[Federal Register Volume 69, Number 154 (Wednesday, August 11, 2004)]
[Rules and Regulations]
[Pages 48916-49781]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-17943]



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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 Parts 403, 412, et al.



Medicare Program; Changes to the Hospital Inpatient Prospective Payment 
Systems and Fiscal Year 2005 Rates; Final Rule

  Federal Register / Vol. 69, No. 154 / Wednesday, August 11, 2004 / 
Rules and Regulations  

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DEPARTMENT OF HEALTH AND HUMAN SERVICES

Centers for Medicare & Medicaid Services

42 CFR Parts 403, 412, 413, 418, 460, 480, 482, 483, 485, and 489

[CMS-1428-F]
RIN 0938-AM80


Medicare Program; Changes to the Hospital Inpatient Prospective 
Payment Systems and Fiscal Year 2005 Rates

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

ACTION: Final rule.

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SUMMARY: We are revising the Medicare hospital inpatient prospective 
payment systems (IPPS) for operating and capital-related costs to 
implement changes arising from our continuing experience with these 
systems; and to implement a number of changes made by the Medicare 
Prescription Drug, Improvement, and Modernization Act of 2003 that was 
enacted on December 8, 2003. In addition, in the Addendum to this final 
rule, we describe the changes to the amounts and factors used to 
determine the rates for Medicare hospital inpatient services for 
operating costs and capital-related costs. These changes are applicable 
to discharges occurring on or after October 1, 2004. We also are 
setting forth rate-of-increase limits as well as policy changes for 
hospitals and hospital units excluded from the IPPS that are paid in 
full or in part on a reasonable cost basis subject to these limits.
    Among the policy changes that we are making are: Changes to the 
classification of cases to the diagnosis-related groups (DRGs); changes 
to the long-term care (LTC)-DRGs and relative weights; changes in the 
wage data, labor-related share of the wage index, and the geographic 
area designations used to compute the wage index; changes in the 
qualifying threshold criteria for and the approval of new technologies 
and medical services for add-on payments; changes to the policies 
governing postacute care transfers; changes to payments to hospitals 
for the direct and indirect costs of graduate medical education; 
changes to the payment adjustment for disproportionate share rural 
hospitals; changes in requirements and payments to critical access 
hospitals (CAHs); changes to the disclosure of information requirements 
for Quality Improvement Organization (QIOs); and changes in the 
hospital conditions of participation for discharge planning and fire 
safety requirements for certain health care facilities.

DATES: The provisions of this final rule are effective on October 1, 
2004.

FOR FURTHER INFORMATION CONTACT:
    Jim Hart, (410) 786-9520, Operating Prospective Payment, Diagnosis-
Related Groups (DRGs), Wage Index, New Medical Services and Technology, 
Standardized Amounts, Hospital Geographic Reclassifications, Postacute 
Care Transfers, and Disproportionate Share Hospital Issuesp; Tzvi 
Hefter, (410) 786-4487, Capital Prospective Payment, Excluded 
Hospitals, Graduate Medical Education, Critical Access Hospitals, and 
Long-Term Care (LTC)-DRGs Issues;
    Mary Collins, (410) 786-3189, CAH Bed Limits and Distinct Part Unit 
Issues; John Eppinger, (410) 786-4518, CAH Periodic Interim Payment 
Issues; Maria Hammel, (410) 786-1775, Quality Improvement Organization 
Issues; Siddhartha Mazumdar, (410) 786-6673, Rural Community Hospital 
Demonstration Project Issues; Jeannie Miller, (410) 786-3164, 
Bloodborne Pathogens Standards, Hospital Conditions of Participation 
for Discharge Planning, and Fire Safety Requirements Issues; Dr. Mark 
Krushat, (410) 786-6809; and Dr. Anita Bhatia, (410) 786-7236, Quality 
Data for Annual Payment Update Issues.

SUPPLEMENTARY INFORMATION:

Availability of Copies and Electronic Access

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Acronyms

ACGME--Accreditation Council on Graduate Medical Education
AHIMA--American Health Information Management Association
AHA--American Hospital Association
AOA--American Osteopathic Association
ASC--Ambulatory Surgical Center
BBA--Balanced Budget Act of 1997, Pub. L. 105-33
BIPA--Medicare, Medicaid, and SCHIP [State Children's Health 
Insurance Program] Benefits Improvement and Protection Act of 2000, 
Pub. L. 106-554
BLS--Bureau of Labor Statistics
CAH--Critical access hospital
CART CMS--Abstraction & Reporting Tool
CBSAs--Core-Based Statistical Areas
CC--Complication or comorbidity
CMS--Centers for Medicare & Medicaid Services
CMSA--Consolidated Metropolitan Statistical Area
COBRA--Consolidated Omnibus Reconciliation Act of 1985, Pub. L. 99-
272
CoP--Condition of Participation
CPI--Consumer Price Index
CRNA--Certified registered nurse anesthetist
DRG--Diagnosis-related group
DSH--Disproportionate share hospital
ESRD--End-stage renal disease
FDA--Food and Drug Administration
FQHC--Federally qualified health center
FSES--Fire Safety Evaluation System
FTE--Full-time equivalent
FY--Federal fiscal year
GME--Graduate medical education
HCRIS--Hospital Cost Report Information System
HIPC--Health Information Policy Council
HIPAA--Health Insurance Portability and Accountability Act of 1996, 
Pub. L. 104-191
HHA--Home health agency
HPSA--Health Professions Shortage Area
ICD-9-CM--International Classification of Diseases, Ninth Revision, 
Clinical Modification
ICD-10-PCS--International Classification of Diseases, Tenth Edition, 
Procedure Coding System
ICF/MRs--Intermediate care facilities for the mentally retarded
IME--Indirect medical education
IPPS--Acute care hospital inpatient prospective payment system
IPF--Inpatient psychiatric facility
IRF--Inpatient rehabilitation facility
JCAHO--Joint Commission on the Accreditation of Healthcare 
Organizations
LAMA--Left Against Medical Advice
LTC-DRG--Long-term care diagnosis-related group

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LTCH--Long-term care hospital
LSC--Life Safety Code
MCE--Medicare Code Editor
MCO--Managed care organization
MDC--Major diagnostic category
MDH--Medicare-dependent small rural hospital
MedPAC--Medicare Payment Advisory Commission
MedPAR--Medicare Provider Analysis and Review File
MEI--Medicare Economic Index
MGCRB--Medicare Geographic Classification Review Board
MMA--Medicare Prescription Drug, Improvement, and Modernization Act 
of 2003, Pub. L. 108-173
MPFS--Medicare Physician Fee Schedule
MSA--Metropolitan Statistical Area
NECMA--New England County Metropolitan Areas
NCHS--National Center for Health Statistics
NCVHS--National Committee on Vital and Health Statistics
NFPA--National Fire Protection Association
NPR--Notice of Program Reimbursement
NQF--National Quality Forum
NVHRI--National Voluntary Hospital Reporting Initiative
OES--Occupational Employment Statistics
OIG--Office of the Inspector General
OMB--Executive Office of Management and Budget
O.R.--Operating room
OSCAR--Online Survey Certification and Reporting (System)
OSHA--Occupational Safety and Health Act
PACE--Programs of All-Inclusive Care for the Elderly
PIP--Periodic interim payment
PMS--Performance Measurement System
PMSAs--Primary Metropolitan Statistical Areas
PPS--Prospective payment system
PRA--Per resident amount
ProPAC--Prospective Payment Assessment Commission
PRRB--Provider Reimbursement Review Board
PS&R--Provider Statistical and Reimbursement System
QIO--Utilization and Quality Control Quality Improvement 
Organization
RHC--Rural health clinic
RHQDAPU--Reporting Hospital Quality Data for Annual Payment Update
RRC--Rural referral center
SCH--Sole community hospital
SNF--Skilled nursing facility
SOCs--Standard occupational classifications
SOM--State Operations Manual
SSA--Social Security Administration
SSI--Supplemental Security Income
TEFRA--Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. 97-
248
UHDDS--Uniform Hospital Discharge Data Set

Table of Contents

I. Background
    A. Summary
    1. Acute Care Hospital Inpatient Prospective Payment System 
(IPPS)
    2. Hospitals and Hospital Units Excluded from the IPPS
    a. IRFs
    b. LTCH
    c. IPFs
    3. Critical Access Hospitals (CAHs)
    4. Payments for Graduate Medical Education (GME)
    B. Provisions of the Medicare Prescription Drug, Improvement, 
and Modernization Act of 2003
    C. Summary of the Provisions of the May 18, 2004 Proposed Rule
    1. Changes to the DRG Reclassifications and Recalibrations of 
Relative Weights
    2. Changes to the Hospital Wage Index
    3. Other Decisions and Changes to the PPS for Inpatient 
Operating and GME Costs
    4. Changes to the PPS for Capital-Related Costs
    5. Changes for Hospitals and Hospital Units Excluded from the 
IPPS
    6. Changes to QIO Disclosure of Information Requirements
    7. Changes Relating to Medicare Provider Agreements: Bloodborne 
Pathogens Standards, Hospital Conditions of Participation for 
Discharge Planning, and Fire Safety Requirements for Certain Health 
Care Facilities
    8. Determining Prospective Payment Operating and Capital Rates 
and Rate-of-Increase Limits
    9. Impact Analysis
    10. Recommendation of Update Factor for Hospital Inpatient 
Operating Costs
    11. Discussion of Medicare Payment Advisory Commission 
Recommendations
    D. Public Comments Received in response to the May 18, 2004 IPPS 
Proposed Rule
II. Changes to DRG Classifications and Relative Weights
    A. Background
    B. DRG Reclassifications
    1. General
    2. MDC 1 (Diseases and Disorders of the Nervous System): 
Intracranial Hemorrhage and Stroke With Infarction
    3. MDC 5 (Diseases and Disorders of the Circulatory System)
    a. Heart Assist System Implant
    b. Cardiac Resynchronization Therapy and Heart Failure
    c. Combination Cardiac Pacemaker Devices and Lead Codes
    d. Treatment of Venous Bypass Graft [Conduit] with 
Pharmaceutical Substance
    4. MDC 6 (Diseases and Disorders of the Digestive System): 
Artificial Anal Sphincter
    5. MDC 8 (Diseases and Disorders of the Musculoskeletal System 
and Connective Tissue)
    a. 360 Spinal Fusions
    b. Multiple Level Spinal Fusion
    c. Insertion of Spinal Disc Prostheses and Other Spiral Devices
    6. MDC 15 (Newborns and Other Neonates with Conditions 
Originating in the Perinatal Period)
    7. MDC 20 (Alcohol/Drug Use and Alcohol/Drug Induced Organic 
Mental Disorders): Drug-Induced Dementia
    8. MDC 22 (Burns): Burn Patients on Mechanical Ventilation
    9. Pre-MDC: Tracheostomy
    10. Medicare Code Editor (MCE) Changes
    11. Surgical Hierarchies
    12. Refinement of Complications and Comorbidities (CC) List
    13. Review of Procedure Codes in DRGs 468, 476, and 477
    a. Moving Procedure Codes from DRG 468 or DRG 477 to MDCs
    b. Reassignment of Procedures among DRGs 468, 476, and 477
    c. Adding Diagnosis or Procedure Codes to MDCs
    14. Pancreatic Islet Cell Transplantation in Clinical Trials
    15. Changes to the ICD-9-CM Coding System
    16. Other Issues
    a. Craniotomy Procedures
    (1) Unruptured Cerebral Aneurysms
    (2) GLIADEL[reg] Chemotherapy Wafers
    (3) DRG 3 (Craniotomy Age 0-17)
    b. Coronary Stent Procedures
    c. Severe Sepsis
    d. Implantable Cardiac Defibrillators
    e. Intestinal Transplantation
    f. Cochlear Implants
    g. Artificial Hearts
    h. Left Atrial Appendage Devices: DRG Assignment for New Code 
37.90
    i. Carotid Artery Stents
    j. Acute Intermittent Porphyria
    C. Recalibration of DRG Weights
    D. LTC-DRG Reclassifications and Relative Weights for LTCHs for 
FY 2005
    1. Background
    2. Changes in the LTC-DRG Classifications
    a. Background
    b. Patient Classifications into DRGs
    3. Development of the FY 2005 LTC-DRG Relative Weights
    a. General Overview of Development of the LTC-DRG Relative 
Weights
    b. Data
    c. Hospital-Specific Relative Value Methodology
    d. Low-Volume LTC-DRGs
    4. Steps for Determining the FY 2005 LTC-DRG Relative Weights
    5. Out of Space Comments Relating to the LTCH PPS Payments Rates
    E. Add-On Payments for New Services and Technologies
    1. Background
    2. Other Provisions of Section 503 of Pub. L. 108-173
    3. FY 2005 Status of Technology Approved for FY 2004 Add-On 
Payments
    a. Drotrecogin Alfa (Activated)--Xigris[reg]
    b. InFUSETM (Bone Morphogenetic Proteins (BMPs) for 
Spinal Fusions)
    4. Reevaluation of FY 2004 Applications That Were Not Approved
    5. FY 2005 Applicants for New Technology Add-On Payments
    a. InFUSETM Bone Graft (Bone Morphogenetic Proteins 
(BMPs) for Tibia Fractures)
    b. Norian Skeletal Repair System (SRS)[reg] Bone Void Filler
    c. InSync[reg] Defibrillator System (Cardiac Resynchronization 
Therapy with Defibrillation (CRT-D))
    d. GliaSite[reg] Radiation Therapy System (RTS)
    e. Natrecor[reg]--Human B-Type Natriuretic Peptide (hBNP)
    f. Kinetra[reg] Implantable Neurostimulator for Deep Brain 
Stimulation

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    g. Intramedullary Skeletal Kinetic Distractor (ISKD)
    h. ActiconTM Neosphincter
    i. TandemHeartTM Percutaneous Left Ventricular Assist 
System
    j. AquadexTM System 100 Fluid Removal System (System 
100)
III. Changes to the Hospital Wage Index
    A. Background
    B. Revised OMB Definitions for Geographical Statistical Areas
    1. Current Labor Market Areas Based on MSAs
    2. Core-Based Statistical Areas
    3. Revised Labor Market Areas
    a. New England MSAs
    b. Metropolitan Divisions
    c. Micropolitan Areas
    d. Transition Period
    C. Occupational Mix Adjustment to FY 2005 Index
    1. Development of Data for the Occupational Mix Adjustment
    2. Calculation of the Occupational Mix Adjustment Factor and the 
Occupational Mix Adjusted Wage Index
    D. Worksheet S-3 Wage Data for the FY 2005 Wage Index Update
    E. Verification of Worksheet S-3 Wage Data
    F. Computation of the Unadjusted Wage Index
    G. Computation of the FY 2005 Blended Wage Index
    H. Revisions to the Wage Index Based on Hospital Redesignation
    1. General
    2. Effects of Reclassification
    3. FY 2005 Issues
    a. FY 2005 MGCRB Reclassifications
    b. Implementation of New MSAs
    c. Redesignations under Section 1886(d)(8)(B) of the Act
    d. Reclassifications Under Section 508 of Public Law 108-173
    e. Wage Index Adjustment Based on Commuting Patterns of Hospital 
Employees
    (1) Data
    (2) Qualifying Counties
    (3) The Adjustment
    (4) Automatic Adjustments
    4. FY 2005 Reclassifications
I. Requests for Wage Index Data Corrections
    1. Worksheet S-3 Wage Data
    2. Occupational Mix Data
    3. All FY 2005 Wage Index Data
    J. Revision of the Labor-Related Share of the Wage Index
IV. Other Decisions and Changes to the IPPS for Operating Costs and 
GME Costs
    A. Postacute Care Transfer Payment Policy
    1. Background
    2. Changes to DRGs Subject to the Postacute Care Transfer Policy
    B. Payments for Inpatient Care in Providers That Change 
Classification Status During a Patient Stay
    C. Geographic Reclassifications--Definitions of Urban and Rural 
Areas
    1. Revised MSAs
    2. Transition Period for DSH Payments to Redesignated Hospitals
    D. Equalization of Urban and Rural Standardized Amounts
    E. Reporting of Hospital Quality Data for Annual Hospital 
Payment Update
    1. Background
    2. Requirements for Hospital Reporting of Quality Data
    3. Submission of Hospital Data for FYs 2006 and 2007
    4. Regulation Change
    F. Revision of the Labor-Related Share of the Hospital Wage 
Index
    G. Wage Index Adjustment for Commuting Patterns of Hospital 
Employees
    H. Additional Payments for New Medical Services and Technology: 
Policy Changes
    I. Rural Referral Centers
    1. Case-Mix Index
    2. Discharges
    J. Additional Payments to Hospitals with High Percentage of End-
Stage Renal Disease (ESRD) Discharges
    K. Indirect Medical Education (IME) Adjustment
    1. IME Adjustment Factor Formula Multipliers
    2. IME Adjustment Formula Multiplier for Redistributed FTE 
Resident Slots
    3. Counting Beds and Patient Days for Purposes of Calculating 
the IME Adjustment and DSH Adjustment
    4. Technical Changes
    L. Payment to Disproportionate Share Hospitals (DSHs)
    1. Background
    2. Enhanced DSH Adjustment for Rural Hospitals and Urban 
Hospitals with Fewer Than 100 Beds
    3. Counting Beds and Patient Days for the IME and DSH 
Adjustments
    a. Provisions of the FY 2004 Proposed Rule, Responses to Public 
Comments, and Provisions of the FY 2005 Final Rule
    1. Unoccupied Beds
    2. Observation Services and Swing-bed Skilled Nursing Services
    3. Dual-Eligible Patient Days
    4. Medicare+Choice (M+C) Days
    M. Payment Adjustments for Low-Volume Hospitals
    N. Medicare Geographic Classification Review Board (MGCRB) 
Reclassifications
    1. Background
    2. Standardized Amount Reclassification Provisions
    3. Reclassification of Urban Rural Referral Centers
    4. Special Circumstances of Sole Community Hospitals (SCHs) in 
Low Population Density States
    5. Possible Reclassifications for Dominant Hospitals and 
Hospitals in Single-Hospital MSAs
    6. Special Circumstances of Hospitals in All-Urban States
    7. Geographic Reclassifications for (SNFs)
    O. Payment for Direct Graduate Medical Education
    1. Background
    2. Reductions of and Increases in Hospitals' FTE Resident Caps 
for GME Payment Purposes under Section 422 of Pub. L. 108-173
    a. General Background on Methodology for Determining the FTE 
Resident Count
    b. Reduction of Hospitals' FTE Resident Caps under the 
Provisions of Section 422 of Pub. L. 108-173
    c. Hospitals Subject to the FTE Resident Cap Reduction
    d. Exemption from FTE Resident Cap Reduction for Certain Rural 
Hospitals
    e. Determining the Estimated Number of FTE Resident Slots 
Available for Redistribution
    f. Determining the Possilbe Reduction to a Hospital's FTE 
Resident Cap
    (1) Reference Resident Level--General
    (2) Expansion of an Existing Program
    (3) Audits of the Reference Cost Reporting Periods
    (4) Expansions Under Newly Approved Programs
    (5) Affiliations
    g. Criteria for Determining Hospitals That Will Receive 
Increases in Their FTE Resident Caps
    h. Application Process for the Increases in Hospitals' FTE 
Resident Caps
    i. CMS Evaluation of Applications for Increases in FTE Resident 
Caps
    j. IME Adjustment Formula Multiplier for Redistributed FTE Slots 
and the Application of Locality-Adjusted National Average Per 
Resident Amount (PRA)
    k. Application of Section 422 to Hospitals That Participate in 
Demonstration Projects or Voluntary Reduction Programs
    l. Application of Section 422 to Hospitals That File Low 
Utilization Medicare Cost Reports
    m. CMS Evaluation Form
    n. Application Process and CMS Central and Regional Office 
Mailing Addresses for Receiving Increases in FTE Resident Caps
    3. Direct GME Initial Residency Period
    a. Background
    b. Direct GME Initial Residency Period Limitation: Simultaneous 
Match Issue
    c. Exception to Initial Residency Period for Geriatric Residency 
or Fellowship Programs
    4. Per Resident Amount: Extension of Update Limitation on High-
Cost Programs
    5. Residents Training in Nonhospital Settings
    a. Background
    b. Moratorium on Disallowances of Allopathic or Osteopathic 
Family Practice Residents Training Time in Nonhospital Settings
    (1) Cost Reports That Are Settled Between January 1, 2004 and 
December 31, 2004
    (2) Family Practice Residents That Are Training in Nonhospital 
Settings Between January 1, 2004 and December 31, 2004
    c. Requirements for Written Agreements for Residency Training in 
Nonhospital Settings
    P. Rural Community Hospital Demonstration Program
    Q. Special Circumstances of Hospitals Facing High Malpractice 
Insurance Rate Increases
    V. Changes to the PPS for Capital-Related Costs
    A. Background
    B. Payments to Hospitals Located in Puerto Rico
    C. Exception Payment for Extraordinary Circumstances

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    D. Treatment of Hospitals Previously Reclassified for the 
Operating IPPS Standardized Amounts
    E. Geographic Classification and Definition of Large Urban Area
    1. Core-based Statistical Areas
    2. Metropolitan Divisions
VI. Changes for Hospitals and Hospital Units Excluded from the IPPS
    A. Payments to Excluded Hospitals and Hospital Units
    1. Payments to Existing Excluded Hospitals and Hospital Units
    2. Updated Caps for New Excluded Hospitals and Units
    3. Implementation of a PPS for IRFs
    4. Implementation of a PPS for LTCHs
    5. Development of a PPS for IPFs
    6. Technical Changes and Corrections
    a. Change Related to Establishment of Payments for Excluded 
Hospitals
    b. Technical Correction Related to Long-Term Care Hospitals
    7. Report of Adjustment (Exceptions) Payments
    B. Criteria for Classification of Hospitals-Within-Hospitals
    C. Critical Access Hospitals (CAHs)
    1. Background
    2. Payment Amounts for CAH Services
    3. Condition for Application of Special Professional Service 
Payment Adjustment
    4. Coverage of Costs for Certain Emergency Room On-Call 
Providers
    5. Authorization of Periodic Interim Payments for CAHs
    6. Revision of the Bed Limit for CAHs
    7. Authority to Establish Psychiatric and Rehabilitation 
Distinct Part Units of CAHs
    8. Waiver Authority for Designation of a CAH as a Necessary 
Provider
    9. Payment for Clinical Diagnostic Laboratory Tests
    10. Continued Participation by CAHs in Counties Reclassified as 
Urban Based on the 2000 Census
    11. Technical Changes in Part 489
VII. Changes to the Disclosure of Information Requirements for 
Quality Improvement Organizations (QIOs)
    A. Background
    B. Provisions of the May 18, 2004 Proposed. Regulations
    C. Technical Changes
VIII. Policy Changes Relating to Medicare Provider Agreements for 
Compliance with Bloodborne Pathogens Standards, Hospital Conditions 
of Participation, and Fire Safety Requirements for Certain Health 
Care Facilities
    A. Conditions of Participation for Discharge Planning
    1. Background
    2. Implementation
    3. Provisions of the Proposed Regulations
    B. Compliance with Bloodborne Pathogens Standards
    1. Background
    2. Provisions of the Proposed Regulations
    C. Fire Safety Requirements for Certain Health Care Facilities
    1. Background
    2. Proposed Changes to the Regulations
IX. MedPAC Recommendations
X. Other Required Information
    A. Requests for Data from the Public
    B. Collection of Information Requirements
    C. Waiver of Proposed Rulemaking for Technical Correction to 
LTCH Regulations

Regulation Text

Addendum--Schedule of Standardized Amounts Effective with Discharges 
Occurring On or After October 1, 2004 and Update Factors and Rate-of-
Increase Percentages Effective With Cost Reporting Periods Beginning On 
or After October 1, 2004

I. Summary and Background
II. Changes to Prospective Payment Rates for Hospital Inpatient 
Operating Costs for FY 2005
    A. Calculation of the Adjusted Standardized Amount
    1. Standardization of Base-Year Costs or Target Amounts
    2. Computing the Average Standardized Amount
    3. Updating the Average Standardized Amount
    4. Other Adjustments to the Average Standardized Amount
    a. Recalibration of DRG Weights and Updated Wage Index--Budget 
Neutrality Adjustment
    b. Reclassified Hospitals--Budget Neutrality Adjustment
    c. Outliers
    d. Section 410A of Pub.L. 108-173 Rural Community Hospital 
Demonstration Program Adjustment
    5. FY 2005 Standardized Amount
    B. Adjustments for Area Wage Levels and Cost-of-Living
    1. Adjustment for Area Wage Levels
    2. Adjustment for Cost-of-Living in Alaska and Hawaii
    C. DRG Relative Weights
    D. Calculation of Prospective Payment Rates for FY 2005
    1. Federal Rate
    2. Hospital-Specific Rate (Applicable Only to SCHs and MDHs)
    a. Calculation of Hospital-Specific Rate
    b. Updating the FY 1982, FY 1987, and FY 1996 Hospital-Specific 
Rates for FY 2005
    3. General Formula for Calculation of Prospective Payment Rates 
for Hospitals Located in Puerto Rico Beginning On or After October 
1, 2004 and Before October 1, 2005
    a. Puerto Rico Rate
    b. National Rate
III. Changes to Payment Rates for Acute Care Hospital Inpatient 
Capital-Related Costs for FY 2005
    A. Determination of Federal Hospital Inpatient Capital-Related 
Prospective Payment Rate Update
    1. Capital Standard Federal Rate Update
    a. Description of the Update Framework
    b. Comparison of CMS and MedPAC Update Recommendation
    2. Outlier Payment Adjustment Factor
    3. Budget Neutrality Adjustment Factor for Changes in DRG 
Classifications and Weights and the Geographic Adjustment Factor
    4. Exceptions Payment Adjustment Factor
    5. Capital Standard Federal Rate for FY 2005
    6. Special Capital Rate for Puerto Rico Hospitals
    B. Calculation of Inpatient Capital-Related Prospective Payments 
for FY 2005
    C. Capital Input Price Index
    1. Background
    2. Forecast of the CIPI for FY 2005
    IV. Changes to Payment Rates for Excluded Hospitals and Hospital 
Units: Rate-of-Increase Percentages
V. Payment for Blood Clotting Factor Administered to Hemophilia 
Inpatients

Tables

    Table 1A--National Adjusted Operating Standardized Amounts, 
Labor/Nonlabor (71.1 Percent Labor Share/28.9 Percent Nonlabor Share 
If Wage Index Is Greater Than 1)
    Table 1B--National Adjusted Operating Standardized Amounts, 
Labor/Nonlabor (62 Percent Labor Share/38 Percent Nonlabor Share If 
Wage Index Is Less Than or Equal to 1)
    Table 1C--Adjusted Operating Standardized Amounts for Puerto 
Rico, Labor/Nonlabor
    Table 1D--Capital Standard Federal Payment Rate
    Table 2--Hospital Case-Mix Indexes for Discharges Occurring in 
Federal Fiscal Year 2003; Hospital Average Hourly Wage for Federal 
Fiscal Years 2003 (1999 Wage Data), 2004 (2000 Wage Data), and 2005 
(2001 Wage Data) Wage Indexes and 3-Year Average of Hospital Average 
Hourly Wages
    Table 3A1--FY 2005 and 3-Year* Average Hourly Wage 
for Urban Areas by MSA
    Table 3A2--FY 2005 3-Year* Average Hourly Wage for 
Urban Areas by CBSA
    Table 3B1--FY 2005 and 3-Year* Average Hourly Wage 
for Rural Areas by MSA
    Table 3B2--FY 2005 and 3-Year* Average Hourly Wage 
for Rural Areas by CBSA
    Table 4A1--Wage Index and Capital Geographic 
Adjustment Factor (GAF) for Urban Areas by MSA
    Table 4A2--Wage Index and Capital Geographic 
Adjustment Factor (GAF) for Urban Areas by CBSA
    Table 4B1--Wage Index and Capital Geographic 
Adjustment Factor (GAF) for Rural Areas by MSA
    Table 4B2--Wage Index and Capital Geographic 
Adjustment Factor (GAF) for Rural Areas by CBSA
    Table 4C1--Wage Index and Capital Geographic 
Adjustment Factor (GAF) for Hospitals That Are Reclassified by MSA
    Table 4C2--Wage Index and Capital Geographic 
Adjustment Factor (GAF) for Hospitals That Are Reclassified by CBSA
    Table 4F1--Puerto Rico Wage Index and Capital 
Geographic Adjustment Factor (GAF) by MSA
    Table 4F2--Puerto Rico Wage Index and Capital 
Geographic Adjustment Factor (GAF) by CBSA
    Table 4G--Pre-Reclassified Wage Index for Urban Areas
    Table 4H--Pre-Reclassified Wage Index for Rural Areas
    Table 4J--Wage Index Adjustment for Commuting Hospital Employees 
(Out-

[[Page 48920]]

Migration) In Qualifying Counties--FY 2005
    Table 5--List of Diagnosis-Related Groups (DRGs), Relative 
Weighting Factors, and Geometric and Arithmetic Mean Length of Stay 
(LOS)
    Table 6A--New Diagnosis Codes
    Table 6B--New Procedure Codes
    Table 6C--Invalid Diagnosis Codes
    Table 6D--Invalid Procedure Codes
    Table 6E--Revised Diagnosis Code Titles
    Table 6F--Revised Procedure Code Titles
    Table 6G--Additions to the CC Exclusions List
    Table 6H--Deletions from the CC Exclusions List
    Table 7A--Medicare Prospective Payment System Selected 
Percentile Lengths of Stay: FY 2003 MedPAR Update March 2004 GROUPER 
V21.0
    Table 7B--Medicare Prospective Payment System Selected 
Percentile Lengths of Stay: FY 2003 MedPAR Update March 2004 GROUPER 
V22.0
    Table 8A--Statewide Average Operating Cost-to-Charge Ratios-July 
2004
    Table 8B--Statewide Average Capital Cost-to-Charge Ratios--July 
2004
    Table 9A1--Hospital Reclassifications and 
Redesignations by IndividualHospital--FY 2005 by MSA
    Table 9A2--Hospital Reclassifications and 
Redesignations by IndividualHospital--FY 2005 by CBSA-FY 2005
    Table 9B--Hospital Reclassifications and Redesignation by 
Individual Hospital Under Section 508 of Public Law 108-173--FY 2004
    Table 10--Geometric Mean Plus the Lesser of .75 of the National 
Adjusted Operating Standardized Payment Amount (Increased to Reflect 
the Difference Between Costs and Charges) or .75 of One Standard 
Deviation of Mean Charges by Diagnosis-Related Groups (DRGs)--July 
2004
    Table 11--FY 2005 LTC-DRGs, Relative Weights, Geometric Average 
Length of Stay, and \5/6\ths of the Geometric Average Length of Stay
    Appendix A--Regulatory Impact Analysis
    Appendix B--Recommendation of Update Factors for Operating Cost 
Rates of Payment for Inpatient Hospital Services

I. Background

A. Summary

1. 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. Section 1886(g) of the Act requires the 
Secretary to pay for the capital-related costs of hospital inpatient 
stays under a prospective payment system (PPS). Under these PPSs, 
Medicare payment for hospital inpatient operating and capital-related 
costs is made at predetermined, specific rates for each hospital 
discharge. Discharges are classified according to a list of diagnosis-
related groups (DRGs).
    The base payment rate is comprised of a standardized amount that 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 the 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 designed to identify hospitals that serve a 
disproportionate share of low-income patients. For qualifying 
hospitals, the amount of this adjustment may vary based on the outcome 
of the statutory calculations.
    If the hospital is an approved teaching hospital, it receives a 
percentage add-on payment for each case paid under the IPPS (known as 
the indirect medical education (IME) adjustment). This percentage 
varies, depending on the ratio of residents to beds.
    Additional payments may be made for cases that involve new 
technologies or medical services that have been approved for special 
add-on payments. To qualify, a new technology or medical service must 
demonstrate that it is a substantial clinical improvement over 
technologies or services otherwise available, and that, absent an add-
on payment, it would be inadequately paid under the regular DRG 
payment.
    The costs incurred by the hospital for a case are evaluated to 
determine whether the hospital is eligible for an additional payment as 
an outlier case. This additional payment is designed to protect the 
hospital from large financial losses due to unusually expensive cases. 
Any outlier payment due is added to the DRG-adjusted base payment rate, 
plus any DSH, IME, and new technology or medical service add-on 
adjustments.
    Although payments to most hospitals under the IPPS are made on the 
basis of the standardized amounts, some categories of hospitals are 
paid the higher of a hospital-specific rate based on their costs in a 
base year (the higher of FY 1982, FY 1987, or FY 1996) or the IPPS rate 
based on the standardized amount. For example, sole community hospitals 
(SCHs) are the sole source of care in their areas, and Medicare-
dependent, small rural hospitals (MDHs) are a major source of care for 
Medicare beneficiaries in their areas. Both of these categories of 
hospitals are afforded this special payment protection in order to 
maintain access to services for beneficiaries (although MDHs receive 
only 50 percent of the difference between the IPPS rate and their 
hospital-specific rates if the hospital-specific rate is higher than 
the IPPS rate).
    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 42 CFR 412.308 and 412.312. Under the 
capital PPS, 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. In addition, hospitals may receive 
an outlier payment for those cases that have unusually high costs.
    The existing regulations governing payments to hospitals under the 
IPPS are located in 42 CFR part 412, subparts A through M.
2. Hospitals and Hospital Units Excluded From the IPPS
    Under section 1886(d)(1)(B) of the Act, as amended, certain 
specialty hospitals and hospital units are excluded from the IPPS. 
These hospitals and units are: Psychiatric hospitals and units; 
rehabilitation hospitals and units; long-term care hospitals (LTCHs); 
children's hospitals; and cancer hospitals. Various sections of the 
Balanced Budget Act of 1997 (Pub. L. 105-33), the Medicare, Medicaid 
and SCHIP (State Children's Health Insurance Program) Balanced Budget 
Refinement Act of 1999 (Pub. L. 106-113), and the Medicare, Medicaid, 
and SCHIP Benefits Improvement and Protection Act of 2000 (Pub. L. 106-
554) provide for the implementation of PPSs for rehabilitation 
hospitals and units (referred to as inpatient rehabilitation facilities 
(IRFs)), psychiatric hospitals and units (referred to as inpatient 
psychiatric facilities (IPFs)), and LTCHs, as discussed below. 
Children's hospitals and cancer hospitals continue to be paid under 
reasonable cost-based reimbursement.
    The existing regulations governing payments to excluded hospitals 
and hospital units are located in 42 CFR parts 412 and 413.

[[Page 48921]]

a. IRFs
    Under section 1886(j) of the Act, as amended, rehabilitation 
hospitals and units (IRFs) have been transitioned from payment based on 
a blend of reasonable cost reimbursement subject to a hospital-specific 
annual limit under section 1886(b) of the Act and prospective payments 
for cost reporting periods beginning January 1, 2002, through September 
30, 2002, to payment at 100 percent of the Federal rate effective for 
cost reporting periods beginning on or after October 1, 2002 (66 FR 
41316, August 7, 2001; 67 FR 49982, August 1, 2002; and 68 FR 45674, 
August 1, 2003). The existing regulations governing payments under the 
IRF PPS are located in 42 CFR part 412, subpart P.
b. LTCHs
    Under the authority of sections 123(a) and (c) of Public Law 106-
113 and section 307(b)(1) of Public Law 106-554, LTCHs are being 
transitioned from being paid for inpatient hospital services based on a 
blend of reasonable cost-based reimbursement under section 1886(b) of 
the Act to 100 percent of the Federal rate during a 5-year period, 
beginning with cost reporting periods that start on or after October 1, 
2002. For cost reporting periods beginning on or after October 1, 2006, 
LTCHs will be paid 100 percent of the Federal rate (May 7, 2004 LTCH 
PPS final rule (69 FR 25674)). LTCHs may elect to be paid based on 100 
percent of the Federal rate instead of a blended payment in any year 
during the 5-year transition period. The existing regulations governing 
payment under the LTCH PPS are located in 42 CFR part 412, subpart O.
c. IPFs
    Sections 124(a) and (c) of Public Law 106-113 provide for the 
development of a per diem PPS for payment for inpatient hospital 
services furnished in IPFs under the Medicare program, effective for 
cost reporting periods beginning on or after October 1, 2002. This 
system must include an adequate patient classification system that 
reflects the differences in patient resource use and costs among these 
hospitals and maintains budget neutrality. We published a proposed rule 
to implement the PPS for IPFs on November 28, 2003 (68 FR 66920). The 
November 28, 2003, proposed rule proposed an April 1, 2004, effective 
date for purposes of ratesetting and calculating impacts. However, the 
proposed rule was unusually complex because it proposed a completely 
new payment system for inpatient hospital services furnished by 
psychiatric hospitals and units and the public requested additional 
time to comment. As a result, we extended the comment period for the 
proposed rule. Thus, we are still in the process of analyzing public 
comments and developing a final rule for publication. Consequently, an 
April 1, 2004, effective date for the IPF PPS is no longer possible.
3. Critical Access Hospitals (CAHs)
    Under sections 1814, 1820, and 1834(g) of the Act, payments are 
made to critical access hospitals (CAHs) (that is, rural hospitals or 
facilities that meet certain statutory requirements) for inpatient and 
outpatient services on a reasonable cost basis. Reasonable cost is 
determined under the provisions of section 1861(v)(1)(A) of the Act and 
existing regulations under 42 CFR parts 413 and 415.
4. Payments for Graduate Medical Education (GME)
    Under section 1886(a)(4) of the Act, costs of approved educational 
activities are excluded from the operating costs of inpatient hospital 
services. Hospitals with approved graduate medical education (GME) 
programs are paid for the direct costs of GME in accordance with 
section 1886(h) of the Act; the amount of payment for direct GME costs 
for a cost reporting period is based on the hospital's number of 
residents in that period and the hospital's costs per resident in a 
base year. The existing regulations governing payments to the various 
types of hospitals are located in 42 CFR part 413.
    On August 1, 2003, we published a final rule in the Federal 
Register (68 FR 45346) that implemented changes to the Medicare 
hospital inpatient prospective payment systems for both operating cost 
and capital-related costs, as well as changes addressing payments for 
excluded hospitals and payments for GME costs. Generally these changes 
were effective for discharges occurring on or after October 1, 2003. On 
October 6, 2003, we published a document in the Federal Register (68 FR 
57731) that corrected technical errors made in the August 1, 2003, 
final rule.

B. Provisions of the Medicare Prescription Drug, Improvement, and 
Modernization Act of 2003

    On December 8, 2003, the Medicare Prescription Drug, Improvement, 
and Modernization Act of 2003 (MMA), Public Law 108-173, was enacted. 
Public Law 108-173 made a number of changes to the Act relating to 
prospective payments to hospitals for inpatient services, payments to 
excluded hospitals and units, and payments to CAHs. This final rule 
implements amendments made by the following sections of Pub. L. 108-
173:
     Section 401, which provides that, for discharges occurring 
in a fiscal year beginning with FY 2004 under the IPPS, Medicare will 
pay hospitals in rural and small urban areas in the 50 States using the 
standardized amount (computed for the previous fiscal year) that would 
be used to pay hospitals in large urban areas (or beginning with FY 
2005, for all hospitals in the previous fiscal year), increased by the 
appropriate market basket percentage increase. One standardized amount 
for hospitals in Puerto Rico would be established that would equal the 
amount for hospitals in large urban areas in Puerto Rico.
     Section 402, which provides that for discharges occurring 
on or after April 1, 2004, the DSH payment adjustment for a hospital 
that is not a large urban or large rural hospital will be calculated 
using the current DSH adjustment formula for large urban hospitals, 
subject to a limit of 12 percent for any of these hospitals that are 
not rural referral centers. (There is no limit on the DSH payment 
percentage for rural referral centers.)
     Section 403, which provides that, for discharges occurring 
on or after October 1, 2004, a hospital's labor-related share to which 
the wage index is applied will be decreased to 62 percent of the 
standardized amount when such a change will result in higher total 
payments to the hospital. This provision also applies to the labor-
related share of the standardized amount for hospitals in Puerto Rico.
     Section 405(a), which provides that inpatient, outpatient, 
and covered SNF services provided by a CAH will be reimbursed at 101 
percent of reasonable costs for services furnished to Medicare 
beneficiaries. This provision is applicable to payments for services 
furnished during cost reporting periods beginning on or after January 
1, 2004.
     Section 405(b), which expands coverage of the costs 
associated with covered Medicare services furnished by on-call 
emergency room providers in CAHs to include services furnished by 
physician assistants, nurse practitioners, and clinical nurse 
specialists, effective for costs incurred for services furnished on or 
after January 1, 2005.
     Section 405(c), which provides that eligible CAHs may 
receive payments for their inpatient services on a periodic interim 
payment (PIP) basis, effective with payments made on or after July 1, 
2004.
     Section 405(d), which allows CAHs to elect to receive 
payments under the

[[Page 48922]]

optional payment method (a payment encompassing both inpatient CAH 
services and physician and practitioner services to outpatients) even 
if some practitioners do not reassign to the CAH their rights to bill 
for professional services to CAH outpatients. This provision applies to 
cost reporting periods occurring on or after July 1, 2004, except that 
in the case of a CAH that made an election of the optional payment 
method before November 1, 2003, the provision applies to cost reporting 
periods beginning on or after July 1, 2001.
     Section 405(e), which increases the limit on the number of 
beds that a CAH may have for acute care from 15 to 25 beds. This 
provision applies to CAH designations made before, on, or after January 
1, 2004. Any election made in accordance with the regulations 
promulgated to implement this provision will only apply prospectively.
     Section 405(g), which provides that a CAH may establish 
psychiatric and rehabilitation distinct part units and limits the 
number of beds in each unit to no more than 10. Services in these 
distinct part units will be paid under the respective payment 
methodology applicable to these distinct-part units. This provision 
applies to cost reporting periods beginning on or after October 1, 
2004.
     Section 405(h), which terminates a State's authority to 
waive the location requirement for a CAH by designating the CAH as the 
necessary provider, effective January 1, 2006. A grandfathering 
provision is included for CAHs that are certified as necessary 
providers prior to January 1, 2006, which allows any CAH that is 
designated as a necessary provider in its State's rural health plan 
prior to January 1, 2006, to maintain its necessary provider 
designation.
     Section 406, which provides for a graduated adjustment to 
the inpatient prospective payment rates to account for the higher costs 
associated with hospitals described under section 1886(d) of the Act 
that are located more than 25 road miles from another subsection (d) 
hospital and that have less than 800 discharges during a fiscal year, 
effective for discharges occurring on or after October 1, 2004. The 
increase in these payments must be based on the empirical relationship 
between the standardized cost per case for such hospitals and the total 
number of discharges of these hospitals and the amount of the 
additional incremental costs (if any) associated with that number of 
discharges, may not be greater than 25 percent, and the determination 
of the percentage payment increase is not subject to administrative or 
judicial review.
     Section 410A, which authorizes the Secretary to establish 
a demonstration program to test the feasibility and advisability of the 
establishment of rural community hospitals to furnish covered inpatient 
hospital services to Medicare beneficiaries. The Secretary must select 
no more than 15 rural community hospitals to participate in the 
demonstration. The Secretary must implement the demonstration program 
not later than January 1, 2005, but may not implement the program 
before October 1, 2004.
     Section 422(a), which provides that a hospital's GME FTE 
resident cap will be reduced, and the reduction will be redistributed 
among other hospitals if the hospital's resident count is less than its 
resident cap (rural hospitals with less than 250 acute care inpatient 
beds will be exempt) in a particular reference period. This provision 
is effective for cost reporting periods beginning on or after July 1, 
2005.
     Section 422(b), which specifies that the formula 
multiplier for the IME adjustment is 0.66 for FTE residents 
attributable to redistributed resident positions, effective for 
discharges occurring on or after July 1, 2005.
     Section 501, which provides the update factor for payments 
for hospital inpatient operating costs for FY 2005 and subsequent 
fiscal years is the market basket percentage increase. For FYs 2005 
through 2007, the update factor will be the market basket percentage 
increase minus 0.4 percentage points for any ``subsection (d) 
hospital'' that does not submit hospital quality data on 10 measures as 
specified by the Secretary.
     Section 502, which modifies the IME formula multiplier to 
be used in the calculation of the IME adjustment for midway through FY 
2004 and provides a new schedule of formula multipliers for FYs 2005 
and thereafter.
     Section 503(a), which includes a requirement for updating 
the ICD-9-CM diagnosis and procedure codes in April 1 of each year, in 
addition to the current process of annual updates on October 1 of each 
year. This change will not affect Medicare payments or DRG 
classifications until the fiscal year that begins after that date.
     Section 503(b), which provides for changes to the 
threshold amount for determining eligibility of new technologies or 
medical services for add-on payments; provides for public input on 
applications for new technology or medical service add-on payments 
prior to the publication of a proposed rule; provides for 
reconsideration of applications received for FY 2004 that were denied; 
provides for preference in the use of DRG adjustments; and provides 
that new technology or medical service payments shall not be budget 
neutral. This provision is effective for fiscal years beginning in FY 
2005.
     Section 504, which increases the national portion of the 
operating PPS payment rate for hospitals in Puerto Rico from 50 percent 
of the Federal rate to 75 percent of the Federal rate and decreases the 
Puerto Rico portion of the operating PPS payment from 50 percent to 25 
percent, effective for discharges occurring on or after October 1, 
2004. For the period of April 1, 2004, through September 30, 2004, 
payments for hospitals in Puerto Rico will be based on 62.5 percent 
Federal rate and 37.5 percent of the Puerto Rico rate.
     Section 505, which provides for an increase in a 
hospital's wage index value to take into consideration a commuter wage 
adjustment for hospital employees who reside in a county and work in a 
different area with a higher wage index.
     Section 508, which provides for the establishment of a 
one-time process for a hospital to appeal its geographic classification 
for wage index purposes. By law, any reclassification resulting from 
this one-time appeal applies for a 3-year period to discharges 
occurring on or after April 1, 2004.
     Section 711, which freezes the annual CPI-U updates to 
hospital-specific per resident amount (PRAs) for GME payments for those 
PRAs that exceed the ceiling, effective for cost reporting periods 
beginning FY 2004, through FY 2013.
     Section 712, which provides for an exception to the 
initial residency period for purposes of direct GME payments for 
geriatric residency or fellowship programs that allows the 2 years 
spent in an approved geriatric program to be counted as part of the 
resident's initial training period, but not to count against any 
limitation on the initial residency period. This provision is effective 
for cost reporting periods beginning on or after October 1, 2003.
     Section 713, which, during a 1-year moratorium period of 
January 1, 2004 through December 31, 2004, allows hospitals to count 
allopathic or osteopathic family practice residents training in 
nonhospital settings for IME and direct GME purposes, without regard to 
the financial arrangement between the hospital and the teaching 
physician practicing in the nonhospital setting to which the resident 
is assigned.
     Section 733, which provides for Medicare payment of 
routine costs, as

[[Page 48923]]

well as costs relating to the transplantation and appropriate related 
items and services, for Medicare beneficiaries participating in a 
clinical trial involving pancreatic islet cell transplantation, 
beginning no earlier than October 1, 2004.
     Section 926, which requires the Secretary to make 
information publicly available that enables hospital discharge 
planners, Medicare beneficiaries, and the public to identify skilled 
nursing facilities (SNFs) that are participating in the Medicare 
program, and requires a hospital, as part of its discharge planning, to 
evaluate a patient's need for SNF care.
     Section 947, which requires that, by July 1, 2004, 
hospitals not otherwise subject to the Occupational Safety and Health 
Act (OSHA) (or a State occupational safety and health plan that is 
approved under section 18(b) of that Act) must comply with the OSHA 
bloodborne pathogens (BBP) standard as part of their Medicare provider 
agreements.

C. Summary of the Provisions of the May 18, 2004 Proposed Rule

    On May 18, 2004, we published a proposed rule in the Federal 
Register (69 FR 28196) that set forth proposed changes to the Medicare 
IPPS for operating costs and for capital-related costs in FY 2005 and 
to implement the provisions of Pub. L. 108-173 specified in section 
I.B. of this preamble. We also set forth proposed changes relating to 
payments for GME costs, payments to certain hospitals and units that 
continue to be excluded from the IPPS and paid on a reasonable cost 
basis, payments for DSH, requirements and payments for CAHs, conditions 
of participation for hospitals relating to discharge planning and fire 
safety requirements, requirements for Medicare provider agreements 
relating to bloodborne pathogen standards, and QIO disclosure of 
information requirements. These changes were proposed to be effective 
for discharges occurring on or after October 1, 2004, unless otherwise 
noted.
    The following is a summary of the major changes that we proposed to 
make:
1. Changes to the DRG Reclassifications and Recalibrations of Relative 
Weights
    As required by section 1886(d)(4)(C) of the Act, we proposed annual 
adjustments to the DRG classifications and relative weights. Based on 
analyses of Medicare claims data, we proposed to establish a number of 
new DRGs and make changes to the designation of diagnosis and procedure 
codes under other existing DRGs.
    Among the proposed changes discussed were:
     Restructuring and retitling of several DRGs to reflect 
expanded coverage of heart assist systems such as ventricular assist 
devices (VAD) or left ventricular assist devices (LVAD) as destination 
(or permanent) therapy for end-stage heart failure patients who are not 
candidates for heart transplantation: DRG 103 (Heart Transplant or 
Implant of Heart Assist System) (proposed title change), DRG 104 
(Cardiac Valve and Other Major Cardiothoracic Procedures with Cardiac 
Catheterization) and DRG 105 (Cardiac Valve and Other Major 
Cardiothoracic Procedures Without Cardiac Catheterization), and DRG 525 
(Other Heart Assist System Implant) (proposed title change).
     Addition of pacemaker device and lead procedure code 
combinations that could lead to the assignment of DRG 115 (Permanent 
Cardiac Pacemaker Implant with Acute Myocardial Infarction, Heart 
Failure, or Shock or ACID Lead or Generator Procedures) and DRG 116 
(Other Permanent Cardiac Pacemaker Implant).
     Movement of the procedure code for 360 spinal fusion from 
DRG 496 (Combined Anterior/Posterior Spinal Fusion) to DRG 497 (Spinal 
Fusion Except Cervical With CC) and DRG 498 (Spinal Fusion Except 
Cervical Without CC).
     Addition of combination codes, which also include heart 
failure, to the list of major problems under DRG 387 (Prematurity With 
Major Problems) and DRG 389 (Full-Term Neonate With Major Problems).
     Modification of DRGs 504 through 509 under MDC 22 (Burns) 
to recognize the impact of long-term mechanical ventilation on burn 
cases and renaming DRG 504 as proposed title ``Extensive Burns or Full 
Thickness Burns With Mechanical Ventilation 96+ Hours With Skin Graft'' 
and DRG 505 as proposed title ``Extensive Burns or Full Thickness Burns 
With Mechanical Ventilation 96+ Hours Without Skin Graft.''
     Deletion of DRG 483 (Tracheostomy for Face, Mouth, and 
Neck Diagnoses) and splitting the assignment of cases to two proposed 
new DRGs on the basis of the performance of a major operating room 
procedure: proposed new DRGs 541 and 542 (Tracheostomy With Mechanical 
Ventilation 96+ Hours or Principal Diagnosis Except Face, Mouth, and 
Neck Diagnosis With and Without Major Operating Room Procedure, 
respectively).
    We also presented our reevaluation of FY 2004 applicants for add-on 
payments for high-cost new medical services and technologies, and our 
analysis of FY 2005 applicants (including public input, as directed by 
Public Law 108-173, obtained in a town hall meeting).
    We proposed the annual update of the long-term care diagnosis-
related group (LTC-DRG) classifications and relative weights for use 
under the LTCH PPS for FY 2005.
2. Changes to the Hospital Wage Index
    We proposed revisions to the wage index and the annual update of 
the wage data. Specific issues addressed included the following:
     The FY 2005 wage index update, using wage data from cost 
reporting periods that began during FY 2001.
     Revision of the labor market areas as a result of OMB 
revised definitions of geographical statistical areas.
     A discussion of the collection of occupational mix data 
and the occupational mix adjustment to the wage index that we proposed 
to apply beginning October 1, 2004.
     Revisions to the wage index based on hospital 
redesignations and reclassifications, including changes that reflect 
the new OMB standards for assignment of hospitals to geographic areas.
     The adjustment to the wage index based on commuting 
patterns of hospital employees who reside in a county and work in a 
different area with a higher wage index, to implement section 505 of 
Public Law 108-173.
     A discussion of eligible hospitals reclassified under the 
one-time appeals process under section 508 of Public Law 108-173.
     Changes to the labor-related share to which the wage index 
is applied in determining the PPS rate for hospitals located in 
specific geographic areas, to implement section 403 of Public Law 108-
173.
     The revised timetable for reviewing and verifying the wage 
data that will be in effect for the FY 2005 wage index.
3. Other Decisions and Changes to the PPS for Inpatient Operating and 
GME Costs
    In the proposed rule, we discussed a number of provisions of the 
regulations in 42 CFR parts 412 and 413 and set forth proposed changes 
concerning the following:
     Expansion of the current postacute care transfer policy.
     Payments for inpatient care in providers that change 
classification status during a patient stay.
     Changes in the definitions of urban and rural areas for 
geographic reclassification purposes.
     Equalization of the standardized amount for urban and 
rural hospitals.

[[Page 48924]]

     The reporting of hospital quality data as a condition for 
receiving the full annual payment update increase.
     Revision of the regulations to reflect the revision of the 
labor share of the wage index.
     Revision of the regulations to reflect the wage index 
adjustment for commuting patterns of hospital employees who live in one 
county and commute to work in other areas with higher level wages.
     Changes in the threshold amount for eligibility for new 
medical services and technology add-on payments.
     Revision to our policy on additional payments to hospitals 
with high percentages of ESRD discharges.
     Changes to the IME adjustment formula multipliers, and the 
formula multiplier applicable to redistribution of unused numbers of 
FTE resident slots.
     Changes in DSH adjustment payments to rural and small 
urban hospitals.
     Payment adjustments for low-volume hospitals.
     Changes in policy affecting hospitals that apply as a 
group for reclassification and a discussion of possible 
reclassifications for dominant hospitals and hospitals in single-
hospital MSAs.
     Changes in policies governing payments for direct GME, 
including the redistribution of unused FTE resident slots; changes in 
the GME initial residency period; extension of the update limitation on 
hospital-specific per resident amounts; and changes in the policies on 
residents training in nonhospital settings, including written 
agreements for teaching physician compensation.
     An announcement of the rural community hospital 
demonstration to be established under section 410A of Public Law 108-
173 and the opportunity for eligible hospitals to apply for 
participation in the demonstration program.
     A solicitation of public comments on the effect of 
increases in malpractice insurance premiums on hospitals participating 
in the Medicare program and beneficiary access of services.
4. Changes to the PPS for Capital-Related Costs
    In the proposed rule, we discussed the payment requirements for 
capital-related costs and proposed changes relating to capital payments 
to hospitals located in Puerto Rico, changes in the policies on 
exception payments for extraordinary circumstances, treatment of 
hospitals previously reclassified for the operating standardized 
amounts, and capital payment adjustments based on the proposed changes 
in geographic classifications.
5. Changes for Hospitals and Hospital Units Excluded From the IPPS
    In the proposed rule, we discussed the following proposed revisions 
and clarifications concerning excluded hospitals and hospital units and 
CAHs:
     Changes in the payment rate for new excluded hospitals.
     Changes to the criteria for determining payments to 
hospitals-within-hospitals.
     Changes to the policies governing payment to CAHs, 
including a change in the payment percentage for services furnished by 
CAHs; changes in the rules governing the election by a CAH of the 
optional method of payment; expansion of the payment to emergency room 
on-call providers to include physician assistants, nurse practitioners, 
and clinical nurse specialists; authorization for the making of 
periodic interim payments (PIPs) for CAHs for inpatient services 
furnished; revision of the bed count limit for CAHs from 15 to 25 acute 
care beds; proposed requirements for establishing psychiatric and 
rehabilitation distinct part units in CAHs; and termination of the 
location requirement for a CAH by designating the CAH as a necessary 
provider.
6. Changes to QIO Disclosure of Information Requirements
    In the proposed rule, we discussed our proposed clarification of 
the requirements for disclosure by QIOs of information on institutions 
and practitioners collected in the course of the QIO's quality 
improvement activities.
7. Changes Relating to Medicare Provider Agreements, Hospital 
Conditions of Participation, and Fire Safety Requirements for Certain 
Health Care Facilities
    We proposed to--
     Require hospitals, as part of the discharge planning 
standard under the Medicare hospital conditions of participation, to 
furnish a list of Medicare-participating home health agencies to 
patients who are expected to receive home health services after 
discharge and to provide information on Medicare-certified SNFs to 
patients who are likely to need posthospital extended care services.
     Require that Medicare provider agreements include 
provisions that would ensure that all hospital employees who may come 
into contact with human blood in the course of their duties are 
provided proper protection from bloodborne pathogens.
     Correct a technical error relating to the application of 
the 2000 edition of the Life Safety Code as the fire safety 
requirements for certain health care facilities; and clarify the 
effective date for the prohibition on the use of roller latches in 
these facilities.
8. Determining Prospective Payment Operating and Capital Rates and 
Rate-of-Increase Limits
    In the Addendum to the May 18, 2004, proposed rule, we set forth 
proposed changes to the amounts and factors for determining the FY 2005 
prospective payment rates for operating costs and capital-related 
costs. We also established the proposed threshold amounts for outlier 
cases. In addition, we addressed update factors for determining the 
rate-of-increase limits for cost reporting periods beginning in FY 2005 
for hospitals and hospital units excluded from the PPS.
9. Impact Analysis
    In Appendix A of the proposed rule, we set forth an analysis of the 
impact that the proposed changes would have on affected hospitals.
10. Recommendation of Update Factor for Hospital Inpatient Operating 
Costs
    In Appendix B of the proposed rule, as required by sections 
1886(e)(4) and (e)(5) of the Act, we provided our recommendations of 
the appropriate percentage changes for FY 2005 for the following:
     A single average standardized amount for all areas for 
hospital inpatient services paid under the IPPS for operating costs 
(and hospital-specific rates applicable to SCHs and MDHs).
     Target rate-of-increase limits to the allowable operating 
costs of hospital inpatient services furnished by hospitals and 
hospital units excluded from the IPPS.
11. Discussion of Medicare Payment Advisory Commission Recommendations
    Under section 1805(b) of the Act, the Medicare Payment Advisory 
Commission (MedPAC) is required to submit a report to Congress, no 
later than March 1 of each year, that reviews and makes recommendations 
on Medicare payment policies. MedPAC's March 2004 recommendation 
concerning hospital inpatient payment policies addressed only the 
update factor for inpatient hospital operating costs and capital-
related costs under the IPPS and for hospitals and distinct part 
hospital units excluded from the IPPS. This recommendation was 
addressed in Appendix B of the May 18, 2004,

[[Page 48925]]

proposed rule. For further information relating specifically to the 
MedPAC March 1 report or to obtain a copy of the report, contact MedPAC 
at (202) 220-3700 or visit MedPAC's Web site at: http://www.medpac.gov.

D. Public Comments Received in Response to the May 18, 2004 Proposed 
Rule

    We received over 30,000 timely items of correspondence containing 
multiple comments on the May 18, 2004 proposed rule. Summaries of the 
public comments and our responses to those comments are set forth below 
under the appropriate heading.
    Comment Period: One commenter indicated that, under the 
Administrative Procedures Act (APA), 5 U.S.C. 553(b), the 60-day 
comment period should have started from the date the proposed rule was 
published in the Federal Register, not the date the rule was placed on 
the CMS Web site.
    Response: We believe publication of the proposed rule is fully 
consistent with the law. The APA does not prescribe any specific length 
for the comment period. In addition, the proposed rule was placed on 
display at the Office of the Federal Register and a copy of the rule 
also appeared on our Web site. The substance of the rule was fully 
available on the Web site, as well as on display at the Office of the 
Federal Register. Finally, we note that, in accordance with section 
1886(d) of the Act, the Secretary is required to ensure that the 
updated IPPS rates are in place at the beginning of the Federal fiscal 
year, or by October 1, 2004. Our priority is to ensure that hospitals 
receive their final updated rates for the new fiscal year.

II. Changes to DRG Classifications and Relative Weights

A. Background

    Section 1886(d) of the Act specifies that the Secretary shall 
establish a classification system (referred to as DRGs) for inpatient 
discharges and adjust payments under the IPPS based on appropriate 
weighting factors assigned to each DRG. Therefore, under the IPPS, we 
pay for inpatient hospital services on a rate per discharge basis that 
varies according to the DRG to which a beneficiary's stay is assigned. 
The formula used to calculate payment for a specific case multiplies an 
individual hospital's payment rate per case by the weight of the DRG to 
which the case is assigned. Each DRG weight represents the average 
resources required to care for cases in that particular DRG, relative 
to the average resources used to treat cases in all DRGs.
    Congress recognized that it would be necessary to recalculate the 
DRG relative weights periodically to account for changes in resource 
consumption. Accordingly, section 1886(d)(4)(C) of the Act requires 
that the Secretary adjust the DRG classifications and relative weights 
at least annually. These adjustments are made to reflect changes in 
treatment patterns, technology, and any other factors that may change 
the relative use of hospital resources. The changes to the DRG 
classification system and the recalibration of the DRG weights for 
discharges occurring on or after October 1, 2004, are discussed below.

B. DRG Reclassifications

1. General
    Cases are classified into DRGs for payment under the IPPS based on 
the principal diagnosis, up to eight additional diagnoses, and up to 
six procedures performed during the stay. In a small number of DRGs, 
classification is also based on the age, sex, and discharge status of 
the patient. The diagnosis and procedure information is reported by the 
hospital using codes from the International Classification of Diseases, 
Ninth Revision, Clinical Modification (ICD-9-CM).
    For FY 2004, cases are assigned to one of 518 DRGs in 25 major 
diagnostic categories (MDCs). Most MDCs are based on a particular organ 
system of the body. For example, MDC 6 is Diseases and Disorders of the 
Digestive System. This approach is used because clinical care is 
generally organized in accordance with the organ system affected. 
However, some MDCs are not constructed on this basis because they 
involve multiple organ systems (for example, MDC 22 (Burns)). The table 
below lists the 25 MDCs.

[[Page 48926]]

[GRAPHIC] [TIFF OMITTED] TR11AU04.000

    In general, cases are assigned to an MDC based on the patient's 
principal diagnosis before assignment to a DRG. However, for FY 2004, 
there are eight DRGs to which cases are directly assigned on the basis 
of ICD-9-CM procedure codes. These DRGs are for heart, liver, bone 
marrow, lung, simultaneous pancreas/kidney, and pancreas transplants 
and for tracheostomies. Cases are assigned to these DRGs before they 
are classified to an MDC. The table below lists the current eight pre-
MDCs.
[GRAPHIC] [TIFF OMITTED] TR11AU04.001

    Within most MDCs, cases are then divided into surgical DRGs and 
medical DRGs. Surgical DRGs are based on a hierarchy that orders 
operating room (O.R.) procedures or groups of O.R. procedures by 
resource intensity.

[[Page 48927]]

Medical DRGs generally are differentiated on the basis of diagnosis and 
age (less than or greater than 17 years of age). Some surgical and 
medical DRGs are further differentiated based on the presence or 
absence of a complication or a comorbidity (CC).
    Generally, nonsurgical procedures and minor surgical procedures 
that are not usually performed in an operating room are not treated as 
O.R. procedures. However, there are a few non-O.R. procedures that do 
affect DRG assignment for certain principal diagnoses, for example, 
extracorporeal shock wave lithotripsy for patients with a principal 
diagnosis of urinary stones.
    Patient's diagnosis, procedure, discharge status, and demographic 
information is fed into the Medicare claims processing systems and 
subjected to a series of automated screens called the Medicare Code 
Editor (MCE). The MCE screens are designed to identify cases that 
require further review before classification into a DRG.
    After patient information is screened through the MCE and any 
further development of the claim is conducted, the cases are classified 
into the appropriate DRG by the Medicare GROUPER software program. The 
GROUPER program was developed as a means of classifying each case into 
a DRG on the basis of the diagnosis and procedure codes and, for a 
limited number of DRGs, demographic information (that is, sex, age, and 
discharge status).
    After cases are screened through the MCE and assigned to a DRG by 
the GROUPER, the PRICER software calculates a base DRG payment. The 
PRICER calculates the payments for each case covered by the IPPS based 
on the DRG relative weight and additional factors associated with each 
hospital, such as IME and DSH adjustments. These additional factors 
increase the payment amount to hospitals above the base DRG payment.
    The records for all Medicare hospital inpatient discharges are 
maintained in the Medicare Provider Analysis and Review (MedPAR) file. 
The data in this file are used to evaluate possible DRG classification 
changes and to recalibrate the DRG weights. However, in the July 30, 
1999, IPPS final rule (64 FR 41500), we discussed a process for 
considering non-MedPAR data in the recalibration process. In order for 
us to consider using particular non-MedPAR data, we must have 
sufficient time to evaluate and test the data. The time necessary to do 
so depends upon the nature and quality of the non-MedPAR data 
submitted. Generally, however, a significant sample of the non-MedPAR 
data should be submitted by mid-October for consideration in 
conjunction with the next year's proposed rule. This allows us time to 
test the data and make a preliminary assessment as to the feasibility 
of using the data. Subsequently, a complete database should be 
submitted by early December for consideration in conjunction with the 
next year's proposed rule.
    Many of the changes to the DRG classifications are the result of 
specific issues brought to our attention by interested parties. We 
encourage individuals with concerns about DRG classifications to bring 
those concerns to our attention in a timely manner so they can be 
carefully considered for possible inclusion in the next proposed rule 
and so any proposed changes may be subjected to public review and 
comment. Therefore, similar to the timetable for interested parties to 
submit non-MedPAR data for consideration in the DRG recalibration 
process, concerns about DRG classification issues should be brought to 
our attention no later than early December in order to be considered 
and possibly included in the next annual proposed rule updating the 
IPPS.
    In the May 18, 2004, proposed rule, we proposed numerous changes to 
the DRG classification system for FY 2005. The changes we proposed to 
the DRG classification system for FY 2005, the public comments we 
received concerning the proposed changes, the final DRG changes, and 
the methodology used to recalibrate the DRG weights are set forth 
below. The changes we are implementing in this final rule will be 
reflected in the revised FY 2005 GROUPER version 22.0 and effective for 
discharges occurring on or after October 1, 2003. Generally, our DRG 
analysis in the May 18, 2004, proposed rule was based on data from the 
December 2003 update of the FY 2003 MedPAR file.
    Unless otherwise noted in this final rule, our DRG analysis is 
based on data from the March 2004 update of the FY 2003 MedPAR file, 
which contains hospital bills received through March 31, 2004, for 
discharges in FY 2003.
2. MDC 1 (Diseases and Disorders of the Nervous System): Intracranial 
Hemorrhage and Stroke With Infarction
    In the May 18, 2004, proposed rule, we noted that it had come to 
our attention that the title of DRG 14 (Intracranial Hemorrhage and 
Stroke With Infarction) may be misleading because it implies that a 
combination of conditions exists when the DRG is assigned. When we 
developed this title, we did not intend to imply that a combination of 
conditions exists. Therefore, we proposed to change the title of DRG 14 
to read ``Intracranial Hemorrhage or Cerebral Infarction''.
    We received one comment on this proposal in support of the DRG 
title change. Therefore, we are adopting as final the proposed change 
of the title of DRG 14 to ``Intracranial Hemorrhage or Cerebral 
Infarction''.
3. MDC 5 (Diseases and Disorders of the Circulatory System)
a. Heart Assist System Implant
    Circulatory support devices, also known as heart assist systems, 
ventricular assist devices (VADs) or left ventricular assist devices 
(LVADs), offer a surgical alternative for end-stage heart failure 
patients. This type of device is often implanted near a patient's 
native heart and assumes the pumping function of the weakened heart's 
left ventricle. In many cases, heart transplantation would be the 
treatment of choice for this type of patient. However, the low number 
of donor hearts limits this treatment option.
    We have reviewed the payment and DRG assignment for this type of 
device many times in the past. The reader is referred to the August 1, 
2002 IPPS final rule (67 FR 49989) for a complete listing of those 
discussions.
    In the August 1, 2002, final rule (67 FR 49990), we attempted to 
clinically and financially align VAD procedures by creating new DRG 525 
(Heart Assist System Implant). We also noted that cases in which a 
heart transplant also occurred during the same hospitalization episode 
would continue to be assigned to DRG 103 (Heart Transplant). At that 
time, we announced that DRG 525 would consist of any principal 
diagnosis in MDC 5, plus one of the following surgical procedure codes:
     37.62, Insertion of nonimplantable heart assist system.
     37.63, Repair of heart assist system.
     37.65, Implant of external heart assist system.
     37.66, Insertion of implantable heart assist system.
    (To avoid confusion, we note that the titles of codes 37.62, 37.63, 
37.65, and 37.66 have been revised for FY 2005 through the ICD-9-CM 
Coordination and Maintenance Committee process as reflected in Table 
6F, Revised Procedure Code Titles in the Addendum to this final rule.)
    Commenters on the May 19, 2003, proposed rule that preceded the 
August 1, 2003, IPPS (FY 2004) final rule notified us that procedure 
code 37.66

[[Page 48928]]

was neither a clinical nor a financial match to the rest of the 
procedure codes now assigned to DRG 525. We did not modify DRG 525 for 
FY 2004. We agreed that we would continue to evaluate whether to make 
further changes to DRG 525. After publication of the August 1, 2003, 
final rule, we again reviewed the MedPAR data concerning DRG 525, and 
came to the conclusion that procedure code 37.62 is different in terms 
of clinical procedures and resource utilization from the other 
procedure codes assigned to DRG 525. Therefore, in a correction to the 
August 1, 2003, IPPS (FY 2004) final rule, published on October 6, 2003 
(68 FR 57733), we revised the composition of DRG 525 by correcting the 
assignment of procedures to DRG 525 in light of the lower charges 
associated with procedure code 37.62. We moved code 37.62 into DRG 104 
(Cardiac Valve and Other Major Cardiothoracic Procedures With Cardiac 
Catheterization) and DRG 105 (Cardiac Valve and Other Major 
Cardiothoracic Procedures Without Cardiac Catheterization), and left 
procedure codes 37.63, 37.65, and 37.66 into DRG 525.
    In addition, we have evaluated a request for expanded coverage for 
VADs and LVADs as destination (or permanent) therapy for end-stage 
heart failure patients who are not candidates for heart 
transplantation. VADs and LVADs had been approved for support of blood 
circulation post-cardiotomy (effective for services performed on or 
after October 18, 1993) and as a bridge to heart transplant (effective 
for services performed on or after January 22, 1996) to assist a 
damaged or weakened heart in pumping blood. The criteria that must be 
fulfilled in order for Medicare coverage to be provided for these 
purposes have been previously discussed in the August 1, 2000, final 
rule (65 FR 47058), and can also be accessed online at: http://www.cms.gov/manuals/pm_trans/r2ncd1.pdf.
    As a result of that review, effective for services performed on or 
after October 1, 2003, VADs have been approved as destination therapy 
for patients requiring permanent mechanical cardiac support. Briefly, 
VADs used for destination therapy are covered only if they have 
received approval from the FDA for that purpose, and the device is used 
according to the FDA-approved labeling instructions. VADs are covered 
for patients who have chronic end-stage heart failure (New York Heart 
Association Class IV end-stage left ventricular failure for at least 90 
days with a life expectancy of less than 2 years). Implanting 
facilities as well as patients must also meet all of the additional 
conditions that are listed in the national coverage determination for 
artificial hearts and related devices, which is posted on the above CMS 
website.
    In the May 18, 2004, proposed rule, we again reviewed the FY 2003 
MedPAR data for all cases in which a VAD had been implanted, using the 
criterion of any case containing a procedure code of 37.66. We found a 
total of 65 cases in 3 DRGs: DRG 103 (Heart Transplant); DRG 483 
(Tracheostomy With Mechanical Ventilation 96+ Hours or Principal 
Diagnosis Except Face, Mouth, and Neck Diagnoses); and DRG 525 (Heart 
Assist System Implant). The following table displays our findings:
[GRAPHIC] [TIFF OMITTED] TR11AU04.002

    The remaining 354 cases in DRG 103 that did not report code 37.66 
had average charges of $282,578. The remaining 171 cases in DRG 525 
that did not contain code 37.66 had an average length of stay of 12.39 
days and average charges of $168,388. The 45 cases in DRG 525 with code 
37.66 accounted for 26 percent of the cases. However, the average 
charges for these cases are approximately $140,340 higher than the 
average charges for cases in DRG 525 that did not report code 37.66.
    Commenters on the FY 2004 final rule suggested adding code 37.66 to 
DRG 103. We were concerned with the timing of that comment, as it was 
received after publication of the proposed rule. We noted that the 
commenters' suggestions on the structure of the DRGs involved were 
significant, and that change of that magnitude should be subject to 
public review and comment. We also noted that we would evaluate the 
suggestion further (68 FR 45370). However, as one of the indications 
for this device has become destination therapy, and as this new 
indication is more clinically aligned with DRG 103, in the May 18, 2004 
proposed rule, we proposed to remove procedure code 37.66 from DRG 525 
and assign it to DRG 103. We also proposed to change the title of DRG 
103 to ``Heart Transplant or Implant of Heart Assist System''. The 
proposed restructured DRG 103 included any principal diagnosis in MDC 
5, plus one of the following surgical procedure codes:
     33.6, Combined heart-lung transplantation.
     37.51, Heart transplantation.
     37.66, Insertion of implantable heart assist system.
    In addition to the proposed changes to DRG 103, we proposed to 
change the title of DRG 525 to ``Other Heart Assist System Implant.''
    Comment: A number of commenters recommended that we continue to 
examine the MedPAR data for code 37.66 and heart transplants to confirm 
that the weight is accurate. Some of these commenters noted that the 
weight might need to be increased in either the short term or next 
year. One commenter who, we believe, did not have access to the 
proposed rule, suggested the same proposed changes that were included 
in the proposed rule.
    Response: We will continue to evaluate the assignment of these 
codes annually for clinical and resource coherence. We point out that 
the relative weights are determined based on a formula and the formula 
is based on historic hospital charges. To increase one weight in a 
manner not consistent with the formula would skew other weights, in 
addition to distorting our mandated budget neutrality provision.
    Comment: Two commenters requested clarification concerning patients 
who receive the implantable heart assist system as a bridge to 
transplant and are discharged and subsequently return for a heart 
transplant. The commenters

[[Page 48929]]

wanted to know if DRG 103 would be assigned in both cases.
    Response: DRG 103 would be assigned to the case when a VAD is 
implanted. It would also be assigned when the patient returns to the 
hospital for a heart transplant. However, we take this opportunity to 
clarify that only one DRG 103 payment will be made per admission. If a 
patient has both the VAD and a heart transplant during the same 
hospital admission, DRG 103 would be paid only once. Depending on the 
circumstances, the case may qualify for cost outlier status, which is 
designed to defray some of the additional expenses of the case.
    Comment: One commenter suggested that the term ``Insertion'' in the 
code title for 37.66 be changed to ``Implant'' to more accurately 
reflect the resource intense nature of the VAD implant.
    Response: We regret that we cannot accommodate this request. The 
cardiac device code titles have been discussed at the two previous ICD-
9-CM Coordination and Maintenance Committee meetings (December 2003 and 
April 2004). At those meetings, we asked for comments about the code 
titles, and in response to public comment, we removed the term 
``Implant'' and substituted ``Insertion'' in the title. As noted 
elsewhere in this preamble, the codes in Table 6 of the Addendum are 
not subject to comment. The codes themselves are final at the time the 
proposed rule is published, which gives our industry partners the 
opportunity to put them into their printed and electronic programs 
without the concern that they may be changed later in the rulemaking 
process.
    Comment: One commenter urged CMS to retain a common DRG assignment 
for procedure codes 37.65 and 37.66. The commenter believed that 
assigning these two procedure codes to different DRGs would not ensure 
that payment is adequate to allow hospitals to provide mechanical 
circulatory support therapies, as clinically indicated, and in a cost-
efficient manner. The commenter further believed that payment for 
implantable VADs (code 37.66) at a higher level than external VADs 
(code 37.65) would create financial incentives unrelated to, and 
potentially at odds with, clinical considerations, which would skew 
device choice and increase Medicare program costs. The commenter stated 
that the initial use of the least expensive device that can provide the 
necessary therapeutic benefit leads to the best clinical outcomes and 
the lowest total system costs. The commenter encouraged CMS to adopt a 
prudent payment policy and an adequate test of whether a patient's 
heart will recover before an implantable VAD procedure is undertaken.
    Response: We reviewed data on DRG 525 in the FY 2003 MedPAR file 
and are summarizing the findings below:
[GRAPHIC] [TIFF OMITTED] TR11AU04.003

    We believe that the data on the length of stay and average charges 
demonstrate considerable differences in the two VAD devices. The 
implantable VAD (code 37.66) had a length of stay more than three times 
longer than that of the external VAD (code 37.65), and charges that 
average over $100,000 per case greater than those of the external VAD. 
To comply with this commenter's suggestion and leave both codes in the 
same DRG would result in overpayment of external VAD procedures and 
underpayment of the implantable VADs. We do not find either alternative 
acceptable.
    We will continue to closely monitor DRGs 103 and 525 on an annual 
basis, and will review our data using the specific procedure codes that 
comprise these two DRGs.
    Comment: One commenter stated that the MedPAR data on charges for 
FY 2003 VAD cases used to develop and defend the proposal to assign 
procedure codes 37.65 and 37.66 to different DRGs are an inadequate 
basis for the proposal. The commenter stated that the FY 2003 data on 
code 37.66 used in support of the proposal (to move these cases to DRG 
103) must be comprised primarily of bridge-to-transplant cases, as the 
use of VADs for destination therapy was only recently approved. 
Therefore, the commenter believes, any destination therapy patients in 
the data must have been clinical trial patients. The commenter asserted 
that these clinical trial patients were a sicker group of patients than 
would normally be found, and that they received more ancillary services 
during the course of the trial than would be likely in normal clinical 
practice. As a result, the data for these patients would be skewed to 
higher average charges and longer lengths of stay.
    Response: The data associated with code 37.66 reflect the insertion 
of an implantable VAD. We do not have a method of capturing the intent 
of the physician upon insertion of this device. When the chest is 
opened and the device is inserted, we have no way of determining if 
this patient requires the device as a bridge-to-transplant as the 
patient awaits a donor organ, or if this VAD is to be considered 
destination therapy. Code 37.66 captures only the procedure performed 
and the device inserted.
    The following table represents FY 2002 data in DRG 525.

[[Page 48930]]

[GRAPHIC] [TIFF OMITTED] TR11AU04.004

    When we compare the above table containing FY 2002 data to the 
previous table containing FY 2003 data, we find similar results in 
length of stay and average charges for codes 37.63, 37.65, and 37.66. 
The FY 2003 data show only one case with code 37.62: it is difficult to 
draw any meaningful conclusions based on one case. These data represent 
cases before bridge-to-transplant was a covered indication for VAD. As 
the data in the 2 years are so similar, we believe that we have 
correctly reassigned code 37.66 to DRG 103.
    Comment: One commenter stated that DRG 525, as amended on October 
1, 2003, to include every type of mechanical circulatory support device 
requiring a sternotomy and multiple-day support, constituted a 
clinically coherent group of surgeries encompassing a range of device 
types and costs. The commenter stated that, as the device types in that 
DRG grouping are available in the same hospital mechanical circulatory 
support programs, blended reimbursement did not constitute a financial 
impediment to proper clinical choice. The commenter stated that the FY 
2003 iteration of DRG 525 should be preserved, which would allow the 
dynamics of the clinical setting and the market to determine the choice 
among available VADs.
    Response: We are aware that reimbursement dynamics may have an 
influence on the practice of medicine. However, we are also aware that 
the placement of cases reporting code 37.66 in DRG 525 may cause a 
financial hardship for hospitals. The movement of code 37.66 to DRG 103 
is appropriate from the perspective of resource utilization, and will 
also alleviate some of the disincentive to offer this procedure to 
patients who meet the medical criteria for implantation.
    Comment: One commenter noted that coverage of VAD procedures should 
be limited to Medicare-certified transplant centers. The commenter also 
noted that VAD implants assigned to DRG 103 are limited to those 
[hospitals] using devices that are approved by the FDA for use outside 
the inpatient hospital setting.
    Response: Section 60--Durable Medical Equipment in the Medicare 
Coverage Manual sets forth our requirements concerning the use of VADs. 
The manual states:
     The VAD must be used in accordance with the FDA approved 
labeling instructions;
     The patient is approved and listed as a candidate for 
heart transplantation by a Medicare-approved heart transplant center; 
and
     The implanting site, if different than the Medicare-
approved transplant center, must receive the Medicare-approved heart 
transplant center under which the patient is listed prior to 
implantation of the VAD.
    In conjunction with the data review of DRGs 103 and 525, we also 
evaluated DRGs 104 and 105. DRGs 104 and 105 were restructured in FY 
2003 by moving code 37.62 into them. We examined the MedPAR data and 
found that the average charges for DRGs 104 and 105 were $113,667 and 
$82,899, respectively, for cases not reporting code 37.62, while cases 
containing code 37.62 had average charges of $124,559 and $166,129, 
respectively.
    The removal of code 37.66 from DRG 525 would have the effect of 
clinically realigning that DRG to be more coherent. As a result of the 
proposal to remove code 37.66 from DRG 525 and assign it to DRG 103, we 
also proposed to remove code 37.62 from DRGs 104 and 105 and assign it 
back into DRG 525. The average charges for code 37.62 in DRGs 104 and 
105 ($124,559 and $166,129) more closely matched the average charges 
reported for the 171 cases in DRG 525, absent code 37.66 ($168,388).
    We indicated that the proposed new DRG 525 would consist of any 
principal diagnosis in MDC 5, plus the following surgical procedure 
codes:
     37.52, Implantation of total replacement heart system*
     37.53, Replacement or repair of thoracic unit of total 
replacement heart system*
     37.54, Replacement or repair of other implantable 
component of total replacement heart system*
---------------------------------------------------------------------------

    * These codes represent noncovered services for Medicare 
beneficiaries. However, it is our longstanding practice to assign 
every code in the ICD-9-CM classification to a DRG. Therefore, they 
have been assigned to DRG 525.
---------------------------------------------------------------------------

     37.62, Insertion of nonimplantable heart assist system
     37.63, Repair of heart assist system
     37.65, Implant of external heart assist system
    We received one comment in support of this portion of our proposal. 
Based on the rationale described above, we are adopting the proposed 
changes to DRGs 103, 104, and 105 as final without modification.
b. Cardiac Resynchronization Therapy and Heart Failure
    In the May 18, 2004 proposed rule, we addressed a request we had 
received from a manufacturer of a Cardiac Resynchronization Therapy 
Defibrillator (CRT-D) device for a modification to DRG 535 (Cardiac 
Defibrillator Implant With Cardiac Catheterization With Acute 
Myocardial Infarction/Heart Failure/Shock) and DRG 536 (Cardiac 
Defibrillator Implant With Cardiac Catheterization Without Acute 
Myocardial Infarction/Heart Failure/Shock). The commenter pointed out 
that defibrillator device implantations, including the CRT-D type of 
defibrillator, are assigned to DRG 535 when the patient also has a 
cardiac catheterization and has either an acute myocardial infarction, 
heart failure, or shock as a principal diagnosis. If the

[[Page 48931]]

patient receiving the defibrillator implant and cardiac catheterization 
does not have a principal diagnosis of acute myocardial infarction, 
heart failure, or shock, the cases are assigned to DRG 536.
    The commenter requested that cases be assigned to DRG 535 when the 
patient has heart failure as either a principal diagnosis or a 
secondary diagnosis. The commenter stated that patients receive a CRT-D 
(as opposed to other types of defibrillators) when they have both heart 
failure and arrhythmia. The commenter was concerned that some coders 
may sequence the heart failure as a secondary diagnosis, which would 
result in the patient being assigned to DRG 536.
    As stated earlier, DRGs 535 and 536 are split based on the 
principal diagnosis of acute myocardial infarction, heart failure, or 
shock. Cases are not assigned to DRG 535 when heart failure is a 
secondary diagnosis.
    The commenter described a scenario where a patient was admitted 
with heart failure for an evaluation of the need for a CRT-D implant. 
The hospitalization studies indicated that the patient had a 
ventricular tachycardia. The commenter indicated that coders would be 
confused as to which code should be listed as the principal diagnosis.
    CMS' determination based on review of this scenario as described 
was that the heart failure led to the admission and would be the 
principal diagnosis. This case would properly be assigned to DRG 535. 
Furthermore, when two conditions are considered to be equally 
responsible for the admission, either one of the two conditions may be 
selected as the principal diagnosis.
    The commenter also stated that its own study shows CRT-D patients 
have significantly higher charges than do other patients in DRGs 535 
and 536 who receive an implantable defibrillator. This was the case 
whether heart failure was used as a principal or secondary diagnosis.
    A cardiac catheterization is a diagnostic procedure generally 
performed to establish the nature of the patient's cardiac problem and 
determine if implantation of a cardiac defibrillator is appropriate. 
Generally, the cardiac catheterization can be done on an outpatient 
basis. Patients who are admitted with acute myocardial infarction, 
heart failure, or shock and have a cardiac catheterization are 
generally acute patients who require emergency implantation of the 
defibrillator. Thus, there are very high costs associated with these 
patients.
    For the analysis in the proposed rule, we examined the MedPAR file 
for all cases in DRGs 535 and 536 and only cases in DRG 536 in which 
acute myocardial infarction or heart failure was listed as a secondary 
diagnosis. The following chart illustrates the results of our findings:
[GRAPHIC] [TIFF OMITTED] TR11AU04.005

    The data show that cases with a secondary diagnosis of acute 
myocardial infarction or heart failure have average charges 
($94,832.14) closer to the overall average charges for DRG 536 
($89,493.85) where they are currently assigned. Overall charges for DRG 
535 were $110,663.57. We do not believe these data support modifying 
DRG 535 and DRG 536 as requested. Many of the CRT-D patients who are 
admitted for heart failure would be assigned into DRG 535. Furthermore, 
modifying the DRG logic for one specific type of defibrillator (CRT-D) 
is not consistent with our overall policy of grouping similar types of 
patients together in the same DRG. In addition, to modify the DRG logic 
for the small percentage of cases where there might be confusion 
concerning the selection of the principal diagnosis does not seem 
prudent. Therefore, we did not propose a modification to DRG 535 or 536 
for CRT-Ds.
    Comment: Several commenters supported our proposal not to change 
the current DRG structure of DRG 535 and DRG 536 for CRT-D devices. Our 
proposal was in response to a manufacturer that had requested that CRT-
D cases be assigned to DRG 535 when the patient has heart failure as 
either a principal diagnosis or a secondary diagnosis.
    Response: After publication of the May 18, 2004 proposed rule, we 
discussed the issue of coding cases implanted with a CRT-D at the June 
2004 meeting of the American Hospital Association's Editorial Advisory 
Board for Coding Clinical for ICD-9-CM. Discussions between coding 
representatives from the American Hospital Association, the American 
Health Information Management Association, the National Centers for 
Health Statistics, and CMS did not identify diagnosis sequencing 
problems for patients receiving a CRT-D, as was suggested by the 
manufacturer. A number of problems in coding the implantation of these 
devices using the procedure codes were discussed. In addition, we 
learned that physicians are not clearly and consistently documenting 
the types of devices being implanted. This is leading to a number of 
questions from hospitals on how to assign the correct codes for an 
implantable cardiac defibrillator (ICD) versus the newer CRT-D. As a 
result of these further discussions, the Editorial Advisory Board for 
Coding Clinical for ICD-9-CM is developing a series of questions and 
answers to clearly illustrate to hospitals how the various devices, 
leads, and generators are to be correctly coded.
    We appreciate the support of the commenters for maintaining the 
current DRG structure for DRGs 535 and 536 and not modifying them in 
this final rule for one specific type of defibrillator.
    Comment: One commenter, a national hospital organization, opposed 
our recommendation not to alter the logic of DRG 535. The commenter 
believed that resynchronization is not performed during an acute 
exacerbation of congestive heart failure. Rather, the

[[Page 48932]]

commenter indicated, the patient returns at a later date once the 
congestive heart failure becomes more stabilized. The commenter added 
that, at that time, the patient often manifests associated arrhythmias 
that require the resynchronization. The commenter believed that, as a 
result, under the current proposal, this case would possibly not group 
to DRG 535 if the congestive heart failure were not sequenced as the 
principal diagnosis.
    Response: The commenter stated that the hospital might not list 
congestive heart failure as the principal diagnosis in the case 
described. However, if this were a planned second admission for the 
implantation of a CRT-D for congestive heart failure, the hospital 
would assign congestive heart failure as the principal diagnosis. The 
associated arrhythmias would be listed as a secondary diagnosis. This 
case would be assigned to DRG 535. If the admission were equally due to 
both the congestive heart failure and the arrhythmias, the hospital 
could choose either one as the principal diagnosis. Once again, the 
hospital could select congestive heart failure as the principal 
diagnosis and DRG 535 would be assigned. It would not be appropriate to 
change the DRG logic for DRG 535 to capture congestive heart failure as 
either the principal diagnosis or secondary diagnosis for CRT-D 
patients when appropriate coding would lead to the correct DRG 
assignment. Therefore, it would not be appropriate to modify the logic 
for DRGs 535 and 536 for congestive heart failure at this time.
    Comment: Commenters who supported our proposal of maintaining the 
current DRG structure for DRGs 535 and 536 suggested that coders should 
follow the ICD-9-CM Official guidelines for Coding and Reporting 
(available on the following Web site: http://www.cdc.gov/nchs/icd9.htm) 
when sequencing the principal diagnosis for admissions involving 
cardiac resynchronization. The commenters indicated that, if the reason 
for the admission is heart failure, that condition would be sequenced 
as the principal diagnosis. The commenter added that when two 
conditions are equally responsible for the admission, the ICD-9-CM 
Official Guidelines for Coding and Reporting allow either condition to 
be sequenced as the principal diagnosis. The commenters further stated 
that, in that case, the condition resulting in the higher-weighted DRG 
adjustment would likely be sequenced as the principal diagnosis. The 
commenter recommended that CMS continue to analyze the data in DRGS 535 
and 536 and seek additional clinical input regarding the typical 
principal diagnosis for patients being admitted to evaluate the need 
for a CRT-D device. The commenters added that further revisions to 
these DRGs may be warranted in the future.
    Response: We agree with the commenters that coders should follow 
the ICD-9-CM Official Guidelines for Coding and Reporting. We also 
agree that although we are currently maintaining the structure of DRGs 
535 and 536, we will continue to examine data for these procedures in 
future years to ensure that assignment of cases to these DRGs remains 
appropriate.
    Comment. One commenter indicated that its hospital was assigning 
the following codes for heart failure cases where the existing 
automatic cardioverter/defibrillator pulse generator is replaced and 
the pocket in which the device is implanted is revised:
     37.98 Replacement of automatic cardioverter/defibrillator 
pulse generator only.
     37.99 Other operations of heart and pericardium.
    The commenter stated that when the hospital submits a claim with 
the code for the replacement of the generator (code 37.98), the case is 
assigned to DRG 115 (Permanent Cardiac Pacemaker Implant With Acute 
Myocardial Infarction, Heart Failure, or Shock or ACID Lead or 
Generator Procedures). When the hospital submits a claim with codes for 
both the generator replacement (code 37.98) and the pocket revision 
(code 37.99), the case is assigned to DRG 111 (Major Cardiovascular 
Procedures Without CC). The commenter was concerned because DRG 111 has 
a lower relative weight than DRG 115. The commenter believed that DRG 
111 does not adequately reimburse the hospital for the replacement of 
the pulse generator device.
    The commenter requested that we consider modifying the DRG logic 
when both codes are submitted, modify the surgical hierarchy, or 
develop separate codes for revisions and relocations of defibrillator 
generators.
    Response: We are addressing the issue of the surgical hierarchy 
surfaced by the commenter in section II.B.11. of this final rule. We 
have carefully evaluated the other issues raised by the commenter, and 
we concur that assigning procedures such as the revision or relocation 
of defibrillator pockets to a vague code such as code 37.99 does not 
allow these procedures to be clearly identified. We believe that 
grouping disparate procedures such as repositioning of leads, removal 
without replacement of pulse generator, and revision or relocation of 
pockets within one code makes the DRG refinements difficult. We will 
discuss this topic at the October 7-8, 2004 meeting of the ICD-9-CM 
Coordination and Maintenance Committee. We will give consideration to 
creating one or more new codes to more clearly identify these 
procedures. With these more precise codes, we should be able to modify 
the DRG logic to resolve this issue.
    Comment: Several commenters requested that we restructure DRG 515 
(Cardiac Defibrillator Implant without Cardiac Catheterization) by 
splitting it into two DRGs based on the presence of acute myocardial 
infarction (AMI), heart failure, or shock. One commenter pointed out 
that we previously split DRG 514 (Cardiac Defibrillator with Cardiac 
Catheterization) into two DRGs based on these conditions. In FY 2004, 
we created DRGs 535 and 536 (Cardiac Defibrillator Implant with Cardiac 
Catheterization With and Without AMI/Heart Failure/Shock, 
respectively). The commenter commended us for splitting DRG 514 into 
these two new DRGs and asked that we now split DRG 515 in a similar 
manner.
    The commenter stated that there was significant difference in 
hospital charges associated with cases in DRG 515 with and without 
these principal diagnoses. The commenter stated that it was important 
to ensure more appropriate payment for all defibrillator cases and 
better align the DRG payment logic across all pacemaker and 
defibrillator cases based on important differences in hospital resource 
requirements.
    The commenter pointed out that, in the FY 2004 IPPS rule, we 
indicated that we did not believe the number of cases within DRG 515, 
or the differences in charges for cases with and without a principal 
diagnosis of acute myocardial infarction, heart failure, or shock, were 
sufficient to merit the creation of two separate DRGs. The commenter 
stated there was an increase in defibrillator implants assigned to DRG 
515 in FY 2003 based on changes in medical science and practice 
patterns, and speculated that a large number of cases now assigned to 
DRG 515 are for patients with a principal diagnosis of acute myocardial 
infarction, heart failure, or shock. The commenter believed that these 
patients will have significant differences in hospital charges and 
lengths of stay as compared to those cases in DRG 515 without these 
principal diagnoses. In addition, the commenter mentioned that other 
DRGs within MDC 5 are split based on the principal diagnosis or the 
presence of complications or comorbidities. In

[[Page 48933]]

summation, the commenter requested that we split DRG 515 into two 
separate new DRGs based on the principal diagnoses of acute myocardial 
infarction, heart failure, or shock. The commenter believed the split 
is justified based on the large number of cases in DRG 515, the large 
percentage of cases that include a principal diagnosis of acute 
myocardial infarction, heart failure, or shock, and the significantly 
higher charges and length of patient stays associated with these cases.
    Another commenter made a similar request to split DRG 515 into two 
separate new DRGs based on the principal diagnosis of acute myocardial 
infarction, heart failure, or shock. The commenter stated that we had 
split DRG 514 into two DRGs (DRGs 535 and 536), and this split has 
worked well in the facility environment to accurately capture charges 
and assign appropriate DRGs to cases.
    Response: We have performed additional analysis of our FY 2003 
MedPAR claims data for DRG 515 using the March 2004 update of the 
files. We found that 32 percent (4,191) of cases reported for DRG 515 
contained a principal diagnosis of acute myocardial infarction, heart 
failure, or shock. These cases had average charges of $84,688, as 
compared to average charges of $77,554 for all cases in DRG 515. 
Therefore, DRG 515 cases with a principal diagnosis of acute myocardial 
infarction, heart failure, or shock had average charges that were 
$7,134 (9 percent) higher than those for all cases in DRG 515. The data 
also show that patients with a principal diagnosis of acute myocardial 
infarction, heart failure, or shock have average lengths of stay of 
6.056 days compared to 4.73 days for all cases in DRG 515. Therefore, 
cases in DRG 515 with a principal diagnosis of acute myocardial 
infarction, heart failure, or shock have an average length of stay that 
is only 1.326 days longer than that for all cases in DRG 515.
    The data that we included in the May 18, 2004, proposed rule (69 FR 
28208) showed significantly larger differences between DRGs 535 and 536 
in average lengths of stay and charges. DRG 535 had an average length 
of stay of 9.5 days and average charges of $110,663.57. DRG 536 had an 
average length of stay of 5.47 days and average charges of $89,493.85. 
The difference in average charges was $21,169.72.
    As a result of this analysis, we find that the requested split of 
DRG 515 would not result in cases with as significantly different 
lengths of stay or charges as compared to the difference between DRGs 
535 and 536. In addition, our current data show only 4,191 cases that 
would be assigned to a new DRG for Cardiac Defibrillator Implant 
without Cardiac Catheterization with a principal diagnosis of acute 
myocardial infarction, heart failure, or shock. Given the limited 
number of cases in DRG 515 and the relatively small differences between 
average charges and length of stay for the two DRGs suggested by the 
commenter, we have decided that a modification of DRG 515 is not 
warranted at this time. However, we will examine the data in the future 
to determine if changes are warranted.
    In summary, we are not making changes to DRG 535 or DRG 536 for 
CRT-D cases at this time. In addition, DRG 515 will remain unchanged 
for FY 2005. However, we will continue to study data on these DRGs to 
consider whether future DRG refinements are warranted.
c. Combination Cardiac Pacemaker Devices and Lead Codes
    In the May 18, 2004, proposed rule, we discussed a comment we had 
received that recommended that we include additional combination 
procedure codes representing cardiac pacemaker device and lead codes 
under DRG 115 (Permanent Cardiac Pacemaker Implant With Acute 
Myocardial Infarction, Heart Failure, or Shock or ACID Lead or 
Generator Procedures) and DRG 116 (Other Permanent Cardiac Pacemaker 
Implant). DRGs 115 and 116 are assigned when a complete pacemaker unit 
with leads is implanted. Combinations of pacemaker devices and lead 
codes that would lead to the DRG assignment are listed under DRGs 115 
and 116. The commenter recommended that the following pacemaker device 
and lead procedure code combinations be added to these two DRGs:
     00.53 & 37.70
     00.53 & 37.71
     00.53 & 37.72
     00.53 & 37.73
     00.53 & 37.74
     00.53 & 37.76
    These codes are defined as follows:
     00.53, Implantation or replacement of cardiac 
resynchronization pacemaker, pulse generator only [CRT-P]
     37.70, Initial insertion of pacemaker lead [electrode], 
not otherwise specified
     37.71, Initial insertion of transvenous lead [electrode] 
into ventricle
     37.72, Initial insertion of transvenous lead [electrode] 
into atrium and ventricle
     37.73, Initial insertion of transvenous lead [electrode] 
into atrium
     37.74, Initial insertion or replacement of epicardial lead 
[electrode] into epicadium
     37.76, Replacement of transvenous atrial and/or 
ventricular lead(s) [electrode]
    We consulted our medical advisors and they agreed that these 
recommended procedure code combinations also describe pacemaker device 
and lead implantations and should be included under DRGs 115 and 116. 
Therefore, we proposed to add the recommended procedure code 
combinations to the list of procedure code combinations under DRGs 115 
and 116.
    Comment: Several commenters, including those from organizations 
representing hospitals and coders, supported our proposal to add the 
pacemaker device and lead procedure code combinations to DRGs 115 and 
116 as specified above. The commenters agreed that these combinations 
indicate that a complete pacemaker unit, including a pacemaker unit and 
leads, is implanted.
    Response: We appreciate the commenters' support for our proposal.
    In summary, we are adopting, as final without modification, our 
proposal to add the procedure code combinations of pacemaker devices 
and lead procedure codes included above and specified in the proposed 
rule to the list of procedure code combinations under DRGs 115 and 116.
d. Treatment of Venous Bypass Graft [Conduit] with Pharmaceutical 
Substance
    In the May 18, 2004, proposed rule, we included in Table 6B of the 
Addendum a new ICD-9-CM procedure code 00.16 (Pressurized treatment of 
venous bypass graft [conduit] with pharmaceutical substance) that was 
approved, effective on October 1, 2004. We received a number of 
comments on this new code.
    Comment: A number of comments from physicians applauded our 
decision to create new procedure code 00.16. The commenters stated 
that, upon approval by the Food and Drug Administration (FDA) of this 
procedure, the code will be used to recognize the E2F Decoy 
(edifoligide) procedure. This procedure will be performed on patients 
undergoing bypass vein graft procedures if the FDA finds the procedure 
to be safe and effective. The commenters stated that they are currently 
performing this procedure on a number of their patients, and asked that 
Medicare payments that are in addition to that for the cardiac bypass 
procedure be made to offset resource utilization and costs incurred by 
hospitals.
    Response: We appreciate the commenters' support for the creation of

[[Page 48934]]

this procedure code. We proposed to classify this procedure as a non-
O.R. procedure in Table 6B of the Addendum to the proposed rule. The 
``N'' under the O.R. column in Table 6B means that the code will not be 
considered an O.R. procedure and therefore, will not affect the DRG 
assignment. While the commenters suggested that extra payment be made 
for this procedure in addition to that for the cardiac bypass 
procedure, they did not suggest a means to do so. Furthermore, because 
procedure code 00.16 will not begin to be used until October 1, 2004, 
we have no data for this new procedure. Accordingly, in this final 
rule, we are retaining as final the proposed classification of 
procedure code 00.16 as a non-O.R., ICD-9-CM procedure code. Code 00.16 
will not affect the DRG assignment.
4. MDC 6 (Diseases and Disorders of the Digestive System): Artificial 
Anal Sphincter
    In the FY 2003 IPPS final rule (67 FR 50242), we created two new 
codes for procedures involving an artificial anal sphincter, effective 
for discharges occurring on or after October 1, 2002: code 49.75 
(Implantation or revision of artificial anal sphincter) that is used to 
identify cases involving implantation or revision of an artificial anal 
sphincter and code 49.76 (Removal of artificial anal sphincter) that is 
used to identify cases involving the removal of the device. In Table 6B 
of that final rule, we assigned both codes to one of four MDCs, based 
on principal diagnosis, and one of six DRGs within those MDCs. In the 
August 1, 2003, IPPS final rule (68 FR 45372), we discussed the 
assignment of these codes in response to a request we had received to 
consider reassignment of these two codes to different MDCs and DRGs. 
The requester believed that the average charges ($44,000) for these 
codes warranted reassignment. In the August 1, 2003, IPPS final rule, 
we stated that we did not have sufficient MedPAR data available on the 
reporting of codes 49.75 and 49.76 to make a determination on DRG 
reassignment of these codes. We agreed that, if warranted, we would 
give further consideration to the DRG assignments of these codes 
because it is our customary practice to review DRG assignment(s) for 
newly created codes to determine clinical coherence and similar 
resource consumption after we have had the opportunity to collect 
MedPAR data on utilization, average length of stay charges, and 
distribution throughout the system.
    Therefore, we reviewed the FY 2003 MedPAR data for the presence of 
codes 49.75 and 49.76. We then arrayed the results by DRG, count, 
average length of stay, charges, and the presence or absence of a 
secondary diagnosis that could be classified as a CC. We found that 
there were a total of 13 cases in 5 total DRGs with CCs, and 9 cases in 
4 total DRGs without CCs, for a total of 22 cases that reported these 
procedure codes. We had anticipated that the majority of cases would 
have been found in DRGs 157 (Anal and Stomal Procedures With CC) and 
158 (Anal and Stomal Procedures Without CC), but found only 2 cases 
grouped to DRG 157 and 4 cases grouped to DRG 158. Our data showed 
average charges of $22,374 for the cases with CC, and average charges 
of $20,831 for the cases without CC. Average charges for DRG 157 were 
$18,196, while average charges for DRG 158 were $9,348.
    Our medical advisors also reviewed the contents of DRGs 157 and 
158. The consensus was that codes 49.75 and 49.76 are not a clinical 
match to the other procedure codes found in these two DRGs. The other 
procedure codes in DRGs 157 and 158 are for simpler and less invasive 
procedures. In some circumstances, these procedures could potentially 
be performed in an outpatient setting or in a physician's office. Our 
medical advisors determined that clinical coherence was not 
demonstrated and recommended that we move these codes to DRGs 146 
(Rectal Resection With CC) and 147 (Rectal Resection Without CC), as 
these anal sphincter procedures more closely resemble the procedures in 
these DRGs. In addition, the average charges for paired DRG 146 
($33,853) and DRG 147 ($21,747) more closely resemble the actual 
average charges found in the MedPAR data for these cases.
    Even though there were few reports of codes 49.75 and 49.76 in the 
MedPAR data and we did not anticipate a significant increase in 
utilization of these procedures, we proposed that these two codes would 
only be removed from paired DRGs 157 and 158 and reassigned to paired 
DRGs 146 and 147 under MDC 6 (Diseases and Disorders of the Digestive 
System). We also proposed that all other MDC and DRG assignments for 
codes 49.75 and 49.76 would remain the same.
    Comment: Two commenters agreed with our proposal and suggested that 
the recommendation be adopted as a final change. One commenter 
recommended that CMS continue to monitor the cost of these cases for 
future consideration of the creation of a new DRG. This commenter 
stated that CMS has limited reassignment of codes 49.75 and 49.76 to 
only one pair of DRGs. Specifically, these procedures were assigned to 
DRGs 157 and 158 and will be reassigned to DRGs 146 and 147. The 
commenter took issue with this limited correction and urged CMS to 
create a new DRG for ``Complex Anal/Rectal Procedure with Implant''.
    Response: As noted above, codes 49.75 and 49.76 are arrayed in four 
MDCs and six DRGs within those MDCs. To clarify the proposed rule, we 
proposed to move these codes within MDC 6, but we did not propose to 
change any other DRG assignment. With an appropriate principal 
diagnosis, and absent any other surgical procedure that would 
reconfigure the case, these codes will continue to be assigned to the 
other four DRGs in the other three MDCs.
    We point out that this reassignment of cases in MDC 6 will double 
the payment for cases now classified to DRG 146, and will more than 
double the payment for cases now classified to DRG 147 based on the 
increases in the relative weights.
    With regard to the suggestion to create a specific DRG for this 
procedure, we remind the commenter that the DRG structure is a system 
of averages, and is based on groups of patients with similar 
characteristics. It has not been our past practice to create a DRG 
based on one device from one manufacturer. We will continue to monitor 
these two procedure codes and the DRGs to which they are assigned for 
the annual IPPS updates. However, for FY 2005, we are adopting the 
proposal to reassign cases reporting codes 49.75 and 49.76 in MDC 6 to 
DRGs 146 and 147 as final, without further modification.
5. MDC 8 (Diseases and Disorders of the Musculoskeletal System and 
Connective Tissue)
a. 360 Degree Spinal Fusions
    In the May 18, 2004 proposed rule, we discussed a comment we had 
received that suggested procedure code 81.61 (360 Spinal fusion) should 
not be included in DRG 496 (Combined Anterior/Posterior Spinal Fusion). 
The commenter stated that code 81.61 does not represent the same types 
of cases as other codes included in DRG 496. The commenter indicated 
that cases reported with code 81.61 involve making only one incision, 
and then fusing both the anterior and posterior portion of the spine. 
All other cases in DRG 496 involve two separate surgical approaches 
used to reach the site of the spinal fusion. For these other patients, 
an incision is made into the patient, and a fusion is made in part of 
the spine. The patient is then turned over and a separate incision is 
made so that a fusion can be made in another part of

[[Page 48935]]

the spine. The commenter added that these two separate incisions and 
fusions are more time consuming than the single incision used for code 
81.61. The commenter also stated that patients receiving the two 
surgical approaches have a longer recovery period and use more hospital 
resources.
    We examined data in the MedPAR file for cases assigned to DRG 496 
and found the following:
[GRAPHIC] [TIFF OMITTED] TR11AU04.006

    We also examined cases in related DRG 497 (Spinal Fusion Except 
Cervical With CC) and DRG 498 (Spinal Fusion Except Cervical Without 
CC) in which code 81.61 was not reported. The results of our 
examination are summarized in the following table.
[GRAPHIC] [TIFF OMITTED] TR11AU04.007

    These data clearly showed that cases with code 81.61 have 
significantly lower average charges than other cases in DRG 496 that 
have two surgical approaches. Cases with code 81.61 are more closely 
aligned with cases in DRG 497 and DRG 498. Furthermore, including code 
81.61 will have the effect of lowering the relative weights for DRG 496 
in future years. Therefore, we proposed to remove code 81.61 from DRG 
496 and reassign it to DRGs 497 and 498.
    Comment: Several commenters supported our proposal to remove code 
81.61 from DRG 496 and reassign it to DRGs 497 and 498. One commenter 
representing a major hospital organization stated that patients 
receiving two surgical approaches have a longer recovery period and use 
more hospital resources. The commenter believed that there is confusion 
regarding the use of code 81.61 that stems from physicians who do not 
use the term ``360 degree spinal fusion'' in the medical record, and 
hospital coders who need to review the operative report to determine 
which surgeries, in fact, qualify for code 81.61. The commenter agreed 
that code 81.61 should be moved from DRG 496 to DRGs 497 and 498. 
However, the commenter recommended that data for code 81.61 be reviewed 
in the future once coding practices have improved. Another commenter 
representing a national organization of health information managers 
also supported our proposal to remove code 81.61 from DRG 496 and 
reassign it to DRGs 497 and 498. The commenter stated that MedPAR data 
indicate that this procedure is less expensive than other procedures 
classified to DRG 496.
    Response: We agree with the commenters that code 81.61 should be 
removed from DRG 496 and reassigned to DRGs 497 and 498. We also agree 
that the data for code 81.61 should be reviewed in the future to 
determine if additional DRG revisions are warranted.
    Comment: Several commenters opposed our proposal to remove 
procedure code 81.61 from DRG 496 and to reassign it to DRGs 497 and 
498. The commenters believed that CMS' reasoning was flawed in three 
areas: clinical coherence, accurate coding, and the incentive for more 
efficient care.
    First, the commenters believed that CMS did not fully address the 
clinical coherence of the cases, electing instead to make its proposal 
largely on the basis of charge coherence, alone. The commenters further 
believed that the combination of anterior and posterior fusions in a 
single surgery is the most appropriate for defining clinical 
characteristic of all cases currently included in DRG 496. The 
commenters stated that except for the number of incisions, a 360-degree 
(anterior and posterior) fusion is clinically comparable to all other 
anterior and posterior fusions because of the patient and the surgical 
characteristics.
    Second, the commenters expressed concerns that a significant number 
of 360-degree single-incision spinal fusion cases were inaccurately 
coded. The commenters pointed out that the data we used to examine the 
reporting of code 81.61 (which was created on October 1, 2002) 
represented only the first year of the use of the code. The commenters 
suggested that a significant number of 360-degree single-incision 
spinal fusion cases were incorrectly coded as involving a two-incision 
approach. Thus, these cases should have been correctly assigned to DRG 
496, but were mislabeled as involving a two-incision approach. One 
commenter stated that, as a manufacturer, it provides a coding hotline 
for hospitals with questions related to spinal cases. For the period 
January 2003 through April 2004, 20 percent (113 out of 563) of the 
total calls related to accurate coding of this procedure.
    One commenter stated that a high rate of coding errors is not 
surprising in the first year of use, given that code 81.61 just became 
effective for FY 2003, that 360-degree spinal fusion is a complex 
topic, and that misinformation may

[[Page 48936]]

have been given. The commenter recommended that consideration of a 
reclassification be held for at least another year or two to ensure 
that a sufficient volume of more accurate data can be collected and 
analyzed.
    Third, with regard to the issue of DRGs serving as an incentive for 
more efficient care, the commenters believed that CMS proposed the 
reassignment of code 81.61 to avoid lowering the relative weight for 
DRG 496 in the future. They stated that, by contrast, CMS has often 
maintained in the past that the DRG weighting process allows changes in 
the resource intensity of specific types of cases (whether upward or 
downward) to be reflected over time, as technology evolves. The 
commenters indicated that the single-incision method may be less time-
consuming, use fewer hospital resources, and allow patients to enjoy a 
shorter recovery period. The commenters stated that collection and 
analysis of additional and more accurate data may well show this. 
However, the commenters recommended that we leave code 81.61 in DRG 496 
as a financial incentive for providers to perform the lower-resource 
procedure. The commenters believed this would lead to the reduction of 
the relative weight for DRG 496 as more providers performed the less 
expensive procedure (single-incision anterior/posterior fusion). The 
commenters stated that the weighting process in DRG 496 is ideally 
designed to accomplish the goal of having hospitals perform a procedure 
that requires less resources.
    Response: We do not agree with the commenters' suggestions that our 
analysis did not fully address the clinical coherence of the cases or 
that our analysis was based largely on charge coherence alone. As we 
stated in the proposed rule, anterior and posterior fusions of the 
spine using one incision are quite different from those fusions 
involving two incisions of the spine. The patient endures a more 
extensive surgery when incisions to the spine are made using approaches 
from both the front and back of the patient. The surgery and recovery 
time are longer when two incisions are made into the patient. While we 
agree that the charge data support our proposal, we disagree that we 
ignored clinical differences in these two approaches.
    We acknowledge that there have been a number of questions 
concerning the use of code 81.61. This code has been discussed at the 
Editorial Advisory Board on Coding Clinic for ICD-9-CM. Based on some 
of the records sent to the Board, it would appear that some hospitals 
are incorrectly applying this code. The Board is attempting to develop 
additional educational material to include in future issues of Coding 
Clinic for ICD-9-CM.
    However, as we discussed in the proposed rule, cases reported with 
code 81.61 had average charges that are significantly lower than spinal 
fusions using two approaches. Approximately 30 percent (829) of the 
2,706 DRG 496 cases reported code 81.61. The 360-degree spinal fusion 
cases had average charges that were only 68 percent of those for all 
cases in DRG 496. The average charge for all cases in DRG 496 was 
$74,967.33, while the average charge for DRG 496 cases with code 81.61 
was only $50,659.69. There were also significant differences in the 
length of stay. The average length of stay for all cases in DRG 496 was 
8.0 days, while it was only 4.7 days for cases with code 81.61.
    While there may be some confusion in the correct coding of 360 
degree spinal fusions with a single incision, there are significant 
differences in the charges of those reported cases with 360 degree 
spinal fusion, single incision approach. If we were to keep code 81.61 
in DRG 496, the result would be a lowering of the weight for DRG 496 in 
future years. We discussed this issue with our medical advisors who 
agreed that the data and clinical similarities support our proposal to 
remove code 81.61 from DRG 496 and reassign it to DRGs 497 and 498. The 
nature of the surgery and the charges are similar to other cases in 
DRGs 497 and 498.
    We believe that the commenters' argument that leaving code 81.61 in 
DRG 496 would subsequently lead to a lowering of the relative weight 
for DRG 496 because it would increasingly consist of cases involving a 
single incision approach that would have lower charges seems to confirm 
CMS' suggestion that the single incision-approaches are significantly 
less resource intensive as well as less surgically invasive than the 
two-incision approaches. Therefore, we do not believe these cases 
belong in DRG 496 along with the more extensive surgeries.
    Comment: One commenter opposed moving code 81.61 from DRG 496 and 
into DRGs 497 and 498. The commenter stated that the amount of time it 
takes to perform a single incision 360-degree spinal fusion is similar 
to that of performing an anterior and posterior spinal fusion with two 
approaches. The commenter stated that any extra time in completing the 
surgery involves turning the patient over so that the separate approach 
(incision) can be made. The commenter stated that, in his hospital, the 
length of stay for one incision versus two incision approaches to 
spinal fusion does not vary significantly.
    Response: While the commenter's hospital may have similar length of 
stays for patients who have single versus two incision approaches to 
spinal fusion, our national data show a significant difference. As 
stated earlier, the average length of stay for DRG 496 was 8.0 days, 
while that for cases with code 81.61 was 4.7 days. We believe the data 
support this DRG change.
    Therefore, we are adopting as final our proposal to remove code 
81.61 from DRG 496 and reassign it to DRGs 497 and 498. We will examine 
data for cases reporting 81.61 in future years to determine if 
additional DRG modifications are needed.
b. Multiple Level Spinal Fusion
    On October 1, 2003 (68 FR 45596), the following new ICD-9-CM 
procedure codes were created to identify the number of levels of 
vertebra fused during a spinal fusion procedure:
     81.62, Fusion or refusion of 2-3 vertebrae.
     81.63, Fusion or refusion of 4-8 vertebrae.
     81.64, Fusion or refusion of 9 or more vertebrae.
    Prior to the creation of these new codes, we received a comment 
recommending the establishment of new DRGs that would differentiate 
between the number of levels of vertebrae involved in a spinal fusion 
procedure. In the August 1, 2003, final rule, we discussed the creation 
of these new codes and the lack of sufficient MedPAR data with the new 
multiple level spinal fusion codes (68 FR 45369). The commenter had 
conducted an analysis and submitted data to support redefining the 
spinal fusion DRGs. The analysis found that increasing the levels fused 
from 1 to 2 levels to 3 levels or more levels increased the mean 
standardized charges by 38 percent for lumbar/thoracic fusions, and by 
47 percent for cervical fusions.
    The following current spinal fusion DRGs separate cases based on 
whether or not a CC is present: DRG 497 (Spinal Fusion Except Cervical 
With CC) and DRG 498 (Spinal Fusion Except Cervical Without CC); DRG 
519 (Cervical Spinal Fusion With CC) and DRG 520 (Cervical Spinal 
Fusion Without CC). However, the difference in charges associated with 
the current CC split was only slightly greater than the difference 
attributable to the number of levels fused as found by the commenter's 
analysis. In addition, adopting the commenter's recommendation would 
have necessitated adjusting the DRG relative weights using non-MedPAR 
data

[[Page 48937]]

because Medicare claims data with the new ICD-9-CM codes would not have 
been available until the FY 2003 MedPAR file. Therefore, at that time, 
we did not redefine the spinal fusion DRGs to differentiate on the 
basis of the number of levels of vertebrae involved in a spinal fusion 
procedure.
    We did not yet have any reported cases utilizing the new multilevel 
spinal fusion codes in our data. We stated that we would wait until 
sufficient data with the new multilevel spinal fusion codes were 
available before making a final determination on whether multilevel 
spinal fusions should be incorporated into the spinal fusion DRG 
structure. The codes went into effect on October 1, 2003, and we have 
not received any data using these codes. Spinal surgery is an area of 
rapid changes. In addition, we have created a series of new procedure 
codes that describe a new type of spinal surgery, spinal disc 
replacement. (See codes 84.60 through 84.69 in Table 6B in the Addendum 
to this final rule that will go into effect on October 1, 2004.) Our 
medical advisors describe this new surgical procedure as a more 
conservative approach for back pain than the spinal fusion surgical 
procedure. With only limited data concerning multiple level spinal 
fusion and the rapid changes in spinal surgery, we believed it was more 
prudent not to propose the establishment of new DRGs based on the 
number of levels of vertebrae involved in a spinal fusion procedure in 
the May 18, 2004, proposed rule.
    In addition, no other surgical DRG is split based on the number of 
procedures performed. For instance, the same DRG is assigned whether 
one or more angioplasties are performed on a patient's arteries. The 
insertion of multiple stents within an artery does not result in a 
different DRG assignment. Similarly, the excision of neoplasms from 
multiple sites does not lead to a different DRG assignment. To begin 
splitting DRGs based on the number of procedures performed or devices 
inserted could set a new and significant precedent for DRG policy. 
Therefore, in the May 18, 2004, proposed rule, we indicated that while 
we would continue to study this area, we did not propose to redefine 
the spinal fusion DRGs based on the number of levels of vertebrae 
fused.
    Comment: Several commenters supported our proposal not to modify 
the spinal fusion DRGs to differentiate between the number of levels of 
vertebrae involved in a spinal fusion procedure. The commenters agreed 
that we should wait until we received sufficient data with the new 
multilevel spinal fusion codes to propose any new DRG revisions for 
using these codes.
    Response: We agree with the commenters that it would be premature 
to propose DRG revisions to the spinal fusion DRGs based on the new 
multiple level spinal fusion codes. Furthermore, as stated in the 
proposed rule, no other surgical DRG is split based on the number of 
procedures performed. To so do would have the potential of dramatically 
increasing the number of DRGs. Therefore, it would be prudent to wait 
for claims data prior to considering such a departure from the current 
DRG structure.
    Comment: One commenter who supported our recommendation expressed 
concern that our decision was grounded in part on the expectation that 
a ``more conservative'' surgical approach for back pain (that is spinal 
disc replacement) will be available soon. (In the proposed rule, we 
noted that new codes for spinal disc prosthesis procedures, codes 84.60 
through 84.69, will go into effect on October 1, 2004). The commenter 
stated that FDA has not approved some of the spinal disc prostheses. 
The commenter believed that this new technology may not become a 
medically accepted procedure in the clinical community. The commenter 
believed that we were implying that we would defer a decision on 
modification of the spinal fusion DRGs until such time as the FDA 
formally approves spinal disc prosthesis procedures. The commenter 
recommended that the spinal fusion DRGs should not be modified at this 
point; that CMS should wait for data using the multiple level spinal 
fusion codes prior to proposing modifications of the spinal fusion 
DRGs; and that CMS not wait to make any modifications to these DRGs 
based upon FDA approval of spinal disc prostheses.
    Response: We agree with the commenter that we should wait to 
evaluate claims data with the new multilevel spinal fusion codes before 
using these codes to revise the DRG structure. While we mentioned that 
new codes were created for FY 2005 for other types of spinal 
procedures, such as spinal disc prostheses, we did not mean to imply 
that we would defer analysis on multilevel spinal fusion until such 
time as the FDA reviews and approves other specific types of procedures 
and devices. We acknowledge that different types of procedures should 
be considered independently.
    In this final rule, we are maintaining the current DRG structure 
for the spinal fusion DRGs. We will wait for claims data on the new 
codes to become available before we consider proposing future revisions 
to the spinal fusion DRGs.
c. Insertion of Spinal Disc Prostheses and Other Spinal Devices
    In the May 18, 2004, proposed rule, we included in Table 6B of the 
Addendum new codes that were created to capture the insertion of spinal 
disc prostheses and other spinal devices (codes 84.59 through 84.69). 
We proposed to assign these new codes to DRGs 499 and 500 (Back and 
Neck Procedures Except Spinal Fusion with and without CC, respectively) 
within MDC 8. Shortly after publication of the proposed rule, we 
discovered errors of omission in the assignment of these codes within 
the MDCs in Table 6B. These codes should have also included DRG 
assignments within MDC 1, MDC 21, and MDC 24, in addition to the 
specified assignment to MCD 8. We corrected these errors of omission in 
a correction notice published on June 25, 2004 (69 FR 35716). The 
correction notice showed the following additional DRG assignments for 
these codes:
    MDC 1, DRGs 531 and 532 (Spinal Procedures With and Without CC, 
respectively).
    MDC 21, DRGs 442 and 443 (Other Procedure for Injuries With and 
Without CC, respectively).
    MDC 24, DRG 486 (Other Procedures for Multiple Significant Trauma).
    The official ICD-9-CM code conversion table showed code 80.51 
(Excision of intervertebral disc) as the predecessor code for codes 
84.60 through 84.69. There was no predecessor code listed for code 
84.59. Code 80.51 was assigned to DRGs 499 and 500 in MDC 8. It was 
also assigned to DRGs 531 and 532 in MDC 1, DRGs 442 and 443 in MDC 21, 
and DRG 486 in MDC 24.
    By correcting the proposed DRG assignment information for codes 
84.59 and 84.60 through 84.69, we clearly indicated our proposal of 
assigning these codes 84.59 and 84.60 through 84.69 to DRGs 531 and 532 
in MDC 1; DRGs 499 and 500 in MDC 8; DRGs 442 and 443 within MDC 21; 
and DRG 486 in MDC 24.
    Comment: Several commenters that are developing spinal disc 
prosthesis devices described these spinal disc prostheses devices as 
minimally invasive alternatives to spinal fusion. The commenters 
indicated that there is controversy among spine surgeons as to the 
cause, or causes, of back pain. However, they stated that many surgeons 
believe degeneration of the nucleus and annular destruction is a major 
source of pain. The commenters stated that if patients fail 
conservative

[[Page 48938]]

treatment, spinal fusion is currently the primary treatment option. The 
commenters further stated that fusing one or more levels in the spine 
results in increased stress and strain and the potential breakdown at 
adjacent disc levels. In addition, the commenters stated that partial 
and total spinal disc replacement prosthesis devices were designed to 
replace the degenerated nucleus or disc and restore the normal disc 
function and anatomy. They believed these devices have the potential of 
decreasing stress, which is redistributed to adjacent levels of the 
spine when spinal fusions are performed. The commenters indicated that 
fusion surgery patients have poor return to work results, that recovery 
periods are extended, and that the spinal disc prosthesis devices 
reduce this recovery period.
    The commenters objected to the proposed assignment of the new 
spinal disc prosthesis codes (84.60 through 84.69) to DRGs 499 and 500 
in MDC 8. The commenters stated that since total and partial spinal 
disc prostheses will be used for patients who would very likely be 
candidates for spinal fusion, the procedures should be assigned to DRGs 
497 and 498 for those in the lumbar spine and to DRGs 519 and 520 for 
those implanted in the cervical spine. One commenter compared the 
implantation of a total spinal disc prosthesis device in the lumbar 
spine to that of fusion of the lumbar spine with the use of a BAK cage. 
The commenter stated that both use an anterior approach to the surgery, 
and both involve implanting devices in the anterior part of the spine. 
One procedure involves implanting the spinal disc prosthesis; the other 
involves implanting a BAK cage while fusing the spine.
    The commenters stated that the costs of treating these types of 
patients with spinal disc prosthesis devices are also similar to the 
costs for those patients in the spinal fusion DRGs. One commenter 
stated that the operating room time would be similar, with the total 
lumbar disc prosthesis devices taking about 111 minutes and the lumbar 
fusion with a BAK cage taking 114 minutes. The commenter presented 
information to show a patient stay of 3.7 days for the total lumbar 
disc prosthesis procedures versus 4.3 days for the lumbar fusion with 
BAK cages. One commenter stated that the cost of the total disc 
prosthesis is approximately $10,585, compared to $4,800 for a BAK cage 
used in a lumbar fusion.
    Response: Based on advice from our medical advisors, we disagree 
with the suggestion that patients having partial and total spinal disc 
prosthesis procedures are clinically similar to patients assigned to 
the spinal fusion DRGs. To mix these two distinctly different 
approaches to the treatment of back pain would violate the principal of 
clinical cohesiveness of DRGs. DRGs 497, 498, 519, and 520 include only 
procedures that involve fusion of the spine. DRGs 499 and 500 include a 
number of other procedures performed on the spine and explicitly 
exclude spinal fusion procedures. Currently, spinal disc prosthesis 
procedures are assigned to code 80.51 (Excision of intervertebral 
disc). The new, more specific codes (84.60 through 84.69) will go into 
effect on October 1, 2004. As stated earlier, code 80.51 is assigned to 
DRGs 499 and 500 within MDC 8. Our proposal of assigning the new spinal 
disc prosthesis codes to DRGs 499 and 500 would maintain current 
practice based on the assignment of the predecessor code 80.51. Our 
medical advisors also stated that it would be inappropriate to move the 
partial and total spinal disc procedures to the spinal fusion DRGs 
because the implantation of these disc devices do not involve fusion of 
the spine. We do not yet have any charge data on these new types of 
spinal procedures because the codes are being implemented on October 1, 
2004. Thus, it would also be premature to assign these new procedures 
to the fusion DRGs.
    In this final rule, we are assigning the total and partial spinal 
disc procedures and other spinal devices (codes 84.59 and codes 84.60 
through 84.69) to DRGs 499 and 500 within MDC 8 as proposed. We will 
continue to monitor data on these procedures as their use increases to 
determine if future DRG modifications are needed.
d. Kyphoplasty
    In the May 18, 2004, proposed rule, in Table 6B of the Addendum, we 
included new ICD-9-CM codes that go into effect October 1, 2004. Among 
these new codes are codes 81.65 (Vertebroplasty) and 81.66 
(Kyphoplasty). We added these new codes to better differentiate between 
the surgical procedures of vertebroplasty and kyphoplasty. Both 
procedures are currently assigned to code 78.49 (Other repair or 
plastic operation on bone) and are assigned to the DRGs 223 and 234 in 
MDC 8, DRGs 442 and 443 in MDC 21, and DRG 486 in MDC 24.
    In the May 18, 2004, proposed rule, we proposed to assign both new 
codes 81.65 and 81.66 to the same DRGs to which code 78.49 is assigned.
    Comment: Several commenters supported the creation of the new 
procedure codes for kyphoplasty and vertebroplasty. However, some of 
the commenters opposed the assignment of code 81.66 to DRGs 233 and 234 
in MDC 8. The commenters stated that kyphoplasty is a significantly 
more resource intensive procedure than vertebroplasty and requires 
special inflatable bone tamps and bone cement. The commenters further 
stated that while kyphoplasty involves internal fixation of the spinal 
fracture and restoration of vertebral height, vertebroplasty involves 
only fixation. The commenters indicated that kyphoplasty procedures are 
more akin to spinal fusion and should be assigned to DRGs 497 and 498 
(Spinal Fusion Except Cervical With and without CC, respectively) in 
MDC 8. The commenters did not object to the DRG assignments for MDC 21 
or MDC 24 for kyphoplasty, or to the proposed DRG assignments for 
81.65.
    Response: Commenters supported the creation of the new procedure 
codes for kyphoplasty and vertebroplasty. The commenters indicated that 
kyphoplasty is more resource intensive than vertebroplasty and is more 
similar to resources used in a spinal fusion. However, we do not have 
data to support this claim because the new codes will not be 
implemented until October 1, 2004. We believe that it would be 
premature to consider DRG refinements using these new ICD-9-CM 
procedure codes at this time.
    Therefore, we are adopting, as final, our proposed assignment of 
new codes 81.65 and 81.66 to DRGs 223 and 234 in MDC 8, DRGs 442 and 
443 in MDC 21, and DRG 486 in MDC 24, as indicated in Table 6B of the 
Addendum to this final rule. We will take the commenters' 
recommendation into consideration when we conduct our annual reviews of 
MedPAR data.
6. MDC 15 (Newborns and Other Neonates With Conditions Originating in 
the Perinatal Period)
    In the May 18, 2004, proposed rule, we indicated that we continue 
to receive comments that MDC 15 (Newborn and Other Neonates With 
Conditions Originating in the Perinatal Period) does not adequately 
capture care provided for newborns and neonates by hospitals. The 
commenters pointed out that we have not updated the DRGs within MDC 15 
as we have for other parts of the DRG system.
    Our primary focus of updates to the Medicare DRG classification 
system is on changes relating to the Medicare patient population, not 
the pediatric or neonatal patient populations. However, we acknowledge 
the Medicare DRGs are

[[Page 48939]]

sometimes used to classify other patient populations. Over the years, 
we have received comments about aspects of the Medicare newborn DRGs 
that appear problematic, and we have responded to these on an 
individual basis. In the May 9, 2002, IPPS proposed rule (67 FR 31413), 
we proposed extensive changes to multiple DRGs within MDC 15. Because 
of our limited data and experience with newborn cases under Medicare, 
we contacted the National Association of Children's Hospitals and 
Related Institutions (NACHRI) to obtain proposals for possible 
revisions of the DRG categories within MDC 15. We received extensive 
comments opposing these revisions. Therefore, we did not implement the 
proposals.
    We advise those non-Medicare systems that need a more up-to-date 
system to choose from other systems that are currently in use in this 
country, or to develop their own modifications. As previously stated, 
we do not have the data or the expertise to develop more extensive 
newborn and pediatric DRGs. Our mission in maintaining the Medicare 
DRGs is to serve the Medicare population. Therefore, we will make only 
minor corrections of obvious errors to the DRGs within MDC 15. In the 
May 18, 2004, IPPS proposed rule, we indicated that we did not plan to 
conduct a more extensive analysis involving major revisions to these 
DRGs.
    Comment: Commenters, including several national hospital 
associations, supported our proposal not to undertake a major revision 
to MDC 15 at this time, but instead to address specific errors brought 
to our attention by providers and other commenters. One commenter, a 
national organization representing health information managers and 
coders, agreed with our approach to updating MDC 15 without undertaking 
a major revision. The commenter stated it believed a comprehensive 
revision of MDC 15 should not be undertaken without broad input from 
all types of hospitals that provide care for neonates to ensure the 
appropriateness of these DRG revisions across all institutions treating 
newborns. The commenter indicated that, given CMS' limited data and 
experience with newborn cases, it supported CMS' decision not to 
conduct a major overhaul of the newborn DRGs. However, the commenter 
agreed that CMS should address specific, individual requests for 
modifications to the newborn DRGs on a case-by-case basis.
    One commenter who supported our proposal indicated that there are 
challenges to developing DRG classifications systems and applications 
appropriate to children. The commenter acknowledged the practical 
difficulties of CMS assuming a larger role in this area, given the 
difference between the Medicare population and that of newborns and 
children. The commenter stated that there are evolving alternative DRG 
classification systems for children. The commenter agreed that a broad-
based fundamental restructuring of the neonatal DRGs would be a huge 
and complex undertaking and indicated that there are other DRG 
classification systems that are attempting at varying levels of 
sophistication to do this restructuring for the neonatal and pediatric 
patient populations. The commenter supported our approach of responding 
to specific requests for updating MDC 15 on a case-by-case basis.
    Response: We appreciate the commenters' support for our decision to 
perform only limited updates to MDC 15 based on specific requests for 
modification. We will continue to address specific requests for 
modification of the newborn DRGs on an individual basis.
    In the IPPS final rule for FY 2004 (68 FR 45360), we added heart 
failure diagnosis codes 428.20 through 428.43 to the list of secondary 
diagnosis of major problem under DRG 387 (Prematurity With Major 
Problems) and DRG 389 (Full-Term Neonate With Major Problems). We 
received a comment after the August 1, 2003 final rule stating that we 
should add the following list of combination codes, which also include 
heart failure, to the list of major problems under DRGs 387 and 389:
     398.91, Rheumatic heart failure (congestive).
     402.01, Malignant hypertensive heart disease, with heart 
failure.
     402.11, Benign hypertensive heart disease, with heart 
failure.
     402.91, Unspecified hypertensive heart disease, with heart 
failure.
     404.01, Malignant hypertensive heart and renal disease, 
with heart failure.
     404.03, Malignant hypertensive heart and renal disease, 
with heart failure and renal failure.
     404.11, Benign hypertensive heart and renal disease, with 
heart failure.
     404.13, Benign hypertensive heart and renal disease, with 
heart failure and renal failure.
     404.91, Unspecified hypertensive heart and renal disease, 
with heart failure.
     404.93, Unspecified hypertensive heart and renal disease, 
with heart failure and renal failure.
     428.9, Heart failure, unspecified.
    We agree that the codes listed above also include heart failure and 
should also be added to DRGs 387 and 389 as major problems. Therefore, 
in the May 18, 2004, proposed rule, we proposed to add the heart 
failure codes listed above to DRGs 387 and 389 as major problems.
    Comment: Several commenters supported the addition of the 
combination codes, including heart failure, to the list of major 
problems under DRGs 387 and 389 because there are a number of other 
heart failure codes already listed as major problems under DRGs 387 and 
389.
    Response: We appreciate the support of the commenters for our 
proposal.
    In this final rule, we are adopting, as final without modification, 
the proposed revisions to add the specified combination codes to the 
list of major problems under DRGs 387 and 389.
7. MDC 20 (Alcohol/Drug Use and Alcohol/Drug Induced Organic Mental 
Disorders): Drug-Induced Dementia
    In the May 18, 2004, proposed rule, we discussed a request that we 
had received from a commenter that we remove the principal diagnosis 
code 292.82 (Drug-induced dementia) from MDC 20 (Alcohol/Drug Use and 
Alcohol/Drug Induced Organic Mental Disorders) and the following DRGs 
under MDC 20:
     DRG 521 (Alcohol/Drug Abuse or Dependence With CC).
     DRG 522 (Alcohol/Drug Abuse or Dependence With 
Rehabilitation Therapy Without CC).
     DRG 523 (Alcohol/Drug Abuse or Dependence Without 
Rehabilitation Therapy Without CC).
    The commenter indicated that a patient who has a drug-induced 
dementia should not be classified to an alcohol/drug DRG. However, the 
commenter did not propose a new DRG assignment for code 292.82.
    Our medical advisors evaluated the request and determined that the 
most appropriate DRG classification for a patient with drug-induced 
dementia would be within MDC 20. The medical advisors indicated that 
because this mental condition is drug induced, it is appropriately 
classified to DRGs 521 through 523 in MDC 20. Therefore, we did not 
propose a new DRG classification for the principal diagnosis code 
292.82.
    Comment: Several commenters supported our proposal not to modify 
DRGs 521 through 523 by removing code 292.82. One commenter 
representing hospital coders disagreed with our proposal to retain code 
292.82 in DRGs 521 through 523. The commenter stated that DRGs 521 
through 523 are described as alcohol/drug abuse and dependence DRGs. 
The

[[Page 48940]]

commenter further indicated that drug-induced dementia could be caused 
by an adverse effect of a prescribed medication or a poisoning. The 
commenter did not believe that assignment of drug-induced dementia to 
DRGs 521 through 523 was appropriate if the drug-induced dementia is 
related to an adverse effect or poisoning due to a prescribed drug. The 
commenter recommended that admissions for drug-induced dementia be 
classified to DRGs 521 through 523 only if there is a secondary 
diagnosis indicating alcohol/drug abuse or dependence.
    The commenter further recommended that drug-induced dementia that 
is due to the adverse effect of drugs be classified to the same DRGs as 
other types of dementia, such as DRG 429 (Organic Disturbances and 
Mental Retardation). The commenter stated that when drug-induced 
dementia is caused by a poisoning, either accidental or intentional, 
the appropriate poisoning code would be sequenced as the principal 
diagnosis and, therefore, these cases would likely already be assigned 
to DRGs 449 and 450 (Poisoning and Toxic Effects of Drugs, Age Greater 
Than 17, With and Without CC, respectively) and DRG 451 (Poisoning and 
Toxic Effects of Drugs, Age 0-17). The commenter suggested that these 
DRG assignments would be the appropriate DRG assignments for drug-
induced dementia due to a poisoning.
    Response: We have considered the issues raised by the commenters 
relating to the DRG assignment for code 292.82 and the suggested 
alternatives for DRG assignment based on sequencing of the principal 
diagnosis and reporting of additional secondary diagnoses. We 
acknowledge that patients do develop drug-induced dementia from drugs 
that are prescribed as well as from drugs that are not prescribed. 
However, we still believe that dementia developed as a result of use of 
a drug is appropriately assigned to DRGs 521 through 523, as mentioned 
by the commenters who supported the current assignment. We also agree 
that if the drug-induced dementia is caused by a poisoning, either 
accidental or intentional, the appropriate poisoning code should be 
sequenced as the principal diagnosis. As the commenter stated, these 
cases would be assigned to DRGs 449 through 451.
    We will continue to evaluate the DRG assignment for this code 
during the next year and further consider the alternative DRG 
structures suggested by the commenters, if warranted. We will also 
further examine the use of secondary diagnoses as a means of better 
classifying patients with drug-induced dementia and consider 
alternative DRG assignments such as those mentioned by the commenters. 
We also encourage hospitals to examine the coding for these types of 
cases to determine if there are any coding or sequencing errors.
    We are adopting as final our proposal to maintain the current 
structure of DRGs 521 through 523. However, we will continue to examine 
the issue to determine whether any changes to the structure of these 
DRGs are warranted.
8. MDC 22 (Burns): Burn Patients on Mechanical Ventilation
    In the May 18, 2004, proposed rule (69 FR 28211), we discussed 
concerns that had been raised by hospitals treating burn patients that 
the current DRG payment for burn patients on mechanical ventilation is 
not adequate. The DRG assignment for these cases depends on whether the 
hospital performed the tracheostomy or the tracheostomy was performed 
prior to transfer to the hospital. If the hospital does not actually 
perform the tracheostomy, the case is assigned to one of the burn DRGs 
in MDC 22 (Burns). If the hospital performs a tracheostomy, the case is 
assigned to Pre-MDC DRG 482 (Tracheostomy for Face, Mouth, and Neck 
Diagnoses) or DRG 483 (Tracheostomy With Mechanical Ventilation 96+ 
Hours or Principal Diagnosis Except Face, Mouth and Neck Diagnoses).
    In the August 1, 2002, final rule, we modified DRGs 482 and 483 to 
recognize code 96.72 (Continuous mechanical ventilation for 96+ hours) 
for the first time in the DRG assignment (67 FR 49996). The 
modification was partially in response to concerns that hospitals could 
omit diagnosis codes indicating face, mouth, or neck diagnoses in order 
to have cases assigned to DRG 483 rather than the much lower paying DRG 
482 (the payment for DRG 483 is more than four times greater than the 
DRG 482 payment weight). In addition, we noted that many patients 
assigned to DRG 483 did not have code 96.72 recorded. We believed this 
was due, in part, to the limited number of procedure codes (six) that 
can be submitted on the current billing form and the fact that code 
96.72 did not affect the DRG assignment prior to FY 2003. The 
modification was the first attempt to refine DRGs 482 and 483 so that 
patients who receive long-term mechanical ventilation for more than 96 
hours are differentiated from those who receive mechanical ventilation 
for less than 96 hours. The modification was intended to ensure that 
patients who have a tracheostomy and continuous mechanical ventilation 
greater than 96 hours (code 96.72) would be assigned to DRG 483. By 
making the GROUPER recognize long-term mechanical ventilation and 
assigning those patients to the higher weighted DRG 483, we encouraged 
hospitals to be more aware of the importance of reporting code 96.72 
and to increase reporting of code 96.72 when, in fact, patients had 
been on the mechanical ventilator for greater than 96 hours. We stated 
in the August 1, 2002 final rule that, once we received more accurate 
data, we would give consideration to further modifying DRGs 482 and 483 
based on the presence of code 96.72.
    As we indicated in the May 18, 2004, proposed rule, to assess the 
DRG payments for burn patients on mechanical ventilation, we analyzed 
FY 2003 MedPAR data for burn cases in the following DRGs to determine 
the frequency for which these burn cases were treated with continuous 
mechanical ventilation for 96 or more consecutive hours (code 96.72):
     DRG 483 (Tracheostomy With Mechanical Ventilation 96+ 
Hours or Principal Diagnosis Except Face, Mouth, and Neck Diagnoses).
     DRG 504 (Extensive 3rd Degree Burns With Skin Graft).
     DRG 505 (Extensive 3rd Degree Burns Without Skin Graft).
     DRG 506 (Full Thickness Burn With Skin Graft or Inhalation 
Injury With CC or Significant Trauma)
     DRG 507 (Full Thickness Burn With Skin Graft or Inhalation 
Injury Without CC or Significant Trauma)
     DRG 508 (Full Thickness Burn Without Skin Graft or 
Inhalation Injury With CC or Significant Trauma)
     DRG 509 (Full Thickness Burn Without Skin Graft or 
Inhalation Injury Without CC or Significant Trauma)
     DRG 510 (Nonextensive Burns With CC or Significant Trauma)
     DRG 511 (Nonextensive Burns Without CC or Significant 
Trauma)
    The following chart summarizes those findings:

[[Page 48941]]

[GRAPHIC] [TIFF OMITTED] TR11AU04.008

    We found 120 cases that reported code 96.72 within the 3,394 burn 
DRG cases (DRGs 504 through 511). Cases reporting code 96.72 have 
significantly longer average lengths of stay and average charges. The 
majority (54) of these cases that reported code 96.72 were in DRG 506. 
The cases with code 96.72 reported had average charges approximately 
1.5 times higher than other cases in DRG 506 without code 96.72.
    We noted that there were 21 cases that reported code 96.72 within 
DRG 510. Since the 21 patients were on continuous mechanical 
ventilation for 96 consecutive hours or more, it seems surprising that 
the principal diagnosis was listed as one of the nonextensive burn 
codes included in DRG 510. A closer review of these cases shows some 
questionable coding and reporting of information. It would appear that 
hospitals did not always correctly select the principal diagnosis (the 
reason after study that led to the hospital admission). For instance, 
one admission was for a second-degree burn of the ear. This patient was 
on a ventilator for over 96 hours. It would appear that the reason for 
the admission was a diagnosis other than the burn of the ear. Other 
cases where the patient received long-term mechanical ventilation 
included those with a principal diagnosis of first degree burn of the 
face, second degree burn of the nose, second degree burn of the lip, 
and an unspecified burn of the foot. These four cases reported average 
charges ranging from $48,551 to $186,824 and had lengths of stay 
ranging from 8 to 36 days.
    The impact of long-term mechanical ventilation is quite clear on 
burn cases as was shown by the data above. Therefore, in the May 18, 
2004, proposed rule, we proposed to modify the burn DRGs 504 through 
509 under MDC 22 to recognize this impact. We also proposed to modify 
DRG 504 and DRG 505 so that code 96.72 will be assigned to these DRGs 
when there is a principal or secondary diagnosis of extensive third 
degree burns or full thickness burns (those cases currently assigned to 
DRGs 504 through 509). In other words, when cases currently in DRGs 506 
through 509 also have code 96.72 reported, they would now be assigned 
to DRGs 504 or 505. We also proposed to modify the titles of DRGs 504 
and 505 to reflect the proposed changes in reporting code 96.72 as 
follows:

[[Page 48942]]

     Proposed DRG 504, (Extensive Burns or Full Thickness Burns 
With Mechanical Ventilation 96+ Hours With Skin Graft)
     Proposed DRG 505, (Extensive Burns or Full Thickness Burns 
With Mechanical Ventilation 96+ Hours Without Skin Graft)
    Cases currently assigned to DRGs 504 and 505 that do not entail 96+ 
hours of mechanical ventilation will continue to be assigned to DRGs 
504 and 505 because they would have extensive burns, as required by the 
DRG logic.
    We did not propose to include DRG 510 and DRG 511 within this 
revised DRG logic. Cases currently assigned to DRG 510 or DRG 511 that 
also report code 96.72 would not be reassigned to DRGs 504 and 505. We 
recommended that hospitals examine cases that are assigned to DRG 510 
or DRG 511 and that have code 96.72 to determine if there are possible 
coding problems or other issues. As stated earlier, in examining 
reported cases within DRG 510, we noted several cases with code 96.72 
that appear to have an incorrect principal diagnosis. It would appear 
that the principal diagnosis may more appropriately be related to an 
inhalation injury, if the injury was present at the time of admission.
    We solicited comments on our proposal to move cases reporting code 
96.72 from DRGs 506 through 509 and assign them to DRGs 504 and 505. We 
also solicited comments on our proposal not to include DRGs 510 and 511 
in this proposed revision.
    Comment: Several commenters supported our recommended changes for 
the burn DRGs 504 through 509 under MDC 22. The commenters agreed that 
utilizing long-term mechanical ventilation of 96 or more hours (code 
96.72) would assist in identifying the more expensive burn patients. 
One commenter stated that the proposed DRG changes would be greatly 
beneficial to burn center hospitals and to patients who have suffered 
burn injuries. The commenters supported the proposal to move cases 
reporting code 96.72 that are currently assigned to DRGs 506 through 
509 into DRGs 504 and 505. The commenter also agreed with our proposal 
that cases assigned to DRGs 510 and 511 that also report code 96.72 
should not be reassigned to DRGs 504 and 505, because the data cited 
appeared to indicate incorrect principal diagnoses were reported in 
these cases. The commenters also recommended that consideration be 
given to further refinements of DRGs 504 and 505. The commenters 
recommended that in the future CMS consider further DRG splits for 
cases in DRGs 504 and 505 that have extensive third degree burns with 
an inhalation injury and 96+ hours of mechanical ventilation or perhaps 
creating a new DRG specifically for these patients.
    Response: We appreciate the commenters' support of our proposal. As 
we indicated in the May 18, 2004, proposed rule and in our discussion 
of the reporting of code 96.72 in the August 1, 2002, IPPS final rule 
(67 FR 49996), we did not have data on cases of reported burns among 
patients who receive mechanical ventilation until the FY 2003 MedPAR 
data became available. In the FY 2003 IPPS final rule, we had asked 
hospitals to examine their coding and reporting practices and to begin 
reporting code 96.72 when burn patients were on long-term mechanical 
ventilation. Hospitals have now increased their reporting of code 96.72 
among burn cases when patients were on long-term mechanical 
ventilation. With these improved data, in the proposed rule, we were 
able to identify the impact that mechanical ventilation had on the 
treatment of burn patients.
    In the proposed rule, we discussed our concern that hospitals may 
have a sequencing problem for some reported cases of minor burns in 
which the patient was on long-term mechanical ventilation. We suggested 
that some of these patients may have been admitted to the hospital for 
an inhalation injury as opposed to a minor burn. The American Hospital 
Association (AHA) has reviewed our data and shares our concern. The AHA 
has informed us that it is drafting instructional material that will 
appear in Coding Clinic for ICD-9-CM to assist hospitals in sequencing 
the principal diagnosis for burn cases in which the patients have an 
inhalation injury and a minor skin burn.
    We will continue to analyze cases assigned to the burn DRGs to 
determine if additional DRG refinements, such as the alternative 
suggestions mentioned by the commenters, are necessary.
    Comment: Another commenter representing hospital coders expressed 
its support of the proposed restructuring of the burn DRGs to account 
for the use of mechanical ventilation. The commenter shared our concern 
about possible errors in the sequencing of diagnoses on claims 
resulting in a nonextensive burn being reported as the principal 
diagnosis instead of the more serious inhalation or respiratory 
condition that was the actual reason for the inpatient admission. The 
commenter asked that we encourage hospitals to review admissions 
assigned to DRG 510 or 511 that have a code for mechanical ventilation 
(codes 96.70 through 96.72) assigned in order to identify any coding 
errors. The commenter recommended that hospitals identify cases in 
which poor medical record documentation resulted in miscoding of the 
reason for the inpatient admission or mechanical ventilation for burn 
patients. The commenter further recommended that hospitals use these 
cases as the basis for physician education to improve documentation 
practices.
    Response: We appreciate the commenter's support of the proposed DRG 
changes for burn patients on mechanical ventilation. As we indicated in 
the proposed rule, we agree with the commenters' suggestion that 
hospitals should review their medical records for cases assigned to DRG 
510 or 511 that had a code for mechanical ventilation to determine if 
there are coding errors. We agree that it is important for hospitals to 
have good medical record documentation in order to code accurately.
    After analysis of the public comments received, we are adopting, as 
final, our proposed changes to the burn DRGs. In summary, we are 
modifying DRGs 504 and 505 so that cases in which there is a principal 
diagnosis of extensive third degree burns or full thickness burns with 
code 96.72 reported are assigned to these two DRGs, rather than to DRGs 
506 through 509. We are also changing the title of DRG 504 to 
``Extensive Burns or Full Thickness Burns With Mechanical Ventilation 
96+ Hours With Skin Graft'' and the title of DRG 505 to ``Extensive 
Burns or Full Thickness Burns With Mechanical Ventilation 96+ Hours 
Without Skin Graft''. We will continue to follow these DRGs to 
determine if additional changes are needed.
9. Pre-MDC: Tracheostomy
    In the August 1, 2002, IPPS final rule (67 FR 49996), for FY 2003, 
we modified DRG 482 (Tracheostomy for Face, Mouth, and Neck Diagnoses) 
and DRG 483 (Tracheostomy With Mechanical Ventilation 96+ Hours or 
Principal Diagnosis Except Face, Mouth, and Neck Diagnoses) to 
recognize procedure code 96.72 (Continuous mechanical ventilation 96+ 
hours) in the DRG 483 assignment. As discussed above and in the 
proposed rule, we were concerned about an underreporting of code 96.72 
and wanted to encourage increased reporting of this code.
    In the May 18, 2004, proposed rule, we indicated that we had 
examined cases in the MedPAR file in which code 96.72 was reported 
within DRGs 482 and 483. The following chart illustrates the average 
charges and lengths of stays for cases within DRGs 482 and 483 with and 
without code 96.72 reported:

[[Page 48943]]

[GRAPHIC] [TIFF OMITTED] TR11AU04.009

    Of the 3,557 cases reported in DRG 482, only 22 cases reported code 
96.72. These 22 cases did not have a tracheostomy performed. All 22 
cases reported code 30.4 (Laryngectomy), which also leads to an 
assignment of DRG 482. It would appear that the long-term mechanical 
ventilation was performed through an endotracheal tube instead of 
through a tracheostomy. While the average charges for DRG 482 cases 
with code 96.72 reported were significantly higher than the average 
charges for other cases in the DRG, we did not believe that the very 
limited number of cases (22) warranted a proposed DRG modification. 
Therefore, we did not propose any modification for DRG 482. In the May 
18, 2004, IPPS proposed rule, we indicated that we will continue to 
monitor cases assigned to this DRG.
    We did not receive any comments on our proposal not to modify DRG 
482 and, therefore, are not making any changes to the DRG in this final 
rule.
    In the proposed rule we stated that in DRG 483, 19,669 cases were 
reported with code 96.72. However, we noted that the data were counter-
intuitive. While one would expect to find higher average charges for 
cases reported with code 96.72, the opposite is the case. Cases in DRG 
483 reported with code 96.72 had average charges that were $40,623 
lower than those not reported with code 96.72. Clearly, the presence or 
absence of code 96.72 does not explain differences in charges for 
patients within DRG 483.
    As stated earlier, we are concerned that hospitals may not always 
report code 96.72 because of space limitations. The electronic billing 
system limits the number of procedure codes that can be reported to six 
codes. We then looked at whether or not another major O.R. procedure 
was performed in addition to a tracheostomy. The DRG 483 logic requires 
that all patients assigned to DRG 483 have a tracheostomy. We examined 
cases in DRG 483 in the MedPAR file and discovered that those patients 
in DRG 483 who had a major procedure performed in addition to the 
tracheostomy had higher charges. A major procedure is a procedure whose 
code is included on the list that would be assigned to DRG 468 
(Extensive O.R. Procedure Unrelated to Principal Diagnosis), except for 
tracheostomy codes 31.21 and 31.29. Currently, this additional O.R. 
procedure does not affect the DRG assignment for cases assigned to DRG 
483. The following chart reflects our findings.
[GRAPHIC] [TIFF OMITTED] TR11AU04.010

    We found that cases of patients assigned to DRG 483 who had a major 
procedure (in addition to the required tracheostomy) had average 
charges that were $87,023 higher than the average charges for cases 
without a major O.R. procedure and had an average length of stay of 5 
days more than those without a major O.R. procedure. We found that the 
performance of an additional major O.R. procedure helps to identify the 
more expensive patients within DRG 483.
    Therefore, as a result of our findings, in the May 18, 2004, 
proposed rule, we proposed to modify DRG 483 by dividing these cases 
into two new DRGs depending on whether or not there is a major O.R. 
procedure reported (in addition to the tracheostomy). We proposed to 
delete DRG 483 and create two new DRGs as follows:
     Proposed new DRG 541 (Tracheostomy With Mechanical 
Ventilation 96+ Hours or Principal Diagnosis Except Face, Mouth, and 
Neck Diagnoses With Major O.R. Procedure)
     Proposed new DRG 542 (Tracheostomy With Mechanical 
Ventilation 96+ Hours or Principal Diagnosis Except Face, Mouth and 
Neck Diagnoses Without Major O.R. Procedure)
    We solicited comments on our proposal to delete DRG 483 and replace 
it with two proposed new DRGs by splitting the assignment of cases on 
the basis of the performance of a major O.R. procedure (in addition to 
the tracheostomy).
    Comment: Some commenters supported our proposed changes to DRG 483. 
One commenter stated that, based on the data presented by CMS, the 
proposal appears to be a reasonable approach to distinguish the more 
expensive cases in DRG 483. The commenter also stated that hospitals 
are not always reporting code 96.72 due to space limitations (that is, 
the electronic billing system limits the number of procedures that can 
be reported to six procedure codes). The commenter stated that patients 
in this patient population (undergoing procedures with procedure code 
96.72) may have several significant

[[Page 48944]]

O.R. procedures that may be sequenced before code 96.72, resulting in 
code 96.72 not appearing on the claim.
    Response: We appreciate the commenters' support of our proposed DRG 
revision as a reasonable approach to distinguish the more expensive 
cases from the less expensive cases in DRG 483. We continue to 
encourage hospitals to report code 96.72 for patients on mechanical 
ventilation for 96+ hours.
    Comment: Some commenters opposed our DRG change because of issues 
surrounding our proposed inclusion of DRG 483 as a DRG that would 
qualify for payment as a post-acute care transfer case.
    Response: We are responding to the specific comments received 
regarding the proposed inclusion of DRG 483 under the postacute care 
transfer discussion in section IV.A. of the preamble of this final 
rule. The commenters did not provide other specific objections to the 
proposed deletion of DRG 483 and the proposed creation of new DRGs 541 
and 542.
    Comment: Several commenters requested clarification of what 
procedures would be classified as major O.R. procedures in relationship 
to our proposed changes to DRG 483.
    Response: As we stated in the May 18, 2004 proposed rule, a major 
O.R. procedure is a procedure whose code is included on the list that 
would be assigned to DRG 468, except for tracheostomy codes 31.21 and 
31.29. These are the procedure codes listed as O.R. procedures in 
Appendix E of the Diagnosis Related Groups Definitions Manual. The 
reporting of a major procedure with a procedure code from Appendix E, 
along with an unrelated principal diagnosis, results in a case being 
assigned to DRG 468. Major O.R. procedures do not include prostatic or 
nonextensive procedures, or both, which are assigned to DRGs 476 and 
477.
    Currently, the reporting of an additional major O.R. procedure code 
does not affect the DRG assignment for cases assigned to DRG 483. In 
the proposed rule, we proposed to modify this logic by deleting DRG 483 
and creating two new DRGs 541 and 452 that are split on the basis of 
the performance of a major O.R. procedure (in addition to tracheostomy 
codes 31.21 and 31.29).
    Comment: Several commenters agreed that the CMS data support the 
subdivision of DRG 483 based on the presence of an additional major 
O.R. procedure. They agreed that this approach helps to identify the 
more expensive patients within DRG 483. One commenter stated that the 
proposed modifications were valuable. Another commenter stated that the 
proposed DRG revisions will better reflect the costs of furnishing care 
to these two categories of patients.
    Response: We agree with the commenters that subdividing the cases 
assigned to DRG 483 based on the presence of an additional major O.R. 
procedure helps to identify the more expensive patients. We also agree 
that the proposed new DRGs should lead to more equitable payment for 
the more expensive tracheostomy cases. Therefore, we are proceeding 
with finalizing our proposal of deleting DRG 483 and replacing it with 
DRGs 541 and 542.
    Comment: One commenter expressed concern regarding the proposed 
creation of a new DRG for mechanical ventilation as a pre-MDC for all 
patients undergoing more than 96 hours of mechanical ventilation. The 
commenter suggested that we delete DRG 475 (Respiratory System 
Diagnoses with Ventilator Support) from MDC 4 and move all of these 
cases reporting code 96.72 to a new DRG for mechanical ventilation in 
the pre-MDC section.
    Response: Patients undergoing more than 96 hours of mechanical 
ventilation are captured through code 96.72. Currently, patients with a 
respiratory system diagnosis listed in MDC 4 who receive mechanical 
ventilation are assigned to DRG 475. Cases are assigned to DRG 475 if 
one of the following procedure codes is reported:
     96.70, Continuous mechanical ventilation of unspecified 
duration.
     96.71, Continuous mechanical ventilation for less than 96 
consecutive hours.
     96.72, Continuous mechanical ventilation for 96 
consecutive hours or more.
    In the August 1, 2002, final rule (67 FR 49996), we discussed the 
reporting of code 96.72. We pointed out the importance of hospitals 
accurately reporting the use of long-term mechanical ventilation (code 
96.72). We stated in the August 1, 2002, final rule that, once we 
received more accurate data, we would give consideration to further 
modifying DRGs 482 and 483 based on the presence of code 96.72. As 
discussed previously, in this final rule, we are modifying DRG 483 to 
differentiate between patients with and without other major O.R. 
procedures (in addition to the tracheostomy). We are also modifying the 
burn DRGs to better classify those patients on long-term mechanical 
ventilation.
    As stated in the May 4, 2001, proposed rule (66 FR 22646): 
``Central to the success of the Medicare inpatient hospital prospective 
payment system is that DRGs have remained a clinical description of why 
the patient required hospitalization.'' Thus, the central 
classification criteria for DRG assignment has been the reason the 
patient was admitted (that is, the principal diagnosis for medical 
patients and the procedures performed for surgical patients). For a 
medical patient admitted for respiratory disease, the use of mechanical 
ventilation was used as a classification criteria because the 
mechanical ventilation was directly associated with the reason for 
hospital admission. The one exception to this rule is for patients who 
received a tracheostomy for long-term mechanical ventilation. These are 
catastrophic patients who, in general, have serious disease in multiple 
organ systems. Tracheostomies are performed on patients when it is 
anticipated that the patients will remain on mechanical ventilation for 
an extended period. The tracheostomy patients with long-term mechanical 
ventilation were all assigned to the same DRG regardless of their 
reason for admission. As we discussed previously, we are subdividing 
the patients assigned to DRG 483 into two new DRG 541 and 542 based on 
the presence of an additional major O.R. procedure.
    We believe it would not be appropriate to classify mechanical 
ventilation patients who do not receive a tracheostomy in the same 
manner as long-term mechanical ventilation patients who receive a 
tracheostomy. The patients who do not receive a tracheostomy tend to 
require mechanical ventilation for shorter periods and do not use the 
level of resources required by tracheostomy patients.
    The reason for admission for patients with short-term mechanical 
ventilation can vary greatly and include degenerative nervous system 
diseases, short-term acute disease, trauma, and terminal care. Further, 
the resource requirements for patients on short-term mechanical 
ventilation vary greatly, depending on the patient's reason for 
admission. We believe it is more appropriate to classify patients with 
short-term mechanical ventilation based on their reason for admission 
and to provide additional payments for patients with extreme resource 
use through outlier payments. Therefore, we are not accepting the 
commenter's request that we delete DRG 475 and create a new DRG in the 
Pre-MDC section for mechanical ventilation. We will maintain DRG 475 as 
it is currently configured.
    In summary, in this final rule, we are deleting DRG 483 and 
establishing the

[[Page 48945]]

following new DRGs 541 and 542 as replacements:
     DRG 541 (Tracheostomy With Mechanical Ventilation 96+ 
Hours or Principal Diagnosis Except Face, Mouth, and Neck Diagnoses 
With Major O.R. Procedure)
     DRG 542 (Tracheostomy With Mechanical Ventilation 96+ 
Hours or Principal Diagnosis Except Face, Mouth, and Neck Diagnoses 
Without Major O.R. Procedure)
10. Medicare Code Editor (MCE) Changes
    As explained under section II.B.1. of this preamble, the Medicare 
Code Editor (MCE) is a software program that detects and reports errors 
in the coding of Medicare claims data. In the May 18, 2004, IPPS 
proposed rule (69 FR 28213), we proposed to make changes to three of 
the edits in the MCE.
    a. Edit 11 (Noncovered Procedures) in the MCE contains codes that 
describe procedures for which Medicare does not provide reimbursement. 
In the proposed rule, we stated that we had received a request to 
remove procedure codes relating to stem cell transplants from Edit 11 
to conform the MCE edit to our published coverage decisions in the 
Medicare Coverage Issues Manual. Chapter 13.5 of the Program Integrity 
Manual (PIM) states that contractor discretion exists to cover 
diagnoses for which coverage is not explicitly precluded by a national 
coverage decision. Specifically this section states: that ``a local 
medical review policy (LMRP)'' must be clear, concise, properly 
formatted and not restrict or conflict with NCDs or coverage provisions 
in interpretive manuals. If an NCD or coverage provision in an 
interpretive manual states that a given item is `covered for diagnoses/
conditions A, B, and C,' contractors may not use that as a basis to 
develop LMRP to cover only ``diagnosis/conditions A, B, C''. When an 
NCD or coverage provision in an interpretive manual does not exclude 
coverage for other diagnoses/conditions, contractors must allow for 
individual consideration unless the LMRP supports automatic denial for 
some or all of those other diagnoses/conditions.''
    The national coverage decision on stem cell transplantation 
provides for coverage of certain diagnoses and excludes coverage for 
other diagnoses. However, the vast majority of diagnoses are not 
mentioned as either covered or noncovered. In accordance with the 
above-cited provision of the PIM, contractors must allow for individual 
consideration of these diagnoses. Thus, they are not appropriate for 
inclusion in the edit for noncovered procedures.
    In the proposed rule, we indicated that we agreed that we need to 
make conforming changes relating to stem cell transplants. Therefore, 
we proposed the following restructure of Edit 11:
    This list contains ICD-9-CM procedure codes identified as 
``Noncovered Procedures'' that are always considered noncovered 
procedures:
     11.71, Keratomileusis
     11.72, Keratophakia
     11.75, Radial keratotomy
     11.76, Epikeratophakia
     36.32, Other transmyocardial revascularization
     37.35, Partial ventriculectomy
     37.52, Implantation of total replacement heart system
     37.53, Replacement or repair of thoracic unit of total 
replacement heart system
     37.54, Replacement or repair of other implantable 
component of total replacement heart system
     39.28, Extracranial-intracranial (EC-IC) vascular bypass
     44.93, Insertion of gastric bubble (balloon)
     50.51, Auxiliary liver transplant
     52.83, Heterotransplant of pancreas
     57.96, Implantation of electronic bladder stimulator
     57.97, Replacement of electronic bladder stimulator
     63.70, Male sterilization procedure, not otherwise 
specified
     63.71, Ligation of vas deferens
     63.72, Ligation of spermatic cord
     63.73, Vasectomy
     64.5, Operations for sex transformation, not elsewhere 
classified
     66.21, Bilateral endoscopic ligation and crushing of 
fallopian tubes
     66.22, Bilateral endoscopic ligation and division of 
fallopian tubes
     66.29, Other bilateral endoscopic destruction or occlusion 
of fallopian tubes
     66.31, Other bilateral ligation and crushing of fallopian 
tubes
     66.32, Other bilateral ligation and division of fallopian 
tubes
     66.39, Other bilateral destruction or occlusion of 
fallopian tubes
     98.52, Extracorporeal shockwave lithotripsy [ESWL] of the 
gallbladder and/or bile duct
     98.59, Extracorporeal shockwave lithotripsy of other sites
    The following list contains ICD-9-CM procedure codes identified as 
``Noncovered Procedures'' only when any of the following diagnoses are 
present as either a principal or secondary diagnosis.
Procedure List
     41.01, Autologous bone marrow transplant without purging
     41.04, Autologous hematopoietic stem cell transplant 
without purging
     41.07, Autologous hematopoietic stem cell transplant with 
purging
     41.09, Autologous bone marrow transplant with purging
Principal or Secondary Diagnosis List
     204.00, Acute lymphoid leukemia, without mention of 
remission
     205.00, Acute myeloid leukemia, without mention of 
remission
     206.00, Acute monocytic leukemia, without mention of 
remission
     207.00, Acute erythremia and erythroleukemia, without 
mention of remission
     208.00, Acute leukemia of unspecified cell type, without 
mention of remission
     205.10, Acute myeloid leukemia, in remission
     205.11, Chronic myeloid leukemia, in remission
    The following list contains ICD-9-CM procedure codes identified as 
``Noncovered Procedures'' only when any of the following diagnoses are 
present as either a principal or secondary diagnosis.
Procedure List
     41.02, Allogeneic bone marrow transplant with purging
     41.03, Allogeneic bone marrow transplant without purging
     41.05, Allogeneic hematopoietic stem cell transplant 
without purging
     41.08, Allogeneic hematopoietic stem cell transplant with 
purging
Principal or Secondary Diagnosis List
     203.00, Multiple myeloma, without mention of remission
     203.01, Multiple myeloma, in remissionThe following list 
contains ICD-9-CM procedure codes identified as ``Non-Covered 
Procedures'' except when there is at least one principal or secondary 
diagnosis code present from both list 1 and list 2.
Procedure List
     52.80, Pancreatic transplant, not otherwise specified
     52.82, Homotransplant of pancreas
Diagnosis List 1:
     250.00, Diabetes mellitus without mention of complication, 
type II [non-insulin dependent type] [NIDDM type] [adult-onset type] or 
unspecified type, not stated as uncontrolled
     250.01, Diabetes mellitus without mention of complication, 
type I [insulin dependent type] [IDDM] [juvenile type], not stated as 
uncontrolled

[[Page 48946]]

     250.02, Diabetes mellitus without mention of complication, 
type II [non-insulin dependent type] [NIDDM type] [adult-onset type] or 
unspecified type, uncontrolled
     250.03, Diabetes mellitus without mention of complication, 
type I [insulin dependent type] [IDDM type] [juvenile type], 
uncontrolled
     250.10, Diabetes with ketoacidosis, type II [non-insulin 
dependent type] [NIDDM type] [adult-onset type] or unspecified type, 
not stated as uncontrolled
     250.11, Diabetes with ketoacidosis, type I [insulin 
dependent type] [IDDM] [juvenile type], not stated as uncontrolled
     250.12, Diabetes with ketoacidosis, type II [non-insulin 
dependent type] [NIDDM type] [adult-onset type] or unspecified type, 
uncontrolled
     250.13, Diabetes with ketoacidosis, type I [insulin 
dependent type] [IDDM type] [juvenile type], uncontrolled
     250.20, Diabetes with hyperosmolarity, type II [non-
insulin dependent type] [NIDDM type] [adult-onset type] or unspecified 
type, not stated as uncontrolled
     250.21, Diabetes with hyperosmolarity, type I [insulin 
dependent type] [IDDM] [juvenile type], not stated as uncontrolled
     250.22, Diabetes with hyperosmolarity, type II [non-
insulin dependent type] [NIDDM type] [adult-onset type] or unspecified 
type, uncontrolled
     250.23, Diabetes with hyperosmolarity, type I [insulin 
dependent type] [IDDM] [juvenile type], uncontrolled
     250.30, Diabetes with other coma, type II [non-insulin 
dependent type] [NIDDM type] [adult-onset type] or unspecified type, 
not stated as uncontrolled
     250.31, Diabetes with other coma, type I [insulin 
dependent type] [IDDM] [juvenile type], not stated as uncontrolled
     250.32, Diabetes with other coma, type II [non-insulin 
dependent type] [NIDDM type] [adult-onset type] or unspecified type, 
uncontrolled
     250.33, Diabetes with other coma, type I [insulin 
dependent type] [IDDM] [juvenile type], uncontrolled, type I [insulin 
dependent type] [IDDM type] [juvenile type], uncontrolled
     250.40, Diabetes with renal manifestation, type II [non-
insulin dependent type] [NIDDM type] [adult-onset type] or unspecified 
type, not stated as uncontrolled
     250.41, Diabetes with renal manifestation, type I [insulin 
dependent type] [IDDM] [juvenile type], not stated as uncontrolled
     250.42, Diabetes with renal manifestation, type II [non-
insulin dependent type] [NIDDM type] [adult-onset type] or unspecified 
type, uncontrolled
     250.43, Diabetes with renal manifestation, type I [insulin 
dependent type] [IDDM type] [juvenile type], uncontrolled
     250.50, Diabetes with ophthalmic manifestations, type II 
[non-insulin dependent type] [NIDDM type] [adult-onset type] or 
unspecified type, not stated as uncontrolled
     250.51, Diabetes with ophthalmic manifestations, type I 
[insulin dependent type] [IDDM] [juvenile type], not stated as 
uncontrolled
     250.52, Diabetes with ophthalmic manifestations, type II 
[non-insulin dependent type] [NIDDM type] [adult-onset type] or 
unspecified type, uncontrolled
     250.53, Diabetes with ophthalmic manifestations, type I 
[insulin dependent type] [IDDM type] [juvenile type], uncontrolled
     250.60, Diabetes with neurological manifestations, type II 
[non-insulin dependent type] [NIDDM type] [adult-onset type] or 
unspecified type, not stated as uncontrolled
     250.61, Diabetes with neurological manifestations, type I 
[insulin dependent type] [IDDM] [juvenile type], not stated as 
uncontrolled
     250.62, Diabetes with neurological manifestations, type II 
[non-insulin dependent type] [NIDDM type] [adult-onset type] or 
unspecified type, uncontrolled
     250.63, Diabetes with neurological manifestations, type I 
[insulin dependent type] [IDDM type] [juvenile type], uncontrolled
     250.70, Diabetes with peripheral circulatory disorders, 
type II [non-insulin dependent type] [NIDDM type] [adult-onset type] or 
unspecified type, not stated as uncontrolled
     250.71, Diabetes with peripheral circulatory disorders 
type I [insulin dependent type] [IDDM] [juvenile type], not stated as 
uncontrolled
     250.72, Diabetes with peripheral circulatory disorders, 
type II [non-insulin dependent type] [NIDDM type] [adult-onset type] or 
unspecified type, uncontrolled
     250.73, Diabetes with peripheral circulatory disorders, 
type I [insulin dependent type] [IDDM type] [juvenile type], 
uncontrolled
     250.80, Diabetes with other specified manifestations, type 
II [non-insulin dependent type] [NIDDM type] [adult-onset type] or 
unspecified type, not stated as uncontrolled
     250.81, Diabetes with other specified manifestations, type 
I [insulin dependent type] [IDDM] [juvenile type], not stated as 
uncontrolled
     250.82, Diabetes with other specified manifestations, type 
II [non-insulin dependent type] [NIDDM type] [adult-onset type] or 
unspecified type, uncontrolled
     250.83, Diabetes with other specified manifestations, type 
I [insulin dependent type] [IDDM] [juvenile type], uncontrolled
     250.90, Diabetes with unspecified complication, type II 
[non-insulin dependent type] [NIDDM type] [adult-onset type] or 
unspecified type, not stated as uncontrolled
     250.91, Diabetes with unspecified complication, type I 
[insulin dependent type] [IDDM] [juvenile type], not stated as 
uncontrolled
     250.92, Diabetes with unspecified complication, type II 
[non-insulin dependent type] [NIDDM type] [adult-onset type] or 
unspecified type, uncontrolled
     250.93, Diabetes with unspecified complication, type I 
[insulin dependent type] [IDDM] [juvenile type], uncontrolled

    Note: The proposed rule contained inadvertent typographical 
errors in the above list on four diabetes codes at 250.50 through 
250.53. These errors have been corrected in this list in the final 
rule.

Diagnosis List 2
     403.01, Malignant hypertensive renal disease, with renal 
failure
     403.11, Benign hypertensive renal disease, with renal 
failure
     403.91, Unspecified hypertensive renal disease, with renal 
failure
     404.02, Malignant hypertensive heart and renal disease, 
with renal failure
     404.03, Malignant hypertensive heart and renal disease, 
with heart failure and renal failure
     404.12, Benign hypertensive heart and renal disease, with 
renal failure
     404.13, Benign hypertensive heart and renal disease, with 
heart failure and renal failure
     404.92, Unspecified hypertensive heart and renal disease, 
with renal failure
     404.93, Unspecified hypertensive heart and renal disease, 
with heart failure and renal failure
     585, Chronic renal failure
     V42.0, Organ or tissue replaced by transplant, kidney
     V43.89, Organ or tissue replaced by other means, other

[[Page 48947]]

    We received one comment in support of our proposal to restructure 
Edit 11 in the MCE. Therefore, we are adopting the proposal as final.
    In addition, it has come to our attention that two of the new codes 
created for use for discharges effective October 1, 2004, should also 
be included on Edit 11 in order to conform to current coverage policy. 
These changes were not included in the proposed rule. However, the 
addition of these codes is not a change in CMS policy. Rather, it is 
simply a procedural change that is necessary to effectuate CMS' 
existing coverage policy and to facilitate the appropriate payment (or 
non-payment) of claims reporting these codes. Therefore, we are making 
the following additional changes to the MCE:
     In the ``Non-Covered Procedures'' section of Edit 11, we 
are adding code 00.62 (Percutaneous angioplasty or atherectomy of 
intracranial vessel(s)) to the list of procedure codes that are always 
considered noncovered procedures.
     ICD-9-CM O.R. procedure code 00.61 (Percutaneous 
angioplasty or atherectomy of precerebral (extracranial vessel(s)) is 
identified as a ``Non-Covered Procedure'' except when the following 
non-O.R. procedure and secondary diagnosis are also present:
    Non-O.R. Procedure: 00.63 (Percutaneous insertion of carotid artery 
stent(s); and
    Secondary Diagnosis: V70.7 (Examination of participant in clinical 
trial).
    We are making these changes in Version 22.0 of the MCE software 
program.
    b. Edit 6 (Manifestations Not Allowed As Principal Diagnosis) in 
the MCE contains codes that describe the manifestation of an underlying 
disease, not the disease itself, and therefore, should not be used as a 
principal diagnosis. The following codes describe manifestations of an 
underlying disease; they should not be used as a principal diagnosis 
according to ICD-9-CM coding convention. Therefore, in the May 18, 
2004, proposed rule, we proposed to add the following diagnosis codes 
to Edit 6:
     289.52, Splenic sequestration
     517.3, Acute chest syndrome (inadvertently erroneously 
cited as 571.3 in the May 18, 2004 proposed rule)
     785.52, Septic shock
    Coding conventions in the ICD-9-CM Diagnostic Tabular List specify 
that etiologic conditions be coded first.
    We received two comments in support of our proposal to add three 
diagnosis codes to Edit 6 of the MCE. However, both commenters pointed 
out a typographical error in one of the citations of the diagnosis 
codes. Code 571.3 should have read 517.3.
    We are adopting, as final, our proposed additions of the diagnosis 
codes to Edit 6, with the correction of the one code number cited.
    c. Edit 9 (Unacceptable Principal Diagnoses) contains codes ``that 
describe a circumstance which influences an individual's health status 
but is not a current illness of injury; therefore, these codes are 
considered unacceptable as a principal diagnosis.'' (This definition 
can be found on page 1094 of the DRG Definitions Manual, Version 21.0). 
Last year, we became aware that two codes should be removed from this 
list, as they can be legitimate causes for inpatient admission. 
However, we were made aware of this too late in the process to make a 
change to this edit prior to FY 2004. In the May 18, 2004, IPPS 
proposed rule (69 FR 28197), we indicated that we will now be able to 
make the necessary system changes before the start of FY 2005. 
Therefore, we proposed to remove the following codes from Edit 9:
     V53.01, Adjustment of cerebral ventricular (communicating) 
shunt
     V53.02, Adjustment of neuropacemaker (brain) (peripheral 
nerve) (spinal cord)
    We received one comment in support of our proposed removal of codes 
V53.01 and V53.02 from Edit 9 in the MCE. Therefore, we are adopting, 
as final, our proposed removal of the two codes from Edit 9.
11. Surgical Hierarchies
    Some inpatient stays entail multiple surgical procedures, each one 
of which, occurring by itself, could result in assignment of the case 
to a different DRG within the MDC to which the principal diagnosis is 
assigned. Therefore, it is necessary to have a decision rule within the 
GROUPER by which these cases are assigned to a single DRG. The surgical 
hierarchy, an ordering of surgical classes from most resource-intensive 
to least resource-intensive, performs that function. Application of 
this hierarchy ensures that cases involving multiple surgical 
procedures are assigned to the DRG associated with the most resource-
intensive surgical class.
    Because the relative resource intensity of surgical classes can 
shift as a function of DRG reclassification and recalibrations, we 
reviewed the surgical hierarchy of each MDC, as we have for previous 
reclassifications and recalibrations, to determine if the ordering of 
classes coincides with the intensity of resource utilization.
    A surgical class can be composed of one or more DRGs. For example, 
in MDC 11, the surgical class ``kidney transplant'' consists of a 
single DRG (DRG 302) and the class ``kidney, ureter and major bladder 
procedures'' consists of three DRGs (DRGs 303, 304, and 305). 
Consequently, in many cases, the surgical hierarchy has an impact on 
more than one DRG. The methodology for determining the most resource-
intensive surgical class involves weighting the average resources for 
each DRG by frequency to determine the weighted average resources for 
each surgical class. For example, assume surgical class A includes DRGs 
1 and 2 and surgical class B includes DRGs 3, 4, and 5. Assume also 
that the average charge of DRG 1 is higher than that of DRG 3, but the 
average charges of DRGs 4 and 5 are higher than the average charge of 
DRG 2. To determine whether surgical class A should be higher or lower 
than surgical class B in the surgical hierarchy, we would weight the 
average charge of each DRG in the class by frequency (that is, by the 
number of cases in the DRG) to determine average resource consumption 
for the surgical class. The surgical classes would then be ordered from 
the class with the highest average resource utilization to that with 
the lowest, with the exception of ``other O.R. procedures'' as 
discussed below.
    This methodology may occasionally result in assignment of a case 
involving multiple procedures to the lower-weighted DRG (in the 
highest, most resource-intensive surgical class) of the available 
alternatives. However, given that the logic underlying the surgical 
hierarchy provides that the GROUPER search for the procedure in the 
most resource-intensive surgical class, this result is unavoidable.
    We note that, notwithstanding the foregoing discussion, there are a 
few instances when a surgical class with a lower average charge is 
ordered above a surgical class with a higher average charge. For 
example, the ``other O.R. procedures'' surgical class is uniformly 
ordered last in the surgical hierarchy of each MDC in which it occurs, 
regardless of the fact that the average charge for the DRG or DRGs in 
that surgical class may be higher than that for other surgical classes 
in the MDC. The ``other O.R. procedures'' class is a group of 
procedures that are only infrequently related to the diagnoses in the 
MDC, but are still occasionally performed on patients in the MDC with 
these diagnoses. Therefore, assignment to

[[Page 48948]]

these surgical classes should only occur if no other surgical class 
more closely related to the diagnoses in the MDC is appropriate.
    A second example occurs when the difference between the average 
charges for two surgical classes is very small. We have found that 
small differences generally do not warrant reordering of the hierarchy 
because, as a result of reassigning cases on the basis of the hierarchy 
change, the average charges are likely to shift such that the higher-
ordered surgical class has a lower average charge than the class 
ordered below it.
    Based on the preliminary recalibration of the DRGs, in the May 18, 
2004 proposed rule, we proposed modifications of the surgical hierarchy 
as set forth below.
    We proposed to revise the surgical hierarchy for the pre-MDC DRGs 
and MDC 8 (Diseases and Disorders of the Musculoskeletal System and 
Connective Tissue).
    In the pre-MDC DRGs, we proposed to reorder DRG 541 (Tracheostomy 
With Mechanical Ventilation 96 + Hours or Principal Diagnosis Except 
Face, Mouth, and Neck Diagnoses With Major O.R. Procedure) and DRG 542 
(Tracheostomy With Mechanical Ventilation 96+ Hours or Principal 
Diagnosis Except Face, Mouth, and Neck Diagnoses Without Major O.R. 
Procedure) above DRG 480 (Liver Transplant).
    In MDC 8, we proposed to--
     Reorder DRG 496 (Combined Anterior/Posterior Spinal 
Fusion), DRG 497 (Spinal Fusion Except Cervical With CC), and DRG 498 
(Spinal Fusion Except Cervical Without CC) above DRG 471 (Bilateral or 
Multiple Major Joint Procedures of the Lower Extremity).
     Reorder DRG 519 (Cervical Spinal Fusion With CC) and DRG 
520 (Cervical Spinal Fusion Without CC) above DRG 216 (Biopsies of the 
Musculoskeletal System and Connective Tissue).
     Reorder DRG 213 (Amputation for the Musculoskeletal System 
and Connective Tissue Disorders) above DRG 210 (Hip and Femur 
Procedures Except Major Joint Age> 17 With CC), DRG 211 (Hip and Femur 
Procedures Except Major Joint Age> 17 Without CC), and DRG 212 (Hip and 
Femur Procedures Except Major Joint Age 0-17).
     Reorder DRG 499 (Back and Neck Procedures Except Spinal 
Fusion With CC) and DRG 500 (Back and Neck Procedures Except Spinal 
Fusion Without CC) above DRG 218 (Lower Extremity and Humerus 
Procedures Except Hip, Foot, and Femur Age> 17 With CC), DRG 219 (Lower 
Extremity and Humerus Procedures Except Hip, Foot, and Femor Age> 17 
Without CC), and DRG 220 (Lower Extremity and Humerus Procedures Except 
Hip, Foot, and Femur Age 0-17).
    In the proposed rule, we were unable to test the effects of the 
proposed revisions to the surgical hierarchy and to reflect these 
changes in the proposed relative weights because the revised GROUPER 
software was unavailable at the time the proposed rule was completed. 
Rather, we simulated most major classification changes to approximate 
the placement of cases under the proposed reclassification, and then 
determined the average charge for each DRG. These average charges 
served as our best estimate of relative resource used for each surgical 
class. We have now tested the proposed surgical hierarchy changes after 
the revised GROUPER was received and are reflecting the final changes 
in the DRG relative weights in this final rule. Further, as discussed 
in section II.C. of this preamble, the final recalibrated weights are 
somewhat different from the proposed weights because they are based on 
more complete data.
    We have tested the proposed revisions using the March 2004 update 
of the FY 2003 MedPAR file and the revised GROUPER software and have 
found that the revisions are supported by the data, and no additional 
changes are indicated except those discussed below pertaining to the 
implementation of new DRG 543 (Craniotomy with Implantation of 
Chemotherapeutic Agent or Acute Complex Central Nervous System 
Principal Diagnosis). (For a complete description of this change see 
the discussion under ``Other Issues'' in section II.B.16 of this 
preamble.) Due to the implementation of DRG 543, we also are reordering 
the following DRGs in MDC 1 (Disease and Disorders of the Nervous 
System): DRG 543 above DRGs 1 (Craniotomy Age > 17 With CC) and 2 
(Craniotomy Age> 17 Without CC). Therefore, we are adopting these 
changes as final.
    Comment: One commenter requested a change in the surgical hierarchy 
for a case where procedure code 37.99 (Other operations on heart and 
pericardium) and code 37.98 (Replacement of an automatic cardioverter/
defibrillator pulse generator only) is reported during the same 
admission. This case is assigned to either DRG 110 (Major 
Cardiovascular Procedures With CC) or DRG 111 (Major Cardiovascular 
Procedures Without CC). The commenter requested that this case be 
reassigned to DRG 115 (Permanent Cardiac Pacemaker Implant with AMI, 
Heart Failure, or Shock or AICD Lead or Generator Procedure) because it 
has a higher DRG weight than DRG 110 or DRG 111.
    Response: The surgical hierarchy places a patient with multiple 
procedures in the most resource intensive class of DRGs, but not 
necessarily in the most resource intensive DRG. In the scenario 
described by the commenter, there are two surgical classes, one 
including DRGs 110 and 111 and the other including DRG 115 and DRG 116 
(Other Permanent Cardiac Pacemaker Implant). The average charges for 
the class containing DRGs 110 and 111 are approximately $16,604 more 
than for the class containing DRGs 115 and 116. As a result, the class 
containing DRGs 110 and 111 is ordered higher in the surgical group 
than the class containing DRGs 115 and 116. As a result, the case is 
assigned to either DRG 110 or DRG 111.
12. Refinement of Complications and Comorbidities (CC) List
    In the September 1, 1987 final notice (52 FR 33143) concerning 
changes to the DRG classification system, we modified the GROUPER logic 
so that certain diagnoses included on the standard list of CCs would 
not be considered valid CCs in combination with a particular principal 
diagnosis. We created the CC Exclusions List for the following reasons: 
(1) To preclude coding of CCs for closely related conditions; (2) to 
preclude duplicative or inconsistent coding from being treated as CCs; 
and (3) to ensure that cases are appropriately classified between the 
complicated and uncomplicated DRGs in a pair. We developed this list of 
diagnoses, using physician panels, to include those diagnoses that, 
when present as a secondary condition, would be considered a 
substantial complication or comorbidity. In previous years, we have 
made changes to the list of CCs, either by adding new CCs or deleting 
CCs already on the list. In the May 18, 2004, proposed rule, we did not 
propose to delete any of the diagnosis codes on the CC list.
    Comment: One commenter requested that ICD-9-CM codes 996.64 
(Infection due to indwelling urinary catheter) and 599.0 (Urinary tract 
infection) be removed from the CC List so that hospitals are not 
rewarded with higher payment when they allow patients to develop 
urinary tract infections. The commenter pointed out that these 
conditions are often avoidable complications of hospitalization, and 
that hospitals allow these infections to occur in order to receive 
higher payments from Medicare.

[[Page 48949]]

    Response: We do not agree with the assertion that hospitals allow 
urinary tract infections to occur in Medicare patients in order to 
receive higher payment rates. While it is true that some urinary tract 
infections are preventable through the use of improved sterile 
technique, reduced indwelling catheter duration, more appropriate use 
of broad spectrum antibiotics and improved patient mobilization, among 
others, we do not believe there is a direct causal link between 
substandard hospital care and the presence of urinary tract infection 
in general.
    Particularly in the elderly Medicare population, urinary tract 
infections occur in diverse clinical scenarios that lead to 
colonization and ultimately overt clinical infection within the urinary 
tract. General debilitation, various acute illnesses, immobility, 
impaired host defense mechanisms, dehydration and the post-surgical 
state are but a few of the situations in which urinary tract infections 
may occur, and which do in fact require higher resource utilization 
when they occur. Therefore, we are not removing codes 996.64 and 599.0 
from the CC List.
    In this final rule, as we proposed, we are not deleting any of the 
diagnosis codes on the CC list for FY 2005.
    In the May 19, 1987, proposed notice (52 FR 18877) and the 
September 1, 1987, final notice (52 FR 33154), we explained that the 
excluded secondary diagnoses were established using the following five 
principles:
     Chronic and acute manifestations of the same condition 
should not be considered CCs for one another.
     Specific and nonspecific (that is, not otherwise specified 
(NOS)) diagnosis codes for the same condition should not be considered 
CCs for one another.
     Codes for the same condition that cannot coexist, such as 
partial/total, unilateral/bilateral, obstructed/unobstructed, and 
benign/malignant, should not be considered CCs for one another.
     Codes for the same condition in anatomically proximal 
sites should not be considered CCs for one another.
     Closely related conditions should not be considered CCs 
for one another.
    The creation of the CC Exclusions List was a major project 
involving hundreds of codes. We have continued to review the remaining 
CCs to identify additional exclusions and to remove diagnoses from the 
master list that have been shown not to meet the definition of a CC.\1\
---------------------------------------------------------------------------

    \1\ See the September 30, 1988 final rule (53 FR 38485) for the 
revision made for the discharges occurring in FY 1989; the September 
1, 1989 final rule (54 FR 36552) for the FY 1990 revision; the 
September 4, 1990 final rule (55 FR 36126) for the FY 1991 revision; 
the August 30, 1991 final rule (56 FR 43209) for the FY 1992 
revision; the September 1, 1992 final rule (57 FR 39753) for the FY 
1993 revision; the September 1, 1993 final rule (58 FR 46278) for 
the FY 1994 revisions; the September 1, 1994 final rule (59 FR 
45334) for the FY 1995 revisions; the September 1, 1995 final rule 
(60 FR 45782) for the FY 1996 revisions; the August 30, 1996 final 
rule (61 FR 46171) for the FY 1997 revisions; the August 29, 1997 
final rule (62 FR 45966) for the FY 1998 revisions; the July 31, 
1998 final rule (63 FR 40954) for the FY 1999 revisions, the August 
1, 2000 final rule (65 FR 47064) for the FY 2001 revisions; the 
August 1, 2001 final rule (66 FR 39851) for the FY 2002 revisions; 
the August 1, 2002 final rule (67 FR 49998) for the FY 2003 
revisions; and the August 1, 2003 final rule (68 FR 45364) for the 
FY 2004 revisions.) In the July 30, 1999 final rule (64 FR 41490), 
we did not modify the CC Exclusions List for FY 2000 because we did 
not make any changes to the ICD-9-CM codes for FY 2000.
---------------------------------------------------------------------------

    In the May 18, 2004, proposed rule, we proposed a limited revision 
of the CC Exclusions List to take into account the proposed changes 
that will be made in the ICD-9-CM diagnosis coding system effective 
October 1, 2004. (See section II.B.15. of this preamble for a 
discussion of ICD-9-CM changes.) We proposed these changes in 
accordance with the principles established when we created the CC 
Exclusions List in 1987.
    We received no comments on the proposed changes. Therefore, we will 
adopt the CC Exclusions List as proposed.
    Tables 6G and 6H in the Addendum to this final rule contain the 
revisions to the CC Exclusions List that will be effective for 
discharges occurring on or after October 1, 2004. Each table shows the 
principal diagnoses with changes to the excluded CCs. Each of these 
principal diagnoses is shown with an asterisk, and the additions or 
deletions to the CC Exclusions List are provided in an indented column 
immediately following the affected principal diagnosis.
    CCs that are added to the list are in Table 6G--Additions to the CC 
Exclusions List. Beginning with discharges on or after October 1, 2004, 
the indented diagnoses will not be recognized by the GROUPER as valid 
CCs for the asterisked principal diagnosis.
    CCs that are deleted from the list are in Table 6H--Deletions from 
the CC Exclusions List. Beginning with discharges on or after October 
1, 2004, the indented diagnoses will be recognized by the GROUPER as 
valid CCs for the asterisked principal diagnosis.
    Copies of the original CC Exclusions List applicable to FY 1988 can 
be obtained from the National Technical Information Service (NTIS) of 
the Department of Commerce. It is available in hard copy for $152.50 
plus shipping and handling. A request for the FY 1988 CC Exclusions 
List (which should include the identification accession number (PB) 88-
133970) should be made to the following address: National Technical 
Information Service, United States Department of Commerce, 5285 Port 
Royal Road, Springfield, VA 22161; or by calling (800) 553-6847.
    Users should be aware of the fact that all revisions to the CC 
Exclusions List (FYs 1989, 1990, 1991, 1992, 1993, 1994, 1995, 1996, 
1997, 1998, 1999, 2001, 2002, 2003, and 2004) and those in Tables 6G 
and 6H of this final rule for FY 2005 must be incorporated into the 
list purchased from NTIS in order to obtain the CC Exclusions List 
applicable for discharges occurring on or after October 1, 2004. (Note: 
There was no CC Exclusions List in FY 2000 because we did not make 
changes to the ICD-9-CM codes for FY 2000.)
    Alternatively, the complete documentation of the GROUPER logic, 
including the current CC Exclusions List, is available from 3M/Health 
Information Systems (HIS), which, under contract with CMS, is 
responsible for updating and maintaining the GROUPER program. The 
current DRG Definitions Manual, Version 21.0, is available for $225.00, 
which includes $15.00 for shipping and handling. Version 22.0 of this 
manual, which includes the final FY 2005 DRG changes, is available for 
$225.00. These manuals may be obtained by writing 3M/HIS at the 
following address: 100 Barnes Road, Wallingford, CT 06492; or by 
calling (203) 949-0303. Please specify the revision or revisions 
requested.
13. Review of Procedure Codes in DRGs 468, 476, and 477
    Each year, we review cases assigned to DRG 468 (Extensive O.R. 
Procedure Unrelated to Principal Diagnosis), DRG 476 (Prostatic O.R. 
Procedure Unrelated to Principal Diagnosis), and DRG 477 (Nonextensive 
O.R. Procedure Unrelated to Principal Diagnosis) to determine whether 
it would be appropriate to change the procedures assigned among these 
DRGs.
    DRGs 468, 476, and 477 are reserved for those cases in which none 
of the O.R. procedures performed are related to the principal 
diagnosis. These DRGs are intended to capture atypical cases, that is, 
those cases not occurring with sufficient frequency to represent a 
distinct, recognizable clinical group. DRG 476 is assigned to those 
discharges in which one or more of the following

[[Page 48950]]

prostatic procedures are performed and are unrelated to the principal 
diagnosis:
     60.0, Incision of prostate
     60.12, Open biopsy of prostate
     60.15, Biopsy of periprostatic tissue
     60.18, Other diagnostic procedures on prostate and 
periprostatic tissue
     60.21, Transurethral prostatectomy
     60.29, Other transurethral prostatectomy
     60.61, Local excision of lesion of prostate
     60.69, Prostatectomy, not elsewhere classified
     60.81, Incision of periprostatic tissue
     60.82, Excision of periprostatic tissue
     60.93, Repair of prostate
     60.94, Control of (postoperative) hemorrhage of prostate
     60.95, Transurethral balloon dilation of the prostatic 
urethra
     60.96, Transurethral destruction of prostate tissue by 
microwave thermotherapy
     60.97, Other transurethral destruction of prostate tissue 
by other thermotherapy
     60.99, Other operations on prostate

    All remaining O.R. procedures are assigned to DRGs 468 and 477, 
with DRG 477 assigned to those discharges in which the only procedures 
performed are nonextensive procedures that are unrelated to the 
principal diagnosis.\2\
---------------------------------------------------------------------------

    \2\ In the August 1, 2003 final rule (68 FR 45365) we moved 
several procedures from DRG 468 to DRGs 476 and 477 because the 
procedures are nonextensive. The original list of the ICD-9-CM 
procedure codes for the procedures we consider nonextensive 
procedures, if performed with an unrelated principal diagnosis, was 
published in Table 6C in section IV. of the Addendum to the 
September 30, 1988 final rule (53 FR 38591). As part of the final 
rules published on September 4, 1990 (55 FR 36135), August 30, 1991 
(56 FR 43212), September 1, 1992 (57 FR 23625), September 1, 1993 
(58 FR 46279), September 1, 1994 (59 FR 45336), September 1, 1995 
(60 FR 45783), August 30, 1996 (61 FR 46173), and August 29, 1997 
(62 FR 45981), we moved several other procedures from DRG 468 to DRG 
477, and some procedures from DRG 477 to DRG 468. No procedures were 
moved in FY 1999, as noted in the July 31, 1998 final rule (63 FR 
40962); in FY 2000, as noted in the July 30, 1999 final rule (64 FR 
41496); in FY 2001, as noted in the August 1, 2000 final rule (65 FR 
47064); or in FY 2002, as noted in the August 1, 2001 final rule (66 
FR 39852). In the August 1, 2002 final rule (67 FR 49999), we did 
not move any procedures from DRG 477. However, we did move 
procedures codes from DRG 468 and placed them in more clinically 
coherent DRGs.
---------------------------------------------------------------------------

a. Moving Procedure Codes from DRG 468 or DRG 477 to MDCs
    We annually conduct a review of procedures producing assignment to 
DRG 468 or DRG 477 on the basis of volume, by procedure, to see if it 
would be appropriate to move procedure codes out of these DRGs into one 
of the surgical DRGs for the MDC into which the principal diagnosis 
falls. The data are arrayed two ways for comparison purposes. We look 
at a frequency count of each major operative procedure code. We also 
compare procedures across MDCs by volume of procedure codes within each 
MDC.
    We identify those procedures occurring in conjunction with certain 
principal diagnoses with sufficient frequency to justify adding them to 
one of the surgical DRGs for the MDC in which the diagnosis falls. 
Based on this year's review, we did not identify any procedures in DRG 
477 that should be removed. Therefore, in the May 18, 2004 proposed 
rule, we did not propose to move any procedures from DRG 477 to one of 
the surgical DRGs in this final rule.
    We did not receive any comments on our proposal not to move any 
procedures from DRG 477 to one of the surgical DRGs and, therefore, are 
adopting our proposal as final.
b. Reassignment of Procedures among DRGs 468, 476, and 477
    We also annually review the list of ICD-9-CM procedures that, when 
in combination with their principal diagnosis code, result in 
assignment to DRGs 468, 476, and 477, to ascertain if any of those 
procedures should be reassigned from one of these three DRGs to another 
of the three DRGs based on average charges and the length of stay. We 
look at the data for trends such as shifts in treatment practice or 
reporting practice that would make the resulting DRG assignment 
illogical. If we find these shifts, we would propose to move cases to 
keep the DRGs clinically similar or to provide payment for the cases in 
a similar manner. Generally, we move only those procedures for which we 
have an adequate number of discharges to analyze the data. Based on a 
comment we received in response to last year's proposed rule (68 FR 
45366), in the May 18, 2004 proposed rule, we proposed to move 
procedure code 51.23 (Laparoscopic cholecystectomy) from DRG 468 
(Extensive O.R. Procedure Unrelated to Principal Diagnosis) into DRG 
477 (Nonextensive O.R. Procedure Unrelated to Principal Diagnosis).
    The commenter suggested that a laparoscopic procedure was probably 
not an extensive O.R. procedure; it was more likely a nonextensive O.R. 
procedure. We indicated that we agreed and, therefore, proposed this 
change. In addition, we proposed to add several new procedure codes to 
DRGs 476 and 477. These procedures are also listed on Table 6B--New 
Procedure Codes in the Addendum to this final rule. However, DRGs 476 
and 477 are not limited to one MDC, so the new codes are also included 
here for nonextensive cases in which the procedures are unrelated to 
the principal diagnosis:
     44.67, Laparoscopic procedures for creation of 
esophagogastric sphincteric competence
     44.68, Laparoscopic gastroplasty
     44.95, Laparoscopic gastric restrictive procedure
     44.96, Laparoscopic revision of gastric restrictive 
procedure
     44.97, Laparoscopic removal of gastric restrictive 
device(s)
     44.98, Laparoscopic adjustment of size of adjustable 
gastric restrictive device
    In DRG 476, the above codes are to be added to the section ``With 
or Without Operating Room Procedures'' in the GROUPER logic.
    We did not propose to move any procedure codes from DRG 476 to DRGs 
468 or 477, or from DRG 477 to DRGs 468 or 476.
    We did not receive any comments on this proposal and, therefore, 
are adopting it as final.
c. Adding Diagnosis or Procedure Codes to MDCs
    Based on our review this year, we did not propose to add any 
diagnosis codes to MDCs. We did not receive any comments on this 
proposal. Therefore, we are adopting our proposal as final and are 
making no changes to MDCs other than those specified in other portions 
of this section II. of the preamble of this final rule.
14. Pancreatic Islet Cell Transplantation in Clinical Trials
    Section 733(a) of Public Law 108-173 directs the Secretary, acting 
through the National Institute of Diabetes and Digestive and Kidney 
Disorders (NIDDKD) to conduct a clinical investigation of pancreatic 
islet cell transplantation that includes Medicare beneficiaries. 
Section 733(b) of Public Law 108-173 provides for Medicare payments, 
beginning no earlier than October 1, 2004, for the routine costs as 
well as the costs of the transplantation and appropriate related items 
and services for Medicare beneficiaries who are participating in a 
clinical trial as if such transplantation were covered under Medicare 
Part A or Part B. Routine costs are defined as reasonable and necessary 
routine patient care costs (as defined in the CMS Coverage Issues 
Manual, Section 30-1) including immunosuppressive drugs and other 
followup care. Section 733(c)(2) of Public Law 108-173 defines 
transplantation and appropriate related

[[Page 48951]]

items and services as items and services related to the acquisition and 
delivery of the pancreatic islet cell transplantation, notwithstanding 
any national noncoverage determination contained in the CMS Coverage 
Issues Manual.
    As we indicated in the May 18, 2004, proposed rule, while the DRG 
payment will cover the transplant injection and the subsequent hospital 
stay, we considered establishing an add-on payment to the DRG payment 
amount to reimburse the acquisition costs associated with islet cell 
procurement (69 FR 28218). Historically, organ acquisition costs have 
been reimbursed as a cost pass-through. However, islet cell transplants 
are not exactly the same as solid organ transplants. While solid 
pancreata are procured, islet cells are not transplanted in the solid 
organ state as are other types of organs. Rather, the pancreata are 
procured by an organ procurement organization (OPO) and are then sent 
to an islet cell resource center that extracts the islet cells from the 
pancreata and sends the cells on to the transplant center. Because the 
procurement and processing system for islet cell transplants is not the 
same as for solid organ transplants, we proposed not paying for these 
costs as a pass-through. With the anticipated small number of 
beneficiaries in the clinical trial and the Medicare program's 
unfamiliarity with the isolation process, we believed it would be most 
appropriate at this time to have a set payment rate for acquisition 
costs, rather than attempting a case-by-case determination of the 
reasonableness of these costs in each institution. We note there is 
precedent to exclude acquisition costs from the pass-through payment 
process. For example, stem cell transplants and corneal transplants do 
not have acquisition costs reimbursed as a cost pass-through payment.
    We proposed that the add-on payment would be a single amount that 
includes pre-transplant tests and services, pancreas procurement, and 
islet isolation services. In addition, we proposed to use an add-on as 
opposed to increasing the DRG amount because the DRGs at issue are also 
applied in cases involving a variety of other procedures that do not 
include the costly islet cell acquisition required for this procedure. 
Thus, including these costs in the DRGs would have the potential of 
skewing the weights for all other DRGs. We solicited comments on 
whether an add-on payment amount is the appropriate way to reimburse 
islet cell acquisition costs, or whether another methodology may be 
more appropriate.
    In addition, while we had some data available regarding the cost of 
pancreas procurement, in the proposed rule we specifically asked for 
any other data that supported the costs of acquisition and the costs of 
isolation cell resource centers. We stated that, because of 
insufficient data, we were unable to publish a proposed acquisition 
amount in the FY 2005 proposed rule. However, we indicated that, after 
analyzing data submitted during the comment period, other data acquired 
by CMS, and any suggested changes from the methodology proposed, the 
final organ acquisition payment amount would be announced in the FY 
2005 IPPS final rule.
    Pancreatic islet cell transplantation during the clinical trial 
will be performed to decrease or eliminate the need for insulin in 
patients with Type I diabetes. Patients with Type II islet diabetes are 
not included in this trial. Islet cells are acquired from a cadaveric 
pancreas donor (islet allotransplantation).
    As described in II.B.1. of this preamble, ICD-9-CM diagnosis and 
procedure codes are used to determine DRG assignments. In 1996, CMS 
(then HCFA) created codes for islet cell transplantation:
     52.84, Autotransplantation of cells of islets of 
Langerhans.
     52.85, Allotransplantation of cells of islets of 
Langerhans.
    The Medicare GROUPER does not consider codes 52.84 and 52.85 as 
O.R. procedures and, therefore, these codes do not move the case from a 
medical DRG into a surgical DRG unless another procedure is performed. 
Based on the circumstances noted above under which pancreatic islet 
cell transplantation would be performed, we identified the three most 
logical DRGs to which we believe cases should be assigned. If a patient 
has Type I diabetes mellitus with ESRD and a pancreatectomy is 
performed, the case would group to DRG 468 (Extensive O.R. Procedure 
Unrelated to Principal Diagnosis). If a patient has Type I diabetes 
mellitus with ESRD and is also receiving a kidney transplant 
(simultaneous kidney and islet transplantation), the case would group 
to DRG 302 (Kidney Transplant). If a patient has Type I diabetes 
mellitus with ESRD and a history of a kidney transplant and then has 
the islet cells inserted via an open approach, the case would group to 
DRG 315 (Other Kidney and Urinary Tract O.R. Procedures). We note that 
this third scenario reflects incorrect coding practice. However, in 
this final rule we are modifying the structure of DRG 315 so that 
patients receiving infusions of islet cells without any other surgical 
intervention will be appropriately assigned to this DRG.
    As each case is assigned to a DRG based on all of the ICD-9-CM 
codes reported, cases could also be assigned to DRGs other than those 
mentioned above. In fact, as indicated in the proposed rule, our review 
of FY 2003 MedPAR data revealed that codes 52.84 and 52.85 were present 
in only four cases, and that each case was assigned to a different DRG. 
We found one case each in DRG 18 (Cranial and Peripheral Nerve 
Disorders With CC), DRG 192 (Pancreas, Liver, and Shunt Procedures 
Without CC), DRG 207 (Disorders of the Biliary Tract With CC), and DRG 
302 (Kidney Transplant). As the GROUPER software program does not 
recognize codes for islet cell transplantation as O.R. procedure codes, 
the presence of these codes did not modify the DRG assignment in these 
four cases.
    We were reluctant to propose assigning the islet cell codes to one 
specific DRG, as the islet cell infusion will have different 
indications depending on the merits of each case, as is shown from the 
MedPAR data mentioned above. In addition, we do not currently have 
accurate cost data or charges for patients in this type of clinical 
trial, which makes it difficult to determine an appropriate DRG weight. 
As a result, assignment of cases to a specific DRG might have the 
consequence of either overpaying or underpaying the cases. We believe 
that both of these consequences are unacceptable. Therefore, we did not 
propose that cases involved in the clinical trial be assigned to one 
specific DRG for payment purposes. As we believe that these cases will 
have been assigned to DRGs 302, 315, and 468, we proposed to establish 
an add-on payment for cases in these three DRGs containing procedure 
codes 52.84 or 52.85. As stated earlier, we were not able to establish 
the amount of this add-on until we had determined procurement costs for 
the islet cells. We solicited information from transplant centers and 
organ procurement organizations on costs for these types of 
transplantations.
    Comment: Several commenters noted that the assignment of DRG 315, 
as currently constructed, to patients participating in the clinical 
trial does not reflect appropriate coding practice, as a laparotomy 
code for hepatic vessel catheterization should not be recorded.
    Response: The commenters are correct in their assessment. 
Therefore, we are modifying the structure of DRG 315 so that patients 
receiving infusions of islet cells without any other surgical

[[Page 48952]]

intervention will appropriately be assigned to DRG 315. We are aware 
that patients will often require more than one admission for islet cell 
transplantation. We are making this modification in order to recognize 
the surgical aspects of islet cell transplantation in the absence of 
any other surgical procedure.
    The logic for DRG 315 is modified as follows:
O.R. Procedures
    This list remains the same as V21.0 of the GROUPER.
    or
Non-O.R. Procedures
    52.84, Autotransplantation of cells of islets of Langerhans
    52.85, Allotransplantation of cells of islets of Langerhans
    or
Principal Diagnosis
    This list remains the same as V21.0 of GROUPER.
    and
Non-O.R. Procedure
    This list remains the same as V21.0 of GROUPER.
    Comment: One commenter stated that it was not clinically 
appropriate to categorize islet cell transplants into DRG 315, as these 
transplants do not involve either the kidney or the urinary tract 
directly. Rather, the islet cells are transplanted into the patient's 
liver. The commenter indicated that islet transplants have no relevance 
to the genito-urinary system, but rather to the 
hepatopancreaticobiliary system. Therefore, the commenter believed that 
the proposed classification to DRG 315 is clinically inappropriate.
    Response: DRGs are diagnosis related groups. Each surgical DRG is 
comprised of procedure codes in combination with a principal diagnosis 
that causes the case to be assigned to a particular major diagnostic 
category (MDC). Because there are so many procedures in most DRGs, it 
is impossible to capture the purpose of all procedures in the title.
    Comment: Some commenters suggested that the most appropriate 
resolution is to create a new DRG for islet transplants performed 
alone. The commenters mentioned that solid organ transplants are 
classified into their own DRGs, and that this precedent should be 
continued.
    Response: DRGs are created based on the need of the program to 
identify clinical coherence and resource consumption. Ideally, both 
components will be part of the decision making process in DRG creation. 
In this case, we have no substantial data upon which to determine an 
appropriate relative weight for the resources that will be utilized in 
all islet cell transplant cases. In addition, there may be different 
scenarios in which patients are transfused with islet cells. These 
cases could include patients receiving a kidney transplant during the 
same admission, or cases in which the islet cells comprise the only 
procedure during the admission. As cases will be varied in this 
clinical trial, we prefer to have MedPAR data and case histories prior 
to creating specific new DRGs for these cases.
    Comment: Some commenters believed that the most closely related DRG 
from a clinical as well as resource perspective is DRG 513 (Pancreas 
Transplant). The commenters noted that the diagnoses are the same for 
islet and pancreas transplants, and that the patient populations 
involved in these two procedures are virtually identical in terms of 
comorbidities and the nature of their primary disease. In addition, the 
technical aspects of islet transplants are of a surgical nature, 
whether performed in an operating room or in the interventional 
radiology suite. One commenter noted that pancreas transplants are in 
reality just another method of transplanting the insulin producing 
islet cells since the other functions of the pancreas are superfluous.
    Response: While the patient populations requiring intervention are 
similar, we do not believe that one can equate an operation of the 
magnitude of a pancreas transplant with a less intensive islet cell 
transplantation in which the portal vein is accessed and islet cells 
infused through a catheter. It is only because the technical aspects of 
islet transplants are of a surgical nature that we have modified 
surgical DRG 315 to reflect the transfusion of islet cells.
    Comment: One commenter suggested that the most appropriate DRG for 
simultaneous kidney and islet cell transplantation would be DRG 512 
(Simultaneous Pancreas/Kidney Transplant), as the resource allocation 
and patient population involved in both types of admissions are 
comparable. The commenter noted that so few of these combination 
procedures have been performed that no assumption can be projected 
based on the experience to date.
    Response: We do not agree that an islet cell transplantation is the 
equivalent of a pancreas transplantation. Cases involving simultaneous 
kidney and islet cell transplantation will group to DRG 302, and will 
receive an add-on payment for the infusion of the islet cells.
    Comment: Some commenters believed CMS should pay for islet 
acquisition services as a cost pass-through. Several of these 
commenters stated that they found insufficient justification to pay for 
islet cell transplants through an add-on when pancreata used for solid 
organ transplantation are paid as a cost pass-through. These commenters 
stated that the costs of procuring a pancreas used for solid organ 
transplantation are the same as procuring a pancreas for islet cell 
transplantation. One commenter agreed that payment through an add-on is 
the best approach.
    Response: We continue to believe that reimbursing acquisition costs 
as an add-on to the DRG is an appropriate reimbursement mechanism. 
However, we have decided that reimbursing pancreata procured for islet 
cells as an add-on while the acquisition of all other organs are 
reimbursed as a cost pass-through may be premature at this time. 
Accordingly, we will pay for organ acquisition costs as a cost pass-
through. Costs associated with the procurement of the pancreata will be 
included in the islet acquisition costs center of the transplant center 
cost report. We will continue to study the appropriateness of paying 
for pancreata used for islets as an add-on in the future. Islet 
isolation will be paid as an add-on as proposed. We discuss this add-on 
below.
    Comment: Some commenters were concerned that pre-transplant costs 
would not be appropriately reflected in the proposed add-on 
methodology. These commenters recommended that the pre-transplant costs 
be paid as a cost-pass through.
    Response: After additional analysis, we agree that it may be 
difficult to ensure an appropriate payment amount for pre-transplant 
costs in an add-on methodology. Therefore, pre-transplant costs will be 
handled in the same manner as they are for all other solid organ 
transplantation and will be included in the islet acquisition cost 
center of the cost report. Pre-transplant costs will not be included as 
an add-on to the DRG payment.
    Comment: Some commenters believed that islet isolation services 
should be paid on a cost pass-through rather than as an add-on. One 
commenter mentioned that islet centers have differing arrangements with 
transplant centers on how the isolation is performed. The commenters 
added that these same centers have differing processes in isolating the 
islet cells. Some commenters also indicated that there are 
inconsistencies in the isolation center data provided to CMS for use in

[[Page 48953]]

developing the add-on payment and expressed concerns about the validity 
of these data.
    Response: We continue to believe that paying for islet isolation 
services as an add-on amount to the DRG is appropriate in the context 
of this clinical trial. We derived the isolation add-on amount through 
analysis of direct costs data submitted by 10 of the prominent 
isolation centers in the country. These centers may well have differing 
arrangements and differing processes, but despite these differences, 
the costs and components of costs showed reasonable similarities. The 
differences were also notable, but we were able to adjust for these 
differences. In addition to including direct costs, we added 
actuarially-derived overhead amounts that are used in the hospital 
payment methodology and provided a 20-percent capital adjustment for 
building and equipment and a market basket adjustment to take the 
payment amount to a FY 2005 funding level. Historically, capital costs 
are approximately 10 percent of the total hospital costs. However, we 
recognize that the isolation centers are equipment intensive, and to 
account for that equipment, we are doubling that rate so that capital 
costs are 20 percent of the total isolation payment. We believe that 20 
percent is sufficient to account for capital at the isolation centers. 
In future years, we would like to obtain capital costs amortized on a 
per isolation basis. The varying processes and arrangements are all 
included in our computation, and $18,848 will be paid as the islet 
isolation add-on to the DRG payment.
    Comment: One commenter wanted to be sure that costs of transporting 
islet cells to and from the islet isolation center are included in the 
add-on payment.
    Response: Shipping costs from the OPO to the islet isolation center 
are included in procurement costs. The islet isolation centers did not 
provide data on shipping to the transplant centers; however, we have 
included an actuarially based overhead amount that we believe is 
sufficient to cover these costs.
    Comment: Some commenters noted that more than one infusion of islet 
cells is typically required to establish insulin independence and 
believed that this argued in favor of payment on a cost pass-through 
basis rather than as an add-on amount.
    Response: We recognize that normally two or more infusions are 
required for islet transplants. We also understand that it is extremely 
rare for two infusions to be performed at the same time. Accordingly, 
we have constructed our payment mechanism to pay one DRG for the 
infusion and one islet isolation add-on amount per discharge under most 
circumstances for allograft islet cell transplants. However, in those 
rare instances in which two infusions occur during the same hospital 
stay, two add-on payments for isolation of the islet cells can be made 
along with the single DRG payment. The cost associated with the 
procurement of two pancreata will be paid as an acquisition cost on a 
reasonable cost basis. We will issue billing instructions on this issue
    Comment: Some commenters asked for guidance on the appropriate 
methodology for OPOs to use in identifying costs incurred in procuring 
pancreata for islet cell transplantation. Some OPOs have indicated that 
they currently are providing pancreata for islet cell transplantation 
but do not receive their full standard acquisition charge (SAC) for the 
organ.
    Response: In some cases, OPOs have been billing pancreata for islet 
cell transplant at a lower tissue rate. This is an improper billing 
method. The quality and resources required to procure the organ are 
identical, and a full charge should be made. Organs that are determined 
to be nonviable can be billed at a lesser research rate .
    Comment: One commenter indicated that the costs included in 
pancreas acquisition at OPOs vary, making an add-on payment 
impractical.
    Response: As mentioned above, we will continue paying acquisition 
costs as a cost pass-through. However, all OPOs should have included in 
their costs direct donor hospital charges, surgeon retrieval fee, 
registry fees, donor testing, and transportation. These costs should 
not be shifted to another organization.
    Comment: One commenter noted that it was unclear how physicians' 
services involved in the oversight of the isolation process would to be 
paid since it does not appear that there is an existing CPT code for 
these services.
    Response: The commenter is correct that there is no CPT code for 
the physician's oversight services at the isolation center. CPT codes 
are for direct patient care services; the services at the isolation 
center do not meet that level of patient participation. In a similar 
vein, the medical directors at OPOs do not bill for their services 
using a CPT code. Rather, they are paid by the OPO both for organ 
retrieval and medical director services. We have included physician 
costs in the salary portion of the isolation portion of the add-on 
amount.
    Comment: One commenter believed that the costs associated with the 
isolation portion of the add-on amount should be between $30,000 and 
$40,000. This commenter further explained that isolation centers incur 
cost and time to develop improvements to the islet isolation technology 
and pointed out the startup costs associated with an FDA approved 
isolation center.
    Response: As noted earlier, we have calculated the islet isolation 
portion of the add-on amount as $18,848. We suspect that the $30,000 to 
$40,000 estimate referenced by the commenter included costs 
attributable to research and other services, which are not considered 
to be routine and reasonably necessary for patient care.
    Comment: One commenter suggested two levels of add-on payments to 
account for the difference in expenses for autograft versus allograft 
islet cells transplants. While the proposed add-on methodology included 
the cost of pre-transplant tests and services, organ procurement and 
islet isolation services, autograft transplants have no associated 
organ procurement costs, as the islet cells are taken from the 
patient's own pancreas. Autograft transplants still require pre-
transplant services and the actual islet isolation procedure itself.
    Response: Our original understanding was that autograft transplants 
would not be included in the NIH study. After review of the legislation 
and accompanying Conference Report and consultation with NIH, we 
believe that an autograft should not occur in this trial. However, in 
the unlikely event that an autograft islet cell transplant is performed 
as part of the study on a Medicare beneficiary, we will provide an 
autograft add-on amount that includes payment for isolation but not for 
organ procurement. No acquisition cost of the pancreas will be provided 
because the cost of removal of the organ is included in the DRG payment 
for the native pancreatectomy procedure itself. The isolation add-on 
amount will be $18,848 for an autograft islet cell transplant.
    In this rule we are finalizing our proposed payment methodology for 
acquisition costs associated with procuring pancreata for islet cells 
with modification. We will pay for the organ acquisition costs as a 
cost pass-through rather than as an add-on payment to the DRG as 
proposed. In addition, we are finalizing our proposal to pay for islet 
isolation services as an add-on.
15. Changes to the ICD-9-CM Coding System
    As described in section II.B.1. of this preamble, the ICD-9-CM is a 
coding system used for the reporting of diagnoses and procedures 
performed on

[[Page 48954]]

a patient. In September 1985, the ICD-9-CM Coordination and Maintenance 
Committee was formed. This is a Federal interdepartmental committee, 
co-chaired by the National Center for Health Statistics (NCHS) and CMS, 
charged with maintaining and updating the ICD-9-CM system. The 
Committee is jointly responsible for approving coding changes, and 
developing errata, addenda, and other modifications to the ICD-9-CM to 
reflect newly developed procedures and technologies and newly 
identified diseases. The Committee is also responsible for promoting 
the use of Federal and non-Federal educational programs and other 
communication techniques with a view toward standardizing coding 
applications and upgrading the quality of the classification system.
    The Official Version of the ICD-9-CM contains the list of valid 
diagnosis and procedure codes. (The Official Version of the ICD-9-CM is 
available from the Government Printing Office on CD-ROM for $25.00 by 
calling (202) 512-1800.) The Official Version of the ICD-9-CM is no 
longer available in printed manual form from the Federal Government; it 
is only available on CD-ROM. Users who need a paper version are 
referred to one of the many products available from publishing houses.
    The NCHS has lead responsibility for the ICD-9-CM diagnosis codes 
included in the Tabular List and Alphabetic Index for Diseases, while 
CMS has lead responsibility for the ICD-9-CM procedure codes included 
in the Tabular List and Alphabetic Index for Procedures.
    The Committee encourages participation in the above process by 
health-related organizations. In this regard, the Committee holds 
public meetings for discussion of educational issues and proposed 
coding changes. These meetings provide an opportunity for 
representatives of recognized organizations in the coding field, such 
as the American Health Information Management Association (AHIMA), the 
American Hospital Association (AHA), and various physician specialty 
groups, as well as individual physicians, medical record 
administrators, health information management professionals, and other 
members of the public, to contribute ideas on coding matters. After 
considering the opinions expressed at the public meetings and in 
writing, the Committee formulates recommendations, which then must be 
approved by the agencies.
    The Committee presented proposals for coding changes for 
implementation in FY 2005 at public meetings held on April 3, 2003, 
December 4-5, 2003, and April 1-2, 2004, and finalized the coding 
changes after consideration of comments received at the meetings and in 
writing by January 12, 2004. Those coding changes are announced in 
Tables 6A through 6F of the Addendum to this rule. Copies of the 
minutes of the procedure codes discussions at the Committee's 2003 
meetings can be obtained from the CMS Web site: http://www.cms.gov/paymentsystems/icd9/. The minutes of the diagnoses codes discussions at 
the 2003 meetings are found at: http://www.cdc.gov/nchs/icd9.htm. Paper 
copies of these minutes are no longer available and the mailing list 
has been discontinued.
    For a report of procedure topics discussed at the April 1-2, 2004, 
meeting, see the Summary Report at: http://www.cms.hhs.gov/paymentsystems/icd9/. For a report of the diagnosis topics discussed at 
the April 1-2, 2004 meeting, see the Summary Report at: http://www.cdc.gov/nchs/icd9.htm.
    We encourage commenters to address suggestions on coding issues 
involving diagnosis codes to: Donna Pickett, Co-Chairperson, ICD-9-CM 
Coordination and Maintenance Committee, NCHS, Room 2404, 3311 Toledo 
Road, Hyattsville, MD 20782. Comments may be sent by e-mail to: 
[email protected].
    Questions and comments concerning the procedure codes should be 
addressed to: Patricia E. Brooks, Co-Chairperson, ICD-9-CM Coordination 
and Maintenance Committee, CMS, Center for Medicare Management, 
Hospital and Ambulatory Policy Group, Division of Acute Care, C4-08-06, 
7500 Security Boulevard, Baltimore, MD 21244-1850. Comments may be sent 
by e-mail to: [email protected].
    The ICD-9-CM code changes that have been approved will become 
effective October 1, 2004. The new ICD-9-CM codes are listed, along 
with their DRG classifications, in Tables 6A and 6B (New Diagnosis 
Codes and New Procedure Codes, respectively) in the Addendum to this 
final rule. As we stated above, the code numbers and their titles were 
presented for public comment at the ICD-9-CM Coordination and 
Maintenance Committee meetings. Both oral and written comments were 
considered before the codes were approved. In the May 18, 2004, 
proposed rule, we only solicited comments on the proposed 
classification of these new codes.
    For codes that have been replaced by new or expanded codes, the 
corresponding new or expanded diagnosis codes are included in Table 6A. 
New procedure codes are shown in Table 6B. Diagnosis codes that have 
been replaced by expanded codes or other codes or have been deleted are 
in Table 6C (Invalid Diagnosis Codes). These invalid diagnosis codes 
will not be recognized by the GROUPER beginning with discharges 
occurring on or after October 1, 2004. Table 6D usually contains 
invalid procedure codes, however, for FY 2005, there are no invalid 
procedure codes. Revisions to diagnosis code titles are in Table 6E 
(Revised Diagnosis Code Titles), which also includes the DRG 
assignments for these revised codes. Table 6F includes revised 
procedure code titles for FY 2005.
    The first of the 2004 public meetings was held on April 1-2, 2004. 
In the September 7, 2001, final rule implementing the IPPS new 
technology add-on payments (66 FR 46906), we indicated we would attempt 
to include proposals for procedure codes that would describe new 
technology discussed and approved at the April meeting as part of the 
code revisions effective the following October.
    Section 503(a) of Public Law 108-173 includes a requirement for 
updating ICD-9-CM codes twice a year instead of the current process of 
annual updates on October 1 of each year. This requirement is included 
as part of the amendments to the Act relating to recognition of new 
technology under the IPPS. Section 503(a) amended section 1886(d)(5)(K) 
of the Act by adding a new clause (vii) which states that the 
``Secretary shall provide for the addition of new diagnosis and 
procedure codes in April 1 of each year, but the addition of such codes 
shall not require the Secretary to adjust the payment (or diagnosis-
related group classification) * * * until the fiscal year that begins 
after such date.'' Because this new statutory requirement will have a 
significant impact on health care providers, coding staff, publishers, 
system maintainers, software systems, among others, in the May 18, 
2004, proposed rule, we solicited comments on our proposals described 
below to implement this requirement. This new requirement will improve 
the recognition of new technologies under the IPPS system by providing 
information on these new technologies at an earlier date. Under the 
proposal, data would be available 6 months earlier than would be 
possible with updates occurring only once a year on October 1. Many 
coding changes apply to longstanding medical issues.
    While the new requirement states that the Secretary shall not 
adjust the payment of the DRG classification for the April 1 new codes, 
the Department

[[Page 48955]]

will have to update its DRG software and other systems in order to 
recognize and accept the new codes. We will also have to publicize the 
code changes and the need for a mid-year systems update by providers to 
capture the new codes. Hospitals will have to obtain the new code books 
and encoder updates, and make other system changes in order to capture 
and report the new codes. We indicated that we are aware of the 
additional burden this will have on health care providers.
    The ICD-9-CM Coordination and Maintenance Committee has held its 
meetings in April and December of each year in order to update the 
codes and the applicable payment and reporting systems by October 1 of 
each year. Items are placed on the agenda for the ICD-9-CM Coordination 
and Maintenance Committee meeting if the request is received at least 2 
months prior to the meeting. This requirement allows time for staff to 
review and research the coding issues and prepare material for 
discussion at the meeting. It also allows time for the topic to be 
publicized in meeting announcements in the Federal Register as well as 
on the CMS website. The public decides whether or not to attend the 
meeting based on the topics listed on the agenda. In order to provide 
an update on April 1, it became clear that a December Committee meeting 
would not provide time to finalize and publicize these code revisions. 
Final decisions on code title revisions are currently made by March 1 
so that these titles can be included in the IPPS proposed rule. A 
complete addendum describing details of all changes to ICD-9-CM, both 
tabular and index, are publicized on CMS and NCHS web pages in May of 
each year. Publishers of coding books and software use this information 
to modify their products that are used by health care providers. This 
5-month time period has proved to be necessary for hospitals and other 
providers to update their systems.
    A discussion of this timeline and the need for changes are included 
in the December 4-5, 2003 ICD-9-CM Coordination and Maintenance 
Committee minutes. The public provided comment that additional time 
would be needed to update hospital systems and obtain new code books 
and coding software. There was considerable concern expressed about the 
impact this new update would have on providers. Therefore, we have 
rescheduled the second Committee meeting for 2004 for October 7-8, 
2004. Those who wish to have a coding issue discussed at the October 
Committee meeting will be required to submit their request by August 7, 
2004. The Department will continue this process to accommodate all 
requesters who submit appropriate requests in a timely manner.
    In the May 18, 2004 proposed rule, we proposed to implement section 
503(a) by developing a mechanism for approving, in time for the April 
update, diagnoses and procedure code revisions needed to describe new 
technologies and medical services for purposes of the new technology 
add-on payment process. We also proposed the following process for 
making these determinations. Topics considered during the October ICD-
9-CM Coordination and Maintenance Committee meeting would be considered 
for an April 1 update if a strong and convincing case is made by the 
requester at the Committee's public meeting. The request must identify 
the reason why a new code is needed in April for purposes of the new 
technology process. The participants at the meeting and those reviewing 
the Committee meeting summary report would be provided the opportunity 
to comment on this expedited request. All other topics would be 
considered for the October 1 update. Participants at the Committee 
meeting would be encouraged to comment on all such requests.
    We stated that we believe that this proposal captures the intent of 
section 503(a). This requirement was included in the provision revising 
the standards and process for recognizing new technology under the 
IPPS. In addition, the need for approval of new codes outside the 
existing cycle (October 1) arises most frequently and most acutely 
where the new codes will capture new technologies that are (or will be) 
under consideration for new technology add-on payments. Thus, we 
believe this provision was intended to expedite data collection through 
the assignment of new ICD-9-CM codes for new technologies seeking 
higher payments. We indicated that our proposal was designed to carry 
out that intention, while minimizing the additional administrative 
costs associated with mid-year changes to the ICD-9-CM codes.
    Comment: Several comments expressed concerns about the impact the 
April 1 ICD-9-CM coding update will have on providers. While the 
commenters acknowledged the requirement was mandated by section 503(a) 
of Public Law 108-173, the commenters urged CMS to carefully consider 
the number of these mid-year coding updates. The commenters stated that 
these changes will have a significant impact on providers' systems. One 
commenter representing a large hospital organization recommended that 
codes being considered for the April 1 update be limited only to new 
technologies that present a strong and convincing case for new 
technology add-on payment. The commenter recommended that the annual 
April 1 update be limited to as few codes as possible for the following 
reasons:
     The addition of a significant number of new codes outside 
the traditional October 1 implementation will result in doubling the 
costs associated with the purchase of new code books and updating 
encoder software programs, requiring hospitals to purchase new code 
books twice a year. The commenter stated that at least one publisher 
has already announced that two editions of the code books will be 
published every year.
     Many health plans, including Medicare, require a 
significant lead-time to incorporate new codes into their systems. The 
commenter expressed concern that some payers will not be able to 
support a large number of codes being implemented outside the 
traditional October 1 update.
     A considerable amount of education and coder training 
takes place every year with the introduction of new and updated codes. 
Introducing a large number of new codes on a twice-yearly basis, rather 
than annually, will increase this burden.
    The commenter urged that the new codes be released with a 5-month 
lead-time as is the case now for ICD-9-CM updates. Currently the public 
is notified in May of the same year for ICD-9-CM codes being 
implemented on October 1. The commenter requested that the public be 
notified by November of codes that will be implemented on April 1.
    The commenter pointed out that, by tradition, new ICD-9-CM codes 
have been published in the Federal Register, as part of the annual IPPS 
proposed rule. The commenter urged CMS to develop a process for the 
wide dissemination of new and modified ICD-9-CM codes for April 1 
implementation. The commenter requested that this process be published 
in the IPPS final rule to inform users of the process.
    These comments were supported by organizations representing State 
hospitals and coding specialists. The commenters agreed with CMS' 
proposal to use the public meetings of the ICD-9-CM Coordination and 
Maintenance Committee to consider requests for an April 1 
implementation date for a new ICD-9-CM code. The commenters agreed that 
these updates should primarily focus on new technology

[[Page 48956]]

issues. When an individual or organization requests implementation of 
an ICD-9-CM code on April 1, the commenters agreed that the requestor 
should make a strong and convincing case as to why a new code is needed 
in April for purposes of the new technology process.
    Response: We agree that section 503(a) of Public Law 108-173 
requires that ICD-9-CM codes needed to capture new technology must be 
implemented on April 1 and October 1 of each year. We also agree that 
the April updates will be disruptive to current provider systems. Any 
April updates must be carefully considered and evaluated in order to 
capture new technology in an expedited manner. Those commenters who 
request an April implementation of a new ICD-9-CM code must make a 
strong and convincing case at the ICD-9-CM Coordination and Maintenance 
Committee as to why a new code is needed in April for purposes of the 
new technology process. The public will be provided an opportunity to 
discuss this request. Comments regarding the publication and 
dissemination of codes to be implemented on April 1 are discussed 
below.
    Comment: One commenter called the twice a year updates of ICD-9-CM 
an important step forward in allowing new products to enter the market 
more quickly and receive adequate payment sooner. The commenter 
expressed some concerns about CMS' proposed approach to these updates. 
The commenter stated that, by using the April updates for new 
technology, we would not have a true twice yearly coding update, but 
rather an opportunity for only a small group of services or 
technologies to receive more prompt coding updates. The commenter 
stated that the April update should be an open opportunity for any 
coding updates to be considered.
    Response: We agree with the commenter that the process for 
discussing updates to ICD-9-CM should be an open process. This has been 
the practice of the ICD-9-CM Coordination and Maintenance Committee 
since it was established in 1985. As previously stated, we will provide 
the opportunity for a requestor to make a clear and convincing case for 
the need to update specific ICD-9-CM codes in April. The public will be 
provided an opportunity to discuss the merits of any codes under 
consideration for the April updates.
    Comment: Several commenters requested details on how the public 
will be notified of the April ICD-9-CM code updates. They requested 
clarification as to whether the current publication processes will be 
used. One commenter representing a national organization of codes and 
health information managers urged CMS to provide information on April 1 
code updates at least 4 months prior to implementation. Other 
commenters representing hospital organizations urged CMS to provide 
updates 5 months ahead of implementation, or by November of the prior 
year.
    Response: Current addendum and code title information is published 
on the CMS Web page at: http://www.cms.hhs.gov/paymentsystems/icd9 /icd9. 
Summary tables showing new, revised, and deleted code titles are also 
posted on the following CMS Web page: http://www.cms.hhs.gov/medlearn/icd9code.asp. Information on ICD-9-CM diagnosis codes can be found at: 
http://www.cdc.gov/nchs/icd9.htm. Information on new, revised, and 
deleted ICD-9-CM codes is also provided to the AHA for publication in 
the Coding Clinic for ICD-9-CM. AHA also distributes information to 
publishers and software vendors.
    CMS also sends copies of all ICD-9-CM coding changes to its 
contractors for use in updating their systems and providing education 
to providers.
    We agree that these same means of disseminating information on new, 
revised, and deleted ICD-9-CM codes should be used to notify providers, 
publishers, software vendors, contractors, and others of changes to the 
ICD-9-CM codes that will be implemented in April. We will continue to 
provide the information in this manner.
    Currently, code titles are also published in the IPPS proposed and 
final rules. The code titles are adopted as part of the ICD-9-CM 
Coordination and Maintenance Committee process. The code titles are not 
subject to comment in the proposed or final rules. We will continue to 
publish the October code updates in this manner within the IPPS 
proposed and final rules. However, we do not publish a mid-year IPPS 
rule, so the April 1 code updates will not be published in a mid-year 
IPPS rule. We will assign the new procedure code to the same DRG in 
which its predecessor code was assigned so there will be no DRG impact 
as far as DRG assignment. This mapping was specified by Public Law 108-
173. Any proposed coding updates will be available through the websites 
indicated above and through the Coding Clinic for ICD-9-CM. Publishers 
and software vendors currently obtain code changes through these 
sources in order to update their code books and software systems. We 
will strive to have the April 1 updates available through these 
websites 5 months prior to implementation (that is, early November of 
the previous year), as is the case for the October 1 updates. Code book 
publishers are evaluating how they will provide any code updates to 
their subscribers. Some publishers may decide to publish mid-year book 
updates. Others may decide to sell an addendum that lists the changes 
to the October 1 code book. Coding personnel should contact publishers 
to determine how they will update their books. CMS and its contractors 
will also consider developing provider education articles concerning 
this change to the effective date of certain ICD-9-CM codes.
    Comment: Commenters requested clarification as to whether the April 
1 updates would be limited to procedure codes. The commenters supported 
our proposed approach for implementing the new legislative requirement 
to update ICD-9-CM codes twice a year. Specifically, they agreed that 
limiting the implementation of new codes on April 1 to those for which 
a strong and convincing case is made for an expedited implementation is 
the best approach and will reduce the additional administrative costs 
associated with twice-yearly updates to the coding system. The 
commenters acknowledged that the section of 503(a) of Public Law 108-
173 that includes the requirement for updating ICD-9-CM codes twice a 
year is primarily related to the recognition of new technology under 
the IPPS, but the language in the legislation does not limit the 
requirement to procedure codes. The commenters stated that CMS' 
proposed approach requires the requestor of a code proposal to identify 
the reason why a new code is needed on April 1 for purposes of the new 
technology process. One commenter stated that this requirement seems to 
preclude diagnosis code updates. Another commenter requested 
clarification in the final rule as to whether new diagnosis codes are 
intended to be included in the April 1 update.
    Response: We agree that section 503(a) of Pub. L. 108-173 did not 
limit ICD-9-CM code updates to procedure codes. The legislation covered 
all of ICD-9-CM, which includes both diagnoses and procedures codes. 
Therefore, consideration will be given to updates to both the diagnosis 
and procedure parts of ICD-9-CM on April 1 if a strong and convincing 
case can be made that either a diagnosis or procedure code is necessary 
to capture a new technology. We acknowledge that it may be necessary to 
recognize a new disease, such as SARS, on April 1 so that a new 
technology directed toward the disease can be more easily

[[Page 48957]]

identified. We anticipate that most, if not all, requests for April 1 
ICD-9-CM code updates will apply to procedure codes, as the commenters 
have stated. While it is unlikely that there will be many such disease 
code requests for an April 1 update, we will not restrict any such 
requests for consideration.
    Comment: Commenters representing national and state hospital 
associations as well as other organizations suggested that providing 
twice-yearly updates to the ICD-9-CM is only a temporary solution to 
meeting the coding needs of providers who may need to report new 
technology. The organizations stated that a more permanent and long-
term-solution would be the implementation of ICD-10-CM and ICD-10-PCS 
as quickly as possible. Several other commenters recommended moving 
forward with the implementation of ICD-10 as quickly as possible. One 
commenter urged DHHS to adopt and implement ICD-10-CM and ICD-10-PCS as 
quickly as possible in the United States. The commenter further stated 
that the sooner the health care industry and CMS begin to use and 
collect data more closely representing actual diagnosis and procedures, 
the better the picture of our health services and healthcare services 
will be; reimbursement will be more accurate; and there will be less 
administrative burden on health care providers and on CMS. One 
commenter asked that the regulatory process for implementing ICD-10 be 
started by the end of 2004. Another commenter stated that ICD-9-CM is 
becoming increasingly difficult to update and progress should be made 
on implementing ICD-10.
    Response: We acknowledge that there are some concerns with the ICD-
9-CM code set. The National Committee on Vital and Health Statistics 
(NCVHS) has recommended that DHHS, under its HIPAA responsibilities, 
prepare a notice of proposed rulemaking regarding the proposed adoption 
of ICD-10 as a HIPAA standard to replace ICD-9-CM. We are assessing the 
NCVHS recommendations.
    DHHS has been actively working on the development of new coding 
systems to replace the ICD-9-CM. In December 1990, the NCVHS issued a 
report noting that, while the ICD-9-CM classification system had been 
responsive to changing technologies and identifying new diseases, there 
was concern that the ICD classification might be stressed to a point 
where the quality of the system would soon be compromised. The ICD-10-
CM (for diagnoses) and the ICD-10-PCS (for procedures) were developed 
in response to these concerns. These efforts have become increasingly 
important because of the growing number of problems with the ICD-9-CM, 
which was implemented 25 years ago.
16. Other Issues
a. Craniotomy Procedures
    As discussed in the August 1, 2003, IPPS final rule (68 FR 45353), 
for FY 2004 we conducted an analysis of the charges for various 
procedures and diagnoses within DRG 1 (Craniotomy Age > 17 With CC) and 
DRG 2 (Craniotomy Age > 17 Without CC) to determine whether further 
changes to these DRGs were warranted. Based on our analysis and 
consideration of public comments received on our May 19, 2003, IPPS 
proposed rule (68 FR 27161), in the August 1, 2003, IPPS final rule, we 
created three new DRGs: DRG 528 (Intracranial Vascular Procedures With 
a Principal Diagnosis of Hemorrhage) for patients with an intracranial 
vascular procedure and an intracranial hemorrhage; and DRGs 529 
(Ventricular Shunt Procedures With CC) and 530 (Ventricular Shunt 
Procedures Without CC) for patients with only a vascular shunt 
procedure.
    In the May 18, 2004, proposed rule, we indicated that we had 
received further comments (discussed below) regarding the composition 
of DRGs 1 and 2 that relate to the appropriate DRG assignment of 
unruptured cerebral aneurysm cases and cases involving implantation of 
GLIADEL[reg] chemotherapy wafers. We had also received comments on 
possible revisions to DRG 3 (Craniotomy Age 0-17).
(1) Unruptured Cerebral Aneurysms
    In the August 1, 2003, final rule (68 FR 45354), in response to a 
comment that suggested we create a companion DRG to DRG 528 for 
intracranial vascular procedures for unruptured cerebral aneurysms, we 
evaluated cases in the MedPAR file involving unruptured cerebral 
aneurysm and determined that the average charges for unruptured 
cerebral aneurysm cases were consistent with the variation of charges 
found in DRGs 1 and 2. Therefore, we did not propose a change in the 
DRG classification. We indicated that we would continue to monitor 
cases involving unruptured cerebral aneurysms.
    In the May 18, 2004, proposed rule, we discussed our examination of 
cases in the FY 2003 MedPAR file that reported unruptured cerebral 
aneurysms. We found 657 unruptured aneurysm cases assigned to DRG 1 and 
481 unruptured cerebral aneurysm cases assigned to DRG 2. The average 
charges for these unruptured cerebral aneurysm cases in DRG 1 ($50,879) 
are slightly lower than the overall charges for all cases in that DRG 
($51,300). For unruptured cerebral aneurysm cases assigned to DRG 2, we 
found the average charges of approximately $29,524 are consistent with 
the overall average charges of that DRG of approximately $28,416.
    Based on the results of our analysis, we indicated that we still do 
not believe a proposal to modify the DRG assignment of unruptured 
cerebral aneurysm cases is warranted.
    We received one comment on this issue from an organization 
representing hospitals. The commenter agreed that no change is 
warranted for the DRG assignment of unruptured aneurysm cases at this 
time.
(2) GLIADEL[reg] Chemotherapy Wafers
    In the August 1, 2003 final rule (68 FR 45354), we stated that we 
had received comments requesting a change to the DRG assignment of 
cases involving implantation of GLIADEL[reg] chemotherapy wafers to 
treat brain tumors. One of the commenters had offered two options: (1) 
create a new DRG for cases involving implantation of GLIADEL[reg] 
chemotherapy wafers; and (2) reassign these cases to DRG 484 
(Craniotomy for Multiple Significant Trauma).
    At that time, we had analyzed data in the March 2003 update of the 
FY 2003 MedPAR file and found a total of 61 cases in which procedure 
code 00.10 (Implantation of a chemotherapy agent) was reported for 
cases assigned to DRGs 1 and 2. There were 38 cases assigned to DRG 1 
and 23 cases assigned to DRG 2. The GROUPER logic for these DRGs 
assigns cases with CCs to DRG 1 and those without CCs to DRG 2. 
Consistent with the GROUPER logic for these DRGs, we had found that the 
average standardized charges in DRGs 1 and 2 were approximately $64,864 
and $42,624, respectively. However, while the estimated average charges 
for GLIADEL[reg] wafer cases of $50,394 may have been higher than the 
average standardized charges for DRG 2, they were within the normal 
variation of overall charges within each DRG. In addition, the volume 
of cases in these two DRGs was too small to warrant the establishment 
of a separate new DRG for this technology. Therefore, we stated that we 
wanted to review a full year of data and take the time to consider 
alternative options that might appear warranted before proposing a 
change.
    In the May 18, 2004, proposed rule, we discussed our examination of 
more

[[Page 48958]]

complete MedPAR data (December 2003 update for FY 2003) on cases 
reporting GLIADEL[reg] chemotherapy wafers. We found a total of 127 
cases in which procedure code 00.10 was reported for cases assigned to 
DRGs 1 and 2. There were 80 cases assigned to DRG 1 and 47 cases 
assigned to DRG 2. The average charges for these cases in DRGs 1 and 2 
were approximately $61,866 and $47,189, respectively. The average 
charges for these cases were higher than the overall charges of DRGs 1 
and 2 of approximately $51,300 and $28,416, respectively. Although the 
average charges for the GLIADEL[reg] wafer cases within these DRGs are 
higher than the average charges of all cases in these DRGs, they remain 
within the range of average charges for other procedures included in 
these DRGs. The majority of the GLIADEL[reg] wafer cases are assigned 
to the second highest weighted DRG in MDC 1 behind DRG 528 
(Intracranial Vascular Procedure With a Principal Diagnosis of 
Hemorrhage) in which the weights were derived from average charges of 
approximately $113,884. In DRG 1, there are 10 procedures that have 
higher average charges than the GLIADEL[reg] wafer cases. However, in 
DRG 2, the charges associated with GLIADEL[reg] wafer cases are the 
highest of the procedures included within the DRG.
    DRGs are based on the principal diagnosis, secondary diagnosis, and 
procedures performed on the patient. DRGs are not generally created to 
recognize the presence or absence of specific technologies for each 
patient. In the past, we have made one exception to this rule. The 
exception was the creation of two new DRGs for drug-eluting stents: DRG 
526 (Percutaneous Cardiovascular Procedure With Drug-Eluting Stent With 
Acute Myocardial Infarction) and DRG 527 (Percutaneous Cardiovascular 
Procedure With Drug-Eluting Stent Without Acute Myocardial Infarction) 
(67 FR 50003). We took this unprecedented approach in response to the 
unique circumstances surrounding the potential breakthrough nature of 
this technology. We currently have 59,613 drug-eluting stent cases 
annually, far more cases than the volume for GLIADEL[reg] wafers. We 
believe that the volume of GLIADEL[reg] wafer cases remains too small 
to warrant the taking of the exceptional step of establishing a 
separate new DRG for this technology.
    Commenters also have proposed the reassignment of GLIADEL[reg] 
wafer cases to other existing DRGs, such as DRG 484 (Craniotomy for 
Multiple Significant Trauma), DRG 528 (Intracranial Vascular Procedures 
With Principal Diagnosis of Hemorrhage), DRG 492 (Chemotherapy With 
Acute Leukemia as a Secondary Diagnosis or With Use of a High Dose 
Chemotherapeutic Agent), or DRG 481 (Bone Marrow Transplant). In the 
proposed rule, we stated that we had examined these alternatives, and 
had come to the conclusion that none of these alternatives meets the 
standard of clinical coherence under the DRG system. For example, 
reconfiguring DRG 484 to include GLIADEL[reg] wafer cases would not 
produce a clinically coherent DRG because DRG 484 contains cases where 
craniotomy is performed in the setting of multiple significant trauma. 
Similarly, assigning GLIADEL[reg] wafer cases to DRG 528 would not 
produce a clinically coherent DRG because DRG 528 contains cases where 
craniotomy is performed as part of a vascular procedure with a primary 
diagnosis of hemorrhage, as in the case of a ruptured aneurysm. DRG 492 
is clinically inappropriate because it contains cases of acute leukemia 
treated with chemotherapy, and DRG 481 is clinically inappropriate 
because it contains cases involving bone marrow transplant. None of 
these DRGs contains cases of glioblastoma multiforme or other primary 
brain tumors. Therefore, in the May 18, 2004 proposed rule, we did not 
propose to adopt any of these changes.
    As discussed in the May 18, 2004 proposed rule, we also considered 
several other approaches to reassigning GLIADEL[reg] wafer cases in a 
manner that is appropriate both in terms of clinical coherence and 
resource use. For example, we considered the creation of a new DRG that 
includes GLIADEL[reg] wafer cases along with other types of local 
therapy for intracerebral malignant disease. Specifically, we 
considered the creation of a new DRG that includes GLIADEL[reg] wafers 
and a Gliasite Radiation Therapy System, a relatively new form of 
intracavitary brachytherapy. Such a DRG would be clinically coherent 
because it would contain cases of malignant brain tumors treated with 
local therapy. However, our analysis of existing FY 2003 MedPAR data 
suggested that such a DRG would probably not provide enhanced 
reimbursement for the GLIADEL[reg] wafer cases, and that, in fact, 
decreased reimbursement for GLIADEL[reg] wafer cases is a more likely 
result. Therefore, we did not propose a specific change. However, we 
stated that we would continue to monitor our data to determine whether 
a change is warranted in the future.
    We recognize that the implantation of chemotherapeutically active 
wafers for local therapy of malignant brain tumors represents a 
significant medical technology that currently offers clinical benefits 
to patients and holds out the promise of future innovation in the 
treatment of these brain tumors.
    In our proposed rule (69 FR 28221), we invited comments and 
suggestions regarding the appropriate DRG assignment for this 
technology.
    Comment: One comment agreed with the current DRG assignment of DRG 
1 or 2 for GLIADEL[reg] cases.
    Response: We appreciate the commenter's support for the current DRG 
assignment for these cases.
    Comment: Four commenters supported the reassignment of Gliadel[reg] 
cases to DRG 528 (Intracranial Vascular Procedure With a Principal 
Diagnosis of Hemorrhage). The commenters stated that the average cost 
of a patient receiving Gliadel[reg] chemotherapy wafer treatment is 
consistent with the average DRG 528 payments to providers. The 
commenters also believed that treatment using the Gliadel[reg] wafer is 
clinically consistent with the treatment under procedures currently 
assigned to DRG 528.
    Response: As we stated in the May 18, 2004 proposed rule (69 FR 
28222), we do not believe that the GLIADEL[reg] cases meet the clinical 
coherence criteria for inclusion in DRG 528. DRG 528 includes 
hemorrhage or ruptured cerebral aneursym cases. While the surgical 
approach may be similar to GLIADEL[reg], cases assigned to DRG 528 
involve patients who have an acute condition with a high severity of 
illness and a significantly higher rate of mortality during surgery 
than GLIADEL[reg] cases (20.6 percent for DRG 528 cases compared to 
3.15 for GLIADEL[reg] cases). In addition, the average charges for 
cases in DRG 528, approximately $97,540, are significantly higher than 
the average charges for GLIADEL[reg] cases in DRG 1, approximately 
$61,866. Thus, we do not believe that GLIADEL[reg] cases and those 
assigned to DRG 528 are clinically coherent and similar in resource 
use. We continue to believe that reassigning GLIADEL[reg] cases to DRG 
528 is inappropriate and would result in overpayment for GLIADEL[reg] 
cases.
    Comment: One commenter suggested that we reassign GLIADEL[reg] 
cases to DRG 528 for FY 2005 and eventually create a DRG for 
intracerebral therapies. The commenter proposed a new DRG that would 
include implantation of a chemotherapeutic agent and seven new drugs 
that are currently in FDA Phase II and III clinical trials and are 
expected to receive FDA approval in 2 to 5 years. According to the 
commenter, the new drugs are also indicated for glioblastoma multiforme 
and the mode of therapy is

[[Page 48959]]

chemotherapy, radiotherapy, or brachytherapy.
    Response: As we discussed above, we do not believe assignment to 
DRG 528 is appropriate. We review DRG assignments every year and will 
determine the appropriate assignment of the new technologies when it is 
appropriate to do so.
    Comment: Many commenters encouraged CMS to reassign Gliadel[reg] 
chemotherapy wafer treatment to a new or higher paying DRG. The 
commenters believed that higher payment would ensure access to life-
extending treatment for patients suffering from malignant brain tumors. 
These commenters offered no specific recommendations on reassignment of 
these cases to other DRGs.
    Response: In this final rule, we are creating a new DRG that would 
include implantation of chemotherapeutic agent (procedure code 00.10) 
cases or cases in which an acute complex central nervous system 
diagnosis was reported as the principal diagnosis. An example of an 
acute complex diagnosis is an intracranial abscess. GLIADEL[reg] 
chemotherapy wafer cases would be reassigned to this new DRG.
    Although we did not propose this specific solution to the issue of 
payment for GLIADEL[reg] in the proposed rule, we indicated that we 
would continue to consider appropriate changes to the DRG assignment of 
cases involving GLIADEL[reg]. Furthermore, we believe that the creation 
of a new DRG for cases involving implantation of a chemotherapeutic 
agent or cases with an acute complex central nervous system diagnosis 
as the principal diagnosis ensures that GLIADEL[reg] cases are assigned 
to a DRG that is clinically coherent and reflects the resources used to 
treat these cases and appropriately addresses the concerns of those 
commenters who raised questions regarding the DRG assignment for these 
cases.
    The new DRG 543 (Craniotomy with Implantation of Chemotherapeutic 
Agent or Acute Complex Central Nervous System Principal Diagnosis) is 
being placed in MDC 1. It was created from existing DRGs 1 and 2 
(Craniotomy Age >17 With and Without CC, respectively) by removing 
three types of patients based on their principal diagnosis. Therefore, 
new DRG 543 will contain patients who undergo a craniotomy procedure 
with a principal diagnosis belonging to one of the following three 
categories:
    1. Patients with a major central nervous system infection, such as 
bacterial meningitis, encephalitis, or an intracranial abscess.
    2. Patients with a subarachnoid hemorrhage, intracranial 
hemorrhage, or an acute stroke.
    3. Patients with central nervous system trauma resulting in brain 
laceration or brain injury associated with an open head wound.
    In addition, new DRG 543 will include cases involving treatment 
using chemotherapeutic agents and devices implanted in the brain, such 
as implantable chemotherapeutic wafers.
    The cases remaining in DRGs 1 and 2 will be the following types of 
patients:
    1. Patients with chronic central nervous system conditions such as 
malignancies, degenerative conditions, and cerebrovascular disease 
without acute infarct.
    2. Patients with subdural hematoma not associated with an open head 
wound.
    3. Patients with lesser degrees of central nervous system trauma, 
such as skull fracture or other injury but without brain laceration.
    Patients in new DRG 543 would, on average, consume more resources 
because they require greater pre-operative and post-operative care, and 
in many cases require more complicated operative procedures. The FY 
2003 MedPAR data for the new DRG includes 5,413 cases with overall 
average charges of approximately $63,409. These charges are similar to 
the current average charges for Gliadel[reg] cases in DRG 1 of 
approximately $61,866.
    For FY 2005, we will be implementing new DRG 543 with the following 
logic:
     Craniotomy procedure from DRGs 1 and 2 and procedure code 
00.10, Implantation of chemotherapeutic agent; or
     Craniotomy procedure from DRGs 1 and 2 and principal 
diagnosis of acute complex central nervous system listed below.

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BILLING CODE 4121-01-C
(3) DRG 3 (Craniotomy Age 0-17)
    In the May 18, 2004, proposed rule, we addressed a comment we had 
received stating concern that DRG 3 has not been reviewed, while DRGs 1 
and 2 have had some revisions. The commenter believed that, 
particularly with the removal of major trauma cases, age distinctions 
may no longer be significant for craniotomies and the other 
intracranial procedures classified in DRGs 1 through 3. The commenter 
stated that it may be more consistent, from both a clinical and 
resource perspective, to simply eliminate DRG 3 and redistribute the 
pediatric and juvenile cases to DRGs 1 and 2 based on the procedures 
performed and the complications or comorbidities present, instead. We 
stated that this analysis would require supplemental data from non-
MedPAR sources.
    We noted in the proposed rule that the primary focus of updates to 
the Medicare DRG classification system is on changes relating to the 
Medicare patient population, not the pediatric patient population. In 
the FY 2003 data, there were only two cases assigned to DRG 3. 
Therefore, we did not believe a proposal to address the commenter's 
request was warranted. We indicated that we are aware that the Medicare 
DRGs are sometimes used to classify other patient populations. We 
advised those non-Medicare systems that need a more up-to-date system 
to consider choosing from other systems that are currently in use in 
this country, or developing their own modifications.
    Comment: One commenter agreed that there does not appear to be a 
need to address DRG 3 at this time. However, the commenter noted that 
other payers, such as many Medicaid payers, reimburse based on DRG 
groupings and requested that we consider those payers when addressing 
proposed changes to the DRG system in the future.
    Response: For this final rule, we will not be making any changes to 
DRG 3. Decisions about the use of DRGs in Medicaid are made by the 
states. As we stated previously, the primary focus of our updates to 
the Medicare DRG classification system is on changes relating to the 
Medicare patient population.
b. Coronary Stent Procedures
    In the May 18, 2004, proposed rule, we addressed recommendations 
that we had received from several industry representatives about the 
DRG assignments for coronary artery stents. These representatives 
expressed concern about whether the reimbursement for stents is 
adequate, especially for insertion of multiple stents. They also 
expressed concern about whether the current DRG structure represents 
the most clinically coherent classification of stent cases.
    We received two comprehensive recommendations for refinement and 
restructuring of the current coronary stent DRGs. The current DRG 
structure incorporates stent cases into the following two pairs of 
DRGs, depending on whether bare metal or drug-eluting stents are used 
and whether acute myocardial infarction (AMI) is present:
     DRG 516 (Percutaneous Cardiovascular Procedures With AMI)
     DRG 517 (Percutaneous Cardiovascular Procedures With 
Nondrug-Eluting Stent Without AMI)
     DRG 526 (Percutaneous Cardiovascular Procedures With Drug-
Eluting Stent With AMI)
     DRG 527 (Percutaneous Cardiovascular Procedures With Drug-
Eluting Stent Without AMI)
    One of the recommendations involved restructuring these DRGs to 
create two additional stent DRGs that are closely patterned after these 
existing pairs and that would reflect insertion of multiple stents with 
and without AMI. The manufacturer recommended incorporating either 
stenting code 36.06 (Insertion of nondrug-eluting coronary artery 
stent(s)) or code 36.07 (Insertion of drug-eluting coronary artery 
stent(s)) when they are reported along with code 36.05 (Multiple vessel 
percutaneous transluminal coronary angioplasty [PTCA] or coronary 
atherectomy performed during the same operation, with or without 
mention of thrombolytic agent). The manufacturer expressed concern that 
hospitals are steering patients toward coronary artery bypass graft 
surgery in place of stenting in order to avoid significant financial 
losses due to what it considered the inadequate reimbursement for 
inserting multiple stents.
    We appreciated receiving the manufacturer's recommendation, and 
agree that the DRG classification of cases involving coronary stents 
must be clinically coherent and provide for adequate reimbursement, 
including

[[Page 48972]]

adequate reimbursement of cases requiring multiple stents. We also 
agree that the recommendation has some merits and deserves further 
study. However, as stated in the proposed rule, we believed that it was 
premature to act on this recommendation for two reasons. One reason is 
that the current coding structure for coronary artery stents cannot 
distinguish cases in which multiple stents are inserted from cases in 
which only a single stent is inserted. Current codes are able to 
identify performance of PTCA in more than one vessel by use of code 
36.05. However, while this code indicates that PTCA was performed in 
more than one vessel, its use does not reflect the exact number of 
procedures performed or the exact number of vessels treated. Similarly, 
when codes 36.06 and 36.07 are used, they document the insertion of at 
least one stent. However, these stenting codes do not identify how many 
stents were inserted in a procedure, nor distinguish insertion of a 
single stent from insertion of multiple stents. Even the use of one of 
the stenting codes in conjunction with multiple-PTCA code 36.05 does 
not distinguish insertion of a single stent from insertion of multiple 
stents. The use of code 36.05 in conjunction with code 36.06 or code 
36.07 indicates only performance of PTCA in more than one vessel, along 
with insertion of at least one stent. The precise numbers of PTCA-
treated vessels, the number of vessels into which stents were inserted, 
and the total number of stents inserted in all treated vessels cannot 
be determined. Therefore, the capabilities of the current coding 
structure do not permit the distinction between single vessel stenting 
and multiple vessel stenting that would be required under the 
recommended restructuring of the stenting DRGs.
    In addition, because the FDA approved drug-eluting stents for use 
in April 2003, the distinct DRGs for drug-eluting stents have only been 
effective for payment for a little over a year. The MedPAR file thus 
does not contain a full year of data with which to conduct the 
requisite analysis to evaluate the adequacy of the current structure of 
four stenting DRGs. In the proposed rule, we indicated that we would 
consider this recommendation as we evaluate the current DRG structure 
once adequate data on the current stenting DRGs become available. We 
also stated in the proposed rule that we believe it is still premature 
to undertake such a thorough restructuring of the stent DRGs.
    The second recommendation was that we transform the current 
structure of stenting DRGs into two new pairs of DRGs, reclassifying 
stenting cases according to whether bare metal or drug-eluting stents 
are used (as with the present DRGs) and whether the cases are 
``complex'' or ``noncomplex.'' The manufacturer indicated that complex 
cases are those that include certain comorbid conditions or procedural 
factors such as hypertensive renal failure, diabetes, AMI, and 
multivessel PCI. The manufacturer further indicated that this structure 
would provide an improvement in both clinical and resource coherence 
over the current structure that classifies cases according to the type 
of stent inserted and the presence or absence of AMI alone, without 
considering other complicating conditions. Specifically, the 
manufacturer recommended replacing the current structure with the 
following four DRGs:
     Recommended restructured DRG 516 (Complex percutaneous 
cardiovascular procedures with nondrug-eluting stents)
     Recommended restructured DRG 517 (Noncomplex percutaneous 
cardiovascular procedures with nondrug-eluting stents)
     Recommended restructured DRG 526 (Complex percutaneous 
cardiovascular procedures with drug-eluting stents)
     Recommended restructured DRG 527 (Noncomplex percutaneous 
cardiovascular procedures with drug-eluting stents)
    The manufacturer presented an analysis based on FY 2002 MedPAR 
data, in which it evaluated charges and lengths of stay for cases with 
expected high resource use, and reclassified cases into the recommended 
new structure of paired ``complex'' and ``noncomplex'' DRGs. The 
analysis shows some evidence of clinical and resource coherence in the 
recommended DRG structure. However, as we stated in the proposed rule, 
the analysis does not yet provide a convincing case for adopting the 
recommended restructure. First, the analysis does not reveal 
significant gains in resource coherence compared to existing DRGs for 
stenting cases. Second, the analysis is limited in assessing the 
feasibility of using the recommended DRG restructure versus the current 
DRG structure for classification of stent cases. Because the 
manufacturer used FY 2002 MedPAR data in its analysis, it was not able 
to compare the resource coherence of the recommended structure with the 
current structure of four DRGs, but only with the two DRGs that 
preceded the approval of drug-eluting stents. While the manufacturer 
asserted that ``similar results would be expected'' from a comparison 
between its recommended DRG restructure and the current DRG structure, 
we do not believe that it is advisable to undertake a critical DRG 
restructuring without examining the recommendation against actual 
experience under the current structure. As we stated in the proposed 
rule, we believe that this recommendation may have merit, and we will 
conduct a full analysis of the recommendation in comparison to the 
other recommendation for DRG revision and to the current DRG structure 
once adequate data become available.
    The drug-eluting stents had not yet been FDA approved when we 
calculated the relative weights for DRGs 526 and 527 for the FY 2003 
IPPS final rule. Therefore, in the absence of MedPAR data, we based our 
FY 2003 relative weight calculations on prices in countries where drug-
eluting stents were already being used. A full discussion of this 
process can be found in the FY 2004 IPPS final rule (68 FR 45370). For 
computation of the proposed relative weights for FY 2005 in the May 18, 
2004 proposed rule, we used the December update of FY 2003 MedPAR data. 
(As stated in the June 25, 2004 correction notice (69 FR 35921), there 
have been a total of approximately 11,084 cases in DRG 526, and 48,097 
cases in DRG 527, with adjustments made for transfers to other 
facilities.) For computation of the final FY 2005 relative weights, we 
are using the March FY 2004 update of the FY 2003 MedPAR data file for 
cases in these two DRGs. No foreign data have been used to compute the 
relative weights for DRGs 526 and 527 in FY 2005.
    We received a number of comments concerning coronary stents, both 
bare and drug-eluting in response to the May 18, 2004, proposed rule. 
As noted above, we had discussed two external recommendations for 
refinement or restructuring of the current coronary stent DRGs (69 FR 
28222). At that time, we indicated that we believed that arguments for 
change might have merit. However, as there was not an adequate database 
upon which to structure a DRG revision, and because the two proposals 
were so dissimilar, we indicated that we would continue to monitor the 
coronary stent DRGs and would review the DRG structure once adequate 
data became available. We will continue to review the data carefully 
and will assess whether a revised DRG structure is appropriate when we 
have more than 11 months of data experience. The FDA approved the drug-
eluting stent for use in April 2003. Therefore, our MedPAR payment data 
collection began at that time.

[[Page 48973]]

    Comment: Two commenters supported the complex vs. noncomplex case-
mix DRG pairs option. The commenters suggested that the complexities be 
based on diagnoses of congestive heart failure, cerebral vascular 
disease, renal failure, AMI, and the presence of a multiple vessel 
procedure. (We believe that the commenter intended the latter 
complexity to be the presence of code 36.05 (Multiple vessel 
percutaneous transluminal coronary angioplasty [PTCA] or coronary 
atherectomy performed during the same operation, with or without 
mention of thrombolytic agent) in the same inpatient episode.)
    Response: We take this opportunity to clarify that we did not offer 
a choice between two options in the proposed rule. We discussed the two 
options that had been suggested to us. However, we determined that it 
was premature to undertake a thorough restructuring of the four current 
stent DRGs, both because the recommendations differed so completely 
from each other and because we lacked data of adequate historical 
duration with which to make a comprehensive analysis.
    We note that FDA is in the process of determining the efficacy of 
drug-eluting stents in high-risk patient clinical trials, and acute 
myocardial infarction (AMI) has been identified as one of the high-risk 
triggers. We do not believe it is appropriate to further use high-risk 
triggers such as AMI to structure the stent DRGs until FDA's work is 
complete.
    Comment: One commenter recommended restructuring of the four 
existing stent DRGs (DRG 516, 517, 526, and 527) by complex and 
noncomplex components. Specifically, the commenter suggested replacing 
the existing DRG structure that distinguishes between ``with and 
without AMI'' and the presence of bare or drug-eluting stents with a 
structure distinguishing between ``with and without complexity.'' In 
performing its analysis, the commenter reviewed charges within each of 
the four stent DRGs and then stratified the cases into groups with and 
without the following comorbidities or procedural characteristics: a 
principal diagnosis of AMI, or any secondary diagnosis of congestive 
heart failure, renal failure, cerebrovascular disease, or cases 
including code 36.05, reflecting multiple vessel procedure. The 
commenter classified cases with the above characteristics as 
``complex'' and cases without these characteristics as ``noncomplex.''
    The commenter included the following table for comparison purposes:
    [GRAPHIC] [TIFF OMITTED] TR11AU04.023
    
    The commenter's conclusion was that a diagnosis of AMI, by itself, 
was not an accurate reflection of the most resource-intensive 
procedures associated with coronary stenting.
    Response: We appreciate the considerable thought and study that 
went into the analysis that was submitted. However, in reviewing the 
comparison, we identified the similarities of the mean charges between 
the current DRGs and the proposed complex DRGs, and the fact that in 
every single comparison, the mean charges go down in the complex DRGs. 
For example, according to the table, current DRG 516 has mean charges 
of $41,788, while the proposed complex revision of DRG 516 has mean 
charges of $41,762. This is a decrease of $26. Also, current DRG 526 
has mean charges of $51,746, while the proposed complex revision of DRG 
526 has mean charges of $51,054. This is a decrease of $692. These 
results indicate to us that the current DRG structure is accurate in 
terms of resource consumption.
    In addition, we note that under the commenter's proposal, the 
number of cases in the complex DRG categories, while the number of 
noncomplex cases decreases. There would be a shift in the number of 
cases per DRG, but each case would have lower average charges per case, 
which would reduce the relative weight of all four DRGs. We are 
hesitant to adopt this approach, given the comments and concerns that 
reimbursement for stenting procedures is already under funded.
    Comment: One commenter supported our proposal to maintain temporary 
DRGS 526 and 527.
    Response: We appreciate the commenter's support of these temporary 
DRGs. In the FY 2003 IPPS final rule (67 FR 50004), we stated that we 
expect that when claims data are available that reflect the use of 
drug-eluting stents, we would combine drug-eluting stents cases with 
other stent cases in DRGs 516 and 517. A change of that nature would be 
subject to an analysis of the claims data to determine whether these 
data reflect a significant reduction in the use of bare stents, due to 
the overwhelming industry acceptance of the more efficacious drug-
eluting stent. At this time, with only 11 months of claims data, we 
believe that changes to these DRG pairs would be premature. We will 
continue our analysis and monitor the data for these cases.
    Comment: One commenter expressed concern that the relative weights

[[Page 48974]]

published in Table 5 of the Addendum to the proposed rule (69 FR 28642) 
were inadequate to cover the costs of procedures involving this 
technology and might provide financial incentives for hospitals to use 
less effective technologies (such as bare metal stents) or more 
invasive coronary artery bypass graft (CABG) procedures for Medicare 
beneficiaries.
    Response: We note that the relative weights listed in Table 5 of 
the proposed rule are based on MedPAR hospital charge data as of the 
December 2003 update of the files, which were not as complete for FY 
2003 as the data are now. The relative weights in this final rule are 
based on the March FY 2004 update of the FY 2003 MedPAR file, and 
reflect a more comprehensive picture of hospital charges. The final 
weight for DRG 516 is 2.6457, for DRG 517 is 2.1106, for DRG 526 is 
2.9741, and for DRG 527 is 2.3282.
    We also point out that the DRG base rate computed using relative 
weights is only part of the formula used to determine what each 
hospital is paid for each case. Additional payment is made to each 
hospital based on its unique structure, including indirect medical 
education, area wage levels, disproportionate share adjustment, and any 
applicable cost-of-living adjustments in Alaska and Hawaii. Hospitals 
may also receive outlier payments for certain cases involving 
extraordinary high costs.
    We are concerned by the comment regarding the provision of CABG 
procedures when less appropriate to the patient than drug-eluting 
therapy. One commenter believed the conversion from CABG to drug-
eluting stent therapy has already begun and cited MedPAR data to prove 
its point. These data show that during the first quarter of full drug-
eluting stent availability (July, August, and September 2003), Medicare 
CABG discharges declined 9.3 percent from the same quarter in the 
previous year. The commenter also noted a corresponding increase in 
stenting procedures.
    In addition, it has come to our attention that there may be some 
coding errors that are contributing to an erroneous data and 
reimbursement case-mix profile for hospitals. Specifically, it has been 
suggested that some hospitals may be reluctant to include a code for 
vessel angioplasty in conjunction with stent placement. Apparently some 
hospital staff have expressed concerns that a ``true'' angioplasty is 
not being performed, and that they will therefore be censured by 
regulatory agencies for erroneous coding. Therefore, these hospitals 
have instructed their coding staff not to include a code describing 
angioplasty of a vessel and only to include a code for insertion of a 
stent or stents.
    This action is not proper. The AHA publication, Coding Clinic for 
ICD-9-CM, Fourth Quarter, 1996, specifically instructs that a code for 
angioplasty, by any technique, be used when an angioplasty is performed 
in the placement of a stent or stents (page 63). Therefore, the correct 
coding for insertion of coronary stent(s) requires two codes. One code 
describes the angioplasty: 36.01 (Single vessel percutaneous 
transluminal coronary angioplasty [PTCA] or coronary atherectomy 
without mention of thrombolytic agent); 36.02 (Single vessel 
percutaneous transluminal coronary angioplasty [PTCA] or coronary 
atherectomy with mention of thrombolytic agent); or 36.03 (Open chest 
coronary artery angioplasty, or 36.05. The second code describes which 
stent was inserted: either 36.06 (Insertion of non drug-eluting 
coronary artery stent(s)) or 36.07 (Insertion of drug-eluting coronary 
artery stent(s)). Failure to record the angioplasty procedure will 
result in assignment of the case to the medical DRG instead of the 
correct surgical DRG. This erroneous coding action will have an impact 
on many levels. It will result in incorrect data in the database, which 
in turn will result in an erroneous base upon which future DRG relative 
weights are calculated. In addition, in the short term, it will result 
in reduced revenue to the hospitals because of the incorrect DRG 
assignment for all cases in which incorrect coding occurs.
    Comment: One commenter indicated that there is a disincentive for 
the insertion of multiple drug-eluting stents placed during the same 
inpatient admission. This commenter indicated that there might be 
pressures on physicians to bring patients back for an additional stent 
procedure on a subsequent admission. Another commenter suggested that, 
as an interim approach, code 36.05 be used as a trigger for DRG 
assignment to a newly created DRG, or act as a trigger for an add-on 
payment for each stent. The commenter's justification for this 
suggestion was that, because current medical practice indicates that 
over 85 percent of balloon angioplasties currently involve a concurrent 
insertion of a stent, code 36.05 could serve as a good surrogate code 
until such time as new codes are created and available for use.
    Response: One of the suggestions received that we discussed in the 
proposed rule recommended that two new DRGs be created based on 
multiple-vessel procedures with drug-eluting stent(s) and the presence 
or absence of an AMI. The suggester's argument was that the presence of 
code 36.05, which shows treatment of multiple vessels, also indicates 
that more than one stent was inserted. We considered this assertion in 
the proposed rule because we recognize that current ICD-9-CM codes do 
not adequately describe the insertion of more than one stent. However, 
as we discussed in the proposed rule, we believe that the presence of 
code 36.05 only indicates that more than one vessel was surgically 
treated. It does not indicate that more than one stent was placed in 
all cases. We reiterate that no conclusions can be drawn regarding the 
number of stents inserted based upon the number of vessels treated. 
Therefore, we are not prepared to make DRG adjustments based on the 
commenter's assertion. In addition, we are not prepared to assume that 
the presence of code 36.05 is solely responsible for any higher charges 
associated with these cases.
    We do believe that there is a need to further identify the 
insertion of multiple stents and will work with industry 
representatives to conceptualize the most appropriate ICD-9-CM 
procedure code or codes to capture this data. The topic of a new code 
or codes for multiple stent insertion will be addressed at the October 
7, 2004 ICD-9-CM Coordination and Maintenance Committee meeting at CMS' 
headquarters in Baltimore, MD.
    Comment: One commenter expressed concern about the implication of 
maintaining separate and distinct DRGs for drug-eluting stents and 
encouraged CMS to consider fully the impact on less expensive 
technologies, such as intravascular brachytherapy (IVBT). IVBT is the 
use of vascular radiation delivered inside an artery to reduce the 
incidence of restenosis. The commenter noted that the DRG system should 
not create financial incentives to use drug-eluting stents when the 
clinical outcomes and costs of other treatments are similar or better 
in the appropriate patient populations.
    Response: As we have stated above in response to other comments, in 
the absence of more complete data and without thorough evaluation, we 
are reluctant to undertake any restructuring of these four DRGs (516, 
517, 526, and 527) for FY 2005. Therefore, these DRGs will continue to 
be structured as they currently are. In the upcoming fiscal year, as in 
the past, we will be closely monitoring our own data, outside data, and 
any FDA decision on the efficacy of stent placement in a high-risk AMI 
population. We will also consider

[[Page 48975]]

alternative therapies, such as IVBT, as part of that process.
c. Severe Sepsis
    In the May 18, 2004, proposed rule, we addressed a comment we had 
received that recommended a separate DRG be assigned to the diagnosis 
of severe sepsis. Patients admitted with sepsis currently are assigned 
to DRG 416 (Septicemia Age > 17) and DRG 417 (Septicemia Age 0-17) in 
MDC 18 (Infectious and Parasitic Diseases, Systemic or Unspecified 
Sites). The commenter contended that the costs of caring for patients 
with severe sepsis exceed those costs associated with other types of 
sepsis. Therefore, the commenter indicated, severe sepsis should be 
given a separate, unique DRG. Furthermore, the commenter requested that 
all cases in which severe sepsis is present on admission, as well as 
those cases in which it develops after admission (which are currently 
classified elsewhere) be included in this new DRG. The commenter 
suggested using various coexisting conditions and their corresponding 
ICD-9-CM codes (for example, respiratory failure or hypotension and 
renal failure) to identify patients with severe sepsis. The conditions 
suggested do not describe a clinically coherent set of patients that 
have severe sepsis. Using this list of conditions would erroneously 
identify patients as having severe sepsis.
    We acknowledge the high costs of caring for seriously ill patients 
with sepsis. However, we do not find, from a clinical perspective, that 
a subset of patients with severe sepsis exists to the degree that a 
separate DRG classification is justified. Sepsis in all forms is quite 
common across many DRGs in the Medicare population. In addition, we do 
not believe that the commenter's suggested defining criteria for severe 
sepsis are specific, accurate, or unique enough to warrant a new DRG 
classification. Therefore, in the May 18, 2004, proposed rule, we did 
not propose any change to the current DRG structure for sepsis.
    Comment: Several commenters agreed with our proposal not to create 
a new DRG for severe sepsis. Some of the commenters mentioned coding 
problems that exist with new codes 995.90 through 995.94 that were 
created to capture Systemic Inflammatory Response Syndrome (SIRS). The 
commenters acknowledged that the codes were specifically created to 
capture severe sepsis. However, they indicated that there has been much 
confusion among coders in their use. The commenters mentioned coding 
notes included in the ICD-9-CM book that appear to be contradictory. 
The commenters agreed that it was not appropriate to modify the DRGs at 
this time, given the uncertainty about the use of the SIRS codes and 
the accuracy of the reported data.
    One commenter recommended continued monitoring of the population 
with severe sepsis in the future. Another commenter supported our 
proposal not to create a new DRG for severe sepsis, given the data and 
information provided.
    Response: We agree with the commenters that there has been 
confusion in the correct use of the SIRS codes based on use of the ICD-
9-CM code book. The related section of the ICD-9-CM code book is being 
revised on October 1, 2004, to help resolve this confusion. Additional 
coding instructions are also being developed on the correct use of 
these codes. These instructions will be published in the American 
Hospital Association's Coding Clinic for ICD-9-CM. These actions should 
lead to more consistency in identifying and reporting cases of severe 
sepsis. Once this information is available, CMS will review the data to 
determine any needed modifications to the DRG to better capture severe 
sepsis. We agree with the commenters that we should not create a new 
DRG for severe sepsis based on the currently available data, and that 
we should continue to monitor the population with severe sepsis in 
order to better characterize resource utilization in these patients.
    Comment: One commenter expressed disagreement with our decision not 
to modify the DRGs to capture severe sepsis. The commenter asserted 
that using the accepted definition of severe sepsis--``a systemic 
inflammatory response to infection associated with acute organ 
dysfunction''--was adequate to identify patients for the purpose of 
creating new DRGs. The commenter also asserted that severe sepsis is 
common, deadly, and costly; that it involves extensive use of intensive 
care unit resources; and that it is inadequately represented by the use 
of ICD-9-CM procedure code 00.11(Infusion of diotrecogin alfa 
(activated)).
    Response: We agree with the commenter that severe sepsis is a 
common, deadly, and costly clinical entity. We also acknowledge that 
the current coding for all forms of sepsis is problematic. We believe 
that the creation of code 00.17 (Infusion of vasopressor agent), which 
goes into effect on October 1, 2004, in combination with code 00.11 and 
the SIRS codes 995.90 through 995.94, will help to better identify 
patients with severe sepsis. We also note, as mentioned above, that 
improved and modified coding instructions and guidelines will be 
available in October 2004. However, we continue to believe that a 
separate DRG for severe sepsis is not appropriate at this time based on 
the available data. We believe that the defining criteria for severe 
sepsis, using the currently available ICD-9-CM codes, are not specific, 
accurate, or unique enough to warrant a new DRG classification. 
However, we anticipate receiving data using the new and modified codes 
and instructions and will consider this issue again in the future.
    Comment: One commenter disagreed with our decision not to create a 
new DRG for severe sepsis. The commenter urged CMS to ``recognize 
severe sepsis as a clinically coherent condition associated with high 
mortality and a patient population displaying similar characteristics 
in terms of outcome and costs incurred for treatment, which thereby 
deserves its own DRG.'' The commenter asserted that the current DRG for 
sepsis uses the clinically obsolete term ``septicemia.'' The commenter 
also stated that severe sepsis cases now classify to 339 different 
DRGs; however, these DRGs do not distinguish between cases with and 
without severe sepsis. The commenter believed that payment for cases in 
which severe sepsis occurs is inadequate and urged us to work closely 
with the Critical Care Work Group in the development of a new DRG.
    Response: We agree with the commenter that severe sepsis cases fall 
into a wide spectrum of DRGs, and therein lies the problem. The ICD-9-
CM coding system has lacked the requisite specificity and accuracy 
needed to identify patients with severe sepsis. While new codes were 
created specifically for this purpose (codes 995.90 through 995.94), 
coders have had difficulty in consistently using the codes. We have 
worked closely with the Centers for Disease Control and Prevention to 
make refinements to the coding notes and instructions so that these 
codes can be more consistently applied. These revised notes and 
instructions will go into effect on October 1, 2004. We believe that 
when more consistent data are submitted, we will have the necessary 
information to propose further refinements in the DRGs to better 
capture severe sepsis. As mentioned before, CMS will closely monitor 
the classification of patients with severe sepsis in the near future, 
particularly with regard to the use of other codes commonly reported 
for patients with severe sepsis such as new

[[Page 48976]]

code 00.17 (Infusion of vasopressor agent) and code 00.11 (Infusion of 
diotrecogin alfa (activated)). We will also work closely with the 
American Hospital Association and the American Health Information 
Management Association on their efforts to provide education to coders 
in the correct use of the severe sepsis codes (SIRS codes 995.90 
through 995.94).
    Comment: One commenter believed that CMS was shortsighted in its 
failure to create a new DRG for severe sepsis. The commenter also noted 
that severe sepsis is a widespread and deadly disease that has been 
defined since 1992, and that severe sepsis cases currently classify 
into 339 DRGs. The commenter asserted that grouping these cases 
together in at least one DRG would enhance hospitals and practitioners' 
ability to understand the disease and its treatment as well as to 
evaluate the costs of care. This commenter further asserted that only a 
small proportion of patients with severe sepsis and organ dysfunction 
are assigned to DRG 416 (Septicemia Age >17) and DRG 417 (Septicemia 
Age 0-17), and that a large number of surgical cases with severe sepsis 
are ignored. The commenter also noted that cases of severe sepsis that 
develop after admission typically are classified in other DRGs.
    This commenter mentioned the set of proposed criteria put forth by 
another commenter to define severe sepsis (``a systemic inflammatory 
response syndrome associated with organ dysfunction, hypoperfusion, or 
hypotension'') and asserted that this definition has been widely 
accepted within the international clinical community, that it is 
encompassed by code 995.92 (Systemic inflammatory response syndrome due 
to infectious process with organ dysfunction), and that it should be 
used to identify patients for classification to a new DRG.
    Response: As mentioned earlier, we recognize that severe sepsis is 
a widespread and deadly disease that accompanies a wide spectrum of 
other diagnoses. We also recognize that it frequently develops after 
admission, and that it is a frequent complication of surgical cases. In 
addition, we recognize that current coding practices are problematic, 
and we look forward to better refining our ability to identify patients 
with severe sepsis by using codes 00.11 and 00.17 and the SIRS series 
of codes. We look forward to working with groups represented by the 
commenters in the future to optimize the DRG system to best serve this 
important Medicare patient population.
d. Implantable Cardiac Defibrillators
    There is a range of implantable cardiac defibrillators (ICDs) 
available on the market from extremely complex devices with multiple 
leads, settings, and functions to simpler models with a single lead and 
simpler functions. ICDs deliver electrical shocks to the heart to 
eliminate the life-threatening abnormal rhythms such as ventricular 
fibrillation or ventricular tachycardia.
    As indicated in the May 18, 2004, proposed rule, we received a 
coverage request to expand the indications for implantable 
defibrillators to include the population studied in the Sudden Cardiac 
Death in Heart Failure Trial (SCD-HeFT) sponsored by the National 
Institutes of Health. SCD-HeFT treated heart failure patients with 
conventional therapy and randomized them to one of three additional 
treatment strategies: (1) Placebo; (2) amiodarone (drug therapy); or 
(3) single lead implantable defibrillator. The SCD-HeFT investigators 
presented results at the American College of Cardiology annual meeting 
that the basic single-lead implantable defibrillator is effective for 
saving lives in a population at low-moderate risk for sudden cardiac 
death. As part of CMS' coverage decisions, we are considering whether 
to restrict the use of complex defibrillators to patients for whom they 
are medically necessary, that is, the population at low-moderate risk 
for sudden cardiac death.
    Given the potential increase of implantable defibrillator use in 
our population, in the May 18, 2004, proposed rule, we solicited input 
on how to encourage physicians to use the simpler, less costly device 
when advanced devices are not medically preferred. We also solicited 
input on the appropriate measures within the payment systems to 
accommodate payment for classes of defibrillators with very different 
costs. Ideally, we would like not only to align payments with relative 
costs, but also to align the incentives within the payment system with 
medically appropriate uses of different technologies.
    We believe that, within the PPS for inpatient hospital operating 
costs, there are several ways to deal with the expanding use of 
simpler, lower cost defibrillators. One possibility is to maintain the 
current DRG configuration, under which complex, expensive devices and 
simpler, less costly devices would remain within the same DRGs and 
receive the same payment rates. This approach would encourage use of 
the simpler devices, which would receive relatively higher 
reimbursement because their lower charges would be averaged in with the 
higher charges for the more complex devices in setting the DRG weights. 
However, it could lead to complaints that the program is underpaying 
for the more complex, expensive devices as the lower charges for 
simpler, less expensive devices begin to affect (lower) the DRG 
weights.
    Another approach would be to recognize the cost differences between 
various classes of defibrillators by establishing separate DRGs for 
basic single-lead implantable defibrillators as opposed to more 
complex, expensive models. This approach would prevent payments for the 
use of more expensive defibrillators (where medically necessary) from 
being diluted by the effect of the lower charges for basic single-lead 
implantable defibrillators on the weights within common DRGs. However, 
this policy would arguably provide less incentive for use of the lower 
cost devices: the weights for the DRGs containing the less expensive 
devices would be driven solely by their relatively lower charges, 
without being lifted by the higher charges for the more expensive 
models. This approach might also be criticized for departing from the 
averaging principle within the DRG system by basing too much on the 
cost differential alone in reconfiguring these DRGs.
    We solicited comments on these and other approaches to paying for 
defibrillators under the IPPS. We discuss an application for new 
technology add-on payments for a Cardiac Resynchronization Therapy with 
Defibrillator (CRT-D) in section II.E.4.c. of this final rule. We 
discuss comments regarding payments for these devices in that section.
e. Intestinal Transplantation
    Even though we did not address the issue of DRG payment for 
intestinal transplantation in the May 18, 2004, proposed rule, we 
received a comment from an institution that performs intestinal 
transplantation.
    Comment: The commenter expressed concern that the current payment 
policy utilizes a relatively low weight DRG that imposes a significant 
financial burden on health care providers. The commenter requested a 
new DRG for each of three main types of intestinal transplantation: 
isolated intestine, liver plus intestine, and multivisceral (liver, 
stomach, duodenum, pancreas, and small bowel).
    Due to the small patient population associated with these 
transplantations, the commenter suggested that CMS lower the number of 
cases required to create a new DRG. In addition, the commenter 
suggested that CMS utilize

[[Page 48977]]

data on non-Medicare patients and the pediatric population to 
supplement current MedPAR data.
    Response: We have been monitoring intestinal transplantation cases 
since October 2000, when Medicare issued a national coverage decision 
for this transplant, to determine whether it may be appropriate to 
establish a new DRG. An ICD-9-CM procedure code 46.97 (Transplant of 
intestine) was created in October 1, 2000, to uniquely capture isolated 
intestinal transplantation. Acquisition cost centers were established 
for intestines and multivisceral organs to be paid on a reasonable cost 
basis. Based on our past annual reviews, we did not find a sufficient 
number of cases to warrant the creation of a new DRG. The commenter 
provided some rationale for the absence of cases, including the time 
lag between the actual transplant date and the submission of the bill 
and the limited patient population involved.
    If an intestinal transplantation alone is performed on a patient 
with a principal diagnosis in MDC 6 (Diseases and Disorders of the 
Digestive System), the case would be assigned to either DRG 148 (Major 
Small & Large Bowel Procedures With CC) or DRG 149 (Major Small & Large 
Bowel Procedures Without CC). If an intestinal transplantation was 
performed and the patient required a tracheostomy, the case would be 
assigned to DRG 483 (Tracheostomy With Mechanical Ventilation 96+ Hours 
or Principal Diagnosis Except Face, Mouth & Neck Diagnosis). In cases 
where multiple surgical procedures are performed, the case is assigned 
to the DRG associated with the most resource-intensive surgical class. 
If an intestinal and liver transplantation were performed 
simultaneously, the case would be assigned to DRG 480 (Liver 
Transplant). It is not uncommon that a liver transplant would be 
performed with an intestinal transplant. If a multivisceral 
transplantation is performed, the case is also assigned to DRG 480.
    Based on our review of the FY 2003 MedPAR data, we identified six 
cases with procedure code 46.97 all performed at one facility. We are 
concerned that only one facility's data is contained in the MedPAR file 
when there are five Medicare-approved intestinal transplant centers. Of 
the six cases, three cases were assigned to DRG 148, with total charges 
ranging from $839,802 to $903,518 and an average length of stay of 36 
days. Two cases were assigned to DRG 483. One case was assigned to DRG 
154 (Stomach, Esophageal, & Duodenal Procedures Age >17 With CC) 
because, in addition to the intestinal transplantation, there was 
another operation on the stomach. The total charge for the one case in 
DRG 154 was $1,105,627, with a length of stay of 32 days.
    We are open to receiving non-MedPAR data but would limit the data 
to Medicare patients, rather than using non-Medicare data as suggested 
by the commenter. We believe that, if we received data from the five 
approved intestinal transplant centers regarding all Medicare patients 
receiving intestinal transplantations during the fiscal year, the 
minimum requirement of cases may be met. When we receive sufficient 
data, we will again consider a separate intestinal transplant DRG.
    We agree that payment for isolated intestinal transplant is too low 
in DRGs 148 and 149. The average payments for DRGs 148 and 149 are 
approximately $15,314 and $6,567, respectively. As mentioned earlier, 
it is not uncommon for an intestinal transplant to be performed in 
conjunction with transplants of other organs, such as the liver. As a 
matter of fact, intestinal transplants are assigned to DRG 480 now 
since these patients frequently have both an intestinal transplant and 
a liver transplant. Therefore, DRG 480 already contains cases with 
intestinal transplants. Therefore, we would not be disrupting the 
clinical cohesiveness of DRG 480 by adding intestinal transplant.
    Furthermore, intestinal transplantation has become a definitive 
treatment for patients with short gut syndrome and intestinal diseases 
who no longer can be maintained on total parenteral nutrition (TPN). 
Liver failure may be induced by TPN. The average charges for DRG 480 
are approximately $157,129. While the total charges for intestinal 
transplantation are higher than the average charges for DRG 480, we 
believe that DRG 480 is a better assignment of these cases.
    Given this practice, we are moving intestinal transplantation cases 
out of DRGs 148 and 149 and into DRG 480 (Liver Transplant), effective 
FY 2005. ICD-9-CM procedure code 46.97 will be assigned to pre-MDC, DRG 
480. The title for DRG 480 will change to ``Liver Transplant and/or 
Intestinal Transplant''. The result of this reassignment would move 
intestinal transplant cases from a weight of 3.3871 in DRG 148 and 
1.4352 in DRG 149 to a weight of 9.8696. We are aware that, with this 
change, the three main types of intestinal transplantation; isolated 
intestine, liver plus intestine, and multivisceral, will be assigned to 
DRG 480. We will continue to monitor intestinal transplantation to 
determine appropriate assignment of these cases.
f. Cochlear Implants
    Even though we did not specifically address issues relating to the 
DRG payment for cochlear implants in the May 18, 2004, proposed rule, 
we received public comments on this area.
    Comment: One commenter expressed concern about the low 
reimbursement for cochlear implants. Cochlear implants are currently 
assigned to DRG 49 (Major Head and Neck Procedures). The commenter 
stated that cochlear implants represent the only procedure in DRG 49 
involving implantation of a high cost medical device. It was stated 
that the acquisition cost alone represent 85 percent of the total cost 
of the procedure. The commenter noted that although CMS has 
acknowledged the disparity between payment and cost and vowed to 
further evaluate possible reclassification options for cochlear 
implants, nothing has been done to mitigate this payment shortfall.
    Response: Although cochlear implants was not addressed in our May 
18, 2004 proposed rule, we have continued to monitor these cases. In 
our analysis of the FY 2003 MedPAR file, we found 120 cochlear implant 
cases with average charges of approximately $44,366. There were a total 
of 1,602 cases assigned to DRG 49 with average charges of approximately 
$24,971. Cochlear implant cases represent more than 7 percent of the 
total cases in DRG 49.
    We have been unable to identify an alternative DRG assignment for 
these cases. As we discussed in the August 1, 2003, final rule (68 FR 
45367), we continue to believe that assignment of cochlear implant 
cases to DRG 482 (Tracheostomy for Face, Mouth and Neck Diagnoses) is 
inappropriate. A tracheostomy must be performed in order for the case 
to be assigned to this DRG. We remain reluctant to create a new DRG for 
specific, low-volume procedures. Doing so would create a proliferation 
of DRGs and a loss of some of the efficiency incentives inherent in the 
current system.
g. Artificial Hearts
    Comment: One commenter requested that newly created procedure codes 
37.52 (Implantation of total replacement heart system), 37.53 
(Replacement or repair of thoracic unit of total replacement heart 
system), and 37.54 (Replacement or repair of other implantable 
component of total replacement heart system) be assigned to DRG 103 
instead of DRG 525.

[[Page 48978]]

    Response: Codes 37.52, 37.53, and 37.54 are not new codes. They 
were created for the October 1, 2003 ICD-9-CM update. In the proposed 
rule, CMS discussed the restructuring of DRG 525 (69 FR 28208) and 
further listed the codes that were included in that DRG. Codes 37.52, 
37.53, and 37.54 are part of that list. We did not propose the addition 
of codes 37.52, 37.53, or 37.54 to DRG 525 for FY 2005. These codes 
were assigned to DRG 525 upon their formation, as it is our practice to 
assign all codes to DRGs when they are created. We take this 
opportunity to note that Medicare does not cover the use of an 
artificial heart as a permanent replacement for a human heart or as a 
temporary life-support system until a human heart becomes available for 
transplant. Therefore, we believe that a DRG reassignment would be 
inappropriate at this time. No DRG assignment changes will be made to 
codes 37.52, 37.53, or 37.54 for FY 2005.
h. Left Atrial Appendage Devices: DRG Assignment for New Code 37.90
    The issue of the DRG assignment of new code 37.90 (Insertion of 
left atrial appendage device) was not presented as a topic in the May 
18, 2004, proposed rule. At the April 1, 2004, ICD-9-CM Coordination 
and Maintenance Committee meeting, we discussed these devices. A new 
code was created for use in upcoming clinical trials and was fast-
tracked so that the code could be used beginning October 1, 2004, for 
discharges for FY 2005. The new code is listed in Table 6B of the 
Addendum (69 FR 28672 in the proposed rule). Table 6B represents a 
listing of approved final new codes. The codes themselves are not 
subject to comment but their assignment regarding placement as an O.R. 
procedure and the MDC and DRG placement are open to comment. As 
discussed elsewhere in this preamble, the announcement of the adoption 
of the codes as final in the IPPS proposed rule is included in the ICD-
9-CM Coordination and Maintenance Committee meeting process.
    Background: Atrial fibrillation is a common heart rhythm disorder 
that can lead to cardiovascular blood clot formation leading to 
increased risk of stroke. According to product literature, nearly all 
strokes are from embolic clots arising in the left atrial appendage of 
the heart; an appendage for which there is no useful function. Standard 
therapy uses anticoagulation drugs. However, these drugs may be 
contraindicated in certain patients and may cause complications such as 
bleeding. The underlying concept behind the left atrial appendage 
device is to block off the left atrial appendage so that blood clots 
formed therein cannot travel to other sites in the vascular system. The 
device is implanted using a percutaneous catheter procedure under 
fluoroscopy through the femoral vein. Implantation is performed in a 
hospital catheterization laboratory using standard transseptal 
technique, with the patient generally under local anesthesia. The 
procedure takes approximately one hour, and most patients stay 
overnight in the hospital.
    We received several comments concerning the proposal to assign new 
code 37.90 to DRG 518 (Percutaneous Cardiovascular Procedure Without 
Coronary Artery Stent or AMI).
    Comment: All of the commenters discussed the surgical technique 
required for insertion of the device and cited the risk and complexity 
of the procedure, especially due to the transseptal catheterization 
required. The commenters noted that because comparatively simple 
procedures are already grouped to DRG 518, DRG 518 does not reflect the 
resources used in this procedure. The commenters suggested that 
insertion of a left atrial appendage device more closely resembles the 
insertion of an atrial septal defect occluder.
    Response: Insertion of an atrial septal defect occluder would be 
coded to the 35.xx series of ICD-9-CM procedure codes. DRG 108 includes 
code 35.52 (Repair of atrial septal defect with prosthesis, closed 
technique) which may be similar to insertion of the left atrial 
appendage device. Codes in the 35.xx series are assigned to DRG 108 
(Other Cardiothoracic Procedures). We reviewed the MedPAR data and 
found the following:
[GRAPHIC] [TIFF OMITTED] TR11AU04.024

    Because code 37.90 was created for use beginning on October 1, 
2004, we have no data history regarding its utilization. However, given 
that the atrial appendage device is percutaneously inserted, and that 
most of the procedures in DRG 108 are open chest procedures, we do not 
believe that DRG 108 is the most appropriate clinical placement for new 
code 37.90. In addition, review of the data in the table above shows a 
large variance between the hospital charges and length of stay between 
DRG 518 and DRG 108. According to one manufacturer, the projected 
length of stay for insertion of an atrial appendage is overnight for 
observation purposes. The many open chest procedures in DRG 108, some 
requiring the use of cardiopulmonary bypass, would also seem to 
indicate that DRG 108 is not the best choice for clinical coherence. We 
are disinclined to assign this new code to such a resource intensive 
DRG without appropriate data to reinforce and justify such a decision. 
Therefore, we are maintaining the assignment of code 37.90 to DRG 518 
in this final rule.
    Review of code 35.52 (Repair of atrial septal defect with 
prosthesis, closed technique) in the table above shows a decided 
similarity to the cases found in DRG 518. We will analyze the placement 
of code 35.52 as part of next year's proposed rule. We will analyze 
these cases for both clinical coherence and charge data as part of the 
process of identifying the most appropriate DRG assignment for code 
35.52.
i. Carotid Artery Stents
DRG Assignment for New Codes
    At the April 1, 2004, ICD-9-CM Coordination and Maintenance 
Committee meeting, we discussed creation of a new code or codes to 
identify carotid artery stenting, along with a concomitant percutaneous 
angioplasty or atherectomy (PTA) code for delivery of the stent(s). 
This subject was addressed in response to the need to identify carotid 
artery stenting for use

[[Page 48979]]

in clinical trials in the upcoming fiscal year. Public comment 
confirmed the need for specific codes for this procedure. 
Implementation of the code was fast-tracked so that the code could be 
used beginning October 1, 2004, for discharges in FY 2005 for patients 
who are enrolled in an FDA-approved clinical trial and are using on-
label FDA approved stents and embolic protection devices.
    The newly created codes 00.61 (Percutaneous angioplasty or 
atherectomy of precerebral (extracranial vessel(s)) and 00.63 
(Percutaneous insertion of carotid artery stent(s)) were published in 
Table 6B, New Procedure Codes in the proposed rule (69 FR 28671). Table 
6B in the proposed rule represents final codes and the codes themselves 
were not subject to comment, as the notice and comments are part of the 
ICD-9-CM Coordination and Maintenance Committee process. However, their 
assignment regarding placement as an OR procedure, as well as MDC and 
DRG placement, were open to public comment.
    New code 00.61 was assigned to four MDCs and seven DRGs. The most 
likely scenario will have cases being assigned to MDC 1 (Diseases and 
Disorders of the Nervous System in DRGs 533 (Extracranial Procedures 
With CC) and 534 (Extracranial Procedures Without CC). Cases could also 
be assigned to MDC 5 (Diseases and Disorders of the Circulatory 
System), MDC 21 (Injuries, Poisoning, and Toxic Effects of Drugs), and 
MDC 24 (Multiple Significant Trauma). The less likely DRG assignments 
can be reviewed in Table 6B in the Addendum to this final rule.
    Background: Stroke is the third leading cause of death in the 
United States and the leading cause of serious, long-term disability. 
Approximately 70 percent of all strokes occur in people age 65 and 
older. The carotid artery is located in the neck and is the principal 
artery supplying the head and neck with blood. Accumulation of plaque 
in the carotid artery can lead to stroke either by decreasing the blood 
flow to the brain or by having plaque break free and lodge in the brain 
or in other arteries to the head. The PTA procedure involves inflating 
a balloon-like device in the narrowed section of the carotid artery to 
reopen the vessel. A carotid stent is then placed in the artery to 
prevent the vessel from closing and to prevent pieces of plaque from 
entering the bloodstream.
    Effective July 1, 2001, Medicare covers PTA of the carotid artery 
concurrent with carotid stent placement when furnished in accordance 
with the FDA-approved protocols governing Category B Investigational 
Device Exemption (IDE) clinical trials. PTA of the carotid artery, when 
provided solely for the purpose of carotid artery dilation concurrent 
with carotid stent placement, is considered to be a reasonable and 
necessary service only when provided in the context of such clinical 
trials, and therefore is considered a covered service for the purposes 
of these trials. Performance of PTA in the carotid artery when used to 
treat obstructive lesions outside of approved protocols governing 
Category B IDE clinical trials remains a noncovered service.
    We received several comments concerning the proposed assignment of 
new code 00.61 to MDC 1, DRG 533 and DRG 534.
    Comment: All commenters suggested that instead of code 00.61 
grouping to both DRGs 533 and 534, the cases should only be assigned to 
DRG 533. Commenters have suggested that the patients in Category B IDE 
clinical trials will not have the kinds of CCs that would assure 
assignment to DRG 533. Commenters cited other complications such as 
bilateral occlusion, certain anatomical conditions such as a 
``surgically hostile neck,'' and complex diseases, as complications in 
their cases. However, most of the CCs cited by the commenters are not 
able to be captured using current ICD-9-CM codes, and therefore would 
not contribute to the assignment of these cases to DRG 533.
    All of the commenters stated that the payment for DRG 534 is 
inadequate, but did not furnish data regarding the cost of the stent(s) 
and the embolic protection devices, possibly because these devices are 
still in the trial stage and no hospital costs have yet been 
established. Two commenters stated that they knew of reports that a 
number of sites in one of the clinical trials have indicated a 
reluctance to enroll patients due to the low level of payment under DRG 
534. One commenter reviewed cases in the FY 2002 MedPAR data file and 
noted that the cases are primarily clinical trial cases that do not 
include a charge for the carotid stent and embolic protection device. 
Therefore, the commenter added, the reported hospital charges 
significantly understate the charges that would be associated with the 
carotid stenting procedure in a nonclinical trial setting.
    Response: As we have created code 00.61 for use beginning October 
1, 2004, we have no data history regarding its utilization.
    In FY 2003, any carotid stenting procedures performed would have 
been assigned to DRG 5. Insertion of a carotid stent or stents was a 
procedure for which there was no specific coverage decision. In 
addition, the ICD-9-CM codes describing insertion of a stent were 
nonspecific, and the codes used to describe that procedure also applied 
to many other procedures for which there was a coverage decision. The 
commenter is correct that any cases in our data may have been performed 
within the setting of a clinical trial. In FY 2004, we restructured DRG 
5, splitting all those cases into DRGs 533 and 534, and ordered the 
DRGs based on the presence or absence of CCs. When we reviewed the 
available MedPAR data, we used the following proxy: Principal diagnosis 
code 433.10 (Occlusion and stenosis of carotid artery, without mention 
of cerebral infarction), and procedure codes 39.50 (Angioplasty or 
atherectomy of noncoronary vessel), plus code 39.90 (Insertion of 
nondrug-eluting, noncoronary artery stent(s)). The following table 
shows the results of our review:

[[Page 48980]]

[GRAPHIC] [TIFF OMITTED] TR11AU04.025

    When we evaluated the data in the above table, we found relative 
weights have increased for DRG 533 over the past two reporting periods 
compared to the cases in DRG 5. In addition, we found that, although 
the hospital charges had increased between reporting years 2002 and 
2003, the charges were within the mean and .75 standard deviation. As 
the DRG system is one of averages, we are reassured that this payment 
structure is appropriate.
    The FDA has not given final approval to the safety and efficacy of 
carotid PTA with stenting as clinical trials are still ongoing. CMS has 
not yet approved this procedure and device under Medicare, outside of 
the clinical trial setting. To reiterate, specific codes were recently 
created and have not yet been put into use in hospitals. We believe 
that the data that we have reviewed in DRGs 5, 533, and 534 are 
reasonably correct regarding hospital charges for this procedure. We 
believe that adjusting the IPPS system for a specific device that has 
not been used outside the clinical trial setting, without 
substantiating data, obviates the intent of the diagnosis-related 
groups. Therefore, we believe the assignment of code 00.61 to DRGs 533 
and 534 as proposed is appropriate at this time. We will continue to 
monitor DRGs 533 and 534 and procedure codes 00.61 in combination with 
00.63 in upcoming annual DRG reviews.
    At the April 1, 2004, ICD-9-CM Coordination and Maintenance 
Committee Meeting, we also created procedure codes 00.62 (Percutaneous 
angioplasty or atherectomy of intracranial vessel(s), 00.64 
(Percutaneous insertion of other precerebral (extracranial) artery 
stent(s), and 00.65 (Percutaneous insertion of intracranial vascular 
stent(s). We assigned procedure code 00.62 to the same MDCs and DRGs as 
code 00.61, mimicking the DRG assignment for predecessor codes.
    Comment: One commenter encouraged CMS to assign intracranial 
angioplasty cases containing procedure code 00.62 to DRGs 1 and 2 
instead of DRGs 533 and 534. The commenter believed that DRGs 1 and 2 
better reflect the grouping logic for clinical homogeneity and resource 
utilization.
    Response: When new ICD-9-CM codes are created, they are 
automatically assigned to an MDC and a DRG(s). We generally assign new 
codes to the predecessor DRGs until we have compelling MedPAR data that 
indicate otherwise. In the case of code 00.62, the point is moot. 
Medicare does not cover PTA of intracranial vessels, and we are not 
aware of any clinical trials during the upcoming fiscal year. We refer 
readers to the discussion of changes to Edit 11 (Non-Covered 
Procedures) of the Medicare Code Editor under section II.B.10. of this 
preamble. Therefore, in the absence of compelling evidence, we are not 
making any changes to the MDC or DRG assignments of code 00.62.
    In addition, it has come to our attention that there may be some 
coding errors that are contributing to an erroneous reimbursement case-
mix profile for hospitals. Specifically, it has been suggested that 
some hospitals may be reluctant to include a code for vessel 
angioplasty in conjunction with stent placement. Apparently, some 
hospital staff have expressed concerns that a ``true'' angioplasty is 
not being performed, and that, therefore, they will be censured by 
regulatory agencies for erroneous coding. As a result, these hospitals 
have instructed their coding staff not to include a code describing 
angioplasty of a vessel, and to only include a code for insertion of a 
stent or stents.
    This is incorrect. The AHA publication Coding Clinic for ICD-9-CM 
specifically instructs that a code for angioplasty, by any technique, 
is performed in the placement of a stent or stents (Fourth Quarter, 
1996, page 63). Therefore, the correct coding for insertion of coronary 
stent(s) requires two codes. One code describes the angioplasty with 
00.61, and the second code describes the stent insertion with code 
00.63. To fail to record the angioplasty procedure will result in 
assignment of the case to the medical DRG instead of the correct 
surgical DRG. This erroneous coding action will have an impact on many 
levels. It will result in incorrect data in the database, which in turn 
will result in an erroneous base upon which future DRG relative weights 
are calculated. In addition, in the short term, it will result in 
reduced revenue to the hospital because of the incorrect DRG assignment 
for all cases in which this occurs. To reiterate, the correct procedure 
coding for insertion of a carotid stent combines codes 00.61 and 00.63.

[[Page 48981]]

j. Acute Intermittent Porphyria
    In the May 18, 2004 IPPS proposed rule, we did not present as an 
issue the DRG assignment of the code used for acute intermittent 
porphyria. However, we did receive one comment concerning this 
condition.
    Comment: One commenter requested that we give consideration to 
assignment of a DRG to an orphan biologic intended to treat acute 
intermittent porphyria. This condition is a rare metabolic disorder 
affecting fewer than 1,000 persons in the United States. The drug 
manufacturer was concerned that Medicare hospitalization payments do 
not accurately reflect the cost of the treatment. The condition is 
coded to Code 277.1 (Disorders of porphyrin metabolism) and is assigned 
to DRG 299 (Inborn Errors of Metabolism).
    Response: The DRG assignment of code 277.1 was not an issue that 
was addressed in the May 18, 2004 proposed rule. We will take this 
comment into consideration in the future as we conduct analysis of the 
MedPAR data for next year's proposed rule.

C. Recalibration of DRG Weights

    As we proposed, in this final rule, we used the same basic 
methodology for the FY 2005 recalibration as we did for FY 2004 (August 
1, 2003 IPPS final rule (68 FR 45373)). That is, we have recalibrated 
the DRG weights based on charge data for Medicare discharges using the 
most current charge information available (the FY 2003 MedPAR file).
    The MedPAR file is based on fully coded diagnostic and procedure 
data for all Medicare inpatient hospital bills. The FY 2003 MedPAR data 
used in this final rule include discharges occurring between October 1, 
2002, and September 30, 2003, based on bills received by CMS through 
March 31, 2004, from all hospitals subject to the IPPS and short-term 
acute care hospitals in Maryland (which are under a waiver from the 
IPPS under section 1814(b)(3) of the Act). The FY 2003 MedPAR file 
includes data for approximately 11,740,557 Medicare discharges. 
Discharges for Medicare beneficiaries enrolled in a Medicare+Choice 
managed care plan are excluded from this analysis. The data excludes 
CAHs, including hospitals that subsequently became CAHs after the 
period from which the data were taken.
    The methodology used to calculate the DRG relative weights from the 
FY 2003 MedPAR file is as follows:
     To the extent possible, all the claims were regrouped 
using the DRG classification revisions discussed in section II.B. of 
this preamble.
     The transplant cases that were used to establish the 
relative weight for heart and heart-lung, liver, and lung transplants 
(DRGs 103, 480, and 495) were limited to those Medicare-approved 
transplant centers that have cases in the FY 2001 MedPAR file. 
(Medicare coverage for heart, heart-lung, liver, and lung transplants 
is limited to those facilities that have received approval from CMS as 
transplant centers.)
     Organ acquisition costs for kidney, heart, heart-lung, 
liver, lung, pancreas, and intestinal (or multivisceral organs) 
transplants continue to be paid on a reasonable cost basis. Because 
these acquisition costs are paid separately from the prospective 
payment rate, it is necessary to subtract the acquisition charges from 
the total charges on each transplant bill that showed acquisition 
charges before computing the average charge for the DRG and before 
eliminating statistical outliers.
     Charges were standardized to remove the effects of 
differences in area wage levels, indirect medical education and 
disproportionate share payments, and, for hospitals in Alaska and 
Hawaii, the applicable cost-of-living adjustment.
     The average standardized charge per DRG was calculated by 
summing the standardized charges for all cases in the DRG and dividing 
that amount by the number of cases classified in the DRG. A transfer 
case is counted as a fraction of a case based on the ratio of its 
transfer payment under the per diem payment methodology to the full DRG 
payment for nontransfer cases. That is, a transfer case receiving 
payment under the transfer methodology equal to half of what the case 
would receive as a nontransfer would be counted as 0.5 of a total case.
     Statistical outliers were eliminated by removing all cases 
that are beyond 3.0 standard deviations from the mean of the log 
distribution of both the charges per case and the charges per day for 
each DRG.
     The average charge for each DRG was then recomputed 
(excluding the statistical outliers) and divided by the national 
average standardized charge per case to determine the relative weight.
    The new weights are normalized by an adjustment factor of 1.46795 
so that the average case weight after recalibration is equal to the 
average case weight before recalibration. This adjustment is intended 
to ensure that recalibration by itself neither increases nor decreases 
total payments under the IPPS.
    When we recalibrated the DRG weights for previous years, we set a 
threshold of 10 cases as the minimum number of cases required to 
compute a reasonable weight. We used that same case threshold in 
recalibrating the final DRG weights for FY 2005. Using the FY 2003 
MedPAR data set, there are 41 DRGs that contain fewer than 10 cases. We 
computed the weights for these low-volume DRGs by adjusting the FY 2004 
weights of these DRGs by the percentage change in the average weight of 
the cases in the other DRGs.
    Section 1886(d)(4)(C)(iii) of the Act requires that, beginning with 
FY 1991, reclassification and recalibration changes be made in a manner 
that assures that the aggregate payments are neither greater than nor 
less than the aggregate payments that would have been made without the 
changes. Although normalization is intended to achieve this effect, 
equating the average case weight after recalibration to the average 
case weight before recalibration does not necessarily achieve budget 
neutrality with respect to aggregate payments to hospitals because 
payments to hospitals are affected by factors other than average case 
weight. Therefore, as we have done in past years and as discussed in 
section II.A.4.a. of the Addendum to this final rule, we are making a 
budget neutrality adjustment to ensure that the requirement of section 
1886(d)(4)(C)(iii) of the Act is met.
    Comment: Two commenters addressed the proposed DRG weights for 
three DRGs. One commenter was appreciative of the increased proposed 
DRG weight for DRG 36 (Retinal Procedures). The current DRG weight is 
0.6298 and the proposed weight was 0.6766. Another commenter expressed 
concern that the proposed weights for DRGs 535 (Cardiac Defibrillator 
Implant With Cardiac Catheterization With AMI, Heart Failure, or Shock) 
and DRG 536 (Cardiac Defibrillator Implant With Cardiac Catheterization 
Without AMI, Heart Failure or Shock) believes this would not cover the 
cost of the Cardiac Resynchronization Therapy Defibrillator (CRT-D), 
much less the procedure and nursing care costs associated with these 
procedures. The commenter believed that the DRG weight data are 
problematic because they are based on hospital charges. The commenter 
stated that hospitals do not like to mark up the cost of an item at 
$34,000. The commenter inquired whether CMS has evaluated the cost of 
the CRT-Ds from the claims which was calculated using the cost-to-
charge ratio compared to outside data on the cost of the CRT-Ds.
    Response: In the process of recalibration of the DRG weights, we

[[Page 48982]]

consider the most recent charge data available. Both high and low cost 
technologies are absorbed gradually into the data that are used to 
determine the DRG weight.

D. LTC-DRG Reclassifications and Relative Weights for LTCHs for FY 2005

1. Background
    In the June 6, 2003, LTCH PPS final rule (68 FR 34122), we changed 
the LTCH PPS annual payment rate update cycle to be effective July 1 
through June 30 instead of October 1 through September 30. In addition, 
because the patient classification system utilized under the LTCH PPS 
is based directly on the DRGs used under the IPPS for acute care 
hospitals, in that same final rule, we explained that the annual update 
of the long-term care diagnosis-related group (LTC-DRG) classifications 
and relative weights will continue to remain linked to the annual 
reclassification and recalibration of the CMS-DRGs used under the IPPS.
    The annual update to the IPPS DRGs is based on the annual revisions 
to the ICD-9-CM codes and is effective each October 1. In the health 
care industry, annual changes to the ICD-9-CM codes are effective for 
discharges occurring on or after October 1 each year. The use of the 
ICD-9-CM coding system is also compliant with the requirements of the 
Health Insurance Portability and Accountability Act (HIPAA), Public Law 
104-191, under 45 CFR parts 160 and 162. Therefore, the manual and 
electronic versions of the GROUPER software, which are based on the 
ICD-9-CM codes, are also revised annually and effective for discharges 
occurring on or after October 1 each year. Because the LTC-DRGs are 
based on the patient classification system used under the IPPS (CMS-
DRGs), which is updated annually and effective for discharges occurring 
on or after October 1 through September 30 each year, in the May 7, 
2004, LTCH PPS final rule (69 FR 25674), we specified that we will 
continue to update the LTC-DRG classifications and relative weights to 
be effective for discharges occurring on or after October 1 through 
September 30 each year. Furthermore, we stated that we will publish the 
annual update of the LTC-DRGs in the proposed and final rules for the 
IPPS.
    In the May 18, 2004, IPPS proposed rule (69 FR 28225), we proposed 
revisions to the LTC-DRG classifications and relative weights. We are 
finalizing them in this IPPS final rule, to be effective October 1, 
2004, through September 30, 2005, using the latest available data. The 
final LTC-DRGs and relative weights for FY 2005 in this final rule are 
based on the IPPS DRGs (GROUPER Version 22.0) discussed in section II. 
of this final rule.
    Comment: One commenter questioned whether the rate update cycle for 
the LTCH PPS will revert from a July 1 through June 30 cycle to the 
Federal fiscal year cycle (October 1 through September 30) since we 
proposed to update the LTC-DRGs effective for discharges on or after 
October 1, 2004.
    Response: In the June 6, 2003 LTCH PPS final rule (68 FR 34122), we 
changed the LTCH PPS annual payment rate update cycle to be effective 
July 1 through June 30 instead of October 1 through September 30. As we 
discussed in that same LTCH PPS final rule and as we discussed in the 
May 18, 2004, IPPS proposed rule (69 FR 28225), because the patient 
classification system utilized under the LTCH PPS is based directly on 
the DRGs used under the IPPS for acute care hospitals, the annual 
update of the LTC-DRG classifications and relative weights will 
continue to remain linked to the annual reclassification and 
recalibration of the CMS-DRGs used under the IPPS.
    The most recent annual LTCH PPS payment rate update and policy 
changes for the 2005 LTCH PPS rate year (July 1, 2004 through June 30, 
2004) was published in the Federal Register on May 7, 2004 (69 FR 25674 
through 25749). In that same LTCH PPS final rule, we established rate 
updates and policy changes that were effective for discharges occurring 
on or after July 1, 2004, including an update to the standard Federal 
LTCH PPS rate, the LTCH PPS wage index and the LTCH PPS outlier 
threshold. However, because the LTC-DRGS are linked to the IPPS DRGs, 
the LTC-DRG classifications and relative weights established in the 
August 1, 2003, final rule (68 FR 45374), which were effective 
beginning in Federal FY 2004, remain in effect through September 30, 
2004. The updated LTC-DRG classifications and relative weights 
established for FY 2005 shown in Table 11 of this final rule will be 
effective for LTCH discharges on or after October 1, 2004 and before 
September 30, 2005. As we stated in the June 6, 2003 LTCH PPS final 
rule, the rate update cycle for the LTCH PPS will continue to remain on 
a July 1 through June 30 cycle while the annual update to the LTC-DRG 
classifications and relative weights will remain on a Federal fiscal 
year cycle (October 1 through September 30). Accordingly, the updated 
LTCH PPS Federal rate ($36,833.69) and other payment factors (such as 
the outlier threshold and wage index values) effective July 1, 2004 
(see May 7, 2004, (69 FR 25674)), are applied in conjunction with the 
LTC-DRGs and relative weights established in the August 1, 2003, IPPS 
final rule (68 FR 45374) that are in effect through September 30, 2004, 
for LTCH discharges occurring from July 1, 2004 through September 30, 
2004. However, beginning with discharges occurring on or after October 
1, 2004, the LTC-DRGs and relative weights established in this final 
rule will be applied in conjunction with the LTCH PPS Federal rate 
($36,833.69) and other payment factors (such as the outlier threshold 
and wage index values) effective July 1, 2004, as established in the 
May 7, 2004 LTCH PPS final rule (69 FR 25674), for discharges occurring 
through June 30, 2005.
2. Changes in the LTC-DRG Classifications
a. Background
    Section 123 of Public Law 106-113 specifically requires that the 
PPS for LTCHs be a per discharge system with a DRG-based patient 
classification system reflecting the differences in patient resources 
and costs in LTCHs while maintaining budget neutrality. Section 
307(b)(1) of Public Law 106-554 modified the requirements of section 
123 of Public Law 106-113 by specifically requiring that the Secretary 
examine ``the feasibility and the impact of basing payment under such a 
system [the LTCH PPS] on the use of existing (or refined) hospital 
diagnosis-related groups (DRGs) that have been modified to account for 
different resource use of long-term care hospital patients as well as 
the use of the most recently available hospital discharge data.''
    In accordance with section 307(b)(1) of Public Law 106-554 and 
Sec.  412.515 of our existing regulations, the LTCH PPS uses 
information from LTCH patient records to classify patient cases into 
distinct LTC-DRGs based on clinical characteristics and expected 
resource needs. The LTC-DRGs used as the patient classification 
component of the LTCH PPS correspond to the DRGs under the IPPS for 
acute care hospitals. Thus, as we proposed in the May 18, 2004, IPPS 
proposed rule, we will use the IPPS GROUPER Version 22.0 for FY 2005 to 
process LTCH PPS claims in this final rule. The changes to the IPPS DRG 
classification system for FY 2005 (GROUPER Version 22.0) are discussed 
in section II.B. of this preamble.
    Under the LTCH PPS, we determine relative weights for each of the 
CMS DRGs to account for the difference in resource use by patients 
exhibiting the case complexity and multiple medical

[[Page 48983]]

problems characteristic of LTCH patients. In a departure from the IPPS, 
as we discussed in the August 30, 2002, final rule (67 FR 55985), which 
implemented the LTCH PPS, and the August 1, 2003, IPPS final rule (68 
FR 45374), we use low-volume quintiles in determining the LTC-DRG 
weights for LTC-DRGs with less than 25 LTCH cases, since LTCHs do not 
typically treat the full range of diagnoses as do acute care hospitals. 
Specifically, we group those low-volume LTC-DRGs (LTC-DRGs with fewer 
than 25 cases) into 5 quintiles based on average charge per discharge. 
(A listing of the composition of low-volume quintiles for the FY 2004 
LTC-DRGs (based on FY 2002 MedPAR data) appears in section II.D.3. of 
the August 1, 2003 IPPS final rule (68 FR 45377 through 45380).) We 
also adjust for cases in which the stay at the LTCH is less than or 
equal to five-sixths of the geometric average length of stay; that is, 
short-stay outlier cases (Sec.  412.529), as discussed below in section 
II.D.4. of this preamble.
b. Patient Classifications Into DRGs
    Generally, under the LTCH PPS, Medicare payment is made at a 
predetermined specific rate for each discharge; that is, payment varies 
by the LTC-DRG to which a beneficiary's stay is assigned. Similar to 
case classification for acute care hospitals under the IPPS (see 
section II.B. of this preamble), cases are classified into LTC-DRGs for 
payment under the LTCH PPS based on the principal diagnosis, up to 
eight additional diagnoses, and up to six procedures performed during 
the stay, as well as age, sex, and discharge status of the patient. The 
diagnosis and procedure information is reported by the hospital using 
codes from the ICD-9-CM.
    As discussed in section II.B. of this preamble, the CMS DRGs are 
organized into 25 major diagnostic categories (MDCs), most of which are 
based on a particular organ system of the body; the remainder involve 
multiple organ systems (such as MDC 22, Burns). Accordingly, the 
principal diagnosis determines MDC assignment. Within most MDCs, cases 
are then divided into surgical DRGs and medical DRGs. Some surgical and 
medical DRGs are further differentiated based on the presence or 
absence of CCs. (See section II.B. of this preamble for further 
discussion of surgical DRGs and medical DRGs.)
    Because the assignment of a case to a particular LTC-DRG will help 
determine the amount that is paid for the case, it is important that 
the coding is accurate. As used under the IPPS, classifications and 
terminology used under the LTCH PPS are consistent with the ICD-9-CM 
and the Uniform Hospital Discharge Data Set (UHDDS), as recommended to 
the Secretary by the National Committee on Vital and Health Statistics 
(``Uniform Hospital Discharge Data: Minimum Data Set, National Center 
for Health Statistics, April 1980'') and as revised in 1984 by the 
Health Information Policy Council (HIPC) of the U.S. Department of 
Health and Human Services. We wish to point out again that the ICD-9-CM 
coding terminology and the definitions of principal and other diagnoses 
of the UHDDS are consistent with the requirements of the Administrative 
Simplification Act of 1996 of the HIPAA (45 CFR parts 160 and 162).
    The emphasis on the need for proper coding cannot be overstated. 
Inappropriate coding of cases can adversely affect the uniformity of 
cases in each LTC-DRG and produce inappropriate weighting factors at 
recalibration and result in inappropriate payments under the LTCH PPS. 
LTCHs are to follow the same coding guidelines used by the acute care 
hospitals to ensure accuracy and consistency in coding practices. There 
will be only one LTC-DRG assigned per long-term care hospitalization; 
it will be assigned at the discharge. Therefore, it is mandatory that 
the coders continue to report the same principal diagnosis on all 
claims and include all diagnostic codes that coexist at the time of 
admission, that are subsequently developed, or that affect the 
treatment received. Similarly, all procedures performed during that 
stay are to be reported on each claim.
    Upon the discharge of the patient from a LTCH, the LTCH must assign 
appropriate diagnosis and procedure codes from the ICD-9-CM. As of 
October 16, 2002, a LTCH that was required to comply with the HIPAA 
Administrative Simplification Standards and that had not obtained an 
extension in compliance with the Administrative Compliance Act (Pub. L. 
107-105) is obligated to comply with the standards at 45 CFR 162.1002 
and 45 CFR 162.1102. Completed claim forms are to be submitted to the 
LTCH's Medicare fiscal intermediary. Medicare fiscal intermediaries 
enter the clinical and demographic information into their claims 
processing systems and subject this information to a series of 
automated screening processes called the Medicare Code Editor (MCE). 
These screens are designed to identify cases that require further 
review before assignment into an LTC-DRG can be made.
    After screening through the MCE, each LTCH claim will be classified 
into the appropriate LTC-DRG by the Medicare LTCH GROUPER. The LTCH 
GROUPER is specialized computer software based on the same GROUPER used 
under the IPPS. After the LTC-DRG is assigned, the Medicare fiscal 
intermediary determines the prospective payment by using the Medicare 
LTCH PPS PRICER program, which accounts for LTCH hospital-specific 
adjustments. As provided for under the IPPS, we provide an opportunity 
for the LTCH to review the LTC-DRG assignments made by the fiscal 
intermediary and to submit additional information within a specified 
timeframe (Sec.  412.513(c)).
    The GROUPER is used both to classify past cases in order to measure 
relative hospital resource consumption to establish the LTC-DRG weights 
and to classify current cases for purposes of determining payment. The 
records for all Medicare hospital inpatient discharges are maintained 
in the MedPAR file. The data in this file are used to evaluate possible 
DRG classification changes and to recalibrate the DRG weights during 
our annual update (as discussed in section II. of this preamble). The 
LTC-DRG relative weights are based on data for the population of LTCH 
discharges, reflecting the fact that LTCH patients represent a 
different patient mix than patients in short-term acute care hospitals.
3. Development of the FY 2005 LTC-DRG Relative Weights
a. General Overview of Development of the LTC-DRG Relative Weights
    As we stated in the August 30, 2002, LTCH PPS final rule (67 FR 
55981), one of the primary goals for the implementation of the LTCH PPS 
is to pay each LTCH an appropriate amount for the efficient delivery of 
care to Medicare patients. The system must be able to account 
adequately for each LTCH's case-mix in order to ensure both fair 
distribution of Medicare payments and access to adequate care for those 
Medicare patients whose care is more costly. To accomplish these goals, 
we adjust the LTCH PPS standard Federal prospective payment system rate 
by the applicable LTC-DRG relative weight in determining payment to 
LTCHs for each case.
    Under the LTCH PPS, relative weights for each LTC-DRG are a primary 
element used to account for the variations in cost per discharge and 
resource utilization among the payment groups (Sec.  412.515). To 
ensure that Medicare patients classified to each LTC-DRG have access to 
an appropriate level of services and to encourage efficiency, we 
calculate a relative weight

[[Page 48984]]

for each LTC-DRG that represents the resources needed by an average 
inpatient LTCH case in that LTC-DRG. For example, cases in an LTC-DRG 
with a relative weight of 2 will, on average, cost twice as much as 
cases in an LTC-DRG with a weight of 1.
b. Data
    To calculate the LTC-DRG relative weights for FY 2005 in this final 
rule, we obtained total Medicare allowable charges from FY 2003 
Medicare hospital bill data from the March 2004 update of the MedPAR 
file, and we used Version 22.0 of the CMS GROUPER for IPPS, as 
discussed in section II.B. of this preamble, to classify cases. 
Consistent with the methodology under the IPPS, we recalculated the FY 
2005 LTC-DRG relative weights based on the best available data for this 
final rule.
    As we discussed in the May 18, 2004 proposed rule (69 FR 28227), we 
have excluded the data from LTCHs that are all-inclusive rate providers 
and LTCHs that are reimbursed in accordance with demonstration projects 
authorized under section 402(a) of Public Law 90-248 (42 U.S.C. 1395b-
1) or section 222(a) of Public Law 92-603 (42 U.S.C. 1395b-1). 
Therefore, in the development of the FY 2005 LTC-DRG relative weights, 
we have excluded the data of the 22 all-inclusive rate providers and 
the 3 LTCHs that are paid in accordance with demonstration projects 
that had claims in the FY 2003 MedPAR file.
    In the August 1, 2003, final rule (68 FR 45367), we discussed 
coding inaccuracies that were found in claims data for a large chain of 
LTCHs in the FY 2002 MedPAR file used to determine the LTC-DRG relative 
weights for FY 2004. Specifically, the principal diagnosis was not 
reported correctly on many of those LTCHs' claims, which resulted in 
those claims being incorrectly assigned to an LTC-DRG. As we explained 
in the same final rule, we were able to determine the correct diagnoses 
and procedure codes for the claims that contained the coding errors, 
and we used them to group each LTCH case to the appropriate LTC-DRG for 
determining the LTC-DRG relative weights for FY 2004. In addition, we 
stated that since the LTCH PPS was implemented for cost reporting 
periods beginning on or after October 1, 2002 (FY 2003), we believe 
that this problem will be self-correcting as LTCHs submit more 
completely coded data in the future.
    As we discussed in the May 7, 2004, LTCH PPS final rule (69 FR 
25674), an analysis of LTCH claims data from the September 2003 update 
of the FY 2003 MedPAR file contained coding errors. Specifically, a 
large hospital chain of LTCHs continued to consistently code diagnoses 
inaccurately on the claims it submitted, and these coding errors were 
reflected in the September 2003 update of the FY 2003 MedPAR file. Upon 
discovering the coding errors, we notified the large chain of LTCHs 
whose claims contained the coding inaccuracies to request that they 
resubmit those claims with the correct diagnoses codes by December 31, 
2003, so that those corrected claims would be contained in the December 
2003 update of the FY 2003 MedPAR file. As we discussed in that same 
final rule, it appears that those claims were submitted timely with the 
correct diagnoses codes. Therefore, it was not necessary to correct the 
FY 2003 MedPAR data for the development of the rates and factors 
established in the May 7, 2004, LTCH PPS final rule. Accordingly, in 
the May 18, 2004, IPPS proposed rule, we used LTCH claims data from the 
December 2003 update of the FY 2003 MedPAR file for the determination 
of the proposed FY 2005 LTC-DRG relative weights. For this final rule, 
we used the latest available LTCH claims data from the March 2004 
update of the FY 2003 MedPAR file.
c. Hospital-Specific Relative Value Methodology
    By nature LTCHs often specialize in certain areas, such as 
ventilator-dependent patients and rehabilitation and wound care. Some 
case types (DRGs) may be treated, to a large extent, in hospitals that 
have, from a perspective of charges, relatively high (or low) charges. 
This nonarbitrary distribution of cases with relatively high (or low) 
charges in specific LTC-DRGs has the potential to inappropriately 
distort the measure of average charges. To account for the fact that 
cases may not be randomly distributed across LTCHs, we use a hospital-
specific relative value method to calculate the LTC-DRG relative 
weights instead of the methodology used to determine the DRG relative 
weights under the IPPS described above in section II.C. of this 
preamble. We believe this method will remove this hospital-specific 
source of bias in measuring LTCH average charges. Specifically, we 
reduce the impact of the variation in charges across providers on any 
particular LTC-DRG relative weight by converting each LTCH's charge for 
a case to a relative value based on that LTCH's average charge.
    Under the hospital-specific relative value method, we standardize 
charges for each LTCH by converting its charges for each case to 
hospital-specific relative charge values and then adjusting those 
values for the LTCH's case-mix. The adjustment for case-mix is needed 
to rescale the hospital-specific relative charge values (which, by 
definition, averages 1.0 for each LTCH). The average relative weight 
for a LTCH is its case-mix, so it is reasonable to scale each LTCH's 
average relative charge value by its case-mix. In this way, each LTCH's 
relative charge value is adjusted by its case-mix to an average that 
reflects the complexity of the cases it treats relative to the 
complexity of the cases treated by all other LTCHs (the average case-
mix of all LTCHs).
    In accordance with the methodology established under Sec.  412.523, 
we standardize charges for each case by first dividing the adjusted 
charge for the case (adjusted for short-stay outliers under Sec.  
412.529 as described in section II.D.4. (step 3) of this preamble) by 
the average adjusted charge for all cases at the LTCH in which the case 
was treated. Short-stay outliers under Sec.  412.529 are cases with a 
length of stay that is less than or equal to five-sixths the average 
length of stay of the LTC-DRG. The average adjusted charge reflects the 
average intensity of the health care services delivered by a particular 
LTCH and the average cost level of that LTCH. The resulting ratio is 
multiplied by that LTCH's case-mix index to determine the standardized 
charge for the case.
    Multiplying by the LTCH's case-mix index accounts for the fact that 
the same relative charges are given greater weight in a LTCH with 
higher average costs than they would at a LTCH with low average costs 
which is needed to adjust each LTCH's relative charge value to reflect 
its case-mix relative to the average case-mix for all LTCHs. Because we 
standardize charges in this manner, we count charges for a Medicare 
patient at a LTCH with high average charges as less resource intensive 
than they would be at a LTCH with low average charges. For example, a 
$10,000 charge for a case in a LTCH with an average adjusted charge of 
$17,500 reflects a higher level of relative resource use than a $10,000 
charge for a case in a LTCH with the same case-mix, but an average 
adjusted charge of $35,000. We believe that the adjusted charge of an 
individual case more accurately reflects actual resource use for an 
individual LTCH because the variation in charges due to systematic 
differences in the markup of charges among LTCHs is taken into account.
    Comment: MedPAC supported the use of the hospital-specific relative 
value methodology for determining the LTC-DRG relative weights, stating 
that ``[t]his method eliminates distortions in

[[Page 48985]]

weights due to systematic differences among hospitals in the level of 
costs per case and in charge markups.'' The Commission believed that we 
should explore the use of this methodology for the DRG relative weights 
used under the IPPS.
    Response: We appreciate MedPAC's support of the use of the 
hospital-specific relative value methodology for determining the LTC-
DRG relative weights. As we discuss above, because by nature LTCHs 
often specialize in certain types of care, we believe it is important 
to remove any hospital-specific source of bias in measuring LTCHs' 
average charges. Therefore, we have continued to use of the hospital-
specific relative value methodology for determining the final FY 2005 
LTC-DRG relative weights shown in Table 11 of this final rule.
    As discussed above, we believe that the LTCHs' charge data are 
particularly vunerable to having a hospital-specific source of bias 
when measuring LTCHs' average charges because of the small number of 
LTCHs (approximately 300 hospitals with approximately 100,00 discharges 
annually) and the relatively high degree of specialization of many 
LTCHs. There are over 4,000 short-term acute care hospitals paid under 
the IPPS, with approximately 11.9 million discharges annually, that 
generally treat a wide range of conditions, rather than specializing in 
one or two types of conditions. Therefore, although we agree with the 
Commission that the hospital-specific relative value methodology 
eliminates distortions in relative weights due to systematic 
differences among hospitals' charges, we do not believe that it is 
necessary to use the hospital-specific relative value methodology under 
the IPPS since short-term acute care hospitals' charge data is not as 
susceptible to having a hospital-specific source of bias when measuring 
average charges.
    Furthermore, as we discussed in the August 1, 2000, IPPS final rule 
(65 FR 47103), in 1995 the MedPAC's predecessor, the Prospective 
Payment Assessment Commission, made a similar recommendation to adopt 
the hospital-specific relative value methodology under the IPPS. In the 
June 2, 1995, proposed rule (60 FR 29246), we agreed with the 
Commission's judgment that basing the IPPS DRG weights on standardized 
charges results in weights that are somewhat distorted as measures of 
the relative costliness of treating a typical case in each DRG, and 
that the hospital-specific relative value method of setting weights may 
reduce or eliminate distortions present in the current system. However, 
in our discussion on DRG refinements under the IPPS in the same rule 
(60 FR 29209), we reiterated our position published in the final rule 
on September 1, 1992 (57 FR 39761), that we would not propose to make 
significant changes to the DRG classification system under the IPPS, 
unless we are able to either improve our ability to predict coding 
changes by validating in advance the impact that potential DRG changes 
may have on coding behavior, or to make methodological changes to 
prevent building the inflationary effects of the coding changes into 
future program payments. Without further evaluation, we do not believe 
it would be appropriate to change the methodology for determining the 
DRG relative weights under the IPPS at this time. The development of 
the FY 2005 DRG relative weights used under the IPPS for short-term 
acute care hospitals is discussed in section II.C. of this preamble.
d. Low-Volume LTC-DRGs
    In order to account for LTC-DRGs with low-volume (that is, with 
fewer than 25 LTCH cases), in accordance with the methodology discussed 
in the August 30, 2002, LTCH PPS final rule (67 FR 55984) and in the 
May 18, 2004, IPPS proposed rule (69 FR 28228), we group those low-
volume LTC-DRGs into one of five categories (quintiles) based on 
average charges, for the purposes of determining relative weights. For 
this final rule, using LTCH cases from the March 2004 update of the FY 
2003 MedPAR file, we identified 172 LTC-DRGs that contained between 1 
and 24 cases. This list of LTC-DRGs was then divided into one of the 5 
low-volume quintiles, each containing a minimum of 34 LTC-DRGs (172/5 = 
34 with 2 LTC-DRGs as the remainder). For FY 2005, as we described in 
the May 18, 2004 IPPS proposed rule, we are making an assignment to a 
specific low-volume quintile by sorting the low-volume LTC-DRGs in 
ascending order by average charge. For this final rule, this results in 
an assignment to a specific low volume quintile of the sorted 172 low-
volume LTC-DRGs by ascending order by average charge. Since the number 
of LTC-DRGs with less than 25 LTCH cases is not evenly divisible by 
five, the average charge of the low-volume LTC-DRG was used to 
determine which low-volume quintile received the additional LTC-DRG. 
After sorting the 172 low-volume LTC-DRGs in ascending order, we 
grouped the first fifth (34) of low-volume LTC-DRGs with the lowest 
average charge would be grouped into Quintile 1. The highest average 
charge cases are grouped into Quintile 5. Since the average charge of 
the 103rd LTC-DRG in the sorted list is closer to the previous LTC-
DRG's average charge (assigned to Quintile 3) than to the average 
charge of the 104th LTC-DRG in the sorted list (to be assigned to 
Quintile 4), we placed it into Quintile 3. This process was repeated 
through the remaining low-volume LTC-DRGs so that 3 low-volume 
quintiles contain 34 LTC-DRGs and 2 low-volume quintiles contain 35 
LTC-DRGs.
    In order to determine the relative weights for the LTC-DRGs with 
low volume for FY 2005, in accordance with the methodology described in 
the August 30, 2002 LTCH PPS final rule (67 FR 55984) and cited in the 
May 18, 2004 IPPS proposed rule, we used the five low-volume quintiles 
described above. The composition of each of the five low-volume 
quintiles shown below in Table 1 is used in determining the LTC-DRG 
relative weights for FY 2005. We determine a relative weight and 
(geometric) average length of stay for each of the five low-volume 
quintiles using the formula that we apply to the regular LTC-DRGs (25 
or more cases), as described below in section II.D.4. of this preamble. 
We assign the same relative weight and average length of stay to each 
of the LTC-DRGs that make up that low-volume quintile. We note that, as 
this system is dynamic, it is possible that the number and specific 
type of LTC-DRGs with a low volume of LTCH cases will vary in the 
future. We use the best available claims data in the MedPAR file to 
identify low-volume LTC-DRGs and to calculate the relative weights 
based on our methodology.
BILLING CODE 4121-01-P

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[GRAPHIC] [TIFF OMITTED] TR11AU04.026


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[GRAPHIC] [TIFF OMITTED] TR11AU04.027


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[GRAPHIC] [TIFF OMITTED] TR11AU04.028


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[GRAPHIC] [TIFF OMITTED] TR11AU04.029

BILLING CODE 4121-01-C
4. Steps for Determining the FY 2005 LTC-DRG Relative Weights
    As we noted previously, the FY 2005 LTC-DRG relative weights are 
determined in accordance with the methodology described in the August 
1, 2003 IPPS final rule (68 FR 45367) and cited in the May 18, 2004 
IPPS proposed rule (69 FR 28231). In summary, LTCH cases must be 
grouped in the appropriate LTC-DRG, while taking into account the low-
volume LTC-DRGs as described above, before the FY 2005 LTC-DRG relative 
weights can be determined. After grouping the cases in the appropriate 
LTC-DRG, we calculate the relative weights for FY 2005 in this final 
rule by first removing statistical outliers and cases with a length of 
stay of 7 days or less. Next, we adjust the number of cases in each 
LTC-DRG for the effect of short-stay outlier cases under Sec.  412.529. 
The short-stay adjusted discharges and corresponding charges are used 
to calculate ``relative adjusted weights'' in each LTC-DRG using the 
hospital-specific relative value method described above.
    Below we discuss in detail the steps for calculating the FY 2005 
LTC-DRG relative weights.
    Step 1--Remove statistical outliers.
    The first step in the calculation of the FY 2005 LTC-DRG relative 
weights is to remove statistical outlier cases. We define statistical 
outliers as cases that are outside of 3.0 standard deviations from the 
mean of the log distribution of both charges per case and the charges 
per day for each LTC-DRG. These statistical outliers are removed prior 
to calculating the relative weights. We believe that they may represent 
aberrations in the data that distort the measure of average resource 
use. Including those LTCH cases in the calculation of the relative 
weights could result in an inaccurate relative weight that does not 
truly reflect relative resource use among the LTC-DRGs.
    Step 2--Remove cases with a length of stay of 7 days or less.
    The FY 2005 LTC-DRG relative weights reflect the average of 
resources used on representative cases of a specific type. Generally, 
cases with a length of stay 7 days or less do not belong in a LTCH 
because these stays do

[[Page 48990]]

not fully receive or benefit from treatment that is typical in a LTCH 
stay, and full resources are often not used in the earlier stages of 
admission to a LTCH. If we were to include stays of 7 days or less in 
the computation of the FY 2005 LTC-DRG relative weights, the value of 
many relative weights would decrease and, therefore, payments would 
decrease to a level that may no longer be appropriate.
    We do not believe that it would be appropriate to compromise the 
integrity of the payment determination for those LTCH cases that 
actually benefit from and receive a full course of treatment at a LTCH, 
in order to include data from these very short-stays. Thus, in 
determining the FY 2005 LTC-DRG relative weights, we remove LTCH cases 
with a length of stay of 7 days or less.
    Comment: One commenter believes that it is inappropriate to exclude 
cases with a length of stay of 7 days or less from the calculation of 
the proposed LTC-DRG relative weights since it is not uncommon for very 
resource intensive patients to expire within the first 7 days of the 
stay. The commenter also suggested that we consider creating a separate 
LTC-DRG for LTCH patients that expire within the first 7 days of the 
stay.
    Response: While we understand the commenters concerns, as we 
discussed in the August 30, 2002, final rule (67 FR 55989) which 
implemented the LTCH PPS, in calculating the LTC-DRG relative weights, 
we exclude cases with a length of stay of 7 days or less because we 
believe that, generally, cases with a length of stay of 7 days or less 
do not belong in a LTCH. In general, LTCHs are defined by statute as 
hospitals having an average length of stay of greater than 25 days. 
LTCHs typically furnish extended medical and rehabilitative care for 
patients who are clinically complex and have multiple or chronic 
conditions. Generally, LTCH cases with very short lengths of stay (that 
is, 7 days or less) are discharged from the LTCH before the patient 
receives a full course of treatment, and therefore do not use the same 
amount or type of resources as typical LTCH ``inlier'' cases (that is, 
cases in which Medicare covered days exceed five-sixths of the 
geometric average length of stay for the LTC-DRG and the patient is 
discharged prior to receiving a LTCH PPS high cost outlier payment). We 
believe that the length of stay of an ``inlier'' case is indicative of 
a LTCH patient receiving a full course of treatment because such cases 
include cases with stays that received a full LTC-DRG payment, which 
represents the average resources used for that DRG (that is, the case 
does not receive an adjusted short-stay outlier payment or a high-cost 
outlier payment). LTCH discharges with very short lengths of stay (that 
is, 7 days or less) often occur when it is determined, following 
admission to a LTCH, that the beneficiary would receive more 
appropriate care at another setting. Other circumstances that result in 
cases with very short stays (that is, 7 days or less) would involve 
patients who were either discharged to their home or who expired within 
the first 7 days of being admitted to an LTCH. Because LTCH cases with 
very short lengths of stay (that is, 7 days or less) do not use the 
same amount or type of resources as typical LTCH inlier cases, our 
simulations indicate that including these cases would significantly 
bias payments against LTCH inlier cases to a point where LTCH inlier 
cases would be underpaid.
    As we also discussed in the August 30, 2002, LTCH PPS final rule 
(65 FR 55989), the LTC-DRG relative weights reflect the average 
resources used on representative cases of a specific type. Stays of 7 
days or less generally do not fully receive or benefit from treatment 
that is typical in a LTCH stay because the patient is discharged prior 
to receiving a full course of treatment that a LTCH inlier patient 
would receive. In addition, full resources are often not used in the 
earlier stages of an admission to a LTCH because the patient is often 
medically unstable, and initial efforts are focused on stabilizing the 
patient before beginning treatment of the patient's additional 
complications and comorbidities. If we did include stays of 7 days or 
less in the calculation of the LTC-DRG relative weights, the value of 
many relative weights would decrease for cases that do, in fact, 
receive a full course of treatment, and, therefore, LTCH inlier 
payments could decrease to a level that would not be appropriate (that 
is, provide sufficient payment). We continue to believe that it is not 
appropriate to compromise the integrity of the payment amounts for LTCH 
inlier cases that actually benefit from and receive a full course of 
treatment at a LTCH in order to include data from cases with stays of 7 
days or less. Therefore, we disagree with the commenter that cases with 
lengths of stay of 7 days or less should be included in the calculation 
of the LTC-DRG relative weights. Accordingly, in this final rule, in 
calculating the FY 2005 LTC-DRG relative weights, as we proposed, we 
have removed cases with a length of stay of 7 days or less.
    With regard to the commenter's suggestion that we create a separate 
LTC-DRG for patients who expire, as we also discussed in the August 30, 
2002, LTCH PPS final rule (67 FR 56002), we do not believe that a 
separate LTC-DRG for patients who expire is necessary. We continue to 
believe that the short-stay outlier policy at Sec.  412.529 adequately 
addresses payments for patients who expire August 30, 2002, LTCH PPS 
final rule (65 FR 56006), because a case with a length of stay up to 
and including five-sixths of the average length of stay of the LTC-DRG 
is paid under the short-stay outlier policy regardless of whether or 
not the patient expires. Under the short-stay outlier policy (Sec.  
412.529), generally a case is paid the least of 120 percent of the 
estimated cost of the case, 120 percent of the LTC-DRG specific per 
diem amount, or the full LTC-DRG payment.
    We continue to believe that adjusted payments under the short-stay 
outlier policy for cases that expire generally compensate for any 
increased costs associated with treating a severely ill patient who 
dies, including those who expire within 7 days of being admitted to a 
LTCH. We note that one of the principles underlying prospective payment 
is that it is a system of payments based on average costs that assumes 
that some patient stays will consume more resources than the typical 
stay, while other patients will demand fewer resources. Thus, an 
efficiently operated hospital should be able to deliver care to its 
Medicare patients for an overall cost that is at or below the amount 
paid under the LTCH PPS. We continue to believe the LTCH PPS payment 
adequately address payments for patients who expire, and therefore, we 
are not adopting the commenter's suggestion to create a separate LTC-
DRG for LTCH patients that expire within the first 7 days of the stay. 
Accordingly, in establishing the final FY 2005 LTC-DRG relative 
weights, we continue to exclude cases with a length of stay of 7 days 
or less and we continue to include the total charges of cases with a 
length of stay of 8 days or more, including patients who expire, in the 
LTC-DRG to which the case is assigned based on version 22.0 of the 
GROUPER.
    Step 3--Adjust charges for the effects of short-stay outliers.
    The third step in the calculation of the FY 2005 LTC-DRG relative 
weights is to adjust each LTCH's charges per discharge for short-stay 
outlier cases (that is, a patient with a length of stay that is less 
than or equal to five-sixths the average length of stay of the LTC-
DRG).
    We make this adjustment by counting a short-stay outlier as a 
fraction of a discharge based on the ratio of the

[[Page 48991]]

length of stay of the case to the average length of stay for the LTC-
DRG for nonshort-stay outlier cases. This has the effect of 
proportionately reducing the impact of the lower charges for the short-
stay outlier cases in calculating the average charge for the LTC-DRG. 
This process produces the same result as if the actual charges per 
discharge of a short-stay outlier case were adjusted to what they would 
have been had the patient's length of stay been equal to the average 
length of stay of the LTC-DRG.
    As we explained in the May 18, 2004 proposed rule (69 FR 28231), 
counting short-stay outlier cases as full discharges with no adjustment 
in determining the LTC-DRG relative weights would lower the LTC-DRG 
relative weight for affected LTC-DRGs because the relatively lower 
charges of the short-stay outlier cases would bring down the average 
charge for all cases within an LTC-DRG. This would result in an 
``underpayment'' to nonshort-stay outlier cases and an ``overpayment'' 
to short-stay outlier cases. Therefore, in this final rule, we adjust 
for short-stay outlier cases under Sec.  412.529 in this manner because 
it results in more appropriate payments for all LTCH cases.
    Step 4--Calculate the FY 2005 LTC-DRG relative weights on an 
iterative basis.
    The process of calculating the LTC-DRG relative weights using the 
hospital specific relative value methodology is iterative. First, for 
each LTCH case, we calculate a hospital-specific relative charge value 
by dividing the short-stay outlier adjusted charge per discharge (see 
step 3) of the LTCH case (after removing the statistical outliers (see 
step 1)) and LTCH cases with a length of stay of 7 days or less (see 
step 2) by the average charge per discharge for the LTCH in which the 
case occurred. The resulting ratio is then multiplied by the LTCH's 
case-mix index to produce an adjusted hospital-specific relative charge 
value for the case. An initial case-mix index value of 1.0 is used for 
each LTCH.
    For each LTC-DRG, the FY 2005 LTC-DRG relative weight is calculated 
by dividing the average of the adjusted hospital-specific relative 
charge values (from above) for the LTC-DRG by the overall average 
hospital-specific relative charge value across all cases for all LTCHs. 
Using these recalculated LTC-DRG relative weights, each LTCH's average 
relative weight for all of its cases (case-mix) is calculated by 
dividing the sum of all the LTCH's LTC-DRG relative weights by its 
total number of cases. The LTCHs' hospital-specific relative charge 
values above are multiplied by these hospital specific case-mix 
indexes. These hospital-specific case-mix adjusted relative charge 
values are then used to calculate a new set of LTC-DRG relative weights 
across all LTCHs. In this final rule, this iterative process is 
continued until there is convergence between the weights produced at 
adjacent steps, for example, when the maximum difference is less than 
0.0001.
    Step 5--Adjust the FY 2005 LTC-DRG relative weights to account for 
nonmonotonically increasing relative weights.
    As explained in section II.B. of this preamble, the FY 2005 CMS 
DRGs, which the FY 2005 LTC-DRGs are based, contain ``pairs'' that are 
differentiated based on the presence or absence of CCs. The LTC-DRGs 
with CCs are defined by certain secondary diagnoses not related to or 
inherently a part of the disease process identified by the principal 
diagnosis, but the presence of additional diagnoses does not 
automatically generate a CC. As we discussed in the May 18, 2004 IPPS 
proposed rule (69 FR 28232), the value of monotonically increasing 
relative weights rises as the resource use increases (for example, from 
uncomplicated to more complicated). The presence of CCs in an LTC-DRG 
means that cases classified into a ``without CC'' LTC-DRG are expected 
to have lower resource use (and lower costs). In other words, resource 
use (and costs) are expected to decrease across ``with CC''/``without 
CC'' pairs of LTC-DRGs.
    For a case to be assigned to a LTC-DRG with CCs, more coded 
information is called for (that is, at least one relevant secondary 
diagnosis), than for a case to be assigned to an LTC-DRG ``without 
CCs'' (which is based on only one principal diagnosis and no relevant 
secondary diagnoses). Currently, the LTCH claims data include both 
accurately coded cases without complications and cases that have 
complications (and cost more), but were not coded completely. Both 
types of cases are grouped to an LTC-DRG ``without CCs'' because only 
one principal diagnosis was coded. Since the LTCH PPS was only 
implemented for cost reporting periods beginning on or after October 1, 
2002 (FY 2003) and LTCHs were previously paid under cost-based 
reimbursement, which is not based on patient diagnoses, coding by LTCHs 
for these cases may not have been as detailed as possible.
    Thus, in developing the FY 2003 LTC-DRG relative weights for the 
LTCH PPS based on FY 2001 claims data, as we discussed in the August 
30, 2002 LTCH PPS final rule (67 FR 55990), we found on occasion that 
the data suggested that cases classified to the LTC-DRG ``with CCs'' of 
a ``with CC''/``without CC'' pair had a lower average charge than the 
corresponding LTC-DRG ``without CCs.'' Similarly, based on FY 2003 
claims data, we also found on occasion that the data suggested that 
cases classified to the LTC-DRG ``with CCs'' of a ``with CC''/without 
CC'' pair have a lower average charge than the corresponding LTC-DRG 
``without CCs'' for FY 2005.
    We believe this anomaly may be due to coding that may not have 
fully reflected all comorbidities that were present. Specifically, 
LTCHs may have failed to code relevant secondary diagnoses, which 
resulted in cases that actually had CCs being classified into a 
``without CC'' LTC-DRG. It would not be appropriate to pay a lower 
amount for the ``with CC'' LTC-DRG. Therefore, in this final rule, we 
grouped both the cases ``with CCs'' and ``without CCs'' together for 
the purpose of calculating the FY 2005 LTC-DRG relative weights in this 
final rule. As we stated in the August 30, 2002 LTCH PPS final rule (67 
FR 55990), we will continue to employ this methodology to account for 
nonmonotonically increasing relative weights until we have adequate 
data to calculate appropriate separate weights for these anomalous LTC-
DRG pairs. We expect that, as was the case when we first implemented 
the IPPS, this problem will be self-correcting, as LTCHs submit more 
completely coded data in the future.
    There are three types of ``with CC'' and ``without CC'' pairs that 
could be nonmonotonic, that is, where the ``without CC'' LTC-DRG would 
have a higher average charge than the ``with CC'' LTC-DRG. For this 
final rule, using the LTCH cases in the March 2004 update of the FY 
2003 MedPAR file, we identified two of the three types of nonmonotonic 
LTC-DRG pairs.
    The first category of nonmonotonically increasing relative weights 
for FY 2005 LTC-DRG pairs ``with and without CCs'' contains 2 pairs of 
LTC-DRGs in which both the LTC-DRG ``with CCs'' and the LTC-DRG 
``without CCs'' had 25 or more LTCH cases and, therefore, did not fall 
into one of the 5 low-volume quintiles. For those nonmonotonic LTC-DRG 
pairs, as discussed in the May 18, 2004, proposed rule, we combine the 
LTCH cases and compute a new relative weight based on the case-weighted 
average of the combined LTCH cases of the LTC-DRGs. The case-weighted 
average charge is determined by dividing the total charges for all LTCH

[[Page 48992]]

cases by the total number of LTCH cases for the combined LTC-DRG. This 
new relative weight is then assigned to both of the LTC-DRGs in the 
pair. In this final rule, for FY 2005, LTC-DRGs 144 and 145 and LTC-
DRGs 444 and 445 are in this category.
    The second category of nonmonotonically increasing relative weights 
for LTC-DRG pairs with and without CCs consists of zero pairs of LTC-
DRGs that has fewer than 25 cases, and each LTC-DRG is grouped to 
different low-volume quintiles in which the ``without CC'' LTC-DRG is 
in a higher-weighted low-volume quintile than the ``with CC'' LTC-DRG. 
For those pairs, as we discussed in the May 18, 2004, proposed rule (69 
FR 28232), we combine the LTCH cases and determine the case-weighted 
average charge for all LTCH cases. The case-weighted average charge is 
determined by dividing the total charges for all LTCH cases by the 
total number of LTCH cases for the combined LTC-DRG. Based on the case-
weighted average LTCH charge, we determine which low-volume quintile 
the ``combined LTC-DRG'' is grouped. Both LTC-DRGs in the pair are then 
grouped into the same low-volume quintile, and thus have the same 
relative weight. In this final rule, for FY 2005, there are no LTC-DRGs 
that fall into this category.
    The third category of nonmonotonically increasing relative weights 
for LTC-DRG pairs with and without CCs consists of 10 pairs of LTC-DRGs 
where one of the LTC-DRGs has fewer than 25 LTCH cases and is grouped 
to a low-volume quintile and the other LTC-DRG has 25 or more LTCH 
cases and has its own LTC-DRG relative weight, and the LTC-DRG 
``without CCs'' has the higher relative weight. As discussed in the May 
18, 2004 proposed rule (69 FR 28232), we remove the low-volume LTC-DRG 
from the low-volume quintile and combine it with the other LTC-DRG for 
the computation of a new relative weight for each of these LTC-DRGs. 
This new relative weight is assigned to both LTC-DRGs, so they each 
have the same relative weight. In this final rule, for FY 2005, the 
following LTC-DRGs are in this category: LTC-DRGs 85 and 86; LTC-DRGs 
101 and 102; LTC-DRGs 141 and 142; LTC-DRGs 170 and 171; LTC-DRGs 172 
and 173; LTC-DRGs 175 and 175; LTC-DRGs 300 and 301; LTC-DRGs 318 and 
319; LTC-DRGs 442 and 443; and LTC-DRGs 521, 522 and 523 (We note, 3 
LTC-DRGs make up this non-monotonic ``pair'' of DRGs because the 
``without CCs'' DRG is further divided into two DRGs based on the 
presence or absence of rehabilitation therapy, so that there is one DRG 
in this non-monotonic ``pair'' with CCs and two DRGs in this non-
monotonic ``pair'' without CCs).
    Step 6--Determine an FY 2005 LTC-DRG relative weight for LTC-DRGs 
with no LTCH cases.
    As we stated above, we determine the relative weight for each LTC-
DRG using charges reported in the March 2004 update of the FY 2003 
MedPAR file. Of the 520 LTC-DRGs for FY 2005, we identified 171 LTC-
DRGs for which there were no LTCH cases in the database. That is, based 
on data from the FY 2003 MedPAR file used in this final rule, no 
patients who would have been classified to those LTC-DRGs were treated 
in LTCHs during FY 2003 and, therefore, no charge data were reported 
for those LTC-DRGs. Thus, in the process of determining the LTC-DRG 
relative weights, we are unable to determine weights for these 171 LTC-
DRGs using the methodology described in steps 1 through 5 above. 
However, because patients with a number of the diagnoses under these 
LTC-DRGs may be treated at LTCHs beginning in FY 2005, we assign 
relative weights to each of the 171 ``no volume'' LTC-DRGs based on 
clinical similarity and relative costliness to one of the remaining 349 
(520 - 171 = 349) LTC-DRGs for which we are able to determine relative 
weights, based on FY 2003 claims data.
    As there are currently no LTCH cases in these ``no volume'' LTC-
DRGs, as we discussed in the May 18, 2004 proposed rule (69 FR 28233), 
we determine relative weights for the 171 LTC-DRGs with no LTCH cases 
in the FY 2003 MedPAR file used in this final rule by grouping them to 
the appropriate low-volume quintile. This methodology is consistent 
with our methodology used in determining relative weights to account 
for the low-volume LTC-DRGs described above.
    Our methodology for determining relative weights for the ``no 
volume'' LTC-DRGs is as follows: We crosswalk the no volume LTC-DRGs by 
matching them to other similar LTC-DRGs for which there were LTCH cases 
in the FY 2003 MedPAR file based on clinical similarity and intensity 
of use of resources as determined by care provided during the period of 
time surrounding surgery, surgical approach (if applicable), length of 
time of surgical procedure, post-operative care, and length of stay. We 
assign the relative weight for the applicable low-volume quintile to 
the no volume LTC-DRG if the LTC-DRG to which it is crosswalked is 
grouped to one of the low-volume quintiles. If the LTC-DRG to which the 
no volume LTC-DRG is crosswalked is not one of the LTC-DRGs to be 
grouped to one of the low-volume quintiles, we compare the relative 
weight of the LTC-DRG to which the no volume LTC-DRG is crosswalked to 
the relative weights of each of the five quintiles and we assign the no 
volume LTC-DRG the relative weight of the low-volume quintile with the 
closest weight. For this final rule, a list of the no volume FY 2005 
LTC-DRGs and the FY 2005 LTC-DRG to which it is crosswalked in order to 
determine the appropriate low-volume quintile for the assignment of a 
relative weight for FY 2005 is shown below in Table 2.
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    To illustrate this methodology for determining the relative weights 
for the 171 LTC-DRGs with no LTCH cases, we are providing the following 
examples, which refer to the no volume LTC-DRGs crosswalk information 
for FY 2005 provided above in Table 2:


[[Page 48999]]


    Example 1: There were no cases in the FY 2003 MedPAR file used 
for this final rule for LTC-DRG 163 (Hernia Procedures Age 0-17). 
Since the procedure is similar in resource use and the length and 
complexity of the procedures and the length of stay are similar, we 
determined that LTC-DRG 178 (Uncomplicated Peptic Ulcer Without CC), 
which is assigned to low-volume quintile 1 for the purpose of 
determining the FY 2005 relative weights, would display similar 
clinical and resource use. Therefore, we assign the same relative 
weight of LTC-DRG 178 of 0.4586 (Quintile 1) for FY 2005 (Table 11 
in the Addendum to this final rule) to LTC-DRG 163.
    Example 2: There were no LTCH cases in the FY 2003 MedPAR file 
used in this final rule for LTC-DRG 91 (Simple Pneumonia and 
Pleurisy Age 0-17). Since the severity of illness in patients with 
bronchitis and asthma is similar in patients regardless of age, we 
determined that LTC-DRG 90 (Simple Pneumonia and Pleurisy Age >17 
Without CC) would display similar clinical and resource use 
characteristics and have a similar length of stay to LTC-DRG 91. 
There were over 25 cases in LTC-DRG 90. Therefore, it would not be 
assigned to a low-volume quintile for the purpose of determining the 
LTC-DRG relative weights. However, under our established 
methodology, LTC-DRG 91, with no LTCH cases, would need to be 
grouped to a low-volume quintile. We identified that the low-volume 
quintile with the closest weight to LTC-DRG 90 (0.7494; see Table 11 
in the Addendum to this final rule) would be low-volume quintile 2 
(0.8508; see Table 11 in the Addendum to this final rule). 
Therefore, we assign LTC-DRG 91 a relative weight of 0. 8508 for FY 
2005.

    Furthermore, we are providing LTC-DRG relative weights of 0.0000 
for heart, kidney, liver, lung, pancreas, and simultaneous pancreas/
kidney transplants (LTC-DRGs 103, 302, 480, 495, 512, and 513, 
respectively) for FY 2005 because Medicare will only cover these 
procedures if they are performed at a hospital that has been certified 
for the specific procedures by Medicare and presently no LTCH has been 
so certified.
    Based on our research, we found that most LTCHs only perform minor 
surgeries, such as minor small and large bowel procedures, to the 
extent any surgeries are performed at all. Given the extensive criteria 
that must be met to become certified as a transplant center for 
Medicare, we believe it is unlikely that any LTCHs would become 
certified as a transplant center. In fact, in the nearly 20 years since 
the implementation of the IPPS, there has never been a LTCH that even 
expressed an interest in becoming a transplant center.
    However, if in the future a LTCH applies for certification as a 
Medicare-approved transplant center, we believe that the application 
and approval procedure would allow sufficient time for us to determine 
appropriate weights for the LTC-DRGs affected. At the present time, we 
are only including these six transplant LTC-DRGs in the GROUPER program 
for administrative purposes. Because we use the same GROUPER program 
for LTCHs as is used under the IPPS, removing these LTC-DRGs would be 
administratively burdensome.
    Again, we note that as this system is dynamic, it is entirely 
possible that the number of LTC-DRGs with a zero volume of LTCH cases 
based on the system will vary in the future. We used the best most 
recent available claims data in the MedPAR file to identify zero volume 
LTC-DRGs and to determine the relative weights in this final rule.
    Table 11 in the Addendum to this final rule lists the LTC-DRGs and 
their respective relative weights, geometric mean length of stay, and 
five-sixths of the geometric mean length of stay (to assist in the 
determination of short-stay outlier payments under Sec.  412.529) for 
FY 2005.
    Comment: A few commenters believe that the budget neutrality 
requirement found in section 123 of the Public Law 106-113 requires CMS 
to adjust the LTC-DRG relative weights to ensure that total payments to 
LTCHs are budget neutral for the proposed changes to the LTC-DRG 
classifications and relative weights. Alternatively, the commenters 
suggested that we make an adjustment to the LTCH PPS Federal rate to 
account for the estimated $55 million reduction in LTCH PPS payments 
which resulted from the proposed changes in the LTC-DRG classifications 
and relative weights.
    Response: In the May 18, 2004 proposed rule (69 FR 28806), we 
estimated a $55 million aggregate decrease in LTCH PPS payments as a 
result of the proposed changes in the LTC-DRG relative weights and 
proposed version 22.0 GROUPER for FY 2005. We note that we incorrectly 
estimated the impact of the change in the proposed LTC-DRGs for FY 2005 
in the proposed rule because we failed to account for the change in DRG 
classifications and the change in the geometric average length of stay 
for each LTC-DRG. As discussed in section VII.B. of Appendix A to this 
final rule, we are estimating that the impact of the change in LTC-DRGs 
for FY 2005 (including changes in the DRG classifications, relative 
weights and geometric average lent of stay) will result in 
approximately a $14.9 million decrease in LTCH PPS payments. In that 
same proposed rule, we explained that we found that based on an 
analysis of the LTCH claims in the FY 2003 MedPAR files, the average 
LTC-DRG relative weight across all LTC-DRGs has increased due to an 
increase in the number of cases being assigned to higher weighted LTC-
DRGs. As a result, including cases with relatively lower charges into 
LTC-DRGs that have a relatively higher relative weight in the GROUPER 
version 21.0 (FY 2004) decreases the average relative weight in the 
proposed GROUPER version 22.0 (FY 2005).
    As we discussed in the August 30, 2002 LTCH PPS final rule (67 FR 
55960), which implemented the LTCH PPS, section 123 of Public Law 106-
113 requires that the LTCH PPS, among other things, shall include an 
adequate patient classification system that is based on DRGs and that 
reflects the differences in patient resource use and costs, and shall 
maintain budget neutrality. With respect to budget neutrality, we 
interpreted section 123(a)(1) of Public Law 106-113 to require that 
total payments under the LTCH PPS during FY 2003 will be projected to 
equal estimated payments that would have been made for LTCHs' operating 
and capital-related inpatient hospital costs had the LTCH PPS not have 
been implemented. Consistent with this requirement, under Sec.  
412.523(d)(2) an adjustment is made in determining the standard Federal 
rate for FY 2003 so that aggregate payments under the LTCH PPS are 
estimated to equal the amount that would have been paid to LTCHs under 
the reasonable cost-based (TEFRA) payment system if the LTCH PPS were 
not implemented. Therefore, in that same final rule (67 FR 56027 
through 56037), in order to maintain budget neutrality, we adjusted the 
LTCH PPS Federal rate for FY 2003 so that aggregate payments under the 
LTCH PPS are estimated to equal the amount that would have been paid to 
LTCHs under the reasonable cost-based (TERFA) payment system had the 
LTCH PPS had not been implemented.
    In addition, when we implemented the LTCH PPS in the August 30, 
2002 LTCH PPS final rule, we provided subpart O of the regulations at 
42 CFR, including Sec.  412.517, for an annual adjustment to the LTC-
DRG classifications and weighting factors to reflect changes in 
treatment patterns, technology, number of discharges, and other factors 
affecting the relative use of hospital resources. We do not believe 
that section 123 of the Pub. L. 106-113 requires that the annual update 
to the LTC-DRG classifications and relative weights maintain budget 
neutrality. We believe we have satisfied the budget neutrality 
requirement of section 123 of

[[Page 49000]]

the Pub. L. 106-113 by establishing the LTCH PPS Federal rate for FY 
2003 under Sec.  412.523(d)(2) so that aggregate payment under the LTCH 
PPS are projected equal to estimated aggregate payments under the 
reasonable cost-based payment system if the LTCH PPS were not 
implemented. Therefore, we disagree with the commenters that an 
adjustment to the FY 2005 LTC-DRG relative weights or to the LTCH PPS 
Federal rate is required as a result of the annual update to the LTC-
DRGs under Sec.  412.517 for FY 2005. Accordingly, we have updated the 
LTC-DRG classifications and relative weights for FY 2005 (as shown in 
Table 11 of Addendum to this final rule) without an adjustment for 
budget neutrality. We note that this is our policy regardless of 
whether the annual update to the LTC-DRG classifications and relative 
weights results in higher or lower estimated aggregate payments. For 
instance we estimate that the annual update to the LTC-DRG 
classifications and relative weights from FY 2003 to FY 2004 resulted 
in an estimated increase in LTCH PPS payments, yet the update to the 
LTC-DRGs in the August 1, 2003 final rule for FY 2004 were not adjusted 
to maintain budget neutrality. In either case, at this time we do not 
make an adjustment to maintain budget neutrality for the effects of 
changes in the LTC-DRG classifications and relative weights. 
Accordingly, in developing the FY 2005 LTC-DRGs and relative weights 
shown in Table 11 of this final rule, we have not applied an adjustment 
for budget neutrality nor are we adjusting the 2005 LTCH PPS rate year 
Federal rate established in the May 7, 2004, LTCH PPS final rule (69 FR 
25674) to account for the estimated change in LTCH PPS payments which 
result from the annual update to the LTC-DRG classifications and 
relative weights for FY 2005.
    The commenter raises the issue that it may be appropriate for 
certain aspects of the LTCH PPS to maintain budget neutrality when they 
are updated annually as they are in other PPSs, such as the annual 
update to the DRGs and wage index. Under section 123 of Public Law 106-
113 and section 307 of Publicl Law 106-554, the Secretary generally has 
broad authority in developing the LTCH PPS, including whether and how 
to make adjustments to LTCH PPS payments. Specifically, section 
307(b)(1) of Public Law 106-554 provides that ``the Secretary shall 
examine and may provide for appropriate adjustments to the long-term 
hospital payment system, including adjustments to DRG weights, area 
wage adjustments, geographic classification, outliers, updates, and a 
disproportionate share adjustment [* * *].'' We will consider whether 
it is appropriate for use to propose a future revision to the LTCH PPS 
regulations at subpart O of 42 CFR to maintain budget neutrality in the 
annual update of some aspects of the LTCH PPS under our broad 
discretionary authority under the statute to provide ``appropriate 
adjustments to the long-term hospital payment system.'' Any changes to 
the LTCH PPS regulations would be made in accordance with 
Administrative Procedures Act guidelines.
5. Out of Scope Comments Relating to the LTCH PPS Payment Rates
    Comment: A few commenters submitted comments that addressed aspects 
of the existing LTCH PPS, including the standard Federal rate and 
outlier methodology, which are not relevant to the LTCH policy 
proposals set forth in the May 18, 2004 IPPS proposed rule.
    Response: Because those comments pertain to specific aspects of the 
existing LTCH PPS rather than to any specific proposed changes to the 
LTCH PPS presented in the May 18, 2004 IPPS proposed rule, we are 
unable to respond to those comments at this time. Rather, we believe it 
is more appropriate to address those issues in the annual LTCH PPS 
proposed and final rules, and we will consider the issues raised in 
those comments in the context of future rulemaking for the LTCH PPS.

E. Add-On Payments for New Services and Technologies

1. Background
    Sections 1886(d)(5)(K) and (L) of the Act establish a process of 
identifying and ensuring adequate payment for new medical services and 
technologies under the IPPS. Section 1886(d)(5)(K)(vi) of the Act 
specifies that a medical service or technology will be considered new 
if it meets criteria established by the Secretary after notice and 
opportunity for public comment. Section 1886(d)(5)(K)(ii)(I) of the Act 
specifies that the process must apply to a new medical service or 
technology if, ``based on the estimated costs incurred with respect to 
discharges involving such service or technology, the DRG prospective 
payment rate otherwise applicable to such discharges under this 
subsection is inadequate.''
    The regulations implementing this provision establish three 
criteria for special treatment. First, Sec.  412.87(b)(2) defines when 
a specific medical service or technology will be considered new for 
purposes of new medical service or technology add-on payments. The 
statutory provision contemplated the special payment treatment for new 
medical services or technologies until such time as data are available 
to reflect the cost of the technology in the DRG weights through 
recalibration. There is a lag of 2 to 3 years from the point a new 
medical service or technology is first introduced on the market and 
when data reflecting the use of the medical service or technology are 
used to calculate the DRG weights. For example, data from discharges 
occurring during FY 2003 are used to calculate the FY 2005 DRG weights 
in this final rule. Section 412.87(b)(2) provides that a ``medical 
service or technology may be considered new within 2 or 3 years after 
the point at which data begin to become available reflecting the ICD-9-
CM code assigned to the new medical service or technology (depending on 
when a new code is assigned and data on the new medical service or 
technology become available for DRG recalibration). After CMS has 
recalibrated the DRGs, based on available data, to reflect the costs of 
an otherwise new medical service or technology, the medical service or 
technology will no longer be considered `new' under the criterion for 
this section.''
    In the May 18, 2004, proposed rule (69 FR 28237), we stated that 
the 2-year to 3-year period of newness for a technology or medical 
service would ordinarily begin with FDA approval, unless there was some 
documented delay in bringing the product onto the market after that 
approval (for instance, component production or drug production had 
been postponed until FDA approval due to shelf life concerns or 
manufacturing issues). After the DRGs have been recalibrated to reflect 
the costs of an otherwise new medical service or technology, the 
special add-on payment for new medical services or technology ceases 
(Sec.  412.87(b)(2)). For example, an approved new technology that 
received FDA approval in October 2003 and entered the market at that 
time may be eligible to receive add-on payments as a new technology 
until FY 2006 (discharges occurring before October 1, 2005), when data 
reflecting the costs of the technology would be used to recalibrate the 
DRG weights. Because the FY 2006 DRG weights will be calculated using 
FY 2004 MedPAR data, the costs of such a new technology would likely be 
reflected in the FY 2006 DRG weights.
    Section 412.87(b)(3) further provides that, to receive special 
payment treatment, new medical services or technologies must be 
inadequately paid otherwise under the DRG system. To

[[Page 49001]]

assess whether technologies would be inadequately paid under the DRGs, 
we establish thresholds to evaluate applicants for new technology add-
on payments. In the August 1, 2003, final rule (68 FR 45385), we 
established the threshold at the geometric mean standardized charge for 
all cases in the DRG plus 75 percent of 1 standard deviation above the 
geometric mean standardized charge (based on the logarithmic values of 
the charges and transformed back to charges) for all cases in the DRG 
to which the new medical service or technology is assigned (or the 
case-weighted average of all relevant DRGs, if the new medical service 
or technology occurs in many different DRGs). Table 10 in the Addendum 
to the August 1, 2003, final rule (68 FR 45648) listed the qualifying 
threshold by DRG, based on the discharge data that we used to calculate 
the FY 2004 DRG weights.
    However, section 503(b)(1) of Public Law 108-173 amended section 
1886(d)(5)(K)(ii)(I) of the Act to provide for ``applying a threshold * 
* * that is the lesser of 75 percent of the standardized amount 
(increased to reflect the difference between cost and charges) or 75 
percent of one standard deviation for the diagnosis-related group 
involved.'' The provisions of section 503(b)(1) apply to classification 
for fiscal years beginning with FY 2005. We updated Table 10 from the 
October 6, 2003, Federal Register correction document, which contains 
the thresholds that we used to evaluate applications for new service or 
technology add-on payments for FY 2005, using the section 503(b)(1) 
measures stated above, and posted these new thresholds on our Web site 
at: http://www.cms.hhs.gov/providers/hipps/newtech.asp. In the May 18, 
2004, proposed rule, we included preliminary thresholds for evaluating 
applicants for new technology add-on payments for FY 2006. Table 10 of 
this final rule contains the final thresholds that will be used to 
evaluate applicants for new technology add-on payments for FY 2006. 
(Refer to section IV.D. of this preamble for a discussion of a revision 
of the regulations to incorporate the change made by section 503(b)(1) 
of Public Law 108-173.)
    Section 412.87(b)(1) of our existing regulations provides that a 
new technology is an appropriate candidate for an additional payment 
when it represents an advance in medical technology that substantially 
improves, relative to technologies previously available, the diagnosis 
or treatment of Medicare beneficiaries. For example, a new technology 
represents a substantial clinical improvement when it reduces 
mortality, decreases the number of hospitalizations or physician visits 
or reduces recovery time compared to the technologies previously 
available. (See the September 7, 2001 final rule (66 FR 46902) for a 
complete discussion of this criterion.)
    The new medical service or technology add-on payment policy 
provides additional payments for cases with high costs involving 
eligible new medical services or technologies while preserving some of 
the incentives under the average-based payment system. The payment 
mechanism is based on the cost to hospitals for the new medical service 
or technology. Under Sec.  412.88, Medicare pays a marginal cost factor 
of 50 percent for the costs of a new medical service or technology in 
excess of the full DRG payment. If the actual costs of a new medical 
service or technology case exceed the DRG payment by more than the 50-
percent marginal cost factor of the new medical service or technology, 
Medicare payment is limited to the DRG payment plus 50 percent of the 
estimated costs of the new technology.
    The report language accompanying section 533 of Public Law 106-554 
indicated Congressional intent that the Secretary implement the new 
mechanism on a budget neutral basis (H.R. Conf. Rep. No. 106-1033, 
106th Cong., 2nd Sess. at 897 (2000)). Section 1886(d)(4)(C)(iii) of 
the Act requires that the adjustments to annual DRG classifications and 
relative weights must be made in a manner that ensures that aggregate 
payments to hospitals are not affected. Therefore, in the past, we 
accounted for projected payments under the new medical service and 
technology provision during the upcoming fiscal year at the same time 
we estimated the payment effect of changes to the DRG classifications 
and recalibration. The impact of additional payments under this 
provision was then included in the budget neutrality factor, which was 
applied to the standardized amounts and the hospital-specific amounts.
    Section 503(d)(2) of Public Law 108-173 amended section 
1886(d)(5)(K)(ii)(III) of the Act to provide that there shall be no 
reduction or adjustment in aggregate payments under the IPPS due to 
add-on payments for new medical services and technologies. Therefore, 
add-on payments for new medical services or technologies for FY 2005 
and later years will not be budget neutral. We discuss the regulation 
change necessary to implement this provision in section IV.H. of this 
final rule.
    Applicants for add-on payments for new medical services or 
technologies for FY 2006 must submit a formal request, including a full 
description of the clinical applications of the medical service or 
technology and the results of any clinical evaluations demonstrating 
that the new medical service or technology represents a substantial 
clinical improvement, along with a significant sample of data to 
demonstrate the medical service or technology meets the high-cost 
threshold, no later than early October 2004. Applicants must submit a 
complete database no later than mid-December 2004. Complete application 
information, along with final deadlines for submitting a full 
application, will be available at our Web site after publication of 
this FY 2005 final rule at: http://www.cms.hhs.gov/providers/hipps/default.asp. To allow interested parties to identify the new medical 
services or technologies under review before the publication of the 
proposed rule for FY 2006, the Web site will also list the tracking 
forms completed by each applicant.
2. Other Provisions of Section 503 of Public Law 108-173
    Section 503(b)(2) of Public Law 108-173 amended section 
1886(d)(5)(K) of the Act by adding a new clause (viii) to provide for a 
mechanism for public input before publication of a notice of proposed 
rulemaking regarding whether a medical service or technology represents 
a substantial improvement or advancement. The revised process for 
evaluating new medical service and technology applications requires the 
Secretary to--
     Provide, before publication of a proposed rule, for public 
input regarding whether a new service or technology represents an 
advance in medical technology that substantially improves the diagnosis 
or treatment of Medicare beneficiaries.
     Make public and periodically update a list of the services 
and technologies for which an application for add-on payments is 
pending.
     Accept comments, recommendations, and data from the public 
regarding whether a service or technology represents a substantial 
improvement.
     Provide, before publication of a proposed rule, for a 
meeting at which organizations representing hospitals, physicians, 
manufacturers, and any other interested party may present comments, 
recommendations, and data regarding whether a new service or technology 
represents a substantial

[[Page 49002]]

clinical improvement to the clinical staff of CMS.
    In order to satisfy the requirements of this last provision, we 
published a notice in the Federal Register on February 27, 2004, and 
held a town meeting at the CMS Headquarters Office in Baltimore, MD, on 
March 15, 2004. In the announcement notice for the meeting, we stated 
that the opinions and alternatives provided during the meeting would 
assist us in our evaluations of applications by allowing public 
discussions of the substantial clinical improvement criteria for each 
of the FY 2005 new medical service and technology add-on payment 
applications before the publication of the FY 2005 IPPS proposed rule.
    Approximately 70 participants registered and attended in person, 
while additional participants listened over an open telephone line. The 
participants focused on presenting data on the substantial clinical 
improvement aspect of their products, as well as the need for 
additional payments to ensure access to Medicare beneficiaries. In 
addition, we also received many written comments regarding the 
substantial clinical improvement criterion for the applicants. As 
indicated in the May 18, 2004, proposed rule, we considered these 
comments in our evaluation of each new application for FY 2005 in the 
proposed rule. In the proposed rule, we summarized these comments or, 
if applicable, indicated that no comments were received, at the end of 
the discussion of the individual applications.
    Section 503(c) of Public Law 108-173 amended section 1886(d)(5)(K) 
of the Act by adding a new clause (ix) requiring that before 
establishing any add-on payment for a new medical service or 
technology, that the Secretary shall seek to identify one or more DRGs 
associated with the new technology, based on similar clinical or 
anatomical characteristics and the costs of the technology and assign 
the new technology into a DRG where the average costs of care most 
closely approximate the costs of care using the new technology. No add-
on payment shall be made with respect to such a new technology.
    At the time an application is submitted, the DRGs associated with 
the new technology are identified. We only determine that a new 
technology add-on payment is appropriate when the reimbursement under 
these DRGs is not adequate for this new technology. The criterion for 
this determination is the cost threshold, which we discuss below. We 
discuss the assignments of several new technologies within the DRG 
payment system in section II.B. of this final rule. The comment 
regarding the DRG assignment of the treatment for AIP is addressed in 
section II.B.16.i. of this final rule.
    Comment: We received several letters from commenters stating that 
we should address the inequities in the DRG system with respect to 
several drugs and technologies that appeared to go unnoticed by us, 
according to the commenters. Specifically, payments for the treatment 
of acute intermittent porphyria (AIP) were brought to our attention. We 
received additional comments from physicians and a company concerning 
new procedure code 00.16 (Pressurized treatment of venous bypass graft 
(conduit) with pharmaceutical substance). The commenters requested that 
we evaluate potential reimbursement scenarios for these new procedures.
    Response: We discuss the method for applying for consideration for 
the new technology add-on payment in section II.E.1. of this preamble. 
The Medicare program pays for thousands of medical services, drugs and 
technologies and may not necessarily be aware of all new technologies 
that come to the market. We have implemented the new technology add-on 
payment provision by providing a process by which applicants can 
present these technologies to us for add-on payment consideration. 
Commenters should also consider the application process for obtaining 
new ICD-9-CM codes to further aid in obtaining specifically identifying 
procedure codes in an effort to seek new technology add-on payments. We 
discuss the DRG assignment of procedure code 00.16 in section 
II.B.16.c. of this final rule. The comment regarding the DRG assignment 
of the treatment for AIP is addressed in section II.B.16.i. of this 
final rule.
    Comment: Some commenters objected to the application of the newness 
criterion in the proposed rule. These commenters asserted that CMS's 
description of the criterion requiring a technology to be new was 
inconsistent with the statute and the September 7, 2001 final rule. 
Specifically, the commenters maintained that defining the period of new 
as during the 2-year to 3-year period after FDA market approval would 
``represent a significant shift, retroactively changing the conditions 
under which companies have been developing innovative technologies and 
filing new technology applications.'' These commenters further stated 
that this makes the regulatory process unpredictable, ``potentially 
having an adverse effect on patient access to breakthrough medical 
technologies.'' The commenters urged us to ``reaffirm'' our September 
7, 2001, policy and reevaluate the applications that CMS proposed to 
deny on the newness issue.
    Response: The intent of section 1886(d)(5)(K) of the Act and 
regulations under Sec.  412.87(b)(2) is to pay for new medical services 
and technologies for the first 2 to 3 years that a product comes on the 
market, during the period when the costs of the new technology are not 
yet fully reflected in the DRG weights. Generally, we use the FDA 
approval as the indicator of the time when a technology begins to 
become available on the market and data reflecting the costs of the 
technology begin to become available for recalibration of the DRGs. In 
some specific circumstances, we have recognized a date later than the 
FDA approval as the appropriate starting point for the 2-year to 3-year 
period. For example, we have recognized a later date where an applicant 
could prove a delay in actual availability of a product after FDA 
approval. The costs of the new medical service or technology, once paid 
for by Medicare for this 2-year to 3-year period, are accounted for in 
the MedPAR data that are used to recalibrate the DRG weights on an 
annual basis. Therefore, it is appropriate to limit the add-on payment 
window for those technologies that have passed this 2-to 3-year 
timeframe.
    We disagree that our statement of the policy in the proposed rule 
is inconsistent with policy that was implemented in previous rules. In 
the first year that new technology applications were considered in the 
IPPS (that is, during calendar year 2002), we discussed several 
applications and determined whether they could be considered new on the 
basis of when FDA approval was granted to the technologies. Again in 
our August 1, 2003 final rule for FY 2004, we denied applicants on the 
basis that the technologies had gained FDA approval prior to FY 2001; 
and thus, were not eligible for new technology add-on payments. In 
these instances, we employed the actual date of FDA market approval, 
not the date a separate ICD-9-CM code became available, since data 
reflecting the costs associated with those technologies had already 
been included in the DRG weights prior to the adoption of a separate 
ICD-9-CM code.
    Using the ICD-9-CM code alone is not an appropriate test of newness 
because technologies that are new to the market are automatically 
placed into the closest ICD-9-CM category when they first come on the 
market, unless the

[[Page 49003]]

manufacturer requests the assignment of a new ICD-9-CM code because 
existing codes do not adequately reflect or describe the medical 
service or device. The services and technologies that have been placed 
into existing ICD-9-CM codes have been paid for using those 
descriptors. Therefore, while it may be impossible to actually identify 
when a particular product was used because there is no unique code to 
identify it amongst other products in the category, the product is 
nonetheless used and paid for. In addition, hospital charges reflect 
the services provided to patients receiving the new service or device 
whether or not a specific code is assigned. Therefore, data containing 
payments for these new technologies are already in our MedPAR database 
and when DRG recalibration occurs these costs are accounted for. 
Furthermore, assignment of new codes can occur for many reasons other 
than the introduction of new procedures and technologies. For example, 
new codes can simply reflect more refined and discriminating 
descriptions of existing procedures and technologies.
    If we were strictly to use the ICD-9-CM coding system for the 
purposes of identifying what technologies are new, there would be an 
incentive for nearly every product, service and surgical technique to 
apply for a new, unique ICD-9-CM code. The ICD-9-CM system could not 
absorb all these potential new codes. It would also be inappropriate to 
pay more, in the form of new technology add-on payments, for most of 
the codes, as the technology may have been in use prior to the 
assignment of the new code for several years, or several decades in 
some cases. For example, there is currently no procedural distinction 
between a patient receiving a kidney transplant from a living or 
cadaver donor. It is conceivable that this kidney transplant could be 
broken out into several procedures, identifying the source of the 
kidney (from living/deceased, relative/stranger, etc.), and each would 
be a ``new'' procedure if we were to adopt the commenters' approach. 
These procedures have been in use for up to half a century; and 
therefore, clearly should not qualify as a new medical service or 
technology simply because a new ICD-9-CM code has been assigned. 
Another example that further exemplifies the limitations of this ICD-9-
CM-based approach is the esophageal permanent tube, which is a stent 
implanted in a patient who cannot be medically treated and is unable to 
swallow. If we create a new code, and use it to determine if the 
esophageal permanent tube should qualify for new technology payment 
under the commenters' approach, the technology could qualify as new, 
although the procedure has been used for the last 20 years.
    We also note that our existing interpretation does not hamper the 
ability of patients to receive technologies that do not qualify for new 
technology add-on payments. The IPPS will continue to pay for existing 
and new medical services and technologies through the regular payment 
mechanism established by the DRG payment methodology. Therefore, 
patient access to these technologies is not adversely affected by this 
interpretation, and this interpretation is not inconsistent with the 
framework used to review new technology applications in previous years.
    Comment: One commenter stated, ``we believe that the 2-to 3-year 
clock should not start until a technology receives final approval by 
the Food and Drug Administration.'' The commenter also submitted an 
additional comment that stated that the ``date of ICD-9 code assignment 
should start the add-on payment eligibility time clock, not the date of 
FDA approval.''
    Response: We note that the commenter's comments were somewhat 
contradictory on the issue of newness. The timeframe that a new 
technology can be eligible to receive new technology add-on payments 
begins when data become available. Section 412.87(b)(2) clearly states 
that ``a medical service or technology may be considered new within the 
2 to 3 year after the point at which data begins to become available 
reflecting the ICD-9-CM code assigned to the new service or technology 
(depending on when a new code is assigned and data on the new service 
or technology become available for DRG recalibration).'' Section 
412.87(b)(2) also states ``***[a]fter CMS has recalibrated the DRGs, 
based on available data, to reflect the costs of an otherwise new 
medical service or technology, the medical service or technology will 
no longer be considered `new' under the criterion of this section.'' 
Therefore, regardless of whether a technology can be individually 
identified by a separate ICD-9-CM code, if the costs of the technology 
are included in the charge data, and the DRGs have been recalibrated 
using that data, then the device can no longer be considered new for 
the purposes of this provision.
    Comment: A commenter suggested that CMS adopt a different strategy 
for defining the newness criterion. The commenter believes that the 
decision of whether a technology is new should involve consideration of 
both the FDA approval date and the date of issuance of an ICD-9-CM 
code. The commenter explained that if an ICD-9-CM code is issued within 
12 months of FDA approval, the 2-to 3-year period of a technology being 
considered new should begin from the date of issuance of the ICD-9-CM 
code. If a code is issued more than 12 months after FDA approval, the 
2-to 3-year period should begin from the FDA approval date. The 
commenter noted that adoption of this interpretation would strike a 
balance between the FDA approval date and the procedure code effective 
date and is consistent with the preamble of the September 7, 2001 
Federal Register (66 FR 46914) and the text of the regulation (42 CFR 
412.87(b)(2)).
    Response: We note that the time period does not necessarily start 
with the approval date for the medical service or technology and does 
not necessarily start with the issuance of a distinct code. Instead, it 
begins with availability of the product on the market, which is when 
data become available. We have consistently applied this standard, and 
believe that it is most consistent with the purpose of new technology 
add-on payments.
    Comment: MedPAC recommended that we use a different approach to DRG 
recalibration. In these instances, MedPAC recommends that we exclude 
those cases involving a new technology from our DRG recalibration 
method. Doing so ``would avoid overpaying for the technology by 
including its costs in the base payment while also providing an add-on 
payment'' during the overlapping 2-to 3-year period in question. MedPAC 
further stipulates that this approach ``should be used for all cases 
where the new technology can be tracked'' with an ICD-9-CM code or 
where cases can be identified by other characteristics in our MedPAR 
data. They also stressed the importance of maintaining a conservative 
approach when CMS evaluates technologies for add-on payments. In 
addition, they noted that paying indiscriminately for too many 
technologies ``can be seen as unbundling of the DRG system'' which 
would threaten the ``incentives for hospitals to be efficient and weigh 
the benefits of new technologies against their costs.'' Moreover, they 
noted that section 503(b)(1) of Public Law 108-173 changed the cost 
criteria by lowering the threshold to qualify for add-on payments. As 
such, MedPAC believes that the number of technologies that could 
potentially be eligible to qualify will likely increase expenditures to 
the program since these payments are no longer budget neutral.

[[Page 49004]]

    Response: We appreciate MedPAC's recommendations and will consider 
its suggestion regarding excluding the costs of cases involving new 
technologies from DRG recalibration calculations in the future. We also 
believe that we have consistently applied an appropriately high 
standard of clinical improvement to restrict these types of payments to 
relatively few technologies that are truly new. We will continue to 
apply this high standard in our review of applications for new 
technology add-on payments in the future.
    Comment: A commenter noted that if ``CMS believes that it erred in 
developing the payment period policy published in the September 7, 2001 
final rule, then it should propose a policy change applying to all 
applications for new technology add-on payments.'' The commenter also 
stated, that ``the implementation of such a policy change should affect 
only the applications received thereafter, and should not apply to any 
applications currently under consideration.''
    Response: We believe that the commenter, the manufacturer of InFUSE 
TM Bone Graft, wanted to ensure that if we made a change in 
the policy, that change would be done through notice and comment 
rulemaking and that the change would not be applied retroactively to 
applicants that are currently under consideration. However, we note 
that we have not made any changes to the policies implemented in the 
September 7, 2001 final rule.
    Comment: Several commenters urged us to be as clear as possible in 
implementing section 503 of Public Law 108-173. The commenters stated 
that transparency is necessary, particularly for ``small companies 
doing a disproportionate amount of the medical device research and 
development.'' Many commenters urged us to clearly state and adopt an 
approach to the provision so there is ``a clear path to follow and a 
reliable set of requirements to meet.'' Several commenters also noted 
that, despite how we have been applying the definition of new, many of 
the companies that have applied or could apply for new technology add-
on payments do not neatly fall into a standard definition because 
different manufacturers follow different pathways. These commenters 
stated, ``many device manufacturers, especially small device 
entrepreneurs, lack the nationwide marketing, distribution, and 
reputation of the larger companies in the industry. These small 
companies are most affected by the so-called 'payment lag' during which 
new products are under-reimbursed.***'' In addition, commenters stated, 
despite or because of these problems of distribution, the rates of 
adoption and utilization of new products should be accounted for before 
we decide technologies are no longer new. In addition, commenters call 
for CMS to ``clarify what the bar is for a device to represent a 
substantial [clinical] improvement.'' Commenters stated that 
determinations of what represents a substantial clinical improvement 
have been largely subjective, but that, ``for future generations of 
add-on applicants, an elaborated definition would be helpful.''
    Response: As stated previously, we have used as our uniform 
standard, the date of FDA approval in combination with market 
availability to evaluate new technology applications. We also note that 
in our evaluation of previous new technology applications, we have 
stated whether or not the applicants have met the substantial clinical 
improvement criterion as part of the basis for our approval or 
disapproval of the application. We follow the guidelines, as listed in 
the September 7, 2001 final rule, to make these determinations as they 
apply to improving the quality of care for the elderly Medicare 
population. However, as discussed in response to several of the other 
comments, we may need to consider revising our policies in the future 
to make the process more streamlined as more technologies apply for the 
new technology add-on payments. We will also consider the commenter's 
views concerning the payment lag for new products as we continue to 
develop policy in this area. However, at this time we believe that the 
2-to 3-years timeframe remains an appropriate standard for determining 
when the costs of new technologies have been incorporated into the DRG 
weights.
    Comment: Several commenters urged CMS to adopt a uniform standard 
for reviewing new technology add-on payment applications that is 
consistent between both the IPPS and the OPPS. Additionally, one 
commenter believes that CMS is inconsistent in its use of external data 
for verifying or amending payment rates. The commenter recommended that 
CMS should acknowledge that different types of data are appropriate for 
different uses such as revisions to APCs in the outpatient setting and 
adjustment of DRG relative weights in the inpatient setting. The 
commenter added that data requirements for determining eligibility for 
a new technology add-on payment should not be the same as for adjusting 
DRG relative weights. The commenter also recommended that external data 
provided for DRG assignments or payments for new technologies may be 
appropriately proprietary in these cases and the commenter believes CMS 
should release such data in a summary format agreed to by the companies 
and should not make the data available for public inspection without 
the companies' consent. The commenter also suggested that CMS should 
not require identification of a hospital by its Medicare provider 
number in cases where there may be a confidentiality agreement between 
the manufacturer or data vendor and the hospital submitting the data. 
The commenter recommended that CMS use pseudo-identifiers as an 
alternative to actual provider numbers. The commenter also proposed 
that CMS allow the use of external data from recent timeframes without 
corresponding MedPAR data, particularly for procedures involving new 
technologies and codes. The commenter explained that external data from 
private vendors has only a 60-90 day time lag compared to MedPAR, which 
has a lengthier time lag. The commenter further recommended that when 
determining the price of a drug or device CMS should accept the 
disclosure of discounts and rebates at the estimated aggregate level 
since the company may not know the final price paid by the hospital for 
a given product. Finally, the commenter recommended that CMS should 
request that medical technology companies offer the HCPCS codes and 
ICD-9-CM codes that seem most clinically appropriate to the procedure 
since this information would be most helpful to CMS and allow companies 
to target their resources in providing external data. Another commenter 
expressed that companies will not make the best data available ``unless 
CMS agrees to hold it confidential.''
    Another commenter encouraged CMS to expand its acceptance of 
external data in order to ease the process of establishing adequate 
initial inpatient payment for new technology procedures at or as close 
as possible to the time of FDA approval. The commenter also urged CMS 
to accept external data as part of the recalibration of the DRG 
weights. The commenter also recommended that CMS apply reasonable 
standards that take into account the limited amount of data that may be 
available for new technologies and the difficulties involved in 
collecting such data in determining whether external data provides an 
acceptable basis for making a new DRG assignment or adjustment of the 
DRG weights.
    One commenter, a company that gathers data on hospital services, 
noted

[[Page 49005]]

that its data could be used to project national trends and establish 
Medicare policies. The commenter also noted that there are instances 
where its data are more detailed than MedPAR. The commenter believes 
CMS should work with the industry to develop criteria for making use of 
external data. The commenter was also concerned about the difficulty of 
obtaining MedPAR data. The commenter explained that CMS no longer makes 
available quarterly updates to the MedPAR and that the MedPAR data used 
to develop the FY 2005 proposed rule were not made available in a 
timely manner.
    Response: We note that we have followed many of these examples when 
reviewing previous technologies. In the case of Xigris([reg]), we 
worked very closely with the applicant to review the applicant's data 
in order to identify a cohort of cases that would be appropriate 
candidates to receive the new drug. For FY 2005, we have also worked 
very closely with the applicants to help them identify what data 
requirements needed to be met and to help them to determine the best 
strategies to meet these requirements. We note, however, that 
applicants should weigh the advantages of submitting additional data in 
support of an application for new technology add-on payments with the 
need to preserve the confidentiality of certain proprietary data. We 
thank the commenters for their other comments and recommendations 
regarding accepting non-MedPAR data. We intend to take these comments 
into consideration and review the feasibility of adopting one or more 
of these approaches at some time in the future. Because we did not make 
any proposals regarding the use of external data in the May 18, 2004 
proposed rule, we are not making any changes at this time. However, we 
will consider the comments in developing future proposals.
    We also note that we offer two annual updates of the MedPAR data 
used for determining the rates in FY 2005. One update is based on the 
data used for the proposed rule. This update is usually issued in May. 
The second update is based on the data used in the final rule and is 
usually issued in September. Information on purchasing the MedPAR data 
used in determining the rates for FY 2005 can be found on our Web site 
at http://www.cms.hhs.gov/data/order/default.asp. Finally, we note, 
that in the interests of providing the most accurate and complete data 
files and due to time and work constraints, we are no longer able to 
issue quarterly updates of the MedPAR to the public.
    Comment: Commenters in general contended that they ``cannot meet 
the public's demands to adopt new technologies * * * because their 
ability to access capital is deteriorating''. Commenters stated that 
since very few new technologies have qualified for this add-on payment, 
hospitals continue to underutilize and potentially limit use of 
clinically important new technologies in the absence of these higher 
payments. Commenters again urged CMS to increase the payment for new 
technology add-on payments from 50 percent of the cost of the device to 
80 percent of the costs. They stated that to do so would be in line 
with the Conference Committee Agreement accompanying Public Law 108-173 
which states, ``the Secretary should consider increasing the percent of 
payment associated with the add-on payments up to the marginal rate 
used for the inpatient outlier.'' (108 Cong., 2d Sess., 212(2003)). 
Commenters further stated that CMS ``apparently believes that this 
outlier payment level strikes the appropriate balance between ensuring 
that providers are not unduly at financial risk for expensive cases * * 
*'', yet has offered no explanation for why this payment level would 
not be appropriate for the new technology add-on payment as well.
    Response: We note that we have made substantial changes to the 
application threshold in the last year, reducing the cost threshold to 
qualify for new technology add-on payments twice. In addition, we have 
eliminated the budget neutrality provision, thus increasing the total 
moneys spent to pay for deserving, new technologies. While the 
conference report to the MMA recommended that the Secretary should 
consider changing the payment factor, we will not make such a change 
this year. Rather, we will analyze the impacts of the other MMA 
changes, especially the reduction in the cost threshold and the 
elimination of the budget neutrality of the add-on payments, before we 
consider making changes in the payment percentage. We will continue to 
consider the conference report's recommendation and will determine 
whether to proceed with a change in the light of our continuing 
analysis.
    Comment: Commenters urged CMS to adopt an approach to the public 
meetings required by the MMA in a manner that is similar to the ICD-9 
Coordination and Maintenance Committee meetings. Commenters noted that 
a specific agenda and preliminary opinions are released to the public 
prior to these meetings and urged CMS to present preliminary opinions 
on substantial clinical improvement prior to the public meeting on this 
topic.
    Response: We have traditionally not provided our opinion on 
substantial clinical improvement of applicants for new technology add-
on payments until the final rule. We note that if all the criteria are 
met prior to the publication of the proposed rule, we would prefer to 
make our preliminary determinations available at that time. However, to 
date we have not been able to make a sound determination regarding 
substantial clinical improvement until after the publication of the 
proposed rule.
    Section 503(b)(2) of Public Law 108-173 requires CMS to consider 
public comments regarding whether an applicant for new technology 
payments meets the substantial clinical improvement criterion. Comments 
must be received and considered prior to the publication of the 
proposed rule for the annual IPPS update. This requirement, which was 
implemented for the first time through the new technology town hall 
meeting held in March of this year, and the subsequent comment period 
is further evidence that we do take the issue of substantial clinical 
improvement into account prior to the publication of the proposed rule. 
However, the MMA provision does not require the type of procedure 
recommended by the commenter, but merely the opportunity for 
presentation of comments, recommendations, and data to CMS.
    We designed the town hall-styled meeting this spring to provide a 
forum for public comment on the applicants. This format appeared to be 
received well by most of the attendees. We accepted comments and topics 
from attendees and presenters at the meeting, as well as accepting 
comments on substantial clinical improvement of the applicants after 
the meeting. If presenters would like a more detailed agenda to be 
published prior to the rule, we welcome them to register to attend the 
annual meeting and provide the information requested in the Federal 
Register notice announcing the meeting (this includes personal 
information for registration purposes as well as topics to be presented 
at the meeting). If we have this information well in advance of the 
meeting, the agenda will reflect all issues that have been raised 
regarding the assessment of the substantial clinical improvement 
criterion for each applicant. We welcome further input on how to better 
incorporate input prior to the announcement of the next town hall 
meeting on this topic.
    In the May 18, 2004 proposed rule (69 FR 28236), we also evaluated 
whether new technology add-on payments will

[[Page 49006]]

continue in FY 2005 for the two technologies that currently receive 
such payments. In accordance with section 503(e)(2) of Public Law 108-
173, we also reconsidered one application for new technology add-on 
payments that was denied last year. Finally, we presented our 
evaluations of 10 new applications for add-on payments in FY 2005.
3. FY 2005 Status of Technology Approved for FY 2004 Add-On Payments
a. Drotrecogin Alfa (Activated)--Xigris[reg]
    Xigris[reg], a biotechnology product that is a recombinant version 
of naturally occurring Activated Protein C (APC), was approved by the 
FDA on November 21, 2001. In the August 1, 2002, IPPS final rule (67 FR 
50013), we determined that cases involving the administration of 
Xigris[reg], (as identified by the presence of code 00.11 (Infusion of 
drotrecogin alfa (activated)) were eligible for additional payments in 
FY 2003. (The August 1, 2002, final rule contains a detailed discussion 
of this technology.)
    In the August 1, 2003, final IPPS rule (68 FR 45387), we indicated 
that, for FY 2004, we would continue to make add-on payments for cases 
involving the administration of Xigris[reg] as identified by the 
presence of code 00.11. This was because we determined that Xigris[reg] 
was still within the 2-year to 3-year period before the costs of this 
new technology would be reflected in the DRG weights.
    Xigris[reg] became available on the market at the time of its FDA 
licensure on November 21, 2001. Early in FY 2005, Xigris[reg] will be 
beyond the 2-year to 3-year period during which a technology can be 
considered new. Therefore, in the May 18, 2004 proposed rule, we 
proposed that Xigris[reg] would not continue to receive new technology 
add-on payments in FY 2005. During the period of 2 years and 8 months 
since it came onto the market, Xigris[reg] has been used frequently in 
the appropriate DRGs. For FY 2005, we analyzed the number of cases 
involving this technology in the FY 2003 MedPAR file. We found 4,243 
cases that received Xigris[reg], the majority of which fell 
appropriately into DRGs 415, 416, 475, and 483, with by far the most 
cases in DRG 416 (Septicemia Age >17). Accordingly, the costs of 
Xigris[reg] are now well represented in those DRGs. Therefore, we 
proposed that FY 2004 would be the final year for Xigris[reg] to 
receive add-on payments.
    Prior to the publication of the May 18, 2004, proposed rule, we 
received no public comments regarding the continuation of add-on 
payments for Xigris[reg]. During the 60-day comment period for the 
proposed rule, we received 3 comments on this application.
    Comment: The manufacturer submitted comments that were highly 
critical of CMS' proposal to discontinue add-on payments for 
Xigris[reg]. The commenter brought up several points, which it 
believes, show that CMS is in violation of the statutory provisions. 
First, the manufacturer expressed opposition to the proposal to 
terminate the new technology add-on payments. It agreed that it was 
important to consider when a product comes on the market, but stated, 
``[w]hether a technology is `new' is not salient in determining whether 
a third year of add-on payments should continue.'' It stated that the 
costs of the drug had not been adequately accounted for as required by 
statute and that the period during which it was eligible to receive 
add-on payments should continue another year, until 3 full years of 
add-on payments had been made. It stated, that ``the fact that costs of 
a new technology or service may be included in the Medicare hospital 
discharge database (MedPAR) starting at the time an item or service is 
introduced into the marketplace is irrelevant. What matters is the 
ability to examine 2 years of cost data for cases coded as having used 
the new technology or service.'' Further, it argued, ``these cost data 
cannot be identified and collected until the ICD code is assigned and 
used in the coding of cases.'' It also stated that, since this 3-year 
maximum period had not yet ended, the costs of the cases could not have 
adequately been accounted for in our DRG recalibration using only data 
from FY 2003. It further stated that we should wait to remove them from 
add-on payment status until data from the FY 2004 MedPAR are available 
to recalibrate the DRGs. The manufacturer also stated that ``the point 
of the legislative changes was to improve the old way of doing business 
* * *. It is unfortunate that CMS proposes to take the path of least 
resistance because it is the Medicare beneficiaries who will ultimately 
suffer.''
    Another commenter stated that our proposal to deny additional add-
on payments in FY 2005 will deny Medicare beneficiaries the access to 
Xigris[reg]. An additional commenter noted that, particularly because 
CMS was unable to implement the systems changes necessary to pay the 
new technology add-on payment for Xigris[reg] until 8 months after the 
new code and higher payment were allowed, many hospitals were unclear 
as to the significance of correctly coding the new ICD-9-CM code 
identifying Xigris[reg], and therefore, the data for the first year of 
add-on payments do not adequately reflect the actual use of the drug.
    Response: As stated previously, when we determine the newness 
criterion for new technology add-on applications, we use the date of 
FDA approval to determine that data including the technology are being 
incorporated into DRG recalibration, except in those rare cases where 
evidence can be presented that demonstrates that the product could not 
be marketed immediately after FDA approval. We have used this method of 
determining newness since we began reviewing new technology 
applications. While there was no clearly distinguishable code assigned 
to Xigris[reg] prior to the implementation of the new ICD-9-CM code 
00.11 on October 1, 2002, treatment with Xigris[reg] was identified 
prior to that time by procedure code 99.19. While this may not suit the 
applicant in terms of the ability to track specific cases that involved 
the use of Xigris[reg], the drug was being used for more than 10 months 
prior to the assignment of code 00.11 and the costs associated with the 
drug were, therefore, clearly included in the FY 2003 MedPAR update. 
Additionally, we note that the manufacturer itself was able to identify 
patients that would or could use Xigris(r), as discussed in the May 9, 
2002 proposed rule. There we stated, ``Lilly also submitted detailed 
ICD-9-CM diagnosis and procedure codes for a subset of * * * patients 
with billing data. * * *'' (67 FR 31428). Because the manufacturer was 
able to identify a subset of patients without billing data at that 
time, we have met the criteria set forth by the manufacturer itself in 
being able to identify ``2 years of cost data for cases coded as having 
used the new technology. * * *'' The data we have captured since 
including the data used for the FY 2003 proposed rule analysis, have 
adequately accounted for costs associated with these cases. Including 
the 2 subsequent years during which Xigris[reg] was eligible to receive 
new technology add-on payments, this makes a total of 3 years of data 
that CMS has used to incorporate the costs associated with the drug 
into the weights of the DRGs into which these cases fall.
    In the FY 2004 annual update, we estimated that there would be 
3,000 cases involving Xigris[reg] in the relevant DRGs and we note that 
there are now 4,313 cases involving the drug in the March update of the 
FY 2003 MedPAR. We have conducted an analysis of the FY 2002 MedPAR to 
determine the frequency of these cases in the DRGs in

[[Page 49007]]

which Xigris[reg] has been used. We have identified 593 cases using 
procedure code 99.19 in these 5 DRGs, which is significantly lower than 
the most recent 2 years of data. Additionally, we recognize that this 
code included other drugs and that not all 593 cases reporting this 
code in these 5 DRGs necessarily involved Xigris[reg]. However, this 
low number of cases is consistent with what we would expect, given that 
the initial ICD-9-CM code did not drive DRG placement or payments. It 
is also consistent with the reasoning behind our of approval 
Xigris[reg] for new technology add-on payments, since it was clearly a 
new technology that provided great potential benefit to Medicare 
beneficiaries and met the other criteria as defined by the statute. It 
is also reasonable to expect that, once the new ICD-9-CM code went into 
effect, with a payment incentive to encourage its rapid adoption and 
use, the number of cases including this code rose dramatically. While 
the figure of 593 cases using procedure code 99.19 in the relevant 
cases in FY 2002 is not very high, we note that in the August 1, 2002 
final rule we stated that, based on the sales figures from the company 
at that time, there was already ``$35 million in sales reported by 
Lilly through February 2002 (since the drug was approved in November 
2001). (At $6,800 per patient, $35 million in sales equates to just 
over 5,000 cases for the first 4 months since FDA approval.)'' (67 FR 
50015). Therefore, we are confident that we have adequate data 
reflecting the use of Xigris[reg] over the past 3 years. If we were to 
continue add-on payments beyond FY 2004, the technology would be beyond 
its 2-3 year maximum as allowed by the statute. We have used these data 
to recalibrate the DRGs into which these cases most frequently fall, so 
the costs of the technology have already been accounted for in those 
DRG weights. Similarly, although we regret that systems changes delayed 
the processing of add-on payments for Xigris[reg] in FY 2003, hospitals 
received add-on payments for all cases reporting the ICD-9-CM code for 
Xigris[reg]. Furthermore, the costs of the new technology are 
nonetheless represented in the 2003 MedPAR data, whether hospitals used 
the new ICD-9-CM code for Xigris[reg] (00.11) or the earlier procedure 
code (99.19). We do not agree with the assertion that Medicare 
beneficiaries will no longer have access to this important drug once 
the new technology add-on payments associated with it are terminated. 
To the contrary, we will continue to pay for the drug through DRG 
payment, and as noted above, the costs associated with the drug have 
been included in the weights of the relevant DRGs through the DRG 
recalibration.
    Comment: The manufacturer also noted that section 
1886(d)(5)(K)(ii)(IV) of the Act requires, ``that discharges involving 
such a service or technology that occur after the close of the period 
[of add-on payments] will be classified within a new or existing 
diagnosis-related group with a weighting factor * * * that is derived 
from the cost data collected with respect to discharges occurring 
during such period.'' The commenter argues that there is no room for 
interpretation of the statute and that, since the average costs of 
cases involving the technology are very high, they should be assigned 
either to a new DRG or remapped to higher-weighted DRGs to reflect the 
cost of the cases. Another commenter asked that, if CMS refused to 
continue add-on payments for the entirety of FY 2005, such payments 
should be ``maintained at least until the agency has analyzed the 
available data and has classified cases in which Xigris[reg] is 
administered into an appropriate DRG.''
    Response: We do not agree with the implications the commenter draws 
from the statutory language. We have assigned cases involving the use 
of Xigris[reg] to clinically coherent DRGs, and the weights of these 
DRGs have been recalibrated to reflect the costs of these technology. 
We have also analyzed the costs of these cases and determined that, 
although the average standardized charge for these cases is higher than 
the average charges for the DRGs into which the cases involving 
Xigris[reg] fall, there appears to be no justification to warrant 
creation of a new DRG or re-assignment of cases involving Xigris[reg] 
into higher-weighted DRGs. We do not believe that it is necessary to 
assign cases involving Xigris[reg] to a separate unique DRG, as 
requested by the manufacturer, in order to satisfy the statutory 
requirement. Indeed, we note that the commenter's own comment stated, 
``Xigris[reg] is administered to only a small proportion of the severe 
sepsis population and is not representative of the comprehensive 
incidence of the disease.'' Therefore, by the manufacturer's own 
statements, we cannot use cases involving the code for Xigris[reg] as 
the standard by which to assign severe sepsis cases. We discuss the DRG 
assignment of Xigris[reg] in section II B.16.c. of this final rule.
    Comment: One national hospital association agreed with our proposal 
to discontinue add-on payments for this technology. The commenter noted 
that the termination of the add-on payments falls outside the timeframe 
in which a technology is new for add-on payment purposes. The 
association strongly encouraged CMS to continue monitoring the use of 
Xigris[reg] and associated conditions of severe sepsis to determine if 
future revisions to the current DRGs will be necessary. Another 
commenter urged us to continue to monitor the use and diffusion of all 
new technologies that qualify or have previously qualified for this 
provision. Commenters urged CMS to require that all hospitals continue 
to code for the use of the new technologies, even after the period of 
add-on payment for the technologies has ended, thus ensuring adequate 
tracking of diffusion of the new technologies as they continue to be 
used.
    Response: We appreciate the commenter's support for our decision to 
remove this technology from add-on payment status. We note that we 
review new technology add-on payment recipients annually to determine 
whether they continue to meet the criteria to receive add-on payments. 
In the case of Xigris[reg], this review led us to find that it no 
longer meets the newness criterion. While we encourage hospitals to 
continue to code for the drug, even though there is no longer a payment 
incentive to do so, we cannot require hospitals to code for the use of 
the drug.
    We are finalizing our proposal to remove Xigris[reg] from new 
technology status and will no longer pay new technology add-on payments 
for this technology, starting October 1, 2004. The manufacturer also 
asked us to consider creating a DRG specifically for severe sepsis. We 
discuss this request in section II.B.16.c. of the preamble to this 
final rule.
b. InFUSETM (Bone Morphogenetic Proteins (BMPs) for Spinal 
Fusions)
    InFUSETM was approved by FDA for use on July 2, 2002, 
and became available on the market immediately thereafter. In the 
August 1, 2003 IPPS final rule (68 FR 45388), we approved 
InFUSETM for add-on payments under Sec.  412.88, effective 
for FY 2004. This approval was on the basis of using 
InFUSETM for single-level, lumbar spinal fusion, consistent 
with the FDA's approval and the data presented to us by the applicant. 
Therefore, we limited the add-on payment to cases using this technology 
for anterior lumbar fusions in DRGs 497 (Spinal Fusion Except Cervical 
With CC) and 498 (Spinal Fusion Except Cervical Without CC). Cases 
involving InFUSETM that are eligible for the new technology 
add-on payment are identified by assignment to DRGs 497 and 498 as a 
lumbar spinal fusion, with the combination of ICD-9-

[[Page 49008]]

CM procedure codes 84.51 (Insertion of interbody spinal fusion device) 
and 84.52 (Insertion of recombinant bone morphogenetic protein).
    Because InFUSETM was approved by the FDA for use on July 
2, 2003, it is still within the 2-year to 3-year period during which a 
technology can be considered new under the regulations. Therefore, in 
the May 18, 2004 proposed rule, we proposed to continue add-on payments 
for FY 2005 for cases receiving InFUSETM for spinal fusions 
in DRGs 497 (Spinal Fusion Except Cervical With CC) and 498 (Spinal 
Fusion Except Cervical Without CC). We also proposed to continue 
limiting the add-on payment for cases receiving InFUSETM, to 
those cases identified by the presence of procedure codes 84.51 and 
84.52. However, we proposed to eliminate add-on payment for the 
interbody fusion device that is used in combination with this 
recombinant human bone morphogenetic protein (rhBMP) product (procedure 
code 84.52). We note that currently add-on payments for 
InFUSETM include costs for the interbody fusion device (the 
LT Cage, identified by procedure code 84.51), used in the spinal fusion 
procedure with the InFUSETM product. Because this device is 
not a new technology, but in fact has been in use for 9 years for 
spinal fusions, we believe that it is inappropriate to pay for this 
device in conjunction with the genuinely new rhBMP technology. 
Therefore, we proposed no longer to pay for the interbody fusion device 
as bundled in the current maximum add-on payment amount of $4,450 for 
cases that qualify for additional payment. The proposal would reduce 
the add-on payment to account for no longer including the costs of the 
LT Cage in computing the add-on payment amount. This would reduce the 
cost of this new technology by $4,990, which results in a total cost of 
$3,910 for InFUSETM. Therefore, we proposed a maximum add-on 
amount of $1,955 for cases that qualify for additional payment. 
Although we proposed to eliminate payment for the LT Cage, we would 
still require the presence of procedure code 84.51 (in combination with 
procedure code 84.52) when making new technology add-on payments for 
InFUSETM. This is due to the fact that the LT Cage is still 
required by the FDA when InFUSETM is used for single level 
spinal fusions.
    Prior to the publication of the May 18, 2004 proposed rule, we 
received public comments in accordance with section 503(b)(2) of Public 
Law 108-173 regarding the continuation of add-on payments for this 
technology. Commenters expressed support for the continuation of new 
technology add-on payments for this technology in FY 2005.
    We are finalizing that proposal in this final rule.
    We received the following comments in response to the May 18, 2004 
proposed rule.
    Comment: Several commenters supported our proposal to no longer pay 
for the LT Cage as a bundled add-on payment with InFUSETM. 
They noted that it was not appropriate to pay for the LT Cage as part 
of the InFUSETM add-on since the technology has been 
available for several years.
    Response: When we initially reviewed the application, the applicant 
indicated to us that the FDA approval was for a pre-packaged product 
that included the LT Cage, the InFUSETM biotechnology 
product, and an absorbable collagen sponge to carry the rhBMP. While 
the FDA label required the product to be used with the LT Cage, we were 
initially under the impression that these devices were provided to 
hospitals in the same package. It later was brought to our attention 
that the product was not marketed this way and that in fact the rhBMP 
product is supplied to hospitals in several different sized ``kits'' 
that have differing amounts of InFUSETM in them, and that 
the LT Cage is purchased separately. As such, it is not only easy to 
see why the add-on payment should be unbundled, but also easy to do so.
    Comment: Some commenters, including the manufacturer, were opposed 
to our proposal to discontinue bundled payment for InFUSETM 
in combination with the LT Cage. They argue that to remove the payment 
for the LT Cage would result in even further restricting the use of 
this much needed technology that eliminates a painful second surgery 
and extensive blood loss for the patients who must otherwise undergo 
spinal fusions via conventional, autogeneous bone-harvesting methods. 
Other commenters were very concerned that the lower add-on payment 
amount would result in hospitals using cages other than the FDA-
approved LT Cage with this technology. These commenters stated that to 
encourage this off-label use by not continuing the higher payments is 
contrary to our statement in last year's final rule requiring that a 
product qualify for add-on payments based upon usage consistent with 
its FDA labeling.
    Response: In this clear case where a new technology is being used 
in conjunction with an old technology, we do not believe it is 
appropriate to continue to pay an add-on payment for the old device, as 
this device has already been in use for 9 years and has been accounted 
for in DRG payments. We are finalizing our proposal to approve 
InFUSETM for spinal fusion for an additional year of new 
technology add-on payments, through the end of FY 2005. We note that in 
order to receive new technology add-on payment for InFUSETM, 
we are continuing to require both the procedure code for 
InFUSETM (84.52) and the code for the LT Cage (84.51) due to 
the FDA label that requires the LT Cage to be used in conjunction with 
the InFUSETM product. While the procedure code for the LT 
Cage (84.51) does include other brands and types of cages for spinal 
fusion, we expect that doctors will maintain the best clinical standard 
for their patients and will continue to use the LT Cage with the 
InFUSETM product. We are therefore finalizing our proposal 
to unbundle the new technology add-on payments for this device for FY 
2005 by removing payment for the LT Cage from the add-on payment for 
cases involving InFUSETM. We are also finalizing the maximum 
add-on payment amount of $1955 for cases that are eligible to receive 
the add-on payment.
    Comment: Other commenters were pleased about our proposal to 
discontinue bundled payments that include the LT Cage for spinal 
fusions because this bundled payment precluded payment for similar 
technologies that are used in spinal fusion surgery but that do not 
require use of the LT Cage. One commenter noted that another BMP 
product was just awarded FDA approval for spinal fusion involving 
posterolateral approach. This commenter requested that the other 
devices of this nature be included in any approval of rhBMPs for new 
technology add-on payments or an unfair economic advantage would be 
created.
    Response: As we discussed in the September 7, 2001, final rule (66 
FR 46915), an approval of a new technology for special payment should 
extend to all technologies that are substantially similar. Otherwise, 
our payment policy would bestow an advantage to the first applicant to 
receive approval for a particular new technology. The new product, 
called OP-1 Putty, manufactured by Stryker Biotech, utilizes a similar 
mechanism to promote natural bone growth by using a closely related 
bone morphogenetic protein called rhBMP-7 (InFUSETM is 
rhBMP-2). Because the OP-1 Putty is now available on the market (it 
received FDA approval for spinal fusions in May of this year) for 
similar spinal fusion procedures and also eliminates the need

[[Page 49009]]

for the autograft bone surgery, we are extending new technology add-on 
payments to this technology as well, for FY 2005. Because the new 
product does not require the LT Cage to be used simultaneously, we are 
requiring that providers use different codes when the different 
products are used.
    Cases using InFUSETM should be identified by the 
combination of procedure codes 84.51 and 84.52, as described above and 
as required in the previous year of new technology add-on payments for 
this technology. For cases using the OP-1 Putty, the procedure code 
84.52 (Insertion of recombinant bone morphogenetic protein) must be 
coded in combination with procedure codes identifying posterolateral 
spinal fusions, as is consistent with the FDA approval for this device. 
Therefore, procedure code 84.52 must be coded with any of the following 
procedure codes: 81.08 (Lumbar/lumbosac fusion posterior technique), 
81.38 (refusion of lumbar posterior approach), 81.05 (Dorsal and 
dorsolumbar fusion, posterior technique), or 81.35 (Refusion of dorsal 
and dorsolumbar spine, posterior technique) in order to receive add-on 
payments under this provision. Both of these devices have FDA approval 
that is consistent with cases that would be assigned to DRGs 497 or 
498. Because Stryker Biotech did not submit a new technology add-on 
payment application, we were unable to do a complete analysis of the 
cost of the device. However, we have been able to determine that the 
costs associated with the OP-1 Implant are similar to those associated 
with InFUSETM. Therefore, we believe that the same payment 
amount for new technology add-on payments is appropriate for both 
devices. Accordingly, cases containing one of the above combinations of 
procedure codes and that fall into DRGs 497 or 498 will be eligible to 
receive the add-on payment, with a maximum of $1,955 for FY 2005.
4. Reevaluation of FY 2004 Applications That Were Not Approved
    Section 503(e)(2) of Public Law 108-173 requires us to reconsider 
all applications for new medical service or technology add-on payments 
that were denied for FY 2004. We received two applications for new 
technologies to be designated eligible for add-on payments for new 
technology for FY 2004. We approved InFUSETM for use in 
spinal fusions for new technology add-on payments in FY 2004. We denied 
the application for new technology add-on payments for the GLIADEL 
[reg] wafer.
GLIADEL [reg] Wafer
    Gliablastoma Multiforme (GBM) is a very aggressive primary brain 
tumor. Standard care for patients diagnosed with GBM includes surgical 
resection followed by radiation and, in some cases, systemic 
chemotherapy. According to the manufacturer, the GLIADEL[supreg] wafer 
is indicated for use at the time of surgery in order to prolong 
survival in patients with GBM. Implanted directly into the cavity that 
is created when a brain tumor is surgically removed, the 
GLIADEL[supreg] wafer delivers chemotherapy directly to the site where 
the tumor is most likely to recur.
    The FDA gave initial approval for the GLIADEL[supreg] wafer on 
September 23, 1996, for use as an adjunct to surgery to prolong 
survival in patients with recurrent GBM for whom surgical resection is 
indicated. In 2003, Guilford Pharmaceuticals submitted an application 
for approval of the GLIADEL[supreg] wafer for add-on payments and 
stated that the technology should still be considered new for FY 2004, 
despite its approval by the FDA on September 23, 1996. The manufacturer 
stated that the technology was still new because it had not been 
possible to specifically identify cases involving use of the 
GLIADEL[supreg] wafer in the MedPAR data prior to the adoption of a new 
ICD-9-CM code 00.10 (Implantation of a chemotherapeutic agent) on 
October 1, 2002. However, as discussed in the September 7, 2001 final 
rule (66 FR 46914), the determination concerning whether a technology 
meets this criterion depends on the date of its availability for use in 
the Medicare population rather than the date a specific code may be 
assigned. A technology can be considered new for 2 or 3 years after 
data reflecting the costs of the technology begin to become available. 
Data on the costs of this technology began to become available in 
September 1996. As a result, the costs of this technology are currently 
reflected in the DRG weights. As discussed in the final rule for FY 
2004 (68 FR 45391), on February 26, 2003, the FDA approved the 
GLIADEL[supreg] wafer for use in newly diagnosed patients with high-
grade malignant glioma as an adjunct to surgery and radiation. However, 
our understanding is that many newly diagnosed patients were already 
receiving this therapy. To the extent that this is true, the charges 
associated with this use of the GLIADEL[supreg] wafer were also 
reflected in the DRG relative weights. Therefore, the GLIADEL[supreg] 
wafer did not meet this criterion for FY 2004.
    Section 503(e)(2) of Public Law 108-173 required us to reconsider 
this application, but did not revise the criterion for determining 
whether a medical service or technology is new. As stated above, the 
FDA originally approved the GLIADEL[supreg] wafer on September 23, 
1996. Therefore, this technology is beyond the period in which it can 
be considered new. Accordingly, in the May 18, 2004, proposed rule, we 
proposed to deny this application for new technology add-on payments 
for FY 2005.
    Prior to the publication of the May 18, 2004, proposed rule, we 
received no public comments regarding our reconsideration of this 
application for add-on payments. During the 60-day comment period for 
the May 18, 2004, proposed rule, we received the following public 
comments regarding our reconsideration of the application.
    Comment: One commenter stated, ``[a]s a country that prides itself 
on being a leader in cancer research, it is disheartening that patients 
must battle to gain access to the benefits that this research has 
provided.''
    Response: We continue to pay for technologies that do not meet the 
criteria to receive new technology add-on payments through the regular 
payment mechanism established by the DRG payment methodology. 
Therefore, patient access to these technologies should not be adversely 
affected by a determination that a technology does not qualify to 
receive add-on payments.
    Comment: One commenter believes that the GLIADEL[supreg] 
chemotherapy wafer merits a separate DRG, which the applicant contends 
would be similar to our treatment of the establishment of new DRGs for 
drug-eluting stents. The commenter acknowledges that DRGs are ``not 
normally created to recognize the presence or absence of new 
technology.'' Nevertheless, the commenter argues that CMS' recognition 
of the ``unique circumstances surrounding the potential breakthrough 
nature'' of drug-eluting stents should also be applied to 
GLIADEL[supreg] wafer.
    Response: Guilford asked us to consider reclassifying this device 
into another DRG. We discuss issues relating to the DRG assignment of 
the GLIADEL[supreg] wafer in section II.B.16.c. of this final rule. In 
that discussion, we announce our decision to create a new DRG 543 
(Craniotomy with implantation of chemotherapeutic agent or acute 
complex central nervous system principle diagnosis) to which Gliadel 
cases will be assigned. The cases assigned to this new DRG have similar 
resource utilization and comparable charges to cases involving the 
GLIADEL[supreg] wafer. As a result, we

[[Page 49010]]

believe this DRG assignment will result in appropriate payments for 
these cases. In this rule we are finalizing our denial of new 
technology add-on payments for this technology.
5. FY 2005 Applicants for New Technology Add-On Payments
a. InFUSETM Bone Graft (Bone Morphogenetic Proteins (BMPs) 
for Tibia Fractures)
    Bone Morphogenetic Proteins (BMPs) have been shown to have the 
capacity to induce new bone formation and, therefore, to enhance 
healing. Using recombinant techniques, some BMPs (referred to as 
rhBMPs) can be produced in large quantities. This has cleared the way 
for their potential use in a variety of clinical applications such as 
in delayed unions and nonunions of fractured bones and spinal fusions. 
One such product, rhBMP-2, is developed for use instead of a bone graft 
with spinal fusions.
    Medtronic Sofamor Danek submitted an application for the 
InFUSETM Bone Graft for use in tibia fractures for approval 
as a new technology eligible for add-on payments in FY 2005. Medtronic 
submitted a similar application for new technology add-on payments in 
FY 2004 for InFUSETM Bone Graft/LT-CAGETM Lumbar 
Tapered Fusion Device. As discussed above, we approved this application 
for FY 2004, and will continue to make new technology payments for FY 
2005 for InFUSETM when used in spinal fusions (refer to 
section III.E.3.b. of this preamble).
    In cases of open tibia fractures, InFUSETM is applied 
using an absorbable collagen sponge, which is then applied to the 
fractured bone in order to promote new bone formation. The manufacturer 
contends that this use is severely limited due to the greatly increased 
costs for treating these cases with InFUSETM at the time of 
wound debridement and closure. The manufacturer has conducted a 
clinical trial and FDA approval for the use of InFUSETM for 
open tibia fractures was awarded on April 30, 2004. The application for 
add-on payments for the use of InFUSETM for open tibia 
fractures proposes that such payment would encourage the use of 
InFUSETM for treatment of these fractures of grade II or 
higher (up to and including grade III, which often must be amputated 
due to the severity of injury). The additional payment, according to 
the applicant, would encourage more hospitals to use the technology at 
the time of initial wound closure and would result in reduced rates of 
infection and nonunion currently associated with the treatment of these 
injuries.
    The manufacturer submitted data on 315 cases using 
InFUSETM for open tibia fractures in the FY 2002 MedPAR 
file, as identified by procedure code 79.36 (Reduction, fracture, open, 
internal fixation, tibia and fibula) and diagnosis codes of either 
823.30 (Fracture of tibia alone, shaft, open) or 823.32 (Fracture of 
fibula and tibia, shaft, open). The applicant also noted that the 
patients in their clinical trials as well as patients that would be 
likely candidates to receive InFUSETM for tibia fractures 
would include those cases that had malunion of their fractures 
(diagnosis code 733.81) or nonunion of fractures (diagnosis code 
733.82). The applicant also submitted data for a hospital sample that 
included 63 cases using the same identifying codes. Based on the data 
submitted by the applicant, InFUSETM would be used in four 
different DRGs: 217 (Wound Debridement and Skin Graft Except Hand, for 
Musculoskeletal and Connective Tissue Disorders), 218 and 219 (Lower 
Extremity and Humerus Procedures Except Hip, Foot, Femur Age > 17, With 
and Without CCs, respectively) and 486 (Other O.R. Procedures for 
Multiple Significant Trauma). The analysis performed by the applicant 
resulted in a case-weighted cost threshold of $27,111 for these four 
DRGs. The average case-weighted standardized charge for cases using 
InFUSETM in these four DRGs would be $46,468. Therefore, the 
applicant maintains that InFUSETM for open tibia fractures 
meets the cost criterion.
    Further discussions with the applicant revealed that the more 
appropriate DRGs to which this device should be limited are DRGs 218 
and 219 (Lower Extremity and Humerus Procedures Except Hip, Foot and 
Femur Age > 17, With and Without CC). The manufacturer projects that 
there would be approximately 550 cases (based on the number of open 
tibia fractures that would have qualified for InFUSETM in 
the FY 2002 MedPAR) in FY 2005. Since FDA approval for use of 
InFUSETM for open tibia fractures, we have performed an 
analysis to determine the number of cases that may have already 
received InFUSETM for treatment of open tibia fractures. We 
identified 3,788 cases in DRGs 218 and 219 (Lower Extremity & Humerus 
Procedures except hip, foot, femur, age >17, with and without CCs) that 
also had procedure code 79.36 (Reduction, fracture, open, internal 
fixation, tibia and fibula) and any of the following diagnosis codes: 
823.30 (Fracture of tibia alone, shaft, open), 823.32 (Fracture of 
fibula with tibia, shaft, open), 733.81 (Malunion of fracture), or 
733.82 (Nonunion of fracture). We identified 38 cases in DRGs 218 and 
219 that contained a code identifying a BMP product (identified by the 
presence of procedure code 84.52) in the FY 2003 MedPAR.
    In the May 18, 2004, proposed rule, we noted that as part of its 
application, the applicant submitted evidence on the substantial 
clinical improvement criterion. The applicant cited data from a 
prospective, controlled study published on December 12, 2002 in The 
Journal of Bone and Joint Surgery (Govender , S., Crismma, C., Genant, 
H.K., Valentin-Opran, V., ``Recombinant Human Bone Morphogenetic 
Protein-2 for Treatment of Open Tibia Fractures,'' Vol. 84-A, No. 12. 
p. 2123). The study, also known as BESTT study group, involved 49 
trauma centers in 11 countries. The study enrolled 450 patients who had 
sustained an open tibia shaft fracture that normally would be treated 
by intramedullary nail fixation and soft tissue management. The 
patients were randomly and blindly assigned to one of three groups: The 
standard of care as stated above, the standard of care plus 
implantation of an absorbable collagen sponge soaked with .75 mg/ml of 
rhBmP-2, or the standard of care plus implantation of an absorbable 
collagen sponge soaked with 1.50 mg/ml of rhBMP-2. The study followed 
up with 421 (94 percent) of all patients. The applicant stated that the 
study found that patients who received the standard of care plus an 
absorbable collagen sponge soaked with 1.50 mg/ml of rhBMP-2 achieved 
the following results compared to the standard of care without the 
rhBMP: a 44-percent reduction in the rate of secondary surgery, an 
average of 39 days reduction in time of clinical healing and lower 
infection rates. As a result, the applicant maintains that 
InFUSETM in tibia fractures represents a substantial 
clinical improvement over previously available technologies.
    In the May 18, 2004, proposed rule, we did not present a full 
analysis of this application under the substantial clinical improvement 
criterion because the technology had not yet received FDA approval for 
this use in time for consideration in the proposed rule. However, we 
noted that, although the cited study provides some evidence of clinical 
efficacy, we had some concerns about whether the study conclusively 
demonstrates substantial clinical improvement over previously available 
technologies because of its design. (It is important to note, as we 
stated in the August 1, 2002, Federal Register (67 FR

[[Page 49011]]

50015), that we do not employ FDA guidelines to determine what drugs, 
devices, or technologies qualify for new technology add-on payments 
under Medicare. Our criteria do not depend on the standard of safety 
and efficacy that the FDA sets for general use, but on a demonstration 
of substantial clinical improvement in the Medicare population, 
particularly patients over age 65.) We indicated that we would present 
our full analysis of the evidence regarding clinical improvement in the 
final rule.
    Since the publication of the proposed rule, the manufacturer has 
provided additional information regarding substantial clinical 
improvement. The applicant provided research indicating both the 
efficacy of the rhBMP product in the elderly, Medicare population as 
well as satisfactorily answering any remaining questions our physicians 
had regarding the clinical trials for this use of InFUSETM.
    In the proposed rule, we indicated that we determined that this 
technology still qualifies as new in the context of extending new 
technology add-on payments for InFUSETM for single-level 
spinal fusions (refer to InFUSETM for spinal fusion in 
section 3(b) above). We noted that, in the September 7, 2001 final rule 
(66 FR 46915), we stated that if an existing technology was assigned to 
different DRGs than those in which the technology was initially used, 
the new use may be considered for new technology add-on payments if it 
also meets the substantial clinical improvement and inadequacy of 
payment criteria. Under the policy suggested in that rule, approval of 
InFUSETM for tibia fractures would start a new period of 
add-on payments for the new use of this technology. However, we stated 
that we had some reservations about whether this result would be 
appropriate. We stated that it might be possible, under the policy 
described in the September 7, 2001 final rule, for a technology to 
receive new technology add-on payments for many years after it is 
introduced, provided that use of the technology is continually expanded 
to treatment of new conditions (in this case, every time the product is 
used to treat a new bone injury). We invited comment on whether it 
would be more appropriate merely to extend the existing approval of 
InFUSETM for spinal fusions to cases where 
InFUSETM is used for open tibia fractures, without extending 
the time period during which the technology will qualify for add-on 
payments. We also invited comments on whether use of 
InFUSETM for open tibia fractures should qualify for add-on 
payments under the cost and substantial clinical improvement criteria.
    Comment: One commenter wrote ``to bring to Medicare's immediate 
attention that there is more that one BMP manufacturer with approved 
indications for long bone fractures * * *''. The commenter went on to 
note that ``Stryker[Biotech]'s * * * OP-1 Implant for recalcitrant long 
bone non-unions received FDA clearance in October, 2001.'' The 
commenter urged Medicare that ``the decision for add-on payment should 
be for the BMP, not the manufacturer.''
    Response: We agree with the commenter that determinations 
concerning new technology add-on payments should not make distinctions 
between different manufacturers of the same technology. As we stated in 
the proposed rule on May 18, 2004: ``an approval of a new technology 
for special payment should extend to all technologies that are 
substantially similar. Otherwise, our payment policy would bestow an 
advantage to the first applicant to receive approval for a particular 
new technology.'' (69 FR 28242). In this case, we had received no 
information concerning the existence of the OP-1 Implant for long bone 
fusion, created by Stryker Biotech, prior to this comment. Since the 
OP-1 Implant received FDA clearance in October, 2001, it has been 
necessary to reevaluate whether InFUSETM for open tibia 
fractures can still be considered new in the light of this new 
information. This determination turns on two considerations: whether 
these products are substantially similar, and whether the indications 
for the two products lead to the assignment of cases involving the use 
of the two products to the same DRGs. The crucial consideration in 
determining whether a technology is new from a payment policy 
perspective is whether data reflecting the costs of the technology have 
been incorporated into setting the DRG weights. A technology can be 
considered new for 2 to 3 years after the point at which charge data 
begin to become available.
    We have been able to determine that the OP-1 Implant created by 
Stryker Biotech in fact was approved by the FDA under Humanitarian 
Device Exemption (HDE) on October 17, 2001, for the indication of ``use 
as an alternative to autograft in recalcitrant long bone nonunions 
where use of autograft is unfeasible and alternative treatments have 
failed.'' It came onto the market shortly after approval. The trials 
where the OP-1 Implant was used demonstrated the safety and efficacy of 
OP-1 Implant for patients with complicated fractures of the tibia.\3\ 
These cases and the study protocol are similar to those described in 
the clinical trials involving InFUSETM for open tibia 
fractures. In fact, many of the cases that were brought for review 
during the application process for InfuseTM were patients 
that had already experienced non-union, were not candidates for 
autograft (due to already having autograft surgery and there not being 
enough material left in the hip to acquire more, or poor quality of the 
bone, etc.), or had fractures in long bones other than the tibia (many 
cases were femur fractures). Therefore, we believe the technology 
involving use of rhBMP to treat severe long bone fractures, including 
open tibial fractures, and recalcitrant long bone fractures has been in 
use for more than 3 years. In addition, cases involving use of the OP-1 
Implant for long bone nonunions and open tibia fractures are assigned 
to the same DRGs (218 and 219, Lower extremity procedures with and 
without complication or comorbidity, respectively). Therefore, data 
reflecting the costs associated with this technology began to become 
available in the relevant DRGs in 2001, and are now reflected in the 
DRG weights. We therefore find that the use of rhBMPs for these 
indications is not a new technology for the purposes of the new 
technology add-on payment. In addition, if we were to approve 
InFUSETM for open tibia fractures for the new technology 
add-on payment there would be no way to distinguish the claims getting 
InFUSETM BMP and those cases receiving the OP-1 Implant BMP, 
because they are indistinguishable by patient characteristics or ICD-9 
code.
---------------------------------------------------------------------------

    \3\ Friedlaender, GE, at al. ``Osteogenic Protein-1 (Bone 
Morphogenetic Protein-7) in the Treatment of Tibial Nonunions: A 
Prospective, Randomize Clinical Trial Comparing rhOP-1 with Fresh 
Bone Autograft.'' Journal of Bone & Joint Surgery. 2001;83A(S1): 
151-158.
---------------------------------------------------------------------------

    Accordingly, we are denying the application for add-on payments for 
InFUSETM for open tibia fractures because this device is not 
a substantial clinical improvement over existing technologies, and 
therefore is not a new technology for purposes of new technology add-on 
payments. We acknowledge, however, that products may evolve that are 
very closely related but that have very different clinical efficacies, 
and we are committed to continuing to refine and share our methodology 
for deciding what should or should not be considered a new and 
innovative technology. In this context, we would note that MedPAC has 
encouraged us ``to be conservative in [evaluating] * * * technologies 
for add-

[[Page 49012]]

on payments, ensuring that technologies are substantially different 
from predecessor technologies, costly, and with clinical benefit.''
    Comment: Several commenters stated their concerns regarding a 
number of issues raised in our discussion in the proposed rule. They do 
not think that it would be appropriate to deny add-on payments for 
InFUSETM for tibia fractures regardless of the existing 
status of the device for use in other surgeries. They stated that CMS 
should not indiscriminately impose our policy criteria without 
considering the clinical opinions of experts involved in these cases 
and as a result deny patients access to the latest breakthrough medical 
technologies. Several other commenters wrote to encourage CMS to make 
add-on payments for the InFUSETM bone graft for treatment of 
``compound fractures of the tibia.'' The manufacturer commented that it 
would go against CMS precedent not to consider the new indication for 
InFUSETM as qualifying for its own determination of 
substantial clinical improvement since we had made a similar analysis 
in FY 2004 for GLIADEL[reg] wafer. One commenter also supported the 
review and approval of new technology add-on payments where the new 
technology is being used for a different medical procedure than the 
original use and will group to separate DRGs.
    Response: As stated previously, we do not believe that patient 
access to breakthrough technologies is being denied. Because another 
device using rhBMPs for these indications has been in use for 3 years 
and the costs for this technology have been included in the weights for 
the DRGs where cases involving InFUSETM for open tibia 
fractures have been assigned, this technology is not a substantial 
clinical improvement over exisitng technologies and can no longer be 
considered ``new.'' We further note that because we determined that the 
GLIADEL[reg] wafer did not meet the newness criterion, we did not 
conduct an analysis on the substantial clinical improvement criterion 
in FY 2004.
b. Norian Skeletal Repair System (SRS)[reg] Bone Void Filler
    Brigham and Women's Hospital submitted an application for approval 
of the Norian Skeletal Repair System (SRS)[reg] Bone Void Filler 
(Norian SRS[reg] Cement), manufactured by Synthes for new technology 
add-on payments for FY 2005. Synthes has been assisting the applicant 
with supplemental information and data to help the applicant with the 
application process. According to the manufacturer, Norian SRS[reg] 
Cement is an injectable, fast-setting carbonated apatite cement used to 
fill defects in areas of compromised cancellous bone during restoration 
or augmentation of the skeleton. The product provides a bone-void 
filler that resorbs and is replaced with bone during the healing 
process.
    On December 23, 1998, the FDA approved Norian SRS[reg] for use as 
an adjunct for fracture stabilization in the treatment of low impact, 
unstable, metaphyseal distal radius fractures, in cases where early 
mobilization is indicated. On December 20, 2001, the FDA approved 
Norian SRS[reg] Cement for use in bony voids or defects that are not 
intrinsic to the stability of the bony structure. Norian SRS[reg] 
Cement is intended to be placed or injected into bony voids or gaps in 
the skeletal system. These defects may be surgically created osseous 
defects or osseous defects caused by traumatic injury to the bone.
    Despite the time that has elapsed since FDA approval, the 
manufacturer contends that Norian SRS[reg] Cement should still be 
considered new for several reasons. First, until April 2002, Norian 
SRS[reg] Cement was hand mixed using a mortar and pestle. Once Norian 
SRS[reg] Cement was approved by the FDA in December 2001 (for the 
indication of use in bony voids or defects that are not intrinsic to 
the stability of the bony structure), the manufacturer issued a new 
pneumatic mixer. According to the manufacturer, this new pneumatic 
mixer allows for better preparation, reliability, and ease of use. In 
addition, a new injection syringe mechanism was developed and made 
available in May 2002 and replaced the ``Norian Delivery Device''. The 
manufacturer believes these new procedures for mixing and delivery of 
the product to the patient should be considered new services as stated 
in section 1886(d)(5)(k)(ii) of the Act and Sec.  412.87(b)(1) of the 
regulations. Second, the manufacturer contends that the cement should 
still be considered new because there is no ICD-9-CM code to uniquely 
identify Norian SRS[reg] Cement within the DRGs.
    In the May 18, 2004, proposed rule, we indicated that, although 
there have been changes in the way Norian SRS[reg] Cement is mixed and 
delivered to the patient, we do not believe these changes are 
significant enough to regard the technology as new. While these changes 
may enhance the ease with which the technology is used, the product 
remains substantially the same as when it was initially developed. As 
we have indicated previously, technology can be considered new only for 
2 to 3 years after data reflecting the costs of the technology begin to 
become available. Data on the costs of this technology began to become 
available after FDA approval in 1998, and these costs are currently 
reflected in the DRG weights. As we discussed in the September 7, 2001, 
final rule (66 FR 46914), the determination concerning whether a 
technology meets this criterion depends on the date of its availability 
for use in the Medicare population rather than the date a specific code 
may be assigned. Therefore, we proposed that Norian SRS[reg] Cement 
does not meet the newness criterion.
    Although we proposed to deny add-on payments because the technology 
does not meet the newness criterion, we noted that the manufacturer 
submitted information on the cost criterion and the substantial 
clinical improvement criterion. The manufacturer submitted 52 Medicare 
and non-Medicare cases using Norian SRS[reg] Cement. There 
are currently no ICD-9-CM codes that can distinctly identify Norian 
SRS[reg] Cement within the MedPAR data; therefore, we cannot 
track this technology with our own analysis of MedPAR data. Based on 
the data submitted by the manufacturer, cases using Norian 
SRS[reg] Cement were found in 12 DRGs, with 71.1 percent of 
the cases in DRGs 210, 218, 219, and 225. Based on the 52 cases 
submitted by the applicant, the case-weighted threshold across all DRGs 
was $22,493. The average case-weighted standardized charge was $29,032. 
As a result, the applicant and manufacturer maintained that Norian 
SRS[reg] Cement meets the cost criterion.
    According to the manufacturer, Norian SRS[reg] Cement 
represents a substantial clinical improvement for the following 
reasons: It enhances short-term and long-term structural support, 
improves the rate and durability of healing, decreases donor site 
morbidity, decreases risk of infection at graft site, lowers the risk 
of operative complications from shorter operative procedures, lowers 
the rate of post-treatment hospitalizations and physician visits, and 
finally, reduces pain.
    In the May 18, 2004, proposed rule, we did not present a full 
evaluation of the application for add-on payments for Norian 
SRS[reg] Cement under these criteria because the technology 
did not meet the newness criterion. Therefore, we proposed to deny add-
on payments for this technology.
    In the proposed rule we indicated that prior to publication of the 
proposed rule, we had received no public comments on this application 
for add-on payments. During the 60-day

[[Page 49013]]

comment period for the proposed rule, we received the following public 
comments on this application.
    Comment: One commenter, the manufacturer, noted that Norian 
SRS[reg] Cement should still be considered ``new'' since 
there is sufficient information on the record, including sales data, to 
prove that Norian SRS[reg] Cement could not have been 
included in the DRGs until the middle of 2002. The commenter also noted 
that public comments were indeed submitted prior to the proposed rule 
supporting a new technology add-on payment for Norian 
SRS[reg] Cement. Another commenter also explained that 
Norian SRS[reg] Cement should be considered new since it was 
not generally distributed to the public for use because of technical 
difficulties in mixing the product even though the product had been 
produced and released for quite some time.
    Response: As stated previously and as we discussed in the September 
7, 2001 final rule (66 FR 46914), the determination concerning whether 
a technology is new depends on the date of its availability for use in 
the Medicare population, rather than the date a specific code may be 
assigned. Data on the costs of this technology began to become 
available after FDA approval in 1998, and these costs are currently 
reflected in the DRG weights. Therefore we do not consider Norian 
SRS[reg] cement to meet the newness criterion. As a result 
we are denying add-on payments for this technology in FY 2005.
    As a final note, the February 27, 2004, Federal Register notice 
specified the method of submitting comments on the town hall meeting. 
Our statement in the proposed rule that we did not receive comments 
regarding this application referred to not having received any comments 
using that method. We are glad to receive the information now. We did, 
however, consider this comment as part of our discussion to deny add-on 
payments for this technology in FY 2005.
    Comment: One commenter noted that the Norian SRS[reg] 
Cement is an outstanding product that allows the stabilization of 
fractures that would normally develop postoperative deformity and 
problems after surgery. The commenter added that allograft or autogenic 
bone graft that uses a bone void filler would often deform and cause 
settling of the joint while the Norian SRS[reg] cement seems 
to glue all of the small fracture fragments together and can hold 
together very tenuous reductions extremely well. The commenter also 
noted that it only began to use the Norian SRS[reg] Cement 
once the new mixer system became available. Another commenter also 
noted that the clinical benefits of Norian SRS[reg] cement 
allow for earlier removal of external fixators and pins without risk of 
collapse of the fracture site and allow permanent internal fixation to 
load share with the Norian SRS[reg] cement. This results in 
earlier range of motion in a safe manner, which ultimately results in 
earlier return to a functional and productive lifestyle for patients.
    Response: We thank the commenters for providing information on the 
clinical benefits of Norian SRS[reg] cement. However, as stated above, 
we do not consider Norian SRS[reg] cement to meet the newness criterion 
and are denying add-on payments for this technology in FY 2005.
    Comment: Some commenters supported the creation of procedure code 
84.55 (insertion of bone filler) but requested the title of the code be 
revised to injection of bone void filler cement from insertion of bone 
filler in order to capture cases of bone void filler cements that 
require mixing and are applied via injection. One commenter requested 
we review the data upon implementation of this code to see how these 
devices affect the DRG weights.
    Response: A new code was created for bone void filler which will be 
implemented on October 1, 2004. The code is as follows: 84.55 Insertion 
of bone void filler. Various options for this new code were discussed 
at the April 1-2, 2004, ICD-9-CM Coordination and Maintenance 
Committee. A summary of this meeting can be found at: http://www.cms.hhs.gov/paymentsystems/icd9.
    Public comments received at the meeting and later submitted in 
writing were mixed. The manufacturer and some physicians supported new 
codes that differentiated between bone void fillers that were pre-mixed 
and required little or no mixing prior to insertion versus those that 
required more extensive pre-mixing. The manufacturer suggested a new 
code for the injection of bone void filler and another new code for 
insertion of bone void filler. Representatives of hospital and coder 
organizations were opposed to such a differentiation and recommended 
the creation of a single new code to capture this technology: 84.55, 
Insertion of bone void filler. The hospital and coding organizations 
stated that hospital coders would have difficulty differentiating 
between the insertion versus the injection of bone void filler. They 
stated that this would be especially true in cases where it would be 
necessary to determine the amount of mixing of the product that was 
necessary. These organizations did not believe that the medical records 
would provide this type of documentation.
    The American Hospital Association will be providing education to 
hospital coders on the use of this and other new codes. We will review 
data on claims submitted using this new code to determine if DRG 
modifications are necessary.
    We are finalizing our proposal not to approve this technology for 
new technology add-on payments.
    c. InSync[reg] Defibrillator System (Cardiac Resynchronization 
Therapy with Defibrillation (CRT-D))
    Cardiac Resynchronization Therapy (CRT), also known as bi-
ventricular pacing, is a therapy for chronic heart failure. A CRT 
implantable system provides electrical stimulation to the right atrium, 
right ventricle, and left ventricle to recoordinate or resynchronize 
ventricular contractions and improve the oxygenated blood flow to the 
body (cardiac output).
    Medtronic submitted an application for approval of the InSync[reg] 
Defibrillator System, a cardiac resynchronization therapy with 
defibrillation system (CRT-D), for new technology add-on payments for 
FY 2005. This technology combines resynchronization therapy with 
defibrillation for patients with chronic, moderate-to-severe heart 
failure who meet the criteria for an implantable cardiac defibrillator. 
Unlike conventional implantable cardiac defibrillators, which treat 
only arrhythmias, CRT-D devices have a dual therapeutic nature intended 
to treat two aspects of a patient's heart disease concurrently: (1) The 
symptoms of moderate to severe heart failure (that is, the ventricular 
dysynchrony); and (2) high risk of ventricular arrhythmias, as 
documented by a electrophysiologic testing or clinical history or both, 
which would cause sudden cardiac death.
    InSync[reg] Defibrillation System received FDA approval on June 26, 
2002. However, another manufacturer, Guidant, received FDA approval for 
its CRT-D device on May 2, 2002. Guidant, and another competitor that 
has yet to receive FDA approval for its CRT-D device, have requested 
that their devices be included in any approval of CRT-D for new 
technology add-on payments. As we discussed in the September 7, 2001 
final rule (66 FR 46915), an approval of a new technology for special 
payment should extend to all technologies that are substantially 
similar. Otherwise, our payment policy would bestow an advantage to the 
first applicant to receive approval for a particular new technology.
    The applicant contends that, despite the approval of a similar 
device in May

[[Page 49014]]

2002, the InSync[reg] Defibrillator System should still be considered 
new for several reasons: First, an ICD-9-CM code was only issued in FY 
2003, which falls within the 2-year to 3-year range provided in the 
regulations. Second, the utilization of CRT-Ds is still growing and has 
not reached full utilization and, therefore, CRT-Ds remain 
underreported within the FY 2003 MedPAR data that are being used to 
recalibrate the DRG weights for FY 2005. Finally, the applicant 
believes reporting of CRT-Ds may be insufficient to accurately 
recalibrate the DRGs because the new ICD-9-CM codes for CRT-Ds are 
unlikely to be used consistently and accurately by hospitals in the 
first year.
    We have discussed the relationship between existence of a specific 
ICD-9-CM code for a technology and our determination of its status as a 
new technology. As discussed in the September 7, 2001 final rule (66 FR 
46914), the determination of whether a technology is new depends on the 
date of its availability for use in the Medicare population, rather 
than the date a specific code may be assigned. Because CRT-Ds were 
available upon the initial FDA approval in May 2002, we consider the 
technology to be new from this date and not the date a code was 
assigned.
    Using the March 2004 update file to the FY 2003 MedPAR file, we 
have identified 11,004 cases using CRT-D in the FY 2003 MedPAR 
database. Of these, 10,750 cases were reported in DRGs 514 and 515 
(then Cardiac Defibrillator Implant With and Without Cardiac Catheter, 
respectively). In DRG 515, we found 3,960 cases with procedure code 
00.51 (Implantation of cardiac resynchronization defibrillator, total 
system (CRT-D)) and 6,790 cases in DRG 514. DRG 514 is no longer valid, 
effective in FY 2004. In FY 2004, we assigned new cases of 
defibrillator implants with cardiac catheters from DRG 514 to new DRGs 
535 (Cardiac Defibrillator Implant with Cardiac Catheter With Acute 
Myocardial Infraction (AMI) Heart Failure/Shock) and 536 (Cardiac 
Defibrillator Implant with Cardiac Catheter Without Acute Myocardial 
Infarction (AMI) Heart Failure/Shock). Using the 6,790 cases from the 
FY 2003 MedPAR found in DRG 514, we examined the primary diagnosis 
codes necessary for assignment to DRG 535 along with procedure code 
00.51 and found 3,413 cases of CRT-D for DRG 535. The remaining 3,377 
CRT-D cases found in DRG 514 using procedure code 00.51 fall into DRG 
536. For FY 2003, the total number of cases of CRT-D found in the FY 
2003 MedPAR data for DRGs 514 and 515 were 48,700. Cases reporting CRT-
Ds thus represent 22 percent of all cases for these DRGs.
    A medical service or technology can no longer be considered new 
after 2 to 3 years, when data reflecting the costs of the technology 
begin to become available. Data on the costs of this technology began 
to become available in May 2002. Our analysis of data from the FY 2003 
MedPAR file also shows that the costs of CRT-D are represented by a 
substantial number of cases within the DRGs. However, as discussed 
above, the technology still remains within the 2-year to 3-year period 
during which it can be considered new. Therefore, we indicated in the 
proposed rule that we were considering whether the CRT-D technology 
still meets the newness criterion. We stated that we would welcome 
comments on this issue as we analyzed whether to approve this 
technology in the final rule.
    Comment: Two commenters, the applicant and another manufacturer of 
CRT-D devices, commented that the utilization of CRT-D is still growing 
and has not reached full utilization. One of the commenters further 
noted that industry estimates forecast that CRT-D will ultimately 
account for over 50 percent of the defibrillator market by 2006 (or 
double the amount seen in FY 2003). As a result, additional time and 
utilization is necessary with CRT-D before the DRGs can be recalculated 
to reflect the full costs of CRT-D in the DRG weights. Some commenters, 
including the applicant, also explained that the volume of cases in the 
FY 2003 MedPAR is indicative of the breakthrough nature of the 
technology and the benefit it confers to heart failure patients. The 
fact that some hospitals were willing to absorb the costs of the 
technology and make CRT-D available to their patients should have no 
effect if the technology remains new and eligible for new technology 
add-on payments. In light of the above, the applicant believes the 
technology should be considered new under the timeframe of newness and 
that the existing MedPAR data are insufficient to update the DRG 
weights for FY 2005. Another commenter noted that over the last 12 
months, the volume of patients receiving the CRT-D in the commenter's 
hospital has risen by 28 percent. The commenter added that for the 
coming year the volume of patients receiving the CRT-D is expected to 
rise an additional 30 percent.
    MedPAC questioned if this technology still meets the newness 
criterion. MedPAC noted that the technology could diffuse further and 
represent an even greater share of cases. However, MedPAC believes it 
is clear that costs of the technology are already reflected in the data 
used to set the DRG weights. MedPAC recommended that one way to deal 
with this issue would be to exclude cases of the technology when it can 
be tracked from the calculation of the mean charges from the DRG during 
recalibration of the relative weights. This would avoid overpaying for 
the technology by including its costs in the base payment while also 
providing an add-on payment.
    One commenter, the applicant, was concerned that MedPAC's 
recommendation might lead to the lowering of payment for implantable 
cardioverter defibrillators (ICDs). The commenter recommended that CMS 
not take any action that would lower payment for a technology that 
already experiences inadequate payment.
    Response: Although we have a large amount of cases of CRT-D 
reflected within the DRGs, as stated by the commenter, the potential 
population that can receive the CRT-D could be much larger as time 
elapses. While the regulations state that a technology is no longer new 
when data begin to become available reflecting the new technology in 
the DRGs, the commenter has argued that the CRT-D is not fully 
reflected in the DRGs since it has not reached its full market 
utilization. In the proposed rule, we expressed concerns regarding the 
extent of the data already reflected in the DRGs, which suggests that 
CRT-D should no longer be considered ``new''. However, at this point we 
cannot make a definite determination that the CRT-D is fully reflected 
within the DRGs; and therefore, we have concluded that CRT-D should be 
considered to meet the newness criterion.
    We have responded to MedPAC's recommendation on excluding a new 
technology from recalibration of the relevant weight above. We will 
consider this recommendation as we continue to develop policy in this 
area.
    Comment: Some commenters believed that the date of issuance of an 
ICD-9-CM code should start the 2- to 3-year period of a technology 
being new instead of the FDA approval date. The commenters explained 
that considering a technology new from the FDA approval date is 
inconsistent with the regulations in 42 CFR Sec.  412.87(b)(2). One 
commenter further noted that distinct hospital charge data for CRT-D 
only became available after the issuance of a ICD-9-CM code and CRT-D 
charge data did not become publicly available until May 2004. As a 
result the commenter maintains that the CRT-D is still within the 2-3 
year period of being considered ``new''. Another commenter

[[Page 49015]]

added that even though CRT-D was approved in May of 2002, it is 
uncertain if hospitals adjusted their charges at that time in order to 
reflect the higher costs of CRT-D procedures, especially given the lack 
of a unique ICD-9-CM code. Furthermore, it was not possible to uniquely 
identify CRT-D in the data until a unique ICD-9-CM code was issued. 
Therefore, the commenter believes it does not seem appropriate to 
consider the CRT-D new from the FDA approval date of May 2002. One 
commenter was concerned that continued inadequate payment for the CRT-D 
has the potential to limit patient access to this new technology. 
Therefore, the commenter encouraged CMS to consider the CRT-D to meet 
the newness criterion.
    One commenter, the applicant, added that prior to the MMA, CRT-D 
did not meet the cost threshold and therefore the applicant did not 
apply for new technology add-on payments. The commenter noted that had 
Congress acted earlier an application would have been submitted earlier 
as well. The applicant believes that finding the CRT-D to meet the 
newness criterion and approval of add-on payments for CRT-D is 
consistent with Congress' intent to ensure more new technologies 
qualify for add-on payments.
    Response: As stated previously, we have determined that CRT-D meets 
the newness criterion. For a further discussion on the newness 
criterion regarding FDA approval dates and the issuance of ICD-9-CM 
codes, please see section II.E.2. of the preamble to this final rule.
    We note that the applicant submitted information on the cost and 
substantial clinical improvement criteria. The applicant commissioned 
Navigant Consulting, Inc. to collect charge data on CRT-D. Navigant 
found 354 Medicare cases among 30 hospitals. Cases were identified 
using ICD-9-CM procedure code 00.51. Of these 354 cases, 44.1 percent 
were reported in DRG 515, 23.7 percent were reported in DRG 535, and 
32.2 percent were reported in DRG 536. These DRGs result in a case-
weighted threshold of $78,674. The average case-weighted standardized 
charge for the 354 cases mentioned above was $79,163. Based on these 
data, the manufacturer contends that InSync[reg] Defibrillator System 
would meet the cost criterion.
    In the September 7, 2001 final rule, we stated that the data 
submitted must be of a sufficient sample size to demonstrate a 
significant likelihood that the sample mean approximates the true mean 
across all cases likely to receive the new technology. Using a standard 
statistical methodology for determining the needed (random) sample size 
based on the standard deviations of the DRGs identified by the 
applicant as likely to include cases receiving a CRT-D, we have 
determined that a random sample size of 354 cases can be reasonably 
expected to produce an estimate within $3,500 of the true mean.\4\ Of 
course, the data submitted, which include Medicare data from 30 
hospitals, do not represent a random sample of all cases in these DRGs 
across all hospitals.
---------------------------------------------------------------------------

    \4\ The formula is n = 4[sigma]/B\2\, where [sigma] is the 
standard deviation of the population, and B is the bound on the 
error of the estimate (the range within which the sample means can 
reliably predict the population mean). See Statistics for Management 
and Economics, Fifth Edition, by Mendenhall, W., Reinmuth, J., 
Beaver, R., and Duhan, D.
---------------------------------------------------------------------------

    The manufacturer also contends that the added capability of the 
InSync[reg] Defibrillator System device provides significant benefits 
over and above a conventional defibrillator. The InSync[reg] 
Defibrillator System device treats both the comorbid conditions of 
ventricular arrhythmias and moderate to severe heart failure, and takes 
the place of the existing treatment of drug therapy for heart failure 
plus a conventional implantable cardiac defibrillator for ventricular 
arrhythmia. The applicant states this CRT-D is a substantial clinical 
improvement for patients who remain symptomatic despite drug therapy 
and who are also at high risk for ventricular arrhythmias. According to 
the applicant, some of the improved outcomes that result from using a 
CRT-D device instead of existing treatments include: improved quality 
of life, improved exercise tolerance, improved homodynamic performance, 
and reduced hospitalizations and mortality due to chronic heart 
failure.
    We welcomed comments on whether this technology meets the new 
technology criterion, but especially about whether it meets the newness 
criterion in the light of the extent to which it is represented cases 
within the relevant DRGs. We indicated that we would determine whether 
to approve this technology in the light of any comments that we 
received and our continuing analysis.
    Prior to the publication of the May 18, 2004, proposed rule, we 
received public comments in accordance with section 503(b)(2) of Public 
Law 108-173 regarding this application for add-on payments. Commenters 
noted that CRT-D has had positive clinical outcomes by reversing 
remodeling of the heart and improving the heart's ability to pump more 
efficiently. One commenter added that CRT-D has helped decrease 
hospitalizations and length of stay.
    During the 60-day comment period for the May 18, 2004, proposed 
rule, we received the following public comments on this application.
    Comment: The applicant submitted additional data aside from the 
data discussed in the proposed rule showing that CRT-D meets the cost 
criterion. The applicant searched the FY 2003 MedPAR for cases with 
procedure code 00.51 and found 3,947 cases in DRG 515, 3,396 cases in 
DRG 535 and 3,351 cases in DRG 536. The average standardized charge for 
these DRGs were $81,950 for DRG 515, $104,092 for DRG 535 and $97,250 
for DRG 536. This resulted in a case weighted average standardized 
charge of $93,776. The case weighted threshold using the threshold 
amounts from table 10 was $81,161. Based on this analysis, the 
applicant maintains that CRT-D meets the cost criterion since the case 
weighted average standardized charge is greater then the case weighted 
threshold. One commenter believes that the average costs of the CRT-D 
meet or exceed the cost threshold. The commenter added that CRT-D 
procedures are more complex and take longer than conventional ICD 
implantations. One commenter added that the DRGs do not provide 
adequate reimbursement for cases with a CRT-D.
    Response: We also searched the latest update to the FY 2003 MedPAR 
and found 3960 cases in DRG 515 with an average standardized charge of 
$82,520, 3,413 cases in DRG 535 with an average standardized charge of 
$104,755 and 3,377 cases in DRG 536 with an average standardized charge 
of $98,329. This resulted in a case weighted average standardized 
charge of $94,546. Using the thresholds from table 10, the case 
weighted threshold for DRGs 515, 535 and 536 was $81,169. As a result, 
the average standardized charge is greater than the case weighted 
threshold and therefore the CRT-D meets the cost criterion for new 
technology add-on payments.
    Comment: The applicant also submitted the following comments on the 
substantial clinical improvement criterion. The commenter first noted 
that CRT-D meets the definition of substantial clinical improvement 
described in 42 CFR 412.87(b)(1) because prior to May 2, 2002 there was 
no device available that provided cardiac resynchronization therapy in 
combination with an implantable cardiac defibrillator, and that the 
introduction of the CRT-D device enabled the treatment of patients with 
symptomatic heart failure despite maximal medical therapy in addition 
to providing a potentially life saving

[[Page 49016]]

defibrillator in those patients who are at high risk for ventricular 
arrhythmias. Another commenter agreed with the applicant that the CRT-D 
represents a substantial clinical improvement because it provides 
treatment for a new and different patient population (those with heart 
failure and high risk for ventricular arrhythmias). Two commenters 
further noted multiple studies that demonstrated objective and 
subjective clinical improvement in patients with moderate to severe 
heart failure when treated with CRT or CRT-D as quantified by such 
measures as New York Heart Association Class, 6 minute walk distance, 
peak oxygen uptake, left ventricular ejection fraction, and area of 
regurgitant mitral jet. It was also noted by the applicant that CRT-D 
was shown in the COMPANION study to significantly reduce all cause of 
mortality. One of the commenters also noted that CRT-D reduced symptoms 
and improved quality of life. Another commenter added that the CRT-D 
provides dual therapy for patients with dual indications, and that it 
is not simply a combination of two existing devices. One commenter 
believed that there is some potential benefit from reduced hospital 
readmissions and cost savings to both the hospital and Medicare program 
when using the CRT-D.
    Response: We agree that CRT-D provides a valuable treatment to 
Medicare beneficiaries who have refractory, symptomatic congestive 
heart failure despite optimal medical management and who are also at 
significant risk for potentially fatal ventricular arrhythmias. We 
recognize that prior to the advent of CRT-D patients could not have had 
access to the benefits of both cardiac resynchronization therapy and an 
implantable defibrillator. For these reasons CMS believes the CRT-D 
device represents a substantial clinical improvement for the purposes 
of a new technology add-on payment.
    Comment: The applicant commented that the FDA's view of CRT-P and 
CRT-D devices further supports the distinction between the two 
technologies. The commenter explained that the FDA did not allow for 
the pooling of data for the Miracle trial (study of a CRT-P) and 
MIRACLE ICD trial (study of a CRT-D) as the studies and devices 
addressed different patient populations and indications. The FDA 
required that the safety and efficacy of the devices be proven 
separately as a result of the differences between the devices and 
because biventricular pacing was a new technology. The commenter 
explained that the FDA believed that the two types of CRT therapy would 
affect two different populations (indications for an ICD and CRT-D 
versus indications for a CRT-P with no arrhythmia). The commenter 
finally noted that the FDA listed the CRT-D as one of ten ``Advances in 
Patient Care'' in its Fiscal Year 2002 Office of Device Evaluation 
Annual Report. In reference to CRT-D the report stated ``[t]he device, 
the first of its kind, can be used to treat symptoms of advanced heart 
failure in certain people who already need an ICD.'' The commenter 
emphasized the FDA's language describing the device as the ``first of 
its kind.''
    Response: We again agree that the CRT-D device represents a 
substantial clinical improvement because it is capable of treating 
patients with the two distinct conditions of congestive heart failure 
and ``at high risk for sudden cardiac death,'' who prior to its 
availability could not have received the benefits of both cardiac 
resynchronization therapy and immediate defibrillation in the event of 
sustained ventricular arrhythmia. We have therefore determined that 
this device meets the substantial clinical improvement criterion.
    Comment: The applicant submitted three different scenarios on the 
potential add-on payment amount for the new technology. The device 
consists of a defibrillator, right atrial and right ventricular leads, 
left ventricular lead, lead delivery system and a balloon catheter. The 
first scenario would pay for the device and all the leads associated 
with implanting the device. The second approach, which was supported by 
the applicant, excluded the costs of the right atrial and right 
ventricular leads because these items are used in ICDs whose costs are 
already reflected in DRGs 515, 535 and 536. The last scenario excluded 
all costs associated with the ICD since the DRGs have already captured 
all costs of an ICD in the CRT-D.
    Response: After reviewing all the criteria, we have determined that 
CRT-D is eligible for add-on payments in FY 2005. Cases involving CRT-D 
that are eligible for new technology add-on payments are identified by 
either one of the following two ICD-9-CM procedure codes: 00.51 
(Implantation of Cardiac Resynchronization Defibrillator, Total System 
(CRT-D)) or 00.54 (Implantation or Replacement of Pulse Generator 
Device Only (CRT-D)). We agree with the commenter that option number 
two is the best approach to determine the costs of the CRT-D for the 
purpose of new technology add-on payments. Using this approach, the 
total costs for the device are $32,525. Under Sec.  412.88(a)(2), new 
technology add-on payments are limited to the lesser of 50 percent of 
the costs of the technology or 50 percent of the costs in excess of the 
DRG payment for the case. As a result, the maximum add-on payment for a 
case involving the CRT-D is $16,262.50.
    Comment: One commenter recommended that CRT-D add-on payments 
should expire in May of FY 2005. The commenter explained that the 
newness criterion should be extended to the full 2-3 year period from 
the FDA approval date.
    Response: Predictability is an important aspect of the prospective 
payment system methodology. Accordingly, we believe that it is 
appropriate to apply a consistent payment methodology for new 
technologies throughout the fiscal year. Furthermore, we note that the 
CRT-D will still be within the 2 to 3 year period in which it can be 
considered new for most of FY 2005. As a result, we will make add-on 
payments for cases involving CRT-D for the entire FY 2005.
d. GliaSite[reg] Radiation Therapy System (RTS)
    The Pinnacle Health Group submitted an application for approval of 
GliaSite[reg] Radiation Therapy System (RTS) for new 
technology add-on payments. GliaSite[reg] RTS was approved 
by the FDA for use on April 25, 2001. The system involves several 
components, including a drug called Iotrex and a 
GliaSite[reg] catheter. Iotrex is an organically bound 
liquid form of Iodine \125\ used in intracavitary brachytherapy with 
GliaSite[reg] RTS. Iotrex is a single nonencapsulated 
(liquid) radioactive source. The liquid is a solution of sodium 
\3\-(\125\)iodo-4-hydroxybenzenesulfonate and is used to 
deliver brachytherapy for treatment of brain cancer.
    The delivery system for Iotrex is the GliaSite[reg] RTS 
catheter. Iotrex is administered via injection through a self-sealing 
port into the primary lumen of the barium-impregnated catheter that 
leads to the balloon reservoir. After a malignant brain tumor has been 
resected, the balloon catheter (GliaSite[reg]) is implanted 
temporarily inside the cavity. The patient is released from the 
hospital. After a period of 3 days to 3 weeks, the patient is 
readmitted. During the second admission, the appropriate dose (200 to 
600 millicuries) of radiation is then administered. Iotrex is infused 
into the GliaSite[reg] catheter and intracavitary radiation 
is delivered to the target area. The gamma radiation emitted by Iotrex 
is delivered directly to

[[Page 49017]]

the margins of the tumor bed. After 3 to 7 days, the Iotrex is removed.
    GliaSite[reg] RTS was approved by the FDA for use on 
April 25, 2001. Technology is no longer considered new 2 to 3 years 
after data reflecting the costs of the technology begin to become 
available. Because data regarding this technology began to become 
available in 2001, we determined that GliaSite[reg] RTS does 
not meet the criterion that a medical service or technology be 
considered new. Therefore, in the May 18, 2004 proposed rule, we 
proposed to deny approval of GliaSite[reg] RTS for new 
technology add-on payments.
    Although we proposed not to approve this application because 
GliaSite[reg] RTS does not meet the newness criterion, we 
noted that the applicant submitted information on the cost criterion 
and substantial clinical improvement criterion. The applicant stated 
that the number of cases in DRG 7 for FY 2004 was projected to be 
14,782, and estimated that 10 percent (or about 1,478) of those 
patients would be candidates for GliaSite[reg] RTS. The 
applicant estimated that the standardized charge for all cases using 
the technology in DRG 7 was $49,406. Based on this calculation, the 
manufacturer stated in its application that this figure is greater than 
the cost threshold of $32,115 for DRG 7. Therefore, according to the 
manufacturer, it appears that GliaSite[reg] RTS would meet 
the cost criterion.
    The applicant also claims this way of delivering brachytherapy to 
the brain is significantly more patient friendly. The use of a single 
intracavitary applicator positioned inside the resection cavity during 
the initial surgery in place of an interstitial-seed implant removes 
the need for additional invasive procedures and the need for multiple 
puncture sites (up to 20). In addition, the manufacturer claims that 
the approach used in the GliaSite[reg] RTS system improves 
dose-delivery and provides a more practical means of delivering the 
brachytherapy.
    However, as discussed above, because GliaSite[reg] RTS 
did not meet the newness criterion, we proposed to deny add-on payments 
for this technology in FY 2005.
    Prior to the publication of the May 18, 2004 proposed rule, we 
received no public comments on this application for add-on payments. 
During the 60-day comment period for the proposed rule, we received the 
following public comments on this application.
    Comment: Many commenters objected to the proposed denial of new 
technology status for Iotrex (the chemotherapy agent in the 
GliaSite[reg] RTS). They stated that it represents a 
substantial improvement over conventional brachytherapy treatment for 
brain tumors by reducing the number of radioactive seeds implanted into 
the patient's brain (via up to 20 catheters). Commenters also stated 
that this therapy reduces the problems associated with conventional 
therapy by providing a more ``conformal therapy with no target tissue 
underdosing, less target tissue overdosing and no healthy tissue `hot 
spots.' '''
    Commenters also noted that this therapy is more widely available at 
over 140 centers starting in 2003 (whereas brachytherapy treatment is 
only offered at 5 centers nationwide). While more widely spread, 
commenters nonetheless stated that prior to 2003, when the treatment 
was accepted at the 140 centers noted above, ``significantly fewer 
hospitals offered this therapy'' due to a combination of licensing and 
safety requirements that must be met in order for providers to purchase 
and use this radioisotope. Commenters stated that meeting these 
requirements of the Nuclear Regulatory Commission or applicable State 
authorities governing the distribution and use of Iotrex was time-
consuming, taking on average 6 to 8 months or more per hospital, and 
caused a significant delay in the adoption and use of this therapy, 
despite the FDA approval date. Commenters also stated that by denying 
GliaSite[reg] RTS new technology status, CMS is not 
permitting appropriate payment for the device and is ``likely 
restricting access to this therapy.''
    Response: The regulations clearly state that a medical service or 
technology may be considered new within 2 or 3 years after the point at 
which data begin to become available reflecting the ICD-9-CM code 
assigned to the new service or technology (depending on when a new code 
is assigned and data on the new service or technology become available 
for DRG recalibration). Notably, the regulations continue, ``[a]fter 
CMS has recalibrated the DRGs, based on available data, to reflect the 
costs of an otherwise new medical service or technology, the medical 
service or technology will no longer be considered `new' under the 
criterion of this section.'' This device received FDA approval in April 
of 2001. Information provided by the applicant demonstrates that 
despite the delays caused by licensing and safety requirements, the 
device was available on the market no later than fall of 2001 and data 
began to become available at that time. The applicant's own comments 
indicate that since that time, a relatively large number of hospitals 
have adopted this therapy, with 69 hospitals having the required 
license halfway through FY 2002, and 118 hospitals with the required 
license at the end of FY 2003. Therefore, the costs of the device have 
already been reflected in three cycles of DRG recalibrations using 
costs contained in the second half of FY 2001, and captured in the 
entirety of FYs 2002 and 2003 MedPAR data. Since the product has been 
on the market since 2001, and since many hospitals that treat this 
disease are currently using the device, and have since early in FY 
2002, this device is now beyond the 2 to 3 year period in which it can 
still be considered new.
    Comment: One commenter noted that the DRG for craniotomy (DRGs 1 
and 2) does not adequately cover the cost of the catheter and isotope. 
The commenter stated that ``some centers are readmitting the patients 
for reoperation to place the catheter'' and ``some are treating 
patients as outpatient to avoid losing money on the DRG.''
    Response: Since Medicare has paid for the device for the hospitals 
that have correctly coded the use of the product in the correct DRGs as 
well as in other DRGs and in other areas of our system (as disclosed by 
this commenter), the costs have nonetheless been accounted for in our 
data and the treatment cannot be considered new.
    We therefore finalize the decision to deny new technology add-on 
status for the GliaSite[reg] RTS (Iotrex) for FY 2005.
e. Natrecor[reg]--Human B-Type Natriuretic Peptide (hBNP)
    Scios, Inc. submitted an application for approval of 
Natrecor[reg] for new technology add-on payments. Natrecor 
is a member of a new class of drugs, Human B-type Natriuretic Peptide 
(hBNP), and it is manufactured from E. coli with recombinant DNA 
technology. It binds to the particulate guanylate cyclase receptor of 
vascular smooth muscle endothelial cells, leading to increased 
intracellular concentrations of guanosine 3'5'-cyclic monophosphate, 
and therefore to enhanced smooth muscle cell relaxation, ultimately 
causing dilation of arteries and veins. The applicant states that 
Natrecor[reg] is more potent and relieves symptoms of heart 
failure more rapidly, while also causing less hemodynamic instability 
than intravenous nitroglycerin, the most commonly used vasodilator for 
heart failure.
    Natrecor[reg] was approved by the FDA for the treatment 
of acute congestive heart failure on August 10, 2001. It is indicated 
for the intravenous treatment of patients with acutely decompensated 
congestive heart failure (dyspnea).

[[Page 49018]]

Congestive heart failure is the result of impaired pumping capacity of 
the heart. It causes a variety of clinical consequences, including 
water retention, sodium retention, pulmonary congestion, and diminished 
perfusion of blood to all parts of the body.
    The applicant concedes that the FY 2003 MedPAR file includes 
hospital charge information for patients receiving 
Natrecor[reg]. The manufacturer contends that 
Natrecor[reg] should still be considered new for several 
reasons. The first reason is that these data will not provide an 
accurate representation of hospital utilization of this product nor an 
adequate reimbursement rate for hospitals treating acute congestive 
heart failure patients with Natrecor[reg] in FY 2005. The FY 
2003 MedPAR file represents the first full year in which the ICD-9-CM 
procedure code 00.13 (Injection or infusion of nesiritide) was in 
effect. Therefore, the manufacturer anticipates a slow increase in the 
accuracy of coding and billing in FY 2003. In addition, the 
manufacturer stated that market penetration for this product was 3 
percent for FY 2003, but is expected to be significantly higher for FY 
2005.
    However, technology is no longer considered new 2 to 3 years after 
data reflecting its costs begin to become available. Because data 
reflecting the costs of Natrecor[reg] began to become 
available in 2001, these costs are currently reflected in the DRG 
weights. In addition, as discussed in the September 7, 2001 final rule 
(66 FR 46914), the determination of whether a technology is new depends 
on the date of its availability for use in the Medicare population 
rather than the date a specific code was assigned. Because 
Natrecor[reg] was available upon FDA approval, it does not 
meet the criterion that a medical service or technology be considered 
new.
    Although we proposed not to approve this application because 
Natrecor[reg] does not meet the newness criterion, in the proposed 
rule, we noted that the applicant submitted information on the cost 
criterion and substantial clinical improvement criterion. Scios 
commissioned Premier, Inc. to search its database of 196 hospitals for 
cases in FY 2003 that used Natrecor[reg]. Premier identified 9,811 
cases across many DRGs using National Drug Codes from pharmacy 
databases. The majority of cases (approximately 42 percent) were found 
in DRG 127 (Heart Failure and Shock), while the remaining cases were 
found in other DRGs that individually had a maximum of 8 percent of the 
9,811 cases identified by Premier. The case-weighted threshold across 
all DRGs for Natrecor[reg], using data provided by Premier, was 
$26,509. (DRGs with less than 25 discharges were not included in this 
analysis.) The average charge for cases with Natrecor[reg] was $70,137. 
The average case-weighted standardized charge across all DRGs was 
$43,422. Because the average standardized charge is greater than the 
case-weighted threshold, the applicant stated that Natrecor[reg] meets 
the cost criterion.
    The manufacturer stated that Natrecor[reg] represents a substantial 
clinical improvement over existing treatments for decompensated 
congestive heart failure because it provides novel clinical effects, 
leads to fewer complications, and improves overall clinical outcomes. 
Specifically, Natrecor[reg] reduces left ventricular preload, 
afterload, and pulmonary capillary wedge pressure without inducing 
tachyphylaxis, and it causes a balanced vasodilation of veins, 
arteries, and coronary arteries that increases cardiac output. It has 
also been shown to significantly reduce dyspnea, and it blocks the 
rennin-aldosterone-angiotensin system, thereby reducing sodium 
retention and enhancing diuresis and natriuresis. In addition, 
Natrecor[reg] is not pro-arrhythmic; it does not increase cardiac work 
by causing tachycardia, and it does not cause electrolyte imbalances.
    However, as discussed above, Natrecor[reg] does not meet the 
newness criterion. Therefore, in the May 18, 2004 proposed rule, we 
proposed to deny add-on payments for this technology in FY 2005.
    Prior to the publication of the proposed rule, we received no 
public comments on this application for add-on payments. During the 60-
day comment period for the proposed rule, we received the following 
public comments on this application.
    Comment: Some commenters, including the applicant, disagreed with 
CMS' position that Natrecor[reg] is ineligible for an add-on payment 
since it is not ``new''. A commenter explained that in the proposed 
rule CMS stated that the 2-to-3 year period for collection of cost data 
begins when the drug or biological receives FDA approval and not when 
an ICD-9-CM code is issued. The commenter felt this contradicts the 
statutory language in section 1886 (d)(5)(K)(ii)(II) and the regulatory 
text in 42 CFR 412.87(b)(2). The commenter stated that that based on 
the statutory and regulatory text, a technology should be considered 
new from the date a code is issued. As a result, since Natrecor[reg] 
did not receive a unique code until October 1, 2002, it should still 
fall within the 2-3 year period to be considered new.
    The commenter further noted that heart failure patients who receive 
Natrecor[reg] are more costly than patients who do not receive 
Natrecor[reg]. Based on data the applicant submitted, the commenter 
explained that the average charge for a patient receiving Natrecor[reg] 
is 47.5 percent higher than the case weighted average charge threshold 
of $32,485. The commenter also added that based on data from the 
Premier database, even though 48 percent of all cases of Natrecor[reg] 
map to DRG 127, Natrecor[reg] has had a very small impact on DRG 127 
since it represents only 1.8 percent of all charges in DRG 127 which is 
a result of the fact that only 8.4 percent of all patients assigned to 
DRG 127 received Natrecor[reg]. As a result, the commenter disagreed 
with CMS' contention that charges for Natrecor[reg] are adequately 
reflected in the relevant DRGs. The commenter concluded that limited 
Medicare reimbursement coupled with the high cost of a breakthrough 
biologic therapy have led to restrictions on the use of Natrecor[reg]. 
Also, the number of patients that could receive Natrecor[reg] in DRG 
127 is much higher then the current figure of 8.4 percent.
    Another commenter believed that CMS should provide its full 
evaluation of the cost and clinical data submitted by this applicant 
(and all other applicants) in order to provide for better insight into 
the agency's decision-making process. The commenter was concerned that 
during the comment period an application could satisfy the criterion 
upon which CMS had proposed to deny the application in the proposed 
rule, while in the final rule CMS could deny the application on a 
different criterion that had not been discussed in the proposed rule. 
As a result, the commenter recommended a full analysis of all the 
criteria in the proposed rule.
    Response: As stated above, a technology is no longer considered new 
2 to 3 years after data reflecting its costs begin to become available. 
Because data reflecting the costs of Natrecor[reg] began to become 
available in 2001, these costs are currently reflected in the DRG 
weights. For a further discussion on the newness criterion regarding 
FDA approval dates and the issuance of ICD-9-CM codes, please see the 
preamble above.
    We conduct sufficient analysis on each application in order to 
provide sufficient opportunity to comment. We do not believe that it is 
necessary to provide a full analysis of all the criteria in cases 
where, for example, we believe

[[Page 49019]]

that sufficient evidence is available to propose denying the 
application on the basis of the newness criterion. However, even in 
these cases we provide an account of any information submitted by the 
applicant in order to provide opportunity for comment.
    Comment: One commenter believes that CMS should be more proactive 
when it comes to DRG reclassifications of new technologies. The 
commenter cited Natrecor[reg] as an example of a new technology with 
over 10,000 cases in which the current reimbursement is inadequate. The 
commenter noted that after CMS denied the application for add-on 
payments, no consideration was given to the reclassification of the new 
technology. The commenter encouraged CMS to make strides to ensure that 
patient access to important, life threatening therapies is not 
threatened by inappropriate PPS payments.
    Response: When reviewing new technology applications, we consider 
if the applicant has met all the criteria for new technology add-on 
payments. The applicant or anyone from the public is free to make a 
separate request for consideration of a new DRG assignment as we 
discuss in section II. B. of this final rule.
    Because Natrecor[reg] does not meet the newness criterion, we are 
finalizing our proposal not to approve add-on payments for this 
technology in FY 2005.
f. Kinetra[reg] Implantable Neurostimulator for Deep Brain Stimulation
    Medtronic, Inc. submitted an application for approval of the 
Kinetra[reg] implantable neurostimulator device for new technology add-
on payments. The Kinetra[reg] device was approved by the FDA on 
December 16, 2003. The Kinetra[reg] implantable neurostimulator is 
designed to deliver electrical stimulation to the subthalamic nucleus 
(STN) or internal globus pallidus (GPi) in order to ameliorate symptoms 
caused by abnormal neurotransmitter levels that lead to abnormal cell-
to-cell electrical impulses in Parkinson's Disease and essential 
tremor. Before the development of Kinetra[reg], treating bilateral 
symptoms of patients with these disorders required the implantation of 
two neurostimulators (in the form of a product called 
SoletraTM, also manufactured by Medtronic): one for the 
right side of the brain (to control symptoms on the left side of the 
body), the other for the left side of the brain (to control symptoms on 
the right side of the body). Additional procedures are required to 
create pockets in the chest cavity to place the two generators required 
to run the individual leads. The Kinetra[reg] neurostimulator 
generator, implanted in the pectoral area, is designed to eliminate the 
need for two devices by accommodating two leads that are placed in both 
the left and right sides of the brain to deliver the necessary 
impulses. The manufacturer argues that the development of a single 
neurostimulator that treats bilateral symptoms provides a less invasive 
treatment option for patients, and simpler implantation, follow up, and 
programming procedures for physicians.
    In December 2003, the device was approved by the FDA. Therefore, it 
qualifies under the newness criterion because FDA approval was within 
the statutory timeframe of 2-3 years and its costs are therefore not 
yet reflected in the DRG weights. Because there are no data available 
to evaluate costs associated with Kinetra[reg], we conducted the cost 
analysis using SoletraTM, the predecessor technology used to 
treat this condition, as a proxy for Kinetra[reg]. The pre-existing 
technology provides the closest means to track cases that have actually 
used similar technology and serves to identify the need and use of the 
new device. The manufacturer informed us that the cost of the 
Kinetra[reg] device is twice the price of a single SoletraTM 
device. Since most patients would receive two SoletraTM 
devices if the Kinetra[reg] device is not implanted, data regarding the 
cost of SoletraTM give a good measure of the actual costs 
that will be incurred. Medtronic submitted data for 104 cases that 
involved the SoletraTM device (26 cases in DRG 1 (Craniotomy 
Age > 17 With CC), and 78 cases in DRG 2 (Craniotomy Age > 17 Without 
CC)). These cases were identified from the FY 2002 MedPAR file using 
procedure codes 02.93 (Implantation, intracranial neurostimulator) and 
86.09 (Other incision of skin and subcutaneous tissue). In the analysis 
presented by the applicant, the mean standardized charges for cases 
involving SoletraTM in DRGs 1 and 2 were $69,018 and 
$44,779, respectively. The mean standardized charge for these 
SoletraTM cases according to Medtronic's data was $50,839.
    For the proposed rule, we used the same procedure codes to identify 
187 cases involving the SoletraTM device in DRGs 1 and 2 in 
the FY 2003 MedPAR file. Similar to the Medtronic data, 53 of the cases 
were found in DRG 1, and 134 cases were found in DRG 2. The average 
standardized charges for these cases in DRGs 1 and 2 were $51,163 and 
$44,874, respectively. Therefore, the case-weighted average 
standardized charge for cases that included implantation of the 
SoletraTM device was $46,656. The new cost thresholds 
established under the revised criteria in Public Law 108-173 for DRGs 1 
and 2 are $43,245 and $30,129, respectively. Accordingly, the case-
weighted threshold to qualify for new technology add-on payment using 
the data we identified would be $33,846. Under this analysis, 
Kinetra[reg] would qualify for the cost threshold.
    We note that an ICD-9-CM code was approved for dual array pulse 
generator devices, effective October 1, 2004, for IPPS tracking 
purposes. The new ICD-9-CM code that will be assigned to this device is 
86.95 (Insertion or replacement of dual array neurostimulator pulse 
generator), which includes dual array and dual channel generators for 
intracranial, spinal, and peripheral neurostimulators. The code will 
not identify cases with this specific device and will only be used to 
distinguish single versus dual channel-pulse generator devices.
    The manufacturer claims that Kinetra[reg] provides a range of 
substantial improvements beyond previously available technology. These 
include a reduced rate of device-related complications and 
hospitalizations or physician visits and less surgical trauma because 
only one generator implantation procedure is required. Kinetra[reg] has 
a reed switch disabling function that physicians can use to prevent 
inadvertent shutoff of the device, as occurs when accidentally tripped 
by electromagnetic inference (caused by common products such as metal 
detectors and garage door openers). Kinetra[reg] also provides 
significant patient control, allowing patients to monitor whether the 
device is on or off, to monitor battery life, and to fine-tune the 
stimulation therapy within clinician-programmed parameters. While 
Kinetra[reg] provides the ability for patients to better control their 
symptoms and reduce the complications associated with the existing 
technology, it does not eliminate the necessity for two surgeries. 
Because the patients who receive the device are often frail, the 
implantation generally occurs in two phases: the brain leads are 
implanted in one surgery, and the generator is implanted in another 
surgery, typically on another day. However, implanting Kinetra[reg] 
does reduce the number of potential surgeries compared to its 
predecessor (which requires two surgeries to implant the two single-
lead arrays to the brain and an additional surgery for implantation of 
the second generator). Therefore, the Kinetra[reg] device reduces the 
number of surgeries from 3 to 2.

[[Page 49020]]

    In the May 18, 2004, proposed rule, we indicated that, despite the 
improvement Kinetra[reg] represents over its immediate predecessor, 
SoletraTM, we had concerns about whether the device is 
significantly different in terms of how it achieves its desired 
clinical result. The stimulation mechanism by which it treats patient 
symptoms remains substantially the same as the predecessor device. The 
enhancements cited by the manufacturer are primarily to features such 
as control, power, monitoring, and reliability. Nevertheless, these 
improvements, along with the reduced number of surgeries required, may 
be sufficient to warrant a determination that the device represents a 
substantial clinical improvement. We welcomed further public comment on 
the issue of whether the device is sufficiently different from the 
previously used technology to qualify as a substantially improved 
treatment for the same patient symptoms.
    In the proposed rule, we also invited comments concerning the cost 
of the device. If the new device, at twice the cost of the existing 
technology, merely replaces the costs of two of the previous devices, 
then the charges for Kinetra[reg] are not substantially different from 
current charges resulting from the use of either device alone. Because 
the costs for the predecessor device meet the statutory cost criterion, 
the successor technology would meet the criterion as well, at least 
under the manufacturer's assumption that a single Kinetra[reg] costs 
twice as much as each of the two SoletrasTM required to 
perform the same function. However, since there should be less surgery 
involved, more patient control, less risk of complications, and fewer 
office visits as a result of using Kinetra[reg], we stated in the 
proposed rule that we would expect the costs for patients who receive 
the new device to drop. We stated that, for those reasons, it may not 
be appropriate to base the cost analysis for Kinetra[reg] on the 
manufacturer's assumption that total costs for SoletraTM and 
Kinetra[reg] are substantially the same.
    In addition, in the proposed rule, we invited public comment 
concerning the approval of the device for add-on payment, given the 
uncertainty over the frequency with which the patients receiving the 
device have the generator implanted in a second hospital stay, and the 
frequency with which this implantation occurs in an outpatient setting. 
Any hospital performing the implantation in two separate patient stays, 
whether they are both inpatient or whether one is inpatient and the 
second is outpatient, would be paid double for the single device. 
Therefore, we had some concern about the appropriateness of approving 
add-on payments for a device that may already receive payment at a 
nonbundled rate for a high percentage of patients who receive the 
device. We also investigated whether a second hospital stay is needed 
for implantation of Kinetra[reg].
    Despite these issues, we indicated that we would continue to 
consider whether it was appropriate to approve add-on status for 
Kinetra[reg] for FY 2005. If approved for add-on payments, the device 
would be reimbursed up to half of the costs for the device. Since the 
manufacturer has stated that the cost for Kinetra[reg] would be 
$16,570, the maximum add-on payment for the device would be $8,285. We 
stated that we would make a final determination in the light of public 
comments that we received on the proposed rule and our continuing 
analysis.
    Prior to publication of the proposed rule, we received no public 
comments on this application. During the 60-day comment period for the 
proposed rule, we received the following public comments on this 
application.
    Comment: The applicant responded to our request for comments by 
providing further detail on the cost of the device, how it derived the 
higher cost for the device and recommendations on how we might proceed 
if we were to approve the device for add-on payments. It noted that the 
device has substantially higher manufacturing costs than the 
predecessor device, SoletraTM, which has a smaller battery 
and much lower production cost. The applicant also stated that the 
device meets the substantial clinical improvement criterion due to the 
much improved user outcomes for patients that receive Kinetra[reg] as 
opposed to those that receive the SoletraTM. In addition to 
the factors listed above, it noted that not only does the device reduce 
invasiveness and risk of surgical complications to implant the device, 
but the shorter operating time needed to implant one device reduces the 
duration of anesthesia in one episode that these patients need for 
surgical placement. The time to reach the desired and improved 
therapeutic outcome is greatly reduced. The need for follow up care is 
substantially reduced and the intervals between battery replacement 
operations with the new device are significantly increased (anywhere 
from 15 months to 2 years longer, based on various comments received).
    The applicant also provided data that satisfactorily answered our 
remaining questions with regard to the reasons for staged implantation 
of the device in some patients. It noted that many patients simply 
cannot physically tolerate the long day of surgery, and particularly 
the general anesthesia required to implant the generator if the 
procedure is all done in one day or one hospital stay. In addition, due 
to the nature of the brain surgery involved to place the leads, care 
must be given to ensure that no hemorrhages are present before 
proceeding with implanting the rest of the device. Other physicians 
noted that patient medications must also be taken into account when 
planning the implantation of the device. One commenter, a physician 
using the device in his practice, also noted the improved mobility and 
function of patients receiving this device and the reduced interference 
in daily and leisure activities for patients receiving this device over 
the SoletraTM generators. Other physicians noted that 
patients actually spend less time in the hospital under the staged 
method for implanting the device and tolerate the procedures much 
better. Some nurses noted that there are additional educational 
requirements associated with the Kinetra[reg] device due to the unique 
patient control, but this training and the additional time to set up 
the initial programming of the device result in reduced follow-up 
visits and re-programming, and allow the patients to monitor their 
symptoms in the stress-free environment of the home instead of the 
doctor's office.
    Response: We believe that sufficient evidence has been provided by 
the applicant to demonstrate that this device satisfies the significant 
clinical improvement criterion and should receive new technology add-on 
payment for FY 2005. We have found that, based on the new evidence 
provided, Kinetra[reg] does represent a substantial clinical 
improvement over the previous SoletraTM device. 
Specifically, the increased patient control, reduced surgery, fewer 
complications, and elimination of environmental interference 
significantly improve patient outcomes. Since we stated in the proposed 
rule that the device meets the newness criterion, and that the device 
meets the cost threshold in the DRGs to which it is assigned, this 
determination of substantial clinical improvement warrants the approval 
of Kinetra[reg] for new technology add-on payments for FY 2005.
    Comment: The applicant also recommended that, if approved for add-
on payment, CMS should require both the procedure code that identifies 
the neurostimulator device for deep brain stimulation (02.93) in 
addition to the code that identifies the placement of the

[[Page 49021]]

generator in the chest cavity (86.95). In addition, it commented that 
any concern over double-payment if implantation occurs in a staged 
manner (that is, in separate inpatient admissions or in different 
settings that Medicare pays for) would be ameliorated if we require 
that both these two ICD-9-CM codes be required in a case that is mapped 
to either DRG 1 or 2 (Craniotomy with and without CC).
    Response: We agree that this is the best approach to resolving both 
the reimbursement issue as well as concerns over the possibility of 
paying for the device twice if performed in different settings (that 
is, a staged implantation). We are approving new technology add-on 
payments for the Kinetra[reg] device for FY 2005 in this final rule. 
Cases receiving Kinetra[reg] for Parkinson's disease or essential 
tremor on or after October 1, 2004 will be eligible to receive an add-
on payment of up to $8,285, or half the cost of the device, which is 
approximately $16,570. These cases will be identified by the presence 
of procedure codes 02.93 (Implantation or replacement of intracranial 
neurostimulator leads) and 86.95 (Insertion or replacement of dual 
array neurostimulator pulse generator). If a claim has only the 
procedure code identifying the implantation of the intracranial leads, 
or if the claim identifies only insertion of the generator, no add-on 
payment will be made.
    Comment: Commenters expressed disappointment that we did not 
approve this device in our proposed rule. However, they remarked upon 
the complex issues that were raised by our concerns. Specifically, 
commenters urged that CMS adopt and maintain a uniform standard between 
the inpatient PPS and the outpatient PPS, urging CMS to make consistent 
decisions for devices that may be used appropriately in both settings. 
The commenters specifically referenced different sets of language 
defining substantial improvements from the OPPS rules, urging the IPPS 
to follow the guidance of the policies set forth in the OPPS.
    Response: The commenters' specific reference to the language in the 
November 1, 2002 outpatient prospective payment system final rule (67 
FR 66781 through 66783) that refers to determinations of substantial 
clinical improvement where factors such as ``increased battery life'' 
and ``miniaturization, might so improve convenience, durability and 
ease of operation'' was taken out of context. The November 1, 2002 
final OPPS rule states, ``[n]evertheless, there may be some 
improvements in the medical technology itself that are so significant 
that we may wish to recognize them for separate payment * * * even 
though they do not directly result in substantial clinical 
improvements.'' To date, the OPPS has only applied these explicit 
substantial clinical improvement criteria to pass-through device 
category applications. We have not yet determined whether to apply this 
particular standard within IPPS. However, we are approving the 
Kinetra[reg] device for new technology add-on payments for FY 2005, 
without reference to these considerations. We will continue to consider 
whether to employ specific factors such as those identified for the 
OPPS in the IPPS.
    Comment: Several commenters noted the importance of the 
programmability of the device, especially for patients who live at a 
distance from their physician and would not be able to visit frequently 
to adjust the level of stimulation as would be necessary with the 
SoletraTM device. One commenter (a physician) noted that 
``the problem [with the SoletraTM device] has been so severe 
in some patients that [he has] had to loan them a regular physician 
programmer so that they could do the adjustments at home.'' He noted 
further that the SoletraTM programmer is not meant for 
patient use and encouraged CMS to approve add-on payment for 
Kinetra[reg] so he can use it in his practice.
    Response: We do not know the protocol for doctor-patient 
programming of the SoletraTM device, however, we are 
approving add-on payment for Kinetra[reg] for FY 2005.
    Comment: We received one comment that cited that ``the use of 
Kinetra[reg] in the VA system is preferred by an almost 3 to 1 ratio 
versus the previous technology'' whereas the usage in Medicare was only 
approximately 1 to 4.
    Response: We do not know where the commenter received the data in 
this comment, as we were not given this data by the applicant. However, 
we are approving Kinetra[reg] for add-on payment for FY 
2005.
g. Intramedullary Skeletal Kinetic Distractor (ISKD)
    Orthofix, Inc. submitted an application for approval of the 
Intramedullary Skeletal Kinetic Distractor (ISKD) Internal Limb 
Lengthener for new technology add-on payments for FY 2005. The device 
received FDA marketing approval on May 2, 2001. The ISKD System is a 
``closed'' lengthening system. There are no fixation pins exiting the 
skin, thus eliminating this portal for entry of infectious organisms. 
The device is implanted in the intramedullary canal. This provides 
mechanical stability and support to the bone segments during the 
distraction, regeneration and consolidation phases, thus reducing the 
opportunity for misalignment.
    In the May 18, 2004, proposed rule, we indicated that we had 
reviewed the application and technology, and we had determined that the 
device is not new and cannot be approved for new technology add-on 
payments because it came on the market on May 2, 2001. The costs of the 
device are thus reflected in the FY 2001 MedPAR file, as acknowledged 
by the manufacturer's data. As a result, the costs of the device are 
already reflected in the DRG weights.
    The manufacturer submitted charge data for cases found in the FY 
2001 MedPAR file, as well as data from several hospitals that have used 
the device. The manufacturer identified cases using ICD-9-CM codes 
78.35 (Limb lengthening procedure, femur) and 78.37 (Limb lengthening, 
tibia/fibula). These procedure codes occur in four DRGs: DRGs 210 and 
211 (Hip and Femur Procedures Except Major Joint Procedures Age > 17, 
With and Without CC, respectively) and DRGs 218 and 219 (Lower 
Extremity and Humerus Procedures Except Hip, Foot and Femur Age > 17, 
With and Without CC). The average charges for cases involving these 
procedure codes identified by the applicant were not standardized. The 
average charges provided for DRGs 210, 211, 218, and 219 were $26,692, 
$18,187, $32,959 and $20,228, respectively. The manufacturer then added 
the cost of the device, which the manufacturer states is $6,750. The 
manufacturer projects that, in FY 2005, there will be 9 cases in DRG 
210, 4 cases in DRG 211, 28 cases in DRG 218, and 19 cases in DRG 219, 
which results in a case-weighted threshold of $22,347. Thus, according 
to the manufacturer's data, because the case-weighted average 
standardized charges of $27,003 for the technology are greater than the 
cost threshold of $22,347 for these projected 60 cases, the ISKD would 
qualify for new technology add-on payments.
    The manufacturer also stated that the ISKD met the substantial 
clinical improvement criterion because, in addition to the improvements 
mentioned above (reduces infection rates and provides mechanical 
stability), lengthening with the ISKD occurs gradually and with no soft 
tissue impingement, reducing two factors commonly associated with pain 
during distraction. In addition, the manufacturer pointed out that with 
the ISKD, the lengthening procedure is

[[Page 49022]]

discreet because there are no external pins. There is no cumbersome 
external frame that may hinder the patient's activities of daily 
living, or draw further attention to the discrepant limb. In addition, 
the patient may have partial weight bearing during the lengthening 
process and resume some activities of normal living.
    However, because the device is already captured in our DRG weights, 
in the May 18, 2004 proposed rule, we proposed to deny the application 
for the ISKD device for new technology add-on payments for FY 2005.
    Prior to publication of the proposed rule, we received no public 
comments on this application. During the 60-day comment period for the 
proposed rule, we received the following public comments on this 
application.
    Comment: The applicant noted that it was very disappointed with 
CMS' proposal to deny add-on payments for this device. It stated that, 
although the device may be paid for in the DRG system, so few cases 
have received the device that the costs related to the device are not 
accurately reflected in the data used to recalibrate the DRG weights. 
It argues that the low volume of cases that have received the device 
has been a direct result of underpayment for the device and that CMS is 
denying this treatment to beneficiaries by not paying more for this 
device. The applicant also stated that if we had asked for market data 
in the application, it would have provided that information to us 
sooner, and would have had the opportunity to present its argument that 
the device did, in fact, have a delay between FDA approval and coming 
to the market. It stated that the ``delay between FDA approval and 
commercial availability was due to a halt in production while certain 
changes on the ISKD were validated.'' It also noted that the company 
``conducted a comprehensive review of its sales database'' and has 
determined that the first commercial sales of the device were made in 
February 2002, and as such, the costs of the device were not included 
in the FY 2001 MedPAR.
    Response: This device has been on the market for more than the 2- 
to 3-year period for which new technology add-on payments are allowed. 
Even though there may have been a delay in commercial availability of 
the device, the company stated that sales were made in February of 
2002. We note that we are not using strictly the FY 2001 MedPAR as our 
basis for determining newness in FY 2005, but are denying add-on 
payments to those products that were on the market prior to midway into 
FY 2002. Products that were in use prior to April of 2002 have data for 
more than half of FY 2002 so that the costs of the new technology were 
included in the DRG recalibration in subsequent years. We have been 
making payments for the ISKD device since it came on the market and 
data reflecting the cost of the device are therefore already reflected 
in the DRG weights. Therefore, we cannot find that the device is new 
and we are finalizing our proposal to deny this applicant new 
technology add-on payments.
h. ActiconTM Neosphincter
    American Medical Systems submitted an application for approval of 
the ActiconTM Neosphincter for new technology add-on 
payments for FY 2005. The ActiconTM Neosphincter is a small, 
fluid-filled prosthesis that is completely implanted within the body. 
The ActiconTM Neosphincter prosthesis has been developed to 
treat severe fecal incontinence (the accidental loss of solid or liquid 
stool at least weekly). It is designed to mimic the natural process of 
bowel control and bowel movements. The prosthesis consists of three 
components: an occlusive cuff implanted around the anal canal, a 
pressure-regulating balloon implanted in the prevesical space, and a 
control pump with septum implanted in the scrotum. All components are 
connected with color-coded, kink-resistant tubing.
    The FDA approved the Acticon Neosphincter for use on December 18, 
2001. A technology can be considered new only 2 to 3 years after data 
reflecting the costs of the technology begin to become available. Data 
on the costs of this technology began to become available after the 
December 2001 FDA approval. As a result, the costs of this technology 
are currently reflected in the DRG weights. Therefore, in the proposed 
rule, we indicated that we had determined that ActiconTM 
Neosphincter does not meet this criterion.
    Although we proposed not to approve this application because 
ActiconTM Neosphincter does not meet the newness criterion, 
we noted that the applicant submitted information on the cost criterion 
and substantial clinical improvement criterion. The applicant submitted 
23 cases (that are indistinguishable as to whether they are Medicare or 
non-Medicare) using ICD-9-CM procedure codes 49.75 (Implantation or 
revision of artificial anal sphincter) and 49.76 (Removal of artificial 
anal sphincter) in order to identify cases where the 
ActiconTM Neosphincter was used. Of these cases, 9 were in 
DRG 157 (Anal and Stomal Procedures With CC), and 14 were in DRG 158 
(Anal and Stomal Procedures Without CC). The average standardized 
charge per case was $16,758. The case-weighted threshold for DRGs 157 
and 158 (39.1 percent of cases in DRG 157 and 60.1 percent of cases in 
DRG 158) for this technology is $14,426. Therefore, according to the 
applicant, the ActiconTM Neosphincter meets the cost 
criterion.
    The applicant states in its application that the 
ActiconTM Neosphincter represents a substantial clinical 
improvement for the following reasons: (1) There is no other existing 
device in the United States that can be used to treat severe fecal 
incontinence; and (2) self-treatment for severe fecal incontinence has 
proven to be largely unsuccessful and surgical options have 
historically been more limited, including sphincteroplasty or muscle 
transposition.
    However, because ActiconTM Neosphincter does not meet 
the newness criterion, we proposed to deny add-on payments for this new 
technology. The applicant also requested a DRG reclassification for 
this technology. In section II.B.4 of the preamble of this final rule, 
we are finalizing our proposal to remove codes 49.75 and 49.76 from 
DRGs 157 and 158, and reassign them to DRGs 146 (Rectal Resection With 
CC) and 147 (Rectal Resection Without CC) in MDC 6 (Diseases and 
Disorders of the Digestive System) only. All other MDC and DRG 
assignments for codes 49.75 and 49.76 remain the same.
    Prior to the publication of the May 18, 2004 proposed rule, we 
received public comments in accordance with section 50(b)(2) of Pub. L. 
108-173 regarding this application for add-on payments.
    One commenter noted that the implant of the ActiconTM 
Neosphincter avoids the life-altering and disfiguring consequences of a 
permanent stoma. Another commenter noted that the implant of the 
ActiconTM Neosphincter avoids the need for a colostomy, 
which limits a patient's ability to travel and work due to the fact 
they could have a fecal accident at any time. However, because we 
concluded that the ActiconTM Neosphincter is no longer new, 
we proposed that it is not eligible for add-on payments.
    During the 60-day comment period for the May 18, 2004 proposed 
rule, we received the following public comments on this application.
    Comment: One commenter, the applicant, commented that the 
ActiconTM Neosphincter should still be considered new under 
the newness criterion since the device received FDA approval on 
December 18, 2001 and

[[Page 49023]]

ICD-9-CM codes (49.75 and 49.76) became effective October 1, 2002. The 
commenter believes that only after the ICD-9-CM codes became available 
did data begin to reflect the costs of the technology in the DRGs. 
Based on the issuance of the codes, there is only 1\1/2\ years of data 
and this is the first year CMS is using data with the new ICD-9-CM 
codes that reflect the ActiconTM Neosphincter within the 
DRGs. As a result, the commenter maintains that the 
ActiconTM Neosphincter is still ``new'' under 42 CFR 
412.87(b)(2).
    The commenter also noted that the standardized charges per case of 
$16,758 are actually the standardized costs per case. The correct 
average charge per case based on the data submitted is $41,396.
    Response: As stated above, a technology can be considered new only 
2 to 3 years after data reflecting the costs of the technology begin to 
become available. Data on the costs of this technology began to become 
available after the December 2001 FDA approval and the costs of this 
technology are currently reflected in the DRG weights. As a result, the 
ActiconTM Neosphincter does not meet the newness criterion. 
For a further discussion regarding the effect of FDA approval dates and 
the issuance of ICD-9-CM codes upon our evaluation of the newness 
criterion, please see the preamble above.
    Also, in reference to the cost data, we appreciate the commenter 
pointing out this error and agree that the average case weighted 
standardized charge is $41,396. Because the average case weighted 
standardized charge is greater then the average case weighted threshold 
of $14,426, the commenter maintains that the ActiconTM 
Neosphincter meets the cost criterion. However, because the 
ActiconTM Neosphincter does not meet the newness criterion, 
we are denying add-on payments for this technology in FY 2005.
    We are finalizing our proposal not to approve this technology for 
add-on payments for FY 2005.
i. TandemHeartTM Percutaneous Left Ventricular Assist System
    Brigham and Women's Hospital submitted an application for approval 
of the TandemHeartTM Percutaneous Ventricular Assist System 
(PVTA) manufactured by Cardiac Assists, Inc., for new technology add-on 
payments for FY 2005. Cardiac Assists, Inc. has been assisting the 
applicant with supplemental information and data to support the 
application process. According to the manufacturer, the device contains 
a controller, arterial and venous cannulae, and the 
TandemHeartTM Percutaneous Ventricular Assist Device (pVAD) 
that works parallel with the left ventricle to provide left ventricular 
circulatory support. The device is intended for extracorporeal 
circulatory support using an extracorporeal bypass circuit. The 
duration of use approved by the FDA is for periods of up to 6 hours.
    On November 11, 2000, FDA approved the AB-180 XC Blood Pump (also 
known as the TandemHeart\TM\ pVAD) as a single use, disposable 
centrifugal blood pump designed to circulate blood through an 
extracorporeal circuit. On May 23, 2003, FDA approved the CardiacAssist 
Transseptal Cannula Set for transseptal catherization of the left 
atrium via the femoral vein for the purpose of providing a means for 
temporary (6 hours or less) left ventricular bypass when connected to a 
suitable extracorporeal blood pump unit that returns blood to the 
patient via the femoral artery or other appropriate site. The 
manufacturer stated that, although the TandemHeart\TM\ pVAD was 
approved in November 2000, this device should still be considered new 
because the device was not marketed and sold to hospitals until the 
CardiacAssist Transseptal Cannula Set was approved by FDA in May 2003. 
We have received confirmation from hospitals that the TandemHeart\TM\ 
pVAD was indeed not marketed until FDA approved the CardiacAssist 
Transseptal Cannula Set. Also, only half of a year's worth of data 
containing the TandemHeart\TM\ pVAD is reflected within the FY 2003 
MedPAR file. The manufacturer stated that approximately 60 
TandemHeart\TM\ pVADs have been used since the FDA approved the Cardiac 
Arrest Transseptal Cannula Set in May 2003. Therefore, the costs of the 
TandemHeart\TM\ pVAD are not adequately reflected within the DRGs. As a 
result, we consider the TandemHeart\TM\ pVAD to be new under our 
criterion.
    As stated above, according to the manufacturer, approximately 60 
TandemHeart\TM\ pVADs have been used since the FDA approved the Cardiac 
Assist Transseptal Cannula Set in May 2003 (not all of these have been 
used in Medicare beneficiaries). However, only two actual cases were 
submitted by the applicant with an ICD-9-CM code of 37.65 (Implant of 
an external pulsatile heart assist system) used to identify the device. 
As stated in the September 7, 2001, final rule (66 FR 46916), data 
submitted by the applicant must be of a sufficient sample size to 
demonstrate a significant likelihood that the true mean across all 
cases likely to receive the technology will exceed the threshold 
established by CMS. We indicated in the proposed rule that, because we 
lack a significant sample of data reflecting the costs of this 
technology, we could not accurately determine the average charge per 
case for the TandemHeart\TM\ pVAD. Neither could we determine whether 
this technology meets our cost criterion. We indicated that if we 
received sufficient data to complete our analysis in time for inclusion 
in the final rule, we would assess whether this technology meets the 
cost criterion.
    In response to this request, the manufacturer and applicant 
submitted supplementary data on the TandemHeart\TM\ pVAD. We received a 
total of 11 actual cases that used the Tandem Heart. Although these 
cases are approximately 18 percent of all TandemHeart\TM\ pVAD cases, 
we cannot consider this a significant sample of cases to determine if 
the Tandem Heart meets the cost criterion. Of the 11 cases submitted, 
the variance in charges from the lowest charge per case to highest 
charge per case was close to 1 million dollars. Such a large variance 
in charges per case will require us to consider many more cases in 
excess of the 11 cases submitted and the 60 total cases that have used 
the device since its inception before we can determine if the 
TandemHeart\TM\ pVAD meets the cost criterion. Also, because this is a 
small pool of cases, one unrepresentative case could skew the results 
of the data. As a result, because there are insufficient data for us to 
determine whether the TandemHeart\TM\ pVAD meets the cost criterion, we 
are denying add-on payments for this technology in FY 2005.
    Although we are not approving this application because we did not 
have sufficient data to determine whether TandemHeart\TM\ pVAD meets 
the cost criterion, in the proposed rule we noted that the applicant 
submitted information on the substantial clinical improvement 
criterion. The applicant stated in its application that the 
TandemHeart\TM\ pVAD represents a substantial clinical improvement 
because, at present, the only alternative to intra-aortic balloon pump 
support is the surgical implantation of a ventricular assist device. 
The TandemHeart\TM\ pVAD is the only therapeutic intervention that is 
capable of achieving effective circulatory support to stabilize 
cardiogenic shock patients that could be placed via a percutaneous 
approach. In the proposed rule, we indicated that we would present a 
full analysis of this technology under the significant improvement

[[Page 49024]]

criterion if we received sufficient data in time for this final rule to 
evaluate whether the technology met the cost criterion. For this final 
rule, as we have determined above, the TandemHeart\TM\ pVAD does not 
meet the cost criterion and therefore we are not presenting our full 
analysis of this technology under the substantial improvement 
criterion. However, we note, although the TandemHeart\TM\ pVAD appears 
to be a promising new technology for providing circulatory support in 
profound, refractory left ventricular failure, our review of the 
submitted literature did not find that adequate clinical experience or 
clinical evidence exists to demonstrate substantial clinical 
improvement to the degree we feel is necessary to warrant a new 
technology special add-on payment. As a result of this and the fact 
that there are insufficient data to determine whether the 
TandemHeart\TM\ pVAD meets the cost criterion, we are denying add-on 
payments in FY 2005 for this technology.
    Nevertheless, we encourage the manufacturers of the TandemHeart\TM\ 
pVAD device to continue their efforts to compile objective clinical 
data that demonstrate its clinical efficacy, particularly with regard 
to improved clinical outcomes in patients with this very serious, life 
threatening condition. Because the device only became available for use 
in May 2003, it could remain eligible for consideration for new 
technology add-on payments in FY 2006.
    The applicant also requested an ICD-9-CM code for this technology. 
We discuss this request in section II.B.3. of the preamble of this 
final rule.
j. Aquadex \TM\ System 100 Fluid Removal System (System 100)
    CHF Solutions, Inc. submitted an application for the approval of 
the System 100 for new technology add-on payments for FY 2005. The 
System 100 is designed to remove excess fluid (primarily excess water) 
from patients suffering from severe fluid overload through the process 
of ultrafiltration. Fluid retention, sometimes to an extreme degree, is 
a common symptom of patients with chronic congestive heart failure. 
This technology removes excess fluid without causing hemodynamic 
instability. It also avoids the inherent nephrotoxicity and 
tachyphylaxis associated with aggressive diuretic therapy, the mainstay 
of current therapy for fluid overload in congestive heart failure.
    The System 100 consists of: (1) A S-100 console; (2) a UF 500 blood 
circuit; (3) an extended length catheter (ELC); and (4) a catheter 
extension tubing. The System 100 is designed to monitor the 
extracorporeal blood circuit and to alert the user to abnormal 
conditions. Vascular access is established via the peripheral venous 
system, and up to 4 liters of excess fluid can be removed in an 8-hour 
period.
    On June 3, 2002, FDA approved the System 100 for use with 
peripheral venous access. On November 20, 2003, FDA approved the System 
100 for expanded use with central venous access and catheter extension 
use for infusion or withdrawal circuit line with other commercially 
applicable venous catheters. According to the applicant, although the 
System 100 was first approved by FDA in June 2002, the System 100 was 
not used by hospitals until August 2002 because it took a substantial 
amount of time to market and sell the device to hospitals. As a result, 
the applicant believes that the System 100 should still be considered 
new. The applicant has presented data and evidence demonstrating that 
the System 100 was not marketed until August 2002. Therefore, we also 
believe August 1, 2002 is the relevant date for determining the 
availability of the System 100.
    The applicant estimates that 308 patients (approximately 120 cases 
per year) have used the System 100 since its inception and the 
potential population for use of the device is 60,000 cases per year. 
These 308 cases represent a small percentage of the potential number of 
cases that can utilize the System 100. Therefore, the System 100 is not 
adequately reflected within the DRG weights (as discussed in the 
September 7, 2001 final rule (66 FR 46914)). In addition, the System 
100 is within the 2 to 3 year period contemplated under Sec.  
412.87(b)(2) of the regulations. Therefore, the System 100 could be 
considered new. However, the ultrafiltration process that the System 
100 employs can also be considered to be a type of hemodialysis, which 
is an old and well-established technology. In the proposed rule, we 
indicated that we have concerns about whether new technology add-on 
payments should be extended to a well-established technology, even when 
a new clinical application is developed for that technology. As 
discussed above, in the September 7, 2001 final rule (66 FR 46915), we 
noted that if an existing technology is used for treating patients not 
expected to be assigned to the same DRG as the patients already 
receiving the technology, it may be considered for approval if it also 
meets the other cost and clinical improvement criteria. In this case, 
the device does treat a different patient population of congestive 
heart failure than the patient population for renal dialysis. Under the 
policy described in the September 7, 2001, final rule, this technology 
may be considered new for the purposes of determining whether it 
qualifies for add-on payments. However, in the proposed rule, we 
indicated that we have some concerns about whether this is an 
appropriate result, and about whether technologies that have been in 
use for many years, in some cases decades, should be able to qualify 
for add-on payments for new technologies. Therefore, we invited 
comments on whether this technology should be considered new, and on 
the general issue of whether existing technologies should be approved 
for add-on payments when new applications are developed for these 
technologies and whether special standards regarding, for example, 
clinical improvement, should be applied in such cases.
    Comment: One commenter, the applicant, explained that the System 
100 should still be considered new for numerous additional reasons. The 
commenter explained that System 100 has received numerous patents 
issued from the United States Patent Office for many aspects of the 
technology thus demonstrating its uniqueness and newness. The commenter 
also added that the technology should be considered new since the FDA 
recognized the features of the technology, such as proprietary design 
of the filter assembly and its unique low flow capability, as a 
different technology because the device can be used in a different 
patient population. The commenter further explained that no other 
technology operates in this low flow range using automatic pressure 
control algorithms and peripheral vascular access while delivering ease 
of use and patient safety.
    Some commenters recommended that CMS maintain the criteria and 
definition established in the September 7, 2001, Federal Register (66 
FR 46915) that if an existing technology is used for treating patients 
not expected to be assigned to the same DRG as the patients already 
receiving the technology, it may be considered for approval if it also 
meets the other cost and clinical improvement criterion. As a result, 
the commenters maintain that according to the September 7, 2001, final 
rule the System 100 meets these criteria and should be approved for new 
technology add-on payments.
    Response: We appreciate the commenter's comments on the newness 
criterion. As noted above, we do not employ FDA guidelines to determine

[[Page 49025]]

what drugs, devices or technologies qualify for new technology add-on 
payments. We also do not consider patents issued by the United States 
Patent Office as an indicator of a new technology. For a more detailed 
discussion of the criteria for newness and substantial clinical 
improvement please see the September 7, 2001, Federal Register (66 FR 
46914).
    We will continue to review the policy stated in our September 7, 
2001, rule. We invite further public comment on this issue in the 
interim.
    The applicant submitted five sets of data to demonstrate that the 
System 100 meets the cost criterion. Of these five, three sets of data 
were flawed in the analysis of the cost criterion. Therefore, as in the 
proposed rule, we discuss only the data that are most accurate and 
relevant. It is important to note at the outset of the cost analysis 
that the console is reusable and is, therefore, a capital cost. Only 
the circuits and catheters are components that represent operating 
expenses. Section 1886(d)(5)(K)(i) of the Act requires that the 
Secretary establish a mechanism to recognize the costs of new medical 
services or technologies under the payment system established under 
that subsection, which establishes the system for paying for the 
operating costs of inpatient hospital services. The system of payment 
for capital costs is established under section 1886(g) of the Act, 
which makes no mention of any add-on payments for a new medical service 
or technology. Therefore, it is not appropriate to include capital 
costs in the add-on payments for a new medical service or technology 
and these costs should also not be considered in evaluating whether a 
technology meets the cost criterion. The applicant has applied for add-
on payments for only the circuits and catheter, which represent the 
operating expenses of the device. However, in the proposed rule we 
stated our belief that the catheters cannot be considered new 
technology in any sense. As a result, we considered only the UF 500 
disposable blood circuit as relevant to the evaluation of the cost 
criterion.
    The applicant commissioned Covance to search the FY 2002 MedPAR 
file. The applicant used a combination of diagnosis codes to determine 
which cases could potentially use the System 100. Covance found 27,589 
cases with the following combination of ICD-9-CM diagnosis codes: 428.0 
through 428.9 (Heart Failure), 402.91 (Unspecified with Heart Failure), 
or 402.11 (Hypertensive Heart Disease with Heart Failure), in 
combination with 276.6 (Fluid Overload) and 782.3 (Edema). The 27,589 
cases were found among 281 DRGs with 49.4 percent of cases mapped 
across DRGs 88, 89, 127, 277 and 316. The applicant eliminated those 
DRGs with less than 150 cases, which resulted in a total of 22,024 
cases that could potentially use the System 100. The case-weighted 
average standardized charge across all DRGs was $14,534. The case-
weighted threshold across all DRGs was $17,789. Although the case-
weighted threshold is greater than the case-weighted standardized 
charge, it is necessary to include the standardized charge for the 
circuits used in each case. In order to establish the charge per 
circuit, the manufacturer submitted data regarding 51 actual cases that 
used the System 100. Based on these 51 cases, the standardized charge 
per circuit was $2,209. The manufacturer also stated that an average of 
two circuits are used per case. Therefore, adding $4,418 for the charge 
of the two circuits to the case-weighted average standardized charge of 
$14,534 results in a total case-weighted standardized charge of 
$18,952. This is greater than the case-weighed threshold of $17,789. In 
the May 18, 2004 proposed rule, we welcomed comments from the public on 
the charge information submitted by the applicant for the circuits.
    Comment: One commenter noted that we stated, ``[c]atheters cannot 
be considered new technology in any sense.'' The commenter stated that 
this language on catheters is unduly broad and it is possible that the 
introduction of a new catheter could represent a substantial clinical 
improvement. The commenter also noted that a catheter could be 
considered new under CMS policy specified in the September 7, 2001, 
Federal Register (66 FR 46915) that discusses if the new use of an 
existing technology is for treating patients not expected to be 
assigned to the same DRG, it may be considered for approval of new 
technology add-on payments.
    Response: We thank the commenter for pointing this out and we agree 
that in a certain circumstance a catheter could be considered a new 
technology under our current policy. We also note that we are 
continuing to review our policy regarding whether a new use of an 
existing technology may be considered for approval of new technology 
add-on payments.
    For the proposed rule, using the FY 2003 MedPAR file, we used the 
same combination of diagnosis codes to identify 28,660 cases across all 
DRGs. As in the applicant's analysis, we eliminated those DRGs with 
less than 150 cases, which resulted in 22,395 cases. The case-weighted 
average standardized charge for these cases is $15,447. The case-
weighted threshold to qualify for new technology add-on payments using 
the data we identified would then be $18,029. Again, as in the 
applicant's analysis, it was necessary to include in the charge of 
$4,418 for the circuits. This results in a total case-weighted average 
standardized charge of $19,865, which is also greater than the case-
weighted threshold of $18,029. Based on these two analyses, the System 
100 meets the cost criterion.
    The applicant contends that the System 100 represents a substantial 
clinical improvement for the following reasons: It removes excess fluid 
without the use of diuretics; it does not lead to electrolyte 
imbalance, hemodynamic instability or worsening renal function; it can 
restore diuretic responsiveness; it does not adversely affect the 
renin-angiotensin system; it reduces hospital length of stay for the 
treatment of congestive heart failure, and it requires only peripheral 
venous access. In the proposed rule we stated our belief that there was 
some basis for concluding that the System 100 represents a substantial 
clinical improvement over current standard treatment of fluid overload 
in congestive heart failure. However, in the May 18, 2004 proposed 
rule, we also invited comment on whether the data submitted are indeed 
adequate to demonstrate significant clinical improvement.
    Prior to the publication of the May 18, 2004, proposed rule, we 
received public comments in accordance with section 503(b)(2) of Public 
Law 108-173 regarding this application for add-on payments. Several 
commenters noted that the System 100 provides physicians a new 
treatment option for patients with fluid overload who are unresponsive 
to diuretics and has been documented in clinical studies and other 
published articles to effectively treat fluid overload. Another 
commenter noted that patients who have been treated with the System 100 
seem to have improved health versus those who have lingered on diuretic 
therapy or have been treated by hemodialysis. The commenter also noted 
that the System 100 reduces hospital stays. Other commenters noted that 
the System 100 is safer for those patients in terms of reduced 
electrolyte imbalance and renal dysfunction and is a major step forward 
in the treatment of decompensated heart failure.
    We considered these comments in our evaluation in the proposed rule 
of whether the System 100 meets this substantial clinical improvement 
criterion. During the 60-day comment period for the proposed rule, we

[[Page 49026]]

received the following comments on this application.
    Comment: One commenter, the applicant, illustrated that there 
remains a growing unmet clinical need for effective treatment of the 
congestive heart failure population. The need for new technologies to 
treat fluid overload is demonstrated through data from the ADHERE 
registry which states that the percentage of heart failure patients 
discharged but still symptomatic of fluid retention is 39 percent. The 
registry had other notable facts and concluded that chronic diuretic 
therapy is due to fluid overload seen in patients with and without 
renal insufficiency and is an independent predictor of poor clinical 
outcomes and higher resource utilization. The commenter concluded that 
the emerging knowledge of congestive heart failure patients suffering 
from fluid overload demonstrates the need for efficient and effective 
fluid removal such as the System 100.
    Some commenters also commented that the System 100 meets the 
established criteria for new technology since it is clearly and 
distinctly new and different from any currently available technology 
and provides clinical services to patients who previously were 
ineligible for this kind of therapy, and treats a different patient 
population--heart failure versus renal failure. Furthermore, these 
commenters also noted that patients with fluid overload are treated in 
a different DRG than patients who have renal failure.
    The applicant also noted that there are some clinical trials that 
have demonstrated the clinical safety and effectiveness as well as cost 
effectiveness of the System 100 in treating patients with fluid 
overload.
    Response: We thank the commenters for their comments on this 
criterion. After careful review of all available information, we have 
determined that although we recognize the potential benefit of this new 
technology for Medicare beneficiaries (as stated by the commenter), we 
do not believe there is sufficient objective clinical evidence to 
determine that the System 100 meets the substantial clinical 
improvement criterion (such as a large prospective, randomized clinical 
trial), given the prevalence of congestive heart failure in the 
Medicare population. For example, a large prospective, randomized 
clinical trial that demonstrates improved outcomes, especially in 
morbidity and mortality, when compared to standard therapy for this 
sub-population of Medicare patients with congestive heart failure was 
not submitted. As a result, we are denying add-on payments for this 
technology for FY 2005.

III. Changes to the Hospital Wage Index

A. Background

    Section 1886(d)(3)(E) of the Act requires that, as part of the 
methodology for determining prospective payments to hospitals, the 
Secretary must adjust the standardized amounts ``for area differences 
in hospital wage levels by a factor (established by the Secretary) 
reflecting the relative hospital wage level in the geographic area of 
the hospital compared to the national average hospital wage level.'' In 
accordance with the broad discretion conferred under the Act, we 
currently define hospital labor market areas based on the definitions 
of statistical areas established by the Office of Management and Budget 
(OMB). A detailed discussion of the FY 2005 hospital wage index based 
on the statistical areas, including OMB's revised definitions of 
Metropolitan Areas, appears under section III.B of this preamble.
    Beginning October 1, 1993, section 1886(d)(3)(E) of the Act 
requires that we update the wage index annually. Furthermore, this 
section provides that the Secretary base the update on a survey of 
wages and wage-related costs of short-term, acute care hospitals. The 
survey should measure, to the extent feasible, the earnings and paid 
hours of employment by occupational category, and must exclude the 
wages and wage-related costs incurred in furnishing skilled nursing 
services. This provision also requires us to make any updates or 
adjustments to the wage index in a manner that ensures that aggregate 
payments to hospitals are not affected by the change in the wage index. 
The adjustment for FY 2005 is discussed in section II.B. of the 
Addendum to this final rule.
    As discussed below in section III.G. of this preamble, we also take 
into account the geographic reclassification of hospitals in accordance 
with sections 1886(d)(8)(B) and 1886(d)(10) of the Act when calculating 
the wage index. Under section 1886(d)(8)(D) of the Act, the Secretary 
is required to adjust the standardized amounts so as to ensure that 
aggregate payments under the IPPS after implementation of the 
provisions of sections 1886(d)(8)(B) and (C) and 1886(d)(10) of the Act 
are equal to the aggregate prospective payments that would have been 
made absent these provisions. The budget neutrality adjustment for FY 
2005 is discussed in section II.B. of the Addendum to this final rule.
    Section 1886(d)(3)(E) of the Act also provides for the collection 
of data every 3 years on the occupational mix of employees for short-
term, acute care hospital participating in the Medicare program, in 
order to construct an occupational mix adjustment to the wage index. A 
discussion of the initial collection of these data and the occupational 
mix adjustment that we are applying beginning October 1, 2004 (the FY 
2005 wage index) appears under section III.C. of this preamble.

B. Revised OMB Definitions for Geographical Statistical Areas

1. Current Labor Market Areas Based on MSAs
    The wage index is calculated and assigned to hospitals on the basis 
of the labor market area in which the hospital is located. In 
accordance with the broad discretion under section 1886(d)(3)(E) of the 
Act, we currently define hospital labor market areas based on the 
definitions of Metropolitan Statistical Areas (MSAs), Primary MSAs 
(PMSAs), and New England County Metropolitan Areas (NECMAs) issued by 
OMB. OMB also designates Consolidated MSAs (CMSAs). A CMSA is a 
metropolitan area with a population of one million or more, comprising 
two or more PMSAs (identified by their separate economic and social 
character). For purposes of the hospital wage index, we use the PMSAs 
rather than CMSAs because they allow a more precise breakdown of labor 
costs. If a metropolitan area is not designated as part of a PMSA, we 
use the applicable MSA.
    These different designations use counties as the building blocks 
upon which they are based. Therefore, hospitals are assigned to either 
an MSA, PMSA, or NECMA based on whether the county in which the 
hospital is located is part of that area. For purposes of the IPPS wage 
index, we combine all of the counties in a State outside a designated 
MSA, PMSA, or NECMA together to calculate a statewide rural wage index.
2. Core-Based Statistical Areas
    OMB reviews its Metropolitan Area (MA) definitions preceding each 
decennial census. In the fall of 1998, OMB chartered the Metropolitan 
Area Standards Review Committee to examine the MA standards and develop 
recommendations for possible changes to those standards. Three notices 
related to the review of the standards were published on the following 
dates in the Federal Register, providing an opportunity for public 
comment on the recommendations of the Committee: December 21, 1998 (63 
FR 70526);

[[Page 49027]]

October 20, 1999 (64 FR 56628), and August 22, 2000 (65 FR 51060).
    In the December 27, 2000, Federal Register (65 FR 82228 through 
82238), OMB announced its new standards. According to that notice, OMB 
defines a Core-Based Statistical Area (CBSA), beginning in 2003, as ``a 
geographic entity associated with at least one core of 10,000 or more 
population, plus adjacent territory that has a high degree of social 
and economic integration with the core as measured by commuting ties. 
The standards designate and define two categories of CBSAs: 
Metropolitan Statistical Areas and Micropolitan Statistical Areas.'' 
(65 FR 82235)
    According to OMB, MSAs are based on urbanized areas of 50,000 or 
more population, and Micropolitan Statistical Areas (referred to in 
this discussion as Micropolitan Areas) are based on urban clusters of 
at least 10,000 population but less than 50,000 population. Counties 
that do not fall within CBSAs are deemed ``Outside CBSAs.'' In the 
past, OMB defined MSAs around areas with a minimum core population of 
50,000, and smaller areas were ``Outside MSAs.''
    The general concept of the CBSAs is that of an area containing a 
recognized population nucleus and adjacent communities that have a high 
degree of integration with that nucleus. The purpose of the standards 
is to provide nationally consistent definitions for collecting, 
tabulating, and publishing Federal statistics for a set of geographic 
areas. CBSAs include adjacent counties that have a minimum of 25 
percent commuting to the central counties of the area. This is an 
increase over the minimum commuting threshold for outlying counties 
applied in the previous MSA definition of 15 percent.
    On June 6, 2003, OMB announced the new CBSAs, comprised of MSAs and 
the new Micropolitan Areas based on Census 2000 data. (A copy of the 
announcement may be obtained at the following Internet address: http://www.whitehouse.gov/omb/bulletins/fy04/b04-03.html.) The new definitions 
recognize 49 new MSAs and 565 new Micropolitan Areas, and extensively 
revise the composition of many of the existing MSAs. There are 1,090 
counties in MSAs under these new definitions (previously, there were 
848 counties in MSAs). Of these 1,090 counties, 737 are in the same MSA 
as they were prior to the changes, 65 are in a different MSA, and 288 
were not previously designated to any MSA. There are 674 counties in 
Micropolitan Areas. Of these, 41 were previously in an MSA, while 633 
were not previously designated to an MSA. There are five counties that 
previously were designated to an MSA but are no longer designated to 
either an MSA or a new Micropolitan Area: Carter County, KY; St. James 
Parish, LA; Kane County, UT; Culpepper County, VA; and King George 
County, VA.
3. Revised Labor Market Areas
    In its June 6, 2003 announcement, OMB cautioned that these new 
definitions ``should not be used to develop and implement Federal, 
State, and local nonstatistical programs and policies without full 
consideration of the effects of using these definitions for such 
purposes. These areas should not serve as a general-purpose geographic 
framework for nonstatistical activities, and they may or may not be 
suitable for use in program funding formulas.''
    We have previously examined alternatives to the use of MSAs for the 
purpose of establishing labor market areas for the Medicare wage index. 
In the May 27, 1994, proposed rule (59 FR 27724), we presented our 
latest research concerning possible future refinements to the labor 
market areas. Specifically, we discussed and solicited comment on the 
proposal by the Prospective Payment Assessment Commission (ProPAC, a 
predecessor organization to the Medicare Payment Advisory Commission 
(MedPAC)) for hospital-specific labor market areas based on each 
hospital's nearest neighbors, and our research and analysis on 
alternative labor market areas. Even though we found that none of the 
alternative labor market areas that we studied provided a distinct 
improvement over the use of MSAs, we presented an option using the MSA-
based wage index but generally giving a hospital's own wages a higher 
weight than under the current system. We also described for comment a 
State labor market option, under which hospitals would be allowed to 
design labor market areas within their own State boundaries.
    We described the comments we received in the June 2, 1995, proposed 
rule (60 FR 29219). There was no consensus among the commenters on the 
choice for new labor market areas. Many individual hospitals that 
commented expressed dissatisfaction with all of the proposals. However, 
several State hospital associations commented that the options merited 
further study. Therefore, we contacted the association representatives 
that participated in our November 1993 meeting on labor market issues 
in which we solicited ideas for additional types of labor market 
research to conduct. None of the individuals we contacted suggested any 
ideas for further research.
    Consequently, we have continued to use MSAs to define labor market 
areas for purposes of the wage index. While we recognize MSAs are not 
designed specifically to define labor market areas, we believe they do 
represent a useful proxy for this purpose, and our analysis and 
discussion here are focused on issues related to adopting the new CBSAs 
to define labor market areas.
    Comment: Many commenters recommended various revisions to the 
proposed labor market definitions. Many of these comments focused on 
specific situations, especially situations in which previously large 
MSAs were divided into smaller MSAs under the new definitions, and the 
converse situation in which MSAs expanded under the new definitions. 
One commenter, proposed an extensive reoconfiguration of CMS' labor 
market areas. Specifically, the commenter recommended that, instead of 
expanding certain MSAs, we create a system of overlapping markets, 
beginning with a core labor market, consisting of the original MSA and 
center city, and creating overlapping subdivisions, or ``tiers,'' out 
of the areas outside the core. Furthermore, the commenter cites a U.S. 
Government Accountability Office (GAO) report that called for CMS to 
refine its MSA-based wage index areas so that they might better 
represent actual hospital labor markets, which could potentially entail 
reducing the size of some large urban markets because of the large 
disparities between the wage levels in central cities, large towns, and 
outlying counties.
    The proposal begins with all counties associated with the urban 
area, either under the old or new MSAs, which are then subdivided based 
upon PMSAs or Metropolitan Divisions. These areas would be ranked 
according to wage level, assigning the highest wage area as the 
``core.'' Then overlapping labor markets would be formed as each 
subsequent ranked area is packaged with the center city, creating tiers 
of labor markets. A wage index would be developed for each tier, 
retaining a high wage value reflective of the center city, and 
successively lower wage levels for the surrounding areas. As the labor 
markets incorporate one another and build upon the central area, the 
system acknowledges the interaction between the given areas but fairly 
accounts for the wage level differences encompassed therein.
    The commenter asserts that this system will adequately recognize 
the higher labor costs in the core area and moderate the funding 
differential between the central area and the

[[Page 49028]]

outlying communities, who are undoubtedly linked to the core area. It 
would also afford more reclassification opportunities for hospitals 
within the greater metropolitan area and prevent the `orphanization' of 
hospitals whose provider neighbors are reclassified into higher wage 
areas while they retain their geographic wage index.
    Other commenters objected to the division of certain MSAs, and 
advocated restoring the larger MSAs that existed under the previous 
definitions. These commenters contended that the smaller MSAs do not 
adequately capture the regional nature of markets for hospital labor.
    Other commenters, especially those that would benefit from specific 
changes, supported the changes previously cited. Hospitals in a high 
wage area supported the proposal to split their area off from the lower 
wage areas around the fringe of the large MSA to which they had 
belonged under the old definitions. Hospitals that are included in a 
higher wage MSA under the new definitions also expressed strong support 
for the expansion of this MSA, and specifically requested that we make 
no changes in the proposal.
    Response: We appreciate the detailed and substantive 
recommendations provided by these commenters. These recommendations 
merit further study and consideration. However, we do not believe that 
it would be prudent to proceed with any of these recommendations at 
this time, for several reasons. First, these recommendations are not 
entirely consistent, since some emphasize expanding existing MSAs or 
preserving large MSAs that existed under the old definitions, and 
others emphasize creating smaller units or at least distinguishing 
segments within larger MSAs. In addition, the range of comments on 
specific situations indicates the importance of taking into 
consideration all of the effects that these proposed revisions might 
have. Specifically, hospitals that stand to benefit from the new 
definitions might experience lesser gains from the proposed revisions. 
Finally, we believe that the 1-year transition that we have proposed 
will alleviate the concerns of many hospitals, by limiting the 
reductions that they might otherwise experience from the introduction 
of the new labor market areas. We will continue to study these issues.
    Comment: Several commenters have suggested that the implementation 
of the new MSAs be delayed at least another year so that alternative 
solutions may be reviewed.
    Response: The new MSA designations were released June 6, 2003. We 
stated in our August 1, 2003 final rule that CMS was unable to 
implement the new MSAs immediately but intended to evaluate the impact 
of the changes for the FY 2005 proposed rule. In essence, we have 
already delayed the implementation of the new Census information.
    Comment: One commenter mentioned the need to closely monitor the 
population changes in the large Micropolitan areas, as crossing the 
threshold to 50,000 would create a new MSA. The commenter cited the 
case of Eagle Pass, TX, which, according to July 1, 2003 population 
estimates, now exceeds the 50,000 threshold. The commenter states that 
failure to recognize such areas will unnecessarily cripple growing 
areas.
    Response: In the past, CMS has updated its MSA database annually 
before the publication of the proposed rule based on OMB's listing of 
MSAs. While an area may have an estimated population exceeding the 
threshold, we can only update once OMB recognizes this change. At this 
time, OMB still recognizes Eagle Pass, TX as a Micropolitan Area.
    Comment: Many commenters believe that the large MSA should not be 
divided into the Metropolitan Divisions as outlined by the new OMB 
definitions.
    Response: In previous years we have utilized PMSAs, a division of 
the larger CMSA. We believe the usage of Metropolitan Divisions 
represent the closest approximation to PMSAs, the building block of our 
current Labor Market Definitions. Therefore, we do not believe that we 
should abandon the use of these new definitions since they most 
accurately retain our current structuring of labor market areas. 
However, given the scope and drastic implications of these new 
boundaries and to buffer the subsequent negative impact on numerous 
hospitals, we have decided to provide, during FY 2005, a blend of wage 
indexes to those hospitals that would experience a drop in their wage 
indexes because of the adoption of the new labor market areas. Any 
hospital experiencing a decrease in their wage index relative to its FY 
2005 wage index because of the labor market area changes will receive 
50 percent of the wage index using the new labor market definitions and 
50 percent of the wage index that the provider would have received 
under the old MSA standards. This blend will apply to any provider 
experiencing a decrease due to the new definitions, including providers 
who are reclassifying under MCGRB requirements, section 1886(d)(8)(B) 
of the Act or section 508 of Public Law 108-173. We describe the 
determination of this blend in detail below. It is important to note 
that this blend will not protect hospitals from the effects of a drop 
in wage index due to any reason other than the usage of the new MSAs. 
For example, the blend will not apply to changes due to the use of new 
wage data in calculating the FY 2005 wage index. In other words, the 
two wage indexes (one wage index reflecting the labor market 
definitions employed in FY 2004, the other wage index reflecting the 
new CBSA definitions) used in determining the blended wage index both 
reflect the new FY 2005 wage data. Both these wage indexes also reflect 
the 10 percent occupational mix adjustment that we discuss in section 
III.G of this final rule.
a. New England MSAs
    As stated above, we currently use NECMAs to define labor market 
areas in New England, because these are county-based designations 
rather than the 1990 MSA definitions for New England, which used minor 
civil divisions such as cities and towns. Under the previous MSA 
definitions, NECMAs provided more consistency in labor market 
definitions for New England compared with the rest of the country, 
where MSAs are county-based. Under the new CBSAs, OMB has defined the 
MSAs and Micropolitan Areas in New England on the basis of counties. 
OMB also established New England City and Town Areas, which are similar 
to the previous New England MSAs. Therefore, to maintain consistency in 
the definition of labor market areas between New England and the rest 
of the country, in the May 18, 2004 proposed rule (69 FR 28250), we 
proposed to use the New England MSAs under the new CBSA definition.
    Comment: Some commenters have expressed concern regarding the 
adoption of a county-based system for the New England MSAs. They 
believe that abandoning the city- and town-based areas will 
inaccurately reflect the labor market areas in New England.
    Response: In order to create consistency among all labor market 
areas and facilitate the maintenance of these areas, we will use the 
county-based areas for all MSAs in the nation. Census has now defined 
the New England area around counties, creating a city- and town-based 
system as an alternative. We believe that adopting county-based labor 
market areas for the entire country provides consistency and stability 
in program payment, and minimizes programmatic complexity. In addition, 
we have consistently employed a county-based system for

[[Page 49029]]

New England for precisely that reason: to maintain consistency with the 
labor market definitions used throughout the country. Because we have 
never used cities and towns, employing a county-based system in New 
England maintains that consistent practice.
b. Metropolitan Divisions
    A Metropolitan Division is a county or group of counties within a 
CBSA that contains a core population of at least 2.5 million, 
representing an employment center, plus adjacent counties associated 
with the main county or counties through commuting ties. A county 
qualifies as a main county if 65 percent or more of its employed 
residents work within the county and the ratio of the number of jobs 
located in the county to the number of employed residents is at least 
.75. A county qualifies as a secondary county if 50 percent or more, 
but less than 65 percent, of its employed residents work within the 
county and the ratio of the number of jobs located in the county to the 
number of employed residents is at least .75. After all the main and 
secondary counties are identified and grouped, each additional county 
that already has qualified for inclusion in the MSA falls within the 
Metropolitan Division associated with the main/secondary county or 
counties with which the county at issue has the highest employment 
interchange measure. Counties in a Metropolitan Division must be 
contiguous. (65 FR 82236)
    As noted above, in the past, OMB designated CMSAs as Metropolitan 
Areas with a population of one million or more and comprising two or 
more PMSAs. We currently use the PMSAs rather than CMSAs to define 
labor market areas because they comprise a smaller geographic area with 
potentially varying labor costs due to different local economies. 
Similarly, in the May 18, 2004 proposed rule, we proposed to use the 
Metropolitan Divisions where applicable under the CBSA definitions.
    Under the CBSA definitions, there are 11 MSAs containing 
Metropolitan Divisions: Boston; Chicago; Dallas; Detroit; Los Angeles; 
Miami; New York; Philadelphia; San Francisco; Seattle; and Washington, 
DC. Although these MSAs were also CMSAs under the prior definitions, in 
some cases their areas have been significantly altered. Under the prior 
definitions, Boston was a single NECMA. It is now comprised of 4 
Divisions. Los Angeles went from 4 PMSAs to 2 Divisions because 2 MSAs 
became separate MSAs. The New York CMSA went from 15 PMSAs down to only 
4 Divisions. Five PMSAs in Connecticut now become separate MSAs, and 
the number of PMSAs in New Jersey goes from 5 to 2, with the 
consolidation of 2 New Jersey PMSAs (Bergen-Passaic and Jersey City) 
into the New York-Wayne-White Plains, NY-NJ Division. In San Francisco, 
only 2 Divisions remain where there were once 6 PMSAs, some of which 
are now separate MSAs.
    Previously, Cincinnati, Cleveland, Denver, Houston, Milwaukee, 
Portland, Sacramento, and San Juan were all designated as CMSAs, but 
are not any longer. As noted previously, the population threshold to be 
designated a CMSA was one million. In most of these cases, counties 
formerly in a PMSA have become a separate, independent MSA, leaving 
only the MSA for the core area under the new CBSA definitions.
    Comment: Many commenters have expressed their concern regarding the 
division of large MSAs of 2.5 million population or greater. They are 
concerned that this dividing of previously larger areas will result in 
dramatic disparities in wage indexes in what once was a congruous area. 
Additionally, many hospitals are concerned they did not have the 
opportunity to reclassify given the dramatic effect of this division of 
previously consolidated areas.
    Response: As indicated above, Metropolitan Divisions represent the 
closest approximation to PMSAs, the building block of our current labor 
market definitions. Therefore, we do not believe that we should abandon 
the use of these new definitions since they most accurately retain our 
current structuring of labor market areas. However, given the scope and 
drastic implications of these new boundaries and to buffer the 
subsequent negative impact on numerous hospitals, we have decided to 
provide, during FY 2005, a blend of wage indexes to those hospitals 
that would experience a drop in their wage indexes because of the 
adoption of the new labor market areas. Any hospital experiencing a 
decrease in their wage index relative to its FY 2005 wage index because 
of the labor market area changes will receive 50 percent of the wage 
index using the new labor market definitions and 50 percent of the wage 
index that the provider would have received under the old MSA 
standards. This blend will apply to any provider experiencing a 
decrease due to the new definitions, including providers who are 
reclassifying under MCGRB requirements, section 1886(d)(8)(B) of the 
Act or section 508 of Public Law 108-173. We describe the determination 
of this blend in detail below. It is important to note that this blend 
will not protect hospitals from the effects of a drop in wage index due 
to any reason other than the usage of the new MSAs. For example, the 
blend will not apply to changes due to the use of new wage data in 
calculating the FY 2005 wage index. In other words, the two wage 
indexes (one wage index reflecting the labor market definitions 
employed in FY 2004, the other wage index reflecting the new CBSA 
definitions) used in determining the blended wage index both reflect 
the new FY 2005 wage data.
c. Micropolitan Areas
    One of the major issues with respect to the new definitions is 
whether to use Micropolitan Areas to define labor market areas for the 
purpose of the IPPS wage index. Because the new Micropolitan Areas are 
essentially a third area definition made up mostly of currently rural 
areas, but also some or all of current MSAs, how these areas are 
treated will have significant impacts on the calculation and 
application of the wage index. Treating Micropolitan Areas as separate 
and distinct labor market areas would affect both the wage indexes of 
the hospitals in the Micropolitan Areas and the hospitals in the labor 
market areas where those hospitals are currently located (both 
positively and negatively).
    Because we currently use MSAs to define urban labor market areas 
and we group all the hospitals in counties within each State that are 
not assigned to an MSA together into a statewide rural labor market 
area, we have used the terms ``urban'' and ``rural'' wage indexes in 
the past for ease of reference. However, the introduction of 
Micropolitan Areas complicates this terminology because these areas 
include so many hospitals that are currently included in the statewide 
rural labor market areas. In order to facilitate the discussion below, 
we use the term ``rural'' hospitals to describe hospitals in counties 
that are not assigned to either an MSA or a Micropolitan Area. This 
should not be taken to indicate that hospitals in Micropolitan Areas 
are no longer ``rural'' hospitals. In fact, we proposed that hospitals 
in Micropolitan Areas are included in the statewide rural labor market 
areas, for the reasons outlined below. The reader is referred to 
section IV.B. of the preamble of this final rule for a more specific 
discussion of the implications of these changes for defining urban and 
rural areas under Sec.  412.62(f).
    Chart 1 below, which was included in the proposed rule, 
demonstrates the distributions of hospitals by their current and new 
designations. Approximately 50 percent of hospitals currently 
designated rural are now in

[[Page 49030]]

either Micropolitan Areas (691 hospitals) or MSAs (197 hospitals). The 
vast majority of hospitals currently in MSAs remain in an MSA (2,478, 
although in some cases the MSAs have been reconfigured), while 2 are 
now in rural areas and 65 are now in Micropolitan Areas.
[GRAPHIC] [TIFF OMITTED] TR11AU04.036

    In order to evaluate the impact of these changes, we grouped 
hospitals based on the county where they are located according to the 
new MSA and Micropolitan areas using the definitions on the Census 
Bureau's Web site: http://www.census.gov/population/www/estimates/metrodef.html. We then compared the FY 2004 wage indexes (using data 
from hospitals' FY 2001 cost reports) calculated based on the current 
MSAs, without any effects of hospital geographic reclassifications. 
Consistent with current policy, we applied the rural floor in the case 
where the statewide rural wage index is greater than the wage index for 
a particular urban area. We excluded Indian Health Service hospitals 
from the analysis due to the special characteristics of the prospective 
payment system for these hospitals. Hospitals in Maryland were excluded 
from the analysis because they remain excluded from the IPPS under the 
waiver at section 1814(b)(3) of the Act. Our analysis also did not 
reflect any changes to the Puerto Rico-specific wage index, which is 
applicable only to the Puerto Rico standardized amounts (the analysis 
does include the national wage index values for Puerto Rico hospitals).
    Chart 2 below, which was included in the proposed rule, shows the 
impact on hospitals' wage indexes of recalculating new wage indexes 
based on the new MSAs, and treating the new Micropolitan Areas as 
separate labor market areas. Specifically, the table shows the impact 
of treating the new MSA and Micropolitan Areas as labor market areas 
and calculating a wage index for each one. The most dramatic impact of 
this change would be on hospitals that are currently classified as 
rural. Only 10 currently rural hospitals would experience no changes in 
their wage indexes after applying the new MSA definitions. Five of 
these hospitals are in Delaware and Connecticut (three and two 
hospitals respectively), where the only counties in the State currently 
considered rural are now part of Micropolitan Areas.
    Approximately 62 percent (1,092 out of 1,749) of currently rural 
hospitals experience decreases in their wage indexes under this change. 
Among hospitals that remain rural after separately recognizing 
Micropolitan Areas (those hospitals in counties ``outside CBSAs''), 
rural hospitals in six States (Arizona, Florida, Idaho, Indiana, 
Minnesota, and Missouri) experience a positive impact after applying 
the new MSA definitions. These hospitals benefit because the net effect 
on their wage index of other hospitals moving into Micropolitan Areas 
is positive. The majority of the currently rural hospitals (762 out of 
1,092) that experience decreases in their wage indexes are hospitals 
that would remain rural under the new definitions. Moreover, among the 
646 rural hospitals whose wage indexes would increase under the new 
definitions, 547 would now be in an MSA or Micropolitan Area.
    Furthermore, in many cases, the magnitude of the changes is quite 
large. Nearly one-half of all rural hospitals would experience payment 
changes of at least 5.0 percent, either negatively or positively, if we 
were to adopt labor market areas based in part on the new Micropolitan 
Areas.
    In contrast, there are 938 currently urban hospitals (37 percent) 
with wage indexes that are unaffected by the new MSA definitions. These 
hospitals are in MSAs or PMSAs that are either unchanged (for example, 
the Austin, Buffalo, Milwaukee, Oakland, Phoenix, San Diego, and Tampa-
St. Petersburg MSAs are all unchanged) or include new counties without 
any hospitals in those counties that are now part of the existing MSA 
(for example, counties were added to the Atlanta, Denver, Little Rock, 
Omaha, Portland, Richmond, Toledo, Virginia Beach-Norfolk MSAs but 
hospitals were not added).
    The most significant negative impact (more than a 20-percent 
decrease) among hospitals currently in an MSA is on those located in 
counties that become Micropolitan areas or rural areas. Among hospitals 
with the largest positive impacts (more than a 20-percent increase), 
the changes appear to be largely due to changes in the counties that 
are now included (under the CBSAs) in the MSA labor market area.

[[Page 49031]]

[GRAPHIC] [TIFF OMITTED] TR11AU04.037

    One of the reasons Micropolitan Areas have such a dramatic impact 
on the wage index is, because Micropolitan Areas encompass smaller 
populations than MSAs, they tend to include fewer hospitals per 
Micropolitan Area. Currently, there are only 25 MSAs with one hospital 
in the MSA. However, under the new definitions, there are 373 
Micropolitan Areas with one hospital, and 49 MSAs with only one 
hospital.
    This large number of labor market areas with only one hospital and 
the increased potential for dramatic shifts in the wage indexes from 1 
year to the next is a problem for several reasons. First, it creates 
instability in the wage index from year to year for a large number of 
hospitals. Second, it reduces the averaging effect of the wage index, 
lessening some of the efficiency incentive inherent in a system based 
on the average hourly wages for a large number of hospitals. In labor 
market areas with a single hospital, high wage costs are passed 
directly into the wage index with no counterbalancing averaging with 
lower wages paid at nearby competing hospitals. Third, it creates an 
arguably inequitable system when so many hospitals have wage indexes 
based solely on their own wages, while other hospitals' wage indexes 
are based on an average hourly wage across many hospitals.
    For these reasons, in the May 18, 2004, proposed rule, we proposed 
not to adopt Micropolitan Areas as independent labor market areas. 
Although we considered alternative approaches that would aggregate 
Micropolitan Areas in order to reduce the number of one-hospital labor 
market areas, these approaches created geographically disconnected 
labor market areas, an undesirable outcome. Therefore, we proposed to 
maintain our current policy of defining labor market areas based on the 
new MSAs (and Divisions, where they exist) using OMB's new criteria and 
the 2000 Census data.
    Chart 3, which was included in the proposed rule, displays the 
impacts of using this approach on hospital wage indexes. The most 
apparent difference comparing this chart to Chart 2 is the reduction in 
the numbers of currently rural hospitals impacted by more than 2.0 
percent. Recognizing Micropolitan Areas as independent labor market 
areas results in negative impacts of more than 2.0 percent for 757 
currently rural hospitals, while the comparative number, when 
recognizing only MSAs, is 256. Conversely, the number of currently 
rural hospitals positively impacted by more than 2.0 percent declines 
from 479 to 154.
    The greatest negative impacts among hospitals currently designated 
rural are in Idaho, where the statewide rural wage index falls 6.7 
percent as a result of 6 formerly rural hospitals now being included in 
either new or redefined MSAs. The wage index for rural Utah hospitals 
declines by 5.7 percent, for similar reasons. Conversely, formerly 
rural hospitals that are not part of an MSA generally experience 
positive impacts.
    Among hospitals that are currently in MSAs, the number of hospitals 
with decreases in their wage indexes of at least 10 percent increases 
from 36 to 45. These are primarily hospitals that are now located in 
Micropolitan Areas that are included in the statewide labor market 
area. There are 46 counties with 72 hospitals that are currently in an 
MSA that would be treated as rural.

[[Page 49032]]

[GRAPHIC] [TIFF OMITTED] TR11AU04.038

    Comment: Many commenters addressed the usage of Micropolitan Areas. 
Some commenters believe that we should adopt a policy recognizing each 
of the individual Micropolitan Areas. These commenters pointed out that 
some hospitals would benefit from the adoption of Micropolitan Areas as 
in the case of higher wage hospitals in currently rural areas that 
would receive a wage index more closely reflecting their own wage 
level. However, other commenters endorsed our proposal to treat 
Micropolitan Areas as part of the statewide rural areas. Many hospitals 
and several national hospital associations supported our decision not 
to employ Micropolitan Areas for the reasons that we presented. MedPAC 
also expressed support for the proposal to include Micropolitan Areas 
in the statewide rural areas.
    Response: We continue to believe that the reasons we presented in 
the proposed rule for including Micropolitan Areas in the statewide 
rural areas are compelling. We are therefore finalizing our proposal to 
treat the Micropolitan Areas as ``rural.''
d. Transition Period
    We have in the past provided for transition periods when adopting 
changes that have significant payment implications, particularly large 
negative impacts. When we recently removed the wage costs of teaching 
physicians and residents from the wage index data of teaching 
hospitals, we spread out the impact over 3 years by blending the 
hospitals' average hourly wages with and without the data. Similarly, 
the regulations at Sec.  412.102 provide for a 3-year transition to the 
DSH adjustment payments to a hospital redesignated from urban to rural.
    Given the significant payment impacts upon some hospitals because 
of these changes, we considered options to transition from the current 
MSAs to the new MSAs. As noted above, the most dramatic negative 
impacts are among hospitals currently located in an MSA but would 
become rural under the new definitions. Some negative impacts also 
occur among urban hospitals that remain in MSAs that have been 
reconfigured. However, these impacts are generally smaller than those 
among currently urban hospitals that would become rural. To help 
alleviate the decreased payments for currently urban hospitals that 
would become rural, in the May 18, 2004 proposed rule, we proposed to 
allow them to maintain their assignment to the MSA where they are 
currently located for the 3-year period FY 2005, FY 2006, and FY 2007. 
Specifically, we will assign these hospitals, as we did in the proposed 
rule, the prereclassified wage index of the urban area to which they 
currently belong. (For purposes of wage index computation, the wage 
data of these hospitals will remain assigned to the statewide rural 
area in which they are located.) We are finalizing this policy in the 
final rule. We are using the wage data from these hospitals as part of 
setting the rural wage index. The higher wage indexes these hospitals 
are receiving is being taken into consideration in determining whether 
they qualify for the out-commuting adjustment and the amount of any 
adjustment. Beginning in FY 2008, these hospitals would receive their 
statewide rural wage index, although they will be eligible to apply for 
reclassification by the MGCRB, both during this transition period as 
well as subsequent years.
    We also considered the option of allowing a transition to the new 
MSAs for all hospitals, such as a blend of wage indexes based on the 
old and new MSAs for some specified period of time. We noted that, 
although this would help some hospitals that are negatively impacted by 
the changes to the MSAs, it would dampen the payment increases for 
those hospitals that are positively impacted by the changes. Therefore, 
although we notified the public that a blended rate was a viable 
option, we did not propose this in the proposed rule. We also noted 
that OMB in the past has

[[Page 49033]]

announced MSA changes on an annual basis due to population changes, and 
we have not transitioned these changes.
    Comment: Many commenters urged CMS to adopt broader protections for 
hospitals against changes in the wage index due to the adoption of the 
new labor market areas. Many of these commenters advocated extending 
hold harmless protection to other categories of providers beyond those 
that we provided for in the proposed rule. Commenters offered various 
recommendations about how to provide such protection. Most commenters 
advocated transition mechanisms such as hold harmless or blending only 
for those hospitals that would experience a wage index decrease from 
the effects of the labor market area changes. MedPAC recommended 
providing a transition to all hospitals that experience large decreases 
in their wage indexes due to these changes and phasing in the changes 
for these hospitals over three years. MedPAC also recommended that the 
threshold for large decreases be set so that the cost of this provision 
over the transition period would equal the cost of our proposal to 
implement the new market definitions with a hold harmless for urban 
hospitals that become rural under the new definitions.
    Response: We recognize that many hospitals will experience 
decreases in wage index as a result of the labor market area changes. 
At the same time, significant numbers of hospitals will benefit from 
these changes. In addition, as of September 1, 2004, hospitals will be 
able to seek reclassification for FY 2006 using the new labor market 
areas, if they believe another area's wage index is more appropriate 
and if they meet the requirements for reclassification by the MGCRB. 
Therefore, we have decided to provide a 1-year transition blend for 
hospitals that, due solely to the changes in the labor market 
definitions, experience a decrease in their FY 2005 wage index compared 
to the wage index they would have received using the labor market areas 
included in calculating their FY 2004 wage index. Each hospital 
experiencing a decrease in its wage index due to the labor market 
changes will receive 50 percent of its wage index based upon the new 
CBSA configurations and 50 percent based upon FY 2004 MSA boundaries 
(in both cases using the FY 2001 wage data). This blend will not apply 
to any hospital that experiences a drop for any reason other than the 
new MSA definitions, nor will it apply to hospitals that benefit from a 
higher wage index due to the labor market definition changes.
    Specifically, we will determine for each hospital a new wage index 
employing the FY 2001 wage index data and the old labor market 
definitions, and a wage index employing FY 2001 wage index data and the 
new labor market definitions. Any hospital experiencing a decrease in 
its wage index under the new labor market definitions will receive a 
blended wage index consisting of 50 percent of each of these wage 
indexes (that is, 50 percent of the wage index using the FY 2001 wage 
index data and the old labor market definitions, and 50 percent of the 
wage index using FY 2004 wage index data and the new labor market 
definitions). Both the comparison and the blending will employ post 
reclassification wage indexes; that is, wage indexes computed after 
applying the established rules for assigning the wage data for 
reclassifying hospitals to one or more wage areas.
    As part of this transition, as we proposed in the proposed rule, we 
will also allow currently urban hospitals that become rural under the 
new definitions to maintain their assignment to the MSA where they are 
currently located for the 3-year period FY 2005, FY 2006, and FY 2007. 
Specifically, we will assign these hospitals, as we did in the proposed 
rule, the prereclassified wage index of the urban area to which they 
currently belong. (For purposes of wage index computation, the wage 
data of these hospitals will remain assigned to the statewide rural 
area in which they are located.) Beginning in FY 2008, these formerly 
urban hospitals will receive their statewide rural wage index, although 
they would be eligible to apply for reclassification by the MGCRB, both 
during this transition period as well as subsequent years. The 
hospitals receiving this transition will not be considered urban 
hospitals but rather they will maintain their status as rural 
hospitals. Thus, the hospital would not be eligible, for example, for a 
large urban add-on under capital PPS. Thus, it is the wage index, but 
not the urban or rural status, of these hospitals that is being 
affected by this transition.
    Comment: One commenter asked us to clarify whether the special 
provisions of Sec.  412.102 of the regulations apply to these 
hospitals, that is, hospitals that were classified as urban under the 
previous labor market definitions, but are rural under the new labor 
market definitions. The commenter pointed out that this section of the 
regulations provides special protections for hospitals against abrupt 
reductions in DSH payments resulting from transitions from urban to 
rural status.
    Response: We agree with the commenter that the provisions of Sec.  
412.102 apply in this case. Specifically, as described in Sec.  
412.102, in the first year after a hospital loses urban status, the 
hospital will receive an additional payment that equals two thirds of 
the difference between the urban disproportionate share payments 
applicable to the hospital before its redesignation from urban to rural 
and the rural disproportionate share payments applicable to the 
hospital subsequent to its redesignation from urban to rural. In the 
second year after a hospital loses urban status, the hospital will 
receive an additional payment that equals one third of the difference 
between the urban disproportionate share payments applicable to the 
hospital before its redesignation from urban to rural and the rural 
disproportionate share payments applicable to the hospital subsequent 
to its redesignation from urban to rural.
    We decided not to provide for a longer transition, as recommended 
by MedPAC and other commenters, because we have already, in effect, 
provided one year at a higher wage index level for these hospitals by 
retaining the previous labor market definitions for one year after the 
new labor market definitions became available. However, we are still 
allowing a longer, 3-year hold-harmless transition for the group of 
hospitals that were previously urban, and are now rural under the new 
definitions. We are continuing to provide for a longer transition for 
these hospitals because, as a group they have experienced a steeper and 
more abrupt reduction in their wage index due to the labor market 
revisions.
    We will apply this blended transition in a budget neutral manner. 
Specifically, we will make an adjustment to the rates to ensure that 
total payments, including the effects of the transition provisions, 
will equal what payments would have been if we had fully implemented 
the new labor market areas. We believe that doing so is most consistent 
with the requirement of section 1886(d)(3)(E) of the Act that any 
``adjustments or updates [to the adjustment for different area wage 
levels] * * * shall be made in a manner that assures that aggregate 
payments * * * are not greater or less than those that would have been 
made in the year without such adjustment.'' In addition, as a policy 
matter, it would not be feasible for us to allow for a transition only 
for hospitals that experience a decrease as a result of the new labor 
market definitions, were we not to implement such a transition in a 
budget

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neutral manner. Because we have adopted a policy of allowing for a 
transition only when it would benefit the hospital, we believe it is 
appropriate to ensure that such a transition does not increase Medicare 
payments beyond the payments that would be made had we simply adopted 
the new labor market definitions without any transition provisions. We 
note that, consistent with past practice, we are not adopting the new 
labor market definitions themselves in a budget neutral manner. We do 
not believe that the revision to the labor market areas in and of 
itself constitutes an ``adjustment or update'' to the adjustment for 
area wage differences, as provided under section 1886(d)(3)(E) of the 
Act.

C. Occupational Mix Adjustment to FY 2005 Index

    As stated earlier, section 1886(d)(3)(E) of the Act provides for 
the collection of data every 3 years on the occupational mix of 
employees for each short-term, acute care hospital participating in the 
Medicare program, in order to construct an occupational mix adjustment 
to the wage index, for application beginning October 1, 2004 (the FY 
2005 wage index). The purpose of the occupational mix adjustment is to 
control for the effect of hospitals' employment choices on the wage 
index. For example, hospitals may choose to employ different 
combinations of registered nurses, licensed practical nurses, nursing 
aides, and medical assistants for the purpose of providing nursing care 
to their patients. The varying labor costs associated with these 
choices reflect hospital management decisions rather than geographic 
differences in the costs of labor.
1. Development of Data for the Occupational Mix Adjustment
    In the September 19, 2003, Federal Register (68 FR 54905), we 
published a final notice of intent to collect occupational mix data 
from hospitals using the Medicare Wage Index Occupational Mix Survey, 
Form CMS-10079. (The survey and instructions may be accessed at the Web 
site: http://cms.hhs.gov/providers/hipps/ippswage.asp.) The survey 
requires hospitals to report the number of total paid hours for 
directly hired and contract employees in occupations that provide the 
following services: nursing, physical therapy, occupational therapy, 
respiratory therapy, medical and clinical laboratory, dietary, and 
pharmacy. These services each include several standard occupational 
classifications (SOCs), as defined by the Bureau of Labor Statistics 
(BLS) on its Occupational Employment Statistics (OES) survey (http://www.bls.gov/oes/2001/oes_tec.htm), that may be used by hospitals in 
different mixes to provide specific aspects of patient care. CMS 
decided to use BLS's SOCs to categorize employees for the occupational 
mix survey in an effort to ease hospitals' reporting burden; most 
hospitals have had experience with collecting and reporting their 
employment data according to the SOC definitions. The survey includes a 
total of 19 SOCs that provide services for the above 7 categories and 
an ``all other occupations'' category. The hours collected on the 
survey would be used to determine the proportion of a general service 
category total that is attributable to each of the category's SOCs, 
that is, the category's occupational mix.
    In order to accurately reflect a hospital's employment, we 
initially planned to require all hospitals to provide occupational mix 
data collected from a 1-year period. Several hospitals and their 
representatives advised us that a 1-year reporting period was feasible 
because salary and wage data are maintained quarterly for revenue and 
tax reporting purposes. However, several hospitals expressed concern 
that their payroll and other personnel accounting systems are typically 
not set up to collect data on hours for contract employees. The 
hospitals and their representatives advised us that the approximately 
2-month timeframe (see dates below) for collecting and submitting the 
occupational mix data to the fiscal intermediaries would not allow 
hospitals enough time to develop a year's worth of hours data for 
contract workers. Therefore, given the short timeframe for collecting 
the occupational mix data, and to reduce hospitals' reporting burden 
associated with the initial collection of the data, we decided to allow 
hospitals the option of providing their hours data for the 19 SOCs 
either prospectively for a 4-week period beginning on or between 
December 28, 2003, and January 11, 2004, and ending no later than 
February 7, 2004, or retrospectively for a 12-month period, that is, 
calendar year 2003. Although we recognize that using data from only a 
4-week period increases our risk of obtaining results that reflect 
seasonal rather than normal employment trends, we believe that the 4-
week prospective reporting period should enable hospitals to plan and 
provide more accurate data according to our survey instructions and 
definitions. (See the discussion below on the verification and validity 
of our occupational mix survey results.)
    An advance copy of the occupational mix survey was provided to 
hospitals in mid-December 2003 so that hospitals could begin gathering 
their data and documentation necessary to complete the survey. The 
official survey was published as a CMS One-Time Notification (Pub. 100-
20, R47OTN) on January 23, 2004. We instructed our fiscal 
intermediaries to distribute and collect completed occupational mix 
surveys from any hospital that is subject to IPPS, or any hospital that 
would be subject to IPPS if not granted a waiver. If a hospital was not 
an IPPS provider during FY 2001 or, otherwise, did not submit a FY 2001 
cost report, the hospital was not required to submit occupational mix 
data. Consistent with the wage data, CAHs were excluded from the 
occupational mix survey. In addition, the FY 2005 wage index does not 
include occupational mix data for hospitals that submitted FY 2001 wage 
data, but terminated participation in the Medicare program as IPPS 
providers before calendar year 2003. For such terminated hospitals, 
there would be no occupational mix data to collect for our survey 
period.
    Hospitals had to submit their completed occupational mix surveys to 
their fiscal intermediaries by February 16, 2004. Our initial 
collection of these data was completed by March 1, 2004, the deadline 
for fiscal intermediaries to submit hospitals' survey data to CMS. We 
released a public use file containing the data on March 8, 2004 
(through the Internet on our Web site at: http://cms/hhs.gov/providers/
hipps/ippswage.asp). In a memorandum also dated March 8, 2004, we 
instructed all fiscal intermediaries to inform the IPPS hospitals they 
service of the availability of the occupational mix data file and the 
process and timeframe for requesting corrections and revisions. If a 
hospital wished to request a change to its data as shown in that file, 
the hospital had to submit the changes to its fiscal intermediary by 
March 22, 2004. In addition, as this was hospitals' first experience 
with the occupational mix survey, we provided hospitals another 
opportunity, if they missed the February 16 filing deadline, to submit 
their completed surveys. The deadline for this one-time, final 
opportunity to submit occupational mix data to fiscal intermediaries 
for the FY 2005 wage index was also March 22, 2004. The final deadline 
for fiscal intermediaries to submit hospitals' data to CMS was April 
16, 2004. (From April 16 until the final rule is published, the 
process, criteria, and timetable for correcting occupational mix data 
was the same as

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for Worksheet S-3 wage data, under Section H.) Occupational mix survey 
data received by us through March 15, 2004, were used in computing the 
proposed wage index in the May 18, 2004, proposed rule. Data received 
from intermediaries after March 15 through April 16, 2004, are included 
in this final rule.
    The final response rate for the occupational mix survey was 93.8 
percent. We received occupational mix data from 3,768 hospitals. We 
expected to receive completed survey data from 4,018 hospitals that 
submitted cost report wage data for FY 2001 and were still IPPS 
hospitals during calendar year 2003 or on January 1, 2004. In the 
proposed rule, we said that for any hospital that was expected to 
provide occupational mix data but did not, we would consider using 
proxy occupational mix data to adjust the hospital's wage data in the 
final wage index. One option would be to assume that the hospital only 
has employees in the highest level SOC for each of the general service 
categories included on the occupational mix survey. Another option 
would be to assume that such hospitals have the national SOC mix for 
each general service category. We invited public comment to this 
proposal. We noted that the wage index in the proposed rule did not 
include proxy data for hospitals that did not complete and submit the 
occupational mix survey.
    Comment: Some commenters supported the intent of the occupational 
mix adjustment to the wage index. The commenter believed that an 
occupational mix adjusted wage index more accurately reflects 
hospitals' labor costs. Other commenters questioned whether there is a 
need for the occupational mix adjustment with the implementation of the 
provisions of Public Law 108-173 that has also increased payments to 
hospitals in rural areas. One commenter, an association representing 
hospitals in a large metropolitan area, stated that its members are 
concerned that any redistribution of monies from urban teaching 
hospitals to rural hospitals will result in further underpayment by 
Medicare to hospitals that utilize the most sophisticated and costly 
equipment, technology, and staff needed to treat the sickest patients. 
Further, the commenter believed that an occupational mix classification 
system is inherently flawed due to the diverse manner in which hospital 
services are rendered throughout the United States.
    Several commenters expressed concern that the occupational mix 
adjustment is contrary to CMS' quality initiatives that place emphasis 
on improvement in quality outcomes and standards of care, which may 
require hospitals to employ more highly skilled caregivers. In 
addition, some commenters believed that the occupational mix adjustment 
opposes the direction that State governments are undertaking in 
mandating registered nurse staffing ratios; the resulting adjustment 
may be negative for hospitals in these states. Two commenters opposed 
the occupational mix adjustment because the commenters believed that 
the adjustment is unnecessary, increases the information burden for 
hospitals, and adds to the data that CMS must regularly audit. A few 
commenters recommended that we request Congress to rescind the BIPA 
provision that requires the occupational mix adjustment because our 
proposed adjustment does not have the anticipated impact.
    Response: We appreciate these and other comments and concerns we 
received regarding the proposed initial implementation of the 
occupational mix adjusted wage index. We acknowledge that a wage index 
adjusted for occupational mix could have a redistributive effect on 
Medicare payments to hospitals, and, combined with the provisions of 
Public Law 108-173, some hospitals may be significantly negatively 
impacted. However, we also agree with the theory that an occupational 
mix adjusted wage index should more accurately reflect relative labor 
costs among hospitals by removing the differences that result from 
hiring higher skilled or lower skilled workers. For hospitals that 
employ a higher skill mix because they treat more complicated cases, 
the DRG assignment of cases should reflect the extra cost. Therefore, 
we do not agree with the recommendation that we should approach 
Congress to rescind the law that requires the occupational mix 
adjustment.
    While the law requires us to implement the adjustment with the FY 
2005 wage index, we also intend to minimize the negative impact that 
this initial implementation of the occupational mix adjustment may have 
on some hospitals' wage index values. The final FY 2005 wage index 
adjustment is only partially adjusted for occupational mix. A complete 
discussion of the blended wage index appears in section III.G. of the 
preamble to this final rule. We welcome input from MedPAC, hospitals, 
and associations in assessing the impact of the occupational mix 
adjustment on hospitals' wage index values and monitoring how current 
hospital staffing trends affect the expected outcome of the adjustment.
    Comment: Several commenters addressed the issue of how we should 
handle the occupational mix adjustment for hospitals that did not 
complete the survey. The majority of commenters recommended that we use 
the unadjusted wage data or the national SOC mix so that other 
hospitals in the MSA are not adversely impacted by negative proxy data. 
One commenter requested us to adopt the first option, that, for any 
hospital that did not respond to the survey, CMS should assume that the 
hospital employs all of its workers in the highest level SOC for each 
category. The commenter believed that hospitals were provided enough 
time to ensure that their data collected for the occupational mix 
adjustment were accurate. One commenter suggested that we could achieve 
a 100 percent response rate to the survey if we make the survey 
mandatory. Another commenter recommended that we set the same 
consequences for failure to complete the occupational mix survey as 
those for not submitting a cost report and notify hospitals of these 
consequences in the survey instructions.
    Response: We agree that other hospitals should not be harmed by a 
hospital's failure to respond to the occupational mix survey. If we 
were to apply the first option, the worst-case scenario, the wage index 
values for most of the areas that have hospitals that did not complete 
the survey would decrease significantly compared to leaving such 
hospitals' wage data unadjusted for occupational mix. Therefore, for 
the final FY 2005 wage index, we decided to use the unadjusted wage 
data for hospitals that did not submit occupational mix survey data. 
For calculation purposes, this equates to applying the national SOC mix 
to the wage data for such hospitals, because hospitals having the same 
mix as the nation would have an occupational mix adjustment factor 
equaling 1.0000. We note that we will revisit this matter with 
subsequent collections of the occupational mix data. We will explore 
the possibilities of making it mandatory for all IPPS hospitals to 
complete the survey, as well as establishing penalties for hospitals 
that fail to submit occupational mix data.
    Comment: Some commenters opposed our decision to allow hospitals to 
provide occupational mix data prospectively for a 4-week period. The 
commenters believed that the 4-week reporting period occurred during 
hospitals' peak season and is not representative of hospitals' annual 
staffing (about 30 percent of hospitals

[[Page 49036]]

used this option). The commenter suggested that the next survey should 
be for a full year only.
    Response: We believe that in the first year of the occupational mix 
adjustment, it was reasonable to use a 4-week period. A 4-week period 
represents a sampling of the occupational mix that occurs in a hospital 
during the year. We do not have available data to determine if the 4-
week reporting period is a peak season for hospitals, as the commenter 
contends, or even whether a hospital's employment mix significantly 
changes during peak seasons. However based on the similarity of our 
results and the results found by the Bureau of Labor Statistics, we 
believe use of the 4-week period did not significantly affect the data 
we received for the adjustment. Nevertheless, in order to further 
assure the accuracy of the adjustment, in future years, we will require 
data collected from a full year.
    Comment: Several commenters reported that the short timeframe for 
hospitals to complete, review, and correct the survey data and lack of 
clarity by hospitals in determining the proper category to place 
certain employees (for example, a registered nurse who also conducts 
administrative duties) led to errors and inconsistencies in reporting 
that may have contributed to the unexpected outcomes. One commenter 
noted errors in the date fields of the survey, stating that about 8 
percent of hospitals appear to have incorrect dates in the date fields 
and large variances in hours reported between Worksheet S-3 and the 
occupational mix survey. The commenter recommended that CMS clarify its 
definitions and notify hospitals of the next survey's design at least 
60 days or, ideally, 6 months prior to the period the data collection 
will begin. This would allow hospitals more time to prepare their 
payroll and other systems to collect more accurate data. Some 
commenters suggested that, due to possible errors and inconsistencies 
in the initial data collection, CMS should gather new data next year, 
rather than waiting 3 years for the next collection of occupational mix 
data.
    Response: We did not believe that the survey definitions would be 
problematic for hospitals because of hospitals' experience with the BLS 
OES survey. In fact, several hospitals and associations strongly 
recommended that we use the BLS definitions for the occupational mix 
survey. In future years, if hospitals wish to receive further 
clarification of the definitions of the occupational categories then we 
welcome their assistance. We also plan in future years to provide the 
next survey to hospitals prior to the period that the data collection 
begins. The suggested 60-day preparation period appears reasonable, and 
we will consider such a schedule for future occupational mix data 
collections. With regard to administering another survey next year, we 
are reluctant to do so because of the additional reporting burden for 
hospitals. Further, we would have to issue the survey immediately for 
implementation with the FY 2006 index. However, we have not ruled out 
the possibility of revising the survey and administering another survey 
before 2007. According to section 1886(d)(3)(E) of the Act, the 
Secretary has the authority to administer the occupational mix survey 
more than once during a 3-year period.
    Comment: Two commenters suggested changes to the categories that 
are included in the occupational mix survey. One commenter recommended 
that CMS exclude the dietary categories and medical assistants. The 
commenter noted significant variations among hospitals in these 
categories that may have been due to lack of clarity regarding the 
category definitions. The commenter further cautioned that, although 
only a small portion of hospital workers are in these occupational 
categories, misreporting in these categories could significantly 
distort the occupational mix data because the categories have low 
hourly rates. MedPAC recommended that CMS assess whether including 
subcategories of RNs would result in a more accurate occupational mix 
adjustment. MedPAC believed that including all RNs in a single category 
may obscure significant wage differences among the subcategories of 
RNs, for example, the wages of surgical RNs and floor RNs may differ. 
To offset additional reporting burden for hospitals, MedPAC suggested 
that CMS could eliminate some of the general service categories that 
account for fewer hours, since most of the total occupational mix 
adjustment is correlated with the nursing general service category.
    Response: We believe that it is appropriate to include the dietary 
and medical assistant occupations in the FY 2005 adjustment. Although 
these occupations represent a small portion of a hospital's total 
workforce, hospitals employ these occupations in different mixes, just 
as for the other survey categories. In the absence of data showing that 
there is minimum variation among hospitals in their employment of these 
occupations, we are not convinced, as the commenter suggests, that the 
variations reflected in the survey results are due to a lack of clarity 
regarding the category definitions. With regards to MedPAC's 
recommendation to expand the RN category, we would need to investigate 
this matter further to assess its impact on the occupational mix 
adjustment, hospital's reporting burden, and intermediary's review 
workload. We welcome any data or studies related to both of these 
issues.
    Comment: Several commenters noted that the occupational mix 
adjusted wage index in the proposed rule was based on data from the 
March 8, 2004 public use file. However, 263 surveys were added to the 
database in the May 13, 2004 public use file. The commenters urged CMS 
to recalculate its final analysis of the occupational mix adjustment 
using the data for all hospitals that submitted the survey data.
    Response: As we stated in the proposed rule (69 FR 28253), and 
above, the occupational mix adjustment in the proposed rule was based 
on data we received by March 15, 2004. We further stated in the 
proposed rule, and above, that data received after March 15 and through 
April 16 would be included in the final wage index. The FY 2005 wage 
index in this final rule includes the most complete and updated set of 
occupational mix survey data that we received timely from hospitals, 
that is, by April 16, 2004.
    Comment: Two commenters recommended that CMS collect data on 
hospitals' service mix to include as part of the occupational mix 
adjustment. The commenters believe that hospitals that provide more 
services requiring highly skilled workers, such as oncology services, 
should not be penalized in the wage index for providing those services. 
One of the commenters also suggested that the adjustment should account 
for productivity, because hospitals should not be penalized if they 
hire highly skilled workers who work effectively with minimum support 
staff.
    Response: We are concerned that collecting data on service mix and 
productivity would substantially increase the reporting burden for 
hospitals and the complexity of the occupational mix adjustment. We are 
also uncertain as to what impact these additional factors would 
actually have on the occupational mix adjustment. If hospitals hire 
more highly skilled workers because they treat more complex cases, 
Medicare's DRG assignment already reflects the higher costs of 
providing these services. We note that the wage index under section 
1886(d)(3)(E) is intended to account for geographic differences in 
labor costs--not skill mix. We welcome the

[[Page 49037]]

commenters to provide more details of the data and methodology that 
would be required to include these factors in the occupational mix 
adjustment, as well as any analysis of the impact of these factors on 
the occupational mix adjustment.
    Comment: Several commenters expressed concern about CMS' use of 
unaudited occupational mix data and suggested that a review process is 
needed. Some commenters believed that CMS should not implement the 
occupational mix adjustment because the survey data were not verified 
by the fiscal intermediaries. One commenter added that CMS should 
provide the fiscal intermediaries ample time and resources to complete 
more thorough reviews of future occupational mix data.
    Response: We plan to audit the occupational mix survey data in 
future years. However, given the short timeframe for collecting the 
occupational mix data and implementing the adjustment with the FY 2005 
wage index, there was no time for fiscal intermediaries to conduct such 
reviews. Further, as this was the first time we collected data on hours 
for the 19 occupational categories, we had no baseline data to develop 
edit thresholds to incorporate in an intermediary review program. Thus, 
it would have been difficult to develop an audit program for use by 
fiscal intermediaries. We notified hospitals that they were responsible 
for submitting to us accurate data for Medicare payment purposes. 
Because hospitals will be affected by their own submission of data, we 
believe that hospitals had ample incentive to ensure that the data they 
submitted were correct and, therefore, self-audited their own data. 
Finally, we note that our policy of applying the occupational mix 
adjustment to only 10 percent of the wage index takes into account that 
this is the first year for submitting, analyzing, and applying the 
occupational mix data.
    Although the occupational mix data were not as extensively reviewed 
as may occur in future years, we are required by law to implement an 
occupational mix adjustment with the FY 2005 wage index. The next 
collection of occupational mix data will include an intermediary review 
period and an opportunity for hospitals to respond to any adjustments 
made by the intermediaries during the review.
    As this was the first administration of the occupational mix 
survey, we did not provide fiscal intermediaries an extensive program 
for reviewing the hours of data collected. However, hospitals were 
required to be able to provide any documentation that could be used by 
the fiscal intermediaries to verify the survey data. In addition, after 
reviewing the compiled survey data, we contacted fiscal intermediaries 
to request corrections from a few hospitals that provided data for 
reporting periods that were out of range with our specified 12-month or 
4-week data collection periods. As the wage index is a relative measure 
of labor costs across geographic areas, it is important that the data 
collected from hospitals reflect a common period. We also tested the 
validity of our occupational mix survey data by comparing our results 
to those of the 2001 BLS OES survey. As shown in Charts 4 and 5 below, 
the results of our survey are rather consistent with the findings of 
the BLS OES survey, especially for the nursing and physical therapy 
categories.
    In addition, to compute the occupational mix adjustment, we 
collected data on the average hourly rates for the 19 SOCs so that we 
could derive a weighted average hourly rate for each labor market area. 
(More details about the occupational mix calculation are included in 
section III.C.2. of this preamble.) To decrease hospital's reporting 
burden for this initial collection of the occupational mix data, and to 
facilitate the timely collection of the data, we did not require 
hospitals to report data on their total wages or average hourly rates 
associated with the 19 SOCs. Instead, we used national average hourly 
rates from the BLS OES 2001 National Industry-Specific Occupational 
Employment and Wage Estimates, SIC--Hospitals (accessible at Web site: 
http://www.bls.gov/oes/2001/oesi3_806.htm), as reflected in Chart 4 
below.
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2. Calculation of the Occupational Mix Adjustment Factor and the 
Occupational Mix Adjusted Wage Index
The method used to calculate the occupational mix adjusted wage index 
follows:
    Step 1--For each hospital, the percentage of the general service 
category attributable to an SOC is determined by dividing the SOC hours 
by the general service category's total hours. Repeat this calculation 
for each of the 19 SOCs.
    Step 2--For each hospital, the weighted average hourly rate for an 
SOC is determined by multiplying the percentage of the general service 
category (from Step 1) by the national average hourly rate for that SOC 
from the 2001 BLS OES survey (see Chart 4 above). Repeat this 
calculation for each of the 19 SOCs.
    Step 3--For each hospital, the hospital's adjusted average hourly 
rate for a general service category is computed by summing the weighted 
hourly rate for each SOC within the general category. Repeat this 
calculation for each of the 7 general service categories.
    Step 4--For each hospital, the occupational mix adjustment factor 
for a general service category is calculated by dividing the national 
adjusted average hourly rate for the category by the hospital's 
adjusted average hourly rate for the category. (The national adjusted 
average hourly rate is computed in the same manner as Steps 1 through 
3, using instead, the total SOC and general service category hours for 
all hospitals in the occupational mix survey database.) Repeat this 
calculation for each of the 7 general service categories. If the 
hospital's adjusted rate is less than the national adjusted rate 
(indicating the hospital employs a less costly mix of employees within 
the category), the occupational mix adjustment factor will be greater 
than 1.0000. If the hospital's adjusted rate is greater than the 
national adjusted rate, the occupational mix adjustment factor will be 
less than 1.0000.
    Step 5--For each hospital, the occupational mix adjusted salaries 
and wage-related costs for a general service category is calculated by 
multiplying the hospital's total salaries and wage-related costs (from 
Step 5 of the unadjusted wage index calculation in section F) by the 
percentage of the hospital's total workers attributable to the general 
service category (this is corrected from the proposed rule, in which we 
applied, instead, the national percentages to all hospitals) and by the 
general service category's occupational mix adjustment factor (from 
Step 4 above). Repeat this calculation for each of the 7 general 
service categories. The remaining portion of the hospital's total 
salaries and wage-related costs that is attributable to all other 
employees of the hospital is not adjusted for occupational mix.
    Step 6--For each hospital, the total occupational mix adjusted 
salaries and wage-related costs for a hospital are calculated by 
summing the occupational mix adjusted salaries and wage-related costs 
for the 7 general service categories (from Step 5) and the unadjusted 
portion of the hospital's salaries and wage-related costs for all other 
employees. To compute a hospital's occupational mix adjusted average 
hourly wage, divide the hospital's total occupational mix adjusted 
salaries and wage-related costs by the hospital's total hours (from 
Step 4 of the unadjusted wage index calculation in Section F).
    Step 7--To compute the occupational mix adjusted average hourly 
wage for an urban or rural area, sum the total occupational mix 
adjusted salaries and

[[Page 49043]]

wage-related costs for all hospitals in the area, then sum the total 
hours for all hospitals in the area. Next, divide the area's 
occupational mix adjusted salaries and wage-related costs by the area's 
hours.
    Step 8--To compute the national occupational mix adjusted average 
hourly wage, sum the total occupational mix adjusted salaries and wage-
related costs for all hospitals in the nation, then sum the total hours 
for all hospitals in the nation. Next, divide the national occupational 
mix adjusted salaries and wage-related costs by the national hours. The 
national occupational mix adjusted average hourly wage is 26.4114.
    Step 9--To compute the occupational mix adjusted wage index, divide 
each area's occupational mix adjusted average hourly wage (Step 7) by 
the national occupational mix adjusted average hourly wage (Step 8).
    Step 10--To compute the Puerto Rico specific occupational mix 
adjusted wage index, follow the Steps 1 through 9 above. The Puerto 
Rico occupational mix adjusted average hourly wage is 12.2577.
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BILLING CODE 4120-01-C
    In implementing an occupational mix adjusted wage index based on 
the above calculation, the final wage index values for 16 rural areas 
(36.0 percent) and 210 urban areas (4.4 percent) would decrease as a 
result of the adjustment. Six (6) rural areas (12.8 percent) and 111 
urban areas (28.8 percent) would experience a decrease of 1 percent or 
greater in their wage index values. The largest negative impact for a 
rural area would be 2.1 percent and for an urban area, 4.0 percent. 
Meanwhile, 31 rural areas (66.0 percent) and 176 urban areas (45.6 
percent) would experience an increase in their wage index values. 
Although these results show that rural hospitals would gain the most 
from an occupational mix adjustment to the wage index, their gains may 
not be as great as might have been expected. Further, it might not have 
been anticipated that over one-third of rural hospitals would actually 
fare worse under the adjustment. Overall, a fully implemented 
occupational mix adjusted wage index would have a redistributive effect 
on Medicare payments to hospitals.
    Comment: Several commenters raised concerns about the data CMS 
utilized to compute the occupational mix adjustment. One commenter 
noted that CMS computed the occupational mix adjustment using various 
sources of data from various time periods: (1) Average hourly wage data 
from the BLS 2001 OES survey; and (2) hours data collected on the 
Medicare occupational mix survey from calendar year 2003 or 4 weeks in 
2004. The commenter added that CMS applied the adjustment to wage costs 
collected on the Medicare cost report during FY 2001. The commenter 
believed that the data used in computing the occupational mix adjusted 
wage index should derive from the same time period because significant 
labor changes can occur in 2 to 3 years in the health care industry.
    Some commenters also expressed concern about CMS' reliance on BLS 
data for average hourly rate information that led to CMS collecting 
hours data for occupations that are excluded from the wage index 
(certified registered nurse anesthestists (CRNAs), nurse practitioners 
(NPs) and clinical nurse specialists (CNSs)). The commenters recognized 
that CMS attempted to simplify the reporting and effort required by 
utilizing the BLS information. However, they recommended that future 
surveys collect salaries and hours from hospitals and on the same basis 
as Worksheet S-

[[Page 49048]]

3 of the cost report. The commenters believed that this would 
facilitate the intermediary's and CMS' review of the survey data.
    Response: It is our intent to collect both salaries and hours data 
directly from hospitals for the computation of the occupational mix 
adjustment. We agree that, ideally, both the data used to compute the 
occupational mix adjustment and the wage data to which the adjustment 
is applied should derive from approximately the same time period and 
include the same occupational categories. However, we do not believe it 
was unreasonable in this instance, and in this short timeframe to use 
data from different time periods. We believe the consistency of our 
outcomes with the BLS OES data reflects this. In addition, if hospitals 
were concerned about collecting data from different time periods, we 
believe this is an issue that should have been commented upon when the 
actual occupational mix survey was published in 2003. We also believe 
that the BLS OES data are the best available for representing hospital 
hourly wage data. For future data collections, we will revise the 
occupational mix survey to allow hospitals to provide both salaries and 
hours data for each of the employment categories that are included on 
the survey. We will also assess whether future occupational mix surveys 
should be based on the calendar year or if the data should be collected 
on a fiscal year basis as part of the Medicare cost report. One 
logistical problem is that cost report data are collected yearly, but 
occupational mix survey data are collected only every 3 years.
    Comment: Several comments addressed the methodology we used to 
calculate the occupational mix adjustment to the wage index. Most 
commented that the methodology appears theoretically sound, although 
the results appear counterintuitive. The commenters noted that one 
third of rural hospitals would experience a decline in their 
occupational mix adjusted wage index, while several large academic 
medical centers would experience an increase in their wage indexes. 
However, the commenters believed that the unexpected results are due 
more to errors in the data rather than our methodology for computing 
the occupational mix adjustment.
    Four commenters cited problems with our computation of the 
occupational mix adjustment. The first commenter suggested that CMS 
should compute and apply the adjustment to the MSA average hourly wage 
rather than to each hospital's average hourly wage to reduce the effect 
that an individual hospital's data could have on an area wage index. 
The second commenter suggested that CMS should calculate an 
occupational mix adjustment for each of the 19 SOCs rather than the 7 
general service category groupings. The third commenter noted that CMS 
applied the occupational mix adjustment for each general service 
category to a percentage of total salaries that was computed based on 
hours represented by each general service category. This commenter 
believed that, instead, the adjustment should have been applied to a 
percentage of total salaries that was based on wage costs represented 
by each of the general service categories. The fourth commenter cited 
that, in Step 5 of the occupational mix adjustment calculation in the 
proposed rule, CMS applied national weights to adjust all hospitals' 
total salaries for occupational mix, rather than applying hospital-
specific weights. This commenter suggested that, in applying the 
national weights to all hospitals' total wages, some area wage index 
values could be negatively impacted.
    Response: We appreciate the input that we received from MedPAC, the 
Bureau of Labor Statistics, and the hospital community during our 
research and development of the occupational mix adjustment. We believe 
that our calculation of the occupational mix adjustment in this final 
rule is appropriate based on the purpose of the adjustment and the data 
we had available to calculate the adjustment.
    We disagree with the comment that the occupational mix adjustment 
should be applied at the MSA level instead of the hospital level. By 
adjusting hospitals' data for occupational mix, we are treating the 
occupational mix adjustment consistent with the way we treat the wage 
index; that is, in calculating the wage index, we first compute 
adjusted salaries and hours for each hospital, then we sum the adjusted 
salaries and hours for all hospitals in an area to derive an area 
average hourly wage.
    We also disagree with the suggestion that CMS should calculate an 
occupational mix adjustment for each of the 19 SOCs rather than the 
aggregated 7 general service category groupings. The adjustment is 
intended to control for hospitals' employment choices within certain 
service groupings, where, to an extent, the employees' skills are 
interchangeable. Therefore, we believe it is appropriate to apply the 
adjustment to the general service category grouping.
    With regards to the suggestion that the adjustment should have been 
applied to a percentage of total salaries that was based on salary 
costs represented by each of the general service categories, the 
initial implementation of the occupational mix adjustment did not 
provide for the collection of data on salaries. Therefore, we could not 
use the salaries for a general service category to derive the 
proportion of a hospital's total salaries to be adjusted for 
occupational mix. Based on our experience with wage and hours data, we 
believe that the proportions we derived from hours data would closely 
approximate the proportions that we would have derived if salaries data 
were available and used. Further, this use of hours data is consistent 
with a methodology we allow hospitals to use for allocating their wage-
related costs on Worksheet S-3. Some hospitals base these allocations 
on proportions of total hours rather than salaries.
    Finally, we acknowledge the error the commenter cited regarding 
Step 5. As shown above, we applied hospital-specific weights to adjust 
hospitals' total salaries in computing the occupational mix adjustment 
in this final rule.
    Comment: Several hospitals stated that they had difficulty 
determining the impact of the occupational mix adjustment on their area 
wage index values. The commenters acknowledged that CMS provided public 
use files in March and May of the survey data and a public use file in 
June indicating hospitals' occupational mix adjustment factors. The 
commenters requested that CMS provide more detailed information about 
the findings of the occupational mix adjustment. One commenter 
suggested that CMS provide a table in the Addendum of the rule that 
shows what the area wage index values would have been without the 
occupational mix adjustment.
    Response: In our continuing efforts to meet the information needs 
of the public, we will provide two additional public use files for the 
final occupational mix adjusted wage index: a file including each 
hospital's unadjusted and adjusted average hourly wage and a file 
including each area's unadjusted and adjusted average hourly wage and 
wage index value. These additional files will be posted on the 
Internet, at http://cms.hhs.gov/providers/hipps/ippswage.asp. We will 
also post these files with future applications of the occupational mix 
adjustment.

D. Worksheet S-3 Wage Data for the FY 2005 Wage Index Update

    The FY 2005 wage index values (effective for hospital discharges 
occurring on or after October 1, 2004 and before October 1, 2005) in 
section

[[Page 49049]]

VI. of the Addendum to this final rule are based on the data collected 
from the Medicare cost reports submitted by hospitals for cost 
reporting periods beginning in FY 2001 (the FY 2004 wage index was 
based on FY 2000 wage data).
    The FY 2005 wage index includes the following categories of data 
associated with costs paid under the IPPS (as well as outpatient 
costs):
     Salaries and hours from short-term, acute care hospitals 
(including paid lunch hours and hours associated with military leave 
and jury duty).
     Home office costs and hours.
     Certain contract labor costs and hours (which includes 
direct patient care, certain top management, pharmacy, laboratory, and 
nonteaching physician Part A services).
     Wage-related costs (The September 1, 1994, Federal 
Register included a list of core wage-related costs that are included 
in the wage index, and discussed criteria for including other wage-
related costs (59 FR 45356)).
    Consistent with the wage index methodology for FY 2004, the wage 
index for FY 2005 also excludes the direct and overhead salaries and 
hours for services not subject to IPPS payment, such as SNF services, 
home health services, costs related to GME (teaching physicians and 
residents) and certified registered nurse anesthetists (CRNAs), and 
other subprovider components that are not paid under the IPPS. The FY 
2005 wage index also excludes the salaries, hours, and wage-related 
costs of hospital-based rural health clinics (RHCs), and Federally 
qualified health centers (FQHCs) because Medicare pays for these costs 
outside of the IPPS (68 FR 45395). In addition, salaries, hours and 
wage-related costs of CAHs are excluded from the wage index, for the 
reasons explained in the FY 2004 IPPS final rule (68 FR 45397).
    Data collected for the IPPS wage index are also currently used to 
calculate wage indexes applicable to other providers, such as SNFs, 
home health agencies, and hospices. In addition, they are used for 
prospective payments to rehabilitation, psychiatric, and long-term care 
hospitals, and for hospital outpatient services.
    Comment: One commenter noted that the data CMS uses to compute the 
wage index is 4 years old and urged CMS to use more recent data. The 
commenter suggested that, due to the time lapse, the wage index does 
not sufficiently capture trends of health care professional shortages 
in certain labor markets and the corresponding salary increases 
associated with the rise in demand for certain health care 
professionals.
    Response: We discussed this matter in a previous notice (65 FR 
47070). Due to the time period allowed for: (1) Hospitals to complete 
and submit their cost reports to their intermediaries, (2) fiscal 
intermediaries to perform a separate, detailed review of all wage data 
and submit hospitals' reviewed wage data to CMS, and (3) CMS to compile 
a complete set of all hospitals' wage data from a common Federal fiscal 
year period, we do not have available more recent, complete, and 
reliable data to calculate the wage index. Therefore, hospitals' wage 
data are always 3 to 4 years old, depending on the end date of the 
hospital's cost reporting period, before we can use the data in 
calculating the wage index.
    Comment: One commenter noted that, in the August 1, 2002, Federal 
Register rule (67 FR 50022), CMS stated that it would begin to collect 
contract labor wage costs and hours for management services and the 
following overhead services: administrative and general, housekeeping, 
and dietary. The commenter requested CMS to also add a line 25.01 to 
Worksheet S-3, Part II to collect wage costs and hours for contract 
laundry services and include the costs in the wage index calculation. 
Based on the commenter's analysis of the May public use file, 1,468 
hospitals had no data on line 25 (direct costs for laundry services) 
and 1,599 hospitals had less than $100,000 in wage costs on this line. 
The commenter believed that the data indicates that many hospitals 
contract their laundry services, and including the costs for contract 
laundry services would provide equity in the wage index.
    Response: In the August 1, 2002, rule, we stated that, while we 
agree that it may be appropriate to include indirect patient care 
contract labor costs in the wage index, in light of concerns about 
hospitals' ability to accurately document and report the costs, we 
believe that the best approach is to assess and include these costs 
incrementally. We will begin collecting data on contract management, 
administrative and general, housekeeping, and dietary services with 
cost reporting periods beginning on or after October 1, 2003 (that is, 
the FY 2004 cost reports). Hospitals will submit their FY 2004 cost 
reports to their intermediaries during calendar year 2005 through early 
2006. Intermediaries will complete their wage index desk reviews and 
submit hospitals' FY 2004 audited wage data to us by early 2007. We 
will use data from the FY 2004 cost reports to compute the FY 2008 wage 
index. Before including these additional costs in the wage index, we 
will analyze the impact of the costs on area wage index values and 
provide a detailed analysis for public comment. Our decision on whether 
to include these contract costs, and other contract costs in the 
future, such as, contract laundry services, will depend on the outcome 
of our analyses and public comment.
    Comment: One commenter requested CMS to designate provider-based 
clinics (PBCs) as an IPPS-excluded area in order to remove the costs 
from the wage index. The commenter stated that PBCs are like physician 
private offices, which are excluded from the wage index. PBCs bill the 
technical component under certain outpatient ambulatory payment 
classifications (APCs) and the professional component under the 
physician fee schedule. The commenter noted that PBC costs are not paid 
under IPPS.
    Response: We appreciate the commenter's suggestion. However, as 
this matter was not addressed in the FY 2005 proposed rule, or any 
previous rulemaking, we are not prepared to provide a decision about 
PBC costs in this final rule. We intend to explore a comprehensive 
assessment of the costs in a future rule.

E. Verification of Worksheet S-3 Wage Data

    The wage data for the FY 2005 wage index were obtained from 
Worksheet S-3, Parts II and III of the FY 2001 Medicare cost reports. 
Instructions for completing the Worksheet S-3, Parts II and III are in 
the Provider Reimbursement Manual, Part I, sections 3605.2 and 3605.3. 
The data file used to construct the wage index includes FY 2001 data as 
of June 25, 2004. As in past years, we performed an intensive review of 
the wage data, mostly through the use of edits designed to identify 
aberrant data.
    We asked our fiscal intermediaries to revise or verify data 
elements that resulted in specific edit failures. The unresolved data 
elements that were included in the calculation of the proposed FY 2005 
wage index have been resolved and are reflected in the calculation of 
the final FY 2005 index. For the final FY 2005 wage index in this final 
rule, we removed the data for 237 hospitals from our database: 147 
hospitals became critical access hospitals by the time we published 
from the FY 2005 wage index), and 76 hospitals were low Medicare 
utilization hospitals or failed edits that could not be corrected 
because the hospitals terminated the program or changed ownership. In 
addition, we removed the wage data for 14 hospitals with incomplete or 
inaccurate data resulting in zero or negative, or otherwise

[[Page 49050]]

aberrant, average hourly wages. As a result, the final FY 2005 wage 
index is calculated based on FY 2001 wage data from 3,955 hospitals.
    In constructing the FY 2005 wage index, we include the wage data 
for facilities that were IPPS hospitals in FY 2001, even for those 
facilities that have terminated their participation in the program as 
hospitals, as long as those data do not fail any of our edits for 
reasonableness. We believe that including the wage data for these 
hospitals is, in general, appropriate to reflect the economic 
conditions in the various labor market areas during the relevant past 
period. However, we exclude the wage data for CAHs (as discussed in 68 
FR 45397). The wage index in this final rule excludes hospitals that 
are designated as CAHs by February 24, 2004, the date of the latest 
available Medicare CAH listing at the time we released the proposed 
wage index public use file on February 27, 2004.

F. Computation of the Unadjusted Wage Index

    The method used to compute the FY 2005 wage index without an 
occupational mix adjustment follows:
    Step 1--As noted above, we based the FY 2005 wage index on wage 
data reported on the FY 2001 Medicare cost reports. We gathered data 
from each of the non-Federal, short-term, acute care hospitals for 
which data were reported on the Worksheet S-3, Parts II and III of the 
Medicare cost report for the hospital's cost reporting period beginning 
on or after October 1, 2000, and before October 1, 2001. In addition, 
we included data from some hospitals that had cost reporting periods 
beginning before October 2000 and reported a cost reporting period 
covering all of FY 2001. These data were included because no other data 
from these hospitals would be available for the cost reporting period 
described above, and because particular labor market areas might be 
affected due to the omission of these hospitals. However, we generally 
describe these wage data as FY 2001 data. We note that, if a hospital 
had more than one cost reporting period beginning during FY 2001 (for 
example, a hospital had two short cost reporting periods beginning on 
or after October 1, 2000, and before October 1, 2001), we included wage 
data from only one of the cost reporting periods, the longer, in the 
wage index calculation. If there was more than one cost reporting 
period and the periods were equal in length, we included the wage data 
from the later period in the wage index calculation.
    Step 2--Salaries--The method used to compute a hospital's average 
hourly wage excludes certain costs that are not paid under the IPPS. In 
calculating a hospital's average salaries plus wage-related costs, we 
subtracted from Line 1 (total salaries) the GME and CRNA costs reported 
on lines 2, 4.01, 6, and 6.01, the Part B salaries reported on Lines 3, 
5 and 5.01, home office salaries reported on Line 7, and excluded 
salaries reported on Lines 8 and 8.01 (that is, direct salaries 
attributable to SNF services, home health services, and other 
subprovider components not subject to the IPPS). We also subtracted 
from Line 1 the salaries for which no hours were reported. To determine 
total salaries plus wage-related costs, we added to the net hospital 
salaries the costs of contract labor for direct patient care, certain 
top management, pharmacy, laboratory, and nonteaching physician Part A 
services (Lines 9 and 10), home office salaries and wage-related costs 
reported by the hospital on Lines 11 and 12, and nonexcluded area wage-
related costs (Lines 13, 14, and 18).
    We note that contract labor and home office salaries for which no 
corresponding hours are reported were not included. In addition, wage-
related costs for nonteaching physician Part A employees (Line 18) are 
excluded if no corresponding salaries are reported for those employees 
on Line 4.
    Step 3--Hours--With the exception of wage-related costs, for which 
there are no associated hours, we computed total hours using the same 
methods as described for salaries in Step 2.
    Step 4--For each hospital reporting both total overhead salaries 
and total overhead hours greater than zero, we then allocated overhead 
costs to areas of the hospital excluded from the wage index 
calculation. First, we determined the ratio of excluded area hours (sum 
of Lines 8 and 8.01 of Worksheet S-3, Part II) to revised total hours 
(Line 1 minus the sum of Part II, Lines 2, 3, 4.01, 5, 5.01, 6, 6.01, 
7, and Part III, Line 13 of Worksheet S-3). We then computed the 
amounts of overhead salaries and hours to be allocated to excluded 
areas by multiplying the above ratio by the total overhead salaries and 
hours reported on Line 13 of Worksheet S-3, Part III. Next, we computed 
the amounts of overhead wage-related costs to be allocated to excluded 
areas using three steps: (1) We determined the ratio of overhead hours 
(Part III, Line 13) to revised hours (Line 1 minus the sum of Lines 2, 
3, 4.01, 5, 5.01, 6, 6.01, and 7); (2) we computed overhead wage-
related costs by multiplying the overhead hours ratio by wage-related 
costs reported on Part II, Lines 13, 14, and 18; and (3) we multiplied 
the computed overhead wage-related costs by the above excluded area 
hours ratio. Finally, we subtracted the computed overhead salaries, 
wage-related costs, and hours associated with excluded areas from the 
total salaries (plus wage-related costs) and hours derived in Steps 2 
and 3.
    Step 5--For each hospital, we adjusted the total salaries plus 
wage-related costs to a common period to determine total adjusted 
salaries plus wage-related costs. To make the wage adjustment, we 
estimated the percentage change in the employment cost index (ECI) for 
compensation for each 30-day increment from October 14, 2000 through 
April 15, 2002 for private industry hospital workers from the Bureau of 
Labor Statistics' Compensation and Working Conditions. We use the ECI 
because it reflects the price increase associated with total 
compensation (salaries plus fringes) rather than just the increase in 
salaries. In addition, the ECI includes managers as well as other 
hospital workers. This methodology to compute the monthly update 
factors uses actual quarterly ECI data and assures that the update 
factors match the actual quarterly and annual percent changes. The 
factors used to adjust the hospital's data were based on the midpoint 
of the cost reporting period, as indicated below.

[[Page 49051]]

[GRAPHIC] [TIFF OMITTED] TR11AU04.049

    For example, the midpoint of a cost reporting period beginning 
January 1, 2001, and ending December 31, 2001, is June 30, 2001. An 
adjustment factor of 1.03638 would be applied to the wages of a 
hospital with such a cost reporting period. In addition, for the data 
for any cost reporting period that began in FY 2001 and covered a 
period of less than 360 days or more than 370 days, we annualized the 
data to reflect a 1-year cost report. Dividing the data by the number 
of days in the cost report and then multiplying the results by 365 
accomplish annualization.
    Step 6--Each hospital was assigned to its appropriate urban or 
rural labor market area before any reclassifications under section 
1886(d)(8)(B) or section 1886(d)(10) of the Act. Within each urban or 
rural labor market area, we added the total adjusted salaries plus 
wage-related costs obtained in Step 5 for all hospitals in that area to 
determine the total adjusted salaries plus wage-related costs for the 
labor market area.
    Step 7--We divided the total adjusted salaries plus wage-related 
costs obtained under both methods in Step 6 by the sum of the 
corresponding total hours (from Step 4) for all hospitals in each labor 
market area to determine an average hourly wage for the area.
    Step 8--We added the total adjusted salaries plus wage-related 
costs obtained in Step 5 for all hospitals in the nation and then 
divided the sum by the national sum of total hours from Step 4 to 
arrive at a national average hourly wage. Using the data as described 
above, the national average hourly wage is $26.3570.
    Step 9--For each urban or rural labor market area, we calculated 
the hospital wage index value by dividing the area average hourly wage 
obtained in Step 7 by the national average hourly wage computed in Step 
8.
    Step 10--Following the process set forth above, we developed a 
separate Puerto Rico-specific wage index for purposes of adjusting the 
Puerto Rico standardized amounts. (The national Puerto Rico 
standardized amount is adjusted by a wage index calculated for all 
Puerto Rico labor market areas based on the national average hourly 
wage as described above.) We added the total adjusted salaries plus 
wage-related costs (as calculated in Step 5) for all hospitals in 
Puerto Rico and divided the sum by the total hours for Puerto Rico (as 
calculated in Step 4) to arrive at an overall average hourly wage of 
$12.2568 for Puerto Rico. For each labor market area in Puerto Rico, we 
calculated the Puerto Rico-specific wage index value by dividing the 
area average hourly wage (as calculated in Step 7) by the overall 
Puerto Rico average hourly wage.
    Step 11--Section 4410 of Public Law 105-33 provides that, for 
discharges on

[[Page 49052]]

or after October 1, 1997, the area wage index applicable to any 
hospital that is located in an urban area of a State may not be less 
than the area wage index applicable to hospitals located in rural areas 
in that State. Furthermore, this wage index floor is to be implemented 
in such a manner as to ensure that aggregate IPPS payments are not 
greater or less than those that would have been made in the year if 
this section did not apply. For FY 2005, this change affects 208 
hospitals in 57 urban areas. The areas affected by this provision are 
identified by a footnote in Table 4A in the Addendum of this final 
rule.

G. Computation of the FY 2005 Blended Wage Index

    As we proposed in the May 18, 2004, proposed rule, for the final FY 
2005 wage index, we are using a blend of the occupational mix adjusted 
wage index and the unadjusted wage index, in order to minimize the 
redistributive impact of the occupational mix adjustment (as discussed 
in section III.C.2. of this preamble) for the first year of its 
implementation. Specifically, we are basing the FY 2005 wage index on a 
blend of 10 percent of an average hourly wage, adjusted for 
occupational mix, and 90 percent of an average hourly wage, unadjusted 
for occupational mix. Using this blend, the national average hourly 
wage is $26.3624 and the Puerto Rico specific average hourly wage is 
$12.2569. We chose this blend for FY 2005 in recognition that this was 
the first time, for the administration of the occupational mix survey, 
hospitals had a short timeframe for collecting their occupational mix 
survey data and documentation, we could not collect optimum data (that 
is, wages and hours data from a 1-year period for all hospitals) within 
the mandatory timeframe for implementing the adjustment, and we had no 
baseline data to use in developing a desk review program that could 
ensure the accuracy of the occupational mix survey data.
    In addition, we are moving cautiously with implementing the 
occupational mix adjustment in recognition of changing trends in the 
hiring of nurses, the largest group in our survey. Since the enactment 
of section 304(c) of Public Law 106-554, the law requiring the 
occupational mix adjustment to the wage index, some States have 
implemented laws that establish floors on the minimum level of 
registered nurse staffing that hospitals must maintain in order to 
continue to be licensed and certified by the State. In addition, some 
rural areas that are facing a shortage of physicians may be hiring more 
registered nurses as extenders or substitutes for physicians. Such 
trends may explain why the occupational mix impacts in section III.C.2. 
of this preamble are not as expected for rural areas in particular.
    Further, we are using this blend because, although we want to 
minimize the immediate impact of the occupational mix adjustment on 
hospitals' wage index values, we do not want to nullify the value and 
intent of the occupational mix adjustment. We believe that the blended 
wage index we are proposing satisfies both of these goals. With only 10 
percent of the wage index adjusted for occupational mix, the wage index 
values for 14 rural areas (21.3 percent) and 205 urban areas (53.1 
percent) would decrease as a result of the adjustment. However, the 
decreases would be minimum; the largest negative impact for a rural 
area would be only 0.21 percent and for an urban area, 0.40 percent. 
Conversely, 31 rural areas (66 percent) and 172 urban areas (44.6 
percent) would benefit from this adjustment, with 1 urban area 
increasing 2.2 percent and all other areas gaining 0.7 percent or less. 
Overall, a wage index that has only 10 percent of the salaries adjusted 
for occupational mix would have a minimal redistributive effect on 
Medicare payments to hospitals. (See Appendix A to this final rule for 
further analyses of the impact of the occupational mix adjustment on 
the FY 2005 wage index.)
    The wage index values in Tables 4A, 4B, 4C, 4F, 4G, and 4H and the 
average hourly wages in Tables 2, 3A, and 3B in the Addendum to this 
final rule include the occupational mix adjustment. We note that, 
although we are using a blended wage index for FY 2005, at this time we 
are not applying an incremental phase-in of the occupational mix 
adjustment beyond FY 2005. The application of the occupational mix 
adjustment beyond FY 2005 will be determined and discussed in 
subsequent IPPS updates.
    Comment: Commenters generally agreed with CMS' decision to only 
partially implement the occupational mix adjustment with the FY 2005 
wage index. A majority of commenters supported the proposed blended 
wage index in which the occupational mix adjusted portion is 10 
percent. A few commenters suggested other applications of the 
adjustment as follows:
     Lower the percent adjusted for occupational mix to 5 
percent or less. In addition, CMS should not raise the percent until 
the occupational mix survey process is improved.
     Apply an occupational mix adjustment to only 1 percent of 
the wage index.
     Apply a higher percentage of the occupational mix 
adjustment if the results for the hospital are positive and a lower 
percentage if the results are negative.
     Fully apply the adjustment to hospitals that are 
positively impacted and use a blend of 10 percent for hospitals that 
are negatively impacted.
     Phase in the adjustment, for example, over a period of 10 
years (apply 10 percent per year). After the adjustment is fully 
implemented, cap the adjustment at 2 percent. That is, an occupational 
mix adjusted wage index value should be no greater or less than 2 
percent of what the wage index value would have been in the absence of 
the occupational mix adjustment.
     Hold hospitals harmless on the use of occupational mix 
adjustment for 3 years.
    One commenter stated that CMS should impose a temporary moratorium 
on the use of the occupational mix data until more accurate and 
reliable data can be gathered and studied.
    Response: Due to the general support we received for our proposal 
to base the FY 2005 wage index on a blend of 10 percent of an average 
hourly wage adjusted for occupational mix and 90 percent of an average 
hourly wage unadjusted for occupational mix, we are proceeding as 
proposed. As we stated above, we will determine and discuss the 
application of future adjustments in subsequent IPPS updates.

H. Revisions to the Wage Index Based on Hospital Redesignation

1. General
    Under section 1886(d)(10) of the Act, the Medicare Geographic 
Classification Review Board (MGCRB) considers applications by hospitals 
for geographic reclassification for purposes of payment under the IPPS. 
Hospitals must apply to the MGCRB to reclassify by September 1 of the 
year preceding the year during which reclassification is sought. 
Generally, hospitals must be proximate to the labor market area to 
which they are seeking reclassification and must demonstrate 
characteristics similar to hospitals located in that area. The MGCRB 
issues its decisions by the end of February for reclassification to 
become effective for the following fiscal year (beginning October 1). 
The regulations applicable to reclassifications by the MGCRB are 
located in Sec. Sec.  412.230 through 412.280.
    Section 1886(d)(10)(D)(v) of the Act provides that, beginning with 
FY 2001,

[[Page 49053]]

a MGCRB decision on a hospital reclassification for purposes of the 
wage index is effective for 3 fiscal years, unless the hospital elects 
to terminate the reclassification. Section 1886(d)(10)(D)(vi) of the 
Act provides that the MGCRB must use the 3 most recent years' average 
hourly wage data in evaluating a hospital's reclassification 
application for FY 2003 and any succeeding fiscal year.
    Section 304(b) of Public Law 106-554 provides that the Secretary 
must establish a mechanism under which a statewide entity may apply to 
have all of the geographic areas in the State treated as a single 
geographic area for purposes of computing and applying a single wage 
index, for reclassifications beginning in FY 2003. The implementing 
regulations for this provision are located at Sec.  412.235.
    Section 1886(d)(8)(B) of the Act requires the Secretary to treat a 
hospital located in a rural county adjacent to one or more urban areas 
as being located in the MSA to which the greatest number of workers in 
the county commute if: the rural county would otherwise be considered 
part of an urban area under the standards for designating MSAs if the 
commuting rates used in determining outlying counties were determined 
on the basis of the aggregate number of resident workers who commute to 
(and, if applicable under the standards, from) the central county or 
counties of all contiguous MSAs. In light of the new CBSA definitions 
and the Census 2000 data, we undertook to identify those counties 
meeting these criteria. The eligible counties are identified below, as 
well as a discussion of counties that no longer meet the criteria under 
this provision.
2. Effects of Reclassification
    Section 1886(d)(8)(C) of the Act provides that the application of 
the wage index to redesignated hospitals is dependent on the 
hypothetical impact that the wage data from these hospitals would have 
on the wage index value for the area to which they have been 
redesignated. These requirements for determining the wage index values 
for redesignated hospitals is applicable both to the hospitals located 
in rural counties deemed urban under section 1886(d)(8)(B) of the Act 
and hospitals that were reclassified as a result of the MGCRB decisions 
under section 1886(d)(10) of the Act. Therefore, as provided in section 
1886(d)(8)(C) of the Act,\5\ the wage index values were determined by 
considering the following:
---------------------------------------------------------------------------

    \5\ Although section 1886(d)(8)(C)(iv)(I) of the Act also 
provides that the wage index for an urban area may not decrease as a 
result of redesignated hospitals if the urban area wage index is 
below the wage index for rural areas in the State in which the urban 
area is located, this was effectively made moot by section 4410 of 
Pub. L. 105-33, which provides that the area wage index applicable 
to any hospital that is located in an urban area of a State may not 
be less than the area wage index applicable to hospitals located in 
rural areas in that State.
    Also, section 1886(d)(8)(C)(iv)(II) of the Act provides that an 
urban area's wage index may not decrease as a result of redesignated 
hospitals if the urban area is located in a State that is composed 
of a single urban area.
---------------------------------------------------------------------------

     If including the wage data for the redesignated hospitals 
would reduce the wage index value for the area to which the hospitals 
are redesignated by 1 percentage point or less, the area wage index 
value determined exclusive of the wage data for the redesignated 
hospitals applies to the redesignated hospitals.
     If including the wage data for the redesignated hospitals 
reduces the wage index value for the area to which the hospitals are 
redesignated by more than 1 percentage point, the area wage index 
determined inclusive of the wage data for the redesignated hospitals 
(the combined wage index value) applies to the redesignated hospitals.
     If including the wage data for the redesignated hospitals 
increases the wage index value for the urban area to which the 
hospitals are redesignated, both the area and the redesignated 
hospitals receive the combined wage index value. Otherwise, the 
hospitals located in the urban area receive a wage index excluding the 
wage data of hospitals redesignated into the area.
     The wage data for a reclassified urban hospital is 
included in both the wage index calculation of the area to which the 
hospital is reclassified (subject to the rules described above) and the 
wage index calculation of the urban area where the hospital is 
physically located.
     Rural areas whose wage index values would be reduced by 
excluding the wage data for hospitals that have been redesignated to 
another area continue to have their wage index values calculated as if 
no redesignation had occurred (otherwise, redesignated rural hospitals 
are excluded from the calculation of the rural wage index).
     The wage index value for a redesignated rural hospital 
cannot be reduced below the wage index value for the rural areas of the 
State in which the hospital is located.
3. FY 2005 Issues
    Recent policies and decisions that will affect hospitals' 
geographic classifications for FY 2005 are discussed below. First, we 
describe decisions by the MGCRB on applications received in accordance 
with the ongoing reclassification process described in the regulations 
at Sec. Sec.  412.230 through 412.280. Second, we describe the 
implications for reclassification decisions by the MGCRB to be 
effective during FY 2005 of our adoption of new MSA definitions for the 
FY 2005 wage index. Third, we discuss the new counties identified under 
the standards at section 1886(d)(8)(B) of the Act, based on the new 
CBSA and the Census 2000 data. Fourth, we discuss the interactions of 
these changes with reclassifications approved under the one-time appeal 
process for hospital wage index reclassifications at section 508 of 
Public Law 108-173. Fifth, we discuss our implementation of section 505 
of Public Law 108-173. Under this provision, the Secretary must 
establish a new process, similar to the current wage index 
reclassification process, to make adjustments to the hospital wage 
index, based on commuting patterns of hospital employees.
a. FY 2005 MGCRB Reclassifications
    In the August 1, 2003 IPPS final rule, we indicated that hospitals 
submitting applications for reclassification by the MGCRB for FY 2005 
should base those applications on the current (for Medicare payment 
purposes) MSAs (68 FR 45401). At the time this final rule was 
constructed, the MGCRB had completed its review of FY 2005 
reclassification requests. There were 339 hospitals approved for wage 
index reclassifications by the MGCRB for FY 2005. Because MGCRB wage 
index reclassifications are effective for 3 years, hospitals 
reclassified during FY 2003 or FY 2004 are eligible to continue to be 
reclassified based on prior reclassifications to current MSAs during FY 
2005. There were 55 hospitals reclassified for wage index in FY 2003 
and 102 hospitals reclassified for wage index in FY 2004.
    In the past, hospitals have been able to apply to be reclassified 
for purposes of either the wage index or the standardized amount. 
Existing regulations at Sec.  412.230(a)(5)(ii) state that, after 2002, 
a hospital may not be reclassified for purposes of the standardized 
amount if the area to which the hospital seeks reclassification does 
not have a higher standardized amount than the standardized amount the 
hospital currently receives. Standardized amount reclassifications are 
only effective for 1 year, so hospitals must reapply every year. At the 
time the FY 2005 reclassification applications were due, hospitals 
applied on the basis that the law still provided for a higher

[[Page 49054]]

standardized amount for hospitals in large urban areas. However, 
section 401 of Public Law 108-173 established that all hospitals will 
be paid on the basis of the large urban standardized amount beginning 
with FY 2004. Consequently, all hospitals will be paid on the basis of 
the same standardized amount, which effectively makes standardized 
amount reclassifications moot, at least for purposes of the 
standardized amount. As a result, the MGCRB denied all applications for 
standardized amount reclassifications for FY 2005. In light of the fact 
that all hospitals are now paid on the basis of the same standardized 
amount, in the proposed rule, we explained our proposed method for 
eliminating standardized amount reclassifications. Although there could 
still be some benefit in terms of payments for some hospitals under the 
DSH adjustment for operating IPPS, section 402 of Public Law 108-173 
equalized DSH payments for rural and urban hospitals, with the 
exception that the rural DSH adjustment is capped at 12 percent (except 
that rural referral centers have no cap) (a detailed discussion appears 
in section IV.H. of this preamble).
    No commenters objected to our proposal to eliminate standardized 
amount reclassifications.
b. Implementation of New MSAs
    As discussed above, we are implementing the new CBSAs for FY 2005. 
Under these new CBSAs definitions, many existing MSAs are reconfigured. 
Therefore, because hospitals applied for reclassification during FY 
2005 on the basis of the MSAs currently used to define labor market 
areas for FY 2004, the definition of the MSA to which they have been 
reclassified, or the area where they are located, may have changed 
under our implementation. Hospitals that were reclassified for FY 2005 
were asked to verify that the reclassified wage index for the labor 
market area into which they had been reclassified (in Table 4C in the 
Addendum to the May 18, 2004 proposed rule) exceeded the wage index of 
the labor market area where they are located (in Table 4A or 4B in the 
Addendum of the May 18, 2004 proposed rule) after our proposed 
implementation of the new MSAs. Hospitals could have withdrawn their FY 
2005 reclassifications within 45 days of the publication of the 
proposed rule.
    In some cases, the new CBSA definitions result in previously 
existing MSAs being divided into two or more separate MSAs. Given that 
the areas to which the hospitals reclassified no longer exist in FY 
2005, we needed to propose rules we could use to determine such 
hospitals' reclassification areas. We proposed assigning the hospital 
to the nearest county in the current MSA, and the hospital's FY 2005 
reclassification is to the new MSA (under the CBSA definitions) that 
includes that county to which it has been assigned.
    For example, the Ann Arbor, MI MSA currently includes the counties 
of Lenawee, MI; Livingston, MI; and Washtenaw, MI. Under the new CBSA 
definitions, the Ann Arbor, MI MSA is comprised solely of the county of 
Washtenaw, MI. Lenawee, MI now comprises the Adrian, MI Micropolitan 
Area, and Livingston, MI is now in the Warren-Farmington Hills-Troy, MI 
Metropolitan Division of Detroit. Therefore, a hospital that was 
reclassified by the MGCRB into Ann Arbor for either FY 2003, FY 2004, 
or FY 2005 would be assigned to either the Ann Arbor, MI MSA or the 
Warren-Farmington Hills-Troy, MI Metropolitan Division, depending on 
whether the hospital was closer to Washtenaw or Livingston (A 
reclassified hospital located closest to Lenawee County would be 
assigned to an MSA based on whether it is closer to Washtenaw or 
Livingston, which are still in MSAs. We would not consider Lenawee 
because it is now considered part of the statewide rural area.)
    Reclassified hospitals that have been assigned to a new MSA are 
identified in Table 9A in the Addendum of this final rule by the 
identification of the county used to designate them. We determined that 
the hospital is in closest proximity to the county listed based on 
mapping data available to us at the time of the preparation of this 
final rule. Hospitals that disagreed with our determination of the 
closest proximate county on which to assign them to a new MSA were 
given the opportunity to submit a comment indicating the basis for 
their disagreement.
    Comment: Many hospitals approved for reclassification under the 
traditional reclassification process objected to our proposal to assign 
hospitals to the nearest county in the MSA to which it was 
reclassified. Several hospitals recommended allowing hospitals to amend 
their FY 2005 reclassification applications or implementing the policy 
adopted in 1994. Others recommended that CMS consider retracting the 
proposal, in its entirety and, in doing so, allow hospitals to be 
reclassified to the area approved by the MGCRB for the full 3 years. In 
the September 1, 1993 final rule (58 FR 46292), the adopted methodology 
for effectuating FY 1994 MGCRB decisions resulted in the assignment of 
hospitals to the revised labor market area that included ``most or all 
of the counties that comprised the labor market area to which the 
hospital was reclassified by the MGCRB based on the current labor 
market area definitions.'' Others recommended that CMS consider 
retracting the proposal in its entirety and in doing so allow hospitals 
to be reclassified to the area approved by the MGCRB for the full 3 
years.
    Finally, two sets of hospitals commented on special circumstances 
that would arise under the rule as proposed. One group of hospitals 
from Rhode Island commented that the nearest county proposal does not 
take into consideration instances where a hospital or group of 
hospitals reclassified to an area defined under the old MSA definitions 
is assigned to the nearest county which, under the new definitions, is 
in its own home MSA. In another situation, a group of hospitals in the 
Midwest described a situation where, under the new definitions, the MSA 
the hospitals reclassified to splits and the hospitals are assigned to 
the MSA that contains the nearest county from the old MSA. In some 
cases, a hospital may also satisfy the normal distance requirement for 
reclassification into one or more of the new MSAs that were once part 
of the old MSA. In these cases, the commenter believed that a hospital 
should be permitted to reclassify to any MSA that was once part of the 
old MSA for which it meets the normal proximity requirement.
    Response: We acknowledge that the new MSA designations have 
considerable effect on hospital geographic reclassifications under both 
section 1886(d)(8)(B) and 1886(d)(10) of the Act. Because the MGCRB 
reclassifications approved for FY 2005 and prior years are based on the 
old MSA designations, it was necessary to reconcile (as we did with the 
FY 1994 reclassification decisions) the processes of implementing the 
new MSA designations with the MGCRB decisions for FY 2003, FY 2004, and 
FY 2005. As was the case with the implementation of new MSA definitions 
in FY 1994, we have sought to implement the MGCRB decisions in the 
manner that is most consistent with implementing the new labor market 
areas. As we stated in the May 25, 1993 proposed rule (58 FR 30234), 
``* * * we believe that in reconciling the two processes, we must 
balance our obligation to implement the reclassifications prescribed by 
the MGCRB's decisions with our duty to implement the new labor market 
areas in as uniform a manner as possible. Thus, we believe that when a 
hospital

[[Page 49055]]

has been reclassified based on the old MSA definitions, payment to the 
hospital should be based on the new MSA definition most compatible with 
the reclassification decision.'' On the basis of our evaluations, we 
decided not to employ the FY 1994 reclassification assignment rule. 
This is because doing so would have led in many cases to anomalous 
results in the context of the current MSA changes. For example, we 
needed to take in account instances where MSAs split, creating smaller 
MSAs on the boundaries of what was the old MSA. If we were to apply the 
FY 1994 rule to the new MSA designations, many hospitals would have 
been reclassified into MSAs farther away than a new bordering MSA. We 
believe this would have been inconsistent with the proximity rules that 
govern reclassifications.
    However, the commenters on the two situations described above 
persuade us that two refinements to the basic rule are appropriate.
     We will assign the hospital or group of hospitals 
previously reclassified in accordance with sections 1886(d)(8)(B) and 
1886(d)(10) of the Act to an MSA that is splitting, to the MSA outside 
the hospital's own MSA that contains the nearest county from the old 
MSA. For example, under the new MSA designations, the Boston-Worcester-
Lancaster-Lowell-Brockton, MA-NH NECMA was split into several new MSAs. 
The reclassification of Rhode Island hospitals to the old Boston NECMA 
resulted, under our proposal, in an assignment to the Providence-New 
Bedford-River Falls, RI-MA MSA, their home MSA. This is because the 
nearest proximate county of the old Boston NECMA, Bristol County, is 
now part of the Providence-New Bedford-River Falls, RI-MA MSA. Under 
this revision, the Rhode Island hospitals approved for reclassification 
for FY 2005 will be assigned to the Boston-Cambridge-Quincy, MA-NH MSA, 
the nearest outside MSA that contains a county from the old Boston-
Worcester-Lancaster-Lowell-Brockton, MA-NH NECMA.
     In cases where a hospital (or group of hospitals) was 
reclassified under section 1886(d)(8)(B) or section 1886(d)(10) of the 
Act to an MSA that has been split, the hospital may be reclassified to 
any MSA containing counties from the old MSA reclassification provided 
that the hospital demonstrates that it meets the applicable proximity 
requirements in 42 CFR 412.230(b) and (c) (for individual hospitals), 
Sec.  412.232(a)(1) (for a rural group), and Sec.  412.234(a)(2) and 
(a)(3) (for an urban group) or in relation to the MSA.
    We have changed the reclassification assignments for hospitals that 
brought this situation to our attention. Hospitals in this situation 
that wish to be reassigned to the nearest alternate county, for which 
they meet the applicable proximity criteria, may notify us in writing 
within 30 days of the date of publication of this final rule. The 
notification should contain:
     The hospital's name and street address.
     The hospital's provider number.
     The name, title, and telephone number of a contact person.
     The area (name and MSA number) identified in the FY 2005 
reclassification application and the name and MSA number of the 
``assigned'' area.
     Documentation certifying that they meet the requisite 
proximity requirement for assignment to the nearest alternate county.
    We also note that the 1-year transition blend that we have adopted 
for FY 2005 will have the effect of giving hospitals that would 
experience a decrease in wage index due to the new MSA designations, 50 
percent of the wage index determined using the old area definitions for 
MSAs to which the hospital reclassified, and 50 percent of the wage 
index determined using the new area definition for the MSA to which the 
hospital is assigned in this final rule. This provision will mitigate 
any negative effects of the new labor market areas on reclassifying 
hospitals and all other hospitals.
    Comment: One commenter suggested that CMS provide that a hospital 
will not lose SCH status, or other special designations that are 
dependent upon being located in a rural area, by being redesignated 
into an MSA. The commenter further elaborated that the loss of SCH 
status can have profound implications for a hospital, including loss of 
special payment under the hospital inpatient and outpatient payment 
systems and loss of favorable treatment for purposes of geographic 
reclassification. The commenter recommended that CMS provide that 
hospitals with SCH status that are redesignated into an urban area will 
maintain SCH status. The commenter also recommended that, likewise, CMS 
provide that these hospitals will continue to be eligible for hold-
harmless payments under the outpatient PPS, even though these hospitals 
will no longer be physically located in an urban area.
    Response: The regulations at Sec.  412.103(a)(3) provide for a 
hospital located in an urban area to be reclassified as a rural 
hospital if it would qualify as an SCH if it were located in a rural 
area, or if it meets any of the other conditions specified. Because any 
reclassification under this provision is effective as of the filing 
date of the application, existing SCHs that have been redesignated to 
urban areas and otherwise meet all of the requirements for SCH status 
could retain their SCH designation by filing an application for 
reclassification as rural with their CMS Regional Office before October 
1, 2004.
    In order to retain its SCH status when the area in which it is 
located is redesignated from rural to urban, a hospital must apply for 
reclassification as rural under the regulations at Sec.  412.103(a). 
Section 412.103(a) specifies that a prospective payment hospital that 
is located in an urban area may be reclassified as a rural hospital if 
it submits a complete application and meets any of the specified 
conditions, including Sec.  412.103(a)(3), which states, ``The hospital 
would qualify as a rural referral center as set forth in Sec.  412.96, 
or as a sole community hospital as set forth in Sec.  412.92, if the 
hospital were located in a rural area.'' A hospital seeking 
reclassification under this section must submit a complete application 
in writing to its CMS Regional Office. Because any reclassification 
under this provision is effective as of the filing date of the 
application, existing SCHs that have been redesignated to urban areas 
effective October 1, 2004, and otherwise meet all of the requirements 
for SCH status, could retain their SCH designation, without a break in 
status, by filing an application for reclassification as rural with 
their CMS Regional Office before October 1, 2004.
    We note that a hospital located in an urban area and more than 35 
miles from other like hospitals would qualify as an SCH under Sec.  
412.92(a). In order to retain its SCH status by qualifying as an urban 
SCH under this provision, a hospital must submit an application to its 
fiscal intermediary, in accordance with the classification procedure at 
Sec.  412.92(b). According to that procedure, the fiscal intermediary 
would review the request and send the request, with its recommendation, 
to the CMS Regional Office responsible for the hospital. The CMS 
Regional Office would review the request and the fiscal intermediary's 
recommendation and notify the fiscal intermediary of its approval or 
disapproval. SCH status is effective 30 days after the date of CMS' 
written notification to the fiscal intermediary. Therefore, written 
notification dated by

[[Page 49056]]

September 1, 2004, would be effective by October 1, 2004.
    We note that comments regarding the hospital outpatient PPS will 
need to be addressed as part of the outpatient prospective payment 
system rule that is under development.
    Comment: One commenter requested CMS to clarify that rural RRCs 
will not lose that status when they become urban.
    Response: Section 4202(b) of Public Law 105-33 states, in part, 
``Any hospital classified as a rural referral center by the Secretary * 
* * for fiscal year 1991 shall be classified as such a rural referral 
center for fiscal year 1998 and each subsequent year.'' In the August 
29, 1997 final rule with comment period, we reinstated RRC status for 
all hospitals that lost the status due to triennial review or MGCRB 
reclassification, but not to hospitals that lost RRC status because 
they were now urban for all purposes because of the OMB designation of 
their geographic area as urban (62 FR 45999).
    However, subsequently, in the August 1, 2000 final rule, we 
indicated we were revisiting that decision (65 FR 47089). Specifically, 
we stated we would permit hospitals that previously qualified as an RRC 
and that lost their status due to OMB redesignation of the county in 
which they are located from rural to urban to be reinstated as an RRC. 
This policy extends to RRCs located in counties that become urban as a 
result of the new MSAs implemented in this final rule.
    Comment: One commenter suggested that CMS utilize its broad 
discretion under the Act to designate urban hospitals as RRCs for 
purposes of geographic reclassification if such hospitals reflect the 
same characteristics of those facilities currently designated urban 
RRCs. The commenter stated that, otherwise, CMS will fail in its desire 
to treat all RRCs equally and will continue to significantly 
disadvantage other urban hospitals that play the same critical role in 
treating Medicare rural beneficiary populations. The commenter 
suggested designating any hospital meeting the criterion of Sec.  
412.103(a)(3) as it relates to RRCs as an urban RRC for geographic 
reclassification purposes.
    Response: While CMS has broad discretion regarding establishing 
criteria for geographic reclassification purposes under section 
1886(d)(10) of the Act, we are limited in designating a hospital as an 
RRC. Section 1886(d)(5)(C)(I) of the Act limits the Secretary to giving 
RRC status to a hospital that is classified as a rural hospital (with 
certain exceptions for previously designated RRCs, as noted above). In 
other words, CMS is, in fact, limited from granting first-time RRC 
status to a hospital that is not classified as a rural hospital.
    Comment: Another commenter stated that some hospitals, due to 
geography and market size, are located in an urban area but serve a 
high number of rural patients. The commenter further stated that CMS 
noted RRCs play a significant role in treating Medicare beneficiaries 
from rural areas, whether or not a particular hospital is physically 
located in a rural or urban area. The commenter asked that CMS review 
the RRC criteria and revise it so that urban hospitals can qualify for 
RRC status and be on the same level as their urban RRC counterparts.
    Response: There is already a regulatory provision for these urban 
hospitals that are like RRCs to obtain that status by first being 
reclassified as rural. Section 412.103(a)(3) provides for hospitals 
that would otherwise qualify as an RRC if they were rural to be 
reclassified as rural.
c. Redesignations Under Section 1886(d)(8)(B) of the Act
    Beginning October 1, 1988, section 1886(d)(8)(B) of the Act 
required us to treat a hospital located in a rural county adjacent to 
one or more urban areas as being located in the MSA to which the 
greatest number of workers in the county commute, if the rural county 
would otherwise be considered part of an urban area under the standards 
published in the Federal Register on January 3, 1980 (45 FR 956) for 
designating MSAs (and for designating NECMAs), and if the commuting 
rates used in determining outlying counties (or, for New England, 
similar recognized areas) were determined on the basis of the aggregate 
number of resident workers who commute to (and, if applicable under the 
standards, from) the central county or counties of all contiguous MSAs 
(or NECMAs). Hospitals that met the criteria using the January 3, 1980 
version of these OMB standards were deemed urban for purposes of the 
standardized amounts and for purposes of assigning the wage data index.
    Section 402 of Public Law 106-113 provides that, with respect to 
FYs 2001 and 2002, a hospital may elect to have the 1990 standards 
applied to it for purposes of section 1886(d)(8)(B) of the Act and 
that, beginning with FY 2003, hospitals will be required to use the 
standards published in the Federal Register by the Director of OMB 
based on the most recent decennial census. We implemented section 402 
in the August 1, 2001, Federal Register (66 FR 39868). However, at that 
time, updated standards based on the Census 2000 data were not 
available.
    For FY 2005, we are using OMB's 2000 CBSA standards and the Census 
2000 data to identify counties qualifying under section 1886(d)(8)(B) 
of the Act for FY 2005. The number of qualifying counties, shown in the 
following chart, increases from 28 to 98. As we proposed, we are 
providing that, effective for discharges on or after October 1, 2004, 
hospitals located in the rural counties listed in the first column of 
the following table will be redesignated for purposes of assigning the 
wage index to the urban area listed in the second column.
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BILLING CODE 4120-01-C
    As in the past, hospitals redesignated under section 1886(d)(8)(B) 
of the Act are also eligible to be reclassified to a different area by 
the MGCRB. Affected hospitals were requested to compare the 
reclassified wage index for the labor market area in Table 4C in the 
Addendum of the proposed rule into which they have been reclassified by 
the MGCRB to the wage index for the area to which they are redesignated 
under section 1886(d)(8)(B) of the Act. Hospitals were given the 
opportunity to withdraw from an MGCRB reclassification within 45 days 
of the publication of the proposed rule.
    When we apply the OMB 2000 CBSA standards, 16 rural counties no 
longer meet the qualifying criteria to be redesignated, either because 
they are now included in a metropolitan area (with the exception of 
Barry, MI and Cass, MI, most of the counties are now in the 
metropolitan area in which they were grouped in accordance with section 
402) or they fail to meet the 25-percent cumulative out-migration 
threshold when we apply the new OMB standards. Counties that are now 
identified as metropolitan are: Chilton, AL; Macoupin, IL; Piatt, IL; 
Brown, IN; Carroll, IN; Jefferson, KS; Barry, MI; Cass, MI; Ionia, MI; 
Greene, NC; Preble, OH.
    Counties that failed to meet the 25-percent threshold are: 
Marshall, AL; Putnam, FL; Wilson, NC; Van Wert, OH; and Lawrence, PA.
    Comment: Several commenters expressed concern with our proposed 
adoption of the OMB area designations and the impact on county 
designations governed by section 1886(d)(8)(B). Specifically, these 
commenters objected to the proposed adoption because use of the 2000 
Census data to develop the revised designations resulted in five 
counties no longer meeting the qualifying criteria for section 
1886(d)(8)(B) county designation. The commenters argue that because 
they were not given adequate notice that these counties were in danger 
of losing their section 1886(d)(8)(B) county designation, the abrupt 
decrease will have a significant impact on operations. The commenters 
are requesting that CMS extend the three-year hold harmless transition 
to hospitals located in those counties losing their section 
1886(d)(8)(B) county designation.
    Response: In the proposed rule, to help alleviate dramatic negative 
impacts in payment for hospitals designated as urban under the old MSA 
standards, but slated to be classified as rural, we proposed to 
implement a 3-year hold harmless transition period that would allow 
these hospitals to maintain their assignment to the MSA where they are 
currently located for FY 2005, FY 2006, and FY 2007. Specifically, we 
will assign these hospitals, as we did in the proposed rule, the 
prereclassified wage index of the urban area to which they currently 
belong. (For purposes of wage index computation, the wage data of these 
hospitals will remain assigned to the statewide rural area in which 
they are located.) We are finalizing this policy in the final rule. We 
did not propose that the transition period apply to hospitals located 
in those counties losing their designation under section 1886(d)(8)(B). 
Consistent with our longstanding policy that counties redesignated 
under section 1886(d)(8)(B) of the Act, are considered urban for 
purposes of the standardized amount, we are extending the 3-year 
transition to the hospitals located in counties formerly designated as 
urban under 1886(d)(8)(B), because the hospitals are, in fact, losing 
their designated urban status. We are using the wage data from these 
hospitals as part of setting the rural wage index. The higher wage 
indexes these hospitals are receiving are being taken into 
consideration in determining whether they qualify for the out-commuting 
adjustment and the amount of any adjustment. During this 3-year 
transition period, these hospitals are eligible to apply for 
reclassification by the MGCRB. In FY 2008, these hospitals will receive 
their statewide rural wage index. Thus, the hospital would not be 
eligible, for example, for a large urban add-on under capital PPS. 
Thus, it is the wage index, but not the urban or rural status of the 
hospitals, that is being affected by this transition.
    Comment: Commenters indicated that CMS utilized an older 2000 
Census Crosswalk that has since been updated in December of 2003. 
Commenters wanted to know whether or not CMS intends to use this 
updated crosswalk for the final regulation.
    Response: Our initial investigation and analysis of the impact of 
the new metropolitan areas began in the early fall of 2003. In the 
process of this analysis, the update of the crosswalk was overlooked 
and was not incorporated into the proposed rule. We have updated the 
crosswalk for this final regulation and, therefore, the updates are 
incorporated in the calculations and the subsequent output in the 
tables.
    Comment: Commenters noted that CMS improperly classified Merrimack, 
NH and Litchfield, CT. These counties are ``deemed urban'' and, 
therefore, must be included in an urban area.

[[Page 49060]]

    Response: We recognize this oversight. Based on the strongest 
commuting ties, we have incorporated Merrimack, NH into the Manchester-
Nashua, MA MSA (31700), and Litchfield, CT has been placed into the 
Hartford-West Hartford-East Hartford, CT MSA (25540).
    Comment: Commenters expressed opposition to and support of the 
decision to not adopt micropolitan areas. They indicated that the 
financial and reimbursement impact of using these areas is unknown at 
this time, and it appears that further consideration of the effects of 
these changes by CMS is necessary. Some commenters argued that those 
micropolitan areas that were previously included in a metropolitan are 
now unjustly dubbed ``rural.''
    Response: We have provided hospitals in urban counties now 
designated as micropolitan and therefore rural as ``hold harmless,'' 
assigning them the urban wage index for the MSA from which they came. 
We will continue to review the role of micropolitan areas in the 
development of labor market areas for the purposes of the wage index.
d. Reclassifications Under Section 508 of Public Law 108-173
    Under section 508 of Public Law 108-173, a qualifying hospital may 
appeal the wage index classification otherwise applicable to the 
hospital and apply for reclassification to another area of the State in 
which the hospital is located (or, at the discretion of the Secretary, 
to an area within a contiguous State). Hospitals were required to 
submit their applications by February 15, 2004. We implemented this 
process through notices published in the Federal Register on January 6, 
2004 (69 FR 661) and February 13, 2004 (69 FR 7340). Such 
reclassifications are applicable to discharges occurring during the 3-
year period beginning April 1, 2004 and ending March 31, 2007. Under 
section 508(b), reclassifications under this process do not affect the 
wage index computation for any area or for any other hospital and 
cannot be effected in a budget neutral manner.
    The applications submitted under this process were reviewed and 
decided upon by the MGCRB. The MGCRB issued notifications of its 
decisions on April 16, 2004. Reclassifications under this one-time 
appeal process interact with: FY 2005 MGCRB reclassification decisions 
under the ongoing reclassification process described in the regulations 
at Sec. Sec.  412.230 through 412.280; the implementation of the new 
MSA definitions; and the new redesignations under section 1886(d)(8)(B) 
of the Act.
    In the notices implementing this process, we indicated that, with 
limited exceptions, hospitals eligible for reclassification under 
section 508 of Public Law 108-173 are not otherwise reclassified, 
effective for discharges on or after October 1, 2004. Therefore, aside 
from the exceptions specified in the notices, hospitals reclassified 
under this one-time appeal process were not otherwise reclassified by 
the MGCRB for FY 2005. For the hospitals exempted from the ``not 
otherwise classified'' requirement and that received a section 508 
reclassification under the one-time appeal process, the section 508 
takes precedence over any other MGCRB reclassification. We show the 
reclassifications effective under the one-time appeal process in Table 
9B, in the Addendum to this final rule.
    Comment: One hospital commented that the proposed adoption of the 
new MSA designations will result in the hospital being located in a 
county that has been incorporated, under the new designations, into the 
MSA to which they were approved for reclassification. Because they will 
now be located in the area to which they were granted reclassification, 
the hospital argued that its FY 2005 reclassification is, in effect, 
moot.
    Response: We acknowledge that there are situations where hospitals 
that have been reclassified by the MGCRB are located in counties that 
have been incorporated, under the new designations, into the area to 
which the hospitals were approved for reclassification. As a result, 
hospitals in this situation are already located in the area to which 
they requested to be reclassified. In this case, under the new 
designations, these hospitals will be paid by virtue of this change 
based on the payment rates applicable to the requested area and their 
wage data will be reflected in the wage index for that area. Although 
we have acknowledged above that hospitals reclassified to MSAs that 
split need not be reclassified back into their home area, that rule 
would not apply in the situation raised by the commenter. In the 
commenter's case, the area to which it reclassified has now been 
expanded to absorb the hospital's home county. Thus, we need not 
identify an area that can serve as a substitute for the 
reclassification area. Rather, there is no need for the hospital to 
reclassify when it now is originally classified into its desired area.
    Comment: Several hospitals approved for reclassification under 
section 508 objected to our proposal regarding the treatment of 
hospitals that were reclassified under section 508 to areas that have 
since divided because of implementation of the new labor market 
definitions. As we discuss in further detail in section III.H.3.b. 
above, in some cases, the new CBSA definitions result in previously 
existing MSAs being divided into two or more separate MSAs. Given that 
the areas to which the hospitals reclassified no longer exist in FY 
2005, we proposed assigning the hospital to the nearest county in the 
current MSA, and the hospital's FY 2005 reclassification is to the new 
MSA (under the CBSA definitions) that includes that county to which it 
has been assigned. The hospitals argue that consistent with section 
508, when a previous labor market area has split into several different 
areas, they should be permitted to select the area to which to 
reclassify.
    Response: We appreciate the commenters' suggestions and their 
interest in this matter. Based on those comments, and on a careful 
review of the provisions of section 508, we have decided to change our 
proposed policy in the limited case of hospitals that reclassified in 
accordance with section 508 to areas that, because of the new labor 
market definitions, have now been divided into several areas. Because 
section 508(a)(1) of Public Law 108-173 allows a hospital to appeal its 
wage area classification to the Board and ``select another area within 
the state (or, at the discretion of the Secretary, to a contiguous 
State) to which to be reclassified,'' we believe, in these limited 
circumstances, a hospital should be permitted to select the area into 
which it should be reclassified. Specifically, a hospital reclassified 
under the section 508 process to an MSA that, under the new labor 
market definitions, divided into several areas, will be given the 
opportunity to select which of those areas it wishes to reclassify to. 
We believe this is in keeping with the statutory intent of section 508. 
To effect the selection, we will automatically assign these hospitals 
to the divisor MSA with the highest wage index. Hospitals reclassified 
under the one-time appeals process that have been assigned to a new MSA 
are identified in Table 9B, column 7, in the Addendum of this final 
rule. If these hospitals disagree with our selection, they must submit 
to us, in writing, a request to select a different divisor area. 
Requests must be received by us within 30 days of publication of this 
final rule. Requests should be sent to the following address: Centers 
for Medicare and Medicaid Services, Center for Medicare Management, 
Hospital and Ambulatory

[[Page 49061]]

Policy Group, Division of Acute Care, Mailstop C4-08-06, 7500 Security 
Boulevard, Baltimore, Maryland 21244-1850. Attn: Section 508 Appeals.
    In the proposed rule, we also stated that hospitals reclassified 
under the section 508 one-time appeal process that are also in counties 
identified under the redesignation process in accordance with section 
1886(d)(8)(B) of the Act were asked to compare the wage index 
applicable to the area to which they were reclassified under section 
508 with the wage index applicable to the area to which they were 
redesignated under section 1886(d)(8)(B) of the Act, if those areas are 
different. Again, affected hospitals were allowed to withdraw their 
one-time appeal process reclassifications within 45 days of the 
publication of the proposed rule.
    Comment: A hospital association expressed concern that, due to our 
proposal to implement the new CBSAs, hospitals granted a 
reclassification under section 508 of Public Law 108-173 or the 
traditional MCGRB reclassification process may realize little or no 
benefit from the reclassification. The association stated that the 
requirement that a hospital base its decision to withdraw an existing 
reclassification is ``unnecessary'' and ``unfair'' because it requires 
the hospital to ``give up'' the reclassification when there exists the 
possibility that changes effected in the final rule could result in the 
reclassification being beneficial. The association believed that, for 
hospitals reclassified under section 508 or the traditional MGCRB 
process, we should automatically apply the higher wage index for each 
hospital, with no action required by the hospital. Many other 
commenters recommended that CMS allow reclassifying hospitals 30 days 
after publication of the final rule to withdraw their reclassification 
requests.
    Response: In the August 1, 2001 final rule, we included a detailed 
discussion of the withdrawal, termination, and cancellation procedures 
for reclassified hospitals (66 FR 39887). In that rule, we stated that 
a hospital may cancel a previous withdrawal or termination of a 3-year 
wage index reclassification by submitting written notice of intent to 
the MGCRB no later than the deadline for submitting reclassification 
applications effective at the start of the following fiscal year. This 
provision allows the hospital to reinstate the original 
reclassification for the wage index. As we stated in the August 1, 2001 
final rule, we provided this option so that `` a hospital that later 
discovers that the withdrawal of its approved wage index 
reclassification was disadvantageous would have the ability to 
reinstate its MGCRB approval for the wage index for the remaining years 
in the 3-year term.'' Even in light of the existing provision, we are 
persuaded by the comments received in response to the proposed rule, in 
this limited circumstance, to allow hospitals a 30-day period where 
they can make final, informed determinations regarding whether to 
maintain or withdraw their existing reclassification on the basis of 
the information published in the final rule. This 30-day period is also 
applicable to those hospitals that adhered to the established process 
and notified the MGCRB of their decision to withdraw or terminate their 
section 1886(d)(10) or section 508 reclassification. Hospitals will 
have 30 days after the publication date of this rule to submit, in 
writing, to the MGCRB a request to withdraw their reclassification 
request or to rescind their previous withdrawal or termination request.
e. Wage Index Adjustment Based on Commuting Patterns of Hospital 
Employees (Section 505 of Pub. L. 108-173)
    Section 505 of Public Law 108-173 established new section 
1886(d)(13) of the Act. The new section 1886(d)(13) requires that the 
Secretary establish a process to make adjustments to the hospital wage 
index based on commuting patterns of hospital employees. The process 
provides for an increase in the wage index for hospitals located in 
certain counties that have a relatively high percentage of hospital 
employees who reside in the county but work in a different county with 
a higher wage index. Such adjustments to the wage index are effective 
for 3 years beginning with discharges occurring on or after October 1, 
2004. Adjustments under this provision are not subject to the inpatient 
PPS budget neutrality requirements at section 1886(d)(3)(E) or section 
1886(d)(8)(D) of the Act.
    The Secretary is required to establish criteria to identify 
``qualifying counties,'' and hospitals located in such qualifying 
counties are to receive an adjustment to their wage index. Section 
1886(d)(13)(B)(i) of the Act directs the Secretary to establish a 
threshold percentage difference between the county's wage index and the 
weighted average of the wage indexes of the surrounding higher wage 
index area(s) to which hospital employees commute that must be met in 
order for the county to qualify. Section 1886(d)(13)(B)(ii) of the Act 
specifies that the Secretary is also to establish the minimum out-
migration threshold in order to qualify, which may not be less than 10 
percent. Section 1886(d)(13)(iii) of the Act requires that the average 
hourly wage for all hospitals in the county must be equal to or exceed 
the average hourly wage for all hospitals in the labor market area. 
Section 1886(d)(13)(E) of the Act indicates this process may be based 
on the process used by the MGCRB. This section also gives the Secretary 
the authority to require hospitals to submit data necessary to 
implement this provision, or to use other data sources as available.
    Hospitals located in counties that qualify for the payment 
adjustment are to receive an increase in the wage index that is equal 
to a weighted average of the differences between the wage indexes of 
the MSA(s) with higher wage indexes and the wage index of the resident 
county, weighted by the overall percentage of hospital workers residing 
in the qualifying county who are employed in any MSA with a higher wage 
index. We have employed the prereclassified wage indexes in making 
these calculations. We also are not taking into account any of the 
transition payments that are being used to account for the change in 
labor market definitions announced by CMS. We believe it is reasonable 
to interpret the term ``wage index'' in section 1886(d)(13)(D) to mean 
the prereclassified, preadjusted wage index. In response to comment, we 
discuss below our reasons for using the prereclassified wage indexes in 
both identifying higher wage index areas and in calculating the out-
migration adjustment. We believe that it is also reasonable to 
interpret ``wage index'' under section 1886(d)(13) as applying solely 
to the wage index that exists using the most recent CMS definitions for 
labor market areas. Section 505 is a new provision, first being 
implemented for FY 2005, and we do not believe it is necessary to 
incorporate transitional wage index payments, when there is no 
transition necessary. Hospitals were fully able to assess the 
implications of the new labor market areas on implementation of section 
505 through review of the proposed rule. Thus, the higher wage index 
areas will be identified, and the out-migration adjustment will be 
calculated without taking into account the effect on wage index caused 
by either of our transitional rules. We include a detailed discussion 
of these transitional rules in section III.B.3. of this preamble. The 
wage index increase is effective for 3 years, unless a hospital 
requests to waive the application of the payment adjustment. Hospitals 
that receive this payment adjustment are not eligible for

[[Page 49062]]

reclassification under section 1886(d)(8) or section 1886(d)(10) of the 
Act.
(1) Data
    To implement this provision, we analyzed commuting data compiled by 
the U.S. Census Bureau. The data derive from a special tabulation of 
Census 2000 journey-to-work data, compiled from responses to the long-
form (sample) census survey questions on where people worked. When the 
Census conducts its decennial survey, each household receives either a 
short form or a long form. On average, about 1 in every 6 households 
receive the long form. The results from the long form are used to 
formulate descriptive population estimates. Thus, the data set is based 
on the Census 2000 sample and represents estimates of the actual 
figures that would be obtained from a complete count.
    The data provide information about commuting patterns of workers at 
the county level for residents of the 50 States and the District of 
Columbia. Each record within the data set represents a combination of a 
particular resident county, a workplace county, and a particular 
industry category. Thus, the record shows the county-of-residence by 
county-of-work commuter flows. The resident county represents the 
county where the worker resides, while the workplace county represents 
the county where the worker works. The industry category associated 
with workers is based on the 108 Industrial Structure codes developed 
by the Bureau of Economic Analysis. These Industrial Structure codes 
break down economic activities by defining industries (such as 
``fabricated metal product manufacturing,'' ``legal services,'' and 
``gasoline stations''). We limited the data set to those employees 
working in the category designated ``hospitals'' (BEA code 622000).
    Using these data, we are able to identify the total number of 
hospital workers who live in each county and the number of workers 
within that county who commute to hospitals in other counties. For 
example, the data can be used to determine that, from a sample of 100 
hospital employees who live in County A, 50 commute to work at 
hospitals within County A, 20 commute to work at hospitals within 
County B, and 30 commute to work at hospitals within County C.
    There are some intrinsic limitations to the data. The file shows 
the weighted worker estimate for flows using a threshold or minimum 
size of 50 unweighted worker (from all industry codes) records. This 
means that only county-to-county flows that are comprised of at least 
50 unweighted worker records are shown in this file. The Census Bureau 
omitted all other county-to-county flows from the file for 
confidentiality reasons. While this could eliminate the workflows of 
some hospital residents, we believe the eliminations would not have a 
major impact on the policy.
    When Census calculated this special tabulation, the estimates of 
workers numbering from 1 through 7 have been rounded to 4. Values of 8 
or greater have been rounded to the nearest multiple of 5, unless the 
estimate already ended in 5 or 0, in which case it was not changed. In 
addition, in this special tabulation, workers are defined as people 16 
years and older who were employed and at work during the Census long 
form reference week. This is the week prior to when the questionnaire 
was filled out, which was the last week of March 2000 for most people.
    In addition, because these data derive from the decennial census, 
the data file will not change until the census is taken again in 2010. 
This does not mean that the list of qualifying counties will not change 
from year to year. The out-migration percentage for each county is a 
function both of the commuting data and changes in the wage index 
values. Because the wage indexes associated with each work and resident 
county change each year, a county's out-migration percentages can still 
vary each year because a higher wage index area in one year, might not 
be a higher wage index area in the next year. For example, if 100 
hospital employees living in County A (wage index 1.00 in FY 2004) 
commute to County B (wage index 1.10 in FY 2004), then County B would 
be a higher wage index area for 2004. If in FY 2005, County A's wage 
index increases to 1.02 and County B's wage index decreases to 1.01, 
those 100 workers commuting from County A to County B will not be 
commuting to a higher wage index area for 2005. Consequentially, County 
A's out-migration percentage would decrease from 100 percent in 2004 to 
0 percent in 2005. These normal changes in wage index values could also 
result in a county not deemed a qualifying county for FY 2005, becoming 
a qualifying county in FY 2006 or later.
    We believe these data provide a useable data source to implement 
this provision. However, in the May 18, 2004 proposed rule, we 
solicited comments on the availability and value of alternative data 
sources. Although the statute authorizes the Secretary to require all 
hospitals to submit data on the commuting patterns of their employees, 
such a requirement would be a major undertaking for the hospital 
industry and CMS. It was not possible to pursue this approach in time 
to implement the provision by FY 2005. However, in addition to 
soliciting comments on the merits of relying on the Census data, we 
welcomed comments on the feasibility of surveying hospitals on the 
residence and commuting patterns of all their hospital employees for 
purposes of developing future year adjustments.
    Comment: One commenter questioned whether it would be possible in 
future years to update commuting data using data from U.S. Census 
Bureau's American Community Survey (ACS) rather than using data from 
the 2000 census.
    Response: The ACS is part of the U.S. Census Bureau's effort to 
streamline and improve the census, and is intended to replace the long 
form and provide some demographic information every year instead of 
once every 10 years. Starting in July 2004, 1 in every 480 households 
throughout America will receive and be asked to participate in the 
survey each month. Since this is a new initiative, we are unable to 
determine whether the data that will be collected is appropriate for 
use in calculating the out-migration adjustment. However, as the U.S. 
Census Bureau moves forward with this initiative, we will continue to 
monitor the initiative's progress and evaluate the feasibility of using 
data from the ACS to calculate the out-migration adjustment.
    Comment: Several comments stated that the commuting data does not 
reflect the ``new potential for increased commuting,'' in a specific 
instance where a county used to be part of an MSA, but no longer is due 
to the new MSA definitions. The commenters stated that the reduced 
reimbursement resulting from the new MSA definitions will create the 
potential for increased commuting in future years, even though the 
county qualified for an out-migration adjustment. The commenters 
recommended we ``adjust the commuting index to a more appropriate value 
based on opportunity and not based solely on historical data.''
    Response: The commenters did not provide suggestions on how we 
would consistently measure the ``opportunity'' for increased commuting. 
Therefore, we are unable to address the commenters' concerns at this 
time. As we stated in the proposed rule, we will use the decennial 
census in order to determine commuting rates. We note that as part of 
its new definitions of statistical areas, OMB takes into account the 
level of commuting. Thus, the new areas should reflect any increased 
commuting that

[[Page 49063]]

has already occurred from one county to another.
    Comment: One commenter stated that it is unclear as to how we will 
measure commuting patterns and determine the applicability of the wage 
index adjustment. The commenter requested that we describe the proposed 
data resources and methodology that will be used for applying the wage 
index adjustment.
    Response: We note that in the May 18, 2004 proposed rule and in 
this final rule, we discussed the data set used for measuring out-
migration patterns and the process for determining the out-migration 
adjustments. (See sections III.H.3.e.(1) and 3.e.(3) of this preamble, 
respectively.)
    Comment: A commenter asked if the data used by CMS to compute the 
out-migration adjustment will be made available via a public use file.
    Response: We plan to make the data used for determining the 
qualifying counties and the out-migration adjustment available after 
the publication of this final rule on the CMS Web site at http://www.cms.gov.
    Comment: One commenter requested that CMS allow hospitals to submit 
their own commuting data to apply for the out-migration adjustment.
    Response: Because the adjustment is based on the number of hospital 
workers in a county who commute to other higher wage index areas, we 
believe it would be extremely problematic for individual hospitals to 
track and submit the data necessary for the out-migration adjustment. 
The hospital could not simply survey their own employees to obtain this 
necessary data, but would have to survey all hospital workers who live 
in the county where the hospital is located and commute to hospitals in 
other higher wage index areas.
    In addition, we did not receive any specific comments on the 
availability of an alternative data source or on the feasibility of 
surveying hospitals on the residence and commuting patterns of their 
employees for purposes of developing future year adjustments. We also 
received comments supportive of our general implementation process and 
its administrative simplicity. The commenters noted the merits of using 
this data set and not placing an additional burden on hospitals through 
a survey of employees. Therefore, we will use our proposed data set for 
purposes of computing the qualifying counties and the out-migration 
adjustment. However, we will continue to explore the possibility that 
hospitals could submit their own data in future refinements of our 
policy.
(2) Qualifying Counties
    As noted previously, section 1886(d)(13)(B)(iii) of the Act 
requires that, to qualify for this commuting wage index adjustment, the 
average hourly wage for all hospitals in the county must be equal to or 
exceed the average hourly wage for all hospitals in the labor market 
area in which the county is located. To determine which counties meet 
this requirement, we calculated the average of hospitals' 3-year 
average hourly wages for all hospitals in a given county. We compared 
this county average 3-year average hourly wage to the 3-year average 
hourly wage for the labor market area where the county is located. We 
chose to use the 3-year average hourly wage because we believe it 
provides a more accurate and stable estimate for the wages paid by a 
given hospital over a period of time. This statutory requirement limits 
the number of eligible counties, as counties with an average 3-year 
average hourly wage less than the 3-year average hourly wage of the MSA 
where the county is located were not considered to meet this 
requirement.
    Some resident counties do not have average hourly wages because 
either there is no hospital located in the county, or the only hospital 
in the county is new and has not yet submitted wage data. We did not 
consider these counties to have met the average hourly wage criteria 
and thus hospitals in these counties are not yet eligible to receive an 
increase in wage index. This is consistent with our regulations at 
Sec.  412.230(e)(2)(iii), which require a new hospital to accumulate at 
least 1 year of wage data, before it is eligible to apply for 
reclassification.
    As noted previously, section 1886(d)(13)(B)(ii) of the Act 
specifies that the Secretary is to establish the minimum out-migration 
threshold in order to qualify, which may not be less than 10 percent. 
To determine the out-migration percentage for each county, we 
identified higher wage index areas, by comparing 2005 prereclassified 
wage index of a resident county with the 2005 prereclassified wage 
index of the MSA or rural statewide area where the work county is 
located. We use the prereclassified wage index so that hospitals in the 
county are not disadvantaged by reclassification of other hospitals 
into the county.
    Comment: One commenter recommended that the wage index amounts 
utilized in the calculation for the higher wage county be based on the 
wage index utilized for Medicare payment including those increases in 
wage index due to a group reclassification appeal. The commenter stated 
that not utilizing this higher wage index amount would put the 
hospitals addressed by the commuting adjustment provision at a serious 
disadvantage.
    Response: We considered using the post-reclassified wage index as 
the basis for computing the higher wage index counties. In situations 
like the group reclassification where all hospitals in a given county 
are receiving the same wage index, it could be possible to use the 
post-reclassified wage index for determining higher wage index counties 
and for calculating the out-migration adjustment. However, it is not as 
straightforward for counties where not all hospitals are receiving the 
same wage index due to individual hospital reclassifications. For 
example, in one county there may be two hospitals that receive 
different wage indexes because one hospital has been reclassified. 
Given the differing wage indexes in this situation, it is unclear which 
wage index would be most appropriate to use as the basis for comparison 
for this county or if some form of a blended wage index should be 
calculated. This issue is further complicated by the use of a blended 
wage index this year to mitigate the effects of the new MSA 
definitions. Due to these complicating factors, and the fact that the 
prereclassified wage index most accurately reflects the wages being 
paid to hospital employees in a given geographic area, we believe that 
the most equitable method is to use the prereclassified wage index when 
calculating the qualifying counties and the out-migration adjustment. 
However, we will continue to examine the possibility of employing post-
reclassification wage indexes as we refine our policy for future 
adjustments.
    Comment: One commenter asked how the out-migration adjustment will 
be made in subsequent years, specifically if CMS increases the wage 
index of qualifying counties by the out-migration adjustment when 
calculating higher wage index counties in subsequent years. The 
commenter identified a potential ripple effect if the data we use in 
year two incorporates the new higher wage index value (resulting from 
the additional out-migration adjustment) when identifying the county-
to-county flows where hospital employees were commuting to a higher 
wage index area.
    Response: We appreciate the opportunity to clarify this important 
point. We recognize that if we used the new wage index (wage index plus 
commuting adjustment) when computing the higher wage index counties, 
the effect of the out-migration adjustment could ripple out each year 
to

[[Page 49064]]

more counties. Consequently, in future years, we plan to identify the 
higher wage index counties and compute the adjustment using the 
prereclassified wage index without the additional out-migration 
adjustment. We believe that this will more appropriately reflect the 
intent of the statute without creating unanticipated effects.
    Once we limited the dataset to those county-to-county flows where 
hospital employees were commuting to a higher wage index area, we 
calculated the out-migration percentage for resident counties. To 
calculate the out-migration percentage, we calculated the total number 
of hospital employees in a resident county who were commuting to a 
higher wage area as a percentage of the total number of hospital 
employees residing in the resident county. For example, there are 100 
hospital employees who live in County A (wage index 1.0). Of those 100 
employees, 50 commute to County B (wage index 1.10), 20 commute to 
County C (wage index 1.05), and 30 work within County A. Because 70 out 
of 100 people commute to higher wage areas, County A's out-migration 
percentage is equal to 70 percent.
    To implement section 1886(d)(13)(B)(ii) of the Act, in the May 18, 
2004 proposed rule (69 FR 28267), we proposed that the out-migration 
threshold to qualify for this adjustment would be the statutory minimum 
of 10 percent. We believe that this threshold provides an opportunity 
for a reasonable number of hospitals that would not have recourse to 
the normal reclassification process to receive an appropriate 
adjustment to their wage index. We welcomed public comment on this 
proposed threshold.
    Comment: Many commenters supported our decision to set the out-
migration threshold at the statutory minimum of 10 percent.
    Response: We note that we did not receive any comments recommending 
that we increase the threshold and we do not plan to change the 
threshold in this final rule. Therefore, we are finalizing the out-
migration threshold at the statutory minimum of 10 percent.
    As noted previously, section 1886(d)(13)(B)(i) of the Act directs 
the Secretary to establish a threshold percentage difference between 
the county's wage index and the weighted average wage indexes of the 
higher wage index areas to which hospital employees commute. However, 
unlike the threshold for the level of out-migration, the statute does 
not designate a minimum level for this threshold. Because of the nature 
of the adjustment provided under this provision, in the May 18, 2004 
proposed rule (69 FR 28268), we proposed to establish that the minimum 
difference in the wage indexes between the resident county and the work 
county can be any percentage greater than zero. We proposed this 
threshold because the wage index increment for hospitals in qualifying 
counties under the statutory formula is a function of the differences 
between that county's wage index and the wage indexes of the areas into 
which resident hospital workers of that county are commuting. In those 
cases where that difference is very small, the adjustment to the wage 
index will also be very small. (See the discussion of the statutory 
formula in section III.H.3.e.(3) of this preamble.) Therefore, we 
believe that a threshold of anything greater than zero is justifiable 
and consistent with the purposes of this provision.
    Comment: Many commenters supported our decision not to set a 
minimum difference between the wage index that applies to the county 
and the higher wage index areas.
    Response: We do not plan to change the minimum difference 
requirement in this final rule; and therefore, establish the minimum 
difference in the wage indexes between the resident county and the work 
county to be any percentage greater than zero.
    Our analysis for the proposed rule indicated that 224 counties 
qualify under the proposed criteria. There were 411 hospitals located 
in these qualifying counties. For the final rule, we have identified 
230 counties that qualify under the proposed criteria. There were 415 
hospitals located in these qualifying counties. Hospitals located in 
qualifying counties are identified in Table 4J in the Addendum to this 
final rule. Of the 415 hospitals, 181 are reclassified under section 
1886(d)(8) of the Act, redesignated under section 1886(d)(10) of the 
Act or received a section 508 reclassification and are signified in 
Table 4J in the Addendum to this final rule with asterisks. Given the 
statutory limitation on hospitals receiving the out-migration 
adjustment and reclassification under section 1886(d)(8) of the Act, 
redesignation under section 1886(d)(10) of the Act, or reclassification 
under section 508, we assume that hospitals represented by asterisks 
that have already been reclassified or redesignated, wish to retain 
their reclassification or redesignation and not receive the out-
migration adjustment. Only one of the redesignated hospitals informed 
us that they would like to waive the application of their redesignation 
for the purposes of receiving the out-migration adjustment. As 
described in section III.H.3.e.(4) of this preamble, hospitals have an 
additional 30 days from the date of publication of this final rule to 
notify CMS if they would like to waive their reclassification or 
redesignation in order to receive the out-migration adjustment.
(3) The Adjustment
    Hospitals located in the qualifying counties identified in Table 4J 
in the Addendum to this final rule that have not already reclassified 
through section 1886(d)(10) of the Act, redesignated through section 
1886(d)(8) of the Act, received a section 508 reclassification, or 
requested to waive the application of the out-migration adjustment will 
receive the wage index adjustment listed in the table. This adjustment 
increase is equal to the percentage of the hospital employees residing 
in the qualifying county who are employed in any higher wage area, 
multiplied by the sum of: the products, for each higher wage index 
area, of the difference between the wage index for such higher wage 
index area and the wage index of the qualifying county, and the 
percentage of hospital employees residing in the qualifying county who 
are employed in any higher wage index area who are employed in such 
higher wage index area. This increase in wage index is depicted using 
the following equation:

Adjustment = A * [Sigma][(B-C) * (D/E)]

    A is the percentage of hospital employees residing in a qualifying 
county who are employed in any higher wage index area. B represents the 
wage index of the higher wage index area. C represents the wage index 
of the qualifying resident county. D represents the number of hospital 
employees residing in the qualifying county involved who are employed 
in such higher wage index area. E represents the total number of 
hospital employees residing in qualifying county who are employed in 
any higher wage index area.
    For example, County A is identified as a qualifying county. As 
illustrated before, if 100 hospital employees live in County A (wage 
index = 1.00), 50 commute to County B (wage index = 1.10), 20 commute 
to County C (wage index = 1.05); and 30 commute within County A, the 
out-migration percentage is equal to 70 percent.
    The adjustment for hospitals in County A would be:

= .70 * (((1.10 - 1.00)*(50/70)) + ((1.05 - 1.00)*(20/70)))
= .70 * ((.10 * .714) + (.05 * .285))
= .70 * (0.0714 + 0.01428)
= .70 * (0.0856)

[[Page 49065]]

= 0.05998

    So, hospitals in County A could receive a new wage index of 
1.05998, instead of 1.000 for the following 3 years.
    The adjustments calculated for qualifying hospitals are listed in 
Table 4J in the Addendum to this final rule. These adjustments are 
effective for each county for a period of 3 fiscal years beginning with 
discharges occurring on or after October 1, 2004. The commuting 
adjustments for each county will remain static for the 3-year period, 
after which the county's status as a qualifying county and the 
adjustment will be recalculated.
    Comment: Several commenters questioned the temporary nature of the 
out-migration adjustment. They suggested that CMS modify the rule to 
extend the out-migration adjustment beyond the 3-year period in order 
to reflect ongoing wage competition.
    Response: Section 1886(d)(13)(F) of the Act specifies that the wage 
index increase shall be applied for a period of 3 fiscal years. 
Therefore, we do not have the discretion to extend the time period. 
However, we will evaluate and designate qualifying counties each year. 
Therefore, it is possible that after a qualifying county's 3-year 
period ends, the county again will become a qualifying county and 
receive a new out-migration adjustment for another 3-year time period.
    Comment: Several commenters noted that the commuting adjustment is 
based the commuting flows of hospital employees alone, while clinicians 
can work in many nonhospital environments. Thus, the commenter stated 
that the data used for the commuting adjustment does not address the 
economic reality facing certain areas because it does not incorporate 
data from clinicians working in nonhospital environments.
    Response: Section 1886(d)(13) of the Act specifies that the 
adjustment be based on the out-migration patterns of hospital 
employees. Thus, we do not have flexibility to incorporate data based 
on the commuting patterns of clinicians working in nonhospital 
environments in the out-migration adjustment.
    Comment: One commenter requested that the out-migration adjustment 
be given to all counties within an MSA, to avoid competitive 
disadvantages within an MSA.
    Response: Section 1886(d)(13) of the Act specifies that the 
adjustment is applied to qualifying counties, not to MSAs. In keeping 
with this provision, we are adopting the provision that was in the 
proposed rule that we will apply the out-migration adjustment at a 
county level and not to all counties within an MSA.
    Comment: Several commenters stated that the out-migration 
adjustment only captures the success of other hospitals recruiting 
labor from areas, but fails to recognize the cost of recruiting and 
retaining hospital employees. One commenter noted that the formula does 
not take into account the in-migration of hospital employees who live 
in other MSAs and recommends that CMS address this issue to include a 
more comprehensive measure of the interchange between adjacent MSAs.
    Response: Section 1886(d)(13) of the Act specifies that the 
adjustment be made based on the out-migration of hospital employees. 
Therefore, we do not have the discretion to make additional adjustments 
based on the in-migration of hospital employees.
    Comment: One commenter stated that the out-migration adjustment 
demonstrates that ``CMS is aware that many hospital's wage index would 
be significantly affected by the OMB's revised definitions of 
geographic statistical areas.'' The commenter also stated that the 
provision does not go far enough to stabilize the severe impact of 
changes in the MSAs.
    Response: Section 505 of Public Law 108-173 established a provision 
to recognize the out-migration of hospital employees. This statutory 
provision is separate and distinct from OMB's release of updated MSA 
definitions. We believe the commenter is incorrect in linking the two 
provisions, because the out-migration adjustment was not explicitly 
established to mitigate the effects of the new MSA definitions. We also 
note that the blended wage index described in section III.G. of the 
preamble of this final rule is specifically intended to help mitigate 
the impacts of the adoption of the new MSA definitions.
(4) Automatic Adjustments
    Section 1886(d)(13)(A) of the Act allows the Secretary to establish 
the process for receiving this increase in wage index through 
application or otherwise. Listed in Table 4J in the Addendum to this 
final rule are the counties and corresponding hospitals that qualify 
for an increase in wage index through our implementation of the 
section. This list includes the universe of hospitals that could 
receive the adjustment, including those who are redesignated under 
section 1886(d)(8) of the Act or reclassified under section 1886(d)(10) 
of the Act. Hospitals located in qualifying counties that have not 
already been reclassified or redesignated to another geographic area 
for purposes of the wage index amount (including reclassifications 
under section 508 of Pub. L. 108-173) will automatically receive the 
increase in wage index. This commuting wage index adjustment will be 
effective for the county for a period of 3 fiscal years, FY 2005 
through FY 2007. As discussed previously, yearly changes in the wage 
indexes associated with areas could result in changes in the out-
migration percentage for a given county. Irrespective of these changes, 
a county will not lose its status as a qualifying county due to wage 
index changes during the 3-year period, and counties will receive the 
same wage index increase for those 3 years. However, a county that 
qualifies in FY 2005 may no longer qualify in FY 2008, or it may 
qualify but receive a different adjustment level.
    In the May 18, 2004 proposed rule, we invited public comment on the 
automatic application of such a wage index adjustment, and whether an 
application process should be developed under which individual 
hospitals would have to apply in order to receive the adjustment. We 
noted that, given the short timeframe before implementation of this 
provision on October 1, 2004, we believe that there is no practical 
alternative to providing for an automatic adjustment for FY 2005. 
However, one possibility was to employ an automatic adjustment process 
this year, and to replace the automatic process with an application 
process for future years. We invited comments on whether to establish 
the automatic process permanently, or to devise an application process 
for future years. We also invited public comment on whether any 
application process should be the responsibility of the MGCRB or some 
other entity.
    Comment: One commenter expressed support for the automatic nature 
of the out-migration adjustment.
    Response: We appreciate the commenter's support. In addition, we 
did not receive specific comments on whether we should devise an 
application process for the out-migration adjustment in future years. 
However, we believe that numerous comments in support of our general 
implementation process and its administrative simplicity suggest that 
hospitals also appreciate the merits of an automatic application of the 
out-migration adjustment. Thus, we are adopting our proposal of 
applying the adjustment on an automatic basis to all hospitals in 
qualifying counties except those that have already been reclassified 
under section 1886(d)(10) of the Act, or

[[Page 49066]]

under section 508 of Public Law 108-173 redesignated under section 
1886(d)(8)of the Act, or requested waiver of the application of the 
out-migration adjustment.
    Hospitals receiving this wage index increase under section 
1886(d)(13)(F) of the Act are not eligible for reclassification under 
section 1886(d)(8) or section 1886(d)(10) of the Act, including 
reclassifications under section 508 of Public Law 108-173. As 
previously noted, the wage index increase is effective for 3 years, 
unless a hospital elects to waive the application of the wage index 
adjustment. Hospitals that wished to waive the application of this wage 
index adjustment were asked to notify CMS within 45 days of the 
publication of the proposed rule. However, consistent with Sec.  
412.273, hospitals that have been reclassified by the MGCRB were 
permitted to withdraw their applications within 45 days of the 
publication of the proposed rule in the Federal Register. Hospitals 
that have been reclassified by the MGCRB (including reclassifications 
under section 508 of Public Law 108-173) were permitted to terminate an 
existing 3-year reclassification within 45 days of the publication of 
the proposed rule in order to receive the wage index adjustment under 
this provision. Hospitals that are eligible for this adjustment and 
that have not been reclassified through section 1886(d)(10) of the Act 
or under section 508 of Public Law 108-173, redesignated through 
section 1886(d)(8) of the Act, or requested waiver of the application 
of the out-migration adjustment will automatically receive the wage 
index adjustment listed in Table 4J in the Addendum to this final rule. 
In our proposed rule, we stated that the request for withdrawal of an 
application for reclassification or termination of an existing 3-year 
reclassification had to be received by the MGCRB within 45 days of 
publication of the proposed rule. We asked hospitals to carefully 
review the wage index adjustment that they would receive under this 
provision (as listed in Table 2 in the Addendum to the proposed rule) 
in comparison with the wage index that they would receive under MGCRB 
reclassification (Table 9 in the Addendum to the proposed rule).
    Comment: Many commenters questioned the timing of hospitals 
reclassification decisions for FY 2005 because of the changes to the 
wage index reclassification in this year's proposed rule (including the 
new MSA definitions, section 1886(d)(8)(B) redesignations, and the out-
migration adjustment). The commenters noted that since the 45-day 
timeframe for hospitals to waive their reclassification request ends 
before publication of the final rule, hospitals are unable to 
appropriately evaluate the impacts of their reclassification decisions 
before to the deadline for withdrawing an approved reclassification. 
Commenters suggested that CMS allow hospitals 30 days after publication 
of the final rule to withdraw a reclassification request in order to 
receive the out-migration adjustment instead. Commenters also requested 
that CMS clarify that hospitals eligible for the out-migration 
adjustment, but were already reclassified for FY 2005, were not 
required to submit a formal waiver request to retain their existing 
reclassification.
    In addition, several commenters questioned how the out-migration 
adjustment affects counties that are redesignated under section 
1886(d)(8)(B) of the Act (Lugar counties). Specifically, one commenter 
requested clarification on how hospitals that are eligible for 
redesignation under section 1886(d)(8)(B) of the Act and the out-
migration adjustment are to notify CMS as to which provision they wish 
to take advantage of because hospitals are automatically redesignated 
under section 1886(d)(8)(B) of the Act, and do not have a 
reclassification request to withdraw. The commenter also requested that 
hospitals be given the opportunity to determine whether they want to 
accept the section 1886(d)(8(B) of the Act redesignation or the out-
migration adjustment when the final rule is published.
    Response: Section 1886(d)(13)(G) of the Act specifies that the out-
migration adjustment is not eligible for a hospital that has received 
redesignation under section 1886(d)(8) of the Act or reclassification 
under section 1886(d)(10) of the Act during that period (unless they 
waive their reclassification/redesignation). In the vast majority of 
cases, we believe that it is most advantageous for hospitals that have 
been granted redesignation under section 1886(d)(8) of the Act, 
reclassification under section 1886(d)(10) of the Act or section 508 of 
Public Law 108-173 to retain the redesignation or reclassification 
instead of the out-migration adjustment. However, there may be a 
circumstance in which it is in the hospital's best interest to 
terminate its redesignation or reclassification because the out-
migration adjustment results in a higher wage index. Given the number 
of changes in the proposed rule and the apparent confusion regarding 
the automatic application of the out-migration adjustment, we are 
allowing hospitals a 30-day period from the date of this final rule 
during which they can decide if they would rather take advantage of 
their redesignation or reclassification or the out-migration 
adjustment. Therefore, hospitals will have 30 days from the date of 
publication of this final rule to submit to CMS a request to withdraw 
their reclassification requests under section 1886(d)(10) of the Act, 
section 508 of Public Law 108-173, or their redesignated status under 
section 1886(d)(8) of the Act and receive the out-migration adjustment 
instead. Hospitals must submit their request to the following address: 
Centers for Medicare & Medicaid Services, Center for Medicare 
Management, Attention: Wage Index Adjustment Waivers, Division of Acute 
Care, C4-08-06, 7500 Security Boulevard, Baltimore, MD 21244-1850.
    As previously noted, we will assume that hospitals that have been 
redesignated under section 1886(d)(8) of the Act, reclassified under 
section 1886(d)(10) of the Act or under section 508 of Public Law 108-
173 would prefer to keep their redesignation/reclassification unless 
they explicitly notify CMS that they would like to receive the out-
migration adjustment instead. Additionally, we are clarifying that 
hospitals that wish to retain their redesignation/reclassification 
(instead of getting the out-migration adjustment) for FY 2005 did not 
and do not have to submit a formal request to CMS, and will 
automatically retain their reclassification/redesignation status for FY 
2005.
    The hospitals listed in Table 4J include all the hospitals that 
could possibly take advantage of the out-migration adjustment. 
Hospitals marked with an asterisk represent those hospitals that could 
have received the out-migration adjustment, but are assumed to be 
taking advantage of their reclassification or redesignation status (and 
consequently not the out-migration adjustment) for FY 2005. These 
hospitals do not have to do anything if they would like to remain 
reclassified/redesignated and not receive the out-migration adjustment.
    Comment: Several commenters requested that we clarify if hospitals 
will have the same option to withdraw their reclassification or 
redesignation if they would rather receive the out-migration adjustment 
in subsequent years.
    Response: In subsequent fiscal years, we will use the same process 
we proposed for FY 2005 to allow hospitals to withdraw their 
reclassification or redesignation requests and receive the

[[Page 49067]]

out-migration adjustment as long as their county remains a qualifying 
county. That is, hospitals will be able to terminate their 
reclassification or redesignation and take advantage of the out-
migration adjustment if they notify CMS within 45 days of the notice of 
proposed rulemaking. We note that in upcoming years, we do not expect 
to allow any withdrawals after that date, as we have done in this final 
rule (allowing 30 days after publication of the final rule to withdraw 
a reclassification or redesignation). We note that by the time the 
proposed rule is published in 2005, hospitals will be familiar with the 
new labor market areas and the policies for adopting such areas will 
have been finalized.
    Comment: Several commenters requested clarification on the ability 
of hospitals to apply for reclassification in future year if they 
receive the out-migration adjustment in FY 2005. Specifically, the 
commenter asked whether a hospital that qualifies for the out-migration 
adjustment effective for October 1, 2004, through September 30, 2005, 
will be able to request geographic reclassification effective for 
October 1, 2005, under the normal reclassification process. Similarly, 
another commenter asked if a hospital would be able to receive the out-
migration adjustment at the time their MGCRB reclassification expires.
    Response: It is our intent that hospitals should be able to 
evaluate the merits of reclassification and the out-migration 
adjustment on an annual basis. Given the statutory prohibition on 
hospitals being redesignated or reclassified (under section 1886(d)(8) 
or section 1886(d)(10) of the Act) and receiving the commuting 
adjustment, hospitals cannot receive both the out-migration adjustment 
and reclassification in the same year. We agree with the commenter that 
a hospital should not have to forgo the out-migration adjustment in FY 
2005 in order to be able to apply for reclassification in FY 2006. 
Hospitals that qualify for the out-migration adjustment in a given year 
can take advantage of that adjustment in that year, and can still apply 
to be reclassified in the subsequent year. Hospitals that apply for 
reclassification for FY 2005 will be viewed as implicitly waiving the 
out-migration adjustment for that fiscal year, assuming they receive 
the reclassification requested. Conversely, if a hospital's 
reclassification request is not approved in a given year and the 
hospital remains eligible for the out-migration adjustment, the 
hospital will automatically receive the out-migration adjustment.
4. FY 2005 Reclassifications
    The wage index values for FY 2005 (except those for hospitals 
receiving wage index adjustments under section 505 of Pub. L. 108-173) 
are shown in Tables 4A, 4B, 4C, and 4F in the Addendum to this final 
rule. Hospitals that are redesignated will be required to use the wage 
index values shown in Table 4C. Areas in Table 4C may have more than 
one wage index value because the wage index value for a redesignated 
urban or rural hospital cannot be reduced below the wage index value 
for the rural areas of the State in which the hospital is located. 
Therefore, those areas with more than one wage index shown have 
hospitals from more than one State reclassified into them, and the 
rural wage index for a State in which at least one hospital is 
physically located is higher than the wage index for the area to which 
the hospital is reclassified.
    Tables 3A and 3B in the Addendum to this final rule list the 3-year 
average hourly wage for each labor market area before the redesignation 
of hospitals, based on FYs 1999, 2000, and 2001 cost reporting periods. 
Table 3A lists these data for urban areas and Table 3B lists these data 
for rural areas. In addition, Table 2 in the Addendum to this final 
rule includes the adjusted average hourly wage for each hospital from 
the FY 1999 and FY 2000 cost reporting periods, as well as the FY 2001 
period used to calculate the FY 2005 wage index. The 3-year averages 
are calculated by dividing the sum of the dollars (adjusted to a common 
reporting period using the method described previously) across all 3 
years, by the sum of the hours. If a hospital is missing data for any 
of the previous years, its average hourly wage for the 3-year period is 
calculated based on the data available during that period.
    We are including in the Addendum of this final rule Table 9A, which 
shows hospitals that have been reclassified under either section 
1886(d)(8) or section 1886(d)(10)(D) of the Act. This table includes 
400 hospitals reclassified for FY 2005 by the MGCRB (for wage index 
purposes), as well as hospitals that were reclassified for the wage 
index in either FY 2003 (53 hospitals) or FY 2004 (102 hospitals) and 
are, therefore, in either the second or third year of their 3-year 
reclassification. This table also includes hospitals located in urban 
areas that have been redesignated rural in accordance with section 
1886(d)(8)(E) of the Act (17). In addition, it includes rural hospitals 
redesignated to urban areas under section 1886(d)(8)(B) of the Act for 
purposes of the wage index (98).
    Under Sec.  412.273, hospitals that have been reclassified by the 
MGCRB are permitted to withdraw their applications within 45 days of 
the publication of a proposed rule. The request for withdrawal of an 
application for reclassification or termination of an existing 3-year 
reclassification that would be effective in FY 2004 must be received by 
the MGCRB within 45 days of the publication of the proposed rule. If a 
hospital elects to withdraw its wage index application after the MGCRB 
has issued its decision but prior to the above date, it may later 
cancel its withdrawal in a subsequent year and request the MGCRB to 
reinstate its wage index reclassification for the remaining fiscal 
year(s) of the 3-year period (Sec.  412.273 (b) (2) (i)). The request 
to cancel a prior withdrawal must be made in writing to the MGCRB no 
later than the deadline for submitting reclassification applications 
for the following fiscal year (Sec.  412.273 (d)). For further 
information about withdrawing, terminating, or canceling a previous 
withdrawal or termination of a 3-year reclassification for wage index 
purposes, we refer the reader to Sec.  412.273, as well as the August 
1, 2002, IPPS final rule (67 FR 50065) and the August 1, 2001 IPPS 
final rule (66 FR 39887).
    Changes to the wage index that result from withdrawals of requests 
for reclassification, wage index corrections, appeals, and the 
Administrator's review process have been incorporated into the wage 
index values published in this final rule. These changes may affect not 
only the wage index value for specific geographic areas, but also the 
wage index value redesignated hospitals receive; that is, whether they 
receive the wage index that includes the data for both the hospitals 
already in the area and the redesignated hospitals. Further, the wage 
index value for the area from which the hospitals are redesignated may 
be affected.
    Applications for FY 2006 reclassifications are due to the MGCRB by 
September 1, 2004. We note that this is also the deadline for canceling 
a previous wage index reclassification withdrawal or termination under 
Sec.  412.273(d). Applications and other information about MCGRB 
reclassifications may be obtained, beginning in mid-July 2004, via the 
CMS Internet Web site at: http://cms.hhs.gov/providers/prrb/mgcinfo.asp, or by calling the MCGRB at (410) 786-1174. The mailing 
address of the MGCRB is: 2520 Lord Baltimore Drive, Suite L, Baltimore, 
MD 21244-2670.

[[Page 49068]]

I. Requests for Wage Index Data Corrections

1. Worksheet S-3 Wage Data
    In the August 1, 2003, final rule (68 FR 27194), we revised the 
process and timetable for application for development of the wage 
index, beginning with the FY 2005 wage index. The preliminary and 
unaudited Worksheet S-3 wage data file was made available on October 8, 
2003 through the Internet on CMS's Web site at: http://cms.hhs.gov/providers/hipps/ippswage.asp. In a memorandum dated October 10, 2003, 
we instructed all Medicare fiscal intermediaries to inform the IPPS 
hospitals they service of the availability of the wage data file and 
the process and timeframe for requesting revisions (including the 
specific deadlines listed below). We also instructed the fiscal 
intermediaries to advise hospitals that these data are also made 
available directly through their representative hospital organizations.
    If a hospital wished to request a change to its data as shown in 
that wage data file, the hospital was to submit corrections along with 
complete, detailed supporting documentation to its intermediary by 
November 24, 2003. Hospitals were notified of this deadline and of all 
other possible deadlines and requirements, including the requirement to 
review and verify their data as posted on the preliminary wage data 
file on the Internet, through the October 10, 2003 memorandum 
referenced above.
    The fiscal intermediaries notified the hospitals in early February 
of any changes to the wage data as a result of the desk reviews and the 
resolution of the hospitals' early November change requests. The fiscal 
intermediaries also submitted the revised data to CMS in early 
February. CMS published the proposed wage index public use file that 
included hospitals' revised wage data on February 27, 2004. In a 
memorandum also dated March 1, 2004, we instructed fiscal 
intermediaries to notify all hospitals regarding the availability of 
the proposed wage index public use file and the criteria and process 
for requesting corrections and revisions to the wage data. Hospitals 
had until March 12, 2004, to submit requests to the fiscal 
intermediaries for reconsideration of adjustments made by the fiscal 
intermediaries as a result of the desk review, and to correct errors 
due to CMS's or the intermediary's mishandling of the wage data. 
Hospitals were also required to submit sufficient documentation to 
support their requests.
    After reviewing requested changes submitted by hospitals, fiscal 
intermediaries transmitted any additional revisions resulting from the 
hospitals' reconsideration requests by April 16, 2004. The deadline for 
hospitals to request CMS intervention in cases where the hospital 
disagreed with the fiscal intermediary's policy interpretations was 
April 23, 2004.
    Hospitals were also instructed to examine Table 2 in the Addendum 
to the proposed rule. Table 2 of the proposed rule contained each 
hospital's adjusted average hourly wage used to construct the wage 
index values for the past 3 years, including the FY 2001 data used to 
construct the FY 2005 wage index. We noted that the hospital average 
hourly wages shown in Table 2 of the proposed rule only reflected 
changes made to a hospital's data and transmitted to CMS by March 15, 
2004.
    The final wage data public use file was released in May 2004 to 
hospital associations and the public on the Internet at http:/
www.cms.hhs.gov/providers/hipps/ippswage.asp. The May 2004 public use 
file was made available solely for the limited purpose of identifying 
any potential errors made by CMS or the fiscal intermediary in the 
entry of the final wage data that result from the correction process 
described above (revisions submitted to CMS by the fiscal 
intermediaries by April 16, 2004). If, after reviewing the May 2004 
final file, a hospital believed that its wage data were incorrect due 
to a fiscal intermediary or CMS error in the entry or tabulation of the 
final wage data, it was provided the opportunity to send a letter to 
both its fiscal intermediary and CMS that outlined why the hospital 
believed an error exists and provide all supporting information, 
including relevant dates (for example, when it first became aware of 
the error). These requests had to be received by CMS and the fiscal 
intermediaries no later than June 11, 2004. The intermediary reviewed 
requests upon receipt and contacted CMS immediately to discuss its 
findings.
    After the release of the May 2004 wage index file, changes to the 
hospital wage data were only made in those very limited situations 
involving an error by the intermediary or CMS that the hospital could 
not have known about before its review of the final wage data file. 
Specifically, neither the intermediary nor CMS accepted the following 
types of requests:
     Requests for wage data corrections that were submitted too 
late to be included in the data transmitted to CMS by fiscal 
intermediaries on or before April 16, 2004.
     Requests for correction of errors that were not, but could 
have been, identified during the hospital's review of the March 1, 
2004, wage data file (or the March 8 occupational mix data; see section 
III.H.2. of this preamble).
     Requests to revisit factual determinations or policy 
interpretations made by the intermediary or CMS during the wage index 
data correction process.
2. Occupational Mix Data
    The process and criteria for requesting corrections to the 
occupational mix survey data are described in section III.C.1 of this 
preamble. As stated in that section, from April 16, 2004 forward, the 
process for correcting the final occupational mix survey data is the 
same, and on the same schedule, as described above for correcting the 
final Worksheet S-3 wage data.
3. All FY 2005 Wage Index Data
    Verified corrections to the wage index received timely (that is, by 
June 11, 2004) have been incorporated into the final wage index in this 
final rule, and are effective October 1, 2004.
    We created the processes described above to resolve all substantive 
wage index data index correction disputes before we finalize the wage 
and occupational mix data for the FY 2005 payment rates. Accordingly, 
hospitals that did not meet the procedural deadlines set forth above 
will not be afforded a later opportunity to submit wage data 
corrections or to dispute the intermediary's decision with respect to 
requested changes. Specifically, our policy is that hospitals that do 
not meet the procedural deadlines set forth above will not be permitted 
to challenge later, before the Provider Reimbursement Review Board, the 
failure of CMS to make a requested data revision (See W. A. Foote 
Memorial Hospital v. Shalala, No. 99-CV-75202-DT (E.D. Mich. 2001), 
also Palisades General Hospital v. Thompson, No. 99-1230 (D.D.C. 
2003)).
    Again, we believe the wage index data correction process described 
above provides hospitals with sufficient opportunity to bring errors in 
their wage data to the fiscal intermediaries' attention. Moreover, 
because hospitals had access to the final wage index data by early May 
2004, they had the opportunity to detect any data entry or tabulation 
errors made by the fiscal intermediary or CMS before the development 
and publication of the final FY 2005 wage index in this final rule, and 
the implementation of the FY 2005 wage index on October 1, 2004. If 
hospitals availed themselves of this opportunity, the wage index 
implemented on October 1 should be

[[Page 49069]]

accurate. Nevertheless, in the event that errors are identified after 
publication of the final rule, we retain the right to make midyear 
changes to the wage index under very limited circumstances.
    Specifically, in accordance with Sec.  412.63(x)(2) of our existing 
regulations, we make midyear corrections to the wage index for an area 
only if a hospital can show: (1) That the intermediary or CMS made an 
error in tabulating its data; and (2) that the requesting hospital 
could not have known about the error or did not have an opportunity to 
correct the error, before the beginning of FY 2005 (that is, by the 
June 11, 2004 deadline). This provision is not available to a hospital 
seeking to revise another hospital's data that may be affecting the 
requesting hospital's wage index. As described earlier, since a 
hospital had to show that it could not have known about the error, or 
that it did not have the opportunity to correct the error, before the 
publication of the FY 2005 wage index. As indicated earlier, since a 
hospital had the opportunity to verify its data, and the fiscal 
intermediary notified the hospital of any changes, we do not expect 
that midyear corrections will be necessary. However, if the correction 
of a data error changes the wage index value for an area, the revised 
wage index value will be effective prospectively from the date the 
correction is approved.
    Comment: One national hospital association commended CMS for the 
revised wage index development process and timeframe that CMS 
implemented with the FY 2005 wage index. The commenter believed that 
releasing the wage data file before intermediaries begin their desk 
reviews of the wage data makes the process more efficient than in prior 
years and recommended that CMS follow a similar process for 2006. The 
commenter suggested that notifying hospitals of the schedule as soon as 
possible and extending the hospital review timeframe would enhance the 
process.
    Another commented that nearly 13 percent of hospitals made changes 
to their wage data after the release of the February public use file. 
The commenter believed that this percentage of changes is too high and 
creates budgeting challenges for hospitals, as well as, contributes to 
difficulties in determining reclassification decisions.
    Response: We will continue to explore ways to improve the process 
for developing the wage index. With the new process in place, the rate 
of revisions between the proposed (February) and final (May) public use 
files has decreased dramatically, from approximately 30 percent in 
prior years to less than 15 percent for the FY 2005 wage index. 
However, we agree with the commenter that the volume of changes after 
the proposed rule is still too high. We encourage hospitals to work 
with their intermediaries as early as possible to ensure that their 
wage data are correct early in the process. For the FY 2006 wage index, 
we will apply the same process that we used for the FY 2005 wage index.
    Comment: One commenter requested that CMS provide more specific 
guidance to fiscal intermediaries for handling the June appeals, that 
is, hospitals' requests to correct errors in the May public use files, 
just as CMS provides for the earlier stages of the correction process.
    Response: We plan to provide more specific instructions regarding 
the intermediaries' handling of the June appeals in forthcoming 
instructions for the wage index development process, beginning with the 
FY 2006 wage index.
    Comment: One commenter suggested that CMS should put a process in 
place that allows other hospitals negatively impacted by another 
hospitals' incorrect data to make a request to obtain a correction. The 
commenter is concerned that sometimes the hospital with the incorrect 
data has no incentive to request a correction, for example, the 
hospital has closed or changed enrollment status to a CAH other non-
IPPS hospital.
    Response: The opportunity that the commenter requested is already 
available. If a hospital believes that another hospital's wage data may 
be erroneous in the public use files, the hospital may notify CMS that 
there is a potential problem with the other hospital's data. CMS and 
the other hospital's intermediary will review the data and attempt to 
contact the other hospital to determine the appropriate action. Any 
correction to a hospital's wage data can only be based on data that 
derives directly from the hospital.

J. Revision of the Labor-Related Share of the Wage Index

    Section 1886(d)(3)(E) of the Act directs the Secretary to adjust 
the proportion of the national prospective payment system base payment 
rates that are attributable to wages and wage-related costs by a factor 
that reflects the relative differences in labor costs among geographic 
areas. It also directs the Secretary to estimate from time to time the 
proportion of hospital costs that are labor-related: ``The Secretary 
shall adjust the proportion (as estimated by the Secretary from time to 
time) of hospitals' costs which are attributable to wages and wage-
related costs of the DRG prospective payment rates. * * *'' The portion 
of hospital costs attributable to wages and wage-related costs is 
referred to as the labor-related share. The labor-related share of the 
prospective payment rate is adjusted by an index of relative labor 
costs, which is referred to as the wage index. In the past, we have 
defined the labor-related share for prospective payment acute care 
hospitals as the national average proportion of operating costs that 
are related to, influenced by, or vary with the local labor market. The 
labor-related share for the acute care hospital inpatient prospective 
payment system has been calculated as the sum of the weights for wages 
and salaries, fringe benefits, nonmedical professional fees, contract 
labor, postage, and labor-intensive services.
    In its June 2001 Report to Congress, MedPAC recommended that the 
Secretary ``should reevaluate current assumptions about the proportion 
of providers'' costs that reflect resources purchased in local and 
national markets.'' (Report to the Congress: Medicare in Rural America, 
Recommendation 4D, page 80.) MedPAC recommended that the labor-related 
share include the weights for wages and salaries, fringe benefits, 
contract labor, and other labor-related costs for locally purchased 
inputs only. MedPAC noted that this would likely result in a lower 
labor share, which would decrease the amount of the national base 
payment amount adjusted by the wage index. As a result, hospitals 
located in low-wage markets (those with a wages index less than 1.0) 
would receive higher payments, while those located in high-wage labor 
markets would receive lower payments.
    In our proposed and final regulations updating the IPPS for FY 2003 
(67 FR 31404, May 9, 2002 and 67 FR 49982, August 1, 2002), we 
discussed the methodology that we have used to determine the labor-
related share. We noted that, at that time, the results of employing 
that methodology suggested that an increase in the labor-related share 
(from 71.066 percent to 72.495 percent) was warranted. However, we 
decided not to propose such an increase in the labor-related share 
until we conducted further research to determine whether a different 
methodology for determining the labor-related share should be adopted. 
The labor-related share has thus remained 71.066 percent.
    Section 403 of Public Law 108-173 amended sections 1886(d)(3)(E) of 
the Act to provide that the Secretary must employ 62 percent as the 
labor-related share unless this ``would result in lower

[[Page 49070]]

payments than would otherwise be made.'' However, this provision of 
Public Law 108-173 did not the change the legal requirement that the 
Secretary estimate ``from time to time'' the proportion of hospitals'' 
costs that are ``attributable to wages and wage-related costs.'' In 
fact, section 404 of Public Law 108-173 requires the Secretary to 
develop a frequency for revising the weights used in the hospital 
market basket, including the labor share, to reflect the most current 
data more frequently than once every 5 years. This reflects 
Congressional intent that hospitals will receive payment based on a 62-
percent labor share, or the labor share estimated from time to time by 
the Secretary, whichever results in higher payments.
    Section 404 further requires us to include in the final IPPS rule 
for FY 2006 an explanation of the reasons for, and options considered, 
in determining the frequency for revising the weights used in the 
hospital market basket, including the labor share. In the meantime, we 
are also continuing our research into the assumptions employed in 
calculating the labor-related share. Our research involves analyzing 
the compensation share separately for urban and rural hospitals, using 
regression analysis to determine the proportion of costs influenced by 
the area wage index, and exploring alternative methodologies to 
determine whether all or only a portion of professional fees and 
nonlabor intensive services should be considered labor-related. We will 
present our analysis and conclusions regarding the frequency and 
methodology for updating the labor share in the proposed and final 
rules for FY 2006.
    In section IV.F. of this preamble, we discuss our incorporation of 
the requirements of section 403 of Public Law 108-173 in a new Sec.  
412.64(h) of the regulations.
    As discussed above, the Secretary had determined, prior to the 
enactment of Public Law 108-173, that the labor-related share would be 
71.066 percent. As a result, application of a 62-percent labor share 
would result in lower payments for any hospital with a wage index 
greater than 1.0. Therefore, we are modifying our payment system 
software for FY 2005 to apply wage indexes greater than 1.0 to 71.066 
percent of the standardized amount, and to apply wage indexes less than 
or equal to 1.0 to 62 percent of the standardized amount.
    We did not receive any specific comments on the proposed 
implementation of section 403 of Public Law 108-173. Therefore, we are 
adopting as final the proposed policy change without modification.

IV. Other Decisions and Changes to the IPPS for Operating Costs and GME 
Costs

A. Postacute Care Transfer Payment Policy (Sec.  412.4)

1. Background
    Existing regulations at Sec.  412.4(a) define discharges under the 
IPPS as situations in which a patient is formally released from an 
acute care hospital or dies in the hospital. Section 412.4(b) defines 
transfers from one acute care hospital to another, and Sec.  412.4(c) 
defines transfers to certain postacute care providers. Our policy 
provides that, in transfer situations, full payment is made to the 
final discharging hospital and each transferring hospital is paid a per 
diem rate for each day of the stay, not to exceed the full DRG payment 
that would have been made if the patient had been discharged without 
being transferred.
    The per diem rate paid to a transferring hospital is calculated by 
dividing the full DRG payment by the geometric mean length of stay for 
the DRG. Based on an analysis that showed that the first day of 
hospitalization is the most expensive (60 FR 45804), our policy 
provides for payment that is double the per diem amount for the first 
day (Sec.  412.4(f)(1)). Transfer cases are also eligible for outlier 
payments. The outlier threshold for transfer cases is equal to the 
fixed-loss outlier threshold for nontransfer cases, divided by the 
geometric mean length of stay for the DRG, multiplied by the length of 
stay for the case, plus one day.
    Medicare adopted its IPPS transfer policy because, if the program 
were to pay the full DRG payment regardless of whether a patient is 
transferred or discharged, there would be a strong incentive for 
hospitals to transfer patients to another IPPS hospital early in the 
patients' stay in order to minimize costs while still receiving the 
full DRG payment. The transfer policy adjusts the payments to 
approximate the reduced costs of transfer cases.
    Previously, when a patient chose to depart from a hospital against 
the medical opinion of treating physicians, the case was treated as a 
left against medical advice (LAMA) discharge and coded as discharge 
status ``07-Left Against Medical Advice (LAMA)'' on the inpatient 
billing claim form. Because, by definition, LAMA discharges were 
assumed not to involve the active participation of the hospital 
administration, our policy had been to treat LAMA cases as discharges. 
This policy applied even if the patient was admitted to another 
hospital on the date of the LAMA discharge. Consequently, until FY 
2004, we made a full DRG payment for any discharge coded as a LAMA 
case.
    Last year, in response to an Office of Inspector General (OIG) 
report issued in March 2002 (A-06-99-00045), we became concerned that 
some hospitals were incorrectly coding transfers as LAMA cases. 
Therefore, in the August 1, 2003 final IPPS rule (68 FR 45405), we 
expanded our definition of a transfer under Sec.  412.4(b) to include 
all patients who are admitted to another IPPS hospital on the same day 
that the patient is discharged from an IPPS hospital, unless the first 
(transferring) hospital can demonstrate that the patient's treatment 
was completed at the time of discharge from that hospital. In other 
words, unless the same-day readmission is to treat a condition that is 
unrelated to the condition treated during the original admission (for 
example, the beneficiary is in a car accident later that day), any 
situation where the beneficiary is admitted to another IPPS hospital on 
the same date that he or she is discharged from an IPPS hospital would 
be considered a transfer, even if the patient left against medical 
advice from the first hospital.
    This policy prohibits payment of two claims for the same patient on 
the same day. Therefore, if a hospital believes a claim has been 
wrongly denied, the original discharging hospital must resubmit the 
claim with documentation that the discharge was appropriate and 
unrelated to the subsequent same-day admission.
    Comment: One commenter requested that we clarify our policy 
regarding LAMAs. The commenter noted that in the FY 2004 proposed rule, 
we ``considered and appropriately rejected * * * a knowledge standard'' 
when we amended the transfer policy to include LAMAs. Under the 
standard that was rejected, a hospital would have been required to code 
LAMAs as transfers based on knowledge of a same-day admission to 
another hospital. However, the commenter notes that in the May 18, 2004 
proposed rule, we stated that hospitals ``are now allowed to report a 
patient as left against medical advice only if they have no knowledge 
that the patient has been admitted to another hospital on the same 
day.'' The commenter notes that this could be interpreted as reflecting 
a change in policy, returning to the knowledge standard that we 
rejected in the August 1, 2003 final rule.
    Response: We did not intend to change our policy in the preamble of 
the

[[Page 49071]]

May 18, 2004 proposed rule. A discharging hospital is not required to 
identify cases in which a patient is admitted to another hospital on 
the same day. Our claims processing software has been revised to 
identify cases in which a patient is admitted to a hospital after being 
discharged from another hospital on the same day.
    Comment: Some commenters noted that the edits to the CWF will cause 
claims to be rejected and that providers will have to recode the claims 
and resubmit them. Others expressed concerns that hospitals 
appropriately discharge their patients to home ``only to have other 
providers outside of the hospital admit patients to other entities and 
healthcare settings,'' imposing on hospitals an unfair burden that is 
caused by patient choice and is not of their own doing. As a result, 
claims are frequently denied for these providers as a result of the 
lack of a method to ensure consistent inpatient processing of claims. 
The commenter cites ``unplanned situations (for example, LAMA, 
readmissions post-discharge to home, patients seeking additional care 
at other facilities)'' that result in ``unnecessary payment delays and 
rework of claims'' by the facilities that originally treated the 
patients. The commenter further argues, ``these unnecessary process 
issues result in additional overhead costs that will never be recovered 
by the already reduced transfer per diem payments that the original 
treating facility ultimately receives.''
    Response: As we discussed above, we adopted this policy in the 
August 1, 2003 final rule (68 FR 45404 through 45406) in response to an 
OIG report indicating that transfers were frequently miscoded as LAMAs. 
Since we have implemented the systems edits to identify these cases, 
the number of cases identified by these edits has provided further 
evidence that this policy is appropriate.
2. Changes to DRGs Subject to the Postacute Care Transfer Policy (Sec.  
412.4(c) and (d))
    Under section 1886(d)(5)(J) of the Act, a ``qualified discharge'' 
from one of 10 DRGs selected by the Secretary to a postacute care 
provider is treated as a transfer case beginning with discharges on or 
after October 1, 1998. This section required the Secretary to define 
and pay as transfers all cases assigned to one of 10 DRGs selected by 
the Secretary, if the individuals are discharged to one of the 
following postacute care settings:
     A hospital or hospital unit that is not a subsection 
1886(d) hospital. (Section 1886(d)(1)(B) of the Act identifies the 
hospitals and hospital units that are excluded from the term 
``subsection (d) hospital'' as psychiatric hospitals and units, 
rehabilitation hospitals and units, children's hospitals, long-term 
care hospitals, and cancer hospitals.)
     A SNF (as defined at section 1819(a) of the Act).
     Home health services provided by a home health agency, if 
the services relate to the condition or diagnosis for which the 
individual received inpatient hospital services, and if the home health 
services are provided within an appropriate period (as determined by 
the Secretary).
    In the July 31, 1998 IPPS final rule (63 FR 40975 through 40976), 
we specified the appropriate time period during which we would consider 
a discharge to postacute home health services to constitute a transfer 
as within 3 days after the date of discharge. In addition, in the July 
31, 1998 final rule, we did not include in the definition of postacute 
care transfer cases patients transferred to a swing-bed for skilled 
nursing care (63 FR 40977).
    Section 1886(d)(5)(J) of the Act directed the Secretary to select 
10 DRGs based upon a high volume of discharges to postacute care and a 
disproportionate use of postacute care services. As discussed in the 
July 31, 1998 final rule, these 10 DRGs were selected in 1998 based on 
the MedPAR data from FY 1996. Using that information, we identified and 
selected the first 20 DRGs that had the largest proportion of 
discharges to postacute care (and at least 14,000 such transfer cases). 
In order to select 10 DRGs from the 20 DRGs on our list, we considered 
the volume and percentage of discharges to postacute care that occurred 
before the mean length of stay and whether the discharges occurring 
early in the stay were more likely to receive postacute care. We 
identified 10 DRGs to be subject to the postacute care transfer rule 
starting in FY 1999.
    Section 1886(d)(5)(J)(iv) of the Act authorizes the Secretary to 
expand the postacute care transfer policy beyond 10 DRGs for FY 2001 or 
subsequent fiscal years. In the FY 2004 IPPS final rule (68 FR 45412), 
we expanded the postacute care transfer policy to include additional 
DRGs. We established the following criteria that a DRG must meet, for 
both of the 2 most recent years for which data are available, in order 
to be added to the postacute care transfer policy:
     At least 14,000 postacute care transfer cases;
     At least 10 percent of its postacute care transfers 
occurring before the geometric mean length of stay;
     A geometric mean length of stay of at least 3 days; and
     If a DRG is not already included in the policy, a decline 
in its geometric mean length of stay during the most recent 5 year 
period of at least 7 percent.
    We identified 21 new DRGs that met these criteria. We also 
determined that one DRG from the original group of 10 DRGs (DRG 263) no 
longer met the volume criterion of 14,000 transfer cases. Therefore, we 
removed DRGs 263 and 264 (DRG 264 is paired with DRG 263) from the 
policy and expanded the postacute care transfer policy to include 
payments for transfer cases in the new 21 DRGs, effective October 1, 
2003. As a result, a total of 29 DRGs were subject to the postacute 
care transfer policy in FY 2004.
    In the FY 2004 IPPS final rule, we indicated that we would review 
and update this list periodically to assess whether additional DRGs 
should be added or existing DRGs should be removed (68 FR 45413). We 
have analyzed the available data from the FY 2003 MedPAR file. For the 
2 most recent years of available data (FY 2002 and FY 2003), we have 
found that no additional DRGs qualify under the four criteria set forth 
in the IPPS final rule for FY 2004. We have also analyzed the DRGs 
included under the policy for FY 2004 to determine if they still meet 
the criteria to remain under the policy. In addition, we have analyzed 
the special circumstances arising from a change to one of the DRGs 
included under the policy in FY 2004.
    As discussed in the May 18, 2004 IPPS proposed rule (69 FR 28212) 
and in section II.B.9. of this final rule, we proposed to eliminate DRG 
483. Under our proposal, the cases that would have been placed into DRG 
483 would be split into two proposed new DRGs, 541 (Tracheostomy With 
Mechanical Ventilation 96+ Hours or Principal Diagnosis Except Face, 
Mouth and Neck Diagnoses With Major O.R. Procedure) and 542 
(Tracheostomy with Mechanical Ventilation 96+ Hours or Principal 
Diagnosis Except Face, Mouth and Neck Diagnoses Without Major O.R. 
Procedure). This would be done by subdividing the cases in the existing 
DRG 483 based on the presence of a major O.R. procedure, in addition to 
the tracheostomy code that is currently required to be assigned to this 
DRG. Therefore, if the patient's case involves a major O.R. procedure 
(a procedure whose code is included on the list that is assigned to DRG 
468 (Extensive O.R. Procedure Unrelated to Principal

[[Page 49072]]

Diagnosis), except for tracheostomy codes 31.21 and 31.29), the case 
would be assigned to the proposed new DRG 541. We indicated that if the 
patient does not have an additional major O.R. procedure (that is, 
there is only a tracheostomy code assigned to the case), the case would 
be assigned to proposed new DRG 542. In section II.B.9. of this 
preamble, we are finalizing our proposal to eliminate DRG 483 and 
create new DRGs 541 and 542.
    As discussed in the May 18, 2004 proposed rule, neither of the new 
DRGs 541 and 542 would have enough cases to meet the first criterion 
for inclusion in the postacute care transfer policy. DRG 483 had 44,788 
total cases with 15,520 transfer cases in FY 2002, and 44,618 total 
cases with 20,034 transfer cases in FY 2003. These cases will now split 
between new DRG 541 (20,812 total cases) and new DRG 542 (23,387 total 
cases). As a result, neither of these new DRGs would meet the existing 
threshold of 14,000 transfer cases (6,779 projected transfer cases for 
new DRG 541, and 8,570 projected transfer cases for new DRG 542). 
Nevertheless, we indicated that we believe the cases that will now be 
incorporated into these two new DRGs remain appropriate candidates for 
application of the postacute care transfer policy. The new DRGs 541 and 
542 will contain the same cases that were included in existing DRG 483, 
which qualified for inclusion in the postacute care transfer policy. 
Furthermore, many of the cases in the new DRGs 541 and 542 will 
continue to require postacute care.
    For the proposed rule, when we analyzed the cases that we projected 
would fall into the two new DRGs in the FY 2005 GROUPER Version 22.0, 
we found that a high proportion of cases in both the new DRGs were 
projected to be transfer cases: 33 percent of all cases in DRG 541, and 
37 percent in DRG 542. In addition, based on the data from cases in DRG 
483 in the FY 2003 MedPAR file, a high proportion of the transfer cases 
in these proposed new DRGs were projected to fall into the short-stay 
transfer category: 41 percent of transfer cases in new DRG 541 and 42 
percent of transfer cases in new DRG 542 were projected to occur before 
the geometric mean length of stay for these new DRGs. By contrast, 
among all DRGs, approximately 15 percent of transfer cases are short-
stay transfer cases. The percentage of transfer cases that were short-
stay cases that would be in both new DRGs 541 and 542 would be more 
than 2 standard deviations above the mean percentage of short-stay 
cases across all DRGs. (Two standard deviations above the mean across 
all DRGs is 37 percent for FY 2005.) Therefore, we proposed that the 
subdivision of DRG 483 should not change the original application of 
the postacute care transfer policy to the cases once included in that 
DRG. We did not believe that it was appropriate for these cases to fall 
outside the scope of this policy solely because of a revision to the 
DRG structure that was driven by policy reasons unrelated to the 
postacute care transfer provision. We proposed that the high proportion 
of transfer cases among all cases that would be assigned to these new 
DRGs, along with the unusually high proportion of short-stay cases 
among those transfer cases, provided solid reasons for considering 
whether alternate criteria might better address the special 
circumstances that can arise from changes in DRGs unrelated to the 
postacute care transfer policy.
    Therefore, in the May 18, 2004 proposed rule, we proposed alternate 
criteria to be applied in cases where DRGs do not satisfy the existing 
criteria, for discharges occurring on or after October 1, 2004 (69 FR 
28273-28374). The proposed new criteria were designed to address 
situations such as those posed by the split of DRG 483, where there 
remain substantial grounds for inclusion of cases within the postacute 
care transfer policy, although one or more of the original criteria may 
no longer apply. Therefore, we proposed to examine DRGs for inclusion 
within the policy against two sets of criteria, first, the original 
four criteria, and then, the proposed alternate set of criteria. Under 
our proposal, DRGs that did not satisfy the first set of criteria would 
still be included if they satisfied the second set. Specifically, a DRG 
would still be subject to the postacute care transfer policy under the 
alternative set of criteria if, for the 2 most recent years for which 
data are available, there were at least 5,000 total transfers to 
postacute care among the cases included in the DRG, and if, among the 
cases included in the DRG, the percentage of transfer cases that were 
short-stay transfer cases was at least 2 standard deviations above the 
geometric mean length of stay across all DRGs (which is 37 percent for 
FY 2005). We indicated that we would also continue to require a 
geometric mean length of stay of at least 3 days among the cases 
included in the DRG. Finally, we proposed to require that, if a DRG was 
not already included in the policy, it either experienced a decline in 
its geometric mean length of stay during the most recent 5-year period 
of at least 7 percent or contained only cases that would have been 
included in a DRG to which the policy applied in the prior year.
    Under the proposed alternate criteria, DRGs 430, 541, and 542 would 
have qualified for inclusion in the postacute care transfer policy. DRG 
430 met the proposed threshold of 5,000 transfer cases in both of the 2 
most recent years, with 11,973 transfer cases and 46 percent short-stay 
transfer cases in FY 2002, and 12,202 transfer cases and 38 percent 
short-stay transfers in FY 2003. In addition, DRG 430 experienced a 7-
percent decline in length of stay from FY 2000 to FY 2004. DRG 430 also 
had a 5.8 day average length of stay during those years. As discussed 
in the proposed rule, the cases to be included in new DRGs 541 and 542 
contain a sufficient number of transfers to meet the first alternate 
criterion, and among the cases to be included in these DRGs, the 
percentages of transfer cases occurring before the geometric mean 
length of stay new DRGs exceed 2 standard deviations above the 
geometric mean length of stay for all DRGs. The average lengths of stay 
for the cases to be included in new DRGs 541 and 542 are 37.7 days and 
28.9 days, respectively.
    We proposed to revise the regulations governing the postacute 
transfer policy to include the alternative criteria described above 
(Sec.  412.4(d)). We also proposed that DRG 430 and new DRGs 541 and 
542 would be included in the postacute care transfer policy.
    In the May 18, 2004 proposed rule, we also called attention to the 
data concerning DRG 263, which was subject to the postacute care 
transfer policy until FY 2004. We removed DRG 263 from the postacute 
care transfer policy for FY 2004 because it did not have the minimum 
number of cases (14,000) transferred to postacute care (13,588 transfer 
cases in FY 2002, with more than 50 percent of transfer cases being 
short-stay transfers). The FY 2003 MedPAR data show that there were 
15,602 transfer cases in the DRG in FY 2003, of which 46 percent were 
short-stay transfers. Because we removed the DRG from the postacute 
care transfer policy in FY 2004, it must meet all criteria to be 
included under the policy in subsequent fiscal years. Because the 
geometric mean length of stay for DRG 263 shows only a 6-percent 
decrease since 1999, DRG 263 does not qualify to be added to the policy 
for FY 2005 under the existing criteria that were included in last 
year's rule. DRG 263 would have qualified under the volume threshold 
and percent of short-stay transfer cases under the proposed new 
alternate criteria contained in the proposed rule. However, it still 
did not

[[Page 49073]]

meet the proposed required decline in length of stay to qualify to be 
added to the policy in FY 2005.
    Comment: Several commenters objected to the proposed alternate 
criteria for DRGs to be included in the postacute care transfer policy. 
Some commenters believed that the proposed criteria were inappropriate 
because they appeared contrived to ensure that cases in the former DRG 
483, which had a very high DRG weight and resulted in significant 
Medicare payments, would not be paid at the higher rate associated with 
those cases. One commenter stated that if CMS' creation of the two new 
DRGs for tracheostomies with and without surgical procedures does not 
create less variation in length of stay and cost per case, there is no 
need to split DRG 483 and no need to expand the transfer policy 
criteria. The commenters argued that if the split of DRG 483 into more 
specific DRGs will better account for variations in the original DRG, 
then the historical logic behind the transfer policy in these cases is 
no longer valid. Some commenters also believed that the alternate 
criteria did not meet the objective of the provision, which is to 
ensure that the postacute care transfer policy only subjects high 
volume DRGs to this payment method.
    Response: We disagree with some of the points raised by these 
commenters. In the proposed rule (69 FR 28273) we clearly indicated 
that the alternate criteria to be included in the postacute care 
transfer policy still required relatively high volumes of postacute 
care transfer cases, as well as very high proportions of short stay 
transfer cases. We specifically chose a very high threshold for the 
percent of these postacute care transfer cases that are short-stay 
cases in order to avoid including inappropriate DRGs within the 
postacute care transfer policy. In many areas of Medicare program 
policy we employ a threshold of one standard deviation or less in order 
to qualify for inclusion to or exclusion from certain provisions. In 
this instance, we deliberately chose a much higher threshold in order 
to ensure that only those DRGs with the highest rate of short-stay 
postacute care transfers would be included in the policy.
    However, in the light of these and other comments, we are not 
adopting the proposed alternate criteria in this final rule. We note 
that the postacute care transfer policy was not considered at the time 
the decision was made to split DRG 483. We do not intend to change our 
rationale for reorganizing DRGs into more coherent groups or to 
compromise the clinical cohesiveness of the DRG system in order ensure 
cases are included in or excluded from the postacute care transfer 
policy or other CMS policies. We have discussed the reasons for 
splitting DRG 483 in section II.B.9. of the proposed rule and in this 
final rule. However, we do note that, while these cases will continue 
to be included in the postacute care transfer policy and subject to per 
diem payments, we anticipate that fewer cases will actually receive 
these reduced payments as the new DRGs better reflect the resources 
required to treat these patients. As a result, hospitals will have less 
incentive to discharge these patients to postacute care.
    Comment: Some commenters suggested that in place of the proposed 
alternate criteria, we should adopt a policy of keeping cases within 
the scope of the postacute care transfer policy permanently once they 
initially qualify for inclusion in the policy. These commenters noted 
that removing DRGs from the postacute care transfer policy makes the 
payment system less stable and results in inconsistent incentives over 
time. They also argued that ``a drop in the number of transfers to 
postacute settings is to be expected after the transfer policy is 
applied to a DRG, but the frequency of transfers may well rise again if 
the DRG is removed from the policy.'' Other commenters expressed 
concern about our changing of the policy criteria in 2 consecutive 
years. These commenters argued that such frequent changes in policy 
give the appearance that the policy has been contrived to achieve 
certain desired results and make the regulatory process unpredictable 
and unfair. They further imply that these ``band-aid fixes'' to the 20-
year old Medicare system do not bode well for the confidence of outside 
organizations in regards to the program.
    Response: We did consider grandfathering cases already included in 
the policy because this approach is, on the surface, the simplest 
method of ensuring these cases continue to be paid appropriately. 
However, we determined that in order to adopt this approach, we would 
also need to determine an appropriate timeframe for the grandfathering 
period. We did not believe that we could adequately predict or project 
what timeframe would be appropriate, not only in the case of the 
splitting of DRG 483 into DRGs 541 and 542, but also for future 
situations where this kind of split may occur. Therefore, we tried to 
develop appropriate, alternative criteria based on actual case data 
that could be monitored and applied from year to year.
    However, due to the large number of comments received and the 
strong arguments they have raised in favor of a more straightforward 
approach, we have decided not to adopt the alternate criteria proposed 
in the May 18, 2004 proposed rule. Instead, in this final rule we are 
adopting the policy of simply grandfathering, for a period of 2 years, 
any cases that were previously included within a DRG that has split, 
when the split DRG qualified for inclusion in the postacute care 
transfer policy for both of the previous 2 years. Under this policy, 
the cases that were previously assigned to DRG 483, and that will now 
fall into DRGs 541 and 542, will continue to be subject to the 
postacute care transfer policy for the next 2 years. We will monitor 
the frequency with which these cases are transferred to postacute 
settings and the percentage of these cases that are short-stay transfer 
cases. Because we are not adopting the proposed alternate criteria for 
DRG inclusion the postacute care transfer policy at this time, DRG 430 
(Psychoses) does not meet the criteria for inclusion and will not be 
subject to the postacute care transfer policy for FY 2005.
    We appreciate the recommendation to address situations such as the 
splitting of DRGs by simply including all cases within the postacute 
care transfer policy permanently once they have initially qualified. 
While we are not adopting this policy at this time, we will actively 
consider it for adoption at a later date. Meanwhile, we believe that 
grandfathering the cases formerly included in DRG 483 for 2 years is an 
appropriate interim measure that ensures a consistent payment approach 
to these cases while affording us sufficient time to undertake a 
thorough review of this issue. In the meantime, we welcome comments on 
how to treat the cases formerly included in a split DRG after the 
grandfathering period. We note that, if we were to adopt the policy 
recommended by the commenter, cases in DRGs 263 and 264 would again 
become subject to the policy. As noted above, these DRGs are already 
very close to meeting the criteria required to be re-included in the 
policy. However, we will monitor cases until next year or until such 
time that another change to this policy is warranted.
    The table below displays the 30 DRGs that we are including in the 
postacute care transfer policy, effective for discharges occurring on 
or after October 1, 2004. This table includes the effects of dropping 
DRG 483, which we are deleting from the DRG list, and adding the two 
new DRGs 541 and 542 that will now incorporate the cases formerly 
assigned to DRG 483. As discussed above, these cases are being 
grandfathered into the policy for 2

[[Page 49074]]

years. The other DRGs meet the criteria specified above during both of 
the 2 most recent years for which data were available prior to the 
publication of this final rule (FYs 2002 and 2003), as well as their 
paired-DRG if one of the DRGs meeting the criteria includes a CC/no-CC 
split.
BILLING CODE 4120-01-P
[GRAPHIC] [TIFF OMITTED] TR11AU04.053

BILLING CODE 4120-01-C
    Section 1886(d)(5)(J)(i) of the Act recognizes that, in some cases, 
a substantial portion of the costs of care is incurred in the early 
days of the inpatient stay. Similar to the policy for transfers between 
two acute care hospitals, the transferring hospital in a postacute care 
transfer receives twice the per diem rate for the first day of 
treatment and the per diem rate for each following day of the stay 
before the transfer, up to the full DRG payment. However, three of the 
DRGs subject to the postacute care transfer policy exhibit a 
disproportionate share of costs very early in the hospital stay in 
postacute care transfer situations. For these DRGs, hospitals receive 
50 percent of the full DRG payment plus the single per diem (rather 
than double the per diem) for the first day of the stay and

[[Page 49075]]

50 percent of the per diem for the remaining days of the stay, up to 
the full DRG payment.
    In previous years, we determined that DRGs 209 and 211 met this 
cost threshold and qualified to receive this special payment 
methodology. Because DRG 210 is paired with DRG 211, we include payment 
for cases in that DRG for the same reason we include paired DRGs in the 
postacute care transfer policy (to eliminate any incentive to code 
incorrectly in order to receive higher payment for those cases). The FY 
2003 MedPAR data show that DRGs 209 and 211 continue to have charges on 
the first day of the stay that are higher than 50 percent of the 
average charges in the DRGs. Therefore, we proposed to continue the 
special payment methodology for DRGs 209, 210, and 211 for FY 2005 (69 
FR 28274).
    We received no comments on this proposal. Therefore, we will 
continue the special payment methodology for these DRGs in FY 2005.
    Comment: One commenter requested that we require physicians and 
postacute care facilities to notify the original treating hospital that 
a patient has been treated within 3 days at another facility. The 
commenter indicated that this step would reduce the burden on hospitals 
in relation to the postacute transfer policy.
    Response: While we appreciate the commenter's concern to reduce the 
burdens on hospitals, we are reluctant to impose this burden on other 
entities, especially since these other entities are not affected by the 
payment decisions that are involved.

B. Payments for Inpatient Care in Providers That Change Classification 
Status During a Patient Stay (Sec. Sec.  412.2(b)(3) and 412.521(e)

    Situations may occur in hospital inpatient care settings where a 
Medicare provider changes its Medicare payment classification status 
during a patient's stay, for example, an acute care hospital is 
reclassified as a LTCH. (We refer to the patients in these situations 
as ``crossover patients.'') Different Medicare payment systems apply to 
care furnished to Medicare beneficiaries during inpatient stays, 
depending on the classification status of the provider. For example, 
payments to an acute care hospital for inpatient services are made 
under the IPPS on a per discharge basis, using a DRG classification 
system. Payments to LTCHs that are classified under section 
1886(d)(1)(B)(iv)(I) of the Act are made under the LTCH PPS on a per 
discharge basis using a LTC-DRG classification system. The main 
difference between a LTCH that is classified under section 
1886(d)(1)(B)(iv)(I) of the Act and an acute care hospital is the 
average length of stay at the hospital. Specifically, section 
1886(d)(1)(B)(iv)(I) of the Act defines a LTCH as ``a hospital which as 
an average inpatient length of stay (as determined by the Secretary) of 
greater than 25 days.''
    Questions have arisen as to how Medicare should pay for an 
inpatient stay in a hospital when the hospital changes its 
classification status during the course of the beneficiary's single 
hospital stay. Specifically, how should Medicare pay for a patient's 
stay when the first part of that stay is in the acute care hospital 
(before the hospital was reclassified as a LTCH and the second part of 
that stay is in the same hospital after it is reclassified as a LTCH. 
Although the situation may occur in other settings, this payment issue 
is most prevalent for services furnished to crossover patients in a 
newly established LTCH. The fact is that all new LTCHs that seek LTCH 
classification under section 1886(d)1)(B)(iv)(I) of the Act begin as 
other provider types, generally as acute care hospitals, and then these 
providers under the regulations at Sec.  412.23(e)(3) are required to 
meet the average length of stay criterion by showing that for the 
period of at least 5 months of a preceding 6-month period, the 
hospital's average Medicare inpatient length of stay is greater than 25 
days. Once the entity meets the criteria under Sec.  412.23(e)(3), they 
are reclassified as LTCHs and are then paid under the LTCH PPS. It is 
for those patients who were admitted to the acute care hospital before 
the acute care hospital was reclassified as a LTCH and are discharged 
after the hospital is classified as a LTCH that we proposed to codify a 
revised crossover policy in the May 18, 2004 IPPS proposed rule.
    To address payment for inpatient care for such crossover patients, 
we had issued instructions for hospital billing purposes (paper-based 
manual, Hospital Manual, HCFA Pub. 10, section 404, which has been 
replaced by the Medicare Claims Processing Manual, Pub. 100-4, Chapter 
3, section 100.4.1) that were in effect prior to the implementation of 
the PPS for LTCHs (that is, prior to October 1, 2002). The manual 
instructed hospitals as follows: ``The hospital must submit a discharge 
bill with the old provider number and an admission notice with the new 
provider number. The date of discharge and the date of admission are 
the same date, which is the first day of the new fiscal period. All 
subsequent billings are submitted under the new provider number.''
    It is important to note that at the time this manual provision was 
written, IPPS-excluded hospitals were reimbursed under the reasonable 
cost-based (TEFRA) payment system, not other prospective payment 
systems. Thus, under the manual instructions, if a patient was in an 
acute care hospital and the hospital reclassified to a LTCH during the 
patient's stay, Medicare would then make payment for what was, in 
reality, only one episode of care as if it were two episodes. 
Specifically, the days of the stay while the facility was certified as 
an acute care hospital generated a full DRG payment under the IPPS; and 
the services provided from the time the facility was reclassified as a 
LTCH were paid under the TEFRA payment system. The patients were 
treated as if they were ``admitted'' to the ``new'' facility until the 
patient was actually discharged. We had proposed to revisit the issue 
of Medicare payment for crossover patients now that there has been a 
fundamental change in the Medicare payment system for LTCHs. That is, 
LTCHs are now being paid under a LTCH PPS which was effective for LTCHs 
for cost reporting periods beginning on or after October 1, 2002.
    Under the LTCH PPS for crossover patients, under the existing 
Manual instructions, Medicare makes a full DRG payment under the IPPS 
to the acute care hospital for the ``first portion'' of the patient 
stay, and when the acute care hospital is reclassified as a LTCH, 
Medicare makes a second PPS payment under the LTCH PPS for the ``second 
portion'' of the stay. We believe that this results in excessive 
Medicare payments and results in the inappropriate use of the Medicare 
Trust Fund. We believe the result described above is contrary to a 
basic premise of a PPS, which is that a single PPS payment is adequate 
and appropriate reimbursement for the entire bundle of services that a 
hospital provides during the course of a patient's stay. We believe the 
care provided prior to and after the reclassification of a LTCH is 
really one bundle of services associated with a single hospitalization. 
The ``discharge'' from the acute care hospital and ``admission'' to the 
LTCH has only been a ``paper discharge'' that was triggered solely by a 
change in the classification status of the hospital treating the 
patient. In the instant case, the beneficiary by mere coincidence, was 
an inpatient of the acute care hospital when it reclassified-the acute 
care hospital did not materially change the medical care it provided to 
the beneficiary during his/her single hospitalization because its 
classification

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as an acute care hospital ended on one day and changed to LTCH 
classification on the next day. Under the existing manual instructions, 
the hospital is receiving not one payment, but two PPS payments, for a 
bundle of services that should have been adequately and properly 
reimbursed by a single PPS payment.
    As explained in the May 18, 2004 proposed rule (69 FR 28275), 
presently, if the DRG assigned to the ``discharge'' from the acute care 
hospital for a crossover patient falls within one of the DRGs covered 
by the postacute care transfer policy at Sec.  412.4(c) of the 
regulations, the provider will receive a payment under the postacute 
care transfer policy as if the patient, who in fact has not moved, was 
transferred to a postacute care provider. Payment under the postacute 
care transfer policy is triggered when a discharge bill with the old 
provider number and an admission notice with the new provider number is 
submitted and processed by the Medicare standard bill processing 
systems as a transfer. Because the patient is, in reality, at the 
``same'' facility (an acute care hospital that has been reclassified as 
a LTCH) and is in one episode of care, we do not believe the 
application of the existing transfer policy is the appropriate 
methodology for dealing with the crossover patient situation described 
above. Under the postacute care transfer policy, the affect on payment 
is limited to a specific scenario; the payment to the transferring 
hospital is only affected if the patient is discharged prior to the day 
before the geometric mean length of stay for the DRG. When the patient 
is discharged by the day before the geometric mean length of stay, the 
``discharging'' acute care hospital will receive the equivalent of the 
full IPPS DRG payment and the LTCH hospital will also receive a full 
LTCH PPS payment. Therefore, although the transfer policy addresses 
discharges from an acute care hospital that occur prior to the 
geometric mean length of stay for each DRG, it does not address 
crossover patients where the hospital is reclassified after the patient 
has a length of stay of at least the geometric mean length of stay.
    As we have stated previously in this discussion, we believe that it 
is inappropriate to continue to allow the current payment policy for 
crossover patients. An acute care hospital before reclassification as a 
LTCH may admit and treat patients with multicomorbidities that result 
in longer hospital stays than are characteristic of the patient census 
at a LTCH. Invariably, at the time the acute care hospital becomes a 
LTCH, there will be patients who were admitted to the acute care 
hospital and who remain in the facility when it is reclassified as a 
LTCH and are ultimately discharged from the LTCH. An acute care 
hospital's change in classification status to a LTCH should have no 
impact on the course of treatment that is already underway for the 
patient in what would now be a LTCH. Thus, since we believe the 
proposed patient is receiving one consistent course of treatment 
throughout this stay, in the May 18, 2004 proposed rule, we proposed to 
revise the present policy and allow for only one Medicare payment for 
the patient's entire stay. In proposing this change in policy, we 
proposed to provide for one Medicare payment where previously there 
would have been two payments made for one stay; instead payment would 
be based on the PPS of the facility that is actually discharging the 
patient.
    Under the proposed approach, we would include those days of care 
and costs incurred by the hospital for the crossover patient before the 
facility met the LTCH classification criteria, in determining payments 
to the LTCH for that patient under the LTCH PPS. Under this policy, for 
example, if an acute care hospital admits a patient on December 28 and 
the hospital reclassifies to a LTCH on January 1 when its cost 
reporting period begins, and the patient is physically discharged from 
the LTCH on February 5, one payment would be made for this entire stay 
(December 28-February 5), and payment would be based on the LTCH-DRGs 
under the LTCH PPS. We are counting the patient's entire 
hospitalization (that is, all days and costs of the patient stay in the 
facility that occurred prior to and after reclassification) in 
determining the applicable payment under the LTCH PPS. This provision 
would also count all the days of the patient stay, that is prior to and 
after reclassification, as LTCH days for purposes of determining 
whether the facility continues to meet the average length of stay 
requirement for LTCHs. We believe this is consistent with the 
discretionary authority granted to the Secretary at section 
1886(d)(1)(B)(iv)(I) of the Act for determining lengths of stay for 
LTCHs. Specifically, section 1886(d)(1)(B)(iv)(I) of the Act provides 
that a LTCH is a hospital that has an average length of stay (as 
determined by the Secretary) of greater than 25 days. Thus, the 
Secretary determines how a LTCH's average length of stay is to be 
determined. (We are also using the broad discretionary authority 
provided in section 1871 of the Act to not count the days of the 
patient's stay in the acute care hospital prior to reclassification as 
acute care days.)
    In addition, we are using the broad authority in section 1871 of 
the Act to not pay for the days of the patient's stay in the acute care 
hospital as acute care days. Section 1871 authorizes the Secretary to 
promulgate regulations that are necessary to carry on the 
administration of the Medicare program. In addition, as stated in the 
proposed rule, we believe counting all days for the patient's stay and 
applying them in determining the PPS at the hospital that actually 
discharges the patients even though part of the stay was in a prior 
cost reporting period is consistent with the policy as recently revised 
at Sec.  412.23(e)(3) of the regulations, which provides that if a LTCH 
patient is admitted in one cost reporting period and discharged in a 
second cost reporting period, all of the days of the patient's stay 
even those from prior fiscal years are counted in the cost reporting 
period in which the patient is discharged. In this example of the 
crossover patient, including the days in December may result in a full 
LTC-DRG payment rather than a lower payment possible under the short-
stay outlier policy (Sec.  412.529) based solely on the length of the 
stay of the patient at the LTCH once it was reclassified. (Under the 
short-stay policy, we would adjust (lower) the Federal prospective 
payment if the payment is for a length of stay that is up to and 
including five-sixths of the geometric average length of stay for the 
LTC-DRG assigned to the case.)
    While this final rule specifically addresses the situation of a 
crossover patient that is in an acute hospital that reclassifies as a 
LTCH during the course of the patient's stay, we believe the policy may 
be equally applicable to other crossover situations. For example, an 
acute care hospital may meet the requirements to be paid as a 
rehabilitation hospital (under IRF PPS) and there could be 
rehabilitation patients who were admitted to the acute care hospital 
who were not discharged from the hospital until after the facility was 
designated as an IRF. However, at this time, we are not making a change 
to the existing payment policy in situations other than the LTCH 
crossover patient. We have only addressed the LTCH crossover patient 
since, based on the statutory and regulatory qualifying criteria, every 
LTCH must first be certified as a hospital before it can meet the LTCH 
criteria. Therefore, it is inevitable that there will be crossover 
patients in the newly classified LTCH. However, the same is not true 
for other hospital

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certifications. For example, a rehabilitation hospital can be certified 
as an IRF, without first being certified and paid as an acute care 
hospital for inpatient services. However, we intend to revisit the 
existing crossover patient policy as it affects other crossover 
situations in the future and would welcome receiving the industry's 
views on how Medicare payment policy should address those situations.
    Accordingly, we are finalizing our proposed revisions to Sec.  
412.2(b) of the regulations to add a new paragraph (3) which would be 
applicable to acute care hospitals, and to add a new paragraph (e) to 
Sec.  412.521 which would be applicable to LTCHs. The additions will 
specify that Medicare would make only one payment for a crossover 
patient to the LTCH that is discharging the patient based on the entire 
stay, both prior to the change to LTCH status and after the change. In 
order to implement the final policy, we will create systems adjustments 
that will enable the single claim generated by the discharging provider 
to include patient days under the initial provider number. We note that 
our final provisions to define and pay for crossover patient stays as 
one episode of care based on the PPS of the discharging provider are 
consistent with existing regulations. (Existing regulations have 
established that payment under the per discharge PPS constitutes 
``payment-in-full'' for acute care hospitals and for LTCHs.
    Comment: The commenters agreed that hospitals should not be 
receiving two payments for crossover patients, and stated that our 
proposed change in policy to pay for only one stay appears reasonable. 
Moreover, they suggested that we consider applying this policy to all 
conversions, including acute care to rehabilitation, rehabilitation to 
LTCH, and LTCH to rehabilitation so that payment rules could be 
consistent with those presented in this final rule.
    Response: We appreciate the commenters' support of our policy 
change to allow only one payment in crossover situations. As we stated 
above, we believe this policy could be equally applicable in other 
crossover situations, and will be revisiting the crossover policy as it 
affects other similar situations in the future.
    Therefore, we are proposing to finalize our proposal without 
modification.

C. Geographic Reclassifications--Definitions of Urban and Rural Areas 
(Sec.  412.63(b), Sec.  412.64(b), and 412.102)

1. Revised MSAs
    As we discussed in section III.B. and III.G. of the May 18, 2004 
proposed rule and of this final rule, we proposed how we would 
implement OMB's revised standards for defining MSAs and our plan to use 
the New England MSAs established by OMB. These proposals relate to our 
policies in established regulations under Sec.  412.63(b) governing 
geographic classification of hospitals for purposes of the wage index 
and the standardized amounts in determining the Federal rates for 
inpatient operating costs. In this section, we define the geographic 
areas for purposes of reclassification of hospitals. Therefore, 
consistent with our proposed changes to reflect the new definitions of 
CBSAs based on the Census 2000 data, effective for discharges occurring 
on or after October 1, 2004, in the May 18, 2004 proposed rule (69 FR 
28277), we proposed to revise Sec.  412.63(b) and add a new Sec.  
412.64(b) to reflect the existing geographic classification 
definitions.
    We note that commenters did not express objections to this specific 
proposal. However, commenters expressed concern regarding various 
aspects of our proposal to adopt the new definition of CBSAs. We 
address these comments throughout this final rule.
2. Transition Period for DSH Payments to Redesignated Hospitals
    Section 412.102 of the regulations provides for a 3-year transition 
to the standardized amount and DSH adjustment payments to a hospital 
redesignation from urban to rural.
    Comment: One commenter asked CMS to clarify whether the transition 
period that allows urban hospitals reclassified as rural to maintain 
their assignment to the MSA where they are currently located for 3 
years applies to both the wage index and the DSH payment adjustment.
    Response: As described in Sec.  412.102, in the first year after a 
hospital loses urban status, the hospital will receive an additional 
payment that equals two-thirds of the difference between the urban DSH 
payments applicable to the hospital before its designation from urban 
to rural and the rural DSH payments applicable to the hospital 
subsequent to its redesignation from urban to rural. In the second year 
after a hospital loses urban status, the hospital will receive an 
additional payment that equals one-third of the difference between the 
urban DSH payment applicable to the hospital before its redesignation 
from urban to rural and the rural DSH payments applicable to the 
hospital subsequent to its redesignation from urban to rural.

D. Equalization of Urban and Rural Standardized Amounts (Sec.  
412.63(c) and Sec.  412.64)

    Sections 1886(d)(2)(D) and (d)(3) of the Act previously required 
the Secretary to compute two average standardized amounts for 
discharges occurring in a fiscal year: one for hospitals located in 
large urban areas and one for hospitals located in other areas. In 
addition, under sections 1886(d)(9)(B)(iii) and (d)(9)(C)(i) of the 
Act, the average standardized amount per discharge was determined for 
hospitals located in large urban and other areas in Puerto Rico. In 
accordance with section 1886(b)(3)(B)(i) of the Act, prior to April 1, 
2003, the large urban average standardized amount was 1.6 percent 
higher than the other area average standardized amount. The two 
standardized amounts are currently equal, as discussed in the following 
paragraphs.
    Section 402(b) of Public Law 108-7 required that, effective for 
discharges occurring on or after April 1, 2003, and before October 1, 
2003, the Federal rate for all IPPS hospitals would be based on the 
large urban standardized amount. Subsequently, Public Law 108-89 
extended section 402(b) of Public Law 108-7 to discharges occurring on 
or after October 1, 2003, and before April 1, 2004. Finally, section 
401(a) of Public Law 108-173 required that, beginning with FY 2004 and 
thereafter, an equal standardized amount is to be computed for all 
hospitals at the level computed for large urban hospitals during FY 
2003, updated by the applicable percentage update. This provision in 
effect makes permanent the equalization of the standardized amounts at 
the level of the previous standardized amount for large urban 
hospitals. Section 401(c) also equalizes the Puerto Rico-specific urban 
and other area rates.
    Accordingly, in the May 18, 2004 proposed rule (69 FR 28277) and in 
this final rule, we are providing for a single national standardized 
amount and a single Puerto Rico standardized amount for FY 2005 and 
thereafter, as discussed in detail in the Addendum to this final rule. 
We are revising existing Sec.  412.63 that includes the provisions 
related to computation of the standardized amount to make it applicable 
to fiscal years through FY 2004 and establishing a new Sec.  412.64 
that will include the provisions applicable to the single national 
standardized amount applicable for FY 2005 and subsequent

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years. Similarly, we are revising existing Sec.  412.210 for Puerto 
Rico to make it applicable to fiscal years through FY 2004 and adding a 
new Sec.  412.211 for FY 2005 and subsequent years for the Puerto Rico 
standardized amount. We are also making conforming changes to various 
other sections of the regulations to reflect the single standardized 
amount for the States and for Puerto Rico.
    The comments received in response to this specific proposal 
concurred with the proposal on the basis that it is consistent with the 
implementation of recent legislative changes.

E. Reporting of Hospital Quality Data for Annual Hospital Payment 
Update (Sec.  412.64(d))

1. Background
    Section 501(b) of Public Law 108-173 amended section 1886(b)(3)(B) 
of the Act to add a new subclause (vii) to revise the mechanism used to 
update the standardized amount for payment for inpatient hospital 
operating costs. Specifically, the amendment provides that the update 
percentage increase (also known as the market basket update) for each 
of FYs 2005 through 2007 will be reduced by 0.4 percentage points for 
any ``subsection (d) hospital'' that does not submit data on a set of 
10 quality indicators established by the Secretary as of November 1, 
2003. (The statutory reference to a ``subsection (d) hospital'' 
restricts the application of this provision to hospitals paid under the 
IPPS. Therefore, the provision does not apply to hospitals and hospital 
units excluded from the IPPS, nor to payments to hospitals under other 
systems such as the outpatient hospital PPS.) The statute also provides 
that any reduction will apply only to the fiscal year involved, and 
will not be taken into account in computing the applicable percentage 
increase for a subsequent fiscal year. This measure establishes an 
incentive for IPPS hospitals to submit data on the quality measures 
established by the Secretary.
    In the May 18, 2004 proposed rule (69 FR 28277), we proposed to 
implement the provisions of section 501(b) as described at the CMS Web 
site: http://www.cms.hhs.gov/quality/hospital.
    At a press conference on December 12, 2002, the Secretary of HHS 
announced a series of steps that HHS and its collaborators are taking 
for public reporting of hospital quality information. These 
collaborators include the American Hospital Association, the Federation 
of American Hospitals, the Association of American Medical Colleges, 
the Joint Commission on Accreditation of Healthcare Organizations 
(JCAHO), the National Quality Forum, the American Medical Association, 
the Consumer-Purchaser Disclosure Project, the American Association of 
Retired Persons, the American Federation of Labor-Congress of 
Industrial Organizations and the Agency for Healthcare Research and 
Quality, as well as CMS, QIOs, and others.
    CMS began the public reporting initiative in July 2003 with a 
professional Web site that provides data intended for health care 
professionals. The professional Web site will be followed by a consumer 
Web site. The information on the consumer Web site will include the 
data from the professional Web site but in an easy-to-use format for 
consumers. It is intended to be an important tool for individuals to 
use in making decisions about their health care coverage. This 
information will assist beneficiaries by providing comparison 
information for consumers who need to select a hospital. It will also 
serve as a way of encouraging hospitals to adopt quality improvement 
strategies.
    The 10 measures that were employed in this voluntary initiative as 
of November 1, 2003, are:
     Heart Attack (Acute Myocardial Infarction)
    Was aspirin given to the patient upon arrival to the hospital?
    Was aspirin prescribed when the patient was discharged?
    Was a beta-blocker given to the patient upon arrival to the 
hospital?
    Was a beta-blocker prescribed when the patient was discharged?
    Was an ACE inhibitor given for the patient with heart failure?
     Heart Failure
    Did the patient get an assessment of his or her heart function?
    Was an ACE inhibitor given to the patient?
     Pneumonia
    Was an antibiotic given to the patient in a timely way?
    Had a patient received a pneumococcal vaccination?
    Was the patient's oxygen level assessed?
    These measures have been endorsed by the National Quality Forum 
(NQF) and are a subset of the same measures currently collected for the 
JCAHO by its accredited hospitals. Many hospitals are currently 
participating in the Department's National Voluntary Hospital Reporting 
Initiative (NVHRI) and are already submitting data to the QIO Clinical 
Warehouse. The Secretary adopted collection of data on these 10 quality 
measures in order to: (1) Provide useful and valid information about 
hospital quality to the public; (2) provide hospitals a sense of 
predictability about public reporting expectations; (3) begin to 
standardize data and data collection mechanisms; and (4) foster 
hospital quality improvement.
2. Requirements for Hospital Reporting of Quality Data
    For the hospital reporting initiative for the Medicare annual 
payment update provided for under section 501(b) of Public Law 108-173, 
we will be collecting data on the 10 clinical measures for all 
patients. We refer to this program as the Reporting Hospital Quality 
Data for the Annual Payment Update (RHQDAPU) program to distinguish it 
from the continuing NVHRI.
    The procedures for participating in the RHQDAPU can be found on the 
QualityNet Exchange at the Web site: http://www.qnetexchange.org in the 
``Reporting Hospital Quality Data for Annual Payment Update Reference 
Checklist.'' This checklist also contains all of the forms to be 
completed by hospitals participating in the program. In order to 
participate in the RHQDAPU, hospitals must follow the following steps:
     The hospital must identify a QualityNet Exchange 
administrator who follows the registration process and submits the 
information through the QIO. This must be done, regardless of whether 
the hospital uses a vendor for transmission of data.
     All participants must first register with the QualityNet 
Exchange, regardless of the method used for data submission. If a 
hospital is currently participating in the voluntary reporting 
initiative, re-registration on the QualityNet Exchange is unnecessary. 
However, registration includes completion of the RHQDAPU Notice of 
Participation form. All hospitals must send the RHQDAPU form to their 
QIOs no later than August 1, 2004, for the FY 2005 update.
     The hospital must collect data for all 10 measures and 
submit the data to the QIO Clinical Warehouse either using the CMS 
Abstraction & Reporting Tool (CART), the JCAHO Oryx Core Measures 
Performance Measurement System (PMS), or another third-party vendor who 
has met the measurement specification requirements for data 
transmission to the QualityNet Exchange. The QIO Clinical Warehouse 
will submit the data to CMS on behalf of the hospitals. The submission 
will be done through QualityNet Exchange, which is a secure site that 
voluntarily

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meets or exceeds all current Health Insurance Portability and 
Accountability Act (HIPAA) requirements, while maintaining QIO 
confidentiality as required by law. The information in the Clinical 
Warehouse is considered QIO data, and therefore, is subject to the 
stringent confidentiality regulations in 42 CFR Part 480.
    Hospitals must begin the submission of data under the provisions of 
section 1886(b)(3)(B)(vii)(II) of the Act, as added by section 501(b) 
of Public Law 108-173, by July 1, 2004. Because section 501(b) of 
Public Law 108-173 grants a 30-day grace period for submission of data 
with respect to FY 2005, in the May 18, 2004 proposed rule, we proposed 
to allow hospitals until August 1, 2004, for completed submissions to 
be successfully accepted into the QIO Clinical Warehouse. Hospitals 
would be required to submit data for the first calendar quarter of 2004 
discharges in order to meet the requirements for the FY 2005 payment 
update. Hospitals participating in the NVHRI that submitted the 
required 10 measures for the fourth calendar quarter of 2003 by the 
CMS-established deadline of May 15, 2004, and that met the registration 
requirements for the market basket update, would be given until August 
15, 2004, to submit data for the first calendar quarter of 2004. There 
will be no chart-audit validation criteria in place for the FY 2005 
payment update beyond the CART edits, currently in force, applied to 
data entering the QIO Clinical Warehouse. In addition, we proposed that 
we would estimate the minimum number of discharges anticipated to be 
submitted by a hospital using Medicare administrative data. We proposed 
to use this anticipated minimum number to establish our expectations of 
the number of cases for each hospital. Hospitals that do not treat a 
condition or have very few discharges would not be penalized and would 
receive the full annual payment update if they submit all the data they 
do possess. New hospitals should begin collecting and reporting data 
immediately and complete the registration requirements for the market 
basket update. The same standards that are applied to established 
hospitals would be applied to new hospitals when determining the 
expected number of discharges for the calendar quarters covered for 
each fiscal year.
    In the May 18, 2004 proposed rule, we stated that the annual 
payment updates would be based on the successful submission of data to 
CMS via the QIO Clinical Warehouse by the established deadlines. 
Hospitals may withdraw from RHQDAPU at any time up to August 1, 2004. 
Hospitals withdrawing from the program would not receive the full 
market basket update. Instead, they would receive a 0.4 percentage 
points reduction in the update. By law, a hospital's actions each 
fiscal year will not affect its update in a subsequent fiscal year. 
Therefore, a hospital must meet the requirements for RHQDAPU each 
fiscal year the program is in effect, and failure to receive the full 
update in one fiscal year will not affect its update in a succeeding 
fiscal year.
    Comment: All of the commenters who addressed our proposed plans to 
implement section 501(b) of Public Law 108-173 supported hospitals 
providing quality performance data. Most of the commenters also 
mentioned that it was important for CMS and the Joint Commission on 
Accreditation of Healthcare Organizations (JCAHO) to align their 
respective quality measures and procedures to make collection and 
submission of this data as easy as possible.
    Response: We are working with the JCAHO to accomplish this 
alignment on the current quality measures. We are also setting up a 
process to align any and all future measures that may be required by 
either organization. In addition, we have taken the necessary steps to 
ensure that this alignment is reflected in our chart audit validation 
process. We are committed to making the submission of the quality 
measures as seamless as possible for submitting either the core 
measures defined by JCAHO or the quality measures contained in the CMS 
Abstraction and Reporting Tool (CART).
    Comment: Many of the comments expressed concerns about the proposed 
chart audit validation procedures.
    Response: We believe that all of the data to be collected by CMS in 
its Clinical Warehouse must be timely, complete, and accurate. To 
accomplish this, we proposed reabstraction of data submitted to the 
Warehouse using the Clinical Data Abstraction Contractors (CDAC). The 
CDAC will request paper charts from each hospital that has submitted 
data to the warehouse and reabstract the quality measures using the CMS 
CART. Based upon the percent agreement rate at the element level (that 
is, the variables abstracted from the chart and used to construct each 
measure), hospitals achieving an 80-percent agreement with the CDAC 
abstraction will be considered as providing valid data. We will 
randomly sample charts for each hospital each quarter and aggregate 
across all charts to calculate the percent agreement. Several comments 
were concerned about our process for requesting copies of the charts. 
Under the proposed rules, hospitals are allowed 30 days to provide the 
charts. A followup request is sent, if necessary, 15 days following the 
initial request. Charts not received by the 31st day are considered 
missing and a zero-percent agreement is assigned to that missing chart.
    Comment: One commenter asked that we notify the hospital through 
our QNet Exhange Web site to alert the hospitals that a request for 
charts has been sent.
    Response: We agree that this alert would be helpful and have 
included this in future enhancements to our processes.
    Comment: Several commenters asked that we allow hospitals to submit 
additional information should the initial results be unfavorable.
    Response: At this time, we believe allowing hospitals to submit 
additional information would create an untenable workload for our 
contractors. We have approximately 4,000 hospitals submitting data in 
response to section 501(b) of Public Law 108-173. In addition, we are 
collecting data from other hospitals that are participating in the 
NVHRI. We estimate that we will be receiving data from as many as 4,500 
hospitals. We also believe it is important to keep the turnaround time 
for processing the validation records as short as possible. It is 
important both for our reporting requirements and for the hospitals to 
receive the validation results as soon as possible. To allow extensions 
for providing data on a piecemeal basis would extend the process beyond 
reasonable time limits. The CDAC process for requesting charts has been 
in place for over 6 years. We have been collecting both quality data 
and administrative data from all hospitals in the country during that 
time. We believe our process is functioning well, and we take steps to 
ensure that the chart requests are properly addressed and sent in a 
timely manner. We believe that hospitals understand the importance of 
these requests and will provide the charts in a timely manner.
    Comment: Many of the commenters expressed concern about reconciling 
differences between the hospital abstracted and CDAC abstracted data. 
Several commenters asked that we allow hospitals to supplement the 
submitted medical charts during an appeal process.
    Response: We have devised an appeal process that allows a hospital 
to review the validation results with their local QIO. If, after this 
review, the QIO agrees with the hospital's interpretation, the appeal 
is forwarded to the CDAC for review and correction, if necessary. We

[[Page 49080]]

do not believe we can allow hospitals to supplement the submitted 
medical charts during this appeal process. The original request asks 
for the complete chart, and we expect to receive all the information 
and documentation necessary to support the abstraction of the quality 
measures. Additional documentation puts the CDAC abstractors at a 
disadvantage and extends the time to complete the validation process. 
We understand that human error is possible and this is why we have set 
the required percent agreement at less than 100 percent.
    Comment: Other commenters recommended that the adjudication of any 
differences noted between the hospital abstraction and the CDAC 
abstraction should be subject to third party review and verification.
    Response: We believe that adopting this recommendation would create 
a lengthy and complicated process. We also believe that abstraction of 
the clinical data to calculate the quality measures is a straight-
forward process. The information requested by each question in the 
abstraction tool is either there, as stated, or it is not. These data 
are not qualitative in their derivation and not subject to human 
opinion. Also, our stated policy for ensuring that the data in the 
warehouse meet our requirements for consistency and accuracy is that 
the CDAC abstraction using the CART tool constitutes the correct data, 
or gold standard. We have devoted a great deal of resources to ensuring 
that the CDAC abstraction process is consistent and accurate through 
our training and internal quality assurance. We consistently achieve 
inter rater reliability rates approaching 100 percent in the CDAC.
    Comment: All of the commenters who addressed the sampling process 
asked that we reduce the percent agreement from our current 80 percent 
to at least 60 percent initially and gradually raise the rate to 80 
percent.
    Response: We do not believe that this is necessary or desirable for 
two reasons. First, we believe that the 80 percent level is a minimum 
level of agreement that we can accept at any time. This means that four 
out of five comparisons are the same. A 60 percent agreement would mean 
that only three out of five comparisons are the same. We do not believe 
this level of agreement is acceptable to meet our goal of ensuring 
submission of timely, complete, and accurate data.
    Second, for the FY 2005 annual payment update, we do not have a 
chart audit validation requirement. We realize that hospitals need time 
to understand the chart audit validation process and learn how to 
provide accurate and reliable data. We also need time to implement and 
test our procedures to ensure that we meet our goals of timely and 
accurate submission of data and provide a fair opportunity to hospitals 
to become familiar with the process. In support of the NVHRI program, 
we have started the validation process on data submitted to the 
warehouse beginning with calendar year 2003. We are providing feedback 
to the participating NVHRI hospitals that have deposited data in the 
warehouse and have instructed the QIOs to assist hospitals in 
correcting any issues or problems that are identified. The first data 
submission requirement for section 501(b) is the first calendar quarter 
of 2004. We will conduct chart audit validation on these data and 
provide feedback to all of the hospitals. The results of this first 
quarter will not affect annual payment update determinations for FY 
2005 or subsequent fiscal years. We believe that this test period will 
provide hospitals the necessary lead time to improve their data 
abstraction processes and provide them with the opportunity to achieve 
the necessary 80 percent level of agreement prior to institution of the 
validation requirement for the annual payment update for FY 2006. By 
allowing the hospitals a penalty free period to meet the 80 percent 
level we maintain consistent expectations regarding the submission of 
accurate data and reduce any confusion that a constantly changing goal 
might introduce.
    Comment: One commenter suggested we modify our assessment of 
percent agreement to differentiate between transcription errors and 
errors of omission. This commenter contended that the goal of the 
validation process is to determine if the standard of care has been 
met.
    Response: We disagree. The goal of the chart audit validation 
process is to ensure that the hospital is submitting accurate data. In 
order to calculate quality measures, which are used to determine the 
standard of care, we need to have complete and accurate data. Errors of 
omission and transcription errors both contribute to errors in 
calculation of quality measures. Therefore, we believe it is important 
to include both errors in calculating the percent agreement. We agree 
that it is important to differentiate between these errors in order to 
provide feedback to the hospitals. The process we have in place to 
provide this feedback gives each hospital the detail abstraction 
results from the CDAC so that staff may determine the types of errors 
and take appropriate action.
    In support of our goal of obtaining complete, timely and accurate 
data, the chart audit validation process will be applied to all data 
submitted to the clinical data warehouse. Several commenters argued 
that the validation in support of section 501(b) should only apply to 
the 10 quality measures required to be submitted. While such a 
restriction would not be in support of our policy on the integrity of 
the data in the clinical warehouse, we understand that receiving the 
full annual payment update is only subject to submission of the 10 
required measures. To varying degrees, all of the data contained in the 
clinical warehouse are used to inform different parties on the quality 
of care delivered to patients. Therefore, we plan to apply the 
validation results in a two-step process. For purposes of the annual 
payment update, the validation will be restricted to the 10 measures. 
For purposes related to publishing data, we will apply the validation 
results to all of the measures submitted. This second validation will 
not affect the annual payment update.
    Comment: Several commenters made suggestions on the quarterly 
sample size used to assess the percent agreement. One commenter 
recommended that we allow hospitals to submit additional records if the 
hospitals fail the initial validation. A second commenter suggested 
that we request a larger number of records and allow the hospital to 
select a subset to forward to the CDAC.
    Response: In order to maintain the integrity of the chart audit 
validation process, the selection of records must be random and 
independent of the hospital's control to ensure that the records being 
reviewed are representative of the data submitted by the hospital. We 
do not believe we can compromise the validity of the audit procedure by 
giving up control of the cases selected.
    Comment: Several commenters suggested that we consider optional 
standards for small volume hospitals. They contended that small 
differences in data validation can produce large percent differences 
that may adversely affect validation rates.
    Response: Our plans call for calculating the percent agreement 
based upon the individual variables abstracted from each chart 
aggregated across all of the charts abstracted. That is, we will pool 
the variables to create a denominator and then calculate the percent 
agreement. This approach creates a percent agreement that is 
independent of the number of cases a hospital may treat. The problem 
for small volume hospitals is that they may

[[Page 49081]]

not generate enough cases to meet our minimum sample sizes. Our chart 
audit validation rules would have us then request all of the charts 
generated by these small volume hospitals and we would, in essence, be 
evaluating the ``universe'' of data for these hospitals. In such a 
case, we would be calculating the actual percent agreement for that 
hospital, rather than estimating this percent as in a hospital where we 
have sampled the cases. It is our intent to monitor the demands our 
processes will have on small volume hospitals and to consider 
modifications so as to not over burden these hospitals. However, we do 
believe that Medicare beneficiaries are entitled to the same high level 
of quality care in all hospitals providing services and that all 
hospitals should be subject to a similar level of assurance by CMS.
    Comment: Several commenters requested that we engage in a series of 
training programs and briefings to educate the hospitals about the 
validation process and, in particular, provide information on the 
variables used in calculating the percent agreement.
    Response: We agree that this is an important aspect of this process 
and we have instructed the QIOs to assist hospitals to understand the 
results of the chart audit validation as well as begin to educate the 
hospitals on the process itself. We have published on our QNet Exchange 
Web site all of the documentation that supports the chart audit 
validation process, including the list of variables included in our 
calculations. However, we will continue to explore better ways to 
educate hospitals, through our QIOs, on all of our processes.
    Comment: Several commenters urged us to allow reasonable variation 
in abstracted data, especially for the variables containing continuous 
data such as the timing data. One commenter stated that our allowed 
variances seemed to be arbitrary.
    Response: We note that we have published the variation allowed for 
each of these continuous data variables. Our decisions on how much 
variation to allow in calculating these timing measures are the result 
of input from our clinical experts. Each variable was carefully 
considered in this context. For example, the variation allowed for the 
pneumonia and surgical infection timing is based on the fact that the 
measures derived from those values are measured in hours. In contrast, 
the acute myocardial infarction indicators are measured in minutes so 
the timing variables need to be more accurate. We will conduct research 
on this issue as we collect data to test and refine our theoretical 
expectations against the empirical data.
    Comment: One commenter urged us to streamline and automate our 
registration and attestation processes so that potential administrative 
problems do not prevent eligible hospitals from receiving their annual 
payment update.
    Response: We agree that this is an important issue. It is our 
policy to guard against just such a situation. We will be upgrading our 
systems, with input from the hospital community, to minimize this 
potential problem.
    Comment: One commenter raised concerns about the accessibility of 
the clinical warehouse data through our QNet Exchange server. The 
commenter suggested that other users, such as corporate quality 
assurance staff employed by a hospital system and not necessarily the 
specific hospital, as well as staff from JCAHO accredited ORYX vendors 
should be able to see a hospital's data to assist that hospital in its 
data collection and reporting and quality assurance activities.
    Response: Under current policy, only staff from a specific hospital 
are allowed to access that hospital's data through a system of user 
registration and password protections. This is a result of the laws and 
regulations that govern the data our QIOs maintain in the Clinical 
Warehouse. Specifically, regulations prohibit QIOs from releasing data 
that identifies individual hospitals without first notifying the 
hospitals and allowing a 30-day response period. In principle, we agree 
with the suggestion that other users, such as corporate quality 
assurance staff employed by a hospital system and not necessarily the 
specific hospital, as well as staff from JCAHO accredited ORYX vendors 
should be able to see a hospital's data (not patient-identified data) 
to assist that hospital in its data collection and reporting and 
quality assurance activities. We believe we can resolve the legal 
issues satisfactorily and we anticipate implementation of mechanisms to 
allow this type of access in the Fall of 2004.
    Comment: Several commenters expressed a concern that the 
designation of the 10 quality indicators in section 501(b) fixes, by 
law, measures that in fact are subject to change depending upon medical 
science and the evolving field of quality measurement. While realizing 
that CMS cannot change the required data by regulation, the commenters 
nonetheless believed that some accommodation should be considered for 
allowing these measures to be modified or changed as the knowledge in 
the field of quality measurement changes.
    Response: We agree that the field of quality measurement is a 
changing landscape and that, sometimes, accommodations need to be made. 
However, we would point out that section 501(b) contains a sunset 
clause for these 10 measures. Submission of the data on the 10 quality 
measures is only required for FYs 2005, 2006, and 2007 in order for a 
hospital to receive the full annual payment update. Otherwise, we are 
required to enforce the law as written.
    Comment: Several commenters made note of our attempts to estimate 
the minimum number of cases that CMS expects from each hospital. They 
were particularly concerned that this number will not be an accurate 
representation of the number of cases a hospital may treat.
    Response: The estimate of the minimum number of cases that we are 
providing is based upon the average number of Medicare discharges per 
quarter found in the administrative data for each hospital over the 
last 2 years. In contrast, section 501(b) requires that the submitted 
data include all payers and not just the Medicare beneficiaries. We 
recognize that this distinction is a shortcoming in our calculation of 
the minimum number of cases. However, we do not have any data from 
which to estimate how many non-Medicare patients a hospital treats. Our 
intent is to monitor the submissions from the hospitals and to update 
our estimates as we gain experience, taking into account sampling where 
appropriate.
    Comment: One commenter believed it was important that its 
organization participate in the formulation of quality measures, given 
the importance attached to these measures.
    Response: All of the measures CMS currently collects, as well as 
those measures collected by the JCAHO, are endorsed by the National 
Quality Forum (NQF). This organization uses a consensus process to 
develop quality measures for all health care settings. Its 
deliberations include all aspects of a quality measure, including 
current standards of practice, documentation requirements, and the 
scientific research supporting the measure. Membership is open to all 
interested parties. These organizations can contact the NQF and 
participate through this mechanism. The 10 measures are required by 
statute and have been endorsed by the NQF.
    Comment: One commenter was concerned about new hospitals that are 
not able to meet the registration and reporting requirements simply 
because they were not in existence during the first quarter of calendar 
year 2004, but will be operating throughout FY 2005.

[[Page 49082]]

    Response: We agree that new hospitals should not be disadvantaged 
by their inability to report data prior to opening. Therefore, we will 
hold these hospitals harmless with respect to the update. The 
instructions we have given the QIOs are to have these new hospitals 
register with QNet Exchange as soon as possible; complete the pledge to 
participate in the annual payment update; complete the form that tells 
CMS the hospital has zero discharges for the first quarter of calendar 
year 2004, and begin submitting the required data as it becomes 
available in the future.
    Comment: Several commenters were concerned about our intent to 
publish the quality measure data that we receive through section 
501(b). These commenters focused on the validation of the published 
data and on the use of composite hospital level scores, as opposed to 
individual measures.
    Response: We have stated that we intend to use validation results 
as part of the criteria for publishing the hospital data. This is still 
our intent. However, we recognize that situations may change and we may 
have to modify this decision. It is our practice, in this situation, to 
notify the community should this decision change. As to the use of a 
composite score at the hospital level, we have not made our final 
decisions about the format for publishing these data, but we are 
considering the use of composite scores.
3. Submission of Hospital Data for FYs 2006 and 2007
    For FYs 2006 and 2007, we will require hospitals to submit data 
quarterly, starting August 15, 2004. Eligibility for the full annual 
payment update will be based on the most recent four quarters of data. 
These data would be submitted on the same schedule for data 
transmission currently in force for CART data. That is, data must be 
submitted to the QIO Clinical warehouse no later than 15 calendar days 
after the fourth month following the end of the calendar quarter. This 
schedule is available at http://www.qnetexchange.org. We will establish 
validation requirements for submitted data for FYs 2006 and 2007. 
Submissions would, at a minimum, need to be accurate, timely, and 
complete. That is--
     The hospital-submitted data must meet minimum levels of 
reliability through chart audit re-abstractions over all topics. At the 
data element level, there must be an 80 percent agreement between the 
original abstraction and the re-abstraction using the CART tool.
     The submitted data must be on schedule, pass all warehouse 
edits, and be successfully accepted into the warehouse.
     Completeness of submitted data will be assessed to ensure 
the number of submitted cases corresponds to the number of bills 
submitted by the hospital to CMS.
    We are planning to publish the most recent 12 months of discharge 
data(4 quarters) for all data accepted into the warehouse and passing 
all validation requirements. For FY 2005, we will publish as much data 
as we have available. Hospitals will have the opportunity to review the 
information prior to posting on the CMS Web site. However, there will 
be no opportunity to withhold the publication of the information. The 
preview will only be to correct obvious errors. Comments regarding the 
requirements for the submission of quality data for FY 2006 and FY 2007 
are presented above in conjunction with the comments regarding the 
general requirements for hospital reporting of quality data.
4. Regulation Change
    In the May 18, 2004 proposed rule (69 FR 28279), we proposed to 
establish a new Sec.  412.64(d)(2) to provide that, for FYs 2005, 2006, 
and 2007, the applicable percentage change is reduced by 0.4 percentage 
points in the case of any subsection (d) hospital that does not submit 
data to CMS on the 10 quality indicators established by the Secretary 
as of November 1, 2003. Any reduction will apply only to the fiscal 
year involved, and will not be taken into account in computing the 
applicable percentage increase for a subsequent fiscal year.
    Comment: MedPAC reiterated its support of the concept of tying 
payment to quality performance. MedPAC did question the need to 
financially reward or penalize hospitals just for submitting data. It 
also noted that the statute requires hospitals to report on the quality 
measures that were a part of the NVHRI as of November 2003. MedPAC 
recommended that the Secretary should have the authority to update the 
measures on a regular basis, adding or retiring measures as clinical 
guidelines change or when providers reach high levels of performance in 
certain areas.
    Response: While payment for performance may be an ultimate goal, 
the current law is specific in tying the annual payment update data to 
reporting only. We point out that hospitals, as a condition of 
participation and payment, are required to submit charts of Medicare 
patients for review upon the request of the program. The failure to do 
so may result in a denial of payment for that discharge. We appreciate 
MedPAC's recommendation that the Secretary should have the authority to 
update the measures that are reported. As MedPAC's comment implies, 
adoption of this recommendation would require a statutory change.
    Comment: One commenter asked whether the Medicare intermediaries 
would receive specific instructions about how to implement this 
differential update for hospitals that do and do not submit quality 
data.
    Response: As we indicated in the proposed rule, we will be 
modifying our payment software to apply the correct updates to 
hospitals, depending on whether they submit the requisite data on the 
10 quality indicators. The software will automatically provide payment 
based on the fully updated rate to hospitals that have submitted data 
on the requisite quality measures.
    In this final rule, we are adopting, as final, the new Sec.  
412.64(d)(2) as proposed. This new section of the regulations provides 
that, for FYs 2005, 2006, and 2007, the applicable percentage change is 
reduced by 0.4 percentage points in the case of any subsection (d) 
hospital that does not submit data to CMS on the 10 quality indicators 
established by the Secretary as of November 1, 2003. Any reduction will 
apply only to the fiscal year involved, and will not be taken into 
account in computing the applicable percentage increase for a 
subsequent fiscal year.
    We show the different standardized amounts that apply to hospitals 
that submit the requisite quality data, and to hospitals that do not, 
in the Addendum to this final rule.

F. Revision of the Labor-Related Share for the Hospital Wage Index 
(Sec.  412.64(h))

    As discussed in section III. of the preamble of this final rule, 
section 1886(d)(3)(E) of the Act directs the Secretary to adjust the 
proportion of the national prospective payment system base payment 
rates that are attributable to wages and wage-related costs by a factor 
that reflects the relative differences in labor costs among geographic 
areas. It also directs the Secretary to estimate from time to time the 
proportion of hospital costs that are labor-related. The portion of 
hospital costs attributable to wages and wage-related costs is referred 
to as the labor-related share. The labor-related share of the 
prospective payment rate is adjusted by an index of relative labor 
costs, which is referred to as the wage index. In the past, we have 
defined the labor-related share for prospective payment

[[Page 49083]]

acute care hospitals as the national average proportion of operating 
costs that are related to, influenced by, or vary with the local labor 
market. The labor-related share for the acute care hospital inpatient 
prospective payment system has been calculated as the sum of the 
weights for wages and salaries, fringe benefits, nonmedical 
professional fees, contract labor, postage, and labor-intensive 
services. For FY 2004, the labor share of the hospital wage index was 
established at 71.066 percent.
    Section 403 of Public Law 108-173 amended section 1886(d)(3)(E) of 
the Act to provide that the Secretary must use 62 percent as the labor-
related share unless application of this percentage ``would result in 
lower payments than would otherwise be made.'' However, this provision 
of Public Law 108-173 did not change the legal requirement that the 
Secretary estimate ``from time to time'' the proportion of hospitals'' 
costs that are ``attributable to wages and wage-related costs.'' In 
fact, section 404 of Public Law 108-173 requires the Secretary to 
develop a frequency for revising the weights used in the hospital 
market basket, including the labor share, to reflect the most current 
data more frequently than once every 5 years. Section 404 further 
requires us to include in the final IPPS rule for FY 2006 an 
explanation of the reasons for, and options considered, in determining 
such frequency.
    Under section III. of this final rule (and in the May 18, 2004 
proposed rule), we discuss our implementation of section 1886(d)(3)(E) 
of the Act, as amended by section 403, as it applies to the development 
of the FY 2005 wage index. In this section IV.F. of the preamble, we 
are incorporating the provisions of section 403 of Public Law 108-173 
under a new Sec.  412.64(h). Specifically, we are specifying that CMS 
will adjust the proportion of the Federal rate for inpatient operating 
costs that are attributable to wages and labor-related costs for area 
differences in hospital wage levels by a factor (established by CMS 
based on survey data) reflecting the relative level of hospital wages 
and wage-related costs in the geographic area (that is, urban or rural 
area as determined by the regulations) of the hospital compared to the 
national average level of hospital wages and wage-related costs. The 
wage index will continue to be updated annually. In addition, we are 
specifying that CMS will determine the proportion of the Federal rate 
that is attributable to wages and labor-related costs from time to 
time, employing a methodology that is described in the annual 
regulation updating the system of payment for inpatient hospital 
operating costs. However, CMS will employ 62 percent as the proportion 
of the rate that is adjusted for the relative level of hospital wages 
and wage-related costs, unless employing that percentage would result 
in lower payments for the hospital than employing the proportion 
determined under the methodology described in the preceding sentence.
    We did not receive any public comments on our proposed 
implementation of section 403 of Public Law 108-173. Therefore, we are 
adopting as final, the proposed addition of the section 403 provisions 
in Sec.  412.64(h) of the regulations.

G. Wage Index Adjustment for Commuting Patterns of Hospital Employees 
(Sec.  412.64(i))

    As discussed in section III.H.3.e. of this final rule (and in the 
May 18, 2004 proposed rule), section 505 of Public Law 108-173 
established new section 1886(d)(13) of the Act. We refer readers to 
section III.H.3.e for a discussion of this adjustment.
    We are incorporating the provisions of section 505 of Public Law 
108-173 in the regulations by adding a new Sec.  412.64(i).
    To identify ``qualifying counties,'' we use commuting data compiled 
by the U.S. Census Bureau based on a special tabulation of Census 2000 
journey-to-work data. This information is gathered from responses to 
the Census long-form (sample) questions on where people worked. The 
resulting county-of-residence by county-of-work commuter flow file uses 
108 Industrial Structure codes, developed by the Bureau of Economic 
Analysis. We limited the data set to those employees working in the 
category designated ``hospitals.'' (BEA code 622000).
    In order to be considered a qualifying county, the hospitals in 
such county must meet the criteria listed Sec.  412.64(i). First, the 
difference between the county's wage index and the weighted wage index 
of the surrounding higher wage index areas to which hospital workers 
commute must be greater than zero. Thus, any increase in the wage index 
resulting from this provision that is greater than zero percent would 
be recognized for meeting this criterion. Second, the county must meet 
the minimum out-migration threshold of 10 percent (the minimum out-
migration percentage permitted by statute). Third, the average hourly 
wage of the hospitals located in the county must equal or exceed the 
wage index of the labor market area in which the county is located.
    As stated in section III.H.3.e. of this preamble, for this third 
criterion, we will use the average of hospitals' 3-year average hourly 
wage for all hospitals in a given county. We compared this county 
average hourly wage to the 3-year average hourly wage for the labor 
market area where the county is located. We are using the 3-year 
average hourly wage because we believe it gives a better estimate for 
the wages paid by a given hospital over a period of time.
    In addition, as stated in section III.H.3.e of this preamble that 
we will apply the out-migration adjustment in an automatic manner. All 
hospitals located in qualifying counties will automatically receive the 
increase in wage index, unless the hospital has already been 
reclassified to another geographic area, including reclassifications 
under section 508 of Public Law 108-173. If a hospital has been 
redesignated under section 1886(d)(8)(B) of the Act, reclassified under 
section 1886(d)(10) of the Act, or reclassified under section 508 of 
Public Law108-173, we assume that the hospital wishes to remain 
reclassified/redesignated and does not want to receive the out-
migration adjustment. This wage index increase will be effective for a 
period of 3 fiscal years, FY 2005 through FY 2007.
    Hospitals receiving this wage index increase under section 
1886(d)(13)(F) of the Act are not eligible for reclassification under 
section 1886(d)(8)(B) or section 1886(d)(10) of the Act, or under 
section 508 of Public Law 108-173. Therefore, in the proposed rule, 
consistent with Sec.  412.273, we stated that hospitals that were 
reclassified by the MGCRB were permitted to terminate their 
reclassifications or redesignations within 45 days of the publication 
of the proposed rule in the Federal Register (that is, by July 2, 
2004).
    In this final rule, we have allowed for a one time rule for FY 2005 
that would allow hospitals a 30-day period after publication of this 
final rule when they can decide if they would rather take advantage of 
their redesignation/reclassification or the out-migration adjustment. 
Hospitals will have 30 days after the publication of this rule in the 
Federal Register to either-- (1) submit to us a request to terminate 
their reclassifications under section 1886(d)(10) of the Act (or under 
section 508 of Public Law 108-173) or redesignated status under section 
1886(d)(8)(B) of the Act and receive the out-migration adjustment 
instead; or (2) reactivate a hospital's reclassification/redesignation 
if a hospital withdrew its reclassification/redesignation within 45

[[Page 49084]]

days of publication of the May 18, 2004 proposed rule. (Only one 
hospital requested waiver of its redesignation.) If we do not receive a 
request for termination or reactivation within this 30-day period, we 
will assume that hospitals that have been redesignated under section 
1886(d)(8)(B) of the Act or reclassified under section 1886(d)(10) of 
the Act or under section 508 of Public Law 108-173 would prefer to keep 
their redesignation/reclassification. In addition, if within 30 days of 
publication of this final rule, we do not receive a request from the 
one hospital that withdrew its redesignation to reactivate such 
redesignation, we will assume that the hospital wishes to receive the 
out-migration adjustment. Finally, we wish to clarify that (except for 
the one hospital that has already withdrawn its redesignation) 
hospitals that wish to retain their redesignation/reclassification 
(instead of receiving the out-migration adjustment) for FY 2005 did not 
and do not have to submit a formal request to CMS, and will 
automatically retain their reclassification/redesignation status for FY 
2005.

H. Additional Payments for New Medical Services and Technology: Policy 
Changes (Sec. Sec.  412.87 and 412.88)

    As discussed in section II.D. of the preamble of this final rule 
(and in the preamble of the May 18, 2004 proposed rule), sections 
1886(d)(5)(K) and (L) of the Act establish a process of identifying and 
ensuring adequate payment for new medical services and technologies 
under the IPPS, effective for discharges beginning on or after October 
1, 2001. Section 1886(d)(5)(K)(ii)(I) of the Act specifies that the 
process must apply to a new medical service or technology if, ``based 
on the estimated costs incurred with respect to discharges involving 
such service or technology, the DRG prospective payment rate otherwise 
applicable to such discharges under this subsection is inadequate.'' 
Section 1886(d)(5)(K)(vi) of the Act specifies that a medical service 
or technology will be considered ``new'' if it meets criteria 
established by the Secretary after notice and opportunity for public 
comment.
    Sections 1886(d)(5)(K)(ii) through (d)(5)(K)(vi) of the Act further 
provide--
     For an additional payment for new medical services and 
technology in an amount beyond the DRG prospective payment system 
payment rate that adequately reflects the estimated average costs of 
the service or technology.
     That the requirement for an additional payment for a new 
service or technology may be satisfied by means of a new technology 
group (described in section 1886(d)(5)(L) of the Act), an add-on 
payment, a payment adjustment, or any other similar mechanism for 
increasing the amount otherwise payable with respect to a discharge.
     For the collection of data relating to the cost of a new 
medical service or technology for not less than 2 years and no more 
than 3 years after an appropriate inpatient hospital services code is 
issued. The statute further provides that discharges involving new 
services or technology that occur after the collection of these data 
will be classified within a new or existing DRG group with a weighting 
factor derived from cost data collected for discharges occurring during 
such period.
    Section 412.87(b)(1) of our existing regulations provides that a 
new technology will be an appropriate candidate for an additional 
payment when it represents an advance in medical technology that 
substantially improves, relative to technologies previously available, 
the diagnosis or treatment of Medicare beneficiaries (see the September 
7, 2001 final rule (66 FR 46902)). Section 412.87(b)(3) provides that, 
to receive special payment treatment, new technologies meeting this 
clinical definition must be demonstrated to be inadequately paid 
otherwise under the DRG system.
    In the August 1, 2003 final IPPS rule, we revised the threshold 
amount for determining if payment for a new technology or medical 
service is inadequate, effective for FY 2005 and subsequent fiscal 
years (68 FR 45392). We lowered the previously established threshold of 
1 standard deviation to 75 percent of 1 standard deviation (based on 
the logarithmic values of the charges) beyond the geometric mean 
standardized charges for all cases in the DRG to which the new 
technology is assigned (or the case-weighted average of all relevant 
DRGs, if the new technology occurs in many different DRGs), transformed 
back to charges.
    Section 503(b) of Public Law 108-173 amended section 
1886(d)(5)(K)(ii)(I) of the Act to specify that in determining whether 
payments for a new technology or medical service are inadequate, the 
Secretary is to determine and apply a threshold amount that is the 
``lesser of 75 percent of the standardized amount (increased to reflect 
the difference between cost and charges) or 75 percent of 1 standard 
deviation for the DRG involved.'' As a result of enactment of section 
503(b), as we proposed in the May 18, 2004 proposed rule, we are 
revising our regulations at Sec.  412.87(b)(3) to incorporate the 
revised threshold amount.
    The report language accompanying section 533 of Public Law 106-554 
indicated Congressional intent that the Secretary implement the new 
mechanism on a budget neutral basis (H.R. Conf. Rep. No. 106-1033, 
106th Cong., 2nd Sess., at 897 (2000)). Section 1886(d)(4)(C)(iii) of 
the Act requires that the adjustments to annual DRG classifications and 
relative weights must be made in a manner that ensures that aggregate 
payments to hospitals are not affected. Therefore, in the past, we 
accounted for projected payments under the new medical service and 
technology provision during the upcoming fiscal year at the same time 
we estimated the payment effect of changes to the DRG classifications 
and recalibration. The impact of additional payments under this 
provision was then included in the budget neutrality factor, which was 
applied to the standardized amounts and the hospital-specific amounts.
    To balance appropriately the Congressional intent to increase 
Medicare payments for eligible new technologies with concern that the 
total size of those payments not result in significantly reduced 
payments for other cases, we set a target limit for estimated add-on 
payments for new technology under the provisions of sections 
1886(d)(5)(K) and (L) of the Act at 1.0 percent of estimated total 
operating prospective payments. In accordance with Sec.  412.88(c) of 
the regulations, if the target limit was exceeded, we would reduce the 
level of payments for approved technologies across the board, to ensure 
estimated payments did not exceed the limit.
    Section 503(d)(1) of Public Law 108-173 amended section 
1886(d)(5)(K)(ii)(III) of the Act to remove the budget neutrality 
provision for add-on payments for a new medical service or technology. 
Section 503(d)(2) specifies that ``There shall be no reduction or other 
adjustment to payments under section 1886 of the Social Security Act 
because an additional payment is provided'' for new technology. 
Accordingly, as a result of the enactment of section 503(d) of Public 
Law 108-173, we will no longer include the impact of additional 
payments for new medical services and technologies in the budget 
neutrality factor. In addition, as we proposed in the May 18, 2004 
proposed rule, we are deleting Sec.  412.88(c) of the regulations. All 
the comments that we received on add-on payments for new technologies 
are addressed in section II.E. of the preamble to this final rule.

[[Page 49085]]

I. Rural Referral Centers (Sec.  412.96)

    Under the authority of section 1886(d)(5)(C)(i) of the Act, the 
regulations at Sec.  412.96 set forth the criteria that a hospital must 
meet in order to qualify under the IPPS as a rural referral center. For 
discharges occurring before October 1, 1994, rural referral centers 
received the benefit of payment based on the other urban standardized 
amount rather than the rural standardized amount. Although the other 
urban and rural standardized amounts are the same for discharges 
occurring on or after October 1, 1994, rural referral centers continue 
to receive special treatment under both the DSH payment adjustment and 
the criteria for geographic reclassification.
    Section 402 of Public Law 108-173 raised the DSH adjustment for 
other rural hospitals with less than 500 beds and rural referral 
centers. Other rural hospitals with less than 500 beds are subject to a 
12-percent cap on DSH payments. Rural referral centers are not subject 
to the 12.0 percent cap on DSH payments that is applicable to other 
rural hospitals (with the exception of rural hospitals with 500 or more 
beds). Rural referral centers are not subject to the proximity criteria 
when applying for geographic reclassification, and they do not have to 
meet the requirement that a hospital's average hourly wage must exceed 
106 percent of the average hourly wage of the labor market area where 
the hospital is located.
    Section 4202(b) of Public Law 105-33 states, in part, ``[a]ny 
hospital classified as a rural referral center by the Secretary * * * 
for fiscal year 1991 shall be classified as such a rural referral 
center for fiscal year 1998 and each subsequent year.'' In the August 
29, 1997 final rule with comment period (62 FR 45999), we also 
reinstated rural referral center status for all hospitals that lost the 
status due to triennial review or MGCRB reclassification, but not to 
hospitals that lost rural referral center status because they were now 
urban for all purposes because of the OMB designation of their 
geographic area as urban. However, subsequently, in the August 1, 2000 
final rule (65 FR 47089), we indicated that we were revisiting that 
decision. Specifically, we stated that we would permit hospitals that 
previously qualified as a rural referral center and lost their status 
due to OMB redesignation of the county in which they are located from 
rural to urban to be reinstated as a rural referral center. Otherwise, 
a hospital seeking rural referral center status must satisfy the 
applicable criteria.
    One of the criteria under which a hospital may qualify as a rural 
referral center is to have 275 or more beds available for use (Sec.  
412.96(b)(1)(ii)). A rural hospital that does not meet the bed size 
requirement can qualify as a rural referral center if the hospital 
meets two mandatory prerequisites (a minimum case-mix index and a 
minimum number of discharges) and at least one of three optional 
criteria (relating to specialty composition of medical staff, source of 
inpatients, or referral volume) (Sec.  412.96(c)(1) through (c)(5)). 
(See also the September 30, 1988 Federal Register (53 FR 38513)). With 
respect to the two mandatory prerequisites, a hospital may be 
classified as a rural referral center if--
     The hospital's case-mix index is at least equal to the 
lower of the median case-mix index for urban hospitals in its census 
region, excluding hospitals with approved teaching programs, or the 
median case-mix index for all urban hospitals nationally; and
     The hospital's number of discharges is at least 5,000 per 
year, or, if fewer, the median number of discharges for urban hospitals 
in the census region in which the hospital is located. (The number of 
discharges criterion for an osteopathic hospital is at least 3,000 
discharges per year, as specified in section 1886(d)(5)(C)(i) of the 
Act.)
1. Case-Mix Index
    Section 412.96(c)(1) provides that CMS will establish updated 
national and regional case-mix index values in each year's annual 
notice of prospective payment rates for purposes of determining rural 
referral center status. The methodology we use to determine the 
proposed national and regional case-mix index values is set forth in 
regulations at Sec.  412.96(c)(1)(ii). The proposed national median 
case-mix index value for FY 2005 includes all urban hospitals 
nationwide, and the proposed regional values for FY 2005 are the median 
values of urban hospitals within each census region, excluding those 
hospitals with approved teaching programs (that is, those hospitals 
receiving indirect medical education payments as provided in Sec.  
412.105). These proposed values are based on discharges occurring 
during FY 2003 (October 1, 2002 through September 30, 2003) and include 
bills posted to CMS' records through March 2004.
    In the May 18, 2004 proposed rule (69 FR 28281), we proposed that, 
in addition to meeting other criteria, if they are to qualify for 
initial rural referral center status for cost reporting periods 
beginning on or after October 1, 2004, rural hospitals with fewer than 
275 beds must have a case-mix index value for FY 2003 that is at 
least--
     1.3550; or
     The median case-mix index value (not transfer-adjusted) 
for urban hospitals (excluding hospitals with approved teaching 
programs as identified in Sec.  412.105) calculated by CMS for the 
census region in which the hospital is located. (See the table set 
forth in the May 18, 2004 proposed rule at 69 FR 28282.)
    Based on the latest data available (FY 2003 bills received through 
March 2004), in addition to meeting other criteria, hospitals with 
fewer than 275 beds, if they are to qualify for initial rural referral 
center status for cost reporting periods beginning on or after October 
1, 2004, must have a case-mix index value for FY 2004 that is at 
least--
     1.2496; or
     The median case-mix index value (not transfer-adjusted) 
for urban hospitals (excluding hospitals with approved teaching 
programs as identified in Sec.  412.105) calculated by CMS for the 
census region in which the hospital is located.
    The final median case-mix index values by region are set forth in 
the following table:

[[Page 49086]]

[GRAPHIC] [TIFF OMITTED] TR11AU04.054

    Hospitals seeking to qualify as rural referral centers or those 
wishing to know how their case-mix index value compares to the criteria 
should obtain hospital-specific case-mix index values (not transfer-
adjusted) from their fiscal intermediaries. Data are available on the 
Provider Statistical and Reimbursement (PS&R) System. In keeping with 
our policy on discharges, these case-mix index values are computed 
based on all Medicare patient discharges subject to DRG-based payment.
2. Discharges
    Section 412.96(c)(2)(i) provides that CMS will set forth the 
national and regional numbers of discharges in each year's annual 
notice of prospective payment rates for purposes of determining rural 
referral center status. As specified in section 1886(d)(5)(C)(ii) of 
the Act, the national standard is set at 5,000 discharges. In the May 
18, 2004 proposed rule, we proposed to update the regional standards 
based on discharges for urban hospitals' cost reporting periods that 
began during FY 2001 (that is, October 1, 2000 through September 30, 
2001), which is the latest available cost report data we had at that 
time. In last year's final rule we inadvertently indicated that we 
relied upon data regarding discharges occurring during FY 2002. 
However, we have now determined that our values for FY 2004 were based 
upon data regarding discharges occurring during FY 2000.
    Therefore, in the May 18, 2004 proposed rule (69 FR 28282), we 
proposed that, in addition to meeting other criteria, a hospital, if it 
is to qualify for initial rural referral center status for cost 
reporting periods beginning on or after October 1, 2004, must have as 
the number of discharges for its cost reporting period that began 
during FY 2001 a figure that is at least--
     5,000 (3,000 for an osteopathic hospital); or
     The median number of discharges for urban hospitals in the 
census region in which the hospital is located. (See the table set 
forth in the May 18, 2004 proposed rule at 69 FR 28282.)
    Based on the latest discharge data available at this time, that is, 
for cost reporting periods that began during FY 2002, the final median 
number of discharges for urban hospitals by census region area are as 
follows:
[GRAPHIC] [TIFF OMITTED] TR11AU04.055


[[Page 49087]]


    We note that the median number of discharges for hospitals in each 
census region is greater than the national standard of 5,000 
discharges. Therefore, 5,000 discharges is the minimum criterion for 
all hospitals.
    We reiterate that if an osteopathic hospital is to qualify for 
rural referral center status for cost reporting periods beginning on or 
after October 1, 2004, the hospital would be required to have at least 
3,000 discharges for its cost reporting period that began during FY 
2002.
    We note that in section IV.N.3 of this preamble, we discuss public 
comments that we received on the effects on RRCs of the new 
geographical area designations for wage index purposes.

J. Additional Payments to Hospitals With High Percentage of End-Stage 
Renal Disease (ESRD) Discharges (Sec.  412.104)

    Under existing regulations at Sec.  412.104(a), CMS provides for 
additional Medicare payments to a hospital for inpatient dialysis 
provided to Medicare beneficiaries with end-stage renal disease (ESRD) 
if the hospital's ESRD Medicare beneficiary discharges are 10 percent 
or more of its total Medicare discharges. This provision states that 
discharges classified into DRG 302 (Kidney Transplant), DRG 316 (Renal 
Failure), or DRG 317 (Admit for Renal Dialysis) are excluded for 
purposes of determining a hospital's eligibility for this special 
payment. We have been informed that, under this provision, hospitals 
may be counting all discharges of ESRD Medicare beneficiaries towards 
determining the 10 percent factor rather than counting only those 
discharges where the ESRD beneficiary received inpatient dialysis.
    When we established this regulation in the August 31, 1984 final 
rule (49 FR 34747), we stated that this special payment was intended to 
ameliorate those circumstances in which the concentration of ESRD 
beneficiaries receiving inpatient dialysis may be such that the 
hospital would not be able to absorb the entire expense with revenue 
from other less costly cases. We further stated that we believed those 
few hospitals most extremely impacted by the ESRD beneficiary 
population should be afforded some protection against the chance of 
encountering inpatient dialysis expenses that could not be offset by 
revenue from cases in which the DRG payment was greater than the 
hospital's cost. Because this special payment is intended to limit the 
adverse impact on hospitals delivering inpatient dialysis services to 
ESRD beneficiaries, we firmly believe that only those discharges of 
beneficiaries who receive dialysis services during an inpatient stay 
should be counted in determining a hospital's eligibility for the 
additional payment. After a careful review of Sec.  412.104(a), we 
acknowledge that hospitals may require additional guidance in 
appropriately determining their eligibility for this special payment. 
Therefore, in the May 18, 2004 proposed rule (69 FR 28282), we proposed 
to revise Sec.  412.104(a) to make it clear that, in determining a 
hospital's eligibility for the additional Medicare payment, only 
discharges involving ESRD Medicare beneficiaries who have received a 
dialysis treatment during an inpatient hospital stay are to be counted. 
We indicated that this proposed change would be applied prospectively, 
effective for cost reporting periods beginning on or after October 1, 
2004.
    Comment: One commenter requested clarification as to whether the 
proposed change to Sec.  412.104, which provides for an additional 
payment to hospitals with a high percentage of ESRD discharges, applies 
to LTCHs.
    Response: The additional payment to hospitals with a high 
percentage of ESRD discharges provided at Sec.  412.104 is applicable 
only to short-term, acute care hospitals paid under the IPPS. It does 
not apply to LTCHs paid under the LTCH PPS.
    Comment: Some commenters opposed the proposed revisions to the 
regulation because they believe this regulation was intended to 
compensate hospitals for higher costs of treating all ESRD patients, 
not just those receiving inpatient dialysis treatment.
    Response: Section 412.104 specifically provides for an additional 
payment to a hospital for inpatient dialysis provided to ESRD 
beneficiaries. This payment is based on the estimated weekly cost of 
dialysis and the average length of stay of ESRD beneficiaries for the 
hospital. Therefore, we believe it is entirely consistent with the 
regulations to provide this additional payment only when dialysis is 
actually provided during the inpatient stay.
    Comment: Several commenters expressed concern that a revision of 
the regulation would place an undue financial burden on hospitals that 
treat a significant number of ESRD beneficiaries, and that hospitals 
may discontinue these services in the future.
    Response: Our data indicate that approximately 41 hospitals are 
currently receiving approximately $15 million dollars through this add-
on payment. While we cannot precisely quantify the impact of this 
revision, we believe that the impact will be modes because ESRD 
patients admitted to the hospital will typically require dialysis 
during their hospital stay.
    Comment: Some commenters believed that, because hospitals and 
fiscal intermediaries are currently counting all ESRD beneficiaries, 
the proposed change would lead to confusion. The commenter also 
indicated that, in the cost report, there is no way to indicate only 
discharges of ESRD beneficiary who are receiving dialysis.
    Response: We do not believe that this policy will create confusion. 
The cost report instructions will be amended to reflect the policy in 
the final rule. As we stated earlier, we believe this revision to the 
regultaion will have little effect on additional hospitals with respect 
to the add-on payment.
    Comment: Several commenters expressed concern that the proposed 
revision would distort the existing formula to compute the add-on 
payment and would under compensate those hospitals that now treat a 
large number of African-American patients who seem to be those affected 
largely by ESRD.
    Response: The formula is now based on several factors; the most 
significant is the cost of inpatient dialysis. We are not revising the 
formula. Therefore, we do not agree that the revision would distort the 
formula. Further, we do not believe this revision would adversely 
affect any specific group of beneficiaries.
    Comment: Several commenters expressed concern that CMS did not 
comply with the Regulatory Flexibility Act (RFA), in proposing this 
revision.
    Response: As we indicated in the proposed rule (69 FR 28807), our 
impact analysis identified those hospitals currently receiving 
compensation through the add-on payment, as well as the amount paid to 
each hospital. Currently, there are approximately 41 hospitals 
receiving approximately $15 million. As we stated in the proposed rule, 
we are unable to quantify the impact more precisely.
    Comment: One commenter objected to the exclusion of DRGs 316 and 
317 from the add-on payment. The commenter believed the exclusion 
places an unfair burden on hospitals.
    Response: We do not believe that the exclusion of these DRGs is 
inappropriate, because their weights already include a payment amount 
for inpatient dialysis.
    Comment: One commenter recommended that the add-on payment for 
inpatients receiving dialysis be updated. Specifically, the commenter 
recommended that the average weekly cost of dialysis be increased from 
the current $335.

[[Page 49088]]

    Response: Under Sec.  412.104(b)(3), the average cost of dialysis 
includes only those costs that are determined to be directly related to 
the dialysis services. These costs include salary, employee health and 
welfare, drugs, supplies, and laboratory services. We will review these 
costs and consider the commenter's recommendation to update the average 
weekly cost of dialysis as part of our next annual IPPS rulemaking.
    Comment: One comment referenced correspondence that CMS had written 
with instructions to include all ESRD beneficiaries when considering 
the add-on payment.
    Response: The correspondence cited reflected our policy at the time 
the correspondence was issued. However, we have further evaluated that 
policy and, as we stated in the proposed rule, believe that a revision 
is necessary to ensure that the add-on payment is made in accordance 
with the intent of the law.

K. Indirect Medical Education (IME) Adjustment (Sec.  412.105)

1. IME Adjustment Factor Formula Multipliers (Section 502(a) of Public 
Law 108-173 and Sec.  412.105(d)(3)(vii) and Sec.  412.105(d)(3)(viii) 
Through (d)(3)(xii) of the Regulations)
    Section 1886(d)(5)(B) of the Act provides that prospective payment 
hospitals that have residents in an approved graduate medical education 
(GME) program receive an additional payment to reflect the higher 
indirect costs of teaching hospitals relative to nonteaching hospitals. 
The regulations regarding the calculation of this additional payment, 
known as the indirect medical education (IME) adjustment, are located 
at Sec.  412.105. The IME adjustment is based in part on the applicable 
IME adjustment factor. The IME adjustment factor is calculated using a 
hospital's ratio of residents to beds, which is represented as r, and a 
formula multiplier, which is represented as c, in the following 
equation: c x [{ 1 + r{time}  .405 - 1]. The formula is 
traditionally described in terms of a certain percentage increase in 
payment for every 10-percent increase in the resident-to-bed ratio.
    Section 502(a) of Public Law 108-173 modified the formula 
multiplier c to be used in the calculation of the IME adjustment. Prior 
to enactment of Public Law 108-173, the formula multiplier was fixed at 
1.35 for discharges occurring during FY 2003 and thereafter. Section 
502(a) modifies the formula multiplier beginning midway through FY 2004 
and provides for a new schedule of formula multipliers for FYs 2005 and 
thereafter as follows:
     For discharges occurring on or after April 1, 2004, and 
before October 1, 2004, the formula multiplier is 1.47.
     For discharges occurring during FY 2005, the formula 
multiplier is 1.42.
     For discharges occurring during FY 2006, the formula 
multiplier is 1.37.
     For discharges occurring during FY 2007, the formula 
multiplier is 1.32.
     For discharges occurring during FY 2008 and fiscal years 
thereafter, the formula multiplier is 1.35.
    In the May 18, 2004 proposed rule (69 FR 28283), we proposed to 
revise Sec.  412.105(d)(3)(vii) and add Sec.  412.105(d)(3)(viii) 
through (d)(3)(xii) to incorporate these changes in the formula 
multipliers.
    Comment: One commenter opposed decreases in the IME adjustment 
factor. The commenter asserted that hospitals are already being taxed 
beyond their ability to shoulder the costs of graduate medical 
education and that further decreases in payment for such costs will 
threaten important educational programs.
    Response: The proposed regulatory changes to the IME adjustment 
factor are mandated by section 502(a) of Public Law 108-173. We do not 
have the discretion to change the IME adjustment factor that is 
mandated by statute. However, the changes to the IME factor provided by 
section 502(a) of Public Law 108-173 generally constitute increases, 
not decreases as indicated by the commenter. As stated above, prior to 
enactment of Public Law 108-173, the formula multiplier was fixed at 
1.35 for discharges occurring during FY 2003 and thereafter. Section 
502(a) modified the formula multiplier beginning midway through FY 2004 
and provided for a new schedule of formula multipliers for FYs 2005 and 
thereafter, as previously noted.
    We are adopting, as final without modification, the proposed 
revision of Sec.  412.105(d)(3)(vii) and the proposed addition of Sec.  
412.105(d)(3)(viii) through (d)(3)(xii) to incorporate changes in the 
formula multipliers.
2. IME Adjustment Formula Multiplier for Redistributed FTE Resident 
Slots (Section 422(b)(1)(C) of Public Law 108-173)
    Under new section 1886(h)(7)(B) of the Act, added by section 422(a) 
of Public Law 108-173, a hospital may receive an increase in its FTE 
resident cap as a result of the agency's redistribution of unused 
resident positions. (This provision is discussed in detail in section 
IV.J.2. of the preamble of this final rule.) Section 422(b)(1)(C) of 
Public Law 108-173 amended section 1886(d)(5)(B) of the Act to add a 
new subclause (ix) to provide that, for discharges occurring on or 
after July 1, 2005, for a hospital whose FTE resident cap is increased 
as a result of a redistribution of unused resident positions, the IME 
adjustment factor is to be calculated using a formula multiplier of 
0.66 with respect to any additional residents counted by the hospital 
as a result of that increase in the hospital's FTE resident cap. Thus, 
in the May 18, 2004 proposed rule (69 FR 28283), we proposed that a 
hospital that counts additional residents as a result of an increase in 
its FTE resident cap under section 1886(h)(7)(B) of the Act would 
receive IME payments based on the sum of two different IME adjustment 
factors: (1) An IME adjustment factor that is calculated using the 
schedule of formula multipliers described in section IV.G.1. of this 
preamble established by section 502(a) of Public Law 108-173, and which 
also uses the hospital's number of FTE residents, not including 
residents attributable to an FTE cap increase under section 
1886(h)(7)(B) of the Act, in the numerator of the resident-to-bed 
ratio; and (2) an IME adjustment factor that is calculated using the 
formula multiplier of 0.66, and the additional number of FTE residents 
that is attributable to the increase in the hospital's FTE resident cap 
under section 1886(h)(7)(B) of the Act in the numerator of the 
resident-to-bed ratio. (The number of available beds used in the 
denominator would be the same for both IME adjustments.)
    We note that section 422(b) of Public Law 108-173, which addresses 
the application of the IME adjustment to the residents counted as a 
result of an increase in a hospital's FTE resident cap under section 
422(a), makes no reference to section 1886(d)(5)(B)(vi) of the Act. 
That is, the statute does not provide for an exclusion from application 
of the cap on the resident-to-bed ratio at section 1886(d)(5)(B)(vi)(I) 
of the Act or from application of the rolling average count at section 
1886(d)(5)(B)(vi)(II) of the Act for residents added as a result of FTE 
cap increases under section 1886(h)(7)(B). There is no specific 
pronouncement in section 422 exempting residents counted as a result of 
the FTE resident cap increases under section 422(a) from the cap on the 
resident-to-bed ratio and the rolling average, and we see no apparent 
reason to treat those residents differently for purposes of these two 
provisions. Therefore, in the May 18, 2004 proposed rule, we proposed 
to require that if a

[[Page 49089]]

hospital increases its IME FTE count of residents as a result of 
section 1886(h)(7)(B) of the Act, those FTE residents are immediately 
subject to the cap on the resident-to-bed ratio and the rolling average 
calculation. We explained further that, given potentially significant 
shifts of FTE positions among hospitals as a result of the new section 
1886(h)(7) of the Act, the inclusion of FTE residents added as a result 
of section 1886(h)(7)(B) of the Act in the cap on the resident-to-bed 
ratio and in the rolling average introduces a measure of stability and 
predictability, and mitigates radical shifts in IME payments from 
period to period. Thus, a hospital's increase in IME payment may be 
delayed for one year to the extent that the resident-to-bed ratio for 
the current cost reporting period is capped by the resident-to-bed 
ratio for the previous cost reporting period. Further, the additional 
FTE residents would be phased in over a 3-year period in the hospital's 
FTE count because they are immediately included in the rolling average 
calculation.
    The following illustrates how we proposed to calculate the IME 
payment for a hospital that receives an increase to its FTE resident 
cap as a result of section 1886(h)(7)(B) of the Act. For example, 
Hospital A has a fiscal year end (FYE) of September 30, and a 1996 IME 
FTE cap of 20 FTEs. During its FYEs September 30, 2003, September 30, 
2004, and September 30, 2005, Hospital A trains 25 FTE residents. 
Effective July 1, 2005, under section 1886(h)(7)(B) of the Act, 
Hospital A receives an increase to its IME 1996 cap of 5 FTEs, for a 
total adjusted IME cap of 25 FTEs. Hospital A has maintained an 
available bed count of 200 beds in FYE September 30, 2004 and 
throughout FYE September 30, 2005. For the FYE September 30, 2005 cost 
report, the IME adjustment factor is calculated as follows:
    Step 1. For discharges occurring on October 1, 2004, through 
September 30, 2005 for residents NOT counted pursuant to section 
1886(d)(5)(B)(ix) of the Act:
     Rolling average count of FTE residents: 20+20+20/3 = 20.
     Current year resident-to-bed ratio: 20/200 = .10
     Cap on resident-to-bed ratio (from prior year): 20/200 = 
.10
     Compare, and use the lower of, prior year resident-to-bed 
ratio and current year resident-to-bed ratio: .10 = .10.
     Compute IME adjustment factor: 1.42 x [{1 + .10{time}  
.405 -1] = 0.0559.
    Step 2. For discharges occurring on July 1, 2005 through September 
30, 2005 for residents counted pursuant to section 1886(d)(5)(B)(ix) of 
the Act:
     Rolling average count of FTE residents: 25+20+20/3 = 21.7.
     Resident-to-bed ratio for 7/1/05-9/30/05: 21.7/200 = .11
     Cap on resident-to-bed ratio (from prior year): 20/200 = 
.10
     Compare, and use the lower of, prior year resident-to-bed 
ratio and resident-to-bed ratio for 7/1/05-9/30/05: .10 < .11. Capped 
by prior year ratio of .10.
     Compute IME adjustment factor: 0.66 x [{1 + 0{time}  
.405-1] = 0.0.
    In this example, the addition of 5 FTE residents under section 
1886(h)(7)(B) caused Hospital A's resident-to-bed ratio for discharges 
occurring on July 1, 2005, through September 30, 2005, to exceed the 
resident-to-bed ratio of .10 from the prior year. Since the multiplier 
of 0.66 is to be used for determining IME payment ``insofar as an 
additional payment amount * * * is attributable to resident positions 
redistributed to a hospital * * *'' under section 1886(d)(5)(B)(v) of 
the Act, as amended by section 422(b)(1)(C) of Public Law 108-173, 
Hospital A does not receive any IME payment attributable to the 5 FTE 
residents added as a result of section 1886(h)(7)(B) of the Act for 
discharges occurring on July 1, 2005, through September 30, 2005. As 
shown under the fifth bullet point in Step 2 of the example above, a 
resident-to-bed ratio of zero is used to compute the IME adjustment for 
FTE residents attributable to increases in the FTE resident cap under 
section 1886(h)(7)(B) of the Act for discharges occurring on or after 
July 1, 2005 and on or before September 30, 2005. The ratio of .10 
would not be used to compute the IME adjustment for FTE residents 
attributable to an increase in the FTE resident cap under section 
1886(h)(7)(B) because the ratio of .10 is attributable to the 20 FTE 
residents from the prior year, and is not related to residents added 
under section 1886(h)(7)(B) of the Act. (We noted that a hospital's 
resident-to-bed ratio in the current year might decrease despite 
residents added as a result of section 1886(h)(7)(B) of the Act, due to 
an increase in the number of available beds in the denominator of the 
current year resident-to-bed ratio. In such a case, because the current 
year ratio would be less than the prior year ratio, the hospital's 
resident-to-bed ratio would not be capped by the prior year resident-
to-bed ratio, and, therefore, the hospital could receive an IME payment 
in the current year (that is, there would not be a 1-year delay) 
relating to residents added under section 1886(h)(7)(B) of the Act).
    However, an increase in the resident-to-bed ratio in the current 
period may establish a higher cap for the following period, and, all 
other things being equal, a hospital could then receive IME payment for 
FTE residents added as a result of section 1886(h)(7)(B) of the Act 
after a 1-year lag. In the example above, Hospital A would receive an 
IME payment for residents added as a result of section 1886(h)(7)(B) of 
the Act in its cost reporting period ending September 30, 2006, as 
follows:
    Step 1. For residents NOT counted pursuant to section 
1886(d)(5)(B)(ix) of the Act:
     Rolling average count of FTE residents: 20 + 20 + 20/3 = 
20.
     Current year resident-to-bed ratio: 20/200 = .10
     Cap on resident-to-bed ratio (from prior year): 20/200 = 
.10
     Compare, and use the lower of, prior year resident-to-bed 
ratio and current year resident-to-bed ratio: .10 = .10.
     Compute IME adjustment factor: 1.37 x [{1 + .10{time}  
.405-1] = 0.0559.
    Step 2. For 5 FTE residents counted pursuant to with section 
1886(d)(5)(B)(ix) of the Act:
     Rolling average count of FTE residents: 25 + 25 + 20/3 = 
23.3.
     Resident-to-bed ratio for FYE 9/30/06: 23.3/200 = .12
     Cap on resident-to-bed ratio (from prior year): 25/200 = 
.13
     Compare, and use the lower of, prior year resident-to-bed 
ratio and current year resident-to-bed ratio: .13 > .12. Current year 
ratio of .12 is the lower of the two.
     Take the difference between the rolling average count of 
FTE residents counted as a result of section 1886(h)(7)(B) of the Act, 
and the rolling average count of FTE residents not counted as a result 
of section 1886(h)(7)(B) of the Act, (rolling average count under step 
2 minus rolling average count under step 1): 23.3 - 20 = 3.3.
     Compute current year resident-to-bed ratio attributable to 
residents added under section 1886(h)(7)(B): 3.3/200 = 0.02.
     Compute IME adjustment factor: 0.66 x [{1 + .02{time}  
.405-1] = 0.0053.
    Step 3. Compute IME payment for FYE September 30, 2006: [Total DRG 
payments for discharges occurring on October 1, 2005 through September 
30, 2006] x [0.0592] (that is, 0.0539 + 0.0053).
    In the May 18, 2004 proposed rule, we proposed to revise Sec.  
412.105 to incorporate these changes under proposed new paragraph 
(d)(4), proposed new paragraph (e)(2),

[[Page 49090]]

proposed new paragraph (f)(1)(iv)(B), and proposed added new last 
sentence of paragraph (f)(1)(v).
    Comment: One commenter stated that the calculation of the IME 
payment relating to additional residents counted as a result of an 
increase in the hospital's FTE cap received under section 1886(h)(7)(B) 
of the Act is extremely cumbersome and will require difficult and 
extensive changes to the Medicare cost report, particularly if the 
additional residents are to be subject to the rolling average and the 
resident-to-bed ratio. The commenter suggested that instead of revising 
Worksheet E, Part A to include this calculation, CMS should consider 
including this calculation on a separate worksheet, with the results 
added to Worksheet E, Part A.
    Response: First, we note that we are required by section 
1886(d)(5)(B)(ix) to apply a different IME formula multiplier to 
calculate the IME payment relating to these residents. Therefore, some 
level of additional complexity is not avoidable. Additionally, we have 
stated in previous responses concerning the IME calculation relating to 
residents counted under section 1886(h)(7)(B) of the Act, under our 
final policy, we are not requiring that these residents be subject to 
the rolling average and resident-to-bed ratio calculations. Thus, we 
believe our final policy substantially reduces the complexity of the 
proposed calculations that concerned the commenter. Even so, we do 
realize that the presence of an additional calculation on Worksheet E, 
Part A for IME (and also on Worksheet E-3, Part IV for direct GME) 
further complicates an already difficult calculation. We will attempt 
to revise the worksheets in the simplest and least disruptive manner.
    Comment: Several commenters noted that there is a mathematical 
error on page 28284 of the May 18, 2004 Federal Register. The second 
column on page 28284, in ``Step 1'', shows an IME computation of: 1.37 
x [{ 1-. 10{time} .405 -1] = 0.0559. The result of this 
computation should be .053917, not the .0559 as indicated.
    Response: We agree with the commenters that the computed result for 
``Step 1'' of the example is 0.053917, not 0.0559.
    Comment: One commenter noted that there appears to be an error on 
page 28284 of the May 18, 2004 Federal Register. On page 28284, third 
column, in ``Step 3'', shows an IME adjustment factor computation of: 
0.0539 + 0.0053 = .0592. The commenter believes the adjustment factor 
should be calculated as 0.0559 + 0.0053 = .0612 since 0.0559 is the 
factor calculated in ``Step 1'' for residents not counted as a result 
of cap redistribution.
    Response: As noted previously, ``Step 1'' of the IME adjustment 
factor calculation (shown in the second column of page 28284) contains 
an error. The result of ``Step 1'' should read 0.0539, not the 0.0559 
as indicated. With this change, ``Step 3'' shows the correct IME 
adjustment factor calculation (0.0539 + 0.0053 = .0592).
3. Counting Beds and Patient Days for Purposes of Calculating the IME 
Adjustment (Sec.  412.105(b)) and DSH Adjustment ((Sec.  
412.106(a)(1)(i))
    As stated in section IV.K.1 of the preamble, Sec.  412.105 of our 
existing regulations specifies that the calculation of the IME 
adjustment is based on the IME adjustment factor, which is calculated 
using hospitals' ratios of residents to beds. The determination of the 
number of beds is based on available bed days. This determination of 
the number of available beds is also applicable for other purposes, 
including the level of the disproportionate share hospital (DSH) 
adjustment payments under Sec.  412.106(a)(1)(i).
    In the FY 2004 IPPS proposed rule (68 FR 27201 through 27208, May 
19, 2003), we proposed changes to our policy on determining the number 
of beds and patient days as it pertains to both the IME and DSH 
adjustments. In the FY 2004 IPPS final rule (68 FR 45415 through 
45422), we indicated that, due to the nature and number of public 
comments we received on the proposed policies regarding unoccupied 
beds, observation beds for patients ultimately admitted as inpatients, 
dual-eligible patient days, and Medicare+Choice (M+C) days, we would 
address the comments in a separate document. In the May 18, 2004 
proposed rule, we stated that we planned to respond to comments in this 
final rule. Under section IV.L.3. of this preamble, we are responding 
to public comments received on the proposals in the May 19, 2003 and 
the May 18, 2004 proposed rules as they relate to both the IME and DSH 
payment adjustments and finalizing our policies in these four areas.
4. Technical Changes
     In Sec.  412.105(a)(1), introductory text, we include a 
cross-reference to ``paragraph (f) and (h)'' of Sec.  412.105. 
Paragraph (h) no longer exists in this section. Therefore, in the May 
18, 2004 proposed rule (69 FR 28284), we proposed to remove the cross-
reference to paragraph (h).
     In Sec.  412.105(f)(1)(i)(A), we reference national 
organizations listed in Sec.  415.200(a). The cross-reference to Sec.  
415.200(a) is incorrect. In the May 18, 2004 proposed rule (69 FR 
28284), we proposed to correct the cross-reference to read ``Sec.  
415.152.''
    We did not receive any comments on these two proposals for 
technical changes and, therefore, are adopting them as final.
     In section IV.O. of the preamble of this final rule (and 
in the May 18, 2004 proposed rule), we discuss our redesignation of 
existing Sec.  413.86 governing payments for direct costs of GME to 
nine separate sections. Many of the paragraphs in the existing Sec.  
413.86 are cited in Sec.  412.105 governing the IME adjustment. We 
proposed to make changes to the cross-reference in Sec.  412.105 to 
conform them to these redesignated separate sections.
    We did not receive any comments on this proposal; and therefore, 
are adopting this proposal as final.

L. Payment to Disproportionate Share Hospitals (DSHs) (Section 402 of 
Pub. L. 108-173 and Sec.  412.106 of Existing Regulations)

1. Background
    Section 1886(d)(5)(F) of the Act provides for additional payments 
to subsection (d) hospitals that serve a disproportionate share of low-
income patients. The Act specifies two methods for a hospital to 
qualify for the Medicare disproportionate share hospital (DSH) 
adjustment. Under the first method, hospitals that are located in an 
urban area and have 100 or more beds may receive a DSH payment 
adjustment if the hospital can demonstrate that, during its cost 
reporting period, more than 30 percent of its net inpatient care 
revenues are derived from State and local government payments for care 
furnished to indigent patients. These hospitals are commonly known as 
``Pickle hospitals.'' The second method, which is also the most 
commonly used method for a hospital to qualify, is based on a complex 
statutory formula under which payment adjustments are based on the 
level of the hospital's DSH patient percentage, which is the sum of two 
fractions: the ``Medicare fraction and the Medicaid fraction.'' The 
Medicare fraction is computed by dividing the number of patient days 
that are furnished to patients who were entitled to both Medicare Part 
A and Supplemental Security Income (SSI) benefits by the total number 
of patient days furnished to patients entitled to benefits under 
Medicare Part A. The Medicaid fraction is computed by dividing the 
number of patient days furnished to patients who, for those

[[Page 49091]]

days, were eligible for Medicaid but were not entitled to benefits 
under Medicare Part A by the number of total hospital patient days in 
the same period.

[GRAPHIC] [TIFF OMITTED] TR11AU04.068

2. Enhanced DSH Adjustment for Rural Hospitals and Urban Hospitals With 
Fewer Than 100 Beds
    Hospitals whose DSH patient percentage exceeds 15 percent are 
eligible for a DSH payment adjustment (prior to April 1, 2001, the 
qualifying DSH patient percentage varied, in part, by the number of 
beds (66 FR 39882)). The DSH payment adjustment may vary based on the 
DSH patient percentage and the type of hospital. The statute provides 
for different payment adjustments for urban hospitals with 100 or more 
beds and rural hospitals with 500 or more beds, hospitals that qualify 
as RRCs or SCHs, and other hospitals.
    Effective April 1, 2004, section 402 of Public Law 108-173 amended 
section 1886(d)(5)(F) of the Act to revise the formulae used to 
calculate DSH payment adjustments for certain hospitals that qualify 
for the adjustments under the second method. Specifically, under the 
new section 1886(d)(5)(F)(xiv), added by section 402, for hospitals 
that are not large urban or large rural hospitals, DSH payments are 
calculated using the same DSH adjustment formula used for large urban 
hospitals. However, the DSH payment adjustment for most of these 
categories of hospitals, except for hospitals classified as RRCs, 
including RRCs that are also SCHs, is capped at 12 percent. In 
addition, the formula for large urban hospitals with 100 beds or more, 
and large rural hospitals with 500 beds or more, has not been revised 
by section 402. Finally, Pickle hospitals are not affected by this 
change; they will continue to receive a DSH adjustment under the 
alternative formula.
    Effective for discharges occurring on or after April 1, 2004, the 
following DSH payment adjustment formulae apply for the following 
specified categories of hospitals:
     For urban hospitals with fewer than 100 beds and whose 
disproportionate patient percentage is equal to or greater than 15 
percent and less than or equal to 20.2 percent:
    (Disproportionate patient percentage - 15 percent) (65 percent) + 
2.5 percent.

>=15% <20.2% 2.5% + [.65 x (DSH pct. - 15%)]

     For urban hospitals with fewer than 100 beds and whose 
disproportionate patient percentage is greater than 20.2:
    (Disproportionate patient percentage - 20.2 percent) (82.5 percent) 
+ 5.88 percent.

>=20.2% 5.88% + [.825 x (DSH pct. - 20.2%)]

    For urban hospitals with fewer than 100 beds, the maximum DSH 
payment adjustment is 12 percent.
     For rural hospitals that are SCHs and are not RRCs and 
whose disproportionate patient percentage is equal to or greater than 
15 percent and less than or equal to 20.2 percent:
    (Disproportionate patient percentage - 15 percent) (65 percent) + 
2.5 percent).

>=15% <20.2% (2.5% + [.65 x (DSH pt.% - 15%])

     For rural hospitals that are SCHs and are not RRCs and 
whose disproportionate patient percentage is greater than 20.2 percent:
    (Disproportionate patient percentage - 20.2 percent) (82.5 percent) 
+ 5.88 percent.

>=20.2% 5.88% + [.825 x (DSH pct. - 20.2%)]

    For rural hospitals that are SCHs and are not RRCs, the maximum DSH 
payment adjustment is 12 percent.
     For RRCs whose disproportionate patient percentage is 
greater than or equal to 15 percent and less than or equal to 20.2 
percent:
    (Disproportionate patient percentage - 15 percent) (65 percent) + 
2.5 percent.

>=15% <20.2% 2.5% + [.65 x (DSH pct. - 15%)]

     For RRCs whose disproportionate patient percentage is 
greater than 20.2 percent:
    (Disproportionate patient percentage--20.2 percent) (82.5 percent) 
+ 5.88 percent.

>=20.2% 5.88% + [.825 x (DSH pct. - 20.2%)]

    For rural referral centers there is no maximum DSH payment 
adjustment.
     For rural hospitals that are both RRCs and SCHs and whose 
disproportionate patient percentage is greater than or equal to 15 
percent and less than or equal to 20.2 percent:
    (Disproportionate patient percentage - 15 percent) (65 percent) + 
2.5 percent.

>=15% <20.2% 2.5% + [.65 x (DSH pct. - 15%)]

     For rural hospitals that are both RRCs and SCHs whose 
disproportionate patient percentage is greater than 20.2 percent:
    (Disproportionate patient percentage - 20.2 percent) (82.5 percent) 
+ 5.88 percent.

>=20.2% 5.88% + [.825 x (DSH pct. - 20.2%)]

    For rural hospitals that are both RRCs and SCHs there is no maximum 
DSH payment adjustment.
     For rural hospitals with fewer than 500 beds and whose 
disproportionate patient percentage is equal to or greater than 15 
percent and less than or equal to 20.2 percent:
    (Disproportionate patient percentage - 15 percent) (65 percent) + 
2.5 percent.

>=15% <20.2% 2.5% + [.65 x (DSH pct. - 15%)]

     For rural hospitals with fewer than 500 beds and whose 
disproportionate patient percentage is greater than 20.2 percent:
    (Disproportionate patient percentage - 20.2 percent) (82.5 percent) 
+ 5.88 percent.

>=20.2% 5.88% + [.825 x (DSH pct. - 20.2%)]

    For rural hospitals with fewer than 500 beds, the maximum DSH 
payment adjustment is 12 percent.
    These revised formulae, which became effective for discharges 
occurring on or after April 1, 2004, were implemented through a CMS 
One-Time Notification (CR 3158), issued on March 26, 2004. The notice 
describes the changes required by section 402 of Public Law 108-173. In 
the May 18, 2004 proposed rule (69 FR 28284 through 28286) we described 
the changes to the DSH adjustment calculations required under section 
402 of Public Law 108-173 as well as the required modifications to its 
regulations to implement section 402 of Public Law 108-173.
    The following DSH formulae were not affected by the changes made by 
section

[[Page 49092]]

402 of Public Law 108-173 and remain in effect:
     For urban hospitals with 100 beds or more and whose 
disproportionate patient percentage is equal to or greater than 15 
percent and less than or equal to 20.2 percent:
    (Disproportionate patient percentage - 15 percent) (65 percent) + 
2.5 percent.

>=15% <=20.2% 2.5% + [.65 x (DSH pct. - 15%)]

     For urban hospitals with 100 beds or more and whose 
disproportionate patient percentage is greater than 20.2 percent:
    (Disproportionate patient percentage - 20.2 percent) (82.5 percent) 
+ 5.88 percent.

>=20.2% 5.88% + [.825 x (DSH pct. - 20.2%)]

    For urban hospitals with 100 beds or more there is no maximum DSH 
payment adjustment.
     For rural hospitals with 500 beds or more and whose 
disproportionate patient percentage is equal to or greater than 15 
percent and less than or equal to 20.2 percent:
    (Disproportionate patient percentage - 15 percent) (65 percent) + 
2.5 percent.

>=15% <20.2% 2.5% + [.65 x (DSH pct. - 15%)]

     For rural hospitals with 500 beds or more and whose 
disproportionate patient percentage is greater than 20.2 percent:

    [(Disproportionate patient percentage - 20.2 percent) (82.5 
percent)] + 5.88 percent.

>=20.2% 5.88% + [.825 x (DSH pct. - 20.2%)]

    For rural hospitals with 500 beds or more there is no maximum DSH 
payment adjustment.
    Comment: We received several comments in regard to section 402 of 
Public Law 108-173. One commenter requested that CMS clarify how the 
DSH percentage will be computed to implement these provisions for a 
provider whose year-end period overlaps with the April 1, 2004 date. 
Another commenter stated that when the DSH policy was developed, 
consideration was given to the financial condition of the hospitals 
providing a high level of care to low-income patients, and as a result 
of that consideration, a cap was placed on the size of DSH payments to 
rural hospitals. Additionally, the commenters believe that without any 
publicly articulated policy basis, Congress has called for raising this 
cap and increasing DSH payments, but only increasing them for rural 
hospitals, even though these hospitals are not treating more low-income 
patients and have not seen their financial condition deteriorate. The 
commenter believes that urban hospitals are in far worse and declining 
financial condition, and are to receive comparable benefit.
    Response: As we stated in the May 18, 2004 proposed rule (69 FR 
28285) hospitals whose DSH patient percentage exceeds 15 percent are 
eligible for a DSH payment adjustment (prior to April 1, 2001, the 
qualifying DSH patient percentage varied, in part, by the number of 
beds (66 FR 39882)). The DSH payment adjustment may vary based on the 
DSH patient percentage and the type of hospital. The revised formula 
increases the DSH add-on payment that a hospital receives because the 
cap has been increased. For example, effective for discharges occurring 
on or after April 1, 2004, a hospital that is not a large urban 
hospital that qualifies for a DSH adjustment will receive its DSH 
payments using the current DSH adjustment formula for large urban 
hospitals, subject to a limit. The DSH adjustment for these hospitals, 
except RRCs will be capped at 12 percent instead of the 5.25 percent 
used prior to discharges occurring before April 1, 2004. We have 
determined that the revised formulae used to calculate the DSH payment 
adjustments for certain hospitals will result in making a change in the 
Medicare cost report. We will make two separate computations of the DSH 
percentage on the Medicare cost report for discharges occurring before 
April 1, 2004 and one after April 1, 2004.
    In response to the comment regarding rural hospitals receiving a 
higher cap and DSH payment, as we stated previously, the statute allows 
a hospital that is not a large urban hospital that qualifies for a DSH 
adjustment to receive its DSH payments using the current DSH adjustment 
formula for large urban hospitals, subject to a limit. Like large urban 
hospitals with 100 beds or more and rural hospitals with 500 beds or 
more, the revised formula removes the cap for RRCs and SCHs that are 
also RRCs.
    Therefore, in this final rule, we are adopting as final the policy 
expressed in the May 18, 2004 proposed rule to revise the formulae used 
to calculate the DSH payment adjustment for certain hospitals that 
qualify for the adjustments, and amending our regulations at Sec.  
412.106 accordingly. This policy is effective for discharges occurring 
on or after April 1, 2004.
3. Counting Beds and Patient Days for the IME and DSH Adjustments
    In the May 19, 2003 IPPS proposed rule for FY 2004 (68 FR 27201), 
we proposed changes to our policy on counting beds and patient days for 
the purposes of the DSH and IME adjustments. We proposed changes to the 
way unoccupied beds are counted. We also proposed to clarify how 
observation beds and swing-beds are counted, as well as our policy 
regarding nonacute care (that is, a level of care that would not 
generally be payable under the IPPS) beds and days. In regard to 
patient days, we proposed changes to the way observation days, dual-
eligible days and M+C days are counted. We recognize that section 101 
of Public Law 108-173 changed the title of Medicare+Choice to Medicare 
Advantage. However, throughout this preamble and our regulations, we 
are continuing to use the title, Medicare+Choice (M+C). We will make a 
global change of this reference in a separate regulatory document.
    As discussed earlier under section IV.N.1. of this preamble, the 
IME adjustment provided for under section 1886(d)(5)(B) of the Act 
applies to prospective payment hospitals that have residents in an 
approved GME program. These hospitals receive an additional payment to 
reflect the higher indirect costs of teaching hospitals relative to 
nonteaching hospitals and the level of the payment varies based in part 
on the applicable IME adjustment factor. The IME adjustment factor is 
calculated using a hospital's ratio of residents to beds. As in the May 
19, 2003 proposed rule (68 FR 45415), we are combining in this final 
rule our discussion of changes to the policies for counting beds and 
patient days in relation to the regulations at Sec. Sec.  412.105(b) 
and 412.106(a)(1)(ii) because the underlying concepts are similar, and 
we believe they generally should be interpreted in a consistent manner 
for both purposes.
    Due to the number and nature of the public comments received on the 
proposals regarding the counting of available beds and patient days in 
the May 19, 2003 proposed rule, we did not respond to the public 
comments on some of the proposals in the final rule for FY 2004 (August 
1, 2003 final rule (68 FR 45415)). We indicated in that final rule that 
we would address public comments regarding unoccupied beds, observation 
beds, dual-eligible days, and M+C days in a separate document. In the 
May 18, 2004 proposed rule, we indicated that we planned to address the 
comments in this IPPS final rule for FY 2005.

[[Page 49093]]

a. Provisions of the FY 2004 Proposed Rule, Responses to Public 
Comments, and Provisions of the FY 2005 Final Rule
    In the May 19, 2003, FY 2004 IPPS proposed rule (68 FR 27205), we 
discussed proposed changes to our policies for counting beds and 
patient days in relation to the IME and DSH adjustments. Specifically, 
we proposed to amend Sec.  412.105(b) and Sec.  412.106(a)(1)(ii) as 
they pertain to the counting of beds and patients days for 
determination of the IME adjustment and DSH payment adjustment. We 
proposed to amend Sec.  412.105(b) to indicate that the bed days in a 
unit that is unoccupied by patients receiving a level of care that 
would be generally payable under the IPPS (IPPS level of care) for the 
3 preceding months are to be excluded from the available bed day count 
for the current month. In addition, we proposed that the beds in a unit 
that was occupied by a patient(s) receiving an IPPS level of care 
during the 3 preceding months should be counted unless they could not 
be made available for patient occupancy within 24 hours, or they are 
used to provide outpatient observation services or swing-bed skilled 
nursing care (68 FR 27204). Regarding nonacute care beds and days, we 
proposed to revise Sec.  412.105(b) to clarify that beds in units or 
wards established or used to provide a level of care that is not 
consistent with what would be payable under the IPPS cannot be counted. 
We also proposed to revise the DSH regulations at Sec.  
412.106(a)(1)(ii) to clarify that the number of patient days includes 
only those days attributable to patients that receive care in units or 
wards that furnish a level of care that would generally be payable 
under the IPPS (68 FR 27205).
    In the May 19, 2003 proposed rule, we proposed to revise our 
regulations to specify our policy that observation and skilled nursing 
swing-bed days are to be excluded from the counts of both available 
beds and patient days, unless a patient treated in an observation bed 
is ultimately admitted, in which case the bed and patient days would be 
included in those counts.
    The final categories of patient days addressed in the proposed rule 
of May 19, 2003 were the dual-eligible patient days and the 
Medicare+Choice (M+C) days. We proposed in the rule that the days of 
patients who are dually-eligible, (that is, Medicare beneficiaries who 
are also eligible for Medicaid) and have exhausted their Medicare Part 
A coverage will not be included in the Medicare fraction. Instead, we 
proposed that these days should be included in the Medicaid fraction of 
the DSH calculation. In regard to M+C days, we proposed that once a 
beneficiary elects Medicare Part C, those patient days attributable to 
the beneficiary should not be included in the Medicare fraction of the 
DSH patient percentage. The patient days should be included in the 
count of total patient days in the denominator of the Medicaid 
fraction, and if the M+C beneficiary is also eligible for Medicaid, the 
patient's days would be included in the numerator of the Medicaid 
fraction as well.
    In the August 1, 2003 final rule (68 FR 45346), we finalized some 
of these proposals. For the proposals we did not finalize, we indicated 
that we would address the comments in a separate document. The 
proposals for nonacute care beds and days, observation and swing-bed 
days, LDP beds and days, and days for 1115 demonstration projects were 
finalized in the August 1, 2003 final rule. However, due to the large 
number of comments we received on our proposals for unoccupied beds, 
observation beds for patients ultimately admitted as inpatients, dual-
eligible patient days, and M+C days, we decided to address the comments 
on these proposed policies in a separate final document. In this IPPS 
final rule, we are addressing those comments, as well as some 
additional comments that we received in response to the May 18, 2004 
proposed rule, and finalizing the policies.
    As we did in the IPPS proposed rule of May 19, 2003 and the August 
1, 2003 IPPS final rule, we are combining our discussion of policies 
for counting beds and patient days in relation to the calculations at 
Sec. Sec.  412.105(b) and 412.106(a)(1) which relate to the IME and DSH 
payment adjustments, because the underlying concepts are similar, and 
we believe they should generally be interpreted in a consistent manner 
for both purposes. Specifically, we clarified that beds and patient 
days that are counted for these purposes should be limited to beds or 
patient days in hospital units or wards that would be directly included 
in determining the allowable costs of inpatient hospital care payable 
under the IPPS on the Medicare cost reports. As a preliminary matter, 
beds, and patient days associated with these beds, that are located in 
units or wards that are excluded from the IPPS (for example, 
psychiatric or rehabilitation units, or outpatient areas), and thus 
from the determination of allowable costs of inpatient hospital care 
under the IPPS on the Medicare cost report, are not to be counted for 
purposes of Sec. Sec.  412.105(b) and 412.106(a)(1)(ii).
    The remainder of this discussion pertains to beds and patient days 
in units or wards that are not excluded from the IPPS and for which 
costs are included in determining the allowable costs of inpatient 
hospital care under the IPPS on the Medicare cost report.
    As we noted in our FY 2004 proposed and final rules, our policies 
on counting beds are applied consistently for both IME and DSH although 
the incentives for hospitals can be different for IME and DSH. For 
purposes of IME, teaching hospitals have an incentive to minimize their 
number of available beds in order to increase the resident-to-bed ratio 
and maximize the IME adjustment. On the other hand, for DSH purposes, 
urban hospitals with under 100 beds and rural hospitals with under 500 
beds may have an incentive to increase their bed count in order to 
qualify for the higher DSH payments for urban hospitals with over 100 
beds or rural hospitals with over 500 beds (although we recognize that, 
as a result of section 402 of Public Law 108-173, the DSH payment 
adjustment no longer varies based upon the hospital's number of beds 
effective for discharges on or after April 1, 2004). However, under 
section 402 of Public Law 108-173, urban hospitals under 100 beds and 
rural hospitals under 500 beds are subject to a 12 percent cap on the 
DSH payment adjustment.
    While some of the topics discussed below pertain only to counting 
available beds (unoccupied beds) and some only to counting patient days 
(dual-eligible days and Medicare+Choice days), other topics are 
applicable to both bed-counting and day-counting policies (observation 
beds and days and swing-beds and days). Therefore, for ease of 
discussion, we have combined all topics pertaining to counting 
available beds and patient days together in the following discussion.
    We received numerous comments on our May 19, 2003 and May 18, 2004 
proposals and our responses and final policies are included in this 
preamble.
1. Unoccupied Beds
    The existing regulations for counting hospital beds for IME and DSH 
are at Sec.  412.105(b). The bed count is based on total available bed 
days during the hospital's cost reporting period, divided by the number 
of days in the cost reporting period. The regulations specify certain 
types of beds to be excluded from this count (for example, beds or 
bassinets in the healthy newborn nursery, custodial care beds, and beds 
in excluded distinct part hospital units).

[[Page 49094]]

    Further instructions for counting beds are detailed in section 
2405.3, Part I, of the Medicare Provider Reimbursement Manual (PRM). 
That section states that a bed must be permanently maintained for 
lodging inpatients and it must be available for use and housed in 
patient rooms or wards. Thus, beds in a completely or partially closed 
wing of the facility are considered available only if the hospital can 
put the beds into use when they are needed.
    Currently, if a bed can be staffed for inpatient care either by 
nurses on staff or from a nurse registry within 24 to 48 hours, the 
unoccupied bed is determined available.\6\ In most cases, it is a 
straightforward matter to determine whether unoccupied beds can be 
staffed within this timeframe because they are located in a unit that 
is otherwise staffed and occupied (an unoccupied bed is available for 
patient care but it is not occupied by a patient on a particular day). 
The determination is not as simple in situations where a room in an 
otherwise occupied unit has been altered for other purposes, such as 
for a staff lounge or for storage.
---------------------------------------------------------------------------

    \6\ This policy was first articulated in correspondence to the 
Blue Cross and Blue Shield Association (BCBSA) on November 2, 1988, 
and published in BCBSA's Administrative Bulletin No.1841, 88.01, on 
November 18, 1988.
---------------------------------------------------------------------------

    Beds in unoccupied rooms or wards are to be excluded from the bed 
count if the associated costs are excluded from depreciable plant 
assets because the area is not available for patient use.\7\ However, 
issues continue to arise with regard to how to treat entire units or 
even entire floors that are unoccupied over a period of time. For 
example, in a Provider Reimbursement Review Board (PRRB) decision, the 
hospital acknowledged that an entire floor was temporarily unoccupied 
for approximately 2 years. Rooms on the floor were used for office 
space, storage, and outpatient services. The PRRB held that current 
rules allowed these beds to be counted. Specifically, the PRRB found 
the beds could reasonably be made ready for inpatient use within 24 to 
48 hours, the rooms were counted on the hospital's cost report as 
depreciable plant assets available for patient care, and the hospital 
could adequately provide patient care in the beds using staff nurses or 
nurses from a nurse registry. Upon review, the Administrator also 
ultimately upheld this decision based on existing policies and 
instructions.
---------------------------------------------------------------------------

    \7\ Ibid.
---------------------------------------------------------------------------

    We do not believe that an accurate bed count should include beds 
that are essentially hypothetical in nature; for example, when the beds 
are on a floor that is not used for inpatient care throughout the 
entire cost reporting period (and, indeed, may have been used for other 
purposes). Followed to the extreme, a hospital could count every bed in 
its facility, even if it had no intention of ever using a bed for 
inpatient care, as long as it would be theoretically possible to place 
an inpatient in the bed. We do not believe such a result would 
accurately reflect a hospital's capacity to provide inpatient services. 
Although teaching hospitals have an incentive to minimize the bed count 
for IME payment purposes, some DSH hospitals have had an incentive to 
maximize the bed count for the same reason. Our current policy is 
intended to reflect a hospital's available bed count as accurately as 
possible, achieving a balance between capturing short-term shifts in 
occupancy and long-term changes in capacity. Therefore, we believe 
further clarification and refinement of our policies relating to 
counting available beds is necessary.
    In the FY 2003 IPPS proposed rule published on May 9, 2002 (67 FR 
31462), we proposed that, if a hospital's reported bed count results in 
an occupancy rate (average daily census of patients divided by the 
number of beds) below 35 percent, the applicable bed count, for 
purposes of establishing the number of available beds for that 
hospital, would exclude beds that would result in an average annual 
occupancy rate below 35 percent. However, at the time the FY 2003 IPPS 
final rule was published on August 1, 2002 (67 FR 50060), we decided 
not to proceed with the proposed changes as final and to reconsider the 
issue as part of a future comprehensive analysis of our bed and patient 
day counting policies.
    In the May 19, 2003 proposed rule, we proposed to determine whether 
beds in a unit or ward are available based upon whether the unit or 
ward was used to provide patient care of a level generally payable 
under the IPPS (``IPPS level of care'') at any time during the 3 
preceding months, rather than propose to establish a minimum standard 
occupancy rate. If any of the beds in the unit or ward were used to 
provide an IPPS level of care at any time during the preceding 3 
months, all of the beds in the unit or ward are considered available 
and are to be counted for purposes of determining available bed days 
during the current month. (However, individual bed days may be excluded 
from that count if the bed is used to provide other services such as 
observation bed or swing-bed service, as discussed below.) If no 
patient care of a type generally payable under the IPPS was provided in 
that unit or ward during the 3 preceding months, the beds in the unit 
or ward are to be excluded from the determination of available bed days 
during the current month (proposed Sec. Sec.  412.105(b)(2) and 
412.106(a)(1)(ii)(C)).
    Comment: Many commenters objected to our proposals to amend our 
policy for counting unoccupied beds. Some commenters believed we should 
not apply an occupancy test, regardless of how long a hospital's beds 
sit idle. Other commenters believed the proposed 3-month test to show 
that a unit is unoccupied was unreasonable, and suggested that our 
policy should recognize small-scale, short-term renovations that take 
individual rooms out of service for less than 3 months.
    A few commenters recommended the threshold for excluding an 
unoccupied unit should be reduced from 3 months to 1 month. Several 
commenters requested tangible evidence to support a 3-month threshold 
for excluding unoccupied beds.
    Response: We believe that our proposal to amend our policy for 
counting unoccupied beds would provide a clear standard for both 
hospitals and fiscal intermediaries to use to determine whether 
otherwise unoccupied beds are to be counted. We note that if the 
required time period for excluding the unoccupied beds were set too 
low, hospitals could potentially manipulate their available bed count 
by not admitting any patients to a unit or ward during low occupancy 
periods, thereby distorting the measure of hospital beds. We believe 
that, 3 months (one quarter of a hospital's fiscal year), represents a 
reasonable standard for determining whether beds in a unit or ward are 
not being used to provide patient care and should be excluded from the 
hospital's available bed count.
    Comment: One commenter stated that we should include the beds in 
the determination of the available bed count if they are located in an 
area that is included in the determination of allowable costs on the 
Medicare cost report. One commenter suggested that a policy that does 
not recognize such beds for DSH payment purposes because they do not 
meet an occupancy standard contradicts the recognized allowable nature 
of the costs associated with those beds. This commenter also requested 
that we apply the same 24-hour availability standard, regardless of the 
reason a bed is unoccupied. The commenter expressed the opinion that, 
whether a bed is associated with an altered patient room or merely a 
bed in a unit housing unoccupied beds, if the bed can be staffed and 
readied to house

[[Page 49095]]

a patient within a designated period of time, the bed should be counted 
for DSH payment calculations.
    Another commenter stated that if a hospital can demonstrate its 
intent to remove beds from service, the beds should be excluded from 
the bed count on the first day they are removed from service without 
meeting the 3-month waiting period. Other commenters believed the 
proposal should allow hospitals to exclude specific rooms from the 
available bed count when the individual rooms are undergoing 
renovations (as opposed to the entire unit). Some commenters indicated 
that, instead of clarifying and simplifying our bed counting policy, 
our proposal would complicate the current policy.
    Response: The range of comments on this proposal demonstrates the 
difficulty in administering our current policy, and the importance of a 
uniform bed-counting policy for purposes of determining the number of 
beds for IME and DSH.
    We proposed to use a 3-month standard to determine whether beds in 
a unit or ward should be considered unoccupied and excluded from the 
count of available beds because we believed it would provide a clear 
standard for both hospitals and fiscal intermediaries to use to 
determine whether beds should be counted. We believed 3 months 
represents a reasonable timeframe to demonstrate whether beds within a 
unit or ward are or are not being used to provide an IPPS-level of 
patient care, and to determine whether beds in the unit or ward should 
be included in the determination of a hospital's available bed count.
    We continue to believe that the 3 month standard is appropriate. As 
noted previously, there are conflicting views among hospitals over 
whether this timeframe is too long or too short. Some hospitals argue 
that there should be no limitation on a hospital's ability to count 
unoccupied beds. Others argue that hospitals should be able to exclude 
beds on a daily basis as they undertake renovations.
    We believe our proposed policies generally provide a balance 
between these contrasting positions while establishing a clearer 
standard to follow. We also continue to believe our proposed policies 
will strike an appropriate balance between capturing short-term shifts 
in occupancy and reflecting long-term changes in capacity, which will 
result in a reasonable representation of the hospital's number of 
available beds. However, based on the comments, we recognize the need 
for some refinement and further elaboration upon our proposal. For 
example, we stated in the proposed rule of May 19, 2003, that the 
proposed policy to exclude from the count of available beds only the 
beds in units or wards that were not occupied by a patient receiving an 
IPPS level of care at any time during the 3 preceding months would be 
also be applicable to rooms undergoing renovations. However, we 
understand that many renovations do not involve entire units or wards, 
but do make individual rooms unavailable for patient care during the 
course of the renovation. Therefore, we are specifying in this final 
rule that beds in individual rooms within units or wards that would 
otherwise be considered occupied and available, but that are actually 
unavailable due to renovations, will be excluded from the available bed 
count.
    However, in order to avoid day-to-day fluctuations in available 
beds resulting from minor renovations, and to ensure consistent 
application of this policy, we continue to believe it is necessary to 
establish a uniform, minimum time period that a bed must be unavailable 
before it is excluded. Therefore, in order for any bed within a unit or 
ward that would otherwise be considered occupied to be excluded because 
it is unavailable, the bed must remain unavailable for 30 consecutive 
days. In other words, if an individual bed or group of beds within an 
otherwise occupied unit or ward could not be made available within a 
24-hour period for whatever reason (for example, renovations, use as 
office space, use for provision of ancillary services) for 30 
consecutive days, the beds should be excluded from the hospital's 
available bed count for those 30 consecutive days. This policy would 
apply to all situations that would render a bed unavailable, not just 
to the examples listed above. With respect to our proposal to exclude 
from the available bed count all of the beds in any unit or ward that 
is unoccupied for the 3 preceding months, we continue to believe that 
this is an appropriate standard to establish whether the beds in that 
unit or ward are available for use by the hospital for an IPPS level of 
care. At some point, the measure of a hospital's number of available 
beds must bear a relationship to its patient population. We believe the 
3 month timeframe, which requires that the beds in a unit or ward are 
counted if an IPPS level of care is provided to even one patient every 
3 months, is a reasonable threshold that affords a good deal of 
flexibility to the hospital to maintain as available some beds in low 
occupancy units or wards.
    Comment: One commenter requested that we postpone the proposal to 
decrease a hospital's total number of beds for purposes of calculating 
the IME and DSH payments if the hospital's occupancy rate falls below a 
threshold of 35 percent. Specifically, the commenter requested that we 
perform further analysis of the bed count methodology and determine the 
impact on smaller hospitals in rural areas.
    Response: In the May 19, 2003 proposed rule, we made reference to 
the proposed rule published on May 9, 2002 (67 FR 31462) in which we 
proposed that if a hospital's reported bed count results in an 
occupancy rate (average daily census of patients divided by the number 
of beds below 35 percent), we would exclude from beds that would result 
in an average annual occupancy rate below 35 percent. However, in the 
August 1, 2002 IPPS final rule (67 FR 50060), we decided not to proceed 
with the proposed change as final and to reconsider the issue as part 
of a future comprehensive analysis of our bed and patient day counting 
policies. In the proposed rule of May 19, 2003 (68 FR 27203), we 
proposed to determine whether beds in a unit or ward are available 
based upon whether any bed in the unit or ward was used to provide 
(``an IPPS level of care'') at any time during the 3 preceding months 
rather than to establish a minimum standard occupancy rate.
    Comment: One commenter asked whether if an entire ward has been 
closed for 4 months, the beds should be excluded only for the fourth 
month, or whether after the 3-month period has been met, the beds would 
be excluded from the date that the ward closed.
    Response: If any of the beds in a unit or ward were used to provide 
an IPPS level of care at any time during the preceding 3 months, all of 
the beds in the unit or ward would be counted for purposes of 
determining available bed days during the current month. If no IPPS 
level of care was provided within that unit or ward during the 3 
preceding months, the beds in the unit or ward are to be excluded from 
the count of available bed days during the current month.
    In the example given by the commenter, if an entire ward had been 
used to provide an IPPS level of care during December, but closed for 
the months of January, February, and March, the beds would be excluded 
from the available bed count for the month of April. However, the beds 
would be counted for the months of January through March if a bed in 
the ward had been used to provide an IPPS level of care in December. If 
a bed in the

[[Page 49096]]

ward is occupied for even a portion of the month of April, all of the 
beds located in the ward would be considered available for the entire 
month of May. If no bed in the ward is occupied during the month of 
April, all of the beds would not be counted in the available bed count 
for May (because no IPPS level of care was provided in that ward for 
the months of February, March and April).
    Comment: One commenter recommended that we reconsider our proposal 
to exclude unoccupied beds from the available bed count and rely on the 
hospital license as the definitive bed count for purposes of 
determining the applicable bed count.
    Response: Our policy is not to rely on the hospital license as the 
definitive bed count for purposes of determining the applicable bed 
count. There are several reasons we do not believe it is appropriate to 
rely on a hospital's license to determine the applicable bed count. 
Hospitals often are licensed for many more beds than they currently 
occupy. Using a hospital's number of licensed beds as the measure of 
available beds would allow hospitals with excess capacity to show a 
higher number of beds which, could inappropriately allow some hospitals 
to meet the bed thresholds for DSH payment calculation purposes. We 
also note that the IME adjustment for teaching hospitals could be 
reduced significantly, and artificially, by including in a hospital's 
bed count the number of licensed beds that are not in use. In addition, 
individual states determine the number of licensed beds for hospitals. 
There is no consistent method from State to State on the requirements 
or standards for determining these licensed beds. Lack of a consistent 
method or standard for establishing the number of licensed beds could 
unfairly disadvantage hospitals in some states, and benefit hospitals 
in others; the inconsistency among States in bed-licensing methods or 
standards makes licensed beds an unreliable representation of a 
hospital's number of available beds.
    Comment: Another commenter stated that, if the provider can 
document that a space is under evaluation as a future location for 
health care related services (although perhaps it is now only used for 
storage), the number of beds associated with these spaces should be 
considered allowable. If, in a year, the provider has not put beds into 
service or made the beds available by using them to provide an IPPS 
level of care, the fiscal intermediary could consider the space as non-
allowable, for purposes of determining a hospital's bed count.
    Response: The purpose of our policy change is to provide clearer 
guidance, and to be more consistent in determining which beds should be 
considered available and included in a hospital's bed count. We believe 
that allowing hospitals to identify or document that a space is under 
evaluation as a location for future health care related services, and 
considering some number of beds associated with the space to be 
available would add significant vagueness and imprecision to the 
policy.
    In summary, in this final rule, we are revising our regulations at 
Sec.  412.105(b) and Sec.  412.106(a)(1)(ii) to specify that bed days 
in a unit that was occupied to provide an IPPS level of care for at 
least one day during the 3 preceding months are included in the 
available bed day count for a month. In addition, bed days for any bed 
within a unit that would otherwise be considered occupied should be 
excluded from the available bed day count for the current month if the 
bed has remained unavailable (could not be made available for patient 
occupancy within 24 hours) for 30 consecutive days, or if the bed is 
used to provide outpatient observation services or swing-bed skilled 
nursing care. This policy will be effective for discharges occurring on 
or after October 1, 2004.
2. Observation Services and Swing-bed Skilled Nursing Services
    Observation services are those services furnished by a hospital on 
the hospital's premises that include use of a bed and periodic 
monitoring by a hospital's nursing or other staff in order to evaluate 
an outpatient's condition or to determine the need for a possible 
admission to the hospital as an inpatient. When a hospital places a 
patient under observation but has not formally admitted him or her as 
an inpatient, the patient is initially treated as an outpatient, and 
the services are reimbursed as outpatient services. Consequently, the 
observation days are not recognized under the IPPS as part of the 
inpatient operating costs of the hospital. However, if the patient is 
subsequently admitted as an inpatient, the observation services are 
reimbursed as inpatient services.
    Observation services may be provided in a distinct outpatient 
observation bed area, (which is not a routine inpatient acute care unit 
or ward for which costs are included for purposes of the IPPS), but 
they may also be provided in a bed located within a routine inpatient 
care unit or ward. As we mentioned above, the discussion of our 
policies on counting beds and days in this final rule pertains to beds 
and patient days that occur in units or wards that are not excluded 
from the IPPS and for which costs are included in determining the 
allowable costs of inpatient hospital care under the IPPS on the 
Medicare cost report. However, we note that whether the observation 
services are provided in a separate outpatient observation area or in a 
bed within an inpatient acute care unit or ward, our general policy is 
that the days attributable to beds used for observation services are 
excluded from the counts of available bed days and patient days at 
(Sec. Sec.  412.105(b) and 412.106(a)(1)(ii)). This policy was 
clarified in a memorandum that was sent to all CMS Regional Offices 
(for distribution to fiscal intermediaries) dated February 27, 1997. 
This memorandum stated that if a hospital provides observation services 
in beds that are generally used to provide hospital inpatient services, 
the days that those beds are used for observation services are to be 
excluded from the available bed day count (even if the patient is 
ultimately admitted as an acute inpatient).
    A swing-bed is a bed that is available for use to provide acute 
inpatient care and is also available for use to provide SNF-level care. 
The requirements for a hospital to be considered a swing-bed hospital 
are located under existing regulations at Sec.  482.66, and for a 
swing-bed CAH, under existing regulations at Sec.  485.645. Under 
existing Sec.  413.114(a)(1), payment for posthospital SNF care 
furnished in swing-beds is made in accordance with the provisions of 
the SNF prospective payment system (effective for SNF services 
furnished in cost reporting periods beginning on and after July 1, 
2002). Similar to beds and patient days, associated with observation 
services, when the swing-bed is used to furnish SNF care \8\ those beds 
and patient days are excluded from the counts of available bed days and 
patient days (Sec. Sec.  412.105(b) and 412.106(a)(1)(ii)).
---------------------------------------------------------------------------

    \8\ Ibid.
---------------------------------------------------------------------------

    Observation services and swing-beds skilled nursing services are 
both special, frequently temporary, alternative uses of acute inpatient 
care beds. Thus, the days a bed in an (otherwise occupied) acute 
inpatient care unit or ward is used to provide outpatient observation 
services are to be deducted from the available bed count under Sec.  
412.105(b) and the patient day count under Sec.  412.106(a)(1)(ii). 
Otherwise, the bed would be considered available for IPPS-level acute 
care services (as long as it meets the other criteria to be considered 
available). This same policy applies to

[[Page 49097]]

swing-beds for days the bed is used to provide SNF-level care. The 
policies to exclude observation days and SNF-level swing-bed days from 
the count of available bed days and patient days, as described above 
stem from the fact that although the services are provided in beds that 
would otherwise be available to provide an IPPS level of services, 
these days are not payable under the IPPS, except in the case of 
observation days when the patient is ultimately admitted as an 
inpatient).
    In the proposed rule of May 19, 2003, we proposed to amend our 
policy with respect to observation days for patients who are ultimately 
admitted for inpatient acute care. As we noted previously, our current 
policy is that observation days are excluded from the available bed day 
and the patient day counts. (This policy was communicated in a 
memorandum to all CMS Regional Offices on February 27, 1997). 
Specifically, we proposed that, if a patient is admitted as an acute 
inpatient subsequent to receiving outpatient observation services, we 
would include the days associated with the observation services in the 
available bed day and patient day counts. We proposed this policy 
because it would be consistent with our policy generally to count beds 
and days when the costs associated with the beds and days would be 
considered inpatient operating costs under the IPPS.
    In order to avoid any potential future misunderstandings about our 
policies regarding the exclusion of observation and swing-bed days 
under the regulations at Sec.  412.105(b) and Sec.  412.106(a)(1)(ii), 
we proposed to revise our regulations to specify our policy that 
observation and swing-bed days are to be excluded from the counts of 
both available beds and patient days, unless a patient, who receives 
outpatient observation services is ultimately admitted for acute 
inpatient care, in which case the beds and days would be included in 
those counts.
    Comment: One commenter indicated that the proposed change does not 
seem unreasonable, although it will require administrative changes for 
hospitals to count these days as part of their reporting processes. 
However, the commenter suggested that, if the change is finalized, it 
should be included in all Medicare calculations of days and length of 
stay; for example, when determining the length of stay for patients 
subject to the per diem payment methodology for transfers.
    Another commenter pointed out that the costs associated with these 
days would still be ancillary costs and treated as such on the Medicare 
cost report. Thus, it would be necessary to report these days 
separately from other inpatient routine care days so that the costs can 
be appropriately allocated.
    Some commenters noted that the proposed change would result in 
Medicare treating these days inconsistently from other payers and, 
therefore, it would require a significant amount of a hospital's time 
and resources to track observation patients that ultimately become 
inpatients. On the other hand, some commenters asserted that this 
change would result in Medicare's policy becoming consistent with other 
payers' treatment of observation patient days attributable to patients 
who are admitted as inpatients.
    Response: We recognize the issues raised by the commenters with 
regard to treating these days consistently for purposes of determining 
the length of stay in calculating per diem payments and for cost 
allocation purposes. We have determined that these days are similar to 
those days for patients who go to the emergency room and are ultimately 
admitted to the hospitals. Once a patient has been admitted into the 
hospital, the time and costs they incurred in the emergency room are 
also included in the inpatient stay. Including observation patients in 
the available bed and patient day count once they are admitted as 
inpatients requires making a change in the Medicare cost report. On 
Worksheet S-3, of CMS Form 2552-96, we will include a line to show 
observation days for patients subsequently admitted as inpatients and a 
separate line for observation days for patients not admitted.
    Comment: Some commenters objected to the general exclusion of 
observation bed days from the available bed day count on the grounds 
that it is a flawed premise that the size of a hospital's bed 
complement should be impacted by the payment policy classification of 
the services provided to the patient. That is, the commenter believed a 
bed should not be excluded from the available bed day count because it 
is used to provide services not payable under the IPPS on a particular 
day.
    Response: When the application of IPPS payment policy hinges on a 
determination of a hospital's bed size, it seems reasonable to 
determine bed size based on the portion of the hospital that generates 
the costs that those IPPS payments are designed to compensate. In 
addition, we use available bed days as the basis to determine a 
hospital's bed count for purposes of the IME adjustment. Therefore, we 
believe it is appropriate to consider how a bed is used on a given day. 
For example, if a bed is used for observation services on a given day, 
it is not available for inpatient services. As stated above, our bed 
counting policies start with the premise that the treatment of beds 
should be generally consistent with the treatment of the patient days 
and the costs of those days on the Medicare cost report. Therefore, we 
continue to believe it is appropriate to exclude outpatient observation 
days, even when the beds used to provide that service are located in an 
otherwise available routine inpatient care unit or ward.
    In determining whether a bed should be considered available, our 
policy has been to treat the bed in the same manner as we treat the 
patient days and costs associated with the bed. For example, we include 
intensive care unit beds in the available bed count because patient 
days in these units are included in total patient days and the costs 
are included in the calculation of allowable costs under the IPPS. If a 
patient is placed for observation in a bed generally used to provide 
inpatient services, and is then admitted to the hospital, the patient 
days that occurred before the inpatient admission are included in the 
inpatient stay, the costs prior to the admission are included in 
allowable inpatient costs, and the bed days are included in the 
available bed day count. However, if the patient placed for observation 
is released from the hospital without being admitted, then the 
observation days and costs are excluded from the calculation of 
inpatient days and costs, and the bed days are excluded from the 
available bed day count.
    A change in the Medicare cost report is required in order to 
include observation days for patients that are subsequently admitted as 
inpatients in the available bed and patient day counts. Therefore, on 
Worksheet S-3, of CMS Form 2552-96, we will include a line, to show 
observation days for patients subsequently admitted as inpatients and a 
separate line for observation days for patients not admitted. This 
policy change will be applied to all cost reporting periods beginning 
on or after October 1, 2004.
    In summary, in this final rule we are adopting the proposed changes 
to Sec.  412.105(b) and Sec.  412.106(a)(1)(ii), which specify that 
observation and swing-bed days are to be excluded from the counts of 
both available bed days and patient days unless a patient receiving 
outpatient observation services in a bed that is generally used to 
provide hospital inpatient acute care services is ultimately admitted, 
in which case the beds and days associated with the observation 
services would be included in those counts. This policy will be 
effective for cost reporting

[[Page 49098]]

periods beginning on or after October 1, 2004.
3. Dual-Eligible Patient Days
    As described above, the DSH patient percentage is equal to the sum 
of the percentage of Medicare inpatient days attributable to patients 
entitled to both Medicare Part A and SSI benefits, and the percentage 
of total inpatient days attributable to patients eligible for Medicaid 
but not entitled to Medicare Part A benefits. If a patient is a 
Medicare beneficiary who is also eligible for Medicaid, the patient is 
considered dual-eligible and the patient days are included in the 
Medicare fraction of the DSH patient percentage but not the Medicaid 
fraction. This is consistent with the language of section 
1886(d)(5)(F)(vi)(II) of the Act, which specifies that patients 
entitled to benefits under Part A are excluded from the Medicaid 
fraction.
    It has come to our attention that we inadvertently misstated our 
current policy with regard to the treatment of certain inpatient days 
for dual-eligibles in the proposed rule of May 19, 2003 (68 FR 27207). 
In that proposed rule, we indicated that a dual-eligible beneficiary is 
included in the Medicare fraction even after the patient's Medicare 
Part A hospital coverage is exhausted. That is, we stated that if a 
dual-eligible patient is admitted without any Medicare Part A hospital 
coverage remaining, or the patient exhausts Medicare Part A hospital 
coverage while an inpatient, the non-covered patient days are counted 
in the Medicare fraction. This statement was not accurate. Our policy 
has been that only covered patient days are included in the Medicare 
fraction (Sec.  412.106(b)(2)(i)). A notice to this effect was posted 
on CMS's Web site (http://www.cms.hhs.gov/providers/hipps/dual.asp) on 
July 9, 2004.
    Comment: We received numerous comments that commenters were 
disturbed and confused by our recent Web site posting regarding our 
policy on dual-eligible patient days. The commenters believed that this 
posting was a modification or change in our current policy to include 
patient days of dual-eligible Medicare beneficiaries whose Medicare 
Part A coverage has expired in the Medicaid fraction of the DSH 
calculation. In addition, the commenters believed that the information 
in this notice appeared with no formal notification by CMS and without 
the opportunity for providers to comment.
    Response: The notice that was posted on our Web site was not a 
change in our current policy. Our current policy is, if a patient is a 
Medicare beneficiary who is also eligible for Medicaid, the patient is 
considered dual-eligible and the patient days are included in the 
Medicare fraction of the DSH patient percentage but not the Medicaid 
fraction. This is consistent with the language of section 
1886(d)(5)(F)(vi)(II) of the Act, which specifies that patients 
entitled to benefits under Medicare Part A are excluded from the 
Medicaid fraction.
    The Web site posting is a correction of an inadvertent misstatement 
made in the May 19, 2003 proposed rule (68 FR 27207). This Web site 
posting was not a new proposal or policy change. As a result, we do not 
believe it is necessary to utilize the rule making process in 
correcting a misstatement that was made in the May 19, 2003 proposed 
rule regarding this policy.
    In the proposed rule of May 19, 2003 (68 FR 27207), we proposed to 
change our policy to begin to count in the Medicaid fraction of the DSH 
patient percentage the patient days of dual-eligible Medicare 
beneficiaries whose Medicare coverage has expired. We note that the 
statutory provision referenced above stipulates that the Medicaid 
fraction is to include patients who are eligible for Medicaid. However, 
the statute also requires that patient days attributable to patients 
entitled to benefits under Medicare Part A are to be excluded from the 
Medicaid fraction.
    Comment: Numerous commenters opposed our proposal to begin to count 
in the numerator of the Medicaid fraction of the DSH patient 
percentage, the patient days of dual-eligible Medicare beneficiaries 
whose Medicare inpatient coverage has expired. They objected that the 
proposal would result in a reduction of DSH payments when the exhausted 
coverage days are removed from the Medicare fraction and included in 
the Medicaid fraction. According to these commenters, any transfer of a 
particular patient day from the Medicare fraction (based on total 
Medicare patient days) to the Medicaid fraction (based on total patient 
days) would dilute the value of that day and, therefore, reduce the 
overall patient percentage and the resulting DSH payment adjustment.
    One commenter observed that a patient who exhausts coverage for 
inpatient hospital services still remains entitled to other Medicare 
Part A benefits. This commenter found it difficult to reconcile the 
position that these patients are not entitled to Medicare Part A 
benefits when they can receive other covered Part A services, such as 
SNF services.
    In addition, some commenters stated that these days should not be 
included in either the Medicare or Medicaid fraction. They indicated 
that the days should not be included in the Medicare fraction because 
that computation includes the number of patient days actually furnished 
to patients who were entitled to both Medicare Part A and SSI benefits. 
The commenters stated that the days should also be excluded from the 
Medicaid fraction because that computation excludes hospital patient 
days for patients who, for those days, were entitled to benefits under 
Medicare Part A.
    Commenters also indicated that the proposal would put an increased 
administrative burden on the hospitals to support including these 
patient days in the Medicaid fraction. They recommended that if we 
finalize this policy, the requirement that hospitals submit 
documentation justifying the inclusion of the days in the Medicaid 
fraction should be removed.
    Response: We proposed this change to facilitate consistent handling 
of these days across all hospitals, in recognition of the reality that, 
in some States, fiscal intermediaries are reliant upon hospitals to 
identify days attributable to dual-eligible patients whose Medicare 
Part A hospitalization benefits have expired. We believe it is 
important that all IPPS policies be applied consistently for all 
hospitals around the country.
    However, we acknowledge the point raised by the commenter that 
beneficiaries who have exhausted their Medicare Part A inpatient 
coverage may still be entitled to other Part A benefits. We also agree 
with the commenter that including the days in the Medicare fraction has 
a greater impact on a hospital's DSH patient percentage than including 
the days in the Medicaid fraction. This is necessarily so because the 
denominator of the Medicare fraction (total Medicare inpatient days) is 
smaller than the denominator of the Medicaid fraction (total inpatient 
days). However, we note that we disagree with the commenter's assertion 
that including days in the Medicaid fraction instead of the Medicare 
fraction always results in a reduction in DSH payments. For instance, 
if a dual-eligible beneficiary has not exhausted Medicare Part A 
inpatient benefits, and is not entitled to SSI benefits, the patient 
days for that beneficiary are included in the Medicare fraction, but 
only in the denominator of the Medicare fraction (because the patient 
is not entitled to SSI benefits). The inclusion of such patient days in 
the Medicare fraction has the result of decreasing the Medicare 
fraction in the DSH patient percentage.

[[Page 49099]]

    For these reasons, we have decided not to finalize our proposal 
stated in the May 19, 2003 proposed rule to include dual-eligible 
beneficiaries who have exhausted their Part A hospital coverage in the 
Medicaid fraction. Instead, we are adopting a policy to include the 
days associated with dual-eligible beneficiaries in the Medicare 
fraction, whether or not the beneficiary has exhausted Medicare Part A 
hospital coverage. If the patient is entitled to Medicare Part A and 
SSI, the patient days will be included in both the numerator and 
denominator of the Medicare fraction. This policy will be effective for 
discharges occurring on or after October 1, 2004. We are revising our 
regulations at Sec.  412.106(b)(2)(i) to include the days associated 
with dual-eligible beneficiaries in the Medicare fraction of the DSH 
calculation.
4. Medicare+Choice (M+C) Days
    Under existing Sec.  422.1, an M+C plan means ``health benefits 
coverage offered under a policy or contract by an M+C organization that 
includes a specific set of health benefits offered at a uniform premium 
and uniform level of cost-sharing to all Medicare beneficiaries 
residing in the service area of the M+C plan.'' Generally, each M+C 
plan must provide coverage of all services that are covered by Medicare 
Part A and Part B (or just Part B if the M+C plan enrollee is only 
entitled to Part B).
    We have received questions whether the patient days associated with 
patients enrolled in an M+C Plan should be counted in the Medicare 
fraction or the Medicaid fraction of the DSH patient percentage 
calculation. The question stems from whether M+C plan enrollees are 
entitled to benefits under Medicare Part A since M+C plans are 
administered through Medicare Part C.
    We note that, under existing regulations at Sec.  422.50, an 
individual is eligible to elect an M+C plan if he or she is entitled to 
Medicare Part A and enrolled in Part B. However, once a beneficiary has 
elected to join an M+C plan, that beneficiary's benefits are no longer 
administered under Part A. In the proposed rule of May 19, 2003 (68 FR 
27208), we proposed that once a beneficiary elects Medicare Part C, 
those patient days attributable to the beneficiary would not be 
included in the Medicare fraction of the DSH patient percentage. Under 
our proposal, these patient days would be included in the Medicaid 
fraction. The patient days of dual-eligible M+C beneficiaries (that is, 
those also eligible for Medicaid) would be included in the count of 
total patient days in both the numerator and denominator of the 
Medicaid fraction.
    Comment: Several commenters indicated that they appreciated CMS's 
attention to this issue in the proposed rule. The commenters also 
indicated that there has been insufficient guidance on how to handle 
these days in the DSH calculation. However, several commenters 
disagreed with excluding these days from the Medicare fraction and 
pointed out that these patients are just as much Medicare beneficiaries 
as those beneficiaries in the traditional fee-for-service program.
    Response: Although there are differences between the status of 
these beneficiaries and those in the traditional fee-for-service 
program, we do agree that once Medicare beneficiaries elect Medicare 
Part C coverage, they are still, in some sense, entitled to benefits 
under Medicare Part A. We agree with the commenter that these days 
should be included in the Medicare fraction of the DSH calculation. 
Therefore, we are not adopting as final our proposal stated in the May 
19, 2003 proposed rule to include the days associated with M+C 
beneficiaries in the Medicaid fraction. Instead, we are adopting a 
policy to include the patient days for M+C beneficiaries in the 
Medicare fraction. As noted previously, if the beneficiary is also an 
SSI recipient, the patient days will be included in the numerator of 
the Medicare fraction. We are revising our regulations at Sec.  
412.106(b)(2)(i) to include the days associated with M+C beneficiaries 
in the Medicare fraction of the DSH calculation.

M. Payment Adjustments for Low-Volume Hospitals (Sec.  412.101)

    Section 406 of Public Law 108-173 amended section 1886(d) of the 
Act to add a new subclause (12) to provide for a new payment adjustment 
to account for the higher costs per discharge of low-volume hospitals 
under the IPPS. Section 1886(d)(12)(C)(i) of the Act, as added by 
section 406, defines a low-volume hospital as a ``subsection (d) 
hospital * * * that the Secretary determines is located more than 25 
road miles from another subsection (d) hospital and that has less than 
800 discharges during the fiscal year.'' Section 1886(d)(12)(C)(ii) of 
the Act further stipulates that the term ``discharge'' refers to total 
discharges, and not merely to Medicare discharges. Specifically, the 
term refers to the ``inpatient acute care discharge of an individual 
regardless of whether the individual is entitled to benefits under part 
A.'' Finally, the provision requires the Secretary to determine an 
applicable percentage increase for these low-volume hospitals based on 
the ``empirical relationship'' between ``the standardized cost-per-case 
for such hospitals and the total number of discharges of these 
hospitals and the amount of the additional incremental costs (if any) 
that are associated with such number of discharges.'' The statute thus 
mandates the Secretary to develop an empirically justifiable adjustment 
formula based on the relationship between costs and discharges for 
these low-volume hospitals. The statute also limits the adjustment to 
no more than 25 percent.
    MedPAC has published an analysis of the financial performance and 
cost profiles of low-volume hospitals (MedPAC June 2001 Report to 
Congress, page 66). Its analysis indicated that hospitals with 500 
discharges or less generally have negative Medicare margins. 
Specifically, hospitals with 200 discharges or less have margins of -
16.4 percent, and hospitals with 201 to 500 discharges have margins of 
-2.1 percent. MedPAC's analysis further revealed that hospitals with a 
small volume of discharges have higher costs per discharge than larger 
facilities, after controlling for the other cost factors recognized in 
the payment system. MedPAC's analysis thus indicates that low-volume 
providers are disadvantaged by payment rates based on average volume. 
In analyzing the relationship between costs per case and discharges, 
MedPAC also found that this relationship begins to level off and 
reaches zero variation at around 500 discharges. Therefore, MedPAC 
recommended an adjustment formula in the form of:

1.25 -(.0005*D), if D<500 discharges

    Where 1.25 represents the maximum 25-percent add-on, .0005 is the 
payment adjustment per case (derived by dividing .25 by 500 discharges) 
and ``D'' is the number of discharges.
    Using FY 2001 cost report data, we found an even larger disparity 
than MedPAC found between low-volume providers and their higher-volume 
counterparts. Although Medicare margins remain healthy overall at 9.32 
percent, the Medicare margin for providers with 200 or less discharges 
is -46.26 percent, and the margin for providers with 201 to 500 
discharges is -11.74 percent. For the May 18, 2004 proposed rule, we 
employed a bivariate regression analysis to determine the fit between 
total hospital discharges and operating costs from FY 2001.
    As discussed in the proposed rule, we found a very strong 
correlation between costs and the total number of discharges. We then 
examined the variation in cost-per-case among subsection (d) hospitals, 
using both log

[[Page 49100]]

and nonlog functions. When the analysis was limited to hospitals with 
fewer than 1,000 discharges, we found a strong relationship between 
cost per case and low volume. We found that the greatest variation from 
the mean costs per case exists between 1 and 150 discharges, indicating 
(as MedPAC also found) that hospitals with the lowest case volume 
generally experience greater costs per case than hospitals with higher 
volume. However, after about 150 discharges, the trend line begins to 
level off rapidly. The trend line reaches zero variation from mean cost 
per case at approximately 450 discharges (cost per case in log form) or 
500 discharges (nonlog form). Immediately after that point, the trend 
line in both forms becomes negative, while still maintaining a very 
smooth line. Both because of where the trend line crosses zero and 
because there is very little variation from the mean after this point, 
we believed that 500 discharges was the appropriate cutoff for an add-
on payment under this provision.
    Based on these results, we proposed to adopt a slightly revised 
version of MedPAC's recommended formula for an add-on payment to low-
volume hospitals:

Adjustment = 1.25-(.0005*D), if 00'' in order to 
avoid the anomalous result that a hospital without any discharges would 
qualify for the maximum 25-percent adjustment.
    However, these proposals were based only on our univariate analysis 
conducted before publication of the proposed rule. In the proposed 
rule, we indicated our concerns about whether we had sufficient 
information (for example, total hospital case-mix) to support valid 
multivariate analyses. We also noted our plan to conduct more detailed 
multivariate analyses for the final rule.
    We also noted that, under our proposed formula, some hospitals that 
meet the statutory definition of low-volume hospital would receive no 
adjustment. Specifically, hospitals with more than 500 but fewer than 
800 total discharges for the fiscal year would receive no adjustment 
under this formula. Despite the statutory definition of a low-volume 
hospital as a subsection (d) hospital that has less than 800 discharges 
during the fiscal year, the statutory provision mandating this 
adjustment also requires the Secretary to determine the empirical 
relationship between the standardized cost-per-case, the total number 
of discharges, and the amount of incremental costs associated with the 
number of discharges. In addition, the provision requires that the 
applicable percentage increase shall be ``based upon such relationship 
in a manner that reflects * * * such incremental costs.'' We believe 
that the statutory language thus gives the Secretary the flexibility to 
set the percentage increase at zero for a given number of discharges if 
the empirical evidence shows that hospitals experience no higher 
incremental costs when they reach that number of discharges. In other 
words, the statute does not require the Secretary to provide an 
adjustment in the absence of empirical evidence that an adjustment is 
warranted by higher incremental costs.
    Comment: Many commenters objected to our proposal to provide an 
adjustment for only some hospitals that meet the statutory definition 
of a low-volume hospital. Some of these commenters contended that such 
a proposal was contrary to the statute. Other commenters stated that 
the proposal neglected to provide additional payments for many small 
hospitals that may be struggling financially.
    Response: We continue to believe that the statutory language gives 
the Secretary the flexibility to set the percentage increase at zero 
for a given number of discharges if the empirical evidence shows that 
hospitals experience no higher incremental costs when they reach that 
number of discharges. In other words, the statute does not require the 
Secretary to provide an adjustment in the absence of empirical evidence 
that an adjustment is warranted by higher incremental costs. Indeed, we 
believe that the statutory language implies that no adjustment would be 
warranted for any hospitals that meet the definition of ``low-volume 
hospital'' if the requisite empirical analysis of the ``relationship 
between the standardized cost-per-case, the total number of discharges, 
and the amount of incremental costs associated with the number of 
discharges'' does not support an adjustment. We also note MedPAC's 
agreement with our proposal to limit the adjustment to the level 
supported by the empirical analysis.
    While the statute defines low-volume hospitals in terms of total 
inpatient acute care discharges and mandates that the adjustment be 
based upon the amount of incremental costs associated with the number 
of discharges, it does not specify whether the count of discharges, 
either for purposes of the definition or the payment adjustment 
formula, should be based on the payment year or some previous year. 
Specifically, the statute defines low-volume hospital as ``for a fiscal 
year, a subsection (d) hospital * * * [that] has less than 800 
discharges during the fiscal year'' (emphasis added).
    As we indicated in the proposed rule, we believe that this 
statutory language gives us the flexibility to define which fiscal year 
to use in determining the number of discharges, both for purposes of 
the definition of ``low-volume hospital'' and the payment adjustment 
formula. Prospective payment systems place substantial value on 
providing hospitals with predictability regarding payments. If the 
determination of whether hospitals qualify for low-volume payment 
adjustments and the computation of the payment adjustment amount are 
based on the number of discharges in the current fiscal year, neither 
CMS nor the hospital will know with certainty whether a hospital 
qualifies for the adjustment, or what the amount of the adjustment 
would be, until after the end of the payment year (probably not until 
the time of final cost report settlement for the year). In such 
circumstances, CMS could be faced with the prospect of recouping large 
overpayments in some cases or reimbursing for large underpayments in 
others. Hospitals would face similar uncertainties. On the other hand, 
if these determinations are based on discharge counts from a prior 
fiscal year, hospitals will know in advance whether they will be 
receiving a payment adjustment and what the size of the adjustment will 
be. Both hospitals and CMS will be able to plan accordingly.
    Therefore, in the proposed rule, we proposed to base the count of 
discharges, for purposes both of meeting the qualifying definition and 
determining the amount of the payment adjustment, on the number of 
inpatient acute care discharges occurring during the cost reporting 
period for the most recent submitted cost report. We recognize that 
this policy may temporarily disadvantage certain hospitals. For 
example, a hospital that had more than 500 discharges in its most 
recent submitted cost report may have fewer than 500 discharges during 
the first fiscal year in which this low-volume payment adjustment is 
available. Such a hospital would not qualify for the low-volume 
adjustment during the first fiscal year of the adjustment under the 
proposed policy,

[[Page 49101]]

but it would qualify under an alternative policy of basing the 
discharge count on the fiscal year for which payment is made. However, 
even in such cases, the hospital would not be certain about whether it 
would receive an adjustment until its cost report for the payment year 
is settled. In addition, under the proposed policy, the hospital would 
still be certain of receiving a low-volume adjustment for any fiscal 
year in which it had 500 or fewer discharges. The hospital would 
receive the adjustment during the fiscal year after the cost report is 
submitted for any fiscal year in which the hospital had 500 discharges 
or less.
    Comment: MedPAC recommended that we consider employing a 3-year 
moving average of discharges in determining the adjustment and they 
noted that a 3-year moving average would better track a hospital's 
underlying patient volume.
    Response: We appreciate and understand the basis for this 
recommendation. However, we believe that the text of the statute, which 
defines a low-volume hospital as one that has ``less than 800 
discharges during the fiscal year,'' precludes taking a multiyear 
approach to the number of discharges.
    Comment: MedPAC recommended that we revise this proposed policy, 
and consider basing the adjustment on the actual number of discharges 
in the payment year, rather than relying on 2-year old cost report 
data. MedPAC noted that our proposed approach would delay recognition 
of changes to a hospital's actual volume in determining the adjustment, 
and that reconciliation of the final discharge count for the payment 
year could be carried out less than a year from the end of the cost 
reporting period.
    Response: We appreciate MedPAC's recommendation and will take it 
into consideration for future years. However, we are not adopting the 
recommendation at this time for several reasons. The recommendation to 
employ the current year count of discharges would require establishment 
of a reconciliation process, which would probably be implemented by 
means of revisions to the Medicare cost report form. As we discuss 
later in this section of the preamble, we are significantly modifying 
the proposed low volume adjustment on the basis of the empirical 
analysis that we have conducted since the proposed rule. In the light 
of this analysis, we will be reanalyzing the empirical data in the FY 
2006 rulemaking process and reexamining whether an adjustment is 
warranted based on the statutory requirement that the adjustment be 
empirically justified. Until we have determined whether a low-volume 
adjustment is warranted by the empirical data over the long term, we do 
not believe that it would be prudent to establish a new reconciliation 
process and revise the Medicare cost report form.
    A further implication of our proposed policy was that a new 
hospital would not receive an adjustment during its first year of 
operation, even if it has fewer than 500 total discharges during that 
year. While this approach is somewhat disadvantageous for hospitals in 
their first year of existence, we believe that it is justified in order 
to avoid establishing a settlement process to finalize payments under 
this new proposed adjustment. Therefore, we proposed that new hospitals 
that meet the distance requirement would not be eligible for the 
adjustment until data become available to determine that the annual 
number of discharges is 500 or less. Under this approach, new hospitals 
would not receive a low-volume adjustment during at least the first 2 
years of their existence. (This is generally the amount of time that 
elapses before submission of a cost report.) This policy is consistent 
with the treatment of some existing hospitals, for example, hospitals 
that have declining numbers of discharges, and would not be eligible 
for the adjustment until their data show 500 or fewer discharges.
    Comment: Several commenters encouraged us to provide a mechanism 
for new hospitals to qualify to receive an adjustment without waiting 
for settlement of the hospital's first cost report.
    Response: Providing for new hospitals to receive an adjustment 
during the first year of operation would require establishment of a 
reconciliation process, probably through revision of the Medicare cost 
report. For the reasons discussed previously, we do not believe that it 
would be prudent to revise the cost report and establish a 
reconciliation process at this time.
    As we noted previously, the statute defines a low-volume hospital 
as a subsection (d) hospital that the Secretary determines is located 
more than 25 road miles from another subsection (d) hospital and that 
has less than 800 discharges during the fiscal year. In order to 
enforce the requirement that a qualifying hospital be located more than 
25 miles from another subsection (d) hospital, we proposed that a 
hospital that wishes to qualify for the adjustment must provide its 
fiscal intermediary with evidence that it meets this distance 
requirement. The intermediary will then certify, on the basis of the 
evidence presented by the hospital and any other relevant evidence that 
it may be able to develop, that the hospital meets this requirement. 
Other relevant evidence may include maps, mapping software, and 
inquiries to State and local police, transportation officials, or other 
government officials.
    As discussed previously, we indicated in the proposed rule that for 
the final rule we planned to conduct more detailed multivariate 
analysis on the empirical basis for a low-volume adjustment. We have 
expanded and refined our analysis in several significant ways and, as a 
result, are revising our proposal in this final rule.
    In order to further evaluate the low volume proposal, we 
empirically modeled the relationship between hospital costs-per-case 
and total discharges in several ways. We used both regression analysis 
and straight-line statistics to examine this relationship.
    We conducted three different regression analyses. For all of the 
analyses, we simulated the FY 2005 cost environment because the low-
volume policies would be applied during that year. We also analyzed the 
relationship between costs and discharges based purely on FY 2001 and 
FY 2002 data. The FY 2005 models were given the most weight in our 
conclusions as payments have undergone several changes between FY 2001 
and FY 2005, making the results of the earlier data less relevant. 
Furthermore, many of these policy changes may already have helped 
increase payments to low-volume hospitals.
    In the first regression analysis, we used a dummy variable approach 
to model the relationship between standardized costs and total 
discharges. We standardized costs to remove the effects of differences 
in area wage levels, case-mix, outliers, and, for hospitals in Alaska 
and Hawaii, the applicable cost-of-living adjustment. This model was 
similar to that used by MedPAC on 1997 data. The results of these 
regression models on the earlier years of data, FY 2001 and FY 2002, 
provided support for giving hospitals with less than 200 total 
discharges positive payment adjustments, as they were found to have 
higher Medicare costs per Medicare discharge in comparison to high-
volume hospitals. These results are somewhat consistent with the 
similar analysis performed by MedPAC, as MedPAC found that hospitals 
with up to 200 discharges were in most need of a payment adjustment. 
However, MedPAC also found evidence for

[[Page 49102]]

providing an adjustment to hospitals with up to 500 discharges, which 
the data for FYs 2001 and 2002 do not show. Furthermore, the analysis 
revealed no statistically significant relationship between standardized 
costs and total discharges when modeling under the FY 2005 environment. 
These results suggest that the relationship between standardized costs 
and total discharges is becoming less significant over time, which may 
indicate that changes to the payment structure (for example, changes in 
the labor share, and the equalization of standardized amounts) over 
time have already had some positive impact on low-volume hospital 
payments.
    We also used a descriptive analysis approach to understand the 
empirical relationship between costs and total discharges. We grouped 
all hospitals by their total discharges and compared the mean Medicare 
per discharge payment-to-Medicare per discharge cost ratios. Hospitals 
with less than 800 total discharges were split into 24 cohorts based on 
increments of 25 discharges. For the most part, the mean payment-to-
cost ratios were below one (implying that Medicare per discharge costs 
exceeded Medicare per discharge payments), for cohorts of hospitals 
with less than 200 discharges. However, consistent with the regression 
findings, the point at which the ratio seemed to transition from 
consistently being below 1 to above 1 decreased over time from 
approximately 225 discharges in 2001 to 150 discharges in 2005. There 
was also no obvious increasing trend in the ratios, from which it would 
be possible to infer a formula to generate adjustments for hospitals 
based upon the number of discharges. Because nearly 70 percent of 
hospitals with less than 200 discharges had ratios below 0.80, this 
analysis supports applying the highest payment adjustment to all 
providers with less than 200 discharges that are eligible for the low 
volume adjustment. This finding also raises concerns that the large 
variation in costs relative to payments and the low sample sizes for 
low-volume hospitals may bias the regressions toward insignificant 
results.
    The second regression analysis modeled the Medicare per discharge 
cost-to-Medicare per discharge payment ratio as a function of total 
discharges. The cost-to-payment ratio model more explicitly accounts 
for the relative values of per discharge costs and per discharge 
payments. These models provided some evidence for a statistically 
significant negative relationship between the cost-to-payment ratio and 
total discharges. However, that result was limited to FY 2001 and FY 
2002 data and no significant relationship between the cost-to-payment 
ratio and total discharges was found with simulated FY 2005 data. These 
results also lend support to the notion that the relationship between 
the cost-to-payment ratio and total discharges has become less 
significant over time, and that changes to the payment structure have 
had some positive impact on low-volume hospital payments.
    The third regression analysis employed per discharge costs minus 
per discharge payments as the dependent variable and total discharges 
as an explanatory variable. The results of this analysis were similar 
to the other regression analyses: some evidence was provided for an 
adjustment with the FY 2001 and FY 2002 data, but not with the 
simulated FY 2005 data. In fact, the 2005 results suggest (with a 
positive intercept and positive coefficient on total discharges) that 
payments are greater than costs for all hospitals, including the low-
volume hospitals. Again, these results are consistent with the notion 
of previous changes to the payment structure having already had 
positive impacts on low-volume hospital payments.
    In conjunction with this third regression analysis, we also 
examined the straight-line statistical relationship between per 
discharge costs minus per discharge payments and total discharges. The 
results of this analysis indicate that this relationship is negative 
for the majority of hospitals with less than 200 discharges.
    The declining trend in the significance of the relationship between 
hospital costs and discharges and, in particular, the statistically 
insignificant relationship with the simulated FY 2005 results may 
provide some case for not making a low-volume adjustment. However, we 
are persuaded by the earlier data and the descriptive statistics that 
hospitals with less than 200 discharges have sufficiently higher costs 
relative to payments to justify an adjustment, although more modest in 
scope than the adjustment we proposed. Therefore, in this final rule we 
are providing a low-volume adjustment for hospitals with less than 200 
discharges. As noted above, the descriptive data do not reveal any 
pattern that could provide a formula for calculating an adjustment in 
relation to the number of discharges. However, the descriptive analysis 
of the data does indicate that, for a large majority of the hospitals 
with less than 200 discharges, the maximum adjustment of 25 percent 
would be appropriate. This is because, for example, the payment-to-cost 
ratios for more than 70 percent of these hospitals are 0.80 or less. 
The maximum adjustment of 25 percent would therefore leave most of 
these hospitals with payment-to-cost ratios still below 1.00. Because a 
large majority of hospitals with less than 200 discharges have payment-
to-cost ratios below 1.00, we are providing that hospitals with less 
than 200 total discharges in the most recent submitted cost report will 
receive an adjustment of 25 percent on each Medicare discharge. 
Therefore, we are revising Sec.  412.101(a) and (b) to implement these 
changes.
    We believe that, in the light of all the analysis that we have 
conducted, extending a 25 percent low-volume adjustment to all 
hospitals with less than 200 discharges is most consistent at this time 
with the statutory requirement to provide relief to low-volume 
hospitals where there is empirical evidence that higher incremental 
costs are associated with low numbers of discharges. However, we 
acknowledge that the empirical evidence does not provide robust support 
for this conclusion. Therefore, we will thoroughly reexamine the 
empirical evidence next year, and propose to modify or even eliminate 
the adjustment if the empirical evidence indicates that it is 
appropriate to do so at that time. Our analysis indicates that there 
are fewer than 100 hospitals with less than 200 total discharges. We 
are unable to determine how many of these hospitals also meet the 
requirement that a low-volume hospital be more than 25 road miles from 
the nearest subsection (d) hospital in order to qualify for the 
adjustment. However, the majority of the low-volume hospitals that we 
have been able to identify are located in urban areas. Some indications 
suggest that a number of these hospitals may be specialty hospitals, 
which are generally small institutions concentrating in one area of 
surgical practice, such as orthopedics or heart surgery. It is not 
entirely clear that it is the intent of this statutory provision to 
provide additional payment to this type of hospital. Others may be 
eligible to apply to become CAHs. We will monitor the numbers and types 
of hospitals that receive the low-volume adjustment as the 
intermediaries make determinations concerning which facilities meet all 
the requirements for the adjustment.

[[Page 49103]]

N. Medicare Geographic Classification Review Board (MGCRB) 
Reclassifications (Sec. Sec.  412.230, 412.234, and 412.236)

1. Background
    With the creation of the MGCRB, beginning in FY 1991, under section 
1886(d)(10) of the Act, hospitals could request reclassification from 
one geographic location to another for the purpose of using the other 
area's standardized amount for inpatient operating costs or the wage 
index value, or both (September 6, 1990 interim final rule with comment 
period (55 FR 36754), June 4, 1991 final rule with comment period (56 
FR 25458), and June 4, 1992 proposed rule (57 FR 23631)). Implementing 
regulations in Subpart L of Part 412 (Sec. Sec.  412.230 et seq.) set 
forth criteria and conditions for redesignations for purposes of the 
wage index or the average standardized amount, or both, from rural to 
urban, rural to rural, or from an urban area to another urban area, 
with special rules for SCHs and rural referral centers.
    Effective with reclassifications for FY 2003, section 
1886(d)(10)(D)(vi)(II) of the Act provides that the MGCRB must use the 
average of the 3 years of hourly wage data from the most recently 
published data for the hospital when evaluating a hospital's request 
for reclassification. The regulations at Sec.  412.230(e)(2)(ii) 
stipulate that the wage data are taken from the CMS hospital wage 
survey used to construct the wage index in effect for prospective 
payment purposes. To evaluate applications for wage index 
reclassifications for FY 2005, the MGCRB used the 3-year average hourly 
wages published in Table 2 of the August 1, 2003 IPPS final rule (68 FR 
50135). These average hourly wages are taken from data used to 
calculate the wage indexes for FY 2002, FY 2003, and FY 2004, based on 
cost reporting periods beginning during FY 1998, FY 1999, and FY 2000, 
respectively.
2. Standardized Amount Reclassification Provisions
    As specified in Sec.  412.230(d)(1), to be reclassified to an 
adjacent area for the purpose of using that area's standardized amount, 
an individual hospital seeking redesignation must demonstrate that its 
incurred costs are comparable to hospital costs in the adjacent area 
(that is, hospitals must demonstrate that their costs exceed their 
current payments by 75 percent of the additional payments they would 
receive through reclassification) and that it has the necessary close 
proximity to that area (that is, an urban hospital must be no more than 
15 miles and a rural hospital no more than 35 miles from the adjacent 
area; or at least 50 percent of the hospital's employees must reside in 
the adjacent area).
    Under section 402(b) of Public Law 108-7, Congress provided that 
all inpatient PPS hospitals be paid at the large urban average 
standardized amount for discharges occurring on or after April 1, 2003 
and before October 1, 2003. Under Public Law 108-89, Congress extended 
section 402(b) of Public Law 108-7 to discharges occurring through 
March 31, 2004. Section 401 of Public Law 108-173 further extended the 
equalization of urban and rural operating standardized payment amounts. 
(See section IV.B. of this preamble for a more detailed discussion.) 
Section 401 also equalized the Puerto Rico-specific urban and other 
area rates by requiring that the Puerto Rico-specific urban and other 
area rates be made retroactive to October 1, 2003. The Puerto Rico-
specific equalization of the urban and rural operating standardized 
amounts became effective for discharges beginning on or after April 1, 
2004.
    As a result of these legislative changes, the standardized amount 
reclassification criterion is no longer necessary or appropriate. 
Therefore, in the May 18, 2004 proposed rule (69 Fr 28288), we proposed 
to revise Sec.  412.230 and Sec.  412.234 to remove all standardized 
amount criteria provisions. We proposed to remove the provisions of 
Sec.  412.230(d) (existing paragraph (e) would be redesignated as 
paragraph (d)), and to remove Sec.  412.234(c) and (d)(2) (existing 
paragraph (d)(1) would be redesignated as paragraph (c) and revised), 
which contain the criterion requiring individual hospitals and urban 
hospital groups to demonstrate that their costs are more comparable to 
the average amount they would be paid if they were reclassified than 
the amount they would be paid under their current classification.
    With the implementation of the equalization of the national 
adjusted operating standardized amount for large urban and other areas 
provision of Public Law 108-173, we also proposed the following 
technical revisions to several sections under Subpart L of Part 412, 
which set forth the criteria and conditions for redesignations.
     We proposed to delete the cross-reference to ``Sec.  
412.230(d)(2)'' cited in Sec.  412.230(a)(4) and to make redesignation 
changes for the existing cross-reference changes to paragraph (e), 
which was proposed to be redesignated as paragraph (d).
     We proposed to delete Sec.  412.230(a)(5)(ii) (the 
existing paragraphs (a)(5)(iii), (a)(5)(iv), and (a)(5)(v) was proposed 
to be redesignated as paragraphs (a)(5)(ii), (a)(5)(iii), and 
(a)(5)(iv), respectively. Under existing Sec.  412.230(a)(5)(ii), we 
defined, for fiscal years 1997, 1998, and 2002, the limitation for 
redesignation for purposes of the standardized amount. Our policy has 
been that a hospital may not be redesignated for purposes of the 
standardized amount to an area that does not have a higher standardized 
amount than the standardized amount the hospital currently receives.
    Comment: Many commenters agreed with our proposed revisions. One 
commenter stated that, as a RRC approved for reclassification, the 
hospital should be allowed to retain its reclassification to the MSA 
with which it competes, as opposed to assignment to an area that does 
not include any other ``academic tertiary care hospitals''. The 
commenter also stated that by allowing hospitals to maintain 
reclassification to the selected MSA, CMS would be adhering to the 
original intent of the geographic reclassification provision. In 
addition, the commenter advises that through CMS's recognition that 
``rural hospital's continued financial viability is necessary in order 
to preserve access to needed services for Medicare beneficiaries in 
these providers' service areas'' and acknowledgement of the ``need to 
maintain access to tertiary care for Medicare beneficiaries in 
relatively isolated areas,'' rural referral centers and other similar 
teaching hospitals have in the past been insulated from the adverse 
financial consequences that result from changes in rules and 
regulations. In light of its concerns, the commenter recommends that 
CMS establish a separate exception for major rural teaching hospitals 
by revising Sec.  412.230 to add two provisions. The commenter believes 
that adoption of the suggested rules would allow a major teaching 
hospital to reclassify to an MSA where a substantial number of its 
competing hospitals are located within the same census region, thus 
affording them the flexibility to reclassify to an appropriate MSA.
    The first revision recommended by the commenter is to revise Sec.  
412.230(a)(4) to add a new title, ``Special Rule for Major Rural 
Teaching Hospital,'' to revise the text to read as follows:
    ``A hospital that is a major teaching hospital located in a rural 
area does not have to demonstrate a close proximity to the area to 
which it seeks redesignation. The hospital may seek redesignation to

[[Page 49104]]

a large urban area (as defined in Sec.  412.63(c)(6)) that includes 
five or more major teaching hospitals and that is located in the same 
census region as the applicant. For purposes of this section, a major 
teaching hospital is a hospital that (i) has a documented affiliation 
agreement with a medical school accredited by the Liaison Committee on 
Medical Education (``LCME''), and (ii) sponsors, or participates 
significantly in residency programs in Medicine, Surgery, Obstetrics/
Gynecology, Pediatrics, Family Practice, or Psychiatry.''
    The second recommendation is that Sec.  412.230(e)(4) be retitled, 
``Major Rural Teaching Hospital Exception, and revised to read ``If a 
hospital was a major teaching hospital in a rural area as of September 
30, 2004, it does not have to demonstrate that it meets the criterion 
set forth in paragraph (e)(1)(iii) of this section concerning its 
average hourly wage.''
    Response: We appreciate the opportunity to consider the revisions 
recommended by the commenter. In response to the commenter's concern 
regarding the proposal to assign reclassified hospitals to the nearest 
county, because we have addressed similar concerns in this final rule, 
we are not readdressing that response here. We encourage the commenter 
to refer to section III.H of this final rule for a more detailed 
response to this issue.
    With respect to the recommendation that Sec.  412.230 be revised to 
establish a separate exception for major rural teaching hospitals we 
are not persuaded that there is a need to establish the suggested 
exception for several reasons. First, this hospital, while defined as a 
major rural teaching hospital, is also a rural referral center. Given 
its status as a rural referral center, it is not subject to the 
proximity criteria because it already has a special status as a rural 
referral center. As a result of this special status the hospital has an 
advantage over other reclassifying hospitals in that it can utilize a 
larger radius in seeking reclassification opportunities (Sec.  
412.230(a)(3)). In addition, rural referral centers (and SCHs) may also 
reclassify to any MSA to which they qualify under Sec.  412.230(b). 
With respect to the hospitals ability to reclassify based on its status 
as a rural referral center, we believe these criteria provide adequate 
opportunity for reclassification.
    Second, while we understand the commenter's point about its 
competitors, we do not believe that this justifies establishing such 
broad exceptions as exempting a specific type of rural hospital from 
meeting the proximity requirement or from having to demonstrate that it 
meets any wage comparability test for reclassification purposes. 
Therefore, we are not adopting either of the recommended revisions.
    In the May 18, 2004 proposed rule, we proposed to delete existing 
Sec.  412.236. Section 412.236 sets forth the redesignation criteria 
for hospitals in a NECMA. Under the new CBSAs, OMB has defined the MSAs 
and Micropolitan areas in New England on the basis of counties. As 
discussed in section III.B. of the May 18, 2004 proposed rule, to 
maintain consistency in the definition of labor market areas between 
New England and the rest of the country, we proposed to use the New 
England MSAs under the new CBSA definition. Proposing to adopt the New 
England MSAs requires not only that we delete the reference to NECMAs 
in existing definitions, but that we also delete reference to criteria 
applicable to hospitals located in a NECMA that apply for 
reclassification. In keeping with the proposal to define labor market 
areas as MSAs, including those in New England, the criteria and 
conditions for redesignation set forth in Sec.  412.230 will be 
applicable to New England hospitals seeking to reclassify.
    In an effort to refine the reclassification guidelines, we 
established Sec. Sec.  412.234 and 412.236 in the existing guidelines 
to allow for reclassification of urban groups and New England groups, 
respectively (56 FR 25458). Under Sec.  412.232(a) and Sec.  
412.234(a), we set forth similar criteria for rural and urban hospitals 
to be reclassified as a group, respectively. Prior to the 
implementation of legislation to eliminate the differential in the 
standardized amount, urban county groups that were interested in 
applying for purposes of the wage index submitted applications to the 
MGCRB for consideration. Many urban county group applications were 
unable to reclassify solely because they failed to meet the 
standardized amount criteria. In light of the fact that the 
standardized amount criteria are no longer appropriate, we believe it 
would be appropriate to make an adjustment to the hospital's wage index 
by assigning, to hospitals that were unable to reclassify in 
applications for both FY 2004 and FY 2005, the wage index for the MSA 
requested in the FY 2004 and FY 2005 group application. Section 
1886(d)(5)(I)(i) of the Act provides the Secretary with broad authority 
to make adjustments and exceptions under the IPPS. Specifically, the 
section provides that the ``Secretary shall provide by regulation for 
such other exceptions and adjustments to such payment amounts under 
this subsection as the Secretary deems appropriate.'' Under this unique 
circumstance, in the May 18, 2004 proposed rule, we proposed to 
exercise the broad authority under section 1886(d)(5)(I)(i) of the Act, 
to make an exception to the assignment of wage index value for certain 
hospitals that failed to reclassify as a group under Sec.  412.234 for 
FY 2004 and FY 2005. Specifically, effective with discharges occurring 
during the 3-year period beginning October 1, 2004 through September 
30, 2007, any hospital whose urban county group application under Sec.  
412.234 would have been approved by the MGCRB but for the failure to 
meet the requirements in Sec.  412.234 (c), would be assigned the wage 
index for the MSA identified in the FY 2004 and FY 2005 group 
application (in cases where the group identified more than one 
preference, the hospital would be assigned the wage index that is most 
advantageous). In the proposed rule, we indicated that hospitals that 
wish to receive the wage index of the area identified in their FY 2004 
and FY 2005 group applications under this provision would need to only 
notify CMS in writing, at the address provided under the Addresses 
section of the proposed rule, before the close of the comment period. 
We further stated that the notification should only contain:
     The hospital's name and street address.
     The hospital's provider number.
     The name, title, and telephone number of a contact person 
for communications.
     The area (name and MSA number) identified in their FY 2005 
group application.
     Copies of any and all MGCRB decision notification letters 
for FY 2004 and FY 2005.
    Comment: Several commenters stated that the requirement that 
hospitals needed to have failed to reclassify as an urban group under 
Sec.  412.234 for ``FY 2004 and FY 2005'' is ``unreasonable and 
arbitrary.'' The commenters recommended that the criteria be modified 
to provide relief to all urban group hospitals that applied in FY 2005, 
irrespective of whether they applied for consideration in FY 2004.
    Response: We proposed to exercise the Secretary's authority to 
provide for ``exceptions and adjustments'' to payments under the IPPS. 
To assign a different wage index to a group of hospitals that were 
unable to reclassify because of a reclassification criterion that is no 
longer appropriate due to a statutory change. We do not believe it was 
``unreasonable and arbitrary'' to

[[Page 49105]]

restrict the extraordinary exercise of this exceptions authority to a 
small group of hospitals that had persisted in seeking reclassification 
as an urban county group over two consecutive years. Several hospitals 
notified us that they have met the requirements that we announced in 
the proposed rule. In this final rule, we are providing for these 
hospitals to be assigned to the wage index of the MSA identified in 
their FY 2004 and FY 2005 group applications.
    We do not agree with the commenters that we should extend this 
exception to all hospitals that were unable to reclassify as a group 
solely because they failed to meet the standardized amount criterion in 
either FY 2004 or FY 2005. However, we have been persuaded by the 
factual situations described by several commenters to extend this 
exception modestly beyond what we proposed. In several cases, some 
hospitals that were parties to group reclassification applications in 
FY 2004 or FY 2005 have been able to reclassify as individual 
hospitals, either through the regular MGCRB process or through the 
special one-time wage index appeal process under section 508 of MMA. In 
cases where a significant proportion of the group applicants have been 
able to reclassify otherwise, the remaining hospitals in the group can 
be placed at a significant competitive disadvantage. Therefore, we are 
providing in this final rule, to provide for an adjustment to the wage 
index of the hospitals that meet the following criteria:
     The hospital was part of an urban county group 
reclassification application for FY 2004 or FY 2005 that failed solely 
on the basis of the standardized amount criterion;
     At least one-third of the hospitals that had been parties 
to the urban county group reclassification application have 
subsequently been reclassified for FY 2005 either through the regular 
MGCRB reclassification process or the special one-time wage index 
appeal process under section 508 of MMA;
     The hospitals can demonstrate that the hospitals that have 
since reclassified to another area, have a wage index at least 10 
percent higher than the wage index of the MSA where the hospital is 
located.
    A hospital that meets all of these criteria will be assigned the 
wage index of the area identified in their FY 2004 or FY 2005 urban 
county group reclassification application.
    Hospitals will have 30 days after the publication date of this 
final rule to notify us of their eligibility on the basis of the 
criteria described above.
    Comment: Several commenters expressed concern that the proposed 
adoption of CBSA designations will require urban hospital groups 
seeking reclassification to be located within a CBSA, and to seek 
reclassification to another area within that CBSA (that is, another 
Metropolitan Division). They stated that if the proposal is implemented 
the opportunity for reclassification will not be available to urban 
hospital groups located in states such as California, Connecticut, New 
Hampshire, North Carolina, and New York. In other words, the proposal 
limits hospital group reclassification to hospitals located in CBSAs 
with multiple Metropolitan Divisions. Several of the commenters 
recommended that if CMS adopts the new CBSAs, it should modify the 
urban group proximity criteria to require that hospitals that are 
located in counties located in the same CSA under the new MSAs would 
meet the proximity requirement. Other commenters expanded on this 
recommendation by recommending that CMS ``grandfather'' counties where 
a group reclassification is in place and ``deem'' those counties as 
eligible for future group reclassifications to contiguous Metropolitan 
Divisions included in the same CSA.
    Response: Section 1886(d)(10)(D)(i)(II) of the Act requires the 
Secretary to publish guidelines ``for determining whether the county in 
which the hospital is located should be treated as being a part of a 
particular Metropolitan Statistical Area.'' The statute does not 
specify the particular criteria to be used, but instead confers broad 
authority on the Secretary in establishing guidelines. Under current 
regulations, hospitals seeking group reclassification must be located 
within a CMSA, and they may seek reclassification only to another area 
within that CMSA. As we stated in the May 18, 2004 proposed rule, we 
proposed to adopt the new CBSA designations as announced by OMB to 
define labor market areas, specifically, the MSA category as defined by 
the standards. Given that the implications of implementing the new 
labor market areas as proposed result in the unintended restriction of 
reclassifications for some urban county groups, we have been persuaded 
that there is a need to modify our urban group reclassification policy 
so as to preserve the reclassification opportunities for these urban 
county groups. Therefore, in this final rule we are modifying the urban 
county group reclassification criteria set forth in Sec.  412.234(a)(3) 
to specify that ``hospitals located in counties that are, under the new 
MSA designations, in the same CSA under the new MSA designations and 
the same CMSA under the former MSA designations qualify as meeting the 
proximity requirement for reclassification to the urban area to which 
they seek redesignation.'' We thank the commenters for bringing this 
issue to our attention.
3. Reclassification of Urban Rural Referral Centers
    Under existing regulations at Sec.  412.230(e)(3), rural referral 
centers (RRCs) (including hospitals that were ever RRCs) are exempt 
from one of the average hourly wage criteria that apply to other 
hospitals seeking reclassification. Specifically, an RRC is exempt from 
the requirement under Sec.  412.230(e)(1)(iii) that the hospital's 3-
year average hourly wage meet a threshold percentage in relation to the 
average hourly wage of all the hospitals in the area in which the 
hospital is located. These threshold percentages are 108 percent for 
hospitals located in urban areas, and 106 percent for hospitals located 
in rural areas. However, an RRC is not exempt from another threshold 
requirement, namely the requirement under Sec.  412.230(e)(1)(iv) that 
the hospital's 3-year average hourly wage must meet a threshold 
percentage of the 3-year average hourly wage of the hospitals located 
in the area to which the hospital seeks reclassification. As in the 
case of the first threshold, this threshold percentage is different for 
urban and rural hospitals. An urban hospital's 3-year average hourly 
wage must be at least 84 percent of the average hourly wage of the 
hospitals located in the area to which the hospital seeks 
reclassification, while a rural hospital's 3-year average hourly wage 
must be at least 82 percent of the average hourly wage of the hospitals 
located in the area to which the hospital seeks reclassification.
    In the May 18, 2004 proposed rule (69 FR 28289), we indicated that 
it had come to our attention that the requirement of Sec.  
412.230(e)(1)(iv) places RRCs located in urban areas on a different 
footing than RRCs located in rural areas. In some cases, urban RRCs 
that have been denied reclassification because they failed to meet the 
84-percent threshold would have been able to meet the 82-percent 
threshold that would have applied if they were located in a rural area. 
RRCs play a significant role in treating Medicare beneficiaries from 
rural areas, whether or not a particular RRC is physically located in a 
rural area or an urban area. Thus, we

[[Page 49106]]

believe that it would be more appropriate for all RRCs, whether they 
are actually located in urban or rural areas, to be treated on an equal 
basis with respect to the qualifications for geographic 
reclassification. Therefore, we proposed to revise Sec.  
412.230(e)(1)(iii) of the regulations to provide that RRCs, including 
RRCs located in urban areas, must meet the 82-percent threshold that 
applies to rural hospitals rather than the 84-percent threshold that 
applies to urban hospitals.
    Furthermore, we had become aware of at least one case in which an 
RRC was reclassified by the MGCRB for FY 2004, but upon applying to the 
MGCRB for FY 2005, was found to be ineligible for reclassification 
because its 3-year average hourly wage was now less than 84 percent of 
the hospitals located in the MSA to which it applied for 
reclassification. In this case, the hospital's 3-year average hourly 
wage was still greater than 82 percent of the MSA to which it had 
applied for reclassification. In such a case, we believe that it would 
be appropriate to make an accommodation for one year, so that the 
hospital is not subjected to the financial strain that may be caused by 
receiving a lower wage index for one year until it qualifies to apply 
for reclassification under the revised threshold criterion that we are 
proposing here. Therefore, we proposed that, in such a case, we would 
exercise our authority under section 1886(d)(5)(I)(i) of the Act to 
make an exception by assigning to the hospitals for one additional year 
the wage index that applied to the hospital in FY 2004 through FY 2005. 
We proposed to use this authority to provide, under this unique 
circumstance, special protection to a small number of hospitals that 
would otherwise be subject to a temporary, but serious, disadvantage. 
Specifically, we would assign an RRC that meets the conditions 
described above, the wage index value of the MSA to which it was 
reclassified by the MGCRB in FY 2004. In order to be eligible for this 
exception, the hospital may not qualify for any geographic 
reclassification for discharges effective October 1, 2004 (under the 
regular rules or the special one-time appeal provision). This 
assignment would be valid only for FY 2005, after which the hospital 
would have the opportunity to apply for reclassification under the 
proposed new threshold for all RRCs in the proposed rule.
    We proposed to revise proposed redesignated Sec.  412.230(d)(3) and 
add a new Sec.  412.64(j) to incorporate this proposal.
    Comment: A number of commenters expressed support for our proposal 
to revise Sec.  412.230(e)(1)(iii) of the regulations to require that 
the 3-year AHW of RRCs, including those located in urban areas, must be 
at least 82 percent of the AHW of the hospitals in the targeted area 
and to allow an urban RRC which did not qualify for reclassification 
for FY 2005 to receive the wage index of the MSA to which it was 
reclassified in FY 2004. One commenter, questioned the rationale for 
extending the reclassification exception for only 1 year while other 
hospitals qualifying for reclassification are reclassified for 3 fiscal 
years. The commenter stated that the proposed 1-year extension impairs 
the hospital's ability to make plans regarding financial status more 
than 1 year in advance. The commenter recommended that the exception 
allowing qualifying urban RRCs to be reclassified be applicable for 3 
years. Other commenters recommended that ``CMS continue to allow a 35 
mile proximity requirement for urban RRCs.''
    Response: We appreciate the commenter's support for our proposal 
that RRCs, including those located in urban areas must, meet the 82 
percent threshold that applies to rural hospitals rather than the 84 
percent threshold applicable to urban hospitals. The premise behind the 
development of the proposal and the exception was to put urban RRCs on 
an equal footing with RRCs located in rural areas. As the commenter 
noted, a 1-year exception, even in light of their ability to apply for 
reclassification in FY 2006, does not provide the equal footing they 
would realize if the exception were extended for 3 years. We agree with 
the commenter and, in this final rule, we are modifying the 
reclassification exception for urban RRCs and therefore will allow 
qualifying urban RRCs to be reclassified for 3 years.
    With respect to the recommendation that ``CMS continue to allow a 
35 mile proximity requirement for urban RRCs'', it is important to note 
that under the special access guidelines at Sec.  412.230(a)(3), we 
exempt RRCs and SCHs from the adjacency and proximity requirements in 
Sec.  412.230(a)(2), therefore, RRCs and SCHs are not required to 
demonstrate a close proximity to the area to which it seeks to 
reclassify.
    Comment: A commenter recommended that CMS consider, for purposes of 
geographic reclassification, designating as RRCs these urban hospitals 
that reflect characteristics similar to urban RRCs. The commenter 
advised that failure to do so will continue to ``significantly 
disadvantage'' urban hospitals that play a significant role in treating 
Medicare rural beneficiary populations. As one way to accomplish this, 
the commenter recommended that CMS designate any hospital as an urban 
RRC if it meets the criteria of Sec.  412.103(a)(3) as it relates to 
RRCs.
    Response: Under Medicare law, the location of a hospital can affect 
its payment as well as whether the facility qualifies for special 
treatment both for operating and capital payments. The commenter 
recommends that CMS designate urban hospitals that reflect 
characteristics similar to urban RRCs as RRCs and advises that Sec.  
412.103 provides the means to accomplish this. Section 401(a) of Public 
Law 106-113, which amended section 1886(d)(8) by adding paragraph (E), 
directs the Secretary to treat any subsection (d) hospital located in 
urban areas as being located in the rural area of the State in which it 
is located if the hospital files an application and if it meets one of 
the established criteria set forth on Sec.  412.103. (We provided a 
detailed discussion of this policy in the August 1, 2000 interim final 
rule with comment period (65 FR 47029) and the August 1, 2001 final 
rule (FR 66 39884).) Because there are several provisions of the Social 
Security Act that provide procedures under which a hospital can apply 
for reclassification from one geographic area to another, we still do 
not believe, as we stated in the aforementioned final rules, that there 
is a need to specify further qualifying criteria for reclassifications 
governed by Sec.  412.103 guidelines. Therefore, as discussed above, we 
are adopting the change requiring all RRCs, regardless of location in 
an urban or rural area, to meet the 82-percent threshold. In addition, 
we are modifying our proposal for those RRCs that were reclassified to 
an urban area in FY 2004 and that failed to be reclassified in FY 2005 
in order to provide a reclassification for 3 years using our authority 
under section 1886(d)(5)(i)(I) of the Act.
4. Special Circumstances of Sole Community Hospitals (SCHs) in Low 
Population Density States
    Medicare program policy has long provided special treatment for 
hospitals in rural areas. For many years, rural hospitals have 
experienced lower margins than other hospitals, and Congress has 
created several special measures to address the unique issues of 
hospitals in rural areas. For example, Congress created the CAH program 
in 1997 to ensure that beneficiaries in isolated areas had access to 
emergency

[[Page 49107]]

services and certain essential inpatient services. To qualify for CAH 
designation, a hospital must be located more than 35 miles from the 
nearest similar hospital and have an average length of stay not 
exceeding 4 days. A CAH must provide 24-hour emergency care services 
and have no more than 25 acute care beds. CAHs are currently paid 101 
percent of their current Medicare allowable costs for inpatient and 
outpatient services. Similarly, the SCH program has long served to 
maintain access to needed health services for beneficiaries in isolated 
communities. SCHs are paid based on whichever of the following rates 
yields the greatest aggregate payment: the Federal national rate; the 
updated hospital-specific rate based on FY 1982 costs per discharge; 
the updated hospital-specific rate based on FY 1987 costs per 
discharge; or the updated hospital-specific rate based on FY 1996 costs 
per discharge.
    Many rural hospitals have taken advantage of the opportunity to 
participate in the CAH program in recent years. We expect the number of 
hospitals to increase because of the changes made to the CAH program 
under recently enacted Public Law 108-173 (for example, increasing the 
reasonable cost payment rate from 100 percent to 101 percent and 
increasing the qualifying bed size limitation from 15 to 25). Because 
CAHs are paid on the basis of their reasonable costs, the wage index is 
not a factor in their payments, and geographic reclassification is thus 
not an issue for these hospitals. However, for many rural hospitals 
that cannot qualify for CAH status, the wage index remains an important 
factor in their payment, even in the case of SCHs paid on their 
hospital-specific rate, for which the only impact of the wage index may 
be on their inpatient capital and outpatient payments. The regulations 
governing reclassifications by the MGCRB provide special treatment for 
SCHs by exempting them from the normal rules that require hospitals to 
demonstrate a close proximity (15 miles in the case of urban hospitals; 
35 miles for rural hospitals), and allowing these hospitals to 
reclassify to the urban area or the rural area that is the closest to 
the hospital.
    Wage index assignment is an especially pressing issue for hospitals 
in States with low population densities. In such States, employees are 
likely to commute greater distances to work. More distant areas are 
thus likely to compete for labor than is the case in more densely 
populated States. Because of this concern, and the program's 
longstanding recognition of these hospitals, we exercised our 
discretion in implementing the special one-time wage index 
reclassification appeal provision of section 508 of Public Law 108-173 
to provide special consideration for SCHs in States with fewer than 10 
people per square mile, based on 2000 census data (Alaska, Montana, 
North Dakota, South Dakota, and Wyoming). Specifically, we provided 
that SCHs in such a State could reclassify to an MSA within its State. 
More than 20 SCHs in those States were able to reclassify under this 
provision.
    However, a number of SCHs from those States were precluded from 
reclassifying under the terms of section 508. In the May 18, 2004 
proposed rule (69 FR 28289), we indicated that we were concerned that 
these hospitals could now be placed at a serious disadvantage in 
comparison to other SCHs in their States and regions. Under the 
authority of section 1886(d)(5)(I)(i) of the Act, we proposed to 
provide, under these unique and temporary circumstances, special 
protection to a small number of hospitals that would otherwise be 
subject to a temporary, but serious, disadvantage. Specifically, we 
proposed to allow an SCH in one of the States with fewer than 10 people 
per square mile (Alaska, Montana, North Dakota, South Dakota, and 
Wyoming) to adopt the wage index of another geographic area within its 
State for 3 years.
    Under the proposal, such wage index assignments would become 
effective for FY 2005 through FY 2007. Because the wage index 
assignments would be made in order to remedy a temporary disadvantage, 
the assignments would be for the 3-year period only and would not be 
available thereafter. In order to receive the wage index of another 
area under this proposal, we proposed that a SCH may not qualify for 
reclassification (under the regular rules or the special one-time 
appeal provision) effective for discharges on or after October 1, 2004. 
SCHs in the identified States will not be required to meet proximity or 
access requirements similar to those required for reclassification in 
order to qualify for change in wage index under this provision. Under 
this proposal, SCHs that wished to receive the wage index of another 
area within their State under this provision needed only to notify CMS 
in writing, at the address in the ``Addresses'' section provided for 
comments on the proposed rule, before the close of the comment period. 
The notification should have contained:
     The hospital's name and street address.
     The hospital's provider number.
     The name, title, and telephone number of a contact person 
for communications.
     A statement certifying the SCH status.
     The name of the area within the State whose wage index the 
hospital wishes to adopt.
    Comment: Many commenters expressed their support of our proposal 
and providing us with notification that they meet the conditions for 
receiving this exception.
    Response: We will adjust the wage indexes of these hospitals 
accordingly. We have listed these hospitals, and their wage index 
assignments, in Table 9B of the Addendum to this final rule.
    Comment: One commenter expressed support for the provision and 
noted that it would have qualified for the exception, except that it 
had been designated as a CAH effective July 1, 2004. This hospital 
requested that we provide the exception retroactively back to April 1, 
2004, the date on which the commenter would have begun to receive an 
adjustment under section 508 of the MMA if it had been able to qualify.
    Response: We do not believe that it would be appropriate to provide 
this adjustment retroactively. Doing so runs counter to the basis for 
payment in a prospective payment system. We would note that the 
hospital is now receiving payment on a favorable basis at 101 percent 
of cost as a CAH.
    Comment: One commenter expressed concern regarding CMS's proposal 
to allow an SCH located in one of 5 identified low-population density 
States to adopt the wage index of another geographic area within its 
State for 3 years. The commenter objected to the proposal on the basis 
that because CMS is not proposing a broader exception, hospitals such 
as the SCHs and other hospitals who met criteria under section 508 in 
the commenter's State, are being disadvantaged given the fact that 
hospitals in neighboring States will be reclassified.
    Response: As we noted in the proposed rule, we believe that given 
the pressing issues associated with wage index assignment issues for 
hospitals in States with low population densities, the likelihood that, 
in such States, employees are likely to commute greater distances to 
work, and the fact that more distant areas are thus likely to compete 
for labor than is the case in more densely populated States. Given 
these circumstances, we continue to believe that such an exception for 
these SCHs is warranted. Therefore, in this final rule, we are 
finalizing the special exception provision, as proposed, by adjusting 
the wage indexes of those

[[Page 49108]]

SCHs that provided notification that they met the conditions for 
receiving this exception.
5. Possible Reclassifications for Dominant Hospitals and Hospitals in 
Single-Hospital MSAs
    In the May 18, 2004 proposed rule (69 FR 28290), we indicated that 
representatives of individual hospitals had expressed concern about the 
special circumstances of dominant hospitals and hospitals in single-
hospital MSAs in relation to the wage index and the rules governing 
geographic reclassification. The term ``dominant hospital'' generally 
refers to a hospital that pays a substantial proportion of all the 
wages paid by hospitals geographically located in the hospital's area. 
A dominant hospital necessarily has a preponderate influence on the 
wage index calculation for the area in which it is located. As a 
result, dominant hospitals find it difficult to meet the threshold 
requirements for wage index reclassification; for example, the 
requirement that an urban hospital's average hourly wage is at least 
108 percent of the average hourly wage of hospitals in the area in 
which the hospital is located (Sec.  412.230(e)(1)(iii)(B)). Indeed, a 
dominant hospital would find it difficult to meet any threshold based 
on the ratio of the hospital's average hourly wage to the average 
hourly wage of hospitals in the area, unless the dominant hospital's 
wage data were removed from the denominator for purposes of the 
comparison. Dominant hospitals have argued that this places them in an 
unfair situation. While the lower wages of other, smaller hospitals in 
the area can still have the effect of holding down their wage index, 
their dominant position makes it difficult, or even impossible, to 
reclassify to another area where the wage index may more closely 
reflect their costs.
    Hospitals in single-hospital MSAs face a situation that is similar 
in certain respects, but quite different in others. By definition, the 
wage index for the sole hospital in an MSA is based completely on that 
hospital's wage data. Such a hospital receives, in effect, its own 
unique wage index, reflecting the hospital's exact position in relation 
to the national average hourly wage. As a result, these hospitals 
cannot qualify for reclassification, unless they are exempt from the 
wage threshold requirements due to rural referral center status. By 
definition, the ratio of such a hospital's average hourly wages to the 
area average hourly wage is always 100 percent, and these hospitals 
thus cannot meet either the 108 percent threshold for urban hospitals 
or the 106 percent threshold for rural hospitals (Sec.  
412.230(e)(1)(iii)(B)). Unlike dominant hospitals, hospitals in single-
hospital MSAs cannot argue that they are disadvantaged by the effect 
that lower wage hospitals can have on the area wage index. However, 
these hospitals have contended that they are sometimes in the position 
of competing for labor with hospitals in nearby MSAs with higher wage 
indexes. Under these circumstances, these hospitals cannot reclassify 
to the higher wage index area even if they meet the relevant distance 
requirements. These hospitals also contend that they cannot afford to 
compete with hospitals that are paid under a higher wage index, and the 
3-year lag in the data used to compute the wage index can place them in 
a permanent position of playing catch up. On the other hand, it is also 
true that such a disadvantage may be only temporary because increasing 
wages may eventually equalize wage index values despite the temporary 
financial disadvantage that would accrue to these hospitals during the 
3-year lag period.
    In the proposed rule, we invited comment on the concerns raised by 
hospitals in these two situations and on possible methods of addressing 
these concerns. We indicated that a number of measures might be 
considered to address the concerns of these hospitals. In the case of 
dominant hospitals, the threshold requirements for reclassification 
could be revised to provide that a hospital's average hourly wage is at 
least 108 percent (in the case of urban hospitals) or 106 percent (in 
the case of rural hospitals) of the average hourly wages of all other 
hospitals in the area. Removing a dominant hospital's wages from the 
denominator of the ratio would remove the current disadvantage imposed 
by their dominant status, and make it more realistic for a dominant 
hospital to meet the threshold requirement. An existing provision under 
Sec.  412.230(e)(4) provides this treatment for certain dominant 
hospitals, specifically those that were approved for reclassification 
each year from 1992 through 1997. We could develop a parallel provision 
that applies to dominant hospitals generally. The use of this revised 
ratio could be restricted to the special circumstances of dominant 
hospitals, or extended to all hospitals. We could also adopt a revised 
threshold for dominant hospitals, as we did in the notice setting forth 
the criteria for reclassification under the one-time wage index appeal 
provision of section 508 of Public Law 108-173 (69 FR 7342). Consistent 
with the criteria from that notice, a dominant hospital might be 
defined for this purpose as a hospital that pays at least 40 percent of 
all the wages paid by hospitals geographically located in the 
hospital's area. We indicated that we were considering adopting one of 
these measurers in the final rule, and invited comments on the 
advisability of doing so.
    In the case of hospitals in single-hospital MSAs, we cited one new 
provision that we had proposed to implement in this proposed rule that 
might address some of their concerns (see section III.G.3.2. of the 
preamble of the proposed rule). Section 505 of Public Law 108-173 
provides for a new wage index adjustment for hospitals in lower wage 
areas in cases where significant numbers of hospital workers commute 
from the lower wage area to higher wage areas nearby. The statute 
requires that at least 10 percent of the hospital workers in a county 
must be commuting to a higher wage area, or areas, in order for the 
hospitals in the county to receive the adjustment. The adjustment 
formula provides for an increase to the wage index for hospitals in the 
county, based on the differences between the wage index that applies to 
the county and the higher wage indexes of nearby areas, in proportion 
to the percentages of hospital workers commuting to the higher wage 
index areas. To the degree that hospitals in single-hospital MSAs 
experience disadvantages in competing for hospital workers with 
hospitals in higher wage index areas, we expect that the counties in 
which these hospitals are located would qualify for this adjustment. We 
also indicated that we were actively considering whether to address the 
concerns of these hospitals more directly. At the same time, we 
intended to analyze the extent to which this provision would alleviate 
the concerns of these hospitals. We welcomed comments on the special 
circumstances of hospitals in single-hospital MSAs and whether their 
special circumstances should be addressed by revisions to the 
regulations governing reclassification, or other measures.
    Comment: A number of commenters expressed support for adopting a 
provision to address the concerns of dominant hospitals. Several 
commenters supported defining a dominant hospital as a hospital that 
pays at least 40 percent of all wages paid by hospitals geographically 
located in the hospital's MSA, and providing that any hospital so 
defined should be ``given the same reclassification options as rural 
and urban rural referral centers.'' One of these commenters

[[Page 49109]]

further recommended that dominant hospitals should be entitled to the 
full implementation of the occupational mix adjustment. Other 
commenters recommended that we consider revising Sec.  412.230(e)(4) to 
eliminate the requirement that the applicant hospital ``was approved 
for redesignation * * * for each year from fiscal year 1992 through 
fiscal year 1997.'' The effect of this revision would be that the test 
for dominant hospitals would be that the three-year AHW be at least 108 
percent (106 percent for rural hospitals) of the three-year AHW of all 
the other hospitals in the area. Other commenters supported the idea 
that, for purposes of determining the AHW of the area where the 
hospital is located, the 108/106 percent test should be revised for all 
hospitals so that applicant hospitals are required to compare their 
AHWs to all the other hospitals in the area. One of these commenters 
argued that including a hospital's own AHW in the equation does not 
support the underlying purpose of the 108/106 percent test, which is 
for the hospital to demonstrate that its wage costs are 
disproportionately high when compared to its neighbors. Other 
commenters recommended that we exempt dominant hospitals altogether 
from the 108/106 percent threshold requirement or consider a new 
threshold requirement for reclassification that would be at least 110 
percent of all other hospitals in the MSA. One commenter recommended 
that CMS consider establishing criteria that would give special 
consideration to these hospitals by, for example, allowing a dominant 
hospital to reclassify to MSAs that are ``less than 55 miles'' from the 
MSA where the hospital is located. Finally, some commenters expressed 
opposition or hesitation about providing any special provision to 
address the concerns of the dominant hospitals. MedPAC, for example, 
suggested that the new out-commuting adjustment is a promising 
approach, observing that the blended formulation of that adjustment, 
which generally yields a lower wage index than traditional 
reclassification, might be appropriate since these hospitals have an 
above-average degree of influence on the wage indexes of the areas 
where they are located.
    Response: We are persuaded that it is equitable, as a matter of 
general policy for all hospitals, to revise the wage comparison formula 
for all hospitals in the manner recommended by some of the commenters. 
Specifically, in this final rule we are revising the regulations at 
Sec.  412.230(e)(1)(iii)(B) to provide that, in order to qualify for 
reclassification, the hospital's average hourly wage is at least 106 
percent (in the case of a hospital located in a rural area) or at least 
108 percent (in the case of a hospital located in an urban area), of 
the average hourly wage of all other hospitals in the area in which the 
hospital is located. While this revision addresses, at least in part, 
the concerns of the dominant hospitals, and while it will allow some 
dominant hospitals to qualify for reclassification, this is not the 
primary consideration in favor of this revision to the regulations. The 
predominant consideration is rather the general point that the purpose 
of the comparison test is to distinguish whether a hospital is 
sufficiently different in terms of the wages it pays from other 
hospitals in its geographic region. Defining the ratio in terms of all 
other hospitals in the area captures the appropriate comparison more 
precisely. Therefore, we are also not adopting any of the other 
alternatives suggested.
    Comment: A number of commenters also expressed support for adopting 
a provision to address the concerns of hospitals that are the only 
hospitals in an MSA. Several commenters recommended that CMS consider 
exempting hospitals in single hospital MSAs from the 108/106 percent 
threshold requirement. One commenter suggested that CMS consider using 
its discretion to either eliminate or significantly reduce the number 
of single hospital MSAs by, merging into the nearest MSA only those 
single hospital MSAs whose hospitals meet the 84 percent threshold 
requirement, merging all single hospital MSAs into the closest MSA, for 
purposes of the wage index, or allowing hospitals in single hospital 
MSAs to reclassify to the closest MSA if they satisfy all of the RRC 
criteria except for the rural location requirement. One commenter 
recommends that CMS exercise its discretion to implement a 4-year 
transition period for hospitals in single hospital MSAs. The transition 
period would, in addition to protecting these hospitals from financial 
hardship, allow them the opportunity to equalize their wage index 
without experiencing any temporary adverse financial impact. The 
commenter further suggests that during the transition period these 
hospitals should be afforded the same exemption as RRCs under Sec.  
412.230(e)(3). The commenter argued that, by allowing these providers 
to be paid at a higher wage index they will, in turn, be in a better 
position to raise wage levels and compete with neighboring urban 
hospitals. As in the case of the dominant hospitals, MedPAC suggested 
that the new out-commuting adjustment is a promising approach for 
addressing this issue.
    Response: We have decided not to adopt any of the policy changes 
proposed by commenters concerning the issue of single hospital MSAs at 
this time. We agree with MedPAC that the new out-commuting provision is 
a promising vehicle for addressing the concerns raised by hospitals in 
single-hospital MSAs. To the degree that hospitals in single-hospital 
MSAs experience disadvantages in competing for hospital workers with 
hospitals in higher wage index areas, we would expect that the counties 
in which these hospitals are located would exhibit rates of commuting 
by hospital workers to the higher wage index areas that might meet the 
threshold for receiving the adjustment. We also agree with MedPAC that 
the adjustment under this provision, which generally yields a lower 
wage index than traditional reclassification, may be appropriate since 
the wage indexes for these hospitals are calculated solely on the basis 
of the hospitals' own wage data. Although certain of the hospitals in 
single-hospital MSAs that have contacted us about their situations do 
not qualify for the adjustment this year, we believe that it is 
appropriate to gain more experience with the workings of this new 
provision before we adopt any policy revisions designed to address 
separately reclassification by these hospitals.
6. Special Circumstances of Hospitals in All-Urban States
    Section 4410 of Public Law 105-33 (BBA) provides that, for the 
purposes of section 1886(d)(3)(E) of the Act, for discharges occurring 
on or after October 1, 1997, the area wage index applicable to any 
hospital that is located in an urban area of a State may not be less 
than the area wage index applicable to hospitals located in rural areas 
in the State. This provision, commonly referred to as the ``rural 
floor,'' affects the payments received by 150 hospitals in 49 MSAs in 
FY 2004. For these 150 hospitals, the applicable wage index and overall 
payment amounts under the IPPS are higher than they would be if their 
wage indexes were computed solely on the basis of the wage data from 
their MSAs. The wage index floor is applied in a budget neutral manner, 
so that aggregate IPPS payments each year are not greater or less than 
those that would have been made in the absence of this provision.
    In the May 18, 2004 proposed rule (69 FR 28291), we discussed the 
fact that the ``rural floor'' under section 4410 of

[[Page 49110]]

Public Law 105-33 does not apply in the two States that have no rural 
areas under the labor market definitions that apply within the IPPS. In 
the past, hospitals in those two States had commented that the absence 
of a rural floor disadvantages them for wage index purposes compared to 
hospitals in States where the ``rural floor'' provision can apply. 
Specifically, some hospitals contend that they would have higher wage 
indexes, and higher payments overall, if there were a rural area in 
their State to set a floor under the wage indexes within the State.
    In the proposed rule, we indicated that we were considering whether 
it would be appropriate to adopt some measure to address the concerns 
of these hospitals. For example, we indicated that we were examining 
the ratios between the lowest and highest wage index values in States 
where the ``rural floor'' affects the wage indexes of some hospitals. 
We further indicated that we might consider employing the average ratio 
of highest-to-lowest wage indexes in those States to set an imputed 
``rural floor'' for all-urban States. For example, assume the average 
``lowest-to-highest'' ratio of States with rural floors is 0.9500. 
Assume further that the lowest wage index in an all-urban State is 
1.0000, and the highest is 1.1000. The ``lowest-to-highest'' ratio for 
that State is 0.9091. If we apply the average ``lowest-to-highest'' 
ratio to the highest wage index in the all-urban State, we would 
multiply 0.9500 by 1.1000, which yields 1.0450. The imputed analogue to 
the ``rural floor'' for the all-urban State would then be 1.0450. Any 
hospital with a regular wage index value less than 1.0450 would then 
receive the new imputed floor.
    In the proposed rule, we welcomed comments on the position of 
hospitals in all-urban States relative to hospitals that receive the 
``rural floor'' in other States. We also welcomed comments on whether 
it would be advisable to adopt an imputed floor measure or some 
alternative measure to address the concerns of hospitals in these 
States. We noted that, in order to be consistent with the statutory 
provision establishing the rural floor, we would apply any such measure 
in budget neutral manner, that is, we would adjust the standardized 
amount so that aggregate IPPS payments each year are not greater or 
less than those that would have been made in the absence of this 
provision.
    Comment: We received a number of comments in favor of proceeding 
with a provision to establish an imputed floor in all-urban states. 
These commenters asserted that the absence of a rural floor does 
disadvantage them for wage index purposes compared to hospitals in 
States where the ``rural floor'' provision can apply.
    While generally supportive of our proposal, these commenters 
offered alternative suggestions to the example we had provided about 
how the formula for determining such an imputed floor might work. For 
example, one commenter suggested using the median, instead of the 
average, ratio of the highest to lowest wage indexes in the States 
where a rural floor could potentially affect the wage indexes of some 
hospitals. This formulation, according to the commenter, would provide 
more predictability and would be subject to less distortion as 
situations change in the States with rural floors. Other commenters 
recommended expanding any provision for an imputed rural floor to at 
least one additional State, which has geographic rural areas, but no 
hospitals actually classified as rural.
    Response: We agree with the commenters that any provision to 
provide an imputed floor for States without rural areas should also 
apply to any State which has geographic rural areas but no hospitals 
actually classified as rural. Using this definition, there are three 
States that can be considered all-urban for the purposes of this 
provision. As discussed in more detail below, we also agree with the 
commenters that a variation of the methodology that we suggested in the 
final rule is more appropriate for determining the level of the imputed 
floor. Specifically, we believe that the most appropriate methodology 
is to compare the average ratio of lowest-to highest wage indexes of 
the three all-urban States to the ratio of the lowest-to-highest wage 
index of each of those States individually. For each State, we would 
base the imputed floor on the higher of these two ratios. Therefore, in 
this final rule, we are revising the regulations at Sec.  412.64(h) to 
describe the methodology for computing the minimum wage index value for 
all-urban states and to define an all-urban State.
    Comment: Some commenters objected to the establishment of an 
imputed floor in all-urban States. These commenters contended that any 
special provision for urban-only States should be subject to 
legislative action.
    Response: Although we appreciate the commenters' observation, we 
would note that the Secretary has broad authority under section 
1886(d)(3)(E) of the Act to ``adjust the proportion (as estimated by 
the Secretary from time to time) of hospitals' costs which are 
attributable to wages and wage-related costs of the DRG prospective 
payment rates *-*-* for area differences in hospital wage levels by a 
factor (established by the Secretary) * * *'' (Emphasis added). 
Therefore, we believe that we do have the discretion to adopt a policy 
that would adjust wage areas in the stated manner.
    Comment: Some commenters also pointed out that other States, 
including those with rural floors, face various inequities in the wage 
index system, and recommended that a more general solution would be 
preferable to piecemeal approaches such as an imputed floor for only a 
few States. Finally, some commenters objected because they were not 
persuaded that the problem described was sufficiently serious to 
justify a special protection for a few States that would require a 
reduction in the rates paid to all hospitals.
    Response: We appreciate the reservations expressed by the 
commenters opposing the policy that we discussed in the May 18, 2004 
proposed rule. While we are adopting a policy that establishes an 
imputed floor for the three all-urban States in this final rule, we are 
limiting this policy change to 3 years (that is, FYs 2005, 2006, and 
2007). During that time, we will monitor the operation of this policy 
in these all urban States and determine whether to make additional 
changes to the policy or eliminate it.
    In this final rule, we are adopting a variation of the policy that 
we discussed in the May 18, 2004 proposed rule. We note first that 
there are similarities among the three States that are not impacted by 
the rural floor. Obviously, they are urban States. In addition, each of 
the three States has one predominant labor market area. That, in turn, 
forces hospitals that are not located in the predominant labor market 
area to compete for labor with hospitals that are located in that area. 
However, because there is no ``floor'' to protect those hospitals not 
located in the predominant labor market area from facing continued 
declines in their wage index, it becomes increasingly difficult for 
those hospitals to continue to compete for labor. In the BBA, Congress 
spoke of an ``anomaly'' in States where hospitals located in urban 
areas had a wage index that was below the wage index applicable for 
hospitals located in rural areas. (See H.R. Rep. No. 149, 105th Cong., 
1st Sess. At 1305.) We think it is also an anomaly that hospitals in 
all-urban States with predominant labor market areas do not have any 
type of protection, or ``floor,'' from declines in their wage index. 
Therefore, we are adopting the logic similar to that

[[Page 49111]]

articulated by Congress in the BBA and are adopting an imputed rural 
policy for a 3-year period.
    In the proposed rule, we suggested a policy option that would have 
developed a ratio of the lowest-to-highest wage index for all States 
that had a rural wage index and therefore, had the potential to be 
impacted by the rural floor. Based on the comments that we have 
received, and based on the similarities between the three all-urban 
States, we think that it is more appropriate to compare the three 
individual all-urban States to those three States as a class. Under the 
proposed rule, we suggested that we would analyze the average ratio of 
the lowest-to-highest wage indexes of all States potentially affected 
by the rural floor. Under the policy we are adopting in this final 
rule, we compare the average ratio of the lowest-to-highest wage 
indexes (occupational mix-adjusted, both prereclassification and 
postreclassification) of the three all-urban States to the ratio of the 
lowest-to-highest wage index (occupational-mix adjusted, both 
prereclassification and postreclassification) of each of those States 
individually. We note that in doing so, we consider only the wage 
indexes of all-urban States in the mainland United States. The 
Commonwealth of Puerto Rico is also an urban area that does not benefit 
from the rural floor because there are no hospitals located in rural 
areas in Puerto Rico. However, there are sufficient differences between 
Puerto Rico and the three mainland all-urban states. For example, the 
highest area wage index in the Commonwealth of Puerto Rico is 0.5230; 
by contrast, the lowest wage index in the three mainland all-urban 
States is almost twice as high. Moreover, the lowest-to-highest ratio 
of wage indexes in Puerto Rico is significantly less than the lowest-
to-highest ratio of wage indexes of any State on the mainland United 
States. Moreover, Puerto Rico hospitals are paid on a blended Federal/
Commonwealth-specific rate. We therefore, do not believe that it is 
appropriate to consider the wage indexes of Puerto Rico hospitals in 
the development of this policy.
    Under our final rule, we would then take the higher of those two 
numbers (that is, the State-specific ratio and the average ratio of the 
three all-urban States) and multiply it by the highest area wage index 
applicable in a State (again, we would look at the postreclassification 
wage indexes). The product is the imputed ``floor,'' below which no 
wage index in the State could fall. In order to account for the fact 
that some hospitals receive a blended wage index (see section 
III.B.3.d. of this final rule), we computed these ratios, and the 
corresponding imputed floors, separately using the old labor market 
definitions and the new labor market definitions. We then compared the 
blended wage indexes (that is, the wage index determined on the basis 
of the old labor market areas, and the wage index determined on the 
basis of the new labor market areas) separately with the corresponding 
imputed floors.
    As a result, hospitals receiving a blended wage index could be at 
the floor for neither wage index, for their old labor market wage index 
alone, for their new labor market wage index alone, or for both wage 
indexes. After this determination, we blended the two wage indexes 
(including the effects of the imputed floor on each side): 50 percent 
of the wage index determined on the basis of the old labor market areas 
(whether at the floor level or above), and 50 percent of the wage index 
determined on the basis of the new labor market areas (whether at the 
floor level or above).
7. Geographic Reclassifications for SNFs
    Several SNFs indicated support for our proposal to implement the 
new CBSA designations for IPPS hospitals. They also commented that our 
continued delay in implementing a reclassification system for SNFs, as 
authorized by section 315 of BIPA, places Medicare SNFs at an unfair 
disadvantage in competing with reclassified hospitals for professional 
staff.
    We appreciate the commenters' support for our proposed adoption of 
the new CBSA designations for IPPS hospitals. With respect to the 
comment regarding the implementation of a SNF reclassification system, 
section 1888(e)(4)(G)(ii) of the Act requires that we adjust the 
Federal rates for SNFs to account for differences in area wage levels 
using a wage index that we find appropriate. Since the inception of a 
PPS for SNFs, we have used hospital wage data in developing a wage 
index to be applied to SNFs. Section 315 of the BIPA does authorize us 
to establish a reclassification system for SNFs, similar to the 
hospital methodology. However, the statute makes this change contingent 
upon the collection of the data necessary to establish an area wage 
index for SNFs based on SNF wage data. As part of our ongoing program 
analysis, we periodically reevaluate the suitability of establishing an 
SNF-specific wage index and a provider reclassification methodology. 
However, we note that, in order to effect such changes, we must first 
be able to provide reasonable assurance as to the accuracy of the 
underlying cost report data and the equitable distribution of funds 
under the new methodology.

O. Payment for Direct Graduate Medical Education (Existing Sec.  
413.86)

1. Background
    Section 1886(h) of the Act, as added by section 9202 of the 
Consolidated Omnibus Budget Reconciliation Act (COBRA) of 1985 (Pub. L. 
99-272) and implemented in regulations at existing Sec.  413.86, 
establishes a methodology for determining payments to hospitals for the 
costs of approved GME programs. Section 1886(h)(2) of the Act, as added 
by COBRA, sets forth a payment methodology for the determination of a 
hospital-specific, base-period per resident amount (PRA) that is 
calculated by dividing a hospital's allowable costs of GME for a base 
period by its number of residents in the base period. The base period 
is, for most hospitals, the hospital's cost reporting period beginning 
in FY 1984 (that is, the period of October 1, 1983 through September 
30, 1984). The PRA is multiplied by the weighted number of full-time 
equivalent (FTE) residents working in all areas of the hospital (and 
nonhospital sites, when applicable), and the hospital's Medicare share 
of total inpatient days to determine Medicare's direct GME payments. In 
addition, as specified in section 1886(h)(2)(D)(ii) of the Act, for 
cost reporting periods beginning on or after October 1, 1993, through 
September 30, 1995, each hospital-specific PRA for the previous cost 
reporting period is not updated for inflation for any FTE residents who 
are not either a primary care or an obstetrics and gynecology resident. 
As a result, hospitals that train primary care and obstetrics and 
gynecology residents, as well as nonprimary care residents in FY 1994 
or FY 1995, have two separate PRAs: one for primary care and obstetrics 
and gynecology and one for nonprimary care.
    The BBRA (Pub. L. 106-113) amended section 1886(h)(2) of the Act to 
establish a methodology for the use of a national average PRA in 
computing direct GME payments for cost reporting periods beginning on 
or after October 1, 2000, and on or before September 30, 2005. The BBRA 
established a ``floor'' for hospital-specific PRAs equal to 70 percent 
of the locality-adjusted national average PRA. In addition, the BBRA 
established a ``ceiling'' that limited the annual adjustment to a 
hospital-specific PRA if the PRA exceeded 140 percent of the locality-
adjusted national average

[[Page 49112]]

PRA. Section 511 of the BIPA (Pub. L. 106-554) increased the floor 
established by the BBRA to equal 85 percent of the locality-adjusted 
national average PRA. Existing regulations at Sec.  413.86(e)(4) 
specify that, for purposes of calculating direct GME payments, each 
hospital-specific PRA is compared to the floor and the ceiling to 
determine whether a hospital-specific PRA should be revised.
    Section 1886(h)(4)(F) of the Act established caps on the number of 
allopathic and osteopathic residents that hospitals may count for 
purposes of calculating direct GME payments. For most hospitals, the 
caps were the number of allopathic and osteopathic FTE residents 
training in the most recent cost reporting period ending on or before 
December 31, 1996.
    Comment: Several commenters noted that policy experts are beginning 
to forecast shortages in physician supply in the near future. One 
commenter stated: ``[a]s presented at the Federal [Council on Graduate 
Medical Education] meeting, the physician workforce analysis indicated 
that while the supply of physicians is expected to increase over the 
next two decades, demand for services is likely to grow even more 
rapidly. According to the analysis, the three major factors driving the 
increase in demand will be the projected U.S. population growth of 18 
percent between 2000 and 2020, the aging of the population as the 
number of Americans over 65 increases from 35 million in 2000 to 54 
million in 2020, and the changing age-specific per capita physician 
utilization rates, with those under age 45 using fewer services and 
those over age 45 using more services. The analysis notes that changing 
work patterns of physicians, such as decreases in working hours, could 
lead to greater shortfalls, while increases in productivity could 
moderate any shortfalls.''
    In response to the projected physician shortfall, one commenter 
urged CMS to work with Congress ``to explore expansion of physician 
training opportunities if research demonstrates a need for more U.S. 
medical school graduates.'' These commenters argued that Congress 
should lift the statutorily mandated 1996 FTE caps for direct GME and 
IME. Stated another commenter: ``[i]t is time for the Medicare resident 
caps to be lifted. While Medicare has periodically imposed other types 
of regulatory `freezes,' these have always been temporary. The current 
caps have been in place for over six years--far exceeding what 
typically would be viewed as reasonable.''
    Response: We appreciate the commenters' concern about the statutory 
1996 caps on the count of FTE residents for purposes of direct GME and 
IME payments, particularly in light of the alleged national physician 
shortage. If the Congress considers further legislation regarding the 
cap on the number of residents that may be counted for Medicare payment 
purposes, CMS would provide assistance to Congress and the provider 
industry on this issue.


    Note to Readers: This final rule includes a major redesignation 
of the contents of Sec.  413.86. As a result of the numerous 
amendments we have made over the years, the size of Sec.  413.86 has 
become voluminous and difficult to follow because of the multiple 
levels of coding. We are taking a first step to split the one 
section (Sec.  413.86) into nine individual sections (Sec. Sec.  
413.75 through 413.83). We are designating each first level 
paragraph under existing Sec.  413.86 as a separate new section and 
vacate Sec.  413.86. At this time, we are not making any changes in 
the language of these new redesignated sections, except for the 
changes that are discussed in section IV.O. of this preamble (which 
conform to the existing language of Sec.  413.86) and any 
appropriate cross-reference and conforming changes. We are providing 
a detailed crosswalk of the existing paragraphs of Sec.  413.86 to 
the new Sec. Sec.  413.75 through 413.83. In addition, in any 
discussion of changes we are making, we are providing both the 
existing citation under Sec.  413.86 and the redesignated section 
and paragraph. At a later date, we may further refine the contents 
of the redesignated sections to improve readability.


2. Reductions of and Increases in Hospitals' FTE Resident Caps for GME 
Payment Purposes Under Section 422 of Public Law 108-173 (Redesignated 
Sec.  413.79 (a Redesignation of Sec.  413.86(g))
a. General Background on Methodology for Determining the FTE Resident 
Count
    As we explain earlier in this preamble, Medicare makes both direct 
and indirect GME payments to hospitals that train residents in approved 
medical residency training programs. Direct GME payments are made in 
accordance with section 1886(h) of the Act, based generally on 
hospital-specific PRAs, the number of FTE residents a hospital trains, 
and the hospital's Medicare patient share. IME payments are made in 
accordance with section 1886(d)(5)(B) of the Act, based generally on 
the ratio of the hospital's FTE residents to the number of hospital 
beds. Accordingly, the calculation of both direct GME and IME payments 
is affected by the number of FTE residents that a hospital is allowed 
to count; generally, the greater the number of FTE residents a hospital 
counts, the greater the amount of Medicare direct GME and IME payments 
the hospital will receive. In an attempt to end the implicit incentive 
for hospitals to increase the number of FTE residents, Congress 
instituted a cap on the number of allopathic and osteopathic residents 
a hospital is allowed to count for direct GME and IME purposes under 
the provisions of section 1886(h)(4)(F) of the Act for direct GME and 
section 1886(d)(5)(B)(v) of the Act for IME. Dental and podiatric 
residents were not included in this statutorily mandated cap.
b. Reduction of Hospitals' FTE Resident Caps Under the Provisions of 
Section 422 of Public Law 108-173
    Medicare makes direct GME and IME payments based only on the number 
of FTE residents that is within a hospital's FTE resident cap. Some 
hospitals have trained a number of allopathic and osteopathic residents 
in excess of their FTE resident caps. Other hospitals have reduced 
their resident counts to some level below their FTE resident caps. 
Section 422 of Public Law 108-173 added a new section 1886(h)(7) to the 
Act to provide for reductions in the statutory resident caps under 
Medicare for certain hospitals and authorize a ``redistribution'' of 
the FTE resident slots resulting from the reduction in the FTE resident 
caps to other hospitals.
    The new section 1886(h)(7)(A) of the Act provides that a hospital's 
FTE resident cap will be reduced if its reference resident level, as 
described below, is less than its otherwise applicable FTE resident 
cap. Rural hospitals with less than 250 acute care inpatient beds are 
exempt from these reductions. For other hospitals, any such reduction 
will be equal to 75 percent of the difference between the hospital's 
otherwise applicable FTE resident cap and its reference resident level.
    Under the new section 1886(h)(7)(B) of the Act, the Secretary is 
authorized to increase the otherwise applicable FTE resident caps for 
certain categories of hospitals for portions of cost reporting periods 
occurring on or after July 1, 2005, by an aggregate number that does 
not exceed the estimated overall reduction in FTE resident caps for all 
hospitals under section 1886(h)(7)(A). A single hospital may receive an 
increase in its FTE resident cap of no more than 25 additional FTEs. In 
determining which hospitals would receive an increase in their FTE 
resident caps, section 1886(h)(7)(B) of the Act directs us to--
     Take into account the demonstrated likelihood of the 
hospital filling the additional positions within the first three cost 
reporting periods beginning on or after July 1, 2005.

[[Page 49113]]

     Establish a priority order to distribute resident slots 
first to programs in hospitals located in rural areas; second, to urban 
hospitals that are not in large urban areas; and third, to other 
hospitals operating a training program in a State where there is no 
other training program for a particular specialty in the State.
    In summary, section 422 of Public Law 108-173 added a new section 
1886(h)(7) of the Act that prescribes a methodology for determining 
reductions to certain hospitals' FTE resident caps based on unused FTE 
resident slots, provides for certain exceptions to the FTE resident cap 
reductions, and includes general criteria that CMS must consider in 
making a ``redistribution'' to other hospitals of the estimated number 
of FTE resident positions resulting from the reductions in the FTE 
resident caps. In this final rule, we are establishing procedures for 
determining whether, and by what amount, a hospital's FTE resident cap 
is subject to a reduction under section 1886(h)(7) of the Act. We also 
are specifying an application process for hospitals that seek to 
receive increases in their FTE resident caps and the specific criteria 
that we will use to determine which hospitals will receive the 
increases in their FTE resident caps under section 1886(h)(7)(B) of the 
Act.
c. Hospitals Subject to the FTE Resident Cap Reduction
    As indicated earlier, section 1886(h)(7)(A) of the Act, as added by 
section 422 of Public Law 108-173, provides that if a hospital's 
``reference resident level'' is less than its ``otherwise applicable 
resident limit,'' its ``otherwise applicable resident limit'' will be 
reduced by 75 percent of the difference between its ``otherwise 
applicable resident limit'' and its ``reference resident level.'' Under 
the amendments made by section 422, the ``reference resident level'' 
generally refers to the number of unweighted allopathic and osteopathic 
FTE residents who are training at a hospital in a given cost reporting 
period. The ``otherwise applicable resident limit'' refers to a 
hospital's FTE resident cap established under sections 1886(h)(4)(F)(i) 
and (h)(4)(H) of the Act. A hospital's permanent FTE cap under section 
1886(h)(4)(F)(i) of the Act is based on (1) for an urban hospital, the 
number of unweighted allopathic or osteopathic FTE residents in the 
hospital's most recent cost reporting period ending on or before 
December 31, 1996 (the ``1996 cap''), adjusted as specified under 
existing regulations at Sec.  413.86(g)(4) (redesignated Sec.  
413.79(c)(2)), and, if applicable, the 1996 cap adjusted for new 
programs as specified under existing Sec.  413.86(g)(6) (redesignated 
Sec.  413.79(e)); or (2) for a rural hospital, 130 percent of the 1996 
cap, adjusted as specified under existing Sec.  413.86(g)(4) and, if 
applicable, 130 percent of the 1996 cap adjusted for new programs as 
specified under Sec.  413.86(g)(6), or 130 percent of the 1996 cap with 
both adjustments. We also note that a hospital's 1996 cap may be 
adjusted in other instances (such as temporary adjustments for program 
or hospital closure) if the hospital is a member of a Medicare GME 
affiliated group under existing Sec.  413.86(b) (redesignated Sec.  
413.75(b)), but we will discuss the applicability of affiliations under 
section 1886(h)(7)(A) of the Act in more detail at section IV.O.2.f.(5) 
of this preamble.
    In our discussion of the provisions of section 422 of Public Law 
108-173 under this section of this final rule, we will generally refer 
to a hospital's number of unweighted allopathic and osteopathic FTE 
residents in a particular period as a hospital's ``resident level.'' We 
will also refer to a hospital's resident level in the applicable 
``reference period,'' as explained further below, as the hospital's 
``reference resident level.'' In addition, we will refer to the 
``otherwise applicable resident cap'' as the hospital's FTE resident 
cap that is applicable during a particular cost reporting period. Thus, 
as we proposed in the May 18, 2004 proposed rule (69 FR 28293), we are 
providing that if a hospital's resident level is less than the 
hospital's otherwise applicable resident cap in the ``reference 
period'' (as explained below), effective for portions of cost reporting 
periods occurring on or after July 1, 2005, we will permanently reduce 
the hospital's FTE resident cap by 75 percent of the difference between 
the reference resident level and the otherwise applicable FTE resident 
cap. For example, if a hospital's otherwise applicable FTE resident cap 
for the reference period is 100, and its resident level for that period 
is 80 FTEs, we will reduce the hospital's FTE resident cap by 15 FTEs 
[0.75 (100 - 80)] = 15). (Redesignated Sec.  413.79(c)(3)).
    Comment: One commenter expressed concern that the reduction to the 
FTE resident cap of a hospital that has had trouble filling vacancies 
in certain specialty programs may jeopardize the funding available for 
residents training in programs that the hospital has been able to fill. 
The commenter asked that CMS further analyze the impact that ``slot re-
allocations'' could have on other specialties at a particular hospital, 
and should consider the effect that such reductions may have on the 
overall availability of services to patients.
    Response: Although the commenter may be concerned about the impact 
that cap reductions may have on a hospital's ability to provide patient 
care and maintain its residency programs at historical levels, we do 
not believe we have the authority to design and implement a ``re-
allocation'' process that considers such factors. Rather, as explained 
in response to other comments, under section 1886(h)(7)(A)(i), the 
Secretary is directed to reduce the FTE resident caps of hospitals in 
instances where the resident levels were below the FTE resident caps in 
the reference cost reporting period. There is no statutory provision 
that authorizes CMS to consider the overall impact on patient care 
delivery or on residency training in making reductions to FTE resident 
caps.
d. Exemption From FTE Resident Cap Reduction for Certain Rural 
Hospitals
    Section 1886(h)(7)(A)(i)(II) of the Act, as added by section 422 of 
Public Law 108-173, specifically exempts rural hospitals (as defined in 
section 1886(d)(2)(D)(ii) of the Act) with less than 250 acute care 
inpatient beds from the possible 75 percent reduction to their FTE 
resident caps. Section 1886(d)(2)(D)(ii) of the Act defines a rural 
area as any area outside a Metropolitan Statistical Area (MSA). Under 
the existing regulations at Sec.  413.62(f)(ii), an ``urban area'' 
means (1) a Metropolitan Statistical Area (MSA) or New England County 
Metropolitan Area (NECMA); or (2) the following New England counties: 
Litchfield County, Connecticut; York County, Maine; Sagadahoc County, 
Maine; Merrimack County, New Hampshire; and Newport County, Rhode 
Island. Under existing Sec.  413.62(f)(iii), a ``rural area'' means any 
area outside an urban area. In addition, we note that under section 
III. of this preamble, which discusses wage areas, we are no longer 
recognizing NECMAs as a distinct category of wage areas. Thus, for 
purposes of the amendments made by section 422, we are providing that 
any hospital located in an area that is not in a MSA is a rural 
hospital, regardless of any reclassification under Sec.  412.102 or 
Sec.  412.103. We note that this definition of ``rural'' is consistent 
with our policy under section III. of this preamble concerning 
designation of wage index areas.
    A hospital's bed size is based on its number of available beds, as 
determined for IME payment purposes under Sec.  412.105 of the 
regulations. For purposes of determining whether a rural

[[Page 49114]]

hospital has less than 250 beds, in the May 18, 2004 proposed rule (69 
FR 28293), we proposed to use data from the rural hospital's most 
recent cost reporting period ending on or before September 30, 2002. 
(This information may be found on Worksheet S-3, Part I of the Medicare 
cost report, CMS-2552-96, the sum of lines 1 and 6 through 10 in column 
2, minus line 26 in column 6, divided by the number of days in the cost 
reporting period.) This is the cost reporting period under section 
1886(h)(7)(A)(ii)(I) of the Act that is to be used in determining a 
hospital's reference resident level (the unweighted allopathic and 
osteopathic FTE resident count) (unless a hospital makes and CMS grants 
a timely request under section 1886(h)(7)(A)(ii)(II) of the Act). We 
proposed that if a rural hospital has less than 250 beds in its most 
recent cost reporting period ending on or before September 30, 2002, 
the hospital would not be subject to a possible reduction to its FTE 
resident cap under section 1886(h)(7)(A) of the Act. However, if a 
rural hospital has at least 250 beds in its most recent cost reporting 
period ending on or before September 30, 2002, we proposed that the 
rural hospital would be subject to a possible reduction to its FTE 
resident cap. (Proposed redesignated Sec.  413.79(c)(3)(i).)
    Comment: Several commenters inquired as to whether our proposed 
changes for wage areas, if finalized, would affect a teaching 
hospital's status as urban or rural for purposes of section 422. 
Specifically, the commenters asked how a hospital that is currently 
located in a rural area (that is, non-MSA), but under our proposals for 
wage areas, would be located in an MSA effective October 1, 2004, would 
be treated for purposes of determining if and by much its FTE resident 
cap would be reduced. The commenter also questioned whether it would be 
considered a rural hospital under the first and second level priority 
categories under the criteria for determining whether the hospital will 
receive increases in its FTE resident caps. Several commenters believed 
that any hospital that was considered rural during the most recent cost 
reporting period ending on or before September 30, 2002 should be 
considered rural for purposes of section 422 and if reporting less than 
250 beds, any resident positions below its FTE resident cap should be 
exempt from redistribution.
    Response: Under section 1886(h)(7) of the Act, there are two 
instances in which a hospital's rural or urban designation could affect 
determinations made under this section for that hospital. First, under 
section 1886(h)(7)(A)(i)(II) of the Act, rural hospitals with less than 
250 acute care inpatient beds are exempted from the possible 75 percent 
reduction to their FTE resident caps. Second, section 
1886(h)(7)(B)(iii)(I) of the Act, established ``hospitals located in 
rural areas'' as the first priority category for CMS to determine which 
hospitals will receive increases in their FTE resident caps. In both 
instances, we proposed that, for purposes of the amendments made by 
section 422, any hospital located in an area that is not in an MSA is a 
rural hospital, regardless of any reclassification under Sec.  412.102 
or Sec.  412.103. However, we did not specify as of what date a 
hospital must be located in an area that is not an MSA in order to be a 
rural hospital. That is, a hospital may be located in an area that is 
not currently in an MSA, but will become an MSA effective October 1, 
2004. (Alternatively, a hospital may be located in an area that is 
currently an MSA, but will become rural effective October 1, 2004.) We 
believe it is reasonable and consistent with the July 1, 2005 effective 
date for both reductions and increases in FTE resident caps under 
section 1886(h)(7) of the Act, to use the urban or rural designation 
that is in effect on July 1, 2005. Therefore, we are requiring that, 
for purposes of section 1886(h)(7) of the Act (that is, both for 
purposes of determining if a hospital is a rural hospital with less 
than 250 beds, and also whether a hospital qualifies to receive higher 
priority to receive an increase in its FTE resident caps), a hospital 
located in an area that is not in an MSA effective October 1, 2004, is 
a rural hospital. Any hospital that is located in an area that is not 
currently in an MSA, but will become an MSA effective October 1, 2004, 
will not be considered a rural hospital for the purpose of applying 
section 1886(h)(7) of the Act. Alternatively, a hospital located in an 
area that is currently an MSA, but will become rural effective October 
1, 2004, will be considered a rural hospital for the purpose of 
applying section 1886(h)(7) of the Act.
    In section IV.O.2.i. of the preamble to the May 18, 2004 proposed 
rule, we proposed six priority categories (derived from the priorities 
established by section 1886(h)(7)(B) of the Act) to determine the order 
in which hospitals would be eligible to receive increases in their FTE 
resident caps. The first three priority categories are reserved for 
rural hospitals (hospitals that are located outside of an MSA as of 
July 1, 2005). The fourth level priority category is reserved for 
hospitals located in a ``small'' urban MSA (defined as an MSA with a 
population of less than 1,000,000). And the fifth and sixth level 
priority categories are reserved for hospitals located in ``large'' 
urban areas (defined by section 1886(d)(2)(D) of the Act as an MSA with 
a population of more than 1,000,000). For purposes of determining the 
order in which hospitals would be eligible to receive increases in 
their FTE resident caps under section 1886(h)(7)(B) of the Act, we are 
requiring that a hospital located in an MSA with a population of less 
than 1,000,000 effective October 1, 2004, is a ``small'' urban hospital 
and that a hospital located in an MSA with a population of more than 
1,000,000 effective October 1, 2004 is a ``large'' urban hospital.
    We note that there may be hospitals with less than 250 beds that 
are currently located outside of an MSA that will be redesignated as of 
October 1, 2004, to be located within an MSA. As such, these hospitals 
do not qualify for exemption from FTE resident cap reductions under 
section 1886(h)(7)(A)(i)(II) of the Act. As stated above, we did not 
specify in the proposed regulations the date on which a hospital must 
be in an area that is not an MSA in order to be a rural hospital. 
Hospitals located outside of an MSA with fewer than 250 beds may have 
believed that the hospital is exempt from section 1886(h)(7) of the Act 
and, therefore, failed to consider whether to file a timely request (by 
June 14, 2004) to use the cost report containing July 1, 2003 (to 
reflect an expansion of an existing program) or to request that its 
reference resident level be adjusted to include residents in certain 
newly approved programs. Therefore, we are allowing hospitals that are 
redesignated as of October 1, 2004 to be located within an MSA to make 
a timely request by August 23, 2004 to use the cost report containing 
July 1, 2003, as the reference cost report if the requirements of 
1886(h)(7)(A)(ii)(II) of the Act (expansion of existing programs) are 
met. Furthermore, we are allowing hospitals that meet the requirements 
of section 1886(7)(A)(ii)(III) of the Act (expansions under newly 
approved programs) to request by August 23, 2004 that their reference 
resident levels be adjusted to include residents in certain newly 
approved programs.
    Comment: One commenter noted that the proposed rule stated that CMS 
would be addressing, in the IPPS FY 2005 final rule, issues related to 
determining a hospital's bed count, such as observation beds and unused 
beds, some of which may be clarifications of existing policy. The 
commenter asked

[[Page 49115]]

for clarification as to whether these policies concerning the bed count 
will be applied in determining whether a rural hospital with less than 
250 beds.
    Response: In the May 18, 2004 proposed rule, we proposed that, for 
purposes of determining whether a rural hospital has less than 250 
beds, we would use data from the rural hospital's most recent cost 
reporting period ending on or before September 30, 2002. We proposed 
that if a rural hospital has less than 250 beds in its most recent cost 
reporting period ending on or before September 30, 2002, it would not 
be subject to a possible reduction to its FTE resident cap under 
section 1886(h)(7)(A) of the Act. We separately indicated that we plan 
to address comments concerning unoccupied beds, observation beds, and 
some other patient day issues that were proposed in the May 19, 2003 
IPPS proposed rule in the IPPS final rule for FY 2005. As planned, in 
Sec.  412.105(b) of this final rule, we have finalized a new policy 
concerning unoccupied beds, which has a prospective effective date of 
October 1, 2004. Therefore, the new policy concerning unoccupied beds 
would not impact the determination of a rural hospital's bed size based 
on its most recent cost report ending on or before September 30, 2002. 
We have also amended our policy in this final rule with respect to 
observation days for patients who are ultimately admitted as 
inpatients. This policy is a revision of existing policy, the effective 
date is prospective (October 1, 2004), and consequently, this policy 
would not impact the determination of a rural hospital's bed size based 
on its most recent cost report ending on or before September 30, 2002. 
The other policies that we have finalized concerning dual-eligible days 
and Medicare+Choice days do not apply to the determination of a 
hospital's bed size. However, we note that in the August 1, 2003 IPPS 
final rule, we clarified at 42 CFR 412.105(b)(3) that beds otherwise 
countable for IME purposes when used for outpatient observation 
services, skilled nursing swing-bed services, or ancillary labor/
delivery services, are excluded from the allowable count of available 
bed days. Because this policy was a clarification of existing policy, 
it would apply to the determination of a hospital's bed size in its 
most recent cost reporting period ending on or before September 30, 
2002.
    Comment: Some commenters expressed ``deep concern'' over what they 
believed is an unintended consequence of section 422 in that rural 
hospitals with at least 250 beds face possible reductions to their 
current FTE resident caps, when those caps were increased by previous 
legislation that was intended to encourage the growth of residency 
training in rural areas. The commenters were specifically referring to 
section 407(b) of Public Law 106-113 (the Balanced Budget Refinement 
Act (BBRA) of 1999), which provided for a 30 percent increase to rural 
hospitals' direct GME and IME FTE resident caps, effective April 1, 
2000. The commenters explained that the extensive plans they had set in 
motion to expand their residency programs were nowhere near completion 
as of their reference cost reporting period under section 886(h)(7)(A). 
They stated that this ``sudden reversal'' of the 30 percent increase to 
their caps would prevent them from meeting their educational and 
patient care missions in rural communities, and asked that the final 
rule contain a provision excepting these larger rural hospitals from 
cap reductions under section 1886(h)(7)(A) of the Act.
    Response: We understand that the commenters are in a somewhat 
unique situation, but we note that Congress specifically limited the 
exception from the application of section 1886(h)(7)(A) of the Act to 
rural hospitals with less than 250 beds. We do not believe we have the 
authority to expand the exception to rural hospitals with 250 beds or 
more from reductions under section 1886(h)(7)(A) of the Act. However, 
we believe that if these hospitals have been in the process of 
increasing the number of residents training in existing programs, they 
will likely qualify to request that their cost reporting period that 
includes July 1, 2003 be used as the reference cost reporting period. 
We believe that, between the effective date of section 407(b) of the 
BBRA and the cost report that includes July 1, 2003, these hospitals 
had several years to increase their resident counts. Therefore, a 
sizeable portion of this increase should be reflected on the cost 
report that includes July 1, 2003, thereby limiting the amount of slots 
lost under section 1886(h)(7)(A)(i) of the Act. In addition, because 
these hospitals are located in a rural area, they would be among those 
to receive first priority to obtain additional slots if they apply for 
increases to their FTE resident caps under section 1886(h)(7)(B) of the 
Act.
e. Determining the Estimated Number of FTE Resident Slots Available for 
Redistribution
    Under section 1886(h)(7)(A) of the Act, we will determine the 
number of resident positions available for redistribution by estimating 
possible reductions to hospitals' FTE resident caps. We believe that 
section 422 allows us to distinguish between the FTE counts that are 
used to determine the number of FTE resident slots that are available 
for redistribution (that is, the ``resident pool''), and the actual 
number of FTE residents by which hospitals' FTE resident caps are 
ultimately reduced. In the May 18, 2004 proposed rule (69 FR 28293), we 
proposed to estimate the reduction to a hospital's FTE resident cap 
under section 1886(h)(7)(A) of the Act for purposes of determining the 
number of FTEs that a hospital might contribute to the resident pool. 
This interpretation was based on the language at section 
1886(h)(7)(B)(i) of the Act, as added by section 422(a)(3), which 
states that the ``aggregate number of increases in the otherwise 
applicable resident limits under this subparagraph may not exceed the 
Secretary's estimate of the aggregate reduction in such limits * * *'' 
(emphasis added). We proposed to interpret this language to mean the 
aggregate number of FTE residents by which we increase the FTE resident 
caps of qualifying hospitals under section 1886(h)(7)(B) of the Act 
must not be more than the estimate of the aggregate number of FTE 
residents by which we would reduce the FTE resident caps of hospitals 
whose reference resident levels are less than their otherwise 
applicable FTE resident caps. However, we could subsequently perform an 
audit, as described further in section IV.O.2.f.(3) of this preamble, 
in order to make a final determination regarding any reductions to a 
hospital's FTE resident cap.
    To ensure that we will begin making payments for most hospitals 
based on the revised FTE resident caps by July 1, 2005, in the May 18, 
2004 proposed rule, we proposed to set a date by which we will have 
estimated a hospital's resident level and compared it to the hospital's 
otherwise applicable resident cap to estimate whether, and by how much, 
the hospital's FTE resident cap would be reduced. We did not propose to 
commit to make a final determination as to whether, and by how much, a 
particular hospital's FTE resident cap should be reduced as of this 
date, nor did we propose to commit to inform any hospital that it will 
receive an increase to its FTE resident cap by this date. Rather, we 
only proposed to use this date as an internal ``deadline'' to ensure 
that we will have sufficient time to distribute the resident pool and 
begin making payments for most hospitals based on the revised FTE 
resident caps by July 1, 2005. We proposed that this date be May 1, 
2005, and that the date

[[Page 49116]]

would apply for all hospitals for purposes of determining an estimate 
of whether and by how much their FTE resident caps should be reduced.
    Accordingly, in the event that the fiscal intermediaries have not 
completed an audit (explained further under section IV.O.2.f.(3) of 
this preamble) by May 1, 2005, we proposed that CMS may estimate the 
number of FTE residents by which a hospital's FTE resident cap should 
be reduced by May 1, 2005. For example, a fiscal intermediary may 
estimate by May 1, 2005, that Hospital A's FTE resident cap should be 
reduced by 10 FTEs. Thus, we would place 10 FTEs into the resident 
pool. It is possible that even after May 1, 2005, the fiscal 
intermediary may continue to audit Hospital A's relevant cost report(s) 
to determine if, in fact, 10 FTEs is the appropriate amount by which to 
reduce Hospital A's FTE resident cap, and could ultimately conclude 
that Hospital A's FTE resident cap should only be reduced by 8 FTEs. If 
the fiscal intermediary makes this final determination by May 1, 2005, 
we would change the number of FTE residents in the resident pool 
attributable to Hospital A from 10 FTEs to 8 FTEs. If the fiscal 
intermediary does not make this determination by May 1, 2005, based on 
the audit, we would only reduce Hospital A's FTE resident cap by 8 FTEs 
effective July 1, 2005, but the number of FTE residents in the resident 
pool attributable to Hospital A would remain at 10 FTEs (the estimated 
number as of May 1, 2005). Similarly, if the fiscal intermediary 
ultimately concluded that Hospital A's FTE resident cap should be 
reduced by 12 FTEs, but this final determination is not made by May 1, 
2005, Hospital A's FTE resident cap would be reduced by 12 FTEs 
effective July 1, 2005, but the number of FTE residents in the resident 
pool attributable to Hospital A would remain at 10 FTEs.
    As we stated above, because we believe that section 422 allows us 
to distinguish between the FTE counts that are used to determine the 
size of the resident pool, and the actual number of FTE residents by 
which hospitals' FTE resident caps are ultimately reduced, we proposed 
in the May 18, 2004 proposed rule, to use preliminary information in 
certain instances to estimate possible reductions to hospitals' FTE 
resident caps. As described further below, sections 1886(h)(7)(A)(ii) 
and (h)(7)(A)(iii) of the Act direct CMS to adjust the determination of 
a hospital's reference resident level in certain instances, due to an 
expansion of an existing program that is not reflected on the most 
recent settled cost report, or to include the number of residents for 
which a new program was accredited, or for hospitals that are members 
of the same Medicare GME affiliated group as of July 1, 2003. We note 
that, in adjusting the determination of the reference resident level in 
these instances, the reference resident level established for purposes 
of determining possible reductions to a hospital's FTE resident cap 
under section 1886(h)(7)(A) of the Act may not be the actual or audited 
number of FTE residents that we would otherwise use for direct GME or 
IME payment purposes. For example, for expansions under newly approved 
programs (as explained in more detail in section IV.O.2.f.(3) of this 
preamble), we proposed to adjust the reference resident level to 
include the number of residents for which a new program was accredited 
at a hospital even though, at the time the fiscal intermediary is 
determining possible reductions to a hospital's FTE resident cap, the 
hospital may not be training the full complement of residents for which 
the program was accredited. Thus, the number of FTE residents 
(including those training in the newly accredited program) for purposes 
of IME and direct GME payment would be dependent upon the actual number 
of FTE residents the hospital is permitted to count in a particular 
cost reporting period, as determined in accordance with the regulations 
at Sec.  412.105 for IME and Sec.  413.86 for direct GME.
    In addition, in the proposed rule we stated that we realize that 
there may be instances where a hospital's FTE resident cap or a 
hospital's FTE resident count for the reference cost reporting period 
might be under appeal. We believed that appeals related to these issues 
should be resolved through the normal course of business. In the event 
that an appeal that may affect determinations made under section 
1886(h)(7)(A) of the Act is not resolved by May 1, 2005, we proposed 
that we would estimate the number of FTE residents by which a 
hospital's FTE resident cap should be reduced (or not reduced, as 
applicable) by May 1, 2005.
    Comment: One commenter requested a waiver from the FTE resident cap 
reduction provisions of section 422 for a special circumstance. The 
commenter detailed a situation where a hospital, because of financial 
difficulties, had discontinued its residency program and had submitted 
a plan to the state in which the hospital is located to close the 
hospital. Through action of the state's Supreme Court, the hospital's 
petition for authorization to close the Hospital was denied. A 
committee appointed by the state Supreme Court selected another 
hospital as a sponsor that lent financial support to the subject 
hospital. A formal merger between the two hospitals has been opposed by 
the state's Attorney General. The subject hospital's residency programs 
have not grown to the level maintained prior to the petition for 
closure and the hospital was training residents well below its FTE 
resident cap during the reference cost reporting period. As such, the 
hospital believes that its FTE resident caps will be reduced pursuant 
to section 422. The commenter requests that the hospital be exempt from 
FTE resident cap reductions and that this exemption extend to the 
Medicare GME affiliated group of which the hospital is a part to 
preserve the group's future ability to build their teaching programs.
    Response: We sympathize with the commenter and believe that the 
particular circumstances experienced by this hospital are unusual and 
not specifically addressed by the Act or the proposed regulations. 
However, as we noted above, the statute provided for only a limited 
exemption from the provisions of section 1886(h)(7)(A)(i) of the Act 
for small rural hospitals. Therefore, we cannot grant the commenter's 
request. As we stated above, hospitals that believe they will receive a 
reduction to their FTE resident cap are not precluded under section 
1886(h)(7)(B) of the Act from applying for an increase in their FTE 
resident cap.
    Comment: Numerous commenters were concerned about how to determine 
possible cap reductions in instances where a hospital's FTE resident 
count for the reference cost reporting period is under appeal. One 
commenter was concerned that the number of FTE residents by which a 
hospital's FTE resident cap would be reduced would not reflect the 
final settlement of the cost report, which could unfairly harm 
hospitals whose FTE resident counts in the reference period were 
ultimately increased through the cost report appeal process. Another 
commenter emphasized that if appeals for payment purposes are made 
completely independently of the FTE resident count determinations for 
purposes of section 422, ``it could potentially result in the rather 
bizarre situation of a hospital's resident cap being permanently 
lowered by an amount that is later found to be based on an erroneous 
resident count determination.'' The commenter continued that the result 
would ``undermine the credibility of CMS, its fiscal intermediaries, 
and the process for making determinations under section 422, and 
therefore, CMS should ensure that it will not occur.''

[[Page 49117]]

    One commenter noted that CMS proposed to estimate the aggregate 
reduction in FTE resident caps under section 1886(h)(7)(A) of the Act 
based on available data as of May 1, 2005, which means that, for some 
hospitals, the hospital-specific actual reduction in the FTE resident 
cap can be based on further audit and appeal activity that may take 
place at any time after May 1, 2005. Thus, according to CMS' proposal, 
the number of FTEs in the resident pool attributable to a specific 
hospital might be higher than or lower than the actual number by which 
that hospital's FTE count will be reduced as of July 1, 2005. The 
commenter objected to this proposal and urged a more ``budget neutral'' 
approach that would promote finality for section 422. The commenter 
claimed that not only might this proposal lead to an improper increase 
or reduction in the estimated aggregate reduction in FTE resident caps, 
but it would also generate undue uncertainty about whether, and by how 
much, any given hospital's FTE cap will be reduced as of July 1, 2005. 
The commenter proposed that, to avoid this uncertainty and to promote 
finality, each hospital's FTE resident count should be permanently 
reduced by the same number of FTEs attributable to that hospital that 
are added to the pool for redistribution as of May 1, 2005. Under the 
commenter's proposal, fiscal intermediaries will need to conduct and 
attempt to complete audit activity by May 1 (or perhaps a later 
deadline if CMS so chooses). Whether those audits are complete or not, 
CMS would use the best available data as of the deadline so that the 
aggregate total of increases to the ``redistribution pool'' would equal 
the total of the permanent decreases to the hospitals' FTE resident 
caps effective July 1, 2005. Appeals and audits of the reference period 
that continue after May 1, 2005, would ultimately only impact that 
particular fiscal year's direct GME and IME reimbursement, but would 
have no impact on FTE resident cap adjustments under section 
1886(h)(7)(A) of the Act. As such, the commenter agreed with CMS' 
statement in the proposed rule that the actual FTE resident count used 
for purposes of direct GME or IME payment in the reference period need 
not equal the FTE resident count used for purposes of determining 
possible reductions to a hospital's FTE resident cap under section 
1886(h)(7)(A) of the Act. Finally, the commenter stated that since, 
under its proposal, all hospitals would know prior to the start of an 
impacted fiscal year precisely by how many FTEs their caps would be 
reduced, this advance knowledge would aid hospitals in deciding whether 
and to what extent they would enter into Medicare GME affiliation 
agreements as of July 1, 2005.
    Response: In the May 18, 2004 proposed rule (69 FR 28294), we 
stated that we realize there may be instances where a hospital's FTE 
resident cap or a hospital's FTE resident count for the reference cost 
reporting period might be under appeal. We further stated that we 
believe appeals related to these issues should be resolved through the 
normal course of business. In the event an appeal that may affect 
determinations made under section 1886(h)(7)(A) of the Act is not 
resolved by May 1, 2005, we proposed that we would estimate the number 
of FTE residents by which a hospital's FTE resident cap should be 
reduced (or not reduced, as applicable) by May 1, 2005.
    Since the publication of the proposed rule, and after considering 
the detailed and thoughtful comments we received on the issue of cost 
reports that are under appeal, we believe that it is in the best 
interest of the Medicare program, CMS, the fiscal intermediaries, and 
the hospitals, to adopt an approach that allows for finality as early 
as possible during the process of implementing this provision. We 
believe that Congress gave some consideration to the challenges we 
would encounter in implementing a provision as complex as section 422 
in such a short timeframe by providing the Secretary with the 
discretion to distinguish between the FTE counts that are used to 
estimate the number of FTE resident slots that are available for 
redistribution (that is, the ``redistribution pool''), and the actual 
number of FTE residents by which hospitals' FTE resident caps are 
ultimately reduced. We therefore had proposed to interpret the language 
at section 1886(h)(7)(B)(i) of the Act to mean that the aggregate 
number of FTE residents by which we increase the FTE resident caps of 
qualifying hospitals under section 1886(h)(7)(B) of the Act must not be 
more than the estimated aggregate number of FTE residents by which we 
would reduce the FTE resident caps of hospitals whose reference 
resident levels are less than their otherwise applicable FTE resident 
caps.
    We also believe the Congress expected and provided for 
administrative expediency under section 1886(h)(7)(A)(ii)(I) of the Act 
by stating that a possible reduction in a hospital's FTE resident cap 
would, generally, be based upon ``the reference resident level for the 
most recent cost reporting period of the hospital ending on or before 
September 30, 2002, for which a cost report has been settled (or, if 
not, submitted (subject to audit)), as determined by the Secretary'' 
(emphasis added). As stated in the May 18, 2004 proposed rule (69 FR 
28295-28296), we proposed to interpret this language to mean that, if a 
hospital's cost report for the most recent cost reporting period ending 
on or before September 30, 2002, has been settled, then, unless the 
hospital submits a timely request to use the cost reporting period that 
includes July 1, 2003, we would use the hospital's settled cost report 
without further audit to determine possible reductions to the FTE 
resident caps. Furthermore, the fact that the Congress took the unusual 
step of including the language at section 1886(h)(7)(D) of the Act 
which provides that, ``There shall be no administrative or judicial 
review * * * with respect to determinations made under this 
paragraph,'' supports the position advocating for finality. If we were 
to delay determinations concerning hospital-specific FTE cap 
determinations until all affected cost reports are settled, audited, 
and appealed through the various channels normally available to 
providers, the language at section 1886(h)(7)(D) of the Act would be 
rendered meaningless. Therefore, despite its complexity and potential 
for profound and long-term GME payment ramifications, we believe that 
the Congress did not expect the implementation of this provision to 
linger indefinitely. Rather, by limiting appeal rights, and instituting 
an effective date of July 1, 2005 (which requires implementation in a 
relatively short timeframe), the Congress expected section 1886(h)(7) 
of the Act to be implemented with expediency and finality.
    Consistent with Congressional intent and in response to comments, 
we believe it would be disruptive to CMS, the fiscal intermediaries, 
and the hospitals if we do not establish a framework that encourages 
determinations under section 1886(h)(7)(A)(i) of the Act to be made 
final by July 1, 2005. Therefore, we are not finalizing our proposed 
policy to wait for reference period cost reports that are under appeal 
to be resolved before making a final determination as to whether and by 
how much a hospital's FTE resident cap will be reduced. We do, however, 
perceive the need in certain instances to continue audit work for a 
limited time period past July 1, 2005 to promote the accuracy of FTE 
resident cap determinations. In this final rule, we are adopting a 
policy that will require the

[[Page 49118]]

fiscal intermediaries to use the latest available cost report or audit 
data at the time they make their determinations. That is, if a 
hospital's reference period cost report has been settled, then the 
fiscal intermediary will make a final determination as to whether and 
by how much a hospital's FTE resident cap would be reduced based on the 
FTE resident level in that settled cost report. If the hospital's 
reference period cost report is under appeal and a final decision has 
not been rendered at the time the fiscal intermediary makes the 
determination, then the fiscal intermediary would not wait until a 
decision is rendered, but instead, would use the reference resident 
level from the settled (per the Notice of Program Reimbursement (NPR)) 
cost report. If the settled reference period cost report had been 
appealed and the final decision is rendered in time for the fiscal 
intermediary to make the FTE resident cap determination, then the 
fiscal intermediary would use the FTE resident level that will be used 
in issuing the subsequent NPR as established through the appeal. 
However, if the reference period cost report has never been settled at 
the time the fiscal intermediary is making the determination as to 
whether and by how much a hospital's FTE resident cap should be 
reduced, then, whether the reference period cost report is the as-
submitted most recent cost report ending on or before September 30, 
2002, or the cost report that includes July 1, 2003, the reference 
resident level is subject to audit by the fiscal intermediary, and the 
final determination regarding any possible reduction to the hospital's 
FTE resident cap is not subject to appeal. Although we will make every 
effort to provide fiscal intermediaries with the resources and funding 
they need to complete as many audits as possible in time to notify each 
hospital by July 1, 2005 of their FTE cap determinations under section 
1886(h)(7)(A) of the Act, there may be instances where the audits of 
the reference resident levels may not be completed by July 1, 2005. 
However, we anticipate that the fiscal intermediaries will be able to 
complete audits related to section 1886(h)(7)(A) of the Act by December 
2005, which is six months into the July 1, 2005--June 30, 2006 academic 
year. All determinations made after July 1, 2005 and through December 
2005 will be effective retroactively to July 1, 2005.
    Comment: One commenter noted that some hospitals' 1996 FTE resident 
caps have yet to be finalized, or have been finalized only recently. 
The commenter requested that CMS consider these situations when 
comparing caps to resident counts. The commenter gave an example in 
which some hospitals may have an FTE resident count in the reference 
period cost report that once matched their corresponding FTE resident 
cap, but that cap was later increased during the audit and appeal 
process. If the settled (post-audit and/or appeal) FTE resident cap is 
used in the cap and count comparison, the hospital's FTE resident cap 
would be reduced, ``even though the hospital was at its cap as it knew 
it to be as of 2002.'' The commenter asserted that such a result would 
be ``patently unfair'' and should be addressed in the final rule.
    Response: The commenter's point is well taken, but we note that the 
reverse situation could also occur in that a hospital's 1996 FTE 
resident cap may later be reduced as the result of an appeal. If the 
reduced settled FTE resident cap were to be used in the cap and count 
comparison under section 1886(h)(7)(A) of the Act, the reduction in the 
hospital's FTE resident cap would be lessened (or there could be no 
reduction at all), even though the hospital's FTE resident count was 
below its cap ``as it knew it to be as of 2002.'' Accordingly, where 
the hospitals'' FTE resident cap used in its reference cost report is 
revised on an appeal, some hospitals could benefit by using the 
original FTE resident cap while other hospitals would not. We do not 
believe it is appropriate to decide our policy based on the possible 
occurrence of a circumstance that could produce favorable results for 
some and unfavorable results for others. Therefore, as stated in 
response to the previous comment regarding situations where the FTE 
resident count in the reference cost reporting period is under appeal, 
in the interest of finality, we will instruct the fiscal intermediaries 
to use the latest determined 1996 FTE resident caps for direct GME and 
IME that are available as of the time the determination regarding any 
possible FTE resident cap reduction is being made. If, as of the time 
the fiscal intermediary makes the determination as to whether and by 
how much a hospital's FTE resident cap should be reduced, an appeal of 
the FTE resident cap for the reference cost reporting period has not 
been resolved (that is, a final decision has not been rendered), then 
the fiscal intermediary would use the FTE resident cap amount from the 
initially settled (per the NPR) reference period cost report. However, 
if, as of the time that the fiscal intermediary makes the determination 
as to whether and by how much a hospital's FTE resident cap should be 
reduced, the FTE resident cap appeal has been resolved, we would use 
the FTE resident cap as established by the appeal.
    We are, however, sympathetic to the commenter's point that there 
could be instances where, as the result of an appeal of the 1996 FTE 
resident cap that was resolved at the time the fiscal intermediary 
makes the determination, the hospital's FTE resident cap would be 
reduced, ``even though the hospital was at its cap as it knew it to be 
as of 2002.'' Such a hospital may apply for an increase in its FTE 
resident cap under section 1886(h)(7)(B) of Act. In this final rule, 
under section IV.O.2.m. of this preamble, we are adding an Evaluation 
Criterion to address this situation where a hospital's FTE resident cap 
was reduced under section 1886(h)(7)(A)(i) of the Act because the 
resident level in its reference period cost report equaled or was above 
its FTE resident cap in effect at that time, but as a result of the 
resolution of an appeal concerning the FTE resident cap (for example, 
the 1996 FTE resident cap, as adjusted for new programs, if 
applicable), the FTE resident cap was later increased to an amount that 
is greater than the reference resident level.
    Comment: Several commenters acknowledged CMS' need to estimate the 
aggregate reduction in FTE resident caps in order to ``redistribute'' 
positions to other hospitals by the July 1, 2005 implementation 
deadline, but expressed concern that if the finalized number of FTE 
resident cap reductions exceeds the number of redistributed cap slots, 
the result would be a permanent reduction in the national total number 
of resident positions eligible for Medicare program support. The 
commenters asserted that this was not the intent of Public Law 108-173. 
Rather, one commenter believed that, while the Congress was permitting 
the use of estimate in administering the redistribution, the Congress 
was not ``sanctioning'' aggregate additions or reductions to the number 
of FTE residents counted for purposes of Medicare direct GME and IME 
reimbursement. Another commenter noted that Public Law 108-173 requests 
that CMS submit a report to the Congress by July 1, 2005, that contains 
recommendations regarding whether to extend the application deadline 
for hospitals seeking to increase their resident limits. The commenter 
stated that, because of audit and appeal timeframes, CMS may not know 
the final aggregate number of FTE resident cap reductions by July 1, 
2005, urged CMS to address this situation in its report, and 
recommended that the

[[Page 49119]]

application process be extended or reopened in the event that the final 
resident limit reductions exceed distributed slots.
    Response: We acknowledge the commenters' concern that, to the 
extent the number of slots in the ``resident pool'' attributable to 
certain hospitals is based on estimates of the amount by which those 
hospitals' FTE residents caps will be reduced, and the finalized number 
of FTE resident cap reductions exceeds the number of redistributed cap 
slots, the result would be a permanent reduction in the total number of 
resident positions that would be counted for purposes of Medicare 
direct GME and IME payments. As explained in response to previous 
comments, we will make every effort to provide fiscal intermediaries 
with the resources and funding they need to complete as many audits as 
possible in time to notify each hospital by July 1, 2005, of their 
determinations under section 1886(h)(7)(A) of the Act. Therefore, we 
anticipate that by May 1, 2005, the number of hospitals for which we 
believe additional audit work is required (and, therefore, we 
``estimated'' the amount by which their FTE resident caps would be 
reduced) will be relatively small. However, we acknowledge that, as a 
result of the possibility of some remaining audits (which we believe 
will be completed by the end of calendar year 2005), there is a slight 
possibility that the final number of FTE cap reductions could be more 
than the estimated size of the ``resident pool'' as of July 1, 2005. To 
address this concern, in drafting the report to Congress due by July 1, 
2005, we will consider ways in which this potential situation may be 
addressed, and, if appropriate, would request that Congress extend the 
deadline for increases in resident limits.
    Comment: One commenter agreed with CMS that, given the short 
timeframe for implementation of section 422 and the complexity involved 
in determining the number of positions available for redistribution, it 
is reasonable for CMS to exercise its discretion to make a ``best 
estimate'' of the aggregate number of FTE cap reductions under section 
1886(h)(7)(A) of the Act by a particular date and proceed with the 
``redistribution'' under section 1886(h)(7)(B) of the Act. However, the 
commenter was ``extremely concerned'' that CMS ensure that hospitals at 
risk of having their FTE resident cap reduced have ample opportunities 
to submit additional documentation to the fiscal intermediary so that 
the hospital's residents are not ``undercounted''. The commenter noted 
that section 1886(h)(7)(D) of the Act specifies that ``There shall be 
no administrative or judicial review under section 1869, 1878, or 
otherwise, with respect to determinations made under this paragraph.'' 
The commenter urged CMS to not interpret this statement to mean that a 
determination of the fiscal intermediary with regard to FTE resident 
cap reductions will be final, without any external appeal mechanism. 
Rather, the commenter suggested CMS should appoint an ombudsman who 
would be available to adjudicate hospital-specific issues as they 
arise.
    Response: As stated in response to the previous comment, we believe 
the fact that Congress included the language at section 1886(h)(7)(D) 
of the Act stating that ``There shall be no administrative or judicial 
review * * * with respect to determinations made under this 
paragraph,'' clearly means that the Congress did intend for the 
determination of the fiscal intermediary with regard to FTE resident 
cap reductions to be final, without any external appeal mechanism. 
Because of this statutory language, together with the requirement that 
all reductions and increases in FTE resident caps be made effective 
July 1, 2005, we do not believe it is appropriate to allow hospitals 
(or CMS) to appeal determinations concerning the FTE cap reductions (or 
the FTE cap increases, for that matter) under section 1886(h)(7) of the 
Act. In addition, as indicated previously, we believe that Congress 
intended this provision to be implemented fairly, but efficiently, 
avoiding the delays and uncertainty that would be produced by an 
appeals process. Furthermore, we note that, as with any audit and cost 
report settlement process, the fiscal intermediaries will provide the 
hospitals with an opportunity to review and respond to the audit 
adjustments before they are finalized.
    Comment: One commenter said the proposed regulations are unclear as 
to whether the policy to ensure that the aggregate number by which FTE 
resident caps are increased through the redistribution provisions at 
section 1886(h)(7)(B) of the Act, does not exceed the estimated 
aggregate number by which FTE resident caps are reduced under section 
1886(h)(7)(A) of the Act would be applied individually to each hospital 
that requests additional residency slots, or whether the policy would 
be applied to the national aggregate amounts. The commenter stated that 
if a hospital loses resident positions as part of the reductions under 
section 1886(h)(7)(A) of the Act, it could be due to a number of 
factors that have ``nothing to do with the ability of a program to 
recruit and retain residents'' in other programs. The commenter 
requested that if CMS intended that the rule requiring that aggregate 
increases not exceed aggregate decreases be applied on a hospital-
specific basis, it should be eliminated.
    Response: The commenter is referring to our proposal relating to 
the language at section 1886(h)(7)(B)(i) of the Act, as added by 
section 422(a)(3) of the MMA, which states that the ``aggregate number 
of increases in the otherwise applicable resident limits under this 
subparagraph may not exceed the Secretary's estimate of the aggregate 
reduction in such limits * * * '' (emphasis added). As explained in 
response to previous comments, we proposed to interpret this language 
to mean that the aggregate number of FTE residents by which we increase 
the FTE resident caps of qualifying hospitals under section 
1886(h)(7)(B) of the Act may not exceed the estimate of the aggregate 
number of FTE residents by which we would reduce the FTE resident caps 
of hospitals whose reference resident levels are less than their 
otherwise applicable FTE resident caps. As is evident from the use of 
the word ``aggregate'' and the plural form of ``hospital,'' we intended 
that this principle be applied on a national aggregate basis, and not 
to each hospital individually. Rather, as long as the total number of 
FTE residents by which we increase the FTE resident caps of all 
hospitals nationally is not more than the estimated number of FTE 
residents by which we reduce the FTE resident caps of all hospitals 
nationally, we will have complied with the statute at section 
1886(h)(7)(B)(i) of the Act.
f. Determining the Possible Reduction to a Hospital's FTE Resident Cap
(1) Reference Resident Level--General
    In order to determine if a hospital's resident level is less than 
the hospital's otherwise applicable FTE resident cap, section 
1886(h)(7)(A)(ii) of the Act, as added by section 422 of Pub. L. 108-
173, directs the Secretary to use one of two reference cost reporting 
periods. Section 1886(h)(7)(A)(ii)(I) of the Act directs CMS to use a 
hospital's most recent cost reporting period ending on or before 
September 30, 2002, ``for which a cost report has been settled (or, if 
not, submitted (subject to audit)), as determined by the Secretary,'' 
as the reference period, unless we grant the hospital's timely request 
to use a later cost report under section 1886(h)(7)(A)(ii)(II) of the 
Act, as described under section IV.O.2.f.(2) of

[[Page 49120]]

this preamble. Generally, if the hospital's resident level for either 
direct GME or IME is less than the hospital's otherwise applicable 
resident cap for direct GME or IME, respectively, for the most recent 
cost reporting period ending on or before September 30, 2002, the 
hospital's FTE resident cap for direct GME or IME will be reduced by 75 
percent of the difference between the resident level and the otherwise 
applicable FTE resident cap. On April 30, 2004, we issued a One-Time 
Notification (OTN) (Transmittal 77, CR 3247), ``Instructions Related to 
`Redistribution of Unused Resident Positions', Section 422 of the 
Medicare Modernization Act of 2003 (MMA), Public Law 108-173, for 
Purposes of Graduate Medical Education (GME) Payments'' that prescribed 
certain requirements related to the implementation of section 422 and 
established a deadline by which a hospital must exercise its option to 
request that we use a later cost report as the reference cost report. 
If the hospital's cost report for the most recent cost reporting period 
ending on or before September 30, 2002, is settled by April 30, 2004, 
the date on which the OTN was issued, we proposed in the May 18, 2004 
proposed rule to use that cost report to determine if, and by how much, 
a hospital's FTE resident cap should be reduced. We noted that the 
``settled'' cost report does not necessarily mean the initial cost 
report settlement. The fiscal intermediary may have previously settled 
the cost report, reopened it to audit it, and then settled the cost 
report again, issuing a revised Notice of Program Reimbursement (NPR). 
Thus, we would refer to the more recently issued NPR. When a hospital's 
cost report for the most recent cost reporting period ending on or 
before September 30, 2002, has been settled by April 30, 2004, we 
proposed to use the most recently settled cost report as of April 30, 
2004, to determine any reduction to the hospital's FTE resident cap 
under section 1886(h)(7)(A)(ii)(I) of the Act (unless we grant the 
hospital's timely request under section 1886(h)(7)(A)(ii)(II) of the 
Act to use a later cost report, as described in section IV.O.2.f.(2) of 
this preamble). If the hospital's cost report for the most recent cost 
reporting period ending on or before September 30, 2002 has not yet 
been settled as of April 30, 2004, we proposed that the as-submitted 
cost report would be used to determine any reduction in the FTE 
resident cap, subject to audit by the fiscal intermediary. If the cost 
report was initially settled, but then reopened, and the fiscal 
intermediary has not issued a revised NPR prior to April 30, 2004, the 
data from the initially settled cost report will be used to determine 
the possible reductions to the FTE resident caps. (Discussion and 
comments on this portion of the proposed rule are located at section 
IV.O.2.f.(3) of this preamble.)
(2) Expansion of an Existing Program
    Section 1886(h)(7)(A)(ii)(II) of the Act, as added by section 
422(a) of Public Law 108-173, provides that if a hospital's resident 
level increased due to an expansion of an existing program, and that 
expansion is not reflected on the hospital's most recent settled cost 
report, a hospital may make a timely request to CMS that, rather than 
using its most recent cost reporting period ending on or before 
September 30, 2002, to determine if its FTE resident cap should be 
reduced, CMS should use the cost report for the hospital's cost 
reporting period that includes July 1, 2003. For example, assume a 
hospital's most recent settled cost report is September 30, 2000 (that 
is, no NPRs were issued for subsequent year cost reports). The hospital 
increased its resident level due to an expansion of an existing program 
in its fiscal year ending September 30, 2001. The hospital may submit a 
timely request that CMS use its cost report that includes July 1, 2003 
(which would be its cost report for the fiscal year ending September 
30, 2003), to determine if and by how much the hospital's FTE resident 
cap should be reduced. (Proposed redesignated Sec.  
413.79(c)(3)(ii)(A)(2)). As explained on page 3 of the April 30, 2004 
OTN, to be considered a timely and proper request, a hospital's request 
to use its cost reporting period that includes July 1, 2003, must be 
signed and dated by the hospital's chief financial officer (or 
equivalent) and submitted to its fiscal intermediary on or before June 
4, 2004 (later revised to June 14, 2004). In its timely request, the 
hospital must include the following:
    (1) The FTE resident caps for direct GME and IME and the number of 
unweighted allopathic and osteopathic FTE residents for direct GME and 
IME in its most recently settled cost report (that is, its cost report 
that is more recently settled as of April 30, 2004.
    (2) The FTE resident caps for direct GME and IME and the unweighted 
allopathic and osteopathic FTE residents for direct GME and IME for 
each cost report after its most recently settled cost report, up to and 
including its cost reporting period that includes July 1, 2003. If the 
cost reporting period that includes July 1, 2003, has not ended as of 
June 4, 2004, the hospital must report the estimated number of 
unweighted allopathic and osteopathic residents for that cost reporting 
period.
    (3) If not already reported in accordance with steps 1 and 2 above, 
the FTE resident caps for direct GME and IME and the number of 
unweighted allopathic and osteopathic FTE residents for direct GME and 
IME in its most recent cost reporting period ending on or before 
September 30, 2002.
    In addition, as we stated in the April 30, 2004 OTN, a hospital 
should refer to its most recently settled cost report as of the 
issuance of the OTN (that is, April 30, 2004) to determine whether the 
hospital believes it has expanded an existing program in a cost 
reporting period subsequent to the one for the most recently settled 
cost report.
    In the May 18, 2004 proposed rule, we also proposed that, for 
purposes of this provision, an ``expansion of an existing program'' 
means that, except for expansions due to newly approved programs, as 
described below in section IV.O.2.f.(4) of this preamble, the 
hospital's total number of unweighted allopathic and osteopathic FTE 
residents training in existing programs in a cost reporting period up 
to and including the hospital's cost report that includes July 1, 2003, 
is greater than the resident level in the hospital's most recent 
settled cost report. (Proposed redesignated Sec.  
413.79(c)(3)(ii)(A)(3)). In other words, generally, we proposed that as 
long as a hospital trained more unweighted allopathic and osteopathic 
FTE residents in a cost reporting period after its most recent settled 
cost report in programs that were existing during the cost reporting 
period for the most recently settled cost report, it may submit a 
timely request that its cost report that includes July 1, 2003, be used 
for purposes of determining any FTE resident cap reduction under 
section 1886(h)(7)(A)(i) of the Act. We noted that if a hospital 
expanded an existing program after its most recent settled cost report, 
and then subsequently reduced its FTE resident count to the extent that 
it actually trained fewer unweighted allopathic and osteopathic FTE 
residents in its cost report that includes July 1, 2003, than in its 
most recent cost reporting period ending on or before September 30, 
2002, the hospital would not benefit from, and would likely not make, a 
timely request that its cost report that includes July 1, 2003, be used 
for purposes of determining a possible reduction to its FTE resident 
cap.
    Comment: One commenter stated that, even though the current 
deadline of June 14, 2004, for timely requests has

[[Page 49121]]

passed, because the process was included in the proposed rule and is 
subject to comment and possible revisions, CMS should reopen the timely 
request deadline for all hospitals. Another commenter was ``extremely 
dismayed'' that CMS stated that the timely requests are ``binding'' 
even if the reduction to the hospital's FTE resident cap would have 
been less had the hospital not submitted a timely request to use the 
cost report that includes July 1, 2003. The commenter declared that it 
is ``absolutely not reasonable for CMS to make a [hospital's] request 
such as this `binding' in full knowledge that inherent in making such a 
request, there must be at least a small element of estimation, and an 
incorrect estimate might eventually work to a hospital's disadvantage 
when the data and documentation issues are reviewed more thoroughly.'' 
The commenter recommended that if it is found that a hospital's 
reduction to its FTE resident cap would be less if the hospital had not 
made the timely request, the request should be ``null and void,'' and 
the hospital should either be allowed to withdraw its request, or CMS 
should use the hospital's most recent cost report ending on or before 
September 30, 2002, as the reference cost report.
    Response: We acknowledge the unique circumstances surrounding 
implementation of section 1886(h)(7) of the Act in that it requires 
hospitals to supply, and CMS and the fiscal intermediaries to review, a 
large amount of technically difficult information regarding FTE 
resident counts and caps in a relatively short timeframe, in order to 
assess and make modifications effective July 1, 2005. If we had more 
time to implement section 1886(h)(7) of the Act, we would have waited 
until after publication of this final rule to establish a deadline for 
all hospitals to submit timely requests due to expansions of existing 
programs not reflected on the most recent settled cost report, (or due 
to expansions under newly approved programs). We note that many of the 
reference cost reporting periods are subject to audit under section 
1886(h)(7)(A)(ii) of the Act. Given our limited time and audit 
resources, we believe it would be inefficient for the fiscal 
intermediaries to audit the cost reporting period that includes July 1, 
2003, for a hospital that submitted a timely request, and then, in the 
event that the hospital regrets having submitted that request, audit 
the cost report ending on or before September 30, 2002. Therefore, due 
to the extremely tight timeframe mandated by the statute, and 
considering that GME audits can be lengthy and complicated processes, 
we believe that we needed to issue the OTN on April 30, 2004, establish 
June 4, (later changed to June 14) 2004, as the deadline for a 
hospital's ``timely request'' under section 1886(h)(7)(A)(ii) of the 
Act, and make submissions of timely requests ``binding''. We note that, 
to allow hospitals more time to evaluate their FTE resident data, we 
reissued this OTN (CR 3247, Transmittal 87) on May 26, 2004 with a 
revised ``timely request'' deadline of June 14, 2004. In those OTNs, we 
explained that, ``In the Fiscal Year (FY) 2005 Hospital Inpatient 
Prospective Payment System (PPS) proposed rule, we will be proposing 
procedures for determining the number of ``unused'' residency 
positions, as well as an application process for hospitals that seek 
additional residency slots, and specific criteria that we will use in 
determining which hospitals will receive the additional residency 
positions. However, since the procedures would not be finalized before 
publication of the FY 2005 Hospital Inpatient PPS final rule (by August 
1, 2004), and the provisions of that final rule would not become 
effective until October 1, 2004 (at least 60 days after publication of 
the final rule), we are notifying you and your providers in this OTN of 
certain information that we will need in order to determine in a timely 
fashion the number of unused resident positions available for 
redistribution'' (emphasis added).
    In issuing the OTNs, and in conjunction with the additional 
information provided in the proposed rule, we believe that we provided 
enough information for hospitals to determine whether their FTE 
residents caps would be subject to reduction, whether the hospital had 
an expansion of an existing program, and whether it would be 
advantageous for the hospital to submit a timely request to use the 
cost report that includes July 1, 2003 as the reference period. 
Furthermore, we believe that, as a general proposition, a hospital 
should know the validity of its FTE resident count, and be able to 
assess whether its FTE count is below its FTE resident cap. Therefore, 
the issuance of proposed and final regulations should have had little, 
if any, impact, on a hospital's decision to submit a timely request. 
However, we do accede that this may not be the case for hospitals 
located in areas for which the urban or rural status will change as of 
October 1, 2004, as described previously in section IV.O.d. of this 
preamble. Accordingly, we are providing another limited opportunity 
after publication of this final rule only for hospitals located in 
areas whose rural status will change to urban as of October 1, 2004, as 
stated in section IV.O.d. of this preamble, to make a timely request 
under section 1886(h)(7)(A)(ii) of the Act.
    Comment: One commenter noted that because the June 14, 2004 
deadline for submitting a timely request was prior to the issuance of 
the final rule, the enforcement of that deadline could be problematic, 
even though CMS issued a One-Time Notification (CR 3247) instituting 
this deadline. The commenter recommended that CMS use the deadline of 
June 14, 2004, issued in the OTN as a guideline, rather than a firm 
deadline, with respect to allowing a hospital to use an alternative 
cost report.
    Response: We disagree with the commenter's suggestion that the June 
14, 2004 deadline for submission of a timely request should be used as 
a guideline, and not a firm deadline. We note that sections 
1886(h)(7)(A)(ii)(II) and (III) of the Act specifically hinge a 
hospital's ability to use its cost report that includes July 1, 2003, 
or to adjust its reference resident level due to newly approved 
programs, on the submission of a timely request, and clearly gives the 
Secretary the discretion to establish what a timely request should be. 
As we explained in the OTN and in response to the previous comment, if 
the modifications under section 1886(h)(7) of the Act had not been made 
effective July 1, 2005, we could have waited until after publication 
(or perhaps even the effective date) of this final rule to establish a 
deadline for all hospitals to submit timely requests. However, because 
we have a limited amount of time in which to implement section 
1886(h)(7) of the Act, and the provisions of this final rule will not 
be effective until October 1, 2004, we chose to exercise our discretion 
and subregulatory authority to issue the OTN and require that timely 
requests must be submitted by June 14, 2004. Accordingly, all requests 
submitted after June 14, 2004 (except for those for which a new 
deadline is established under this final rule) are not timely, and may 
not be used by the fiscal intermediaries to allow for use of the cost 
report that includes July 1, 2003, or to adjust the reference resident 
level to reflect newly approved programs.
    Comment: One commenter was concerned that hospitals ``must choose'' 
between two reference cost reporting periods, regardless of whether 
those cost reports have been settled. The

[[Page 49122]]

commenter believed that there is too much uncertainty surrounding cost 
reports that are not settled, and requested that hospitals be given an 
opportunity to make or withdraw a timely request once both its most 
recent cost report ending on or before September 30, 2002, and its cost 
report that includes July 1, 2003 is settled.
    Response: We are not accepting the commenter's request, because it 
is possible that a hospital's most recent cost report ending on or 
before September 30, 2002, and its cost report that includes July 1, 
2003, will not be settled until well after the effective date of 
section 1886(h)(7) of the Act of July 1, 2005. Waiting until all 
reference cost reports are settled would prevent this provision from 
being implemented in a timely fashion, and would generally be 
disruptive to fiscal intermediaries and to hospitals.
    Comment: One commenter noted that there may be hospitals that have 
increased their resident levels in the reference period due to new 
programs that do not qualify as a ``newly approved program'' under 
section 1886(h)(7)(ii)(III) of the Act because they were either 
accredited after January 1, 2002, or they were in operation during the 
providers' reference periods, or both. The commenter asked whether 
increases in resident counts due to these new programs can be 
considered expansions of existing programs, and, if so, whether the 
commenter could request that its cost report that includes July 1, 2003 
be used to determine if and by how much its FTE resident cap would be 
reduced. The commenter believed that CMS should not deny such a 
hospital the ability to use the cost report that includes July 1, 2003, 
and CMS should not reduce the hospital's FTE resident caps based on a 
lower FTE resident count on the cost report ending on or before 
September 30, 2002 if its FTE resident level has subsequently increased 
due to the addition of the new program(s) not addressed under section 
1886(h)(7)(A)(ii)(III) of the Act.
    Response: Section 1886(h)(7)(A)(ii)(II) of the Act, as added by 
section 422(a) of Public Law 108-173, provides that if a hospital's 
resident level increased due to an expansion of an existing program, 
and that expansion is not reflected on the hospital's most recent 
settled cost report, a hospital may make a timely request to CMS that, 
rather than using its most recent cost reporting period ending on or 
before September 30, 2002, to determine if its FTE resident cap should 
be reduced, CMS should use the cost report for the hospital's cost 
reporting period that includes July 1, 2003. In the May 18, 2004 
proposed rule (69 FR 28295), we proposed that ``expansion of an 
existing program'' means that the hospital's total number of unweighted 
allopathic and osteopathic FTE residents in existing programs in a cost 
reporting period up to and including the hospital's cost report that 
includes July 1, 2003, is greater than the resident level in the 
hospital's most recent settled cost report. In other words, generally, 
as long as a hospital trained more unweighted allopathic and 
osteopathic FTE residents in a cost reporting period after its most 
recent settled cost report in programs that were existing during the 
cost reporting period for the most recently settled cost report, it may 
submit a timely request that its cost report that includes July 1, 
2003, be used for purposes of determining any FTE resident cap 
reduction under section 1886(h)(7)(A)(i) of the Act. We believe this 
definition of an existing program is consistent with the language and 
intent of section 1886(h)(7)(A)(ii)(II) of the Act, which specifically 
addresses expansions of existing programs not reflected on the 
hospital's most recent settled cost report. Therefore, in order for a 
hospital to qualify to submit a timely request to use its cost report 
that includes July 1, 2003, the increase in its overall resident level 
must be due to an increase in the number of residents that were in 
residency programs in which the hospital was training residents in its 
most recent settled cost report. For the purposes of this provision, a 
hospital first must determine whether the total unweighted allopathic 
and osteopathic FTE count (not program-specific, but for all allopathic 
and osteopathic programs combined) in a cost reporting period 
subsequent to its most recent settled cost reporting period up to and 
including the cost report that includes July 1, 2003, is greater than 
the total unweighted allopathic and osteopathic FTE count in its most 
recent settled cost report. If there has been an increase in the total 
unweighted allopathic and osteopathic FTE resident count since the last 
settled cost report, the hospital must determine if that increase is 
due to expansion of a program(s) in which that hospital trained FTE 
residents in its most recent settled cost report, or whether the 
increase is due to a new or a different specialty program for which the 
hospital did not train FTE residents in its most recent settled cost 
report. For example, assume that a hospital's most recent settled cost 
report ending on or before September 30, 2002, is the cost reporting 
period ending December 31, 2000, and the hospital only trained 10 FTE 
internal medicine residents in that period. The hospital began training 
2 FTE residents in a pediatrics program in 2001, so that the hospital's 
total unweighted allopathic and osteopathic resident level on its FYE 
December 31, 2001 cost report increased by 2 FTEs to equal 12. Because 
the increase in the resident level is entirely attributable to the 
residents in the pediatrics program, a specialty program in which the 
hospital did not train FTE residents in its FYE December 31, 2000 cost 
report, this hospital would not qualify to use the cost report that 
includes July 1, 2003, as its reference period because the increase in 
the resident level is due to residents in a new program rather than an 
expansion of an existing program not reflected on the last settled cost 
report. On the other hand, if any of the additional residents counted 
in FYE December 31, 2001 (using the same example) would be internal 
medicine residents, a program in which the hospital did participate and 
train FTE residents in FYE December 31, 2000 (its last settled cost 
report), the hospital may qualify to make a timely request to use the 
cost reporting period that includes July 1, 2003 due to an expansion of 
an existing program that was not reflected on the last settled cost 
report of FYE December 31, 2000.
(3) Audits of the Reference Cost Reporting Periods
    As mentioned under section IV.O.2.f.(1) of this preamble, to 
determine a possible reduction to a hospital's FTE resident cap, 
section 1886(h)(7)(A)(ii)(I) of the Act, as added by section 422(a) of 
Public Law 108-173, directs CMS to use a hospital's most recent cost 
reporting period ending on or before September 30, 2002, ``for which a 
cost report has been settled (or, if not, submitted (subject to audit), 
as determined by the Secretary'' (emphasis added). In the May 18, 2004 
proposed rule (69 FR 28295), we proposed to interpret this language to 
mean that, if a hospital's cost report for the most recent cost 
reporting period ending on or before September 30, 2002, has been 
settled, then, unless the hospital submits a timely request to use the 
cost reporting period that includes July 1, 2003, we would use the 
hospital's settled cost report without further audit to determine 
possible reductions to the FTE resident caps. We also proposed to 
interpret this language to mean that if a hospital's cost report for 
the most recent cost reporting period ending on or before September 30, 
2002, has not been settled, the hospital's as-submitted cost report for 
the most recent cost reporting period ending on or before September 30, 
2002, would be subject to audit by

[[Page 49123]]

the fiscal intermediary. In addition, as stated under section 
1886(h)(7)(A)(ii)(II) of the Act, use of a hospital's cost report that 
includes July 1, 2003 is made ``after audit and subject to the 
discretion of the Secretary.'' A hospital's cost report that includes 
July 1, 2003 may be at various stages of settlement, or may not even be 
submitted at the time this proposed rule is published. For example, if 
a hospital has a fiscal year end of June 30, its cost reporting period 
that includes July 1, 2003 would not end until June 30, 2004. This cost 
report is not required to be submitted until 5 months after the cost 
reporting period closes, which would be by December 1, 2004. In any 
case, the fiscal intermediary would need to make a determination as to 
whether a hospital has actually increased its resident level due to an 
expansion of an existing program that is not reflected on the most 
recent settled cost report. Further, the FTE resident counts that are 
included (or would be included) in the cost report that includes July 
1, 2003, are subject to audit by the fiscal intermediary to ensure that 
an appropriate determination is made as to whether, and by how much, a 
hospital's FTE resident cap will be reduced. To facilitate these 
determinations, in the May 18, 2004 proposed rule, we proposed that the 
fiscal intermediaries may audit the FTE resident counts as necessary in 
the most recently settled cost reports and in the cost reports up to 
and including the cost report for the cost reporting period that 
includes July 1, 2003.
    Fiscal intermediaries will perform desk or onsite audits related to 
section 422, using instructions that will be issued in a separate 
document. As we explained in the OTN, Transmittal No. 77, CR 3247, in 
the interest of time and the most efficient use of audit resources, we 
have required that if a hospital would like CMS to use its cost report 
that includes July 1, 2003, as its reference period due to an expansion 
of an existing program, the hospital must notify the fiscal 
intermediary in accordance with the instructions provided in the OTN by 
June 4, 2004 (later revised to June 14, 2004). If a hospital submits a 
timely request that its cost report that includes July 1, 2003, be 
used, we proposed that the fiscal intermediary would audit that cost 
report and previous cost reports as necessary to determine if the 
hospital increased its resident level due to an expansion of an 
existing program that is not reflected on the most recent settled cost 
report. If a hospital does not submit a timely request to the fiscal 
intermediary that its cost report that includes July 1, 2003, be used, 
we proposed that the fiscal intermediary would use the cost report for 
the most recent cost reporting period ending on or before September 30, 
2002, to determine if, and by how much, a hospital's FTE resident cap 
should be reduced, as specified under section 1886(h)(7)(A)(ii)(I) of 
the Act. If the cost report that is used to determine the possible 
reduction to a hospital's FTE resident count is for a period of less 
than or more than 12 months, we proposed that the fiscal intermediary 
would prorate the FTE resident caps and unweighted FTE residents to 
equal 12-month counts.
    Comment: Some commenters urged CMS to keep in mind that Congress' 
intent is to redistribute only ``unused'' slots, and requested that a 
hospital's FTE resident cap should not be reduced on account of FTEs 
that were disallowed because the hospital did not fulfill paperwork or 
other requirements associated with receiving direct GME or IME 
payments. The commenters believed that the legislation dictates that 
the hospital's FTE resident cap not be reduced as a consequence of 
technical lapses because the slots are unquestionably being ``used'', 
despite the fact that for cost report payment purposes, a lower FTE 
count may be used. One commenter added that, in the case where there is 
a discrepancy between a hospital's submitted FTE resident count and the 
audited FTE resident count, and the audited count would result in a 
(more substantial) lowering of the hospital's FTE resident cap, then 
the determination should be made on the basis of the as-submitted FTE 
resident count.
    Response: We are sympathetic to the commenter's point that it was 
not the intention of Congress to reduce a hospital's FTE resident cap 
solely because the hospital failed to comply with certain paperwork 
requirements necessary for receiving direct GME and IME payment with 
respect to FTE residents that a hospital actually trained. 
Nevertheless, we believe that Congress was aware that there could be 
certain anomalies in a hospital's FTE count in a given year, and 
therefore, provided for some flexibility in determining the reference 
resident levels by granting hospitals the option to use the cost report 
that includes July 1, 2003 due to expansions of existing programs that 
were not reflected on the most recent settled cost report under section 
1886(h)(7)(A)(ii)(II) of the Act, or to adjust the reference resident 
level to include the number of residents in newly approved programs 
under section 1886(h)(7)(A)(ii)(III) of the Act, rather than only using 
the most recent cost report that ended on or before September 30, 2002. 
We believe that Congress in fact intended that CMS use only allowable 
FTE resident counts in determining any applicable reductions to a 
hospital's FTE resident cap under this provision. Furthermore, in 
directing CMS to use ``resident levels'', or FTE data from the 
hospital's cost reporting period ending on or before September 30, 2002 
or the cost reporting period that includes July 1, 2003, the statute 
directs that the cost reports to be used are ``subject to audit''.
    Comment: One commenter stated that the proposed rule does not 
provide an indication of how or when audits under section 422 will be 
performed or what standards will be used to determine a hospital's 
unused resident slots. The commenter asked that CMS provide specific, 
detailed information about such audits and then review and respond to 
providers' comments prior to finalizing the audit protocols.
    Response: We believe it is inappropriate to share the details of 
the audit procedures with providers and allow them the opportunity for 
comment. The Medicare audit program has always been confidential, to be 
shared only with the fiscal intermediaries, and will continue to be so. 
However, as with the audits conducted as part of any cost report 
settlement process, the fiscal intermediaries will request 
documentation needed to audit the FTE resident count and will provide 
hospitals with the opportunity to review and to respond to the proposed 
audit adjustments, prior to the finalization of the audit adjustments.
(4) Expansions Under Newly Approved Programs
    Under section 1886(h)(7)(ii)(III) of the Act, as added by section 
422(a)(3) of Public Law 108-173, a hospital may request that its 
reference resident level be adjusted to include residents in certain 
newly approved programs. Specifically, if a hospital's new program was 
accredited by the appropriate accrediting body (that is, the 
Accreditation Council on Graduate Medical Education (ACGME) or the 
American Osteopathic Association (AOA)) before January 1, 2002, but was 
not in operation during the hospital's reference period, the hospital 
may submit a timely request that we adjust the reference resident level 
to include the number of residents for which a new program was 
accredited at a hospital(s). In the May 18, 2004 proposed rule (69 FR 
28296), for a hospital that requests an adjustment due to a newly 
approved

[[Page 49124]]

program, we proposed to determine a hospital's reference period as we 
otherwise would. If a hospital received accreditation for a new medical 
residency training program before January 1, 2002, but the program was 
not in operation (that is, the hospital did not begin training 
residents in that program) during its reference period (which will be 
either the most recent cost reporting period ending on or before 
September 30, 2002, or the cost reporting period that includes July 1, 
2003), the hospital may submit a timely request by June 4, 2004 (later 
revised to June 14, 2004), as explained in the OTN, that its resident 
level for its reference period be adjusted to reflect the number of 
accredited slots for which that new medical residency training program 
was approved. We note that section 1886(h)(7)(A)(ii)(III) of the Act 
does not require that CMS include the number of residents for which the 
new program is accredited in the hospital's reference cost reporting 
period for purposes of determining direct GME and IME payment in that 
reference cost reporting period. Rather, CMS is only required to 
include the number of residents for which a new program was accredited 
in the resident level for purposes of determining if, and by how much, 
a hospital's FTE resident cap should be reduced under section 
1886(h)(7)(A) of the Act.
    For example, assume a hospital that has a fiscal year end of June 
30 received accreditation in October 2001 to train 10 residents in a 
new surgery program. The hospital does not have an expansion of an 
existing program not reflected on its most recent settled cost report, 
so its reference period is the most recent cost reporting period ending 
on or before September 30, 2002. The hospital first begins to train 
residents in the new surgery program on July 1, 2002. The new surgery 
residents are not reflected on the hospital's June 30, 2002 cost 
report, which is the hospital's most recent cost reporting period 
ending on or before September 30, 2002. Thus, the hospital may submit a 
timely request that we increase its resident level for the cost report 
ending June 30, 2002, by 10 FTE residents to reflect the residents 
approved for the new surgery program for purposes of determining if the 
hospital's reference resident level is below its otherwise applicable 
resident cap. However, we note that if the hospital's fiscal year end 
in this example was September 30, a program accredited in October 2001 
and begun on July 1, 2002, would be in operation during the hospital's 
cost reporting period ending on September 30, 2002, and the hospital 
could not receive an increase to its resident level for its cost 
reporting period ending September 30, 2002, to include the total number 
of accredited resident positions in the new surgery program. If the new 
program was accredited for a range of residents (for example, a 
hospital receives accreditation to train 6 to 8 residents in a new 
internal medicine program), we proposed that the hospital may request 
that its resident level for its most recent cost reporting period 
ending on or before September 30, 2002 be adjusted to reflect the 
maximum number of accredited positions (which, in this example, would 
be 8 internal medicine residents). We also proposed that at the time 
the hospital makes the timely request to have its resident level 
adjusted to include the number of accredited resident positions, the 
new program need not be training the full complement of residents for 
which the program was accredited. (Proposed redesignated Sec.  
413.79(c)(3)(A)(3)(ii)). In addition, if more than one hospital was 
approved as a training site for the residents in the newly accredited 
program (that is, more than one hospital sponsors the program or there 
are other participating institutions that serve as training sites for 
the residents in the program), we proposed that the adjustment to a 
requesting hospital's reference resident level would reflect the 
appropriate portions of the FTE residents in the new program that would 
be training at that hospital.
    Similarly, if, in addition to having accreditation for a new 
program, a hospital has an expansion of an existing program that is not 
reflected on the most recent settled cost report, that hospital may 
submit a timely request that its resident level for the cost reporting 
period that includes July 1, 2003, be adjusted to include the number of 
resident positions for which a new program was accredited. We proposed 
that a hospital whose reference period is the one that includes July 1, 
2003, may only request that its reference resident level be adjusted to 
include the accredited number of residents for a new program if, in 
accordance with section 1886(h)(7)(A)(ii)(III) of the Act, the new 
program was approved by the appropriate accrediting body before January 
1, 2002, but was not in operation during the cost reporting period that 
includes July 1, 2003. This proposal was based on our interpretation of 
the statutory language, which states that ``the Secretary shall adjust 
the reference resident level specified under subclause (I) or (II) to 
include the number of residents that were approved * * * for a medical 
residency program * * * but which was not in operation during the cost 
reporting period used under subclause (I) or (II) * * * '' (emphasis 
added). Because the statute provides for an adjustment to the reference 
resident level ``specified under subclause I or II,'' as mentioned 
above, for hospitals that request an adjustment under section 
1886(h)(7)(A)(ii)(III) of the Act, we proposed to identify the 
applicable reference period as we otherwise would under section 
1886(h)(7)(A)(ii)(I) and (II) of the Act. That is, we proposed to use 
the hospital's most recent cost reporting period ending on or before 
September 30, 2002, as the reference cost reporting period, unless the 
hospital submits a timely request to use the cost reporting period that 
includes July 1, 2003, due to an expansion of an existing program that 
is not reflected on the cost recent settled cost report. We also noted 
that, as mentioned above, subclause (III) requires that the program be 
accredited before January 1, 2002, but not be in operation during the 
hospital's reference cost reporting period, or in this case, the period 
that includes July 1, 2003. This means that, in order for the hospital 
to receive an adjustment to its reference resident level under section 
1886(h)(7)(A)(ii)(III) of the Act for the cost reporting period that 
includes July 1, 2003, the new program also cannot be in operation in 
the cost reporting period that includes July 1, 2003. Thus, while we 
believe it is possible for a hospital to qualify for this adjustment 
because the hospital started a new program that is not reflected on its 
most recent cost reporting period ending on or before September 30, 
2002, we believe that few, if any, hospitals will qualify for this 
adjustment for a new program that was not in operation in the cost 
report that includes July 1, 2003, because it is unlikely that a 
program would receive its accreditation prior to January 1, 2002, and 
still not be in operation by July 1, 2003.
    Comment: Several commenters believed that the proposed ``new 
program'' exception as outlined in the proposed rule and the recently 
issued One-Time Notification (Change Request 3247, Transmittal 87, 
issued on May 26, 2004) is too restrictive. Under the proposal, a 
hospital's resident count can only be increased if no residents from 
the newly approved program were training during the relevant cost 
reporting period. One commenter gave an example that if a new residency 
program ``was accredited on January 1, 2001 and began training 
residents on July 1, 2001, and the hospital's relevant

[[Page 49125]]

cost reporting year for implementing section 422 was July 1, 2001 to 
June 30, 2002, that year would likely reflect only residents being 
trained in the first program year [of the new program.] If the 
hospital's FTE resident count is below its resident FTE cap for that 
year * * * it is at risk of having its cap reduced even though it has 
committed to training the residents in that program and was intending 
to use its 'cap space' for that program.'' The commenter asserted that 
such a result is contrary to the intent of Congress and that the 
proposed rule should be modified in its final version to allow new 
residency programs to grow to their full complement.
    Response: Under section 1886(h)(7)(ii)(III) of the Act, as added by 
section 422(a)(3) of Public Law 108-173, a hospital may request that 
its reference resident level be adjusted to include residents in 
certain newly approved programs. Specifically, if a hospital's new 
program was accredited by the appropriate accrediting body (that is, 
the ACGME or the AOA) or approved by the American Board of Medical 
Specialties (ABMS) before January 1, 2002, but was not in operation 
during the hospital's reference period, the hospital may submit a 
timely request that we adjust the reference resident level to include 
the number of residents for which a new program was accredited at a 
hospital(s). While we sympathize with the commenters' points, we have 
interpreted ``not in operation'' to mean that the hospital was not 
training residents in that program during its reference cost reporting 
period. As such, a residency program that was accredited before January 
1, 2002, and was training any residents during the hospital's reference 
cost reporting period would not be eligible to make a timely request 
that its resident level for its reference period be adjusted to reflect 
the number of accredited slots for which that new medical residency 
training program was approved.
    We are, however, sympathetic to the commenters' point that 
hospitals with new residency programs that were in operation during the 
reference period may not be able to grow to their full complement of 
residents if their FTE resident cap is reduced if their reference FTE 
resident count is below their reference FTE resident cap. However, such 
a hospital may apply for additional FTE resident slots under section 
1886(h)(7)(B) of the Act in an attempt to adjust its cap to allow for 
payment for the additional slots in the new program. In this final 
rule, as discussed under section IV.O.2.m. of this preamble, we are 
adding an evaluation criterion to address the situation where a 
hospital's FTE resident cap was reduced under section 1886(h)(7)(A)(i) 
of the Act and the hospital had started a new residency program 
(accredited before January 1, 2002) that was in operation during the 
reference period but had not yet reached a full complement and the 
hospital has requested additional slots to allow the new program to 
train residents in FTE positions that were not included in the 
reference resident period. For the purposes of this criterion, we are 
defining a new program as a program that has been in operation 
(training residents) for three or fewer years in the reference period. 
In addition, the hospital must not qualify for adjustment to its 
reference FTE resident count under section 1886(h)(7)(ii)(III) of the 
Act and the hospital's FTE resident cap must have been reduced under 
section 1886(h)(7)(A)(i) of the Act.
    Comment: One commenter described a situation where a hospital took 
over permanent sponsorship and training of residents in a program from 
another hospital that was experiencing financial difficulties. The 
hospital became the sponsor of and received accreditation for 16 
residents in the program by November 2002, while continuing to train 
the remnant of residents that transferred from the other hospital. The 
hospital began training its own residents in the program on July 1, 
2003, and planned to grow the program to its full complement of 16 
residents by July 1, 2005. The commenter requested that, due to the 
circumstances surrounding the program which experienced a temporary 
drop in enrollment due to another hospital's financial difficulties, 
the hospital be permitted to adjust its reference resident level on its 
cost report that includes July 1, 2003 to reflect the full 16 
accredited slots, rather than the 10 actual FTEs that were training in 
that cost reporting period.
    Response: As with many situations brought to our attention by 
commenters, we are sympathetic to this commenter's concerns, but we 
note that the language at section 1886(h)(7)(ii)(III) of the Act 
precludes us from granting the commenter's request. Specifically, under 
section 1886(h)(7)(ii)(III) of the Act, a hospital may request that its 
reference resident level be adjusted to include residents in certain 
newly approved programs if the new program was accredited by the 
appropriate accrediting body before January 1, 2002, was not in 
operation during the hospital's reference period, and the hospital 
submits a timely request that we adjust the reference resident level to 
include the number of residents for which a new program was accredited 
at the hospital. Therefore, the commenter's hospital would not qualify 
to have the resident level on its cost report that includes July 1, 
2003 adjusted to reflect residents in its new program for two reasons: 
first, its program received accreditation after January 1, 2002, not 
before January 1, 2002 as the statute specifies; second, the program 
was in operation during the hospital's reference cost reporting period 
(that is, the cost report that includes July 1, 2003). In order for the 
hospital to receive an adjustment to its reference resident level under 
section 1886(h)(7)(A)(ii)(III) of the Act for the cost reporting period 
that includes July 1, 2003, the new program also cannot be in operation 
in the cost reporting period that includes July 1, 2003.
(5) Affiliations
    Section 1886(h)(7)(A)(iii) of the Act, as added by section 
422(a)(3) of Public Law 108-173, directs the Secretary to consider 
whether a hospital is a member of a Medicare GME affiliated group (as 
defined under Sec.  413.86(b)) as of July 1, 2003, in determining 
whether a hospital's FTE resident cap should be reduced. As described 
above, some hospitals that have reduced their resident levels below 
their FTE resident caps may have affiliated with other hospitals that 
would otherwise exceed their FTE resident caps. Thus, while some 
hospitals were below their FTE resident caps prior to entering into a 
Medicare GME affiliation agreement, upon affiliating, their FTE 
resident caps were temporarily reduced because some or all of their 
excess FTE slots were temporarily added to the FTE caps of other 
hospitals as part of the affiliation agreement. Under the Medicare GME 
affiliation agreement, these otherwise ``excess'' FTE slots have been 
transferred for use by other hospitals, and, therefore, CMS would take 
into account the revised caps under the affiliation agreement for both 
the hospital that would otherwise be below its FTE resident cap and the 
revised caps of the other hospital(s) that are part of an affiliated 
group. In determining whether hospitals' FTE resident caps should be 
reduced under section 1886(h)(7)(A)(i) of the Act, section 
1886(h)(7)(A)(iii) of the Act directs CMS to consider hospitals ``which 
are members of the same affiliated group . . . as of July 1, 2003.'' In 
the May 18, 2004 proposed rule (69 FR 28297), we proposed that 
hospitals that are affiliated ``as of July 1, 2003'' means hospitals 
that have in effect a Medicare GME affiliation agreement, as defined in 
existing Sec.  413.86(b), for the program year July 1, 2003 through 
June 30, 2004,

[[Page 49126]]

and have submitted a Medicare GME affiliation agreement by July 1, 2003 
to their fiscal intermediaries with a copy to CMS. These hospitals may 
have already been affiliated prior to July 1, 2003, or may have 
affiliated for the first time on July 1, 2003. In either case, in 
determining possible reductions to a hospital's FTE resident cap, we 
proposed to use a hospital's cap as revised by the July 1, 2003 
Medicare GME affiliation agreement. We believe this interpretation is 
consistent with the intent of section 1886(h)(7)(A)(iii) of the Act, as 
added by section 422(a)(3) of Public Law 108-173, in that a hospital's 
FTE resident cap should not be reduced if some or all of its excess 
resident slots have been transferred for use by hospitals with which it 
is affiliated (that is, the hospital is training at least as many FTE 
residents as are in its ``affiliated'' FTE resident cap).
    Although hospitals in an affiliated group base the FTE cap 
adjustments on an aggregate FTE resident cap, we proposed that we would 
determine whether a hospital's FTE resident cap should be reduced on a 
hospital-specific basis. Section 1886(h)(7)(A)(iii) of the Act states 
that ``the provisions of clause (i) shall be applied to hospitals which 
are members of the same affiliated group * * *'' (emphasis added). 
Clause (i) of section 1886(h)(7)(A) of the Act, as described above, 
requires the reduction of hospitals' FTE resident caps under certain 
circumstances, based on the otherwise applicable FTE resident cap and 
the resident level in the applicable reference period, as described 
above (which would be either a hospital's most recent cost reporting 
period ending on or before September 30, 2002, or the cost reporting 
period that includes July 1, 2003). We proposed to interpret this 
reference to clause (i) to mean that the Secretary is to use a 
hospital's July 1, 2003 ``affiliated'' FTE resident cap as the 
otherwise applicable FTE resident cap when determining a possible 
reduction to the FTE resident cap. In other words, if a hospital is 
affiliated as of July 1, 2003, we proposed to superimpose the 
``affiliated'' FTE resident cap onto the hospital's reference cost 
reporting period.
    Specifically, as we stated under section IV.O.2.f.(1) of this 
preamble, consistent with section 1886(h)(7)(A)(ii)(I) of the Act, to 
determine possible reductions to a hospital's FTE resident cap, we 
proposed that we would use a hospital's most recent cost reporting 
period ending on or before September 30, 2002. If a hospital is part of 
a Medicare affiliated group for the program year beginning July 1, 
2003, we are proposing to compare the hospital's July 1, 2003 
``affiliated'' FTE resident cap to its resident level on the most 
recent cost report ending on or before September 30, 2002. If the 
hospital's resident level from its most recent cost report ending on or 
before September 30, 2002, is below its July 1, 2003 ``affiliated'' FTE 
resident cap, we are proposing to permanently reduce the hospital's FTE 
resident cap, that is, the hospital's FTE resident cap without the 
temporary adjustment under the July 1, 2003 affiliation agreement, by 
75 percent of the difference between the hospital's resident level and 
the July 1, 2003 ``affiliated'' FTE resident cap.
    Alternatively, as stated above under section IV.O.2.f.(2) of this 
preamble, consistent with section 1886(h)(7)(A)(ii)(II) of the Act, a 
hospital may submit a timely request to CMS that its cost report that 
includes July 1, 2003, be used as the reference period to determine 
possible FTE resident cap reductions because of an expansion of an 
existing program that is not reflected on the hospital's most recent 
settled cost report. If a hospital is affiliated for the program year 
beginning July 1, 2003, and we grant the hospital's timely request to 
use the cost reporting period that includes July 1, 2003, because its 
expansion of an existing program(s) is not reflected on the most recent 
settled cost report, we proposed to compare the hospital's July 1, 2003 
``affiliated'' FTE resident cap to its resident level on the cost 
report that includes July 1, 2003. If the hospital's resident level 
from its cost report that includes July 1, 2003 is below its July 1, 
2003 ``affiliated'' FTE resident cap, we proposed to permanently reduce 
the hospital's FTE resident cap, that is, the hospital's FTE resident 
cap without the temporary adjustment under the July 1, 2003 affiliation 
agreement, by 75 percent of the difference between the hospital's 
resident level and the July 1, 2003 ``affiliated'' FTE resident cap.
    For example, Hospital A's most recent cost report ending on or 
before September 30, 2002 is FYE December 31, 2001. Hospital A has a 
direct GME FTE resident cap (unadjusted for an affiliation) of 100, and 
an IME FTE resident cap (unadjusted for an affiliation) of 90. Hospital 
A did not have an expansion of an existing program that was not 
reflected on its most recent settled cost report, and therefore, its 
FYE December 31, 2001 cost report is being used as the reference period 
for purposes of determining a possible reduction to its FTE resident 
caps. Hospital A's unweighted direct GME count of allopathic and 
osteopathic FTE residents on its December 31, 2001 cost report is 60. 
Hospital A's IME count of allopathic and osteopathic FTE residents on 
its December 31, 2001 cost report is 55.
    Hospital B, with a FYE of September 30, expanded an existing 
program, and that expansion is not reflected on its most recent settled 
cost report. Hospital B has submitted, and we have granted, a timely 
request that its cost report that includes July 1, 2003 (that is, its 
FYE September 30, 2003 cost report) be used for purposes of determining 
a possible reduction to its FTE resident caps. Hospital B has a direct 
GME FTE resident cap (unadjusted for an affiliation) of 100, and an IME 
FTE resident cap (unadjusted for an affiliation) of 95. Hospital B's 
direct GME unweighted count of allopathic and osteopathic FTE residents 
on its September 30, 2003 cost report is 120, and its IME count of 
allopathic and osteopathic FTE residents for the same period is 110.
    On July 1, 2003, Hospital A and Hospital B entered into a Medicare 
GME affiliation agreement. Under the affiliation agreement, the 
hospitals' FTE resident caps are revised as follows:

[[Page 49127]]

[GRAPHIC] [TIFF OMITTED] TR11AU04.056

    To apply section 1886(h)(7)(A)(i) of the Act, Hospital A's 
affiliated FTE resident caps as of July 1, 2003, are compared to its 
direct GME and IME allopathic and osteopathic FTE resident counts 
from its FYE December 31, 2001 cost report, and Hospital B's 
affiliated FTE resident caps as of July l, 2003, are compared to its 
direct GME and IME allopathic and osteopathic FTE resident counts 
from its FYE September 30, 2003 cost report, as follows:
[GRAPHIC] [TIFF OMITTED] TR11AU04.057

[GRAPHIC] [TIFF OMITTED] TR11AU04.058

    Effective for portions of cost reporting periods beginning on or 
after July 1, 2005, Hospital A's FTE resident caps for direct GME and 
IME will remain at 100 and 90, respectively, while Hospital B's FTE 
resident caps for direct GME and IME will be reduced to 85 and 80, 
respectively.
    We also noted that there are hospitals that may have been members 
of a Medicare GME affiliated group in program years that coincide with 
or overlap the reference cost reporting periods, but these hospitals 
were not affiliated as of July 1, 2003. As such, they are not subject 
to the May 18, 2004 proposed policy described above applicable to 
section 1886(h)(7)(A)(iii) of the Act, as added by section 422(a)(3). 
For these hospitals, we proposed to compare the resident level in the 
applicable reference period to the FTE resident cap as adjusted by the 
affiliation agreement applicable to that reference period. If a 
hospital's resident level is below its otherwise applicable FTE 
resident cap for that reference period cost report, we proposed to 
permanently reduce the hospital's FTE resident cap, that is, the 
hospital's FTE resident cap without the temporary adjustment under the 
affiliation agreement for that period, by 75 percent of the difference 
between the hospital's resident level and the otherwise applicable FTE 
resident cap. (Proposed redesignated Sec.  413.79(c)(3)(iv)(B)). For 
example, assume a hospital with a June 30 fiscal year end affiliated 
for one program year from July 1, 2001, through June 30, 2002. On its 
June 30, 2002 cost report (that is, its most recent cost report ending 
on or before September 30, 2002), its FTE resident cap is 20, its cap 
as revised by the affiliation agreement is 25, and its resident level 
is 21 FTEs. Because this hospital's resident level of 21 is below its 
otherwise applicable FTE resident cap of 25, the hospital's FTE 
resident cap of 20 will be reduced as follows: 20 - [(.75(25 - 21)] = 
17. We proposed to apply the same methodology described above in the 
event that the reference period is a hospital's cost report that 
includes July 1, 2003 (that is, for a hospital that had an expansion of 
a program that is not reflected on its most recent settled cost report 
and that made a timely request to use the period that includes July l, 
2003), if that hospital is not affiliated as of July 1, 2003, but its 
cost report that includes July 1, 2003 overlaps with a program year for 
which the hospital was affiliated. In other words, section 
1886(h)(7)(A)(i) of the Act will be applied by comparing a hospital's 
reference resident level to the otherwise applicable FTE resident cap, 
as adjusted

[[Page 49128]]

for any affiliation agreement for the reference period.
    Comment: Some commenters acknowledged the challenges that CMS faced 
in implementing section 422, particularly section 1886(h)(7)(A)(iii) of 
the Act related to hospitals that are members of a Medicare GME 
affiliated group ``as of July 1, 2003,'' and commended CMS for its work 
on proposals related to this provision. However, those commenters, 
along with many others, expressed concern about the proposed policy 
related to hospitals that were affiliated as of July 1, 2003, and asked 
that our final policy concerning possible FTE resident cap reductions 
for these hospitals be amended substantially.
    Generally, the comments concerning Medicare GME affiliation 
agreements fell into the following four categories:
    (1) Hospitals that are affiliated for the academic year beginning 
July 1, 2003 should have their applicable FTE resident cap for the 
period including July 1, 2003 compared to their applicable resident 
level for the period including July 1, 2003. The commenters expressed 
great concern regarding the proposed methodology whereby a hospital's 
``affiliated'' FTE resident cap for the period July 1, 2003 to June 30, 
2004 would be compared to the hospital resident FTE counts 
corresponding to a different (in some cases, not even overlapping) 
period for purposes of section 422. Although the commenters recognized 
that, in proposing this methodology, CMS was attempting to reconcile 
and give meaning to seemingly inconsistent provisions within section 
422, they strongly believed that teaching hospitals should be provided 
with, and that CMS has the authority to provide, the ``most 
straightforward'' option. They stated that it would not ``make sense'' 
to reduce the FTE resident cap of a hospital based on a comparison of 
its cap in an affiliation agreement that was from a period different 
than its reference cost reporting period. Therefore, most commenters 
generally recommended that each hospital's specific July 1, 2003 
``affiliated'' FTE resident cap should be compared to its FTE resident 
count for the July 1, 2003 through June 30, 2004 academic year, while 
one commenter recommended that CMS allow each hospital to elect whether 
to have its specific July 1, 2003 ``affiliated'' FTE resident cap 
compared to its FTE resident count for the period July 1, 2003 to June 
30, 2004, for purposes of determining if and by how much the hospital's 
FTE resident caps would be reduced.
    (2) Hospitals that are affiliated for the academic year beginning 
July 1, 2003 should be permitted to compare their FTE resident caps 
from their modified, final submitted Medicare GME affiliation 
agreements for the academic year beginning July 1, 2003 and ending June 
30, 2004 to their applicable resident level for the cost reporting 
period including July 1, 2003. The commenters noted that the existing 
regulations allow hospitals to modify their affiliation agreements by 
June 30 of a particular academic year to reflect the realities of the 
time spent in various training rotations in the event that the planned 
number of FTEs trained at each hospital, as specified in the 
affiliation agreement submitted to the fiscal intermediary by July 1 of 
that year, differs from the actual training rotations that occurred 
during the year. The commenters stressed that, for purposes of the 
``redistribution of unused resident slots'', it is also important to 
allow affiliated hospitals to modify their arrangements to reflect the 
actual distribution of the member hospitals' FTE residents and their 
aggregate FTE resident cap; and the use of final, possibly modified 
affiliated FTE caps could avert unintended adverse consequences.
    (3) Hospitals that are affiliated for the academic year beginning 
July 1, 2003 should be given the opportunity after the final rule is 
published to amend the affiliation agreement that was in place as of 
June 30, 2004. The commenters asked that CMS grant hospitals that were 
affiliated for the academic year beginning July 1, 2003, the option to 
modify those affiliations after publication of the final rule to 
account for ``unintended consequences,'' since the deadline of June 30, 
2004 for potential amendments to the July 1, 2003 agreements occurred 
during the comment period for the FY 2005 IPPS proposed rule, and there 
was still much uncertainty regarding how the agreements would be 
accounted for under section 422. The commenters stated that they should 
be granted this option because, when hospitals elected to join an 
affiliated group as of July 1, 2003, the hospitals ``had no way of 
knowing that this election would have implications for potential 
reductions to their hospital-specific resident FTE caps.''
    (4) Hospitals that are affiliated for the academic year beginning 
July 1, 2003 and that are at or above the aggregate cap should be 
treated as a group and should not lose any resident positions under 
section 422. Several commenters argued that the presence of the 
language at section 1886(h)(7)(A)(iii) of the Act concerning hospitals 
that are ``members of the same affiliated group * * * as of July 1, 
2003'' implies that Congress was giving special consideration to 
hospitals that had elected to join an affiliated group for Medicare 
purposes, and that the initial FTE resident cap and count comparison 
under section 1886(h)(7)(A)(i) of the Act should first be conducted at 
the affiliated group level. The commenters urged CMS to ensure that a 
determination that finds the aggregate count of the hospitals in the 
affiliation to be higher than the aggregate cap should ``automatically 
and without question'' exempt all hospitals within the group from any 
reduction in hospital-specific caps. Some commenters suggested that 
this interpretation is consistent with CMS' current policy on 
affiliated groups for payment purposes when the group as a whole is 
under the aggregate cap. Some commenters also added that in the case 
where the groups aggregate FTE count is below the corresponding 
affiliated aggregate FTE cap, CMS should use a hospital-specific 
comparison to determine which hospitals in the group should have their 
FTE resident caps reduced. Another commenter recommended that CMS 
should aggregate the excess FTE resident slots for the entire 
affiliated group, and any reduction should be prorated among all 
hospitals in the affiliated group.
    Response: We have given a considerable amount of thought to each 
comment received regarding our proposed policy on hospitals that are 
part of a Medicare GME affiliation group for the academic year 
beginning July 1, 2003. In addition, during the comment period for the 
proposed rule, we listened to many questions and concerns raised as a 
result of the issuance of the OTN, which included a deadline of June 
14, 2004 for all hospitals, whether affiliated or not, to submit a 
timely request to the fiscal intermediary if a hospital wanted its cost 
report that includes July 1, 2003 to be used for purposes of 
determining possible reductions to its FTE resident caps. We 
acknowledge that the proposal concerning affiliated groups presented 
certain difficulties, particularly in light of the June 14, 2004 
deadline. To mitigate those concerns, we issued a notice on June 15, 
2004 on the CMS Web site [Notice on ``Redistribution of Unused Resident 
Positions, http://www.cms.hhs.gov/providers/hipps/resident.asp],'' 
which stated, ``If, in response to comments, we finalize any policy 
with respect to application of section 1886(h)(7)(A) of the Act that 
differs from a policy described in the

[[Page 49129]]

OTNs and the proposed IPPS rule, we will provide another limited 
opportunity after publication of the final rule for affected hospitals 
to make or withdraw a timely request under section 1886(h)(7)(A)(ii) of 
the Act.''
    Before stating our final policy, we would first like to explain our 
reasoning behind the proposal concerning affiliated groups relating to 
section 1886(h)(7)(A)(iii) of the Act. As is the case with any 
statutory language, the assumption must be that the Congress included 
this specific language at section 1886(h)(7)(A)(iii) of the Act to 
direct or grant the authority for the Secretary to take (or not take) 
certain action concerning affiliated groups that would not otherwise 
have been taken (or not taken) in the absence of that language. 
However, sections 1886(h)(7)(A)(i) and (C)(ii) of the Act already 
accounted for the application of aggregate caps in instances where 
hospitals might have been affiliated during their reference cost 
reporting periods by defining ``otherwise applicable resident limit'' 
to include adjustments to FTE caps resulting from a hospital's 
participation in a Medicare GME affiliated group. As a result, we do 
not believe there is a ``most straightforward'' interpretation, as the 
commenter suggested, to the language at section 1886(h)(7)(A)(iii) of 
the Act concerning affiliations. We believed (and continue to believe) 
that this language was meant to ``protect'' hospitals that were 
affiliated ``as of July 1, 2003'' in some way. However, we realized 
that, whatever proposal we chose, some hospitals would benefit while 
other hospitals would not. We struggled (and have continued to 
struggle) to interpret the language in a meaningful manner. We 
ultimately proposed to interpret section 1886(h)(7)(A)(iii) of the Act 
to mean that, for hospitals that were affiliated ``as of July 1, 
2003,'' we would superimpose the ``affiliated'' FTE resident caps ``as 
of July 1, 2003] onto the hospitals'' reference cost reporting periods. 
Thus, we proposed that, if a hospital is part of a Medicare GME 
affiliated group for the program year beginning July 1, 2003, we would 
compare the hospital's July 1, 2003 ``affiliated'' FTE resident cap to 
its resident level on the most recent cost report ending on or before 
September 30, 2002. Similarly, for a hospital that submitted a timely 
request to use the cost reporting period that includes July 1, 2003, as 
its reference cost report, we would compare the hospital's July 1, 2003 
``affiliated'' FTE resident cap to its resident level on the cost 
report that includes July 1, 2003.
    Since publication of proposed rule, after reviewing all of the 
comments, we have revisited the proposal and have considered 
alternative interpretations of section 1886(h)(7)(A)(iii) of the Act. 
We believe we are adopting an interpretation of the statute that is 
both consistent with the statute and addresses the commenters' 
concerns. First, we are convinced by the commenters' argument that the 
presence of the language at section 1886(h)(7)(A)(iii) of the Act 
concerning hospitals that are ``members of the same affiliated group * 
* * as of July 1, 2003'' (emphasis added), means that the Secretary 
should treat those hospitals, and only those hospitals, that are 
affiliated for the academic year beginning July 1, 2003 as a group for 
purposes of determining possible FTE resident cap reductions. That is, 
for hospitals that are affiliated ``as of July 1, 2003,'' the 
comparison under section 1886(h)(7)(A)(i) of the Act between the FTE 
resident cap and count should first be conducted at the affiliated 
group level, and if the hospitals' aggregate FTE resident counts are 
equal to or exceed the hospitals' aggregate affiliated FTE resident 
caps for direct GME and IME respectively, then no reductions would be 
made to any of the individual hospitals' FTE resident caps (that is, 
the hospitals' FTE resident caps without the temporary adjustment under 
the July 1, 2003 affiliation agreement), even if, when considered on a 
hospital-specific basis, one or more of the member hospitals FTE caps 
would otherwise have been reduced under section 1886(h)(7)(A)(i) of the 
Act.. As we will explain further below, we are also interpreting ``as 
of July 1, 2003'' to mean that the determination as to whether the 
aggregate affiliated FTE resident cap exceeds the aggregate FTE 
resident count is made using the sum of the hospital-specific FTE 
resident caps and the sum of the hospital-specific FTE resident counts 
from each affiliated group-member hospital's cost report that includes 
July 1, 2003. We also believe that if hospitals that are ``members of 
the same affiliated group * * * as of July 1, 2003'' are to be treated 
as a group in instances where the FTE resident counts of the group as a 
whole equal or exceed the aggregate affiliated FTE resident cap, then 
it is also appropriate that these hospitals should be treated as a 
group in instances where the FTE resident counts of the group as a 
whole are below the aggregate affiliated FTE resident cap. Section 
1886(h)(7)(A)(iii) of the Act states that ``the provisions of clause 
(i) shall be applied to hospitals which are members of the same 
affiliated group * * *'' (emphasis added). Clause (i) of section 
1886(h)(7)(A) of the Act, as described above, requires the reduction of 
hospitals' FTE resident caps under certain circumstances, based on the 
otherwise applicable FTE resident cap and the resident level in the 
applicable reference period. In this final rule, we are interpreting 
the reference in section 1886(h)(7)(A)(iii) of the Act to clause (i) to 
mean that, where the aggregate FTE resident counts of the affiliated 
group as a whole are below the aggregate affiliated FTE resident cap, 
the Secretary is to use a hospital's cost reporting period that 
includes July 1, 2003 as the reference period to determine possible 
reductions to the FTE resident caps. This would apply even when the 
hospital did not submit a timely request to use the cost report that 
includes July 1, 2003 (that is, regardless of whether there was an 
expansion of an existing program that was not reflected on an 
affiliated hospital's most recent settled cost report). Using FTE 
information from each hospital's cost report that includes July 1, 
2003, we will determine the extent to which any hospitals in the 
affiliated group trained a number of FTE residents in excess of their 
individual ``affiliated'' FTE resident caps. Any hospital in the 
affiliated group that trained a number of FTE residents in excess of 
its individual ``affiliated'' FTE resident caps, would not have its FTE 
resident caps reduced. However, any hospital in the affiliated group 
that trained fewer FTE residents than its individual ``affiliated'' FTE 
resident caps would have its FTE resident caps reduced, and the 
aggregate reduction will be shared pro rata among the hospitals whose 
FTE counts were below their ``affiliated'' FTE caps during their cost 
report that includes July 1, 2003. Accordingly, we envision that the 
fiscal intermediaries will determine possible FTE resident cap 
reductions to hospitals that are affiliated for the academic year 
beginning July 1, 2003 in the following manner:
    First, the fiscal intermediaries will identify those hospitals that 
are affiliated ``as of July 1, 2003,'' which as we proposed, means 
hospitals that have in effect a Medicare GME affiliation agreement, as 
defined in existing Sec.  413.86(b), for the program year July 1, 2003 
through June 30, 2004, and have submitted a Medicare GME affiliation 
agreement by July 1, 2003 to their fiscal intermediaries with a copy to 
CMS. Consistent with existing regulations

[[Page 49130]]

regarding affiliated groups (63 FR 26338 May 12, 1998), since a 
hospital could have an agreement with one hospital for a particular 
program and another hospital for a different program, the affiliated 
group for aggregate cap purposes includes the original two hospitals 
that have an agreement and every hospital that has an agreement with 
any of those hospitals. Then, for direct GME and IME respectively, the 
fiscal intermediaries will identify the ``1996'' FTE resident cap 
(adjusted for new programs, if applicable), and the unweighted 
allopathic and osteopathic FTE resident count from each hospital that 
is part of that affiliated group, from each hospital's cost report that 
includes July 1, 2003. (Note that since the 1996 cap and FTE count 
information from the cost report that includes July 1, 2003 is being 
used for purposes of section 422, the caps as amended on the July 1, 
2003 affiliation agreement are irrelevant. The only purpose for the 
July 1, 2003 affiliation agreement is to identify those hospitals that 
are affiliated ``as of July 1, 2003''). In many cases, the hospitals in 
the affiliated group will not all have the same fiscal year end. 
Therefore, for example, for a hospital with a FYE of June 30, the 
fiscal intermediary will identify the FTE resident cap (that is, the 
``1996'' cap, as adjusted for new programs, if applicable) and the 
unweighted allopathic and osteopathic FTE resident count from the 
hospital's FYE June 30, 2004 cost report. For a hospital with a FYE of 
December 31, the fiscal intermediary will identify the FTE resident cap 
(that is, the ``1996'' cap, as adjusted for new programs, if 
applicable) and the unweighted allopathic and osteopathic FTE resident 
count from the hospital's FYE December 31, 2003 cost report. Next, the 
fiscal intermediary will add those FTE resident caps from those cost 
reports to determine the aggregate ``affiliated'' cap. The fiscal 
intermediary will also add the FTE resident counts for IME and direct 
GME respectively from those cost reports to determine the aggregate 
count. If the aggregate FTE resident counts are equal to or exceed the 
aggregate FTE resident caps, then no reductions would be made under 
section 1886(h)(7)(A)(i)(I) of the Act to the FTE resident caps of any 
of those hospitals in the affiliated group. Each hospital's ``1996'' 
FTE resident cap would not be reduced effective July 1, 2005, even if 
on a hospital-specific basis, a hospital had trained fewer residents in 
its cost report that includes July 1, 2003 than its adjusted 
``affiliated'' cap. As stated above for hospitals affiliated as of July 
1, 2003, where the number of residents trained by those affiliated 
hospitals equals or exceeds their aggregated ``1996'' FTE resident 
caps, no reductions under section 1886(h)(7)(A)(i) of the Act would be 
required. However, where the aggregate FTE resident counts are below 
the aggregate FTE resident caps, a reduction to a hospital's FTE 
resident cap would be necessary. In these cases, for each hospital, the 
fiscal intermediary will determine the following FTE information from 
the cost report that includes July 1, 2003:
    (1) The ``1996'' FTE resident cap (as adjusted by new programs, if 
applicable)--For IME from worksheet E, Part A of the Medicare cost 
report, the sum of lines 3.04 and 3.05. For direct GME from worksheet 
E-3, Part IV of the Medicare cost report, the sum of lines 3.01 and 
3.02.
    (2) The ``affiliated'' FTE resident cap--For IME, line 3.07. For 
direct GME, line 3.04.
    (3) The total number of allopathic and osteopathic FTE residents--
For IME, line 3.08. For direct GME, line 3.05.
    (4) The difference between the aggregate ``affiliated'' FTE 
resident cap and the total FTE resident counts for all of the 
affiliated hospitals--For IME, [Sigma] line 3.08 minus [Sigma] (lines 
3.04 + 3.05). For direct GME, [Sigma] line 3.05 minus [Sigma] (lines 
3.01 + 3.02).
    (5) For IME, for those hospitals whose FTE resident count from line 
3.08 is greater than the ``affiliated'' FTE resident cap on line 3.07, 
indicate ``zero.'' For direct GME, for those hospitals whose FTE 
resident count from line 3.05 is greater than the ``affiliated'' FTE 
resident cap on line 3.04, indicate ``zero.'' For IME, for those 
hospitals whose FTE resident count from line 3.08 is less than the 
``affiliated'' FTE resident cap on line 3.07, determine the difference 
between the hospital's ``affiliated'' FTE resident cap and the 
hospital's FTE resident count-line 3.08 minus line 3.07. For direct 
GME, for those hospitals whose FTE resident count from line 3.05 is 
less than the ``affiliated'' FTE resident cap on line 3.04, determine 
the difference between the hospital's ``affiliated'' FTE resident cap 
and the hospital's FTE resident count--line 3.05 minus line 3.04.
    (6) For IME and direct GME separately, to determine the total 
amount by which the FTE resident counts are below the ``affiliated'' 
FTE resident caps, add the amounts determined under step 5 for each 
hospital that trained fewer residents than its ``affiliated'' FTE 
resident caps.
    (7) For IME and direct GME separately, determine a pro rata cap 
reduction for each hospital by dividing the hospital-specific amount in 
step 5 by the total amount for all of those hospitals in step 6, and 
multiply by the amount in step 4. (that is, (step5/step6) x step 4).
    (8) For IME and direct GME separately, determine the actual cap 
reduction for each hospital by multiplying the pro rata cap reduction 
from step 8 by 0.75.
    (9) For IME and direct GME separately, determine the reduced FTE 
resident cap for each hospital by subtracting the actual cap reduction 
from step 8 from the ``1996'' FTE resident cap from step 1. This is the 
hospital's FTE resident cap effective July 1, 2005.
    The following is an example of how the reductions to the FTE 
resident caps will be determined where the FTE resident counts in the 
aggregate for hospitals that were affiliated as of July 1, 2003 are 
below the hospitals' FTE resident caps in the aggregate. (For ease of 
illustration, this example focuses on reductions to the IME caps only, 
but the methodology is the same for reductions to the direct GME caps):
    Hospitals A, B, and C are affiliated for the academic year 
beginning July 1, 2003. Hospital C is also affiliated with Hospitals D 
and E for the academic year beginning July 1, 2003. Thus, the 
affiliated group for GME payment purposes, and for purposes of 
determining possible FTE cap reductions under 422 consists of Hospitals 
A, B, C, D, and E. Hospital A's and B's cost report that includes July 
1, 2003 is their FYE June 30, 2004. Hospital C's and D's cost report 
that includes July 1, 2003 is their FYE December 31, 2003, and Hospital 
E's cost report that includes July 1, 2003 is its FYE September 30, 
2003. Using steps 1 through 10 above, the reductions to the FTE 
resident caps of those hospitals in the affiliated group who trained 
residents below their ``affiliated'' FTE resident caps are determined 
in the table below.

[[Page 49131]]

[GRAPHIC] [TIFF OMITTED] TR11AU04.059

    Hospitals A, B, and C trained residents either equal to or in 
excess of their ``affiliated'' FTE resident caps (as determined under 
step 5), and therefore, no reduction is made to their ``1996'' FTE 
resident cap (step 9). However, Hospital D's FTE resident count of 75 
was 15 less than its ``affiliated'' FTE resident cap of 90, and 
Hospital E's FTE resident count of 65 was 60 less than its 
``affiliated'' FTE resident cap of 125 (as determined under step 5). 
Under this methodology, the fact that Hospitals A and B exceeded their 
respective ``affiliated'' FTE resident caps minimizes the reductions to 
Hospital D's and E's ``1996'' FTE resident caps through the calculation 
of a pro rata reduction under step 7. (Hospital C's ``affiliated'' FTE 
resident cap equaled its FTE resident count). Thus, under step 8, the 
actual cap reduction of 6 FTEs for Hospital D is determined by taking 
75 percent of 8 (rather than 75 percent of 15), and the actual cap 
reduction of 24 FTEs for Hospital E is determined by taking 75 percent 
of 32 (rather than 75 percent of 60). As a result, under step 9, 
Hospital D's final FTE resident cap effective on July 1, 2005 is 
determined to be 109 FTEs, and Hospital E's final FTE resident cap 
effective on July 1, 2005 is determined to be 6 FTEs. We note that the 
total final FTE resident cap effective July 1, 2005 is 410 FTEs (the 
total under step 9), which, mathematically, is the same as subtracting 
400 (the total FTEs trained in the group) from 440 (the aggregate 
``1996'' FTE resident caps), multiplying by 75 percent, and subtracting 
the result from the original aggregate cap of 440 (that is, [440 - 
(0.75(440 - 400))] = 410).
    We also note that the reductions to Hospital D's and E's ``1996'' 
FTE resident caps were minimized only because Hospitals A and B 
exceeded their ``affiliated'' FTE resident caps. If all hospitals in 
the affiliated group had trained residents below their ``affiliated'' 
FTE resident caps based on their cost reports that include July 1, 
2003, then a pro rata reduction would not benefit these hospitals. The 
``1996'' FTE resident caps of all of the hospitals in the affiliated 
group would be reduced by 75 percent of the difference between each 
hospital's ``affiliated'' FTE resident cap and FTE resident count.
    We believe this final policy concerning hospitals that are 
affiliated ``as of July 1, 2003'' addresses the commenters'' concerns 
in that it protects hospitals from any loss of slots if the aggregate 
counts equal to or exceed the ``affiliated'' FTE resident caps, and 
could limit the loss of slots in instances where the aggregate counts 
are below the ``affiliated'' FTE resident caps. We have also addressed 
the commenters'' concerns in that, in instances where the aggregate 
count is below the ``affiliated'' FTE resident caps, it accounts for 
the final, modified affiliation agreements, since it uses the 
affiliated cap as reported on the cost report, and it also allows for a 
comparison of contemporaneous caps and counts. However, the commenters 
also requested that we provide an opportunity for hospitals that were 
affiliated ``as of July 1, 2003'' to modify their affiliation 
agreements after publication of the final rule, if the final policy is 
significantly different from the proposed policy. We do not believe it 
is appropriate to allow hospitals to modify their affiliation 
agreements after publication of the final rule. The only reason we 
allow hospitals to modify their agreements by June 30 of an academic 
year is to make the FTE counts of each hospital in the affiliation 
reflect the realities of the cross-training that occurred within that 
academic year. Thus, the decision as to whether or not an affiliation 
agreement should be modified should be based solely on whether the FTE 
counts first projected in the affiliation agreement on July 1 of a year 
differ from the actual FTEs that trained at each hospital during the 
year. We do not believe it is appropriate to allow a modification of 
the affiliation agreement by a hospital in order to minimize the 
applicable reductions under section 1886(h)(7)(A)(i) of the Act.
    Comment: One commenter described a situation where a hospital that 
is located in an other than large urban area is part of an affiliated 
group as of July 1, 2003 with a rural hospital that has less than 250 
beds. The commenter stated that while the rural hospital is exempt from 
reductions to its FTE resident caps, the urban hospital could be 
``penalized'' because of the slots acquired under the affiliation 
agreement with the rural hospital, if the urban hospital did not fill 
all of those slots in its reference cost reporting period. The 
commenter believed that Congress did not intend to discourage urban 
hospitals from affiliating with rural hospitals, and asked that CMS 
carve out any FTEs associated with the rural hospital from the urban 
hospital's FTE resident cap for purposes of determining the number of 
unused residency slots at the urban hospital.
    Response: With the exception of rural hospitals with less than 250 
beds as specified at section 1886(h)(7)(A)(i)(II) of the Act, we cannot 
exempt other hospitals outright from possible reductions to their FTE 
resident caps. However, as we stated in response to the previous 
comment concerning hospitals that were part of an affiliated group as 
of July 1, 2003, if the hospitals' aggregate FTE resident counts equal 
or exceed the aggregate ``affiliated'' FTE resident caps, then no 
reductions would be made to any of the hospitals' specific ``1996'' FTE 
resident caps, even if on an

[[Page 49132]]

individual basis, a hospital in the group was training fewer residents 
than its ``affiliated'' FTE resident cap. But if the aggregate FTE 
resident counts are below the aggregate ``affiliated'' FTE resident 
caps, then (except for rural hospitals with less than 250 beds), a 
hospital in the affiliated group that trained less FTE residents than 
its individual ``affiliated'' FTE resident cap would have its ``1996'' 
FTE resident cap reduced. Accordingly, the urban hospital described by 
the commenter would be subject to possible FTE resident cap reductions 
only if, for the hospital(s) with which it was affiliated as of July 1, 
2003, the aggregate FTE resident counts were below the aggregate 
``affiliated'' FTE resident caps and the urban hospital was also 
training fewer residents than its ``affiliated'' cap. However, since 
the rural hospital's FTE resident caps are protected from reductions 
under section 1886(h)(7)(A)(i)(II) of the Act, the urban hospital could 
continue to affiliate with the rural hospital on and after July 1, 
2005, and, to the extent that the rural hospital has FTE slots 
available to ``lend'' to the urban hospital, the urban hospital could 
receive a temporary increase to its FTE resident caps via the 
affiliation agreement with the rural hospital. Therefore, although this 
urban hospital may lose slots under section 1886(h)(7)(A)(i) of the 
Act, it may be able to receive additional slots temporarily by 
affiliating with the rural hospital. In addition, the urban hospital 
may apply for a permanent increase to its FTE resident cap of up to 25 
additional FTEs under section 1886(h)(7)(B) of the Act.
    Comment: One commenter noted that under the proposed regulations at 
FR 69 28297 May 18, 2004 a hospital's reference resident level would be 
compared to the hospital's reference FTE resident cap as adjusted by 
Medicare GME affiliation agreements if the affiliation agreement is in 
effect as of July 1, 2003 or for program years that coincide with or 
overlap the reference cost reporting period. The commenter asked for 
clarification regarding a hospital that otherwise has an FTE resident 
cap of zero, but during its reference period, the hospital received a 
temporary increase to its FTE resident cap by participating in a 
Medicare GME affiliated group. The commenter stated that in its 
reference period, its resident level was below its FTE cap as adjusted 
by the affiliation agreement and asked if, as a result, CMS would 
reduce its FTE resident cap below zero.
    Response: As we stated in the proposed rule FR 69 28299 May 18, 
2004, hospitals that are participating in a Medicare GME affiliation 
agreement as of July 1, 2003 or for program years that coincide with or 
overlap the reference cost reporting period are not subject to the 
proposed policy applicable to section 1886(h)(7)(iii) of the Act, as 
added by section 422(a)(3). For such hospitals, we will compare the 
resident level in the applicable reference period to the FTE resident 
cap as adjusted by the affiliation agreement applicable to that 
reference period. If a hospital's resident level is below its otherwise 
applicable FTE resident cap for that reference period cost report, we 
are proposing to permanently reduce the hospital's FTE resident cap, 
that is, the hospital's FTE resident cap without the temporary 
adjustment under the affiliation agreement for that period, by 75 
percent of the difference between the hospital's resident level and the 
otherwise applicable FTE resident cap. However, a resident FTE cap 
would not be reduced below zero. That is, if the hospital's cap without 
adjustment under the affiliation agreement is zero, the hospital would 
not receive a reduction in their FTE resident cap if their reference 
resident count is below the reference affiliated resident FTE cap.
g. Criteria for Determining Hospitals That Will Receive Increases in 
Their FTE Resident Caps
    Generally, under section 1886(h)(7) of the Act, as added by section 
422(a)(3) of Public Law 108-173, CMS is to reduce by 75 percent the 
``unused'' resident slots from hospitals that were below their FTE 
resident caps in a specific reference period, and ``redistribute'' the 
FTE slots for use by other hospitals. Under section 1886(h)(7)(B) of 
the Act, as added by section 422 of Public Law 108-173, the Secretary 
is authorized to increase the otherwise applicable FTE resident cap for 
each qualifying hospital that submits a timely application by a number 
that the Secretary may approve, for portions of cost reporting periods 
occurring on or after July 1, 2005. In implementing section 
1886(h)(7)(B) of the Act, we note the difficulty in deciding which 
teaching hospitals are more ``deserving'' than others to receive the 
redistributed unused resident slots. Therefore, in the May 18, 2004 
proposed rule (69 FR 28299), we proposed a decision making process that 
we believe was an objective process. In addition, we noted that section 
422 does not provide detailed guidance to the Secretary for deciding 
which hospitals should receive the unused resident slots, but rather 
gives the Secretary discretion in making the choice of which hospitals 
should qualify.
    Section 1886(h)(7)(B) of the Act, as added by section 422, does 
establish certain parameters in the statutory language for hospitals to 
qualify to receive increases in their FTE resident caps. First, section 
1886(h)(7)(B)(i) of the Act states that the aggregate number of 
increases in the otherwise applicable resident limits (caps) may not 
exceed the estimate of the aggregate reduction in the resident limits 
determined under section 1886(h)(7)(A) of the Act (as specified in 
section IV.O.2.e. of this preamble). Section 1886(h)(7)(B)(iv) of the 
Act states that in no case will any hospital receive an FTE cap 
increase of more than 25 FTE additional residency slots as a result of 
the redistribution. (Proposed redesignated Sec.  413.79(c)(4)). In 
addition, section 1886(h)(7)(B)(ii) of the Act specifies that in 
determining which hospitals will receive the increases in their FTE 
resident caps, the Secretary is required to take into account the 
demonstrated likelihood that the hospital would be able to fill the 
position(s) within the first three cost reporting periods beginning on 
or after July 1, 2005.
    In setting up an application process for hospitals to apply for the 
unused resident slots discussed in section IV.O.2.h. of this preamble, 
we had proposed to implement this ``demonstrated likelihood'' 
requirement as an eligibility criterion that a hospital must meet in 
order for CMS to further consider the hospital's application for an 
increase in its FTE resident cap. Thus, we had proposed that, in order 
to be eligible for consideration for an increase under section 
1886(h)(7)(B) of the Act, a hospital must first demonstrate the 
likelihood that it will able to fill the slots within the first three 
cost reporting periods beginning on or after July 1, 2005, by meeting 
at least one of the following four criteria and by providing 
documentation that it meets that criterion in its application for an 
increase in its FTE resident cap:
    Demonstrated Likelihood Criterion 1. The applying hospital intends 
to use the additional FTEs to establish a new residency program(s) on 
or after July 1, 2005 (that is, a newly approved program that begins 
training residents on or after July 1, 2005).
    The hospital must meet the requirements in provisions (1) and (2) 
below:
    (1) In order to demonstrate that the hospital is, in fact, 
establishing a new residency program, the hospital must--
     Submit an application for approval of a new residency 
program to the ACGME or the AOA by December 1, 2004, and include a copy 
of that application with the application to CMS for an increase in its 
FTE resident cap; or

[[Page 49133]]

     Submit an application for approval of a new residency 
program to the ACGME or the AOA by December 1, 2004, and, if 
establishing an allopathic program, include a copy of the hospital's 
institutional review document or program information form concerning 
the new program with the application for the unused FTE resident slots; 
or
     Submit an application for approval of a new residency 
program to the ACGME or the AOA by December 1, 2004, and include 
written correspondence from the ACGME or AOA acknowledging receipt of 
the application for the new program, or other types of communication 
from the accrediting bodies concerning the new program approval process 
(such as notification of site visit).
    (2) To demonstrate that the hospital will be likely to fill the 
slots requested, the hospital must comply with one of the following:
     If the hospital has other previously established programs, 
submit documentation that each of the hospital's existing residency 
programs had a resident fill rate of at least 95 percent in each of 
program years 2001 through 2003; or
     If the hospital has other previously established residency 
programs, submit copies of the cover page of the hospital's employment 
contracts with the residents who are or will be participating in the 
new residency program (resident specific information may be redacted); 
or
     If the hospital is establishing a new residency program in 
a particular specialty, submit documentation indicating that the 
specialty has a resident fill rate nationally, across all hospitals, of 
at least 95 percent.
    Demonstrated Likelihood Criterion 2. The applying hospital intends 
to use the additional FTEs to expand an existing residency training 
program (that is, to increase the number of FTE resident slots in the 
program) on or after July 1, 2005, and before July 1, 2008.
    The hospital must comply with the requirements in provisions (1) 
and (2) below:
    (1) To demonstrate that the hospital intends to expand an existing 
program, the hospital must comply with one of the following:
     Document that the appropriate accrediting body (the ACGME 
or the AOA) has approved the hospital's expansion of the number of FTE 
residents in the program; or
     Document that the National Residency Match Program or the 
American Osteopathic Association Residency Match Program has accepted 
or will be accepting the hospital's participation in the match for the 
existing program that will include additional resident slots in that 
residency training program; or
     If expanding an allopathic program, submit a copy of the 
hospital's institutional review document or program information form 
for the expansion of the existing residency training program.
    (2) To demonstrate that the hospital will be likely to fill the 
slots of the expanded residency program, the hospital must comply with 
one of the following:
     Submit copies of the cover page of the hospital's 
employment contracts with the residents who are or will be 
participating in the expanded program (resident specific information 
may be redacted) and copies of the cover page of the hospital's 
employment contracts with the residents participating in the program 
prior to the expansion of the program.
     If the hospital has other previously established residency 
programs, submit documentation that each of the residency programs had 
a resident fill rate of at least 95 percent in each of program years 
2001 through 2003.
     If the hospital is expanding an existing program in a 
particular specialty, submit documentation that the specialty has a 
resident fill rate nationally, across all hospitals, of at least 95 
percent.
     If the hospital is expanding a program in order to train 
residents that need a program because another hospital in the State has 
closed a similar program, and the applying hospital received a 
temporary adjustment to its FTE cap(s) (under the requirements of Sec.  
413.86(g)(9)), submit documentation of this action.
    Demonstrated Likelihood Criterion 3. The hospital is applying for 
an increase in its FTE resident cap because the hospital is already 
training residents in an existing residency training program(s) in 
excess of its direct GME FTE cap or IME FTE cap, or both.
    The hospital must submit, with its application, each of the 
following:
     Copies of the most recent as-submitted Medicare cost 
reports documenting on Worksheet E, Part A and Worksheet E3, Part IV 
the resident counts and FTE resident caps for both direct GME and IME 
for the relevant cost reporting periods.
     Copies of the 2004 residency match information concerning 
the number of residents the hospital intends to have in its existing 
programs.
     Copies of the most recent accreditation letters on all of 
the hospital's training programs in which the hospital trains and 
counts FTE residents for direct GME and IME.
    Demonstrated Likelihood Criterion 4. The hospital is applying for 
the unused FTE resident slots because the hospital is at risk of losing 
accreditation of a residency training program if the hospital does not 
increase the number of FTE residents in the program on or after July l, 
2005.
    The hospital must submit, with its application for an increase in 
its FTE resident cap, documentation from the appropriate accrediting 
body of the hospital's risk of lost accreditation as a result of an 
insufficient number of residents in the program.
    In the May 18, 2004 proposed rule, we proposed that each hospital 
must meet at least one of the above criteria in order to demonstrate 
the likelihood that it will be able to fill the additional slots 
associated with any increase in the hospital's FTE resident cap within 
the first three cost reporting periods beginning on or after July 1, 
2005. In other words, each hospital that wishes to apply for an 
increase in its FTE resident cap must, as a preliminary matter, meet 
the eligibility requirement of demonstrating the likelihood that it 
will fill the additional positions, in order for CMS to further 
consider the hospital's application for an increase in its FTE resident 
cap.

General Comment on the Process for Applying for the Increase to the FTE 
Caps Under Section 422

    Comment: Several commenters complimented CMS on the proposed 
process for applying for the section 422 increase to the FTE caps. One 
commenter stated: ``[the commenter] appreciates that CMS had a very 
difficult task in determining which teaching hospitals that wish to 
increase their FTE resident caps are `deserving' of such an increase. 
The combination of very specific statutory language (for example, the 
hospital priority ordering) on the one hand and the discretion granted 
to the agency on the other hand, along with the short timeframe for 
implementation, clearly created significant challenges, and [the 
commenter] applauds the thought and effort that went into developing 
the criteria, and CMS's attempt to develop an `objective process.' ''
    On the other hand, several commenters believed the proposed 
administrative process for hospitals to receive cap increases under 
section 422 was complex and burdensome. One commenter believed that CMS 
should withdraw the proposals on the increases under section 422 to 
``reconsider its position on this issue.'' Another

[[Page 49134]]

commenter stated that the proposed process is ``so complicated and 
burdensome that most hospital systems will not participate in the 
process. Only large university affiliated residency programs have 
personnel to pursue this process of reallocation of [the estimated] 
pool of resident numbers.'' In addition, another commenter believed the 
proposed process for applying for the increase under section 422 is 
``exceedingly complex and convoluted.'' This commenter urged CMS to 
``take pains to minimize the complexity of the redistribution process 
so as to ensure that all eligible hospitals are able to quickly assess 
the opportunities.''
    Response: We appreciate the consideration from the commenters on 
the difficult nature of implementing section 1886(h)(7)(B) of the Act. 
We also recognize the complexity in the application process. We believe 
the ``complexity'' is largely a function of CMS's need to meet the 
statutory requirements for prioritizing the requests and for assuring 
that the requesting hospital has demonstrated the likelihood of filling 
the requested slots within 3 years. We hope that the complexity does 
not deter hospitals from availing themselves of the opportunity to 
apply for an increase to their FTE resident caps under section 422 of 
the MMA.

Comments on the Proposed Demonstrated Likelihood Criteria

    Comment: We received a variety of comments from the public on the 
proposed Demonstrated Likelihood requirements, as described in the May 
18, 2004 proposed rule. Some of the commenters were supportive of the 
proposals. One commenter stated: ``[w]e believe it serves no worthy 
programmatic or policy purpose for CMS to grant increases in resident 
FTE caps absent clear and convincing evidence that a hospital making 
the application is an institution with a proven track record of 
training residents in an environment in which physicians-in-training 
wish to be educated.'' Another commenter ``wholeheartedly'' 
complimented CMS for proposing, as a prerequisite to a hospital's 
consideration to receive an FTE resident cap increase under section 
422, ``that each hospital meet at least one of the four criteria'' 
proposed.
    On the other end of the spectrum, many commenters requested that 
there be flexibility in the requirements for hospitals to ``demonstrate 
the likelihood''. For instance, several commenters suggested that it is 
unnecessary and burdensome for hospitals to submit accreditation 
letters in the Demonstrated Likelihood Criteria 1 through 4. One 
commenter suggested that hospitals that seek increases under section 
422 be permitted to submit to CMS a ``narrative explaining their need 
and use of the additional slots,'' as an option available to 
demonstrate likelihood. This commenter also suggested that other types 
of documentation should be acceptable to CMS for a hospital to 
demonstrate the likelihood. The commenter suggested ``minutes from 
internal management, graduate medical education, or board meetings, 
internal correspondence to the designated institutional office (DIO), 
or other forms of documentation that demonstrate the institution is 
seriously discussing initiating new programs.''
    Response: We understand that the demonstrated likelihood criteria 
may be difficult to meet for some hospitals that wish to apply for an 
increase to their FTE resident caps. By proposing multiple options 
within each Demonstrated Likelihood Criterion, we hoped to provide 
flexibility to hospitals, to allow several options for hospitals to 
meet this preliminary eligibility criterion to be considered to receive 
an increase in its FTE resident cap, but to do so in as an objective 
and documentable way as possible. For this reason, as a first level 
test, to allow a hospital to demonstrate that it would be very likely 
to use any increase in its FTE resident cap for a program that is, or 
will likely soon be approved, we proposed to rely on accreditation 
letters from the appropriate approving bodies for the residency 
programs at the applicant hospitals. We regret that some commenters 
believe this would be burdensome. However, the commenters' alternative 
proposal to allow a hospital to submit a ``narrative explaining their 
need and use of additional slots'' is, by its nature, subjective and 
not easily verifiable, which is exactly what CMS sought to avoid in 
developing the application process. To address the other suggestions 
from the commenter regarding the reliance on ``minutes from internal 
management * * * '' and other types of documentation to support the 
Demonstrated Likelihood Criterion, we considered each of the 
suggestions. It appears to us that each of the alternative types of 
documentation proposed by the commenters would not objectively 
demonstrate that the hospitals are seriously planning to start a new 
program or expand an existing program. Thus, we do not agree that these 
other types of documentation would demonstrate the likelihood that the 
hospital would fill any additional FTE slots if its application to 
receive an increase in its FTE resident cap was approved. We believe 
that our demonstrated likelihood criteria, as finalized in this rule 
and explained further below, provide an appropriate balance between the 
flexibility desired by hospitals seeking to meet this eligibility 
criterion and the objectivity required for CMS to be assured that the 
criterion is meaningful and measurable.
    Comment: We received one comment on the option under proposed 
Demonstrated Likelihood Criterion 1, for hospitals to demonstrate they 
can fill the slots of a new program that is established on or after 
July 1, 2005, that states:
    `` Application for approval of the new residency program 
has been submitted to the ACGME or the AOA by December 1, 2004. (Copy 
attached.)''
    The commenter states that, although the requirement for such 
documentation ``may be reasonable,'' the commenter believes the 
timeframe established by CMS ``is simply not feasible.'' The commenter 
believes the December 1, 2004 date ``would require a hospital to apply 
to ACGME or AOA prior to knowing whether it will be granted the 
additional slots.'' The commenter requests that CMS reevaluate the 
timeframe associated with this option.
    Response: We understand the commenter's concern about the 
uncertainty of an applicant hospital as to whether it would receive an 
increase in its FTE resident caps when it applies by December 1, 2004 
for accreditation for a new program(s). However, we deliberately set up 
this criterion so that CMS is able to determine, at the time we 
evaluate hospital applications for increases in FTE resident caps, 
which hospitals are able to demonstrate the likelihood of filling the 
slots of the new program. Applications for new programs that will be 
submitted to the ACGME or the AOA after December 1, 2004 (which is the 
deadline for most hospital applications for increases in FTE resident 
caps) are not at all helpful to CMS for determining which hospitals can 
demonstrate the likelihood, since CMS will need to make FTE cap 
increase determinations under section 422 effective July 1, 2005. For 
this reason, we have decided to maintain the originally proposed date 
requirements associated with this option under this Demonstrated 
Likelihood Criterion 1.
    Comment: We received many comments on Demonstrated Likelihood 
Criteria 1 and 2, concerning the ability of the hospital to demonstrate 
that it will be likely to fill the requested slots. Specifically, these 
commenters were concerned with the option under each criterion that 
``if the hospital is

[[Page 49135]]

[expanding an existing/establishing a new] residency program in a 
particular specialty, [the hospital must] submit documentation 
indicating that the specialty has a resident fill rate nationally, 
across all hospitals, of at least 95 percent.''
    One commenter, representing a particular specialty in medicine, 
disliked the option of a national fill rate of 95 percent in the 
specialty, stating that the commenter preferred the option in the 
Demonstrated Likelihood Criteria 1 and 2 to use a hospital-specific 
fill rate to demonstrate that the hospital will likely fill the number 
of slots requested: ``if the hospital has other previously established 
programs, submit documentation that each of the hospital's existing 
residency programs had a resident fill rate of at least 95 percent in 
each of program years 2001 through 2003.''
    Another commenter requested that if the national fill rate option 
is retained by CMS, that the threshold percentage of 95 percent should 
be reduced.
    Several commenters asked CMS to define ``fill rate,'' as used in 
the Demonstrated Likelihood Criteria. They noted that the term fill 
rate is often confused with the ``match fill rate,'' and that not all 
resident positions are filled through a match process. However, these 
commenters felt that use of a clearly defined national fill rate is an 
appropriate measure. One commenter stated that, by ``fill rate,'' the 
commenter believed we were referring to resident match data. Several 
commenters requested that we also include in our definition that 
``national fill rate'' refers to the fill rate as of July 1st of each 
year.
    One commenter was opposed to the use of the national fill rate as 
an indication that a program is likely to fill new FTE resident slots 
awarded pursuant to section 1886(h)(7)(B) of the Act, because it 
believed this measure would be misleading. The commenter noted that 
hospitals may choose to conduct a training program with fewer residents 
than allowed by their approved accredited slots and that ``the fact 
that all of the accredited resident slots are not utilized may have 
little bearing on the ability of the institution to attract residents 
to its residency programs.''
    Response: Section 1886(h)(7)(B)(ii) of the Act specifies that in 
determining which hospitals will receive the increases in their FTE 
resident caps, we are required to take into account the demonstrated 
likelihood that the hospital would fill the position(s) within the 
first three cost reporting periods beginning on or after July 1, 2005. 
In order to make this determination, we proposed four objective 
criteria, at least one of which must be met, in order to demonstrate a 
likelihood of filling the positions within the first three cost 
reporting periods beginning on or after July 1, 2005. Two of the 
criteria are for hospitals that intend to use the additional FTE 
resident cap slots to establish a new residency program(s) on or after 
July 1, 2005, or to expand an existing residency program on or after 
July 1, 2005. It is especially difficult to develop criteria that are 
administratively feasible, objective, and verifiable in order to 
demonstrate the likelihood that a hospital's future plans will be 
implemented. In an effort to design criteria that would objectively 
demonstrate that hospitals would fill additional residency positions 
associated with a new or expanded program(s), we proposed several 
criteria, one of which is that the specialty for which the hospital 
intends either to start a new program or to expand an existing program 
has a resident fill rate nationally, across all hospitals that offer 
the program, of at least 95 percent. We believe new or expanded 
programs in a specialty that is 95 percent full nationally, across all 
hospitals, would be a reasonable basis for determining that a hospital 
has demonstrated the likelihood that it will fill new positions in that 
specialty.
    However, we agree with the commenters that the ``national fill 
rate'' should be defined with more accuracy. Furthermore, in light of 
the comments we received regarding ``fill rate'' and ``residency 
match,'' we agree that it is necessary to more explicitly distinguish 
between ``residency match'' and ``resident fill rate'' for the purpose 
of determining that there is a demonstrated likelihood a hospital will 
fill the slots if granted an increase in its FTE resident cap under 
section 1886(h)(7)(B) of the Act.
    For purposes of the application for the increase to the FTE caps 
under section 422, we are defining ``national fill rate'' for each 
academic year, as the number of residents training in a program 
nationally as compared to the number of accredited slots in that 
program as of June 30 of that year. This information is available from 
the ACGME and the AOA. Furthermore, we are requiring that, for the 
purposes of an application for an increase to a hospital's FTE resident 
cap under section 1886(h)(7)(B) of the Act, a hospital must use the 
``fill rate'' for the most recent academic year for which data is 
available.
    We agree with the commenter that hospitals may train fewer 
residents than the number of available accredited slots in their 
approved programs due to reasons other than an inability to fill those 
slots. Accordingly, we agree that the proposed 95 percent threshold 
national fill rate for demonstrating the likelihood of filling FTE 
resident slots in a new or expanded program may not take into account 
some of the reasons (other than an inability to fill the positions) 
that a program may be training fewer residents than it is accredited to 
train. Therefore, as suggested by the commenter, we are lowering the 
fill rate ``threshold'' to 85 percent. We believe that this lower rate 
will reasonably identify those programs that are likely to fill FTE 
resident positions in newly approved or expanded programs (while 
providing some latitude to account for other factors, beside ability to 
fill accredited slots, that affect the national fill rate), and to 
fully utilize an increase in FTE resident cap slots that may be 
available under section 1886(h)(7)(B) of the Act. By establishing a 
threshold of 85 percent, we believe, based on the most current data 
available from both the ACGME and AOA, that we will have identified 
approximately 30 percent of the currently approved programs, as meeting 
this criterion. Accordingly, we believe the revised threshold will 
better identify those programs as having a demonstrated likelihood of 
actually filling the new or expanded programs.
    Furthermore, based upon our additional research in response to 
public comments, we believe that a national fill rate is not 
necessarily the only indicator of the ability of hospitals to fill 
residency positions in its MSA or State. There may be characteristics 
particular to a region, such as population density, variety of practice 
settings, or access to technology or procedures that may allow a 
specified area to have a fill rate in a specific program that exceeds 
the program's national fill rate. Therefore, we are expanding the ways 
that a hospital may satisfy the ``fill rate'' criterion. In this final 
rule, we are specifying that a hospital may demonstrate the likelihood 
of filling FTE resident positions associated with a possible increase 
in its FTE resident cap under section 422 by documenting that any of 
the following applies to the new program or to an expansion of an 
existing program:
     The specialty program has a resident fill rate nationally, 
across all hospitals, of at least 85 percent.
     The specialty program has a resident fill rate within the 
state in which the hospital is located of at least 85 percent.
     If the hospital is located within an MSA, the specialty 
program has a

[[Page 49136]]

resident fill rate within the MSA of at least 85 percent.
    We are amending the proposed CMS Evaluation Form part A1(2) and 
part A2(2) to include the following language: ``The specialty program 
has a resident fill rate either nationally, or within the state or the 
MSA in which the hospital is located, of at least 85 percent.'' For the 
purposes of demonstrating the likelihood of filling FTE resident 
positions for purposes of section 1886(h)(7)(B)(ii) of the Act, ``fill 
rate'' means, for the most recent academic year for which data is 
available, the number of residents training in a program compared to 
the number of accredited slots in that program as of June 30 of that 
year.
    As we stated in the proposed rule, we believe that, of all the 
medical specialties, geriatrics is the one specialty that is devoted 
primarily to the care of Medicare beneficiaries. In addition, we note 
that encouraging residency training in geriatrics in the context of 
Medicare payments for direct GME and IME is consistent with 
Congressional intent as expressed, among other places, in section 712 
of Public Law 108-173. As such, we are giving special consideration to 
geriatric programs to meet the ``fill rate'' criterion for 
demonstrating the likelihood of filling FTE resident slots under 
section 422. Geriatrics is not a separately approved training program; 
rather, it is a subspecialty of another specialty program. For example, 
there is a geriatrics subspecialty of family practice. In this final 
rule, for the purposes of meeting the 85 percent fill rate criterion, 
we will allow hospitals that are starting a new geriatrics program or 
expanding an existing geriatric program to use the fill rate associated 
with the overall specialty program (rather than the fill rate for the 
geriatric subspecialty) to meet this demonstrated likelihood criterion.
    The proposed Demonstrated Likelihood Criterion 3 (as finalized in 
this rule) allows hospitals that are already training a number of FTE 
residents in an existing residency training program(s) in excess of its 
direct GME FTE cap or IME FTE cap, or both, to meet the demonstrated 
likelihood requirement. In order to document that it meets this 
criterion a hospital must submit copies of the 2004 ``residency match'' 
information concerning the number of residents the hospital has in an 
existing program. For purposes of the application of this demonstrated 
likelihood criterion, we are defining ``residency match'' as a national 
process administered by the National Residency Matching Program (NRMP), 
the San Francisco Matching Program, the American Osteopathic 
Association Residency Match Program, or the Urology Matching Program, 
by which applicants to approved medical residency programs are paired 
with programs on the basis of preferences expressed by both the 
applicants and the program directors.
    The proposed Demonstrated Likelihood Criterion 1 and Demonstrated 
Likelihood Criterion 2 (also finalized in this rule) also allow a 
hospital to demonstrate the likelihood of filling the requested slots 
by demonstrating that the hospital's existing residency programs had a 
``resident fill rate'' of at least 95 percent in each of program years 
2001 through 2003. For the purpose of fulfilling these demonstrated 
likelihood criteria, we are defining ``resident fill rate'' to mean, 
for the most recent academic year for which data is available, the 
number of residents training in each program at a hospital as compared 
to the number of accredited slots in each program at that hospital as 
of June 30 of that year. Furthermore, for the reasons stated above, we 
are lowering the threshold percentage from 95 percent to 85 percent.
    Comment: One commenter questioned the need for the option under 
Demonstrated Likelihood Criteria 1 and 2 of a hospital providing the 
resident fill rate for its other residency programs. The commenter 
believes that a hospital's ability to fill the slots of a new program, 
for example, ``bears no relationship'' to the fill rate of the 
hospital's other program(s).
    Response: We disagree with the commenter's contention that the fill 
rates in the hospital's existing residency programs ``bear no 
relationship'' to the hospital's ability to fill slots in other 
programs. We continue to believe that the hospital's fill rate in all 
of its programs is a meaningful indicator to ``demonstrate the 
likelihood'' that a hospital will fill slots in a new program or an 
expansion of an existing program for purposes of section 422 of Public 
Law 108-173. We believe the hospital's location, faculty, patient base, 
and reputation all have a direct bearing on the overall ability of a 
hospital to fill either its new or its existing residency positions and 
that this criterion provides an objective method of demonstrating the 
likelihood that the hospital will fill residency positions for purposes 
of section 422. As such, we continue to believe that it is appropriate 
to include the fill rates of existing programs as one of the methods by 
which a hospital may demonstrate the likelihood of filling FTE 
residency positions for purposes of section 422. Of course, where a 
hospital's fill rates fall below the acceptable threshold, the hospital 
may still demonstrate a likelihood of filling the requested slots based 
on the fill rate, either nationally, within the MSA, or within the 
State that the hospital is located, for that program.
    Comment: We received one comment on the option under the proposed 
Demonstrated Likelihood Criterion 2 that states that the hospital may 
demonstrate the likelihood of filling FTE resident slots by 
demonstrating that:
     Hospital has employment contracts with the residents who 
are or will be participating in the expanded program (resident specific 
information may be redacted) and employment contracts with the 
residents participating in the program prior to the expansion of the 
program. (Copy of the cover page of both documents attached.)
    Similar documentation requirements were proposed under Demonstrated 
Likelihood Criterion 1 for new programs.
    The commenter believed that it is ``onerous and unnecessary'' for 
CMS to require hospitals to submit resident employment contracts. The 
commenter also believed that hospitals would be unable to provide 
contract information by December 1, 2004 (the application deadline for 
most hospitals to request the increase to the FTE caps under section 
422) since residents who will be training in a program that starts July 
1, 2005 will not be identified until Spring 2005.
    Response: We agree with the commenter that residency match results 
from the National Residency Match Program (NRMP) for the academic year 
beginning July 1, 2005 will not be available until March 2005. 
Similarly, residency match results from the American Osteopathic 
Association (AOA) for the academic year beginning July 1, 2005 will not 
be available until February 2005. Since employment contracts are not 
signed until after this date, we agree that hospitals will be unable to 
provide copies of the cover page of residents' employment contracts as 
a method of demonstrating the likelihood that the hospital will fill 
residency positions for purposes of an increase in its FTE resident 
caps by the December 1, 2004 application deadline. Therefore, we are 
removing this option from the final rule. Under the final rule, 
hospitals will be required to demonstrate the likelihood of filling the 
requested slots by either of the two other methods--
     If the hospital has other previously established programs, 
submit

[[Page 49137]]

documentation that each of the hospital's existing residency programs 
had a resident fill rate of at least 85 percent in each of program 
years 2001 through 2003; or
     If the hospital is establishing or expanding a program in 
a particular specialty, submit documentation indicating that the 
specialty has a resident fill rate either nationally, or within the 
state, or MSA in which the hospital is located, of at least 85 percent.
    Comment: One commenter had concerns with the option under 
Demonstrated Likelihood Criterion 2 that states:
    `` The National Residency Match Program or the American 
Osteopathic Association Residency Match Program has accepted or will be 
accepting the hospital's participation in the match for the existing 
program that will include additional resident slots in that residency 
training program. (Documentation attached.)''
    The commenter stated that if ``CMS will recognize only program 
expansions that take effect on or after July 1, 2005, for hospitals 
that utilize the NRMP, their resident match information is not required 
until early 2005--after the December 2005 application deadline.'' The 
commenter also questioned how a hospital under this option would 
demonstrate that the matching program ``will be accepting'' the 
hospital's match participation with the expanded resident slots.
    Response: Under the proposed Demonstrated Likelihood Criterion 2, a 
hospital may demonstrate that it intends to expand an existing program 
by documenting that either the National Residency Match Program or the 
AOA Residency Match Program have accepted or will be accepting the 
hospital's participation in the match for the existing program that 
will include additional resident slots in that residency training 
program. We agree with the commenter that resident match information 
for the academic year beginning July 1, 2005 is not due to the NRMP 
until February 2005. As such, hospitals will not be able to document 
that the NRMP has accepted or will be accepting the hospital's 
participation in the match for the existing program that will include 
additional resident slots by the December 1, 2004 application deadline. 
Therefore, we are removing this option for hospitals to demonstrate 
that they intend to expand an existing program from the final rule for 
NRMP programs. Programs utilizing the NRMP will be required to 
demonstrate the intent to expand an existing program by either of the 
two other methods:
     Document that the appropriate accrediting body (the ACGME 
or the AOA) has approved the hospital's expansion of the number of FTE 
residents in the program.
     If expanding an allopathic program, submit a copy of the 
hospital's institutional review document or program information form 
for the expansion of the existing residency program.
    We note that the listing of programs participating in the AOA Match 
Program will be available on the National Matching Services website as 
of November 1, 2004. Therefore, programs utilizing the AOA Match 
Program may, in addition to the two options listed above, demonstrate 
the intent to expand an existing program by documenting that the AOA 
has accepted the hospital's participation in the match program by the 
December 1, 2004 application deadline. Therefore, this method of 
demonstrating the hospital's intent to expand an existing program will 
be adopted as final for programs participating in the AOA Match 
Program.
    Comment: One commenter expressed concern about Demonstrated 
Likelihood Criterion 1 and the option to include information regarding 
the application for the approval of the new program. The commenter 
mentioned that, in many cases, there are letters of intent that are 
sent to the accrediting body a year or two prior to submission of the 
application for accreditation. This commenter states that ``since in 
many instances, the institution cannot increase its slots, or begin a 
new program, without the Medicare reimbursement, many programs would be 
in the situation of needing a full-blown application to the accrediting 
body, before they know if they will be awarded new positions by a 
raising of their cap. It makes sense to allow this earlier letter of 
intent, to allow those institutions the ability to start a new program, 
if they receive the increase in paid positions under this program.''
    Response: We believe that a letter of intent does not meet the 
standard of ``demonstrated likelihood of the hospital filling the 
positions.'' It would only seem to portend hopeful intention on the 
part of the hospital, rather than a commitment. Therefore, we are not 
adopting the commenter's suggestion of a letter of intent as source of 
documentation.
    Comment: One commenter was concerned about the accreditation 
options under Demonstrated Likelihood Criteria 1 and 2. For example, 
the option under Demonstrated Likelihood Criterion 2, states--
    `` The appropriate accrediting body (the ACGME or the AOA) 
has approved the hospital's expansion of the number of FTE residents in 
the program. (Documentation attached.)''
    One commenter believed that this option should recognize and 
accommodate hospitals that are planning to expand a residency 
program(s), but have already received ACGME accreditation.
    Response: We understand that in many instances, hospitals receive 
accreditation from the approving body before training residents in the 
expanded program (which can be a period of a year or more after 
receiving the accreditation). We believe that our proposed language 
above already accommodates the idea of hospitals receiving 
accreditation for the expanded number of FTE slots.
    Comment: We received two comments on the option to document, for 
proposed Demonstrated Likelihood Criteria 1 and 2, that the appropriate 
accrediting body has approved the hospital's new program or expansion 
of the number of FTE residents in the program. One commenter notes that 
an application for residency program expansion ``is a complex, 
extensive document that cannot be prepared in the roughly six-month 
time frame from this notice of proposed rule making to the December 1st 
deadline. A request for expansion often triggers an `early' site visit 
by the specialty Residency Review Committee (RRC) and site visitor 
schedules are booked six to 12 months in advance.'' Another commenter 
notes that the proposed date by which a hospital would be required to 
document the approval of the accrediting body would mean that the 
hospital would have to file an application with the ACGME/AOA ``before 
knowing whether it will receive the additional slots necessary to fund 
[the] new or expanded program. We urge CMS to reconsider this timeframe 
to allow hospitals to receive slots contingent on receiving [AOA/ACGME] 
approval.''
    Response: CMS understands that the applications for approval of 
new/expanded programs for the ACGME and the AOA are extensive documents 
that demonstrate a commitment on behalf of the hospitals to establish/
expand a program. For this reason, we believed applications for 
approval are good sources of documentation to demonstrate the 
likelihood for purposes of the section 422 increase. We recognize that 
applying for program approval is a lengthy process that takes a 
significant period of time before approval is given by the ACGME/AOA. 
The commenter is correct in believing

[[Page 49138]]

that it would be unlikely that hospitals would have enough time to 
apply for program approval from the ACGME/AOA (either for expansion or 
new program accreditation) within the timeframe set up by CMS for 
applying for the section 422 caps. However we have chosen December 1, 
2004 as the date on which to show the approval, (since, as explained 
earlier, we intend to begin the allocation of the section 422 cap 
process in December)--and need to know at that time whether hospitals 
can demonstrate the likelihood of filling the slots. Under this 
criterion, we believe we will enable hospitals that were already 
contemplating new/expanded program approval from the ACGME/AOA to be 
considered to receive an increase in their FTE resident caps under 
section 422. Under another criterion, we have addressed the situation 
where a hospital was already training residents above its 1996 FTE 
caps, before CMS proposed and finalized the application process 
implementing section 422. We do not believe a hospital that is merely 
contemplating the future possibility that it will train a number of 
residents in excess of its FTE resident caps can demonstrate the 
likelihood that it will fill additional positions within the timeframe 
for our decision process under section 1886(h)(7)(B) of the Act.
    Therefore, we are not making additional changes to this option 
under Demonstrated Likelihood Criteria 1 or 2.
    Comment: We received one general comment that the ``single best 
piece of evidence'' for a hospital to ``demonstrate the likelihood'' of 
filling the slots under section 422 is the fact that a hospital is 
already training a number of residents in excess of its FTE caps.
    Response: We agree with the commenter that hospitals are able to 
fulfill the demonstrated likelihood requirement by documenting to CMS 
that they are training a number of FTE residents that exceeds their FTE 
cap(s) in the manner described in this final rule.
    Comment: One commenter asked for flexibility in the choices under 
the proposed Demonstrated Likelihood Criteria 1 and 2. Specifically, 
the commenter pointed out that sections A1(1) and (2) and A2(1) and (2) 
of both criteria offer options in order to fulfill the demonstrated 
likelihood requirement; and that CMS proposed that the hospital be able 
to meet ``one of the following'' choices under each requirement. The 
commenter suggested that CMS add language that directs the hospital 
applicant to ``check all that apply'' at the beginning of A1(1) and (2) 
and A2(1) and (2) of the criteria.
    Response: We understand that a particular hospital applicant may be 
able to meet more than one of the choices under A1(1) and (2) and A2(1) 
and (2).
    For instance, it is possible that, in order to meet A1(1), a 
hospital may have written correspondence from the ACGME or AOA 
acknowledging receipt of the application for a new residency program, 
but may also have the actual application for the approval of the new 
program. We would not ask hospitals to provide any more documentation 
than is necessary under each of the options under A1(1) that is chosen 
by the applicant hospital; however, to provide hospitals with 
additional flexibility, if an applicant hospital would like to choose 
more than one of the options under A1(1) and (2) and A2(1) and (2), we 
are adding language at the beginning of each of A1(1) and (2) and A2(1) 
and (2) of Demonstrated Likelihood Criteria 1 and 2 that says ``Check 
at least one of the following, if applicable''.
    Comment: One commenter stated that there are a few residency 
programs in a particular specialty that received accreditation from the 
ACGME in 2003, for which the hospitals sponsoring these programs are 
training their first class of PG-1 residents in July 2004. The 
commenter urged CMS to revise the proposed Demonstrated Likelihood 
Criterion 1 that relates to establishing a new residency program on or 
after July 1, 2005. Specifically, the commenter stated that the new 
programs described were accredited after January 1, 2002, ``* * * and 
can more appropriately demonstrate ability to fill to the full 
complement of residents in the next three cost reporting years, except 
that those years will be 2004-2007, rather than 2005-2008.''
    Response: Section 1886(h)(7)(B)(ii) of the Act, as modified by 
section 422 of Public Law 108-173, specifies that: ``[i]n determining 
for which hospitals the increase in the otherwise applicable resident 
limit is provided * * * the Secretary shall take into account the 
demonstrated likelihood of the hospital filling the positions within 
the first 3 cost reporting periods beginning on or after July 1, 
2005.'' (Emphasis added.) We provided several methods for hospitals to 
be able to demonstrate to CMS under the proposed Demonstrated 
Likelihood Criterion 1 that they can fill the slots by showing to CMS 
that they are establishing a new residency program on or after July 1, 
2005. We believe hospitals that establish new residency programs before 
July 1, 2005, could possibly meet Demonstrated Likelihood Criterion 2, 
relating to a hospital that is expanding an existing residency program 
on or after July 1, 2005. From the perspective of applying for the cap 
increase under section 422, the new program that starts training 
residents in 2004 is an ``existing residency program'' if established 
before July 1, 2005, and it is ``expanding'' if that program is 
increasing in the number of FTE residents in the first three cost 
reporting periods beginning on or after July 1, 2005.
    Comment: We received one comment asking whether a hospital that 
applies for an increase in its FTE resident cap under section 422 and 
establishes a newly accredited program that starts in 2006 would be 
eligible to receive ``the full complement of accredited positions, or 
only the first and second year (for example, 12 of 18 accredited slots) 
under these [proposed] regulations.'' Similarly, another commenter 
described the situation of a hospital that establishes a new residency 
program that, because of the length of the accreditation process and a 
relatively long match period, will be unable to accept its first class 
of PGY-1 residents until July 1, 2006. The commenter urged CMS to 
clarify whether a new program like this will be able to receive a full 
complement of residents for the three years beginning July 1, 2006.
    Response: Assuming the applicant hospital can demonstrate the 
likelihood that it will fill the slots relating to a possible increase 
in its FTE resident caps under section 422, as provided in the criteria 
on the CMS Evaluation Form, and finalized in this final rule, the 
applicant hospital may request on its application an increase of up to 
25 FTE residents for direct GME and IME. However, if the applicant 
hospital does not demonstrate the likelihood that it will fill any FTE 
slots as claimed for programs described by the hospital on the CMS 
Evaluation Form(s) at any point within the hospital's first three cost 
reporting periods beginning on or after July 1, 2005, the hospital will 
not be eligible to apply for the increase to the FTE caps under section 
422. We do not believe our proposed Demonstrate Likelihood Criterion 1 
reflects this point and, accordingly, are making the following changes 
with this final rule:
    ``A1: Demonstrated Likelihood Criterion 1. The hospital intends to 
use the additional FTEs to establish a new residency program (listed 
above) on or after July 1, 2005 (that is, a newly approved program that 
begins training residents at any point within the hospital's first 
three cost reporting periods beginning on or after July 1, 2005).''
    Comment: One commenter stated that a hospital may meet the 
demonstrated

[[Page 49139]]

likelihood requirement by documenting that it is establishing a new 
program or expanding an existing program, on or after July 1, 2005. The 
commenter asked whether the hospital is then limited to submitting a 
CMS Evaluation Form only for that program: The commenter suggested that 
if the answer is yes and CMS ultimately grants additional slots to the 
hospital based on the needs for that program, it seems unclear whether 
CMS would take the view that the additional cap slots could only be 
used for the program listed in the application.
    Response: As we have stated in this final rule, each application by 
a hospital must be program specific. That is, the hospital must 
complete a separate CMS Evaluation Form for each program and 
demonstrate the likelihood of filling the slots in each program. 
However, increases in hospital's FTE resident caps under section 422 
for direct GME and IME, once granted to a hospital, are no longer 
program specific. Rather, the caps are applied to any residents the 
hospital trains in excess of its otherwise applicable FTE cap(s) (Which 
could include the hospital's 1996 caps, subject to permanent 
adjustments for new programs or reductions under section 1886(h)(7)(A) 
of the Act.).
    Comment: One commenter believed that the proposed rule omitted the 
documentation requirement in the Demonstrated Likelihood Criteria for 
new programs and expansions of existing programs for ``what should be 
key''; that is, that the applicant hospital requesting the additional 
slots for the new/expansion program would have already exceeded its 
1996 FTE caps in previous years.
    Response: While we believe a majority of those hospitals applying 
for the increase to the FTE caps for new programs and expansions of 
existing programs will already be training a number of residents that 
exceeds their FTE caps, we do not believe this circumstance is a 
necessary condition for all of the hospitals that apply. For example, a 
hospital whose FTE resident cap is reduced under section 1886(h)(7)(A) 
of the Act may have been planning to establish a new program in July 
2006 that would have put the hospital's FTE resident count above its 
1996 FTE cap at that time. Therefore, we see no reason to require that, 
at the time of the hospital's application, the hospital necessarily 
either exceed or be at its FTE cap, in order to meet the demonstrated 
likelihood requirement. Thus, we are not adopting the commenter's 
proposal to require hospitals to be training a number of residents that 
is at or over their FTE caps in order to meet the Demonstrated 
Likelihood Criteria 1 or 2.
    We note that we will be aware if an applicant hospital is training 
residents in excess of its FTE caps, even if the hospital checks off 
Demonstrated Likelihood Criteria 1 or 2 because, as part of the 
hospital's application for the section 422 increase to the caps, we 
proposed that the hospital must provide both the FTE resident counts 
for direct GME and IME and FTE resident caps for direct GME and IME 
reported by the hospital in the most recent as-filed cost report (69 FR 
28301). We are finalizing this application requirement with this final 
rule. (We have included a summary of the application requirements at 
the end of this section of this preamble).
    Comment: One commenter indicated that there is a lack of clarity 
with proposed Demonstrated Likelihood Criterion 1 by stating that the 
precise documentation requirements differ between what is discussed in 
the preamble and what is proposed on the CMS Evaluation Form. The 
commenter believed that the submission of a new program application 
should not be required under second option under (1).
    Response: It may have appeared to the commenter that the 
documentation requirements in the preamble language and the proposed 
CMS Evaluation Form for Demonstrated Likelihood Criterion 1 were 
different, because the preamble language states that the hospital must, 
in conjunction with every available option, submit a copy of the 
application for approval for the residency program ``to the ACGME or 
the AOA by December 1, 2004'', whereas the proposed CMS Evaluation Form 
asks for a copy of the new program application for only one of the 
options. We would like to clarify that the documentation required for 
(1) under A1 is limited to what is requested on the CMS Evaluation 
Form, as finalized in this final rule. We are not requiring a copy of 
the new program application as part of the documentation associated 
with the second option under (1). In the second option, we are only 
requiring a copy of the institutional review document or program 
information form concerning the new program that hospitals include as 
part of their applications for approval.
    Comment: Several commenters suggested that CMS include options 
under the demonstrated likelihood criteria that take into account 
programs that seek certification from the American Board of Medical 
Specialties (``ABMS''). For example, under Demonstrated Likelihood 
Criterion 1, under the first requirement, the hospital is given choices 
for documenting its application for new program accreditation from the 
ACGME or the AOA. The commenters asked what hospitals should do to 
demonstrate likelihood if the programs for which the hospitals are 
requesting cap increases for under section 422 are certified by the 
ABMS.
    Response: We agree with the commenter that there are certain 
residency programs that are certified by the ABMS and that do not 
require certification by the ACGME or AOA. Our regulations currently 
recognize these programs as approved programs for purposes of direct 
GME and IME payments. Therefore, we believe it is appropriate to 
include the ABMS as a certifying organization for the purposes of 
Demonstrated Likelihood Criterion 1 and Demonstrated Likelihood 
Criterion 2. We are adding the following language to the CMS Evaluation 
Form at A1(1):
     ``Application for approval of the new residency program 
has been submitted to the ACGME, AOA, or the ABMS by December 1, 2004. 
(Copy Attached.)''
     ``The hospital has received written correspondence from 
the ACGME, AOA, or ABMS acknowledging receipt of the new program, or 
other types of communication from the accrediting bodies concerning the 
new program approval process (such as notification of site visit). 
(Copy Attached.)''
    We are also adding the following language to the CMS Evaluation 
Form at A2(1): ``The appropriate accrediting body (the ACGME, AOA, or 
ABMS) has approved the hospital's expansion of the number of FTE 
residents in the program. (Documentation attached.)''
    Comment: We received several comments suggesting that the 
requirements under proposed Demonstrated Likelihood Criterion 3 are 
burdensome. Proposed Demonstrated Likelihood Criterion 3 states--
     A3: Demonstrated Likelihood Criterion 3. Hospital is 
applying for an increase in its FTE resident cap because the hospital 
is already training residents in an existing residency training 
program(s) in excess of its direct GME FTE cap or IME FTE cap, or both. 
(Copies of each of the following attached.)
     Copies of the most recent as-submitted Medicare cost 
reports documenting on Worksheet E, Part A and Worksheet E3, Part IV 
the resident counts and FTE resident caps for both direct GME and IME 
for the relevant cost reporting periods.
     Copies of the 2004 residency match information concerning 
the number of

[[Page 49140]]

residents the hospital intends to have in its existing programs.
     Copies of the most recent accreditation letters on all of 
the hospital's training programs in which the hospital trains and 
counts FTE residents for direct GME and IME.''
    The commenters questioned why all of the documentation requirements 
are necessary to demonstrate that the hospital is already exceeding its 
FTE cap at the time the hospital is applying for an increase in its FTE 
resident caps. Specifically, one commenter suggested that the most 
obvious way for CMS to get the information on whether the hospital is 
counting residents above its FTE caps is the Medicare cost report. 
However, the commenter believed that ``[i]n many instances an FTE 
request [to count a number of residents that is] greater than the cap 
is not entered into the cost report due to the fact that it is futile 
to do so as the reimbursement will not change. However, Intern and 
Resident Information Survey (IRIS) data, contract cover pages, resident 
schedules, etc. can all be used to demonstrate that the actual resident 
FTE that could be counted for IME and DME purposes is greater than the 
cap allows. This commenter proposed that CMS allow hospitals to use 
these alternative sources of information.'' This commenter believed 
that the second option, to use 2004 residency match information, only 
shows an intent to fill slots, not that the slots have actually been 
filled. The commenter believed that it would be more accurate to look 
at the hospital's 2004 fill rate, which is available after July 1, 
2004. Finally, this commenter had concerns with the third option under 
this criterion--to look at accreditation letters on all the hospital's 
programs. The commenter believed that the Residency Review Committee 
(RRC) for family practice does not accredit a program with a specific 
number, and encouraged CMS to change this requirement because it ``does 
not fit the configuration of family practice residency accreditation.''
    Response: We agree with the comment that ``the most obvious way'' 
for CMS to determine whether a hospital is training FTE residents in 
excess of its FTE cap is to look at Medicare cost report information. 
Regarding the comment that some hospitals do not show on the cost 
report that they are over their FTE caps because the excess FTE 
residents would have no effect on Medicare direct GME and IME payments, 
We do not agree that hospitals should not be reporting all the FTE 
residents that the hospital is training. According to the regulations 
under Sec.  413.86(f) (as redesignated as Sec.  413.78), hospitals must 
report the actual total number of FTE residents. The total number of 
residents the hospital trained (even if it is in excess of the cap(s)) 
is actually used in determining direct GME and IME payments. For 
example, if the number of FTE residents exceeds the hospital's FTE cap 
for direct GME, if the hospital has two different per resident amounts 
(PRAs) for primary care and non-primary care, we prorate the reduction 
in the allowable number of FTE residents to bring the number of primary 
care and non-primary care FTEs to the hospital's FTE cap. In addition, 
we note that representatives of hospitals must attest on the Medicare 
cost report to the truth and accuracy of the information reported. 
Thus, it is required that hospitals include the total number of FTE 
residents in their cost reports, even if the hospital, is not allowed 
to count the residents for purposes of Medicare direct GME and IME 
payments as a result of application of the FTE resident cap(s).
    To respond to the comment concerning the use of IRIS data, we 
believe that IRIS data is most useful from the perspective of looking 
back at the past and assuring that hospitals are not submitting 
duplicate FTE counts; we do not believe IRIS data would be helpful to 
determine whether hospitals can ``demonstrate the likelihood of filling 
the positions'' in the future. The documentation requirement regarding 
resident employment contracts is addressed in another comment and 
response above.
    We agree with the commenter that the second documentation 
requirement, regarding 2004 residency match information for all the 
programs at the hospital, only shows an intent to fill slots and not 
that slots have actually been filled. In proposing to require 2004 
match information, we sought this information even though it is more 
relevant to a hospital's ``intent to fill'' programs because we 
believed the information would portend that the hospital would continue 
to be over its FTE cap on or after July 1, 2005, as the statute 
requires in the demonstrated likelihood requirement. However, we agree 
with the commenter, and have decided to offer another option under 
Demonstrated Likelihood Criterion 3 to allow hospitals to provide fill 
rate information of all programs at the hospital in 2004, in addition 
to offering 2004 match information.
    Finally, regarding the documentation requirement for the copies of 
the recent accreditation letters for all of the hospital's programs, we 
disagree with the commenter's suggestion that we intended to match the 
listed number of resident positions in the accreditation letters with 
the number of slots claimed on the Medicare cost report. Our purpose in 
proposing to require accreditation documentation for all programs is so 
that we could ensure that all the hospital's programs continue to be 
accredited, that is, to verify the legitimacy of the applicant 
hospital's programs, not to ``match'' the number on the accreditation 
letters to the FTE counts on the cost report Worksheets E, Part A and 
Worksheet E3, Part IV. In addition, we understand that although the 
ACGME does not specifically approve a limited number of slots for 
family practice programs, the number of available slots in each program 
is determined by the program itself and that data is then reported to 
the ACGME. Therefore, we are not accepting the commenter's request to 
excuse hospitals from providing accreditation documentation for family 
practice programs.
    Comment: A number of commenters focused on proposed Demonstrated 
Likelihood Criterion 4, which states--
    ``Demonstrated Likelihood Criterion 4. The hospital is applying for 
the unused FTE resident slots because the hospital is at risk of losing 
accreditation of a residency training program if the hospital does not 
increase the number of FTE residents in the program on or after July l, 
2005. (Documentation attached from the appropriate accrediting body of 
the hospital's risk of lost accreditation as a result of an 
insufficient number of residents in the program.)''
    Several commenters asked CMS to provide further explanation as to 
why CMS believed these circumstances merit the addition of this 
proposed Demonstrated Likelihood Criterion, particularly where the 
hospital is not training a number of FTE residents in excess of its 
1996 FTE cap(s). One commenter asked why hospitals under this criterion 
do not demonstrate to CMS that the additional cap slots under section 
422 are necessary because, increasing the resident slots would 
otherwise cause the hospitals to exceed their FTE caps. This commenter 
also believed that, under this criterion, hospitals should demonstrate 
fill rates as part of the documentation requirements.
    Another commenter believed that this criterion does not fit with 
the requirement that the hospital demonstrate the likelihood that it 
will fill FTE resident slots ``[i]n fact, it says just the opposite--
that the program has not been able to fill its slots, and is under a 
threat of academic consequences. In such cases, we believe

[[Page 49141]]

it is perhaps better for the program to close, than to waste new slots 
on a program that has little chance of filling.''
    Response: When we proposed Demonstrated Likelihood Criterion 4, we 
were under the impression that there were some hospitals that were 
training a number of residents below their FTE caps, and were at risk 
of losing their accreditation if they did not fill their residency 
program with more slots. However, based upon the public comments we 
received questioning why the criterion is necessary, and given that we 
did not receive any comments in support of the criterion, we agree that 
we should delete Demonstrated Likelihood Criterion 4 from the CMS 
Evaluation Form in this final rule.
    h. Application Process for the Increases in Hospitals' FTE Resident 
Caps
    As stated above, in the May 18, 2004 proposed rule, we proposed an 
objective decision-making process for determining how hospitals will be 
prioritized when identifying the hospitals that will receive increases 
in their FTE resident caps. In order for hospitals to be considered for 
increases in their FTE resident caps, section 1886(h)(7)(B)(i) of the 
Act, as added by section 422(a)(3) of Public Law 108-173 requires that 
each ``qualifying hospital'' submit a ``timely application.'' We 
proposed that each hospital must submit the following information on 
its application for an increase in its FTE resident cap:
     The name and Medicare provider number of the hospital.
     The total number of requested FTE resident slots (for all 
residency programs at the hospital) for direct GME or IME, or both (up 
to 25 FTEs).
     A completed copy of the CMS Evaluation Form (as described 
below) for each residency program for which the applicant hospital 
intends to use the requested increase in the number of FTE residents 
and source documentation to support the assertions made by the hospital 
on the Evaluation Form. (For example, if the hospital checks off on the 
Evaluation Form that the hospital is located in a geographic Health 
Professions Shortage Area (HPSA), the hospital would include 
documentation to support that assertion.) A copy of the blank proposed 
CMS Evaluation Form appears at the end of this section of the preamble.
     FTE resident counts for direct GME and IME and FTE 
resident caps for direct GME and IME reported by the hospital in the 
most recent as-filed cost report.
     An attestation, signed and dated by an officer or 
administrator of the hospital who signs the hospital's Medicare cost 
report, of the following information in the hospital's application for 
an increase in its FTE resident cap:
    ``I hereby certify that I understand that misrepresentation or 
falsification of any information contained in this application may be 
punishable by criminal, civil, and administrative action, fine and/or 
imprisonment under federal law. Furthermore, I understand that if 
services identified in this application were provided or procured 
through payment directly or indirectly of a kickback or where otherwise 
illegal, criminal, civil, and administrative action, fines and/or 
imprisonment may result. I also certify that, to the best of my 
knowledge and belief, it is a true, correct, and complete application 
prepared from the books and records of the hospital in accordance with 
applicable instructions, except as noted. I further certify that I am 
familiar with the laws and regulations regarding Medicare payment to 
hospitals for the training of interns and residents.''
    We further proposed that any hospital that wishes to receive an 
increase in its FTE resident cap(s) must submit a copy of its completed 
application (as described above) to the CMS Central Office and to the 
CMS Regional Office for the region in which the applicant hospital is 
located, and that the application must be received on or before 
December 1, 2004. (The mailing addresses for the CMS offices are 
indicated at the end of this section of the preamble.) We note that 
some hospitals' FTE counts will be subject to audit for purposes of 
section 1886(h)(7)(A) of the Act, and those audits may not be completed 
by December 1, 2004. Because the results of such an audit may be a 
factor in a hospital's decision whether to request an increase in its 
FTE resident cap under section 1886(h)(7)(B) of the Act, we proposed to 
allow a later date for those hospitals to apply for increases in their 
FTE resident caps. Therefore, if a hospital's resident level is audited 
for purposes of section 1886(h)(7)(A) of the Act, and that hospital 
also wishes to apply for an increase in its FTE resident cap(s) 
available through section 1886(h)(7)(B) of the Act, we proposed that 
this hospital must submit a completed application to CMS and that the 
application must be received on or before March 1, 2005. We proposed 
that all completed applications that are timely received according to 
the above deadlines will be evaluated by us according to the criteria 
described under section IV.O.2.i. of this preamble for determining the 
priority distribution of FTE resident slots. Hospitals that satisfy at 
least one of the ``demonstrated likelihood'' criteria will be further 
evaluated by the evaluation criteria described below. We proposed that 
those hospitals that are chosen to receive an increase in their FTE 
resident caps would be notified by CMS by July 1, 2005.
    Comment: Several commenters expressed concerns regarding CMS's 
overall approach to evaluating the application for the increase to 
hospitals' FTE caps under section 422. They disagreed with the proposed 
requirement that, as part of a hospital's application for the increase 
to the 1996 FTE caps, that is, for the section 422 cap, the hospital 
must submit a completed copy of the CMS Evaluation Form for each 
residency program for which the applicant hospital demonstrates a need 
for the requested increase in the number of FTE residents. One of the 
commenters stated that ``we have fundamental and serious concerns with 
* * * an evaluation form that focuses on residency programs, rather 
than hospital applicants * * * we think CMS' proposed process could 
lead, at a minimum, to a de facto situation of program-specific caps, 
which is contrary to the spirit and intent of the BBA.'' The commenters 
were concerned with the possibility that CMS may take the view that the 
section 422 cap could only be used for the residency programs listed in 
the hospital's application for the increase. The commenters were also 
concerned that the evaluation criteria list program-specific criteria 
on the CMS Evaluation Form (such as a point for using the unused 
resident slots for establishing a new geriatrics program or for 
expanding an existing geriatrics program; or for a point for a new 
program that did not qualify for an adjustment because of the deadlines 
associated with the BBA). One commenter stated that CMS ``should not 
favor one specialty over another but should view all specialty programs 
equally and leave decisions regarding the use of additional residency 
positions to the hospital.'' The commenters preferred CMS to focus on 
the evaluation of the application for the section 422 cap on the 
hospitals and not on the hospital's residency programs.
    Response: We understand the commenters' concerns about the 
possibility that we have proposed a program-specific section 422 cap. 
We did not propose and we are not finalizing in this final rule a 
program-specific section 422 cap. That is, once a hospital receives an 
increase in its otherwise applicable FTE resident cap

[[Page 49142]]

effective July 1, 2005, the portion of the cap relating to an increase 
under section 422 is applied to FTEs in any program that the hospital 
is training in excess of its 1996 FTE cap (which is subject to any 
permanent adjustments for new programs and any reductions under section 
1886(h)(7)(A) of the Act), regardless of the hospital's program-
specific basis for being granted the section 422 cap increase.
    We note, however, that hospitals must sign an attestation as part 
of the hospital's application for the overall increase to the cap under 
section 422 to certify that the information claimed in the application 
is true at the time of the application. Thus, if a hospital claims on 
one of its CMS Evaluation Forms that the hospital is applying for the 
increase because it plans to use the FTEs because it is training 
residents from a program or a hospital that closed, and the applicant 
hospital no longer qualifies for a temporary adjustment to its cap, 
then at least at the time of the application, the hospital intends to 
use at least that part of its section 422 cap for this stated purposes 
(that is documented in the hospital's application). The section 422 
caps, as well as the adjusted 1996 FTE caps, are applied to FTE 
residents counted by the hospital in all programs in the aggregate, not 
on a program-specific basis.
    In response to the comments concerning our proposal to require a 
separate CMS Evaluation Form for each residency program for which the 
applicant hospital requests an increase in the number of FTE residents, 
we proposed such a requirement so that, as stated above and also in the 
proposed rule, we would be able to determine a hospital's 
``demonstrated likelihood'' and to discern within which level priority 
category (first through sixth) the applicant hospital's application 
should be placed based on the residency specialty program for which the 
FTE cap increase is being requested. As we have stated, a hospital may 
apply for an increase in its FTE caps for more than one residency 
program at the hospital. It is possible that applications for the 
programs would fall within different level priority categories. For 
example, a hospital may apply for an increase in its cap(s) for one 
program that is the ``only specialty training program in the State'' 
(which would place the hospital's application in the fifth level 
priority category on the CMS Evaluation Form) and for another program 
that is not the only program in the State (which, assuming the hospital 
is located in a large urban area, would place the hospital on that 
Evaluation Form in the sixth level priority category). Therefore, we 
proposed that hospitals complete an Evaluation Form for each residency 
program for which it is requesting an increase in its FTE resident cap. 
For these reasons, we are finalizing our proposed policy. We believe it 
would be difficult for us to establish ``demonstrated likelihood'' and 
to determine which hospital requests should have priority over others 
to receive the section 422 cap without asking hospitals to submit a CMS 
Evaluation Form for each program they are requesting as part of their 
application for the section 422 cap.
    Finally, to respond to the comments concerning program-specific 
criteria on the CMS Evaluation Form, we proposed such criteria in an 
attempt to not only encourage certain public health and community 
goals, but also to correct certain anomalies relating to the FTE 
resident cap that may have been unintended consequences resulting from 
the BBA-mandated FTE caps. We believe our proposed program-specific 
criteria are important because we would, at least at the outset of 
awarding the section 422 cap increases, like to encourage certain 
behaviors in graduate medical education.
    To demonstrate the point that the section 422 caps are hospital-
specific and not program-specific, we give the following example to 
represent a scenario that we would view as an appropriate use of the 
section 422 caps:

    Example: Hospital-specific section 422 caps. Hospital D, an 
urban hospital located in an other than large urban area that is 
training residents at its direct GME and IME 1996 FTE caps, applies 
to CMS for the section 422 caps because the hospital intends to 
expand its existing geriatrics residency program from 5 FTEs to 10 
FTEs beginning July 1, 2005, and therefore checks off C2 on the CMS 
Evaluation Form and also demonstrates a likelihood of filling the 
slots of the program. CMS awards Hospital D 5 FTE residents for its 
direct GME and IME section 422 caps to be used by Hospital D 
beginning on or after July 1, 2005. In the middle of the 2008 
program year, Hospital D realizes that it only had been able to 
increase its geriatrics residency program for two additional 
geriatrics residents. Hospital D would accordingly prefer to use 3 
FTEs for direct GME and IME out of its section 422 cap for another 
unrelated program, because it would like to expand the number of FTE 
residents for that program. Thus, beginning July 1, 2009, Hospital D 
may count 2 FTE residents for geriatrics and 3 additional FTEs for 
another program in its section 422 caps.

    Comment: One commenter asked whether ``each residency program 
within a single hospital'' must submit a separate CMS Evaluation Form.
    Response: First, hospitals, not individual residency programs at 
hospitals, apply for the section 422 caps. As we have indicated 
earlier, the section 422 caps are not program-specific; rather, they 
are hospital-specific. Second, as discussed above and also in the 
proposed rule, we are requiring that each hospital submit as part of 
its application a separate CMS Evaluation Form for each residency 
program for which the applicant hospital intends to justify an increase 
in the number of FTE residents slots.
    Comment: One commenter asked whether each hospital under a Medicare 
GME affiliation agreement should submit a CMS Evaluation Form for ``the 
same specialty program.''
    Response: We are assuming the commenter is referring to a hospital 
that is applying for the section 422 cap increase and such a hospital 
will also participate in a Medicare GME affiliation agreement as of 
July 1, 2005, such that it is rotating residents in a particular 
program from the hospital to another hospital in the affiliation. We 
are clarifying in this final rule that--(1) hospitals that participate 
in a Medicare GME affiliation agreement under Sec.  413.79(f) on or 
after July 1, 2005, may apply for the increase to their caps under 
section 422; and (2) hospitals that receive section 422 cap increases 
from CMS and participate in a Medicare GME affiliation agreement under 
Sec.  413.79(f) on or after July 1, 2005 may only affiliate for the 
purpose of adjusting their 1996 FTE caps (adjusted for new programs and 
any reductions under section 1886(h)(7)(A) of the Act) for direct GME 
and IME. The additional slots that a hospital receives under section 
422 may not be aggregated and applied to the FTE resident caps of any 
other hospitals. Adjustments under section 422 are limited to no more 
than 25 FTEs for any hospital that applies. We believe that if we were 
to allow affiliations using the section 422 cap increases, hospitals 
could circumvent the 25 FTE limit on the section 422 cap increases. We 
also believe this prohibition on affiliations relating to the section 
422 cap increases is needed to facilitate tracking for the different 
direct GME and IME payment rates associated with FTE residents that are 
counted as a result of the section 422 cap increases. It would be very 
difficult for both providers and fiscal intermediaries to identify 
these ``422'' FTE residents in an affiliation agreement with two or 
more hospitals (some affiliations have multiple hospital participants). 
Therefore, we believe it is appropriate to prohibit hospitals that 
receive section 422 cap increases from including those FTE increases in 
the aggregate FTE cap in an affiliated group, effective July 1, 2005. 
However, hospitals that receive

[[Page 49143]]

section 422 cap increases may affiliate with other hospitals using the 
remainder of their FTE resident caps, that is, the 1996 cap as adjusted 
for new programs and reductions under section 1998(h)(&)(A) of the Act. 
The following is an example of an affiliation between two hospitals 
(one of the affiliated hospitals has a section 422 cap for direct GME 
and IME):

    Example: Affiliation agreement with section 422 caps. Hospital A 
has a 1996 FTE resident cap of 100 for both direct GME and IME and, 
effective July 1, 2005, a section 422 cap of 15 for both direct GME 
and IME. Hospital B has a 1996 FTE resident cap of 60 for both 
direct GME and IME and no section 422 cap. For the academic year 
ending June 30, 2006, the two hospitals enter into a Medicare GME 
affiliation agreement. Their combined 1996 direct GME and IME cap is 
160 FTE residents (100 Hospital A + 60 Hospital B). The hospitals 
are prohibited from forming a Medicare GME affiliation agreement 
using the 15 FTE in Hospital A's section 422 cap. They may 
reallocate the 1996 FTE resident caps under the affiliation so that 
Hospital A's direct GME and IME 1996 cap is 90 and Hospital B's 
direct GME and IME 1996 cap is 70. Both Hospital A and Hospital B 
have a FYE of June 30. In addition to its 1996 cap of 90, Hospital A 
would have a section 422 cap(s) of 15 FTEs.
    Hospital A: During FY 2006, Hospital A trains 100 FTE residents. 
Of the 100 FTE residents, Hospital A is able to count up to 90 FTEs 
in its 1996 cap as adjusted by the Medicare GME affiliation 
agreement described above and 10 residents as part of its section 
422 cap.

     For direct GME, the 90 residents counted as part of the 
1996 FTE cap are paid at the hospital's actual per resident amounts 
(primary care PRA and/or nonprimary care PRA) inflated to the current 
cost reporting period.
     For direct GME, the 10 FTE residents (100 total FTE--90 
FTE counted in the 1996 cap) that Hospital A counts above its 1996 FTE 
cap, as adjusted by the affiliation agreement, are counted as part of 
the section 422 cap. These 10 FTE residents are paid at the locality-
adjusted national average PRA under Sec.  413.77(d)(2)(ii), inflated to 
the current cost reporting period.
     In order to calculate the IME adjustment factor for the 90 
FTE residents counted as part of the 1996 FTE cap, Hospital A uses 1.37 
(per section 502(a) of Public Law 108-173) as the IME adjustment factor 
formula multiplier.
     In order to calculate the IME adjustment factor for the 10 
FTE residents counted as part of the section 422 cap, Hospital A uses 
.66 (per section 422(b)(1)(C) of Pub. L. 108-173) as the IME adjustment 
formula multiplier.
     The remaining 5 FTE available under Hospital A's section 
422 cap are unused during the FYE June 30, 2006.
    Hospital B: During FY 2006, Hospital B trains 75 FTE residents. Of 
these 75 residents, only 70 residents are counted as a result of 
Hospital B's 1996 FTE cap as adjusted by the Medicare GME affiliation 
agreement.
     For direct GME, the 70 FTE residents counted as part of 
the 1996 FTE cap are paid at the hospital's actual per resident amounts 
(primary care PRA or nonprimary care PRA) inflated to the current cost 
reporting period.
     In order to calculate the IME adjustment factor for the 70 
FTE residents counted as part of the 1996 FTE cap, Hospital B uses 1.37 
(per section 502(a) of Pub. L. 108-173) as the IME adjustment factor 
formula multiplier.
    Hospital B cannot receive Hospital A's unused section 422 cap slots 
through the affiliation agreement. Therefore, 5 FTE residents training 
at Hospital B cannot be counted for purposes of direct GME and IME 
payment.
    Comment: One commenter asked for clarification on which hospitals 
are eligible to submit an application for the section 422 caps by March 
1, 2005, rather than December 1, 2004.
    Response: We stated at the proposed rule the following information 
for the timeframe for submission of the section 422 cap increase 
applications:
    ``We further propose that any hospital that wishes to receive an 
increase in its FTE resident cap(s) must submit a copy of its completed 
application * * * to the CMS Central Office and to the CMS Regional 
Office for the region in which the applicant hospital is located, and 
that the application must be received on or before December 1, 2004 * * 
* We note that some hospitals' FTE counts will be subject to audit for 
purposes of section 1886(h)(7)(B) of the Act, and those audits may not 
be completed by December 1, 2004. Because the results of such an audit 
may be a factor in a hospital's decision whether to request an increase 
in its FTE resident cap under section 1886(h)(7)(B) of the Act, we 
propose to allow a later date for those hospitals to apply for 
increases in their FTE resident caps. Therefore, if a hospital's 
resident level is audited for purposes of section 1886(h)(7)(A) of the 
Act, and that hospital also wishes to apply for an increase in its FTE 
resident cap(s) available through section 1886(h)(7)(B) of the Act, we 
propose that such a hospital must submit a completed application to CMS 
and that the application must be received on or before March 1, 2005.'' 
We hope this information is helpful and are finalizing the December 1, 
2004 and March 1, 2005 deadline applications for the different 
hospitals in this final rule.
i. CMS Evaluation of Applications for Increases in FTE Resident Caps
    As noted in section IV.O.2.h. of this preamble, in the May 18, 2004 
proposed rule, we proposed to require hospitals to submit, with their 
applications for increases in their FTE resident caps, a completed copy 
of the CMS Evaluation Form. As we have stated, we proposed to make the 
process of evaluating the applications as objective as possible. 
Therefore, we proposed to use a CMS Evaluation Form that the hospital 
must complete and submit as part of its application. The CMS Evaluation 
Form will ask the hospital to check off which of the ``demonstrated 
likelihood'' criteria (described above in section IV.O.2.g. of this 
preamble) the hospital meets. We also proposed to require the hospital 
to provide the documentation that supports the ``demonstrated 
likelihood'' criteria it has checked off on the Evaluation Form.
    Assuming that hospitals interested in applying for the increase in 
their FTE caps meet the eligibility criterion of ``demonstrated 
likelihood,'' we proposed that applicant hospitals indicate on the CMS 
Evaluation Form the category(ies) for which it believes it will 
qualify. We will use this indication to prioritize the applications. 
This prioritization is derived from section 1886(h)(7)(B) of the Act, 
as added by section 422 of Public Law 108-173. That section established 
the following priority order to determine the hospitals that will 
receive increases in their FTE caps:
     First, to hospitals that are ``located in rural areas, as 
defined in section 1886(d)(2)(D)(ii) of the Act'' (section 
1886(h)(7)(B)(iii)(I) of the Act). Section 1886(d)(2)(D)(ii) of the Act 
defines a rural area as any area outside a Metropolitan Statistical 
Area (MSA). Under the existing implementing regulations at Sec.  
413.62(f)(ii), an ``urban area'' means (1) a Metropolitan Statistical 
Area (MSA) or New England County Metropolitan Area (NECMA); or (2) the 
following New England counties: Litchfield County, Connecticut; York 
County, Maine; Sagadahoc County, Maine; Merrimack County, New 
Hampshire; and Newport County, Rhode Island. Under existing Sec.  
413.62(f)(iii), a ``rural area'' means any area outside an urban area. 
However, we note that under section III. of this preamble, which 
discusses changes in wage areas for FY 2005, we proposed to no longer 
recognize NECMAs as a distinct category of wage areas. Thus, for 
purposes of the amendments made

[[Page 49144]]

by section 422, we proposed that any hospital located in an area that 
is not in a MSA is a rural hospital, regardless of any reclassification 
under Sec.  412.102 or Sec.  412.103. We note that this definition of 
``rural'' is consistent with our policy under section III. of this 
preamble concerning designation of wage index areas.
     Second, to hospitals that are located in urban areas that 
are not large urban areas, as defined for purposes of section 1886(d) 
of the Act (section 1886(h)(7)(B)(iii)(II) of the Act). Section 
1886(d)(2)(D) of the Act defines ``large urban area'' as an ``urban 
area which the Secretary determines * * * has a population of more than 
1,000,000.'' Existing implementing regulations at Sec.  412.63(c)(6) 
state generally that the term ``large urban area'' means an MSA with a 
population of more than 1,000,000. Again, we note that we proposed 
changes to the definition of ``urban area'' to reflect the new 
geographic areas designated by the Office of Management and Budget 
under section III. of this preamble. Therefore, if the eligible 
hospital applying for an increase in its FTE resident cap is an urban 
hospital that is located in the proposed redefined MSA area with a 
population of less than 1,000,000, CMS will give such a hospital second 
priority (after all rural hospitals in the first priority category 
under the statute) in deciding which hospitals should receive an 
increase in their FTE resident caps.
     Third, hospitals that currently operate, or will operate, 
a residency training program in a specialty for which there are not 
other residency training programs in the State (section 
1886(h)(7)(B)(iii)(III) of the Act). We proposed to interpret ``a 
specialty for which there are not other residency training programs in 
the State'' to mean the only specialty in either allopathy or 
osteopathy in a particular State. For example, if in State X, Hospital 
A would like to use the additional FTE residents in order to establish 
a new osteopathic emergency medicine program (which would be the first 
osteopathic emergency medicine program in State X), and Hospital B has 
already established an allopathic emergency medicine program in State 
X, Hospital A's application for an increase in its FTE resident cap(s) 
would be put in the third priority category because Hospital A would be 
establishing a new osteopathic emergency medicine program, a specialty 
for which there are not other osteopathic emergency medicine programs 
in the State. We believe that a more ``expansive'' interpretation of 
``a specialty for which there are not other residency programs'' allows 
more hospitals to fit into this third priority category. In addition, 
it is our understanding that allopathic and osteopathic programs are, 
at least, nominally different disciplines in medicine. As a result, we 
believe that this more ``expansive'' interpretation for ``a specialty 
for which there are not other residency programs'' is the more 
appropriate interpretation.
    As we described above, we proposed that applicant hospitals 
indicate on the CMS Evaluation Form the category(ies) for which it 
believes it will qualify; we will use this indication to prioritize the 
applications. Each of the categories (described below) is derived from 
the priorities established by section 1886(h)(7)(B) of the Act, as 
added by section 422 of Public Law 108-173. We proposed to use the 
following categories to determine the order in which hospitals would be 
eligible to receive increases in their FTE resident caps:
    First Level Priority Category: The hospital is a rural hospital and 
has the only specialty training program in the State.
    Second Level Priority Category: The hospital is a rural hospital 
only.
    Third Level Priority Category: The hospital is an urban hospital 
that is located in a ``not large urban area'' and has the only 
specialty program in the State.
    Fourth Level Priority Category: The hospital is an urban hospital 
that is located in a ``not large urban area.''
    Fifth Level Priority Category: The hospital has the only specialty 
training program in the State.
    Sixth Level Priority Category: The hospital meets none of the 
statutory priority criteria.
    We believe the first and third level categories are appropriate for 
our evaluation purposes (which is explained further below) because some 
hospitals that apply for the additional resident slots may fit into 
more than one of the three statutory priority categories listed in 
section 1886(h)(7)(B) of the Act. In addition, we proposed to give 
consideration first to those hospitals that meet more than one of the 
statutory priority categories over those hospitals that meet only one 
of the statutory priorities (see second, fourth, and fifth level 
priority categories.) We also proposed a sixth level priority category 
to identify those section 1886(d) of the Act hospitals that apply for 
additional resident slots, but do not fit into any of the priority 
categories listed in section 1886(h)(7)(B) of the Act (that is, 
hospitals in large urban areas).
    As specified by the statute, we proposed to put each hospital's 
application for an increase in its FTE resident cap (based on how the 
hospital describes itself on the CMS Evaluation Form) into one of the 
``level priority categories'' for evaluation purposes, giving first and 
second priority to the rural hospitals, as defined above. In addition, 
we note that we proposed that hospital applicants provide residency 
specialty program information as part of the application for the 
increase to the cap(s), as well as a CMS Evaluation Form for each 
residency program for which the applicant hospital intends to use the 
increased FTE resident slots. Our intention in proposing these 
requirements was for CMS to be able to discern within which level 
priority category the applicant hospital's application should be placed 
based on the residency specialty program for which the FTE cap increase 
is being requested. In other words, it is possible that a hospital will 
apply for an increase in its FTE caps for more than one residency 
program at the hospital. It is possible that applications for the 
programs would fall within different level priority categories, for 
example, if a hospital in a large urban area is applying for an 
increase in its cap(s) for one program that is the ``only specialty 
training program in the State'' would place the hospital's application 
in the fifth level priority category on the CMS Evaluation Form. For 
another program that is NOT the only program in the State, for a 
hospital in a large urban area, would place the hospital on that 
Evaluation Form in the sixth level priority category. Therefore, we 
proposed that hospitals complete an Evaluation Form for each residency 
program for which it is requesting an increase in its FTE resident cap.
    Comment: Several commenters supported our proposals on the level 
priority categories, as stated in the proposed rule. One commenter 
stated that it was ``extremely appreciative that CMS included a sixth 
category, for hospitals that do not meet any of the statutorily defined 
priority criteria (for example, hospitals located in large urban 
areas), within the priority ordering.''
    Response: We appreciate the commenters' support of the our 
proposals concerning the level priority categories.
    Comment: We received several comments that addressed our 
interpretation of the third statutory priority at section 
1886(h)(7)(B)(iii)(III) of the Act, which granted priority for a 
``residency program for which there are not other residency training 
programs in the State.'' Several commenters were very supportive of our 
proposed interpretation of this language to mean

[[Page 49145]]

``the only specialty in either allopathy or osteopathy in a particular 
State.'' One commenter stated: ``[w]e strongly support this approach, 
and we believe it appropriately reflects the fact that osteopathic and 
allopathic disciplines offer residents- and patients-different 
approaches to health care.''
    Another commenter, while supportive of our proposed implementation 
of section 1886(h)(7)(B)(iii)(III) of the Act, requested that we 
include interpretation that addresses a family medicine specialty which 
trains residents to care for ``special populations-the underserved who 
require care to be delivered by physicians who have had special 
language and cultural training because the population served required 
it.''
    Finally, another commenter asked us to clarify whether a hospital 
would be ``the only program in the state'' under section 
1886(h)(7)(B)(iii)(III) of the Act, if the only other residency program 
in the state for a particular specialty is at a Federal or military 
hospital.
    Response: We are pleased that the commenters are supportive of our 
proposed interpretation of ``the only specialty in either allopathy or 
osteopathy in a particular State.'' We are finalizing this 
interpretation with this final rule.
    In response to the second comment, we believe we have limited 
discretion in interpreting the statutory priorities to accommodate the 
situation of a family practice program in which residents treat 
underserved populations, unless a family practice program in a 
particular state is the only family medicine program in that state. 
However, we hope we have accommodated hospitals that strive to serve 
``special populations'' by proposing many of the Evaluation Criteria on 
the CMS Evaluation Form (see, for example, Evaluation Criteria Three or 
Seven).
    Finally, in response to the third comment, we understand that 
residency programs at Veteran's Affairs, Department of Defense, or 
other Federal hospitals are accredited program by either the ACGME or 
the AOA. Just because many of these military and Federal hospitals do 
not receive Medicare direct GME and IME payments for the training of 
interns and residents, does not mean that the residency programs at 
these hospitals do not exist for purposes of section 
1886(h)(7)(B)(iii)(III) of the Act. Therefore, we are clarifying here 
that if the residency program is accredited, even if that program is 
training residents at a Federal facility or military hospital, that 
program specialty exists for purposes of interpreting section 
1886(h)(7)(B)(iii)(III) of the Act.
    Comment: We received several comments objecting to the priority for 
the increase to the cap under section 422 to rural hospitals. One 
commenter believed that the proposed first and second level priority 
categories to rural hospitals ``will undermine the expansion plans of 
many urban teaching hospitals, especially those that share the same 
corporate structure and are part of a multi-hospital system.'' The 
commenter requested that CMS remove the rural hospitals as the first 
and second level priorities for the increase to the caps under section 
422.
    Response: We believe we have limited statutory discretion in 
determining which hospitals should receive the increase to their caps 
under section 422. Our proposed level priority categories are derived 
from section 1886(h)(7)(B) of the Act, as added by section 422 of 
Public Law 108-173. That section established a priority order to 
determine the hospitals that will receive increases in their FTE caps. 
Section 1886(h)(7)(B)(iii)(I) of the Act of the Act gives first 
priority to hospitals that are ``located in rural areas''. We 
understand there may be situations where urban hospitals, due to 
circumstance, stand to lose FTE slots because of section 1886(h)(7)(A) 
of the Act, and the increase to the caps under section 1886(h)(7)(B) of 
the Act gives first priority to rural hospitals. However, the statute 
that mandated the priorities determines this situation.
    Comment: We received one comment requesting that CMS give priority 
under the section 422 cap increase to hospitals in small urban areas 
that are Level 1 Trauma Centers.
    Response: While we do not believe we have discretion in 
interpreting the priority categories, we believe that hospitals that 
are Level 1 Trauma Centers provide good emergency services to the 
public. Along these lines, we have agreed to add a new Evaluation 
Criterion 14 with this final rule (see below) that addresses residency 
training for new or expanding residency programs in emergency medicine.
    Comment: We received one comment on the priority categories 
generally that requested that CMS refine its methodology so that 
hospitals that ``already exceed their FTE caps are given first priority 
within their Priority category.''
    Response: As we have stated, the Congress has set the priorities as 
to which hospitals should receive the increase to their FTE caps first, 
without stating specifically that the hospitals applying for the cap 
increase must be at or above its FTE caps to qualify for the increase. 
However, as we believe, like most commenters, that most hospitals that 
apply for the section 422 caps will be above their 1996 FTE caps, we 
have agreed to add new Evaluation Criterion 12 to address the situation 
of hospitals exceeding their FTE caps (see discussion of Evaluation 
Criteria below).

CMS Evaluation of Application for Increases in FTE Resident Caps

    We note that section 1886(h)(7)(B)(iii) of the Act states that 
``increases of residency limits within the same priority category * * * 
shall be determined by the Secretary.'' Therefore, we proposed to use 
the following criteria for evaluating the applications for increases in 
hospitals' FTE resident caps within each of the six level priority 
categories described above:
    Evaluation Criterion One. The hospital that is requesting the 
increase in its FTE resident cap(s) has a Medicare inpatient 
utilization over 60 percent, as reflected in at least two of the 
hospital's last three most recent audited cost reporting periods for 
which there is a settled cost report. We have selected 60 percent 
utilization because it will identify hospitals where Medicare 
beneficiaries will benefit the most from the presence of a residency 
program, and it is consistent with the utilization percentage required 
for Medicare-dependent, small rural hospitals (MDHs) as specified in 
Sec.  412.108. In addition, it identifies a type of hospital that 
warrants atypical treatment by the Medicare program because it is so 
reliant on Medicare funding.
    Evaluation Criterion Two. The hospital will use the additional 
slots to establish a new geriatrics residency program, or to add 
residents to an existing geriatrics program. We believe that, of all 
the medical specialties, geriatrics is the one specialty that is 
devoted primarily to the care of Medicare beneficiaries. In addition, 
we note that encouraging residency training in geriatrics is consistent 
with Congressional intent as expressed, among other places, in section 
712 of Public Law 108-173.
    Evaluation Criterion Three. The hospital does not qualify for an 
adjustment to its FTE caps under existing Sec.  413.86(g)(12) (proposed 
to be redesignated as Sec.  413.79(k) in the proposed rule) for a rural 
track residency program, but is applying for an increase in its FTE 
resident cap(s) under section 1886(h)(7)(B) of the Act because it 
rotates (or in the case of a new program, will rotate) residents for at 
least 25 percent of the duration of the

[[Page 49146]]

residency program to any combination of the following: a rural area, as 
defined in section 1886(d)(2)(D)(ii) of the Act and Sec.  
412.62(f)(1)(iii) of the regulations; a rural health clinic (RHC), as 
defined in section 1861(aa)(1) of the Act and Sec.  491.2 of the 
regulations; or a Federally Qualified Health Center (FQHC), as defined 
in section 1861(aa)(3) of the Act and Sec.  405.2401(b) of the 
regulations. We believe that the Congress intended that the Secretary 
use section 422 to encourage resident training in rural areas, and we 
believe this criterion furthers this intention. We proposed to include 
residency training in FQHCs in this criterion because we understand 
that some FQHCs are located in rural areas. In addition, we indicated 
our encouragement of residency training at FQHCs because we believe 
that, similar to rural providers and RHCs, FQHCs provide services for 
medically underserved areas or populations, or both.
    Evaluation Criterion Four. In portions of cost reporting periods 
prior to July 1, 2005, the hospital qualified for a temporary 
adjustment to its FTE cap under existing Sec.  413.86(g)(9) (proposed 
to be redesignated as Sec.  413.79(h) in the proposed rule) because it 
was training displaced residents from either a closed program or a 
closed hospital, and, even after the temporary adjustment, the hospital 
continues to train residents in the specialty(ies) of the displaced 
residents and is training residents in excess of the hospital's direct 
GME FTE cap or IME FTE cap, or both, for that reason. We believe this 
criterion is appropriate because it will help to sustain the level of 
residency training in the community.
    Evaluation Criterion Five. The hospital is above its FTE caps 
because it was awaiting accreditation of a new program from the ACGME 
or the AOA during the base period for its FTE cap(s), but was not 
eligible to receive a new program adjustment as stated under existing 
Sec.  413.86(g)(6)(ii) (proposed to be redesignated as Sec.  
413.79(e)(2) in the proposed rule). Under existing Sec.  
413.86(g)(6)(ii) and Sec.  413 86(g)(13) (proposed to be redesignated 
as Sec.  413.79(l) in the proposed rule), a hospital that had 
allopathic or osteopathic residents in its most recent cost reporting 
period ending on or before December 31, 1996 could receive an 
adjustment to its unweighted FTE cap for a new medical residency 
training program that either received its initial accreditation or 
began training residents on or after January 1, 1995 and on or before 
August 5, 1997. If a hospital failed to meet those deadlines, it was 
not eligible to have its cap(s) adjusted to include residents in a new 
program. Under the proposed criterion, a hospital would apply for 
additional FTE residents if the hospital had submitted its application 
for a new program to the accrediting body before August 5, 1997, and 
received its accreditation after August 5, 1997 but before August 5, 
1998. This would allow some hospitals to receive increases in their FTE 
resident caps in cases in which, in good faith, the hospital had 
submitted an application for accreditation for a new program prior to 
the date of enactment of FTE resident caps under the BBA, but because 
of the timing of the implementation of the FTE resident cap(s), had not 
yet received direct GME and IME payment for residents in the newly 
accredited program during the base period for the hospital's FTE 
resident cap(s).
    Evaluation Criterion Six. The hospital is training residents in 
excess of its FTE resident caps because, despite qualifying for an FTE 
cap adjustment for a new program under Sec.  413.86(g)(6)(i) or 
(g)(6)(ii) (proposed to be redesignated as Sec.  413.79(e)(1) and 
(e)(2) in the proposed rule), it was unable to ``grow'' its program to 
the full complement of residents for which the program was accredited 
before the hospital's FTE resident cap was permanently set beginning 
with the fourth program year of the new program. Similar to evaluation 
criterion five above, this criterion would allow some hospitals that 
had, in good faith, started up a new residency program as required in 
the regulations but could not completely fill the new program within 
the allowed regulatory period, to receive increases in their FTE 
resident caps. For instance, this could have occurred because the 
program was a program of long duration (such as a 5-year general 
surgery program), and the hospital did not have the opportunity to 
``grow'' the program to its full complement of residents because the 
regulations at Sec. Sec.  413.86(g)(6)(i) or (g)(6)(ii) allow a program 
to grow for only 3 years before the hospital's FTE resident cap is 
permanently adjusted for the new program.
    Evaluation Criterion Seven. The hospital is located in any one (or 
a combination) of the following: a geographic HPSA, as defined in 42 
CFR 5.2; a population HPSA, (also defined at 42 CFR 5.2); or a Medicare 
physician scarcity county, as defined under section 413 of Public Law 
108-173. We proposed to use this 3-part criterion in order to capture, 
as objectively as possible, medically underserved areas or patient 
populations (many of which are Medicare beneficiaries), or both. We 
understand that if a particular community has been designated a HPSA 
(either a geographic or population HPSA), the designation information 
is available to hospitals from the Health Resources and Services 
Administration (HRSA) HPSA database at the Web site: http://belize.hrsa.gov/newhpsa/newhpsa.cfm. In addition, hospitals will be 
able to determine whether they are located in a Medicare physician 
scarcity county (consistent with section 413 of Pub. L. 108-173) on the 
CMS Internet Web site at www.cms.hhs.gov or upon publication of the 
annual final rule setting forth the Medicare physician fee schedule 
(which is generally published by November 1 of each year). We note that 
if Medicare does not publish the final rule setting forth the Medicare 
physician fee schedule in time for the application deadline for 
increases in FTE resident caps (December 1, 2004, or March 1, 2005, 
depending on the hospital), we proposed that we will not use the 
Medicare physician scarcity county designations (as defined under 
section 413 of Pub. L. 108-173) for purposes of this criterion.
    Evaluation Criterion Eight. The hospital is in a rural area (as 
defined under section 1886(d)(2)(D)(ii) of the Act) and is a training 
site for a rural track residency program (as specified under Sec.  
413.86(g)(12) (proposed to be redesignated as Sec.  413.79(k) in the 
proposed rule)), but is unable to count all of the FTE residents 
training at the rural hospital in the rural track because the rural 
hospital's FTE cap is lower than the hospital's unweighted count of 
allopathic or osteopathic FTE residents beginning with portions of cost 
reporting periods on or after July 1, 2005.
    Evaluation Criterion Nine. The hospital is affiliated with a 
historically Black medical college. According to the language in the 
Conference Report for Public Law 108-173 (pages 204-205), the 
Conference agreement on section 422 generally restated the three 
statutory priority categories described above (rural, ``small'' urban, 
and only specialty program in the State) in terms of giving guidance to 
the Secretary for deciding which hospitals should receive the 
redistributed FTE resident slots. However, there was one additional 
cited criterion that the Conference indicated the Secretary should use 
in evaluating the hospital applications. Specifically, the Conference 
agreement states that the Secretary should consider whether the 
hospital is a ``historically large medical college'' (emphasis added). 
Upon consideration of this particular terminology, which, on its face, 
seems to contradict the three statutory priority

[[Page 49147]]

categories (that is, rural, ``small'' urban, and only specialty program 
in the State), we proposed to view the reference to ``historically 
large medical colleges'' as a scrivener's error, and to read this 
language to refer to ``historically Black medical colleges.'' This 
proposed interpretation accomplishes two goals: first, we believe this 
interpretation serves the greater policy goal of encouraging residency 
training for the benefit of medically underserved populations. Second, 
we believe that this interpretation reflects the Conferees' intent in 
the language in the Conference Report. In addition, we proposed to 
identify ``historically Black medical colleges'' as Howard University 
College of Medicine, Morehouse School of Medicine, Meharry Medical 
College, and Charles R. Drew University of Medicine and Science. These 
four medical schools are identified as ``historically Black medical 
colleges'' by the American Medical Association (see http://www.ama-assn.org/ama/pub/category/7952.html). We proposed that the hospital 
will meet this criterion if it intends to use an increase in its FTE 
resident cap(s) under section 1886(h)(7)(B) of the Act to count 
residents in residency programs sponsored by any of the historically 
Black medical college listed above.
    Evaluation Criterion Ten. The hospital is training residents in 
residency program(s) sponsored by a medical school(s) that is 
designated as a Center of Excellence for Underserved Minorities (COE) 
under section 736 of the Public Health Service Act in FY 2003. We 
understand that the COE program was established to be a catalyst for 
institutionalizing a commitment to underserved students and faculty, 
and to serve as a national resource and educational center for 
diversity and minority health issues. Therefore, we believe that it is 
appropriate to encourage hospitals to train residents in residency 
programs sponsored by medical schools that are designated as COEs. A 
hospital can verify whether it is training residents in programs 
sponsored by a medical school that is a COE. Medical schools that are 
COEs in FY 2003 are listed at the following Web site: http://bhpr.hrsa.gov/diversity/coe/grantees2003.htm. We note that, in FY 2003, 
there were 28 medical schools that were designated to be COEs.
    In the May 18, 2004 proposed rule, we proposed to use the above set 
of criteria to evaluate the applications by hospitals for increases in 
their FTE resident caps that fall within each of the six level priority 
categories. We proposed to place each application in the appropriate 
priority level category based on a review of the information the 
hospitals check off on the proposed CMS Evaluation Form for each 
allopathic and osteopathic specialty program requested by the applicant 
hospital, and the corresponding requested FTE cap increase (see the 
proposed form below). We proposed to place all of these evaluation 
criteria on the Evaluation Form and to ask the hospital to check off 
which criteria on the form apply for each specialty program for which 
an FTE cap increase is requested. Based on the assertions checked off 
on the form, we would score each CMS Evaluation Form (one point per 
criterion checked off). The higher scoring CMS Evaluation Form(s) for 
each applicant hospital within each level priority category would be 
awarded the FTE resident cap increases first. As we described above, we 
proposed to award the cap increases in the order of the six specified 
level priority categories because, as a general rule, we believe 
hospitals that meet more than one of the statutory priorities should be 
awarded the increases in their FTE resident caps first before other 
hospitals. We also believe that hospitals that meet a higher statutory 
priority category should receive first consideration by us over 
hospitals that meet lower statutory priorities. That is the reason, for 
instance, we proposed the first level (rural hospital + only specialty 
program in the State) and second level (rural only) priority categories 
to give all rural hospitals first consideration by us before any small 
urban hospital, as required by the statute.
    Thus, first level priority category hospitals that score highest on 
the evaluation criteria on the CMS Evaluation Form for a particular 
specialty program would receive the increases in their FTE resident 
caps first. For example, if Hospital D is a rural hospital and is 
establishing the first osteopathic internal medicine residency program 
in State Y, thereby falling within the first level priority category, 
and Hospital D checks off on the CMS Evaluation Form that it has a 
Medicare utilization of 60 percent, is located in a geographic HPSA, 
and is affiliated with a historically Black medical college, Hospital D 
would receive a score of 3 points on the completed CMS Evaluation Form. 
We proposed that we would first award FTE cap increases to hospitals 
whose CMS Evaluation Forms for a particular program receive 10 points 
based on the number of evaluation criteria checked off by the hospital 
for the program (if there are any) and then to those with successively 
fewer points within the level priority category. Hospital D would 
receive the increase in its FTE resident cap(s) requested on its 
application after all the hospitals in the first level priority 
category whose applications receive 10 through 4 points are awarded 
their requests first.
    We proposed that we would award the increases in FTE resident caps 
to all those hospitals that are in the first level priority category 
(rural hospitals + only specialty program in the State) before 
evaluating those hospitals in the second level priority category (rural 
hospital), and would award the FTE resident slots to all those 
hospitals in the second level priority category before evaluating those 
hospitals in the third level priority category (``small'' urban 
hospital + only specialty in the State), and so on. Once we reach an 
aggregate number of FTE resident cap increases from the aggregate 
estimated pool of FTE resident positions under section 1886(h)(7)(A) of 
the Act, but are unable, based on the number of remaining slots, to 
meet all of the requests at the next level priority category at the 
next score level, we proposed to prorate any remaining estimated FTE 
resident slots among all the applicant hospitals within that level 
priority category and with the same score on the hospital's 
application.
    For example, assume all applicant hospitals in the first through 
fourth level priority categories receive the requested increases in 
their FTE resident caps by us, and we evaluate hospital applications 
next and accompanying CMS Evaluation Forms in the fifth level priority 
category (only specialty program in the State). At the point that we 
have awarded cap increases for all the fifth level priority category 
hospitals that scored 5 or above on their CMS Evaluation Forms for each 
residency program, we find that there is only a sufficient number of 
resident slots remaining in the estimated pool to grant half of the 
requests for slots from hospitals that scored 4 points. We proposed 
that we would prorate all of the remaining FTEs among the 4-point CMS 
Evaluation Forms and accompanying applications in the fifth level 
priority category. Thus, if we could have awarded a total of 200 FTE 
slots for direct GME and 185 FTE slots for IME to only the first 50 
percent of the 4-point CMS Evaluation Forms in the fifth level priority 
category at the point that the estimated pool of FTE slots is spent, we 
proposed to prorate all of the 200 FTE slots for direct GME and 185 FTE 
slots for IME among all of the 4-point CMS Evaluation Forms and 
accompanying applications in that fifth priority category, no matter 
what level

[[Page 49148]]

of FTE resident cap increase was requested on the individual hospital's 
application.
    We recognize the complexity of the proposed evaluation process for 
the award of increases in hospital's FTE resident caps under section 
1886(h)(7)(B) of the Act. Therefore, we have included the following 
examples depicting the proposed procedures:

    Example 1. Hospital M in State Z is an urban hospital located in 
an MSA that has a population of less than 1 million. Hospital M can 
demonstrate the likelihood that it will fill the requested five FTEs 
resident slots for direct GME and IME for a geriatric program 
because it is currently training a number of FTE residents that 
exceeds both of its FTE caps, and has attached to its application 
for an increase in its FTE resident caps a copy of Hospital M's past 
three Medicare cost reports (as filed or audited, whichever is most 
recent and available), which documents on Worksheet E, Part A and 
Worksheet E3, Part IV that, according to the resident counts and the 
FTE resident caps, Hospital M is training residents in excess of its 
caps. Hospital M has taken on geriatric residents from a teaching 
hospital in the community that closed, and is also located in a 
Medicare physician scarcity county.
    We would evaluate Hospital M's application accordingly. It will 
be determined a fourth level priority category (``small'' urban 
hospital); and will receive a score of 4 (expanding geriatrics 
program, Medicare physician scarcity area, residents from a closed 
hospital, training residents in excess of its 1996 FTE caps).
    Example 2. Hospital K is a large academic medical center located 
in an MSA with a population of greater than 1,000,000 and is in a 
population HPSA. Hospital K regularly trains residents in programs 
sponsored by Meharry Medical College, and wishes to add more 
residents from Meharry, and therefore, has requested accreditation 
from the ACGME to expand the number of Meharry residents training in 
both allopathic surgery and osteopathic pediatrics programs. 
Hospital K is above both its direct GME and IME FTE caps.
    Hospital K's CMS Evaluation Forms for allopathic surgery and 
osteopathic pediatrics would be submitted separately by the hospital 
and we would evaluate it (separately) accordingly. Both requests 
would put the hospital in the sixth level priority category (large 
urban hospital); it can demonstrate the likelihood of filling the 
slots (because Hospital K can document both that the hospital is 
above its caps and that it has requested ACGME accreditation to 
expand the programs); and will receive a score of 3 (population 
HPSA, historically Black medical college, training residents in 
excess of its FTE caps).
    Example 3. Hospital E is a rural hospital located in a Medicare 
physician scarcity area and a geographic HPSA. It is a rural 
training site for an already established rural track residency 
program that has only been a training site since 2002. Therefore, 
Hospital E has an FTE resident cap of zero FTEs for direct GME and 
IME.
    Hospital E's CMS Evaluation Form for the rural track family 
practice program and accompanying application would be evaluated by 
us accordingly. Second level priority category (rural hospital); it 
can demonstrate the likelihood of filling slots (because Hospital E 
can document that it is both over its cap of zero FTEs, and that it 
is a training site for an accredited rural track residency program; 
and will receive a score of 3 (a training site for a rural track, 
and a Medicare physician scarcity area, and a geographic HPSA, and 
training residents in excess of its FTE caps).
    Example 4. Hospital W is a rural hospital that has FTE caps of 
15 FTEs for both direct GME and IME. Hospital W requests a total FTE 
cap adjustment of 25 FTEs for both direct GME and IME; 5 FTEs are to 
expand an existing geriatric fellowship; and 20 FTEs are to 
establish the first osteopathic emergency medicine program in State 
K, in which Hospital W is located. Hospital W can document that it 
is at its FTE caps with existing residency programs. We would make 
the following assessment for Hospital W's Evaluation Form for the 
geriatric fellowship: Hospital W falls into the second level 
priority category for being a rural hospital; it can demonstrate the 
likelihood that it will fill the 5 FTE slots of the geriatric 
program by documenting that it has requested additional slots in the 
accreditation of the geriatrics program. Hospital W would receive a 
score of 1 on its CMS Evaluation Form for the geriatrics program. We 
would make the following assessment for Hospital W's CMS Evaluation 
Form for the new osteopathic emergency medicine program: Hospital W 
would meet the first level priority category for this Evaluation 
Form because, not only is it a rural hospital, but it is also 
requesting 20 FTEs for the only osteopathic emergency medicine 
program in the State; it can demonstrate the likelihood that it will 
fill the 20 osteopathic emergency medicine FTEs by documenting the 
accreditation request and also that it is over its FTE caps. 
Hospital W would receive a score of zero, because it did not meet 
any of the evaluation criteria on the CMS Evaluation Form. Although 
this request receives a score of zero, it will be granted its 
request as level one priority request before any other level 
priority category.

    Comment: We received many comments in general support for our 
proposed evaluation criteria on the CMS Evaluation Form. One commenter 
stated: ``[w]e applaud CMS in attempting to meet not just the letter of 
the law, but the spirit, in crafting its priority list to include 
priorities such as rural and underserved areas, minority institutions, 
etc.'' Another commenter stated that ``[a]lthough the evaluation 
process as a whole is lengthy and confusing, we note that several of 
the individual criteria respond to longstanding problems with the way 
resident caps were determined under the BBA * * * We applaud CMS' 
decision to address these problems now through the resident 
redistribution process.'' The commenter listed the proposed Evaluation 
Criteria Four, Five, and Six as serving this purpose.
    Response: We appreciate the commenters' support of our proposals in 
this section.
    Comment: Many commenters supported our proposed Evaluation 
Criterion Two, which states that the ``hospital needs the additional 
slots to establish a new geriatrics residency program, or adding 
residents to an existing geriatrics program.'' Many of these commenters 
were pleased with CMS' acknowledgment in the proposed rule that 
``geriatrics is the one specialty that is devoted primarily to the care 
of Medicare beneficiaries'' and strongly urged CMS to include this 
geriatrics language for Evaluation Criterion Two in this final rule. 
One commenter, in support of CMS finalizing the proposed Evaluation 
Criterion Two concerning geriatric programs, stated: ``[a]s evidenced 
in a recent study published in Health Affairs (Apr 7, 2004), in states 
with higher concentrations of [general practitioners], Medicare spends 
less money per beneficiary and gets better quality. And the opposite is 
true for states with higher specialist concentrations.''
    Response: We appreciate the commenters' support of our proposal to 
include a point in the Evaluation Criteria for residency training in 
geriatrics residency programs. We are accordingly finalizing this 
proposed criterion in this final rule.
    Comment: Two commenters requested that CMS add a new criterion to 
the evaluation criteria to evaluate the hospital applications for the 
increase in hospitals' FTE caps that would give hospitals a point in 
their applications if the hospital will use the additional slots to 
establish a new family practice program, or add residents to an 
existing family practice program.
    Response: We agree to add a new evaluation criterion on the CMS 
Evaluation Form in this final rule that addresses primary care 
residency training, because we believe there is a statutory basis in 
the Medicare program for encouraging primary care residency training. 
The statute at section 1886(h) of the Act cites primary care programs 
for special treatment. For example, with both primary care and non-
primary care programs, the statute has permanently assigned a higher 
direct GME PRA for the hospital's primary care residency programs. As 
specified at section 1886(h)(5)(H) of the Act, ``primary care 
resident'' means ``a resident enrolled in an approved medical residency 
training program in family medicine, general internal medicine, general 
pediatrics, preventive medicine, geriatric medicine,

[[Page 49149]]

or osteopathic general practice.'' We are incorporating this definition 
at Sec.  413.75(b). Therefore, in this final rule, we are including a 
new Evaluation Criterion 11 to read as follows:
    ``C11: Evaluation Criterion 11. The hospital needs the additional 
slots to establish a new primary care residency program, or to expand 
an existing primary care residency program, as primary care is defined 
under Sec.  413.75(b).''
    Comment: We received several comments asking CMS ``to favor rural 
and other underserved training sites'' in determining priority for the 
increase under section 422.
    Response: By proposing such criteria as Evaluation Criteria Three 
or Seven, we believe we have addressed awarding hospitals that train 
residents in rural and underserved areas. We are finalizing the 
proposed criteria on these issues, as well as adding new Evaluation 
Criteria that may also address these issues.
    Comment: We received several comments concerning our proposed 
Evaluation Criterion Four, which states--
    ``In portions of cost reporting periods prior to July 1, 2005, the 
hospital qualified for a temporary adjustment to its FTE cap under 
existing Sec.  413.86(g)(9) (proposed to be redesignated as Sec.  
413.79(h) in the proposed rule) because it was training displaced 
residents from either a closed program or a closed hospital, and, even 
after the temporary adjustment, the hospital continues to train 
residents in the specialty(ies) of the displaced residents and is 
training residents in excess of the hospital's direct GME FTE cap or 
IME FTE cap, or both, for that reason.''
    One commenter noted that hospital closure ``is not the only chaotic 
factor with which existing teaching hospitals in a given area must cope 
* * * changes in a community's demography and needs, the hospital's 
facilities and resources, and the resident training programs of other 
hospitals * * *'' are other factors that hospitals consider when 
deciding use of resident slots. Therefore, the commenter requested that 
CMS consider a ``key priority'' for the redistribution of unused 
positions under section 422 should be ``to keep the slots within the 
original MSA, or for resident slots lost by facilities not in an MSA, 
within the original state.'' Similarly, other commenters requested that 
CMS modify the proposed Evaluation Criterion 4 to address hospitals 
that are training residents from one or more hospitals in its community 
``who have downsized their residency program(s) but did not close these 
programs.'' One commenter believed that this ``downsizing'' could occur 
because the Residency Review Committee (RRC) required the downsizing.
    Another commenter requested that CMS consider modifying this 
evaluation criterion to account for a hospital that ``qualified for a 
temporary adjustment because it was training displaced residents from 
either a closed program or a closed hospital regardless of whether the 
[hospital] continued to train residents in that specialty.'' The 
commenter believed that CMS should ``award'' hospitals that served a 
``distinct public good,'' regardless of whether they continued to train 
residents in the same specialty.
    One commenter recommended that CMS change the criterion to a 
requirement of documentation of acceptance of the resident(s) from the 
closed hospital/closed program plus proof of ``closure notice.''
    Finally, another commenter encouraged CMS to ``keep closed hospital 
resident slots in the community by distributing those slots to the 
facility that completed the training of those residents, with permanent 
count increases.''
    Response: We recognize that there are many considerations that 
hospitals must take into account when determining the need for more 
resident slots, including the need for more training within a 
community, hospital (or program). However, in including Evaluation 
Criterion Four, we did not intend to attempt to maintain resident 
levels on a state or MSA basis. Rather, we were only addressing 
concerns that have been brought to our attention by hospitals that 
have, in the past, provided for training residents from either closed 
hospitals or closed programs. We also do not agree with the commenter 
that we should address the need of hospitals that take on the training 
of residents from hospitals where programs are ``downsized.''
    To address the second commenter's suggestion on modifying the 
criterion to award hospitals that received the temporary adjustment to 
the cap for training residents from programs or hospitals that closed, 
regardless of whether the hospitals continue to train residents in the 
same specialty, we proposed Evaluation Criterion Four because we 
believed it would address an issue left unresolved by the temporary 
adjustment for closed hospitals or programs. We understand from 
speaking to many hospitals that took on the training of displaced 
residents, that they continued to have cap problems long after they had 
received the temporary cap adjustment under Sec.  413.79(h), since 
these hospitals continued to train other residents in those slots even 
after the original displaced residents completed their training. 
Because we understand that the specialty program at the hospital that 
allowed the displaced residents to complete their training continues to 
fulfill a need in the community of the hospital for training in that 
program, we believe our Evaluation Criterion Four should be finalized 
as proposed, thereby rewarding those hospitals that serve this 
community in this fashion.
    To address the comment requesting that, instead of the hospital 
documenting that the hospital had qualified for a temporary adjustment 
to its cap and was still training residents in the same specialty, that 
CMS should look to whether the hospital documented ``acceptance of the 
resident'' and ``proof of closure,'' as we stated above, by proposing 
Evaluation Criterion Four, we attempted to address the specific 
situation of a hospital continuing to have cap problems as a result of 
training more residents in that program long after it had received the 
temporary cap adjustment under Sec.  413.79(h). We understand that 
there are multiple situations of hospitals training residents from a 
closed hospital/program; however, we believe the documentation 
requirements in the proposed criterion more closely reflects the 
situation we intended to address. Therefore, we are not adopting the 
commenters changes in this final rule.
    Finally, to address the commenter's concern with our awarding 
hospitals permanent cap adjustments that take on residents from closed 
hospitals, we hoped to do so by proposing the Evaluation Criterion 
Four. While there is no guarantee that hospitals that meet Evaluation 
Criterion Four necessarily receive the section 422 caps (that is, the 
permanent cap adjustments sought by the commenter), we attempted to 
acknowledge the important role and ``public good'' such hospitals serve 
by finalizing Evaluation Criterion Four.
    Comment: Many commenters believed that, generally, only hospitals 
that are counting FTE residents that exceed their 1996 FTE caps for 
direction GME and/or IME would be interested in applying for the 
section 422 caps. One commenter stated: ``[a] primary purpose (if not 
the primary purpose) of section 422 [in Pub. L. 108-173] is to provide 
`cap relief' to hospitals that have resident counts that exceed their 
caps.'' Therefore, the commenters believed that CMS should reflect the 
situation of a hospital exceeding its 1996 FTE cap in the evaluation 
criteria on the CMS Evaluation Form.

[[Page 49150]]

    In addition, two commenters believed that CMS should assign special 
weighting factors or extra points (rather than just one point per 
evaluation criterion as stated in the proposed rule) to such a 
criterion on the final CMS Evaluation Form. Similarly, another 
commenter believed that CMS should adjust the Evaluation Criteria to 
include 0-2 points based on the percentage by which the applicant 
hospital's projected FTE count is in excess of 1996 FTE caps.
    Response: Although we believe we may have already addressed the 
concern of hospitals exceeding their 1996 FTE caps in some of the 
evaluation criteria on the CMS Evaluation Form, we agree with the 
commenters that a primary purpose of the Congress of writing section 
422 is to address situations of ``cap relief'' for hospitals that have 
exceeded their caps. Therefore, we are adding another criterion to the 
final evaluation criteria on the CMS Evaluation Form that states--
    ``C12: Evaluation Criterion 12. The hospital is above its direct 
GME and/or IME FTE cap on the count of residents, as stated in the 
Medicare cost report on the worksheets E, part A or the worksheets E3, 
part IV, in the hospital's most recently as submitted Medicare Cost 
Report.''
    Because we are also finalizing the other Evaluation Criteria on the 
proposed CMS Evaluation Form that address hospitals that exceeded their 
caps, we are not awarding extra weighting factors or extra point(s) to 
the new ``exceed FTE cap'' Evaluation Criterion, as the commenters 
suggested. We already believe that we are awarding two points for those 
hospitals that meet any of the proposed Evaluation Criteria (that are 
finalized with this final rule) plus the new ``exceed FTE cap'' 
criterion. For the same reason, we will not be ``prorating'' points 
based on how much an applicant hospital is projecting it will exceed 
its 1996 FTE caps. Therefore, we will only be awarding one point if a 
hospital meets the ``exceed FTE cap'' evaluation criterion on the CMS 
Evaluation Form.
    Comment: We received several comments asking CMS to include 
recognition in the evaluation criteria on the CMS Evaluation Form of 
emergency medicine residency programs. Two commenters stated that 
``[e]mergency physicians are required to see a large number of patients 
to gain experience and clinical expertise across a large range of 
injuries and illnesses they will need to diagnose and treat.'' Along a 
similar vein, these commenters believe that CMS should recognize 
programs that include ``bio-terrorism and disaster preparedness 
training and coordination with State EMS organizations and the 
Department of Homeland Security.''
    Response: Because the Congress has specifically addressed the 
importance of emergency physicians and bio-terrorism preparedness (see, 
for example, the Conference Report accompanying H.R. 267, page 803, 
Report 108-401), we agree to add a point in the Evaluation Criterion on 
the CMS Evaluation Form in this final rule to address emergency 
medicine programs that include bio-terrorism training as part of their 
programs. New Evaluation Criterion 14 states--
    ``C14: Evaluation Criterion 14. The Hospital is above its cap and 
needs the additional slots to establish a new emergency medicine 
residency program or expand an existing emergency medicine residency 
program. The emergency medicine residency program includes training in 
bio-terrorism preparedness.''
    Comment: We received several comments on the proposed Evaluation 
Criterion One that gives a point to a hospital that ``is requesting the 
increase in its FTE resident cap(s) [and] has a Medicare inpatient 
utilization over 60 percent, as reflected in at least two of the 
hospital's last three most recent audited cost reporting periods for 
which there is a settled cost report.''
    Two commenters stated that, because of the time lag associated with 
settling Medicare cost reports, CMS should accept submitted Medicare 
cost reports for the proposed Medicare utilization Evaluation 
Criterion. The commenters also believed that ``CMS * * * should 
consider modifying this criterion to include Medicare share based only 
on Medicare inpatients as a share of Medicare and privately insured 
patients. Many teaching hospitals treat a significant number of 
Medicaid and uninsured patients and they should not be disadvantaged.''
    We received several comments suggesting that instead of relying on 
the Medicare inpatient percentage, CMS should consider hospitals that 
are eligible for Medicare Disproportionate Share Hospitals (DSH) 
payments. Another commenter stated that CMS should consider any 
hospital that has a Medicare DSH percentage greater than 25%, ``since 
that is an indicator that the hospital is serving a disproportionate 
share of low income patients.''
    Another commenter requested that we modify the Evaluation Criterion 
so that a hospital would qualify if it had a Medicare inpatient 
utilization of 50 percent or greater. Finally, another commenter 
suggested that we modify this Evaluation Criterion so that a hospital 
would qualify if its inpatient utilization for Medicare, Medicaid and 
uninsured patients is over 60 percent.
    Response: As we stated in the proposed rule at 69 FR 28302, we 
proposed Evaluation Criterion One because we believe 60 percent would 
``identify hospitals where Medicare beneficiaries will benefit the most 
from the presence of a residency program, and it is consistent with the 
utilization percentage required for Medicare-dependent, small rural 
hospitals (MDHs) as specified in Sec.  412.108. In addition, it 
identifies a type of hospital that warrants atypical treatment by the 
Medicare program because it is so reliant on Medicare funding.'' We 
modeled the proposed Evaluation Criterion One off of the Medicare 
policy concerning MDHs, which at Sec.  412.108, specifies, among other 
things, that the hospital must capture the Medicare utilization ``on at 
least two of the hospital's last three most recent audited cost 
reporting periods for which there is the Secretary has a settled cost 
report.'' We continue to believe that the 60 percent threshold is 
appropriate for purposes of establishing priorities under section 422, 
and based on the hospital's post recently settled cost reports. 
Therefore, we are not adopting the commenters' proposal to accept 
submitted Medicare cost reports or to lower the threshold of Medicare 
inpatient utilization to 50 percent or greater to meet this Evaluation 
Criterion.
    In addition, we are not adopting the commenters' proposal to 
include inpatient Medicare utilization based as a share of Medicare and 
privately insured patients, or as a share of Medicare, Medicaid and 
uninsured patients, for purposes of the Evaluation Criterion One. It 
has been a longstanding policy for Medicare Part A payments, including 
in Medicare graduate medical education patients, that Medicare 
inpatient utilization is calculated based upon a hospital's Medicare 
inpatient days divided by total hospital inpatient days. The ``total 
hospital inpatient days'' has always included any patients admitted in 
a hospital--that would include uninsured patients, privately insured 
patients and others. We do not believe it is appropriate to interpret 
``total hospital inpatient days'' to include only Medicare patients and 
privately insured patients; doing so, would allow hospitals to have 
higher ``Medicare inpatient utilization'' for purposes of meeting this 
evaluation criterion than they would ordinarily for purposes of any 
other Medicare payments.

[[Page 49151]]

    In response to the suggestions that we should look at hospital 
eligibility for Medicare DSH or look at whether the hospital has a 
Medicare DSH percentage of 25 percent instead of looking at the 60 
percent of Medicare inpatient utilization for the applicant hospital, 
we do not believe these indicators show a commitment to Medicare 
populations. Rather, these indicators measure Medicaid and SSI 
beneficiaries treated at the hospital as a proxy for uncompensated 
care. Accordingly, we continue to believe that Medicare utilization is 
the way for hospitals to demonstrate their commitment to Medicare 
populations and not by measuring Medicare DSH.
    Comment: One commenter questioned whether CMS proposed accompanying 
documentation requirements with the proposed Evaluation Criteria on the 
CMS Evaluation Form. The commenter stated: ``It seems that the 
attestation is all that is required for those hospitals that indicate 
on the application form that they meet one or more of the criteria * * 
* this proposal seems somewhat at odds with the proposed documentation 
requirements associated with the demonstrated likelihood criteria * * 
*''
    Response: We disagree with the comments since we did propose 
documentation requirements accompanying the proposed evaluation 
criteria on the CMS Evaluation Form. Among the requirements we proposed 
at 69 FR 28300-28301 that hospitals must meet to apply for the section 
422 increase to the FTE caps is that the hospital must include: ``[a] 
completed copy of the CMS Evaluation Form * * * for each residency 
program for which the applicant hospital intends to use the requested 
increase in the number of FTE residents and source documentation to 
support the assertions made by the hospital on the Evaluation Form. 
(For example, if the hospital checks off on the Evaluation Form that 
the hospital is located in a geographic Health Professions Shortage 
Area (HPSA), the hospital would include documentation to support that 
assertion.) (Emphasis added.) We are finalizing this proposed 
requirement, as stated in part here, in this final rule.
    Comment: We received one comment asking CMS to clarify that a 
hospital which is within a level priority category and meets a 
Demonstrated Likelihood Criterion will be entitled to obtain residency 
slots before any hospital located in the next (that is lower) level 
priority category, even if the first hospital meets none of the 
Evaluation Criteria.
    Response: As we explained above and also in the proposed rule, we 
are awarding section 422 cap increases first by level priority 
category, and then, within each level priority category, by points from 
the Evaluation Criteria on the CMS Evaluation Form, per hospital 
program. Thus, the commenter is correct; in the case where Hospital A 
qualified to be in level priority category one for a program, but 
scores no points on the Evaluation Criteria on the CMS Evaluation Form 
for that program, and Hospital B qualifies to be in level priority 
category two for a program, and scored 5 points on the Evaluation 
Criteria on the CMS Evaluation Form for a program, Hospital A will 
receive the section 422 cap increase before Hospital B, because 
Hospital A qualified to be in the higher level priority category.
    Comment: Two commenters believed that CMS should include 
consideration of children's hospitals among the evaluation criteria on 
the CMS Evaluation Form. Specifically, the commenters proposed that we 
add an evaluation criterion to give a point to hospitals that treat a 
``predominantly pediatric patient population.'' One commenter also 
proposed that we add another evaluation criterion to give another point 
for hospitals that treat ``a high percentage of SCHIP [State Children's 
Health Insurance Program] beneficiaries or uninsured patients.''
    Response: While we appreciate the commenters' desire to add 
evaluation criteria and garner additional points for use by children's 
hospitals when applying to receive section 422 increases to their FTE 
resident caps, we note that there are already evaluation criteria in 
the proposed rule (all of which we are finalizing) that may be 
applicable to children's hospitals. For instance, a children's hospital 
may be rotating residents for at least 25 percent of the duration of 
the residency program to a rural area, a rural health clinic, or a 
federally qualified health center. Or, a children's hospital may be 
training displaced residents from a closed program, or training 
residents above its 1996 FTE cap because it was awaiting accreditation 
of a new program from the ACGME or AOA during the base period for its 
FTE cap(s), but was not eligible to receive a new program adjustment. 
In addition to these evaluation criteria, there are several others that 
children's hospitals may use when applying to receive an increase in 
their FTE resident caps. Therefore, we are not adopting the commenter's 
proposal to add evaluation criteria specific to children's hospitals.
    Comment: We received several comments on the proposed Evaluation 
Criterion Three, which states--
    ``C3: Evaluation Criterion Three. The hospital does not qualify for 
an adjustment to its FTE caps under existing Sec.  413.86(g)(12) for a 
rural track residency program, but is applying for an increase in its 
FTE resident cap(s) under section 1886(h)(7)(B) of the Act because it 
rotates (or in the case of a new program, will rotate) residents for at 
least 25 percent of the duration of the residency program to any one 
(or in combination thereof) of the following: a rural area, as defined 
in section 1886(d)(2)(D)(ii) of the Act and Sec.  412.62(f)(1)(iii) of 
the regulations; a rural health clinic (RHC), as defined in section 
1861(aa)(1) of the Act and Sec.  491.2 of the regulations; or a 
Federally Qualified Health Center (FQHC), as defined in section 
1861(a)(3) of the Act and Sec.  405.2401(b) of the regulations.''
    Several commenters applauded CMS for proposing this Evaluation 
Criterion Three. One of the commenters asked CMS to clarify whether 
this criterion would apply to residents in existing programs, and not 
just new ones.
    Another commenter believed that for allopathic family practice 
residents, it would be a problem to rotate residents out of the 
hospital for a period of time greater than 3 months out of the program: 
``we believe the current threshold requirement of 25 percent time in 
the current evaluation criterion three is not in keeping with the best 
data available. 25 percent of time for a family practice training 
program is 9 months. Our data show that only 3 months training time in 
rural areas is necessary to show large changes in outcomes. Since the 
family practice RRC also requires two years of continuity training with 
the same patient population, most programs, unless they are located in 
rural areas themselves, or are rural training tracks, cannot meet a 25 
percent requirement. We request that this threshold be decreased to a 
commensurate percentage.''
    Response: We appreciate the commenters' support of proposed 
Evaluation Criterion Three. To respond to the first comment concerning 
whether the criterion would apply to existing residency programs that 
rotate residents for at least 25 percent of the duration of the program 
to those locations, we point to the language in the proposed criterion 
that says ``because it rotates (or in the case of a new program, will 
rotate).'' We believe we have included resident rotations for both new 
and existing residency programs.
    In response to the second commenter, we understand the concerns of 
allopathic family practice programs that may have ``continuity'' 
problems from

[[Page 49152]]

the RRC where residents are rotated outside of the hospital for 25 
percent of the duration of the program, however, as noted in this final 
rule, we are specifically addressing family practice programs (that is, 
primary care programs) in Evaluation Criterion 11. Therefore, even if 
hospitals with family practice programs are not able to fulfill this 
particular Evaluation Criterion, they may be able to meet Evaluation 
Criterion 11, among possibly others.
    Comment: One commenter addressed the proposed Evaluation Criterion 
Seven on the CMS Evaluation Form, which states--
    `` C7: Evaluation Criterion Seven. The hospital is located 
in any one (or in combination thereof) of the following: a geographic 
HPSA, as defined in 42 CFR 5.2; a population HPSA, (also defined at 42 
CFR 5.2); or a Medicare physician scarcity county, as defined under 
section 413 of Public Law 108-173.''
    The commenter believed that CMS should ``continue with this idea, 
but broaden its approach to include time residents spend training in 
these areas, not just where the hospital is located.'' In addition, 
this commenter believed that CMS should have another evaluation 
criterion based upon where the graduates of a residency program go into 
practice. The commenter states: ``[m]any worthwhile programs not 
located in rural or underserved designated areas produce a fair number 
of residents who locate their practices in such areas. As such, in 
keeping with the Congressional intent of this section of statute, it 
makes sense for CMS to award a priority point for those situations as 
well.''
    Response: We believe it would be duplicative to allow applicant 
hospitals to receive a point in the evaluation criteria for example 
rotating residents to a nonhospital setting that is located in a 
geographic or population HPSA or Medicare physician scarcity county, 
when the applicant hospitals already will receive a point in the 
evaluation criteria under Evaluation Criterion Three (as revised in 
this final rule) for rotating residents for a significant period to a 
rural area or a FQHC. Therefore, we are adopting the proposed 
Evaluation Criterion Seven as final.
    To address the second comment concerning awarding a point based not 
on the location of the hospital, but on where the new graduates of 
programs have their practices, while we appreciate that hospitals 
believe they have increased the retention of physicians to rural and 
underserved populations when residents train in their programs; 
however, it is difficult for the Medicare program to track such after-
the program data for purposes of audit of where particular graduates 
work after finishing their training. Therefore, we are not adopting the 
commenter's suggestion concerning physician retention, as well.
    Comment: We received one comment requesting that CMS add an 
Evaluation Criterion for hospitals that train ophthalmology residents. 
The commenter states that a high number of Medicare beneficiaries 
benefit from physicians in this specialty. In another comment, we 
received a request to address hospitals that train residents in 
palliative sub-specialty programs.
    Response: Unlike geriatrics, primary care, and emergency medicine, 
we do not believe that the Congress has specified ``ophthalmology 
residency training'' or ``palliative residency training'' for special 
consideration within the Medicare statute, nor in any Conference Report 
language. While we believe both ophthalmology and palliative medicine 
provide services to Medicare patients, since physicians in these areas 
serve many individuals, not only Medicare beneficiaries, we do not 
agree to add a new Evaluation Criterion to the CMS Evaluation Form to 
address ophthalmology or palliative training.
    Comment: We received one comment requesting that CMS add an 
Evaluation Criterion for any hospital that is a state operated public 
hospital. The commenter requests that, in the alternative, CMS ``add an 
Evaluation Criterion for any hospital that is a (i) public hospital or 
(ii) the only public hospital in its MSA.''
    Response: While we believe that public hospitals serve an important 
role in health care, particularly, for medically underserved areas of 
this country, we do not agree to add a new Evaluation Criterion to the 
CMS Evaluation Form to address public hospitals, specifically. We 
believe that we may have addressed the needs of some public hospitals 
by many of the proposed Evaluation Criteria, and some of the new ones 
that we are finalizing in this final rule, as well. For instance, 
Evaluation Criteria Seven, which would address many hospitals located 
in a HPSA or a Medicare physician scarcity county may provide a point 
for some public hospitals. Other than the evaluation criteria, we do 
not believe it is appropriate to single out a hospital by type of 
ownership for special consideration.
    Comment: One commenter described the situation of a hospital that 
is ``in partnership'' with a FQHC concerning a family practice program, 
where the FQHC is the sponsor of the residency program, and the 
hospital ``passes through'' every dollar in Medicare direct GME and IME 
payments the hospital receives to the FQHC, and the hospital was 
``caught'' by the BBA-mandated caps. The commenter requested that CMS 
add a new evaluation criterion to the CMS Evaluation Form that 
addresses this situation.
    Response: While we are sympathetic to the situation of hospitals 
clearly serving medically underserved populations (which is generally 
the case of a residency program that is sponsored by a FQHC), we 
believe that proposed Evaluation Criteria Three, Five, or Six may 
address the hospital described by the commenter. Therefore, we decline 
to address the situation described by the commenter with an Evaluation 
Criterion on the CMS Evaluation Form in this final rule. However, we 
would encourage these hospitals to apply for the increase to the caps 
under section 422.
    Comment: We received one comment on the proposed Evaluation 
Criterion Nine, which concerns awarding a point for hospitals 
``affiliated with a historically Black medical college.'' The commenter 
disagreed with the CMS proposed interpretation of the Conference Report 
language that accompanied Public Law 108-173, which stated that the 
Secretary should consider whether the hospital is a ``historically 
large medical college'' in evaluating hospital applications for the 
increase to their caps under section 422. In the proposed rule, we 
stated--''[u]pon consideration of this particular terminology, which, 
on its face, seems to contradict the three statutory priority 
categories (that is, rural, ``small'' urban, and only specialty program 
in the State), we proposed to view the reference to ``historically 
large medical colleges'' as a scrivener's error, and to read this 
language to refer to ``historically Black medical colleges.'' This 
proposed interpretation accomplishes two goals--first, we believe this 
interpretation serves the greater policy goal of encouraging residency 
training for the benefit of medically underserved populations. Second, 
we believe that this interpretation reflects the Conferees' intent in 
the language in the Conference Report.'' The commenter believed that 
the CMS interpretation of the Conference Report terminology is 
``inaccurate and arbitrary* * *'' and that historically large medical 
colleges'' deserve special consideration as they play an important role 
in educating a large portion of medical students. In some cases these 
hospitals may be training at a level above their cap and deserve 
recognition for that.''

[[Page 49153]]

    Response: We believe our proposed interpretation of the term in the 
Conference Report, ``historically large medical colleges,'' is 
appropriately interpreted to mean ``historically Black medical 
colleges,'' as we explained in the proposed rule. We believe 
historically Black medical colleges serve an important role for 
medically underserved populations and we would like to award hospitals 
that train residents that are in programs sponsored by historically 
Black medical colleges. While we also agree with the commenter that 
``historically large medical colleges'' play an important role in 
graduate medical education, we do not believe a literal reading of the 
report language can be consistent with Congress' explicit statement of 
priorities at section 1886(h)(7)(B) of the Act. In any case, we believe 
that we have addressed the issue of large medical college hospitals 
training residents above their FTE caps with other evaluation criteria 
addressed in this final rule.
    Comment: We received one comment that requested CMS add an 
Evaluation Criterion for any hospital that has a Medicare Case Mix 
Index (CMS) greater than 1.70. The commenter believes: ``[t]his is an 
indicator that the hospital is serving severely ill patients who most 
benefit from being treated in a teaching institution.''
    Response: We appreciate the commenter's suggested Evaluation 
Criterion, but we have chosen not to adopt it, since a criteria based 
on severity of illness in general is not necessarily a measurement of 
the need for additional residents in any specific program.
j. IME Adjustment Formula Multiplier for Redistributed FTE Resident 
Slots (Section 422(b)(1)(C) of Public Law 108-173) and the Application 
of Locality-Adjusted National Average Per Resident Amount (PRA)
    Section 1886(h)(7)(B)(v) of the Act, as added by section 422 of 
Public Law 108-173, provides that, with respect to additional residency 
slots attributable to the increase in the hospital's FTE resident cap 
as a result of redistribution of resident positions, the approved FTE 
resident amount, or PRA, is deemed to be equal to the locality-adjusted 
national average per resident amount computed for that hospital. In 
other words, section 1886(h)(7)(B)(v) of the Act requires that, for 
purposes of determining direct GME payments for portions of cost 
reporting periods occurring on or after July 1, 2005, a hospital that 
receives an increase in its direct GME FTE resident cap under section 
1886(h)(7)(B) of the Act will receive direct GME payments with respect 
to those additional FTE residents using the locality-adjusted national 
average PRA. Thus, in the May 18, 2004 proposed rule (69 FR 28305), we 
proposed that a hospital that receives an increase in its FTE resident 
cap under section 1886(h)(7)(B) of the Act would receive direct GME 
payments based on the sum of two different direct GME calculations: one 
that is calculated using the hospital's actual PRAs (primary care PRA 
or nonprimary care PRA) applicable under existing Sec.  413.86(e)(4) 
(proposed to be redesignated as Sec.  413.77(d) in the proposed rule) 
and the hospital's number of FTE residents not attributable to an FTE 
cap increase under section 1886(h)(7)(B) of the Act; and another that 
is calculated using the locality-adjusted national average PRA under 
existing Sec.  413.86(e)(4)(ii)(B) (proposed to be redesignated as 
Sec.  413.77(d)(2)(ii) in the proposed rule) inflated to a hospital's 
current cost reporting period, and the hospital's number of FTE 
residents that is attributable to the increase in the hospital's FTE 
resident cap under section 1886(h)(7)(B) of the Act.
    Section 422(a) of Public Law 108-173 contains a cross-reference in 
the new section 1886(h)(7)(B)(v) of the Act to the locality adjusted 
national average PRA ``computed under paragraph (4)(E).'' However, 
section 1886(h)(4)(E) of the Act does not relate to the locality-
adjusted national average PRA. Rather, it relates to the circumstances 
under which a hospital may count FTE resident time spent training in 
nonhospital sites.
    We have concluded that the cross-reference to section 1886(h)(4)(E) 
of the Act is a legislative drafting error, or scrivener's error. 
Instead, we believe the Congress intended to refer to section 
1886(h)(2)(E) of the Act, which explicitly provides for the 
determination of locality-adjusted national average PRAs. Because the 
drafting error is apparent, and a literal reading of the cross-
reference as specified in the statute would produce absurd results, we 
proposed to interpret the cross-reference to section 1886(h)(4)(E) of 
the Act in the new section 1886(h)(7)(B)(v) of the Act as if the 
reference were to section 1886(h)(2)(E) of the Act.
    We note that section 1886(h)(7)(B)(v) of the Act, which addresses 
the applicability of the locality-adjusted national average PRAs with 
respect to redistributed slots for the direct GME payment, makes no 
reference to section 1886(h)(4)(G) of the Act, which is the provision 
concerning the rolling average count of FTE residents. That is, the 
statute does not provide for an exclusion from application of the 
rolling average for residents counted as a result of FTE cap increases 
under section 1886(h)(7)(B) of the Act. In light of the absence of a 
specific pronouncement in section 1886(h)(7)(B) of the Act exempting 
those residents from application of the rolling average, and with no 
apparent reason to treat residents counted as a result of the FTE cap 
increases under section 1886(h)(7)(B) of the Act differently for 
purposes of the rolling average, we had proposed to require that if a 
hospital increases its direct GME FTE count of residents as a result of 
an FTE resident cap increase under section 1886(h)(7)(B) of the Act, 
those FTE residents would be immediately subject to the rolling average 
calculation. Furthermore, we believed that, given potentially 
significant shifts of FTE slots among hospitals as a result of section 
1886(h)(7) of the Act, the inclusion of FTE residents counted as a 
result of section 1886(h)(7)(B) of the Act in the rolling average would 
introduce a measure of stability and predictability, and mitigates 
radical shifts in direct GME payments from period to period.
    Comment: We received several comments on the implementation of 
section 1886(d)(5)(B) of the Act as modified by section 422(b) of 
Public Law 108-173, concerning the reduction in the IME adjustment 
factor, and also section 1886(h)(7)(B)(iv) of the Act, as added by 
section 422 of Public Law 108-173, concerning the application of the 
locality adjusted national average PRA, when a hospital receives an 
increase to its FTE caps for IME and direct GME under section 422. One 
commenter objected to our application of these two statutory 
provisions. The commenter stated that ``although we recognize that CMS 
does not have the authority to alter those formula defined in the 
statute, * * * [we] strongly believe that the Medicare reimbursement 
formula for all residency positions should be consistent and the 
section 422 of the [Medicare Modernization Act of 2003] should not have 
mandated a locality-adjusted national average per resident amount and 
reduction in the IME factor.''
    Other commenters similarly had concerns with the CMS proposed 
application of the reduced payment rates required for the IME 
adjustment factor and the locality-adjusted national average PRA. 
Specifically, these commenters disagreed with the proposed 
implementation of the rolling average methodology and also the intern

[[Page 49154]]

and resident to bed ratio (or ``IRB'') cap on IME payments, as stated 
in the proposed rule. The commenters disagreed with the ``immediate'' 
application of these two policies to the FTE cap adjusted under section 
422. One commenter stated that applying the IRB cap as proposed `` * * 
* effectively reduces a hospitals IME payments below the 50 percent 
level, and possibly to zero for the first year, and the 3-year rolling 
average which results in a 3 year phase-in causes additional IME 
payment delays for these redistributed residents. We believe this IME 
payment provision as proposed makes it much more difficult for 
providers to obtain and maintain board approval for commitment of new 
residency programs when CMS is not even proposing payments at 50 
percent of their standard IME payment levels for these redistributed 
residents.'' The commenter asked that CMS reconsider the application of 
the rolling average and the IRB cap to the section 422 FTE increase.
    Another commenter, also in support of CMS excepting the application 
of the rolling average and the IRB cap to the section 422 increase, 
reminded us that ``in the past, CMS [has] created exceptions to the 
application of the rolling average and the [IRB] cap when there were 
compelling reasons to do so, even in the absence of a statutory 
mandate.'' The commenter gave the examples of the initial years of the 
new residency program adjustment to the 1996 caps as provided under 
Sec.  413.79(e) (formerly Sec.  413.86(g)(6)), and the temporary 
adjustment to the 1996 caps from residents that are displaced from 
program or hospital closure, as provided under redesignated Sec.  
413.79(e) (formerly Sec.  413.86(g)(6)). This commenter also pointed 
out that it would be a ``double penalty'' to finalize the rolling 
average and IRB cap policy as proposed--``the first penalty being a 
payment rate penalty and the second penalty being an inability to count 
the residents fully in the first and second years.''
    In addition, another commenter asked CMS to consider providing a 3-
year exemption from the rolling average for IME and direct GME and also 
the IRB cap for IME payments for any FTEs added as a result of section 
422, in a manner similar to the new residency program adjustment to the 
FTE caps, which allows hospitals to except residents from the rolling 
average that are in the ``initial years'' of the new program. The 
commenter stated that ``the current proposed policy [of immediate 
application of the rolling average and the IRB cap] * * * makes it 
unnecessarily difficult for qualifying rural and small city hospitals 
to properly take advantage of the redistribution process.''
    Response: We appreciate hospitals' concern with the complexity of 
receiving different direct GME and IME payments for the residency slots 
received as per section 422 and the ``regular'' direct GME and IME 
payments for the residency slots counted within the hospitals' 1996 FTE 
caps on the count of residents in accordance with sections 
1886(d)(5)(B) and (h)(4) of the Act. As the first commenter correctly 
states, section 422 of Public Law 108-173 mandates different direct GME 
and IME payments for the increased slots received under section 422, 
and CMS has no discretion but to implement these two provisions as 
written. Due to the complex nature of the different payments for the 
different FTEs (``section 422 FTEs'' and ``1996 cap FTEs''), we will 
refer to the increase a hospital receives in its 1996 FTE cap under 
section 422 as ``the section 422 cap'' for purposes of direct GME and 
IME payments. The section 422 cap will be labeled as such on Worksheets 
E, Part A and Worksheets E-3, Part IV on the Medicare cost report so 
that both hospitals and the fiscal intermediaries will be able to more 
easily determine the different direct GME and IME payments for the 
different FTEs, depending on whether the FTE residents trained at the 
hospital are within the hospital's adjusted 1996 FTE cap, or are above 
that adjusted 1996 FTE cap and, therefore, subject to a section 422 
cap.
    To address the comments concerning the proposed immediate 
application of the rolling average to FTEs counted within the section 
422 cap for purposes of direct GME and IME payments, and the 
application of the IRB cap to section 422 FTEs counted for purposes of 
IME payments, we agree with the commenters that the proposal could 
create a disincentive for hospitals to apply for the increase to their 
caps under section 422 because of the ``extra-reduced'' direct GME and 
IME payments that would result from the application of the IRB cap and 
rolling average in the initial years of counting the FTEs within the 
section 422 caps. We are also concerned that the proposed immediate 
application of the rolling average and the IRB cap may, as one 
commenter put it, make it ``much more difficult for providers to obtain 
and maintain board approval for commitment of new residency programs.'' 
Furthermore, we believe that the application of the IRB cap and rolling 
average to residents counted within the section 422 caps would add 
significantly to the administrative burdens of both hospitals and 
fiscal intermediaries to track these residents for purposes of the 
differing payment rates for IME and direct GME. For these reasons, 
effective for portions of cost reporting periods and discharges 
beginning on or after July 1, 2005, CMS will not include the FTEs 
counted within the section 422 cap in the 3-year rolling average 
calculation for purposes of direct GME and IME payments. In addition, 
effective with discharges on or after July 1, 2005, CMS will not apply 
the IRB cap to the FTEs counted within a hospital's section 422 cap, 
for purposes of IME payment.
    Although one commenter suggested a 3-year exception to the IRB cap 
and the rolling average, we agree with the commenters that argued that 
it is appropriate to not apply either of these limitations on the 
reduced payment authorized by section 1886(h)(7) of the Act.
    Because the policies stated above are changed from those stated in 
the proposed rule at 69 FR 28283 for IME and 69 FR 28305 for direct 
GME, we provide the following two examples to clarify how the 
calculations for the payments will work when FTEs are counted within a 
hospital's section 422 cap:

    Example 1: IME adjustment factor.  This example illustrates how 
the IME adjustment factor would be calculated for a hospital that 
receives an increase to its FTE resident cap as a result of section 
1886(h)(7)(B) of the Act. Hospital A has a fiscal year end (FYE) of 
September 30, and a 1996 IME FTE cap of 20 FTEs. During its FYEs 
September 30, 2003, September 30, 2004, and September 30, 2005, 
Hospital A trains 25 FTE residents. Effective for discharges 
beginning on or after July 1, 2005, under section 1886(h)(7)(B) of 
the Act, Hospital A receives an increase to its IME cap of 5 FTEs. 
These additional 5 FTEs are the hospital's IME section 422 cap. The 
hospital now has an IME 1996 cap of 20 FTEs and an IME section 422 
cap of 5 FTEs. Hospital A has maintained an available bed count of 
200 beds for FYE September 30, 2004 and continuously through FYE 
September 30, 2005. The IME adjustment factor formula multiplier for 
discharges occurring during FY 2005 is 1.42 (as required by section 
502(a) of Pub. L. 108-173). The IME adjustment factor formula 
multiplier for redistributed FTE resident slots is .66 (set by 
section 422(b)(1)(C) of Pub. L. 108-173). For the FYE September 30, 
2005 cost report, the IME adjustment factor is calculated as 
follows:
    Step 1: For discharges occurring October 1, 2004, through 
September 30, 2005, for residents counted but NOT pursuant to 
section 1886(d)(5)(B)(ix) of the Act:
     Rolling average count of FTE residents: 20+20+20/3=20.
     Current year resident-to-bed ratio: 20/200=.10.
     Cap on resident-to-bed ratio (from prior year): 20/
200=.10.

[[Page 49155]]

     Compare, and use the lower of, prior year resident-to-
bed and current year resident-to-bed ratio: .10 = .10.
     Compute IME adjustment factor for FTE residents counted 
in the 1996 cap: 1.42 x [{1+.10{time} \.405\ -1] = 0.0559
    Step 2: For discharges occurring on July 1, 2005 through 
September 30, 2005 for residents counted as part of the section 422 
cap pursuant to section 1886(d)(5)(B)(ix) of the Act:
     Resident-to-bed ratio for 7/1/05--9/30/05: 5/200=.025
     Compute IME adjustment factor related to the section 
422 cap: 0.66 x [{1+.025{time} \.405\-1] = 0.0066
    Step 3: Compute the combined IME adjustment factor for the 
hospital (attributable to both the 1996 cap and the section 422 
cap):
     For discharges occurring October 1, 2004, through June 
30, 2005, the IME adjustment factor for the hospital is 0.0559 (Step 
1).
     For discharges occurring July 1, 2005 through September 
30, 2005, the combined IME adjustment factor for the hospital is 
0.0625 (that is, 0.0559 + 0.0066) (Step 1 + Step 2).
    Since the additional FTEs counted within the section 422 cap are 
not in the 3-year rolling average calculation or subject to the IRB 
cap, Hospital A is able to add 0.0066 to the IME adjustment factor 
for discharges occurring July 1, 2005, through September 30, 2005.
    Example 2: Direct GME payment. This example illustrates how the 
direct GME payment would be calculated for a hospital that receives 
an increase to its FTE resident cap as a result of section 
1886(h)(7)(B) of the Act. For example, Hospital B has a fiscal year 
end (FYE) of June 30, and a 1996 direct GME FTE cap of 20 FTEs. 
During its FYEs June 30, 2004 and June 30, 2005, Hospital B trained 
20 nonprimary care residents. During FYE June 30, 2006, Hospital B 
trains 25 nonprimary care FTE residents. Hospital B's FYE June 30, 
2006 nonprimary care PRA is $100,000. The FYE June 30, 2006 
locality-adjusted national average PRA for Hospital B is $84,000. 
Hospital B's Medicare utilization is 35 percent in FTE June 30, 
2006. Effective July 1, 2005, under section 1886(h)(7)(B) of the 
Act, Hospital B receives an increase to its direct GME cap of 5 
FTEs. These additional 5 FTEs are the hospital's direct GME section 
422 cap. The hospital now has a direct GME 1996 cap of 20 FTEs and a 
direct GME section 422 cap of 5 FTEs. For the FYE June 30, 2006 cost 
report, the direct GME payment is calculated as follows:
    Step 1: For residents counted but NOT pursuant to section 
1886(h)(7)(B) of the Act:
     Rolling average count: 20+20+20/3 = 20.
     Direct GME computation: $100,000 x 20 x .35 = $700,000.
    Step 2: For residents counted pursuant to section 1886(h)(7)(B) 
of the Act (the section 422 cap):
     Direct GME computation: $84,000 x 5 x .35 = $147,000.
    Step 3: Total direct GME payment for FYE June 30, 2006: $700,000 
+ $147,000 = $847,000.

    Comment: One commenter stated that the calculation of the IME 
payment relating to additional residents counted as a result of an 
increase in the hospital's FTE cap received under section 1886(h)(7)(B) 
of the Act is extremely cumbersome and will require difficult and 
extensive changes to the Medicare cost report, particularly if the 
additional residents are to be subject to the rolling average and the 
resident-to-bed ratio. The commenter suggested that instead of revising 
Worksheet E, Part A to include this calculation, CMS should consider 
including this calculation on a separate worksheet, with the results 
added to Worksheet E, Part A.
    Response: First, we note that we are required by section 
1886(d)(5)(B)(ix) of the Act to apply a different IME formula 
multiplier to calculate the IME payment relating to these residents. 
Therefore, some level of additional complexity is not avoidable. 
Additionally, we have stated in previous responses concerning the IME 
calculation relating to residents counted under section 1886(h)(7)(B) 
of the Act, under our final policy, we are not requiring that these 
residents be subject to the rolling average and resident-to-bed ratio 
calculations. Thus, we believe that our final policy substantially 
reduces the complexity of the proposed calculations that concerned the 
commenter. Even so, we do realize that the presence of an additional 
calculation on Worksheet E, Part A for IME (and also on Worksheet E-3, 
Part IV for direct GME) further complicates an already difficult 
calculation. We will attempt to revise the worksheets in the simplest 
and least disruptive manner.
    Comment: One commenter discussed the situation of a hospital that 
was subject to the reductions as required under section 1886(h)(7)(A) 
of the Act because it was below its 1996 FTE cap, that also applies for 
the cap increase (that is, the section 422 cap) as provided under 
section 1886(h)(7)(B) of the Act. The commenter believed that only the 
``aggregate'' FTE amount, that is, the difference in number of 
positions between the reduction in the cap and the cap increase, both 
provided under section 422, should be the sole basis for the 
application of the reduced direct GME and IME payment rates. Using the 
commenter's reasoning in an example, there is Hospital A, which has a 
1996 FTE cap of 100 FTEs on June 30, 2005. Hospital A's resident FTE 
cap is raised to110 FTEs as of July 1, 2005 under the section 422 
increase. Under the section 422 reductions, Hospital A's cap was 
lowered to 90 FTEs, also as of July 1, 2005. As per the commenter's 
proposal, CMS would apply the reduced direct GME and IME payment rates 
only to 10 FTEs for Hospital A, because 10 FTEs is the difference in 
number of positions between Hospital A's reduction in the cap and 
Hospital A's cap increase. Thus, the commenter suggested that, in the 
situation of a hospital that was reduced under section 422 for a 
greater number of FTEs than the hospital received as a section 422 cap, 
there would be no ``redistributed'' residents and, thus, there would be 
no application of the reduced payment rates.
    Response: We do not agree with the commenter's suggestion. We 
believe that sections 1886(h)(7)(A) and (B) of the Act--the section 422 
reduction and increase provisions, respectively--are two very different 
processes that require separate determinations by CMS. The only 
connections between subparagraphs (A) and (B) are that the cap 
increases through (B) are made by us through an estimated pool of FTE 
slots gathered from the reductions made through (A), and that both the 
reductions under (A) and the increases under (B) are effective July 1, 
2005. The similarities end there. We believe the reductions and the 
increases are stand-alone provisions and that the Congress did not 
intend that we would use the difference in the number of positions 
between the reduction in the cap and the cap increase, both provided 
under section 422, as the ``sole basis'' for the application of the 
reduced direct GME and IME payment rates, as the commenter suggested. 
We believe that a ``redistribution'' under section 1886(h)(7)(B) of the 
Act is simply an increase to the adjusted 1996 cap, as reduced where 
applicable by section 1886(h)(7)(A) of the Act. It is not the 
difference between the section 422 reduction and the section 422 
increase for any one applicant hospital.

Other Issues on the Request for Increase in the FTE caps Under Section 
422

    Comment: One commenter requested that CMS clarify the question of 
whether rural hospitals that establish a new residency program are 
precluded from receiving a new residency program adjustment under Sec.  
413.86(g)(6)(i) (redesignated as Sec.  413.79(e)(1)), if the hospitals 
can also receive an increase to their FTE caps if they apply under 
section 422. Similarly, another commenter stated that for expansion of 
rural programs up to 130 percent of their BBA-set cap, it should be 
made clear that CMS' proposals concerning section 422 do not supersede 
the BBRA provision, but are in addition to it, ``so a rural hospital 
that wishes to increase its BBA-set cap, may do so up to 130 percent, 
and may of course use this provision for any positions beyond that 
number.'' Finally, several commenters

[[Page 49156]]

asking CMS to exclude applicant hospitals from consideration under 
section 422 if they are eligible for current regulatory exceptions to 
the 1996 FTE caps.
    Response: Rural hospitals may receive an adjustment to their FTE 
caps for establishing a new residency program under redesignated Sec.  
413.79(e)(1)), at any time, and are not precluded from requesting the 
new residency program adjustment even if the hospitals also receive an 
increase to their FTE caps under section 422. However, we note that 
hospitals, rural or urban, may not apply for a permanent adjustment to 
their FTE caps under current Medicare regulations and also apply for an 
increase to their FTE caps under section 422 for the same new residency 
program. Though, such hospitals may apply for an increase under section 
422 for a different residency program(s).
    In response to the second commenter's suggestion, there is nothing 
that precludes a rural hospital from requesting an increase to its FTE 
cap under section 422 even if it also received a 130 percent expansion 
under the BBRA of 1999. We do not believe that when the Congress 
enacted section 1886(h)(7)(B) of the Act, it intended to limit rural 
hospital from receiving any additional slots. In fact, the Congress 
gave rural hospitals priority in the redistribution process.
    Comment: One commenter asked whether CMS plans to provide oversight 
of a hospital's section 422 caps. Specifically, the commenter wanted to 
know if hospitals could use the FTE cap increase as per section 422 for 
any program at the applicant hospital, ``in spite of receiving them on 
the basis of demand for starting or expanding a specific specialty 
program.''
    Response: As we stated above, once a hospital receives its section 
422 cap after applying for the increase as stated in this final rule, 
beginning July 1, 2005, the section 422 cap is applied to FTEs in any 
program that the hospital is training in excess of its 1996 FTE cap, 
regardless of the hospital's program-specific basis for being granted 
the section 422 cap.
    However, we note that, in order to qualify to apply for the 
increase to its FTE caps under section 422, a hospital must fulfill the 
demonstrated likelihood criteria on the CMS Evaluation Form (as 
finalized in this rule). The hospital must complete a CMS Evaluation 
Form for each residency program for which the hospital requests a FTE 
cap increase. In addition to a CMS Evaluation Form(s), the hospital 
must include as part of its application for the section 422 caps an 
attestation to the truth and veracity for the information included in 
the hospitals application. Thus, while the section 422 cap is an 
aggregate non-program-specific cap, when we determine which hospitals 
are to receive the section 422 caps, we are basing our determinations 
on the program-specific information provided by the hospital at the 
time of the hospital's application.
    Comment: Two commenters asked whether both the requests for the 
increases in the IME cap and the direct GME cap could be on the same 
hospital application for the section 422 caps.
    Response: As we stated above and also in the proposed rule, as part 
of the requirements that a hospital must fulfill in order to complete 
an application for the section 422 caps, is the requirement that the 
applicant hospital must include the total number of requested FTE 
resident slots (for all residency programs at the hospital) for direct 
GME or IME, or both (up to 25 FTEs). Thus, both of the increases in the 
IME and the direct GME cap request (that is, the total number of 
requested FTE resident slots (for all residency programs at the 
hospitals)) are required to be on the same hospital application for the 
section 422 caps.
    As stated above, a hospital must submit the following in order to 
apply for the section 422 caps:
     The name and Medicare provider number of the hospital.
     The total number of requested FTE resident slots (for all 
residency programs at the hospital) for direct GME or IME, or both (up 
to 25 FTEs).
     A completed copy of the CMS Evaluation Form for each 
residency program for which the applicant hospital intends to use the 
requested increase in the number of FTE residents and source 
documentation to support the assertions made by the hospital on the 
Evaluation Form.
     FTE resident counts for direct GME and IME and FTE 
resident caps for direct GME and IME reported by the hospital in the 
most recent as-filed cost report.
     An attestation, signed and dated by an officer or 
administrator of the hospital who signs the hospital's Medicare cost 
report, of the following information in the hospital's application for 
an increase in its FTE resident cap:
    ``I hereby certify that I understand that misrepresentation or 
falsification of any information contained in this application may be 
punishable by criminal, civil, and administrative action, fine and/or 
imprisonment under federal law. Furthermore, I understand that if 
services identified in this application were provided or procured 
through payment directly or indirectly of a kickback or where otherwise 
illegal, criminal, civil, and administrative action, fines and/or 
imprisonment may result. I also certify that, to the best of my 
knowledge and belief, it is a true, correct, and complete application 
prepared from the books and records of the hospital in accordance with 
applicable instructions, except as noted. I further certify that I am 
familiar with the laws and regulations regarding Medicare payment to 
hospitals for the training of interns and residents.''
    Comment: One commenter asked why the ``resident cap redistribution 
process'' is not included in the proposed regulations text, and that 
only ``summary information'' is provided under proposed Sec.  
413.79(c)(4).
    Response: We proposed only ``summary information'' at proposed 
Sec.  413.79(c)(4) because the process for applying for the section 422 
caps is a one-time process, not to be repeated, as we understand it. We 
see no reason to put in all of the steps for applying for the section 
422 caps into regulations, as well as our evaluation process of the 
applications. There may be some hospitals that will apply for the 
section 422 caps, and other hospitals that will not apply. However, to 
avoid any misunderstanding as to the process for applying for the 
section 422 caps, in this final rule, we are revising Sec.  
413.79(c)(4) to state ``For portions of cost reporting periods 
beginning on or after July 1, 2005, a hospital may receive an increase 
in its otherwise applicable FTE resident cap up to an additional 25 
FTEs (as determined by CMS) if the hospital meets the requirements and 
qualifying criteria of section 1886(h)(7) of the Act and implementing 
instructions issued by CMS, including the preamble to the August 11, 
2004, and if the hospital submits an application to CMS within the 
timeframe specified by CMS.''.
k. Application of Section 422 to Hospitals That Participate in 
Demonstration Projects or Voluntary Reduction Programs
    Section 1886(h)(7)(B)(vi) of the Act, as amended by section 
422(a)(3) of Public Law 108-173, states that ``Nothing in this 
subparagraph shall be construed as permitting the redistribution of 
reductions in residency positions attributable to voluntary reduction 
programs * * * under a demonstration project approved as of October 31, 
2003.'' This language is referring to the New York Medicare GME 
Demonstration Project and the Voluntary Resident Reduction Project 
(VRRP) under section 402 of Public Law 90-248. In July 1997, 42 New 
York teaching hospitals participated in the

[[Page 49157]]

demonstration project. As there were two entry points for this 
demonstration, an additional seven hospitals joined the program in July 
1998. The purpose of the demonstration project was to test 
reimbursement changes associated with residency training to determine 
whether hospitals could use time-limited transition funding to replace 
and reengineer the services provided by a portion of their residency 
trainees. In exchange for reducing its count of residents by 20 to 25 
percent over a 5-year period, while maintaining or increasing its 
primary care-to-specialty ratio of residents, a participating hospital 
(or consortium of hospitals) would receive ``hold harmless payments'' 
for 6 years. These payments represented a declining percentage of the 
Medicare GME reimbursement the participating hospitals would have 
received had their number of residents not been reduced.
    For hospitals that successfully completed the demonstration 
project, the Balanced Budget Act of 1997 states that if a hospital 
increases the number of full-time equivalent residents permitted under 
its reduction plan as of the completion of the plan, it is liable for 
repayment of the total amounts paid under the demonstration. Following 
the demonstration's period of performance, which ended June 30, 2003, 
if a hospital exceeds its post-demonstration cap and trains residents 
in excess of the FTE levels achieved under the demonstration, the 
hospital is not permitted to count those excess residents for purposes 
of Medicare GME payments until such time as the hold harmless funds 
paid under the demonstration project have been repaid in full.
    Similarly, with the VRPP, hospitals could use time-limited 
transition funding to replace the services provided by a portion of 
their residents. In exchange for reducing its count of residents by 20 
to 25 percent over a 5-year period, while maintaining or increasing its 
primary care-to-specialty ratio of residents, a VRRP participating 
hospital would receive ``hold harmless payments'' for 5 years. These 
payments represented a declining percentage of the Medicare GME 
reimbursement the VRRP participating hospital would have received had 
its number of residents not been reduced.
    In the May 18, 2004 proposed rule, we indicated that we believe 
that the language of section 1886(h)(7)(B)(vi) of the Act precludes the 
Secretary from redistributing residency positions that are unused due 
to a hospital's participation in a demonstration project or the VRRP to 
other hospitals that seek to increase their FTE resident caps under 
section 1886(h)(7)(B)(i) of the Act. That is, if we were to specify 
that hospitals that participated in a demonstration project or the VRRP 
are subject to possible reductions to their FTE resident caps under 
section 1886(h)(7)(A)(i) of the Act, any excess slots resulting from 
reductions made under section 1886(h)(7)(A)(i) of the Act attributable 
to the demonstration or the voluntary reduction program at these 
hospitals would not be allocated to the resident pool and redistributed 
to other hospitals. We also believed that section 1886(h)(7)(B)(vi) of 
the Act is silent as to whether the Secretary should apply the possible 
reductions under section 1886(h)(7)(A)(i) of the Act to the FTE 
resident caps of these hospitals. The Congress recognized the unique 
status of reductions in FTE resident counts made by these hospitals 
that participated in a demonstration project under the authority of 
section 402 of Public Law 90-248, or a VRRP under section 1886(h)(6) of 
the Act, in which these hospitals received hold-harmless payments from 
Medicare for reducing the number of residents that they were training. 
Accordingly, in the May 18, 2004 proposed rule (69 FR 28306), we 
proposed to recognize the unique status of FTE reductions made by these 
hospitals, and to apply the discretion that the Congress granted the 
Secretary under section 1886(h)(7)(A)(ii) of the Act in determining the 
reference resident level applicable to these hospitals, to determine 
the extent to which section 1886(h)(7)(A)(i) of the Act applies to 
these hospitals.
    We note that section 1886(h)(7)(B)(vi) of the Act only applies to 
these hospitals to the extent that a hospital's ``reductions in 
residency positions'' were ``attributable'' to its participation in the 
demonstration project or the VRRP. In determining the reference 
resident level for these hospitals, we proposed to adjust the reference 
resident level for ``reductions in residency positions attributable'' 
to participation in the demonstration project or the VRRP. We proposed 
to define ``reductions in residency positions attributable'' to 
participation in the demonstration project or the VRRP as the 
difference between the number of unweighted allopathic and osteopathic 
residents training at the hospital at the start of a hospital's 
participation in the demonstration project or the VRRP, (that is, the 
base number of residents as defined by the terms of the demonstration 
project and the VRRP,) and the number of such residents training at the 
hospital in the hospital's most recent cost reporting period ending on 
or before September 30, 2002. We proposed that, in determining any 
possible adjustments to the reference resident level for hospitals that 
participated in the demonstration project or the VRRP, we would 
differentiate between hospitals that withdrew from participation prior 
to the beginning of the most recent cost reporting period ending on or 
before September 30, 2002, and hospitals that either have not withdrawn 
from participation, or withdrew sometime during or after the most 
recent cost reporting period ending on or before September 30, 2002.
    Specifically, we proposed that, if a hospital was participating in 
the demonstration project or the VRRP at any time during the hospital's 
most recent cost reporting period ending on or before September 30, 
2002, for purposes of determining possible reductions to the FTE 
resident caps, we would compare the higher of the hospital's base 
number of residents, and the resident level in the hospital's most 
recent cost reporting period ending on or before September 30, 2002, to 
the hospital's otherwise applicable FTE resident cap. If the higher of 
the base number of residents or the resident level in the hospital's 
most recent cost reporting period ending on or before September 30, 
2002, is still less than the otherwise applicable FTE resident cap, we 
proposed to reduce the hospital's FTE resident cap amount by 75 percent 
of the difference, effective July 1, 2005. We also proposed to use 
those slots in the redistribution process under section 1886(h)(7)(B) 
of the Act since those slots are not ``attributable'' to participation 
in the demonstration project or the VRRP.
    Under section 1886(h)(7)(A)(ii)(II) of the Act, a hospital may 
submit a timely request to use its cost report that includes July 1, 
2003, for purposes of determining the reference resident level if the 
hospital has an expansion of an existing program that is not reflected 
on the hospital's most recent settled cost report. If a hospital that 
was still participating in the demonstration project or the VRRP at 
some time during its most recent cost reporting period ending on or 
before September 30, 2002, had an expansion of an existing program that 
is not reflected on its most recent settled cost report, and the 
resident level for its cost reporting period that includes July 1, 
2003, is higher than the resident level for the most recent cost 
reporting period ending on or before September 30, 2002, and is higher 
than the base number of residents, we anticipate that the hospital 
would submit a timely request that its resident

[[Page 49158]]

level from its cost reporting period that includes July 1, 2003, be 
compared to its otherwise applicable FTE resident cap, for purposes of 
determining a possible reduction to the hospital's FTE resident cap. We 
believe that under the proposed policy discussed above, a hospital 
would only request that we utilize its cost reporting period that 
includes July 1, 2003, if the number of allopathic and osteopathic 
residents it trained in that cost reporting period is higher than its 
base number of residents and its base number of residents is less than 
its FTE resident cap. If we grant the hospital's request that we 
utilize its cost reporting period that includes July 1, 2003, and the 
resident level for that period is less than the FTE resident cap, we 
would reduce the FTE resident cap by 75 percent of the difference 
between the two numbers. We also proposed to use those slots in the 
redistribution process under section 1886(h)(7)(B) of the Act, because 
those slots are not ``attributable'' to participation in the 
demonstration project or the VRRP.
    If a hospital withdrew from participation in the demonstration 
project or the VRRP prior to its most recent cost reporting period 
ending on or before September 30, 2002, we proposed that such a 
hospital would be subject to the procedures applicable to all other 
hospitals for determining possible reductions to the FTE resident caps. 
However, we note that such a hospital may still apply for an increase 
to its FTE caps as specified under section 1886(h)(7)(B) of the Act 
(the proposals for applying for the increase are described above).
    Comment: One commenter was appreciative of the fact that CMS 
acknowledged that section 1886(h)(7)(B)(vi) of the Act only applies to 
hospitals that participated in the demonstration project to the extent 
that a hospital's ``reductions in residency positions'' were 
attributable to its participation in the demonstration project, and 
that, in determining the reference resident level for these hospitals, 
CMS proposed to adjust the reference resident level for reductions in 
residency positions attributable to participation in the demonstration 
project. The commenter supported our proposal that, for a hospital that 
was participating in the demonstration project during the most recent 
cost reporting year ending on or before September 30, 2002, CMS would 
compare the higher of the hospital's base number of residents, and the 
resident level in the hospital's most recent cost reporting period 
ending on or before September 30, 2002, to the hospital's otherwise 
applicable FTE resident cap. However, the commenter requested that CMS 
expand upon its proposal to allow additional hospitals that do not meet 
the proposed criteria to demonstrate that certain reductions were also 
``attributable'' to their participation in the demonstration project 
and, therefore, should be exempt from reduction to their FTE resident 
caps, for the following reasons: First, some hospitals withdrew prior 
to their most recent cost reporting period ending on or before 
September 30, 2002, because they realized that remaining in the 
demonstration project and maintaining reduced resident counts would 
compromise their educational and patient care missions in the long run. 
Second, because the terms and conditions of the demonstration project 
``` front-loaded' the hold harmless payments by means of a declining 
percentage of the hospital's usual Medicare GME reimbursement, all 
demonstration hospitals gained incentivized to make as large a 
reduction as possible in the early years of the demonstration 
project.'' The commenter noted that, while some hospitals that withdrew 
prior to their most recent cost reporting period ending on or before 
September 30, 2002, were able to rebuild their residency programs close 
to or at the pre-demonstration project level, other hospitals have only 
just begun or are still in the planning stages for rebuilding their 
programs. The commenter further stressed the point that section 
1886(h)(7)(B)(vi) of the Act, which prohibits the redistribution of 
reductions in residency positions attributable to voluntary reduction 
programs, does not specify a timeframe within which those hospitals 
need to refill those positions, and that, therefore, CMS should not 
impose such a criterion that differentiates between hospitals that 
withdrew from participation prior to the beginning of the most recent 
cost reporting period ending on or before September 30, 2002, and 
hospitals that either have not withdrawn from participation, or 
withdrew sometime during or after the most recent cost reporting period 
ending on or before September 30, 2002.
    The commenter recommended a multi-part criterion for hospitals that 
withdrew prior to the most recent cost reporting period ending on or 
before September 30, 2002, to demonstrate that particular resident 
reductions were attributable to the demonstration project and should be 
exempted from redistribution. The criterion focused on a two-part test 
for exemption from redistribution: hospital eligibility and residency 
program eligibility. The commenter suggested that a residency program's 
eligibility for consideration under the second-level criterion would be 
dependent on a hospital's satisfaction of the first-level criterion.
    The commenter proposed that a hospital would have to meet the 
following criteria to prove the ``first level criterion'' for hospital 
eligibility:
     The hospital participated in demonstration project and 
withdrew prior to the most recent cost reporting period ending on or 
before September 30, 2002;
     The hospital's resident FTE count declined between the 
demonstration project base year and the point at which the hospital 
withdrew from the demonstration project; and
     The hospital's applicable FTE resident count in the 
hospital's reference resident level year is below both the hospital's 
demonstration project base year FTE resident count and the hospital's 
otherwise applicable FTE resident cap number.
    The commenter proposed that the hospital would have to meet the 
following criteria to prove the ``second level criterion'' of residency 
program eligibility:
     The residency program was in operation during the base 
year for the demonstration project.
     The FTE resident count for that particular residency 
program declined between the demonstration project base year and the 
point at which the hospital withdrew from the demonstration project.
     The FTE resident count for that particular residency 
program in the hospital's reference resident level year is below both 
(a) the FTE resident count for that particular residency program during 
the base year for the demonstration project, and (b) the FTE resident 
count for that particular residency program during the most recent cost 
reporting period ending on or before December 31, 1996.
    While the commenter believed that satisfaction of these two 
criteria prove that these reduced resident positions are attributable 
to demonstration project and should be exempt from redistribution, the 
commenter indicated that it would be pleased to work with CMS to 
develop basic documentation requirements to support the exemption 
should CMS believe such a requirement is needed. The commenter also 
noted that hospitals that withdrew from the demonstration project prior 
to the most recent cost reporting period ending on or before September 
30, 2002, might have, in certain instances, added resident positions in 
departments other than where resident reductions

[[Page 49159]]

attributable to the demonstration project were made. Therefore, in 
order to ensure that the number of individual reduced residency 
position eligible for exemption does not exceed the appropriate number 
of positions, the number of exemptions should be ``capped'' at the 
difference between (i) the number of FTE residents in the hospital's 
reference resident level year, and (ii) the lower of the hospital's 
demonstration project base year FTE resident count and the hospital's 
otherwise applicable FTE resident cap number.
    The commenter concluded that it recognizes that CMS may not be able 
to address all details of its recommended methodology in the final 
rule, and expressed hope that time constraints would not preclude CMS 
from giving ample consideration to the reasonableness of its 
recommendation and its consistency with the relevant provisions within 
section 422 of Public Law 108-173.
    Response: As we explained in the May 18, 2004 proposed rule, while 
we believe that the language of section 1886(h)(7)(B)(vi) of the Act 
concerning hospitals that participated in the New York Medicare GME 
demonstration project or the VRRP precludes the Secretary from 
redistributing residency positions that are unused due to a hospital's 
participation in a demonstration project or the VRRP to other hospitals 
that seek an increase in their FTE resident caps under section 
1886(h)(7)(B)(i) of the Act, we also believe that section 
1886(h)(7)(B)(vi) of the Act is silent as to whether the Secretary 
should apply the possible reductions under section 1886(h)(7)(A)(i) of 
the Act to the FTE resident caps of these hospitals. As the commenter 
noted, we proposed that, in determining the reference resident level 
for these hospitals, we would adjust the reference resident level for 
reductions in residency positions attributable to participation in the 
demonstration project or the VRRP. In making this proposal, we 
considered the potential operational difficulties that would be imposed 
on both hospitals and the fiscal intermediary if we were to require 
that each hospital document reductions attributable to the 
demonstration project, whether at the hospital level, or at the program 
level. Thus, to avoid undue administrative burden, and in absence of a 
clearly specified timeframe or cut off point for reductions 
attributable to participation in the demonstration or the VRRP in 
section 1886(h)(7)(B)(vi) of the Act, we proposed to use the hospital's 
most recent cost reporting period ending on or before September 30, 
2002, which is the cost reporting period the Secretary is first 
directed to use under section 1886(h)(7)(A)(ii) of the Act, to 
determine any possible adjustments to the reference resident level for 
hospitals that participated in the demonstration project or the VRRP. 
Specifically, we proposed to differentiate between hospitals that 
withdrew from participation prior to the beginning of the most recent 
cost reporting period ending on or before September 30, 2002, and 
hospitals that either have not withdrawn from participation, or 
withdrew sometime during or after their most recent cost reporting 
period ending on or before September 30, 2002. We believe it is 
necessary to establish a timeframe for a hospital's participation in a 
demonstration or VRRP because, at some point after withdrawal, it can 
no longer be said that reductions in the number of FTE residents are 
attributable to participation in a demonstration or VRRP. We believe 
that using the most recent cost reporting period ending on or before 
September 30, 2002, as the delineator for determining which hospitals 
may receive possible adjustments to their reference resident levels was 
clear, administratively feasible, had basis in the statute, and would 
be a reasonable reflection of which reductions were attributable to 
participation in a demonstration or VRRP. Therefore, we strongly 
disagree with the commenter's assertion that our proposed use of this 
cost reporting period was a ``bright line'' distinction that implied 
that there was some ``predetermined maximum amount of time'' for 
hospitals that participated in a demonstration project to refill their 
vacated resident positions. In fact, those hospitals could refill, or 
not refill, those slots as they saw fit. Furthermore, to the extent 
that a hospital (involved in the demonstration project or otherwise) 
may have planned to increase its resident counts in the future, these 
plans are not recognized under section 1886(h)(7)(A) of the Act, which 
requires 75 percent of any ``unused'' slots must be ``redistributed.'' 
The Congress did, however, recognize the unique status of reductions in 
FTE resident counts attributable to a hospital's participation in a 
demonstration project or the VRRP in the statute at section 
1886(h)(7)(B)(vi) of the Act. Therefore, we do not believe our proposal 
would allow resident positions to be redistributed in ``some wholesale 
manner,'' as the commenter suggested.
    However, we do acknowledge the commenter's comprehensive and 
clearly articulated recommended methodology for documenting, both at 
the hospital level, and at the program-specific level, that select 
unused resident positions were attributable to the demonstration 
project, and should be exempted from redistribution. We note that 
hospitals, including those that participated in the demonstration, may 
reduce their FTE resident counts for many possible reasons. Thus, it 
would be impossible to determine with certainty, under any possible 
methodology, that a particular reduction in the number of FTE residents 
is purely attributable to participation in the demonstration or VRRP. 
Although we have considered various ways of documenting reductions in 
FTE resident counts attributable to participation in the demonstration 
project, we decided that any possible improvement in the definition of 
``attributable to'' reductions would be offset by the difficulty for 
hospitals to produce this detailed, program-specific documentation, and 
the significant additional audit workload that would be imposed on the 
fiscal intermediary. In addition, we note that the commenter's 
suggested methodology seems to focus solely on reductions in resident 
positions that occurred in specific programs between the time that the 
hospitals entered the demonstration project and the time that they 
withdrew. We believe a more credible method of demonstrating that 
reductions should be exempt from redistribution would be to document 
what has happened in those programs since the time that the hospital 
withdrew from the demonstration project, especially for those hospitals 
that ended participation in the demonstration in earlier years, and 
have had more time to add back to their FTE resident count those 
reductions that were solely attributable to participation in the 
demonstration. We believe evidence that the hospital's resident counts 
have grown since its withdrawal more convincingly advocates for an 
exemption from reduction for those resident slots, as opposed to 
emphasis on the number of slots that had been reduced prior to 
withdrawal. Thus, while we considered the commenter's recommendation 
that the hospitals should be required to supply program-specific 
information from the reference cost reporting period, the base year for 
the demonstration project, and for the most recent cost reporting 
period ending on or before December 31, 1996, we are not inclined to 
impose such detailed documentation requirements for the purpose of 
determining which of a hospital's reductions in FTE resident counts are 
attributable to participation in the

[[Page 49160]]

demonstration project, and we question whether this data could 
necessarily be conclusive. Accordingly, we are not adopting the 
commenter's suggested multi-part methodology.
    However, in light of the comments, and after reviewing the proposed 
policy, we have decided that, in finalizing our policy, we will further 
consider the length of time a hospital participated in the 
demonstration project or the VRRP before it withdrew. Specifically, we 
will provide the same protection that we proposed for hospitals that 
were still participating in the demonstration project during the cost 
reporting period ending on or before September 30, 2002, to hospitals 
that withdrew prior to that cost reporting period if the period of time 
the hospital participated in the demonstration project is longer than 
the period of time the hospital has been withdrawn from the 
demonstration project. For instance, the maximum amount of time that a 
hospital entering the demonstration project in 1997 could participate 
in the demonstration project was 6 years (from July 1997 to June 2003). 
A hospital that participated in the demonstration for more than 3 years 
would necessarily have participated in the demonstration for more years 
than it did not (that is, it would have been withdrawn from the 
demonstration for less than 3 years). We note that, for those hospitals 
entering the demonstration project at the second entry point in 1998, 
the maximum amount of time those hospitals could participate in the 
demonstration project was 5 years. If a hospital participated in the 
demonstration for a greater period of time than the time period that 
has elapsed since it withdrew from the demonstration project, we 
acknowledge that the hospital may not have had a sufficient amount of 
time to refill its residency slots to its base year level by its cost 
report that includes July 1, 2003. Therefore, in this final rule, we 
are finalizing our policy with respect to hospitals that participated 
in a demonstration project or the VRRP to state that, if a hospital 
participated in the demonstration project or the VRRP for a longer 
period of time than it has been withdrawn from the demonstration 
project or the VRRP, for purposes of determining possible reductions to 
the FTE resident caps, we would compare the higher of the hospital's 
allopathic and osteopathic base number of residents for the 
demonstration project or the VRRP, or the resident level in the 
hospital's most recent cost reporting period ending on or before 
September 30, 2002, to the hospital's otherwise applicable FTE resident 
cap. If the higher of the allopathic and osteopathic base number of 
residents or the resident level in the hospital's most recent cost 
reporting period ending on or before September 30, 2002, is still less 
than the otherwise applicable FTE resident cap, we would reduce the 
hospital's FTE resident cap amount by 75 percent of the difference, 
effective July 1, 2005. We will also include those cap reductions in 
the redistribution process under section 1886(h)(7)(B) of the Act 
because those reductions are not ``attributable'' to participation in 
the demonstration project or the VRRP.
    Although hospitals that participated in the demonstration project 
for less time than they have been withdrawn from the demonstration 
project may also have reduced their FTE resident counts at one point, 
we believe that those hospitals (particularly those that withdrew from 
the demonstration project after realizing, as the commenter states, 
that their educational and patient care missions would be compromised 
in the ``long run''), should have been able to increase their FTE 
resident counts to their base year levels. If not by their most recent 
cost reporting period ending on or before September 30, 2002 then in 
time to qualify to make a timely request to use its cost report that 
includes July 1, 2003 under section 1886(h)(7)(A)(ii)(II) of the Act. 
We emphasize that the Congress recognized that, for a variety of 
reasons, a hospital's FTE resident count on its most recent cost 
reporting period ending on or before September 30, 2002, might not be 
as high as it typically is, or that its FTE resident count may have 
increased after its most recent cost report ending on or before 
September 30, 2002. Under sections 1886(h)(7)(A)(ii)(II) and (III) of 
the Act, Congress provided for the possibility that hospitals may have 
expanded existing programs or may have planned to start new programs, 
by allowing hospitals the option to use their cost report that includes 
July 1, 2003 for expansions of existing programs, or to adjust the 
reference resident level in the case of newly approved programs. We 
believe hospitals that withdrew early (that is, those that withdrew so 
early from the demonstration that the time they were participating was 
shorter than the time they were not), and are committed to maintaining 
their residency programs consistent with its educational and patient 
care missions would have been able to substantially restore their 
residency programs by their cost report that includes July 1, 2003. 
Those hospitals that participated in the demonstration project for a 
lesser amount of time than they have been withdrawn and, since their 
withdrawal have been increasing their resident counts, could have 
availed themselves of the option to submit a timely request by June 14, 
2004, to use their cost report that includes July 1, 2003, as the 
reference cost report.
    In summary, we are finalizing our policy with respect to hospitals 
that participated in a demonstration project or the VRRP to state that 
if a hospital participated in the demonstration project or the VRRP for 
a longer period of time than the time period that it has been withdrawn 
from the demonstration project or the VRRP, for purposes of determining 
possible reductions to the FTE resident caps, we would compare the 
higher of the hospital's allopathic and osteopathic base number of 
residents, and the resident level in the hospital's most recent cost 
reporting period ending on or before September 30, 2002, to the 
hospital's otherwise applicable FTE resident cap. If the higher of the 
allopathic and osteopathic base number of residents or the resident 
level in the hospital's most recent cost reporting period ending on or 
before September 30, 2002, is still less than the otherwise applicable 
FTE resident cap, we would reduce the hospital's FTE resident cap 
amount by 75 percent of the difference between the higher number and 
the otherwise applicable cap, effective July 1, 2005. We would also 
include those slots in the redistribution process under section 
1886(h)(7)(B) of the Act since those slots are not ``attributable'' to 
participation in the demonstration project or the VRRP.
    Under section 1886(h)(7)(A)(ii)(II) of the Act, a hospital may 
submit a timely request to use its cost report that includes July 1, 
2003, for purposes of determining the reference resident level if the 
hospital has an expansion of an existing program that is not reflected 
on the hospital's most recent settled cost report. Accordingly, if a 
hospital that was participating in the demonstration project or the 
VRRP for a greater amount of time than it has been withdrawn from 
participation in the demonstration project or the VRRP, had an 
expansion of an existing program that is not reflected on its most 
recent settled cost report, and the hospital submitted (and CMS 
approved) a timely request that its resident level from its cost 
reporting period that includes July 1, 2003, be compared to its 
otherwise applicable FTE resident cap, we would compare the higher of 
the hospital's allopathic and osteopathic base number of residents, and 
the resident level in the hospital's cost reporting period that 
includes July 1, 2003, to the hospital's

[[Page 49161]]

otherwise applicable FTE resident cap. If the higher of the allopathic 
and osteopathic base number of residents or the resident level in the 
hospital's cost reporting period that includes July 1, 2003 is still 
less than the otherwise applicable FTE resident cap, we would reduce 
the hospital's FTE resident cap amount by 75 percent of the difference 
between the higher number and the otherwise applicable cap, effective 
July 1, 2005. We would also include those slots in the redistribution 
process under section 1886(h)(7)(B) of the Act since those slots are 
not ``attributable'' to participation in the demonstration project or 
the VRRP.
    If a hospital participated in the demonstration project or the VRRP 
for an amount of time that is less than the amount of time that has 
elapsed since it withdrew from the demonstration project or the VRRP, 
such a hospital would be subject to the procedures applicable to all 
other hospitals for determining possible reductions to the FTE resident 
caps. However, we note that such a hospital may still apply for an 
increase to its FTE caps as specified under section 1886(h)(7)(B) of 
the Act.
    We are also clarifying one point concerning the ``base number'' of 
residents. In the May 18, 2004 proposed rule, we explained that for 
purposes of determining whether the FTE resident caps of hospitals that 
participated in the demonstration project or the VRRP would be reduced, 
we would determine the ``difference between the number of unweighted 
allopathic and osteopathic residents training at the hospital at the 
start of a hospital's participation in the demonstration project or the 
VRRP, (that is, the base number of residents as defined by the terms of 
the demonstration project and the VRRP), and the number of these 
residents training at the hospital in the hospital's most recent cost 
reporting period ending on or before September 30, 2002'' (69 FR 28307, 
emphasis added). However, we inadvertently overlooked the fact that the 
demonstration project and the VRRP applied to dental and podiatric 
residents, in addition to allopathic and osteopathic residents. Thus, 
for hospitals that were training dental and podiatric residents at the 
start of their participation in the demonstration project or the VRRP, 
these residents were also included in the base number of residents. 
Because FTE resident caps apply only to allopathic and osteopathic 
residents, we are clarifying that, for purposes of determining possible 
reductions to the FTE resident caps of a hospital that participated in 
the demonstration project or the VRRP, any dental and podiatry FTE 
residents should be subtracted from a hospital's base number of FTE 
residents. If a hospital participated in the demonstration project or 
the VRRP for a longer period time than it was not participating, for 
purposes of determining possible reductions to the FTE resident caps, 
we would compare the higher of the hospital's base number of residents, 
excluding any dental and podiatric residents, and the reference 
resident level, to the hospital's otherwise applicable FTE resident 
cap.
l. Application of Section 422 to Hospitals That File Low Utilization 
Medicare Cost Reports
    In general, section 422 of Public Law 108-173 applies to hospitals 
that are Medicare-participating providers and that train residents in 
approved residency programs. However, because Medicare-participating 
children's hospitals primarily serve a non-Medicare population and, 
therefore, receive minimal Medicare payments relative to other 
Medicare-participating hospitals, some children's hospitals choose 
(with approval from their fiscal intermediaries) to submit low 
utilization (abbreviated) Medicare cost reports. Typically, such low 
utilization cost reports do not include the information that would be 
necessary for us to calculate Medicare GME payments, such as FTE 
resident counts and caps. Thus, children's hospitals that submit these 
low utilization cost reports do not receive Medicare GME payments.
    Under section 1886(h)(7)(A) of the Act, as added by section 422(a) 
of Public Law 108-173, in the May 18, 2004 proposed rule (69 FR 28307), 
we proposed that determinations as to whether, and by how much, a 
children's hospital's FTE resident cap will be reduced will be made 
using the same methodology (that is, utilizing the same reference cost 
reporting periods and the same reference resident levels) that we 
proposed for other Medicare-participating teaching hospitals. We note 
that the low utilization cost reports may be filed with or without 
Worksheet E-3, Part IV (the worksheet on which the Medicare direct GME 
payment is calculated). If a children's hospital files a low 
utilization cost report in a given cost reporting period, and does not 
file the Worksheet E-3, Part IV, for Medicare purposes, that hospital 
is not considered by Medicare to be a teaching hospital in that cost 
reporting period. (We realize that a children's hospital that files a 
low utilization cost report may have a ``resident cap'' that is 
applicable for payment purposes under the Children's Hospital Graduate 
Medical Education (CHGME) Payment Program, administered by the Health 
Resources and Services Administration (HRSA), but this resident cap is 
not the Medicare FTE resident cap.) As stated in the One-Time 
Notification published on April 30, 2004 (Transmittal 77, CR 3247), if 
a children's hospital filed a low utilization cost report in its most 
recent cost reporting period ending on or before September 30, 2002, 
and did not file the Worksheet E-3, Part IV, there could be no 
reduction under section 1886(h)(7)(A) of the Act because there is no 
reference resident level for such a hospital. This would be the case 
even in instances where such a children's hospital has a FTE resident 
cap (for example, from 1996) that is recognized for Medicare purposes, 
because there would still be no reference resident level for its most 
recent cost reporting period ending on or before September 30, 2002, on 
which to determine a possible reduction to the children's hospital FTE 
resident cap.
    Although section 1886(h)(7)(A) of the Act does not apply to 
children's hospitals that filed a low utilization cost report (and no 
Worksheet E-3, Part IV) for the most recent cost reporting period 
ending on or before September 30, 2002, we proposed that, regardless of 
how a children's hospital has previously filed its Medicare cost report 
(that is, a full cost report or an abbreviated one), or how it is 
treated for CHGME payment purposes, a children's hospital would be 
eligible to apply for an increase in its FTE resident cap under section 
1886(h)(7)(B) of the Act, subject to the same demonstrated likelihood 
and evaluation criteria proposed above for all hospitals. However, we 
proposed that, in order to receive an increase in its FTE resident cap 
under section 1886(h)(7)(B) of the Act, effective July 1, 2005, in 
addition to complying with the proposed application requirements 
described above, the hospital must file Worksheet E-3, Part IV, with 
its Medicare cost report for its cost reporting period that includes 
July 1, 2005. We proposed that the children's hospital comply with this 
requirement because section 422 is intended to allow a hospital to 
increase its FTE counts for purposes of Medicare GME payments. We do 
not believe it would be appropriate to grant an increase in a 
hospital's FTE resident cap under section 1886(h)(7)(B) of the Act if 
the hospital does not use the slots for Medicare purposes (but only for 
purposes of the CHGME Payment Program) as would be evidenced by not 
filing a Worksheet E-3, Part IV.
    Comment: Several commenters requested that we exempt all children's 
hospitals or hospitals filing a low

[[Page 49162]]

utilization Medicare cost report, or both, from possible reductions to 
FTE resident caps under section 422 of Public Law 108-173. The 
commenters pointed out that Medicare-participating children's hospitals 
primarily serve a non-Medicare population and may choose (with approval 
from their fiscal intermediary) to submit low utilization (abbreviated) 
cost reports. They added that, although not a required part of a low 
utilization Medicare cost report, some children's hospitals may have 
filed Worksheet E-3, Part IV with the cost report. The commenters 
indicated that Worksheet E-3, Part IV details the hospital's FTE 
resident count and FTE resident cap for direct GME purposes and that 
CMS proposed to apply the provisions of section 1886(h)(7)(A) of the 
Act if the low utilization filer had filed Worksheet E-3, Part IV for 
the reference cost reporting period. The commenters believed it would 
be unfair to distinguish between low utilization filers based on the 
inclusion of Worksheet E-3, Part IV and, therefore, possibly make 
reductions to the FTE resident cap for some low utilization filers and 
not for others. They requested that we deem submission of Worksheet E-
3, Part IV to be irrelevant to whether FTE reductions apply to any low 
utilization filers. Another commenter requested that we not apply FTE 
resident cap reductions to children's hospitals that submitted low 
utilization reports in the 1996 base year.
    Response: We believe the commenters have taken the policy regarding 
low utilization filers out of context. Low utilization cost reports may 
be filed with or without Worksheet E-3, Part IV. The proposed rule does 
not exempt any of these low utilization filers from the provisions of 
section 422. Rather, as we stated in the May 18, 2004 proposed rule (69 
FR 28308), ``if a children's hospital filed a low utilization cost 
report in its most recent cost reporting period ending on or before 
September 30, 2002, and did not file the Worksheet E-3, Part IV, there 
could be no reduction under section 1886(h)(7)(A) of the Act because 
there is no reference resident level for such a hospital.'' (Emphasis 
added.) Our policy focuses on the existence of a reference resident 
level rather than if the hospital is filing a low utilization cost 
report. Therefore, as we stated in the proposed rule, section 
1886(h)(7)(A) of the Act does not apply to children's hospitals that 
filed a low utilization cost report and did not file Worksheet E-3, 
Part IV because, for these hospitals, no reference FTE resident count 
exists. Furthermore, we do not have the authority to exempt hospitals 
from possible reductions under section 422. The only hospitals that are 
exempted by statute are rural hospitals with fewer than 250 beds, as 
explicitly mandated by section 1886(h)(7)(A)(i)(II) of the Act. 
Therefore, we do not have the authority to exempt children's hospitals 
that file a low utilization cost report either in the reference year or 
in the 1996 base year.
    Comment: One commenter noted that children's hospitals that file 
low utilization cost reports may not have filed Worksheet E-3, Part IV 
and, therefore, may not have the prior and penultimate years' FTE 
resident counts necessary to calculate the rolling average FTE resident 
count after receiving an increase in FTE resident caps in accordance 
with section 422 of Public Law 108-173. The commenter proposed that if 
a children's hospital has not filed Worksheet E-3, Part IV with its low 
utilization cost reports, the hospital include supporting 
documentation, such as the prior periods' Form HRSA-99 forms with the 
request for an increase in its FTE resident cap, for the purposes of 
computing the rolling average.
    Response: We agree with the commenter that a children's hospital 
that files low utilization cost reports without Worksheet E-3, Part IV 
must supply whatever supporting documentation as may be deemed 
necessary to the financial intermediary in order to calculate a 3-year 
rolling average FTE resident count. However, we note, that as explained 
earlier in this final rule, we excluded any FTE resident cap increases 
that a hospital may receive as a result of section 422 (the section 422 
cap) from the rolling average determination. Therefore, the process of 
collecting documentation necessary for calculating a rolling average 
would only apply to calculation of the number of residents at the 
hospital that are subject to a hospital's 1996 FTE resident cap, not to 
FTE residents counted for purposes of the section 422 cap.
    Comment: One commenter requested that CMS emphasize that the 
redistribution of FTE resident cap slots under section 1886(h)(7)(A) of 
the Act applies only to the Medicare program. The commenter pointed out 
that many children's hospitals qualify for annual grants under the 
federal Children's Hospitals GME (CHGME) Payment Program, which is 
administered by the Health Resources and Services Administration 
(HRSA). The commenter added that, by statute, HRSA determines the FTE 
resident counts for CHGME payment purposes based on Medicare rules 
regarding counting FTE residents (42 U.S.C 256e(c)(1)(B)). The 
commenter believed it would be inappropriate for HRSA to enact any 
provisions of Public Law 108-173 that would result in reductions (or 
increases) to children's hospital's FTE resident cap and requested that 
CMS clearly explain that section 1886(h)(7) of the Act applies only to 
the Medicare program.
    Response: While we appreciate the commenter's concerns regarding 
the effects of section 422 of Public Law 108-173 on the CHGME Payment 
Program, we have no authority to limit HRSA's use of CMS' 
determinations. All comments on CHGME should be directed to HRSA.
BILLING CODE 4120-01-P

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BILLING CODE 4120-01-C
n. Application Process and CMS Central Office and Regional Office 
Mailing Addresses for Receiving Increases in FTE Resident Caps
    In order for hospitals to be considered for increases in their FTE 
resident caps, each qualifying hospital must submit a timely 
application. The following information must be submitted on 
applications to receive an increase in FTE resident caps:
     The name and Medicare provider number of the hospital.
     The total number of requested FTE resident slots for 
direct GME or IME, or both, up to 25 direct GME FTE and 25 IME FTE per 
hospital.
     A completed copy of the CMS Evaluation Form for each 
residency program for which the hospital intends to use the requested 
increase in FTE residents. This form can be found at: http://www.cms.hhs.gov/forms/.
     Source documentation to support the assertions made by the 
hospital on the CMS Evaluation Form. For example: if the hospital 
indicates on the Evaluation Form that it is located in a geographic 
Health Professions Shortage Area (HPSA), the hospital would include 
documentation to support that assertion.
     FTE resident counts for direct GME and IME and FTE 
resident caps for direct GME and IME reported by the hospital in the 
most recent as-filed cost report.
     An attestation, signed and dated by an officer or 
administrator of the hospital who signs the hospital's Medicare cost 
report, of the following information:
    ``I hereby certify that I understand that misrepresentation or 
falsification of any information contained in this application may be 
punishable by criminal, civil, and administrative action, fine and/or 
imprisonment under federal law. Furthermore, I understand that if 
services identified in this application were provided or procured 
through payment directly or indirectly of a kickback or where otherwise 
illegal, criminal, civil, and administrative action, fines and/or 
imprisonment may result. I also certify that, to the best of my 
knowledge and belief, it is a true, correct, and complete application 
prepared from the books and records of the hospital in accordance with 
applicable instructions, except as noted. I further certify that I am 
familiar with the laws and regulations regarding Medicare payment to 
hospitals for the training of interns and residents.''
    The completed application and supporting documentation (as 
described above) must be submitted to the CMS Central Office and the 
CMS Regional Office for the region in which the applicant hospital is 
located. The application must be received on or before December 1, 
2004. The addresses of the CMS central office and regional offices are 
listed below.
    We note that some hospitals' FTE counts will be subject to audit 
for the purposes of section 1886(h)(7)(A) of the Act and those audits 
may not be completed by December 1, 2004. Because the results of such 
an audit may be a factor in a hospital's decision whether to request an 
increase in its FTE resident cap, we will allow a later date for those 
hospitals to apply for increases in their FTE resident caps. Therefore, 
if a hospital's resident level is audited for the purposes of section 
1886(h)(7)(A) of the Act, and that hospital also wishes to apply for an 
increase in its FTE resident cap(s), that hospital must submit a 
completed application to CMS that is received on or before March 1, 
2005.
    CMS Central and CMS Regional Office Mailing Addresses for 
Applications for Increases in FTE Resident Caps:
    Central Office: Centers for Medicare and Medicaid Services (CMS), 
Director, Division of Acute Care, 7500 Security Boulevard, Mail Stop 
C4-08-06, Baltimore, Maryland 21244.
    Region I (Connecticut, Maine, Massachusetts, New Hampshire, Rhode 
Island, and Vermont): Centers for Medicare and Medicaid Services 
(CMS),Associate Regional Administrator, Division of Medicare Financial 
Management,Region I, JFK Federal Building, Room 2325, Boston, MA 02203, 
Phone: (617) 565-1185.
    Region II (New York, New Jersey, U.S. Virgin Islands, and Puerto 
Rico): Centers for Medicare and Medicaid Services (CMS), Associate 
Regional Administrator, Division of Medicare Financial Management, 
Region II, 26 Federal Plaza, 38th Floor, New York, NY 10278, Phone: 
(212) 264-3657.
    Region III (Delaware, Maryland, Pennsylvania, Virginia and West 
Virginia, and the District of Columbia):
    Centers for Medicare and Medicaid Services (CMS), Associate 
Regional Administrator, Division of Medicare Financial Management, 
Region III, Public Ledger Building, Suite 216, 150 South Independence 
Mall West, Philadelphia, PA 19106, Phone: (215) 861-4140.
    Region IV (Alabama, North Carolina, South Carolina, Florida, 
Georgia, Kentucky, Mississippi, and Tennessee): Centers for Medicare 
and Medicaid Services (CMS), Associate Regional Administrator, Division 
of Medicare Financial Management, Region IV, Atlanta Federal Center, 61 
Forsyth Street, SW., Suite 4T20, Atlanta, GA 30303-8909, Phone: (404) 
562-7500.
    Region V (Illinois, Indiana, Michigan, Minnesota, Ohio, and 
Wisconsin): Centers for Medicare and Medicaid Services (CMS), Associate 
Regional Administrator, Division of Medicare Financial Management, 
Region V, 233 North Michigan Avenue, Suite 600, Chicago, IL 60601, 
Phone: (312) 886-6432.
    Region VI (Arkansas, Louisiana, New Mexico, Oklahoma, and Texas): 
Centers for Medicare and Medicaid Services (CMS), Associate Regional 
Administrator, Division of Medicare Financial Management, Region VI, 
1301 Young Street, Suite 714, Dallas, TX 75202, Phone: (214) 767-6423.
    Region VII (Iowa, Kansas, Missouri, and Nebraska): Centers for 
Medicare and Medicaid Services (CMS), Associate Regional Administrator, 
Division of Medicare Financial Management, Region VII, Richard Bolling 
Federal Building, Room 235, 601 East 12th Street, Kansas City, MO 
64106.
    Region VIII (Colorado, Montana, North Dakota, South Dakota, Utah 
and Wyoming): Centers for Medicare and Medicaid Services (CMS), 
Associate Regional Administrator, Division of Medicare Financial 
Management, Region VIII, Colorado State Bank Building, 1600 Broadway, 
Suite 700, Denver, CO 80202, Phone: (303) 844-2111.
    Region IX (Arizona, California, Hawaii, and Nevada and Territories 
of American Samoa, Guam and the Commonwealth of the Northern Mariana 
Islands): Centers for Medicare and Medicaid Services (CMS), Associate 
Regional Administrator, Division of Medicare Financial Management, 
Region IX, 75 Hawthorne St., Suite 408, San Francisco, CA 94105, Phone: 
(415) 744-3501.
    Region X (Alaska, Idaho, Oregon, and Washington): Centers for 
Medicare and Medicaid Services (CMS), Associate Regional Administrator, 
Division of Medicare Financial Management, Region X, 2201 Sixth Avenue, 
MS-40, Seattle, WA 98121, Phone: (206) 615-2306.
3. Direct GME Initial Residency Period (New Sec.  413.79, a 
Redesignation of Existing Sec.  413.86(g))
a. Background
    As we have generally described above, the amount of direct GME 
payment to a hospital is based in part on the number of FTE residents 
who are training at the hospital during a year.

[[Page 49170]]

The number of FTE residents training at a hospital, and thus the amount 
of direct GME payment to a hospital, is directly affected by CMS policy 
on how ``initial residency periods'' are determined for residents.
    Section 1886(h)(5)(A) of the Act defines ``approved medical 
residency training program'' as ``a residency or other postgraduate 
medical training program, participation in which may be counted toward 
certification in a specialty or subspecialty.'' This provision is 
implemented in regulations at existing Sec.  413.86(b). In accordance 
with section 1886(h)(5)(I) of the Act, the term ``resident'' is defined 
to include ``an intern or other participant in an approved medical 
residency training program.'' Existing Sec.  413.86(b) defines 
``resident'' as an ``intern, resident, or fellow who participates in an 
approved medical residency training program * * * as required in order 
to become certified by the appropriate specialty board.''
    Section 1886(h)(4)(C)(ii) of the Act provides that while a resident 
is in the ``initial residency period,'' the resident is weighted at 
1.00 (existing Sec.  413.86(g)(2) of the regulations). Section 
1886(h)(4)(C)(iii) of the Act requires that if a resident is ``not in 
the resident's initial residency period,'' the resident is weighted as 
.50 FTE resident (existing Sec.  413.86(g)(3) of the regulations).
    Section 1886(h)(5)(F) of the Act defines ``initial residency 
period'' as the ``period of board eligibility,'' and, subject to 
specific exceptions, limits the initial residency period to an 
``aggregate period of formal training'' of no more than 5 years for any 
individual. Section 1886(h)(5)(G) of the Act generally defines ``period 
of board eligibility'' for a resident as ``the minimum number of years 
of formal training necessary to satisfy the requirements for initial 
board eligibility in the particular specialty for which the resident is 
training.'' Existing Sec.  413.86(g)(1) of the regulations generally 
defines ``initial residency period'' as the ``minimum number of years 
required for board eligibility.'' Existing Sec.  413.86(g)(1)(iv) 
provides that ``time spent in residency programs that do not lead to 
certification in a specialty or subspecialty, but that otherwise meet 
the definition of approved programs * * * is counted toward the initial 
residency period limitation.'' Section 1886(h)(5)(F) of the Act further 
provides that ``the initial residency period shall be determined, with 
respect to a resident, as of the time the resident enters the residency 
training program.''
    The initial residency period is determined as of the time the 
resident enters the ``initial'' or first residency training program and 
is based on the period of board eligibility associated with that 
medical specialty. Thus, this provision limits the amount of direct GME 
that Medicare pays a hospital for a resident who switches specialties 
to a program with a longer period of board eligibility or completes 
training in a specialty and then continues training in a subspecialty 
(for example, cardiology and gastroenterology are subspecialties of 
internal medicine).
b. Direct GME Initial Residency Period Limitation: Simultaneous Match 
Issue
    We understand there are numerous programs, including 
anesthesiology, dermatology, psychiatry, and radiology, that require a 
year of generalized clinical training to be used as a prerequisite for 
the subsequent training in the particular specialty. For example, in 
order to become board eligible in anesthesiology, a resident must first 
complete a generalized training year and then complete 3 years of 
training in anesthesiology. This first year of generalized residency 
training is commonly known as the ``clinical base year.'' Commonly, the 
clinical base year requirement is fulfilled by completing either a 
preliminary year in internal medicine (although the preliminary year 
can also be in other specialties such as general surgery or family 
practice), or a transitional year program (which is not associated with 
any particular medical specialty).
    In many cases, during the final year of medical school, medical 
students apply for training in specialty programs. Typically, a medical 
student who wants to train to become a specialist is ``matched'' to 
both the clinical base year program and the residency training 
specialty program at the same time. For example, the medical student 
who wants to become an anesthesiologist will apply and ``match'' 
simultaneously for a clinical base year in an internal medicine program 
for year 1 and for an anesthesiology training program in years 2, 3, 
and 4.
    Based on our interpretation of the statute, our policy is that the 
initial residency period is determined for a resident based on the 
program in which he or she participates in the resident's first year of 
training, without regard to the specialty in which the resident 
ultimately seeks board certification. Therefore, for example, a 
resident that chooses to fulfill the clinical base year requirement for 
an anesthesiology program with a preliminary year in an internal 
medicine program will be ``labeled'' with the initial residency period 
associated with internal medicine, or 3 years (3 years of training are 
required to become board eligible in internal medicine), even though 
the resident may seek board certification in anesthesiology, which 
requires a minimum of 4 years of training to become board eligible. As 
a result, this resident would be weighted at 0.5 FTE in his or her 
fourth year of training for purposes of direct GME payment.
    We understand that some hospitals have been assigning residents 
that complete a clinical base year in a different specialty from the 
one in which they ultimately train an initial residency period and a 
weighting factor based on the specialty associated with second program 
year in which the residents train. As a result, some residents have 
been assigned a weighting factor of 1.0 FTE for years beyond their 
initial residency periods, rather than the applicable 0.5 FTE weighting 
factor. This error results in Medicare overpayments, the size of which 
is dependent upon the hospital's direct GME PRA and its Medicare 
utilization. In addition, we have received numerous requests from the 
health care industry to revise our policy concerning the initial 
residency period for residency programs that require a clinical base 
year because some entities in the industry believe that our current 
policy is unfair to those individuals who ``match'' simultaneously for 
both a preliminary year (for example, the clinical base year in 
internal medicine) and the longer specialty residency program (for 
example, anesthesiology, dermatology, or radiology).
    To address these concerns, in the May 18, 2004 proposed rule (69 FR 
28311), we indicated that we were considering making a change in policy 
that addresses these ``simultaneous match'' residents. Specifically, we 
were considering a policy that, if a hospital can document that a 
particular resident matches simultaneously for a first year of training 
in a clinical base year in one medical specialty, and for additional 
year(s) of training in a different specialty program, the resident's 
initial residency period would be based on the period of board 
eligibility associated with the specialty program in which the resident 
matches for the subsequent year(s) of training and not on the period of 
board eligibility associated with the clinical base year program, for 
purposes of direct GME payment. In addition, we considered a new 
definition of ``residency match'' to mean, for purposes of direct GME, 
a national process by which applicants to approved medical residency 
programs are paired with programs on the basis of

[[Page 49171]]

preferences expressed by both the applicants and the program directors.
    This policy could apply regardless of whether the resident 
completes the first year of training in a separately accredited 
transitional year program or in a preliminary (or first) year in 
another residency training program such as internal medicine.
    Under this policy, hospitals would apply a weight of 1.0 FTE 
(instead of 0.5) for an additional year or two to some residents who, 
as a prerequisite for training in a specialty program, complete a first 
year of training in a different specialty program. This would probably 
cause an increase in direct GME payments. This provision would apply to 
such programs as anesthesiology, dermatology, radiology, and physical 
medicine and rehabilitation. In 2004, there were approximately 1,840 
residents in these specialties that would be affected by this proposal, 
as compared to the approximately 83,000 residents in total for whom 
Medicare makes direct GME payments. Under current policy, these 1,840 
residents would be weighted at 0.5 FTE in their 4th year (and 5th year, 
if applicable) of training. Therefore, direct GME spending for these 
1,840 residents should currently be $26.5 million (1,840 x 0.5 x 
82,249\9\ x .35\10\). We indicated in the proposed rule that, under the 
policy we are considering, direct GME spending would be twice that 
amount at $53 million (1,840 x $82,249 x .35). However, because we 
believe a number of fiscal intermediaries may have been applying 
current policy incorrectly and instead have been weighting 
approximately 920 residents at 1.0 in their 4th year (and 5th year, if 
applicable) of training, the cost of this change would be expected to 
be closer to $13.25 million (920 x 0.5 x $82,249 x .35). We provided 
this cost impact analysis to the public for its information in 
consideration of any such proposed change.
---------------------------------------------------------------------------

    \9\ $82,249 is the estimated national average per resident 
amount for FY 2005.
    \10\ .35 is the estimated average Medicare utilization.
---------------------------------------------------------------------------

    We note that in the Conference Committee report that accompanied 
Public Law 108-173, the Committee stated that ``The conferees also 
clarify that under section 1886(h)(5)(F) of the Act, the initial 
residency period for any residency for which the ACGME requires a 
preliminary or general clinical year of training is to be determined in 
the resident's second year of training.'' (Conference Committee 
Agreement Accompanying Public Law 108-173, 108 Cong., 2d Sess., 276 
(2003)) The Conference Committee included this language as part of its 
explanation of section 712 of Public Law 108-173, which clarifies an 
exception to the initial residency period for geriatric fellowship 
programs (see section IV.O.3.c. of this preamble). We indicated in the 
proposed rule that we were considering making a policy change for 
determining the initial residency period for a resident who 
participates in a clinical base year program based on the resident's 
second year of training, as the Conference Committee suggests. However, 
we understand that not all residents who participate in the clinical 
base year programs simultaneously match in specialty training programs 
before the residents' first year of training. Thus, if we were to 
propose a ``second year'' policy, there would be no way to distinguish 
in the second year of training among those residents who simultaneously 
matched in a specialty program prior to their first year of training; 
those residents who did not match simultaneously, but participated in a 
clinical base year and then continued on to train in a different 
specialty; and those residents who simply switched specialties in their 
second year. As we have stated earlier, the initial residency period is 
to be determined based on the ``initial'' or first program in which a 
resident trains. Section 1886(h)(5)(F) of the Act provides that ``the 
initial residency period shall be determined, with respect to a 
resident, as of the time the resident enters the residency training 
program.'' (Emphasis added.)
    Therefore, we indicated in the proposed rule that we believe it is 
appropriate for us to consider changes to the ``simultaneous match'' 
policy that would allow for documentation that the residents' training 
program is arranged to continue in another medical specialty after the 
resident completes the clinical base year. However, we also 
specifically solicited comments concerning the issue of how to 
establish the initial residency period for a resident who does not 
match simultaneously for the first and second year, completes the first 
year in a preliminary program in one specialty, and then continues his 
or her training in a different specialty program that requires 
completion of a clinical base year.
    In the proposed rule, we note that if we were to propose this 
change in the initial residency period policy, the change, if 
finalized, could result in an adjustment to the PRA applicable for the 
direct GME payments made to the hospital for a resident in a clinical 
base year. By treating the first year as part of a nonprimary care 
specialty program (for example, anesthesiology), the hospital would be 
paid at the lower nonprimary care PRA rather than the higher primary 
care PRA, which would be used for residents training in a clinical base 
year in a primary care program (for example, internal medicine). We 
noted in conjunction with our proposal that the initial residency 
period would be established based upon the period of board eligibility 
for the specialty program for residents who simultaneously match with a 
clinical base year and a specialty program that we believe all of the 
programs that require a clinical base year are nonprimary care 
specialties. Because we were considering a policy change that the 
initial residency period would be based upon the period of board 
eligibility for the specialty program rather than the clinical base 
year, we indicated that we would also consider a policy change that the 
nonprimary care PRA would apply for the duration of their initial 
residency period.
    Thus, as we indicated in the proposed rule, we are considering 
making theabove policy changes to address the clinical base year 
initial residency period issue. We specifically solicited comments on 
the changes we were considering to the existing initial residency 
period policy and other approaches to address this issue, particularly 
those that do not increase Medicare expenditures.
    Comment: We received many comments commending CMS for the proposed 
policy discussion concerning residency training in specialties that 
require a clinical base year. One commenter stated that ``we agree 
that, for purposes of direct GME payment, a resident's initial 
residency period should be based on the period of board eligibility 
associated with the specialty program in which the resident matches for 
the subsequent year(s) of training and not on the period of board 
eligibility associated with the clinical base year program.''
    However, many commenters believed that instead of a ``simultaneous 
match'' policy, CMS should adopt as final the policy stated in the 
Conference Committee report that accompanied Public Law 108-173, in 
which the conferees clarified that the initial residency period for any 
residency ``for which ACGME requires a preliminary or general clinical 
year of training is to be determined in the resident's second year of 
training.'' (Conference Committee Agreement Accompanying Public Law 
108-173, 108 Cong., 2d Sess., 276 (2003)). Many commenters further

[[Page 49172]]

stated that ``CMS should make a clear statement that for a resident 
whose first year of training is completed in a program that provides a 
general clinical base year as required by the ACGME for certain 
specialties, an IRP should be assigned in the second year based on the 
specialty the resident enters in the second year of training.'' The 
commenters believed that not having a ``second year'' policy for 
determining the IRP for those residents that must complete a clinical 
base year ``violates the statute, does not reflect congressional 
intent, and results in inequitable payments to teaching hospitals for 
residents training in certain specialties.''
    Response: We appreciate the comments that compliment our proposal 
to clarify the direct GME policy on determining the IRP for residents 
that complete a clinical base year of training and simultaneous match 
in the clinical base year program and the specialty training program. 
We understand the provider community's enthusiasm for a ``second year'' 
policy for determining the IRP for residents who must complete a 
clinical base year. However, as we have stated above and also in the 
proposed rule, we believe that if we were to propose a ``second year'' 
policy, there would be no way to distinguish among those residents in 
their second year of training who simultaneously match in a specialty 
program prior to their first year of training; those residents who 
participated in a clinical base year and then continued on in a 
specialty; and those residents who simply switched specialties in their 
second year. We believe that the proposed simultaneous match policy is 
more consistent with congressional intent, as stated in the statute. As 
we discussed above, and also in the proposed rule, we believe the 
statute requires that the initial residency period be determined based 
on the ``initial'' or first program in which a resident trains. Section 
1886 (h)(5)(F) of the Act provides that ``the initial residency period 
shall be determined, with respect to a resident, as of the time the 
resident enters the residency training program.'' (Emphasis added.) 
Thus, we believe that our proposed ``simultaneous match'' policy will 
allow for auditable documentation of the residents' intent upon 
entering the clinical base year and is therefore appropriate.
    We stated in the proposed rule that we believe ``it is appropriate 
for us to consider changes to the `simultaneous match' policy that 
would allow for documentation that the residents' training program is 
arranged to continue in another medical specialty after the resident 
completes the clinical base year'' (69 FR 28312). We have not heard 
from the public on how a ``second year'' policy could be documented at 
the time the resident enters the residency program (that is, the 
clinical base year), so that we may distinguish between residents who 
fully intend to complete a different medical specialty at the start of 
the clinical base year and other residents who complete a clinical base 
year. We recognize that there may be some disparity in counting 
residents for direct GME who simultaneously match in a clinical base 
year and a different specialty, and those residents who complete a 
clinical base year and then go on to a different specialty program. 
However, we believe the policy we proposed will be effective in 
correcting the problem of many of the residents who are ``caught'' by 
our IRP policies. Therefore, we believe it is appropriate to finalize 
the simultaneous match policy to state at Sec.  413.79(a): ``effective 
October 1, 2004, if a hospital can document that a particular resident 
matches simultaneously for a first year of training in a clinical base 
year, and for a second year of training in the specialty program in 
which the resident intends to seek board certification, the resident's 
initial residency period would be based on the specific specialty 
program for the subsequent year(s) of training in which the resident 
matches and not on the clinical base year program.''
    Comment: Similar to the comments above, one commenter stated that 
it did not believe the statute requires CMS to determine the IRP for 
residents who must complete a clinical base year of training in the 
first year of the resident's first year of training, and advocated a 
second year IRP policy for such residents. The commenter noted that 
CMS's policy allowing the initial residency period to be determined in 
the second year for residents training in transitional year programs 
``is clear evidence that such a timeframe is permissible under the 
statute.''
    Response: As stated above, we believe that our proposed 
simultaneous match policy is the more appropriate policy to finalize 
than a second year policy for residents training in a clinical base 
year. The statute requires that the initial residency period be 
determined based on the ``initial'' or first program in which a 
resident trains. Section 1886 (h)(5)(F) of the Act provides that ``the 
initial residency period shall be determined, with respect to a 
resident, as of the time the resident enters the residency training 
program.'' (Emphasis added.) The simultaneous match policy will allow 
for hospitals to document the residents' intent upon entering the 
clinical base year, as the statute requires.
    As we mentioned above and also in the proposed rule, the clinical 
base year requirement can be fulfilled by residents that train in 
preliminary medicine, which is the first year of an internal medicine 
residency, or transitional years programs, which are unaffiliated with 
a particular specialty. For a resident that matches in a transitional 
year program and simultaneously matches in a specialty training 
program, Medicare will use the specialty training program to determines 
that resident's IRP. In the limited circumstance where a resident 
trains in the transitional year program, without simultaneously 
matching in a specialty program, Medicare is simply unable to determine 
what specialty the resident has ``entered'' for purposes of determining 
that resident's IRP. The earliest moment that Medicare is able to 
determine such a resident's IRP is when the resident ``enters'' the 
specialty program--the resident's second year of training. Thus, in the 
limited circumstance of a resident that trains in a transitional year 
program that is unaffiliated with a particular specialty and does not 
simultaneously match in a specialty program, Medicare will look to the 
resident's second year of training as when the resident has ``entered'' 
the residency program for purposes of determining the IRP. We note that 
this situation of the transitional year program is substantially 
different from the situation where the resident begins training in a 
specialty, for example, internal medicine, as the resident's clinical 
base year. In the latter case, we are able to establish an initial 
residency period based on the number of years required for 
certification in that specialty and have no need to wait until the 
second year.
    Comment: One commenter believed that our proposed definition of 
``residency match,'' a national process by which applicants to approved 
medical residency programs are paired with programs on the basis of 
preferences expressed by both the applicants and the program directors, 
is unclear and ambiguous in regard to residents who are in a required 
clinical base year training program. The commenter requested 
clarification from CMS.
    Response: We are finalizing a policy with this final rule that 
states that, effective October 1, 2004, if a hospital can document that 
a particular resident has matched simultaneously for a first year of 
training in a clinical base year, and for a second year of training in 
the

[[Page 49173]]

specialty program in which the resident intends to seek board 
certification, the resident's initial residency period (IRP) will be 
based on the specific specialty program in which the resident matched 
for the subsequent year(s) of training, and not based on the clinical 
base year program, for purposes of direct GME payment. We understand 
that the term, ``residency match'' is commonly used by both providers 
and residents. We are defining ``residency match'' to mean, for 
purposes of Medicare direct GME, a national process carried out by the 
National Residency Matching Program (NRMP), the San Francisco Matching 
Program, the Urology Matching Program, or the American Osteopathic 
Association Residency Match Program by which applicants to approved 
medical residency programs are formally paired with programs on the 
basis of preferences expressed by both the applicants and the program 
directors.
    Comment: Several commenters noted that they ``had no knowledge of 
any prior CMS policy that is in any way conflicted with the provisions 
of the legislative history.'' These commenters state it was ``always'' 
their understanding that the IRP was set in the second year for 
residents that have undertaken a clinical base year during their first 
year of residency. The commenters also state that the fiscal 
intermediaries servicing the hospitals have ``never expressed 
disagreement with this policy.''
    Similarly, another commenter specifically requested that CMS not 
implement the proposed clarification to apply the possibly shorter 
initial residency period for the specialty associated with the clinical 
base year prior to portions of cost reporting periods on or before 
October 1, 2004.
    Finally, another commenter stated that CMS ``has never previously 
issued any formal rule regarding how clinical base year training 
affects the determination of the initial residency period.''
    Response: We believe that we have consistently held to our policy 
concerning the determination of the IRP for residents that complete a 
clinical base year. We have stated that section 1886(h)(5)(F) of the 
Act provides that ``the initial residency period shall be determined, 
with respect to a resident, as of the time the resident enters the 
residency training program.'' (Emphasis added.) Thus, until the 
effective date of this final rule, our policy has been that, for a 
resident that completes a clinical base year, the initial residency 
period for this resident is determined based on the period of board 
eligibility for the specialty associated with the first (that is, 
clinical base year) program. We are prospectively changing this policy 
in this final rule for those residents that simultaneously match, as 
explained further in this preamble, effective October 1, 2004.
    To address the commenter's point concerning the actions of the 
fiscal intermediaries on this policy, we are not in a position to 
specifically respond at this time regarding how some intermediaries may 
have determined initial residency periods for particular residents. 
However, we understand that there are many teaching hospitals around 
the country that have been determining IRPs for residents that complete 
clinical base years correctly (that is, based on our longstanding 
policy that has been in effect until this final notice). In this rule, 
we are responding to comments regarding our proposed policy and 
prospectively revising our current policy. There are other avenues, 
outside of this final rule, through which the commenter's concerns 
regarding our current policy could be appropriately addressed.
    Comment: We received several comments on our proposal to apply the 
non-primary care PRA for the duration of the initial residency period 
for residents that simultaneously matched in a clinical base year 
program and a longer specialty program. The commenters believed that 
there is ``nothing in the MMA's legislative history that would indicate 
that such an adjustment is necessary. Accordingly, it is unclear why 
any change to this policy would now be required.''
    Response: We proposed a policy change to determine the initial 
residency period for residents that simultaneously match for both a 
clinical base year and a subsequent specialty program based upon the 
period of board eligibility for the subsequent specialty program, that 
is, the program in which the resident will seek certification. We 
believed, and continue to believe, it is appropriate to propose a 
policy that treats residents consistently in terms of the specialty 
program in which they are considered to be training. When the specialty 
program for which the resident simultaneously matches for the second 
year is a non-primary care specialty, under our policy as revised under 
this final rule, we would assign the IRP in the resident's first year 
of training based on the period of board eligibility associated with 
the non-primary care specialty. Thus, we believe it is consistent to 
apply the non-primary care PRA for that resident's FTE time, even 
during the first, clinical base year of training and we are finalizing 
this policy at Sec.  413.77(f) of the regulations.
    Comment: We received one comment which stated that there are 
teaching hospitals that have ``historically called the first year of 
training for these complex specialties a ``general clinical year,'' 
instead of a ``transitional year * * *.'' For this reason, the 
commenter states the hospitals are ``significantly, adversely affected 
by not being allowed to count the full value of FTEs training in these 
specialties, when, in fact, there is no difference between a ``general 
clinical year'' and a ``transitional year.'' This ``penalty for 
semantics'' is illogical, and obviously, unfair.''
    Another commenter described the general practice residency (GPR) 
for dentistry. The commenter states that the GPR program should be 
treated as a transitional year program (like an allopathic program), 
with the initial residency period for a resident who completes a GPR 
program determined by the IRP for the program the resident enters next, 
that is, the specialty program.
    Response: In contrast to other comments received, we believe the 
above commenters are describing a situation where hospitals were aware 
of our current policy on determining the initial residency period for 
residents that complete a clinical base year. As we stated above, and 
also in the proposed rule, we believe there are stand-alone 
transitional year programs that are separately accredited one-year 
programs unaffiliated with a particular specialty. There are also other 
clinical base year programs, which are affiliated with a particular 
medical specialty and when a resident completes a year of training in 
that program, that year could be counted toward board certification in 
that specialty. We do not know the nature of the programs the 
commenters have labeled as a ``general clinical year,'' and, ``general 
practice residency,'' therefore, cannot respond to the commenters' 
specific circumstances. We note that the distinction between a 
transitional year program, which is not associated with any particular 
medical specialty, and other clinical base year programs that are 
associated with a particular specialty and participation in which can 
be counted toward board certification in that specialty, remains 
applicable regardless of ``semantics'' or the ``terminology'' a 
hospital uses for its clinical base year programs. Thus, ``semantics'' 
or terminology is not the basis on which a fiscal intermediary should 
determine the initial residency period of a particular resident.
    Comment: One commenter argued strongly for the adoption of a 
``second

[[Page 49174]]

year policy'' (that is, a policy under which the IRP for all residents 
would be established based upon the period of board eligibility for the 
specialty in which the resident trains in the second residency year). 
The commenter stated that, ``CMS proposal suffers from the practical 
difficulty that determining intent [of the resident] can be difficult. 
Many times, intent is not communicated in writing, or even orally, and 
can only be inferred by facts and circumstances * * * [t]he best 
evidence of a resident's `intent' is where the resident goes after a 
clinical base year.''
    Response: We agree with the commenter that ``intent'' of the 
resident can indeed be difficult for us to determine, which is, in 
part, why our policy has been based upon the first, or initial, program 
in which the resident trains, (which can be determined and documented). 
We disagree with the commenter that ``[t]he best evidence of a 
resident's intent is where the resident goes after a clinical base 
year,'' because we believe the best evidence of a resident's intent is 
the program in which the resident actually trains in the first year of 
residency. After significant deliberation and reflection on the 
comments, we also believe documentation that a resident has matched 
simultaneously for a first year of generalized training and a specialty 
program that begins thereafter is also sufficient evidence of a 
resident's intent to continue training in the specialty program, and 
not in the specialty associated with the generalized clinical base 
year. Therefore, we are adopting as our final policy the policy that we 
solicited for comments in the proposed rule. Specifically, if a 
hospital can document that a resident matched simultaneously, we will 
determine the resident's IRP in the first year based upon the period of 
board eligibility for the specialty program the resident had 
``matched'' to enter in the second year.
    Comment: We received one comment that cited the language in section 
1886(h)(5)(F) of the Act: ``enters the residency program'' (emphasis 
added by the commenter) as evidence that the statute allows CMS to 
establish the IRP in the second training year in all cases. The 
commenter stated that the statutory language ``can just as easily be 
interpreted as referring to entering [the longer, specialty program] as 
to entering the clinical base year or transitional year.''
    Response: With this final rule, we are changing our policy 
regarding the determination of the IRP for residents that match 
simultaneously for a clinical base year and subsequent specialty 
program. Specifically, if hospitals can document that a resident 
matched simultaneously, we will determine the resident's IRP in the 
first year based upon the period of board eligibility for the specialty 
program the resident is ``matched'' to enter in the second year. We do 
not believe we always wait to establish a resident's IRP in the second 
year of training when a resident will have ``entered'' a residency 
training program in the first year. Where there is no documentation 
available in the first year of training to demonstrate that a resident 
intends to continue training, after completing the first year, in a 
different medical specialty and, ultimately, to obtain board 
certification in that specialty, we continue to believe it is 
appropriate to assign the IRP based on the specialty associated with 
the first year of residency training.
    Comment: We received one comment that noted that the proposed rule 
did not include an implementation date.
    Response: We are stating in this final rule that the implementation 
date for the policy change regarding the initial residency period for 
``simultaneous match'' residents is for portions of cost reporting 
periods occurring on or after October 1, 2004.
    Comment: One commenter implied that CMS should not consider the 
costs of the proposed IRP policy as estimated by CMS in the proposed 
rule in determining whether the proposal should be finalized, since CMS 
did not account for all of the factors that may serve to offset some of 
the costs of the proposed IRP policy. For instance, the commenter said 
that CMS did not take into account the savings resulting from the 
proposal to require that the non-primary care PRA be applied by 
hospitals to residents training in their clinical base year and for the 
duration of their training in that specialty. The commenter added that 
savings could result from the application of the possible 
``simultaneous match'' policy to residents who begin their training in 
a specialty such as surgery, which requires a minimum of five years for 
board eligibility, and subsequently pursue training in a specialty that 
requires four years of training for board eligibility, since these 
residents would actually see a decrease in the number of years in which 
they would be weighted at 1.0 FTE under the proposed policy. The 
commenter also recommended that, rather than comparing the present 
costs of direct GME payments to the projected costs subsequent to 
implementation of the policy, CMS should compare the projected costs of 
not implementing the policy against the projected costs resulting from 
implementation. The commenter believed that the incremental difference 
between implementation and non-implementation of the proposed policy is 
likely far smaller than estimated in the proposed rule since, even if 
CMS were not to implement the policy under consideration, hospitals 
would now be aware of the current policy, which would lead to an 
increase in positions in transitional year programs.
    Response: We acknowledge the points raised by the commenter, but 
note that the commenter's concerns are moot since, as explained in 
response to previous comments, we have decided to adopt the 
``simultaneous match'' policy as final in this final rule.
c. Exception to Initial Residency Period for Geriatric Residency or 
Fellowship Programs (Section 712 of Pub. L. 108-173 and Redesignated 
Sec.  413.79(a) (a Redesignation of Existing Sec.  413.86(g)(1))
    As explained further below, under Medicare direct GME payment 
rules, the initial residency period is generally defined as the minimum 
number of years of training required for a resident to become board 
eligible in a specialty (not to exceed 5 years) and is established at 
the time the resident enters his or her first training program. For 
purposes of direct GME payments, a resident's full-time equivalent 
(FTE) training time is weighted at 1.0 during the initial residency 
period and 0.5 for training that continues beyond the initial residency 
period. Section 1886(h)(5)(F) of the Act generally limits a resident's 
initial residency period to no longer than 5 years. That section also 
provides an exception that allows FTE training time spent by residents 
in an approved geriatric residency program to be treated as part of the 
resident's initial residency period, that is, weighted at 1.0 FTE for 
up to an additional 2 years after conclusion of the otherwise 
applicable initial residency period.
    We understand, based on information provided by the American 
Geriatric Society (AGS), that in 1998, the American Board of Internal 
Medicine and the American Board of Family Physicians (hereinafter ``the 
Boards'') reduced the minimum number of years of formal training 
required for residents to become board eligible in geriatrics from 2 
years to 1 year. As a result, the initial residency period, and full 
direct GME funding for residents in geriatric training programs, would 
be limited to 1 year.
    However, we understand that many teaching hospitals continue to run 
geriatric residency or fellowship programs of at least 2 years in 
length (some are even 3 years). We also understand that, despite the 
decrease in

[[Page 49175]]

the minimum requirements for board eligibility, the Accreditation 
Council for Graduate Medicare Education (ACGME) continues to accredit 
some geriatric training programs for the full duration of the 
fellowships. For example, if a hospital's geriatric fellowship is 3 
years in length, the program may continue to be accredited by the ACGME 
for the full 3 years, but the FTE time spent by a resident training in 
the geriatric program would be weighted at 1.0 for the first year of 
the resident's training and at 0.50 for the second and third year of 
the fellowship. (However, we note that FTE residents' time is not 
weighted for purposes of IME payments.)
    Effective October 1, 2003, section 712 (a) of Public Law 108-173 
clarified that Congress intended to provide an exception to the initial 
residency period for purposes of direct GME payments for geriatric 
residency or fellowship programs such that ``where a particular 
approved geriatric training program requires a resident to complete 2 
years of training to initially become board eligible in the geriatric 
specialty, the 2 years spent in the geriatric training program are 
treated as part of the resident's initial residency period, but are not 
counted against any limitation on the initial residency period.'' 
Therefore, in the May 18, 2004 proposed rule (69 FR 28312), we proposed 
that, effective for cost reporting periods beginning on or after 
October 1, 2003, if a resident is training in an accredited geriatric 
residency or fellowship program of 2 (or more) years in duration, 
hospitals may treat training time spent during the first 2 years of the 
program as part of the resident's initial residency period and weight 
the resident's FTE time at 1.0 during that period, regardless of the 
fact that the minimum number of years of training required for board 
eligibility in geriatrics is only 1 year. We noted that the statutory 
language quoted above does not allow a hospital to treat time spent by 
a resident in the second year of geriatric training as part of the 
resident's initial residency period in the case where the resident 
trained in a geriatric residency or fellowship program that is 
accredited as a 1-year program because, in that case, the resident 
could be board eligible after only 1 year of training.
    Even though the Congress gave the Secretary authority to implement 
section 712 of Public Law 108-173 through an interim final rule with 
comment period, we chose to provide instructions in a One-Time 
Notification (OTN) to fiscal intermediaries and providers (Transmittal 
61, CR 3071), ``Changes to the FY 2004 Graduate Medical Education (GME) 
Payments as Required by the Medicare Modernization Act of 2003 (MMA), 
Pub .L. 108-173,'' issued on March 12, 2004, and indicated in the 
proposed rule that we are implementing the statutory provision in our 
regulations through the notice and comment rulemaking process. We 
proposed to revise proposed redesignated Sec.  413.79(a) (a 
redesignation of Sec.  413.86(g)(1)) to incorporate the provision of 
section 712(a) of Pub. L. 108-173. We received no comments on this 
proposed change in regulation. Therefore, we are adopting the proposed 
regulation without modification.
4. Per Resident Amount: Extension of Update Limitation on High-Cost 
Programs (Section 711 of Pub. L. 108-173 and Sec.  
413.77(d)(2)(iii)(B)(3) (a Redesignation of Existing Sec.  
413.86(e)(4)(ii)(C)(2)(iii)))
    Section 1886(h)(2) of the Act, as amended by section 311 of the 
Balanced Budged Refinement Act (BBRA) of 1999 (Pub. L. 106-113), 
establishes a methodology for the use of a national average per 
resident amount (PRA) in computing direct GME payments for cost 
reporting periods beginning on or after October 1, 2000, and on or 
before September 30, 2005. Generally, section 1886(h)(2)(D)(ii) of the 
Act establishes a ``floor'' for hospital-specific PRAs at 70 percent of 
the locality-adjusted national average PRA. In addition, section 
1886(h)(2)(D)(iv) of the Act establishes a ``ceiling'' that limits the 
annual adjustment of a hospital-specific PRA if the PRA exceeded 140 
percent of the locality-adjusted national average PRA. Section 511 of 
the Benefits Improvement and Protection Act (BIPA) of 2000 (Pub. L. 
106-554) further amended section 1886 (h)(2) of the Act to increase the 
floor that was established by the BBRA to 85 percent of the locality-
adjusted national average PRA. For purposes of calculating direct GME 
payments, each hospital-specific PRA is compared to the floor and 
ceiling to determine whether the hospital-specific PRA should be 
revised. (We direct readers to Program Memorandum A-01-38, March 21, 
2001 for historical reference on calculating the floor and ceiling.)
    Section 711 of Public Law 108-173 amended section 1886 
(h)(2)(D)(iv) of the Act to freeze the annual CPI-U updates to 
hospital-specific PRAs for those PRAs that exceed the ceiling for FYs 
2004 through 2013. Therefore, in the May 18, 2004 proposed rule (69 FR 
28313), we proposed that, for cost reporting periods beginning during 
FY 2004 through FY 2013, we would calculate a ceiling that is equal to 
140 percent of the locality-adjusted national average PRA for each 
hospital and compare it to each hospital-specific PRA. If the hospital-
specific PRA for the preceding year is greater than 140 percent of the 
locality-adjusted national average PRA ``ceiling'' in the current 
fiscal year, the hospital-specific PRA for the current year is frozen 
at the preceding fiscal year's hospital-specific PRA and is not updated 
by the CPI-U factor. We note that a hospital may have more than one 
PRA. Each of a hospital's PRAs must be separately compared to the 
``ceiling'' PRA to determine whether that PRA should be frozen at the 
level for the previous year or updated by the CPI-U factor.
    For example, to determine the applicable PRA for a cost reporting 
period beginning during FY 2004, we proposed to compare the hospital-
specific PRA from the cost reporting period that began during FY 2003 
to the FY 2004 locality-adjusted national average PRA for that 
hospital. If the FY 2003 hospital-specific PRA exceeds 140 percent of 
the FY 2004 locality-adjusted national average PRA, the FY 2004 
hospital-specific PRA is frozen at the level of the FY 2003 hospital-
specific PRA and is not updated by the CPI-U factor for FY 2004.
    Due to the effective date of the statutory provision of section 711 
of Public Law 108-173, we issued a notification to fiscal 
intermediaries and providers regarding the provision in the OTN issued 
on March 12, 2004 (Transmittal 61, CR 3071). In the May 18, 2004 
proposed rule, to incorporate the changes made by section 711 of Public 
Law 108-173 in our regulations regarding the determination of PRAs, we 
proposed to: (1) Revise proposed redesignated Sec.  
413.77(d)(2)(iii)(B)(3) (a proposed redesignation of existing Sec.  
413.86(e)(4)(ii)(C)(2)(iii)) to make it applicable only to FY 2003; (2) 
further redesignate proposed newly redesignated Sec.  
413.77(d)(2)(iii)(B)(4) (the proposed redesignation of existing Sec.  
413.86(e)(4)(ii)(C)(2)(iv)) as Sec.  413.77(d)(2)(iii)(B)(4); and (3) 
add a proposed new Sec.  413.77(d)(2)(iii)(B)(4).
    Comment: One commenter stated that many hospitals incur direct GME 
costs beyond those reimbursed by Medicare through the PRA due to the 
difficulties in recruiting physicians to certain areas and the 
shortages of physicians in certain specialty programs. The commenter 
stated that the freeze in the inflation updates to the per resident 
amounts will inhibit a hospital from providing high quality education, 
and will result in additional physician shortages.

[[Page 49176]]

    Response: The commenter is referring to section 711 of Public Law 
108-173 that freezes the annual CPI-U updates to hospital-specific PRAs 
for those PRAs that exceed the ceiling for FYs 2004 through 2013. While 
we are sympathetic to the commenter's concerns, this provision is 
statutory and must be implemented as mandated.
5. Residents Training in Nonhospital Settings
a. Background
    With respect to reimbursement of direct GME costs, since July 1, 
1987, hospitals have been allowed to count the time residents spend 
training in sites that are not part of the hospital (referred to as 
``nonprovider'' or ``nonhospital sites'') under certain conditions. 
Section 1886(h)(4)(E) of the Act requires that the Secretary's rules 
concerning computation of FTE residents for purposes of direct GME 
payments ``provide that only time spent in activities relating to 
patient care shall be counted and that all the time so spent by a 
resident under an approved medical residency training program shall be 
counted towards the determination of full-time equivalency, without 
regard to the setting in which the activities are performed, if the 
hospital incurs all, or substantially all, of the costs for the 
training program in that setting.'' (Section 1886(h)(4)(E) of the Act, 
as added by section of 9314 of the Omnibus Budget Reconciliation Act of 
1986, Pub. L. 99-509.)
    Regulations regarding time spent by residents training in 
nonhospital sites for purposes of direct GME payment were first 
implemented in the September 29, 1989 final rule (54 FR 40286). We 
stated in that rule (under Sec.  413.86(f)(3)) that a hospital may 
count the time residents spend in nonprovider settings for purposes of 
direct GME payment if the residents spend their time in patient care 
activities and there is a written agreement between the hospital and 
the nonprovider entity stating that the hospital will incur all or 
substantially all of the costs of the program. The regulations at that 
time defined ``all or substantially all'' of the costs to include the 
residents'' compensation for the time spent at the nonprovider setting.
    Prior to October 1, 1997, for IME payment purposes, hospitals could 
only count the time residents spend training in areas subject to the 
IPPS and outpatient areas of the hospital. Section 4621(b)(2) of the 
BBA of 1997 (Pub. L. 105-33) revised section 1886(d)(5)(B) of the Act 
to allow providers to count time residents spend training in 
nonprovider sites for IME purposes, effective for discharges occurring 
on or after October 1, 1997. Specifically, section 1886(d)(5)(B)(iv) of 
the Act was amended to provide that ``all the time spent by an intern 
or resident in patient care activities under an approved medical 
residency program at an entity in a nonhospital setting shall be 
counted towards the determination of full-time equivalency if the 
hospital incurs all, or substantially all, of the costs for the 
training program in that setting.''
    In the regulations at Sec. Sec.  412.105(f)(1)(ii)(C) and 
413.86(f)(4) (as issued in the July 31, 1998 Federal Register), we 
specify the requirements a hospital must meet in order to include the 
time spent by a resident training in a nonhospital site in its FTE 
count for Medicare reimbursement for portions of cost reporting periods 
occurring on or after January 1, 1999 for both direct GME and for IME 
payments. The regulations at Sec.  413.86(b) redefine ``all or 
substantially all of the costs for the training program in the 
nonhospital setting'' as the residents' salaries and fringe benefits 
(including travel and lodging where applicable), and the portion of the 
cost of teaching physicians' salaries and fringe benefits attributable 
to direct GME. A written agreement between the hospital and the 
nonhospital site is required before the hospital may begin to count 
residents training at the nonhospital site; the agreement must provide 
that the hospital will incur the costs of the resident's salary and 
fringe benefits while the resident is training in the nonhospital site. 
The hospital must also provide reasonable compensation to the 
nonhospital site for supervisory teaching activities, and the written 
agreement must specify that compensation amount.
b. Moratorium on Disallowances of Allopathic or Osteopathic Family 
Practice Residents Training Time in Nonhospital Settings (Section 713 
of Pub. L. 108-173 and Redesignated Sec.  413.78 (a Redesignation of 
Existing Sec.  413.86(f))
    As we mentioned above, under existing Sec.  413.86(f)(4), for 
portions of cost reporting periods occurring on or after January 1, 
1999, the time residents spend in nonhospital settings such as 
freestanding clinics, nursing homes, and physicians' offices in 
connection with approved programs may be included in determining the 
hospital's number of FTE residents for purposes of calculating both 
direct GME and IME payments, if the following conditions are met:
    (1) The resident spends his or her time in patient care activities.
    (2) There is a written agreement between the hospital and the 
nonhospital site that indicates that the hospital will incur the costs 
of the resident's salary and fringe benefits while the resident is 
training in the nonhospital site, and the hospital is providing 
reasonable compensation to the nonhospital site for supervisory 
teaching activities. The agreement must indicate the compensation the 
hospital is providing to the nonhospital site for supervisory teaching 
activities.
    (3) The hospital incurs ``all or substantially all'' of the costs 
for the training program in the nonhospital setting. ``All or 
substantially all'' means the residents'' salaries and fringe benefits 
(including travel and lodging where applicable) and the portion of 
teaching physicians' salaries and fringe benefits attributable to 
direct graduate medical education.
    In order for the hospital to incur ``all or substantially all'' of 
the costs in accordance with the regulations, the actual cost of the 
time spent by teaching physicians in supervising residents in the 
nonhospital setting must be compensated by the hospital. The amount of 
supervisory GME costs is dependent upon the teaching physician's salary 
and the percentage of time that he or she devotes to activities related 
to the residency program at the nonhospital site. As long as there are 
supervisory costs associated with the nonhospital training, the 
hospital must reimburse the nonhospital setting for those costs in 
order to count FTE resident time spent in the nonhospital site for 
purposes of IME and direct GME payments.
    Many hospitals have entered into written agreements with teaching 
physicians that state that the teaching physician is ``volunteering'' 
his or her time in the nonhospital site, and, therefore, the hospital 
is not providing any compensation to the teaching physician. Other 
hospitals have paid only a nominal amount of compensation for the 
supervisory teaching physicians' time in the nonhospital setting. 
Because the existing regulations at Sec.  413.86(f)(4) state that the 
hospital must incur all or substantially all of the direct GME costs, 
including those costs associated with the teaching physician, 
regardless of whether the written agreement states that the teaching 
physician is ``volunteering,'' we have required that the hospital must 
pay these costs in order to count FTE residents training in the 
nonhospital site, as long as these teaching physician costs exist.

[[Page 49177]]

    However, during the 1-year period from January 1, 2004 through 
December 31, 2004, section 713 of Public Law 108-173, through a 
moratorium, allows hospitals to count allopathic or osteopathic family 
practice residents training in nonhospital settings for IME and direct 
GME purposes, without regard to the financial arrangement between the 
hospital and the teaching physician practicing in the nonhospital 
setting to which the resident is assigned. We implemented section 713 
in the One-Time Notification (OTN), ``Changes to the FY 2004 Graduate 
Medical Education (GME) Payments as Required by the Medicare 
Modernization Act of 2003 (MMA)'' (CR 3071, Transmittal 61, issued on 
March 12, 2004). Generally, to implement the provisions of section 713, 
we stated in the OTN that, when settling prior year cost reports during 
this 1-year period, or for family practice residents actually training 
in nonhospital settings during this 1-year period, the fiscal 
intermediaries should allow the hospitals to count allopathic and 
osteopathic family practice residents training in the nonhospital 
setting for direct GME and IME payment purposes without regard to the 
financial arrangement between the hospital and the nonhospital site 
pertaining to the teaching physicians' costs associated with the 
residency program.
(1) Cost Reports That Are Settled Between January 1, 2004 and December 
31, 2004
    When fiscal intermediaries settle cost reports during January 1, 
2004 through December 31, 2004 (Calendar Year (CY) 2004), a hospital 
that seeks to count allopathic or osteopathic family practice FTE 
residents training in a nonhospital setting(s) is allowed to count 
those FTEs for IME and direct GME purposes, even in instances where the 
written agreement between the hospital and a teaching physician or a 
nonhospital site does not mention teaching physician compensation, 
specifies only a nominal amount of compensation, or states that the 
teaching physician is ``volunteering'' his or her time training the 
residents. For example, when a fiscal intermediary is settling a cost 
report during CY 2004 that has a fiscal year end of June 30, 2001, the 
fiscal intermediary will allow the hospital to count family practice 
FTE residents that trained in a nonhospital setting during the period 
covered by the June 30, 2001 cost report, regardless of the financial 
arrangement in place between the hospital and the teaching physician at 
the nonhospital site during the period covered by the June 30, 2001 
cost report.
    We note that this moratorium does not apply to cost reports that 
are not settled during January 1 through December 31, 2004, that do not 
coincide with, or overlap, the January 1 through December 31, 2004 
period. For example, if a cost report for fiscal year ended December 
31, 2003 (or June 30, 2003, or others) is not settled during the 
January 1 through December 31, 2004 period, the moratorium would not 
apply.
    Comment: One commenter expressed concern with the implementation of 
the moratorium on disallowances of allopathic or osteopathic family 
practice residents' training time in nonhospital settings. 
Specifically, the commenter was concerned that fiscal intermediaries 
may purposely delay audits or the issuance of settled cost reports to 
avoid the impact of the moratorium. The commenter requested CMS to 
clearly and firmly direct fiscal intermediaries to settle all cost 
reports in 2004 that they otherwise would settle and inform 
intermediaries that they may not take the moratorium into account in 
determining whether and when to settle cost reports.
    Response: We have already addressed the issue of how fiscal 
intermediaries are to implement this moratorium. In Change Request 
3071, Pub. 100-20, Transmittal No. 61, issued to the fiscal 
intermediaries on March 12, 2004, we stated that, ``Scheduling of cost 
report audit or settlement activities during calendar year 2004 should 
be done in accordance with normal procedures. If, since January 1, 
2004, but before issuance of this OTN, you have settled cost reports 
and did not allow hospitals to count family practice residents at 
nonhospital sites where the hospitals did not pay for all of the 
teaching physician costs, then review such settlements and, if 
appropriate, reopen and reverse the disallowance. If, as of issuance of 
this OTN, you have disallowed such residents in the process of settling 
a cost report, but have not yet issued the Notice of Program 
Reimbursement (NPR), then reverse the disallowance of those residents. 
Cost reports that have already been settled prior to January 1, 2004 
should not be reopened to allow a hospital to count family practice 
residents at nonhospital sites where the hospital did not pay for all 
of the teaching physician costs, even if requested by a hospital.''
    Therefore, scheduling of audit or settlement activities should be 
done using normal procedures. Given the above instruction, fiscal 
intermediaries should not take the moratorium into consideration or 
delay settlement and audit activities. Because we have instructed 
fiscal intermediaries to follow normal procedures, we request that 
hospitals respect our instructions and refrain from pressuring fiscal 
intermediaries to settle more cost reports than they would during the 
normal course of business in an attempt to take advantage of this 
moratorium.
(2) Family Practice Residents That Are Training in Nonhospital Settings 
Between January 1, 2004 and December 31, 2004
    In addition to allowing family practice residents that trained in 
nonhospital settings to be counted in cost reports that the fiscal 
intermediaries settle during the period of January 1, 2004 through 
December 31, 2004, without regard to the financial arrangements between 
the hospital and the teaching physician at the nonhospital site, the 
fiscal intermediaries are to allow family practice residents that 
actually are or will be training in nonhospital settings during January 
1, 2004, through December 31, 2004, without regard to the financial 
arrangements between the hospital and the teaching physician at the 
nonhospital site. That is, when fiscal intermediaries settle cost 
reports that cover service periods of January 1, 2004 through December 
31, 2004, a hospital that seeks to count allopathic or osteopathic 
family practice FTE residents training in a nonhospital setting(s) 
would be allowed to count those FTEs, even in instances where the 
written agreement between the hospital and a teaching physician or a 
nonhospital site does not mention teaching physician compensation, 
specifies only a nominal amount of compensation, or states that the 
teaching physician is ``volunteering'' his or her time training the 
residents. If a hospital has a fiscal year that is other than a 
calendar year, the hospital may count the family practice residents 
training in the nonhospital setting during those portions of its fiscal 
years that fall within the January 1, 2004 and December 31, 2004 
period. For example, when a fiscal intermediary is settling a 
hospital's June 30, 2004 cost report, the hospital would be allowed to 
count family practice FTE residents that trained in a nonhospital 
setting during the period of January 1, 2004 through June 30, 2004, 
regardless of the financial arrangement between the hospital and the 
teaching physician at the nonhospital site from January 1 through June 
30, 2004. Similarly, when a fiscal intermediary settles the hospital's 
June 30, 2005 cost report, the hospital would be allowed to count 
family practice FTE residents that trained in a nonhospital setting 
during the period of July 1, 2004

[[Page 49178]]

through December 31, 2004, regardless of the financial arrangement 
between the hospital and the teaching physician at the nonhospital site 
from July 1 through December 31, 2004. (However, we note that family 
practice residents that train in nonhospital settings beginning January 
1, 2005, and after are not subject to the moratorium provided under 
section 713 of Pub. L. 108-173.)
    Because we are interpreting this moratorium to apply to prior 
period cost reports that are settled during calendar year (CY) 2004, 
and to cost reports that are settled after CY 2004 that cover training 
that occurred during the period of January 1, 2004 through December 31, 
2004, a gap in applicability of the moratorium may result for family 
practice residents training in nonhospital settings. For example, a 
hospital might be permitted to count certain FTE family practice 
residents that are included in its FY 2001 cost report in accordance 
with the moratorium because that cost report is settled during CY 2004. 
However, the hospital might not be permitted to count certain FTE 
family practice residents in its FY 2002 and FY 2003 cost reports 
because these cost reports would not be settled during CY 2004 and the 
moratorium would not apply. The hospital then could be permitted to 
count certain FTE family practice residents in its FY 2004 cost report 
in accordance with the moratorium, because the FY 2004 cost report 
would contain family practice residents who actually trained in a 
nonhospital setting during CY 2004.
    Regardless of whether the fiscal intermediaries are settling prior 
period cost reports during CY 2004, or settling cost reports after CY 
2004 that cover training during the period of January 1, 2004 through 
December 31, 2004, we emphasize that the moratorium provided in section 
713 of Public Law 108-173 only applies for purposes of counting FTE 
residents in allopathic and osteopathic general family practice 
programs that were in existence (that is, training residents) as of 
January 1, 2002 and where the requirement to incur the teaching 
physician compensation related to direct GME may not have been met. 
Therefore, in the May 18, 2004 proposed rule (69 FR 28315), for 
residents training in nonhospital settings, we proposed that the 
moratorium applies only: (1) To FTE residents in general family 
practice programs (and not to dental, podiatric, or other allopathic or 
osteopathic specialty programs); (2) to family practice programs that 
were in existence as of January 1, 2002; and (3) with the exception of 
teaching physician compensation, to training in nonhospital settings 
that meet the requirements in the existing regulations at Sec.  
413.86(f)(4) (proposed to be redesignated as Sec.  413.78(d)).
    We did not propose any regulation text changes to address this 
provision in the proposed rule. We note that section 713(b) of Public 
Law 108-173 directs the Inspector General of the Department of Health 
and Human Services to conduct a study of the appropriateness of 
alternative methodologies for payment of residency training in 
nonhospital settings and to submit a report to Congress on the results 
of the study, along with recommendations, as appropriate, by December 
8, 2004. We will await the release of the Inspector General's report 
and may consider additional policy and regulation changes at that time 
if they are warranted.
    Comment: Many commenters expressed strong opposition to CMS' policy 
regarding IME and DGME payments for residents training at a nonhospital 
setting(s). The commenters believe that the requirement that hospitals 
pay supervising physicians in nonhospital settings for the salary and 
fringe benefits that is attributable to the time spent teaching 
residents is severely detrimental to residency programs that depend on 
nonhospital training and runs counter to long-standing traditions 
prevalent in physician education.
    Several commenters stated that there is inconsistency in the 
treatment of supervisory costs in nonhospital settings by CMS and 
fiscal intermediaries and requested clarification regarding CMS policy 
regarding compensation of supervisory physicians who ``volunteer'' 
their time to train residents in a nonhospital setting.
    Several commenters proposed that CMS clarify in the final rule that 
where supervising physicians freely agree to volunteer their time and 
the hospital pays all other training costs (residents' salaries, 
benefits, and other training costs) that the hospital has incurred 
``all or substantially all'' of the costs of the program.
    Several commenters urged CMS to extend the MMA moratorium on 
disallowances of allopathic or osteopathic family practice residents 
training time in nonhospital settings (redesignated Sec.  413.78) to 
cover all current, prior, and future nonhospital education. Another 
commenter believes that this moratorium should not be limited to Family 
Practice residents, but rather should cover any residents that train in 
nonhospital settings.
    Response: While we sympathize with the commenter's concerns, the 
cost reporting period specified for the moratorium on disallowances of 
allopathic or osteopathic family practice residents training time in 
nonhospital settings is set by Section 713 of Public Law 108-173. 
Furthermore, we have no discretion to expand the moratorium to 
residency programs other than Family Practice. Many hospitals have 
claimed that the teaching physician is ``volunteering'' his or her time 
in the nonhospital site, and, therefore, the hospital is not providing 
any compensation to the teaching physician. The redesignated regulation 
at Sec.  413.78 states that the hospital must incur all or 
substantially all of the direct GME costs. This requirement included 
those costs associated with the teaching physician, regardless of 
whether the written agreement states that the teaching physician is 
``volunteering.'' The statute and our regulations require that the 
hospital must pay the costs of training residents at the nonhospital 
site in order to count FTE residents training at that site including 
teaching physician costs, as long as these teaching physician costs 
exist. We did not propose any regulation text changes that address 
these supervisory costs of training residents at nonhospital 
setting(s). Section 713(b) of Public Law 108-173 directs the Inspector 
General of the Department of Health and Human Services to conduct a 
study of the appropriateness of alternative methodologies for payment 
of residency training in nonhospital settings and to submit a report to 
the Congress on the results of the study, along with recommendations, 
as appropriate, by December 8, 2004. We will await the release of the 
Inspector General's report and may consider additional policy, 
regulation changes, and instructions to financial intermediaries at 
that time if they are warranted.
    Comment: One commenter believes that there is unmeasured monetary 
value afforded to nonhospital sites that are training residents and 
that supervisory costs should be compared to what nonhospital sites 
gain as a result of training residents. For example, ``off-site 
locations may also have reduced clinical staff hours, as some of the 
work delegated to residents is similar or identical to what might be * 
* * work normally performed by clinical staff in offices without 
residents.'' The commenter believes compensation for supervising 
physicians that does not take into account these economic benefits 
would result in a ``gross overpayment'' to nonhospital sites.

[[Page 49179]]

    Response: In order to count residents training at nonhospital 
sites, for purposes of direct and indirect GME payments, the statute 
requires a hospital to pay the nonhospital site for all or 
substantially all of the costs for the training program in that 
setting. Although we understand that a benefit does accrue to the 
nonhospital site because there is GME training being conducted at that 
site, a determination of the cost of the training must be made and the 
hospital must pay the nonhospital site for those costs. We are not 
proposing to make any changes regarding compensation for supervising 
physicians at nonhospital sites at this time. As stated above, section 
713(b) of Public Law 108-173 directs the Inspector General of the 
Department of Health and Human Services to conduct a study of the 
appropriateness of alternative methodologies for payment of residency 
training in nonhospital settings and to submit a report to the Congress 
on the results of the study, along with recommendations, as 
appropriate, by December 8, 2004. We will await the release of the 
Inspector General's report and will consider the possibility of policy 
and regulation changes at that time if warranted.
    Comment: Many commenters proposed that CMS ``make very clear in 
regulation or intermediary instruction that if there are no payments 
made to the non-hospital site by the hospital, that is not an a priori 
reason to deny time spent by residents in that environment. If the 
hospital is paying the residents' salary and benefits, travel costs, 
lodging, etc., there may in fact be no costs (hence payments) to the 
non-hospital site. This would frequently be the case in situations 
where the preceptor is volunteering his/her teaching or supervisory 
time.''
    Response: We did not propose any changes in policy concerning this 
issue. We note that Section 713(b) of Public Law 108-173 directs the 
Inspector General of the Department of Health and Human Services to 
conduct a study of the appropriateness of alternative methodologies for 
payment of residency training in nonhospital settings and to submit a 
report to the Congress on the results of the study, along with 
recommendations, as appropriate, by December 8, 2004. We will await the 
release of the Inspector General's report and will consider additional 
policy, regulation changes, and instructions to financial 
intermediaries at that time if warranted.
c. Requirements for Written Agreements for Residency Training in 
Nonhospital Settings (Redesignated Sec.  413.78 (a Redesignation of 
Existing Sec.  413.86(f))
    As mentioned above, under section 1886(h)(4)(E) of the Act, a 
hospital may count residents training in nonhospital settings for 
direct GME purposes (and under section 1886(d)(5)(B)(iv) of the Act, 
for IME purposes), if the residents spend their time in patient care 
activities and if ``* * * the hospital incurs all, or substantially 
all, of the costs for the training program in that setting.'' We 
believe the Congress intended to facilitate residency training in 
nonhospital settings by requiring hospitals to commit to incur, and 
actually incur, all or substantially all of the costs of the training 
programs in the nonhospital sites. Accordingly, in implementing section 
1886(h)(4)(E) of the Act, first in the regulations at Sec.  
413.86(f)(3), effective July 1, 1987, and later at Sec.  413.86(f)(4), 
effective January 1, 1999, we required that, in addition to incurring 
all or substantially all of the costs of the program at the nonhospital 
setting, there must be a written agreement between the hospital and the 
nonhospital site stating that the hospital will incur all or 
substantially all of the costs of training in the nonhospital setting. 
The later regulations further specify that the written agreement must 
indicate the amount of compensation provided by the hospital to the 
nonhospital site for supervisory teaching activities. (In the May 18, 
2004 proposed rule, we noted that Sec.  413.86(f)(3) was proposed to be 
redesignated as Sec.  413.78(c), and Sec.  413.86(f)(4) was proposed to 
be redesignated as Sec.  413.78(d).)
    We required the written agreements in regulations in order to 
provide an administrative tool for use by the fiscal intermediaries to 
assist in determining whether hospitals would incur all or 
substantially all of the costs of the training in the nonhospital 
setting in accordance with Congressional intent. Furthermore, our 
policy has required that the written agreement between the hospital and 
the nonhospital site be in place prior to the time that the hospital 
begins to count the FTE residents training in the nonhospital site. A 
written agreement signed before the time the residents begin training 
at the nonhospital site that states that the hospital will incur the 
costs of the training program at the nonhospital site indicates the 
hospital's ongoing commitment to incur the costs of training at that 
site.
    In settling cost reports where hospitals have included residents 
training at nonhospital sites in their FTE count, the fiscal 
intermediaries have encountered numerous situations where hospitals 
have complied with the requirement to incur all or substantially all of 
the costs of training in nonhospital settings. However, despite our 
longstanding regulations that state the requirement for a written 
agreement, these hospitals have not met the regulatory requirements 
related to written agreements. For example, some hospitals had no 
written agreement in place during the training in the nonhospital 
setting, or written agreements were not timely (that is, they were 
prepared after the residents began or, in some cases, finished training 
at the nonhospital site), or the agreements did not include a specific 
amount of compensation to be provided by the hospital to the 
nonhospital site for supervisory teaching activities. As a result, 
hospitals have faced disallowances of direct GME and IME payments 
relating to FTE residents training in nonhospital settings because the 
hospitals did not comply with the regulatory requirements concerning 
written agreements.
    In retrospect, we believe the regulatory requirements concerning 
the written agreements may not have been the most efficient aid to 
fiscal intermediaries in determining whether hospitals would actually 
incur all or substantially all of the costs of the training programs in 
nonhospital settings. The fiscal intermediaries have been required to 
ensure that hospitals are complying with the regulations regarding 
written agreements, in addition to determining whether a hospital 
actually incurred the appropriate costs. We believe it would be more 
appropriate and less burdensome for both fiscal intermediaries and 
hospitals if we instead focus the fiscal intermediaries' reviews on the 
statutory requirement that hospitals must incur all or substantially 
all of the costs of the program in the nonhospital setting. Therefore, 
in the May 18, 2004 proposed rule (69 FR 28315), we proposed to revise 
the regulations under proposed new Sec.  413.78 (a proposed 
redesignation of existing Sec.  413.86(f)) to remove the requirement 
for a written agreement between the hospital and the nonhospital 
setting as a precondition for a hospital to count residents training in 
nonhospital settings for purposes of direct GME and IME payments. 
However, consistent with our belief that the Congress intended that 
hospitals commit to incur, and actually incur, all or substantially all 
of the costs of the

[[Page 49180]]

training programs in the nonhospital sites in order to facilitate 
training at nonhospital sites, we are also proposing that, in order for 
the hospital to count residents training in a nonhospital setting, the 
hospital must pay for the nonhospital site training costs concurrently 
with the training that occurs during the cost reporting period.
    We understand that residents' rotations, including those to 
nonhospital settings, are generally in discrete blocks of time (for 
example, 4-week or 6-week rotations). Therefore, to account for various 
rotation lengths, we proposed under the new proposed Sec.  413.78(e) 
that, in order to count residents training in a nonhospital setting, a 
hospital must pay all or substantially all of the costs of the training 
in a nonhospital setting(s) by the end of the month following a month 
in which the training in the nonhospital site occurred. If a hospital 
is counting residents training in a nonhospital setting for direct GME 
and IME purposes in any month of its cost reporting period, the 
hospital must make payment by the end of the following month to cover 
all or substantially all of the costs of training in that setting 
attributable to the preceding month. If the residents are employed by 
the hospital, and receive their salary payments (and fringe benefits) 
every 2 weeks, the hospital may continue to pay the residents' salaries 
every 2 weeks during the residents' rotation to the nonhospital 
setting. This should still result in payment being made for residents' 
time spent in nonhospital settings by the end of the following month. 
(We also note that the hospital must pay travel and lodging expenses, 
if applicable.) We proposed that the hospital would be required to pay 
the nonhospital site for the portion of the cost of teaching 
physicians' salaries and fringe benefits attributable to direct GME by 
the end of the month following the month in which the training in the 
nonhospital setting occurred. We proposed that if a hospital does not 
pay for all or substantially all of the costs of the program in the 
nonhospital setting by the end of the month following the month in 
which the training occurred, the hospital could not count those FTE 
residents in the month that the training occurred. Therefore, we 
proposed to determine if residents training in nonhospital sites should 
be counted on a month-to-month basis, depending on whether a hospital 
paid for the training costs of those residents by the end of the month 
following the month in which the training occurred.
    The following are examples of how a hospital that sends residents 
to train in nonhospital sites would make payments concurrently with the 
nonhospital site training:

    Example 1.  Hospital A, with a fiscal year end (FYE) of 
December 31, trains 10 internal medicine residents and 6 family 
practice residents. Each January, April, July, and October, Hospital 
A sends 5 internal medicine FTE residents to the Physicians' Clinic 
for 4 weeks. Each month, Hospital A sends 2 family practice FTE 
residents to the Family Clinic. The residents are employed by 
Hospital A, and the residents receive fringe benefits from and are 
paid every 2 weeks by Hospital A, regardless of whether they are 
training in Hospital A or at a nonhospital site. In order to make 
payments concurrently with the training that is occurring in the 
nonhospital sites, Hospital A must pay the Physicians' Clinic by the 
end of February, May, August, and November, respectively, of each 
cost reporting year, to cover the costs of teaching physician 
compensation and fringe benefits attributable to direct GME. 
Similarly, because residents are training at the Family clinic each 
month, Hospital A must pay the Family Clinic by the end of each 
month for the previous month's costs of teaching physician 
compensation and fringe benefits attributable to direct GME. There 
are no travel and lodging costs associated with these rotations to 
nonhospital sites.
    Example 2.  University A will sponsor an ophthalmology 
program with eight residents beginning on July 1, 2005. The 
residents will be on the payroll of the University, but they will 
train at Hospital B and at the University's Eye Clinic, which is a 
nonhospital setting. Hospital B has a June 30 FYE. Four of the 
residents will train in the Eye Clinic from August 1 to October 15, 
and the other four residents will train in the Eye Clinic from 
February 15 to April 30. Thus, residents are training in the Eye 
Clinic during the months of August, September, October, February, 
March, and April. If Hospital B wishes to count these FTE residents 
for IME and direct GME purposes in its cost reporting year ending 
June 30, 2006, and onward, it must pay the Eye Clinic at the end of 
September, October, November, March, April, and May, respectively, 
for the previous month's cost of the residents' salaries and fringe 
benefits, and the teaching physician compensation and fringe 
benefits attributable to direct GME.
    Example 3.  Hospital C sends a resident to train at a 
nonhospital site from January 28 to February 20. The resident was 
employed by the nonhospital site during this time. Hospital C paid 
the nonhospital site for the cost of the resident's salary and 
fringe benefits and the teaching physician compensation and fringe 
benefits attributable to direct GME by February 28 to account for 
the training that occurred from January 28 through January 31. 
However, Hospital C did not pay the nonhospital site by March 31 to 
account for the training that occurred in February. Therefore, 
Hospital C could not count the resident's time in the nonhospital 
setting from February 1 through February 20 for direct GME and IME 
purposes.

    We note that our proposal to require hospitals to pay for the 
nonhospital site training costs concurrently with the training that 
occurs in the nonhospital site was a departure from our current policy 
concerning the timeframe in which a hospital must make payment for the 
training costs. Currently, we apply the existing regulations at Sec.  
413.100(c)(2)(i), which state that a short-term liability (such as the 
hospital's obligation to pay the nonhospital site for the residency 
training costs) must be liquidated within 1 year after the end of the 
cost reporting period in which the liability is incurred. However, 
because we are proposing to no longer require that a written agreement 
between the hospital and the nonhospital site be in place prior to the 
time that the hospital begins to count the FTE residents training in 
the nonhospital site, we believe that a reasonable alternative to 
ensure that a hospital is facilitating the training at the nonhospital 
site through its ongoing commitment to incur all or substantially all 
of the costs is to require the hospital to make payments concurrently 
with the training that occurs in the nonhospital site in order to count 
the FTE residents for purposes of direct GME and IME payments.
    We are aware that there are situations where, rather than providing 
direct financial compensation to the nonhospital site for supervisory 
teaching activities, the hospital is incurring all or substantially all 
of the teaching physician costs through nonmonetary, in-kind 
arrangements. In the May 18, 2004 proposed rule, we proposed that, in 
order to be considered concurrent with the nonhospital site training, 
in-kind arrangements must be provided or made available to the teaching 
physician at least quarterly, to the extent that there are residents 
training in a nonhospital setting(s) in a quarter.
    We proposed to revise Sec.  413.86(f) (proposed to be redesignated 
as Sec.  413.78 in this proposed rule) to add a new paragraph (Sec.  
413.78(e)) to state that a hospital must incur all or substantially all 
of the costs of training in a nonhospital setting by the end of the 
month following a month in which the training in the nonhospital site 
occurred, to the extent that there are residents training in a 
nonhospital setting in a month. This proposed change would be effective 
for portions of cost reporting periods occurring on or after October 1, 
2004. We proposed to revise paragraph (d) of the proposed redesignated 
Sec.  413.78 to reflect the effective cost reporting periods of the 
provisions under the new paragraph (e).

[[Page 49181]]

    Comment: Many commenters voiced strong opposition to the proposed 
regulation that requires hospitals to pay for all or substantially all 
of the costs of training residents at the nonhospital setting(s) by the 
end of the month following a month in which the training in the 
nonhospital setting(s) occurred. The commenters believe that this 
proposed regulation would not be less burdensome than the existing 
system and indeed would increase the administrative burdens to 
hospitals and intermediaries alike.
    Response: As we stated in the May 18, 2004 proposed rule, we 
believe the Congress intended to facilitate residency training in 
nonhospital settings by requiring hospitals to commit to incur, and 
actually incur, all or substantially all of the costs of the training 
programs in the nonhospital sites. Accordingly, in implementing section 
1886(h)(4)(E) of the Act, first in the regulations at Sec.  
413.86(f)(3), effective July 1, 1987, and later at Sec.  413.86(f)(4), 
effective January 1, 1999, we required that, in addition to incurring 
all or substantially all of the costs of the program at the nonhospital 
setting, there must be a written agreement between the hospital and the 
nonhospital site stating that the hospital will incur all or 
substantially all of the costs of training in the nonhospital setting.
    In the May 18, 2004 proposed rule, we indicated our belief that it 
would be more appropriate and less burdensome for both fiscal 
intermediaries and hospitals if, instead of focusing on the written 
agreement, we focus on the statutory requirement that hospitals must 
incur all or substantially all of the costs of the program in the 
nonhospital setting. Therefore, we proposed to remove the requirement 
for a written agreement between the hospital and the nonhospital 
setting as a precondition for a hospital to count residents training in 
nonhospital settings for purposes of direct GME and IME payments. 
Instead, we proposed that, in order to count residents training in a 
nonhospital setting, a hospital must pay all or substantially all of 
the costs of the training in a nonhospital setting(s) by the end of the 
month following a month in which the training in the nonhospital site 
occurred. Payment of these costs by the end of the month following a 
month in which the training occurs would show an ongoing commitment to 
incur the cost of training residents at the nonhospital site and is 
consistent with the Congress' intent.
    In response to the commenter's concerns, we are revising the 
proposed finalized policy at Sec.  413.78 (a redesignation of Sec.  
413.86(f)). We are concerned that hospitals may not always be able to 
comply with the timeframe for payment of nonhospital supervisory costs 
as indicated by the commenters. Therefore, we will allow hospitals to 
demonstrate their ongoing commitment to incur the costs of the training 
program in the nonhospital setting, and to count the FTE residents 
training thereby meeting at least one of the following criteria: (1) 
There is a written agreement between the hospital and the nonhospital 
site stating that the hospital will incur all or substantially all of 
the costs of training in the nonhospital setting. If the hospital 
chooses the written agreement option, the existing requirements as 
specified in the regulations at Sec.  413.100(c)(2)(i) and Sec.  
413.86(f)(4) would apply. Or, (2) the hospital pays the costs 
associated with the training program in the nonhospital setting(s) by 
the end of the third month following a month in which the training in 
the nonhospital setting(s) occurred. Allowing hospitals to choose 
between these two options and lengthening the required timeframe for 
concurrent payment of the costs of the training in a nonhospital site 
provides additional flexibility to hospitals and fiscal intermediaries 
while still ensuring compliance with the statutory requirement to 
demonstrate that hospitals will incur all or substantially all of the 
costs of the training program in the nonhospital setting.
    Comment: Several commenters believe that our proposal to require 
hospitals to pay the costs of training residents at a nonhospital site 
by the end of the month following a month in which the training 
occurred is inconsistent with longstanding Medicare policy. They note 
that the regulations at Sec.  413.100(c)(2)(i) allow a hospital to 
recognize an accrued cost for Medicare payment purposes if it is paid 
within one year after the end of the cost reporting period in which the 
liability was incurred. Several commenters proposed that a hospital be 
considered to have incurred the cost of training residents in a 
nonhospital setting, with or without a written agreement, if this cost 
is paid in accordance with Sec.  413.100(c)(2)(i). One commenter 
proposed that a hospital be considered to have incurred the cost of 
training residents in a nonhospital setting, with or without a written 
agreement, if this cost is paid by the end of the month following the 
end of the cost reporting period.
    Response: We agree that Sec.  413.100(c)(2)(i) permits a hospital 
to recognize an accrued cost for Medicare payment purposes if it is 
paid within one year after the end of the cost reporting period in 
which the liability was incurred. However, we have required a written 
agreement under our regulations in order to provide an administrative 
tool for use by the fiscal intermediaries to assist in determining 
whether hospitals would incur all or substantially all of the costs of 
the training in the nonhospital setting. As stated above, we are now 
allowing a hospital to choose how it will demonstrate that it will 
incur the nonhospital site training costs: either by executing a 
written agreement with the nonhospital site in accordance with existing 
regulations, or by concurrently paying the costs of training residents 
in the nonhospital setting (that is, by the end of the third month 
following the month in which the training occurred).
    Comment: One commenter disagreed with CMS' policy requiring that 
the written agreement between a hospital and a nonhospital site be in 
place prior to residents commencing training at the nonhospital site. 
The commenter proposed that the written agreement be valid if in place 
at any time during the cost reporting year in which the training at the 
nonhospital site occurs.
    Response: Regulations at 42 CFR 413.78 (previously Sec.  
413.86(f)(4)) specify that there must be a written agreement between 
the hospital and the non-hospital site stating that the hospital will 
incur specific costs of training in the non-hospital site, including 
costs for supervisory teaching activities. It is our policy under that 
regulation that the written agreement between the hospital and non-
hospital site be in place prior to the time that the hospital begins to 
count the FTE residents training in the non-hospital site. As discussed 
earlier in this final notice, we are allowing a hospital to meet the 
requirement to pay all or substantially all of the costs of the program 
in the nonhospital setting, by either submitting a copy of the written 
agreement that was prepared prior to the residents' training or by 
documenting that payments were actually made within the required three 
month time period. We believe the new option for a hospital to 
demonstrate that it will incur the costs of a nonhospital site training 
program provides sufficient additional flexibility for providers. We 
are not adopting the commenter's proposal to allow hospitals to use a 
written agreement that is executed or submitted after the training has 
occurred. We do not believe allowing the written agreement to be put in 
place retrospectively, after resident training in the nonhospital site 
has commenced, would be consistent with our long-standing policy to 
demonstrate that the

[[Page 49182]]

hospital will incur all or substantially all of the costs of the 
training program in the nonhospital site.
    Comment: One commenter representing a particular medical specialty 
recommended that CMS use proof of program accreditation as evidence of 
a written agreement between hospitals and nonhospital settings. The 
commenter pointed out that written agreements between hospitals and 
nonhospital sites are required by the specialty's accreditation 
process. Therefore, the commenter added, time spent in these 
nonhospital sites is eligible for reimbursement.
    Response: Under our existing regulations, the written agreement 
between a hospital and a nonhospital site must include several specific 
elements as follows:
     The hospital will incur the cost of the resident's salary 
and fringe benefits while the resident is training in the nonhospital 
site.
     The hospital is providing reasonable compensation to the 
nonhospital site for supervisory teaching activities.
     The agreement must indicate the compensation the hospital 
is providing for supervisory teaching activities.
    We must be able to verify that the written agreement conforms to 
these requirements of the regulation. Therefore, the actual written 
agreement must be used as proof rather than using proof of the 
program's accreditation as a proxy, because the proof of accreditation 
may not include all of the required information specified at 
redesignated Sec.  413.78(d)(2).
    Comment: One commenter requested that we place language in the 
regulations regarding the timing of nonmonetary compensation made 
available to supervising physicians that train residents in nonhospital 
settings. The commenter notes that while the preamble to the proposed 
rule addresses the timeframe for making in-kind compensation available 
to supervising physicians, the text of the regulations does not.
    Response: The purpose of the preamble to a rule is to further 
explain, and often, to provide practical examples and guidance on the 
policy laid out in the regulation text. It would be highly impractical 
to address every specific circumstance to which our policies would 
apply in the text of our regulations. In this case, we believe the 
preamble to this final rule is sufficient to convey the policy 
regarding the timing of in-kind compensation made available to 
supervising physicians at nonhospital settings.
    Comment: Several commenters asked for clarification regarding in-
kind compensation for supervisory physicians in nonhospital settings. 
We proposed that in order to be considered concurrent with the 
nonhospital site training, in-kind arrangements must be provided or 
made available to the teaching physician at least quarterly. The 
commenters asked that we elaborate on in-kind arrangements and give 
examples. The commenters also asked for examples of in-kind 
arrangements between a hospital and a solo physician that is training 
residents at a nonhospital site.
    Response: There are situations where rather than providing direct 
financial compensation to the nonhospital site for supervisory teaching 
activities, the hospital is providing compensation through non-
monetary, in-kind arrangements. If the hospital is using the written 
agreement option to show that it will incur all or substantially all of 
the cost of training residents in the nonhospital setting(s), our 
regulations require that the written agreement describe the 
arrangements that are involved. For example, the hospital may provide 
continuing education and other professional and educational support for 
supervising physicians in the nonhospital site in lieu of financial 
support. Another example of in-kind compensation is office space 
provided by the hospital to the supervising physician. The value of 
this space may be substituted for monetary compensation for teaching 
activities. This type of support must be described in the written 
agreement in lieu of a monetary amount for the hospital. If the 
hospital is opting to pay all or substantially all of the cost of 
training in the nonhospital setting(s) concurrently with the training 
that occurs during the cost reporting period, we had proposed that the 
in-kind arrangements must be provided or made available to the teaching 
physician at least quarterly, to the extent that there are residents 
training in a nonhospital setting(s) in a quarter. However, in order to 
make the policy regarding monetary and in-kind compensation consistent, 
we are requiring in the final rule that in-kind compensation be 
provided or made available by the end of the third month following the 
month in which the training occurs.
    We note further that, in the case of a solo practitioner, 
compensation at the practice is based solely and directly on the number 
of patients that the solo practitioner treats and for which the solo 
practitioner bills. Section 1886(h)(4)(E) of the Act requires that 
hospitals pay all or substantially all of the cost of training at the 
nonhospital site in order to count the FTE residents at that site. In 
this instance, we recognize that there are no costs associated with the 
supervisory teaching physician's time because the physician is not 
receiving compensation in any form or from any source while conducting 
teaching activities. Under these circumstances, we acknowledge that no 
direct or in-kind payment needs to be made to the supervising physician 
in order for the hospital to incur all or substantially all of the 
costs of the training program in the nonhospital setting, and to count 
the FTE residents' training time in the nonhospital setting.
    Out of scope comments relating to GME:
    Comment: Several comments addressed miscellaneous IME and direct 
GME issues, including accreditation of dental programs, community 
education programs, community support, per resident amounts, the 
general application of affiliated groups, and redistribution of costs.
    Response: We did not make any proposals relating to these issues in 
the May 18, 2004 proposed rule. Therefore, we decline to respond to 
these comments in this final rule. However, we will consider them for 
purposes of future rulemaking.

P. Rural Community Hospital Demonstration Program

    Section 410A(a) of Public Law 108-173 requires the Secretary to 
establish a demonstration to test the feasibility and advisability of 
establishing ``rural community hospitals'' for Medicare payment 
purposes for covered inpatient hospital services furnished to Medicare 
beneficiaries. A rural community hospital, as defined in section 
410A(f)(1), is a hospital that--
     Is located in a rural area (as defined in section 
1886(d)(2)(D) of the Act) or treated as being so located under section 
1886(d)(8)(E) of the Act;
     Has fewer than 51 beds (excluding beds in a distinct part 
psychiatric or rehabilitation unit) as reported in its most recent cost 
report;
     Provides 24-hour emergency care services; and
     Is not designated or eligible for designation as a CAH.
    Sections 410A(a)(2) and (4) of Public Law 108-173 specify that the 
Secretary is to select for participation not more than 15 rural 
community hospitals in rural areas of States that the Secretary 
identifies as having low population densities. As we indicated in the 
May 18, 2004 IPPS proposed rule (69 FR 28317) and corrected in the June 
25, 2004 correction notice (69 FR 39521),

[[Page 49183]]

using 2002 data from the U.S. Census Bureau, we identified 10 States 
with the lowest population density in which rural community hospitals 
must be located to participate in the demonstration: Alaska, Idaho, 
Montana, Nebraska, Nevada, New Mexico, North Dakota, South Dakota, 
Utah, and Wyoming. (Source: U.S. Census Bureau Statistical Abstract of 
the United States: 2003)
    Under the demonstration, participating hospitals will be paid the 
reasonable costs of providing covered inpatient hospital services 
(other than services furnished by a psychiatric or rehabilitation unit 
of a hospital that is a distinct part), applicable for discharges 
occurring in the first cost reporting period beginning on or after 
implementation of the demonstration program. For discharges occurring 
in subsequent cost reporting periods, payment is the lesser of 
reasonable cost or a target amount, which is the prior year's cost or, 
after the second cost reporting period, the prior year's target amount, 
adjusted by the inpatient prospective payment update factor. Covered 
inpatient hospital services means inpatient hospital services (defined 
in section 1861(b) of the Act) and includes extended care services 
furnished under an agreement under section 1883 of the Act.
    Sections 410A(a)(5) and (a)(6) require the demonstration to be 
implemented not later than January 1, 2005, but not before October 1, 
2004. The demonstration is to operate for 5 years. The payment change 
for a participating hospital under this demonstration will be 
implemented with the hospital's first cost reporting period beginning 
on or after October 1, 2004.
    Section 410A of Public Law 108-173 requires that ``in conducting 
the demonstration program under this section, the Secretary shall 
ensure that the aggregate payments made by the Secretary do not exceed 
the amount which the Secretary would have paid if the demonstration 
program under this section was not implemented.'' Generally, when CMS 
implements a demonstration on a budget neutral basis, the demonstration 
is budget neutral in its own terms; in other words, aggregate payments 
to the participating providers do not exceed the amount that would be 
paid to those same providers in the absence of the demonstration. This 
form of budget neutrality is viable when, by changing payments or 
aligning incentives to improve overall efficiency, or both, a 
demonstration may reduce the use of some services or eliminate the need 
for others, resulting in reduced expenditures for the demonstration 
participants. These reduced expenditures offset increased payments 
elsewhere under the demonstration, thus ensuring that the demonstration 
as a whole is budget neutral or yields savings. However, the small 
scale of this demonstration, in conjunction with the payment 
methodology, makes it extremely unlikely that this demonstration could 
be viable under the usual form of budget neutrality. Specifically, 
cost-based payments to 15 small rural hospitals is likely to increase 
Medicare outlays without producing any offsetting reduction in Medicare 
expenditures elsewhere. Therefore, a rural community hospital's 
participation in this demonstration is unlikely to yield benefits to 
the participant if budget neutrality were to be implemented by reducing 
other payments for these providers.
    In order to achieve budget neutrality, as we proposed, we are 
adjusting national inpatient PPS rates by an amount sufficient to 
account for the added costs of this demonstration. In other words, we 
are applying budget neutrality across the payment system as a whole 
rather than merely across the participants of this demonstration. We 
believe that the language of the statutory budget neutrality 
requirement permits the agency to implement the budget neutrality 
provision in this manner. This is because the statutory language refers 
merely to ensuring that ``aggregate payments made by the Secretary do 
not exceed the amount which the Secretary would have paid if the 
demonstration * * * was not implemented,'' and does not identify the 
range across which aggregate payments must be held equal. In the May 
18, 2004 proposed rule, we invited public comment on this proposal. We 
discuss the payment rate adjustment that would be required to ensure 
the budget neutrality of this demonstration in the Addendum of this 
final rule.
    Comment: One commenter requested that the demonstration be opened 
to a larger number of States. The commenter stated that arbitrarily 
designating a number of States does not serve Medicare beneficiaries 
and is contrary to the intent of legislation that was proposed prior to 
the enactment of Public Law 108-173.
    Response: Because Public Law 108-173 allows no more than 15 
demonstration sites, we targeted the program in the States with the 
lowest population densities, consistent with the legislative language. 
We recognize that there are many hospitals serving people in sparsely 
populated rural areas in other States. Given the limitations imposed by 
Public Law 108-173, unfortunately we are unable to include many 
hospitals in additional States that could benefit from this provision. 
We have selected the demonstration areas to conform to the requirements 
of the law and to allow a reasonable process for determining the 
eligibility of applicants, given the legislative language of the 
statute.
    Comment: One commenter stated that CMS has historically implemented 
demonstration projects on a budget neutral basis within the context of 
the given demonstration. The commenter opposed our proposal to fund the 
Rural Community Hospital Demonstration Program by reducing the payment 
rate to all hospitals paid on the basis of DRGs, and indicated that 
requiring nonparticipating hospitals to fund hospitals participating in 
a demonstration project is a bad policy precedent.
    Response: The Rural Community Hospital Demonstration Program is 
mandated by section 410A of Public Law 108-173. It is aimed at testing 
the feasibility and advisability of reimbursement based on reasonable 
cost for covered inpatient services for rural hospitals as defined by 
the legislation. The commenter is correct in stating that CMS usually 
implements demonstrations in which savings occurring among participants 
guarantee budget neutrality. However, we believe that the statutory 
authority allows us to define budget neutrality across the payment 
system. In short, we believe that the method that we proposed to ensure 
budget neutrality, which is mandated by law, is permissible under the 
statute.
    To participate in this demonstration, a hospital must be located in 
one of the identified States and meet the criteria for a rural 
community hospital. Eligible hospitals that desire to participate in 
the demonstration must submit an application to CMS. Information about 
the demonstration and details on how to apply can be found on the CMS 
Web site: http://www.cms.hhs.gov/researchers/demos/rch.asp.
    The data collection instrument for the demonstration has been 
approved by OMB under the title ``Medicare Waiver Demonstration 
Application,'' under OMB approval number 0938-0880, with a current 
expiration date of July 30, 2006.

Q. Special Circumstances of Hospitals Facing High Malpractice Insurance 
Rate Increases

    In the May 18, 2004 proposed rule (69 FR 28318), we indicated that 
we had received comments from several hospitals about the effects of 
rapidly

[[Page 49184]]

escalating malpractice insurance premiums on hospital financial 
performance and continued access for Medicare beneficiaries to high 
quality inpatient hospital services. We are aware that malpractice 
insurance premiums have increased at a high rate in some areas of the 
country during the last few years. While we are not aware of any 
specific situations in which malpractice premiums have created issues 
of access to inpatient hospital services for Medicare beneficiaries, 
some hospitals have expressed concern that they may be compelled to 
curtail their current operations by the rate of increase in their 
malpractice premiums. Therefore, in the proposed rule, we invited 
comments on the effect of increases in malpractice insurance premiums 
on hospitals participating in the Medicare program, and whether 
increasing malpractice costs may pose access problems for Medicare 
beneficiaries.
    Comment: Several commenters from individual hospitals and hospital 
associations commented on the trends in malpractice insurance premiums 
and the effects, or potential effects, of higher malpractice premiums 
on access to care. Several of these commenters provided detailed 
information about the specific experiences of individual hospitals or 
groups of hospitals.
    Response: We appreciate the commenters' responses and especially 
the detailed information provided by several of the commenters. We will 
study this information carefully as we continue to consider whether 
increasing malpractice costs may pose access problems for Medicare 
beneficiaries.

V. Changes to the PPS for Capital-Related Costs

A. Background

    Section 1886(g) of the Act requires the Secretary to pay for the 
capital-related costs of inpatient acute hospital services ``in 
accordance with a PPS established by the Secretary.'' Under the 
statute, the Secretary has broad authority in establishing and 
implementing the PPS for hospital inpatient capital-related costs. We 
initially implemented the PPS for capital-related costs in the August 
30, 1991 IPPS final rule (56 FR 43358), in which we established a 10-
year transition period to change the payment methodology for Medicare 
hospital inpatient capital-related costs from a reasonable cost-based 
methodology to a prospective methodology (based fully on the Federal 
rate).
    Federal fiscal year (FY) 2001 was the last year of the 10-year 
transition period established to phase in the PPS for hospital 
inpatient capital-related costs. For cost reporting periods beginning 
in FY 2002, capital PPS payments are based solely on the Federal rate 
for the acute care hospitals (other than certain new hospitals and 
hospitals receiving certain exception payments). The basic methodology 
for determining capital prospective payments using the Federal rate is 
set forth in Sec.  412.312. For the purpose of calculating payments for 
each discharge, the standard Federal rate is adjusted as follows:
    (Standard Federal Rate) x (DRG Weight) x (Geographic Adjustment 
Factor (GAF)) x (Large Urban Add-on, if applicable) x (COLA Adjustment 
for hospitals located in Alaska and Hawaii) x (1 + Capital DSH 
Adjustment Factor + Capital IME Adjustment Factor, if applicable)
    Hospitals also may receive outlier payments for those cases that 
qualify under the thresholds established for each fiscal year as 
specified in Sec.  412.312(c) of the existing regulations.
    The regulations at Sec.  412.348(f) provide that a hospital may 
request an additional payment if the hospital incurs unanticipated 
capital expenditures in excess of $5 million due to extraordinary 
circumstances beyond the hospital's control. This policy was originally 
established for hospitals during the 10-year transition period, but as 
we discussed in the August 1, 2002 IPPS final rule (67 FR 50102), we 
revised the regulations at Sec.  412.312 to specify that payments for 
extraordinary circumstances are also made for cost reporting periods 
after the transition period (that is, cost reporting periods beginning 
on or after October 1, 2001).
    During the transition period, under Sec. Sec.  412.348(b) through 
(e), eligible hospitals could receive regular exception payments. These 
exception payments guaranteed a hospital a minimum payment percentage 
of its Medicare allowable capital-related costs depending on the class 
of hospital (Sec.  412.348(c)), but were available only during the 10-
year transition period. After the end of the transition period, 
eligible hospitals can no longer receive this exception payment. 
However, even after the transition period, eligible hospitals receive 
additional payments under the special exceptions provisions at Sec.  
412.348(g), which guarantees all eligible hospitals a minimum payment 
of 70 percent of its Medicare allowable capital-related costs provided 
that special exceptions payments do not exceed 10 percent of total 
capital IPPS payments. Special exceptions payments may be made only for 
the 10 years from the cost reporting year in which the hospital 
completes its qualifying project, and the hospital must have completed 
the project no later than the hospital's cost reporting period 
beginning before October 1, 2001. Thus, an eligible hospital may 
receive special exceptions payments for up to 10 years beyond the end 
of the capital PPS transition period. Hospitals eligible for special 
exceptions payments were required to submit documentation to the 
intermediary indicating the completion date of their project. (For more 
detailed information regarding the special exceptions policy under 
Sec.  412.348(g), refer to the August 1, 2001 IPPS final rule (66 FR 
39911 through 39914) and the August 1, 2002 IPPS final rule (67 FR 
50102).)
    Under the PPS for capital-related costs, Sec.  412.300(b) of the 
regulations defines a new hospital as a hospital that has operated 
(under current or previous ownership) for less than 2 years. (For more 
detailed information see the August 30, 1991 final rule (56 FR 43418).) 
During the 10-year transition period, a new hospital was exempt from 
the capital PPS for its first 2 years of operation and was paid 85 
percent of its reasonable costs during that period. Originally, this 
provision was effective only through the transition period and, 
therefore, ended with cost reporting periods beginning in FY 2002. 
Because we believe that special protection to new hospitals is also 
appropriate even after the transition period, as discussed in the 
August 1, 2002 IPPS final rule (67 FR 50101), we revised the 
regulations at Sec.  412.304(c)(2) to provide that, for cost reporting 
periods beginning on or after October 1, 2002, a new hospital (defined 
under Sec.  412.300(b)) is paid 85 percent of its allowable Medicare 
inpatient hospital capital-related costs through its first 2 years of 
operation, unless the new hospital elects to receive fully-prospective 
payment based on 100 percent of the Federal rate. (Refer to the August 
1, 2001 IPPS final rule (66 FR 39910) for a detailed discussion of the 
statutory basis for the system, the development and evolution of the 
system, the methodology used to determine capital-related payments to 
hospitals both during and after the transition period, and the policy 
for providing exception payments.)

B. Payments to Hospitals Located in Puerto Rico

    As explained in section III.G. of this preamble, operating PPS and 
capital PPS payments to hospitals located in Puerto Rico are currently 
paid based on a blend of the Federal rate and the Puerto Rico rate. The 
Puerto Rico capital rate is derived from the costs of Puerto Rico 
hospitals only, while the capital

[[Page 49185]]

Federal rate is derived from the costs of all acute care hospitals 
participating in the IPPS (including Puerto Rico). As also discussed in 
the section III.G. of this preamble, section 504 of Pub. L. 108-173 
increases the national portion of the operating IPPS payment for Puerto 
Rico hospitals from 50 percent to 75 percent and decreases the Puerto 
Rico portion of the operating IPPS payments from 50 percent to 25 
percent for discharges occurring on or after October 1, 2004. Under the 
broad authority of section 1886(g) of the Act, for the IPPS for 
capital-related costs, in the May 18, 2004 proposed rule, we proposed 
to revise the calculation of capital IPPS payments to hospitals located 
in Puerto Rico to parallel the change in operating IPPS payments to 
hospitals located in Puerto Rico, for discharges occurring on or after 
October 1, 2004. Therefore, we proposed to revise Sec.  412.374 of the 
regulations to provide that, for discharges occurring on or after 
October 1, 2004, payments under the IPPS for capital-related costs to 
hospitals located in Puerto Rico would be based on a blend of 25 
percent of the Puerto Rico capital rate and 75 percent of the capital 
Federal rate.
    We did not receive any comments on our proposal to increase the 
national portion of the capital IPPS payment for Puerto Rico hospitals 
from 50 percent to 75 percent and decrease the Puerto Rico portion of 
the capital IPPS payment from 50 percent to 25 percent beginning in FY 
2005. Accordingly, as we proposed, we are revising Sec.  412.374 of the 
regulations to provide that, for discharges occurring on or after 
October 1, 2004, payments under the IPPS for capital-related costs to 
hospitals located in Puerto Rico will be based on a blend of 25 percent 
of the Puerto Rico capital rate and 75 percent of the capital Federal 
rate.
    As we noted in the May 18, 2004 proposed rule, this change will 
increase capital IPPS payments to hospitals located in Puerto Rico 
because the Federal capital rate is higher than the Puerto Rico capital 
rate. In addition, we noted that this change is similar to the change 
in capital IPPS payments made to hospitals located in Puerto Rico 
beginning in FY 1998 that had paralleled the statutory change in the 
Puerto Rico blended payment amount required for operating IPPS payments 
to hospitals located in Puerto Rico as mandated by section 4406 of 
Public Law 105-33 (62 FR 46012 and 46048, August 29, 1997).
    We did not receive any comments on our proposed blend change. 
Accordingly, we are adopting the proposed revision of Sec.  412.374 as 
final without change.

C. Exception Payment for Extraordinary Circumstances

    During the transition period, hospitals were guaranteed a minimum 
payment of a percentage of their Medicare allowable capital-related 
costs, depending on the class of hospital; that is, the minimum payment 
level for sole community hospitals was no greater than 90 percent, for 
urban hospitals with at least 100 beds meeting particular 
disproportionate share criteria, the minimum payment level was 80 
percent, and for all other hospitals, the minimum payment level was 70 
percent (Sec. Sec.  412.348(c)(i) through (iii)). Regular exception 
payments provided the means to ensure that hospitals received the 
minimum levels of capital payment. However, any amount by which a 
hospital's cumulative capital payments exceeded its cumulative minimum 
payment levels was deducted from the additional exception payment the 
hospital was eligible to receive (Sec.  412.348(e)). This type of 
exception payment ended with the end of the 10-year transition period.
    In the August 1, 2002 IPPS final rule (67 FR 50102), we specified 
that payments to hospitals that incur capital expenditures in excess of 
$5 million due to extraordinary circumstances beyond the hospital's 
control would be made for cost reporting periods after the transition 
period, that is, cost reporting periods beginning on or after October 
1, 2001, as established at Sec.  412.312(e). Generally, the exception 
payments for extraordinary circumstances are 85 percent of Medicare's 
share of allowable capital-related costs attributed to the 
extraordinary circumstances (100 percent for sole community hospitals). 
This amount is offset by any amount by which a hospital's cumulative 
payments exceed its cumulative minimum payment levels (adjusted for the 
extraordinary circumstances) under the PPS for capital-related costs. 
The minimum payment levels and the offsetting amounts were the same as 
those established for regular exceptions as indicated at Sec.  
412.348(f)(4). The regulation refers to the regular exception minimum 
payment levels at Sec.  412.348(c)(1) and the offsetting amounts at 
Sec.  412.348(e)(2).
    Because the regulations governing the regular exception payments, 
which include the minimum payment levels regulations at Sec.  
412.348(c) and the offsetting amounts at Sec.  412.348(e), were 
effective during the transition period only, we had not previously 
addressed whether or not the minimum payment levels under Sec.  
412.348(c) and the offsetting amounts at Sec.  412.348(e) remain 
applicable for extraordinary circumstances exceptions in the post-
transition period. In the August 1, 2002 IPPS final rule (67 FR 50102), 
we clarified our policy at a new Sec.  412.312(e) that exception 
payments for extraordinary circumstances continued to apply to periods 
beginning on or after October 1, 2001. When we added Sec.  412.312(e), 
we did not believe it was necessary to explain in the preamble that the 
minimum payment levels in Sec.  412.348(c) or the offsetting amounts in 
Sec.  412.348(e) were incorporated into Sec.  412.312(e). However, in 
order to avoid any confusion, in the May 18, 2004 IPPS proposed rule, 
we clarified our current policy that, although the minimum payment 
levels established at Sec.  412.348(c)(1) are no longer in effect, they 
continue to be relevant in order to calculate the extraordinary 
circumstances exception payments after the end of the transition 
period. The extraordinary exception payment calculation incorporates 
the minimum payment levels as well as the offsetting deduction for 
cumulative payments. We further indicated that, although the regular 
exception payments themselves have expired, it has always been our 
policy that the minimum payment levels will continue to be part of the 
formula for calculating extraordinary exception payments after the end 
of the transition period. In the May 18, 2004 proposed rule, we 
proposed to amend Sec.  412.312(e) to reflect our current policy that, 
for cost reporting periods beginning on or after October 1, 2001, the 
minimum payment levels established at Sec.  412.348(c)(1) are part of 
the formula for calculating extraordinary circumstances exception 
payments.
    Similarly, in the May 18, 2004 proposed rule, we clarified our 
current policy that the offsetting amounts established at Sec.  
412.348(e)(2) also are part of the formula for determining 
extraordinary circumstances exception payments after the end of the 
transition period, in spite of the fact that the regular exception 
payment provision that included the offsetting amounts at Sec.  
412.348(e)(2) expired at the end of the transition period. Accordingly, 
we proposed to revise Sec.  412.348(e) to clarify that, for cost 
reporting periods beginning on or after October 1, 2001, the offsetting 
amounts established at Sec.  412.348(e)(2) remain in effect for 
extraordinary circumstances exception payments.
    In addition, we also proposed to revise the period of time used to 
determine the offsetting amounts in

[[Page 49186]]

Sec.  412.348(e)(2). Under existing regulations, the additional payment 
for extraordinary circumstances is offset by any amount by which a 
hospital's cumulative payments exceed its cumulative minimum payment 
levels under the IPPS for capital-related costs. In order to determine 
this offsetting amount, a hospital must keep a record of the difference 
between its cumulative capital payments and its cumulative minimum 
payment levels since it became subject to the PPS for capital-related 
costs. For instance, under existing regulations, if a hospital would be 
eligible for an additional payment for extraordinary circumstances in 
FY 2005 and the hospital had been subject to the IPPS for capital-
related cost since that IPPS was implemented in FY 1992, the offsetting 
amount would be the difference in the hospital's cumulative capital 
payments and its cumulative minimum payment levels for the past 13 
years. Similarly, under existing regulations, if a hospital would be 
eligible for an additional payment for extraordinary circumstances in 
FY 2012 and the hospital had been subject to the capital IPPS since it 
was implemented in FY 1992, the offsetting amount would be the 
difference in the hospital's cumulative capital payments and its 
cumulative minimum payment levels for the past 20 years.
    We believe that when the provisions for exception payments were 
originally implemented with the start of capital IPPS in FY 1992, it 
was anticipated that the offsetting amounts at Sec.  412.348(e)(2) 
would be determined based on a period of no longer than 10 years. 
However, under existing regulations, exception payments for 
extraordinary circumstances are offset by the difference in the 
hospital's cumulative payments and its cumulative minimum payment 
levels since it became subject to the IPPS for capital-related-costs, 
which for most hospitals is over 13 years. Therefore, in the May 18, 
2004 proposed rule, for cost reporting periods beginning during FY 2005 
and thereafter, we proposed to revise Sec.  412.312(e) to specify that 
the offsetting amounts in Sec.  412.348(e)(2) would be based on the 
hospital's capital payments and minimum payment levels from the most 
recent 10 years rather than from the entire period of time the hospital 
has been subject to the PPS for capital-related costs.
    We did not receive any comments on our proposed changes to the 
provision for exceptions payments for extraordinary circumstances after 
the transition period. Accordingly, we are revising Sec.  412.312(e) to 
clarify the minimum payment levels and offsetting amounts that are 
applicable in determining exceptions payments for extraordinary 
circumstances after the transition period. Specifically, as proposed, 
we are amending Sec.  412.312(e) to specify that the minimum payment 
levels established at Sec.  412.348(c)(1) are part of the formula for 
calculating extraordinary circumstances exception payments for cost 
reporting periods beginning on or after October 1, 2001. In addition, 
as proposed, we are amending Sec.  412.348(e) to specify that the 
offsetting amounts established at Sec.  412.348(e)(2) remain in effect 
for extraordinary circumstances exception payments for cost reporting 
periods beginning on or after October 1, 2001. As we proposed, we are 
also amending Sec.  412.312(e) to specify that for cost reporting 
periods beginning during FY 2005 and thereafter, the offsetting amounts 
in Sec.  412.348(e)(2) will be based on the hospital's capital payments 
and minimum payment levels from the most recent 10 years rather than 
from the entire period of time the hospital has been subject to the PPS 
for capital-related costs.
    Under this finalized policy, if a hospital has been paid under the 
IPPS for capital-related costs for less than 10 years, the offsetting 
amounts will be based on the hospital's capital payments and minimum 
payment levels beginning with the date the hospital became subject to 
the PPS for capital-related costs. For example, if a hospital is 
eligible for an additional payment for extraordinary circumstances in 
FY 2005 and the hospital had been subject to the IPPS for capital-
related costs since FY 1992 (13 years), the offsetting amounts used in 
the calculation of the extraordinary circumstances exception payment 
will be based on the hospital's cumulative capital PPS payments and 
cumulative minimum payment levels for the hospital's cost reporting 
period beginning during FY 1995 through FY 2004. Similarly, if a 
hospital is eligible for an additional payment for extraordinary 
circumstances in FY 2005 and the hospital had only been subject to the 
PPS for capital-related costs since FY 2000 (5 years), the offsetting 
amounts used in the calculation of the extraordinary circumstances 
exception payment will be based on the hospital's cumulative capital 
IPPS payments and cumulative minimum payment levels for the hospital's 
cost reporting periods beginning during FY 2000 through FY 2004

D. Treatment of Hospitals Previously Reclassified for the Operating 
IPPS Standardized Amounts

    As we discussed in section IV.C. of this preamble, prior to April 
1, 2003, the standardized amounts varied under the operating IPPS based 
on a hospital's geographic location (large urban versus other urban and 
rural areas). Furthermore, previously, a hospital could be reclassified 
to a large urban area by the MGCRB for the purpose of the standardized 
amount if certain criteria were met (as described in Part 412, Subpart 
L of the Medicare regulations).
    Similarly, the standard capital Federal rate under the PPS for 
capital-related costs is adjusted to reflect the higher costs incurred 
by hospitals located in large urban areas (large urban add-on at Sec.  
412.316), as well as for hospitals in urban areas with at least 100 
beds serving low-income patients (capital disproportionate share (DSH) 
adjustment at Sec.  412.320). In the past, if a rural or other urban 
hospital was reclassified to a large urban area for purposes of the 
operating IPPS standardized amount under Sec.  412.63, the hospital 
also was then eligible for a large urban add-on payment, as well as a 
DSH payment, under the IPPS for capital-related costs.
    Section 402(b) of the Consolidated Appropriations Resolution, 2003, 
Public Law 108-7, and section 402 of Public Law 108-89, (a Welfare 
Reform Act), provide that, for discharges occurring on or after April 
1, 2003 and before March 31, 2004, under the operating IPPS, all 
hospitals are paid based on the large urban standardized amount, 
regardless of geographic location or MGCRB redesignation. Section 
401(a) of Public Law 108-173 amended section 1886(d)(5)(A)(iv) by 
adding a subsection (II) that permanently equalizes the standardized 
amounts for large urban areas and for other urban and rural areas for 
discharges occurring on or after April 1, 2004.
    In addition, under section 1886(d) of the Act, a hospital may 
reclassify under the operating IPPS only for the purpose of either its 
standardized amount or its wage index adjustment, or both. As further 
specified in regulations at Sec.  412.230, a hospital may be 
reclassified for purposes of the standardized amount only if the area 
to which the hospital seeks redesignation has a higher standardized 
amount than the hospital currently receives. Because there are no 
longer differences in standardized amounts due to geographic 
classification as a result of the section 401 amendment, hospitals are 
no longer

[[Page 49187]]

eligible to reclassify solely for standardized amount purposes. 
Accordingly, as discussed in the May 18, 2004 proposed rule, the MGCRB 
denied all FY 2005 standardized amount reclassification requests. We 
note that although Public Law 108-7 and Public Law 108-89 also 
equalized the standardized amounts for all hospitals in FY 2004, 
because these laws were not enacted until after the MGCRB had already 
made its reclassification determinations for FY 2004, eligible 
hospitals received reclassification approval for the purposes of the 
standardized amount for FY 2004. However, in this case, Public Law 108-
173 was enacted before the MGCRB issued its reclassification decisions 
for FY 2005. Therefore, we did not propose that any hospital would be 
reclassified for the purpose of the standardized amounts in FY 2005.
    As we explained in the May 18, 2004 proposed rule, the changes to 
the operating IPPS described above have an effect on payments under the 
IPPS for capital-related costs. Rural and other urban hospitals that 
were previously eligible to receive the large urban add-on and DSH 
payments under the IPPS for capital-related costs if they reclassified 
to a large urban area for the purpose of the standardized amount under 
the operating IPPS, will no longer be reclassified, and therefore, will 
not be eligible to receive those additional payments under the IPPS for 
capital-related costs.
    Our analysis indicates that rural and other urban hospitals will 
gain approximately $0.5 billion in FY 2005 in operating IPPS payments 
due to the equalization of the standardized amounts compared to a 
relatively small adjustment to payments for capital-related costs under 
the IPPS. We understand that Congress was aware of the effect of the 
equalization of the standardized amounts on the rural and other urban 
hospitals' adjustments under the IPPS for capital-related costs. This 
approach is consistent with section 4203 of the BBA, which prevented 
hospitals from reclassifying to a different area to get an additional 
payment solely for DSH purposes under the operating IPPS. The 
restriction at section 4203 clearly indicates Congress' intent to 
maintain the principle that reclassifications under section 1886(d) of 
the Act are only intended to be made for purposes of either the 
standardized amount or the wage index adjustment.
    Therefore, in the May 18, 2004 proposed rule, we clarified that, 
beginning in FY 2005, only hospitals geographically located in a large 
urban area (as defined in proposed revised Sec.  412.63(c)(6)) would be 
eligible for large urban add-on payments under the PPS for capital-
related costs under Sec.  412.312(b)(2)(ii) and Sec.  412.316(b). We 
proposed that, beginning in FY 2005, only hospitals serving low-income 
patients that are geographically located in an urban area (as defined 
in proposed new Sec.  412.64 and discussed in section IV.D. of this 
preamble) with 100 or more beds (or that meet the criteria in Sec.  
412.106(c)(2)) would be eligible for DSH payments under the PPS for 
capital-related costs under Sec.  412.320.
    We did not received any comments on the effect of the equalization 
of the operating IPPS standardized amounts on payments under the PPS 
for capital-related costs. Therefore, as we proposed, beginning in FY 
2005 and thereafter, only hospitals geographically located in a large 
urban area (as defined in revised Sec.  412.63(c)(6)) will be eligible 
for large urban add-on payments under the PPS for capital-related costs 
under Sec.  412.312(b)(2)(ii) and Sec.  412.316(b). Similarly, as we 
proposed, beginning in FY 2005 and thereafter, only hospitals serving 
low-income patients that are geographically located in an urban area 
(as defined in new Sec.  412.64 and discussed in section IV.D. of this 
preamble) with 100 or more beds (or that meet the criteria in Sec.  
412.106(c)(2)) will be eligible for DSH payments under the PPS for 
capital-related costs under Sec.  412.320.

E. Geographic Classification and Definition of Large Urban Area

1. Core-Based Statistical Areas
    As we discuss in greater detail in section III.B. of this preamble, 
we are adopting changes to the MSA criteria used to define hospital 
labor market areas based on the new Core-Based Statistical Areas (CBSA) 
definitions announced by OMB on June 6, 2003, which are based on 2000 
Census data. We currently define hospital labor market areas based on 
the definitions of Metropolitan Statistical Areas (MSAs), Primary MSAs 
(PMSAs), and New England County Metropolitan Areas (NECMAs) under 
standards issued by OMB in 1990. In addition, OMB designates 
Consolidated MSAs (CMSAs). A CMSA is a metropolitan area with a 
population of one million or more, comprised of two or more PMSAs 
(identified by their separate economic and social character). Under the 
operating PPS, the wage index is calculated and assigned to hospitals 
on the basis of the labor market area in which the hospital is located. 
For purposes of the hospital wage index, we use the PMSAs rather than 
CMSAs because they allow a more precise breakdown of labor costs. 
However, if a metropolitan area is not designated as part of a PMSA, we 
use the applicable MSA.
    As we discuss in sections III.B.3. and IV.C. of this preamble, in 
the May 18, 2004 proposed rule, we proposed to adopt OMB's new CBSA 
designations to define labor market areas for discharges occurring on 
or after October 1, 2004, which would be set forth in regulations under 
a proposed new Sec.  412.64. Currently, the large urban location 
adjustment under Sec.  412.316(b) and the DSH adjustment for certain 
urban hospitals under Sec.  412.320 for payments for capital-related 
costs rely on the existing geographic classifications set forth at 
Sec.  412.63. Because we proposed to adopt OMB's new CBSA designations 
for FY 2005 and thereafter, under proposed new Sec.  412.64, we 
proposed to revise Sec.  412.316(b) and Sec.  412.320(a)(1) to specify 
that, for discharges on or after October 1, 2004, the payment 
adjustments under these sections, respectively, would be based on the 
geographic classifications at proposed new Sec.  412.64.
    Comment: One commenter expressed concern that the implementation of 
the new MSA definitions (proposed Sec.  412.64) will result in some 
hospitals losing the 3-percent large urban add-on payment adjustment 
provided for at Sec.  412.316(b) that they previously qualified for 
under the current MSA definitions (at existing Sec.  412.63). The 
commenter recommended that we grandfather the large urban add-on 
payment adjustment for the affected hospitals or, alternatively, 
maintain the add-on for the affected hospitals for 5 years.
    Response: The commenter is correct that as a result of the 
implementation of the new MSA definitions, hospitals that had 
previously been located in a large urban area under the current MSA 
definitions, but will now be located in another urban or rural area 
under the new MSA definitions will no longer qualify for certain 
payment adjustments that they previously qualified for under the prior 
MSA definitions, including the 3-percent large urban add-on payment 
adjustment at Sec.  412.312(b)(2)(ii) and Sec.  412.316(b). As 
discussed previously, in the May 18, 2004 proposed rule, we solicited 
comments on the effect of the equalization of the operating IPPS 
standardized amount. Specifically, we discussed that rural and other 
urban hospitals that were previously eligible to receive the large 
urban add-on payment adjustment (and DSH payment adjustment) under the 
IPPS for capital-related costs if they reclassified to a

[[Page 49188]]

large urban area for the purpose of the standardized amount under the 
operating IPPS, will no longer be reclassified and, therefore, will not 
be eligible to receive those additional payments under the IPPS for 
capital-related costs beginning in FY 2005. As we noted previously, we 
received no comments on that clarification.
    One of the results of the decennial census is that changes in 
population data may affect a hospital's geographic classification under 
OMB's standards. We explain in further detail in section III.B. of this 
preamble the reason for adopting OMB's revised definitions for 
geographical statistical areas. The OMB announced the new MSAs based on 
Census 2000 data over a year ago (a copy of the June 6, 2003 
announcement may be obtained at the following Internet address: http://www.whitehouse.gov/omb/bulletins/fy04/b04-03.html). Although OMB's 
revised definitions were available early last summer, we did not 
propose to adopt the changes until FY 2005 so that we could thoroughly 
assess the impact of adopting these revised geographical criteria.
    In section III.B.3.d. of the preamble, we also discuss the 
establishment of a transition period for the wage index to help 
mitigate the change from the current MSAs to the new MSAs based on the 
OMB's revised CBSA definitions. However, as we note below in section 
III. of the Addendum to this final rule, total payments to hospitals 
under the IPPS are relatively unaffected by changes in the capital PPS 
payments since capital IPPS payments constitute about 10 percent of 
hospital's total (operating and capital) PPS payments and in addition, 
the changes we proposed are only a small percentage of total capital 
IPPS payments. The large urban add-on payment adjustment under section 
Sec.  412.312(b)(2)(ii) and Sec.  412.316(b) provides for an additional 
payment equal to 3 percent of the amount otherwise payable to the 
hospital based on the capital Federal rate. Because the large urban 
add-on payment adjustment is a very small percentage of a hospital's 
total IPPS payments, we do no estimate a ``significant payment 
implication'' to those hospitals that will no longer be eligible for 
the large urban add-on payment adjustment under the new MSA 
definitions. Therefore, we do not believe that it is necessary to 
grandfather or maintain the large urban add-on for the hospitals that 
previously qualified for that adjustment under the current MSA 
definitions. As previously discussed, we proposed and adopted as final 
our policy that, beginning in FY 2005 and thereafter, only those 
hospitals geographically located in a large urban area (as defined in 
revised Sec.  412.63(c)(6)) will be eligible for the large urban add-on 
payment adjustment provided under Sec.  412.312(b)(2)(ii) and Sec.  
412.316(b). Similarly, beginning in FY 2005 and thereafter, to receive 
capital IPPS DSH payments under Sec.  412.320, a hospital will need to 
be geographically located in an urban area (as defined in new Sec.  
412.64) and meet all other requirements of Sec.  412.320. Accordingly, 
we are adopting our proposed revisions as final without change.
2. Metropolitan Divisions
    Under the revised MSA criteria based on CBSAs, a Metropolitan 
Division is a county or group of counties located within an MSA with a 
core population of at least 2.5 million, representing an employment 
center, plus adjacent counties associated with the main county or 
counties through commuting ties (see section III.B.3.b. of this 
preamble for further details). In the May 18, 2004 proposed rule, to 
conform to the proposed changes to the MSA criteria discussed in 
section III.B. of this preamble, we proposed to use the Metropolitan 
Divisions where applicable under the CBSA definitions. Thus, similar to 
our treatment of PMSAs as labor market areas where applicable, we 
proposed to use the Metropolitan Divisions rather than MSAs to define 
labor market areas.
    Currently, under the existing MSA criteria, a large urban area is 
defined at existing Sec.  412.63(c)(6) as an MSA with a population of 
more than 1,000,000 or a NECMA with a population of more than 970,000 
based on the most recent available population data published by the 
Bureau of the Census. As noted above, we currently use the PMSAs rather 
than CMSAs to define labor market areas. Accordingly, we currently 
determine large urban areas under existing Sec.  412.63(c)(6) based on 
the most recent available population data for each PMSA rather than the 
CMSA. Similarly, because we proposed to treat Metropolitan Divisions of 
MSAs as labor market areas under the proposed changes based on CBSA 
designations, we proposed to designate large urban areas based on the 
most recent available population data for each Metropolitan Division, 
rather than the MSA.
    As discussed in section III.B.3.b. of the proposed rule and this 
final rule under the CBSA definitions, there are 11 MSAs containing 
Metropolitan Divisions: Boston; Chicago; Dallas; Detroit; Los Angeles; 
Miami; New York; Philadelphia; San Francisco; Seattle; and Washington, 
DC. Within these 11 areas are a total of 29 Metropolitan Divisions, 
which would be treated as MSAs. Of those 29 MSAs, 23 meet the 
definition of large urban area under Sec.  412.63(c)(6) (as denoted in 
Tables 4A and 4B in the Addendum to this final rule). Under the 
proposed and final changes to the MSA criteria, there are a total of 62 
large urban areas, including those 23 Metropolitan Divisions, as 
denoted in Tables 4A and 4B in the Addendum to this final rule.
    In the May 18, 2004 proposed rule, we proposed to clarify that the 
current definition of large urban area at existing Sec.  412.63(c)(6) 
would remain in effect for the purpose of the large urban add-on 
adjustment to the Federal rate under the PPS for capital-related costs 
under Sec. Sec.  412.312(b)(2)(ii) and 412.316(b). With the 
equalization of the operating standardized amounts (as discussed in 
section IV.D. of this preamble), we proposed to revise the regulations 
under Sec.  412.63(c), and make them effective for FYs 1984 through 
2004, and to add a new Sec.  412.64 that would be applicable for FYs 
2005 and thereafter. We indicated that because we would compute a 
single standardized amount for hospitals located in all areas beginning 
in FY 2005, the term ``large urban area'' is no longer applicable under 
the operating PPS and therefore, a definition of large urban area would 
not be included under the proposed new Sec.  412.64. However, the term 
``large urban area'' continues to be applicable under the capital IPPS 
for the large urban add-on adjustment at Sec. Sec.  412.312(b)(2)(ii) 
and 412.316(b). Therefore, we proposed to revise Sec. Sec.  
412.312(b)(2)(ii) and 412.316(b) to state that the definition of large 
urban area set forth at Sec.  412.63(c)(6) would continue to be in 
effect under the capital PPS for discharges occurring on or after 
October 1, 2004. In addition, since under the new definitions, NECMAs 
no longer exist, we clarify as an interpretive matter that the 
reference in Sec.  412.63(c)(6) to NECMAs will be interpreted as 
referring to New England MSAs.
    We did not receive any comments on our proposed clarification that 
the current definition of large urban area at existing Sec.  
412.63(c)(6) would remain in effect for the purpose of the large urban 
add-on adjustment to the capital IPPS Federal rate under Sec. Sec.  
412.312(b)(2)(ii) and 412.316(b). Accordingly, as we proposed, we are 
revising Sec. Sec.  412.312(b)(2)(ii) and 412.316(b) to state that the 
definition of large urban area set forth at Sec.  412.63(c)(6) will 
continue to be in effect under the capital IPPS for discharges 
occurring on or after October 1, 2004.

[[Page 49189]]

VI. Changes for Hospitals and Hospital Units Excluded from the IPPS

A. Payments to Excluded Hospitals and Hospital Units (Sec. Sec.  
413.40(c), (d), and (f))

1. Payments to Existing Excluded Hospitals and Hospital Units
    Section 1886(b)(3)(H) of the Act (as amended by section 4414 of 
Public Law 105-33) established caps on the target amounts for certain 
existing hospitals and hospital units excluded from the IPPS for cost 
reporting periods beginning on or after October 1, 1997 through 
September 30, 2002. For this period, the caps on the target amounts ( 
as defined at Sec.  413.40(c)(4)(iii)(B)) applied to the following 
three classes of excluded hospitals or units: psychiatric hospitals and 
units, rehabilitation hospitals and units, and LTCHs. In accordance 
with section 1886(b)(3)(H)(i) of the Act and effective for cost 
reporting periods beginning on or after October 1, 2002, payments to 
these classes of existing excluded hospitals or hospital units are no 
longer subject to caps on the target amounts.
    In accordance with existing Sec. Sec.  413.40(c)(4)(ii) and 
(d)(1)(i) and (ii), where applicable, excluded psychiatric hospitals 
and units continue to be paid on a reasonable cost basis, and payments 
are based on their Medicare inpatient operating costs, not to exceed 
the ceiling, up to the date that an inpatient psychiatric facility PPS 
discussed in section VII.A. of this preamble becomes effective. The 
ceiling is computed using the hospital's or unit's target amount from 
the previous cost reporting period, updated by the rate-of-increase 
specified in Sec.  413.40(c)(3)(viii) of the regulations, and then 
multiplying this figure by the number of Medicare discharges.
    Effective for cost reporting periods beginning on or after October 
1, 2002, rehabilitation hospitals and units are paid in accordance with 
the IRF PPS at 100 percent of the Federal rate. In addition, effective 
for cost reporting periods beginning on or after October 1, 2002, LTCHs 
are no longer paid on a reasonable cost basis, but are paid under a 
DRG-based PPS. However, as part of the PPS for LTCHs, we established a 
5-year transition period from reasonable cost-based reimbursement to a 
fully Federal PPS. Under the LTCH PPS, a LTCH that is subject to the 
blend methodology may elect to be paid 100 percent of the Federal 
prospective rate. We have proposed, but not finalized, an inpatient 
psychiatric facility (IPF) prospective payment system under which 
psychiatric hospitals and psychiatric units would no longer be paid on 
a reasonable cost basis but would be paid on a prospective per diem 
basis. (Sections VI.A.3, 4, and 5 of this preamble contain a more 
detailed discussion of the IRF PPS, the LTCH PPS and the proposed IPF 
PPS.)
2. Updated Caps for New Excluded Hospitals and Units
    Section 1886(b)(7) of the Act established a payment limitation for 
new psychiatric hospitals and units, rehabilitation hospitals and 
units, and long-term care hospitals that first receive payment as a 
hospital or unit excluded from the IPPS on or after October 1, 1997. A 
discussion of how the payment limitation was calculated can be found in 
the August 29, 1997 final rule with comment period (62 FR 46019); the 
May 12, 1998 final rule (63 FR 26344); the July 31, 1998 final rule (63 
FR 41000); and the July 30, 1999 final rule (64 FR 41529).
    The amount of payment for a ``new'' psychiatric hospital or unit 
(as defined at 42 CFR 413.40(f)(2)(ii) will be determined as follows:
     Under existing Sec.  413.40(f)(2)(ii), for the first two 
12-month cost reporting periods, the amount of payment is the lesser 
of: (1) The operating costs per case; or (2) 110 percent of the 
national median (as estimated by the Secretary) of the target amounts 
for the same class of hospital or unit for cost reporting periods 
ending during FY 1996, updated by the hospital market basket increase 
percentage to the fiscal year in which the hospital or unit first 
receives payments under section 1886 of the Act, as adjusted for 
differences in area wage levels. The amount of payment, as determined 
above, is also referred to as a payment limitation or target amount 
since the payment for the first 2 years of a hospital or unit cannot 
exceed the amount determined under Sec.  413.40(f)(2)(ii).
     Under existing Sec.  413.40(c)(4)(v), for cost reporting 
periods following the hospital's or unit's first two 12-month cost 
reporting periods, the target amount is equal to the amount determined 
under Sec.  413.40(f)(2)(ii) for the preceding cost reporting period, 
updated by the applicable hospital market basket increase percentage to 
the third cost reporting period.
    The amounts included in the following table are the payment amounts 
(or payment limitations) reflecting the updated 110 percent of the 
national median target amounts of new excluded psychiatric hospitals 
and units. The payment amount is for cost reporting periods beginning 
during FY 2005. These figures have been updated with the most recent 
data available to reflect the projected market basket increase 
percentage of 3.3 percent. This projected percentage change in the 
market basket reflects the average change in the price of goods and 
services purchased by hospitals to furnish inpatient hospital services 
(as projected by the Office of the Actuary of CMS based on its 
historical experience with the IPPS). For a new provider, the labor-
related share of the target amount is multiplied by the appropriate 
geographic area wage index, without regard to IPPS reclassifications, 
and added to the nonlabor-related share in order to determine the per 
case payment limitation on payment under the statutory payment 
methodology for new providers (section 1886(b)(7)(A)(i) of the Act and 
Sec.  413.40(f)(2)(ii) of the regulations).
[GRAPHIC] [TIFF OMITTED] TR11AU04.066

    Effective for cost reporting periods beginning on or after October 
1, 2002, this payment limitation was no longer applicable to new LTCHs 
as defined under Sec.  412.23(e)(4), since LTCHs with a first cost 
reporting period beginning on or after October 1, 2002, are paid 100 
percent of the Federal rate for LTCH PPS. However, new LTCHs, as 
defined under Sec.  413.40(f)(2)(ii), which were paid as LTCHs before 
the effective date of the LTCH PPS, were eligible for a blended payment 
for up to 5 years under the LTCH PPS for cost reporting periods 
beginning on or after October 1, 2002.

[[Page 49190]]

Those hospitals would have had their payments determined using the 
payment limitation for use in determining the TEFRA portion of this 
blend. However, an update of this payment limitation is no longer 
necessary after FY 2002 because the same payment limitation published 
for FY 2002 was effective for 2 years for ``new'' LTCHs as defined 
under Sec.  413.40(f)(2)(ii), including those ``new'' LTCHs with a 
first cost reporting period beginning in FY 2002. A target amount would 
be determined for any subsequent years that those ``new'' LTCHs were 
eligible for a blended payment under the LTCH PPS. Thereafter, the LTCH 
is paid under the LTCH PPS. Accordingly, since a new hospital 
established on or after October 1, 2002 is no longer subject to this 
payment limitation and any new hospital as defined at Sec.  
413.40(f)(2)(ii) would also not have its FY 2002 payment limitation for 
new LTCHs as defined under Sec.  413.40(f)(2)(ii).
    A freestanding inpatient rehabilitation hospital, an inpatient 
rehabilitation unit of an acute care hospital, and an inpatient 
rehabilitation unit of a CAH are collectively referred to as an IRF.
    Effective for cost reporting periods beginning on or after October 
1, 2002, this payment limitation is also no longer applicable to new 
rehabilitation hospitals and units because they are paid 100 percent of 
the Federal prospective rate under the IRF PPS. Therefore, it is also 
no longer necessary to update the payment limitation for new 
rehabilitation hospitals or units.
3. Implementation of a PPS for IRFs
    Section 1886(j) of the Act, as added by section 4421(a) of Public 
Law 105-33, provided for the phase-in of a case-mix adjusted PPS for 
inpatient hospital services furnished by a rehabilitation hospital or a 
rehabilitation hospital unit (referred to in the statute as 
rehabilitation facilities) for cost reporting periods beginning on or 
after October 1, 2000, and before October 1, 2002, with a fully 
implemented PPS for cost reporting periods beginning on or after 
October 1, 2002. Section 1886(j) of the Act was amended by section 125 
of Public Law 106-113 to require the Secretary to use a discharge as 
the payment unit under the PPS for inpatient hospital services 
furnished by rehabilitation facilities and to establish classes of 
patient discharges by functional-related groups. Section 305 of Public 
Law 106-554 further amended section 1886(j) of the Act to allow 
rehabilitation facilities, subject to the blend methodology, to elect 
to be paid the full Federal prospective payment rather than the 
transitional period payments specified in the Act.
    On August 7, 2001, we issued a final rule in the Federal Register 
(66 FR 41316) establishing the PPS for inpatient rehabilitation 
facilities, effective for cost reporting periods beginning on or after 
January 1, 2002. There was a transition period for cost reporting 
periods beginning on or after January 1, 2002 and ending before October 
1, 2002. For cost reporting periods beginning on or after October 1, 
2002, payments are based entirely on the Federal prospective payment 
rate determined under the IRF PPS.
4. Implementation of a PPS for LTCHs
    In accordance with the requirements of section 123 of Public Law 
106-113, as modified by section 307(b) of Public Law 106-554, we 
established a per discharge, DRG-based PPS for LTCHs as described in 
section 1886(d)(1)(B)(iv) of the Act for cost reporting periods 
beginning on or after October 1, 2002, in a final rule issued on August 
30, 2002 (67 FR 55954). The LTCH PPS uses information from LTCH 
hospital patient records to classify patients into distinct LTC-DRGs 
based on clinical characteristics and expected resource needs. Separate 
payments are calculated for each LTC-DRG with additional adjustments 
applied.
    We published in the Federal Register on May 7, 2004, a final rule 
(69 FR 25673) that updated the payment rates for the LTCH PPS and made 
policy changes effective for a new LTCH PPS rate year of July l, 2004, 
through June 30, 2005. The 5-year transition period from reasonable 
cost-based reimbursement to the fully Federal prospective rate will end 
with cost reporting periods beginning on or after October 1, 2005 and 
before October 1, 2006.
5. Development of a PPS for IPFs
    Section 124 of the Medicare, Medicaid and SCHIP Balanced Budget 
Refinement Act of 1999 (BBRA) requires the development of a per diem 
prospective payment system (PPS) for payment of inpatient hospital 
services furnished in psychiatric hospitals and psychiatric units of 
acute care hospitals (inpatient psychiatric facilities (IPFs)). We 
published a proposed rule to implement the IPF PPS on November 28, 2003 
(68 FR 66920). We published a proposed rule to implement the IPF PPS on 
November 28, 2003 (68 FR 66920). On January 30, 2004, we published a 
notice to extend the comment period for 30 additional days (69 FR 
4464). The comment period closed on March 26, 2004.
    Under the proposed rule, we would compute a Federal per diem base 
rate to be paid to all IPFs based on the sum of the average routine 
operating, ancillary, and capital costs for each patient day of 
psychiatric care in an IPF adjusted for budget neutraility. The Federal 
per diem base rate would be adjusted to reflect certain characteristics 
such as age, specified DRGs, and selected high-cost comorbidities, and 
certain facility characteristics such as wage index adjustment, rural 
location, and indirect teaching costs.
    The November 28, 2003 proposed rule assumed an April 1, 2004 
effective date for the purpose of ratesetting and calculating impacts. 
However, we are still in the process of analyzing public comments and 
developing a final rule for publication. The effective date of the IPF 
PPS would occur 5 months following publication of the final rule.
6. Technical Changes and Corrections
a. Change Related to Establishment of Payments for Excluded Hospitals
    We have become aware of a number of technical errors in the 
existing regulations governing how we determine payments to hospitals 
that are excluded from the IPPS. The existing regulations under Sec.  
413.40 set forth requirements for establishing the ceiling on the rate 
of increase in operating costs per case for hospital inpatient services 
furnished to Medicare beneficiaries that will be recognized as 
reasonable for purposes of determining the amount of Medicare payments. 
The rate-of-increase ceiling applicable to cost reporting periods has 
been adjusted a number of times since it was first applied for hospital 
cost reporting periods beginning on or after October 1, 1982. In 
revising the regulations over the years to reflect the different 
applicable adjustments for cost reporting periods for specific 
providers, we have inadvertently overlooked updating or conforming 
Sec.  413.40 to reflect various statutory changes. We note that, 
although we erroneously omitted the technical changes in the regulation 
text, we did, in fact, comply with the changes required by the statute 
when determining the rate-of-increase ceiling. Therefore, in the May 
18, 2004 proposed rule (69 FR 28323), we proposed to make several 
changes to Sec.  413.40(c)(4)(iii) in order to conform it to section 
1886(b)(3)(J) of the Act. These changes are as follows: (1) In Sec.  
413.40(c)(4)(iii)(A)(1) and (c)(4)(iii)(B)(4)(i), the phrase ``on or 
after October 1, 2001'', should read ``during FY 2001''; and in Sec.  
413.40(c)(4)(iii)(A)(2), the phrase ``on

[[Page 49191]]

or after October 1, 2000'' should read ``during FY 2001''. In order to 
include pertinent changes that were erroneously omitted from the 
regulatory text and to conform the text to section 1886(b)(2)(A) of the 
Act, we proposed to delete the phrase ``and ending before October 1, 
2000'' in Sec.  413.40(d)(4)(i) because, in section 1886(b)(2)(A) of 
the Act, there is no ending date for the continuous improvement bonus 
payment. In addition, at Sec.  413.40(d)(4)(ii), we proposed to delete 
the word ``ending'' from the introductory phrase so that the phrase 
would read, ``For cost reporting periods beginning on or after October 
1, 2000 and before September 30, 2001.'' The word ``ending'' in the 
existing language at best limits the provision to cost reporting 
periods beginning on October 1, 2000. The provision was intended to 
apply to cost reporting periods beginning during all of FY 2001.
    We did not receive any public comments on this proposal and, 
therefore, are adopting it as final without modification.
b. Technical Correction Related to Long-Term Care Hospitals
    In the June 6, 2003 Federal Register (68 FR 34122), we published a 
final rule establishing the annual update of the payment rates for the 
Medicare prospective payment system for inpatient hospital services 
provided by LTCHs. In that final rule, we added a new paragraph (h)(6) 
to Sec. Sec.  412.22. This paragraph eliminated the bed size limitation 
for pre-1997 LTCHs with satellite facilities once the LTCH is paid at 
100 percent of the Federal rate.
    In the August 1, 2003 Federal Register (68 FR 45674), we published 
a final rule that established the annual update for payment rates for 
the Medicare prospective payment system for inpatient hospital services 
provided by IRFs. The IRF PPS final rule added a new paragraph (h)(7) 
to Sec. Sec.  412.22. Through an inadvertent error, in the August 1, 
2003 IRF PPS final rule, we removed and reserved Sec. Sec.  
412.22(h)(6) that was added by the June 6, 2003 LTCH PPS final rule. 
Therefore, we are correcting this error by adding a new paragraph 
Sec. Sec.  412.22(h)(6) to reinstate the regulatory language from the 
June 6, 2003 LTCH PPS final rule.
7. Report of Adjustment (Exception) Payments
    Section 4419(b) of Public Law 105-33 requires the Secretary to 
publish annually in the Federal Register a report describing the total 
amount of adjustment (exception) payments made to excluded hospitals 
and units, by reason of section 1886(b)(4) of the Act, during the 
previous fiscal year.
    The process of requesting, adjudicating, and awarding an adjustment 
payment is likely to occur over a 2-year period or longer. First, an 
excluded hospital or unit must file its cost report for a fiscal year 
with its intermediary within 5 months after the close of its cost 
reporting period. The fiscal intermediary then reviews the cost report 
and issues a Notice of Program Reimbursement (NPR) within approximately 
2 months after the filing of the cost report. If the hospital's 
operating costs are in excess of the ceiling, the hospital may file a 
request for an adjustment payment within 6 months from the date of the 
NPR. The intermediary, or CMS, depending on the type of adjustment 
requested, then reviews the request and determines if an adjustment 
payment is warranted. This determination is often not made until more 
than 6 months after the date the request is filed. Therefore, it is not 
possible to provide data in this final rule. However, in an attempt to 
provide interested parties with data on the most recent adjustments for 
which we do have data, we are publishing data on adjustments that were 
processed by the fiscal intermediary or CMS during FY 2003.
    The table below includes the most recent data available from the 
fiscal intermediaries and CMS on adjustment payments that were 
adjudicated during FY 2003. As indicated above, the adjustments made 
during FY 2003 only pertain to cost reporting periods ending in years 
prior to FY 2002. Total adjustment payments awarded to excluded 
hospitals and units during FY 2003 are $11,931.305. The table depicts 
for each class of hospitals, in the aggregate, the number of adjustment 
requests adjudicated, the excess operating cost over ceiling, and the 
amount of the adjustment payment.
[GRAPHIC] [TIFF OMITTED] TR11AU04.067

B. Criteria for Classification of Hospitals-Within-Hospitals

    Existing regulations at Sec.  412.22(e) define a hospital-within-a-
hospital as a hospital that occupies space in a building also used by 
another hospital, or in one or more separate buildings located on the 
same campus as buildings used by another hospital. Moreover, existing 
Sec.  412.22(f) provides for the grandfathering of hospitals-within-a-
hospitals that were in existence on or before September 30, 1995.
    One of the goals of our hospital-within-a-hospital regulations at 
Sec.  412.22(e) has been to prevent a LTCH co-located with an acute 
care hospital to function as a unit of that hospital, a situation 
precluded under section 1886(d)(1)(B) of the Act. This policy protects 
the integrity of the IPPS by ensuring that costly, long-stay patients 
who could reasonably continue treatment in that setting would not be 
unnecessarily discharged to an onsite LTCH, a behavior that would skew 
and undermine the Medicare IPPS DRG system. Further, there is concern 
that the hospital-within-hospital configuration could result in patient 
admission, treatment, and discharge patterns that are guided more by 
attempts to maximize Medicare payments than by patient welfare. We 
believe that the unregulated linking of an IPPS hospital and a hospital 
excluded from the IPPS could lead to two Medicare payments for what was 
essentially one episode of patient care.
    In the September 1, 1994 IPPS final rule (59 FR 45389), we first 
discussed hospitals-within-hospitals, describing them as entities that 
were manipulating

[[Page 49192]]

the conditions of participation (COPs) for hospitals under Medicare, 
set forth in regulations at 42 CFR Part 482, to permit them to receive 
exclusion from the prospective payment systems. Specifically, these 
hospitals have begun to organize what they themselves refer to as the 
`hospital-within-a-hospital' model. Under this model, an entity may 
operate in space leased from a hospital, and have most or all services 
furnished under arrangements by employees of the lessor hospital. The 
newly organized entity may be operated by a corporation formed and 
controlled by the lessor hospital, or by a third entity that controls 
both. In either case, the new entity seeks State licensure and Medicare 
participation as a hospital, demonstrates that it has an average length 
of stay of over 25 days, and obtains an exclusion from the IPPS. The 
effect of this process is to extend the long-term care hospital 
exclusion to what is, for all practical purposes, a ``long-term care 
unit.'' We noted that the averaging concept that underlies the IPPS 
recognizes that some patients will stay longer and consume more 
resources than expected, while others will have shorter, less costly 
stays. We envisioned that abuse of the PPSs could result if an acute 
care hospital under the IPPS ``diverted all long-stay cases to the 
excluded unit, leaving only shorter, less costly cases to be paid for 
under the IPPS. In such cases, hospitals would profit inappropriately 
from prospective payments.'' Further, we stated that we believed that 
the ``exclusion of long-term care `units' was inconsistent with the 
statutory scheme.'' Section 1886(d)(1)(B) of the Act clearly provides 
for an exclusion of LTCHs from the acute care IPPS. While the statute 
also provides for an exclusion for psychiatric units and rehabilitation 
units, it does not provide for an exclusion of long-term care units. 
(59 FR 45389)
    In addition, in that September 1, 1994 final rule, we proceeded to 
establish ``separateness and control'' regulations at (then) Sec.  
412.23(e) that required the two hospitals to have separate medical and 
administrative governance and decision-making and also ensured that 
each hospital operated as a separate facility. We believed at that time 
that such rules were sufficient solutions to our concerns about these 
new entities and, therefore, we did not preclude common ownership of 
the host and the LTCH at that time.
    In the ensuing decade, we have revisited the issue of hospitals-
within-hospitals several times (for example, 60 FR 45836, September 1, 
1995; 62 FR 46012, August 29, 1997; 67 FR 56010, August 30, 2002; 68-7 
FR 45462, August 1, 2003) during which we clarified and amplified the 
separateness and control requirements. In the August 29, 1997 IPPS 
final rule, we extended the application of these rules beyond LTCHs to 
include other classes of facilities that might seek exclusion from the 
IPPS as hospitals-within-hospitals, such as IRFs. In addition, in the 
August 29, 1997 final rule, we also established a ``grandfathering'' 
provision for hospitals-within-hospitals in existence prior to 
September 30, 1995, at Sec.  412.22(f), and in the August 1, 2003 IPPS 
final rule, we clarified and codified the requirements for 
``grandfathered'' hospitals-within-hospitals (68 FR 45463).
    As stated earlier, presently, a hospital-within-a-hospital must 
meet the separateness and control criteria set forth at Sec.  
412.22(e). In order to be excluded from the IPPS, the hospital-within-
a-hospital must have a separate governing body, a separate chief 
medical officer, a separate medical staff, and a separate chief 
executive officer. Regarding the performance of basic hospital 
functions (Sec.  412.22(e)(5)), currently, the hospital must meet at 
least one of the following criteria: (i) The hospital performs the 
basic functions through the use of employees or under contracts or 
other agreements with entities other than the hospital occupying space 
in the same building or on the same campus, or a third entity that 
controls both hospitals; (ii) for the same period of at least 6 months 
immediately preceding the first cost reporting period for which 
exclusion is sought, the cost of the services that the hospital 
obtained under contracts or other agreements with the hospital 
occupying space in the same building or on the same campus, or with a 
third entity that controls both hospitals, is no more than 15 percent 
of the hospital's total inpatient operating costs, as defined in Sec.  
412.2(c) (that is, inpatient operating costs include operating costs 
for routine services, such as costs of room, board, and routine nursing 
services; operating costs for ancillary services such as laboratory or 
radiology; special care unit operating costs; malpractice insurance 
costs related to serving inpatients; and preadmission services); or 
(iii) for the same period of at least 6 months immediately preceding 
the first cost reporting period for which exclusion is sought, the 
hospital has an inpatient population of whom at least 75 percent were 
referred to the hospital from a source other than another hospital 
occupying space in the same building or on the same campus or with a 
third entity that controls both hospitals.
    It is our experience that the vast majority of hospitals-within-
hospitals have elected to meet the second of the three criteria at 
Sec.  412.22(e)(5), that is, the cost of the services that the hospital 
obtained from the co-located hospital or with a third entity that 
controls both hospitals is no more than 15 percent of its total 
inpatient operating costs. In establishing the 15-percent rule, we 
originally believed that we would be able to detect a true corporate 
identity and actual function and to guard against an arrangement that 
could undermine the statutory preclusion of long-term care units. We 
sought to distinguish admissions to independently operating facilities 
from what were, in effect, transfers of patients from one unit of the 
corporation to another unit of the corporation without a truly distinct 
and separate corporate identity. Our underlying policy rationale was 
that, if an entity could not be separately identified, it effectively 
would be functioning as a mere unit of the parent entity in violation 
of the statutory prohibition on long-term care units. We explained in 
the September 1, 1994 rule (59 FR 45390) that ``if an entity is 
effectively part of another hospital and the principles of the 
prospective payment system do apply well to the organization as a 
whole, then it would not be appropriate to exclude part of that 
organization from the prospective payment system.''
    Although we have periodically revisited the phenomenon of 
hospitals-within-hospitals in our rules and we have revised or 
clarified some related issues, we have not proposed significant changes 
in our policies in this area for some time. This is despite the 
significant changes that have been made in the payment systems for 
Medicare-certified, excluded hospitals and units. Medicare payments to 
two types of IPPS-excluded hospitals, LTCHs and IRFs, are now made on a 
prospective basis. We believe that, in part, the new LTCH PPS is one of 
the reasons for the rapidly increasing number of LTCH hospitals-within-
hospitals. In its June 2003 Report to the Congress, MedPAC identified 
hospitals-within-hospitals as the fastest growing type of LTCHs, and 
specified that the number had grown from 10 in 1993 to 114 in 2002, an 
average annual increase of approximately 30 percent (p. 85). In the 
August 30, 2002 final rule that implemented the PPS for LTCHs, we noted 
that ``* * * we remain extremely concerned about rapid growth in LTCH 
hospitals-within-hospitals and will be collecting data on the 
relationship

[[Page 49193]]

among host hospitals, hospitals-within-hospitals, and parent 
corporations in order to determine the need for additional regulation'' 
(67 FR 56010). We indicated that if, as a consequence of these 
monitoring activities, we determine the need to revisit existing 
regulations dealing with ownership and control of hospitals-within-
hospitals, we would follow the notice and comment rulemaking process 
(67 FR 56011).
    The LTCH PPS was implemented for cost reporting periods beginning 
on or after October 1, 2002. We have gathered considerable anecdotal 
information from inquiries from the provider community, fiscal 
intermediaries, and, particularly, from the survey and certification 
divisions of our CMS Regional Offices.
    As we had indicated in the May 18, 2004 proposed rule (69 FR 28323 
through 28327), we believe that existing policies regarding hospitals-
within-hospitals do not sufficiently protect the Medicare program from 
the problems that we envisioned in the September 1, 1994 final rule. We 
also questioned the effectiveness of the ``separateness and control'' 
requirements alone because entities have used complex arrangements 
among corporate affiliates, and obtained services from those 
affiliates, thereby impairing or diluting the separateness of the 
corporate entity. While technically remaining within the parameters of 
the rule, these arrangements have intermingled corporate interests so 
that the corporate distinctness has been lost.
    In corporate law, several standards are used to determine how much 
separateness is sufficient for corporate autonomy to be recognized. The 
courts have applied a number of tests and considered a number of 
factors in determining when a parent corporation is liable for the acts 
of its subsidiary, including the parent corporation's exercise of 
control over the decision making of the subsidiary; the subsidiary's 
actions as an alter ego of the parent corporation such that recognition 
of a distinct corporate entity would lead to fraud or an injustice or 
would defeat public policy and the interrelatedness of operations. 
While we do not believe that it is necessary to apply any single test 
that might be used in the context of assigning liability, we believe 
that some of the same considerations apply when trying to determine 
whether there is functional separateness among related or affiliated 
organizations.
    The requirement for separate governing bodies, separate medical 
boards, separate medical officers, and separate chief executive 
officers in co-located hospitals under the same ownership does not 
prevent, on a practical level, the establishment of admission, 
treatment, and discharge policies that maximize payments. Some of these 
co-located facilities are under common ownership, either nonprofit or 
for profit, and, therefore, the payments generated from care delivered 
at both settings affect their mutual interests. Even when the hospital-
within-a-hospital and the host hospital are separately owned, we 
believe that there may have been incentives to prematurely discharge 
patients to a post-acute care setting in spite of the fact that the 
acute care hospital could continue to provide the appropriate level of 
care. We found this situation even more troubling regarding LTCHs, in 
particular, because LTCHs are certified as acute care hospitals and the 
statutory and regulatory distinction between LTCHs and acute care 
hospitals is generally the greater than 25-day average length of stay 
criterion at Sec.  412.23(e)(2). In many parts of the country, there 
are no LTCHs and appropriate care for patients who could otherwise be 
treated in LTCHs is being delivered in acute care hospitals, often 
followed by post-acute care at SNFs. Because a similar level of care is 
often available in either an acute care hospital or a LTCH, we believe 
that, when an acute care hospital and a LTCH are co-located, there are 
significant inducements for patients to be moved to the provider 
setting that generates the highest Medicare payments.
    This movement of patients is facilitated by the fact of co-location 
because, rather than arranging for the patient to be admitted to 
another offsite facility and transporting the patient by ambulance to 
another hospital, all that may actually be required to ``discharge'' 
the patient from one hospital and admit the patient to another is 
wheeling the patient down the hall or on and off an elevator.
    Although co-location of Medicare providers, at best, may embody the 
positive economic benefits of sharing expensive medical equipment and 
provide a measure of convenience for patient families, at worst, co-
location and patient-shifting can serve to undermine the basic premise 
of the IPPS DRG classification system and generate inappropriate 
Medicare payments. This is the case because payment for specific 
diagnoses is determined by setting DRG weights that represent a 
national averaging of hospital costs for each diagnosis. In addition, 
the Federal standardized payment amount was based on the average cost 
of a patient across all hospitals. This assumes that, on average, both 
high-cost and low-cost patients are treated at a hospital. Although 
Medicare might pay a hospital less than was expended for a particular 
case, over a period of time, the hospital would also receive more than 
was expended for other cases. However, an acute care hospital that 
consistently discharges a higher cost patient to a post-acute care 
setting for the purpose of lowering its costs undercuts the foundation 
of the IPPS DRG system, which is based on averages. In this 
circumstance, the hospital would recoup larger payments from the 
Medicare system than is intended under the DRG system because the 
course of acute treatment has not been completed. At the same time, the 
patient, still under active treatment for an acute illness, will be 
admitted to a LTCH, thereby generating a second admission and Medicare 
payment that would not have taken place but for the fact of co-
location.
    In the May 18, 2004 proposed rule, we indicated that we believe the 
15-percent policy is being sidestepped through creative corporate 
reconfigurations. Therefore, if the LTCH is nominally complying with 
the 15-percent requirement, it has not been required to meet the basic 
hospital function requirements at existing Sec.  412.22(e)(5)(iii). 
Thus, it is free to accept even 100 percent of patients from the onsite 
host, and share the same basic hospital functions as the host. Reliance 
on meeting the 15-percent criterion has enabled the creation of LTCH 
hospitals-within-hospitals that rely upon affiliated entities both for 
their operations and for their patient referrals. This results in a 
situation very similar to the hospital-within-hospital serving as a 
LTCH unit of the acute care hospital, which is precluded by the 
statute.
    One of the reasons we proposed revisions to the existing criteria 
for hospitals-within-hospitals in the May 18, 2004 proposed rule was 
because we believe that determining whether a hospital has complied 
with the 15-percent criterion is burdensome for a fiscal intermediary 
on an ongoing basis. Presently, review of corporate arrangements 
represents a snapshot in time that may assess a particular set of 
business transactions but does not provide relevant details to reveal 
the extent of the unity of interests between the parties over time. 
Further, the widespread existence of such complex configurations, as 
well as the ongoing creation of new business arrangements, convinced us 
that a hospital-within-a-hospital's compliance with Sec.  
412.22(e)(5)(ii) may be fluid,

[[Page 49194]]

unreliable, or, in some cases, nonexistent.
    Another reason we proposed revisions to the existing criteria for 
hospitals-within-hospitals in the May 18, 2004 proposed rule is because 
the concerns that we expressed in 1994 and 1995, when excluded 
hospitals were paid under the reasonable cost-based TEFRA system, are 
even more compelling with the implementation of PPSs for LTCHs and 
IRFs, because now one episode of care for a beneficiary could generate 
two full Medicare prospective payments, one under the IPPS, and another 
under the applicable excluded hospital PPS. In addition, the 
substantial increase in the number of hospitals-within-hospitals adds 
further urgency to reevaluation of the existing hospital-within-a-
hospital policies. Therefore, it is incumbent upon us to revise our 
regulations in order to offer the greatest possible protection against 
potential abuses.
    Accordingly, for qualification purposes, we proposed to delete the 
15-percent criterion at Sec.  412.22(e)(5)(ii) and the rarely elected 
criterion at Sec.  412.22(e)(5)(i) that required the hospital-within-a-
hospital to perform basic hospital functions, which include nursing 
services, medical records, pharmacy services, radiology, laboratory 
services, infection control, and discharge planning, through the use of 
employees or under contracts or other agreements with entities other 
than the host hospital or a third entity that controls them both. 
Because we believe that efficient use of excess space at a hospital and 
the sharing of medical facilities and services may represent the 
strongest argument for the existence of hospitals-within-hospitals, 
from the standpoint of efficiency and cost reduction, we do not believe 
that these criteria should be maintained.
    We proposed that all hospitals-within-hospitals would be required 
to comply only with the criterion set forth at the existing Sec.  
412.22(e)(5)(iii), which requires that at least 75 percent of the 
admissions to the hospital-within-a-hospital be referred from a source 
other than the host hospital. We believe that this ``functional 
separateness'' test (62 FR 46014, August 29, 1997) directly addresses 
our concern that the excluded hospital not function either as a vehicle 
to generate more favorable Medicare reimbursement for each provider or 
as a de facto unit. Compliance with the 75-percent criterion is a 
requirement that we can verify without the involvement of corporate 
attorneys and a yearly reevaluation of corporate documents and 
transactions. The goal of the proposed provisions was to diminish the 
possibility that a hospital-within-a-hospital could actually be 
functioning as a unit of an acute care hospital and generating 
unwarranted payments under the much more costly LTCH PPS.
    Therefore, under the proposed policy in the May 18, 2004 proposed 
rule, a hospital must demonstrate that it has a separate governing 
body, a separate chief medical officer, and a separate chief executive 
officer, and that at least 75 percent of its admissions originate from 
a source other than its host hospital, in order to be totally excluded 
from the IPPS. Fiscal intermediaries would reevaluate compliance with 
these regulations annually. In implementing our belief that separation 
and control can best be objectively determined by limiting compliance 
to the 75-percent criterion as the single ``performance of hospital 
functions'' test, we proposed several policy options that are detailed 
below that, if not met, notwithstanding compliance with the separate 
governance and control requirements under existing Sec.  412.22(e)(1) 
through (4), could result in the either total discontinuance of IPPS-
exclusion payment status or Medicare payment adjustments for hospital-
within-a-hospital patients from the host hospitals.
    As noted above, DRG weights and hence payments under the IPPS are 
established annually based on the average concept that recognizes that, 
for patients with a particular diagnosis, some will stay longer and 
consume more hospital resources than expected, while others will have 
shorter, less costly stays. Under the IPPS, a full DRG payment is 
triggered on the first day of admission to the acute care hospital. 
Medicare adopted an IPPS transfer policy at Sec.  412.4(b) in order to 
pay appropriately for cases that were discharged to other IPPS 
hospitals prior to the hospitals delivering full treatment to a 
beneficiary. We also promulgated the post-acute care transfer policy at 
Sec. Sec.  412.4(c) and (d) to discourage premature transfers or 
discharges from IPPS hospitals for particular DRGs to post-acute care 
settings, including LTCHs (63 FR 40977, July 31, 1998, 68 FR 45469, 
August 1, 2003). The issues that we addressed in formulating the acute 
and post-acute care transfer policies are similar to those we are 
raising as our present concerns: that the incentives of the IPPS could 
result in acute care hospitals shifting a portion of the cost of 
services that should reasonably be treated in that setting to other 
providers; that the acute care hospitals would still collect a full DRG 
payment under the IPPS for less than a full course of treatment; and 
that an additional and unnecessary Medicare payment would be made to 
the second provider. We believe that the potential for linking clinical 
decisions to the highest Medicare payments is even stronger when the 
acute care hospital and a postacute care provider are co-located and, 
even more so, if they are also under common ownership.
    Therefore, in the May 18, 2004 proposed rule, we also proposed to 
revise Sec.  412.22(e), effective October 1, 2004, to preclude common 
ownership (wholly or in part) of hospitals-within-hospitals and host 
hospitals (proposed new Sec.  412.22(e)(2)(ii)). However, we also 
proposed to ``grandfather'' those hospitals-within-hospitals that were 
under common ownership with their host hospitals prior to June 30, 
2004, and to continue to pay them as hospitals excluded from the IPPS, 
as long as they comply with the existing control criteria at Sec.  
412.22(e)(1) through (4) (as set forth in proposed new Sec.  
412.22(e)(2)(i)) and with the proposed mandatory 75-percent criterion 
(as set forth in proposed new Sec.  412.22(e)(2)(iii)).
    In addition, in the May 18, 2004 proposed rule, we presented, for 
public comment, three payment options that we believe would diminish 
the possibility of a hospital-within-a-hospital actually functioning as 
a unit of an acute care hospital and at the same time generating 
unwarranted payments under the more costly LTCH PPS.
    Option 1. Under the first option, as discussed earlier, in order 
for a hospital-within-a-hospital to receive payment as an IPPS-excluded 
hospital, we proposed to retain as the only qualifying criterion that 
the hospital-within-a-hospital have at least 75 percent of its 
admissions from a source other than the host hospital (existing Sec.  
412.22(e)(5)(iii)). The hospital-within-a-hospital would still be 
required to demonstrate that it meets the separateness and control 
criteria at Sec.  412.22(e-). Under this option, a hospital-within-
hospital that admitted more than 25 percent of its patients from the 
host hospital would not be paid as an IPPS-excluded hospital for any of 
its patients. The hospital or unit that does not meet the criteria 
under this option would receive payment as an acute care hospital for 
all of its patients.
    As stated earlier, we believe that compliance with the 75-percent 
criterion under this option is a requirement that fiscal intermediaries 
would be able to evaluate annually in an efficient manner without the 
involvement of corporate attorneys and a yearly reevaluation of 
corporate documents and transactions. Further, we believe that this 
option would ensure increased protections to the

[[Page 49195]]

Medicare program and greatly diminish opportunities for maximizing 
Medicare payments under the PPS.
    Option 2. Under the second option, as we had proposed earlier, we 
would require the hospital to meet the existing qualifying 75-percent 
criterion under Sec.  412.22(e)(5)(iii). However, under this option, we 
would allow a hospital-within-a-hospital that failed to meet the 75-
percent criterion to be paid as a PPS-excluded hospital only for the 
patients admitted to the hospital-within-a-hospital from providers 
other than the host hospital. For example, no payments would be made to 
a LTCH for those patients that had been transferred to the LTCH from 
the host hospital because it failed to meet this criterion. Payments 
for patients referred from the host hospitals would only be paid to the 
host under the IPPS. We would treat services provided by the hospital-
within-a-hospital as services furnished ``under arrangement.'' 
Therefore, in keeping with our existing policy at Sec.  411.15(m) that 
restricts separate Medicare payment to hospital services furnished 
under arrangements, we would make payment only to the acute care 
hospital from which the patients were referred for ``under 
arrangements'' furnished by the hospital-within-a-hospital.
    Option 3. Under the third option, as we proposed earlier, we would 
require that the hospital-within-a-hospital must meet the existing 
qualifying 75-percent criterion under Sec.  412.22(e)(iii). However, 
under this option, we would pay the hospital-within-a-hospital directly 
for services, even for services provided to patients admitted to the 
hospital-within-a-hospital from the co-located acute care hospital. 
However, the payment to the hospital-within-a-hospital for those 
patients would be the lesser of what would be paid under the IPPS for 
that DRG, or what would be paid to the hospital-within-a-hospital under 
the applicable excluded hospital payment system. Payments to the 
hospital-within-a-hospital for patients admitted to the hospital-
within-a-hospital from another hospital that was not the co-located 
hospital would be made under the hospital-within-a-hospital payment 
system with no adjustment. Therefore, for example, a LTCH that was a 
hospital-within-a-hospital and failed to meet the 75-percent criterion 
would be paid the lesser of the IPPS payment or the LTCH PPS payment 
for its patients that were admitted from its host hospital. However, 
for patients admitted from other hospitals, the LTCH hospital-within-a-
hospital would be paid under the LTCH PPS with no adjustment.
    In the May 18, 2004 proposed rule, we indicated that we believe 
that adoption of any of these three options is within the broad 
discretion conferred on the Secretary by section 123 of Public Law 106-
113 (BBRA) and by section 307 of Public Law 106-554 (BIPA), which grant 
the Secretary the authority to develop a per discharge PPS for payment 
of inpatient hospital services by LTCHs and to provide for appropriate 
adjustments to the LTCH PPS.
    We proposed to revise the existing separateness and control 
regulations at Sec.  412.22(e) for hospitals-within-hospitals and to 
require that in order to be excluded from the IPPS, all hospitals-
within-hospitals must admit no more than 25 percent of their patients 
from the onsite host hospital. (See section Sec.  412.534.) We also 
proposed to preclude common ownership of host hospitals and excluded 
hospitals, while grandfathering existing hospitals-within-hospitals and 
hosts that are under common ownership, as long as they comply with the 
proposed mandatory 75-percent criterion. We further sought comments on 
the options presented if the hospital-within-a-hospital fails to meet 
the 75-percent criterion that would either require that all of the 
hospital's Medicare payment would be made under the IPPS or, 
alternatively, to allow a hospital-within-a-hospital to still be paid 
as an excluded hospital for its admissions from onsite providers while 
applying specific payment adjustments for patients admitted from the 
host hospital.
    In the proposed rule, we solicited comments on the three options 
presented and whether they provide sufficient protection against the 
phenomenon of inadequate separateness and control as described in the 
proposed rule. We want to emphasize that, under any of the options, 
nowhere is a change in physician clinical decisionmaking or a change in 
the manner in which a physician or hospital practices medicine 
intended. The policy options outlined in the proposed rule simply 
addressed the appropriate level of payments once those decisions have 
been made.
    Comment: One commenter expressed the opinion that the increase in 
the number of LTCHs is in part due to the conversion of IRFs to LTCHs 
that is due to the enforcement of the criterion for exclusion from the 
IPPS as a rehabilitation hospital or unit which is set forth in 
Sec. Sec.  412.23(b)(2) and 412.30, and relates to the inpatient 
population treated by a hospital or unit. This criterion is frequently 
referred to as the ``IRF 75-percent rule.'' In addition, the same 
commenter recommended that those IRFs and IPFs that are converting to 
LTCHs should first have to meet the length of stay requirements for 
exclusion as a LTCH by operating and being paid under the IPPS for 1 
year. The commenter believed that such a requirement would be 
consistent with the LTCH PPS final rule published on May 7, 2004 (69 FR 
25674), which the commenter described as requiring a satellite facility 
to qualify under the IPPS for 1 year.
    Response: Our primary reason for disagreeing with the comment on 
this point is that the 75 percent rule as described in prior regulation 
is not currently being enforced. Until recently, as explained further 
below, our regulations at 42 CFR 412.23(b)(2) stated that, except in 
the case of a newly participating rehabilitation hospital seeking 
exclusion for its first 12-month cost reporting period, a hospital 
could qualify for exclusion from the IPPS and payment under the IRF PPS 
only if at least 75 percent of the inpatient population of the hospital 
required intensive rehabilitative services for one or more of 10 
specified medical conditions. On June 7, 2002, CMS issued a memorandum 
to fiscal intermediaries instructing them to suspend enforcement of the 
75 percent rule. After further review of this issue, and notice and 
comment rulemaking on it, on May 7, 2004, CMS issued revised 
regulations, effective for cost reporting periods starting on or after 
July 1, 2004, which changed the list of qualifying medical conditions 
and, for a hospital's first cost reporting period beginning on or after 
July 1, 2004, require only a 50 percent compliance level. These 
regulations are set forth, and explained in detail, in the final rule 
published at 69 FR 25752.
    Although we have heard anecdotally that some of IRFs have converted 
to LTCHs or are in the process of evaluating such a conversion, we have 
no objective evidence to support the view that such conversions are 
occurring in large enough numbers to be a significant factor in causing 
the recent increase in the number of LTCHs. Thus, while there may be 
many reasons for the growth in the number of LTCHs, we continue to 
believe that it is likely that this increase may have been induced to a 
significant extent by the establishment and implementation of a LTCH 
PPS.
    We also considered, but do not agree with, the commenter's 
recommendation that IRFs and IPFs wishing to convert to LTCHs should 
first have to operate and be paid under the IPPS for a specified time 
period, described by the commenter as 1 year, in order to make

[[Page 49196]]

the policies applicable to IRFs and IPFs consistent with 42 CFR Sec.  
412.23(e)(4)(ii), as revised by the May 7, 2004 LTCH PPS final rule (69 
FR 25706-25708) regarding a satellite facility (as defined in Sec.  
412.22(h)) or a remote location of a hospital (as defined in Sec.  
413.65(a)(2)) that voluntarily reorganizes as a separate Medicare-
participating hospital. The regulations in Sec.  412(e)(4) are clear 
that the applicable average length of stay requirement for exclusion 
from the IPPS as an LTCH can be satisfied only based on discharges that 
occur on or after the effective date of its Medicare participation as a 
separate hospital and not based on operating experience obtained when 
the facility was not itself a separate Medicare participating hospital 
but instead was a part of a larger institution which participated in 
Medicare as a hospital. However, a facility excluded from the IPPS as a 
rehabilitation hospital under 42 CFR 412.23(b)(2) is already a hospital 
as required by Sec.  412.23(e)(4), and its discharges can be used to 
determine whether it satisfies the applicable length of stay 
requirement. Thus, because the Medicare participation status of a 
separate rehabilitation hospital is different from that of a satellite 
or a remote location, consistency with Sec.  412.23(e)(4)(ii) does not 
require the change suggested by this commenter, and we have therefore 
not adopted that change in this final rule.
    Comment: One commenter shared CMS' concerns regarding the potential 
for manipulation of the intent of the separateness and common ownership 
regulations, and was also in agreement that hospitals-within-hospitals 
should be prevented from functioning as units of acute care hospitals.
    Response: We appreciate the commenter's support of our concerns 
regarding the current hospital-within-hospital policy and took the 
comment into account in developing this final rule. We are finalizing 
revisions to separateness and control regulations at Sec.  412.22(e) 
and adding a new regulation at Sec.  412.534, Special payment 
provisions for long-term care hospitals-within-hospitals.
    We are limiting the finalized policy revisions addressing host 
hospitals and LTCH HwHs and also to satellites of LTCHs that is, of 
LTCH HwHs, or free-standing LTCHs and not to other co-located PPS 
excluded hospitals). These policies, as were the existing policies, are 
also applicable to any type of host hospital, including IRFs.
    We are finalizing policy to eliminate the existing three 
``Performance of basic hospital functions'' options under existing 
Sec.  412.22(e)(5) for qualifying as a LTCH HwH or a LTCH satellite 
(the 15 percent rule and the basic functions test, and the 75/25 test). 
If a LTCH HwH meets existing separateness and control of administrative 
and medical governance provisions at Sec.  412.22(e)(1) through (e)(4), 
payment will be made under the LTCH PPS as specified in Sec.  412.534. 
Under Sec.  412.534, if a LTCH HwH or LTCH satellite's admissions from 
its host hospital exceed 25 percent (or the applicable percentage) of 
its discharges for the LTCH HwH or LTCH satellite's cost reporting 
period, an adjusted payment will be made at the lesser of the otherwise 
payable amount under the LTCH PPS or the amount that would be 
equivalent to what Medicare would otherwise pay under the IPPS. In 
determining whether a hospital meets the 25 percent criterion, patients 
transferred from the host hospital that have already qualified for 
outlier payments at the host would not count as part of the host's 25 
percent (or the applicable percentage) and therefore the payment would 
not be subject to the adjustment. Those patients would be eligible for 
full payment under the LTCH PPS. (Cases admitted from the host before 
the LTCH crosses the 25 percent threshold would be paid an otherwise 
unadjusted payment under the LTCH PPS.)
    We are finalizing additional adjustments to the 25 percent policy 
for specific circumstances. For rural host hospitals with LTCH HwHs or 
LTCH satellites, instead of the 25 percent criterion, the majority 
(that is, more than 50 percent) of the patients would have to be from 
hospitals other than the host. In addition, in determining the 
percentage of patients admitted from the host, any patients that had 
been Medicare outliers at the host and then discharged to the LTCH HwH 
or LTCH satellite would be considered as if they were admitted from a 
non-host hospital. For urban single or MSA dominant hospitals, we would 
allow the LTCH HwH or LTCH satellite to admit from the host up to the 
host's percentage of total Medicare discharges for like hospitals in 
the MSA. We would apply a floor of 25 percent and a ceiling of 50 
percent to this variation. In addition, in determining the percentage 
of patients admitted from the host, any patients that had been Medicare 
outliers at the host and then transferred to the LTCH HwH or LTCH 
satellite would be considered as if they were admitted from a non-host 
hospital.
    In this final rule, after further analysis and consideration of the 
commenter's concerns, we have made various changes in the proposed 
policy as detailed later in this section. We have provided a 4-year 
transition for existing LTCH HwHs or LTCH satellites that will provide 
a reasonable period during which the host and the LTCH HwH or LTCH 
satellite will be able to adapt to the requirements of the new policy. 
Also included in this policy are LTCHs-under-formation that satisfy the 
following two-prong requirement: the hospital was certified as an acute 
care hospital on or before October 1, 2004, under Part 489; and was 
designated as a LTCH before October 1, 2005. For cost reporting periods 
beginning on or after October 1, 2004 through September 30, 2005, these 
hospitals will be grandfathered, with the first year as a ``hold 
harmless.'' Therefore, grandfathered LTCH HwH or LTCH satellites will 
only need to continue to meet the existing separateness criteria at 
Sec.  412.22(e) which includes compliance with either paragraphs 
(e)(5)(i)(ii), or (iii) for that first cost reporting period. However, 
we are requiring that even for grandfathered facilities, in the first 
cost reporting period, the percentage of discharges admitted from the 
host hospital may not exceed the percentage of discharges admitted from 
the host hospital in its FY 2004 cost reporting period. Therefore, 
while we are grandfathering existing LTCH HwHs and allowing for a 4-
year transition, beginning on or after October 1, 2004 and before 
October 1, 2005 (FY 2005), those hospitals may not increase the 
percentage of discharges admitted from the host in excess of the 
percentage that they had admitted in FY 2004. After the first 
grandfathered cost reporting period, these LTCH HwHs will be required 
to meet a percentage transition over the 3 years beginning in FY2006. 
For the second year (cost reporting periods beginning on or after 
October 1, 2005 but before October 1, 2006), the applicable percentage 
from the host will be the lesser of the percentage of their discharges 
admitted from their host for their FY 2004 cost reporting period or 75 
percent. For the third year (cost reporting periods beginning on or 
after October 1, 2006 but before October 1, 2007), the applicable 
percentage from the host will be the lesser of the percentage of their 
discharges admitted from their host for their FY 2004 cost reporting 
period beginning or 50 percent, and finally 25 percent (or other 
applicable percentage) beginning with the third year (cost reporting 
periods beginning on or after October 1, 2008.
    Comment: Several commenters believed that hospitals-within-
hospitals have grown in numbers because they are a more efficient and 
less expensive

[[Page 49197]]

model. The commenters further stated that these providers are cost-
effective and convenient for physicians associated with both the 
hospital with a hospital and the host hospital, and state that the 
location and ability to work closely with the acute care hospital leads 
to efficient usage of space and sharing of medical facilities and 
services. Another commenter noted that many hospitals-within-hospitals 
have strict admission standards; this is to ensure that a patient 
requires hospital-level care. One commenter pointed to a report 
compiled over a 6-month period across all provider types that asserted 
that the Medicare program saved money for all LTCHs regardless of their 
designation as freestanding or hospital-within-hospital. Under the 
circumstances, the commenter believed that CMS should not place 
restrictions on patient access to beneficial care through the 
application of a cap on the percentage of host hospital admissions.
    Response: As we discussed in the proposed regulation, even though 
the co-location of Medicare providers may possibly have some positive 
economic benefits to both hospitals, such as the sharing of expensive 
medical equipment as well as provide a measure of convenience for 
patient families, at its worst, co-location and patient shifting can 
serve to undermine a basic premise of both the IPPS and the LTCH PPS, 
``which is that a single discharge-based PPS payment is adequate and 
appropriate reimbursement for the entire bundle of services that a 
hospital provides during the course of a patient's stay.'' (69 FR 
28275). That is, with the implementation of PPS for LTCHs, now one 
episode of care for a beneficiary who is transferred from an acute care 
hospital to a co-located LTCH could generate two full Medicare 
prospective payments, one under the IPPS, and another under the 
applicable excluded hospital PPS.
    As we had discussed previously in the September 1, 1994 final rule 
implementing the original hospital-within-hospital criteria, we believe 
a long term care hospital-within-a-hospital that is not adequately 
separated from the facility with which it is co-located is 
``essentially a long term care hospital unit that accounts for only a 
part of the larger hospital's patient load. Exclusion of long-term care 
units [from the IPPS] could inadvertently encourage hospitals to try to 
abuse the prospective payment systems, by diverting all long-stay cases 
to the excluded unit, leaving only the shorter, less costly cases to be 
paid for under the prospective payment systems. In such cases, 
hospitals would profit inappropriately from prospective payments.'' (59 
FR 45389).
    Moreover, exclusion of long term care ``units'' is inconsistent 
with the statutory scheme. Section 1886(d)(1)(B) of the Act clearly 
provides for exclusions from the prospective payment system for 
psychiatric and rehabilitation units, but the statute does not provide 
for exclusion of long-term care units. Because we believe such 
exclusions are contrary to the purpose and scheme of section 
1886(d)(1)(B) of the Act, we proposed to revise the regulations to 
prevent inappropriate exclusions.'' (56 FR 45389). Notwithstanding the 
commenter's concerns, we continue to believe that a revision to the 
current hospital-within-a-hospital policy is necessary in order to 
prevent potential abuses to the Medicare program.
    Comment: Several commenters that noted that, although existing 
separateness and control regulations at Sec.  412.22(e) govern all 
hospitals excluded from the IPPS and our proposed changes would apply 
to all types of hospitals-within-hospitals, the concerns underlying our 
proposed revisions actually focus on the particular relationship 
between a host acute care hospital and a co-located LTCH. The 
commenters requested that we limit any revisions in the hospitals-
within-hospitals regulations to address that particular configuration. 
Two other commenters recommended the exclusion of children's hospitals 
because this policy could impose a significant potential barrier to 
children's hospitals' ability to respond to the growing demand for 
their services for the children of their regions, as well as to receive 
adequate payment from other payers.
    Response: As we noted above, in the September 1, 1994 IPPS final 
rule (59 FR 45389), our concern with the ``new'' phenomenon of 
hospitals-within-hospitals and the ensuing separateness and control 
regulations that we established were originally directed at the 
relationship between a host acute care hospital and a co-located entity 
that was seeking State licensure and Medicare participation as a 
hospital, and then after demonstrating that it has an average length of 
stay of over 25 days, would obtain an exclusion from the IPPS and 
designation as a LTCH. We believed that the effect of this process 
would be an extension of the long-term care hospital exclusion to what 
was, for all practical purposes, a ``long-term care unit.'' Only in the 
August 29, 1997 IPPS final rule did we extend the application of Sec.  
412.22(e) beyond LTCHs to include other classes of facilities that 
might seek exclusion from the IPPS as hospitals-within-hospitals, 
including IRFs (62 FR 46012, August 29, 1997).
    Notwithstanding this extension of our hospital-within-a-hospital 
policy, our data reveal that the vast majority of hospitals-within-
hospitals are LTCHs and the considerable growth, discussed above, is in 
the number of new LTCH hospitals-within-hospitals. Thus, because we 
believe this to be a significant issue with regard to LTCH HwHs or LTCH 
satellites (as seen by the increase in the number of LTCH HwHs or LTCH 
satellites), at this time, we will be limiting the scope of this policy 
only to LTCH HwHs (and also to satellites of LTCHs, as noted elsewhere 
in these responses). Although we will continue to monitor the 
establishment of other excluded hospital groups as well as LTCH HwHs or 
LTCH satellites, we are presently finalizing revised regulations 
targeted to the unique relationship between LTCH HwHs or LTCH 
satellites and host hospitals. We believe that this is necessary and 
appropriate because we are concerned about the potential for LTCH HwHs 
or LTCH satellites to, in effect, function as units of the host, and 
there is no statutory authority for LTCH ``units'' excluded from the 
IPPS under section 1886(d)(1)(B) of the Act but there is for the 
establishment of IRFs and psychiatric units of acute care hospitals. 
Therefore, historically, it has been less likely that an acute care 
hospital will be co-located with a free-standing IRF or psychiatric 
hospital as a HwH or satellite since the acute care hospital can 
establish its own rehabilitation or psychiatric unit. However, the fact 
that an acute care hospital is precluded from establishing its own LTCH 
``unit'' may account for an increase in the number of separately 
certified co-located LTCHs at acute care hospitals.
    In addition to this statutory basis, our concern with LTCHs 
existing as LTCH HwHs or LTCH satellites continues to be that an on-
site LTCH can easily be utilized ``seamlessly'' as a step-down unit of 
the host hospital. A LTCH, in fact, is certified by Medicare and 
licensed by its State as an acute care hospital. (This is not the case 
where a patient is transferred from an acute care hospital to an IRF or 
psychiatric unit since the transfer of an acute care patient to an IRF 
or an IPF unit of the acute care hospital would typically indicate a 
determination that there would be a clinical advantage to that 
patient's receiving highly specialized rehabilitation or psychiatric 
services otherwise unavailable at the acute care hospital.)

[[Page 49198]]

    As we noted above, for an on-site LTCH, configured as a LTCH HwH or 
LTCH satellite, to actually function as a unit of the acute care 
hospital, despite the statutory preclusion, would undermine payments 
under the IPPS DRG classification system and generate inappropriate 
Medicare payments. This is the case because payments for specific 
diagnoses under the IPPS were determined by setting DRG weights that 
represent a national averaging of hospital costs for each diagnosis and 
assumes that, generally, both high-cost and low-cost patients are 
treated at a hospital. In addition, the Federal standardized payment 
amount was also based on the average cost of all patients across all 
hospitals.
    Presently, because of the particular concerns that we have 
expressed, we believe that our policy revisions may relate more 
directly to LTCHs that exist as LTCH HwHs or LTCH satellites than to 
other excluded hospital designations. Therefore, although we will 
continue to monitor increases and changes in the HwH or the satellite 
``universe'' and may revisit this issue in the future, the policy 
revisions for HwHs or satellites that we are finalizing in this notice 
will apply only to a situation where the HwH or satellite is a LTCH or 
a satellite of a LTCH.
    Comment: Two commenters questioned whether a LTCH HwH or satellite 
or satellite that is co-located with an IRF would be subject to the 
separateness and control policies that we proposed.
    Response: When we first addressed the existence of LTCH HwHs in the 
September 1, 1994 final rule for the IPPS (59 FR 45389), we were 
responding to the proliferation of a particular entity: a LTCH hosted 
by an acute care hospital. We expanded our definition of LTCH HwH to 
include all excluded hospitals in the September 1, 1995 final rule for 
the IPPS (60 FR 45836) because we recognized that co-location of other 
hospital types could give rise to payment concerns similar to those 
that we believed were likely to occur between a host hospital and a 
LTCH HwH. Therefore, although the vast majority of host/LTCH HwH 
arrangements are between acute care hospitals and LTCH HwHs, in Sec.  
412.22(e), we addressed circumstances under which a ``hospital that 
occupies space in a building also used by another hospital, or in one 
or more entire buildings located on the same campus as buildings used 
by another hospital'' will be excluded from the IPPS, but we do not 
specify a particular designation of excluded hospital.
    Similarly, existing regulations at Sec.  412.22(e) do not specify 
what type of hospital the host hospital must be. Section 1886(d)(1)(B) 
of the Act, which establishes the distinction between a ``subsection 
(d) hospital'' and hospitals excluded from the IPPS, also includes a 
provision on grandfathering for certain HwHs and specifies that ``[A] 
hospital that was classified by the Secretary on or before September 
30, 1995, as a hospital described in clause (iv) [not a ``subsection 
(d) hospital''] shall continue to be so classified notwithstanding that 
it is located in the same building as, or on the same campus as, 
another hospital.'' Although the statute establishes that certain HwHs 
will continue to be paid as an excluded hospital, the designation of 
the host is not limited. (We did not receive any comments suggesting 
that we restrict the proposed regulations to only one type of host.)
    We are presently limiting the finalized revisions to the 
separateness and control policy to LTCH HwHs, as noted in the previous 
response. Our concerns, as discussed earlier, about the relationship 
between a host hospital and a LTCH HwH or LTCH satellite would apply 
equally to situations where the LTCH HwH or LTCH satellite is co-
located with either an acute care hospital or an IRF, and the existing 
statutory preclusion against the existence of LTCH units would also 
apply if the host hospital was an excluded hospital.
    Therefore, we are clarifying that a LTCH HwH or LTCH satellite that 
is co-located with any hospital is subject to the revised regulations. 
We also want to note that even under existing LTCH HwH regulations at 
Sec.  412.22(e) or LTCH satellite regulations at Sec.  412.22(h), 
regardless of the designation of the host hospital, a LTCH that existed 
as a LTCH HwH that failed to meet requirements of (e)(1) through (e)(4) 
or one of the three performance of basic hospital functions tests at 
(e)(5)(i), (ii) or (iii) would have been paid under the IPPS. 
Similarly, if a satellite failed to meet the separateness criteria 
under Sec.  412.22(h), the satellite would also be paid as an acute 
care hospital under IPPS.
    We have established in this final rule, under Sec.  412.534, that 
if a LTCH HwH or LTCH satellite admits more than 25 percent (or the 
applicable percentage) of its patients during a cost reporting period 
from its host, Medicare will pay an adjusted LTCH PPS payment based on 
the lesser of the otherwise unadjusted LTCH PPS rate or an amount 
equivalent to what would have otherwise been payable under the IPPS for 
each discharge. (Since LTCHs are certified as acute care hospitals, we 
believe that this is an appropriate policy determination.) Furthermore, 
this payment policy is applicable in all situations where a LTCH HwH or 
a LTCH satellite is co-located with another hospital.
    Comment: One commenter noted that the proposed revision of the 
separateness and control policy at Sec.  412.22(e)(v)(2)(iii) 
calculates the 75 percent of patients that must be ``referred to the 
hospital from a source other than hospital occupying space in the same 
building or on the same campus'' based on the ``inpatient population'' 
of the HwH. The commenter questions whether this limitation was 
intended to apply solely to Medicare beneficiaries. Two other 
commenters express concern that the proposed 25 percent rule, will 
affect admissions to the HwH directly from the host acute care hospital 
of even non-Medicare patients.
    Response: When we first established the requirements at Sec.  
412.22(e) to determine separateness between host hospitals and LTCHs in 
the September 1, 1994 final rule for the IPPS (59 FR 45389), the 
average length of stay calculation for purposes of designation as a 
LTCH was based on an average inpatient length of stay of greater than 
25 days as calculated under paragraph Sec.  412.23(e)(3)(i) 
implementing section 1886(d)(1)(B)(iv)(I) of the Act. Under (then) 
Sec.  412.23(e)(3)(i), the calculation was determined by ``dividing the 
number of total inpatient days (less leave or pass days) by the number 
of total discharges for the hospital's most recent complete cost 
reporting period.'' With the implementation of the LTCH PPS, we revised 
the regulations at Sec.  412.23(e)(2)(i) and (e)(3)(i) to calculate the 
average length of stay based solely on Medicare patients, a change 
which we believed was more in keeping with the establishment of a 
specialized PPS for Medicare patients who required long-stay 
hospitalizations at LTCHs. (See 67 FR 55970, August 30, 2002.) (We did 
not change the formula for calculating the average length of stay for 
an LTCH governed by section 1886(d)(1)(B)(iv)(II) of the Act, 
implemented at Sec.  412.23(e)(2)(ii), for a ``subclause (II)'' LTCH 
because we believed that in establishing a ``subclause (II)'' LTCH the 
Congress provided an exception to the general definition of LTCHs under 
subclause (I), and we had no reason to believe that the change in 
methodology for determining the average inpatient length of stay would 
better identify the hospitals that the Congress intended to excluded

[[Page 49199]]

under subclause (II)). See 67 FR 55974, August 30, 2002.)
    When we proposed the recent revision to existing regulations at 
Sec.  412.22(e)(5)(iii), we intended to apply the revision to the 
existing regulations and calculate the percentage of patients admitted 
to the LTCH from the host based solely on Medicare inpatients in 
conformity with Sec.  412.23(e)(2)(i) and (e)(3)(i). We appreciate the 
commenter's bringing this to our attention, and we will revise the 
regulation text to reflect that the 25 percent or other applicable 
percentage test will only apply to Medicare patients. (Since 
qualification of LTCHs under Sec.  412.23(e)(2)(ii) is not based only 
on Medicare patients, the LTCH HwH provisions at Sec.  412.534 would 
not apply to these hospitals.) We would also note that by restricting 
the calculation of the percentage of patients so it will be based 
solely on Medicare patients for the purposes of complying with payment 
under the 25 percent or other applicable percentage test (new Sec.  
412.534), we have, in effect, assumed that payment to the LTCH may be 
affected by the number of Medicare patients that a LTCH HwH or LTCH 
satellite admits from the host hospital but will not be impacted by the 
LTCH HwH or LTCH satellite admitting any number of non-Medicare 
patients from the host hospital because the number of non-Medicare 
patients will have no effect on a LTCH HwH or LTCH satellite's meeting 
the 25 percent or other applicable percentage requirement.
    In addition, as discussed later in this preamble, we are finalizing 
a policy to count discharges from the host that had achieved outlier 
status at the host prior to being admitted to the LTCH HwH or LTCH 
satellite, as if they were LTCH patients from other than the host. 
Because that determination is not possible for non-Medicare patients, 
we are only applying the 25 percent test to Medicare patients.
    Comment: One commenter challenged our concern that inappropriate 
patient shifting from a host acute care hospital to a LTCH hospital-
within-a-hospital could result in undermining the IPPS by noting that 
even if such behavior is taking place, the annual reweighting of DRGs 
is a self-correcting mechanism for the IPPS that works to adjust 
payments to approximate costs.
    Response: The ``self-correcting'' remedy noted by the commenter 
could in theory provide considerable protection to the integrity of the 
IPPS-DRG system, if all acute care hospitals hosted LTCH HwHs because 
charge data gathered for purposes of recalibrating DRG weights would be 
based on equivalent or at least similar circumstances throughout the 
nation. However, according to our most recent data, there are less than 
130 LTCH HwHs as of June 2004 and approximately 4000 acute care 
hospitals. The charge data gathered from the acute care hospitals that 
are used to recalibrate the DRG weights is data for the full range of 
patients within each DRG across all acute care hospitals in the nation. 
Because in the vast majority of these hospitals, the acute care 
hospital does not have a co-located LTCH hospital-within-a-hospital, 
the DRG weight for a specific DRG is reflective of the higher cost of 
hospital-level care for the types of patients that in relatively few 
hospitals may be treated at LTCHs. Therefore, Medicare payments to the 
overwhelming majority of acute care hospitals without LTCH HwHs that 
will continue to treat a patient for the entire episode of care and 
which may ultimately become a high-cost outlier discharge would be the 
same for a particular DRG as it would be to one of the relatively few 
acute care hospitals that hosts a LTCH hospital-within-a-hospital and 
has the option of discharging a patient to the hospital-within-a-
hospital prior to the full provision of clinical services to that same 
patient. In that situation, Medicare would have overpaid the acute care 
hospital under the IPPS (and the admission to the LTCH HwH would 
generate an additional payment under the LTCH PPS) for the same episode 
of care that in most parts of the country would have been delivered 
solely at the acute care hospital. Therefore, although the IPPS relies 
on the ``self-correcting'' nature of the DRG system for annual 
recalibration, we continue to believe that since there are so few acute 
care hospitals that have co-located LTCHs, this mechanism is not an 
effective remedy for such situations.
    Comment: Several commenters suggested that the existing post-acute 
transfer policy already address many of the concerns with inappropriate 
payments under the IPPS in situations where a patient is discharged to 
a LTCH hospital-within-a-hospital while the patient is still under 
active treatment at the co-located acute care hospital. Further, the 
commenters suggested an expansion of the existing post-acute transfer 
policy to include DRGs of patients frequently discharged from acute 
care hospitals to LTCHs as an alternative remedy to our proposed 
policies revising separateness and control policies for hosts and 
hospitals-within-hospitals. The commenter noted that this policy was 
mandated by statute and is the ``primary vehicle'' that Congress has 
chosen to deal with ``substitution of service questions.''
    Response: The post-acute transfer policy at Sec.  412.4(c) which 
implemented section 1886(d)(5)(J) of the Act, stipulates that if an 
acute care hospital discharges a case assigned one of a specified 
groups of DRGs to a post-acute setting, such as a LTCH, prior to 
reaching the geometric means length of stay for that particular DRG, 
the discharge is considered to be a ``transfer'' and the Medicare 
payment to the acute care hospital under the IPPS is adjusted 
reflecting that less than a full course of treatment had been 
delivered.
    In developing the revised separateness policy, we have looked at 
data from our 1996 through 2003 MedPAR files, focusing our data 
analyses on changes in lengths of stay that exceed the geometric mean 
length of stay for various DRGs at acute care hospitals with hospitals-
within-hospitals as compared to those without hospitals-within-
hospitals.
    Our concern is that rather than just transferring patients before 
the geometric mean length of stay, which could be subject to a transfer 
policy adjustment if the case was assigned to one of the specified 29 
DRGs, in general, we believe that these acute care hospitals are often 
discharging their patients to the onsite LTCH so as to reduce the 
length of stay of outlier patients. If the patient is discharged after 
the geometric mean ALOS, the payment for that patient would no longer 
be adjusted under the transfer policy. Accordingly, we do not believe 
that possible expansion of the existing post-acute transfer policy to 
other DRGs, which we discuss elsewhere in this final rule, would 
necessarily address the problem we are attempting to address with the 
25 percent or other applicable percentage provision.
    Comment: Four commenters asserted that our concerns about 
inappropriate payments to LTCHs under Medicare are already being 
addressed through several policies which are already in place: The post 
acute transfer policy under the IPPS which limits reimbursement to host 
hospitals when a patient is transferred to a LTCH; both the 3-days or 
less and the greater than 3-day interruption of stay policies under the 
LTCH PPS, the onsite discharge and readmission policy under the LTCH 
PPS; the greater than 25-day average length of stay policy for LTCHs; 
the short-stay outlier policy under the LTCH PPS; and requirements for 
medical necessity review. Finally, another commenter recommended a 
reduced payment methodology for host

[[Page 49200]]

acute care hospitals discharging patients early to LTCH HwHs. That is, 
the early discharge could be addressed with the geometric mean length 
of stay; an edit could monitor the length of stay; and if early 
discharge occurs, the commenter suggested converting the PPS per 
discharge payment to a per diem payment.
    Response: The existence of the policies noted by the commenters 
confirms the fact that, as PPS policies have evolved, we have 
continually been concerned about the issue of inappropriate Medicare 
payments, particularly at points of intersection between various 
payment systems. Although each policy establishes certain safeguards, 
none effectively address the concern that we are dealing with in this 
revision of hospitals-within-hospitals regulations: That of 
inappropriate patient movement from a host hospital to a co-located 
LTCH. As discussed above, the post-acute transfer policy at Sec.  412.4 
ensures that a full DRG is not paid to the admitting IPPS hospital if a 
patient, whose diagnosis falls into one of a very limited number of 
categories, is transferred to an alternative provider after an 
extremely short stay at the acute care hospital. Both the 3-day or less 
and the greater than 3-day interruption of stay policies at Sec.  
412.531, as well as the onsite discharge and readmission policies at 
Sec.  412.532, are only triggered if a LTCH patient is discharged from 
the LTCH and is then subsequently readmitted to the LTCH after an 
interruption. These policies do not address our concern with 
inappropriate discharges from host hospitals to LTCH HwHs or LTCH 
satellites because they are focused on the site of care during the LTCH 
stay rather than on shifting care from the host to the LTCH HwH.
    In response to the commenter's statement that the requirement that 
for LTCH designation, an acute care hospital must demonstrate that it 
has an average patient length of stay of greater than 25 days is 
another existing policy that protects against inappropriate payments to 
LTCHs, we would note that section 1886(d)(1)(B)(IV)(I) of the Act 
(implemented at Sec.  412.23(e)(2)(i)), is the specific statutory basis 
for of a LTCH as a type of acute care hospital that is excluded from 
the IPPS. This statutory definition only defines how long patients must 
stay on average at the LTCH, once they are admitted for the LTCH to 
maintain its IPPS exemption. It has no impact on the movement of 
patients from a host hospital to a LTCH HwH or LTCH satellite or the 
length of stay of that patient at the host before that patient is 
admitted to the LTCH. With this length of stay mandate in mind, 
however, at the outset of the LTCH PPS for FY 2003, we established the 
short stay outlier policy under the LTCH PPS at Sec.  412.529 to 
provide proportionately appropriate payments to LTCHs when patients 
receive treatment for considerably less than the statistically-defined 
average length of stay for a particular LTC-DRG. This policy 
established a payment policy under the LTCH PPS for short-stays at the 
LTCH and does not address truncated stays at a host hospital (since 
this policy does not look to see if the stay at the host was 
truncated). The commenters mentioned medical review requirements at 
Sec.  412.508, a process that, at least presently, actually consists of 
a QIO reviewing a statistical sample of hospital records or is prompted 
by a specific incident-review request or appeal. Although the option of 
a retrospective QIO evaluation of medical appropriateness of a hospital 
discharge is always an option available to beneficiaries, we do not 
believe that such a specific situation provides significant protection 
for purposes of establishing payment policy under Medicare since so few 
discharges are actually subjected to QIO review.
    Thus, as noted above, we do not believe that the results of any of 
these existing policies can effectively speak to the issues that we are 
addressing in the revised hospital-within-hospital policy. While we 
appreciate the commenter's recommendation concerning a reduced payment 
methodology for early discharges from the host acute care hospital, we 
do have an existing policy, the post-acute transfer policy discussed in 
the previous comment and response, that appears to be similar to what 
was described by the commenter. As we state above, we do not believe 
that even an extension of that policy addresses the issues we have 
identified here as the basis for the new separateness policy.
    Comment: Two commenters stated that because the LTCH PPS was just 
implemented in October 2002, there has not been enough time to review 
the impact of this payment system on the industry. The commenters urged 
us to adopt the recommendations promulgated by MedPAC in its June 2004 
Report to the Congress as well as to conduct a serious study of the 
LTCH industry and to continue to monitor growth and payment issues 
prior to implementing additional regulations. Two other commenters 
supported a time-limited moratorium (3 years) on new LTCHs to allow QIO 
reviews to become well established and CMS research to be completed.
    Response: Although we agree with much of what the commenter stated 
regarding the fact that the LTCH PPS is relatively new and the impact 
of the payment system on the industry is not yet certain, we do not 
believe that our regulations are premature. While we continue to 
monitor and evaluate the impact of the LTCH PPS on the LTCH industry, 
we believe that the policy revisions that we are finalizing in this 
rule arise from concerns with the host/ hospital-within-a-hospital 
relationship that have been present since our September 1, 1994 final 
rule (59 FR 45390) and, thus, predate the implementation of the LTCH 
PPS. These concerns have achieved new urgency with the considerable and 
continuing growth in the number of LTCH hospitals-within-hospitals. 
Although one method of dealing with our concerns is a time-limited 
moratorium on the establishment of new LTCHs, and hospitals-within-
hospitals in particular, we believe that such a step is best left to 
the Congress. Even if this occurred, however, it would not address any 
problems occurring in existing hospital-within-hospital LTCHs. In 
addition to finalizing this separateness policy, however, we plan to 
continue our monitoring efforts and to publish a detailed evaluation of 
MedPAC's recommendations in Federal Register documents updating the 
LTCH PPS for rate year 2006.
    Comment: Several commenters expressed concern that the policies 
that we proposed were based upon assumptions that were not supported by 
data. Three commenters, in particular, included reports that were 
commissioned by industry groups, two of which evaluated data from 
specific LTCH chains that have hospitals-within-hospitals and one which 
analyzed MedPAR data for acute care hospitals from FY 2000. The data 
from one LTCH chain indicate that a large percentage of hospitals-
within-hospitals admit considerably more than 25 percent of their 
patients from their host acute care hospitals. Another chain provided 
data indicating that, at least for its hospitals-within-hospitals, 
patients are generally reaching outlier status at the host acute care 
hospital prior to being discharged to the hospital-within-a-hospital. 
Data were also provided indicating that as a percentage of all of the 
host's discharges, the number of patients of the host that are 
discharged to LTCH hospitals-within-hospitals is extremely low (in the 
low single digits).
    Response: We disagree with the commenters' statement that our 
policy revisions are not supported by data. Although we noted in the 
proposed rule that given the relatively recent implementation of the 
LTCH PPS, our

[[Page 49201]]

data sources are relatively limited, the policies that we are 
finalizing for LTCH HwHs or LTCH satellites are the result of policy 
evaluations, anecdotal information, as well as data analyses. We also 
note, elsewhere in this preamble, that our concerns about the potential 
for inappropriate Medicare payments under the IPPS arising from the co-
location of an acute care hospital and a LTCH, were first stated in the 
September 1, 1994 final rule for the IPPS (59 FR 45389).
    When we proposed the regulations that we are finalizing in this 
document regarding LTCH HwHs, we noted that we were proposing to revise 
payment policies for LTCH HwHs because we had become aware that, along 
with the considerable growth in their numbers, there was a trend 
indicating widespread corporate reconfigurations affecting the host/
LTCH HwH relationship, particularly with regard to LTCH HwH. The 
existence of Web sites sponsored by industry consultants urging 
underutilized acute care hospitals to increase profits by renting space 
to LTCH HwHs in order to reduce the number of long-stay patients, 
further added to our concern
    Since we first became aware of the existence of LTCH HwHs in 1994, 
we have been aware of the strong resemblance that they bore to LTCH 
units of acute care hospitals, a configuration precluded by statute. We 
believe that it is incumbent upon us to continually refine our payment 
systems in light of concerns about the continued viability of the 
Medicare Trust Fund. In finalizing the revised LTCH HwH policy, 
therefore, as discussed previously in this preamble, we believe that 
this policy will help to protect the integrity of the IPPS DRG system 
as well as discouraging inappropriate payments under the LTCH PPS, the 
system that provides for the highest per discharge payment to a 
provider in the Medicare program. These policy goals typically require 
both proactive as well as reactive decisions on our part. We are aware 
that the majority of LTCH HwHs presently admit considerably more than 
25 percent (or the applicable percentage) of patients from their host 
hospitals and have taken that fact into account when we designed the 
transition policy for existing LTCH HwHs or LTCH satellites described 
elsewhere in these responses.
    Nothing in our data analyses was contradicted by the above-
mentioned studies sponsored by the LTCH industry. In finalizing the 
separateness policy in this regulation, we are aware that not all hosts 
with LTCH HwHs or LTCH satellites are manipulating their discharge 
patterns in order to avoid reaching outlier status. In response to the 
commenter that suggests we use, as a qualifying criteria, the percent 
of the host's patients that are admitted to the LTCH HwH, our data 
verifies that as a percentage of the total number of patients the host 
discharges, the percentage that are discharged to LTCH HwHs or LTCH 
satellites, is low. But this is logical and to be expected since most 
LTCH HwHs or LTCH satellites consist of approximately 25 beds in 
contrast to significantly larger host hospitals. However, we are 
focusing on the percentage of patients admitted to the LTCH HwH or LTCH 
satellite from the host and since data from the LTCH HwH indicates that 
even the relatively small percentage of the host's patients (as a 
fraction of all the host's patients) is sufficient to assure that most 
if not all of the relatively smaller LTCH beds are occupied, we are 
concerned with the appropriateness of payments to the LTCH based on our 
existing policy for those patients, and we believe that our new policy 
is warranted.
    In analyzing the discharge data, we have looked at data from 1996 
through 2003 from our MedPAR files, focusing our data analyses on 
changes in lengths of stay that exceed the geometric mean cases at host 
hospitals that are co-located with LTCH HwHs or LTCH satellites as 
opposed to those without LTCH HwHs or LTCH satellites. Our concern is 
that, in general, a significant volume of these cases are being 
discharged to the onsite LTCH prior to reaching outlier status. We 
compared the number of Medicare covered days for specific DRGs with 
data from hospitals before and after they became a host hospital. We 
selected DRGs that MedPAC had identified as being more likely to lead 
to cases in which a host hospital would transfer the patient from the 
acute care hospital to their co-located long-term acute care facility.
    Acute hospitals were grouped into cohorts for each year from 1996 
through 2003: those that were freestanding as distinct from those that 
currently were hosting a long-term care hospital. For all but one DRG 
(482), the mean amount of covered days across all years for hospitals 
that were currently hosting a LTCH was lower in comparison to when they 
were not hosting a LTCH. Four DRGs (263, 265, 266 and 483) experienced 
decreases over ten percent. We also looked at covered days for DRGs 
483, 126, 264, and 475 for the year 1999 (since all the acute care 
hospitals in the analysis were not hosting LTCH HwHs or LTCH satellites 
that year) in comparison to 2002 and 2003 (because all the acute care 
hospitals in the analysis were hosting LTCH HwHs or LTCH satellites in 
those years). For most of these DRGs (particularly DRG 483), the number 
of discharges with a very high number of Medicare days decreases quite 
significantly at the acute care hospital after it became a host. We 
believe that this data indicates a correlation between the presence of 
a LTCH as a LTCH HwH or a LTCH satellite within an acute care hospital 
and a shorter length of stay for Medicare beneficiaries at the acute 
care hospital.
    We, therefore, believe that the regulations that we are finalizing 
represent a reasonable response to our continuing policy concerns, 
industry monitoring, anecdotal information, as well as an evaluation of 
our available data. As additional data is gathered, we will continue 
our monitoring and analytic activities and determine whether additional 
policy revisions or refinements may be warranted.
    Comment: One commenter asks whether satellites of HwHs will be 
required to meet the 25 percent test regarding their relationship with 
their host hospital.
    Response: Although we did not explicitly discuss the impact of the 
proposed change on satellites, we believe that since satellites are 
also parts of a hospital that is within another hospital, it is 
appropriate to require that satellites of LTCHs meet the 25 percent or 
other applicable percentage test regarding discharges admitted from 
their host hospitals. These satellites may be linked either to LTCHs 
that are also co-located with a host hospital, that is, a LTCH HwH or 
LTCH satellite, or they may be a satellite of a free-standing LTCH. 
Under the current regulations, we have developed requirements for 
satellites of excluded hospitals at Sec.  412.22(h) that have generally 
mirrored those we have required for LTCH HwHs at Sec.  412.22(e) (64 FR 
41532, July 30, 1999; 67 FR 50105, August 1, 2002) except for the 
application of the 15 percent requirement, discussed in detail above, 
because attempting to apply this 15 percent test could actually serve 
to undermine separateness and control rules already in effect for a 
satellite and a host. In the August 1, 2002 final rule for the IPPS, we 
stated, that ``[S]ince the costs for the entire excluded hospital (at 
both the main hospital and the satellite facility) are reported on one 
cost report by looking at the costs that are shared between the 
satellite facility and the acute care hospital, the costs of services 
that the satellite facility receives from its `host' hospital will 
invariably be less than 15 percent of the costs of the entire hospital, 
even if all the costs of the

[[Page 49202]]

satellite facility were incurred by the host hospital.'' (67 FR 50106).
    As we are finalizing regulations that abandon reliance on the 15 
percent test as an indicator of separateness and control for LTCHs, and 
rather establishing the 25 percent or other applicable percentage test 
as the determinant of ``functional separateness'' between a LTCH HwH or 
LTCH satellite and its host hospital for determining the appropriate 
payment level for LTCH patients admitted from the host, we are also 
establishing this same requirement for satellites of LTCHs under new 
regulations at Sec.  412.534. There is a considerable similarity 
between a LTCH HwH and a LTCH satellite, notwithstanding that 
satellites are ``parts of a hospital'' and HwHs are distinct 
facilities. We believe that the same concerns that we have expressed 
throughout this preamble regarding the potential for medically-
unwarranted patient shifting between a host hospital and a LTCH HwH or 
LTCH satellite resulting in inappropriate Medicare payments are also 
present when an acute hospital is co-located with a satellite of a 
LTCH. In the July 30, 1999 IPPS final rule, when we stipulated that 
satellites of excluded hospitals would be required to meet the PPS 
exclusion requirements applicable to a hospital or unit, we noted that 
requirements for separate identification of the beds, patients, and 
costs of the satellite ``closely parallel similar requirements 
applicable to all excluded units under Sec.  412.25(a)(3) and (a)(7) 
through (a)(12).'' Therefore we believe that there are both 
administrative and procedural precedents for the application of 
separateness requirements to satellites. Accordingly, we have revised 
the regulations to clarify that the separateness policy applies to LTCH 
satellites under new Sec.  412.534, as well. In order for a LTCH 
satellite to be included in the grandfathering provision and payment 
policy phase-in, under Sec.  412.534, which we have established for 
certain LTCH HwHs, discussed in detail below, the LTCH satellite will 
have had to be in existence by October 1, 2004. (Note: Satellites do 
not have a 6-month qualifying period.) If a LTCH satellite does not 
meet that requirement, (that is, if it is established after October 1, 
2004) Medicare payments will be governed by Sec.  412.534 (a) through 
(e). In determining whether the satellite meets the 25 percent (or 
other applicable percentages, discussed earlier) threshold, we would 
compare the total number of patients treated at the satellite location 
to the number of those patients that were admitted from the co-located 
host (subject to the outlier adjustment discussed earlier.)
    Throughout this preamble, when we refer to this policy applying to 
LTCH HwHs, we intend this to apply as well to LTCH satellites that are 
co-located with a host hospital. In fact, a satellite location of a 
hospital is also co-located within another hospital.
    Comment: Regarding our proposed policy precluding common ownership 
of an acute care hospital and a HwH, we received three comments in 
favor of the preclusion and ten comments urging us not to finalize this 
proposed policy. One commenter noted that where the LTCH is co-located 
but not commonly owned, the LTCH has no incentive to accept 
inappropriate patients from the host hospital. Two other commenters 
noted that that the financial incentive to accept inappropriate 
patients from a host hospital only exists when the acute care hospital 
and the LTCH are commonly owned, a situation that can exist even 
without co-location, that is, a freestanding LTCH, exempt from the 
requirements of Sec.  412.22(e) may be owned and governed by the 
hospital from which it receives the majority of its referrals. Three 
commenters expressed concern that in prohibiting common ownership of a 
host and a LTCH, we were unintentionally creating a regulatory 
preference for for-profit LTCHs. Another commenter stated that not-for-
profit hospitals would particularly suffer from any preclusion of 
common ownership and since LTCH ``start-ups'' already sustain financial 
loss because of the 6-month qualification period during which they are 
paid under the IPPS and, therefore, only if a community-based non-
profit organization senses a real need in the community for LTCH 
services would it invest, develop and open an LTCH either as a HwH or 
free-standing. Two other commenters emphasized the distinction between 
ownership and control, noting that advantageous arrangements between 
entities that are not under common ownership could produce more 
``control'' than would be present in a common ownership situation that 
is being administered in compliance with present regulations.
    Several commenters requested that if we finalized the preclusions 
against common ownership, that we include in our proposed 
grandfathering provision, those HwHs that were ``under development'' to 
the extent that they were already operating as acute care hospitals 
within a host while collecting data that would enable them to qualify 
as LTCHs. Two of the commenters responded to our proposal to 
grandfather existing commonly owned hosts and HwHs while prohibiting 
the establishment of any new such arrangements by stating that 
grandfathering ``any form of ownership or control by a related entity'' 
would create inequity among providers as well as perpetuate any 
potential or existing abuses of Medicare policy. Two other commenters 
focused on the particular situation facing rural referral centers and 
sole community hospitals, two distinct categories of acute care 
hospitals that serve in unique markets and requested that even if our 
proposed policy prohibiting common ownership was finalized, that an 
exception be granted in these situations where there may be no other 
alternatives than for these isolated facilities to develop their own 
LTCHs. Another commenter further asserted that our present policies for 
separateness and control, which also governs commonly owned hosts and 
LTCH HwHs are sufficient and effective.
    Response: We thank the commenters that endorsed our proposed policy 
to prospectively preclude common ownership of a host hospital and a 
LTCH HwH. Our goal in proposing this policy was based on our concern 
that common ownership of a host hospital as well as a HwH (in 
particular, a LTCH) could result in revenue-driven rather than 
medically necessary discharge and admission determinations between the 
commonly-owned facilities that were also co-located since the benefits 
would accrue to one corporate entity. In response to another commenter, 
we are also aware that even in the absence of common ownership, or if a 
commonly-owned host and a HwH were being administered in strict 
compliance with existing policies, the host/LTCH HwH configuration 
where each component is separately owned could provide inappropriate 
benefits to each facility. (For example, as noted elsewhere in this 
preamble, we are familiar with Internet advertisements sponsored by 
certain consultants and hospital corporations that specialize in LTCH 
HwH that urge underutilized acute care hospitals to decrease or 
eliminate their high cost outliers by leasing space to a LTCH HwH, a 
result which would lead to inappropriate Medicare payments to both the 
host as well as the LTCH HwH.) We also acknowledge the commenters that 
noted that common ownership, even between hospitals that did not share 
a location, could result in incentives for patient discharges and 
admissions more related to reimbursement than for clinical purposes. 
From the initial implementation of the LTCH PPS in

[[Page 49203]]

2002, we established on-going monitoring as an essential component of 
the LTCH PPS (67 FR 56014, August 30, 2002) and we will continue to 
review data from varieties of LTCHs that reflect discharge and 
admission patterns from other Medicare providers: LTCH HwHs that are 
under common ownership with hosts and LTCH HwHs that are independently 
owned, as well as free-standing LTCHs, in order to evaluate whether 
further regulation may be necessary in order to address inappropriate 
Medicare payments. In response to the commenter who noted that a 
common-ownership preclusion would particularly affect not-for profit 
acute care hospitals that already have sustained a financial loss 
because any LTCH must be paid under IPPS for 6 months, we would respond 
that the qualifying period for LTCH designation is a requirement for 
all LTCHs, under Sec.  412.23(e)(3), both not-for-profit and for 
profit. After reviewing all of the comments, in this final rule, we are 
not finalizing the proposed policy precluding common ownership. In the 
proposed notice, we had offered a number of alternative policies to 
address the situation of a HwH that admitted more than 25 percent of 
its patients from its co-located host hospital. As an additional policy 
response to address this problem, we had proposed to regulate common 
ownership. However, we believe that because we are addressing our major 
concerns with commonly owned hosts and LTCH HwHs or satellites with the 
finalized 25 percent test which we believe will impact in the number 
and type of patients discharged from the host and admitted to the LTCH 
HwH, we do not need to also regulate against common ownership at this 
time. We will continue to monitor the common ownership issue and, if 
appropriate, revisit it at a later date. Therefore, one of the 
commenters that expressed concern regarding an ``inequity'' of 
competition between those LTCH HwH that would be subject to new 
regulation as opposed to those LTCH HwHs under common ownership with 
their host that would be grandfathered, is no longer an issue. We have 
revisited the issue of common ownership, first discussed in the 
September 1, 1994, final rule for the IPPS (59 FR 45392) because, we 
did not agree with the commenter that asserted that our existing 
policies were ``sufficient and effective `` to address our concerns 
with the circumstance of common ownership. However, we do believe that 
our new revision of the entire separateness policy, set forth in the 
next response, is presently an adequate response to our significant 
policy concerns in the area of LTCH HwHs including commonly owned host/
LTCH HwH arrangements. Since we are not finalizing the policy that 
precludes common ownership of a host and its LTCH HwH it is unnecessary 
to respond to those commenters that requested an extension of the 
proposed grandfathering provision and also to those commenters who 
believe that grandfathering of common ownership arrangements would 
perpetuate unnecessary abuses of the Medicare system. We will address 
other comments on grandfathering of existing LTCH HwHs unrelated to the 
common ownership issue elsewhere in these comments.
    Comment: Several commenters urged us to retain the 15 percent 
criterion at existing Sec.  412.22(e)(5)(ii) and to strengthen both its 
enforceability as well as associated sanctions. One commenter objected 
to the change in policy and stated that if the 15 percent policy was 
enforced then ``bad players'' could be sanctioned. One of the 
commenters, a corporate officer of a LTCH HwH scheduled to open in 
August 2004 stated that complying even with the existing 15 percent 
rule would require turning away from ``otherwise sound business 
practices.'' Two of the commenters further suggested that we extend 
separateness and control policies to limit specific business 
arrangements such as loans or financial arrangements, whereby the host 
funds or contributes to the working capital of the LTCH HwH or 
reimburses operating expenses or losses; that the 15 percent rule be 
reframed as a preclusion with civil and/or criminal penalties attached 
in the event of violation; and that executive officers be required to 
file an annual attestations of compliance with separateness and control 
as part of the cost reporting procedure. Two commenters specifically 
suggest that we consider adopting provisions of the Sarbanes-Oxley Act 
of 2002 for the purposes of policing corporate financial reporting 
which includes requirements that CEOs and CFOs of public corporations 
certify via an attestation to the veracity of financial statements and 
disclosures with severe penalties for willful and knowing violations. 
The commenters believed that the attestation procedure, as well as the 
potential for civil or criminal liability, would shift the burden of 
enforcement of the 15 percent criterion from the fiscal intermediary to 
the providers. One commenter characterized our proposed policy as one 
that removes the 15 percent criteria, which can be monitored and 
replaces it with a test that is directly related to and acts to limit 
the admission and treatment of patients in need of hospitalization. On 
the other hand, there was one commenter who supported our proposal to 
strengthen separateness requirements and encouraged enforcement of 
existing requirements. The same commenter indicated an awareness of 
hospital systems setting up a co-located LTCH HwH that ``on paper'' 
appeared to meet our requirements but in effect was controlled by the 
host, leading to the on-site LTCH functioning as a unit. This commenter 
suggested that we require a written certification and supporting 
documentation verifying that the separation requirements have been met.
    Response: When we established the regulations governing payment 
policy for hospitals within hospitals at Sec.  412.22(e) in the 
September 1, 1994 final rule for the IPPS (59 FR 45389) our goal was to 
create ``a firewall'' between the acute care host hospital and a new 
entity that we feared would actually function as a LTCH unit of that 
hospital, a statutorily precluded configuration.
    As stated above in this preamble, in the May 18, 2004 proposed 
rule, we proposed to eliminate the 15 percent rule because we were 
aware that the vast majority of LTCH HwHs were choosing to comply with 
that option as opposed to the more rigorous separation of basic 
functions (for example, medical records, pharmaceutical services, 
radiological services, laboratory services (Sec.  482. 21 through 
Sec. Sec.  482.27, 482.301 482.42, 482.43, and 482.45) or the 
``functional separateness'' test of the 25 percent referral requirement 
(62 FR 46014, August 29, 1997) and we did not believe that allowing a 
LTCH HwH to choose that the 15 percent rule among the existing policies 
regarding hospitals-within-hospitals had, in fact, sufficiently 
protected the Medicare program from the problems that we first 
envisioned in the September 1, 1994 final rule.
    Moreover, queries from providers and consultants as well as 
information from fiscal intermediaries, and our regional offices, 
concerns expressed by MedPAC in its June 2003 Report to the Congress 
and at meetings held at outset of the implementation of the LTCH PPS 
(which was implemented for cost reporting periods beginning on or after 
October 1, 2002), and the recent growth in the LTCH universe, 
particularly LTCH HwHs, convinced us that it was incumbent upon us to 
revisit separateness and control policies. Furthermore, we were 
recently given the opportunity to review a number of corporate 
documents, including Articles

[[Page 49204]]

of Incorporation of existing host/LTCH HwH arrangements as well as 
pending arrangements for the establishment of LTCH HwHs. These reviews 
made us aware of the development of a new generation of complex and 
creative corporate reconfigurations that would make it difficult and 
burdensome, if not impossible, for our fiscal intermediaries to 
ascertain compliance with Sec.  412.22(e) based on the 15-percent 
policy. We want to note that we understand that many LTCH HwHs made 
every possible effort to comply with the 15 percent provision.
    However, in response to commenters suggesting a range of options 
which preserve the 15 percent criterion, such as toughening the 
policies to prohibit specific business arrangements; the attachment of 
civil and/or criminal penalties in the event of violations; a 
requirement for annual attestations be required by corporate officers; 
adoption of particular corporate policing provisions of the Sarbanes-
Oxley Act of 2002, we would note that retaining the 15 percent 
criterion, even under any of the proffered circumstances would be an 
administrative burden on CMS and its contractors since they would 
require extensive reviews, audits, and monitoring to ferret out the 
``bad players.'' We also want to note, in response to the commenter who 
expressed concern about having to depart from ``sound business 
practice'' in order to comply with the 15 percent rule, that it is our 
statutory responsibility under sections 1102 and 1871 of the Act to 
establish regulations as may be necessary to effectively administer the 
Medicare program. A hospital retains the ability to conduct its 
corporate affairs as it sees fit and to the extent that the hospital's 
behavior does not conform to Medicare payment requirements, the 
hospital has made a choice, since it has been put on notice that it 
will not be paid under the regulations governing the Medicare program. 
The participation of a business in the Medicare program generally 
indicates that the provider has decided that the advantages of 
participation outweigh any adaptations in business practices required 
by our rules.
    We now believe that allowing LTCH HwHs to qualify by complying with 
the 15 percent test did not operate to prevent the creation of LTCH HwH 
that were actually functioning as units of hosts. Further, even if at 
their creation, there was effective compliance with the 15 percent 
test, monitoring continued compliance was nearly impossible. But even 
if it were possible to accurately monitor a LTCH HwH or satellite's 
compliance with the 15 percent test, we now believe that meeting this 
particular test, would not sufficiently ensure that Medicare payments 
otherwise payable under the LTCH PPS, for LTCH patients admitted from 
the host (that exceed 25 percent (or the applicable percentage of the 
HwH's discharges)) are appropriate. Moreover, we consider that for 
Medicare payment purposes, the significant movement of patients between 
the host hospital and the LTCH HwH or satellite continues to be the 
most effective indication of whether they are functioning as distinct 
hospitals or whether, in violation of statutory intent, in fact, the 
configuration is resulting in these facilities behaving as acute care 
hospitals with sub-acute units.
    As we previously stated, we want to reiterate that we are not 
substituting a criterion that will limit admission and/or treatment of 
Medicare beneficiaries by eliminating the 15 percent policy. We agree 
with the commenter who stated that our goal in establishing this policy 
revision was to prevent a co-located LTCH HwH or satellite from 
appearing to comply with our requirements ``on paper,'' but actually to 
be controlled by and functioning as a unit of the host. In response to 
the same commenter, we would also note that under the finalized policy, 
submission of documentation to fiscal intermediaries regarding 
compliance with existing separateness and control policies under Sec.  
412.22(e)(1) through (e)(4) is required to be paid as an IPPS excluded 
LTCH HwH or satellite under Sec.  412.22(h)(2)(D) and we will continue 
to require such documentation to demonstrate compliance with those 
requirements. As noted elsewhere in these responses, detailed 
instructions will be sent to fiscal intermediaries regarding 
implementation procedures for payment adjustments under new Sec.  
412.534.
    In this final notice, therefore, effective for cost reporting 
periods beginning on or after October 1, 2004, for LTCH HwHs we are 
eliminating the 15 percent test under existing Sec.  412.22(e)(5)(ii), 
and the performance of basic hospital functions test under subsection 
Sec.  412.22(e)(5)(i) and the 75 percent of admissions from other than 
the host criteria at Sec.  412.22(e)(5)(iii). If a LTCH demonstrates 
compliance with the medical and administrative separateness and control 
policies at Sec.  412.22(e)(1) through (e)(4), under our finalized 
policy, it will satisfy LTCH HwH requirements. The 25-percent or other 
applicable percentage test, described in the next response, will be the 
threshold criteria for a new payment adjustment for LTCH HwHs or 
satellites in new regulations at Sec.  412.534.
    Comment: We received numerous comments from LTCHs, industry groups, 
Congressional representatives, and individual medical professionals 
expressing great concern with respect to our various payment proposals, 
which are based on utilizing the 25 percent test. As proposed in the 
proposed rule, the 25 percent test would have been the sole determinant 
for a LTCH HwH or satellite to receive payment as a hospital excluded 
from the IPPS. We received several comments urging us not to adopt any 
of the proposed payment policies; that they were arbitrary and 
unprecedented and would result in lesser payments to the LTCH HwH or 
satellite based upon the source of patients. The commenters argued that 
reducing payments to the LTCH HwH or satellite for patients admitted 
from the host hospital beyond 25 percent of the LTCH HwH or satellite's 
total annual discharges would have two highly negative effects. First, 
this policy would result in the denial of necessary and appropriate 
care to patients who could benefit from treatment at the LTCH HwH or 
satellite. Additionally, a lower level of reimbursement would lead to 
the closing of LTCHs with all the attendant consequences of such 
closures such as shortage of hospital beds, industry insecurity leading 
to the inability to retain and attract professional staff, and loss of 
jobs for employees of the LTCH HwH or satellite. The policy that we are 
suggesting, several commenters assert, sets a ``maximum limitation'' on 
the admission of patients from the host, arbitrarily diverting patients 
away from LTCHs that share buildings with other hospitals.
    A number of commenters stated that our proposed policy constitutes 
discrimination against certain LTCHs solely because of their location, 
and if finalized, will disrupt health care service delivery and also 
exert a destabilizing effect on patient care programs and capital 
projects. One commenter asserts that the location of a duly licensed 
hospital may not be utilized as a basis for excluding it from 
participation in the Medicare program as a LTCH. Several other 
commenters assert that there would also be an impact on the 
availability of intensive care unit beds in the acute care hospitals, 
creating shortages which could threaten the availability of care for 
trauma patients in certain communities, if patients no longer needing 
these services were not discharged to onsite LTCHs.
    Response: We do not agree with the commenters who interpret our 
regulations as establishing arbitrary and

[[Page 49205]]

unprecedented limits on the right of a LTCH HwH to receive payment 
under the LTCH PPS. We are providing an adjustment to the payment under 
the LTCH PPS in accordance with the broad authority conferred on the 
Secretary by the Congress in section 307(b) of Public Law 106-554 to 
include ``appropriate adjustments'' in the establishment of a PPS for 
LTCHs. The finalized payment policies described below and the concerns 
that they represent echo concerns first expressed in the September 1, 
1994 final rule for the IPPS, when we began to regulate new entities 
that we named ``hospitals within hospitals.'' As noted elsewhere in 
these responses, the reason why we proposed the changes in the May 18, 
2004 proposed rule at this time is the nexus between these decade-old 
concerns and the recent explosive growth in the numbers of LTCH HwHs. 
Furthermore, these regulations are grounded in a thorough review of the 
available data as well as exhaustive policy evaluations and are 
rationally related to the analyses of such information. In addition, we 
would emphasize most strongly that these regulations do not establish 
either arbitrary or unprecedented limits on the rights of a LTCH HwH or 
LTCH satellite to be paid under the LTCH PPS. Although we have made 
significant revisions to the policies in the May 18, 2004 proposed 
rule, our basic premise is unchanged.
    As we first stated in that September 1, 1994 final rule, ``we agree 
that the extent to which a facility accepts patients from outside 
sources can be an important indicator of its function as a separate 
facility, not merely a unit of another hospital. In general, a 
facility's functional separateness should be reflected in its ability 
to attract patients from sources other than the hospital that it 
serves. For example, if a facility receives all (or nearly all) of its 
admissions independently (that is, from outside sources), it can 
reasonably be assumed to be functioning separately from the host 
hospital. (59 FR 45391).
    Having reevaluated the first two options that we presented in the 
May 18, 2004 proposed rule (69 FR 28326 through 28327) in light of 
comments that we received, we believe that the policy that we are 
finalizing is reasonable, and more directly addresses the relationship 
between movement of patients between the host hospital and the LTCH HwH 
or satellite and inappropriate or unnecessary Medicare payments, our 
central concern. Under the above policy, a LTCH must continue to 
demonstrate compliance with the medical and administrative separateness 
and control policies at Sec.  412.22(e)(1) through (e)(4). In the 
proposed rule, we stated that we would eliminate the two alternative 
qualifications for LTCH HwH (the 15 percent rule and the basic 
functions test) and instead rely solely on the 25 percent or other 
applicable percentage threshold for qualification purposes. We have 
refined this policy, in this final notice, and for purposes of 
qualifying as a LTCH HwH, we will eliminate all three performance of 
basic hospital functions options in Sec.  412.22(e)(5) if a LTCH HwH 
complies with Sec.  412.22(e)(1) through (e)(4) which addresses 
separateness and control of administrative and medical governance, the 
LTCH will qualify as a LTCH HwH. Instead, the 25 percent or other 
applicable percentage test will be the threshold for a new payment 
adjustment for LTCH HwH in new regulations at Sec.  412.534, where 
Medicare payment policy under the LTCH PPS is promulgated and will 
apply to LTCH satellites as well. We are establishing a distinction in 
this new payment adjustment between patients admitted from the host and 
from sources other than the host because we believe that even if a 
facility satisfies the requirements of Sec.  412.23(e)(1) and (e)(2) 
and is eligible for payment as a LTCH and also satisfies revised Sec.  
412.22(e)(1) through (e)(4) for purposes of being considered a LTCH HwH 
it may still appear to be functioning like a unit because of the number 
of patients that it admits from its host hospital. Payments will be 
made to the LTCH HwH or satellite for all Medicare patients under the 
otherwise unadjusted LTCH PPS only until the 25 percent or other 
applicable percentage threshold is reached after which point unadjusted 
(that is, not limited by a LTCH PPS payment amount that is equivalent 
to the amount otherwise payable under IPPS) payments will be made under 
the LTCH PPS for all Medicare patients admitted to the LTCH from 
sources other than the host. Once a LTCH HwH or satellite exceeds the 
25 percent or other applicable percentage threshold, Medicare LTCH PPS 
payments for patients admitted to the LTCH from the host will be 
adjusted. This per discharge payment adjustment for patients from the 
host exceeding the threshold, will be based on the lesser of payments 
otherwise paid under the LTCH PPS or an adjusted payment under the LTCH 
PPS that is equivalent to the applicable payment that would otherwise 
be made under the IPPS. Payments for a non-host patients would continue 
to be made under the otherwise unadjusted LTCH PPS.
    The policy that we will be finalizing is a variation of option III 
in the May 18, 2004 proposed rule and is applicable only to LTCHs 
governed under section 1886(d)(1)(B)(iv)(I) of the Act because the 
policy addresses payment policy related to the percentage of Medicare 
patients that are admitted to the LTCH HwH or satellite and as noted in 
a previous response, for a ``subclause (II)'' LTCH, the 25 percent test 
will not be applied because their certification as a LTCH is not tied 
to Medicare patients.
    We believe that this policy captures the intent of section 
1886(d)(1)(B)(iv)(I) of the Act which established LTCHs as a separate 
category of acute care hospitals for patients with average stays of 
greater than 25 days but precluded the establishment of LTCH units. To 
the extent that the source of its admissions reveal that the LTCH HwH 
or satellite is behaving like a unit of its host hospital, in 
contravention of both the statute and implementing regulations, 
Medicare will make adjusted per discharge payments under the LTCH PPS. 
When the facility appears to be functioning in compliance with the 
intent of the statute and implementing regulations, however, Medicare 
will make otherwise unadjusted payments under the LTCH PPS. In 
determining whether a hospital meets the 25 percent or other applicable 
percentage criterion, patients transferred from the host hospital that 
have already qualified for outlier payments at the acute host would not 
count as part of the host percentage. We believe that this is 
appropriate because as we discuss earlier in these responses, a patient 
reaching outlier status at a host hospital may be presumed to have 
received a full course of treatment in that setting. Further, in such a 
case, our policy presumes that a discharge to a LTCH HwH or satellite 
for post-acute care treatment may be clinically appropriate and 
therefore should reasonably be eligible for otherwise unadjusted 
payment under the LTCH PPS. In addition, if a LTCH HwH or satellite 
exceeds the 25 percent or other applicable percentage threshold (with 
host outlier patients paid as non-host patients), Medicare will pay the 
lesser of the LTCH PPS payment or a reduced LTCH PPS payment based on 
an amount equivalent to what would otherwise be paid under the IPPS. 
(The adjustment would only be applied to discharged patients admitted 
from the host hospital that exceed the 25 percent (or the applicable 
percentage) threshold. Cases transferred from the host up to the LTCH 
applicable percentage threshold would be paid the unadjusted LTCH PPS 
rate.)

[[Page 49206]]

    In this final rule, we have revised our use of the 25 percent test 
as a determinant of LTCH HwH satellite status that was originally set 
forth in the proposed policy and rather established it as a payment 
threshold under new Sec.  412.534. We have provided a 4-year transition 
for existing LTCH HwHs or satellites to allow for a reasonable period 
during which the host and the LTCH HwH or satellite will be able to 
adapt to the requirements of the new policy. Also included in this 
transition policy are LTCHs-under-formation that satisfy the following 
two-prong requirement: the hospital was certified as an acute care 
hospital on or before October 1, 2004, under Part 489; and was 
designated as a LTCH before October 1, 2005. We believe that these LTCH 
HwHs, since they have undergone significant efforts which could be 
adversely affected by these final rules, should be allowed a 4-year 
transition as well. For cost reporting periods beginning on or after 
October 1, 2004 through September 30, 2005, these hospitals will be 
grandfathered, with the first year as a ``hold harmless.'' Therefore, 
grandfathered LTCH HwHs will only need to continue to meet the existing 
separateness criteria at Sec.  412.22(e) which includes compliance with 
either paragraphs (e)(5)(i), (ii), or (iii) for that first cost 
reporting period. Grandfathered LTCH HwHs and LTCH satellites would not 
need to meet the 25 percent or other applicable threshold for the cost 
reporting periods beginning on or after October 1, 2004 through 
September 20, 2005. However, we are requiring that even for 
grandfathered facilities, in the first cost reporting period, the 
percentage of discharges admitted from the host hospital may not exceed 
the percentage of discharges admitted from the host hospital in its FY 
2004 cost reporting period. Therefore, we are grandfathering existing 
LTCH HwH and those LTCHs under-development that meet the 2 prong test 
and LTCH satellites that were in existence by October 1, 2004. 
Grandfathered HwHs and satellites may not increase the percentage of 
discharges admitted from the host in excess of the percentage they had 
in FY 2004. After the first grandfathered cost reporting period, these 
LTCH HwH will be required to meet a percentage transition over the 3 
years beginning in FY2006. For the second year (cost reporting periods 
beginning on or after October 1, 2005, but before October 1, 2006), the 
applicable percentage from the host will be the lesser of the 
percentage of their discharges admitted from their host for their FY 
2004 cost reporting period or 75 percent. For the third year (cost 
reporting periods beginning on or after October 1, 2006, but before 
October 1, 2007), the applicable percentage from the host will be the 
lesser of the percentage of their discharges admitted from their host 
for their FY 2004 cost reporting period or 50 percent, and finally 25 
percent (or the applicable percentage) threshold will apply beginning 
with the fourth year (cost reporting periods beginning on or after 
October 1, 2007). We have adopted a transition of 75 percent, 50 
percent, and then 25 percent since we felt it was reasonable to allow 
existing LTCH HwHs and HwHs under-development, as defined using the 
two-prong test above, 3 years to gradually meet our regulatory 
threshold.
    Transitions are a frequently incorporated feature of new Medicare 
payment policies. Examples are the 4-year phase-in of the IPPS, the 5-
year phase-in of the LTCH PPS, and the 3-year phase-in of the IRF PPS. 
In establishing a 1-year grandfathering as well as 3 additional years 
during which an existing LTCH HwH or satellite or ``pipeline'' LTCH HwH 
will be able to discharge the lesser of a proportionally-declining 
percentage or the hospital-specific percentage of Medicare patients 
that it admitted from its host during its final cost-reporting year 
prior to the implementation of this new 25 percent or other applicable 
threshold for the LTCH PPS payment adjustment, we are providing a 
reasonable and equitable methodology by which LTCH HwHs or satellites 
will be able to adapt to our new requirements.
    Comment: Several commenters expressed concern about the impact of 
the proposed 25 percent test on rural hospitals. In particular, a 
commenter pointed out a situation where a single tertiary acute care 
hospital is the only provider for a multi-county area, capable of 
treating medically complex patients in the entire region and which 
hosts a LTCH HwH or satellite. In a rural county, for example, 
commenters assert that there would not be sufficient patient volume to 
support any other LTCH. In such markets, small or medium sized 
communities, the commenters maintain that our proposed 25 percent test 
would deprive communities of LTCH services or force construction of 
free-standing LTCHs.
    Response: After considering the commenters' concerns and after 
further analysis, we are further revising the 25 percent criterion to 
provide for a payment adjustment for rural hospitals (Sec.  412.62(f)) 
or urban single or MSA-dominant hospitals (that is a hospital in an MSA 
that discharges more than 25 percent of all Medicare inpatient acute 
care hospital discharges in that MSA for like hospitals.) The Congress 
has authorized special treatment for rural areas under the Medicare 
program because of the particular geographic and demographic challenges 
in those locations as well as the differences between the provision and 
availability of medical services in rural as compared to urban areas. 
Further, in establishing this adjustment the Secretary is exercising 
the broad discretion granted by the Congress under section 307(b) of 
Public Law 106-554 to provide for appropriate payment adjustments in 
the LTCH PPS. Therefore, for rural acute care hospitals with LTCH HwHs 
or satellites, following the phase-in period, instead of the 25 percent 
criterion, we have provided that the majority, (that is, of at least 50 
percent) of the patients would have to be from the hospitals other than 
the host. Where the majority of the patients are admitted from 
hospitals other than the host in this instance, since there are few 
other hospitals from which the LTCH HwH or satellite can admit 
inpatients, we believe the majority is a reasonable criterion to 
establish that the LTCH HwH or satellite is not acting as a unit of the 
acute hospital. As with other hospitals, any Medicare patient that had 
been at the rural host in outlier status and then transferred to the 
LTCH HwH or satellite would be treated as if the patient had been 
admitted from a non-host hospital in determining the percentage of 
patients admitted from the rural host hospital.
    Additionally, for urban single or MSA dominant hospitals, which 
would generally be providing services under similar circumstances as 
rural hospitals, that is, being the only hospital in the area, we would 
allow the LTCH HwH or satellite to discharge Medicare patients admitted 
from the host up to the host's percentage of total Medicare discharges 
in the MSA for the most recent fiscal year that data is available for a 
hospital similarly certified as the host. We would apply a floor of 25 
percent and a ceiling of 50 percent (representing a numerical majority 
of patients) to this group. We believe the maximum threshold of a 
majority of its patients admitted from the host indicates that the HwH 
is a separate hospital and is not operating as a unit of the host. For 
example, if there are only two acute care hospitals in the MSA and 
based upon the most recent data available, hospital A had 500 Medicare 
discharges in its fiscal year while hospital B had 1500 Medicare 
discharges, the total number of Medicare discharges for that MSA is

[[Page 49207]]

2000 discharges. If hospital B has a co-located LTCH HwH or satellite 
we would calculate its separateness percentage (that is, the percentage 
of Medicare patients that it could admit from the host for otherwise 
unadjusted LTCH PPS payments) based on its percentage of total Medicare 
discharges in the MSA. In this instance, hospital B has discharged 75 
percent (1500/2000) of the discharges in the MSA. Accordingly, we would 
require that following the phase-in of the policy, the LTCH HwH or 
satellite be held to a determination that a ceiling of 50 percent (that 
is, less than a majority) of its discharges were admissions from the 
host hospital. Again, as previously noted, in determining the 
percentage of Medicare patients admitted from the host, as with all 
LTCH HwHs or satellites, any patient that had been in outlier status at 
the host and then transferred to the LTCH HwH or satellite would be 
treated as if they were admitted from a non-host hospital.
    As the above description of our revised payment policy for LTCH HwH 
or satellite demonstrates, we are not setting a ``maximum limitation'' 
on the admission of patients from the host. We are not establishing 
policies to prevent these facilities from delivering necessary and 
appropriate medical care and compliance with the policy need not result 
in hospital closures, industry insecurity, and a loss of professional 
and support staff. Instead, if the LTCH or satellite does not meet the 
applicable variation of the 25 percent test, rather than losing its 
ability to be paid as a hospital excluded from the IPPS in its entirety 
we will reduce Medicare payments under this policy only for those 
patients whose discharges exceed the threshold. Because hospitals will 
still be paid an appropriate amount for the care they deliver, we do 
not believe that those hospitals will close nor should there be 
industry insecurity or loss of professional or support staff. This 
reduction is to account for the fact that the LTCH is not functioning 
as a separate hospital but rather is effectively behaving as a unit. We 
would emphasize again that LTCH HwHs or satellites are free to admit 
any patient from any source without limit or restriction. In this 
policy revision, we merely address how Medicare will pay for patients 
in LTCH HwHs or satellites and establish the applicable thresholds that 
are the basis for such payment.
    We disagree with the comment that suggests that we are 
``discriminating'' against a hospital because of its location (within 
another hospital), we would respond that there are a significant number 
of Medicare payment policies that address certain hospitals for 
``special treatment'' because of their locations such as sole community 
hospitals (Sec.  412.92), rural referral centers (Sec.  412.96), and 
critical access hospitals (Sec.  413.70). Therefore, we believe it is 
appropriate to consider a hospital's location in determining payments. 
Similarly, it has been a long-standing practice to anticipate potential 
opportunities for ``gaming'' or to encourage behavioral change on the 
part of providers by establishing payment policies, often related to 
physical location, such as the onsite discharge and admission policy, 
under the TEFRA system for excluded hospitals at Sec.  413.40 (a)(3)(B) 
and under a similar policy in the LTCH PPS at Sec.  412.532. Further, 
in response to comments that suggest that the impact of our policy will 
be a disruption to health care delivery, patient care programs, and 
capital projects, we would state that we do not agree with these 
predictions. Rather, we believe that a reasoned analysis of the 
policies that we are finalizing, described in detail above, will reveal 
that they are neither destructive nor onerous to the effective 
functioning of either a host or a LTCH HwH or satellite.
    Finally, with regard to the potential shortage of intensive care 
beds in the host and the possible consequential harm to the treatment 
of local trauma victims that commenters threaten will result from a 
limitation of admissions to the LTCH or satellite, we would once again 
respond that our policy does not limit patient admissions, it sets 
appropriate payment for patient categories. Moreover, while we 
understand the concerns about the availability of intensive care unit 
beds in an acute care hospital, we believe that this is a problem that 
may occur due to other unexpected circumstances, for example, issues 
related to the need to appropriately staff those ICU beds. We do not 
believe that the policy that we are finalizing would increase the 
possibility of this problem arising, particularly since it is generally 
clinically appropriate to move a patient no longer in need of ICU 
treatment to a ``step-down'' unit of the host acute care hospital and 
not to maintain the patient needlessly in an ICU bed.
    In addition, as we explained earlier, for some patients in the 
acute care hospital, Medicare payment under the IPPS would include 
high-cost outlier payments. Under the policy described above, if an ICU 
patient had been moved to a ``step-down'' unit at the host hospital and 
the costs of treatment resulted in the case qualifying as a high cost 
outlier, Medicare payment for an admission of such a patient to the 
LTCH or satellite from the host acute care hospital would not be 
included as an admission from the host and would be paid based at the 
higher LTCH PPS rate. Accordingly, we believe with this policy we have 
addressed some of the concerns raised by the commenters as to the 
effect of the separateness percentage policy on access to services. We 
would also remind the commenters that we have established adjustments 
to the 25 percent test for rural hospitals or urban single or MSA 
dominant hospitals in response to situations where communities have a 
scarcity of inpatient options, thus further tailoring the revised 
policy to the unique needs of these communities.
    Comment: Several commenters expressed concern with the impact of 
the proposed 25 percent test on rural hospitals.
    Response: The Congress has authorized special treatment for rural 
areas under the Medicare program in a number of areas. In addition, we 
agree with the commenter that in rural areas it often will be difficult 
for a LTCH HwH or satellite not to exceed the 25 percent threshold 
since the co-located acute care hospital may be the only one in the 
area. To address this issue, as noted in the previous response, we are 
finalizing a modification of our 25 percent test for rural hospitals 
(and also for urban single or MSA-dominant hospitals). We would also 
note, however, that while we have addressed the commenters' concerns 
with LTCH HwHs in rural areas, in fact, there are very few rural LTCHs, 
even including free-standing LTCHs. With approximately 320 LTCHs in 
existence, the vast majority of rural areas throughout the country do 
not have either free-standing LTCHs or LTCH HwHs or satellites. 
Therefore, currently almost all patients in need of hospital-level 
long-stay care are being treated as high-cost outliers in rural acute 
care hospitals and are not treated in LTCHs.
    Comment: Several commenters questioned CMS' authority to impose new 
criteria for exclusion of long-term care hospitals and contend that 
existing separateness and control rules already enables us to 
distinguish between hospitals and units. The commenters state that the 
sole reliance on the 25 percent test establishes ``admissions 
criteria,'' and the Secretary does not have the right to disqualify a 
LTCH HwH or satellite meeting other exclusion criteria from payment 
under the LTCH PPS based on a failure to meet admissions criteria. The 
commenters stated that the term ``hospital'' is defined in section 
1861(a) of the Act

[[Page 49208]]

and that section 1886(d)(1)(B)(iv) of the Act provides an exclusion 
from the prospective payment systems for a hospital having an average 
length of stay greater than 25 days. These commenters therefore 
maintain that if a LTCH qualifies for Medicare participation by meeting 
the applicable participation requirements in 42 CFR Part 489 and also 
meets the statutory ``greater than 25 day length of stay criterion'', 
CMS has no right to ``remove'' this status because of where the LTCH is 
located or because of the source of its admissions. Several commenters 
claim that the proposed policy is ``arbitrary and capricious'' and one 
commenter maintains that the regulations fail the ``Chevron test.''
    Response: We do not agree that we have imposed additional criteria 
for the exclusion of LTCHs. Rather we are imposing new criteria for 
adjusting payments under the LTCH PPS for LTCH HwHs or satellites.
    The commenters are correct in noting that the term ``hospital'' is 
defined in section 1861(e) of the Act and that a statutory definition 
of a LTCH is the one set forth in section 1886(d)(1)(B)(iv)(I) of the 
Act. However, this fact does not mean that the Secretary is precluded 
from acting, under the general rule-making authorization in sections 
1102 and 1871 of the Act, to establish further rules and regulations as 
necessary to administer the Medicare program and to prevent exclusions 
or excessive payments that are contrary to the purpose of the statutory 
scheme. Section 123 of BBRA of 1999 as amended by section 307 (b) of 
BIPA of 2000 confers upon the Secretary tremendous discretion in 
creating the LTCH PPS. As explained in the preamble to the proposed 
rule published on May 18, 2004, we continue to be concerned that only 
qualified facilities be excluded from the IPPS and paid under the 
existing LTCH PPS and that payments under each system (IPPS and LTCH 
PPS) be made appropriately.
    When we first established regulations for LTCH HwH, in the 
September 1, 1994 final rule for the IPPS, in Sec.  412.22(e), we 
stated that a LTCH HwH or satellite must ``meet the following criteria 
in order to be excluded from the prospective payment systems specified 
in Sec.  412.1(a)(1).'' At that time, we explained in the preamble as 
follows: ``[A]s discussed above and in the proposed rule, we are adding 
new criteria to prevent an inappropriate exclusion from the prospective 
payment system. The purpose of excluding entities from the prospective 
payment system is to address situations in which the principles of 
prospective payment do not apply well. The considerations underlying 
exclusions may not apply to situations involving a ``hospital within a 
hospital.'' If an entity is effectively part of another hospital and 
the principles of prospective payment do apply well to the organization 
as a whole, then it would not be appropriate to exclude part of that 
organization from the prospective payment system. Moreover, we believe 
that granting an exclusion to a LTCH HwH or satellite may be contrary 
to the statutory scheme. The statute provides for exclusion of certain 
types of hospitals and certain types of hospital units. Significantly, 
the statute does not provide for exclusion of LTC units. A LTCH HwH or 
satellite may essentially be a long-term care unit of another hospital. 
We believe these distinctions are meaningful and that it would 
undermine the distinctions if we allowed exclusion of entities that are 
essentially long-term care units (59 FR 45390, September 1, 1994). 
``Thus, in order to prevent exclusions that are contrary to the purpose 
of the statutory scheme [section 1886(d)(1)(B) of the Act] we proposed 
additional criteria for entities seeking exclusion. Sections 1102 and 
1871 of the Act confer authority on the Secretary to establish rules 
and regulations as may be necessary to administer the Medicare 
program.'' (59 FR 45390, September 1, 1994). Existing regulations, 
therefore, finalized in 1994 established the regulatory principle that 
in order to be paid as a hospital excluded from the IPPS, separateness 
and control requirements would have to be met.
    The 25 percent or other applicable percentage threshold test that 
we are finalizing in this document in new Sec.  412.534 does not remove 
LTCH status from a hospital that otherwise meets these separateness and 
control requirements, as the commenter suggests. In fact, we are 
defining a level of payment distinction based upon an adjustment that, 
following the 4-year phase-in, will enable an existing hospital or 
satellite or new HwHs effective with cost reporting periods beginning 
on or after October 1, 2004, to retain its excluded status but to be 
paid under an otherwise unadjusted LTCH PPS payment for up to 25 
percent (or the adjusted threshold established for rural, urban single, 
or MSA dominant hospitals) of its discharged patients that are admitted 
to the LTCH HwHs or satellites from the host hospital. If the LTCH or 
satellite exceeds this 25 percent (or the applicable percentage) 
threshold, Medicare payments under the LTCH PPS will be based on the 
lesser of an otherwise unadjusted LTCH PPS payment for the case or an 
amount equivalent to what would have otherwise been paid for that case 
under the IPPS. We would note that this policy merely represents a new 
adjustment in the evolution of the LTCH PPS. We believe that LTCH HwHs 
that discharge greater than the appropriate percentage of patients 
admitted from their hosts may be understood to be functioning as units 
and therefore, we believe that it is appropriate to adjust the payment 
to be made to the LTCH under the LTCH PPS. The payment adjustment we 
are implementing is not the equivalent to setting ``admissions 
criteria'' for treatment at a LTCH. As noted elsewhere in these 
responses, a LTCH is free to admit as many patients as it can safely 
treat and from whatever source(s) it chooses. The policy revision that 
we are finalizing in this document establishes a payment formula that 
will enable the LTCH to be paid under the LTCH PPS appropriately for 
patients admitted to the LTCH from other than the host and 
appropriately for patients admitted to the LTCH HwH or satellite from 
the host where the LTCH has exceeded the applicable threshold, albeit 
at different LTCH PPS rates. We want to emphasize that the medical and 
administrative governance component of the separateness and control 
criteria at Sec.  412.22(e)(1) through (e)(4) will continue to apply to 
LTCH HwH or satellite but, as explained in detail above, we are 
deleting paragraph (e)(5), the performance of basic hospital functions 
test to LTCHs as a basis for determining whether they may be paid as an 
IPPS-exempt hospital. Rather the 25 percent or other applicable 
percentage criterion will be used as a basis for a payment adjustment 
under the LTCH PPS.
    We believe that the regulations that we are finalizing represent a 
permissible construction of the statute precluding the establishment of 
LTCH units at section 1886(d)(1)(B) of the Act, and are consistent with 
sections 1102 and 1871 of the Act which confer authority on the 
Secretary to establish rules and regulations as may be necessary to 
administer the Medicare program. It is also consistent with our 
statutory authority under section 123 of BBRA as amended by section 
307(b) of BIPA. Moreover, they are consistent with the statute and the 
statutory scheme. The finalized payment policies described below and 
the concerns that they represent echo concerns first expressed in the 
September 1, 1994 final rule for the IPPS, when we began to regulate 
new entities that we named `hospitals within hospitals' and after ten 
years,

[[Page 49209]]

represent a reasonable extension of existing regulatory policies.
    Comment: We received several comments that asserted that in 
establishing the category of hospitals excluded from the IPPS, the 
Congress recognized that the DRG payment system did not accurately 
reflect the patient census and types of treatment found in those 
hospitals. These commenters also quoted the requirements of the BBRA 
and BIPA for the establishment of a specific PPS for LTCHs ``reflecting 
differences in patient resource use'' and that therefore paying a LTCH 
under the IPPS, as we described in our third payment option in the 
proposed rule, would constitute a statutory violation.
    Response: In the proposed rule, we expressed this payment scheme 
incorrectly when we described payment as ``the lesser of the IPPS 
payment or the LTCH PPS payment.'' The payment formula, as we described 
in a previous response, is not, in fact, an IPPS payment at all but 
instead is an adjusted payment under the LTCH PPS. In section 307(b) of 
Public Law 106-554, the Congress conferred broad authority on the 
Secretary to include ``appropriate adjustments'' in the establishment 
of a PPS for LTCHs. As stated in previous responses, we are providing 
an adjustment to Medicare payments under the LTCH PPS in the event that 
a LTCH HwH or satellite LTCH admits a greater number of patients from 
its host above the 25 percent or other applicable percentage threshold. 
This adjustment to the LTCH PPS would allow, for each additional case 
that the LTCH admitted that were discharges from the host, beyond 25 
percent (or the applicable percentage), a payment that would be based 
on the lesser of an amount payable under this subpart that is 
equivalent to what would have otherwise been paid under the IPPS or the 
otherwise payable LTCH PPS payment amount. We believe that this 
specific adjustment to payments under the LTCH PPS is comparable to 
other adjustments that we established under the LTCH PPS, such as the 
short-stay outlier policy (Sec.  412. 529) and both the 3-day or less 
and the greater than 3-day interruption of stay policy (Sec.  412.531), 
in that we have attempted to adjust the otherwise payable LTCH PPS 
payment rate to more accurately pay for a specific type of patient 
stay. If a patient stay is governed under any one of these policies, 
payment under the LTCH PPS will be computed differently than it would 
for a typical LTCH stay where the patient remains in the LTCH for 
greater than \5/6\ of the average length of stay for the applicable 
LTC-DRG to which the episode is grouped. We believe that paying the 
LTCH an LTCH PPS adjusted payment that is the lesser of the LTCH PPS 
payment amount or a payment equivalent to the amount that would have 
otherwise been made under the IPPS, when a particular LTCH exceeds the 
percentage of admissions established under the formula set forth above, 
is entirely compatible with the broad statutory authority conferred on 
the Secretary, in section 307 of the BIPA, to establish a LTCH PPS and 
provide for ``appropriate payment adjustments'' under that system.
    Comment: We received six comments on the grandfathering of existing 
host/LTCH HwH arrangements where the LTCH HwH had in the past met the 
15 percent test for purposes of demonstrating compliance with the 
performance of basic hospital functions requirements. Four commenters 
urged us not to finalize the proposed revisions to the separateness and 
control policies but, as an alternative, to grandfather all existing 
LTCH HwHs and hence exempt them from prospective compliance with new 
finalized regulations until ``an in-depth study of the industry has 
been completed or until alternative qualifying criteria are 
implemented.'' One commenter opposed any grandfathering provision, 
absent a statutory approval, stating that such a policy provided no 
benefit for Medicare patients or the Medicare program and could serve 
to institutionalize behavior that we had already determined was in 
contravention of the intent of LTCH HwH regulations. Two commenters 
specifically suggested that we permit entities to unwind abusive 
practices within a specific period of time rather than legitimize 
abuses through grandfathering. Two commenters expressed concern about 
including providers that are in the formative stages any grandfathering 
protection. One commenter specifically urged us to include hospitals 
that were in their 6-month qualification period for LTCH classification 
and would be in compliance by January 1, 2005 and to deem them to meet 
existing governance, separateness and control policies and therefore to 
be eligible for any grandfathering provision that we would finalize. 
These commenters suggest that we establish a provision similar to that 
in section 507 of Public Law 108-173 that established a moratorium on 
physician-referrals to specialty hospitals in which they have an 
ownership or investment interest but grandfathered in those facilities 
under development. Without such a provision, the commenters believe 
that the financial backers (the host hospital in partnership with a 
venture capital group) would lose a considerable investment of time and 
resources.
    Response: As noted in a previous response, the LTCH HwH or 
satellite policy that we are finalizing to ease the transition to the 
new policy for existing LTCH HwHs and satellites, we specify a 1-year 
grandfathering for LTCH HwHs or satellites that had been paid under the 
LTCH PPS as of October 1, 2004 and also for LTCH HwHs-in-formation that 
qualify under the following two-pronged test: they were certified as 
acute care hospitals, under Part 489, on or before October 1, 2004; and 
they achieved LTCH designation prior to October 1, 2005. This two-
pronged test identifies hospitals that by the effective date of this 
regulation, have been operating in anticipation of becoming a HwH under 
the existing rules.
    The finalized policy provides for an adjusted payment for LTCH HwHs 
and satellites that admit more than 25 percent of their patients (with 
an adjusted percentage for rural and urban single or dominant 
hospitals) effective for cost reporting periods beginning on or after 
October 1, 2004. Further, for both existing LTCH HwH and LTCH 
satellites and those LTCHs-in-formation that meet the above tests, 
following the 1-year hold-harmless provision, we have provided a 3-year 
transition, in order to allow LTCH HwHs or satellites and their hosts 
what we believe is sufficient time to adapt to the new requirements and 
enable them to ultimately meet the 25 percent or other applicable 
percentage test. We believe that establishing this provision is a fair 
and equitable response to concerns expressed by providers, members of 
the Congress who have written on behalf of their constituent LTCHs, and 
LTCH trade groups.
    The LTCH PPS, from its inception, has included an evaluation and 
monitoring component which focuses on the LTCH industry and in light of 
policy recommendations made by MedPAC in its June 2004 Report to the 
Congress, we plan to expand these initiatives. However, we do not 
believe that it would be appropriate to delay implementing these 
payment policies affecting LTCH HwHs or satellites pending the results 
of such on-going analysis. We also see no need to adopt a policy that 
would allow time for entities to correct prohibited practices prior to 
the imposition of sanctions since we are eliminating the necessity to 
comply with the performance of basic hospital functions requirements 
under Sec.  412.22(e)(5) and rather relying on changes to the payment 
policy to

[[Page 49210]]

address situations where a LTCH HwH or satellite exceeds the percentage 
threshold of patients admitted from the host, effective with cost 
reporting periods beginning on or after October 1, 2004. With the 
October 1, 2004 implementation of this final rule, for LTCHs that are 
not grandfathered, we will rely on the 25 percent test as a basis for a 
payment adjustment under the LTCH PPS at new Sec.  412.534, if a LTCH 
HwH complies with the medical and administrative separateness and 
control requirements of Sec.  412.22(e)(1) through (e)(4) or the LTCH-
in-formation meets the LTCH HwH requirements prior to October 1, 2005 
and the satellite meets the requirements at Sec.  412.22(h). We also do 
not believe the statutory protection for those facilities under 
development promulgated by in the moratorium on physician-owned 
specialty hospitals established under section 507 of the Public Law 
108-173 is applicable to this provision.
    Comment: We received numerous comments urging us not to finalize 
the proposed policies that would prevent admissions to LTCH HwHs or 
satellites from being based on determinations of medical necessity, 
clinical assessment, and treatment practices, but rather, based on a 
restrictive numerical admission standard. Comments from industry 
groups, members of the Congress, host hospitals, LTCH HwHs or 
satellites, and physicians practicing at these providers, and in 
communities where they are located, objected to the proposed 
elimination of other options for qualification as a LTCH and instead, 
requiring LTCH HwHs or satellites to comply with the 25 percent test. 
The commenters believe this change in policy will have a significant 
impact on physician decision-making and admission policies at LTCH HwH 
or satellite. Several physicians accused us of being disingenuous in 
drawing a sharp distinction between payment policy and its impact on 
medical decision-making.
    Response: We disagree with the commenters' assertion that 
finalizing our 25 percent or other applicable percentage test for 
determining payments to LTCH HwH or satellite will interfere with a 
physician's efforts to procure the highest level of medical care for 
Medicare beneficiaries. Once again, we must state that we are not 
preventing the admission of patients to the LTCH HwH or satellite; 
rather we are establishing a methodology for determining what are fair 
and reasonable payments based on the type of patient being treated at 
the LTCH HwH or satellite. We continue to believe that there is a clear 
distinction between medical decision-making and payment policy, 
particularly on the physician level, when the patient is a Medicare 
beneficiary and the medically necessary services are covered by 
Medicare.
    There has always been a range of payments under Medicare for 
services that, from a medical standpoint, could appear to be identical. 
Since its inception, the LTCH PPS has included patient-level 
adjustments to the per discharge Federal payment rate, whereby Medicare 
would adjust payments depending upon the patient's length of stay, or 
whether the patient was being readmitted to the LTCH following a brief 
stay for treatment in another setting, or from a co-located provider. 
Similarly, in general, under Medicare's PPSs for inpatient services 
there have always been facility-level adjustments for variables 
including size and location of the hospital, presence of training 
programs, or the nature of the population served. Thus, payment for a 
patient at one facility could differ considerably from payment for a 
patient with similar clinical needs at another facility. Additionally, 
acute care hospitals, rehabilitation hospitals, and LTCHs can often be 
a legitimate site of care provided to a specific patient. However, 
Medicare's distinct PPSs for each of these provider types would provide 
for different payments to the specific hospital that treated the 
patient based upon the provider category. This is another example that 
demonstrates that under Medicare, payments for the same diagnosis, even 
for the same patient, could vary depending upon where the patient was 
admitted. Even within the same facility, a different Medicare payment 
would be made under the acute hospital IPPS for a rehabilitation or a 
psychiatric DRG than would be made for the same diagnosis if the 
patient is admitted to the IPPS-excluded rehabilitation or psychiatric 
unit at that hospital. We do not agree that in setting payment policy 
we are restraining physicians from utilizing their best clinical 
judgment on behalf of their patients. We continue to believe that 
payments made under the policy that we are finalizing in this document 
simply represent another patient-level adjustment under the LTCH PPS.
    Comment: We received numerous comments from LTCHs, industry groups, 
Congressional representatives, and individual medical professionals 
expressing great concern that the proposed policy, which required 
compliance with the 25 percent test, would have very deleterious 
consequences for Medicare beneficiaries. The commenters asserted that 
the policy would establish new admissions criteria and, in effect, act 
as a quota or cap on patient admissions to LTCH HwHs eliminating 
beneficiary and family choice as to treatment settings, produce 
needless trauma for beneficiaries, and reduce beneficiary access to the 
level of quality care that such settings could provide. Several 
commenters state that our proposed policies would violate section 1801 
which, among other matters, preclude any Federal officer or employee 
from interfering in the practice of medicine or the provision of 
services; and section 1802 of the Act, which they interpret to mean 
that Medicare beneficiaries cannot be denied health services. The 
commenters believe that LTCHs forced to monitor admissions from the 
host will have a strong incentive to deny patients medically necessary 
inpatient service as the percentage of admissions from the host 
approaches 25 percent. Three commenters emphasized that there would be 
less likelihood of medical errors if a patient discharged from an acute 
care hospital could be admitted to an onsite co-located facility 
because of consistency in care and ``fewer handoffs'' would decrease 
the possibility of errors occurring. The costs of care would also be 
reduced because it would be unnecessary to repeat tests and other 
ordered procedures. Furthermore, the commenters felt that proposing 
such a policy indicated a lack of appreciation for the specialized care 
provided by LTCH HwHs and LTCHs in general.
    Response: We disagree with the commenters who assert that through 
finalizing the 25 percent (or the applicable percentage) criterion, as 
a basis for adjusting payments to LTCH HwHs or satellites for patients 
admitted to the LTCH from the host acute care hospital, we are 
restricting patient care. As stated in the previous responses, we have 
established a payment policy, not a patient care policy. We would 
remind commenters who express disapproval of a LTCH monitoring its 
admission numbers as it approaches its threshold, that even before the 
October 1, 2002 implementation of the LTCH PPS, LTCHs under the TEFRA 
system had to monitor their admissions as well as their lengths of stay 
lest they fall below the greater than 25 day average length of stay 
qualification threshold for designation as a LTCH. From our research in 
designing the short-stay outlier policy during the development of the 
LTCH PPS, we became distinctly aware of admission choices made by 
LTCHs, particularly as the cost reporting period was drawing to a 
close, if the length of stay averages were below the

[[Page 49211]]

greater than the 25 day threshold required by the statute. Thus, this 
phenomenon is neither unique nor new. The establishment of a payment 
policy that may result in payment adjustments for certain admissions is 
well within the existing regulatory framework. We fail to see the 
relationship between the payment policy we are finalizing and an 
increase in the likelihood of medical errors, unnecessary tests, or 
other ordered procedures, patient trauma, or disruption in the 
consistency of care. Nor do we see compliance with the policy as 
leading to increased costs. We are finalizing this policy because we 
are concerned that the co-location of an acute hospital and a LTCH with 
significant patient movement from the acute hospital to the LTCH may 
violate the intent of the prohibition of LTCH units under section 
1886(d)(1)(B) of the Act, a prohibition that was established in order 
to protect the Medicare system against unnecessary and inappropriate 
payments. We are finalizing a payment policy premised upon the fact 
that LTCH HwHs or satellites that admit more than a specified 
percentage of patients from their hosts are functioning as units and we 
are adjusting payments to the LTCH HwH or satellite accordingly. 
However, as explained earlier, we have revised the policy as proposed 
to reflect unique location factors and we allow for full payments 
beyond the threshold if the transferred patient has reached outlier 
status at the acute hospital. In this final rule, we have also provided 
for grandfathering of existing LTCH HwHs or satellites and certain LTCH 
HwHs that will be designated as LTCHs prior to October 1, 2005 and an 
additional 3-year phase-in to full compliance requirements. In these 
revisions, we have attempted to respond to valid concerns raised by our 
commenters as well as maintain the integrity of the statutory scheme in 
section 1886(d)(1)(B) of the Act which precludes LTCH units.
    Although we strongly disagree that our payment policy will have the 
effect of restricting patient care at LTCH HwHs or satellites, we will 
respond to the commenters regarding the sections of the Act that they 
believe we are violating. As explained above, we do not believe that 
this policy interferes with the practice of medicine or provision of 
health care services under section 1801 of the Act. The policies that 
we are finalizing, as we explained earlier, are merely payment 
provisions. Nor are we violating section 1802 of the Act by interfering 
with a beneficiary's right to total self-determination regarding health 
care. This interpretation of the provision is incorrect. The statute 
actually says, ``Any individual entitled to insurance benefits under 
this title may obtain health services from any institution, agency or 
person qualified to participate under this title if such institution, 
agency, or person undertakes to provide him such service.'' (emphasis 
added) In addition, our finalized rules do not preclude a beneficiary 
from seeking admission to a hospital of his or her choice. We continue 
to believe that we have not promulgated rules that will prohibit a LTCH 
from providing necessary services to Medicare patients, even if they 
are patients that are admitted from the co-located host hospital. Our 
LTCH HwH and satellite rules do not prohibit a hospital from admitting 
a patient. Rather, our LTCH HwH and satellite rules are payment rules 
that set forth how a LTCH HwH or satellite will be paid under a 
particular set of circumstances.
    Comment: We received a comment from MedPAC that brought the 
following points to our attention: (1) The rapid growth in LTCH HwHs 
and rapid increases in Medicare spending for LTCH services; (2) the 
existence of a LTCH HwH quadrupled the probability that a beneficiary 
would use LTCH care; (3) freestanding LTCHs also have strong 
relationships with acute care hospitals, and that where on average LTCH 
HwHs receive 61 percent of their patients from their hosts, 
freestanding LTCHs receive 42 percent from their primary referring 
hospital; (4) concerns with LTCHs may be related to the payment systems 
and CMS policies for SNFs and acute care hospitals and should not 
therefore be considered in isolation; (5) there are some risks in CMS's 
proposed 25 percent policy; (a) The 25 percent rule that only applies 
to LTCH HwHs and not to freestanding LTCHs and may therefore be 
inequitable; (b) it does not ensure that patients go to the most 
appropriate post-acute setting; (c) this approach may be circumvented 
by an increase in the number of freestanding LTCHs instead of LTCH HwH. 
MedPAC shares our concern that the LTCH payment system creates an 
incentive for unbundling of the IPPS in addition to overpayment for the 
care provided by LTCHs and that this concern is great, particularly, in 
the case of a LTCH HwH. In MedPAC deliberations, the Commission 
considered recommending a moratorium on LTCH HwHs but did not adopt it. 
Finally, MedPAC stated that it reserves judgment on our proposed 
policies for LTCH HwHs pending more empirical evidence demonstrating 
the unique risk posed by them.
    Response: We appreciate the comments from MedPAC, which are 
consistent with our strong concerns with the growth in the number of 
LTCH HwH and our continuing questions about the relationships between 
treatment at acute care hospitals and LTCHs, as well as the linkage 
between payment policies and substitution of services especially among 
acute care hospitals, LTCHs, and some SNFs. While we also understand 
the reservations expressed in the comments, we want to emphasize that, 
as explained earlier, we are establishing these revised payment 
policies in this final notice for LTCH HwHs or satellites and not 
freestanding LTCHs because of the considerable growth in the number of 
LTCH HwH and because, ever since we first became aware of the existence 
of LTCH HwHs in 1994, we have been mindful of the strong resemblance 
that they bore to LTCH units of acute care hospitals, a configuration 
precluded by statute. The proposed policies are not intended to ensure 
that patients go to ``the most appropriate post-acute setting.'' 
Rather, we believe that it is incumbent upon us to continually refine 
our payment systems to maintain the continued viability of the Medicare 
Trust Fund. In finalizing the revised LTCH HwH policy, therefore, as 
discussed previously in this preamble, we believe that this policy will 
help to protect the integrity of the IPPS DRG system as well as 
discouraging inappropriate payments under the LTCH PPS, the system that 
provides for the highest per discharge payment to a provider in the 
Medicare program. These policy goals typically require both proactive 
as well as reactive decisions on our part. We strongly support MedPAC's 
approach in their recent recommendations for developing standards that 
would identify the unique characteristics of a LTCH that warrant 
increased payments under the LTCH PPS. It is also important, as 
recommended by MedPAC to identify the specific types of patients that 
should be the unique patient load of LTCHs. Prior to the end of the 4 
year transition period, CMS will reevaluate the HwHs criteria to assess 
the feasibility of developing facility and clinical criteria for 
determining the appropriate facilities and patients to be paid for 
under the Medicare LTCH PPS. If, during that time period, data from 
well-designed studies (or other compelling clinical evidence) indicate 
that developing this criteria is feasible, we would consider revisions 
to the HwH

[[Page 49212]]

regulations. We intend to analyze these issues and discuss any findings 
in the forthcoming FY 2006 LTCH PPS notice.
    Comment: Several commenters allege that the proposed requirement 
for compliance with the 25 percent test will undermine two existing 
requirements of the Medicare program: Discharge planning and the 
involvement of the Quality Improvement Organizations (QIOs). Regarding 
discharge planning, the commenters argue that the 25 percent test will 
impact the host hospitals' requirement for discharge planning by 
limiting the most obvious site for continued treatment, which would be 
the onsite LTCH, and they believe that our proposed policy will 
encroach upon the responsibility of the QIOs to determine whether or 
not a case meets the standard of medical necessity.
    Response: We do not agree with the commenters that the proposed 
policies in any way undermine the discharge planning function at the 
acute care hospital, set forth in Sec.  482.43, or affect the 
involvement of QIOs in medical review at Sec.  412.508. First of all, 
we must assert that the 25 percent test (which as a result of the 
changes in this final notice, for some hospitals, will actually be 
higher than 25 percent) does not set a cap or quota on the number of 
patients from the host hospital that the LTCH is permitted to admit. We 
are establishing payment policy based on a policy rationale first 
established in the September 1, 1994 final rule for the IPPS (59 FR 
45390) wherein we stated that ``the extent to which a facility accepts 
patients from outside sources can be an important indicator of its 
status as a separate facility, not merely a unit of another hospital.'' 
As noted elsewhere in these responses, we have revised existing 
regulations to specify a new standard solely for the purpose of 
determining appropriate Medicare payments. Accordingly, the finalized 
policy is a change only to payment policy and should not directly 
impact discharge planning. Under Sec.  482.43 ``* * * [a] hospital must 
have in effect a discharge planning process that applies to all 
patients.'' Paragraph (b)(3) of this regulation specifies that ``[T]he 
discharge planning evaluation must include an evaluation of the 
likelihood of a patient needing post-hospital services and of the 
availability of the services.'' (emphasis added.) Although we expect 
that the financial implications of the payment policy adjustments that 
we are finalizing may be factored into determinations of whether or not 
a particular post-acute provider is willing to admit a specific 
patient, there are additional factors that could typically affect the 
``availability of services'' (that is, the decision by the post-acute 
provider about whether to admit the patient in question). These factors 
include available bed space or ongoing compliance with regulations 
specific to each provider-type, such as the need for a LTCH to annually 
meet its greater than 25-day average length of stay requirements. 
Therefore, in light of the factors that must be considered by a post-
acute hospital, we believe that rather than undermining the discharge 
planning process, the payment policy for LTCH HwHs or satellites that 
we are finalizing in this notice may join other issues that generally 
would be evaluated prior to accepting a patient from another hospital.
    In response to the commenters' assertions that our proposed 
regulations undermine the role of QIOs as a vehicle to identify and 
prevent inappropriate utilization of LTCH HwHs or satellites, we note 
that, despite the importance of QIO activities in specific case review, 
and identification of treatment trends, we do not believe that, at 
least presently, the involvement of QIOs would be effective in dealing 
with problems of inappropriate payments for patients admitted to the 
LTCH HwH or satellite from the host hospital since so few discharges 
are actually subjected to QIO review.
    Comment: We received a comment from an organization representing 
fiscal intermediaries requesting further information on implementation 
procedures should the proposed policies be finalized. In particular, 
there were questions about implementing on a systems level any of the 
three options proposed under the proposed 25 percent rule. The 
commenter suggests that we base payments for LTCH HwHs on one 
methodology for all Medicare patients, regardless of source of referral 
and therefore supports the option by which if the percentage of 
patients that a LTCH receives from its acute care hospital host exceeds 
25 percent that the LTCH will no longer be paid as an excluded 
hospital. Another comment from an industry association urged us to 
subject any procedure by which a fiscal intermediary would evaluate 
compliance with a 25 percent test to public comment, because the 
commenter believes that our ``* * * proposals are too vague and 
complicated for public comment at this time.''
    Response: Although we understand that establishing a ``bright-
line'' policy whereby if hospitals fail the 25 percent (or the 
applicable percentage) test they would not be paid as excluded 
hospitals, is technically less complicated for fiscal intermediaries, 
we believe that the policy that we have established appropriately 
addresses our policy concerns and is also equitable to those LTCHs that 
exist as LTCH HwHs or satellites and their host hospitals. We further 
believe that as discussed earlier in this preamble, there are ample 
systems-wide precedents (for example, transfer policy under the IPPS) 
for the type of policy adjustments that we are finalizing. Finally, the 
systems procedures that we establish in order to implement our policies 
are communicated in program memoranda that we will issue to our fiscal 
intermediaries following the October 1 effective date of the final rule 
and are not subject to notice and comment rule-making.
    Comment: The majority of those commenters who disagreed with any of 
the specifics of our proposed policies for HwHs acknowledged our 
concerns about the unprecedented growth in the number of LTCH HwHs and 
the potential for inappropriate discharging of Medicare patients from 
the host hospitals to the LTCH HwH. Several commenters commended us for 
our ``efforts to identify systemic abuses and to make policy changes 
that will result in cost savings.'' A number of commenters believe that 
our concern goes back to the broader issue which is that, presently, 
there is no clear and enforceable definition of LTCHs on a facility 
level and there are no appropriate medical standards for patient 
admission or retention. Moreover, there is no established criteria for 
what would constitute an appropriate discharge pattern from an acute 
care hospital to an on-site LTCH. Three commenters claim that our 
proposed policy does not address underlying issues of payment for an 
inappropriate level of care. There was significant concurrence among 
the majority of commenters, regardless of the degree to which they 
either endorsed or disagreed with our proposed policies, that we should 
study admission, discharge, and treatment patterns between acute care 
hospitals and all LTCHs, co-located or free-standing, and establish 
facility-level and patient criteria that could lead to criteria for 
``certification'' as recommended by MedPAC in its June 2004 Report to 
the Congress. (Several commenters noted that one LTCH industry group 
has established a set of admission standards already being used by its 
member LTCHs.) Two commenters further encouraged us to establish a 
workgroup in collaboration with the Congress, providers, industry 
groups, and other

[[Page 49213]]

interested parties to explore these issues.
    Response: We thank the commenters for agreeing with our concerns 
regarding the unprecedented growth in the number of LTCH HwHs the 
potential for inappropriate patient shifting between host hospitals and 
LTCH HwHs, and significantly, our efforts to identify abuses that 
threaten the viability of the Medicare Trust Fund. We agree with 
commenters that it may be worthwhile to examine patient and facility 
issues. Further examining of these issues may be beneficial in 
establishing the most effective and cost-efficient utilization of LTCHs 
and in assuring that Medicare beneficiaries receive the appropriate 
level of treatment and care in that setting. We continue to believe, 
however, that the policies that we have revised in this final notice 
are an appropriate response to concerns about Medicare payments to host 
hospitals and LTCH HwHs or satellites expressed throughout this 
preamble.
    We also endorse the widespread enthusiastic industry support 
garnered by the recommendations in MedPAC's June 2004 Report to the 
Congress on ``Defining long-term care hospitals.'' Although we continue 
to believe that the policy revisions regarding payments for patients 
from host hospitals to LTCH HwHs or satellites are necessary and 
appropriate to address the immediate problem we have identified with 
LTCH HwHs or satellites, which is underscored by the recent growth in 
those facilities, we believe that MedPAC has definitely identified the 
most significant issues for Medicare regarding payment policy for 
LTCHs, in general. We intend to address MedPAC's suggestions in a more 
thorough evaluation and discussion of the issues MedPAC has raised, in 
future Federal Register publications updating the next year's LTCH PPS. 
We further believe that MedPAC's June 2004 Report to the Congress has 
made a substantial contribution to a frank and fair exchange on issues 
dealing with payments to LTCHs. We wish to commend the Commission on a 
level of analysis that helped focus CMS on the growth in LTCH HwHs.
    We are also aware that versions of admission criteria for LTCHs 
have been produced and have heard that some LTCHs have begun to use 
them. In response to the two commenters who urged us to convene a 
workgroup made up of providers, industry groups, and the Congress, we 
value our frequent contacts with all of these groups and will determine 
whether we will convene this group in the future.
    We are finalizing revisions to separateness and control regulations 
at Sec.  412.22(e) and adding new regulation at Sec.  412.534, Special 
payment provisions for long-term care hospitals within hospitals.
    Effective for cost reporting periods beginning on or after October 
1, 2004, we are limiting the finalized policy revisions to addressing 
LTCH HwHs and also satellites of LTCHs (either LTCH HwH or free-
standing). The policies will also be applicable for any type of host, 
including an IRF. We are finalizing policy to eliminate the existing 
three ``Performance of basic hospital functions'' options under 
existing Sec.  412.22(e)(5) for qualifying as a LTCH HwH (the 15 
percent rule and the basic functions test, and the 75/25 test). If a 
LTCH HwH meets existing separateness and control of administrative and 
medical governance provisions at Sec.  412.22(e)(1) through (e)(4), 
payment will be made under the LTCH PPS as specified in Sec.  412.534. 
Under Sec.  412.534, if a LTCHs or satellite's discharges admitted from 
its host hospital exceed 25 percent (or the applicable percentage) of 
its discharges for the LTCH HwHs or satellite's cost reporting period, 
an adjusted payment will be made of the lesser of the otherwise full 
payment under the LTCH PPS and an amount that would be equivalent to 
what Medicare would otherwise pay under the IPPS. In determining 
whether a hospital meets this percent test, patients transferred from 
the host hospital that have already qualified for outlier payments at 
the host would not count as part of the host 25 percent (or the 
applicable percentage) and the payment for those patients would also 
not be subject to the adjustment. Those patients would be eligible for 
full payment under the LTCH PPS. (Discharges admitted from the host 
before the LTCH crosses the 25 percent (or the applicable percentage) 
threshold would be paid without the adjustment under the LTCH PPS.)
    We are also finalizing additional adjustments to the 25 percent 
policy for specific circumstances. For rural acute care hospitals with 
LTCH HwHs or satellites, instead of the 25 percent criterion, the 
majority, (that is, 50 percent or more) of the discharges would have to 
be from the hospitals other than the host. In addition, in determining 
the percentage of discharges admitted from the host, any patient that 
had been a Medicare outlier at the host and then admitted to the LTCH 
HwH or satellite would be considered as if they were admitted from a 
non-host hospital. For urban single or MSA dominant hospitals, we would 
allow the LTCH HwH or satellite to discharge patients admitted from the 
host up to the host's percentage of total Medicare discharges in the 
MSA for like hospitals. We would apply a floor of 25 percent and a 
ceiling of more than 50 percent to this variation. In addition, in 
determining the percentage of patients admitted from the host, any 
patient that had been Medicare outliers at the host and then admitted 
to the LTCH HwH or satellite would be considered as if they were 
admitted from a non-host hospital.
    We are finalizing a 4-year phase-in of this policy for existing 
LTCH HwHs and satellites and also for LTCHs-under-formation that 
satisfy the following two-prong requirement: On or before October 1, 
2004 they have certification as acute care hospitals, under Part 489; 
and before October 1, 2005 designation as a LTCH. For cost reporting 
periods beginning on or after October 1, 2004 and before October 1, 
2005 these hospitals will be grandfathered, with the first year as a 
``hold harmless'' followed by a percentage transition over the 3 years 
beginning in FY 2006. Grandfathered LTCH HwHs will need to continue to 
meet the existing separateness criteria at Sec.  412.22(e) which 
includes compliance with either paragraph (e)(5)(i), (ii), or (iii) for 
that first cost reporting period. We are requiring that even for 
grandfathered facilities, for cost reporting periods beginning on or 
after October 1, 2004 and before October 1, 2005, the percentage of 
discharges admitted from the host hospital may not exceed the 
percentage of discharges admitted from the host hospital in its FY 2004 
cost reporting period, which we have chosen since we are implementing 
the revised policy for cost reporting periods beginning on or after 
October 1, 2004 (FY 2005). We are establishing a transition percentage 
threshold for the percentage of discharges that may be admitted from 
the host before the payment adjustment applies to the discharge that 
were admitted from the host in excess of the threshold. After the first 
grandfathered cost reporting period, these LTCH HwHs and satellites 
will be required to meet a percentage transition over the 3 years 
beginning in FY2006. For the second year (cost reporting periods 
beginning on or after October 1, 2005, but before October 1, 2006) the 
percentage of the threshold will be the lesser of the percentage of 
their admissions from their host for their cost reporting period 
beginning on or after October 1, 2003 or 75 percent. For the third year 
(cost reporting periods beginning on or after October 1, 2006, but 
before October 1, 2007), the

[[Page 49214]]

percentage of the threshold will be the lesser of the percentage of 
their discharges admitted from their host for their cost reporting 
period beginning on or after October 1, 2003 or 50 percent, and for 
cost reporting periods beginning on or after October 1, 2007, the 
percentage threshold will be 25 percent or the applicable percentage.
    Technical Change. In Sec.  412.22(e) of our regulations, we refer 
to a hospital-within-a-hospital as a hospital that ``occupies space in 
a building also used by another hospital, or in one or more entire 
buildings located on the same campus as buildings used by another 
hospital'' (emphasis added). The reference to ``entire'' buildings is 
incorrect. We should have referred to ``separate'' buildings. 
Therefore, in the May 18, 2004 proposed rule, we proposed to correct 
this error.

C. Critical Access Hospitals (CAHs)

1. Background
    Section 1820 of the Act provides for the establishment of Medicare 
Rural Hospital Flexibility Programs, under which individual States may 
designate certain facilities as critical access hospitals (CAHs). 
Facilities that are so designated and meet the CAH conditions of 
participation in 42 CFR Part 485, Subpart F, will be certified as CAHs 
by CMS. Regulations governing payments to CAHs for services to Medicare 
beneficiaries are located in 42 CFR Part 413.
2. Payment Amounts for CAH Services (Section 405(a) of Public Law 108-
173 and Sec. Sec.  413.70 and 413.114 of the Regulations)
    Prior to the enactment of Public Law 108-173, section 1814(l) of 
the Act provides that the Medicare payment amount for inpatient 
services furnished by a CAH is the reasonable costs of the CAH in 
providing the services. Section 1834(g)(1) of the Act provides that the 
Medicare amount of payment for outpatient services furnished by a CAH 
is also made on a reasonable cost basis, unless the CAH makes an 
election, under section 1834(g) of the Act, to receive a payment amount 
that is the sum of the reasonable cost of hospital outpatient facility 
services plus 115 percent of the amount otherwise paid for professional 
services. Section 1883(a)(3) of the Act provides for payment to a CAH 
for covered skilled nursing facility services furnished under an 
agreement entered into under section 1883 of the Act on the basis of 
the reasonable costs of such services. Regulations implementing these 
provisions are set forth in Sec.  413.70(a), for inpatient CAH 
services; in Sec.  413.70(b), for payment under the standard method for 
the reasonable costs of facility services, and outpatient CAH services; 
in Sec.  413.70(b)(3), for the optional method of payment for 
outpatient services (reasonable costs for facility services plus fee 
schedule for professional services); and in Sec.  413.114, for SNF 
services of a CAH with a swing-bed agreement.
    Section 405(a) of Public Law 108-173 amended sections 1814(l), 
1834(g)(1), and 1883(a)(3) of the Act to provide that, effective for 
services furnished during cost reporting periods beginning on or after 
January 1, 2004, the amount of the payment for inpatient, outpatient, 
and SNF services, respectively, furnished by a CAH is equal to 101 
percent of the reasonable cost of the CAH in providing these services.
    In the May 18, 2004 proposed rule (69 FR 28327-28328), we proposed 
to revise Sec. Sec.  413.70(a)(1), (b)(2), and (b)(3) and Sec.  413.114 
of our regulations to incorporate the change in the payment percentage 
made by section 405(a) of Public Law 180-173. We also proposed to make 
a technical correction to Sec.  413.70(b)(2)(i) to remove paragraphs 
(b)(2)(i)(C) and (D). We proposed to delete these paragraphs to conform 
the regulations to provisions of the outpatient hospital PPS.
    We note that in the IPPS final rule published in the Federal 
Register on August 1, 2001 (66 FR 39936), we added a new paragraph 
(a)(1)(iv) to Sec.  413.70. However, when the change was incorporated 
into the Code of Federal Regulations, paragraphs (a)(1)(i), (a)(1)(ii), 
and (a)(1)(iii) were inadvertently omitted. Our proposed revision of 
Sec.  413.70(a)(1) would correct the omission of these three 
paragraphs.
    We did not receive any public comments on our proposals. 
Accordingly, in this final rule, we are adopting the proposals as final 
without modification.
3. Condition for Application of Special Professional Service Payment 
Adjustment (Section 405(d) of Public Law 108-173 and Sec.  413.70(b) of 
the Regulations)
    As stated earlier, section 1834(g) of the Act provides for two 
methods of payment for outpatient CAH services. Under the provisions of 
section 1834(g) of the Act, a CAH will be paid under a reasonable cost 
method unless it elects payment under an optional method. Under the 
reasonable cost payment method, facility services are paid on a 
reasonable cost payment basis by the fiscal intermediary to the CAH, 
and physician and other professional services to CAH outpatients are 
paid for under the physician fee schedule, with payments being made by 
the carrier. Under the optional method (frequently referred to as 
``method 2''), CAHs submit bills for both facility and professional 
services to the fiscal intermediary. If a CAH elects the optional 
method of billing for outpatient services, Medicare payment for its 
facility services are made at the same level as would apply under the 
reasonable cost reimbursement method, but services of professionals to 
outpatients are paid for at 115 percent of the amounts that would 
otherwise be paid for under the physician fee schedule. To make the 
optional method election feasible and to help prevent possible 
duplicate billing, we require practitioners furnishing services to 
outpatients of a CAH to agree to reassign to the CAH their rights to 
bill the Medicare program for those services.
    Existing regulations at Sec.  413.70(b) set forth these payment 
options and specify that an election of the optional method, once made 
for a cost reporting period, remains in effect for all of that period 
and applies to all services furnished to CAH outpatients during that 
period. This means that, under existing regulations, a CAH may elect 
the optional method payment only if all of its practitioners agree to 
reassign their billing rights for outpatient services to the CAH.
    Section 405(d)(1) of Public Law 108-173 amended section 1834(g)(2) 
of the Act by adding a sentence after paragraph (B) to specify that the 
Secretary may not require, as a condition for a CAH to make an election 
of the optional method of payment, that each physician or other 
practitioner providing professional services in the CAH must assign 
billing rights with respect to the services. However, the optional 
payment method does not apply to those physicians and practitioners who 
have not assigned such billing rights. In other words, section 405(d) 
of Public Law 108-173 amended the Medicare law to authorize CAHs to 
elect the optional payment method even if some practitioners do not 
reassign to the CAH their rights to bill for professional services to 
CAH outpatients. However, it also specifies that the 15-percent 
increase in payment for those services is not available for 
professional services for which billing rights are not reassigned to 
the CAH.
    The provisions of section 405(d)(1) of Public Law 108-173 are 
effective for cost reporting periods beginning on or after July 1, 
2004. However, section 405(d)(2)(B) of Public Law 108-173 also states, 
in a special rule of application,

[[Page 49215]]

that in the case of a CAH that made an election before November 1, 
2003, the provisions of section 405(d)(1) of Public Law 108-173 are 
effective for cost reporting periods beginning on or after July 1, 
2001.
    Consistent with section 405(d)(2)(B) of Public Law 108-173, we do 
not intend to attempt recovery of certain amounts paid improperly in 
the past to CAHs for professional services that the CAHs billed under 
the optional payment method, even though the CAHs had not obtained 
reassignments of billing rights from all physicians and other 
practitioners furnishing professional services to their outpatients, as 
required by Sec.  413.70 as in effect at that time. However, in the May 
18, 2004 proposed rule (69 FR 28328), we proposed to clarify that the 
special rule of application in section 405(d)(2)(B) of Public Law 108-
173 is not to be interpreted to permit a CAH to obtain payment under 
the optional payment method for any cost reporting period based on an 
election made for a prior period or on an optional payment method 
election that was withdrawn or revoked prior to the start of the cost 
reporting period for which it was made.
    To illustrate the application of section 405(d)(2)(B) of Public Law 
108-173, assume that on October 1, 2002, a CAH elected method 2 for its 
cost reporting period starting on January 1, 2003, but did not obtain 
reassignments from all physicians treating its outpatients, as required 
by regulations in effect at that time. Under section 405(d)(2)(B) of 
Public Law 108-173, CMS would not recover any amounts from the CAH for 
payments for services furnished during that cost reporting period 
(January 1, 2003, through December 31, 2004) that are attributable to 
that election, even though the election was inappropriate based on the 
regulations that were in effect at the time it was made. Assume further 
that the same CAH recognized its error and did not make a method 2 
election for its cost reporting period beginning January 1, 2004, thus 
receiving payment under method 1. The fact that the election of October 
1, 2002, was made prior to November 1, 2003, is not material in this 
case and cannot be interpreted to justify method 2 payment for the cost 
reporting period beginning January 1, 2004, because that method 2 
election related to an earlier cost reporting period and not to the 
cost reporting period beginning January 1, 2004. The same result would 
occur if the CAH had elected method 2 on October 1, 2003, but 
subsequently revoked that election on October 15, 2004.
    In the proposed rule, we proposed to revise Sec.  413.70(b)(3)(i) 
to reflect the changes made by section 405(d) of Public Law 108-173. We 
proposed to specify in Sec.  413.70(b)(3)(i) that a CAH may elect to be 
paid for outpatient services in any cost reporting period beginning on 
or after July 1, 2004, under the method described in Sec. Sec.  
413.70(b)(3)(ii) and (b)(3)(iii). In Sec.  413.70(b)(3)(i)(A), we 
proposed to clarify that such an election is to be made at least 30 
days before the start of the cost reporting period for which the 
election is made. In Sec.  413.70(b)(3)(i)(B), we proposed to specify 
that the provision applies to all services furnished to outpatients 
during that cost reporting period by a physician or other practitioner 
who has reassigned his or her rights to bill for those services to the 
CAH in accordance with the reassignment regulations under 42 CFR Part 
424, Subpart F. In that paragraph, we also proposed to specify that if 
a physician or other practitioner does not reassign his or her billing 
rights to the CAH in accordance with 42 CFR Part 424, Subpart F, 
payment for the physician's or practitioner's services to CAH 
outpatients will be made on a fee schedule or other applicable basis 
specified in 42 CFR Part 414, Subpart B. We also proposed to add a new 
paragraph (C) to Sec.  413.70(b)(3)(i) to state that, in case of a CAH 
that made an election under Sec.  413.70(b)(3) before November 1, 2003, 
for a cost reporting period beginning before December 1, 2004, the 
rules in paragraph (b)(3)(i)(B) are effective for cost reporting 
periods beginning on or after July 1, 2001. In addition, we proposed in 
Sec.  413.70(b)(3)(i)(B) to clarify that an election for the optional 
method would be effective only for any cost reporting period for which 
it was made and does not apply to an election that was withdrawn or 
revoked before the start of the cost reporting period for which it was 
made.
    We did not receive any public comments on our proposals. 
Accordingly, in this final rule, we are adopting the proposals as final 
without modification.
4. Coverage of Costs for Certain Emergency Room On-Call Providers 
(Section 405(b) of Public Law 108-173 and Sec. Sec.  413.70(b)(4) and 
485.618 of the Regulations)
    Under existing regulations at Sec.  413.70(b)(4), which implement 
section 1834(g)(5) of the Act, Medicare payments to a CAH may include 
the costs of compensation and related costs of on-call emergency room 
physicians who are not present on the premises of a CAH, are not 
otherwise furnishing services, and are not on-call at any other 
provider or facility when determining the reasonable cost of outpatient 
CAH services. Section 405(b) of Public Law 108-173 amended section 
1834(g)(5) of the Act to expand the reimbursement to a CAH of 
compensation costs for on-call emergency room providers beyond 
physicians to include physician assistants, nurse practitioners, and 
clinical nurse specialists for the costs associated with covered 
Medicare services furnished on or after January 1, 2005.
    In the May 18, 2004 proposed rule (69 FR 28329), we proposed to 
revise Sec.  413.70(b)(4)(i) and (ii) to include the expanded list of 
emergency room on-call providers for whom reimbursement for reasonable 
compensation and related costs in a CAH would be available. We also 
proposed to make a conforming change to Sec.  485.618(d) governing the 
standard for emergency room personnel who are on call under the CAH 
conditions of participation.
    Comment: One commenter recommended that the proposed change to 
Sec.  485.618(d), under which a clinical nurse specialist is added to 
the list of practitioners who may be on call to provide emergency 
services to CAH patients, be revised by adding a comma after the phrase 
``clinical nurse specialist.'' The commenter believed this change will 
help to clarify that all practitioners who have on-call 
responsibilities, and not only clinical nurse specialties, should have 
training or experience in emergency care.
    Response: We agree and have made this change to Sec.  485.618(d) 
and a conforming change to Sec.  413.70(b)(4)(ii)(B) in this final 
rule.
    Accordingly, in this final rule, we are adopting the proposed 
changes to Sec.  485.618(d) as final with one further technical change, 
as discussed above, to clarify that all practitioners who have on-call 
responsibilities should have training or experience in emergency care.
5. Authorization of Periodic Interim Payments for CAHs (Section 405(c) 
of Public Law 108-173 and Proposed Sec. Sec.  413.64(h)(2)(vi) and 
413.70(d) of the Regulations)
    Section 1815(e)(2) of the Act provides that payments may be made on 
a periodic interim payment (PIP) basis for specified covered Medicare 
services. Section 405(c)(1) of Public Law 108-173 amended section 
1815(e)(2) of the Act by adding a new subsection (E) to provide for 
payments for inpatient services furnished by CAHs on a PIP basis, 
effective for payments made on or

[[Page 49216]]

after July l, 2004. Section 405(c)(2) of Public Law 108-173 directs the 
Secretary to develop alternative methods for the timing of the payments 
under the PIP method.
    We have already established in existing regulations under Sec.  
413.64(h) provisions for making payments under the PIP method to 
providers for certain Medicare covered services. The principles and 
rules of Sec.  413.64 have been incorporated into regulations governing 
payment on a PIP basis to acute care IPPS hospitals as well as to other 
providers, such as SNFs and LTCHs, that are paid on a prospective 
basis. We believe these principles and rules could be equally applied 
to CAHs. Therefore, in the May 18, 2004 proposed rule (69 FR 28329), to 
implement the provisions of section 405(c) of Public Law 108-173, we 
proposed to add a new Sec.  413.64(h)(2)(vi) to specify inpatient 
services furnished by CAHs as an additional type of covered service for 
which PIP is available, effective for payments made on or after July 1, 
2004.
    It has been our longstanding policy under Sec.  413.64(h)(6) that 
payment will be made biweekly under the PIP method, unless the provider 
requests a longer fixed interval (not to exceed 1 month) between 
payments. We believe that this provision grants adequate flexibility 
for the timing of payments under the PIP method to all qualifying 
providers, including CAHs. Under the proposed policy for CAHs, if a CAH 
chooses to receive its payments less frequently than biweekly, it could 
inform its Medicare fiscal intermediary. Section 413.64(h)(6) does not 
provide for the payments to be made more frequently than biweekly to 
providers for which PIP is currently available. We believe this is 
equally appropriate for the payments for inpatient services furnished 
by CAHs.
    In summary, we proposed to apply the same rules and procedures for 
payments under the PIP method that we apply to acute care hospitals and 
certain other Medicare providers. Therefore, CAHs, in applying for and 
receiving payments for inpatient services under the PIP provision, 
would be operating under the same rules as other providers for which 
PIP is available under Sec.  413.64(h), including the flexibility 
discussed above of the timing of their payments as provided for under 
Sec.  413.64(h)(6). We also proposed to establish a new paragraph (d) 
under Sec.  413.70 to provide that, for payments on or after July l, 
2004, a CAH may elect to receive PIP for inpatient services furnished 
by CAHs, subject to the provisions of Sec.  413.64(h). The new Sec.  
413.70(d) summarizes the application of the PIP provisions under Sec.  
413.64(h)(6) for CAH inpatient services and notes the availability of 
accelerated payments for CAHs that are not receiving PIPs.
    Comment: Two commenters noted that section 405(c) of Public Law 
108-173 provides that PIP for CAHs applies to payments made on or after 
July 1, 2004. One commenter believed that the new paragraph (d) under 
Sec.  413.70 providing for PIP for CAHs ``subject to the provisions of 
Sec.  413.64(h)'' suggests that payment of PIP would be for cost 
reports beginning on or after July 1, 2004. The commenters stated that 
some fiscal intermediaries have indicated that existing CAH facilities 
will not be able to receive PIP until the start of their first cost 
reporting period beginning on or after July 1, 2004 and that a CMS 
regional office has provided direction that the election of PIP is 
limited to the beginning of a CAH cost reporting period. The commenters 
asked CMS to clarify that qualifying CAHs are eligible for PIP, 
effective for payments made on or after July 1, 2004, not for cost 
reports beginning on or after that date.
    Response: Qualifying CAHs are eligible for PIP for payments made on 
or after July 1, 2004. New Sec.  413.64(h)(2)(vi) specifies that for 
inpatient CAH services furnished by a CAH, PIP is available for 
qualifying CAHs, effective for payments made on or after July 1, 2004. 
New Sec.  413.70(d) also provides that a CAH may elect to receive PIP 
effective for payments made on or after July 1, 2004. Section 
413.64(h)(3) has long provided that a provider that establishes to the 
satisfaction of its fiscal intermediary that it meets the requirements 
to receive PIP may elect to receive PIP, beginning with the first month 
after its request that the fiscal intermediary finds administratively 
feasible. This provision provides fiscal intermediaries some 
flexibility in beginning PIP for a provider, but we expect that fiscal 
intermediaries will begin PIP for providers, including CAHs, within a 
reasonable period of time after the fiscal intermediary has determined 
that the provider qualifies for PIP.
    Comment: One commenter indicated that some fiscal intermediaries 
have interpreted the regulations at Sec.  413.64(h) that a new CAH 
cannot receive PIP until at least one CAH cost report has been filed. 
Another commenter indicated that one CMS regional office has suggested 
that PIP is only available to those CAHs that have at least one full 
12-month cost report under cost-based reimbursement.
    Response: Section 413.64(h)(3)(ii) has long contained the 
requirement that, to qualify for PIP, the provider has filed at least 
one completed Medicare cost report accepted by the fiscal intermediary 
as providing an accurate basis for computation of payment. However, the 
requirement contains an exception in the case of a provider requesting 
payment under PIP upon first entering the Medicare program. Therefore, 
a new CAH to the Medicare program need not have filed a cost report to 
be able to qualify for PIP. However, in the absence of a completed cost 
report, the fiscal intermediary must have other information in order to 
satisfy itself that it can make accurate PIP payments. A provider 
without a completed cost report needs to supply all information that 
the fiscal intermediary requests in order for the intermediary to make 
its determination as to whether it can make accurate payments to the 
provider under the PIP method. Section 413.64(h)(5) provides that 
approval of PIP is conditioned upon the intermediary's best judgment as 
to whether accurate payments can be made under the PIP method. 
Therefore, if the fiscal intermediary is satisfied with the information 
it has received that it can make accurate payments under the PIP 
method, it will approve PIP for the provider. If the fiscal 
intermediary is not satisfied that it can make accurate payments, it is 
not to approve PIP for the provider.
    A CAH need not have at least one full 12-month cost report under 
cost-based reimbursement to qualify for PIP. However, as discussed 
above, a fiscal intermediary is not to approve PIP unless it is 
satisfied that PIP will result in accurate payments. For a provider 
without a full 12-month cost report under cost reimbursement, the 
fiscal intermediary may request additional information from the 
provider in order to assure itself that it can make accurate payment to 
the provider under PIP. If the fiscal intermediary is satisfied with 
the information it has received that it can make accurate payments 
under the PIP method, it will approve PIP for the provider. If the 
fiscal intermediary is not satisfied, it is not to approve PIP for the 
provider.
    After careful consideration of the comments received, we do not 
believe any changes are necessary, and we are adopting our proposal as 
final without modification.
    Technical Changes to Sec.  413.64. In the May 18, 2004 proposed 
rule, we proposed to use this opportunity to remove Sec. Sec.  
413.64(h)(3)(iv) and 413.64(h)(4), which contain an outdated 
requirement that a provider must repay any outstanding current 
financing payments before being permitted to be paid under the PIP 
method. Current financing payments have not been

[[Page 49217]]

available since 1973. We did not receive any public comments on this 
proposed technical change. Therefore, we are adopting it as final.
6. Revision of the Bed Limit for CAHs (Section 405(e) of Pub. L. 108-
173 and Sec. Sec.  485.620(a) and 485.645(a)(2) of the Regulations)
    Prior to the enactment of Public Law 108-173, sections 
1820(c)(2)(B)(iii) and 1820(f) of the Act restricted CAHs to 15 acute 
care beds and a total of 25 beds if the CAH had been granted swing-bed 
approval. The number of beds used at any time for acute care inpatient 
services could not exceed 15 beds.
    Section 405(e) of Public Law 108-173 amended sections 
1820(c)(2)(B)(iii) and 1820(f) of the Act to allow CAHs a maximum of 25 
acute care beds for inpatient services, regardless of the swing-bed 
approval. This amendment is effective on January 1, 2004 and applies to 
CAHs designated before, on, or after this date. However, section 
405(e)(3) of Public Law 108-173 also notes that any election made in 
accordance with the regulations promulgated to carry out the bed size 
amendments only applies prospectively.
    We implemented this provision via a survey and certification letter 
on January 1, 2004. (See Survey and Certification Letter No. 0414, 
issued December 11, 2003.) Effective January 1, 2004, this provision 
allows any currently participating CAH, or applicant for CAH approval, 
to maintain up to 25 inpatient beds. If swing-bed approval has been 
granted, all 25 beds can be used interchangeably for acute care or 
swing-bed services. However, no CAH will be considered to have had 25 
acute care beds prior to January 1, 2004. In the May 18, 2004 proposed 
rule (69 FR 28329), we proposed to amend our regulations at Sec. Sec.  
485.620(a) and 485.645(a)(2) to reflect the increase in the number of 
beds permitted in a CAH, in accordance with the amendments made by 
section 405(e) of Public Law 108-173.
    We received no comments within the scope of this proposal and, in 
this final rule, we are adopting as final, without modification, our 
proposed amendments to Sec. Sec.  485.620(a) and 485.645(a)(2) to 
reflect the increase in the number of beds to 25 permitted in a CAH, in 
accordance with the amendments made by section 405(e) of Public Law 
108-173.
7. Authority to Establish Psychiatric and Rehabilitation Distinct Part 
Units of CAHs (Section 405(g)(1) of Pub. L. 108-173 and New Sec.  
485.646 of the Regulations)
    As stated earlier, sections 1820(c)(2)(B) and 1861(mm) of the Act 
set forth the criteria for designating a CAH. Under this authority, the 
Secretary has established in regulations the minimum requirements a CAH 
must meet to participate in Medicare (42 CFR Part 485, Subpart F). The 
CAH designation is targeted to small rural hospitals with a low patient 
census and short patient stays.
    Under the law in effect prior to Public Law 108-173, CAHs are 
excluded from operating distinct part units (that is, separate sections 
of hospitals that are dedicated to providing inpatient rehabilitation 
or psychiatric care and are paid under payment methods different from 
those used for the acute care areas of the hospitals). The statute 
(section 1886(d)(l)(B) of the Act) and implementing regulations under 
42 CFR Part 412, Subpart B require distinct part units to be units of 
``subsection (d) hospitals,'' which are hospitals paid under the IPPS. 
Because CAHs are not ``subsection (d) hospitals'' paid under IPPS, but 
instead are paid for inpatient care on a reasonable cost basis under 
section 1814(l) of the Act, they are effectively prohibited from having 
distinct part units.
    Section 405(g)(1) of Public Law 108-173 modified the statutory 
requirements for CAHs under section 1814(l) and section 1820(c)(2) of 
the Act to allow CAHs to establish distinct part rehabilitation and 
psychiatric units of up to 10 beds each, which will not be included in 
the revised total 25 CAH bed count under section 405(e) of Public Law 
108-173 (discussed in detail in section VI.D.6. of this preamble). In 
addition, as explained more fully below, the average 96-hour stay does 
not apply to the 10 beds in the distinct part units and inpatient 
admissions; days of inpatient care in these distinct part units are not 
taken into account in determining the facility's compliance with the 
requirement for a facility-wide average length of stay that does not 
exceed 96 hours.
    Section 405(g)(1) of Public Law 108-173 provides under section 
1820(c)(2)(E)(i) of the Act that a distinct part rehabilitation or 
psychiatric unit of a CAH must meet the conditions of participation 
that would otherwise apply to the distinct part unit of a hospital if 
the distinct part unit were established by a subsection (d) hospital in 
accordance with the matter following clause (v) of section 
1886(d)(1)(B) of the Act, including any applicable regulations adopted 
by the Secretary. CAHs will now be permitted to operate distinct-part 
psychiatric and rehabilitation units, and it is clear that the law, 
consistent with this change, requires the same level of health and 
safety protection for patients in distinct part units of a CAH that is 
currently required for patients in distinct part units operated by an 
acute care hospital. The amendments to section 405(g)(1) Public Law 
108-173 are effective for the cost reporting periods beginning on or 
after October 1, 2004.
    As CAHs were excluded from operating distinct part units prior to 
the enactment of section 405(g) Public Law 108-173, the CAH conditions 
of participation did not address the necessary requirements and 
standards for operating such units. As noted previously, section 
1820(c)(2)(E)(i) of the Act makes it clear that the requirements, 
including conditions of participation, for operating these units in a 
CAH are to be the same as is currently required for these units 
operated by an acute care hospital. Accordingly, we proposed that, in 
accordance with the requirements of section 405(g) Public Law 108-173, 
a rehabilitation or psychiatric distinct part unit of a CAH must meet 
all of the hospital conditions of participation at 42 CFR Part 482, 
Subparts A, B, C, and D and the criteria for exclusion from the IPPS at 
42 CFR Part 412 as described below. These requirements will only apply 
to the services provided in the distinct part unit of a CAH and not the 
entire CAH.
    Currently, psychiatric distinct part units of hospitals are subject 
to specific Medicare regulations established in 42 CFR 412.27 regarding 
the types of patients admitted, the scope of services furnished, and 
the qualifications of staff. For example, psychiatric distinct part 
units may admit only patients whose condition requires inpatient 
hospital care for a psychiatric principal diagnosis. The regulations at 
Sec.  412.27(b) further requires a hospital that wishes to establish a 
psychiatric distinct part unit to furnish, through the use of qualified 
personnel, psychological services, social work services, psychiatric 
nursing, and occupational and recreational therapy. The hospital must 
maintain medical records for the unit that permit determination of the 
degree and intensity of services provided to individuals treated in the 
unit. Inpatient psychiatric services must be under the supervision of a 
clinical director, service chief, or equivalent who is qualified to 
provide the leadership

[[Page 49218]]

required for an intensive treatment program, and who is board certified 
in psychiatry (42 CFR 412.27(d)(2)). The distinct part unit must have a 
director of social services, a qualified director of psychiatric 
nursing services who is a registered nurse with a master's degree in 
psychiatric or mental health nursing, or its equivalent from an 
accredited school of nursing, or is qualified by education and 
experience in the care of individuals with mental illness. There must 
also be an adequate number of registered nurses to provide 24-hour 
coverage as well as licensed practical nurses and mental health 
workers. These and other applicable requirements are set forth in 
greater detail in Sec.  412.27.
    Rehabilitation distinct part units of hospitals are currently 
subject to criteria in 42 CFR 412.29. This section specifies that such 
a unit must meet either the requirements for new units (Sec.  
412.30(a)) or those for existing units (Sec.  412.30(c)). In addition, 
the units must furnish through qualified personnel rehabilitation 
nursing, physical and occupational therapy, and, as needed, speech 
therapy and social services or psychological services, and orthotics 
and prosthetics. The unit must have a director of rehabilitation 
services who is trained or experienced in medical management of 
inpatients who require rehabilitation services and is a doctor of 
medicine or a doctor of osteopathy. Rehabilitation distinct part units 
may treat only patients likely to benefit significantly from an 
intensive inpatient program, utilizing services such as physical, 
occupational, or speech therapy. These and other applicable 
requirements are set forth in greater detail in Sec.  412.29 and Sec.  
412.30.
    To implement the requirements of section 1820(c)(2)(E)(i) of the 
Act, as added by section 405(g)(1) of Public Law 108-173, in the May 
18, 2004 proposed rule (69 FR 28330), we proposed to add a new Sec.  
485.647 to 42 CFR Part 485, Subpart F. In proposed Sec.  485.647(a)(1), 
we proposed to specify that if a CAH provides inpatient psychiatric 
services in a distinct part unit, the services provided in that unit 
must comply with the hospital requirements specified in Subparts A, B, 
C, and D of Part 482, with the common requirements for IPPS-excluded 
units in Sec.  412.25(a)(2) through (f), and with the additional 
requirements of Sec.  412.27 for psychiatric units excluded from the 
IPPS. In proposed Sec.  485.647(a)(2), we proposed to specify that if a 
CAH provides inpatient rehabilitation services in a distinct part unit, 
the services provided in that unit must comply with the hospital 
requirements specified in Subparts A, B, C, and D of Part 482, with the 
common requirements for IPPS-excluded units in Sec.  412.25(a)(2) 
through (f), and with the additional requirements of Sec.  412.29 and 
Sec.  412.30, which relate specifically to rehabilitation units 
excluded from the IPPS. To provide for consistent application of 
section 405(g)(1) Public Law 108-173 and avoid any confusion, we also 
proposed to revise Sec.  412.22, which contains the common requirements 
for excluded hospital units, to state that, for purposes of 42 CFR Part 
412, Subpart B, the term ``hospital'' includes a CAH.
    As noted earlier, sections 1820(c)(2)(E)(ii) and (c)(2)(E)(iii) of 
the Act, as added by section 405(g)(1) of Public Law 108-173, provide 
that each distinct part unit of a CAH may have up to 10 beds and that, 
in determining the number of beds a CAH has for purposes of compliance 
with the 25-bed limit described earlier, the beds in a distinct part 
unit are not to be taken into account. We interpret the exclusion of 
these beds from consideration for purposes of the 25-bed limit as also 
indicating that the admissions and lengths of stay in distinct part 
unit beds are not to be considered in determining the facility-wide 
average length stay of a CAH for purposes of the 96-hour limitation on 
CAH's average length of inpatient stay. We proposed to codify these 
rules in paragraphs (b)(1) through (b)(3) of proposed Sec.  485.647.
    Section 1820(c)(2)(E)(iv) of the Act, as added by section 405(g)(1) 
of Public Law 108-173, imposes severe sanctions on CAHs that fail to 
operate their distinct part units in compliance with applicable 
requirements. That section states that if a psychiatric or 
rehabilitation unit of a CAH does not meet the requirements of section 
1820(e)(2)(E)(i) of the Act with respect to a cost reporting period, no 
payment may be made to the CAH for services furnished in that unit for 
that period. Payment to the CAH for services in the unit may resume 
only after the CAH unit has demonstrated to CMS that the unit meets the 
requirement of section 1820(e)(2)(E)(1) of the Act. We proposed to 
codify this requirement by adding a new paragraph (g) to Sec.  412.25, 
which contains the common requirements for excluded units.
    Section 405(g)(1) of Public Law 108-173 amended section 1814(l) of 
the Act by adding a new paragraph (2) to that provision. New section 
1814(l)(2) of the Act states that, in the case of a distinct-part 
psychiatric or rehabilitation unit of a CAH, the amount of payment for 
inpatient CAH services of such a unit is to equal the amount that would 
be paid if these services were inpatient hospital services of a 
psychiatric or rehabilitation unit, respectively, of the kind described 
in the matter following clause (v) of section 1886(d)(1)(B) of the Act. 
To implement the requirements of section 1814(1)(2) of the Act, we 
proposed that, for CAHs that establish rehabilitation or psychiatric 
distinct part units, or both, in their facility, Medicare payment for 
inpatient services provided in those units would be made under the 
applicable existing payment methodology described below for IRFs and 
IPFs.
    Presently, IRFs are paid under a per discharge PPS that became 
effective for cost reporting periods beginning on or after January 1, 
2002. The regulations governing the IRF PPS are located under 42 CFR 
Part 412, Subpart P (Sec.  412.600 through Sec.  412.632).
    At this time psychiatric hospitals and units that are excluded from 
the IPPS are paid for their inpatient operating costs on a reasonable 
cost basis, subject to a hospital-specific limit. However, as required 
by statute, a per diem PPS for Medicare payments for inpatient hospital 
services furnished in psychiatric hospitals and units (referred to as 
inpatient psychiatric facilities (IPFs)) was proposed in the Federal 
Register on November 28, 2003 (68 FR 66920). We are in the process of 
developing the final rule for this proposed rule. When finalized, the 
IPF PPS will replace the reasonable cost based payment system currently 
in effect.
    To clarify the requirements of section 1814(1)(2) of the Act 
regarding payment for inpatient CAH services of a distinct part 
psychiatric or rehabilitation unit of a CAH, in the May 18, 2004 
proposed rule, we proposed to revise the title and first sentence of 
paragraph (a)(1) of Sec.  413.70, and to add a new paragraph (a)(4) to 
that section, to clarify that payment for inpatient services of a CAH 
distinct part unit is not made in accordance with the otherwise 
applicable rules for payment for inpatient CAH services, but under 
other rules described in new Sec.  413.70(e). We also proposed in new 
paragraph Sec.  413.70(e), that payment for inpatient services of 
distinct part rehabilitation units of CAHs is made in accordance with 
regulations governing the IRF PPS at 42 CFR Part 412, Subpart F (Sec.  
412.600 through Sec.  412.632). We also proposed to state that payment 
for inpatient services of distinct part psychiatric units of CAHs is 
made in accordance with regulations governing IPPS-excluded psychiatric 
units of hospitals at 42 CFR 413.40.

[[Page 49219]]

    Comment: One commenter expressed concern with the requirement that 
a CAH must have an ``adequate'' number of doctors with appropriate 
qualifications ``to provide essential psychiatric services.'' The 
commenter was concerned that, due to the small size of CAHs and the 
limited number of psychiatrists in rural areas, CAHs may hire 
psychiatrists who spend only a small portion of their time at the CAH. 
The commenter suggested that we consider requiring clinical directors 
to devote a specified minimum amount of time to each psychiatric unit 
they serve to offset the possibility of an inadequate supply of 
physicians.
    Response: We believe the clinical director must devote the 
appropriate amount of time to meet the needs of the patients in the 
unit. We stated in the proposed rule that CAHs that operate a distinct-
part psychiatric unit must comply with the same health and safety 
requirements as other Medicare-certified acute care hospitals that 
operate distinct-part psychiatric units. Currently, distinct-part 
psychiatric units of hospitals are subject to specific Medicare 
regulations regarding the staff and scope of services for psychiatric 
inpatient care. In addition to a clinical director, the distinct-part 
psychiatric unit must have a director of social services, a qualified 
director of psychiatric nursing services who is a registered nurse with 
a master's degree in psychiatric or mental health nursing, or its 
equivalent from an accredited school of nursing, or is qualified by 
education and experience in the care of individuals with mental 
illness. We believe that these requirements, and others set forth in 
greater detail in Sec.  412.27, are required to l safeguard the care of 
individuals in a CAH distinct-part psychiatric unit.
    Comment: One commenter stated that requiring CAH distinct part 
psychiatric and rehabilitation units to meet all of the hospital 
conditions of participation at 42 CFR Part 42, Subparts A, B, C and D 
will require both the JCAHO and the State survey agencies to conduct 
two surveys when assessing CAHs. The commenter stated that this 
requirement would result in a burdensome oversight strategy that would 
cause CAHs to decide not to add distinct part units.
    Response: Section 405(g)(1) of Public Law 108-173 states that a 
distinct-part rehabilitation or psychiatric unit of a CAH must meet the 
conditions of participation that would otherwise apply to a distinct-
part unit of a hospital. Therefore, we believe that it is clear that 
the Congress wants the same level of health and safety protection for 
patients in a distinct-part unit operated by a CAH as those that are 
currently required for patients in a distinct-part unit operated by an 
acute care hospital.
    Therefore, it will be necessary for a distinct-part psychiatric or 
rehabilitation unit of a CAH to undergo a survey to demonstrate 
compliance with the requirements stipulated in the statute. Until a CAH 
receives approval and a provider number from CMS for any DPUs, the 
services furnished in those units will not be eligible for Medicare 
reimbursement. The CAH is not required to furnish such uncompensated 
services to Medicare beneficiaries prior to its approval.
    Comment: As previously noted, proposed Sec.  412.25(g) would 
require denial of payment to a CAH for services of a distinct-part 
psychiatric or rehabilitation unit of a CAH if that unit does not meet 
the requirements of proposed Sec.  485.647 with respect to a cost 
reporting period. Under the proposal, no payment may be made to the CAH 
for services furnished in that unit for that period. The section 
further states that payment to the CAH for services in the unit may 
resume only after the unit has demonstrated to CMS that the unit meets 
the requirements of Sec.  485.647.
    One commenter stated that the rule is unclear as to whether, if a 
failure to meet proposed Sec.  485.647 is both noted and corrected in 
the same cost reporting period, would payment resume as soon as the 
noncompliance is corrected. The commenter recommended that the section 
be revised to state that payment will be denied only from the date on 
which the deficiency was noted to the date on which it was corrected.
    Response: We do not believe that the commenter's recommendation is 
supported by the statute. As noted above, section 405(g)(1) of Public 
Law 108-173, states that if a psychiatric or rehabilitation unit of a 
CAH does not meet the requirements of section 1820(c)(2)(E)(i) of the 
Act with respect to a cost reporting period, no payment may be made to 
the CAH for services furnished in that unit for that period. Because 
the law is so specific on this issue, we do not have the flexibility to 
resume payment for services of a unit during any part of the same 
period in which the unit fails to meet applicable requirements of 
section 1820(c)(2)(E)(i) of the Act, as implemented by the regulations 
in new Sec.  485.649. On the contrary, the law would permit payment to 
the CAH for services for such a unit to resume only after the start of 
the first cost reporting period beginning after the unit has 
demonstrated to CMS that the unit meets the requirements of Sec.  
485.647. We have revised Sec.  412.25(g) to clarify that. Payment to 
the CAH for services provided in such a unit may resume only after the 
start of the first cost reporting period beginning after the unit has 
demonstrated to CMS that the unit meets the requirements of Sec.  
485.647.
    Although we considered carefully the comments received regarding 
distinct-part units of CAHs, we concluded that they did not raise 
considerations that would require changes to the proposed rule. 
Therefore, in this final rule, we are adopting as final the proposed 
amendments to Sec.  413.70(a)(1) and the proposed addition of Sec.  
413.70(a)(4), Sec.  413.70(e), and Sec.  485.647 to implement the 
requirements under section 405(g)(1) of Public Law 108-173 for CAHs to 
establish and receive payment under Medicare for psychiatric and 
rehabilitation distinct part units. In the May 18 2004, proposed rule, 
we proposed to implement this provision under proposed Sec.  485.647. 
However, the statute would permit payment to the CAH for services of 
such a unit to resume only after the start of the first cost reporting 
period beginning after the unit has demonstrated to CMS that the unit 
meets the requirements of proposed Sec.  485.647. In this final rule, 
we are revising Sec.  412.25(g) to clarify that payments to the CAH for 
services provided in such a unit may resume only after the start of the 
first cost reporting period beginning after the unit has demonstrated 
to CMS that the unit meets the requirements of Sec.  485.647.
    Comment: Several commenters questioned how distinct-part unit beds 
are to be classified in a CAH if the facility had distinct-part unit 
beds prior to converting to a CAH. The commenters inquired if the 
distinct-part unit beds will be considered new or converted beds.
    Response: In order for Medicare to classify a provider as a CAH, 
the provider must meet specific regulatory requirements. Therefore, we 
believe a CAH evolved into a different provider classification from the 
type of provider it was prior to converting to a CAH. Under the statute 
in effect prior to Public Law 108-173, a CAH was not allowed to 
establish an inpatient rehabilitation DPU. Section 405(g)(1) of Public 
Law 108-173 modified the statutory requirements for CAHs under section 
1820(c)(2) of the Act to allow a CAH to establish a rehabilitation DPU 
of up to 10 beds. A CAH that meets all inpatient rehabilitation DPU 
regulatory requirements, on or after the effective date of this final 
rule, will be allowed to establish an inpatient rehabilitation DPU 
whose size does not exceed 10 beds. According to Sec.  412.30(b)(1)(i), 
a

[[Page 49220]]

new unit is a hospital unit that the hospital has not previously sought 
to exclude from the IPPS. In addition, before the hospital unit may be 
considered a new unit, Sec.  412.30(b)(1)(ii) of our regulations 
requires that the hospital have ``obtained approval, under State 
licensure and Medicare certification, for an increase in its hospital 
bed capacity that is greater than 50 percent of the number of beds in 
the unit.'' Because a CAH is a different provider from the entity it 
was prior to converting to being a CAH, and was not previously allowed 
to establish an inpatient rehabilitation DPU, a CAH never sought 
exclusion for any inpatient rehabilitation unit. Therefore, if a CAH 
establishes an inpatient rehabilitation DPU, that DPU will be 
considered to be a new unit in accordance with Sec.  412.30(b)(1)(i) of 
our regulations, as long as the CAH also meets the requirements 
specified in Sec.  412.30(b)(1)(ii) of our regulations.
    Comment: One commenter requested that their hospital be 
grandfathered into the CAH program and be allowed to maintain a 15-bed 
psychiatric distinct-part unit.
    Response: We do not have the authority to grandfather a hospital 
into the CAH program. A facility can be certified as a CAH if the 
facility is designated as a CAH by the State survey agency or by CMS 
and found to meet the conditions of participation in 42 CFR Part 485, 
Subpart F. Regardless, the statute does not allow CAHs to exceed the 
10-bed limit for distinct-part units.
    We considered carefully the comments received regarding distinct-
part units of CAHs. To implement the requirements under section 
405(g)(1) of Public Law 108-173 for CAHs to establish and receive 
payment under Medicare for psychiatric and rehabilitation distinct part 
units, in this final rule, we are adopting the proposed amendments to 
Sec.  413.70(a)(1) and the proposed addition of Sec. Sec.  
413.70(a)(4), 413.70(e), and 485.647 as final, with one modification. 
That is, we are revising Sec.  412.25(g) to clarify that payments to 
the CAH for services provided in such a unit may resume only after the 
start of the first cost reporting period beginning after the unit has 
demonstrated to CMS that the unit meets the requirements of Sec.  
485.647.
8. Waiver Authority for Designation of a CAH as a Necessary Provider
    Section 405(h) of Public Law 108-173 amended section 
1820(c)(B)(i)(II) of the Act by adding language that terminates a 
State's authority to waive the location requirement for a CAH by 
designating the CAH as a necessary provider, effective January 1, 2006. 
Currently, a CAH is required to be located more than a 35-mile drive 
(or in the case of mountainous terrain or secondary roads, a 15-mile 
drive) from a hospital or another CAH, unless the CAH is certified by 
the State as a necessary provider of health care services to residents 
in the area. Under this provision, after January 1, 2006, States will 
no longer be able to designate a CAH based upon a determination that it 
is a necessary provider of health care.
    In addition, section 405(h) of Public Law 108-173 amended section 
1820(h) of the Act to include a grandfathering provision for CAHs that 
are certified as necessary providers prior to January 1, 2006. Under 
this provision, any CAH that is designated as a necessary provider in 
its State's rural health plan prior to January 1, 2006, will be 
permitted to maintain its necessary provider designation.
    In the May 18, 2004 proposed rule (69 FR 28331), we proposed to 
revise our regulations at Sec.  485.610(c) to incorporate the 
amendments made by section 405(h) of Public Law 108-173.
    Comment: Commenters were concerned that some hospitals may receive 
the necessary provider designation by the State before January 1, 2006, 
but would not have had enough time to complete the State survey and 
certification process in order to be fully converted to a CAH by 
January 1, 2006. The commenters recommended that we grandfather a 
hospital that is certified as a necessary provider by January 1, 2006, 
as long as that hospital is continuing the process toward conversion to 
a CAH.
    Response: Both the preamble and the regulations text concerning 
this issue in the proposed rule state that a CAH that is designated as 
a necessary provider in its State's rural health plan as of January 1, 
2006, will maintain its necessary provider designation after January 1, 
2006. However, in keeping with the clear intent of section 405(h) of 
Public Law 108-173, if a facility is not a CAH as of January 1, 2006, 
the ability to be designated as a necessary provider before becoming a 
CAH will no longer exist after January 1, 2006. Extending the time to 
allow for such a facility to convert to a CAH would violate this 
intent. Therefore, we are not accepting these commenters' 
recommendation.
    Comment: One commenter stated several CAHs in Nebraska are 
considering replacing their aged facilities and wanted to know if a CAH 
could retain its necessary provider status if it relocates. The 
commenter inquired if the necessary provider status would remain with 
the provider number and not be determined by the physical location of 
the building.
    Response: There are many factors involved with a relocation of a 
CAH that may or may not change a CAH's status as a necessary provider. 
It is not possible to make a statement in this final rule that would 
apply to all situations. The issue of retaining a necessary provider 
status after a CAH relocates is a local certification issue that the 
regional offices will evaluate on a case-by-case basis.
    In this final rule, we are adopting as final, without modification, 
the provisions of Sec.  485.610(c) that incorporates the amendments 
made by section 405(h) of Public Law 108-173.
9. Payment for Clinical Diagnostic Laboratory Tests
    Medicare payment for clinical diagnostic laboratory tests provided 
to the outpatients of CAHs was established through the regulatory 
process and published in the Federal Register as part of the FY 2004 
IPPS final rule (68 FR 45346, August 1, 2003). Payment to a CAH for 
clinical diagnostic laboratory tests for outpatients is made on a 
reasonable cost basis only if the individuals for whom the tests are 
performed are outpatients of the CAH and are physically present at the 
CAH at the time specimens are collected. Otherwise, payment for these 
tests is made on a fee schedule basis.
    We published this final rule to clarify our policy in this area and 
ensure that all relevant issues were publicly noted. For reasons which 
are set forth in detail in the FY 2004 IPPS final rule, we do not agree 
that providing reasonable cost payment to individuals who are not 
present at the CAH when the specimen is collected is appropriate. We 
believe that extending reasonable cost payment in these instances is 
inconsistent with Medicare law and regulations and duplicates existing 
coverage. It also creates confusion for beneficiaries and others by 
blurring the distinction between CAHs and other types of providers (for 
example, SNFs and HHAs) and increases the costs of providing care to 
Medicare patients without enhancing either the quality or the 
availability of that care.
    Following publication of the FY 2004 IPPS final rule, we received a 
number of letters and statements in Open Door Calls indicating that 
some commenters continue to believe that this policy will impose a 
hardship on Medicare beneficiaries in rural areas. Several of these 
commenters argued that it might cause frail elderly nursing home 
patients to have to be moved to a CAH to have blood drawn or other 
specimen

[[Page 49221]]

collection performed instead of sending a laboratory technician to the 
patient's bedside for the same purpose. We agree with the commenters 
that this would not be an appropriate result. However, we would note 
that there are also alternative ways in which specimen collection and 
travel are payable under Medicare (for example, the laboratory benefit 
under Part B or HHAs that have laboratory provider numbers). Therefore, 
we do not expect beneficiaries to face reduced access to services under 
this policy.
    In response to continuing claims of potential access problems, we 
invited commenters to submit further, more specific comments that 
provide specific information on actual, rather than merely potential or 
anticipated access problems. In response, we received many 
communications asserting that these problems would occur, but no 
credible documentation that they actually are occurring. As a result of 
these responses, we did not propose any further change in policy on 
this issue in the May 18, 2004 proposed rule (69 FR 28331-28332). We 
indicated that we would like to renew our request for specific, 
verifiable documentation as to any actual access problems being 
generated by this policy, and would review carefully any such 
documentation we receive to determine whether current policy should be 
reconsidered.
    Comment: Some commenters asserted that CMS policy in this area is 
shortsighted and not in the best interest of rural beneficiaries or 
hospitals, or that it would restrict access to laboratory services in 
rural areas, but provided no documentation of access problems or other 
evidence to support their assertions.
    Response: While we read the commenters' letters with interest, we 
noted that they merely restated former comments, but did not provide 
any objective evidence in support of their comments that maintaining 
the current policy regarding payment for clinical diagnostic laboratory 
tests would compromise access to these tests in rural areas. Therefore, 
we made no changes in our policy in this area based on these comments.
    Comment: One commenter stated that five CAHs in the commenter's 
State (Kansas) have either eliminated or seriously limited the 
processing of specimens drawn from off-site locations in response to 
the payment policy for clinical diagnostic laboratory tests.
    Response: We appreciate this additional information and will take 
it into account as we consider whether any revision should be made to 
this policy.
10. Continued Participation by CAHs in Counties Reclassified as Urban 
Based on the 2000 Census
    Under section 1820(c)(2)(B)(i) of the Act, a facility is eligible 
for designation as a CAH only if it is located in a county or 
equivalent unit of local government in a rural area (as defined in 
section 1886(d)(2)(D) of the Act), or is being treated as being located 
in a rural area pursuant to section 1886(d)(8)(E) of the Act. The 
regulations implementing this location requirement are located at 42 
CFR 485.610(b)(2). As previously noted, some facilities currently 
participating as CAHs are located in counties which are located in 
areas considered as ``rural areas'' in FY 2004 under the definition in 
section 1886(d)(2)(D) of the Act but will, as of October 1, 2004, be 
considered to be located in MSAs because of the most recent census data 
and implementation of the new MSA definitions announced by OMB on June 
6, 2003. We received a number of comments on this issue.
    Comment: Several commenters recommended that CMS exercise executive 
discretion to allow continued CAH participation by facilities which are 
currently (that is, for FY 2004) participating as CAHs but are located 
in counties which will be considered part of MSAs effective October 1, 
2004, as a result of data from the 2000 census and implementation of 
the new MSA definitions announced by OMB on June 6, 2003. The 
commenters stated that if such facilities' CAH participation were 
terminated, they would be likely to again seek State licensure and 
Medicare participation as hospitals in order to be able to continue 
operations. However, this change to hospital status would not be 
automatic but would require the facility either to be re-licensed as a 
hospital by the State and to successfully demonstrate compliance with 
the hospital conditions of participation (COPs) based either on a CMS 
survey conducted by the State survey agency under contract with CMS, or 
on hospital accreditation by the JCAHO or the American Osteopathic 
Association (AOA). Once the facility has resumed participation as 
defined under section 1886(d) of the Act, the facility could then be 
treated as a ``rural'' hospital under section 1886(d)(8)(E)(ii)(II) of 
the Act, which provides such treatment for any hospital located in an 
area designated by law or regulation of the State as a rural area. If 
the facility were to obtain such a designation and met other criteria 
for CAH conversion, it would then be qualified for designation by the 
State and certification by CMS as a CAH, notwithstanding its location 
in an MSA. The commenters believed such a sequence of changes in the 
status of a facility (that is, from being a CAH to being a hospital to 
again being a CAH) would be costly and time consuming for both the 
facility and CMS, and would not serve any useful purpose, because at 
the conclusion of the process the facility would resume participating 
as a CAH, as it did during FY 2004. Therefore, some of these commenters 
recommended that CMS continue to treat CAHs in such counties as being 
rural for an indefinite time period. Other commenters recommended that 
CAHs in such counties be considered rural until at least January 1, 
2006, in order to allow them an opportunity to obtain rural 
designations under applicable State law or regulations from their State 
legislatures or regulatory agencies.
    Another commenter did not recommend any particular course of action 
to be taken by CMS, but asked whether there were any plans to develop a 
grandfather provision to avoid a break in CAH participation by 
facilities affected by the new census results.
    Response: We agree with the commenters' concerns and are revising 
Sec.  485.610 by adding a new paragraph (b)(3) to provide special 
treatment for such facilities. Under the new paragraph, a CAH that is 
located in a county that, in FY 2004, was not part of a MSA as defined 
by the OMB, but as of FY 2005 was included as part of a MSA as a result 
of the most recent census data and implementation of the new MSA 
definitions announced by OMB on June 6, 2003, would nevertheless be 
considered to meet the rural location requirement and, therefore, could 
continue participating without interruption as a CAH from October 1, 
2004, through the earlier of the date on which the CAH obtains a rural 
designation under Sec.  412.103, or December 31, 2005. Such a facility 
would be allowed to continue participating as a CAH and would not be 
required to convert back to being a hospital unless it was not able to 
obtain a rural designation under Sec.  412.103. We are also amending 
Sec.  412.103 to clarify that such a CAH is eligible for rural 
designation under that section.
    Comment: One commenter suggested that changes in the status of an 
area from rural to urban as a result of the most recent census data and 
implementation of the new MSA definitions be applied only for purposes 
of determining the wage index values for providers paid under a system 
that

[[Page 49222]]

uses a wage index adjustment, and not for determining a rural location 
for purposes of eligibility of a facility to participate in Medicare as 
a CAH.
    Response: We reviewed this suggestion but concluded that section 
1820 of the Act, which specifically refers to rural areas as, defined 
in sections 1886(d)(2)(D) and 1886(d)(8)(E) of the Act, do not 
authorize us to implement the new census results and MSA designation 
rules in such a selective way. Therefore, in this final rule, we are 
not adopting this recommendation.
11. Proposed Technical Changes in Part 489
    In several sections of Part 489, we have discovered a need to 
update cross-references to conform them to the redesignation of the 
Medicare transfer rules from Sec.  489.24(d) to Sec.  489.24(d). 
Specifically, as we proposed in the May 18, 2004 proposed rule (69 FR 
28332), we are correcting the cross-reference to ``Sec.  489.24(d)'' in 
Sec. Sec.  489.20(m) and 489.53(b)(2) to read ``Sec.  489.24(e)''.
12. Issues Beyond the Scope of the Proposed Rule
    In the proposed rule published on May 18, 2004, we proposed changes 
affecting CAHs only if they were related to MSA definitions and the 
results of the 2000 census, or to the provisions of section 405 of 
Public Law 108-173. In addition, as previously noted, we requested 
documentation regarding the effects of the rule on payment for clinical 
diagnostic laboratory tests by a CAH, but did not propose any change in 
that rule.
    In response to the proposed rule, many commenters chose to raise 
issues that are beyond the scope of our proposals. In this final rule, 
we are not summarizing or responding to those comments in this 
document. However, we will review the comments and consider whether to 
take other actions, such as revising or clarifying CMS program 
operating instructions or procedures, based on the information and 
recommendations in the comments.

VII. Changes to the Disclosure of Information Requirements for Quality 
Improvement Organizations (QIOs)

A. Background

    Section 1152 of the Act defines a utilization and quality control 
peer review organization (now referred to as a quality improvement 
organization (QIO). Section 1153 provides for contracts with such 
organizations to review items and services furnished by physicians, 
other practitioners, and providers to Medicare patients to verify that 
the items and services are reasonable, medically necessary, and 
allowable under the Act; meet professionally recognized standards of 
health care; and are furnished in the appropriate setting. Section 1154 
of the Act outlines the functions of a QIO, which include 
responsibility for: (1) Collecting and maintaining information 
necessary to carry out its responsibilities; (2) examining pertinent 
records maintained by the practitioner or provider verifying the 
medical necessity and quality of services provided by any practitioner 
or provider of health care services to Medicare patients; (3) ensuring 
that health care practitioners and providers maintain evidence of 
medical necessity and quality of health care services provided to 
Medicare patients; and (4) exchanging information with intermediaries, 
carriers, and other public or private review organizations as 
appropriate. Section 1160 of the Act provides that information acquired 
by QIOs in the exercise of their duties and functions must be held in 
confidence. Information cannot be disclosed except as allowed under 
section 1160 of the Act and the existing regulations governing the 
release of QIO peer review information in 42 CFR Part 480. 
Specifically, Part 480 sets forth the policies and procedures for 
disclosure of information collected, acquired, or generated by a QIO 
(or the review component of a QIO subcontractor) in the performance of 
its responsibilities under the Act and the Medicare regulations, as 
well as the acquisition and maintenance of information needed by a QIO 
to comply with its responsibilities under the Act.
    QIOs assist institutions and practitioners seeking to improve the 
quality of care given to Medicare beneficiaries. CMS aims to ensure 
that adequate protections of information collected by QIOs are in place 
and, at the same time, to ensure that the quality improvement 
activities of these institutions and practitioners are not 
unnecessarily hindered by regulations. It has come to our attention 
that the existing regulations omit information disclosure procedures 
that would allow for the effective and efficient exchange of 
information that is an essential part of quality improvement 
activities. In addition, it has come to our attention that, although 
the QIO does not need the consent of the institution to release 
nonconfidential information, the existing 30-day advance notice 
requirement to an institution prior to releasing public information or 
any other nonconfidential information that identifies an institution, 
when an institution consents to or requests the release of information, 
impedes the ability of QIOs to conduct quality improvement work. If the 
institution requests or consents to the release of the information, the 
institution is already aware of the QIO's intention to disclose the 
nonconfidential information. Therefore, we see no reason to require the 
additional 30-day advance notice. Likewise, there is no reason to 
require a 30-day notice for practitioners who request the release of 
information for quality improvement activities or other permissible 
releases under the regulations.

B. Provisions of the May 18, 2004 Proposed Regulations

    In the May 18, 2004 IPPS proposed rule (69 FR 28332), we proposed 
to make several changes in the regulations in Part 480 to expedite the 
exchange of information and minimize delays and expenditures currently 
required of QIOs, institutions, and practitioners as discussed below.
    Existing Sec.  480.105(a) requires that a QIO must notify an 
identified institution of its intent to disclose nonconfidential 
information about the institution and provide a copy of the information 
at least 30 calendar days before the disclosure. Section 480.105 also 
includes certain notice requirements a QIO must meet before disclosing 
confidential information that identifies practitioners and physicians. 
Section 480.106 presently includes several exceptions to these notice 
requirements. We proposed to revise Sec.  480.106 to establish 
additional exceptions to the notice requirements in Sec.  480.105(a) 
and (b)(2). We proposed to specify that the notice requirements in 
Sec.  480.105(a) and (b)(2) would not apply if (1) the institution or 
practitioner has requested, in writing, that the QIO make the 
disclosure; (2) the institution or practitioner has provided written 
consent for the disclosure; or (3) the information is public 
information as defined in Sec.  480.101 and specified in Sec.  480.120.
    Existing Sec.  480.133(a)(2)(iii) specifies that a QIO may disclose 
to any person, agency, or organization confidential information on a 
particular practitioner or reviewer with the consent of that 
practitioner or reviewer, provided that the information does not 
identify other individuals. In the May 18, 2004 IPPS proposed rule (69 
FR 28369), we proposed to revise Sec.  480.133(a)(2)(iii) to allow for 
the release of information at the written request of the practitioner 
or reviewer, in addition to information releasable with the consent of 
the

[[Page 49223]]

practitioner or reviewer under the existing provision. Specifically, 
the proposed revised Sec.  480.133(a)(2)(iii) would provide that a QIO 
may disclose confidential information about a particular practitioner 
or reviewer at the written request of, or with the written consent of 
that practitioner or reviewer. The recipient of the information would 
have the same redisclosure rights and responsibilities as the 
requesting or consenting practitioner or reviewer would, under the 
authority of Subpart B of Part 480. In addition, we proposed a similar 
revision to Sec.  480.140 relating to the release of quality review 
study information. Specifically, we proposed to revise Sec.  480.140 by 
adding a new paragraph (d) (the existing paragraphs (d) and (e) would 
be redesignated as paragraphs (e) and (f), respectively) to provide 
that a QIO may disclose quality review study information with 
identifiers of particular practitioners or institutions at the written 
request of, or with the written consent of, the identified 
practitioner(s) or institution(s). The recipient of the information 
would have the same redisclosure rights and responsibilities as the 
requesting or consenting practitioner or institution would, under the 
authority of Subpart B of Part 480. (We note that we published a 
correction to the language for this proposal in the Federal Register on 
June 25, 2004 (69 FR 35920). In that notice, we indicated that we had 
inadvertently referred to a ``reviewer'' and a ``consenting reviewer'' 
in this provision. We should have indicated an ``institution'' and a 
``consenting institution.'')
    In the May 18, 2004 proposed rule, we indicated that we believed 
these proposed revisions would reduce the existing burden on 
practitioners, institutions, and QIOs and, at the same time, ensure 
that necessary protections on information remain in place. We also 
believed that the proposed revisions would allow QIOs, institutions, 
and practitioners to share vital information in an effective manner and 
further our efforts to ensure the highest quality of care possible for 
Medicare beneficiaries.

C. Technical Changes

    In the May 18, 2004 IPPS proposed rule (69 FR 28369), we proposed 
to revise the title of Part 480 under Subchapter F of Chapter IV of 42 
CFR to conform it to a previous regulatory change in the name of the 
organization conducting medical reviews under Medicare from a peer 
review organization to a quality improvement organization. The proposed 
new title is ``Part 480--Acquisition, Protection, and Disclosure of 
Quality Improvement Organization Information''.
    In a final rule published in the Federal Register on November 24, 
1999 (64 FR 66279), we redesignated Part 476 as Part 480. However, as 
part of the redesignation process, we inadvertently failed to make 
appropriate changes to the cross-references in various sections under 
the redesignated Part 480. In the May 18, 2004 proposed rule, we 
proposed to correct those cross-references.
    We received a number of public comments in support of the proposals 
for QIO information requirements and therefore, are adopting as final 
the proposals and the title change without further modification.

VIII. Policy Changes Relating to Medicare Provider Agreements for 
Compliance With Bloodborne Pathogens Standards, Hospital Conditions of 
Participation, and Fire Safety Requirements for Certain Health Care 
Facilities

A. Hospital Conditions of Participation for Discharge Planning

1. Background
    As part of the definition of ``hospital,'' sections 1861(e)(1) 
through (e)(8) of the Act set forth specific requirements that a 
hospital must meet to participate in the Medicare program. Section 
1861(e)(9) of the Act specifies that a hospital also must meet other 
requirements as the Secretary finds necessary in the interest of the 
health and safety of individuals who are furnished services in 
hospitals. Implementing regulations for section 1861(e) of the Act, 
setting forth the conditions of participation (CoPs) that a hospital 
must meet to participate in the Medicare program, are located in 42 CFR 
Part 482.
    The purposes of these CoPs are to protect patient health and safety 
and to ensure that high quality care is furnished to all patients in 
Medicare-participating hospitals. In accordance with section 1864 of 
the Act, State survey agencies conduct surveys of hospitals to 
determine compliance with the Medicare CoPs, using interpretive 
guidelines and survey procedures found in the State Operations Manual 
(SOM), CMS Publication No. 7. In accordance with section 1865 of the 
Act and the implementing regulations at 42 CFR 488.5(a) and 488.6, 
hospitals accredited by the Joint Commission on Accreditation of 
Healthcare Organizations (JCAHO), the American Osteopathic Association 
(AOA), or other national accreditation organizations are not routinely 
surveyed by States for compliance with the CoPs, but are deemed to meet 
most of the hospital CoPs based on their accreditation. However, all 
hospitals that participate in the Medicare program are required to be 
in compliance with the CoPs, regardless of their accreditation status. 
Under section 1905(a) of the Act, the hospital CoPs also apply to 
hospitals participating in Medicaid (Sec.  440.10(a)(3)(iii) and Sec.  
482.1(a)(5)).
    Under Sec.  489.10(d), a Medicare provider agreement is subject to 
the State survey agency's determination of whether a hospital meets the 
CoPs. The State survey agency makes corresponding recommendations to 
CMS about the hospital's certification; that is, whether the hospital 
has met the standards or requirements necessary to provide Medicare and 
Medicaid services and receives Federal and State reimbursement.
    Section 4321(a) of Public Law 105-33 (BBA) amended section 
1861(ee)(2) of the Act to require that Medicare-participating 
hospitals, as part of the discharge planning process, share with each 
patient, as appropriate, a list of available home health services 
through individuals and entities, including Medicare-certified home 
health agencies (HHAs) that participate in Medicare, serve the 
geographic area in which the patient resides, and request to be listed 
by the hospital as available. In addition, section 4321(a) prohibits 
hospitals from limiting or steering patients to any specific HHA or 
qualified provider that may provide posthospital home health services 
and requires hospitals to identify (in a form and manner specified by 
the Secretary) any HHA or other entity to whom the individual is 
referred in which the hospital has a disclosable financial interest 
consistent with section 1866(a)(1)(S) of the Act or which has a 
financial interest in the hospital if the patient is referred to that 
entity.
    Congress enacted section 4321 of Public Law 105-33 to protect 
patient choice and enable Medicare beneficiaries to make more informed 
choices about the providers from which they receive certain Medicare 
services. We believe that this provision was intended to address 
concerns that some hospitals were referring patients only to HHAs in 
which they had a financial interest, and that shared financial 
relationships were influencing referrals to other entities. Hospitals 
essentially have a captive patient population and, through the 
discharge planning process, can influence a patient's choice regarding 
who provides posthospitalization services.

[[Page 49224]]

    Congress also enacted section 926 of Public Law 108-173 (MMA) to 
improve the administration of the Medicare program by protecting 
patient choice and enabling Medicare beneficiaries to make more 
informed choices about the providers from which they receive Medicare 
services. Section 926(a) of Public Law 108-173 requires the Secretary 
to publicly provide information that enables hospital discharge 
planners, Medicare beneficiaries, and the public to identify SNFs that 
are participating in the Medicare program. Section 926(b) of Public Law 
108-173 amended section 1861(ee)(2)(D) of the Act to require Medicare-
participating hospitals, as part of the discharge planning process, to 
include a discharge planning evaluation of a patient's likely need for 
posthospital extended care services and the availability of these 
services through facilities that participate in the Medicare program 
and that serve the geographic area in which the patient resides. The 
amendments to the Act made by section 926(b) of Public Law 108-173 
apply to discharge plans made on or after a date specified by the 
Secretary, which may be no later than 6 months after the Secretary 
provides for the availability of information required by section 926(a) 
of Public Law 108-173.
2. Implementation
    We implemented the requirements of section 4321(a) of Public Law 
105-33 relating to information on HHAs through a HCFA (now CMS) 
directive that was issued to the Regional Offices and State survey 
agencies on October 31, 1997. Enforcement has been carried out through 
the State agency survey and certification process. We note that even 
though it was not a requirement under section 4321(a) to provide 
currently available information on HHAs to the public (as now required 
under section 1861(ee)(2)(D) of the Act, as amended), we have 
established a ``Home Health Compare'' link on the CMS Web site, http://www.medicare.gov, that identifies HHAs that are currently participating 
in the Medicare or Medicaid program.
3. Provisions of the Proposed Regulations
    In the May 18, 2004 IPPS proposed rule (69 FR 28196, 28333), we 
proposed to incorporate in our regulations under Sec.  482.43 the 
requirements of section 4321(a) of Public Law 105-33 relating to 
providing information on HHAs to hospital patients as part of the 
discharge planning process. We noted that we had previously issued a 
proposed rule on December 19, 1997 (62 FR 66726) to implement the 
provisions of section 4321(a) of Public Law 105-33. However, section 
902 of Public Law 108-173 now requires us to finalize rules within 3 
years after publication of the proposed rule, except under 
``exceptional circumstances.'' While it is not clear whether Congress 
intended this policy to apply retroactively, out of an abundance of 
caution, we issued a new proposed rule because of the length of time 
that has elapsed since the issuance of the 1997 proposed rule. 
Moreover, the provisions of Public Law 108-173 contain information 
requirements for SNFs substantially similar to the ones required for 
HHAs. In developing the May 18, 2004 proposed rule, we took into 
consideration the issues raised in the public comments we received on 
the December 19, 1997 proposed rule relating to HHAs.
    Information on SNFs related to the requirement imposed by section 
926(a) of Public Law 108-173 is currently available to the public and 
can be accessed at the CMS Web site, http://www.medicare.gov, by 
clicking on the ``Nursing Home Compare'' link or by calling 1-800-
MEDICARE (800-633-4227). Nursing Home Compare, launched in November 
2002, meets the statutory requirement of section 926(a) by enabling 
hospital discharge planners, Medicare beneficiaries, and the public to 
identify the 17,000 nursing homes that participate in the Medicare or 
Medicaid program. Nursing Home Compare can be used to locate a nursing 
home by State and county, by proximity (city or zip code), or by name. 
In addition, Nursing Home Compare provides detailed information about 
the past performance of every Medicare-certified and Medicaid-certified 
nursing home in the country. The data on this Web site describe nursing 
home characteristics, quality measures, inspection results, and nursing 
staff information. The Nursing Home Compare tool received 9.3 million 
page views in 2003 and was the most popular tool on http://www.medicare.gov. If an interested individual does not have access to 
the Internet, the individual can call 1-800-MEDICARE (800-633-4227) and 
request a printout of the nursing homes in a designated area.
    In the May 18, 2004 proposed rule, we proposed to amend the 
regulations at Sec.  482.43 to incorporate the provisions of section 
4321(a) of Public Law 105-33 and section 926(b) of Public Law 108-173 
into the hospital CoPs. Specifically, we proposed to add new paragraphs 
(c)(6), (c)(7), and (c)(8) to include the requirement for hospitals to 
provide lists of Medicare-certified HHAs and SNFs as part of the 
discharge planning process. We proposed that the discharge planning 
evaluation would be required to include a list of Medicare-certified 
HHAs that have requested to be placed on the list as available to the 
patient and that serve the geographic area in which the patient 
resides. We proposed to require the SNF list to include Medicare-
certified SNFs located in the geographic area in which the patient 
requests. However, we did not propose to require that the list of 
Medicare-certified SNFs contain exclusively those SNFs that are located 
in the area in which the patient resides. Because many available 
Medicare-certified SNFs are not located in proximity to where the 
patient resides, especially in rural areas, we believe that a 
requirement that restricts information to those SNFs in the areas where 
the patient resides is too restrictive and would limit the availability 
of posthospital extended care services to Medicare beneficiaries.
    Section 4321(a) of Public Law 105-33 requires listing the 
availability of home health services through individuals and entities. 
We have received inquiries regarding the identity of those individuals 
and entities. In the May 18, 2004 IPPS proposed rule (69 FR 28333) we 
proposed that, because section 1861(m) of the Act identifies home 
health services as ``specific items or services furnished to an 
individual, who is under the care of a physician, by an HHA, or by 
others under arrangements with an HHA,'' section 4321(a) is referring 
to Medicare-participating HHAs.
    We proposed that the hospital present the list of HHAs or SNFs only 
to patients for whom home health care or posthospital extended care 
services are indicated as appropriate, as determined by the discharge 
planning evaluation. We do not expect that patients without a need for 
home health care or posthospital extended care services would receive 
the list. In addition, we proposed to require the hospital to document 
in the patient's medical record that a list of HHAs or SNFs was 
presented to the patient or an individual acting on the patient's 
behalf. Hospitals would not have to duplicate the list in the patient's 
medical record. The information in the medical record would serve as 
documentation that the requirement was met. The hospital would have the 
flexibility to determine exactly how and where in the patient's medical 
record this information would be documented.
    We proposed that we would allow a hospital the flexibility to 
implement the requirement to present the lists in a manner that is most 
efficient and least burdensome in its particular setting. A

[[Page 49225]]

hospital can simply print a list from the Home Health Compare or 
Nursing Home Compare site on the CMS Web site, http://www.medicare.gov 
or develop and maintain its own list of HHAs and SNFs. When the patient 
requires home health services, the CMS Web site list can be printed 
based on the geographic area in which the patient resides. When the 
patient requires posthospital extended care services, the CMS Web site 
list would be printed based on the geographic area requested by the 
patient. Or, in the rare instance when a hospital does not have 
Internet access, the hospital can call 1-800-MEDICARE (1-800-633-4227) 
to request a printout of a list of HHAs or SNFs in the desired 
geographic area. Information on this Web site should not be construed 
as an endorsement or advertisement for any particular HHA or SNF.
    Under the proposed rule, if a hospital chooses to develop its own 
list of HHAs or SNFs, the hospital would have the flexibility of 
designing the format of the list. However, the list should be utilized 
neither as a recommendation nor endorsement by the hospital of the 
quality of care of any particular HHA or SNF. If a HHA or SNF does not 
meet all of the criteria for inclusion on the list (Medicare-certified 
and is located in the geographic area in which the patient resides or 
in the geographic area requested by the patient), we did not propose to 
require the hospital to place that HHA or SNF on the list. In addition, 
in accordance with the provisions of the Act, we proposed that HHAs 
must request to be listed by the hospital as available. We also 
proposed that the list must be legible and current (updated at least 
annually), and that the listed information be shared with the patient 
or an individual acting on the patient's behalf at least once during 
the discharge planning process. However, we indicated that, under the 
proposal, information regarding the availability of HHAs or SNFs may 
need to be presented more than once during the discharge planning 
process to meet the patient's need for additional information or as the 
patient's needs and condition change.
    In the May 18, 2004 proposed rule (69 FR 28333), we proposed to 
require that, as part of the discharge planning process, the hospital 
must inform the patient or the patient's family of their freedom to 
choose among participating Medicare providers of posthospital services 
and must, when possible, respect patient and family preferences when 
they are expressed (proposed Sec.  482.43(c)(7)). In addition, the 
hospital may not use the discharge plan to specify or otherwise limit 
the patient's choice of qualified providers that may provide home 
health care or posthospital extended care services. The intent of the 
proposed provision was to provide the patient with the freedom of 
choice to determine which HHA or SNF will provide care in accordance 
with section 1802 of the Act, which states that beneficiaries may 
obtain health services from any Medicare-participating provider.
    Finally, we proposed to require the hospital to identify in each 
discharge plan those HHAs or SNFs to which the patient is referred that 
the hospital has a disclosable financial interest or HHAs or SNFs that 
have a financial interest in the hospital (proposed Sec.  
482.43(c)(8)). For the purposes of implementing section 4321(a) of 
Public Law 105-33, we proposed to define a disclosable ``financial 
interest'' as any financial interest that a hospital is required to 
report according to the provider enrollment process, which is governed 
by section 1124 of the Act and implementing regulations located in 42 
CFR Part 420, Subpart C, and accompanying manual provisions. If a 
hospital refers patients about to be discharged and in need of 
posthospital services only to entities it owns or controls, the 
hospital would be infringing on the rights of the patient to choose the 
facility he or she would like to go to for services. The proposed 
disclosable financial interest requirement is an effort to increase the 
beneficiary's awareness of the actual or potential financial incentives 
for a hospital as a result of the referral. To allow hospitals the 
flexibility of determining how these financial interests are disclosed 
to the patient, we did not propose to require a specific form or manner 
in which the hospital must disclose financial interest. The hospital 
could simply highlight or otherwise identify those entities in which a 
financial interest exists directly on the HHA and SNF lists. Or, the 
hospital could choose to maintain a separate list of those entities in 
which a financial interest exists.
    In the May 18, 2004 IPS proposed rule (69 FR 28335), we indicated 
that hospitals and managed care organizations (MCOs) have expressed 
concern as to whether the change made by section 4321(a) of Public Law 
105-33 was intended to apply to patients in managed care plans. MCO 
members are limited as to what services they may obtain from sources 
other than through the MCO. We believe that providing MCO members with 
a standardized list of all HHAs or SNFs in the requested geographic 
area could be misleading and potentially financially harmful because 
MCO enrollees may be liable for services that they obtain from 
providers other than the MCO, and patients may interpret a list of HHAs 
or SNFs that are not available to them under their health plan to mean 
that they are authorized by the MCO. This does not mean that Medicare 
MCO members in particular are denied the freedom of choice they are 
entitled to under section 1802 of the Act. Medicare beneficiaries 
exercise their freedom of choice when they voluntarily enroll in the 
MCO and agree to adhere to the plan's coverage provisions.
    The list provided to MCO patients should include available and 
accessible HHAs or SNFs in a network of the patient's MCO. Hospitals 
also have the option, in the course of discussing discharge planning 
with patients, to determine whether the beneficiary has agreed to 
excluded services or benefits or coverage limitations through 
enrollment in a MCO. If this is the case, the hospital could inform the 
patient of the potential consequences of going outside the plan for 
services.
    We also indicated in the proposed rule that we had received many 
inquiries about how the requirements contained in section 4321(a) of 
Public Law 105-33 are monitored and enforced. Once codified in the 
hospital CoPs, a hospital's obligations under both section 4321(a) of 
Public Law 105-33 and section 926 (b) of Public Law 108-173 would be 
monitored as part of the hospital survey and certification process. 
Anyone aware of instances in which patients were inappropriately 
influenced or steered toward a particular HHA or SNF in a way that 
violated the regulation would have the opportunity to file a complaint 
with the State survey agency. The State survey agency would then 
investigate and follow up with the complainant. Noncompliance with the 
hospital CoPs could result in a hospital losing its ability to 
participate in the Medicare program.
    Requiring hospitals to provide a list of Medicare-certified HHAs or 
SNFs would provide patients with more options and assist them in making 
informed decisions about the providers from which they receive Medicare 
services. Specifically, the intent of the proposed modifications to the 
discharge planning CoPs was to provide the patient with the freedom of 
choice to determine which HHA or SNF available in the geographic area 
in which the patient resides or the geographic area requested by the 
patient, would provide them care in accordance with section 1802 of the 
Act, which states that beneficiaries may

[[Page 49226]]

obtain health services from any Medicare-participating provider.
    We received numerous comments from providers and provider 
organizations regarding the hospital CoP for discharge planning. 
Commenters supported our intent to protect patient choice and enable 
patients and their families to make more informed decisions. Commenters 
focused on various operational issues, such as format and scope of HHA 
and SNF lists to be provided, the process for updating lists, the 
feasibility of providing SNF information based on geographic location, 
a hospital's responsibility in providing information to Medicare 
managed care enrollees, and expanding the requirement beyond HHAs and 
SNFs.
    Comment: Commenters requested that the HHAs and SNFs be listed 
alphabetically on different lists according to provider type. In 
addition, the commenters requested that the list include the services 
that the HHA offers (for example, skilled nursing, physical therapy, 
occupational therapy, speech therapy, clinical social work, mental 
health nursing, and home health aides). Commenters stated that 
including the list of services that the HHA offers would make it clear 
to patients which agency they can choose according to their needs and 
the services the agency provides. Commenters stated that hospital lists 
are often confusing and contain numerous types of providers and 
services offered in a single document. Another commenter stated that 
hospitals should be required to provide HHAs with notice that the list 
is being updated, and should provide HHAs with a copy of the list once 
compiled to ensure that the HHAs are listed and the information 
provided is accurate.
    Response: Hospitals have the flexibility to either print a list of 
HHAs or SNFs from the CMS Web site or develop and maintain their own 
lists. Hospitals that choose to develop and maintain their own lists 
have the flexibility to determine the format. We agree that the list 
should be user friendly and that information regarding HHAs and SNFs 
should not be co-mingled within the same list. However, as long as HHA 
information is categorized separately from SNF information, the two 
lists could be included in the same document. We expect hospital 
discharge planners to be able to assist patients in identifying the 
HHAs and SNFs appropriate to fit the patient's needs. This information 
is available on the CMS Web site and can be included on the HHA list at 
the discretion of each hospital. We do not believe it is necessary to 
prescribe a process for hospitals to update their lists. We expect 
hospitals to update their lists at least annually. Hospitals have the 
flexibility to develop their own process for this update. Information 
on the CMS Web site is updated as new information becomes available. We 
believe the commenters' concerns are addressed by the CMS Web site. We 
encourage hospitals to use the Home Health and Nursing Home Compare Web 
sites to access information. We believe that utilization of the CMS Web 
sites will be the most efficient and least burdensome way for many 
hospitals to implement these requirements.
    Comment: Several commenters stated that requiring hospitals to 
provide lists of Medicare certified SNFs located in the geographic area 
chosen by the patient updating the list for frequent changes, and 
identifying SNFs with which disclosable financial interests exist would 
impose an additional, unnecessary, and unreasonable burden on hospital 
discharge planners. They further stated that current regulations 
already require hospitals to provide choices to Medicare beneficiaries 
for posthospital services. Commenters stated that the proposed rule 
acknowledges ``hospitals currently access this information as an 
essential component of the discharge planning process.'' Commenters 
also stated that the equipment required for Internet access, the labor 
involved in telephoning an agency with limited hours of operation, as 
well as actual time to obtain information telephonically, add to the 
costs of providing care.
    Response: In this final rule, we are implementing a statutory 
requirement contained in section 926 of Public Law 108-173. Congress 
enacted this legislation to improve the administration of the Medicare 
program by protecting patient choice and enabling Medicare 
beneficiaries to make more informed decisions about the providers from 
which they receive Medicare services. Hospitals have the flexibility to 
implement this requirement in a way that makes the most sense for them. 
One option would be for a hospital to print out or call the 800 number 
to request a list of SNFs located in the selected geographic areas or 
entire state that the hospital serves on a regular basis, for example, 
annually. It is not necessary to generate a new, separate list for 
every patient. If Internet access is not available to discharge 
planners or calling the 1-800-MEDICARE (800-663-4227) are both 
determined to be unfeasible, the hospitals will be free to develop and 
maintain their own lists. We expect hospitals to keep the lists 
current. Hospitals have the flexibility in determining how and how 
frequently they update their lists. The intent is to protect patient 
choice and provide patients and their families with the information 
necessary to make informed decisions. As the commenters pointed out, we 
believe that discharge planners currently access this information as an 
essential component of the discharge planning process. Therefore, we 
believe the additional burden is minimal.
    Comment: A commenter expressed agreement with our proposal that SNF 
information should be presented based on the geographic area requested 
by the patient. Commenters further stated that the same requirement 
should be imposed on hospitals with respect to HHAs. The commenter 
recommended deleting the reference to serving ``the geographic area (as 
defined by the HHA)'' and deleting the requirement that ``HHAs must 
request to be listed by the hospital as available.''
    Response: Section 4321(a) of the BBA specifically requires that 
HHAs serving the area in which the patient resides request to be listed 
by the hospital as available. We believe the HHA is in the best 
position to identify its service area and, presumably, would not 
misrepresent its service area by requesting to be listed for an area 
they do not serve. Section 926 of Public Law 108-173 does not contain a 
similar requirement for SNFs.
    Comment: A commenter stated that her hospital currently provides a 
list of HHAs and indicates for patients any agencies in which the 
hospital has a financial interest. The Commenters states that this 
process works well in supporting patient choice. However, two 
commenters stated that expanding this requirement to SNFs does not work 
because nursing home placement is primarily driven by bed availability 
and special care accommodations; location is secondary. The commenter 
stated that patients who are given a list of nursing homes in a 10-mile 
radius will be overwhelmed by the number of nursing homes and confused 
as to where to begin. The commenter further stated that such a list 
would only create expectations that the patient can go to any of these 
facilities and that they truly do have options when in reality options 
may be extremely limited or nonexistent due to lack of available of 
beds. The commenter supports a process that communicates to the patient 
what research was done in checking bed availability and gives the 
patient a list of true options for choice if options do in fact exist. 
The commenters also

[[Page 49227]]

suggested that SNF quality information might be helpful if options are 
limited due to bed availability.
    Response: We appreciate the commenters' support of the HHA list and 
patient choice. We recognize that bed availability is a major issue in 
terms of SNF placement. Our intent is to provide patients with real 
options. We would not expect that the patient be given an exhaustive 
list of SNFs with no available beds. The intent is to provide patients 
and their families with information in order to make informed 
decisions. As the discharge planner identifies which SNFs have 
available beds, this information should be shared with the patient and 
patient's family. The nursing home compare Web site currently provides 
nursing home quality information. A hospital may elect to share this 
quality information with the patient and patient's family or simply 
direct them to this Web site as a resource.
    Comment: One commenters suggested delaying implementation of the 
SNF list as a formal requirement until a better system for identifying 
SNF bed availability and special care accommodations could be 
developed. The commenters made the following recommendations: (1) 
Update the Nursing Home Compare tool to include a section on special 
care accommodations available (for example, skilled, nonskilled, 
residential, Alzheimer, and availability of specialized ancillary 
staff), as well as the number of unskilled beds, Medicaid designated 
beds/specialty beds by category, to facilitate planning efforts; (2) 
amend the Home Health Compare ``search'' function to include the 
ability to identify agencies based on the main service area of the 
agency versus the geographic location of the agency; (3) eliminate the 
sorting of HHAs by zip code; (4) revise the print format to fit 8 1/2 x 
11 size paper; and (5) develop State or regional databases that will 
facilitate patient placement in available SNF beds. The commenters also 
requested that future policy changes be released in notices in addition 
to the Federal Register to facilitate more comments and 
recommendations.
    Response: Delaying implementation of this requirement is not an 
option. Section 926 of Public Law 108-173 requires that information 
regarding SNFs that participate in the Medicare program be available on 
hospital discharge plans within 6 months of enactment of the law. 
Revision of the content and format of the Home Health and Nursing Home 
Compare websites is beyond the scope of this rule. However, we have 
forwarded the commenters' recommendations to appropriate agency staff 
for consideration. We alert the public to notices published in the 
Federal Register in a variety of ways. These ways include several of 
listings that may be accessed on the CMS Web site at http://www.cms.hhs.gov (for example, the Quarterly Provider Update and current 
publications and press releases). In addition, the public may register 
at CMS Web site to receive email updates. Public notice is also 
provided at the monthly Open Door Forums.
    Comment: One commenters expressed concern regarding the 
identification and disclosure of SNF providers that accept 
Medicare+Choice because current tools only indicate Medicare and 
Medicaid participation. Another commenter requested that we modify the 
proposed regulations to explicitly indicate the responsibilities of 
hospitals with regard to managed care organization (MCO) enrollees.
    Response: We believe that identifying MCO participating HHAs or 
SNFs is currently part of a hospital's discharge planning process. We 
also believe that providing MCO members with a standardized list of all 
HHAs or SNFs that does not identify those that are authorized by the 
MCO could be misleading. Patients may interpret this type of list to 
mean that all of the HHAs or SNFs listed are authorized by the MCO. It 
could be potentially financially harmful because MCO enrollees may be 
liable for services that they obtain from providers other than the MCO. 
The list provided to MCO patients should include all available and 
accessible HHAs or SNFs as well as those authorized by a patient's MCO. 
The hospital could simply identify these MCO authorized HHAs or SNFs 
for the patient by highlighting them on the list. The patient has the 
freedom to choose a HHA or SNF not authorized by the MCO. If the 
patient chooses a HHA or SNF not authorized by the MCO, the hospital 
should inform the patient of the potential consequences of going 
outside the plan for services. Therefore, we are adding Sec.  
482.43(c)(6)(ii) to ensure that patients enrolled in MCOs are provided 
with listings that identify authorized HHAs or SNFs.
    Comment: Commenters recommended that the lists be made available to 
all patients who potentially require any type of posthospital services, 
not just those determined by the discharge planning evaluation to 
require HHA or SNF services. Another commenter stated that all 
beneficiaries should be provided with written information advising them 
that they may be entitled to home health services.
    Response: We note that the language of the statute only requires 
that lists of HHAs and SNFs be provided to the appropriate patients. In 
addition, we believe it would be unnecessarily burdensome to require 
that hospitals develop and provide a list of all posthospital services 
to their patients. Hospitals are free to provide all patients with 
written information advising them that they may be entitled to home 
health services. However, we do not believe that the intent of the 
statute is to require that this information be provided to all 
patients.
    Comment: A commenter suggested that hospitals be required to direct 
the patients and their family to the Home Health Compare website. The 
commenter stated that the website provides both a useful tool for 
locating area specific HHAs while providing a means for patients to 
conduct a comparative review.
    Response: We appreciate the commenter's support of the Home Health 
Compare website. Hospitals are free to direct patients and their 
families to this website as part of their discharge planning process. 
However, we believe requiring hospitals to direct patients and their 
families to the Home Health Compare website is not appropriate because 
some patients and their families may not have Internet access.
    Comment: A commenter requested that the words ``when possible'' be 
removed from Sec.  482.43(c)(7). The commenter stated that in her 
experience hospitals would just say that they could not reach the 
agency and not even call the agency in question. Two commenters 
suggested that the hospital be required to document when they called 
and to whom the discharge planner spoke. The commenter requested the 
following language be added: ``The hospital discharge planner or anyone 
else from the hospital may not recommend that a patient use a 
particular agency or tell the patient that they have to use the 
hospital agency because they are in that hospital.'' Lastly, the 
commenter requested that the word ``respect'' be changed to ``honor.''
    Response: We understand the commenters' concern that hospitals may 
steer patients to certain HHAs. However, we believe there are 
legitimate circumstances when it may not be possible to respect patient 
and family preferences. For example, a preferred HHA or SNF may not be 
able to accommodate the patient's needs within the required timeframe 
or a preferred HHA may be unable to provide the required services. We 
believe a requirement to include documentation

[[Page 49228]]

of these circumstances would create an unnecessary burden for 
hospitals. Section 482.43(c)(7) stipulates that the hospital must not 
exclude qualified providers that are available to the patient. Steering 
a patient to a particular agency or limiting access to an agency 
constitutes excluding qualified providers. Such practices would be a 
violation of this regulatory provision. We note that the meanings of 
``respect'' and ``honor'' are similar, and, therefore, we are retaining 
the word ``respect''.
    Comment: One commenter requested that we use the statutory language 
in section 1861(ee)(2)(H) of the Act, requiring that plans ``not 
specify or otherwise limit the qualified provider which may provide 
posthospital home health services.'' The commenter stated that it might 
be useful to include within the rule the particular prohibition set out 
in the statute.
    Response: We agree with the commenter and are revising Sec.  
482.83(c)(7) to reflect this change.
    Comment: Commenters recommended that the regulation be modified to 
include hospice among the posthospital care providers where a list of 
hospices is made available to the patient, along with the other 
protections on the patient's freedom of choice. Another commenter 
stated that hospitals should be required to provide lists of all 
providers and services available to patients upon discharge.
    Response: Section 1861(ee) of the Act requires hospitals to have a 
discharge planning process that meets certain enumerated requirements. 
Included in that statutory provision is the requirement that the 
discharge planning evaluation incorporate an evaluation of the 
patient's likely need for appropriate posthospital services and the 
availability of those services. Section 4321 of the BBA amended the 
discharge planning requirements to require that the discharge planning 
evaluation indicate the availability of home health services provided 
by individuals or entities that participate in the Medicare program. 
Specifically, section 4321(a) of the BBA provided that the discharge 
planning evaluation include an evaluation of the patient's likely need 
for posthospital services and the availability of those services; 
``including the availability of home health services through 
individuals and entities that participate in the program under this 
title and that serve the area in which the patient resides and that 
request to be listed by the hospital as available.'' We have 
interpreted this provision to require that hospitals need only indicate 
the availability of home health services provided by HHAs that request 
to be listed in the discharge plan, as opposed to the universe of 
individuals and entities that participate in the program. We believe 
that our interpretation is consistent with the BBA provision. As noted 
previously, section 4321(a) requires that hospitals, in their discharge 
planning evaluation, provide a listing regarding the ``availability of 
home health services.'' Section 1861(m) of the Act defines home health 
services as services ``furnished by a home health agency'' (as opposed 
to other posthospital entities). Section 926 of Public Law 108-173 
further amended 1861(ee) to include information regarding skilled 
nursing facilities that participate in the Medicare program. Therefore, 
in accordance with the Act, we interpret these provisions as not 
applying to individuals or entities that provide posthospital services 
other than HHAs and SNFs. However, we expect the discharge planner to 
facilitate patient choice in any posthospital extended care services as 
part of the discharge planning process even though the statute does not 
require a specific list beyond HHAs and SNFs. We are revising Sec.  
482.43(c)(7) to clarify our policy regarding patient choice in 
posthospital care services.
    Comment: Commenters stated that CMS should provide authorization to 
state surveyors to find a violation of the hospital CoPs if the overall 
effect of a discharge/referral practice evidences a clear intent to 
subvert or violate the purpose of section 4321 of the BBA. One 
commenter also stated that CMS should specify that exclusion of a 
hospital's own HHA from the list does not permit the hospital to 
``steer'' a beneficiary to that agency, and that it is improper for a 
hospital to limit inclusion on the list to accredited HHAs. Another 
commenter requested that CMS address the issue of whether review of a 
patient's hospital record by an HHA that the patient has not selected 
violates the HIPAA privacy requirements.
    Response: Compliance with the hospital CoPs is monitored by the 
State survey agencies as part of the survey and certification process 
or, in the case of accredited hospitals, by JCAHO, the AOA or other CMS 
approved accreditation organizations. Noncompliance with the 
regulations contained within the hospital CoPs can result in a hospital 
losing its status as a Medicare participating provider. Anyone aware of 
instances where patients are being inappropriately influenced or 
steered toward a particular HHA, SNF or other entity in which the 
hospital or individual has a financial interest can file a complaint 
with the appropriate State survey agency. The list provided to the 
patient must include certified HHAs, both accredited and nonaccredited, 
to meet the intent of the statute.
    In addition, disclosing a patient's hospital record to an HHA that 
the patient has not selected would be a violation of HIPAA, Public Law 
104-191. Regulations implementing HIPAA are published in 45 CFR Parts 
160 and 164.
    Comment: One commenter recommended that details discussed in the 
preamble be included as regulation text. These details include: use of 
the Home Health Compare website; hospitals that create their own lists 
should include, at a minimum, those providers who request inclusion on 
the list; and hospital lists should be updated annually.
    Response: A hospital has the flexibility to implement the 
requirements in a manner that is most efficient and least burdensome in 
its particular setting. Hospitals may choose to develop their own list 
of HHAs or utilize the Home Health Compare website. We do not believe 
reference to the Home Health Compare website needs to be in the 
regulation as hospitals are free to develop their own list. The 
regulation requires that the hospital list include HHAs that: 
Participate in the Medicare program; serve the geographic area (as 
defined by the HHA) in which the patient resides; and request to be 
listed by the hospital as available. In terms of frequency of updating 
the list, we have decided to be less prescriptive and not require the 
hospital to update the list annually as discussed in the preamble of 
the proposed rule. Instead, we expect hospitals to keep their lists 
current. This provides hospitals the flexibility to determine how often 
it is necessary to update their lists.
    Comment: One commenter stated that HHAs new to the Medicare program 
are not listed on the Home Health Compare website until they have 
submitted OASIS data for at least 6 months. The commenter also stated 
that when a search is conducted using zip code or county, Home Health 
Compare only brings up agencies who have served a patient within that 
zip code or county within the past year. The commenter requested that 
Medicare-certified HHAs be allowed to request inclusion on the hospital 
list at any time.
    Response: We appreciate the points made by the commenter. However, 
the regulation does not prescribe the timeframe in which a HHA can 
request inclusion on a hospital list. The hospital has the freedom to 
determine a

[[Page 49229]]

timeframe if they determine that a timeframe is necessary.
    Comment: One commenter requested that hospital staff, other than 
discharge planners, not discuss particular posthospital providers with 
patients before the patient has selected a provider.
    Response: We agree that it may be confusing to patients if hospital 
staff other than those involved in the discharge planning process 
discuss posthospital providers with patients. However, discharge 
planning is a multidisciplinary process that includes staff beyond the 
discharge planner. The intent of this regulation is to support the 
patient's freedom to choose. No one on the hospital staff may specify 
or otherwise limit the qualified providers that are available to the 
patient.
    Comment: One commenter stated that financial interests should be 
disclosed to patients before exercising their right to choose a HHA, 
not after the patient is referred.
    Response: We agree that financial interests should be disclosed to 
patients before patients exercise their right to choose a HHA. We do 
not interpret the term ``referred'' to mean that a patient has made a 
decision and has chosen a particular HHA. We interpret this to mean 
that a patient is referred to a list of HHAs. The discharge plan must 
identify those HHAs in which a disclosable financial interest exists. 
HHAs in which a disclosable financial interest exists can simply be 
highlighted in some fashion on the list.
    Comment: One commenter stated that the discharge planning process 
should provide the same information to all patients regardless of 
payer. Another commenter requested clarification as to whether or not 
this policy is intended to apply to both PPS hospitals and CAHs.
    Response: The hospital CoPs apply to all patients in Medicare- and 
Medicaid-participating hospitals regardless of payer. We expect all 
patients to receive the same information. The hospital CoPs are not 
applicable to CAHs.
    Comment: One commenter stated that, if hospitals are creating their 
own lists, there are no standards for the process that HHAs are to 
follow to ensure placement on the hospital listing.
    Response: The standards for ensuring placement on the hospital list 
are outlined in the regulation. The hospital must include in the 
discharge plan a list of HHAs or SNFs that are available to the 
patient, that are participating in the Medicare program, and that serve 
the geographic area (as defined by the HHA) in which the patient 
resides, or in the case of a SNF, in the geographic area requested by 
the patient. HHAs must request to be listed by the hospital as 
available.
    Comment: One commenter urged CMS to move forward with implementing 
the remainder of the BBA provisions at sections 4321(b) and (c).
    Response: In the November 22, 2002 Federal Register (67 FR 70373), 
we published a proposed rule entitled, ``Medicare Program: 
Nondiscrimination in Posthospital Referral to Home Health Agencies and 
Other Entities'' (CMS-1223-P), which specified our proposal to 
implement sections 4321(b) and (c) of the BBA. The final rule is 
currently in the agency clearance process.
    Based on public comments, we are making two revisions to the 
regulations text in this final rule. In Sec.  482.43, we are adding a 
new paragraph (c)(6)(ii) that states, ``For patients enrolled in 
managed care organizations, the hospital must indicate the availability 
of home health and posthospital extended care services through 
individuals and entities that have a contract with the managed care 
organizations.''
    In addition, we are revising Sec.  482.43(c)(7) to read, ``The 
hospital, as part of the discharge planning process, must inform the 
patient or patient's family of their freedom to choose among 
participating Medicare providers of posthospital care services and 
must, when possible, respect patient and family preferences when they 
are expressed'' and ``The hospital must not specify or otherwise limit 
the qualified providers that are available to the patient.''
    The remainder of the proposed provisions is adopted as final 
without change.

B. Compliance With Bloodborne Pathogens Standards

1. Background
    Section 1866(a)(1) of the Act sets forth provider agreement 
requirements that Medicare-participating hospitals must meet. 
Implementing regulations for these requirements are set forth at 42 CFR 
489.20.
    Section 947 of Public Law 108-173 amended section 1866(a)(1) of the 
Act to require that, by July 1, 2004, hospitals not otherwise subject 
to the Occupational Safety and Health Act (OSHA) (or a State 
occupational safety and health plan that is approved under section 
18(b) of that Act) must comply with the OSHA bloodborne pathogens (BBP) 
standards at 29 CFR 1910.1030 as part of their Medicare provider 
agreements. These OSHA standards can be found on OSHA's Web site at 
http://www.osha.gov/SLTC/bloodbornepathogens/. Section 947 of Public 
Law 108-173, which applies to hospitals participating in Medicare as of 
July 1, 2004, was enacted to ensure that all hospital employees who may 
come into contact with human blood or other potentially infectious 
materials in the course of their duties are provided proper protection 
from bloodborne pathogens. This amendment further provides that a 
hospital that fails to comply with OSHA's BBP standards may be subject 
to a civil money penalty. The civil money penalty will be imposed and 
collected in the same manner that civil money penalties are imposed and 
collected under 29 U.S.C. section 666 and section 1128A(a) of the Act. 
However, failure to comply with the BBP standards will not lead to 
termination of a hospital's provider agreement.
    Currently, most hospitals are subject either to the OSHA BBP 
standards or to other BBP standards (generally, State standards) that 
meet or exceed the OSHA standards. However, non-Federal public 
hospitals located in States that do not have their own BBP standards 
are not subject to OSHA standards, including the OSHA BBP standards. 
Twenty-six States and the District of Columbia, and Guam do not have 
their own BBP standards under an OSHA-approved State plan. Therefore, 
an estimated 600,000 employees of such non-federal public hospitals 
located in those 26 States, the District of Columbia, and Guam are not 
afforded the same protections from BBPs as employees of all other 
hospitals in the United States. The States and territories that would 
be affected by the change made by section 947 of Public Law 108-173 are 
Alabama, Arkansas, Colorado, Delaware, Florida, Georgia, Idaho, 
Illinois, Kansas, Louisiana, Maine, Massachusetts, Mississippi, 
Missouri, Montana, Nebraska, New Hampshire, North Dakota, Ohio, 
Oklahoma, Pennsylvania, Rhode Island, South Dakota, Texas, West 
Virginia, Wisconsin, the District of Columbia, the Virgin Islands, and 
Guam.
2. Provisions of the Proposed Regulations
    In the May 18, 2004 IPPS proposed rule (69 FR 28196, 28372), we 
proposed to incorporate the provisions of Public Law 108-173 in Sec.  
489.20 of the Medicare regulations governing provider agreements by 
adding a new paragraph (t). In paragraph (t), we proposed that 
hospitals not otherwise subject to the OSHA BBP standards must comply 
with the OSHA BBP standards at 29 CFR 1910.1030 as part of their 
Medicare provider agreement.

[[Page 49230]]

We proposed to further specify that if a hospital fails to comply with 
OSHA's BBP standards, the hospital may be subject to a civil money 
penalty. The civil money penalty would be imposed and collected in the 
same manner that civil money penalties are imposed and collected under 
29 U.S.C. 666 and section 1128A(a) of the Act. However, as we noted 
previously, failure to comply with the BBP standards would not lead to 
termination of a hospital's provider agreement. In addition, we 
proposed to refer in the proposed provision to the Federal Civil 
Penalties Inflation Adjustment Act. This reference was intended to 
alert the reader that the civil money penalty amounts determined under 
29 U.S.C. 666 and section 1128A(a) of the Act may, under the Federal 
Civil Penalties Inflation Adjustment Act, be increased to adjust for 
inflation.
    We did not receive any timely public comments in response to the 
section in the May 18, 2004 proposed rule regarding implementation of 
OSHA's Bloodborne Pathogens regulations for hospitals. Therefore, we 
are finalizing the proposed bloodborne pathogens for hospitals 
regulatory provisions without modification.

C. Fire Safety Requirements for Certain Health Care Facilities

1. Background
    On January 10, 2003, we published a final rule in the Federal 
Register (68 FR 1374) that adopted the 2000 edition of the Life Safety 
Code (LSC) published by the National Fire Protection Association (NFPA) 
as the fire safety requirements (with specified exceptions) that we are 
applying to the following types of providers participating in the 
Medicare and Medicaid programs: Long-term care facilities, hospitals, 
intermediate care facilities for the mentally retarded (ICF/MRs), 
ambulatory surgical centers (ASCs), hospices that provide inpatient 
services, religious nonmedical health care institutions, CAHs, and 
Programs of All-Inclusive Care for the Elderly (PACE).
    In addition to adopting the 2000 edition of the LSC, we stated our 
intent to delete references to all previous editions of the LSC. 
However, as a result of a technical error, the reference to previous 
editions of the LSC in Sec.  483.70(a)(1) of the regulations for long-
term care facilities was not deleted. Allowing long-term care 
facilities to comply with the 1967, 1973, and 1981 editions of the LSC 
would not adequately protect long-term care facility patients from the 
threat of fire and other emergencies. These editions do not recognize 
newer technology, nor the advances in fire safety that have been 
developed in the ensuing years. In addition, the existing conflicting 
regulatory language is confusing and contrary to the best interests of 
long-term care facilities and their patients. Therefore, in the May 18, 
2004 IPPS proposed rule (69 FR 28196, 28371), we proposed to correct 
this technical error. We did not propose to make any substantive policy 
change.
    In the January 10, 2003 final rule, we also specified that we were 
not adopting the provisions of Chapter 19.3.6.3.2, exception number 2 
of the LSC regarding the use of roller latches for application to 
religious nonmedical health care institutions, hospices, hospitals, 
long-term care facilities, PACE programs, ICF/MRs and CAHs. We prohibit 
the use of roller latches in existing and new buildings, except for 
ASCs under Chapter 20 and Chapter 21 of the LSC, and provide for the 
replacement of existing roller latches, phased in over a 3-year period 
beginning March 11, 2003. We indicated that allowing health care 
facilities to continue using roller latches would not adequately 
protect patients in those facilities. Through fire investigations, 
roller latches have proven to be an unreliable door latching mechanism 
requiring extensive on-going maintenance to operate properly. Many 
roller latches in fire situations failed to provide adequate protection 
to patients in their room during an emergency. Roller latches that are 
not maintained pose a threat to the health and safety of patients and 
staff. We added that we had found through our online survey, 
certification, and reporting (OSCAR) system data that doors that 
include roller latches are consistently one of our most cited 
deficiencies. In fact, in SNFs, roller latches in corridor doors are 
consistently the number one cited deficiency under the life safety 
requirements.
    We learned that the language regarding the date when these 
facilities must be in compliance with the prohibition on the use of 
roller latches may be misinterpreted and needs to be clarified. 
Therefore, in the May 18, 2004 proposed rule, we proposed to clarify 
our intent by revising the regulations as discussed under section 
VIII.C.2. of this preamble. We did not propose to make any substantive 
policy changes.
    Under our proposal, the flexibility of the January 10, 2003 final 
rule would remain the same. The Secretary has broad authority to grant 
waivers to facilities under section 1819(d)(2)(B) and section 
1919(d)(2)(B) of the Act. The proposed amendments would continue to 
allow the Secretary to grant waivers on a case-by-case basis if the 
safety of the patients would not be compromised and if specific 
provisions of the LSC would result in unreasonable hardship on the 
provider. The Secretary also may accept a State's fire and safety code 
instead of the LSC if the State's fire and safety code adequately 
protects patients. Further, the NFPA's Fire Safety Evaluation System 
(FSES), an equivalency system, provides alternatives to meeting various 
provisions of the LSC, thereby achieving the same level of fire 
protection as the LSC.
2. Proposed Changes to the Regulations
    In the May 18, 2004 IPPS proposed rule (69 FR 28337), we proposed 
to revise Sec.  483.70(a) to delete references to the 1967, 1973, and 
1981 editions of the LSC. We also proposed to revise the following 
regulations applicable to the specified facilities to clarify that the 
facility must be in compliance with Chapter 19.2.9, Emergency Lighting, 
beginning March 13, 2006. In addition, we proposed to also specify 
that, beginning March 13, 2006, Chapter 19.3.6.3.2, exception number 2 
(concerning roller latches), does not apply to the facility.
    a. For religious nonmedical health care institutions: Sec.  
403.744(a) and (c).
    b. For hospices, Sec.  418.100(d)(1), (d)(4), and new (d)(5).
    c. For PACE programs, Sec.  460.72(b)(1)(i), ((b)(3), and new 
(b)(4).
    d. For hospitals, Sec.  482.41(b).
    e. For long-term care facilities, Sec.  483.70(a).
    f. For ICF/MRs, Sec.  483.470(j).
    g. For CAHs, Sec.  485.623(d)(1), (d)(5), and new (d)(6).
    We did not receive any timely public comments in response to the 
section in the May 18, 2004 proposed rule regarding changes to the Life 
Safety Code regulations for religious nonmedical health care 
institutions, hospices, programs of all-inclusive care for the elderly, 
hospitals, long-term care facilities, ICFs/MR, and CAHs. Therefore, we 
are adopting as final, without modification, the proposed changes to 
the LSC regulations.

IX. MedPAC Recommendations

    We are required by section 1886(e)(4)(B) of the Act to respond to 
MedPAC's IPPS recommendations in our annual IPPS rules. We have 
reviewed MedPAC's March 1, 2004 ``Report to the Congress: Medicare 
Payment Policy'' and have given it careful consideration in conjunction 
with the policies set forth in this document. For further information

[[Page 49231]]

relating specifically to the MedPAC report or to obtain a copy of the 
report, contact MedPAC at (202) 653-7220, or visit MedPAC's Web site 
at: http://www.medpac.gov.
    We note that MedPAC, in its March 1, 2004 report, included only one 
recommendation concerning Medicare inpatient hospital payment policies. 
MedPAC's Recommendation 3A-1 states that Congress should increase 
payment rates for the IPPS by the projected rate of increase in the 
hospital market basket for FY 2005. We note that section 501(a)(3) of 
Public Law 108-173 requires that the payment rates for the IPPS be 
increased by the market basket percentage increase for all hospitals 
during FYs 2005, 2006, and 2007. However, section 501(a) also provides 
for reducing the update by 0.4 percentage points for any hospital that 
fails to submit data on a list of 10 quality indicators. We discuss 
this recommendation further in Appendix B of this final rule in the 
context of our recommendation concerning the update factor for 
inpatient hospital operating costs and for hospitals and hospital 
distinct-part units excluded from the IPPS.

X. Other Required Information

A. Requests for Data From the Public

    In order to respond promptly to public requests for data related to 
the prospective payment system, we have established a process under 
which commenters can gain access to raw data on an expedited basis. 
Generally, the data are available in computer tape or cartridge format; 
however, some files are available on diskette as well as on the 
Internet at http://www.hcfa.gov/stats/pufiles.htm. In the May 18, 2004 
proposed rule, we published a list of data files that are available for 
purchase from CMS or that may be downloaded from the Internet free of 
charge (68 FR 28337 through 28339).

B. Collection of Information Requirements

    Under the Paperwork Reduction Act of 1995 (PRA), we are required to 
provide 60-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 evaluate fairly whether an information collection should be 
approved by OMB, section 3506(c)(2)(A) of the Paperwork Reduction Act 
of 1995 requires that we solicit comment on the following issues:
     The need for the information collection and its usefulness 
in carrying out the proper functions of our agency.
     The accuracy of our estimate of the information collection 
burden.
     The quality, utility, and clarity of the information to be 
collected.
     Recommendations to minimize the information collection 
burden on the affected public, including automated collection 
techniques.
    In the May 18, 2004 proposed rule, we solicited public comments on 
each of these issues for the information collection requirements in the 
proposed rule discussed below under which associated burdens are 
subject to the PRA.

Section 412.22 Excluded Hospitals and Hospital Units: General Rules

    In summary, this section outlines the requirements for excluded 
hospitals and hospital units. This section states that a LTCH that 
occupies space in a building used by another hospital, or in one or 
more separate buildings located on the same campus as buildings used by 
another hospital must notify its fiscal intermediary and CMS in writing 
of its co-location.
    The collection requirement has not changed. While this requirement 
is subject to the PRA, this requirement is currently approved in OMB 
No. 0938-0897, with a current expiration date of July 31, 2006.

Section 412.25 Excluded Hospital Units: Common Requirements

    In summary, this section applies the excluded hospital unit 
requirements to psychiatric or rehabilitation CAH units that are now 
permitted under the provisions of Public Law 108-173. This section 
states that if a psychiatric rehabilitation unit of a CAH does not meet 
the applicable requirements, payment will not be made and will resume 
only after the unit has demonstrated to CMS that it meets the 
applicable requirements.
    We believe the collection requirements are exempt as defined in 5 
CFR 1320.4, information collections conducted or sponsored during the 
conduct of a criminal or civil action, or during the conduct of an 
administrative action or investigation, or audit. We also believe the 
collection requirements to be exempt as defined in 5 CFR 1320.3(c)(4) 
because we believe this would affect less than 10 persons.

Section 412.64 Federal Rates for Inpatient Operating Costs for Federal 
Fiscal Year 2005 and Subsequent Fiscal Years

    In summary, this section outlines the requirements and process for 
determining the adjustment of the wage index to account for the 
commuting patterns of hospital workers. This section states that a 
hospital may waive the application of the wage index adjustment by 
notifying CMS in writing within 45 days after the publication of the 
annual notice of proposed rulemaking for the IPPS.
    The burden associated with this requirement is the time and effort 
for the hospital to prepare a written notice asking to waive the 
application of the wage index adjustment and to send the notice to CMS.
    The burden associated with this requirement is estimated to be 30 
minutes per hospital. Therefore, we estimate it would take 5 total 
annual hours (30 minutes x 10 hospitals seeking a waiver).

Section 412.101 Special Treatment: Inpatient Hospital Payment 
Adjustment for Low-Volume Hospitals

    In summary, this section outlines the requirements for determining 
a payment adjustment for low-volume hospitals. This section states 
that, in order to qualify for the higher incremental costs adjustment, 
the hospital must provide its fiscal intermediary with evidence that it 
meets the distance requirement specified in this section.
    The burden associated with this requirement is the time and effort 
for the hospital to provide the fiscal intermediary with evidence that 
it meets the specified distance requirement.
    The burden associated with this requirement is estimated to be 1 
hour per hospital. Therefore, we estimate it would take 500 total 
annual hours (1 hour x 500 hospitals seeking the incremental costs 
adjustment).

Section 412.103 Special Treatment: Hospitals Located in Urban Areas and 
That Apply for Reclassification as Rural

    In summary, this section outlines the requirements and process for 
a rural hospital to become reclassified. This section states that a 
prospective payment hospital that is located in an urban area may be 
reclassified as a rural hospital if it submits an application in 
accordance with this section.
    In the May 18, 2004 proposed rule, we proposed to revise this 
section. However, the collection requirement remains the same. While 
this requirement is subject to the PRA, this

[[Page 49232]]

requirement is currently approved in OMB No. 0938-0573, with a current 
expiration date of October 31, 2005.

Section 412.211 Puerto Rico Rates for Federal Fiscal Year 2004 and 
Subsequent Fiscal Years

    In summary, this section outlines the requirements and process for 
determining the adjusted prospective payment rate for inpatient 
hospital services in Puerto Rico. This section states that a hospital 
may waive the application of the wage index adjustment for commuting 
hospital employees by notifying CMS in writing within 45 days after the 
publication of the annual notice of proposed rulemaking for the 
inpatient prospective payment system.
    The burden associated with this requirement is the time and effort 
for the hospital to prepare a written notice asking to waive the 
application of the wage index adjustment and to send the notice to CMS.
    The burden associated with this requirement is estimated to be 30 
minutes per hospital. Therefore, we estimate it would take 5 total 
annual hours (30 minutes x 10 hospitals seeking a waiver).

Section 412.234 Criteria for All Hospitals in an Urban County Seeking 
Redesignation to Another Urban Area

    In summary, this section outlines the requirements for determining 
an urban hospital's redesignation to another urban area. This section 
states that hospitals must submit appropriate wage data to the fiscal 
intermediary as outlined.
    In the May 18, 2004 proposed rule, we proposed to revise this 
section. However, the collection requirement remains the same. While 
this requirement is subject to the PRA, this requirement is currently 
approved in OMB No. 0938-0907, with a current expiration date of 
December 31, 2005.

Section 413.70 Payment for Services of a CAH

    In summary, this section outlines the requirements for a CAH to 
make an election to be paid for outpatient facility services plus the 
fee schedule for professional services under an optional single payment 
method. This section states that a CAH may make this election in any 
cost reporting period. This election must be made in writing, made on 
an annual basis, and delivered to the fiscal intermediary servicing the 
CAH at least 30 days before the start of each affected cost reporting 
period.
    In the May 18, 2004 proposed rule, we proposed to revise this 
section. However, the collection requirement remains the same. While 
this requirement is subject to the PRA, this requirement is currently 
approved in OMB No. 0938-0050, with a current expiration date of 
November 30, 2005.

Section 413.78 Direct GME Payments: Determinations of the Total Number 
of FTE Residents

    In summary, this section outlines the requirements for the 
determination of the total number of FTE residents in determining 
direct GME payments to hospitals. Currently, this section states that, 
for residents who spend time in nonprovider settings, there must be a 
written agreement between the hospital and the outside entity that 
states that the resident's compensation for training time spent outside 
of the hospital setting is to be paid by the hospital. In the May 18, 
2004 proposed rule, we proposed to remove the written agreement 
requirement from this section.
    This requirement is exempt from the PRA in accordance with Public 
Law 99-272 or Public Law 108-173, or both.

Section 413.79 Direct GME Payments: Determination of the Weighted 
Number of FTE Residents

    In summary, this section outlines the requirements for the 
determination of the weighted number of FTE residents for direct GME 
payments to hospitals. Under this section in the May 18, 2004 proposed 
rule, we proposed that a hospital seeking an adjustment to the limit on 
its unweighted resident count under section 422 of Public Law 108-173 
must provide documentation justifying the adjustment. In addition, the 
section states that a hospital wishing to receive a temporary 
adjustment to its FTE resident cap because it is participating in a 
Medicare GME affiliated group must submit the Medicare GME affiliation 
agreement to the CMS fiscal intermediary and to CMS's Central Office. 
This section specifies the information that a request must contain.
    These requirements are exempt from the PRA in accordance with 
Public Law 99-272 or Public Law 108-173, or both.

Section 413.80 Direct GME Payments: Determination of Weighting Factors 
for Foreign Medical Graduates

    In summary, this section specifies the information that a hospital 
must submit to the fiscal intermediary to include foreign medical 
graduates in its FTE count for a particular cost reporting period.
    This requirement is exempt from the PRA in accordance with Public 
Law 99-272 or Public Law 108-173, or both.

Section 413.83 Direct GME Payments: Adjustment of a Hospital's Target 
Amount or Prospective Payment Hospital-Specific Rate

    In summary, this section outlines the requirements for seeking an 
adjustment to the hospital's target amount or hospital-specific rate. 
This section states that a hospital may request that the intermediary 
review the classification of operating costs that were previously 
misclassified for purposes of adjusting the hospital's target amount or 
hospital-specific rate. A hospital's request for review must include 
sufficient documentation demonstrating that an adjustment is warranted. 
This section also specifies the terms in which the information should 
be provided.
    This requirement is exempt from the PRA in accordance with Public 
Law 99-272 or Public Law 108-173, or both.

Section 480.106 Exceptions to QIO Notice Requirements

    In summary, in the May 18, 2004 proposed rule, we proposed to 
revise this section to add exceptions to the notice requirements for 
disclosure of QIO information to any person, agency, or organization. 
The notice requirements do not apply if the institution or practitioner 
has requested, in writing, that the QIO make the disclosure; the 
institution or practitioner has provided, in writing, consent for the 
disclosure; or the information is public information.
    The burden associated with these requirements is the time and 
effort for the institution or practitioner to provide a written request 
that the QIO make the disclosure or consent to the disclosure.
    We believe the collection requirements are exempt as defined in 5 
CFR 1320.3(c)(4) because we believe this would affect less than 10 
persons.

Section 480.133 Disclosure of Information About Practitioners, 
Reviewers, and Institutions

    In summary, this section outlines the requirements concerning the 
disclosure of QIO information about practitioners, reviewers, and 
institutions. This section states that a QIO may disclose information 
on a particular practitioner or reviewer at the written request of, or 
with the written consent of, that practitioner or reviewer, with the 
recipient subject to the same rights and responsibilities on 
redisclosure as the requesting or consenting practitioner or reviewer.

[[Page 49233]]

    We believe the collection requirements are exempt as defined in 5 
CFR 1320.3(c)(4) because we believe this would affect less than 10 
persons.

Section 480.140 Disclosure of Quality Review Study Information

    In summary, this section outlines the requirements concerning the 
disclosure of quality review study information. This section states 
that a QIO may disclose quality review study information with 
identifiers of particular practitioners or institutions, or both, at 
the written request of, or with the written consent of, the identified 
practitioner(s) or institution(s). The consent or request must specify 
the information that is to be disclosed and the intended recipient of 
the information. The recipient would be subject to the same rights and 
responsibilities on redisclosure as the requesting or consenting 
practitioner or institution.
    We believe the collection requirements to be exempt as defined in 5 
CFR 1320.3(c)(4) because we believe this would affect less than 10 
persons.

Section 482.43 Condition of Participation: Discharge Planning

    In summary, this section outlines the requirements of the discharge 
planning process. This section states that the hospital must include in 
the discharge plan, a list of HHAs or SNFs that are available to the 
patient, that participate in the Medicare program, that serve the 
geographic area, and that request to be listed by the hospital as 
available and to maintain documentation. This section also specifies 
other information that the discharge plan must contain.
    The burden associated with these requirements is the time and 
effort for the hospital to provide a list to beneficiaries, for whom 
home health care or posthospital extended care services are necessary, 
and document the patient's medical record.
    The burden associated with these requirements is estimated to be 5 
minutes per hospital per discharge. Therefore, we estimate the total 
national burden to be 327,684 hours annually to comply with these 
requirements (652 discharges per hospital per year x 6,031 hospitals x 
5 minutes each).
    We did not receive any comments on the proposed information 
collection and recordkeeping requirements.
    The new information collection and recordkeeping requirements, 
described above, have been submitted to the OMB for review under the 
authority of the PRA. These requirements will not be effective until 
they have been approved by OMB.

C. Waiver of Proposed Rulemaking for Technical Correction to LTCH 
Regulations

    We ordinarily publish a notice of proposed rulemaking in the 
Federal Register to provide a period for public comment before the 
provisions of a notice take effect. However, we can waive this 
procedure if we find good cause that notice and comment procedure is 
impracticable, unnecessary, or contrary to the public interest and 
incorporate a statement of the findings and the reasons for it into the 
notice issued.
    In section VI.A.6 of the preamble of this final rule, we discuss a 
technical correction that we are making to the regulations to reinstate 
Sec.  412.22(h)(6) to the regulations governing payments to LTCHs under 
the LTCH PPS. We find it unnecessary to undertake notice and comment 
rulemaking with respect to the addition of Sec.  412.22(h)(6) to the 
regulation text because this correction merely reinstates a paragraph 
of regulation text implemented in one final rule and inadvertently 
erroneously removed by another final rule. We also note that the policy 
codified in Sec.  412.22(h)(6) underwent notice and comment rulemaking 
before being finalized. Thus, because the public has already had the 
opportunity to comment on this policy, additional comment would be 
unnecessary.
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    Note to Readers: Redesignated Sec. Sec.  413.77, 413.78 and 
413.79 were the only three sections of the redesignated Sec. Sec.  
413.75 through 413.83 that contain proposed policy changes in the 
May 18, 2004 proposed rule:


     Sec. Sec.  413.77(d) introductory text, (d)(2), 
(d)(2)(iii)(B), (d)(2)(iii)(B)(3), (d)(2)(iii)(B)(4), 
(d)(2)(iii)(B)(5), (d)(2)(iii)(C), and (f).
     Sec. Sec.  413.78(e), (e)(1), (e)(2), and (e)(3).
     Sec.  413.79(a), (c)(1), (c)(2), (c)(3), (c)(4), and 
(c)(5).
    These policy changes, any public comments we received, our 
responses to these comments and any further changes we have made in 
response to these comments are discussed in section IV.O. of the 
preamble of this final rule.
    The remaining portions of the redesignated Sec. Sec.  413.75 
through 413.83 contain only coding, cross-reference, and conforming 
redesignation changes. In the May 18, 2004 proposed rule, we solicited 
comments on redesignation, coding, and cross-reference changes.
    We were notified of one error in our proposed redesignation of the 
contents of Sec.  413.86. We erroneously redesignated the contents of 
Sec.  413.86(j) and (j)(1) through (j)(7) as paragraphs (g) and (g)(1) 
through (g)(7) under Sec.  413.80 which relates to determination of 
weighting factors for foreign medical graduates. The contents of Sec.  
413.86(j) and (j)(1) through (j)(7) are general GME requirements 
relating to the information that a hospital must furnish to include a 
resident in the FTE count for a particular cost reporting period. 
Therefore, in this final rule, we have correctly redesignated Sec.  
413.86(j) and (j)(1) through (j)(7) as paragraphs (d) and (d)(1) 
through (d)(7) under Sec.  413.75.

List of Subjects

42 CFR Part 403

    Health insurance, Hospitals, Incorporation by reference, 
Intergovernmental relations, Medicare, Reporting and recordkeeping 
requirements.

42 CFR Part 412

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

42 CFR Part 413

    Health facilities, Kidney diseases, Medicare, Puerto Rico, 
Reporting and recordkeeping requirements.

42 CFR Part 418

    Health facilities, Hospice care, Incorporation by reference, 
Medicare, Reporting and recordkeeping requirements.

42 CFR Part 460

    Aged, Health care, Incorporation by reference, Medicaid, Medicare, 
Reporting and recordkeeping requirements.

42 CFR Part 480

    Health care, Health records, Medicare, Peer Review Organizations 
(PRO), Penalties, Privacy, Reporting and recordkeeping requirements.

42 CFR Part 482

    Grant programs-health, Health facilities, Medicaid, Medicare, 
Reporting and recordkeeping requirements.

42 CFR Part 483

    Grant programs-health, Health facilities, Health professions, 
Health records, Medicaid, Medicare, Nursing homes, Nutrition, Reporting 
and recordkeeping requirements, Safety.

42 CFR Part 485

    Grant programs-health, Health facilities, Medicaid, Medicare, 
Reporting and recordkeeping requirements.

42 CFR Part 489

    Health facilities, Medicare, Reporting and recordkeeping 
requirements.


[[Page 49240]]



0
For the reasons stated in the preamble of this final rule, the Centers 
for Medicare & Medicaid Services is amending 42 CFR chapter IV as 
follows:
0
A. Part 403 is amended as follows:

PART 403--SPECIAL PROGRAMS AND PROJECTS

0
1. The authority citation for part 403 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 403.744 is amended by--
0
A. Revising paragraph (a).
0
B. Revising paragraph (c).
    The revision reads as follows:


Sec.  403.744  Condition of Participation: Life safety from fire.

    (a) General. An RNHCI must meet the following conditions:
    (1) Except as otherwise provided in this section--
    (i) The RNHCI must meet the applicable provisions of the 2000 
edition of the Life Safety Code of the National Fire Protection 
Association. The Director of the Office of the Federal Register has 
approved the NFPA 101[reg]2000 edition of the Life Safety 
Code, issued January 14, 2000, for incorporation by reference in 
accordance with 5 U.S.C. 552(a) and 1 CFR part 51. A copy of the Code 
is available for inspection at the CMS Information Resource Center, 
7500 Security Boulevard, Baltimore, MD or at the National Archives and 
Records Administration (NARA). For information on the availability of 
this material at NARA, call 202-741-6030, or go to: http://www.archives.gov/federal_register/code_of_federal_regulations/ibr_locations.html. Copies may be obtained from the National Fire 
Protection Association, 1 Batterymarch Park, Quincy, MA 02269. If any 
changes in this edition of the Code are incorporated by reference, CMS 
will publish notice in the Federal Register to announce the changes.
    (ii) Chapter 19.3.6.3.2, exception number 2 of the adopted Life 
Safety Code does not apply to an RNHCI.
    (2) [Reserved]
* * * * *
    (c) Phase-in period. Beginning March 13, 2006, an RNHCI must be in 
compliance with Chapter 19.2.9, Emergency Lighting. Beginning March 13, 
2006, Chapter 19.3.6.3.2, exception number 2 does not apply to RNHCIs.

0
B. Part 412 is amended 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 412.2 is amended by adding a new paragraph (b)(3) to read as 
follows:


Sec.  412.2  Basis of payment.

* * * * *
    (b) Payment in full. * * *
    (3) If a patient is admitted to an acute care hospital and then the 
acute care hospital meets the criteria at Sec.  412.23(e) to be paid as 
a LTCH, during the course of the patient's hospitalization, Medicare 
considers all the days of the patient stay in the facility (days prior 
to and after the designation of LTCH status) to be a single episode of 
LTCH care. Medicare will not make payment under subpart H for any part 
of the hospitalization. Payment for the entire patient stay (days prior 
to and after the designation of LTCH status) will be made in accordance 
with the requirements specified in Sec.  412.521. The requirements of 
this paragraph (b)(3) apply only to a patient stay in which a patient 
is in an acute care hospital and that hospital is designated as a LTCH 
on or after October 1, 2004.
* * * * *

0
3. Section 412.4 is amended by revising paragraph (d) to read as 
follows:


Sec.  412.4  Discharges and transfers.

* * * * *
    (d) Qualifying DRGs. (1) For purposes of paragraph (c) of this 
section, and subject to the provisions of paragraph (d)(2) of this 
section, the qualifying DRGs must meet the following criteria for both 
of the 2 most recent fiscal years for which data are available:
    (i) The DRG must have a geometric mean length of stay of at least 3 
days.
    (ii) The DRG must have at least 14,000 cases identified as 
postacute care transfer cases.
    (iii) The DRG must have at least 10 percent of the postacute care 
transfers occurring before the geometric mean length of stay for the 
DRG.
    (iv) If the DRG is one of a paired DRG based on the presence or 
absence of a comorbidity or complication, one of the DRGs meets the 
criteria specified under paragraphs (d)(1)(i) through (d)(1)(iii) of 
this section.
    (v) To initially qualify, the DRG must meet the criteria specified 
in paragraphs(d)(1)(i) through (d)(1)(iv) of this section and must have 
a decline in the geometric mean length of stay for the DRG during the 
most recent 5-year period of at least 7 percent. Once a DRG initially 
qualifies, the DRG is subject to the criteria specified under 
paragraphs (d)(1)(i) through (d)(1)(iv) of this section for each 
subsequent fiscal year.
    (2) For purposes of paragraph (c), a discharge is also considered 
to be a transfer if it meets the following conditions:
    (i) The discharge is assigned to a DRG that contains only cases 
that were assigned to a DRG that qualified under this paragraph within 
the previous 2 years; and
    (ii) The latter DRG was split or otherwise modified within the 
previous 2 fiscal years.
* * * * *

0
4. Section 412.22 is amended by--
0
A. Adding a sentence at the end of paragraph (a).
0
B. Revising paragraph (e).
0
C. Adding a new paragraph (h)(6).
    The additions and revision read as follows:


Sec.  412.22  Excluded hospitals and hospital units: General rules.

    (a) Criteria. * * * For purposes of this subpart, the term 
``hospital'' includes a critical access hospital (CAH).
* * * * *
    (e) Hospitals-within-hospitals. Except as provided in paragraph (f) 
of this section, a hospital that occupies space in a building also used 
by another hospital, or in one or more separate buildings located on 
the same campus as buildings used by another hospital, must meet the 
following criteria in order to be excluded from the prospective payment 
systems specified in Sec.  412.1(a)(1):
    (1) Except as specified in paragraph (e)(2) of this section, for 
cost reporting periods beginning on or after October 1, 1987, and 
before October 1, 2004--
    (i) Separate governing body. The hospital has a governing body that 
is separate from the governing body of the hospital occupying space in 
the same building or on the same campus. The hospital's governing body 
is not under the control of the hospital occupying space in the same 
building or on the same campus, or of any third entity that controls 
both hospitals.
    (ii) Separate chief medical officer. The hospital has a single 
chief medical officer who reports directly to the governing body and 
who is responsible for all medical staff activities of the hospital. 
The chief medical officer of the hospital is not employed by or under 
contract with either the hospital occupying space in the same building 
or on the same campus or any third entity that controls both hospitals.

[[Page 49241]]

    (iii) Separate medical staff. The hospital has a medical staff that 
is separate from the medical staff of the hospital occupying space in 
the same building or on the same campus. The hospital's medical staff 
is directly accountable to the governing body for the quality of 
medical care provided in the hospital, and adopts and enforces by-laws 
governing medical staff activities, including criteria and procedures 
for recommending to the governing body the privileges to be granted to 
individual practitioners.
    (iv) Chief executive officer. The hospital has a single chief 
executive officer through whom all administration authority flows, and 
who exercises control and surveillance over all administrative 
activities of the hospital. The chief executive officer is not employed 
by, or under contract with, either the hospital occupying space in the 
same building or on the same campus or any third entity that controls 
both hospitals.
    (v) Performance of basic hospital functions. The hospital meets one 
of the following criteria:
    (A) The hospital performs the basic functions specified in 
Sec. Sec.  482.21 through 482.27, 482.30, 482.42, 482.43, and 482.45 of 
this chapter through the use of employees or under contracts or other 
agreements with entities other than the hospital occupying space in the 
same building or on the same campus, or a third entity that controls 
both hospitals. Food and dietetic services and housekeeping, 
maintenance, and other services necessary to maintain a clean and safe 
physical environment could be obtained under contracts or other 
agreements with the hospital occupying space in the same building or on 
the same campus, or with a third entity that controls both hospitals.
    (B) For the same period of at least 6 months used to determine 
compliance with the criterion regarding the age of patients in Sec.  
412.23(d)(2) or the length-of-stay criterion in Sec.  412.23(e)(2), or 
for hospitals other than children's or long-term care hospitals, for a 
period of at least 6 months immediately preceding the first cost 
reporting period for which exclusion is sought, the cost of the 
services that the hospital obtains under contracts or other agreements 
with the hospital occupying space in the same building or on the same 
campus, or with a third entity that controls both hospitals, is no more 
than 15 percent of the hospital's total inpatient operating costs, as 
defined in Sec.  412.2(c). For purposes of this paragraph (e)(1)(v)(B), 
however, the costs of preadmission services are those specified under 
Sec.  413.40(c)(2) rather than those specified under Sec.  412.2(c)(5).
    (C) For the same period of at least 6 months used to determine 
compliance with the criterion regarding the age of inpatients in Sec.  
412.23(d)(2) or the length-of-stay criterion in Sec.  412.23(e)(2), or 
for hospitals other than children's or long-term care hospitals, for 
the period of at least 6 months immediately preceding the first cost 
reporting period for which exclusion is sought, the hospital has an 
inpatient population of whom at least 75 percent were referred to the 
hospital from a source other than another hospital occupying space in 
the same building or on the same campus.
    (2) Effective for long-term care hospitals-within-hospitals for 
cost reporting periods beginning on or after October 1, 2004, the 
hospital must meet the governance and control requirements at 
paragraphs (e)(1)(i) through (e)(1)(iv) of this section.
    (3) Notification of co-located status. A long-term care hospital 
that occupies space in a building used by another hospital, or in one 
or more separate buildings located on the same campus as buildings used 
by another hospital that meets the criteria of (e)(1) or (e)(2) of this 
section must notify its fiscal intermediary and CMS in writing of its 
co-location within 60 days of its first cost reporting period that 
begins on or after October 1, 2002.
* * * * *
    (h) Satellite facilities. * * *
    (6) The provisions of paragraph (h)(2)(i) of this section do not 
apply to any long-term care hospital that is subject to the long-term 
care hospital prospective payment system under Subpart O of this 
subpart, effective for cost reporting periods occurring on or after 
October 1, 2002, and that elects to be paid based on 100 percent of the 
Federal prospective payment rate as specified in Sec.  412.533(c), 
beginning with the first cost reporting period following that election, 
or when the LTCH is fully transitioned to 100 percent of the Federal 
prospective rate, or to a new long-term care hospital, as defined in 
Sec.  412.23(e)(4).
* * * * *

0
5. Section 412.25 is amended by adding a new paragraph (g), to read as 
follows:


Sec.  412.25  Excluded hospital units: Common requirements.

* * * * *
    (g) CAH units not meeting applicable requirements. If a psychiatric 
or rehabilitation unit of a CAH does not meet the requirements of Sec.  
485.647 with respect to a cost reporting period, no payment may be made 
to the CAH for services furnished in that unit for that period. Payment 
to the CAH for services in the unit may resume only after the start of 
the first cost reporting period beginning after the unit has 
demonstrated to CMS that the unit meets the requirements of Sec.  
485.647.


0
6. Section 412.63 is amended by--
0
A. Revising the heading of the section.
0
B. Revising paragraph (a).
0
C. Adding introductory text to paragraph (b).
0
D. Revising paragraph (c)(1), (c)(5), and (c)(6)
0
E. Revising paragraph (u).
    The revisions and addition read as follow:


Sec.  412.63  Federal rates for inpatient operating costs for Federal 
fiscal years 1984 through 2004.

    (a) General rule.
    (1) CMS determines a national adjusted prospective payment rate for 
inpatient operating costs for each inpatient hospital discharge in 
Federal fiscal years 1985 through 2004 involving inpatient hospital 
service of a hospital in the United States, subject to the PPS, and 
determines a regional adjusted PPS rate for operating costs for such 
discharges in each region for which payment may be made under Medicare 
Part A.
    (2) Each such rate is determined for hospitals located in urban or 
rural areas within the United States and within each such region, 
respectively, as described under paragraphs (b) through (u) of this 
section.
* * * * *
    (b) Geographic classifications. Effective for fiscal years 1985 
through 2004, the following rules apply.
* * * * *
    (c) Updating previous standardized amounts. (1) For discharges 
occurring in fiscal year 1985 through fiscal year 2003, CMS computes 
average standardized amounts for hospitals in urban areas and rural 
areas within the United States, and in urban areas and rural areas 
within each region. For discharges occurring in fiscal year 2004, CMS 
computes an average standardized amount for hospitals located in all 
areas.
* * * * *
    (5) For fiscal years 1987 through 2004, CMS standardizes the 
average standardized amounts by excluding an estimate of indirect 
medical education payments.
    (6) For fiscal years 1988 through 2003, CMS computes average 
standardized amounts for hospitals located in large urban areas, other 
urban areas, and rural areas. The term large urban area means

[[Page 49242]]

an MSA with a population of more than 1,000,000 or an NECMA, with a 
population of more than 970,000 based on the most recent available 
population data published by the Census Bureau. For fiscal year 2004, 
CMS computes an average standardized amount for hospitals located in 
all areas.
* * * * *
    (u) Applicable percentage change for fiscal year 2004. The 
applicable percentage change for fiscal year 2004 is the percentage 
increase in the market basket index for prospective payment hospitals 
(as defined in Sec.  413.40(a) of this subchapter) for hospitals in all 
areas.
* * * * *

0
7. A new Sec.  412.64 is added to Subpart D to read as follows:


Sec.  412.64  Federal rates for inpatient operating costs for Federal 
fiscal year 2005 and subsequent fiscal years.

    (a) General rule. CMS determines a national adjusted prospective 
payment rate for inpatient operating costs for each inpatient hospital 
discharge in Federal fiscal year 2005 and subsequent fiscal years 
involving inpatient hospital services of a hospital in the United 
States subject to the prospective payment system for which payment may 
be made under Medicare Part A.
    (b) Geographic classifications. (1) For purposes of this section, 
the following definitions apply:
    (i) The term region means one of the 9 metropolitan divisions 
comprising the 50 States and the District of Columbia, established by 
the Executive Office of Management and Budget for statistical and 
reporting purposes.
    (ii) The term urban area means--
    (A) A Metropolitan Statistical Area, as defined by the Executive 
Office of Management and Budget; or
    (B) The following New England counties, which are deemed to be 
parts of urban areas under section 601(g) of the Social Security 
Amendments of 1983 (Public Law 98-21, 42 U.S.S. 1395ww (note)): 
Litchfield County, Connecticut; York County, Maine; Sagadahoc County, 
Maine; Merrimack County, New Hampshire; and Newport County, Rhode 
Island.
    (C) The term rural area means any area outside an urban area.
    (D) The phrase hospital reclassified as rural means a hospital 
located in a county that, in FY 2004, was part of an MSA, but was 
redesignated as rural after September 30, 2004, as a result of the most 
recent census data and implementation of the new MSA definitions 
announced by OMB on June 6, 2003.
    (2) For hospitals within an MSA that crosses census division 
boundaries, the MSA is deemed to belong to the census division in which 
most of the hospitals within the MSA are located.
    (3) For discharges occurring on or after October 1, 2004, a 
hospital located in a rural county adjacent to one or more urban areas 
is deemed to be located in an urban area and receives the Federal 
payment amount for the urban area to which the greater number of 
workers in the county commute if the rural county would otherwise be 
considered part of an urban area, under the standards for designating 
MSAs if the commuting rates used in determining outlying counties were 
determined on the basis of the aggregate number of resident workers who 
commute to (and, if applicable under the standards, from) the central 
county or central counties of all adjacent MSAs. These EOMB standards 
are set forth in the notice of final revised standards for 
classification of MSAs published in the Federal Register on December 
27, 2000 (65 FR 82228), announced by EOMB on June 6, 2003, and 
available from CMS, 7500 Security Boulevard, Baltimore, Maryland 21244.
    (4) For purposes of this section, any change in an MSA designation 
is recognized on October 1 following the effective date of the change. 
Such a change in MSA designation may occur as a result of redesignation 
of an MSA by the Executive Office of Management and Budget.
    (c) Computing the standardized amount. CMS computes an average 
standardized amount that is applicable to all hospitals located in all 
areas, updated by the applicable percentage increase specified in 
paragraph (d) of this section.
    (d) Applicable percentage change for fiscal year 2005 and for 
subsequent fiscal years.
    (1) Subject to the provisions of paragraph (d)(2) of this section, 
the applicable percentage change for fiscal year 2005 and for 
subsequent years for updating the standardized amount is the percentage 
increase in the market basket index for prospective payment hospitals 
(as defined in Sec.  413.40(a) of this subchapter) for hospitals in all 
areas.
    (2) For fiscal years 2005, 2006, and 2007, the applicable 
percentage change specified in paragraph (d)(1) of this section is 
reduced by 0.4 percentage points in the case of a ``subsection (d) 
hospital,'' as defined under section 1886(d)(1)(B) of the Act, that 
does not submit quality data on a quarterly basis to CMS, as specified 
by CMS. Any reduction of the percentage change will apply only to the 
fiscal year involved and will not be taken into account in computing 
the applicable percentage increase for a subsequent fiscal year.
    (e) Maintaining budget neutrality.
    (1) CMS makes an adjustment to the standardized amount to ensure 
that--
    (i) Changes to the DRG classifications and recalibrations of the 
DRG relative weights are made in a manner so that aggregate payments to 
hospitals are not affected; and
    (ii) The annual updates and adjustments to the wage index under 
paragraph (h) of this section are made in a manner that ensures that 
aggregate payments to hospitals are not affected.
    (2) CMS also makes an adjustment to the rates to ensure that 
aggregate payments after implementation of reclassifications under 
subpart L of this part are equal to the aggregate prospective payments 
that would have been made in the absence of these provisions.
    (f) Adjustment for outlier payments. CMS reduces the adjusted 
average standardized amount determined under paragraph (c) through (e) 
of this section by a proportion equal to the proportion (estimated by 
CMS) to the total amount of payments based on DRG prospective payment 
rates that are additional payments for outlier cases under subpart F of 
this part.
    (g) Computing Federal rates for inpatient operating costs for 
hospitals located in all areas. For each discharge classified within a 
DRG, CMS establishes for the fiscal year a national prospective payment 
rate for inpatient operating costs based on the standardized amount for 
the fiscal year and the weighting factor determined under Sec.  
412.60(b) for that DRG.
    (h) Adjusting for different area wage levels. CMS adjusts the 
proportion of the Federal rate for inpatient operating costs that are 
attributable to wages and labor-related costs for area differences in 
hospital wage levels by a factor (established by CMS based on survey 
data) reflecting the relative level of hospital wages and wage-related 
costs in the geographic area (that is, urban or rural area as 
determined under the provisions of paragraph (b) of this section) of 
the hospital compared to the national average level of hospital wages 
and wage-related costs. The adjustment described in this paragraph (h) 
also takes into account the earnings and paid hours of employment by 
occupational category.
    (1) The wage index is updated annually.
    (2) CMS determines the proportion of the Federal rate that is 
attributable to wages and labor-related costs from time to time, 
employing a methodology that

[[Page 49243]]

is described in the annual regulation updating the system of payment 
for inpatient hospital operating costs.
    (3) For discharges occurring on or after October 1, 2004, CMS 
employs 62 percent as the proportion of the rate that is adjusted for 
the relative level of hospital wages and wage-related costs, unless 
employing that percentage would result in lower payments for the 
hospital than employing the proportion determined under the methodology 
described in paragraph (h)(2) of this section.
    (4) For discharges on or after October 1, 2004 and before September 
30, 2007, CMS establishes a minimum wage index for each all-urban 
State, as defined in paragraph (h)(5) of this section. This minimum 
wage index value is computed using the following methodology:
    (i) CMS computes the ratio of the lowest-to-highest wage index for 
each all-urban State;
    (ii) CMS computes the average of the ratios of the lowest-to-
highest wage indexes of all the all-urban States;
    (iii) For each all-urban State, CMS determines the higher of the 
State's own lowest-to-highest rate (as determined under paragraph 
(h)(4)(i) of this section) or the average lowest-to-highest rate (as 
determined under paragraph (h)(4)(ii) of this section);
    (iv) For each State, CMS multiplies the rate determined under 
paragraph (h)(4)(iii) of this section by the highest wage index value 
in the State;
    (v) The product determined under paragraph (h)(4)(iv) of this 
section is the minimum wage index value for the State.
    (5) An all-urban State is a State with no rural areas, as defined 
in this section, or a State in which there are no hospitals classified 
as rural. A State with rural areas and with hospitals reclassified as 
rural under Sec.  412.103 in not an all-urban State.
    (i) Adjusting the wage index to account for commuting patterns of 
hospital workers.
    (1) General criteria. For discharges occurring on or after October 
1, 2004, CMS adjusts the hospital wage index for hospitals located in 
qualifying counties to recognize the commuting patterns of hospital 
employees. A qualifying county is a county that meets all of the 
following criteria:
    (i) Hospital employees in the county commute to work in an MSA (or 
MSAs) with a wage index (or wage indices) higher than the wage index of 
the MSA or rural statewide area in which the county is located.
    (ii) At least 10 percent of the county's hospital employees commute 
to an MSA (or MSAs) with a higher wage index (or wage indices).
    (iii) The 3-year average hourly wage of the hospital(s) in the 
county equals or exceeds the 3-year average hourly wage of all 
hospitals in the MSA or rural statewide area in which the county is 
located.
    (2) Amount of adjustment. A hospital located in a county that meets 
the criteria under paragraphs (i)(1)(i) through (i)(1)(iii) of this 
section will receive an increase in its wage index that is equal to a 
weighted average of the difference between the prereclassified wage 
index of the MSA (or MSAs) with the higher wage index (or wage indices) 
and the prereclasssified wage index of the MSA or rural statewide area 
in which the qualifying county is located, weighted by the overall 
percentage of the hospital employees residing in the qualifying county 
who are employed in any MSA with a higher wage index.
    (3) Process for determining the adjustment.
    (i) CMS will use the most accurate data available, as determined by 
CMS, to determine the out-migration percentage for each county.
    (ii) CMS will include, in its annual proposed and final notices of 
updates to the hospital inpatient prospective payment system, a listing 
of qualifying counties and the hospitals that are eligible to receive 
the adjustment to their wage indexes for commuting hospital employees, 
and the wage index increase applicable to each qualifying county.
    (iii) Any wage index adjustment made under this paragraph (i) is 
effective for a period of 3 fiscal years, except that hospitals in a 
qualifying county may elect to waive the application of the wage index 
adjustment. A hospital may waive the application of the wage index 
adjustment by notifying CMS in writing within 45 days after the 
publication of the annual notice of proposed rulemaking for the 
hospital inpatient prospective payment system.
    (iv) A hospital in a qualifying county that receives a wage index 
adjustment under this paragraph (g) is not eligible for 
reclassification under Subpart L of this part.
    (j) Wage index assignment for rural referral centers for FY 2005.
    (1) CMS makes an exception to the wage index assignment of a rural 
referral center for FY 2005 if the rural referral center meets the 
following conditions:
    (i) The rural referral center was reclassified for FY 2004 by the 
MGCRB to another MSA, but, upon applying to the MGCRB for FY 2005, was 
found to be ineligible for reclassification because its average hourly 
wage was less than 84 percent (but greater than 82 percent) of the 
average hourly wage of the hospitals geographically located in the MSA 
to which the rural referral center applied for reclassification for FY 
2005.
    (ii) The hospital may not qualify for any geographic 
reclassification under subpart L of this part, effective for discharges 
occurring on or after October 1, 2004.
    (2) CMS will assign a rural referral center that meets the 
conditions of paragraph (j)(1) of this section the wage index value of 
the MSA to which it was reclassified by the MGCRB in FY 2004. The wage 
index assignment is applicable for discharges occurring during the 3-
year period beginning October 1, 2004 and ending September 30, 2007.
    (k) Midyear corrections to the wage index.
    (1) CMS makes a midyear correction to the wage index for an area 
only if a hospital can show that--
    (i) The intermediary or CMS made an error in tabulating its data; 
and
    (ii) The hospital could not have known about the error, or did not 
have the opportunity to correct the error, before the beginning of the 
Federal fiscal year.
    (2) A midyear correction to the wage index is effective 
prospectively from the date the change is made to the wage index.
    (l) Judicial decision. If a judicial decision reverses a CMS denial 
of a hospital's wage data revision request, CMS pays the hospital by 
applying a revised wage index that reflects the revised wage data as if 
CMS's decision had been favorable rather than unfavorable.

0
8. Section 412.87 is amended by revising paragraph (b)(3) to read as 
follows:


Sec.  412.87  Additional payment for new medical services and 
technologies: General provisions.

* * * * *
    (b) Eligibility criteria. * * *
    (3) The DRG prospective payment rate otherwise applicable to 
discharges involving the medical service or technology is determined to 
be inadequate, based on application of a threshold amount to estimated 
charges incurred with respect to such discharges. To determine whether 
the payment would be adequate, CMS will determine whether the charges 
of the cases involving a new medical service or technology will exceed 
a threshold amount that is the lesser of 75 percent of the standardized 
amount (increased to reflect the difference between cost

[[Page 49244]]

and charges) or 75 percent of one standard deviation beyond the 
geometric mean standardized charge for all cases in the DRG to which 
the new medical service or technology is assigned (or the case-weighted 
average of all relevant DRGs if the new medical service or technology 
occurs in many different DRGs). Standardized charges reflect the actual 
charges of a case adjusted by the prospective payment system payment 
factors applicable to an individual hospital, such as the wage index, 
the indirect medical education adjustment factor, and the 
disproportionate share adjustment factor.


Sec.  412.88  [Amended]

0
9. Section 412.88 is amended by removing paragraph (c).

0
10. A new Sec.  412.101 is added to read as follows:


Sec.  412.101  Special treatment: Inpatient hospital payment adjustment 
for low-volume hospitals.

    (a) General considerations.
    (1) CMS provides an additional payment to a qualifying hospital for 
the higher incremental costs associated with a low volume of 
discharges. The amount of any additional payment for a qualifying 
hospital is calculated in accordance with paragraph (b) of this 
section.
    (2) In order to qualify for this adjustment, a hospital must have 
less than 200 discharges during the fiscal year, as reflected in its 
cost report specified in paragraph (a)(3) of this section, and be 
located more than 25 road miles from the nearest subsection (d) 
hospital.
    (3) The fiscal intermediary makes the determination of the 
discharge count for purposes of determining a hospital's qualification 
for the adjustment based on the hospital's most recent submitted cost 
report.
    (4) In order to qualify for the adjustment, a hospital must provide 
its fiscal intermediary with sufficient evidence that it meets the 
distance requirement specified under paragraph (a)(2) of this section. 
The fiscal intermediary will base its determination of whether the 
distance requirement is satisfied upon the evidence presented by the 
hospital and other relevant evidence, such as maps, mapping software, 
and inquiries to State and local police, transportation officials, or 
other government officials.
    (b) Determination of the adjustment amount. The low-volume 
adjustment for hospitals that qualify under paragraph (a) of this 
section is 25 percent for each Medicare discharge.
    (c) Eligibility of new hospitals for the adjustment. A new hospital 
will be eligible for a low-volume adjustment under this section once it 
has submitted a cost report for a cost reporting period that indicates 
that it meets the number of discharge requirements during the fiscal 
year and has provided its fiscal intermediary with sufficient evidence 
that it meets the distance requirement, as specified under paragraph 
(a)(2) of this section.

0
11. Section 412.102 is amended by revising the introductory text to 
read as follows:


Sec.  412.102  Special treatment: Hospitals located in areas that are 
reclassified from urban to rural as a result of a geographic 
redesignation.

    Effective on or after October 1, 1983, a hospital reclassified as 
rural, as defined in subpart D of this part, may receive an adjustment 
to its rural Federal payment amount for operating costs for two 
successive fiscal years.
* * * * *

0
12. Section 412.103 is amended by--
0
A. Revising paragraph (a) introductory text.
0
B. Adding a new paragraph (a)(4).
    The revision and addition read as follows:


Sec.  412.103  Special treatment: Hospitals located in urban areas and 
that apply for reclassification as rural.

    (a) General criteria. A prospective payment hospital that is 
located in an urban area (as defined in subpart D of this part) may be 
reclassified as a rural hospital if it submits an application in 
accordance with paragraph (b) of this section and meets any of the 
following conditions:
* * * * *
    (4) For any period after September 30, 2004 and before January 1, 
2004, a CAH in a county that, in FY 2004, was not part of a MSA as 
defined by the Office of Management and Budget, but as of FY 2005 was 
included as part of an MSA as a result of the most recent census data 
and implementation of the new MSA definitions announced by OMB on June 
6, 2003, may be reclassified as being located in a rural area for 
purposes of meeting the rural location requirement in Sec.  485.610(b) 
of this chapter if it meets any of the requirements in paragraphs 
(a)(1), (a)(2), or (a)(3) of this section.
* * * * *

0
13. Section 412.104 is amended by revising paragraph (a) to read as 
follows:


Sec.  412.104  Special treatment: Hospitals with high percentage of 
ESRD discharges.

    (a) Criteria for classification. CMS provides an additional payment 
to a hospital for inpatient services provided to ESRD beneficiaries who 
receive a dialysis treatment during a hospital stay, if the hospital 
has established that ESRD beneficiary discharges, excluding discharges 
classified into DRG 302 (Kidney Transplant), DRG 316 (Renal Failure), 
or DRG 317 (Admit for Renal Dialysis), where the beneficiary received 
dialysis services during the inpatient stay, constitute 10 percent or 
more of its total Medicare discharges.
* * * * *

0
14. Section 412.105 is amended by--
0
A. Revising paragraph (b).
0
B. Revising paragraph (d)(3)(vii).
0
C. Adding new paragraphs (d)(3)(viii) through (xii).
0
D. Adding a new paragraph (d)(4).
0
E. Redesignating the contents of paragraph (e) as paragraph (e)(1) and 
adding a new paragraph (e)(2).
0
F. Redesignating the contents of paragraph (f)(1)(iv) as paragraph 
(f)(1)(iv)(A) and adding new paragraphs (f)(1)(iv)(B) and 
(f)(1)(iv)(C).

Cross-Reference Changes

0
G. In paragraphs (a), (f), and (g) as indicated in the left column of 
the table below, remove the cross-reference indicated in the middle 
column from wherever it appears, and add the cross-reference in the 
right column:

[[Page 49245]]

[GRAPHIC] [TIFF OMITTED] TR11AU04.075

    The revisions and additions read as follows:


Sec.  412.105  Special treatment: Hospitals that incur indirect costs 
for graduate medical education programs.

* * * * *
    (b) Determination of the number of beds. For purposes of this 
section, the number of beds in a hospital is determined by counting the 
number of available bed days during the cost reporting period and 
dividing that number by the number of days in the cost reporting 
period. This count of available bed days excludes bed days associated 
with--
    (1) Beds in a unit or ward that is not occupied to provide a level 
of care that would be payable under the acute care hospital inpatient 
prospective payment system at any time during the 3 preceding months 
(the beds in the unit or ward are to be excluded from the determination 
of available bed days during the current month);
    (2) Beds in a unit or ward that is otherwise occupied (to provide a 
level of care that would be payable under the acute care hospital 
inpatient prospective payment system) that could not be made available 
for inpatient occupancy within 24 hours for 30 consecutive days;
    (3) Beds in excluded distinct part hospital units;
    (4) Beds otherwise countable under this section used for outpatient 
observation services, skilled nursing swing-bed services, or ancillary 
labor/delivery services. This exclusion would not apply if a patient 
treated in an observation bed is ultimately admitted for acute 
inpatient care, in which case the beds and days would be included in 
those counts;
    (5) Beds or bassinets in the healthy newborn nursery; and
    (6) Custodial care beds.
* * * * *
    (d) Determination of education adjustment factor.
* * * * *
    (3) Step three. * * *
    (vii) For discharges occurring on or after October 1, 2002 and 
before April 1, 2004, 1.35.
    (viii) For discharges occurring on or after April 1, 2004 and 
before October 1, 2004, 1.47.
    (ix) For discharges occurring during fiscal year 2005, 1.42.
    (x) For discharges occurring during fiscal year 2006, 1.37.
    (xi) For discharges occurring during fiscal year 2007, 1.32.
    (xii) For discharges occurring during fiscal year 2008 and 
thereafter, 1.35.
    (4) For discharges occurring on or after July 1, 2005, with respect 
to FTE residents added as a result of increases in the FTE resident cap 
under paragraph (f)(1)(iv)(C) of this section, the factor derived from 
completing steps one and two is multiplied by `c', where `c' is equal 
to 0.66.
    (e) Determination of payment amount.
    (1) * * *
    (2) For discharges occurring on or after July 1, 2005, a hospital 
that counts additional residents as a result of an increase in its FTE 
resident cap under paragraph (f)(1)(iv)(C) of this section will receive 
indirect medical education payments based on the sum of the following 
two indirect medical education adjustment factors:
    (i) An adjustment factor that is calculated using the schedule of 
formula multipliers in paragraph (d)(3) of this section and the 
hospital's FTE resident count, not including residents attributable to 
an increase in its FTE cap under paragraph (f)(1)(iv)(C) under this 
section; and
    (ii) An adjustment factor that is calculated using the applicable 
formula multiplier under paragraph (d)(4) of this section, and the 
additional number of FTE residents that are attributable to the 
increase in the hospital's FTE resident cap under paragraph 
(f)(1)(iv)(C) in this section.
    (f) Determining the total number of full-time equivalent residents 
for cost

[[Page 49246]]

reporting periods beginning on or after July 1, 1991.
    (1) * * *
    (iv) (A) * * *
    (B) Effective for portions of cost reporting periods beginning on 
or after July 1, 2005, a hospital's otherwise applicable FTE resident 
cap may be reduced if its reference resident level is less than its 
otherwise applicable FTE resident cap in a reference cost reporting 
period, in accordance with the provisions of Sec.  413.79(c)(3) of this 
subchapter. The reduction is 75 percent of the difference between the 
otherwise applicable FTE resident cap and the reference resident level.
    (C) Effective for portions of cost reporting periods beginning on 
or after July 1, 2005, a hospital may qualify to receive an increase in 
its otherwise applicable FTE resident cap (up to 25 additional FTEs) if 
the criteria specified in Sec.  413.79(c)(4) of this subchapter are 
met.
* * * * *

0
15. Section 412.106 is amended by--
0
A. Revising paragraphs (a)(1)(ii)(B) and (a)(1)(ii)(C).
0
B. Adding a new paragraph (a)(1)(ii)(D).
0
C. Revising paragraph (b)(2)(i) introductory text.
0
D. In paragraph (a)(1)(iii), removing the cross-reference ``Sec.  
412.62(f)'' and adding in its place ``Sec.  412.62(f) or Sec.  
412.64''.
0
E. Revising paragraphs (d)(2)(ii), (d)(2)(iii), and (d)(2)(iv) to read 
as follows:


Sec.  412.106  Special treatment: Hospitals that serve a 
disproportionate share of low-income patients.

    (a) General considerations.
    (1) * * *
    (ii) * * *
    (B) Beds otherwise countable under this section used for outpatient 
observation services, skilled nursing swing-bed services, or ancillary 
labor/delivery services. This exclusion would not apply if a patient 
treated in an observation bed is ultimately admitted for acute 
inpatient care, in which case the beds and days would be included in 
those counts;
    (C) Beds in a unit or ward that is not occupied to provide a level 
of care that would be payable under the acute care hospital inpatient 
prospective payment system at any time during the 3 preceding months 
(the beds in the unit or ward are to be excluded from the determination 
of available bed days during the current month); and
    (D) Beds in a unit or ward that is otherwise occupied (to provide a 
level of care that would be payable under the acute care hospital 
inpatient prospective payment system) that could not be made available 
for inpatient occupancy within 24 hours for 30 consecutive days.
* * * * *
    (b) * * *
    (2) * * *
    (i) Determines the number of patient days that--
* * * * *
    (d) Payment adjustment factor. 
* * * * *
    (2) Payment adjustment factors. 
* * * * *
    (ii) If the hospital meets the criteria of paragraph (c)(1)(ii) of 
this section, the payment adjustment factor is equal to one of the 
following:
    (A) If the hospital is classified as a rural referral center--
    (1) For discharges occurring before April 1, 2001, the payment 
adjustment factor is 4 percent plus 60 percent of the difference 
between the hospital's disproportionate patient percentage and 30 
percent.
    (2) For discharges occurring on or after April 1, 2001, and before 
April 1, 2004, the following applies:
    (i) If the hospital's disproportionate patient percentage is less 
than 19.3 percent, the applicable payment adjustment factor is 2.5 
percent plus 65 percent of the difference between 15 percent and the 
hospital's disproportionate patient percentage.
    (ii) If the hospital's disproportionate patient percentage is 
greater than 19.3 percent and less than 30 percent, the applicable 
payment adjustment factor is 5.25 percent.
    (iii) If the hospital's disproportionate patient percentage is 
greater than or equal to 30 percent, the applicable payment adjustment 
factor is 5.25 percent plus 60 percent of the difference between 30 
percent and the hospital's disproportionate patient percentage.
    (3) For discharges occurring on or after April 1, 2004, the 
following applies:
    (i) If the hospital's disproportionate patient percentage is less 
than or equal to 20.2 percent, the applicable payment adjustment factor 
is 2.5 percent plus 65 percent of the difference between 15 percent and 
the hospital's disproportionate patient percentage.
    (ii) If the hospital's disproportionate patient percentage is 
greater than 20.2 percent, the applicable payment adjustment factor is 
5.88 percent plus 82.5 percent of the difference between 20.2 percent 
and the hospital's disproportionate patient percentage.
    (B) If the hospital is classified as a sole community hospital--
    (1) For discharges occurring before April 1, 2001, the payment 
adjustment factor is 10 percent.
    (2) For discharges occurring on or after April 1, 2001 and before 
April 1, 2004, the following applies:
    (i) If the hospital's disproportionate patient percentage is less 
than 19.3 percent, the applicable payment adjustment factor is 2.5 
percent plus 65 percent of the difference between 15 percent and the 
hospital's disproportionate patient percentage.
    (ii) If the hospital's disproportionate patient percentage is equal 
to or greater than 19.3 percent and less than 30 percent, the 
applicable payment adjustment factor is 5.25 percent.
    (iii) If the hospital's disproportionate patient percentage is 
equal to or greater than 30 percent, the applicable payment adjustment 
factor is 10 percent.
    (3) For discharges occurring on or after April 1, 2004, the 
following applies:
    (i) If the hospital's disproportionate patient percentage is less 
than or equal to 20.2 percent, the applicable payment adjustment factor 
is 2.5 percent plus 65 percent of the difference between 15 percent and 
the hospital's disproportionate patient percentage.
    (ii) If the hospital's disproportionate patient percentage is 
greater than 20.2 percent, the applicable payment adjustment factor is 
5.88 percent plus 82.5 percent of the difference between 20.2 percent 
and the hospital's disproportionate patient percentage.
    (iii) The maximum payment adjustment factor is 12 percent.
    (C) If the hospital is classified as both a rural referral center 
and a sole community hospital, the payment adjustment is--
    (1) For discharges occurring before April 1, 2001, the greater of--
    (i) 10 percent; or
    (ii) 4 percent plus 60 percent of the difference between the 
hospital's disproportionate patient percentage and 30 percent.
    (2) For discharges occurring on or after April 1, 2001 and before 
April 1, 2004, the greater of the adjustments determined under 
paragraphs (d)(2)(ii)(A) or (d)(2)(ii)(B) of this section.
    (3) For discharges occurring on or after April 1, 2004, the 
following applies:
    (i) If the hospital's disproportionate patient percentage is less 
than 20.2 percent, the applicable payment adjustment factor is 2.5 
percent plus 65 percent of the difference between 15 percent and the 
hospital's disproportionate patient percentage.
    (ii) If the hospital's disproportionate patient percentage is 
greater than 20.2 percent, the applicable payment adjustment factor is 
5.88 percent plus

[[Page 49247]]

82.5 percent of the difference between 20.2 percent and the hospital's 
disproportionate patient percentage.
    (D) If the hospital is classified as a rural hospital and is not 
classified as either a sole community hospital or a rural referral 
center, and has 100 or more beds--
    (1) For discharges occurring before April 1, 2001, the payment 
adjustment factor is 4 percent.
    (2) For discharges occurring on or after April 1, 2001 and before 
April 1, 2004, the following applies:
    (i) If the hospital's disproportionate patient percentage is less 
than 19.3 percent, the applicable payment adjustment factor is 2.5 
percent plus 65 percent of the difference between the hospital's 
disproportionate patient percentage and 15 percent.
    (ii) If the hospital's disproportionate patient percentage is equal 
to or greater than 19.3 percent, the applicable payment adjustment 
factor is 5.25 percent.
    (3) For discharges occurring on or after April 1, 2004, the 
following applies:
    (i) If the hospital's disproportionate patient percentage is less 
than or equal to 20.2 percent, the applicable payment adjustment factor 
is 2.5 percent plus 65 percent of the difference between 15 percent and 
the hospital's disproportionate patient percentage.
    (ii) If the hospital's disproportionate patient percentage is 
greater than 20.2 percent, the applicable payment adjustment factor is 
5.88 percent plus 82.5 percent of the difference between 20.2 percent 
and the hospital's disproportionate patient percentage.
    (iii) The maximum payment adjustment factor is 12 percent.
    (iii) If the hospital meets the criteria of paragraph (c)(1)(iii) 
of this section--
    (A) For discharges occurring before April 1, 2001, the payment 
adjustment factor is 5 percent.
    (B) For discharges occurring on or after April 1, 2001 and before 
April 1, 2004, the following applies:
    (1) If the hospital's disproportionate patient percentage is less 
than 19.3 percent, the applicable payment adjustment factor is 2.5 
percent plus 65 percent of the difference between the hospital's 
disproportionate patient percentage and 15 percent.
    (2) If the hospital's disproportionate patient percentage is equal 
to or greater than 19.3 percent, the applicable payment adjustment 
factor is 5.25 percent.
    (C) For discharges occurring on or after April 1, 2004, the 
following applies:
    (1) If the hospital's disproportionate patient percentage is less 
than or equal to 20.2 percent, the applicable payment adjustment factor 
is 2.5 percent plus 65 percent of the difference between 15 percent and 
the hospital's disproportionate patient percentage.
    (2) If the hospital's disproportionate patient percentage is 
greater than 20.2 percent, the applicable payment adjustment factor is 
5.88 percent plus 82.5 percent of the difference between 20.2 percent 
and the hospital's disproportionate patient percentage.
    (3) The maximum payment adjustment factor is 12 percent.
    (iv) If the hospital meets the criteria of paragraph (c)(1)(iv) of 
this section--
    (A) For discharges occurring before April 1, 2001, the payment 
adjustment factor is 4 percent.
    (B) For discharges occurring on or after April 1, 2001 and before 
April 1, 2004, the following applies:
    (1) If the hospital's disproportionate patient percentage is less 
than 19.3 percent, the applicable payment adjustment factor is 2.5 
percent plus 65 percent of the difference between the hospital's 
disproportionate patient percentage and 15 percent.
    (2) If the hospital's disproportionate patient percentage is equal 
to or greater than 19.3 percent, the applicable payment adjustment 
factor is 5.25 percent.
    (C) For discharges occurring on or after April 1, 2004, the 
following applies:
    (1) If the hospital's disproportionate patient percentage is less 
than or equal to 20.2 percent, the applicable payment adjustment factor 
is 2.5 percent plus 65 percent of the difference between 15 percent and 
the hospital's disproportionate patient percentage.
    (2) If the hospital's disproportionate patient percentage is 
greater than 20.2 percent, the applicable payment adjustment factor is 
5.88 percent plus 82.5 percent of the difference between 20.2 percent 
and the hospital's disproportionate patient percentage.
    (3) The maximum payment adjustment factor is 12 percent.
* * * * *

0
16. Section 412.108 is amended by revising paragraph (a)(1) 
introductory text to read as follows:


Sec.  412.108  Special treatment: Medicare-dependent, small rural 
hospitals.

    (a) Criteria for classification as a Medicare-dependent, small 
rural hospital.
    (1) General considerations. For cost reporting periods beginning on 
or after April 1, 1990 and ending before October 1, 1994, or beginning 
on or after October 1, 1997 and ending before October 1, 2006, a 
hospital is classified as a Medicare-dependent, small rural hospital if 
it is located in a rural area (as defined in subpart D of this part) 
and meets all of the following conditions:
* * * * *

0
17. Section 412.204 is amended by--
0
A. Revising the introductory text of paragraph (a).
0
B. Revising the title and introductory text of paragraph (b).
0
C. Adding new paragraphs (c) and (d).
    The revision and addition read as follows:


Sec.  412.204  Payment to hospitals located in Puerto Rico.

    (a) FY 1988 through FY 1997. For discharges occurring on or after 
October 1, 1987 and before October 1, 1997, payments for inpatient 
operating costs to hospitals located in Puerto Rico that are paid under 
the prospective payment system are equal to the sum of--
* * * * *
    (b) FY 1998 through March 31, 2004. For discharges occurring on or 
after October 1, 1997 and before April 1, 2004, payments for inpatient 
operating costs to hospitals located in Puerto Rico that are paid under 
the prospective payment system are equal to the sum of--
* * * * *
    (c) Period of April 1, 2004 through September 31, 2004. For 
discharges occurring on or after April 1, 2004 and before October 1, 
2004, payment for inpatient operating costs to hospitals located in 
Puerto Rico that are paid under the prospective payment system are 
equal to the sum of--
    (1) 37.5 percent of the Puerto Rico prospective payment rate for 
inpatient operating costs, as determined under Sec.  412.208 or Sec.  
412.210; and
    (2) 62.5 percent of the national prospective payment rate for 
inpatient operating costs, as determined under Sec.  412.212.
    (d) FY 2005 and thereafter. For discharges occurring on or after 
October 1, 2004, payments for inpatient operating costs to hospitals 
located in Puerto Rico that are paid under the prospective payment 
system are equal to the sum of--
    (1) 25 percent of the Puerto Rico prospective payment rate for 
inpatient operating costs, as determined under Sec.  412.208 or Sec.  
412.211; and
    (2) 75 percent of a national prospective payment rate for inpatient 
operating costs, as determined under Sec.  412.212.

0
18. Section 412.210 is amended by--
0
A. Revising the title of the section.
0
B. Revising paragraph (a)(1) to read as follows:

[[Page 49248]]

Sec.  412.210  Puerto Rico rates for Federal fiscal years 1989 through 
2003.

    (a) General rule. (1) CMS determines the Puerto Rico adjusted 
prospective payment rate for inpatient operating costs for each 
inpatient hospital discharge occurring in Federal fiscal years 1989 
through 2003 that involves inpatient hospital services of a hospital in 
Puerto Rico subject to the prospective payment system for which payment 
may be made under Medicare Part A.
* * * * *

0
19. New Sec.  412.211 is added to read as follows:


Sec.  412.211  Puerto Rico rates for Federal fiscal year 2004 and 
subsequent fiscal years.

    (a) General rule. CMS determines the Puerto Rico adjusted 
prospective payment rate for inpatient operating costs for each 
inpatient hospital discharge occurring in Federal fiscal year 2004 and 
subsequent fiscal years that involves inpatient hospital services of a 
hospital in Puerto Rico subject to the prospective payment system for 
which payment may be made under Medicare Part A.
    (b) Geographic classifications.
    (1) For purposes of this section, the following definitions apply:
    (i) The term urban area means a Metropolitan Statistical Area (MSA) 
as defined by the Executive Office of Management and Budget.
    (ii) The term rural area means any area outside of an urban area.
    (2) For discharges occurring on or after October 1, 2004, a 
hospital located in a rural county adjacent to one or more urban areas 
is deemed to be located in an urban area and receives the Federal 
payment amount for the urban area to which the greater number of 
workers in the county commute if the rural county would otherwise be 
considered part of an urban area, under the standards for designating 
MSAs if the commuting rates used in determining outlying counties were 
determined on the basis of the aggregate number of resident workers who 
commute to (and, if applicable under the standards, from) the central 
county or central counties of all adjacent MSAs. These EOMB standards 
are set forth in the notice of final revised standards for 
classification of MSAs published in the Federal Register on December 
27, 2000 (65 FR 82228), announced by EOMB on June 6, 2003, and 
available from CMS, 7500 Security Boulevard, Baltimore, Maryland 21244.
    (c) Computing the standardized amount. CMS computes a Puerto Rico 
standardized amount that is applicable to all hospitals located in all 
areas, increased by the applicable percentage change specified in Sec.  
412.64(d)(1).
    (d) Computing Puerto Rico Federal rates for inpatient operating 
costs for hospitals located in all areas. For each discharge classified 
within a DRG, CMS establishes for the fiscal year a Puerto Rico 
prospective payment rate for inpatient operating costs equal to the 
product of--
    (1) The average standardized amount for the fiscal year for 
hospitals located in all areas; and
    (2) The weighting factor determined under Sec.  412.60(b) for that 
DRG.
    (e) Adjusting for different area wage levels. CMS adjusts the 
proportion of the Puerto Rico rate for inpatient operating costs that 
are attributable to wages and labor-related costs for area differences 
in hospital wage levels by a factor (established by CMS based on survey 
data) reflecting the relative level of hospital wages and wage-related 
costs in the geographic area (that is, urban or rural area as 
determined under the provisions of paragraph (b) of this section) of 
the hospital compared to the Puerto Rico average level of hospital 
wages and wage-related costs. The adjustment specified in this 
paragraph (e) also takes into account the earnings and paid hours of 
employment by occupational category.
    (1) The wage index is updated annually.
    (2) CMS determines the proportion of the Puerto Rico rate that is 
attributable to wages and labor-related costs from time to time, 
employing a methodology that is described in the annual update of the 
prospective payment system for payment of inpatient hospital operating 
costs published in the Federal Register.
    (3) For discharges occurring on or after October 1, 2004, CMS 
employs 62 percent as the proportion of the rate that is adjusted for 
the relative level of hospital wages and wage-related costs, unless 
employing that percentage would result in lower payments for the 
hospital than employing the proportion determined under the methodology 
described in paragraph (e)(2) of this section.
    (f) Adjusting the wage index to account for commuting patterns of 
hospital workers.
    (1) General criteria. For discharges occurring on or after October 
1, 2004, CMS adjusts the hospital wage index for hospitals located in 
qualifying areas to recognize the commuting patterns of hospital 
employees. A qualifying area is an area that meets all of the following 
criteria:
    (i) Hospital employees in the area commute to work in an MSA (or 
MSAs) with a wage index (or wage indices) higher than the wage index of 
the area.
    (ii) At least 10 percent of the county's hospital employees commute 
to an MSA (or MSAs) with a higher wage index (or wage indices).
    (iii) The 3-year average hourly wage of the hospital(s) in the area 
equals or exceeds the 3-year average hourly wage of all hospitals in 
the MSA or rural area in which the county is located.
    (2) Amount of adjustment. A hospital located in an area that meets 
the criteria under paragraphs (f)(1)(i) through (f)(1)(iii) of this 
section will receive an increase in its wage index that is equal to a 
weighted average of the difference between the prereclassified wage 
index of the MSA (or MSAs) with the higher wage index (or wage indices) 
and the prereclasssified wage index of the qualifying area, weighted by 
the overall percentage of the hospital employees residing in the 
qualifying area who are employed in any MSA with a higher wage index.
    (3) Process for determining the adjustment.
    (i) CMS will use the most accurate data available, as determined by 
CMS, to determine the out-migration percentage for each area.
    (ii) CMS will include, in its annual proposed and final notices of 
updates to the hospital inpatient prospective payment system, a listing 
of qualifying areas and the hospitals that are eligible to receive the 
adjustment to their wage indexes for commuting hospital employees, and 
the wage index increase applicable to each qualifying area.
    (iii) Any wage index adjustment made under this paragraph (f) is 
effective for a period of 3 fiscal years, except that hospitals in a 
qualifying county may elect to waive the application of the wage index 
adjustment. A hospital may waive the application of the wage index 
adjustment by notifying CMS in writing within 45 days after the 
publication in the Federal Register of the annual notice of proposed 
rulemaking for the hospital inpatient prospective payment system.
    (iv) A hospital in a qualifying area that receives a wage index 
adjustment under this paragraph (f) is not eligible for 
reclassification under Subpart L of this part.

0
20. Section 412.212 is amended by revising paragraph (b) to read as 
follows:


Sec.  412.212  National rate.

* * * * *
    (b) Computing Puerto Rico standardized amounts. (1) For Federal 
fiscal years before FY 2004, CMS computes a discharge-weighted average 
of the--

[[Page 49249]]

    (i) National urban adjusted standardized amount determined under 
Sec.  412.63(j)(1); and
    (ii) National rural adjusted average standardized amount determined 
under Sec.  412.63(j)(2)(i).
    (2) For fiscal years 2004 and subsequent fiscal years, CMS computes 
a discharge-weighted average of the national adjusted standardized 
amount determined under Sec.  412.64(e).
* * * * *

0
21. Section 412.230 is amended by--
0
A. Revising paragraph (a)(1).
0
B. Revising paragraph (a)(4).
0
C. Removing paragraph (a)(5)(ii) and redesignating paragraphs 
(a)(5)(iii), (a)(5)(iv), and (a)(5)(v) as paragraphs (a)(5)(ii), 
(a)(5)(iii), and (a)(5)(iv), respectively.
0
D. Removing paragraph (d).
0
E. Removing paragraph (e)(2)(i)(C).
0
F. Redesignating paragraph (e) as paragraph (d).
0
G. In redesignated paragraph (d)(1), removing the cross-reference 
``paragraphs (e)(3) and (e)(4)'' and adding in its place ``paragraphs 
(d)(3) and (d)(4)''.
0
H. In redesignated paragraph (d)(2)(iii), removing the cross-reference 
``paragraph (e)(2)'' and adding in its place ``paragraph (d)(2)''.
0
I. Revising redesignated paragraphs (d)(3)(i), (d)(3)(ii), and adding 
(d)(3)(iii)(C).
0
J. In redesignated paragraph (d)(4), removing the cross-reference 
``paragraphs (e)(1)(i) and (e)(1)(iii)'' and adding in its place 
``paragraph (d)(1)(i) and (d)(1)(iii)''.
0
K. In redesignated paragraph (d)(4)(iii), removing the cross-reference 
``paragraph (e)'' and adding in its place ``paragraph (d)''.


Sec.  412.230  Criteria for an individual hospital seeking 
redesignation to another rural area or an urban area.

    (a) General. (1) Purposes. Except as specified in paragraph 
(a)(5)--
    (i) For fiscal years prior to fiscal year 2005, an individual 
hospital may be redesignated from a rural area to an urban area, from a 
rural area to another rural area, or from a rural area to another urban 
area for the purposes of using the other area's standardized amount for 
inpatient operating costs, the wage index value, or both.
    (ii) Effective for fiscal year 2005 and subsequent fiscal years, an 
individual hospital may be redesignated from a rural area to an urban 
area, from a rural area to another rural area, or from a rural area to 
another urban area for the purposes of using the other area's wage 
index value.
* * * * *
    (4) Application of criteria. In applying the numeric criteria 
contained in paragraphs (b)(1), (b)(2), (d)(1)(iii), (d)(1)(iv)(A), and 
(d)(1)(iv)(B) of this section, rounding of numbers to meet the mileage 
or qualifying percentage standards is not permitted.
* * * * *
    (d) Use of urban or other rural area's wage index.
* * * * *
    (3) Rural referral center exceptions.
    (i) If a hospital was ever a rural referral center, it does not 
have to demonstrate that it meets the criterion set forth in paragraph 
(d)(1)(iii) of this section concerning its average hourly wage.
    (ii) If a hospital was ever a rural referral center, it is required 
to meet only the criterion that applies to rural hospitals under 
paragraph (d)(1)(iv) of this section, whether or not it is actually 
located in an urban or rural area.
    (iii) * * *
    (C) With respect to redesignations for Federal fiscal year 2006 and 
later years, the hospital's average hourly wage is, in the case of a 
hospital located in a rural area, at least 106 percent, and, in the 
case of a hospital located in an urban area, 108 percent of the average 
hourly wage of all other hospitals in the area in which the hospital is 
located.
* * * * *

0
22. Section 412.232 is amended by--
0
A. Revising paragraph (a)(1).
0
B. Revising paragraph (a)(4).
0
C. Revising paragraph (b).


Sec.  412.232  Criteria for all hospitals in a rural county seeking 
urban redesignation.

    (a) Criteria. * * *
    (1) The county in which the hospitals are located--
    (i) For fiscal years prior to fiscal year 2005, must be adjacent to 
the MSA or NECMA to which they seek redesignation.
    (ii) For fiscal years beginning with fiscal years 2005, must be 
adjacent to the MSA to which they seek redesignation.
* * * * *
    (4) The hospital may be redesignated only if one of the following 
conditions is met:
    (i) The prereclassified average hourly wage for the area to which 
they seek redesignation is higher than the prereclassified average 
hourly wage for the area in which they are currently located.
    (ii) For fiscal years prior to fiscal year 2005, the standardized 
amount for the area to which they seek redesignation is higher than the 
standardized amount for the area in which they are located.
    (b) Metropolitan character.
    (1) For fiscal years prior to FY 2005, the group of hospitals must 
demonstrate that the county in which the hospitals are located meets 
the standards for redesignation to an MSA or an NECMA as an outlying 
county that were published in the Federal Register on March 30, 1990 
(55 FR 12154) using Bureau of the Census data or Bureau of Census 
estimates made after 1990.
    (2) For fiscal years beginning with FY 2005, the group of hospitals 
must demonstrate that the county in which the hospitals are located 
meets the standards for redesignation to an MSA as an outlying county 
that were published in the Federal Register on December 27, 2000 (65 FR 
82228) using Census Bureau data or Census Bureau estimates made after 
2000.
* * * * *

0
23. Section 412.234 is amended by--
0
A. Revising paragraph (a)(3).
0
B. Revising paragraph (a)(4)
0
C. Removing paragraph (c).
0
D. Redesignating paragraph (d) as paragraph (c) and revising the 
redesignated paragraph (c).
    The revisions read as follows.


Sec.  412.234  Criteria for all hospitals in an urban county seeking 
redesignation to another urban area.

    (a) General criteria. * * *
    (3) (i) For Federal fiscal years before fiscal year 2006, the 
counties in which the hospitals are located must be part of the 
Consolidated Metropolitan Statistical Area (CMSA) that includes the 
urban area to which they seek redesignation.
    (ii) For fiscal years 2006 and thereafter, hospitals located in 
counties that are in the same Consolidated Statistical Area (CSA) 
(under the MSA definitions announced by the OMB on June 6, 2003) as the 
urban area to which they seek redesignation; or in the same 
Consolidated Metropolitan Statistical Area (CMSA) (under the standards 
published by the OMB on March 30, 1990) as the urban area to which they 
seek redesignation qualify as meeting the proximity requirement for 
reclassification to the urban area to which they seek redesignation.
    (4) The hospital may be redesignated only if one of the following 
conditions is met:
    (i) The prereclassified average hourly wage for the area to which 
they seek redesignation is higher than the prereclassified average 
hourly wage for the area in which they are currently located.
    (ii) For fiscal years prior to fiscal year 2005, the standardized 
amount for the area to which they seek redesignation is

[[Page 49250]]

higher than the standardized amount for the area in which they are 
located.
* * * * *
    (c) Appropriate wage data. The hospitals must submit appropriate 
wage data as provided for in Sec.  412.230(d)(2).


Sec.  412.236  [Removed]

0
24. Section 412.236 is removed.


Sec.  412.252  [Amended]

0
25. In Sec.  412.252, paragraph (b), the phrase ``or in a NECMA'' is 
removed.

0
26. Section 412.274 is amended by revising paragraph (b)(1) to read as 
follows:


Sec.  412.274  Scope and effect of an MGCRB decision.

* * * * *
    (b) Effective date and term of the decision.
    (1) For reclassifications prior to fiscal year 2005, a standardized 
amount classification change is effective for 1 year beginning with 
discharges occurring on the first day (October 1) of the second Federal 
fiscal year following the Federal fiscal year in which the complete 
application is filed and ending effective at the end of that Federal 
fiscal year (the end of the next September 30).
* * * * *

0
27. Section 412.312 is amended by --
0
A. Revising paragraph (b)(2)(ii).
0
B. Revising paragraph (e).
    The revisions read as follows.


Sec.  412.312  Payment based on the Federal rate.

    (b) Payment adjustments. * * *
    (2) Geographic adjustment factors. * * *
    (ii) Large urban add-on. An additional adjustment is made for 
hospitals located in a large urban area to reflect the higher costs 
incurred by hospitals located in those areas. For purposes of the 
payment adjustment under this paragraph, the definition of large urban 
area set forth at Sec.  412.63(c)(6) continues to be in effect for 
discharges occurring on or after September 30, 2004.
* * * * *
    (e) Payment for extraordinary circumstances. For cost reporting 
periods beginning on or after October 1, 2001--
    (1) Payment for extraordinary circumstances is made as provided for 
in Sec.  412.348(f).
    (2) Although no longer independently in effect, the minimum payment 
levels established under Sec.  412.348(c) continue to be used in the 
calculation of exception payments for extraordinary circumstances, 
according to the formula in Sec.  412.348(f).
    (3) Although no longer independently in effect, the offsetting 
amounts established under Sec.  412.348(c) continue to be used in the 
calculation of exception payments for extraordinary circumstances. 
However, for cost reporting periods beginning during FY 2005 and 
subsequent fiscal years, the offsetting amounts in Sec.  412.348(c) are 
determined based on the lesser of--
    (i) The preceding 10-year period; or
    (ii) The period of time under which the hospital is subject to the 
prospective payment system for capital-related costs.
* * * * *

0
28. Section 412.316 is amended by revising paragraph (b) to read as 
follows:


Sec.  412.316  Geographic adjustment factors.

* * * * *
    (b) Large urban location. CMS provides an additional payment to a 
hospital located in a large urban area equal to 3.0 percent of what 
would otherwise be payable to the hospital based on the Federal rate.
    (1) For discharges occurring on or before September 30, 2004, the 
payment adjustment under this section is based on a hospital's location 
for the purpose of receiving payment under Sec.  412.63(a). The term 
``large urban area'' is defined under Sec.  412.63(c)(6).
    (2) For discharges occurring on or after October 1, 2004, the 
definition of large urban area under Sec.  412.63(c)(6) continues to be 
in effect for purposes of the payment adjustment under this section, 
based on the geographic classification under Sec.  412.64.
* * * * *

0
29. Section 412.320 is amended by revising paragraph (a)(1) to read as 
follows:


Sec.  412.320  Disproportionate share adjustment factor.

    (a) Criteria for classification.
* * * * *
    (1) The hospital is located in an urban area, has 100 or more beds 
as determined in accordance with Sec.  412.105(b), and serves low-
income patients as determined under Sec.  412.106(b).
    (i) For discharges occurring on or before September 30, 2004, the 
payment adjustment under this section is based on a hospital's 
location, for the purpose of receiving payment, under Sec.  412.63(a).
    (ii) For discharges occurring on or after October 1, 2004, the 
payment adjustment under this section is based on the geographic 
classifications specified under Sec.  412.64.
* * * * *

0
30. Section 412.374 is amended by--
0
A. Revising paragraph (a).
0
B. Redesignating paragraphs (b) and (c) as paragraphs (c) and (d), 
respectively.
0
C. Adding a new paragraph (b).
    The revisions and addition read as follows:


Sec.  412.374  Payments to hospitals located in Puerto Rico.

    (a) FY 1998 through FY 2004. Payments for capital-related costs to 
hospitals located in Puerto Rico that are paid under the prospective 
payment system are equal to the sum of the following:
    (1) 50 percent of the Puerto Rico capital rate based on data from 
Puerto Rico hospitals only, which is determined in accordance with 
procedures for developing the Federal rate; and
    (2) 50 percent of the Federal rate, as determined under Sec.  
412.308.
    (b) FY 2005 and FYs thereafter. For discharges occurring on or 
after October 1, 2004, payments for capital-related costs to hospitals 
located in Puerto Rico that are paid under the prospective payment 
system are equal to the sum of the following:
    (1) 25 percent of the Puerto Rico capital rate based on data from 
Puerto Rico hospitals only, which is determined in accordance with 
procedures for developing the Federal rate; and
    (2) 75 percent of the Federal rate, as determined under Sec.  
412.308.
* * * * *

0
31. Section 412.521 is amended by adding a new paragraph (e) to read as 
follows:


Sec.  412.521  Basis of payment.

* * * * *
    (e) Special payment provisions for patients in acute care hospitals 
that change classification status to LTCH status during a patient stay. 
(1) If a patient is admitted to an acute care hospital and then the 
acute care hospital meets the criteria at Sec.  412.23(e) to be paid as 
a LTCH during the course of the patient's hospitalization, Medicare 
considers all the days of the patient stay in the facility (days prior 
to and after the designation of LTCH status) to be a single episode of 
LTCH care. Payment for the entire patient stay (days prior to and after 
the designation of LTCH status) will include the day and cost data for 
that patient at both the acute care hospital and the LTCH in 
determining the payment to the LTCH under this subpart. The 
requirements of this paragraph (e)(1) apply only to a patient stay in 
which a patient is in an acute care hospital and that hospital is

[[Page 49251]]

designated as a LTCH on or after October 1, 2004.
    (2) The days of the patient's stay prior to and after the 
hospital's designation as a LTCH as specified in paragraph (e)(1) of 
this section are included for purposes of determining the beneficiary's 
length of stay.

0
32. Section 412.534 is added to read as follows:


Sec.  412.534.  Special payment provisions for long-term care hospitals 
within hospitals and satellites of long-term care hospitals.

    (a) Scope. The policies set forth in this section apply to 
discharges occurring in cost reporting periods beginning on or after 
October 1, 2004 from long-term care hospitals as described in Sec.  
412.23(e)(2)(i) meeting the criteria in Sec.  412.22(e)(2), or 
satellite facilities of long-term care hospitals that meet the criteria 
in Sec.  412.22(h).
    (b) Patients admitted from hospitals not located in the same 
building or on the same campus as the long-term care hospital. Payments 
to the long-term care hospital for patients admitted to the long-term 
hospital or to a satellite of the long-term care hospital from another 
hospital that is not the co-located hospital are made under the rules 
in this subpart with no adjustment under this section.
    (c) Patients admitted from the hospital located in the same 
building or on the same campus as the long-term care hospital or 
satellite facility. Payments to the long-term care hospital for 
patients admitted to it or to its satellite facility from the co-
located hospital will be made under either paragraph (c)(1) or 
paragraph (c)(2) of this section.
    (1) For any cost reporting period beginning on or after October 1, 
2004 in which the long-term care hospital or its satellite facility has 
a Medicare inpatient population of whom no more than 25 percent were 
referred to the hospital or its satellite facility from the co-located 
hospital, payments are made under the rules at Sec.  412.500 through 
Sec.  412.541 in this subpart with no adjustment under this section.
    (2) Except as provided in paragraph (d), (e), or (f) of this 
section, for any cost reporting period beginning on or after October 1, 
2004 in which the long-term care hospital or satellite facility has a 
Medicare inpatient population of whom more than 25 percent were 
referred to the hospital or satellite facility from the co-located 
hospital, payments for the patients who are admitted from the co-
located hospital and who cause the long-term care hospital or satellite 
facility to exceed the 25 percent threshold for discharges of patients 
from the co-located hospital are the lesser of the amount otherwise 
payable under this subpart or the amount payable under this subpart 
that is equivalent to the amount that would be otherwise determined 
under the rules at Subpart A, Sec.  412.1(a). Payments for the 
remainder of the long-term care hospital's or satellite facility's 
patients are made under the rules in this subpart at Sec.  412.500 
through Sec.  412.541 with no adjustment under this section.
    (3) In determining the percentage of patients admitted to the long-
term care or satellite facility from the co-located hospital under 
paragraphs (c)(1) and (c)(2) of this section, patients on whose behalf 
an outlier payment was made to the co-located hospital are not counted 
towards the 25 percent threshold.
    (d) Special treatment of rural hospitals. (1) In the case of a 
long-term care hospital or satellite facility that is located in a 
rural area as defined in Sec.  412.62(f) and is co-located with another 
hospital for any cost reporting period beginning on or after October 1, 
2004 in which the long-term care hospital or satellite facility has a 
Medicare inpatient population of whom more than 50 percent were 
referred to the long-term care hospital or satellite facility from the 
co-located hospital, payments for the patients who are admitted from 
the co-located hospital and who cause the long-term care hospital or 
satellite facility to exceed the 50 percent threshold for discharges of 
patients from the co-located hospital are the lesser of the amount 
otherwise payable under this subpart or the amount payable under this 
subpart that is equivalent to the amount that would otherwise be 
payable under Sec.  412.1(a). Payments for the remainder of the long-
term care hospital's or satellite facility's patients are made under 
the rules in this subpart at Sec.  412.500 through Sec.  412.541 with 
no adjustment under this section.
    (2) In determining the percentage of patients admitted from the co-
located hospital under paragraph (d)(1) of this section, patients on 
whose behalf outlier payment was made at the co-located hospital are 
not counted toward the 50 percent threshold.
    (e) Special treatment of urban single or MSA dominant hospitals. 
(1) In the case of a long-term care hospital or satellite facility that 
is co-located with the only other hospital in the MSA or with a MSA-
dominant hospital as defined in paragraph (e)(4) of this section, for 
any cost reporting period beginning on or after October 1, 2004 in 
which the long-term care hospital or satellite facility has a Medicare 
inpatient population of whom more than the percentage calculated under 
paragraph (e)(2) of this section were referred to the hospital from the 
co-located hospital, payments for the patients who are admitted from 
the co-located hospital and who cause the long-term care hospital to 
exceed the applicable threshold for discharges of patients from the co-
located hospital are the lesser of the amount otherwise payable under 
this subpart or the amount under this subpart that is equivalent to the 
amount that would otherwise be determined under Subpart A, Sec.  
412.1(a). Payments for the remainder of the long-term care hospital's 
or satellite facility's patients are made under the rules in this 
subpart with no adjustment under this section.
    (2) For purposes of paragraph (e)(1) of this section, the 
percentage used is the percentage of total Medicare discharges in the 
Metropolitan Statistical Area in which the hospital is located that are 
from the co-located hospital for the cost reporting period for which 
the adjustment was made, but in no case is less than 25 percent or more 
than 50 percent.
    (3) In determining the percentage of patients admitted from the co-
located hospital under paragraph (e)(1) of this section, patients on 
whose behalf outlier payment was made at the co-located hospital are 
not counted toward the applicable threshold.
    (4) For purposes of this paragraph, an ``MSA-dominant hospital'' is 
a hospital that has discharged more than 25 percent of the total 
hospital Medicare discharges in the MSA in which the hospital is 
located.
    (f) Transition period for long-term care hospitals and satellite 
facilities paid under this subpart. In the case of a long-term care 
hospital or a satellite facility that is paid under the provisions of 
this Subpart O of Part 412 on October 1, 2004 or of a hospital that is 
paid under the provisions of this Subpart O on October 1, 2005 and 
whose qualifying period under Sec.  412.23(e) began on or before 
October 1, 2004, the amount paid is calculated as specified below:
    (1) For each discharge during the first cost reporting period 
beginning on or after October 1, 2004, and before October 1, 2005, the 
amount paid is the amount payable under this subpart, with no 
adjustment under this Sec.  412.534.
    (2) For each discharge during the cost reporting period beginning 
on or after October 1, 2005, and before October 1, 2006, the percentage 
that may be admitted from the host with no payment adjustment may not 
exceed the lesser of the percentage of patients admitted from

[[Page 49252]]

the host during fiscal year 2004 or 75 percent.
    (3) For each discharge during the cost reporting period beginning 
on or after October 1, 2006, and before October 1, 2007, the percentage 
that may be admitted from the host with no payment adjustment may not 
exceed the lesser of the percentage of patients admitted from the host 
during fiscal year 2004 or 50 percent.
    (4) For each discharge during cost reporting periods beginning on 
or after October 1, 2007, the percentage that may be admitted from the 
host with no payment adjustment may not exceed 25 percent or the 
applicable percentage determined under paragraph (d) or (e) of this 
section.

0
C. Part 413 is amended as follows:

PART 413--PRINCIPLES OF REASONABLE COST REIMBURSEMENT; PAYMENT FOR 
END-STAGE RENAL DISEASE SERVICES; OPTIONAL PROSPECTIVELY DETERMINED 
PAYMENT RATES FOR SKILLED NURSING FACILITIES

0
1. The authority citation for part 413 is revised to read as follows:

    Authority: Secs. 1102, 1812(d), 1814(b), 1815, 1833(a), (i), and 
(n), 1871, 1881, 1883, and 1886 of the Social Security Act (42 
U.S.C. 1302, 1395d(d), 1395f(b), 1395g, 1395l(a), (i), and (n), 
1395hh, 1395rr, 1395tt, and 1395ww).


0
2. Section 413.40 is amended by--
0
A. Republishing the introductory text of paragraphs (c)(4), (c)(4)(iii) 
and (c)(4)(iii)(A), and revising paragraphs (c)(4)(iii)(A)(1) and 
(c)(4)(iii)(A)(2).
0
B. Republishing the introductory text of paragraph (c)(4)(iii)(B) and 
revising paragraph (c)(4)(iii)(B)(4)(i).
0
C. Revising the introductory text of paragraphs (d)(4)(i) and 
(d)(4)(ii).
    The revisions read as follows:


Sec.  413.40  Ceiling on the rate of increase in hospital inpatient 
costs.

* * * * *
    (c) Costs subject to the ceiling.
* * * * *
    (4) Target amounts. The intermediary will establish a target amount 
for each hospital. The target amount for a cost reporting period is 
determined as follows:
* * * * *
    (iii) In the case of a psychiatric hospital or unit, rehabilitation 
hospital or unit, or long-term care hospital, the target amount is the 
lower of the amounts specified in paragraph (c)(4)(iii)(A) or 
(c)(4)(iii)(B) of this section.
    (A) The hospital-specific target amount.
    (1) In the case of all hospitals and units, except long-term care 
hospitals for cost reporting periods beginning during FY 2001, the 
hospital-specific target amount is the net allowable costs in a base 
period increased by the applicable update factors .
    (2) In the case of long-term care hospitals, for cost reporting 
periods beginning during FY 2001, the hospital-specific target amount 
is the net allowable costs in a base period increased by the applicable 
update factors multiplied by 1.25.
    (B) One of the following for the applicable cost reporting period--
* * * * *
    (4) For cost reporting periods beginning during fiscal years 2001 
and 2002--
    (i) The amounts determined under paragraph (c)(4)(iii)(B)(3)(i) of 
this section are: increased by the market basket percentage up through 
the subject period; or in the case of a long-term care hospital for 
cost reporting periods beginning during FY 2001, the amounts determined 
under paragraph (c)(4)(iii)(B)(3)(i) of this section, increased by the 
market basket percentage up through the subject period and further 
increased by 2 percent.
* * * * *
    (d) Application of the target amount in determining the amount of 
payment.
* * * * *
    (4) Continuous improvement bonus payments. (i) For cost reporting 
periods beginning on or after October 1, 1997, eligible hospitals (as 
defined in paragraph (d)(5) of this section) receive payments in 
addition to those in paragraph (d)(2) of this section, as applicable. 
These payments are equal to the lesser of--
* * * * *
    (ii) For cost reporting periods beginning on or after October 1, 
2000, and before September 30, 2001, eligible psychiatric hospitals and 
units and long-term care hospitals (as defined in paragraph (d)(5) of 
this section) receive payments in addition to those in paragraph (d)(2) 
of this section, as applicable. These payments are equal to the lesser 
of--
* * * * *

0
3. Section 413.64 is amended by--
0
A. Revising the introductory text of paragraph (h)(2) and adding a new 
paragraph (h)(2)(vi).
0
B. Removing paragraph (h)(3)(iv).
0
C. Removing and reserving paragraph (h)(4).
    The additions and revisions read as follows:


Sec.  413.64  Payments to providers: Specific rules.

* * * * *
    (h) Periodic interim payment method of reimbursement.
* * * * *
    (2) Covered services furnished on or after July 1, 1987. Effective 
with claims received on or after July l, 1987, or as otherwise 
specified, the periodic interim payment (PIP) method is available for 
the following:
* * * * *
    (vi) Effective for payments made on or after July 1, 2004, 
inpatient CAH services furnished by a CAH as specified in Sec.  413.70. 
Payment on a PIP basis is described in Sec.  413.70(d).
* * * * *
    (4) [Reserved]
* * * * *

0
4. Section 413.70 is amended by--
0
A. Revising the heading of paragraph (a) and paragraph (a)(1).
0
B. Adding a new paragraph (a)(4).
0
C. Revising paragraph (b)(2)(i).
0
D. Revising paragraph (b)(2)(iii).
0
E. Revising the heading of paragraph (b)(3) and the contents of 
paragraphs (b)(3)(i) and (b)(3)(ii).
0
F. Revising paragraph (b)(4).
0
G. Adding a new paragraph (d).
0
H. Adding a new paragraph (e).
    The revisions and additions read as follows:


Sec.  413.70  Payment for services of a CAH.

    (a) Payment for inpatient services furnished by a CAH (other than 
services of distinct part units). (1) Effective for cost reporting 
periods beginning on or after January 1, 2004, payment for inpatient 
services of a CAH, other than services of a distinct part unit of the 
CAH, is 101 percent of the reasonable costs of the CAH in providing CAH 
services to its inpatients, as determined in accordance with section 
1861(v)(1)(A) of the Act and the applicable principles of cost 
reimbursement in this part and in Part 415 of this chapter, except that 
the following payment principles are excluded when determining payment 
for CAH inpatient services:
    (i) Lesser of cost or charges;
    (ii) Ceilings on hospital operating costs;
    (iii) Reasonable compensation equivalent (RCE) limits for physician 
services to providers; and
    (iv) The payment window provisions for preadmission services, 
specified in Sec.  412.2(c)(5) of this subchapter and Sec.  
413.40(c)(2).
* * * * *
    (4) Payment for inpatient services of distinct part psychiatric or

[[Page 49253]]

rehabilitation units is described in paragraph (e) of this section.
    (b) Payment for outpatient services furnished by CAH.
* * * * *
    (2) Reasonable costs for facility services. (i) Effective for cost 
reporting periods beginning on or after January 1, 2004, payment for 
outpatient services of a CAH is 101 percent of the reasonable costs of 
the CAH in providing CAH services to its outpatients, as determined in 
accordance with section 1861(v)(1)(A) of the Act and the applicable 
principles of cost reimbursement in this part and in Part 415 of this 
chapter, except that the following payment principles are excluded when 
determining payment for CAH outpatient services:
    (A) Lesser of cost or charges; and
    (B) RCE limits.
    (iii) Payment for outpatient clinical diagnostic laboratory tests 
is not subject to the Medicare Part B deductible and coinsurance 
amounts. Payment to a CAH for clinical diagnostic laboratory tests will 
be made at 101 percent of reasonable cost under this section only if 
the individuals are outpatients of the CAH, as defined in Sec.  410.2 
of this chapter, and are physically present in the CAH, at the time the 
specimens are collected. Clinical diagnostic laboratory tests performed 
for persons who are not physically present when the specimens are 
collected will be made in accordance with the provisions of sections 
1833(a)(1)(D) and 1833(a)(2)(D) of the Social Security Act.
* * * * *
    (3) Election to be paid 101 percent of reasonable costs for 
facility services plus fee schedule for professional services.
    (i) A CAH may elect to be paid for outpatient services in any cost 
reporting period beginning on or after July 1, 2004 under the method 
described in paragraphs (b)(3)(ii) and (b)(3)(iii) of this section.
    (A) The election must be made in writing, made on an annual basis, 
and delivered to the fiscal intermediary servicing the CAH at least 30 
days before the start of the cost reporting period for which the 
election is made.
    (B) An election of this payment method, once made for a cost 
reporting period, remains in effect for all of that period and, 
effective for cost reporting periods beginning on or after July 1, 
2004, applies to all services furnished to outpatients during that 
period by a physician or other practitioner who has reassigned his or 
her rights to bill for those services to the CAH in accordance with 42 
CFR part 424, Subpart F of this chapter. If a physician or other 
practitioner does not reassign his or her billing rights to the CAH in 
accordance with 42 CFR part 424, payment for the physician's or 
practitioner's services to CAH outpatients will be made on a fee 
schedule or other applicable basis as specified in Subpart B of part 
414 of this subchapter.
    (C) In the case of a CAH that made an election under this section 
before November 1, 2003, for a cost reporting period beginning before 
December 1, 2003, the rules in paragraph (b)(3)(i)(B) of this section 
are applicable to cost reporting periods beginning on or after July 1, 
2001.
    (D) An election made under paragraph (b)(3)(i)(B) or paragraph 
(b)(3)(i)(C) of this section is effective only for a period for which 
it was made and does not apply to an election that was withdrawn or 
revoked prior to the start of the cost reporting period for which it 
was made.
    (ii) If the CAH elects payment under this method, payment to the 
CAH for each outpatient visit will be the sum of the following:
    (A) For facility services not including any services for which 
payment may be made under paragraph (b)(3)(ii)(B) of this section, 101 
percent of the reasonable costs of the services as determined under 
paragraph (b)(2)(i) of this section; and
    (B) For professional services that are furnished by a physician or 
other practitioner who has reassigned his or her rights to bill for 
those services to the CAH in accordance with Part 424, Subpart F of 
this chapter, and that would otherwise be payable to the physician or 
other practitioner if the rights to bill for them had not been 
reassigned, 115 percent of the amounts that otherwise would be paid for 
the service if the CAH had not elected payment under this method.
* * * * *
    (4) Costs of certain emergency room on-call providers. (i) 
Effective for cost reporting periods beginning on or after October 1, 
2001, the reasonable costs of outpatient CAH services under paragraph 
(b) of this section may include amounts for reasonable compensation and 
related costs for an emergency room physician who is on call but who is 
not present on the premises of the CAH involved, is not otherwise 
furnishing physicians' services, and is not on call at any other 
provider or facility. Effective for costs incurred for services 
furnished on or after January 1, 2005, the payment amount of 101 
percent of the reasonable costs of outpatient CAH services may also 
include amounts for reasonable compensation and related costs for the 
following emergency room providers who are on call but who are not 
present on the premises of the CAH involved, are not otherwise 
furnishing physicians' services, and are not on call at any other 
provider or facility: physician assistants, nurse practitioners, and 
clinical nurse specialists.
    (ii) For purposes of this paragraph (b)(4)--
    (A) ``Amounts for reasonable compensation and related costs'' means 
all allowable costs of compensating emergency room physicians, 
physician assistants, nurse practitioners, and clinical nurse 
specialists who are on call to the extent that the costs are found to 
be reasonable under the rules specified in paragraph (b)(2) of this 
section and the applicable sections of Part 413. Costs of compensating 
these specified medical emergency room staff are allowable only if the 
costs are incurred under written contracts that require the physician, 
physician assistant, nurse practitioner, or clinical nurse specialist 
to come to the CAH when the physician's or other practitioner's 
presence is medically required.
    (B) Effective for costs incurred on or after January 1, 2005, an 
``emergency room physician, physician assistant, nurse practitioner, or 
clinical nurse specialist who is on call'' means a doctor of medicine 
or osteopathy, a physician assistant, a nurse practitioner, or a 
clinical nurse specialist, with training or experience in emergency 
care who is immediately available by telephone or radio contact, and is 
available onsite within the timeframes specified in Sec.  485.618(d) of 
this chapter.
* * * * *
    (d) Periodic interim payments. Subject to the provisions of Sec.  
413.64(h), a CAH receiving payments under this section may elect to 
receive periodic interim payments (PIP) for Part A inpatient CAH 
services, effective for payments made on or after July l, 2004. Payment 
is made biweekly under the PIP method unless the CAH requests a longer 
fixed interval (not to exceed one month) between payments. The biweekly 
interim payment amount is based on the total estimated Medicare payment 
(after estimated beneficiary deductibles and coinsurance) for the cost 
reporting period. Each payment is made 2 weeks after the end of a 
biweekly period of service, as described in Sec.  413.64(h)(6). These 
PIP provisions are further described in Sec.  413.64(h)(6). Under 
certain circumstances that are described in Sec.  413.64(g), a CAH that 
is not receiving PIP may request an accelerated payment.

[[Page 49254]]

    (e) Payment for services of distinct part psychiatric and 
rehabilitation units of CAHs. Payment for inpatient services of 
distinct part psychiatric units of CAHs is made in accordance with 
regulations governing IPPS-excluded psychiatric units of hospitals at 
Sec.  413.40. Payment for inpatient services of distinct part 
rehabilitation units of CAHs is made in accordance with regulations 
governing the IRF PPS at Subpart P (Sec. Sec.  412.600 through 412.632) 
of Part 412 of this subchapter.


Sec.  413.80  [Redesignated as Sec.  413.89]

0
5. Section 413.80 is redesignated as Sec.  413.89.


Sec.  413.85  [Amended]

0
6. In Sec.  413.85--
0
A. Under paragraph (b)(2), the cross-reference ``Sec.  413.86'' is 
removed and the cross-reference ``Sec. Sec.  413.75 through 413.83'' is 
added in its place.
0
B. Under paragraph (c)(3), under the definition ``Redistribution of 
costs,'' the cross-reference ``Sec.  413.86'' is removed and ``Sec.  
413.75 through 413.83'' is added in its place.


Sec.  413.86  [Removed] and Subpart F [Amended]

0
7. Section 413.86 is removed and Sec. Sec.  413.75 through 413.83 are 
added under Subpart F to read as follows:
Subpart F--Specific Categories of Costs
Sec.
413.75 Direct GME payments: General requirements.
413.76 Direct GME payments: Calculation of payments for GME costs.
413.77 Direct GME payments: Determination of per resident amounts.
413.78 Direct GME payments: Determination of the total number of FTE 
residents.
413.79 Direct GME payments: Determination of the weighted number of 
FTE residents.
413.80 Direct GME payments: Determination of weighting factors for 
foreign medical graduates.
413.81 Direct GME payments: Application of community support and 
redistribution of costs in determining FTE resident counts.
413.82 Direct GME payments: Special rules for States that formerly 
had a waiver from Medicare reimbursement principles.
413.83 Direct GME payments: Adjustment of a hospital's target amount 
or prospective payment hospital-specific rate.

Subpart F--Specific Categories of Costs


Sec.  413.75  Direct GME payments: General requirements.

    (a) Statutory basis and scope-- (1) Basis. This section and 
Sec. Sec.  413.76 through 413.83 implement section 1886(h) of the Act 
by establishing the methodology for Medicare payment of the cost of 
direct graduate medical educational activities.
    (2) Scope. This section and Sec. Sec.  413.76 through 413.83 apply 
to Medicare payments to hospitals and hospital-based providers for the 
costs of approved residency programs in medicine, osteopathy, 
dentistry, and podiatry for cost reporting periods beginning on or 
after July 1, 1985.
    (b) Definitions. For purposes of this section and Sec. Sec.  413.76 
through 413.83, the following definitions apply:
    ``All or substantially all of the costs for the training program in 
the nonhospital setting'' means the residents' salaries and fringe 
benefits (including travel and lodging where applicable) and the 
portion of the cost of teaching physicians' salaries and fringe 
benefits attributable to direct graduate medical education (GME).
    Approved geriatric program means a fellowship program of one or 
more years in length that is approved by one of the national 
organizations listed in Sec.  415.152 of this chapter under that 
respective organization's criteria for geriatric fellowship programs.
    Approved medical residency program means a program that meets one 
of the following criteria:
    (1) Is approved by one of the national organizations listed in 
Sec.  415.152 of this chapter.
    (2) May count towards certification of the participant in a 
specialty or subspecialty listed in the current edition of either of 
the following publications:
    (i) The Directory of Graduate Medical Education Programs published 
by the American Medical Association, and available from American 
Medical Association, Department of Directories and Publications, 515 
North State Street, Chicago, Illinois 60610; or
    (ii) The Annual Report and Reference Handbook published by the 
American Board of Medical Specialties, and available from American 
Board of Medical Specialties, One Rotary Center, Suite 805, Evanston, 
Illinois 60201.
    (3) Is approved by the Accreditation Council for Graduate Medical 
Education (ACGME) as a fellowship program in geriatric medicine.
    (4) Is a program that would be accredited except for the 
accrediting agency's reliance upon an accreditation standard that 
requires an entity to perform an induced abortion or require, provide, 
or refer for training in the performance of induced abortions, or make 
arrangements for such training, regardless of whether the standard 
provides exceptions or exemptions.
    Base period means a cost reporting period that began on or after 
October 1, 1983 but before October 1, 1984.
    Community support means funding that is provided by the community 
and generally includes all non-Medicare sources of funding (other than 
payments made for furnishing services to individual patients), 
including State and local government appropriations. Community support 
does not include grants, gifts, and endowments of the kind that are not 
to be offset in accordance with section 1134 of the Act.
    CPI-U stands for the Consumer Price Index for All Urban Consumers 
as compiled by the Bureau of Labor Statistics.
    Foreign medical graduate means a resident who is not a graduate of 
a medical, osteopathy, dental, or podiatry school, respectively, 
accredited or approved as meeting the standards necessary for 
accreditation by one of the following organizations:
    (1) The Liaison Committee on Medical Education of the American 
Medical Association.
    (2) The American Osteopathic Association.
    (3) The Commission on Dental Accreditation.
    (4) The Council on Podiatric Medical Education.
    FMGEMS stands for the Foreign Medical Graduate Examination in the 
Medical Sciences (Part I and Part II).
    FTE stands for full-time equivalent.
    GME stands for graduate medical education.
    Medicare GME affiliated group means--
    (1) Two or more hospitals that are located in the same urban or 
rural area (as those terms are defined in Sec.  412.62(f) of this 
subchapter) or in a contiguous area and meet the rotation requirements 
in Sec.  413.79(g)(2).
    (2) Two or more hospitals that are not located in the same or in a 
contiguous urban or rural area, but meet the rotation requirement in 
Sec.  413.79(g)(2), and are jointly listed--
    (i) As the sponsor, primary clinical site, or major participating 
institution for one or more programs as these terms are used in the 
most current publication of the Graduate Medical Education Directory; 
or
    (ii) As the sponsor or is listed under ``affiliations and outside 
rotations'' for one or more programs in operation in Opportunities, 
Directory of Osteopathic Postdoctoral Education Programs.
    (3) Two or more hospitals that are under common ownership and, 
effective for all Medicare GME affiliation agreements beginning July 1, 
2003, meet the rotation requirement in Sec.  413.79(g)(2).

[[Page 49255]]

    Medicare GME affiliation agreement means a written, signed, and 
dated agreement by responsible representatives of each respective 
hospital in a Medicare GME affiliated group, as defined in this 
section, that specifies--
    (1) The term of the Medicare GME affiliation agreement (which, at a 
minimum is 1 year), beginning on July 1 of a year;
    (2) Each participating hospital's direct and indirect GME FTE caps 
in effect prior to the Medicare GME affiliation;
    (3) The total adjustment to each hospital's FTE caps in each year 
that the Medicare GME affiliation agreement is in effect, for both 
direct GME and IME, that reflects a positive adjustment to one 
hospital's direct and indirect FTE caps that is offset by a negative 
adjustment to the other hospital's (or hospitals') direct and indirect 
FTE caps of at least the same amount;
    (4) The adjustment to each participating hospital's FTE counts 
resulting from the FTE resident's (or residents') participation in a 
shared rotational arrangement at each hospital participating in the 
Medicare GME affiliated group for each year the Medicare GME 
affiliation agreement is in effect. This adjustment to each 
participating hospital's FTE count is also reflected in the total 
adjustment to each hospital's FTE caps (in accordance with paragraph 
(3) of this definition); and
    (5) The names of the participating hospitals and their Medicare 
provider numbers.
    Medicare patient load means, with respect to a hospital's cost 
reporting period, the total number of hospital inpatient days during 
the cost reporting period that are attributable to patients for whom 
payment is made under Medicare Part A divided by total hospital 
inpatient days. In calculating inpatient days, inpatient days in any 
distinct part of the hospital furnishing a hospital level of care are 
included and nursery days are excluded.
    Primary care resident is a resident enrolled in an approved medical 
residency training program in family medicine, general internal 
medicine, general pediatrics, preventive medicine, geriatric medicine 
or osteopathic general practice.
    Redistribution of costs occurs when a hospital counts FTE residents 
in medical residency programs and the costs of the program had 
previously been incurred by an educational institution.
    Resident means an intern, resident, or fellow who participates in 
an approved medical residency program, including programs in 
osteopathy, dentistry, and podiatry, as required in order to become 
certified by the appropriate specialty board.
    Rural track FTE limitation means the maximum number of residents 
(as specified in Sec.  413.79(l)) training in a rural track residency 
program that an urban hospital may include in its FTE count and that is 
in addition to the number of FTE residents already included in the 
hospital's FTE cap.
    Rural track or integrated rural track means an approved medical 
residency training program established by an urban hospital in which 
residents train for a portion of the program at the urban hospital and 
then rotate for a portion of the program to a rural hospital(s) or a 
rural nonhospital site(s).
    Shared rotational arrangement means a residency training program 
under which a resident(s) participates in training at two or more 
hospitals in that program.
    (c) Payment for GME costs--General rule. Beginning with cost 
reporting periods starting on or after July 1, 1985, hospitals, 
including hospital-based providers, are paid for the costs of approved 
GME programs as described in Sec. Sec.  413.76 through 413.83.
    (d) Documentation requirements. To include a resident in the FTE 
count for a particular cost reporting period, the hospital must furnish 
the following information. The information must be certified by an 
official of the hospital and, if different, an official responsible for 
administering the residency program.
    (1) The name and social security number of the resident.
    (2) The type of residency program in which the individual 
participates and the number of years the resident has completed in all 
types of residency programs.
    (3) The dates the resident is assigned to the hospital and any 
hospital-based providers.
    (4) The dates the resident is assigned to other hospitals, or other 
freestanding providers, and any nonprovider setting during the cost 
reporting period, if any.
    (5) The name of the medical, osteopathic, dental, or podiatric 
school from which the resident graduated and the date of graduation.
    (6) If the resident is an FMG, documentation concerning whether the 
resident has satisfied the requirements of this section.
    (7) The name of the employer paying the resident's salary.


Sec.  413.76  Direct GME payments: Calculation of payments for GME 
costs.

    A hospital's Medicare payment for the costs of an approved 
residency program is calculated as follows:
    (a) Step one. The hospital's updated per resident amount (as 
determined under Sec.  413.77) is multiplied by the actual number of 
FTE residents (as determined under Sec.  413.79). This result is the 
aggregate approved amount for the cost reporting period.
    (b) Step two. The product derived in step one is multiplied by the 
hospital's Medicare patient load.
    (c) Step three. For portions of cost reporting periods occurring on 
or after January 1, 1998, the product derived in step one is multiplied 
by the proportion of the hospital's inpatient days attributable to 
individuals who are enrolled under a risk-sharing contract with an 
eligible organization under section 1876 of the Act and who are 
entitled to Medicare Part A or with a Medicare+Choice organization 
under Title XVIII, Part C of the Act. This amount is multiplied by an 
applicable payment percentage equal to--
    (1) 20 percent for 1998;
    (2) 40 percent for 1999;
    (3) 60 percent in 2000;
    (4) 80 percent in 2001; and
    (5) 100 percent in 2002 and subsequent years.
    (d) Step four. Effective for portions of cost reporting periods 
occurring on or after January 1, 2000, the product derived from step 
three is reduced by a percentage equal to the ratio of the 
Medicare+Choice nursing and allied health payment ``pool'' for the 
current calendar year as described at Sec.  413.87(f), to the projected 
total Medicare+Choice direct GME payments made to all hospitals for the 
current calendar year.
    (e) Step five. (1) For portions of cost reporting periods beginning 
on or after January 1, 1998 and before January 1, 2000, add the results 
of steps two and three.
    (2) Effective for portions of cost reporting periods beginning on 
or after January 1, 2000, add the results of steps two and four.
    (f) Step six. The product derived in step two is apportioned 
between Part A and Part B of Medicare based on the ratio of Medicare's 
share of reasonable costs excluding GME costs attributable to each part 
as determined through the Medicare cost report.


Sec.  413.77  Direct GME payments: Determination of per resident 
amounts.

    (a) Per resident amount for the base period--(1) Except as provided 
in paragraph (d) of this section, the intermediary determines a base-
period

[[Page 49256]]

per resident amount for each hospital as follows:
    (i) Determine the allowable GME costs for the cost reporting period 
beginning on or after October 1, 1983 but before October 1, 1984. In 
determining these costs, GME costs allocated to the nursery cost 
center, research and other nonreimbursable cost centers, and hospital-
based providers that are not participating in Medicare are excluded and 
GME costs allocated to distinct-part hospital units and hospital-based 
providers that participate in Medicare are included.
    (ii) Divide the costs calculated in paragraph (a)(1)(i) of this 
section by the average number of FTE residents working in all areas of 
the hospital complex (including those areas whose costs were excluded 
under paragraph (a)(1)(i) of this section) for its cost reporting 
period beginning on or after October 1, 1983 but before October 1, 
1984.
    (2) In determining the base-period per resident amount under 
paragraph (a)(1) of this section, the intermediary--
    (i) Verifies the hospital's base-period GME costs and the 
hospital's average number of FTE residents;
    (ii) Excludes from the base-period GME costs any nonallowable or 
misclassified costs, including those previously allowed under Sec.  
412.113(b)(3) of this chapter; and
    (iii) Upon a hospital's request, includes GME costs that were 
misclassified as operating costs during the hospital's prospective 
payment base year and were not allowable under Sec.  412.113(b)(3) of 
this chapter during the GME base period. These costs may be included 
only if the hospital requests an adjustment of its prospective payment 
hospital-specific rate or target amount as described in Sec.  413.82(a) 
of this chapter.
    (3) If the hospital's cost report for its GME base period is no 
longer subject to reopening under Sec.  405.1885 of this chapter, the 
intermediary may modify the hospital's base-period costs solely for 
purposes of computing the per resident amount.
    (4) If the intermediary modifies a hospital's base-period GME costs 
as described in paragraph (a)(2)(ii) of this section, the hospital may 
request an adjustment of its prospective payment hospital-specific rate 
or target amount as described in Sec.  413.82(a) of this chapter.
    (5) The intermediary notifies each hospital that either had direct 
GME costs or received indirect education payment in its cost reporting 
period beginning on or after October 1, 1984, and before October 1, 
1985, of its base-period average per resident amount. A hospital may 
appeal this amount within 180 days of the date of that notice.
    (b) Per resident amount for cost reporting periods beginning on or 
after July 1, 1985, and before July 1, 1986. For cost reporting periods 
beginning on or after July 1, 1985, and before July 1, 1986, a 
hospital's base-period per resident amount is adjusted as follows:
    (1) If a hospital's base period began on or after October 1, 1983, 
and before July 1, 1984, the amount is adjusted by the percentage 
change in the CPI-U that occurred between the hospital's base period 
and the first cost reporting period to which the provisions of this 
section apply. The adjusted amount is then increased by one percent.
    (2) If a hospital's base period began on or after July 1, 1984 and 
before October 1, 1984, the amount is increased by one percent.
    (c) Per resident amount for cost reporting periods beginning on or 
after July 1, 1986. Subject to the provisions of paragraph (d) of this 
section, for cost reporting periods beginning on or after July 1, 1986, 
a hospital's base-period per resident amount is adjusted as follows:
    (1) Except as provided in paragraph (c)(2) of this section, each 
hospital's per resident amount for the previous cost reporting is 
adjusted by the projected change in the CPI-U for the 12-month cost 
reporting period. This adjustment is subject to revision during the 
settlement of the cost report to reflect actual changes in the CPI-U 
that occurred during the cost reporting period.
    (2) For cost reporting periods beginning on or after October 1, 
1993 through September 30, 1995, each hospital's per resident amount 
for the previous cost reporting period will not be adjusted for any 
resident FTEs who are not either a primary care resident or an 
obstetrics and gynecology resident.
    (d) Per resident amount for cost reporting periods beginning on or 
after October 1, 2000 and ending on or before September 30, 2013. For 
cost reporting periods beginning on or after October 1, 2000 and ending 
on or before September 30, 2013, a hospital's per resident amount for 
each fiscal year is adjusted in accordance with the following 
provisions:
    (1) General provisions. For purposes of this Sec.  413.77--
    (i) Weighted average per resident amount. The weighted average per 
resident amount is established as follows:
    (A) Using data from hospitals' cost reporting periods ending during 
FY 1997, CMS calculates each hospital's single per resident amount by 
adding each hospital's primary care and nonprimary care per resident 
amounts, weighted by its respective FTEs, and dividing by the sum of 
the FTEs for primary care and nonprimary care residents.
    (B) Each hospital's single per resident amount calculated under 
paragraph (d)(1)(i)(A) of this section is standardized by the 1999 
geographic adjustment factor for the physician fee schedule area (as 
determined under Sec.  414.26 of this chapter) in which the hospital is 
located.
    (C) CMS calculates an average of all hospitals' standardized per 
resident amounts that are determined under paragraph (d)(1)(i)(B) of 
this section. The resulting amount is the weighted average per resident 
amount.
    (ii) Primary care/obstetrics and gynecology and nonprimary care per 
resident amounts. A hospital's per resident amount is an amount 
inclusive of any CPI-U adjustments that the hospital may have received 
since the hospital's base year, including any CPI-U adjustments the 
hospital may have received because the hospital trains primary care/
obstetrics and gynecology residents and nonprimary care residents as 
specified under paragraph (c)(2) of this section.
    (2) Adjustment beginning in FY 2001 and ending in FY 2013. For cost 
reporting periods beginning on or after October 1, 2000, and ending on 
or before September 30, 2013, a hospital's per resident amount is 
adjusted in accordance with paragraphs (d)(2)(i) through (d)(2)(iv) of 
this section, in that order:
    (i) Updating the weighted average per resident amount for 
inflation. The weighted average per resident amount (as determined 
under paragraph (d)(1)(i) of this section) is updated by the estimated 
percentage increase in the CPI-U during the period beginning with the 
month that represents the midpoint of the cost reporting periods ending 
during FY 1997 (that is, October 1, 1996) and ending with the midpoint 
of the hospital's cost reporting period that begins in FY 2001.
    (ii) Adjusting for locality. The updated weighted average per 
resident amount determined under paragraph (d)(2)(i) of this section 
(the national average per resident amount) is adjusted for the locality 
of each hospital by multiplying the national average per resident 
amount by the 1999 geographic adjustment factor for the physician fee 
schedule area in which each hospital is located, established in 
accordance with Sec.  414.26 of this chapter.
    (iii) Determining necessary revisions to the per resident amount. 
The locality-adjusted national average per resident amount, as 
calculated in accordance

[[Page 49257]]

with paragraph (d)(2)(ii) of this section, is compared to the 
hospital's per resident amount and is revised, if appropriate, 
according to the following three categories:
    (A) Floor. (1) For cost reporting periods beginning on or after 
October 1, 2000, and before October 1, 2001, if the hospital's per 
resident amount would otherwise be less than 70 percent of the 
locality-adjusted national average per resident amount for FY 2001 (as 
determined under paragraph (d)(2)(ii) of this section), the per 
resident amount is equal to 70 percent of the locality-adjusted 
national average per resident amount for FY 2001.
    (2) For cost reporting periods beginning on or after October 1, 
2001, and before October 1, 2002, if the hospital's per resident amount 
would otherwise be less than 85 percent of the locality-adjusted 
national average per resident amount for FY 2002 (as determined under 
paragraph (d)(2)(ii) of this section), the per resident amount is equal 
to 85 percent of the locality-adjusted national average per resident 
amount for FY 2002.
    (3) For subsequent cost reporting periods beginning on or after 
October 1, 2002, the hospital's per resident amount is updated using 
the methodology specified under paragraph (c)(1) of this section.
    (B) Ceiling. If the hospital's per resident amount is greater than 
140 percent of the locality-adjusted national average per resident 
amount, the per resident amount is adjusted as follows for FY 2001 
through FY 2013:
    (1) FY 2001. For cost reporting periods beginning on or after 
October 1, 2000 and on or before September 30, 2001, if the hospital's 
FY 2000 per resident amount exceeds 140 percent of the FY 2001 
locality-adjusted national average per resident amount (as calculated 
under paragraph (d)(2)(ii) of this section), subject to the provision 
stated in paragraph (d)(2)(iii)(B)(5) of this section, the hospital's 
per resident amount is frozen at the FY 2000 per resident amount and is 
not updated for FY 2001 by the CPI-U factor.
    (2) FY 2002. For cost reporting periods beginning on or after 
October 1, 2001, and on or before September 30, 2002, if the hospital's 
FY 2001 per resident amount exceeds 140 percent of the FY 2002 
locality-adjusted national average per resident amount, subject to the 
provision stated in paragraph (d)(2)(iii)(B)(5) of this section, the 
hospital's per resident amount is frozen at the FY 2001 per resident 
amount and is not updated for FY 2002 by the CPI-U factor.
    (3) FY 2003. For cost reporting periods beginning on or after 
October 1, 2002, and on or before September 30, 2003, if the hospital's 
per resident amount for the previous cost reporting period is greater 
than 140 percent of the locality-adjusted national average per resident 
amount for that same previous cost reporting period (for example, for 
cost reporting periods beginning in FY 2003, compare the hospital's per 
resident amount from the FY 2002 cost report to the hospital's 
locality-adjusted national average per resident amount from FY 2002), 
subject to the provision stated in paragraph (d)(2)(iii)(B)(5) of this 
section, the hospital's per resident amount is adjusted using the 
methodology specified in paragraph (c)(1) of this section, except that 
the CPI-U applied for a 12-month period is reduced (but not below zero) 
by 2 percentage points.
    (4) FY 2004 through FY 2013. For cost reporting periods beginning 
on or after October 1, 2003, and on or before September 30, 2013, if 
the hospital's preceding year per resident amount exceeds 140 percent 
of the current year's locality-adjusted national average per resident 
amount (as calculated under paragraph (d)(2)(ii) of this section), 
subject to the provision stated in paragraph (d)(2)(iii)(B)(5) of this 
section, the hospital-specific per resident amount is frozen for the 
current year at the preceding year's hospital-specific per resident 
amount and is not updated by the CPI-U factor.
    (5) General rule for hospitals that exceed the ceiling. For cost 
reporting periods beginning on or after October 1, 2000, and on or 
before September 30, 2013, if a hospital's per resident amount exceeds 
140 percent of the hospital's locality-adjusted national average per 
resident amount and it is adjusted under any of the criteria under 
paragraphs (d)(2)(iii)(B)(1) through (d)(2)(iii)(B)(3) of this section, 
the current year per resident amount cannot be reduced below 140 
percent of the locality-adjusted national average per resident amount.
    (C) Per resident amounts greater than or equal to the floor and 
less than or equal to the ceiling. For cost reporting periods beginning 
on or after October 1, 2000 and on or before September 30, 2013, if a 
hospital's per resident amount is greater than or equal to 70 percent 
and less than or equal to 140 percent of the hospital's locality-
adjusted national average per resident amount for each respective 
fiscal year, the hospital's per resident amount is updated using the 
methodology specified in paragraph (c)(1) of this section.
    (e) Exceptions--(1) Base period for certain hospitals. If a 
hospital did not have any approved medical residency training programs 
or did not participate in Medicare during the base period, but either 
condition changes in a cost reporting period beginning on or after July 
1, 1985, the intermediary establishes a per resident amount for the 
hospital using the information from the first cost reporting period 
during which the hospital participates in Medicare and the residents 
are on duty during the first month of that period. Any GME program 
costs incurred by the hospital before that cost reporting period are 
reimbursed on a reasonable cost basis. The per resident amount is based 
on the lower of the amount specified in paragraph (e)(1)(i) or in 
paragraph (e)(1)(ii) of this section, subject to the provisions of 
paragraph (e)(1)(iii) of this section.
    (i) The hospital's actual costs, incurred in connection with the 
GME program for the hospital's first cost reporting period in which 
residents were on duty during the first month of the cost reporting 
period.
    (ii) Except as specified in paragraph (e)(1)(iii)of this section--
    (A) For base periods that begin before October 1, 2002, the updated 
weighted mean value of per resident amounts of all hospitals located in 
the same geographic wage area, as that term is used in the prospective 
payment system under Part 412 of this chapter.
    (B) For base periods beginning on or after October 1, 2002, the 
updated weighted mean value of per resident amounts of all hospitals 
located in the same geographic wage area is calculated using all per 
resident amounts (including primary care and obstetrics and gynecology 
and nonprimary care) and FTE resident counts from the most recently 
settled cost reports of those teaching hospitals.
    (iii) If, under paragraph (e)(1)(ii)(A) or paragraph (e)(1)(ii)(B) 
of this section, there are fewer than three existing teaching hospitals 
with per resident amounts that can be used to calculate the weighted 
mean value per resident amount, for base periods beginning on or after 
October 1, 1997, the per resident amount equals the updated weighted 
mean value of per resident amounts of all hospitals located in the same 
census region as that term is used in Sec.  412.62(f)(1)(i) of this 
chapter.
    (2) Short or long base-period cost reporting periods. If a 
hospital's base-period cost reporting period reflects GME costs for a 
period that is shorter than 50 weeks or longer than 54 weeks, the 
intermediary converts the allowable costs for the base period into a 
daily

[[Page 49258]]

figure. The daily figure is then multiplied by 365 or 366, as 
appropriate, to derive the approved per resident amount for a 12-month 
base-period cost reporting period. If a hospital has two cost reporting 
periods beginning in the base period, the later period serves as the 
base-period cost reporting period.
    (3) Short or long cost reporting periods beginning on or after July 
1, 1985. If a hospital's cost reporting period is shorter than 50 weeks 
or longer than 54 weeks, the hospital's intermediary should contact CMS 
Central Office to receive a special CPI-U adjustment factor.
    (f) Residency match. Effective for cost reporting periods beginning 
on or after October 1, 2004, with respect to a resident who matches 
simultaneously for a first year of training in a primary care 
specialty, and for an additional year(s) of training in a nonprimary 
care specialty, the per resident amount that is used to determine 
direct GME payment with respect to that resident is the nonprimary care 
per resident amount for the first year of training in the primary care 
specialty and for the duration of the resident's training in the 
nonprimary care specialty.
    (g) Special use of locality-adjusted national average per resident 
amount. Effective for portions of cost reporting periods beginning on 
or after July 1, 2005, for a hospital that counts additional residents 
as a result of an increase in its FTE resident cap under Sec.  
413.79(c)(4) direct GME payments attributable to those additional FTE 
residents are calculated using the locality-adjusted national average 
per resident amount, as determined under paragraph (d)(2)(ii) of this 
section. The hospital will receive direct GME payments based on the sum 
of the following two direct GME calculations:
    (1) A calculation using the per resident amount(s) as determined 
under paragraph (d) of this section and the hospital's number of FTE 
residents that is not attributable to an FTE resident cap increase 
under Sec.  413.79(c)(4); and
    (2) A calculation using the locality-adjusted national average per 
resident amount, as determined under paragraph (d)(2)(ii) of this 
section, inflated to the hospital's current cost reporting period, and 
the hospital's number of FTE residents that is attributable to the 
increase in the hospital's FTE resident cap under Sec.  413.79(c)(4).


Sec.  413.78  Direct GME payments: Determination of the total number of 
FTE residents.

    Subject to the weighting factors in Sec. Sec.  413.79 and 413.80, 
and subject to the provisions of Sec.  413.81, the count of FTE 
residents is determined as follows:
    (a) Residents in an approved program working in all areas of the 
hospital complex may be counted.
    (b) No individual may be counted as more than one FTE. A hospital 
cannot claim the time spent by residents training at another hospital. 
Except as provided in paragraphs (c), (d), and (e) of this section, if 
a resident spends time in more than one hospital or in a nonprovider 
setting, the resident counts as partial FTE based on the proportion of 
time worked at the hospital to the total time worked. A part-time 
resident counts as a partial FTE based on the proportion of allowable 
time worked compared to the total time necessary to fill a full-time 
internship or residency slot.
    (c) On or after July 1, 1987, and for portions of cost reporting 
periods occurring before January 1, 1999, the time residents spend in 
nonprovider settings such as freestanding clinics, nursing homes, and 
physicians' offices in connection with approved programs is not 
excluded in determining the number of FTE residents in the calculation 
of a hospital's resident count if the following conditions are met--
    (1) The resident spends his or her time in patient care activities.
    (2) There is a written agreement between the hospital and the 
outside entity that states that the resident's compensation for 
training time spent outside of the hospital setting is to be paid by 
the hospital.
    (d) For portions of cost reporting periods occurring on or after 
January 1, 1999, and before October 1, 2004, the time residents spend 
in nonprovider settings such as freestanding clinics, nursing homes, 
and physicians' offices in connection with approved programs may be 
included in determining the number of FTE residents in the calculation 
of a hospital's resident count if the following conditions are met--
    (1) The resident spends his or her time in patient care activities.
    (2) The written agreement between the hospital and the nonhospital 
site must indicate that the hospital will incur the cost of the 
resident's salary and fringe benefits while the resident is training in 
the nonhospital site and the hospital is providing reasonable 
compensation to the nonhospital site for supervisory teaching 
activities. The agreement must indicate the compensation the hospital 
is providing to the nonhospital site for supervisory teaching 
activities.
    (3) The hospital must incur all or substantially all of the costs 
for the training program in the nonhospital setting in accordance with 
the definition in Sec.  413.75(b).
    (4) The hospital is subject to the principles of community support 
and redistribution of costs as specified in Sec.  413.81.
    (e) For portions of cost reporting periods occurring on or after 
October 1, 2004, the time residents spend in nonprovider settings such 
as freestanding clinics, nursing homes, and physicians' offices in 
connection with approved programs may be included in determining the 
number of FTE residents in the calculation of a hospital's resident 
count if the following conditions are met--
    (1) The resident spends his or her time in patient care activities.
    (2) The hospital must incur all or substantially all of the costs 
of the training program in a nonhospital setting(s) (in accordance with 
the definition under Sec.  413.75(b)).
    (3) The hospital must comply with one of the following:
    (i) The hospital must pay all or substantially all of the costs of 
the training program in a nonhospital setting(s) attributable to 
training that occurs during a month by the end of the third month 
following the month in which the training in the nonhospital site 
occurred; or
    (ii) There is a written agreement between the hospital and the 
nonhospital site that states that the hospital will incur the cost of 
the resident's salary and fringe benefits while the resident is 
training in the nonhospital site and the hospital is providing 
reasonable compensation to the nonhospital site for supervisory 
teaching activities. The agreement must indicate the compensation the 
hospital is providing to the nonhospital site for supervisory teaching 
activities.
    (4) The hospital is subject to the principles of community support 
and redistribution of costs as specified in Sec.  413.81.


Sec.  413.79  Direct GME payments: Determination of the weighted number 
of FTE residents.

    Subject to the provisions in Sec.  413.80, CMS determines a 
hospital's number of FTE residents by applying a weighting factor to 
each resident and then summing the resulting numbers that represent 
each resident. The weighting factor is determined as follows:
    (a) Initial residency period. Generally, for purposes of this 
section, effective July 1, 1995, an initial residency period is defined 
as the minimum number of years required for board eligibility.
    (1) Prior to July 1, 1995, the initial residency period equals the 
minimum

[[Page 49259]]

number of years required for board eligibility in a specialty or 
subspecialty plus 1 year. An initial residency period may not exceed 5 
years in order to be counted toward determining FTE status except in 
the case of a resident in an approved geriatric program whose initial 
residency period may last up to 2 additional years.
    (2) Effective October 1, 2003, for a resident who trains in an 
approved geriatric program that requires the residents to complete 2 
years of training to initially become board eligible in the geriatric 
specialty, the 2 years spent in the geriatrics program are treated as 
part of the resident's initial residency period.
    (3) Effective July 1, 2000, for residency programs that began 
before, on, or after November 29, 1999, the period of board eligibility 
and the initial residency period for a resident in an approved child 
neurology program is the period of board eligibility for pediatrics 
plus 2 years.
    (4) Effective August 10, 1993, residents or fellows in an approved 
preventive medicine residency or fellowship program also may be counted 
as a full FTE resident for up to 2 additional years beyond the initial 
residency period limitations.
    (5) For combined residency programs, an initial residency period is 
defined as the time required for individual certification in the longer 
of the programs. If the resident is enrolled in a combined medical 
residency training program in which all of the individual programs 
(that are combined) are for training primary care residents (as defined 
in Sec.  413.75(b)) or obstetrics and gynecology residents, the initial 
residency period is the time required for individual certification in 
the longer of the programs plus 1 year.
    (6) For residency programs other than those specified in paragraphs 
(a)(2) through (a)(4) of this section, the initial residency period is 
the minimum number of years of formal training necessary to satisfy the 
requirements for initial board eligibility in the particular specialty 
for which the resident is training, as specified in the most recently 
published edition of the Graduate Medical Education Directory.
    (7) For residency programs in osteopathy, dentistry, and podiatry, 
the minimum requirement for certification in a specialty or 
subspecialty is the minimum number of years of formal training 
necessary to satisfy the requirements of the appropriate approving body 
listed in Sec.  415.152 of this chapter.
    (8) For residency programs in geriatric medicine, accredited by the 
appropriate approving body listed in Sec.  415.152 of this chapter, 
these programs are considered approved programs on the later of--
    (i) The starting date of the program within a hospital; or
    (ii) The hospital's cost reporting periods beginning on or after 
July 1, 1985.
    (9) The time spent in residency programs that do not lead to 
certification in a specialty or subspecialty, but that otherwise meet 
the definition of approved programs, as described in Sec.  413.75(b), 
is counted toward the initial residency period limitation.
    (10) Effective for cost reporting periods beginning on or after 
October 1, 2004, if a hospital can document that a resident 
simultaneously matched for one year of training in a particular 
specialty program, and for a subsequent year(s) of training in a 
different specialty program, the resident's initial residency period 
will be determined based on the period of board eligibility associated 
with the program for which the resident matched for the subsequent 
year(s) of training.
    (b) Weighting factor--(1) If the resident is in an initial 
residency period, the weighting factor is one.
    (2) If the resident is not in an initial residency period, the 
weighting factor is 1.00 during the period beginning on or after July 
1, 1985 and before July 1, 1986, .75 during the period beginning on or 
after July 1, 1986 and before July 1, 1987, and .50 thereafter without 
regard to the hospital's cost reporting period.
    (c) Unweighted FTE counts.
    (1) Definitions. As used in this paragraph (c):
    (i) Otherwise applicable resident cap refers to a hospital's FTE 
resident cap that is determined for a particular cost reporting period 
under paragraph (c)(2) of this section.
    (ii) Reference resident level refers to a hospital's resident level 
in the applicable reference period specified under paragraph (c)(3)(ii) 
of this section.
    (iii) Resident level refers to the number of unweighted allopathic 
and osteopathic FTE residents who are training in a hospital in a 
particular cost reporting period.
    (2) Determination of the FTE resident cap. Subject to the 
provisions of paragraphs (c)(3) and (c)(4)of this section and Sec.  
413.81, for purposes of determining direct GME payment--
    (i) For cost reporting periods beginning on or after October 1, 
1997, a hospital's resident level may not exceed the hospital's 
unweighted FTE count (or, effective for cost reporting periods 
beginning on or after April 1, 2000, 130 percent of the unweighted FTE 
count for a hospital located in a rural area) for these residents for 
the most recent cost reporting period ending on or before December 31, 
1996.
    (ii) If a hospital's number of FTE residents in a cost reporting 
period beginning on or after October 1, 1997, and before October 1, 
2001, exceeds the limit described in this section, the hospital's total 
weighted FTE count (before application of the limit) will be reduced in 
the same proportion that the number of FTE residents for that cost 
reporting period exceeds the number of FTE residents for the most 
recent cost reporting period ending on or before December 31, 1996.
    (iii) If the hospital's number of FTE residents in a cost reporting 
period beginning on or after October 1, 2001 exceeds the limit 
described in this section, the hospital's weighted FTE count (before 
application of the limit) for primary care and obstetrics and 
gynecology residents and nonprimary care residents, respectively, will 
be reduced in the same proportion that the number of FTE residents for 
that cost reporting period exceeds the number of FTE residents for the 
most recent cost reporting period ending on or before December 31, 
1996.
    (iv) Hospitals that are part of the same Medicare GME affiliated 
group (as described under Sec.  413.75(b)) may elect to apply the limit 
on an aggregate basis as described under paragraph (f) of this section.
    (v) The fiscal intermediary may make appropriate modifications to 
apply the provisions of this paragraph (c) of this section based on the 
equivalent of a 12-month cost reporting period.
    (3) Determination of the reduction to the FTE resident cap due to 
unused FTE resident slots. If a hospital's reference resident level is 
less than its otherwise applicable FTE resident cap as determined under 
paragraph (c)(2) of this section or paragraph (e) of this section in 
the reference cost reporting period (as described under paragraph 
(c)(3)(ii) of this section), for portions of cost reporting periods 
beginning on or after July 1, 2005, the hospital's otherwise applicable 
FTE resident cap is reduced by 75 percent of the difference between the 
otherwise applicable FTE resident cap and the reference resident level. 
Under this provision--
    (i) Exemption for certain rural hospitals. A rural hospital, as 
defined at Sec.  412.62(f)(iii), with less than 250 beds (as determined 
at Sec.  412.105(b)) in its most recent cost reporting period ending on 
or before September 30, 2002, is exempt from any reduction to the 
otherwise applicable FTE resident cap

[[Page 49260]]

limit under paragraph (c)(3) of this section.
    (ii) Reference cost reporting periods.
    (A) To determine a hospital's reference resident level, CMS uses 
one of the following periods:
    (1) A hospital's most recent cost reporting period ending on or 
before September 30, 2002, for which a cost report has been settled or 
if the cost report has not been settled, the as-submitted cost report 
(subject to audit); or
    (2) A hospital's cost reporting period that includes July 1, 2003 
if the hospital submits a timely request to CMS to increase its 
resident level due to an expansion of an existing program and that 
expansion is not reflected on the hospital's most recent settled cost 
report. An expansion of an existing program means that, except for 
expansions due to newly approved programs under paragraph 
(c)(3)(ii)(A)(3) of this section, the number of unweighted allopathic 
and osteopathic FTE residents in any cost reporting period after the 
hospital's most recent settled cost report, up to and including the 
hospital's cost report that includes July 1, 2003, is greater than the 
number of unweighted allopathic and osteopathic FTE residents in 
programs that were existing at that hospital during the hospital's most 
recent settled cost report.
    (3) A hospital may submit a timely request that CMS adjust the 
resident level for purposes of determining any reduction under 
paragraph (c)(3) of this section for the following purposes:
    (i) In the hospital's reference cost reporting period under 
paragraph (c)(3)(ii)(A)(1) of this section, to include the number of 
FTE residents for which a new program was accredited by the appropriate 
allopathic or osteopathic accrediting body (listed under Sec.  415.152 
of this chapter) before January 1, 2002, if the program was not in 
operation during the reference cost reporting period under paragraph 
(c)(3)(ii)(A)(1); or
    (ii) In the hospital's reference cost reporting period under 
paragraph (c)(3)(ii)(A)(2) of this section, to include the number of 
FTE residents for which a new program was accredited by the appropriate 
allopathic or osteopathic accrediting body (listed under Sec.  415.152 
of this chapter) before January 1, 2002, if the program was not in 
operation during the cost reporting period that includes July 1, 2003, 
and if the hospital also qualifies to use its cost report under 
paragraph (c)(3)(ii)(A)(2) of this section due to an expansion of an 
existing program.
    (B) If the cost report that is used to determine a hospital's 
otherwise applicable FTE resident cap in the reference period is not 
equal to 12 months, the fiscal intermediary may make appropriate 
modifications to apply the provisions of paragraph (c)(3)(i)(A) of this 
section based on the equivalent of a 12-month cost reporting period.
    (iii) If the new program described in paragraph (c)(3)(ii)(A)(3)(i) 
or paragraph (c)(3)(ii)(A)(ii) was accredited for a range of residents, 
the hospital may request that its reference resident level in its 
applicable reference cost reporting period under paragraph 
(c)(3)(ii)(A)(1) or (c)(3)(ii)(A)(2) of this section be adjusted to 
reflect the maximum number of accredited slots applicable to that 
hospital.
    (iv) Consideration of Medicare GME affiliated group agreements. For 
hospitals that are members of the same affiliated group for the program 
year July 1, 2003 through June 30, 2004, in determining whether a 
hospital's otherwise applicable resident FTE resident cap is reduced 
under paragraph(c)(3) of this section, CMS treats these hospitals as a 
group. Using information from the hospitals' cost reports that include 
July 1, 2003, if the hospitals' aggregate FTE resident counts are equal 
to or greater than the aggregate otherwise applicable FTE resident cap 
for the affiliated group, then no reductions are made under paragraph 
(c)(3) of this section to the hospitals' otherwise applicable FTE 
resident caps. If the hospitals' aggregate FTE resident count is below 
the aggregate otherwise applicable FTE resident cap, then CMS 
determines on a hospital-specific basis whether the individual 
hospital's FTE resident count is less than its otherwise applicable 
resident cap (as adjusted by affiliation agreement(s)) in the 
hospital's cost report that includes July 1, 2003. If the hospital's 
FTE resident count is in excess of its otherwise applicable FTE 
resident cap, the hospital will not have its otherwise applicable FTE 
resident cap reduced under paragraph (c)(3) of this section. Hospitals 
in the affiliated group that have FTE resident counts below their 
individual otherwise applicable FTE resident caps are subject to a pro 
rata reduction in their otherwise applicable FTE resident caps that is 
equal, in total, to 75 percent of the difference between the aggregate 
FTE cap and the aggregate FTE count for the affiliated group. The pro 
rata reduction to the individual hospital's otherwise applicable 
resident cap is calculated by dividing the difference between the 
hospital's individual otherwise applicable FTE resident cap and the 
hospital's FTE resident count by the total amount by which all of the 
hospitals' individual FTE resident counts are below their otherwise 
affiliated FTE resident caps, multiplying the quotient by the 
difference between the aggregate FTE resident cap and the aggregate FTE 
resident counts for the affiliated group, and multiplying that result 
by 75 percent.
    (4) Determination of an increase in otherwise applicable resident 
cap. For portions of cost reporting periods beginning on or after July 
1, 2005, a hospital may receive an increase in its otherwise applicable 
FTE resident cap up to an additional 25 FTEs (as determined by CMS) if 
the hospital meets the requirements and qualifying criteria of section 
1886(h)(7) of the Act and implementing instructions issued by CMS and 
if the hospital submits an application to CMS within the timeframe 
specified by CMS.
    (5) Special rules for hospitals that participate in demonstration 
projects or voluntary resident reduction plans.
    (i) If a hospital was participating in a demonstration project 
under section 402 of Pubic Law 90-248 or the voluntary reduction plan 
under Sec.  413.88 for a greater period of time than the time period 
that elapsed since it withdrew from participation (or if it completed 
its participation) in the demonstration program or the voluntary 
reduction plan, for purposes of determining a possible reduction to the 
FTE resident caps under paragraph (c)(3) of this section, CMS compares 
the higher of the hospital's base number of residents (after 
subtracting any dental and podiatric FTE residents) or the hospital's 
reference resident level to the hospital's otherwise applicable 
resident cap determined under paragraph (c)(2) of this section.
    (ii) If a hospital participated in the demonstration project or the 
voluntary resident reduction plan for a period of time that is less 
than the time that elapsed since it withdraw from participation in the 
demonstration project or the voluntary reduction plan, the special 
rules in paragraph (c)(5)(i) do not apply, and the hospital is subject 
to the procedures applicable to all other hospitals for determining 
possible reductions to the FTE resident caps under paragraph (c)(3) of 
this section.
    (iii) CMS will not redistribute residency positions that are 
attributable to a hospital's participation in a demonstration project 
or a voluntary resident reduction plan to other hospitals that seek to 
increase their FTE resident caps under paragraph (c)(4) of this 
section.

[[Page 49261]]

    (d) Weighted FTE counts. Subject to the provisions of Sec.  413.81, 
for purposes of determining direct GME payment--
    (1) For the hospital's first cost reporting period beginning on or 
after October 1, 1997, the hospital's weighted FTE count is equal to 
the average of the weighted FTE count for the payment year cost 
reporting period and the preceding cost reporting period.
    (2) For cost reporting periods beginning on or after October 1, 
1998, and before October 1, 2001, the hospital's weighted FTE count is 
equal to the average of the weighted FTE count for the payment year 
cost reporting period and the preceding two cost reporting periods.
    (3) For cost reporting periods beginning on or after October 1, 
2001, the hospital's weighted FTE count for primary care and obstetrics 
and gynecology residents is equal to the average of the weighted 
primary care and obstetrics and gynecology counts for the payment year 
cost reporting period and the preceding two cost reporting periods, and 
the hospital's weighted FTE count for nonprimary care residents is 
equal to the average of the weighted nonprimary care FTE counts for the 
payment year cost reporting period and the preceding two cost reporting 
periods.
    (4) The fiscal intermediary may make appropriate modifications to 
apply the provisions of this paragraph (d) based on the equivalent of 
12-month cost reporting periods.
    (5) If a hospital qualifies for an adjustment to the limit 
established under paragraph (c)(2) of this section for new medical 
residency programs created under paragraph (e) of this section, the 
count of the residents participating in new medical residency training 
programs above the number included in the hospital's FTE count for the 
cost reporting period ending during calendar year 1996 is added after 
applying the averaging rules in this paragraph (d), for a period of 
years. Residents participating in new medical residency training 
programs are included in the hospital's FTE count before applying the 
averaging rules after the period of years has expired. For purposes of 
this paragraph (d), for each new program started, the period of years 
equals the minimum accredited length for each new program. The period 
of years begins when the first resident begins training in each new 
program.
    (6) Subject to the provisions of paragraph (h) of this section, FTE 
residents that are displaced by the closure of either another hospital 
or another hospital's program are added to the FTE count after applying 
the averaging rules in this paragraph (d), for the receiving hospital 
for the duration of the time that the displaced residents are training 
at the receiving hospital.
    (7) Subject to the provisions under paragraph (k) of this section, 
effective for cost reporting periods beginning on or after April 1, 
2000, FTE residents in a rural track program at an urban hospital are 
included in the urban hospital's rolling average calculation described 
in this paragraph (d).
    (e) New medical residency training programs. If a hospital 
establishes a new medical residency training program as defined in 
paragraph (l) of this section on or after January 1, 1995, the 
hospital's FTE cap described under paragraph (c) of this section may be 
adjusted as follows:
    (1) If a hospital had no allopathic or osteopathic residents in its 
most recent cost reporting period ending on or before December 31, 
1996, and it establishes a new medical residency training program on or 
after January 1, 1995, the hospital's unweighted FTE resident cap under 
paragraph (c) of this section may be adjusted based on the product of 
the highest number of residents in any program year during the third 
year of the first program's existence for all new residency training 
programs and the number of years in which residents are expected to 
complete the program based on the minimum accredited length for the 
type of program. The adjustment to the cap may not exceed the number of 
accredited slots available to the hospital for the new program.
    (i) If the residents are spending an entire program year (or years) 
at one hospital and the remainder of the program at another hospital, 
the adjustment to each respective hospital's cap is equal to the 
product of the highest number of residents in any program year during 
the third year of the first program's existence and the number of years 
the residents are training at each respective hospital.
    (ii) Prior to the implementation of the hospital's adjustment to 
its FTE cap beginning with the fourth year of the hospital's residency 
program(s), the hospital's cap may be adjusted during each of the first 
3 years of the hospital's new residency program using the actual number 
of residents participating in the new program. The adjustment may not 
exceed the number of accredited slots available to the hospital for 
each program year.
    (iii) Except for rural hospitals, the cap will not be adjusted for 
new programs established more than 3 years after the first program 
begins training residents.
    (iv) An urban hospital that qualifies for an adjustment to its FTE 
cap under paragraph (e)(1) of this section is not permitted to be part 
of a Medicare GME affiliated group for purposes of establishing an 
aggregate FTE cap.
    (v) A rural hospital that qualifies for an adjustment to its FTE 
cap under paragraph (e)(1) of this section is permitted to be part of a 
Medicare GME affiliated group for purposes of establishing an aggregate 
FTE cap.
    (2) If a hospital had allopathic or osteopathic residents in its 
most recent cost reporting period ending on or before December 31, 
1996, the hospital's unweighted FTE cap may be adjusted for new medical 
residency training programs established on or after January 1, 1995 and 
on or before August 5, 1997. The adjustment to the hospital's FTE 
resident limit for the new program is based on the product of the 
highest number of residents in any program year during the third year 
of the newly established program and the number of years in which 
residents are expected to complete each program based on the minimum 
accredited length for the type of program.
    (i) If the residents are spending an entire program year (or years) 
at one hospital and the remainder of the program at another hospital, 
the adjustment to each respective hospital's cap is equal to the 
product of the highest number of residents in any program year during 
the third year of the first program's existence and the number of years 
the residents are training at each respective hospital.
    (ii) Prior to the implementation of the hospital's adjustment to 
its FTE cap beginning with the fourth year of the hospital's residency 
program, the hospital's cap may be adjusted during each of the first 3 
years of the hospital's new residency program, using the actual number 
of residents in the new programs. The adjustment may not exceed the 
number of accredited slots available to the hospital for each program 
year.
    (3) If a hospital with allopathic or osteopathic residents in its 
most recent cost reporting period ending on or before December 31, 
1996, is located in a rural area (or other hospitals located in rural 
areas that added residents under paragraph (e)(1) of this section), the 
hospital's unweighted FTE limit may be adjusted in the same manner 
described in paragraph (e)(2) of this section to reflect the increase 
for residents in the new medical residency training programs 
established after August 5, 1997. For these hospitals, the limit will 
be adjusted for additional new programs

[[Page 49262]]

but not for expansions of existing or previously existing programs.
    (4) A hospital seeking an adjustment to the limit on its unweighted 
resident count policy must provide documentation to its fiscal 
intermediary justifying the adjustment.
    (f) Medicare GME affiliated group. A hospital may receive a 
temporary adjustment to its FTE cap, which is subject to the averaging 
rules under paragraph (e)(3) of this section, to reflect residents 
added or subtracted because the hospital is participating in a Medicare 
GME affiliated group (as defined under Sec.  413.75(b)). Under this 
provision--
    (1) Each hospital in the Medicare GME affiliated group must submit 
the Medicare GME affiliation agreement, as defined under Sec.  
413.75(b) of this section, to the CMS fiscal intermediary servicing the 
hospital and send a copy to CMS's Central Office no later than July 1 
of the residency program year during which the Medicare GME affiliation 
agreement will be in effect.
    (2) Each hospital in the Medicare GME affiliated group must have a 
shared rotational arrangement, as defined in Sec.  413.75(b), with at 
least one other hospital within the Medicare GME affiliated group, and 
all of the hospitals within the Medicare GME affiliated group must be 
connected by a series of such shared rotational arrangements.
    (3) During the shared rotational arrangements under a Medicare GME 
affiliation agreement, as defined in Sec.  413.75(b), more than one of 
the hospitals in the Medicare GME affiliated group must count the 
proportionate amount of the time spent by the resident(s) in its FTE 
resident counts. No resident may be counted in the aggregate as more 
than one FTE.
    (4) The net effect of the adjustments (positive or negative) on the 
Medicare GME affiliated hospitals' aggregate FTE cap for each Medicare 
GME affiliation agreement must not exceed zero.
    (5) If the Medicare GME affiliation agreement terminates for any 
reason, the FTE cap of each hospital in the Medicare GME affiliated 
group will revert to the individual hospital's pre-affiliation FTE cap 
that is determined under the provisions of paragraph (c) of this 
section.
    (g) Newly constructed hospitals. A hospital that began construction 
of its facility prior to August 5, 1997, and sponsored new medical 
residency training programs on or after January 1, 1995, and on or 
before August 5, 1997, that either received initial accreditation by 
the appropriate accrediting body or temporarily trained residents at 
another hospital(s) until the facility was completed, may receive an 
adjustment to its FTE cap.
    (1) The newly constructed hospital's FTE cap is equal to the lesser 
of--
    (i) The product of the highest number of residents in any program 
year during the third year of the newly established program and the 
number of years in which residents are expected to complete the 
programs based on the minimum accredited length for each type of 
program; or
    (ii) The number of accredited slots available to the hospital for 
each year of the programs.
    (2) If the new medical residency training programs sponsored by the 
newly constructed hospital have been in existence for 3 years or more 
by the time the residents begin training at the newly constructed 
hospital, the newly constructed hospital's cap will be based on the 
number of residents training in the third year of the programs begun at 
the temporary training site.
    (3) If the new medical residency training programs sponsored by the 
newly constructed hospital have been in existence for less than 3 years 
by the time the residents begin training at the newly constructed 
hospital, the newly constructed hospital's cap will be based on the 
number of residents training at the newly constructed hospital in the 
third year of the programs (including the years at the temporary 
training site).
    (4) A hospital that qualifies for an adjustment to its FTE cap 
under this paragraph (g) may be part of an affiliated group for 
purposes of establishing an aggregate FTE cap.
    (5) The provisions of this paragraph (g) are applicable during 
portions of cost reporting periods occurring on or after October 1, 
1999.
    (h) Closure of hospital or hospital residency program.
    (1) Definitions. For purposes of this section--
    (i) Closure of a hospital means the hospital terminates its 
Medicare agreement under the provisions of Sec.  489.52 of this 
chapter.
    (ii) Closure of a hospital residency training program means the 
hospital ceases to offer training for residents in a particular 
approved medical residency training program.
    (2) Closure of a hospital. A hospital may receive a temporary 
adjustment to its FTE cap to reflect residents added because of another 
hospital's closure if the hospital meets the following criteria:
    (i) The hospital is training additional residents from a hospital 
that closed on or after July 1, 1996.
    (ii) No later than 60 days after the hospital begins to train the 
residents, the hospital submits a request to its fiscal intermediary 
for a temporary adjustment to its FTE cap, documents that the hospital 
is eligible for this temporary adjustment by identifying the residents 
who have come from the closed hospital and have caused the hospital to 
exceed its cap, and specifies the length of time the adjustment is 
needed.
    (3) Closure of a hospital's residency training program. If a 
hospital that closes its residency training program voluntarily agrees 
to temporarily reduce its FTE cap according to the criteria specified 
in paragraph (h)(3)(ii) of this section, another hospital(s) may 
receive a temporary adjustment to its FTE cap to reflect residents 
added because of the closure of the residency training program if the 
criteria specified in paragraph (h)(3)(i) of this section are met.
    (i) Receiving hospital(s). A hospital may receive a temporary 
adjustment to its FTE cap to reflect residents added because of the 
closure of another hospital's residency training program if--
    (A) The hospital is training additional residents from the 
residency training program of a hospital that closed a program; and
    (B) No later than 60 days after the hospital begins to train the 
residents, the hospital submits to its fiscal intermediary a request 
for a temporary adjustment to its FTE cap, documents that it is 
eligible for this temporary adjustment by identifying the residents who 
have come from another hospital's closed program and have caused the 
hospital to exceed its cap, specifies the length of time the adjustment 
is needed, and submits to its fiscal intermediary a copy of the FTE 
reduction statement by the hospital that closed its program, as 
specified in paragraph (h)(3)(ii)(B) of this section.
    (ii) Hospital that closed its program(s). A hospital that agrees to 
train residents who have been displaced by the closure of another 
hospital's program may receive a temporary FTE cap adjustment only if 
the hospital with the closed program--
    (A) Temporarily reduces its FTE cap based on the FTE residents in 
each program year training in the program at the time of the program's 
closure. This yearly reduction in the FTE cap will be determined based 
on the number of those residents who would have been training in the 
program during that year had the program not closed; and
    (B) No later than 60 days after the residents who were in the 
closed program begin training at another hospital, submit to its fiscal 
intermediary a statement signed and

[[Page 49263]]

dated by its representative that specifies that it agrees to the 
temporary reduction in its FTE cap to allow the hospital training the 
displaced residents to obtain a temporary adjustment to its cap; 
identifies the residents who were in training at the time of the 
program's closure; identifies the hospitals to which the residents are 
transferring once the program closes; and specifies the reduction for 
the applicable program years.
    (i) Additional FTEs for residents on maternity or disability leave 
or other approved leave of absence. Effective for cost reporting 
periods beginning on or after November 29, 1999, a hospital may receive 
an adjustment to its FTE cap of up to three additional resident FTEs, 
if the hospital meets the following criteria:
    (1) The additional residents are residents of a primary care 
program that would have been counted by the hospital as residents for 
purposes of the hospital's FTE cap but for the fact that the additional 
residents were on maternity or disability leave or a similar approved 
leave of absence during the hospital's most recent cost reporting 
period ending on or before December 31, 1996;
    (2) The leave of absence was approved by the residency program 
director to allow the residents to be absent from the program and 
return to the program after the leave of absence; and
    (3) No later than 6 months after August 1, 2000, the hospital 
submits to the fiscal intermediary a request for an adjustment to its 
FTE cap, and provides contemporaneous documentation of the approval of 
the leave of absence by the residency director, specific to each 
additional resident that is to be counted for purposes of the 
adjustment.
    (j) Residents previously trained at VA hospitals. For cost 
reporting periods beginning on or after October 1, 1997, a non-Veterans 
Affairs (VA) hospital may receive a temporary adjustment to its FTE cap 
to reflect residents who had previously trained at a VA hospital and 
were subsequently transferred to the non-VA hospital, if that hospital 
meets the following criteria:
    (1) The transferred residents had been training previously at a VA 
hospital in a program that would have lost its accreditation by the 
ACGME if the residents continued to train at the VA hospital;
    (2) The residents were transferred to the hospital from the VA 
hospital on or after January 1, 1997, and before July 31, 1998; and
    (3) The hospital submits a request to its fiscal intermediary for a 
temporary adjustment to its FTE cap, documents that it is eligible for 
this temporary adjustment by identifying the residents who have come 
from the VA hospital, and specifies the length of time those residents 
will be trained at the hospital.
    (k) Residents training in rural track programs. Subject to the 
provisions of Sec.  413.81, an urban hospital that establishes a new 
residency program, or has an existing residency program, with a rural 
track (or an integrated rural track) may include in its FTE count 
residents in those rural tracks, in addition to the residents subject 
to its FTE cap specified under paragraph (c) of this section. An urban 
hospital with a rural track residency program may count residents in 
those rural tracks up to a rural track FTE limitation if the hospital 
complies with the conditions specified in paragraphs (k)(2) through 
(k)(6) of this section.
    (1) If an urban hospital rotates residents to a separately 
accredited rural track program at a rural hospital(s) for two-thirds of 
the duration of the program for cost reporting periods beginning on or 
after April 1, 2000, and before October 1, 2003, or for more than one-
half of the duration of the program for cost reporting periods 
beginning on or after October 1, 2003, the urban hospital may include 
those residents in its FTE count for the time the rural track residents 
spend at the urban hospital. The urban hospital may include in its FTE 
count those residents in the rural track training at the urban 
hospital, not to exceed its rural track FTE limitation, determined as 
follows:
    (i) For the first 3 years of the rural track's existence, the rural 
track FTE limitation for each urban hospital will be the actual number 
of FTE residents, subject to the rolling average at paragraph (d)(7) of 
this section, training in the rural track at the urban hospital.
    (ii) Beginning with the fourth year of the rural track's existence, 
the rural track FTE limitation is equal to the product of the highest 
number of residents, in any program year, who during the third year of 
the rural track's existence are training in the rural track at the 
urban hospital or the rural hospital(s) and are designated at the 
beginning of their training to be rotated to the rural hospital(s) for 
at least two-thirds of the duration of the program for cost reporting 
periods beginning on or after April 1, 2000, and before October 1, 
2002, or for more than one-half of the duration of the program 
effective for cost reporting periods beginning on or after October 1, 
2003, and the number of years those residents are training at the urban 
hospital.
    (2) If an urban hospital rotates residents to a separately 
accredited rural track program at a rural nonhospital site(s) for two-
thirds of the duration of the program for cost reporting periods 
beginning on or after April 1, 2000, and before October 1, 2003, or for 
more than one-half of the duration of the program for cost reporting 
periods beginning on or after October 1, 2003, the urban hospital may 
include those residents in its FTE count, subject to the requirements 
under Sec.  413.78(d). The urban hospital may include in its FTE count 
those residents in the rural track, not to exceed its rural track FTE 
limitation, determined as follows:
    (i) For the first 3 years of the rural track's existence, the rural 
track FTE limitation for each urban hospital will be the actual number 
of FTE residents, subject to the rolling average specified in paragraph 
(d)(7) of this section, training in the rural track at the urban 
hospital and the rural nonhospital site(s).
    (ii) Beginning with the fourth year of the rural track's existence, 
the rural track FTE limitation is equal to the product of--
    (A) The highest number of residents in any program year who, during 
the third year of the rural track's existence, are training in the 
rural track at--
    (1) The urban hospital and are designated at the beginning of their 
training to be rotated to a rural nonhospital site(s) for at least two-
thirds of the duration of the program for cost reporting periods 
beginning on or after April 1, 2000 and before October 1, 2003, or for 
more than one-half of the duration of the program for cost reporting 
periods beginning on or after October 1, 2003; and
    (2) The rural nonhospital site(s); and
    (B) The number of years in which the residents are expected to 
complete each program based on the minimum accredited length for the 
type of program.
    (3) If an urban hospital rotates residents in the rural track 
program to a rural hospital(s) for less than two-thirds of the duration 
of the program for cost reporting periods beginning on or after April 
1, 2000, and before October 1, 2003, or for one-half or less than one-
half of the duration of the program for cost reporting periods 
beginning on or after October 1, 2003, the rural hospital may not 
include those residents in its FTE count (if the rural track is not a 
new program under paragraph (e)(3) of this section, or if the rural 
hospital's FTE count exceeds that hospital's FTE cap), nor may the 
urban hospital include those residents when calculating its rural track 
FTE limitation.
    (4) If an urban hospital rotates residents in the rural track 
program to a rural nonhospital site(s) for less than

[[Page 49264]]

two-thirds of the duration of the program for cost reporting periods 
beginning on or after April 1, 2000 and before October 1, 2003, or for 
one-half or less than one-half of the duration of the program for cost 
reporting periods beginning on or after October 1, 2003, the urban 
hospital may include those residents in its FTE count, subject to the 
requirements under Sec.  413.78(d). The urban hospital may include in 
its FTE count those residents in the rural track, not to exceed its 
rural track limitation, determined as follows:
    (i) For the first 3 years of the rural track's existence, the rural 
track FTE limitation for the urban hospital will be the actual number 
of FTE residents, subject to the rolling average specified in paragraph 
(d)(7) of this section, training in the rural track at the rural 
nonhospital site(s).
    (ii) Beginning with the fourth year of the rural track's existence, 
the rural track FTE limitation is equal to the product of--
    (A) The highest number of residents in any program year who, during 
the third year of the rural track's existence, are training in the 
rural track at the rural nonhospital site(s) or are designated at the 
beginning of their training to be rotated to the rural nonhospital 
site(s) for a period that is less than two-thirds of the duration of 
the program for cost reporting periods beginning on or after April 1, 
2002, and before October 1, 2003, or for one-half or less than one-half 
of the duration of the program for cost reporting periods beginning on 
or after October 1, 2003; and
    (B) The length of time in which the residents are being training at 
the rural nonhospital site(s) only.
    (5) All urban hospitals that wish to count FTE residents in rural 
tracks, not to exceed their respective rural track FTE limitation, must 
also comply with all of the following conditions:
    (i) An urban hospital may not include in its rural track FTE 
limitation or (assuming the urban hospital's FTE count exceeds its FTE 
cap) FTE count residents who are training in a rural track residency 
program that were already included as part of the hospital's FTE cap.
    (ii) The hospital must base its count of residents in a rural track 
on written contemporaneous documentation that each resident enrolled in 
a rural track program at the hospital intends to rotate for a portion 
of the residency program to a rural area.
    (iii) All residents that are included by the hospital as part of 
its rural track FTE count (not to exceed its rural track FTE 
limitation) must train in the rural area. However, where a resident 
begins to train in the rural track program at the urban hospital but 
leaves the program before completing the total required portion of 
training in the rural area, the urban hospital may count the time the 
resident trained in the urban hospital if another resident fills the 
vacated FTE slot and completes the training in the rural portion of the 
rural track program. An urban hospital may not receive GME payment for 
the time the resident trained at the urban hospital if another resident 
fills the vacated FTE slot and first begins to train at the urban 
hospital.
    (6) If CMS finds that residents who are included by the urban 
hospital as part of its FTE count did not actually complete the 
training in the rural area, CMS will reopen the urban hospital's cost 
report within the 3-year reopening period as specified in Sec.  
405.1885 of this chapter and adjust the hospital's Medicare GME 
payments (and, where applicable, the hospital's rural track FTE 
limitation).
    (l) For purposes of this section, a new medical residency training 
program means a medical residency that receives initial accreditation 
by the appropriate accrediting body or begins training residents on or 
after January 1, 1995.


Sec.  413.80  Direct GME payments: Determination of weighting factors 
for foreign medical graduates.

    (a) The weighting factor for a foreign medical graduate is 
determined under the provisions of Sec.  413.79 if the foreign medical 
graduate--
    (1) Has passed FMGEMS; or
    (2) Before July 1, 1986, received certification from, or passed an 
examination of, the Educational Committee for Foreign Medical 
Graduates.
    (b) Before July 1, 1986, the weighting factor for a foreign medical 
graduate is 1.0 times the weight determined under the provisions of 
Sec.  413.79. On or after July 1, 1986, and before July 1, 1987, the 
weighting factor for a graduate of a foreign medical school who was in 
a residency program both before and after July 1, 1986 but who does not 
meet the requirements set forth in paragraph (a) of this section is .50 
times the weight determined under the provisions of Sec.  413.79.
    (c) On or after July 1, 1987, these foreign medical graduates are 
not counted in determining the number of FTE residents.
    (d) During the cost reporting period in which a foreign medical 
graduate passes FMGEMS, the weighting factor for that resident is 
determined under the provisions of Sec.  413.79 for the part of the 
cost reporting period beginning with the month the resident passes the 
test.
    (e) On or after September 1, 1989, the National Board of Medical 
Examiners Examination, Parts I and II, may be substituted for FMGEMS 
for purposes of the determination made under paragraphs (a) and (d) of 
this section.
    (f) On or after June 1, 1992, the United States Medical Licensing 
Examination may be substituted for the FMGEMS for purposes of the 
determination made under paragraphs (a) and (d) of this section. On or 
after July 1, 1993, only the results of steps I and II of the United 
States Medical Licensing Examination will be accepted for purposes of 
making this determination.


Sec.  413.81  Direct GME payments: Application of community support and 
redistribution of costs in determining FTE resident counts.

    (a) For purposes of determining direct GME payments, the following 
principles apply:
    (1) Community support. If the community has undertaken to bear the 
costs of medical education through community support, the costs are not 
considered GME costs to the hospital for purposes of Medicare payment.
    (2) Redistribution of costs. The costs of training residents that 
constitute a redistribution of costs from an educational institution to 
the hospital are not considered GME costs to the hospital for purposes 
of Medicare payment.
    (b) Application. A hospital must continuously incur costs of direct 
GME of residents training in a particular program at a training site 
since the date the residents first began training in that program in 
order for the hospital to count the FTE residents in accordance with 
the provisions of Sec. Sec.  413.78, 413.79 (c) through (e), and 
413.79(k). This rule also applies to providers that are paid for direct 
GME in accordance with Sec.  405.2468 of this chapter, Sec.  422.270 of 
this subchapter, and Sec.  413.70.
    (c)(1) Effective date. Subject to the provisions of paragraph 
(c)(2) of this section, payments made in accordance with determinations 
made under the provisions of paragraphs (a) and (b) of this section 
will be effective for portions of cost reporting periods occurring on 
or after October 1, 2003.
    (2) Applicability for certain hospitals. With respect to an FTE 
resident who begins training in a residency program on or before 
October 1, 2003, and with respect to whom there has been a 
redistribution of costs or community support determined under the 
provisions of paragraphs (a) and (b) of this section, the hospital may 
continue

[[Page 49265]]

to count the FTE resident until the resident has completed training in 
that program, or until 3 years after the date the resident began 
training in that program, whichever comes first.


Sec.  413.82  Direct GME payments: Special rules for States that 
formerly had a waiver from Medicare reimbursement principles.

    (a) Effective for cost reporting periods beginning on or after 
January 1, 1986, hospitals in States that, prior to becoming subject to 
the prospective payment system, had a waiver for the operation of a 
State reimbursement control system under section 1886(c) of the Act, 
section 402 of the Social Security Amendments of 1967 (42 U.S.C. 1395b-
1 or section 222(a) of the Social Security Amendment of 1972 (42 U.S.C. 
1395b-1 (note)) are permitted to change the order in which they 
allocate administrative and general costs to the order specified in the 
instructions for the Medicare cost report.
    (b) For hospitals making this election, the base-period costs for 
the purpose of determining the per resident amount are adjusted to take 
into account the change in the order by which they allocate 
administrative and general costs to interns and residents in approved 
program cost centers.
    (c) Per resident amounts are determined for the base period and 
updated as described in Sec.  413.77. For cost reporting periods 
beginning on or after January 1, 1986, payment is made based on the 
methodology described in Sec.  413.76.


Sec.  413.83  Direct GME payments: Adjustment of a hospital's target 
amount or prospective payment hospital-specific rate.

    (a) Misclassified operating costs--(1) General rule. If a hospital 
has its base-period GME costs reduced under Sec.  413.77(a) of this 
section because those costs included misclassified operating costs, the 
hospital may request that the intermediary review the classification of 
the affected costs in its rate-of-increase ceiling or prospective 
payment base year for purposes of adjusting the hospital's target 
amount or hospital-specific rate. For those cost reports that are not 
subject to reopening under Sec.  405.1885 of this chapter, the 
hospital's reopening request must explicitly state that the review is 
limited to this one issue.
    (2) Request for review. The hospital must request review of the 
classification of its rate-of-increase ceiling or prospective payment 
base year costs no later than 180 days after the date of the notice by 
the intermediary of the hospital's base-period average per resident 
amount. A hospital's request for review must include sufficient 
documentation to demonstrate to the intermediary that adjustment of the 
hospital's hospital-specific rate or target amount is warranted.
    (3) Effect of intermediary's review. If the intermediary, upon 
review of the hospital's costs, determines that the hospital's 
hospital-specific rate or target amount should be adjusted, the 
adjustment of the hospital-specific rate or the target amount is 
effective for the hospital's cost reporting periods subject to the 
prospective payment system or the rate-of-increase ceiling that are 
still subject to reopening under Sec.  405.1885 of this chapter.
    (b) Misclassification of GME costs--(1) General rule. If costs that 
should have been classified as GME costs were treated as operating 
costs during both the GME base period and the rate-of-increase ceiling 
base year or prospective payment base year and the hospital wishes to 
receive benefit for the appropriate classification of these costs as 
GME costs in the GME base period, the hospital must request that the 
intermediary review the classification of the affected costs in the 
rate-of-increase ceiling or prospective payment base year for purposes 
of adjusting the hospital's target amount or hospital-specific rate. 
For those cost reports that are not subject to reopening under Sec.  
405.1885 of this chapter, the hospital's reopening request must 
explicitly state that the review is limited to this one issue.
    (2) Request for review. The hospital must request review of the 
classification of its costs no later than 180 days after the date of 
the intermediary's notice of the hospital's base-period average per 
resident amount. A hospital's request for review must include 
sufficient documentation to demonstrate to the intermediary that 
modification of the adjustment of the hospital's hospital-specific rate 
or target amount is warranted.
    (3) Effect of intermediary's review. If the intermediary, upon 
review of the hospital's costs, determines that the hospital's 
hospital-specific rate or target amount should be adjusted, the 
adjustment of the hospital-specific rate and the adjustment of the 
target amount is effective for the hospital's cost reporting periods 
subject to the prospective payment system or the rate-of-increase 
ceiling that are still subject to reopening under Sec.  405.1885 of 
this chapter.


Sec.  413.87  [Amended]

0
8. In Sec.  413.87--
0
A. Under paragraph (e), the cross-reference ``Sec.  413.86(d)(4)'' is 
removed and the cross-reference ``413.76(d)'' is added in its place.
0
B. Under paragraph (f)(1)(i), the cross-reference ``413.86(d)(3)'' is 
removed and the cross-reference ``413.76(c)'' is added in its place.


Sec.  413.88  [Amended]

0
9. In Sec.  413.88--
0
A. Under paragraph (b)(1), the cross-reference ``413.86(b)'' is removed 
and the cross-reference ``Sec.  413.75(b)'' is added in its place.
0
B. Under paragraph (b)(2), the cross-reference ``Sec.  413.86(b)'' is 
removed and the cross-reference ``Sec.  413.75(b)'' is added in its 
place.
0
C. Under paragraph (d)(7), the reference ``413.86(b)'' is removed and 
the cross-reference ``Sec.  413.75(b)'' is added in its place.
0
D. Under paragraphs (g)(1)(i)(A) and (B), the cross-reference ``Sec.  
413.86(g)'' is removed and the cross-reference ``Sec.  413.79'' is 
added in its place, wherever it appears.
0
E. Under paragraph (h)(1)(i), the cross-reference ``Sec.  413.86(d)'' 
(2 times) is removed and the cross-reference ``Sec.  413.76'' (2 times) 
is added in its place.
0
10. Section 413.114 is amended by revising the last sentence of 
paragraph (a)(2) to read as follows:


Sec.  413.114  Payment for posthospital SNF care furnished by a swing-
bed hospital.

    (a) * * *
    (2) Services furnished in cost reporting periods beginning on and 
after July 1, 2002. * * * Posthospital SNF care furnished in general 
routine inpatient beds in CAHs is paid based on reasonable cost for 
cost reporting periods beginning on and after July l, 2002 and before 
January 1, 2004, and is paid based on 101 percent of reasonable cost 
for cost reporting periods beginning on and after January 1, 2004, in 
accordance with the provisions of subparts A through G of this part 
(other than paragraphs (c) and (d) of this section).
* * * * *

0
11. Section 413.302 is amended by revising the definition of ``Urban 
area'' to read as follows:


Sec.  413.302  Definitions.

    For purposes of this subpart--
* * * * *
    Urban area means--
    (1) Prior to October 1, 2004, a Metropolitan Statistical Area 
(MSA), or New England County Metropolitan Area (NECMA), as defined by 
the Office of Management and Budget, or a New England county deemed to 
be an urban area as listed in Sec.  412.62(f)(1)(ii)(B) of this 
chapter.

[[Page 49266]]

    (2) Effective October 1, 2004, a Metropolitan Statistical Area 
(MSA), as defined by the Office of Management and Budget, or a New 
England county deemed to be an urban area as specified under Sec.  
412.64.

0
D. Part 418 is amended as follows:

PART 418--HOSPICE CARE

0
1. The authority citation for part 418 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 418.100 is amended as follows:
0
A. Revising paragraph (d)(1).
0
B. Revising paragraph (d)(4).
0
C. Adding a new paragraph (d)(5).
    The revision and addition read as follows:


Sec.  418.100  Condition of participation: Hospices that provide 
inpatient care directly.

* * * * *
    (d) Standard: Fire protection. (1) Except as otherwise provided in 
this section--
    (i) The hospice must meet the provisions applicable to nursing 
homes of the 2000 edition of the Life Safety Code of the National Fire 
Protection Association. The Director of the Office of the Federal 
Register has approved the NFPA 101 [reg] 2000 edition of the Life 
Safety Code, issued January 14, 2000, for incorporation by reference in 
accordance with 5 U.S.C. 552(a) and 1 CFR part 51. A copy of the Code 
is available for inspection at the CMS Information Resource Center, 
7500 Security Boulevard, Baltimore, MD or at the National Archives and 
Records Administration (NARA). For information on the availability of 
this material at NARA, call 202-741-6030, or go to: http://www.archives.gov/federal_register/code_of_federal_regulations/ibr_locations.html. Copies may be obtained from the National Fire 
Protection Association, 1 Batterymarch Park, Quincy, MA 02269. If any 
changes in this edition of the Code are incorporated by reference, CMS 
will publish notice in the Federal Register to announce the changes.
    (ii) Chapter 19.3.6.3.2, exception number 2 of the adopted edition 
of the LSC does not apply to a hospice.
* * * * *
    (4) Beginning March 13, 2006, a hospice must be in compliance with 
Chapter 9.2.9, Emergency Lighting.
    (5) Beginning March 13, 2006, Chapter 19.3.6.3.2, exception number 
2 does not apply to hospices.
* * * * *

0
E. Part 460 is amended as follows:

PART 460--PROGRAMS OF ALL-INCLUSIVE CARE FOR THE ELDERLY (PACE)

0
1. The authority citation for part 460 continues to read as follows:

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

Subpart E--PACE Administrative Requirements

0
2. Section 460.72 is amended by--
0
A. Revising paragraph (b)(1).
0
B. Revising paragraph (b)(3).
0
C. Adding paragraph (b)(4).
    The revision and addition read as follows:


Sec.  460.72  Physical environment.

* * * * *
    (b) Fire safety. (1) General rule. Except as otherwise provided in 
this section--
    (i) A PACE center must meet the applicable provisions of the 2000 
edition of the Life Safety Code (LSC) of the National Fire Protection 
Association that apply to the type of setting in which the center is 
located. The Director of the Office of the Federal Register has 
approved the NFPA 101 [reg] 2000 edition of the Life Safety Code, 
issued January 14, 2000, for incorporation by reference in accordance 
with 5 U.S.C. 552(a) and 1 CFR part 51. A copy of the Code is available 
for inspection at the CMS Information Resource Center, 7500 Security 
Boulevard, Baltimore, MD or at the National Archives and Records 
Administration (NARA). For information on the availability of this 
material at NARA, call 202-741-6030, or go to: http://www.archives.gov/federal_register/code_of_federal_regulations/ibr_locations.html. 
Copies may be obtained from the National Fire Protection Association, 1 
Batterymarch Park, Quincy, MA 02269. If any changes in this edition of 
the Code are incorporated by reference, CMS will publish notice in the 
Federal Register to announce the changes.
    (ii) Chapter 19.3.6.3.2, exception number 2 of the adopted edition 
of the LSC does not apply to PACE centers.
* * * * *
    (3) Beginning March 13, 2006, a PACE center must be in compliance 
with Chapter 9.2.9, Emergency Lighting.
    (4) Beginning March 13, 2006, Chapter 19.3.6.3.2, exception number 
2 does not apply to PACE centers.
* * * * *

0
F. The title of Part 480 under Subchapter F is revised to read as 
follows:

PART 480--ACQUISITION, PROTECTION, AND DISCLOSURE OF QUALITY 
IMPROVEMENT ORGANIZATION INFORMATION

0
G. Part 480 is amended as follows:
0
1. The authority citation for Part 480 continues to read:

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


0
2. Section 480.106 is amended by adding a new paragraph (c) to read as 
follows:


Sec.  480.106  Exceptions to QIO notice requirements.

* * * * *
    (c) Other. The notification requirements in Sec.  480.105(a) and 
(b)(2) do not apply if:
    (1) The institution or practitioner has requested, in writing, that 
the QIO make the disclosure;
    (2) The institution or practitioner has provided, in writing, 
consent for the disclosure; or
    (3) The information is public information as defined in Sec.  
480.101(b) and specified under Sec.  480.120.

0
3. Section 480.133 is amended by revising paragraph (a)(2)(iii) to read 
as follows:


Sec.  480.133  Disclosure of information about practitioners, reviewers 
and institutions.

    (a) * * *
    (2) Disclosure to others. * * *
    (iii) A QIO may disclose to any person, agency, or organization 
information on a particular practitioner or reviewer at the written 
request of or with the written consent of that practitioner or 
reviewer. The recipient of the information has the same redisclosure 
rights and responsibilities as the requesting or consenting 
practitioner or reviewer as provided under this Subpart B.
* * * * *

0
4. Section 480.140 is amended by redesignating paragraphs (d) and (e) 
as paragraphs (e) and (f), respectively, and adding a new paragraph (d) 
to read as follows:


Sec.  480.140  Disclosure of quality review study information.

* * * * *
    (d) A QIO may disclose quality review study information with 
identifiers of

[[Page 49267]]

particular practitioners or institutions, or both, at the written 
request of, or with the written consent of, the identified 
practitioner(s) or institution(s).
    (1) The consent or request must specify the information that is to 
be disclosed and the intended recipient of the information.
    (2) The recipient of the information has the same redisclosure 
rights and responsibilities as the requesting or consenting 
practitioner or institution as provided under this Subpart B.
* * * * *

0
5. Cross-Reference Changes


Sec. Sec.  480.101, 480.104, 480.105, 480.106, 480.120, 480.121, 
480.130, 480.132, 480.133, 480.136, 480.137, 480.138, 480.141, 
480.142  [Amended]

0
In the table below, for each section indicated in the left column, 
remove the cross-reference indicated in the middle column from wherever 
it appears in the section, and add the cross-reference in the right 
column:
BILLING CODE 4120-01-P
[GRAPHIC] [TIFF OMITTED] TR11AU04.076

BILLING CODE 4120-01-C

0
H. Part 482 is amended as follows:

PART 482--CONDITIONS OF PARTICIPATION FOR HOSPITALS

0
1. The authority citation for part 482 continues to read as follows:

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


0
2. Section 482.41 is amended by--revising paragraph (b).


Sec.  482.41  Conditions of participation: Physical environment.

* * * * *
    (b) Standard: Life safety from fire. (1) Except as otherwise 
provided in this section--
    (i) The hospital must meet the applicable provisions of the 2000 
edition of the Life Safety Code of the National Fire Protection 
Association. The Director of the Office of the Federal Register has 
approved the NFPA 101[reg]

[[Page 49268]]

2000 edition of the Life Safety Code, issued January 14, 2000, for 
incorporation by reference in accordance with 5 U.S.C. 552(a) and 1 CFR 
part 51. A copy of the Code is available for inspection at the CMS 
Information Resource Center, 7500 Security Boulevard, Baltimore, MD or 
at the National Archives and Records Administration (NARA). For 
information on the availability of this material at NARA, call 202-741-
6030, or go to: http://www.archives.gov/federal_register/code_of_federal_regulations/ibr_locations.html. Copies may be obtained from 
the National Fire Protection Association, 1 Batterymarch Park, Quincy, 
MA 02269. If any changes in this edition of the Code are incorporated 
by reference, CMS will publish notice in the Federal Register to 
announce the changes.
    (ii) Chapter 19.3.6.3.2, exception number 2 of the adopted edition 
of the LSC does not apply to hospitals.
    (2) After consideration of State survey agency findings, CMS may 
waive specific provisions of the Life Safety Code which, if rigidly 
applied, would result in unreasonable hardship upon the facility, but 
only if the waiver does not adversely affect the health and safety of 
the patients.
    (3) The provisions of the Life Safety Code do not apply in a State 
where CMS finds that a fire and safety code imposed by State law 
adequately protects patients in hospitals.
    (4) Beginning March 13, 2006, a hospital must be in compliance with 
Chapter 19.2.9, Emergency Lighting.
    (5) Beginning March 13, 2006, Chapter 19.3.6.3.2, exception number 
2 does not apply to hospitals.
    (6) The hospital must have procedures for the proper routine 
storage and prompt disposal of trash.
    (7) The hospital must have written fire control plans that contain 
provisions for prompt reporting of fires; extinguishing fires; 
protection of patients, personnel and guests; evacuation; and 
cooperation with fire fighting authorities.
    (8) The hospital must maintain written evidence of regular 
inspection and approval by State or local fire control agencies.
* * * * *

0
3. Section 482.43 is amended by adding new paragraphs (c)(6), (c)(7), 
and (c)(8) to read as follows:


Sec.  482.43  Conditions of participation: Discharge planning.

* * * * *
    (c) * * *
    (6) The hospital must include in the discharge plan a list of HHAs 
or SNFs that are available to the patient, that are participating in 
the Medicare program, and that serve the geographic area (as defined by 
the HHA) in which the patient resides, or in the case of a SNF, in the 
geographic area requested by the patient. HHAs must request to be 
listed by the hospital as available.
    (i) This list must only be presented to patients for whom home 
health care or post-hospital extended care services are indicated and 
appropriate as determined by the discharge planning evaluation.
    (ii) For patients enrolled in managed care organizations, the 
hospital must indicate the availability of home health and posthospital 
extended care services through individuals and entities that have a 
contract with the managed care organizations.
    (iii) The hospital must document in the patient's medical record 
that the list was presented to the patient or to the individual acting 
on the patient's behalf.
    (7) The hospital, as part of the discharge planning process, must 
inform the patient or the patient's family of their freedom to choose 
among participating Medicare providers of posthospital care services 
and must, when possible, respect patient and family preferences when 
they are expressed. The hospital must not specify or otherwise limit 
the qualified providers that are available to the patient.
    (8) The discharge plan must identify any HHA or SNF to which the 
patient is referred in which the hospital has a disclosable financial 
interest, as specified by the Secretary, and any HHA or SNF that has a 
disclosable financial interest in a hospital under Medicare. Financial 
interests that are disclosable under Medicare are determined in 
accordance with the provisions of Part 420, Subpart C, of this chapter.
* * * * *

0
I. Part 483 is amended as follows:

PART 483--REQUIREMENTS FOR STATES AND LONG TERM CARE FACILITIES

0
The authority citation for part 483 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 483.70 is amended by revising paragraph (a) to read as 
follows.


Sec.  483.70  Physical environment.

* * * * *
    (a) Life safety from fire.
    (1) Except as otherwise provided in this section--
    (i) The facility must meet the applicable provisions of the 2000 
edition of the Life Safety Code of the National Fire Protection 
Association. The Director of the Office of the Federal Register has 
approved the NFPA 101[supreg] 2000 edition of the Life Safety Code, 
issued January 14, 2000, for incorporation by reference in accordance 
with 5 U.S.C. 552(a) and 1 CFR part 51. A copy of the Code is available 
for inspection at the CMS Information Resource Center, 7500 Security 
Boulevard, Baltimore, MD or at the National Archives and Records 
Administration (NARA). For information on the availability of this 
material at NARA, call 202-741-6030, or go to: http://www.archives.gov/federal_register/code_of_federal_regulations/ibr_locations.html. 
Copies may be obtained from the National Fire Protection Association, 1 
Batterymarch Park, Quincy, MA 02269. If any changes in this edition of 
the Code are incorporated by reference, CMS will publish notice in the 
Federal Register to announce the changes.
    (ii) Chapter 19.3.6.3.2, exception number 2 of the adopted edition 
of the LSC does not apply to long-term care facilities.
    (2) After consideration of State survey agency findings, CMS may 
waive specific provisions of the Life Safety ode which, if rigidly 
applied, would result in unreasonable hardship upon the facility, but 
only if the waiver does not adversely affect the health and safety of 
the patients.
    (3) The provisions of the Life safety Code do not apply in a State 
where CMS finds, in accordance with applicable provisions of sections 
1819(d)(2)(B)(ii) and 1919(d)(2)(B)(ii) of the Act, that a fire and 
safety code imposed by State law adequately protects patients, 
residents and personnel in long term care facilities.
    (4) Beginning March 13, 2006, a long-term care facility must be in 
compliance with Chapter 19.2.9, Emergency Lighting.
    (5) Beginning March 13, 2006, Chapter 19.3.6.3.2, exception number 
2 does not apply to long-term care facilities.
* * * * *
Book 2 of 2 Books

Pages 49269-49782

[[Page 49269]]

-----------------------------------------------------------------------

Part II--Continued





Department of Health and Human Services





-----------------------------------------------------------------------



Centers for Medicare & Medicaid Services



-----------------------------------------------------------------------



42 CFR Parts 403, 412, et al.



Medicare Program; Changes to the Hospital Inpatient Prospective Payment 
Systems and Fiscal Year 2005 Rates; Final Rule

[[Page 49270]]



[[Page 49271]]


0

3. Section 483.470 is amended by revising paragraph (j) to read as follows:

Sec.  483.470

Condition of participation: Physical environment.

* * * * *

                                         (j) Standard: Fire protection.
            (1) General. Except as otherwise provided in this section--
    (i) The facility must meet the applicable provisions of either the 
    Health Care Occupancies Chapters or the Residential Board and Care 
Occupancies Chapter of the 2000 edition of the Life Safety Code of the 
National Fire Protection Association. The Director of the Office of the 
Federal Register has approved the NFPA 101[supreg] 2000 edition of the 
       Life Safety Code, issued January 14, 2000, for incorporation by 
reference in accordance with 5 U.S.C. 552(a) and 1 CFR part 51. A copy 
of the Code is available for inspection at the CMS Information Resource 
     Center, 7500 Security Boulevard, Baltimore, MD or at the National 
    Archives and Records Administration (NARA). For information on the 
   availability of this material at NARA, call 202-741-6030, or go to: 
          http://www.archives.gov/federal_register/code_of_federal_regulations/ibr_locations.html. Copies may be obtained from the 
 National Fire Protection Association, 1 Batterymarch Park, Quincy, MA 
 02269. If any changes in this edition of the Code are incorporated by 
reference, CMS will publish notice in the Federal Register to announce 
                                                           the changes.
(ii) Chapter 19.3.6.3.2, exception number 2 of the adopted LSC does not 
                                                   apply to a facility.
  (2) The State survey agency may apply a single chapter of the LSC to 
      the entire facility or may apply different chapters to different 
               buildings or parts of buildings as permitted by the LSC.
(3) A facility that meets the LSC definition of a residential board and 
       care occupancy must have its evacuation capability evaluated in 
    accordance with the Evacuation Difficulty Index of the Fire Safety 
             Evaluation System for Board and Care facilities (FSES/BC).
 (4) If CMS finds that the State has a fire and safety code imposed by 
State law that adequately protects a facility's clients, CMS may allow 
     the State survey agency to apply the State's fire and safety code 
                                                    instead of the LSC.
   (5) Beginning March 13, 2006, a facility must be in compliance with 
                                    Chapter 19.2.9, Emergency Lighting.
  (6) Beginning March 13, 2006, Chapter 19.3.6.3.2, exception number 2 
                                          does not apply to a facility.
(7) Facilities that meet the LSC definition of a health care occupancy. 
   After consideration of State survey agency recommendations, CMS may 
waive, for appropriate periods, specific provisions of the Life Safety 
                            Code if the following requirements are met:
(i) The waiver would not adversely affect the health and safety of the 
                                                               clients.
      (ii) Rigid application of specific provisions would result in an 
                                unreasonable hardship for the facility.

* * * * *

0

J. Part 485 is amended as follows:

PART 485--CONDITIONS OF PARTICIPATION: SPECIALIZED PROVIDERS

0

1. The authority citation for Part 485 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 485.610 is amended by--

0

A. Revising the introductory text to paragraph (b).

0

B. Adding a new paragraph (b)(3).

0

C. Revising paragraph (c).

                             The addition and revision read as follows:

Sec.  485.610

Condition of participation: Status and location.

* * * * *

 (b) Standard: Location in a rural area or treatment as rural. The CAH 
 meets the requirements of either paragraph (b)(1) or (b)(2) or (b)(3) 
                                                 of this section. * * *
(3) Effective only for October 1, 2004 through September 30, 2006, the 
CAH does not meet the location requirements in either paragraph (b)(1) 
                                             or (b)(2) of this section.
(3) Effective only for October 1, 2004 through September 30, 2006, the 
CAH does not meet the location requirements in either paragraph (b)(1) 
or (b)(2) of this section and is located in a county that, in FY 2004, 
     was not part of a Metropolitan Statistical Area as defined by the 
Office of Management and Budget, but as of FY 2005 was included as part 
         of such an MSA as a result of the most recent census data and 
 implementation of the new MSA definitions announced by OMB on June 6, 
                                                                  2003.
      (c) Standard: Location relative to other facilities or necessary 
  provider certification. The CAH is located more than a 35-mile drive 
(or, in the case of mountainous terrain or in areas with only secondary 
  roads available, a 15-mile drive) from a hospital or another CAH, or 
  before January 1, 2006, the CAH is certified by the State as being a 
necessary provider of health care services to residents in the area. A 
 CAH that is designated as a necessary provider as of October 1, 2006, 
will maintain its necessary provider designation after October 1, 2006.

0

3. Section 485.618 is amended by--

0

A. Revising paragraph (d)(1) introductory text.

0

B. In paragraph (d)(2)(iv), removing the cross-reference ``paragraph 
(d)(2)(ii)'' and adding in its place the cross-reference ``paragraph 
(d)(2)(iii)''.

0

C. In paragraph (d)(3), removing the cross-reference ``paragraph 
(d)(2)(ii)'' and adding in its place the cross-reference ``paragraph 
(d)(2)(iii)''.

                                         The revision reads as follows:

Sec.  485.618

Condition of participation: Emergency services.

* * * * *

(d) Standard: Personnel. (1) Except as specified in paragraph (d)(2) of 
     this section, there must be a doctor of medicine or osteopathy, a 
        physician assistant, a nurse practitioner, or a clinical nurse 
 specialist, with training or experience in emergency care on call and 
    immediately available by telephone or radio contact, and available 
                                onsite within the following timeframes:

* * * * *

0

4. Section 485.620 is amended by revising paragraph (a) to read as follows:

Sec.  485.620

Condition of participation: Number of beds and length of stay.

     (a) Standard: Number of beds. Except as permitted for CAHs having 
distinct part units under Sec.  485.646, the CAH maintains no more than 
  25 inpatient beds after January 1, 2004, that can be used for either 
                                       inpatient or swing-bed services.

* * * * *

0

5. Section 485.623 is amended by--

0

A. Revising paragraph (d)(1)

0

B. Revising paragraph (d)(5).

0

C. Adding a new paragraph (d)(6).

                            The revisions and addition read as follows.

Sec.  485.623

Condition of participation: Physical plant and environment.

* * * * *

                                   (d) Standard: Life safety from fire.
                     (1) Except as otherwise provided in this section--
(i) The CAH must meet the applicable provisions of the 2000 edition of 
 the Life Safety Code of the National Fire Protection Association. The 
  Director of the Office of the Federal Register has approved the NFPA 
  101[supreg] 2000 edition of the Life Safety Code, issued January 14, 
2000, for incorporation by reference in accordance with 5 U.S.C. 552(a) 
                                                                    and

[[Page 49272]]

  1 CFR part 51. A copy of the Code is available for inspection at the 
CMS Information Resource Center, 7500 Security Boulevard, Baltimore, MD 
    or at the National Archives and Records Administration (NARA). For 
information on the availability of this material at NARA, call 202-741-
  6030, or go to: http://www.archives.gov/federal_register/code_of_federal_regulations/ibr_locations.html. Copies may be obtained from 
the National Fire Protection Association, 1 Batterymarch Park, Quincy, 
 MA 02269. If any changes in this edition of the Code are incorporated 
      by reference, CMS will publish notice in the Federal Register to 
                                                  announce the changes.
 (ii) Chapter 19.3.6.3.2, exception number 2 of the adopted edition of 
                          the Life Safety Code does not apply to a CAH.

* * * * *

   (5) Beginning March 13, 2006, a critical access hospital must be in 
                     compliance with Chapter 9.2.9, Emergency Lighting.
  (6) Beginning March 13, 2006, Chapter 19.3.6.3.2, exception number 2 
                           does not apply to critical access hospitals.

0

6. Section 485.645 is amended by republishing the introductory text of 
paragraph (a) and revising paragraph (a)(2) to read as follows:

Sec.  485.645

Special requirements for CAH providers of long-term care services (``swing-
beds'').

* * * * *

            (a) Eligibility. A CAH must meet the following eligibility 
                                                          requirements:

* * * * *

(2) The facility provides not more than 25 inpatient beds. Any bed of a 
   unit of the facility that is licensed as a distinct-part SNF at the 
time the facility applies to the State for designation as a CAH is not 
                           counted under paragraph (a) of this section.

* * * * *

0

7. A new Sec.  485.647 is added under subpart F to read as follows:

Sec.  485.647

Condition of participation: psychiatric and rehabilitation distinct part 
units.

                                                        (a) Conditions.
(1) If a CAH provides inpatient psychiatric services in a distinct part 
unit, the services furnished by the distinct part unit must comply with 
the hospital requirements specified in Subparts A, B, C, and D of Part 
 482 of this subchapter, the common requirements of Sec.  412.25(a)(2) 
   through (f) of Part 412 of this chapter for hospital units excluded 
 from the prospective payment systems, and the additional requirements 
  of Sec.  412.27 of Part 412 of this chapter for excluded psychiatric 
                                                                 units.
 (2) If a CAH provides inpatient rehabilitation services in a distinct 
part unit, the services furnished by the distinct part unit must comply 
with the hospital requirements specified in Subparts A, B, C, and D of 
         Part 482 of this subchapter, the common requirements of Sec.  
412.25(a)(2) through (f) of Part 412 of this chapter for hospital units 
    excluded from the prospective payments systems, and the additional 
requirements of Sec. Sec.  412.29 and Sec.  412.30 of Part 412 of this 
                  chapter related specifically to rehabilitation units.
                                          (b) Eligibility requirements.
    (1) To be eligible to receive Medicare payments for psychiatric or 
rehabilitation services as a distinct part unit, the facility provides 
                        no more than 10 beds in the distinct part unit.
  (2) The beds in the distinct part are excluded from the 25 inpatient-
                         bed count limit specified in Sec.  485.620(a).
   (3) The average annual 96-hour length of stay requirement specified 
  under Sec.  485.620(b) does not apply to the 10 beds in the distinct 
         part units specified in paragraph (b)(1) of this section, and 
  admissions and days of inpatient care in the distinct part units are 
   not taken into account in determining the CAH's compliance with the 
      limits on the number of beds and length of stay in Sec.  485.620.

0

K. Part 489 is amended as follows:

PART 489--PROVIDER AGREEMENT AND SUPPLIER APPROVAL

0

1. The authority citation for part 489 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 489.20 is amended as follows:

0

A. In paragraph (m), the cross-reference ``Sec.  489.24(d)'' is removed and 
the cross-reference ``Sec.  489.24(e)'' is added in its place.

0

B. A new paragraph (t) is added.

Sec.  489.20

Basic commitments.

* * * * *

(t) Hospitals that are not otherwise subject to the Occupational Safety 
and Health Act of 1970 (or a State occupational safety and health plan 
   that is approved under section 18(b) of the Occupational Safety and 
 Health Act) must comply with the bloodborne pathogens (BBP) standards 
  under 29 CFR 1910.1030. A hospital that fails to comply with the BBP 
  standards may be subject to a civil money penalty in accordance with 
section 17 of the Occupational Safety and Health Act of 1970, including 
  any adjustments of the civil money penalty amounts under the Federal 
  Civil Penalties Inflation Adjustment Act, for a violation of the BBP 
 standards. A civil money penalty will be imposed and collected in the 
    same manner as civil money penalties under section 1128A(a) of the 
                                                   Social Security Act.

Sec.  489.53

[Amended]

0

3. In Sec.  489.53(b)(2), the cross-reference ``489.24(d)'' is removed and 
the cross-reference ``489.24(e)'' is added in its place.

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

(Catalog of Federal Domestic Assistance Program No. 93.773, Medicare--
Hospital Insurance; and Program No. 93.774, Medicare--Supplementary Medical 
Insurance Program)


Dated: August 2, 2004.

Mark B. McClellan,





Administrator, Centers for Medicare & Medicaid Services.





Dated: August 2, 2004.

Tommy G. Thompson,





Secretary.





[Editorial Note: The following Addendum and appendixes will not appear in 
the Code of Federal Regulations.]

Addendum--Schedule of Standardized Amount Effective with Discharges 
Occurring On or After October 1, 2004 and Update Factors and Rate-of-
Increase Percentages Effective With Cost Reporting Periods Beginning On or 
After October 1, 2004

I. Summary and Background

    In this Addendum, we are setting forth the amounts and factors for 
 determining prospective payment rates for Medicare hospital inpatient 
operating costs and Medicare hospital inpatient capital-related costs. 
We are also setting forth rate-of-increase percentages for updating the 
target amounts for hospitals and hospital units excluded from the IPPS.
For discharges occurring on or after October 1, 2004, except for SCHs, 
MDHs, and hospitals located in Puerto Rico, each hospital's payment per 
  discharge under the IPPS will be based on 100 percent of the Federal 
           national rate, which will be based on the national adjusted 
standardized amount. This amount reflects the national average hospital 
                costs per case from a base year, updated for inflation.
    SCHs are paid based on whichever of the following rates yields the 
                                                               greatest

[[Page 49273]]

    aggregate payment: the Federal national rate; the updated hospital-
       specific rate based on FY 1982 costs per discharge; the updated 
   hospital-specific rate based on FY 1987 costs per discharge; or the 
   updated hospital-specific rate based on FY 1996 costs per discharge.
    Under section 1886(d)(5)(G) of the Act, MDHs are paid based on the 
Federal national rate or, if higher, the Federal national rate plus 50 
   percent of the difference between the Federal national rate and the 
  updated hospital-specific rate based on FY 1982 or FY 1987 costs per 
    discharge, whichever is higher. MDHs do not have the option to use 
                                  their FY 1996 hospital-specific rate.
For hospitals in Puerto Rico, the payment per discharge is based on the 
sum of 25 percent of a Puerto Rico rate that reflects base year average 
 costs per case of Puerto Rico hospitals and 75 percent of the Federal 
   national rate. (See section II.D.3. of this Addendum for a complete 
                                                          description.)
     As discussed below in section II. of this Addendum, we are making 
     changes in the determination of the prospective payment rates for 
    Medicare inpatient operating costs for FY 2005. The changes, to be 
 applied prospectively effective with discharges occurring on or after 
      October 1, 2004, affect the calculation of the Federal rates. In 
 section III. of this Addendum, we discuss our changes for determining 
  the prospective payment rates for Medicare inpatient capital-related 
costs for FY 2005. Section IV. of this Addendum sets forth our changes 
for determining the rate-of-increase limits for hospitals excluded from 
 the IPPS for FY 2004. Section V. of this Addendum sets forth policies 
      on payment for blood clotting factors administered to hemophilia 
  patients. The tables to which we refer in the preamble of this final 
                    rule are presented in section VI. of this Addendum.

II. Changes to Prospective Payment Rates for Hospital Inpatient Operating 
Costs for FY 2005

   The basic methodology for determining prospective payment rates for 
  hospital inpatient operating costs is set forth at Sec. Sec.  412.63 
     and 412.64. The basic methodology for determining the prospective 
    payment rates for hospital inpatient operating costs for hospitals 
located in Puerto Rico is set forth at Sec. Sec.  412.210, 412.211, and 
       412.212. Below, we discuss the factors used for determining the 
                                             prospective payment rates.
  In summary, the standardized amounts set forth in Tables 1A, 1B, 1C, 
                       and 1D of section VI. of this Addendum reflect--
   The requirements of section 401 of Public Law 108-
 173, equalizing the standardized amounts for urban and other areas at 
 the level computed for urban hospitals during FY 2004, updated by the 
applicable percentage increase required under section 501(a) of Pub. L. 
                                                               108-173;
   The requirements of section 403 of Public Law 108-
 173, establishing two labor-related shares that are applicable to the 
standardized amounts depending on whether the hospital's payments would 
  be higher with a lower (in the case of a wage index below 1.0000) or 
         higher (in the case of a wage index above 1.0000) labor share;
  Updates of 3.3 percent for all areas (that is, the 
 full market basket percentage increase of 3.3 percent, as required by 
section 501(a) of Public Law 108-173), and reflecting the requirements 
     of section 501(b) of Public Law 108-173, to reduce the applicable 
percentage increase by 0.4 percentage points for hospitals that fail to 
 submit data in a form and manner specified by the Secretary, relating 
            to the quality of inpatient care furnished by the hospital;
   An adjustment to ensure the DRG recalibration and 
wage index update and changes are budget neutral, as provided for under 
 sections 1886(d)(4)(C)(iii) and (d)(3)(E) of the Act, by applying new 
       budget neutrality adjustment factors to the standardized amount;
  An adjustment to ensure the effects of the special 
  transition measures adopted in relation to the implementation of new 
                                 labor market areas are budget neutral;
   An adjustment to ensure the effects of geographic 
       reclassification are budget neutral, as provided for in section 
   1886(d)(8)(D) of the Act, by removing the FY 2004 budget neutrality 
                                  factor and applying a revised factor;
    An adjustment to apply the new outlier offset by 
        removing the FY 2004 outlier offsets and applying a new offset;
    An adjustment to ensure the effects of the rural 
community hospital demonstration required under section 410A of Public 
Law 108-173 are budget neutral, as required under section 410A(c)(2) of 
                                                    Public Law 108-173.

A. Calculation of the Adjusted Standardized Amount

1. Standardization of Base-Year Costs or Target Amounts

The national standardized amount is based on per discharge averages of 
  adjusted hospital costs from a base period (section 1886(d)(2)(A) of 
     the Act) or, for Puerto Rico, adjusted target amounts from a base 
   period (section 1886(d)(9)(B)(i) of the Act), updated and otherwise 
  adjusted in accordance with the provisions of section 1886(d) of the 
Act. The September 1, 1983 interim final rule (48 FR 39763) contained a 
  detailed explanation of how base-year cost data (from cost reporting 
        periods ending during FY 1981) were established in the initial 
development of standardized amounts for the IPPS. The September 1, 1987 
final rule (52 FR 33043, 33066) contains a detailed explanation of how 
the target amounts were determined, and how they are used in computing 
                                                 the Puerto Rico rates.
  Sections 1886(d)(2)(B) and (d)(2)(C) of the Act require us to update 
base-year per discharge costs for FY 1984 and then standardize the cost 
        data in order to remove the effects of certain sources of cost 
variations among hospitals. These effects include case-mix, differences 
in area wage levels, cost-of-living adjustments for Alaska and Hawaii, 
    indirect medical education costs, and costs to hospitals serving a 
                         disproportionate share of low-income patients.
  Under sections 1886(d)(2)(H) and (d)(3)(E) of the Act, the Secretary 
  estimates, from time-to-time, the proportion of costs that are wages 
 and wage-related costs. The standardized amount is divided into labor-
  related and nonlabor-related amounts; only the proportion considered 
   the labor-related amount is adjusted by the wage index. The current 
labor-related share is 71.1 percent. The current labor-related share in 
                                           Puerto Rico is 71.3 percent.
       Section 403 of Public Law 108-173 revises the proportion of the 
   standardized amount that is considered labor-related. Specifically, 
     section 403 of Public Law 108-173 requires that 62 percent of the 
    standardized amount be adjusted by the wage index, unless doing so 
  would result in lower payments to a hospital than would otherwise be 
 made (section 403(b) Public Law 108-173 extends this provision to the 
 Puerto Rico standardized amounts). As a consequence, we are adjusting 
 62 percent of the national and Puerto Rico standardized amount by the 
wage index for all hospitals whose wage indexes are less than or equal 
to 1.0000; otherwise, the wage index is applied to 71.1 percent of the 
                                                   standardized amount.

2. Computing the Average Standardized Amount

  Sections 1886(d)(2)(D) and (d)(3) of the Act previously required the 
Secretary to compute the following two average standardized amounts for 
   discharges occurring in a fiscal year: one for hospitals located in 
                                                      large urban areas

[[Page 49274]]

      and one for hospitals located in other areas. In addition, under 
  sections 1886(d)(9)(B)(iii) and (d)(9)(C)(i) of the Act, the average 
standardized amount per discharge was determined for hospitals located 
     in large urban and other areas in Puerto Rico. In accordance with 
          section 1886(b)(3)(B)(i) of the Act, the large urban average 
standardized amount was 1.6 percent higher than the other area average 
                                                   standardized amount.
       Section 402(b) of Public Law 108-7 required that, effective for 
 discharges occurring on or after April 1, 2003, and before October 1, 
   2003, the Federal rate for all IPPS hospitals would be based on the 
      large urban standardized amount. Subsequently, Public Law 108-89 
 extended section 402(b) of Public Law 108-7 beginning with discharges 
on or after October 1, 2003 and before March 31, 2004. Finally, section 
401(a) of Public Law 108-173 requires that, beginning with FY 2004 and 
    thereafter, an equal standardized amount is to be computed for all 
   hospitals at the level computed for large urban hospitals during FY 
  2003, updated by the applicable percentage update. This provision in 
effect makes permanent the equalization of the standardized amounts at 
         the level of the previous standardized amount for large urban 
hospitals. Section 401(c) Public Law 108-173 also equalizes the Puerto 
Rico-specific urban and other area rates. Accordingly, we are providing 
   in this final rule for a single national standardized amount, and a 
    single Puerto Rico standardized amount, for FY 2005 and thereafter.

3. Updating the Average Standardized Amount

       In accordance with section 1886(d)(3)(A)(iv) of the Act, we are 
    updating the equalized standardized amount for FY 2005 by the full 
estimated market basket percentage increase for hospitals in all areas, 
as specified in section 1886(b)(3)(B)(i)(XIX) of the Act, as amended by 
section 501 of Public Law 108-173. The percentage change in the market 
 basket reflects the average change in the price of goods and services 
     purchased by hospitals to furnish inpatient care. The most recent 
    forecast of the hospital market basket increase for FY 2005 is 3.3 
    percent. Thus, for FY 2005, the update to the average standardized 
                  amount equals 3.3 percent for hospitals in all areas.
As discussed above in section IV.E. of this final rule, section 501(b) 
of Public Law 108-173 amended section 1886(b)(3)(B) of the Act to add a 
        new subclause (vii) to revise the mechanism used to update the 
standardized amount for payment for inpatient hospital operating costs. 
Specifically, the amendment provides for a reduction of 0.4 percentage 
    points to the update percentage increase (also known as the market 
 basket update) for each of FYs 2005 through 2007 for any ``subsection 
       (d) hospital'' that does not submit data on a set of 10 quality 
   indicators established by the Secretary as of November 1, 2003. The 
statute also provides that any reduction will apply only to the fiscal 
    year involved, and will not be taken into account in computing the 
     applicable percentage increase for a subsequent fiscal year. This 
      measure establishes an incentive for hospitals to submit data on 
quality measures established by the Secretary. The standardized amount 
 in Tables 1A through 1D of section VI. of this addendum reflect these 
                                                  differential amounts.
Although the update factors for FY 2005 are set by law, we are required 
by section 1886(e)(3) of the Act to report to the Congress our initial 
  recommendation of update factors for FY 2005 for both IPPS hospitals 
and hospitals excluded from the IPPS. Our recommendation on the update 
 factors (which is required by sections 1886(e)(4)(A) and (e)(5)(A) of 
                the Act) is set forth as Appendix B of this final rule.

4. Other Adjustments to the Average Standardized Amount

   As in the past, we are adjusting the FY 2005 standardized amount to 
    remove the effects of the FY 2004 geographic reclassifications and 
outlier payments before applying the FY 2005 updates. We then apply the 
      new offsets for outliers and geographic reclassifications to the 
                                       standardized amount for FY 2005.
   We do not remove the prior year's budget neutrality adjustments for 
 reclassification and recalibration of the DRG weights and for updated 
wage data because, in accordance with section 1886(d)(4)(C)(iii) of the 
Act, estimated aggregate payments after the changes in the DRG relative 
weights and wage index should equal estimated aggregate payments prior 
 to the changes. If we removed the prior year adjustment, we would not 
                                                satisfy this condition.
  Budget neutrality is determined by comparing aggregate IPPS payments 
    before and after making the changes that are required to be budget 
       neutral (for example, reclassifying and recalibrating the DRGs, 
 updating the wage data, and geographic reclassifications). We include 
   outlier payments in the payment simulations because outliers may be 
                       affected by changes in these payment parameters.
  We are also adjusting the standardized amount this year by an amount 
    estimated to ensure that aggregate IPPS payments do not exceed the 
    amount of payments that would have been made in the absence of the 
 rural community hospital demonstration required under section 410A of 
Public Law 108-173. This demonstration is required to be budget neutral 
                        under section 410A(c)(2) of Public Law 108-173.

a. Recalibration of DRG Weights and Updated Wage Index--Budget Neutrality 
Adjustment

 Section 1886(d)(4)(C)(iii) of the Act specifies that, beginning in FY 
1991, the annual DRG reclassification and recalibration of the relative 
 weights must be made in a manner that ensures that aggregate payments 
     to hospitals are not affected. As discussed in section II. of the 
 preamble, we normalized the recalibrated DRG weights by an adjustment 
factor, so that the average case weight after recalibration is equal to 
 the average case weight prior to recalibration. However, equating the 
    average case weight after recalibration to the average case weight 
   before recalibration does not necessarily achieve budget neutrality 
   with respect to aggregate payments to hospitals because payments to 
     hospitals are affected by factors other than average case weight. 
      Therefore, as we have done in past years, we are making a budget 
       neutrality adjustment to ensure that the requirement of section 
                                  1886(d)(4)(C)(iii) of the Act is met.
   Section 1886(d)(3)(E) of the Act requires us to update the hospital 
wage index on an annual basis beginning October 1, 1993. This provision 
 also requires us to make any updates or adjustments to the wage index 
 in a manner that ensures that aggregate payments to hospitals are not 
affected by the change in the wage index. For FY 2005, we are applying 
     an occupational mix adjustment to the wage index. We describe the 
occupational mix adjustment in section III.C. of this final rule. Since 
 section 1886(d)(3)(E) of the Act requires us to update the wage index 
       on a budget neutral basis, we are including the effects of this 
occupational mix adjustment on the wage index in our budget neutrality 
                                                          calculations.
We are also adjusting the standardized amounts this year to ensure that 
the special transition to full implementation of the labor market areas 
      is budget neutral. Specifically, we ensured budget neutrality by 
  comparing aggregate IPPS payments including the special blended wage 
                                                        indexes that we

[[Page 49275]]

       are providing for certain hospitals in this final rule with the 
payments that would have been made if those hospitals had not received 
   blended wage indexes. As we discuss in section II. B. 3. d. of this 
final rule, we are providing a special blended wage index for hospitals 
       whose FY 2005 wage indexes would decrease solely because of the 
    adoption of the new labor market areas. Specifically, any hospital 
   experiencing a decrease in their wage index relative to its FY 2004 
   wage index because of the labor market area changes will receive 50 
percent of the wage index using the new labor market definitions and 50 
 percent of the wage index that the provider would have received under 
                                                 the old MSA standards.
 Section 4410 of Public Law 105-33 provides that, for discharges on or 
 after October 1, 1997, the area wage index applicable to any hospital 
that is not located in a rural area may not be less than the area wage 
   index applicable to hospitals located in rural areas in that State. 
 This provision is required by section 4410(b) of Public Law 105-33 to 
be budget neutral. Therefore, we include the effects of this provision 
    in our calculation of the wage update budget neutrality factor. As 
  discussed in section IV.N.6 of the preamble, we are imputing a floor 
for States that have no rural areas under the labor market definitions 
 that apply within the IPPS. We are also including the effects of this 
 new provision in our calculation of the wage update budget neutrality 
                                                                factor.
We previously were required to adjust the rates to ensure that any add-
 on payments for new technology under section 1886(d)(5)(K) of the Act 
be budget neutral. However, section 503(d)(2) of Public Law 108-173 has 
 repealed this requirement. We discuss this provision in section II.E. 
of this final rule. In accordance with this provision, we are making no 
           budget neutrality adjustment to account for approval of new 
                           technologies for add-on payments in FY 2005.
          To comply with the requirement that DRG reclassification and 
      recalibration of the relative weights be budget neutral, and the 
 requirement that the updated wage index be budget neutral, we used FY 
       2003 discharge data to simulate payments and compared aggregate 
payments using the FY 2004 relative weights and wage index to aggregate 
  payments using the FY 2005 relative weights and wage index. The same 
     methodology was used for the FY 2004 budget neutrality adjustment 
(although the FY 2004 adjustment included the effects of new technology 
                                                      add-on payments).
  Based on this comparison, we computed a budget neutrality adjustment 
       factor equal to 0.999876. We also are adjusting the Puerto Rico-
specific standardized amount for the effect of DRG reclassification and 
  recalibration. We computed a budget neutrality adjustment factor for 
     Puerto Rico-specific standardized amount equal to 1.000564. These 
  budget neutrality adjustment factors are applied to the standardized 
 amounts without removing the effects of the FY 2004 budget neutrality 
                                                           adjustments.
Using the same data, we also compared payments including the effects of 
 the blended wage indexes that we are providing in this final rule for 
certain hospitals with what payments would have been in the absence of 
      these blended wage indexes. As discussed above, we are providing 
blended wage indexes for hospitals whose FY 2005 wage indexes decrease 
         solely as a result of the labor market changes. Based on this 
    comparison, we computed a budget neutrality adjustment of 0.998162.
     In addition, we are applying these same adjustment factors to the 
 hospital-specific rates that are effective for cost reporting periods 
     beginning on or after October 1, 2004. (See the discussion in the 
                           September 4, 1990 final rule (55 FR 36073)).

b. Reclassified Hospitals--Budget Neutrality Adjustment

        Section 1886(d)(8)(B) of the Act provides that, effective with 
       discharges occurring on or after October 1, 1988, certain rural 
hospitals are deemed urban. In addition, section 1886(d)(10) of the Act 
provides for the reclassification of hospitals based on determinations 
 by the MGCRB. Under section 1886(d)(10) of the Act, a hospital may be 
                           reclassified for purposes of the wage index.
  Under section 1886(d)(8)(D) of the Act, the Secretary is required to 
adjust the standardized amount to ensure that aggregate payments under 
           the IPPS after implementation of the provisions of sections 
     1886(d)(8)(B) and (C) and 1886(d)(10) of the Act are equal to the 
 aggregate prospective payments that would have been made absent these 
  provisions. (Neither the wage index reclassifications provided under 
      section 508 of Public Law 108-173 nor the wage index adjustments 
  provided under section 505 of Public Law 108-173 are budget neutral. 
        Section 508(b) Public Law 108-173 provides that the wage index 
    reclassifications approved under section 508(a) Public Law 108-173 
``shall not be effected in a budget neutral manner.'' Section 505(a) of 
Public Law 108-173 similarly provides that any increase in a wage index 
 under that section shall not be taken into account ``in computing any 
budget neutrality adjustment with respect to such index under'' section 
1886(d)(8)(D) of the Act.) To calculate this budget neutrality factor, 
we used FY 2003 discharge data to simulate payments, and compared total 
           IPPS payments prior to any reclassifications under sections 
1886(d)(8)(B) and (C) and 1886(d)(10) of the Act to total IPPS payments 
      after such reclassifications. Based on these simulations, we are 
applying an adjustment factor of 0.993833 to ensure that the effects of 
                              this reclassification are budget neutral.
     The adjustment factor is applied to the standardized amount after 
      removing the effects of the FY 2004 budget neutrality adjustment 
factor. We note that the FY 2005 adjustment reflects FY 2005 wage index 
 reclassifications approved by the MGCRB or the Administrator, and the 
    effects of MGCRB reclassifications approved in FY 2003 and FY 2004 
                (section 1886(d)(10)(D)(v) of the Act makes wage index 
                              reclassifications effective for 3 years).

c. Outliers

 Section 1886(d)(5)(A) of the Act provides for payments in addition to 
       the basic prospective payments, for ``outlier'' cases involving 
   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 outlier payment). To determine whether the costs of a case 
 exceed the fixed-loss threshold, a hospital's cost-to-charge ratio is 
      applied to the total covered charges for the case to convert the 
charges to costs. Payments for eligible cases are then made based on a 
    marginal cost factor, which is a percentage of the costs above the 
                                                             threshold.
  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 operating DRG payments plus outlier payments. Section 
 1886(d)(3)(B) of the Act requires the Secretary to reduce the average 
standardized amount 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.

[[Page 49276]]

   i. FY 2005 outlier fixed-loss cost threshold. In the August 1, 2003 
IPPS final rule (68 FR 45476-45478), we established a threshold for FY 
 2004 that was equal to the prospective payment rate for the DRG, plus 
          any IME and DSH payments and any additional payments for new 
    technology, plus $31,000. The marginal cost factor (the percent of 
      costs paid after costs for the case exceed the threshold) was 80 
                                                               percent.
  To calculate the FY 2005 outlier thresholds, in the proposed rule we 
    simulated payments by applying proposed FY 2005 rates and policies 
      using cases from the FY 2003 MedPAR file. Therefore, in order to 
      determine the appropriate FY 2005 threshold, it was necessary to 
inflate the charges on the MedPAR claims by 2 years, from FY 2003 to FY 
   2005. We used a 2-year average annual rate of change in charges per 
  case to inflate FY 2003 charges to approximate FY 2005 charges. This 
was the same methodology as we used to determine the FY 2004 threshold.
  The 2-year average annual rate of change in charges per case from FY 
     2001 to FY 2002, and from FY 2002 to FY 2003, was 14.5083 percent 
annually, or 31.1 percent over 2 years. As we have done in the past, we 
     used hospital cost-to-charge ratios from the most recent Provider 
       Specific File, in this case the December 2003 update. This file 
includes cost-to-charge ratios reflecting implementation of changes we 
           made last year (68 FR 34494). As of October 1, 2003, fiscal 
  intermediaries use either the most recent settled or the most recent 
 tentative settled cost report, whichever is from the latest reporting 
 period. Because in the past cost-to-charge ratios were taken from the 
latest settled cost reports and for some hospitals there were delays in 
settling their cost reports, the cost-to-charge ratios on the Provider 
     Specific File may have been from cost reporting periods that were 
      several years prior. This change results in more up-to-date and, 
generally, lower cost-to-charge ratios. Using this methodology, in the 
May 18, 2004 proposed rule, we proposed to establish a fixed-loss cost 
  outlier threshold equal to the prospective payment rate for the DRG, 
        plus any IME and DSH payments, and any add-on payments for new 
                                              technology, plus $35,085.
    We also stated in the May 18, 2004 proposed rule that the proposed 
         outlier threshold for FY 2005 was higher than might have been 
 anticipated on the basis of the more up-to-date and, generally, lower 
    cost-to-charge ratios used in our calculations. We believed that a 
    significant factor in this result may have been the 2-year average 
 annual rates of change that we are employing to update charges in the 
   MedPAR data from FY 2003 to FY 2005. As we discussed above, for the 
    proposed rule, we used the 2-year average annual rate of change in 
charges per case from FY 2001 to FY 2002, and from FY 2002 to FY 2003, 
which is 14.5083 percent annually, or 31.1 percent over 2 years. These 
   rates of increase derive from the period before the changes we made 
last year to the outlier payment policy and to the calculation of cost-
   to-charge ratios (68 FR 34494). In fact, they derive from the years 
 just prior to the adoption of the policy changes, when some hospitals 
    were increasing charges at a rapid rate in order to increase their 
outlier payments. Therefore, they represent rates of increase that may 
    be higher than the rates of increase under our new policy. We have 
 always used actual data from prior years, rather than projections, to 
  update charges for purposes of determining the outlier threshold. In 
   light of the proposed increase to the outlier threshold for FY 2005 
   compared to the threshold previously in effect, in the May 18, 2004 
  proposed rule we solicited comments on the data we were proposing to 
     use to update charges for purposes of computing the threshold. We 
   especially encouraged commenters to provide any recommendations for 
     data that might better reflect current trends in charge increases.
 Comment: Several commenters opposed our proposal to raise the outlier 
threshold. These commenters urged us to lower the threshold or at least 
maintain the threshold at its current level. Some commenters explained 
  that this increase to the threshold would make it more difficult for 
hospitals to qualify for outlier payments and put them at greater risk 
  when treating high cost cases. The commenters also requested that we 
     take into account all changes from the June 9, 2003 final rule on 
outliers when calculating the outlier threshold. The commenters further 
 noted that, in the proposed rule, we estimated total outlier payments 
 for FY 2004 to be 4.4 percent of all inpatient payments, which is 0.7 
   percentage points less than the 5.1 percent that is offset from the 
 standardized amounts. Based on this analysis, one commenter estimated 
   the threshold should have been set at $26,565 instead of $31,000 to 
result in outlier payments of 5.1 percent for FY 2004. Other commenters 
                                recommended similarly lower thresholds.
 Most commenters also stated that we estimated a 2-year average annual 
  rate of change in charges of 31 percent. Some commenters recommended 
  that we use the market basket rate rather than charge data to update 
charges or return to the previous methodology that measured the percent 
change in costs using the two most recently available cost reports. One 
commenter also expressed concern over the estimated rate of increase in 
        charges. The commenters urged us to revise this figure and, if 
     necessary, use other data than historical data to set the outlier 
threshold. One commenter suggested that we limit the impact of hospital 
charge increases by requiring hospitals to report their percentage rate 
  increases. This would allow us to adjust individual hospital cost-to-
charge ratios without penalizing all hospitals for the actions of a few 
hospitals. The commenter also recommended the possibility of comparing 
   changes in costs, adjusted for acuity, between cost reporting years.
    Two commenters submitted the same data analysis explaining why the 
outlier threshold should be lowered. Both of the commenters noted that 
 using the March 2004 Hospital Provider Cost Report Information System 
  (HCRIS) file rather than the December 2003 HCRIS file for hospitals' 
cost-to-charge ratios resulted in a threshold of $32,510 instead of the 
  proposed $35,085 for FY 2005. As a result, one of the commenters was 
 strongly opposed to the proposed charge inflation methodology because 
it would overstate the outlier threshold and cause a payment reduction 
                                                          to hospitals.
The data analysis also used the March 2004 HCRIS file and a blend of a 
cost and charge inflation factor of 7.17 percent for costs and 14.5083 
percent for charges and accounted for the fact that hospitals' CCRs are 
 expected to decline throughout the fiscal year as a result of the use 
      of more current data reflecting the changes in hospital charging 
       practices after the June 9, 2003 final rule. This resulted in a 
 threshold of $28,445. One of the commenters noted that in last year's 
Federal Register, similar recommendations were made to account for the 
decline in CCRs when setting the outlier threshold. At that time, based 
        on a similar analysis for FY 2004, the commenter recommended a 
  threshold of $25,375 and estimates that a threshold of $25,325 in FY 
  2004 would have resulted in outlier payments equal to 5.1 percent of 
total DRG payment. Based on the analysis above, the commenter believes 
 this is an appropriate mechanism for estimating the outlier threshold 
  and recommends an outlier threshold of $28,445 or lower for FY 2005. 
  The other commenter further noted that this blend of cost and charge 
    inflation factors may make the threshold more accurate and reliable

[[Page 49277]]

                  and may help control for some of the time lag issues.
   The analysis then applied the same methodology described above, but 
instead used a charge inflation factor of 14.5083 percent from FY 2003 
to FY 2004, and projected a charge inflation factor of 10 percent from 
    FY 2004 to FY 2005. This resulted in a threshold of $26,660 for FY 
2005. One of the commenters explained that a projection of charges for 
  FY 2005 is necessary because, due to various circumstances that have 
  occurred in the past year such as increased pressure on hospitals to 
     reduce charges for the uninsured and hearings and investigations, 
        significant charge increases by hospitals, charges will not be 
    increasing at the same high rate as in recent years. The commenter 
     believes it is necessary to account for these industry changes in 
  estimating charge increases or there will be an overstatement of the 
  outlier threshold. Based on this analysis, the commenter recommended 
    that, if the trend in the rate of increase reflects a decline, the 
 threshold for FY 2005 should be lower than $28,445 to account for the 
   declining rate of increase in charges in the coming fiscal year. In 
  addition, based on this analysis, the other commenter recommended an 
  outlier threshold of no higher than $27,000 for FY 2005, in order to 
  ensure that hospitals receive outlier payments equal to at least 5.1 
percent of total DRG payments and have access to these special payments 
                        in order to offset the cost of high cost cases.
One of the commenters also compared our methodology prior to FY 2003 in 
which we used cost inflation in our estimate of the outlier threshold. 
       The commenter used a cost inflation factor of 7.17 percent when 
     estimating the threshold for FY 2005. Using a methodology of cost 
    inflation without a charge inflation factor and without the latest 
HCRIS file resulted in an outlier threshold of $24,465 for FY 2005. The 
  commenter added that using the same cost methodology with the latest 
   HCRIS file yielded an outlier threshold of $22,830 for FY 2005. The 
 commenter explained that we started using the charge inflation factor 
 instead of costs because there were problems with timely cost reports 
 due to the implementation of the Outpatient PPS. This problem has now 
been resolved and along with the reasons stated above recommended that 
revert to a methodology using costs when calculating the annual outlier 
                                                             threshold.
  One of the commenters also noted that none of the calculations above 
 factored in the impact of reconciliation that would result in an even 
                                               lower outlier threshold.
   Other commenters offered similar analysis and recommended similarly 
     lower thresholds. MedPAC also expressed concern that the proposed 
 outlier threshold for FY 2005 would lead to outlier payments that are 
  too low in FY 2005. MedPAC recommended that we take into account the 
anticipated slower growth in charges and identify methods and data that 
 would permit our estimate of charge growth to reflect current trends, 
such as by inflating charges from FY 2003 to FY 2005 using the rate of 
change in charges between the 9 months after the June 9, 2003 change in 
                 outlier policy and the same period the preceding year.
Response: In response to the many comments we received suggesting that 
   we revise the methodology for determining the outlier threshold, we 
have revised our methodology in order to calculate the FY 2005 outlier 
thresholds. We believe this revision to our methodology for FY 2005 is 
 necessary in order to address both the changes to the outlier payment 
        methodology and the exceptionally high rate of hospital charge 
 inflation that is reflected in the data for FYs 2001, 2002, and 2003. 
We also incorporated the policies from the June 9, 2003 regulation into 
      our calculation of the outlier threshold for FY 2004. Due to the 
limited time from the publication of that regulation to the publication 
 of the IPPS final rule for FY 2004, however, we had insufficient data 
          to determine the full impact that the changes to the outlier 
methodology would have on hospital charges. For FY 2005, because we now 
     have more recent data reflecting the impact of the changes to the 
outlier payment methodology upon hospital charges, we have revised our 
methodology for computing the outlier threshold for FY 2005 to account 
                                 for these changes in hospital charges.
    We simulated payments by applying FY 2005 rates and policies using 
  cases from the FY 2003 MedPAR file. Therefore, in order to determine 
     the appropriate FY 2005 threshold, it is necessary to inflate the 
     charges on the MedPAR claims by 2 years, from FY 2003 to FY 2005. 
  Instead of using the 2-year average annual rate of change in charges 
  per case from FY 2001 to FY 2002 and FY 2002 to FY 2003, however, we 
  are using more recent data to determine the annual rate of change in 
charges for the FY 2005 outlier threshold. Specifically, we are taking 
   the unprecedented step of using the first half-year of data from FY 
    2003 and comparing this data to the first half year of data for FY 
       2004. We believe this comparison will result in a more accurate 
determination of the rate of change in charges per case between FY 2003 
and FY 2005. Although a full year of data is available from FY 2003, we 
   do not have a full year of FY 2004 data. We therefore believe it is 
optimal to employ comparable periods in determining the rate of change 
from one year to the next. We also believe this methodology is the best 
    methodology for determining the rate of change in charges per case 
since it uses the most recent charge data available. Also, as stated in 
the June 9, 2003 Federal Register (68 FR 34505), we believe the use of 
 charge inflation is more appropriate than our previous methodology of 
 cost inflation because charges tend to increase at a much faster rate 
     than costs. Although some of the commenters have pointed out that 
charges have increased at a slower rate since the June 9, 2003 outlier 
final rule, we believe the use of charges is still appropriate because 
  the basic tendency of charges to increase faster than costs is still 
                                                               evident.
We note that we are adopting this methodology to calculate the outlier 
        threshold for FY 2005 as a result of the special circumstances 
 surrounding the revisions to the outlier payment methodology. We will 
       continue to consider other methodologies for determining charge 
        inflation when calculating the outlier threshold in the future.
   As stated above, we are using a new methodology to establish the FY 
2005 threshold. The 1-year average annual rate of change in charges per 
  case from the first half of FY 2003 to the first half of FY 2004 was 
 8.9772 percent, or 18.76 percent over 2 years. As discussed above, as 
 we have done in the past, we used hospital cost-to-charge ratios from 
   the most recent Provider Specific File, in this case the April 2004 
           update. This file includes cost-to-charge ratios reflecting 
implementation of changes we made last year to the policy affecting the 
applicable cost-to-charge ratios (68 FR 34494). We do not believe that 
  it is necessary to make a specific adjustment to our methodology for 
 computing the outlier threshold to account for any decline in cost-to-
     charge ratios in FY 2005, as the commenter has requested. We have 
 already taken into account the most significant factor in the decline 
in cost-to-charge ratios, specifically, the change from using the most 
recent final settled cost report to the most recent tentatively settled 
    cost report. Furthermore, we strongly prefer to employ actual data 
rather than projections in estimating the outlier threshold because we 
                    employ actual data in updating charges, themselves.

[[Page 49278]]

      However, we will continue to monitor the experience and evaluate 
         whether further requirements to our methodology are warranted.
 Using this methodology, we are establishing a fixed-loss cost outlier 
 threshold equal to the prospective payment rate for the DRG, plus any 
IME and DSH payments, and any add-on payments for new technology, plus 
                                                               $25,800.
  We are not including in the calculation of the outlier threshold the 
possibility that hospitals' cost-to-charge ratios and outlier payments 
  may be reconciled upon cost report settlement. Reconciliation occurs 
      when hospitals' cost-to-charge-ratios at the time of cost report 
  settlement are different than the tentatively settled cost-to-charge-
ratio used to make outlier payments during the fiscal year. However, we 
  believe that due to changes in hospital charging practices following 
implementation of the new outlier regulations in the June 9, 2003 final 
       rule, the majority of hospitals' cost-to-charge ratios will not 
   fluctuate significantly enough between the tentatively settled cost 
      report and the final settled cost report to meet the criteria to 
  trigger reconciliation of their outlier payments. Furthermore, it is 
       difficult to predict which specific hospitals may be subject to 
       reconciliation in any given year. As a result, we believe it is 
         appropriate to omit reconciliation from the outlier threshold 
                                                           calculation.
  ii. Other changes concerning outliers. As stated in the September 1, 
1993 final rule (58 FR 46348), we establish outlier thresholds that are 
    applicable to both hospital inpatient operating costs and hospital 
inpatient capital-related costs. When we modeled the combined operating 
     and capital outlier payments, we found that using a common set of 
     thresholds resulted in a lower percentage of outlier payments for 
   capital-related costs than for operating costs. We project that the 
  thresholds for FY 2005 will result in outlier payments equal to 5.10 
       percent of operating DRG payments and 4.9385 percent of capital 
                                    payments based on the Federal rate.
In accordance with section 1886(d)(3)(B) of the Act, we reduced the FY 
    2005 standardized amount by the same percentage to account for the 
                     projected proportion of payments paid to outliers.
   The outlier adjustment factors that are applied to the standardized 
                                     amount for FY 2005 are as follows:

------------------------------------------------------------------------
                                        Operating
                                       standardized     Capital federal
                                         amounts              rate
------------------------------------------------------------------------
National..........................           0.949005           0.950615
Puerto Rico.......................           0.973192           0.973757
------------------------------------------------------------------------

 We apply the outlier adjustment factors after removing the effects of 
     the FY 2004 outlier adjustment factors on the standardized amount.
  To determine whether a case qualifies for outlier payments, we apply 
  hospital-specific cost-to-charge ratios to the total covered charges 
 for the case. Operating and capital costs for the case are calculated 
  separately by applying separate operating and capital cost-to-charge 
ratios. These costs are then combined and compared with the fixed-loss 
                                                     outlier threshold.
      The June 9, 2003 outlier final rule (68 FR 34494) eliminated the 
application of the statewide average for hospitals whose cost-to-charge 
ratios fall below 3 standard deviations from the national mean cost-to-
       charge ratio. However, for those hospitals for which the fiscal 
    intermediary computes operating cost-to-charge ratios greater than 
1.240 or capital cost-to-charge ratios greater than 0.169, or hospitals 
     for whom the fiscal intermediary is unable to calculate a cost-to-
 charge ratio (as described at Sec.  412.84(i)(3) of our regulations), 
     we are still using statewide average ratios to calculate costs to 
determine whether a hospital qualifies for outlier payments.\11\ Table 
     8A in section VI. of this Addendum contains the statewide average 
     operating cost-to-charge ratios for urban hospitals and for rural 
    hospitals for which the fiscal intermediary is unable to compute a 
  hospital-specific cost-to-charge ratio within the above range. These 
statewide average ratios replace the ratios published in the August 1, 
   2003 IPPS final rule (68 FR 45637). Table 8B in section VI. of this 
    Addendum contains the comparable statewide average capital cost-to-
   charge ratios. Again, the cost-to-charge ratios in Tables 8A and 8B 
     will be used during FY 2005 when hospital-specific cost-to-charge 
ratios based on the latest settled cost report are either not available 
                                  or are outside the range noted above.

\11\ These figures represent 3.0 standard deviations from the mean of the 
log distribution of cost-to-charge ratios for all hospitals.

 iii. FY 2003 and FY 2004 outlier payments. In the August 1, 2003 IPPS 
 final rule (68 FR 45478), we stated that, based on available data, we 
 estimated that actual FY 2003 outlier payments would be approximately 
  6.5 percent of actual total DRG payments. This estimate was computed 
based on simulations using the FY 2002 MedPAR file (discharge data for 
  FY 2002 bills). That is, the estimate of actual outlier payments did 
not reflect actual FY 2003 bills, but instead reflected the application 
              of FY 2003 rates and policies to available FY 2002 bills.
   Our current estimate, using available FY 2003 bills, is that actual 
 outlier payments for FY 2003 were approximately 5.7 percent of actual 
    total DRG payments. Thus, the data indicate that, for FY 2003, the 
percentage of actual outlier payments relative to actual total payments 
    is higher than we projected before FY 2003 (and, thus, exceeds the 
 percentage by which we reduced the standardized amounts for FY 2003). 
 Nevertheless, consistent with the policy and statutory interpretation 
 we have maintained since the inception of the IPPS, we do not plan to 
 make retroactive adjustments to outlier payments to ensure that total 
    outlier payments for FY 2003 are equal to 5.1 percent of total DRG 
                                                              payments.
We currently estimate that actual outlier payments for FY 2004 will be 
approximately 3.5 percent of actual total DRG payments, 1.6 percentage 
     points lower than the 5.1 percent we projected in setting outlier 
 policies for FY 2004. This estimate is based on simulations using the 
 FY 2003 MedPAR file (discharge data for FY 2003 bills). We used these 
 data to calculate an estimate of the actual outlier percentage for FY 
     2004 by applying FY 2004 rates and policies, including an outlier 
                       threshold of $31,000 to available FY 2003 bills.

d. Section 410A of Public Law 108-173 Rural Community Hospital 
Demonstration Program Adjustment

Section 410A of Public Law 108-173 requires the Secretary to establish 
 a demonstration that will modify reimbursement for inpatient services 
 for up to fifteen small rural hospitals. Section 410A(c)(2) of Public 
   Law 108-173 requires that ``in conducting the demonstration program 
     under this section, the Secretary shall ensure that the aggregate 
                                                   payments made by the

[[Page 49279]]

Secretary do not exceed the amount which the Secretary would have paid 
if the demonstration program under this section was not implemented.'' 
   As discussed in section IV.P. of this final rule, we are satisfying 
 this requirement by adjusting national IPPS rates by a factor that is 
   sufficient to account for the added costs of this demonstration. We 
 estimate that the average additional annual payment that will be made 
        to each participating hospital under the demonstration will be 
approximately $855,893. We based this estimate on the recent historical 
   experience of the difference between inpatient cost and payment for 
        hospitals that would be eligible for the demonstration. For 15 
 participating hospitals, the total annual impact of the demonstration 
program is estimated to be $12,838,390. The required adjustment to the 
       Federal rate used in calculating Medicare inpatient prospective 
                 payments as a result of the demonstration is 0.999855.
 In order to achieve budget neutrality, we are adjusting national IPPS 
  rates by an amount sufficient to account for the added costs of this 
demonstration. In other words, we are applying budget neutrality across 
           the payment system as a whole rather than merely across the 
participants of this demonstration. We believe that the language of the 
statutory budget neutrality requirement permits the agency to implement 
   the budget neutrality provision in this manner. This is because the 
     statutory language requires that ``aggregate payments made by the 
Secretary do not exceed the amount which the Secretary would have paid 
if the demonstration * * * was not implemented,'' but does not identify 
          the range across which aggregate payments must be held equal.
In the May 18, 2004 proposed rule, we invited public comments on how we 
                  were proposing to implement this statutory provision.
 Comment: One commenter observed that we have historically implemented 
demonstration projects on a budget neutral basis within the context of 
the given demonstration. The commenter opposed our proposal to fund the 
Rural Community Hospital demonstration by reducing the payment rate to 
        all hospitals paid on the basis of DRGs, saying that requiring 
       nonparticipating hospitals to fund hospitals participating in a 
               demonstration project is a poor policy precedent to set.
       Response: The Rural Community Hospital Demonstration Program is 
mandated by section 410A of Public Law 108-173. It is aimed at testing 
     the feasibility and advisability of payment for covered inpatient 
services based on reasonable cost for rural hospitals as defined by the 
      legislation. The commenter is correct in stating that we usually 
implement demonstrations in which savings occurring among participants 
guarantee budget neutrality. However, in this case it is not realistic 
       to expect hospitals chosen for the demonstration to generate an 
       offsetting reduction in costs. Furthermore, we believe that the 
  statutory authority allows us to define budget neutrality across the 
 payment system. We believe that the method that we proposed to assure 
           budget neutrality is the only feasible way to implement the 
                               demonstration, which is mandated by law.

5. FY 2005 Standardized Amount

   The adjusted standardized amount is divided into labor and nonlabor 
portions. Tables 1A and 1B in section VI. of this Addendum contain the 
   national standardized amount that we are applying to all hospitals, 
  except hospitals in Puerto Rico. The amounts shown in the two tables 
differ only in that the labor-related share applied to the standardized 
      amounts in Table 1A is 71.1 percent, and the labor-related share 
     applied to the standardized amounts in Table 1B is 62 percent. As 
    described in section II.A.1. of this Addendum, we are implementing 
 section 403 of Pub. L. 108-173, which provides that the labor-related 
  share is 62 percent, unless the application of that percentage would 
  result in lower payments to a hospital than would otherwise be made. 
   The effect of this provision is that the labor-related share of the 
standardized amount is 62 percent for all hospitals whose wage indexes 
                                      are less than or equal to 1.0000.
   However, the labor-related share of the standardized amount remains 
      71.1 percent (reflecting the Secretary's current estimate of the 
        proportion of costs that are wages and wage-related costs) for 
hospitals whose wage indexes are greater than 1.0000. In addition, both 
   tables include standardized amounts reflecting the full 3.3 percent 
       update for FY 2005, and standardized amounts reflecting the 0.4 
percentage point reduction to the update applicable for hospitals that 
  fail to submit quality data consistent with section 501(b) of Public 
  Law 108-173. (Tables 1C and 1D show the new standardized amounts for 
Puerto Rico, reflecting the different labor shares that apply, that is, 
                                           71.3 percent or 62 percent.)
 The following table illustrates the changes from the FY 2004 national 
  average standardized amount. The first column shows the changes from 
  the 2004 standardized amounts for hospitals that satisfy the quality 
        data submission requirement for receiving the full update (3.3 
  percent). The second column shows the proposed changes for hospitals 
receiving the reduced update (2.9 percent). The first row in the table 
 shows the updated (through FY 2003) average standardized amount after 
     restoring the FY 2004 offsets for outlier payments and geographic 
      reclassification budget neutrality. The DRG reclassification and 
  recalibration and wage index budget neutrality factor is cumulative. 
   Therefore, the FY 2004 factor is not removed from the amount in the 
       table. We have added separate rows to this table to reflect the 
                different labor-related shares that apply to hospitals.

BILLING CODE 4120-01-P

[[Page 49280]]

[GRAPHIC] [TIFF OMITTED] TR11AU04.077

BILLING CODE 4120-01-C
    Under section 1886(d)(9)(A)(ii) of the Act, the Federal portion of 
the Puerto Rico payment rate is based on the discharge-weighted average 
of the national large urban standardized amount (as set forth in Table 
1A). The labor and nonlabor portions of the national average 
standardized amounts for Puerto Rico hospitals are set forth in Table 
1C of section VI. of this Addendum. This table also includes the Puerto 
Rico standardized amounts. The labor share applied to the Puerto Rico 
standardized amount is 71.3 percent, or 62 percent, depending on which 
is more advantageous to the hospital. (Section 403(b) of Public Law 
108-173 provides that the labor-related share for hospitals in Puerto 
Rico will be 62 percent, unless the application of that percentage 
would result in lower payments to the hospital.

B. Adjustments for Area Wage Levels and Cost-of-Living

    Tables 1A through 1D, as set forth in section VI. of this Addendum, 
contain the labor-related and nonlabor-related shares that we are using 
to calculate the prospective payment rates for hospitals located in the 
50 States, the District of Columbia, and Puerto Rico. This section 
addresses two types of adjustments to the standardized amounts that are 
made in determining the prospective payment rates as described in this 
Addendum.
1. Adjustment for Area Wage Levels
    Sections 1886(d)(3)(E) and 1886(d)(9)(C)(iv) of the Act require 
that

[[Page 49281]]

we make an adjustment to the labor-related portion of the national and 
Puerto Rico prospective payment rates, respectively, to account for 
area differences in hospital wage levels. This adjustment is made by 
multiplying the labor-related portion of the adjusted standardized 
amounts by the appropriate wage index for the area in which the 
hospital is located. In section III. of the preamble to this final 
rule, we discuss the data and methodology for the FY 2005 wage index. 
The FY 2005 wage index is set forth in Tables 4A, 4B, 4C, and 4F of 
section VI. of this Addendum.
2. Adjustment for Cost-of-Living in Alaska and Hawaii
    Section 1886(d)(5)(H) of the Act authorizes an adjustment to take 
into account the unique circumstances of hospitals in Alaska and 
Hawaii. Higher labor-related costs for these two States are taken into 
account in the adjustment for area wages described above. For FY 2005, 
we are adjusting the payments for hospitals in Alaska and Hawaii by 
multiplying the nonlabor portion of the standardized amount by the 
appropriate adjustment factor contained in the table below.

 Table of Cost-of-Living Adjustment Factors, Alaska and Hawaii Hospitals
------------------------------------------------------------------------
                                                         Cost of Living
                         Area                          Adjustment Factor
------------------------------------------------------------------------
Alaska-All--areas....................................               1.25
Hawaii:
    County of Honolulu...............................               1.25
    County of Hawaii.................................              1.165
    County of Kauai..................................             1.2325
    County of Maui...................................             1.2375
    County of Kalawao................................             1.2375
------------------------------------------------------------------------
 (The above factors are based on data obtained from the U.S. Office of
  Personnel Management.)

C. DRG Relative Weights

    As discussed in section II. of the preamble, we have developed a 
classification system for all hospital discharges, assigning them into 
DRGs, and have developed relative weights for each DRG that reflect the 
resource utilization of cases in each DRG relative to Medicare cases in 
other DRGs. Table 5 of section VI. of this Addendum contains the 
relative weights that we are using for discharges occurring in FY 2005. 
These factors have been recalibrated as explained in section II. of the 
preamble of this final rule.
D. Calculation of Prospective Payment Rates for FY 2005
General Formula for Calculation of Prospective Payment Rates for FY 
2005
    The proposed operating prospective payment rate for all hospitals 
paid under the IPPS located outside of Puerto Rico, except SCHs and 
MDHs, equals the Federal rate based on the corresponding amounts in 
Table 1A or Table 1B in section VI. of this Addendum.
    The prospective payment rate for SCHs equals the higher of the 
applicable Federal rate (from Table 1A or Table 1B) or the hospital-
specific rate as described below. The prospective payment rate for MDHs 
equals the higher of the Federal rate, or the Federal rate plus 50 
percent of the difference between the Federal rate and the hospital-
specific rate as described below. The prospective payment rate for 
Puerto Rico equals 25 percent of the Puerto Rico rate plus 75 percent 
of the applicable national rate from Table 1C or Table 1D in section 
VI. of this Addendum.
1. Federal Rate
    For discharges occurring on or after October 1, 2004 and before 
October 1, 2005, except for SCHs, MDHs, and hospitals in Puerto Rico, 
payment under the IPPS is based exclusively on the Federal rate.
    The Federal rate is determined as follows:
    Step 1--Select the appropriate average standardized amount 
considering the applicable wage index (Table 1A for wage indexes 
greater than 1.0000 and Table 1B for wage indexes less than or equal to 
1.0000) and whether the hospital has submitted qualifying quality data 
(full update for qualifying hospitals, update minus 0.4 percent for 
nonqualifying hospitals).
    Step 2--Multiply the labor-related portion of the standardized 
amount by the applicable wage index for the geographic area in which 
the hospital is located or the area to which the hospital is 
reclassified (see Tables 4A, 4B, and 4C of section VI. of this 
Addendum).
    Step 3--For hospitals in Alaska and Hawaii, multiply the nonlabor-
related portion of the standardized amount by the appropriate cost-of-
living adjustment factor.
    Step 4--Add the amount from Step 2 and the nonlabor-related portion 
of the standardized amount (adjusted, if appropriate, under Step 3).
    Step 5--Multiply the final amount from Step 4 by the relative 
weight corresponding to the appropriate DRG (see Table 5 of section VI. 
of this Addendum).
    The Federal rate as determined in Step 5 may then be further 
adjusted if the hospital qualifies for either the IME or DSH 
adjustment.
2. Hospital-Specific Rate (Applicable Only to SCHs and MDHs)

a. Calculation of Hospital-Specific Rate

    Section 1886(b)(3)(C) of the Act provides that SCHs are paid based 
on whichever of the following rates yields the greatest aggregate 
payment: the Federal rate; the updated hospital-specific rate based on 
FY 1982 costs per discharge; the updated hospital-specific rate based 
on FY 1987 costs per discharge; or the updated hospital-specific rate 
based on FY 1996 costs per discharge.
    Section 1886(d)(5)(G) of the Act provides that MDHs are paid based 
on whichever of the following rates yields the greatest aggregate 
payment: the Federal rate or the Federal rate plus 50 percent of the 
difference between the Federal rate and the greater of the updated 
hospital-specific rates based on either FY 1982 or FY 1987 costs per 
discharge. MDHs do not have the option to use their FY 1996 hospital-
specific rate.
    Hospital-specific rates have been determined for each of these 
hospitals based on either the FY 1982 costs per discharge, the FY 1987 
costs per discharge or, for SCHs, the FY 1996 costs per discharge. For 
a more detailed discussion of the calculation of the hospital-specific 
rates, we refer the reader to the September 1, 1983 interim final rule 
(48 FR 39772); the April 20, 1990 final rule with comment (55 FR 
15150); the September 4, 1990 final rule (55 FR 35994); and the August 
1, 2000 final rule (65 FR 47082). In addition, for both SCHs and MDHs, 
the hospital-specific rate is adjusted by the budget neutrality 
adjustment factor (that is, by 0.999876) as discussed in section 
II.A.4.a. of this Addendum. The resulting rate was used in determining 
the payment rate an SCH or MDH will receive for its discharges 
beginning on or after October 1, 2004.

b. Updating the FY 1982, FY 1987, and FY 1996 Hospital-Specific Rates 
for FY 2005

    We are increasing the hospital-specific rates by 3.3 percent (the 
hospital market basket percentage increase) for SCHs and MDHs for FY 
2005. Section 1886(b)(3)(C)(iv) of the Act provides that the update 
factor applicable to the hospital-specific rates for SCHs is equal to 
the update factor provided under section 1886(b)(3)(B)(iv) of the Act, 
which, for SCHs in FY 2005,

[[Page 49282]]

is the market basket rate of increase. Section 1886(b)(3)(D) of the Act 
provides that the update factor applicable to the hospital-specific 
rates for MDHs also equals the update factor provided under section 
1886(b)(3)(B)(iv) of the Act, which, for FY 2005, is the market basket 
rate of increase.
3. General Formula for Calculation of Prospective Payment Rates for 
Hospitals Located in Puerto Rico Beginning On or After October 1, 2004 
and Before October 1, 2005
    Section 504 of Public Law 108-173 changes the current blend of 50 
percent the Puerto Rico national prospective payment rate and 50 
percent of the Puerto Rico-specific prospective payment rate to 62.5 
percent Puerto Rico national and 37.5 percent Puerto Rico-specific 
effective for discharges occurring on or after April 1, 2004 and before 
October 1, 2004. Effective for discharges occurring on or after October 
1, 2004, the effective blend is 75 percent of the Puerto Rico national 
prospective payment rate and 25 percent of the Puerto Rico-specific 
rate.

a. Puerto Rico Rate

    The Puerto Rico prospective payment rate is determined as follows:
    Step 1--Select the appropriate average standardized amount 
considering the applicable wage index (Table 1C for wage indexes 
greater than 1.0000 and Table 1D for wage indexes less than or equal to 
1.0000).
    Step 2--Multiply the labor-related portion of the standardized 
amount by the appropriate Puerto Rico-specific wage index (see Table 4F 
of section VI. of the Addendum).
    Step 3--Add the amount from Step 2 and the nonlabor-related portion 
of the standardized amount.
    Step 4--Multiply the result in Step 3 by 25 percent.
    Step 5--Multiply the amount from Step 4 by the appropriate DRG 
relative weight (see Table 5 of section VI. of the Addendum).

b. National Rate

    The national prospective payment rate is determined as follows:
    Step 1--Select the appropriate average standardized amount 
considering the applicable wage index (Table 1C for wage indexes 
greater than 1.0000 and Table 1D for wage indexes less than or equal to 
1.0000).
    Step 2--Add the amount from Step 1 and the nonlabor-related portion 
of the national average standardized amount.
    Step 3--Multiply the result in Step 2 by 75 percent.
    Step 4--Multiply the amount from Step 3 by the appropriate DRG 
relative weight (see Table 5 of section VI. of the Addendum).
    The sum of the Puerto Rico rate and the national rate computed 
above equals the prospective payment for a given discharge for a 
hospital located in Puerto Rico. This rate may then be further adjusted 
if the hospital qualifies for either the IME or DSH adjustment.

III. Changes to Payment Rates for Acute Care Hospital Inpatient 
Capital-Related Costs for FY 2005

    The PPS for acute care hospital inpatient capital-related costs was 
implemented for cost reporting periods beginning on or after October 1, 
1991. Effective with that cost reporting period, hospitals were paid 
during a 10-year transition period (which extended through FY 2001) to 
change the payment methodology for Medicare acute care hospital 
inpatient capital-related costs from a reasonable cost-based 
methodology to a prospective methodology (based fully on the Federal 
rate).
    The basic methodology for determining Federal capital prospective 
rates is set forth in regulations at ''412.308 through 412.352. Below 
we discuss the factors that we are using to determine the capital 
Federal rate for FY 2005, which will be effective for discharges 
occurring on or after October 1, 2004. The 10-year transition period 
ended with hospital cost reporting periods beginning on or after 
October 1, 2001 (FY 2002). Therefore, for cost reporting periods 
beginning in FY 2002, all hospitals (except Anew@ hospitals under 
''412.304(c)(2) and 412.324(b)) are paid based on 100 percent of the 
capital Federal rate. For FY 1992, we computed the standard Federal 
payment rate for capital-related costs under the IPPS by updating the 
FY 1989 Medicare inpatient capital cost per case by an actuarial 
estimate of the increase in Medicare inpatient capital costs per case. 
Each year after FY 1992, we update the capital standard Federal rate, 
as provided at '412.308(c)(1), to account for capital input price 
increases and other factors. The regulations at '412.308(c)(2) provide 
that the capital Federal rate is adjusted annually by a factor equal to 
the estimated proportion of outlier payments under the capital Federal 
rate to total capital payments under the capital Federal rate. In 
addition, '412.308(c)(3) requires that the capital Federal rate be 
reduced by an adjustment factor equal to the estimated proportion of 
payments for (regular and special) exceptions under '412.348. Section 
412.308(c)(4)(ii) requires that the capital standard Federal rate be 
adjusted so that the effects of the annual DRG reclassification and the 
recalibration of DRG weights and changes in the geographic adjustment 
factor are budget neutral.
    For FYs 1992 through 1995, '412.352 required that the capital 
Federal rate also be adjusted by a budget neutrality factor so that 
aggregate payments for inpatient hospital capital costs were projected 
to equal 90 percent of the payments that would have been made for 
capital-related costs on a reasonable cost basis during the fiscal 
year. That provision expired in FY 1996. Section 412.308(b)(2) 
describes the 7.4 percent reduction to the capital rate that was made 
in FY 1994, and '412.308(b)(3) describes the 0.28 percent reduction to 
the capital rate made in FY 1996 as a result of the revised policy of 
paying for transfers. In FY 1998, we implemented section 4402 of Public 
Law 105-33, which required that, for discharges occurring on or after 
October 1, 1997, and before October 1, 2002, the unadjusted capital 
standard Federal rate is reduced by 17.78 percent. As we discussed in 
the August 1, 2002 IPPS final rule (67 FR 50102) and implemented in 
'412.308(b)(6)), a small part of that reduction was restored effective 
October 1, 2002.
    To determine the appropriate budget neutrality adjustment factor 
and the regular exceptions payment adjustment during the 10-year 
transition period, we developed a dynamic model of Medicare inpatient 
capital-related costs; that is, a model that projected changes in 
Medicare inpatient capital-related costs over time. With the expiration 
of the budget neutrality provision, the capital cost model was only 
used to estimate the regular exceptions payment adjustment and other 
factors during the transition period. As we explained in the August 1, 
2001 IPPS final rule (66 FR 39911), beginning in FY 2003, an adjustment 
for regular exception payments is no longer necessary because regular 
exception payments were only made for cost reporting periods beginning 
on or after October 1, 1991, and before October 1, 2001 (see 
'412.348(b)). Because, effective with cost reporting periods beginning 
in FY 2002, payments are no longer being made under the regular 
exception policy, we no longer use the capital cost model. The capital 
cost model and its application during the transition period are 
described in Appendix B of the August 1, 2001 IPPS final rule (66 FR 
40099).
    In accordance with section 1886(d)(9)(A) of the Act, under the IPPS 
for acute care hospital operating costs, hospitals located in Puerto 
Rico are paid for operating costs under a special

[[Page 49283]]

payment formula. Prior to FY 1998, hospitals in Puerto Rico were paid a 
blended capital rate that consisted of 75 percent of the applicable 
standardized amount specific to Puerto Rico hospitals and 25 percent of 
the applicable national average standardized amount. However, effective 
October 1, 1997, in accordance with section 4406 of Public Law 105-33, 
operating payments to hospitals in Puerto Rico are based on a blend of 
50 percent of the applicable standardized amount specific to Puerto 
Rico hospitals and 50 percent of the applicable national average 
standardized amount. In conjunction with this change to the operating 
blend percentage, effective with discharges on or after October 1, 
1997, we also revised the methodology for computing capital payments to 
hospitals in Puerto Rico and computing capital payments based on a 
blend of 50 percent of the Puerto Rico capital rate and 50 percent of 
the capital Federal rate.
    As we discuss in section VI. of this Addendum to the final rule, 
section 504 of Public Law 108-173 increased the national portion of the 
operating IPPS payments for Puerto Rico hospitals from 50 percent to 
62.5 percent and decreased the Puerto Rico portion of the operating 
IPPS payments from 50 percent to 37.5 percent for discharges occurring 
on or after April 1, 2004 through September 30, 2004 (see the March 26, 
2004 One-Time Notification (Change Request 3158)). In addition, section 
504 of Public Law 108-173 provides that the national portion of 
operating IPPS payments for Puerto Rico hospitals is equal to 75 
percent and the Puerto Rico portion of operating IPPS payments is equal 
to 25 percent for discharges occurring on or after October 1, 2004. 
Consistent with this change in operating IPPS payments to hospitals in 
Puerto Rico, for FY 2005, as we discuss in section V.B. of this 
Addendum to this final rule, we are revising the methodology for 
computing capital IPPS payments to hospitals located in Puerto Rico. We 
are computing capital payments to hospitals located in Puerto Rico 
based on a blend of 25 percent of the Puerto Rico capital rate and 75 
percent of the capital Federal rate for discharges occurring on or 
after October 1, 2004.
    Section 412.374 provides for the use of a blended payment system 
for payments to Puerto Rico hospitals under the PPS for acute care 
hospital inpatient capital-related costs. Accordingly, under the 
capital IPPS, we compute a separate payment rate specific to Puerto 
Rico hospitals using the same methodology used to compute the national 
Federal rate for capital-related costs.

A. Determination of Federal Hospital Inpatient Capital-Related 
Prospective Payment Rate Update

    In the final IPPS rule published in the Federal Register on August 
1, 2003 (68 FR 45346), we established a capital Federal rate of $415.47 
for FY 2004. However, a correction notice to the FY 2004 IPPS final 
rule issued in the Federal Register on October 6, 2003 (68 FR 57731) 
contains corrections and revisions to the wage index and geographic 
adjustment factor (GAF). In conjunction with the change to the wage 
index and GAF corrections, we established a revised capital IPPS 
standard Federal rate of $414.18 effective for discharges occurring in 
FY 2004. Furthermore, the One-Time Notification (Change Request 3158), 
issued on March 26, 2004, implemented various changes in operating IPPS 
payments required by sections 401, 402 and 504 of Public Law 108-173. 
As a result of these changes to payments under the operating IPPS, the 
fixed loss amount for determining the cost outlier threshold was 
revised effective for discharges occurring on or after April 1, 2004, 
through September 30, 2004. Because the regulations at '412.312(c) 
establish a unified outlier methodology for inpatient operating and 
capital-related costs, a single set of thresholds are used to identify 
outlier cases under both the operating IPPS and the capital IPPS. As a 
result of the revision to the fixed loss amount used for determining 
the cost outlier threshold effective for discharges occurring on or 
after April 1, 2004, through September 30, 2004, we established a new 
capital IPPS standard Federal rate of $413.48 effective for discharges 
occurring on or after April 1, 2004, through September 30, 2004.
    Because there are two capital IPPS standard Federal rates in effect 
during FY 2004 ($414.18 from October 2003 through March 2004 and 
$413.48 from April 2004 through September 2004), we are using an 
average of the rates effective for the first half of FY 2004 (October 
1, 2003 through March 31, 2004) ($414.18) and the second half FY 2004 
(April 1, 2004 through September 30, 2004) ($413.48) to determine the 
FY 2005 capital Federal rate. (The average is $413.83 (($414.18 + 
$413.48)/2.) As a result of the changes to the factors used to 
determine the capital Federal rate that are explained in this Addendum, 
the FY 2005 capital standard Federal rate is $416.63.
    In the discussion that follows, we explain the factors that were 
used to determine the FY 2005 capital Federal rate. In particular, we 
explain why the FY 2005 capital Federal rate has increased 0.68 percent 
compared to the FY 2004 capital Federal rate. We also estimate 
aggregate capital payments will increase by 6.0 percent during this 
same period. This increase is due to several factors, including an 
increase in the number of hospital admissions, an increase in case-mix, 
an increase in the GAF values, and an estimated increase in outlier 
payments. This increase in capital payments is more than last year (1.4 
percent), mostly due to the increase in wage index values (and GAF 
values) provided for by sections 505 and 508 of Public Law 108-173, and 
the projected increase in outlier payments as a result of the decrease 
in the fixed-loss amount for FY 2005. (We note that in the proposed 
rule, our projection that aggregate capital IPPS payments would remain 
unchanged largely because of a projected decrease in Medicare Part A 
(fee-for-service) admissions was incorrect. In fact, our estimate of 
aggregate capital IPPS payments should have included a projected 
increase (rather than decrease) in Medicare Part A enrollment and 
therefore, we should have estimated that aggregate capital IPPS 
payments would increase from FY 2004 to FY 2005 in the proposed rule.)
    Total payments to hospitals under the IPPS are relatively 
unaffected by changes in the capital prospective payments. Since 
capital payments constitute about 10 percent of hospital payments, a 1-
percent change in the capital Federal rate yields only about 0.1 
percent change in actual payments to hospitals. Aggregate payments 
under the capital IPPS are estimated to increase in FY 2005 compared to 
FY 2004.
1. Capital Standard Federal Rate Update a. Description of the Update 
Framework
    Under '412.308(c)(1), the capital standard Federal rate is updated 
on the basis of an analytical framework that takes into account changes 
in a capital input price index (CIPI) and several other policy 
adjustment factors. Specifically, we have adjusted the projected CIPI 
rate of increase as appropriate each year for case-mix index-related 
changes, for intensity, and for errors in previous CIPI forecasts. The 
update factor for FY 2005 under that framework is 0.7 percent based on 
the best data available at this time. The update factor is based on a 
projected 0.7 percent increase in the CIPI, a 0.0 percent adjustment 
for intensity, a 0.0 percent adjustment for case-mix, a 0.0 percent 
adjustment for the FY 2003 DRG reclassification and recalibration, and 
a forecast error correction of 0.0 percent. We explain the basis for 
the FY 2005 CIPI projection in section III.C. of this

[[Page 49284]]

Addendum. Below we describe the policy adjustments that have been 
applied.
    The case-mix index is the measure of the average DRG weight for 
cases paid under the IPPS. Because the DRG weight determines the 
prospective payment for each case, any percentage increase in the case-
mix index corresponds to an equal percentage increase in hospital 
payments.
    The case-mix index can change for any of several reasons:
    ! The average resource use of Medicare patients changes (--real-- 
case-mix change);
    ! Changes in hospital coding of patient records result in higher 
weight DRG assignments (Acoding effects@); and
    ! The annual DRG reclassification and recalibration changes may not 
be budget neutral (``reclassification effect'').
    We define real case-mix change as actual changes in the mix (and 
resource requirements) of Medicare patients as opposed to changes in 
coding behavior that result in assignment of cases to higher weighted 
DRGs but do not reflect higher resource requirements. In the update 
framework for the IPPS for operating costs, we adjust the update 
upwards to allow for real case-mix change, but remove the effects of 
coding changes on the case-mix index. We also remove the effect on 
total payments of prior year changes to the DRG classifications and 
relative weights, in order to retain budget neutrality for all case-mix 
index-related changes other than patient severity. (For example, we 
adjusted for the effects of the FY 2003 DRG reclassification and 
recalibration as part of our update for FY 2005.) We have adopted this 
case-mix index adjustment in the capital update framework as well.
    For FY 2005, we are projecting a 1.0 percent total increase in the 
case-mix index. We estimate that the real case-mix increase will equal 
1.0 percent in FY 2005. The net adjustment for change in case mix is 
the difference between the projected total increase in case mix and the 
projected increase in real case-mix change. Therefore, the net 
adjustment for case-mix change in FY 2005 is 0.0 percentage points.
    We estimate that FY 2003 DRG reclassification and recalibration 
will result in a 0.0 percent change in the case-mix when compared with 
the case-mix index that would have resulted if we had not made the 
reclassification and recalibration changes to the DRGs. Therefore, we 
are making a 0.0 percent adjustment for DRG reclassification and 
recalibration in the update for FY 2005 to maintain budget neutrality.
    The capital update framework contains an adjustment for forecast 
error. The input price index forecast is based on historical trends and 
relationships ascertainable at the time the update factor is 
established for the upcoming year. In any given year, there may be 
unanticipated price fluctuations that may result in differences between 
the actual increase in prices and the forecast used in calculating the 
update factors. In setting a prospective payment rate under the 
framework, we make an adjustment for forecast error only if our 
estimate of the change in the capital input price index for any year is 
off by 0.25 percentage points or more. There is a 2-year lag between 
the forecast and the measurement of the forecast error. A forecast 
error of 0.0 percentage points was calculated for the FY 2003 update. 
That is, current historical data indicate that the forecasted FY 2003 
CIPI used in calculating the FY 2003 update factor (0.7 percent) 
slightly overstated the actual realized price increases (0.6 percent) 
by 0.1 percentage points. This slight overprediction was mostly due to 
an underestimation of the interest rate cuts by the Federal Reserve 
Board in 2003, which impacted the interest component of the CIPI. 
However, since this estimation of the change in the CIPI is less than 
0.25 percentage points, it is not reflected in the update recommended 
under this framework. Therefore, we are making a 0.0 percent adjustment 
for forecast error in the update for FY 2005.
    Under the capital IPPS system framework, we also make an adjustment 
for changes in intensity. We calculate this adjustment using the same 
methodology and data that are used in the framework for the operating 
PPS. The intensity factor for the operating update framework reflects 
how hospital services are utilized to produce the final product, that 
is, the discharge. This component accounts for changes in the use of 
quality-enhancing services, for changes in within-DRG severity, and for 
expected modification of practice patterns to remove noncost-effective 
services.
    We calculate case-mix constant intensity as the change in total 
charges per admission, adjusted for price level changes (the CPI for 
hospital and related services) and changes in real case-mix. The use of 
total charges in the calculation of the intensity factor makes it a 
total intensity factor, that is, charges for capital services are 
already built into the calculation of the factor. Therefore, we have 
incorporated the intensity adjustment from the operating update 
framework into the capital update framework. Without reliable estimates 
of the proportions of the overall annual intensity increases that are 
due, respectively, to ineffective practice patterns and to the 
combination of quality-enhancing new technologies and within-DRG 
complexity, we assume, as in the operating update framework, that one-
half of the annual increase is due to each of these factors. The 
capital update framework thus provides an add-on to the input price 
index rate of increase of one-half of the estimated annual increase in 
intensity, to allow for within-DRG severity increases and the adoption 
of quality-enhancing technology.
    We have developed a Medicare-specific intensity measure based on a 
5-year average. Past studies of case-mix change by the RAND Corporation 
(``Has DRG Creep Crept Up? Decomposing the Case Mix Index Change 
Between 1987 and 1988'' by G. M. Carter, J. P. Newhouse, and D. A. 
Relles, R-4098-HCFA/ProPAC (1991)) suggest that real case-mix change 
was not dependent on total change, but was usually a fairly steady 1.0 
to 1.4 percent per year. We use 1.4 percent as the upper bound because 
the RAND study did not take into account that hospitals may have 
induced doctors to document medical records more completely in order to 
improve payment.
    We calculate case-mix constant intensity as the change in total 
charges per admission, adjusted for price level changes (the CPI for 
hospital and related services), and changes in real case-mix. As we 
noted above, in accordance with Sec.  412.308(c)(1)(ii), we began 
updating the capital standard Federal rate in FY 1996 using an update 
framework that takes into account, among other things, allowable 
changes in the intensity of hospital services. For FYs 1996 through 
2001, we found that case-mix constant intensity was declining and we 
established a 0.0 percent adjustment for intensity in each of those 
years. For FYs 2001 and 2002, we found that case-mix constant intensity 
was increasing and we established a 0.3 percent adjustment and 1.0 
percent adjustment for intensity, respectively.
    Using the methodology described above, for FY 2005 we examined the 
change in total charges per admission, adjusted for price level changes 
(the CPI for hospital and related services), and changes in real case-
mix for FYs 1999 through 2003. As we discussed in the May 18, 2004 IPPS 
proposed rule (69 FR 28382), we found that, over this period and in 
particular the last 4 years of this period (FYs 2000 through 2003), the 
charge data appear to be skewed. More

[[Page 49285]]

specifically, we found a dramatic increase in hospital charges for FYs 
2000 through 2003 without a corresponding increase in the hospital 
case-mix index. These findings are similar to the considerable increase 
in hospitals' charges, which we found when we were determining the 
intensity factor in the FY 2004 update recommendation as discussed in 
the August 1, 2003 final rule (68 FR 45482). If hospitals were treating 
new or different types of cases, which would result in an appropriate 
increase in charges per discharge, then we would expect hospitals' case 
mix to increase proportionally.
    As we discussed in the August 1, 2003 final rule (68 FR 45482), 
because our intensity calculation relies heavily upon charge data and 
we believe that this charge data may be inappropriately skewed, we 
established a 0.0 percent adjustment for intensity for FY 2004. In that 
same final rule, we stated that we believe that it is appropriate to 
propose a zero intensity adjustment until we believe that any increase 
in charges can be tied to intensity rather than to attempts to maximize 
outlier payments. As discussed previously in this section, we believe 
that the most recently available charge data used to make this 
determination may still be inappropriately skewed. Therefore, in the 
May 18, 2004 proposed rule (69 FR 28382), we proposed a 0.0 percent 
adjustment for intensity for FY 2005. As we explained in that same 
proposed rule, in the past FYs (1996 through 2000) when we found 
intensity to be declining, we believed a zero (rather then negative) 
intensity adjustment was appropriate. Similarly, we believe that it is 
appropriate to apply a zero intensity adjustment for FY 2005 until any 
increase in charges can be tied to intensity rather than to attempts to 
maximize outlier payments. We received no comments on our proposed 0.0 
percent adjustment for intensity. Therefore, in this final rule, we are 
making a 0.0 percent adjustment for intensity in the update framework 
for FY 2005.
    Comment: One commenter recommended that we update the standard 
Federal rate for capital-related costs by the same percentage as the 
standardized amount for operating costs (that is, 3.3 percent).
    Response: As noted above, the capital standard Federal rate is 
updated annually based on an analytical framework that takes into 
account changes in the input price index for capital costs (that is, 
CIPI or the capital market basket) and other policy adjustment factors. 
While the other policy adjustment factors in the capital PPS update 
framework (that is, case-mix change, intensity, and DRG 
reclassification and recalibration) are the same as the policy 
adjustment factors in our update recommendation for the standardized 
rate for operating costs discussed in Appendix B of this final rule, 
each update framework utilizes an input price index that measures the 
price changes associated with the respective category of costs (that 
is, capital costs or operating costs) during a given year. The 3.3 
percent update to the standardized amount for operating costs for FY 
2005 is based on our most recent estimate of the input price index for 
operating costs and thus it is not an appropriate index to use for 
updating the standard Federal rate for capital-related costs.
    As discussed in section III.C. of this preamble, we believe that 
the CIPI is the most appropriate input price index for capital costs to 
measure capital price changes in a given year. As we discussed above, 
the final update to the standard capital Federal rate for FY 2005 is 
0.7 percent. This update is based on a projected 0.7 percent increase 
in the CIPI. As we discussed above, we are not projecting any increase 
for intensity, case-mix, DRG reclassification and recalibration, or 
forecast error for FY 2005.
    Above we described the basis of the components used to develop the 
0.7 percent capital update factor for FY 2005 as shown in the table 
below.

         CMS's FY 2005 Update Factor to the Capital Federal Rate
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Capital Input Price Index..................................          0.7
Intensity:.................................................          0.0
Case-Mix Adjustment Factors:
Projected Case-Mix Change..................................          1.0
Real Across DRG Change.....................................         B1.0
    Subtotal...............................................          0.0
Effect of FY 2003 Reclassification and Recalibration.......          0.0
    Forecast Error Correction..............................          0.0
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b. Comparison of CMS and MedPAC Update Recommendation
    In the past, MedPAC has included update recommendations for capital 
PPS in a Report to Congress. In its March 2004 Report to Congress, 
MedPAC did not make an update recommendation for capital PPS payments 
for FY 2005. However, in that same report, MedPAC made an update 
recommendation for hospital inpatient and outpatient services (page 
87). MedPAC reviews inpatient and outpatient services together since 
they are so closely interrelated. MedPAC's recommendation of the full 
market basket update for both the inpatient and outpatient PPSs is 
based on their assessment of beneficiaries' access to care, volume 
growth, access to capital, quality, and the relationship of Medicare 
payments to costs in the hospital sector.
2. Outlier Payment Adjustment Factor
    Section 412.312(c) establishes a unified outlier methodology for 
inpatient operating and inpatient capital-related costs. A single set 
of thresholds is used to identify outlier cases for both inpatient 
operating and inpatient capital-related payments. Section 412.308(c)(2) 
provides that the standard Federal rate for inpatient capital-related 
costs be reduced by an adjustment factor equal to the estimated 
proportion of capital related outlier payments to total inpatient 
capital-related PPS payments. The outlier thresholds are set so that 
operating outlier payments are projected to be 5.1 percent of total 
operating DRG payments.
    In the August 1, 2003 IPPS final rule (68 FR 45482), we estimated 
that outlier payments for capital in FY 2004 would equal 4.79 percent 
of inpatient capital-related payments based on the FY 2004 capital 
Federal rate. Accordingly, we applied an outlier adjustment factor of 
0.9521 to the FY 2004 capital Federal rate. However, as we noted above, 
we published a correction notice in the

[[Page 49286]]

Federal Register on October 6, 2003 (68 FR 57731), which established 
revised rates and factors for FY 2004. In that same correction notice 
(68 FR 57734), we estimated that outlier payments for capital in FY 
2004 would equal 4.77 percent of inpatient capital-related payments 
based on the FY 2004 capital Federal rate. Accordingly, we established 
a revised outlier adjustment of 0.9523 for use in determining the FY 
2004 capital Federal rate. In addition, as we noted above, a One-Time 
Notification (Change Request 3158) issued on March 26, 2004, 
implemented various changes in operating IPPS payments required by 
sections 401, 402, and 504 of Public Law 108-173, effective for 
discharges on or after April 1, 2004, through September 30, 2004. As a 
result of changes made to payments under the operating IPPS, the rates 
and some of the factors, including the outlier adjustment, under the 
capital IPPS were also revised effective for discharges on or after 
April 1, 2004, through September 30, 2004. The revised outlier 
adjustment effective for the second half of FY 2004 (April 2004 through 
September 2004) is 0.9508.
    Based on the thresholds as set forth in section II.A.4.c. of this 
Addendum, we estimate that outlier payments for capital will equal 4.94 
percent of inpatient capital-related payments based on the capital 
Federal rate in FY 2005. Therefore, we are applying an outlier 
adjustment factor of 0.9506 to the capital Federal rate. Thus, the 
percentage of capital outlier payments to total capital standard 
payments for FY 2005 is higher than the percentages estimated for the 
first half (4.77 percent for October 2003 through March 2004) and the 
second half (4.92 percent for April 2004 through September 2004) of FY 
2004.
    The outlier reduction factors are not built permanently into the 
capital rates; that is, they are not applied cumulatively in 
determining the capital Federal rate. As we discussed above, there were 
two outlier adjustment factors applied during FY 2004 (0.9523 from 
October 2003 through March 2004 and 0.9508 from April 2004 through 
September 2004). The FY 2005 outlier adjustment of 0.9506 is a -0.09 
percent change from the average FY 2004 outlier adjustment of 0.9515 
(the mean of the factors for the first half of FY 2004 (0.9523) and the 
second half of FY 2004 (0.9508) calculated from unrounded numbers). The 
net change in the outlier adjustment to the capital Federal rate for FY 
2005 is 0.9991 (0.9506/0.9515). Thus, the outlier adjustment decreases 
the FY 2005 capital Federal rate by 0.09 percent compared with the 
average FY 2004 outlier adjustment.
3. Budget Neutrality Adjustment Factor for Changes in DRG 
Classifications and Weights and the Geographic Adjustment Factor
    Section 412.308(c)(4)(ii) requires that the capital Federal rate be 
adjusted so that aggregate payments for the fiscal year based on the 
capital Federal rate after any changes resulting from the annual DRG 
reclassification and recalibration and changes in the geographic 
adjustment factor (GAF) are projected to equal aggregate payments that 
would have been made on the basis of the capital Federal rate without 
such changes. Since we implemented a separate geographic adjustment 
factor for Puerto Rico, we apply separate budget neutrality adjustments 
for the national geographic adjustment factor and the Puerto Rico 
geographic adjustment factor. We apply the same budget neutrality 
factor for DRG reclassifications and recalibration nationally and for 
Puerto Rico. Separate adjustments were unnecessary for FY 1998 and 
earlier fiscal years since the geographic adjustment factor for Puerto 
Rico was implemented in FY 1998.
    In the past, we used the actuarial capital cost model (described in 
Appendix B of the August 1, 2001 IPPS final rule (66 FR 40099)) to 
estimate the aggregate payments that would have been made on the basis 
of the capital Federal rate with and without changes in the DRG 
classifications and weights and in the GAF to compute the adjustment 
required to maintain budget neutrality for changes in DRG weights and 
in the GAF. During the transition period, the capital cost model was 
also used to estimate the regular exception payment adjustment factor. 
As we explain in section III.A.4. of this Addendum, beginning in FY 
2002, an adjustment for regular exception payments is no longer 
necessary. Therefore, we are no longer using the capital cost model. 
Instead, we are using historical data based on hospitals' actual cost 
experiences to determine the exceptions payment adjustment factor for 
special exceptions payments.
    To determine the final factors for FY 2005, we compared (separately 
for the national capital rate and the Puerto Rico capital rate) 
estimated aggregate capital Federal rate payments based on the FY 2004 
DRG relative weights and the average FY 2004 GAF (that is, the mean of 
the GAFs applied from October 2003 through March 2004 and the GAFs 
applied from April 2004 through September 2004) to estimated aggregate 
capital Federal rate payments based on the FY 2005 relative weights and 
the FY 2005 GAF. For the first half of FY 2004 (October 1, 2003 through 
March 31, 2004), the budget neutrality adjustment factors were 0.9908 
for the national capital rate and 0.9974 for the Puerto Rico capital 
rate (see the October 6, 2003 correction notice). For the second half 
of FY 2004 (April 1, 2004 through September 30, 2004), the budget 
neutrality adjustment factor was revised to 0.9907 for the national 
capital rate (see the March 26, 2004 One-Time Notification). The budget 
neutrality factor for the Puerto Rico capital rate remained unchanged 
(0.9974). In making the comparison, we set the regular and special 
exceptions reduction factors to 1.00.
    To achieve budget neutrality for the changes in the national GAF, 
based on calculations using updated data, we are applying an 
incremental budget neutrality adjustment of 0.9997 for FY 2005 to the 
average of the previous cumulative FY 2004 adjustments of 0.9908 
((0.9908 + 0.9907)/2), yielding a cumulative adjustment of 0.9905 
through FY 2005 (calculations were done with unrounded numbers). For 
the Puerto Rico GAF, we are applying an incremental budget neutrality 
adjustment of 0.9912 for FY 2005 to the average of the previous 
cumulative FY 2004 adjustment of 0.9974, yielding a cumulative 
adjustment of 0.9886 through FY 2005.
    We then compared estimated aggregate capital Federal rate payments 
based on the FY 2004 DRG relative weights and the average FY 2004 GAF 
to estimated aggregate capital Federal rate payments based on the FY 
2005 DRG relative weights and the FY 2005 GAF. The incremental 
adjustment for DRG classifications and changes in relative weights is 
1.0009 both nationally and for Puerto Rico. The cumulative adjustments 
for DRG classifications and changes in relative weights and for changes 
in the GAF through FY 2005 are 0.9914 nationally and 0.9895 for Puerto 
Rico. The following table summarizes the adjustment factors for each 
fiscal year:
BILLING CODE 4120-01-P

[[Page 49287]]

[GRAPHIC] [TIFF OMITTED] TR11AU04.078

BILLING CODE 4120-01-C
    The methodology used to determine the final recalibration and 
geographic (DRG/GAF) budget neutrality adjustment factor for FY 2005 is 
similar

[[Page 49288]]

to that used in establishing budget neutrality adjustments under the 
IPPS for operating costs. One difference is that, under the operating 
IPPS, the budget neutrality adjustments for the effect of geographic 
reclassifications are determined separately from the effects of other 
changes in the hospital wage index and the DRG relative weights. Under 
the capital IPPS, there is a single DRG/GAF budget neutrality 
adjustment factor (the national capital rate and the Puerto Rico 
capital rate are determined separately) for changes in the GAF 
(including geographic reclassification) and the DRG relative weights. 
In addition, there is no adjustment for the effects that geographic 
reclassification has on the other payment parameters, such as the 
payments for serving low-income patients, indirect medical education 
payments, or the large urban add-on payments.
    In the August 1, 2003 IPPS final rule (68 FR 45346), we calculated 
a GAF/DRG budget neutrality factor of 1.0059 for FY 2004. As we noted 
above, as a result of the revisions to the GAF effective for FY 2004 in 
the October 6, 2003 correction notice, we calculated a GAF/DRG budget 
neutrality factor of 1.0026 for discharges occurring in FY 2004. As we 
also noted above, as a result of implementing sections 401, 402, and 
504 of Public Law 108-173, we calculated a GAF/DRG budget neutrality 
factor of 1.0026 for discharges occurring on or after April 1, 2004 
through September 30, 2004. Furthermore, as noted above, the average of 
capital rates and factors in effect for the first half (October 2003 
through March 2004) and second half (April 2004 through September 2004) 
of FY 2004 was used in determining the final FY 2005 capital rates.
    For FY 2005, we are applying a GAF/DRG budget neutrality factor of 
1.0006. The GAF/DRG budget neutrality factors are built permanently 
into the capital rates; that is, they are applied cumulatively in 
determining the capital Federal rate. This follows from the requirement 
that estimated aggregate payments each year be no more or less than 
they would have been in the absence of the annual DRG reclassification 
and recalibration and changes in the GAF. The final incremental change 
in the adjustment from FY 2004 to FY 2005 is 1.0006. The cumulative 
change in the capital Federal rate due to this adjustment is 0.9914 
(the product of the incremental factors for FY 1993, FY 1994, FY 1995, 
FY 1996, FY 1997, FY 1998, FY 1999, FY 2000, FY 2001, FY 002, FY 2003, 
average FY 2004 and the final incremental factor for FY 2005: 0.9980 x 
1.0053 x 0.9998 x 0.9994 x 0.9987 x 0.9989 x 1.0028 x 0.9985 x 0.9979 x 
0.9934 x 0.9956 x 1.0025 x 1.0006 = 0.9914).
    This final factor accounts for DRG reclassifications and 
recalibration and for changes in the GAF. It also incorporates the 
effects on the GAF of FY 2005 geographic reclassification decisions 
made by the MGCRB compared to FY 2004 decisions. However, it does not 
account for changes in payments due to changes in the DSH and IME 
adjustment factors or in the large urban add-on.
4. Exceptions Payment Adjustment Factor
    Section 412.308(c)(3) requires that the capital standard Federal 
rate be reduced by an adjustment factor equal to the estimated 
proportion of additional payments for both regular exceptions and 
special exceptions under Sec.  412.348 relative to total capital PPS 
payments. In estimating the proportion of regular exception payments to 
total capital PPS payments during the transition period, we used the 
actuarial capital cost model originally developed for determining 
budget neutrality (described in Appendix B of the August 1, 2001 IPPS 
final rule (66 FR 40099)) to determine the exceptions payment 
adjustment factor, which was applied to both the Federal and hospital-
specific capital rates.
    An adjustment for regular exception payments is no longer necessary 
in determining the FY 2005 capital Federal rate because, in accordance 
with Sec.  412.348(b), regular exception payments were only made for 
cost reporting periods beginning on or after October 1, 1991 and before 
October 1, 2001. Accordingly, as we explained in the August 1, 2001 
IPPS final rule (66 FR 39949), in FY 2002 and subsequent fiscal years, 
no payments will be made under the regular exceptions provision. 
However, in accordance with Sec.  412.308(c), we still need to compute 
a budget neutrality adjustment for special exception payments under 
Sec.  412.348(g). We describe our methodology for determining the 
special exceptions adjustment used in calculating the FY 2005 capital 
Federal rate below.
    Under the special exceptions provision specified at Sec.  
412.348(g)(1), eligible hospitals include SCHs, urban hospitals with at 
least 100 beds that have a disproportionate share percentage of at 
least 20.2 percent or qualify for DSH payments under Sec.  
412.106(c)(2), and hospitals with a combined Medicare and Medicaid 
inpatient utilization of at least 70 percent. An eligible hospital may 
receive special exceptions payments if it meets (1) a project need 
requirement as described at Sec.  412.348(g)(2), which, in the case of 
certain urban hospitals, includes an excess capacity test as described 
at Sec.  412.348(g)(4); (2) an age of assets test as described at Sec.  
412.348(g)(3); and (3) a project size requirement as described at Sec.  
412.348(g)(5).
    Based on information compiled from our fiscal intermediaries, six 
hospitals have qualified for special exceptions payments under Sec.  
412.348(g). Since we have cost reports ending in FY 2003 for all of 
these hospitals, we calculated the adjustment based on actual cost 
experience. Using data from cost reports ending in FY 2003 from the 
March 2004 update of the HCRIS data, we divided the capital special 
exceptions payment amounts for the six hospitals that qualified for 
special exceptions by the total capital PPS payment amounts (including 
special exception payments) for all hospitals. Based on the data from 
cost reports ending in FY 2003, this ratio is rounded to 0.0004. 
Because we have not received all cost reports ending in FY 2003, we 
also divided the FY 2003 special exceptions payments by the total 
capital PPS payment amounts for all hospitals with cost reports ending 
in FY 2002. This ratio also rounds to 0.0004. Because special 
exceptions are budget neutral, we are offsetting the capital Federal 
rate by 0.04 percent for special exceptions payments for FY 2005. 
Therefore, the exceptions adjustment factor is equal to 0.9996 (1-
0.0004) to account for special exceptions payments in FY 2005.
    In the August 1, 2003 IPPS final rule (68 FR 45384) for FY 2004, we 
estimated that total (special) exceptions payments would equal 0.05 
percent of aggregate payments based on the capital Federal rate. 
Therefore, we applied an exceptions adjustment factor of 0.9995 (1 -
0.0005) in determining the FY 2004 capital Federal rate. (We note that 
the special exceptions adjustment factor for FY 2004 was not revised in 
either the October 6, 2003 correction notice or the March 26, 2004 One-
Time Notification.) As we stated above, we estimate that exceptions 
payments in FY 2005 will equal 0.04 percent of aggregate payments based 
on the FY 2005 capital Federal rate. Therefore, we are applying an 
exceptions payment adjustment factor of 0.9996 to the capital Federal 
rate for FY 2005. The exceptions adjustment factor for FY 2005 is 0.01 
percent higher than the factor for FY 2004 published in the August 1, 
2003 IPPS final rule (68 FR 45346). The exceptions reduction factors 
are not built permanently into the capital rates;

[[Page 49289]]

that is, the factors are not applied cumulatively in determining the 
capital Federal rate. Therefore, the net change in the exceptions 
adjustment factor used in determining the FY 2005 capital Federal rate 
is 1.0001 (0.9996/0.9995).
5. Capital Standard Federal Rate for FY 2005
    In the August 1, 2003 IPPS final rule (68 FR 45346) we established 
a capital Federal rate of $415.47 for FY 2004. As we noted above, as a 
result of the revisions to the GAF for FY 2004, in the October 6, 2003 
correction notice, we established a capital Federal rate of $414.18 for 
discharges occurring in FY 2004. As we also discussed above, a One-Time 
Notification issued on March 26, 2004, which implemented various 
changes in operating IPPS payments required by sections 401, 402, and 
504 of Public Law 108-173, resulted in a revised capital Federal rate 
of $413.48 effective for discharges occurring on or after April 1, 2004 
through September 30, 2004. Because there are two capital IPPS standard 
Federal rates in effect during FY 2004 ($414.18 from October 2003 
through March 2004 and $413.48 from April 2004 through September 2004), 
we are using an average of the rates effective for the first half 
($414.18) and the second half ($413.48) of FY 2004 of $413.83 (($414.18 
+ $413.48)/2) in determining the FY 2005 capital Federal rate. In this 
final rule, we are establishing a capital Federal rate of $416.63 for 
FY 2005. The capital Federal rate for FY 2005 was calculated as 
follows:
     The FY 2005 update factor is 1.0070; that is, the update 
is 0.7 percent.
     The FY 2005 budget neutrality adjustment factor that is 
applied to the capital standard Federal payment rate for changes in the 
DRG relative weights and in the GAF is 1.0006.
     The FY 2005 outlier adjustment factor is 0.9506.
     The FY 2005 (special) exceptions payment adjustment factor 
is 0.9996.
    Because the capital Federal rate has already been adjusted for 
differences in case-mix, wages, cost-of-living, indirect medical 
education costs, and payments to hospitals serving a disproportionate 
share of low-income patients, we are making no additional adjustments 
in the capital standard Federal rate for these factors, other than the 
budget neutrality factor for changes in the DRG relative weights and 
the GAF.
    We are providing a chart that shows how each of the factors and 
adjustments for FY 2005 affected the computation of the FY 2005 capital 
Federal rate in comparison to the average FY 2004 capital Federal rate. 
The FY 2005 update factor has the effect of increasing the capital 
Federal rate by 0.70 percent compared to the average FY 2004 Federal 
rate. The GAF/DRG budget neutrality factor has the effect of increasing 
the capital Federal rate by 0.06 percent. The FY 2005 outlier 
adjustment factor has the effect of decreasing the capital Federal rate 
by 0.09 percent compared to the average FY 2004 capital Federal rate 
and the FY 2005 exceptions payment adjustment factor has the effect of 
increasing the capital Federal rate by 0.01 percent compared to the 
exceptions payment adjustment factor for the FY 2004 capital Federal 
rate. The combined effect of all the changes is to increase the capital 
Federal rate by 0.68 percent compared to the average FY 2004 capital 
Federal rate.

    Comparison of Factors and Adjustments: FY 2004 Capital Federal Rate \1\ and FY 2005 Capital Federal Rate
----------------------------------------------------------------------------------------------------------------
                                                                                                       Percent
                                                              FY 2004 \1\    FY 2005       Change       change
----------------------------------------------------------------------------------------------------------------
Update factor \2\...........................................       1.0070       1.0070       1.0070         0.70
GAF/DRG Adjustment Factor \2\...............................       1.0025       1.0006       1.0006         0.06
Outlier Adjustment Factor \3\...............................       0.9515       0.9506       0.9991        -0.09
Exceptions Adjustment Factor \3\............................       0.9995       0.9996       1.0001         0.01
Capital Federal Rate........................................      $413.83      $416.63       1.0068         0.68
----------------------------------------------------------------------------------------------------------------
\1\ Because there are two capital IPPS standard Federal rates in effect during FY 2004 ($414.18 from October
  2003 through March 2004 and $413.48 from April 2004 through September 2004), an average of the rates and
  factors effective for the first half (October 2003 through March 2004) and the second half (April 2004 through
  September 2004)) of FY 2004 were used.
\2\ The update factor and the GAF/DRG budget neutrality factors are built permanently into the capital rates.
  Thus, for example, the incremental change from FY 2004 to FY 2005 resulting from the application of the 1.006
  GAF/DRG budget neutrality factor for FY 2005 is 1.0006.
\3\ The outlier reduction factor and the exceptions adjustment factor are not built permanently into the capital
  rates; that is, these factors are not applied cumulatively in determining the capital rates. Thus, for
  example, the net change resulting from the application of the FY 2005 outlier adjustment factor is 0.9506/
  0.9515, or 0.9991.

    We are also providing a chart that shows how the final FY 2005 
capital Federal rate differs from the proposed FY 2005 capital Federal 
rate.

 Comparison of Factors and Adjustments: FY 2005 Proposed Capital Federal Rate and FY 2005 Final Capital Federal
                                                      Rate
----------------------------------------------------------------------------------------------------------------
                                                              Proposed FY    Final FY                  Percent
                                                                  2005         2005        Change       change
----------------------------------------------------------------------------------------------------------------
Update Factor...............................................       1.0070       1.0070       1.0000         0.00
GAF/DRG Adjustment Factor...................................       1.0015       1.0006       0.9991        -0.09
Outlier Adjustment Factor...................................       0.9497       0.9506       1.0009         0.09
Exceptions Adjustment Factor................................       0.9996       0.9996       1.0000         0.00
Capital Federal Rate........................................      $416.59      $416.63       1.0001         1.01
----------------------------------------------------------------------------------------------------------------

6. Special Capital Rate for Puerto Rico Hospitals
    As discussed above, beginning in FY 1998, hospitals in Puerto Rico 
are currently paid based on 50 percent of the Puerto Rico capital rate 
and 50 percent of the capital Federal rate. The Puerto Rico capital 
rate is derived from the costs of Puerto Rico hospitals only, while the 
capital Federal rate is derived from the costs of all acute care 
hospitals participating in the PPS (including

[[Page 49290]]

Puerto Rico). Section 504 of Public Law 108-173 increased the national 
portion of the operating IPPS payment for Puerto Rico hospitals from 50 
percent to 75 percent and decreases the Puerto Rico portion of the 
operating IPPS payments for hospitals located in Puerto Rico from 50 
percent to 37.5 percent for discharges occurring on or after April 1, 
2004, through September 30, 2004. In addition, section 504 of Public 
Law 108-173 provides that the national portion of operating IPPS 
payments for Puerto Rico hospitals is equal to 75 percent and the 
Puerto Rico portions of the operating IPPS payments is equal to 37.5 
percent for discharges occurring on or after October 1, 2004. As 
discussed in section V.B. of the preamble of this final rule, under the 
broad authority of section 1886(g) of the Act, for FY 2005 we are 
increasing the national portion of the capital IPPS payment to 
hospitals located in Puerto Rico from 50 percent to 75 percent, as 
well. Therefore, for discharges occurring on or after October 1, 2004, 
capital payments to hospitals in Puerto Rico will be based on a blend 
of 25 percent of the Puerto Rico capital rate and 75 percent of the 
capital Federal rate.
    To adjust hospitals' capital payments for geographic variations in 
capital costs, we apply a GAF to both portions of the blended capital 
rate. The GAF is calculated using the operating IPPS wage index and 
varies, depending on the MSA or rural area in which the hospital is 
located. We use the Puerto Rico wage index to determine the GAF for the 
Puerto Rico part of the capital-blended rate and the national wage 
index to determine the GAF for the national part of the blended capital 
rate.
    Because we implemented a separate GAF for Puerto Rico in FY 1998, 
we also apply separate budget neutrality adjustments for the national 
GAF and for the Puerto Rico GAF. However, we apply the same budget 
neutrality factor for DRG reclassifications and recalibration 
nationally and for Puerto Rico. As we stated above in section III.A.4. 
of this Addendum, for Puerto Rico the GAF budget neutrality factor is 
0.9912, while the DRG adjustment is 1.0009, for a combined cumulative 
adjustment of 0.9895.
    In computing the payment for a particular Puerto Rico hospital, the 
Puerto Rico portion of the capital rate (50 percent for FY 2004; 25 
percent for FY 2005 and thereafter) is multiplied by the Puerto Rico-
specific GAF for the MSA in which the hospital is located, and the 
national portion of the capital rate (50 percent, for FY 2004; 75 
percent, for FY 2005 and thereafter) is multiplied by the national GAF 
for the MSA in which the hospital is located (which is computed from 
national data for all hospitals in the United States and Puerto Rico). 
In FY 1998, we implemented a 17.78 percent reduction to the Puerto Rico 
capital rate as a result of Pub. L. 105-33. In FY 2003, a small part of 
that reduction was restored.
    For FY 2004, before application of the GAF, the special capital 
rate for Puerto Rico hospitals was $203.17 for discharges occurring on 
or after October 1, 2003 through March 31, 2004 (see the October 6, 
2003 correction notice) and $202.96 for discharges occurring on or 
after April 1, 2004 through September 30, 2004 (see the March 26, 2004 
One-Time Notification). With the changes we are proposing to the 
factors used to determine the capital rate, the FY 2005 special capital 
rate for Puerto Rico is $199.02.

B. Calculation of Inpatient Capital-Related Prospective Payments for FY 
2005

    Because the 10-year capital PPS transition period ended in FY 2001, 
all hospitals (except A new hospitals under Sec.  412.324(b) and under 
Sec.  412.304(c)(2)) are paid based on 100 percent of the capital 
Federal rate in FY 2005. The applicable capital Federal rate was 
determined by making adjustments as follows:
     For outliers, by dividing the capital standard Federal 
rate by the outlier reduction factor for that fiscal year; and
     For the payment adjustments applicable to the hospital, by 
multiplying the hospital's GAF, disproportionate share adjustment 
factor, and IME adjustment factor, when appropriate.
    For purposes of calculating payments for each discharge during FY 
2005, the capital standard Federal rate is adjusted as follows: 
(Standard Federal Rate) x (DRG weight) x (GAF) x (Large Urban Add-on, 
if applicable) x (COLA adjustment for hospitals located in Alaska and 
Hawaii) x (1 + Disproportionate Share Adjustment Factor + IME 
Adjustment Factor, if applicable). The result is the adjusted capital 
Federal rate. Hospitals also may receive outlier payments for those 
cases that qualify under the thresholds established for each fiscal 
year. Section 412.312(c) provides for a single set of thresholds to 
identify outlier cases for both inpatient operating and inpatient 
capital-related payments. The outlier thresholds for FY 2005 are in 
section II.A.4.c. of this Addendum. For FY 2005, a case qualifies as a 
cost outlier if the cost for the case plus the IME and DSH payments is 
greater than the prospective payment rate for the DRG plus $25,800.
    An eligible hospital may also qualify for a special exceptions 
payment under Sec.  412.348(g) for up through the 10th year beyond the 
end of the capital transition period if it meets: (1) A project need 
requirement described at Sec.  412.348(g)(2), which in the case of 
certain urban hospitals includes an excess capacity test as described 
at Sec.  412.348(g)(4); and (2) a project size requirement as described 
at Sec.  412.348(g)(5). Eligible hospitals include SCHs, urban 
hospitals with at least 100 beds that have a DSH patient percentage of 
at least 20.2 percent or qualify for DSH payments under Sec.  
412.106(c)(2), and hospitals that have a combined Medicare and Medicaid 
inpatient utilization of at least 70 percent. Under Sec.  
412.348(g)(8), the amount of a special exceptions payment is determined 
by comparing the cumulative payments made to the hospital under the 
capital PPS to the cumulative minimum payment level. This amount is 
offset by: (1) Any amount by which a hospital's cumulative capital 
payments exceed its cumulative minimum payment levels applicable under 
the regular exceptions process for cost reporting periods beginning 
during which the hospital has been subject to the capital PPS; and (2) 
any amount by which a hospital's current year operating and capital 
payments (excluding 75 percent of operating DSH payments) exceed its 
operating and capital costs. Under Sec.  412.348(g)(6), the minimum 
payment level is 70 percent for all eligible hospitals.
    During the transition period, new hospitals (as defined under Sec.  
412.300) were exempt from the capital PPS for their first 2 years of 
operation and were paid 85 percent of their reasonable costs during 
that period. Effective with the third year of operation through the 
remainder of the transition period, under Sec.  412.324(b) we paid the 
hospital under the appropriate transition methodology. If the hold-
harmless methodology were applicable, the hold-harmless payment for 
assets in use during the base period would extend for 8 years, even if 
the hold-harmless payments extend beyond the normal transition period. 
As discussed in section VI.A. of the preamble of this final rule, under 
Sec.  412.304(c)(2), for cost reporting periods beginning on or after 
October 1, 2002, we pay a new hospital 85 percent of their reasonable 
costs during the first 2 years of operation unless it elects to receive 
payment based on 100 percent of the capital Federal rate. Effective 
with the third year of

[[Page 49291]]

operation, we pay the hospital based on 100 percent of the capital 
Federal rate (that is, the same methodology used to pay all other 
hospitals subject to the capital PPS).

C. Capital Input Price Index

1. Background
    Like the operating input price index, the capital input price index 
(CIPI) is a fixed-weight price index that measures the price changes 
associated with capital costs during a given year. The CIPI differs 
from the operating input price index in one important aspect--the CIPI 
reflects the vintage nature of capital, which is the acquisition and 
use of capital over time. Capital expenses in any given year are 
determined by the stock of capital in that year (that is, capital that 
remains on hand from all current and prior capital acquisitions). An 
index measuring capital price changes needs to reflect this vintage 
nature of capital. Therefore, the CIPI was developed to capture the 
vintage nature of capital by using a weighted-average of past capital 
purchase prices up to and including the current year.
    We periodically update the base year for the operating and capital 
input prices to reflect the changing composition of inputs for 
operating and capital expenses. The CIPI was last rebased to FY 1997 in 
the August 1, 2002 final rule (67 FR 50044).
2. Forecast of the CIPI for FY 2005
    Based on the latest forecast by Global Insight, Inc. (first quarter 
of 2004), we are forecasting the CIPI to increase 0.7 percent in FY 
2005. This reflects a projected 1.3 percent increase in vintage-
weighted depreciation prices (building and fixed equipment, and movable 
equipment) and a 2.8 percent increase in other capital expense prices 
in FY 2005, partially offset by a 2.6 percent decline in vintage-
weighted interest expenses in FY 2005. The weighted average of these 
three factors produces the 0.7 percent increase for the CIPI as a whole 
in FY 2005.

IV. Changes to Payment Rates for Excluded Hospitals and Hospital Units: 
Rate-of-Increase Percentages

    As discussed in section VI of the preamble of this final rule, in 
accordance with section 1886(b)(3)(H)(i) of the Act and effective for 
cost reporting periods beginning on or after October 1, 2002, payments 
to existing psychiatric hospitals and units, rehabilitation hospitals 
and units, and long-term care hospitals excluded from the IPPS are no 
longer subject to limits on a hospital-specific target amount 
(expressed in terms of the inpatient operating cost per discharge) that 
are set for each hospital, based on the hospital's own historical cost 
experience trended forward by the applicable rate-of-increase 
percentages (update factors).
    Effective for cost reporting periods beginning on or after October 
1, 2002, rehabilitation hospitals and units are paid 100 percent of the 
IRF PPS Federal rate. Effective for cost reporting periods beginning on 
or after October 1, 2002, LTCHs also are no longer paid on a reasonable 
cost basis, but are paid under a LTCH DRG-based PPS. As part of the 
payment process for LTCHs, we established a 5-year transition period 
from reasonable cost-based reimbursement to a fully Federal PPS. 
However, a LTCH may elect to be paid based on 100 percent of the 
Federal prospective payment rate. We have proposed, but not finalized, 
an IPF PPS under which psychiatric hospitals and units would no longer 
be paid on a reasonable cost basis but would be paid on a prospective 
per diem basis. (68 FR 66920, November 28, 2003)
    In accordance with existing Sec. Sec.  413.40(c)(4)(ii) and 
(d)(1)(i) and (ii), where applicable, excluded psychiatric hospitals 
and units continue to be paid on a reasonable cost basis and payments 
are based on their Medicare inpatient operating costs, not to exceed 
the ceiling (as defined in Sec.  413.40(a)(3)). In addition, LTCHs that 
are paid under a blended methodology will have the TEFRA portion 
subject to the ceiling as well.
    Section 1886(b)(7) of the Act had established a payment limitation 
for new rehabilitation hospitals and units, psychiatric hospitals and 
units, and long-term care hospitals that first received payment as a 
hospital or unit excluded from the IPPS on or after October 1, 1997. 
However, effective for cost reporting periods beginning on or after 
October 1, 2002, this payment limitation is no longer applicable to new 
rehabilitation hospitals or units because they are paid 100 percent of 
the Federal prospective rate under the IRF PPS. Also, for LTCHs that 
have their cost reporting period beginning on or after October 1, 2002, 
those new LTCHs are paid based on 100 percent of the fully Federal 
prospective rate. In contrast, those ``new'' LTCHs that meet the 
definition of ``new'' under Sec.  412.40(f)(2)(ii) and that have their 
first cost reporting periods beginning on or after October 1, 1997 and 
before October 1, 2002, may be paid under the LTCH PPS transition 
methodology. Since those hospitals, by definition, would have been 
considered new before October 1, 2002, they would have been subject to 
the updated payment limitation on new hospitals that was published in 
the FY 2003 IPPS final rule (67 FR 50103). A discussion of how the 
payment limitation was calculated can be found in the August 29, 1997 
final rule with comment period (62 FR 46019); the May 12, 1998 final 
rule (63 FR 26344); the July 31, 1998 final rule (63 FR 41000); and the 
July 30, 1999 final rule (64 FR 41529).
    The amount of payment for a ``new'' psychiatric hospital or unit 
would be determined as follows:
     Under existing Sec.  413.40(f)(2)(ii), for the first 12-
month cost reporting periods beginning on or after October 1, 1997, the 
amount of payment for a new hospital or unit that was not paid as an 
excluded hospital or unit before October 1, 1997, is the lower of: (1) 
The hospital's net inpatient operating costs per case; or (2) 110 
percent of the national median of the target amounts for the same class 
of excluded hospitals and units, adjusted for differences in wage 
levels and updated to the first cost reporting period in which the 
hospital receives payment. The second 12-month cost reporting period is 
subject to the same target amount applied to the first cost reporting 
period.
     In the case of a hospital that received payments under 
Sec.  413.40(f)(2)(ii) as a newly created hospital or unit, to 
determine the hospital's or unit's target amount for the hospital's or 
unit's third 12-month cost reporting period, the payment amount 
determined under Sec.  413.40(f)(2)(ii)(A) for the preceding cost 
reporting period is updated to the third cost reporting period.
    The amounts included in the following table reflect the updated 110 
percent of the national median target amounts of new excluded 
psychiatric hospitals and units for cost reporting periods beginning 
during FY 2005. These figures are updated with the most recent data 
available to reflect the projected market basket increase percentage of 
3.3 percent. This projected percentage change in the market basket 
reflects the average change in the price of goods and services 
purchased by hospitals to furnish inpatient hospital services (as 
projected by CMS' Office of the Actuary based on its historical 
experience with the IPPS). For a new provider, the labor-related share 
of the target amount is multiplied by the appropriate geographic area 
wage index, without regard to IPPS reclassifications, and added to the 
nonlabor-related share in order to determine the per case limit on 
payment under the statutory

[[Page 49292]]

payment methodology for new providers.

------------------------------------------------------------------------
  Class of excluded hospital or     FY 2005 labor-     FY 2005 nonlabor-
              unit                   related share       related share
------------------------------------------------------------------------
Psychiatric.....................              $7,535              $2,995
------------------------------------------------------------------------

    This payment limitation is no longer applicable to new LTCHs that 
meet the definition of Sec.  412.23(e)(4) because they will be paid 100 
percent of the Federal rate. (Section 412.23(e)(4) states that, for 
purposes of payment under the LTCH PPS, a new LTCH is a provider of 
inpatient services that meets the qualifying criteria in paragraphs 
(e)(1) and (e)(2) of this section and, under present or previous 
ownership (or both), its first cost reporting period as an LTCH begins 
on or after October 1, 2002). Under the LTCH PPS, new LTCHs are based 
on 100 percent of the fully Federal prospective rate (they may not 
participate in the 5-year transition from cost-based reimbursement to 
prospective payment). In contrast, those ``new'' LTCHs that meet the 
definition of ``new'' under Sec.  413.40(f)(2)(ii) and that have their 
first cost reporting periods beginning on or after October 1, 1997, and 
before October 1, 2002, may be paid under the LTCH PPS transition 
methodology. Because those hospitals, by definition, would have been 
considered new before October 1, 2002, they would have been subject to 
the updated payment limitation on new hospitals that was published in 
the FY 2003 IPPS final rule (67 FR 50103). Under existing regulations 
at Sec.  413.40(f)(2)(ii), the ``new'' hospital would be subject to the 
same cap in its second cost reporting period; this cap would not be 
updated for the new hospital's second cost reporting year. Thus, 
because the same cap is to be used for the ``new'' LTCH's first two 
cost reporting periods, it is no longer necessary to publish an updated 
cap.

V. Payment for Blood Clotting Factor Administered to Hemophilia 
Inpatients

    In the August 1, 2003 IPPS final rule (68 FR 45487) and in the May 
18, 2004 proposed rule (69 FR 28389), we instructed the fiscal 
intermediaries to use the Single Drug Pricer (SDP) to price blood 
clotting factors. The SDP payment allowance for blood clotting factors 
is based on 95 percent of the average wholesale price (AWP). We did not 
receive any comment on this issue.
    Section 303(c) of Public Law 108-173 amended the Act by adding 
section 1847A, which changed the drug pricing system under Medicare. 
Beginning in 2005, section 1847A of the Act establishes a new payment 
methodology based on average sales price (ASP). The ASP methodology 
requires that the Medicare payment allowance limit for clotting factors 
be equal to 106 percent of the weighted average of the lower of the ASP 
or the wholesale acquisition cost of the products within each HCPCS 
code. This payment is subject to the Part B deductible and coinsurance 
requirements.
    While these changes will be applied to claims paid by Medicare 
carriers, for clotting factors furnished to inpatients under this 
provision, we have decided for FY 2005 to continue using the pricing 
limits currently in effect. We will evaluate these limits and, if 
warranted, we will propose a change for public comment in next year's 
proposed rule.

VI. Tables

    This section contains the tables referred to throughout the 
preamble to this final rule and in this Addendum. Tables 1A, 1B, 1C, 
1D, 2, 3A1, 3A2, 3B1, 3B2, 
4A1, 4A2, 4B1, 4B2, 
4C1, 4C2, 4D1, 4D2, 
4F1, 4F2, 4G, 4H, 4J, 5, 6A, 6B, 6C, 6D, 6E, 6F, 
6G, 6H, 7A, 7B, 8A, 8B, 9A1, 9A2, 9B, 10, and 11 
are presented below. The tables presented below are as follows:

Table 1A--National Adjusted Operating Standardized Amounts, Labor/
Nonlabor (71.1 Percent Labor Share/28.9 Percent Nonlabor Share If Wage 
Index Is Greater Than 1)
Table 1B--National Adjusted Operating Standardized Amounts, Labor/
Nonlabor (62 Percent Labor Share/38 Percent Nonlabor Share If Wage 
Index Is Less Than or Equal To 1)
Table 1C--Adjusted Operating Standardized Amounts for Puerto Rico, 
Labor/Nonlabor
Table 1D--Capital Standard Federal Payment Rate
Table 2--Hospital Case-Mix Indexes for Discharges Occurring in Federal 
Fiscal Year 2003; Hospital Average Hourly Wage for Federal Fiscal Years 
2003 (1999 Wage Data), 2004 (2000 Wage Data), and 2005 (2001 Wage Data) 
Wage Indexes and 3-Year Average of Hospital Average Hourly Wages
Table 3A1--FY 2005 and 3-Year Average Hourly Wage for Urban 
Areas by MSA
Table 3A2--FY 2005 3-Year Average Hourly Wage for Urban 
Areas by CBSA
Table 3B1--FY 2005 and 3-Year Average Hourly Wage for Rural 
Areas by MSA
Table 3B2--FY 2005 and 3-Year Average Hourly Wage for Rural 
Areas by CBSA
Table 4A1--Wage Index and Capital Geographic Adjustment 
Factor (GAF) for Urban Areas by MSA
Table 4A2--Wage Index and Capital Geographic Adjustment 
Factor (GAF) for Urban Areas by CBSA
Table 4B1--Wage Index and Capital Geographic Adjustment 
Factor (GAF) for Rural Areas by MSA
Table 4B2--Wage Index and Capital Geographic Adjustment 
Factor (GAF) for Rural Areas by CBSA
Table 4C1--Wage Index and Capital Geographic Adjustment 
Factor (GAF) for Hospitals That Are Reclassified by MSA
Table 4C2--Wage Index and Capital Geographic Adjustment 
Factor (GAF) for Hospitals That Are Reclassified by CBSA
Table 4F1--Puerto Rico Wage Index and Capital Geographic 
Adjustment Factor (GAF) by MSA
Table 4F2--Puerto Rico Wage Index and Capital Geographic 
Adjustment Factor (GAF) by CBSA
Table 4G--Pre-Reclassified Wage Index for Urban Areas
Table 4H--Pre-Reclassified Wage Index for Rural Areas
Table 4J--Wage Index Adjustment for Commuting Hospital Employees (Out-
Migration) in Qualifying Counties--FY 2005
Table 5--List of Diagnosis Related Groups (DRGs), Relative Weighting 
Factors, Geometric and Arithmetic Mean Length of Stay
Table 6A--New Diagnosis Codes
Table 6B--New Procedure Codes
Table 6C--Invalid Diagnosis Codes
Table 6D--Invalid Procedure Codes
Table 6E--Revised Diagnosis Code Titles
Table 6F--Revised Procedure Code Titles
Table 6G--Additions to the CC Exclusions List
Table 6H--Deletions from the CC Exclusions List
Table 7A--Medicare Prospective Payment System Selected Percentile

[[Page 49293]]

Lengths of Stay FY 2003 MedPAR Update March 2004 GROUPER V21.0
Table 7B--Medicare Prospective Payment System Selected Percentile 
Lengths of Stay FY 2003 MedPAR Update March 2004 GROUPER V22.0
Table 8A--Statewide Average Operating Cost-to-Charge Ratios--July 2004
Table 8B--Statewide Average Capital Cost-to-Charge Ratios--July 2004
Table 9A1--Hospital Reclassifications and Redesignations by 
Individual Hospital by MSA--FY 2005
Table 9A2--Hospital Reclassifications and Redesignations by 
Individual Hospital by CBSA--FY 2005
Table 9B--Hospital Reclassifications and Redesignations by Individual 
Hospital Under Section 508 of Pub. L. 108-173--FY 2004
Table 10--Geometric Mean Plus the Lesser of .75 of the National 
Adjusted Operating Standardized Payment Amount (Increased to Reflect 
the Difference Between Costs and Charges) or .75 of One Standard 
Deviation of Mean Charges by Diagnosis-Related Groups (DRGs)--July 2004
Table 11--FY 2005 LTC-DRGs, Relative Weights, Geometric AverageLength 
of Stay, and 5/6ths of the Geometric Average Length of Stay
BILLING CODE 4120-01-P

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BILLING CODE 4120-01-C

Appendix A--Regulatory Analysis of Impacts

I. Background and Summary

    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.
    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). Based on the overall percentage change 
in payments per case estimated using our payment simulation model (a 
5.8 percent increase), we estimate that the total impact of these 
proposed changes for FY 2005 payments compared to FY 2004 payments 
to be approximately a $5.05 billion increase. This amount does not 
reflect changes in hospital admissions or case-mix intensity, which 
would also affect overall payment changes.
    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 by nonprofit status or by having revenues of 
$5 million to $25 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.
    In addition, section 1102(b) of the 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 previously defined a small rural hospital as a hospital 
with fewer than 100 beds that is located outside of a Metropolitan 
Statistical Area (MSA) or New England County Metropolitan Area 
(NECMA). However, under the new labor market definitions that we are 
proposing to adopt, we no longer employ NECMAs to define urban areas 
in New England. Therefore, we now define a small rural hospital as a 
hospital with fewer than 100 beds that is located outside of a 
Metropolitan Statistical Area (MSA). 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 continue to classify these 
hospitals as urban hospitals.
    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 that 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 will not mandate any requirements for State, local, or tribal 
governments.
    Executive Order 13132 establishes certain requirements that an 
agency must meet when it promulgates a proposed rule (and subsequent 
final rule) that imposes substantial direct 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 would not have 
any negative impact on the rights, roles, and responsibilities of 
State, local, or tribal governments.
    In accordance with the provisions of Executive Order 12866, this 
final rule was reviewed by the Office of Management and Budget.
    The following analysis, in conjunction with the remainder of 
this document, demonstrates that this final rule is consistent with 
the regulatory philosophy and principles identified in Executive 
Order 12866, the RFA, and section 1102(b) of the Act. The final rule 
will affect payments to a substantial number of small rural 
hospitals as well as other classes of hospitals, and the effects on 
some hospitals may be significant.

II. Objectives

    The primary objective of the IPPS is to create incentives for 
hospitals to operate efficiently and minimize unnecessary costs 
while at the same time ensuring that payments are sufficient to 
adequately compensate hospitals for their legitimate costs. In 
addition, we share national goals of preserving the Medicare Trust 
Fund.
    We believe the changes in this final rule will further each of 
these goals while maintaining the financial viability of the 
hospital industry and ensuring access to high quality health care 
for Medicare beneficiaries. We expect that these final changes will 
ensure that the outcomes of this payment system are reasonable and 
equitable while avoiding or minimizing unintended adverse 
consequences.

III. Limitations of Our Analysis

    The following quantitative analysis presents the projected 
effects of our final policy changes, as well as statutory changes 
effective for FY 2005, on various hospital groups. We estimate the 
effects of individual policy changes by estimating payments per case 
while holding all other payment policies constant. We use the best 
data available, but we do not attempt to predict behavioral 
responses to our policy changes, and we do not make adjustments for 
future changes in such variables as admissions, lengths of stay, or 
case-mix. As we have done for previous proposed rules, we solicited 
comments and information about the anticipated effects of these 
changes on hospitals and our methodology for estimating them. Any 
comments that we received in response to the proposed rule are 
addressed in this final rule.

IV. Hospitals Included In and Excluded From the IPPS

    The prospective payment systems for hospital inpatient operating 
and capital-related costs encompass nearly all general short-term, 
acute care hospitals that participate in the Medicare program. There 
were 41 Indian Health Service hospitals in our database, which we 
excluded from the analysis due to the special characteristics of the 
prospective payment method for these hospitals. Among other short-
term, acute care hospitals, only the 47 such hospitals in Maryland 
remain excluded from the IPPS under the waiver at section 1814(b)(3) 
of the Act.
    As of July 2004, there are 3,897 IPPS hospitals to be included 
in our analysis. This represents about 80 percent of all Medicare-
participating hospitals. The majority of this impact analysis 
focuses on this set of hospitals. There are also approximately 934 
critical access hospitals (CAHs). These small, limited service 
hospitals are paid on the basis of reasonable costs rather than 
under the IPPS. There are also 1,167 specialty hospitals and units 
that are excluded from the IPPS. These specialty hospitals include 
psychiatric hospitals and units, rehabilitation hospitals and units, 
long-term care hospitals, children's hospitals, and cancer 
hospitals. The impacts of our policy changes on these hospitals are 
discussed below.

V. Impact on Excluded Hospitals and Hospital Units

    As of July 2004, there were 1,167 specialty hospitals excluded 
from the IPPS. Of these 1,167 specialty hospitals, 475 psychiatric 
hospitals, 80 childrens, 11 cancer hospitals and the less than 10 
percent of LTCHs that are paid under the LTCH PPS blend methodology 
are being paid, in whole or in part, on a reasonable cost basis 
subject to the rate-of-increase ceiling under Sec.  413.40. The 
remaining providers--216 rehabilitation and approximately 90 percent 
of the 338 long-term care hospitals are paid 100 percent of the 
Federal rate under the IRF and LTCH PPS, respectively. In addition, 
there were 1,374 psychiatric units (paid on a reasonable cost basis) 
and 1,001 rehabilitation units (paid under IRF PPS) in hospitals 
otherwise subject to the IPPS. Under Sec.  413.40(a)(2)(i)(A), the 
rate-of-increase ceiling is not applicable to the 47 specialty 
hospitals and units in Maryland that are paid in accordance with the 
waiver at section 1814(b)(3) of the Act.
    In the past, hospitals and units excluded from the IPPS have 
been paid based on their reasonable costs subject to limits as 
established by the Tax Equity and Fiscal Responsibility Act of 1982 
(TEFRA). Hospitals that continue to be paid based on their 
reasonable costs are subject to TEFRA limits for FY 2005. For these 
hospitals, the update is the percentage increase in the excluded 
hospital market basket, currently estimated at 3.3 percent.
    Inpatient rehabilitation facilities (IRFs) are paid under a 
prospective payment system

[[Page 49756]]

(IRF PPS) for cost reporting periods beginning on or after January 
1, 2002. For cost reporting periods beginning during FY 2005, the 
IRF PPS is based on 100 percent of the adjusted Federal IRF 
prospective payment amount, updated annually. Therefore, these 
hospitals are not impacted by this final rule.
    Effective for cost reporting periods beginning on or after 
October 1, 2002, LTCHs are paid under a LTCH PPS, based on the 
adjusted Federal prospective payment amount, updated annually. LTCHs 
will receive a blended payment (Federal prospective payment and a 
reasonable cost-based payment) over a 5-year transition period. 
However, under the LTCH PPS, a LTCH may also elect to be paid at 100 
percent of the Federal prospective rate at the beginning of any of 
its cost reporting periods during the 5-year transition period. For 
purposes of the update factor, the portion of the LTCH PPS 
transition blend payment based on reasonable costs for inpatient 
operating services would be determined by updating the LTCH's TEFRA 
limit by the estimate of the excluded hospital market basket (or 3.3 
percent).
    Section 124 of the Medicare, Medicaid and SCHIP Balanced Budget 
Refinement Act of 1999 (BBRA) requires the development of a per diem 
prospective payment system (PPS) for payment of inpatient hospital 
services furnished in psychiatric hospitals and psychiatric units of 
acute care hospitals (inpatient psychiatric facilities (IPFs)). We 
published a proposed rule to implement the IPF PPS on November 28, 
2003 (68 FR 66920). On January 30, 2004, we published a notice to 
extend the comment period for 30 additional days (69 FR 4464). The 
comment period closed on March 26, 2004.
    Under the proposed rule, CMS would compute a Federal per diem 
base rate to be paid to all IPFs based on the sum of the average 
routine operating, ancillary, and capital costs for each patient day 
of psychiatric care in an IPF adjusted for budget neutrality. The 
Federal per diem base rate would be adjusted to reflect certain 
patient characteristics such as age, specified DRGs, and selected 
high-cost comorbidities, and certain facility characteristics such 
as a wage index adjustment, rural location, and indirect teaching 
costs.
    The November 28, 2003 proposed rule assumed an April 1, 2004 
effective date for the purpose of ratesetting and calculating 
impacts. However, we are still in the process of analyzing public 
comments and developing a final rule for publication.
    The impact on excluded hospitals and hospital units of the 
update in the rate-of-increase limit depends on the cumulative cost 
increases experienced by each excluded hospital or unit since its 
applicable base period. For excluded hospitals and units that have 
maintained their cost increases at a level below the rate-of-
increase limits since their base period, the major effect is on the 
level of incentive payments these hospitals and hospital units 
receive. Conversely, for excluded hospitals and hospital units with 
per-case cost increases above the cumulative update in their rate-
of-increase limits, the major effect is the amount of excess costs 
that will not be reimbursed.
    We note that, under Sec.  413.40(d)(3), an excluded hospital or 
unit whose costs exceed 110 percent of its rate-of-increase limit 
receives its rate-of-increase limit plus 50 percent of the 
difference between its reasonable costs and 110 percent of the 
limit, not to exceed 110 percent of its limit. In addition, under 
the various provisions set forth in Sec.  413.40, certain excluded 
hospitals and hospital units can obtain payment adjustments for 
justifiable increases in operating costs that exceed the limit. At 
the same time, however, by generally limiting payment increases, we 
continue to provide an incentive for excluded hospitals and hospital 
units to restrain the growth in their spending for patient services.

VI. Quantitative Impact Analysis of the Policy Changes Under the IPPS 
for Operating Costs

A. Basis and Methodology of Estimates

    In the proposed rule, we announced policy changes and payment 
rate updates for the IPPS for operating and capital-related costs, 
which are being finalized in this final rule. Based on the overall 
percentage change in payments per case estimated using our payment 
simulation model (a 5.8 percent increase), we estimate the total 
impact of these changes for FY 2005 payments compared to FY 2004 
payments to be approximately a $5.05 billion increase. This amount 
does not reflect changes in hospital admissions or case-mix 
intensity, which would also affect overall payment changes.
    We have prepared separate impact analyses of the final changes 
to each system. This section deals with final changes to the 
operating prospective payment system. Our payment simulation model 
relies on the most recent available data to enable us to estimate 
the impacts on payments per case of certain changes we proposed and 
are finalizing in this final rule. However, there are other changes 
we proposed for which we do not have data available that would allow 
us to estimate the payment impacts using this model. For those 
changes, we have attempted to predict the payment impacts of those 
changes based upon our experience and other more limited data.
    The data used in developing the quantitative analyses of changes 
in payments per case presented below are taken from the FY 2003 
MedPAR file and the most current Provider-Specific File that is used 
for payment purposes. Although the analyses of the changes to the 
operating PPS do not incorporate cost data, data from the most 
recently available hospital cost report were used to categorize 
hospitals. Our analysis has several qualifications. First, we do not 
make adjustments for behavioral changes that hospitals may adopt in 
response to the proposed policy changes, and we do not adjust for 
future changes in such variables as admissions, lengths of stay, or 
case-mix. Second, due to the interdependent nature of the IPPS 
payment components, it is very difficult to precisely quantify the 
impact associated with each finalized change. Third, we draw upon 
various sources for the data used to categorize hospitals in the 
tables. In some cases, particularly the number of beds, there is a 
fair degree of variation in the data from different sources. We have 
attempted to construct these variables with the best available 
source overall. However, for individual hospitals, some 
miscategorizations are possible.
    Using cases in the FY 2003 MedPAR file, we simulated payments 
under the operating IPPS given various combinations of payment 
parameters. Any short-term, acute care hospitals not paid under the 
IPPS (Indian Health Service hospitals and hospitals in Maryland) 
were excluded from the simulations. The impact of payments under the 
capital IPPS, or the impact of payments for costs other than 
inpatient operating costs, are not analyzed in this section. 
Estimated payment impacts of final FY 2005 changes to the capital 
IPPS are discussed in section VIII of this Appendix.
    The final changes discussed separately below are the following:
     The effects of the annual reclassification of diagnoses 
and procedures and the recalibration of the DRG relative weights 
required by section 1886(d)(4)(C) of the Act.
     The effects of applying a lower labor-related share for 
hospitals with wage indexes less than or equal to 1.0, as required 
under section 403 of Public Law 108-173.
     The effects of the adoption of the new MSAs as 
announced by OMB in June 2003.
     The effects of the finalized changes in hospitals' wage 
index values reflecting wage data from hospitals' cost reporting 
periods beginning during FY 2001, compared to the FY 2000 wage data.
     The effects of adjusting hospitals' wage data to 
reflect the occupational mix based on our survey of hospitals.
     The effect of the finalized wage and recalibration 
budget neutrality factors.
     The effects of geographic reclassifications by the 
MGCRB that will be effective in FY 2005.
     The effects of the finalized implementation of section 
505 of Public Law 108-173, which provides for an increase in a 
hospital's wage index if the hospital qualifies by meeting a 
threshold percentage of residents of the county where the hospital 
is located who commute to work at hospitals in counties with higher 
wage indexes.
     The total change in payments based on final FY 2005 
policies and MMA-imposed changes relative to payments based on FY 
2004 policies.
     The effects of providing a special transitional blended 
wage index for hospitals whose FY 2005 wage indexes will decrease 
solely as a result of adopting the new labor market definitions.
    To illustrate the impacts of the final FY 2005 changes, our 
analysis begins with a FY 2005 baseline simulation model using: the 
final update of 3.3 percent; the FY 2004 DRG GROUPER (version 21.0); 
the MSA designations for hospitals based on OMB's MSA definitions 
prior to June 2003; the FY 2004 wage index; and no MGCRB 
reclassifications. Outlier payments are set at 5.1 percent of total 
operating DRG and outlier payments.
    The baseline simulation model also reflects changes enacted by 
Public Law 108-173 to the IME and DSH adjustments. Section 402 
provides that, for discharges occurring on or

[[Page 49757]]

after April 1, 2004, all hospitals that qualify will receive DSH 
payments using the prior (before April 1, 2004) DSH adjustment 
formula for urban hospitals with 100 or more beds. Except for urban 
hospitals with 100 or more beds and rural referral centers, the DSH 
adjustment is capped at 12 percent. Section 502, modifies the IME 
adjustment for midway through FY 2004 and provides a new schedule of 
formula multipliers for FYs 2005 and thereafter.
    Section 501(b) of Public Law 108-173 provides that, for FYs 2005 
through 2007, the update factors will be reduced by 0.4 percentage 
points for any hospital that does not submit quality data. For 
purposes of the FY 2005 simulations in this final impact analysis, 
we have determined that most hospitals will qualify for the full 
update. Hospitals were not required to submit these data in order to 
qualify for a full update until July 2004, and we were therefore 
unable to determine for the proposed rule the rate of compliance 
with this requirement for receiving the full update.
    Each final and statutory policy change is then added 
incrementally to this baseline model, finally arriving at an FY 2005 
model incorporating all of the final changes. This allows us to 
isolate the effects of each change.
    Our final comparison illustrates the percent change in payments 
per case from FY 2004 to FY 2005. Five factors not discussed 
separately as described above have significant impacts here. The 
first is the update to the standardized amount. In accordance with 
section 1886(b)(3)(B)(i) of the Act, we have updated standardized 
amounts for FY 2005 using the most recently forecasted hospital 
market basket increase for FY 2005 of 3.3 percent. (Hospitals that 
failed to comply with the quality data submission requirement to 
receive the full update received an update reduced by 0.4 percentage 
points to 2.9 percent.) Under section 1886(b)(3)(B)(iv) of the Act, 
the updates to the hospital-specific amounts for sole community 
hospitals (SCHs) and for Medicare-dependent small rural hospitals 
(MDHs) are also equal to the market basket increase, or 3.3 percent.
    A second significant factor that impacts changes in hospitals' 
payments per case from FY 2004 to FY 2005 is the change in MGCRB 
status from one year to the next. That is, hospitals reclassified in 
FY 2004 that are no longer reclassified in FY 2005 may have a 
negative payment impact going from FY 2004 to FY 2005; conversely, 
hospitals not reclassified in FY 2004 that are reclassified in FY 
2005 may have a positive impact. In some cases, these impacts can be 
quite substantial, so if a relatively small number of hospitals in a 
particular category lose their reclassification status, the 
percentage change in payments for the category may be below the 
national mean. However, this effect is alleviated by section 
1886(d)(10)(D)(v) of the Act, which provides that reclassifications 
for purposes of the wage index are for a 3-year period.
    A third significant factor is that we currently estimate that 
actual outlier payments during FY 2004 will be 3.6 percent of total 
DRG payments. When the FY 2004 final rule was published, we 
projected FY 2004 outlier payments would be 5.1 percent of total DRG 
plus outlier payments; the average standardized amounts were offset 
correspondingly. The effects of the lower than expected outlier 
payments during FY 2004 (as discussed in the Addendum to this final 
rule) are reflected in the analyses below comparing our current 
estimates of FY 2004 payments per case to estimated FY 2005 payments 
per case (with outlier payments projected to equal 5.1 percent of 
total DRG payments).
    Fourth, as noted above, sections 402 and 502 of Public Law 108-
173, establish higher DSH and IME payments, respectively. As a 
result, payments for these factors will be higher in FY 2005 than in 
FY 2004.
    Fifth, section 508 of Public Law 108-173 established a one-time 
appeal process for hospitals to be reclassified in order to receive 
a higher wage index for a period of 3 years beginning with 
discharges on or after April 1, 2004.

B. Analysis of Table I

    Table I displays the results of our analysis. The table 
categorizes hospitals by various geographic and special payment 
consideration groups to illustrate the varying impacts on different 
types of hospitals. The top row of the table shows the overall 
impact on the 3,897 hospitals included in the analysis. This number 
is 152 fewer hospitals than were included in the impact analysis in 
the FY 2004 final rule (68 FR 45661).
    The next four rows of Table I contain hospitals categorized 
according to their geographic location: all urban, which is further 
divided into large urban and other urban; and rural. We previously 
defined a small rural hospital as a hospital with fewer than 100 
beds that is located outside of a Metropolitan Statistical Area 
(MSA) or New England County Metropolitan Area (NECMA). However, 
under the new labor market definitions that we are proposing to 
adopt, we no longer employ NECMAs to define urban areas in New 
England. Therefore, we will now define a small rural hospital as a 
hospital with fewer than 100 beds that is located outside of a 
Metropolitan Statistical Area (MSA). There are 2,661 hospitals 
located in urban areas included in our analysis. Among these, there 
are 1,448 hospitals located in large urban areas (populations over 1 
million), and 1,213 hospitals in other urban areas (populations of 1 
million or fewer). In addition, there are 1,236 hospitals in rural 
areas. The next two groupings are by bed-size categories, shown 
separately for urban and rural hospitals. The final groupings by 
geographic location are by census divisions, also shown separately 
for urban and rural hospitals.
    The second part of Table I shows hospital groups based on 
hospitals' FY 2005 payment classifications, including any 
reclassifications under section 1886(d)(10) of the Act. For example, 
the rows labeled urban, large urban, other urban, and rural show 
that the number of hospitals paid based on these categorizations 
after consideration of geographic reclassifications are 2,693, 
1,455, 1,238, and 1,204, respectively.
    The next three groupings examine the impacts of the final 
changes on hospitals grouped by whether or not they have GME 
residency programs (teaching hospitals that receive an IME 
adjustment) or receive DSH payments, or some combination of these 
two adjustments. There are 2,785 nonteaching hospitals in our 
analysis, 912 teaching hospitals with fewer than 100 residents, and 
200 teaching hospitals with 100 or more residents.
    In the DSH categories, hospitals are grouped according to their 
DSH payment status, and whether they are considered urban or rural 
for DSH purposes. Previously, hospitals in the rural DSH categories 
in the impact table represented hospitals that were not reclassified 
for purposes of the standardized amount. (However, they may have 
been reclassified for purposes of the wage index.) However, 
reclassification for purposes of the standardized amount has been 
terminated as a result of the equalization of the standardized 
amounts. As a result, there are no longer cases in which 
reclassifications change the status of rural hospitals for DSH 
purposes. There is little or no impact from the termination of 
standardized amount reclassification under the operating IPPS, since 
there are few concrete cases in which change from rural to urban 
status now would have any effect under the revised DSH payment 
formulas. The next category groups hospitals considered urban after 
geographic reclassification, in terms of whether they receive the 
IME adjustment, the DSH adjustment, both, or neither.
    The next five rows examine the impacts of the final changes on 
rural hospitals by special payment groups (SCHs, rural referral 
centers (RRCs), and Medicare dependant hospitals (MDHs)), as well as 
rural hospitals not receiving a special payment designation. There 
were 126 RRCs, 430 SCHs, 178 MDHs, and 73 hospitals that are both 
SCH and RRC.
    The next two groupings are based on type of ownership and the 
hospital's Medicare utilization expressed as a percent of total 
patient days. These data are taken primarily from the FY 2001 
Medicare cost report files, if available (otherwise FY 2000 data are 
used). Data needed to determine ownership status were unavailable 
for 140 hospitals. Similarly, the data needed to determine Medicare 
utilization were unavailable for 246 hospitals. The next two rows 
compare the impacts on those hospitals that converted from urban 
MSAs to rural CBSAs and for the hospitals that converted from rural 
MSAs to urban CBSAs.
    The next series of groupings concern the geographic 
reclassification status of hospitals. The first grouping displays 
all hospitals that were reclassified by the MGCRB for FY 2005. The 
next two groupings separate the hospitals in the first group by 
urban and rural status. The final row in Table I contains hospitals 
located in rural counties but deemed to be urban under section 
1886(d)(8)(B) of the Act.
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BILLING CODE 4120-01-C

C. Impact of the Proposed Changes to the DRG Reclassifications and 
Recalibration of Relative Weights (Column 2)

    In column 2 of Table I, we present the combined effects of the 
DRG reclassifications and recalibration, as discussed in section II. 
of the preamble to this final rule. Section 1886(d)(4)(C)(i) of the 
Act requires us annually to make appropriate classification changes 
and to recalibrate the DRG weights in order to reflect changes in 
treatment patterns, technology, and any other factors that may 
change the relative use of hospital resources.
    We compared aggregate payments using the FY 2004 DRG relative 
weights (GROUPER version 21.0) to aggregate payments using the 
proposed FY 2005 DRG relative weights (GROUPER version 22.0). We 
note that, consistent with section 1886(d)(4)(C)(iii) of the Act, we 
have applied a budget neutrality factor to ensure that the overall 
payment impact of the DRG changes (combined with the wage index 
changes) is budget neutral. This final budget neutrality factor of 
0.999876 is applied to payments in Column 7. Because this is a 
combined DRG reclassification and recalibration and wage index 
budget neutrality factor, it is not applied to payments in this 
column.
    The major DRG classification changes we are finalizing include: 
reassigning the procedure code for implanting left ventricular 
assist devices (LVADs) from DRG 525 to DRG 103 (now titled ``Heart 
Transplant or Implant of Heart Assist System''); reassigning the 
procedure codes involving artificial anal sphincters from DRGs 157 
and 158 to DRGs 146 (Rectal Resection With CC) and 147 (Rectal 
Resection Without CC); modifying the burn DRGs 504 through 509 to 
recognize the higher costs of long-term mechanical ventilation by 
reassigning all those cases to DRGs 504 and 505; splitting the DRG 
483 into two new DRGs based on the presence or absence of major OR 
procedures, DRG 541 (Tracheostomy with Mechanical Ventilation 96+ 
Hours or Principal Diagnosis Except Face, Mouth and Neck Diagnoses 
With Major Operating Room Procedure) and 542 (Tracheostomy with 
Mechanical Ventilation 96+ Hours or Principal Diagnosis Except Face, 
Mouth and Neck Diagnoses Without Major Operating Room Procedure).
    In the aggregate, these final changes would result in 0.1 
percent decrease in overall payments to hospitals. On average, the 
impacts of these changes on any particular hospital group are very 
small, with urban hospitals experiencing a 0.1 percent decrease and 
rural hospitals experiencing a 0.1 percent increase. The largest 
impacts are 0.5 percent decrease among hospitals in Puerto Rico, and 
a 0.6 percent increase among urban hospitals that are converting to 
rural hospitals.

D. Impact of the Change in the Labor-Related Share

    Section 403 of the MMA provides that, for discharges occurring 
on or after October 1, 2004, a hospital's labor-related share of the 
standardized amount will be decreased to 62 percent of the 
standardized amount unless such a change will result in lower total 
payments to the hospital. This provision also applies to the labor-
related share of the standardized amount for hospitals in Puerto 
Rico. The overall impact of implementing this provision is a 0.5 
percent payment increase to all hospitals (approximately $500 
million). Large urban hospitals will experience a 0.2 percent 
increase while other urban hospitals will experience a 0.7 percent 
increase. Rural hospitals are expected to benefit from this 
provision with a 1.1 percent increase in payments in FY 2005.
    Among regions, hospitals in Puerto Rico experience the largest 
increase of 6.2 percent (due to the relatively very low national 
wage index levels in Puerto Rico). The smallest increase among urban 
hospitals is in the New England region, and the Pacific region, with 
a 0.0 percent change, respectively. The largest increase among rural 
regions is expected to be East South Central, with a 2.0 percent 
increase in payments.

E. Impact of Changing to New Labor Market Areas (Column 4)

    In accordance with the broad discretion under section 
1886(d)(3)(E) of the Act, we currently define hospital labor market 
areas based on the definitions of Metropolitan Statistical Areas 
(MSAs), Primary MSAs (PMSAs), and New England County Metropolitan 
Areas (NECMAs) issued by OMB. On June 6, 2003, OMB announced new 
Core Based Statistical Areas (CBSAs), comprised of MSAs and the new 
Micropolitan Statistical Areas based on Census 2000 data. We are 
adopting the new MSA definitions, including the 49 new Metropolitan 
areas designated under the new definitions. We are also adopting MSA 
definitions in New England in place of NECMAs. We are not adopting 
the newly defined Micropolitan Statistical Areas for use in the 
payment system: as Micropolitan Statistical Areas will remain part 
of the statewide rural areas for purposes of IPPS payments. 
(However, as discussed in section III.B.1.d of the preamble to this 
final rule, we are adopting a special transition policy for 
hospitals that were formerly in urban areas, but are now in areas 
considered rural or Micropolitan under the OMB definitions.)
    The impact of these changes to the new CBSAs is isolated in 
column 4 by holding the other payment parameters constant in this 
simulation. That is, column 4 shows the percentage changes in 
payments when going from a model using the current MSA designations 
to a model using the new CBSA designations (for Metropolitan areas 
only). Overall, the new CBSAs will lead to a zero percent change. 
Urban hospitals' wage indexes will increase by 0.1 percent. Rural 
hospitals will experience a 0.3 percent decrease in overall payments 
as a result of this provision. Among rural hospitals, the largest 
impact of updating the labor market definitions is seen among rural 
hospitals in the South Atlantic, which will experience the next 
largest impact, with a 0.8 percent decrease.
    Among urban hospitals, New England will experience a 0.1 percent 
decrease. These impacts result primarily from dividing the 
previously amalgamated Boston NECMA into four Metropolitan Divisions 
and several other small Metropolitan Statistical Areas.

F. Impact of Final Wage Index Changes (Columns 5 and 6)

    Section 1886(d)(3)(E) of the Act requires that, beginning 
October 1, 1993, we annually update the wage data used to calculate 
the wage index. In accordance with this requirement, the final wage 
index for FY 2005 is based on data submitted for hospital cost 
reporting periods beginning on or after October 1, 2000 and before 
October 1, 2001. The impact of the new data on hospital payments is 
isolated in column 5 by holding the other payment parameters 
constant in this simulation. That is, column 5 shows the percentage 
changes in payments when going from a model using the FY 2004 wage 
index, based on FY 2000 wage data, to a model using the FY 2005 pre-
reclassification wage index, based on FY 2001 wage data. The wage 
data collected on the FY 2001 cost report is the same as the FY 2000 
wage data that were used to calculate the FY 2004 wage index. 
However, for the FY 2005 wage index, we added an occupational mix 
adjustment to the wage index. The occupational mix adjustment is 
based on data collected on the Medicare Wage Index Occupational Mix 
Survey, Form-CMS-10079. The data collection period for the survey 
was calendar year 2003 through February 7, 2004. The effects of the 
occupational mix adjustment are shown in the next column (6).
    Column 5 shows the impacts of updating the wage data using FY 
2001 cost reports. Overall, the new wage data will lead to a 0.1 
percent decrease for all hospitals. Urban hospitals would also 
experience a 0.1 percent decrease. Among regions, the largest 
increase is in the urban West South Central, which is experiencing a 
0.5 percent increase. The largest declines from updating the wage 
data are seen in the urban Middle Atlantic and Mountain regions (0.9 
and 0.4 percent decreases, respectively). The rural West North 
Central and Pacific regions both experience a 0.3 percent increase, 
while the rural Mountain region experiences a 0.2 percent increase.
    The national average hourly wage increased 6.7 percent compared 
to FY 2004. Therefore, the only manner in which to maintain or 
exceed the previous year's wage index was to match the national 6.7 
increase in average hourly wage. Of the 3,885 hospitals with wage 
index values in both FYs 2004 and 2005, 1,917, or 49.3 percent, also 
experienced an average hourly wage increase of 6.7 percent or more.
    The following chart compares the shifts in wage index values for 
hospitals for FY 2005 relative to FY 2004. Among urban hospitals, 
104 will experience an increase of between 5 percent and 10 percent 
and 103 will experience an increase of more than 10 percent. A total 
of 25 rural hospitals would experience increases greater than 5 
percent, but none will experience increases of greater than 10 
percent. On the negative side, 30 urban hospitals will experience 
decreases in their wage index values of at least 5 percent, but less 
than 10 percent. One urban hospital will experience decreases in 
their wage index values greater than 10 percent.

[[Page 49763]]

    The following chart shows the projected impact for urban and 
rural hospitals.

------------------------------------------------------------------------
                                                   Number of hospitals
  Percentage change in area wage index values  -------------------------
                                                   Urban        Rural
------------------------------------------------------------------------
Increase more than 10 percent.................          103            0
Increase more than 5 percent and less than 10           104           25
 percent......................................
Increase or decrease less than 5 percent......        2,420        1,289
Decrease more than 5 percent and less than 10            30           11
 percent......................................
Decrease more than 10 percent.................            1            0
------------------------------------------------------------------------

    The next column (6) shows the impacts on the calculation of the 
FY 2005 wage index of adjusting for occupational mix. Section 
1886(d)(3)(E) of the Act provides for the collection of data every 3 
years on the occupational mix of employees for each short-term, 
acute care hospital participating in the Medicare program, in order 
to construct an occupational mix adjustment to the wage index, 
beginning with the FY 2005 wage index. A complete discussion of the 
initial collection of these data and the occupational mix adjustment 
that we are proposing to apply, beginning October 1, 2004 (the FY 
2005 wage index), appears under section III.C. of this preamble. The 
calculation of the wage index now includes a blended rate of 90 
percent of an unadjusted wage index and 10 percent of a wage index 
adjusted for occupational mix. We project an overall change increase 
of 0.0 percent for all hospitals. The biggest change is in the rural 
hospitals in the South Atlantic, East South Central, and West South 
Central regions, which are projected to experience a 0.1 percent 
increase for FY 2005.

G. Combined Impact of Proposed DRG and Wage Index Changes, 
Including Budget Neutrality Adjustment (Column 7)

    The impact of the DRG reclassifications and recalibration on 
aggregate payments is required by section 1886(d)(4)(C)(iii) of the 
Act to be budget neutral. In addition, section 1886(d)(3)(E) of the 
Act specifies that any updates or adjustments to the wage index are 
to be budget neutral. As noted in the Addendum to this final rule, 
we compared simulated aggregate payments using the FY 2004 DRG 
relative weights and wage index to simulated aggregate payments 
using the final FY 2005 DRG relative weights and blended wage index.
    We computed a proposed wage and recalibration budget neutrality 
factor of 0.999876. The 0.0 percent impact for all hospitals 
demonstrates that these changes, in combination with the budget 
neutrality factor, are budget neutral. In Table I, the combined 
overall impacts of the effects of both the DRG reclassifications and 
recalibration and the updated wage index are shown in column 7. The 
changes in this column are the sum of the final changes in columns 
2, 3, 4, 5 and 6, combined with the budget neutrality factor and the 
wage index floor for urban areas required by section 4410 of Pub. L. 
105-33 to be budget neutral. There also may be some variation of 
plus or minus 0.1 percentage point due to rounding.
    Among urban regions, the largest impacts are in the Middle 
Atlantic and Puerto Rico, with 0.7 and 0.9 percent declines, 
respectively. The West South Central region experiences the largest 
increase of 0.54 percent. Among rural regions, the West North 
Central region benefits the most with a 0.5 percent increase, while 
East South Central region experiences the largest decline (0.3 
percent).

H. Impact of Blended Wage Index Transition for Hospitals Receiving 
Lower Wage Index Values Under the New MSAs

    Section 1886(d)(3)(E) of the Act specifies that any updates or 
adjustments to the wage index are to be budget neutral. As discussed 
in section III of the preamble and in section II.B. of the addendum 
to this rule, we are implementing a 1 year transition period for the 
wage index to help mitigate reductions in wage index values 
resulting from the implementation of the new CBSA. During this 
transition period, providers who receive a wage index value under 
the new CBSA that is lower than the value that they would have 
received under the old MSA will receive a blended wage index 
comprised of 50 percent of the old MSA wage index and 50 percent of 
the New MSA wage index. Additionally, providers who were urban under 
the old MSA but are now rural under the new CBSA will continue to 
receive the wage index of the urban area to which they were 
previously assigned. To compute the budget neutrality factor for 
this transition period, we compared simulated aggregate payments 
using the new CBSA wage index values to simulated aggregate payments 
using the new CBSA and old MSA blended wage index values. We 
computed a transition budget neutrality factor of 0.998162. The 0.0 
percent impact for all hospitals demonstrates that the overall 
effect of the blended wage index values in combination with the 
transition budget neutrality factor, is budget neutral. While there 
is a 0.2 percent decline in payments for urban West North Central 
and -0.1 percent decline for urban Pacific and rural New England 
regions, most of the other provider groupings in Table 1 are not 
affected by this transition and several groups of rural providers 
benefit from receiving the blended wage index values.
    As described in section III of the preamble to this final rule, 
to help alleviate the decreased payments for currently urban 
hospitals that would become rural, we are adopting a policy to allow 
them to maintain their assignment to the MSA where they are 
currently located for the 3-year period FY 2005, FY 2006, and FY 
2007. The impact upon these hospitals is shown in the row labeled 
``Urban to Rural Hospitals.'' Conversely, the row labeled ``Rural to 
Urban Hospitals'' displays formerly rural hospitals that are now in 
MSAs under the new definitions.

I. Impact of MGCRB Reclassifications (Column 9)

    Our impact analysis to this point has assumed hospitals are paid 
on the basis of their actual geographic location (with the exception 
of ongoing policies that provide that certain hospitals receive 
payments on bases other than where they are geographically located, 
such as hospitals in rural counties that are deemed urban under 
section 1886(d)(8)(B) of the Act). The changes in column 8 reflect 
the per case payment impact of moving from this baseline to a 
simulation incorporating the MGCRB decisions for FY 2005. These 
decisions affect hospitals' standardized amount and wage index area 
assignments.
    By February 28 of each year, the MGCRB makes reclassification 
determinations that will be effective for the next fiscal year, 
which begins on October 1. The MGCRB may approve a hospital's 
reclassification request for the purpose of using another area's 
standardized amount, wage index value, or both. The final FY 2005 
wage index values incorporate all of the MGCRB's reclassification 
decisions for FY 2005. The wage index values also reflect any 
decisions made by the CMS Administrator through the appeals and 
review process through February 28, 2004. Additional changes that 
result from the Administrator's review of MGCRB decisions or a 
request by a hospital to withdraw its application are reflected in 
this final rule for FY 2005.
    The overall effect of geographic reclassification is required by 
section 1886(d)(8)(D) of the Act to be budget neutral. Therefore, we 
applied an adjustment of 0.993833 to ensure that the effects of 
reclassification are budget neutral. (See section II.A.4.b. of the 
Addendum to this final rule.)
    As a group, rural hospitals benefit from geographic 
reclassification. Their payments will rise 1.8 percent in column 8. 
Payments to urban hospitals will decline 0.3 percent. Hospitals in 
other urban areas will experience an overall decrease in payments of 
0.2 percent, while large urban hospitals will also lose 0.3 percent. 
Among urban hospital groups (that is, bed size, census division, and 
special payment status), payments generally would decline.
    A positive impact is evident among all of the rural hospital 
groups. The smallest increase among the rural census divisions are

[[Page 49764]]

0.5 for Mountain and 0.9 percent for the Pacific region. The largest 
increases are in the rural East South Central region, with an 
increase of 2.5 percent and in the West South Central region, which 
would experience an increase of 3.0 percent.
    Among all the hospitals that were reclassified for FY 2005 
(including hospitals that received wage index reclassifications in 
FY 2003 or FY 2004 that extend for 3 years), the MGCRB changes are 
estimated to provide a 3.8 percent increase in payments. Urban 
hospitals reclassified for FY 2005 are expected to receive an 
increase of 3.9 percent, while rural reclassified hospitals are 
expected to benefit from the MGCRB changes with a 3.8 percent 
increase in payments. Payments to urban and rural hospitals that did 
not reclassify are expected to decrease slightly due to the MGCRB 
changes, decreasing by 0.5 percent for urban hospitals and 0.3 
percent for rural hospitals.

J. Impacts of Implementing the Wage Index Adjustment for Out-
Migration (Column 10)

    Section 505 of Pub. L. 108-173 established new section 
1886(d)(13) of the Act. The section 1886(d)(13) requires that the 
Secretary establish a new process to make adjustments to the 
hospital wage index based on commuting patterns of hospital 
employees. The process provides for an increase in the wage index 
for hospitals located in certain counties that have a relatively 
high percentage of hospital employees who reside in the county but 
work in a different area with a higher wage index. Hospitals located 
in counties that qualify for the payment adjustment are to receive 
an increase in the wage index that is equal to a weighted average of 
the difference between the wage index of the resident county and the 
higher wage index work area(s), weighted by the overall percentage 
of workers who are employed in an area with a higher wage index. 
Using our final criteria, 230 counties and 415 hospitals qualify to 
receive a commuting adjustment.
    Due to the statutory formula to calculate the adjustment and the 
small number of counties that qualify, the impact on hospitals is 
minimal, with an overall impact on all hospitals of 0.1 percent. 
However, some regions experienced a discernible impact. For example, 
the urban East South Central region experiences a 0.2 percent 
increase due to this provision. This is due in part to the fact that 
a hospital in that region will experience the largest increase for 
any hospital under this provision.

K. All Changes (Column 11)

    Column 11 compares our estimate of payments per case, 
incorporating all changes reflected in this final rule for FY 2005 
(including statutory changes), to our estimate of payments per case 
in FY 2004. This column includes all of the proposed policy changes. 
Because the reclassifications shown in column 9 do not reflect FY 
2004 reclassifications, the impacts of FY 2005 reclassifications 
only affect the impacts from FY 2004 to FY 2005 if the 
reclassification impacts for any group of hospitals are different in 
FY 2005 compared to FY 2004.
    Column 11 reflects all FY 2005 changes relative to FY 2004, 
shown in columns 2 through 10 and those not applied until the final 
rates are calculated. The average increase for all hospitals is 
approximately 5.8 percent. This increase includes the effects of the 
3.3 percent market basket update. It also reflects the 1.5 
percentage point difference between the projected outlier payments 
in FY 2004 (5.1 percent of total DRG payments) and the current 
estimate of the percentage of actual outlier payments in FY 2004 
(3.6 percent), as described in the introduction to this Appendix and 
the Addendum to this final rule. As a result, payments are projected 
to be 1.5 percentage point lower in FY 2004 than originally 
estimated resulting in a 1.5 percentage point greater increase for 
FY 2005 than would otherwise occur. It also includes the impact of 
adjusting the labor share, shown in column 3, of approximately 0.5 
percent. The remaining 0.5 percent increase is attributable to the 
indirect medical education formula changes for teaching hospitals; 
changes in payments due to the wage reclassifications under section 
508 of the MMA, in effect for the whole year; and increased payments 
to Puerto Rico hospitals as a result of section 504 of the MMA, 
which changed the mix of the Federal standardized amount and the 
Puerto Rico-specific standardized amount. The overall increase also 
reflects changes to payments that resulted from implementing other 
changes as required by Public Law 108-173. These changes are 
discussed in other rules and in many sections of the preamble to 
this final rule.
    Section 213 of Public Law 106-554 provides that all SCHs may 
receive payment on the basis of their costs per case during their 
cost reporting period that began during 1996. For FY 2005, eligible 
SCHs receive 100 percent of their 1996 hospital-specific rate. The 
impact of this provision is modeled in column 11 as well. 
Additionally, section 402 of Public Law 108-173 increases the 
disproportionate share hospital (DSH) adjustment for hospitals that 
serve a disproportionate share of low-income Medicare and Medicaid 
patients, which include rural hospitals and urban hospitals with 
fewer than 100 beds, sole community hospitals, rural referral 
centers, and rural hospitals with less than 500 beds. The increase 
in DSH payments became effective for discharges occurring on or 
after April 1, 2004. As provided in the new Medicare law, the cap on 
DSH payment adjustments increased from 5.25 percent to 12 percent 
for urban hospitals with fewer than 100 beds, sole community 
hospitals, and rural hospitals with less than 500 beds. There is no 
cap on rural referral centers, large urban hospitals over 100 beds, 
or rural hospitals over 500 beds.
    We are no longer required to ensure that any add-on payments for 
new technology under section 1886(d)(5)(K) of the Act are budget 
neutral. However, we are still providing an estimate of the payment 
increases here, as they will have a significant impact on total 
payments made in FY 2005. New technology add-on payments are limited 
to the lesser of 50 percent of the costs of the technology, or 50 
percent of the costs in excess of the DRG payment for the case. 
Because it is difficult to predict the actual new technology add-on 
payment for each case, we are estimating the increase in payment for 
FY 2005 as if every claim with these add-on payments received the 
maximum add-on payment. As discussed in section II.E. of the 
preamble of this final rule, we finalizing the new technology status 
of the InFUSEtm Bone Grafttm Lumbar Tapered 
Fusion Device for spinal fusions (including new technologies that 
employ the same code). We estimate the total add-on payments 
associated with cases involving these new devices for FY 2005 would 
be $7.8 million. In addition, several other technologies have 
received approval (as discussed in the preamble of this final rule) 
for FY 2005. We have approved CRT-D devices for new technology add-
on payments for FY 2005. We estimate this approval to increase 
overall payments by $341 million. We also approved 
Kinetratm implants for new technology add-on payments for 
FY 2005. We estimate this approval to increase overall payments by 
$11.9 million. The total increase in payments for FY 2005, if every 
claim with these devices were to receive the maximum add-on payments 
amount, is estimated to be $360.7 million. The increase in payments 
for these new technologies is not reflected in the tables.
    There might also be interactive effects among the various 
factors comprising the payment system that we are not able to 
isolate. For these reasons, the values in column 10 may not equal 
the sum of the changes described above.
    The overall change in payments per case for hospitals in FY 2005 
would increase by 5.8 percent. Hospitals in urban areas would 
experience a 5.7 percent increase in payments per case compared to 
FY 2004. Hospitals in rural areas, meanwhile, would experience a 6.2 
percent payment increase. Hospitals in large urban areas would 
experience a 5.4 percent increase in payments and hospitals in other 
urban areas would experience a 6.1 percent increase in payments.
    Among urban census divisions, the largest payment increase would 
be 15.8 percent in Puerto Rico. This is due largely to the change in 
calculation of their payment rate to 75 percent of the National 
amount and equalization of the urban and rural standardized amounts 
at the amount for large urban hospitals. Additionally, the change to 
CBSAs makes all hospitals in Puerto Rico classify as urban hospitals 
instead of rural. This is also why the column showing impacts on 
rural Puerto Rico hospitals shown in previous years has been removed 
from Table I. Hospitals in the urban East South Central and West 
South Central regions would experience the next largest overall 
increases of 5.9 percent and 6.4 percent, respectively. The smallest 
urban increase would occur in the Mountain region, with an increase 
of 4.5 percent. These above average increases are primarily due to 
the changes in payments created for many hospitals as a result of 
implementing Public Law 108-173.
    Among rural regions in column 11, no hospital category will 
experience overall payment decreases. The East South Central and 
West South Central regions will benefit the most, with 9.2 and 7.1 
percent increases,

[[Page 49765]]

respectively. The smallest increase will occur in the Mountain 
region, with 4.4 percent increases in payments.
    Among special categories of rural hospitals in column 11, those 
hospitals receiving payment under the hospital-specific methodology 
(SCHs, MDHs, and SCH/RRCs) would experience payment increases of 4.1 
percent, 8.3 percent, and 4.5 percent, respectively. This outcome is 
primarily related to the fact that, for hospitals receiving payments 
under the hospital-specific methodology, there were several 
increases to payments made in relation to implementation of the 
Public Law 108-173.
    Hospitals that were reclassified for FY 2005 are estimated to 
receive a 5.8 percent increase in payments. Urban hospitals 
reclassified for FY 2005 are anticipated to receive an increase of 
5.3 percent, while rural reclassified hospitals are expected to 
benefit from reclassification with a 6.2 percent increase in 
payments. Those hospitals located in rural counties but deemed to be 
urban under section 1886(d)(8)(B) of the Act are expected to receive 
an increase in payments of 5.3 percent.
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BILLING CODE 4120-01-C
    Table II presents the projected impact of the final changes for 
FY 2005 for urban and rural hospitals and for the different 
categories of hospitals shown in Table I. It compares the estimated 
payments per case for FY 2004 with the average estimated per case 
payments for FY 2005, as calculated under our models. Thus, this 
table presents, in terms of the

[[Page 49768]]

average dollar amounts paid per discharge, the combined effects of 
the changes presented in Table I. The percentage changes shown in 
the last column of Table II equal the percentage changes in average 
payments from column 10 of Table I.

VII. Impact of Other Policy Changes

    In addition to those final changes discussed above that we are 
able to model using our IPPS payment simulation model, we are 
finalizing various other changes in this final rule. Generally, we 
have limited or no specific data available with which to estimate 
the impacts of these changes. Our estimates of the likely impacts 
associated with these other final changes are discussed below.

A. Impact of Change to Postacute Care Transfer Payment Policy

    Existing regulations at Sec.  412.4(b) define transfers from one 
acute care hospital to another, and Sec.  412.4(c) defines transfers 
to certain postacute care providers. The per diem rate paid to a 
transferring hospital is calculated by dividing the full DRG payment 
by the geometric mean length of stay for the DRG. The transferring 
hospital receives a per diem payment for cases that are transferred 
prior to the geometric mean length of stay for the DRG (Sec.  
412.4(f)(1)). Under section IV.A. of the preamble of this final 
rule, we discuss our adoption of a grandfathering period for which 
remapped claims will be included within the scope of the postacute 
care transfer policy. The occasion for this revision is our decision 
to delete DRG 483, and to assign the cases that previously were 
included within DRG 483 to two new DRGs, 541 and 542. As a result of 
grandfathering into the postacute care transfer policy those cases 
that were previously assigned to 483, the cases in the two new DRGs, 
541 and 542 will be subject to the postacute care transfer policy 
for FY 2005. We estimate that the inclusion of DRGs 541 and 542 will 
have no effect on payments, because all of the cases included within 
those DRGs were previously included within DRG 483 and, thus, 
already fall within the policy.

B. Impact of LTC-DRG Reclassifications and Relative Weights for 
LTCHs

    In section II.D. of the preamble of this final rule, we discuss 
the changes in the LTC-DRG relative weights for FY 2005 on the 
version 22.0 of the CMS GROUPER. We estimate that the changes will 
result in an aggregate decrease in LTCH payments of approximately a 
$14.9 million based on LTCH cases in the FY 2003 MedPAR file. (We 
note that in the May 18, 2002 IPPS proposed rule we incorrectly 
estimated the impact of the change in the LTC-DRGs for FY 2005 as 
approximately a $55 million decrease in LTCH PPS payments because we 
failed to account for the change in DRG classifications and the 
change in the geometric average length of stay for each LTC-DRG.) As 
we discuss in further detail in the 2005 LTCH PPS rate year final 
rule published on May 7, 2004, based on an analysis of LTCH claims 
data in the FY 2003 MedPAR file, we found that the average LTC-DRG 
relative weight has increased due to an increase of cases being 
assigned to LTC-DRGs with higher relative weights. This increase may 
be attributable to a number of factors, including improvements in 
coding practices, which are typically found when moving from a 
reasonable cost-based payment system to a PPS. The impact of 
including cases with relatively lower charges into LTC-DRGs that 
have a relatively higher relative weight in the GROUPER version 21.0 
(FY 2004) is a decrease in the average relative weight for those 
LTC-DRGs in GROUPER version 22.0. We believe that the changes in the 
LTC-DRG relative weights, which include a number of LTC-DRGs with 
lower proposed relative weights, will result in a slight decrease in 
LTCH PPS payments.

C. Impact of Policy on Payments for Inpatient Care in Providers 
That Change Classification Status During a Patient Stay

    In section IV.B. of the preamble to this final rule, we discuss 
a change to our policy to preclude making more than one payment 
under Medicare for cases in which a Medicare provider changes its 
Medicare payment classification during a patient's stay; that is an 
acute care hospital changes to a LTCH. Although this situation may 
occur in other settings, this payment issue is most prevalent for 
services furnished to cross-over patients in a newly established 
LTCH. Currently, when this situation arises, Medicare makes two 
payments for what is essentially only one beneficiary episode of 
care, one under the IPPS and one under the LTCH PPS. The intent of 
this policy is to eliminate the unnecessary Medicare payments for 
such patients. While we believe that this policy may generate 
considerable savings for the Medicare program, we do not have 
readily available data to precisely estimate the effect of this 
change.

D. Impact on Policy Reporting of Hospital Quality Data for Annual 
Hospital Payment Update

    In section I.V.E. of the preamble to this final rule, we discuss 
the implementation of section 501(b) of Public Law 108-173, which 
provides that the update factor for the operating payments for FY 
2005 and subsequent fiscal years is the market basket percentage 
increase. Section 501(b) also provides that, for FYs 2005 through 
2007, the update factor will be the market basket percentage 
increase minus 0.4 percentage points for any hospital that does not 
submit quality data as specified in the law. We are unable to 
precisely estimate the effect of this provision because, while 
receiving the full update for those years is conditional upon the 
submission of quality data by a hospital, submission of the data is 
not mandated unconditionally. Furthermore, the final date for 
submission of quality data for purposes of receiving the full 
adjustment in FY 2005 is August 1, 2004. This date is too late to 
take the final submission data into account in preparation for this 
final rule. However, preliminary results indicate that over 90 
percent of IPPS hospitals had submitted quality data. We have also 
made efforts to ensure that QIOs provide assistance to all hospitals 
that wish to submit data. The Congressional Budget Office, in its 
analysis of Public Law 108-173, assumed that a significant number of 
hospitals would not provide the data required for a full payment 
update, and therefore estimated savings to the Medicare program of 
approximately $100 million per year. However, we believe that a very 
high proportion of hospitals will respond to the incentive provided 
by section 501(b) and submit quality data in order to receive the 
full update. For purposes of this final rule, we are therefore 
assuming that no appreciable savings will result from this 
provision.

E. Impact of Policy on Threshold Criteria for Add-On Payments for 
New Technology and Medical Services

    In section IV.H. of the preamble of this final rule, we 
finalized our policy to revise the threshold amount for determining 
whether a new technology or medical service is an appropriate 
candidate for an additional payment if it is inadequately paid 
otherwise under the DRG system. We are no longer required to ensure 
that any add-on payments for new technology under section 
1886(d)(5)(K) of the Act are budget neutral. However, these payments 
will have a significant impact on total payments made in FY 2005. As 
discussed in section II.E. of the preamble of this final rule, we 
are finalizing our decision to maintain the new technology status of 
the InFUSETM Bone Graft/ Lumbar Tapered Fusion Device for 
spinal fusions. New technology add-on payments are limited to the 
lesser of 50 percent of the costs in excess of the DRG payment for 
the case. Because it is difficult to predict the actual new 
technology add-on payment for each case, we are estimating the 
increase in payments for FY 2005 as if every case eligible for ad-on 
payments will receive the maximum payment amount.
    We also extended the new technology add-on payments for this 
technology to OP-1 Implants. We estimate the total add-on payments 
associated with cases involving these new devices for FY 2005 will 
be $7.8 million. In addition, several other technologies have 
received approval (as discussed in the preamble of this final rule) 
for FY 2005. We have approved CRT-D devices for new technology add-
on payments for FY 2005. We estimate this will increase overall 
payments by $341 million. We also approved KinetraTM 
implants for new technology add-on payments for FY 2005. We estimate 
this approval will increase overall payments by $11.9 million. The 
total increase in payments for FY 2005, if every claim with these 
devices were to receive the maximum add-on payment amount, is 
estimated to be $360.7 million.

F. Impact of Policy on Additional Payments to Hospitals with High 
Percentage of End-Stage Renal Disease Discharge

    In section IV.J. of the preamble of this final rule, we are 
revising our regulations to state that, in determining eligibility 
of hospitals for additional Medicare payments for hospitals with 
high percentages of ESRD discharges, only discharges involving ESRD 
Medicare beneficiaries who have received a dialysis treatment during 
an inpatient hospital stay are to be counted.
    This revision to the policy will reduce the number of hospitals 
that will qualify for this

[[Page 49769]]

additional payment. Specifically, discharges of Medicare ESRD 
beneficiaries who have not received dialysis treatment during the 
course of their hospital stays will no longer be counted in 
determining whether hospitals meet the threshold for receiving this 
additional payment. Some hospitals that have previously qualified 
for this extra payment will therefore be unable to qualify under 
this revised policy. Therefore, this change is expected to result in 
a reduction in Medicare program expenditures. However, we are unable 
to quantify the level of program savings because we lack data on the 
proportion of the discharges previously counted toward the threshold 
determination under this provision that involved Medicare ESRD 
beneficiaries who did not receive dialysis services during their 
hospital stays. Overall program expenditures under this provision 
have been approximately $15 million annually to approximately 41 
hospitals. We estimate that the savings due to this policy change 
will be some proportion of that figure since some of the hospitals 
that currently qualify for the adjustment, will no longer qualify 
for these payments under the revised criteria.

G. Impact of Policy on Payment Adjustments for Low-Volume Hospitals

    In section IV.M. of the preamble of this final rule, we discuss 
our implementation of section 406 of Public Law 108-173, which 
provides for a new payment adjustment to account for the higher 
costs per discharge of low-volume hospitals under the IPPS.
    Based on the empirical analysis, we are limiting the adjustment 
to hospitals with 200 or fewer discharges. It is difficult to 
estimate precisely the impact of this provision. There were 
approximately 100 hospitals with 200 or fewer total discharges in 
the most recent year for which we have data. However, we have not 
yet determined which hospitals satisfy the requirement that the 
hospital be located more than 25 road miles from another subsection 
(d) hospital. We are adopting our proposal to require that a 
hospital that wishes to qualify for the adjustment must provide its 
fiscal intermediary with evidence that it meets this distance 
requirement. Until intermediaries are able to make these 
determinations, we are unable to determine how many hospitals 
qualify for the adjustment.
    However, the aggregate impact of this provision is likely to be 
relatively small. Hospitals with fewer than 200 total discharges in 
a year are likely to have correspondingly few Medicare discharges, 
perhaps 50 to 60 Medicare discharges or fewer. Although each 
discharge will receive the maximum adjustment of 25 percent, we 
believe that aggregate expenditures will be no greater than under 
the adjustment in the proposed rule. The Congressional Budget Office 
estimated that this provision will increase Medicare program 
expenditures by less than $50 million annually. In the absence of a 
more precise estimate for the reasons indicated above, we agree with 
the Congressional Budget Office's determination.

H. Impact of Policy on Medicare Geographic Classification Review 
Board (MGCRB) Reclassifications (Sec. Sec.  412.230, 412.234, and 
412.236)

    Sections 1886(d)(2)(D) and (d)(3) of the Act previously required 
the Secretary to compute two average standardized amounts for 
discharges occurring in a fiscal year: one for hospitals located in 
large urban areas and one for hospitals located in other areas. In 
addition, under sections 1886(d)(9)(B)(iii) and (d)(9)(C)(i) of the 
Act, the average standardized amount per discharge was determined 
for hospitals located in large urban and other areas in Puerto Rico. 
In accordance with section 1886(b)(3)(B)(i) of the Act, the large 
urban average standardized amount was 1.6 percent higher than the 
other area average standardized amount.
    Section 402(b) of Public Law 108-7 required that, effective for 
discharges occurring on or after April 1, 2003, and before October 
1, 2003, the Federal rate for all IPPS hospitals will be based on 
the large urban standardized amount. Subsequently, Public Law 108-
89, extended section 402(b) of Public Law 108-7 beginning with 
fiscal year 2004 and thereafter, and equal standardized amount is to 
be computed for all hospitals at the level computed for large urban 
hospitals during FY 2003, updated by the applicable percentage 
update. This provision in effect makes permanent the equalization of 
the standardized amounts at the level of the previous standardized 
amount for large urban hospitals. As a result of this legislative 
change, the standardized amount reclassification criterion is no 
longer necessary or appropriate. Therefore, as discussed in section 
IV.N. of this final rule, we have removed all standardized amount 
criteria provisions from the regulations governing geographic 
reclassification. Specifically, we removed the provisions that 
contain the criterion requiring individual hospitals and urban 
hospital groups to demonstrate that their costs are more comparable 
to the average amount they would be paid if they were reclassified 
than the amount they would be paid under their current 
classification.
    In conjunction with this change, we have finalized that, under 
the Secretary's general authority to make exceptions, any hospital 
whose urban county group application under Sec.  412.234 would have 
been approved by the MGCRB for FY 2004 and FY 2005, but for the 
failure to meet the requirements in Sec.  412.234(c), will be 
assigned the wage index for the MSA identified in the FY 2004 and FY 
2005 group application (in cases where the group identified more 
than one preference, the hospital will be assigned the wage index 
that is most advantageous). In response to comments, we have also 
expanded this exception to include certain other hospitals. 
Specifically, we will also provide this exception for some hospitals 
whose urban county group application under Sec.  412.234 would have 
been approved by the MGCRB for either FY 2004 or FY 2005, but for 
the failure to meet the requirements in Sec.  412.234(c). However, 
these hospitals must meet the additional requirements that at least 
one-third of the hospitals included in its group reclassification 
have since reclassified to another wage area, and that the hospitals 
that have since reclassified must have a wage index at least 10 
percent higher than the wage index of the MSA in which they are 
located.
    Finally, we have also revised the reclassification rules 
governing the wage thresholds that hospitals must meet in order to 
be reclassified. Previously, except for rural referral centers, 
individual hospitals were required to demonstrate that their 3-year 
average hourly wages are greater than or equal to a designated 
threshold (108 percent for urban hospitals, 106 percent for rural 
hospitals) of the average hourly wages of hospitals in the area in 
which the hospital is located. We have revised this standard to 
provide that a hospital's averages are greater than or equal to a 
designated threshold (108 percent for urban hospitals, 106 percent 
for rural hospitals) of the average hourly wages of all the other 
hospitals in the area in which the hospital is located.
    For our final decision to remove all standardized amount 
criteria provisions from the regulations, we are unable to quantify 
the impact of this change precisely. The deletion of the 
standardized amount criterion may allow more hospital group 
applications to qualify for reclassification. However, we cannot 
determine how many groups would be affected by this change, and, of 
those, how many groups would actually organize to apply under the 
revised standard. This change would not affect the aggregate level 
of Medicare expenditures since reclassification decisions are budget 
neutral under section 1886(d)(8)(B) of the Act. However, the 
exercise of the Secretary's exception authority to assign a new wage 
index to certain hospitals that failed to be approved for 
reclassification in FY 2004 and FY 2005 is not budget neutral. We 
have approved only a very small number of hospitals for a new wage 
index assignment under this proposed exception. This includes the 
hospitals that qualify under the revised criteria that we announce 
in this final rule. Based on our analysis, we believe that the 
aggregate impact on program payments will be in the range of $15 
million to $20 million annually for the 3 years during which this 
exception will be in place.
    We are unable to quantify the precise impact of the change in 
the definition of the wage thresholds that individual hospitals must 
meet in order to qualify for reclassification. Our analysis 
indicates that approximately 100 more hospitals will now meet the 
applicable threshold (108 percent for urban hospitals, 106 percent 
for rural hospitals). However, we are unable to determine how many 
of these hospitals will also meet the other criteria for 
reclassification, especially the criterion that a hospital's 3-year 
average hourly wage must be greater than or equal to a certain 
threshold (84 percent in the case of urban hospitals, 82 percent in 
the case of rural hospitals) of the average hourly wage of the 
hospitals in the area to which it seeks reclassification. However, 
this change will not lead to additional program expenditures since 
hospital reclassifications are budget neutral under section 
1886(d)(8)(B) of the Act.
    In addition, we are unable to quantify the precise impact of the 
finalized change

[[Page 49770]]

precisely to the average hourly wage threshold for rural referral 
centers. Only a limited number of rural referral centers are 
actually located in urban areas. Effective October 1, 2000, if a 
hospital located in what is now an urban area was ever a rural 
referral center, it is reinstated to rural referral center status 
(65 FR 47089). We are unable to determine how many of these rural 
referral centers that would not otherwise have qualified for 
reclassification would now be able to meet the 82 percent threshold. 
However, this change does not affect the aggregate level of Medicare 
expenditures since reclassification decisions are budget neutral 
under section 1886(d)(8)(B) of the Act. The exercise of the 
Secretary's exception authority to assign a new wage index to 
certain rural referral centers that failed to be approved for 
reclassification in FY 2005 is not budget neutral. Only one hospital 
has demonstrated that it meets the conditions for receiving this 
special exception. The aggregate impact on program payments will be 
in the range of $10 million to $15 million for the 3-years during 
which this exception will be in effect.
    Further, our use of the authority in section 1886(d)(5)(I)(i) of 
the Act, to provide special protection to a small number of 
hospitals in States with fewer than 10 people per square mile (as 
determined using 2000 census data) will only increase Medicare 
program expenditures by approximately $3 million to $6 million. A 
total of 9 hospitals have satisfied the criteria for receiving this 
exception. However, these hospitals are relatively small, and some 
of them are paid under their hospital specific rates, which 
restricts the gain from reclassification in most cases to capital 
PPS payments and payments for outpatient services.

I. Impact of Policy Changes for Available Beds and Patient Days 
Used in the IME and DSH Adjustments

    Under the IPPS, the IME and the DSH adjustments utilize 
statistics regarding the number of beds and patient days of a 
hospital to determine the level of the respective payment 
adjustment. For IME, hospitals receiving this adjustment want to 
minimize their number of beds in order to maximize their resident-
to-bed ratio. For DSH, urban hospitals with 100 or more beds qualify 
for a higher payment adjustment, so some hospitals have an incentive 
to maximize their bed count to qualify for higher payments. Existing 
regulations specify that the number of beds is determined by 
counting the number of available bed days during the cost reporting 
period and dividing that number by the number of days in the cost 
reporting period.
    In this final rule, we finalized our policy regarding unoccupied 
beds, observation beds of patients ultimately admitted as 
inpatients, dual-eligible patient days, and Medicare+Choice patient 
days. We do not anticipate that these policy changes will have a 
significant impact on payments. Based on an analysis from our 
actuarial staff, we anticipate the impact of all four of these 
policy changes to be less than $50 million for FY 2005.

J. Impact of Proposed Policy on Payment for Direct Costs of 
Graduate Medical Education

1. Redistribution of Unused Resident Slots

    As discussed in section IV.O.2.b. of this preamble, section 422 
of Public Law 108-173 added a new section 1886(h)(7) to the Act that 
provides for reductions in the statutory FTE resident caps under 
Medicare for certain hospitals and authorizes a ``redistribution'' 
of the FTE resident slots resulting from the reduction in the FTE 
resident caps to other hospitals.
    For purposes of this final rule, we have estimated the impact of 
section 422 on hospitals for FY 2005, making assumptions about 
update factors, geographic (locality) adjustment factors, and the 
number of unused residency positions for each hospital. For purposes 
of calculating the impact for direct GME payments, we used the 
projected national average per resident amount (PRA) for FY 2005 of 
$82,249, as determined in accordance with existing Sec.  
413.86(e)(4)(ii)(B) (redesignated as Sec.  413.77(d)(2)(ii) in this 
final rule), since section 1886(h)(7)(B)(v) of the Act requires that 
a hospital that receives an increase in its direct GME FTE resident 
cap under section 1886(h)(7)(B) of the Act will receive direct GME 
payments with respect to those additional FTE residents using the 
locality-adjusted national average PRA. Based on our analysis of 
hospitals' FTE resident caps and FTE resident counts from the 
Hospital Cost Report Information System (HCRIS) for the most recent 
cost reporting periods ending on or before September 30, 2002, and 
making assumptions for hospitals that submit a timely request to use 
their cost report that includes July 1, 2003, we estimate that 
approximately 2,600 FTE resident slots that were previously unfilled 
(and therefore, no direct GME or IME payments were made for those 
slots) will be redistributed to and filled by hospitals that request 
an increase to their FTE residents caps under section 1886(h)(7)(B) 
of the Act. (We note that this estimate of 2,600 slots is not 
necessarily the same as the estimate we will ultimately use to 
redistribute resident positions under section 1886(h)(7)(B)) of the 
Act. Since payments for direct GME are determined based on a 
hospital's Medicare inpatient utilization, for purposes of this 
impact, we have applied a factor of .35 as the average Medicare 
inpatient utilization. Accordingly, for FY 2005, we estimate an 
increase of $75.6 million in direct GME payments.
    For purposes of estimating the impact on IME payments, we used 
an IME formula multiplier of 0.66, since section 1886(d)(5)(B)(ix) 
of the Act states that for a hospital whose FTE resident cap is 
increased as a result of a redistribution of unused resident 
positions, the IME adjustment factor is to be calculated using a 
formula multiplier of 0.66 with respect to any additional residents 
counted by the hospital as a result of that increase in the 
hospital's FTE resident cap. Based on an estimate of unused resident 
positions using FTE resident data from HCRIS for the most recent 
cost reporting periods ending on or before September 30, 2002, and 
making assumptions for hospitals that submit a timely request to use 
their cost report that includes July 1, 2003, we estimate that for 
FY 2005, IME payments will increase by approximately $66.5 million. 
Thus, since section 422 is not effective until the fourth quarter of 
FY 2005 (that is, July 1, 2005), the estimated total increase in 
Medicare payments for FY 2005 attributable to section 422 is $35.53 
million ([$75.6 million + $66.5 million] divided by 4).

2. Per Resident Amount: Extension of Update Limitation on High-Cost 
Programs

    In section IV.O.4. of the preamble of this final rule, we 
discuss our implementation of section 711 of Public Law 108-173, 
which freezes the annual CPI-U inflation factors to hospital-
specific PRAs for direct GME payments for those PRAs that exceed the 
established ceiling for FYs 2004 through 2013. Under existing 
regulations, for FY 2005, if a hospital's PRA for the previous cost 
reporting period would be greater than 140 percent of the locality-
adjusted national average PRA for that same previous cost reporting 
period, the hospital's PRA would be updated for inflation, except 
that the CPI-U applied for a 12-month period is reduced by 2 
percentage points. Under the new provisions of section 711 of Public 
Law 108-173 for FY 2005, if a hospital-specific PRA for the previous 
cost period would be greater than 140 percent of the locality-
adjusted national average PRA for that same previous cost reporting 
period, the hospital-specific PRA would be frozen at the FY 2004 
PRA, and not updated for inflation. Therefore, the impact in direct 
GME payments for FY 2005 (attributable to section 711 of the Public 
Law 108-173) is the difference between updating the PRAs by the 
applicable CPI-U inflation factor minus 2 percentage points, and not 
updating the PRAs by any CPI-U inflation factor. We have calculated 
an impact for this provision, but the resulting savings are 
negligible (less than $100,000).

3. Residents Training in Nonhospital Settings

    In section IV.O.5. of the preamble of this final rule, we 
discuss our implementation of section 713 of Public Law 108-173, 
which, through a moratorium, allows hospitals to count allopathic or 
osteopathic family practice residents training in nonhospital 
settings for IME and direct GME without regard to the financial 
arrangements between the hospital and the teaching physician 
practicing in the nonhospital setting in which the resident is 
assigned. We are unable to quantify the impact of these provisions 
because we do not know the number of residents or programs that are 
affected by these changes.
    In addition, under section IV.O.5 of this preamble, we discuss 
our changes related to requirements for written agreements for 
residency training in nonhospital settings. We revised the 
regulations to allow hospitals to count residents training in a 
nonhospital setting if the hospital meets at least one of the 
following criteria: (1) There is a written agreement between the 
hospital and the nonhospital site stating that the hospital will 
incur all or substantially all of the costs of training in the 
nonhospital setting. If the hospital chooses the written agreement 
option, the existing requirements as specified in the regulations at 
413.100(c)(2)(i) and 413.78(d) (redesignated 413.86(f)(4)) would 
apply. (2) The hospital is paying those costs

[[Page 49771]]

associated with training residents at the nonhospital setting(s) by 
the end of the third month following a month in which the training 
in the nonhospital setting(s) occurred. A hospital must satisfy 
either of these options in order for the hospital to count residents 
training in a nonhospital setting. There is no monetary impact 
related to this change because this is administrative in nature, and 
does not affect a hospital's direct GME or IME payments.

K. Impact of Policy on Rural Community Hospital Demonstration 
Program

    In section I.V.P. of the preamble of this final rule, we discuss 
our proposal to implement section 410 A of Pub. L. 108-173 requiring 
the Secretary to establish a demonstration that will modify 
reimbursement for inpatient services for up to 15 small rural 
hospitals. Section 410A(c)(2) requires that ``in conducting the 
demonstration program under this section, the Secretary shall ensure 
that the aggregate payments made by the Secretary do not exceed the 
amount which the Secretary would have paid if the demonstration 
program under this section was not implemented.'' As discussed in 
section IV.P. of this final rule, we are satisfying this requirement 
by adjusting national IPPS rates by a factor that is sufficient to 
account for the added costs of this demonstration. We estimate that 
the average additional annual payment that will be made to each 
participating hospital under the demonstration will be approximately 
$855,893. We based this estimate on the recent historical experience 
of the difference between inpatient cost and payment for hospitals 
that have applied for the demonstration. For 15 participating 
hospitals, the total annual impact of the demonstration program is 
estimated to be $12,838,390. We describe the budget neutrality 
adjustment required for this purpose in the Addendum to this final 
rule.

L. Impact of Criteria for Hospitals-Within-Hospitals

    In section VI.B. of the preamble of the proposed rule, we 
discussed three payment policy options for revising and 
strengthening the criteria to be used to classify hospitals-within-
hospitals for purposes of payments and several additional policy 
revisions. In this final rule we are finalizing our decision to 
adopt a modification of the third option. Additionally, the 
finalized payment policies will only apply to LTCHs hospitals-
within-hospitals, not to all hospital designations excluded from the 
IPPS; and they will also apply to satellites of LTCHs hospitals-
within-hospitals. We have not finalized our proposed preclusion of 
common ownership of acute care hosts and LTCH hospitals-within-
hospitals. The intent of our policies requiring separateness of 
administrative and medical governance and decision-making between 
the hospital-within-a-hospital and its host has been to discourage 
patient shifting between the LTCH hospital-within-a-hospital and its 
host for financial rather than medical purposes and to prevent the 
LTCH hospital-within-a-hospital from functioning as a unit of the 
acute care host hospital, a configuration precluded by statute. In 
2002, there were 114 hospitals-within-hospitals, and these entities 
are increasing at an average annual rate of 30 percent (MedPAC, June 
2003, p. 85). To the extent that these policy revisions will 
eliminate hospital-within-hospital arrangements that circumvented 
our existing requirements, the Medicare program will avoid making 
unnecessary payments under the more costly excluded hospital PPSs. 
We cannot estimate the numbers of existing entities that will be 
affected by these revisions, nor can we estimate the specific DRGs 
that will be affected at those hospitals. In addition, we do not 
know the number of new applications for either LTCH hospital-within-
a-hospital or LTCH satellite status that would subject to review 
under these new standards. Therefore, we are unable to quantify the 
effect these changes will have upon Medicare expenditures. However, 
we believe that this change in policy will likely result in a 
savings to the Medicare program.

M. Impact of Proposed Policy Changes Related to CAHs

    In section VI.C.2. through VI.C.5. of the preamble of this final 
rule, we discuss the changes in regulations we are making to 
implement provisions in section 405 of Public Law 108-173 relating 
to payments to CAHs which include payment based on 101 percent of 
the reasonable cost for certain services; the revised condition for 
a CAH's election of the optional payment method for physician 
services provided at the CAH; the availability to CAHs of the 
periodic interim payment method (PIP); and expansion of types of 
emergency room providers who may be on call at CAHs.
    These changes, taken together with the increase in the number of 
beds permitted to CAHs for acute care inpatient services discussed 
below, increase the incentive for conversion to CAH status by 
allowing larger rural hospitals and those with specialized units to 
become CAHs without materially reducing the size and scope of their 
activities. The added 1 percent reimbursement and flexibility to 
allow some physicians to opt out of method 2 for CAH billing should 
also increase the rate of conversion, while at the same time 
increasing the cost of CAHs to the Medicare program. The two payment 
methods are described in detail in section V.I.D.3. of the preamble 
and at Sec.  413.70(b). The Congressional Budget Office's official 
estimate was that section 405 of Public Law 108-173 would increase 
Medicare program expenditures by approximately $100 million 
annually. We do not have the information to quantify the extent of 
the anticipated increase more precisely or to determine how much 
each provision of section 405 might contribute to that increase.
    In section VI.C.6. of this preamble, we discuss our revision to 
our regulations to reflect the provisions of section 405(e) of 
Public Law 108-173, which provides for an increase in the number of 
beds permitted to CAHs for acute care inpatient services, from 15 to 
25 beds. We anticipate that both Medicare providers and 
beneficiaries will welcome this change. The increase in the number 
of beds will benefit CAHs that experience seasonal increases in 
patient census due to weather conditions and tourism. With the 
increase, more Medicare beneficiaries may have access to health care 
in their communities without the need to be transferred to another 
hospital because the CAH is at capacity for acute care beds. In 
addition, the bed size increase will eliminate an obstacle for some 
small rural hospitals that, except for the bed size restriction of 
15 acute care beds, could qualify for CAH status. Although we 
anticipate that these changes will increase the rate at which 
hospitals convert to CAH status, we do not have the information 
needed to make quantitative estimates of the extent of this 
increase.
    In section VI.C.7. of the preamble of this final rule, we 
discuss our regulatory changes to implement section 405(g) of Public 
Law 108-173, which grants authority for CAHs to establish 
psychiatric and rehabilitation distinct part units. This final rule 
will allow CAHs the option of providing rehabilitation and 
psychiatric services in such units.
    Although we view the anticipated results of the final 
regulations as beneficial to the Medicaid and Medicare programs as 
well as to Medicare and Medicaid beneficiaries and State 
governments, we recognize that some of the provisions could be 
controversial and that some affected entities may respond 
unfavorably. We also recognize that not all of the potential effects 
of these provisions can definitely be anticipated, especially in 
view of their interaction with other Federal, State, and local 
activities regarding outpatient services. In particular, considering 
the effects of our simultaneous efforts to improve the delivery of 
outpatient services, it is impossible to quantify meaningfully a 
projection of the future effect of these provisions on a CAH's 
operating costs or on the frequency of substantial noncompliance and 
termination procedures.
    We estimate that only those facilities that have the 
capabilities to operate a distinct part unit prior to becoming a CAH 
will elect to operate such a unit. Hospitals that currently operate 
a distinct part unit and wish to continue providing psychiatric and 
rehabilitation services to the community may continue to do so after 
converting to a CAH. Allowing a facility that converts to a CAH to 
continue providing inpatient rehabilitation and psychiatric services 
in rural areas will help to ensure availability of services that are 
disproportionately located in urban areas. Distinct-part units may 
be less common in rural areas due to the challenge of finding the 
resources needed to operate a distinct part unit. The United States 
General Accounting Office (GAO), in its September 2003 Report to 
Congress, entitled ``Modest Eligibility Expansion for Critical 
Access Hospital Program Should Be Considered,'' reported that a 
distinct part unit might provide a financial benefit to the hospital 
because it enables the hospital to spread its fixed costs over more 
services. CAHs potentially can experience a net gain on their 
Medicare payments.
    Among the existing CAHs, 25 previously operated a distinct part 
unit but had to close it as part of becoming a CAH. GAO identified 
683 rural hospitals as ``potential CAHs'' based on their having an 
annual average of

[[Page 49772]]

no more than 15 acute care patients per day. About 14 percent (93) 
of these potential CAHs operate an inpatient psychiatric or 
rehabilitation distinct part unit, which they previously would have 
had to close to convert to CAH status. Among the potential CAHs that 
operate a distinct part, about half had a net loss on Medicare 
services, indicating they might benefit from CAH conversion.\12\
---------------------------------------------------------------------------

    \12\ Information from United States General Accounting Office's 
Report to Congress, ``Modest Eligibility Expansion for Critical 
Access Hospital Program Should be Considered,'' GAO-03-948, 
September 2003.
---------------------------------------------------------------------------

    Based on the GAO data, we estimate that approximately 50 
hospitals that currently operate distinct part units will not incur 
any additional expense to convert to a CAH and, in fact, may 
increase their revenue. Therefore, we are only estimating burden for 
current CAHs (approximately 27) that might want to operate a 
distinct part unit due to their previous experience in operating a 
distinct part unit.
    Inpatient psychiatric services in a CAH's distinct part unit 
must be under the supervision of a clinical director, service chief, 
or equivalent who is qualified to provide the leadership required 
for an intensive treatment program, and who is board certified in 
psychiatry. The distinct part unit must have a director of nursing 
who is a registered nurse with a master's degree in psychiatric or 
mental health nursing or its equivalent from a school accredited by 
the National League of Nursing, who is qualified by education and 
experience in the care of persons with mental illness, and a 
director of social services. There must also be an adequate number 
of registered nurses to provide 24-hour coverage as well as licensed 
practical nurses and mental health workers.
    A rehabilitation distinct part unit of a CAH will be required to 
provide rehabilitation nursing, physical and occupational therapy, 
speech therapy, and, as needed, social services or psychological 
services and orthotics and prosthetics. The distinct part unit also 
must have a director of rehabilitation who, among other 
requirements, is trained or experienced in medical management of 
patients who require rehabilitation services and is a doctor of 
medicine or a doctor of osteopathy.
    In addition, a CAH must comply with the common requirements for 
excluded units at Sec.  412.25. Therefore, both psychiatric and 
rehabilitation distinct part units will be required to meet those 
requirements, including written admission criteria that are applied 
uniformly to both Medicare and non-Medicare patients and these units 
must have admission and discharge records that are separately 
identified from those of the CAH in which it is located and are 
readily available. Both of these types of distinct part units also 
must have policies specifying that necessary clinical information be 
transferred to the unit and have utilization review standards 
applicable for the type of care offered in the unit. Psychiatric 
distinct part units will also have to meet requirements of Sec.  
412.27, including maintenance of medical records that permit 
determination of the degree and intensity of the treatment provided 
to individuals who are furnished services in the unit. Each patient 
must also have an individual comprehensive treatment plan. Section 
412.29 requires individuals having rehabilitation distinct part 
units to also have to meet the criteria of a preadmission screening 
procedure under which each prospective patient's condition and 
medical history are reviewed to determine whether the patient is 
likely to benefit significantly from an inpatient program. The unit 
must have also a plan of treatment for each inpatient. 
Notwithstanding the above discussion, we are not attributing burden 
for these requirements because they are industry standards for 
providing quality care and hospitals operating psychiatric and 
rehabilitation distinct part units are currently required to do so 
in compliance with those standards. Therefore, we estimate that the 
only increase in burden for the rehabilitation and psychiatric 
distinct part units of CAHs will be for the additional personnel 
requirement.

           Estimated Costs for Psychiatric Distinct Part Units
------------------------------------------------------------------------
        Hours/estimated salary/ of CAHs            Annual cost
------------------------------------------------------------------------
Clinical Director or service chief; annual salary of          $2,025,000
 $75,000 x 27 CAHs......................................
24-hours nursing coverage--1 RN per 12 hour shift (2 RNs       2,814,480
 total) = Annual salary of $52,120 x 2;.................
One LPN per 12 hour shift = Annual salary of $32,500 x 2       1,755,000
 = $65,000 x 27 CAHs;...................................
Director of nursing--Annual salary of $60,000 x 27 =           1,620,000
 $1,620,000.............................................
Director of social services--Annual salary of $53,000 x        1,431,000
 27 = $1,431,000........................................
Psychiatric aides--Annual salary of $25,650 x 2 =              1,385,100
 $51,300 x 27 CAHs......................................
                                                         ---------------
    TOTAL...............................................      11,050,580
------------------------------------------------------------------------


         Estimated Costs for Rehabilitation Distinct Part Units
------------------------------------------------------------------------
        Hours/estimated salary/ of CAHs            Annual cost
------------------------------------------------------------------------
Director of Rehabilitation--Annual salary $75,000 x 27 =      $2,025,000
 $2,025,000.............................................
Occupational Therapist--Annual salary $53,300 x 27 =           1,439,100
 $1,439,100.............................................
Physical Therapist--Annual salary $55,800 x 27 =               1,506,600
 $1,506,600.............................................
Speech Therapist--Annual salary $52,800 x 27 =                 1,425,600
 $1,425,600.............................................
Rehabilitation nurse--Annual salary $32,500 x 27 =......         877,500
                                                         ---------------
    TOTAL...............................................       7,273,800
------------------------------------------------------------------------

    In section VI.C.8. of the preamble of this final rule, we are 
implementing section 405(h) of Public Law 108-173 which terminates a 
State's authority to waive the location requirement or more than a 
35-mile drive (or in the case of mountainous terrain or secondary 
roads, a 15-mile drive) for a CAH by designating the CAH as a 
necessary provider. We do not have the information to quantify the 
extent of the anticipated increase more precisely or to determine 
how much this provision might contribute to that increase.
    In section VI.C.9 of the preamble of this final rule, we 
reaffirm the policy on payment for clinical diagnostic laboratory 
tests provided by CAHs, as currently stated in the regulations at 42 
CFR 413.70(b)(2)(iii), under which payment is made on a reasonable 
cost basis only if the patient is physically present in the CAH at 
the time of specimen collection. Since we are not revising current 
policy in this area, we anticipate no change in cost or burden as a 
result of this restatement of existing policy.
    In section VI.C.10 of the preamble of this final rule, we 
describe a revision to the regulations which we are making in order 
to permit uninterrupted participation by CAHs which are otherwise in 
compliance with CAH requirements but are located in a county that is 
currently designated as rural but will be considered urban as of 
October 1, 2004, as a result of data from the 2000 census and 
implementation of the new MSA

[[Page 49773]]

definitions announced by OMB on June 6, 2003. Under the final rule, 
such a CAH will have a specified time period during which it will be 
allowed to continue participating as a CAH under the rural location 
requirement in 42 CFR 485.610(b) while seeking formal redesignation 
as rural under the regulations at 42 CFR 412.103. This will avoid 
any need for the facility to reorganize itself as a hospital rather 
than a CAH before seeking redesignation from urban to rural under 
Sec.  412.103.
    Since this provision affects only those CAHs in affected 
counties as of October 1, 2004, and because we expect that 
facilities seeking the redesignation will in fact obtain it within 
the grandfathering period, the net effect of the provision is to 
allow the facilities to retain their current status. Thus, we do not 
anticipate any change in cost or burden from the provision.

N. Impact of Policy Change Regarding Disclosure of Information by 
QIOs.

    In section VII.A. of this final rule, we are revising our 
regulations to add provisions to allow QIOs to disclose information 
about practitioners and institutions and information from quality 
review studies if the practitioner or institution consents to or 
requests the disclosure of the information in writing. This 
disclosure will be in addition to the existing disclosure previously 
based on written consent of the institution or practitioner. In 
addition, we are finalizing exceptions to the 30-day advance notice 
requirement to an institution or practitioner by a QIO of its intent 
to disclose confidential and nonconfidential information on a 
practitioner or an institution is at the request of or consent of 
the institution or practitioner. We are specifying that the 
notification requirements will not apply if the institution or 
practitioner has requested in writing that the QIO make the 
disclosure, has provided written consent for the disclosure, or the 
information is public information.
    We believe that these revisions will reduce the existing burden 
on practitioners, institutions, and QIOs and, at the same time, 
ensure that necessary protections on information remain in the 
place. These provisions will allow QIOs, institutions, and 
practitioners to share vital information in an effective manner and 
further our efforts to ensure the highest quality of care for 
Medicare beneficiaries.

O. Impact of Policy Change for Medicare Hospital Conditions of 
Participation for Discharge Planning

    In section VIII.A. of the preamble of this final rule, we 
discuss our proposal to amend the regulations at Sec.  482.43 to 
incorporate the provisions of section 4321(a) of Public Law 105-33 
and section 926(b) of Public Law 108-173 into the hospital 
conditions of participation. We are finalizing the requirement for 
hospitals to provide lists of Medicare-certified HHAs and SNFs as 
part of the discharge planning process. The discharge planning 
evaluation will be required to include a list of Medicare-certified 
HHAs that have requested to be placed on the list as available to 
the patient and that serve the geographic area in which the patient 
resides. We are requiring the SNF list to include Medicare-certified 
SNFs located in the geographic area in which the patient requests. 
We are not requiring that the list of Medicare-certified SNFs 
contain those SNFs that are just located in the area in which the 
patient resides. Because many available Medicare-certified SNFs are 
not located in close geographic area where the patient resides, 
especially in rural areas, we believe that a requirement that 
restricts a patient to SNFs in areas where the patient resides is 
too restrictive and will limit the availability of posthospital 
extended care services to Medicare beneficiaries.
    The nature of the regulatory provision is such that minimal 
regulatory burden will be placed upon only hospitals, HHAs and SNFs. 
Therefore, we did not consider any regulatory relief options. We 
also certify that this provision will not have a significant 
economic impact on a substantial number of small entities or a 
significant impact on the operations of a substantial number of 
small rural hospitals.
    Compliance with section 4321(a) of the BBA and section 926(b) of 
Public Law 108-173 requires a hospital to collect on an initial and 
ongoing basis information to develop and maintain a current list of 
HHAs or SNFs. We anticipate that this effort will be minimal because 
hospitals currently access this information as an essential 
component of the discharge planning process. We do not anticipate 
that the operations of a substantial number of small rural hospitals 
will be significantly impacted. The impact will be even further 
minimized if a hospital chooses to access this information via the 
Home Health Compare or Nursing Home Compare tools on the CMS 
website, www.medicare.gov or if the hospital calls 1-800-MEDICARE 
(1-800-633-4227) to request a printout of the HHAs or SNFs in the 
desired geographic area.
    The anticipated effects on patients will be an enhanced ability 
to make informed choices about the care they receive from HHAs or 
SNFs upon discharge from a hospital. Based on 2003 CMS data, there 
are approximately 6,000 Medicare-certified hospitals, 6,900 
Medicare-certified HHAs, and 17,000 SNFs.
    The requirements set forth in this provision will place minimal 
burden on hospitals, HHAs, and SNFs. A possible outcome of the 
implementation of all parts of the rule may be to influence hospital 
referral patterns, thus having an impact on HHAs, and SNFs receiving 
post-hospitalization referrals. The information made available to 
maintain compliance with the statute and this provision might impact 
patient choices about who furnishes Medicare services to them and, 
in turn, may have an indeterminable impact on entities that receive, 
or do not receive, the patient's ``business'' as a result.
    This provision will improve our information campaign to assist 
beneficiaries in their choices for health care delivery. Patient 
choice under the Medicaid program may be similarly affected if the 
providers reported on under this rule also participate in that 
program.
    We considered developing a standardized process, format, and 
timeframe for all hospitals to use in developing, maintaining, and 
updating a current list of HHAs and SNFs. Instead, we have chosen a 
less prescriptive approach. Hospitals have the flexibility to define 
a process for developing, maintaining, and updating their list of 
HHAs or SNFs in a manner that makes the most sense for both the 
hospital and the patients they serve. The hospital will have the 
flexibility to develop and maintain their own list of HHAs and SNFs, 
or simply print a list from the Home Health Compare or Nursing Home 
Compare site at the CMS website, www.medicare.gov, based on the 
geographic area requested by the patient. Or, in the rare instance 
when a hospital does not have Internet access, the hospital can call 
1-800-MEDICARE (1-800-633-4227) to request a printout of the list of 
HHAs or SNFs in the desired geographic area. In this way, hospitals 
will be able to develop and implement systems and processes that are 
the most effective and efficient in providing quality care and 
meeting the needs of their patients, as well as complying with the 
requirements of the regulation. In summary, this provision will 
establish a process for implementing the statutory requirements 
under section 4321(a) of the BBA and section 926(b) of the MMA. This 
approach will enhance the information made available to Medicare 
beneficiaries and place minimal burden on all affected entities 
directly and on entities that may be indirectly affected.

P. Impact of Policy Changes Relating to Medicare Provider 
Agreements for Compliance with Bloodborne Pathogens Standards for 
Medicare-Participating Hospitals

    In section VIII.B. of the preamble to this final rule, we 
discuss our proposal to implement section 947 of Public Law 108-173 
under which hospitals not otherwise subject to the Occupational 
Safety and Health Act (OSHA) (or a State occupational safety and 
health plan that is approved under section 18(b) of that Act) must 
comply with the OSHA bloodborne pathogens standard as part of their 
Medicare provider agreements, effective July 1, 2004.
    Given that the Occupational Safety and Health Administration 
(OSHA) has already prepared a Regulatory Impact and Regulatory 
Flexibility Analysis for the Bloodborne Pathogens standard that was 
published December 6, 1991 [56 FR 64004], we have included relevant 
portions of their analyses in our estimate. Thus, the impact of this 
final rule on the public hospitals included in the 26 States without 
State plans, as well as the District of Columbia, Guam, and the 
Virgin Islands has been assessed.
    OSHA noted that most hospitals perform a great variety of 
services, and there are many different exposure scenarios. One 
frequently reported exposure was needlestick, with the greatest 
potential for exposure occurring during needle recapping. Other 
hospital procedures that are associated with frequent exposure 
include phlebotomy, IV line placement, bronchoscopy, intubation, 
airway suction, endoscopy, colonoscopy, and proctosigmoidoscopy. 
Areas with the greatest

[[Page 49774]]

potential for exposure include the emergency room, surgical suite, 
hemodialysis center, and intensive care unit. Laundry workers and 
janitors may also be exposed, particularly when handling soiled 
linen or refuse.
    OSHA's standard for reducing worker exposure to bloodborne 
pathogens is based on the adoption of universal precautions as a 
method of infection control. This approach, which is fundamentally 
different from traditional procedures that isolate known infectious 
individuals and materials in the health care setting, assumes that 
all human blood and body fluids are potentially infectious for HIV, 
HBV, and other bloodborne pathogens. The rationale for this approach 
is that carriers of these diseases are not always identifiable in 
the health care setting, and that contaminated materials are not 
always properly labeled. Thus, the exposed worker can be at great 
risk without warning.
    OSHA estimated that 6,197 hospitals with a total of 2,386,165 
employees would be affected by the BBP standards. However, OSHA 
found that most hospitals had already implemented measures to 
protect workers from occupational exposure to blood and other 
potentially infectious materials, and that many were very close to 
full compliance with the standard. OSHA's estimates of the number of 
affected hospitals and the number of employees did not include State 
and local government hospitals located in States without 
occupational safety and health plans in place, that is, the 
hospitals that will be affected by our final rule.
    Net compliance costs were estimated for each provision of the 
standard based on OSHA surveys and information submitted in response 
to the rulemaking docket. The costs represented the additional costs 
of fully complying with the requirements of the standard, after 
deducting from total cost the current baseline activities that 
already voluntarily occurred at affected facilities. Personal 
protective equipment accounted for the largest amount of net 
compliance costs. Training, vaccine and post-exposure follow-up, and 
housekeeping were also found to be significant cost components. One-
time costs were annualized to reflect the opportunity cost of 
capital. OSHA estimated the total annual costs to the affected 
hospitals to be approximately $321,913,697 or $51,947 per hospital 
annually.
    The magnitude of cost increases associated with the standard was 
estimated to be relatively small, and OSHA stated that they should 
not create significant economic hardship for most affected 
hospitals. OSHA predicted that the costs would be passed through the 
system, with resultant minor price increases to patients, customers 
and other downstream recipients of health services. However, OSHA 
noted that without the BBP standards, the economic impact of 
inadequate protections from BBP would fall on hospital employees and 
the general public.
    OSHA stated that, in general, the economic impacts of the 
standard were not judged to be of sufficient magnitude to threaten 
the existence of any affected sector, nor were impacts judged 
sufficient to disrupt or otherwise adversely alter industry 
structure. OSHA did not believe that productivity of hospital 
employees would be significantly affected by the BBP requirements. 
OSHA stated that they believed familiarization with the requirements 
and techniques would restrict time lost and that any decrease in 
productivity would be offset by the peace of mind associated with a 
safer work setting.
    Based on OSHA'S conclusions, we did not deem it necessary to 
update the 1989 cost data used in their analysis. Although the costs 
of meeting the BBP standards will have increased over time, we note 
that at the time, OSHA found most hospitals had already implemented 
measures to protect workers from exposure to blood and other 
potentially infectious materials and that many hospitals were very 
close to full compliance. We expect that hospitals not covered under 
the BBP standards (that is, hospitals that will be affected by our 
final rule) also had implemented measures to protect their employees 
from exposure to blood and other potentially infectious materials 
and that many hospitals were already close to full compliance with 
the BBP standards. We also expect that in the intervening years, 
hospitals that will be affected by this final rule will have further 
increased their worker protections. It is likely that many of the 
hospitals that will be affected by this final rule are already very 
close to full compliance with the BBP standards.
    While smaller hospitals' limited ability to diversify could be a 
potential disadvantage in their attempts to pass compliance costs 
forward, OSHA concluded that it did not appear that they would lag 
behind larger hospitals to any significant extent in their ability 
to provide employees with protection against infectious hazards.
    On January 18, 2001, OSHA published a final rule that added two 
new recordkeeping requirements to the BBP standards [66 FR 48250]. 
First, the amended standard requires employers to ``establish and 
maintain a sharps injury log for the recording of percutaneous 
injuries''. Second, any employer ``who is required to establish an 
Exposure Control Plan'' must ``solicit input from non-managerial 
employees responsible for direct patient care who are potentially 
exposed to injuries from contaminated sharps in the identification, 
evaluation, and selection of effective engineering and work practice 
controls and shall document the solicitation in the
    According to OSHA's analysis, the maximum total annual cost of 
the two requirements will be $33,892,653, consisting of $1,294,352 
associated with maintaining a sharps injury log and $32,598,300 
associated with soliciting and documenting employee input into the 
Exposure Control Plan. This will amount to $67 per hospital 
annually, which will not cause significant economic impact on either 
large or small affected establishments.
    The requirements set forth in this final rule will place minimal 
burden on hospitals. A possible outcome of the implementation of all 
parts of the rule may be to influence hospitals' use of proper 
mechanisms and supplies necessary to ensure employee protection from 
BBPs.
    The anticipated effects on employees will be the assurance that 
provisions are made to reduce the potential for contact with BBPs 
when performing work-related duties. Based on 2003 CMS data, there 
are approximately 6,000 Medicare-certified hospitals of which 849 
are non-federal, government-owned hospitals located in States that 
do not have their own health and safety standards.
    This final rule will improve the quality of working conditions 
for employees who care for Medicare beneficiaries in these non-
federal, government-owned hospitals and will ensure hospital 
employee safety while performing their duties in Medicare 
participating hospitals while placing minimal burden on all affected 
entities directly and on entities that may be indirectly affected.

Q. Impact of Fire Safety Requirements for Certain Health Care 
Facilities.

    In section VI.C. of the preamble of this final rule, we discuss 
our proposal to clarify that long-term care facilities must be in 
compliance with Chapter 19.2.9, Emergency Lighting, beginning March 
13, 2006. In addition we also specify that beginning March 13, 2006, 
Chapter 19.3.6.3.2, exception number 2 does not apply to these 
facilities.
    In the January 10, 2003 final rule adopting the 2000 edition of 
the Life Safety Code, we examined the overall economic impact and 
the impact on small entities and rural hospitals as required by 
Executive order 12866 (September 1993, Regulatory Planning and 
Review), the Regulatory Flexibility Act (RFA) (September 16, 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. We also examined the anticipated effects of the rule. 
We determined that the 2003 final rule did not meet the criteria to 
be considered economically significant or to be a major rule. 
Furthermore, we examined the Federalism implication of the 2003 
final rule and determined that the rule would not have a substantial 
effect on State, local, or tribal governments. The correcting 
amendments in this final rule will merely bring the Code of Federal 
Regulations language into conformity with the analyses that we have 
already conducted and described in the Regulatory Impact Statement 
section of the 2003 final rule. (See 68 FR 1374, published January 
10, 2003).

VIII. Impact of Proposed Changes in the Capital PPS

A. General Considerations

    Fiscal year (FY) 2001 was the last year of the 10-year 
transition period established to phase in the PPS for hospital 
capital-related costs. During the transition period, hospitals were 
paid under one of two payment methodologies: fully prospective or 
hold harmless. Under the fully prospective methodology, hospitals 
were paid a blend of the capital Federal rate and their hospital-
specific rate (see Sec.  412.340). Under the hold-harmless 
methodology, unless a hospital elected payment based on 100 percent 
of the capital Federal rate, hospitals were paid 85 percent of 
reasonable costs for old capital costs (100 percent for SCHs) plus 
an amount for new capital costs based on a proportion

[[Page 49775]]

of the capital Federal rate (see Sec.  412.344). As we state in 
section V. of the preamble of this final rule, with the 10-year 
transition period ending with hospital cost reporting periods 
beginning on or after October 1, 2001 (FY 2002), beginning in FY 
2002 capital prospective payment system payments for most hospitals 
are based solely on the capital Federal rate. Therefore, we no 
longer include information on obligated capital costs or projections 
of old capital costs and new capital costs, which were factors 
needed to calculate payments during the transition period, for our 
impact analysis.
    In accordance with Sec.  412.312, the basic methodology for 
determining a capital prospective payment system payment is:
    (Standard Federal Rate) x (DRG weight) x (Geographic Adjustment 
Factor (GAF)) x (Large Urban Add-on, if applicable) x (COLA 
adjustment for hospitals located in Alaska and Hawaii) x (1 + 
Disproportionate Share (DSH) Adjustment Factor + Indirect Medical 
Education (IME) Adjustment Factor, if applicable).
    In addition, hospitals may also receive outlier payments for 
those cases that qualify under the threshold established for each 
fiscal year.
    The data used in developing the impact analysis presented below 
are taken from the March 2004 update of the FY 2003 MedPAR file and 
the March 2004 update of the Provider Specific File that is used for 
payment purposes. Although the analyses of the changes to the 
capital prospective payment system do not incorporate cost data, we 
used the March 2004 update of the most recently available hospital 
cost report data (FY 2002) to categorize hospitals. Our analysis has 
several qualifications. First, we do not make adjustments for 
behavioral changes that hospitals may adopt in response to policy 
changes. Second, due to the interdependent nature of the IPPS, it is 
very difficult to precisely quantify the impact associated with each 
change. Third, we draw upon various sources for the data used to 
categorize hospitals in the tables. In some cases (for instance, the 
number of beds), there is a fair degree of variation in the data 
from different sources. We have attempted to construct these 
variables with the best available sources overall. However, for 
individual hospitals, some miscategorizations are possible.
    Using cases from the March 2004 update of the FY 2003 MedPAR 
file, we simulated payments under the capital IPPS for FY 2004 and 
FY 2005 for a comparison of total payments per case. Any short-term, 
acute care hospitals not paid under the general IPPS (Indian Health 
Service Hospitals and hospitals in Maryland) are excluded from the 
simulations.
    As we explain in section III.A.4. of the Addendum of this final 
rule, payments are no longer made under the regular exceptions 
provision under Sec. Sec.  412.348(b) through (e). Therefore, we no 
longer use the actuarial capital cost model (described in Appendix B 
of the August 1, 2001 final rule (66 FR 40099)). We modeled payments 
for each hospital by multiplying the capital Federal rate by the GAF 
and the hospital's case-mix. We then added estimated payments for 
indirect medical education, disproportionate share, large urban add-
on, and outliers, if applicable. For purposes of this impact 
analysis, the model includes the following assumptions:
     We estimate that the Medicare case-mix index would 
increase by 0.7 percent in FY2004 and 1.0 percent in FY 2005.
     We estimate that the Medicare discharges will be 13.8 
million in FY 2004 and 13.9 million in FY 2005 for a 0.91 percent 
increase from FY 2004 to FY 2005.
     The capital Federal rate was updated beginning in FY 
1996 by an analytical framework that considers changes in the prices 
associated with capital-related costs and adjustments to account for 
forecast error, changes in the case-mix index, allowable changes in 
intensity, and other factors. The final FY 2005 update is 0.7 
percent (see section III.A.1.a. of the Addendum to this final rule).
     In addition to the final FY 2005 update factor, the FY 
2005 capital Federal rate was calculated based on a GAF/DRG budget 
neutrality factor of 1.0006, an outlier adjustment factor of 0.9506, 
and a (special) exceptions adjustment factor of 0.9996.

2. Results

    In the past, in this impact section we presented the 
redistributive effects that were expected to occur between ``hold-
harmless'' hospitals and ``fully prospective'' hospitals and a 
cross-sectional summary of hospital groupings by the capital IPPS 
transition period payment methodology. We are no longer including 
this information because all hospitals (except new hospitals under 
Sec.  412.324(b) and under Sec.  412.304(c)(2)) are paid 100 percent 
of the capital Federal rate in FY 2005.
    We used the actuarial model described above to estimate the 
potential impact of our changes for FY 2005 on total capital 
payments per case, using a universe of 3,897 hospitals. As described 
above, the individual hospital payment parameters are taken from the 
best available data, including the March 2004 update of the FY 2003 
MedPAR file, the March 2004 update to the Provider-Specific File, 
and the most recent cost report data from the March 2004 update of 
HCRIS. In Table III, we present a comparison of total payments per 
case for FY 2004 compared to FY 2005 based on the final FY 2005 
payment policies. Column 2 shows estimates of payments per case 
under our model for FY 2004. Column 3 shows estimates of payments 
per case under our model for FY 2005. Column 4 shows the total 
percentage change in payments from FY 2004 to FY 2005. The change 
represented in Column 4 includes the 0.7 percent update to the 
capital Federal rate, a 1.0 percent increase in case-mix, changes in 
the adjustments to the capital Federal rate (for example, the effect 
of the new hospital wage index on the geographic adjustment factor), 
and reclassifications by the MGCRB, as well as changes in special 
exception payments. The comparisons are provided by: (1) Geographic 
location; (2) region; and (3) payment classification.
    The simulation results show that, on average, capital payments 
per case can be expected to increase 5.1 percent in FY 2005. In 
addition to the 0.7 percent increase due to the capital market 
basket update, this projected increase in capital payments per case 
is largely attributable to the changes in the GAF values (which 
include the increase to IPPS hospital wage index values provided for 
by sections 505 and 508 of Pub. L. 108-173) and estimated increase 
in outlier payments (as a result of the decrease in the fixed-loss 
amount) in FY 2005. Our comparison by geographic location shows that 
urban hospitals are expected to experience a 5.4 percent increase in 
IPPS capital payments per case, while rural hospitals are only 
expected to experience a 2.5 percent increase in capital payments 
per case. This difference is mostly due to a projection that urban 
hospitals will experience a larger increase in payments due to 
changes in the GAF values and a larger projected increase in outlier 
payments from FY 2004 to FY 2005 compared to rural hospitals.
    All regions are estimated to receive an increase in total 
capital payments per case from FY 2004 to FY 2005. Changes by region 
vary from a minimum increase of 1.7 percent (Middle Atlantic rural 
region) to a maximum increase of 6.0 percent (Middle Atlantic, 
Pacific, and West South Central urban regions). The relatively small 
increase in projected capital payments per discharge for hospitals 
located in the Middle Atlantic rural region is largely attributable 
to the changes in the GAF values (that is, the GAFs for most of 
these hospitals for FY 2005 are lower than the average of the GAFs 
for FY 2004) and a projection that hospitals located in the Middle 
Atlantic rural region will receive a smaller increase in outlier 
payments than hospitals located in the Pacific and West South 
Central urban regions. The relatively large increase in capital 
payments per discharge for hospitals located in the Pacific, Middle 
Atlantic, and West South Central urban regions is largely due to the 
changes in the GAF values (that is, the GAFs for most of these 
hospitals for FY 2005 are higher than the average of the GAFs for FY 
2004) and a larger than average increase in projected outlier 
payments resulting from the decrease in the fixed-loss amount for FY 
2005.
    Hospitals located in Puerto Rico are expected to experience an 
increase in total capital payments per case of 9.0 percent. This 
relatively large increase in payment per case for hospitals located 
in Puerto Rico is largely due to the change in the Federal portion 
(from 50 percent to 75 percent) of the blended payments to Puerto 
Rico hospitals beginning in FY 2005 (as discussed in section V.B. of 
the preamble of this final rule).
    By type of ownership, proprietary hospitals are projected to 
have the largest rate of increase of total payment changes (5.5 
percent). Similarly, payments to voluntary and government hospitals 
are expected to increase 5.0 percent and 4.8 percent, respectively. 
As noted above, this slightly larger projected increase in capital 
payments per case for proprietary hospitals is mostly due to a 
larger than average increase in projected outlier payments resulting 
from the decrease in the fixed-loss amount for FY 2005.
    Section 1886(d)(10) of the Act established the MGCRB. 
Previously, hospitals could

[[Page 49776]]

apply for reclassification for purposes of the standardized amount, 
wage index, or both. Section 401(c) of Pub. L. 108-173 equalized the 
standardized amounts under the operating IPPS. Therefore, beginning 
in FY 2005, there is no longer reclassification for the purposes of 
the standardized amounts; hospitals may apply for reclassification 
for purposes of the wage index in FY 2005. Reclassification for wage 
index purposes also affects the geographic adjustment factor because 
that factor is constructed from the hospital wage index.
    To present the effects of the hospitals being reclassified for 
FY 2005 compared to the effects of reclassification for FY 2004, we 
show the average payment percentage increase for hospitals 
reclassified in each fiscal year and in total. The reclassified 
groups are compared to all other nonreclassified hospitals. These 
categories are further identified by urban and rural designation.
    Hospitals reclassified for FY 2005 as a whole are projected to 
experience a 3.5 percent increase in payments. Payments to 
nonreclassified hospitals in FY 2005 are expected to increase 5.3 
percent. Hospitals reclassified during both FY 2004 and FY 2005 are 
projected to experience an increase in payments of 3.3 percent. 
Hospitals reclassified during FY 2005 only are projected to receive 
an increase in payments of 6.4 percent. This relatively large 
increase is primarily due to changes in the GAF (wage index) values, 
which includes the increase to the IPPS hospital wage index values 
provided for by sections 505 and 508 of Public Law 108-173.
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[[Page 49777]]

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[[Page 49778]]


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BILLING CODE 4120-01-C

VIII. Impact of Proposed Changes in the Capital PPS

A. General Considerations

    Fiscal year (FY) 2001 was the last year of the 10-year 
transition period established to phase in the PPS for hospital 
capital-related costs. During the transition period, hospitals were 
paid under one of two payment methodologies: fully prospective or 
hold harmless. Under the fully prospective methodology, hospitals 
were paid a blend of the capital Federal rate and their hospital-
specific rate (see Sec.  412.340). Under the hold-harmless 
methodology, unless a hospital elected payment based on 100 percent 
of the capital Federal rate, hospitals were paid 85 percent of 
reasonable costs for old capital costs (100 percent for SCHs) plus 
an amount for new capital costs based on a proportion of the capital 
Federal rate (see Sec.  412.344). As we state in section V. of the 
preamble of this final rule, with the 10-year transition period 
ending with hospital cost reporting periods beginning on or after 
October 1, 2001 (FY 2002), beginning in FY 2002 capital prospective 
payment system payments for most hospitals are based solely on the 
capital Federal rate. Therefore, we no longer include information on 
obligated capital costs or projections of old capital costs and new 
capital costs, which were factors needed to calculate payments 
during the transition period, for our impact analysis.
    In accordance with Sec.  412.312, the basic methodology for 
determining a capital prospective payment system payment is:
    (Standard Federal Rate) x (DRG weight) x (Geographic Adjustment 
Factor (GAF)) x (Large Urban Add-on, if applicable) x (COLA 
adjustment for hospitals located in Alaska and Hawaii) x (1 + 
Disproportionate Share (DSH) Adjustment Factor + Indirect Medical 
Education (IME) Adjustment Factor, if applicable).
    In addition, hospitals may also receive outlier payments for 
those cases that qualify under the threshold established for each 
fiscal year.
    The data used in developing the impact analysis presented below 
are taken from the March 2004 update of the FY 2003 MedPAR file and 
the March 2004 update of the Provider Specific File that is used for 
payment purposes. Although the analyses of the changes to the 
capital prospective payment system do not incorporate cost data, we 
used the March 2004 update of the most recently available hospital 
cost report data (FY 2002) to categorize hospitals. Our analysis has 
several qualifications. First, we

[[Page 49779]]

do not make adjustments for behavioral changes that hospitals may 
adopt in response to policy changes. Second, due to the 
interdependent nature of the IPPS, it is very difficult to precisely 
quantify the impact associated with each change. Third, we draw upon 
various sources for the data used to categorize hospitals in the 
tables. In some cases (for instance, the number of beds), there is a 
fair degree of variation in the data from different sources. We have 
attempted to construct these variables with the best available 
sources overall. However, for individual hospitals, some 
miscategorizations are possible.
    Using cases from the March 2004 update of the FY 2003 MedPAR 
file, we simulated payments under the capital IPPS for FY 2004 and 
FY 2005 for a comparison of total payments per case. Any short-term, 
acute care hospitals not paid under the general IPPS (Indian Health 
Service Hospitals and hospitals in Maryland) are excluded from the 
simulations.
    As we explain in section III.A.4. of the Addendum of this final 
rule, payments are no longer made under the regular exceptions 
provision under Sec. Sec.  412.348(b) through (e). Therefore, we no 
longer use the actuarial capital cost model (described in Appendix B 
of the August 1, 2001 final rule (66 FR 40099)). We modeled payments 
for each hospital by multiplying the capital Federal rate by the GAF 
and the hospital's case-mix. We then added estimated payments for 
indirect medical education, disproportionate share, large urban add-
on, and outliers, if applicable. For purposes of this impact 
analysis, the model includes the following assumptions:
     We estimate that the Medicare case-mix index would 
increase by 0.7 percent in FY 2004 and 1.0 percent in FY 2005.
     We estimate that the Medicare discharges will be 13.8 
million in FY 2004 and 13.9 million in FY 2005 for a 0.91 percent 
increase from FY 2004 to FY 2005.
     The capital Federal rate was updated beginning in FY 
1996 by an analytical framework that considers changes in the prices 
associated with capital-related costs and adjustments to account for 
forecast error, changes in the case-mix index, allowable changes in 
intensity, and other factors. The final FY 2005 update is 0.7 
percent (see section III.A.1.a. of the Addendum to this final rule).
     In addition to the final FY 2005 update factor, the FY 
2005 capital Federal rate was calculated based on a GAF/DRG budget 
neutrality factor of 1.0006, an outlier adjustment factor of 0.9506, 
and a (special) exceptions adjustment factor of 0.9996.

2. Results

    In the past, in this impact section we presented the 
redistributive effects that were expected to occur between ``hold-
harmless'' hospitals and ``fully prospective'' hospitals and a 
cross-sectional summary of hospital groupings by the capital IPPS 
transition period payment methodology. We are no longer including 
this information because all hospitals (except new hospitals under 
Sec.  412.324(b) and under Sec.  412.304(c)(2)) are paid 100 percent 
of the capital Federal rate in FY 2005.
    We used the actuarial model described above to estimate the 
potential impact of our changes for FY 2005 on total capital 
payments per case, using a universe of 3,897 hospitals. As described 
above, the individual hospital payment parameters are taken from the 
best available data, including the March 2004 update of the FY 2003 
MedPAR file, the March 2004 update to the Provider-Specific File, 
and the most recent cost report data from the March 2004 update of 
HCRIS. In Table III, we present a comparison of total payments per 
case for FY 2004 compared to FY 2005 based on the final FY 2005 
payment policies. Column 2 shows estimates of payments per case 
under our model for FY 2004. Column 3 shows estimates of payments 
per case under our model for FY 2005. Column 4 shows the total 
percentage change in payments from FY 2004 to FY 2005. The change 
represented in Column 4 includes the 0.7 percent update to the 
capital Federal rate, a 1.0 percent increase in case-mix, changes in 
the adjustments to the capital Federal rate (for example, the effect 
of the new hospital wage index on the geographic adjustment factor), 
and reclassifications by the MGCRB, as well as changes in special 
exception payments. The comparisons are provided by: (1) Geographic 
location; (2) region; and (3) payment classification.
    The simulation results show that, on average, capital payments 
per case can be expected to increase 5.1 percent in FY 2005. In 
addition to the 0.7 percent increase due to the capital market 
basket update, this projected increase in capital payments per case 
is largely attributable to the changes in the GAF values (which 
include the increase to IPPS hospital wage index values provided for 
by sections 505 and 508 of Pub. L. 108-173) and estimated increase 
in outlier payments (as a result of the decrease in the fixed-loss 
amount) in FY 2005. Our comparison by geographic location shows that 
urban hospitals are expected to experience a 5.4 percent increase in 
IPPS capital payments per case, while rural hospitals are only 
expected to experience a 2.5 percent increase in capital payments 
per case. This difference is mostly due to a projection that urban 
hospitals will experience a larger increase in payments due to 
changes in the GAF values and a larger projected increase in outlier 
payments from FY 2004 to FY 2005 compared to rural hospitals.
    All regions are estimated to receive an increase in total 
capital payments per case from FY 2004 to FY 2005. Changes by region 
vary from a minimum increase of 1.7 percent (Middle Atlantic rural 
region) to a maximum increase of 6.0 percent (Middle Atlantic, 
Pacific, and West South Central urban regions). The relatively small 
increase in projected capital payments per discharge for hospitals 
located in the Middle Atlantic rural region is largely attributable 
to the changes in the GAF values (that is, the GAFs for most of 
these hospitals for FY 2005 are lower than the average of the GAFs 
for FY 2004) and a projection that hospitals located in the Middle 
Atlantic rural region will receive a smaller increase in outlier 
payments than hospitals located in the Pacific and West South 
Central urban regions. The relatively large increase in capital 
payments per discharge for hospitals located in the Pacific, Middle 
Atlantic, and West South Central urban regions is largely due to the 
changes in the GAF values (that is, the GAFs for most of these 
hospitals for FY 2005 are higher than the average of the GAFs for FY 
2004) and a larger than average increase in projected outlier 
payments resulting from the decrease in the fixed-loss amount for FY 
2005.
    Hospitals located in Puerto Rico are expected to experience an 
increase in total capital payments per case of 9.0 percent. This 
relatively large increase in payment per case for hospitals located 
in Puerto Rico is largely due to the change in the Federal portion 
(from 50 percent to 75 percent) of the blended payments to Puerto 
Rico hospitals beginning in FY 2005 (as discussed in section V.B. of 
the preamble of this final rule).
    By type of ownership, proprietary hospitals are projected to 
have the largest rate of increase of total payment changes (5.5 
percent). Similarly, payments to voluntary and government hospitals 
are expected to increase 5.0 percent and 4.8 percent, respectively. 
As noted above, this slightly larger projected increase in capital 
payments per case for proprietary hospitals is mostly due to a 
larger than average increase in projected outlier payments resulting 
from the decrease in the fixed-loss amount for FY 2005.
    Section 1886(d)(10) of the Act established the MGCRB. 
Previously, hospitals could apply for reclassification for purposes 
of the standardized amount, wage index, or both. Section 401(c) of 
Public Law 108-173 equalized the standardized amounts under the 
operating IPPS. Therefore, beginning in FY 2005, there is no longer 
reclassification for the purposes of the standardized amounts; 
hospitals may apply for reclassification for purposes of the wage 
index in FY 2005. Reclassification for wage index purposes also 
affects the geographic adjustment factor because that factor is 
constructed from the hospital wage index.
    To present the effects of the hospitals being reclassified for 
FY 2005 compared to the effects of reclassification for FY 2004, we 
show the average payment percentage increase for hospitals 
reclassified in each fiscal year and in total. The reclassified 
groups are compared to all other nonreclassified hospitals. These 
categories are further identified by urban and rural designation.
    Hospitals reclassified for FY 2005 as a whole are projected to 
experience a 3.5 percent increase in payments. Payments to 
nonreclassified hospitals in FY 2005 are expected to increase 5.3 
percent. Hospitals reclassified during both FY 2004 and FY 2005 are 
projected to experience an increase in payments of 3.3 percent. 
Hospitals reclassified during FY 2005 only are projected to receive 
an increase in payments of 6.4 percent. This relatively large 
increase is primarily due to changes in the GAF (wage index) values, 
which includes the increase to the IPPS hospital wage index values 
provided for by sections 505 and 508 of Public Law 108-173.
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[[Page 49780]]

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[[Page 49781]]


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BILLING CODE 4120-01-C

Appendix B--Recommendation of Update Factors for Operating Cost Rates 
of Payment for Inpatient Hospital Services

I. Background

    Section 1886(e)(4)(A) of the Act requires that the Secretary, 
taking into consideration the recommendations of the Medicare 
Payment Advisory Commission (MedPAC), recommend update factors for 
inpatient hospital services for each fiscal year that take into 
account the amounts necessary for the efficient and effective 
delivery of medically appropriate and necessary care of high 
quality. Under section 1886(e)(5) of the Act, we are required to 
publish the final update factors recommended by the Secretary in the 
final rule. Accordingly, this Appendix provides the recommendations 
of appropriate update factors for the IPPS standardized amount, the 
hospital-specific rates for SCHs and MDHs, and the rate-of-increase 
limits for hospitals and hospitals units excluded from the IPPS. We 
also discuss our update framework and respond to MedPAC's 
recommendations concerning the update factors.

II. Secretary's Final Recommendations for Updating the Prospective 
Payment System Standardized Amount

    In recommending an update, the Secretary takes into account the 
factors in the update framework, as well as other factors, such as 
the recommendations of MedPAC, the long-term solvency of the 
Medicare Trust funds, and the capacity of the hospital industry to 
continually provide access to high quality care to Medicare 
beneficiaries through adequate payment to health care providers. We 
received no comments regarding this issue.

III. Secretary's Final Recommendation for Updating the Rate-of-Increase 
Limits for Excluded Hospitals and Hospital Units

    We did not receive any comments concerning our proposed 
recommendation for updating the rate-of-increase for excluded 
hospitals and hospital units. Our final recommendation does not 
differ from the proposed recommendation. The second quarter forecast 
of the market basket percentage increase remains 3.3 for excluded 
hospitals and hospital units (compared to the 3.3 percent estimated 
in the proposed rule). Thus, the policy finalized in this final rule 
is that the update for the remaining hospitals and hospital units 
excluded from the IPPS remains 3.3 percent.
[FR Doc. 04-17943 Filed 8-2-04; 4:47 pm]
BILLING CODE 4120-01-P