An interview with Dr. David Friend, Managing Director and Chief Transformation Officer of BDO’s Center for Healthcare Excellence & Innovation

Medicare’s Comprehensive Care for Joint Replacement Model signifies a change in how a narrow set of healthcare services are paid for and delivered. Dr. Friend explains the details and ramifications of this program, which are especially acute for SNFs, as well as why he sees it as “the camel’s nose in the tent,” merely the beginning of wholesale change for acute and post-acute care providers.

PULSE: Please provide a brief explanation of the changes that will come about as a result of the Comprehensive Care for Joint Replacement Payment Model for Acute Care Hospitals Furnishing Lower Extremity Joint Replacement Services—the CJR bundled payment program that goes into effect April 1st, 2016?

DR. DAVID FRIEND: Medicare is rolling out this payment program in 67 metropolitan statistical areas (MSAs) nationally. Participating MSAs were selected by CMS because they recognized wide variation in the cost of total joint procedures. It is intended to apply only where people have traditional Medicare insurance. So if you’re in Medicare Advantage, or if you’re in some other kind of value-based system, it does not apply. And the purpose really is to begin the process by which hospitals will become accountable for providing care, not only while the patient is initially hospitalized , but also upon discharge to skilled nursing or home health.

The CJR program gathers together all of the services for a total joint procedure for the initial hospitalization and for 90 days of subsequent care. It is profound in the sense that it is episodic in nature, and it forces all of the people whoare taking care of patients to think about the care of the patient in a more cooperative, holistic way.

One of the big provisions is that there is currently something called a three-day rule, or three-night rule, which basically says that for a patient to leave a hospital and to go to a nursing home in order for Medicare to provide coverage, the patient has to have been hospitalized for three days. Hospitals are allowed to waive the three day stay requirement if the patient is sent to a skilled facility with a three star or better rating. The impact of that is profound, first of all, on the skilled nursing facilities (SNFs), because by creating a safe harbor, it’s going to dramatically incent hospitals to send patients to higher quality SNFs. Previously, there has been no direct incentive to do so, either legally or payment wise, but this creates a safe harbor that encourages hospitals to use three star or better SNFs. Secondly, it’s towards the movement of expressly linking payment to healthcare quality, which has not been done previously. We tended to pay for things regardless of their clinical quality, and this is the beginning of a dramatic change.

PULSE: Can you provide a little more detail on the five-star ratings system and how it comes into play?

DR. FRIEND: Sure. Well, there’s been a five-star system in place for nursing homes for quite a while. It has been comprised of measures in terms of staffing, clinical quality, and how people did in surveys, and this produced an overall number. It has been a system that has not been used to differentiate payment amounts by Medicare or other payers.

For example, if you took a restaurant analogy, you might have a restaurant with terrible food and a restaurant with very good food. The payer would pay the same for a meal regardless of the quality of the food or service. We’re now moving to a system where, in fact, the quality of the food is going to be a determinant in whether, A, you go to that restaurant, and B, how much the restaurant gets paid. And while this kind of concept applies virtually in every other part of the economy, where people have an understanding of what something is going to cost and what they’re going to get in return, that has been missing in healthcare.

The system is going to start rewarding providers, including SNFs, to provide better care. This also reduces the variation that we see currently in care, particularly in SNFs where you can see the price of for a hip replacement procedure ranging from $10,000 to $80,000 all in, with arguably, no difference in quality. If there’s really no difference in quality, why should there be such a dramatic price variance? So this is an attempt to reduce variance, to drive up the quality of the care, and to have a more consistent payment methodology.

All of the post-acute care providers are impacted by this move to payment based on quality. Nursing homes are particularly impacted because while this impacts the hospitals and everyone in the chain, for the hospitals, at least in the first year or two, it’s a relatively small amount of money. However, for SNFs, because they are so dependent on the Medicare beds—where they make most of their margin—even the slightest reduction in the Medicare census or in the amount of money they’re receiving per patient can dramatically impact their operating results. That’s why this impact is going to be felt more acutely in skilled nursing than anywhere else.

PULSE: So do you anticipate that the reimbursement levels are going to go down due to the negotiating power of the bundle recipients?

DR. FRIEND: It’s already happening. It’s going both up and down. If you are a quality SNF that offers the ability to prevent readmissions and provides good care, many of those facilities are in the position to negotiate rate increases. There are other facilities that are either going to see fewer patients or receive lower rates.

The payment systems in CJR are retrospective. The SNF can enter into a collaborative arrangement with the hospital convener and earn money from savings on the overall cost of care for the patient. Quality measures must be met to qualify for these gain sharing payments. I would not infer that we are entering a capitated payment state under CJE even though it certainly could look that way. Whether that’s two days or 20 days, that will largely be up to the nursing home. We’re going to pay much more according for outcome than by a nightly rate.

Some SNF operators are could make significantly more money, particularly if they have quality, their electronic health record can tie into the hospital, and they are seen as a step-down unit of the hospital. They can command a tremendous premium and be very full, and they will actually be much more successful. This legislative change is a huge win for those kinds of providers. Again, there are other providers who will either lose patients because they can’t compete or are going to be forced to cut price. There will be economic winners as well as significant economic losers.

PULSE: From the perspective of investors interested in the post-acute care space and particularly in SNFs, how does this affect valuations and what implications does it have for consolidation in the post-acute care space?

DR. FRIEND: I think it radically impacts valuations, both up and down. I can only conclude that there is a tremendous amount of mispriced assets right now in the market. So for smart investors who have an information advantage and can see the mispricing and arbitrage it there’s opportunities to make a great deal of money. However, if you don’t have the information advantage or you don’t understand what’s happening there will be significant risks to lose money. In general, we think this is becoming a far more sophisticated game.

To your point on consolidation, I would suggest that this is a very mom and pop industry that probably is ripe for tremendous consolidation. But against that is the fact that this is a local business. Healthcare is very local. It is really done one geography at a time. Given this, players in the space should focus on developing strength in certain geographies.

PULSE: While this program could have far reaching implications it’s important to remember that it only applies to comprehensive care for joint replacement for lower extremities. So it’s not the total Medicare population, right?

DR. FRIEND: Correct. There are only 794 hospitals and 67 MSAs, but I believe this is just the beginning. I believe what’s going to happen is that this is going to be so successful that this process will be adopted very rapidly by commercial payers and by Medicaid. And I also believe this is going to rapidly expand from this one particular DRG—right now it only affects DRG 469 and 470—however we believe that this is the future of how healthcare is going to be driven. It is the camel’s nose under the tent. Once the government sees how effective this is and how they started driving down variation and waste, the momentum to do this is going to be unstoppable. We are in very early stages here, but my belief, clearly — and I’m on the record as saying this — this is the beginning of the wholesale change, the way we’re going to take care of people, because it makes so much sense to do it this way. And the current system makes so little sense.

PULSE: How are hospitals responding to these changes?

DR. FRIEND: Hospitals are going to be forced to carefully evaluate partners that can help them manage patients in the CJR program “outside the hospital walls”. Hospitals have never been financially linked to the process of care once the patient is discharged. That is the driver, we believe, for the fundamental change to a focus on sending people to higher quality facilities. Many hospitals are looking at this and saying, “You know what? The average per case is a couple thousand dollars, so it’s not worth it to us to go through all of these machinations.” But in year two, three, four, (because of the way CMS has organized the payment for this program)I think it’s going to become worth it to them. Also, the hospitals are going to find that they are under pressure from the employers of this country who are going to demand of the hospitals that they reduce healthcare costs and improve efficiency.

From a patient care perspective, if I’m going to take my mother to a hospital for a hip replacement, my first question is going to be, do you control the entire supply chain, or are you one of those old-think hospitals that still think once you discharge the patient you have no responsibility? And I think more and more patients, as they become more educated, are going to ask the same kinds of questions, but like anything else, it takes time. It takes time, right? Nothing happens overnight in our economy, but momentum does get built.

So while the hospitals in some cases will ignore this for a while or say they don’t want to do it or it’s too complicated, I think over time the hospitals that do this are going to be rewarded with more volume, and the hospitals that don’t do this are going to find their own volumes start to shrink. So, again, once you have a much more efficient way of doing things, it’s difficult to run a very inefficient system and still compete. There might be hospitals in this country who are, ultimately, going to be pushed out of the total joint business altogether.

PULSE: So what are some implications of the CJR for other post-acute care providers, specifically home health?

DR. FRIEND: Well, it’s very significant, because now we’re going to free up the hospitals. For example, rather than just having a linear progression where you stayed in the hospital for three nights and then you went to skilled nursing for ten days and then you went to home health, the hospitals can have a lot more flexibility. The hospital might decide not to keep your mother in for three nights but instead keep her in for five nights, get her strong enough and then leap frog the skilled nursing facility and go directly to home health. That’s one possibility.

Home health is going to be seen as an alternative to skilled nursing as well as a complement. More and more, you’re going to see what we call the four Rs: the right care, the right place, the right time, and the right cost. Managing those four Rs is going to be the function of the hospital.

Beyond that I think there’s going to be an explosion of businesses and technologies that are going to make us rethink patient care. I think we will look back 10 or 20 years from now and say our patient care was in the Stone Age compared to what it could be. We’re going to unleash a tremendous entrepreneurial energy that has been stifled by these very rigid payment systems. The innovators eventually prevail. There are many, many examples where the incumbent did not want the new technology but I think healthcare is just ripe for a revolution because we can do it so much better than it’s being done today.

Ultimately, if you’re in the right spaces here, you’re going to do very well, and if you’re an incumbent, like a Kodak equivalent, you’re going to be extinguished. And we think this is going to come with a ferocity that people don’t expect because the pace of change in the economy — the rate of change in technology is astounding. Three billion people have smartphones on the planet, and fifteen years ago virtually no one did. Try to think about healthcare fifteen, or even ten years from now and what’s possible. I think this is all great for consumers and quality, but it’s going to make the industry undergo rapid change. The incumbents will resist, but the incumbent phone manufacturers resisted as well, and we know how that worked out.