Medicaid Nursing Home Payments: States' Payment Rates Largely	 
Unaffected by Recent Fiscal Pressures (17-OCT-03, GAO-04-143).	 
                                                                 
Almost half of all Americans over the age of 65 will rely on	 
nursing home care at some point in their lives, and two in three 
nursing home residents have their care covered at least in part  
by Medicaid. Under Medicaid, states set nursing home payment	 
rates and the federal government reimburses a share of state	 
spending. According to the most recently available data, Medicaid
nursing home expenditures exceed $43 billion, and total Medicaid 
spending for fiscal year 2003 is expected to double by 2012. Such
projections of increased Medicaid spending come as most states	 
are confronting their third consecutive year of fiscal pressure. 
According to the National Association of State Budget Officers	 
(NASBO), in fiscal year 2003, 30 states collected less revenue	 
than they budgeted for, and 37 states reduced enacted budgets by 
almost $14.5 billion. In light of concerns about the adequacy of 
nursing home resources, GAO was asked to examine how state	 
Medicaid programs determine nursing home payment rates and	 
whether these payment methods or rates have changed given recent 
state fiscal pressures. GAO interviewed state and nursing home	 
industry officials in 19 states and obtained documentation about 
nursing home payment rates and methods, including state methods  
to determine nursing home per diem rates for fiscal years 1998	 
through 2004.							 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-04-143 					        
    ACCNO:   A08743						        
  TITLE:     Medicaid Nursing Home Payments: States' Payment Rates    
Largely Unaffected by Recent Fiscal Pressures			 
     DATE:   10/17/2003 
  SUBJECT:   Health care costs					 
	     Health care facilities				 
	     Health care services				 
	     Nursing homes					 
	     Payments						 
	     Medical services rates				 
	     Managed health care				 
	     Health care programs				 
	     Cost analysis					 
	     State-administered programs			 
	     Medicaid Program					 

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GAO-04-143

United States General Accounting Office

GAO

                       Report to Congressional Requesters

October 2003

MEDICAID NURSING HOME PAYMENTS

      States' Payment Rates Largely Unaffected by Recent Fiscal Pressures

GAO-04-143

Highlights of GAO-04-143, a report to congressional requesters

Almost half of all Americans over the age of 65 will rely on nursing home
care at some point in their lives, and two in three nursing home residents
have their care covered at least in part by Medicaid. Under Medicaid,
states set nursing home payment rates and the federal government
reimburses a share of state spending. According to the most recently
available data, Medicaid nursing home expenditures exceed $43 billion, and
total Medicaid spending for fiscal year 2003 is expected to double by
2012. Such projections of increased Medicaid spending come as most states
are confronting their third consecutive year of fiscal pressure. According
to the National Association of State Budget Officers (NASBO), in fiscal
year 2003, 30 states collected less revenue than they budgeted for, and 37
states reduced enacted budgets by almost $14.5 billion.

In light of concerns about the adequacy of nursing home resources, GAO was
asked to examine how state Medicaid programs determine nursing home
payment rates and whether these payment methods or rates have changed
given recent state fiscal pressures. GAO interviewed state and nursing
home industry officials in 19 states and obtained documentation about
nursing home payment rates and methods, including state methods to
determine nursing home per diem rates for fiscal years 1998 through 2004.

www.gao.gov/cgi-bin/getrpt?GAO-04-143.

To view the full product, including the scope and methodology, click on
the link above. For more information, contact Kathryn G. Allen at (202)
512-7118.

October 2003

MEDICAID NURSING HOME PAYMENTS

States' Payment Rates Largely Unaffected by Recent Fiscal Pressures

Recognizing the large share of Medicaid spending that is allocated to
nursing homes and the importance of spending their Medicaid dollars
effectively, the 19 states GAO reviewed have designed multifaceted
approaches to setting nursing home payment rates. All of these states base
payment rates on homes' actual costs and most develop rates specific to
each home. These payment methods also generally incorporate incentives to
achieve certain goals, such as promoting efficiency or encouraging homes
to target spending toward resident care. States typically update payment
rates regularly to reflect changes in nursing homes' costs due to factors
such as inflation or residents' changing care needs.

Although each of the 19 states experienced recent fiscal pressure, states'
nursing home payment rates have remained largely unaffected. Any future
changes, however, remain uncertain. During fiscal years 1998 through 2004,
only 4 of these states-Illinois, Massachusetts, Michigan, and Texas-cut
the per diem rates paid to all nursing homes at some point, and in 2 of
these states, the rate reduction was for less than 1 year. Two other
states- Connecticut and Oregon-also froze nursing home per diem rates for
a portion of this period. In addition, all 19 states modified the methods
they use to determine nursing home payment rates during this time, such as
changing ceilings on payment rates; however, irrespective of shifting
fiscal pressure, the extent to which states changed specific features of
their payment methods generally remained constant, with varying effects on
payment rates to individual homes within states. Further, in over
threequarters of these states, nursing home per diem rates grew, on
average, by an amount that exceeded the skilled nursing facility market
basket index, the index used by the Centers for Medicare & Medicaid
Services to measure changes in the price of nursing home goods and
services for Medicare, from fiscal years 1998 through 2003. Many states
were able to avoid making significant changes to nursing home payment
rates by relying on existing resources, such as tobacco settlement and
budget stabilization funds, and increasing revenue by imposing cigarette
or nursing home provider taxes. Even with these alternative funding
sources and recent temporary federal fiscal relief, however, officials in
some states suggest that nursing home payment reductions are possible in
the future.

GAO received comments on a draft of this report from Medicaid officials in
the 19 states reviewed, who generally agreed with the characterization of
their respective nursing home payment methods. GAO also received technical
comments from representatives of two organizations that represent the
nursing home industry.

Contents

  Letter

Results in Brief
Background
State Nursing Home Payment Methods Link Rates to Costs,

Encourage Efficiency, and Typically Target Funds to Direct Resident Care

State Fiscal Pressures Generally Have Not Affected Medicaid Payment Rates
to Nursing Homes, but Future Changes Remain Uncertain

External Comments

                                       1

                                      2 4

                                       9

                                     17 26

Appendix I Scope and Methodology

Appendix II 	Summary of Certain Payment Characteristics Used in Selected
States

Appendix III 	Changes to Nursing Home Payment Methods or Rates in 19
States

  Appendix IV GAO Contact and Staff Acknowledgments 51

GAO Contact 51 Acknowledgments 51

Related GAO Products

  Tables

Table 1: Features Found in Medicaid Nursing Home Payment

Methods in 19 States, September 2003 10 Table 2: Types of Cost Centers and
Related Costs Commonly Found in 19 States' Medicaid Nursing Home Payment
Methods 14 Table 3: Examples of Funding Sources States Reported Using to

Respond to Fiscal Pressures, 1998-2003 23

Table 4: Existing or Pending Nursing Home Provider Taxes in 13 of

19 Reviewed States, September 2003 25 Table 5: Study States Categorized by
Selection Factors 28 Table 6: Peer Grouping Techniques Used in Reviewed
States, as of

June 2003 32 Table 7: Direct Resident Care, Indirect Care, and
Administrative

Cost-Center Ceilings in Reviewed States with Individual

Home Rates, as of June 2003 34 Table 8: Direct Resident Care, Indirect
Care, and Administrative

Cost-Center Ceilings in Reviewed States with Flat Payment

Rates, as of June 2003 36 Table 9: Efficiency Incentives Used in Reviewed
States, as of

June 2003 38 Table 10: Case-Mix Classification Systems Used in Reviewed

States, as of June 2003 40 Table 11: Occupancy Standards Used in Reviewed
States, as of

June 2003 42 Table 12: State-Reported Changes to Existing Nursing Home

Payment Methods or Rates, State Fiscal Years 1998-2004 44

  Figure

Figure 1: Average Annual Percentage Change in Average Per Diem Rates, by
State, Compared to the SNF Market Basket Index, State Fiscal Years
2001-2003

Abbreviations

AAHSA American Association of Homes and Services for

the Aging AHCA American Health Care Association BBA Balanced Budget Act of
1997 CBO Congressional Budget Office CPI Consumer Price Index CMS Centers
for Medicare & Medicaid Services CNA certified nursing assistant IOC
Inspection of Care NASBO National Association of State Budget Officers
NCSL National Conference of State Legislatures NGA National Governors
Association OBRA Omnibus Budget Reconciliation Act OSCAR Online Survey
Certification and Reporting RUG Resource Utilization Group SCHIP State
Children's Health Insurance Program SFY state fiscal year SNF skilled
nursing facility TILE Texas Index for Level of Effort UPL upper payment
limit

This is a work of the U.S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed in
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United States General Accounting Office Washington, DC 20548

October 17, 2003

The Honorable Charles E. Grassley
Chairman
The Honorable Max Baucus
Ranking Minority Member
Committee on Finance
United States Senate

The Honorable W.J. "Billy" Tauzin
Chairman
Committee on Energy and Commerce
House of Representatives

The Honorable John Shimkus
House of Representatives

Almost half of all Americans over the age of 65 will rely on nursing home
care at some point in their lives. Medicaid, a joint federal-state program
that spent over $43 billion on nursing home services in fiscal year 2001,
pays at least in part for the care provided to approximately two in three
nursing home residents. Under Medicaid, states set their own nursing
home payment rates and the federal government provides funds to match
states' share of spending as determined by a federal formula.1
Expenditures for Medicaid nursing home services have grown over the
past several years and are expected to continue to grow as the baby boom
generation ages, with 2001 expenditures expected to more than double by
2012. Projections of such increased Medicaid spending come as states
faced their third consecutive year of fiscal pressure in 2003. According
to
the National Association of State Budget Officers (NASBO), 37 states
reduced their fiscal year 2003 enacted budgets by almost $14.5 billion,
the
largest spending cut since 1979, in part due to lower than expected
revenue collections.

In view of your concerns about the adequacy of nursing home resources,
you asked us to examine whether recent fiscal pressures have affected

1The federal share of Medicaid funding varies by state and is based on a
state's per capita income in relation to the national per capita income.
For fiscal year 2003, the federal share of individual states' Medicaid
expenditures ranged from 50 to 76.6 percent, averaging 57 percent across
states.

how states determine nursing home payment rates or the rates they pay
homes. Specifically, you asked us to provide information on (1) state
Medicaid programs' methods to determine nursing home payment rates for
services provided to Medicaid residents and (2) how these payment methods
and rates have changed given recent state fiscal pressures.

To answer these questions, we interviewed officials from the state
Medicaid and budget offices, as well as representatives from the local
affiliates of national nursing home associations, in 19 states.2 We
selected these states based on a number of criteria, including overall
population, Medicaid nursing home residents per capita, and largest
decline or smallest growth in state tax revenue from 2000 through 2002.
From the officials we interviewed we obtained documentation, including
state laws and regulations, on how states determined nursing home payment
rates (including changes) from state fiscal years 1998 through 2004, as
well as the average per diem rates states paid nursing homes from state
fiscal years 1998 through 2003.3 We conducted our work from September 2002
through September 2003 in accordance with generally accepted government
auditing standards. (For additional information on our scope and
methodology, see app. I.)

                                Results in Brief

Recognizing the large share of Medicaid spending that is allocated to
nursing homes and the importance of spending their Medicaid dollars
effectively, states have designed multifaceted approaches to pay nursing
homes for the care they provide to Medicaid-covered residents. All 19
states we reviewed base nursing home payment rates on homes' costs, and
over three-quarters of these states develop rates that are specific to
each home. The 19 states also incorporate various incentives in their
payment methods to achieve certain goals, such as promoting efficient and
economical home operations or encouraging homes to target spending

2We originally selected 20 states: Alabama, Arizona, Arkansas, California,
Colorado, Connecticut, Florida, Illinois, Iowa, Massachusetts, Michigan,
New Jersey, New York, North Dakota, Oregon, Pennsylvania, Rhode Island,
South Dakota, Texas, and Vermont. We subsequently excluded Arizona from
our analysis because its payment method applies to only 5 percent of
Medicaid nursing home residents. Costs of care provided to the remaining
95 percent of the state's nursing home residents are paid by the state's
managed-care program.

3We examined states' methods for determining payment for nursing homes'
operating costs, which include the costs of direct resident care, indirect
care services (such as dietary, laundry, and medical supplies), and
administration. Per diem rates for fiscal year 2004 were not available for
all states.

toward direct resident care. For example, to promote efficiency, most of
these states impose ceilings on the payment homes can receive. States do
not, however, encourage efficiency to the same degree for all types of
costs; instead, their payment methods often impose a higher ceiling for
costs related to direct resident care than to other costs, thus
encouraging homes to spend more on resident care. In addition, to reflect
changing nursing home costs due to certain factors, such as inflation,
almost all the states we reviewed update payment rates annually, often
using current information on individual homes' costs. Twelve of the 19
states also adjust payment rates based on the care needs or case-mix of a
home's residents. These adjustments are intended to further link payments
to potential costs while encouraging homes to accept residents who require
more costly care.

Despite each of the 19 states experiencing recent fiscal pressure, states'
nursing home payment rates have remained largely unaffected. Any future
changes, however, remain uncertain. During fiscal years 1998 through 2004,
only 4 of these states-Illinois, Massachusetts, Michigan, and Texas-cut
the per diem rates paid to all nursing homes at some point, and in 2 of
these states the rate reduction was for less than 1 year. Two other
states-Connecticut and Oregon-also froze nursing home per diem rates for a
portion of this time period. In addition, all 19 states modified the
methods they use to determine nursing home payment rates during this time,
such as changing ceilings on payment rates; however, irrespective of
shifting fiscal pressure, the extent to which states changed specific
features of their payment methods generally remained constant, with
varying effects on payment rates to individual homes within states.
Further, in over three-quarters of these states, nursing home per diem
rates grew, on average, by an amount that exceeded the skilled nursing
facility (SNF) market basket index, which is used by the Centers for
Medicare & Medicaid Services (CMS) to measure changes in the price of
nursing home goods and services for Medicare, from fiscal years 1998
through 2003. More than three-quarters of the states indicated that they
have forestalled more significant changes to their payment rates by
relying on alternative funding sources to help balance their state
budgets, such as tobacco settlement or budget stabilization funds, and
increasing revenue by imposing cigarette or nursing home provider taxes.
Even with these alternative funding sources and recent temporary federal
fiscal relief, however, officials in some states suggest that nursing home
payment reductions are possible in the future.

Background

We received comments on a draft of this report from Medicaid officials in
the 19 states that were included in our review, who generally agreed with
our characterization of their respective nursing home payment methods, as
well as from representatives of two organizations that represent the
nursing home industry. State and association officials provided clarifying
and technical comments regarding nursing home payment methods and rates,
which we incorporated as appropriate throughout the report.

Medicaid operates as a joint federal-state program to finance health care
coverage for certain categories of low-income individuals, over 11 million
of whom are elderly or disabled.4 In total, Medicaid cost almost $258
billion in fiscal year 2002, and the Congressional Budget Office (CBO)
projects that fiscal year 2003 spending will double by 2012. Today,
Medicaid ranks as the third largest mandatory spending program in the
federal budget and represents the largest source of federal funds to the
states, accounting for 41 percent of all federal outlays for grants to
states and local governments in fiscal year 2001. In terms of overall
state expenditures, outlays for Medicaid rank second only to elementary
and secondary education, accounting for an estimated 15 percent of general
fund expenditures in state fiscal year 2002.5

Within broad federal guidelines, states have considerable flexibility in
how they administer their Medicaid programs. The federal statute requires
state programs to cover certain services and populations, such as nursing
home services for qualifying elderly and for disabled individuals aged 21
and over.6 Each state determines what medical services to cover,
establishes eligibility requirements, sets provider payment rates, and
develops its own administrative structure. As a result, Medicaid
essentially operates as 56 separate programs: 1 in each of the 50 states,
the District of Columbia, Puerto Rico, and each of the U.S. territories.
Nursing homes care for people with a wide range of clinical conditions and
provide a variety of

4This figure represents 27 percent of total Medicaid enrollment in fiscal
year 2000, the most recent year for which data are available by type of
beneficiary.

5National Governors Association and National Association of State Budget
Officers, The Fiscal Survey of States (Washington D.C.: June 2003),
http://www.nasbo.org (downloaded June 27, 2003).

6In addition to the mandatory services states are required to include in
their Medicaid programs, states may choose to cover certain optional
services, including personal care services and physical and occupational
therapies.

services, including basic custodial care, medical social services, skilled
nursing care, and rehabilitative therapies. Medicaid is the single largest
funding source for nursing home services, providing about one-half of
total expenditures for these services in 2003.7 Medicaid supports the care
of an even larger share of nursing home residents, paying at least in part
for the services provided to approximately two in three residents
nationwide.8

Federal requirements regarding states' methods for reimbursing nursing
homes for the services they provide to Medicaid residents have changed
over time. A 1972 amendment to the Social Security Act required that
states reimburse nursing homes on a reasonable cost-related basis.9 Under
this requirement, states developed methods to identify nursing homes'
reasonable costs as well as set rates based on these costs, both of which
were subject to federal verification and approval. Nursing home providers
filed a number of federal lawsuits contesting the adequacy of states'
payment rates.

In 1980, Congress passed legislation, commonly referred to as the Boren
Amendment, which provided that Medicaid payment rates for nursing homes
had to be "reasonable and adequate to meet the costs which must be
incurred by efficiently and economically operated facilities."10 The Boren
Amendment also transferred responsibility for verifying that rates
complied with these standards from the federal government to states;
however, it did not grant states unlimited discretion in developing
payment rates. The 1980 Conference Report that accompanied the Boren
Amendment stated that rates should not be developed "solely on the basis

7According to CMS's actuarial estimates, national nursing home spending
will total more than $108 billion in 2003. Medicaid and Medicare will
cover about 50 percent and 11 percent of these costs, respectively, and
about 37 percent of these costs will be covered by out-of-pocket payments,
private health insurance, and other private funds. (These percentages do
not add to 100 because of rounding.)

8Certain Medicaid enrollees, including nursing home residents, are
required to contribute shares of their incomes to the costs of their care,
which in part explains why the share of nursing home residents supported
in some measure by Medicaid is greater than Medicaid's share of total
nursing home revenues.

9Social Security Amendments of 1972, Pub. L. No. 92-603, S: 249, 1972
U.S.C.A.A.N. 1548, 1667. Prior to this amendment, there were no
substantive federal standards governing state payment for nursing home
services.

10Ominbus Budget Reconciliation Act (OBRA) of 1980, Pub. L. No. 96-499, S:
962(a), 94 Stat. 2599, 2650. The Boren Amendment was extended to payments
for inpatient hospital services as part of OBRA 1981 (Pub. L. No. 97-35 S:
2173, 95 Stat. 808 (1981)).

of budgetary appropriations" and required states to submit annual
assurances to the Secretary of Health and Human Services that rates
complied with Boren regulations.11 The Conference Report also clarified
that while the Boren Amendment was intended to give states discretion to
develop the methods and standards on which payment rates would be based,
the federal government retained final authority in approving states'
rates.12

During the roughly 17 years following the enactment of the Boren
Amendment, providers in many states filed suits alleging that Medicaid
payment rates were not sufficient and therefore violated federal
requirements that rates be reasonable and adequate to cover the costs of
efficiently and economically operated nursing homes. In 1990, the Supreme
Court found that the amendment imposed a binding obligation on states to
adopt reasonable and adequate payment rates and held that providers could
sue to enforce this obligation and challenge Medicaid payment rates in
federal court.13 After this decision, nursing home providers continued to
rely on the courts to review payment rates they considered insufficient
and verify that these rates complied with federal payment standards.

The Balanced Budget Act of 1997 (BBA) repealed the Boren Amendment,
providing states with increased flexibility to develop approaches to pay
nursing homes that participate in Medicaid.14 States are no longer
required to submit annual rate findings to the federal government but
instead must develop and implement a public process for determining rates,
which requires that states publish all proposed and final rates-including
their methodologies and justifications-and ensure that providers,
beneficiaries, and their representatives are given reasonable opportunity
to review and comment on rates.15 Additionally, states must continue to

11H.R. Conf. Rep. No. 96-1479 at 154 (1980), reprinted in 1980
U.S.C.A.A.N. 5903, 5945.

12H.R. Conf. Rep. No. 96-1479 at 154 (1980).

13Wilder v. Virginia Hospital Association, 496 U.S. 498 (1990).

14Pub. L. No. 105-33, S: 4712, 111 Stat. 509 (1997).

15States may fulfill public process requirements in a number of ways,
including holding public hearings to disclose proposed rates and payment
methods; using an open commission or similar process to set rates; or
publishing changes to payment methods in newspapers of general circulation
and making copies of proposed and final rates, payment methods, and
justifications underlying changes available to the public.

ensure that payments are consistent with efficiency, economy, and quality
of care standards.16

                             State Fiscal Pressures

In 2003, states faced their third consecutive year of fiscal pressure,
with revenue collections again falling short of planned expenditures. A
June 2003 survey conducted by NASBO and the National Governors Association
(NGA) found that 30 states collected less revenue in fiscal year 2003 than
they planned for in their budgets, with sales tax collections 2.5 percent
lower than originally budgeted and personal and corporate income tax
collections 8.6 percent and 8.3 percent lower than expected,
respectively.17 According to an April 2003 survey conducted by the
National Conference of State Legislatures (NCSL), 39 states and the
District of Columbia faced budget shortfalls at some point during fiscal
year 2003, totaling over $29 billion.18

At the same time states have experienced shortfalls in their expected
revenue collections, they have also experienced significant growth in
Medicaid expenditures. According to CMS, the state and local share of
Medicaid spending grew almost 14 percent in fiscal year 2002 and is
projected to grow almost 10 percent in 2003.19 In their June 2003 survey,
NASBO and NGA reported that 25 states experienced Medicaid budget
shortfalls in state fiscal year 2002, and 28 states reported these
shortfalls in 2003.

1642 U.S.C. S:1396a(a).

17NGA and NASBO.

18National Conference of State Legislatures (NCSL), State Budget Update:
April 2003 (Washington, D.C.: April 2003).

19The 2002 spending growth is based on Medicaid expenditure data from CMS.
Projections of increased spending for 2003 are based on calendar year
actuarial estimates published by CMS staff in Health Affairs. See S.
Heffler et al., "Health Spending Projections For 20022012", Health
Affairs, vol. 22, no. 2 (Bethesda, Md.: Project Hope, 2003);
http://www.healthaffairs.org/WebExclusives/Heffler_Web_Excl_020703.htm
(downloaded June 13, 2003). The projected increase in states' 2003
Medicaid spending includes spending for the State Children's Health
Insurance Program (SCHIP), which was created under BBA to provide health
care coverage to children of low-income families with incomes that exceed
the eligibility limits for Medicaid.

Fiscal pressures have compelled states to confront difficult choices,
especially because 49 states and the District of Columbia are required to
balance their budgets.20 Recognizing that the Medicaid program represents
a large component of many states' budgets, virtually all states have
implemented or planned new cost-containment measures in order to control
Medicaid spending growth in 2003, according to another recent state
survey.21 For example, 45 states reported that they planned to reduce
spending on prescription drugs, which is an optional benefit, during
fiscal year 2003. In addition, benefit reductions, such as limits for
vision care and dental services, and changes to eligibility requirements,
such as a lowered income threshold for Medicaid program eligibility, were
additional costcontainment measures used or proposed by states.

In May 2003, Congress passed the Jobs and Growth Tax Relief Reconciliation
Act, which included $20 billion in fiscal relief to state and local
governments.22 Of these funds, $10 billion is earmarked for Medicaid,
providing temporary enhancements to the federal share of Medicaid funding
through June 2004 to help states maintain Medicaid services and
eligibility.23 The remaining $10 billion in fiscal relief is divided among
the states based on population and can be used to assist states in
providing government services.

20Vermont is the only state that is not required to balance its budget
each year. See Kaiser Commission on Medicaid and the Uninsured, The Role
of Medicaid in State Budgets (Washington, D.C.: October 2001).

21See Victoria Wachino et al., Medicaid Spending Growth: a 50-State Update
for Fiscal Year 2003 (Washington, D.C.: Kaiser Commission on Medicaid and
the Uninsured, January 2003).

22Pub. L. No. 108-27, 117 Stat. 752, 764 (2003).

23Temporary enhancements to the federal share of Medicaid funding involve
both a "holdharmless" provision that prevents each state's federal
matching rate from decreasing below certain levels and an across-the-board
increase to federal matching rates for all states. Under the hold-harmless
provision, states receive the higher of their fiscal year 2002 or fiscal
year 2003 federal matching rates for the period April 1 through September
30, 2003, and the higher of their fiscal year 2003 or fiscal year 2004
federal matching rates for the period October 1, 2003, through June 30,
2004. In addition, an across-the-board increase of 2.95 percentage points
is applied to each state's matching rate as determined under the
hold-harmless provision for the period April 1, 2003, through June 30,
2004, provided the state does not restrict Medicaid eligibility below the
levels specified in its state plan as of September 2, 2003.

  State Nursing Home Payment Methods Link Rates to Costs, Encourage Efficiency,
  and Typically Target Funds to Direct Resident Care

Recognizing the importance of spending Medicaid dollars effectively, the
19 states we reviewed have designed methods to develop nursing home
payment rates that include incentives for homes to deliver care
efficiently, operate economically, and concentrate resources on direct
resident care. While nursing home payment rates in most of these states
are related to individual homes' costs of delivering needed services, most
states also limit payment for certain types of costs and many provide
additional payments for direct resident care. Most of these states also
regularly adjust rates to reflect changes in homes' costs or in the care
needs of the residents that homes serve.

Table 1 provides an overview of various payment features used by the 19
states we reviewed as of September 2003. These features will be discussed
below in greater detail. Because states pursue different strategies to
meet their various objectives, methods to determine rates differ
considerably among states. However, over half of the states we reviewed
include at least five such features in their payment methods, with states
most commonly using payment ceilings and annual rate updates.

 Table 1: Features Found in Medicaid Nursing Home Payment Methods in 19 States,
                          September 2003 Rate updates

State

                                                            Add-on 
                                                           payment 
                                                        for direct 
                      Home-            Ceilings    Peer   resident 
                            Efficiency    or            
                specific    incentive  flat rate              care 
                  rates                          groups 

        Rates consistently inflated in nonrebase years Rates rebased annually

Case-mix system

Alabama X X XXXX

Arkansas X X X

California X X X X

Colorado X X X X

Connecticut X X X X X

Florida X XXXX

Illinois X X X X X

a

Iowa X X XXX

Massachusetts X X X

Michigan X X X X

New Jersey X X X X

New York X XXX X

North Dakota X X X X

Oregon X X

Pennsylvania X X X X X

Rhode Island X X X

South Dakota X X X X

Texas X X XbX

c

Vermont X X XX

Total 15 7 1910 9 9 812

Source: States' Medicaid programs.

aIn Iowa, nursing home payment rates were rebased annually until July 1,
2001, when the state began to phase in its new payment method.

bUntil September 1, 2001, Texas rebased rates annually. Since this time,
the state rebases rates biennially in conjunction with developing its
budget and inflates rates to the midpoint of the 2-year period.

cVermont provides an add-on payment to reimburse wages and other expenses
for all nursing home staff except the nursing home administrator.

    States Typically Develop an Individual Rate for Each Home

All 19 states we reviewed base the per diem, or daily, rate they pay to
nursing homes on costs, as reported in cost reports. While 4 states-
California, Massachusetts, Oregon, and Texas-use the average or median
costs of all homes to pay the same, flat rate, with some adjustments, to
all homes or homes within a specified group, the remaining 15 states
compute a rate for each home based on the individual home's costs.24
States that pay home-specific rates attempt to make more effective use of
their resources for nursing homes. They avoid paying lower-cost homes
rates significantly in excess of their costs, which can occur when rates
are based on the average or median costs across homes. In addition, by not
making such excess payments to lower-cost homes, states with home-specific
rates can use the same overall budget to pay more higher-cost homes rates
that are closer to their costs.

    States Design Payment Methods to Encourage Efficient Nursing Home Operations

States design their payment methods to encourage nursing homes to deliver
care efficiently and economically. For example, all 19 states develop
their payment rates prospectively, or prior to the time during which the
rates apply, using historical cost reports. Prospective rates encourage
nursing homes to operate efficiently and incur only necessary costs.25
Homes that deliver care for less than the payment amount profit;
conversely, providers experience losses if costs are higher than the
payment rate.

Seven of the states we reviewed use explicit efficiency incentives to
further encourage homes to minimize spending by providing them with
additional payment if they keep their spending below a certain amount. For
example, Connecticut nursing homes with indirect care or

24In Massachusetts, Oregon, and Texas, payment rates to individual homes
are adjusted to reflect variation in resident care needs, while California
pays groups of similar homes the same rate. In addition, Massachusetts
pays a small portion of capital costs on a homespecific basis, and from
state fiscal years 2000 through 2003, Texas imposed a staff compensation
accountability requirement for homes to spend 85 percent of their direct
resident care rate on staffing wages and benefits. Homes that did not
spend this limit had to pay the state the difference between what they
spent and 85 percent of the flat, direct resident care rate.

25Under the alternative, retrospective payment systems, the actual costs
incurred during the year are paid after the submission and review of a
home's cost report at the end of the year. Retrospective systems are
recognized as inflationary; consequently, all states we reviewed set rates
prospectively. However, Michigan performs limited retrospective
adjustments to the payment rate for individual homes to cover changes in
certain costs, such as qualifying renovations.

administrative costs below the median of all homes' costs in these
categories have up to 25 percent of this difference incorporated into
their per diem rates.26 (See app. II for more detail on how states develop
nursing home payment rates.)

To further encourage homes to operate efficiently, the 15 of the 19 states
that pay home-specific rates place ceilings, or limits, on the costs that
are reflected in their nursing home payment rates.27, 28 These ceilings
encourage homes to control spending as they will not be reimbursed for
costs that exceed these ceilings. Since the majority of homes have
demonstrated that they can provide care at costs below the ceiling, states
may regard costs above the ceiling as excessive.

In addition to imposing ceilings, many states use other mechanisms to
limit the costs that they recognize when determining homes' per diem
rates. While in some cases these mechanisms may also encourage efficiency,
in other cases they may result in fewer homes receiving their full costs
than what the ceiling levels indicate. For example, regardless of
increasing nursing home costs, Colorado limits the annual increase in
administrative costs it recognizes to 6 percent, while South Dakota allows
no more than an 8 percent annual increase in overall payment rates. In
addition, although Rhode Island and North Dakota rebase their per diem
rates regularly, they do not rebase cost-center ceilings as frequently.
For example, Rhode Island inflates cost-center ceilings annually instead
of rebasing them, and North Dakota rebases ceilings every 3 years on
average, inflating them during the interim years. (See app. II for
descriptions of additional limits states place on nursing home payments.)

To avoid penalizing homes for costs beyond their control, 10 of the states
we reviewed categorize homes into peer groups and then set ceilings for
each peer group rather than having a single statewide ceiling for all
homes. States often establish peer groups for homes in the geographic
areas that

26Seventeen of the 19 states we reviewed also incorporate occupancy
standards, which reduce the per diem rate for nursing homes with resident
occupancy that is below an established level. App. II addresses occupancy
standards in more detail.

27The ceiling is typically based on a percentage of the median costs, or a
certain percentile of costs, for all homes in the state or within a
category of homes. Individual homes' rates are typically determined by the
lower of their own costs or the ceiling.

28In the four states that generally pay a flat rate to all homes or to all
homes in a group, the flat rate also promotes efficiency since homes with
costs below the rate are able to retain the difference.

have similar labor markets and associated wage costs or homes of
comparable size (i.e., homes with a large or small number of beds) that
should operate at similar levels of efficiency. For example, since costs
per day may vary by geographic location-such as urban versus rural areas-
establishing peer groups by location allows states to set higher ceilings
for homes in the more costly areas. Peer groups may be unnecessary in
states with ceilings that are set well above the median costs and where
most homes have costs below the ceilings or in states where wages vary
little across areas.

Despite the various ways states encourage nursing home efficiency,
industry representatives and industry-sponsored studies nonetheless raise
concerns that Medicaid payments do not cover the full costs of all nursing
homes. For example, a 2002 industry-sponsored study reported that nursing
home costs for Medicaid-covered residents in 2000 exceeded Medicaid
payment rates an average of $10 per resident day in the 37 states included
in the study.29 In addition, industry representatives in 7 of the states
we reviewed expressed concern that state payment methods do not adequately
account for increases in certain costs, such as liability insurance or
direct resident care staff wages and benefits.30,31 However, by
incorporating certain features, such as ceilings, into their nursing home
payment methods, states have intentionally designed their payment methods
so that not all homes receive their full costs and so that lowercost
homes, which are more likely to be efficient and economical, have payment
rates nearer to their costs.

29BDO Seidman, LLP, A Briefing Chartbook on Shortfalls in Medicaid Funding
for Nursing Home Care (July 2002).

30For example, Texas Medicaid officials examined Texas nursing home cost
report data from fiscal years 1998 through 2001 and found that average
liability insurance costs per nursing home bed increased almost threefold,
from $207 to $592. Nonetheless, these costs represented less than 1
percent of total costs for the typical Texas nursing home in 1998 and less
than 2 percent of the typical home's costs in 2001.

31Additionally, industry representatives in six states expressed concern
regarding payment methods for homes' capital costs, noting that capital
payment may be insufficient for a variety of reasons, including states'
use of nursing homes' historic values, which do not reflect homes' current
capital values, when determining payment rates and low ceilings in the
capital cost center. A detailed analysis of payment methods for nursing
homes' capital costs was beyond the scope of this report.

Nursing Home Payment Through the design of their payment methods, states
generally seek to Methods Encourage encourage nursing home spending on
direct resident care. All 19 states we Spending in Areas reviewed divide
nursing home costs into categories, or cost centers, with

common categories being direct resident care, indirect care,Specifically
Related to administrative, and capital (see table 2). By varying their
payment policiesDirect Resident Care for each category, most states seek
to target more of their funds to direct

resident care.32

Table 2: Types of Cost Centers and Related Costs Commonly Found in 19
States' Medicaid Nursing Home Payment Methods

Cost center Type of included costs

Direct resident care Nursing staff salaries, wages, and benefits

Indirect care 	Dietary, medical supplies, laundry, social services and
activities, and maintenance

Administrative Administrative salaries and expenses and office supplies

Capital 	Building and equipment expenses including depreciation, taxes,
interest, and rent

Source: State Medicaid programs.

Note: Indirect care and administrative costs are combined into a single
cost center in 8 states and separated into two centers in 11 states.

How states establish ceilings or efficiency incentives for each cost
center may encourage nursing homes to spend more money on direct resident
care than other areas. In nine of the states we reviewed that pay
homespecific rates, the direct resident care ceiling is higher than the
administrative ceiling, thus allowing a higher proportion of homes to have
their payments based on their total direct resident care costs than is the
case for their administrative costs. For example, for all homes within
each peer group in Connecticut, the direct resident care ceiling is set at
135 percent of the median direct resident care costs while the
administrative ceiling is set at 100 percent of the median administrative
costs. In addition, five of the seven states with efficiency incentives
that reward homes for spending less do not apply them to direct resident
care costs, thereby minimizing the incentive for homes to restrict
spending in this area.33

32The states we reviewed categorize nursing home costs into two to seven
centers.

33In addition, 9 of the 17 states with occupancy standards do not apply
these standards to the direct resident care cost center, and consequently
payment for these costs is not limited in homes with low occupancy (see
app. II).

Further, nine of the states we reviewed used add-on payments to reimburse
wages or other expenses for staff who provide direct resident care or to
promote the provision of high-quality direct resident care. For example,
in 2000, Massachusetts began providing an add-on payment to nursing homes
for certified nursing assistants (CNA), who assist residents with
activities such as bathing and eating. This add-on is based on CNA
salaries and Medicaid nursing home utilization. Because homes often use
add-on payments to increase their spending on direct resident care, these
payments may lead to higher costs on homes' cost reports and therefore
could result in higher future per diem rates.34

    States Update Payment Rates to Reflect Changing Costs

To reflect changes in nursing homes' costs, 17 of the 19 states we
reviewed regularly calculate new payment rates or adjust existing rates
for inflation. To rebase, or calculate new rates, states generally use
costs as reported in nursing homes' most recent cost reports that reflect
inflation or other cost changes such as those due to more expensive
technologies, a different staff mix, or changing direct resident care
needs.35 Nine of the 19 states we reviewed rebase rates annually, and 8
states rebase homes' rates every 2 to 4 years.36 The 2 remaining states,
however, rebase infrequently, if ever; Illinois has only rebased rates
once in the past 9 years, and New York has not fully rebased homes' rates
since 1986.37

34Texas allows homes to qualify for additional direct resident care
payments through its staff enhancement program, in which 92 percent of
nursing homes participate. The state's staff compensation accountability
provision, which was in effect from fiscal years 2000 through 2003,
provided homes with an incentive to target funds toward direct resident
care. This provision was eliminated in state fiscal year 2004, which began
on September 1, 2003.

35Frequent rebasing could have mixed effects on nursing homes' spending.
Since homes that limit expenditures could receive a lower payment rate
when states rebase rates, frequent rebasing may reduce the incentive for
homes that are paid prospective rates to limit overall spending. However,
frequent rebasing may also prevent homes from making excessive cost
reductions that could adversely affect resident care.

36Arkansas rebases its payment rate using two different schedules: Costs
related to direct resident care staff and food are rebased every year,
whereas costs associated with services not directly related to residents,
such as administrative costs, are rebased at least once every 3 years.

37New York does, however, rebase the payment for homes' capital costs
annually. According to a state official, the effect of rebasing capital
costs on nursing home rates varies by home; however, in recent years, the
capital portion of many homes' rates has declined.

Most states we reviewed also apply a standard inflation factor, such as
the Consumer Price Index (CPI) or the SNF market basket index, to adjust
rates during years they do not rebase or to reflect inflation between the
midpoint of the cost report year and the midpoint of the year when the
rates will be paid, a period that generally ranges from 18 to 36 months.38
However, Illinois has not consistently updated rates for inflation during
non-rebase years since 1994, and Iowa's new nursing home payment method,
which was fully implemented on July 1, 2003, does not have a provision for
adjusting rates during non-rebase years.39 In addition, rather than using
a standard inflation factor, Connecticut and Illinois use legislatively
determined amounts to update rates when they do not rebase.40 These
amounts vary from year to year and are influenced by budget availability.

    By Adjusting Rates for Case-Mix, States Link Payment to Resident Needs

Instead of paying rates that are based on the costs required to care for a
nursing home's residents during the cost reporting period, 12 of the 19
states we reviewed use case-mix systems to tie payment to the costs
associated with a home's current resident care needs. Using a variety of
methods, states classify homes' residents by the level of care they
require and adjust payment rates to reflect the costs associated with
treating current residents with different levels of need.41 While the rate
adjustment occurs with varying frequency, most states adjust rates for
case-mix two to four times a year.

Adjusting rates for case-mix may encourage homes to accept residents who
require more expensive care, and it also provides states with a tool to
compare more appropriately homes' costs and to not penalize homes that
have higher costs due to a more costly mix of residents. In addition, case

38The SNF market basket index, which is the CMS index of prices for
nursing home inputs (e.g., wages, food, and drugs), is used to adjust
nursing home payments for Medicare. Some states use the CPI for a specific
geographic area to adjust rates; for example, Vermont uses the CPI for New
England.

39Nursing home payment rates in Iowa were rebased annually under the prior
payment system, which was in effect until July 1, 2001.

40Connecticut uses its legislatively determined inflation factor to update
rates annually.

41Seven of the 12 states rely on a variation of the Resource Utilization
Group (RUG) Patient Classification System-the case-mix classification
system used for Medicare-to classify nursing home residents, while the
remaining 5 states have developed their own classification systems. The
RUG system classifies nursing home residents into groups depending on
their therapy, nursing, and special care needs.

  State Fiscal Pressures Generally Have Not Affected Medicaid Payment Rates to
  Nursing Homes, but Future Changes Remain Uncertain

mix adjusted rates particularly help target payments in states that
otherwise pay the same, flat rate. Three of the four flat-rate states we
reviewed make case-mix adjustments to the rates so payments more closely
approximate the costs likely incurred by individual homes for treating
residents.

Recent state fiscal pressures have not resulted in widespread reductions
in Medicaid payment rates to nursing homes in most states we reviewed,
although all of these states modified how they pay nursing homes from
fiscal years 1998 through 2004. While in some cases modifications to
payment methods have clearly increased or decreased payment rates, in
other instances the effect of these modifications on payment rates for
individual homes is mixed. Further, in nearly three-quarters of the states
we reviewed, nursing home per diem rates grew, on average, by an amount
that exceeded the SNF market basket index for state fiscal years 2001
through 2003, similar to the years immediately following the repeal of the
Boren Amendment. To avoid making significant changes to nursing homes'
payment rates, many states reported that they relied on existing
resources, such as budget stabilization funds and tax increases, to
generate additional funding. Other factors have also influenced the nature
and extent of states' changes to nursing home payment rates. Even with
recent temporary federal fiscal relief, however, officials in some states
suggest that nursing home payment reductions are possible in the future.

    State Fiscal Pressure Has Not Led to Major Changes in Medicaid Nursing Home
    Payment Methods or Rates

Over the past several years, the states we reviewed have faced increasing
budget pressures, and all reported experiencing fiscal pressure in fiscal
year 2003. These budget pressures followed consecutive years of
significant economic growth in many states. For example, through state
fiscal year 2000, Connecticut experienced 10 years of budget surpluses;
however, in state fiscal year 2001 the surpluses ended, and the state's
deficit was over $800 million. Also, in 2001, Massachusetts began
experiencing increased fiscal pressures mainly because of decreased tax
revenues and lower capital gains.

Irrespective of shifting fiscal pressures experienced by these states,
their modifications to nursing home payment methods have not resulted in
widespread payment reductions to nursing homes from fiscal years 1998
through 2004. During this time, all 19 states we reviewed either modified

components of their payment methods, such as changing cost-center ceilings
or implementing case-mix systems, or created new payment methods, as was
the case in Arkansas and Iowa.42 However, the extent to which states
changed specific features of their payment methods generally remained
constant during this time, with varying effects on payment rates to
individual homes within states. (See app. III for a list of selected state
changes.)

In addition, despite each of the 19 states experiencing recent fiscal
pressure, only 4 states-Illinois, Massachusetts, Michigan, and Texas-
explicitly cut the per diem rates paid to all nursing homes at some point
during state fiscal years 1998 through 2004, and the rate reduction was
for less than 1 year in 2 of these states. For example, for the 3-month
period of March through May 2003, Massachusetts reduced payment rates to
nursing homes by approximately 2.5 percent, but increased payment rates in
June 2003 by about 6.3 percent.43 Similarly, Michigan reduced nursing home
rates from January through September 2002 by approximately 1 percent.44
With the start of Michigan's fiscal year 2003 (October 1, 2002), this
reduction was lifted; however, facing budgetary constraints, the state
again reduced nursing home payment rates from March 2003 through September
2003 by roughly 1.85 percent.45 While reductions in per diem rates were
temporary in these 2 states, the reduction in per diem rates in Illinois
and Texas were for longer periods of time. Illinois, for example,
implemented an across-the-board 5.9 percent cut to existing rates to all
Medicaid providers, including nursing homes, in July 2002, and froze

42Some states we reviewed also noted limited changes made to Medicaid
services and eligibility, such as Florida's elimination of denture
coverage for all adults in 2002, which could affect nursing home
residents.

43The June 2003 increase in per diem rates was due to provider tax
revenues. In addition, according to a state official, the state has
proposed eliminating the March 2003 cut of 2.5 percent as part of a plan
to increase per diem rates by an additional 3.1 percent. If approved, the
new per diem rates will be retroactive to September 1, 2003, and will be
in effect for the remainder of fiscal year 2004, which began on July 1,
2003. Increases in per diem rates for the first 2 months of state fiscal
year 2004-July and August 2003-will be spread over the remaining months of
the fiscal year.

44For Michigan nursing homes, this reduction applied to payment for direct
resident care, indirect care, and administrative costs, but was not
applied to payment for capital costs. While this reduction was in effect,
the state implemented a provider tax on all nursing home beds, and revenue
from this tax was used to provide an increase to Medicaid per diem rates
beginning July 1, 2002.

45The reduction was only applied to payment for homes' direct resident
care, indirect care, and administrative costs.

payment rates at this reduced level for fiscal year 2004, which began on
July 1, 2003. Similarly, in its 2004/2005 biennial budget, which began
September 1, 2003, Texas reduced payment rates to Medicaid providers, with
nursing home per diem rates being reduced by 1.75 percent from their
fiscal year 2003 levels.

In addition to these four states, Oregon froze Medicaid payment rates to
nursing homes in fiscal year 2003 at fiscal year 2002 rates and extended
this freeze at the beginning of fiscal year 2004. Beginning on July 1,
2003, Connecticut froze Medicaid payment rates to nursing homes at January
2003 levels and also reduced the level of payment increases granted to
other Medicaid long-term care providers.46

The effect of states' other modifications on payment methods varies. While
some changes have obvious positive or negative effects on payment rates,
the effect of other changes on payments to individual nursing homes is
mixed. For example, New Jersey's decreased ceiling for administrative and
indirect care costs-from 105 to 100 percent of the median costs for all
homes-and Michigan's elimination of add-on payments for quality incentives
and direct resident care staff wages likely lowered payment rates to some
extent for some nursing homes. Conversely, payment to some nursing homes
in New York and Vermont increased because of recently implemented add-on
payments for direct resident care staff wages. Effects of other changes on
nursing home payments, such as Colorado's implementation of a case-mix
system in 2000 or the addition of two counties to California's Bay Area
peer group in 2002, could either increase or decrease payment rates
depending on the home.

Although the effect that changes to payment methods have on rates for
individual nursing homes may be mixed, average per diem rates in the
states we reviewed generally have kept pace with increasing nursing home
costs as measured by the SNF market basket index from state fiscal years
1998 through 2003. As figure 1 shows, from state fiscal years 2001 through
2003-a period during which all 19 states we reviewed were experiencing
increased fiscal pressures-the average annual percentage change in states'
average per diem rates in 14 of the 19 states exceeded the SNF

46Oregon's rate freeze will continue, pending CMS approval of a waiver
pertaining to the state's new provider tax legislation. Under
Connecticut's rate freeze, nursing homes will continue to receive their
January 2003 rates through the end of calendar year 2004.

market basket index.47 This trend is similar to what occurred to rates
during the years immediately following the repeal of the Boren
Amendment-1998 through 2000-when states' fiscal conditions were generally
much more positive. In that earlier period, the average annual percentage
change in states' average per diem rates met or exceeded the SNF market
basket index in 14 of these states, although the states that fell below
the SNF market basket index differed somewhat between the two periods.48

47The SNF market basket index measures changes in the costs of the
resources nursing homes use, such as wages for staff or prices of supplies
and equipment. It does not reflect necessary changes in the quantities of
resources nursing homes must use, such as increased staff time when
residents' needs become more complex over time. However, changes in
residents' needs from year to year, on average, are modest. The SNF market
basket index overstates the costs that Medicaid per diem nursing home
rates are intended to reimburse since it includes prescription drug costs,
which Medicaid programs typically pay separately. The index may not
reflect certain cost changes in individual states. For example, in recent
years, significant increases in malpractice insurance costs, which likely
exceed the national average cost increase reflected in the index, have
been reported in several states. Also, some states have instituted or
increased provider taxes nursing homes must pay-a cost change not
immediately reflected in the index. Four states we reviewed -Arkansas,
Massachusetts, Michigan, and New York-implemented such a tax during the
time period reflected in figure 1. For example, New York imposed a
provider tax of 6 percent of nursing homes' adjusted gross revenues in
state fiscal year 2003; as a result, the SNF market basket index
understates cost increases experienced by the state's nursing homes during
the time period of our analysis by 1.6 percentage points. Based on
discussions with payment experts, we believe that the SNF market basket
index is the best proxy measurement available to determine how Medicaid
nursing home per diem rates have kept pace with nursing homes' changing
costs. In addition, states capture changes in costs not fully reflected in
the SNF market basket index when they rebase rates, which 17 of the states
we reviewed do regularly.

48The average annual percentage change in states' average per diem rates
fell below the SNF market basket index from 1998 through 2000 in Arkansas
and South Dakota; from 2001 through 2003 in Connecticut and Massachusetts;
and for both periods in California, Illinois, and New York.

Figure 1: Average Annual Percentage Change in Average Per Diem Rates, by
State, Compared to the SNF Market Basket Index, State Fiscal Years
2001-2003

16 Average annual percentage change

14

12

10

8

6

4

2

0 ALARCACOCT FL IL IA MAMI NJ NYNDORPA RISD TX VT State

Average percentage change in SNF market basket index

Source: State Medicaid programs.

Notes: Each bar represents the compounded average of the annual percentage
change in statewide average per diem rates from 2001 through 2003, and is
based on GAO analyses of Medicaid nursing home per diem rates from 2000
through 2003. For each of these fiscal years, states provided the most
readily available per diem rates, which were most commonly those rates in
effect at the beginning of the fiscal year. All states provided homes'
average rates weighted by resident days except Arkansas and Pennsylvania,
which provided projected rates for state fiscal year 2003. Per diem rates
were unavailable for 2003 in Michigan.

From state fiscal years 2001 through 2003, the average annual change in
per diem rates fell below the SNF market basket index in five states-
California, Connecticut, Illinois, Massachusetts, and New York. The
factors that contributed to per diem rates falling below this index varied
among these states.49 For example, Illinois' rate reduction in fiscal year
2003 of almost 6 percent contributed to the average rate change falling
below the SNF market basket index. In addition, the lack of regular
rebasing likely contributed to lower per diem rates in Illinois and New

49For other reasons, some states' annual average percentage change in the
per diem rates fluctuated above or below the SNF market basket index. For
example, Arkansas implemented a new nursing home payment system in January
2001, and as a result rate increases were significantly higher than the
SNF market basket index.

York. Illinois rebased rates only once from fiscal years 1994 through
2001, and as previously noted, New York has not fully rebased rates since
1986.

In addition, industry officials in some states told us that the inflation
factor used to update rates in non-rebase years is insufficient to meet
nursing homes' changing costs. For example, industry officials in New York
said that the inflation factor the state uses to update homes' rates
annually, the CPI, does not reflect increasing health care costs. In
addition, Connecticut-which rebases rates at least once every 2 to 4
years-uses a legislatively set inflation factor to increase rates in
non-rebase years, which for the past several years has been limited to
approximately 2 percent. Industry and Medicaid officials contend that this
legislated amount, which has consistently fallen below the SNF market
basket index, does not correspond with increases in actual nursing home
costs.

    States Averted More Significant Payment and Programmatic Changes to Nursing
    Homes through Several Means

To help balance their budgets, states we reviewed have relied on
alternative funding sources-including budget stabilization and tobacco
settlement funds- and have enhanced revenue by increasing taxes (see table
3).50

50Some states have also enhanced their revenue through the use of upper
payment limit (UPL) schemes in nursing homes. We have noted problems with
some state UPL programs in the past; however, independently reviewing the
validity of these programs was beyond the scope of this report. See U.S.
General Accounting Office, Medicaid: HCFA Reversed Its Position and
Approved Additional State Financing Schemes, GAO-02-147 (Washington, D.C.:
Oct. 30, 2001), and Medicaid: State Financing Schemes Again Drive Up
Federal Payments, GAO/T-HEHS-00-193 (Washington, D.C.: Sept. 6, 2000).
Also see related GAO products at the end of this report.

Table 3: Examples of Funding Sources States Reported Using to Respond to
Fiscal
Pressures, 1998-2003

Tobacco Budget settlement stabilization Cigarette tax Medicaid State fund
fund increase trust fund

Alabama

Arkansas

California X

Colorado X

Connecticut X

Florida X

Illinois X X

Iowa XX

Massachusetts X X

Michigan X X X

New Jersey X X X

New York X X X

North Dakota X

Oregon X X

Pennsylvania X X

Rhode Island X

South Dakota

Texas
Vermont X X

Total 129 6

Source: State Medicaid programs.

Sixteen of the 19 states we reviewed reported using alternative funding
sources, such as tobacco settlement, budget stabilization, cigarette tax
increases, and Medicaid trust funds to deal with their states' budgetary
pressures. Most commonly, states relied on tobacco settlement funds to
ease fiscal pressures. While many of the states we reviewed have employed
alternative funding sources or cigarette tax increases, not all the states
relied on these funds to cope with their budget situations. For

instance, all 19 states received tobacco settlement funds, yet only 12
used these funds from 1998 through 2003 to respond to fiscal pressures.51

To help fund Medicaid nursing home payments in particular, several states
rely on nursing home provider taxes, and in light of recent fiscal
pressures, an increasing number of states have recently adopted or
proposed these taxes in an effort to fund nursing home payments or to
avert service reductions.52 Of the 19 states we reviewed, 8 currently have
provider taxes for nursing homes, with at least 4 of these states
implementing the tax since 2001, when fiscal pressures began increasing in
many states. In addition, 5 of the states reviewed currently have pending
for CMS's approval a proposal to adopt a provider tax on nursing homes
(see table 4). Of all types of providers, nursing homes were most commonly
subject to new provider taxes in state fiscal years 2003 and 2004,
according to a recent survey of all 50 states and the District of
Columbia.53

51Tobacco settlement funds are received by all 50 states, the District of
Columbia, and the 5 U.S. territories. Annually, tobacco companies pay 46
states for past health care costs related to tobacco use as required by
the Master Settlement Agreement of 1998. The remaining 4 states-Florida,
Minnesota, Mississippi, and Texas-receive payments from tobacco companies
per the requirements of individual settlement agreements. See U.S. General
Accounting Office, States' Allocations of Fiscal Years 2002 and 2003
Master Settlement Agreement Payments, GAO-03-407 (Washington, D.C.: Feb.
28, 2003).

52As a general rule, states may impose a health-care related nursing home
provider tax for up to 6 percent of nursing homes' gross revenues if the
tax is broad-based and uniformly applied to all health care providers in a
provider class-for example, to all nonpublic nursing homes as either a
dollar amount per bed or a percent of individual homes' revenues. See 42
U.S.C. S: 1396b (w)(3)(B) and (C); 42 C.F.R. S: 433.68 (f). In a state
with a nursing home provider tax, a nursing home may claim, as an
allowable Medicaid cost, the portion of the provider tax paid that relates
to providing services to Medicaid beneficiaries. Upon paying the home's
claim for reimbursement, the state subsequently receives federal matching
funds for these paid claims, including the provider tax.

53See Vernon Smith, et al., States Respond to Fiscal Pressure: State
Medicaid Spending Growth and Cost Containment in Fiscal Years 2003 and
2004, Results from a 50-State Survey (Washington, D.C.: Kaiser Commission
on Medicaid and the Uninsured, September 2003).

Table 4: Existing or Pending Nursing Home Provider Taxes in 13 of 19
Reviewed States, September 2003

Status State

Existing 	Alabama Arkansas Illinois Massachusetts Michigan New York Rhode
Island Vermont

Pending 	Colorado Iowa New Jersey Oregon Pennsylvania

Source: State Medicaid programs.

Officials in some states told us that they have avoided making substantial
reductions to nursing home payment rates because of other factors. For
example, state legislative or regulatory action is typically required to
change nursing home payment methods, and garnering sufficient support for
such changes-especially for rate reductions-is often difficult. In
addition, the nursing home industry has actively worked to avoid decreases
in payment rates in several states. For example, industry officials in
Alabama, Iowa, and Texas cited campaigns that they considered successful
in various ways, such as preventing rate reductions or encouraging rate
increases. Specifically, nursing home industry officials in Iowa said that
two proposed nursing home rate cuts were defeated in part because of their
opposition. Also, industry officials in Texas said that through their
efforts, nursing homes were able to obtain rate increases for fiscal year
2002.

    Future Options for Dealing with Fiscal Pressures May Be More Uncertain

  External Comments

Although the extent of states' continued fiscal pressure is unknown,
states expect their poor fiscal situations to continue through fiscal year
2004. According to an April 2003 NCSL study, 28 states and the District of
Columbia expected budget shortfalls totaling over $53 billion in fiscal
year 2004.54 These budget gaps may be difficult to fill as many states
reported that they have depleted or nearly depleted their alternative
funding sources. Over half of the states we reviewed that used budget
stabilization funds, and 3 of the 12 states that used tobacco settlement
funds, reported having depleted or nearly depleted these sources.

Some states we reviewed reported their plans to confront continuing budget
pressures in fiscal year 2004. As previously noted, at least six of these
states reduced or froze their nursing home payment rates at some point
during the past 2 fiscal years. In addition, these and other states have
recently undertaken or are currently considering actions to reduce future
nursing home payment rates. For example, California rebased nursing home
rates for the 2004 rate year, which began on August 1, 2003, but has
already frozen 2005 payment rates at current levels. Similarly, in August
2003, Connecticut froze per diem rates at their January 2003 levels
through December 2004. Even with recent temporary federal fiscal relief,
officials in some states suggest that nursing home payment reductions are
possible in the future. For example, a Michigan state official indicated
that reductions in 2004 per diem rates are probable because the
legislative appropriation is likely insufficient to rebase rates.

We provided a draft of this report to the Medicaid Director in each of the
19 study states for technical review. All states generally agreed with our
characterization of their respective nursing home payment methods and,
when necessary, provided clarifying or technical comments, which we
incorporated as appropriate. In addition, we obtained oral comments on a
draft of this report from representatives of two nursing home
associations, the American Health Care Association (AHCA) and the American
Association of Homes and Services for the Aging (AAHSA). We have modified
the report, as appropriate, in response to their technical comments.

54National Conference of State Legislatures (NCSL), State Budget Update:
April 2003 (Washington, D.C.: April 2003).

As agreed with your offices, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days
after its
issue date. At that time, we will send copies to the Administrator of CMS
and appropriate congressional committees. We will also make copies
available to others upon request. In addition, the report will be
available at
no charge on the GAO Web site at http://www.gao.gov.

If you or your staffs have any questions, please contact me at (202) 512
7118. An additional contact and other staff members who made
contributions to this report are listed in appendix IV.

Kathryn G. Allen
Director, Health Care-Medicaid

and Private Health Insurance Issues

                       Appendix I: Scope and Methodology

To examine Medicaid nursing home payment methods and rates, we selected 20
states for our review. The 20 states included the following:

o  	10 states (1 from each of the 10 Centers for Medicare & Medicaid
Services (CMS) regions) with the largest decline or smallest growth in
revenue from 2000 through 2002 within their regions, based on data in the
November 2002 fiscal survey of states conducted by the National
Association of State Budget Officers (NASBO) and the National Governors
Association (NGA);

o  5 states with the largest population based on 2000 Census data; and

o  	5 states with the highest number of Medicaid nursing home residents
per capita, as indicated by the most recent data in CMS's Online Survey
Certification and Reporting (OSCAR) database (see table 5).

Nationwide, these 20 states represented approximately 62 percent of
Medicaid nursing home expenditures in fiscal year 2001 and 59 percent of
Medicaid nursing home residents in fiscal year 2000, according to the most
recently available CMS data.

Table 5: Study States Categorized by Selection Factors

                           States selected for sample

                                                               Highest number 
                                                                of Medicaid   
                                                                nursing home  
              Largest decline or smallest growth in    Largest residents per  
                                            revenue            
                from 2000 through 2002 (CMS region) population         capita 

                         Alabama (IV)         California     Connecticut      
                         Arizona (IX)            Florida        Massachusetts 
                        Arkansas (VI)           Illinois         Rhode Island 
                      Colorado (VIII)           New York         North Dakota 
                           Iowa (VII)              Texas         South Dakota 
                         Michigan (V)                    
                      New Jersey (II)                    
                           Oregon (X)                    
                   Pennsylvania (III)                    
                          Vermont (I)                    

Source: National Governors Association and National Association of State
Budget Officers, The Fiscal Survey of States (Washington, D.C.: November
2002), http://www.nasbo.org (downloaded Dec. 6, 2002); The U.S. Census
Bureau; and CMS's OSCAR.

In each of the 20 states, we interviewed officials from the Medicaid and
budget offices. From these officials, we obtained information about
nursing home payment methods (including changes) for state fiscal years
1998 through 2004 and per diem rates for state fiscal years 1998 through
2003. In addition, to gain a broader understanding of Medicaid nursing

Appendix I: Scope and Methodology

home payments, we interviewed representatives from the offices of the
American Health Care Association (AHCA) and/or the American Association of
Homes and Services for the Aging (AAHSA) in each of the 20 states. We also
interviewed national representatives of AHCA and AAHSA and consultants and
experts in the field of Medicaid nursing home payment. Because Arizona's
Medicaid program is predominantly a managed care system, the state
determines payment rates for only 5 percent of the nursing home
population. Therefore, this report excludes Arizona and presents our
findings from analyses of the other 19 states.

To examine the extent to which states base nursing home payment rates on
homes' costs, we reviewed documentation, including some state laws and
regulations.1 Relying on these documents as well as our interviews with
state officials, we also identified key features of payment methods, such
as whether rates are home-specific and how frequently states update or
rebase the rates they pay nursing homes. In addition, we summarized the
extent to which states' payment methods incorporate features such as peer
grouping, cost-center ceilings, and case-mix adjustment systems.

To determine how state fiscal pressures have affected Medicaid programs
with regard to nursing home payment rates and methods, we collected per
diem rates from state fiscal years 1998 through 2003, fiscal year 2003
being the most current year for which per diem rates were available, and
information about changes made to nursing home payment methods from state
fiscal years 1998 through 2004. We used the per diem rate data to compare
the average annual percentage change in states' average nursing home
payment rates from state fiscal years 1998 through 2003 to the
corresponding years' change in the skilled nursing facility (SNF) market
basket index.2 The SNF market basket index, which is developed and updated
annually by Global Insights, Inc., is used by CMS to reflect changes in
the prices of goods and services included in the Medicare SNF

1We did not perform a comprehensive review of state laws and regulations
related to nursing home payment methods.

2To conduct this analysis, we obtained the most readily available data
from the states. Depending on the state, the data provided were typically
for the respective state's fiscal year, although some states provided data
by calendar year. We converted calendar year rates provided by Iowa to
fiscal year rates for the last 6 months of state fiscal year 1998 and for
state fiscal years 1999 through 2001. For state fiscal years 2002 and
2003, Iowa provided per diem rates and resident days for each nursing
home, which we used to calculate the statewide average per diem rate.

Appendix I: Scope and Methodology

prospective payment system.3 States typically provided us with their
average Medicaid nursing home per diem rates weighted by resident days;
however, in a few instances we had to use a state's home-specific rates
and resident days to calculate the weighted average per diem rate. For
2003, an average per diem rate was not available in Michigan, and
projected per diem rates were provided by Arkansas and Pennsylvania.

We encountered limitations with data provided by two other states. For
example, North Dakota law generally prohibits nursing homes from charging
private-pay residents more than the Medicaid rate;4 however, rates
provided to us by the state were based on total resident days, which
include payments for 3 to 5 percent of residents whose care is paid at
typically higher Medicare rates. Therefore, the rates provided to us may
be slightly higher than the average Medicaid rate. Conversely, the rates
provided by Pennsylvania may be slightly lower than the actual average
nursing home Medicaid rate because they include nursing homes residents'
temporary hospital stays, which account for approximately 1 percent of
total resident days and for which homes only receive one-third of the per
diem rate. Finally, we reviewed information compiled by NASBO, NGA, and
NCSL related to states' fiscal outlook and possible future reductions in
the Medicaid program, including reductions affecting nursing homes.

3Global Insights, Inc., is an economic and financial information company.
4N.D. Cent. Code S: 50-24.4-19.1 (1999).

Appendix II: Summary of Certain Payment Characteristics Used in Selected States

States use many of the same features within their payment methods. We
describe below certain features of the payment methods used in the states
we reviewed: peer groups, cost-center ceilings, efficiency incentives,
casemix systems, and occupancy standards.

Peer Groups 	Ten states we reviewed classify homes into peer groups, or
categories based on characteristics such as size or location, and
typically set separate cost-center ceilings for each peer group.1 The
states we reviewed most commonly categorize nursing homes by geographic
region or home type.2 However, how states use peer groups varies (see
table 6). For example, some states, such as New Jersey, use peer groups
within all cost centers, while other states, such as Alabama, only group
homes in one cost center. Further, states differ in the number and type of
peer grouping categories they use. For example, Illinois's peer grouping
uses seven geographic regions in all cost centers; Connecticut bases its
peer grouping on two geographic regions and two home types in the direct
resident care cost center; and Florida's peer grouping is based on three
geographic regions and two home sizes in both the direct resident care and
administrative cost centers.

1The nine states reviewed that did not classify homes into peer groups
were Arkansas, Colorado, Massachusetts, North Dakota, Oregon, Rhode
Island, South Dakota, Texas, and Vermont.

2Home type includes categories such as home ownership (e.g., proprietary,
nonprofit, or governmental); resident care need (e.g., skilled nursing
homes, low-intensity homes for those with mental retardation, or chronic
convalescent nursing homes); and whether the home is hospital-based or
freestanding.

Appendix II: Summary of Certain Payment Characteristics Used in Selected
States

Table 6: Peer Grouping Techniques Used in Reviewed States, as of June 2003 State
                                  Peer groups

Alabama Two home sizes in the administrative cost center

California 	Eight home types based on resident care need in all cost
centers: five of the eight home types further grouped by three geographic
regions and/or two home sizes; two of the eight home types further grouped
by each resident's ventilator need; and one of the eight home types does
not use additional peer groups

Connecticut 	Two geographic regions and two home types based on resident
care need in the direct resident care cost center

Florida 	Three geographic regions and two home sizes in the direct
resident care and administrative cost centers

Illinois Seven geographic regions in all cost centers

Iowa 	Two home types based on whether the home is Medicare-certified and
hospital-based or freestanding

Michigan 	Two home types based on ownership or whether the home is
hospitalbased or freestanding

New Jersey 	Three home types based on ownership or resident care need in
all cost centers

New York 	Two home sizes, two levels of care, and whether home is
hospital-based or freestanding in the indirect care cost center; 16
geographic regions for wage adjustment in the indirect care and direct
resident care cost centers; two home types based on ownership and further
grouped by lease type and date or financing method in the capital cost
center

Pennsylvania 	Four geographic regions and three home sizes in the direct
resident care, indirect care, and administrative cost centers

                        Source: State Medicaid programs.

Appendix II: Summary of Certain Payment Characteristics Used in Selected
States

                              Cost-Center Ceilings

To limit the maximum amount states pay for costs within a given cost
center, ceilings are typically set at a percentage of median costs, or a
certain percentile of costs, for all nursing homes in a state or a subset
of nursing homes with similar characteristics in states that pay
home-specific rates.3 Homes in these states generally receive rates based
on the lower of their actual costs or the ceiling.4 While most states we
reviewed divide their operating costs into three centers-direct resident
care, indirect care, and administration-plus a center for capital
costs-the number of cost centers in the states we reviewed ranges from two
in Oregon to seven in Rhode Island. In addition, states differ in how they
categorize costs. For example, 8 states combine indirect care and
administrative costs into a single cost center. Similarly, states may
differ in how they categorize certain costs. For instance, Pennsylvania's
direct resident care center includes medical supplies, which are
considered indirect costs in Connecticut and Rhode Island. Table 7
describes ceilings for operating costs in the 15 states that pay
individual/home-specific rates, and table 8 describes how the remaining 4
states-California, Massachusetts, Oregon, and Texas-develop their flat
rates, which serve as a type of ceiling, to pay for all nursing homes in
the state.

3In addition to imposing ceilings, many states use other mechanisms to
limit the costs they will recognize when determining homes' rates.

4In states that use efficiency incentives, homes are also eligible to
receive an additional payment included in their per diem rate.

Appendix II: Summary of Certain Payment Characteristics Used in Selected States

Table 7: Direct Resident Care, Indirect Care, and Administrative
Cost-Center Ceilings in Reviewed States with Individual Home Rates, as of
June 2003

                              Cost-center ceilings

State Direct resident care Indirect care Administrative

Alabama 	110 percent of median costs for all 110 percent of median costs
for all 105 percent of median costs for all homesa homes homes within each
peer group

c

Arkansas 	105 percent of 90th percentile for all Flat rate set at 110
percent of median costs for all homes homesb

Colorado	125 percent of average costs weighted 120 percent of average
costs 120 percent of average costs by total resident days for all homes
weighted by total resident days for all weighted by total resident days
for all

d

within each peer group 	homes within each peer group for homes within each
peer group room and board costs; 125 percent of weighted average costs for
all homes within each peer group for other indirect costs

Connecticut 	135 percent of median costs for all 115 percent of median
costs for all 100 percent of median costs for all homes within each peer
group homes homes

Florida 	1.75 standard deviations above median 1.75 standard deviations
above One standard deviation above median costs for all homes within each
peer median costs for all homes within costs for all homes within each
peer group each peer groupe groupe

Illinois None 75th percentile of costs for all homes within each peer
group

Iowa 	120 percent of median costs for all 110 percent of median costs for
all homes homesf

Michigan 	80th percentile of costs for all homes 80th percentile of costs
for all homes within each peer groupg within each peer group

              120 percent of median  110 percent through       100 percent of 
New Jersey costs for all          150 percent of          median costs for 
                                                                          all 
              homes within each peer median costs,          homes within each 
                      group          depending on specific     peer group     
                                     type of costs, for all 
                                     homes within           
                                        each peer group     

New Yorkh	Ceiling based on updated 1983 prices 105 percent of average
costs for all homes within each peer group for each level of resident care
need

North Dakota 99th percentile of costs for all homesi, j 85th percentile of costs
             for all homesi 75th percentile of costs for all homes

Pennsylvania 	117 percent of median costs for all 112 percent of median
costs for all 104 percent of median costs for all homes within each peer
group homes within each peer group homes within each peer groupk

Rhode Island 80th percentile of costs for all homes 80th percentile of costs for
                all homes 80th percentile of costs for all homes

South Dakotal	115 percent of median costsm for all 105 percent of median
costsm for all 105 percent of median costsn for all homes, and 80 percent
of costs that fall homes, and 80 percent of costs that homes, and 80
percent of costs that from 115 percent through 125 percent fall from 105
percent through 110 fall from 105 percent through 110 of the median
percent of the median percent of the median

           115 percent of median  105 percent of   Median costs for all homes 
Vermont costs for all          median costs for except                     
                                  all              
                   homes               homes           special hospital-based 
                                                                 homes, which 
                                                   are capped at 137 percent  
                                                   of the                     
                                                     median for all homeso    

Source: State Medicaid programs.

Appendix II: Summary of Certain Payment Characteristics Used in Selected
States

Note: While the table identifies standard names for cost centers, states
use a variety of names, such as nursing instead of direct resident care or
operations instead of administration.

aIn Alabama, nursing homes receive the lower of 110 percent of their
direct resident care costs or 110 percent of the direct resident care
ceiling.

bThrough June 30, 2004, Arkansas imposes a floor of 90 percent of the
median costs for all homes in the direct resident care center. Homes with
costs below the floor retain the difference between their costs and the
floor.

cAccording to an Arkansas official, the state considers its rates to be
home-specific since the majority of the rate is paid on a home-specific
basis through the direct resident care cost center.

dIn Colorado, nursing homes are limited to a maximum increase in payments
for administrative costs of 6 percent annually.

eIn Florida, two additional ceilings may be applied to the indirect care
and administrative cost centers. The nursing home's payment is limited to
the lowest of all ceilings.

fIn Iowa, the direct resident care ceiling for urban nursing homes is
adjusted by a geographic wage index, which generally increases the ceiling
for these homes by approximately 10 percent.

gIndirect care/administrative payment to each Michigan nursing home is
limited to a percentage of the amount reimbursed in the direct resident
care cost center. The exact percentage for each home depends on its size,
and as of June 2003, ranged from 32.6 percent for homes with at least 150
beds to about 33.6 percent for homes with 50 or fewer beds.

hIn the direct resident care, indirect care, and administrative cost
centers, New York imposes a floor of 92.5 percent of the average costs for
all nursing homes within each peer group. Homes with costs below the floor
retain the difference between their costs and the floor.

iIn North Dakota, a 3 percent operating margin is added to the payment for
all nursing homes in the direct resident care and indirect care cost
centers.

jNorth Dakota's direct resident care ceiling was changed to $85 at the
start of state fiscal year 2004.

kIn Pennsylvania, payment for nursing homes' administrative costs is
limited to 12 percent of total payment for direct resident care, indirect
care, and administrative costs.

lSouth Dakota nursing homes are limited to no more than an 8 percent
annual increase in their overall payment rates.

mSouth Dakota determines median costs after excluding nursing homes in
which residents have low care needs, as these homes generally have lower
direct resident care and indirect care costs.

nWhen calculating the administrative cost center median, South Dakota
excludes the costs of nursing homes that are part of large national
chains, because according to state Medicaid officials, these homes
generally operate with administrative costs that are significantly higher
than independent homes.

oVermont's special hospital-based homes must meet the following criteria
as of June 16, 2001. They must be (1) within a hospital building, (2) part
of the same corporation that governs the hospital, and (3) file Medicare
cost reports jointly with the hospital.

Appendix II: Summary of Certain Payment Characteristics Used in Selected
States

Table 8: Direct Resident Care, Indirect Care, and Administrative
Cost-Center Ceilings in Reviewed States with Flat Payment Rates, as of
June 2003

                              Cost-center ceilings

               State Direct resident care        Indirect care Administrative 
                                            Flat rate set at the median costs 
          California Flat rate set at the                       for all homes 
                     median costs for all          within certain peer groups 
                     homes within certain 
                              peer groups 

Massachusetts Flat rate set at median Flat rate determined by adding 85
percent of costs for all homesa median for administrative costs to median
of indirect costs for all homes

            Oregon   Flat rate set at       Flat rate set at approximately 90 
                                                                   percent of 
                     approximately 90         statewide average costs for all 
                                                                        homes 
                    percent of statewide 
                   average costs for all 
                                  homesb 

            Texas Flat rate set at 107    Flat rate set at   Flat rate set at 
                                                       107                107 
                  percent of weighted  percent of weighted  percent of median 
                       average for all average costs for        costs for all 
                                homes' all                              homes 
                  updated 1998 costsc               homesc 

Source: State Medicaid programs.

Note: While the table identifies standard names for cost centers, states
use a variety of names, such as nursing instead of direct resident care or
operations instead of administration.

aIn Massachusetts, rates paid to all nursing homes are also adjusted based
on resident care need.

bIn Oregon, nursing homes with residents who require complex care can
receive additional payments.

cIn Texas, rates paid to all nursing homes are also adjusted based on
resident care need.

Appendix II: Summary of Certain Payment Characteristics Used in Selected States

                             Efficiency Incentives

Seven states we reviewed include efficiency incentives in their payment
methods, which typically allow nursing homes with costs below a
predetermined amount (generally the cost-center ceiling or the median
costs) in one or more cost centers to have a portion of the difference
incorporated into their per diem rates (see table 9).5 For example,
Connecticut uses efficiency incentives in both its indirect care and
administrative cost centers. In the indirect care center, nursing homes
with costs below the median have 25 percent of the difference between
their costs and the median costs added to their per diem rates. The
following hypothetical example demonstrates how this efficiency incentive
generally would work. If a home's costs were $20 per day in the indirect
care cost center, and the median indirect care costs for all homes were
$24 per day, then the home has costs that are $4 below the median and
would have 25 percent of the difference between its costs and the median,
or $1, added to its rate. Each of the seven states applies efficiency
incentives differently.

5The 12 states reviewed that did not use efficiency incentives in their
payment methods are Arkansas, California, Florida, Massachusetts,
Michigan, New Jersey, New York, Oregon, Rhode Island, South Dakota, Texas,
and Vermont.

Appendix II: Summary of Certain Payment Characteristics Used in Selected States

    Table 9: Efficiency Incentives Used in Reviewed States, as of June 2003

State Direct resident care cost center Indirect care cost center
Administrative cost center

Alabama 	If a home's costs are below the ceiling, it receives 50 percent
of the difference between its costs and the ceiling

Colorado	If a home's costs are below the ceiling, it receives 12.5 percent
of the difference between its costs and the ceiling

Connecticut 	If a home's costs are below the If a home's costs are below
the median, it receives 25 percent of the median, it receives 25 percent
of the difference between its costs and difference between its costs and
median costs median costs

Illinois 	If a home's costs are below the ceiling, it receives 50 percent
of the difference between the 35th and 75th percentiles of its peer
group's costs

Iowa 	If a home's costs are below 95 If a home's costs are below 96
percent of the median, it receives 65 percent percent of the median, it
receives 100 of the difference between its costs and the median, up to 8
percent of the

                                       a

percent of the difference between its median
costs and the median, up to 10
percent of the median

North Dakota 	If a home's costs are below the ceiling, it receives 70
percent of the difference between its costs and the ceiling, up to $2.60
per resident day

Pennsylvania 	If a home's costs are below the If a home's costs are below
the ceiling, it receives 3 percent of the ceiling, it receives 3 percent
of the difference between its costs and the difference between its costs
and the ceiling, and up to 30 percent of the ceiling, and up to 30 percent
of the remaining difference up to ceiling remaining difference up to
ceiling

Source: State Medicaid programs.

aIowa combines nursing homes' indirect care and administrative costs into
a single cost center.

Appendix II: Summary of Certain Payment Characteristics Used in Selected
States

                                Case-Mix Systems

Case-mix systems categorize residents into groups based on the level of
care they need and adjust payment rates to homes accordingly. Twelve of
the 19 states we reviewed use case-mix systems, although the type of
system and the number of case-mix categories vary widely.6 While 5 states
have designed their own systems to measure case-mix, the remaining 7
states rely on some variation of the Resource Utilization Group (RUG)
Patient Classification System, which is also used to determine the acuity
level of nursing home residents in the Medicare program.7 The 7 states
that use various versions of the RUG Patient Classification System place
residents in 16 to 44 resident classification groups. In contrast, Oregon
places residents into one of two groups, basic or complex care.8 The
casemix classification system used by each state is shown in table 10.

6The seven states reviewed that did not use case-mix systems to categorize
residents were Alabama, Arkansas, California, Connecticut, Florida,
Michigan, and Rhode Island.

7CMS uses the RUG-III 44-group model to determine the case-mix of
Medicare-covered nursing home residents.

8In Oregon, approximately 95 percent of nursing home residents are grouped
in the basic care category.

Appendix II: Summary of Certain Payment Characteristics Used in Selected
States

Table 10: Case-Mix Classification Systems Used in Reviewed States, as of
June 2003

State Case-mix classification system

Colorado RUG-III, 34 groups

Illinois State-specific system, 36 groupsa, b

Iowa RUG-III, 34 groups

Massachusetts State-specific system,c 10 groups

New Jersey State-specific system,d 7 groups

New York RUG-II, 16 groups

North Dakota RUG-III, 34 groups

Oregon State-specific system,e 2 groups

Pennsylvania RUG-III, 44 groups

South Dakota RUG-III, 34 groups

Texas State-specific system,f 11 groups

Vermont RUG-III, 44 groups

Source: State Medicaid programs.

aIllinois's case-mix system is based on its Inspection of Care (IOC)
report. The IOC measures resident needs and services using 36 direct care
pricing criteria to determine an average case-mix score for each nursing
home. In 1994, the state stopped routinely administering comprehensive IOC
reports. From 1994 through 2002, a nursing home could request an update to
its IOC report if its resident turnover was at least 25 percent. However,
in October 2002 the state stopped using the entire IOC system altogether
and no longer prepares IOC reports. The last report for each nursing home
is used to adjust payment rates for case-mix.

bIllinois implemented a new case-mix system based on the Minimum Data Set,
also used by CMS, in state fiscal year 2004, which began on July 1, 2003.
A 2-year hold harmless provision protects nursing homes from experiencing
decreased rates as a result of this new system. However, since per diem
rates were frozen at the beginning of state fiscal year 2004, the new
case-mix system did not immediately increase payment rates to nursing
homes.

cMassachusetts's case-mix system is based on its Management Minutes
Questionnaire. Residents are grouped into 1 of 10 categories based on the
level of care they require in activities of daily living and skilled
nursing. On the basis of this classification, nursing homes are paid one
of six different rates.

dNew Jersey's case-mix system provides payment for additional hours of
nursing for residents needing seven different services.

eOregon's case-mix system provides an additional payment to nursing homes'
basic rate for residents with complex care needs, for example, residents
who need intravenous injections or who have open wounds requiring
aggressive treatment.

fTexas's case-mix system is the Texas Index for Level of Effort (TILE).
TILE is a state-designed, 11group system modeled on a version of the RUG
Patient Classification System. Nursing home residents are placed in 1 of
the 11 groups depending on their need for various resources.

Appendix II: Summary of Certain Payment Characteristics Used in Selected States

                              Occupancy Standards

By applying an occupancy standard, states reduce the per diem rates paid
to nursing homes with occupancy below the state-established minimum
levels. Of the 19 states reviewed, 17 use occupancy standards, which vary
from 75 percent in Arkansas to 98 percent in Rhode Island, to determine
nursing home payment rates.9 The following hypothetical example
demonstrates how a state may apply an occupancy standard. A state applies
an occupancy standard of 85 percent in the indirect care cost center, but
a nursing home has a 75 percent occupancy level (along with annual costs
of $200,000 in the indirect care cost center and 36 beds). Using the
home's actual occupancy, its payment rate for the indirect care cost
center would be $20.29 (or $200,000/[.75 x 36 beds x 365 days]), whereas
adjusting the home's payment in the indirect care cost center for the
state's occupancy standard results in a lower rate of $17.91
($200,000/[.85 x 36 beds x 365 days]). The extent to which states apply
occupancy standards varies. Three of the states we reviewed-Alabama,
Arkansas, and Iowa-apply the occupancy standard to only one cost center,
and 7 others-Connecticut, Florida, Massachusetts, Michigan, New York,
Rhode Island, and South Dakota-apply the occupancy standard to all cost
centers (see table 11).

9The two states reviewed that did not incorporate occupancy standards into
their nursing home payment methods were California and Oregon.

Appendix II: Summary of Certain Payment Characteristics Used in Selected States

     Table 11: Occupancy Standards Used in Reviewed States, as of June 2003

      State          Standard               Applicable cost center(s)         
     Alabama   85 percent occupancy                  Capital                  
    Arkansas   75 percent occupancy                  Capital                  
    Colorado   85 percent occupancy          Administrative (rural facilities 
                                                                    exempted) 
               90 percent occupancy                  Capital                  
Connecticut 95 percent occupancy                    All                    

Florida  Home's total occupancy must be below the statewide average Allb 
             occupancy less one standard deviation and home's Medicaid 
            occupancy must be below the statewide average Medicaid     
            a occupancy less one standard deviation                    

     Illinois    93 percent occupancy        Indirect care/administrative and 
                                                                      capital 
       Iowa      c80 percent occupancy             dIndirect care             
Massachusetts 96 percent occupancy                   All                   
     Michigan    85 percent occupancy                   All                   
    New Jersey   95 percent occupancy                 Capital                 

90 percent occupancy 	Direct resident care, indirect care, and
administrative

New York     90 percent occupancy               All                        
North Dakota 90 percent occupancy               Administrative and capital 
Pennsylvania 90 percent occupancy               Administrative and capital 
Rhode Island  98 percent of statewide average   All                        
                            occupancy              

South Dakota 3 percent below the statewide                 All             
                average occupancy                 
      Texas     Lower of 85 percent occupancy or  Administrative and capital  
                statewide average                 
                            occupancy             
     Vermont                                       All except direct resident 
                      90 percent occupancy                               care 

Source: State Medicaid programs.

Note: Unless otherwise noted, the state's occupancy standard is expressed
as a minimum percentage of the number of beds occupied each day in a
nursing home over a given year.

aIn Florida, these figures are revised semiannually, based on updated
census data provided by the nursing homes. The amount that a home's per
diem rate is reduced depends on its actual occupancy.

bFlorida does not apply the occupancy standard to the property component
of capital in the approximately 90 percent of nursing homes that are
reimbursed for capital using a fair rental value system.

cIowa's occupancy standard increased to 85 percent on July 1, 2003.

dWithin the indirect care cost center, Iowa only applies its occupancy
standard to administrative and capital costs.

                     Appendix III: Changes to Nursing Home
                     Payment Methods or Rates in 19 States

Officials in the states we reviewed identified changes to payment rates or
to the methods their respective Medicaid programs use to determine nursing
home payment rates from state fiscal years 1998 through 2004 (see table
12). While some changes have obvious positive or negative effects on
payment rates, the effect of other changes can be mixed. For example,
while Colorado's elimination of its quality incentive add-on payment
likely lowers payment to some nursing homes, payment to some nursing homes
in Vermont increased because of recently implemented add-on payments for
direct resident care staff wages. The effect of other changes, such as
California adding two counties to the Bay Area peer group in 2002, are
likely to affect rates in both directions for different homes.

In addition to changes to how they paid nursing homes, two states-
Arkansas and Iowa-designed and implemented completely new payment
methodologies during this time. For example, Iowa's prior payment method
did not classify homes into peer groups, did not adjust rates for the
costs related to homes' resident care needs, and limited payment to the
70th percentile of all homes' total costs. Under the state's new payment
method, which was phased in completely in July 2003, homes are classified
into peer groups, rates are adjusted for resident care costs using the
RUG-III classification system, and a ceiling of 120 percent of median
costs for all homes is imposed on payment for direct resident care costs.

  Appendix III: Changes to Nursing Home Payment Methods or Rates in 19 States

  Table 12: State-Reported Changes to Existing Nursing Home Payment Methods or
                      Rates, State Fiscal Years 1998-2004

                  Cost-center                                         
                  ceilings or                  Case-mix               
                              Calculation   classification                    
           Peer   efficiency  of              Occupancy       Add-on  Payment
                                              Inflation               
State          incentives     costs     system standard             rate   
         grouping                               factor       payments 

Alabama 	Moved liability insurance costs to administrative cost center
instead of pass-through in 2002

California 	Added two counties to Bay Area peer group in 2002

Implemented Froze per
a wage add-diem rates
on for some from August
direct 2003
resident care through
staff in 1999 July 2005 at
and for other August 2003
staff in 2000;a levels
delayed
implementa
tion of
another direct
resident care
wage add-on,
which will
apply to
payments
from
February
2002 through
July 2004,
until
December
2004

Colorado  Suspended Eliminated Implemented  Eliminated          Eliminated 
                            limit                                   Increased 
            efficiency on annual   case-mix     occupancy   quality lag time  
            incentive in increase  system in   standard in          incentive 
                     in                                           add-between 
                   administrative    2000        direct       on in 2002 cost 
                      payment for                                      report 
               cost center for                  resident           submission 
                  combined                                  
             3 months in direct                 care and             and rate 
                     and                                    
               2003 indirect care             indirect care       implementa- 
                    costs in 2000             cost centers        tion from 2 
                                                 in 2000          to10 months 
                                                                     for most 
                                                                     homes in 
                                                                         2002 

  Appendix III: Changes to Nursing Home Payment Methods or Rates in 19 States

                     Cost-center                                        
                     ceilings or                Case-mix                
                                 Calculation classification                      
              Peer   efficiency  of            Occupancy      Add-on    Payment
                                               Inflation                
                                                 system                          
State    grouping incentives     costs       standard     payments     rate
                                                 factor                 
Connecticut                                                             Delayed  
                                                            Implemented rate     
                                                              direct    increase 
                                                                            from 
                                                               resident   July   
                                                                   care   2002   
                                                                and     until    
                                                             indirect   January  
                                                               care      2003;   
                                                             staffing    froze   
                                                            wage add-on rates at 
                                                             in 1999;    January 
                                                                            2003 
                                                             eliminated   levels 
                                                                     in  through 
                                                               2001     December 
                                                                          2004   

Florida         Eliminated Partially         Implemented       Implemented 
                   peer group rebased           case-mix               direct 
                    and home- administrative    system in       resident care 
                 specific     cost center for   1999;                staffing 
                 ceilings for state fiscal      eliminated in         minimum 
                indirect care year (SFY)        2001                add-on in 
                 from January 2003                                      2002; 
                 to June 2002                                         delayed 
               and for direct                                     increase in 
                resident care                                          direct 
                    beginning                                   resident care 
                 January 2002                                        staffing 
                                                                      minimum 
                                                                 from January 
                                                                    until May 
                                                                    2004      

Illinois 	Eliminated routine updates to case-mix data from 1998 through
2001 and eliminated case-mix updates altogether in 2002;b implemented new
case-mix system based on the CMS's Minimum Data Set in SFY 2004 Froze
rates for SFY 1998 through 2001;b cut rate by 5.9 percent in SFY 2003;
froze rates at SFY 2003 levels in SFY 2004

  Appendix III: Changes to Nursing Home Payment Methods or Rates in 19 States

                  Cost-center                                         
                  ceilings or                Case-mix                 
                              Calculation classification                      
           Peer   efficiency  of             Occupancy      Add-on    Payment
                                             Inflation                
State grouping incentives     costs    system standard  payments    rate   
                                              factor                  
Iowac                                        Increased             
                                                  Reduced Implemented 
                                          from 80 to cost   add-on    
                                                   report             
                                               85 percent payment for 
                                                inflation             
                                              in indirect quality in  
                                            factor by 3.4             
                                                care cost  July 2002  
                                               percentage             
                                                center in             
                                                points in             
                                             SFY 2004 SFY             
                                                     2004             

Massachusetts 	Decreased ceilings for direct resident care, indirect care,
and administrative cost centers in 1998

Implemented Reduced per
certified diem rates by
nursing roughly 2.6
assistant percent from
wage add-on March
in 2000; through June
implemented 2003d
two one-time
add-on
payments for
nursing home
performance
and for
nursing
homes to
meet
Department
of Mental
Retardation
requirements
in SFY 2004

Michigan 	Changed Eliminated Reduced per inflation quality diem rates by
factor used incentive add-approximately to adjust for on in 1999; 1
percent for time eliminated 9 months in between direct 2002;e cost report
resident care reduced per submission staffing wage diem rates by and rate
pass-through approximately implemen-in 2000 1.85 percent tation from for 7
months SNF market in 2003;e basket index changed to beginning of
legislatively rate year from determined start of each factor in home's
fiscal 1999 year to start

of state fiscal year in SFY 2004

  Appendix III: Changes to Nursing Home Payment Methods or Rates in 19 States

                  Cost-center                                         
                  ceilings or                  Case-mix               
                              Calculation   classification                    
           Peer   efficiency  of              Occupancy       Add-on  Payment
                                              Inflation               
State          incentives     costs     system standard             rate   
         grouping                               factor       payments 

New Jersey 	Increased direct resident care costcenter ceiling in SFY 2002;
decreased indirect and administrative cost-center ceilings in 1999
Recategorized Increased

costs included from 85 to

in certain cost 90 percent

centers in 1999	in direct resident care, indirect care, and administrative
cost centers in 2000;f decreased from 90 to 85 percent in direct resident
care, indirect care, and administrative cost centers in 2003

New York 	Added direct resident care staffing wage add-on in 2002

North Dakota          Decreased         Changed the         Provided staff 
                      direct resident     version of the             wage and 
                        care cost-          RUG system           benefit add- 
                      center ceiling       used in 1999          on from 2001 
                        in SFY 2004                             through 2003g 

Oregon 	Froze rates at SFY 2002 level for SFY 2003; extended freeze in SFY
2004h

  Appendix III: Changes to Nursing Home Payment Methods or Rates in 19 States

                  Cost-center                                         
                  ceilings or                  Case-mix               
                              Calculation   classification                    
           Peer   efficiency  of              Occupancy       Add-on  Payment
                                              Inflation               
State          incentives     costs     system standard             rate   
         grouping                               factor       payments 

        Pennsylvania                 Changed                     Delayed rate 
                                   payment of                     adjustments 
                                  major movable                       pending 
                                 property costsi                  legislative 
                                   to a pass-                       action in 
                                     through                         SFY 2004 
                                   instead of          
                                including in the       
                                  indirect care        
                                 cost center in        
                                      2001             

Rhode Island	Implemented pass-through for direct resident care costs in
SFY 2002

South Dakota Eliminated Decreased Implemented Inflated rates peer payments
for nurse's aide instead of groups in certain homes wage pass-rebasing in
SFY 2000 in the direct through in SFY 1999; resident care, SFY 2003
limited annual indirect care, increase in and overall administrative
payment rate cost centers to 8 percent from in SFY 2000; SFY 2000 inflated
rates through 2002j instead of rebasing in SFY 2004

  Appendix III: Changes to Nursing Home Payment Methods or Rates in 19 States

                  Cost-center                                         
                  ceilings or                  Case-mix               
                              Calculation   classification                    
           Peer   efficiency  of              Occupancy       Add-on  Payment
                                              Inflation               
State          incentives     costs     system standard             rate   
         grouping                               factor       payments 

Texas 	Incorporated payment for enhanced staffing program in direct
resident care cost center for participating facilities in 2000 Implemented
a requirement that homes spending less than 85 percent of the direct
resident care rate on staffing wages and benefits refund the difference
between this amount and their costs in SFY 2000; eliminated in SFY 2004;
rebased biennially and inflated rates to the midpoint of the 2year period
instead of rebasing annually in SFY 2002; cut rates by 1.75 percent and
eliminated rate rebasing and inflation update in SFY 2004

Vermont Changed case-Eliminated mix system to 90 percent include acuity
occupancy of Medicaid standard residents only from direct in 1998 resident
care cost center in SFY 2003

Source: State Medicaid programs.

Note: Information provided by states is current as of September 2003.
Unless noted as SFY, years indicated in the table refer to the calendar
years that specific changes were made or implemented.

Appendix III: Changes to Nursing Home Payment Methods or Rates in 19
States

aThese California add-on payments are integrated into nursing home cost
reports and eventually become part of the regular per diem rate
calculation. The add-on payments are phased out after all homes have the
add-on included in their rates.

bIllinois did not routinely adjust for case-mix or consistently update
rates from 1994 through 2001. However, the state did adjust rates
periodically for inflation based on budget availability.

cIowa completed the phase-in of a new payment methodology, which included
a case-mix adjustment system and peer groups, in July 2003.

dThis reduction was implemented as a 6.5 percent cut to Massachusetts'
payments for nursing homes' indirect care and administrative costs.

eThese reductions applied to Michigan's payments for nursing homes' direct
resident care, indirect care, and administrative costs but not to payments
for capital costs, so the overall reduction to homes' per diem rates was
somewhat less than 1 percent in 2002 and somewhat less than 1.85 percent
in 2003.

fNew Jersey did not apply the occupancy standard to nursing homes with
occupancy from 85 through 90 percent if their previous year's occupancy
was 90 percent or greater.

gNorth Dakota eliminated this add-on payment in 2003, when the costs of
the increased staff salaries and benefits funded by the add-on became part
of the regular per diem rate calculation.

hOregon's rate freeze will remain in effect, pending CMS approval of a
waiver proposal pertaining to the state's new provider tax.

iIn Pennsylvania, major movable property costs include tangible items
costing $500 or more that are used to provide services to nursing home
residents and could include beds and office equipment.

jDecreased payments affect South Dakota nursing homes that have costs
above 115 percent of the median in the direct resident care cost center or
above 105 percent of the median in the indirect care or administrative
cost centers.

Appendix IV: GAO Contact and Staff Acknowledgments

GAO Contact Susan Anthony, (312) 220-7666

Acknowledgments 	Christine DeMars, Behn M. Kelly, Sari B. Shuman, Margaret
Smith, and Christi Turner made key contributions to this report.

Related GAO Products

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Reinforces Importance of Enhanced Oversight. GAO-03-561. Washington, D.C.:
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Widened. GAO-03-620. Washington, D.C.: July 10, 2003.

Nursing Homes: Quality of Care More Related to Staffing than Spending.
GAO-02-431R. Washington, D.C.: June 13, 2002.

Medicaid: HCFA Reversed Its Position and Approved Additional State
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Nursing Workforce: Recruitment and Retention of Nurses and Nurse Aides Is
a Growing Concern. GAO-01-750T. Washington, D.C.: May 17, 2001.

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Needed Services. GAO-01-563T. Washington, D.C.: March 27, 2001.

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Spending. GAO/HEHS-99-29R. Washington, D.C.: February 19, 1999.

Long-Term Care: Baby Boom Generation Presents Financing Challenges.
GAO/T-HEHS-98-107. Washington, D.C.: March 9, 1998.

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