AHA's Position on the Wrongful Denial of Medicare Losses on Sale Involving Mergers and Consolidations of Non-profit Hospitals by
the Department of Health and Human Services

The American Hospital Association (AHA), on behalf of its member hospitals, is concerned about the position that the Department of Health and Human Services' (HHS) Centers for Medicare & Medicaid Services (CMS) has taken denying non-profit hospitals appropriate adjustments to their Medicare payments in cases where those hospitals merged or consolidated with other non-profit corporations prior to December 1, 1997. HHS' position, in this instance, is not only unfair to the hospitals directly affected by it, but also highlights a persistent concern that AHA has about HHS reinterpreting its rules retroactively in a manner that disadvantages or harms hospitals. We urge HHS to use the opportunity presented here to correct the wrongful denial of Medicare losses on changes of ownership involving non-profit hospitals. In addition, and as part of its commendable initiative on regulatory reform, we urge HHS to clearly establish as a core operating principle consistent and fair application of rules and policies that hospitals must rely upon to make decisions about patient care, staff training and retention, Medicare billing and other business transactions essential to the vitality of the hospital field.

Background. In 1979 the Health Care Financing Administration (now CMS) issued regulations expressly requiring the adjustment of Medicare payments to recognize gains or losses for hospitals involved in mergers or consolidations. 42 C.F.R. 413.134(l). Conceptually, these payment adjustments were corrections to a hospital's prior reimbursements for depreciation, which had been paid on an estimated basis and therefore needed to be adjusted to reflect actual depreciation upon the hospital's change in ownership. These regulations applied to all types of providers, whether for-profit or not-for-profit. Based on a provision in the Balanced Budget Act of 1997, Medicare regulations have since been amended to eliminate the recognition of gains or losses for all hospital changes in ownership on or after December 1, 1997. Transactions prior to that date were unaffected by this regulatory amendment.

In the late 1990's the fiscal intermediaries settled a significant number of final Medicare cost reports filed by not-for-profit hospitals that, consistent with then applicable regulations, reported a loss on the disposal of assets resulting from mergers or consolidations that took place prior to December 1, 1997 in connection with their combination into larger health systems. In some cases these losses were recognized and paid by the respective fiscal intermediary consistent with existing law, regulations and previous CMS guidance. In such instances, CMS later instructed intermediaries to reopen cost reports and recover the previously allowed costs. In other cases, intermediaries denied the claimed losses from the outset, often under CMS instructions, despite clear regulations to the contrary.

By its express terms, the December 1, 1997 regulation change was prospective only. However, on October 19, 2000, CMS issued Program Memorandum A-00-76 which it claimed "clarified" its policy on transactions prior to that date. In fact, however, A-00-76 was an attempt to rationalize the reversal of policy that CMS had already implemented through its denials of losses for pre-December 1997 transactions of not-for-profit hospitals. The Program Memorandum broadly instructed intermediaries to disallow the losses of not-for-profit hospitals regardless of whether the transaction occurred before or after December 1, 1997. In fact, because the regulation change had already withdrawn the ability to claim such losses after that date, the only transactions affected by the Program Memorandum were those involving not-for-profit hospitals that occurred prior to December 1, 1997, which was three years prior to the date the Program Memorandum was issued. Such retroactive rulemaking is clearly impermissible, grossly unfair to hospitals and inconsistent with HHS' regulatory reform initiative.

Discussion. Initially, the purported reason for the denials in pre-December 1, 1997 transactions was that, in many of these transactions, representation on the board of the new merged or consolidated system included a "significant number" of individuals from the acquired predecessor institutions. CMS concluded that losses could not be recognized because the parties to the transaction were "related." Termed "continuity of control," this novel interpretation was directly contrary to a lengthy and consistent line of CMS regulations and manuals, as well as written guidance provided to hospitals through 1995, which stated clearly that the relationship of the parties must be established prior to the transaction to cause the non-recognition of gain or loss upon a change in ownership. CMS's new theory ignores the fact that mergers and consolidations often result in post-transaction boards composed substantially of representatives from institutions that were previously unrelated. This is as true of for-profit transactions as it is of not-for-profits. In the 2000 Program Memorandum, CMS restated its new "continuity of control" theory, but then added completely new and never before seen theories that are similarly designed to preclude recognition of loss only for not-for-profit hospitals. Articulated for the first time in that memorandum, CMS challenges the economics, the motives, the bona fides, and indeed, even the validity of mergers and consolidations and other changes of ownership among not-for-profit hospitals. CMS contended that changes in ownership of not-for-profit hospitals do not generally merit recognition of gains or losses because, supposedly unlike for-profit hospitals, not-for-profit hospitals are typically mindful of their service to their communities in such transactions.

Also for the first time, CMS stated in the memorandum its position that the applicable regulation permitting recognition of gains or losses in the case of mergers and consolidation, 42 C.F.R. 413.134(k), was written "to address only for-profit mergers and consolidations." Despite several earlier written statements by CMS to the contrary, and despite regulations specifically permitting revaluation and recognition of gains and losses in transactions prior to December 1, 1997 (without regard to the income tax status of the provider), CMS is now taking the position that different considerations apply to not-for-profit mergers and consolidations than have been applied to both not-for-profit and for-profit transactions in the past. In a move unsupported by any regulation or published manual, this action unfairly and without any sound legal or policy basis deprives not-for-profit hospitals of their legal right to claim depreciation losses resulting from the merger or consolidation of two or more hospitals occurring prior to December 1, 1997.

CMS's reasons for adopting this retroactive and discriminatory policy seem to be based on economic changes affecting hospitals in the 1990s. Because of general increases in the value of hospital assets through the 1970s and 80s, the rules requiring recognition of gains and losses upon changes of ownership historically resulted in the recapture by Medicare of millions of dollars in gains. During the 1990s, however, certain well-recognized factors caused the value of hospital assets to shrink: changes in technology, changes in clinical practice, cutbacks in certain government reimbursements, and the impact of managed care. A 1997 OIG report indicated that these depreciation adjustments had become exclusively losses that were now costing Medicare. That factor certainly led to the statutory/regulatory change effective December 1, 1997. We believe it also has caused CMS to apply this policy to not-for-profit transactions that occurred before that date. However, CMS has no sound legal or policy basis to apply this change retroactively.

In addition to the blatantly retroactive nature of this change, the flaws in CMS' justification for this change in policy are apparent on the face of the Program Memorandum. With respect to its "related organizations" theory, CMS bases its policy on the proposition that for-profit and not-for-profit organizations are different in the extent to which former officers and directors are included on the board of directors or in the management of the newly merged or consolidated organization. CMS can provide no basis for this contention. The resulting governing board and/or management team of a merged or consolidated not-for-profit organization is likely to be composed substantially of officers and directors of the former entities. The same may well be true for other hospital mergers or consolidations, especially if the former entities had relatively equal bargaining power in the transaction. For this reason, the existing regulations require an inspection of the parties' relationship prior to the transaction. CMS fails to explain this change in its interpretation of the related parties rule.

CMS's analysis of the bona fide sale requirement as it applies to not-for-profit entities is similarly flawed. CMS states that there is a "sale" whenever there is a consolidation of for-profit entities, but not when not-for-profit entities consolidate or merge, because the two types of entities may be acting according to different interests. In the first place, we question whether the applicable regulation applies the concept of a bona fide sale to a change of ownership resulting from a merger or consolidation. In any event, however, there is no doubt that the transactions in question were genuine, i.e., they were undertaken for legitimate business reasons rather than simply to manipulate Medicare reimbursement. (The rationale behind this concept is the same as that behind the related parties rule-to prevent artificial manipulation.) The reasons for all hospital consolidations and mergers are: efficiency, ability to compete, and reaction to managed care and other market forces. There is simply no basis for CMS's conclusions that mergers and consolidations among all types of hospitals do not involve the same incentives and objectives.

Conclusion. With the use of flawed reasoning and retroactive rule making, CMS is attempting to reach back and reverse its policies in effect prior to December 1997, when all of the ownership changes in question were consummated. This is wrong because:

  • Changes in reimbursement rules must operate prospectively only. CMS's longstanding policy to recognize gains and losses was reversed by regulation for transactions on or after December 1, 1997. However, the Program Memorandum issued in 2000 in essence reverses that policy for not-for-profit hospitals for transactions prior to December 1, 1997.
  1. Beginning in 1979, a lengthy and consistent body of law, regulation and interpretation required that CMS share in the gains and losses that resulted when unrelated providers were merged or consolidated.
  2. Although Medicare enjoyed the financial benefits resulting from gains for approximately 25 years, well-recognized forces operating in the health care field began to inflict real economic losses on providers beginning in the 1990s.

AHA is not seeking a determination of any specific payment amounts at this time. Rather, we are seeking to have HHS correct the effects of the retroactive rulemaking. To do so, HHS should:

  • Correct its policy on the denial of Medicare losses for hospital changes of ownership by:
  1. withdrawing the retroactive Program Memorandum A-00-76;
  2. advising intermediaries to reconsider all determinations denying the losses in question and to apply the interpretations of laws and regulations in effect at the time of the changes of ownership; and,
  3. in any cases where a re-determination results in a recovery of previously allowed losses, suspending recovery during the period of appeal.
  • Adopt a policy of consistent and fair application of rules and policies that hospitals must rely upon as part of HHS' wide-ranging regulatory reform initiative.

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