Nursing homes remain a steady business in a wobbly economy, thanks largely to the fact government reimbursements remain stable for now.

That sure-footedness is in question, though, with investors anxiously awaiting the 2010 reimbursement proposal from the Centers for Medicare and Medicaid Services, slated for around May 1.

Some fear that CMS may suggest significant cuts in Medicare reimbursements, and that anxiety could hurt the stocks of major players - including Kindred Healthcare Inc. (KND), Skilled Healthcare Group Inc. (SKH) and Sun Healthcare Group Inc. (SUNH) - at least until the rule is finalized later this year. Any suggested reimbursement increases or cuts in the CMS proposal could change before the department formally sets rates.

All three companies' shares have been sliced more than 50% from their 52-week highs last fall, although they've all held steady so far this year.

Sun Healthcare declined to comment for this story, and Kindred and Skilled Healthcare did not return calls seeking comment.

With about three-fourths of the $99.2 billion industry's revenues funded by Medicaid and Medicare, according to research firm IBISWorld, reimbursement is the sector's "sword of Damocles," Morgan Keegan analyst Robert Mains said. Many investors may remember the wave of nursing home bankruptcies in the late 1990s, due in part due to significant reductions in Medicare payouts in the wake of the Balanced Budget Act of 1997.

While that isn't likely to happen again, reimbursement concerns "always overhang these companies," Mains said. "You don't get to negotiate with the government."

For now, nursing home funding is secure. Concerns about Medicaid, which IBISWorld says provides about half the sector's revenue, have been mostly alleviated, with the stimulus bill providing about $87 billion to states. Nursing homes represent the largest outlay for Medicaid programs, according to Stifel Nicolaus.

Also, nursing home facilities are considered need-based, and they have been somewhat more recession-resistant than their assisted-living and independent-living counterparts.

"In good times or in bad times, people are going to nursing homes," Mains said.

As for Medicare, nursing homes received a 3.4% "market basket," or inflationary cost, rate increase for the fiscal year starting last October, while escaping cuts elsewhere.

But some analysts say nursing homes may not be so lucky this time.

 
   Patients And Payments

While Medicaid provides nearly half of sector's overall revenues, publicly traded companies have been increasing their focus on Medicare patients needing more acute care, because reimbursements are higher. Sun Healthcare, for instance, operates about 50 rehab recovery suites, where it provides such intensive short-term services as hip replacements.

Some analysts are concerned that CMS may propose a resource utilization group reweighting, which would change reimbursement rates based on a resident's expected needs. A change, which the industry has been anticipating for some time, could reduce rates for the highest-paying patients with the greatest needs in favor of the lower-paying ones needing less care.

While that change is expected to be industry-neutral overall, it would have a bigger impact on for-profit companies, who are putting a greater focus on higher-acuity patients, Wachovia Capital Markets analyst Gary Lieberman said. This reweighting may or may not be proposed for 2010, and even then it may not be adopted in the final ruling.

Industry observers are also closely watching what CMS does with the third component to Medicare reimbursement, the forecast error adjustment. Since CMS refined the payment system by adding nine high acuity/high reimbursement groups in 2006, it has discovered that more patients than anticipated fell into these areas, leading to the government spending $770 million more than anticipated in 2009, Lieberman said.

In order to make up for that, CMS will have to reduce reimbursement by 3.3% to 3.4% for one year, Lieberman said. The organization proposed this cut last year, but it was pulled from the finalized rule for what Lieberman believes were political reasons.

"We expect this again to be in the proposed rule and because of the ambitious [and costly] health-care reform legislation that will be proposed, every potential saving will seriously need to be considered," Lieberman said.

In Sun's latest conference call, Chief Executive Richard Matros said he could foresee some reduction in market basket reimbursement, but he didn't think it would be "anything draconian."

Standard & Poor's analyst Jeffrey Englander also doesn't expect any drastic cuts in Medicare reimbursement in the immediate future. While some changes may be made, nursing homes are well-positioned in the current health-care environment because they are "a more cost-efficient provider with good clinical outcomes," Englander said.

-By Kelly Nolan; Dow Jones Newswires; 201-938-4049; kelly.nolan@dowjones.com