Home Business Information

Changes authorized by the Balanced Budget Act of 1997 have removed many of the payment benefits that motivated past home health agency acquisition activity and temporarily have slowed the rapid pace of acquisitions of home health agencies. The act required that Medicare's cost-based payment system be replaced with a prospective payment system (PPS) and established an interim payment system to provide a framework for home health agencies to make the transition to the PPS.

As a consequence, realistic valuations of home health agencies will be determined primarily by cash flows, with consideration given to operational factors, such as quality of patient care, service territory, and information systems capabilities. The limitations imposed by the change in payment mechanism will cause acquisition interest to shift away from home health agencies with higher utilization and revenue expansion to agencies able to control costs and achieve operating leverage.

Faced with the need to control healthcare costs, providers increasingly are turning to home care as an important component of a cost-effective integrated delivery system (IDS). The National Association for Home Care (NAHC) estimates that the average daily charges for hospital and skilled nursing facility stays in 1996 were $1,965 and $414, respectively, compared with about $86 for a home care visit.

These cost considerations and expanded patient eligibility caused the number of Medicare-certified home health agencies to almost double from 1990 through 1996 (see Exhibit 1). During that period, estimated Medicare home care outlays increased from about $3.9 billion to about $18.1 billion.(b) Although the combination of all home care services and products, excluding prescription drugs, represents only about 4 percent of the total national expenditures on personal health care,(c) the perceived cost-effectiveness of home care has caused it to become among the fastest growing sectors of the healthcare industry. National expenditures for home care services grew at a compounded annual growth rate of about 18 percent between 1990 and 1996, compared with growth rates of 6.2 percent for inpatient care, 6.6 percent for physician services, and 7.2 percent for total U.S. healthcare services over the same period.(d)

Until recently, Medicare-certified home health agencies were entitled to payment for reasonable costs incurred in providing patient care, with the primary restriction on payment being a set limit on per visit service costs related to patient care. This system was introduced in 1965, and before 1990, it did not appear to promote excessive utilization of services. From 1990 to 1997, however, the average annual number of home care visits per Medicare beneficiary more than doubled, from 36 to 78.(e) According to HCFA, much of this rapid rise in home care expenditures is attributable to the failure of the cost-based payment system to control home care provider operations and utilization through economic incentives.

As a result, a number of measures were included in the Balanced Budget Act of 1997 to rein in rising home care expenditures. The most significant measure was a change in the mechanism HCFA uses to pay Medicare-certified home health agencies. Specifically, the act required HCFA to establish a home health agency prospective payment system (PPS) by October 1, 1999. The act also called for the establishment of a home health agency interim payment system (IPS) to end cost-based payment and provide a mechanism for home health agencies to transition to a full PPS.

With the passage of the Balanced Budget Act, payment rates for home care services under the IPS were reduced to 2 percent below levels that were in place during the 1993-94 cost-reporting period for most home health agencies. Under the IPS, an annual per beneficiary limit on payment from Medicare also was introduced to control utilization. The per beneficiary limit is computed using a blend of 75 percent of reasonable costs and 25 percent of a regional limit. For most home health agencies, revenue reductions are expected to range from 15 to 22 percent below 1997 limits. f Industry sources estimate that 65 percent of freestanding home health agencies have costs that exceed the payment limits imposed by the IPS.g The impact of the IPS is expected to be far greater on hospital-based agencies because many hospitals routinely allocate overhead costs to their home care businesses.