[Background Material and Data on Programs within the Jurisdiction of the Committee on Ways and Means (Green Book)]
[Program Descriptions]
[Section 2. Medicare]
[From the U.S. Government Printing Office, www.gpo.gov]

                         SECTION 2-MEDICARE

(Note:  This chapter does not include information or data on the changes 
to the Medicare Program from Public Law 108-173, signed on December 8, 


	Payments for Services
	Federal Outlays
Eligibility and Coverage
Benefits and Beneficiary Cost-Sharing
        Part A
        Part B
        Hospital Insurance Trust Fund - Income
        Supplementary Medical Insurance Trust Fund - Income
        Financial Status of Hospital Insurance Trust Fund
        Financial Status of Supplementary Medical Insurance Trust Fund
Part A Services - Coverage and Payments
	Short-Term General Hospitals
        Specialty Hospitals and Distinct Part Units
	Skilled Nursing Facility Services
        Home Health Services
        Hospice Services
Part B Services - Coverage and Payments
        Physicians' Services
        Nonphysician Practitioner Services
        Clinical Laboratory Services
        Durable Medical Equipment and Prosthetics and Orthotics
        Hospital Outpatient Department Services
        Ambulatory Surgical Center Services
        Ambulance Services
        Home Health Services
        Prescription Drugs
        Other Part B Services
End Stage Renal Disease Services
Selected Issues
        Secondary Payer
        Supplementing Medicare Coverage
Legislative History, 1997-2003
        Balanced Budget Act (BBA) of 1997 (P.L.105-33)
        Balanced Budget Refinement Act (BBRA) of 1999 (P. L. 106-113) 
        Medicare, Medicaid, and SCHIP Benefits Improvement and 
                Protection Act (BIPA) of 2000 (P.L. 106-554) 
        Public Health Security and Bioterrorism Preparedness and 
        	Response Act (P.L. 107-188)
        Consolidated Appropriations Resolution, 2003 (P.L.108-7)
        To Extend the Temporary Assistance for Needy Families Block 
                Grant Program, and for Other Purposes (P.L. 108-89)
        CBO Savings and Revenue Estimates for Budget Reconciliation and 
                Related Acts, 1981-2003
Medicare Historical Data 


	Medicare is a nationwide health insurance program for the aged 
and certain disabled persons. The program consists of two partsBPart A,
hospital insurance (HI) and Part B, supplementary medical insurance 
(SMI). Total program outlays were $256.8 billion in fiscal year 2002. 
Net outlays, after deduction of beneficiary premiums, were $230.9 


Almost all persons over age 65 are automatically entitled to Medicare  
Part A.  Part A also provides coverage, after a 24-month waiting period, 
for  persons under age 65 who are receiving Social Security cash 
benefits on the basis of disability.  Most persons who need a kidney 
transplant or renal dialysis also may be covered, regardless of age.  
In fiscal year 2003, Part A covered an estimated 40.3 million aged and 
disabled persons (including those with chronic kidney disease). Medicare 
Part B is voluntary.  All persons over age 65 and all persons enrolled 
in Part A may enroll in Part B by paying a monthly premium - $58.70 in 
2003.  In fiscal year 2003, Part B covered an estimated 38.3 million 
aged and disabled persons. 


	Part A provides coverage for inpatient hospital services, up to 
100 days of post hospital skilled nursing facility (SNF) care, some home 
health services, and hospice care. Patients must pay a deductible ($840 
in 2003) each time their hospital admission begins a benefit period. 
(A benefit period begins when a patient enters a hospital and ends when 
she has not been in a hospital or SNF for 60 days.) Medicare pays the 
remaining costs for the first 60 days of hospital care.  The limited 
number of beneficiaries requiring care beyond 60 days are subject to 
additional charges. Patients requiring SNF care are subject to a daily 
coinsurance charge for days 21-100 ($105 in 2003).  There are no cost-
sharing charges for home health care and limited charges for hospice 
care. Part B provides coverage for physicians' services, laboratory 
services, durable medical equipment (DME), hospital outpatient 
department (OPD) services, and other medical services.  The program 
generally pays 80 percent of Medicare's fee schedule or other 
approved amount after the beneficiary has met the annual $100 
deductible. The beneficiary is liable for the remaining 20 percent. 


	Taken together, spending for inpatient hospital and physicians' 
and related services accounts for close to 75 percent of Medicare fee-
for-service payments (spending for managed care plans is not broken 
down by service category).  Medicare makes payments for inpatient 
hospital services under a prospective payment system (PPS); a 
predetermined rate is paid for each inpatient stay based on the 
patient's diagnosis at discharge.  Payment for physicians' services 
is made on the basis of a fee schedule. Specific payment rules are 
also used for other services.


	Medicare is administered by the Centers for Medicare & Medicaid 
Services (CMS) within the U.S. Department of Health and Human Services 
(DHHS). (Prior to June 14, 2001, this agency was known as the Health 
Care Financing Administration (HCFA).)  Much of the day-to-day work 
of reviewing claims and making payments is done by fiscal intermediaries 
(for Part A) and carriers (for Part B). These are commercial health 
insurers or Blue Cross Blue Shield plans. 


	Medicare Part A is financed primarily through the HI payroll 
tax levied on current workers and their employers.  Employers and 
employees each pay a tax of 1.45 percent on all earnings.  The self-
employed pay a single tax of 2.9 percent on earnings. 
	Part B is financed through a combination of monthly premiums 
levied on program beneficiaries and Federal general revenues.  In 
2003, the premium is $58.70. Beneficiary premiums have generally 
represented about 25 percent of Part B costs; Federal general 
revenues (i.e., tax dollars) account for the remaining 75 percent. 


	Total program outlays were $256.8 billion in fiscal year 2002.  
Net outlays (i.e., net of premiums beneficiaries pay for enrollment, 
largely for Part B) were $230.9 billion.  Tables 2-1, 2-2, and 2-3 
provide historical spending and coverage data for Medicare.





Part A 
	Most Americans age 65 or older are automatically entitled to 
protection under Part A.  These individuals (or their spouses) 
established entitlement during their working careers by paying the 
HI payroll tax on earnings covered by either the Social Security or 
Railroad Retirement Systems. 
	The HI tax was extended to Federal employment with respect 
to wages paid on or after January 1, 1983.  Beginning January 1, 1983, 
Federal employment is included in determining eligibility for 
protection under Medicare Part A.  A transitional provision allows 
individuals who were in the employ of the Federal Government both 
before and during January 1, 1983, to have their prior Federal 
employment considered as employment for purposes of providing Medicare 
coverage. Employees of State and local governments, hired after March 
31, 1986, are also liable for the HI tax. 
	Persons age 65 or older who are not automatically entitled to 
Part A may obtain coverage, providing they pay the full actuarial cost.  
The 2003 monthly premium is $316 ($174 for persons who have at least 
30 quarters of covered employment).

Part B 
	Part B of Medicare is voluntary. All persons age 65 or older 
(even those not entitled to Part A) may elect to enroll in the SMI 
Program by paying the monthly premium.  The 2003 premium is $58.70 
per month. Persons who voluntarily enroll in Part A are required to
enroll in Part B. 


Part A 
	Part A also covers, after a 2-year waiting period, people under 
age 65 who are either receiving monthly Social Security benefits on the 
basis of disability or receiving payments as disabled Railroad 
Retirement System annuitants. (Dependents of the disabled are not 
eligible.) The 24-month waiting period is waived for persons with 
amyotrophic lateral sclerosis.  In addition, most people who need a 
kidney transplant or renal dialysis because of chronic kidney disease 
are entitled to benefits under Part A regardless of age. 

Part B 
	Persons eligible for Part A by virtue of disability or chronic 
	kidney disease may also elect to enroll in Part B. 



ENTITLEMENT, SELECTED YEARS 1968-2001-continued 








	Part A coverage includes: 
	Inpatient hospital care--The first 60 days of inpatient hospital 
services in a benefit period are subject to a deductible ($840 in 
calendar year 2003).  A benefit period begins when a patient enters a 
hospital and ends when he or she has not been in a hospital or SNF for 
60 days.  For days 61-90 in a benefit period, a daily coinsurance amount 
($210 in calendar year 2003) is imposed.  When more than 90 days are 
required in a benefit period, a patient may elect to draw upon a 60-day 
lifetime reserve. A coinsurance amount ($420 in calendar year 2003) is 
imposed for each reserve day.  No coverage is provided for stays in
excess of 150 days in a benefit period.
	Skilled Nursing Facility (SNF) care--The program covers up to 
100 days of post-hospital SNF care for persons in need of continued 
skilled nursing care and/or skilled rehabilitation services on a daily 
basis.  After the first 20 days, there is a daily coinsurance charge 
($105 in calendar year 2003).
	Home health care--Home health visits are provided to persons 
who need skilled care on an intermittent basis.  The Balanced Budget 
Act (BBA) of 1997 gradually transferred from Part A to Part B home 
health visits that are not part of the first 100 visits following a 
beneficiary's stay in a hospital or SNF (i.e., postinstitutional 
visits) and during a home health spell of illness.  Beginning January 1, 
2003, Part A covers only postinstitutional home health services for up 
to 100 visits during a home health spell of illness, except for those 
persons with Part A coverage only, who are covered for services 
without regard to the postinstitutional limitation. 
	Hospice care--Hospice care services are provided to terminally 
ill Medicare beneficiaries with a life expectancy of 6 months or less 
for two 90-day periods, followed by an unlimited number of 60-day 
periods.  The medical director or physician member of the hospice 
nterdisciplinary team must recertify, at the beginning of 60-day 
periods, that the beneficiary is terminally ill. 


	Part B of Medicare generally pays 80 percent of the approved 
amount (generally a fee schedule or other predetermined amount) for 
covered services in excess of an annual deductible ($100). Services 
covered include: 
	Doctor's services--This category includes surgery, consultation, 
and home, office and institutional visits. Certain limitations apply for 
services rendered by dentists, podiatrists, and chiropractors and for 
the treatment of mental illness. 
	Services of nonphysician practitioners--This category includes 
physician assistants, nurse practitioners, certified registered nurse 
anesthetists, clinical psychologists, and clinical social workers. 
	Other medical and health services--This category includes 
laboratory and other diagnostic tests, x-ray and other radiation 
therapy, outpatient hospital services, rural health clinic services, 
DME, home dialysis supplies and equipment, artificial devices (other 
than dental), physical and speech therapy, and ambulance services. 
	Specified preventive services--These services include: an 
annual screening mammography for all women over age 40; a screening 
Pap smear and a screening pelvic exam once every 2 years, except for 
women who are at a high risk of developing cervical cancer; specified 
colorectal cancer screening procedures; diabetes self-management 
training services; bone mass measurements for high-risk persons; and 
prostate cancer screenings. 
	Drugs and vaccines--Generally Medicare does not pay for 
outpatient prescription drugs or biologicals. Part B does pay for 
immunosuppressive drugs following a covered organ transplant, 
erythropoietin (EPO) for treatment of anemia for persons with 
chronic kidney failure, and certain oral cancer drugs.  The program 
also covers flu shots, pneumococcal pneumonia vaccines, and hepatitis B 
vaccines for those at risk.  [Note: H.R. 1, the Medicare Prescription 
Drug, Improvement, and Modernization Act of 2003 (P.L. 108-173) 
provides for prescription drug benefits through Medicare.)
	Home health services--Home health services include those 
not covered under Part A. (As noted above, BBA 1997 transferred some 
home health costs from Part A to Part B.)  Part B also covers all 
medically necessary home health visits for persons not covered under 
Part A. The 20-percent coinsurance and $100 deductible do not apply 
for such benefits.
	Table 2-4 illustrates the deductible, coinsurance, and
premium amounts for both Part A and Part B services from the inception 
of Medicare. 


	The Medicare Hospital Insurance (HI) Trust Fund finances services 
covered under Medicare Part A. The Supplementary Medical Insurance (SMI) 
Trust Fund finances services covered under Medicare Part B. The trust 
funds are maintained by the Department of the Treasury. Each trust fund 
is actually an accounting mechanism; there is no actual transfer of 
money into and out of the fund. Income to each trust fund is credited 
to the fund in the form of interest-bearing government securities. The 
securities represent obligations that the government has issued to 
itself. Expenditures for services and administrative costs are recorded 
against the fund. 


	The primary source of income to the HI fund is HI payroll taxes. 
This source accounted for $152.7 billion (85.5 percent) of the total 
$178.6 billion in income for fiscal year 2002. Additional income sources 
include premiums paid by voluntary enrollees, government credits, 
interest on Federal securities, and taxation of a portion of Social 
Security benefits. 



Payroll taxes 
	The HI Trust Fund is financed primarily through Social Security 
payroll tax contributions paid by employees and employers.  Each pays a 
tax of 1.45 percent on all earnings in covered employment.  The self-
employed pay 2.9 percent.  Prior to 1994, there was an upper limit on 
earnings subject to the tax.  An upper limit ($87,000 in 2003) continues 
to apply under Social Security.  Therefore incomes up to $87,000 have a 
combined tax rate of 7.65 percent (6.2 percent for Social Security and 
1.45 percent for Medicare).  Only the Medicare tax applies to any income
in excess of $87,000.

Other income
	The following are additional sources of income to the HI fund: 
	Railroad retirement account transfers--In fiscal year 2002, 
$425 million was transferred from the railroad retirement fund. This 
is the estimated amount that would have been in the fund if railroad 
employment had always been covered under the Social Security Act. 
	Reimbursements for uninsured person--HI benefits are provided to 
certain uninsured persons who turned 65 before 1968. Persons who turned 
65 after 1967 but before 1974 are covered under transitional provisions.  
Similar transitional entitlement applies to Federal employees who retire
before earning sufficient quarters of Medicare-qualified Federal 
employment provided they were employed before and during January 1983.  
Payments for these persons are made initially from the HI Trust Fund, 
with reimbursement from the general fund of the Treasury for the costs, 
including administrative expenses, of the payments. In fiscal year 
2002, $442 million was transferred to HI on this basis.
	Premiums from voluntary enrollees--Certain persons not eligible 
for HI protection either on an insured basis or on the uninsured basis 
described above may obtain protection by enrolling in the program and 
paying a monthly premium ($316 in 2003; for persons who have at least 
30 quarters of covered employment, $174 in 2003).  This accounted for 
an estimated $1.6 billion of financing in fiscal year 2002. 
	Payments for military wage credits--Periodic transfers are 
authorized between the general fund and the treasury and the HI trust 
fund, if needed, to adjust prior payments for the costs arising from 
wage credits granted to military service before 1957.  The law 
authorizes a quinquennial adjustment to the amount transferred in 1983. 
No adjustment was made in FY 2002.
	Tax on Social Security benefits--Beginning in 1994, the trust 
fund acquired an additional funding source. The Omnibus Budget 
Reconciliation Act of 1993 (OBRA 1993) increased the maximum amount of 
Social Security benefits subject to income tax from 50 to 85 percent 
and provided that the additional revenues would be credited to the HI 
Trust Fund. Revenue from this source totaled $8.3 billion in fiscal 
year 2002.
	Interest--The remaining income to the trust fund consists 
almost entirely of interest on the investments of the trust fund.  
Interest amounted to an estimated $15.1 billion in fiscal year 2002. 


	Part B is financed from premiums paid by the aged, disabled and 
chronic renal disease enrollees and from general revenues.  The premium 
rate is derived annually based on the projected costs of the program for 
the coming year.  The monthly premium amount in calendar year 2003 is 
	When the program first went into effect in July 1966, the Part 
B monthly premium was set at a level to finance one-half of Part B 
program costs.  Legislation enacted in 1972 limited the annual 
percentage increase in the premium to the same percentage by which 
Social Security benefits were adjusted for changes in cost of living 
(i.e., cost-of-living adjustments).  Under this formula, revenues from 
premiums soon dropped from 50 to below 25 percent of program costs 
because Part B program costs increased much faster than inflation as 
measured by the Consumer Price Index (CPI) on which the Social Security 
cost-of-living adjustment is based.  Beginning in the early 1980s, 
Congress regularly voted to set Part B premiums at a level to cover 
5 percent of program costs, in effect overriding the cost-of-living 
adjustment limitation.  BBA 1997 permanently set the Part B premium 
equal to 25 percent of program costs. General revenues cover the 
remaining 75 percent of Part B program costs.


	The Hospital Insurance (HI) Trust Fund balance is dependent on 
total income to the HI Trust Fund exceeding total outlays from the fund.  
Tables 2-5 and 2-6 show historical information from the 2003 Trustees' 
Report on the operation of the trust fund.  Each year, the HI Trustees 
make projections for the date the trust fund will become insolvent 
(Table 2-7).  The 1997 report stated that under the Trustees 
intermediate assumptions, the fund would become insolvent in 2001.  
Subsequent reports significantly delayed the projected insolvency date.  
However, the 2003 report projects that the fund will become insolvent 4 
years earlier (2026) than had been projected in the 2002 report. 
 	The initial improvements after 1997 reflected a number of 
factors including improvements in the economy as a whole (which were 
reflected in higher payroll tax revenues) and a lower rate of growth 
in program expenditures. A key factor was the enactment of BBA 1997. 
This legislation provided for the transfer of a portion of home health 
spending (which at the time was the fastest growing component of Part A 
expenditures) from Part A to Part B.  It also included additional 
provisions to stem the growth in Part A expenditures.  These provisions 
included the implementation of new payment limits for home health 
services, a prospective payment system (PPS) for skilled nursing 
facility (SNF) services, and limits on the increases in hospital payments.  
BBA 1997 also established the Medicare+Choice (M+C) Program and modified 
the calculation of payments to managed care entities. 

FISCAL YEARS 1970-2012 




	Following enactment of BBA 1997, a number of observers claimed 
that the actual savings achieved by BBA 1997 were larger than was 
intended when the legislation was enacted.  As a result, legislation 
was enacted in 1999 (Balanced Budget Refinement Act of 1999 (BBRA)) 
and in 2000 (the Medicare, Medicaid, and SCHIP Benefits Improvement 
and Protection Act of 2000 (BIPA)) which mitigated the impact of BBA 
1997 on providers.




	Because the SMI Trust Fund is financed through beneficiary 
premiums and Federal general revenues, it does not face the prospect 
of depletion, as does the HI Trust Fund. However, the rising cost of 
the program is placing a burden on the  trust fund, and by extension on 
beneficiaries (in the form of premiums) and Federal general revenues.  
Table 2-8 shows historical information from the 2003 Trustees' Report.



Trends in Medicare Hospital Utilization and Spending
	As shown in Table 2-9, Medicare program spending on hospital 
services  has increased from approximately $77.8 billion in calendar 
year (CY) 1995 to  $92.5 billion in CY2001, about a 19 percent change
over the time period.  The number of acute, short-term general hospitals 
paid under the inpatient prospective payment system (IPPS) has declined 
from 5,166 to 4,361, a drop of over 15 percent that can be attributed, 
in part, to hospital closures, mergers, and the growth in Medicare's 
critical access hospital program. Despite the drop in the number of 
IPPS hospitals, IPPS program spending has increased from over $69 
billion in CY1995 to over $81 billion in CY2001, an increase of 
approximately 17 percent.  In contrast to the overall decline in 
number of hospitals, the number of specialty hospitals, particularly 
long-term care hospitals but also rehabilitation hospitals and distinct 
part units, has increased.  Medicare program spending, particularly in 
long-term care hospitals and in rehabilitation units, has increased 
significantly over the period. Table 2-10 shows hospital utilization 
for Medicare enrollees by type of hospital in CY2001.  96.4 percent of 
Medicare's hospital discharges were from IPPS hospitals and averaged 
about $7,262 in program spending per discharge.  Discharges from 
specialty hospitals comprised about 3.6 percent of total Medicare 
discharges in CY2001 and averaged about $9,178 in Medicare spending per 
discharge.  Table 2-11 shows the Medicare hospital discharges as well 
as program and beneficiary payments from short-stay hospitals, ranked 
by diagnosis-related groups (DRGs), for FY2001.  The top 25 DRGs 
represented 51.5 percent of total discharges and close to 53 percent 
of total payments to these hospitals.  In fact, over 31 percent of 
the total discharges and almost 28 percent of the total spending 
is represented by the top 10 DRGs on the list.  Finally, Table 2-12 
shows the trendsin factors affecting hospital expenditures, from FY1983 
to FY2002.   The annual update represents a payment-weighted average 
annual increase for IPPS hospitals and IPPS excluded hospitals.  A 
hospital's case mix is a measure of the relative costliness and 
changes in coding of its Medicare patients compared with the national 
average.  The change in case mix shown in the table represents the 
change in the average case mix for hospitals in one fiscal year 
compared to the preceding fiscal year.  In FY2002, the average update
received by hospitals was 2.56 percent, the case mix change for the 
average hospital increased 0.5 percent, and Medicare's average payment 
per discharge increased 5.04 percent.

Hospital payment systems
	This section will discuss the major provisions establishing 
Medicare's payment systems for inpatient services provided by different 
types of hospitals.  The section will first describe the separate 
operating and capital prospective payment systems (PPS) for acute 
inpatient care in short-term, general hospitals.   Those costs that 
have been excluded from the inpatient PPS (IPPS) will then be described 
and this will be followed by a discussion of short-term hospitals that 
receive special treatment under IPPS: sole community hospitals (SCHs), 
rural referral centers (RRCs) and Medicare dependent hospitals (MDHs).  
Medicare's swing bed program which permits certain small rural hospitals 
to provide Medicare covered acute and post acute care in the same bed 
(that is, are permitted to swing the bed from providing acute care to 
post-acute care) and the critical access hospital (CAH) program where 
certain small, limited service facilities can now optout of IPPS will 
then be discussed.  Geographic reclassification procedures for IPPS 
hospitals will also be described.  This will be followed by description 
of the payment systems used to pay those hospitals that were originally 
exempt from IPPS:  inpatient rehabilitation facilities (including 
distinct part units in general hospitals), long-term care hospitals,
psychiatric facilities (including distinct part units in general 
hospitals) and finally cancer and children's hospitals.








Operating prospective payment system
	Medicare Part A pays for the operating costs associated with 
acute inpatient care in short-term hospitals using the inpatient 
prospective payment system (IPPS), established by Congress in the 
Social Security Amendments of 1983 (Public Law 98-21).   Before the 
enactment of IPPS, Medicare paid hospitals retrospectively for incurred 
costs, subject to certain limits, definitions of allowable costs, and 
tests of reasonableness.  Despite these limits, medical costs continued 
to grow faster than the rate of inflation in the early 1980s.  IPPS was 
enacted to constrain the growth of Medicare's inpatient hospital 
payments by providing incentives for these acute hospitals to provide 
care more efficiently.  Under IPPS, Medicare payments are made at 
predetermined, specific rates which represent the average cost, 
nationwide, of treating a Medicare patient according to his or her 
medical condition.  Hospitals that are able to provide services for 
less than the fixed IPPS payment may keep the difference. Hospitals 
with costs that exceed the fixed IPPS payment lose money on the case.  
In general, the components of IPPS have served as a model for 
prospective payment systems subsequently developed for other types of 
hospitals. The foundation for Medicare's prospective rates for both 
inpatient operating and inpatient capital payments is a patient 
classification system which now encompasses 518 diagnosis related 
groups (DRGs).  A hospital's payment will vary depending upon the 
DRG assigned to a Medicare discharge.  DRG assignment is primarily 
based on a patient's discharge diagnoses and type of treatment received 
(either medical or surgical with certain classifications dependent upon 
the hospital procedures provided during the stay).  Depending upon the 
DRG, a patient's age, sex, and discharge destination may be considered 
as well. Each DRG has a relative value (or case-mix weight) that 
reflectsthe cost of treating Medicare patients in that particular 
group in comparison to the treatment cost of the average Medicare 
case.  DRGs that are expected to use more resources than the average 
Medicare case have a relative value above one; those DRGs that are 
expected to be less costly have a value of less than one.  The Centers 
for Medicare & Medicaid Services (CMS) annually reviews the DRG 
classification system to insure that clinically similar cases with 
relatively comparable costs are grouped together which may result in 
the reassignment of procedure codes to other DRGs as well as the 
creation or discontinuation of specificDRGs. For example, from FY2003 
to FY2004, 5 DRGs were discontinued and 13 DRGs were created. CMS also
recalibrates the relative values associated with each DRG annually 
using hospitals' average standardized billed charges for each DRG; such 
recalibration is subject to a budget neutrality adjustment to ensure 
that Medicare's aggregate payments do not increase because of the 
recalibrated DRG weights.  The relative weight of any DRG may change 
from year to year.  The weights for 223 DRGs for FY2004 declined from 
those for FY2003 (all but 38 DRGs by less than 5 percent) while the 
weights for 280 DRGs for FY2004 increased from those for FY2003 (all 
but 46 DRGs by less than 5 percent).  Data for DRG relative weights 
may be found at http:www.cms.gov.





	A hospital's DRG payment is the product of two components: 
(1) a standardized amount (or base rate) which is adjusted by the 
hospital's area average wage level; and (2) the DRG's relative weight. 
The base rate is intended to represent the cost of a typical (average) 
Medicare inpatient discharge.  Presently, two separate standardized 
amounts are calculated: one amount is used to pay for Medicare 
discharges from hospitals in large urban areas (either metropolitan 
statistical areas that have a population of more than a million or New
England County metropolitan areas that have a population of more than 
970,000) and the other amount is used to pay for discharges from 
hospitals in other areas.  The large urban area standardized amount 
is 1.6 percent larger than the other area amount.  However, the 
Consolidated Appropriations Resolution, 2003 (CAR) (P.L.108-7) provided 
for a temporary payment increase for rural and small urban hospitals; 
all Medicare discharges from April 1, 2003 to September 30, 2003 were 
paid on the basis of the large urban area amount.  The temporary 
authorization legislation that extended transitional Medicaid (P.L. 
108-89) also extended Medicare's  payment equalization between large 
urban hospitals and other hospitals until March 31, 2004.  That law 
signed October 1, 2003 requires the Secretary to equalize the base 
amounts by November 1, 2003 and compensate hospitals for missed 
payments.   Two amounts are still calculated for hospitals in Puerto 
Rico based on a 50/50 blend of a Federal amount and a Puerto Rico-
specific amount.  
	The hospital wage index is used to adjust the standardized 
amount to account for the local wage variation or cost of labor in the 
hospital's area.  This adjustment is accomplished by multiplying a 
portion of the national standardized payment amount by a wage index.  
Presently approximately 71 percent of the base rate is adjusted by the 
wage index.  The wage index is intended to measure the average wage l
evel for hospital workers in each urban area (metropolitan statistical 
area or MSA) or rural area (comprised of counties that have not been 
assigned to MSAs) relative to the national average wage level.  Some 
states, such as New Jersey and Rhode Island, where every county is 
included in a MSA have no rural wage index.   
	The Secretary is required to update the wage index annually 
based on a survey of wages and wage-related costs of short-term acute 
care hospitals.   An area's aggregate hospital compensation is divided 
by aggregate paid hours of hospital employment in the area to produce 
the area's average hourly wage.  The area's wage index is calculated 
by dividing the average hourly wage for each area by the national 
average hourly wage (determined by dividing national aggregate 
compensation by national aggregate paid hours of employment).  A wage 
index used to calculate a hospital's Medicare payment will be that 
index associated with the area where the hospital is located or that 
associated with the area where the hospital has been reclassified or 
redesignated.  The index number, such as 0.7492 for hospitals in rural 
Alabama or 1.5119 for hospitals in Oakland, CA, for each rural area 
(or non-MSA) or MSA in the United States is published by CMS in the 
Federal Register in August of each year.  A separate wage index for 
hospitals in Puerto Rico is calculated using only data from those 
hospitals as well.   Any updates or adjustments to the wage index 
are done in a budget neutral fashion, so that aggregate payments to 
hospitals are not affected by the annual changes. Since the national 
average wage level is represented by an index value of 1.000, the 
wage index value for any area has a direct and simple interpretation. 
The value of 1.5119 for Oakland, CA means that the hourly wage rate 
for hospital workers is about 51 percent higher in that MSA than 
nationwide. In FY2004, the average annual wage in Oakland, CA was 
$36.87 and the national average hourly wage was $24.72.  When 
computing the hospital payment rates applicable for hospitals in the 
Oakland, CA MSA, which has a population of more than 1 million, the 
labor-related share or 71 percent of the large urban area standardized 
amount is multiplied by 1.5119 in order to adjust for the higher level 
of hourly wage rates in this area. Similarly, the calculation of the 
per discharge payment for hospitals in rural Alabama would involve a 
reduction to the labor-related component of its standardized payment 
amount to reflect the fact that the average hourly wage in this 
area is $18.50 or about 25 percent lower than the national average 
(as indicated by the rural Alabama's wage index value of 0.7492).  
To calculate Medicare's base payment for hospitals in each of these 
areas, the nonlabor related share of the standardized amount is added 
to the wage-adjusted labor related share.  The calculation of the 
base payment amount for both areas is shown in Table 2-13.  This amount 
would be multiplied by the applicable DRG weight to calculate Medicare's 
payment for a specific discharge. 



	In general, the differences in the amount of these per discharge 
payments would reflect both the 1.6 percent differential in the 
standardized amount between large urban and other areas as well as the 
differences in the relative area wages.  However, the 1.6 percent payment 
differential between the standardized amounts has been eliminated for 
discharges from October 1, 2003 until March 31, 2004.  All hospitals 
will be reimbursed using the large urban area amount.  Also, the per 
discharge payments for hospitals in Alaska and Hawaii would reflect a 
cost-of-living adjustment to the nonlabor related portion of the 
standardized amount to recognize the higher cost of supplies and other 
nonlabor inputs.  In FY2004, the nonlabor portion of the base rate 
(approximately 29 percent of the standardized amount) for hospitals in 
these states is increased by up to 25 percent.  
	Other Operating PPS Payment Adjustments--Factors other than a 
hospital's location will affect the amount of Medicare payment received 
for a particular DRG. 
 In addition to the basic DRG payment for each case, teaching hospitals 
 or those hospitals that serve a large number of Medicaid or poor 
 Medicare beneficiaries may receive supplemental IPPS payments. A typical 
 or outlier cases may result in additional IPPS payments; under certain 
 circumstances, cases that are transferred to other acute hospitals or 
 certain post-acute settings may receive special treatment under IPPS.  
 Finally, hospitals may receive additional payments to compensate for 
 use of specifically identified new technologies.  
	Indirect Medical Education Adjustment--Medicare recognizes the
costs of graduate medical education (GME) under two mechanisms: an 
indirect medical education (IME) adjustment within IPPS and, as 
discussed later, direct graduate medical education (DGME) payments 
made outside of IPPS.  An IME adjustment provides additional IPPS 
payments to hospitals for the indirect costs attributable to approved 
medical education programs for physicians; Medicare does not recognize 
the indirect costs associated with the education of other health 
professions.  A teaching hospital's higher patient care costs relative 
to nonteaching hospitals may be due to a variety of factors, including 
patient severity of illness that is not fully captured by the DRG 
patient classification system, the extra demands placed on the hospital 
staff as a result of the teaching activity, or additional tests and 
procedures that may be ordered by residents.  About 1,100 hospitals, 
constituting about one fourth of all IPPS hospitals, receive IME 
payments.  According to CBO's most recent estimate, Medicare's spending 
on IME for both operating and capital IPPS systems will be $6.1 billion 
in FY2003.  This includes payments to teaching hospitals for patients 
enrolled in Medicare +Choice plans.  MedPAC has found that Medicare's 
IME payments exceed the estimated cost relationship between teaching 
intensity and costs per case.  Using 1999 cost data, MedPAC estimates 
that approximately half of the total IME payments in FY2003 are above 
the estimated impact of teaching on hospital costs.    
	A hospital's IME payment is based on a percentage add-on to the 
IPPS rate that is established by a complicated curvilinear formula that 
currently provides a payment increase of approximately 5.5 percent for 
each 10 percent increase in the hospital's intern and resident-to-bed 
(IRB) ratio.  Hospitals with a higher IRB ratio, a measure of teaching 
intensity, receive a larger add-on adjustment to their DRG payments. 
For example, a hospital with 5 residents for every 100 beds (an IRB 
of 0.05) would have a 2.7 percent increase in its DRG payments; a 
hospital with 25 residents for every 100 beds (an IRB of 0.25) would 
receive a 12.8 percent IME adjustment to its DRG payments.
	With certain exceptions, BBA 1997 limits the number of 
allopathic and osteopathic residents that Medicare will count in the 
IME formula (the numerator of the IRB ratio) at the level reported by 
the hospital in its most recent cost report ending on or before 
December 31, 1996.  Effective for cost reporting periods on or after 
October 1, 1997, the IME resident counts are based on a 3-year rolling 
average of the resident counts, subject to the resident limits or full-
time equivalent (FTE) cap.  If a hospital is above its limit, the count 
for the purposes of the rolling average is the FTE cap.  In addition to 
the resident limit, BBA 1997 also placed a 
limit on the IRB ratio itself.  A hospital's IRB ratio used to calculate 
its IME adjustment for the current payment year cannot exceed its IRB 
ratio from the immediately preceding cost reporting period.  
	Disproportionate Share Hospital Adjustment--Since 1986, an 
increasing number of hospitals have received additional payments 
because they serve a disproportionate share of low-income patients.  
The justification for DSH spending has changed over time.  Originally, 
the DSH adjustment was intended to compensate hospitals that treat a 
large proportion of low-income patients for the higher costs associated 
with their treatment.  Now, the adjustment is considered as 
a way to protect access to care for vulnerable populations.   
 	Most DSH hospitals, approximately 2,800 hospitals, receive the 
 additional payments based on a formula calculated using the proportion 
 of the hospital's Medicare inpatient days provided to poor Medicare 
 beneficiaries (those who receive Supplemental Security Income or SSI) 
 added to the proportion of total hospital days provided to Medicaid 
 recipients.  A few urban hospitals receive DSH payments under an 
 alternative formula that considers the proportion of a hospital's 
 patient care revenues that are received from State and local indigent 
 care funds.   CBO estimates that DSH spending (in both operating and 
 capital PPS) will be $6.3 billion in FY2003 

	The DSH threshold is the minimum percentage of measured DSH care 
(measured under either the disproportionate day or Pickle formula) that 
must be provided by a hospital in order to qualify for additional 
payments.  A hospital will not receive operating DSH payments unless 
its low- income patient share exceeds 15 percent or, as discussed 
earlier, it qualifies as a Pickle hospital.  After that minimum 
threshold of 15 percent is met, a hospital's DSH adjustment, the 
percentage add-on to the hospital's IPPS payment, will vary by the 
hospital's bed size or urban or rural location.  Under the current 
operating DSH thresholds and formulas, the DSH adjustment that a small 
urban or rural hospital can receive is capped at 5.25 percent while 
large (100 beds and more) urban hospitals and large rural hospitals 
(500 beds and more) can still receive an uncapped adjustment that 
can be significantly greater.  However, certain rural hospitals, those 
that are sole community hospitals (SCHs) or rural referral centers 
(RRCs), may receive a higher DSH adjustment than other rural hospitals.  
Table 2-14 shows the minimum  DSH thresholds required to qualify for 
the additional DSH payments and the formulas  for computing the 
adjustment for different hospitals effective for discharges after 
April 1, 2001 authorized by the Medicare, Medicaid, and SCHIP  
Benefits Improvement and Protection Act of 2000 (BIPA). 



	Outliers--Additional amounts are paid to hospitals for a 
typical cases known as "outliers."  These are cases that have 
extraordinarily high costs compared to most discharges classified in the 
same DRG.  Prior to FY1998 certain cases with extraordinarily long 
lengths of stay would have qualified for outlier payments as well.  
Outlier payments are financed by an offset or reduction in the base 
payment amount per discharge.  The statute requires that total outlier 
payments to all hospitals covered by the system represent no less than 
5 percent and no more than 6 percent of the total estimated PPS payments 
for the fiscal year.  Generally, CMS has established 5.1 percent as 
the target for outlier spending.
	To qualify as a cost outlier, a hospital's charges for a case, 
adjusted to its costs, must exceed a hospital's IPPS payment rate 
(including payments for IME, DSH, and for new technology) for the DRG 
by a certain threshold.  Generally, the cost for a case is calculated 
by multiplying the charges for the inpatient stay by the hospital's 
ratio of cost to charges as reported in its most recent settled, or 
the most recent tentatively settled, cost report, whichever is from 
the later cost reporting period. The additional payment amount is equal 
to 80 percent of the difference  (90 percent for certain DRGs for burn 
victims) between the hospital's entire cost for the stay and the 
threshold amount. The threshold, which is adjusted by the hospital's 
wage index, is published every year in the Federal Register.  For 
FY2004, the threshold is $31,000. 
	Outlier payments have never equaled their targeted offset. In 
earlier years, Medicare underspent its target; most recently, outlier 
payments have exceeded the budgeted target, in part because of abrupt 
increases in certain hospitals' charges.  CMS analyses indicates that 
years in which outlier payments have been more than expected have been 
offset by outlier spending in years when it has been less than expected.  
Since FY1997, however, actual outlier payments have exceeded the 5.1 
percent offset by an aggregate of 11.2 percentage points; outlier 
spending has been $8.5 billion more than anticipated; an estimated 
$1.5 billion of that overspending occurred in FY2002.  Total outlier 
spending in FY2002 is estimated to be approximately $5.4 billion.  
Certain changes, such as elimination of the use of statewide average 
cost to charge ratios and use of more recent hospital specific cost 
to charge ratios (from tentatively settled cost reports), in Medicare's 
outlier payment policies were instituted late in FY2003 or in FY2004 to 
address outlier overspending.  
	Transfers--Prior to BBA 1997, cases that were designated and 
reimbursed as transfer cases were for those patients that were 
discharged from one short-term general hospital and readmitted to 
another on the same day.  Under the current payment policy for these 
cases, the sending acute hospital (the hospital that transfers the 
patient to another acute hospital) is paid twice the DRG per diem for 
the first day and the per diem for all remaining days up to the full 
payment amount.  The final discharging acute hospital (the hospital 
that receives the patient) receives the full DRG payment amount.  
Both hospitals remain eligible for cost outliers, DSH payments and 
GME payments for these transfer cases.  The per diem payment is 
calculated as the hospital-specific DRG payment divided by the national 
geometric mean length of stay for all discharges in that DRG. 
	Patients discharged from an acute care hospital to postacute 
care settings were not initially included under this transfer policy.  
BBA 1997 directed that the Secretary select 10 DRGs with a high volume 
of discharges to postacute care or a disproportionate use of postacute 
services and pay these cases as transfers beginning in FY 1999. 
Postacute care includes those providers excluded from IPPS (including 
long-term care  hospitals, inpatient rehabilitation facilities or 
distinct part units, psychiatric hospitals or units), skilled nursing 
facilities, and clinically related home health care provided within 3 
days after the date of discharge.  Acute patients in these DRGs that 
are transferred to swing beds for skilled nursing care are not 
considered to be postacute transfers.  After FY 2000, the Secretary 
was authorized to expand this policy to additional DRGs.  In FY2004, 
the transfer policy was codified to cover 29 DRGs; 2 of the original 
DRGs were eliminated and 21 other DRGs were added to the transfer policy.  
Generally, to be included under the policy, a DRG must have at least 
14,000 postacute care transfer cases; at least 10 percent of its 
postacure care transfers occurring before the geometric mean length of 
stay; and a geometric mean length of stay of at least 3 days for both of 
the 2 most recent years for which data are available.  For a new DRG to 
be included under this policy,  its geometric mean length of stay must 
decline by at least  7 percent during the most recent 5-year period.  To 
minimize coding distortions, CMS includes both DRGs from a paired DRG 
combination (where a patient's assignment in one or the other of the 
DRGs depends on the presence of a complication or comorbid condition) 
automatically under the policy even if only one of the DRGs meet these 
criteria.  Under the postacute transfer policy, the sending hospital 
will receive twice the per diem rate for the first day and the per diem 
rate for each following day of the stay up to the full DRG payment amount.   
However, 3 of the 29 selected DRGs have a disproportionate share of the 
costs early in the hospital stay.  For these DRGs, a sending hospital 
receives 50 percent of the full DRG payment plus the per diem amount for 
the first day of the stay and 50 percent of the per diem amount for 
each of the remaining days of the stay, up to the full DRG payment.  
Medicare payment to any postacute providers involved in the stay are 
not affected by this policy.
	Additional Payments for New Technology--BIPA established a 
process of identifying and paying more for new medical services and 
technologies provided to Medicare beneficiaries by short-term general
hospitals.  As defined by CMS, new technologies are those that represent 
an advance in medical technology that substantially improves diagnosis 
and treatment of Medicare beneficiaries when compared to previously 
available technologies. It takes 2 to 3 years from the point when a new 
technology is brought to market to the point where that data is 
incorporated in the Medicare charge data used to calculate DRG weights.  
To qualify for an additional IPPS payment, these technologies must be 
inadequately paid by the existing DRG system with costs that are not 
captured by the recalibration of DRG weights.  As implemented by CMS, 
a new technology will qualify for special payments if the applicant can 
show that average charge for a case using the new technology is one 
standard deviation above the geometric mean of the standardized charges 
for all cases in the relevant DRG (or when a case may be assigned to 
multiple DRGs, the weighted average of all DRGs to which the case 
may be assigned).  Medicare pays 50 percent of the costs of the new 
technology that are above the DRG payment, up to a maximum of 50 percent 
of the estimated cost of the new technology.  The add-on payments are 
budget-neutral with a target limit of 1 percent of total operating 
prospective payments.  If the target limit is exceeded, the marginal 
payment rate for new technologies would be reduced.  
	For FY2003, CMS received 5 applications for new technologies 
to be considered for the inpatient add-on payment; one biotechnology 
treatment for sepsis was approved for the add-on payment.  However, 
in FY 2003, CMS recognized the likely introduction of a new 
technology in a different, unprecedented fashion. In that year, CMS 
created 2 new DRGs for patients receiving an angioplasty that uses 
drug-eluting stents, a higher cost technology that was expected to be 
widely adopted once approved by the Food and Drug Administration 
(FDA).  Subject to a positive decision by FDA, the DRGs became active 
for appropriate discharges occurring on or after April, 2003.  CMS 
constructed the weights for the new DRGs using non-Medicare price data 
and utilization assumptions as explained in the August 1, 2003 Federal 
Register.  For FY2004, CMS received 2 applications for new technologies 
to be considered for inpatient add-on payments and granted one for a 
spinal fusion technology.  For FY2005 and in subsequent years, CMS has 
reduced the qualifying threshold to 75 percent of one standard deviation 
beyond the geometric mean standardized charges for all cases in 
the DRG to which the new medical service or technology is assigned. 

Capital prospective payment system
	Unlike the prospective payment systems that have been recently 
implemented for specialty hospitals, Medicare sets separate per discharge 
payment rates to cover the costs for depreciation, interest, rent and 
other property-related expenses in short-term general hospitals.  Until 
FY1992, Medicare paid its share of acute hospitals' reasonable capital-
related costs, based on the percentage of hospital services used by 
Medicare beneficiaries.  Starting in FY1992, subject to a 10-year 
transition period extending through FY2001, inpatient capital costs were 
paid on the basis of an increasing proportion of an annual Federal rate 
and a decreasing proportion of a hospital's historic costs for capital.  
For all cost reporting periods beginning in FY 2002, all hospitals, 
except new hospitals, are paid based on 100 percent of the Federal rate.
	As in the case with operating IPPS, standardized capital payment 
amounts are reduced to finance outlier payments and adjusted to account 
for the effect of DRG reclassifications and hospital reassignments, 
special exceptions payments as well as other mandated budget neutrality 
factors.  In FY2004 the Federal rate for capital was set at about $427 
for Medicare discharges from hospitals in large urban areas and about 
$415 for Medicare discharges from hospitals in other areas. Capital IPPS 
payments typically constitute about 10 percent of total Medicare IPPS 
inpatient payments to short-term hospitals for inpatient care, a 
percentage that has fluctuated over time and can vary by type and 
location of hospital.
	Medicare's capital IPPS for acute hospitals includes similar 
adjustment factors as its operating IPPS; however, the adjustments in 
capital IPPS can be structured differently than those in the IPPS.  
Generally, under capital IPPS, the Federal rate is based on average 
base year capital costs per case in FY1989, updated by inflation and 
other cost changes.  Hospitals in large urban areas receive an 
additional 3 percent increase to their Federal rate.  Hospitals in 
Alaska and Hawaii receive an additional cost of living adjustment in
capital IPPS.  
	Capital IPPS payments are adjusted using a hospital;s geographic 
adjustment factor (GAF, which is calculated from the hospital's wage 
index) and Medicare patients' case-mix intensity which uses the same 
DRG patient classification system used in operating IPPS.  Medicare's 
capital IPPS also incorporates special payments for outliers as well 
as payments for DSH and IME.  With respect to outlier reimbursement, a 
single set of thresholds is used to identify outlier cases for both 
inpatient operating and capital-related IPPS.  Although the outlier 
reduction factor for operating IPPS is statutorily set between 
5 percent and 6 percent, the outlier reduction factor for capital PPS 
is not. In FY2004, the capital outlier reduction factor was 4.79 percent. 
	With respect to the capital DSH adjustment, only urban hospitals 
with more than 100 beds may receive a DSH adjustment; there is no 
qualifying threshold specified.  Rather, any hospital with a positive 
DSH percentage will receive approximately a 2.1 percent increase in its 
capital payments for each 0.01 increase in its DSH percentage.  The 
''Pickle'' hospitals (that qualify for a 35 percent operating DSH 
adjustment because at least 30 percent of their inpatient revenues 
are from State or local indigent care funds) are given a capital DSH 
adjustment of 14.16 percent.  
	With respect to the capital IME adjustment, teaching hospitals 
receive additional IPPS payments based on the ratio of residents to 
average daily inpatient census, rather than the ratio of residents to 
beds as in operating IPPS.  The adjustment factor will increase capital 
payments approximately 2.8 percentage points for each 10 percent 
increase in this IME measure.   
	Finally, capital IPPS incorporates special exception payments 
for different categories of hospitals.  CMS has established a special 
exceptions process which provides for additional payments to eligible 
hospitals for up to 10 years from the year that it completes a 
replacement or renovation project that meets certain criteria. The 
project must have been completed no later than the end of the 
hospital's last cost reporting period before October 1, 2001. Eligible 
hospitals include sole community hospitals; urban hospitals with at 
least 100 beds with a minimum DSH adjustment of 20.2 percent; hospitals 
that receive DSH as a Pickle hospital; and hospitals that have a 
combined Medicaid and Medicare utilization of at least 70 percent. 
These hospitals must meet specified project need and project size 
requirements. CMS estimates that 27 hospitals will qualify for special 
exception payments in cost reporting periods beginning in FY 2000.
	Capital exception payments are also made to hospitals that incur 
unanticipated capital expenses due to circumstances beyond the 
hospital's control.  Specifically, these would include unanticipated 
capital expenditures in excess of $5 million (net of insurance proceeds 
or other Federal or State monies) attributed to extraordinary 
circumstances including floods, fires, or earthquakes.  Hospitals will 
receive a minimum of 85 percent of Medicare's share of the allowable 
capital-related costs attributed to these circumstances. SCHs will 
receive at least  100 percent of these allowable costs.

Annual Updates  
	The IPPS standardized amounts are increased each year using an 
update factor which may be determined, in part, by the projected 
increase in the hospital market basket (MB) index.  CMS rebases the 
operating MB index every 5 years to reflect the changing composition of 
hospital inputs being purchased.  Most recently, the MB was rebased and 
revised for FY2003 payments to reflect FY1997 cost data and to 
incorporate a separate category for blood and blood products.  
	The hospital input price index reflects the average change in 
the price of a set of mutually exclusive spending categories.  The 
relative importance of the spending categories (cost or expenditure 
weights) are calculated using Medicare cost reports and other data from 
a base year.  These are the numerical shares that each category 
contributes to the total MB; the cost weights over all categories add 
up to 100 percent.  The more that an input good is used in the 
production of inpatient hospital care, the higher the associated 
expenditure weight will be and the greater the influence the projected 
inflation in that category will have on the change in the MB.  Price 
proxies (or measures of price inflation) are selected for each spending 
category.  The proxies are derived from publicly available statistical 
series published on a routine basis, preferably no less often than each 
quarter. For example, the proxy selected for the wages and salary 
expense category is the employment cost index for civilian hospital 
workers.  To calculate the MB, the weight for each category is 
multiplied by the level of the price proxy.  The sum of these 
products for all cost categories equals the composite index level 
of the MB in a given year.  Dividing this sum by the index level 
from an earlier year produces an estimate of the growth rate in the 
MB over that time period.  As shown in  Table 2-15, the projected 
inflation of 3.8 percent for wages and salaries comprise 50.69 
percent of the estimate of total hospital operating MB used to set 
the FY2004 IPPS rates.  
  	Generally, Congress sets the update for operating payments for 
several years in advance in statute.  According to CMS, the IPPS update 
is the single most important payment variable for the hospital sector 
as it affects nearly $100 billion per year in Medicare hospital 
payments. Typically, over the life of IPPS, the operating update has 
been set at a level below a full MB update.   For example, in FY2003, 
the update for operating costs was set at MB - 0.55 percentage 
points; the best estimate of the MB available when the final 
regulation was issued was  3.5 percent.  The FY2003 update equaled a 
2.95 percent increase.  However, for FY2004 and in subsequent years, 
absent further legislation, the operating update will equal the 
change in the MB.  The MB update reflected in the IPPS operating 
update each year is the most recently available forecast when 
the final regulation is published.  Unlike the capital IPPS update, 
the operating update does not include a correction for forecast error.  
As indicated by Table 2-16, for most of IPPS, the forecasted value of 
the MB incorporated in the IPPS update  has been larger than the 
final estimate of the MB change.  



	Although Congress sets the operating update, CMS sets the 
capital update using an update framework that consists of a capital 
input price index (CIPI) and several adjustment factors.  In FY2003, 
CMS rebased and revised the CIPI to incorporate a FY1997 base year 
and to reflect a more recent structure of capital costs.  The capital 
price index is structured differently from the operating MB, because 
capital is acquired and paid for over time instead of being consumed 
in the same time period in which it is purchased.  The CIPI incorporates 
2 sets of weights:  one set identifies the relative importance of each 
of the cost categories to the average capital costs in a hospital and 
the other set of weights (called vintage weights) identifies the 
proportion of capital spending within each cost category that is 
attributable to each year of the useful life of the capital asset.  
The capital cost categories include depreciation (physical capital 
including both building and fixed equipment as well as moveable 
equipment), interest (financial capital) and other related capital 
expenses (such as insurance).   With respect to the relative importance 
of each of the capital cost categories, depreciation of building and 
fixed equipment comprises 34.22 percent of the CIPI; depreciation of 
movable equipment comprises 37.13 percent of the CIPI and interest 
costs comprises 23.46 percent of the CIPI.  Lease expenses are not a 
separate cost category in the CIPI, but are distributed among the 
other capital cost categories with 10 percent of lease costs assumed 
to be overhead.  

YEARS 1984-2002


	CMS sets the capital update using their update framework which 
includes the CIPI rate of increase adjusted for patient care intensity 
(or efficiency) changes, case-mix adjustments, DRG reclassifications 
and recalibrations and a correction for the forecast error from 
2 years earlier. CMS includes an intensity adjustment to reflect 
policy considerations with respect to assessed improvements in 
efficiency, within-DRG severity increases and the adoption of quality
enhancing technology. Other adjustments within the update framework 
are based on CMS's attribution of the source of observed changes in 
the case-mix index for Medicare discharges.  The change in the 
case-mix index can result from changes in the average resource use 
of Medicare patients (a ''real'' case-mix change), changes in 
hospital coding practices that would result in higher weight DRG 
assignments (coding effects), and changes in DRG reclassification 
and recalibration.  To the extent that the real case-mix increase 
is captured by the observed change in the case mix index measure,
no additional adjustment will be incorporated in the capital update 
framework.  Also, the DRG reclassification effect is included with 
a 2-year lag.  For example, the FY2003 capital update framework 
included a -0.3 percent reduction attributed to an overstatement 
of the change originally attributed to DRG recalibration and 
reclassification that occurred in FY2001. Finally, CMS will make 
an adjustment for forecast error if their estimate of the CIPI for 
any year is off by 0.25 percentage points or more; again there is 
a 2-year lag between the forecast and the measurement of forecast 
error.  For example, the -0.3 percent forecast correction factor 
in FY2003 indicates that the current data establishes that the 
forecasted value of the CIPI used in the FY2001 update framework 
was overstated. The impact of the policy adjustments vary from year 
to year.  For example, in FY2003, the CIPI was 0.7, but the capital 
update was 1.1 percent due to the influence of other factors. 
	However in FY2004, the capital update was 0.7 percent, an 
increase that was entirely driven by the rate of change in the CIPI; 
other adjustments were deemed to either have a negligible impact or 
cancelled each other out.  Table 2-17 shows the capital update 
framework and associated adjustments from FY1999 to FY2004.


	For both operating and capital IPPS, the annual increase to 
the base rates will depend not only on the update amounts, but will 
also be affected by the annual budget neutrality offsets attributed 
to DRG recalibrations, wage index changes, hospital reclassifications, 
and outliers. 

Payments made outside capital and operating IPPS
	Specific categories of hospital expenses, including direct 
medical education costs, are not included in the hospital prospective 
payment system.   	 Direct medical education costs--The direct 
costs of approved medical education programs (such as the salaries 
of residents and teachers and other education costs for residents, 
for nurses, and for allied health professionals trained in provider-
operated programs) are paid separately from IPPS.  The direct medical 
education costs for the training of nurses and allied health 
professionals in provider-operated programs are paid for on a 
reasonable cost basis.  The direct costs of residency training 
programs for physicians are paid according to a formula that uses 
each hospital' per resident costs, updated from a base year and 
subject to certain limits as explained below.  CMS estimates 
Medicare spending on direct graduate medical education (DGME) 
payments for allied health professionals at $250 million for fee-
for-service beneficiaries and an additional payment of up to $60 million 
made to hospital-based nursing and allied health programs to account 
for utilization by beneficiaries who are enrolled in Medicare+Choice 
programs; CMS estimates Medicare spending on DGME payments for 
residency training programs for physicians at $2.3 billion in FY2002.   
	Medicare's payment to each hospital for the direct costs of 
physician's residency training programs equals the hospital's cost 
per full-time equivalent (FTE) resident, times the weighted average 
number of FTE residents, times the percentage of inpatient days 
attributable to Medicare Part A beneficiaries, including days provided 
to Medicare +Choice enrollees.  Generally, each hospital's per resident 
amount (PRA) is calculated using data from the hospital's cost reporting 
period that began in fiscal year 1984, increased by 1 percent for 
hospital cost reporting periods beginning July 1, 1985, and updated in 
subsequent cost reporting periods by the change in the Consumer Price 
Index (CPI).  Hospitals with both primary care and obstetrics and 
gynecology residents and nonprimary care residents in FY1994 or 
FY1995 may have two separate PRAs: one for primary care and obstetrics 
and gynecology and one for nonprimary care.  Primary care residents are 
defined to include family medicine, general internal medicine, general 
pediatrics, preventive medicine, geriatric medicine, and osteopathic 
general practice.   
	Although teaching hospitals' per resident costs vary greatly 
between hospitals, recently some of the variation in Medicare 
reimbursement for these amounts has been reduced.  Starting in 
FY2001, hospitals with PRAs below 70 percent of the national average 
were increased to 70 percent of the geographically adjusted value or 
the floor amount.   Starting during FY2002,  this floor was increased 
to 85 percent of the locality adjusted, updated, and weighted national
PRA.  Also hospitals with PRAs above 140 percent of the geographically 
adjusted national average or the ceiling amount did not receive an 
inflation update for 2 years (FY2001 and FY2002) and will receive a 
lower update than other hospitals (CPI minus 2 percent) for 3 years 
(FY2003- FY2005).  
	Only residents in their initial residency period are counted as 
a full FTE. Residents who are not in their initial residency period are 
counted as one-half of an FTE.  There is no limit on the number of years 
that an individual resident can be counted as 0.5 FTE as long as the 
resident continues to train in an approved program.  Generally, the 
initial residency period is the minimum number of years required for 
a resident to become board eligible in the specialty in which the 
resident first began training, not to exceed 5 years.  The number of 
years considered as an initial residency period varies by physician 
specialty.  The initial residency program in combined residency 
programs is defined as the time required for certification in the 
longer of the programs.  In certain combined programs, an additional 
year in the initial period is permitted.  Residents who are foreign 
or international medical graduates are not counted as FTE residents 
unless they have passed certain examinations.   
	In general, Medicare's DGME payment to any hospital is limited 
by a cap that is based on the  number of allopathic and osteopathic 
residents that the hospital counted for the purposes of DGME payments 
on its cost report ending on or before December 31, 1996.  Generally, 
a hospital's  unweighted  FTE count may not exceed this limit, but 
certain adjustments may be made for newly established medical residency 
training programs, terminations of teaching programs, rural training 
programs, and affiliated groups of teaching hospitals.  A hospital's 
DGME payments are based on a 3-year rolling average of resident counts 
(using data from the payment year cost reporting period and the 
preceding two cost reporting periods), subject to the resident limits.  
This rolling average calculation will include dental and podiatry 
	Payments for Other Excluded Cost Categories--Certain hospitals 
receive additional payments for different categories of services that 
have been excluded from IPPS and are paid separately.  Medicare pays 
for a percentage of the bad debts attributable to unpaid deductible 
and copayment amounts related to covered services received by 
Medicare beneficiaries.  In FY1998, approximately 3,900 hospitals 
received $409 million in bad debt payments.  The estimated net expenses 
associated with Medicare organ acquisition in certified transplantation 
centers are excluded from IPPS and paid on a reasonable cost basis. In 
FY1998, 208 hospitals received about $340.3 million for net organ 
acquisition costs.  Qualifying rural hospitals are paid on a reasonable 
cost basis for anesthesia services  furnished by hospital employed 
nonphysician anesthetists (certified registered nurse anesthetists 
and anesthesiologist's assistants) or obtained under arrangement.  In 
FY1999, 639 hospitals received approximately $33.9 million in Medicare
payments for these services.  Finally, teaching hospitals can elect to 
receive reasonable cost payments in lieu of fee schedule payments that 
might otherwise be made for direct medical and surgical services of 
physicians who are employees or who otherwise agree not to bill 
separately for such services.  The services include the services and the 
supervision of interns and residents providing care to Medicare 
beneficiaries.  In FY1998, 14 teaching hospitals were paid about $25.6 
million for these services. 
	Special Treatment for Certain Acute Care Facilities--Certain 
facilities receive special treatment under IPPS, particularly those 
facilities identified as isolated or essential hospitals primarily 
located in rural areas, including rural referral centers, sole 
community hospitals, and Medicare dependent hospitals. Small rural 
facilities have been able to offer long-term care services without 
establishing a distinct unit by offering such care in hospital swing 
beds (beds that swing between offering acute care and long-term care 
services.)  Starting in 1998, small, limited service facilities have 
been able to opt out of Medicare IPPS under the critical access 
hospital program and receive reasonable cost reimbursement for their 
	Sole Community Hospitals (SCHs)--SCHs are hospitals that, 
because of factors such as isolated location, weather conditions, 
travel conditions, or absence of other hospitals, are the sole source 
of inpatient services reasonably available in a geographic area.  Any 
hospital seeking SCH status can qualify if it is located more than 35 
miles from a like hospital.  Depending upon its circumstances, including 
its bed size, a hospital can qualify as a SCH under various distance, 
market share or travel time standards.  Specifically, a hospital that is 
located more than 35 miles from other like hospitals or one with at 
least 45 minutes of travel time between it and its nearest like hospital 
because of distance, posted speed limits, and predictable weather 
conditions will qualify as a SCH.  A rural hospital that is located 
between 25 and 35 miles from another like hospital can qualify as a SCH 
if it: (1) passes a market share test where no more than 25 percent of 
the Medicare beneficiaries or population within its service area can be 
admitted to other like hospitals located within a 35-mile radius or in 
its service area, whichever is larger; (2) has fewer than 50 beds, 
does not offer specialty services that are needed by some of the 
Medicare beneficiaries or other residents in its service area, and 
has its Medicare fiscal intermediary certify that it would have 
otherwise met the market share test if it did offer the needed services; 
or (3) had its like hospitals inaccessible for at least 30 days in each  
2 out of the 3 preceding years.  For these purposes, a hospital's 
service area is defined, generally speaking, as the smallest number 
of zip codes from which it draws 75 percent of its admissions during 
the most recent  12-month cost reporting period ending before its 
SCH application. A rural hospital that is located between 15 and 25 
miles from other like hospitals can qualify as a SCH if its other 
like hospitals are inaccessible for at least 30 days in each 2 out 
of the 3 preceding years.  
	The rural SCH qualification criteria may be applicable to urban 
hospitals. BBRA provided that an urban hospital may be redesignated as 
being located in a rural area if it meets one of several criteria.  
Specifically an urban hospital can apply to the Secretary and be 
reclassified to a rural area if (1) it is in a rural census tract of a 
metropolitan area; (2) it is designated by the State as in a rural 
area or as a rural hospital; or (3) it meets all the requirements for 
rural SCHs except that it is located in an urban area.  An urban 
hospital that qualifies as a rural SCH and reclassifies to a rural area 
through this process is not permitted to be reclassified subsequently 
through the Medicare Geographic Classification Review Board (MGCRB).
	CMS does not consider all providers offering inpatient services 
to be ''like hospitals'' when determining whether an applicant can 
qualify as an SCH.  Specifically, critical access hospitals (CAHs) are 
not considered like hospitals by CMS, because these facilities are not 
full-service inpatient providers.  Moreover, CMS will not consider a 
nearby hospital to be a like hospital unless the inpatient services 
provided by the nearby hospital ''overlap'' with those offered by the 
SCH or SCH applicant.  As established in regulation, effective for 
cost reporting periods  on or after October 1, 2002, a nearby hospital 
will not be considered a like hospital unless the percentage of its 
total inpatient days equals 8 percent or more of the total patient 
days provided by the SCH or SCH applicant.  The comparison includes 
all days provided in units that provide the level of care payable 
under IPPS; days provided in PPS-exempt, distinct part units would 
not be included in the comparison.  This regulatory provision was 
adopted because of the development of freestanding specialty 
hospitals that focus on specific cardiovascular, orthopedic, or 
other surgical procedures.
	The primary advantage of the SCH classification is the option to 
use a hospital's updated historical operating costs when calculating 
Medicare inpatient payments when this results in higher payments to the 
hospital.  Specifically, an SCH may use the higher of the following 
payment rates as the basis of its Medicare reimbursement: the current 
IPPS base payment rate in comparison to its hospital-specific per 
discharge costs from either FY1982, FY1987, or FY1996 updated to the 
current year.  The FY1996 base year option became effective for 
discharges on or after FY2001 on a phased-in basis and is fully 
implemented for SCH discharges beginning in FY2004.  An SCH will only 
receive outlier payments, disproportionate share hospital payments, or 
indirect medical education payments (adjustments within the IPPS system) 
when it is paid using the current IPPS base rate (and not the rates 
based on its updated hospital specific per discharge costs).  An SCH's 
Medicare payments will be calculated using the rate that results in the 
highest payment as established by its fiscal intermediary in the 
settlement of the hospital's cost report. 
	Another significant advantage for an SCH is the ability to 
request additional payments for any year if the hospital experiences a 
decrease of more than 5 percent in its total inpatient cases due to 
circumstances beyond its control.  The request must include an 
analysis of the reasons for the decrease in discharges, explain the 
resulting effect on the per discharge costs, and show that the decrease 
is due to circumstances beyond the hospital's control.  There are other 
special inpatient payment considerations an SCH may receive. 
Specifically, those rural SCHs that are paid on the basis of the current 
IPPS base rate (and not on the basis of their hospital-specific costs) 
that qualify for disproportionate share hospital (DSH) payments will 
receive a 10 percent payment increase rather than the maximum 5.25 
percent DSH adjustment received by other rural hospitals. Moreover, 
SCHs are not required to meet one of the tests, the  proximity 
requirement, in order to reclassify to a different geographic area and 
receive a higher wage index, base payment rate (if applicable) or both. 
In terms of payments for outpatient services, the outpatient laboratory 
fee schedule can be increased by 2 percentage points for these services 
provided by an SCH.
	Certain SCHs not meeting the criteria have been allowed to 
continue to qualify for payments as an SCH.  Under most circumstances, 
hospitals designated as SCHs prior to December 19, 1989 are permitted 
to retain their SCH status.  Generally, an approved SCH classification 
will remain in effect without the need for approval unless there is a 
noticeable change in the circumstances under which the classification 
was approved.  However, a hospital (even a "grandfathered" SCH) can 
lose its special status as an SCH if successfully reclassified by the 
MGCRB for the purposes of using a higher base payment.
	Medicare Dependent Hospitals--Small rural hospitals that treat 
a relatively high proportion of Medicare patients can be classified as 
Medicare dependent hospitals (MDHs). Generally speaking, a MDH is 
located in a rural area, has 100 beds or less, is not classified as 
an SCH, and has at least 60 percent of acute inpatient days or 
discharges attributable to Medicare in the hospital cost reporting 
period that began during fiscal year 1987 or in two of the three most 
recently audited cost reporting periods for which there is a settled 
cost report.  Originally intended to be a temporary classification 
status, Congress has extended the MDH designation several times.  
BBRA extended the sunset date for MDH classification to September 30, 
	The financial advantages of an MDH designation are less than 
those afforded to an SCH designation.  An MDH can receive higher 
Medicare payments than other acute care hospitals in the same 
circumstances.  Specifically, an MDH hospital will be paid based on 
its adjusted FY1982 or FY1987 hospital specific costs rather than the 
national base rate if that will result in higher payments. However, an 
MDH will receive only 50 percent of the difference between the base rate 
and its adjusted FY1982 or FY1987 hospital-specific costs. The other 
benefit is that an MDH, like an SCH,  continues to be protected from a 
decrease of more than 5 percent in its total inpatient cases due 
to circumstances beyond its control.

	Rural Referral Centers (RRCs)--RRCs are relatively large rural 
hospitals that generally provide a broad array of services and treat 
patients from a wide geographic area.  These rural hospitals are thought 
to have operating costs more similar to urban hospitals than to the 
average smaller community hospitals, because of bed size, a large number 
of complicated cases, a high number of discharges, or a large number of 
referrals from other hospitals or from physicians outside the hospital's 
service area.  Originally, only rural hospitals with 500 or more beds 
received special treatment as a referral center.  Presently, RRCs must 
have at least 275 beds or meet specific criteria which indicate that the 
facility receives a high referral volume from other hospitals.   
	A rural hospital can qualify as a RRC if it meets the bed size 
criteria of  275 or more beds and meets the following referral standards 
and service area standards: at least 50 percent of its Medicare patients 
are referred from other hospitals or from physicians not on the 
hospital's staff and at least 60 percent of its Medicare patients reside 
more than 25 miles from the hospital.   Alternatively, a rural hospital 
must meet certain case-mix and discharge standards.  Specifically, the 
hospital must have (1) a case-mix index equal to or greater than the 
national or regional median case mix index for all urban hospitals, 
excluding hospitals with approved teaching programs; and (2) at least 
5,000 discharges per year (3,000 discharge for osteopathic hospitals) 
or at least the median number of discharges for urban hospitals in the 
same region.  Under this alternative standard, a hospital must meet 
one of the following referral or service area standards:  more than 
50 percent of the hospital's medical staff are specialists, at least 
60 percent of its discharges are for inpatients who reside more than 
25 miles from the hospital, or at least  40 percent of inpatients 
treated at the hospital have been referred either from physicians 
not on the hospital's staff or from other hospitals.  
	Under the original structure of IPPS, RRCs received the urban 
rather than the rural base payment rate.   When the other urban and 
rural payment rates were equalized in FY1995, RRCs lost some of the 
benefit of their classification status. However, qualifying RRCs 
receive a higher DSH adjustment than do other rural hospitals. Also, 
as discussed subsequently, RRCs continue to be entitled to preferential 
consideration before the Medicare Geographic Classification Review 
Board.  An RRC does not need to demonstrate proximity to an area or 
establish  that its wages exceed 106 percent of the average wage in the 
area where it seeks to be redesignated.
 	Hospital Swing Beds--Small rural hospitals have had difficulty 
in establishing separately identifiable units for Medicare and Medicaid 
long-term care because of limitations in their physical plant and 
accounting capabilities.  These hospitals had an excess of hospital 
beds and their communities had a scarcity of long-term care beds in 
Medicare and Medicaid participating facilities.  Under the swing bed 
program started under OBRA 1980 (P.L. 96-499), certain rural hospitals 
with fewer than 50 beds were permitted to use their inpatient 
facilities, as necessary, to furnish long-term care services. OBRA 
1987 extended the Medicare swing-bed program to rural hospitals with 
less than 100 beds with certain payment limitations.  Prior to the 
skilled nursing facility (SNF) PPS described subsequently, hospitals 
with swing beds were paid the average Medicare rate per patient day 
for routine services provided in freestanding SNFs in their census 
region; ancillary services were reimbursed on a reasonable cost basis. 
Most swing bed providers have been paid using the SNF PPS, starting 
for cost reporting periods on or after July 1, 2002.  Critical access 
hospitals (discussed subsequently) with swing beds are exempt from the 
SNF PPS.  In 2002, there were 1,067 swing-bed hospitals certified to 
provide acute care or SNF services.
	Critical Access Hospitals--BBA 1997 provided for the Rural 
Hospital Flexibility Program which created a new Medicare category of 
rural entities, critical access hospitals (CAHs), and authorized a 
companion grant program of $25 million annually for 5 years to establish 
networks for improving access to health care services in rural 
communities. Based on earlier demonstration programs of rural primary 
care hospitals and medical assistance facilities, CAHs provide 
emergency, outpatient and limited inpatient services in rural areas.  
Before a hospital can be designated as a CAH, the State must submit and 
have approved a rural health plan implementing the Medicare Rural 
Hospital Flexibility Program. 	The original CAH  provisions were 
subsequently modified.  Currently, to qualify as a CAH, the rural, 
for-profit, nonprofit, or public hospital must be located more than 
35 miles from another hospital or 15 miles in areas with mountainous 
terrain or those where only secondary roads are available.  These milage 
standards may be waived if the hospital has been designated by the State 
as a necessary provider of health care.  Under certain circumstances, 
hospitals that have closed within the past 10 years may be designated 
as CAHs.  All CAHs must provide 24-hour emergency services; and operate 
a limited number of inpatient beds in which hospital stays can average 
no more than 96 hours.  Although CAHs are limited to 15 acute-care beds, 
these facilities may have an additional 10 swing beds that are set up 
for skilled nursing facility level care.  While all 25 beds can be used 
as swing beds, only 15 of the 25 can be used for acute care at any time.  
Any bed of a unit of the facility that is licensed as a distinct-part 
SNF is not included in these bed counts.  Generally, a rural hospital 
designated as a CAH receives reasonable, cost based reimbursement for 
care rendered to Medicare beneficiaries.  CAHs may elect either a cost-
based hospital outpatient service payment or an all-inclusive rate 
which is equal to a reasonable cost payment for facility services plus 
115 percent of the fee schedule payment for professional services.  The 
reasonable cost of outpatient CAH services may include the reasonable 
compensation and related costs for an emergency room physician who is 
on call but not present on the premise of the CAH, if the physician is 
not otherwise furnishing physicians' services and is not on call at 
any other provider or facility.  Ambulance services that are owned 
and operated by CAHs are reimbursed on a reasonable cost basis if 
these ambulance services are 35 miles from another ambulance system.  
	As of April 2003, 763 hospitals have been certified by CMS as CAHs;  
442 of these CAHS have been governor-designated as necessary providers as 
opposed to meeting the Federally mandated mileage and location standards.  
More than half (51 percent) of all CAHs are located in 10 States; 3 
States, Delaware, New Jersey, and Rhode Island, do not participate in 
the program.  Sixty-nine additional hospitals have CAH designations 
that are pending.
	Geographic Reclassification of Hospitals--Unlike other 
providers, acute hospitals may apply to the Medicare Geographic 
Classification Review Board (MGCRB) for a change in classification from 
a rural area to an urban area, or reassignment from one urban area to 
another urban area.   The MGCRB was created to determine whether a 
hospital should be redesignated to an area with which it has close 
proximity for purposes of using the other area's standardized amount, 
wage index, or both.  If reclassification is granted, the new wage index 
will be used to calculate Medicare's payment for inpatient and outpatient 
services.  Other services offered by the hospital such as rehabilitation 
services in a distinct part unit will be paid using the wage index from 
the hospital's original area.  Hospital reclassifications are established 
on a budget neutral basis so aggregate IPPS payments will not increase 
as a result.  A hospital may apply for reclassification individually, 
as a member of a group of hospitals,  and as a member of a statewide 
wage index area; depending upon the type of application, different 
criteria apply. 
	Generally, for an individual hospital to qualify for 
reclassification, it must demonstrate a close proximity to the areas 
where they seek to be reclassified. This proximity can be established 
if one of two conditions is met: (1) an  urban hospital must be no more 
than 15 miles and a rural hospital must be no more than 35 miles from 
the area where it wants to be reclassified; or (2) at least 50 percent 
of the hospital's employees reside in the area.  A RRC or a SCH (or a 
hospital that is both a RRC and a SCH) does not have to meet the 
proximity test.  If qualified, it can be redesignated to the urban area 
that is closest to the hospital.  If a rural area is closer, then the SCH 
or the RRC may seek reclassification to either the closest rural area or 
the closest urban area.
	After establishing appropriate proximity, a hospital may qualify 
for the payment rate of another area if it proves that its incurred 
costs are comparable to those of hospitals in that area.  To use an 
area's base payment, a hospital must demonstrate that its average 
case-mix adjusted cost per discharge is equal to or more than its 
current rate plus 75 percent of the difference between that rate and 
the rate it would receive if reclassified.  To use an area's wage index, 
a hospital must demonstrate that its average hourly wage is equal to at 
least 82 percent (a rural hospital) or 84 percent (an urban hospital) of 
the average hourly wage of hospitals in the area to which it seeks 
redesignation. Also an urban hospital cannot be reclassified unless its 
average hourly wage is at least 108 percent of the average hourly wage of 
the area in which it is located; this standard is 106 percent for rural 
hospitals seeking reclassification to an area.  An exception to these 
standards has been established for a dominating hospital that comprises 
at least 40 percent of the area's total wages.  
	For redesignations starting in FY2003, the average hourly wage 
comparisons used to determine whether a hospital can use another area's 
wage index are based on 3 years worth of lagged data submitted by 
hospitals as part of their cost report.  For instance, FY2004 wage index 
reclassifications were based on weighted 3-year averages of average 
hourly wages using data from FY1998, FY1999, and FY2000 cost reports.  
Starting in FY2003, redesignations are for  3 years unless a hospital 
withdraws or terminates the redesignation.
	There are some limitations on reassignment. Effective for 
FY2002 and subsequently, a hospital may not be reclassified for purposes 
of using another area's standardized amount if the area to which the 
hospital seeks reclassification does not have a higher standardized 
amount than that currently received by the hospital. A hospital that 
seeks reclassification for the purpose of using another area's wage 
index may apply for reclassification only to an area that has a higher 
pre-reclassified average hourly wage than that of the hospital's original 
geographic area. 
 In addition, a hospital seeking reclassification for both wage index 
and base payments purposes may not be redesignated to more than one area.  
Under certain circumstances, all the hospitals in a rural county can be 
redesignated into an urban area; all the hospitals in an urban county can 
be redesignated into another urban area; and all the hospitals in the 
State can be redesignated and paid using a statewide wage index.
	Certain rules have been established in statute and by regulation 
that specify the changes to an area's wage index value that occur when 
hospitals are reclassified by the MGCRB.  For example, an MSA's wage 
index value is never lower than its State's rural wage index value.  
If a hospital reclassification causes the wage index in the new area to 
fall by 1 percent or less, the area's original wage index applies to 
these newly assigned hospitals (as well as to the original hospitals in 
the area).  However, if reclassification causes the wage index value to 
fall by more than 1 percent, the area's wage index is recalculated 
(with the wage data from the redesignated hospitals) and the combined 
wage index value applies to redesignated hospitals; the wage index 
values for hospitals located in the area are not affected. In MSAs where 
the wage index value increases because of reclassification, all 
hospitals in the area (those that are physically located there and 
those that have been reassigned) use the higher wage index. Hospitals 
in areas whose wage index values would be reduced by excluding the wage 
data for hospitals that have be reclassified continue to have their wage 
indexes calculated as if no reclassification occurred.  Hospitals in 
rural areas whose wage index values increase because of reclassification 
are allowed to benefit through recalculation.  
	Aside from reclassifications through the MGCRB, hospitals have 
also been reclassified by law.  Specifically certain rural hospitals can 
reclassify as urban if the county in which the hospital is located is 
adjacent to two or more MSAs and meets criteria regarding commuting 
patterns of its residents to the central counties of the adjacent MSAs.  
BBRA 1999 provided for an update of the standards used for the 
geographic reclassification of these ''rural deemed urban'' hospitals. 
BBRA 1999 also provided that certain urban hospitals could be 
reclassified as rural hospitals if the hospital is located in a rural 
census tract of an MSA (as determined under the most recent Goldsmith 
Modification); is located in an area designated by State law or 
regulation as a rural area; or the hospital would qualify as a referral 
center or as an SCH if the hospital were located in a rural area; or 
the hospital meets other criteria as specified by the Secretary. 
Finally, BBRA 1999 established that certain counties should be 
considered as part of specified urban areas for the purposes of Medicare 
inpatient reimbursement.  


	Certain facilities were excluded from IPPS when it was 
implemented in 1984 because the DRGs  were thought not to adequately 
represent their patients' resource needs or the volume of Medicare 
patients was deemed to be insufficient so that payments based on averages 
and made on a per discharge basis would be inadequate.  The excluded 
providers include rehabilitation, long-term care,  psychiatric, 
children's, and cancer hospitals, rehabilitation and psychiatric 
hospital distinct part units, religious nonmedical heath care 
institutions, and hospitals located outside the 50 States and Puerto 
Rico.  Hospitals in certain States have been excluded from IPPS and 
operate under a State hospital reimbursement control system approved 
by the Secretary under Section 1886(c) of the Social Security Act 
(as added by Tax Equity and Fiscal Responsibility Act of 1982 or 
TEFRA and subsequently modified).   At this point, only hospitals 
in Maryland are paid according to a State reimbursement control system.  
	This section will primarily discuss the payment systems for 
those specialty hospitals and units that have been excluded from IPPS 
and paid on the basis of reasonable costs subject to the TEFRA  limits: 
cancer hospitals; children's hospitals;  psychiatric hospitals and 
units; rehabilitation hospitals and units; and long-term care hospitals.  
Certain of these facilities are currently paid under different, 
recently implemented provider-specific prospective payment systems. 
Inpatient rehabilitation facilities (IRFs) began to be reimbursed under 
a PPS in January 2002; long-term care hospitals (LTCHs) began to be 
reimbursed under a PPS in October, 2002.  The section will begin with 
brief background information on the TEFRA payment system still used to 
pay cancer, children's, and psychiatric hospitals and units, followed 
by descriptions of the IRF-PPS and LTCH-PPS.  

Cancer Hospitals, Children's Hospitals, and Psychiatric Hospitals and 

	In order to qualify for exemption from IPPS, a psychiatric 
hospital or distinct part unit must be primarily engaged in providing, 
by or under the supervision of a psychiatrist, psychiatric services for 
the diagnosis and treatment of persons with mental illness as well as 
meet the conditions of participation for hospitals and the special 
conditions of participation for psychiatric hospitals.  A distinct part 
psychiatric unit must meet the requirements established for distinct 
part units in hospitals including separately identifiable admission and 
discharge records, physically separate beds and must also meet 
additional requirements established in regulation.  Eleven cancer 
hospitals are currently exempt from IPPS. These hospitals generally are 
recognized by the National Cancer Institute as either a comprehensive or 
clinical cancer research center; are primarily organized for the 
treatment of and research on cancer (not as a subunit of an acute 
general hospital or university-based medical center); and have at 
least 50 percent of its discharges with a diagnosis of neoplastic 
disease.  Eighty-one children's hospitals are currently exempt from 
IPPS.  These hospitals are those engaged in furnishing services to 
inpatients who are predominantly individuals under the age of 18.
	Essentially, under TEFRA rate of increase limits, a specialty 
hospital is paid on a reasonable cost basis subject to the rate of 
increase ceiling.  A TEFRA hospital is paid the lower of its actual 
operating costs or a facility-specific target amount and will receive 
additional payments depending upon the relationship of its cost per 
discharge to its target amount.  Generally, a provider with costs under 
its target will be rewarded with a bonus payment; a provider with costs 
per discharge above its target will receive a relief payment. A 
provider's target amount is based on its Medicare allowable costs per 
discharge in a base year, updated to the current year by an annual 
update factor.  In FY2004, the update is the increase in the MB for 
excluded hospital which is 3.4 percent.  Medicare pays the capital 
costs in these providers on a reasonable cost basis.  
	Generally, new providers have had significantly higher costs 
(and subsequently higher target amounts) than older, established 
providers.  In an effort to reduce disparities, BBA 1997 modified the 
way in which bonus and relief payments are calculated.  Also, facilities 
and exempt units that were excluded from IPPS before FY1991 were 
permitted to update (or rebase) their target amount for FY1998 and beyond.  
New providers that are exempt from IPPS (those that receive payments for 
the first time on or after October 1, 1997) will receive the lesser of 
their operating costs or 110 percent of the national median of the 
updated, locality adjusted target amount for similarly situated hospitals 
for each of its first two cost reporting periods for which it has a 
settled cost report.  This payment option for new providers now applies 
only to new psychiatric hospitals and units.    

Inpatient Rehabilitation Facilities and Distinct Part Units
	An inpatient rehabilitation facility (IRF), both freestanding IRFs 
and  distinct part rehabilitation units of acute hospitals, must meet 
certain requirements to be excluded from IPPS and paid as an IRF.  At least
75 percent of a facility's inpatient population must require intensive 
rehabilitation services for one of 10 conditions including treatment of 
stoke, spinal cord injury, major multiple trauma, brain injury, 
polyarthritis, and other specific conditions.  Also a rehabilitation unit 
must have beds that are physically separate from the hospital's other 
beds, separately identified admission and discharge records from those 
of the hospital, and policies that specify that necessary clinical 
information is sent to the unit upon transfer of a hospital's patient 
to the unit.  	Simply stated, under PPS, Medicare pays an IRF a 
predetermined, fixed amount per discharge, depending upon a patient's 
impairment level, functional status, comorbid conditions and age. 
Certain adjustments are made for facility level characteristics to 
account for area wage variations, rural location and the percentage of 
low-income patients (LIPs) served.  IRF-PPS also includes case level 
adjustments.  Specifically, reduced or additional amounts are paid for 
early transfers, short-stay outliers, patients who die before transfer 
and patients who are extraordinarily costly (outliers). These payments 
encompass inpatient operating and capital costs of furnishing covered 
rehabilitation services, but not the costs of approved educational 
activities, Medicare bad debts and other services that are paid outside 
of the IRF-PPS.  Medicare's PPS payment to an IRF for any patient will 
depend upon a clinician's comprehensive assessment of that patient 
upon admission and again at discharge.  These documented assessments 
must be based on the direct observation of and communication with the 
patient; information may be supplemented with information from other 
sources, including family members or other clinicians.  The prescribed
patient assessment instrument (PAI) form, the Uniform Data Set for 
Medical Rehabilitation (UDSmr), encompasses about  55 questions used 
to ascertain a patient's functional independence including motor 
skills and cognitive capacities and to establish a patient's 
comorbidities.  A patient's assessments (from both admission and 
discharge) are transmitted to CMS electronically once and at the 
same time.  Failure to meet the IRF PAI transmission deadlines 
results in  a 25 percent reduction in Medicare's payment in all but 
extraordinary circumstances.   
	Using data from the patient's initial assessment, each Medicare 
patient is classified into one of 100 mutually exclusive case-mix groups 
(CMGs).  First, a patient is placed into one of 21 rehabilitation 
impairment categories (RICs) that encompass clinically similar 
conditions, such as stroke or traumatic brain injury, as the primary 
cause of admission.  Next, a patient is placed into a CMG within the 
RIC; the CMG assignment depends upon the patient's functional status 
and, in some instances, age.  Within a CMG, a patient is assigned to 
one of 4 categories or comorbidity tiers using clinical information 
from the patient's discharge assessment.  The presence of 
comorbidities was found to substantially increase the average cost 
of a specific CMG.  Patients with the most serious conditions are 
assigned to tier 1; patients with the least serious conditions are 
assigned to tier 3; those without any relevant comorbidities are
assigned to the "none" tier. 95 CMGs encompass the 21 RICs; 5 other 
CMGs have been established for patients with special circumstances; 
one of the 5 CMGs is for patients with very short stays and the 4
remaining are for patients who die before treatment is completed.
Each of these 5 special CMGs have only one payment rate and no 
comorbidity tiers.	CMS established relative or cost weights 
using cost report data from FY1996, FY1997, and FY1998 and charge 
data from calendar year (CY) 1999. The relative weights account for a 
patient's resource needs for each of the CMGs and payment tiers; 385 
relative weights are used to determine Medicare payment rates. Unlike 
those used in IPPS, these relative weights are not updated annually.  
Within any given CMG,  the cost weight for a patient with a high 
comorbidity is greater  than the cost weights for those patients with 
low or no comorbidities. This cost weight is multiplied by a 
standardized payment conversion factor (also referred to as the 
budget neutral conversion factor) to calculate the payment for a given 
patient.   The standard payment amount was originally constructed using 
the facility-specific information from 508 facilities, including cost 
reports from FY1995, FY1996, and FY1997; applicable target amounts, 
as well as Medicare claims (including corresponding UDSmr data) from 
CY1996 and CY1997.  CMS estimated payments that would have been made 
under the prior payment system; calculated the average weighted payment 
per discharge under the IRF-PPS, and determined a budget neutral 
conversion factor.  This payment amount was then subject to a 
behavioral offset of 1.16 percent to account for coding improvements 
and patient discharges that would occur earlier in the IRF stay. In 
FY2004, the standard payment amount is $12,525.  
	For FY2004 IRF-PPS payments, CMS uses FY1999 acute care hospital 
wage data (used in the FY2003 IPPS but with no accounting for geographic 
assignments) to compute the IRF wage index values.  The labor-related 
portion (72.395 percent) of the Federal payment rate is multiplied by 
the IPPS wage index value for the IRF's area (either MSA or rural area).  
This wage-adjusted amount is added to the non-labor related portion of 
the rate to determine the wage-adjusted Federal payment rate. IRFs in 
rural areas receive an additional 19.14 percent increase to the Federal 
payment rate.   An additional payment is made to IRFs that serve low-
income patients (LIPs).  The same measure, the percentage of poor 
Medicare and Medicaid days in a given facility, that is used to 
establish DSH payments for most IPPS hospitals is used as the measure 
for LIPs served in an IRF.  In the IRF-PPS, the additional payments 
are calculated using a logarithmic formula where the LIP measure is 
raised to the power of .4839.  An IRF will receive additional payments 
if it serves at least one low-income patient.  
	Table 2-18 shows the IRF-PPS adjusted payment calculation for 
CMG 0112 (without comorbidities) in 2 different facilities.  CMG 0112 
is used to establish Medicare payments for stroke patients from 82 to 
88 years old who have motor scores that range from 12 and 26 (without 
comorbidities).  It has a relative weight of 2.0015; Medicare's Federal 
prospective payment rate for this CMG is $25,068.79 ($12,525*2.0015'
$25,068.79).  This represents the Federal rate before the relevant 
facility-level adjustments are applied.  IRF-PPS payments will be 
adjusted to account for a facility's relative area wage, rural 
location, and low-income percentage.  In FY2004 a facility in rural 
Alabama has a wage index value of 0.7660 and one in the Oakland, CA 
MSA has a wage index value of 1.5072. Both facilities have a 26 
percent DSH percentage which qualifies them for a LIP adjustment of 
11.82 percent. 



	In addition to facility level adjustments, an IRF may receive 
additional or reduced Medicare payment for any given case, depending 
upon the Medicare patient's circumstances.  Additional payments are 
made for cases that are high cost outliers.  A patient will be 
considered to be an outlier if the estimated cost of the case exceeds 
an adjusted threshold amount.  This cost is calculated by multiplying 
the charge by the facility's overall cost-to-charge ratio obtained 
from the latest settled or tentatively settled cost report.   An IRF 
will receive 80 percent of the difference between the estimated cost 
of the case and the outlier threshold. In this instance, the threshold 
amount is the sum of the facility level CMG payment and the threshold 
amount multiplied by those facility level adjustments.  For FY2004, 
the unadjusted threshold amount is $11,211, which CMS estimates will 
result in total estimated outlier payments of approximately 3 percent 
of total IRF-PPS payments.
	Medicare pays a reduced amount for a patient who is an early 
transfer.  The patient has a length of stay that is greater than 3 days 
but less than the average for the assigned CMG and is transferred to 
another rehabilitation facility (which has been defined as a 
rehabilitation facility, a long-term care hospital, a short-term 
hospital, or a nursing home.)  No payment reduction applies for patients 
who are discharged to a home health agency or other outpatient therapy 

	Also, the IRF will receive the full amount if the transfer 
occurs after the patient has been treated for the average length of 
stay associated with the CMG.   The payment rate for early transfers 
is based on the per diem payment for the applicable CMG (to which the 
patient has been assigned).  The IRF will receive an additional one half-
day payment to recognize the higher costs generally associated with the 
patient's first day of care.  The early transfer payment would include 
any facility level payment adjustments.  
	Medicare pays for short-stay outliers using one of the 5 special 
CMGs.  These are patients who are not transfers, but are discharged from 
the facility after being hospitalized no more than 3 days.  These short-
stay outliers may occur because the patient could not tolerate a full 
course of intensive inpatient rehabilitation treatment, left against 
medical advice, or died within 3 days of admission.  Also, patients who 
are discharged from and return to the same IRF by midnight of the 3rd 
consecutive calendar day are considered interrupted stays.  Medicare 
makes only one IRF-PPS payment for these cases.  In addition to PPS 
payments, Medicare will pay IRFs for certain items such as Medicare 
beneficiaries' bad debts, the costs of approved educational programs and 
for blood clotting factors provided to Medicare inpatients who have 
hemophilia outside of the PPS.
	Each year the IRF-PPS standardized payment amount in increased 
based on the modified MB for excluded hospitals (those not paid under 
IPPS).  This MB is based on cost report data from Medicare participating 
inpatient rehabilitation and psychiatric facilities as well as long-
term, children's and cancer hospitals which were subject to TEFRA 
payment limitations.  The TEFRA MB only includes operating costs, so 
the IRF-PPS update is based on a modified TEFRA MB that reflects capital 
costs.  CMS revised and rebased the MB with capital for excluded 
hospitals to incorporate 1997 cost report data starting in FY2004.  The 
new MB includes an explicit cost category for blood and blood products.  
Also, the calculation of this modified MB with capital is based on a
ratio of operating to capital costs where operating costs account for 
91.032 percent of the total costs and capital costs account for the 
remaining 8.968 percent of the total costs.  

Long-Term Care Hospitals
	Long-term care hospitals (LTCHs) are designed to provide 
extended medical and rehabilitative care for patients who are 
clinically complex and have multiple acute or chronic conditions.  
Most patients in LTCHs have several diagnosis codes on their Medicare 
claims.  Approximately one-half of the patients have five or more 
diagnoses on their claims.  LTCHs consist of a relatively heterogeneous 
group of providers that typically provide a range of services, 
including comprehensive rehabilitation, head trauma treatment, and pain 
management.  Although some LTCHs treat a wide range of conditions, 
others specialize in one or two types of conditions.  The country's 
oldest LTCHs evolved from tuberculosis and chronic disease hospitals 
and may now still focus on patients with chronic conditions.  The newer 
facilities are designed primarily to care for ventilator dependent 
patients.  Finally LTCHs are distributed unevenly across the United 
States; one third of the facilities are located in Massachusetts, 
Texas, and Louisiana.  Old LTCHs (those participating in Medicare when 
IPPS was implemented) are generally located in the northeastern region 
of the United States, while new LTCHs are typically located in the 
southern region.  Old LTCHs are either government controlled or nonprofit.  
In contrast, one half of the LTCHs that began participation in Medicare 
between 1983 and 1993 and two-thirds of those that began participation in 
Medicare in FY1994 or later are proprietary facilities. In recent years, 
the LTCH group has evolved to include hospitals-within-hospitals (or co-
located hospitals) and satellite facilities in addition to traditional 
freestanding facilities.  The best available information indicates that 
as of 1997, roughly  21 percent of the LTCHs were co-located hospitals 
and 68 percent were freestanding; the affiliation status of the remaining 
11 percent could not be identified.   The number of LTCHs participating 
in Medicare has significantly increased.  In 1991, there were 91 LTCHs, 
a number that increased to 155 in 1994, 225 in 1999, 252 in 2000, and 
297 in April 2003.  
	LTCHs are certified under Medicare as short-term acute care 
hospitals which have been excluded from IPPS.  An LTCH has a Medicare 
inpatient average length of stay (ALOS) greater than 25 days or an 
ALOS for all patients of greater than 20 days if the hospital meets 
certain requirements.  Both covered and noncovered medically necessary 
days for Medicare patients are included in the  25-day ALOS calculation. 
Although, by statute, there are no LTCH distinct part units, there are 
satellite and hospital-within-a-hospital LTCHs that are co-located or 
share the same campus with acute care hospitals and other Medicare 
providers.  To be exempt from IPPS, a hospital-within-a-hospital must 
have a separate governing body, chief executive officer, chief medical 
officer, and medical staff and meet one of the following criteria: (1)
perform basic functions independently from the host hospital; (2) incur 
no more than 15 percent of its total inpatient operating costs for items 
and services supplied by the hospital in which it is located; or (3) have 
at least 75 percent of its patients admitted from sources other than the 
host hospital.  A satellite provider is a hospital-within-a-hospital 
facility that is owned by a separate, existing LTCH and is subject to 
distinct criteria established by regulation. Different payment rules 
can apply to these co-located Medicare providers, depending on the 
number and percentage of Medicare discharges and readmissions between 
the entities.   
	 Effective for the first cost reporting period beginning on or 
after  October 1, 2002, LTCHs are paid under a PPS, subject to a 5-year 
transition period. During the transition period, a facility's percentage 
payment based on the Federal rate increases by increments of 20 
percentage points over the 5 year period.  For instance, in the first 
year of its transition period, a LTCH was paid on a blended rate based 
on 20 percent of the Federal rate and 80 percent of its TEFRA target 
amount; the transition blend is based on 40 percent of the Federal rate 
and 60 percent of its TEFRA target amount in the second year.  By cost 
reporting periods beginning or after October 1, 2006, the transition 
period will be complete. Alternatively, a LTCH may elect the one time 
option to be paid based on 100 percent of the Federal prospective rate.  
Also, any new LTCH must be paid on 100 percent of the Federal rate.  
	Under this PPS, Medicare pays a LTCH a predetermined amount per 
discharge, depending upon the patient's assignment into one of 510 LTC-
DRGs. The patient classification system, LTC-DRGs, is based on IPPS DRGs 
that are reweighted to reflect the resource use of longer stay patients.  
Only one LTC-DRG is assigned to a hospitalization at the patient's 
discharge. The LTCH-PPS includes several facility level adjustments such 
as the area wage index and a cost of living adjustment (COLA) of up to 
25 percent for LTCHs in Alaska and Hawaii, but it does not include 
adjustments for rural location, low income patients served, or IME. 
With respect to case level adjustments, the LTCH-PPS will pay reduced 
amounts for short-stay outliers (but not cases that are deemed to be 
interrupted stays) and additional amounts for high cost outliers. Unlike 
the IRF-PPS, there are no special payment policies for transfer cases or 
deaths. The LTCH-PPS payment encompasses payments for both operating 
and capital-related costs of inpatient care, but certain costs, 
including those associated with approved educational programs, 
Medicare's bad debt expenses, or blood clotting factors, are paid for 
separately.  Starting July 1, 2003, CMS changed the LTCH-PPS from the 
Federal fiscal year (from October 1 through September 30) to a rate 
year that begins July 1 through June 30, of each year.  This date 
change affects the timing of the annual issuance of the LTCH update, 
Federal rate, and applicable facility and case level payment 
adjustments such as revisions to the wage index values and the fixed 
loss amount or high cost outlier threshold.  Changes to the LTC-DRGs 
classifications and their relative weights will remain on a Federal fiscal 
year schedule as will the effective dates for the LTCH-PPS transition 
blend period.
	CMS has adapted the IPPS patient classification system to 
better reflect the resource use and patient load in LTCHs.   Because 
LTCHs often specialize in certain types of cases, such as ventilator 
dependent patients, CMS uses a hospital-specific relative value method 
to calculate the relative weights for LTC-DRGs that differs from the 
method used to calculate the IPPS DRG relative weights.  Generally, 
the charges associated with a given LTC-DRG at each facility are 
adjusted to remove the effect of its pricing strategy (the facility's 
average markup in charges) and patient intensity (the facility's case 
mix index).  In calculating these relative weights, statistical 
outliers and cases with a length of stay of 7 days or less are removed.  
Weights also are adjusted for cases where the LTCH stay is less than 
five-sixths of the geometric average length of stay. Unlike IPPS, low 
volume LTC-DRGs, (those with less than 25 cases) are used to construct 
LTC-DRG weights.  The 161 low volume LTC-DRGs are grouped into 5 
quintiles based on average charge per discharge.  CMS calculates a 
relative weight and average length of stay for these quintiles using 
the same formula as the regular LTC-DRGs; those values are then 
assigned to each of the low volume LTC-DRGs that are included in the 
quintile.  CMS identified 159 of the 510 LTC-DRGs with no LTCH cases 
in the FY2001 claims data used to establish the cost weights.  These 
no volume LTC-DRGs are crosswalked to other clinically similar LTC-
DRGs and then grouped into the most appropriate of the 5 quintiles 
established for low volume LTC-DRGs. CMS made other adjustments to 
certain paired LTC-DRGs to correct for incompletely coded claims.   
Finally, LTC-DRGs representing organ transplants were given a 0.00 
cost weight, since none of the currently participating LTCHs are 
Medicare-approved transplant centers (or apparently, have ever 
expressed any interest in becoming such providers.)	The cost 
weight for a LTC-DRG multiplied by a standard Federal rate represents 
the framework for Medicare's payment for a given patient which, as 
mentioned earlier, is then subject to facility level and case level 
payment adjustments.  CMS used cost report data from FY1996 through
FY1999 and FY2001 claims data, updated to FY2003,  to calculate the 
LTCH standard Federal payment rate.  Data from certain providers 
that did not maintain charge data (providers that billed using an all 
inclusive rate) or that operated under demonstration projects were 
excluded.  CMS adjusts the standard Federal rate by a reduction 
factor of 8 percent as an offset for the estimated LTCH outlier 
payments. By statute, total payments under LTCH-PPS must be equal to 
the amount that would have been paid if the PPS had not been 
implemented. Accordingly, CMS included a 0.34 percent reduction in 
the Federal rate to account for behavioral changes that would occur 
as LTCH respond to incentives inherent in the new payment system.  
CMS includes a budget neutrality offset to account for the increased 
spending that results from LTCHs electing full Federal payment during 
the transition period.  The amount of the offset is re-estimated each 
year.  In FY2003, CMS imposed a 6.6 percent budget neutrality offset 
(using a factor of 0.934 which is 1.0 minus .066) to account for $50 
million in projected additional costs that would occur that year because 
of the number of LTCH that CMS anticipated would elect payment based on 
the Federal rate.  In the 2004 rate year, the budget neutrality offset 
was established at 6 percent to account for the $120 million in 
additional payments attributed to the LTCH-PPS transition period.  The 
budget offset applies to all LTCH payments, not just those computed 
using the full Federal payment during the transition period; a LTCH 
that is being paid on a transition blend with some proportion of its 
payments based on its TEFRA rate would have its TEFRA based payments 
reduced as well.  Finally, CMS will review LTCH payments and may make 
a one-time prospective adjustment to the LTCH PPS by October 1, 2006, 
to correct for any errors in the original budget neutrality 
	Like the IRF-PPS, the LTCH-PPS uses the IPPS wage index data for 
its adjustment.  However, because CMS did not find a significant 
relationship between LTCHs' costs and their geographic location, the 
LTCH wage index adjustment is being phased in using 20 percentage point 
increments each year over a 5-year period, starting with cost reporting 
periods beginning on or after October 1, 2002.  The timing of the 
implementation of the wage index adjustment is linked to the provider's 
actual cost reporting period.  Annual updates to the wage index, however,  
are linked to the LTCH rate year.  Consequently, the wage adjustment for 
a particular LTCH may change during its cost reporting period.  For 
instance, a LTCH with a cost reporting period from January 1, 2003 
through  December 31, 2003 is paid using 1/5th of the applicable wage 
index value for that entire cost reporting period.  From January 1, 2003 
to June 30, 2003,  its payments will be based on 1/5th of the FY2002 
IPPS wage index value for its area; from July 1, 2003 to December 1, 
2003, its payments will be based on 1/5th of the FY2003 IPPS wage index 
value for its area.  Starting January 1, 2004, it will receive 2/5ths 
of the FY2003 IPPS wage index value.  
	To illustrate this wage adjustment, assume the LTCH with a cost 
reporting period beginning on January 1 is located in the Chicago, MSA.  
This MSA has an FY2002 IPPS wage index value of 1.1008, so the LTCH 
would receive a wage index adjustment of 1.0202 starting CY2003, the 
first year of its phase-in period.  It would receive this wage index 
adjustment until June 30, 2003.  Starting for discharges on July 1, 
2003, all LTCHs will be paid using the FY2003 IPPS wage index values 
(with no accounting for geographic reclassifications); the applicable 
FY2003 wage index value for the Chicago MSA is 1.15.  The LTCH would 
receive a wage index adjustment of 1.0209 for discharges from July 1, 
2003 to December 31, 2003 (1/5th of 1.1044) when it is still in its 
first year of the wage index phase-in period.  Starting in CY2004, the 
LTCH will be paid using 2/5ths of the applicable wage index value.  The 
LTCH would receive a wage index adjustment of 1.0418 (2/5ths of 1.15) 
starting on January 1, 2004 for the next 6 months; this adjustment 
would change on July 1, 2004 when the LTCH wage index would be updated. 
	CMS has established the Federal rate of $35,726 for the 2004 
LTCH-PPS rate year.  The labor-related portion (72.885 percent) of the 
Federal payment rate is multiplied by the applicable area's wage index 
value of the physical location of the LTCH.  This wage-adjusted amount 
is added to the non-labor related portion of the rate which will be 
adjusted for COLA if applicable to determine the adjusted Federal 
payment rate.   Table 2-19 illustrates the LTCH-PPS adjusted payment 
calculation for the LTCH in Chicago discussed earlier and a case in 
LTCH-DRG 09, Spinal Disorders and Injuries, which has a relative weight 
of 1.4118.  This particular LTCH has opted for payment based on 100 
percent of the Federal rate.  As mentioned earlier, the budget offset 
would apply equally to LTCH that is being paid on a transition blend; 
its TEFRA based payments would be reduced as well.



	Aside from facility level adjustments, the LTCH-PPS includes 
certain case level adjustments as well.  Generally, a short-stay outlier 
will be paid the lesser of 120 percent of the cost of the case, 120 
percent of the LTC-DRG specific per diem payment, or the full LTC-DRG 
payment.  In this PPS, a short-stay outlier is a case that has a length 
of stay less than or equal to 5/6s of the ALOS for the LTC-DRG to which 
the case is assigned.  For example, if the ALOS for a particular 
LTC-DRG is 30 days, then the short-stay outlier policy would apply to 
any stays that are 25 days or less in length (5/6s of 30 days is 25 
	An interrupted stay is a case where a LTCH patient is discharged 
and then admitted directly to an inpatient acute care hospital, an IRF, 
a skilled nursing facility, or a swing-bed and then returns to the same 
LTCH within a fixed period of time which varies by provider type.  The 
limit is 9 days or less in an acute hospital; 27 days or less in an IRF; 
45 days or less in an SNF or in a swing-bed.  If the patient returns to 
the LTCH within these fixed limits, Medicare treats the case as an 
interrupted stay and only one payment to the LTCH is made. 

	Finally, Medicare pays additional amounts for cases that are 
high cost outliers where the estimated cost of the case exceeds the 
outlier threshold.  This threshold is the LTC-DRG payment plus a 
fixed-loss amount.  CMS establishes the fixed loss amount annually so 
that projected outlier payments equal 8 percent of estimated total LTCH-
PPS payments.  The fixed-loss amount for the 2004 rate year is $19,590.  
CMS will pay 80 percent of cost above the outlier threshold for high 
cost outlier cases. 
	Like the IRF-PPS, the LTCH-PPS Federal payment rate is increased 
annually based on most recent estimate of the modified TEFRA MB for 
excluded hospitals (those not paid under IPPS) adjusted for capital 
costs.  CMS revised and rebased the excluded hospital with capital MB 
to a 1997 base year and included an explicit cost category for blood 
and blood products.  As mentioned earlier, the calculation of this 
modified MB with capital reflects a ratio of operating-to-capital costs 
where operating costs comprise 91.032 percent of the total costs 
and capital costs account for the remaining 8.968 percent of total costs.  
Starting July 1, 2003, CMS changed the annual update to the LTCH Federal 
payment rate from the Federal fiscal year (from October 1 through 
September 30) to a rate year that begins July 1 through June 30, of each 
year.  The 2004 update calculation included an adjustment for the change 
in the update cycle.  The full 12-month MB with capital increase was 
estimated to be 3.3 percent which was reduced by -0.8 percent; the 
2004 LTCH PPS rate year increase was 2.5 percent. 


	Medicare covers extended care services provided in nursing homes 
for beneficiaries who require additional skilled nursing care and 
rehabilitation services following a hospitalization. These extended 
care services, commonly known as skilled nursing facility (SNF) benefits, 
are covered under Part A for up to 100 days per spell of illness and 
must be provided in an SNF certified to participate in Medicare. A spell
of illness is that period which begins when a beneficiary is furnished 
inpatient hospital or SNF care and ends when the beneficiary has been 
neither an inpatient of a hospital nor an SNF for 60 consecutive days.
A beneficiary may have more than one spell of illness per year. 
	In order to be eligible for SNF care, the beneficiary must have 
been an inpatient of a hospital for at least 3 consecutive days and must 
be transferred to an SNF, usually within 30 days of discharge from the 
hospital. Furthermore, a physician must certify that the beneficiary is 
in need of skilled nursing care or other skilled rehabilitation services 
on a daily basis, which, as a practical matter, can only be provided on 
an inpatient basis and which are related to the condition for which the 
beneficiary was hospitalized.

	Prior to a congressionally mandated prospective payment system, 
Medicare paid for SNF care on a retrospective cost-based basis. This 
meant that SNFs were paid for the reasonable costs (as defined by the 
program) they incurred for the care they provided as determined at the 
end of the SNF's fiscal year.  SNFs had few incentives to maximize 
efficiency and minimize their costs, and little inducement to control 
the amount or number of services they provided.
 	Prospective payment system--In BBA 1997, Congress required that 
a prospective payment system (PPS) for SNF care be phased in over 3 
years, beginning with the SNF's first cost reporting period after July 
1, 1998. SNF prospective payment involves grouping patients according 
to the type and intensity of services they require and setting a daily 
payment rate for each payment group. Like other PPSs that pay health 
care providers for care to Medicare beneficiaries on the basis of 
predetermined, fixed amounts, Medicare payments to SNFs are intended to 
pay the provider for its Medicare beneficiary costs on average. That 
is, although the payment is a predetermined daily rate, a facility's 
actual costs may be above or below that amount for an individual 
patient. The incentive facilities have is to manage costs so that, on 
average, costs do not exceed the PPS average amounts.  SNFs that provide 
the services at lower costs than the Medicare payment are able to keep 
the difference. 
	Unit of Payment--Under SNF PPS, a SNF receives a daily payment 
that covers all the services provided to the beneficiary that day 
including room and board, nursing, therapy, food, and medicine with 
very limited exceptions.  Some care costs are paid separately under 
the statute such as physician visits and dialysis services. The daily base 
payment, called the ''Federal per-diem rate,'' is based on actual 1995 
SNF costs that have been trended forward for inflation and varies by the 
urban or rural location of the SNF.  The Federal per-diem rate is broken 
down into four components, two of which are adjusted for case mix: nursing 
componentBadjusted for case-mix; therapy componentBadjusted for case mix; 
therapy componentBnot adjusted for case mix; and the non-case mix adjusted 
	Case-Mix System--The statute requires the Secretary to develop an 
appropriate adjustment to the Federal rate to account for case mix.  The 
case mix system developed adjusts the Federal per-diem rate for treatment 
and care needs of the beneficiary and is called Resource Utilization 
Groups, version III (RUG-III). RUG-III is composed of 7 major categories 
that are further differentiated into 44 specific patient groupings.  
The 7 major categories are ''hierarchical,'' that is, patients are 
automatically grouped into the highest paying groups given their 
condition.  The 7 categories, in hierarchical order, are: 
Rehabilitation, Extensive Services, Special Care, Clinically Complex, 
Impaired Cognition, Behavior Problems, and Reduced Physical Function 
(see Table 2-20.)  Patients in need of rehabilitative therapy services 
are automatically assigned one of the  14 rehabilitation groups, 
depending upon the minutes of rehabilitative services  they receive 
in a week, the combinations of disciplines providing the services, 
and the patient's activities of daily living (ADL) scores (ADL scores 
measure patients' abilities in toileting, grooming, dressing and so 
forth).  The next category, Extensive Services, is composed of 3 
groups which use services requiring more technical knowledge and 
skill as the variables for patient assignment, rather than ADL scores.  
The third category, Special Care, is made up of 3 groups composed of
patients with one or more of the conditions in this category.  ADL 
scores determine group assignment within this category.  The fourth 
category, Clinically Complex, is composed of 6 groups comprising 
patients with a variety of conditions including burns, septicemia and 
pneumonia or who require more complex care.  ADL scores and patient 
depression determine group assignment within this category.  The fifth 
category is Impaired Cognition, which is comprised of 4 groups of 
patients with poor cognitive performance. Patients receiving care that 
falls within this category are unlikely to qualify for Medicare 
coverage of their stay because of the skilled care requirements. The 
sixth category is Behavior Only, which has 4 groups.  Patients receiving
care that falls in this category have exhibited behaviors that include 
resisting care, being combative or who have hallucinations or delusions. 
These patients are unlikely to qualify for Medicare coverage of their 
stay because they may not require skilled care.  The final RUG category 
is Physical Function Reduced which contains 10 groups.  Patients in this 
category are those who do not have any of the conditions or 
characteristics for the other groups.  As with the earlier two RUGs, 
patients in this group are unlikely to require the skilled care needed 
to qualify for Medicare payment.


	BBRA 99 increased payments for 15 RUGS by 20 percent beginning  
April 1, 2000 and ending when the Secretary implements refinements to the 
RUGs. The RUGs that were increased were for rehabilitation services, 
extensive services, special care services, and clinically complex 
services.  BIPA 2000 modified the add-on to correct for a payment 
anomaly created by BBRA 99 where several of the mid-intensity 
rehabilitation RUGs were paid at a higher rate than the high intensity 
rehabilitation RUGS.  These temporary increases result in additional 
payments to SNFs of approximately $1 billion a year.
	Since the inception of SNF PPS, CMS has been conducting research
on refinements to the RUGs.   In April, 2000 the Secretary proposed
refining the RUGs by adding payment categories to better compensate 
SNFs for providing care to medically complex patients as well as to 
better account for the "non-therapy ancillary service" costs (such as 
prescription drugs and respiratory therapy). However, the proposal was 
withdrawn when, upon further analysis, CMS determined that the existing 
RUGs did a better job than the proposed ones in describing differences 
in patient resource use.  Since then, the Secretary has not proposed 
any refinements.  In the SNF PPS proposed rule published May 16, 
2003, CMS announced that the RUGs would not be refined for FY 2004, thus 
keeping in place the temporary add-on payments.  A press release on the 
proposed rule stated, "After careful review of the available data, CMS 
determined that the research is not sufficiently advanced at the present 
time to implement the refinements this year." CMS is continuing its 
research on refinements to the RUGs system.  BIPA 2000 requires the 
Secretary to study different systems for categorizing SNF patients and 
to report to Congress by January 1, 2005 with the results and any 
recommendations for changing the SNF PPS statute.
	Wage Adjustment--The final adjustment under SNF PPS is to 
adjust for differences in wages between geographic areas.  The labor-
related portion of the payment rate is approximately 76 percent. The 
statute gives the Secretary discretion to use the wage index he finds 
appropriate.  The Secretary uses the most recent hospital wage index 
to adjust SNF PPS payments.  In 2001, the Secretary explored using SNF 
wages to construct a SNF PPS wage index. The proposal was not adopted 
for several reasons: reliability of the existing data (there were 
significant variations in the SNF-specific wage data and a large number 
of SNFs were unable to provide adequate wage and hourly data); SNF 
record keeping burden (SNFs would have to keep detailed data, submitting 
it to fiscal intermediaries annually, and facing audit of those data); 
and significant resource commitment by CMS (the editing, reviewing, and 
auditing of the data for approximately 14,000 SNFs would require 
significant new resources).
	Payment Calculation--As discussed above, SNF PPS payments are 
daily payments.  The urban or rural unadjusted Federal per diem rate is 
broken down into four categories, two of which are adjusted for case mix 
using the patient's RUG. Each of the RUGs is then broken into a labor-
related and non labor-related share and the labor portion is multiplied 
by the wage index for the area in which the SNF is located.  The non-
labor portion of the base payment amount is added back in to arrive at 
the total daily payment.   The payment formula is: Daily payment = 
(Labor-related case-mix adjusted rate x area wage index) + (non-labor-
related case-mix adjusted rate).  An example of the calculations is 
shown in Table 2-21. The case-mix adjusted rate = (Nursing component of 
Federal Rate x Nursing weight for RUG)+(Therapy component of Federal 
Rate x Therapy weight for RUG)+ (Therapy non-case mix component)+(Non-
case mix component).  
	Outliers--The statute does not permit payments for outliers 
under SNF PPS. 
 In the other PPSs that have outlier payments, the statute contains 
 explicit  authority for the Secretary to make outlier payments.
	Updates--The SNF Federal rates are updated annually using the 
SNF market basket index.  The SNF market basket index is a measure of 
change in the price of goods and services used in providing care for 
Medicare beneficiaries in a SNF. For  FY 2004, SNFs received a full 
market basket update of 3.0 percent. In addition, for FY 2004, the 
Secretary issued a regulation that corrected cumulative forecast error 
in the market basket since SNF PPS began on July 1, 1998.  As a result 
the FY 2004 rates will be increased by an additional 3.26 percent.



	Payments Outside the PPS--BBRA expanded the list of services 
that are excluded by statute from the SNF PPS: certain chemotherapy 
items and administration services, certain radioisotope services, 
certain prosthetic devices, and ambulance services furnished in 
conjunction with renal dialysis treatments. BBRA required that any 
increase in total payments that result from these exclusions be budget 
neutral, that is, that the Federal per-diem amounts be reduced 
proportionate to the payments.

SNF payments and utilization 
	For a number of years, SNF care was one of Medicare's fastest 
growing benefits. Table 2-22 shows that SNF utilization and spending 
first began to increase substantially in 1988 and 1989. These increases 
can be traced to changes that occurred in the benefit at that time. 
First, HCFA issued new coverage guidelines that became effective early 
in 1988. Prior to this time, studies had pointed to a lack of adequate 
written guidance on coverage criteria that led to inconsistencies in 
coverage decisions for a benefit that was intended to be uniform across 
the country. As a result, many SNFs were reluctant to accept Medicare 
beneficiaries because of the possibility that a submitted claim would 
be retroactively denied.  The 1988 guidelines clarified coverage 
criteria by providing numerous examples of covered and noncovered care. 
Furthermore, the guidelines explained that even when a patient's full or 
partial recovery is not possible, care could be covered if it were 
needed to prevent deterioration or to maintain current capabilities. 
Previously, some care had been denied coverage because patients' 
health status was not expected to improve. 
	The second major, though temporary, change in Medicare's SNF 
benefit came in 1988 with the enactment of the Medicare Catastrophic 
Coverage Act (MCCA). Effective beginning in 1989, this legislation 
eliminated the SNF benefit's prior hospitalization requirement; revised 
the coinsurance requirement to be equal to 20 percent of the national 
average estimated per-diem cost of SNF services for the first 8 days of 
care; and authorized coverage of up to 150 days of care per calendar 
year (rather than 100 days per spell of illness). These changes were 
repealed in 1989, and the SNF benefit's structure assumed its prior 
form. Studies have suggested that the coverage guidelines and MCCA 
changes together might have caused a long-run shift in the nursing home 
industry toward Medicare patients that did not end with repeal of MCCA.
	Table 2-22 shows that SNF spending in calendar year 1990 stood 
at $2.3 billion; by 1997 it had increased to $12.9 billion, for an 
average annual growth rate of 28 percent.  With implementation of the 
PPS payment system in mid-1998, however, the rate of increase dropped 
precipitously: between 1997 and 1998 payments decreased 0.9 percent, 
and payments decreased by 18.3 percent in 1999. Between 1992 and 1997 
the number of Medicare beneficiaries receiving SNF care doubled from 
778,000 to 1.5 million. The number of covered days grew from 27 million 
to 50 million, or by 85 percent. After the implementation of SNF PPS in 
July 1998, spending dropped below that of earlier years.  Not until 
2001 did SNF spending exceed 1998 levels.  This drop in spending has 
been attributed to both increased activities in preventing fraud and 
abuse and to the implementation of the new PPS.  Payment increases 
contained in BBRA 99 and BIPA 2000 helped account for the increase in 
payments seen after 1999.




Coverage and Benefits
	The Medicare home health benefit has specific statutory 
eligibility criteria: a beneficiary must be confined to his or her home 
(that is, be ''homebound'', be under the care of a physician, and need 
skilled nursing care on an intermittent basis or other skilled therapy 
care.  A homebound individual is defined as one who cannot leave home 
without a considerable and taxing effort, or who requires the aid of a 
supportive device (such as crutches, a cane, a wheelchair, or a walker), 
or if the individual has a condition such that leaving the home is 
medically contraindicated. Absences from home may occur infrequently 
for short periods of time for purposes such as to receive medical 
treatment, attend certain adult day care programs, or attend church. 
Skilled care includes skilled nursing or therapy (physical, speech/
language, occupational) services that are delivered under the care of 
a physician and in accordance with a plan of care that is periodically 
reviewed by a physician.  Skilled nursing care and home health aide 
services must be provided on a part-time or intermittent basis, which 
is defined as ''less than 8 hours each day and 28 or fewer hours each 
week (or, subject to review on a case-by-case basis as the need for 
care, less than 8 hours each day or 35 or fewer hours per week).''
	For beneficiaries meeting the qualifying criteria, Medicare's 
home 	health benefit covers the following services: 
1. Part-time or intermittent nursing care provided by or under the 
supervision of a registered nurse; 
2.  Physical or occupational therapy or speech-language pathology 
3.  Medical social services; 
4. Part-time or intermittent services of a home health aide who has 
successfully completed a training program approved by the Secretary; 
5.  Medical supplies (excluding drugs and biologicals) and durable 
medical equipment (DME); 
6.  Medical services provided by an intern or resident in training 
under an approved training program with which the agency may be 
affiliated; and 
7.  Certain other outpatient services which involve the use of 
equipment that cannot readily be made available in the beneficiary's 

	Home health care is covered by Medicare as long as the care is 
medically reasonable and necessary for the treatment of illness or 
injury. Although the number of home health visits a beneficiary may 
receive is unlimited, services must be provided pursuant to a plan of 
care that is prescribed and periodically reviewed by a physician. In 
general, Medicare's home health benefit is intended to serve 
beneficiaries needing acute medical care requiring the services of 
skilled health care personnel. It was never envisioned as providing 
coverage for the nonmedical supportive care and personal care 
assistance needed by chronically impaired persons. It is not a 
long-term care program for the disabled or the frail elderly. 
Beneficiaries do not have any copayments for home health services.
	Home health aide visits include ''hands-on personal care to 
the beneficiary or services that are needed to maintain the 
beneficiary's health or to facilitate treatment of the beneficiary's 
illness or injury.''  Covered home health aide services include personal 
care of a patient, simple dressing changes that do not require the 
skills of a licensed nurse and assistance with medications that 
ordinarily are self-administered and do not require the skills of a 
licensed nurse.
	Home health services are provided by private or public home 
health agencies (HHAs) that specialize in provision of such services 
and that are certified to participate in Medicare by CMS. HHAs may 
be public or government-sponsored entities, private nonprofit 
agencies, or proprietary for-profit agencies. Hospitals may own or 
sponsor an HHA. Home health care givers may be employees of the HHA or 
may work for an agency under contract. Often, Medicare beneficiaries 
constitute the great majority of an HHA's caseload, although other users 
include individuals covered by Medicaid and those with private 
insurance or who pay out of pocket. 

Financing for Home Health Benefits
	The financing for the home health care benefit is split between 
the Hospital Insurance Trust Fund (Part A) and the Supplementary Medical 
Insurance Trust Fund (Part B).  At the inception of the home health 
benefit, Part A paid for up to 100 home health visits for beneficiaries 
enrolled in Part A and who had had a 3-day prior hospitalization.  
Home health care was also covered under Part B, up to 100 visits, for 
beneficiaries who had no prior hospitalization, or who had exhausted 
their 100 Part A visits, or who had Part B coverage only.  The Omnibus 
Budget Reconciliation Act of 1980 liberalized the rules governing 
Medicare's coverage of home health services, including eliminating the 
requirement for a prior hospitalization and removing the limitation on 
the number of visits.  This had the effect of shifting the financing for 
home health services almost entirely over to the Part A Trust Fund.  
The only beneficiaries for whom Part B payments were made were those who 
had no Part A coverage. 
	BBA 97 reimposed joint financing of the home health benefit 
between Parts A and B by gradually transferring those home health 
services unassociated with a hospital stay from Part A to Part B.  
Medicare Part A covers the first 100 visits following a 3-day hospital 
stay or a SNF stay.  The transfer was phased in over a 6-year period.  
Transferring certain certain home health service costs to the Part B 
Trust fund results in increased outlays and thus increased Part B premium 
costs to beneficiaries.  This increased cost in premiums was phased in 
over 7 years.  Beneficiaries without Part B coverage receive unlimited 
Part A coverage for home health services.

	Prior to implementation of a congressionally mandated 
prospective payment system, Medicare paid for home health care on a 
retrospective cost-based basis. This meant that HHAs were paid for 
the reasonable costs (as defined by the program) they incurred in 
providing care to Medicare beneficiaries.  These reasonable costs 
were determined at the end of the HHAs fiscal year, and were 
subject to certain limitations. Prior to BBA 97, HHAs had one cost 
limit: a limit on the costs of providing each visit.  This ''per-
visit cost limit'' was applied in the aggregate B that is, the 
limit was calculated by multiplying the cost limit by all the 
Medicare visits the agency made in the year -- not to individual 
visits.  The per-visit cost limit gave agencies an incentive to 
control the costliness of the visits provided. However, 
agencies could easily circumvent the limit by providing two short 
visits rather than one long visit. In the period preceding BBA 97, 
the number of visits provided to Medicare beneficiaries increased 
dramatically as did Medicare expenditures for home health services (see 
Table 2-25).  In an attempt to control the costs of the care provided to
Medicare beneficiaries, Congress, in BBA 97, reduced the per-visit cost
limits and imposed an additional cost limit, the aggregate per 
beneficiary limit, until prospective payment could be implemented.  
The reduced and new cost limits were called the interim payment system. 
The aggregate per beneficiary limit was calculated by multiplying the 
limit by the number of Medicare beneficiaries served by the agency.  
It was based on the average costs incurred by agencies during agencies' 
fiscal year ending before October 1, 1994.  After BBA 97, HHAs were 
reimbursed the lesser of: (1) their actual reasonable costs; (2) 
their reasonable costs subject to the per visit limit; or (3) their 
reasonable costs subject to the aggregate per beneficiary limit.  
	Prospective payment system--In BBA 97, Congress required that a 
prospective payment system (PPS) for home health care be implemented for 
cost reporting periods beginning on or after October 1, 1999.  The 
effective date of home health PPS was amended to October 1, 2000, for 
all agencies, because of the inability of CMS to make systems changes 
for the new payment system while the agency was fixing its computer 
systems for the year 2000 computer problems.
	Home health prospective payment involves grouping patients 
according to the type and intensity of services they require and setting 
a payment rate for each payment group.  Payment is based on the unit of 
payment adjusted for the area wages in which a beneficiary resides and 
is adjusted for the care needs of the beneficiary.  Like other PPSs 
that pay health care providers for care to Medicare beneficiaries on 
the basis of predetermined, fixed amounts, Medicare payments to HHAs 
are intended to pay the agency for its Medicare beneficiary costs on 
average. That is, although the payment is a predetermined rate, an 
agency's actual costs may be above or below that amount for an 
individual patient. The incentive agencies have is to manage costs so 
that, on average, costs do not exceed the PPS average amounts.  HHAs 
that provide the services at lower costs than the Medicare payment 
are able to keep the difference. 
	Unit of Payment--Under home health (HH) PPS, an HHA receives 
a payment for a 60-day episode of care for beneficiaries.  The 60-day 
episode includes skilled nursing, therapy, aide visits, medical 
supplies, and medical social workers.  Physician services, durable 
medical equipment and osteoporosis drugs are not included in the HH PPS.  
The 60-day episode base payment, called the ''national standardized 
60-day episode rate'' is based on actual, audited FY 1997 home health 
costs that have been trended forward for inflation.  The base payment 
amount for FY2003 is $2,159.39 for a 60-day episode of care.  There 
is not a distinction between urban and rural base payment amounts. 
	Wage Adjustment--The unit of payment is adjusted to account for 
differences in the area wages.  The statute gives the Secretary 
discretion to use the wage index he finds appropriate and explicitly 
authorizes the Secretary to use the hospital wage index for home 
health PPS.  The Secretary uses the previous year's  hospital wage 
index (that does not contain the reclassifications or floors in the 
hospital wage index used to adjust hospital PPS payments) to adjust 
for differences in area wages.  In FY 2004, the FY 2003 pre-floor and 
pre-reclassified hospital wage index is used to adjust payments. The 
wage index for the area in which the beneficiary is actually served is 
used to adjust the payments.  CMS has explored 
using a wage index specific to HHAs in the past, but has not adopted 
one because the earlier efforts had data and methodological issues.
	Case Mix System--The statute requires the Secretary to develop 
"...appropriate case mix adjustment factors for home health services in 
a manner that explains a significant amount of the variation in cost 
among different units of services."  The case mix system developed 
adjusts the base payment rate for the treatment and care needs of 
beneficiaries and is called Home Health Resource Groups (HHRGs). The 
HHRGs estimate the resource use for specific combinations of  clinical, 
functional and service levels.  There are 4 clinical severity levels, 
5 functional severity levels, and 4 services utilization levels.  The 
combinations result in 80 HHRGs. Each combination defines one of the 
80 groups in the case-mix system.  Each patient is assigned to one of 
the groups as determined following an assessment of the patient's 
condition and care needs using the Outcome and Assessment Information 
Set (OASIS).  A patient with high clinical severity, moderate 
functional severity, and low services utilization severity is placed in 
the same group (C3F2S1) with all other patients whose summed scores 
place them in the same set of severity levels for the three dimensions.  
Table 2-23 shows the HHRGs and their relative case mix weights.
	Payment Calculation--The standardized 60-day episode rate is 
adjusted for the area wage index where the beneficiary served resides 
and for case mix using the applicable HHRG.  To calculate payment, the 
episode rate (in column a of  Table 2-24) is multiplied by the labor 
portion (0.77668) and then by the appropriate area wage index 
(column c).  The result is added to the non-labor portion of the 
episode rate (column d).  That sum (in column e) is multiplied by 
the appropriate HHRG weight (column g) to arrive at a 60-day episode 






	HHAs are paid 60 percent of the wage- and case mix- adjusted 
payment after submitting a request for anticipated payment (RAP). The 
RAP may be submitted at the beginning of a beneficiary's care once the 
HHA has received verbal orders from the beneficiary's physician and 
the assessment is completed.  The remaining payment is made when the 
beneficiary's care is completed or the 60-day episode ends.  Depending 
upon the circumstances additional adjustments such as an outlier 
payment or a significant change in condition adjustment may be made to 
the adjusted episode payment.  These additional adjustments are 
described below.
	Updates--The home health 60-day episode rate is updated annually 
using the home health market basket index.  The home health market 
basket index is a measure of change in the price of goods and services 
used in providing care for Medicare beneficiaries receiving home care.  
For FY 2004, agencies received a full market basket update of 3.3 
	Outliers--The outlier adjustment provides additional payment to 
an HHA when the cost of an episode of care is unusually large.  Outlier 
payments are made for episodes whose estimated costs exceed a 
threshold amount for each HHRG. Five percent of total home health 
payments are set aside for outlier payments.
	Significant Change in a Beneficiary's Condition (SCIC)--An 
HHA's payments can be modified within a patient's 60-day episode when 
a significant change in a beneficiary's condition occurs.  To obtain 
this adjustment, an HHA must obtain the necessary change order from the 
physician; note the required changes in treatment in the beneficiary's 
plan of care; and complete a new OASIS evaluation, which will produce a 
new case-mix adjustment factor.  Payment will be an amount that is 
proportional between the HHRG prior to the change and 
the HHRG after the significant change in condition.
	Partial Episode Payment--The partial episode payment adjustment 
is made if a beneficiary transfers from one HHA to another HHA during a 
60-day episode.  The first HHA to provide care will have its payment 
reduced by a portion equal to the amount of time during the 60-day 
episode in which care was provided.  The second HHA will conduct an 
assessment, and a new, 60-day episode of care will begin. 
	Low Utilization Payment Adjustment (LUPA)--The PPS payment for 
an agency is adjusted if a beneficiary's care is delivered in 4 or 
fewer visits.  The payment is a standardized, service-specific per-visit 
amount multiplied by the number of visits actually provided during the 
Background and Trends in Medicare HHA Utilization and Spending  
	During the first 10 years of the Medicare Program, home health 
care accounted for less than 2 percent of total Medicare spending.  
Although home health spending was increasing rapidly (at an average 
annual rate of about 23 percent between 1970 and 1980), Medicare 
spending overall was also increasing significantly (the average annual 
rate of growth was about 17 percent between 1970 and 1980).  Between 
1980 and about 1990 home health grew to 2 to 3 percent of total program 
spending reflecting the faster growth in home health spending than 
Medicare as a whole. This small increase reflected the 1980 
liberalizations in the home health benefit as well as the effect the 
inpatient hospital prospective payment system had on overall Medicare 
spending.  Some analysts had predicted that the inpatient PPS (which 
began in 1984) would lead to even larger growth in home health care 
utilization by Medicare beneficiaries than had occurred in the prior 
decade. However, home health care spending increases that might have 
occurred as a result of the inpatient PPS were offset by changes in 
the law and in certain administrative procedures. For instance, the 1984 
Deficit Reduction Act required HCFA to reduce the number of ''fiscal 
intermediaries'' with which HCFA contracts to process Medicare home 
health care claims. These entities approve or deny beneficiary 
eligibility for home health care as well as HHA claims for payment. As 
HCFA reduced the number of fiscal intermediaries, eligibility and 
claims decisions became more standardized.  HCFA also intensified 
educational programs for claims processors, required HHAs to submit 
increased documentation with each claim, and increased the number of 
claims subjected to in-depth medical reviews.  The home health care 
claims denial rate rose from 3.4 percent in 1985 to 7.9 percent in 1987. 
These actions served to moderate the rate of growth of the home health 
	A significant event in the history of the Medicare home health 
benefit was settlement of a class action lawsuit filed in 1988 (Duggan 
v. Bowen) which challenged HCFA's interpretation of the ''part-time or 
intermittent'' provision in section 1861(m) of the Social Security Act.  
As a result of the decision, HCFA revised the agency's policy regarding 
the interpretation of the statutory language, changing the policy 
interpretation from part-time and intermittent to part-time or 
intermittent.  This change allowed the number of visits to be increased 
because they no longer had to be ''intermittent'' but could be made on 
a daily basis.HCFA's revised guidelines also loosened the claims 
procedures that had been tightened between 1985 and 1987.  The revised 
guidelines may have opened the door to eligibility for persons who have 
ongoing medical problems that require personal care assistance 
associated more with long-term care rather than acute care.  From 1987 
to 1997 the number of beneficiaries receiving home health services more 
than doubled and the average number of visits per home care patient 
increased more than threefold, from 23 visits in 1987 to 73 in 1997 
(Table 2-25).  During this time period, the number of HHAs participating 
in Medicare also increased sharply, growing from 5,686 agencies in 1989 
to 10,492 in 1997.  This dramatic growth in the number of beneficiaries 
served and the number of visits provided also resulted in similarly 
dramatic increase in Medicare spending for home health.  Home health 
spending rose from $1.9 billion in 1987 to about $17.5 billion in 1997, 
an average annual increase of almost 25 percent (Table 2-25).  This 
growth led to changes in payment in the BBA, as well as other provisions 
that affected HHAs, and also led to scrutiny by the HHS Office of the 
Inspector General and the General Accounting Office regarding fraudulent 
practices by some home health agency operators.  CMS changed a number of 
practices regarding home health agencies and initiated a moratorium on 
allowing new HHAs to enter the Medicare program from September 1997 
through January 1998.
	After the BBA, Medicare payments to HHAs decreased sharply, 
falling more than 35 percent in the first full year the aggregate per 
beneficiary cost limits were in place and an additional 24 percent in 
the second year.  The number of beneficiaries served decreased more than 
10 percent a year for the three years after BBA passed.  This decrease 
was due to the stepped up program integrity activities directed at HHAs 
and to a change in a qualifying service by BBA. The average number of 
visits per beneficiary served also decreased dramatically, falling 
almost 30 percent in the first full year after BBA due to the application 
of the interim payment system.
	After implementation of the HH PPS October 1, 2000, payments 
increased by 8.5 percent in 2001 and by 13 percent in 2002. The number of 
visits and, to a lesser degree, the number of beneficiaries served, 
continued to decline after the implementation of PPS.  In 2001, the 
average number of visits per person dropped to 28 and the number of 
beneficiaries served per thousand dropped to 71.


Coverage and benefits 
	Medicare covers hospice care for terminally ill beneficiaries, 
in lieu of most other Medicare services related to the curative treatment 
of their illness.  Beneficiaries who elect hospice may still receive 
curative treatments for illnesses or injuries unrelated to their 
terminal illness and they may disenroll from hospice at any time.  
Congress established the hospice benefit in the Tax Equity and Fiscal 
Responsibility Act of 1982 (TEFRA) for a period of 3 years.  Congress 
made the benefit permanent in the Consolidated Omnibus Budget 
Reconciliation Act of 1985 (COBRA). 



	Hospice care emphasizes palliative medical care, that is, relief 
from pain, and supportive social and counseling services for terminally 
ill beneficiaries and their families. Services are provided primarily in 
the patient's home. Hospice is designed to provide a broad range of 
services including prescription drugs for pain control and symptom 
management, skilled nursing care, physician services, home health aide 
services, homemaker services, patient counseling, and family bereavement 
	For a person to be considered terminally ill and eligible for 
Medicare's hospice benefit, the beneficiary's attending physician and 
the medical director of the hospice (or physician member of the hospice 
team) must certify that the individual has a life expectancy of 6 months 
or less. Beneficiaries electing hospice are covered for two 90-day 
periods, followed by an unlimited number of 60-day periods. The medical 
director or physician member of the hospice team must recertify at the 
beginning of each period that the beneficiary is terminally ill. Services 
must be provided under a written plan of care established and 
periodically reviewed by the individual's attending physician and by 
the medical director of the hospice. 
	Covered hospice services include the following: (1) nursing care 
provided by or under the supervision of a registered nurse; (2) physical 
or occupational therapy or speech-language pathology services; (3) medical 
social services; (4) services of a home health aide who has successfully 
completed a training program approved by the Secretary of the U.S. 
Department of Health and Human Services (DHHS); (5) homemaker services; 
(6) medical supplies (including drugs and biologicals) and the use of 
medical appliances; (7) physician services; (8) short-term inpatient care 
(including both respite care and procedures necessary for pain control 
and acute and chronic symptom management); (9) counseling, including 
dietary counseling, for care of the terminally ill beneficiary and for 
family adjustment to the patient's death (bereavement counseling is not 
a reimbursable service); and (10) any other item or service which is 
specified in a patient's plan of care and which Medicare can pay for. 
	Medicare's hospice benefit is intended to be principally an 
in-home benefit. For this reason, Medicare law prescribes that respite
care, or relief for the primary care giver of the terminally ill patient, 
may be provided only on an intermittent, nonroutine, and occasional 
basis and may not be provided consecutively over longer than 5 days. 
In addition, the aggregate number of inpatient care days provided in any 
12-month period to Medicare beneficiaries electing hospice care can not 
exceed 20 percent of the total number of days of hospice coverage 
provided to these persons. 
	Only two covered hospice servicesBoutpatient drugs or 
biologicals and respite careBare subject to coinsurance. Outpatient 
drugs and biologicals are subject to a coinsurance amount that 
approximates 5 percent of the cost of the drug to the hospice program, 
except that the amount may not exceed $5 per prescription. For respite 
care, coinsurance equals 5 percent of program payments for respite, but 
may not exceed Medicare's inpatient hospital deductible during a hospice 
coinsurance period (defined as the period when hospice election is not 
broken by more than 14 days).
	Covered services must be provided by a Medicare-certified 
hospice. Certified hospices must be either public agencies or private 
organizations primarily engaged in providing covered hospice services 
and must make services available on a 24-hour basis, in individuals' 
homes, on an outpatient basis, and on a short-term inpatient basis. 
Hospices must routinely and directly provide substantially all of the 
following "core" services: nursing care, medical social services, and 
counseling services. The remaining hospice services may be provided 
either directly by the hospice or under arrangements with others. If 
services are provided through arrangements with other providers, the 
hospice must maintain professional management responsibility for all 
such services, regardless of the facility in which the services are 
	The hospice program must also have an interdisciplinary group of 
personnel which includes at least one registered professional nurse and 
one social worker employed by the hospice; one physician employed by or 
under contract with the hospice; plus at least one pastoral or other 

Prospective Payment System
	In implementing Medicare's hospice benefit, HCFA established a 
prospective payment methodology in 1983.  This early prospective payment 
system pays hospices according to the general type of care provided to a 
beneficiary on a daily basis.  Unlike other PPSs there is no additional 
adjustment for case mix.  Like other PPSs that pay health care providers 
for care to Medicare beneficiaries on the basis of predetermined, fixed 
amounts, Medicare payments to hospices are intended to pay for the costs 
of care for a hospice beneficiary, on average. That is, although the 
payment is a predetermined daily rate, a hospice's actual costs may be 
above or below that amount for an individual patient. The incentive 
facilities have is to manage costs so that, on average, costs do not 
exceed the PPS average amounts. Hospices that provide the services at 
lower costs than the Medicare payment are able to keep the difference. 

	Unit of Payment-- Under the hospice prospective payment, 
hospices are paid one of four prospectively determined rates, which 
correspond to four different levels of care, for each day a Medicare 
beneficiary is under the care of the hospice. Payment will thus vary by 
the length of the patient's period in the hospice program as well as by 
the characteristics of the services (intensity and site) furnished to 
the beneficiary.  Each rate is adjusted for the geographic location in
which the service is delivered to account for variations in area wages 
as described below.
	The four rate categories are: 
1. Routine home careBRoutine home care payment is made for a day on 
which an individual is at home and is not receiving continuous home 
care. The routine home care rate is paid for every day a patient is 
at home and under the care of the hospice regardless of whether the 
hospice actually visits the home and regardless of the volume or 
intensity of the services provided on any given day as long as fewer 
than 8 hours of care is provided. The FY 2004 base routine home care 
rate is $118.08 per day. 
	2. Continuous home careBContinuous home care payment is made 
for a day on which an individual receives hospice care consisting 
predominantly of nursing care on a continuous basis at home. Home 
health aide or homemaker services or both may also be provided on a 
continuous basis. Continuous home care is furnished only during brief
periods of crisis and only as necessary to maintain the terminally ill 
patient at home. Home care must be provided for a period of at least 
8 hours before it would be considered to fall within the category of
continuous home care. Payment for continuous home care will vary 
depending on the number of hours of continuous services provided. 
For FY 2004, the base continuous home 
care rate is $689.18 for 24 hours or $28.72 per hour. 
3. Inpatient respite careB Inpatient respite care payment is made for a 
day on which the individual who has elected hospice care receives care 
in an approved facility on a short- term (not more than 5 days at a 
time) basis for the respite of his or her caretakers. For FY 2004, the 
base inpatient respite care rate is $122.15 per day.
4. General inpatient careB General inpatient care payment is made for 
a day on which an individual receives general inpatient care in an 
inpatient facility for pain control or acute or chronic symptom 
management which cannot be managed in other settings. Care may be 
provided in a hospital, skilled nursing facility (SNF), or inpatien
unit of a freestanding hospice. For FY 2004, the base general inpatient 
care rate is $525.28 per day. 
	Wage Adjustment--Each of the four payment rates is adjusted for 
differences in wages between geographic areas.  The labor-related 
portion of the payment rate is approximately 69 percent.  The hospital 
wage index is used to adjust the labor-related portion of the hospice 
payment rates.  The use of the hospital wage index to adjust hospice 
payments was determined using negotiated rulemaking. As a result, CMS 
uses the most recent hospital wage index available at the time the 
Federal Register notice announcing the wage index is published.  In 
addition, also as a product of the negotiated rulemaking, wage index
values greater than 0.8 are multiplied by a budget neutrality 
adjustment.  Wage index values below 0.8 are adjusted to be the greater 
of: (1) a 15 percent increase, subject to a maximum wage index value of
0.8, or (2) the product of  multiplying the hospital wage index value 
for a given area by the budget neutrality adjustment.  The budget 
neutrality adjustment for FY 2004 is 1.061238.  For FY 2004, the FY 2003 
hospital wage index, adjusted as described above, will be used.  
	Payment Calculation--The applicable hospice rate category is 
adjusted for the area wage index where the beneficiary served resides. 
To calculate payment, the applicable rate category labor portion (in 
column b of Table 2-26) is multiplied by the appropriate area wage 
index (column c).  The result is added to the non-labor portion of the 
episode rate (column d).  That sum (in column e) is the daily hospice 
payment amount.



	Cap Amount-- Medicare law requires that payments to a hospice 
for care furnished over the period of a year be limited to a "cap 
amount." The cap amount is a per beneficiary amount applied on an 
aggregate rather than a case-by-case basis. Therefore, each individual 
hospice's cap amount is calculated by multiplying the yearly per 
beneficiary cap amount by the number of Medicare beneficiaries who 
received hospice care from the hospice during the cap period. Medicare 
defines a cap year as the period from November 1 through October 31 of 
the following year. The hospice cap for the period November 1, 2002, 
through October  31, 2003, is $18,661.29 per beneficiary per year, and 
is not adjusted for variations in area wages.
	Updates--Hospice daily payment rates for routine home care, 
continuous home care, inpatient respite care, and general inpatient 
care are updated annually by the increase in the hospital market basket.  
For FY 2004 the update is the full hospital market basket increase of 
3.4 percent.
	The hospice cap amount is adjusted annually by the percentage 
change in the medical care component of the Consumer Price Index for 
All Urban Consumers (CPI-U). 

Hospice program data
	Table 2-27 shows that the number of hospices participating in 
Medicare grew from 553 in July, 1988 to 2,325 in December, 2002. 
Freestanding hospices grew at the fastest average annual rate (13 
percent) followed by hospital-based hospices (10 percent) and  home 
health agency-based hospices (9 percent).  Medicare payments for 
hospice care in FY 1991 were $446 million and grew to $3.6 billion in 
FY 2001, an average annual increase of 23 percent (Table 2-28).  This 
growth in spending was fueled by the increased number of beneficiaries 
using the hospice benefit rather than an increase in the intensity of 
services provided to beneficiaries. From FY 1991 through FY 2001, the 
number of beneficiaries using Medicare's hospice benefit increased at 
an average annual rate of 18 percent.  However the average dollar amount 
spent per beneficiary grew at a more modest 4 percent average annual 
rate between FY 1991 and FY 2001.  The number of days that a 
beneficiary elects hospice care increased steadily from FY 1991 through 
1995, then decreased between 1996 and 1999, before increasing in FY 
2000 and FY 2001.  The large declines in the number of days in the FY 
1996 through FY 1999 period has been attributed to increased enforcement 
of the "life expectancy" requirement.  The increase in days in FY 2000 
and 2001 is attributable to educational efforts by CMS regarding the 
life expectancy requirement B that is, CMS wrote to hospices that 
hospices will not be penalized if a beneficiary lives longer than 6 
months and that the hospice benefit is not limited to 6 months. Of 
the types of care provided by hospices, continuous home care grew at 
the fastest rate over the FY 1991 through FY 2001 time period, 
increasing at an average annual rate of 31 percent.  Routine home 
care had the next highest growth rate, an average annual rate of 
24 percent, followed by physician services (21 percent) and  general 
inpatient care (19 percent).

HOSPICE, 1988-2002




	Medicare provides coverage for physicians' services.  This 
category includes surgery, consultation, and home, office and 
institutional visits. Certain limitations apply for services rendered 
by dentists, podiatrists, and chiropractors and for the treatment of 
mental illness. These are referred to as limited licensed practitioners.

Reimbursement - In General
	Medicare pays for physicians' services on the basis of a fee 
schedule which went into effect in 1992. The fee schedule assigns 
relative values to services. Each of the approximately 7,500 physician 
service codes is assigned its own relative value.   Relative values 
reflect three factors: physician work, practice expenses, and 
malpractice costs. These relative values are adjusted for geographic 
variations in the costs of practicing medicine.  Geographically-
adjusted relative values are then converted into a dollar payment 
amount by multiplying by a dollar figure known as the conversion 
factor. The annual percentage update to the conversion factor equals 
the Medicare economic index (which measures inflation) subject to an 
adjustment to match spending for physicians' services under the 
sustainable growth rate system.

YEARS 1991-2001


Calculation of Fee Schedule
	The fee schedule has three components:  the relative value for 
the service; a geographic adjustment, and a national dollar conversion 
	Relative Value--The relative value for a service compares the 
relative physician work involved in performing one service with the 
work involved in providing other physician' services.  It also reflects 
average practice expenses and malpractice expenses associated with the 
particular service.  The relative value for each service is the sum of 
three components: 
      -  Physician work component, which measures physician time, 
skill, and intensity in providing a service; 
      -  Practice expense component, which measures average practice 
such as office rents and employee wages (which, for certain services 
can vary depending on whether the service is performed in a facility, 
such as an ambulatory surgical facility, or in a non-facility setting); 
      -  Malpractice expense component, which reflects average 
professional liability insurance costs. 
	Geographic Adjustment--The geographic adjustment is designed 
to account for variations in the costs of practicing medicine.  A 
separate geographic adjustment is made for each of the three components 
of the relative value unit, namely a work adjustment, a practice 
expense adjustment, and a malpractice adjustment.  These are added 
together to produce an indexed relative value unit for the service for 
the locality.  There are 92 service localities nationwide. 
(Table 2-29 shows the geographic indices used for the 2002-2003 period.)
	The geographic adjustments are indexes that reflect cost 
differences among areas compared to the national average in a ''market 
basket'' of goods.  The work adjustment is based on a sample of median 
hourly earnings of workers in six professional specialty occupation 
categories.  The practice expense adjustment is based on employee wages, 
office rents, medical equipment and supplies, and other miscellaneous 
expenses.  The malpractice adjustment reflects malpractice insurance 
costs.  The law specifies that the practice expense and malpractice 
indices reflect the full relative differences.  However, the work 
index must reflect only one-quarter of the difference.  Using only 
one-quarter of the difference generally means that rural and small 
urban areas would receive higher payments and large urban areas lower 
payments than if the full difference were used.
	Conversion Factor--The conversion factor is a dollar figure. The 
payment for a service equals the  geographically adjusted relative value 
for the  service multiplied by the conversion factor.  The conversion 
factor is the same for all services.    The conversion factor is updated 
each year. (See below.) The 2003 conversion factor, which became 
effective March 1, 2003, is $36.7856. Anesthesiologists are paid under 
a separate fee schedule which uses base and time units; a separate 
conversion factor ($17.05 in 2003) applies. 
	Table 2-30 shows the conversion factors that have applied since 
implementation of the fee schedule in 1992.  For several years during
this period, more than one conversion factor applied.  However, 
beginning in 1998, one conversion factor applied for all services. 
Annual Update to the Conversion Factor
	The conversion factor is updated each year according to a 
formula specified in law.  The intent of the formula is to place a 
restraint on overall spending for physicians' services.  Several factors 
enter into the calculation of the formula.  These include: 1) the Medicare 
economic index (MEI) which measures inflation in the inputs needed to 
produce physicians services; 2) the sustainable growth rate (SGR) which 
is essentially a target for Medicare spending growth; and 3) the update 
adjustment factor which modifies the update, which would otherwise be 
allowed by the MEI, to bring spending in line with the SGR target.
	The SGR system was established because of the concern that the 
fee schedule itself would not adequately constrain increases in 
spending for physicians' services. While the fee schedule specifies a 
limit on payments per service, it does not place a limit on the volume or 
mix of services.  The use of SGR targets is intended to serve as a 
restraint on aggregate spending. The SGR targets are not limits on 
expenditures.  Rather the fee schedule update reflects the success or 
failure in meeting the target.  If total physician expenditures exceed 
the target, the update for a future year is reduced.  If expenditures 
are less than the target, the update is increased. 

LOCALITY, 2002-2003




	General Requirements--The annual percentage update to the 
conversion factor, equals the MEI, subject to an adjustment (known as 
the update adjustment factor) to match target spending for physicians' 
services under the SGR system. The conversion factor is further 
adjusted to meet certain budget neutrality requirements.
	Update Adjustment Factor--The update adjustment sets the 
conversion factor at a level so that projected spending for the year 
will meet allowed spending by the end of  the year.  Allowed spending 
for the year is calculated using the SGR. However, in no case can the 
update adjustment factor be less than minus 7 percent or more than plus 
3 percent.
	Beginning in 2001, the update adjustment factor is the sum of: 
1) the prior year adjustment component, and 2) the cumulative adjustment 
component.  The prior year adjustment component is determined by:  1) 
computing the difference between allowed expenditures for physicians' 
services for the prior year and the amount of actual expenditures for 
that year; 2) dividing this amount by the actual expenditures for that 
year; and 3) multiplying that amount by 0.75.  The cumulative adjustment
component is determined by:  1) computing the difference between allowed 
expenditures for physicians' services from April 1, 1996 through 
the end of the prior year and the amount of actual expenditures during 
such period; 2) dividing that difference by actual expenditures for 
the prior year as increased by the SGR for the year for which the 
update adjustment factor is to be determined; and 3) multiplying that 
amount by 0.33.  Use of both the prior year adjustment component and 
the cumulative adjustment component allows any deviation between 
cumulative actual expenditures and cumulative allowed expenditures to be 
corrected over several years rather than a single year.
	Sustainable Growth Rate--The law specifies a formula for 
calculating the SGR.  It is based on changes in four factors:  1) 
estimated changes in fees; 2) estimated change in the average number 
of Part B enrollees (excluding Medicare+Choice beneficiaries); 3) 
estimated projected growth in real gross domestic product (GDP) growth 
per capita; and 4) estimated change in expenditures due to changes in 
law or regulations.
	By November 1 of each year, (using the best data available as 
of  September 1), CMS is required to publish in the Federal Register, 
the SGRs for three time periods.  These periods are  the upcoming year, 
the current year, and the preceding year.  Thus the SGR is estimated 
and revised twice, based on later data. 
	By November 1, 2002, CMS was to publish an estimate of the SGR 
for CY2003, a revision of the CY2002 SGR estimated in 2001 and a 
revision of the CY2001 SGR first estimated 2 years earlier and 
revised 1 year earlier. Publication of these amounts was first 
delayed until December 31, 2002. These amounts were subsequently 
revised as a result of the enactment of the Consolidated Appropriations 
Resolution, 2003 (CAR) (P.L.108-7) which allowed CMS to go back and use 
actual data to determine the SGRs for FY 1998 and FY1999 for the 
purposes of determining future fee schedule updates.  Two factors in the 
SGR calculation accounted for the major differences between estimated 
and actual data.  These were fee-for-service enrollment in Medicare 
(because fewer people than expected enrolled in managed care) and 
changes in the real per capita growth in the GDP.  Changing the FY 
1998 and FY 1999 numbers to reflect actual data had the effect of 
increasing the SGR used for the calculation of the 2003 update.

Calculation of the Conversion Factor for 2002 and 2003
	As noted above, the annual update to the conversion factor 
reflects the MEI plus an adjustment to reflect the success or failure in 
meeting the SGR target. In 2002, the update derived from these 
calculations resulted in an update of:  -4.8 percent.  In addition, 
certain required budget neutrality adjustments were made through 
adjustments to the conversion factor.  The final update to the 
conversion factor was:  -5.4 percent.  Thus, the conversion factor 
for 2002 ($36.1992) was 5.4 percent less than the conversion factor for 
2001 ($38.2581). Despite the negative update in 2002, CBO estimates 
that payments under the physician fee schedule increased  from $40.4 
billion in 2001 to $44.2 billion in 2002.  This is largely attributable
to the increase in the volume of services provided to beneficiaries. 
	As noted, the law requires the fee schedule for the following 
year to be issued by November 1.  However, due to technical 
complications, publication of the 2003 fee schedule was first delayed 
until December 31, 2002.  It would have provided for an additional 
4.4 percent cut. It was revised on February 28, 2003 in response to 
the enactment of the Consolidated Appropriations Resolution, 2003 
(CAR) (P.L.108-7). As a result of the CAR provision, the update for 
2003 is  1.6 percent. As a result of the delays, the 2003 fee schedule 
became effective March 1, 2003. 
	Table 2-31 shows how the 2003 conversion factor was calculated. 
The MEI for 2003 is 3.0 percent.  The update adjustment factor (after 
applying the formula described above) is 0.989. An additional statutory 
reduction (-0.2  percent) applies in 2003. An additional budget 
neutrality adjustment (-0.4) is made to account for the increase in work 
relative values for anesthesia services resulting from the 5-year review.  
This results in a 2003 conversion factor of $36.7856.  



Bonus Payments  
	The law specifies that physicians who provide covered services 
in any rural or urban health professional shortage area (HPSA) are 
entitled to an incentive payment.  This is a 10 percent bonus over the 
amount which would otherwise be paid under the fee schedule.  The bonus 
is only paid if the services are actually provided in the HPSA, as 
designated under the Public Health Service Act.

Limits on Beneficiary Liability
	In General--Medicare payments are made for physicians' services 
after the annual deductible requirement of $100 has been satisfied. 
Payment is set at 80 percent of the fee schedule with beneficiaries 
responsible for the remaining 20 percent, which is referred to as 
coinsurance.  Medicare payment is made either on an "assigned" or 
"unassigned" basis.  By accepting assignment, physicians agree to take 
the Medicare fee schedule amount as payment in full. Thus, if assignment 
is accepted, beneficiaries are not liable for any additional out-of-
pocket payments. In contrast, if assignment is not accepted, 
beneficiaries may be liable for charges in excess of the Medicare 
approved charge, subject to limits. This process is known as balance 

	When a physician agrees to accept assignment on all Medicare 
claims in a given year, the physician is referred to as a participating 
physician. Physicians who do not agree to accept assignment on all 
Medicare claims in a given year are referred to as nonparticipating 
physicians.  It should be noted that the term "nonparticipating 
physician" does not mean that the physician doesn't deal with Medicare. 
Nonparticipating physicians still treat Medicare patients and receive 
Medicare payments for providing covered services.. There are a number of 
incentives for physicians to become participating physicians, the chief 
of which is that the fee schedule payment amount for nonparticipating 
physicians is only 95 percent of the recognized amount paid to 
participating physicians. Additional incentives include more rapid 
claims payment and widespread distribution of participating physician 
directories. Nonparticipating physicians may not charge more than 115 
percent of Medicare's allowed amount for any service. Medicare's allowed 
amount for nonparticipating physicians is set at 95 percent of that for 
participating physicians. Thus, nonparticipating physicians are only 
able to bill  9.25 percent (115 percent times 95 percent) over the 
approved amount for participating physicians. 
	Mental Health Services Payment Limitation--Certain mental 
health services are subject to a payment limitation under which 50 
percent cost-sharing, rather than 20 percent cost-sharing applies.  
Services subject to the higher cost-sharing are services provided in 
connection with the treatment of mental, psychoneurotic, and personality 
disorders of a patient who is not an inpatient of a hospital. The term 
"mental, psychoneurotic, and personality disorders" is defined as the 
specific psychiatric conditions described in the American Psychiatric 
Association's (APA) Diagnostic and Statistical Manual of Mental 
Disorders. The payment limitation applies only to treatment services. 
It does not apply to diagnostic services. Testing services performed 
to evaluate a patient's progress during treatment are considered part 
of treatment and are subject to the higher cost-sharing. The limitation 
does not apply to partial hospitalization services that are not directly 
provided by a physician.

Assignment and Participation Data
	The total number of assigned claims as a percentage of total 
claims received by Medicare carriers is known as the assignment rate. 
Table 2-32 shows the assignment rate for services provided by physicians, 
limited licensed practitioners (podiatrists, chiropractors, and 
optometrists) and non-physician practitioners (such as nurse 
practitioners and clinical social workers). The assignment rate declined 
until the mid-1970s when the rate leveled off at about 50 percent. Since 
1985, the rate has increased significantly, rising to 98.3 percent of 
claims and 99.3 percent of covered charges in 2002.  Table 2-33 shows 
the state-by-state assignment rates for services provided by physicians 
and limited licensed practitioners.  Virtually all of these claims (when 
measured as a percentage of covered charges) are paid on assignment. In 
2002, the lowest such rate was in South Dakota and Idaho  (94.9 percent) 
while the highest rate (100 percent) was in Massachusetts. Physician 
participation rates have risen significantly since the inception of the 
participation program in 1984. For the calendar year 2002 participation 
period, the physician participation rate (including limited licensed 
practitioners) had risen to 89.7 percent, accounting for 96.7 percent 
of covered charges (Table 2-34). Specialists in cardiovascular disease 
had the highest assignment rates.  Table 2-35 shows the participation 
rates by specialty.  Table 2-36 shows the percentage of participating 
physicians and limited licensed practitioners as a percentage of total 
physicians and limited licensed practitioners for each State. 



BY STATE, SELECTED YEARS 1985-2002            






PERIODS 1985-2002



	Medicare covers certain services provided by nonphysician 
practitioners such as nurse practitioners and physician assistants. 
These practitioners are paid under the physician fee schedule and 
are required to accept assignment on all claims.  Nonphysician 
practitioners are different from limited licensed practitioners 
(such as podiatrists and chiropractors) who have the option of 
whether or not to accept assignment.

Physician Assistants and Nurse Practitioners 
	Separate payments are made for physician assistant services, 
when provided under the supervision of a physician. Separate payments 
are also made for nurse practitioner services, provided in 
collaboration with a physician. Payment for these services can only
be made if no facility or other provider charges are paid in connection 
with the service. Payment equals 80 percent of the lesser of either 
the actual charge or 85 percent of the fee schedule amount for the same 
service if provided by a physician. For assistant-at-surgery services, 
payment equals 80 percent of the lesser of either the actual charge or 
85 percent of the amount that would have been recognized for a physician 
serving as an assistant- at-surgery. The physician assistant may be in 
an independent contractor relationship with the physician.   

Certified Nurse Midwife Services 
	Certified nurse midwife services are paid at 65 percent of the 
physician fee schedule amount.

Certified Registered Nurse Anesthetists 
	Certified registered nurse anesthetists are paid under the same 
fee schedule used for anesthesiologists (see above). Payments for 
services furnished by an anesthesia care team composed of an 
anesthesiologist and a certified registered nurse anesthetist are capped 
at 100 percent of the amount that would be paid if the anesthesiologist 
were practicing alone. The payments are evenly split between each 

Clinical Psychologists and Clinical Social Workers 
	Diagnostic and therapeutic services provided by clinical 
psychologists are paid under the physician fee schedule. Payments for 
services provided by clinical social workers are equal to 75 percent 
of the amount allowed for clinical psychologists. Some services are 
subject to the psychiatric services limitation which limits Medicare 
payments for some services to 50 percent of incurred expenses. 

Physical or Occupational Therapists 
	Payments for physical therapy and occupational therapy services 
are made under the physician fee schedule.  In 1999, an annual $1,500 
per-beneficiary limit applied to all outpatient physical therapy services 
(including speech-language pathology services), except for those 
furnished by a hospital outpatient department (OPD).  A separate $1,500 
limit applied to all outpatient occupational therapy services except for 
those furnished by hospital OPDs.  Therapy services furnished as incident 
to physicians' professional services were included in these limits. 
The $1,500 limits were to apply each year, with updates for inflation 
beginning in 2002. However, BBRA 1999 suspended application of these 
limits in 2000 and 2001 and BIPA suspended application in 2002.  Thus, 
no limits applied in these 3 years. CMS implemented the limit $1,590 
(reflecting inflation updates)  September 1, 2003. 


	Medicare provides coverage for diagnostic clinical laboratory 
services. These services may be provided by an independent laboratory, 
a physician's office laboratory, or a hospital laboratory to outpatients. 
Laboratories must meet the requirements of the Clinical Laboratory 
Improvement Act Amendments of 1988. This legislation, which focused on the 
quality and reliability of medical tests, expanded Federal oversight to 
virtually all laboratories in the country, including physician office 
	BBA 1997 required the Secretary to adopt uniform coverage 
policies for laboratory tests using a negotiated rulemaking process. The 
policies would be designed to eliminate variation among carriers and to 
simplify administrative requirements. A final rule detailing national 
coverage and administrative policies for labs paid under Part B was 
published on November 23, 2001.  It was effective November 25, 2002, 
except that labs could request up to an additional 12 months to make 
the necessary changes to their computer systems. 
	The rule establishes 23 national coverage determinations (NCDs) 
for  the most commonly ordered lab tests.  For each of the 23 clinical 
diagnosis lab service NCDs listed in the final rule, there is a list of 
current procedural technology (CPT) codes identifying the test, panel 
of tests, or group of tests covered under the NCD. In addition, for each 
NCD there are 3 lists of diagnosis codes, known as ICD-9-CM codes 
(International Classification of Diseases, Ninth Revision, Clinical 
Modification).   The first list, "ICD-9-CM codes covered by Medicare" 
includes codes where there is a presumption of medical necessity, 
though the claim may be subject to review. The second list, "ICD-9-CM 
codes denied," includes lists of codes that are never covered.  The 
third list, "ICD-9-CM codes that do not support medical necessity" 
include diagnoses that generally are not covered for the test, but for 
which there are limited exceptions. Additional documentation could 
support a determination of medical necessity in certain cases.  For 
each of the 23 NCDs, each ICD-9-CM code falls into one of the 3 
ICD-9-CM lists. 

	Since 1984, Medicare has paid for clinical laboratory 
services on the basis of a fee schedule. Fee schedules have been 
established on a carrier service area basis. The law set the initial 
payment amount for services performed in physicians' offices or 
independent laboratories at the 60th percentile of the prevailing 
charge established for the 12-month period beginning July 1, 1984. 
Similarly, the initial fee schedule payment amount for services provided 
by hospital-based laboratories serving hospital outpatients was set at 
the 62d percentile of the prevailing charge level. Subsequent 
amendments to the payment rules limited application of the hospital 
fee schedule to "qualified hospitals." A qualified hospital is a sole 
community hospital (as that term is used for payment purposes under 
Medicare's hospital inpatient prospective payment system (IPPS)) which
provides some clinical diagnostic tests 24 hours a day in order to serve 
a hospital emergency room which is available to provide services 24 hours 
a day, 7 days a week. 
	Payments under the fee schedule equal the lesser of the actual 
charge billed for the test, the local fee or the national limitation 
amount (NLA). For tests for which NLAs were set before 2001, the NLA is 
74 percent of the median of local fees.  For tests for which NLAs are 
first established after such date, the NLA is 100 percent of the median 
of the local fees. A national minimum payment amount is established for 
Pap smears; in 2003, this minimum payment is $14.76.
	The fee schedule payment amounts have been increased periodically 
since 1984 to account for inflation. The updates have generally occurred 
on January 1 of each year.  BBA 97 eliminated the updates for 1998-2002.  
The update for 2003 is 1.1 percent.
	Payment for clinical laboratory services (except for those 
provided by a rural health clinic) may only be made on the basis of 
assignment.  Payment for clinical laboratory services equals 100 percent 
of the fee schedule amount; no beneficiary cost sharing is imposed. 


	Medicare Part B covers a wide variety of medical supplies if 
they are medically necessary and are prescribed by a physician. Under 
the program, durable medical equipment (DME) includes such items as 
hospital beds, blood glucose monitors, and wheelchairs. The benefit 
also includes related supplies, such as drugs and biologicals that are 
necessary for the effective use of the product. Guidelines define DME as 
equipment that: (1) can withstand repeated use; (2) is used to serve a 
medical purpose; (3) generally is not useful in the absence of an 
illness or injury; and (4) is appropriate for use in the home. All of 
these requirements must be met before an item can be covered.
	Medicare also covers prosthetic devices. These are defined as 
items that replace all or part of an internal body organ, such as 
colostomy bags, pacemakers, and breast prostheses for postmastectomy 
patients. Prosthetics and orthotics include such items as leg, arm, 
back and neck braces, and artificial legs, arms, and eyes.

Reimbursement for durable medical equipment
	Medicare pays for DME on the basis of a fee schedule originally 
established by the Omnibus Budget Reconciliation Act of 1987 (OBRA 1987). 
Under the DME fee schedule, Medicare pays 80 percent of the lower of 
either the item's actual charge or the fee schedule amount. The 
beneficiary is responsible for the remaining 20 percent.  Under the 
fee schedule, covered DME items are classified into five groups: (1) 
inexpensive or routinely purchased DME; (2) items requiring frequent 
and substantial servicing; (3) customized items (equipment constructed 
or modified substantially to meet the needs of an individual patient); 
(4) other items of DME (frequently referred to as the ''capped rental'' 
category); and (5) oxygen and oxygen equipment. Some items that do not 
meet the definition of DME, such as disposable surgical dressings, 
are also covered under the fee schedule.
	In general, the fee schedule payment rates for DME are 
determined locally (on a statewide basis). However, these local 
payments are subject to floor and ceiling limits determined nationally. 
Medicare will not pay less than 85 percent of the weighted average of 
all local payment amounts (floor), and will not pay more than 100 
percent of this average (ceiling).
	Prosthetics and orthotics are also paid according to a fee 
schedule similar to the DME fee schedule. The payment rates are 
determined regionally (there are 10 regions) and are subject to national 
limits which also have ceilings and floors. The floor is 90 percent of 
the weighted average of all regional payment amounts, and the ceiling is 
120 percent of this weighted average.
	The fee schedules are generally updated annually by the CPIBU. 
However, BBA 1997 eliminated updates for DME for fiscal years 1998B2002.  
In 2003, the update returned to the CPI-U.  The update for prosthetics 
and orthotics was limited to 1.0 percent through fiscal year 2002.  
Subsequent legislation temporarily restored payment updates.  For oxygen 
and oxygen equipment, BBA 1997 set the national payment limits beginning 
in fiscal year 1999 to 70 percent of 1997 levels. 
	Medicare pays for a few items of medical equipment on a 
reasonable cost basis, rather than under the fee schedule. These include 
medical supplies; home dialysis equipment; therapeutic shoes; parenteral 
and enteral nutrients (PEN), equipment, and supplies; transfusion 
medicine; and blood products. BBA 1997 authorized the Secretary to 
establish fee schedules for these items.  The final regulation,  
issued August 2001, however, established a fee schedule only for PEN. 
 Its amounts are based on the reasonable charges that would have been 
 used in 2002.  It will be updated by the CPI-U.
	Table 2-37 shows total Medicare spending in calendar year 2001 
for DME, prosthetics and orthotics, and certain other items.



	Inherent reasonableness authority--If the Secretary determines 
that using standard procedures to calculate payment for an item under 
the fee schedule results in an amount which is ''grossly excessive or 
grossly deficient and not inherently reasonable,'' the Secretary is 
authorized to increase or decrease the payment amount accordingly. The 
authority to make these adjustments is generally referred to as the 
inherent reasonableness authority. It involves a complex procedure of 
investigation, commentary, and notification.
	BBA 1997 sought to simplify the procedure and widen the 
application of this authority, requiring that new criteria be 
established for determining if a fee schedule charge was inherently 
unreasonable, and the factors to be used in determining charges that are 
realistic and equitable. Using these criteria, the Secretary would be 
permitted to adjust payment levels. An interim final rule was issued in 
December 2002.  Significantly, the rule states that the inherent 
reasonableness authority will not be used in situations where there is 
less than a 15 percent difference between the current payment rate and 
a proposed payment rate.

Administering the DME benefit
	CMS enters into contracts with insurance companies known as 
carriers under Part B of Medicare, to administer the program, i.e., to 
process claims and make payments. In the case of DME, administration is 
centralized in four regional carriers (known as DME regional carriers, 
or DMERCs) who are responsible for processing claims for all 
beneficiaries living within their areas. As a result of the 
consolidation, which occurred in 1992, variation in coverage policy and 
utilization patterns has been reduced. Suppliers provide Medicare 
beneficiaries with medical equipment and bill the regional carrier in 
their area. Before being issued a Medicare supplier number, suppliers 
must comply with various standards, including maintaining a physical 
location, being responsible for deliveries to beneficiaries and 
honoring all product warranties, and providing proof of appropriate 
liability insurance.

Competitive bidding
	Investigations have shown that Medicare pays higher prices for 
certain medical supplies than those paid by other health care insurers 
and other government agencies, including the Department of Veterans 
Affairs.  BBA 1997 provided authority for Medicare to establish five 
3-year demonstration projects under which suppliers competitively bid 
for contracts to deliver specific items of DME to beneficiaries.  The 
first project was established in 1999 in Polk County, Florida. Suppliers 
submitted bids, competing for the right to provide certain medical 
equipment to the 92,000 Medicare beneficiaries in the area.  Bids were 
evaluated on the basis of quality and price.  Numerous suppliers were 
chosen for each item to maintain beneficiary access.  The demonstration 
project ended September 2002.  A second demonstration project began 
operations in San Antonio, Texas, in February 2001, where approximately 
112,000 Medicare beneficiaries were involved.  That project terminated 
in December 2002.  CMS estimated that competitive bidding in the two 
projects resulted in overall savings of approximately 19.9 percent 
over fee schedule prices.

	Table 2-38 summarizes the history of Medicare payments for 
hospital outpatient services from 1974 through 2001.  Medicare payments 
increased almost 55-fold, from $323 million in 1974 to $17.7 billion in 
2001, with annual rates of increase averaging as high as 26.5 percent 
from 1974 to 1984, falling to 13.3 percent from 1984 to 1994. Most 
recently, from 1995 to 2001, the annual rate of change has been 5.4 
percent per year.  The substantial rates of increase in OPD payments 
per Part B enrollee (from $14 in 1974 to $563 in 2001) reflect the 
increase in the volume of services provided in OPDs as well as growth 
in payments for those services under the retrospective cost-based 
payment system.   Since 1974, hospital charges for outpatient services 
provided to Medicare beneficiaries increased by almost 20 percent per 
year, on average. Medicare's payments for OPD services increased by 16 
percent per year during that time period.   Medicare's payments for 
covered OPD services as a proportion of hospital charges has declined 
from nearly 70 percent in 1983 to 25 percent in 2001.  This declining 
ratio reflects primarily the high rates of increase in hospital charges 
and, to a lesser extent, limits on the rate of increase in Medicare's 
payments for outpatient services due to fee schedules and blended 
payment formulas. 


	As Table 2-39 shows, although the number of hospitals has 
fallen over past decade (from 5,191 in 1991 to 4,347 in 2001), the 
proportion of these hospitals that offer outpatient surgery and 
emergency services has increased.   Almost all hospitals provide 
outpatient services and a significant percentage provide outpatient 
YEARS 1991-2001


	Medicare beneficiaries receive a wide range of services in 
hospital outpatient departments (HOPD), from injections to surgical 
procedures under general anesthesia. Services provided in HOPDs which 
are paid under Medicare Part B include: (1) emergency room and clinic 
services; (2) operating and recovery room services; (3) laboratory 
and pharmacy services; (4) physical therapy and rehabilitation 
services; (5) DME; and (6) chemotherapy and radiation therapy. HOPDs 
also provide diagnostic and preventive procedures such as radiology, 
computer axial tomography (CAT) scans, magnetic resonance imaging, 
endoscopies, and colonoscopies.  Table 2-40 shows the percent 
distribution of HOPD charges by type of service provided to Medicare 
beneficiaries in 2001. Radiology and laboratory services comprise about 
a third of the total hospital outpatient charges.



	In 2001, about 62 percent of the Medicare beneficiaries that 
received fee-for-service Medicare used hospital outpatient services; 
about 150 million outpatient services were paid for under the 
outpatient prospective payment system (OPPS) implemented in short-
term general hospitals.   In 2001, the first full year of the new 
outpatient payment system, OPPS spending was $18.4 billion, including  
$10.4 billion by the program and $8.0 billion in beneficiary cost 
sharing.  In 2001, beneficiary cost sharing (which has historically 
been higher for hospital outpatient services than the typical 20 
percent cost sharing for other Part B services) was about 42 percent 
of total payments. 

	In the early years of the Medicare program, Medicare paid 
for both inpatient and outpatient hospital care based on a hospital's 
reasonable costs attributable to providing covered services for 
Medicare beneficiaries. Using these retrospective payment systems, 
Medicare paid the allowable costs incurred in providing care, the 
amount of which was determined and made after the service was rendered. 
Medicare's payment systems for hospital inpatient care and outpatient 
services were separated in 1983 when a new prospective system was 
implemented for inpatient care.  Under that arrangement, a hospital 
receives a fixed payment, known in advance of providing care, covering 
all care and services required by a patient during a hospital stay 
(exclusive of physician fees) and determined by the diagnosis-related 
group (DRG) into which the patient is classified at admission. However, 
outpatient services remained under the costs-or-charges retrospective 
payment arrangement.  Throughout the 1980s, Medicare payments for 
hospital outpatient services grew as the volume of services provided 
in that setting increased.  Although growth in the Medicare population 
contributed to increased utilization of outpatient care, a substantial 
share of the growth in the volume of outpatient services is attributable 
to advances in medicine and technology that permit procedures formerly 
restricted to the inpatient hospital setting to be provided safely on 
an outpatient basis.  Aggressive management of inpatient utilization 
attributed to the incentives inherent in the IPPS payment system may 
also have influenced the shift in care from hospital inpatient to 
hospital outpatient departments.   Outpatient services have become an 
important revenue source for hospitals; outpatient revenue is relatively 
more important to rural than to urban hospitals.  
	Since the early 1980s, Medicare's payments for HOPD services 
have grown for reasons other than increased volume, and that growth is 
often attributed to the lack of incentives for efficiency or cost 
control inherent in the retrospective cost-based payment system. 
Congress sought to contain the rate of increase in Medicare payments 
for certain outpatient services by requiring implementation of fee 
schedules to pay for those services. For example, Congress required 
the Health Care Financing Administration (HCFA, now called the Centers 
for Medicare & Medicaid Services, or CMS) to establish fee schedules 
for many outpatient diagnostic laboratory procedures and tests; for 
orthotics, prosthetics, and DME; dialysis for persons with end-stage 
renal disease (ESRD); and surgeries that might also take place in 
another outpatient setting such as ambulatory surgical centers (ASCs).   
In the Omnibus Budget Reconciliation Acts of 1986 and 1990, Congress 
directed the Secretary of Health and Human Services (the Secretary) 
to develop a PPS for all HOPD care.  In addition, to achieve more 
immediate savings, legislation required across-the-board reductions in 
Medicare payments for hospital operating costs and capital costs 
(including those associated with outpatient care) starting in 1990.    
	Over time, a fairly complex set of Medicare payment rules for 
outpatient hospital services evolved.  Although Medicare implemented 
fee schedules for some HOPD services, payment for other services 
remained under the retrospective payment system.  For instance, payments 
for  clinic and emergency room visits were paid based on the lesser of 
a hospital's reasonable costs or customary charges.  Certain surgeries 
carried out in the HOPDs, but which are also approved by Medicare to be 
provided in ASCs were paid the lower of costs, charges, or a blended 
payment that incorporated the ASC fee schedule amount (again, excluding 
physicians service which are paid separately). Payment for certain 
radiology services and diagnostic procedures were based on a blended 
payment that included, in part, the Medicare fee schedule for physician 
services.  Moreover, these blended payment calculations varied among 
different types of hospitals.	
	The calculation of a beneficiary's coinsurance amount was 
similarly complex.   A beneficiary's coinsurance payment was calculated
based on 20 percent of the hospital's charges for those services where
Medicare's payment was based on 80 percent of the lower of reasonable 
costs or customary charges. For most services, Medicare's payment was
offset by the beneficiary's payment, so that hospitals were not paid 
more than 100 percent of the Medicare approved amount.  Over time, as 
charges for hospital outpatient services increased faster than hospital
costs (and Medicare's payments), beneficiaries' coinsurance payments 
began to represent a larger and larger share of total payments to 
hospitals for outpatient services.  Also, for certain  services, such 
as ASC approved surgical procedures, Medicare's program payment was not 
fully reduced by the beneficiary's coinsurance payment; hospitals 
received payments that were greater than the Medicare approved amount.  
These formula driven overpayments (FDOs) were estimated to be 
approximately $850 million by industry representatives at the time of 
implementation of OPPS.  
	Despite implementation of fee schedules, blended payment 
amounts, and across-the-board reductions in payments, Medicare HOPD 
payments rose at an annual rate of over 12 percent from 1983 to 1997 
and increased from 7 percent to 20 percent as a share of all Medicare 
payments to hospitals. Many saw the patchwork payment arrangements for 
outpatient services as fraught with disincentives for hospitals to 
provide care efficiently.  Accordingly, BBA 1997 extended the across-
the-board reductions of 5.8 percent for operating costs and 10 percent 
for capital costs through 1999 and directed the Secretary to implement 
OPPS in 1999.  BBA 1997 also eliminated the formula-driven overpayment, 
effective at the start of FY1998, a move that resulted in an almost 
immediate reduction in payments to hospitals.  The legislation 
established a buy-down procedure to reduce beneficiary cost sharing 
for OPD services gradually to 20 percent of Medicare approved amounts.  
Beneficiary coinsurance would be established at 20 percent of the median 
of all hospital outpatient charges per procedure in 1996, updated to 
the time of implementation of OPPS and ''frozen'' at those dollar 
amounts.  Over time, as Medicare's program payments under the new OPPS 
increase with beneficiary payments frozen, the beneficiary payment 
amounts would come to equal 20 percent of Medicare's PPS payments.  
However, the buy down for those services where the difference between
the median charge and the PPS approved amount is large could take decades.  
Under BBA 1997, hospitals were permitted to limit beneficiary copayments 
to 20 percent voluntarily as well as disseminate information regarding 
their reduced beneficiary charges.
	The proposed OPPS regulations were published on September 8, 
1998, for public comment with implementation of the new payment system 
scheduled for implementation in 1999.  Implementation of the changes 
were delayed until after the start of the year 2000 in order to 
accommodate resolution of Y2K data processing problems.   In the 
meantime significant legislative changes to OPPS were enacted.  
The Balanced Budget Refinement Act (BBRA) required the implementation 
of: (1) budget neutral outlier payments, within specified limits, 
for certain high cost patients; (2) budget neutral pass-through 
payments for certain new and innovative high cost devices, drugs, and 
biologicals for 2-3 years; (3) a "2 times" rule which limits the cost 
range of items or services that are included in any one APC (or 
ambulatory payment classification which is the classification system 
for outpatient services described subsequently) so that the highest cost 
item or service in the group cannot be more than two times higher than 
the lowest cost item or service within the group; (4) an annual review 
and update of the APCs and relative weights; (5) transitional corridors 
through 2003 which phase-in reductions in aggregate Medicare payments 
that individual hospitals experience due to OPPS implementation; (6) 
special ``hold harmless'' payments, for small, rural hospitals until 
January 1, 2004, to ensure that they receive no less under OPPS than 
they would have received in aggregate under the prior payment 
system; (7) permanent hold harmless payments for cancer hospitals; 
(8) a limit on beneficiary copayments for HOPD care set at the annual
beneficiary deductible for inpatient care; (9) a budget neutrality 
benchmark for Medicare spending that includes beneficiary coinsurance 
amounts paid under the prior system; (10) coverage of the cost of 
implantable items; (11) use of either the mean or the median of hospital 
costs when establishing relative APC weights; (12) across-the-board  
reductions in payments for hospital operating costs and capital costs 
until implementation of OPPS; and (13) use of the IPPS wage index that 
accounts for hospitals' reclassification to different geographic areas.  
Medicare's hospital outpatient payment system was subsequently modified 
by BIPA to include: (1) scheduled reductions to beneficiary's coinsurance 
payments from 2002 through 2006 until the maximum rate is 40 percent in 
2006; (2) an increase in the 2001 update to the full increase in the 
market basket as well as other increases to the 2001 OPPS rates; (3) 
appropriate adjustments to the conversion factor in later years to 
eliminate the effect of coding or classification changes; (4) 
modifications to the procedures and standards by which certain 
medical devices are categorized and determined eligible for pass-
through payments under the OPPS; and (5) a permanent hold harmless 
provision for children's hospitals.  Implementation of OPPS began 
August 1, 2000. 

Medicare's hospital outpatient payment system
	The OPPS payment is intended to cover hospitals' operating and 
capital costs for the facility services that are furnished.   Under OPPS, 
the unit of payment is the individual service or procedure as assigned to 
one of about 570 ambulatory payment classification groups (APCs).  Services 
are classified into APCs based on their Healthcare Common Procedure Coding 
System (HCPCS), a standardized coding system used to identify products, 
supplies, and services for claims processing and payment purposes.  Some 
new services are assigned to certain ''new technology'' APCs based only 
on similarity of resource use.  Individual outpatient services that are 
similar clinically and comparable in terms of resource utilization are 
arranged into groups according to an APC system.  To the extent possible, 
integral services and items are bundled within each APC; for example, an 
APC for a surgical procedure will include operating and recovery room 
services, anesthesia, and surgical supplies.  Each APC has a status 
indicator to identify which particular OPPS payment policy is 
applicable.  For instance, payments for those APCs with a status 
indicator of ''T'' are reduced if multiple procedures are performed on 
the same visit; payments for those APCs with a status indicator of 
''S'' are not reduced if multiple procedures are performed. 
	Medicare's payment for these services is calculated by 
multiplying the relative weight associated with an APC by a conversion 
factor. A relative value is established for each group and is the same 
for each service assigned to the group. Except for the new technology 
APCs, each APC has a relative weight that is based on the median cost 
of services in that APC.  The CY2003 APC relative weight calculation 
used selected claims from April 1, 2001 through March 31, 2002. CMS 
converted billed charges to costs using cost-to-charge ratios by cost 
centers specific to each hospital.  Data from claims with single or 
multiple procedure codes were aggregated differently to establish the 
median cost for each APC. The median costs of each APC was scaled to the 
median cost associated with APC 0601, the mid-level clinic visit. The 
relative weights for those APCs that significantly decreased from 2002 
to 2003 were subject to a dampening calculation;  the decrease was 
limited to 15 percent plus half the difference of the remaining change 
from 2002 to 2003.  
	New Technology APCs--In contrast to other APC groups, services 
are assigned to the new technology APCs based on their expected costs; 
the groups do not account for clinical aspects of its packaged services. 
There are 17 new technology APCs that range from $0-$50 to $5,000 to 
$6,000, with an additional category at $19,500-$20,500.  The relative 
weights for these APCs are set at the midpoint of the range.  Services 
are included in the new technology APCs for at least 2 years, but no more 
than 3 years.  To be considered for assignment into one of these APCs, the 
technology must be a complete service or procedure that cannot be 
adequately described by an existing payment category.  The covered service 
must be new and ineligible for an additional transitional pass-through 
payment that is described subsequently.   Spending in these new technology 
APCs are not subject to a budget neutrality limit.
 	 Like other Part B fee schedules, the conversion factor 
translates the relative weights into dollar payment amounts.  The 
conversion factor for 2003 is $52.151. For most APCs, the conversion 
factor is adjusted to account for geographic variations in cost.  The 
labor related portion (60 percent) of the conversion factor is adjusted 
by the IPPS wage index accounting for hospital's geographic 
reclassifications.  The conversion factor is updated on a calendar year 
schedule and the annual updates are based on the hospital market basket 
(MB) offset by mandated budget neutrality factors associated with wage-
index changes, changes to APC groups, and the APC relative weights.  
Currently, the 2003 HOPD update was the projected change in the hospital 
inpatient MB of 3.5 percent adjusted by a budget neutrality factor of 
	Medicare's outpatient PPS includes budget neutral case level 
adjustments including pass-through payments for new technology and 
outlier payments for high-cost services.   Transitional corridor 
payments that limit hospitals' losses under OPPS have been established 
through 2003 as well.  Small rural hospitals with 100 or fewer beds 
have such protections through 2003. Also, permanent hold harmless payments 
for cancer, and children's hospitals have been established. 
	Transitional pass-through payments for new technology--
Transitional pass-through payments are supplemental payments to cover 
the incremental cost associated with certain medical devices, drugs and 
biologicals that are inputs to an existing service.  The additional 
payment for a given item is established for a limited period of time from 
2 to 3 years and then the costs are incorporated into the APC relative 
weights. By law, total pass-through payments are limited to a given 
percentage of total OPPS payments.     In 2003, spending on pass-through 
items cannot exceed 2.5 percent of total outpatient PPS payments; in 
CY2004 and subsequently, the percentage is  2.0 percent.  If CMS 
expects that pass-through payments will exceed this limit during a 
year, the agency is required to impose a uniform reduction in pass-
through payments to meet that limit.  CMS did not maintain the 
required budget neutrality from August 2000 to April 2002.
	Current drugs and biologicals that have been in transitional 
pass-through status on or prior to January 1, 2000  were removed from 
that payment status effective January 1, 2003.  CMS established separate 
APC payments for certain of these drugs, including selected orphan 
drugs, blood and blood products, and selected higher cost drugs in 
CY2003.  CMS established a threshold of $150 per claim line for a drug 
to qualify for a separate APC payment as a higher-cost drug,  other 
drugs that had qualified for a transitional pass-through payment were 
packaged into procedural APCs.   For example, in some instances, 
brachytherapy seeds (radioactive isotopes used in cancer treatments) 
were packaged into payments for brachytherapy procedures.   The payment 
rates for these APCs are based on a relative weight calculated in the 
same way as procedural APCs are calculated. 
	Generally, medical devices as well as drugs and biologicals are 
eligible for transitional pass-through payments when the cost of the 
device is not insignificant in relation to the OPPS payment amount; no 
existing or previously existing payment category is appropriate; and 
payment was not being made for the device as a HOPD services as of 
December 31, 1996.  Under certain circumstances, the latter requirement 
may not apply.  The cost of a given drug, biological or device is 
considered not insignificant in relation to the amount payable for the 
applicable APC according to certain thresholds established by CMS. 
Medicare payment for devices is based on the amount that a hospital's 
charges, adjusted to costs exceeds the portion of the OPPS payment 
associated with the device.  Medicare payments for drugs and biologicals  
is based on the difference between 95 percent of their average wholesale 
price and the portion of the otherwise applicable APC payment rate 
attributable to the existing drug, subject to a budget neutrality 
provision.  The pass-through amount for new drugs with a substitute 
drug recognized in a separate drug APC payment is the difference 
between 95 percent of new drug's AWP and the payment rate for the 
comparable dose of the associated drug's APC.   Although transitional 
pass-through payments are subject to a budget neutrality requirement, 
the applicable budget neutrality requirement (2.5 percent through 
CY2003) was not effective until April, 2002.  In 2002, after imposing 
the uniform reduction, CMS paid hospitals about 72 percent of AWP for  
transitional pass-through payments for these drugs and biologicals.   
	Outliers--Outlier payments are made for certain cases with 
high costs relative to the payment rate for the applicable APC group. 
In 2003, outliers are defined as services with estimated costs that 
exceed a threshold of 2.75 times its APC payment rate.  Hospitals 
will be paid for 45 percent of the difference between the threshold 
and the estimated cost of the service.  Aggregate outlier payments 
are limited to 2 percent of total OPPS payments and are financed by 
reducing the conversion factor by 2 percent.  
	Transitional corridor payments--A hospital may receive 
transitional corridor payments through 2003, the amount of which 
will depend upon the difference between a hospital's OPPS payments 
and what it would have received under the previous payment policy.  
Corridor payments will compensate a significant portion of a 
hospital's small loss and a smaller portion of a hospital's larger 
loss. These payments have diminished over the transition period.  In 
2003, corridor payments will compensate a hospital up to 60 percent of 
the difference that is less than 10 percent of what the hospital would 
have received under the previous policy, but only 6 percent of any 
difference that is greater than 10 percent.


	Services provided in an ambulatory surgical center (ASC) are 
paid under Medicare Part B. An ASC is a facility where surgeries that 
do not require an inpatient hospital admission are performed. ASCs 
treat only patients who have already seen a health care provider and 
for whom surgery has been selected as an appropriate treatment. All 
ASCs must have at least one dedicated operating room and the equipment 
needed to perform surgery safely and to provide for recovery from 
anesthesia. Patients electing to have surgery in an ASC arrive for a 
scheduled appointment on the day of the procedure, have the surgery in 
an operating room, and recover under the care of the nursing staff 
before leaving for home.  According to MedPAC, the number of Medicare-
certified ASCs more that doubled from  1,460 in 1991 to 3,371 in 2001.  
From 1997 through 2001, an average of over  270 new facilities began 
participating in Medicare a year, an increase that was partially 
offset by the average of 52 ASCs that closed or merged each year.  
	Medicare began covering ASC services in 1982 as a way to 
reduce costs for surgeries generally carried out on a hospital 
inpatient basis but that could be performed safely in a less costly 
outpatient setting. ASCs must meet certain conditions specified by 
Medicare in order to participate in the program. Some ASCs limit 
services to one type of surgery, such as ophthalmology, and others 
provide a variety of procedures, including gastroenterological, 
orthopedic, pain block, urology, podiatry, and ear, nose, and throat 
procedures.  About half of all Medicare payments to ASCs in 2001 were 
related to cataract removal or lens insertion. 

Payment for ambulatory surgical centers 
	From the start of Medicare coverage of ASC services, Medicare 
based its payments on a prospective payment fee schedule. This system 
was one of the first applications of a fee schedule for outpatient or 
ambulatory care.   The two primary cost components of a surgical 
procedure are the physician's (or practitioner's) professional fees 
for performing the procedure and the costs associated with services 
furnished by the facility where the surgery is performed. Medicare pays 
ASCs for facility and nonphysician personnel costs incurred in connection
with performing specific surgical procedures.  As with other Medicare 
services, physician and certain practitioner fees are paid under the 
physician fee schedule. 
	Currently, over 2,400 procedures are included on the Medicare-
approved list of ASC procedures. CMS determines which procedures will 
constitute the ASC list on the basis of certain criteria related to the 
safety, appropriateness, and effectiveness of performing the procedure 
in an ASC setting.   CMS is required by law to update the list of 
procedures performed in ASCs that are eligible for Medicare pavement.  
The list of approved procedures was most recently updated in 2003.  
These Medicare-approved ASC procedures are consolidated into 9 payment 
groupings, each of which has one payment amount.  The national payment 
rate for each of the groups equals the estimated median cost of 
procedures in the group.  CMS adjusts the labor-related portion of the 
rate (currently 34.45 percent) using the hospital wage index for the 
ASC's location.  Payments are also adjusted when multiple surgical 
procedures are performed at the same time.  Generally, the ASC 
will receive full payment for the most expensive procedure and will 
receive 50 percent payment for the other procedures.
	Medicare is  required to update ASC rates every 5 years based
on a survey of the actual audited costs incurred by a representative 
sample of ASCs for a representative sample of procedures.  Between 
revisions, the rates are to be increased by the Consumer Price Index 
for All Urban Consumers (CPI-U).  However, for fiscal years 1998-2002,
BBA 1997 reduced the annual update to the CPI-U increase minus 
2 percentage points.  ASC's received an increase of approximately 
2 percent for FY2003.  The current projection of the CPI-U for 
FY2004 is 1.0145 percent.
	For services on or after October 1, 2003, Medicare's base 
rates (prior to geographic adjustments) for ASC services are: 


Proposed changes to ASC Medicare payments 
	On June 12, 1998, HCFA issued proposed rules which would make 
major changes in Medicare payments to ASCs.  The major changes include 
replacing the payment groupings with an APC system comprised of 105 
payment groups; updating underlying cost data using 1994 survey data 
updated to the present; and making additions to and deletions from the 
list of Medicare covered ASC procedures.  Payments would range from $53 
to $2,107 and would be updated by the CPI-U annually on a calendar year 
basis.  BBRA 1999 did not address ASC payment rates, the proposed APC 
system, or update procedures.  However, it requires that, if the 
Secretary implements new rates based on the 1994 data (or any rates 
based on pre-99 Medicare cost survey data), those new rates must be 
phased in by basing payments one-third on the new rates in the first 
year, two-thirds in the second year, and fully in the third year.  
BIPA prohibited implementation of a revised payment system for ASC 
facility services before January 1, 2002, extended the phase in of 
the APC system for ASCs to 4 years and required that by January 1, 
2003, ASC rates be rebased using  data from a 1999 or later Medicare 
survey. In its March 28, 2003 regulation, CMS stated that it has 
developed an ASC survey instrument, but believes that developing 
useful cost data will take at least 2 years. Moreover, CMS is 
studying its rate setting approach to ensure that its ASC payment 
system does not inadvertently worsen payment differentials across the 
various ambulatory sites of service that provide the same care. 


Covered Services
	Medicare covers ambulance services only if they are furnished 
to a beneficiary whose condition is such that other means of 
transportation are contraindicated.  The beneficiary's condition 
must require both the transportation itself and the level of service 
provided in order for the billed service to be considered medically 
necessary. 	Nonemergency transportation is considered appropriate 
if: 1) the patient is bed confined and it is documented that the 
beneficiary's condition is such that other methods of transportation 
are contraindicated; or 2) if the medical condition is such that 
ambulance transportation is required. Special rules apply for 
nonemergency services. In the case of scheduled repetitive services, the 
ambulance provider or supplier must obtain an order from the 
beneficiary's attending physician; the order must certify that the 
medical necessity requirements have been met. The following requirements 
apply for services that are unscheduled, or scheduled on a nonrepetitive 
-	The ambulance provider or supplier must obtain, within 48 hours 
after transport, a written order from the beneficiary's attending 
physician if the beneficiary is a resident of a facility. No order is 
required for a beneficiary residing at home or not under the care of a 
-	If the ambulance provider or supplier is unable to obtain the 
statement from the attending physician, then a statement must be 
obtained from a physician assistant, nurse practitioner, clinical nurse 
specialist, registered nurse or discharge planner.  Such individual 
must have personal knowledge of the beneficiary's condition at the 
time the transport is ordered or the service is furnished.  The 
individual must be employed by either the patient's attending 
physician, or the hospital or facility where the beneficiary is 
being treated and from which the beneficiary is transported.
-	If the required certification is not obtained within 21 days, 
the supplier must document attempts to obtain such certification.
	Medicare covers transportation from the point of origin to 
the nearest hospital, critical access hospital or skilled nursing 
facility that is capable of furnishing the required level and type of 
care for the beneficiary's illness or injury. 
 The facility must have available the type of physician or physician 
specialist needed to treat the beneficiary's condition. The program 
also covers trips from such facilities to the beneficiary's home. In 
addition, the program covers trips from a SNF to the nearest supplier of 
medically necessary services not available at the SNF where the 
beneficiary is a resident. Beneficiaries receiving renal dialysis 
treatments for ESRD can be transported to the nearest facility 
furnishing such services.

Payments for Services
	Medicare pays for ambulance services on the basis of a fee 
schedule.  The fee schedule, which went into effect April 1, 2002, is 
being phased-in over a five-year period.  This fee schedule replaces 
the reasonable cost payment system that had applied for hospital 
providers of ambulance services and the reasonable charge payment 
system that had applied to other suppliers of ambulance services.  
(Critical access hospitals are exempt from the fee schedule and continue 
to be paid for ambulance services on the basis of reasonable costs.)
	During a transition period (2002- 2006), payment under the 
program is based on a blend with a gradually increasing portion of the 
payment based on the fee schedule and a decreasing portion on the former 
payment methodology.  In 2002, the payment equaled 20 percent of the 
fee schedule plus 80 percent of the previous reasonable cost or charge 
rates.  In 2003, the blend is 40 percent of the fee schedule rates and 
20 percent of cost or charge rates. In 2004, the blend will be 60 
percent of the fee schedule, 40 percent of the cost or charge rates; in 
2005 the blend will be 80 percent of the fee schedule and 20 percent of 
the cost or charge rates.  In 2006, the payment will be based entirely 
on the fee schedule.
	The fee schedule establishes seven categories of ground 
ambulance services and two categories of air ambulance services.  The 
ground ambulance categories are:  basic life support (BLS), both 
emergency and nonemergency; advanced life support Level 1 (ALS1), both 
emergency and nonemergency; advanced life support level 2 (ALS2); 
speciality care transport (SCT); and paramedic ALS intercept (PI). The 
air ambulance categories are: fixed wing air ambulance (FW) and rotary 
wing air ambulance (RW).
	The fee schedule payment for an ambulance service equals a base 
rate for the level of service plus payment for mileage.  Geographic 
adjustments are made to a portion of the base rate to reflect the 
relative costs of providing services in various areas of the country.  
Additionally, the base rate is increased for air ambulance trips 
originating in rural areas and mileage payments are increased for 
all trips originating in rural areas. 
	The calculation for ground ambulance services is made as 
-	The relative value assigned to the category of service is 
multiplied by the national dollar conversion factor. This is the 
unadjusted base rate.
-	Seventy percent of the unadjusted base rate is multiplied by the 
geographic practice expense adjustment used for the physician fee 
schedule.  This is added to thirty percent of the unadjusted base rate. 
The sum is the adjusted base rate.
-	A mileage calculation is made.  For urban areas, the regular 
mileage rate is multiplied by the number of miles. For rural areas, 
the regular mileage rate is increased by fifty percent for miles 1 - 
17 and by 25 percent for miles 18 - 50; the regular mileage rate 
applies for all miles over 50. (No mileage rate applies for paramedic 
ALS intercept services).
-	The adjusted base rate payment amount is added to the mileage 
payment. The sum is the fee schedule payment amount.
	There are no relative values or conversion factor for air 
ambulance 	services. 
 The fee schedule amount for these services is calculated as follows:
-	Fifty percent of the published unadjusted base rate (for fixed 
or rotary wing, as appropriate) is multiplied by the geographic 
practice expense adjustment used for the physician fee schedule.  
This is added to fifty percent of the unadjusted base rate. The sum 
is the adjusted base rate payment.
-	A mileage calculation is made by multiplying the mileage rate 
by the number of miles.
-	The adjusted base rate payment amount is added to the mileage 
The sum is the fee schedule payment amount.
	For both ground and air ambulance services in 2003, 40 percent 
of the fee schedule payment amount is added to 60 percent of the payment 
calculated using the reasonable charge or cost method (whichever is 
appropriate) to give the actual payment amount.
	The fee schedule amount is updated each year by the CPI-U.  The 
update for 2003 is 1.1 percent.


	Home health services are covered under both Medicare Part A 
and Medicare Part B.  For a discussion of the benefit, see Part A 
discussion above.


	Medicare beneficiaries who are inpatients of hospitals or 
skilled nursing facilities may receive drugs as part of their treatment.  
Medicare payments made to the facilities cover these costs. Medicare 
also makes payments to physicians for drugs or biologicals which cannot 
be self-administered.  This means that coverage is generally limited to 
drugs or biologicals administered by injection. However, if the 
injection is generally self-administered (e.g., insulin), it is not 
	In general, Medicare does not cover outpatient prescription 
However, despite the general limitation, the law specifically 
authorizes coverage for the following: 
-	Immunosuppressive Drugs-Drugs used in immunosuppressive therapy 
(such as cyclosporin) for individuals who have received a Medicare 
covered organ transplant.
?	Erythropoietin (EPO). EPO for the treatment of anemia for 
persons with 
chronic renal failure who are on dialysis.
-	Oral Anti-Cancer Drugs. Drugs taken orally during cancer chemotherapy 
providing they have the same active ingredients and are used for the same 
indications as chemotherapy drugs which would be covered if they were 
not self-administered and were administered as incident to a physician's  
professional service. Also included are oral anti-nausea drugs used as part 
of  an anti-cancer chemotherapeutic regimen.
-	Hemophilia clotting factors. Hemophilia clotting factors for 
hemophilia patients competent to use such factors to control bleeding 
without medical supervision, and items related to the administration of 
such factors.
-	Drugs that are necessary for the effective use of covered 
durable medical equipment, including those which must be put directly 
into the equipment (e.g., tumor chemotherapy agents used with an 
infusion pump).
-	Injectable osteoporosis drug approved for treatment of post-
menopausal osteoporosis provided by a home health agency to a homebound 
individual whose attending physician has certified suffers from a bone 
fracture related to post-menopausal osteoporosis and the individual is 
unable to self-administer the drug.
	The program also covers the following immunizations:
-	Pneumococcal pneumonia vaccine.  The vaccine and its 
administration to a beneficiary if ordered by a physician.
-	Hepatitis B vaccine. The vaccine and its administration to a 
beneficiary who is at high or intermediate risk of contracting 
hepatitis B.
-	Influenza virus vaccine.  The vaccine and its administration 
when furnished in compliance with any applicable State law.  The 
beneficiary may receive the vaccine upon request without a physician's 
order and without physician supervision.

	Payments for these drugs and immunizations are made under 
Medicare  Part B.  The payment for a drug equals 95 percent of the 
average wholesale price (AWP).  On December 3, 2002, CMS sent a notice 
to contractors announcing the establishment of a single national price 
for each Medicare covered drug whose payment allowance is based on 95 
percent of the AWP.  Effective January 1, 2003, individual fiscal 
intermediaries and carriers no longer make the AWP determinations.  
Rather, they rely on the single drug pricer (SDP) files sent to them by 
CMS and process claims on the basis of the price shown on the applicable 
file. The new policy does not apply to drugs billed to DMERCs (durable 
medical equipment regional carriers) because DMERC-paid drug allowances 
are already consistent nationally. The policy also does not apply to 
hospital outpatient drugs (except blood clotting factors) because the 
payment allowance for such drugs is determined by a different procedure.
	Medicare pays 80 percent of the recognized payment amount after 
the beneficiary has met the $100 Part B deductible. The beneficiary is 
liable for the remaining 20 percent coinsurance charges.  These Part B 
cost-sharing charges do not apply for pneumococcal pneumonia or influenza 


Preventive services 
	Screening mammograms--Medicare covers an annual screening 
mammography for all women over age 40. Payment for  the mammogram is 
made under the physicians' fee schedule.
	Screening Pap smears; pelvic exams--Medicare authorizes coverage 
for a screening Pap smear and a screening pelvic exam once every 2 years; 
annual coverage is authorized for women at high risk. Payment is based on 
the clinical diagnostic laboratory fee schedule (see above).  A national 
minimum payment for Pap smears is established.  In 2003, this is $14.76.
	Prostate cancer screening tests--Medicare covers an annual 
prostate cancer screening test for men over age 50. The test can consist 
of any (or all) of the following procedures: (1) a digital rectal exam; 
(2) a prostate-specific antigen blood test; and (3) such other 
procedures as the Secretary finds appropriate for the purpose of early 
detection of prostate cancer. 
	Colorectal cancer screening--The law authorizes coverage of and 
establishes frequency limits for colorectal cancer screening tests.  A 
covered test is any of the following procedures furnished for the 
purpose of early detection of colorectal cancer: (1) screening fecal-
occult blood test (for persons over 50, no more than annually); (2) 
screening flexible sigmoidoscopy (for persons over 50, no more than one 
every 4 years after a previous sigmoidoscopy or more than one every 10 
years following a screening colonoscopy); (3) screening colonoscopy (no 
more than one every 2 years for high-risk individuals and no more 
than one every 10 years (or no more than 4 years after a screening 
flexible sigmoidoscopy) for other persons; and (4) such other procedures 
as the Secretary finds appropriate for the purpose of early detection 
of colorectal cancer. Barium enema tests, as an alternative to either a 
screening flexible sigmoidoscopy or a screening colonoscopy, are 
covered in accordance with the same screening parameters specified for 
those tests.  Services are paid under the physician fee schedule (except 
that fecal occult blood tests are paid under the laboratory fee 
schedule).  A facility payment may also apply if services are performed 
in an ambulatory surgical center or hospital outpatient department.
	Diabetes Outpatient Self-Management Training--Medicare's covered 
benefits include diabetes outpatient self-management training services. 
These services are defined as including educational and training 
services furnished to an individual with diabetes by a certified 
provider in an outpatient setting. They are covered only if the 
physician or qualified non-physician practitioner who is managing the 
individual's diabetic condition certifies that the services are needed.  
Services must be provided under a comprehensive plan of care to ensure 
therapy compliance or to provide the individual with necessary skills 
and knowledge (including skills related to the self-administration of 
injectable drugs) to participate in the management of their own 
condition. Certified providers for these purposes are defined as 
physicians or other individuals or entities that, in addition to 
providing diabetes outpatient self-management training services, 
provide other items or services reimbursed by Medicare. Providers must 
meet quality standards established by the Secretary. CMS currently 
accepts recognition of the American Diabetes Association (ADA) as 
meeting the National Standards for diabetes self-management training 
	Medical Nutrition Therapy Services--Medicare authorizes 
coverage of medical nutrition therapy services (MNT) for certain 
beneficiaries who have diabetes or a renal disease. Services include 
nutritional, diagnostic, therapy and counseling services furnished by a 
registered dietician or nutrition professional, pursuant to a referral by 
a physician. Effective October 1, 2002, basic coverage of MNT for the 
first year a beneficiary receives MNT with either a diagnosis of renal 
disease or diabetes is 3 hours. Basic coverage in subsequent years for 
renal disease or diabetes is 2 hours. The dietitian/nutritionist may
choose how many units are performed per day as long as all of the other 
requirements are met. If the treating physician determines that 
receipt of both MNT and diabetes self-management training  is medically 
necessary in the same episode of care, Medicare will cover both in 
the initial and subsequent years without decreasing either benefit as 
long as they are not provided on the same date of service. The 
dietitian/nutritionist may choose how many units are performed per day. 
In all cases, additional hours are considered to be medically necessary 
and covered if the treating physician determines that there is a change 
in medical condition, diagnosis, or treatment regimen that requires a 
change in MNT and orders additional hours during that episode of care.  
Payment equals 85 percent of the amount established under the physician 
fee schedule for  the service if it had been furnished by a physician.
	Bone mass measurements--Bone mass measurement is covered for 
the following high risk persons: an estrogen-deficient woman at clinical 
risk for osteoporosis; an individual with vertebral abnormalities; an 
individual receiving long-term glucocorticoid steroid therapy; an 
individual with primary hyperparathyroidism; or an individual being 
monitored to assess osteoporosis drug therapy. Payments are made under 
the physician fee schedule.  In general, the services are covered if 
they are provided no more frequently than once every 2 years.
	Glaucoma Screening--The program provides for annual coverage 
for glaucoma screening for beneficiaries in the following high risk 
categories: (1) individuals with diabetes mellitus, (2) individuals 
with a family history of glaucoma, or (3) African-Americans age 50 
and over.  Medicare will pay for glaucoma screening examinations 
when they are furnished by or under the direct supervision in the 
office setting of an ophthalmologist or optometrist, who is legally 
authorized to perform the services under State law. Payments are made 
under the physician fee schedule.

	Medicare pays for services which are furnished via a 
telecommunications system by a physician or practitioner, 
notwithstanding the fact that the individual providing the service is 
not at the same location as the beneficiary.  Payment to the physician 
or practitioner furnishing the service is equal to the amount that 
would be paid if the service had been furnished without the use of a 
telecommunications system.  A facility fee is paid to the originating 
site (i.e. the site where the beneficiary is when the service is 
provided.)  The fee equals the amount established for the preceding 
year, increased by the percentage increase in the Medicare economic 
index (MEI). The 2003 amount is $20.60.

Rural Health Clinics and Federally-Qualified Health Centers
	Medicare covers services furnished by a qualified rural health 
clinic (RHC) located in an area which has a shortage of health 
personnel.  The covered services RHCs may offer are divided into two 
basic groups-- rural health clinic services  and other medical and 
other health services covered under Part B. Items and services which 
meet the definition of rural health clinic services are physicians' 
services; services and supplies incident to a physician's services; 
nurse practitioner and physician assistant services (including the 
services of specialized nurse practitioners and nurse midwives) that 
would be covered if furnished by a physician, provided the nurse 
practitioner or physician assistant is legally permitted to perform 
the services by the State in which they are performed; services and 
supplies incident to the services of nurse practitioners and physician 
assistants that would be covered if furnished incident to a physician's 
services; and visiting nurse services to the homebound.  The program 
also covers services in Federally-qualified health centers (FQHCs). 
Covered services include those covered in RHCs as well as preventive 
primary services.
	Payments for RHC and FQHC services are based on an all 
inclusive rate for each beneficiary visit for covered services.  An 
interim payment is made to the entity based on estimates of allowable 
costs and number of visits; a reconciliation is made at the end of the 
year based on actual costs and visits. Per visit payment limits are 
established for all RHCs (other than those in hospitals with fewer than 
50 beds) and FHQCs.  Payment limits are updated on January 1 of each 
year by the Medicare economic index (MEI) which measures inflation for 
certain medical services. Because of the delay in implementing the MEI, 
there was one update on January 1, 2003 and a second one on March 1, 
2003. For services provided January 1, 2003 - February 28, 2003, the 
RHC upper payment limit was $66.46, the urban FQHC limit was $103.18 
and the rural FQHC limit was $88.71. For services provided March 1, 
2003- December 31, 2003, the RHC upper payment limit is $66.72, the 
urban FQHC limit is $103.58, and the rural FHQC limit is $89.06.  
Assignment is mandatory; no deductible applies for FQHC services. 

Comprehensive Outpatient Rehabilitation Facilities (CORFs)
	A comprehensive outpatient rehabilitation facility (CORF) is a 
public or private institution that is engaged primarily in providing 
(by or under the supervision of physicians) diagnostic, therapeutic, and 
restorative services on an outpatient basis for the rehabilitation of 
injured, disabled or sick persons. The facility must provide at least 
the services of physicians (who are available to the facility  on a full 
or part-time basis), physical therapy, and social or psychological 
services.  Covered services also include occupational therapy, speech 
language pathology services, respiratory therapy, prosthetic and 
orthotic devices, nursing care, drugs which cannot be self-administered, 
supplies, and durable medical equipment.  Payments for services are 
made under the physician fee schedule. Therapy services are subject to 
the therapy payment limitations (described above, for physical and 
occupational therapy providers). Mental health services are subject to 
the payment limitation for mental health services (described above).

Partial Hospitalization Services
	Medicare covers partial hospitalization in connection with the 
treatment of mental illness. The services are covered only if the 
individual would otherwise require inpatient psychiatric care.  The 
course of treatment must be prescribed, supervised, and reviewed by a 
physician. Services must be provided under a program which is hospital-
based or hospital affiliated and must be a distinct and organized 
intensive ambulatory treatment service offering less than 24-hour daily 
care.  The program may also be covered when provided by a community 
mental health center.  
	Payment for professional services is made under the physician 
fee schedule.  Other services are paid under the hospital outpatient 
prospective payment system.



	Medicare's End-Stage Renal Disease (ESRD) Program was 
established in the Social Security Amendments of 1972, and covers 
beneficiaries regardless of age.  Eligible individuals have severe 
impairment of kidney function as a result of diabetes, hypertension, or 
other diseases that lead to ESRD. Prior to passage of the 1972 
Amendments, treatment for ESRD was limited to a few individuals because 
of its high cost and the limited number of dialysis machines.  ESRD is 
invariably fatal without treatment. Treatment takes two forms: 
transplantation and dialysis. 
	 Beneficiaries must be: (1) fully insured for Old-Age and 
Survivors Insurance benefits; (2) entitled to monthly Social Security 
benefits; or (3) spouses or dependents of individuals described in (1) 
or (2). Such individuals must be medically determined to be suffering 
from ESRD and must file an application for 
	 Benefits include all Part A and Part B medical items and 
services. ESRD beneficiaries are automatically enrolled in the Part 
B portion of Medicare and are required to pay the monthly Part B 
premium.  Medicare coverage  begins on the first day of the third month 
after the beneficiary begins a course of renal dialysis.  In the case 
of a transplant candidate, coverage can begin as early as the month in 
which the patient is hospitalized for transplantation. No new waiting
period is required when a beneficiary's entitlement has ended and the 
beneficiary needs to begin another course of dialysis or receive 
another kidney transplant.  Medicare+Choice (M+C) plans may provide 
ESRD benefits to the Medicare beneficiary who is already enrolled in a 
M+C organization and subsequently develops ESRD. However, beneficiaries 
who have been recently diagnosed with ESRD cannot join a M+C plan.
	Table 2-41 shows expenditures, number of beneficiaries, and the 
average expenditure per person for all persons with ESRD (including the 
aged and disabled) from 1974 through 2005. Total projected program 
expenditures for the Medicare ESRD Program for fiscal year 2003 are 
$15.0 billion; for fiscal year 2005, they are estimated to increase 
to $17.4 billion.  In fiscal year 2003, there are an estimated 397,270 
beneficiaries, including successful transplant patients and persons 
entitled to Medicare on the basis of age or disability who also have 
 	When the ESRD Program was created, it was assumed that program 
enrollment would level out at about 90,000 enrollees by 1995. That mark 
was passed several years ago, and no indication exists that enrollment 
will stabilize soon. Table 2-42 shows that new enrollment for all 
Medicare beneficiaries receiving ESRD services grew at an average annual 
rate of 6.8 percent from 1991 to 2000. Most of the growth in program 
participation is attributable to growth in the numbers of elderly people 
receiving services and growth in the numbers of more seriously ill people 
entering treatment. Table 2-42 shows the greatest rate of growth in 
program participation is in people over age 75, at 10.1 percent, 
followed by people of ages 65-74 with a growth rate of 4.4 percent. The 
largest rate of growth in primary causes of people entering ESRD 
treatment was diabetes. People with diabetes frequently have multiple 
health problems, making treatment for renal failure more difficult.



	The rates of growth in older and sicker patients entering 
treatment for ESRD indicate a shift in physician practice patterns. In the 
past, most of these people would not have entered dialysis treatment 
because their age and severity of illness made successful treatment for 
renal failure less likely. Although the reasons that physicians have begun 
treating older and sicker patients are not precisely known, it is clear 
that these practice patterns have resulted, and will continue to result, 
in steady growth in the number of older patients receiving Medicare's 
ESRD services.

Outpatient Immunosuppressive Drug Coverage
	Although the capability to perform transplants had existed since 
the 1950s, problems with rejection of transplanted organs limited its 
treatment for renal failure. The 1983 introduction of a powerful and 
effective immunosuppressive drug, cyclosporin, resulted in a dramatic 
increase in the number of transplants being performed and the success rate 
of transplantation. Medicare currently pays  80 percent of the cost for 
immunosuppressive drugs required after a covered Medicare 





	Immunosuppressive drug coverage under Medicare began with The 
Omnibus Budget Reconciliation Act of 1986 (OBRA >86), which provided  
coverage up to 1 year from the date of discharge from a Medicare-covered 
transplant. Subsequent legislation extended the coverage.  The 
Beneficiary Improvement and Protection Act (BIPA) (P.L. 106-554), 
provided lifetime coverage for immunosuppressive drugs to Medicare aged 
and disabled beneficiaries following a transplant covered by Medicare,
effective December 21, 2000. However, persons who are under age 65 and 
entitled to Medicare based solely on their diagnosis of ESRD will lose 
their ESRD Medicare entitlement 3 years after transplantation, and, 
effectively, lose coverage for the necessary  immunosuppressive drugs. 
They will be eligible again when they reach age 65.


	Table 2-43 indicates that a total of 14,628 kidney transplants 
were performed in Medicare-certified U.S. hospitals in 2001. Kidneys are
the most frequently transplanted organ and Medicare covers nearly 90 
percent of all kidney transplant beneficiaries in the U.S.  Medicare 
appears to be the primary payer in approximately 50 percent of all 
kidney transplants in the U.S. and is at least the secondary payer in 
nearly 60 percent of all kidney transplants.  Despite the significant 
increases in the number and success of kidney transplants, 
transplantation is not the treatment of choice for all ESRD patients. 
A chronic, severe shortage of kidneys available for transplantation 
limits the number of patients who can receive transplants. Even absent 
a shortage of organs, some patients are not suitable candidates for 
transplants because of their age, severity of illness, or other 
complicating conditions. Finally, some ESRD patients do not 
want an organ transplant.
	For all of these reasons, dialysis is likely to remain the 
primary treatment for ESRD.  Medicare pays for 75-80 percent of all 
dialysis care. Dialysis is an artificial method of performing the 
kidney's function of filtering blood to remove waste products and toxins. 
There are two types of dialysis:  hemodialysis and peritoneal dialysis.  
The method chosen by the majority of Medicare beneficiaries is  
hemodialysis, which requires blood to be removed from the body, filtered 
and cleansed through a dialyzerBsometimes called an artificial kidney 
machine--before being returned to the body.  Hemodialysis  is usually 
performed three times a week in a clinic or hospital, and takes three 
to four hours, depending on the patient.

U.S. HOSPITALS, 1999-2001


	Peritoneal dialysis filtering takes place inside the 
body by inserting dialysate fluid through a permanent surgical opening in 
the peritoneum (abdominal cavity). Toxins filter into the dialysate 
fluid and are then drained from the body through the surgical opening.  
There are three types of peritoneal dialysis: intermittent peritoneal 
dialysis (IPD), continuous cycling peritoneal dialysis (CCPD)-- both of 
which require the use of a machine and the assistance of a partner--and 
continuous ambulatory peritoneal dialysis (CAPD)-- which does not 
require a machine. 
	  IPD can be done at home but is usually done in a hospital--
treatments are performed several times a week, for a total of 36 to 
42 hours per week. The CAPD and CCPD require daily exchanges of 
dialysate fluid and both can be performed at home.  CAPD can be done at 
any time and is the most popular form of peritoneal dialysis. The 
process involves draining the dialysate and replacing fresh solution 
which takes 30 to 40 minutes and the solution is usually changed four 
times a day.  CCPD is usually done at night while the individual is 
asleep, requiring 10 to 12 hours per night.


	Medicare reimbursement for dialysis services provided by 
hospital-based and independent facilities are paid at prospectively 
determined rates-the necessary dialysis-related services, equipment, 
and supplies are furnished for a predetermined fixed fee per dialysis 
treatment. The rate, referred to as a composite rate, is derived from 
a base rate and adjusted by local area wage differences and audited 
cost data adjusted for the national proportion of patients dialyzing 
at home versus in a facility.  Adjustments are made to the composite 
rate for hospital-based dialysis facilities to reflect higher overhead 
costs. Some examples of services included under the composite rate are: 
cardiac monitoring, catheter changes, dressing changes, suture removal, 
all oxygen and its administration, and declotting of shunt. If a 
facility fails to furnish any part of the items and services covered 
under the rate, then the facility cannot be paid any amount for the 
part of the items and services that it did furnish.
	Beneficiaries electing home dialysis may choose either to 
receive dialysis equipment, supplies, and support services directly 
from the facility with which the beneficiary is associated (method I) 
or to make independent arrangements for equipment, supplies, and 
support services (method II). Under method I, the equipment, supplies, 
and support services are included in the facility's composite 
rate. Under method II, payments are made on the basis of reasonable 
charges and limited to 100 percent of the median hospital composite 
rate, except for patients on CCPD, in which case the limit is 130 
percent of the median hospital composite rate. Neither the composite 
rate nor the reasonable charge payment for method II is routinely 
	The composite rate for renal dialysis was updated in the BBRA. 
The act increased the composite rate for 2000 by 1.2 percent above 
the revised composite rate that was in effect in 1999.  An additional
1.2 percent was authorized for 2001. BIPA modified the BBRA provision 
to provide for a 2.4 percent increase to the composite rate beginning 
in 2001.  The maximum composite rate cap (maximum allowed payment per 
treatment) as of January 2002 is $144.59 per treatment for urban 
centers and $144.05 for rural areas.
	Kidney transplantation services are inpatient hospital services 
and they are subject to the Medicare prospective payment system (PPS).  
The costs of care for actual and potential kidney donors are fully 
covered by Medicare and include all reasonable preparatory, operation, 
and post-operation recovery expenses associated with donation, without 
regard to deductibles, coinsurance, and premium payments. Post-
operation recovery expenses are limited to the actual period of 
recovery, however. There is also no specific update policy for 
reasonable costs of kidney acquisition, and 100 percent of reasonable 
costs is reimbursed.


	Medicare has a long-standing history of offering its 
beneficiaries an alternative to the traditional fee-for-service program.  
Health Maintenance Organizations and other types of managed care plans 
have been allowed to participate in the Medicare program, beginning 
with private health plan's contracts in the 1970s and the Medicare 
risk contract program in the 1980s.  Then, in 1997, Congress passed the 
Balanced Budget Act of 1997 (BBA, P.L. 105-33), replacing the risk 
contract program with the Medicare+Choice (M+C) program.  The M+C 
program established new rules for beneficiary and plan participation, 
along with a new payment methodology.  In addition to controlling 
costs, the M+C program was also designed to expand private health 
plans to markets where access to managed care plans was limited or 
nonexistent and to offer new types of private health plans. The 106th 
Congress enacted legislation to address some issues arising from 
the BBA changes.  The Balanced Budget Refinement Act of 1999 (BBRA, 
P.L. 106-113) changed the M+C program in an effort make it easier for 
Medicare beneficiaries and plans to participate in the program.  
Further refinements to the M+C program were included in the Medicare,
Medicaid, and SCHIP Benefits Improvement and Protection Act of 2000 
(BIPA, P.L. 106-554).  The 107th Congress passed The Public Health 
Security and Bioterrorism Preparedness and Response Act (P.L. 107-188) 
which included a few temporary changes to deadlines 
in the Medicare+Choice program.
	In  2003, Medicare+Choice plans were available to about 59 
percent of the over 40 million Medicare beneficiaries, and in March 
2003 about 12 percent of them chose to enroll in one of the 146 
(including two private-fee-for service plans) available Medicare+Choice 
plans.  The rapid growth rate of Medicare managed care enrollment in 
the 1990s leveled off with the implementation of the M+C program, and 
in fact, there has been a continuous decline in enrollment since 1999 
when 17 percent of beneficiaries were enrolled in M+C plans.  
	In order to increase enrollment in Medicare managed care and 
to allow beneficiaries to better meet their health care needs, the 
M+C program offers a diverse assortment of managed care plans.  
However, achieving the goals of the M+C program has been difficult, 
in part because the goal to control Medicare spending which led to a 
slowdown in the rate of increase in payments to plans, may have 
dampened interest by managed care entities in developing new markets, 
adding plan options, and maintaining their current markets (see 
Appendix E for further information about the M+C program).



	Generally, Medicare is the ``primary payer,'' that is, it pays 
health claims first, with an individual's private or other public health 
insurance filling in some or all of Medicare's coverage gaps. However, 
in certain cases, the individual's other coverage pays first, while 
Medicare is the secondary payer. This phenomenon is referred to as the 
Medicare Secondary Payer Program. 
	An employer (with 20 or more employees) is required to offer 
workers age 65 and older (and workers' spouses age 65 and older) the 
same group health insurance coverage as is made available to other 
employees. Workers have the option of accepting or rejecting the 
employer's coverage.  If the worker accepts the coverage, the employer's 
plan is primary for the worker and/or spouse who is over age 65; 
Medicare becomes the secondary payer. Employers may not offer a plan 
that circumvents this provision. 
	Similarly, a group health plan, offered by a large employer 
with 100 or more employees, is the primary payer for employees or their 
dependents who are on the Medicare disability program. The provision 
applies only to persons covered under the group health plan because 
the employee (generally the spouse of the disabled person) is in 
"current employment status" (i.e., is an employee or is treated as 
an employee by the employer). Secondary payer provisions also apply 
to ESRD individuals with employer group health plans (regardless of 
employer size). The group health plan is the primary payer for 30 
months for persons who become eligible for Medicare ESRD benefits. 
	Medicare is also the secondary payer when payment has been 
made, or can reasonably be expected to be made, under workers' 
compensation, automobile medical liability, all forms of no-fault 
insurance, and all forms of liability insurance. 
	The law authorizes a data match program which is intended to 
identify potential secondary payer situations. Medicare beneficiaries 
are matched against data contained in Social Security Administration 
and Internal Revenue Service files to identify cases in which a 
working beneficiary (or working spouse) may have employer-based 
health insurance coverage. Cases of previous incorrect Medicare 
payments are identified and recoveries are attempted. Recoveries can be 
initiated up to 3 years after the date the service was furnished.
Further, recoveries may be made from third-party administrators 
except where such administrators cannot recover amounts from the 
employer or group health plan. 
	Table 2-44 shows savings attributable to these Medicare 
secondary payer provisions. In fiscal year 2002, combined Medicare 
Part A and B savings are estimated at $4.3 billion. 




	Most beneficiaries depend on some form of private or public 
coverage to supplement their Medicare coverage. In 2000, only about 
13 percent of beneficiaries relied solely on the traditional fee-for-
service Medicare program for protection against the costs of care; an
additional 13 percent were enrolled in managed care organizations.  
See Appendix B for a discussion of supplementary coverage and 
Appendix E for a discussion of Medicare+Choice.


	This section summarizes major Medicare legislation enacted 
into law, beginning in 1997.  Previous editions of the Green Book 
review legislation enacted prior to that date.  The summary highlights 
major provisions; it is not a comprehensive list of all Medicare 
amendments. Included are provisions which had a significant budget 
impact, changed program benefits, modified beneficiary cost sharing, 
or involved major program reforms. Provisions involving policy changes 
are mentioned the first time they are incorporated in legislation, but 
not necessarily every time a modification is made. The descriptions 
include either the initial effective date of the provision or, in the 
case of budget savings provisions, the fiscal years for which cuts 
were specified. 


	Froze PPS hospital and PPS-exempt hospitals and units and 
limited updates for fiscal years 1999-2002. Established a PPS for 
inpatient rehabilitation hospitals, effective beginning in fiscal
year 2001. Rebased capital payment rates and provided for additional 
reductions over the fiscal year 1997-2002 period. Reduced the indirect 
medical education payment from 7.7 percent to 5.5 percent by fiscal 
year 2001 and reformed direct graduate medical education payments 
(generally effective on enactment or October 1, 1997). 

Skilled nursing facilities 
	Provided for a phase in of a PPS that will pay a Federal 
per-diem rate for covered SNF services (generally effective July 1, 

Home health 
	Provided for the establishment of a PPS for home health 
services. Provided for a reduction in per-visit cost limits prior to 
the implementation of the PPS, clarified the definitions of part-time 
and intermittent care, and provided for a study of the definition of 
homebound. Provided for the transfer of some home health costs from 
Part A to Part B (prospective payment effective October 1, 1999, 
reduction in cost limits effective on enactment, definition 
clarification effective October 1, 1997, and transfer of costs 
effective January 1, 1998). 

	Reduced the hospice payment update for each of fiscal years 
1998-2002, and clarified the definition of hospice care (generally 
effective on enactment).

	Provided for use of a single conversion factor; replaced 
the volume performance standard with the sustainable growth rate; 
provided for phased-in implementation of resource-based practice 
expenses; and permitted use of private contracts under specified 
conditions (generally effective January 1, 1998). 

Hospital outpatient departments 
	Extended reductions in payments for outpatient hospital 
services paid on the basis of costs through December 1999 and 
established a PPS for hospital outpatient departments (OPDs) for 
covered services beginning in 1999 (generally effective on enactment). 

Other providers 
	Froze payments for laboratory services for fiscal years 
1998-2002; provided for establishment of a fee schedule in 2000 
for payment for ambulance services (generally effective on enactment).

Beneficiary payments 
	Permanently set the Part B premium at 25 percent of program 
costs and expanded the premium assistance beginning in 1998 available 
under the Specified Low-Income Medicare Beneficiary (SLMB) Program 
(effective on enactment).

Prevention initiatives 
	Authorized coverage for annual mammograms for all women over 
40. Added coverage for screening pelvic exams, prostate cancer screening 
tests, colorectal cancer screening tests, diabetes self-management 
training services, and bone mass measurements for certain high-risk 
persons (generally effective in 1998, except prostate cancer screening 
effective 2000). 

Supplementary coverage 
	Provided for guaranteed issuance of specified Medigap policies 
without a preexisting condition exclusion for certain continuously 
enrolled aged individuals (effective July 1, 1998). 

Competitive bidding 
	Provided for competitive bidding demonstrations for furnishing 
Part B services (not including physicians services) (effective on 

	Established a 17-member National Advisory Commission on the 
Future of Medicare (with appointments to be made by December 1, 1997). 
Established the Medicare Payment Advisory Commission replacing the 
Prospective Payment Assessment Commission and the Physician Payment 
Review Commission (with appointments to be made by September 30, 1997). 

	Established a new part C of Medicare called Medicare+Choice (M+C). 
Built on the existing Medicare Risk Contract Program which enabled 
beneficiaries to enroll, where available, in health maintenance 
organizations (HMOs) that contracted with the Medicare Program. 
Expanded, beginning in 1999, the private plan options that could 
contract with Medicare to other types of managed care organizations 
(for example, preferred provider organizations and provider-sponsored 
organizations), private fee-for-service plans, and, on a limited 
demonstration basis, high deductible plans (called medical savings 
account plans) offered in conjunction with medical savings accounts 
(effective on enactment). 


Prospective payment system hospitals 
	Froze the indirect medical education adjustment at 6.5 percent 
through fiscal year 2000, reduced the adjustment to 6.25 percent in 
fiscal year 2001 and to 5.5 percent in fiscal year 2002 and subsequent 
years. Froze the reduction in the DSH adjustment to 3 percent in fiscal 
year 2001; changed the reduction to 4 percent in fiscal year 2002. 
Changed the methodology for Medicare's direct graduate medical 
education payments to teaching hospitals to incorporate a national 
average amount calculated using fiscal year 1997 hospital- specific 
per-resident amounts. Increased the number of years that would count as 
an initial period for child neurology residency training programs. 
Provided for the reclassification of certain counties and areas for 
the purposes of Medicare reimbursement.

PPS-exempt hospitals 
	Adjusted the labor-related portion of the 75-percent cap to 
reflect the wage differences in the hospitals' area relative to the 
national average. Increased the amount of continuous bonus payments to 
eligible long-term care and psychiatric providers from 1 percent to 
1.5 percent for cost reporting periods beginning on or after October 
1, 2000 and before September 30, 2001 and to 2 percent for cost 
reporting periods beginning on or after October 1, 2001 and before 
September 30, 2002. Required the Secretary to report on a discharge-
based PPS for long-term care hospitals which would be implemented in 
a budget neutral fashion for cost reporting periods beginning on or 
after October 1, 2002. Required the Secretary to report on a per-diem-
based PPS for psychiatric hospitals which would be implemented in a 
budget neutral fashion for cost reporting periods beginning on or 
after October 1, 2002. Required the Secretary to base the PPS for 
inpatient rehabilitation hospitals on discharges and incorporate 
functional related groups as the basis for payment adjustments. 

Rural providers 
	Permitted reclassification of certain urban hospitals as rural 
hospitals. Updated existing criteria used to designate outlying rural 
counties as part of metropolitan statistical areas for the purposes of 
Medicare's hospital IPPS. Changed certain requirements pertaining to 
Medicare's Critical Access Hospital Program. Extended the Medicare 
dependent hospital classification through fiscal year 2006. Permitted 
certain sole community hospitals to receive Medicare payments based on 
their hospital specific fiscal year 1996 costs. Increased the target 
amount for SCHs by the full market basket amount for discharges occurring 
in fiscal year 2001.

Skilled nursing facilities 
	Increased per-diem payments by 20 percent for 15 resource 
utilization groups (RUGs) under the PPS from April 1, 2000, until such 
time as the Secretary of HHS implements refinements to the RUGs. SNFs 
were permitted to elect to be paid under the full Federal PPS rate for 
SNFs (rather than go through the transitions period).  Provided a 
temporary 4 percent increase in the Federal per-diem rate for SNF 
services for FY 2001 and FY 2002.  The increase could not be considered 
in the base amount used to compute subsequent updates to the Federal 
per-diem rate. Expanded the list of services excluded from SNF PPS to 
include certain chemotherapy items and administration services, certain 
radioisotope services, certain prosthetic devices, and ambulance services 
furnished in conjunction with renal dialysis treatments, beginning in 
FY 2001.  Any increase in total payments resulting from these exclusions 
are required to be budget neutral.  Allowed SNFs with a 60 percent 
immunocompromised patient population to be paid temporarily a 50/50 
blend of their facility-specific and Federal rates beginning with the 
first cost reporting period beginning after enactment of BBRA and ending 
on September 30, 2001.  Required reports on the resource use of AIDS 
patients (by the Secretary), on SNF costs in Alaska and Hawaii (by 
MedPAC), and on respiratory therapy State licensure, certification 
standards, and competency examinations (by the Secretary).

Home health agencies 
	Delayed the 15-percent reduction in home health payments until 
12 months after implementation of the PPS and, within 6 months of 
implementation, required the Secretary to assess the need for any 
reductions. Increased per-beneficiary limits by 2 percent for agencies 
whose per-beneficiary limit was below the national median; excluded DME 
from consolidated billing, and provided agencies an additional $10 per 
beneficiary to offset costs for collecting outcome and 
assessment information set (OASIS) data. 

	Increased payment rates otherwise in effect under the hospice 
PPS for fiscal year 2001 by 0.5 percent and for fiscal year 2002 by 
0.75 percent, provided that these increases are not to be included in 
the base on which subsequent increases will be computed. 

	Made technical changes to limit oscillations in the annual 
update to the conversion factor beginning in 2001 and provided that the 
sustainable growth rate is calculated on a calendar year basis. 
Required the Secretary, in determining practice expense relative 
values, to establish by regulation a process under which the 
Secretary would accept for use and would use, to the maximum extent 
practicable and consistent with sound data practices, data collected by 
outside organizations and entities. 

Hospital outpatient departments 
	Made seven major changes to Medicare payments under the HOPD 
OPPS: (1) required the Secretary of the U.S. Department of Health and 
Human Services (DHHS) to provide payments (within specified limits, 
and on a budget neutral basis) over and above PPS payments for certain 
high cost ("outlier") patients; (2) as a transition to the PPS, for 2-3 
years, on a budget neutral basis, required the Secretary of DHHS to 
provide ``passthrough payments'' to hospital OPDs above and beyond PPS 
payments for costs of certain ``current innovative'' and ``new, high 
cost'' devices, drugs, and biologicals; (3) limited the cost range of 
items or services that are included in any one PPS category and required 
the Secretary to review the PPS groups and amounts annually and to update 
them as necessary; (4) as a transition to the PPS, through 2003, limited 
the reduction in Medicare payments individual hospitals experience due 
to the PPS; (5) provided special payments until 2004 for small, rural 
hospitals to ensure that they receive no less under the outpatient PPS 
than they would have received under the prior system and provided 
the same protection permanently for cancer hospitals; (6) limited 
beneficiary copayments for outpatient care to no more than the amount 
of the beneficiary deductible for inpatient care; and (7) required that 
the pre-PPS payment base used as the budget neutrality benchmark for 
the PPS include beneficiary coinsurance amounts as paid under the 
pre-PPS system (i.e., 20 percent of hospital charges). 

Therapy services 
	Suspended for 2 years (2001 and 2002) application of the caps 
on physical therapy and occupational therapy services. 

Pap smears 
	Set the minimum payment for the test component of a Pap smear 
at $14.60. 

Immunosuppressive drugs 
	Extended the 36-month limit on coverage of immunosuppressive 
drugs for persons exhausting their coverage in 2000-2004. Set the 
increase for persons exhausting benefits in 2000 at 8 months, and 
limited total expenditures to $150 million over the 5 years. 

	Required a number of studies including a Medicare Payment 
Advisory Commission comprehensive study of the regulatory burdens placed 
on all classes of providers under fee-for- service Medicare and the 
associated costs. Required GAO to conduct a study of Medigap policies. 

	Contained several provisions designed to facilitate the 
implementation of M+C. Changed the phase in of the new risk adjustment 
payment methodology based on health status to a blend of 10 percent 
new health status method/90 percent old demographic method in 2000 and 
2001, and not more than 20 percent health status in 2002. Provided for 
payment of a new entry bonus of 5 percent of the monthly M+C payment 
rate in the first 12 months and 3 percent in the subsequent 12 months 
to organizations that offer a plan in a payment area without an M+C plan 
since 1997, or in an area where all organizations announced withdrawal as 
of January 1, 2000. Reduced the exclusion period from 5 years to 2 years 
for organizations seeking to reenter the M+C Program after withdrawing. 
Allowed organizations to vary premiums, benefits, and cost sharing 
across individuals enrolled in the plan so long as these are uniform 
within segments comprising one or more M+C payment areas. Provided for
submission of adjusted community rates by July 1 instead of May 1. 
Provided that the aggregate amount of user fees collected would be 
based on the number of M+C beneficiaries in plans compared to the total 
number of beneficiaries. Delayed implementation of the Medicare+Choice 
Competitive Bidding Demonstration Project. 

OF 2001 PUBLIC LAW 106-554)

IPPS hospitals
	Provided the full market basket update to all hospitals for 
FY2001. Established that  all hospitals are eligible to receive DSH 
payments when their DSH percentage (threshold amount) exceeds 15 
percent. Decreased the scheduled reduction in IPPS hospitals' DSH 
payments.   Established that the cost of new medical technologies 
should be recognized with a budget neutral payment adjustment in 
IPPS by October 1, 2001.  Established that starting for FY2001 
Medicare Geographic Classification Review Board (MGCRB) decisions, 
the reclassification of an IPPS hospital for use of a different area's 
wage index is effective for 3 fiscal years.  Modified teaching 
hospitals' indirect medical education (IME) percentage adjustment.  
Established that a teaching hospital's approved per resident amount 
for cost reporting periods beginning during FY2002 is not less than 
85 percent of the locality adjusted national average per resident 
amount.  Changed a hospital's payment of the direct costs of approved  
nursing and allied health payments to incorporate Medicare managed 
care enrollees.  Permitted certain independent laboratories to continue 
to bill Medicare directly for the technical component of pathology 
services provided to hospital inpatients and hospital outpatients under 
a grandfather arrangement for a 2-year period (2001-2002). 

IPPS exempt hospitals
	Established that total payments for inpatient rehabilitation 
facility (IRF) services in FY2002 would equal the amounts of payments 
that would have been made if the IRF prospective payment system (PPS) 
had not been enacted. Permitted an IRF to make a one-time election 
during the transition period to be paid based on a fully phased-in 
IRF-PPS rate.  Increased the incentive payments for psychiatric 
hospitals and distinct part units to 3 percent for cost reporting 
periods beginning  on or after October 1, 2000.  Increased the 
national cap for long-term care hospitals by 2 percent and the target 
amount by 25 percent for cost reporting periods beginning during FY2001. 
Required the Secretary to examine the feasibility and impact of basing 
payment on the existing (or refined) acute hospital DRGs and using the 
most recently available hospital discharge data when developing the PPS 
for long-term care hospitals.

Rural providers
	Modified the critical access hospital (CAH) program: (1) 
eliminated liability of Medicare beneficiaries for coinsurance, 
deductible, copayment, or other cost sharing amount with respect to 
clinical diagnostic laboratory services furnished as an outpatient 
CAH service; (2) permitted CAHs to elect outpatient payments based on 
reasonable costs plus an amount based on 115 percent of Medicare's fee 
schedule for professional services; (3) exempted swing beds in CAHs from 
the SNF prospective payment system; (4) provided for payment to CAHs for 
the compensation and related costs for on-call emergency room physicians 
who are not present on the premises, are not otherwise furnishing 
services, and are not on-call at any other provider or facility; and 
(5) specified that ambulance services provided by a CAH (or provided by 
an entity that is owned or operated by a CAH) are paid on a reasonable 
cost basis if the CAH or entity is the only provider or supplier of 
ambulance services that is located within a 35-mile drive of the CAH.   
	Modified the Medicare dependent hospital (MDH) classification so 
that an otherwise qualifying small rural hospital may be classified as an 
MDH if at least  60 percent of its days or discharges were attributable 
to Medicare Part A beneficiaries in at least two of the three most 
recent audited cost reporting periods. Permitted sole community hospitals 
to elect payment based on hospital specific, updated FY1996 costs if 
this target amount resulted in higher Medicare payments. Increased 
payments to providers of ground ambulance services for trips originating 
in rural areas that are greater than 17 miles and up to 50 miles.  
Provided permanent authority to physician assistants who owned rural 
health clinics which lost their designation as such to bill Medicare 
directly.  Revised Medicare reimbursement for telehealth services. 
Exempted rural health clinics operated by hospitals with less than 
50 beds from the per-visit payment method.

Skilled Nursing Facilities
	Provided higher payments to SNFs by increasing the update to 
the full market basket for FY 2001 and the market basket minus 0.5 
percentage point for FY 2002 and FY 2003.  The nursing component of 
the Federal rate was temporarily increased by 16.66 percent beginning
April 1, 2000 through October 1, 2002.  BIPA also corrected a payment 
anomaly created by BBRA by temporarily increasing all the rehabilitation 
RUGs by 6.7 percent (rather than the 20 percent for 3 specific 
rehabilitation RUGs).  This adjustment also remains in effect 
until the Secretary implements case mix refinements.  BIPA also limited 
application of the consolidated billing requirement to Part A-covered 
stays and to therapy services furnished during Part A and Part
B-covered stays.  Permited the Secretary to establish a procedure for 
geographic reclassification for SNFs under PPS.  The provision required 
the Secretary to collect the data necessary to establish a wage index 
for SNFs prior to establishing a geographic reclassification process. 
Required reports on different systems for categorizing patients in SNFs 
in a manner that accounts for the relative resource utilization of 
different patient types (by the Secretary); on the adequacy of 
Medicare payments to SNFs (by the GAO); and on nurse staffing ratios 
and the impact of the 16.66 percent increase in the nursing component 
payment rate (by the GAO).

Home Health Agencies
	Delayed the effective date of the 15 percent reduction on payment 
limits for home health services an additional year after the 
implementation of PPS.  Also provided the Secretary can adjust for case 
mix changes that are not the result of real case mix changes.  Provided 
home health agencies with the full market basket update for FY 2001.  
Provided a temporary 10 percent increase in payment for home health 
services furnished in a rural area from April 1, 2001 until  March 31, 
2003.  Provided a two-month periodic interim payment after PPS began 
and subject to repayment with the settlement of the last cost report 
filed before PPS. 
 Clarified that home health agencies are not prevented from using 
telehealth services if the services do not substitute for in-person 
home health services ordered under a plan of care and are not considered 
a home health visit for eligibility or payment purposes. Prohibited the 
Secretary from using solely time or distance in determining branch 
office status and permitted the Secretary to include forms of 
technology in determining what constitutes supervision for purposes of 
determining branch office status.  Clarified the definition of homebound 
to permit beneficiaries who require home health services to attend 
adult day care for therapeutic, psychosocial, or medical treatment and 
remain eligible for the home health benefit. 

 Also clarifies that any absence for the purpose of attending a 
religious services is considered infrequent or of short duration.

	Increased the hospice update by 5.0 percentage points in FY 2001 
and required the Secretary to use 1.0043 as the Wichita, Kansas hospice 
wage index for FY 2000.  Clarified that certification of an 
individual's terminal illness must be based on the physician's or the 
medical director's clinical judgment regarding the normal course of the 
individual's illness.  Also required the Secretary to study and report 
on the appropriateness of the certification process regarding terminal 
illness and any recommendations for legislation by two years after 

Hospital outpatient departments
	Limited the amount of a beneficiary's copayment for a 
procedure in a hospital outpatient department (HOPD) to the hospital 
inpatient deductible applicable in that year, effective April 1, 2001. 
Reduced the effective copayment rate for outpatient services to a 
maximum rate of 57 percent and then gradually reduced the effective 
coinsurance rate in 5 percentage point intervals from 2002 through 2006 
until the maximum rate is 40 percent in 2006, starting in April 2001.  
Increased the 2001 update to the full rate of increase in the market 
basket index.  Increased the 2001 outpatient PPS rates.  Authorized 
the Secretary to adjust the conversion factor in later years to 
eliminate the effect of coding or classification changes.  Modified 
the procedures and standards by which certain medical devices are 
categorized and determined eligible for pass-through payments under the 
PPS. Permitted all qualifying hospitals to be eligible for transitional 
payments under OPPS.  Established that  existing provider-based status 
designations continue for 2 years beginning October 1, 2000. 
Established that children's hospitals would not receive lower Medicare 
payments under the outpatient PPS system than they would have received 
under the prior payment system. 

Ambulatory surgical centers
	Delayed implementation of proposed regulatory changes to the 
ambulatory payment classification system, which are based on 1994 cost 
data, until  January 1, 2002.  Established that the these changes would 
be phased in over 4 years.  Required that the revised payment system, 
based on 1999 (or later) cost data, be implemented January 1, 2003.  
Established that the phase-in of the revised system and 1994 data ends 
when the system with 1999 or later data is implemented.

Preventive Benefits
	Made the following changes to coverage of preventive services: 
1) modified existing law to provide Medicare coverage for biennial 
screening Pap smears and pelvic exams; 2) added Medicare coverage 
for annual glaucoma screenings for persons determined to be at high 
risk for glaucoma, individuals with a family history of glaucoma, and 
individuals with diabetes; 3) authorized coverage for screening 
colonoscopies for all individuals, not just those at high risk; 4) 
specified that screening mammographies are paid under the physician 
fee schedule; and 5) authorized coverage for medical nutrition therapy 
services for beneficiaries who have diabetes or renal disease.

Immunosuppressive Drugs
	Eliminated the time limitations of the coverage of 
immunosuppressive drugs for beneficiaries who have received a transplant
paid for by Medicare.

Persons with Amyotrophic Lateral Sclerosis
	Waived the 24-month waiting period for Medicare coverage 
(otherwise applicable for disabled persons) for persons with amyotrophic 
lateral sclerosis (ALS). 

	Provided for the full inflation update in 2001.  Increased 
payments (from July 1, 2001 - December 31, 2003) for ground ambulance 
trips originating in rural areas that are greater than 17 miles and 
up to 50 miles.

Therapy Services
	Extended the moratorium on physical therapy and occupational 
therapy caps for an additional year through 2002.

Renal Dialysis
	Increased the composite rate payment for renal dialysis by 
2.4 percent for 2001. The Secretary was required to collect data and 
develop an end-stage renal disease (ESRD) market basket whereby the 
Secretary could estimate, before the beginning of each year, the 
percentage increase in costs for the mix of labor and non-labor goods 
and services included in the composite rate. The Secretary was required 
to report to Congress on the index together with recommendations on the 
appropriateness of an annual or periodic update.

Durable Medical Equipment and Prosthetics and Orthotics
	Provided full CPI-U update for DME and PO for 2001, but 
maintained for 2002 the 0 percent update for DME and 1 percent update 
for PO.  Provided coverage for certain prosthetics and custom-
fabricated orthotics.  Provided coverage for replacement of certain 
artificial limbs and replacement parts for such limbs.

Revisions to Medicare Coverage Process
	Clarified when and under what circumstances Medicare coverage 
policy could be challenged. An aggrieved party could file a complaint 
concerning a national coverage decision which would be  reviewed by 
the Department Appeals Board (DAB) of HHS.  An aggrieved party could 
also file a complaint concerning a local coverage determination. In 
this case, the determination would first be reviewed by an 
administrative law judge.  If unsatisfied, complainants could 
subsequently seek review of such local policy by the DAB. In both 
cases, a DAB decision would constitute final HHS action and be subject 
to judicial review.   An affected party would be permitted to submit a 
request to the Secretary to issue a national coverage or noncoverage 

	Established multiple floor rates, based on population and 
location. Applied a 3 percent minimum update in 2001 and returned to 
the current law minimum update of 2 percent thereafter.  Increased the 
M+C payment rates for enrollees with ESRD to reflect the demonstration 
rate of social health maintenance organizations' ESRD capitation 
demonstrations.  Extended the current risk adjustment methodology 
until 2003 and beginning in 2004, begin to phase in a new risk 
adjustment methodology based on data from inpatient hospitals and 
ambulatory settings.  Permitted M+C plans to offer reduced Medicare 
Part B premiums to their enrollees as part of providing any required 
additional benefits or reduced cost-sharing.  Extended the application 
of the new entry bonus for M+C plans to include areas for which 
notification had been provided, as of October 3, 2000, that no plans 
are available January 1, 2001.  Required payment adjustments to 
M+C plans if a legislative change resulted in significant increased 
costs.  Precluded the Secretary from implementing, other than at the 
beginning of a calendar year, regulations that impose new, significant 
regulatory requirements on M+C organizations.  Required the Secretary 
to make decisions, within 10 days, approving or modifying marketing 
material used by M+C organizations, provided that the organization 
used model language specified by the Secretary.  Allowed an M+C 
organization offering a plan in an area with more than one local 
coverage policy to use the local coverage policy for the part of the 
area that was most beneficial to M+C enrollees (as identified by the 
Secretary) for all M+C enrollees enrolled in the plan.  Expanded the 
M+C quality assurance programs for M+C plans to include a separate 
focus on racial and ethnic minorities.  Allowed the Secretary to 
waive or modify requirements that hinder the design of, offering of, 
or enrollment in certain M+C plans, such as M+C plans under contract 
between M+C organizations and employers, labor organizations, or 
trustees of a fund established by employers and/or labor organizations.  
Extended the period for Medigap enrollment for certain M+C enrollees 
affected by termination of coverage. Allowed individuals who enroll in 
an M+C plan after the 10th day of the month to receive coverage 
beginning on the first day of the next calendar month.  Permitted 
ESRD beneficiaries to enroll in another M+C plan if they lost coverage 
when their plan terminated its contract or reduced its service area. 
Required an M+C plan to cover post-hospitalization skilled nursing care 
through an enrollee's "home skilled nursing facility" in certain 
situations. Mandated review of ACR submissions by the HCFA Chief 

(P.L. 107-188)

	Moved CMS' annual announcement of M+C payment rates from no 
later than March 1 to no later than the 2nd Monday in May, effective 
only in 2003 and 2004.  Temporarily moved the deadline for plans to 
submit information about ACRs, M+C premiums, cost sharing, and 
additional benefits (if any) from no later than July 1 to no later 
than the 2nd Monday in September in 2002, 2003, and 2004.  Changed 
the annual coordinated election period from the month of November to 
November 15th through December 31 in 2002, 2003, and 2004.  Allowed 
Medicare beneficiaries to make and change elections to an M+C plan
on an ongoing basis through 2004.  Then beginning in 2005, 
individuals will only be able to make changes on the more limited 
basis, originally scheduled to be phased in beginning in 2002.


	Temporarily increased the base rate used to pay rural and 
small urban hospitals to that used to pay hospitals in large urban 
areas for discharges from  April 1, 2003 to September 30, 2003. 

	Permitted CMS to make adjustments to sustainable growth rate 
figures for previous years, thereby permitting a fee schedule update 
of 1.6 percent for 2003.

Part B Premium
	Extended through 2003 a program that pays the Medicare Part 
B premium for Medicare beneficiaries with incomes between 120 
percent and 135 percent of poverty.

 PURPOSES (P.L. 108-89)

	Extended Medicare's  payment equalization between large 
urban hospitals and other hospitals for discharges through March 
31, 2004.  The law which became effective October 1, 2003 requires 
the Secretary to equalize the base amounts by November 1, 2003 and 
compensate hospitals for missed payments.

RELATED ACTS, 1981-2003

	Table 2-45 shows estimates of savings and revenue increases 
for budget reconciliation legislation enacted from 1981 to 1997 
and spending increases enacted in 1999, 2000 and 2003. These 
estimates were made at the time of enactment by the Congressional 
Budget Office (CBO). It should be noted that the estimates are 
compared with the CBO budget baseline in effect at the time. The 
savings from the various reconciliation bills cannot be added together.




	Tables 2-46 through 2-52 present detailed historical data on the 
Medicare Program. Tables 2-46 and 2-47 present detailed enrollment data. 
Table 2-48 describes the percentage of enrollees participating in a
State buy-in agreement. Tables 2-49, 2-50 and 2-51 show the number of 
persons served and program payments. Table 2-52 shows the utilization 
of short stay hospital services.
















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Medical Insurance Trust Funds, 2003 Annual Report of the Boards of 
Trustees of the Federal Hospital Insurance and Federal Supplementary 
Insurance Trust Funds, March 2003.
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Material and Data on Programs Within the Jurisdiction of the Committee 
on Ways and Means (WCMP 106-14).  Washington D.C.: U.S. Government 
Printing Office.
Federal Register (2003) Medicare Program; Physician Fee Schedule 
Update for Calendar Year 2003; Final Rule 68 (40);9567-9580.
Federal Register (2002) Medicare Program; Revisions to Payment 
Policies Under the Physician Fee Schedule for Calendar Year 2003. 
Final Rule, 67 (251),79966-80184.
National Institutes of Health, National Institute of Diabetes and 
Digestive and Kidney Diseases, U.S. Renal Data System. The Latest 
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States Renal Data System, Bethesda, MD, 2003. Web page:  
Office of the President (2003 and various years). Budget of the 
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