Five Star Senior Living

Last modified by Asif Farooqui on 2019/10/28 18:41

Overview

Five Star Senior Living (FVE) is a corporation formed under the laws of the State of Maryland in 2001. Five Star Senior Living operates senior living communities, including independent living communities, assisted living communities and skilled nursing facilities, or SNFs. As of December 31, 2016, Five Star Senior Living operated 283 senior living communities located in 32 states with 31,830 living units, including 253 primarily independent and assisted living communities with 29,229 living units and 30 SNFs with 2,601 living units. As of December 31, 2016, Five Star Senior Living owned and operated 26 communities (2,703 living units), Five Star Senior Living leased and operated 189 communities (20,339 living units) and Five Star Senior Living managed 68 communities (8,788 living units). Its 283 senior living communities included 10,772 independent living apartments, 16,179 assisted living suites and 4,879 skilled nursing beds. The foregoing numbers exclude living units categorized as out-of-service.¹

As of December 31, 2016, Five Star Senior Living leased from Senior Housing Properties Trust or its subsidiaries, or SNH, 185 senior living communities pursuant to five long-term leases and managed 68 senior living communities for the account of SNH pursuant to long-term management agreements.

Properties

Five Star Senior Living’s present business plan contemplates the ownership, leasing and management of independent living communities, assisted living communities and SNFs. Some of Five Star Senior Living’s properties combine more than one type of service in a single building or campus.

Independent Living Communities

Independent living communities provide high levels of privacy to residents and require residents to be capable of relatively high degrees of independence. An independent living apartment usually bundles several services as part of a regular monthly charge. For example, the base charge may include one or two meals per day in a central dining room, weekly maid service or social director services. Additional services are generally available from staff employees on a fee for service basis. In some independent living communities, separate parts of the community are dedicated to assisted living or nursing services. As of December 31, 2016, Five Star Senior Living’s operations included 10,772 independent living apartments in 95 communities.

Assisted Living Communities

Assisted living communities are typically comprised of one-bedroom units that include private bathrooms and efficiency kitchens. Services bundled within one charge usually include three meals per day in a central dining room, daily housekeeping, laundry, medical reminders and 24-hour availability of assistance with the activities of daily living such as dressing and bathing. Professional nursing and healthcare services are usually available at the community as requested or at regularly scheduled times. Five Star Senior Living also typically provides Alzheimer or memory care services at Five Star Senior Living’s assisted living communities. As of December 31, 2016, Five Star Senior Living’s operations included 16,179 assisted living suites in 228 communities.

Skilled Nursing Facilities

SNFs generally provide extensive nursing and healthcare services similar to those available in hospitals, without the high costs associated with operating theaters, emergency rooms or intensive care units. A typical purpose built SNF generally includes one or two beds per room 1 with a separate bathroom in each room and shared dining facilities. SNFs are staffed by licensed nursing professionals 24 hours per day. As of December 31, 2016, Five Star Senior Living’s operations included 4,879 skilled nursing beds in 70 communities.

Expansion and Portfolio Composition

Five Star Senior Living has historically grown Five Star Senior Living’s business through acquisitions and by entering into additional long-term lease and management arrangements for senior living communities. More recently, Five Star Senior Living has initiated certain operating initiatives, which are meant to improve occupancy, grow ancillary revenues and improve cash flows from Five Star Senior Living’s senior living communities. Since January 1, 2012, Five Star Senior Living expanded Five Star Senior Living’s business as follows (as of December 31, 2016):

Five Star Senior Living acquired three senior living communities with a combined 266 living units.
Five Star Senior Living entered into management agreements with SNH for 46 senior living communities with a combined 5,497 living units, including adding 22 senior living communities with a combined 1,580 living units in 2015 and 2016. In addition, in June 2016 Five Star Senior Living and SNH terminated three of Five Star Senior Living’s four then existing pooling agreements and entered into 10 new pooling agreements that combine Five Star Senior Living’s management agreements with SNH for senior living communities that include assisted living units.
Five Star Senior Living entered into leases with SNH for, and began to operate two senior living communities with a combined 126 living units (excluding the seven senior living communities Five Star Senior Living sold to SNH in June 2016 that SNH simultaneously leased back to Five Star Senior Living under a new long-term lease agreement).
Five Star Senior Living invested $150.4 million in capital improvements in Five Star Senior Living’s senior living communities, net of amounts Five Star Senior Living sold to SNH for increased annual minimum rent.
Five Star Senior Living opened 59 rehabilitation and wellness outpatient clinics, adding 22 in 2015 and 2016.

Five Star Senior Living continually monitors Five Star Senior Living’s portfolio of senior living communities and Five Star Senior Living’s other assets and Five Star Senior Living has in the past strategically sold some of Five Star Senior Living’s senior living communities and Five Star Senior Living’s other assets and divisions when Five Star Senior Living determined it was in Five Star Senior Living’s best interest to do so. Since January 1, 2012, Five Star Senior Living has focused Five Star Senior Living’s business and reconfigured Five Star Senior Living’s portfolio of assets as follows (as of December 31, 2016):

Five Star Senior Living sold 15 senior living communities, both owned and leased, with a combined 1,286 living units.
In June 2016 Five Star Senior Living sold to SNH seven senior living communities and simultaneously leased these communities back under a new long term lease agreement.
Five Star Senior Living and SNH completed the sale of the real estate and the transfer of operations at 2 rehabilitation hospitals and 13 outpatient clinics affiliated with those rehabilitation hospitals to unrelated third parties in 2013. Five Star Senior Living previously leased the rehabilitation hospitals from SNH and the outpatient clinics from others.
Five Star Senior Living completed the sale of Five Star Senior Living’s pharmacy business to an unrelated third party in 2012.
SNH sold a memory care building that Five Star Senior Living historically managed and the separate management agreement for this building was terminated as a result.

The result of Five Star Senior Living’s senior living expansions and portfolio reconfiguration has increased Five Star Senior Living’s focus on operating senior living communities. In addition, Five Star Senior Living recently changed Five Star Senior Living’s name to Five Star Senior Living Inc. This name change reflects Five Star Senior Living’s current business focus, and represents the evolution of Five Star Senior Living’s business from being primarily a clinical caregiver to a full service senior living company. This name change reflects Five Star Senior Living’s focus on not just providing high quality clinical care but also providing hospitality and personalized services and amenities to enhance the lifestyle of Five Star Senior Living’s residents.

Financing Sources

In February 2017, Five Star Senior Living replaced Five Star Senior Living’s then existing $100.0 million secured revolving credit facility, or Five Star Senior Living’s prior credit facility, which was scheduled to mature in April 2017, with a new $100.0 million secured revolving credit facility, or Five Star Senior Living’s new credit facility, which is available for general business purposes, including acquisitions. Five Star Senior Living’s new credit facility matures in February 2020. Subject to Five Star Senior Living’s payment of extension fees and meeting other conditions, Five Star Senior Living has options to extend the stated maturity date of Five Star Senior Living’s new credit facility for two, one-year periods. Five Star Senior Living are required to pay interest on borrowings under Five Star Senior Living’s new credit facility at an annual rate of LIBOR plus a premium of 250 basis points, and also a quarterly commitment fee of 0.35% per annum on the unused part of Five Star Senior Living’s new credit facility. Five Star Senior Living can borrow, repay and re-borrow funds available under Five Star Senior Living’s new credit facility until maturity, and no principal repayment is due until maturity. Five Star Senior Living’s new credit facility is secured by real estate mortgages on 10 senior living communities with a combined 1,219 living units owned by Five Star Senior Living’s guarantor subsidiaries and Five Star Senior Living’s guarantor subsidiaries’ accounts receivable and related collateral.

In addition, Five Star Senior Living has regularly sold to SNH certain capital improvements Five Star Senior Living make to Five Star Senior Living’s senior living communities that Five Star Senior Living lease from SNH. Five Star Senior Living pay increased annual minimum rent to SNH in accordance with the terms of Five Star Senior Living’s leases with SNH because of these sales. Five Star Senior Living expect to continue to make similar capital improvement sales to SNH in the future; however, SNH is not obligated to purchase these capital improvements from Five Star Senior Living.

Five Star Senior Living also has mortgage debt that Five Star Senior Living assumed in connection with Five Star Senior Living’s acquisitions of six of Five Star Senior Living’s senior living communities. Five Star Senior Living may assume additional mortgage debt in connection with future acquisitions or Five Star Senior Living may place mortgages on properties Five Star Senior Living own. Five Star Senior Living may also seek to obtain other additional sources of financing in the future, including term debt or issuing equity or debt securities.

Growth Strategy

Five Star Senior Living believes that the aging of the U.S. population will increase demand for senior living communities and services. Five Star Senior Living plan to profit from this demand by:

Improving the profitability of Five Star Senior Living’s existing operations by increasing revenues and improving operating margins and operating communities that provide high quality services to residents who pay with private resources;
Acquiring additional senior living communities and entering into leases and management agreements for additional senior living communities;
Continuing to develop public awareness of the Five Star Senior Living brand through various marketing efforts and initiatives; and
Growing Five Star Senior Living’s ancillary services to complement existing senior living operations, including increasing Five Star Senior Living’s offerings of outpatient therapy services, home healthcare and concierge services to Five Star Senior Living’s residents and to seniors living outside of Five Star Senior Living’s communities.

Five Star Senior Living seeks to improve the profitability of Five Star Senior Living’s existing senior living operations by increasing revenues through increases in occupancy and in the rates Five Star Senior Living charge, by improving Five Star Senior Living’s operating margins, by managing Five Star Senior Living’s expenses prudently and otherwise improving Five Star Senior Living’s operating efficiencies and by operating communities that provide high quality services to residents who pay with private resources. Five Star Senior Living also seek to improve profitability through continued strategic capital investments at Five Star Senior Living’s senior living communities. In addition to routine renovations and upgrades at Five Star Senior Living’s senior living communities, Five Star Senior Living seeks to expand Five Star Senior Living’s senior living communities when and as opportunities arise. For example, Five Star Senior Living is currently in the process of adding approximately 120 units at certain of Five Star Senior Living’s senior living communities, and Five Star Senior Living intend to pursue additional expansion projects during 2017.

Five Star Senior Living regularly seeks to grow Five Star Senior Living’s business through acquisitions of senior living communities, by entering into additional long term leases and management agreements for senior living communities where residents’ private resources account for all or a large majority of revenues and by selectively expanding certain of Five Star Senior Living’s senior living communities. Since Five Star Senior Living became a public company in 2001, Five Star Senior Living has acquired or commenced leasing 185 senior living communities and began managing 68 senior living communities. For the year ended December 31, 2016, approximately 88% of revenues at the communities Five Star Senior Living began operating since 2001 are derived from residents’ private resources rather than from Medicare and Medicaid.

Five Star Senior Living also continues to develop public awareness of the Five Star Senior Living brand through various marketing initiatives that Five Star Senior Living believes differentiate Five Star Senior Living from other senior living operators. For example, because an exceptional dining experience is often a top priority for senior living community residents, in recent years Five Star Senior Living believes that Five Star Senior Living redefined the dining experience offered at Five Star Senior Living’s senior living communities by partnering with a celebrity chef and creating the ‘‘Five Star Culinary Institute’’ where the chefs at Five Star Senior Living’s senior living communities receive training. Five Star Senior Living also introduced ‘‘Lifestyle360’’, a wellness program focused on the five dimensions of wellness (social, intellectual, spiritual, emotional and physical). Five Star Senior Living believes these programs, among others, create brand equity among current and prospective residents and their families and provide Five Star Senior Living with an opportunity to improve Five Star Senior Living’s operating performance. Five Star Senior Living’s recent name change reflects Five Star Senior Living’s focus on not just providing high quality clinical care but also providing hospitality and other services to enhance the lifestyle of Five Star Senior Living’s residents.

Through Five Star Senior Living’s ancillary services, Five Star Senior Living offers skilled rehabilitation services for short term inpatient stays, such as after joint replacement surgery; home health care in Five Star Senior Living’s assisted living communities; outpatient rehabilitation for people of all ages; and long term skilled nursing care by highly trained professionals. The therapy services Five Star Senior Living offers include physical, occupational, speech and other specialized therapy services. The home health services Five Star Senior Living provides include skilled nursing, physical therapy, occupational therapy, speech language pathology, home health aide services, and social services as needed. In addition, Five Star Senior Living offers personalized concierge services to accommodate Five Star Senior Living’s resident’s specific lifestyle and needs. Concierge services include personal shopping, companion services, enhanced transportation, medication reminders, bedtime assistance, and personalized dining and nutrition planning, delivery and consultation. By providing residents with a range of service options as their needs change, Five Star Senior Living provides greater continuity of care, which Five Star Senior Living believes may encourage Five Star Senior Living’s customers to maintain residency with Five Star Senior Living for a longer period of time while receiving the care and services they need.

Operating Structure

Five Star Senior Living has five operating divisions. Four of these divisions are each responsible for senior living communities located in multiple geographic regions. Each region’s management is responsible for independent living, assisted living and skilled nursing units within its region. The fifth division is responsible for the provision of rehabilitation and wellness services in the inpatient setting and in outpatient clinics. Each division is headed by a divisional vice president with extensive experience in the senior living industry, and is managed from Five Star Senior Living’s regional offices. Five Star Senior Living’s regional offices are responsible for Five Star Senior Living’s senior living communities located within a specified geographic region and are headed by regional directors of operations that have extensive experience in the senior living industry. Each regional office is typically supported by a clinical or wellness director, a rehabilitation services director, a regional accounts manager, a human resources specialist and a sales and marketing specialist. Regional office staff is responsible for all of Five Star Senior Living’s senior living community operations, including:

Resident services;
Medicare and Medicaid billing;
Sales and marketing;
Hiring of community personnel;
Compliance with applicable legal and regulatory requirements; and
Supporting Five Star Senior Living’s development and acquisition plans within their region.

Five Star Senior Living’s corporate headquarters staff, which is located in Massachusetts, is responsible for corporate level systems, policies and procedures, such as:

Company wide policies and procedures;
Human resources;
Information technology services;
Private pay billing for Five Star Senior Living’s independent and assisted living communities;
Licensing and certification maintenance;
Legal services and regulatory compliance;
Central purchasing;
Budgeting and supervision of maintenance and capital expenditures;
Implementation of Five Star Senior Living’s growth strategy; and
Accounting, auditing and finance functions, including operations, budgeting, certain accounts receivable and collections functions, accounts payable, payroll, tax and financial reporting.

Five Star Senior Living has a business management agreement with The RMR Group LLC, or RMR LLC, pursuant to which RMR LLC provides to Five Star Senior Living certain business management services, including services related to compliance with various laws and rules applicable to Five Star Senior Living’s status as a publicly owned company, including Five Star Senior Living’s internal audit function, capital markets and financing activities and investor relations.

Staffing

Independent and Assisted Living Community Staffing

Each of Five Star Senior Living’s independent and assisted living communities has an executive director that is responsible for the day-to-day operations of the applicable community, including quality of care, resident services, sales and marketing, financial performance and staff supervision. The executive director is supported by department heads who oversee the care and service of Five Star Senior Living’s residents, a wellness director who is responsible for coordinating the services necessary to meet the healthcare needs of Five Star Senior Living’s residents and a sales director who is responsible for sales and promoting Five Star Senior Living’s services and brand. These communities also typically have a dining services coordinator, an activities coordinator and a property maintenance coordinator.

Skilled Nursing Facility Staffing

Each of Five Star Senior Living’s SNFs is managed by a state licensed administrator who is supported by other professional personnel, including a director of nursing, an activities director, a marketing director, a social services director, a business office manager and physical, occupational and speech therapists. Five Star Senior Living’s directors of nursing are state licensed nurses who supervise Five Star Senior Living’s registered nurses, licensed practical nurses and nursing assistants. Staff size and composition vary among Five Star Senior Living’s SNFs depending on the size and occupancy of, and the type of care provided at, the applicable SNF. Five Star Senior Living’s SNFs also contract with physicians who provide certain medical services.E

Employee

As of February 17, 2017, Five Star Senior Living had approximately 24,500 employees, including approximately 16,000 full time equivalents. Five Star Senior Living believes Five Star Senior Living’s relations with Five Star Senior Living’s employees are good.

Government Regulation and Reimbursment

The senior living and healthcare industries are subject to extensive and frequently changing federal, state and local laws and regulations. These laws and regulations vary by jurisdiction but may address, among other things, licensure, personnel training, staffing ratios, types and quality of medical care, physical facility requirements, government healthcare program participation, fraud and abuse, payments for patient services and patient records.

Five Star Senior Living is subject to, and Five Star Senior Living’s operations must comply with, these laws and regulations. From time to time, Five Star Senior Living’s communities receive notices from federal, state and local agencies regarding noncompliance with such requirements. Upon receipt of these notices, Five Star Senior Living reviews them for correctness and, based on Five Star Senior Living’s review, Five Star Senior Living either take corrective action or contest the allegation of noncompliance. When corrective action is required, Five Star Senior Living works with the relevant agency to address and remediate any violations. Challenging and appealing any notices or allegations of noncompliance require the expenditure of significant legal fees and management attention. Any adverse determination concerning any of Five Star Senior Living’s licenses or eligibility for Medicare or Medicaid reimbursement, any penalties, repayments or sanctions, and the increasing costs of required compliance with applicable laws may adversely affect Five Star Senior Living’s ability to meet Five Star Senior Living’s financial obligations and negatively affect Five Star Senior Living’s financial condition and results of operations. Also, adverse findings with regard to any one of Five Star Senior Living’s communities may have an adverse impact on Five Star Senior Living’s licensing and ability to operate and attract residents to other communities.

The healthcare industry depends significantly upon federal and state programs for revenues and, as a result, is affected by the budgetary policies of both the federal and state governments. Reimbursements under the Medicare and Medicaid programs for skilled nursing, physical therapy and rehabilitation and wellness services provided operating revenues at Five Star Senior Living’s outpatient clinics and some of Five Star Senior Living’s senior living communities (principally Five Star Senior Living’s SNFs). Five Star Senior Living derived approximately 22%, 22% and 23% of Five Star Senior Living’s consolidated revenues from continuing operations from Medicare and Medicaid programs for each of the years ended December 31, 2016, 2015 and 2014, respectively.

In addition to existing government regulation, Five Star Senior Living is aware of numerous healthcare regulatory initiatives on the federal, state and local levels, which may affect Five Star Senior Living’s business operations if implemented.

Independent Living Communities

Government benefits are not generally available for services at independent living communities, and residents in those communities use private resources to pay for their living units and the services they receive. The rates in these communities are determined by local market conditions and operating costs. However, a number of federal Supplemental Security Income program benefits pay housing costs for elderly or disabled recipients to live in these types of residential communities. The Social Security Act requires states to certify that they will establish and enforce standards for any category of group living arrangement in which a significant number of Supplemental Security Income recipients reside or are likely to reside. Categories of living arrangements that may be subject to these state standards include independent living communities and assisted living communities. Because independent living communities usually offer common dining facilities, in many jurisdictions they are required to obtain licenses applicable to food service establishments in addition to complying with land use and life safety requirements. In addition, in some states, state or county health departments, social service agencies and/or offices on aging have jurisdiction over group residential communities for seniors and license independent living communities. To the extent that independent living communities include units to which assisted living or nursing services are provided, these units are subject to applicable state licensing regulations. If the communities receive Medicaid or Medicare 6 funds, they are subject to certification standards and Conditions of Participation. In some states, insurance or consumer protection agencies regulate independent living communities in which residents pay entrance fees or prepay for services.

Assisted Living Communities

A majority of states provide or are approved to provide Medicaid payments for personal care and medical services to some residents in licensed assisted living communities under waivers granted by or under Medicaid state plans approved by the Centers for Medicare and Medicaid Services, or CMS, of the United States Department of Health and Human Services, or HHS. State Medicaid programs control costs for assisted living and other home and community based services by various means such as restrictive financial and functional eligibility standards, enrollment limits and waiting lists. Because rates paid to assisted living community operators are generally lower than rates paid to SNF operators, some states use Medicaid funding of assisted living as a means of lowering the cost of services for residents who may not need the higher level of health services provided in SNFs. States that administer Medicaid programs for services in assisted living communities are responsible for monitoring the services at, and physical conditions of, the participating communities.

As a result of the large number of states using Medicaid funds to purchase services at assisted living communities and the growth of assisted living in recent years, states have adopted licensing standards applicable to assisted living communities. According to the National Center for Assisted Living and the HHS Office of the Assistant Secretary for Planning and Evaluation, all states regulate assisted living and residential care communities, although states do not use a uniform approach. Most state licensing standards apply to assisted living communities regardless of whether they accept Medicaid funding. Also, according to the National Conference of State Legislatures, a few states require certificates of need, or CONs, from state health planning authorities before new assisted living communities may be developed. Based on Five Star Senior Living’s analysis of recent economic and regulatory trends, Five Star Senior Living believes that assisted living communities that become dependent upon Medicaid or other government payments for a majority of their revenues may decline in value because Medicaid and other public rates may fail to keep up with increasing costs. Five Star Senior Living also believes that assisted living communities located in states that adopt CON requirements or other limitations on the development of new assisted living communities may increase in value because those limitations may help ensure higher nongovernment rates and reduced competition.

HHS, the Senate Special Committee on Aging, and the Government Accountability Office, or the GAO, have studied and reported on the development of assisted living and its role in the continuum of long term care and as an alternative to SNFs. Since 2003, CMS has commenced a series of actions to increase its oversight of state quality assurance programs for assisted living communities and has provided guidance and technical assistance to states to improve their ability to monitor and improve the quality of services paid for through Medicaid waiver programs. CMS is encouraging state Medicaid programs to expand their use of home and community based services as alternatives to institutional services, pursuant to provisions of the Deficit Reduction Act of 2005, or the DRA, the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act, or collectively, the ACA, and other authorities, through the use of several programs. One such program, the Community First Choice Option, or the CFC Option, grants states that choose to participate in the program a 6% increase in federal matching payments for related medical assistance expenditures. As of March 2016, eight states had obtained a State Plan Amendment to participate in the CFC Option. Five Star Senior Living is unable to predict the effect of the implementation of the CFC Option and other similar programs, but their impact may be adverse and material to Five Star Senior Living’s operations and Five Star Senior Living’s future financial results of operations.

Skilled Nursing Facilities

Skilled Nursing Facilities—Reimbursement

A majority of all SNF revenues in the United States comes from publicly funded programs. According to CMS, Medicaid is the largest source of public 7 funding for SNFs, followed by Medicare. In 2015, approximately 32% of nursing care facility and continuing care retirement community revenues came from Medicaid and 24% from Medicare.

SNFs are highly regulated businesses. The federal and state governments regularly monitor the quality of care provided at SNFs. State health departments conduct surveys of resident care and inspect the physical condition of SNF properties. These periodic inspections and occasional changes in life safety and physical plant requirements sometimes require SNF operators to make significant capital improvements. These mandated capital improvements have usually resulted in Medicare and Medicaid rate adjustments, albeit on the basis of amortization of expenditures over the expected useful lives of the improvements.

Under the Medicare SNF prospective payment system, or SNF PPS, capital costs are part of the prospective rate and are not community specific. The SNF PPS and other recent legislative and regulatory actions with respect to state Medicaid rates limit the reimbursement levels for some SNF services. At the same time, federal and state enforcement agencies have increased oversight of SNFs, making licensing and certification of these communities more rigorous.

CMS implemented the SNF PPS pursuant to the Balanced Budget Act of 1997. Under the SNF PPS, SNFs receive a fixed payment for each day of care provided to residents who are Medicare beneficiaries. The SNF PPS requires SNFs to assign each resident to a care group depending on that resident’s medical characteristics and service needs. These care groups are known as Resource Utilization Groups, or RUGs, and CMS establishes a per diem payment rate for each RUG. Effective October 2010, CMS adopted rules that implemented a new SNF PPS case mix classification system known as RUG-IV. CMS also requires the use of a resident assessment instrument called the Minimum Data Set 3.0, which SNFs must use to collect clinical data to assign residents to RUG-IV reimbursement categories. Medicare SNF PPS payments cover substantially all services provided to Medicare residents in SNFs, including ancillary services such as rehabilitation therapies.

CMS updates SNF PPS payment rates each year by a market basket update to account for inflation and periodically implements changes to the RUG categories and payment rates. Since federal fiscal year 2012, the ACA has also reduced SNF PPS payment rates each year by a productivity adjustment based on national economic productivity statistics. Following the implementation of RUG-IV, Medicare billing increased nationally, partially because of the unexpectedly large proportion of patients grouped in the highest paying RUG therapy categories. CMS did not intend for the implementation of RUG-IV to increase Medicare billing. In 2011, CMS adopted a final rule designed to recalibrate the Medicare SNF PPS, which resulted in a reduction in aggregate Medicare payment rates for SNFs of approximately 11.1%, or $3.87 billion, in federal fiscal year 2012. In subsequent years, CMS slightly increased the Medicare SNF PPS rates and estimated that those rates would increase payments to SNFs by an aggregate of approximately 1.8% for federal fiscal year 2013, 1.3% for federal fiscal year 2014, 2.0% for federal fiscal year 2015 and 1.2% for federal fiscal year 2016. In July 2016, CMS issued a final rule updating Medicare payments to SNFs for federal fiscal year 2017, which CMS estimated would increase payments to SNFs by an aggregate of 2.4%, or approximately $920.0 million, compared to payments in federal fiscal year 2016. Due to the previous reduction of Medicare payment rates of approximately 11.1% for federal fiscal year 2012 discussed above, however, Medicare payment rates will be lower for federal fiscal year 2017 than they were in federal fiscal year 2011. The Medicare Access and CHIP Reauthorization Act of 2015, or MACRA, discussed below, limits the market basket increase for SNFs to 1.0% in federal fiscal year 2018. It is unclear whether these adjustments in Medicare rates will compensate for the increased costs Five Star Senior Living may incur for services to Five Star Senior Living’s residents whose services are paid for by Medicare.

The Middle Class Tax Relief and Job Creation Act of 2012, which was enacted in February 2012, incrementally reduced the SNF reimbursement rate for Medicare bad debt from 100% to 65% by federal fiscal year 2015 for beneficiaries dually eligible for Medicare and Medicaid. Because nearly 90% 8 of SNF bad debt has historically been related to dual eligible beneficiaries, this rule has a substantial negative effect on SNFs, including some that Five Star Senior Living operates. The same law also reduced the SNF Medicare bad debt reimbursement rate for Medicare beneficiaries not eligible for Medicaid from 70% to 65% in federal fiscal year 2013 and going forward.

In addition, the Budget Control Act of 2011 and the Bipartisan Budget Act of 2013 allow for automatic reductions in federal spending by means of a process called sequestration, which reduces Medicare payment rates by 2.0% through 2023. In 2014 and 2015, Congress approved two additional one year extensions of Medicare sequestration, through 2025. Medicaid is exempt from the automatic reductions, as are certain Medicare benefits. The automatic 2.0% payment cuts took effect in April 2013 and had an adverse effect on Five Star Senior Living’s operations and financial results. Subsequent legislation appears to have modified some aspects of the sequestration process, but at this time it is unclear what impact this legislation may have on Medicare payments Five Star Senior Living receives. Any future reductions in Medicare payment rates could be adverse and material to Five Star Senior Living’s operations and to Five Star Senior Living’s future financial results of operations.

The federal government is seeking to slow the growth of Medicare and Medicaid payments for SNF services by several methods. In 2006, the government implemented limits on Medicare payments for outpatient therapies and then, pursuant to the DRA, created an exception process under which beneficiaries could request an exception from the cap and be granted the amount of services deemed medically necessary by Medicare. In April 2014, the Protecting Access to Medicare Act of 2014, or PAMA, extended the Medicare outpatient therapy cap exception process through March 2015, further postponing the implementation of firm limits on Medicare payments for outpatient therapies. PAMA also extended the 0.5% increase to the Medicare Physician Fee Schedule, or MPFS, rates through December 2014 and provided no increase in the MPFS rates, to which Five Star Senior Living’s Medicare outpatient therapy rates are tied, in the period between January 2015 and March 2015. In April 2015, Congress passed MACRA, which extended the outpatient therapy cap exceptions process from March 2015 through December 2017, further postponing the implementation of strict limits on Medicare payments for outpatient therapies. MACRA also repealed the Sustainable Growth Rate, or SGR, formula for calculating updates to MPFS rates, which would have led to a 21.2% rate reduction effective April 2015, and replaced the SGR formula with a different reimbursement methodology, which is discussed in more detail below. Under MACRA, there were and will be MPFS conversion factor updates of 0.0% from January 2015 through June 2015, 0.5% from July 2015 through December 2015, 0.5% each year from 2016 through 2019 and 0.0% from 2020 through 2025.

The DRA established the five year Money Follows the Person demonstration project in 2007 to award competitive grants to 30 states to provide home and community based long term care services to qualified individuals relocated from SNFs, and to increase federal medical assistance for each qualifying beneficiary for a limited time period. The ACA expanded eligibility for this program and extended this program for an additional five years through 2016. According to the Henry J. Kaiser Family Foundation, as of May 2016, 43 states and the District of Columbia had operational Money Follows the Person programs. The DRA also established the Post-Acute Care Payment Reform demonstration project under which CMS compared and assessed patient care needs, costs and outcomes of services at different post-acute care sites over three years. In January 2012, CMS issued a report to Congress regarding the project stating that CMS had successfully used a new uniform patient assessment tool to measure patient acuity in acute care hospitals and post-acute settings, providing the basis for the potential development of new standardized information reporting requirements and more uniform post-acute case mix payment systems. States are also permitted to include home and community based services as optional services under their Medicaid state plans or through Medicaid waiver programs, and states opting to do so may establish more stringent needs based criteria for SNF services than for home and community based services. The ACA expands the services that states may provide and limits their 9 ability to set caps on enrollment, waiting lists or geographic limitations on home and community based services.

In addition, the DRA increased the ‘‘look-back’’ period for prohibited asset transfers that disqualify individuals from Medicaid SNF benefits from three to five years. The period of Medicaid ineligibility begins on the date of the prohibited transfer or the date an individual has entered the SNF and would otherwise be eligible for Medicaid coverage, whichever occurs later, rather than on the date of the prohibited transfer, effectively extending the Medicaid penalty period and requiring SNFs to collect charges directly from residents and their transferees.

Although Medicaid is exempt from the sequestration process described above, some of the states in which Five Star Senior Living operates either have not raised Medicaid rates by amounts sufficient to offset increasing costs or have frozen or reduced, or are expected to freeze or reduce, Medicaid rates. Some states are expanding their use of managed care, partly to control Medicaid program costs. According to the CMS Office of the Actuary, Medicaid enrollment is estimated to have increased 9.2% in 2014, 7.6% in 2015 and 3.1% in 2016, due primarily to the expansion in Medicaid eligibility under the ACA, which began in 2014. In addition, Medicaid enrollment is projected to increase at an average annual rate of 1.5% from 2016 through 2025.

Five Star Senior Living is unable to predict the impact on Five Star Senior Living of these or other recent legislative and regulatory actions or proposed actions with respect to federal Medicare rates, state Medicaid rates and the federal payments to states for Medicaid programs.

Skilled Nursing Facilities—Quality Improvement, Pay-for-Performance and Value-Based Purchasing Initiatives.

In addition to the reimbursement and rate changes discussed above, payments to SNFs will be increasingly determined by the quality of care provided. The federal government has enhanced its focus on developing and imposing quality-related regulations, standards and programs to improve the quality of care provided at SNFs and to better align payment to quality outcomes. As mandated by MACRA, PAMA and the Improving Medicare Post-Acute Care Transformation Act of 2014, or the IMPACT Act, HHS and CMS have established different programs to achieve these goals, including the Quality Payment Program, the SNF Value-Based Purchasing Program and the SNF Quality Reporting Program described below. In addition, CMS maintains and enforces Conditions of Participation that healthcare organizations must meet in order to participate in the Medicare and Medicaid programs. These standards are designed to improve quality of care and protect the health and safety of beneficiaries. Through the Conditions of Participation, CMS is able to require certain quality standards protocols, including most recently, requiring SNFs to implement a quality assurance and performance improvement program. Five Star Senior Living is unable to predict the impact of these quality improvement initiatives on Five Star Senior Living’s Medicare reimbursement rates or the cost of Five Star Senior Living’s SNFs’ operations.

In October 2016, CMS issued a final rule to implement the Merit-Based Incentive Payment System, or MIPS, and Advanced Alternative Payment Models, or APMs, which together CMS calls the Quality Payment Program. These reforms were mandated under MACRA and replace the SGR methodology for updates to the MPFS to which Five Star Senior Living’s Medicare outpatient therapy rates are tied. Starting in 2019, providers may be subject to either MIPS payment adjustments or APM incentive payments. MIPS is a new Medicare program that combines certain parts of existing quality and incentive programs into a single program that addresses quality, resource use, clinical practice activities and meaningful use of electronic health records. APMs are innovative models approved by CMS for paying healthcare providers for services provided to Medicare beneficiaries which draw on existing programs, such as the bundled payment and shared savings models. Five Star Senior Living’s Medicare Part B outpatient therapy revenue rates are tied to the MPFS and may be affected by these regulatory changes.

PAMA established a SNF Value-Based Purchasing Program, which is intended to increase quality of care and reduce preventable hospitalizations. Under this program, HHS will assess SNFs based on hospital readmissions and make these assessments available to the public by October 2017. As part of 10 PAMA implementation, in the SNF PPS final rule for fiscal year 2016, CMS adopted a 30 day all-cause, all-condition hospital readmission measure for SNFs, which was replaced with an all-condition, risk-adjusted potentially preventable hospital readmission rate measure in the SNF PPS final rule for fiscal year 2017. Under PAMA, beginning in federal fiscal year 2019, Medicare payment rates will be partially based on SNFs’ performance scores on this measure. To fund the program, CMS will reduce Medicare payments to all SNFs by 2.0% through a withhold mechanism starting in October 2018 and then redistribute between 50% and 70% of the withheld payments as incentive payments to those SNFs with the highest rankings on this measure.

In October 2014, President Obama signed into law the IMPACT Act, which requires certain post-acute care providers, including SNFs, to begin collecting and reporting various types of data. Specifically, under the SNF Quality Reporting Program, HHS required SNFs to begin reporting certain quality measures and resource use measures in a standardized and interoperable format as of October 2016 and to begin reporting certain patient assessment data in such a format by October 2018. Beginning in federal fiscal year 2018, SNFs that fail to timely comply with the reporting requirements will be subject to a 2.0% reduction in their Medicare payment rates for that fiscal year. Beginning October 2018, HHS will make this data publicly available pursuant to certain procedures to be established. The IMPACT Act also requires the Secretary of HHS and the Medicare Payment Advisory Commission to submit reports to Congress recommending a future Medicare PPS for post-acute care providers and analyzing both its effects on the reported metrics and financial effect on post-acute care providers.

In September 2016, CMS issued a final rule to comprehensively update the Conditions of Participation for long term care facilities that participate in Medicare and Medicaid, such as Five Star Senior Living’s SNFs. The final rule, which went into effect beginning in November 2016, institutes a broad range of new requirements, some of which stem from statutory modifications under the ACA and the IMPACT Act. The requirements under the final rule largely match those set forth in the proposed rule, which was released by CMS in July 2015. In particular, the final rule requires Five Star Senior Living’s SNFs, in a multi-phased approach over the next few years, to: train staff on care for residents with dementia and on abuse prevention; consider residents’ health needs when making decisions about the kinds and levels of staffing; ensure that staff have the appropriate skills and competencies to provide individualized, resident centered care; augment care planning activities, including considering residents’ goals and preferences and, on discharge, giving residents necessary follow up information and improving communication with receiving facilities or services; permit dietitians and therapy providers to write orders under certain circumstances; meet heightened food and nutrition services requirements; implement an updated infection prevention and control program, including requiring each of Five Star Senior Living’s SNFs to designate an infection prevention and control officer; and strengthen residents’ rights. In addition, the final rule requires Five Star Senior Living’s SNFs to: alter their staffing levels and competencies based on the results of mandated facility assessments; develop, implement and maintain a compliance and ethics program and a quality assurance and performance improvement program; and implement new practices surrounding the preparation and implementation of care plans and discharge summaries, among other new requirements. These requirements will increase the cost of operations for long term care facilities that participate in Medicare and Medicaid, including Five Star Senior Living’s SNFs. Specifically, CMS estimated in the final rule that the cost of complying with all of the new requirements per facility would be approximately $62,900 in the first year, and approximately $55,000 each year thereafter. However, Five Star Senior Living believes new requirements often cost considerably more than CMS estimates.

In August 2015, CMS announced that it will conduct the second phase of another SNF quality improvement program, the Initiative to Reduce Avoidable Hospitalizations Among Nursing Facility Residents, a pilot program first announced in 2012, which will be continued in partnership with selected organizations from October 2016 to October 2020. In this phase of the initiative, participants will test whether a new payment model for SNFs and practitioners, together with clinical and educational 11 interventions that participants are currently implementing, will further reduce avoidable hospitalizations, lower combined Medicare and Medicaid spending and improve the quality of care received by long stay SNF residents.

As these quality improvement initiatives increase in size and scope, the federal government will likely monitor the impact of these programs more closely. For example, in October 2015, the GAO released a report calling for CMS to improve its data collection and oversight of SNFs to facilitate enhanced monitoring of the success of CMS’s quality improvement activities, and HHS concurred with the GAO’s recommendations. We are unable to predict the impact on Five Star Senior Living of these or other recent legislative and regulatory quality improvement actions or proposed actions.

Skilled Nursing Facilities—Survey and Enforcement

Pursuant to the Omnibus Reconciliation Act of 1987, Congress enacted major reforms to federal and state regulatory systems for SNFs that participate in the Medicare and Medicaid programs. Since then, the GAO has reported that, although much progress has been made, substantial problems remain in the effectiveness of federal and state regulatory activities. The HHS Office of Inspector General, or the OIG, has issued several reports concerning quality of care and billing practices in SNFs, and the GAO has issued several reports recommending that CMS and states strengthen their compliance and enforcement practices, including federal oversight of state actions and to ensure that SNFs provide adequate care and states act more consistently. Moreover, in its fiscal year 2017 work plan, the OIG specifically stated that it will review compliance with various aspects of the SNF PPS, including the documentation requirement in support of claims paid by Medicare, and assess the incidence of serious quality of care issues, such as neglect. In recent years, the OIG and the GAO have also repeatedly called for increased oversight and payment system reform for SNFs.

In June 2015, the OIG issued a report calling for CMS to accelerate efforts to implement a new method for paying SNFs for therapy, based on findings that many SNFs incorrectly or inconsistently used CMS’s new patient assessments. The OIG also recommended that CMS reduce the financial incentive for SNFs to use assessments differently when decreasing and increasing therapy services and that it strengthen the oversight of SNF billing for changes in therapy. CMS concurred with these recommendations. In September 2015, the OIG issued another report questioning the appropriateness of payments to SNFs under the SNF PPS, and stating that Medicare payments for therapy greatly exceeded SNFs’ costs for therapy. The OIG recommended that CMS evaluate the extent to which Medicare payment rates for therapy should be reduced, change the method for paying for therapy, adjust Medicare payments to eliminate any increases that are unrelated to beneficiary characteristics and strengthen oversight of SNF billing. CMS concurred with these recommendations and noted that it is working to identify potential alternative methodologies for paying for SNF PPS services, including therapy.

In addition to scrutiny from the GAO and the OIG, the Senate Special Committee on Aging and other congressional committees have also held hearings on related SNF issues. As a result, CMS has undertaken several initiatives to increase the effectiveness of Medicare and Medicaid SNF survey and enforcement activities. CMS has been taking steps to identify and focus enforcement efforts on SNFs and chains of SNF operators with findings of substandard care or repeat violations of Medicare and Medicaid standards. CMS has also increased its oversight of state survey agencies and has improved the process by which data is captured from these surveys. As an added measure of improving patient care, the ACA provides for the funding of a state background check system for job applicants to long term care providers who will have direct access to patients. CMS has begun the administration of this program, and, as of December 2016, had awarded funding to approximately half of the states.

In addition, CMS adopted regulations expanding federal and state authority to impose civil monetary penalties in instances of noncompliance. When CMS or state agencies identify deficiencies under state licensing and Medicare and Medicaid standards, they may impose sanctions and remedies 12 such as denials of payment for new Medicare and Medicaid admissions, civil monetary penalties, state oversight, temporary management or receivership and loss of Medicare and Medicaid participation or licensure on SNF operators. Five Star Senior Living’s communities may incur sanctions and penalties from time to time. If we are unable to cure deficiencies that have been identified or that are identified in the future, or if appeals of proposed sanctions or penalties are not successful, decertification or additional sanctions or penalties may be imposed. These consequences may adversely affect Five Star Senior Living’s ability to meet Five Star Senior Living’s financial obligations and negatively affect Five Star Senior Living’s financial condition and results of operations.

Certificates of Need

As a mechanism to prevent overbuilding and subsequent healthcare price inflation, many states limit the number of SNFs by requiring developers to obtain CONs before new facilities may be built or additional beds may be added to existing facilities. As noted above, a few states also limit the number of assisted living facilities by requiring CONs. In addition, some states (such as California and Texas) that have eliminated CON laws have retained other means of limiting new development, including moratoria, licensing laws or limitations upon participation in the state Medicaid program. These government requirements limit expansion, which Five Star Senior Living believes may make existing SNFs more valuable by limiting competition.

Healthcare Reform

The ACA, signed into law in March 2010, has resulted in changes to insurance, payment systems and healthcare delivery systems. The ACA is intended to expand access to health insurance coverage and reduce the growth of healthcare expenditures while simultaneously maintaining or improving the quality of healthcare. Some of the provisions of the ACA took effect immediately, whereas others will take effect at later dates. Due to the complexity of the ACA, its ramifications may only become apparent through later regulatory and judicial interpretations. In addition, to the extent the ACA is repealed and replaced under the new Trump Administration and the 115th Congress, additional risks and regulatory uncertainty may arise. Depending upon what aspects of the ACA are repealed and whether and how they are replaced, Five Star Senior Living’s future financial results could be adversely and materially affected.

The ACA establishes an Independent Payment Advisory Board to submit legislative proposals to Congress and take other actions with a goal of reducing Medicare spending growth. When and if such spending reductions take effect they may be adverse and material to Five Star Senior Living’s financial results. The ACA also provides for the National Pilot Program on Payment Bundling to develop and evaluate making bundled payments for services provided during an episode of care, to include hospital and physician services and post-acute care such as SNF services. The pilot program can be expanded at any point after January 2016 if it meets its goals. The ACA also includes the development of Medicare value-based purchasing plans to include quality measures as a basis for bonuses and several initiatives to encourage states to develop and expand home and community based services under Medicaid.

The ACA includes various other provisions affecting Medicare and Medicaid providers, including expanded public disclosure requirements for SNFs and other providers, enforcement reforms and increased funding for Medicare and Medicaid program integrity control initiatives. The ACA has resulted in several changes to existing healthcare fraud and abuse laws, established additional enforcement tools and funding to the government, and provided for increased cooperation between agencies by establishing mechanisms for sharing information relating to noncompliance. Furthermore, the ACA has resulted in enhanced criminal and administrative penalties for noncompliance. For example, the ACA amended the Anti-Kickback Statute to provide that a claim that includes items or services resulting from a violation of the Anti-Kickback Statute now constitutes a false or fraudulent claim for purposes of the False Claims Act.

In June 2012, the U.S. Supreme Court upheld two major provisions of the ACA—the individual mandate, which requires most Americans to maintain health insurance or to pay a penalty, and the Medicaid expansion, which requires states to expand their Medicaid programs by 2014 to cover all individuals under the age of 65 with incomes not exceeding 133% of the federal poverty level. In upholding the Medicaid expansion, the U.S. Supreme Court held that it violated the U.S. Constitution as drafted but remedied the violation by modifying the expansion to preclude the Secretary of HHS from withholding existing federal Medicaid funds from states that fail to comply with Medicaid expansion, instead allowing the Secretary only to deny new expansion funding. Under the ACA, the federal government will pay for 100% of a state’s Medicaid expansion costs for the first three years (2014-2016) and gradually reduce its subsidy to 90% for 2020 and future years. Based on the ruling, states may choose not to participate in the Medicaid expansion program without risking the loss of existing federal Medicaid funding. As of January 1, 2017, 31 states plus the District of Columbia had elected to expand Medicaid eligibility as provided under the ACA and 19 states had elected not to broaden Medicaid eligibility as of that date; those states that ultimately choose not to participate in Medicaid expansion will forgo the federal funds that would otherwise be available for that purpose. It is unclear what effect the U.S. Supreme Court ruling may have on future federal funding for states’ Medicaid programs. Five Star Senior Living expects that the reduction of the federal subsidy to 90% for 2020 and future years, and other budgetary constraints on state governments, may cause some states to reduce Medicaid payments to healthcare services providers like Five Star Senior Living.

In addition, in June 2015, the U.S. Supreme Court decided that income tax credits under the ACA are available to individuals who purchase health insurance on an exchange created by the federal government, in the same way such credits are available to individuals who purchase health insurance on an exchange created by a state. Such subsidies provide certain eligible taxpayers with the ability to purchase or maintain health insurance.

Five Star Senior Living cannot estimate the type and magnitude of the potential Medicare and Medicaid policy changes, rate reductions or other changes and the impact on Five Star Senior Living of the possible failure of these programs to increase rates to match Five Star Senior Living’s increasing expenses, but they may be material to and adversely affect Five Star Senior Living’s future results of operations. Similarly, Five Star Senior Living is unable to predict the impact on Five Star Senior Living of the insurance reforms, payment reforms, and healthcare delivery systems reforms contained in and to be developed pursuant to the ACA. Expanded insurance availability may provide more paying customers for the services Five Star Senior Living provides. If the changes implemented under the ACA result in reduced payments for Five Star Senior Living’s services or the failure of Medicare, Medicaid or insurance payment rates to cover Five Star Senior Living’s costs, however, Five Star Senior Living’s future financial results could be adversely and materially affected.

In addition, other aspects of the ACA that affect employers generally, including the employer shared responsibility provisions that the Internal Revenue Service began enforcing in January 2015, may have an impact on the design and cost of the health coverage that Five Star Senior Living offers to Five Star Senior Living’s employees. Due to the scope and complexity of the provisions of the ACA that apply to employers and employer group health plans, it is difficult to predict the overall impact of the ACA on Five Star Senior Living’s employee benefit plans and Five Star Senior Living’s cost of doing business over the coming years. Five Star Senior Living will continue to analyze how to provide Five Star Senior Living’s employees with cost-effective coverage, taking into account the various requirements of the ACA and the impact of any changes on Five Star Senior Living’s ability to attract and retain employees.

Other Matters

Federal and state efforts to target false claims, fraud and abuse and violations of anti-kickback laws, physician referral laws (including the Ethics in Patient Referrals Act of 1989), privacy laws and consumer protection laws by Medicare and Medicaid providers and providers under other public and private programs have increased in recent years, as have civil monetary penalties, treble damages, repayment requirements and criminal sanctions for noncompliance. The federal False Claims Act, as amended and expanded by the Fraud Enforcement and Recovery Act of 2009, and the ACA, provides significant civil money penalties and treble damages for false claims and authorizes individuals to bring claims on behalf of the federal government for false claims. The federal Civil Monetary Penalties Law authorizes the Secretary of HHS to impose substantial civil penalties, treble damages and program exclusions administratively for false claims or violations of the federal Anti-Kickback Statute. In addition, the ACA increased penalties under federal sentencing guidelines by between 20% and 50% for healthcare fraud offenses involving more than $1.0 million. State Attorneys General typically enforce consumer protection laws relating to senior living services, clinics and other healthcare facilities.

Government authorities are devoting increasing attention and resources to the prevention, detection and prosecution of healthcare fraud and abuse. The OIG has guidelines for SNFs intended to assist them in developing voluntary compliance programs to prevent fraud and abuse; these guidelines recommend that CMS identify SNFs that are billing for higher paying RUGs and more closely monitor their compliance with patient therapy assessments as methods of fraud prevention. CMS contractors are expanding the retroactive audits of Medicare claims submitted by SNFs and other providers, and recouping alleged overpayments for services determined by auditors not to have been medically necessary or not to meet Medicare coverage criteria as billed. State Medicaid programs and other third party payers are conducting similar medical necessity and compliance audits.

The ACA facilitates the Department of Justice’s, or the DOJ’s, ability to investigate allegations of wrongdoing or fraud at SNFs, in part because of increased cooperation and data sharing among CMS, the OIG, the DOJ and the states. In January 2016, the OIG and the DOJ announced a settlement and corporate integrity agreement with the largest provider of contract therapy services in the nation, as well as settlements with four SNFs, all alleged to have submitted false claims for therapy services provided to SNF patients. The significant nature of the settlements indicates that the federal government is increasingly focused on the appropriateness of billing practices of, and medical necessity of services provided at, SNFs. In addition, the ACA requires all states to terminate the Medicaid participation of any provider that has been terminated under Medicare or any other state Medicaid plan. Moreover, state Medicaid fraud control agencies may investigate and prosecute assisted living communities and SNFs, clinics and other healthcare facilities under fraud and patient abuse and neglect laws. In March 2016, the DOJ also announced the launch of 10 regional intergovernmental task forces across the country to identify and take enforcement action against SNFs that provide substandard care to residents. Five Star Senior Living expects that increased enforcement and monitoring by government agencies will cause Five Star Senior Living to expend considerable amounts on regulatory compliance and likely reduce the profits available from providing healthcare services.

Current state laws and regulations allow enforcement officials to make determinations as to whether the care provided at Five Star Senior Living’s communities exceeds the level of care for which a particular community is licensed. A finding that a community is delivering care beyond the scope of its license could result in closure of the community and the immediate discharge and transfer of residents. Some states and the federal government allow certain citations of one community to impact other communities operated by the same entity or a related entity, including communities in other states. Revocation of a license or certification at one of Five Star Senior Living’s communities could therefore impact Five Star Senior Living’s ability to obtain new licenses or certifications or to maintain or renew existing licenses and certifications at other communities, and trigger defaults under Five Star Senior Living’s leases, Five Star Senior Living’s management agreements with SNH and Five Star Senior Living’s new credit facility or adversely affect Five Star Senior Living’s ability to operate or obtain financing in the future. In addition, an adverse finding by state officials could serve as the basis for lawsuits by private plaintiffs and lead to investigations under federal and state laws, which could result in civil and/or criminal penalties against the community as well as a related entity.

Five Star Senior Living’s communities must comply with laws designed to protect the confidentiality and security of individually identifiable patient information. Under the federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, and the Health Information Technology for Economic and Clinical Health Act, or the HITECH Act, Five Star Senior Living’s communities that are covered entities within the meaning of HIPAA must comply with rules adopted by HHS governing the privacy, security, use and disclosure of individually identifiable information, including financial information and protected health information, or PHI, and security rules for electronic PHI. There may be both civil monetary penalties and criminal sanctions for noncompliance with these laws. Under the HITECH Act, penalties for violation of certain provisions may be as high as $50,000 per violation for a maximum civil penalty of $1.5 million per calendar year. In January 2013, HHS released the HIPAA Omnibus Rule, or the Omnibus Rule, which went into effect in March 2013 and required compliance with most provisions by September 2013. Pursuant to the Omnibus Rule, covered entities were required to make certain modifications to any business associate agreements that they have in place with their business associates within the meaning of HIPAA. Further, the Omnibus Rule modified the standard for providing breach notices, which was previously based on an analysis of the harm resulting from any disclosure, to a more objective analysis on whether any PHI was actually acquired or viewed as a result of the breach. In addition to HIPAA, many states have enacted their own security and privacy laws relating to individually identifiable information, including financial information and PHI. In some states, these laws are more burdensome than HIPAA. In instances in which the state provisions are more stringent than or differ from HIPAA, Five Star Senior Living’s communities must comply with both the applicable federal and state standards. If Five Star Senior Living fails to comply with applicable federal or state standards, Five Star Senior Living could be subject to civil sanctions and criminal penalties, which could materially and adversely affect Five Star Senior Living’s business, financial condition and results of operations. HIPAA enforcement efforts have increased considerably over the past few years, with HHS, through its Office for Civil Rights, entering into several multi-million dollar HIPAA settlements in 2016 alone.

Five Star Senior Living’s communities must also comply with the Americans with Disabilities Act, or the ADA, and similar state and local laws to the extent that such communities are ‘‘public accommodations’’ as defined in those laws. The obligation to comply with the ADA and other similar laws is an ongoing obligation, and Five Star Senior Living continues to assess Five Star Senior Living’s communities and make appropriate modifications.

Other legislative proposals introduced in Congress, proposed by federal or state agencies or under consideration by some state governments include the option of block grants for states rather than federal matching money for certain state Medicaid services, laws authorizing or directing Medicare to negotiate rate reductions for prescription drugs, additional Medicare and Medicaid enforcement procedures and federal and state cost containment measures, such as freezing Medicare or Medicaid SNF payment rates at their current levels and reducing or eliminating annual Medicare or Medicaid inflation allowances or gradually reducing rates for SNFs.

Some of the states in which Five Star Senior Living operates either has not raised Medicaid rates by amounts sufficient to offset increasing costs or have frozen or reduced, or are expected to freeze or reduce, Medicaid rates. Medicaid spending grew an estimated 11.6% in 2014 and 9.7% in 2015, and is projected to grow 3.7% in 2016 and 2017, primarily due to increased enrollment as some states chose to expand Medicaid coverage under the ACA. From 2018 through 2025, Medicaid spending is expected to grow by an average annual rate of 5.9%, mainly driven by increased spending per beneficiary due to aging of the population and more gradual growth in enrollment. Effective June 30, 2011, Congress ended certain temporary increases in federal payments to states for Medicaid programs that had been in effect since 2008. Five Star Senior Living expects the ending of these temporary federal payments, combined with other state budgetary pressures, to result in continued challenging state fiscal conditions, particularly in those states that are not participating in Medicaid expansion. As a result, some state budget deficits may increase, and certain states may continue to reduce Medicaid payments to healthcare providers like Five Star Senior Living as part of an effort to balance their budgets. These state level cuts have the potential to negatively impact Five Star Senior Living’s revenue from Medicaid sources.

Insurance

Litigation against senior living and healthcare companies continues to increase, and liability insurance costs continue to increase as a result. In addition, Five Star Senior Living’s employee benefit costs, including health insurance and workers’ compensation insurance costs, continue to increase. To partially offset these insurance cost increases, Five Star Senior Living has taken a number of actions, including:

Becoming fully self insured for all health related claims of covered employees;
Increasing the deductible or retention amounts for which Five Star Senior Living is liable under Five Star Senior Living’s liability insurance;
Establishing an offshore captive insurance company which participates in Five Star Senior Living’s workers’ compensation and professional and general liability insurance programs, which may allow Five Star Senior Living to reduce Five Star Senior Living’s net insurance costs by retaining the earnings on Five Star Senior Living’s reserves, provided Five Star Senior Living’s claims experience does not exceed that projected by various statutory and actuarial formulas;
Increasing the amounts that some of Five Star Senior Living’s employees are required to pay for health insurance coverage and copayments for health services and pharmaceutical prescriptions and decreasing the amount of certain healthcare benefits as well as adding a high deductible health insurance plan as an option for Five Star Senior Living’s employees;
Hiring insurance and other professional advisors to help Five Star Senior Living establish programs to reduce Five Star Senior Living’s workers’ compensation and professional and general liabilities, including a program to monitor and proactively settle liability claims and to reduce workplace injuries;
Hiring insurance and other professional advisors to help Five Star Senior Living establish appropriate reserves for Five Star Senior Living’s retained liabilities and captive insurance programs;
Participating with RMR LLC and other companies to which RMR LLC provides management services in a combined property insurance program through Affiliates Insurance Company, or AIC, and with respect to which AIC is an insurer or reinsurer of certain coverage amounts.
Five Star Senior Living also participates with RMR LLC and other companies to which RMR LLC provides management services in a partial joint program for directors and officers’ liability insurance as well as purchase such insurance for Five Star Senior Living’s own account.

Five Star Senior Living partially self insures up to certain limits for workers’ compensation, professional and general liability, automobile and property coverage. Claims in excess of these limits are insured up to contractual limits, over which Five Star Senior Living is self-insured. Five Star Senior Living’s current insurance arrangements are generally renewable annually. Five Star Senior Living cannot be sure that Five Star Senior Living’s insurance charges and self-insurance reserve requirements will not increase, and Five Star Senior Living cannot predict the amount of any such increase, or to what extent, if at all, Five Star Senior Living may be able to offset any such increase through higher deductibles, retention amounts, self insurance or other means in the future.

Competition

The senior living services business is highly competitive. Five Star Senior Living competes with numerous other senior living community operators, as well as companies that provide senior living services, such as home healthcare companies and other real-estate based service providers. Some of Five Star Senior Living’s existing competitors are larger and have greater financial resources than Five Star Senior Living and some of Five Star Senior Living’s competitors are not for profit entities which have endowment income and may not face the same financial pressures that Five Star Senior Living do. Also, in recent years a significant number of new senior living communities have been developed, and Five Star Senior Living expects this increased development activity to continue in the future. This development activity has increased competitive pressures on Five Star Senior Living, particularly in the geographic markets where this development 17 activity has been most focused, including Arizona, Georgia and Texas. Five Star Senior Living may enter into additional lease and management arrangements with SNH, and Five Star Senior Living’s relationships with SNH and RMR LLC may provide Five Star Senior Living with competitive advantages; however, SNH is not obligated to provide Five Star Senior Living with opportunities to lease or manage additional properties. Five Star Senior Living cannot be sure that Five Star Senior Living will be able to compete successfully or operate profitably.