Encompass Health Flags Top PDGM Concerns

Encompass Health (NYSE: EHC) has two primary concerns with the proposed Patient-Driven Groupings Model (PDGM) for Medicare home health payments.

The Birmingham, Alabama-based organization is one of the largest home health providers in the nation, with more than 198 locations across the country. The company is also the largest inpatient rehabilitation facility (IRF) operator in the country, with nearly 130 IRFs nationwide.

Encompass Health’s main issue with PDGM relates to its so-called “behavioral adjustments,” April Anthony, the company’s CEO of home health and hospice, said on Thursday’s Q2 2018 earnings call. Encompass Health is also concerned about the data that the Centers for Medicare & Medicaid Services (CMS) used in calculations related to labor costs, she said.

Encompass Health plans to hit on both these issues when it submits comments to CMS on the proposed payment model, which are due by Aug. 31.

As called for by the Bipartisan Budget Act of 2018, PDGM is slated to take effect in 2020. The framework is similar to a payment revamp—the Home Health Groupings Model (HHGM)—that was floated last year. In both HHGM and PDGM, payments would be based on a 30-day episode rather than the current 60-day episode, and there would be notable changes to therapy reimbursements as well.

Yet, unlike HHGM, the new PDGM model is Congressionally mandated to be budget-neutral, meaning that it would not result in an overall reduction in Medicare reimbursements for the home health industry. However, this is based on certain assumptions that CMS has made about how home health agencies will act in response to the new payment framework.

For example, CMS believes that agencies will quickly adjust to coding changes related to co-morbidity adjustments to maximize their reimbursements. Other behavioral adjustments relate to changes in clinical group assignment in PDGM and how agencies will adapt to avoid low-utilization payment adjustments (LUPAs).

Assuming providers make all these adjustments, the 30-day payment amount needed to maintain budget neutrality would be about $1,754. If agencies do not make any of these adjustments, the 30-day payment amount would have to be 6.42% higher, at $1,864.

These behavioral adjustments do not appear to be realistic, according to Anthony.

“If you go back and look over the years, the average impact [of behavioral adjustments] in any single year has been well below the 6.5% level, something more in the 2% to 3% range,” she said. “So, we think it’s a little bit disingenuous for Medicare to assume that in one year, the industry is going to react as significantly as a 6.5% baseline adjustment would suggest.”

Encompass Health plans to suggest an alternative approach to CMS, which would involve more phased adjustments. And the provider is not alone in raising concerns about the behavioral adjustments. The National Association for Home Care & Hospice (NAHC) also is focused on the issue.

On the labor front, PDGM could cause providers to provide more care delivered by nurses and aides, while shifting away from therapy. This would drive costs down for Encompass Health, considering that cost-per-visit is lower for nursing versus therapy, Anthony noted. However, CMS allocated costs using Medicare cost reports rather than Bureau of Labor Statistics data, which may have caused a “pretty significant mis-allocation of resources,” she said.

Despite tight labor markets and a caregiver shortage, Anthony is confident that Encompass Health will not have any problems attracting more nurses—if it does, indeed, find a need for them.

Although PDGM is likely to go through several changes throughout the rulemaking process, Encompass Health’s early calculations show that it would result in about a 5.4% reduction in home health revenue. Still, this could be mitigated by changes such as attracting more hospital referrals, as PDGM will reimburse at a higher rate for these patients, compared with those admitted from the community.

“We have 18 months and current and subsequent rulemaking processes to prepare for changes to the system,” Encompass Health CEO Mark Tarr said. “We are skilled at adapting.”

Strong earnings

While it prepares for the coming payment changes, Encompass Health is performing well.

Net operating revenues for the company rose 10.5% on a year-over-year basis in Q2 2018, reaching about $1.1 billion. The company increased its guidance for the second consecutive quarter.

In the home health segment, net operating revenues were up 23.5% year-over-year, hitting $233 million.The hospice segment, in particular, featured a gaudy 67.5% year-over-year increase in revenue.

Some of the home health and hospice growth is attributable to the acquisition of Camellia Healthcare. But given that Camellia’s revenue base was only $78 million in 2017, most of the upside came from the core home health and hospice business, William Blair analyst Matt Larew wrote in a note issued Wednesday evening.

The basic strategy for Encompass Health is to control more of the post-acute continuum of care, fostering collaboration between its IRFs and home health locations to drive down costs and improve outcomes. Same-store home health admissions grew 5.1% in the second quarter. About 90 basis points of that growth was due to the clinical collaboration push, the company stated. The collaboration rate increased from 28.6% in Q2 2017 to 33.2% last quarter.

A major goal of acquisition activity is to support even more collaboration and to extend the company’s reach into hospice. There are promising acquisition opportunities across both major business segments of the company, as well as hospice, CFO Doug Coltharp said during the earnings call. There are potential deals similar to the $135 million Camellia transaction, he added. That purchase added home health, hospice and private duty services.

PDGM has not had much impact on M&A yet, but as 2020 approaches, it could lead to increased deal flow, Anthony surmised. Especially for smaller companies considering a sale, the new payment model could be the “final straw in the haystack,” she said.

Overall, the Encompass Health balance sheet is in “good shape to support internal and external growth,” Stephens analyst Dana Hambly wrote in a note.

Free cash flow is up 10.8% year-to-date, thanks in part to improved collection of accounts receivable, and the company’s leverage ratio was 3x as of the end of Q2.

Both Hambly and Larew praised Encompass Health’s quarterly performance, and investors were decidedly bullish on the company in light of its earnings. Shares were trading up 7.12%, at $75.42, in the late afternoon on Thursday.

Written by Tim Mullaney

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Tim Mullaney on Email
Tim Mullaney
If he’s not in the newsroom, Tim likes to be on the tennis court or traveling to a new destination. Recent highlights include Sri Lanka and Iceland.

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