Medicare payment to teaching hospitals for direct graduate medical education (GME) and indirect medical education (IME) is often critical to those hospitals' bottom line. Unfortunately, the payment rules in this area have become increasingly complicated, due in part to the changes mandated by the BBA and in part to efforts by CMS to ratchet down on what it perceives to be abuses. Hospitals now have to deal with a host of issues ranging from the interplay of two separate caps on the number of full-time equivalent (FTE) residents (the "historic" cap and the rolling, three-year average cap), to issues related to the extent to which the training is associated with research, and what is research. Among the most problematic of these issues, and an area that has been the focus of much of CMS's recent attention, has been the counting of residents who train in nonhospital locations. It is here that CMS's latest regulatory requirements have been focused.

From the Medicare program's inception until the mid-1980s, reimbursement for medical education was based primarily on reasonable costs. Beginning in the mid 1980s, however, the system changed so that the emphasis has been on the number of FTEs who are training at the hospital and at certain off-site locations. Historically, in order for a hospital to claim its FTEs at off-site locations — that is, nonprovider or nonhospital settings, such as freestanding clinics, nursing homes, and physicians' offices — the resident had to spend his or her time in patient care activities, and the hospital must have had a written agreement with the outside entity stating that the resident's compensation for the training time spent outside the hospital was being paid by the hospital. This has been the rule for GME since 1987, see 42 C.F.R. § 413.86(f)(1)(iii) (1987), and it became the rule for IME effective for discharges on or after October 1, 1997, see 42 C.F.R. § 412.105(f)(1)(ii)(C) (1987). Effective January 1, 1999, CMS then imposed an additional standard requiring that, for both IME and GME purposes, the written agreement with the nonhospital site: (1) not only show that the hospital is incurring the cost of the resident salary and fringe benefits while the resident is training at the nonhospital site, but also (2) state that the hospital is providing "reasonable compensation to the nonhospital site for the supervisory teaching activities," and (3) "indicate the compensation the hospital is providing to the nonhospital site for the supervisory teaching activities." See 42 C.F.R. § 413.86(f)(4)(ii) (1998) and 42 C.F.R. § 412.105(f)(1)(ii)(C) (1998).

The nonhospital training rules have proven to be confusing in their application, raising questions about whether CMS will look at the adequacy of the compensation, how "in-kind" services are calculated, circumstances under which physicians may "volunteer" their services, and so on. Given this, a number of providers have sought clarification from CMS about how these rules should be applied. Instead of answering these questions, however, CMS has added yet a new layer of complication.

In the August 1, 2003, Federal Register, CMS took issue with what it perceives to be an abuse of the system, specifically, the claiming by certain hospitals of the costs of dental and podiatry programs where the training at the nonhospital sites is taking place in remote locations and where the hospital has not historically borne these costs. 68 Fed. Reg. 45,346 (Aug. 1, 2003). To address this perceived abuse, CMS has said that it will now rely on the Medicare redistribution and community support principles. Basically, those rules specify that: (1) if the community has undertaken to bear the cost of medical education, those costs are not to be later borne by the Medicare program (the "community support" principle); and (2) if medical education costs have been incurred by an educational institution in the past, they may not later be redistributed to a hospital to claim as Medicare reimbursable costs (the "redistribution" principle). Although these principles historically have been applicable only in the context of reasonable cost reimbursement of GME — a methodology no longer followed — the Secretary has now taken the position that these principles should apply as well to reimbursement under the current system, a system that is predicated on a per-resident amount (PRA) and that has no more than a historic link to reasonable cost reimbursement.

In the August 1, 2003, Federal Register preamble, CMS stated that it had "discovered an inappropriate application of Medicare direct GME and IME payment policies related to the counting of FTE residents in nonhospital settings"; that Congress had given the Secretary "broad discretion" to implement policy on FTE resident counts; and that, since the inception of the Medicare program, CMS policy has been "that Medicare would only share in the costs of medical education until the community assumes the costs." 68 Fed. Reg. at 45,437. Applying this logic, CMS stated that it would be appropriate to "employ the principles of redistribution of costs and community support to specifically address the inappropriate scenarios ...whereby hospitals attempt to inflate their FTE resident counts by assuming payment of training costs for residents in nonhospital sites that were previously funded by a nonhospital entity." Id. Thus, CMS is now maintaining that if a hospital incurs and seeks to claim the costs of training in a particular program at a training site for which the hospital did not incur costs in the past, CMS will consider this to be a redistribution of costs or a violation of the community support principle, leading to a payment disallowance. Significantly, CMS has not limited the application of the new rules to dental or podiatry programs, but rather, is applying the new rules to all GME programs.

The new rules provide as follows:

Consistent with the community support and redistribution program, a hospital must now be able to demonstrate, in addition to the old requirements found at 42 C.F.R. § 413.86(f)(4), that as of January 1, 1999 (or before, at the election of the intermediary), it incurred at least some costs associated with the training of FTEs in each program at each site. Moreover, the hospital must have continuously incurred at least some of the cost of that training since the date the residents first began training in that program, 42 C.F.R. § 413.86(i)(2), meaning that if a nonhospital institution later assumed the full cost of training in that program at any time, the FTEs could not be claimed.
The hospital is also required to incur all or substantially all of the cost of all of the residents training in a particular nonhospital site in a particular program in order to count any FTE residents training there for purposes of IME and GME payment. 68 Fed. Reg. at 45,439. CMS has said, however, that it is permissible to count FTEs for whom the hospital incurs the direct cost of training of those residents that are added to an existing program, even though the hospital may not be permitted to count the "old, redistributed" FTEs already training in the program.

The two rules described above, in combination, thus require the application of two separate FTE counting requirements for nonhospital training. First, the hospital must, in the current year, incur all or substantially all the costs for all residents participating in the training program in that setting. A hospital would be prohibited from counting any FTEs in the current year — including new FTEs added to an existing program at the nonhospital site — unless the hospital incurs all or substantially all of the costs of training all of the residents in that program at that setting in that year. Second, the hospital must not violate the redistribution of costs or the community support principles in order to count the FTEs in that setting, meaning that the hospital must have incurred some of the costs related to those residents in that program for all past periods.

The focus of this discussion, up to this point, has been on training in off-site locations. CMS also stated in its regulation, however, that its application of the redistribution policy is not necessarily limited to FTEs training in nonhospital settings. CMS declared that its application of the new principles "holds true whether the counts relate to residents training in nonhospital sites ..., or to residents training inside the hospital — inpatient or outpatient." 68 Fed. Reg. 45,444-45. Having said that, CMS went on to explain it would be extremely rare for a hospital not to have incurred at least some costs of training in an inpatient setting — with those costs including resident salaries, teaching physician salaries, overhead expenses, and the like. All of those direct costs of the program would need to be redistributed to an outside entity in order for there to be an inappropriate redistribution in the hospital setting. In the nonhospital setting, however, redistribution is much more likely to be found given that it is often the case that some third party is bearing those expenses.
Significantly, CMS also addressed how the receipt of grants, gifts, endowments, or appropriations might affect the analysis. CMS has long recognized that if a hospital receives a grant, gift or endowment to subsidize a residency program at the hospital and if the hospital then requests direct GME payment for training the residents, the subsidy would not be considered community support. For example, if the hospital received a state grant to fund a family practice medicine program at the hospital, the grant would not be considered community support, and the FTEs could be claimed. In its August 1, 2003, publication, however, CMS, stresses that this exception would not apply to "ordinary state or local appropriations," which CMS considers to be community support that is to be offset from the provider's allowable costs. Thus, if a program, at one time, was entirely funded by state or local appropriations so that the hospital did not incur any of the costs for training the residents in that off-site location, CMS will take the position that an inappropriate redistribution of costs has occurred. This would hold true even if the hospital is currently incurring the costs. Additionally, if the grant, gift, or endowment went directly to the nonhospital site, and not to the hospital, to subsidize all of the direct GME costs of the residency program there, CMS will treat the costs of the grant as falling outside of the "grant exception." Under these circumstances, because the grant went to the nonhospital site, the hospital would not be able to claim that it has continuously incurred the cost of the training, and a redistribution of costs would be present.
The new CMS policy regarding redistribution and community support was effective as of October 1, 2003. Although CMS will look to past periods back to January 1, 1999 (or at the intermediary's discretion, even before then), CMS will make no "redistribution" disallowances of FTEs for cost reporting periods beginning prior to October 1, 2003, for GME, and for discharges occurring before October 1, 2003, for IME. Additionally, CMS has recognized that its policies may have caught a number of hospitals by surprise. Therefore, CMS has agreed to grandfather residents who began training in a program on or before October 1, 2003. For residents who began training in a residency program on or before October 1, 2003, and with respect to whom there has been a redistribution or community support, the hospital may continue to count those residents for purposes of direct GME and IME after October 1, 2003, and continue to do so until those residents have completed training in that program, or until three years after the date the residents began training in that program, whichever comes first. What this means is that the true effective date for the regulation, for most residents, will not begin until cost reporting periods (GME) or discharges (IME) on or after October 1, 2006.

Conclusion
The IME and GME payment provisions — and particularly those related to counting FTEs — are among the most complicated in Medicare reimbursement. CMS, through its August 1, 2003, amendments, has added to the confusion. Serious questions can be raised about whether the new policy has statutory support, a point that commenters raised with CMS. Nevertheless, CMS has ignored criticisms of its policy and appears ready to apply its policy in future years. The picture, however, is not altogether bleak. In the first instance, CMS has at least provided for the grandfathering of residents who began training in programs prior to October 1, 2003, and this grandfathering will continue for a period of three years or until the residents' training has ended, whichever comes first. Second, a number of parties have sought relief from Congress. Thus, at least as of this writing, there is the possibility that Congress may intercede and strike down the CMS policy. Absent, however, congressional intervention or a determination by a court that the policies CMS has implemented are illegal, the new policy will make the counting of residents in off-site locations a major risk area for hospitals.