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ABA Health eSource
 October 2005 Volume 2 Number 2

Specialty Hospitals and Adjustments to Payment Rates
by Daniel A. Cody, Reed Smith LLP, San Francisco, California

Daniel A. CodyAs compared to community hospitals, specialty hospitals focus on the health care requirements of specific patient populations or provide a limited range of medical procedures. As such, there are children and cancer specialty hospitals, and specialty hospitals focusing on cardiac, orthopedic, and surgical procedures. In the past decade, the number of specialty hospitals in the United States has increased dramatically.

Believing that the increase in these types of hospitals warranted study (particularly those specialty hospitals having physician ownership), Congress desired to halt the development of new specialty hospitals pending a review. Congress determined that the most effective way to limit the growth of specialty hospitals was to curtail the availability of the “whole hospital” exception under the Stark law. The Stark law prohibits physicians from referring Medicare and Medicaid patients for certain designated health services (“DHS”) to entities in which the physician or members of their family have a direct or indirect financial relationship. 1 These financial relationships may be an ownership or investment interest (for example, stock or partnership shares) or compensation arrangement. 2 The DHS covered by Stark include inpatient and outpatient hospital services. 3

The Stark law details certain exceptions from its general prohibitions, including a whole hospital exception. Under this exception, physicians may make referrals for DHS to hospitals in which they have an ownership or investment interest if: (1) the referring physician is authorized to perform services at the hospital; and (2) the ownership or investment interest is in the entire hospital, rather than a distinct part or department of the hospital. 4

With Congress’ enactment of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “MMA”), the whole hospital exception under Stark was revised and a moratorium instituted so that during the eighteen-month period from December 8, 2003 through June 8, 2005, physician investment interests in a hospital defined as a “specialty hospital” would not qualify for the exception. Under the MMA, a specialty hospital is defined as a hospital “primarily or exclusively engaged in the care and treatment” of one of the following categories: (1) patients with a cardiac condition; (2) patients with an orthopedic condition; or (3) patients receiving a surgical procedure. The phrase “specialty hospital” does not include any hospital that was in operation or under development before November 18, 2003. Because of this exclusion, so-called “grandfathered” specialty hospitals were allowed continued use of the whole hospital exception.

Pursuant to the MMA, both the Department of Health and Human Services (“HHS”) and the Medicare Payment Advisory Committee (“MedPAC”) were tasked with reporting to Congress on certain issues concerning physician-owned cardiac, orthopedic, and surgical specialty hospitals. In its May 2005 “Report to Congress,” HHS noted several advantages with physician-owned specialty hospitals including improved patient satisfaction, high-quality care, and limited financial impact on community hospitals in the same market. 5 HHS also, however, outlined four recommendations designed to review and address perceived inefficiencies in the treatment of specialty hospitals.

First, the report recommended that changes be made in the Medicare program’s hospital inpatient prospective payment system (“PPS”). In particular, the report suggested that there may be inaccuracies in the diagnosis-related group (“DRG”) classification system. Second, the report recommended adjustments to the payment rates for ambulatory surgical centers (“ASCs”). The third recommendation was to more closely scrutinize whether facilities met the Medicare definition of a hospital. Finally, the report recommended that CMS review its procedures for approving facilities for participation in Medicare.

On June 8, 2005, the MMA specialty hospital moratorium expired. On June 9, 2005 (and again in August 2005), CMS issued a fact sheet discussing its policy initiatives in response to the expiration of the moratorium. 6 Generally, CMS reiterated the recommendations outlined in the Report to Congress. CMS discussed changes in payment rates for inpatient hospital services and ASCs. CMS also announced that for the remainder of 2005, the agency will be reviewing its procedures for enrolling specialty hospitals in the Medicare program. During this review and until January 2006, CMS will not process Medicare participation applications from specialty hospitals and no initial state surveys for new specialty hospitals will be authorized.

On August 12, 2005, CMS published in the Federal Register its 2006 inpatient PPS final rule. 7 Following up on its plan to conduct a comprehensive review of the DRG system to better recognize severity of illness, CMS analyzed certain cardiovascular DRGs, identifying those conditions that would lead to a more complicated patient stay thereby requiring greater resources. Using these “Major Cardiovascular Conditions,” CMS revised and replaced nine cardiovascular DRGs with twelve new DRGs.

In addition to these revisions, CMS expects to propose changes for fiscal year 2007 further refining the DRG system. This includes a review of the list of complications and comorbidities that are utilized to assign patients to a higher weighted DRG. By January 2008, CMS similarly expects to implement certain payment adjustments for ASCs. In addition, CMS continues its review of its Medicare participation procedures and the proper definition of a hospital – recently holding a September 30, 2005 Open Door Forum on the issue. With expiration of the moratorium, it appears that CMS will continue to address the recommendations cited in the Report to Congress, likely resulting in further revisions to payment rates for certain facilities.


1 See 42 U.S.C. § 1395nn(a).
2 See id. § 1395nn(a)(2).
3 See id. § 1395nn(h)(6)(K).
4 See id. § 1395nn(d)(3).
5 See HHS, “Study of Physician-owned Specialty Hospitals Required in Section 507(c)(2) of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003,” (Oct 2005) (available at http://www.cms.hhs.gov/media/press/files/052005/RTC-StudyofPhysOwnedSpecHosp.pdf).
6 See CMS, “CMS Outlines Next Steps as Moratorium on New Specialty Hospitals Expires,” (June 9, 2005) (available at http://www.cms.hhs.gov/media/press/release.asp?Counter=1478); CMS, “CMS Modifies Cardiac DRGs to Improve Payment Accuracy,” (Aug. 1, 2005) (available at http://www.cms.hhs.gov/media/press/release.asp?Counter=1526).
7 See CMS, “Changes to the Hospital Inpatient Prospective Payment Systems and Fiscal Year 2006 Rates,” 70 Fed. Reg. 47,278 (Aug. 12, 2005) (available at http://www.cms.hhs.gov/providerupdate/regs/cms1500f.pdf).