The unavoidable problem with investing in home health providers -- including Almost Family (NASDAQ:AFAM), Amedisys (NASDAQ:AMED), Gentiva Health (NASDAQ:GTIV), and LHC Group (NASDAQ:LHCG) -- is that they're compensated at the mercy of government agencies. In what feels like little more than a move to exasperate investors, the Medical Payment Advisory Commission (MedPAC) releases recommendations to Congress every year, suggesting what Medicare compensation should be for home health providers.

Each year from 2005 to 2009, MedPAC has recommended no increase in compensation for home health providers. Its latest draft recommendation, released Jan. 8, again recommends no increase for 2010. In past years, the Centers for Medicare and Medicaid Services (CMS), which ultimately decides Medicare compensation, has summarily ignored these recommendations. So really, if the recommendations aren't usually acted upon, why should investors be anxious?

I'll give you three reasons.

1. Compensation trends
After several years of gains, CMS compensation has levelled off:













*Net of other policies.

Increases as those from 2005-2007 are designed to compensate home health providers for inflation. Now that those hikes have stagnated, and will continue to stagnate for who knows how long, home health providers' margins will suffer, since their employees' salaries and their other expenses will keep on rising.

2. Tone
Even though MedPAC's recommendations have historically been ignored, the commission is growing increasingly hawkish in its suggestions. In its draft recommendation for 2010, MedPAC included not only its typical freeze request, but also an alternate recommendation calling for a 5% cut. When you consider an additional decrease that's already planned, those recommendations actually work out to cuts of 2.75% and 7.5%, respectively. Reductions that steep, coupled with increases in costs, would gut home health margins.

3. A logical place to cut
Alas for home health investors, MedPAC compensation-reduction arguments aren't unreasonable in the face of a well-publicized and simply unsustainable Medicare crisis. Costs must be cut somewhere in the future, and they can reasonably be cut in home health care.

According to MedPAC, profit margins in 2007 were 16.6%; they are projected to be 12.6% in 2009. Home health may serve a vital role in our medical system, and it may be a cost-effective alternative to further inpatient treatment, but that does not mean that the industry is entitled to remarkable margins. It's simply entitled to earn a profit so that it can continue to exist.

Home health investors, be warned: Extraordinary revenue growth means relatively nothing if margins are simultaneously decimated. The warning signs are there.

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