a partial year following the merger of Jordan Health Services and Great Lakes Caring. §S&P rates the parent company Encompas Health Corp.; the data above represents the home health segment only. N.A.--Not available (S&P Global Ratings does not forecast or was unable to obtain certain financial or operation metrics). A--Actual. E--Estimate.|
Near-Term Impacts Of PDGM Will Be Profitability And Liquidity
We expect PDGM will likely increase operating costs (absent any reduction in staff), pressuring margins and short-term liquidity needs, as the new payment plan will reduce reimbursement periods to 30 days from 60 days, approximately doubling the number of claims needing to be processed. We expect providers could see some initial delays in collections following the transition given the significant nature of the changes, including the increase in claims, revisions to scheduling and documentation, and the increase in case-mix groupings absent robust process management and IT systems.
That said home-health providers have had more than a year of advance notice to adjust and prepare for these changes, and many providers use a third-party platform like Homecare Homebase (HCHB), which is a cloud-based automation software to help home-health providers with scheduling, routing, notes, billing, and payments. In addition, we expect minor working capital needs could be offset by the working capital benefit of the shorter 30-day service periods, which reduces the capital needs associated with funding wages in advance of reimbursement from Medicare.
CMS also plans to terminate Request for Anticipated Payments (RAPs), a prepayment in which home-health providers historically received between 50% and 60% of the anticipated episodic payment. In 2020, CMS reduced this payment to 20% and will ultimately eliminate RAPs by the end of 2021. This will increase working capital needs, making the industry less attractive, especially for smaller companies with limited access to capital, driving consolidation.
More consolidation is likely over the next two years
We suspect terminating RAPs may be part of CMS' effort to reduce the number of smaller providers, the level of fraudulent behavior (which is believed to be more common among small players), and the effort needed to audit/monitor for fraud. This is consistent with the effect of the moratoriums on new HHAs in various cities between 2013 and 2016, which limited the number of home-health providers.
Following the initial rollout of the old PPS reimbursement plan, the industry saw significant consolidation, with an estimated 25% of agencies either closing or absorbed by larger players. We expect PDGM will have a similar impact over the medium term, as weaker industry participants will likely face attrition. Additionally, with the phase out of RAP payments and increased need for technological resources, we see fewer small-scale new entrants into the industry. Economies of scale will provide meaningful cost advantages in the low-margin home-health industry, and we expect larger players to be opportunistic in increasing market share and making the industry more efficient.
PDGM: Another attempt to curtail fraud, waste, and misaligned incentives
Given the third-party payor dynamic within healthcare, where the payor is not the same as the beneficiary, fraud and abuse (false and unnecessary claims) is a significant problem, particularly for government payors. In the case of home care in the U.S., Medicare is the primary payor because these services are predominantly provided to the elderly. Although CMS faces a constant battle to minimize fraudulent claims across the health care system, given low barriers to entry and the asset-lite nature of the business model, home health is believed to be an area with above-average levels of fraud, particularly among smaller providers. With taxpayers on the hook, the Medicare program is under constant scrutiny to curtail fraud. In fact, CMS administrator Seema Verma recently unveiled her "five pillars" strategy to prevent fraudulent claims, identify new and emerging risks, ease provider burden, and utilize new technologies.
Historically, the culprits discovered in home health have primarily been small and local agencies collaborating with dishonest physicians or nurses. In the past, CMS issued long-standing moratoria to certain areas of the U.S., preventing new small HHAs from forming. Over the past 10 years, newly registered HHAs have come down significantly each year as a result of these efforts, with slightly more than 11,000 registered HHAs as of year-end 2019. The moratoria was implemented in 2013 extended 10 times, each for six months, with the 2014, 2016, and 2018 extensions including new geographic expansions. Ultimately the moratorium expired Jan. 30, 2019. We expect PDGM will likely have a similar effect reducing new entrants and shuttering small agencies that have less resources to handle the complexity and higher frequency of claim submissions.
Under PDGM, documentation of patient diagnosis and more frequent assessments are required to support reimbursement and should reduce some unnecessary claims. We expect the transition to a 30-day payment period and the gradual elimination of RAP payments by 2021 will disproportionately pressure smaller providers that have limited liquidity and technological resources to adapt, driving consolidation. We expect many small providers to shut down or be acquired by larger providers. Some forecast as many as 30% of home-health providers to close over the next year or two due to the RAP elimination. This provides an opportunity for market share expansion, and increasing economies of scale, for the larger more capable players.
The Effect On Ratings
We believe the current scale, therapy mix, and referral sourcing (scored as positive, neutral, or negative to the rating) are the most relevant factors in evaluating the potential impact on individual companies from the transition to PDGM, relative to their performance in 2019. Moreover, HHA's with stronger liquidity and access to capital will be better able to take advantage of market share opportunities.
We believe providers with substantial scale are more likely to have sufficient resources to implement technological advancements and take advantage of growth opportunities. In contrast, we expect smaller agencies to be more likely to fail under the administrative and working capitals needs of PDGM.
The reimbursement impact from PDGM will vary based on case mix, as some categories will be reimbursed more favorably than in the past (for example, wound care) while other categories will experience lower reimbursement. Under PDGM, the first 30-day payment period is considered "early" and is reimbursed more favorably than the subsequent 30-day periods. Reimbursement is increasing for patients sourced from an institutional setting, with the assumption that the need for care and benefits of care (such as avoiding readmission) are greater. Although patients sourced from community-based settings require a lower cost of care, potentially preserving margins, we expect this to have some negative impact on providers who focus on attracting patients with less-acute medical needs (such as those from the community rather than those recently discharged), who likely need fewer services over the standard 60-day episode of care.
Additionally, we expect agencies that promoted high utilization of therapy (speech, occupational, or physical therapy) sessions (which increased reimbursement) or that otherwise had a higher therapy mix profile, to face a disproportionate negative impact to reimbursement rates. This is because therapy utilization is no longer a key variable driving the level of reimbursement under PDGM. CMS expects agencies to shift their focus and marketing to seek patients with more attractive reimbursement levels and to record the most lucrative diagnosis as the primary diagnosis (for patients with multiple co-morbidities), and has accounted for this with the overarching behavioral adjustment.
|PDGM Factors And The Effects On Ratings|
|Gentiva Health Services (dba Kindred At Home)||Pluto Acquisition I Inc. (dba AccentCare)||BW Homecare Holdings (dba Elara Caring)|
|Therapy mix risk||Negative||Positive||Positive|
|Referral source risk||Neutral||Positive||Neutral|
|Risk to the rating||High||Medium||Medium|
Of the home-care providers we rate, we see Gentiva Health as having higher risk to their current rating, than the other peers, given their exposure to a negative impact from the therapy mix and substantial sourcing from the community, only partially offset by its significant scale, diverse service offerings and strong profitability. We see AccentCare as best positioned to benefit, given their favorable therapy mix and large portion of referrals sourced from the institutional setting, partially offset by its smaller scale.
When The Dust Settles
Though some private-equity-backed companies have prepared for the workflow changes, the relatively high levels of debt leverage and constrained cash flows (after interest expense) could limit business development opportunities (absent an infusion of new equity). In contrast, publicly owned companies with lower debt and robust cash flow generation, such as Encompass Health, Amedisys, and LHC Group, will likely be better equipped for opportunistic acquisitions. However, early signs have indicated attrition of some smaller providers due to the pressures of PDGM, resulting in a transfer of patients to other regional providers. We expect this could preserve some liquidity while increasing market share in certain geographies where larger providers have a significant presence.
We expect skilled nursing facility (SNFs) and long-term acute care hospital (LTACHs) companies could enter the home-health market, for the right opportunity, as that would give them the ability to better manage their discharged patients through the continuum of care (more control to avoid readmissions), and enable them to establish a relationship with potential future customers. The new payment scheme is designed to reduce total costs in the health care system with a higher reimbursement for referrals sourced from the more acute and expensive setting such as SNFs and LTACHs (to reduce readmissions), compared with community based referrals (which are thought to sometimes be less necessary or unnecessary). However, the University of Pennsylvania's March 2019 study based on data between 2010 and 2016 found that although patients discharged from a hospital to home-health care provides immediate savings, the rate of readmissions was higher compared with patients discharged to SNFs.
We also expect companies, such as Phoenix Guarantor Inc. (B/Stable/--), with significant capital could be more opportunistic and enter the home-health industry during the tumult of PDGM. Phoenix has significant scale, strong cash flow expectations for 2020, and limited initial impact from PDGM given their smaller home-health business. We see the potential for it to pursue an opportunity to enter a disrupted industry, adding to their broad continuum of care services.
We expect significant disruption in the industry including closures of smaller agencies, consolidation driven by the largest providers, and potential payment model revisions from CMS, should the industry unexpectedly become unstable. Given the significance of PDGM, there is significant uncertainty how providers will weather the operational transition to PDGM through the initial quarters of 2020. In our view, providers with scale, significant cash flows, an attractive mix of patients (referral from institutions, not high utilization of therapy session) and good access to capital will be well positioned to take advantage of potential opportunities to expand their geographic footprints and market share. We are watching financial performance closely including the impact on working capital, for these issuers over coming quarters.
|As of September 2019|
|Gentiva Health Services (dba Kindred At Home)||Pluto Acquisition I Inc. (dba AccentCare)||BW Homecare Holdings (dba Elara Caring)||Encompass Health Inc.*||Amedisys||LHC Group||Phoenix Guarantor|
|(A) Available revolver||250||115||0||916||453||246||242|
|Total liquidity (A+B+C)||386||143||30||1,011||474||475||251|
|Funds from operations (12-month period)§||~200||~40||~20||~700||~190||~200||~175|
|*Encompass Health balances are preliminary Dec. 31, 2019. §FFO calculated as adjusted EBITDA less cash interest and cash taxes paid. FFO--Funds from operations.|
This report does not constitute a rating action.
|Primary Credit Analyst:||Viral Patel, New York +1 212-438-2403;|
|Secondary Contact:||David A Kaplan, CFA, New York (1) 212-438-5649;|
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