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.