COMMITMENT • INTEGRITY • LEADERSHIP	View full PDF report View Selected Abbreviations
Skilled Nursing Facilities Absent Effective State Oversight, Substandard Quality of Care Has Continued Report Number: 2017-109

INTRODUCTION

Background

Skilled nursing facilities (nursing facilities) provide 24-hour nursing and support services to tens of thousands of elderly and disabled Californians whose primary need is having skilled inpatient care available on an extended basis. In 2015, 80 percent of the nursing facility patients in California were over the age of 65. Nursing facilities, frequently called nursing homes, will be especially important as the population ages and the demand for skilled care rises. The baby boomer generation—marked by a substantial rise in birthrates from 1946 through 1964—began turning 65 in 2011, and by 2029 the entire baby boomer generation will be 65 years old or older. At that point, more than 20 percent of the United States' total population will be over the age of 65. This demand for skilled care adds urgency to the State's need to ensure that nursing facilities provide high-quality care. Nonetheless, recent media reports have highlighted the concerns of consumers and advocates about a number of nursing facility-related issues, including poor care, involuntary evictions, and closures. Often these reports cite the nursing facilities' desire for increased profits as a factor that led to lower quality of care.

In 2015 about 1,100 nursing facilities were located in California, and private owners—including individuals, partnerships, and corporations—owned and operated nearly 88 percent or nearly 1,000 of these facilities. Of the remaining nursing facilities, about 12 percent were operated by nonprofit entities, while fewer than 1 percent were operated by the State. Nursing facilities collect payments for the services they provide from a number of sources, including Medicare, Medi-Cal, private insurance, and patients. Medicare is a federal public health insurance program for individuals over 65, as well as for others with certain disabilities or kidney failure. As a part of the U.S. Social Security Medicaid program, Medi-Cal is funded by a joint partnership between the State and the federal government and is intended to be the payer of last resort after patients exhaust other means of paying for their care. In some cases, nursing facilities collect payments for their services from Medi-Cal or private insurance on a traditional fee-for-service basis, or they collect payments from Medicare. In other cases, nursing facilities collect payments from managed care programs that are funded by Medicare, Medi-Cal, and private insurance. Managed care programs pay flat amounts for patients regardless of the services they use. Figure 1 shows the proportions that these various sources paid for patient care at nursing facilities in California during facility fiscal year 2015. A facility fiscal year is each individual facility's fiscal year as reported to the Office of Statewide Health Planning and Development (Health Planning), and it varies from facility to facility.

Figure 1
Medi-Cal and Medicare Were the Primary Sources of Revenue for Nursing Facilities in California in Facility Fiscal Year 2015

Medi-Cal is the primary payer for nursing care in California, accounting for 41 percent of the $10.2 billion in nursing facilities' health care revenue in facility fiscal year 2015. From Medi‑Cal rate years 2006–07 through 2016–17—which extend from August 1 to July 31—the Medi‑Cal budget for nursing facilities increased by 31 percent, from $3.4 billion to $4.4 billion. Three of the largest private operators of nursing facilities in California—Brius³, Longwood Management Corporation (Longwood), and Plum Healthcare Group (Plum)—collectively account for 16 percent of the 109,000 nursing beds in California and 14 percent of the 1,100 nursing facilities. For their facilities' fiscal year 2015, Medi‑Cal payments accounted for 37 percent of Brius's revenue, 52 percent of Longwood's revenue, and 39 percent of Plum's revenue. We reviewed these three companies in conducting this audit.

State and Federal Agencies Provide Oversight of Nursing Facilities

California assigns oversight responsibilities for nursing facilities to three separate state agencies: the California Department of Public Health (Public Health), Health Planning, and the Department of Health Care Services (Health Care Services), as Figure 2 shows. Public Health, through its Center for Health Care Quality, licenses nursing facilities and periodically inspects them to ensure that the facilities are meeting quality-of-care standards. Health Planning collects annually a variety of financial information from nursing facilities and performs limited desk audits of that information. Health Care Services audits the financial data collected by Health Planning, sets each facility's Medi-Cal payment rate, and makes Medi-Cal payments to each facility. Public Health and Health Care Services also conduct investigations into allegations of fraud, abuse, and quality-of-care concerns at nursing facilities.

Figure 2
Public Health, Health Planning, and Health Care Services Oversee Nursing Facilities in California

At the federal level, the U.S. Centers for Medicare & Medicaid Services (CMS) ensures that California's Medi-Cal program, including its oversight of nursing facilities, meets federal requirements. CMS works with Public Health to ensure that nursing facilities provide adequate quality of care and with Health Care Services to ensure that Medi-Cal payments are appropriate. If nursing facilities fail to achieve substantial compliance with federal regulations, CMS can terminate their participation in Medicare, Medi-Cal, or both. Additionally, the State's Medi-Cal program must meet federal requirements for California to receive federal funding for the program.

Nursing Facility Owners Often Obtain Goods and Services From Other Businesses That They or Their Families Own or Control

Nursing facility owners frequently obtain goods and services from related parties, which are other businesses that they or their immediate family members own or control. As Figure 3 shows, a nursing facility can purchase goods or services from a related‑party business, which shares with that nursing facility a common owner, which is owned by an immediate family member of the nursing facility owner, or which is controlled by such individuals. For example, related parties may provide to nursing facilities such goods as medical supplies and equipment, pharmaceutical drugs, laundry and linens, and food. Related parties may also provide therapy services, maintenance services, financial consulting, and administrative services, such as accounting and human resources support. Further, nursing facilities frequently lease their buildings from related-party property owners. Nursing facility owners may choose to use related parties for a number of reasons, including creating additional revenue streams, lowering their costs, providing tax benefits, limiting their exposure to liability, and creating operational efficiency by having more control over their suppliers. As Figure 4 shows, the three companies we reviewed used related parties for such items as medical supplies, financial services, and administration. The six facilities we reviewed transacted with multiple related-party businesses from facility fiscal years 2014 through 2016. Specifically, Brius engaged in related-party transactions with eight related‑party businesses, Plum with two, and Longwood with three.

Federal and state regulations allow nursing facilities to do business with related parties, but because related-party transactions can pose risks, federal regulations and state law establish certain restrictions on such transactions if facilities receive government funds. One risk is that owners will artificially inflate the prices of goods and services to increase their related-party profits and that some of these profits may come from government funds that the facilities use to pay for goods and services. The use of related parties also generally increases the risk of fraud and abuse because it could be easier for a common owner to engage in fraudulent financial reporting and conceal wrongdoing. However, Medi-Cal mitigates the risk that government funds will pay for related-party profit. This report specifically focuses on nursing facilities' use of state funds through Medi-Cal.

Figure 3
A Nursing Facility Can Purchase Goods or Services From a Related-Party Business That Has an Owner in Common With the Facility

When determining each facility's Medi-Cal payment rate, Health Care Services takes several measures to limit the possibility that Medi-Cal might pay for profits from related-party transactions. We summarize these Medi-Cal safeguards in Table 1. For example, before calculating a nursing facility's payment rate, Health Care Services generally disallows and removes owner profits from related-party transactions during its annual audits of nursing facilities' cost reports. Moreover, federal regulations indicate that the cost for such transactions must not exceed the price of comparable transactions procured elsewhere. In addition, Health Care Services separates the facility's audited costs into seven cost categories that we summarize in Figure 5. Health Care Services then caps each facility's costs within each cost category at levels consistent with its peers. Finally, to limit costs, meet federal requirements, and stay within the State's budget, Health Care Services proportionately reduces Medi‑Cal payments to nursing facilities across the State, essentially ensuring that it does not fully cover any facility's costs for its Medi-Cal patients. According to a technical director from CMS, about two‑thirds of the nation's nursing home residents are on Medicaid—which is called Medi-Cal in California—and nursing facilities generally have to accept these patients to maintain occupancy rates, even if Medicaid does not cover all of the patients' costs. As a result of all these safeguards, it is extremely unlikely that Medi-Cal might pay for owners' profits from artificially inflated related‑party transactions.

Figure 4
In Facility Fiscal Year 2015, the Companies We Reviewed Purchased a Variety of Goods and Services From Related Parties
(Dollars in Millions)

Source: California State Auditor's analysis of selected nursing facilities' cost reports and interviews with selected company executives.

Table 1
The Medi-Cal Rate-Setting Process Includes Safeguards That Significantly Reduce the Possibility That Medi-Cal Will Pay for Related-Party Profits

MEDI-CAL SAFEGUARD	HOW IT WORKS	INTENDED EFFECT
Financial audits	Health Care Services audits annually each nursing facility's cost reports and adjusts or eliminates any nonallowable or excessive costs, including profits from related-party transactions.	Medi-Cal pays for allowable costs only, and it does not pay for nonallowable related-party profits.
Rate caps, cost categories, and peer groups	Health Care Services caps Medi-Cal rates by doing the following: Separating allowable expenses into seven cost categories. Assigning each nursing facility to one of seven county‑specific peer groups. Comparing costs for nursing facilities in each peer group to set rate caps for each cost category.	Medi-Cal limits what it pays high-cost nursing facilities in part based on the costs of other facilities in their peer group.
Fair rental value system	Health Care Services replaces a nursing facility's actual capital costs with a formulaic rate that is based on the age of the nursing facility, its geographical location, and its number of beds.	Nursing facility rent, depreciation, and most other capital costs have no impact on Medi-Cal payments.
Ratchet mechanism	Health Care Services reduces proportionately each nursing facility's Medi-Cal rate to ensure that Medi-Cal payments as a whole stay within each rate year's overall Medi-Cal budget.	The ratchet mechanism ensures that any excessive costs, including related‑party costs, do not lead to an overall increase in payments beyond an established budget threshold.
Two-year lag in methodology	Medi-Cal pays nursing facilities based on their costs from roughly two years earlier.	If a nursing facility's costs increase, it will be two years before Medi-Cal pays the larger amount. The delay encourages nursing facilities to control or reduce costs, and it reduces their incentive to increase costs through transactions with related parties.

Source: California State Auditor's analysis of Health Care Services' implementation of state law and of state and federal regulations.

Figure 5
The Medi-Cal Rate-Setting Methodology Separates Allowable Nursing Facility Costs Into Seven Cost Categories

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Footnote

³ Brius Management Company is a holding company that is owned by two individuals and that first acquired nursing homes in 2006. Since then these individuals have become affiliated with a number of other businesses and partnerships that own additional nursing facilities. However, many media reports and our legislative audit request refer to one of these individuals and to that individual's nursing facilities collectively as Brius Healthcare Services. To avoid confusion, we use the name Brius in this report to refer to the nursing facilities directly or indirectly and wholly or partially owned by the individual owners of Brius Management Company. Go back to text

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