Delivering Quality and Efficiency in Healthcare

Friday, January 19, 2018

We are entering the most significant decade of growth in the Medicare population in the program’s existence, which should provide a sustainable tailwind to the demand for healthcare services. The hospitalization rate among the 65- to 74-year-old age cohort is more than double that of the overall U.S. population and the discrepancy in utilization moves up from there. However, Medicare rates are significantly below commercial rates, so providers with lower relative levels of Medicare business today are likely to encounter a sustainable pricing headwind. According to healthcare analyst Matt Larew “the post-acute-care space offers all of the attractive demographic exposure that investors are seeking in the healthcare services space while avoiding the very real long-term patient preference and payer mix shift headwinds that acute-care operators are facing.” He breaks up his analysis into three themes for the post-acute-care industry.

Theme No. 1: Searching for the Demographic Upside While Avoiding the Mix Shift Risk

Roughly 22% of all hospital discharges, nearly 8 million patients, are discharged to a post-acute-care setting. Perhaps not surprisingly, Medicare beneficiaries are discharged to the post-acute-care continuum at a much higher rate than other patients. Specifically, the post-acute discharge rate for Medicare FFS beneficiaries is about 43% (up from 37.5% in 2008), while the commercial rate is under 12%, Medicaid around 8%, and roughly 5% for uninsured patients.

The Medicare population is expected to increase from roughly 49 million in 2016 (about 15% of the U.S. population) to more than 70 million by 2028 (over 20% of the United States for the first time). For reference, in 1970 fewer than 10% of Americans were over 65 and in 2010 that figure was 13%. As patients age, the demand for inpatient acute care, one of the primary drivers of post-acute-care demand, increases significantly—the hospitalization rate among the 65- to 74-year-old age cohort is more than double that of the overall U.S. population, the 75-to-84 cohort nearly four times the average, and 85-and-older population nearly six times more likely to have an inpatient hospitalization than the average American.

The other primary driver of post-acute-care demand, particularly for home health (over 40% of home health episodes are not preceded by an episode of acute care or post-acute care), is the development of a disability or limiting chronic condition. This too is highly correlated with age, as the likelihood of becoming disabled in a least two activities of daily living or becoming cognitively impaired is roughly 70% for people age 65 and older. That likelihood dramatically increases beyond 65; the probability of having one or more disabilities increases from 26% for a person age 65-74 to 73% for a person age 85 and over.

Given the ongoing demographic shift and the fact that Medicare patients are much more likely to enter the post-acute-care continuum, the tailwind for post-acute services should prove resilient and so too will the demand for more efficient care and care coordination.

Larew believes that companies poised for the strongest multiyear runs have exposure to positive industrywide demographic trends but are not faced with the pricing headwind that comes with the shift toward government payers. Companies that compete in the post-acute-care continuum fit the bill, and broadly he views post-acute care as the most attractive area for investment in the healthcare delivery space.

Theme No. 2: Competition Is Local and Quality Will Win the Day

While the companies in this space offer services across the country, from a competitive standpoint healthcare delivery is distinctly local. In many cases for-profit entities compete for patients with both larger organizations and local healthcare providers. Larew states, “We believe quality superiority versus local competition can be used to evaluate management focus and execution and serve as an indicator of long-term market share gain and positioning for the shift to value-based payment.”

Quality, as measured objectively through metrics like readmissions and hospital-acquired infections and subjectively through patient surveys, is a crucial part of healthcare providers’ missions. But increasingly quality is being used as a tool by payers and patients to favor certain providers over others—payers with their checkbooks and patients and payers with their provider selection. Quality scores can be used as marketing and recruitment tools by providers, while payers are increasingly using them to modify payment rates to providers. In many cases, these modifications are based on a provider’s relative standing to other similar providers in its state or region. (One example of this is CMS’s Home Health Value-Based Purchasing Model [effective January 1, 2016] in nine states to serve as a pilot for a nationwide model. In these states, home health agencies will begin to see payment tied to performance in 2018, with escalating impact through 2022.)

On the hospital side, Medicare began value-based purchasing payment changes based on a hospital’s Total Performance Score, which includes measures related to clinical care, person and community engagement, safety, and efficiency and cost reduction. Starting in fiscal 2013 (October 2012), 1% of DRG payments eligible to hospitals were withheld and reserved for bonus payments. That escalated through fiscal 2017 to 2%, the level it will continue at moving forward.

Similarly, the Hospital Readmissions Reduction Program began withholding 1% of payments in fiscal 2013 for hospitals with relatively high 30-day risk-standardized readmission rates and has withheld 3% of payments since being fully phased in during fiscal 2015. Nearly 80% of all hospitals will be penalized in fiscal 2018, with an average penalty of 0.73%.

While these programs provide less incremental upside (or risk) for hospitals compared with home health providers, these programs will continue to represent sizable financial opportunities. Larew’s broader view is that quality superiority versus local competition can be used to evaluate management focus and execution and serve as an indicator of long-term market share gain and positioning for value-based payment.

Theme No. 3: “Healthcare 2020” Survey Results Call for Better Volumes in 2018 and Accelerating Payer Mix Shift

In September 2017 Larew conducted a 75-person survey of individuals working in healthcare (primarily hospitals and health systems), with one-quarter of respondents working in the C-suite. The goal of the survey was to better understand how issues like volume, site of care, and coverage dynamics will evolve over the medium term rather than focusing on the next three months (though that was also covered).

Our survey cohort calls for volume growth to improve roughly 50 basis points in 2018 compared with the current trend. Longer term, the cohort is bullish on home health and calls for accelerating payer mix shift to Medicare and payment structure away from fee-for-service through 2020. More specifically, over the next three years, our survey calls for a dramatic mix shift toward Medicare and away from commercial. Larew states, “The combination of these mix shifts paints a striking picture—in a span of six years government payers would move from just over half of admissions to nearly two-thirds, while commercial admissions move from over 40% to less than one-third.” Lastly, respondents overwhelmingly called for home health to be the biggest share-taker in the post-acute-care continuum over the next three years, with an average projected share gain of nearly 6%.

This report initiated coverage of Amedisys, LHC Group, Inc., HealthSouth Corporation, LifePoint Health, Inc., HCA Healthcare, Inc., and Tenet Healthcare Corporation. For more information on this or other companies from Matt Larew’s coverage list, please contact your William Blair sales rep.

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