APPENDIX D. MEDICARE REIMBURSEMENT TO HOSPITALS AND PHYSICIANS CONTENTS Part I: Hospitals General Summary Basic Payment System Update Factors Prospective Payment System Update Factors and Increases in Operating Payments Source and Calculation of the Hospital Wage Index Sample Payment Calculation Additional Payment Amounts Graduate Medical Education Disproportionate Share Hospitals ESRD Beneficiary Discharges Outliers Payment for Capital Payments on a Reasonable Cost Basis Physicians in Teaching Hospitals Qualified Nonphysician Anesthetists in Certain Rural Hospitals Organ Acquisition Costs Passthrough Payments for Hemophilia Inpatients Bad Debts of Medicare Beneficiaries Special Treatment of Certain Facilities Under PPS Sole Community Hospitals Medicare Dependent Hospitals Referral Centers Critical Access Hospitals Geographic Reclassification of Hospitals Hospitals Excluded From the Prospective Payment System PPS-Exempt Hospitals State Systems Administration Prospective Payment Assessment Commission/Medicare Payment Advisory Commission Administrative and Judicial Review Review Activities Historical Trends in PPS Payments, Costs, and Margins Medicare Payments to Hospitals Trends in PPS Operating Payments and Costs PPS Inpatient Margins Inpatient Margins by Hospital Type Total Margins Additional Hospital Data Part II: Physicians Physician Payment Reform Medicare Fee Schedule Relative Value Unit Geographic Adjustment Factor Conversion Factor Payment Formula Sustainable Growth Rate and Conversion Factor Updates Limits on Beneficiary Liability Initial Impact of the Balanced Budget Act on Medicare Payments to Physicians Historical Data Assignment Rate Experience Participating Physician Program Data Distribution of Physician Services References PART I: HOSPITALS GENERAL SUMMARY Medicare pays for inpatient hospital care using prospectively set rates established by the prospective payment system (PPS). PPS started for hospital cost reporting periods beginning on or after October 1, 1983. PPS was enacted by the Social Security Amendments of 1983 (Public Law 98-21). This appendix describes the major reimbursement provisions of PPS. Medicare payments are made at predetermined, specific rates which represent the average cost, nationwide, of treating a Medicare patient according to his or her medical condition. The classification system used to group hospital inpatients according to their diagnoses is known as diagnosis-related groups (DRGs). Payments to hospitals will vary depending on whether a hospital is located in a large urban area (greater than 1 million population, or 970,000 in New England) or other area of the country, as determined by the Office of Management and Budget metropolitan statistical area (MSA) system. During a 4-year transition period, a declining portion of the total prospective payment was based on a hospital's historical reasonable costs and an increasing portion was based on a combination of regional and national Federal DRG rates. Since the fifth year of the program (fiscal year 1988), Medicare payments have been generally determined under a national DRG payment methodology. If a hospital can treat a patient for less than the payment amount, it can keep the savings. If the treatment costs more, the hospital must absorb the loss. A hospital is prohibited from charging Medicare beneficiaries any amounts (except for deductibles, copayment amounts, and services not covered by Medicare) which represent any difference between the hospital's cost of providing covered care and the Medicare DRG payment amount. Certain hospital costs are excluded from the PPS and are paid on a reasonable cost basis, subject to rate of increase limits. Authority is provided for States to establish their own all-payer hospital payment systems if they meet certain Federal requirements. BASIC PAYMENT SYSTEM Unless excluded from PPS, each Medicare participating hospital is paid a predetermined payment rate per discharge for each type of patient treated. Types of patients are defined by the DRG patient classification system which assigns each hospital inpatient to one of 499 patient categories (DRGs) based on the diagnosis and the type of treatment received (medical or surgical). A hospital's DRG payment is the product of two components: (1) a standardized amount which is adjusted by the hospital's area average wage level; and (2) the DRG's relative weight. The standardized amount is intended to represent the cost of a typical (average) Medicare inpatient case. Two separate standardized amounts are calculated: one amount applies to hospitals in large urban areas and the other amount applies to hospitals in other areas. The DRG weight represents the relative costliness of an average case in the particular DRG compared to the cost of the average Medicare case. Update Factors PPS payment rates are updated each year using an ``update factor.'' The annual update factor applied to the standardized amounts is determined, in part, by the projected increase in the hospital market basket index (MBI). The MBI measures the cost of goods and services purchased by hospitals, yielding one price inflator for all hospitals in a given year. Table D-1 shows the categories of expense used in developing the index. The update factor may include adjustments for increases in hospital productivity, technological change, and other factors that affect the level of operating cost per discharge. The annual update factor may also be adjusted to correct for increases in average payments per case attributable to increases in case mix due to improvements in coding and reporting accuracy. Before fiscal year 1988, the same factor was used for all hospitals; however, in subsequent years separate factors were applied to hospitals according to their locations. However, beginning October 1, 1995, a single update factor applied for all hospitals in all areas. Table D-2 compares the hospital market basket increases to actual updates for past years and shows the increases in PPS payments per case that resulted from the updates and other policy changes. The Balanced Budget Act of 1997 (BBA 1997) sets the update for fiscal year 1998 at 0 percent; fiscal year 1999 at the MBI minus 1.9 percent; fiscal year 2000 at the MBI minus 1.8 percent; fiscal years 2001 and 2002 at the MBI minus 1.1 percent; and for fiscal year 2003 and each subsequent fiscal year, at the MBI percentage increase for all hospitals in all areas. TABLE D-1.--HOSPITAL PROSPECTIVE PAYMENT SYSTEM INPUT PRICE INDEX (``THE MARKET BASKET'') EXPENSE CATEGORIES AND RATES OF PRICE CHANGE, FISCAL YEARS 1993-2001 -------------------------------------------------------------------------------------------------------------------------------------------------------- Base-year Federal fiscal year percentage rates of price change 1992 ----------------------------------------------------------------------------------------- Expense category weights \1\ (percent) 1993 \2\ 1994 \2\ 1995 \2\ 1996 \2\ 1997 \2\ 1998 \2\ 1999 \2\ 2000 \3\ 2001 \3\ -------------------------------------------------------------------------------------------------------------------------------------------------------- Wages and salaries \4\........................... 50.24 3.1 3.0 2.7 2.9 2.8 3.5 3.2 3.5 3.4 Employee benefits \4\............................ 11.15 5.7 4.2 2.7 2.1 1.5 2.4 2.6 3.5 3.3 Professional fees: Nonmedical \4\................ 2.13 4.2 3.4 2.6 3.0 2.6 3.2 3.0 3.4 3.6 Utilities........................................ 1.54 3.7 2.5 0.3 1.4 2.3 0.3 -0.6 2.9 1.7 Electricity.................................. 0.93 2.2 1.5 2.4 0.2 0.1 -0.8 -1.1 1.5 1.0 Fuel oil, coal, etc.......................... 0.37 6.1 3.2 -6.7 2.6 7.7 0.2 -1.7 6.4 1.3 Water and sewerage........................... 0.25 5.9 5.2 3.5 3.9 2.5 3.8 2.3 2.4 4.2 Liability insurance.............................. 1.19 3.4 -0.7 -3.4 -1.1 -1.5 -0.4 1.3 2.3 2.3 All other........................................ 33.75 2.1 1.6 4.5 1.9 1.1 2.3 1.5 2.7 2.6 All other products........................... 24.83 1.8 1.2 5.1 1.8 0.3 1.9 1.1 2.5 2.4 Pharmaceuticals.......................... 4.16 5.0 3.5 2.5 3.8 2.6 13.8 8.4 2.8 3.6 Food: Direct purchase.................... 2.31 1.0 1.9 0.1 5.0 1.8 -1.7 -0.7 1.3 2.2 Food: Contract service................... 1.07 1.7 1.7 2.2 2.3 2.9 2.6 2.5 2.7 3.7 Chemicals................................ 3.67 1.4 0.5 14.7 -1.0 0.3 -2.8 -4.2 6.0 3.8 Medical instruments...................... 3.08 2.3 0.8 1.1 1.4 -0.8 -1.3 -0.3 -0.6 0.8 Photographic supplies.................... 0.39 -1.0 0.4 0.6 2.9 0.3 -0.4 -0.5 -1.3 0.7 Rubber and plastics...................... 4.75 0.9 0.8 5.6 0.6 -0.6 -0.4 -0.5 2.1 1.7 Paper.................................... 2.08 -0.3 0.1 13.3 2.5 -4.9 2.3 0.0 4.3 2.0 Apparel.................................. 0.87 1.3 0.2 0.5 0.7 0.5 0.7 0.5 -0.3 0.5 Machinery and equipment.................. 0.21 0.4 0.8 1.0 0.5 -0.5 -0.8 -0.6 -0.2 0.1 Miscellaneous............................ 2.24 1.6 0.4 1.7 2.4 1.3 -0.9 1.0 2.9 1.1 All other services........................... 8.93 2.9 2.6 2.6 2.0 3.2 3.3 2.7 3.2 3.3 Telephone................................ 0.58 0.2 1.8 0.8 1.2 1.9 0.4 -0.4 0.8 0.8 Postage \4\.............................. 0.27 0.0 0.0 7.7 2.4 0.0 0.0 2.2 0.7 2.3 All other labor intensive \4\............ 7.28 3.2 2.7 2.5 2.0 3.5 3.8 3.0 3.5 3.6 All other nonlabor intensive............. 0.80 3.0 2.6 2.8 2.8 2.7 1.6 1.9 2.9 2.4 ------------------------------------------------------------------------------------------------------ Total................................ 100.00 3.1 2.6 3.1 2.4 2.0 2.9 2.5 3.2 3.1 -------------------------------------------------------------------------------------------------------------------------------------------------------- \1\ Weights may not sum due to rounding. \2\ Historical data, subject to revision of underlying series. \3\ Projected data, subject to change in future forecasts. \4\ Considered labor related. Source: Health Care Financing Administration, Office of the Actuary. TABLE D-2.--COMPARISON OF INCREASE IN PPS HOSPITAL MARKET BASKET INDEX, AVERAGE PPS UPDATE, AND INCREASE IN PPS PAYMENTS PER CASE, FISCAL YEARS 1984-97 [In percent] ---------------------------------------------------------------------------------------------------------------- Forecasted Increase in increase in Average update operating Fiscal year market basket \2\ payments per index \1\ case \3\ ---------------------------------------------------------------------------------------------------------------- 1984............................................................ 4.9 4.7 18.5 1985............................................................ 4.0 4.5 10.5 1986............................................................ 4.3 0.5 3.2 1987............................................................ 3.7 1.2 5.4 1988............................................................ 4.7 1.5 6.0 1989............................................................ 5.4 3.3 6.6 1990............................................................ 5.5 4.7 6.5 1991............................................................ 5.2 3.4 6.0 1992............................................................ 4.4 3.0 5.2 1993............................................................ 4.1 2.7 3.8 1994............................................................ 4.3 2.0 3.6 1995............................................................ 3.6 2.0 4.0 1996............................................................ 3.5 1.5 4.2 1997............................................................ 2.5 2.0 2.5 ---------------------------------------------------------------------------------------------------------------- \1\ Based on data available when final prospective payment system rates were set. \2\ From 1988 to 1995, there were separate updates for hospitals in large urban, other urban, and rural areas. Update for 1990 adjusted to reflect 1.22 percent across-the-board reduction in DRG weights. \3\ Data on prospective payment system operating payments for 1984 through 1997 are for hospital accounting years beginning during each Federal fiscal year. Changes are based on cohorts of hospitals with Medicare Cost Reports in two consecutive years. Source: Medicare Payment Advisory Commission. Prospective Payment System Update Factors and Increases in Operating Payments Public Law 98-21 required the Secretary to adjust the DRG definitions and relative weights in fiscal year 1986 and at least every 4 years thereafter to reflect changes in treatment patterns, technology, and other factors which may change the relative use of hospital resources. Public Law 99-509, however, required the Secretary to adjust the DRG definitions and relative weights each year, beginning in fiscal year 1988. The Omnibus Budget Reconciliation Act (OBRA) of 1989 required the Secretary to reduce the relative weight for each DRG by 1.22 percent for discharges in fiscal year 1990. In addition, the Secretary was prohibited from adjusting DRG relative weights on other than a budget neutral basis beginning in fiscal year 1991. Table D-3 shows the 25 DRGs accounting for the largest numbers of Medicare inpatient discharges during fiscal year 1997. DRG relative weights appear in table D-17 at the end of part I of this appendix. TABLE D-3.--MEDICARE SHORT-STAY HOSPITAL DIAGNOSIS-RELATED GROUPS RANKED BY DISCHARGE, FISCAL YEAR 1997 [In thousands of dollars] ---------------------------------------------------------------------------------------------------------------- Total Total Rank DRG Description Discharges \1\ Percent Total Medicare beneficiary number payments \2\ payments payments \3\ ---------------------------------------------------------------------------------------------------------------- 1 127 Heart failure and shock....... 725,256 6.1 $3,617,653 $3,255,544 $362,109 2 089 Simple pneumonia and pleurisy 472,587 4.0 2,486,332 2,214,672 271,660 \4\.......................... 3 088 Chronic obstructive pulmonary 391,747 3.3 1,784,597 1,568,248 216,348 disease...................... 4 014 Specific cerebrovascular 377,861 3.2 2,209,676 1,979,829 229,846 disorders except transient ischemic attack.............. 5 209 Major joint and limb 365,405 3.1 3,785,782 3,540,052 245,731 reattachment procedures...... 6 430 Psychoses..................... 303,463 2.5 1,988,671 1,789,701 189,971 7 174 Gastrointestinal hemorrhage 250,987 2.1 1,199,479 1,060,110 139,370 with complicating conditions. 8 079 Respiratory infections and 248,773 2.1 1,967,563 1,836,680 130,884 inflammations \4\............ 9 296 Nutritional and miscellaneous 238,230 2.0 1,057,169 938,326 118,843 metabolic disorders \4\...... 10 112 Vascular procedures except 238,146 2.0 2,470,711 2,345,799 124,912 major reconstruction without pump......................... 11 182 Esophagitis, gastroenteritis, 237,375 2.0 877,168 747,053 130,115 and miscellaneous digestive diseases \4\................. 12 416 Septicemia, age +17........... 232,695 1.9 1,717,950 1,593,369 124,581 13 462 Rehabilitation................ 225,553 1.9 2,240,215 2,187,896 52,319 14 138 Cardiac arrhythmia and 210,855 1.8 813,788 698,436 115,351 conduction disorders, with complicating condition....... 15 320 Kidney and urinary tract 179,001 1.5 796,524 697,926 98,598 infections \4\............... 16 132 Atherosclerosis with 175,844 1.5 552,874 461,773 91,101 complicating conditions...... 17 121 Circulatory disorders with 166,418 1.4 1,123,013 1,121,533 1,480 acute myocardial infarction, with cardiovascular catheter discharged alive............. 18 124 Circulatory disorders 155,525 1.3 992,867 909,723 83,143 excluding acute myocardial infarction, with cardiovascular catheter with complex diagnosis............ 19 148 Major small and large bowel 148,685 1.2 2,572,174 2,478,138 94,036 procedures with complicating conditions................... 20 015 Transient ischemic attack and 146,785 1.2 505,418 414,602 90,817 precerebral occlusions....... 21 143 Chest pain.................... 145,286 1.2 367,102 278,867 88,235 22 210 Hip and femur procedures 142,808 1.2 1,253,713 1,164,275 89,438 except major joint \4\....... 23 478 Other vascular procedures with 126,327 1.1 1,528,418 1,461,624 66,793 complicating conditions...... 24 475 Respiratory system diagnosis 110,465 0.9 2,132,273 2,065,892 66,381 with ventilator support...... 25 140 Angina pectoris............... 108,593 0.9 302,437 242,698 59,739 ------------------------------------------------------------------ Total, all DRGs........... 11,952,088 100.0 88,340,773 81,588,972 6,751,802 ---------------------------------------------------------------------------------------------------------------- \1\ Based on the stay records for 100 percent of Medicare aged and disabled beneficiaries as recorded in the MEDPAR file. \2\ Total payments represent total hospital revenue for Medicare enrollee utilization, including Medicare payments and beneficiary obligations. Excluded bills for no pay, at-risk managed care utilization and no-pay Medicare secondary payer bills. \3\ Beneficiary payments are the responsibility of the beneficiary or other third party payor. \4\ Age +17 with complicating conditions. Source: Health Care Financing Administration. Source and Calculation of the Hospital Wage Index The hospital wage index is used to adjust the national standardized amount to account for the wage level in the hospital's area. This is accomplished by multiplying the labor- related component of the national standardized payment amount by a wage index. The wage index is intended to measure the average wage level for hospital workers in each urban area (metropolitan statistical area or MSA) or rural area (non-MSA parts of States) relative to the national average wage level. The Secretary is required to update the wage index annually beginning October 1, 1993. The Secretary is required to base the update on a survey of wages and wage-related costs of short-term acute care hospitals. Tables D-14, D-15, and D-16, at the end of part I of this appendix, give the current wage index values for urban areas, for all rural areas in a State, and a special index for hospitals that are reclassified. Calculation of the index begins with the area average hospital hourly wage. For each MSA or non-MSA area (i.e., all non-MSA counties in a State), total county compensation and total paid hours data are summed separately over all counties included in the area. Then aggregate hospital compensation for the area is divided by aggregate paid hours of hospital employment in the area to produce the area average hourly wage. The hospital wage index is calculated by dividing the average hourly wage for each area by the national average hourly wage (determined by dividing national aggregate compensation by national aggregate paid hours of employment). This procedure results in an index number, such as 0.8884 (Asheville, North Carolina) or 1.2284 (Sacramento, California), for each MSA or non-MSA area in the United States. Since the national average wage level is represented by an index value of 1.000, the wage index value for any area has a direct and simple interpretation. The value of 1.2284 for Sacramento means that the hourly wage rate for hospital workers is 22.84 percent higher in the Sacramento MSA than nationwide. Thus, in computing the hospital payment rates applicable for hospitals in the Sacramento MSA, the labor-related component of the national large urban adjusted standardized payment amount ($2,809.18) is multiplied by 1.2284 in order to adjust for the higher level of hourly wage rates in this area. Similarly, the calculation of the labor portion of the rates for hospitals in Asheville would involve a reduction in the published labor-related component of the national adjusted standardized payment amount, to reflect the fact that hourly wage levels in this MSA are 11.16 percent lower than the national average (as indicated by the wage index value of 0.8884). Sample Payment Calculation The Federal large urban and other area payment amounts per discharge for fiscal year 2000 were published in the Federal Register on July 30, 1999 (table D-4). The payment rates for most hospitals are computed using the national adjusted operating standardized amounts. Puerto Rico has its own adjusted operating standardized amounts for DRG payment purposes. BBA 1997 changes the way the standardized amount for Puerto Rico is determined from a 25 percent Federal, 75 percent local blend rate, to a 50 percent Federal, 50 percent local rate. TABLE D-4.--NATIONAL AND REGIONAL ADJUSTED STANDARDIZED AMOUNTS, LABOR/NONLABOR, FISCAL YEAR 2000 ---------------------------------------------------------------------------------------------------------------- Large urban areas Other areas ----------------------------------------------- Labor Nonlabor Labor Nonlabor related related related related ---------------------------------------------------------------------------------------------------------------- National average................................................ $2,809.18 $1,141.85 $2,764.70 $1,123.76 Puerto Rico: National.................................................... 2,785.40 1,132.18 2,785.40 1,132.84 Puerto Rico................................................. 1,336.54 538.00 1,315.38 529.48 ---------------------------------------------------------------------------------------------------------------- Source: Federal Register, 1999. Each payment amount is divided into a labor-related component and a nonlabor-related component. The sum of these components represents the standardized amount that would apply for a hospital located in an area with a wage index of 1.0 (i.e., average wage rates for hospital workers in the area match the national average of hospital wage rates across all areas). The basic payment to a hospital for a case in a particular DRG is the applicable national payment amount, adjusted by the local wage index value and multiplied by the weighting factor for the DRG. For an example of a payment calculation, assume a hospital is located in Washington, DC. Such a hospital would be in a large urban area. Payment is based on the large urban national standardized amount. First, the labor-related portion of this amount ($2,809.15 in fiscal year 2000) is multiplied by the appropriate wage index (1.1053 for Washington, DC): $2,809.18 1.1053 = $3,104.99 To this total is added the nonlabor-related portion of the standardized amount: $3,104.99 + $1,141.85 = $4,246.84 For each discharge, this new total is then multiplied by the relative weight factor for the DRG to which the case has been assigned. These weights range from a low of 0.0968 for DRG 448 (allergic reactions, age 0-17) to a high of 17.7902 for DRG 103 (heart transplant). The payment rates for the sample hospital in fiscal year 2000 would therefore vary from a low of $411.09 ($4,246.84 0.0968) to a high of $75,552.13 ($4,246.84 17.7902). Certain hospitals receive other adjustments to their base payment rates under PPS. Hospitals in Alaska and Hawaii have a cost-of-living adjustment to recognize the higher cost of nonlabor input there. In addition, sole community hospitals (SCHs) have the option of payments based on their own updated base-year costs or the PPS rate (see discussion of sole community hospitals below). Hospitals also can be reclassified into areas where they are not located for the purpose of qualifying for a higher standardized payment amount or wage index. These factors may substantially increase payments to some hospitals, although by definition they have no impact on total PPS payments. In addition to the basic payment amount for each case, additional payments may be made to teaching hospitals and hospitals that serve a disproportionate share of low-income patients. Any hospital may receive additional payments for outliers (cases with extraordinarily high costs relative to other cases in the DRG) and for treatment of beneficiaries with end-stage renal disease (ESRD). Finally, certain hospital costs are excluded from PPS and reimbursed separately. The next sections of this appendix discuss additional PPS payments and the separate reimbursement of excluded costs. ADDITIONAL PAYMENT AMOUNTS In addition to the DRG prospective payment rates, Medicare payments are made to hospitals for four additional items or services. Graduate Medical Education Financing of graduate medical education (GME), the period of training following medical school, is provided predominantly through inpatient revenues (both hospital payments and faculty physician fees) and a complex mix of Federal and State government funds. The Federal Government is the largest single explicit financing source for GME through the Medicare Program and through its support of residencies in Veterans Administration hospitals. Medicare recognizes the costs of GME under two mechanisms: direct medical education payments and an indirect medical education (IME) adjustment. Direct medical education costs The direct costs of approved medical education programs (such as the salaries of residents and teachers and other education costs for residents, for nurses, and for allied health professionals trained in provider-operated programs) are excluded from the PPS. The direct medical education costs for the training of nurses and allied health professionals in provider-operated programs are paid for on a reasonable cost basis. Residency training programs for physicians are funded through formula payments based on each hospital's per resident costs. Medicare's payment to each hospital equals the hospital's cost per full-time equivalent (FTE) resident, times the weighted average number of FTE residents, times the percentage of inpatient days attributable to Medicare part A beneficiaries. Each hospital's per FTE resident amount is calculated using data from the hospital's cost reporting period that began in fiscal year 1984, increased by 1 percent for hospital cost reporting periods beginning July 1, 1985, and updated in subsequent cost reporting periods by the change in the Consumer Price Index (CPI). After July 1, 1986, only residents in their initial residency period are counted as a full FTE. The number of years considered as an initial residency period varies by physician specialty. It includes the minimum number of years of formal training necessary to satisfy specialty requirements for board eligibility plus 1 year, but not to exceed 5 years; residents in geriatrics or preventive medicine are allowed 2 additional years. Residents who are not in their initial residency period are counted as one-half of an FTE. Residents who are foreign or international medical graduates are not counted as FTE residents unless they have passed certain examinations. OBRA 1993 provided that the amounts paid per resident for the direct costs of GME would not be updated by the CPI for cost reporting periods beginning during fiscal years 1994 and 1995, except for primary care residents and residents in obstetrics and gynecology. Primary care residents are defined to include family medicine, general internal medicine, general pediatrics, preventive medicine, geriatric medicine, and osteopathic general practice. For fiscal year 1997, the per resident amount was updated by the CPI. BBA 1997 made several changes to the way in which Medicare makes payments for direct GME costs. BBA 1997 includes: (1) a cap on the total number of residents reimbursed under Medicare at the level that existed for the cost reporting period ending on or before December 31, 1996; (2) payments (for both direct and indirect GME) to teaching hospitals for the utilization attributed to Medicare+Choice enrollees; (3) payments to qualified nonhospital providers for their direct GME costs (federally qualified health centers, rural health clinics, MedicarePlus organizations, and other appropriate providers); (4) incentive payments to teaching hospitals that voluntarily agree to reduce the number of medical residents in training; (5) a demonstration project under which direct GME payments are to be made to qualifying consortia that consist of a teaching hospital and one or more specified entities who operate an approved medical residency training program; (6) a study on the variations in the costs of hospital overhead and supervisory physician medical education costs among hospitals; and (7) the requirement that the Medicare Payment Advisory Commission (MedPAC) make recommendations on long-term payment policies regarding teaching hospitals and GME. Teaching hospitals' per resident costs vary greatly between hospitals. The Balanced Budget Refinement Act (BBRA) of 1999 will reduce some of the variation in Medicare reimbursement for these amounts. Starting in fiscal year 2001, hospitals with per resident amounts below 70 percent of the national average will be increased to 70 percent of the geographically adjusted value. Approximately 265 hospitals will receive increased payments under this provision. Those teaching hospitals with per resident amounts above 140 percent of the national average (adjusted for geographic location) will not receive an inflation update for 2 years (fiscal years 2001 and 2002) and will receive a lower update than other hospitals (CPI minus 2 percent) for 3 years (fiscal years 2002-5). About 130 hospitals with per resident amounts over 140 percent of the locality adjusted will be affected by these provisions. Hospitals that have per resident amounts that fall between 70 and 140 percent of the national average adjusted for local cost differences will not be affected by these provisions. Indirect medical education costs Additional payments are made to hospitals under PPS for the indirect costs attributable to approved medical education programs. These indirect costs may be due to a variety of factors, including the extra demands placed on the hospital staff as a result of the teaching activity or additional tests and procedures that may be ordered by residents. Congressional reports on the PPS authorizing legislation indicate that the IME payments are also to account for factors not necessarily related to medical education which may increase costs in teaching hospitals, such as more severely ill patients, increased use of diagnostic testing, and higher staff-to- patient ratios. The additional payment to a hospital is based on a formula that has provided an increase of approximately 7.7 percent in the Federal portion of the DRG payment for each 0.1 increase in the hospital's intern and resident-to-bed ratio on a curvilinear basis (i.e., the increase in the payment is less than proportional to the increase in the ratio of interns and residents to bed size). BBA 1997 includes reductions in the IME adjustment from 7.7 to 7.0 percent in fiscal year 1998; to 6.5 percent in fiscal year 1999; to 6.0 percent in fiscal year 2000; and to 5.5 percent in fiscal year 2001 and subsequent years. BBRA 1999 delayed the reduction in the IME adjustment to 5.5 percent until fiscal year 2002. Teaching hospitals will receive 6.5 percent in fiscal year 2000; 6.25 percent in fiscal year 2001 and 5.5 percent in fiscal year 2002 and in subsequent years. Disproportionate Share Hospitals Public Law 99-272 (Consolidated Omnibus Budget Reconciliation Act) provided that additional payments would be made to hospitals that serve a disproportionate share of low- income patients. The adjustment was extended several times until OBRA 1990 (Public Law 101-508) made it a permanent payment adjustment. A hospital's disproportionate patient percentage is defined as the hospital's total number of inpatient days attributable to Federal Supplemental Security Income Medicare beneficiaries divided by the total number of Medicare patient days, plus the number of Medicaid patient days divided by the total patient days. Table D-5 shows the minimum disproportionate patient percentages required to qualify for the adjustment and the formulas for computing the adjustment effective October 1, 1993. For discharges occurring after September 1994, hospitals with a disproportionate share greater than 20.2 percent would receive a disproportionate share adjustment equal to 5.88 percent plus 0.825 percent of the difference between 20.2 percent and the hospital's disproportionate share patient percentage. BBA 1997 includes reductions in the current disproportionate share hospital (DSH) payment formula amounts of 1 percent for fiscal year 1998; 2 percent in fiscal year 1999; 3 percent in fiscal year 2000; 4 percent in fiscal year 2001; 5 percent in fiscal year 2002; and 0 percent in fiscal year 2003 and each subsequent fiscal year. BBA 1997 also requires the Secretary to submit to the House Ways and Means and Senate Finance Committees, no later than 1 year after enactment, a report that contains a new formula for determining additional DSH payments to hospitals. As of April 1, 2000, the report had not been issued. TABLE D-5.--CRITERIA TO QUALIFY FOR DISPROPORTIONATE SHARE ADJUSTMENT AND FORMULAS FOR COMPUTING ADDITIONAL PAYMENT, EFFECTIVE OCTOBER 1, 1993 ------------------------------------------------------------------------ Qualifying disproportionate Formula or fixed Type of hospital patient percentage percentage (P) adjustment ------------------------------------------------------------------------ Urban, 100 or more beds........ 15 percent......... (P-15)(0.6) 0.65 + 2.5. Urban, 100 or more beds........ 20.2 percent....... (P-20.2) 0.8 + 5.88. Urban, 100 or more beds........ 30 percent of 35 percent. inpatient revenue from State or local indigent care funds. Urban, under 100 beds.......... 40 percent......... 5 percent. Rural, over 500 beds........... Not specified in Same as urban, 100 law; regulations or more beds. set threshold at 15 percent. Rural, over 100 beds........... 30 percent......... 4 percent. Rural, under 100 beds.......... 45 percent......... 4 percent. Rural, sole community hospital. 30 percent......... 10 percent. Rural, rural referral center and-- (a) not a sole community 30 percent......... (P-30)(0.6) + 4.0. hospital, 100 or more beds. (b) not a sole community 45 percent......... (P-30)(0.6) + 4.0. hospital, under 100 beds. (c) also a sole community 30 percent......... Greater of 10 hospital. percent or (P- 30)(0.6) + 4.0. ------------------------------------------------------------------------ Note.--The disproportionate patient percentage (P) is equal to the sum of (a) the number of Medicare inpatient days provided to Supplemental Security Income recipients divided by total Medicare inpatient days, and (b) the number of inpatient days provided to Medicaid beneficiaries divided by total inpatient days. Source: Prospective Payment Assessment Commission. BBRA 1999 froze the reduction in the DSH payment formula to 3 percent for fiscal year 2001 and changed the reduction to 4 percent for fiscal year 2002. The Secretary is also required to collect hospital cost data on uncompensated inpatient/ outpatient care, including non-Medicare bad debt and charity care as well as Medicaid and indigent care charges. ESRD Beneficiary Discharges Effective with cost reporting periods beginning on or after October 1, 1984, additional payments are made to hospitals for inpatient dialysis provided to ESRD beneficiaries if total discharges of such beneficiaries from non-ESRD related DRGs account for 10 percent or more of the hospital's total Medicare discharges. A hospital meeting the criteria is paid an additional payment for each ESRD beneficiary discharge based on the estimated weekly cost of dialysis and the average length of stay of its ESRD beneficiaries. In fiscal year 1996, 35 hospitals received approximately $7 million in ESRD exception payments. Outliers Additional amounts are paid to hospitals for atypical cases (known as ``outliers'') which have either extremely long length of stay (day outliers) or extraordinarily high costs (cost outliers) compared to most discharges classified in the same DRG. The law requires that total outlier payments to all hospitals covered by the system represent no less than 5 percent and no more than 6 percent of the total estimated PPS payments for the fiscal year. Effective with discharges occurring on or after October 1, 1984, a transferring hospital may qualify for an additional payment for extraordinarily high- cost cases meeting the criteria for cost outliers. Outlier payments are financed by an offsetting overall reduction in the base payment amount per discharge. Effective October 1, 1986, Public Law 99-509 established separate urban and rural set- aside factors for financing outlier payments. The separate set- aside factors for rural and urban hospitals for financing outlier payments ended when the other urban/rural payment differential was eliminated in fiscal year 1995, as enacted in OBRA 1990. Public Law 100-203 increased payments for outlier cases classified in DRGs relating to patients with burns from April 1, 1988, through September 30, 1989. This legislation also prohibited the Secretary from issuing any final regulations before September 1, 1988, which changed the method of payment for outlier cases (other than burn cases). The Secretary published new outlier rules on September 30, 1988, effective for discharges on or after October 1, 1988. The new rules modified the thresholds used in determining whether a case is an outlier and increased the allowable payment amounts for cost outliers. The effect of the changes increased the proportion of all outlier payments going to cost outliers. Previously, about 85 percent of outlier payments were made for length-of-stay (LOS) outliers and 15 percent for cost outliers. Under the new rules, 60 percent of payments were made for cost outliers and 40 percent for LOS outliers. (Cases that meet both length-of-stay and cost outlier criteria are paid under the policy that produces the higher payment.) To determine the amount of additional payments for outlier cases, the LOS for each case in a diagnosis-related group (DRG) is first compared against the applicable LOS threshold for the category. If the LOS for a case exceeds the threshold, then the case qualifies as a day outlier. In this instance, the hospital is paid its regular payment rate per discharge (for this DRG), plus a per diem amount (44 percent of the hospital's per diem rate for the DRG) for each Medicare covered day above the LOS threshold. If the case does not qualify as a day outlier, then it may qualify as a cost outlier. The case will qualify for extra payments on this basis if the hospital's Medicare covered charges for the case, adjusted to operating costs (and reduced by its indirect teaching and disproportionate share adjustments, if applicable), exceed its cost outlier threshold for the DRG. In this instance, the hospital is paid its regular payment rate per discharge for the DRG, plus the Federal portion of 75 percent of the difference between its adjusted (and reduced) charges for the case and the cost outlier threshold. In October 1991, Medicare began a transition from cost- based to prospective payment for hospital capital expenses (see below). In the August 30, 1991, final rule implementing this change, the Secretary established a unified outlier payment system for capital and operating costs. For day outliers, payments for covered days were set equal to a percentage of the combined per diem operating and capital payment rates for the DRG. For cost outliers, payments are made only if the combined operating and capital cost for the case exceed the cost outlier threshold for the DRG. As in the case of operating cost payments, standardized capital payment amounts are reduced to establish a pool for outlier payments. OBRA 1993 legislated two changes in outlier policy that became effective in fiscal year 1995. First, day outliers were phased out over a period of 4 years. By fiscal year 1999, all outlier payments were based solely on cost. Second, cost- outlier thresholds are based on a fixed amount beyond the payment rate for each case so that hospitals incur the same loss on every case before outlier payments are applied. BBA 1997 eliminates the use of the IME adjustment and DSH payments as part of costs that trigger outlier payments, effective beginning in fiscal year 1998. The new calculation has the effect of increasing outlier payments to hospitals receiving IME and DSH payments because it increases the hospitals' costs with respect to the outlier threshold. PAYMENT FOR CAPITAL Until fiscal year 1992, Medicare paid a share of hospitals' reasonable capital-related costs, based on services used by beneficiaries as a proportion of total services furnished by the hospital. (Payments in recent years have been subject to fixed percentage reductions described below.) Four basic types of costs are allowable for Medicare reimbursement: 1. Interest on mortgages, bonds, or other borrowing used to finance capital investments or current operations. Interest costs are generally offset by any interest income earned by the hospital on investments; 2. Depreciation, figured on a straight line basis, for plant and equipment, but not for land; 3. Rental payments for plant and equipment; 4. Property taxes and insurance premiums related to capital assets. One other type of capital cost was formerly recognized under Medicare, but has not been reimbursable for hospital services since fiscal year 1989: return on equity for investor- owned hospitals. Return on equity payments provided a return to investors equivalent to what they would have earned if they had used their money for some other purpose. When the new prospective payment system (PPS) was enacted in 1983, Congress excluded capital costs. However, the Secretary was instructed to report to Congress on methods for including capital in PPS and was authorized (but not required) to implement prospective payment for capital on or after October 1, 1986. The Secretary's authority to include capital in PPS was postponed twice. The Supplemental Appropriations Act of 1986 (Public Law 99-349) delayed prospective capital payment until October 1, 1987. OBRA 1987 (Public Law 100-203) delayed prospective payment until October 1, 1991. However, the Secretary was required, not merely authorized, to implement a prospective system by that date. The system was required to provide that capital payments be made on a per-discharge basis, with adjustments based on each discharge's classification under the DRGs or some similar system. At the Secretary's discretion, the system could include adjustments to reflect variations in costs of construction or borrowing, exceptions (including exceptions for hospitals with existing obligations), and adjustments to reflect hospital occupancy rates. While prospective payment for capital was delayed (see below), Congress included in budget reconciliation legislation fixed percentage reductions in amounts otherwise payable by Medicare for capital costs. These cuts began in fiscal year 1987, with a 3.5-percent reduction. Medicare would compute its share of total costs for each hospital and then reduce that computed share by 3.5 percent. The percentage reduction increased to 7 percent for the first quarter of fiscal year 1988, 12 percent for the rest of that fiscal year, and 15 percent for fiscal year 1989 through fiscal year 1991. Delays in completing budget legislation meant that there were brief intervals in 1987 and 1989 when no reduction was taken. The reductions originally applied only to capital costs related to inpatient care. Beginning in fiscal year 1990, capital payments for outpatient hospital services were also reduced. The reductions did not apply to certain types of rural hospitals defined in Medicare law, including SCHs, essential access community hospitals, and rural primary care hospitals. OBRA 1990 (Public Law 101-508) continued capital payment reductions through fiscal year 1995, with the reduction percentage lowered to 10 percent for fiscal years 1992 through 1995. Because prospective payment began in fiscal year 1992, the reductions were not applied directly to each hospital's computed capital costs. Instead, the Secretary was required to set payments under the new system (or under the new system and PPS combined) in such a way as to achieve an aggregate inpatient hospital capital spending reduction of 10 percent, as compared to what would have been spent under the reasonable cost system. The administration's rules for prospective payment for capital costs were published in the Federal Register on August 30, 1991. The rule provides for a 10-year transition to fully prospective payment beginning October 1, 1991. Under the rule, the Secretary establishes a standard per case capital payment rate, based on average capital costs per case in fiscal year 1989 and updated for inflation and other factors. Through fiscal year 1995, the base rate was adjusted in order to meet the requirement that capital payment rates be set in such a way as to achieve an aggregate saving of 10 percent relative to what would have been paid under a full cost system. Beginning with fiscal year 1996, that requirement expired. As a result, the standardized payment rates increased by more than 20 percent. The capital standard Federal payment rate for fiscal year 2000 is $377.03 ($174.81 for Puerto Rico). The rates are adjusted using the DRG weights and a geographic factor based on area wage indices. Tables D-14, D-15, and D-16 at the end of part I of this appendix give the current geographic adjustment factors (GAFs) for urban areas, for all rural areas in a State, and the factors for hospitals that have reclassified. In addition, hospitals in large urban areas receive a 3- percent increase and hospitals in Alaska and Hawaii receive a cost-of-living adjustment. A disproportionate share adjustment is provided for urban hospitals with more than 100 beds. A hospital receives approximately a 2.1 percentage point increase in capital payments for each 10 percent increment in its disproportionate share percentage. An adjustment is also made for the indirect costs of medical education. This adjustment is based on the ratio of residents to average daily inpatient census. Capital payments increase approximately 2.8 percentage points for each 10 percent increment in the residents to average daily census ratio. Additional capital payments are issued for outlier cases. During a transition period that ends September 30, 2000, each individual hospital's capital payment rate is a blended rate based partly on its own historic capital costs and partly on the Federal rate. In fiscal year 1996, rates were 50 percent hospital-specific and 50 percent Federal. The hospital-specific portion will drop by 10 percent a year, until fully Federal rates take effect in fiscal year 2001. OBRA 1993 (Public Law 103-66) reduced the Federal rate for inpatient capital expenses by 7.4 percent to correct for inflation forecast errors. The transition rules include two provisions to assist hospitals most disadvantaged by the shift to prospective payment: a ``hold harmless'' payment system and exception payments for certain facilities. Hospitals with base year capital costs above average continue to be paid on a cost basis for the portion of their costs related to ``old'' capital investments (generally assets put in use or obligated by the end of 1990). The rest of the hospital's capital payments are based on the prospective rates. For example, if 75 percent of a hospital's costs are for depreciation and interest on a pre- 1990 building, the hospital is paid Medicare's share of those costs (subject to the current 10-percent reduction). For ``new'' capital, it receives a portion of the prospective rate based on the hospital's own ratio of new to total capital. In this case, because old capital accounts for 75 percent of costs, the hospital's new capital payment is 25 percent of the prospective rate for each case treated. This hold harmless payment system will continue until the end of the 10-year transition, or until a hospital's old capital costs drop to the point at which it is more advantageous for the hospital to shift to fully prospective payment. Exception payments are made to hospitals whose capital payments under the new system fall significantly short of their actual capital costs. Most hospitals are assured of receiving a minimum of 70 percent of costs. Specified urban hospitals with a disproportionate share of low-income patients receive at least 80 percent of costs, and rural SCHs at least 90 percent. Computation of exception payments is cumulative. If a hospital received more than the minimum in 1 year but a shortfall the next, the surplus from the first year would be applied before any additional payment would be made in the second year. The Balanced Budget Act (BBA) of 1997 requires the Secretary to rebase the capital payment rates for discharges occurring on or after October 1, 1997 by the actual rates in effect in fiscal year 1995, so that aggregate capital payments will equal 90 percent of what payments would have been under reasonable cost payments, with an additional reduction in the capital payment rate of 2.1 percent from October 1, 1997 through September 30, 2002. BBA 1997 eliminates the allowance for return on equity capital. In addition, when a facility undergoes a change of ownership, the BBA 1997 provides for a depreciation adjustment of the historical cost of the asset recognized by Medicare, less depreciation allowed, to the owner of record as of the date of enactment, or to the first owner of record of the asset in the case of an asset not in existence as of the date of enactment. Table D-6 shows the average capital payments per case received by PPS hospitals in each year since the implementation of PPS for inpatient operating costs in 1984. The decrease in average capital payments per case in 1988 reflects the provision in OBRA 1986 and 1987 that reduced Medicare payments below costs. The decrease in 1994 reflects the provision in OBRA 1993 that corrected for previous errors in setting the base capital payment rates. Capital payments generally have stayed between 8 and 9 percent of total inpatient payments. The proportion of capital costs covered by those payments fell from 100 percent under cost-based reimbursement to a low of 87.4 percent in 1990. The implementation of capital PPS initially resulted in increased payment-to-cost ratios, but those fell as the payment rates were adjusted to reflect more accurate data. The jump in the payment-to-cost ratio in 1995--when Medicare inpatient capital payments exceeded cost for the first time ever--reflects the elimination of the budget neutrality requirement in fiscal year 1996. The per case capital payment amount varies widely by hospital group, as shown in table D-7. Urban hospitals had an average payment rate of $727 in 1997, for example, while rural hospitals received only $436 per case. Major teaching hospitals were paid $1,017 for each case, while nonteaching hospitals got $561. However, the share of capital payments as a proportion of total PPS inpatient payments, which include both operating and capital payments, was very similar for different types of hospitals. Despite urban hospitals' much higher average payment, almost twice that paid to rural hospitals, the urban payment equalled 113 percent of their capital costs, while rural hospitals were paid 111.9 percent of their capital costs. TABLE D-6.--PPS CAPITAL PAYMENTS PER CASE, SHARE OF TOTAL PPS INPATIENT PAYMENTS, AND RATIO OF PAYMENTS TO COSTS, 1984-97 ------------------------------------------------------------------------ In percent --------------------------- Capital Share of Year payments per total PPS Payment-to- case inpatient cost ratio payments ------------------------------------------------------------------------ 1984.......................... $310 8.1 100.0 1985.......................... 371 8.6 100.0 1986.......................... 409 9.1 99.3 1987.......................... 426 9.0 97.5 1988.......................... 423 8.5 90.2 1989.......................... 463 8.6 87.9 1990.......................... 476 8.3 87.4 1991.......................... 510 8.4 87.6 1992.......................... 586 9.1 97.2 1993.......................... 589 8.9 95.2 1994.......................... 585 8.5 92.7 1995.......................... 628 8.8 101.6 1996.......................... 702 9.4 119.0 1997.......................... 666 8.8 112.9 ------------------------------------------------------------------------ Note.--Data on prospective payment system capital costs and payments are for hospital accounting years beginning during each Federal fiscal year. Hospitals in Massachusetts and New York excluded from data in 1984 and 1985; hospitals in New Jersey excluded from data in 1984 through 1988; hospitals in Maryland excluded from data in all years. Source: Medicare Payment Advisory Commission analysis of Medicare Cost Report data from the Health Care Financing Administration. TABLE D-7.--PROSPECTIVE PAYMENT SYSTEM CAPITAL PAYMENTS PER CASE, SHARE OF TOTAL PPS INPATIENT PAYMENTS, AND RATIO OF PAYMENTS TO COSTS, BY HOSPITAL GROUP, 1997 ------------------------------------------------------------------------ In percent --------------------------- Capital Capital payments as Hospital group payments per a percentage Payment-to- case of total PPS cost ratio inpatient payments ------------------------------------------------------------------------ Urban......................... $726.51 8.8 113.0 Rural......................... 436.09 8.9 111.9 Large urban................... 779.82 8.7 114.2 Other urban................... 659.12 8.9 111.4 Rural referral................ 522.88 9.0 108.0 Sole community................ 413.64 8.5 111.7 Other rural................... 383.29 8.9 116.1 Major teaching................ 101.67 8.0 117.4 Other teaching................ 715.56 8.7 113.8 Nonteaching................... 561.46 9.2 110.6 Disproportionate share large 831.71 8.4 113.5 urban........................ Disproportionate share other 677.41 8.6 112.8 urban........................ Disproportionate share rural.. 446.47 8.9 112.3 Nondisproportionate share..... 602.22 9.2 111.9 Teaching and disproportionate 828.78 8.3 114.4 share........................ Teaching only................. 740.88 8.9 116.4 Disproportionate share only... 594.31 9.0 111.0 Nonteaching 537.6 9.4 110.3 nondisproportionate share.... Voluntary..................... 683.49 8.8 114.4 Proprietary................... 681.06 9.5 104.4 Urban government.............. 698.11 7.9 112.8 Rural government.............. 390.11 8.6 116.2 All hospitals................. 666.43 8.8 112.9 ------------------------------------------------------------------------ Source: Medicare Payment Advisory Commission analysis of Medicare Cost Report data from the Health Care Financing Administration. PAYMENTS ON A REASONABLE COST BASIS Costs for certain items are excluded from the PPS and thus are not included in the prospective payment rates. As explained in the sections below, Medicare pays for its share of several costs according to the former reasonable cost-based system. Physicians in Teaching Hospitals Physician services in hospitals are paid under the physician fee schedule. If a teaching hospital so elects, the direct medical and surgical services of physicians in such hospitals would be paid for on the basis of reasonable costs. Qualified Nonphysician Anesthetists in Certain Rural Hospitals Anesthesia services furnished by hospital-employed nonphysician anesthetists (certified registered nurse anesthetists and anesthesiologist's assistants) or obtained under arrangement may be paid on a reasonable cost basis, if the rural or nonurban hospital demonstrates to its intermediary that it meets established criteria regarding employment arrangements and volume of services provided. In fiscal year 1999, 639 hospitals received approximately $33.9 million in Medicare payments for these services. Organ Acquisition Costs The estimated net expenses associated with Medicare organ acquisition in certified transplantation centers are excluded from the PPS and paid on a reasonable cost basis. Passthrough Payments for Hemophilia Inpatients The Omnibus Budget Reconciliation Act (OBRA) of 1989 excluded the cost of administering blood clotting factors for hemophilia inpatients from PPS, for items furnished from June 19, 1990, through December 19, 1991. OBRA 1993 further extended this provision through fiscal year 1994. The price per unit for the blood clotting factors was set at a predetermined rate, in consultation with the Prospective Payment Assessment Commission (ProPAC), and the cost of administering the blood clotting factors was determined by multiplying a predetermined price per unit of blood clotting factor by the number of units provided to the individual. BBA 1997 makes the payment for the costs of administering blood clotting factor permanent effective October 1, 1997. Bad Debts of Medicare Beneficiaries An additional payment is made to hospitals for bad debts attributable to unpaid deductible and copayment amounts related to covered services received by Medicare beneficiaries. The Secretary is prohibited from making any change in the policy in effect on August 1, 1987, including changes in hospital documentation requirements. OBRA 1989 prohibited the Secretary from requiring hospitals to change their bad debt collection policy if a fiscal intermediary accepted the policy in accordance with the rules in effect as of August 1, 1987, for indigency determination procedures, for recordkeeping, and for determining whether to refer a claim to an external collection agency. For such facilities, the Secretary also may not collect from the hospital on the basis of an expectation of a change in the hospital's collection policy. BBA 1997 reduces bad debt payments by 25 percent in fiscal year 1998; 40 percent in fiscal year 1999; and 45 percent in fiscal year 2000 and each subsequent fiscal year. SPECIAL TREATMENT OF CERTAIN FACILITIES UNDER PPS Sole Community Hospitals Sole community hospitals (SCHs) are hospitals that, because of factors such as isolated location, weather conditions, travel conditions, or absence of other hospitals, are the sole source of inpatient services reasonably available in a geographic area, or are located more than 35 road miles from another hospital. In addition, the Secretary is authorized to designate a hospital as an SCH if, by reason of factors such as travel time to the nearest alternative source of appropriate inpatient care, location, weather conditions, travel conditions, or absence of other like hospitals, the Secretary determines that it is the sole source of inpatient hospital services reasonably available to individuals in a geographic area. OBRA 1989 established new payment provisions that apply to all SCHs for cost reporting periods beginning after April 1, 1990. An SCH may receive the higher of the following rates as the basis of reimbursement: a target amount based on 100 percent hospital-specific prospective rates based on fiscal year 1982 costs updated to the present; a target amount based on hospital-specific prospective rates based on fiscal year 1987 costs updated to the present; or the Federal PPS rate. Current SCHs not meeting the criteria are allowed to continue to qualify for payments as an SCH. OBRA 1989 made permanent the provision by which an SCH may request additional payments if the hospital experiences a decrease of more than 5 percent in its total inpatient cases due to circumstances beyond its control. An SCH may receive such payments if it meets SCH criteria but is not being paid as an SCH. BBRA 1999 authorizes a SCH that was paid using a target amount based on its 1982 or 1987 hospital specific rates during cost reporting periods beginning during 1999 to rebase its target amount and use 1996 hospital specific rates. The rebased target amount for qualifying hospitals will be fully implemented for discharges during fiscal year 2004 and subsequently. BBRA 1999 also provided a full market basket index (MBI) update for SCH discharges in fiscal year 2001. As of January 1999, 785 hospitals were classified as SCHs. Medicare Dependent Hospitals OBRA 1989 created a new classification of hospitals termed Medicare dependent hospitals (MDH). MDHs are hospitals that are located in a rural area, have 100 beds or less, are not classified as a sole community provider, and for which not less than 60 percent of inpatient days or discharges in the hospital cost reporting period that began during fiscal year 1987 were attributable to Medicare. These hospitals are reimbursed in the same fashion as sole community providers during cost reporting periods beginning on or after April 1, 1990, and ending on or before March 31, 1993. OBRA 1993 (Public Law 103-66) extended additional payments to MDHs through September 30, 1994, on a phase-down basis. BBA 1997 extends the MDH Program through October 1, 2001. BBRA 1999 extended the MDH Program through October 1, 2006. As of January 1999, 356 hospitals were classified as MDHs. Referral Centers The Secretary is authorized to provide exceptions and adjustments as appropriate for rural referral centers (RRCs). These centers are defined as: 1. Rural hospitals having 275 or more beds; 2. Hospitals having at least 50 percent of their Medicare patients referred from other hospitals or from physicians not on the hospital's staff, at least 60 percent of their Medicare patients residing more than 25 miles from the hospital, and at least 60 percent of the services furnished to Medicare beneficiaries are furnished to those who live 25 miles or more from the hospital; or 3. Rural hospitals meeting the following criteria for hospital cost reporting periods beginning on or after October 1, 1985: --A case-mix index equal to or greater than the median case mix for all urban hospitals (the national standard), or the median case mix for urban hospitals located in the same census region, excluding hospitals with approved teaching programs. The case-mix index is a measure of the relative costliness of the hospital's mixture of cases among the DRGs compared to the national average mixture of Medicare cases; --A minimum of 5,000 discharges, the national discharge criterion (3,000 in the case of osteopathic hospitals), or the median number of discharges in urban hospitals for the region in which the hospital is located; and --At least one of the following three criteria: more than 50 percent of the hospital's medical staff are specialists, at least 60 percent of discharges are for inpatients who reside more than 25 miles from the hospital, or at least 40 percent of inpatients treated at the hospital have been referred either from physicians not on the hospital's staff or from other hospitals. Referral centers are paid prospective payments based on the applicable urban payment amount rather than the rural payment amount, as adjusted by the hospital's area wage index. The applicable amount is the ``other urban'' rate (i.e., the rate for urban areas with 1 million or fewer people) for all referral centers except those (if any) located in metropolitan statistical areas (MSAs) greater than 1 million. OBRA 1993 extended the classification through fiscal year 1994 for those referral centers classified as of September 30, 1992. BBA 1997 provides that hospitals designated as RRCs since fiscal year 1991 are permanently classified as RRCs. BBA 1997 also provides that any hospital ever classified as an RRC cannot be denied a request for geographic reclassification on the basis of any comparison of its average hourly wage with the average hourly wage of hospitals in the area where the RRC is located. Although referral centers have lost some of the benefit of their classification status because of the equalization of the other urban and rural payment rates in fiscal year 1995, referral centers continue to be entitled to preferential consideration before the Medicare Geographic Classification Review Board (see below). As of January 1999, 231 hospitals were classified as referral centers. Critical Access Hospitals BBA 1997 provided for the Medicare Rural Hospital Flexibility Program which creates a new category of rural hospitals, critical access hospitals (CAHs) and authorizes a grant program of $25 million annually for 5 years to establish networks for improving access to health care services in rural communities. Based on earlier demonstration programs of rural primary care hospitals and medical assistance facilities, CAHs provide emergency, outpatient and limited inpatient services in rural areas. To qualify as a CAH, the rural, nonprofit or public hospital must be located more than 35 miles from another hospital or designated by the State as a necessary provider of health care; provide 24-hour emergency services; and operate a limited number of inpatient beds in which hospital stays can be no more than 96 hours except under certain circumstances. Generally, a rural hospital designated as a CAH receives reasonable, cost based reimbursement for care rendered to Medicare beneficiaries. Before a hospital can be designated as a CAH, the State must submit and have approved a rural health plan implementing the Medicare Rural Hospital Flexibility Program. The Balanced Budget Refinement Act of 1999 (BBRA 1999) modified the CAH Program and provided that: the 96-hour length- of-stay limitation is applied on an average annual basis; for- profit and, under certain circumstances, hospitals that have closed within the past 10 years may be designated as CAHs; and CAHs may elect either a cost-based hospital outpatient service payment plus a fee schedule payment for professional services or an all-inclusive rate. As of September 1999, 11 States were in the process of drafting rural health plans; 2 States, New Jersey and Rhode Island, are ineligible for program participation because they have no rural areas; and 35 States have HCFA approved rural health plans. Fifty-eight CAHs have been designated. Twelve medical assistance facility hospitals in Montana converted to CAHs on October 1, 1999; and 85 hospitals are in the process of applying for CAH designation. Geographic Reclassification of Hospitals OBRA 1989 (Public Law 101-239) established the Medicare Geographic Classification Review Board to consider appeals by hospitals for a change in classification from rural to urban, or from one urban area to another urban area. The Board was created to determine whether a hospital should be redesignated to an area with which it has close proximity for purposes of using the other area's standardized amount, wage index, or both. For geographic reclassifications effective for discharges in fiscal year 1994 and subsequent years, a hospital may seek reclassification to only one area. Urban hospitals must be no more than 15 miles from the area to which they seek reassignment, and rural hospitals must be no more than 35 miles from such an area. A hospital may qualify for the payment rate of another area if it proves that its incurred costs are comparable to those of hospitals in that area. To use an area's wage index, a hospital must demonstrate that: (1) its average hourly wage is equal to at least 84 percent of the average hourly wage of hospitals in the area to which it seeks redesignation; and (2) its average hourly wage weighted for occupational categories is at least 90 percent of the average hourly wage of hospitals in the area to which its seeks redesignation. For geographic reclassifications effective for discharges in fiscal year 1994 and subsequent years, the wage index guidelines were revised to specify, in addition, that a hospital cannot be reclassified unless its average hourly wage is at least 108 percent of the average hourly wage of the area in which it is located. Effective for fiscal year 1996 and subsequent years, a hospital may not be reclassified for purposes of using another area's standardized amount if the area to which the hospital seeks reclassification does not have a higher standardized amount than that currently received by the hospital. In addition, a hospital that seeks reclassification for the purpose of using another area's wage index may apply for reclassification only to an area that has a higher pre- reclassified average hourly wage than that of the hospital's original geographic area. BBA 1997 provides that hospitals can request geographic reclassification for the purposes of receiving additional disproportionate share hospital (DSH) payments for the period ending 30 months after enactment. Aside from reclassifications through the Medicare Geographic Classification Review Board, hospitals have also been reclassified by law (OBRA 1987, Public Law 100-203). Public Law 100-203 provided for the reclassification of rural hospitals as urban if the county in which the hospital was located was adjacent to two or more MSAs and met criteria regarding commuting patterns of its residents to the central counties of the adjacent MSAs. BBRA 1999 provided for an update of the standards used for the geographic reclassification of ``rural deemed urban'' hospitals. BBRA 1999 also provided that certain urban hospitals could be reclassified as rural hospitals if the hospital is located in a rural census tract of an MSA (as determined under the most recent Goldsmith Modification); is located in an area designated by State law or regulation as a rural area; the hospital would qualify as a referral center or as an SCH if the hospital were located in a rural area or the hospital meets other criteria as specified by the Secretary. Finally, BBRA 1999 reclassified certain counties to accommodate the circumstances of specific hospitals as well. HOSPITALS EXCLUDED FROM THE PROSPECTIVE PAYMENT SYSTEM PPS-Exempt Hospitals The following hospitals are by law excluded from the PPS and are paid on the basis of reasonable costs, subject to the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) rate of increase limits: psychiatric hospitals, rehabilitation hospitals, psychiatric or rehabilitation units which are distinct parts of a hospital, alcohol and drug abuse hospitals and such distinct units of hospitals (for cost reporting periods beginning before October 1, 1987), children's hospitals (with patients averaging under 18 years of age), long-term hospitals (with an average inpatient length of stay greater than 25 days), and cancer hospitals (hospitals extensively involved in treatment for and research on cancer) classified as such before December 31, 1990. In addition, the act provides an exemption for any hospital classified as a cancer hospital before December 31, 1991, that is located in a State that has a PPS waiver under section 1814(b). In addition, there are special cases in which the PPS is not applied, such as emergency services provided to Medicare beneficiaries in hospitals not participating in Medicare. OBRA 1990 increased the cost limits imposed on hospitals exempt from PPS. Under prior law, hospitals with costs in excess of the cost limits imposed by the TEFRA would be reimbursed for their cost up to the TEFRA limit. Under OBRA 1990, hospitals with costs exceeding the cost limits imposed by TEFRA receive 50 percent of the costs that exceed the limit, up to a maximum of 110 percent of the limit. In addition, the Secretary is directed to develop a new prospective payment methodology for exempt hospitals, or to substantially modify the current target-rate system. OBRA 1993 provided for an update factor to the cost limits of market basket minus 1.0 percentage point for fiscal years 1994 through 1997. Hospitals with operating costs in fiscal year 1990 that exceeded the target amount by more than 10 percent are exempt from the update reduction, with partial reductions applied to hospitals near the threshold. Hospitals reimbursed under approved State cost control systems are also excluded from the prospective rates. For PPS-exempt facilities, BBA 1997 sets the fiscal year 1998 update at 0 percent, and for fiscal years 1999-2002, the update factor will vary depending on a hospital's target amount and costs. For hospitals with costs: (1) that equal or exceed their target amounts by 10 percent or more, the update will be equal to the market basket; (2) that exceed their target, but by less than 10 percent, the update factor will be equal to zero or, if greater, the market basket minus 0.25 percentage points for each percentage point by which costs are less than 10 percent over the target; (3) that are either at their target, or below (but not below \2/3\ of the target amount for the hospital), the update factor will be equal to zero or, if greater, the market basket percentage minus 2.5 percentage points; or (4) that do not exceed \2/3\ of their target amount, the update factor will be equal to 0 percent. In addition, BBA 1997 includes several provisions affecting Medicare payments to PPS-exempt hospitals and units. BBA 1997 reduces the capital payment update amount for PPS- exempt hospitals and units by 15 percent for fiscal years 1998- 2002. BBA 1997 establishes a cap on PPS-exempt TEFRA limits, also known as target amounts, for PPS-exempt hospitals or units for cost reporting periods beginning on or after October 1, 1997 and before October 1, 2002. The Secretary is required to estimate the 75th percentile of the target amounts for hospitals for cost reporting periods ending during fiscal year 1996, and then update the amount up to the first cost reporting period beginning on or after October 1, 1997, by a factor equal to the market basket percentage increase. For cost reporting periods beginning during each of fiscal years 1999-2002, the Secretary is required to update the amount by a factor equal to the market basket increase. BBRA 1999 adjusts the labor-related portion of the 75 percent cap to reflect differences between the wage-related costs in the area of the hospital and the national average of such costs within the same class of hospitals beginning for cost reporting periods on or after October 1, 1999. BBA 1997 provides for changing bonus payments to PPS- exempt facilities to equal the lesser of: (1) 15 percent of the amount by which the target amount exceeds the amount of operating costs, or (2) 2 percent of the target amount. In addition, for cost reporting periods beginning on or after October 1, 1997, BBA 1997 provides for continuous improvement bonus payments for certain eligible hospitals. BBRA 1999 increases the amount of bonus payments that may be made to eligible long-term care and psychiatric providers. Eligible providers may receive up to a 1.5 percent bonus payment for cost reporting periods beginning on or after October 1, 2000, and before September 30, 2001, and up to a 2 percent bonus payment for cost reporting periods beginning on or after October 1, 2001, and before September 30, 2002. BBA 1997 establishes different payment and target amount rules for new PPS-exempt hospitals or distinct-part units within hospitals that first received Medicare payments on or after October 1, 1997. BBA 1997 provides PPS-exempt hospitals and distinct units of hospitals that received Medicare payments for services furnished before January 1, 1990, with the option of rebasing the hospital's target amount for the 12-month cost reporting period beginning during fiscal year 1998. BBA 1997 also requires the Secretary to establish a case- mix adjusted PPS for rehabilitation hospitals and distinct-part units, effective beginning in fiscal year 2001. The Secretary is required to establish: (1) classes of discharges of rehabilitation facilities by patient case-mix groups based on impairment, age, related prior hospitalization, comorbidities, and functional capability of the discharged individual and other appropriate factors; and (2) a method of classifying specific discharges from rehabilitation facilities within these groups. BBRA 1999 requires the Secretary to base the PPS for rehabilitation hospitals and distinct part units on discharges. The Secretary is also required to establish classes of patient discharges of rehabilitation facilities by functional related groups, based on impairment, age, comorbidities, and functional capability of the patient as well as other factors deemed appropriated to improve the explanatory power of functional independence measure-function related groups. BBRA 1999 also clarifies that payments to rehabilitation facilities may be adjusted to account for the early transfer of patients to another site of care. The Secretary is also required to submit a study to Congress not later than 3 years after the implementation of PPS on its impact on utilization and access to rehabilitation services. BBA 1997 requires the Secretary to collect data to develop, establish, administer and evaluate a case mix adjusted PPS for long term care hospitals. BBRA 1999 requires the Secretary to report to the appropriate congressional committees by October 1, 2001, on a discharge-based PPS for long term care hospitals which would be implemented in a budget-neutral fashion for cost reporting periods beginning on or after October 1, 2002. The Secretary may require long term care hospitals to submit information to develop the payment system. BBRA 1999 also requires the Secretary to report to the appropriate congressional committees by October 1, 2001, on a per diem-based PPS with an adequate patient classification system for psychiatric hospitals (and distinct part units) which would be implemented in a budget-neutral fashion for cost reporting periods beginning on or after October 1, 2002. The Secretary may require psychiatric hospitals and units to submit information to develop the payment system. State Systems Section 1886(c) of the Social Security Act (as added by TEFRA) gave the Secretary of the U.S. Department of Health and Human Services (DHHS) discretion to reimburse hospitals in a State according to the State's hospital reimbursement control system rather than according to Medicare's reimbursement methods if the State requests this change and if DHHS determines that the State system meets certain requirements. Currently, only Maryland has a waiver to operate its own system. Public Laws 98-21 and 98-369 added several more requirements for State systems. According to final regulations published by DHHS on April 24, 1986 (51 F.R. 15481) implementing these legislative changes, DHHS has the discretion to allow Medicare hospital reimbursement to be made in accordance with a State reimbursement control system if the chief executive officer of the State requests approval of the State system, and provided that the State system: 1. Applies to substantially all non-Federal acute care hospitals in the State; 2. Applies to at least 75 percent of all inpatient revenues or expenses for the State; 3. Provides assurances that payers, hospital employees and patients in the State will be treated equitably under its system; 4. Provides assurances that its system will not result in greater Medicare expenditures over 36-month periods; 5. Does not preclude health maintenance organizations or competitive medical plans from negotiating directly with hospitals concerning payment for inpatient services; 6. Limits hospital charges to Medicare beneficiaries to deductibles, coinsurance, and services for which the beneficiary would not be entitled to have payment made under Medicare part A; and prohibits payment under part B of Medicare for nonphysician services provided to hospital inpatients unless this prohibition is waived. Public Law 101-239 (OBRA 1989) required the Secretary's test of effectiveness of a State cost containment system to be based on the aggregate rate of increase from October 1, 1984, to the most recent date for which annual data are available. This provision also extended the waiver for the New York rural hospital payment demonstration. Special provisions apply to States that have existing demonstration projects approved by HCFA under section 402 of the Social Security Amendments of 1967 or section 222(a) of the Social Security Amendment of 1972 for the operation of State reimbursement control systems. DHHS approval of a State's application to continue the operation of a system upon expiration of the demonstration project is mandatory if, and for so long as, the system meets the minimum requirements described in the six items listed above. Public Law 101-508 revised the Secretary's test of effectiveness of a State cost containment system to be based on the rate of increase in costs per hospital inpatient admission as compared to the rate of increase in such costs with respect to all hospitals between January 1, 1981, and the present. In addition, OBRA 1990 provided that a State no longer qualifying for a prospective payment system (PPS) waiver be provided with a reasonable period, not to exceed 2 years, for transition from the State system to the national payment system, and required restoration of the waiver if the State returned to compliance during the transition period. ADMINISTRATION Prospective Payment Assessment Commission/Medicare Payment Advisory Commission The Prospective Payment Assessment Commission (ProPAC) was a commission composed of 17 independent experts charged with advising the Congress on PPS and Medicare payment policies. BBA 1997 replaced ProPAC and the Physician Payment Review Commission with a 15-member Medicare Payment Advisory Commission (MedPAC). MedPAC is required to submit annual reports to Congress on March 1 and June 1 concerning the Medicare Program. Administrative and Judicial Review Administrative and judicial appeals are allowed under procedures and authorities already established under the Medicare Program. However, the law precludes administrative and judicial review of: (1) the ``budget neutrality'' adjustment (see above), and (2) the diagnosis-related group (DRG) payment amounts, including the establishment of DRGs, the methodology for classifying discharges within DRGs, and the DRG weighting factors. Review Activities Public Law 97-248, known as TEFRA, replaced the existing Professional Standards Review Organization Program with the Utilization and Quality Control Peer Review Program. The Secretary of DHHS was required to enter into performance-based contracts with physician-sponsored or physician-access organizations known as peer review organizations (PROs). As a condition of receiving payments under the PPS, hospitals are required to enter into an agreement with a PRO under which the PRO reviews the validity of diagnostic and procedural information provided by the hospitals; the completeness, adequacy and quality of care provided; and the appropriateness of admissions patterns, discharges, lengths of stay, transfers, and services furnished in outlier cases. Since 1982, the statute governing the PRO Program has been amended numerous times, and as of October 1999 the PROs are operating under the sixth ``scope of work.'' HISTORICAL TRENDS IN PPS PAYMENTS, COSTS, AND MARGINS Medicare Payments to Hospitals In fiscal year 2000, hospitals will be paid an estimated $93.2 billion for Medicare-covered inpatient hospitalization as shown in table D-8. The largest share of this amount, $71.5 billion, will be for PPS inpatient operating costs. The Medicare Program will provide more than 90 percent of these payments and the remaining amount will come from beneficiaries for deductibles and coinsurance. PPS hospitals will also receive some $6.1 billion in capital payments. Another $13.6 billion will be paid for operating and capital costs related to services provided in PPS-excluded facilities, which include psychiatric and rehabilitation hospitals and distinct-part units as well as long-term and children's hospitals. Hospitals will also receive $2.0 billion for the direct costs of training programs, including those for interns and residents and for nursing and allied health personnel. TABLE D-8.--TOTAL MEDICARE PAYMENTS TO HOSPITALS FOR INPATIENT HOSPITALIZATION BY PAYMENT TYPE, FISCAL YEAR 2000 [In billions of dollars] ------------------------------------------------------------------------ Payment category Amount Amount ------------------------------------------------------------------------ Program.......................................... 71.8 Operating.................................... 65.7 Capital...................................... 6.1 Beneficiary copayments........................... 5.8 ----------- Total PPS................................ $77.6 ========== Program.......................................... 12.6 Operating.................................... 11.9 Capital...................................... 0.8 Beneficiary copayments........................... 1.0 ----------- Total PPS-excluded....................... 13.6 ========== Interns and residents............................ 1.7 Nursing and allied health......................... 0.3 ----------- Total direct medical education........... 2.0 ---------- Total................................ 93.2 ------------------------------------------------------------------------ Source: Congressional Budget Office. Trends in PPS Operating Payments and Costs The increase in PPS operating payments per case has differed from the update factor in every year, as shown in table D-9. In the first 2 years of prospective payment, payments per discharge rose sharply, by 18.5 percent and 10.5 percent, respectively. This is attributable to two factors: overestimation of the base year hospital costs upon which the initial PPS rates were set due to the use of unaudited Medicare Cost Reports, and a large increase in the aggregate case mix index in the early years because of more emphasis on accurate DRG coding and complete documentation of the medical record. After an increase of 3.2 percent in 1986, payments per case grew at an annual rate of 5.9 percent from 1987 through 1992, as a result of large increases in both the PPS MBI and the aggregate Medicare case-mix index. From 1993 through 1998, the PPS update was lower with zero percent update in 1998. Lower updates coupled with a declining case mix index (table D- 13) has resulted in smaller increases in PPS payments per case. TABLE D-9.--COMPARISON OF INCREASES IN HOSPITAL MARKET BASKET, AVERAGE PPS UPDATES, PPS OPERATING PAYMENTS PER CASE, AND PPS OPERATING COSTS PER CASE, FISCAL YEARS 1984-98 [In percent] -------------------------------------------------------------------------------------------------------------------------------------------------------- PPS update Increase Forecasted Annual ---------------------------------------------- in PPS Increase increase increase operating in PPS Fiscal year in PPS in PPS ProPAC HCFA Actual payments operating market market recommendation \2\ recommendation update per case costs per basket \1\ basket \3\ case -------------------------------------------------------------------------------------------------------------------------------------------------------- 1984.......................................................... 4.9 5.1 NA 4.7 4.7 18.5 1.8 1985.......................................................... 4.0 4.0 NA 4.5 4.5 10.5 11.0 1986.......................................................... 4.3 3.0 1.5 0.0 0.5 3.2 9.6 1987.......................................................... 3.7 3.3 1.7 0.5 1.2 5.4 9.1 1988.......................................................... 4.7 4.8 2.3 0.8 1.5 6.0 9.0 1989.......................................................... 5.4 5.5 4.2 2.7 3.3 6.6 9.2 1990.......................................................... 5.5 4.6 4.1 4.0 \4\ 4.7 6.5 8.9 1991.......................................................... 5.2 4.4 4.7 3.7 3.4 5.9 7.0 1992.......................................................... 4.4 3.2 3.0 3.0 3.0 5.2 4.7 1993.......................................................... 4.1 3.1 2.8 2.7 2.7 3.8 1.2 1994.......................................................... 4.3 2.6 3.6 \5\ 2.6 2.0 3.6 -1.1 1995.......................................................... 3.6 3.1 2.6 2.0 2.0 4.0 -1.1 1996.......................................................... 3.5 2.4 1.7 1.5 1.5 4.2 -0.6 1997.......................................................... 2.5 2.0 1.0 1.0 2.0 2.5 0.1 1998.......................................................... 2.9 2.9 0.0 0.0 0.0 1.7 NA -------------------------------------------------------------------------------------------------------------------------------------------------------- \1\ Based on data available when final PPS rule was issued. \2\ Based on ProPAC's annual Report and Recommendations to the Congress and market basket forecast when final PPS rule was issued. \3\ Increases for 1984-95 based on data from Medicare Cost Reports, which correspond to hospital cost reporting periods, rather than Federal fiscal years. Increases for 1996-98 based on PPS update and estimated case-mix index increase. \4\ Actual updates for fiscal year 1990 adjusted to reflect 1.22 percent across-the-board reduction in DRG weights. \5\ Annual update based on HCFA's recommendation that rates be frozen at 1993 level through January 1, 1994. NA--Not available. Source: Medicare Payment Advisory Commission. Following an increase of only 1.8 percent in the first year of PPS, PPS operating costs per discharge rose by about 11 percent in the second year, and about 9 percent from 1986 through 1990. However, the 7.0-percent growth in operating costs per case in 1991 was the smallest since the first year of PPS, and the rise of 1.2 percent in 1993 was below general inflation. Costs per case actually decreased from 1994 through 1996, with a small increase (0.1 percent) in 1997. Cost growth experience has not been uniform across hospitals, as shown in table D-10. Through 1990, urban and rural hospitals had about the same rate of increase. In the first year, both groups reacted to prospective payment by holding their cost growth far below the rates prevailing before PPS, while annual cost increases in the following 6 years were much higher for both groups. From 1991 through 1995, however, urban hospitals held their cost growth to 1.9 percent annually, while rural hospital costs rose at a 3.4-percent rate. That pattern continued throughout 1996 and 1997 with costs per case increasing in rural hospitals at a higher rate than in urban hospitals. TABLE D-10.--ANNUAL RATE OF CHANGE IN PPS OPERATING COSTS PER CASE BY HOSPITAL GROUP AND PERIOD, 1984-97 [In percent] ---------------------------------------------------------------------------------------------------------------- Period Hospital group ------------------------------------------------- 1984 1985-90 1991-95 1996 1997 ---------------------------------------------------------------------------------------------------------------- Urban......................................................... 1.6 9.4 1.9 -0.9 0.0 Rural......................................................... 1.5 9.2 3.4 1.3 1.5 Large urban................................................... 0.6 9.2 1.5 -0.9 -0.1 Other urban................................................... 3.2 9.8 2.4 -0.6 0.2 Rural referral................................................ 1.5 9.7 3.4 0.0 1.0 Sole community................................................ 1.3 8.6 3.6 2.3 1.4 Other rural................................................... 1.4 9.2 3.3 1.7 1.7 Major teaching................................................ 1.3 9.1 1.7 -0.3 -0.4 Other teaching................................................ 1.3 9.4 2.2 -0.7 0.1 Nonteaching................................................... 1.9 9.5 2.0 -0.7 0.6 Disproportionate share large urban............................ 0.0 9.0 1.4 -1.0 0.1 Disproportionate share other urban............................ 3.2 9.7 2.6 -0.5 0.2 Disproportionate share rural.................................. 0.3 9.7 3.4 0.5 1.8 Nondisproportionate share..................................... 2.4 9.6 2.2 -0.3 0.0 Teaching and disproportionate share........................... 0.7 9.2 2.0 -0.4 0.0 Teaching only................................................. 2.6 9.7 2.4 -0.7 -0.7 Disproportionate share only................................... 1.8 9.5 1.8 -1.5 0.4 Nonteaching nondisproportionate share......................... 2.0 9.4 2.1 -0.2 0.8 Voluntary..................................................... 1.8 9.3 2.2 -0.3 0.0 Proprietary................................................... 0.7 10.0 0.3 -3.7 0.7 Urban government.............................................. 2.4 9.6 2.1 -0.6 0.1 Rural government.............................................. 1.5 9.3 3.9 2.0 1.7 All hospitals................................................. 1.8 9.5 2.1 -0.6 0.1 ---------------------------------------------------------------------------------------------------------------- Note.--Data on PPS operating costs and payments are for hospital accounting years beginning during each Federal fiscal year. Changes based on cohorts of hospitals with Medicare Cost Reports in two consecutive years. Hospitals in Massachusetts and New York excluded from data in 1984 and 1985; hospitals in New Jersey excluded from data in 1984 through 1988; hospitals in Maryland excluded from data in all years. Source: Medicare Payment Advisory Commission analysis of Medicare Cost Report data from the Health Care Financing Administration. The recent low rate of cost growth among hospitals in large urban areas may reflect the fact that the most rapid changes in the health care system appear to be occurring in the largest cities. From 1991 through 1995, these hospitals' costs per discharge rose at a rate 0.9 percentage points below that for other urban hospitals and 1.9 percentage points below that for rural hospitals. Large urban hospitals continue to show greater success in controlling increases in cost per case in 1996 and 1997 than those categories of hospitals. The pattern of cost increases also varies substantially by ownership. In the first year of PPS, when hospitals perceived potential pressure to control costs, proprietary facilities had by far the smallest increase of any group. Once this pressure lessened, costs increased sharply through 1990 for all groups, including the proprietaries. However, from 1991 on, proprietary hospitals reined in their costs to a far greater extent than the other groups. That pattern continued in 1996 but did not hold true in 1997. In 1997, voluntary and urban government hospitals displayed smaller increases in operating costs per case than proprietary hospitals. PPS Inpatient Margins The PPS inpatient margin compares combined Medicare operating and capital payments with the corresponding costs. In 1997, the aggregate PPS margin rose for the sixth consecutive year as shown in table D-11. This contrasts with a declining trend through the first 8-9 years of prospective payment, during which the margin fell to a low of -2.4 percent in 1991. The turnaround is attributable to the sharp slowdown in hospital cost growth with the continuation of current trends. The aggregate PPS inpatient margin for 1997 is 17.0 percent, the highest PPS inpatient margin in the 14 years of prospective payment. Inpatient Margins by Hospital Type PPS inpatient margins vary by hospital group. The margin for urban hospitals was 14.5 percent in the first year-- exceeding that for rural hospitals by 6.8 percentage points. Beginning in fiscal year 1986, the Congress enacted a series of policy changes designed to increase payment for rural hospitals. By 1988, although the difference between the two groups had decreased to 4.5 percentage points, rural hospitals had negative margins while urban ones were still receiving payments that exceeded their costs. The disparity narrowed to 0.5 percentage points by 1992, but has widened as urban hospitals have constrained their costs more than rural hospitals. TABLE D-11.--PPS INPATIENT (OPERATING PLUS CAPITAL) MARGINS, BY HOSPITAL GROUP, FIRST 14 YEARS OF PPS, 1984-97 [In percent] -------------------------------------------------------------------------------------------------------------------------------------------------------- Hospital group 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 -------------------------------------------------------------------------------------------------------------------------------------------------------- Urban................................... 14.5 13.9 9.8 6.8 3.3 0.8 -1.2 -2.2 -0.9 1.3 5.7 10.7 16.4 18.1 Rural................................... 7.7 7.4 2.2 0.2 -1.2 -2.9 -3.7 -3.7 -1.4 -0.7 0.2 5.1 9.8 9.5 Large urban............................. 15.0 13.9 10.0 6.8 3.1 0.7 -0.7 -1.4 0.4 2.8 7.8 12.7 18.7 20.5 Other urban............................. 13.8 14.0 9.4 6.8 3.7 0.9 -1.9 -3.4 -2.9 -1.0 2.5 7.8 12.8 14.4 Rural referral.......................... 9.9 12.9 7.9 6.1 3.9 1.2 0.0 -0.6 2.9 2.6 2.8 6.1 9.9 10.3 Sole community.......................... 8.0 6.4 2.1 0.3 -1.2 -2.6 -1.2 -0.8 2.5 3.8 4.4 7.3 11.3 10.1 Other rural............................. 7.0 6.0 0.3 -1.9 -3.2 -4.5 -6.0 -6.0 -4.8 -3.8 -2.5 3.7 8.9 8.3 Major teaching.......................... 18.6 19.9 15.2 12.9 10.0 7.9 7.2 7.5 9.3 10.9 16.4 20.5 25.1 28.5 Other teaching.......................... 14.9 14.5 10.5 7.2 3.9 1.4 -1.0 -2.2 -1.2 0.8 4.6 9.3 14.5 16.2 Nonteaching............................. 11.2 10.0 5.2 2.5 -0.7 -3.3 -5.2 -6.4 -5.0 -3.0 0.4 6.0 11.6 12.2 Disproportionate share large urban...... 15.3 14.2 10.8 8.3 5.5 3.5 3.0 2.8 5.0 7.8 13.1 17.6 22.9 24.4 Disproportionate share other urban...... 13.5 14.2 10.0 7.8 5.0 2.4 0.0 -1.3 -1.0 0.9 4.5 10.0 14.8 16.6 Disproportionate share rural............ 8.5 8.2 2.8 0.4 -0.5 -2.1 -2.2 -1.8 0.2 0.5 2.2 7.6 12.3 11.7 Nondisproportionate share............... 12.6 11.9 7.0 3.6 -0.3 -2.9 -5.5 -6.7 -5.5 -4.0 -0.7 4.4 10.4 11.8 Teaching and disproportionate share..... 15.8 15.9 12.4 10.0 7.6 5.3 4.1 3.6 5.0 7.3 11.8 16.2 21.0 23.0 Teaching only........................... 16.1 16.3 11.3 7.0 2.2 -0.1 -3.2 -4.0 -2.9 -1.7 2.2 7.0 13.5 15.6 Disproportionate share only............. 11.6 10.7 6.1 3.6 0.6 -1.6 -3.0 -3.7 -2.3 -0.1 3.9 10.0 15.6 15.9 Nonteaching nondisproportionate share... 10.8 9.5 4.5 1.5 -1.8 -4.6 -6.9 -8.4 -7.2 -5.4 -2.5 2.7 8.2 9.2 Voluntary............................... 14.0 13.7 9.6 6.5 3.1 0.7 -1.3 -2.5 -1.1 0.6 4.3 9.0 14.6 16.4 Proprietary............................. 12.9 11.0 6.3 3.4 0.0 -3.9 -5.7 -4.4 -2.2 1.8 8.6 15.6 21.5 21.2 Urban government........................ 13.5 14.1 9.1 7.6 4.8 3.6 2.7 1.4 2.2 4.9 9.7 14.5 18.8 20.8 Rural government........................ 6.6 5.1 -0.6 -2.3 -2.3 -3.7 -4.0 -4.4 -2.6 -2.0 -2.6 2.5 6.9 6.2 All hospitals........................... 13.4 13.0 8.7 5.9 2.7 0.3 -1.5 -2.4 -1.0 1.0 5.0 10.0 15.5 17.0 -------------------------------------------------------------------------------------------------------------------------------------------------------- Note.--Data on PPS operating and capital costs and payments are for hospital accounting years beginning during each Federal fiscal year. Hospitals in Massachusetts and New York excluded from data in 1984 and 1985; hospitals in New Jersey excluded from data in 1984 through 1988; hospitals in Maryland excluded from data in all years. Source: Medicare Payment Advisory Commission analysis of Medicare Cost Report data from the Health Care Financing Administration. Major teaching hospitals consistently have had the highest aggregate inpatient margin of any hospital group. Moreover, the difference in the margins for major teaching and nonteaching hospitals has grown. For major teaching hospitals, the inpatient margin fell from 19.9 percent in the second year of PPS to a low of 7.2 percent in 1990, while the drop for other teaching and nonteaching hospitals was much sharper. By 1997, all three groups had higher margins than in the early years of the decade, with the largest increase seen in the major teaching group. Their margin was 28.5 percent--12.3 percentage points higher than for other teaching hospitals and 16.3 percentage points higher than for the nonteaching group. These differences had been 3.7 percentage points and 7.4 percentage points, respectively, in the first PPS year. The trend in inpatient margins by ownership category also reflects changes in payment policy and degree of success in controlling costs. In the first year, voluntary, proprietary, and urban government hospitals all had inpatient margins around 13-14 percent, while rural government hospitals lagged behind. In 1990, the inpatient margin for the proprietary group, which had fallen by more than 18 percentage points since the beginning of PPS to -5.7 percent, was the lowest of the four groups. However, as these hospitals held down their cost growth, their margin increased by more than 20 percentage points, to 21.2 percent in 1997. Total Margins The PPS inpatient margin, however, does not represent the bottom line for the hospital industry. The total margin, which includes expenses and revenues related to Medicare and other inpatient and outpatient care as well as other facility activities, increased steadily from the early 1970s to the early 1980s, peaking in 1984. In subsequent years--as Medicare tightened its control over inpatient payment rate increases-- the total margin began to fall (table D-12). In the late 1980s, however, this decline leveled off at 3.5 percent, and by 1991 the total margin had risen to 4.4 percent. It declined slightly in 1992, then started on an upward trend in 1994, standing at 6.3 percent in 1997, the highest level since 1986 and above levels experienced before PPS began. Additional Hospital Data Table D-13 provides historical trends in factors affecting PPS rates and average payments per case, based on data and estimates provided by HCFA's Office of the Actuary. Tables D-14 through D-16 contain wage index information for PPS hospitals for fiscal year 2000. Table D-17 contains information on changes in DRG relative weights from fiscal year 1999 through 2000. TABLE D-12.--TOTAL MARGINS BY HOSPITAL GROUP, 1984-97 [In percent] -------------------------------------------------------------------------------------------------------------------------------------------------------- Hospital group 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 -------------------------------------------------------------------------------------------------------------------------------------------------------- Urban................................................. 7.7 6.9 4.5 3.7 3.6 3.5 3.5 4.3 4.2 4.4 4.9 5.7 5.9 6.2 Rural................................................. 5.0 4.7 3.0 2.9 3.3 4.2 4.7 5.1 5.3 5.1 5.5 6.6 7.0 6.8 Large urban........................................... 7.5 6.6 4.0 3.2 3.0 2.9 2.4 3.6 3.5 3.8 4.2 4.9 5.2 5.4 Other urban........................................... 8.1 7.2 5.4 4.6 4.5 4.7 5.2 5.6 5.3 5.2 6.1 6.9 7.2 7.5 Rural referral........................................ 7.4 8.4 5.7 5.7 5.1 6.5 6.5 6.5 6.7 6.8 7.1 8.6 8.9 9.4 Sole community........................................ 4.8 4.1 2.7 2.3 2.7 3.3 4.3 5.4 5.6 5.6 5.9 6.3 6.1 6.1 Other rural........................................... 4.4 3.7 2.2 2.1 3.0 3.7 4.2 4.5 4.6 4.3 4.7 5.9 5.9 4.9 Major teaching........................................ 5.2 5.7 2.2 2.1 2.4 1.8 0.9 3.5 3.2 3.3 3.1 4.2 3.5 5.1 Other teaching........................................ 8.4 7.3 5.6 4.4 4.3 4.5 4.4 4.7 4.4 4.7 5.3 6.2 6.9 6.6 Nonteaching........................................... 7.3 6.4 4.5 3.8 3.6 3.9 4.4 4.8 4.9 4.9 5.9 6.4 7.0 6.7 Disproportionate share large urban................... 6.6 5.7 3.2 2.4 2.2 2.0 1.3 3.1 3.0 3.5 3.7 4.3 4.3 4.8 Disproportionate share other urban................... 7.9 7.1 5.4 4.7 4.6 4.7 5.3 5.9 5.8 5.4 6.2 7.0 7.2 7.4 Disproportionate share rural......................... 5.8 5.7 2.5 2.8 3.5 4.4 5.7 7.4 7.7 6.0 6.0 7.8 8.2 7.5 Nondisproportionate share............................. 7.7 7.0 4.9 4.2 4.2 4.4 4.5 4.6 4.4 4.6 5.4 8.2 6.8 6.8 Teaching and disproportionate share................... 6.7 6.1 3.6 3.0 2.9 3.0 2.4 4.0 3.9 4.0 4.1 4.9 4.7 5.4 Teaching only......................................... 9.0 8.5 5.9 4.7 5.0 4.6 4.5 4.7 3.9 4.4 5.1 6.5 7.3 7.3 Disproportionate share only........................... 7.7 6.5 4.6 3.7 3.5 3.4 4.2 5.1 5.2 5.1 6.3 6.8 7.5 6.9 No teaching or disproportionate share................. 7.0 6.2 4.4 4.0 3.7 4.3 4.5 4.5 4.7 4.7 5.5 6.1 6.6 6.5 Voluntary............................................. 7.7 7.0 4.9 3.8 3.8 3.9 3.9 4.3 4.0 4.1 4.8 5.7 5.8 6.5 Proprietary........................................... 8.8 7.5 5.6 4.6 3.6 2.9 3.9 5.2 6.6 7.2 9.6 9.3 10.1 6.9 Urban government...................................... 4.4 4.4 0.9 2.3 2.2 2.5 1.7 4.4 4.2 4.4 3.4 4.4 3.9 5.2 Rural government...................................... 4.6 2.9 2.0 1.5 2.4 3.3 4.0 4.8 5.2 4.5 4.7 5.7 6.1 5.3 All hospitals......................................... 7.3 6.6 4.3 3.6 3.5 3.6 3.6 4.4 4.3 4.5 5.0 5.8 6.1 6.3 -------------------------------------------------------------------------------------------------------------------------------------------------------- Note.--Data are percentages. Data on total revenues and expenses are for hospital accounting years beginning during each Federal fiscal year. Hospitals in Massachusetts and New York excluded from data in 1984 and 1985; hospitals in New Jersey excluded from data in 1984-88; hospitals in Maryland excluded from data in all years. Source: Medicare Payment Advisory Commission analysis of Medicare Cost Report data from the Health Care Financing Administration. TABLE D-13.--TRENDS IN FACTORS AFFECTING PPS RATES AND AVERAGE PAYMENTS PER CASE, FISCAL YEARS 1983-2001 [Percentage change from previous year] ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ Fiscal year Rate impact factor ---------------------------------------------------------------------------------------------------------------------------------------- 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ Market basket index.................................... 5.5 4.9 4.1 2.9 3.2 4.7 5.4 5.5 5.2 4.4 4.1 4.3 \1\ 3. \2\ 3. 2.5 2.7 2.4 2.9 3.2 6 5 Annual update factor................................... NA NA NA NA NA 1.7 3.33 5.71 2.83 2.9 2.75 2.11 1.89 1.64 2 0 0.5 1.09 2.01 Case-mix index......................................... NA NA 3.1 2.5 2.1 3.2 2.5 0.85 2.5 1.5 0.8 0.7 1.5 1.4 0.3 -0.6 -0.5 0.5 0.5 Average payments per discharge......................... 9.7 10.4 14.2 7.0 5.0 1.6 9.5 5.6 2.6 8.8 3.6 2.5 4.4 4.1 2.4 -2.0 0.0 2.0 2.9 Average payments per beneficiary....................... 10.9 7.6 5.6 0.8 0.8 0.4 6.1 7.7 3 8.4 6 4.9 4.7 3.5 3.3 -3.2 -2.3 2.1 3.4 ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ \1\ 3.7 for hospitals excluded from the prospective payment system. \2\ 3.4 for hospitals excluded from the prospective payment system. NA--Not available. Source: Health Care Financing Administration. TABLE D-14.--WAGE INDEX AND CAPITAL GEOGRAPHIC ADJUSTMENT FACTOR (GAF) FOR URBAN AREAS, FISCAL YEAR 2000 ------------------------------------------------------------------------ Wage Urban area (constituent counties) index GAF ------------------------------------------------------------------------ 0040 Abilene, TX: Taylor, TX.......................... 0.8179 0.8714 00602 Aguadilla,\2\ PR: Aguada, PR; Aguadilla, PR; 0.4249 0.5565 Moca, PR............................................. 0080 Akron, OH; Portage, OH; Summit, OH............... 1.0163 1.0111 0120 Albany, GA: Dougherty, GA; Lee, GA............... 1.0372 1.0253 0160 Albany-Schenectady-Troy, NY: Albany, NY; 0.8754 0.9129 Montgomery, NY; Rensselaer, NY; Saratoga, NY; Schenectady, NY; Schoharie, NY....................... 0200 Albuquerque, NM: Bernalillo, NM; Sandoval, NM; 0.8499 0.8946 Valencia, NM......................................... 0220 Alexandria, LA: Rapides, LA...................... 0.7910 0.8517 0240 Allentown-Bethlehem-Easton, PA: Carbon, PA; 0.9550 0.9690 Lehigh, PA; Northampton, PA.......................... 0280 Altoona, PA: Blair, PA........................... 0.9342 0.9545 0320 Amarillo, TX: Potter, TX; Randall, TX............ 0.8435 0.8900 0380 Anchorage, AK: Anchorage, AK..................... 1.3009 1.1974 0440 Ann Arbor, MI: Lenawee, MI; Livingston, MI; 1.1483 1.0993 Washtenaw, MI........................................ 0450 Anniston, AL: Calhoun, AL........................ 0.8462 0.8919 0460 Appleton-Oshkosh-Neenah, WI: Calumet, WI; 0.8913 0.9242 Outagamie, WI; Winnebago, WI......................... 0470 Arecibo, PR: Arecibo, PR; Camuy, PR; Hatillo, PR. 0.4815 0.6062 0480 Asheville, NC: Buncombe, NC; Madison, NC......... 0.8884 0.9222 0500 Athens, GA: Clarke, GA; Madison, GA; Oconee, GA.. 0.9800 0.9863 0520 Atlanta,\1\ GA: Barrow, GA; Bartow, GA; Carroll, 1.0050 1.0034 GA; Cherokee, GA; Clayton, GA; Cobb, GA; Coweta, GA; DeKalb, GA; Douglas, GA; Fayette, GA; Forsyth, GA; Fulton, GA; Gwinnett, GA; Henry, GA; Newton, GA; Paulding, GA; Pickens, GA; Rockdale, GA; Spalding, GA; Walton, GA....................................... 0560 Atlantic-Cape May, NJ: Atlantic, NJ; Cape May, NJ 1.1050 1.0708 0580 Auburn-Opelika, AL: Lee, AL...................... 0.7748 0.8397 0600 Augusta-Aiken, GA-SC: Columbia, GA; McDuffie, GA; 0.9013 0.9313 Richmond, GA; Aiken, SC; Edgefield, SC............... 0640 Austin-San Marcos,\1\ TX: Bastrop, TX; Caldwell, 0.9081 0.9361 TX; Hays, TX; Travis, TX; Williamson, TX............. 0680 Bakersfield,\2\ CA: Kern, CA..................... 0.9951 0.9966 0720 Baltimore,\1\ MD: Anne Arundel, MD; Baltimore, 0.9891 0.9925 MD; Baltimore City, MD; Carroll, MD; Harford, MD; Howard, MD; Queen Anne's, MD......................... 0733 Bangor, ME: Penobscot, ME........................ 0.9609 0.9731 0743 Barnstable-Yarmouth, MA: Barnstable, MA.......... 1.3302 1.2158 0760 Baton Rouge, LA: Ascension, LA; East Baton Rouge, 0.8707 0.9095 LA; Livingston, LA; West Baton Rouge, LA............. 0840 Beaumont-Port Arthur, TX: Hardin, TX; Jefferson, 0.8624 0.9036 TX; Orange, TX....................................... 0860 Bellingham, WA: Whatcom, WA...................... 1.1394 1.0935 0870 Benton Harbor,\2\ MI: Berrien, MI................ 0.8831 0.9184 0875 Bergen-Passaic,\1\ NJ: Bergen, NJ; Passaic, NJ... 1.1833 1.1222 0880 Billings, MT: Yellowstone, MT.................... 1.0038 1.0026 0920 Biloxi-Gulfport-Pascagoula, MS: Hancock, MS; 0.7949 0.8545 Harrison, MS; Jackson, MS............................ 0960 Binghamton, NY: Broome, NY; Tioga, NY............ 0.8750 0.9126 1000 Birmingham, AL: Blount, AL; Jefferson, AL; St. 0.8994 0.9300 Clair, AL; Shelby, AL................................ 1010 Bismarck, ND: Burleigh, ND; Morton, ND........... 0.7893 0.8504 1020 Bloomington, IN: Monroe, IN...................... 0.8593 0.9014 1040 Bloomington-Normal, IL: McLean, IL............... 0.8993 0.9299 1080 Boise City, ID: Ada, ID: Canyon, ID.............. 0.9086 0.9365 1123 Boston-Worcester-Lawrence-Lowell-Brockton, MA-NH 1.1369 1.0918 (MA Hospitals)\1\