In the wake of revelations last fall that certain hospitals were receiving substantial Medicare outlier payments, CMS issued a press release on December 3rd indicating it was taking new steps to "protect Medicare from abusive billing practices by hospitals." CMS went on to state that hospitals found "to have engaged in strategies to obtain excessively high Medicare outlier payments will be presumed to be billing for more than they are entitled to...." CMS made it clear that it was going to subject such hospitals to scrutiny with respect to all aspects of their billings to the Medicare program.

Despite CMS's professed shock and surprise at these developments, in fact CMS has been well-aware of the ability of hospitals to increase their charges to take advantage of additional outlier payments since at least 1988. Nonetheless, due to adverse publicity, CMS is now taking drastic steps to scrutinize hospitals that are perceived to have unusually high outlier payments. In addition, CMS is going to change the rules for calculating outliers prospectively, an implicit admission that the current rules did not prohibit hospitals from obtaining the current level of outlier payments.

History of Outliers
Congress created outlier payments in recognition that DRG payments alone would not cover the costs of very complex, high-cost cases. Currently, Medicare uses only cost outliers; day outliers were phased out by 1998. The Medicare statute authorizes outlier payments of no less than 5 percent and no more than 6 percent of total DRG payments. 42 U.S.C. § 1395ww(d)(5)(A)(iv). CMS has set the target for total outlier payments at 5.1 percent. In the early years of PPS, outlier payments failed to reach the 5 percent mark. In more recent years, however, outlier payments have exceeded the statutory 6 percent maximum (6.9 percent in FY 2002). CMS has consistently maintained that it is not required to retroactively adjust outlier payments upwards when they fall short of the 5 percent level. Surely the same principle should apply when outlier payments exceed the 6 percent level.

The Outlier Payment Calculation
Prior to the start of each federal fiscal year, CMS sets a threshold amount to be used to qualify for an inpatient outlier payment, based on projections of what it will take to meet its 5.1 percent target for total outlier payments. For FY 2003, the threshold was set at $33,560, an increase of some 60 percent over the FY 2002 threshold of $21,025. To qualify for an inpatient outlier payment in FY 2003, a hospital's "cost" for a discharge has to exceed the sum of the DRG, IME, DSH, and new technology payments for the discharge plus the threshold of $33,560. The hospital would then be reimbursed for 80 percent of the difference, as outlier payments are intended to cover the "marginal cost of care" beyond the threshold amount.

The current dispute involves CMS's regulatory formula for determining a hospital's cost for a particular discharge. Because outlier payments are paid throughout the year based on billed claims, the current year's cost report cannot be used for this purpose, for that is not even filed until five months after the cost year is over.

To determine the hospital's costs, then, the regulations require that the hospital's current year charges for the covered services related to the discharge be multiplied by the hospital's ratio of costs to charges (RCC) from its most recently settled cost report. 42 C.F.R. §§ 412.80, 412.84. Due to the time lag in filing, auditing, and settling cost reports, there is usually a three-year lag between the RCC used in this formula and the current year's RCC. If, in the meantime, a hospital's charges have increased at a greater rate than its costs, then its current year's RCC would be lower than the old RCC used to compute outliers. By using the old RCC, the outlier formula computes a higher cost for the discharge than may be justified by the current year's RCC, and a higher outlier payment results.

A simplified example illustrates this:


Current Year's Costs	Current Year's Charges	Current RCC	Old RCC (based on charges of $125)	Cost Using Current RCC	Cost Using Old RCC
$100	$150	$100/150=.66	$100/125=.80	$150 x .66=$99	$150 x .80=$120

In addition, the RCCs can vary greatly by hospital department. For outlier calculations, however, the RCCs are calculated on a hospital-wide basis, which may benefit certain departments for which the hospital has a lower RCC.

Moreover, if the old RCC is more than three standard deviations below the national mean, the intermediaries are instructed to substitute statewide RCCs. Statewide RCC averages for FY 2003 range from .282 in urban Nevada to as high as .759 in urban Maryland. For those hospitals, it would be very advantageous to have the statewide RCC used in the formula, for that would result in a higher calculated cost of services provided than if their own, lower RCC was used. Indeed, the very fact that CMS has this default position is a recognition that hospitals can have very low RCCs due to high charges, and that there is nothing improper about it.

The RCC also affects the calculation of outlier payments as well as interim transitional corridor payments under the outpatient prospective payment system (OPPS). When outpatient charges adjusted to cost (using the old RCC) exceed a fixed multiple (2.75 for FY 2003) of the sum of the APC payment, CMS pays 45 percent of the cost in excess of the threshold. 42 C.F.R. 419.43(d).

CMS's Historic View on Hospital Charges
CMS historically has defined a hospital's "customary charges" as those charges made to "patients liable for payment on a charge basis." Provider Reimbursement Manual (PRM) § 2604.3. Moreover, the PRM states that providers should have an established charge structure "which is applied uniformly to each patient" and "which is reasonably and consistently related to the cost of providing the services." PRM § 2203. Significantly, for at least 30 years the PRM has stated that "the Medicare program cannot dictate to a provider what its charges or charge structure may be." Id.

Once Medicare moved from reasonable-cost reimbursement to prospective payment, CMS continued its position that a hospital's charges were to be left to market forces, and could not be regulated by Medicare. This is evidenced by CMS's 1988 discussion when it changed the outlier formula from the use of a national RCC to a hospital-specific RCC. Several commenters specifically raised the fear that this would give hospitals an incentive to manipulate their charges in order to obtain additional outlier payments. In response, CMS recognized that hospitals could indeed raise their charges to do this, but indicated that the following factors would mitigate the incentive to do so: (1) raising charges will lower a hospital's cost-to-charge ratio in the future; (2) other payors that pay based on charges will limit the ability of hospitals to arbitrarily increase their charges; (3) any general acceleration in charge can be incorporated into thresholds set in future years; and (4) outlier payments comprise only a small percentage of total PPS payments, thus diluting the incentive to manipulate charges. 53 Fed. Reg. 38,509 (1988). Thus CMS was perfectly willing to let market forces control hospitals' abilities to raise charges.

As recently as August 2002, CMS justified its 60 percent increase in the outlier threshold for FY 2003 by noting that charges had risen 17 percent in the past two years. 67 Fed. Reg. 49,982, 50,123 (Aug. 1, 2002). Interestingly, CMS also indicated awareness that the delay in updating the hospital-specific RCCs had a distorting effect, but indicated it did "not have any evidence that the higher than expected outlier payments" resulted from the time lag. 67 Fed. Reg. at 50,124.

CMS's Scrutiny of High-outlier-payment Hospitals
In December 2002, CMS set about to identify hospitals that CMS believes may be "attempting to game" the system for the purpose of "maximizing payment." Program Memorandum A-02-122 (December 3, 2002). CMS then instituted a "progressive compliance strategy" for such hospitals, see Program Memorandum A-02-126 (December 20, 2002), as a follow-through on the CMS Administrator's statements in early December that "[h]ospitals found to have engaged in strategies to obtain excessively high Medicare outlier payments will be presumed to be billing for more than they are entitled to ...," and that while intermediary reviews will be triggered by "questionable" outlier payments, "all operations of the targeted hospitals will be thoroughly scrutinized for any other improper conduct."

According to the December 20th program memorandum, intermediaries are required to identify two groups of hospitals: (1) those with outlier payments of 80 percent or more of operating and capital DRG payments for discharges in October and November 2002, and (2) those for which outliers comprise over 20 percent of DRG payments for discharges in October and November 2002 and which had increases in average charges per case of at least 20 percent from 2000 to 2001 and from 2001 to 2002.

With respect to the first group of hospitals, intermediaries are to perform not only uniform charge reviews, but also comprehensive field audits of IME, GME, DSH, bad debt, organ acquisition costs, and any other pass-through costs. In addition, intermediaries will select 20 inpatient and 20 outpatient outliers from the last 12 months. The inpatient outliers will be sent to a Quality Improvement Organization (QIO) for review under separate instructions from CMS. The intermediary will conduct a review of the 20 outpatient records to determine whether care was reasonable and necessary. The findings of these reviews are to be used to pursue overpayments and/or to make referrals to the Benefit Integrity Program.

For the second group of hospitals listed above that are not included in the first group, the intermediaries are required to perform uniform charge reviews to ensure charges apply uniformly to all patients and to conduct a medical review of 20 outpatient claims from the last 12 months.

The emphasis on uniform charge audits in these reviews is no doubt based on the PRM provisions that charges "should be related consistently to the cost of the services and uniformly applied to all patients whether inpatient or outpatient." PRM §§ 2202.4, 2302.6. These provisions might suggest to some that the same service must bear the same charge throughout the whole hospital. That understanding, however, would be incorrect. The regulation governing cost apportionment provides for the computation of RCCs "on a departmental basis." Indeed, the cost reports readily reveal that hospitals have a different RCC for every department, and this has never been seen as a problem. Moreover, the practice of having different charges for the same service depending on the department in which the service was rendered would be perfectly acceptable, because it would reflect, presumably, different costs associated with furnishing That service in different departments, due to such variables as staffing ratios, different overhead and administrative costs, and accessibility issues.

Defending Hospital Charges
There are many legitimate reasons why a hospital's charges may have risen in recent years. Hospital charges may have been lagging behind the "market" in the hospital's area, thus justifying a charge increase. To the extent a hospital has performed a market survey and has increased charges to bring them in line with the market, CMS has little basis to object, given its reliance on market forces as a regulator of hospital charges, as discussed above.

Moreover, Medicare is not the only payor to pay based on charges. Some commercial payors pay on the basis of a percentage of charges, and may be trying to ratchet down the percent they pay. Hospitals may be justified in raising charges to counteract a drop in revenues from these payors.

Another reason for charge increases may be that, because the outlier threshold has increased so much in the past few years (from $11,200 in FY 1999 to $14,500 in 2000, $16,350 in 2001, $21,025 in 2002, and $33,560 in 2003), hospitals may have raised charges simply to maintain approximately the same amount of Medicare outlier revenue. This creates a "chicken and egg" problem for many hospitals: which came first, the high hospital charges or the high outlier thresholds? Similarly, other reductions in Medicare payments over the years, due to the cuts enacted by the Balance Budget Act of 1997 and other provisions, may have led hospitals to raise charges to increase outlier revenues. Since PPS payments are based on averages, hospitals are justified in looking at overall Medicare revenues, and should be able to justify increased Medicare payments in one area to balance deficits in another.

So long as any increases in charges were passed along to all payors (including self-pays) who pay based on hospital charges, and so long as a hospital made reasonable collection efforts to collect those increased payments (including following its policies for write-offs for indigents or uncollectible amounts), then CMS has little theoretical basis to challenge the hospital's actions. This is not to say CMS may not try to do so. Based on the particular facts of any given case, and based on the government's perception that high outlier payments are a form of abuse even if not expressly illegal, the government may allege that a hospital acted improperly in raising its charges solely to increase Medicare outlier revenues.

CMS's Actions to Correct Perceived Outlier Problem
Unlike the regulation governing inpatient outliers that requires use of an RCC from the "latest available settled cost report," 42 C.F.R. § 412.84(h), the outpatient outlier regulation does not specify how charges are to be "adjusted to cost." 42 C.F.R. § 419.43(d)(1). This has permitted CMS to take immediate action to revise the manner in which outpatient outlier payments are calculated, without going through notice-and-comment procedures. To accomplish this, CMS issued Program Memorandum A-03-0004 on January 17, 2003, to instruct intermediaries to recalculate the RCCs for outpatient outliers using a cost report from the hospital's most recent 12-month cost reporting period, whether tentatively or finally settled. Moreover, intermediaries are instructed to recalculate the RCCs whenever a more recent full-year settlement is available. This use of more recently filed and settled cost reports will reduce the lag between the cost-to-charge ratio currently used and the current year's cost-to-charge ratio.

Having acknowledged that it must change its regulations in order to revise the outlier calculations, on March 5, 2003, CMS published a proposed rule to do just that. The proposal would make three significant changes: (1) It would require intermediaries to calculate a hospital's RCC based on the hospital's most recent tentatively settled cost report, rather than using the most recent finally settled cost report; (2) It would eliminate the use of the state-average RCC in those instances where the hospital-specific RCC is more than three standard deviations below the national mean; (3) When the cost report for the year in which the discharge occurs is finally settled, the proposed rule would require recalculation of the outlier payment based on the RCC in the settled cost report, and either recoupment from, or additional payments to, the hospital based on the revised calculation, taking into account the time value of money during the intervening period. CMS did not propose to revise the $33,560 threshold at this time, but may revise it after reviewing claims for the quarter ending December 31, 2002.

It remains to be seen what else CMS will do on this issue. In the meantime, those hospitals that have been identified for further scrutiny by the intermediaries can expect to see all aspects of their billing and cost reporting practices given a very hard look.