OIG report suggests Medicare pays too much to cover capital costs for new hospitals

The HHS Office of Inspector General says the stated justification for using a cost-based methodology to cover new hospitals’ capital expenditures is not borne out by the data.

A new federal report suggests CMS pays excessively to cover capital costs during the first two years of a hospital’s existence.

Based on CMS’s written response, the findings may lead to changes in the approach to covering Medicare-attributed capital expenditures incurred by new hospitals.

Regulations call for capital costs, as calculated on Medicare cost reports, to be covered on a cost-reimbursement basis for the first two years after a hospital’s launch. Thereafter, payment is based on the methodology established by the Inpatient Prospective Payment System (IPPS).

The Office of Inspector General (OIG) at the U.S. Department of Health and Human Services examined Medicare payments issued to cover capital costs at 112 new hospitals between 2012 and 2018. OIG found that payments were $283 million higher than they would have been had the IPPS methodology been used.

Per hospital, the additional payment amounted to about $1.2 million per Medicare cost report, or three times more than would have been paid under the IPPS. But OIG found significant variability among hospitals, ranging from a reduction of $98,500 for one hospital under the cost-based methodology to an increase of more than $8.1 million for another. The median difference was a net gain of just more than $750,000.

Is a higher payment needed?

The cost-based reimbursement methodology for new hospitals was implemented to account for low Medicare volumes and high startup costs. In a subset of 35 hospitals, OIG found that average Medicare-related capital costs were only 3% higher during the first two years compared with the third and fourth years and that relevant costs actually were lower for 21 of the 35 hospitals.

The issue of low Medicare volume seems more pertinent, with OIG reporting that average Medicare utilization was 15% lower among the 35 hospitals in their first two years compared with the next two.

Regarding the need to counterbalance potentially lower capital reserves among new hospitals, OIG noted that 59% of the 112 hospitals were part of health systems that might have provided reserve capital to the new facilities as needed.

“The results of our comparison thus suggest that CMS’s rationale for continuing the IPPS exemption is not sufficient to justify the difference in payments,” OIG stated.

Possible policy adjustments

OIG said CMS should consider issuing regulations that would establish the IPPS as the mechanism for determining reimbursement for a new hospital’s capital costs. Payment adjustments or supplemental payments could be made as needed.

“Such payments would not be based solely on cost and would still allow CMS to realize significant cost savings,” OIG stated. “By using the IPPS for new hospitals in lieu of cost reimbursement, CMS could create incentives for hospitals to operate more efficiently.”

CMS responded in writing to the report and affirmed that it will consider whether to make adjustments to the methodology.

“CMS will further review the OIG’s findings and determine whether any modifications to the capital payment methodology for new hospitals should be proposed in future notice-and-comment rulemaking,” the agency stated in a letter signed by Administrator Chiquita Brooks-LaSure.