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Nursing Homes: A Financial Review

Summary

January 1991


Minnesota state government is strongly linked to the nursing home industry. State policy tries to ensure that citizens have access to nursing homes when needed, without regard to ability to pay. Using state and federal funds, the state pays for most nursing home care, and it is expensive.

During the late 1970s and early 1980s, nursing home costs rose so much that the Legislature decided that strong action was needed. The state developed a reimbursement system that was specifically designed to limit and control payments to nursing homes. <FN - Minn. Laws (1983), Chapter 199.> Also, legislation put an effective moratorium on the construction of additional nursing homes, while state grants helped to develop less expensive, community-based health care systems.

The Legislature's actions have brought nursing homes' annual cost increases down. However, nursing home trade associations argue that, as a result, their industry is on the verge of financial ruin. Further, some industry representatives claim that financial problems are jeopardizing nursing home residents' care.

Because of these claims, in May 1990, the Legislative Audit Commission asked us to study the nursing home industry and focus on these key questions:

  • What is the general financial condition of nursing homes in Minnesota?
  • Has the state's method of reimbursement caused serious statewide problems in nursing home operations, administration, and resident care?

In general, we found that the nursing home industry is under considerable stress--financially and otherwise--but the situation is not critical for most facilities, and residents are in little or no danger from the reimbursement system itself. However, we found evidence which suggests that the reimbursement system and other policy measures may have contributed to nursing homes' physical deterioration and some undesirable cost-cutting.

Industry Changes

Although the moratorium and reimbursement system limit nursing home construction, major remodeling, and other physical changes in nursing homes, the industry has become more professional in management, administration, operations, and service delivery. Despite a statewide labor shortage, health care services have improved and now are delivered with greater emphasis on efficiency.

Residents

One result of government efforts to contain health care costs is that:

  • Nursing home residents are older and more debilitated than they were in the 1970s.

In part, this reflects federal policies which have had the effect of moving Medicare patients out of acute-care hospitals and into nursing homes for recuperation as soon as possible. The change also may reflect state efforts to divert nursing home candidates to less costly alternatives when appropriate, plus medical advances and the general increase in the human life span.

Statewide, about 43,000 individuals receive care annually in Medicaid-certified Minnesota nursing homes. Most of the nursing home residents are women, and their average age is 83. Most residents are not acutely ill, but they have greater care needs, more medical diagnoses, and fewer abilities today than they did ten years ago. On the average, they live in nursing homes three to four years.

Nursing Homes

Despite Medicaid restrictions and the accompanying paperwork, we found that:

  • Almost all nursing homes (96 percent) participate in the Medicaid program and agree to accept payment at the rates established by the Department of Human Services.

The number of nursing homes receiving Medicaid payments from the department has not changed significantly since 1985; during 1989, 448 homes participated in Medicaid.

However, there has been a slight shift in ownership. About the same percentage has remained for-profit (41 percent), but cities and counties have sold some of their homes, often to hospitals or other nonprofit organizations. As a result, we found an increase in hospital-affiliated nursing homes over the past few years. Nearly half (48 percent) of all Minnesota hospitals operated nursing home units in 1989.

Reimbursement system

The state's current method for reimbursing nursing homes has three distinctive features. First, the system sets payment rates "prospectively" for one-year periods, based on nursing homes' previous, allowable expenses plus the projected amount of inflation. Second, rates are tied to the nursing homes' "case mix" or level of services which are actually needed and used by individual residents. Third, reimbursement limits vary by geographic region.

Rates for specific nursing homes are determined mainly on the basis of expenses in four categories: care-related, other operating, pass-through costs (such as licensing fees), and property. Currently, the Legislature is scheduled to hear recommendations which may fundamentally change the property payment method. For this reason, our study focused on other aspects of the reimbursement system, particularly those relating to administration, operations, and resident care. We learned that:

  • The only direct opportunity for nursing homes to earn operating revenues in excess of expenses (or profit) is an efficiency incentive payment of up to $2 per resident day.

All nursing homes--for-profit, nonprofit, and city/county--are eligible to earn incentive payments by controlling the costs of non-nursing services. These include dietary services (but not raw food), laundry, linen, housekeeping, plant operations, maintenance, general costs, and administration. Most nursing homes (77 percent) earn some incentive payments; 40 percent earn the maximum amount.

Conversely, nursing homes typically spend some money which is ineligible for reimbursement under state law or rules. On the average, we found:

  • About five percent of nursing home expenses were ineligible for reimbursement.

Some expenses are disallowed by auditors at the Department of Human Services. It is their job to review cost reports and determine whether expenses are documented, related to resident care, and in keeping with laws and rules. A computer system disallows other expenses if they are above certain limits.

In our survey, 61 percent of administrators acknowledged that they made some expenditures with advance knowledge that they were ineligible for reimbursement through the state's reimbursement system. They explained that, in their opinion, some unreimbursed expenses made good business sense and would help nursing homes in the long run (for example, employee recognition programs and marketing).

Financial Review

We emphasize that our evaluation dealt with the state's reimbursement system and the nursing home industry in general. We did not study the manner in which the Department of Human Services establishes payment rates for specific nursing homes nor the adequacy of the rates with respect to individual residents' care needs. Neither did we evaluate the auditors' work or develop detailed financial statistics which would be important to investors.

Methods

To answer legislators' concern about the financial health of the nursing home industry, we examined audited financial statements and hired an accounting firm with specialized knowledge of the health care industry.

Given the limitations of the best available data, we supplemented our financial analysis with information from nursing homes' cost reports and rate notices and obtained supplementary financial data on hospitals which operate nursing homes. Also, we surveyed administrators and spoke with nursing home owners, industry experts, and residents' representatives.

Nevertheless, it was difficult to evaluate the financial condition of nursing homes. Business practices vary significantly among the homes. There were no specifically identified accounting standards for the industry during the period of our study, nor has the state established a uniform standard for reporting financial results.

Criteria

We tracked financial results over the most recent four-year period for which data were available. Our most important criteria of financial stress were based on the total margin and operating margin. The total margin equals net income (after taxes, if any) from all sources divided by total revenues. The operating margin is calculated before taxes and equals operating income divided by operating revenues. Generally speaking, when these margins were recently highly negative or slightly negative for several years, we judged that nursing homes were highly stressed.

Business owners, investors, and nonprofit organizations are especially mindful of margins (and many more detailed financial ratios) because they standardize performance comparisons over time and across nursing homes. These indicators describe organizations' performance in clear, simple terms and indicate whether resources are at least sufficient to meet expenses.

Financial Stress

The results of our analysis showed that:

  • Forty to 43 percent of Medicaid-certified nursing homes were subject to some financial stress, but the situation was serious for only a few.

The most serious situation existed where nursing homes operated as part of hospitals. Overall, 43 percent of the hospital-nursing homes experienced some financial stress over the period 1985 through 1988. Sixteen of these hospitals had serious financial problems and were being monitored by the Department of Health. In general, we found that the nursing home part of the operation helped rather than hurt. Nine of the 16 hospital-nursing home combinations are in northern Minnesota where health care services tend to be in short supply; none are in the seven-county Twin Cities area.

Among nonhospital nursing homes experiencing difficulty, 40 percent operated under some financial stress over the period 1986 through 1989, but the situation was serious for only six percent. These homes are not concentrated in northern Minnesota. They are scattered throughout the state and represent all three industry sectors: for-profit, nonprofit, and city/county.

Financial Trends

Financial data from audited statements showed that:

  • Sixty to 75 percent of nursing homes broke even or made some profit, overall, between 1986 and 1989.

Based on operating margins, 54 to 62 percent earned excess revenues on nursing home operations or at least covered their expenses.

These results are somewhat different from those which were widely publicized last year by a nursing home trade association. The association stated that an unspecified percentage representing more than half of Minnesota's nursing homes had operating losses in 1988. However, we learned that the association based its report on only 54 percent of all nursing homes, and most of them (73 percent) were nonprofit or operated by cities and counties. Also, when the trade association added some of the missing data last fall, its results changed and came into closer agreement with ours.

Adequacy of Performance

Not only does the state lack uniform standards for reporting nursing homes' financial condition, it also lacks guidelines to help determine whether nursing homes' financial performance is adequate. There is no question, however, that at a minimum, nursing homes must at least break even. Beyond that, it is difficult for us to say what is necessary or desirable. In part, the answer depends on nursing homes' mission, the degree of business risk, state policy, and community standards.

Generally speaking, financial risk is low in the nursing home industry because: (1) the moratorium limits competition; (2) high occupancy provides steady revenue; and (3) most payments are from guaranteed (public) sources. Accordingly, we spoke with some owners and administrators who said they would be satisfied with almost any positive margin. Others, representing many of Minnesota's nonprofit nursing homes, told us that they strived for three or four percent. In their opinion, this is the minimum needed for routine, daily operations, maintenance, repairs, unexpected costs, and temporary changes in their residents and staff. Among for-profit nursing homes, we learned that desirable margins are five to six percent.

A recent study showed that Wisconsin's for-profit nursing homes achieved average total margins of 3.3 to 4.1 percent and nonprofit nursing homes, 2.4 to 3.7 percent. We found that in Minnesota:

  • In each of the past four years, at least one-fourth of the state's nursing homes were operating at or above a total margin of three to four percent.

However, most nursing homes had smaller margins. Not surprisingly, our survey showed that:

  • Eighty-five percent of administrators said that their nursing homes' net income from all sources was insufficient to meet the goals established by owners or controlling organizations.

Our analysis suggested that for-profit nursing home administrators were most disappointed, but they were not alone. Ninety-two percent of the for-profit group said that their nursing homes' net income was insufficient, and 80 percent of the administrators from nonprofit and city/county nursing homes agreed.

Part of the reason for for-profit nursing home administrators' concern stems from a paradoxical situation. That is:

  • Most of the for-profit nursing homes in Minnesota have operated for the past several years with similar or smaller margins than nonprofit nursing homes.

For the profit-making and nonprofit nursing homes alike, we found that operating margins were near zero or about one percent. However, the total margin for most nonprofit nursing homes was higher each year than for for-profit nursing homes. Several factors help to explain the anomaly. First, the for-profit nursing homes are taxed. Second, we found that for-profit nursing homes were more likely than others to spend money which the Department of Human Services subsequently disallowed. Third, the for-profit nursing homes may be more likely to embark upon new, risky lines of business such as apartment complexes and home health services. Fourth, the for-profit facilities less often receive contributions which would positively affect their total margins.

However:

  • Financial performance was more often negative among nursing homes which were operated by cities and counties.

Our study showed that administrators at city/county nursing homes were less likely to strive for efficiency incentive (bonus) payments. Instead, many relied upon local governments for added support.

Recent Failures

Our study showed that 47 nursing homes have changed hands since 1985, and nine of the changes in ownership were the result of financial failure. In addition, one nursing home has gone bankrupt but has not yet been sold. However, most (7 of 10) of the financial failures occurred in two nursing home chains.

While none of the ownership changes caused nursing homes to cease operations, seven of the ten financial failures involved bankruptcy. Another was a case of garnishment, and two nursing homes went into receivership.

In our opinion, nursing homes' recent financial failures can be explained mainly by a few unusual situations. However, we are concerned because most of the cases of financial failure have occurred since 1988. In our opinion, the difficulty of managing successfully under Minnesota's reimbursement system may have caught up with some nursing homes.

Financial Outlook

Our survey corroborated what we concluded from our financial analysis and provided subjective information about nursing homes' future in light of their financial condition. Results showed that:

  • Over half of the nursing home administrators (58 percent) described their financial condition and outlook as fair to good in Fall 1990.

Although 34 percent of nursing home administrators said their facility was in poor financial condition, they indicated at the same time that they could probably continue operating for several more years. Only two percent said their condition was so poor or critical that their nursing home was clearly in danger of closing. One of these was already bankrupt and for sale. Others gave conditional responses, often saying that their future depended on changes in the state's method of reimbursement for property-related costs. None chose to describe the nursing home's financial condition as "very good."

Explanations for Financial Stress

Two related factors best explain why some nursing homes are in financial distress: a shortage of bonus money from efficiency incentive payments and a higher level of unreimbursed expenses.

We believe that nursing homes' disappointing financial performance can be explained partly by the state's limited, flat efficiency incentive payment. While the reimbursement system provides inflationary increases in most cost categories, the maximum possible bonus has been fixed at $2 since the state's reimbursement system was implemented in 1985.

Effects of the Reimbursement System

We found no major crisis in care as a result of the state's reimbursement system. However, some cost-cutting techniques may be detrimental to nursing homes' infrastructure and are unpleasant for residents, their families, staff, and administrators.

In certain respects, the reimbursement system may have contributed to nursing homes' physical deterioration. Our survey showed that:

  • Twenty-eight percent of administrators said their nursing home was in poor structural and mechanical condition or needed to be entirely replaced, compared with ten percent in 1988.
  • More than 60 percent of the administrators reported that building upkeep, maintenance, decorating, and furnishings had changed for the worse since 1985.

The administrators attributed the latter changes directly to the reimbursement system. We noted that this type of response was consistent with the efficiency incentive which is built into the state's reimbursement system, the specific limit of $325 per bed for building repairs and maintenance, the moratorium which generally precludes major remodeling or construction projects, and problems related to the state's method of reimbursing for property-related costs.

We are particularly concerned that:

  • Routine maintenance and repairs have been postponed in favor of earning bonus payments.

In our opinion, this may lead to future problems as even more debilitated, elderly people enter nursing homes which may be ill-equipped and in need of repairs. On the other hand, we found that:

  • In some ways, nursing homes are operating more efficiently without directly affecting residents' care.

Our survey showed that most administrators pursued a variety of techniques to minimize unnecessary expenses for items which have little or no direct bearing on residents' health status. For example, they increased their reliance on convenience foods and decreased their attention to cleaning some areas of nursing homes.

We observed that the administrators' cost-cutting activities caused considerable anxiety for nursing home staff. Moreover:

  • Consumers were more likely to complain when homes were in poor structural and mechanical condition.

Our study revealed that complaints were significantly more likely to be filed on behalf of nursing home residents when administrators rated their nursing homes' physical condition as poor or very poor. Furthermore, complaints in these instances were not confined to physical maintenance problems but covered all aspects of the facilities' operations.

There was no direct relationship between nursing homes' financial condition and consumer complaints or violations of state regulations. However, our results showed that:

  • Nursing homes in financial distress were more likely to be fined than nursing homes in better financial condition.

In general, fines are the Department of Health's last resort when nursing homes fail to make changes which regulations require. While 70 percent of the nursing homes were ordered to make various corrections during fiscal years 1988 or 1989, only 17 percent were fined.

Furthermore, some cost-cutting techniques used by administrators to earn bonus payments may be backfiring in that:

  • Nursing homes had a higher than average chance of being fined for violating regulations in areas of operation where administrators said they used cost-cutting techniques to earn efficiency incentive payments.

On the average, about five percent of all correction orders resulted in fines. However, nine percent of all correction orders in each of two areas--laundry/linen and housekeeping--resulted in fines.

We noted that nursing homes in financial distress tended to receive less efficiency incentive money than other nursing homes. Taken together, these findings suggest that:

  • Financially distressed nursing homes sometimes may have lacked working capital to quickly correct violations uncovered by the Department of Health.

Recommendations

Legislators requested our study in May 1990 because they were concerned about the financial condition of nursing homes. In November, however, they also became concerned about the state's financial condition, when the Commissioner of Finance projected a significant shortfall in revenues. Even though the state's financial problem was officially recognized after most of our study was completed, we tried to take it into account as we finalized our study.

Preliminary Considerations

To provide better information in the future, we think that:

  • The state should arrive at a consensus on what constitutes adequate financial performance for nursing homes.

Currently, there is no standard and, without one, it is hard to evaluate whether nursing homes' revenues need to be increased or costs need to be cut. A general agreement about standards of adequate financial performance should not be considered a guarantee to any specific nursing home but a guideline for monitoring the nursing home industry's general performance. We think the Department of Health is in the best position to monitor nursing homes' financial condition because its Health Economics Program already monitors hospitals' financial performance.

In our opinion, the reimbursement system generally promotes efficient nursing home operations. Administrators can make some additional improvements, but we do not think these would produce significant cost savings to the state. Instead, we suggest that:

  • The Legislature review its policies and state regulations for cost-saving opportunities.

First, legislators should review the geographic regions which now determine nursing home rates. We think that reimbursement should be tied to real differences in the cost of living and other factors which the currently used groups may not reflect. Changes to the geographic groups might save money.

Second, the state might save money by changing the methods by which the Departments of Health and Human Services monitor and regulate nursing homes. Evidence suggests that some of these activities may be inefficient and unnecessarily expensive for the state and nursing homes as well. In all, nursing homes are subject to visits and inspections by 13 different agencies, each on its own schedule. A broad-based regulatory review may be warranted.

Third, policymakers should continue to question the necessity of expensive nursing home care when there are alternatives which are less expensive and equally appropriate. Fourth, we believe it is time to review the monetary impact of equalizing public and private nursing home rates. This policy was adopted in the 1970s, primarily to foster social equity, and its economic impact is unclear. The policy may be a savings to the state, or it may be a cost. Because of the uncertainty we think that, especially during this time of state financial stress, the Legislature would be well served by a thorough analysis of the policy's monetary impact.

Financial Future

Even if the state were to take these steps, the financial condition of nursing homes might be in jeopardy within the near future. Our evaluation showed that many nursing homes have been operating uncomfortably close to the break-even point. They have been coping with problems in the state's method of paying for property costs yet have had limited resources with which to operate, much less profit. Since 1985, their primary source of profit has been fixed, but costs have risen. Of course, the nursing homes can relieve themselves of some financial stress by minimizing unreimbursable expenses, but we doubt that this is always advisable.

Therefore, we think the Legislature should give careful consideration before cutting state support for nursing homes. Considering their generally weak condition, we think some additional state money may be appropriate, even in this period of state financial difficulty.

Most important:

  • The Legislature should correct previously identified problems in the state's method of paying property costs. <FN - KPMG Peat Marwick, Review of the Long Term Care Property Payment System (Minneapolis, May 1990).>

At this date, the cost of this recommendation is unknown, but we understand that a task force so far has been unable to develop an alternative payment method that would correct existing problems without more money.

To provide nursing homes with the potential for improved financial health while maintaining the elements of cost control which are critical to the state, we think that:

  • The Legislature should consider increasing efficiency incentive payments.

For the 1990 rate year, the Department of Human Services will pay a total of $19.8 million in efficiency incentives to about three-fourths of the nursing homes. If the incentive payments rose at the same rate as the formula provided to offset inflation in other operating costs, we estimate that the additional expense would be about $2.2 million.

To monitor nursing homes' financial performance in the future, we recommend that:

  • The Legislature should include nursing homes under the Health Care Cost Information Act of 1984. <FN - Minn. Stat. §§144.695 to 144.703.>

The Department of Health's hospital monitoring program already covers an important part of the nursing home industry, and it can readily be adapted to the rest. We understand that nursing homes and the state would incur some costs to produce and analyze the information, but in our opinion, the data would be more useful and of better quality than that which nursing homes have already purchased.

In our opinion, the Departments of Health and Human Services need financial data on nursing homes so that they can determine whether lack of resources truly threatens residents' care. Thus, we also recommend that:

  • The Department of Human Sevices should help to provide short-term loans to facilities to correct life-threatening conditions within nursing homes, upon recommendation from the Department of Health.

When nursing homes claim that financial hardship prevents them from making vitally necessary corrections, we suggest that the Department of Health review financial data and determine whether a loan is truly required. The Department of Human Services could make the loans through a special state fund and later recover the costs through the reimbursement system, in the same manner as it now collects occasional overpayments.

Conversely, in our opinion, nursing homes should not receive bonus payments for over-zealous efficiencies that result in health and safety violations. Thus, we suggest further that:

  • The Department of Human Services should make efficiency incentive payments contingent upon nursing homes' compliance with important regulations, as determined by the Department of Health.

In these cases, nursing homes could be compelled to use their bonus money to correct problems which may have been caused by excessive pursuit of profit. In other cases, the Department of Health could recommend that efficiency incentive payments be forfeited.

Finally, we suggest that the Legislature at some future date should consider incentives for nursing homes to develop innovative programs. Assuming that the incentives were modest and in keeping with the state's interests, we believe that the investment would be cost-effective. Specifically, we recommend:

  • Small, one-time grants should be available to help selected nursing homes develop unique, cost-effective programs.

When the state's budget allows, we believe that $250,000 for such grants would help to stimulate and encourage the nursing home industry while ultimately benefiting the state.

In conclusion, since the number of Minnesotans over 85 years of age is projected to increase 32 percent by the year 2000, the Legislature also should examine whether and how to continue the current moratorium on nursing home construction. While considerable interest has been focused lately on developing alternatives, we believe that the industry has a legitimate role within the continuum of health care services. In our opinion, the state needs a formal plan to guide decisions to add, subtract, and redistribute nursing home beds in response to local needs. Thus, we encourage the Legislature, nursing home providers, and the Departments of Health and Human Services to take additional steps to ensure that long term care is available, affordable, and appropriate to Minnesotans' current and future needs.

 

 

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