CMS Proposes Payment Reforms For Inpatient Hospital Services In 2008

The Centers for Medicare & Medicaid Services (CMS) today issued a proposed rule that takes significant steps to improve the accuracy of Medicare’s payment under the acute care hospital inpatient prospective payment system (IPPS), while providing additional incentives for hospitals to engage in quality improvement efforts.

The payment reforms include a proposal to restructure the inpatient diagnosis related groups (DRGs) to account more fully for the severity of the patient’s condition. In addition, the proposed rule includes provisions to ensure that Medicare no longer pays hospitals for their additional costs of hospital-acquired conditions (including infections), and includes an expanded list of publicly reported quality measures. The proposed rule would also reduce payment for a DRG involving the implantation of a device, when a hospital replaces a device and the replacement is supplied to the hospital at no or reduced cost.

Medicare’s inpatient rates for operating expenses will increase by 3.3 percent in FY 2008 for those hospitals that report quality data to CMS. Overall, the proposed rule is estimated to increase payments to more than 3,500 acute care hospitals by $3.3 billion.

"The payment reforms included in this proposed rule would continue a process for the third consecutive year to ensure that Medicare payments for inpatient services are more accurate and better reflect the severity of the patient’s condition," said CMS Acting Administrator Leslie V. Norwalk, Esq. "The proposed rule also represents yet another major step forward in Medicare’s efforts to foster higher quality care in inpatient settings."

Expanding on the work of the previous two years, the proposed rule would create 745 new severity-adjusted diagnosis related groups (DRGs) (Medicare Severity DRGs or MS-DRGs) to replace the current 538 DRGs. Projected aggregate spending from the reforms will not change. However, payments would increase for hospitals serving more severely ill patients and decrease for serving patients who are less severely ill. Consistent with public interest expressed on last year’s changes, CMS is proposing to revise the current DRGs so that the system will continue to be based upon a non-proprietary case mix system making it available to the public.

The changes reflect recommendations from the Medicare Payment Advisory Commission (MedPAC). CMS took its initial steps toward implementing the new system when it created new DRGs for cardiac procedures performed in FY 2006. An additional set of DRGs reflecting severity of illness was introduced for discharges in FY 2007. By more accurately recognizing the costs of caring for a patient, the new MS-DRGs will further reduce incentives for hospitals to "cherry pick," the practice of treating only the healthiest and most profitable patients. They also address concerns that specialty hospitals – hospitals that provide a limited range of services and typically are owned in whole or in significant part by physicians who serve as referral sources – may selectively provide such profitable services. For example, concerns about inappropriate payments for specialty hospitals involved payments for certain elective cardiac admissions. Last year, we estimated that payment reforms for 2006 and 2007 reduced payments to cardiac specialty hospitals by over 5 percent. The reforms for FY 2008 are estimated to reduce payments an additional 4 percent.

"The new severity-based DRGs represent one of the most significant improvements to the hospital inpatient payment system since the institution of the prospective payment system in 1983." said Norwalk. "When combined with the reforms that were established last year, these refinements to the hospital payment system should significantly improve the predictability, reliability and fairness of Medicare payments."

Payment to all hospitals would increase by an average of 3.3 percent for FY 2008 when all provisions of the rule are taken into account. Payments to specific hospitals may increase more or less than this amount depending on the patients they serve. For instance, urban hospitals generally treat more severely ill patients and are estimated to receive a 3.5 percent increase in payments.

In addition to the base payment for the DRGs, the law requires Medicare to make a supplemental payment to a hospital if its costs for treating a particular case exceed the usual Medicare payment for that case by a set threshold. Medicare sets the threshold for high cost cases at an amount that is projected to make total outlier payments equal to 5.1 percent of total inpatient payments. For FY 2008, CMS is also proposing to adopt a high cost outlier threshold of $23,015, down from $24,475 in FY 2007. By better recognizing severity of illness in the DRGs, fewer cases would be paid as outliers. However, CMS proposed to lower the outlier threshold to meet the legal requirement to continue paying between 5 and 6 percent of payments as outliers.

The proposed rule recommends changes to the way Medicare pays for hospital capital-related costs based on an analysis that showed substantial positive margins experienced by some hospitals. The rule recommends a full payment update for rural hospitals and no update for urban hospitals. The rule also proposes to eliminate the large urban add-on payment and seeks comment on gradually discontinuing the teaching and disproportionate share (DSH) adjustments to capital payments.

The proposed rule would implement a provision of the Deficit Reduction Act of 2005 (DRA) that takes the first steps toward preventing Medicare from giving hospitals higher payment for the additional costs of treating a patient that acquires a condition (including an infection) during a hospital stay. The DRA requires hospitals to begin reporting secondary diagnoses that are present on the admission of patients, beginning for discharges on or after October 1, 2007. In the meantime, the DRA requires the Secretary of Health and Human Services (HHS) to select at least two conditions that are (1) high cost, high volume or both; (2) assigned to a higher paying DRG when present as a secondary diagnosis; and (3) are reasonably preventable through application of evidence-based guidelines. Beginning in FY 2009, cases with these conditions would not be paid at a higher DRG unless they were present on admission. The proposed rule identifies six conditions, including three serious preventable events (sometimes called "never events") that meet the statutory criteria. CMS seeks public comment on 7 additional conditions.

The proposed rule would add five new quality measures, which would bring to 32 the number of measures hospitals would need to report in FY 2008 in order to qualify for the full market basket update in FY 2009. The five proposed measures include 30-day mortality for Medicare patients with pneumonia, and four additional measures relating to surgical care improvement. In addition, the proposed rule seeks input concerning other measures that could be added for FY 2009 and beyond.

"Taken together, these two initiatives will significantly improve the quality and reliability of care delivered in the nation’s hospitals, said Norwalk. "These reforms represent CMS’s continued push to become a more active purchaser of high quality care for Medicare beneficiaries."

CMS is also proposing to change the way it pays for medical devices that are recalled or replaced at no or reduced cost to the hospital. The proposed policy would be consistent with the policy CMS adopted for outpatient payments beginning January 1, 2007. Under the IPPS, payment for these devices is included in the payment for the DRG. Currently, Medicare pays the same for the second procedure even if the hospital acquires the device for free or at reduced cost, as it did for the initial procedure when the hospital had to purchase the device. The proposed rule would reduce payment when hospitals use a recalled or replacement device at no cost or with partial credit.

In keeping with the plan contained in CMS’s August, 2006 final Report to Congress on specialty hospitals, the proposed rule would create new disclosure requirements for these hospitals. The proposed rule would require physician-owned hospitals to disclose such ownership to patients and provide the names of the physician owners upon request. The proposed rule would also require physician-owned hospitals to require physician owners who are members of the hospital’s medical staff to disclose their ownership to the patients they refer to the hospital. Disclosure would be required at the time of referral. In addition, the proposed rule would require a hospital to notify all patients in writing if a doctor of medicine or doctor of osteopathy is not present in the hospital 24 hours a day, seven days per week, and describe how the hospital will meet the medical needs of a patient who develops an emergency condition while no doctor is on site. CMS would have the authority to terminate a provider agreement for noncompliance with these disclosure requirements.

The proposed rule would continue to phase in a change introduced in FY 2007 which would better align payment with the costs of care by using estimated hospital costs, rather than list charges, to establish relative weights for the DRGs. Under the proposed rule, hospitals would be paid during 2008 based on a blend of one-third list charge-based weights and two-thirds hospital cost-based weights for the DRGs. In 2009, hospitals would be paid 100 percent based on cost-based DRG weights.