Published February 17, 2023

Medicare Payment Primers: Cost-Based Reimbursement – Other Areas Dependent on Cost Report Ratios and Processes

In PYA’s ongoing Medicare Payment Primer Series, we have been delving into the fundamentals of cost-based reimbursement, breaking them down into four parts. The fourth part (#3d) provides examples of significant reimbursement areas where cost report data is used to determine Medicare payment or inform the basis for future payment amounts.

From the Centers for Medicare & Medicaid Services’ (CMS) perspective, the Medicare cost report represents the best available source of data for monitoring provider operations and establishing payment methodologies. An individual hospital cost-to-charge ratio (CCR) can be used to standardize data across a variety of provider types. Even though every hospital may have unique cost and charge structures, applying a CCR, or simply relying on Medicare-defined cost, can “level the playing field.” There are several examples where the application of CCRs or cost contributes to the definition of Medicare payment amounts.

Determination of Uncompensated Care Costs

A portion of Medicare reimbursement for inpatient acute prospective payment system (Inpatient Acute PPS) hospitals/providers is derived from converting hospital-reported charity care and bad debt “charges” to cost using an overall facility cost/charge ratio. Once the cost is determined, a hospital’s values are indexed against the reported data for all hospitals to determine its share of the amount of uncompensated care cost “pool” dollars to allocate to each of the qualifying PPS hospitals.

Determination of Adjusted Hour Wage for Wage Index Purposes

Virtually all of Medicare’s prospective payment systems (PPSs) have a unique component of the payment calculation connected to wage index data. The adjusted hourly wage costs include salaries, contract labor, and fringe benefits. These amounts are determined by cost reporting rules and regulations. The allowable costs are divided by the corresponding hours to calculate the adjusted hourly wage. A facility’s wage index compares the individual facility cost and hours data to all the similar providers, so the values are “indexed.” Facilities are often grouped by census Core-Based Statistical Areas (CBSAs), like states or urban areas. The resulting index is applied to the specific payment amounts. There is a lag between the reporting period and when it is used to determine payments.

Non-Distinct Part Observation Services

Observation services occur within a hospital setting when the physicians are trying to establish the medical necessity for admitting a patient to inpatient status. The patient’s status will ultimately determine the patient’s care plan and the reimbursement the hospital will receive for the episode of care.

Many observation patients are treated within an inpatient unit of a hospital, but observation services are considered ancillary services for billing and payment purposes. Because these patients are treated in an inpatient unit, the cost of these services is calculated by taking the total inpatient routine costs divided by the total routine, plus equivalent observation days, and then multiplying that by the observation days. That cost becomes the cost to which total observation unit charges are applied to develop the observation cost/charge ratio. Medicare’s share of the observation cost is determined by applying the Medicare charges to the observation cost/charge ratio. In this manner, the observation department is treated like any other ancillary service.

There is not a separate cost-based payment for these services in PPS facilities. Rather, the observation cost is part of the “bundle of services” comprising the payment under various PPSs.

Cost/Charge Ratios Used for Outlier Determinations

Outliers are individual cases where the cost of care exceeds thresholds established through regulation. The thresholds are updated annually, and the additional outlier payment (if any) is based, in part, on converting the covered charges for the case to cost using a hospital-specific cost-to-charge ratio that is related only to Medicare charges and cost. For most hospitals, charges will have to be extreme to generate even a small amount of outlier reimbursement.

Determination of Medicare’s Share of Graduate Medical Education “Cost”

Medicare reimbursement for the operating costs of approved graduate medical education programs is determined by the product of a per-resident amount, multiplied by the number of allowable residents and the Medicare load factor (patient day utilization). For many hospitals, the per-resident amount was established in a base period using fully allocated costs for operating the residency programs, divided by the residents trained in that base period.

Once established, the per-resident amount has been updated with modest inflation factors. Further, the actual cost report cost is used to split the allowable Direct Graduate Medical Education (DGME) payment between Part A (Inpatient) and Part B (outpatient) services. This split does not impact the amount of reimbursement; rather, it is used to determine whether the amount is reported in the inpatient or outpatient settlement and “paid” by the Part A or Part B Medicare trust fund.

Reasonable Cost Reimbursement for Approved Nursing and Allied Health Programs (Pass-Through Costs)

Medicare reimburses hospitals for the reasonable costs of operating approved (accredited) nursing and paramedical education programs leading to the initial certification (diploma) for the patient-care-related discipline. Unlike the payments for direct medical education, which are based on a historical per-resident amount calculation, the payments for nursing and paramedical education are based on current-period reasonable costs. In this context, “reasonable cost” includes the direct and indirect costs associated with these programs, reduced by the related tuition and fees revenue. The full cost is “stepped down” to the patient care departments where the training occurs. Medicare’s share of this cost is determined through the apportionment process, with costs allocated to the routine areas attributed to Medicare based on Medicare days to total days.

The costs allocated to the ancillary areas are attributed to Medicare based on the Medicare departmental charges divided by the total charges. The ancillary apportionment is achieved through the use of a cost/charge ratio that only includes the nursing and allied health costs.

There is an additional element of reimbursement for the nursing and allied health program costs attributable to Medicare managed care enrollees. This reimbursement formula is based on the hospital-specific paramedical education costs from a preceding cost reporting period as a percentage of total paramedical education costs. This is further adjusted by the number of the hospital’s Medicare managed care days percentage of total Medicare managed days. This formula produces an index applied to a statutorily determined pool amount.

Comparison of Reimbursement and Cost (Margin Calculation)

For many hospitals, Medicare reimbursement represents a significant portion of their total operation. Understanding the relationship between reimbursement and Medicare-defined costs for various payment streams can provide useful information for operational and strategic purposes. This comparison is also beneficial to policymakers so they can evaluate the efficiency of various payment systems compared to the cost of providing patient care to beneficiaries.

Development of Future Inpatient and Outpatient Rates

With virtually all reimbursement methodologies tied to prospective payment systems, cost–as determined through the cost reporting process–provides CMS (and possibly states) information to develop future payment rates. The overall change in costs on a year-over-year basis may inform the determination of the market basket update. The distribution of costs can influence the labor and non-labor-related portions of payment rates. The cost report data produces the national cost/charge ratios used to evaluate the payment amounts, outlier thresholds, and weighting factors under the inpatient and outpatient payment systems amounts and weighting factors.

Because the data are used for these purposes, CMS has a reasonable expectation that cost report data are accurate and compliant with the regulations and manual guidance.

Resources

Related Insights in our Medicare Payment Primer Series cover:

If you have questions about any matter related to reimbursement, strategy and transactions, compliance, or valuation, one of our executive contacts would be happy to assist. You may email them below, or call (800) 270-9629.

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