Congress passed July 31 landmark legislation that makes sweeping changes to the Medicare and Medicaid programs. Overall, the legislation is expected to reduce Medicare spending by $116.4 billion and Medicaid spending by $8.4 billion over the next five years. About $44 billion of the five-year Medicare savings come from direct reductions in hospital inpatient and outpatient fee-for-service payments -- less than the reductions the president sought during budget negotiations. Hospitals providing a broader range of non-acute care services or involved in managed care arrangements will be affected by additional changes in this new law. The chart and bullet points below describe in more detail the key payment changes that will most affect your institutions:







PPS Update

Zero update

MB minus 1.9

MB minus 1.8

MB minus 1.1

MB minus 1.1

Indirect Medical Education Factor






Bad Debt

75% of costs

60% of costs

55% of costs

55% of costs

55% of costs

Medicare DSH

1% reduction

2% reduction

3% reduction

4% reduction

5% reduction

AAPCC blend

($367 floor in 1998; 2% annual minimum update for all counties)

90% local/10% price-adjusted national


local/18% price-adjusted national

74% local/26% price-adjusted national

66% local/34% price-adjusted national

58% local/42% price-adjusted national

AAPCC carve-out of medical education payments-no carve-out of DSH






Other Important Payment Issues:

Capital Payments -- Reduces capital payments for PPS hospitals by 17.8% in FY 1998 -- this reduction is built into future rates. For PPS-exempt hospitals, capital will be paid at 85 percent of costs for FY 1998-2002.

Transfers -- Beginning in FY 1999, reduces payments for 10 diagnostic-related groups (DRGs) to be determined by the HHS secretary, for shorter-than-average stay PPS cases discharged to a skilled nursing facility, PPS-exempt facility or to home health care. Swing beds are excluded from this provision. The transfer reduction will be limited for DRGs among the 10 specified in which a significant portion of costs are incurred in the beginning of the stay.

Outpatient Payment -- Reduces payments for outpatient services by $1.3 billion in FY 1998. This reduction will be built into the prospective payment rates for outpatient services that will take effect in 1999. Prospective payment rates will be updated annually by the marketbasket minus one percentage point.

Tax Exempt Bonds -- Repeals the $150 million cap on tax-exempt bonds that hospitals can have outstanding for new non-acute care capital expenditures.

Physician Practice Expense -- Delays for one year implementation of the physician practice expense regulation, which would have lowered Medicare payments to hospitals for certain outpatient services calculated in part based on physician payment rates. Phases in its effect over a three-year period. An interim adjustment to physician payments for certain procedures, however, will be made in FY 1998.

Medicare Provider Payment Safeguards or "Boren amendment" -- Repeals the Boren amendment. Replaced by requirement that states must have a public process for setting payment rates.

Medicaid DSH -- Reduces federal Medicaid DSH spending to states by about $10 billion over five years -- about half of the originally proposed reduction. Freezes federal DSH spending at about FY 1995 levels with additional state-specific reductions spelled out in the law. In no case can total Medicaid spending in a state drop below its FY 1995 level less 3.5 percent.

Schedule for Implementation of New Prospective Payment Systems

Skilled Nursing Facilities and Units

Begins July 1, 1998

Outpatient Hospital Services

Begins January 1, 1999

Home Health Services

Begins October 1, 1999

Rehabilitation Hospitals and Units

Begins October 1, 2000

Additional implications for hospitals and health systems

If you're a rural provider:

  • The legislation reinstates the Medicare-dependent hospital program, which expired in 1995, and extends it through FY 2001.
  • Medicare will cover telemedicine consultations in underserved areas.
  • The bill replaces the Essential Access Community Hospital demonstration program with a new limited-service hospital program available in any state. The measure offers cost reimbursement and reduced staffing requirements for rural hospitals that maintain no more than 15 acute care beds, provide 24 hour emergency room services, are more than 35 miles from the nearest facility (15 miles in the case of mountainous terrain or areas with only secondary roads), and keep inpatients up to 96 hours. The mileage requirement can be waived by a state.
  • Rural health clinics based in hospitals with fewer than 50 beds are exempt from new limits on cost reimbursements. Limits that previously applied only to independent clinics are extended to hospital-based clinics in larger hospitals.
  • The legislation establishes a minimum Medicare managed care payment rate of $367 in FY 1998, which will be updated annually.
  • For 30 months, qualified rural hospitals may be geographically reclassified to receive DSH payments.

If you're a teaching hospital:

  • You'll be paid separately for direct and indirect graduate medical education costs related to Medicare managed care enrollees. These payments are "carved out" of health plan payments over five years and are paid directly to providers incurring the costs.
  • You may qualify for graduate medical education incentive payments if you reduce the size of your residency program. Legislation caps residents at your 1996 level and sets a three-year rolling average count.
  • The legislation gradually lowers the indirect medical education funding adjustment factor from 7.7 percent to 5.5 percent by FY 2001.
  • The legislation phases in a reduction in Medicare disproportionate share payments of up to 5% in 2002.

If you have an HMO contract with Medicare:

  • Your monthly Medicare capitation payment (the adjusted average per capita cost or AAPCC) will be no less than $367 in 1998. The monthly payment for each area is guaranteed to increase by at least 2 percent a year. Plus, payments will be based on a phased-in 50/50 blend of local area and national rates. The 50/50 blend is reached in 2003. And graduate medical education payments will be separated from the Medicare capitated payment and paid directly to organizations that incur teaching costs.

If you're interested in becoming a Provider Sponsored Organization:

  • The opportunity is now a reality. PSOs are officially a new Medicare option.
  • A fast-track federal process for 1998-2002 will let you enter the Medicare managed care market quickly. You may apply directly to the Department of Health and Human Services if your state doesn't approve your application for a PSO license within 90 days.
  • You don't need non-Medicare enrollees to contract with Medicare.
  • The legislation lowers the minimum Medicare enrollment requirement to 1,500; in rural areas it's 500.
  • You'll be paid using the revised Medicare managed care payments (the AAPCC) described above.

If you're a PPS-exempt provider:

  • You could increase your target amounts by "rebasing" or using more recent cost-report information to compute the target.
  • A new prospective payment system for rehabilitation hospitals and units will take effect in FY 2001.
  • The legislation reduces capital payments to 85 percent of reasonable costs.
  • The new law sets cost limits for new providers to equal 110 percent of the median for existing exempt facilities.
  • Incentive payments for lower-cost hospitals are reduced to the lower of 15% of the difference between costs and your target amount or 2% of your target amount. Those able to keep costs below their targets for three years are eligible for additional incentive payments.
  • There will be no update for payments to PPS-exempt providers in FY 1998.

If Medicaid and children's health coverage is important to you:

  • The legislation provides an additional $24 billion to states over 5 years to expand health insurance coverage for children. The funds could be used to provide services through Medicaid, purchase insurance or purchase health services directly for children. Up to 2 million additional children could be covered annually as a result.
  • It restores benefits for elderly and disabled legal immigrants who were in the U.S. by August 22, 1996 and receiving Supplemental Security Income (SSI) benefits. It restores Medicaid eligibility for disabled children who were previously eligible under SSI.
  • In addition, Medicaid DSH payments currently paid to Medicaid managed care plans will be carved out and paid directly to hospitals.
  • Medicaid disproportionate-share payments to the states are reduced by about $10 billion.
  • Also, it repeals the Boren amendment's provider payment safeguards, but sets up a public process for determining payment rates and requires a study of the effect of repeal.

If you provide continuing care services:

  • The measure creates a new per-diem prospective payment system for skilled nursing services beginning July 1, 1998. Per-diem rates will be set based on an average of skilled nursing costs for all types of facilities (freestanding and hospital-based) and costs for freestanding facilities only. Rates would be updated annually by the marketbasket minus one percentage point. FY 1997 cost limits are extended to July 1, 1998.
  • A new prospective payment system was created for home health care services beginning October 1, 1999. System design and specifics will be decided through regulation.
  • The measure creates a new prospective payment system for rehabilitation services beginning October 1, 2000. Specifics such as the type of patient classification system to be used and the unit of payment will be decided through regulation.

The AHA Web Site page is chock full of information and details about the health care portions of the legislation. Access / and click on the headline banner "The Federal Budget Deal" for more information. You can also find instructions on our website for directly accessing the legislation itself.


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