Do nursing home owners understate the profits they report to federal regulators by shifting income to related businesses? Two academic experts in nursing home finance found that in one state 63 percent of margins are hidden this way. To put it another way, only 37 percent of true nursing home profits are reported to federal regulators.

A new paper by health economist Ashvin Gandhi of UCLA and financial economist Andrew Olenski of Lehigh University details how operators “tunnel” expenses to related parties and describes the breadth of the practice, which is widespread throughout the health care industry.

Common Practice

Because federal nursing home financial reports are unreliable, the authors used data collected by Illinois. They estimated that 77 percent of firms in the state reported making some related party payments in 2021. The dollar value of these transactions more than doubled from 2001 to 2021 to over $800 million in Illinois alone.

However, they found wide variation in how this practice was used. Some facilities were very aggressive, while others didn’t do it at all.

These related party transactions are designed to overstate costs and understate profits reported to the government. The vast majority are for real estate and management. Less frequently, they purchase services ranging from nursing to laundry.

“Red Herring”

The American Health Care Association, the trade group that represents mostly for-profit nursing homes, said focusing on related party transactions is a “red herring.”

The group sent me a written comment that said, in part, “We do not believe it is common practice to “tunnel” profits to other lines of business….The sad truth is that because long term care is chronically underfunded, ancillary services and related parties sometimes help keep these facilities afloat. These issues are a distraction from the real challenges facing the majority of the long-term care sector.”

Low-Balling Profits

The deals work like this: A nursing home operator sells a facility to a real estate company controlled by the facility’s owner. The real estate firm then leases back the property to the nursing home at an inflated price.

The higher rent reduces profits the nursing home reports to the federal government even as it boosts revenue of the real estate firm or its investors, which generally is not disclosed to regulators. Related party purchases of other services work the same way.

The cost differences are striking. The paper reports a facility that rents from a related party paid an average of $7,094 per bed, compared to $4,377 from an unrelated party.

The authors also found that shifting profits to a related business also helps insulate nursing home operators from malpractice insurance claims. Illinois facilities that used related party transactions reduced premiums by about one-third, or nearly $26,000 annually, even though their paid losses did not change.

Government Payments

The study could have significant implications for the way government pays and regulates the facilities.

For example, AHCA recently objected to a Biden Administration effort to increase staffing in the facilities. It wrote, “Chronic Medicaid underfunding and soaring inflation mean many facilities are operating on shoestring budgets or are on the brink of closure, and these unfunded mandates could push them over the edge—severely impacting seniors’ access to quality care.”

This argument has convinced many members of Congress to oppose the proposed rules. There are reasons why they ought to be modified. And many nursing homes are in financial trouble. But if the new study is correct, widespread industry claims of financial ruin are significantly overstated.

Solving A Mystery

Gandhi and Olseki did not find that related party transactions hurt quality of care. But they did estimate that nursing homes would have income to increase staffing levels by about 30 percent if they paid market, rather than inflated, prices for rent and services.

Their analysis also may help explain a financial mystery. Even as for-profit nursing home operators complain that they cannot survive on the payments they receive from Medicare and Medicaid, willing buyers are paying near-record high averages of roughly $100,000 per bed, equivalent to $10 million for a typical 100-bed facility.

Yet, based on reported profits, they calculated this results in a rate of return of 0.1%, far lower than super-safe US Treasury bonds. These prices could only be justified, the authors say, if actual profits are significantly higher than what many facilities report.

Quality Not Cost

These related party transactions largely result from the unusual economics of nursing homes. Nearly all nursing home revenue comes from either Medicare for skilled nursing care or Medicaid for long-term stays. And the facilities use low reported profits to pressure government to raise payments. Medicare Advantage managed care plans negotiate payment rates with nursing facilities that are much lower than traditional Medicare.

The federal government is taking steps to increase financial disclosure by nursing homes. But it needs to do more to illuminate the nationwide scale of related party transactions. Ultimately, however, nursing home payments should be more closely tied to quality and patient and resident outcomes rather than reported costs.

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