CMS Proposes Sweeping Hospital Payment Reforms

August 10, 2006

Authored by: Kathy L. Poppitt

Thompson & Knight LLP
98 San Jacinto, Suite 1900
Austin, Texas 78701
(512) 469-6173

In April of this year, the Centers for Medicare and Medicaid Services (CMS) proposed sweeping hospital payment reforms that could start to phase in as early as this October.  Virtually all hospitals will be affected but specialty hospitals, particularly those specializing in cardiac and orthopedic surgery will see the most dramatic changes. This article looks at the proposed payment reforms and their potential impact on Medicare hospital inpatient reimbursement.

Medicare reimburses acute care hospitals for inpatient stays through a payment system referred to as the inpatient prospective payment system (IPPS).  Under the IPPS, each case is assigned a diagnosis-related group (DRG) that has a payment weight assigned to it, based on the average resources used to treat Medicare patients in that DRG.  On April 12, CMS issued notice of proposed changes that would mark the first significant revisions to the IPPS since its implementation in 1983.  The proposed rule includes two major types of reforms.  First, CMS will assign weights to DRGs based on estimated hospital costs, rather than on reported charges.  Second, the DRGs would be adjusted to better reflect the patient’s diagnosis and severity of illness.  According to CMS, these proposed reforms will mean that payments for hospital inpatient services will more accurately reflect the costs of providing the services, in light of the severity of illness, and will reduce incentives for hospitals to “cherry pick” or treat only the most profitable patients.

DRG Recalibration of Relative Weights

CMS asserts that using gross charges as a basis for setting the DRG weights causes bias in the weighting process because some hospitals, such as teaching and specialty hospitals, tend to treat certain cases more commonly than others, causing DRG weights to be artificially high for other hospitals.  To address these concerns, CMS is proposing a shift to a hospital-specific relative value cost center methodology (HSRV) which is slated for October 2006 implementation. The HSRV weights will be developed at the cost center level to adjust for certain hospital characteristics such as teaching status, location, and size.  The weights will then be scaled to costs using the national cost center charge ratios developed from cost report data.  The use of HSRVs will redistribute payment among hospital services by putting more weight into routine costs, such as bed costs, and less weight into ancillary services. The result is a general increase in payments for medical services and decrease in payments for surgical services. CMS expects these changes to significantly affect payments to specialty hospitals and to acute care hospitals that focus on certain cardiac cases and, to a lesser degree, certain orthopedic cases.

Severity-Adjusted DRGs

In addition to the shift to HSRV weights, CMS intends to refine the current DRG system to better reflect severity of illness among patients.  Through this reform, which is to be in place by October 2007, the current 526 DRGs will be replaced with approximately 861 consolidated DRGs that are adjusted for patient severity.  Under this consolidated severity-adjusted DRG system, the number of a patient’s complicating conditions determines the subclass of the DRG that the hospital can utilize.  The greater the number of complicating conditions, the higher the subclass of DRG assigned and the more reimbursement the hospital is allowed to capture. CMS expects the adoption of the consolidated severity-adjusted DRGs to result in a redistribution of payment from the surgical to the medical DRGs, but to a much lesser extent than the implementation of the HSRV weights.

Between the implementation of the HSRV weights and the effect of the adoption of the consolidated severity-adjusted DRGs, CMS expects cardiac specialty hospitals and orthopedic hospitals to experience an 11.7 and 9.4 percent decline in payments respectively.  In contrast, urban hospitals are not expected to experience any changes in overall payments as a result of all of the proposed changes and rural hospitals will likely experience a 0.4 percent decline in payments.

What happens next?

The comment period for the proposed rule ended June 12.  CMS actively solicited comprehensive feedback from hospitals, suppliers, and other stakeholders on the rule and anticipates that the final rule will be shaped significantly by the public comment process.  CMS expects the final rule to be published on or around August 1 and implemented beginning October 1.  In the meantime, hospitals can evaluate separately the specific impact of the implementation of the HSRV weights and the severity-adjusted DRGs, review their documentation process which will be critical in determining a patient’s appropriate DRG assignment and the resulting level of reimbursement, and continue to follow developments in the rule-making process as future revisions to the rule, as well as implementation timetables, are likely.  Whatever changes are ultimately made to the proposed rule, it remains certain that the new IPPS system will profoundly affect Medicare payments to all hospitals.

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