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Paul Willging Says...

September 1, 2003
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"Affordability" Might Not Be So Affordable

'Affordability' Might Not Be So Affordable
For years, the assisted living industry has used a benchmark of $25,000 in annual income as the cutoff between affordability and nonaffordability of its product. The data, however, show a different picture altogether. What are the implications for the industry?

Since public funding is directed largely to nursing facilities, and since managed care and long-term care insurance are still limited, the private-pay market continues to be the largest source of revenue for assisted living providers. That fact has focused increased attention on the issue of "affordable" assisted living. Students of "affordability" have placed seniors (particularly those in the 75+ age bracket), into one of three categories: those with annual incomes below $12,000; those with incomes between $12,000 and $25,000; and those with incomes above $25,000. Those in the first category are presumed to be eligible for Medicaid, at least in those states with waiver programs. Those in the third category are assumed to comprise the traditional market for assisted living and congregate services. It is the middle group (the so-called "gap group") that some suggest needs access to affordable assisted living.

But let's start with a quick look at the data. In reality, most residents in market-rate assisted living have annual incomes of less than $25,000. Indeed, a crude comparison of assisted living residents' incomes to the average rate charged by the communities in which they reside reveals that half these residents would not have sufficient monthly income to pay the prevailing rates, were the $25,000 benchmark actually valid. Research suggests that estimates of market demand based solely on numbers of households exceeding a specific income level may miss prospects who have under-reported their income or who have access to additional financial resources (either their assets or help from their families).

While the gap group described above does exist, its size might well be considerably smaller than originally thought. Thus, the primary issue facing assisted living might not be affordability as much as it is consumer awareness and the perceived value of the product.

But, the size of the potential market notwithstanding, the focus on affordability continues unabated. Aspiring to affordability is one thing, though; achieving it is quite another. Opening your community to lower-income residents creates a basic challenge common to the development of any pricing structure-the need to strike a balance between the imperatives of the market and the imperatives of the project. On one hand, you want to be seen as customer-oriented in the local community. On the other, you need to cover your total costs, while delivering acceptable financial ratios.

On the market side, affordability is only one of the many factors involved in setting your prices. Perceived value, competition in the marketplace, the need to plan for likely cost escalation, and your reputation as a provider must all be taken into consideration, as well.

On the project side, the realities driven by your business plan are equally compelling. Indeed, each of the two forces-market and project-will inevitably impact on the other. You need to cover expenses, including debt. You need to provide for the safety margins required by your lenders. You need cash for unforeseen exigencies. You might even want to make a profit! Thus, project-driven considerations will likely determine just how well you can meet those driven by the market, particularly the consideration of affordability, and the converse is equally true.

Assuming affordability is still a goal in view of all this, even for a smaller gap group than was initially anticipated, how can the community achieve it? There are really only two ways. Either your prices have to be reduced, or approaches need to be found either to subsidize the purchaser of service or to help the purchaser convert nonliquid assets into disposable income.

As for reductions in price, they can be achieved either on the development/financing side or in operations. It stands to reason that there is only a short window of opportunity with respect to the first option. Once the project is under construction, financing arrangements have likely been finalized and building design (except, possibly, for some value engineering) has been set in concrete (pun intended). But all this notwithstanding, the opportunities to extract significant savings in financing and development are limited, since those costs themselves make up such a small portion of a project's monthly fees.

So, let's look at operations.

One approach to reducing operating costs (which must actually be considered during the design phase) is shared occupancy. The use of shared units can, of course, have an appreciable impact on monthly fees, reducing them typically from about $2,500 to approximately $1,650-a fairly substantial reduction. However, fees can usually be reduced by only 30 to 40% because, remember, most of your operating costs are labor and other such costs; sharing a room doesn't decrease the amount of staff time allocated to the delivery of personal care services.

There is a real question, too, whether compatible partners can be easily found without violating the critical goals of resident dignity and privacy. Some have argued that the social stimulation that comes with shared occupancy can itself be therapeutic but, ultimately, the customer has to see it that way and desire it. Otherwise, we have simply replicated some of the problems that beset nursing facilities, where shared occupancy (based on the realities of reimbursement systems) has become a way of life.