REIMBURSEMENT TO HOSPITALS1 STATUTORY REQUIREMENTS Medicare benefits are paid on the basis of "reasonable cost" in the case of hospitals. "Reasonable costs" are determined by medicare based on actual costs incurred by the individual provider in furnishing covered services to beneficiaries. All necessary and proper costs which maintain the operation of patient care facilities and activities are included in the computation of reimbursement. Hospitals submit claims to their intermediary on behalf of beneficiaries and agree to accept the program's reasonable cost determination as payment in full for covered services. The beneficiary is responsible for paying for the part A deductible and coinsurance amounts and for noncovered services. The Secretary of the Department of Health and Human Services (HHS)2 is required to issue regulations establishing the method or methods to be used, and the items to be included in determining the reasonable cost of covered care. In developing these regulations, the Secretary is directed to consider the principles generally applied by national organizations in determining the amounts of payments. The regulations may provide for the determination of costs on a per diem, per unit, per capita, or other basis; may provide for using different methods in different circumstances; may provide for the estimates of certain costs; and may provide for the use of charges or percentage of charges where this method reasonably reflects the costs. Further, the Secretary may provide for the establishment of limits on direct or indirect overall incurred costs or incurred costs of specific items or services or groups of items or services to be recognized as reasonable. These limits are to be based on estimates of the costs necessary in the efficient delivery of health services. The law requires the Secretary to apportion the costs of services provided by hospitals between beneficiaries and other patients to assure that neither group bears the costs of the other. The Secretary is also required to provide for the making of suitable retroactive corrective adjustments in the amount of payment to institutions where aggregate reimbursement has proven to be either inadequate or excessive. This section borrows heavily from two Congressional Research Service prints entitled "How Medicare Pays Doctors" and "Hospital Reimbursement Under Medicare." 2 All references to the "Secretary" in this section refer to the Secretary of the Department of Health and Human Services (HHS); all references to the "Department" refer to the Department of HHS. To carry out the congressional mandate, the Department has developed regulations which: -Identify allowable costs, i.e., those items or elements of a provider's actual costs which are reimbursable under the program; these costs must be reasonable and relate to patient care. -Provide a method for cost apportionment, i.e., determining what portion of total allowable costs of a hospital can be attributed to Medicare beneficiaries and therefore be reimbursed under the program. -Provide methods of cost finding, i.e., determining what the total cost is of providing services. -Provide methods for making payments to providers. More detailed information on hospital reimbursement is contained in the Provider Reimbursement Manual prepared by the Health Care Financing Administration (HCFA), Department of Health and Human Services. ALLOWABLE COSTS-GENERAL PRINCIPLES Allowable costs are items or elements of a provider's actual costs which are reimbursable under the program. Such costs must be reasonable and relate to patient care. Reasonable costs include all necessary and proper expenses incurred in rendering services such as administrative costs, maintenance costs, employee salaries, and the cost of employee health and pension plans. It includes both direct and indirect costs and normal standby costs. Excluded from allowable costs are items specifically not reimbursable under the program, and amounts attributable to the furnishing of luxury items or services (i.e., items or services substantially in excess of or more expensive than those considered necessary for the provision of needed health services). Also excluded are items not specifically related to patient care such as telephones, televisions, and radios furnished for the personal comfort of patients. Allowable costs cannot exceed what a prudent and cost-conscious buyer would pay for a given item or service. This is known as the "prudent buyer" principle. Intermediaries are expected to review provider purchasing patterns to assure that excessive costs are not being paid and that providers take advantage of discounts available from bulk purchasing or joint purchasing arrangements. Costs in excess of those normally incurred in purchasing a supply or service are not allowable in the absence of a clear justification for the difference. Certain hospital services may be furnished "under arrangements." This refers to situations where the provider has contracted with an outside organization to perform services for the provider. The amount charged by the supplying organization and paid by the hospital for services rendered becomes a cost to the hospital. This amount is included in the latter's allowable costs to the extent such charges are reasonable. Generally, the reasonableness of supplier charges is determined by whether they are in line with the going rate charged to others within the community. Program payments for services provided under arrangements can never be made directly to the supplier. Detailed rules have been established concerning those specific elements of a provider's costs which are "allowable" for medicare purposes. The following sections outline the major principles. Depreciation Depreciation is that amount which represents the portion of an asset's cost which is allocable to a period of operation. Depreciation accounting is a system of accounting which prorates the cost or other basic value of a tangible capital asset less salvage value (if any) over its estimated useful life. An appropriate allowance for depreciation on buildings and equipment used to render care covered by medicare is an allowable cost. Depreciation is based on the "historical," i.e., original, cost of the asset except that special rules apply in the case of assets acquired prior to 1966. The program recognizes depreciation on assets in use at the time the provider enters the program even though such assets have been fully or partially depreciated on the provider's books. A depreciation allowance is also permitted on assets that are used in a normal standby or emergency capacity or for assets financed by public funds. In general, the useful life of an asset is based on the useful-life guidelines published by the American Hospital Association (Chart of Accounts) or the Internal Revenue Service. Generally, options for straight-line depreciation (which provides a uniform allowance each year) and accelerated depreciation (which permits a larger writeoff in the initial years) which are allowed under the income tax laws are permitted for assets acquired before August 1970; only straight line and (within limits) declining balance depreciation (which is one form of accelerated depreciation) are recognized for assets acquired at a later date. Reevaluation of assets is permitted where a change of ownership has occurred but not in cases involving acquisition of stock. Special rules apply with respect to gains or losses resulting from disposal of assets. Medicare does not require the funding of depreciation; that is, the provider is not required to set aside the amount allowed for depreciation for replacement of the asset. However, as an incentive for funding, investment income on funded depreciation is not treated as a reduction in allowable interest expense. Public Law 97-34, the Economic Recovery Act of 1981, made a number of changes in the calculation of depreciation for tax purposes. However, the law excludes medicare (and other programs administered by HHS) from the new depreciation rules for purposes of determining cost reimbursement under the program. Interest Necessary and proper interest on current and capital indebtedness is included as an "allowable cost" under medicare. Generally, current indebtedness represents short-term loans for working capital for normal operating expenses. Capital indebtedness represents long-term loans in which the funds are used for acquiring facilities and equipment or making capital improvements. To be recognized as an allowable cost, interest must be incurred on funds needed to satisfy the financial needs of the hospital and must be for a purpose reasonably related to patient care. The rate of interest may not be in excess of what a prudent borrower would have had to incur in the money market in an arms-length transaction. The interest must be paid to a lender not related through control, ownership, or personal relationship to the borrowing organization. Generally, allowable interest expenses are reduced by investment income except where such income is from: (1) gifts and grants, whether restricted or unrestricted, and which are held separately and not commingled with other funds; (2) funded depreciation; or (3) a provider's qualified pension fund. Bad debts, charity, and courtesy allowances Bad debts, charity, and courtesy allowances are not "allowable costs" for medicare purposes. However, that portion of bad debts attributable to a medicare beneficiary's failure to pay deductible and coinsurance amounts is reimbursable. To be allowable, such debt must be related to covered services, and the provider must establish that reasonable collection efforts were made, that the debt could not actually be collected when claimed as worthless, and that there was no likelihood of recovery at any time in the future. Cost of educational activities A provider's allowable costs may include the net cost of approved educational activities. Such approved educational activities are formally organized or planned programs of study (as distinguished from on-the-job or similar work-learning programs) engaged in by the provider for the staff members to enhance the quality of patient care. Where required, the acitivity must be licensed by State law. If no State licensing is required, approval must be obtained from the recognized national professional organization for the particular activity. The net cost recognized by the program is determined by deducting from the provider's total costs of these activities, the revenues it receives from tuition and from restricted grants and donations. Research costs Research costs over and above those related to usual patient care are excluded from allowable costs. If research is conducted in conjunction with or as a part of the care of patients, the costs of usual patient care are reimbursable to the extent that they are not met by research funds. The costs of extraordinary patient care which are tied to research objectives are not reimbursable. Extraordinary care is defined as that rendered to research patients which is not medically necessary, reasonable, or ordinarily furnished to patients by providers. Grants, gifts, and income from endowments In general, unrestricted grants, gifts, and income from endowments are not deducted from operating costs in computing "allowable costs" while those designated by a donor for paying specific operating costs must be deducted from the particular operating cost or group of costs to which they apply. Similar rules apply with respect to the allowability of Government grants or similar payments. Further, the Secretary has the authority not to deduct from operating costs certain types of donor-designated grants and gifts (including Government grants) which he determines should be encouraged in the interests of needed health care. Value of services of nonpaid workers Under certain circumstances, the value of services performed by nonpaid workers (generally members of religious orders) is allowable as a reimbursable cost. The amount recognized per individual cannot exceed the amount allowed, excluding overtime, for paid employees who perform similar services. To be recognized, the services performed by nonpaid workers must be directly related to patient care or administrative positions essential to providing that care. Services such as distributing books or magazines to patients, or work in a provider's cafeteria or gift shop, are not allowable costs. Return on equity capital of proprietary providers A reasonable return on equity capital invested and used in providing patient care is an allowable cost for proprietary providers. Equity capital is the net worth of a provider excluding those assets and liabilities not related to patient care. Specifically equity capital includes: (1) a provider's investment in plant, property, and equipment (net of depreciation) related to patient care, plus funds deposited by a provider who leases such items where such deposit is required by the lease; and (2) net working capital maintained for necessary and proper operation of patient care activities. The base amount of equity capital to be used in computing the allowable return is the average investment of the owners during a reporting period. The rate of return is equal to one and one-half times the rate of interest paid by the Federal Treasury on the assets of the Federal Hospital Insurance Trust Fund. Drugs Allowable costs for certain multiple-source drugs are subject to "maximum allowable cost" (MAC) limitations. These limitations, periodically published in the Federal Register, are based on the lowest price at which the drug is widely and consistently available to pharmacists and the most frequently purhased package size. For purchases made after the date for which a MAC limitation has been established for a particular drug, the allowable cost may not exceed the lowest of: (1) the actual cost; (2) the amount which would be paid by a prudent and cost-conscious buyer for the drug if obtained from the lowest-priced source that is widely and consistently available within a provider's service area whether sold by a generic or brand name; or (3) the MAC limit. An exception is permitted where a physician has certified that in his medical judgment a specific brand name drug is medically necessary for a particular patient. Hospital-based physicians Many hospitals retain physicians on a full-time basis particularly in the fields of radiology, anesthesiology, and pathology. These provider-based physicians generally engage in a variety of activities including teaching, research, administration, and other provider-re |