One issue in allocating DSH funds is the extent to which the state's available resources to finance health care for low-income persons should be taken into account in the fund distribution formula. Under current law, Medicare DSH payments are based on national allocation rules without regard to state resources while the federal share of Medicaid DSH payments is determined under a matching formula that varies by state. The Federal Medical Assistance Percentage (FMAP) is intended to provide more generous Medicaid matching percentages to states that have relatively fewer resources to finance health care programs and/or relatively more low-income patients to serve.
The current FMAP formula is based on per capita income and has been criticized for not taking into account total resources available to finance health care and cross-state differences in the cost of health care and the number of people living in poverty. Proposals have been made for an "equitable" FMAP based on the ratio of the state's share of resources (adjusted for differences in health care costs) to the state's share of low-income patients (adjusted for cost-of-living differences and age). Adjusting payments to hospitals using this type of formula would be consistent with a policy that federal support for uncompensated care costs should be higher in those states with limited resources. However, our analyses focus on DSH distributions to individual hospitals rather than aggregate payments to states. If the DSH distribution is based on a utilization or gross revenue measure, using a FMAP-like factor in the allocation formula would be one way to adjust for likely differences in the actual financial risk associated with serving low-income patients (i.e. Medicaid shortfalls and uncompensated care). The assumption would be that hospitals located in states with relatively fewer resources have higher financial risk than hospitals located in states with relatively high resources. We do not believe that it would be appropriate to use an FMAP-like factor if the allocation formula is based on actual financial risk. The purpose of the DSH funds is to protect hospitals from their financial losses associated with serving low-income patients. Two hospitals with comparable financial losses should receive similar levels of protection.