[Federal Register Volume 66, Number 9 (Friday, January 12, 2001)]
[Rules and Regulations]
[Pages 3148-3177]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-635]



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Part III





Department of Health and Human Services





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Health Care Financing Administration



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42 CFR Part 447



Medicaid Program; Revision to Medicaid Upper Payment Limit Requirements 
for Hospital Services, Nursing Facility Services, Intermediate Care 
Facility Services for the Mentally Retarded, and Clinic Services; Final 
Rule

  Federal Register / Vol. 66, No. 9 / Friday, January 12, 2001 / Rules 
and Regulations  

[[Page 3148]]


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DEPARTMENT OF HEALTH AND HUMAN SERVICES

Health Care Financing Administration

42 CFR Part 447

[HCFA-2071-F]
RIN 0938-AK12


Medicaid Program; Revision to Medicaid Upper Payment Limit 
Requirements for Hospital Services, Nursing Facility Services, 
Intermediate Care Facility Services for the Mentally Retarded, and 
Clinic Services

AGENCY: Health Care Financing Administration (HCFA), HHS.

ACTION: Final rule.

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SUMMARY: This final rule modifies the Medicaid upper payment limits for 
inpatient hospital services, outpatient hospital services, nursing 
facility services, intermediate care facility services for the mentally 
retarded, and clinic services. For each type of Medicaid inpatient 
service, existing regulations place an upper limit on overall aggregate 
payments to all facilities and a separate aggregate upper limit on 
payments made to State-operated facilities. This final rule establishes 
an aggregate upper limit that applies to payments made to government 
facilities that are not State government-owned or operated, and a 
separate aggregate upper limit on payments made to privately-owned and 
operated facilities. This rule also eliminates the overall aggregate 
upper limit that had applied to these services.
    With respect to outpatient hospital and clinic services, this final 
rule establishes an aggregate upper limit on payments made to State 
government-owned or operated facilities, an aggregate upper limit on 
payments made to government facilities that are not State government-
owned or operated, and an aggregate upper limit on payments made to 
privately-owned and operated facilities.
    These separate upper limits are necessary to ensure State Medicaid 
payment systems promote economy and efficiency. We are allowing a 
higher upper limit for payment to non-State public hospitals to 
recognize the higher costs of inpatient and outpatient services in 
public hospitals. In addition, to ensure continued beneficiary access 
to care and the ability of States to adjust to the changes in the upper 
payment limits, the final rule includes a transition period for States 
with approved rate enhancement State plan amendments.

EFFECTIVE DATE: The provisions of this final rule are effective March 
13, 2001.

FOR FURTHER INFORMATION CONTACT: Robert Weaver, (410) 786-5914, Nursing 
facility services and intermediate care facility services for the 
mentally retarded.
    Larry Reed, (410) 786-3325, Inpatient and outpatient hospital 
services and clinic services.

SUPPLEMENTARY INFORMATION:

Availability of Copies and Electronic Access

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password required).

I. Statutory and Regulatory Framework

    Title XIX of the Social Security Act (the Act) authorizes Federal 
grants to States for Medicaid programs that provide medical assistance 
to low-income families, elderly individuals, and persons with 
disabilities. Each State Medicaid program is administered by the State 
in accordance with an approved State plan. While the State has 
considerable flexibility in designing its State plan and operating its 
Medicaid program, it must comply with Federal requirements specified in 
the Medicaid statute, regulations, and program guidance. Additionally, 
the plan must be approved by the Secretary, who has delegated this 
authority to HCFA.
    Section 1903(a)(1)(A) of the Act provides for payments to States, 
through Federal financial participation (FFP), in expenditures for 
services covered under an approved State plan. Section 1902(a)(30)(A) 
of the Act requires a State plan to meet certain requirements in 
setting payment amounts for covered Medicaid care and services. One of 
these requirements is that payment for care and services under an 
approved State Medicaid plan be consistent with efficiency, economy, 
and quality of care. This provision provides authority for specific 
upper payment limits set forth in Federal regulations in 42 CFR part 
447 relating to different types of Medicaid covered services. With 
respect to inpatient hospital services, nursing facility (NF) services, 
and intermediate care facility services for the mentally retarded (ICF/
MR), upper payment limits are set forth in regulations at Sec. 447.272, 
``Application of upper payment limits.'' This provision limits overall 
aggregate State payments and aggregate payments to State-operated 
providers. With respect to outpatient hospital services and clinic 
services, similar upper payment limits on aggregate State payments are 
set forth in regulations at Sec. 447.321, ``Outpatient hospital 
services and clinic services: Upper limits of payments.''
    Existing regulations stipulate that aggregate State payments for 
each type of services, that is, inpatient hospital and outpatient 
hospital services, NF services, ICF/MR services, and clinic services 
may not exceed a reasonable estimate of the amount the State would have 
paid under Medicare payment principles. Under Secs. 447.257, ``FFP: 
Conditions relating to institutional reimbursement,'' and 447.304, 
``Adherence to upper limits; FFP, paragraph (c),'' FFP is not available 
for State expenditures that exceed the applicable upper payment limit.
    The statute also permits States some flexibility to use local 
government funds for the non-Federal share of Medicaid expenditures. 
Under section 1902(a)(2) of the Act, States may fund up to 60 percent 
of the non-Federal share of Medicaid expenditures with local government 
funds. Section 1903(w)(6) of the Act specifically limits the 
Secretary's ability to place restrictions on a State's use of certain 
funds transferred to it from a local unit of government subject to the 
requirements in section 1902(a)(2) of the Act.

[[Page 3149]]

    Before 1981, under section 1902(a)(13) of the Act, States were 
required to pay rates for hospital and long-term care services that 
were directly related to cost reimbursement. To obtain approval from 
HCFA, many States set rates using Medicare reasonable cost payment 
principles.
    In 1980 and 1981, the Congress enacted legislation (section 962 of 
the Omnibus Reconciliation Act of 1980 (ORA 1980), Public Law 96-499, 
and section 2173 of the Omnibus Budget Reconciliation Act of 1981 (OBRA 
1981), Public Law 97-35, collectively known as the ``Boren Amendment'') 
that amended section 1902(a)(13) of the Act to give States flexibility 
to deviate from Medicare's reasonable cost payment principles in 
setting payment rates for hospital and long-term care services.
    The Boren Amendment was primarily considered a floor on State 
spending because it required States to set rates that would meet the 
costs incurred by efficiently and economically operated facilities. 
However, the Boren Amendment also supported upper payment limits on 
overall rates. In legislative history, the Congress directed the 
Secretary to maintain ceiling requirements that limited State payments 
in the aggregate from exceeding Medicare payment levels. The Senate 
Finance Committee stated that ``the Secretary would be expected to 
continue to apply current regulations that require that payments made 
under State plans do not exceed amounts that would be determined under 
Medicare principles of reimbursement'' (S. Rep. No. 471, 96th Cong., 
1st sess. (1979).
    In 1986, the Congress implicitly affirmed the use of upper limits 
on payments for inpatient hospital services, NF services, and 
intermediate care facility (ICF) (now ICF/MR) services. Section 9433 of 
the Omnibus Budget Reconciliation Act of 1986, Public Law 99-509, 
precluded the Secretary from placing limits on State payments to 
hospitals that serve a disproportionate number of low-income patients 
with special needs (disproportionate share hospital (DSH) payments) but 
maintained the application of limits on regular inpatient payment 
rates.
    The existing regulations on upper limits were last changed in a 
final rule published in the Federal Register on July 28, 1987 (52 FR 
28141) that addressed the application of the upper payment limit to 
States that had multiple payment rates for the same class of services. 
The July 28, 1987 final rule also addressed the differential rate issue 
in the context of State-operated facilities. Several audits had 
revealed that the circumstances of State-operated facilities created 
incentives for States to overpay these facilities. A high volume of 
uninsured patients had increased the costs of providing services in 
State government-owned or operated facilities. These costs, in turn, 
were passed on to the State. To offset those higher costs, States 
established payment methodologies that paid State government-owned or 
operated facilities at a higher rate than privately operated 
facilities. Higher Medicaid payments to State government-owned or 
operated facilities allowed States to obtain additional Federal 
Medicaid dollars to cover costs formerly met entirely by State dollars. 
To ensure payments to State-operated facilities would be consistent 
with efficiency and economy, the July 28, 1987 final rule applied the 
Medicare upper limit test to State-operated facilities separate from 
other facilities. However, it did not create a separate upper payment 
limit for other government facilities, which allowed their payments to 
count toward the same aggregate upper payment limit as private 
facilities.
    Section 4711 of the Balanced Budget Act of 1997 (BBA), Public Law 
105-33, amended section 1902(a)(13) of the Act to increase State 
flexibility in rate setting by replacing the substantive requirements 
of the Boren amendment with a new public process. The new public 
process requires the State agency to have in place, and use, a public 
process that determines the rates of payment under the plan for 
inpatient services furnished by hospitals, nursing facilities, and 
intermediate care facilities for the mentally retarded. As part of the 
new public process requirements, States must publish proposed and final 
rates, the methodologies underlying the establishment of the rates, and 
the justifications for the rates. The public process must give 
providers, beneficiaries and their representatives, and other concerned 
State residents an opportunity to review and comment on the proposed 
rates, methodologies, and justifications, before they become final. In 
addition, in the case of hospitals, the rates must take into account 
(in a manner consistent with section 1923 of the Act) the situation of 
hospitals that serve a disproportionate number of low-income patients 
with special needs. Under section 4711 of Public Law 105-33, States 
have flexibility to target rate increases to particular types of 
facilities so long as the rates are established in accordance with the 
new public process requirements.
    The Medicare, Medicaid, and SCHIP Benefits Improvement and 
Protection Act of 2000 (BIPA) amends titles XVIII, XIX, and XXI of the 
Social Security Act to provide benefits improvements and beneficiary 
protections in the Medicare and Medicaid Programs and the State child 
health insurance program (SCHIP), as revised by the Balanced Budget Act 
of 1997 and the Medicare, Medicaid, and SCHIP Balanced Budget 
Refinement Act of 1999, and for other purposes. Section 705 of BIPA 
imposes additional requirements upon Medicaid UPL.
    The BIPA addressed publication of this final rule at Section 705, 
``Deadline for Issuance of Final Regulation Relating to Medicaid Upper 
Payment Limits.'' In section 705(a), it requires that we publish these 
final regulations not later than December 31, 2000. It further requires 
that, while this final rule must be based on the proposed rule 
announced October 5, 2000, that this final regulation shall be 
published ``* * * notwithstanding any requirement in the Administrative 
Procedures Act (APA) under chapter 5 of title 5, United States Code, or 
any other provision of law''* * * Section 705(b) of the BIPA provides 
for a longer transition period for States that had an approved State 
plan provision or methodology in effect on October 1, 1992. Section 701 
of BIPA also changes a State's DSH allotments and provides for an 
increase in DSH allotment for extremely low DSH States based on the 
publication date of this rule.
    We further note that waiver of the APA did not require that we 
review all comments received on the proposed rule and respond to them 
in the final rule. Under section 705(b), we considered replacing the 
transition periods in the proposed rule with that provided in this 
section of the law. Instead, we have decided to add a third transition 
period for those States with approved State plans or methodologies in 
effect on or before October 1, 1992.

II. Basis for the Proposed Changes

    It had become apparent that the existing regulations created a 
financial incentive for States to overpay non-State government-owned or 
operated facilities because, through this practice, States, counties, 
and cities were able to effectively lower net State or local 
expenditures for covered services and gain extra Federal matching 
payments. This practice is not consistent with the Medicaid statute and 
has contributed to rapidly growing Medicaid spending.
    The incentive for, and ability of, States to pay excessive rates to 
non-State government-owned or operated Medicaid providers can be 
explained as follows. As stated previously, the existing aggregate 
upper payment limit is applied to both private and non-State

[[Page 3150]]

government-owned or operated facilities. By developing a payment 
methodology that set rates for proprietary and nonprofit facilities at 
lower levels, States were able to set rates for county or city 
facilities at substantially higher levels and still comply with the 
existing aggregate upper payment limit. The Federal government matched 
these higher payment rates to public facilities. Because these 
facilities are public entities, funds to cover the State share were 
transferred from those facilities (or the local government units that 
operate them) to the State, thus generating increased Federal funding 
with no net increase in State expenditures. This is not consistent with 
the statutory requirements that Medicaid payments be economical and 
efficient.
    On July 26, 2000, the Director of the Center for Medicaid and State 
Operations sent a letter to all State Medicaid Directors notifying them 
of the Administration's concern that ``Medicaid payments meet the 
statutory definition of efficiency and economy'' and that we would be 
issuing a proposed rule to address this problem. Additionally, States 
were informed that the Office of the Inspector General (OIG) and the 
General Accounting Office (GAO) had begun to monitor States with State 
plans that permitted these types of payments. Both the GAO and OIG have 
testified before Congress on the scope of these financing practices, 
their impact on State and Federal spending, and on the resultant uses 
of increased Federal funds. Preliminary results of OIG's work to date 
are described below.
    As of December 22, 2000, the OIG had completed six substantial 
reviews in five States. Although the specifics of the enhanced payment 
programs and associated financing mechanisms differed somewhat in each 
State reviewed, the OIG found that payment programs share some common 
characteristics. These similarities are included below.
     In general, enhanced payments to city and county 
government owned providers were not based on the actual cost of 
providing services to Medicaid beneficiaries, or directly related to 
increasing the quality of care provided by the public facilities that 
received the enhanced payments.
     Enhanced payments to public nursing facilities were not 
being retained by the facilities to provide services to Medicaid 
beneficiaries. Instead, the majority of the enhanced payment was 
returned by the providers to the States through intergovernmental 
transfers (IGT). The States then used the funds for other purposes, 
some of which were unrelated to the Medicaid program.
     Unlike the nursing facilities, public hospital providers 
retained the majority of the Medicaid enhanced payments. However, the 
portion of the funds that hospitals returned to the States through IGTs 
resulted in millions of dollars available to the States for other uses.
     While the public hospital providers served a large number 
of Medicaid beneficiaries and uninsured patients, the hospitals either 
(1) did not receive Medicaid disproportionate share hospital (DSH) 
payments from the States, or (2) returned the majority of the Medicaid 
DSH payments to the States through IGTs. It appears, for these 
providers, that States used enhanced payments in the place of DSH 
payments, although Medicaid DSH payments are designed to help hospitals 
that provide care to a large number of Medicaid beneficiaries and 
uninsured patients.
    Similarly, the GAO testified before the Congress that existing 
arrangements violate the basic integrity of Medicaid as a joint 
Federal/State program. GAO asserted that, by taking advantage of a 
technicality, States had used these financing schemes, in effect, to 
replace State Medicaid dollars with Federal Medicaid dollars.

III. Summary of the Provisions of the October 10, 2000 Proposed Rule

    On October 10, 2000, we published a proposed rule in the Federal 
Register (65 FR 60151) that set forth proposed changes in the Medicaid 
upper payment limits for hospital services, NF services, ICF/MR 
services, and clinic services. A detailed description of the specific 
provisions of the proposed rule can be found beginning at 65 FR 60152. 
In the October 10, 2000 proposed rule, we proposed to establish:
     An aggregate upper payment limit for inpatient hospital, 
NF, and ICR/MR services furnished by other government-owned or operated 
facilities.
     An aggregate upper payment limit for outpatient hospital 
and clinic services provided by State government-owned or operated 
facilities and a separate aggregate upper payment limit for outpatient 
hospital and clinic services provided by all other government-owned or 
operated facilities.
     Two transition periods for States with approved rate 
enhancement State plan amendments to comply with the proposed payment 
limits. (The length of the transition period would depend on the 
effective date of the State's plan amendment, which is discussed in 
section III.C. of this preamble.)

IV. Analysis of and Responses to Public Comment

    We received approximately 562 timely items of correspondence 
containing comments on the proposed rule from State Government 
officials, members of Congress, provider organizations, the Office of 
the Inspector General, county government officials, individual 
providers and private citizens. A discussion of the specific provisions 
of the proposed rule and summaries of the public comments received, and 
our responses to the comments are set forth below under the appropriate 
section heading:

Calculation of the UPL

Calculation/Technical Clarifications of UPL (Sec. 447.272(a) & (b), 
Sec. 447.321(a) & (b))

    We received many comments requesting clarification regarding the 
calculation of the proposed UPLs. In the proposed rule, we did not 
propose any changes to the methodology States may use to calculate the 
UPLs but proposed to redefine the groups of providers that would be 
subject to the UPLs.
    Comment: One commenter noted that Sec. 447.272(a) was introduced 
with the clause: ``Except as provided in paragraphs (b)(2) and (c) of 
this section, * * *'' The commenter added, however, that paragraph 
Sec. 447.272(b), which included (b)(2), began with the language: ``In 
addition to being subject to the requirements of paragraph (a) of this 
section, * * *'' The commenter noted that these two clauses can be 
interpreted to be directly contradictory.
    Response: In this final rule, we have eliminated the two clauses 
that were contradictory in our proposed rule. We revised paragraph (a) 
of Secs. 447.272 and 447.321 to identify the different categories of 
facilities that furnish inpatient and outpatient services, 
respectively. Under the proposed rule, these categories included State 
government'owned or operated and other government-owned or operated. In 
this final rule, we renamed the ``other government-owned or operated'' 
category as ``non-State government-owned or operated'' and added a 
third category for privately-owned and operated facilities.
    We revised paragraph (b) of sections Secs. 447.272 and 447.321 to 
provide the general rule for aggregate payment that applies to each 
category of facilities described in paragraph (a).
    Comment: One commenter recommended that we clarify our use of the 
terms ``facilities'' and ``services'' in Secs. 447.272 and 447.321 to 
consistently use the phrase ``services in a facility''

[[Page 3151]]

rather than the term ``services'' by itself. The commenter added that 
the word ``those'' should also be eliminated when it has no reference.
    Response: We have revised Secs. 447.272 and 447.321 to clarify the 
types of services furnished by each group of facilities that are 
included in the UPLs.
    Comment: One commenter recommended that we provide clarification 
for the term ``outpatient hospital'' in Sec. 447.321(a) because it is 
not commonly understood and suggested that we instead make a reference 
to hospital outpatient services.
    Response: We removed the term ``outpatient hospitals'' from 
paragraphs (a) and (b) of Sec. 447.321. In revised Sec. 447.321(a), we 
use the phrase ``outpatient services furnished by hospitals''. In 
addition, at Sec. 447.272(a), we use the language ``inpatient services 
furnished by hospitals'' rather than the term ``inpatient hospitals''.
    Comment: One commenter recommended that in paragraph (b) of 
Secs. 447.272 and 447.321 that HCFA find a more neutral word for ``non-
compliant'' to describe State plan amendments.
    Response: We have revised Secs. 447.272 and 447.321 to eliminate 
the term ``con-compliant.''
    Comment: One commenter suggested that we clarify in the regulation 
that, in determining the UPL, coinsurance and deductible payments paid 
or payable to hospitals by Medicare beneficiaries must be included in 
determining what would have been paid under Medicare. The commenter 
notes that Sec. 447.321(b), which includes this concept, was eliminated 
without explanation.
    Response: Under current UPL regulations at Sec. 447.321, the 
coinsurance and deductible payments, which a Medicare beneficiary would 
be liable to pay, are included in the Medicare approved payment amount 
that can be used in UPL calculations. In this final rule, we will 
continue to allow States to use the Medicare approved payment amounts 
as a factor in their UPL computations.
    Comment: One commenter recommended that States should be able to 
calculate the UPL based on date of service rather than date of payment 
or Federal claiming. The commenter stated that this is consistent with 
how hospital audits are performed. This eliminates other variances 
caused by billing patterns or timeliness of State payments.
    Response: This final rule continues to permit States to compute the 
UPL based on date of service.
    Comment: We received various comments seeking clarification of the 
criteria for hospitals to be considered a public facility subject to 
the new proposed governmental UPL and transition rules. One commenter 
suggested that hospitals should be classified as public if they exhibit 
the same characteristics as safety-net hospitals. A commenter 
recommended that some hospitals should qualify as public even if they 
are not receiving local tax dollars. Some hospitals are located in 
counties that have formed a hospital district which permits the levying 
of special ad valorem taxes to support operation of the hospital.
    Response: Within the context of this regulation, we consider a 
facility to be subject to the new governmental UPL if it can make an 
IGT payment to the State (either directly or indirectly through a 
governmental owner or operator, or other arrangement). We have created 
three aggregate groups based on whether the facility is privately-owned 
and operated, State government-owned or operated or non-State 
government-owned or operated. Facilities fall into the categories of 
non-State government-owned or operated and State government-owned or 
operated based upon their ability to make intergovernmental transfer 
payments back to the State and based upon the governance structure of 
the facility and who retains ultimate liability for the operations of 
the facility. However, all facilities that are prohibited from 
transferring funds back to the State will fall into the privately-owned 
and operated category.
    Comment: Several commenters recommended that we continue the 
current UPL regulations. In addition, commenters suggested that we not 
establish a third aggregate UPL to apply to non-State government-owned 
or operated facilities. Another commenter stated that HCFA is already 
able to ensure economy and efficiency through the State plan approval 
process, so that no additional safeguards are necessary. A commenter 
pointed out that the current limits provide the public with assurances 
that States will not overspend the Medicaid budget.
    Response: We disagree with the commenters. We do not believe that 
the current UPL regulations are sufficient to ensure that State 
Medicaid payments meet the statutory definition of efficiency and 
economy. Because the former UPL regulations permit States to pool 
provider payments, States could set rates to certain providers a 
multiple above the rate they would pay other providers for the same 
service. The OIG has completed substantial reviews of the financial 
mechanisms of five States with approved State plan amendments. As 
described in the preamble of the proposed and final rule, some general 
findings showed that enhanced payments to providers were not based on 
the actual cost of providing services nor were they used to improve the 
quality of Medicaid services provided by the facilities receiving the 
enhanced payments. States used this mechanism to shift their share of 
Medicaid costs and inappropriately increase the Federal Government 
share. States were also able to recycle Federal funds received from 
these enhanced payments to generate additional Federal matching funds 
that may or may not have been used for Medicaid services for Medicaid 
eligible individuals. In addition, we believe the current UPL 
regulations are contributing to increases in Medicaid program costs 
that are out of proportion to the number of services provided and 
patients served. These findings demonstrate that additional safeguards 
are needed to ensure economy and efficiency of Medicaid payments.
    Comment: One commenter stated that although the proposed rule on 
its face only adds a new aggregate limit, as it would be implemented, 
it would effectively modify the current aggregate limits by removing 
non-State governmental facilities from the calculations of the overall 
aggregate limit, and results in three different categories of 
calculation of the aggregate limits (private, State operated and other 
government operated).
    Response: We agree that the practical effect of the proposed UPLs 
would be to create three classes of providers. In considering this 
consequence, in this final rule, we have restructured the proposed 
regulations at Secs. 447.272 and 447.321 to separate the providers into 
three distinct groups that are based on facility ownership and 
operation. States may aggregate payments up to the UPL that is 
applicable to each group. Specifically, in paragraph (b) of 
Secs. 447.272 and 447.321, we have eliminated the aggregate group for 
all providers by facility type and created three separate aggregate 
groups, which include State government-owned or operated, non-State 
government-owned or operated, and privately-owned and operated 
facilities.
    Comment: One commenter recommended that we provide clarification on 
whether the 150 percent aggregate limit for non-State-owned or operated 
public hospitals is an exception to, and not included in, an aggregate 
limit for all hospitals of 100 percent of the Medicare payment 
principles.
    Response: In proposed Secs. 447.272(b) and 447.321(b), we 
eliminated the overall aggregate limit that had applied

[[Page 3152]]

to all classes of facilities and replaced it with three separate 
aggregate groups, based on facility ownership and operation, which are 
independent of each other. Non-State government-owned or operated of 
hospitals comprise one group, and we permit States to make aggregate 
payments to this group not to exceed 150 percent of a reasonable 
estimate of what Medicare would have paid for the same services. 
Because we have eliminated the overall aggregate group for all 
providers by facility type, payments to these facilities are not 
subject to an overall aggregate limit of 100 percent of what Medicare 
would have paid for services in all hospitals. The final rule clarifies 
that the limit for non-State-owned or operated public hospitals is an 
exception to the otherwise applicable limits, and these facilities 
would not be aggregated with other facilities of different types. We 
believe our new format presents the aggregate groups in a manner that 
makes it clear that the UPLs function independent of each other.
    Comment: Commenters recommended that HCFA clarify the limits for 
inpatient and outpatient services for the same non-State government 
owned hospital. The two limits describe ``payments to hospitals'' not 
payments for inpatient hospital services and outpatient hospital 
services.
    Response: The limits for inpatient and outpatient services are 
calculated separately for each service even though they may be provided 
by the same hospital. The current regulations governing inpatient and 
outpatient UPLs require that these UPLs be calculated separately and we 
have not changed these provisions in Secs. 447.272 and 447.321. The 
limits apply to payments for services that in turn would be paid to the 
provider that furnished them to Medicaid eligible individuals.
    Comment: Several commenters recommended that we expand the limits 
to include different Medicaid services. Some commenters suggested we 
aggregate inpatient and outpatient hospital services together and 
others recommended that we also include clinic services with hospital 
services. One commenter suggested that we include clinics in the 
calculations of a non-State-government-owned or operated hospital if 
the clinic refers patients to that hospital or the hospital refers 
patients to a clinic. Similarly, some commenters believed that we 
should apply UPLs on a facility-specific basis but also include both 
inpatient and outpatient services if offered by the facility. These 
commenters felt that the application of the limit on a service basis 
could lead to unanticipated funding shifts based solely on the 
availability of Federal dollars.
    Response: We are not accepting these recommendations. Including 
more than one Medicaid service under the same UPL would create 
incentives that may lead to abuses similar to those we are now trying 
to address since the number of providers across which payments may be 
aggregated would be increased. We considered facility-specific 
limitations as a possible remedy to the problem of excessive payments, 
but elected instead to refine our aggregate UPLs. We believe our 
approach provides an appropriate balance between the needs of States to 
have flexibility in rate setting and our objective to protect the 
integrity of the Medicaid program.
    Comment: One commenter recommended extremely low DSH States be 
exempted from the outpatient UPL requirement for State hospitals.
    Response: We are not accepting this comment, and have clarified in 
the final regulations that States must calculate an outpatient UPL 
separately for State-operated facilities. This will create a uniform 
procedure for calculating the UPL for inpatient and outpatient 
services. We believe the commenter's recommendation could result in 
perpetuating the very abuses this rule is designed to address. As noted 
in the preamble to the proposed rule, the UPLs were originally modified 
to include a separate limit for State operated facilities for NF's, 
ICF/MRs and hospitals for inpatient services so that these facilities 
were not paid at a higher rate than private facilities. Without 
creating a similar aggregate group for facilities that furnish 
outpatient services, States could continue to overpay State facilities 
while under paying the private facilities.
    Comment: One commenter stated that fair and adequate payment for 
all providers is necessary.
    Response: We agree. Under the UPLs, States will be able to set 
rates that fairly compensate Medicaid providers for Medicaid covered 
healthcare services.
    Comment: One commenter recommended that the UPLs be coordinated 
such that if a State's payment to a particular group of facilities does 
not fully use the UPL amount, the ``unused amount'' should be made 
available to increase other UPLs that may be exceeded in another group. 
The commenter believes that this method should be allowed because the 
total limit on a State's claim for Federal financial participation 
would not be increased.
    Response: Allowing States to distribute the any unused amounts 
under the UPL from one aggregate group to another aggregate group that 
may be over its UPL would perpetuate the practices that this action is 
designed to stem and would not be consistent with the statutory 
requirements that Medicaid payments promote economy and efficiency. 
States would still have an incentive to under-pay proprietary and 
nonprofit facilities and over-pay the State operated and non-State 
government operated facilities. Although the total limit of Federal 
financial participation would not be increased, States would still be 
able to obtain extra Federal funds with less of a State match by 
manipulating which facilities receive extra Medicaid payments.
    Comment: Some commenters suggested that small providers, including 
sole community and critical access hospitals, be given special 
treatment and not be included in the UPL calculation.
    Response: All providers, with the exception of Indian Health 
Services facilities are subject to the UPLs. We do not believe there is 
any justification for exempting any group of institutional providers 
from these regulations. Therefore, we are not removing facilities, such 
as sole community hospitals and critical access hospitals. These 
facilities have always been subject UPL regulations and will continue 
to be.
    Comment: One commenter recommended that non-profit nursing homes be 
included with the county owned or operated nursing homes for 
determining the UPL for these facilities.
    Response: Allowing non-profit nursing homes to be in the same 
aggregate group as county owned or operated nursing homes would still 
enable a State to set an excessively high payment rate for the county 
operated facilities, while paying the nonprofit facilities at a lower 
rate. This is not consistent with the statutory requirements that 
Medicaid payments promote economy and efficiency.
    Comment: One commenter asked for clarification on whether 
residential treatment facilities (psychiatric services to those under 
21, but not in a hospital) are subject to the UPLs since hospitals, NFs 
and ICF/MRs are. If residential treatment facilities are not included 
in these UPLs, the commenter asked us to specify the test for 
residential treatment centers. The commenter also asked if State and 
local government-owned residential treatment facilities would be 
subject to a separate upper limit test as a group.

[[Page 3153]]

    Response: The UPL regulations at Sec. 447.272 govern payments to 
inpatient ``hospitals and long term care facilities,'' which includes 
hospitals, nursing facilities, and intermediate care facilities for the 
mentally retarded. Residential treatment facilities are a separate type 
of institutional provider, which may furnish inpatient psychiatric 
services to individuals under age 21. Therefore, payments to these 
residential treatment facilities are governed by regulations at 
Sec. 447.325, ``Other inpatient and outpatient facility services: Upper 
Limits of Payment.'' This regulation permits a State to pay the 
customary charge of the provider, but not pay more than the prevailing 
charges in the locality for comparable services under comparable 
circumstances.
    Comment: One commenter recommended that HCFA provide clarification 
on the similarity of the terms ``a reasonable estimate of `` and 
``amount that can reasonably be estimated.''
    Response: These phrases are used interchangeably to describe the 
States' obligation to make a reasonable estimate under the UPL 
regulations and require no change in policy.
    Comment: Several commenters were concerned about State flexibility 
in calculating the UPL. Some commenters recommended that States have 
the ability to determine how UPLs will be applied on a State by State 
basis to take into account variations in the payment practices among 
State Medicaid programs. Commenters recommended giving States the 
flexibility to apply Medicare payment principles to make a reasonable 
estimate of what Medicare would pay for similar Medicaid services. 
These commenters believe that States should have the flexibility to 
consider either Medicare principles of reasonable cost or prospective 
payment principles in calculating the UPLs or any reasonable 
methodology for comparing payment under Medicare or Medicaid.
    Response: The new UPL regulations afford States some flexibility in 
calculating a reasonable estimate of what Medicare would have paid for 
Medicaid services. In formulating their own approach to computing the 
UPL, States have flexibility to use either Medicare principles of cost 
reimbursement or prospective payment systems as the foundation of their 
estimates. In this regulation, we are not changing the standards that 
we apply to the review of State estimates. While we generally provide 
guidance to States under the State plan review process, we intend to 
issue policy that will clarify approaches we have determined to be 
reasonable, and we will provide additional guidance to States on how to 
compute the UPLs.
    Comment: One commenter notes that the UPL could be calculated based 
on cost data, if available.
    Response: The current regulations at Secs. 447.272 and 447.321 
allow States to use Medicare payment principles to determine what 
Medicare would have paid for Medicaid services. States are allowed to 
continue to use cost data to determine what Medicare would have paid 
for services.
    Comment: Commenters suggested that the same elements of cost for 
Medicare and Medicaid should be included in both the actual payment and 
in the calculation of the UPL. States should have the flexibility to 
determine the content and method of those elements.
    Response: The Medicare payment principles used to calculate the UPL 
are not subject to change through this regulation. We intend to publish 
subsequent implementing policy documents that will clarify the 
calculation of the UPL.
    Comment: Commenters recommended that States should also have the 
flexibility to continue to reach a reasonable estimate based on the 
Medicare payment principles that reasonably relate to similar Medicaid 
services provided under comparable circumstances.
    Response: The UPL requires States to make a reasonable estimate 
based on Medicare payment principles. There are many factors and 
elements that States may consider to support their estimates. Using 
Medicare payment principles for services similar to Medicaid service is 
a permissible approach.
    Comment: One commenter recommended that payment shortfalls to 
hospitals and nursing facilities should be a factor in setting the UPL.
    Response: ``Shortfall'' generally refers to the difference between 
the cost of a service and the payment for the services. Shortfalls 
should not be a factor in setting or calculating the UPL because this 
limit is based on a reasonable estimate of what Medicare would have 
paid for the same services, and therefore, is unaffected by actual 
payments for services. However, because the UPL would allow States to 
set rates that fully cover the cost of Medicaid services, payments to 
cover Medicaid shortfalls would be allowable under the UPLs.
    Comment: One commenter recommended that the UPL should be revised 
when payments are on average, below reasonable economic and efficient 
standards. These added payments should then be utilized to underwrite 
programs that serve low-income individuals.
    Response: Section 1902(a)(30)(A) of the Act requires that payments 
for care and services under an approved State Medicaid plan be 
consistent with efficiency, economy, and quality of care. The new UPLs 
permit States to set facility-specific Medicaid rates that are based on 
costs determined reasonable under Medicare payment principles. 
Therefore, payments should not be below economic and efficiency 
standards.
    Comment: Several commenters recommended that HCFA clarify the 
definition of ``other government owned or operated'' facilities. 
Commenters recommended that the other government-owned or operated 
group should include hospitals that contract with local governments or 
have a high level of medical assistance or indigent care but are not 
owned or operated by the local government. One commenter recommended 
the following qualifying factors for other government owned or operated 
facilities: Local government may own assets, control a majority of the 
hospital's board or must sign off on any major changes in services, 
including expansions into another county. Another commenter recommended 
that States should have maximum flexibility in determining the 
applicability of 150 percent to other government owned or operated 
hospitals because hospitals may have a relationship with their local 
government that may fall outside of the current definition of owned or 
operated. Another commenter questioned if a State can own a facility 
and have a local government operate it and still receive the enhanced 
FFP. The commenter continued to question whether a local government can 
own and have a private contractor operate a facility and still receive 
the enhanced FFP.
    Response: We restructured Sec. 447.272(a) and 447.321(a) and 
included at paragraph (a)(2) of these sections, the category, ``non-
State government owned or operated facilities'' formerly ``other 
government-owned or operated facilities''. We specify that this 
category is limited to ``all government facilities that are neither 
owned nor operated by the State.'' Specifically, for purposes of this 
regulation, non-State government owned or operated facilities are 
government facilities, as defined by their ability to make direct or 
indirect intergovernmental transfer payments to the State, and for 
which the State does not assume primary ownership or legal liability 
for the operations of the facilities. Examples of the kinds of

[[Page 3154]]

facilities that fall into this category are county or city owned and 
operated facilities, quasi-independent hospital districts, and 
hospitals that are owned by local governments but operated by private 
companies through contractual arrangements with those local governments 
as long as the hospital retains the ability to make an IGT to the 
State.
    Comment: We received numerous comments on the language used to 
determine the State-operated facilities. Some commenters recommend that 
the rule be revised to read ``State owned and operated.'' One commenter 
wanted this language if the 150 percent limit was not extended to the 
State operated hospitals. One commenter further explains that if a 
hospital is State owned and county operated, the State could inflate 
the other government group by including the hospital in that group, yet 
not allow the hospital to receive more than 100 percent for the current 
State-owned or operated group. However, another commenter supported our 
rationale for keeping the categories of State and non-State owned 
hospitals separate and distinct. Some commenters recommended that we 
change the language to State owned, but not State operated because 
university hospitals that are State owned, but privately operated, may 
be put into a more restricted group.
    Response: We restructured the regulations at Secs. 447.272(a) and 
447.321(a) and added language to clarify that ``State government-owned 
or operated facilities'' are all facilities that are either owned or 
operated by the State. In making this revision, we intend to capture 
within this group, facilities that are owned by the State, but managed 
or operated by a local government or private company. We further intend 
to distinguish between State-owned or operated facilities and those 
owned or operated by non-State governments. The categories of State 
government operated and non-State government operated are mutually 
exclusive, and consequently facilities cannot be considered as part of 
more than one group when considering the calculation of the UPLs. In 
addition, as we stated earlier, facilities that qualify for both the 
State-government and non-State government categories must be put into 
the State government category.

The 150 Percent Upper Payment Limit for Non-State-Operated Public 
Hospitals--Secs. 447.272(b)(2) and 447.321(b)(2)

    In Secs. 447.272(b)(2) and 447.321(b)(2) of the proposed rule, we 
set forth provisions for a UPL of 150 percent of the reasonable 
estimate of what would have been paid under Medicare payment principles 
for inpatient and for outpatient hospital services provided in non-
State government hospitals. We explained that we were doing this so 
that the new limits being applied to these providers assured that they 
would remain in operation and continue to provide services to the 
Medicaid population. We solicited specific comment on whether the 150 
percent limit is appropriate. We received a significant number of 
comments in response to this proposal.

Support for 150 Percent UPL for Public Hospitals

    Comment: One commenter supports the separation of the other 
government providers from the overall aggregate cap and the 150 percent 
limit for these facilities. Other commenters indicated that the 150 
percent UPL in proposed paragraph (b)(2) of Secs. 447.272 and 447.321 
(now paragraph (c)(1) of Secs. 447.272 and 447.321) generally reflected 
a reasonable balance and response to the problem identified.
    Response: We appreciate the commenters' support for our provisions 
relating to the 150 percent UPL. Therefore, we will retain the 150 
percent provision in paragraph (c)(1) of Secs. 447.272 and 447.321.
    Comment: Some commenters support the 150 percent limit, but only if 
it does not cause a decrease in the aggregate limit for private 
facilities.
    Response: It was our intent in the proposed rule that these 
categories and UPL limits be separate. In this final rule, we have 
clarified that the 150 percent UPL for non-State government-operated 
hospitals is separate from the private hospital category and limit. We 
have restructured paragraph (a) of Secs. 447.272 and 447.321 to 
identify the different categories of facilities that furnish inpatient 
and outpatient services, respectively. Under the proposed rule, these 
categories included State government-owned or -operated and non-State 
government-owned or -operated facilities. In Secs. 447.272(a)(3) and 
447.321(a)(3) of this final rule, we added a third category for 
privately-owned and operated facilities.

Support for a Lower UPL Than 150 Percent for Public Hospitals

    Comment: Some commenters indicated that the 150 percent limit is 
not needed and that the limit should remain 100 percent for all groups. 
These commenters noted that hospitals would receive adequate 
reimbursement if they (1) retained 100 percent of the State and Federal 
shares of Medicaid payments up to this UPL and (2) received and 
retained 100 percent of the State and Federal shares of allowable DSH 
payments. Other commenters noted that there was no evidence that 
hospitals or patients benefited from the increased Federal funds that 
would be obtained from increasing the non-State government-owned or 
operated limit to 150 percent.
    Response: While we agree that there is no clear standard as to what 
UPL would suffice to assure that hospitals and patients benefit, we 
believe the 150 percent standard is reasonable. Given the special 
mission of these public hospitals and their important role in serving 
the Medicaid population, we think that the 150 percent UPL is 
justified.
    We also agree that hospitals should retain the entire amount of the 
State and federal payments they receive to cover the cost of providing 
services to Medicaid and indigent patients. While we have instituted 
reporting requirements as part of this final rule, it is not our intent 
to regulate intergovernmental transfers. Likewise, we have not changed 
the rules related to DSH funds. However, we have made every reasonable 
effort to assure that we pay these facilities only what is necessary to 
meet the demand for service for Medicaid individuals. We intend to 
monitor payments to these providers closely and may propose further 
refinements as we gain experience with the new UPLs. Should we find 
that the payments made under the higher limit are not being retained by 
hospitals to support Medicaid services, we would be open to making 
further revisions in subsequent rulemaking.
    Comment: One commenter noted that DSH funds should be used to fund 
non-State government-owned or operated hospitals rather than increase 
their UPL to 150 percent.
    Response: One of the primary functions of DSH payments is to help 
hospitals cover the costs of providing care to indigent patients. In 
establishing the 150 percent UPL for non-State-owned or operated public 
hospitals, we were careful to list those reasons that we believe 
entitled these facilities to receive higher payments than would 
otherwise be allowed. Although we realize there is an ancillary benefit 
that may cover the costs of providing uncompensated care in these 
facilities, that was not the reason for our decision to set a higher 
UPL for these providers. We were more concerned with assuring the 
continued existence and stability of these core providers who serve the 
Medicaid population.

[[Page 3155]]

    Under current law, States have broad discretion to allocate DSH 
funds among eligible providers and may redirect DSH funds to these 
facilities. However, some States that have replaced DSH funds that 
could have gone to public hospitals with UPL funds may not choose or be 
able to do so under existing DSH allotments. We have not proposed to 
change the rules related to DSH funds in this rule. We have made every 
reasonable effort to assure that we pay only those funds that are 
necessary to these facilities to meet the demand for service for 
Medicaid individuals.

Support for a Higher UPL for Public Hospitals

    Comment: A number of commenters recommended that the final 
regulation increase the 150 percent UPL to 175, 200, 250 percent or 
higher for non-State government-owned or operated facilities. While 
many of the commenters simply stated that the 150 percent limit is 
arbitrary and did not provide additional rationale for changing the 
limit, others did cite various reasons in support of increasing the UPL 
percentage. The reasons cited included the significant reductions in 
funding these providers will face as a result of the new limits, the 
amount of uncompensated care provided by these facilities, and the fact 
that the 150 percent limit does not adequately account for the amount 
of funds that these institutions will have to transfer back to State 
treasuries.
    Response: We are not persuaded that a UPL above 150 percent has 
been justified. We were aware in publishing the proposed rule that 
proper payment data were difficult to obtain and that those who could 
provide such data were reluctant to do so because it would disclose the 
transfer of the excessive payment amounts received by providers back to 
the State. Given that, our discussion with a wide range of groups led 
us to believe that the only group of providers that would suffer harm 
that would hinder their ability to serve the Medicaid population were 
non-State government-owned or -operated hospitals, even when they 
retain the full payment. Even then, it was not absolutely clear what 
level of funding would be needed to both meet these needs and, at the 
same time, curtail the practice of transferring enhanced payments back 
to State treasuries. Given limited data, we proposed a UPL for these 
facilities of 150 percent of a reasonable estimate of Medicare payment 
principles.
    In establishing this 150 percent UPL for non-State-owned or -
operated public hospitals, we were careful to list those reasons that 
we believe entitled these facilities to receive higher payments than 
would otherwise be allowed. Since public entities may be allowed to 
transfer payment back to States, we still have concerns as to whether 
these higher payments would, in fact, be retained by these hospitals to 
allow them to provide needed services to the Medicaid population. We 
are instituting reporting requirements in paragraph (d) of 
Secs. 447.272 and 447.321 that will allow us to monitor and track the 
distribution of these funds.
    Comment: Other commenters noted that a limit of 175 percent of the 
UPL would be consistent with the hospital specific cap of 175 percent 
of the hospitals uncompensated costs for the disproportionate share 
hospitals (DSH) limit allowed by the Congress for the State of 
California and that the Administration has expressed support for 
applying this DSH limit to other States.
    Response: The Administration has separately expressed its support 
for legislation raising the hospital specific cap to 175 percent of 
uncompensated costs for public hospitals. The Administration took this 
position to provide more flexibility in the States administration of 
DSH payments, but the 175 percent hospital specific cap for 
uncompensated costs for DSH was not our basis for establishing the 150 
percent UPL described in the proposed rule. While uncompensated care 
costs did not form the basis for establishing the 150 percent limit, we 
recognize that these UPL payments will offset both the Medicaid payment 
shortfall and the uninsured costs included in DSH payments. DSH and UPL 
continue to be separate payment policies. Therefore, in this final 
rule, we see no basis for applying the same percentages that the 
Administration supports for a different part of the Medicaid program.
    Comment: One commenter noted that the UPL should be set at 175 
percent and should not be lowered until a detailed analysis of the 
consequence of the higher threshold on the availability and access to 
health care services.
    Response: We do not agree. We were aware in publishing the proposed 
rule that proper payment data were difficult to obtain and that those 
who could provide such data were reluctant to do so because it would 
disclose the transfer of the excessive payment amounts received by 
providers back to the State. It was not clear what level of funding 
would be needed to both meet these needs and, at the same time, curtail 
the practice of transferring enhanced payments back to State 
treasuries. Given limited data, we proposed a UPL for these facilities 
of 150 percent of a reasonable estimate of Medicare payment principles. 
We are instituting reporting requirements in paragraph (d) of 
Secs. 447.272 and 447.321 that will allow us to monitor and track the 
distribution of these funds.

Non-Support: Discriminatory

    Comment: Many commenters indicated that application of the 150 
percent limit only to non-State government-owned or -operated hospitals 
is discriminatory. They note that HCFA has no basis for distinguishing 
between private, State, and non-State government-operated hospitals or 
between non-State government-owned or -operated hospitals and other 
non-State government-owned or operated providers such as nursing 
facilities and clinics or other providers that serve the same safety-
net provider role or serve the same patient populations as public 
hospitals, such as FQHCs and RHCs. Many commenters recommended that the 
eligibility criteria for the 150 percent limit should be broadened to 
include facilities that serve the same role or the same populations as 
public hospitals. Some of these commenters recommended specific 
criteria such as a Medicaid utilization rate that is equal to that of 
non-State government-operated hospitals in each State or the 11.75 
percent Medicaid utilization rate that is used by the 340B drug 
discount program of the Public Health Service Act.
    Response: We do not agree. Our discussions with a wide range of 
groups led us to believe that the only group of providers that both 
retained this money and would suffer harm that would hinder their 
ability to serve the Medicaid population were non-State government-
operated hospitals. In establishing this 150 percent UPL for non-State-
operated public hospitals, we were careful to list those reasons that 
we believe entitled these facilities to receive higher payments than 
would otherwise be allowed.
    Non-State government-operated hospitals serve a unique role that we 
do not believe would continue to be adequately funded if it were not 
reflected in Medicaid rates. State-operated hospitals generally have a 
larger tax base from which to fund uncompensated care and services. 
Moreover, State operated hospitals that provide inpatient hospital 
services have been operating under a 100 percent UPL for these services 
since 1987.
    We do not support the inclusion of public clinics, FQHCs or RHCs in 
the 150 percent category. Since these facilities are or can be paid at 
full cost,

[[Page 3156]]

we see no benefit to further inflating these payments. We believe their 
inclusion would only compound the problem of drawing down an inflated 
Federal payment in order to then transfer this overpayment back to the 
State. Moreover, Medicaid payments to FQHCs and RHCs are established in 
statute.
    While we agree that some private providers may also fulfill a 
safety-net health care need similar in circumstance to those we 
described for the non-State government operated hospitals, we do not 
believe that, as a general class, these private hospitals currently 
receive Medicaid payments that are at the 100 percent UPL level and see 
no basis for further raising that level to 150 percent.
    We appreciate the role that other non-State government operated 
facilities such as nursing facilities serve in the provision of health 
care. However, we do not believe that the circumstances described for 
NFs justify receiving the 150 percent UPL. Generally, indigent NF 
patients are Medicaid eligible or become Medicaid eligible and 
therefore the NF qualifies for Medicaid payment. In addition, NFs do 
not as a rule provide the kinds of high cost Medicaid support services 
that non-State government-owned or -operated hospitals provide. Thus, 
the financial factors affecting non-State government-owned or -operated 
hospitals do not equally affect NFs.
    We do not see the benefit of applying definitions of safety-net 
hospitals that are used for other purposes. We believe that while there 
may have been other reasonable alternatives to applying the 150 percent 
UPL to non-State government-operated hospitals, given the structure of 
the current regulations, the problem is most directly addressed by the 
application of the 150 percent UPL to these hospitals.
    Comment: Some commenters indicated that it is unfair to narrow the 
150 percent UPL to exclude NFs based on the prior performance of other 
State programs in returning this money to the State to serve other 
purposes.
    Response: As previously indicated, our criteria for excluding NFs 
from the 150 percent UPL is based on reasons other than the performance 
of other State programs.
    Comment: Some commenters indicated that we should ensure that all 
hospitals are appropriately compensated to higher payment limits for 
non-Medicaid, indigent care, regardless of their type.
    Response: We appreciate the commenters' concerns. However, as 
indicated previously, the financial burden of providing uncompensated 
care did not form the basis for our decision to set a higher UPL for 
non-State government-operated hospitals. Our discussion with a wide 
range of groups led us to believe that the only group of providers that 
both retained this money and would suffer harm that would hinder their 
ability to serve the Medicaid population were non-State government-
operated hospitals. Therefore, we believe that the DSH programs under 
Medicare and Medicaid, which are intended to help defray the costs of 
uncompensated care, are better suited to serve this purpose than a 
higher UPL for Medicaid payments.
    Comment: Commenters noted that the proposed rule was drafted so 
that access to the 150 percent UPL for hospital payments appeared to be 
tied to the phase out of existing excessive payment State plan 
amendment for hospitals. They assumed this to be in error noting that 
150 percent of the aggregate UPL would be available for non-State 
government-owned or -operated hospital services on the effective date 
of the rule.
    Response: The 150 percent UPL is not contingent upon the transition 
period. Given the proper supporting State plan methodologies, States 
will be able to pay these facilities up to the 150 percent UPL as of 
the effective date of this final rule.
    Comment: Commenters asked for confirmation that the 150 percent UPL 
would be available to all States upon submission of a State plan 
amendment (SPA) after the effective date of the final rule.
    Response: Federal financial participation will be available for all 
approved SPAs up to the 150 percent UPL for non-State government-owned 
or -operated hospital services with the effective date of this final 
rule.
    Comment: Some commenters noted that payment under the 150 percent 
UPL limit may exceed the provider's customary charges, as provided in 
Sec. 447.271 and that this was an additional limitation. The commenter 
proposed that we modify or abolish Sec. 447.271 so that charges do not 
limit payments under the 150 percent UPL.
    Response: Since this final rule would allow charges consistent with 
payment at the 150 percent UPL standard, we would interpret 
Sec. 447.271(b) regarding agency payment at a rate greater than its 
costs to be consistent with these final rules. Therefore, we do not 
believe that a change to this section of the regulations is necessary.
    Comment: One commenter noted that contrary to the statement on 
pages 60156 and 60157 of the proposed rule that suggested the 150 
percent UPL for non-State government-owned or operated facilities would 
prevent new proposals, in fact it would require a new SPA if the 
current State plan did not provide for payment up to that level.
    Response: To the extent that a State did not have a State plan 
authority to make payments at this level, a SPA would be needed to 
claim FFP at this level. However, the State could also continue payment 
at their current State plan approved rates that were otherwise in 
conformance with this final rule with no change in its State plan.
    Comment: One commenter indicated that States can not continue to 
fund private safety-net providers such as children's hospitals.
    Response: This final regulation does not make any changes that 
affect payments to children's hospitals or to non-public safety-net 
providers. States can continue to pay these providers rates necessary 
to cover the costs of care up to the aggregate limit for privately 
owned and operated providers. This regulation does assure that the 
Federal Government and the States each contribute their proper share of 
funding to these payments.
    Comment: One commenter stated that the preamble of the proposed 
rule does not distinguish between inpatient and outpatient hospital 
services when noting the role of safety-net hospitals.
    Response: Public safety-net hospitals provide both inpatient and 
outpatient services to large numbers of Medicaid, uninsured and other 
low-income populations. Additionally, these hospitals provide high cost 
community support services in both inpatient and outpatient settings. 
Because these higher cost services, as well as the uncompensated care 
burden these hospitals bear, are not confined to either inpatient or 
outpatient services, we believe it is appropriate for the higher rate 
(of 150 percent of what Medicare would have paid) to be applied to 
payments in both settings.

Managed Care

    The upper payment limits we proposed relate to fee-for-service 
Medicaid payments. However, we did receive many comments requesting 
clarification on how they might affect managed care arrangements.
    Comment: A number of commenters suggested that HCFA clarify the 
policy on how the proposed UPL will affect budget neutrality for 
section 1115 demonstration programs. One commenter recommended we 
further clarify the preamble language to the proposed rule that 
indicates that section 1115 expenditure ceilings would be adjusted to 
account for the effect of the

[[Page 3157]]

regulation. Others noted that the final rule should specify that the 
amount of any increased payments made for hospital services under the 
rule would be added to section 1115 expenditure ceilings. Another 
commenter stated that HCFA should reward States that voluntarily reduce 
their UPL program expenditures below the regulatory limits before the 
deadline by crediting the Federal savings toward the expenditure 
ceilings for section 1115 demonstration projects.
    Response: As we indicated in the preamble to the proposed rule, we 
will make adjustments to the budget ceilings for section 1115 
demonstration programs. These adjustments will be made in accordance 
with the terms and conditions governing each program. In general, these 
terms and conditions provide for adjustments whenever a change in law 
or regulation would affect State spending in the absence of the 
demonstration. To the extent that any State with a section 1115 
demonstration will experience a change in its spending under this final 
rule, we will adjust that State's budget ceiling accordingly. According 
to the terms and conditions governing most demonstrations, the change 
in the budget ceiling is effective upon the effective date of the new 
law or regulations. In order to determine whether they will be 
affected, States should examine their institutional payment provisions 
to determine how their spending will change under the final rule. If 
section 1115 States choose to comply with the new UPL before the end of 
the transition period, the funds that would have otherwise been paid to 
institutions during the transition period remain as savings under the 
waiver, and can be used in accordance with the terms and conditions of 
the waiver. Finally, because each section 1115 program has terms and 
conditions specifying how adjustments will be made, we do not agree 
with the commenters that these procedures need to be specified in 
regulation.
    Comment: Several commenters asked us to clarify whether the 
transition period specified in Secs. 447.272(b)(2) and 447.321(b)(1) of 
the proposed rule applies to States whose UPLs are set via a waiver 
program instead of a State plan amendment.
    Response: As indicated in our previous response, our general policy 
is to make adjustments whenever a change in law or regulations would 
affect State spending in the absence of the waiver. To determine when a 
waiver program would be affected, we would necessarily follow the same 
rules that apply to provider payments made under an approved State 
plan. Since those rules provide for a transition period subject to 
certain conditions, we would apply those same conditions to waiver 
programs to determine when they would be affected. For example, if 
excessive payments are currently being made and had been made before 
October 1, 1999 under a waiver program, then the earliest point the new 
UPLs would affect State spending would be the beginning of State FY 
2002.
    Comment: One commenter urged us to allow flexibility in how the 
UPLs for various types of providers will be calculated under waiver 
programs. In cases where a waiver changes the distribution of Medicaid 
payments among different types of facilities, this commenter 
recommended that the State be allowed to measure compliance with the 
new UPL according to how the payments would have been made in the 
absence of the waiver program.
    Response: We agree that there may be instances when States have 
used waiver programs to make system changes that result in shifting 
payments among different types of facilities, for example, from 
inpatient settings to ambulatory care settings. However, we do not 
agree that waiver programs should be exempted from compliance with 
these UPLs. When States shift patterns of care from inpatient settings 
to ambulatory care settings, the payment follows the service provision. 
The UPL for each set of institutions is calculated according to the 
services provided within those institutions. We believe that the 
Medicare cost principles allow States sufficient flexibility to pay 
each set of providers appropriately without a change in the regulation.
    Comment: Two commenters suggested that HCFA count managed care 
payments and services in the UPL. One of these commenters stated that 
implementation of the regulation should take into consideration the 
extent to which public hospitals participate in managed care. This 
commenter noted that public hospitals with a relatively high managed 
care line of business will receive little relief from this rule if 
managed care payments are excluded from the higher UPL, since the 
special rule would then apply to only a small portion of their 
caseload.
    Response: The UPL for institutional payments specified in this rule 
applies to fee-for-service payments. Managed care payments are subject 
to separate limits contained in Sec. 447.361. In considering the 
question of whether a single limit should apply to both fee for service 
and managed care payments, as the commenter suggests, we had to 
consider two separate issues. The first issue is whether having two 
limits inappropriately places providers at a disadvantage. As the 
commenter correctly points out, some providers have a great deal of 
managed care business and little or no fee for service business. 
However, we believe that providers have the ability and the incentive 
to negotiate appropriate rates with managed care organizations. The 
limit in Sec. 447.361 provides adequate flexibility for managed care 
organizations to pay appropriate rates. In addition, in the case of 
DSH, States will be required as of January 1, 2001 to consider managed 
care payment shortfalls when making disproportionate share payments. 
So, to the extent there may be shortfalls, the DSH payments should 
provide relief.
    The second issue we considered is whether having two separate 
limits may create situations where States may, either inadvertently or 
by design, make excessive payments to providers, both directly and 
through managed care organizations. We believe that as long as States 
cannot make separate or supplemental payments directly to providers for 
services that are included in managed care contracts, except as 
provided for in statute for disproportionate share hospitals and 
federally qualified health centers, this situation cannot occur. The 
prohibition against making direct payments to providers for services 
for which a State is already paying a managed care organization is 
contained in Sec. 434.57.
    Comment: Two commenters noted that the notice of proposed 
rulemaking appears to affect the ability of a State to claim all funds 
anticipated under Section 1115 Medicaid Demonstration Waiver. These 
commenters urged that the State be allowed to claim all funds, despite 
the new UPL regulation.
    Response: As noted above, we will make adjustments to the budget 
ceilings for Section 1115 demonstration programs in cases where State 
spending will be affected by the new UPLs. We do expect that in some 
cases, the new limits will prevent States from claiming all funding 
anticipated under their Section 1115 demonstration program. We 
encourage all Section 1115 States to review their payment methodologies 
to determine whether they will be affected. We will make every effort 
to work with States to ensure that services are not jeopardized as the 
appropriate adjustments are made.
    Comment: A number of commenters encouraged us to exclude payments 
made under Section 1115 or Section 1915(b) programs from the UPL 
calculation. One of these commenters noted that the UPL is not 
necessary as

[[Page 3158]]

a cost control measure, because waiver programs already have 
requirements (budget neutrality for Section 1115 programs and cost 
effectiveness for section 1915(b) programs designed to limit Federal 
exposure.
    Response: In many cases, waiver programs primarily involve managed 
care payments. As stated above, these managed care payments are not 
included in the UPL calculations. However, we realize that in some 
cases, waiver programs involve other types of payments to institutional 
providers, and these payments will be affected by this regulation. This 
regulation is intended to have the same effect whether the payments in 
question are contained in a State plan amendment or in a waiver. We do 
not agree with the commenter that payments made under waiver programs, 
other than managed care payments, should be excluded from the UPL 
calculation.
    Comment: One commenter noted that some States operate under waivers 
in which they receive lower disproportionate share hospital (DSH) 
payments in exchange for receiving higher non-DSH Medicaid payments. In 
these cases, the commenter recommended that the State be allowed to 
count the payments in question as DSH payments, thus exempting them 
from the UPL.
    Response: Although we are aware that some States have re-directed 
part of their DSH program to support Medicaid eligibility expansions, 
we do not believe it is necessary to exempt portions of institutional 
payments from the UPL to reflect this. To the extent the eligibility 
expansions increase institutions' medical utilization, the increased 
utilization should create a higher UPL according to the methodology 
contained within this rule. Since many eligibility expansions are done 
in the context of managed care, and managed care payments are exempt 
from the UPL, we do not believe that States will be disadvantaged in 
any way by this regulation.

Reporting Requirements

    As a condition for establishing a policy of higher UPLs for non-
State government-owned or operated hospitals, we announced in the 
preamble of the proposed rule, our intention to require payments to 
these hospitals be separately identified and reported to HCFA. The 
purpose of this requirement was to ensure the higher payments are 
appropriate and are being fully retained by hospitals. We believe the 
separate identification of these payments will be a necessary 
administrative tool to ensure the proper administration of the Medicaid 
program. We specifically solicited comments on the most suitable 
methods of reporting and accounting for these payments.
    Comment: We received comments suggesting that we expand on the 
reporting requirements. One commenter recommended that HCFA require the 
reporting of both intergovernmental transfer revenues (including 
certified public expenditures if they are used) and supplemental 
payments. This commenter believes this information is necessary to 
understand the extent to which funds are actually going to the health 
care providers or are being retained by health care providers. Other 
commenters noted that a requirement to report payments alone does not 
ensure local public hospitals retain Medicaid payments. All or portions 
of the payments could still be transferred back to the State treasury. 
Since all the new UPLs still permit pooling, albeit to a smaller 
degree, the commenters noted that within each class of providers, 
payments can still be transferred back to the State or diverted 
directly to non-Medicaid purposes. To remedy the deficiencies they 
mention, the commenters recommend that the final rule stipulate that 
payments to public providers, whether State or locally owned or 
operated, will be considered to breach the applicable UPLs unless they 
are retained by the public hospitals, or nursing homes to which they 
are paid and are used by those facilities to meet the costs of 
delivering services to Medicaid (and uninsured) patients. To implement 
this approach, one commenter recommended a certification process by 
which the State Medicaid director or the head of the single State 
agency certifies that the payments represent an expenditure for the 
cost of services furnished to Medicaid patients, which could be 
verified through audits.
    Response: We appreciate the input we received on the development of 
a reporting requirement. Our intent is to develop and enforce a 
reporting requirement that is not overly administratively burdensome on 
States or providers, yet sufficient to help us assess what payments are 
made to facilities in comparison to their UPL and, to the extent 
possible, ensure Medicaid payments are retained by providers to offset 
the costs they incur in furnishing covered services to Medicaid 
patients. After giving consideration to the above comments, we have 
decided not to require reporting of these data at this time. However, 
we reserve the right to require reporting of IGT data in the future. 
However, we do agree that a reporting process to identify facility 
specific payment as well as that facility's individual UPL would be 
appropriate. Therefore, we are adding new Secs. 447.272(f) and 
447.321(f) ``Reporting requirements'' to reflect the addition of a 
reporting process for Medicaid payments to non-State public providers 
and providers within the group of providers that exceed the UPL during 
the transition period on a facility specific basis. We believe this 
will help improve Federal oversight in this area. We will continue to 
give further consideration to additional reporting requirements 
suggestions in further policy guidance and may consult with States, 
providers, and other interested parties in developing them.
    Comment: Several commenters expressed opposition to any additional 
reporting requirements. While some commenters appreciated the intent 
behind this requirement, they believed it is neither practical nor 
appropriate for the Federal government to play such an involved role in 
determining how the State general revenues are appropriated and spent. 
These commenters believe that the current reporting requirements are 
sufficient. Other commenters indicated that this requirement was 
unnecessary and would be a costly burden on States and providers and 
asserted States should receive 90 percent enhanced Federal matching for 
compliance costs.
    Response: We disagree with the commenters that current reporting 
requirements are adequate. The Medicaid program is not a general 
revenue sharing program, but rather an individual entitlement program 
under which States make direct payments to health care providers or 
contracts with prepaid entities. Our interest is not in tracking 
general revenues, but Medicaid payments paid to Medicaid providers on 
behalf of Medicaid eligible individuals for Medicaid eligible services. 
Not only do we feel it is appropriate for us to collect information on 
provider payments, but we believe that it is necessary to ensure 
Federal matching dollars are appropriately expended. Further, we do not 
believe reporting the payments in the manner suggested would be overly 
burdensome as it will be generated either from claims payment data or 
UPL calculation data the State would have already performed as the 
basis of these payments. On the issue of the enhanced 90 percent 
Federal matching rate, the final rule makes no change to policy in that 
area. However, we do not believe that this reporting will generally 
require those activities that qualify for this enhanced match.

[[Page 3159]]

    Comment: We received several comments relating to the nature and 
substance of the reporting requirements. One commenter suggested the 
reporting requirement should be with respect to Medicaid expenditures 
at the State level. This commenter thought it would be reasonable for 
States to report expenditures based on the provider categories in the 
regulation. Another commenter recommended the reporting of enhanced 
payments to public hospitals on an annual basis similar to the 
reporting requirements for DSH payments.
    Response: We agree. Our intent is to develop and enforce a 
reporting requirement that is not administratively burdensome on States 
or providers, yet sufficient to help ensure Medicaid payments are 
retained by providers to offset the costs they incur in furnishing 
covered services to Medicaid patients. We believe that information at a 
provider specific level is needed to ensure the integrity of Medicaid 
payments. With respect to the timing, we think an annual basis is 
sufficient.
    Comment: Several commenters suggested that HCFA establish some type 
of monitoring program. Certain commenters wanted to ensure Federal 
funding is being used for Medicaid purposes and that funds are directed 
to the maintenance of the nation's safety-net hospitals, including 
children's hospitals. One commenter recommended setting up a task force 
to monitor the health care needs of populations in those States that 
have not used IGT funding to determine if Medicaid and other funding 
sources are adequate for States to meet the health care needs of their 
citizens.
    Response: We are always interested in developing more efficient and 
effective ways to administer the Medicaid program. As we indicated in 
our previous response, we intend to give consideration to any 
additional steps that may be necessary to ensure the Medicaid program 
fulfills its statutory purposes and solicit input from States, 
providers, and Medicaid patients. While we do not intend to go beyond a 
certification requirement at this time, we may issue additional policy 
guidance under our general authority to ensure the proper 
administration of the Medicaid program.
    Comment: One commenter stated HCFA must issue proposed rules 
without any specific reporting requirements and that reporting 
requirements ultimately adopted must have appropriate additional notice 
and comment rulemaking as required under the Administrative Procedures 
Act. The commenter stated that HCFA should issue a separate proposed 
rule for the reporting requirement.
    Response: We believe the commenter is referring to the Paperwork 
Reduction Act. We will publish a separate notice in the Federal 
Register and provide a 30-day comment period. Further details regarding 
this process are found in section VI of the preamble, ``Collection of 
information--reporting requirements'.
    Comment: Several commenters felt that the transition period should 
be more stringent unless the excess payments permitted during the 
period are linked to the provision of health care service.
    Response: We agree that payments above the new UPLs that are 
permissible during the transition period should be subject to a 
reporting requirement. We, therefore, will extend the reporting 
requirements to States as a condition of receiving the transition 
period.

Indian Health Service

    We proposed in Sec. 447.272(b)(2) that Indian Health Service (IHS) 
and tribal hospitals funded under the Indian Self-Determination and 
Education Assistance Act (Pub. L. 93-638) would not be subject to the 
UPLs. We received comments regarding the impact of this regulation on 
these entities. A number of these commenters recommend that these IHS 
and tribal hospitals be considered public for the purpose of applying 
the 150 percent UPL. A few commenters indicated concern regarding how 
the shift in funding will affect rates paid to these facilities. In 
response to these comments, we have revised the regulation to clarify 
that these facilities will not be subject to these aggregated UPLs. 
Instead, these facilities are subject to payment limits in 
Sec. 447.325.
    Comment: One commenter recommended that non-State owned public 
nursing facilities located in close proximity to Indian reservations 
should be included in the 150 percent category.
    Response: We do not believe that the circumstances described for 
NFs justify receiving the 150 percent UPL. Generally, indigent NF 
patients are Medicaid eligible or become Medicaid eligible and 
therefore the NF qualifies for Medicaid payment. Thus, the financial 
factors affecting non-State government-operated hospitals do not 
equally affect NFs.
    Comment: One commenter indicated that it is not clear what, if any, 
UPL would apply to Pub. L. 93-638 tribal hospitals. Another suggested 
that we expand the exclusion at Sec. 447.272(b)(2) to include all 
facilities owned or operated by American Indian tribes.
    Response: We generally agree with this comment. We have 
restructured paragraph (c) of Secs. 447.272 and 447.321 to exclude IHS 
and tribal facilities that are funded under Pub. L. 93-638 from the 
UPLs. Instead, these facilities will be subject to the payment limits 
at Sec. 447.325.
    Comment: One commenter indicated that Pub. L. 93-638 tribal 
hospitals should be included as public hospitals.
    Response: We disagree with this comment. The Federal Government 
maintains a government to government relationship with the tribes. 
Accordingly, we do not believe these hospitals should be included in 
either the State government or non-State government pools. Including 
them as public facilities within the UPLs may enable States to set 
lower payments for the IHS and tribal facilities, and set payments for 
government operated providers at higher levels and still comply with 
the aggregate UPLs. Therefore, to avoid these types of incentives, we 
have excluded IHS facilities from the UPLs.
    Comment: One commenter indicated that tribal hospitals serve all 
residents of their region and, in most regions, are the sole health 
care providers. The commenter stated that not only are tribal hospitals 
funded at an amount too low to fulfill their mandate, but the OMB-
negotiated rates are less than rates paid to other public hospitals. 
This commenter also indicated that authorization to make additional 
payments to Pub. L. 93-638 hospitals as public facilities is in the 
best interest of improving access to health care for the rural Medicaid 
population.
    Response: We recognize that tribal facilities, especially 
hospitals, may serve as sole providers in rural communities throughout 
the country. We do not agree that the inpatient per diem and outpatient 
per visit rates are necessarily insufficient. These rates are 
calculated at the full cost of providing Medicaid services under 
Medicare payment principles. While other public hospitals may be paid 
more than IHS hospitals in some instances, this issue may be 
appropriately addressed in public procedures for State ratesetting 
required by section 1902(a)(13) of the Act.
    Also, as noted earlier, it would not be beneficial to the tribal 
facility to be identified as a public provider (government-operated). 
Including tribal facilities as a public provider may cause a reduction 
in payments to the tribal providers so States can shift these amounts 
to their own government facilities within the aggregate UPL.

[[Page 3160]]

Disproportionate Share Hospitals

    Section 1902(a)(13)(A) of the Act requires that, in the case of 
hospitals, payment rates take into account (in a manner consistent with 
the disproportionate share hospital requirements in section 1923 of the 
Act), the situation of hospitals which serve a disproportionate number 
of low-income patients with special needs. We have received comments 
regarding the disproportionate share hospital (DSH) program and its 
relationship to the application of the revised UPLs.
    Comment: Several commenters recommended that the regulation be 
delayed, coordinated with, or made contingent upon, the enactment of 
legislation that will increase the Statewide DSH caps and increase the 
facility-specific DSH caps. Some commenters suggested that the 
regulation be made contingent upon enactment of legislation that will 
increase the facility-specific DSH caps, as long as the legislation 
requires that DSH payments be used for hospitals and IGTs. Another 
commenter recommended that the implementation of the regulation be 
delayed until Congress has the opportunity for careful consideration of 
modification of the DSH legislation.
    Response: The BIPA requires that we publish this final rule by 
December 31, 2000. This same law provides for increases to the State 
DSH allotments (including for extremely low DSH States) and an increase 
in the hospital-specific DSH limits for public hospitals for a 2-year 
period. The effective date of the increase in DSH allotments coincides 
with the date that this final regulation is published in the Federal 
Register. The increase in hospital-specific DSH limits for public 
hospitals for a 2-year period that begins with the State fiscal year 
beginning after September 30, 2002.
    Comment: One commenter suggested that all payments to DSHs be 
exempt from the UPL regulations.
    Response: We disagree with this comment. While Medicaid DSH 
payments to these hospitals have been and remain exempt from UPLs, 
Medicaid services payments to these same hospitals have always been 
subject to the UPLs. Medicaid services payments are made only on behalf 
of Medicaid eligible individuals, and are subject to the efficiency and 
economy requirements in section 1902(a)(30) of the Act. Since the upper 
limits permit States to set reasonable rates for Medicaid services, we 
do believe it is necessary to exempt payments made to a DSH facility on 
behalf of a Medicaid eligible individual.
    Comment: Two commenters indicated that the rule should be modified 
to reflect the special needs of low-DSH allotment States.
    Response: The UPLs established in this regulation are caps placed 
on the amount of Medicaid payments States can make to groups of 
providers for services obtained by Medicaid eligible individuals. The 
limits do not impact the availability of Federal funds States may use 
for the payment of Medicaid DSH expenditures.
    The BIPA provides extremely low DSH States with increases to their 
DSH allotments.
    Comment: One commenter noted that DSH funding should be increased 
by statutory revisions instead of by the 150 percent UPL since DSH 
expenditures are for uncompensated care.
    Response: As noted, recently passed legislation increased 
individual public hospital-specific (uncompensated care cost) limits 
under the DSH program. However, we realize some States and public 
hospitals have come to rely on the funds generated through the enhanced 
program payments. While we agree with this comment to a degree, we 
believe the 150 percent UPL provides an appropriate balance between our 
objective to reduce excessive payments and to allow States flexibility 
to target payments to under-funded hospitals.
    Comment: One commenter indicated that we should amend the proposed 
rule to include an exception to allow ``proportionate share'' payments 
of FFP up to the DSH cap if funds are dedicated or restricted to 
medical services coverage for low-income uninsured individuals in those 
States where the total of all disproportionate share payments does not 
exceed the State's DSH limit.
    Response: A link between the DSH payments and services would 
require a statutory change that would mandate that DSH payments be paid 
for specific services. The disproportionate share hospital program was 
created by Congress to allow States to make provider-specific payments 
to Medicaid providers that treat a disproportionately high number of 
Medicaid and low-income patients. DSH payments are not linked to 
specific patient claims or services. Therefore, we do not have 
authority to link DSH payments to specific services without a statutory 
change.
    Comment: One commenter indicated that the preamble of the proposed 
rule fails to explain why the DSH program, which provides funds for 
hospitals that serve low income patients with special needs, is 
inadequate to this task, thus justifying the 150 percent limit to make 
room for an additional funding stream.
    Response: Our intent in establishing these new limits is to reduce 
excessive payments that some States make to certain government operated 
health care facilities. In light of financial pressures facing 
government-operated hospitals, we believe a higher limit is appropriate 
to ensure Medicaid eligible individuals will continue to have adequate 
access to the health care services they provide.

Transition Periods for States That Have Approved Rate Enhancement 
State Plan Amendments Secs. 447.272(b)(2)(i), (ii) and 
447.321(b)(1)(i), (ii)

    We recognize that immediate implementation of these new upper 
payment limits could disrupt State budget arrangements for States that 
have relied on funding obtained from approved rate enhancement State 
plan amendments (SPAs). Therefore, in the October 10, 2000 proposed 
rule, we included a transition policy for States with approved rate 
enhancement methodologies that would be affected by the proposed upper 
payment limits (65 FR 60151).
    We had proposed two transition periods, which States may qualify 
for based on the effective date of the State plan amendment that 
provided for excessive payments. For approved amendments with an 
effective date on or after October 1, 1999, we proposed a transition 
period that would end on September 30, 2002. At the end of this period, 
Medicaid payments to governmental providers would have to stay within 
the new UPLs. We proposed a longer transition period for States with 
approved amendments that were effective prior to October 1, 1999. For 
these States, we proposed a 3-year phase down to the new UPLs beginning 
in the first full State fiscal year (FY) that begins calendar year 
2002. During the 3-year phase down, States would be required to 
determine the amount of payment in excess of the proposed UPLs and 
gradually reduce this amount in 25 percent increments. We solicited 
comments on the material elements of these transition periods, 
including the starting point for the phase-out, the percentage 
reduction each year, and the appropriate transition period.
    Congress passed the BIPA, which requires that we publish this final 
rule by December 31, 2000. Section 705(b) of BIPA provides for a 
transition period for States with a State Medicaid payment provision or 
methodology that meets both of the following criteria:
    1. It was approved, deemed to have been approved, or was in effect 
on or

[[Page 3161]]

before October 1, 1992 (including any subsequent amendments or 
successor provisions or methodologies and whether or not a State plan 
amendment was made to carry out such provision or methodology after 
such date) or under which claims for Federal financial participation 
were filed and paid on or before such date.
    2. It provides for payments that are in excess of the upper payment 
limit test established under this final rule (or which would be 
noncompliant with this final rule if the actual dollar payment levels 
made under the payment provision or methodology in the State fiscal 
year that begins during 1999 were continued).
    Comment: Many commenters expressed support for any transition 
period to re-adjust State budget plans impacted by the new UPLs. Other 
commenters indicated that the two tiered approach in Secs. 447.272(a) 
and 447.321(a) seemed reasonable and should allow ample time for non-
compliant States to bring their plans into compliance.
    Response: We appreciate the commenters' support. We agree that the 
amount of time permitted under the transition period is sufficient for 
States to come into compliance with the UPLs.
    Comment: Several commenters opposed providing a longer transition 
period to States that have amendments in effect prior to October 1, 
1999. These commenters felt that the 2-year or shorter period was 
sufficient time for all States to bring their spending into compliance 
with the proposed regulations. Two commenters argued that avoiding 
disruption of States budget arrangements is not the purpose of Federal 
Medicaid matching payments nor the Secretary's duty under Federal 
Medicaid law. The 5-year transition simply rewards States that drew 
down more Federal funds than those States that followed statutory 
rules. These commenters were also critical of the 5-year transition 
period because it would be granted to every qualifying State regardless 
of financial circumstances. In support of this position, the commenters 
cited information indicating the financial health of most States is 
good and combined State balances totaled $21.2 billion in FY 2000.
    Response: While we agree with these comments in principle, we 
believe it is appropriate to phase-in the new UPLs over the timeframes 
described in the proposed rule. As addressed elsewhere in the preamble, 
States, providers, and beneficiaries expressed concern over how the 
application of the upper limits would impact Medicaid access and 
quality of care. We believe that the time permitted in the proposed 
rule is reasonable and balances the need to protect the fiscal 
integrity of the Medicaid program with State budget issues.
    Comment: We received many comments that recommended a longer 
transition period ranging from 6 to 10 years instead of our proposal 
for the 2 and 5 year transition period specified in the proposed rule. 
Some of the comments were State specific and others suggested that the 
8-year transition period in HR 2614 (later enacted as BIPA), 
legislation pending in the House should form the basis for an extended 
transition period. Others suggested the length of the transition period 
should be proportional to the length of time the payment arrangement 
had been in effect or extended if economic conditions worsen.
    Response: We believe that the time permitted by our transition 
periods is sufficient and balances the need to protect the integrity of 
the Medicaid program and addresses State budget issues. Our paramount 
interest in issuing these regulations is to preserve the integrity of 
the Medicaid program. Under section 1903(a) of the Social Security Act, 
States are required to fund their share (in accordance with a statutory 
formula) of Medicaid covered health care services furnished to eligible 
individuals. In recognition that States may have diverted Federal 
matching funds for other purposes, whether health-related or not, we 
provided a transition period which would allow all States who qualify 
for a transition period to have at least one legislative session before 
SPAs would have to comply with the new upper limits. We also note that 
in passing section 705 of BIPA, Congress provided a longer transition 
period for States only with excessive payment methodologies in effect 
or approved on or before October 1, 1992. We believe that if Congress 
wanted all States to have an 8-year transition period as provided for 
in BIPA, they would have done so.
    Comment: Many commenters expressed opposition to having different 
transition periods based on the effective date of an SPA. In addition, 
commenters recommended that all affected States have the 5-year 
transition period. One commenter suggested that our basis of 
``reasonable reliance'' on the funds is flawed. This commenter 
indicated that the length of time that these revenues have been 
available to a State is not an indication of the importance of these 
dollars. This commenter also did not believe a distinction could be 
made between affirmatively approved amendments and deemed approved 
amendments. Other commenters criticized the distinction because in 
their view the only difference is the timing of when States choose to 
submit amendments under current regulations.
    Response: We do not agree. We note that all amendments with an 
effective date of October 1, 1999 or later were ``deemed approved'' 
rather than affirmatively approved. The decision to let these SPAs 
lapse into approval was intended to avoid any appearance of 
ratification of these SPAs, and in response to an increase in the 
number and dollar magnitude of new plan submissions. This decision was 
consistent with our goal to address the loophole in existing UPL 
regulations. Depending on State response times to requests for 
additional information, the time between initial submission and 
eventual ``approval'' could take as long as 9 months. We made it clear 
to States whose SPAs were deemed approved after October 1, 1999, that 
we intended to change the regulation, and therefore, put them on notice 
that they could not permanently rely on the additional Federal dollars 
generated through these mechanisms. However, States with SPAs approved 
prior to October 1, 1999 were not aware of our intention to change the 
regulations related to UPL. The reliance concept is applicable because 
these funds have been built into State and provider budgets for longer 
periods of time. We note also that in enacting a third transition 
period for States with excessive payment methodologies in place on or 
before October 1, 1992, the Congress has ratified our approach to 
establish transition periods based on a ``reliance concept.''
    Comment: Some commenters expressed concern that the 2-year phase-in 
period is too rapid and does not provide adequate time for State 
legislatures and Medicaid programs to prepare for the immediate and 
long range budgetary consequences they will confront as a result of the 
rule. One commenter felt that logistical barriers should compel us to 
reexamine the reasonableness of the timeframes it has presented for 
States to come into compliance with the rule. The commenter pointed out 
that 23 States have biennial budgets that have already been 
established, 13 States have legislatures that meet for short periods of 
time, and some States do not have full time legislatures who could 
timely respond within the proposed transition periods.
    Response: We did not find these comments to be persuasive. States 
with biennial budgets would be able to amend their budgets in the 
interim

[[Page 3162]]

legislative session. We also note that all amendments with an effective 
date of October 1, 1999 or later were ``deemed approved'' rather than 
affirmatively approved. The decision to let these SPAs lapse into 
approval was intentional and in response to an increase in the number 
and dollar magnitude of new plan submissions. This decision was 
consistent with our goal to address the loophole in existing UPL 
regulations. As indicated in the proposed rule, during the review of 
these amendments, we informed States of our intent to curtail excessive 
payments and advised the States not to rely on the continuation of this 
funding. Therefore, these States should have made contingency financing 
plans for important programs funded with these enhanced payments, 
knowing that we intended to curtail them as soon as possible. We again 
note that the Congress recently considered our transition periods in 
passing section 705 of BIPA. By requiring us to add a third transition 
period for States with methodologies approved or effective before 
October 1, 1992, Congress has affirmed our transition periods for other 
States.
    Comment: One commenter suggested it would be more appropriate to 
change the scope of the 2-year transition period to make it applicable 
to State plan amendments effective on or after October, 1999, and 
submitted before the effective date of the final regulation. The 
commenter indicated that the date of State plan approval by HCFA is not 
within the control of States and suggests the possibility of two States 
submitting equally acceptable amendments on the same date and having 
them approved by HCFA on different dates.
    Response: We do not agree with this comment. Once the final 
regulations are issued, we will rely on them to review State plan 
amendments and will disapprove amendments that do not comply with them. 
We also note that we have followed a uniform practice that treats all 
States equally in reviewing these amendments. Thus, we do not believe 
there is a possibility of different approval dates for two States with 
equally acceptable amendments submitted on the same date.
    Comment: Several commenters requested that this transition policy 
be revised to clarify that approved amendments with an effective date 
prior to October 1, 1999, but later amended or renewed after October 1, 
1999, qualify for the extended transition period.
    Response: We agree that the transition policy as stated in the 
proposed rule is unclear with respect to States that annually renew or 
amend their rate methodologies that direct excessive payments to public 
non-State government providers. If a State had an approved amendment in 
effect prior to October 1, 1999 and amended or renewed that authority 
after October 1, 1999, the State would appear to qualify for two 
transition periods. In these cases where a State meets the requirements 
to qualify for more than one transition period, our policy is to give 
that State flexibility to decide which transition period to select. 
Because we have clarified this in the preamble, we do not believe we 
need to amend the regulation text.

Technical Clarifications on Transition and Base Year Issues

    Comment: Several commenters felt the base year amount should be 
adjusted to reflect annual changes in the Nursing Facility Market 
Basket Inflation Index and to recognize Balanced Budget Act (BBA) 
``give back'' dollars currently under consideration by the Congress.
    Response: We disagree. These types of adjustments would not impact 
the base year, but instead would be taken into account when making the 
UPL calculation in the year it occurs. For instance, if the excessive 
payment to be phased down is $100 million, that number stays constant, 
and a different percentage (that is, 75, 50, 25) is applied to it each 
year. Over this period of time, the cost of services furnished by 
providers may increase, or the amount Medicare may pay may increase for 
the reasons cited by the commenter. The effect of these increases would 
be to raise the UPL for services in the year they are furnished.
    Comment: A commenter recommended that each State should be able to 
properly reflect any increases that occur in Medicare Skilled Nursing 
Facility Prospective Payment System rates during the course of the 
State FY 2000 in its UPL base period calculations. The commenter 
further recommended that States should be given additional time to 
utilize patient assessments and other data from FY 2000 to more 
precisely re-estimate their FY 2000 UPL for nursing facility services, 
even if these data are not available until after State FY 2000.
    Response: In computing UPLs, we require State estimates to be 
reasonable. With respect to the changing nature of Medicare payment 
systems, in previous refinements to UPL regulations, we issued guidance 
to States indicating that they must use Medicare payment principles in 
effect during the same period the services were furnished. We have also 
advised that States must take into account program differences, such as 
non-covered services or acuity levels that might overstate the 
estimate. These policies permit States flexibility to make refinements 
to Medicare payment systems that were in effect during State FY 2000.
    Comment: The same commenter was also concerned that each State's 
UPL estimate for State FY 2000, which determines the ``excess'' 
payments that will be phased-out, may not reflect any further change to 
the SNF PPS methodology that occur after State FY 2000. The commenter 
asked how a State using SNF PPS to compute its estimate will be able to 
receive a credit for increases in Medicare rates and a commensurate 
reduction in the excessive payments. The commenter suggests that an 
equitable approach would permit the State to factor any change in 
Medicare rates into the calculation of excess payments on an ongoing 
basis.
    Response: Our current policy permits and, in some cases, requires 
States to factor Medicare payment changes into their UPL estimates on 
an ongoing basis. However, these types of changes would not impact the 
base period ``excessive payment'' computation. Instead, they would 
affect the UPL calculations in the year services were furnished. If the 
affect of Medicare payment changes were to increase the UPL for 
services furnished in State FY 2003, then once the UPL amount was 
determined for that year, 75 percent of the base period excessive 
payment would be added to that amount.
    Comment: A commenter noted that the proposed rule differentiates 
between State and non-State government facilities and felt that to be 
consistent, the calculation of the base period and subsequent 
transition period payments should also exclude State owned and operated 
facilities.
    Response: The base calculation is derived by comparing actual 
Medicaid payments paid to all providers to the maximum amount allowed 
under the applicable new UPL for services furnished during State FY 
2000.
    Comment: One commenter asked for clarification of ``State fiscal 
year'' with respect to the base period. The commenter believes the 
proposed rule is ambiguous because the phase-out period is described to 
begin in the State FY that begins in calendar year (CY) 2002. The 
commenter requested that we confirm that the ``State fiscal year 2000'' 
is the State FY year that begins in CY 2000. Another commenter urged 
that base year excessive payment computation be based on the State FY 
between 2000 and 2003 in which the highest amount of payment was made.

[[Page 3163]]

    Response: We did not intend any ambiguity nor do we believe the 
proposed rule is ambiguous with respect to the base period. In the 
discussion of the base period calculation, the proposed rule clearly 
indicates the services and payments for such services in State FY year 
2000 shall be used to compute the excessive payment. In this instance, 
we are referring to the State FY that ends in calendar year 2000 since 
this year would commonly be understood and referred to as State FY 
2000. We are maintaining State FY 2000 as the base period for the 
purpose of computing the phase down amount. This year was selected 
because it represents the last complete State FY prior to this rule 
change.
    Comment: Several commenters indicated that the text of 
Sec. 447.272(b)(2)(iii) as proposed, limits payments to the lower of 
the base State FY 2000 payments or the limit based on the reduction 
schedule. Commenters stated that this restriction could result in a 
lower transition payment than that which would be available in the 
absence of the transition provisions. This requirement also appears in 
Sec. 447.321(b)(1)(iii) and (b)(2)(iii). Commenters recommended that 
the reference to ``base State FY 2000 payments'' be deleted from each 
regulation.
    Response: While we have included generous transition periods, we do 
not think it is appropriate to permit States to make payments that 
would further increase the amount of payment that is in excess of the 
new UPLs. We have revised the text of the transition provisions in 
Secs. 447.272(e) and 447.321(e) to make this clarification. We have 
also extended this policy to all transition periods.
    Comment: Many commenters suggested alternative starting points for 
this transition period. Several commenters recommended that the start 
point of the 3-year ``phase down'' period begin with the start of 
Federal FY 2003 rather than in the State FY that begins in CY 2002. 
These commenters pointed out that this change would ensure all States 
that qualify for this transition period receive the same amount of time 
to come into full compliance with the new UPLs. They also noted that 
this change would extend the same ``hold harmless'' protection afforded 
States in the shorter transition period.
    Response: Because the additional time permitted under the longer 
transition period is based on State fiscal years, we realize that some 
long transition States may have to begin to comply with the 25 percent 
reduction schedule before the expiration of the shorter transition 
period. However, we would not expect this result to create any 
hardships since the longer transition period will permit, at a minimum, 
30 extra months to make payments at higher levels that would have been 
permitted under the shorter transition period. We note that the use of 
State fiscal years is consistent with the Congressional implementation 
of facility specific disproportionate share hospital payment limits, 
except that we have provided States with considerably more time to come 
into full compliance.

General Comments

    Comment: Several commenters asked that we clarify that payments for 
clinic services will receive the same transition period as public 
hospital services.
    Response: The same transition periods apply equally to each of the 
five Medicaid services that are subject to the new UPLs. Should 
Medicaid payments for nursing facility or clinic services exceed the 
maximum permitted under the new UPLs, the State would be afforded the 
applicable ``transition periods'' set forth in Secs. 447.272(e) or 
447.321(e).
    Comment: One commenter indicated that a transition protection 
should be available in any transition year in which a State would 
otherwise exceed the applicable limit. While the proposed rule extends 
the transition periods to States with rate enhancements that would be 
impacted by the new UPLs, the commenter believed that the proposed rule 
was ambiguous with respect to when the rate enhancement arrangement is 
to be determined non-compliant for the purpose of receiving the benefit 
of a transition period. The commenter asserts that the preamble to the 
proposed rule suggests that the relevant period for determining non-
compliance is State FY 1999-2000. Assuming this is the case, the 
commenter believes that freezing the determination of non-compliance to 
a particular year inappropriately denies transition assistance to 
States that have not taken full advantage of UPL flexibility. The 
transition rules were apparently designed to phase-down those States 
that would substantially exceed the new UPL. The commenter feels that 
the transition provisions fail to provide protection to States that may 
exceed the new UPL during the transition because of factors beyond 
their control, even though they were compliant during the base year. 
Because payment levels in such a State can vary due to a number of 
factors, such as increase in Medicaid enrollment, the commenter 
recommends that the determination of eligibility for a transition rule 
should be made on a current period basis.
    Response: A transition period is available to States that have 
approved methodologies that result in provider payments that exceed the 
new UPLs at the time of this rule change. If the payments result from 
an approved State plan methodology that was effective on or after 
October 1, 1999, the State would be eligible for the abbreviated 
transition period. If the payments result from an approved State plan 
methodology that was in effect prior to October 1, 1999, the State 
would qualify for one of the extended transition periods, depending on 
when the State plan methodology was effective or approved. The 
commenter is correct in that State FY 2000 is the relevant period for 
determining the excessive payment amount that will be factored into a 
longer transition period.
    Comment: In phasing out a payment methodology during a particular 
transition period, a commenter asked if we will require new State plan 
amendments to effect reductions in payment, or will we consider 
compliance with the regulation, such as applying the percentage in the 
regulation to the last approved State plan amendment sufficient without 
a new State plan amendment.
    Response: Given the diverse nature of UPL State plan amendments, it 
is difficult to describe a single action that would be appropriate in 
all cases. States are required under 42 CFR 430.12(c) to reflect 
changes in Federal law, regulations, policy interpretations or court 
decisions. We anticipate States, in many cases, will need to change 
their payment methodologies in order to reduce payments to levels that 
comply with the new UPLs and ceilings during the transition period. 
Under Sec. 447.257 and Sec. 447.304, we provide disallowance authority 
to the extent that States do not submit conforming State plan 
amendments. We encourage affected States to contact their HCFA Regional 
Office for guidance specific to their situation.
    Comment: The proposed UPL rule suggests that the transition period 
for States are applicable only to the new category: other government-
owned or operated hospitals. The preamble, however, describes these 
transition periods as applicable to the entire State program. The 
commenter recommends clarification of the transition periods' 
applicability consistent with the preamble.
    Response: The transition provisions apply to approved amendments 
and/or waivers that result in rate enhancements that exceed the new 
UPLs in a particular

[[Page 3164]]

State. In addition, in the case of outpatient hospital services and 
clinic services, a new UPL applies to State government-owned or 
operated and non-State-government owned or operated facilities. 
Although States make payments to all provider types such as inpatient 
hospital, nursing facilities, and clinics, the transition provision 
would only apply to those payment arrangements that result in payments 
that exceed the new UPLs. Under a State's Medicaid program, for 
example, should State payments only to State NFs exceed the new UPLs, 
the State would be eligible only for the transition period relating to 
NF services, and not the other service categories that are subject to 
new UPLs.
    Comment: We received numerous comments recommending that we 
grandfather existing UPL enhanced payment proposals. These comments 
suggested various bases for selection, for example, on approval as of a 
specific point in time, length of time a program had been operating, or 
other qualifying factors such as compliance with a maintenance of 
effort provision or extremely low DSH spending.
    Response: Our intent in issuing these new UPLs is to ensure States 
set provider payments rates that are consistent with efficiency and 
economy and made in accordance with section 1903(a) of the Social 
Security Act. We believe this is necessary to preserve the integrity of 
the Medicaid program. Any type of grandfather solution would 
effectively result in the permanent continuation of the payment 
arrangements that necessitated the issuance of these new payment limits 
and therefore would not be an effective policy in preserving the 
integrity of the Medicaid program. We also believe that a grandfather 
policy would be arbitrary and capricious and would not withstand legal 
challenge. Such targeted relief to specific States or groups of States 
would need to be addressed legislatively.
    Comment: Some commenters suggested that the final regulation 
include a list of States affected by the regulation and which 
transition the State qualifies for.
    Response: On an individual basis, we plan to work with those States 
affected by the new UPLs.
    Comment: A few commenters requested clarification of how amendments 
submitted after the effective date of the regulation would be treated.
    Response: An amendment that would result in payments that exceed an 
applicable UPL would be disapproved.
    Comment: A commenter indicated that States wishing to convert to 
the new UPL should be permitted to do so at any time during the 
transition period. This would allow States to submit new UPL 
transactions based upon the final rule.
    Response: States that would otherwise qualify for a transition 
period are free to adjust payments to comply with the new UPLs at any 
time prior to the expiration of the transition period.
    Comment: Many commenters urged us to approve pending applications 
in their State, or in all States before finalizing the rule.
    Response: We have given all States ample notice of our position 
that these programs are abusive and of our intent to publish this 
regulation to curtail such programs. To affirmatively approve pending 
applications would be counterproductive to our purpose of preserving 
the fiscal integrity of the Medicaid program.

Intergovernmental Transfers

    Although the UPLs we proposed do not regulate IGTs, we received 
many comments related to States' flexibility to use them.

States Ability To Use IGTs

    Comment: Several commenters stated that the IGT program is legal 
and they also pointed out that the abuses cited in the proposed rule 
were approved by HCFA. They indicated that there is a long history of 
using such financing mechanisms to offset the increased cost of Federal 
initiatives and unfunded mandates. They believe we are focusing too 
narrowly and should be looking at overall Medicaid funding needs.
    Response: This regulation does not eliminate the use of IGTs. 
States and the Federal government share the responsibility of financing 
the Medicaid program. IGTs are a financing mechanism States can use to 
help fund their share of allowable program expenditures. Under the 
Medicaid statute, up to 60 percent of State funding may come from local 
public resources. States, counties, and cities have developed their own 
unique arrangements for sharing in Medicaid costs. IGTs have their own 
statutory basis and those provisions are not being interpreted or 
modified by this regulation.
    We agree with the commenter that the current UPL related funding 
schemes fit within the structure of our current regulations. As noted 
earlier in this document, the old regulation was designed to allow 
flexibility for States to pay providers differently to account for 
higher costs of some facilities. However, that flexibility has been 
used in recent years to establish funding arrangements that are 
excessive and abusive and do not assure that federal Medicaid funding 
is spent for Medicaid covered services provided to Medicaid eligible 
individuals. Such funding arrangements represent a direct and immediate 
threat to the integrity of the Medicaid program and therefore need to 
be changed.
    Comment: Several commenters recommended that we avoid changing the 
way the Medicaid UPLs are calculated. Another commenter noted that 
current regulations are adequate to control abuse through the State 
plan approval process.
    Response: Due to excessive payment arrangements resulting from the 
pooling and aggregation of public and private payment rates in the 
current UPL regulations, we believe it is necessary to change the 
current UPL regulations. The UPLs will still be calculated using 
Medicare payment principles, which is not a change from current 
regulations. We disagree that current regulations are adequate to 
control abuses through the State plan approval process because the 
current rules permit States to pool and aggregate UPLs across like 
provider types and do not provide sufficient authority to ensure 
Medicaid payments are consistent with efficiency and economy.
    Comment: Several commenters suggested that States should not be 
allowed to arbitrarily increase their State match rates through the use 
of IGTs. One commenter stated that the problem of ``recycling'' 
enhanced funding needs to be addressed since it's being ``marketed'' to 
additional States and will therefore increase the scope of the problem. 
The commenter believes that these IGT funds may make it appear that 
Medicaid expenditures are increasing when the dollars are not related 
to program costs.
    Response: We are not proposing to modify our current requirements 
relating to IGTs at this time. This regulation addresses excessive 
payments that result by pooling and aggregation of public and private 
payment rates. We believe it is necessary to change these pooling 
arrangements to ensure Medicaid payments to providers are consistent 
with efficiency and economy.

Uses of IGT Funds

    Comment: Commenters recommended that we specify, in this rule, that 
Federal funds received as a share of Medicaid expenditures financed 
through IGTs must be used for Medicaid purposes. Specifically, one 
commenter suggested that UPL funds generated in nursing facilities 
should be required to pay for services provided by nursing facilities.

[[Page 3165]]

    Response: We agree that Federal Medicaid matching funds should be 
used to pay for Medicaid services provided to Medicaid eligible 
individuals and believe the UPLs will help ensure this result. We do 
not believe that simply specifying or requiring that Federal funds 
received as a share of Medicaid expenditures financed through IGTs be 
used for Medicaid purposes will solve the problem. The Office of the 
Inspector General's (OIG's) draft audits have shown that once States 
obtain excess Federal funds through IGTs, they may transfer a portion 
of those dollars from providers to their General State fund and we lose 
the ability to track how Medicaid dollars are spent. Therefore, we 
would have no means of monitoring or enforcing such a provision.
    Comment: Many commenters indicated that their individual States are 
appropriately using funds obtained through IGTs. The commenters believe 
that these States should not be punished for problems in other States. 
The commenters also believe that the regulation should distinguish 
between ``good'' and ``bad'' uses rather than eliminating the program.
    Response: This regulation does not modify or change Medicaid IGT 
requirements. States can continue to use IGTs to finance Medicaid 
payments. States, counties, and cities have developed their own unique 
arrangements for sharing in Medicaid costs and this regulation should 
not disturb such arrangements.
    Comment: One commenter indicated that overall States are meeting 
their responsibilities and cannot offset cuts in IGT funds. Many 
commenters pointed out that States and providers need this money. The 
commenters indicated that the State Medicaid rates are already 
inadequate and will probably be reduced if there is a cut in IGT funds. 
Several commenters are concerned that eliminating the IGT program will 
cause a serious disruption to State and county ``safety-net'' providers 
and other enhanced services that could not otherwise be funded.
    Response: This regulation does not attempt to change States' 
ability to use IGTs. States, counties, and cities have developed their 
own unique arrangements for sharing in Medicaid costs and these 
arrangements are protected by statute. Furthermore, this rule will not 
reduce or limit the amount of Federal funding available to States to 
pay for Medicaid services to Medicaid eligible individuals. We believe 
that States were given ample notice of our intent to publish this rule 
in our letter to State Medicaid Directors on July 26, 2000. In 
addition, the transition periods in the final rule will provide States 
with sufficient time to modify their budgetary planning as necessary.
    States have the flexibility to set payment rates in accordance with 
their public process. States will retain the flexibility to pay 100 
percent of the costs of serving Medicaid patients, and the Federal 
government will pay its share of those costs in accordance with each 
State's Federal medical assistance percentage. In recognition of the 
unique and important role public safety-net hospitals play in caring 
for low income, vulnerable populations, we have provided States with 
flexibility to set higher Medicaid payment rates for these providers. 
However, we do not intend for these higher Medicaid payments to 
ultimately replace State dollars for Medicaid or other enhanced 
services.
    Comment: One commenter reasoned that IGT funds should go to 
children's hospitals even if they are not publicly owned or operated.
    Response: Under current rules, States have the discretion to 
determine how they will use public funds that have been transferred to 
them from or certified by units of government within the State. In 
addition, there are no rules that prevent States from paying children's 
hospitals in accordance with the new UPL regulations for private 
hospitals. With this group of providers, States still have the 
flexibility to pay some hospitals more than others to account for 
differences in cost or caseload.
    Comment: One commenter is concerned that reduced funding to county 
non-acute hospitals will cause patients to be transferred to acute care 
hospitals, resulting in higher hospital stays and higher costs.
    Response: We believe all county hospitals will be able to benefit 
from higher Medicaid service rates permitted under the UPL for county 
hospitals.
    Comment: One commenter recommended that county facilities have a 
``hold harmless provision'' to prevent care decreases. Another 
commenter recommended children's hospitals have a hold harmless 
provision.
    Response: We do not have the authority to require States to hold 
any facility harmless in the implementation of the new Medicaid UPLs. 
If a State is making excessive payments to certain facilities, we 
anticipate the State will have to adjust payments to those facilities 
to comply with the new UPLs.

Quality of Care and Access

    Comment: Numerous commenters expressed concern regarding the impact 
that this rule will have on the quality of patient care in a variety of 
programs and settings due to the potential loss of funding available as 
a result of the implementation of this rule. Many of these commenters 
noted that quality health care depends on adequate funding. Commenters 
expressed concern about the impact of reduced quality of care on the 
following: nursing facilities, hospitals, federally qualified health 
centers (FQHCs) county non-profit nursing facilities, public nursing 
facilities, county facilities, safety-net providers, children's 
hospitals, local health departments, physicians, the State Children's 
Health Insurance Program (SCHIP), eligibility expansions, Medicaid and 
SCHIP outreach, the uninsured population, and rural areas. States 
appear to be using excess Federal funds obtained through current 
flexibility in the Medicaid upper payment limits to support a variety 
of health care services.
    Response: We strongly support the provision of quality health care 
to every Medicaid eligible individual. We also recognize that quality 
health care depends on adequate funding. We do not believe this final 
rule will interfere with the provision of quality health care services 
to Medicaid eligible individuals as it permits States to set payment 
rates that will sufficiently reimburse providers for Medicaid services.
    Comment: Several commenters recommended that we adopt special 
provisions to protect certain providers and populations including 
children's hospitals, nursing facilities, Medicaid eligible 
individuals, children and families, pregnant women, seniors, and people 
with disabilities. Adopting a special provision would be consistent 
with section 1902(a)(30) of the Act, which requires Medicaid payments 
to be consistent with quality of care and sufficient to provide 
adequate access to care.
    Response: In this rule, we are modifying the application of the 
Medicaid upper payment limits. Although we recognize that the groups 
mentioned by the commenters have special health care needs, we feel 
that under the new UPLs, States will clearly be able to set rates that 
fairly compensate all Medicaid service providers for services furnished 
to Medicaid eligible individuals. The purpose of our rule is to protect 
the fiscal integrity of the Medicaid program. We intend to achieve this 
purpose by curtailing excessive rates that some States have established 
to pay certain providers.
    Comment: Commenters pointed out that cutting the IGT funds will 
reduce

[[Page 3166]]

access to care for the elderly and disabled, particularly individuals 
with heavy care needs, and the uninsured.
    Response: First we note that this rule does not place restrictions 
on IGTs which have their own statutory authority. This regulation deals 
with pooling and aggregating Medicaid payments under the current UPL 
categories. Section 1902(a)(30) of the Act requires States to set 
payments that are consistent with efficiency, economy, and quality of 
care. Under this authority, States can establish payment methodologies 
that take into account differences in costs that providers may incur 
based on the acuity level of their Medicaid patient population. The 
UPLs we have established do not interfere with reasonable rates that 
reflect the volume and costs of Medicaid services furnished by a 
provider. We also note that under section 1902(a)(30) of the Act, 
payments must be sufficient to enlist enough providers so that services 
are available to the Medicaid population to the same extent services 
are available to the general population.
    Comment: Several commenters indicated that they believed the rule 
will result in less FFP for States and, although many States have flush 
budgets, they may restrict funds for nursing services and other 
Medicaid benefits, reduce the number of Medicaid eligible individuals, 
and cause redirection of State funds. Another commenter indicated that 
the IGT rule's affect on nursing homes will cause a lack of nursing 
home placement for patients.
    Response: As we stated in the regulatory impact statement of the 
proposed regulation, the rule will not reduce the overall aggregate 
amount that a State can pay for Medicaid services. Each State makes its 
own budgetary and rate setting decisions. Under section 1902(a)(30)(A) 
of the Act, States are required to provide payment that is sufficient 
to enlist enough providers so that care and services are available 
under the plan at least to the extent that the care and services are 
available to the general population in the geographic area. While 
States have considerable flexibility in rate setting, should they 
impose rate reductions as a result of this final rule, they still must 
assure that Medicaid services are available at least to the degree 
these services are available to other populations in the same 
geographic area.
    Comment: Commenters are concerned that the new Medicaid UPLs will 
create financial insecurity for numerous providers and will put the 
following providers at risk of closing their doors or declaring 
bankruptcy: sole-community hospitals, county facilities caring for 
patients who receive specialized services, private safety-net 
hospitals, inner-city and rural safety-net hospitals providing services 
to low-income and uninsured people, nursing homes, large county nursing 
facilities, and skilled for-profit and non-profit nursing homes. In 
addition, a few commenters expressed concern that the proposed rule 
will put certain State's Medicaid programs in jeopardy.
    Response: We recognize the precarious situation of providers who 
face low payment rates and are responsible for providing care and 
services to Medicaid eligible and uninsured individuals. We want to 
emphasize that this regulation permits States to set reasonable rates 
for Medicaid services.
    Comment: Several commenters expressed the concern that the 
regulation will jeopardize the ability of States to develop, maintain, 
and expand home and community-based services, including home and 
community-based waiver programs, for the elderly, persons with 
disabilities, or persons with developmental disabilities. Similarly, 
several other commenters indicated that funds derived from the UPL 
loophole are used for other laudable causes, such as reduction in the 
use of restraint and seclusion, taking nursing home beds out of 
service, providing and enhancing safety-net services to low income 
populations, and behavioral management training. The commenters stated 
that these causes would also be jeopardized.
    Response: We recognize the concerns of these commenters, but note 
that this regulation does not directly affect Federal financial 
participation for these services. States can continue to develop home 
and community-based waiver programs and provide home and community-
based services under their Medicaid programs and the federal government 
will match State expenditures for these services. While some States may 
have used the UPL loophole to support home and community-based services 
or other laudable causes, as described by the commenters, these 
arrangements are inappropriate as they effectively result in Federal 
funds being used in place of required State funding.
    We also believe States have many important incentives to continue 
to develop, maintain, and expand home and community-based services. 
First, home and community-based services, including home and community-
based service waivers serve as a cost-effective alternative to 
institutional care. Second, the provision of home and community-based 
services under the Medicaid program is an important tool for enabling 
States to fulfill their responsibilities in serving persons with 
disabilities ``in the most integrated setting appropriate'' as required 
by the Americans with Disabilities Act. Lastly, the provision of home 
and community-based services is crucial if States are to be responsive 
to the needs and preference of the elderly and persons with 
disabilities who seek alternatives to institutional care.
    Comment: One commenter noted that the proposed rule could result in 
a reduction of services to Medicaid recipients with disabilities unless 
we add a State fiscal maintenance of effort (MOE) provision to protect 
recipients who receive home and community-based services. This 
commenter recommended that we require that each State spend no less in 
each future year (adjusted for health care inflation) on home and 
community-based services provided either under a home and community-
based services waiver or under the Medicaid State plan.
    Response: We do not have sufficient authority to impose an MOE 
requirement because HCBW services are an optional program under the 
Medicaid Statute. We believe States will maintain these programs 
because of the incentives previously mentioned.

Miscellaneous

    We also received a number of comments not directly related to the 
provisions of the proposed rule, which we summarize here.
    Comment: One commenter recommended that we maintain our traditional 
flexibility in interpreting the UPL regulation and allow State 
flexibility.
    Response: We agree that States should maintain the ability to 
establish payment rates for their providers. However, with respect to 
the State's payment rates, section 1902(a)(30) of the Act requires that 
these rates be consistent with efficiency, economy and quality of care. 
HCFA has found that the increase in title XIX Federal funding for 
enhanced payments to nursing homes and hospitals is not consistent with 
the statutory definition of efficiency and economy. Therefore, we are 
taking this action to ensure that State Medicaid payments meet the 
statutory definition of efficiency and economy by issuing this UPL 
regulation to address the enhanced program payments.
    Comment: Several commenters indicated that we do not have the legal 
authority to set UPLs.
    Response: The legal basis for setting the UPL is section 
1902(a)(30) of the Act

[[Page 3167]]

which provides that the State's payment rates be consistent with 
efficiency, economy and quality of care. This provision provides us the 
legal authority, on behalf of the Secretary, to set the UPLs on 
Medicaid payments as set forth in the Federal regulations at 42 CFR 
part 447.
    Comment: The State of Georgia does not have an UPL SPA pending and 
wants to be removed from the list.
    Response: We disagree. The State has a pending amendment to its 
State plan which will make payments previously made to DSHs, to 
hospitals within the State's UPL. To date, the State has not 
demonstrated that these enhanced payments are tied to the cost of 
Medicaid services.
    Comment: One commenter suggested that we consider approaches to 
closing the loophole that will not damage safety-net providers.
    Response: We do not believe that ``closing the loophole'' or 
capping the enhanced payments States are making to providers will 
damage safety-net providers. We have accounted for potential affects of 
this regulation on public hospitals by setting the UPL cap at 150 
percent of what Medicare principles would have paid. We have also 
granted transition periods to States to allow them to continue the 
enhanced programs for a prescribed amount of time.
    Comment: One commenter indicated that as a major rule, this final 
rule can not take effect until 60 days after publication.
    Response: This rule will be effective 60 days from the date of 
publication.
    Comment: One commenter suggested that we consider allowing all 
States to apply UPL funds to health services that would result in net 
savings to Medicaid (for example, training community-care aides). 
Another commenter indicated the UPL funds should only be permitted to 
reduce institutional bias and should be based on removing people from 
nursing homes. One commenter recommended that Medicaid funds should go 
to nursing homes so there will be adequate operating capital.
    Response: The Medicaid statute currently contains several 
authorities States can use to legitimately redirect Medicaid funding in 
the manner suggested by the commenters. Under section 1115 of the Act, 
States can operate programs that expand eligibility and/or include 
services not otherwise covered by Medicaid, if these programs do not 
result in increased Federal spending. Under section 1915(c) of the Act, 
States can establish home and community-based programs as an 
alternative to institutional care. The main distinction between these 
programs and similar programs that may be funded under the former UPLs, 
is that States would be required to fund their share of the costs as 
required by the Medicaid statute. To operate similar programs under the 
UPLs, States would have to represent expenditures for the medically 
necessary provision on institutional care for the purpose of claiming 
Federal matching funds, and then have those institutions transfer 
Federal funds to support non-institutional services. The representation 
is misleading since by definition the funds would not be used by the 
institution to provide medically necessary care and services to its 
inpatients, but rather to support some type of alternative program. We 
believe these types of funding arrangements completely undermine the 
integrity of the Medicaid program. It is our intent that under the new 
UPLs, Medicaid payments claimed as a nursing home expenditure, or as an 
expenditure for some other type of institutional service, will in fact 
be paid to and retained by those facilities to offset the costs they 
incurred in furnishing Medicaid services to eligible individuals.
    Comment: One commenter indicated that safeguarding the financial 
integrity of Medicaid is of paramount concern. Another commenter 
indicated that [Medicaid] program integrity is important.
    Response: We agree with this comment and will continue to work with 
States and provider groups to ensure the integrity of the Medicaid 
program, while preserving the State's current flexibility to set 
payment rates in accordance with section 1902(a)(13)(A) of the Act.
    Comment: One commenter suggested that we create a separate 
alternative which specifically focuses on the State's use of an IGT 
policy rather than an upper payment limit.
    Response: Our primary concern is reducing excessive payments and we 
believe the establishment of upper payment limits is the most direct 
approach to achieve this objective. As indicated in the proposed rule, 
we gave consideration to developing an IGT policy. However, had we 
proposed an IGT policy, our intent would have been to have it 
supplement our proposed UPL modifications. Because we realize that 
States, counties, and cities have developed their own unique 
arrangements for sharing in Medicaid costs, we decided not to pursue 
this policy at the time we proposed the new UPLs. We remain concerned 
with the manner in which IGTs are used in particular instances and 
agree that a policy specific to them may be necessary to ensure that 
Federal funds are used to match bona fide expenditures.
    Comment: Several commenters recommended that we require State 
maintenance of efforts and reject State plan amendments that would 
lower payments to nursing homes. Another commenter indicated that we 
cannot approve State plan amendments that would lower or provide 
inadequate updating.
    Response: The Balanced Budget Act of 1997 repealed certain sections 
of 1902(a)(13) of the Social Security Act (Boren amendments) which had 
previously allowed us to disapprove State plans that implemented 
payment rates that were not ``reasonable and adequate to cover the 
costs of an efficient and economically operated provider.'' Therefore, 
the statutory basis for us to disapprove a plan based upon inadequate 
or unreasonable rates has been repealed. The Boren amendment 
requirements have been replaced with a requirement that States 
establish payment rates using a public process that allows for 
meaningful opportunities for public input. It is during this public 
process that providers should communicate their concerns regarding the 
adequacy of the payment rates to maintain Medicaid services at the 
optimum level required to care for the provider's Medicaid patient 
population.
    While the objective of the new upper limits is to reduce excessive 
payments, we are concerned by the volume of comments we received 
relating to the impact these limits will have on Medicaid quality and 
to services access. Under Section 1902(a)(30) of the Act, States are 
required to make payments that are consistent with efficiency, economy, 
and quality of care and that is sufficient to enlist enough providers 
so that health care services covered by Medicaid are available to the 
extent such services are available to the general population in the 
geographic area. Section 1902(a)(30) is a Medicaid State plan 
requirement, and therefore, we can require States to report how 
proposed changes in payment rates are anticipated to impact the quality 
of care and access to Medicaid services.
    Comment: One commenter noted that excessive Medicaid funding is 
necessary because Medicare reimbursement has been tightened.
    Response: We disagree with this comment. Medicaid and Medicare are 
separate and distinct entitlement programs that are geared towards two 
different populations and administered under the statutory authority of 
two different titles in the Social Security

[[Page 3168]]

Act. A reduction in funds to providers under the Medicare program does 
not grant States the authority to make payments that do not meet the 
statutory requirements of Medicaid.
    Comment: One commenter indicated that the money is currently being 
used to provide services to Medicaid eligible individuals .
    Response: We realize that in some cases, States may be using 
enhanced payments to expand Medicaid eligibility or provide additional 
services. Since Federal-matching payments would necessarily be 
available for these program expansions, in this context, the States 
would be using the enhanced payments rather than the required State 
matching payments. In this case, we believe this practice violates the 
integrity of the Medicaid program and we intend to curtail it with the 
application of the new UPLs.
    Comment: One commenter indicated that States should not be 
penalized for actions under plans approved by us in the past.
    Response: States are not being penalized for methodologies 
permitted by us in the past. We recognize that the UPLs may disrupt 
State budgets. States with these plans have been given a transition 
period, however, and we have an obligation under 1902(a)(30) to ensure 
State payments are consistent with efficiency, economy and quality of 
care.
    Comment: One commenter indicated that GAO and OIG have rushed to 
judgement.
    Response: We believe that the OIG and GAO studies on State enhanced 
payment programs were extremely thorough, and the conclusion drawn from 
these studies well thought through. The OIG continues to study State 
programs and any specifics and further conclusions drawn from the study 
of these programs will be shared with us.
    Comment: One commenter indicated that we are too focused on the 
process States use to meet their Medicaid needs.
    Response: It is our responsibility, as the Federal agency that 
administers the Medicare and Medicaid program, to ensure that the 
fiscal integrity of the Medicaid program is maintained. If we find that 
States are making Medicaid payments which are not consistent with 
efficiency, economy, and quality of care, we, on behalf of the 
Secretary, must act upon the problem through regulation.
    Comment: One commenter suggested that we modify rules to give 
States extra money for indigent care.
    Response: We do not have the regulatory authority, under title XIX, 
to require States to designate specific funds to indigent care.
    Comment: Two commenters recommended three categories of Federal 
funding for each group of hospitals: private, State, non-State 
government owned.
    Response: We have revised the UPL at paragraph (a) of Secs. 447.272 
and 447.321 to account for these three separate groups. We have 
established a separate UPL for each of the following categories: 
privately-operated facilities, non-State government-operated 
facilities, and State government-operated facilities.
    Comment: One commenter indicated that we should not allow States to 
use the Medicaid funds to build bridges, but did believe we should not 
place limits on New Hampshire's Medicaid funding.
    Response: The new upper limits are intended to ensure Medicaid 
payments are consistent with efficiency and economy. Under the former 
UPLs, States could make excessive payments to certain public providers. 
Once paid to a provider, the provider had the flexibility to use the 
funds as it felt appropriate. As illustrated by the initial finding of 
the Inspector General, the funds may be used in a variety of ways. In 
cases in which the funds are donated back to the State, it ultimately 
becomes impossible to track the Medicaid payments due to the 
fungibility of money. By reducing excessive payments, we believe that 
the new UPLs preclude States from using Medicaid funds for non-Medicaid 
purposes. While New Hampshire does have a rate enhancement program, we 
do not know at this time how the new UPLs will ultimately impact them.
    Comment: One commenter inquired about the term of ``fair 
compensation''. The commenter asked if we had a definition of fair 
compensation. The commenter asked if fair compensation was equivalent 
to ``may not exceed a reasonable estimate of what would have been paid 
for those services under Medicare payment principles.'' The commenter 
felt that it was inconceivable to believe any State pays compensation 
rates to its providers that exceed any reasonable definition of fair 
compensation, which seemed to be our position.
    Response: The term ``fair compensation'' is not defined in any 
Federal Medicaid regulations. In the context used in the proposed rule, 
we were pointing out that under the new UPLs we are establishing, 
States will be able to set service rates that fairly compensate 
individual providers for covered Medicaid services furnished to 
Medicaid eligible individuals. In other words, the UPL would permit a 
State to set facility specific rates that are based on the reasonable 
cost each provider incurs in furnishing Medicaid services to Medicaid 
eligible individuals. While we can understand the commenter's dismay 
about States setting excessive rates, our analysis of nursing facility 
payment programs in several States shows that payments to public 
providers are often multiples above the price the State would have paid 
a private facility for the same service. When computed on a per-day 
basis, we have found payments in some States to be in the $1,000-$1500 
range.

Comment Period

Extend Comment Period

    The proposed rule allowed a 30-day comment period.
    Comment: A number of commenters urged HCFA to extend the comment 
period. Twelve commenters recommended that the comment period be 
extended to provide States more time because of the magnitude of the 
policy change. Fourteen commenters felt that the public was not given 
sufficient time to understand the implications of this ruling. A few 
commenters felt that the comment period should be extended to allow 
time to conduct impact analysis and to evaluate the effect of the rule 
on long term care. Two commenters stated that the comment period should 
be extended to allow more time to respond to the possible negative 
impact on resident care and Medicaid accessibility.
    Response: While we appreciate all the comments requesting extension 
of the comment period, it is our belief that the comment period 
provided was reasonable and sufficient. We believe the thirty-day 
period was sufficient particularly in view of the intense national 
publicity given this issue over the last several months and extensive 
consultation with various stakeholders before the proposed rule was 
even published. In recognition that States may have budgetary 
disruptions resulting from the rule, we began advising States earlier 
this year that new SPAs may not be in effect for long and that long 
standing plans would need to come into compliance with a final rule 
change. On July 26, 2000, we issued a State Medicaid Director's letter 
formally informing States of our intention to publish a proposed rule 
to modify the current UPL. In addition, HCFA, the Office of the 
Inspector General and the General Accounting Office testified in 
September on the scope of the financing practices, their impact on 
State and Federal spending, and on the ways that States used the 
increased Federal funds. At this hearing, we informed the Committee and 
other stakeholders about

[[Page 3169]]

our intent to publish a proposed rule and change the current UPL 
regulations.
    We also believe that the proposed transition period allows 
sufficient time for State legislatures and Medicaid programs to prepare 
for any budgetary consequences. As stated in our responses to comments 
on the transition period, our paramount interest in issuing these 
regulations is to preserve the integrity of the Medicaid program. Under 
section 1903(a) of the Social Security Act, States are required to 
share (in accordance with a statutory formula) in the burden of 
financing the costs of Medicaid covered health care services furnished 
to eligible individuals. We recognize that States may have diverted 
Federal matching funds for other purposes (whether health related or 
not). We provided a transition period which would allow all States that 
qualify for a transition period to have at least one legislative 
session to fully analyze and evaluate the effect of the rule and before 
SPAs would have to comply with the new upper limits.
    Comment: One commenter believes that the comment period should be 
extended for at least 60 days because of concerns regarding the impact 
of the regulation on hospitals that serve a disproportionate share of 
low income and indigent patients.
    Response: We do not believe that a longer comment period would 
address these concerns. First, before the publication of the proposed 
rule, the Administration conducted extensive consultations with many 
hospitals and associations serving a disproportionate share of low 
income and indigent patients. The proposed rule has accounted for 
potential effects on such hospitals by setting the UPL cap at 150 
percent of what Medicare payment principles would have paid. In 
addition, the proposed rule granted transition periods to States to 
allow time to adjust State budgets to protect certain programs and 
providers. This transition was intended to balance the need to protect 
the fiscal integrity of the Medicaid program while accounting for State 
budget issues and provider impacts.

Delaying Action or Implementation

    Comment: A number of commenters recommended that we not impose this 
regulation until a long term care policy can be developed with two 
dedicated sources of funding for nursing facilities. One commenter 
indicated that the regulation should not take effect until there is 
legislative change to FMAP formula.
    Response: Delay in implementing this regulation would be contrary 
to Medicaid statute and further contribute to the rapid growth in 
Federal Medicaid spending. Section 1902(a)(30) of the Act requires a 
State plan to meet certain requirements in setting payment amounts to 
obtain Medicaid care and services. One of these requirements is that 
payment for care and services under an approved State Medicaid plan be 
consistent with efficiency, economy, and quality of care. The 
Administration has found that the increase in title XIX Federal funding 
for enhanced payments to nursing homes and hospitals is not consistent 
with the statutory definition of efficiency and economy. Therefore, the 
Administration has charged us with the task of ensuring that State 
Medicaid payments meet the statutory definition of efficiency and 
economy by issuing this UPL regulation to address the enhanced program 
payments.
    Comment: Several commenters requested that HCFA not enact the 
proposed rule.
    Several commenters recommended that the implementation date be 
delayed to permit States to develop legislative and fiscal solutions, 
while one commenter suggested delaying implementation of the rule for 1 
year to allow time to work cooperatively with the States to reach 
mutually agreeable solutions to HCFA's concerns. One commenter 
recommended that HCFA should assess the procedural and substantive 
ramifications on State budgets and Medicaid programs before proceeding 
with this rule.
    Response: As stated in our responses to comments on the transition 
period, our paramount interest in issuing these regulations is to 
preserve the integrity of the Medicaid program. Under section 1903(a) 
of the Social Security Act, States are required to share (in accordance 
with a statutory formula) in the burden of financing the costs of 
Medicaid covered health care services furnished to eligible 
individuals. We recognize that States may have diverted Federal 
matching funds for other purposes (whether health related or not). We 
provided a transition period which would allow all States who qualify 
for a transition period to have at least one legislative session to 
fully analyze, evaluate and assess the procedural and substantive 
ramifications the rule and before SPAs would have to comply with the 
new upper limits.
    We believe it is appropriate to phase-in the new UPLs over the 
timeframes proposed in the proposed rule. As addressed in the preamble, 
States, providers, and beneficiaries expressed concern over how the 
application of the upper limits would impact Medicaid access and 
quality of care. We believe that the time permitted in the proposed 
rule is reasonable and balances the need to protect the fiscal 
integrity of the Medicaid program and State budget issues.
    We would not want to delay the implementation of the rule for one 
year because that would allow additional States to submit SPAs to take 
advantage of the current UPL loophole. This could dramatically increase 
Medicaid expenditures in the near term.

Comments on Impact Analysis

    We received comments on the impact analysis of the proposed rule. 
We invited comment on alternatives we considered and on other possible 
approaches for achieving our objective to ensure Medicaid service 
payments are consistent with efficiency and economy. We specifically 
solicited comment on alternative means of setting the maximum amount 
that may be paid to public hospitals that have traditionally provided 
``safety-net'' care and services to underserved communities and 
individuals who are uninsured. In addition, we requested information 
regarding the mechanisms used to finance these hospitals under the 
existing regulations, as well as suggestions for a means of curbing 
excessive payments while allowing States the flexibility to recognize 
higher costs faced by these hospitals.
    Comment: We received several comments that were critical of the 
impact analysis published in the proposed rule. These commenters 
asserted that the lack of data or uncertainty over how States may 
respond to the new UPLs does not excuse HCFA from its obligations under 
the RFA. Several commenters wanted us to provide a better analysis of 
the impact on small entities, specifically including children's 
hospitals, as well as the impact on State Medicaid programs before 
publication of the final rule.
    Response: Due to data limitations and uncertainty with respect to 
how States may re-adjust payments to maintain the same level of Federal 
Medicaid dollars, we specifically solicited comments on how the new 
UPLs in this final rule would impact Medicaid participating health care 
providers. Unfortunately, we did not receive any information that would 
help us more accurately quantify the impact at the individual provider 
level. In the proposed rule as well as in this final rule, we have 
tried to explain the difficulties and complexities of trying to project 
the potential impact of the new UPLs. Since State Medicaid programs do 
not routinely report the type of data that would be necessary to

[[Page 3170]]

accurately quantify the impact on affected providers, in our analysis 
we have tried to explain the factors that would cause the regulation to 
have an impact.
    Comment: One commenter took strong exception with our assessment 
that non-government owned or operated small entities should not be 
impacted because the UPLs, as proposed, did not apply to them. The 
commenter stated that many community-service providers depend on 
Medicaid for a large part of their revenues, and because they have less 
political influence than hospitals, nursing homes, or physicians, it is 
likely these small community providers would bear a disproportionate 
share of payment reductions resulting from the rules. The commenter 
stated that the State of Michigan claims that the entire cost of its 
home and community-based waiver (HCBW) program is funded by UPL 
revenues and according to one State official, the entire community-
based program may be eliminated if the UPL rule is adopted.
    Response: The commenter's real concern appears to be with State 
budget priorities, which are beyond the scope of this rule. This rule 
will not alter federal funding of HCBW services, and will not preclude 
States from funding their share of such services. We have acknowledged 
that, in some States, public institutional providers may return these 
payments to the State and the State may use the returned payments to 
fund HCBW services. Since States do not report to us on their internal 
funding sources, we do not have data that would allow us to quantify 
the effect of potential State budget reductions on some providers 
because of internal funding shortfalls. The commenter did not furnish 
any specific data. Moreover, any comments on the impact internal 
funding shortfalls may have on providers is necessarily speculative 
since, ultimately, the allocation of State resources is an issue of 
State discretion beyond federal purview. We have emphasized that, under 
the new UPLs, States will be able to set service rates that fairly 
compensate institutional providers. Such rates must be set using a 
public process that includes input from providers. Non-institutional 
HCBW services are not subject to this UPL, and rates for those services 
will not be affected. Furthermore, there are substantial reasons, 
including civil rights requirements and net cost savings in comparison 
to institutional services, why States should continue to fund HCBW 
services. Thus, we do not believe there will be a substantial impact on 
HCBW services from this rule.
    Comment: One Commenter stated that HCFA should ensure that the 
final rule does not exacerbate the financial stresses that rural 
hospitals continue to face in light of the myriad provisions of the 
Balanced Budget Act of 1997 that have resulted in a budget-crushing 
domino effect.
    Response: We do not believe this rule will have a significant 
impact on rural hospitals. These regulations do not interfere with 
States' ability to set adequate payment rates for all providers 
including rural hospitals. In addition, rural hospital owned or 
operated by local governments may benefit from the higher UPLs set for 
hospital providers.
    Due to data limitations, mainly because States do not routinely 
report payment information that would allow us to quantify the impact 
on providers, we have tried, in the absence of data, to explain what 
would and would not be permitted under the final UPL rules. We have 
emphasized that the new UPLs will permit States to set service rates 
that fairly compensate providers. The rules are intended to preclude 
States from setting rates that far exceed the amount of costs a 
provider would be expected to incur relative to the services provided 
to Medicaid individuals.
    Comment: Several commenters indicate that the rule changes will put 
considerable pressure on State budgets. This in turn will make it 
exceptionally difficult to administer programs for children, the 
working poor, and community social service programs, all of which 
provide health care, food, shelter and child care to those populations 
most in need. It will weaken the part of the health organization and 
safety-net providers who run these programs because they will no longer 
have the ability to negotiate for inflationary updates to State health 
care budgets and may even jeopardize the small updates they have 
realized for FY 2001. Without these funds, one commenter noted a 
deficit will result in fractured financing systems and a rising number 
of uninsured individuals. These shortfalls would have to be offset 
through tax increases. The commenters added that HCFA should target 
abuses of the system and control the use of funds.
    Response: The Medicaid program is available to assist States in 
paying for the costs of needed health care services provided to 
Medicaid eligible individuals. While we appreciate the concern over 
State budgets and access to non-Medicaid programs, State funding issues 
are outside of the scope of the Medicaid program. We believe these 
rules will help ensure that Medicaid payments are used to pay for 
Medicaid services provided to Medicaid eligible individuals.
    Comment: One commenter notes that this regulation will reduce 
funding to both public hospitals and private hospitals that have 
emergency rooms or trauma centers. As this funding is used to support 
safety-net hospitals with emergency rooms and trauma centers, its loss 
would force the closure of portions of the trauma network. Another 
impact identified by the commenter is that affected facilities will not 
be able to provide care to the indigent and uninsured.
    Response: We recognize the important role non-State public 
hospitals play in providing emergency room and trauma care and in 
caring for the indigent. For these reasons we have set a higher UPL for 
these facilities. Ultimately, we believe these higher limits will 
substantially increase the overall amount of Federal funding that will 
be available to States for inpatient and outpatient hospital 
expenditures.
    Comment: Several commenters asserted that their State and health 
care facilities stand to lose substantial funding under the 
implementation of the UPL.
    Response: Because commenters did not support these assertions with 
Medicaid service utilization and payment information, we were not able 
to use these comments in trying to quantify the impact of these UPLs in 
this final rule. Since these rules allow States to set reasonable 
Medicaid service rates, we do not believe the asserted impact can be 
fairly attributed to the UPLs.
    Comments: Several commenters supported grandfathering in existing 
arrangements.
    Response: As we indicated in the preamble, we do not think this 
alternative would effectively address the problem of excessive Medicaid 
payments. This approach would permanently permit the continuation of 
excessive payments by States that are currently making them and 
therefore would not achieve our objective to have Medicaid payments be 
consistent with efficiency and economy. We also believe this approach 
would not withstand legal challenge if it were to be effected through a 
regulatory change.
    Comment: One commenter urged us to consider additional alternatives 
which would minimize the impact of the rules on children's hospitals. 
Noting the purpose of the rule, the commenter asserted it is not within 
those provisions to adopt a rule which will result in the severe 
underpayment of children's hospitals and threaten their ability to 
furnish needed health care services.

[[Page 3171]]

    Response: Because the UPLs will allow States to set rates that 
compensate providers fairly for needed health care services they 
furnish to Medicaid individuals, we do not believe children's hospitals 
will experience underpayments as a result of this rule. This comment 
appears to more directly relate to State budget priorities which are 
outside the scope of this rule.
    Comment: One commenter disagreed with our assessment that the 
proposed UPLs are not subject to unfunded mandate reform act. The 
commenters stated that the term ``Federal Mandate'' as used in the 
unfunded mandate reform act means any provision in a regulation that 
imposes an enforceable duty upon State governments including a 
condition of federal assistance. (2 U.S.C. section 1555) Under the 
proposed rule, States have an enforceable duty to amend their State 
plans and claiming procedures. The commenter added that the regulations 
shift the costs of existing federal mandates currently being assumed by 
the Federal government through IGTs to the States. The commenter 
believed the impact is well in excess of $100 million in any one year 
and, therefore, believed an unfunded mandate reform act impact analysis 
is required.
    Response: We disagree with the commenter and maintain our position 
that these new upper limits in this final rule have no unfunded mandate 
implications.
    Comment: One commenter noted that our regulatory approach is 
distinctly superior to any of the other alternatives considered.
    Response: We appreciate the commenter's support of our approach. We 
did explore alternative approaches but none of the options were 
suitable measures to solve the current situation within the current 
laws and regulations without changing the statute or taking away some 
degree of State flexibility.

V. Summary of Changes to the Proposed Rule

    In response to comments on the proposed rule and to provide policy 
clarification and eliminate redundancy, we made a number of changes in 
the final rule. A summary of these changes is as follows:
     Restructured Secs. 447.272 and 447.321 to more clearly 
present our policy.
     Restructured Secs. 447.272(a) and 447.321(a) to identify 
the different categories of facilities that furnish inpatient and 
outpatient services, respectively. Under the proposed rule, these 
categories included State government-owned or operated and non-State 
government-owned or operated facilities. In this final rule, we added a 
third category for privately-owned and operated facilities.
     Restructured the regulations at Secs. 447.272(a) and 
447.321(a) and added language to clarify that ``State government-owned 
or operated facilities'' are ``all facilities that are either owned or 
operated by the State'' to clarify that facilities that qualify for 
both the State-government and non-State government categories must be 
put into the State government category.
     Restructured Secs. 447.272(a) and 447.321(a) and included 
at paragraph (a)(2) of these sections, the category, ``non-State 
government-owned or operated facilities'' formerly ``other government-
owned or operated facilities.''
     Clarified our definition of non-State-owned or operated 
facilities to specify that this category includes ``all facilities that 
are neither owned nor operated by the State.''
     Removed the term ``outpatient hospitals'' from proposed 
Sec. 447.321(a) and (b) and replaced it with the phrase ``outpatient 
services furnished by hospitals.''
     Provided clarification in Secs. 447.272 and 447.321 for 
references to the term ``services'' by replacing it with the phrase 
``services furnished by the group of facilities.''
     Added Secs. 447.272(e) and 447.321(e) to provide the 
provisions for our ``Transition periods''.
     Clarified that States with approved payment methodologies 
before October 1, 1999 and subsequently amended may select either 
transition option.
     Modified the short transition period in Sec. 447.272(e) 
and Sec. 447.321(e) so that it does not erroneously does not make 
reference to States with excessive payment amendments approved after 
the publication date of the rule.
     Modified the transition period in Sec. 447.272(e) and 
Sec. 447.321(e) to add a third transition period for State plan 
amendments effective on or before October 1, 1992 based on section 705 
of BIPA.
     Added Secs. 447.272(f) and 447.321(f) to include reporting 
requirements for States that make Medicaid payments to non-State public 
providers and providers within the groups of providers that exceed the 
UPL during the transition period on a facility specific basis.
     Specified in the preamble that residential treatment 
facilities are governed by regulations at Sec. 447.325, ``Other 
inpatient and outpatient facility services: Upper Limits of Payment.
     Clarified that the institutional UPL specified in the 
final rule will continue to apply only to fee-for-service payments, and 
we made it clear that it is not appropriate to include managed care 
services and payments in the UPL specified in this regulation.
     Specified that changes in the budget neutrality ceilings 
for section 1115 demonstration programs become effective upon the 
effective date of the new law or regulation that necessitated the 
change.
     Clarified in the preamble that these UPLs do not regulate 
IGTs.
     Revised the regulations to update our references to the 
Balanced Budget Act of 1997 legislation for DSH requirements. (See 
Sec. 447.272(c)(3) and Sec. 447.321(c)(3))

VI. Collection of Information Requirements--Paperwork Reduction Act

    Under the Paperwork Reduction Act of 1995 (PRA), agencies are 
required to solicit public comment when a collection of information 
requirement is submitted to the Office of Management and Budget (OMB) 
for review and approval. To fairly evaluate whether an information 
collection should be approved by OMB, section 3506(c)(2)(A) of the PRA 
requires that we solicit comments on the following issues:
     Whether the information collection is necessary and useful 
to carry out the proper functions of the agency;
     The accuracy of the agency's estimate of the information 
collection burden;
     The quality, utility, and clarity of the information to be 
collected; and
     Recommendations to minimize the information collection 
burden on the affected public, including automated collection 
techniques.
    Therefore, we are soliciting public comment on each of these issues 
for the information collection requirements discussed below.

Section 447.272  Inpatient Services: Application of Upper Payment 
Limits

    For payments that exceed the 100 percent limit, the agency must 
annually report to HCFA the total Medicaid payments made to each 
hospital described under paragraph (c)(1) of this section and the 
reasonable estimate of the amount that would be paid for the services 
furnished by each hospital under Medicare payment principles. In 
addition, States that are eligible for a transition period described in 
paragraph (e) of this section, and that make payment that exceed the 
limit under paragraph (b) of this section, must report annually to HCFA 
the total

[[Page 3172]]

Medicaid payments made to each Facility and a reasonable estimate of 
the amount that would be paid for the services furnished by the 
facility under Medicare payment principles.
    It is estimated that there will be approximately 57 State agency 
reports submitted on an annual basis and that it will take 8 hours per 
instance to submit the reporting requirements to HCFA. The total amount 
burden associated with this requirement is 456 hours.

Section 447.321 Outpatient Hospital Services: Application of Upper 
Payment Limits.

    For payments that exceed the 100 percent limit, the agency must 
annually report to HCFA the total Medicaid payments made to each 
hospital described under paragraph (c)(1) of this section and the 
reasonable estimate of the amount that would be paid for the services 
furnished by each hospital under Medicare payment principles. In 
addition, States that are eligible for a transaction period described 
in paragraph (e) of this section, and that make payment that exceed the 
limit under paragraph (b) of this section, must report annually to HCFA 
the total Medicaid payments made to each Facility and a reasonable 
estimate of the amount that would be paid for the services furnished by 
the facility under Medicare payment principles.
    It is estimated that there will be approximately 31 State agency 
reports submitted on an annual basis and that it will take 8 hours per 
instance to submit the reporting requirements to HCFA. The total annual 
burden associated with this requirement is 248 hours.
    We have submitted a copy of this final rule to OMB for its review 
of the information collection requirements in Secs. 447.272 and 
447.321. These requirements are not effective until they have been 
approved by OMB.
    If you have any comments on any of these information collection and 
record keeping requirements, please mail the original and 3 copies 
within 30 days of this publication date directly to the following:

Health Care Financing Administration, Office of Information Services, 
Information Technology Investment Management Group, Division of HCFA 
Enterprise Standards, Room N2-14-26, 7500 Security Boulevard, 
Baltimore, MD 21244-1850. Attn: John Burke HCFA-2071-F;
Office of Information and Regulatory Affairs, Office of Management and 
Budget, Room 10235, New Executive Office Building, Washington, DC 
20503, Attn: Brenda Aguilar, HCFA Desk Officer.

VII. Regulatory Impact Analysis

A. Overall Impact

    We have examined the impact of this final rule as required by 
Executive Order 12866 (September 1993, Regulatory Planning and Review) 
and the Regulatory Flexibility Act (RFA) (September 19, 1980, Public 
Law 96-354). Executive Order 12866 directs agencies to assess all costs 
and benefits of available regulatory alternatives and, if regulation is 
necessary, to select regulatory approaches that maximize net benefits 
(including potential economic, environmental, public health and safety 
effects, distributive impacts, and equity). A regulatory impact 
analysis (RIA) must be prepared for major rules with economically 
significant effects ($100 million or more in any one year). We consider 
this final rule to be a major rule and we have provided an analysis 
below.
    The RFA requires agencies to analyze options for regulatory relief 
of small businesses, nonprofit organizations and government agencies. 
Most hospitals and most other providers and suppliers are small 
entities, either by nonprofit status or by having revenues of $5 
million or less annually. For purposes of the RFA, many hospitals, 
nursing facilities and intermediate care facilities are considered to 
be small entities. Individuals and States are not included in the 
definition of a small entity.
    In addition, section 1102(b) of the Act requires us to prepare a 
regulatory impact analysis if a rule may have a significant impact on 
the operations of a substantial number of small rural hospitals. This 
analysis must conform to the provisions of section 604 of the RFA. For 
purposes of section 1102(b) of the Act, we define a small rural 
hospital as a hospital that is located outside of a Metropolitan 
Statistical Area and has fewer than 50 beds.
    Section 202 of the Unfunded Mandates Reform Act of 1995 also 
requires that agencies assess anticipated costs and benefits before 
issuing any rule that may result in expenditure in any one year by 
State, local, or tribal governments, in the aggregate, or by the 
private sector, of $100 million. We do not believe that this threshold 
applies for this final rule.
    Executive Order 13132 establishes certain requirements that an 
agency must meet when it promulgates a final rule that imposes 
substantial direct requirement costs on State and local governments, 
preempts State law, or otherwise has Federalism implications. We do not 
believe this final rule in any way imposes substantial direct 
compliance costs on State and local governments or preempts or 
supersedes State or local law.
    As we explained in the proposed rule and reiterate in more detail 
below, the impact of the new UPLs are highly uncertain. To be impacted 
by the regulation, a State would have to be making payments to 
government providers as a class that substantially exceed a reasonable 
estimate of the costs expected to be incurred based on the volume of 
services furnished to Medicaid eligible individuals by that class of 
providers.

A. Anticipated Effects

Effects on States and Medicaid programs
    In this final regulation we have attempted to estimate the 
aggregate impact these new rules will have on Federal reimbursements to 
States for Medicaid expenditures.
Impact on the Federal Budget Baseline
    The estimated impact of this final rule on the President's FY 2001 
budget baseline is shown in the table below:

                                              [Dollars in Billions]
----------------------------------------------------------------------------------------------------------------
                                                            FFY     FFY     FFY     FFY     FFY     FFY
                                                           2001    2002    2003    2004    2005    2006    Total
----------------------------------------------------------------------------------------------------------------
Federal Share of Enhanced payments in Medicaid FY 2001       2.9     3.0     3.2     3.3     3.5     3.6    19.5
 budget baseline1.......................................
Estimated payments in excess of UPL \2\.................     1.9     2.0     2.1     2.2     2.3     2.5    13.0
Estimated reduction in FFP as a result of phase-down of      0.0    -0.2    -0.6    -1.1    -1.6    -2.0    -5.4
 excess payments \3\....................................
Estimated increase in FFP from raising UPL for hospitals     0.1     0.4     0.6     0.8     1.0     1.1     4.0
 \4\....................................................
Net change in FFP (sum of previous two lines--may not        0.1     0.2     0.0    -0.3    -0.5    -0.9   -1.4
 add due to rounding)...................................
----------------------------------------------------------------------------------------------------------------
\1\ Derived from fiscal estimates submitted with State plan amendments approved by HCFA before 10/1/99;
  projected using President's FY 2001 budget growth rates.

[[Page 3173]]

 
\2\ Based on data on government non-State providers from Online Survey and Certification Reporting System
  (OSCAR) and Medicaid financial management data.
\3\ Calculated using transition UPL formula described in this rule (See Table illustrative example.)
\4\ FFP on increase in spending anticipated as a result of raising the UPL for hospital services from 100
  percent to 150 percent of what would be paid using Medicare payment principles.

    As indicated in the table, these estimates have been derived from a 
number of sources, including the States' own estimates of the fiscal 
impact of enhanced payment arrangements, data on the number and types 
of providers of nursing home and inpatient and outpatient hospital 
services, Medicaid financial management data, and Medicaid budget 
projections developed for the President's FY 2001 budget. In addition, 
we also consulted draft reports, prepared by the Inspector General of 
the Department of Health and Human Services, on the use of 
intergovernmental transfers to finance enhanced Medicaid payments.
    We have identified 29 States with approved and/or pending rate 
proposals that target enhanced Medicaid payments to hospitals and NF 
facilities that are owned or operated by county or local governments. 
There are 18 States with approved State plan amendments or waivers and 
5 States with pending plan amendments. In addition, there are 6 States 
that have both approved and pending plan amendments. We estimate that 
these proposals currently account for approximately $4.5 billion in 
Federal spending in FY 2001. This estimate is based on State-reported 
Federal fiscal information submitted with State plan amendments and 
State expenditure information where available. It may be understated or 
overstated to the degree that actual State expenditures would vary from 
the estimates included with State plan submissions. For example, a 
State could include a provision in its State Medicaid plan that would 
enable it to spend up to allowable amounts by making additional 
payments to designated facilities. Under this scenario, if the upper 
payment limitation permitted the State to spend an additional $200 
million, the actual annual expenditure could vary from zero to $200 
million depending upon the State's willingness to finance its share of 
the payment.
    As indicated in the table above, we estimate that about $2.9 
billion of this $4.5 billion in FY 2001 is currently reflected in the 
Medicaid budget baseline, and that about two-thirds of this amount 
($1.9 billion in FFY 2001) currently exceeds the upper payment limit 
imposed by this rule. These excess payments will be phased down 
beginning in FY 2002 and, as shown in the table, are projected to 
result in a cumulative FFP reduction of $5.4 billion by FY 2006. (Note: 
Our estimates do not include excess payment amounts subject to the 2-
year transition period for non-compliant plan amendments effective on 
or after October 1, 1999, since these payment amounts are not included 
in the President's FY 2001 budget baseline. According to fiscal impact 
estimates submitted with State plan amendments, these plans entail 
about $0.9 billion in annual FFP for enhanced payments.) Because some 
States may be using the Federal share of enhanced payments in a manner 
that allows some funds to be reinvested in Medicaid (and thereby 
drawing down additional FFP), the potential impact of this reduction in 
FFP may extend to other Medicaid services not reflected in the above 
spending.
    It is important to note that, although it will reduce FFP on excess 
enhanced payments as estimated above, this regulation does not reduce 
the overall aggregate amount States can spend on Medicaid services or 
place a fixed ceiling on the amount of State spending that will be 
eligible for Federal matching dollars. Under the limitations in this 
final rule, States will be able to set reasonable rates as determined 
under Medicare payment principles for Medicaid services furnished by 
public facilities to eligible individuals. The amount of spending 
permitted under the limits will vary directly with the amount of 
Medicaid services furnished by public facilities to eligible 
individuals. While this final rule does not affect the overall 
aggregate amount States can spend, by setting an upper payment limit 
for government facilities, it may impact how States distribute 
available funding to participating health care facilities.
    In addition to potential reductions in FFP, this rule will also 
provide opportunities for increased spending through the provisions 
which increase the UPL for non-State government-owned or operated 
hospitals to 150 percent of the amount which would have been paid for 
inpatient or outpatient services under Medicare payment principles. As 
shown in the table, based on current projections of Medicaid fee-for-
service inpatient and outpatient expenditures, we estimate that 
increasing payment rates for these services to 150 percent of Medicare-
based rates could add $4 billion to federal reimbursements for State 
Medicaid expenditures over the next six years.

Impact on Medicaid Spending Beyond the Current Budget Baseline

    Projections completed since the President's FY 2001 budget now 
indicate that the Federal share of enhanced payments to government 
facilities that are not State-owned or operated could reach $10 billion 
per year by FY 2006 and may account for cumulative spending of more 
than $90 billion over the next ten years. These projections include 
States with approved or pending plan amendments and assume that one-
half of the remaining States would eventually submit amendments 
providing for enhanced payments in the absence of these revised rules.
    Based on the preceding budget analysis, potentially two-thirds of 
these enhanced payments could be in excess of the upper payment limits 
imposed by this final rule and could result in FFP reductions of nearly 
$55 billion over the next 10 years.
    Since our estimates of the potential impact of the policies 
implemented by this regulation exceed $100 million annually, we 
consider this final rule to be a major rule.

Audit Results From the Office of the Inspector General (OIG)

    Earlier this year, OIG initiated audits on 7 hospital and nursing 
facility rate enhancement programs in 6 States. The OIG has completed 
and forwarded draft audit reports to HCFA on 4 nursing facility 
programs. These audit reports provide considerable detail on each 
State's enhancement program. The reports also illustrate how each 
audited program would be impacted if States reduced payments to the new 
allowable UPL levels and chose not to reinvest the excess payments to 
support other Medicaid activities that are eligible for Federal 
matching. In the table below, we have listed the dollar amounts 
associated with each State's enhancement program. The table shows the 
base amount, the new UPL at the end of the transition period, and the 
amount in the base that exceeds the new UPL.

[[Page 3174]]



                                                OIG State Report
                                              [Dollars in millions]
----------------------------------------------------------------------------------------------------------------
                                                                       Base                        Excess above
                             State                                 enhancement    New UPL amount        UPL
----------------------------------------------------------------------------------------------------------------
Pennsylvania...................................................           $858           $127            $731
Alabama........................................................             28.8            1.55           27.25
Nebraska.......................................................             47.6           11              36.6
Washington State...............................................             76.2            2.8            73.4
                                                                ------------------------------------------------
    Total......................................................           1005.6          142.35          863.25
----------------------------------------------------------------------------------------------------------------

C. Effects on Providers

    The chart below indicates the types and number of providers 
potentially affected by this final rule in all 50 States and the 
District of Columbia. We included facilities in all 50 States because 
although not every State is currently making enhanced payments to 
government non-State-owned or -operated facilities, this rule will 
prevent new proposals from all States in the future. We do not believe 
any State has payment arrangements with providers of ICF/MR services or 
clinic services that will be affected by this final rule and, 
therefore, we did not include those providers in the chart below.

                                Potentially Affected Providers by Number and Type
----------------------------------------------------------------------------------------------------------------
                                                                    Government    Government Non-
                          Provider type                           State-owned or  State-owned or       Total
                                                                      operated       operated
----------------------------------------------------------------------------------------------------------------
Nursing Facilities..............................................         \1\ N/A             892             892
Hospitals.......................................................         \2\ 254           1,275          1,529
----------------------------------------------------------------------------------------------------------------
\1\ These facilities are already subject to a separate aggregate upper payment limit and will not be affected by
  the final rule.
\2\ Only hospitals that provide outpatient hospital services may be impacted as inpatient hospital services are
  already subject to a separate aggregate limit.

    As explained earlier in the preamble, it is very difficult to 
predict how States will respond to this final rule and consequently how 
State decisions will impact Medicaid providers. Each State makes its 
own budgetary and rate setting decisions. Since we do not collect 
information about the specific services that facilities use Medicaid 
payments to support, we cannot determine how potential payment rate 
adjustments will affect providers or the patients they serve. Under the 
upper payment limits in this final rule, States will continue to be 
able to set rates that provide fair compensation for Medicaid services 
furnished to Medicaid patients. In addition, hospitals owned or 
operated by local governments could still receive higher payments than 
other hospitals since this rule provides for a higher upper payment 
limit for the facilities. We believe this will ensure Medicaid access 
to the safety-net providers and minimize the impact on those providers. 
Additionally, if these hospitals furnish services to indigent patients, 
they may qualify as a DSH and qualify for funding under a State's 
program.
    With respect to the impact on small rural hospitals, we do not 
believe the final rule will have a significant overall impact on rural 
hospitals. With respect to Medicaid services furnished by rural 
hospitals, the upper payment limits in the final rule do not interfere 
with States setting rates that result in fair compensation. 
Additionally, rural hospitals that are owned or operated by local 
governments should be able to benefit from the higher upper payment 
limits for inpatient and outpatient hospital services. Finally, if a 
rural hospital provides services to indigent patients, they may qualify 
as a DSH and qualify for funding under a State's DSH payment program.

D. Alternatives Considered

    Section 1902(a)(30) of the Act requires in part that Medicaid 
service payments be consistent with efficiency and economy. In addition 
to the interpretation we are providing in this final rule, we 
considered several other alternatives to ensure Medicaid service 
payments are consistent with economy and efficiency. In this section, 
we will explain these other alternatives and why we did not select 
them.
1. Facility-Specific Upper Payment Limit
    Under this option, Medicaid spending would be limited to a 
provider-specific application of Medicare payment principles. FFP would 
not be available on the amount of Medicaid service payment in excess of 
what a provider would have been paid using Medicare payment principles. 
These limits would be applied to all institutions, or just to public 
institutions where the incentives for overpayment are significant. 
While a facility-specific limitation may be the most effective method 
to ensure State service payments are consistent with economy and 
efficiency, when balanced against the additional administrative 
requirements on States and HCFA, coupled with Congressional intent for 
States to have flexibility in rate setting, we are not sure that the 
increased amount of cost efficiency, if any, justifies this approach as 
a viable option.
2. Government-Owned or Operated Facilities Upper Payment Limit
    This option would limit, in the aggregate, the amount of payment 
States can make to public providers. Under this option, State and local 
government providers would be grouped together and payments to them as 
a group could not exceed an aggregate limit. The aggregate limit would 
continue to be based on Medicare payment principles. This option, 
relative to upper payment limitations provided in this final rule, 
would have allowed States to exercise more flexibility granted to them 
in the rate setting process. While this option permits more 
flexibility, we believe the

[[Page 3175]]

aggregation of Medicaid service payments by all types of government 
providers would have the unintended consequence of reopening 
differential rate issues between State facilities and other types of 
government facilities.
3. Intergovernmental Transfers (IGTs)
    Because in many cases we believe there is a connection between 
excessive payments and IGTs, we gave consideration to formulating 
policy with respect to them. Generally, States have a genuine incentive 
to set Medicaid service rates at levels consistent with economy and 
efficiency since they share the financial responsibility with the 
Federal Government. However, as explained earlier, the ability of 
government counties to make IGTs create incentives for States to 
overpay these government facilities to generate enhanced Federal 
matching payment. However, we did not pursue this alternative because 
we recognize that States, counties, and cities have developed their own 
unique arrangements for sharing in Medicaid costs. Furthermore, there 
are statutory limitations placed on the Secretary which limit the 
authority to place restrictions on IGTs.
4. ``Grandfathering'' Existing Arrangements
    Under this option, we would not approve any new plan amendments 
after the effective date of the final rule but would allow those that 
have been approved to continue operating. This would permit States that 
are currently making excessive payments to local government facilities 
to continue making such payments indefinitely. However, allowing some 
States to permanently continue making excessive payments solely because 
they were approved before this rule is published and effective appears 
to be arbitrary, capricious, and inconsistent with our administrative 
authority.

E. The Unfunded Mandates Act

    The Unfunded Mandate Reform Act of 1995 also requires (in section 
202) that agencies perform an assessment of anticipated costs and 
benefits before proposing a rule that may result in a mandated 
expenditure in any one year by State, local, or Tribal governments, in 
aggregate, or by the private sector, of $100 million. Absent FFP, we do 
not believe States will continue to set excessive payment rates for 
Medicaid services furnished by government providers. Generally, 
discontinuing an expenditure should not result in new costs, unless the 
State has to fund the portion of the expenditure that is no longer 
Federally funded with all State and local dollars. There are no Federal 
requirements under the Medicaid statute that mandate States to make 
these types of excessive Medicaid payments to public providers. To the 
contrary, the Medicaid statute requires that Medicaid plans ensure that 
payments to providers under the State Medicaid plan are consistent with 
efficiency and economy. Under the standard set forth in this rule, 
State Medicaid payments to providers under the State Medicaid plan may 
be set at levels that are consistent with efficiency and economy, and 
no additional payments are required. We do not believe the aggregate 
upper payment limits in this final rule have any unfunded mandate 
implications because they do not require any additional expenditures by 
States to providers under their Medicaid program.

F. Federalism

    Executive Order 13132 establishes certain requirements that an 
agency must meet when it promulgates a proposed rule (and subsequent 
final rule) that imposes substantial direct compliance costs on State 
and local governments, preempts State law, or otherwise has Federalism 
implications. In developing the interpretative policies set forth in 
this final rule, we met with interested parties and listened to their 
ideas and concerns. These discussions were held with members of 
Congress and their staff and with various associations representing 
State and local governments, including the National Governors' 
Association, the National Conference of State Legislatures, and the 
National Association of State Medicaid Directors. In addition, we met 
with many hospital associations, advocacy groups, labor organizations, 
and numerous other interested parties.

G. Conclusion

    The financial implications of this final rule are highly uncertain 
for the reasons we have previously indicated. We anticipate that many 
State Medicaid programs will be unaffected by the upper payment limits. 
With respect to affected States, to some degree we will be limiting 
flexibility in the management of their Medicaid programs. If these 
States wish to continue to make payments in excess of the aggregate 
upper payment limits, they will have to fund the excess amount with 
only State and local resources. In the absence of FFP, we anticipate 
States will reinvest these resources to support other Medicaid 
activities to take advantage of and maintain Federal resources. Should 
States realign their payment systems or divert State matching dollars 
to support other Medicaid activities, the total amount of available 
Federal funds should remain unchanged.

Executive Order 12866

    In accordance with the provisions of Executive Order 12866, this 
final rule was reviewed by the Office of Management and Budget.

List of Subjects in 42 CFR Part 447

    Accounting, Administrative practice and procedure, Drugs, Grant 
programs-health, Health facilities, Health professions, Medicaid, 
Reporting and recordkeeping requirements, Rural areas.
    42 CFR part 447 is amended as set forth below:

PART 447--PAYMENTS FOR SERVICES

    1. The authority citation for part 447 continues to read as 
follows:

    Authority: Sec. 1102 of the Social Security Act (42 U.S.C. 
1302).


    2. Section Sec. 447.272 is revised to read as follows:


Sec. 447.272  Inpatient services: Application of upper payment limits.

    (a) Scope. This section applies to rates set by the agency to pay 
for inpatient services furnished by hospitals, NFs, and ICFs/MR within 
one of the following categories:
    (1) State government-owned or operated facilities (that is, all 
facilities that are either owned or operated by the State).
    (2) Non-State government-owned or operated facilities (that is, all 
government facilities that are neither owned nor operated by the 
State).
    (3) Privately-owned and operated facilities.
    (b) General rule. Except as provided in paragraph (c) of this 
section, aggregate Medicaid payments to a group of facilities within 
one of the categories described in paragraph (a) of this section may 
not exceed a reasonable estimate of the amount that would be paid for 
the services furnished by the group of facilities under Medicare 
payment principles in subchapter B of this chapter.
    (c) Exceptions--(1) Non-State government-owned or operated 
hospitals. The aggregate Medicaid payments may not exceed 150 percent 
of a reasonable estimate of the amount that would be paid for the 
services furnished by these hospitals under Medicare payment principles 
in subchapter B of this chapter.

[[Page 3176]]

    (2) Indian Health Services and tribal facilities. The limitation in 
paragraph (b) of this section does not apply to Indian Health Services 
facilities and tribal facilities that are funded through the Indian 
Self-Determination and Education Assistance Act (Public Law 93-638).
    (3) Disproportionate share hospitals. The limitation in paragraph 
(b) of this section does not apply to payment adjustments made under 
section 1923 of the Act that are made under a State plan to hospitals 
found to serve a disproportionate number of low-income patients with 
special needs as provided in section 1902(a)(13)(A)(iv) of the Act. 
Disproportionate share hospital (DSH) payments are subject to the 
following limits:
    (i) The aggregate DSH limit using the Federal share of the DSH 
limit under section 1923(f) of the Act.
    (ii) The hospital-specific DSH limit in section 1923(g) of the Act.
    (iii) The aggregate DSH limit for institutions for mental disease 
(IMDs) under section 1923(h) of the Act.
    (d) Compliance date. Except as permitted under paragraph (e) of 
this section, a State must comply with the upper payment limit 
described in paragraph (b) of this section by March 13, 2001.
    (e) Transition periods--(1) Definitions. For purposes of this 
paragraph, the following definitions apply:
    (i) Transition period refers to the period of time beginning March 
13, 2001 through the end of one of the schedules permitted under 
paragraph (e)(2)(ii) of this section.
    (ii) UPL stands for the maximum payment level under the upper 
payment limit described in paragraph (b) of this section for the 
referenced year.
    (iii) X stands for the payments to a specific group of providers 
described in paragraphs (a)(2) and (a)(3) of this section in State FY 
2000 that exceeded the amount that would have been under the upper 
payment limit described in paragraph (b) of this section if that limit 
had been applied to that year.
    (2) General rules. (i) The amount that a State's payment exceeded 
the upper payment limit described in paragraph (b) of this section must 
not increase.
    (ii) A State with an approved State plan amendment payment 
provision effective on one of the following dates and that makes 
payments that exceed the upper payment limit described in paragraph (b) 
of this section to providers described in paragraphs (a)(2) and (a)(3) 
of this section may follow the respective transition schedule:
    (A) For approved plan provisions that are effective on or after 
October 1, 1999, payments may exceed the limit in paragraph (b) of this 
section until September 30, 2002.
    (B) For approved plan provisions that are effective after October 
1, 1992 and before October 1, 1999, payments during the transition 
period may not exceed the following--
    (1) For State FY 2003: State FY 2003 UPL + .75X.
    (2) For State FY 2004: State FY 2004 UPL + .50X.
    (3) For State FY 2005: State FY 2005 UPL + .25X.
    (4) For State FY 2006; State FY 2006 UPL.
    (C) For approved plan provisions that are effective on or before 
October 1, 1992, payments during the transition period may not exceed 
the following:
    (1) For State FY 2004: State FY 2004 UPL + .85X.
    (2) For State FY 2005: State FY 2005 UPL + .70X.
    (3) For State FY 2006: State FY 2006 UPL + .55X.
    (4) For State FY 2007: State FY 2007 UPL + .40X.
    (5) For State FY 2008: State FY 2008 UPL + .25X.
    (6) For the portion of State FY 2009 before October 1, 2008: State 
FY 2009 UPL + .10X.
    (7) Beginning October 1, 2008: UPL described in paragraph (b) of 
this section.
    (8) When State FY 2003 begins after September 30, 2002, the 
reduction schedule in paragraphs (e)(2)(ii)(C)(1) through 
(e)(2)(ii)(C)(7) will begin on State FY 2003.
    (iii) If a State meets the criteria in paragraph (e)(2)(ii) of this 
section and its State plan amendment expires before the end of the 
applicable transition period, the State may continue making payments 
that exceed the UPL described in paragraph (b) of this section in 
accordance with the applicable transition schedule described in 
paragraph (e)(2)(ii) of this section.
    (f) Reporting requirements. If the reporting requirements in 
paragraphs (f)(1) and (f)(2) of this section apply, a State must 
include payments for services furnished during the entire State FY.
    (1) Non-State government-owned or operated hospitals. If a State 
makes payments to a group of facilities in this category that exceed 
the limit under paragraph (b) of this section, the agency must annually 
report the following information to HCFA:
    (i) The total Medicaid payments made to each hospital described 
under paragraph (c)(1) of this section.
    (ii) The reasonable estimate of the amount that would be paid for 
the services furnished by each hospital under Medicare payment 
principles.
    (2) Payments during the transition periods. States that are 
eligible for a transition period described in paragraph (e) of this 
section, and that make payments that exceed the limit under paragraph 
(b) of this section, must report annually the following information to 
HCFA:
    (i) The total Medicaid payments made to each facility.
    (ii) A reasonable estimate of the amount that would be paid for the 
services furnished by the facility under Medicare payment principles.

    3. Section 447.304 is amended by revising paragraph (c) and the 
note that follows paragraph (c) to read as follows:


Sec. 447.304  Adherence to upper limits; FFP.

* * * * *
    (c) FFP is not available for a State's expenditures for services 
that are in excess of the amounts allowable under this subpart.

    Note: The Secretary may waive any limitation on reimbursement 
imposed by subpart F of this part for experiments conducted under 
section 402 of Pub. L. 90-428, Incentives for Economy 
Experimentation, as amended by section 222(b) of Pub. L. 92-603, and 
under section 222(a) of Pub. L. 92-603.


    4. Section 447.321 is revised to read as follows:


Sec. 447.321  Outpatient hospital and clinic services: Application of 
upper payment limits.

    (a) Scope. This section applies to rates set by the agency to pay 
for outpatient services furnished by hospitals and clinics within one 
of the following categories:
    (1) State government-owned or operated facilities (that is, all 
facilities that are either owned or operated by the State).
    (2) Non-State government-owned or operated facilities (that is, all 
government facilities that are neither owned nor operated by the 
State).
    (3) Privately-owned and operated facilities.
    (b) General rule. Except as provided for in paragraph (c) of this 
section, aggregate Medicaid payments to a group of facilities within 
one of the categories described in paragraph (a) of this section may 
not exceed a reasonable estimate of the amount that would be paid for 
the services furnished by the group of facilities under Medicare 
payment principles specified in subchapter B of this chapter.
    (c) Exceptions--(1) Non-State government-owned or operated

[[Page 3177]]

hospitals. The aggregate Medicaid payments may not exceed 150 percent 
of a reasonable estimate of the amount that would be paid for the 
services furnished by these hospitals under Medicare payment principles 
in subchapter B of this chapter.
    (2) Indian Health Services and tribal facilities. The limitation in 
paragraph (b) of this section does not apply to Indian Health Services 
facilities and tribal facilities that are funded through the Indian 
Self-Determination and Education Assistance Act (Public Law 93-638).
    (d) Compliance date. Except as permitted under paragraph (e) of 
this section, a State must comply with the upper payment limit 
described in paragraph (b) of this section by March 13, 2001.
    (e) Transition periods--(1) Definitions. For purposes of this 
paragraph, the following definitions apply:
    (i) Transition period refers to the period of time beginning March 
13, 2001 through the end of one of the schedules permitted under 
paragraph (e)(2)(ii) of this section.
    (ii) UPL stands for the maximum payment level under the upper 
payment limit described in paragraph (b) of this section for the 
referenced year.
    (iii) X stands for the payments to a specific group of providers 
described in paragraph (a) of this section in State FY 2000 that 
exceeded the amount that would have been under the upper payment limit 
described in paragraph (b) of this section if that limit had been 
applied to that year.
    (2) General rules. (i) The amount that a State's payment exceeded 
the upper payment limit described in paragraph (b) of this section must 
not increase.
    (ii) A State with an approved State plan amendment payment 
provision effective on one of the following dates and that makes 
payments that exceed the upper payment limit described in paragraph (b) 
of this section to providers described in paragraph (a) of this section 
may follow the respective transition schedule:
    (A) For approved plan provisions that are effective on or after 
October 1, 1999, payments may exceed the limit in paragraph (b) of this 
section until September 30, 2002.
    (B) For approved plan provisions that are effective after October 
1, 1992 and before October 1, 1999, payments during the transition 
period may not exceed the following--
    (1) For State FY 2003: State FY 2003 UPL + .75X.
    (2) For State FY 2004: State FY 2004 UPL + .50X.
    (3) For State FY 2005: State FY 2005 UPL + .25X.
    (4) For State FY 2006; State FY 2006 UPL.
    (C) For approved plan provisions that are effective on or before 
October 1, 1992, payments during the transition period may not exceed 
the following:
    (1) For State FY 2004: State FY 2004 UPL + .85X.
    (2) For State FY 2005: State FY 2005 UPL + .70X.
    (3) For State FY 2006: State FY 2006 UPL + .55X.
    (4) For State FY 2007: State FY 2007 UPL + .40X.
    (5) For State FY 2008: State FY 2008 UPL + .25X.
    (6) For the portion of State FY 2009 before October 1, 2008: State 
FY 2009 UPL + .10X.
    (7) Beginning October 1, 2008: UPL described in paragraph (b) of 
this section.
    (8) When State FY 2003 begins after September 30, 2002, the 
reduction schedule in paragraphs (e)(2)(ii)(C)(1) through 
(e)(2)(ii)(C)(7) will begin on State FY 2003.
    (iii) If a State meets the criteria in paragraph (e)(2)(ii) of this 
section and its State plan amendment expires before the end of the 
applicable transition period, the State may continue making payments 
that exceed the UPL described in paragraph (b) of this section in 
accordance with the applicable transition schedule described in 
paragraph (e)(2)(ii) of this section.
    (f) Reporting requirements. If the reporting requirements in 
paragraphs (f)(1) and (f)(2) of this section apply, a State must 
include payments for services furnished during the entire State FY.
    (1) Non-State government-owned or operated hospitals. If a State 
makes payments to a group of facilities in this category that exceed 
the limit under paragraph (b) of this section, the agency must annually 
report the following information to HCFA:
    (i) The total Medicaid payments made to each hospital described 
under paragraph (c)(1) of this section.
    (ii) The reasonable estimate of the amount that would be paid for 
the services furnished by each hospital under Medicare payment 
principles.
    (2) Payments during the transition periods. States that are 
eligible for a transition period described in paragraph (e) of this 
section, and that make payment that exceed the limit under paragraph 
(b) of this section, must report annually the following information to 
HCFA:
    (i) The total Medicaid payments made to each facility.
    (ii) A reasonable estimate of the amount that would be paid for the 
services furnished by the facility under Medicare payment principles.

(Catalog of Federal Domestic Assistance Program No. 93.778, Medical 
Assistance Program)

    Dated: December 20, 2000.
Robert A. Berenson,
Acting Deputy Administrator, Health Care Financing Administration.
    Dated: December 20, 2000.
Donna E. Shalala,
Secretary.
[FR Doc. 01-635 Filed 1-5-01; 11:30 am]
BILLING CODE 4120-01-P