In an inflationary environment, pending Medicare payment updates don’t measure up

• Consumer-focused inflation numbers aren’t as eye-catching in healthcare as in other sectors, but costs are hampering hospitals and health systems.
• Medicare payment updates over the last couple of years and as proposed for 2023 aren’t tracking the surge in costs.
• Hospital groups hope CMS will adjust the 2023 payment rates, but the prospects for such action are questionable.

As inflation reports continue to bring daunting news for consumers and businesses, the effect in healthcare remains relatively muted in some ways.

Whereas the Consumer Price Index (CPI) for All Urban Consumers rose by 1.3% in June, for example, the seasonally adjusted increases for the month were 0.3% for hospital services and 0.1% for physician services. On a year-over-year basis, those two sectors increased by 3.9% and 1%, respectively, compared with 9.1% for the CPI.

But even though the change in overall spending on services is comparatively restrained, with levels partially locked in by calendar-year contracts that rely on advance projections, the financial squeeze on hospitals is significant.

In a bulletin issued July 19, Fitch Ratings wrote that operating margins for nonprofit hospitals “will see further erosion due to ongoing inflationary pressures of elevated labor, supply and capital costs.”

“The vast majority of our rated credits have strong balance sheets that will offset lower margins for a period of time and allow for operational improvements,” the agency added. “Without more substantial changes to the current business model, or with additional coronavirus surges this fall or winter, this balance sheet cushion could eventually erode, which would lead to negative rating actions.”

Disappointment in payment updates

A big concern for hospitals is that, to a greater degree than usual, federal payment rates aren’t keeping up with costs. That means industrywide Medicare margins, which the Medicare Payment Advisory Commission projected at -9% for 2022 in a report issued earlier this year, could deteriorate further.

An analysis by Premier indicates that the hospital inpatient payment updates for the last two years — 2.4% in FY21 and 2.7% in FY22 — have fallen short of what was needed. Based largely on higher-than-expected labor costs, Premier wrote in a comment letter to CMS, the actual increase in the hospital market basket turned out to be 3% in 2021 and is projected to be 4% this year.

Inflation has only gone up in 2022, with Kaufman Hall reporting that hospital costs increased by 10.4% year-to-date through May and were 3.9% higher than budget. Given that sort of context, “A very high payment update in FY23 will be needed to match the rates most acute care providers are now paying their staff,” Premier wrote in an April report.

Such an update wasn’t forthcoming in the FY23 proposed rule, which called for a payment increase of 3.2% based on a 3.1% market-basket update and a 0.1% net adjustment. Moreover, the increase relative to 2021 and 2022 would be quite a bit less because the 2% Medicare sequester is back in full effect after being paused throughout ’21 and for the first three months of ’22 (and being reduced to 1% for Q2 2022).

Meanwhile, next year’s projected raise for outpatient payments is 2.7%. The proposed change to physician payments is a decrease of more than 4%.

Such updates contribute to an unprecedented situation, Fitch noted. Although inflation was several percentage points higher in the late 1970s and early 1980s, “At that time, hospital reimbursement was cost-based, and cost increases were passed to government and private-insurer payers under a much more elastic revenue model.”

Medicare’s prospective payment system, established in 1983, locks in reimbursement rates to a much greater degree, and many health plans have adopted a similar framework.

How CMS should respond

“We are concerned that the data that CMS uses to predict real inflation and cost of labor does not reflect reality and will result in a third consecutive year where the payment update is not reflective of the actual cost increases hospitals are experiencing now and into the future,” Premier wrote.

CMS based the proposed FY23 inpatient update on data derived by the economic forecasting firm IHS Global Inc. for Q4 2021. CMS did note that “if more recent data subsequently become available, we would use such data, if appropriate, to determine the FY23 market-basket update in the final rule,” which will be released in August.

Hospital groups hope CMS will consider revising its methodology to incorporate more recent data and economic trends. They also say the agency should use its “exceptions and adjustments” authority to boost the payment rate beyond what’s indicated by the market-basket calculation.

Premier specifically called for an additional 1.9% increase in the market basket to correct what amounted to underpayments over the last two years. The Federation of American Hospitals wrote that CMS should use the “exceptions and adjustments” option to also negate the 0.4% reduction stemming from the annual productivity adjustment, which was initiated to help hold down federal healthcare spending amid passage of the Affordable Care Act.

Canceling out that adjustment would reflect “the inappropriateness of a negative productivity adjustment at a time when hospitals are facing productivity losses during a pandemic that has created exceptional financial pressures that jeopardize our healthcare delivery system generally and our hospitals in particular,” FAH wrote.

Murky prospects for changes

CMS may look to hold down hospital payments to whatever degree possible, given broader concerns about the federal deficit and specific concerns about the Medicare Hospital Insurance Trust Fund. According to the latest projections, the fund will become insolvent in 2028.

The year 2022 “is almost certainly going to be worse from an inflationary [perspective], and certainly higher inflation leads directly to higher payment updates,” Paul Spitalnic, chief actuary for CMS, said during a June webinar hosted by the American Enterprise Institute.

But based on the current methodology, such updates wouldn’t be implemented until 2024. Furthermore, Spitalnic added, “Payment updates generally will not be as high as some of the CPI figures just because the CPI figures are really being skewed toward energy- and food-based products, as compared to we’re seeing [that] less so on the wage side.”

The more Medicare payments fall short of covering costs, the more providers may try to make up the deficit via commercial payments.

However, as Fitch wrote: “We do not expect to see Medicare or Medicaid rate adjustments to offset inflation given federal budget deficits, and commercial rate increases are also likely to be well below inflation in the short term.”

If nothing else, the company added, health plans may be willing to offer rate increases that exceed those of recent years, “considering the interdependent relationship of providers and payers.”