Medicare Beneficiary Access to Care: The Effects of New Prospective Payment Systems on Outpatient Hospital Care, Home Health Care, and Skilled Nursing Facility Care

Medicare Beneficiary Access to Care: The Effects of New Prospective Payment Systems on Outpatient Hospital Care, Home Health Care, and Skilled Nursing Facility Care

Order Code RL30300
CRS Report for Congress
Received through the CRS Web
Medicare Beneficiary Access to Care: The Effects
of New Prospective Payment Systems on
Outpatient Hospital Care, Home Health Care, and
Skilled Nursing Facility Care
Updated February 2, 2000
Carolyn L. Merck
Specialist in Social Legislation
Domestic Social Policy Division
Congressional Research Service ˜ The Library of Congress

ABSTRACT
The Balanced Budget Act of 1997 (BBA 97) required that prospective payment systems
replace retrospective cost-based reimbursement systems for Medicare beneficiaries receiving
care in hospital outpatient departments, from home health care agencies, and in skilled nursing
facilities. These new payment systems either have reduced or are predicted to reduce
payments to providers, some of whom say that beneficiaries will face restricted access to care
either because they will be turned away or because facilities or agencies will be forced to
close. Investigators have found little evidence that beneficiaries have been denied care,
although federal analysts have recommended that if further evidence emerges indicating unmet
care needs, Congress might make targeted modifications to the new payment systems for
patients with exceptionally costly conditions. This report will be updated when new
information becomes available or when there is congressional action.

Medicare Beneficiary Access to Care: The Effects of New
Prospective Payment Systems on Outpatient Hospital Care,
Home Health Care, and Skilled Nursing Facility Care
Summary
Prior to the Balanced Budget Act of 1997 (BBA 97), Medicare paid for hospital
outpatient department (HOPD) services, home health care, and care in skilled nursing
facilities (SNFs) mostly on a retrospective, cost-reimbursement basis. The BBA 97
replaced those procedures with prospective payment systems (PPSs) under which
provider payments are predetermined, fixed amounts. Some say these new payment
systems have reduced payments to providers, or will do so in the future, resulting in
beneficiaries not getting needed care. Others say denial of care cannot be documented
and that overall payment reductions reflect changed economic conditions and effective
anti-fraud measures. However, analysts have reported to Congress that if evidence
emerges regarding care access problems for the sickest patients, limited, targeted
payment exceptions or increases might be warranted.
The PPS for hospital outpatient departments will not be implemented until after
the start of 2000; thus, it has not yet had any effect. Some of those commenting on
proposed rules that were open for comment from September 8, 1998 through July 30,
1999, say that payments might be inadequate for procedures with bundled payments
for such things as blood products or chemotherapy drugs. Certain low volume, rural
hospitals might realize the largest reductions; data problems make evaluation of
payments to cancer hospitals problematic. The proposed rules sought suggestions
about ways to address bundled payment, rural hospital, and other issues.
The hospital industry also claims that the law unintentionally reduces payments
to hospitals below pre-BBA levels because of an alleged flaw in the formula
determining beneficiary copayment amounts. They say that the new system was
intended to be budget neutral with regard to hospital revenues; others say budget
neutrality was intended to apply only to the government’s costs.
The BBA required development of a home health PPS, but Congress sought
immediate curbs on home heath care spending by establishing an interim payment
system effective in 1997 that has substantially reduced Medicare payments to some
home health agencies (HHAs). Despite claims that beneficiary access to home care
was being impaired due to closure of 14% of HHAs between October 1997 and
January 1999, the General Accounting Office found no conclusive evidence of
reduced access and termed the reduction in the number of agencies a “market
correction” in response to an oversupply of HHAs.
The PPS for Medicare payments to SNFs began in July 1998. Although hospital
discharge planners do not report that they cannot place beneficiaries requiring SNF
care, some analysts say that the daily payment rates may be inadequate for patients
needing extensive skilled nursing care, medications, or laboratory services. HCFA
officials are monitoring the new system and say that changes might be made to some
of the payment groups for very ill patients but that the law requires any payment
increases to be offset by decreases in other payment groups.

Contents
Most Recent Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Prospective Payment Systems: An Overview . . . . . . . . . . . . . . . . . . . . . . . 3
Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Inpatient Hospital PPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Physician PPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Hospital Outpatient PPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Home Health Care PPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Skilled Nursing Facility PPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Hospital Outpatient Departments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Pre-BBA 97 Payment System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
BBA 97 Changes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Beneficiary Coinsurance for HOPD Services . . . . . . . . . . . . . . . . . . . 7
Home Health Care . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Pre-BBA 97 Payment System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
BBA 97 Changes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Skilled Nursing Facilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Pre-BBA 97 Payment System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
BBA 97 Changes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Legal Authority for RUG Regulations . . . . . . . . . . . . . . . . . . . . . . . 17
Congressional Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

Medicare Beneficiary Access to Care: The
Effects of New Prospective Payment Systems on
Outpatient Hospital Care, Home Health Care,
and Skilled Nursing Facility Care
Most Recent Developments
The Consolidated Appropriations Act, 2000, enacted November 29, 1999, (P.L.
106-1113) increases Medicare payments to HOPDs, HHAs, and SNFs and modifies
other provisions of BBA 97. See CRS Report RL30347, Medicare, Medicaid and
State Children’s Health Insurance Program (SCHIP): Changes to Balance Budget
Act of 1997 (BBA 97, P.L. 105-33)Provisions for a summary of the Medicare and
Medicaid provisions.
HOPDs. The new law (a) requires until January 2000 that additional payments
above and beyond the PPS payment designated for a case be paid for certain drugs,
biologicals, and devices, and, for 2 to 3 years, provides additional payments for
certain high cost patients (these payments must be “budget neutral” meaning offsets
must be made elsewhere in the PPS so that there is no net cost to Medicare); (b) limits
the cost range of items or services that are included in any one PPS category; (c)
requires the Secretary to review the PPS groups and amounts annually and to update
them as necessary; (d) through 2003, limits the reduction in Medicare payments
individual hospitals experience due to the PPS; (e) provides special payments until
2004 for small, rural hospitals to ensure that they receive no less under the outpatient
PPS than they would have received under the prior system and provides the same
protection permanently for cancer hospitals; (f) limits beneficiary copayments for
outpatient care to no more than the amount of the beneficiary deductible for inpatient
care; (g) requires that the pre-PPS payment base used to determine the budget
neutrality of Medicare PPS payments include beneficiary coinsurance amounts as paid
under the pre-PPS system (i.e., 20% of hospital charges).
The Congressional Budget Office (CBO) estimates that these changes in
payments to HOPDs will cost $5.2 billion over 5 years and $11 billion over 10 years.
HHAs. The new law (a) provides $10 per beneficiary to offset costs for
collecting OASIS data; (b) delays the 15% reduction in home health payments until
12 months after implementation of the PPS but, within 6 months of implementation,
requires the Secretary to assess the need for any reductions; (c) increases per
beneficiary limits by 2% for older agencies; (d) revises the amount of required surety
bonds; (e) excludes durable medical equipment from consolidated billing.

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CBO estimates that these changes in payments to HHAs will costs $1.3 billion
in the first 5 years, largely from delay of the 15% reduction.
SNFs. The new law (a) from April 1, 2000, until October 1, 2000, increases per
diem payments by 20% for 15 SNF PPS payment categories (Resource Utilization
Groups, “RUGs”); (b) permits payment under the federal PPS rate for agencies for
which it is more advantageous than under the transition rates which include a factor
reflecting individual SNF cost experience; (c) provides for additional payment beyond
the designated PPS rate for ambulance services for dialysis patients and for specific
chemotherapy items and services, radioisotope services, and prosthetic devices; (d)
until October 1, 2001, fixes PPS per diem rates at 50% of the facility-specific rate and
50% of the federal rate for facilities in which 60% of the patients are immuno-
compromised.
CBO estimates that these changes in payments to SNFs will cost $2.2 billion in
the first 5 years.
Introduction
The federal Medicare program finances health insurance coverage for about 39
million disabled individuals and elderly persons age 65 or over nationwide. Currently,
about 84% of beneficiaries participate in Medicare’s traditional fee-for-service
program under which they obtain care from a physician, provider, or facility of their
choice, and Medicare makes a payment on their behalf. Under the Medicare+Choice
program, about 14% of beneficiaries participate in managed care plans, generally
health maintenance organizations (HMOs), for which Medicare makes a monthly
predetermined fixed payment per enrolled beneficiary.
The Balanced Budget Act of 1997 (BBA 97) sought to achieve savings for
certain Medicare-covered services under the fee-for-service program by changing the
way Medicare pays for those services. Prior to the changes made in BBA 97,
Medicare paid for most hospital outpatient department (HOPD) services, home health
care, and care in skilled nursing facilities (SNFs) on a retrospective, cost-
reimbursement basis. The BBA 97 required that those reimbursement systems be
replaced with prospective payment systems (PPSs) under which provider payments
are some form of predetermined, fixed amounts for which future increases are limited
by provisions specified in law. These new payment systems have reduced or, critics
predict, will reduce Medicare payments to some HOPDs, home health agencies
(HHAs), and SNFs, generating allegations that beneficiaries will face problems with
access to care. On those grounds, representatives of the provider industry are seeking
revisions to the BBA law to increase Medicare payments. This report discusses the
new prospective payment systems and care access issues.1
1 CRS Report 97-802, Medicare Provisions in the Balanced Budget Act of 1997 (BBA 97,
P.L. 105-33), by Jennifer O’Sullivan et al., details Medicare payment systems pre-BBA and
describes the BBA savings provisions. It includes background information on Medicare and
serves as a reference document for this report. In addition, CRS Report RS20238, Trends in
Medicare Spending After the Balanced Budget Act, by Hinda Ripps Chaikind, documents
(continued...)

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Prospective Payment Systems: An Overview2
Background. Historically, Medicare has based payments to health care
providers on some measure of reasonable costs which are reimbursed retrospectively.
Retrospective cost reimbursement systems have been criticized for their complexity,
unpredictability, and lack of incentives for providers to maximize efficiency and
contain costs. In contrast, prospective payment systems are comparatively easily
administered, allow costs to be predicted more accurately, include mechanisms for
containing rates of increases, and strengthen providers’ incentives for efficiency.

Prospective payment systems can take a variety of forms with different
approaches being appropriate for different types of care or settings. Determination
of exactly how much to pay is a key factor in designing a PPS because Medicare buys
health care and health care products in private markets. Payment amounts should
reflect market prices in order to ensure beneficiary access to quality care while
simultaneously minimizing program and taxpayer costs. For instance, if Medicare’s
payments were significantly lower than market rates, providers might serve only those
patients who needed little or inexpensive care and avoid others, a practice known as
“risk selection.” Payments that were relatively high could create an incentive for
providers to deliver unnecessary care.
Another key factor in the design of a PPS is the unit of payment. Different units
of payment are appropriate for different settings. For example, the hospital inpatient
PPS is referred to as a “discharge based system” because the unit of payment is an
entire hospital stay for a specified diagnosis. For other types of care, payments might
be based on individual medical procedures such as would be appropriate for a visit to
a physician or an ambulatory care facility. Payments might be based on a daily rate
when an individual receives care on an ongoing basis over several days. Another unit
of payment might cover all care given during an episode or spell of illness.
One of the most important concepts underlying any PPS is that the payments
made by Medicare to providers are based on typical, average costs for a service
provided in a specific setting. PPS amounts paid by Medicare are not intended to
reimburse the provider for costs incurred by or attributable to any individual patient.
Inpatient Hospital PPS. The PPS for inpatient hospital care (Part A of
Medicare) was implemented in 1983. Under that system, hospitals receive
predetermined, fixed payments per hospital admission. Payments are determined by
a patient’s diagnosis and the groupings of costs associated with treatment for an
average patient with that diagnosis. This is known as the diagnosis related group
(DRG) system. A hospital receives the same amount whether a patient is discharged
1 (...continued)
spending reductions that have occurred in various components of Medicare since the original
estimates in 1997.
2 For a detailed discussion of design issues pertaining to prospective payment systems, see
Medicare Payment Advisory Commission. Report for Congress: Medicare Payment Policy.
March 1999. p. 3-24. (Hereafter cited as MedPAC, Report to the Congress: Medicare
Payment Policy)

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earlier or later than average. The payment is fungible in that hospital “savings” from
early discharges can be applied to the cost of care for patients whose stay is longer
than average. Thus, even if a patient’s care is very costly compared with the norm for
his or her DRG, the hospital can finance that patient’s care with funds it received for
other patients whose care was less costly than the norm. The hospital also has an
incentive to provide care efficiently so that its costs do not exceed the average.
Physician PPS. Physicians and certain other practitioners participating in the
fee-for-service Medicare program are paid under Part B of Medicare according to a
fee schedule required by 1986 legislation and implemented in 1992. A fee schedule,
which is a kind of PPS, is a listing of payable fees for specified procedures and
services in specified settings. All physician care is paid under a fee schedule
regardless of the setting in which it is provided.
Hospital Outpatient PPS. The PPS that the Health Care Financing
Administration (HCFA) designed for HOPD services is a fee schedule under which
the facility is paid a specified sum for each of the hundreds of different procedures
that are carried out in that setting. Implementation is scheduled for early in 2000. An
important issue in the fee schedule design for HOPDs is the extent to which costs for
ancillary goods and services are included in the payment for the main procedure.
Inclusion of ancillary services in one overall payment is sometimes referred to as
“bundling” or “packaging.” Ancillary services that might be bundled into a major
service payment include such things as anesthesia, laboratory tests, and certain
diagnostic tests. Inclusion or exclusion and separate payment for ancillary services
might be based on whether the service is integral to the main service or merely related
to it. For procedures such as infusion therapy or chemotherapy in which
administration of drugs is the main service, the price of the drug may be bundled into
the fee schedule amount or, in some cases, paid separately. Separate payment might
be provided if the price of the drug or other item is highly variable or unpredictable
as it might be for a product that is new on the market. In general, the fee schedule
proposed by HCFA uses relatively little bundling of ancillary service costs into the
payment for the main service.
Home Health Care PPS. The BBA requires HCFA to establish a PPS for home
health care, but the law did not specify the unit of care for which home health PPS
prices would be set, leaving that decision up the Secretary of Health and Human
Services (HHS). Although the details of the home health PPS are not yet available
(implementation is scheduled for October 1, 2000), HCFA officials have announced
that payment under the new system will be based on an episode of illness. Thus,
HHAs will receive a specified payment per beneficiary episode of care. Those
payments will be adjusted for patient characteristics and the resources the patient is
expected to use (referred to as a “case mix” adjustment). HCFA had considered using
a home health visit as the PPS unit, but a demonstration project showed that it did not
include incentives to control the volume of services and would not adequately contain
costs compared with the existing system. Instead, research has focused on defining
an episode of care for which payment would cover a given number of days of care.
Skilled Nursing Facility PPS. The PPS for SNFs (implemented mid-1998) is
based on a per diem unit of care, meaning the facility receives a fixed payment for
each Medicare-covered day a beneficiary spends in a SNF. The amount of the

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payment is based on the cost of the resources the patient is likely to use per day.
Patients are classified into resource utilization groups, or “RUGs,”for purposes of
defining the specific payment for each covered day. This classification system serves
as the case-mix adjustment for the SNF PPS. For example, patients needing mostly
physical therapy or speech therapy of different intensities use different kinds and
amounts of resources from patients needing such things as skilled nursing care,
intravenous medications, extensive laboratory testing, or use of a respirator. There
was, and continues to be debate about whether the SNF PPS should provide fixed
payments per day or whether it would be preferable to establish a discharge-based
system under which the payment would be a fixed amount per SNF stay. However,
the clinical and other factors that are related to and predictive of length of stay are not
yet well documented or understood; thus, the per diem approach has been adopted.3
Hospital Outpatient Departments
Pre-BBA 97 Payment System. Medicare payments to hospital outpatient
departments rose at an annual rate of over 12% from 1983 to 1997 and increased
from 7% to 20% as a share of all Medicare payments to hospitals. Much of this
growth resulted from an increase in the volume of services provided in HOPDs,
including volume increases attributable to advances in medicine and technology
permitting procedures formerly restricted to the inpatient hospital setting to be
provided safely on an outpatient basis. During this period when the volume of
outpatient care was growing, HOPDs were paid under a complex cost- and charge-
based reimbursement system that had evolved “into an intricate patchwork of different
mechanisms, each aimed at specific services or specific classes of hospitals.”4
Because of the complex, unwieldy nature of the cost reimbursement system for
hospital outpatient care and its lack of incentives for efficiency and cost controls,
Congress directed the Secretary of HHS to develop a PPS for HOPD services as long
ago as the Omnibus Budget Reconciliation Act of 1986.
As HOPD costs were rising, so were costs to beneficiaries for their coinsurance
for HOPD procedures. Beneficiaries are responsible for paying 20% of Medicare’s
approved charges for most Part B services. However, for HOPD care, beneficiaries
are billed 20% of the hospital’s charges rather than 20% of the Medicare-approved
amount. This occurs because Medicare’s payment for a hospital outpatient procedure
under the complex formula involving a blend of cost and charge reimbursements is
normally not determined until long after the service is rendered. This system not only
“overcharges” beneficiaries because hospital charges are substantially higher than
Medicare-approved amounts, but also results in some hospitals being “overpaid” by
Medicare because the full amount some beneficiaries paid when they received the
care (20% of charges) is not subtracted when Medicare’s share of costs are
computed. This situation is referred to as the “formula-driven overpayment.”
BBA 97 Changes. In BBA 97, Congress eliminated the formula-driven
overpayment effective at the start of FY 1998. The Act also directed the Secretary
3 Ibid., p. 7.
4 Ibid., p. 102.

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of HHS to implement the HOPD PPS in 1999. On September 8, 1998, HCFA
published PPS proposed regulations for comment. However, HCFA subsequently
delayed implementation of the outpatient PPS until after the start of the year 2000 in
order to accommodate resolution of “year-2000" data processing problems and
extended the public comment period on the proposed regulations through July 30,
1999. Thus, Medicare has not yet begun paying HOPDs under the PPS.
The PPS that HCFA designed for outpatient care is a fee schedule which covers
a hospital’s facility and non-physician personnel costs; physicians are paid separately
under a Medicare physician fee schedule. The HOPD fee schedule is a set of flat
payments that Medicare will pay for specified procedures carried out in HOPDs, and
there are many hundreds of these scheduled amounts that are adjusted for costs
attributable to factors such as regional wage variations. The effects on hospital
revenues will differ among hospitals and procedures, reflecting different hospital
outpatient caseloads. The potential unevenness of the effects of the PPS has
prompted concerns about the adequacy of Medicare payments under that system for
certain kinds of outpatient procedures and for certain hospitals.
For instance, providers say the payments would not cover adequately the costs
of procedures requiring blood transfusions and use of blood products and certain
cancer treatments, particularly those for which costly chemotherapy drugs are used.
Cancer hospitals are concerned that their payments for Medicare outpatients would
be inadequate.5 Low-volume, rural hospitals are concerned that the new payment
system would cause disproportionate reductions in their revenues because they serve
a large proportion of their patients on an outpatient basis, and Medicare beneficiaries
constitute a larger share of their outpatient caseloads than other hospitals. Teaching
hospitals also say their costs would not be covered adequately because of their higher
than average costs.6 Some hospital officials say that if their Medicare resources are
reduced substantially under the outpatient PPS, beneficiaries with high-cost needs
might be turned away; others say they may close their outpatient departments.
HCFA is aware that the effects of the new system are uneven among providers
compared with their payments under the prior system. To estimate the effects of the
new system on different hospitals, HCFA carried out a computer simulation of
payments to hospitals under the PPS and compared those payments with each
hospital’s costs and pre-PPS payments. Based on that analysis, HCFA noted in the
proposed regulations that the estimated reductions in Medicare payments under the
PPS could be larger for rural hospitals than for others, and could be largest for low
volume rural hospitals that are the sole provider for the community. The regulations
seek comments on phasing in the new system for those hospitals as a way to alleviate
the impact, although critics in the industry say that whether the system is implemented
sooner or later, the eventual effects would be the same.
5 Cancer hospitals are those extensively involved in treatment for and research on cancer.
There are currently 10 cancer hospitals.
6 MedPAC reports that it has been unable to substantiate the claim that teaching hospitals
would be disproportionately harmed by the outpatient PPS. HCFA noted in the proposed
regulations that the simulation analysis showed that effects of the PPS on teaching hospitals
were small and in some cases not statistically significant.

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With regard to chemotherapy drugs, the regulations provide for “unbundled”
reimbursement for some specific chemotherapeutic agents; that is, the cost of the
drugs would be reimbursed separately from the other costs of the chemotherapy
procedure. The regulations asked for information on additional chemotherapy drugs
that are exceptionally costly and that perhaps should be reimbursed separately.
The regulations also discuss possible large reductions in payments to cancer
hospitals. However, because the procedures these hospitals use for reporting costs
under the pre-PPS system are somewhat different from other hospitals, HCFA noted
that the comparisons of the pre-PPS costs and payments for these hospitals with the
simulated effects of the PPS were likely to be inaccurate. Agency analysts are
continuing to study the data, and HCFA will adjust the rates for these hospitals if the
analysis indicates such adjustments would be appropriate. The regulations also asked
for comments on phasing in the new system for cancer hospitals as a way to moderate
its impact.
HCFA officials say that comments describing payment inadequacies or other
problems with the PPS proposed regulations will be reviewed and taken into
consideration when they write the final regulations. Although many of the concerns
about the HOPD PPS may be addressed through regulation and would not require
congressional action, changes to the fee schedule that would increase Medicare
spending would be outside of HCFA’s regulatory authority because the law requires
the new system to be budget neutral to the government, meaning that total Medicare
payments may not exceed an amount targeted to replicate payments under pre-PPS
law. Nevertheless, the PPS for outpatient care has not been implemented yet, and,
thus, it is not possible to assess any effects on beneficiary access to care. However,
elimination of the formula-driven overpayment has reduced some hospitals’ Medicare
payments.
Beneficiary Coinsurance for HOPD Services. As noted above, Medicare
beneficiaries usually pay more than 20% of the Medicare-approved amount for HOPD
services and may pay as much as 50% or more.7 Because there is no limit on the
amount of a hospital’s charges, some analysts were concerned that beneficiaries
might eventually be billed for an amount equal to 100% of the Medicare-approved
charge for a service if Congress did not change the law. (In most cases, beneficiaries
have “medigap” insurance policies that cover their Medicare coinsurance costs; thus,
their insurance pays the higher amount, but the costs of those policies reflect the high
coinsurance rates for hospital outpatient care.)
In BBA 97, Congress sought to bring beneficiary cost sharing for outpatient
hospital services gradually into line with that required for other Part B care by
freezing the dollar amount hospitals may charge beneficiaries for each type of HOPD
procedure at 20% of the median of all hospital outpatient charges in 1996 (pre-PPS),
updated to 1999 (or the year the PPS is implemented). (The median charge for each
7 For example, assume the charge for an endoscopy for a suspected stomach ulcer at a HOPD
is $2,000. Under current law the hospital would bill a beneficiary $400, or 20% of the
charge. However, Medicare may subsequently approve charges of only $1,600; thus, the
beneficiary would have paid 25%.

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procedure is the amount below which 50% of all charges fall and above which 50%
fall.) This provision will go into effect when the PPS is implemented. Over time,
after implementation of the PPS, the “frozen” dollar amounts hospitals may charge
beneficiaries will come to equal 20% of Medicare’s approved amount under the PPS,
and Medicare’s fee schedule payment will be 80%. This would occur because PPS
payments are to be updated annually by a factor defined in law. However, the
MedPAC estimated that it could take up to 40 years for beneficiary payments to equal
20% of Medicare approved amounts under the PPS.8
The BBA 97 (Section 4523) specifies that the “conversion factors” used to
establish the fee schedule dollar amounts for different procedures under the outpatient
PPS be calculated so that the aggregate amount of payments to HOPDs in the first
year of implementation of the PPS (originally set for 1999) would equal the sum of
(a) the estimated amount that Medicare would have paid hospitals under the old
system in 1999 (or the first year of operation of the PPS), plus (b) the estimated
amount of beneficiary copayments to hospitals computed as 20% of the national
median of HOPD charges, by type of service, during 1996 (updated to 1999).
Pegging Medicare’s aggregate share of payments under the PPS at the amount
that would have been paid without the PPS makes the new system “budget neutral”
with regard to the government’s share of payments to hospitals. However, hospitals
would receive less in total than they would have received under the pre-PPS system
because beneficiary copayments that are pegged to median charges are less in the
aggregate than the amount beneficiaries would have paid under the old system.
HCFA estimates that total payments to HOPDs under the PPS will be 3.8% less than
they would have been without the PPS, and this reduction is attributable to the
reduction in the beneficiary copayment. (If beneficiary copayments had been pegged
at 20% of the average charges, the aggregate sum of payments to hospitals from
Medicare and from beneficiaries would have been closer to the total amount hospitals
would have received without the PPS in 1999.)9
Thus, hospitals say they are being required to accept lower compensation for
their services than they had anticipated based on their perception that the new PPS
was to be budget neutral with regard to their total payments for Medicare
beneficiaries in the first year of the PPS. They say that this situation amounts to
greater “savings” than Congress intended. (It should be noted that any “savings” from
lower payments to hospitals from this provision accrue to beneficiaries or Medigap
plans, not to the government.)10
8 Medicare Payment Advisory Commission. Report to the Congress: Medicare Payment
Policy, Volume I: Recommendations. March 1998. p. 80.
9 Part II, U.S. Dept. of Health and Human Services, HCFA, 42 CFR part 409 et al. Federal
Register, v. 63, no. 173, September 8, 1998. p. 47598.
10 Some representatives of the insurance industry have advocated that Congress mandate a
reduction in Medicare beneficiary HOPD copayments to 20% of the approved amount under
the new fee schedule as soon as it is implemented. This reduction in beneficiaries’ share of
outpatient costs would reduce the insurance carriers’ Medigap plan liabilities, and,
presumably, Medigap premiums. However, it would create a larger reduction in hospital
(continued...)

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HCFA officials say that the law does not authorize the agency to spend money
to make up to hospitals the difference caused by basing beneficiary payments on 1999
median charges and that legislation would be needed to authorize such increased
payments;11 others in the hospital industry disagree. If Congress passed legislation
providing increased funding to hold hospitals harmless from reductions in beneficiary
payments, it would trigger “pay-go” budget rules, and offsetting reductions or
revenue increases would be required. If payments to hospitals were increased without
legislation, the Congressional Budget Office (CBO) would not score any budget
costs, but would increase Medicare/HOPD spending in its baseline estimates for
“current law.” However, HCFA officials say legislation is required.
Home Health Care
Pre-BBA 97 Payment System. Home health services covered by Medicare
include intermittent skilled nursing care or home health aide services as well as
physical therapy, speech pathology, occupational therapy, and medical social services.
Services must be carried out under a plan of care prescribed and reviewed by a
physician. Medicare spending for home health care in 1988 totaled $2.0 billion. By
1994 it had increased to $13.3 billion, and by 1996 it was $17.5 billion, for an average
annual increase of 31% since 1988. This spending growth was largely due to growth
in the number of beneficiaries served and in the number of home visits provided to
each beneficiary qualifying for the benefit. In addition, the supply of HHAs grew at
about 9% per year during most of the 1990s.12
An important event in the history of the Medicare home health benefit was
settlement of a class action lawsuit in 1989. Many believe that much of the increase
in home health spending that occurred from 1989 to the early 1990s was brought
about by HCFA’s liberalizing its guidelines pertaining to eligibility and benefit
coverage as a result of that suit, and the program’s payment rules imposed no
effective limit on the volume of services for which it would provide reimbursement.
Commentators pointed out that the rapid increases in the volume of home health visits
that occurred in a relatively short period of time could not be explained by rapidly
increasing rates of ill health among the Medicare population. For example, in
1988,1.58 million Medicare beneficiaries were home health patients and received an
average of 23 home health visits; in 1993, 2.86 million beneficiaries received an
average of 59 home health visits.
10 (...continued)
revenues than will occur under the PPS with beneficiary copayments pegged at 20% of median
charges and phased down to 20% of approved amounts.
11 Neither CBO nor the Administration has published an estimated cost for making up the
difference to hospitals. Estimates prepared by the hospital industry indicate that their “loss”
might total about $850 million per year, or $4.5 billion over 5 years.
12 Medicare Payment Advisory Commission. Report to the Congress: Selected Medicare
Issues. June 1999. p. 112. (Hereafter cited as MedPAC, Report to the Congress: Selected
Medicare Issues)

CRS-10
Prior to the changes made by the BBA 97, Medicare reimbursed home health
agencies for the lesser of (a) their reasonable costs, or (b) a limited amount per visit,
applied in the aggregate. The per visit limit was set at 112% of the national average
cost, which was calculated separately for each type of service (nursing, therapy, etc.).
It was based on costs for free-standing agencies (i.e., agencies not affiliated with
hospitals) and varied according to whether an agency was located in an urban or rural
area and according to wage level differentials from area to area. Per-visit cost limits
were updated annually by applying a market basket index to base year data derived
from home health agency cost reports. These limits, however, were applied to
aggregate agency payments; that is, an aggregate cost limit was set for each agency
equal to the sum of the agency’s limit for each type of service multiplied by the
number of visits of each type provided by the agency.
This cost-based reimbursement system was criticized as providing few incentives
for home health agencies to maximize efficiency or control the volume of services
they delivered because HHAs were paid for every visit their workers made.
BBA 97 Changes.13 The BBA 97 required that a PPS be implemented for home
health care beginning in 1999 and required that the PPS be designed to reduce home
health payments by 15%. It specified that the 15% reduction was to go into effect
even if the PPS were not ready for implementation in 1999. P.L. 105-277, the
Omnibus Consolidated and Emergency Supplemental Appropriations Act for Fiscal
Year 1999, postponed both the PPS implementation and the 15% reduction from
October 1999 to October 1, 2000. Should the PPS not be implemented at the start
of October 2000 as currently planned, payment limits to HHAs will be reduced by
15%, and when the PPS is subsequently implemented, it will be budget neutral
compared to the interim payment levels with the 15% reduction. Thus, the 15%
reduction occurs only once.
As currently planned by HCFA, the home health PPS unit of payment will be a
patient’s episode of illness, with payments adjusted to reflect patient characteristics
and care needs.14 Payments to HHAs will be bundled to include most of the supplies
and equipment, including durable medical equipment, needed during a patient’s course
13 In addition to changing the payment system, other BBA home health provisions included:
requiring claims to include a physician identifier; elimination of eligibility based solely on
needing a skilled nurse to draw blood; revision of the definitions of “part-time” and
“intermittent” for purposes of establishing eligibility for care by a skilled nurse and home
health aide; transferring from Part A to Part B payments for home health visits that are not
part of the first 100 visits following a hospitalization; requiring home health workers to report
their activities during a visit in 15-minute intervals; extending savings from a July 1994
through June 1996 freeze on home health cost limit updates. It also required a study of the
definition of “homebound” and a study to establish normative guidelines for the frequency and
duration of home health services. The Health Insurance Portability and Accountability Act
(HIPAA) included civil money penalties for physicians who falsely certify that a beneficiary
needs home health care, a provision some say has had a chilling effect on physician referrals.
14 The BBA authorizes up to 5% of payments to be used to reimburse HHAs for care for
“outlier”cases, that is, patients with extensive care needs, although a budget neutrality
requirement in the law specifies that aggregate payments must be reduced to offset those
higher payments.

CRS-11
of care, although HHAs often arrange to have such items provided through an outside
vendor. When the PPS is implemented, equipment and supply vendors will not bill
Medicare directly as they often do under current law but will bill the HHA and be paid
by it. This bundling is sometimes referred to as the “consolidated billing” feature of
the home health PPS.
The Interim Payment System. Because of concern about the rapidly rising
costs of Medicare home health reimbursements due to an increasing volume of
services, Congress included in the BBA 97 an “interim payment system” (IPS) for
Medicare home health care in order to achieve immediate Medicare spending
reductions prior to implementation of the PPS. This interim system was effective for
HHA cost reporting periods starting on or after October 1, 1997, and is to remain in
effect until the PPS is implemented in October, 2000.
The IPS achieves cost savings by establishing a new methodology for limiting
aggregate annual Medicare payments to individual HHAs. Under this procedure an
agency receives payments totaling the least of three amounts (pre-IPS payments were
the lesser of the first two of these amounts):
(a) the agency’s reasonable costs; or
(b) payments determined under the per visit limits, with the limit set
at 106% of the national median cost per visit by service type
(pre-IPS limit was 112% of the national average cost per visit)15;
or
(c) aggregate payments under a new formula based on per
beneficiary limits.
HCFA estimates that 79% of HHAs are subject to the new per beneficiary limit; the
others receive less under the reasonable cost or per visit limit. Determining an
agency’s aggregate Medicare payment limit under the new per beneficiary formula
includes four steps:
(1) Divide the total payments the agency received from Medicare for
cost reporting periods ending in FY1994 by the number of
Medicare patients it served that year to get an average amount
per beneficiary (certain cost and wage updates are applied);
(2) reduce that average amount per beneficiary to 75% of the full
amount;
(3) add a sum that is 25% of the average Medicare per-beneficiary
costs of all agencies in the same census region to get a new
average cost per beneficiary;
15 P.L. 105-277 increased the limit from 105% of the national median cost of a service
(estimated at the time of BBA enactment to be about 98% of the mean) to 106% of the
median.

CRS-12
(4) multiply the agency’s average cost per beneficiary from step
three by the number of Medicare patients the agency is serving
in the current year or cost reporting period. The result is an
aggregate annual payment limit that an agency is held to for
serving all its Medicare patients in a cost reporting period under
the IPS.
If an agency’s average costs for its patients are lower than others in the region,
it benefits from the sum that is added based on the average regional per-beneficiary
limits; if an agency’s costs are higher than others in the area, it loses money from the
regional component of the formula.16 This regional component of the formula also
decreases the disparities that existed among agencies’ costs per beneficiary.
The per beneficiary aggregate limit does not restrict the amount an HHA can
spend on any individual beneficiary. It is simply a technique for arriving at an
aggregate budget amount for an agency’s Medicare patients. However, many HHAs
have misunderstood how this limit works, and there are reports that some agencies
ended care to beneficiaries when the cost reached the amount of the per beneficiary
payment (i.e., the amount arrived at by step three above).

Congress based the per beneficiary calculation on 1993-1994 levels of operation
in order to discount the large volume growth that still appeared to be occurring after
that year (program costs grew by nearly 22% from 1994 to 1995). Using FY1994 as
the base year causes agencies that had increased their costs per patient since then
(generally by increasing the number of visits per patient) to have a larger reduction in
their Medicare revenues under the IPS than agencies that had maintained relatively
constant average costs per beneficiary. Some in the industry said that this effect is
unfair to agencies that had low average patient costs in 1994 but that since then had
incurred an increase in the number of very ill and costly patients needing more than
the average number of visits required by their typical patient in 1994. Others say that
even if their caseload now is similar to that served in 1994, the payment formula does
not provide inadequately for agency cost increases since then. They say some
agencies are being forced to reduce their staff and therefore their capacity to provide
home care and allege that beneficiary access to care has been reduced.
Responses to the Interim Payment System. Representatives of the home health
industry claimed that (a) the IPS was limiting HHAs’ ability to provide necessary care;
(b) agencies with low average costs per beneficiary in the FY1994 base period were
realizing the severest reductions; and (c) these older agencies were being paid
inequitably in comparison with newer agencies because agencies that had not been in
business long enough to have had a cost reporting period ending in FY1994 were
assigned a per beneficiary limit equal to the national median.
To address these concerns, in 1999, Congress modified the IPS formula to
increase per visit limits for HHAs from 105% of the median to 106% and increased
payments to agencies whose per beneficiary limits under the IPS were less than the
16 The per-beneficiary limit for new HHAs that were not in operation in 1994 is set at the
national median amount.

CRS-13
national median per beneficiary limits. The per beneficiary limits for older agencies
were increased by one-third of the difference between the agency’s per beneficiary
limit and the national median of per beneficiary limits. (These changes were included
in P.L. 105-277, the Omnibus Consolidated and Emergency Supplemental
Appropriations Act for Fiscal Year 1999.)
These modifications to home health payments were estimated to increase
Medicare payments to 65% of HHAs. The Act also moved the 15% reduction to
coincide with implementation of the PPS on October 1, 2000. The estimated total
cost was $1.65 billion over 5 years, about $750 million of which came from delaying
the 15% reduction.)
Congress asked the General Accounting Office (GAO) to investigate the effects
of the IPS on beneficiary access to home health care.17 The GAO analyzed data on
home health care utilization patterns before and after implementation of the IPS and
conducted interviews with hospital discharge planners and other “stakeholders” in
communities in which there had been a substantial number of HHA closures. In a
report issued in May, 1999, the GAO found that, although 14% of HHAs closed
between October 1, 1997 and January 1, 1999, over 9,000 HHAs were still in
business, about the same number in operation in 1996. Forty percent (40%) of the
agencies that closed were in three states (Louisiana, Texas, and Oklahoma) where
recent growth in the number of HHAs had been high. The majority of HHA closures
were in urban areas where large numbers of agencies were still providing care.
Characteristically, the HHAs that closed were small agencies that had been providing
over 40% more visits per beneficiary than those that remained open, and many had
been losing patients before implementation of the IPS. GAO termed the reduction in
the number of HHAs a “market correction in response to an oversupply of HHAs”
and noted that the IPS achieved its goal of reducing costs attributable to unnecessary
utilization of home health care.
Because the payment limits imposed by the IPS induce agencies to balance the
number of expensive patients against the number of inexpensive patients they serve
in order to stay within their total Medicare payment limit, questions remain about
whether the IPS also creates incentives for HHAs to refuse to serve beneficiaries with
the most serious medical needs and who require extensive home health visits. A
home health agency might refuse to accept certain expensive patients if it were
concerned that the balance of patients in its caseload would be tipped too far toward
costly cases and result in expenditures exceeding the agency’s total funding limit.
In its June 1999 report, MedPAC addressed the possibility that, as long as the
IPS is in effect, potentially costly home health care beneficiaries might not find the
care they need. The report recommends:
If the Congress is not confident that the Secretary can implement a prospective
payment system for home health services by 2000, then it should explore the
17 U.S. General Accounting Office. Medicare Home Health Agencies: Closures Continue,
With Little Evidence Beneficiary Access Is Impaired. GAO/HEHS-99-120, May 1999.
Washington, 1999.

CRS-14
feasibility of establishing a process for agencies to exclude a small share of their
patients from the aggregate per-beneficiary limits. Such a policy should be
implemented in a budget-neutral manner.18
HCFA officials say that the home health PPS is on schedule for implementation
in October 2000.
In January 1998, CBO projected 10-year BBA home health care savings of
almost $75 billion; their March 1999 re-estimate includes an additional $56 billion in
savings. The original CBO estimate reflected an annual rate of growth in home health
spending of 8.3% a year over 10 years, but the revised estimate shows an annual
increase of 5.6% a year. (Under old law, in the early 1990s, Medicare home health
spending had been growing at rates of between 20% and 30% a year.) However,
CBO’s revised estimates reflect changes in their underlying economic assumptions as
well as revised estimates of the effects of the BBA.
Data on Medicare home health spending reported by HCFA indicated a 6.3%
decrease from $17.6 billion in FY1997 to $16.5 billion in FY1998, which was
approximately the first year of operation of the IPS. However, agency officials
caution that reduced Medicare payments for home health care in 1998 reflect an
intensified case review process HCFA required claims processors to implement along
with the IPS.19 As a result of that intensified review, federal disbursements to HHAs
slowed with the apparent effect of reducing payments, but HCFA expects that, in
time, the payments will be made and spending totals for FY1998 will show an
increase.
Skilled Nursing Facilities20
Pre-BBA 97 Payment System. Before enactment of the SNF PPS in mid-1998,
Medicare paid for most SNF care on a reasonable cost (as defined by the program)
retrospective basis. Despite the imposition of limits on certain reimbursable costs,
cost-based reimbursement has been cited as one of the reasons for significant growth
in SNF spending since 1989. Spending increased from $3.5 billion in 1989 to $11.7
billion in 1996, for an average annual rate of growth of 19%. Payments in 1998
totaled $13.8 billion. Growth in SNF spending can be explained largely by the
increasing number of persons qualifying for the benefit and increases in
reimbursements per day of care. Numbers of persons served had nearly doubled since
1989, reaching 1.63 million persons in 1998. Average payments for care had grown
from $117 per day in 1989 to $262 per day in 1998.
For Medicare reimbursement purposes, the costs SNFs incur for providing
services to beneficiaries are divided into three major categories: (1) routine services
18 MedPAC, Report to the Congress: Selected Medicare Issues, p. 112.
19 It also reflects more intensive fraud and abuse detection activities that have targeted home
health agencies, among other providers.
20 Medicare pays in full for 20 consecutive days of SNF care, and beneficiaries pay a
copayment for days 21 through 100.

CRS-15
costs that include nursing, room and board, administration, and other overhead (these
costs were subject to certain limits per day); (2) ancillary services, such as physical
and occupational therapy and speech language pathology, laboratory services, drugs,
supplies and other equipment; and (3) capital-related costs, including net depreciation
expense, taxes, lease and rental payments, improvements that extend the life or
increase the productivity of assets, net interest expense, etc. Ancillary service and
capital costs were both paid on the basis of reasonable costs and neither were subject
to limits. Increases in ancillary service reimbursements explain much of the per diem
payment growth during the 1990s.
SNFs providing less than 1,500 days of care per year to Medicare patients in the
preceding year had the option of being paid a prospective payment rate set at 105%
of the regional mean for all SNFs in the region. The rate covered routine and capital-
related costs (but not ancillary services) and is calculated separately for urban and
rural areas, adjusted to reflect differences in wage levels. Prospective rates could not
exceed the routine service cost limits that would be applicable to the facility, adjusted
to take into account average capital-related costs with respect to the type and location
of the facility.

BBA 97 Changes. The PPS described in the BBA 97 reflects the Resource
Utilization Group (RUG) design HCFA developed over several years and tested on
a demonstration project basis. The RUG system requires SNFs to categorize their
Medicare patients according to 44 hierarchical groups. The SNF PPS provides
facilities a fixed amount per day per patient (a “per diem” payment), with the amount
of the payment determined by the RUG into which the patient is classified. This RUG
classification system serves as the case-mix adjustment that is used to relate program
payment to individual patient characteristics and resource use. The BBA 97 requires
that the new system be phased in over 3 years starting July 1, 1998 (or the first date
thereafter on which a SNF started a new annual cost reporting period). During this
phase-in period, part of the per diem payment to each SNF is based on the facility’s
historical costs (the “facility specific” component of the PPS), and part is based on the
new federal per diem prospective payment.21
The BBA 97 instructs the Secretary how to (a) compute average per diem
payment rates using Medicare-approved SNF costs in 1995 as the base year; (b)
adjust the average rates for facility case-mix and geographic differences; and (c)
update the per diem rates for years after 1995. This methodology aims at setting the
PPS per diem payments to reflect overall average pre-PPS Medicare costs in order to
achieve budget neutrality for the new payment system when it is first implemented;
moreover, the law specifies limited updates to payments under the RUG system in
future years.
An issue some have raised regarding the current design of the RUG system is the
adequacy of payments for patients with multiple problems requiring skilled nursing
21 During the 3-year phase-in period starting in 1998, a SNF receives per diem rates that are
a “blend” 75% the facility-specific rate and 25% of the federal per diem rate, and the
proportions of facility-specific rate to federal per diem rates shifts annually by 25 percentage
points until the federal PPS rate equals the full payment.

CRS-16
care (“high acuity patients”) and patients who need extensive “ancillary nontherapy
services.” These services include such things as intravenous feedings and intravenous
medicines, tracheostomy care, laboratory tests, use of a ventilator/respirator, imaging
services, and care for surgical wounds or open lesions requiring special supplies and
medicines. The costs of these services can be ascribed directly to individual patients.22
Industry spokespersons say that the PPS provides inadequate compensation for these
costly Medicare patients and will place SNFs at increasing financial risk if they serve
them. They say SNFs may refuse to accept patients that appear to be high cost risks,
end participation in Medicare, or perhaps close altogether. Further, the nursing home
industry claims that, in general, the PPS has reduced their payments below the original
estimates and that the result eventually, if not immediately, will be restricted
beneficiary access to care.
Many do not agree that nursing homes will be as adversely affected as the
industry is predicting or that beneficiary access to care has been or will be
substantially impeded. For instance, the original 10-year savings projections from the
BBA SNF provisions were $41 billion, and the CBOs re-estimate in March 1999
showed an additional $6 billion in savings over 10 years. However, the CBO re-
estimate reflects many factors, including the improved economy, lower inflation, and
heightened efforts by HCFA to reduce fraud and abuse which have resulted in a
decline in incorrect payments.
Other observers point out that Medicare payments to SNFs account for only
approximately 10% on average of a SNFs total revenue. SNFs generally provide care
for a large share of non-Medicare patients and therefore are not so financially
dependent on Medicare revenues that their financial viability and, consequently,
Medicare beneficiary access to care could be jeopardized by the new Medicare
payment system. Medicare covers only up to 100 days of SNF care (including the
days for which beneficiaries are responsible for a copayment), and, on average, those
qualifying for the SNF benefit receive 32 days of covered care (1998); thus, these
Medicare beneficiaries are not long-term care patients who might drain facility
resources for months or years. They say, further, that, like all prospective payment
systems that compensate health care providers for care to Medicare beneficiaries by
the use of predetermined, fixed sums, the payments to the provider are intended to
pay the provider for its Medicare beneficiary costs on average. That is, although the
payment is fixed, a facility’s actual costs may be above or below that amount for an
individual patient. The goal for the facility is to incur costs that, over time, do not
exceed the PPS average amounts.
At the end of August, 1999, the HHS Office of Inspector General (OIG)
published the findings of a survey of the SNF placement experience of 180 hospital
22 In the Explanatory Statement of the Conference Report on BBA 97, conferees included
“intent”language that the Secretary develop for the new system case-mix adjusters that reflect
the medication therapy needs of SNF patients, suggesting that the Secretary should consider
the results of studies conducted by independent organizations, including those which examine
appropriate payment mechanisms for medication therapy under the SNF PPS. Although
“intent” language does not have the force of law, it can influence policy by carrying an
implication of statutory action if the “intent” is not carried out.

CRS-17
discharge planners in eight states.23 The OIG also compared Medicare data on SNF
placements before and after implementation of the PPS. The survey and analysis
found no serious placement problems and no indication that Medicare patients could
not be placed at all. The Medicare data showed a recent increase in the number of
Medicare-certified SNF beds (a key factor in access to care) and did not show any
change in where patients were being placed or in the types of patients who were being
placed. Planners did note that patients with clinically complex care needs were
difficult to place, but did not report that they could not be placed. They also noted
that the admissions practices of some nursing homes had changed and that SNFs were
requiring more detailed clinical information about patients and were visiting the
hospital more frequently to evaluate patients. The report emphasizes that it is an early
assessment of the PPS, but that as of the first 5 months of 1999, there was no direct
evidence that Medicare patients were unable to receive needed SNF care.

Nevertheless, the system has been in effect only since July 1998, and for some
SNFs, implementation began later. If further monitoring suggests that SNFs are
avoiding beneficiaries with complex needs and are unable to reallocate their resources
to cover them, there might be a need for special payment classifications or
reimbursement rates in order to ensure beneficiary access. For instance, if hospital
discharge planners were to find that the SNFs in the areas in which their patients lived
were accepting only a limited number of complex care patients thereby requiring them
to place patients in facilities distant from their homes and families, or if hospitals were
forced to keep individuals who might be ready for discharge to a SNF as in-patients
longer than necessary, some change to the RUG system might be warranted.
Although there are reports of instances in which distant placements and prolonged
hospitalization have occurred, the extent of such situations has not yet been
documented, and the HHS OIG investigation did not find such problems to be
widespread.
At HCFA’s request, a contractor is reviewing the RUG system for refinements
necessary to assure that payments are adequate for complex care patients. In
addition, the BBA 97 requires the Secretary of HHS to establish a medical review
process to examine the effects of the PPS/RUGs, focusing in particular on patients
with nonroutine needs. The medical review process is being carried out by peer
review organizations under contract with HCFA and will focus on indicators of access
and care quality as the new system is phased in.24 They are charged with
recommending changes to the system if access and quality problems are identified.
Legal Authority for RUG Regulations. Because the law specifies neither the
patient care utilization needs that define each of the RUGs nor the amounts payable
for each group, and because these groups and definitions are set forth in regulation,
some have asked whether the Secretary has the authority to increase the number of
RUG categories and/or to redefine certain categories to pay different amounts for
patients with higher costs.
23 23 U.S. Dept. of Health and Human Services. Office of Inspector General. Early Effects
of the Prospective Payment System on Access to Skilled Nursing Facilities. OEI-02-99-
00400, August 1999. Washington, 1999.
24 MedPAC, Report to the Congress: Medicare Payment Policy, p. 86.

CRS-18
HCFA officials take the position that the agency does not have the authority to
make changes to the PPS/RUGs as promulgated in regulations on May 12, 1998, if
such changes would cause the payments to deviate from the objective of the BBA 97
to establish a budget neutral system of payments that reflects, on average, 1995 costs
and specified adjustments and updates. According to HCFA, adding new RUGs or
refining existing RUGs in such ways that costs would be increased for certain
categories of patients would have to be offset by decreases in costs for other
categories in order to keep the entire system of payments at the overall average,
adjusted pre-PPS Medicare cost level targeted in the law.
The statute appears neither to preclude the Secretary from changing the number
or composition of RUG categories nor require such changes. Broad discretion has
been granted to the Secretary to develop a payment system for SNF care. The
applicable standard of review that a court would use in assessing the legality of the
Secretary’s regulations implementing the RUG/PPS is set forth in the Administrative
Procedure Act (APA). The APA requires the reviewing court to “hold unlawful and
set aside agency actions, findings and conclusions found to be (1) arbitrary,
capricious, or which constitute an abuse of discretion, or otherwise not in accordance
with law....”25 As a practical matter, in cases such as this, where Congress has vested
considerable discretion in an agency head to implement a statutory program, the
courts usually defer to the agency’s interpretation of its own enabling legislation. In
according such deference, a court would assess the interpretive components of the
rule to be sure that they represented a permissible construction, but this appraisal is
necessarily a limited one.26
Congressional Review
On June 10, 1999 the Senate Finance Committee conducted a hearing on
Medicare spending under the BBA 97. Witnesses included representatives of the
health care industry as well as officials from federal agencies, including the CBO, the
GAO, MedPAC, and HCFA. Industry representatives expressed concern that they
would be unable to continue to serve Medicare beneficiaries adequately if the new
payment systems were not liberalized. However, the federal witnesses suggested that
Congress should not increase Medicare funding without more specific information
about whether the BBA 97 has reduced payments to providers more than expected
and harmed beneficiary access to care. According to the CBO, although Medicare
spending over the next 5 years has dropped by almost 10% since first estimated in
1997, factors other than the budget act are likely to be responsible for the spending
declines, including federal efforts to reduce fraud and abuse and delays in paying
providers under the new payment systems. Although the federal witnesses did not
advocate revamping the BBA 97, some suggested that, if warranted by further
evidence, targeted adjustments might be appropriate for some hospital outpatient
departments or procedures and for HHAs and SNFs caring for very ill patients.
25 5 U.S.C. § 706(2)(B).
26 Rust v. Sullivan, 500 U.S. 173, 184 (quoting with approval the Court’s holding in Chevron
U.S.A. v. Natural Resources Defense Council, 467 U.S. 837 (1984)).