68% of Nursing Home Profits Hidden Annually Through 'Tunneling' Practices, Research Reveals

New research co-authored by Ashvin Gandhi and Andrew Olenski reveals that a staggering 68% of nursing home profits are annually concealed through "tunneling" practices involving related-party transactions. This widespread financial maneuvering distorts reported profitability, potentially misleading regulators and the public about the industry's true financial health. The study, detailed in an NBER working paper, highlights how these practices allow healthcare providers to inflate costs, understate profits, and shield assets.

The primary mechanisms of this tunneling involve inflated payments for real estate and management services to commonly-owned sister companies. Nursing homes frequently engage in "sale-leaseback" transactions, selling their properties to related parties and then paying significantly higher rents back to them. Similarly, management fees paid to affiliated entities are often inflated, with the study finding markups of 36.1% for real estate and 41.7% for management services.

These hidden profits significantly impact the perception of the industry's financial viability. While reported profits often appear anemic, accounting for tunneled funds raises the implied internal rate of return for typical nursing home investments from 4.83% to 13.11%. Beyond financial misrepresentation, tunneling has tangible consequences, including potentially limiting investments in direct patient care. The researchers estimate that if hidden profits were redirected, nursing home RN staffing ratios could increase by 35.7%.

Furthermore, these practices offer a strategic advantage by shielding assets from malpractice liability. By moving valuable real estate assets off the nursing home's balance sheet, facilities can reduce malpractice-related costs by an average of 32.4% annually, primarily through lower insurance premiums. This makes it harder for claimants to recover damages, despite no change in paid losses.

The issue of "tunneling" extends beyond nursing homes, impacting other sectors of healthcare. As noted by Ashvin Gandhi, "Showing how insurers use inflated transfer prices to skirt MLR requirements is easily worth a top publication." Indeed, research by Frank and Milhaupt (2023) indicates that vertically integrated health insurers use inflated transfer prices to related businesses, such as pharmacy benefit managers (PBMs) or physician groups, to meet Medical Loss Ratio (MLR) thresholds, thereby masking true profitability and circumventing regulatory intent. This broader pattern across healthcare underscores the critical need for increased financial transparency and rigorous oversight of related-party transactions.