Analysis of the Joint Distribution of Disproportionate Share Hospital Payments

2. A Policy Framework for Targeting Financially
Vulnerable Safety Net Hospitals

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Researchers, states and federal policymakers have used a broad range of definitions to characterize safety net hospitals. While the definitions vary, a common theme is that safety net hospitals provide a disproportionate amount of care to vulnerable populations. However, how vulnerable, disproportionate, or care is defined varies greatly. To complicate matters, what constitutes a safety net hospital can vary from community to community (Baxter and Mechanic 1997). For example, in some communities, such as Dallas, a single public hospital is the heart of the local safety net. By contrast, in Milwaukee, which recently closed its public hospital, a few community hospitals form the safety net.

Which hospitals are ulti amately identified as safety net providers has important implications for evaluating whether DSH payments are well targeted: Is the purpose to help relieve hospitals financial burden of caring for low-income populations? Help hospitals in financial distress? Protect low-income Medicare and Medicaid recipients' access to care? Compensate hospitals for providing care to the uninsured? Help states and local governments in areas with high levels of need? Encourage selected hospital behavior suchs providing special services — teaching, emergency room care, trauma care and the like? Or, perhaps, the purpose is some combination of these. The definition of safety net hospital that is adopted has direct implications for which facilities would receive money under a federal DSH fund.

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What Is a Safety Net Hospital?

Below we highlight some of the key dimensions to describing a safety net hospital and how researchers and policymakers have defined safety net hospitals. A summary of these is provided in Table 2.1.

Table 2.1
  Safety Net Hospitals: Key Dimensions and Definitions


Research and Policy Definitions
Legal Mandate or Mission
  • Clinton Health Care Proposal: Legal mandate and in area of high need
  • Gaskin and Hadley: Mandate or mission driven or high share of low-income discharges
Vulnerable Populations
  • Medicare DSH formula: Medicaid and Medicare/SSI recipients
  • Basic Medicaid DSH formula: Three available options, which can be used separately or jointly
    • d) Medicare DSH formula
    • e) Medicaid recipients only or
    • f)Low-income populations including Medicaid and indigent persons
  • Medicaid DSH option: states free to establish own criteria for vulnerable populations
  • IOM: uninsured, Medicaid, and other populations such as people with HIV or mental illness.
Disproportionate Amount of Care Volume of care:
  • Medicare DSH Formula: threshold volume of Medicaid and Medicare SSI patients depending upon selected hospital characteristics such as size and location
  • Federal Medicaid DSH minimum standards:
  • Hospital's Medicaid inpatient rate at least 1 S.D. above state mean Medicaid inpatient rates
    • a)Hospital's "low-income use rate" (Medicaid and charity care patients)(1)>25%
    • b)Many states pay DSH to other hospitals as well
    • c)Costs of uncompensated care:
  • Top 10% of hospitals providing most bad debt and charity care (Baxter and Mechanic 1997)
  • Top 10% of hospitals with highest ratio of bad debt and charity care to operating expense (Fishman 1997)
  • Ratio of hospital's uncompensated care to hospital's total costs >10% (Cunningham and Tu 1997)

Type of care:
Provision of certain types of services (e.g. ER, trauma, burn) as indication of safety net hospital

Level of Aggregation
  • National
  • State
  • Hospital Type
  • Market-Level

Legal Mandate or Mission

Perhaps the most basic definition of a safety net hospital is one that has an "open door" policy to all individuals regardless of their ability to pay. This policy can derive from either a legal mandate to care for charity patients or a mission-driven commitment to such patients. In general, researchers and policymakers have not used this definition alone to identify safety net hospitals. Instead, the legal mandate or mission definition is typically used in combination with other characteristics. For example, in the Clinton health care proposal, safety net hospitals were defined as those hospitals that were legally mandated (mission-driven hospitals were not included) to provide care and were located in areas with high levels of need such as health professional shortage areas (HPSAs). Gaskin and Hadley (1999) classified safety net hospitals as those that have an explicit safety net mission or a high proportion of low-income patients — Medicaid, charity care, or self-pay patients.

Vulnerable Populations

An important distinction of safety net hospitals is that they provide care to vulnerable populations. Unfortunately, there is no general agreement on which groups should be considered vulnerable. The Institute of Medicine's recent report, America's Health Care Safety Net, adopted a broad definition of vulnerable populations--including the "uninsured, Medicaid and other vulnerable patients" (IOM 2000). The other vulnerable groups included homeless persons, persons with HIV, substance abusers, and the mentally ill.

A big issue is whether low-income patients with insurance should be included in the definition of vulnerable. Some argue that vulnerable should be limited to indigent, uninsured patients whereas others argue that Medicaid patients should be considered a vulnerable population (IOM, 2000). The principal argument for excluding low-income Medicare patients (i.e., those that are entitled to SSI) and Medicaid patients is that they have insurance and thus have access to the health care system. The uninsured, by contrast, have no insurance, and generally have very limited ability to pay for their care. The arguments for counting Medicaid patients as a vulnerable population is that, despite having insurance, Medicaid patients often have trouble gaining access to health care services because of the historically low program payment rates. Further, their low-income and complex health care needs make them a vulnerable population. Moreover, including Medicaid patients improves the geographic balance between states that have expansive Medicaid programs and those that do not.

Reflecting its status as a federal health insurance program, the Medicare DSH formula takes into account low-income patients covered by Medicaid as well as Medicare. Hospitals get no credit for serving patients covered by other indigent care programs or the uninsured. Owing to the flexibility provided by Medicaid statute, Medicaid state DSH programs vary greatly, both in terms of how hospitals are determined eligible for payments and how payments are allocated among qualifying hospitals. Colorado, for example, largely relies on the federal minimum definition for identifying DSH hospitals. For payment, they use a range of methods including a proportional payment that varies by how the hospital qualifies for DSH. They also have a special program that makes DSH payments based on the facilities proportional level of services provided to the beneficiaries of the Colorado Indigent Care Program, a state-funded program that provides health care services to low-income persons who do not qualify for Medicaid. Florida operates six DSH programs each using different eligibility criteria. One program pays DSH payments to hospitals that provide inpatient services to high cost Medicaid beneficiaries. Another program provides DSH funds based on the number of inpatient admissions referred from county health departments for treatment of communicable disease. Similarly, Massachusetts has several DSH programs that use a range of criteria to issue payments including the volume of hospital services provided to low-income unemployed persons, low- income children, and low-income disabled individuals.

Disproportionate Amount of Care

Another distinguishing feature of safety net hospitals is that they provide a disproportionate amount of care to vulnerable populations. Several definitions have been used to quantify the amount of care. A key issue is whether it should be based on the volume of care provided to vulnerable populations or the uncompensated cost of that care. While the Medicare and Medicaid DSH programs identify a safety net hospital primarily on the volume of low-income patients it serves, another common strategy, especially in the research literature, is to designate safety net hospitals by their level of uncompensated care costs--that is, the costs of charity care and bad debt.

Measures that rely on revenue data or uncompensated care costs have potential for inaccurate reporting and "gaming". For example, MedPAC found that some hospitals include care not covered by Medicaid as bad debt expense (MedPAC 1998) even though contractual allowances are not bad debt. It is possible data based on gross revenues (such as percentage of gross charges attributable to low-income patients) or utilization (such as the percentage of inpatient days and outpatient visits that are attributable to low-income patients or to the uninsured) may provide better defined measures of serving vulnerable populations. We discuss potential measures of financial vulnerability in greater detail in the next section.

A second issue is how to decide whether the care to vulnerable populations is disproportionate to that provided by other hospitals. Medicare's policies establish a minimum DSH patient percentage threshold that hospitals must meet in order to become eligible for DSH payments under the PPS for operating costs. MedPAC recommends that a threshold be set so that between 50-60 percent of hospitals would qualify for DSH payments. The Medicaid law requires that at a minimum States 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.

Researchers have tended to focus on a more limited set of hospitals with relatively high uncompensated care costs. For example, Baxter and Mechanic (1997) identified hospitals in the top decile of hospitals providing the most bad debt and charity care in a given community as safety net providers. In another study, safety net hospitals were defined as those with the highest (the top 10 percent of hospitals) level of uncompensated care costs relative to operating costs (Fishman 1997). Others have defined safety net hospitals as those that provide high levels of uncompensated care--10 percent or more--relative to a hospital's total costs (Cunningham and Tu 1997).

Specialized Care

Researchers have also identified safety net hospitals as those that provide selected types of services such as emergency room care or trauma care. Here, the argument is that safety net hospitals often provide services that are either too expensive for other hospitals to provide, unprofitable, or attract patients that may be considered undesirable and thus should be compensated (Gage 1998; Gaskin 1998). In addition, targeting DSH payments based on the provision of selected services may be a way to encourage hospitals to provide such services that they may have not provided otherwise or to continue to operate in an area that they might not otherwise (ProPAC 1994). Baxter and Mechanic, for example, used emergency room used as indicator of hospitals' safety net role (Baxter and Mechanic 1997). Specifically, they examined hospitals that provided the top 10 percent of emergency room visits in a given market. A common element in several states' DSH programs is targeting payments to selected facilities such as children's hospitals or hospitals located in medically underserved areas. Similarly, the Medicare DSH program gives special consideration to the market a hospital operates in--for example, rural referral centers and sole community hospitals.

Level of Aggregation

Another dimension to defining which hospitals are safety net providers is the market context. That is, do you compare hospitals nationally, as the Medicare DSH formula does? Or, do you look at the relative contribution of providers at the state level? Or at the market level? And, if it is at the market level, how do you define the market?

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How Should Financial Vulnerability Be Defined?

Developing and evaluating alternative methods for distributing Medicare and Medicaid DSH payments requires measures of the financial pressure faced by each safety net hospital. The measures serve two potential purposes. First, one or more of them could be used as an explicit factor in allocating funds to safety net hospitals. The measures most appropriate for this purpose would be those that are directly related to serving low-income populations such as uncompensated care. Second, more general measures such as a hospital's margin could be used to evaluate how well the DSH allocation policy targets financially vulnerable safety net hospitals without being explicitly incorporated into the allocation formula.

Measures related to serving low-income populations

In the preceding section, we discussed potential measures to identify hospitals that serve vulnerable populations. These measures do not necessarily equate to measures of financial vulnerability. Providing services to Medicare beneficiaries who are entitled to SSI threatens a hospital's financial viability only if there is a higher cost to serving these patients than other patients that is not recognized in the payment rates (which the Medicare DSH adjustment was originally intended to address). Financial viability is also threatened if the overall payment rates under the program are inadequate to cover the costs of providing services. However, if there are no revenue shortfalls, serving Medicare/SSI beneficiaries does not add to a hospital's financial vulnerability. Thus, factors that are used to determine whether a hospital serves vulnerable populations are not necessarily measures of financial vulnerability.

Uncompensated Care

A hospital's uncompensated care load contributes to its financial vulnerability since the hospital must cover the costs of the care through other revenue. Measures of uncompensated care frequently include both charity care and bad debt. Since bad debt may result from irresponsible behavior on the part of non-poor patients, its inclusion in a financial vulnerability measure may discourage hospitals from pursuing collection from such patients. However, many hospitals do not distinguish between charity care, for which the patient is not expected to pay from the time of admission, and bad debt, for which the patient's liability for at least some portion of the bill is waived upon determination of the inability to pay. The fact that such decisions frequently wait until the patient's Medicaid eligibility is determined through the initial application process further complicates this distinction (ProPAC 1997). Moreover, a distinction may be unnecessary. One recent study of Massachusetts hospitals reported that most patients who incurred bad debt had incomes below the poverty line (Weismann et al 1999).

Medicaid Shortfalls

A hospital's Medicaid shortfall can also contribute to its financial vulnerability. A policy issue is whether using Medicaid contractual allowances in an allocation formula would distort both the distribution of payments and the incentives faced by the states. It would reward hospitals in states that have less expansive Medicaid programs and could provide an incentive for the states to reduce their Medicaid level of effort. A measurement issue is the extent to which the shortfall is attributable to the hospital's inefficiency as opposed to Medicaid payment levels. A measure of Medicaid utilization or share of gross revenues (MedPAC's recommended approach) rather than Medicaid shortfalls would address both issues. While this may be an appropriate allocation policy, it is the hospital's shortfalls from serving Medicaid patients that threatens its financial viability. Moreover, federal support is already being provided for the Medicaid population through the federal match. Thus, a measure of the Medicaid shortfall - either directly or indirectly through a measure of the generosity of the state's Medicaid program - should also be considered.

Shortfalls from state or local indigent care program

Shortfalls attributable to serving patients supported through state or local indigent care programs can also contribute to financial vulnerability. Information on these patients is generally not collected separately in national databases. The AHA survey includes patients supported by indigent care programs in the "other government" payer category, along with CHAMPUS, Title V and worker's compensation, and, in some states, state and local government health programs. In the absence of better data, MedPAC assumes that any losses a hospital reports for this category are attributable to indigent care patients (MedPAC 1998).

Other measures of financial vulnerability

Another issue is whether the hospital's overall financial condition should be taken into account in allocating DSH funds, e.g., whether operating losses- whether or not they are directly associated with serving low-income patients- should be considered in an allocation policy. Such measures may be more suitable for evaluating whether the payments are targeted toward the more financially vulnerable hospitals than as an allocation statistic.

A hospital's total revenue margin is the most commonly used measure of financial viability. This measure equals the difference between total net revenues and total expenses as a percentage of total net revenues. It is the most direct indicator of whether the hospital is able to cover its overall expenses with its overall revenues. Hospitals with very low total margins (including many safety net hospitals) find themselves without sufficient funds to pay off debt, increase capital assets, expand services, or finance social missions. A hospital's total margin includes its current subsidies for serving low- income populations. Since a critical question for targeting DSH payments is whether the hospital would be financially viable in the absence of those payments, the hospital's total margin net of DSH payments is a better measure of financial viability for purposes of identifying financially vulnerable safety net hospitals. Comparing total margin net of DSH to total margin including DSH subsidies under alternative DSH allocation methodologies provides an indication of how the hospital's financial viability would be affected assuming no behavioral changes occur in the services it provides or in the revenues it receives from Medicaid and other payers.

The literature suggests that margins alone should not be used to assess hospital financial viability. A hospital with positive margins may have inadequate liquid assets to meet its obligations. Negative margins may reflect changes in accounting rules or a decision to write-off a large expense over a period of years rather than financial distress (Bazzoli 1995). In addition to profitability, an assessment of financial viability should consider liquidity (the ability to pay bills), capital structure (the ability to pay long-term debt), and asset efficiency (how well assets are used in generation of revenues) (Bazzoli 1995; AHA 1998; Zeller 1997). Other factors that have been identified as important indicators of financial condition are working capital efficiency, fixed-asset age, and Medicare case mix index (Prince 1998; Zeller 1997). It is not necessary to use all financial measures in assessing a hospital's financial viability since many of the financial measures are highly correlated (Zeller 1997). Factor analysis has been used to identify the measures or measure sets that are most important in describing a hospital's financial condition (Bazzoli 1995; Zeller 1997).

We note that an advisory panel convened by the American Hospital Association (AHA) felt that both financial and non-financial factors are important considerations in assessing the on-going viability of hospitals (AHA 1998). The panel suggested that bond ratings have value as a leading indicator of financial viability because they take both types of factors into consideration. However, not all hospitals have a bond rating and the ratings include subjective "risk aversion" considerations.(2)

(Reflecting a tightening of standards, current "BBB" ratings have financial ratios comparable to "A" ratings of several years ago (CHIPS, 2000)). Moreover, there are administrative advantages to using indicators that can be readily generated on an on-going basis from Medicare cost report data.

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Policy Issues

The literature concerning safety net hospitals and the current policies for Medicare and Medicaid DSH payments suggest a set of policy issues related to the distribution of DSH funds.

Underlying these major policy issues are empirical questions regarding the sensitivity of the allocations to different measures that could be used to define financially vulnerable safety net hospitals. These questions are important in understanding the impact the policy choices could have on the distribution of DSH funds to particular hospitals and identifying those choices where administrative preferences for readily available measures would have little practical effect on the distributions. In the remainder of this report, we examine the current distribution of DSH across classes of hospitals and analyze how different measures of financially vulnerable safety net hospitals would affect 1) the set of hospitals eligible to receive federal subsidies and 2) the distribution of funds among those hospitals.

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1.  Low income use rate is the sum of two ratios. The first is the share of the hospital's total revenue for patient services that are paid by Medicaid or state/local subsidies. The second is the percent of total hospital charges for inpatient services accounted for by the net (of state and local subsidies for inpatient care) amount of charity care provided to inpatients.

2.  Alternative approaches to using bond ratings as a direct measurement of financial viability would be to draw on research using statistical models to predict bond ratings or to use the financial data on hospitals with poor bond ratings to define financially distressed hospitals. For example, Bazzoli (1995) used the financial ratios for hospitals with BBB- bond ratings from Standard and Poor's to identify a set of financially distressed hospitals (those hospitals that had at least 6 of 8 financial indicators below the median values for the BBB-hospitals).

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