Excluded facility financial status and options for payment system modification - Hospital Payment: Beyond the Prospective Payment System

Health Care Financing Review, Winter, 1993 by John E. Schneider, Jerry Cromwell, Thomas P. McGuire

INTRODUCTION

TEFRA included provisions that changed Medicare's method of reimbursement for all inpatient hospital stays. Prior to TEFRA, section 223 limits constrained only routine costs. TEFRA extended these limits to both routine and ancillary costs. Hospital costs were reimbursable up to a limit which was the lesser of a hospital-specific cost target and a peer group target. There were seven peer groups based on bed size and urbanicity. All hospitals were reimbursed under TEFRA for 1 year only, fiscal year (FY) 1983. Beginning in October 1983, Medicare discharges from general acute care hospitals shifted to the prospective payment system (PPS) based on diagnosis related groups (DRGs).

Certain specialized facilities were excluded from PPS and continue to be paid under the TEFRA system. These are psychiatric, rehabilitation, long-term care, children's, cancer, and drug and alcohol treatment facilities. Psychiatric and rehabilitation distinct-part units of general hospitals were also exempt from PPS. Excluded facilities were exempted from PPS because it was believed that differences in the types of care provided and the settings for this care were unsuited to a rate system based on national averages. The national data base used for creating DRGs either did not include or under-represented these groups.

Since the implementation of PPS, comparatively little research has focused on the financial impact of TEFRA on PPS-exempt hospitals and units, in spite of the increasing number of facilities (Table 1). Harrow and Cromwell (1990) found that the average facility loss per case was between 3 and 6 percent of their average cost. The study concluded that the TEFRA system would impose larger and larger losses over time. Studies conducted by the Prospective Payment Assessment Commission (1991) reached similar conclusions.

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Amid rising concerns that the TEFRA system was imposing undue financial hardship on excluded facilities, renewed attention was devoted to the development of alternatives to TEFRA. For example, Cromwell et al. (1990) studied alternative payment systems for psychiatric facilities, and Langenbrunner et al. (1989) provided a complete discussion of payment options for excluded facilities. In addition, the Omnibus Budget Reconciliation Act (OBRA) of 1990 (Public Law 101-508) contained provisions that mandated the Health Care Financing Administration (HCFA) to develop alternative approaches to the reimbursement of PPS-excluded facilities.

The purpose of this article is to respond to the OBRA 1990 mandate by answering two important research questions. First, has the financial performance of TETRA-excluded facilities continued to deteriorate? Second, if facilities have performed poorly, what modifications could be made to TEFRA to make reimbursement more efficient and equitable?

It should be recognized at the start that not all facilities should be guaranteed to make a profit or even to break even. Inefficient providers should be encouraged to change their management behaviors. The TEFRA system was designed as a cost-sharing reimbursement system subject to a target ceiling on payments that would encourage cost containment. The updating of such targets was the problem. While each facility's per discharge payment began with its own cost base, the same annual updates permitted PPS-included hospitals were applied to excluded facilities as well. Hence, rate updates may have no relation to changes in patient severity, case mix, or treatment innovations. Over time, payment levels could (and do) bear less and less of a relationship to costs, generating more and more financial losers. This is a serious concern. Although any flat rate or ceiling payment system will lead to winners and losers, by grafting a PPS-determined update onto the TEFRA cost-sharing arrangement, the government may have inadvertently treated some facilities unfairly. In reclaiming excess profits from PPS-included hospitals through artificially low updates, the government ignored the fact that it had already reclaimed most of the profits from PPS-excluded facilities through retrospective cost settlements. Growing numbers of TEFRA facilities losing money on Medicare patients has serious equity and efficiency concerns. Facilities serving the public well may be driven out of business by inadequate updates through no fault of their own.

The first part of this article provides an overview of TEFRA financial status. Profit rates per case are calculated for excluded facilities for 3 years (1986, 1987, and 1988) by facility type, region, urbanicity, ownership, and bed size. The distributions of profit rates are also examined across these years to further illustrate changes in profitability.

The second part of this article investigates several alternative reimbursement systems. The alternatives are limited to extensions of the current system and do not attempt to include a case-based PPS for psychiatric or rehabilitation care. Rather, changes in the boundaries of the current system are investigated. Nine basic models, including one incorporating only OBRA 1990 changes, are simulated on 1988 data. All address in one way or another the lack of government sharing in facility Medicare losses. The alternatives are described in detail later in the article.