HD25 - Review of the Medicaid Inpatient Hospital Reimbursement System

Executive Summary:
In 2000, the Virginia General Assembly passed Item 20 K of the Appropriation Act directing JLARC to examine the process and methodology used by the Department of Medical Assistance Services (DMAS) to establish a new payment system for Medicaid inpatient care. Currently, inpatient hospital care is the largest expenditure category for the Medicaid program, accounting for 23 percent of the program's expenditures (see figure on page II).

JLARC conducted a similar review of the Medicaid inpatient program back in 1990. At that time, DMAS received high marks for developing and implementing a reimbursement system for inpatient hospital care that effectively controlled the growth in payments for those services. Particular attention was given to the fact that DMAS saved the State more than $64 million in 1990 by paying hospitals only a portion of their allowable costs associated with serving Medicaid patients. At the same time, however, the report discussed the looming specter of legal challenges to DMAS' reimbursement system and the potential threat this posed to the long-term viability of the system.

Legal challenges were made to the old system. While these challenges have abated, some of the issues that were at the center of the hospital industry's lawsuit against the Commonwealth resurfaced as the State began the process of moving to a new reimbursement system in 1996. Specifically, the Virginia Hospital and Healthcare Association (VHHA) contends that at a time when hospital costs were beginning to increase, DMAS made retroactive cuts to the inpatient reimbursement rates using databases that contained many errors. Further, VHHA asserts that a decision by DMAS to perpetuate the use of a rate "adjustment factor" unfairly reduces the Medicaid reimbursement for inpatient care by a current rate of 21 percent. This study provides a review of the process used by DMAS to establish a new payment system, assesses the soundness of the methodology used by the agency to set the new rates, and examines the adequacy of those rates.

Rate-Setting Methodology Is Logical, But DMAS Experienced Data Problems When Implementing the New Payment System

In general, this study found the rate-setting methodology implemented by DMAS to be generally logical and internally consistent, while containing all the key elements necessary to calculate rates for inpatient hospital care. However, in developing this new and more complex system of reimbursement, the department experienced a number of implementation and technical problems, some of which will have to be addressed as the department moves forward with full implementation of the system. In addition, the department has continued to apply a rate adjustment factor to hospital operating rates that artificially suppresses the payment levels produced by the new reimbursement system.

In terms of implementation problems, the process used to put the system in place, make technical adjustments to the rate-setting methodology, and establish prospective rates was characterized by protracted delays. Because of these delays, DMAS was required, by regulation, to apply the initial rates for the system retroactively, which was not consistent with the general intent of the General Assembly. This action fractured relationships with the Medicaid Payment Advisory Council. Although, the working relationship between the council and DMAS has improved significantly in the past year, questions persist about the appropriate role for this body.

From a technical perspective, the department experienced two problems that affected hospital payment rates. First, the databases used by DMAS caused some patient claims to be inappropriately categorized. The result of this problem is that the severity of some cases was underestimated, and hospitals received an underpayment for those cases. DMAS is working to correct this problem, which JLARC staff estimate could cost a minimum of $11.4 million to resolve.

Second, when setting the payment rates for FY 1999, DMAS used a method for estimating hospital costs that was later determined to have lowered payment rates to hospitals. The General Assembly appropriated $12 million in FY 2000 to compensate hospitals for the revenues lost as a result of this problem.

There is also some disagreement about DMAS' tentative plans to recapture savings from hospital payment rates that were paid in FY 1997 and FY 1998. The regulations that provide DMAS with the authority to capture savings from hospitals based on changes in the length of time that Medicaid recipients received inpatient care were passed in FY 1996. Nonetheless, the methodology used by the department to determine the amount of savings that can be attributed to those changes and recaptured by DMAS falls considerably short of the burden of proof required by the regulations. Therefore, any payment reductions for lengths of stay savings appear unjustified.

DMAS Adjustment Factor that Lowers Payment Rates Is a Concern

Based on the findings of this review, legitimate questions can be raised about the State's policy of lowering payment rates for Medicaid-financed inpatient hospital care through the use of an adjustment factor. Since 1996, hospitals in Virginia have reduced the length of time that Medicaid recipients are hospitalized. Over a five-year period from 1993 to 1998, hospitals have limited the average annual growth rate in the real cost of care for these patients to less than two percent, after adjustments for patient days and patient mix.

Despite these trends, the rates for private hospitals have been adjusted downward in each year since FY 1998 based on an agreement established with the hospital industry (compare bottom two lines of graph in figure on page III). This contributes to the fact that Virginia's payment levels to hospitals for inpatient care are low relative to other states that operate a DRG system. Currently of the 22 states that use a DRG system, Virginia is one of only two states that imposes additional rate reductions through an adjustment factor. Nine of the states that do not use such a factor have no policy requiring that the payment system be periodically rebased. This may result in lower payments over time.

Although the regulations providing for the use of a rate adjustment factor were promulgated without objections from the hospital industry in 1997, it is now very clear that the industry is opposed to the continued use of this policy. As would be expected, if the use of an adjustment factor were eliminated, the General Assembly would face a considerable increase in the cost of the State's program for Medicaid inpatient hospital care. For example, based on the APDRG rates that were established by DMAS for FY 2001, eliminating the adjustment factor could raise the cost of inpatient care by an additional $48 million in payments to private hospitals. Approximately one-half of this amount would have to be paid through State general fund dollars.

Recommendation (1). The Department of Medical Assistance Services should better define the role of the Medicaid Payment Policy Advisory Council.

Recommendation (2). The Department of Medical Assistance Services should refrain from reducing the payment rates in effect in FY 1997 and FY 1998 based on changes in the length of stay for Medicaid recipients of inpatient care.

Recommendation (3). Prior to February 1, 2001, the Department of Medical Assistance Services should submit a plan to the House Appropriation and Senate Finance Committees outlining a strategy to phase out the rate adjustment factor by FY 2003.