Add to that the demise of cost-based payment systems for skilled nursing, home health and rehabilitation, a slowdown of managed care payments and dramatically increased staffing and pharmaceuticals costs, and you have another year of tough sledding ahead.

When you are up to your neck in alligators, it's hard to think about draining the swamp. But this is the ideal time for hospitals to assess how to best manage their discharges that require skilled nursing care.

THE ROLE OF PPS

The Medicare Prospective Payment System for SNFs that began in 1998 is patient-specific and case mix adjusted. But because it is site-undifferentiated, hospital-based SNF units are paid exactly the same way as freestanding SNFs. This is despite the fact that the 1996 costs for SNF patients in hospital-based units were 40 percent greater than those in freestanding skilled nursing facilities. There are no exceptions or exemptions for the more costly patients typically found in hospital-based facilities.

The federal rates are based on resource utilization groups (RUGs), which are weighted on the basis of nursing and rehabilitation staff time required to provide care to a patient. During the first year of PPS, SNFs experienced a reduction of about 17 percent in Medicare payments across the board. For FY 2000, federal rates are only 2.1 percent higher, which is only two-thirds of the actual health care inflation rate (Table 1).

In November 1999, Congress provided a temporary rate increase for SNFs, beginning on April 1, 2000. The federal per diem rate for 15 of the RUGs categories will be increased by 20 percent. The rate hikes will extend until October 1 or until the Health Care Financing Administration refines the Medicare payment for SNFs to account for medically complex patients. While there will be some relief for hospitals and SNFs, the increased payments likely will not cover the full costs of care for all patients in hospital SNFs.

Medicare is phasing in PPS for SNFs over four years. In year one, Medicare determined payment by blending a facility's specific 1995 allowable Medicare costs per patient day with the case mix adjusted federal PPS rates at a 75/25 ratio. In year two, the ratio is 50/50. Year three has a 25/75 ratio, and in year four, all SNFs will be paid the federal rate only. SNFs that became Medicare certified after 1995 received the federal PPS rate from the beginning.

Hospital-based SNFs that are entering the second transition year at a 50/50 ratio of facility-specific and federal payment rates will see the biggest decline in revenues. Table 2 illustrates the potential impact of Medicare PPS on an average hospital-based SNF in year two. While year one was financially unfavorable in this example, year two shows a significant loss for the SNF, assuming the same patient mix and static operating costs. Clearly, this hospital must decide whether or not to keep or close its SNF before it sustains a nearly $500,000 loss projected for FY 2000.

CLOSURE CONSIDERATIONS

The decision to keep or close a hospital-based SNF involves a financial and strategic assessment. Financially, a SNF can add profitability to the hospital, even if the SNF is not profitable itself. Give special consideration to factors such as cost reductions on the medical/surgical units and incremental costs.

Whether the SNF is within the hospital or a hospital-owned, free-standing unit, you must gather certain information to make a valid decision about keeping or closing it. Analyze the following:

* Medicare hospital replacement days are days that the hospital "saves" because it has its own hospital-based SNF. Typically, physicians are reluctant to discharge patients who are borderline medically stable to an external SNF. But when the skilled nursing facility is within the hospital itself--with immediate access to emergency services--discharge may occur two to three days earlier than for an external SNF.

* Medicare external SNF substitute days represent patient days in a hospital-based SNF during which time the patient could have been managed in an external SNF.

* SNF PPS per diem revenues reflect either the federal payment or the transition payment from Medicare for the year under consideration.

* Managed care per diem or allocation is the daily payment to a hospital-based SNF from HMOs or other managed care organizations. If the hospital is globally capitated or under percentage of premium arrangements for HMO patients, use the budgeted allocation for the SNF per diem.

* SNF per diem costs represent the direct costs of providing care in the hospital's SNF on an average day.

* Acute hospital incremental costs include the incremental costs of maintaining a patient in a hospital bed for the additional days that would be necessary if the hospital's SNF closed. Because acute care nursing staff would be minimally impacted, incremental hospital costs (or savings) would be tied to patient-specific ancillaries and supplies where costs can be clearly identified.

* Adjustments for the transfer rule, DSH, GME and outliers. When evaluating the SNF's overall financial value to the hospital, you must consider any losses you may incur because of DRG transfer rule-eligible patients that you transferred to the SNF, and any increases or decreases in hospital Medicare payments under disproportionate share, graduate medical education and outlier programs.

Table 3 addresses some of the financial modeling issues involved in the skilled nursing facility "keep or close" decision-making process. The model assumes:

* 10,000 total patient days

* Medicare payer mix of 100 percent

* Medicare payment at an average PPS rate

* Medical/surgical days accounting for 2,000 of the 10,000 internal days, achieved through appropriate reductions in hospital length of stay

* 8,000 patient days that would have been lost to external nursing facilities (external days) are being captured in the hospital's SNF.

In this example, the incremental cost savings to the hospital, as adjusted for disproportionate share, outliers and the transfer rule impact, offset the losses incurred by the hospital's SNF itself. The annual net financial impact of keeping the hospital's SNF was $50,000.

OVERALL IMPACT

Even if the net financial impact is slightly negative, it would be important for the hospital to consider certain strategic factors before deciding to close an in-hospital SNF. For example:

* How would physicians respond to the closure?

* Would physicians continue to admit the same volume of geriatric patients to the hospital without an in-hospital skilled nursing facility?

* Are there adequate external Medicare SNF beds to place the higher acuity patients that were previously discharged to the in-hospital SNF?

* What impact would the absence of an in-hospital skilled nursing facility have on the hospital's home health agency? For example, how would it impact Medicare patients who require short-term I.V. antibiotic treatments?

* Would closure negatively impact managed care agreements?

* How would patients and their families perceive the closure?

The decision to keep or close an in-hospital skilled nursing facility is complex. It involves a careful measurement of the net financial impact on the entire hospital, and the strategic impact on physicians, patients, families and payers.

"Not everything that counts can be counted, and not everything that can be counted counts," reads a sign in Einstein's office at Princeton University. Good words for providers to remember during this time of reimbursement turbulence. *

Dr. Kathleen M. Griffin is national director of post-acute care and senior services for Health Dimensions Consulting Group, a member organization of the Benedictine Health System, Scottsdale, Ariz. She is also an ADVANCE editorial advisor.