Hospital and nursing home managers are reaching for the aspirin again. No matter who wins on Nov. 6, most Democrats and Republicans agree in principle that federal spending on Medicare and Medicaid will need to go under the knife, above and beyond the cuts written into the 2010 health-care overhaul.

While history suggests it’s hardly a sure thing that the two parties will reach a deal, even the possibility of one is a risk for institutional health-care providers. That’s because there aren’t a lot of other places to find savings. Congress has so far proved unwilling to slice doctors’ pay. Big Pharma makes for a good populist target, but prescription drugs are less than 10 percent of total Medicare and Medicaid spending. That leaves hospitals and nursing homes.

Hospitals will get $450 billion next year from Medicare, the program for the elderly, and Medicaid, the program for the poor. That’s almost half their total funding, according to federal projections. Nursing homes will get $89 billion, equal to 55 percent of their revenue. Losing any of that money will hurt bottom lines and test business models.

Brookdale Senior Living (BKD), Kindred Healthcare (KND), and Sun Healthcare Group (SUNH), the three largest operators of nursing and residential-care facilities by revenue, declined to answer questions about their preparations for possible future cuts. So did HCA Healthcare (HCA) and Community Health Systems (CYH), the country’s largest hospital companies. In conversations with investors, however, executives have laid out a number of possible strategies.

Hospitals in particular are about to lose as much as to 2 percent of their Medicare revenue under the so-called sequestration bill, passed by Congress in return for raising the debt ceiling in 2011. Those cuts may become a dress rehearsal for dealing with further reductions down the road. At a conference hosted by Morgan Stanley (MS) in September, HCA’s president of operations, Samuel Hazen, said his company would try to cope with the cuts to Medicare, which in 2011 contributed almost one-third of revenue, in part by driving harder deals with suppliers, which make up about a quarter of HCA’s spending.

Those who have worked to diversify their business, like HCA, will feel less of a blow. “There is a lot of activity right now in the consulting side,” HCA Chief Financial Officer R. Milton Johnson said at the conference. HCA’s Parallon Business Solutions subsidiary handles purchasing, payroll, IT, and other functions for other hospitals. Tenet Healthcare (THC), the third-largest U.S. hospital company, has a consulting arm that offers a similar menu of services. The unit, called Conifer Health Solutions, logged a 45 percent jump in revenue in the first half of 2012, compared with the same period last year.

Nursing homes, for their part, are pursuing more options. The chief executive of Brookdale, Bill Sheriff, told investors in the company’s most recent earnings call that Brookdale’s expansion into hospice care and outpatient services such as physical therapy has made an “attractive additional contribution” to revenue, “in spite of governmental rate reductions.” Similarly, Richard Lechleiter, chief financial officer at Kindred, said in an August earnings call that his company’s home health and hospice services are “continuing to grow pretty aggressively.” Revenue from those lines of business tripled in the first half of 2012, to $57.3 million, from a year ago.

Hospitals may have an easier time than nursing homes in cutting costs. That’s because labor costs make up 70 percent of spending at nursing homes, according to Mark Parkinson, president of the American Health Care Association, the industry’s trade group. Some states set minimum staffing ratios, leaving nursing homes less flexibility in cutting payroll.

Those rules may bend if government funding keeps falling. After Florida cut Medicaid payments to nursing homes last year, the state also reduced the number of hours of direct care mandated for nursing home residents. “It’s a sad commentary on what has to happen when these rates get cut,” Parkinson says.

To safeguard against the possibility of further government cuts, many nursing homes are shopping for better deals on their mortgages. During fiscal year 2012, which ended Sept. 30, more than 700 nursing homes got loans through the Federal Housing Administration—with refinancings accounting for slightly more than half of those transactions. That’s an annual record, according to U.S. Department of Housing and Urban Development spokesman Brian Sullivan, who says the agency has also made it easier to process those mortgages.

Even with these steps, managers of nursing homes and hospitals will still be hurting if further cuts are mandated. It may be true that almost one-third of U.S. health-care spending is wasted on unneeded care, fraud, and excessive overhead, according to the Institute of Medicine. Cutting wisely without hurting patient care, however, will require a manager to have the skills of a surgeon and the brains of an accountant.

From: BusinessWeek