August 2013 Volume 9 Number 12

Implementation of PPACA’s Cuts to Disproportionate Care Hospital Payments Foreshadows Negative Consequences for Many Hospital Systems

By Esther R. Scherb, Latham & Watkins LLP, Washington, DC*

AuthorMore than three years after the passage of the Patient Protection and Affordable Care Act (“PPACA”),1 and only a handful of months before its effective date, the Centers for Medicare & Medicaid Services (“CMS”) issued a proposed rule on how it intends to implement the legislation’s dramatic changes to the Medicare Disproportionate Share Hospital (“DSH”) program.2 On August 2, 2013, the proposed rule was largely adopted, with some important modifications.3 In all, many hospitals stand to see their DSH payments substantially reduced, while others with historically limited payments will see substantial gains. As a direct consequence of congressional redistribution initiatives, the DSH changes promise new approaches to allocate available Medicare dollars to subsidize care for the uninsured.

First implemented in 1986, the Medicare DSH program was designed to provide payment adjustments to eligible acute care hospitals that treat a disproportionate volume of poor patients, who were viewed as more costly to treat. Because these hospitals with a larger number of the low-income patients, in turn, were expected to experience higher costs for their Medicare patients than other institutions,4 the DSH adjustment was distributed to eligible hospitals as an add-on to each Medicare discharge payment. A shift in views over the last decade argued that DSH payments have not compensated hospitals for more costly care of Medicare patients, but instead subsidized uncompensated care to the uninsured and underinsured.5 This shift culminated with a statutory revision that not only reduces the aggregate amount of available DSH funds for all hospitals, but also directs a markedly different allocation methodology for each eligible hospital. Specifically, Section 3133 of PPACA directs the Secretary of Health and Human Services to first reduce 75 percent of the DSH funds available under the historical DSH formula in proportion to the annual decreases in the numbers of uninsured projected to begin in fiscal year 2014, and then distribute this amount to hospitals, not based on their Medicare volume, but based on their relative uncompensated care.

Notwithstanding that DSH payments are made from Medicare hospital trust fund dollars, paradoxically, a hospital’s payments under the PPACA formula would bear a limited relationship to its Medicare patient load. This article examines some of the apparent unintended consequences of the statutory formula, the impact of the proxy chosen by CMS to measure a hospital’s uncompensated care and the allocation methodology adopted along with operational changes.

Section 3133 of PPACA

Section 3133 of PPACA added a new subsection, 1886(r) to the Social Security Act, substantially revising the current DSH payment formula, under which an eligible hospital will continue to receive 25 percent of the historical formula (referred to as “empirically justified DSH payments”).6 The remaining 75 percent would equal the product of three factors. Factor one aggregates the remaining 75 percent, creating a national pool of Medicare DSH funds for all hospitals under the historical formula. Factor two reduces the aggregated amount beginning in fiscal year 2014, to correspond to the reductions in the nation’s uninsured population, using projections based on available data. Factor three distributes to each hospital, its relative share of the payments based on the hospital’s “amount of uncompensated care” as a percentage of the “aggregate amount of uncompensated care” for all eligible hospitals.7

In identifying the respective proportion of uncompensated care under Factor three, the Secretary has the discretion to use estimates and alternative data that is a “better proxy” for the costs for treating the uninsured.8 It is this delegation of discretion that is relied upon in the CMS final rule.

Consequences of Section 3133 and CMS’s Implementation

1. Proxy to Calculate Uncompensated Care

Particularly problematic for CMS was its lack of reliable data on hospitals’ actual costs of treating uninsured patients,9 thereby requiring the Agency to identify an appropriate proxy. According to CMS, the most precise data to evaluate the respective costs hospitals incur for treating their uninsured patients would be found on Worksheet S-10 of the hospital cost report, designed specifically for this purpose.10 However, the Worksheet was determined to be unreliable because it is still relatively new, has been found lacking in clear instructions, causing hospitals to complete it using varying interpretations, and has been used for payment purposes in only limited ways. Following feedback from stakeholders, CMS selected a proxy to include insured low-income patient days consisting of inpatient days for Medicare patients receiving Supplemental Security Income benefits and for Medicaid patients. Because these low-income inpatient days are based on data subject to audit with which the program has longstanding payment experience, and the data elements are available at the hospital level, CMS found this utilization proxy to be an appropriate interim method to approximate a hospital’s costs of uncompensated care.11 The Agency intends to use the Worksheet S-10 in the future, after working with the hospital community to make the necessary revisions and clarification to the instructions to ensure that the data is reported accurately and consistently.12

Though generally viewed favorably by industry, the selection of the insured low-income days proxy has some profound weaknesses. For example, it does not in itself account for the full complement of low-income utilization, excluding, by way of example, low-income patient care in hospital emergency departments, clinics or other hospital units. Indeed, CMS acknowledged that the inclusion of insured low-income days in exempt units such as inpatient rehabilitation units insofar as the data is available publicly and subject to audit may be appropriately added to a hospital’s low-income days proxy. CMS deferred inclusion of these patient days for future rulemaking, however.13

Also, the patient-day proxy uses days reported on hospital cost reports and does not account for differences in costs based on a hospital’s geographic location or the types of patients treated. CMS concluded that adjustments for wage index only accounts for a portion of the variation in costs and does not address variations in resource use and patient severity; therefore, the Agency found that there was insufficient basis that an adjustment would better reflect variations in uncompensated care costs.14

2. Per-discharge Interim Payment Schedule

CMS proposed initially to change the manner in which uncompensated care DSH payments will be paid.15 Currently, and since the DSH payments were integrated into the inpatient prospective payment system, hospitals received DSH payments as an add-on to the hospital’s diagnosis-related group (“DRG”) payment amount.16 The proposed rule would have retained the add-on approach only for the empirically justified DSH payments.17 CMS proposed to pay hospitals the uncompensated care DSH payments on a periodic basis and separate from DRG payments. CMS did so to address, among other things, administrative efficiencies,18 favoring predictability that the Agency viewed could only be achieved if payments are determined prior to the beginning of the federal fiscal year and, in addition, only on a federal fiscal year basis. In other words, CMS would determine future payments based on best available estimates concerning the product of Factors 1, 2 and 3, and each hospital’s interim payment would begin October 1st. There would not be a reconciliation process that is otherwise available for the discharge-based payment methodology used for the empirically based DSH payments.19 CMS would nonetheless conduct reconciliation to determine threshold eligibility for DSH payments and make adjustments. Hospitals initially found eligible but later determined not to meet the threshold requirements for payment would have to refund payments.20 Conversely, hospitals that are later determined to be eligible would be paid after the payment cycle ends.21

Receiving considerable comments on apparently unintended consequences of the interim payment methodology on the Medicare Advantage (“MA”) program (specifically, that the MA program would have no way of incorporating the full DSH amount into MA hospital payments unless the payments were associated with a specific inpatient claim), CMS revised its position in the final rule to make payment on a per-claim basis. In addition, CMS factored the practical and negative import of the timing of payments. CMS agreed that MA organizations were required to pay non-contracted hospitals the amounts otherwise payable under Medicare’s fee-for-service program and that it was not the Agency’s intent to suggest MA organizations should exclude uncompensated care payments from MA payments to hospitals.22 Indeed, the American Hospital Association (“AHA”) estimated the impact of not doing so to be at least $3 billion on an annual basis.23 CMS also stated in its final rule that it was only addressing MA payments to non-contracted hospitals; although there was an indirect effect on hospital contracts with MA plans, CMS did not interfere with the terms negotiated in such contracts.

CMS in its final rule reiterated that the relative share of uncompensated care payments would be calculated at the beginning of the fiscal year. Payment, however, would be an add-on amount per discharge, based on the hospitals’ historical average claims volume. The cost report settlement process would be used to reconcile payments received during the year to the hospital’s prospective amount calculated under the statutory formula.24 The payment amount would be included in the PRICER25 software used by the Agency to compute each hospital’s DRG amounts.

Proposals to Delay Implementation of Section 3133

The AHA and other organizations commented negatively on a considerable number of aspects of the proposed implementation, including the dramatic annual changes hospitals may experience under the legislative formula.26 The AHA suggested that CMS implement a “stop-loss and stop-gain policy” that would dampen the regulatory impact. Under the suggested policy, a hospital’s Medicare DSH payments would neither decrease nor increase by more than a fixed amount or percentage in a single year. While CMS addressed the comments on possible alternatives, the Agency concluded it lacked the statutory authority to phase-in or delay full implementation in fiscal year 2014.27

To address the unanticipated burdens, Representative John Lewis (D-Georgia) has introduced a bill, DSH Reduction Relief Act of 2013, that would delay the Medicare DSH cuts for two years.28
Though its acceptance is uncertain, such a delay would provide time to address unintended consequences, as well as allow hospitals to prepare for future payment changes, some of which may be substantial.


No doubt there will be many hospitals who are “winners” and many who are “losers” under the statutory formula and CMS’s implementation. Because PPACA’s allocation of DSH payments has limited correlation to a hospital’s volume of Medicare patients, winners may include county hospitals with only a low volume of Medicare patients. As CMS notes in its final rule, “[t]he change to the payment methodology for Medicare DSH payments for FY 2014 was designed to have redistributive effects.”29 Hospitals should monitor the final rule’s impact on their relative share of the aggregate uncompensated care DSH pool in 2014 and future years; although the initial determination as to DSH eligibility in the first instance will not change, the available uncompensated care DSH pool and a hospital’s relative share may vary markedly on an annual basis.

*The author would like to acknowledge the contributions of Greer Donley and Bridget Scherbring, summer associates who assisted with the preparation of this article.


Patient Protection and Affordable Care Act, Pub. L. 111-148, § 3133, 124 Stat. 119 (2010), as amended by the Health Care and Education Reconciliation Act of 2010, Pub. L. 111-152, § 1104, 124 Stat. 1029 (2010).


Hospital Inpatient Prospective Payment Systems for Acute Care Hospitals, 78 Fed. Reg. 27,486, 27,577 (May 10, 2013).


See (to be published in the Federal Register on Aug. 19, 2013), hereinafter cited as “Final Rule” using pagination in the version released on Aug. 2, 2013.


Medicare Payment Advisory Comm’n (MedPAC), Report to the Congress: Medicare Payment Policy (hospital inpatient and outpatient services: assessing payment adequacy and updating payments), p. 70 (March 2007 ).




42 U.S.C. § 1395ww(r)(1) (2012).


42 U.S.C. § 1395ww(r)(2) (2012).


42 U.S.C. § 1395ww(r)(2)(C)(i) (2012).

978 Fed. Reg at 27,585-90; Final Rule at pp. 540-58.


1178 Fed. Reg at 27,588-89; Final Rule at p. 558.
12Final Rule at p. 558.
13Final Rule at p. 560.
14Final Rule at p. 559.
1578 Fed. Reg. at 27,590-92.
16See 42 U.S.C. § 1886(d)(5)(F).
1778 Fed. Reg. at 27,581.
18Id. at 27,591.
1978 Fed. Reg. at 27,591.
22Final Rule at p. 580.
23Letter from the American Hospital Association, to Marilyn Tavenner, Adm’r, CMS. (June 20, 2013) ( ).
24Final Rule at p. 582-85.
25Software called PRICER is used to determine payments for each discharge, which may vary by hospital. See, e.g.,
26Letter from the American Hospital Association, to Marilyn Tavenner, Adm’r, CMS. (June 20, 2013) ( ); see also Letter from the American Association of Medical Colleges, to Marilyn Tavenner, Adm’r, CMS. (June 25, 2013) ( ). In addition to the impact on MA payments and the potential dramatic yearly change to take place in 2014, these organizations commented on the potential adverse effect on the eligibility of sole community hospitals because of their unique Medicare payment system.
27Final Rule at p. 485-86. CMS also addressed comments on a possible cap on the annual payment adjustments and whether a cap would protect against raised concerns that the significant increases or decreases may suggest the available data are inaccurate. Id.
28DSH Reduction Relief Act of 2013, H.R. 1920, 113th Cong. (2013). The bill was referred to the Subcommittee on Health on May 10, 2013 and has 63 cosponsors. To date, there has not been any subcommittee action.
29Final Rule at p. 486.

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