Analysis of the Joint Distribution of Disproportionate Share Hospital Payments

1. Overview of DSH Funding Policies

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Contents

• Medicare DSH Payments
• Medicaid DSH Payments
• Issues Related to Distribution of DSH Funds

Endnotes

Medicare DSH Payments

Evolution of Medicare DSH Policies

Until enactment of the Social Security Amendments of 1983, Medicare payments for hospital inpatient services were based on the costs incurred by the hospital. The amendments created the hospital inpatient prospective payment system (PPS), under which acute care hospitals were paid a fixed rate for the operating costs incurred in treating patients in each diagnosis-related group (DRG). ⁽¹⁾ Payment rates were adjusted to reflect several factors thought to affect a hospital's cost structure, including local wages and the intensity of residency training.

The PPS legislation included a provision that allowed for "such exceptions and adjustments to the payment amounts...as the Secretary (of Health and Human Services) deems appropriate to take into account the special needs of public or other hospitals that serve a significantly disproportionate number of patients who have low income." The accompanying legislative history notes that "(c)oncern has been expressed that public hospitals and other hospitals that serve such patients may...[treat patients that are] more severely ill than average and that the DRG payment system may not adequately take into account such factors" (U.S. Congress, 1983). Nevertheless, the PPS that was implemented beginning in October 1983 did not include an adjustment for serving a disproportionate share of low-income patients.

The Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) established an adjustment that was based on the hospital's disproportionate patient percentage (DPP), with different formulas for urban hospitals with at least 100 beds, other urban hospitals, and rural hospitals. The DPP was defined as the sum of:

• the percentage of the hospital's total Medicare patient days attributable to Medicare patients who also are federal Supplemental Security Income (SSI) beneficiaries (excluding state supplement only beneficiaries), and
• the percentage of the hospital's total patient days attributable to Medicaid beneficiaries (excluding Medicare beneficiaries).

The construction of this variable was an attempt to balance the distribution of payments between those hospitals located in states with generous Medicaid programs and those with more restrictive eligibility criteria and benefits. There also was a separate provision for certain urban hospitals with at least 100 beds that could demonstrate that more than 30 percent of net inpatient care revenue was provided by state or local government for the inpatient care of low income patients not reimbursed by Medicare or Medicaid.⁽²⁾ The Medicare DSH provision went into effect on a temporary basis in May 1986, and it was extended several times until it was made permanent in the Omnibus Budget Reconciliation Act (OBRA) of 1990.

Recent Changes in Medicare DSH Policies

The eligibility criteria and formulae for determining Medicare DSH payments for operating costs have changed over time to include more hospitals and (except for the temporary reductions in the Balanced Budget Act of 1997 (BBA)) to provide more generous payment levels. As a result, DSH payments have grown considerably over the last decade. In fiscal year 1989, Medicare DSH payments were an estimated $1.1 billion. By 1992, these payments had doubled to $2.2 billion, and they had more than doubled again to $4.5 billion by 1997.⁽³⁾ Along with most other components of Medicare payments, the Balanced Budget Act of 1997 (BBA) reduced DSH payments: beginning in 1998, there was to be a progressively increasing across-the-board reduction, reaching 5 percent by 2002. These cuts were estimated to total $0.6 billion over the five years. Subsequently, the Balanced Budget Refinement Act of 1999 (BBRA) and the Benefits and Improvement Act of 2000 (BIPA) restored a portion of the BBA cuts. Under current law, there were temporary across-the-board reductions of 2 percent in FY2001 and 3 percent in FY2002.

Under the PPS for operating costs, the payment formulae vary across types of hospitals. Until BIPA, the minimum DPP or threshold for DSH payments also varied. The BIPA enhanced DSH payments to rural and small urban hospitals by establishing a uniform threshold for eligibility to receive DSH payments and making changes in the payment formulae. The policies for determining DSH payments in FY1998 and under current law are shown in Table 1.1.

Purpose of Medicare DSH Payments

The Centers for Medicare and Medicaid Services (CMS, formerly the Health Care Financing Administration) has generally maintained that the DSH adjustment is intended to cover only the higher costs associated with the care of Medicare beneficiaries in hospitals serving a disproportionate share of low-income patients. For example, when the prospective payment system for capital costs was implemented in FY1992, the DSH adjustment was established administratively based on the estimated effect of the DPP on total inpatient costs per case and has no minimum threshold. On the other hand, the Medicare Payment Advisory Commission (MedPAC) (and its predecessor the Prospective Payment Assessment Commission (ProPAC)), views the DSH adjustment as a policy adjustment independent of hospital cost that is intended to assure access to care for low-income Medicare beneficiaries and other poor people.

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Medicaid DSH Payments

Evolution of Medicaid DSH Policies

Until enactment of OBRA 1981, state Medicaid programs generally were required to pay for hospital inpatient services on a reasonable cost basis, as was done under Medicare. That legislation allowed states to adopt their own payment methodologies for hospital inpatient services so long as their payment rates reflected the costs "which must be incurred by efficiently and economically operated facilities." The legislation also required that state Medicaid programs set reimbursement rates for hospital inpatient services that "take into account the situation of hospitals which serve a disproportionate share of low-income patients with special needs."

The accompanying House Committee Report language refers to "the special costs of hospitals whose patient populations are disproportionately composed of individuals who are either provided medical assistance under the State plan or who have no source of third party payment for such services" (ProPAC, 1994). The report stipulates that:

In determining whether a hospital's Medicaid and 'free care' population is disproportionate, the Committee expects States to consider the proportion of such individuals in the hospital's patient population, compared to all hospitals in the area, as well as...a hospital's share of the total estimated number of such individuals in an area (ProPAC 1994).

In keeping with the federal/state partnership under Medicaid, the states were given considerable latitude in determining which hospitals were eligible for DSH payments and how those funds would be distributed.

During the early 1980s, very few states established specific DSH payment methodologies. By the fall of 1985, only 17 states had defined disproportionate share hospitals and specified methodologies for adjusting their Medicaid payments. In response to this situation, OBRA 1987 required states to make specific payment adjustments and established minimum criteria for designating and adjusting payment for inpatient services provided by disproportionate share hospitals. States were required to designate as disproportionate share hospitals all hospitals meeting one of the following criteria:

• a Medicaid inpatient utilization rate one standard deviation or more above the mean for all hospitals in the state, or
• a low-income utilization rate exceeding 25 percent.

States could designate other hospitals as disproportionate share hospitals as well.

In determining the amount of the DSH payment to eligible hospitals, states could use the Medicare formula or make an adjustment that increased proportionally with the hospital's Medicaid utilization rate. OBRA 1990 expanded the options for determining the DSH payment amounts. The proportional adjustment now applies to the hospital's low-income utilization rate rather than just its Medicaid utilization rate, and separate methodologies are allowed for different types of hospitals.

In the early 1990s, Medicaid DSH payments grew rapidly. This was the result of two developments.

• In 1983, the Health Care Financing Administration (HCFA) limited a state's aggregate Medicaid payments for inpatient hospital services to no more than the amount that would have been paid under Medicare payment policies. In OBRA 1986, however, this limit was made inapplicable to Medicaid DSH payments.
• In June 1989, a HCFA decision that states could not require or solicit contributions from providers for the purpose of obtaining federal matching funds was overturned in the courts. This provided a mechanism for states to generate additional federal matching funds without any net increases in their own budgets. Moreover, OBRA 1990 imposed a moratorium on any additional attempts to restrict states' use of provider-specific taxes or donations through December 1991.

With the removal of the Medicare limit for Medicaid DSH payments, the ability of the states to take advantage of this mechanism was virtually unbounded. DSH spending grew from less than $1 billion in fiscal year 1989 to more than $17 billion in 1992. The Medicaid Voluntary Contribution and Provider-Specific Tax Amendments of 1991 established conditions for allowable provider-specific taxes and donations and state-specific limits on DSH spending. OBRA 1993 further limited DSH payments for individual hospitals to the total of the hospital's Medicaid payment shortfall and its losses on uninsured patients (not counting government appropriations intended to cover those costs). It also required that hospitals designated for Medicaid DSH payments have a Medicaid utilization rate of at least one percent.

Recent Changes in Medicaid DSH Policies

The BBA contained several provisions that affected the amount and distribution of Medicaid DSH payments. To restrict the use of federal funds to finance care in state-owned institutions for mental disease (IMDs) (which traditionally were viewed as a state and local responsibility), the BBA limited the proportion of a state's DSH payments that could go to IMDs to 33 percent by fiscal year 2002.⁽⁴⁾

The BBA also reduced the state-specific federal DSH allotments by $10.4 billion between 1998 and 2002. After 2002, federal DSH expenditures are to increase at the nationwide general rate of inflation (all urban CPI), subject to a state-specific ceiling of 12 percent of the state's total Medicaid expenditures in each year (Coughlin, Ku, and Kim 2000). The BBRA later raised the Medicaid DSH ceilings for several states. The BIPA provided further relief by setting 2001 state-specific allotments at 2000 levels adjusted for inflation and setting 2002 allotments at 2001 levels adjusted for inflation. The allotments for states with extremely low DSH payments (defined as FY1999 expenditures greater than zero but less than one percent of total state expenditures) were increased to one percent in FY2001 and increased for inflation thereafter. Also, states were permitted to provide DSH payments up to 175 percent of net uncompensated care costs to public hospitals for two years.

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Issues Related to Distribution of DSH Funds

Concerns with Medicare Formula

In 1997, ProPAC identified several problems with the current method for distributing Medicare DSH payments (ProPAC 1997a):

• The DPP is a poor indicator of hospitals' care for the poor, particularly because it reflects only Medicaid and not uncompensated care. The changing role of the Medicaid program and the variations in this role across states makes Medicaid an increasingly inappropriate proxy for uncompensated care. Moreover, the omission of uncompensated care means that the leading source of financial pressure on safety net hospitals is not considered in the distribution of Medicare DSH payments.
• Because there are multiple DSH formulae, hospitals with the same share of low-income patients can have substantially different DSH payment adjustments. In particular, there was great disparity in the formulas for urban versus rural hospitals: for example, an urban hospital with 100 beds and a DPP of 25 percent received an adjustment of 9.72 percent, while a rural hospital of the same size with the same DPP received no adjustment (The BIPA partially addressed this concern.)
• Each DSH operating formula includes a minimum DPP threshold, below which the hospital receives no DSH payment and at which the hospital receives some minimum percentage. This sometimes creates a substantial "notch". For example, an urban hospital with 100 beds receives a 2.5 percent adjustment if its DPP is 15.0 percent, but nothing if its DPP is 14.9 percent.

ProPAC concluded that these problems prevented Medicare DSH payments from achieving their intended objectives and made several recommendations.

• Medicare DSH payments should be aimed at protecting access to care for its beneficiaries. Payments therefore should be distributed based on each hospital's share of low-income patient care and its volume of Medicare cases.
• The low-income share measure should reflect the costs of services provided to low-income patients in both inpatient and outpatient settings.
• In addition to Medicare SSI and Medicaid patients, the low-income share measure should include patients sponsored by other state and local indigent care programs as well as uninsured and underinsured patients represented by uncompensated care. This would eliminate disparities caused by differences in Medicaid eligibility rules across states.
• Medicare DSH payments should be concentrated among hospitals with the highest shares of low-income patients. Therefore, a minimum threshold should be established, but there should be no notch in the DSH formula.
• To eliminate the disparity between the payments received by urban and rural hospitals with the same proportion of low-income patients, the same general approach for distributing Medicare DSH payments should apply to all PPS hospitals.
• The Secretary should collect the data necessary to implement a revised Medicare DSH payment mechanism.

In succeeding years, the Medicare Payment Advisory Commission⁽⁵⁾ essentially reiterated ProPAC's recommendations (MedPAC 1998; MedPAC 1999, MedPAC 2001).

Drawing on work by ProPAC, the BBA required the Secretary of HHS to make recommendations to the Congress regarding a revised formula for DSH payments. The formula is to:

• establish a single threshold for hospitals serving low income patients;
• consider the costs incurred by hospitals in serving Medicare patients who are entitled to SSI; and,
• consider the costs incurred by hospitals in serving Medicaid patients who are not entitled to Medicare.

The Secretary's report to Congress has not been released. As indicated above, the BIPA included provisions to establish a single threshold for serving low income patients; however, the different payment formulae remain.

Concerns with Medicaid Distribution

There have been concerns about the distribution of Medicaid DSH funds as well. An early analysis by ProPAC found that "Medicaid DSH payments, in combination with state and local subsidies, played a crucial role in improving the financial status of hospitals with the highest shares of Medicaid patients and other low-income patients" (ProPAC 1994). However, the study also found that although "the increase in Medicaid payments was much more concentrated in hospitals with the largest shares of low-income patients...hospitals with typical (or low) shares of low-income patients … receive a substantial portion of both Medicare DSH payments and the increase in Medicaid payments." This led ProPAC to recommend several changes in the mechanism for distributing Medicaid DSH payments.

A subsequent study by Ku and Coughlin (1995) found that Medicaid DSH and related programs help support uncompensated care, but that only a small share of these funds were available to cover the costs of uncompensated care because of intergovernmental transfers and the amounts retained by the states . In a later re-examination of this issue after the BBA legislation aimed at addressing this issue had taken effect, Coughlin, Ku, and Kim (2000) found that an increasing share of the DSH gains was paid to local public and private hospitals and less was retained by the states. However, the use of DSH by the states remained highly uneven.

Impact of Managed Care

In addition to the policy issues raised regarding the policies used to distribute DSH funds, the growth of Medicare and Medicaid managed care has put pressure on safety net hospitals. Many states are relying on managed care to serve their Medicaid populations (and control costs). Between 1991 and 2000, the proportion of Medicaid beneficiaries enrolled in managed care plans mushroomed from less than 10 percent to 57 percent (Iglehart, 1999; Kaiser, 2002). Under Medicaid managed care, care is moving to the outpatient setting and to hospitals that are not traditional safety net providers. As a result, safety net hospitals may lose not only the patient care payments for former patrons who obtain their care in other settings or at other hospitals, but also a portion of the Medicare and Medicaid DSH payments that they would have received if they had retained those patients.

Medicare managed care growth also affects the flow of Medicare DSH funds to safety net hospitals.⁽⁶⁾ The number of Medicare inpatient discharges eligible for direct DSH payments decreases as the number of Medicare managed care enrollees increases. If the amounts implicit for DSH in the managed care capitated rates are not passed on by Medicare+Choice organizations, there is a decline in hospital revenues.⁽⁷⁾

Joint Distribution of Federal DSH Funds

State-reported information on DSH payments to individual hospitals permits for the first time a national examination of the joint distribution of Medicare and Medicaid funds and how well the funds are targeted toward vulnerable safety net hospitals. Our exploratory analyses of alternative allocation policies are within the context of using a single federal DSH funding mechanism. By assuming there would be a new funding stream to support financially vulnerable safety net hospitals, there is no need to link the funds to services provided to Medicare and Medicaid beneficiaries and there is greater flexibility to address the identified shortcomings of the current system. In the next chapter, we discuss potential criteria that could be used to identify hospitals that would be eligible to receive DSH funds and potential bases for determining how to distribute the funds to those hospitals through a separate funding mechanism.

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Endnotes

1.  In fiscal years 1984 through 1991, the hospital inpatient PPS applied only to operating costs; capital costs continued to be paid on a reasonable cost basis (with reductions beginning in fiscal year 1987) until FY 1992.

2.  Hospitals meeting this criterion are called "Pickle hospitals", after Congressman Pickle of Texas, who sponsored the provision.

3.  These estimates do not include DSH payments for capital costs but include the amounts implicit for DSH in managed care payments.

4.  The Medicaid statute defines an "institution for mental diseases" as a hospital, nursing facility, or other institution of more than 16 beds, that is primarily engaged in providing diagnosis, treatment, or care of persons with mental diseases, including medical attention, nursing care, and related services.

5.  The commission was formed by merging ProPAC with the Physician Payment Review Commission in October 1997.

6.  Nationally, Medicare managed care enrollment grew rapidly from 3.3 percent in 1990 to 15.4 percent in 1998 (U.S. Congress, 1999) and then has declined slightly (KFF, 2002).

7.  The BBA established effective January 1, 1998 a direct pass-though payment to teaching hospitals for indirect medical education costs attributable to Medicare managed care enrollees. There is no comparable provision for DSH payments.

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