[Federal Register Volume 68, Number 110 (Monday, June 9, 2003)]
[Rules and Regulations]
[Pages 34494-34515]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-14492]



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Part II





Department of Health and Human Services





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Centers for Medicare & Medicaid Services



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42 CFR Part 412



Medicare Program; Change in Methodology for Determining Payment for 
Extraordinarily High-Cost Cases (Cost Outliers) Under the Acute Care 
Hospital Inpatient and Long-Term Care Hospital Prospective Payment 
Systems; Final Rule

  Federal Register / Vol. 68 , No. 110 / Monday, June 9, 2003 / Rules 
and Regulations  

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DEPARTMENT OF HEALTH AND HUMAN SERVICES

Centers for Medicare & Medicaid Services

42 CFR Part 412

[CMS-1243-F]
RIN 0938-AM41


Medicare Program; Change in Methodology for Determining Payment 
for Extraordinarily High-Cost Cases (Cost Outliers) Under the Acute 
Care Hospital Inpatient and Long-Term Care Hospital Prospective Payment 
Systems

AGENCY: Centers for Medicare & Medicaid Services (CMS), HHS.

ACTION: Final rule.

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SUMMARY: In this final rule, we are revising the methodology for 
determining payments for extraordinarily high-cost cases (cost 
outliers) made to Medicare-participating hospitals under the acute care 
hospital inpatient prospective payment system (IPPS).
    Under the existing outlier methodology, the cost-to-charge ratios 
from hospitals' latest settled cost reports are used in determining a 
fixed-loss amount cost outlier threshold. We have become aware that, in 
some cases, hospitals' recent rate-of-charge increases greatly exceed 
their rate-of-cost increases. Because there is a time lag between the 
cost-to-charge ratios from the latest settled cost report and current 
charges, this disparity in the rate-of-increases for charges and costs 
results in cost-to-charge ratios that are too high, which in turn 
results in an overestimation of hospitals' current costs per case. 
Therefore, we are revising our outlier payment methodology to ensure 
that outlier payments are made only for truly expensive cases.
    We also are revising the methodology used to determine payment for 
high-cost outlier and short-stay outlier cases that are made to 
Medicare-participating long-term care hospitals (LTCHs) under the long-
term care hospital prospective payment system (LTCH PPS). The policies 
for determining outlier payment under the LTCH PPS are modeled after 
the outlier payment policies under the IPPS.

EFFECTIVE DATE: The provisions of this final rule are effective on 
August 8, 2003.

FOR FURTHER INFORMATION CONTACT: Stephen Phillips, (410) 786-4548 (IPPS 
Outlier Policy) Miechal Lefkowitz, (410) 786-5316 (LTCH PPS Outlier 
Policy)

SUPPLEMENTARY INFORMATION: 

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I. Background

A. Description of the Acute Care Hospital Inpatient Prospective Payment 
System (IPPS)

    Section 1886(d) of the Social Security Act (the Act) sets forth a 
system of payment for the operating costs of acute care hospital 
inpatient stays under Medicare Part A (Hospital Insurance) based on 
prospectively set rates. This payment system is referred to as the 
acute care hospital inpatient prospective payment system (IPPS). Under 
the IPPS, each case is categorized into a diagnosis-related group 
(DRG). Each DRG has a payment weight assigned to it, based on the 
average resources used to treat Medicare patients in that DRG.
    The IPPS base payment rate (also referred to as the average 
standardized amount) is divided into a labor-related share and a 
nonlabor-related share. The labor-related share is adjusted by the wage 
index applicable to the area where the hospital is located, and if the 
hospital is located in Alaska or Hawaii, the nonlabor-related share is 
adjusted by a cost-of-living adjustment factor. This base payment rate 
is multiplied by the DRG relative weight.
    If a hospital treats a high percentage of low-income patients, it 
receives a percentage add-on payment applied to the DRG-adjusted base 
payment rate. This add-on payment, known as the disproportionate share 
hospital (DSH) adjustment, provides for a percentage increase in 
Medicare payments to hospitals that qualify under either of two 
statutory formulas that are designed to identify hospitals that serve a 
disproportionate share of low-income patients. For qualifying 
hospitals, the amount of the DSH adjustment may vary based on the 
outcome of the statutory calculation.
    Also, if a hospital is an approved teaching hospital it receives a 
percentage add-on payment for each case paid under the IPPS. This add-
on payment, known as the indirect medical education (IME) adjustment, 
varies depending on the ratio of residents-to-beds for operating costs 
and according to the ratio of residents-to-average daily census for 
capital costs under the IPPS.
    Additional payments may be made for cases that involve new 
technologies that have been approved for special add-on payments. In 
order to qualify, a new technology must demonstrate that it is a 
substantial clinical improvement over technologies otherwise available, 
and that, absent an add-on payment, it would be inadequately paid under 
the regular DRG payment.
    For particular cases that are unusually costly, known as outlier 
cases (discussed below), the IPPS payment is increased. This additional 
payment is designed to protect a Medicare-participating hospital from 
large financial losses due to unusually expensive cases. Any outlier 
payment due to the hospital is added to the DRG-adjusted base payment 
rate, plus any DSH, IME, and new technology add-on adjustments.
    The regulations governing payments for operating costs under the 
IPPS are located in 42 CFR Part 412. The specific regulations governing 
payments for outlier cases are located at 42 CFR 412.80 through 412.86.
    Section 1886(g) of the Act requires the Secretary to pay for the 
capital-related costs of inpatient hospital services ``in accordance 
with a prospective payment system established by the Secretary.'' The 
basic methodology for determining capital prospective payments is set 
forth in our regulations at Sec. Sec.  412.308 and 412.312. Under the 
capital prospective payment system, payments are adjusted by the same 
DRG for the case as they are under the operating IPPS. Similar 
adjustments are also made for IME and DSH as under the operating IPPS. 
Hospitals also may receive a capital outlier payment for those cases 
that qualify.

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B. Payment for Outlier Cases

1. General
    Section 1886(d)(5)(A) of the Act provides for Medicare payments to 
Medicare-participating hospitals in addition to the basic prospective 
payments for cases incurring extraordinarily high costs. To qualify for 
outlier payments, a case must have costs above a fixed-loss cost 
threshold amount (a dollar amount by which the costs of a case must 
exceed payments in order to qualify for outliers).
    Hospital-specific cost-to-charge ratios are applied to the covered 
charges for a case to determine whether the costs of the case exceed 
the fixed-loss outlier threshold. Payments for eligible cases are then 
made based on a marginal cost factor, which is a percentage of the 
costs above the threshold. For Federal fiscal year (FY) 2003, the 
existing fixed-loss outlier threshold is $33,560.
    The actual determination of whether a case qualifies for outlier 
payments takes into account both operating and capital costs and DRG 
payments. That is, the combined operating and capital costs of a case 
must exceed the fixed-loss outlier threshold to qualify for an outlier 
payment. The operating and capital costs are computed separately by 
multiplying the total covered charges by the operating and capital 
cost-to-charge ratios. The estimated operating and capital costs are 
compared with the fixed-loss threshold after dividing that threshold 
into an operating portion and a capital portion (by first summing the 
operating and capital ratios and then determining the proportion of 
that total comprised by the operating and capital ratios and applying 
these percentages to the fixed-loss threshold). The thresholds are also 
adjusted by the area wage index (and capital geographic adjustment 
factor) before being compared to the operating and capital costs of the 
case. Finally, the outlier payment is based on a marginal cost factor 
equal to 80 percent of the combined operating and capital costs in 
excess of the fixed-loss threshold (90 percent for burn DRGs).
    The following example simulates the IPPS outlier payment for a case 
at a generic hospital that receives IME and DSH payments in San 
Francisco, California (a large urban area). In the example, the patient 
was discharged after October 1, 2002, and the hospital incurred 
Medicare-covered charges of $150,000. The DRG assigned to the case was 
DRG 286 (Adrenal and Pituitary Procedures), which has a FY 2003 
relative weight of 2.0937. There is no new technology add-on payment 
for the case.
    Step 1: Determine the Federal operating and capital payment with 
IME and DSH adjustment based on the following values:

                            Operating Portion
------------------------------------------------------------------------
 
------------------------------------------------------------------------
National Large Urban Standardized Amounts:
    Labor-Related.........................................   $3,022.60
    Nonlabor-Related......................................   $1,228.60
San Francisco MSA Wage Index..............................        1.4142
IME Operating Adjustment Factor...........................        0.0744
DSH Operating Adjustment Factor...........................        0.1413
DRG 286 Relative Weight...................................        2.0937
Labor-Related Portion.....................................        0.711
Nonlabor-Related Portion..................................        0.289
------------------------------------------------------------------------

    Federal Payment for Operating Costs = DRG Relative Weight x 
[(Labor-Related Large Urban Standardized Amount x San Francisco MSA 
Wage Index) + Nonlabor-Related National Large Urban Standardized 
Amount] x (1 + IME + DSH): 2.0937 x [($3,022.60 x 1.4142) + $1,228.60] 
x (1 + 0.0744 + 0.1413) = $14,007.26

                             Capital Portion
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Federal Capital Rate......................................     $407.01
Large Urban Add-On........................................        1.03
San Francisco MSA Geographic Adjustment Factor............        1.2679
IME Capital Adjustment Factor.............................        0.0243
DSH Capital Adjustment Factor.............................        0.0631
------------------------------------------------------------------------

    Federal Payment for Capital Costs = DRG Relative Weight x Federal 
Capital Rate x Large Urban Add-On x Geographic Adjustment Factor x (1 + 
IME + DSH): 2.0937 x $407.01 x 1.03 x 1.2679 x (1 + 0.0243 + 0.0631) = 
$1,210.12
    Step 2: Determine operating and capital costs from billed charges 
by applying the respective cost-to-charge ratios.

------------------------------------------------------------------------
 
------------------------------------------------------------------------
Billed Charges.............................................     $150,000
Operating Cost-to-Charge Ratio.............................         0.50
Operating Costs = (Billed Charges x Operating Cost-to-           $75,000
 Charge Ratio) ($150,000 x .50)............................
Capital Cost-to-Charge Ratio...............................         0.06
Capital Costs = (Billed Charges x Capital Cost-to-Charge          $9,000
 Ratio) ($150,000 x .06)...................................
------------------------------------------------------------------------

    Step 3: Determine outlier threshold.

------------------------------------------------------------------------
 
------------------------------------------------------------------------
Fixed Loss Threshold.......................................      $33,560
Operating Cost-to-Charge Ratio to Total Cost-to-Charge
 Ratio:....................................................
  (Operating Cost-to-Charge Ratio) / (Operating Cost-to-          0.8929
   Charge Ratio + Capital Cost-to-Charge Ratio) (.50)/(.50
   + .06)..................................................
------------------------------------------------------------------------

    Operating Outlier Threshold = {[Fixed Loss Threshold x ((Labor-
Related portion x San Francisco MSA Wage Index) + Nonlabor-Related 
portion)] x Operating Cost-to-Charge Ratio to Total Cost-to-Charge 
Ratio{time}  + Federal Payment with IME and DSH: {$33,560 x 
[(0.711x1.4142) + 0.289] x 0.8929{time}  + $14,007.26=$52,797.78
    Capital Cost-to-Charge-Ratio to Total Cost-to-Charge Ratio = 
[(Capital Cost-to-Charge Ratio)/(Operating Cost-to-Charge Ratio + 
Capital Cost-to-Charge Ratio)]: {(.06)/(.50+.06){time}  = 0.1071
    Capital Outlier Threshold = (Fixed Loss Threshold x Geographic 
Adjustment Factor x Large Urban Add-On x Capital CCR to Total CCR) + 
Federal Payment with IME and DSH: ($33,560x1.2679x1.03x0.1071) + 
$1,210.12=$5,904.02
    Step 4: Determine outlier payment.

Marginal Cost Factor = 0.80
Outlier Payment = (Costs--Outlier Threshold) x Marginal Cost Factor
Operating Outlier Payment = ($75,000-$52,797.78) x 0.80=$17,761.78
    Capital Outlier Payment = ($9,000-$5,904.02) x 0.80=$2,476.78
2. Cost-to-Charge Ratios
    Under our existing regulation at Sec.  412.84(h), the operating 
cost-to-charge ratio and, effective with cost reporting periods 
beginning on or after October 1, 1991, the capital cost-to-charge ratio 
used to adjust covered charges are computed annually by the 
intermediary for each hospital based on the latest available settled 
cost report for that hospital and charge data for the same time period 
as that covered by the cost report.
    In the September 30, 1988 final rule with comment period published 
in the Federal Register (53 FR 38503), we initiated the use of 
hospital-specific cost-to-charge ratios to determine hospitals' costs 
for assessing whether a case qualified for payment as a cost outlier. 
Prior to that change, we determined the cost of discharges based on a 
nationwide cost-to-charge ratio of 60 percent. We indicated at the time 
that the use of hospital-specific cost-to-charge ratios is essential to 
ensure that outlier payments are made only for cases that have 
extraordinarily high costs, and not merely high charges.
    Currently, cost-to-charge ratios are determined using the most 
recent settled cost report for each hospital. At

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the end of the cost reporting period, Medicare charges from all claims 
are accumulated through the Provider Statistical and Reimbursement 
Report (PS&R). The PS&R contains data such as the number of discharges 
and the actual charges from each hospital. The hospital also submits a 
cost report to its fiscal intermediary, which is used to determine 
total allowable inpatient Medicare costs. Once all these data are 
available, the fiscal intermediary then determines the cost-to-charge 
ratio for the hospital by using charges from the PS&R and costs from 
the cost report.
    The Congress intended that outlier payments would be made only in 
situations where the cost of care is extraordinarily high in relation 
to the average cost of treating comparable conditions or illnesses. 
Under our existing outlier methodology, if hospitals' charges are not 
sufficiently comparable in magnitude to their costs, the legislative 
purpose underlying the outlier regulations is thwarted.
    Recent analysis indicates that some hospitals have taken advantage 
of two vulnerabilities in our methodology to maximize their outlier 
payments. One vulnerability is the time lag between the current charges 
on a submitted bill and the cost-to-charge ratio taken from the most 
recent settled cost report. The second vulnerability, in some cases, is 
that hospitals may increase their charges so far above costs that their 
cost-to-charge ratios fall below 3 standard deviations from the 
geometric mean of cost-to-charge ratios and a higher statewide average 
cost-to-charge ratio is applied. In a March 5, 2003 IPPS proposed rule 
(68 FR 10420) and a March 7, 2003 LTCH PPS proposed rule (68 FR 11234) 
that are discussed in sections II., III., IV., V., and VI., and section 
VII., respectively, of this final rule, we proposed to implement new 
regulations to correct these vulnerabilities and to ensure outlier 
payments are paid only for truly high-cost cases.
    Because the fixed-loss threshold is determined based on hospitals' 
historical charge data, hospitals that have been inappropriately 
maximizing their outlier payments have caused the threshold to increase 
dramatically for FY 2003, and even more dramatically for the proposed 
IPPS FY 2004 outlier threshold of $50,645 (68 FR 27235, May 19, 2003). 
As illustrated by the table below, the IPPS cost outlier threshold 
increased by 80 percent from $9,700 in FY 1997 to $17,550 in FY 2001. 
In addition, the cost outlier threshold increased by 91 percent from 
$17,550 in FY 2001 to $33,560 in FY 2003. The proposed FY 2004 
threshold would be a 51-percent increase over the FY 2003 threshold. 
The table also demonstrates, for FYs 2000 and 2001, the level at which 
the threshold would have to have been set in order to result in outlier 
payments equal to 5.1 percent of total DRG payments (absent further 
behavioral responses by hospitals).\1\ We are required by section 
1886(d)(2)(E) of the Act to apply an offset to the average standardized 
amounts equal to the projected outlier payments as a percentage of 
total DRG payments. We have historically projected outlier payments to 
be 5.1 percent of total DRG payments.
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    \1\ We estimate the FY 2003 percent of outlier payments compared 
to total DRG payments is 6.1 percent. Although in the May 19, 2003 
FY 2004 IPPS proposed rule, we estimated this percentage to be 5.5 
percent, we have now determined that this percentage was 
underestimated.

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                                                                    Payments in
                                                                     excess of                    Threshold that
                                                      Outlier      target of 5.1      Outlier       would have
                   Fiscal year                      percentage      percent\1\       threshold     paid out 5.1
                                                                   (in billions                       percent
                                                                    of dollars)
----------------------------------------------------------------------------------------------------------------
1997............................................             5.5            $0.3          $9,700  ..............
1998............................................             6.5             1.0          11,050  ..............
1999............................................             7.6             1.8          11,100  ..............
2000............................................             7.6             1.8          14,050          21,825
2001............................................             7.7             1.9          17,550          26,200
2002............................................             7.9             2.5          21,025             (2)
2003............................................             6.1             (2)          33,560  ..............
----------------------------------------------------------------------------------------------------------------
\1\ All payments are estimated and reflect operating payments only (not capital payments).
\2\ Not available.

II. Issuance of Proposed Rules

    On March 5, 2003, we published in the Federal Register (68 FR 
10420) a proposed rule that would change the methodology for 
establishing how extraordinarily high-cost cases (cost-outliers) 
qualify for an outlier payment. On March 7, 2003, as part of the 
proposed rule published in the Federal Register (68 FR 11234) to update 
the payment rates and policies under the LTCH PPS, we included a 
proposal to apply a similar change in the methodology for establishing 
outlier payments for LTCHs. We proposed these changes in the payment 
methodology for both systems in order to correct situations in which 
rapid increases in charges by certain hospitals have resulted in their 
cost-to-charge ratios being set too high. Use of these cost-to-charge 
ratios has resulted in excessive outlier payments to these hospitals.
    We received approximately 582 timely pieces of correspondence on 
the provisions of the March 5, 2003 IPPS outlier proposed rule. We 
received approximately 22 timely pieces of correspondence on the 
provisions of the March 7, 2003 LTCH PPS proposed rule that related to 
payment for outlier cases. In this section of this final rule, we 
discuss comments we received that are not related to the specific 
changes we proposed, but are instead more general comments related to 
outlier payment policies. We also discuss in this section the general 
issue of allowing a transition period for the changes we are 
implementing.
    Comments directly related to specific proposals to revise the IPPS 
outlier payment policy and our responses to those comments are 
addressed in sections III., IV., V., and VI. of this final rule. 
Comments directly related to the specific proposed LTCH PPS outlier 
payment policy changes and our responses to those comments are 
addressed in section VII. of this final rule.
    We received a number of comments that, while directly or indirectly 
related to outlier policy, were unrelated to the policies discussed in 
the proposed rule. We have not responded to comments that are unrelated 
to the changes that were proposed in the March 5, 2003

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proposed rule and that are implemented in this final rule. We also 
received many detailed comments pertaining to specific implementation 
issues associated with these changes. We also are not addressing them 
in this final rule, but intend to issue implementation instructions 
separately and will respond to these comments at that time.
    Comment: One commenter suggested that we reinstitute day outliers 
as an alternative to the current case methodology for outlier payments. 
The commenter reasoned that day outliers would more fairly and 
equitably pay hospitals for treating high-cost cases and would allow 
for payment of an outlier based on the length of stay of a particular 
Medicare beneficiary.
    Response: Section 1886(d)(5)(A)(i) of the Act eliminates day 
outlier payments for discharges occurring on or after October 1, 1997. 
This provision was enacted in recognition of the fact that the high 
costs of a case are a preferable indicator of whether a case merits 
additional payments as an outlier than a long length stay. Furthermore, 
although we recognize that the issues with our current methodology for 
making outlier payments that are discussed in this final rule indicate 
the need for changes to that methodology, we believe that, after 
implementation of these changes, it will still be preferable to 
continue to use high costs to identify outlier cases.
    Comment: Several commenters argued that, in the past, CMS has 
provided a transition period for the introduction of the capital PPS 
and for the removal of graduate medical education salaries from the 
calculation of the IPPS wage index. Therefore, the commenters 
recommended that a similar transition period be applied for any changes 
to outliers as well.
    MedPAC recommended no transition period because, in recent years, 
some hospitals have received extra payments as a result of substantial 
outlier revenues. MedPAC further noted that this issue has been 
prominent in the news media for many months and hospitals have had 
sufficient opportunity to anticipate the end of these revenues and plan 
accordingly.
    Another commenter also suggested that a transition period was 
unnecessary and recommended an immediate implementation date because 
most of the proposed changes will benefit those hospitals that did not 
try to game the system. In addition, the commenter believed that the 
proposed changes are designed to correct program abuses and any 
transition period would serve no legitimate public purpose and would 
only delay the phaseout of an otherwise overstated threshold.
    Some commenters asked that CMS implement the proposals beginning on 
or after October 1, 2003, in order to allow fiscal intermediaries and 
hospitals adequate time to update their processing systems. The 
commenters added that if the proposals are implemented effective 
October 1, 2003, no disruption would be made mid-year to the cost 
report; that is, only entire cost reports would be reconciled once the 
cost report is final settled.
    Response: As discussed above, the current outlier payment 
methodology includes two distinct vulnerabilities that some hospitals 
have exploited to dramatically increase their outlier payments over a 
brief period of time by raising their charges in excess of increases in 
their costs. As these increases in outlier payments to those hospitals 
are reflected in the data used to calculate the outlier thresholds, 
they force the outlier threshold to rise so that the projected outlier 
payout is equal to the outlier offset to the standardized amounts. The 
result is that hospitals that do not aggressively increase their 
charges do not receive outlier payments or receive reduced outlier 
payments for truly costly cases.
    An extended transition period would allow the effects of this 
inappropriate redistribution of outlier payments to continue into the 
future. We believe it is essential to eliminate those effects as soon 
as possible in order to ensure that outlier payments are made only for 
truly high-cost cases. Although, for reasons discussed below, we are 
delaying implementation of some aspects of the changes we are making 
until October 1, 2003, we are not transitioning any of these changes 
beyond that date.

III. Updating Cost-to-Charge Ratios for IPPS Hospitals

A. Background and Provisions of the May 5, 2003 Proposed Rule

    Currently, we use the most recent settled cost report when 
determining cost-to-charge ratios for IPPS hospitals. Generally, the 
covered charges on bills submitted for payment during FY 2003 are 
converted to costs by applying a cost-to-charge ratio from cost reports 
that began in FY 2000 or, in some cases, FY 1999 or even earlier. These 
covered charges reflect all of a hospital's charge increases to date, 
in particular those that have occurred since FY 2000 and are not 
reflected in the FY 2000 cost-to-charge ratios. If a hospital's rate-
of-charge increases since FY 2000 exceeds the rate of the hospital's 
cost increases during that time, the hospital's cost-to-charge ratio 
based on its FY 2000 cost report will be too high, and applying it to 
current charges will overestimate the hospital's costs per case during 
FY 2003. Overestimating costs may result in some cases receiving 
outlier payments when these cases, in actuality, are not high-cost 
cases.
    Because a hospital has the ability to increase its outlier payments 
during the time lag between the current charges and the cost-to-charge 
ratio from the settled cost report, through dramatic charge increases, 
in the March 5, 2003 IPPS outlier payment proposed rule, we proposed 
new regulations at Sec.  412.84(i)(1) that would allow fiscal 
intermediaries to use more up-to-date data when determining the cost-
to-charge ratio for each hospital. As mentioned above, currently, 
fiscal intermediaries use the hospital's most recent settled cost 
report. We proposed to revise our regulations to specify that fiscal 
intermediaries will use either the most recent settled cost report or 
the most recent tentative settled cost report, whichever is from the 
later cost reporting period.
    Hospitals must submit their cost reports within 5 months after the 
end of their fiscal year. CMS makes a decision to accept a cost report 
within 30 days. Once the cost report is accepted, CMS makes a tentative 
settlement of the cost report within 60 days. The tentative settlement 
is a cursory review of the filed cost report to determine the amount of 
payment to be paid to the hospital if an amount is due on the as-filed 
cost report. After the cost report is tentatively settled, it can take 
12 to 24 months, depending on the type of review or audit, before the 
cost report is final-settled. Thus, using cost-to-charge ratios from 
tentative settled cost reports, as we proposed in the March 5, 2003 
proposed rule, reduces the time lag for updating cost-to-charge ratios 
by a year or more.
    However, even the later ratios calculated from the tentative 
settled cost reports would overestimate costs for hospitals that have 
continued to increase charges much faster than costs during the time 
between the tentative settled cost report period and the time when the 
claim is processed. That is, even though we proposed to reduce the lag 
in time by revising the regulations to use the latest tentative settled 
cost report rather than the latest settled cost report, if the cost 
report is from a later cost reporting period, there would still be a 
lag of 1 to 2 years during which a hospital's charges may still 
increase faster than costs. Therefore, we proposed to add a new 
provision to the regulations that, in the event more

[[Page 34498]]

recent charge data indicate that a hospital's charges have been 
increasing at an excessive rate (relative to the rate-of-increase among 
other hospitals), CMS would have the authority to direct the fiscal 
intermediary to change the hospital's operating and capital cost-to-
charge ratios to reflect the high charge increases evidenced by the 
later data. In addition, we proposed to allow a hospital to contact its 
fiscal intermediary to request that its cost-to-charge ratios, 
otherwise applicable, be changed if the hospital presents substantial 
evidence that the ratios are inaccurate. Any such requests would have 
to be approved by the CMS Regional Office with jurisdiction over that 
fiscal intermediary.

B. Summary of Public Comments and Departmental Responses

    Comment: Several commenters were troubled by our proposal that CMS 
would have the authority to direct fiscal intermediaries to change a 
hospital's cost-to-charge ratio based on excessive charges, and the 
proposal that would allow a hospital to contact its fiscal intermediary 
to request its cost-to-charge ratio be changed if the hospital presents 
substantial evidence to support its request. Specifically, the 
commenters requested that CMS establish clear guidelines for both 
processes and define what constitutes ``excessive charges'' and 
``substantial evidence.''
    One commenter noted that some hospital cost reports from 1997 have 
still not been settled. The commenter asked that there be a graduated 
update of the cost-to-charge ratio data, updating the data by no more 
than 2 years in any payment period. For example, the commenter stated, 
a hospital currently paid using 1997 data would be updated to 1999 in 
the first payment period under the new methodology and to 2001 in the 
second period.
    Response: Although we understand the commenters' desire that 
thresholds and parameters established in advance be used to determine 
when CMS will direct the fiscal intermediaries to apply a cost-to-
charge ratio different than one calculated using the latest tentative 
settled cost report or the latest settled cost report, whichever is 
from the latest period, we also believe it is important for CMS to have 
the flexibility to respond appropriately in the future if unforeseen 
evidence of similar manipulation of outlier payments comes to light. We 
believe that establishing fixed thresholds in the regulations or in 
preamble language could limit our ability to respond quickly to stop 
such abuse. In addition, we believe that predetermined and public 
thresholds can serve as benchmarks for those hospitals intending to 
inappropriately maximize outlier payments in the future and would allow 
hospitals to operate just below the threshold to avoid detection.
    With regard to the standards we would apply to determine whether we 
would direct the fiscal intermediaries to apply a different cost-to-
charge ratio (for example, ``excessive charges''), we would compare 
hospitals' rate-of-increase in charges to the rate-of-increase among 
other hospitals. Hospitals with increases in charges that are far above 
the national average rate-of-increase, for example, would be likely to 
have an alternative ratio assigned. These hospitals would then have the 
opportunity to request that an alternative ratio be assigned by 
presenting substantial evidence in support of their request. Such 
evidence, for example, would be documentation that the hospitals' costs 
had increased, leading to the increase in charges. At this time, we are 
still developing the specific procedures involved and plan to issue 
further guidance through program memoranda.
    However, we recognize that, for some hospitals, updating to the 
cost-to-charge ratio calculated using the latest tentative settled cost 
reports may represent a substantial leap forward in the data and a 
potentially large decrease in their cost-to-charge ratios. Although we 
believe it is appropriate that all hospitals' charges are adjusted by 
the most accurate cost-to-charge ratio when estimating costs, we 
recognize the potential negative impact that may occur for some 
hospitals solely due to the delay in settling their cost reports. 
Therefore, in this final rule, we are not mandating use of the latest 
settled or tentatively settled cost report for discharges occurring 
prior to October 1, 2003. This delay in the effective date from that 
proposed in the proposed rule should ease the burden of the change in 
cost-to-charge ratios for most hospitals.
    Although we are implementing the change to require the use of the 
latest of the settled or tentative settled cost report to compute the 
cost-to-charge ratio for discharges occurring on or after October 1, 
2003, we believe that it is necessary to implement the other proposed 
provision authorizing CMS to specify an alternative cost-to-charge 
ratio for some hospitals, to be effective for discharges occurring on 
or after August 8, 2003. Such an alternative would reflect available 
data, such as the most recent rate-of-increase in charges, to 
approximate the most accurate cost-to-charge ratio (which may include 
data in the latest tentatively settled cost report or other data that 
may be available).
    Although this provision will be effective for all hospitals 60 days 
after the date of publication of this final rule, we understand that, 
given the large workload and limited resources of our fiscal 
intermediaries, attempting to implement this provision for all 
hospitals receiving outlier payments at the same time would create an 
administrative burden. In addition, given the effective date of this 
final rule, most of the changes in this regulation will apply only for 
approximately the last 2 months of FY 2003. We are aware that hospitals 
have projected their outlier payments for the current fiscal year based 
on the policies in effect as of October 1, 2002, and any change in the 
middle of the fiscal year could disrupt their budgets. As a result, we 
intend to limit the impact of this provision during FY 2003 to ensure 
that the limited resources of fiscal intermediaries are focused upon 
updating the cost-to-charge ratios for those hospitals that appear to 
have disproportionately benefited from the time lag in updating their 
cost-to-charge ratios and to maintain the overall predictability of FY 
2003 payments for most hospitals. Accordingly, we intend to issue a 
program instruction in the near future to assist fiscal intermediaries 
in implementing this provision during the remainder of FY 2003. The 
criteria for FY 2004 will target a somewhat broader group of hospitals, 
but will still be limited to those hospitals that have benefited the 
most from the time lag in updating cost-to-charge ratios, and the 
majority of hospitals will not be affected.
    Comment: Some commenters suggested a transition period for 
implementing the adoption of the latest tentative settled cost-to-
charge ratios and gave a detailed recommendation of how the transition 
period would be implemented. The commenters recommended two different 
methods for how a transition period could be implemented:
    One recommendation was that FY 2002 would be considered the base 
year amount. The commenter explained that, beginning with the effective 
date of the final rule, hospitals would receive a blended cost-to-
charge ratio of its base year amount and the cost-to-charge ratio from 
the most recent tentative cost report. In the first year, hospitals' 
cost-to-charge ratios would consist of 66.7 percent from a base year 
and 33.3 percent from the most recent tentative settled cost report. In 
the second year the cost-to-charge ratio would consist of 33.3 percent 
from the base year and 66.7

[[Page 34499]]

percent from the most recent tentative settled cost report. In the 
third year, this gradual decrease from the base year could continue or 
CMS could cease from blending the cost-to-charge ratio.
    The second recommendation was a 3-year transition period using 
blended cost-to-charge ratios as follows: The first year would be 75 
percent of the old cost-to-charge ratio and 25 percent of the new. The 
second year would be 50 percent of the old cost-to-charge ratio and 50 
percent of the new cost-to-charge ratio. The third year would be 25 
percent of the old cost-to-charge ratio and 75 percent of the new cost-
to-charge ratio. During the transition period, CMS would monitor 
outlier payments to ensure they remain in statutory limits. Only those 
hospitals that have not been identified by CMS as having excessive 
outlier payments would qualify for the transition period.
    Response: As noted previously, we believe it is essential to 
eliminate the effects of the inappropriate redistribution of outlier 
payments as soon as possible; that is, by not allowing hospitals that 
have benefited from the time lag resulting from the use of the latest 
settled cost-to-charge ratios to continue to do so. We do not believe 
any transition period would be appropriate, as it would continue to 
lead to lower outlier payments to those hospitals that have already 
been harmed by the inappropriate redistribution of outliers described 
above. Therefore, although in this final rule we are delaying the 
effective date of this provision until discharges occurring on or after 
October 1, 2003, so that most hospitals that had relied on outlier 
payments based on existing policy may continue to do so for the 
remainder of the Federal fiscal year, we are not adopting the 
commenters' suggestions to further delay the effective date by allowing 
for a blended cost-to-charge ratio.
    Comment: Several other commenters offered different recommendations 
on how CMS should administer updating of a hospital's cost-to-charge 
ratio. One commenter recommended that hospitals be notified in advance 
of any change to their cost-to-charge ratio and be given the 
opportunity to appeal the fiscal intermediary's decision of any change 
to their cost-to-charge ratio. Another commenter suggested that 
parameters be set, such as those in Program Memorandums A-02-122 
(released December 3, 2002) and A-02-126 (released December 20, 2002), 
to determine when a cost-to-charge ratio should be updated. One 
commenter proposed that CMS use an expedited process when a hospital is 
requesting that its cost-to-charge ratio be decreased and not require 
the use of ``substantial evidence'' for a reduction. For increases in 
cost-to-charge ratios, the commenter suggested that CMS might want to 
reserve final approval and substantial evidence standards. Other 
commenters suggested that hospitals be provided with an expedited 
appeals process to resolve quickly any disputes with the fiscal 
intermediaries over the accuracy of their cost-to-charge ratios. Some 
commenters supported using a hospital's tentative settled cost report 
to update cost-to-charge ratios but believed that fiscal intermediaries 
should have discretion to change a hospital's cost-to-charge ratio.
    Response: As we proposed, in this final rule we are implementing a 
new regulation that specifies that CMS may direct the fiscal 
intermediary to change a hospital's operating and capital cost-to-
charge ratios to reflect the high-charge increases evidenced by the 
later data. Fiscal intermediaries will not have their own discretion to 
update a hospital's cost-to-charge ratio. Only CMS will have the 
authority to direct the fiscal intermediary that an update is necessary 
in the event more recent charge data indicates that a hospital's 
charges have been increasing at an excessive rate (relative to the 
rate-of-increase among other hospitals).

C. Provisions of the Final Rule Relating to Updating Cost-to-Charge 
Ratios

    We are establishing a new Sec.  412.84(i)(1), which specifies that, 
for discharges occurring on or after 60 calendar days after the date of 
publication of this final rule, in the event more recent charge data 
indicate that a hospital's charges have been increasing at an excessive 
rate (relative to the rate-of-increase among other hospitals), CMS may 
direct the fiscal intermediary to change the hospital's operating and 
capital cost-to-charge ratios to reflect the high-charge increases 
evidenced by the later data. A hospital may also request that its 
fiscal intermediary use a different (higher or lower) cost-to-charge 
ratio based on substantial evidence presented by the hospital. Before 
the change can go into effect, the CMS Regional Office must approve the 
request.
    We also are establishing Sec.  412.84(i)(2), which provides that, 
for discharges occurring on or after October 1, 2003, the operating and 
capital cost-to-charge ratios applied at the time a claim is processed 
are based on either the most recent settled cost report or the most 
recent tentative settled cost report, whichever is from the latest cost 
reporting period.

IV. Statewide Average Cost-to-Charge Ratios

A. Background and Provisions of the March 5, 2003 Proposed Rule

    As hospitals raise their charges faster than their costs increase, 
over time their cost-to-charge ratios will decline. If hospitals 
continue to increase charges at a faster rate than their costs increase 
over a long period of time, or if they increase charges at extreme 
rates, their cost-to-charge ratios may fall below the range considered 
reasonable under the regulations (0.194 for operating cost-to-charge 
ratios and 0.012 for capital cost-to-charge ratios in FY 2003 (67 FR 
50125)), and, under current regulations at Sec.  412.84(h), their 
fiscal intermediaries will assign a statewide average cost-to-charge 
ratio. These statewide averages are generally considerably higher than 
the threshold. Therefore, under existing regulations, these hospitals 
benefit from an artificially high ratio being applied to their already 
high charges. Furthermore, hospitals can continue to increase charges 
faster than costs, without any further downward adjustment to their 
cost-to-charge ratios.
    For example, in a 3-year span, one hospital was found to have an 
increase in charges of 60 percent from FY 1999 to FY 2000, 35 percent 
from FY 2000 to FY 2001, and 13 percent from FY 2001 to FY 2002. This 
hospital's actual operating cost-to-charge ratio for FY 2003 was 0.093. 
Because this number is below the threshold of 0.194, the fiscal 
intermediary assigned this hospital the statewide average cost-to-
charge ratio of 0.328 (from Table 8A of the August 1, 2002 IPPS final 
rule (67 FR 50263)). In this case, the assignment of the statewide 
average cost-to-charge ratio to this hospital increased the hospital's 
estimated costs per case far above the estimate using the actual ratio, 
leading to substantially higher outlier payments to the hospital as a 
result of this policy.
    In December 2002, we issued Program Memorandum A-02-122, which 
requested fiscal intermediaries to identify all hospitals receiving the 
statewide average operating or capital cost-to-charge ratio because 
their cost-to-charge ratios fell below the floor of reasonable 
parameters. We received a list of 43 hospitals that were assigned the 
statewide average operating cost-to-charge ratio and 14 hospitals that 
were receiving the statewide average capital cost-to-charge ratio. 
Three hospitals were found on both lists. Prior to application of the 
statewide average cost-to-charge ratios, the average actual operating 
cost-to-charge ratio for the 43 hospitals was 0.164, and the average 
actual capital cost-to-charge ratio for the

[[Page 34500]]

14 listed hospitals was 0.008. In contrast, the statewide average 
operating cost-to-charge ratio for the 43 hospitals was 0.3425 and the 
statewide average capital cost-to-charge ratio for the 14 hospitals was 
0.035.
    Because of hospitals' ability to increase their charges to lower 
their cost-to-charge ratios in order to be assigned the statewide 
average, in the March 5, 2003 proposed rule, we proposed to remove the 
requirement in our existing regulations that specified that a fiscal 
intermediary will assign a hospital the statewide average cost-to-
charge ratio when the hospital has a cost-to-charge ratio that falls 
below the floor. We proposed that hospitals would receive their actual 
cost-to-charge ratios, no matter how low their ratios fall.
    We proposed that statewide average cost-to-charge ratios would 
still apply in those instances in which a hospital's operating or 
capital cost-to-charge ratio exceeds the upper threshold. We indicated 
that cost-to-charge ratios above this range are probably due to faulty 
data reporting or entry and should not be used to identify and pay for 
outliers. In addition, we proposed that hospitals that have not yet 
filed their first Medicare cost reports with their fiscal 
intermediaries would still receive the statewide average cost-to-charge 
ratios.

B. Summary of Public Comments and Departmental Responses

    Comment: Many commenters supported the proposal to remove the 
existing requirement that specified that a fiscal intermediary will 
assign a hospital the statewide average cost-to-charge ratio when the 
hospital has a cost-to-charge ratio that falls below the floor. 
However, they argued that the requirement to use the statewide average 
ratio for those hospitals that are above 3 standard deviations from the 
geometric mean should also be removed. The commenters reasoned that the 
policy should be consistent for the floor and the ceiling. As an 
alternative to using the statewide average (instead of ratios above the 
ceiling), some commenters suggested that we reduce the parameter of 3 
standard deviations above the mean to a lower standard. Another 
commenter stated that CMS was acting in bad faith by eliminating the 
statewide average for the floor but not the ceiling.
    Response: The changes we are making in this final rule are in 
response to a specific problem associated with hospitals intentionally 
taking advantage of our policy to assign the statewide cost-to-charge 
ratios when a hospital's own ratio fell below the floor. There is no 
similar incentive for hospitals to increase their ratios to the 
ceiling. Also, we believe it is unlikely a hospital would maintain a 
cost-to-charge ratio as high as 3 standard deviations of the geometric 
mean over a period of years. Therefore, we continue to believe the 
statewide average should be assigned for those hospitals with ratios 
above the ceiling.
    Comment: One commenter argued that a transition period would be 
necessary because this change would have an immediate impact on 
affected hospitals' credit stability and patient service levels in 
certain regions. Another commenter suggested a transition period for 
those hospitals that did not engage in aggressive pricesetting. The 
commenter suggested a gradual phaseout of the statewide average. On the 
other hand, many commenters also supported the immediate elimination of 
the statewide average from the floor.
    Response: We believe that, for hospitals receiving the statewide 
average cost-to-charge ratio because their actual ratio fell below 3 
standard deviations below the geometric mean, their actual ratio is a 
more accurate reflection of the relationship between their costs and 
charges. Although it may not have been a specific objective of each 
hospital currently in this situation to increase charges until its 
ratio fell below the floor, we are not persuaded there is any 
justification to continue making outlier payments to these hospitals on 
the basis of a cost-to-charge ratio that clearly results in excessive 
outlier payments. Therefore, we are adopting as final the proposed 
change that eliminates the use of the statewide average for hospitals 
below 3 standard deviations from the geometric mean effective for 
discharges occurring on or after 60 calendar days after the date of 
publication of this final rule.

C. Provisions of the Final Rule Relating to Statewide Average Cost-to-
Charge Ratios

    We are implementing new regulations at Sec. Sec.  412.84(h) and 
(i)(1) that are effective 60 calendar days after the date of 
publication of this final rule, that remove the existing requirement 
that a fiscal intermediary will assign a hospital the statewide average 
cost-to-charge ratio when the hospital has a cost-to-charge ratio that 
falls below the floor. Hospitals will receive their actual cost-to-
charge ratios, no matter how low their ratios fall.
    The statewide average cost-to-charge ratios will still apply in 
those instances in which a hospital's operating or capital cost-to-
charge ratios fall outside of reasonable parameters (that is, exceed 
the upper threshold). In addition, hospitals that have not yet filed 
their first Medicare cost reports with their fiscal intermediaries 
would still receive the statewide average cost-to-charge ratios. CMS 
will continue to set forth the reasonable parameters and the statewide 
cost-to-charge ratios in each year's annual notice of prospective 
payment rates published in the Federal Register in accordance with 
Sec.  412.8(b).

V. Reconciling Outlier Payments Through Settled Cost Reports

A. Background and Provisions of the March 5, 2003 Proposed Rule

    Under the IPPS, hospitals submit a bill for each Medicare patient 
stay for which they expect a payment from Medicare. The bill includes 
information needed to: (1) Classify the case to a DRG; (2) determine 
whether the case was a transfer; (3) identify whether a new technology 
eligible for add-on payments was involved; and (4) calculate the costs 
of a case to determine whether it is eligible for an outlier payment or 
a new technology add-on payment. This latter calculation is based on 
the covered charges reported on the bill, which, as discussed above, 
are also used to estimate the covered costs of the case by applying the 
cost-to-charge ratio.
    The information from the bill is processed through the fiscal 
intermediary's claims processing system to determine the payment amount 
for each case. Unless a hospital qualifies for periodic interim 
payments under Sec.  412.116(b), or other interim payments, payment is 
made on the basis of the actual amount determined for each bill 
processed. For hospitals that qualify for periodic interim payments, 
the fiscal intermediary estimates a hospital's IPPS payments and makes 
biweekly payments equal to \1/26\ of the total estimated amount of 
payment for the year. However, outlier payments are not made on an 
interim basis, but are made on a claim-by-claim basis (even for 
hospitals that qualify for interim payments under Sec.  412.116(b)), 
and generally represent final payment (Sec.  412.116(e)). This policy 
is in contrast to payments under the IME adjustment and the DSH 
adjustment, both of which are routinely adjusted when hospitals' cost 
reports are settled to reflect updated data such as the number of 
residents or patient days during the actual cost reporting period.
    However, as stated earlier in this preamble, we are increasingly 
aware that some hospitals have taken advantage of the existing outlier 
policy

[[Page 34501]]

by increasing their charges at extremely high rates, knowing that there 
would be a time lag before their cost-to-charge ratios would be 
adjusted to reflect the higher charges. The steps we proposed in the 
March 5, 2003 proposed rule, and are implementing here, to direct 
fiscal intermediaries to update cost-to-charge ratios using the most 
recent tentative settled cost reports (and in some cases, even later 
data) and using actual rather than statewide average ratios for 
hospitals that have cost-to-charge ratios higher than 3.0 standard 
deviations below the geometric mean cost-to-charge ratio, would greatly 
reduce the opportunity for hospitals to manipulate the system to 
maximize outlier payments. However, these steps would not completely 
eliminate all such opportunity. A hospital would still be able to 
dramatically increase its charges by far above the rate-of-increase in 
costs during any given year. This possibility is of great concern, 
given the recent findings that some hospitals have been able to receive 
large outlier payments by doing just that.
    Therefore, we proposed to add a provision to our regulations to 
provide that outlier payments would become subject to reconciliation 
when hospitals' cost reports are settled. Under this policy, payments 
would be processed throughout the year using operating and capital 
cost-to-charge ratios based on the best information available at that 
time. We proposed that when the cost report is settled, any 
reconciliation of outlier payments by fiscal intermediaries would be 
based on operating and capital cost-to-charge ratios calculated based 
on a ratio of costs to charges computed from the cost report and charge 
data determined at the time the cost report coinciding with the 
discharge is settled.
    This process would require some degree of recalculating outlier 
payments for individual claims. It is not possible to distinguish, on 
an aggregate basis, how much a hospital's outlier payments would change 
due to a change in its cost-to-charge ratios. This is because, in the 
event of a decline in a ratio, some cases may no longer qualify for any 
outlier payments while other cases may qualify for lower outlier 
payments. Therefore, the only way to determine accurately the net 
effect of a decrease in cost-to-charge ratios on a hospital's total 
outlier payments is to assess the impact on a claim-by-claim basis. We 
indicated in the proposed rule that we were still assessing the 
procedural modifications that would be necessary to implement this 
change.
    Because, under our proposal, outlier payments would be based on the 
relationship between the hospital's costs and charges at the time a 
discharge occurred, the proposed methodology would ensure that when 
final outlier payments are made, they would reflect an accurate 
assessment of the actual costs the hospital incurred. Nevertheless, a 
final vulnerability remains. Even though the final payment would 
reflect a hospital's true cost experience, there would still be the 
opportunity for a hospital to manipulate its outlier payments by 
dramatically increasing charges during the year in which the discharge 
occurs. In this situation, the hospital would receive excessive outlier 
payments, which, although the hospital would incur an overpayment and 
have to refund the money when the cost report is settled, would allow 
the hospital to obtain excess payments from the Medicare Trust Fund on 
a short-term basis.
    Under section 1886(d)(5)(A)(iii) of the Act, the amount of any 
outlier payment should ``approximate the marginal cost of care'' in 
excess of the DRG payment and the fixed-loss threshold. Accordingly, 
because a hospital would have had access to any excess outlier payments 
until they are repaid to the Trust Fund (or, in the case of an 
underpayment, would not have had access to the appropriate amount 
during the same period), it may be necessary to adjust the amount of 
the final outlier payment to reflect the time value of the funds for 
that time period. Therefore, we proposed to add Sec.  412.84(m) to 
provide that when the cost report is settled, outlier payments would be 
subject to an adjustment to account for the value of the money during 
the time period it was inappropriately held by the hospital. This 
adjustment would also apply in cases where outlier payments were 
underpaid to the hospital. In those cases, the adjustment would result 
in additional payments to hospitals. Any adjustment would be based upon 
a widely available index to be established in advance by the Secretary, 
and would be applied from the midpoint of the cost reporting period to 
the date of reconciliation (or when additional payments are issued, in 
the case of underpayments). This adjustment to reflect the time value 
of a hospital's outlier payments would ensure that the outlier payment 
received by the hospital at the time its cost report is settled 
appropriately reflects the hospital's approximate marginal costs, in 
excess of the DRG payment and fixed-loss threshold, of providing the 
care.
    This proposed adjustment was also intended to account for the 
unique susceptibility of outlier payments to manipulation. Hospitals 
set their own level of charges and are able to change their charges, 
without review by their fiscal intermediaries. As outlined above, 
changes in charges directly affect the level of outlier payments. This 
lack of fiscal intermediary review of a factor affecting a hospital's 
payments is in contrast to other IPPS adjustments, such as the IME 
adjustment or the DSH adjustment, where the fiscal intermediary must 
agree to a change to the determining factor (the resident-to-bed ratio 
or the share of low-income patients, respectively).
    Under section 1886(d)(5)(A)(iv) of the Act, outlier payments for 
any year must be projected to be not less then 5 percent nor more than 
6 percent of the total estimated operating DRG payments plus outlier 
payments. Section 1886(d)(3)(B) of the Act requires the Secretary to 
reduce the average standardized amounts by a factor to account for the 
estimated proportion of total DRG payments made to outlier cases. 
Despite the fact that each individual hospital's outlier payments may 
be subject to adjustment when the cost report is settled, we continue 
to believe that the fixed-loss outlier threshold (discussed in section 
VI. of this final rule) should be based on projected payments using the 
latest available historical data without retroactive adjustments, 
either midyear or at the end of the year, to ensure that actual outlier 
payments are equal to 5.1 percent of total DRG payments. That is, our 
proposed change was intended only to allow for use of the actual cost-
to-charge ratio from the cost reporting period that corresponds to the 
discharges for which the outlier payments are made to adjust outlier 
payments to reflect the hospital's true costs of providing care. This 
adjustment would be made irrespective of whether the nationwide 
percentage of outlier payments relative to total operating DRG payments 
is equal to the outlier offset that is applied to the average 
standardized amounts (generally, 5.1 percent).
    Outlier payments are intended to recognize the fact that hospitals 
occasionally treat cases that are extraordinarily costly and otherwise 
not adequately compensated under an average-based payment system. 
However, we can only estimate actual costs based on the charges for a 
case because charges are the only data available that indicate the 
resource usage for an individual case. Therefore, our ability to 
identify true outlier cases is dependent on the accuracy of the cost-
to-charge ratios. To the extent some hospitals may be motivated to 
maximize outlier payments by taking advantage of the lag in updating 
the cost-to-charge

[[Page 34502]]

ratios, the payment system remains vulnerable to overpayments to 
individual hospitals. Therefore, we believe the only way to eliminate 
the potential for such overpayments is to provide a mechanism for final 
settlement of outlier payments using actual cost-to-charge ratios from 
final settled cost reports.
    However, the fixed-loss outlier threshold is an important aspect of 
the prospective nature of the IPPS. The outlier payment policy is 
designed to alleviate any financial disincentive hospitals may have 
against providing any medically necessary care their patients may 
require, even those patients who become very sick and require 
extraordinary resources. The preestablished threshold allows hospitals 
to approximate their Medicare payment for an individual patient while 
that patient is still in the hospital. Even though we proposed to make 
outlier payments susceptible to a reconciliation based on the 
hospital's actual cost-to-charge ratios during the contemporaneous cost 
reporting period, the hospital should still be in a position to make 
this approximation. Hospitals have immediate access to the information 
needed to determine what their cost-to-charge ratio will be when their 
cost reports are settled. Even if the final cost-to-charge ratio is 
likely to be different from the ratio used initially to process and pay 
the claim, as noted above, hospitals not only have the information 
available to estimate their cost-to-charge ratios, but also have the 
ability to control them, through the structure and levels of their 
charges.
    If we were to make retroactive adjustments to outlier payments to 
ensure total payments are 5.1 percent of DRG payments (by retroactively 
adjusting outlier payments), we would be removing this important aspect 
of the prospective nature of the IPPS. Because such an across-the-board 
adjustment would either lead to more or less outlier payments for all 
hospitals, hospitals would no longer be able to reliably approximate 
their payment for a patient while the patient is still hospitalized. We 
believe it would be neither necessary nor appropriate to make such an 
aggregate retroactive adjustment.
    Furthermore, we believe it is consistent with the intent of the 
language at section 1886(d)(5)(A)(iv) of the Act not to do so. This 
section calls for the Secretary to ensure that outlier payments are 
equal to or greater than 5 percent and less than or equal to 6 percent 
of projected or estimated (not actual) DRG payments. We believe this 
language reflects the intent of Congress regarding the prospectivity of 
the IPPS. However, we do not believe it prevents settling outlier 
payments based on hospitals' actual cost-to-charge ratios during the 
period when the discharge occurs.

B. Summary of Public Comments and Departmental Responses

    Comment: Many commenters argued that it is inappropriate to 
reconcile outlier payments through settled cost reports because IPPS 
payments are prospective and any type of reconciliation would make 
outlier payments retrospective.
    In addition, some commenters claimed that cost report 
reconciliation for outliers is inconsistent with the government's 
position in prior litigation involving the Medicare outlier payment 
methodology. The commenters cited County of Los Angeles v. Shalala, 192 
F.3d 1005 (D.C. Cir. 1999), and stated that in this case the Secretary 
succeeded in arguing to the United States Court of Appeals for the 
District of Columbia that the Act does not require retroactive 
adjustments to outlier payments in order to ensure that the actual 
amount of outlier reimbursement furnished to hospitals is between 5 and 
6 percent of the total payments made under IPPS, notwithstanding the 
language in section 1886(d)(5)(A)(iii) of the Act (42 U.S.C. 
1395ww(d)(5)(A)(iii)) mandating that outlier payments may not be less 
than 5 percent nor more than 6 percent of the total payments projected 
or estimated to be made based on DRG prospective payment rates. The 
commenters further asserted that any reconciliation of outlier payments 
would be inconsistent with the government's policy of refusing to make 
retroactive adjustments to outlier payments when estimates and 
projections prove inaccurate.
    Response: As an initial matter, our position in the court cases is 
more accurately presented as stating that the language of the statute 
does not clearly mandate that the actual amount of outlier payments 
must be between 5 and 6 percent of total payments and that our policy 
of not making retroactive adjustments to ensure that actual payments 
fall between that range is consistent with the intent of Congress. 
However, the commenter is correct that we have scrupulously guarded the 
prospective nature of the IPPS over the years. The IPPS has continued 
and served as a model for prospective payment systems for other 
provider types under Medicare because it is fair and predictable. We 
believe any change to the system, especially one as significant as 
making outlier payments subject to retroactive adjustments, must be 
evaluated in terms of its impact on those key characteristics of the 
IPPS.
    As noted above and in the proposed rule, in light of the gross 
abuses of the current methodology by some hospitals and the negative 
impact such overpayments ultimately have on other hospitals due to 
their effect on the threshold, we believe the option of reconciling 
outlier payments based on the settled cost report for hospitals that 
have been initially paid using a significantly inaccurate cost-to-
charge ratio compared to the actual ratio from the cost reporting 
period is now appropriate. In our view, reconciling outlier payments 
because they were originally paid on the basis of a significantly 
inaccurate cost-to-charge ratio is similar to recovering outlier 
payments when adjustments are made to covered charges for any services 
that are not found to be medically necessary or appropriate Medicare 
services upon medical or other review. This review is explicitly 
provided for at Sec.  412.84(d). This provision was established when 
the IPPS was first implemented for FY 1984 (48 FR 39785).
    The court cases referenced by the commenters all addressed the 
issue of whether outlier payments must be retroactively adjusted when 
the level of the threshold determined in advance of the fiscal year to 
which it applies ultimately results in actual outlier payments that are 
a smaller percentage of total DRG payments than was originally 
projected. We believe that an important goal of a PPS is 
predictability. Therefore, we believe that the fixed-loss outlier 
threshold should be projected based on the best available historical 
data and should not be adjusted retroactively. A retroactive change to 
the fixed-loss outlier threshold would affect all hospitals subject to 
the IPPS, thereby undercutting the predictability of the system as a 
whole.
    However, if we deem it necessary as a result of a hospital-specific 
data variance to reconcile outlier payments of an individual hospital, 
such action on our part would not affect the predictability of the 
entire system. Rather, because each hospital is on notice as to our 
revised methodology for determining cost-to-charge ratios and that 
outlier payments are subject to possible reconciliation, and because 
each hospital has the necessary data regarding its own costs and 
charges to predict its actual cost-to-charge ratio, we are able to 
maintain the predictability of the system as a whole. Further, because 
reconciliation of outlier payments will affect only certain hospitals, 
the administrative burden of implementing such a policy is minimized.

[[Page 34503]]

Accordingly, we continue to believe that the fixed-loss outlier 
threshold should be based on projected payments using the latest 
available historical data without retroactive adjustments. This was our 
position in the court cases cited by the commenter, and it has been our 
consistent and often stated position, including above in this final 
rule and the March 5, 2003 proposed rule.
    Comment: Some commenters suggested that we clarify how 
reconciliation will be implemented and only reconcile outlier payments 
to those providers whose cost-to-charge ratios increased or decreased 
outside of certain parameters. The commenters suggested that we 
reconcile outlier payments only for those hospitals that would 
otherwise receive substantial outlier overpayments or underpayments 
(for example, where the cost-to-charge ratio increased or decreased by 
15 percent). Limiting any reconciliation to those hospitals would have 
the desired impact of focusing the attention of CMS on those hospitals 
that deserve additional scrutiny without placing such a burden on all 
hospitals. Another commenter believed the savings of reconciliation 
would be offset by the additional workload for fiscal intermediaries 
and hospitals.
    One commenter suggested that we eliminate the proposal of 
reconciliation and use a quarterly or semiannual review similar to 
periodic interim payment reviews. The commenter explained that these 
reviews would be performed by a joint effort of the provider and the 
fiscal intermediary, resulting in interim cost-to-charge ratio 
adjustments throughout the fiscal year (with no lump-sum adjustment or 
individual claims adjustment), based on cost and charge data available 
from hospital records.
    Response: In the proposed rule, we proposed to establish the 
authority for CMS to reconcile outlier payments, but we did not propose 
to require that all hospitals' outlier payments be reconciled. We 
acknowledge the commenters' concerns about the administrative costs 
associated with reprocessing and reconciling all inpatient claims and 
the desirability of limiting which hospitals' outlier payments will be 
reconciled. Therefore, we agree that any reconciliation of outlier 
payments should be done on a limited basis.
    Moreover, although this provision is effective 60 days after the 
date of publication of this final rule, given the large workload and 
limited resources of our fiscal intermediaries, attempting to implement 
this provision for all hospitals receiving outlier payments at the same 
time would create an administrative burden. In addition, most of the 
changes in this regulation will apply for approximately the last 2 
months of FY 2003. We intend to limit the impact of this provision 
during FY 2003 to ensure that the limited resources of fiscal 
intermediaries are focused upon those hospitals that appear to have 
disproportionately benefited from the time lag in updating their cost-
to-charge ratios and to maintain the overall predictability of FY 2003 
payments for most hospitals. Accordingly, we intend to issue a program 
instruction in the near future to assist fiscal intermediaries in 
implementing this provision during the remainder of FY 2003.
    In the same program instruction, we will issue thresholds for 
fiscal intermediaries to reconcile outlier payments for other hospitals 
during FY 2003.
    For cost reporting periods beginning during FY 2004, we are 
considering instructing fiscal intermediaries to conduct reconciliation 
for hospitals whose actual cost-to-charge ratios are found to be plus 
or minus 10 percentage points from the cost-to-charge ratio used during 
that time period to make outlier payments, and that have total FY 2004 
outlier payments that exceed $500,000. We believe these thresholds 
would appropriately capture those hospitals whose outlier payments will 
be substantially inaccurate when using the ratio from the 
contemporaneous cost reporting period. Hospitals exceeding these 
thresholds during their applicable cost reporting periods would become 
subject to reconciliation of their outlier payments. These thresholds 
would be reevaluated annually and, if necessary, modified each year. 
However, fiscal intermediaries would also have the administrative 
discretion to reconcile additional hospitals' cost reports based on 
analysis that indicates the outlier payments made to those hospitals 
are significantly inaccurate.
    We continue to believe that cost report reconciliation is the most 
appropriate way to ensure that outlier payments are made only for truly 
costly cases. We believe the type of ongoing reviews suggested by the 
commenter referenced above would be an inefficient approach to 
addressing this problem, because it would require extensive ongoing 
reviews of every hospital's cost and charge data. However, we believe 
the problems leading to this final rule actually occur among a limited 
number of hospitals.
    Comment: Some commenters believed that reconciliation is 
unnecessary because the proposed changes that would eliminate the use 
of statewide averages and mandate use of the most recent tentative cost 
report would suffice to keep hospitals from gaming outliers. Therefore, 
they believed CMS should abandon its proposal to reconcile outlier 
payments.
    Response: The steps we are taking in this final rule to direct 
fiscal intermediaries to update cost-to-charge ratios using the most 
recent tentative settled cost reports and using actual cost-to-charge 
ratios rather than statewide average ratios will greatly reduce the 
opportunity for hospitals to manipulate the system to maximize outlier 
payments. However, these steps will not completely eliminate all such 
opportunity. A hospital would still be able to dramatically increase 
its charges far above its rate-of-increase in costs during any given 
year in order to obtain excessive outlier payments. Therefore, we 
believe reconciliation is necessary to ensure that outlier payments are 
appropriately paid in the future.
    Comment: One commenter suggested the use of a rolling 3-year 
average instead of reconciliation. The commenter explained that if a 
hospital is found to have a cost-to-charge ratio that significantly 
decreased over a short period of time, the cost-to-charge ratio that 
would be used to pay outliers would be projected by applying the 3-year 
average rate of change in cost-to-charge ratios over a rolling 3-year 
period. Cost reports used from that 3-year period would include the 
most recent audited or tentatively settled cost report for each year. 
The commenter provided an example where the cost-to-charge ratio from 
the most recent tentatively settled cost report is trended down to 
reflect the fact that over a longer period of time, charge increases 
have exceeded cost increases. This rolling 3-year average would be 
applied to hospitals that trigger this mechanism for a period of 
several years, until the period where the charge increases that gave 
rise to the use of the projection has worked its way through the 
method.
    Response: The changes in this final rule are designed to take away 
any incentive for hospitals to seek outlier payments that are 
excessive. We believe the method recommended by the commenter still 
leaves the potential to game the system. For example, a hospital with a 
high cost-to-charge ratio can lower its charges substantially in any 
given year and receive extra outlier payments until the 3-year average 
is applied. Also, even after the 3-year moving average is applied, the 
hospital can continue to raise its charges in any given year and 
continue to receive outlier payments that do not reflect its

[[Page 34504]]

actual cost-to-charge ratio. At the end of the fiscal year, the 
hospital would receive a new cost-to-charge ratio based on its 3-year 
rolling average when in reality its actual cost-to-charge ratio is much 
lower. A hospital could continue to stay ahead of the system every year 
and receive outlier payments that do not reflect its actual cost-to-
charge ratio. This is the exact behavior we are trying to prevent and, 
therefore, we believe we need to implement the process of 
reconciliation to dissuade hospitals from gaming the system.
    Comment: Other commenters believed reconciliation would lead to 
further unpredictability and volatility in the Medicare payment system 
and would have implications for cost report simplification. Another 
commenter expressed similar concerns that some hospitals' cost reports 
may not be settled for longer than 2 to 3 years and would be subject to 
large overpayments that would then be subject to an adjustment for the 
time value of money. Similarly, a hospital's cost report can be 
reopened at a later date even after final settlement, which would cause 
further uncertainty if reconciliation had been conducted in the past.
    Response: We plan to issue further guidance through program 
memoranda detailing the specific operational aspects of reconciling 
outlier payments on the cost report. At this time, we are still 
developing the specific procedures involved, including the exact timing 
of any reconciliation in terms of the cost reporting settlement process 
and the appeals process.
    Comment: Several commenters argued that it would be inappropriate, 
illogical, and inconsistent with current policies to single-out 
outliers for adjustments to account for the time value of money. The 
commenters pointed out that other IPPS payment adjustments, such as IME 
and DSH, are subject to reconciliation but hospitals are not charged 
for the time value of money when those overpayments or underpayments 
are reconciled. However, another commenter agreed that outlier payments 
are substantially different from IME and DSH payments and the premise 
for adjusting for the time value of money with respect to outlier 
payments (when it is limited to situations where the cost-to-charge 
ratio is substantially inaccurate, and does not involve policy 
disputes) is not applicable to other adjustments such as IME and DSH.
    Response: As we noted above and in the proposed rule, outlier 
payments are uniquely susceptible to manipulation because hospitals set 
their own level of charges and are able to change their charges without 
notification to, or review by, their fiscal intermediary. Such changes 
by a hospital directly affect its level of outlier payments, unlike IME 
or DSH where the fiscal intermediary must agree to a change to the 
underlying data. Therefore, even though the money may be recouped if 
the outlier payments are reconciled, the hospital would essentially be 
able to unilaterally increase its charges and acquire an interest-free 
loan in the meantime. For that reason, we believe it is appropriate to 
apply an adjustment for the time value of overpayments or underpayments 
identified at cost report reconciliation. Because the other changes we 
are making in this final rule will largely ensure the payments 
hospitals receive for outlier cases are accurate, we do not anticipate 
it will be necessary to apply this adjustment broadly. Therefore, the 
actual total impact of this adjustment should be relatively small.
    Comment: One commenter argued that there is no statutory 
authorization for this adjustment. The commenter referenced section 
1815(d) of the Act (42 U.S.C. 1395g(d)), which provides that interest 
is charged when a final determination is made and payment is not made 
within 30 days of the date of the determination. The commenter 
concluded there is no authority to impose interest in any fashion 
except in a manner consistent with this statutory authorization, and, 
thus, the proposed time value adjustment should be withdrawn.
    Response: The reference cited by the commenter authorizes Medicare 
to charge and pay interest when an overpayment or underpayment is made. 
However, the referenced statutory authority is not the basis for the 
proposal to adjust outlier payments for the time value of money when 
reconciliation is made. Rather, this adjustment is consistent with the 
statutory requirement at section 1886(d)(5)(A)(iii) that outlier 
payments approximate the marginal cost of care beyond the threshold. 
That is, because hospitals are uniquely able to manipulate outlier 
payments by increasing charges, it is necessary to establish a 
mechanism whereby an adjustment can be made to ensure payments 
appropriately reflect the true marginal costs of care for outlier 
cases. As a result, the outlier adjustment can be distinguished from 
other IPPS payment adjustments where interest is applied, such as IME 
or DSH, because changes to these adjustments are subject to review by 
the fiscal intermediary before additional payments are made.

C. Provisions of the Final Rule Relating to Reconciliation of Outlier 
Payments Through Settled Cost Reports

    We are adding Sec.  412.84(i)(3) to provide that, effective 60 
calendar days after the date of publication of this final rule, outlier 
payments will become subject to adjustment when hospitals' cost reports 
coinciding with the discharge are settled.
    Payments will be processed throughout the year using the 
appropriate historical operating and capital cost-to-charge ratios, 
consistent with the regulations. When the cost report is settled, any 
reconciliation of outlier payments by fiscal intermediaries will be 
based on operating and capital cost-to-charge ratios calculated based 
on a ratio of costs to charges computed from the cost report and charge 
data determined at the time the cost report coinciding with the 
discharge is settled. We intend to issue program instructions to the 
fiscal intermediaries that will provide specific criteria for 
identifying those hospitals subject to reconciliation for the remainder 
of FY 2003 and for FY 2004. These criteria for FY 2003 will allow the 
fiscal intermediaries to focus their limited resources on only those 
hospitals that appear to have disproportionately benefited from the 
time lag in updating their cost-to-charge ratios. The criteria for FY 
2004 will target a somewhat broader group of hospitals, but will still 
be limited to those hospitals that have benefited the most from the 
time lag in updating cost-to-charge ratios, and the majority of 
hospitals will not be affected. Also, fiscal intermediaries will have 
the administrative discretion to reconcile additional hospitals' cost 
reports based on analysis that indicates the outlier payments made to 
those hospitals are significantly inaccurate.
    In addition, effective for discharges occurring on or after 60 
calendar days after the date of publication of this final rule, for 
those hospitals for which reconciliation is necessary, outlier payments 
will be adjusted to account for the time value of any underpayments or 
overpayments (Sec.  412.84(m)).

VI. Fixed-Loss Outlier Threshold for IPPS Hospitals

A. Background and Provisions of the March 5, 2003 Proposed Rule

    As noted above, under section 1886(d)(5)(A)(iv) of the Act, outlier 
payments for any year must be projected to be not less than 5 percent 
nor more than 6 percent of total estimated operating DRG payments plus 
outlier payments. Section 1886(d)(3)(B) of the

[[Page 34505]]

Act requires the Secretary to reduce the average standardized amounts 
by a factor to account for the estimated proportion of total DRG 
payments made to outlier cases. Similarly, section 1886(d)(9)(B)(iv) of 
the Act requires the Secretary to reduce the average standardized 
amounts applicable to hospitals in Puerto Rico to account for the 
estimated proportion of total DRG payments made to outlier cases.
    In the August 1, 2002, IPPS final rule, we established the FY 2003 
outlier fixed-loss threshold at $33,560 (67 FR 50122). This was a 
nearly 60-percent increase over the FY 2002 threshold of $21,025. The 
primary reason for this dramatic increase was a change in our 
methodology to use the rate of increase in charges rather than the 
rate-of-increase in costs to determine the threshold. That is, because 
we use FY 2001 cases to project the threshold for FY 2003, it is 
necessary to inflate the charges on the FY 2001 bills to approximate 
the charges on a similar claim for FY 2003. Prior to the calculation of 
the FY 2003 outlier threshold, we used the rate-of-cost increase from 
the most recent cost reports available to inflate actual charges on the 
prior year's bills to estimate what the charges would be in the 
upcoming year.
    Our analysis indicated hospitals' charges were increasing at a much 
faster rate than costs. Therefore, in the August 1, 2002, IPPS final 
rule, we changed our methodology to inflate charges (67 FR 50122). 
Rather than using the observed rate-of-increase in costs from the cost 
reports, we inflated the FY 2001 charges by a 2-year average annual 
rate of change in actual charges per case from FY 1999 to FY 2000, and 
from FY 2000 to FY 2001, to estimate what the charges would be in FY 
2003 for a similar claim.
    The provisions of this final rule make several changes to better 
target outlier payments to the most costly cases. As a result, outlier 
payments to the hospitals that have been most aggressively increasing 
their charges to maximize outlier payments will be dramatically 
reduced. However, we are concerned that unrestrained charge increases 
have continued to occur during FY 2003 prior to the implementation of 
these final changes, and will likely result in outlier payments in 
excess of the 5.1 percent offset established by the August 1, 2002, 
IPPS final rule. (We now estimate FY 2003 outlier payments are equal to 
6.1 percent of total DRG payments.) For example, hospitals intending to 
maximize outlier payments during FY 2003 could continue to do so by 
increasing charges enough to outpace the increase in the threshold. In 
fact, given the public attention on this behavior over the past few 
months and the potential for other hospitals to begin to aggressively 
increase their charges, and consequently their outlier payments, it is 
possible this type of aggressive gaming of the outlier policy has 
become more widespread in recent months.
    Because of the extreme uncertainty regarding the effects of 
aggressive hospital charging practices on FY 2003 outlier payments to 
date, we did not propose any change to the FY 2003 fixed-loss threshold 
($33,560) in the March 5, 2003, proposed rule. However, we noted that 
data for the first quarter of FY 2003 inpatient claims would be 
available soon and these data would allow us to evaluate whether 
outlier payments to date appear to be approximately 5.1 percent of 
total DRG payments. We solicited comments and data from hospitals with 
respect to the recent trends in hospital charges and the implications 
for outlier payments if the fixed-loss threshold were to remain at 
$33,560. We indicated in the March 5, 2003, proposed rule that, based 
upon that analysis and the comments we received in response to the 
proposed rule, we would adjust the threshold accordingly in the final 
rule.

B. Summary of Public Comments and Departmental Responses

    Comment: Many commenters recommended that we lower the outlier 
threshold to ensure that hospitals have access to these special 
payments to cover extremely high-cost Medicare patients. In addition, 
they argued that because the threshold was raised from $21,025 in FY 
2002 to $33,650 in FY 2003 based on policies in place at the beginning 
of the year, the threshold should now be lowered to reflect these mid-
year changes.
    Some commenters suggested that if a new threshold cannot be 
calculated by the publication date of the final rule, we should apply 
the FY 2002 threshold until a new threshold could be calculated. They 
argued that use of this threshold would enable all legitimate claims to 
qualify for cost outlier status.
    MedPAC noted that failing to adjust the threshold would continue to 
deny additional payments to hospitals that have extraordinarily costly 
cases, thwarting the legislative purpose of the policy. One commenter 
suggested we lower the threshold close to the FY 2002 amount because it 
was not the intent of the Congress to have such a high outlier 
threshold for those hospitals that did not try to manipulate the 
outlier system and have sustained high losses for true outlier cases.
    One commenter argued that last year, for purposes of setting a FY 
2003 outlier threshold, CMS inflated charges using a 2-year average 
annual rate of change in charges per case from FY 1999 to FY 2000, and 
from FY 2000 to FY 2001, because CMS analysis demonstrated that charges 
have been growing at a much faster rate than recent estimates of cost 
growth. The commenter argued that, based on the new proposals in the 
proposed rule, this methodology was now unnecessary because the 
assumption of a lag in cost reports no longer applies.
    One commenter recommended that we lower the threshold to the FY 
2002 amount and implement this threshold retroactively to October 1, 
2002. The commenter explained that many hospitals did not game the 
system and have had their outlier payments reduced over the years 
because the threshold has increased dramatically over the last 3 years 
due to a limited number of hospitals who gamed the system.
    Response: We reestimated the fixed-loss threshold reflecting the 
changes implemented in this final rule that will be in effect during a 
portion of FY 2003. To do that reestimation, we inflated charges from 
the FY 2002 Medicare Provider Analysis and Review (MedPAR) file by the 
2-year average annual rate of change in charges per case to predict 
charges for FY 2004. We believe the use of charge inflation is more 
appropriate than our previous methodology of cost inflation because 
charges are increasing at a much faster rate than costs. Therefore, we 
disagree that we should return to using the previous methodology based 
on cost inflation. Originally, when the FY 2003 threshold of $33,560 
was set, we used FY 2001 MedPAR records. Because more recent data are 
now available, we believe it would be appropriate to use FY 2002 data 
to reestimate the FY 2003 threshold, taking into account the changes 
implemented by this final rule.
    As noted previously, we continued to pay substantially more than 
was projected for outlier payments in FY 2002. Our most recent estimate 
is that we paid approximately 7.9 percent of total DRG payments in 
outliers, well in excess of our original projection of 5.1 percent, and 
higher than the percentage of total DRG payments for outliers in FY 
2001. That percentage was 7.7. Therefore, using FY 2002 cases to 
estimate the outlier threshold for FY 2003 would result in a threshold 
of $42,300. However, after accounting for the changes implemented in 
this final rule, we estimate the threshold would be only slightly 
higher than the current threshold (by approximately $600).

[[Page 34506]]

    We believe it is appropriate not to change the FY 2003 outlier 
threshold at this time. Although our current empirical estimate of the 
threshold indicates it could be slightly higher, there are other 
considerations that lead us to conclude the threshold should remain at 
$33,560. Increasing the threshold would result in lower outlier 
payments for all hospitals, not just those that have been aggressively 
maximizing their outlier payments. Changing the threshold for the 
remaining few months of the fiscal year could disrupt hospitals' 
budgeting plans and would be contrary to the overall prospectivity of 
the IPPS. We do believe that we have the authority to revise the 
threshold, given the extraordinary circumstances that have occurred (in 
particular, the manipulation of the policy by some hospitals). However, 
in light of the relatively small difference between the current 
threshold and our revised estimate, and the limited amount of time 
remaining in the fiscal year, we have concluded it is more appropriate 
to maintain the threshold at $33,560.
    We note that, in the May 19, 2003, IPPS proposed rule for FY 2004, 
we proposed an outlier threshold of $50,645 for FY 2004 (68 FR 27235). 
Because that proposed rule was published prior to the publication of 
this final rule, the FY 2004 outlier threshold was calculated without 
accounting for the changes implemented in this final rule. The changes 
implemented here will be reflected in the calculation of the final FY 
2004 outlier threshold.

C. Provisions of the Final Rule Relating to the Fixed-Loss Outlier 
Threshold

    We are maintaining the fixed-loss outlier threshold at $33,560 for 
the remainder of FY 2003. We also are maintaining the marginal cost 
factor, the percentage of costs above the threshold that is paid for 
outlier cases, at 80 percent.

VII. Adjustment for High-Cost Outliers and Short-Stay Outliers Under 
the LTCH PPS

A. Background

    Under the LTCH PPS, as implemented in the regulations at Sec.  
412.525(a), we make an adjustment for additional payments for outlier 
cases that have extraordinarily high costs relative to the costs of 
most discharges. In the LTCH PPS final rule for the 2004 LTCH PPS rate 
year, we intend to summarize the proposals relating to outlier payments 
under the LTCH PPS that were made in the March 7, 2003, LTCH PPS 
proposed rule (68 FR 11250), and will explain that we have responded to 
comments submitted on behalf of LTCHs and finalized the LTCH PPS 
outlier policy in this final outlier rule. We believe it is appropriate 
to finalize the changes to the IPPS outlier policies and the LTCH PPS 
outlier policy at the same time because the LTCH PPS outlier policy is 
modeled after the IPPS outlier policy. Accordingly, following is a 
summary of the LTCH PPS outlier policy as proposed in the March 7, 
2003, proposed rule and our responses to the public comments we 
received on that proposed rule.
    Under the regulations at Sec.  412.525(a), we make an adjustment 
for additional payments for outlier cases that have extraordinarily 
high costs relative to the costs of most discharges. Providing 
additional payments for outliers strongly improves the accuracy of the 
LTCH PPS in determining resource costs at the patient and hospital 
level. These additional payments reduce the financial losses that would 
otherwise be caused by treating patients who require more costly care 
and, therefore, reduce the incentives to underserve these patients. We 
include a provision for outlier payments under the LTCH PPS and set the 
outlier threshold before the beginning of the applicable rate update 
year so that total outlier payments are projected to equal 8 percent of 
total payments under the LTCH PPS.
    Under Sec.  412.525(a), we make outlier payments for any discharges 
if the estimated cost of a case exceeds the adjusted LTCH PPS payment 
for the LTC-DRG plus a fixed-loss amount. The fixed-loss amount is the 
amount used to limit the loss that a hospital will incur under an 
outlier policy. This results in Medicare and the LTCH sharing financial 
risk in the treatment of extraordinarily costly cases. The LTCH's loss 
is limited to the fixed-loss amount and the percentage of costs above 
the marginal cost factor. We calculate the estimated cost of a case by 
multiplying the overall hospital cost-to-charge ratio by the Medicare 
allowable covered charge. In accordance with Sec.  412.525(a), we pay 
outlier cases 80 percent of the difference between the estimated cost 
of the patient case and the outlier threshold (the sum of the adjusted 
Federal prospective payment for the LTC-DRG and the fixed-loss amount).
    We determine a fixed-loss amount, that is, the maximum loss that a 
LTCH can incur under the LTCH PPS for a case with unusually high costs 
before the hospital will receive any additional payments. We calculate 
the fixed-loss amount by simulating aggregate payments with and without 
an outlier policy. The fixed-loss amount results in estimated total 
outlier payments projected to be equal to 8 percent of projected total 
LTCH PPS payments.
    Outlier payments under the LTCH PPS are determined consistent with 
the IPPS outlier policy. Currently, under the IPPS, a floor and a 
ceiling are applied to an acute care hospital's cost-to-charge ratio 
and if the acute care hospital's cost-to-charge ratio is either below 
the floor or above the ceiling, the applicable statewide average cost-
to-charge ratio is assigned to the acute care hospital. Similarly, if a 
LTCH's cost-to-charge ratio is below the floor or above the ceiling, 
currently the applicable statewide average cost-to-charge ratio is 
assigned to the hospital. In addition, for LTCHs for which we are 
unable to compute a cost-to-charge ratio, we also assign the applicable 
statewide average. Currently, MedPAR claims data and cost-to-charge 
ratios based on the latest available cost report data from the Hospital 
Cost Report Information System (HCRIS) and corresponding MedPAR claims 
data are used to establish a fixed-loss threshold amount under the LTCH 
PPS.

B. Establishment of the Fixed-Loss Amount for Outlier Payments Under 
the LTCH PPS

    For FY 2003, based on FY 2001 MedPAR claims data and cost-to-charge 
ratios based on the latest available data from HCRIS and corresponding 
MedPAR claims data from FYs 1998 and 1999, we established a fixed-loss 
amount of $24,450. In the March 7, 2003, proposed rule, for the 2004 
LTCH PPS rate year, we proposed to continue to use the March 2002 
update of the FY 2001 MedPAR claims data to determine a fixed-loss 
threshold that would result in outlier payments projected to be equal 
to 8 percent of total payments, based on the policies described in that 
proposed rule, because these data were the best data available. We 
calculated cost-to-charge ratios for determining the March 7, 2003, 
proposed fixed-loss amount based on the latest available cost report 
data in HCRIS and corresponding MedPAR claims data from FYs 1998, 1999, 
and 2000.
    Consistent with the proposed outlier policy changes for acute care 
hospitals under the IPPS discussed in the March 5, 2003, proposed rule 
(68 FR 10420), in the March 7, 2003, LTCH PPS proposed rule, we 
proposed to no longer assign the applicable statewide average cost-to-
charge ratio when a LTCH's cost-to-charge ratio falls below the floor. 
We proposed this policy change because, as is the case for acute care 
hospitals, we believe LTCHs could arbitrarily increase their charges in 
order to maximize

[[Page 34507]]

outlier payments. Even though this arbitrary increase in charges should 
result in a lower cost-to-charge ratio in the future (due to the lag 
time in cost report settlement), currently when a LTCH's actual cost-
to-charge ratio falls below the floor, the LTCH's cost-to-charge ratio 
would be raised to the applicable statewide average. This application 
of the statewide average would result in inappropriately higher outlier 
payments. Accordingly, we proposed to apply the LTCH's actual cost-to-
charge ratio to determine the cost of the case, even where the LTCH's 
actual cost-to-charge ratio falls below the floor. No longer applying 
the applicable statewide average cost-to-charge ratio when a LTCH's 
actual cost-to-charge ratio falls below the floor would result in a 
lower future cost-to-charge ratio. Applying this lower cost-to-charge 
ratio to charges in the future to determine the cost of the case would 
result in more appropriate outlier payments. Therefore, consistent with 
the proposed policy change for acute care hospitals under the IPPS, we 
proposed that LTCHs would receive their actual cost-to-charge ratios no 
matter how low their ratios fall. Also, consistent with the proposed 
policy change for acute care hospitals under the IPPS, we proposed 
under Sec.  412.525(a)(4), by cross-referencing proposed Sec.  
412.84(i), to continue to apply the applicable statewide average cost-
to-charge ratio when a LTCH's cost-to-charge ratio exceeds the ceiling 
by proposing to adopt the proposed policy at proposed Sec.  
412.84(i)(1)(ii). Cost-to-charge ratios above this range are probably 
due to faulty data reporting or entry, and, therefore, should not be 
used to identify and make payments for outlier cases because such data 
are clearly errors and should not be relied upon.
    In addition, we proposed to make a similar change to Sec.  
412.529(c), by cross-referencing proposed Sec.  412.84(i), for 
determining short-stay outlier payments to indicate that the applicable 
statewide average cost-to-charge ratio would be applied when a LTCH's 
cost-to-charge ratio exceeds the ceiling, but not when a LTCH's cost-
to-charge ratio falls below the floor. Since cost-to-charge ratios are 
also used in determining short-stay outlier payments, the rationale for 
the proposed change mirrored that for high-cost outliers.
    Therefore, consistent with IPPS outlier policy, in determining the 
proposed fixed-loss amount for the 2004 LTCH PPS rate year in the March 
7, 2003, LTCH PPS proposed rule, we proposed to use only the current 
combined operating and capital cost-to-charge ratio ceiling under the 
IPPS of 1.421 (as explained in the IPPS final rule (67 FR 50125, August 
1, 2002)). We believe that using the current combined IPPS operating 
and capital cost-to-charge ratio ceiling for LTCHs is appropriate 
since, as we explained in the August 30, 2002, LTCH PPS final rule (67 
FR 55960), LTCHs are certified as acute care hospitals that meet the 
criteria set forth in section 1861(e) of the Act in order to 
participate in the Medicare program. As we also discussed in the August 
30, 2002, LTCH PPS final rule (67 FR 55956), in general, hospitals are 
paid as a LTCH only because their average length of stay is greater 
than 25 days in accordance with Sec.  412.23(e). Furthermore, prior to 
qualifying as a LTCH under Sec.  412.23(e)(2)(i), the hospitals 
generally are paid as acute care hospitals under the IPPS during the 
period in which they demonstrate that they have an average length of 
stay of greater than 25 days. Accordingly, if a LTCH's cost-to-charge 
ratio is above this ceiling, we proposed to assign the applicable IPPS 
statewide average cost-to-charge ratio. (Currently, the applicable IPPS 
statewide averages can be found in Tables 8A and 8B of the August 1, 
2002, IPPS final rule (67 FR 50263).) We also would assign the 
applicable statewide average for LTCHs for which we are unable to 
compute a cost-to-charge ratio. Accordingly, in the March 7, 2003, LTCH 
PPS proposed rule, for the proposed 2004 LTCH PPS rate year, we 
proposed a fixed-loss amount of $19,978. Thus, we proposed to pay an 
outlier case 80 percent of the difference between the estimated cost of 
the case and the outlier threshold (the sum of the adjusted Federal 
LTCH payment for the LTC-DRG and the proposed fixed-loss amount of 
$19,978).

C. Reconciliation of Outlier Payments Upon Cost Report Settlement

    Under existing regulations at Sec.  412.525(a), we specify that no 
retroactive adjustment will be made to the outlier payments upon cost 
report settlement to account for differences between the estimated 
cost-to-charge ratios and the actual cost-to-charge ratios for outlier 
cases. This policy is consistent with the existing outlier payment 
policy for short-term acute care hospitals under the IPPS. However, as 
discussed earlier, in the March 5, 2003 IPPS proposed rule (68 FR 
10420), we proposed to revise the methodology for determining cost-to-
charge ratios for acute care hospitals under the IPPS because we became 
aware that payment vulnerabilities exist in the current IPPS outlier 
policy. Because the LTCH PPS high-cost outlier and short-stay policies 
are modeled after the IPPS outlier policy, we believe they are 
susceptible to the same payment vulnerabilities and, therefore, merit 
revision.
    As proposed for acute care hospitals under the IPPS at proposed 
Sec.  412.84(m) in the March 5, 2003, proposed rule, we proposed in the 
March 7, 2003, LTCH PPS proposed rule under Sec.  412.525(a)(4)(ii), by 
cross-referencing proposed Sec.  412.84(m), that, for LTCHs, any 
reconciliation of outlier payments would be made upon cost report 
settlement to account for differences between the actual cost-to-charge 
ratio and the estimated cost-to-charge ratio for the period during 
which the discharge occurs. As was the case with the proposed changes 
to the outlier policy for acute care hospitals under the IPPS, we 
indicated that we were still assessing the procedural changes that 
would be necessary to implement this change for LTCHs under the LTCH 
PPS. In addition, we proposed to make a similar change in Sec.  
412.529(c)(4)(ii), by cross-referencing proposed Sec.  412.84(m), to 
indicate that any reconciliation of payments for short-stay outliers 
would be made upon cost report settlement to account for differences 
between the estimated cost-to-charge ratio and the actual cost-to-
charge ratio for the period during which the discharge occurs.
    In addition, because we currently use cost-to-charge ratios based 
on the latest settled cost report, again consistent with the policy for 
acute care hospitals under the IPPS, any dramatic increases in charges 
by LTCHs during the payment year are not reflected in the cost-to-
charge ratios when making outlier payments under the LTCH PPS. 
Consistent with the proposed policy change for acute care hospitals 
under the IPPS at proposed Sec.  412.84(i) discussed in the March 5, 
2003 IPPS proposed rule, because a LTCH has the ability to increase its 
outlier payments through a dramatic increase in charges and because of 
the lag time in the data used to calculate cost-to-charge ratios, in 
the March 7, 2003 LTCH PPS proposed rule, we proposed that fiscal 
intermediaries would use more recent data when determining a LTCH's 
cost-to-charge ratio. Therefore, under Sec.  412.525(a)(4)(ii), by 
cross-referencing proposed Sec.  412.84(i), we proposed that fiscal 
intermediaries would use either the most recent settled cost report or 
the most recent tentative settled cost report, whichever is later. In 
addition, we proposed to make a similar change to the short-stay 
outlier policy at Sec.  412.529(c)(4)(ii), by cross-referencing 
proposed Sec.  412.84(i), to indicate that subject to the proposed 
provisions in the regulations at Sec.  412.84(i), fiscal

[[Page 34508]]

intermediaries would use either the most recent settled cost report or 
the most recent tentative settled cost report, whichever is later.
    In the March 7, 2003, LTCH PPS proposed rule, when we calculated 
the proposed fixed-loss amount of $19,978 for the proposed 2004 LTCH 
PPS rate year, we did not assign the applicable statewide average cost-
to-charge ratio when a LTCH's actual cost-to-charge ratio fell below 
the floor, consistent with the proposed IPPS outlier policy. However, 
because many features of the LTCH PPS are dependent upon IPPS outlier 
policies, we did not believe it was appropriate to finalize the 
proposed changes to the LTCH PPS outlier policy in the LTCH PPS final 
rule. Therefore, in calculating the final fixed-loss amount, we intend 
to apply the existing outlier policy (that is, not the policies 
proposed in the March 7, 2003, LTCH PPS proposed rule), using the 
statewide average for LTCHs whose cost-to-charge ratios fall below the 
floor. In addition, after analyzing the data that we would use to 
calculate the fixed-loss amount, we would only apply the statewide 
average to one LTCH that would have a cost-to-charge ratio that falls 
below the floor. Based on this analysis, we have concluded that it will 
not be necessary to recalculate a new fixed-loss amount once this 
outlier rule becomes effective because the difference between a fixed-
loss amount based on the elimination of the floor and a fixed-loss 
amount based on the statewide average would be negligible. Thus, the 
fixed-loss amount published in the LTCH PPS final rule will not be 
affected by changes in the outlier policy.

D. Application of Outlier Policy to Short-Stay Outlier Cases

    Under some rare circumstances, a LTCH discharge could qualify as a 
short-stay outlier case (as defined under Sec.  412.529) and also as a 
high-cost outlier case. In such a scenario, a patient could be 
hospitalized for less than five-sixths of the geometric average length 
of stay for the specific LTC-DRG, and yet incur extraordinarily high 
treatment costs. If the costs exceeded the LTCH PPS outlier threshold 
(that is, the short-stay outlier payment plus the fixed-loss amount), 
the discharge would be eligible for payment as a high-cost outlier. 
Thus, for a short-stay outlier case, the high-cost outlier payment is 
based on 80 percent of the difference between the estimated cost of the 
case plus the outlier threshold (the sum of the fixed-loss amount and 
the amount paid under the short-stay outlier policy).

E. Summary of Public Comments on the LTCH PPS Outlier Policy in the 
March 7, 2003, Proposed Rule and Departmental Responses

    Of the approximately 30 pieces of correspondence we received on the 
March 7, 2003, LTCH PPS proposed rule, 22 pieces contained public 
comments on the proposed LTCH PPS high-cost and short-stay outlier 
policies that were included in the proposed rule. A summary of those 
comments and our departmental responses follow.
    Comment: Many commenters supported our proposal to use the most 
recent tentatively settled Medicare cost report to determine the cost-
to-charge ratios to be used for outlier payments under the LTCH PPS, 
since this policy would provide the most current data reviewed by the 
fiscal intermediaries for purposes of the outlier payment. A number of 
commenters also agreed with the proposal to eliminate the use of 
statewide averages for hospitals with cost-to-charge ratios below the 
minimum floor cost-to-charge ratio, stating that this proposal would 
remove incentives to rapidly increase charges relative to costs.
    Response: We agree with the commenters and we are adopting the 
proposal to use the most recent tentatively settled Medicare cost 
report to determine the cost-to-charge ratios and the proposal to 
eliminate the use of statewide averages for hospitals with cost-to-
charge ratios below the minimum floor cost-to-charge ratio. However, we 
want to take the opportunity in this final rule to clarify some points 
about the application of these policies.
    The IPPS outlier policy in this final rule, which requires applying 
a hospital's actual cost-to-charge ratio to determine the cost of a 
case, even where the hospital's actual cost-to-charge ratio falls below 
the floor, will become effective 60 calendar days after the date of 
publication of this final rule. This policy will similarly become 
effective for LTCHs 60 calendar days after the date of publication of 
this final rule. For purposes of making actual outlier payments for 
discharges between July 1, 2003, and the effective date of this outlier 
rule (60 calendar days after the date of publication), LTCHs' cost-to-
charge ratios that are below the floor will be replaced by the 
statewide average as under existing policy, while any outlier payments 
made on or after the effective date of this outlier rule will be 
determined under the new policy using the LTCHs' actual cost-to-charge 
ratio, even if that cost-to-charge ratio is below the floor.
    Following is an example of how the policy eliminating the floor 
cost-to-charge ratio will apply beginning July 1, 2003:
    As of July 1, 2003, Hospital A has a cost-to-charge ratio of 0.250, 
which is above the current cost-to-charge ratio floor of 0.206. 
Therefore, for purposes of determining outlier payment in the 2004 LTCH 
PPS rate year (July 1, 2003, to June 30, 2004), Hospital A would 
continue to use its cost-to-charge ratio of 0.250 (unless the fiscal 
intermediary changes Hospital A's cost-to-charge ratio due to tentative 
settlement of a cost report) and use the fixed-loss amount to be 
published in the LTCH PPS final rule for the 2004 LTCH PPS rate year.
    Hospital B has a cost-to-charge ratio of 0.200, which is below the 
cost-to-charge ratio floor of 0.206. For purposes of determining 
outlier payments from July 1, 2003, until the effective date of this 
final rule (60 calendar days after the date of publication), Hospital B 
continues to use the statewide average cost-to-charge ratio. However, 
beginning with the effective date of the final rule, Hospital B uses 
its actual cost-to-charge ratio of 0.200 (unless the fiscal 
intermediary changes Hospital B's cost-to-charge ratio due to tentative 
settlement of a cost report), and continues to use the fixed-loss 
amount to be published in the LTCH PPS final rule.
    Comment: Numerous other commenters representing LTCHs disagreed 
with our proposed policy that, for LTCHs, any reconciliation of outlier 
payments would be made upon cost report settlement to account for 
differences between the actual cost-to-charge ratio and the estimated 
cost-to-charge ratio for the period during which the discharge occurs. 
One commenter stated that the proposal would create accounting 
difficulties for hospitals and fiscal intermediaries, and suggested 
that if CMS is concerned about ``gaming'' related to outlier payments, 
then, as an alternative, the fiscal intermediaries could monitor 
charges per diem using PS&R data, or a quarterly reporting mechanism 
can be established similar to the HCFA-91. Other commenters wrote that 
constant updates to the cost-to-charge ratios for outlier payments 
would be a costly and burdensome process for LTCHs and fiscal 
intermediaries to administer. The commenters recommended that CMS 
maintain its current policy of using the most recent final cost report 
for cost-to-charge ratios with no changes until the following fiscal 
year.
    Another commenter stated that requiring the fiscal intermediary to 
notify providers every time a change is

[[Page 34509]]

made to the cost-to-charge ratio in the fiscal intermediary's system 
will cause the provider to make multiple unnecessary adjustments to 
properly account for the difference in payment for high-cost outliers 
and short-stay outlier cases. The commenter proposed that the fiscal 
intermediary should be required to send the provider notification each 
time the cost-to-charge ratio will be changed in its system.
    Response: As explained in response to comments on the IPPS outlier 
proposed rule, although the provision concerning reconciliation is 
effective 60 days after the date of publication of this final rule, we 
understand that, given the large workload and limited resources of our 
fiscal intermediaries, attempting to implement this provision for all 
hospitals receiving outlier payments at the same time would create an 
administrative burden. Accordingly, we intend to issue a program 
instruction in the near future to assist fiscal intermediaries in 
implementing this provision during the remainder of the LTCH rate year.
    Notably, however, for LTCHs, particularly because the universe of 
LTCHs is relatively small, we do not believe it will be overly 
burdensome for the fiscal intermediaries to rerun a LTCH's claims to 
determine the accurate outlier payment amount. We also do not believe 
that the reconciliation of outlier payments for LTCHs will be overly 
burdensome because LTCHs are on notice of the revised methodology.
    We also are not adopting the commenter's recommendation to 
establish a system for monitoring PS&R data or for quarterly reporting. 
While those procedures might aid in detecting aberrant charge 
increases, we believe that the reconciliation process is preferable 
because it allows for outlier payments to be ultimately determined 
based on actual cost-to-charge ratios, rather than on estimates. 
Finally, we agree with the commenter that the fiscal intermediaries 
should notify the hospitals whenever a change is made to the cost-to-
charge ratio. We plan to provide more details on this procedure in 
program instructions to be issued after the publication of this final 
rule.
    Comment: Several commenters questioned whether CMS has the 
authority to retroactively adjust outlier payments, stating that it is 
``completely contrary to the entire concept of a prospective payment 
system,'' and would generate budgeting uncertainty and administrative 
burden for hospitals and CMS.
    One commenter claimed that the Secretary of the Department of 
Health and Human Services has argued in court that the Medicare statute 
does not allow retroactive adjustments to outlier payments. (See County 
of Los Angeles v. Shalala, 192 F.3d 1005 (D.C. Cir. 1999).)
    Another commenter argued that since the LTCH PPS is uniquely 
different from the IPPS in that a much greater percentage of overall 
payment under the LTCH PPS is dependent upon cost-to-charge ratios 
(high-cost outliers and short-stay outliers combined), subjecting such 
a large portion of payments to a cost-based settlement approach defeats 
the purpose and benefits of a PPS. Specifically, the commenter noted 
that since the cost-to-charge ratio is used to determine payment for 
both high-cost outliers and for short-stay outliers, which combined, 
can represent a significant percentage of all discharges from a LTCH, 
both the classification of a case as a short-stay or high-cost outlier 
and the resulting payment amount would have to be reassessed and 
possible retroactive adjustments would have to be made following an 
audit of more recent cost report data. Therefore, the commenter 
believed that a policy that allows for retroactive adjustments to prior 
payment amounts introduces a large amount of uncertainty and complexity 
that the PPS was intended to eliminate.
    Response: As an initial matter, our position in the court cases is 
more accurately presented as stating that the language of the statute 
does not clearly mandate that the actual amount of outlier payments 
must be between 5 and 6 percent of total outlier payments under the 
IPPS, and that our policy of not making retroactive adjustments to 
ensure that actual payments fall between that range is consistent with 
the intent of Congress. However, the commenters are correct in pointing 
out that a basic premise of a PPS is predictability of payment, the 
prospectivity of the system is undermined when it is manipulated and 
abused in order to maximize reimbursement. Under the IPPS, in light of 
the gross abuses of the current methodology by some hospitals, and the 
negative impact such overpayments ultimately have on other hospitals 
due to their impact on the fixed-loss amount, we believe the option of 
reconciling outlier payments based on the settled cost report for 
hospitals that have been initially paid using a significantly 
inaccurate cost-to-charge ratio compared to the actual ratio from the 
cost reporting period is now appropriate. We believe that at this time 
it is appropriate to adopt this policy for the LTCH PPS because it will 
contribute to the overall accuracy and fairness of the fixed-loss 
amount under the prospective payment system.
    As we stated above, in our view, reconciling outlier payments 
because they were originally paid on the basis of a significantly 
inaccurate cost-to-charge ratio is similar to recovering outlier 
payments when adjustments are made to covered charges for any services 
that are not found to be medically necessary or appropriate under 
Medicare upon medical or other review. This review is explicitly 
provided for under the IPPS policy at Sec.  412.84(d). This provision 
was established when the IPPS was first implemented for FY 1984 (48 FR 
39785).
    The court cases referenced by the commenters all addressed the 
issue of whether outlier payments must be retroactively adjusted when 
the level of the fixed-loss amount under the IPPS determined in advance 
of the fiscal year to which it applies ultimately results in actual 
IPPS outlier payments that are a smaller percentage of total IPPS DRG 
payments than was originally projected. We believe that an important 
goal of a PPS is predictability. Therefore, we believe that the fixed-
loss outlier threshold, whether under the IPPS or the LTCH PPS, should 
be projected based on the best available historical data and should not 
be adjusted retroactively. We believe that a retroactive change to the 
fixed-loss outlier threshold would affect all hospitals subject to a 
PPS, thereby undercutting the predictability of the system as a whole. 
However, if we deem it necessary as a result of a hospital-specific 
data variance to reconcile outlier payments of an individual hospital, 
such action on our part would not affect predictability of the entire 
system. Rather, because each hospital is on notice as to our revised 
methodology for determining cost-to-charge ratios and that outlier 
payments are subject to possible reconciliation, we are able to 
maintain the predictability of the system as a whole. Further, because 
reconciliation of outlier payments will affect only certain hospitals, 
the administrative burden of implementing such a policy is minimized. 
Accordingly, we continue to believe that the fixed-loss amount should 
be based on projected payments using the latest available historical 
data without retroactive adjustments. This was our position in the 
court cases cited by the commenter, and it has been our consistent and 
often stated position, including earlier in this final rule and in the 
March 5, 2003, IPPS outlier proposed rule.
    Comment: One commenter recommended that subregulatory

[[Page 34510]]

guidelines for the review of outlier payments be established, 
specifying what changes to the cost-to-charge ratios would trigger a 
review and what entity is responsible for determining whether a review 
is necessary. The commenter added that CMS should ensure that outlier 
thresholds are estimated to reflect 8 percent of total payments. 
Another commenter stated that the proposed reconciliation to cost-to-
charge ratios should be limited only to those hospitals that meet 
certain criteria, such as hospitals that cross a defined threshold of 
charge increases combined with a high level of outlier payments 
compared to the norm. The commenter requested that the final rule 
include specific criteria to be used for the determination of hospitals 
that will be subject to such an adjustment.
    Response: As we stated earlier in this final rule, we intend to 
issue a program instruction to the fiscal intermediaries in the near 
future that will provide specific criteria to be used in the 
reconciliation of outlier payments for the remainder of the LTCH PPS 
rate year.
    For cost reporting periods beginning on or after October 1, 2003, 
we are considering instructing fiscal intermediaries to conduct 
reconciliation for those LTCHs whose actual cost-to-charge ratios are 
found to be plus or minus 10 percentage points from the cost-to-charge 
ratio used during that time period to make outlier payments, and that 
have total FY 2004 outlier payments (high-cost and short stay outlier 
payments combined) that exceed $500,000. We believe these thresholds 
would appropriately capture those LTCHs whose outlier payments will be 
substantially inaccurate when using the ratio from the contemporaneous 
cost reporting period compared to the ratio from the latest cost 
reporting period. LTCHs exceeding these thresholds during their 
applicable cost reporting periods would become subject to 
reconciliation of their outlier payments. These thresholds would be 
reevaluated annually and, if necessary, modified each year. However, 
fiscal intermediaries would also have the administrative discretion to 
reconcile additional LTCHs' cost reports based on analysis that 
indicates the outlier payments made to those hospitals are 
significantly inaccurate.
    In addition, we will continue to ensure that outlier payments are 
projected to be equal to 8 percent of total LTCH PPS payments by using 
the best and most recent available data in computing the fixed-loss 
amount.
    Comment: One commenter strongly supported and recommended approval 
of the proposals to use the most recent settled or tentatively settled 
cost report or other latest available data from the provider or the 
fiscal intermediary, and the reconciliation for outlier payments upon 
cost report settlement. The commenter was in favor of these proposals 
because the commenter believed that they correct the ``inappropriately 
harmful impact'' that the current rules have on those hospitals that 
hold charge increases to a level lower than their cost increases. The 
commenter recommended that these proposed policies should be applied 
retroactively to the beginning of the LTCH PPS. However, the commenter 
did not agree that an adjustment for the time value of overpayments or 
underpayments should be applied to outlier payments received in a cost 
reporting period, since the issue has already been addressed in the 
regulations at 42 CFR 405.378, and no other aspect of a final 
settlement reflects payment of interest.
    Another commenter asserted that interest should not be assessed 
after the cost report is settled and before the provider has a chance 
to review and appeal potentially erroneous claims. Instead, the 
commenter recommended that CMS should allow a 180-day appeal period to 
give providers an opportunity to review the settlement and file appeals 
without interest.
    Response: As we stated earlier, we are adopting as final the 
proposals to eliminate the use of statewide averages for hospitals with 
cost-to-charge ratios below the minimum floor cost-to-charge ratio, the 
use of the cost-to-charge ratio from a tentatively settled cost report 
or alternative best available data, and finalizing the reconciliation 
policy for outlier payments upon cost report settlement. We understand 
the commenters' concerns and acknowledge that a change in policy is 
needed, but under our rulemaking authority, there is a serious question 
as to whether we could apply these policies retroactively. Therefore, 
consistent with the rationale explained under the IPPS section of this 
final rule, the effective date of the policies concerning elimination 
of the floor, and using alternative data from the fiscal intermediary 
or the provider, is for discharges occurring on or after August 8, 
2003. The use of the later of either the most recent tentatively 
settled cost report or the most recent settled cost report is effective 
for discharges occurring on or after October 1, 2003. The effective 
date of reconciliation of outlier payments is for discharges occurring 
on or after August 8, 2003.
    As noted previously, although the provision concerning 
reconciliation is effective 60 days after the date of publication of 
this final rule, we understand that, given the large workload and 
limited resources of our fiscal intermediaries, attempting to implement 
this provision for all hospitals receiving outlier payments at the same 
time would create an administrative burden. We intend to issue a 
program instruction in the near future to assist fiscal intermediaries 
in implementing this provision during the remainder of the LTCH rate 
year.
    We are implementing these effective dates under Sec. Sec.  
412.84(i) and (m), as referenced under the LTCH PPS outlier regulations 
at Sec. Sec.  412.525(a)(4) and 412.529(c)(5).
    In regard to the commenter's objection to the policy concerning the 
time value of money, outlier payments are uniquely susceptible to 
manipulation because hospitals set their own level of charges without 
review by the fiscal intermediary. Therefore, despite the recovery of 
the overpayment by CMS, a hospital would essentially benefit from an 
interest-free loan simply by increasing its charges in the interim. In 
order to ensure that hospitals are reimbursed fairly for extremely 
costly cases, it is necessary to establish a mechanism whereby an 
adjustment can be made to help guarantee that payments appropriately 
reflect the marginal costs of care for outlier cases. Under the LTCH 
PPS, it is also important to ensure that hospitals are paid correctly 
for short-stay outlier cases. We believe an adjustment for the time 
value of money is the appropriate mechanism to use to ensure equity and 
accuracy of payments.
    Comment: Several commenters noted the potential implications a 
retroactive adjustment to high-cost outlier payments may have on a 
beneficiary's use of lifetime reserve days. Medicare beneficiaries in a 
LTCH are much more likely to exceed their 90 days of available 
inpatient care during a LTCH stay than during a short-term acute 
hospital stay. A Medicare beneficiary's lifetime reserve days (days 91 
through 150) are not used as long as coinsurance days are available or 
as long as a stay is covered under the LTC-DRG. However, as soon as a 
day of care moves the beneficiary into the high-cost outlier category, 
this day and subsequent days are counted against the beneficiary's 
lifetime reserve days, and the stay is paid by Medicare as a high-cost 
outlier, with beneficiary coinsurance equal to half of the inpatient 
deductible amount. The commenters stated that the proposed policy would 
result in retroactive adjustments to the day on which a patient's stay 
moves into the

[[Page 34511]]

high cost category, thereby retroactively adjusting the lifetime 
reserve days available to a beneficiary.
    One commenter stated that coverage based on a changing cost-to-
charge ratio would not be a sound policy, and CMS should consider 
changing the high-cost outlier threshold determination to a per diem 
methodology to ensure that all beneficiaries receive the same number of 
benefit days and coverage.
    The commenters also pointed out that, for similar reasons, a policy 
that would retroactively reconcile outlier payments will create an 
unworkable system for the administration of Medicare supplemental 
(Medigap and Medicaid) payments, since such a policy anticipates that 
the Medigap and Medicaid programs will make retroactive adjustments to 
beneficiary benefits and payments. The commenters recommended that CMS 
consider severing the link between the count of Part A benefit days and 
cost outlier status and, instead, count beneficiary Part A days on a 
per diem basis so that the Part A benefit is not dependent upon changes 
to the cost-to-charge ratio and high-cost outlier status.
    Response: We have reviewed all the comments concerning the effect 
of the policy for reconciling outlier payments on a beneficiary's 
lifetime reserve days and eligibility for coverage under the Medigap 
and Medicaid programs. We believe that the commenters have raised a 
number of valid concerns. While we are adopting as final the policy to 
reconcile outlier payments upon cost report settlement to account for 
differences between the estimated cost-to-charge ratio and the actual 
cost-to-charge ratio for the period during which the discharge occurs, 
we believe that, because the outlier policy changes are intended to 
address accuracy of outlier payments rather than coverage or 
eligibility, any changes to a LTCH's outlier payments made as a result 
of reconciliation should not retroactively affect a beneficiary's 
lifetime reserve days or coverage status under Medigap or Medicaid. 
Specifically, no retroactive adjustments will be made to determine the 
day on which a beneficiary's stay moves to high-cost outlier status, 
and, therefore, no retroactive adjustments will be made to lifetime 
reserve days used or available. The reconciliation of outlier payments 
to the LTCH by the fiscal intermediary will simply be a redetermination 
of outlier payment upon cost report settlement. Similarly, no 
retroactive adjustments are required to be made to beneficiary benefits 
and payments under Medigap and Medicaid.
    Accordingly, we do not believe it is necessary to adopt the policy 
suggested by the commenters under which beneficiary Part A days would 
be counted on a per diem basis, since the receipt of Part A benefits 
will not be dependent upon changes to the cost-to-charge ratio and 
outlier status.
    Comment: Commenters wrote that since the LTCH PPS is new and CMS 
and the LTCH industry have almost no experience with the LTCH PPS and 
outlier payments, CMS has no policy reason for changing the LTCH PPS 
outlier policy at this time. The commenters stated that additional time 
and experience under the new system are needed before CMS has the 
information necessary to appropriately address potential problems.
    Response: We disagree with the commenters' assertion that because 
the LTCH PPS is still in its nascent stages, the challenges that have 
surfaced under the IPPS may not yet necessarily apply to the LTCH PPS. 
However, we believe those same challenges may arise in the LTCH PPS 
context because many of this system's features are modeled after the 
IPPS. We believe that being proactive in ensuring the accuracy of 
outlier payments by making additional payments only for truly high-cost 
cases is a matter of sound public policy. It is also our responsibility 
to ensure the integrity of the Medicare Trust Fund, which we believe 
this policy accomplishes. We note that we will continue to monitor all 
aspects of the LTCH PPS, and may propose to make other adjustments in 
the future if warranted.
    Comment: One commenter asked that CMS clarify the effective date of 
the proposed cost-to-charge ratio policies. The commenter stated that 
if the effective date is for discharges occurring on or after July 1, 
2003, then, for LTCHs with a fiscal year end date of June 30, the 
implementation process would be eased for the fiscal intermediaries and 
LTCHs. However, for those LTCHs that do not have a fiscal year end date 
of June 30, the commenter asserted that the task of accounting for the 
proposed cost-to-charge ratio regulations would be administratively 
burdensome for the fiscal intermediaries and LTCHs. Therefore, the 
commenter requested that the effective date for the proposed outlier 
regulations should be for cost reporting periods beginning on or after 
July 1, 2003.
    Response: We do not believe that the implementation of the outlier 
policies will be overly burdensome to LTCHs. As we noted previously, 
although this provision is effective 60 days after the date of 
publication of this final rule, we understand that, given the large 
workload and limited resources of our fiscal intermediaries, attempting 
to implement this provision for all hospitals receiving outlier 
payments at the same time would create an administrative burden. We 
intend to issue a program instruction in the near future to assist 
fiscal intermediaries in implementing this provision during the 
remainder of the LTCH rate year.
    Also, as we stated in responses to comments above, the outlier 
policy on applying a LTCH's actual cost-to-charge ratio to determine 
the cost of a case, even where the LTCH's actual cost-to-charge ratio 
falls below the floor, will become effective for discharges occurring 
on or after August 8, 2003. For purposes of making outlier payments 
between July 1, 2003, and August 8, 2003, cost-to-charge ratios that 
fall below the floor will be replaced by the statewide average, while 
any outlier payments made on or after August 8, 2003, will be 
determined using the actual cost-to-charge ratio, even if that cost-to-
charge ratio falls below the floor.
    The policies at Sec.  412.84(i)(1), (3), and (4) and Sec.  
412.84(m), as referenced under the LTCH PPS outlier regulations at 
Sec.  412.525(a)(4) and Sec.  412.529(c)(5) concerning use of 
alternative ratios and the elimination of the floor on cost-to-charge 
ratios are effective for discharges occurring on or after August 8, 
2003. The effective date of the policy concerning use of the most 
recent tentatively settled cost report or the most recent settled cost 
report at Sec.  412.84(i)(2) is for discharges occurring on or after 
October 1, 2003. The effective date of the policy regarding 
reconciliation of outlier payments is for discharges occurring on or 
after August 8, 2003.
    For example, regardless of the fiscal year begin date, between July 
1, 2003, and August 8, 2003, if a hospital's cost-to-charge ratio is 
below the floor, the hospital would continue to use the statewide 
average cost-to-charge ratio as under existing policy. However, 
beginning with discharges occurring on or after August 8, 2003, the 
hospital would use its actual cost-to-charge ratio, even if it were 
below the floor, and not the statewide average cost-to-charge ratio. 
Similarly, effective August 8, 2003, under Sec.  412.84(i)(1), CMS may 
use an alternative cost-to-charge ratio, or a hospital may request that 
the fiscal intermediary use a different cost-to-charge ratio based on 
substantial evidence presented by the hospital. Then, regardless of a 
hospital's fiscal year begin date, effective for discharges occurring 
on or after October 1, 2003, a hospital's cost-to-charge ratio will be 
based on the data available from the most recently tentatively settled 
or final

[[Page 34512]]

settled cost report, whichever is later. Finally, once a hospital 
submits to the fiscal intermediary its cost report for the period 
ending on or after August 8, 2003, the fiscal intermediary would use 
the program instructions we intend to issue in the near future that 
will provide specific criteria for implementing this provision on 
reconciliation.
    Comment: A commenter who wrote on behalf of LTCHs that have a 
fiscal year end date of December 31, asked the following questions 
related to the proposed cost-to-charge ratio policy: (1) Will the cost-
to-charge ratio for outlier payments be derived from the prior year's 
(December 31, 2002) cost report or from the fiscal year ending December 
31, 2001, cost report, since the fiscal year ending December 31, 2002, 
cost report is not due to the Medicare fiscal intermediary until May 
31, 2003? (2) Will the cost-to-charge ratio change when the fiscal year 
ending December 31, 2003, cost report is filed on May 31, 2004? (3) 
Will the cost-to-charge ratio for fiscal year ending December 31, 2003, 
outlier payments change when the cost report is tentatively settled and 
finalized in 2004 or 2005? (4) Will the cost-to-charge ratios for 
fiscal year ending December 31, 2003, change when appeals are settled 
in 2006 or 2007? (5) Will each Medicare claim applicable to outlier 
payments be reprocessed when the cost-to-charge ratio changes?
    Response: It appears that the commenter is essentially asking how 
cost report settlement will affect changes to a hospital's cost-to-
charge ratio. As explained above, each hospital's cost-to-charge ratio 
may change effective for discharges occurring on or after August 8, 
2003, in instances where the cost-to-charge ratio is below the floor, 
or CMS believes an alternative cost-to-charge ratio should be used. A 
hospital's cost-to-charge ratio also may change effective for 
discharges occurring on or after October 1, 2003, based on the most 
recent tentatively settled cost report, or the final settled cost 
report, whichever is later.
    In response to the commenter's third question, the reconciliation 
policy is effective for discharges occurring on or after 60 calendar 
days after the publication of this final rule. As we stated above, we 
intend to issue a program instruction to fiscal intermediaries in the 
near future that will provide specific criteria for determining how the 
reconciliation of outlier payments will be implemented. However, we 
note, as with other cost report settlement issues, the hospital may 
appeal the Notice of Program Reimbursement for the December 31, 2004, 
cost report and the cost-to-charge ratio, and, therefore, outlier 
payments may change depending on the outcome of the appeal.
    Finally, in response to the commenter's fifth question, not all 
claims may be reprocessed when the cost-to-charge ratio changes upon 
reconciliation. Again, as explained previously, we intend to issue a 
program instruction to fiscal intermediaries that will provide specific 
criteria for determining how the reconciliation of outlier payments 
will be implemented.
    Comment: One commenter supported the proposal to use more recent 
cost-to-charge ratios to calculate outlier payments and eliminate the 
use of the statewide average cost-to-charge ratio floor, but expressed 
concern that an abrupt change to cost-to-charge ratios would create 
significant and unanticipated reductions in outlier payments and urged 
CMS to implement a transition period for all hospitals that would be 
adversely affected by the proposed policy changes.
    Response: We have received many comments stating that a transition 
period is necessary, mostly in relation to the proposed policy for IPPS 
outlier payments. In the context of LTCHs, we do not believe that this 
policy will result in significant reductions in historic outlier 
payments, because the LTCH PPS is a new system, there were no outlier 
payments under the previous reasonable cost-based payment methodology, 
and LTCHs only recently had the opportunity to choose whether they wish 
to be reimbursed on a blend of LTCH PPS and reasonable cost-based 
payments over a 5-year period, or on 100 percent of the Federal rate. 
Therefore, we do not believe that the proposed changes to the outlier 
policy will place any LTCHs at risk for a substantial loss of 
reimbursement. In addition, as stated above, we believe that the 
proposed policy changes will ensure that the fixed-loss amount is 
established at a reasonable level and that each hospital will be 
reimbursed for high-cost and short-stay outlier cases in an accurate 
and equitable manner. Thus, we believe that it is in the best interest 
of CMS and the hospital community as a whole to forego a transition 
period and implement the proposed changes to the outlier policy as soon 
as possible.

E. Provisions of the Final Rule

    Consistent with the final IPPS outlier policy in this final rule, 
we are revising Sec. Sec.  412.525(a)(4) and 412.529(c)(5) to specify 
that, for discharges from LTCHs under the LTCH PPS occurring on or 
after October 1, 2002, and before August 8, 2003, no reconciliations 
will be made to high-cost outlier payments or to short-stay outlier 
payments, respectively, upon cost report settlement to account for 
differences between the estimated cost-to-charge ratio and the actual 
cost-to-charge ratio of the case. We are specifying in Sec. Sec.  
412.525(a)(4)(iii) and 412.529(c)(5)(iii) that for discharges from 
LTCHs under the LTCH PPS occurring on or after October 1, 2003, high-
cost outlier payments and short-stay outlier payments, respectively, 
are subject to the provisions of Sec.  412.84(i)(2) (which are 
applicable to IPPS hospitals).

G. Short-Stay Outlier Cases

    A short-stay outlier case may occur when a beneficiary receives 
less than the full course of treatment at the LTCH before being 
discharged. These patients may be discharged to another site of care or 
they may be discharged and not readmitted because they no longer 
require treatment. Furthermore, patients may expire early in their LTCH 
stay.
    As we discussed in the August 30, 2002, LTCH PPS final rule (67 FR 
55970), generally LTCHs are defined by statute as having an average 
length of stay of greater than 25 days. We believe that a payment 
adjustment for short-stay outlier cases results in more appropriate 
payments, because these cases most likely would not receive a full 
course of treatment in such a short period of time and a full LTC-DRG 
payment may not always be appropriate. Payment-to-cost ratios simulated 
for LTCHs, for the cases described above, show that if LTCHs receive a 
full LTC-DRG payment for those cases, they would be significantly 
``overpaid'' for the resources they have actually expended.
    Under Sec.  412.529, we adjust the per discharge payment for a 
short-stay outlier patient to the least of 120 percent of the cost of 
the case, 120 percent of the LTC-DRG specific per diem amount 
multiplied by the length of stay of that discharge, or the full LTC-DRG 
payment, for all cases with a length of stay up to and including five-
sixths of the geometric average length of stay of the LTC-DRG.
    As we discussed in section VI.C.3. of the March 7, 2003, proposed 
rule, in the March 5, 2003, proposed rule (68 FR 10420), we proposed to 
revise the methodology for determining cost-to-charge ratios for acute 
care hospitals under the IPPS because we became aware that payment 
vulnerabilities exist in the current IPPS outlier policy. Because the 
LTCH PPS high-cost outlier and short-stay outlier payments are also 
based on cost-to-charge ratios as under the IPPS, we believe they are

[[Page 34513]]

susceptible to the same payment vulnerabilities as the IPPS and, 
therefore, merit revision. As proposed for acute care hospitals under 
the IPPS at proposed Sec.  412.84(i) and (m) in the March 5, 2003, 
proposed rule (68 FR 10429) and as we proposed for LTCHs above for 
high-cost outlier payments at Sec.  412.525(a)(4)(ii), we proposed 
under Sec.  412.529 that short-stay outlier payments would be subject 
to the proposed provisions in the regulations at Sec.  412.84(i) and 
(m). Therefore, consistent with the proposed changes to the high-cost 
outlier policy discussed in section VI.C.3. of the March 7, 2003, 
proposed rule, we proposed, by cross-referencing Sec.  412.84(i), that 
fiscal intermediaries would use either the most recent settled cost 
report or the most recent tentatively settled cost report, whichever is 
later, in estimating a LTCH's cost-to-charge ratio. We also proposed, 
by cross-referencing Sec.  412.84(i), that the applicable statewide 
average cost-to-charge ratio would only be applied when a LTCH's cost-
to-charge ratio exceeds the ceiling. Finally, we proposed, by cross-
referencing Sec.  412.84(m), that any reconciliation of payments for 
short-stay outliers would be made upon cost report settlement to 
account for differences between the estimated cost-to-charge ratio and 
the actual cost-to-charge ratio for the period during which the 
discharge occurs. We further noted that as was the case with the 
proposed changes to the outlier policy for acute care hospitals under 
the IPPS, we were still assessing the procedural changes that would be 
necessary to implement this change.
    We received numerous comments on the proposed changes to the 
outlier policy as it relates to short-stay outliers. We have summarized 
and responded to these comments in the previous section related to 
outlier payments under the LTCH PPS. Therefore, as discussed above, 
under Sec.  412.529, short-stay outlier payments are subject to the 
provisions of Sec. Sec.  412.84(i)(1), (3), and (4) and Sec.  412.84(m) 
for discharges occurring on or after August 8, 2003, and subject to the 
provisions of Sec.  412.84(i)(2) for discharges occurring on or after 
October 1, 2003.

VIII. Collection of Information Requirements

    Under the Paperwork Reduction Act of 1995 (PRA), we are required to 
provide 30-day notice in the Federal Register and solicit public 
comment before a collection of information requirement is submitted to 
the Office of Management and Budget (OMB) for review and approval. In 
order to fairly evaluate whether an information collection should be 
approved by OMB, section 3506(c)(2)(A) of the Paperwork Reduction Act 
of 1995 (PRA) requires that we solicit comment on the following issues:
    [sbull] The need for the information collection and its usefulness 
in carrying out the proper functions of our agency.
    [sbull] The accuracy of our estimate of the information collection 
burden.
    [sbull] The quality, utility, and clarity of the information to be 
collected.
    [sbull] Recommendations to minimize the information collection 
burden on the affected public, including automated collection 
techniques.
    In the March 5, 2003, proposed rule, we solicited comment on the 
recordkeeping requirements referenced in the proposed amendments to 
Sec.  412.84. Under the proposed amendments to Sec.  412.84(h), a 
hospital may request that its fiscal intermediary use a different 
(higher or lower) cost-to-charge ratio based on substantial evidence 
presented by the hospital. The burden imposed by this section is the 
time it takes to write the request. We estimated that 120 hospitals 
would make this request per year and that it would take each one 8 
hours for a total annual burden of 960 hours.
    We did not receive any comments on this information collection 
requirement and are making no revisions to it. We will submit this 
information collection requirement to the Office of Management and 
Budget for review and approval in accordance with the Paperwork 
Reduction Act. The requirement will not go into effect until we receive 
OMB approval.
    If you comment on this information collection and recordkeeping 
requirement, please mail, e-mail or fax copies directly to the 
following:

Centers for Medicare & Medicaid Services, Office of Strategic 
Operations and Regulatory Affairs, Regulations Development and 
Issuances Group, Attn: Julie Brown, CMS-1243-F, Room C5-16-03, 7500 
Security Boulevard, Baltimore, MD 21244-1850;
 and
Office of Information and Regulatory Affairs, Office of Management and 
Budget, Room 10235, New Executive Office Building, Washington, DC 
20503. Attn.: Brenda Aguilar, CMS Desk Officer, [email protected]. 
Fax: (202) 395-6974.

IX. Impact Analysis

A. Introduction

    We have examined the impacts 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, Pub. L. 
96-354), section 1102(b) of the Social Security Act, the Unfunded 
Mandates Reform Act of 1995 Pub. L. 104-4), and Executive Order 13132.

B. Executive Order 12866

    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 1 year).
    We have determined that this final rule is a major rule as defined 
in 5 U.S.C. 804(2). We estimate the total impact of the policies 
implemented in this final rule will be to reduce outlier payments for 
the remainder of FY 2003 by $150 million. Therefore, we have prepared 
the quantitative analysis under this impact analysis section at IX.G. 
of this preamble.

C. Regulatory Flexibility Analysis

    The RFA requires agencies to analyze options for regulatory relief 
of small businesses. For purposes of the RFA, small entities include 
small businesses, nonprofit organizations, and government agencies. 
Most hospitals and most other providers and suppliers are small 
entities, either based on their nonprofit status or by having revenues 
of $6 million to $29 million in any 1 year. For purposes of the RFA, 
all hospitals and other providers and suppliers are considered to be 
small entities. Individuals and States are not included in the 
definition of a small entity. As stated above, we have prepared the 
quantitative analysis under this impact analysis section at IX.G. of 
this preamble.

D. Effects on Rural Hospitals

    Section 1102(b) of the Social Security Act requires us to prepare a 
regulatory impact analysis for any final rule that 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 603 of the RFA. With the exception of hospitals located in 
certain New England counties, for purposes of section 1102(b) of the 
Act, we define a small rural hospital as a hospital with fewer than 100 
beds that is located outside of a Metropolitan Statistical

[[Page 34514]]

Area (MSA) or New England County Metropolitan Area (NECMA). Section 
601(g) of the Social Security Amendments of 1983 (Pub. L. 98-21) 
designated hospitals in certain New England counties as belonging to 
the adjacent NECMA. Thus, for purposes of the IPPS, we classify these 
hospitals as urban hospitals.
    It is clear that the changes we are making in this final rule will 
affect both a substantial number of small rural hospitals as well as 
other classes of hospitals, and that the effects on some hospitals 
might be significant. Therefore, the discussion of the quantitative 
analysis under section IX.G. of this preamble, in combination with the 
rest of this final rule, constitutes a combined regulatory impact 
analysis and regulatory flexibility analysis.

E. Unfunded Mandates

    Section 202 of the Unfunded Mandates Reform Act of 1995 (Pub. L. 
104-4) also requires that agencies assess anticipated costs and 
benefits before issuing any proposed rule or a final rule, which has 
been preceded by a proposed rule, that may result in an expenditure in 
any one year by State, local, or tribal governments, in the aggregate, 
or by the private sector, of $110 million. This final rule does not 
result in any unfunded mandates for State, local, or tribal governments 
or the private sector, as defined by section 202.

F. Federalism

    Executive Order 13132 establishes certain requirements that an 
agency must meet when it promulgates a proposed rule and a subsequent 
final rule that imposes substantial direct requirement costs on State 
and local governments, preempts State law, or otherwise has Federalism 
implications. We have reviewed this final rule in light of Executive 
Order 13132 and have determined that it does not have any negative 
impact on the rights, roles, and responsibilities of State, local, or 
tribal governments.

G. Quantitative Analysis

    As described above, the changes we are making in this final rule 
will better target outlier payments to the most costly cases. First, we 
are providing that fiscal intermediaries will no longer assign the 
statewide average cost-to-charge ratio in place of the actual cost-to-
charge ratio when the hospital's actual ratio is more than 3 standard 
deviations below the geometric mean cost-to-charge ratio. Second, we 
are implementing the use of the most recent tentatively settled 
Medicare cost report to determine a hospital's cost-to-charge ratio. 
Third, outlier payments may be subject to reconciliation when the cost 
report corresponding with the outlier cases is settled, using the 
actual cost-to-charge ratio calculated from the final settled cost 
report rather than the cost-to-charge ratio from the latest tentative 
settled cost report at the time the claim is processed.
    We anticipate these changes will lower payments to hospitals that 
have been aggressively gaming the existing outlier payment methodology 
by manipulating their charges toward those hospitals with truly high-
cost cases (by lowering the thresholds). For some hospitals, the 
effects of the reduced payments may be quite dramatic. For those 
hospitals, the impact of this final rule will be to significantly 
decrease their outlier payments. It is difficult to quantify precisely 
the impact on these hospitals of this change because we will not know 
the final applicable cost-to-charge ratios until the cost reports are 
settled. However, assuming that once concurrent cost-to-charge ratios 
are used for these hospitals, their outlier payments as a percent of 
their total DRG payments are similar to past levels, we estimate a 
reduction of $50 million in outlier payments to these hospitals for the 
2 months remaining in FY 2003.
    For the 43 hospitals currently receiving outlier payments on the 
basis of a statewide average cost-to-charge ratio because their actual 
ratios are below the lower threshold, their outlier payments will begin 
to decline effective for discharges occurring on or after 60 days 
following the date of publication of this final rule. However, it is 
difficult to quantify the impacts upon these hospitals because we do 
not have data available to assess whether they have increased their 
charges in order to offset any anticipated reduction in their outlier 
payments. However, assuming no behavioral responses on the part of 
hospitals, we estimate that, for the approximately 2 months remaining 
in FY 2003 after this change goes into effect, payments to these 
hospitals will decline by $95 million.
    For most hospitals, this final rule will not have an impact on 
their FY 2003 outlier payments. This is because the fixed-loss 
threshold is remaining at $33,560, and for the changes effective during 
FY 2003, we will instruct the fiscal intermediaries to focus their 
limited resources only on those hospitals that appear to have 
disproportionately benefited from the time lag in updating their cost-
to-charge ratios. Also, we will not require the use of more recent 
cost-to-charge ratios until FY 2004.
    We have examined the potential impact of the changes in the 
methodology for determining cost-to-charge ratios for purposes of 
payment of high-cost outliers and short-stay outliers under the LTCH 
PPS. Because the LTCH PPS is a new system that has only been in effect 
since October 1, 2002, and the vulnerabilities that have surfaced under 
the IPPS do not yet necessarily apply to LTCHs, we do not believe these 
policies will have a significant financial impact on LTCHs in FY 2003.

H. Alternatives Considered

    For purposes of this analysis, we considered several alternatives 
to the changes we are finalizing in this rule as discussed above. One 
alternative would be to not make any changes to the current outlier 
policy. However, we believe that in light of the evidence that 
hospitals have been manipulating our current outlier policy, it is 
important to change the current policy as it existed prior to this 
final rule, to ensure these payments go to truly expensive cases. 
Therefore, we do not believe retaining that current policy is a viable 
option.
    We also considered establishing a policy that hospitals' cost-to-
charge ratios would be based on their rates-of-increase in charges as 
an alternative to reconciling outlier payments on the cost reports. 
However, we believe this approach would be extremely complex. In 
addition, this approach would require us to make assumptions about the 
relationship between costs and charges that may not apply in particular 
circumstances. Therefore, this alternative would be likely to lead to 
inequitable treatment of some hospitals.
    We considered eliminating the application of statewide average 
cost-to-charge ratios altogether. However, it is necessary to have some 
ratio to assign to new hospitals that have not yet filed their first 
cost report. Also, we believe it remains appropriate to assign the 
statewide average cost-to-charge ratio in cases where a hospital's 
cost-to-charge ratio exceeds 3 standard deviations from the geometric 
mean.

I. 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 412

    Administrative practice and procedure, Health facilities, Medicare, 
Puerto Rico, Reporting and recordkeeping requirements.

0
For the reasons stated in the preamble of this final rule, the Centers 
for

[[Page 34515]]

Medicare & Medicaid Services amends 42 CFR part 412 as follows:

PART 412--PROSPECTIVE PAYMENT SYSTEMS FOR INPATIENT HOSPITAL 
SERVICES

0
1. The authority citation for Part 412 continues to read as follows:

    Authority: Secs. 1102 and 1871 of the Social Security Act (42 
U.S.C. 1302 and 1395hh).

0
2. Section 412.84 is amended by--
0
A. Revising paragraph (h).
0
B. Redesignating paragraphs (i), (j), and (k) as paragraphs (j), (k), 
and (l), respectively.
0
C. Adding a new paragraph (i).
0
D. In redesignated paragraph (k), removing the phrase ``paragraph (k) 
of this section'' and adding in its place ``paragraph (l) of this 
section.''
0
E. In redesignated paragraph (l), removing the phrase ``paragraph (j) 
of this section'' and adding in its place ``paragraph (k) of this 
section.''
0
F. Adding a new paragraph (m).
0
The additions and revisions read as follows:


Sec.  412.84  Payment for extraordinarily high-cost cases (cost 
outliers).

* * * * *
    (h) For discharges occurring before October 1, 2003, the operating 
and capital cost-to-charge ratios used to adjust covered charges are 
computed annually by the intermediary for each hospital based on the 
latest available settled cost report for that hospital and charge data 
for the same time period as that covered by the cost report. For 
discharges occurring before August 8, 2003, statewide cost-to-charge 
ratios are used in those instances in which a hospital's operating or 
capital cost-to-charge ratios fall outside reasonable parameters. CMS 
sets forth the reasonable parameters and the statewide cost-to-charge 
ratios in each year's annual notice of prospective payment rates 
published in the Federal Register in accordance with Sec.  412.8(b).
    (i)(1) For discharges occurring on or after August 8, 2003, CMS may 
specify an alternative to the ratios otherwise applicable under 
paragraphs (h) or (i)(2) of this section. A hospital may also request 
that its fiscal intermediary use a different (higher or lower) cost-to-
charge ratio based on substantial evidence presented by the hospital. 
Such a request must be approved by the CMS Regional Office.
    (2) For discharges occurring on or after October 1, 2003, the 
operating and capital cost-to-charge ratios applied at the time a claim 
is processed are based on either the most recent settled cost report or 
the most recent tentative settled cost report, whichever is from the 
latest cost reporting period.
    (3) For discharges occurring on or after August 8, 2003, the fiscal 
intermediary may use a statewide average cost-to-charge ratio if it is 
unable to determine an accurate operating or capital cost-to-charge 
ratio for a hospital in one of the following circumstances:
    (i) New hospitals that have not yet submitted their first Medicare 
cost report. (For this purpose, a new hospital is defined as an entity 
that has not accepted assignment of an existing hospital's provider 
agreement in accordance with Sec.  489.18 of this chapter.)
    (ii) Hospitals whose operating or capital cost-to-charge ratio is 
in excess of 3 standard deviations above the corresponding national 
geometric mean. This mean is recalculated annually by CMS and published 
in the annual notice of prospective payment rates issued in accordance 
with Sec.  412.8(b).
    (iii) Other hospitals for whom the fiscal intermediary obtains 
accurate data with which to calculate either an operating or capital 
cost-to-charge ratio (or both) are not available.
    (4) For discharges occurring on or after August 8, 2003, any 
reconciliation of outlier payments will be based on operating and 
capital cost-to-charge ratios calculated based on a ratio of costs to 
charges computed from the relevant cost report and charge data 
determined at the time the cost report coinciding with the discharge is 
settled.
* * * * *
    (m) Effective for discharges occurring on or after August 8, 2003, 
at the time of any reconciliation under paragraph (h)(3) of this 
section, outlier payments may be adjusted to account for the time value 
of any underpayments or overpayments. Any adjustment will be based upon 
a widely available index to be established in advance by the Secretary, 
and will be applied from the midpoint of the cost reporting period to 
the date of reconciliation.


Sec.  412.116  [Amended]

0
3. In Sec.  412.116(e), the second sentence is removed.

0
4. Section 412.525 is amended by revising paragraph (a)(4) to read as 
follows:


Sec.  412.525  Adjustments to the Federal prospective payment.

    (a) Adjustments for high-cost outliers. * * *
    (4)(i) For discharges occurring on or after October 1, 2002 and 
before August 8, 2003, no reconciliations will be made to outlier 
payments upon cost report settlement to account for differences between 
the estimated cost-to-charge ratio and the actual cost-to-charge ratio 
of the case.
    (ii) For discharges occurring on or after August 8, 2003, high-cost 
outlier payments are subject to the provisions of Sec. Sec.  
412.84(i)(1), (i)(3), and (i)(4) and (m) for adjustments of cost-to-
charge ratios.
    (iii) For discharges occurring on or after October 1, 2003, high-
cost outlier payments are subject to the provisions of Sec.  
412.84(i)(2) for adjustments to cost-to-charge ratios.
* * * * *

0
5. Section 412.529 is amended by revising paragraph (c)(5) to read as 
follows:


Sec.  412.529  Special payment provision for short-stay outliers.

* * * * *
    (c) * * *
    (5)(i) For discharges occurring on or after October 1, 2002 and 
before August 8, 2003, no reconciliations will be made to short-stay 
outlier payments upon cost report settlement to account for differences 
between cost-to-charge ratio and the actual cost-to-charge ratio of the 
case.
    (ii) For discharges occurring on or after August 8, 2003, short-
stay outlier payments are subject to the provisions of Sec. Sec.  
412.84(i)(1), (i)(3), and (i)(4) and (m) for adjustments of cost-to-
charge ratios.
    (iii) For discharges occurring on or after October 1, 2003, short-
stay outlier payments are subject to the provisions of Sec.  
412.84(i)(2) for adjustments to cost-to-charge ratios.

(Catalog of Federal Domestic Assistance Program No. 93.773, 
Medicare--Hospital Insurance.)

    Dated: May 30, 2003.
Thomas A. Scully,
Administrator, Centers for Medicare & Medicaid Services.

    Approved: June 3, 2003.
Tommy G. Thompson,
Secretary.
[FR Doc. 03-14492 Filed 6-5-03; 3:27 pm]
BILLING CODE 4120-01-P