With record speed, CMS has published a final rule to change the way in which outlier payments are determined. 68 Fed. Reg. 34,494 (June 9, 2003). The rule finalizes, with some modification, the CMS proposal published on March 5, 2003 in response to perceived abusive charging practices by some hospitals that caused the outlier threshold to skyrocket from $14,500 in FY 2000 to $33,560 in FY 2003, with the result that fewer hospitals qualified for outlier payments. [For more background on the outlier issue, please refer to Ms. Hedlund's article, "CMS Clamps Down on Outlier Payments," which appeared in the Spring/Summer 2003 Health Law Alert.]

Outlier payments are designed to pay for high-cost cases, when the cost of the case exceeds a certain threshold. Of course, the actual cost of a case will not be known until the hospital's cost report is filed and settled several years later. To bridge the gap, the outlier methodology calculates a hospital's "cost" for a case by using the hospital's current charges on the submitted bill multiplied by the hospital's ratio of costs to charges (RCC) from a prior cost report. CMS believes that some hospitals have dramatically increased their charges in order to have a higher calculated cost, and thereby receive a higher outlier payment. In the final rule, codified at 42 C.F.R. § 412.84(h), (i), and (m), CMS has made the following changes to attempt to rectify this situation.

Updating Cost-to-Charge Ratios
Currently, CMS uses a hospital's RCC from its most recently settled cost report to convert the covered charges on bills submitted in the current year to a calculated cost. The last settled cost report is commonly at least two years old and in some instances may be three to four years old. Therefore, the last settled cost report does not reflect a hospital's current charge levels.

To reduce this time lag, CMS has determined that, beginning October 1, 2003, the RCC will be updated using data from either the most recently settled or the most recently tentatively settled cost report, whichever is from the latest cost reporting period. This will reduce the time lag for updating the RCC by a year or more.

Prior to October 1, 2003, CMS will continue to use the most recently settled cost report. However, for discharges on or after August 8, 2003 (the effective date of the final rule) through September 30, 2003, CMS may direct an intermediary to change a hospital's RCC in the event more recent charge data indicates that a hospital's charges have been increasing at an excessive rate relative to other hospitals. CMS indicates it will limit these adjustments to those hospitals that appear to have benefited disproportionately from the time lag. Also, during this period between August 8 and September 30, 2003, a hospital may request that its intermediary use a higher or lower RCC based upon "substantial evidence." Such a request must be approved by the CMS Regional Office.

CMS specifically declined to adopt the suggestions of several commenters that it adopt a three-year transition period, during which time a blended RCC would be used, noting that "it is essential to eliminate the effects of the inappropriate redistribution of outlier payments as soon as possible; that is, by not allowing hospitals that have benefited from the time lag resulting from the use of the latest settled [RCCs] to continue to do so." 68 Fed. Reg. at 34,499. CMS also declined to adopt suggestions that there be an appeal process if the intermediary decides to change a hospital's RCC. CMS notes that the intermediaries will not have their own discretion to update a hospital's RCC, and will do so only at CMS's direction.

Elimination of Statewide Average Cost-to-Charge Ratios
If a hospital raises its charges at a higher rate than its costs have increased, then the hospital's actual RCC will decline. Under the current outlier methodology, if a hospital's RCC falls below three standard deviations below the national geometric mean (0.194 for operating RCCs and 0.012 for capital RCCs in FY 2003), intermediaries were instructed to substitute the statewide RCCs. CMS is of the mind that many hospitals took advantage of the system by raising their charges, knowing that they would receive this statewide RCC as a "default" when their own RCCs fell below this range of reasonableness. Therefore, in the final rule CMS eliminates the substitution of this statewide average for RCCs falling below the national mean.

The statewide average RCC will still apply, however, in instances in which a hospital's RCC exceeds the upper threshold of three standard deviations above the geometric mean. Despite comments that the policy should be consistent for both the floor and the ceiling, CMS declined to remove the statewide CCR for the ceiling, noting that hospitals do not have an incentive to increase their ratios to the ceiling.

Reconciling Outlier Payments Through Settled Cost Reports
The most controversial provision of the outlier rule involves CMS's requirement that outlier payments be reconciled when the cost report for the year coinciding with the outlier claim is finally settled, by using the actual RCC from that cost report. Such a reconciliation would be subject to an adjustment to reflect "the time value of the funds" held.

Many hospitals objected to this reconciliation provision as being contrary to the prospective nature of PPS payments. Indeed, in cases where hospitals have sought retroactive adjustments to outlier payments when the aggregate outlier payments fell short of the statutory 5 percent minimum, the Secretary has convinced the courts that the Social Security Act does not require such retroactive adjustments. See, e.g., County of Los Angeles v. Shalala, 192 F.3d 1005 (D.C. Cir. 1999).

In an attempt to head off challenges to this reconciliation provision, CMS notes in the preamble to the final rule that it has always "scrupulously guarded the prospective nature of the IPPS over the years." 68 Fed. Reg. at 34,502. It goes on to state that, in light of the "gross abuses of the current methodology by some hospitals," id., and the resulting harm to other hospitals from the increased threshold, CMS has determined that reconciling outlier payments for individual hospitals is nonetheless appropriate. CMS distinguishes its refusal to make aggregate, nationwide adjustments in outlier payments from its proposal to make hospital-specific reconciliations due to data variances attributable to individual hospitals, stating that the latter "would not affect the predictability of the entire system." Id. CMS further notes that each hospital is on notice of the revised methodology and has the necessary data regarding its own cost and charges to predict its RCC, and thus concludes that this reconciliation plan does not thwart the "predictability of the system as a whole." Id.

Nonetheless, given the administrative burden associated with reprocessing and reconciling all inpatient claims, CMS did agree that any reconciliation should be done only on a limited basis. For FY 2003, CMS intends to focus a reconciliation process "upon those hospitals that appear to have disproportionately benefited from the time lag in updating their [RCCs]...."

In a recent program instruction issued to intermediaries to implement the revised outlier methodology, CMS identifies thresholds for reconciling payments. Program Memorandum Transmittal No. A-03-058 (July 3, 2003). For FY 2004, CMS instructs intermediaries to conduct reconciliations for those hospitals for which the actual RCC is found to be plus or minus 10 percentage points from the RCC used during the time period to make outlier payments and that have total FY 2004 outlier payments in excess of $500,000. In addition, the intermediaries would also have administrative discretion to reconcile additional hospitals' cost reports if the outlier payments to those hospitals appear to be "significantly inaccurate."

Any overpayment or underpayment of outlier payments resulting from this reconciliation process will be subject to adjustment to account for the time value of money.

Outlier Threshold
The outlier fixed-loss threshold for FY 2003 was set at $33,560, nearly a 60 percent increase over the FY 2002 threshold of $21,025. In this final rule, CMS indicates that it will leave this threshold in place for the remainder of FY 2003, having determined that changing the threshold for the remaining few months of the year would disrupt hospitals' budgeting plans and be contrary "to the overall prospectivity of the IPPS."

In the proposed IPPS rule for FY 2004, 68 Fed. Reg. 27,154 (May 19, 2003), CMS proposed an outlier threshold of $50,645 for FY 2004. That threshold did not include the changes incorporated into the final outlier rule. The final FY 2004 outlier threshold of $31,000 was calculated using the new outlier rule. 68 Fed. Reg. 45,346 (Aug. 1, 2003). As expected, the new rule resulted in a significantly lower outlier threshold.

LTCH Outliers
In the final rule, CMS also applied similar policies to the high-cost outliers and short-stay outliers under the long term care hospital (LTCH) PPS, codified at 42 C.F.R. §§ 412.525(a) and .529(c). CMS is retaining the fixed loss threshold of $19,978 for FY 2004.

Conclusion
By implementing these changes to the outlier methodology, CMS hopes it has quashed the ability of some hospitals to raise their charges to receive increased outlier payments. CMS intends that, as a result of these measures, outlier payments be redistributed among more hospitals, to ensure they are used to pay for truly high-cost cases.