Christopher L. Keough
Stephanie A. Webster


At a Glance

  • The 340B program provides an opportunity for hospitals to achieve significant cost savings on outpatient drugs.
  • Disputes surrounding the Medicare DSH payment calculation, and potential misunderstandings of Medicare provider-based rules, pose obstacles to hospitals that wish to continue or gain participation in the program.
  • Eligible hospitals should pay close attention not only to the rules governing the 340B program, but also to Medicare reimbursement rules to ensure access to drug discounts available under the program.   

Section 340B of the Public Health Service Act establishes a program under which certain hospitals may obtain significant discounts on drugs furnished to outpatients.

The program was first adopted in 1992, and in its early years, the 340B drug discount was available only to a limited group of hospitals, mainly consisting of public and private, not-for-profit hospitals in urban areas that treated a large proportion of low-income patients (disproportionate share [DSH] hospitals). Following 2003 amendments to the Medicare DSH statute and more recent changes to the 340B statute, a broader group of hospitals may qualify for the discount, including some rural hospitals and children's hospitals.  

However, continuing controversies with the DSH payment calculation present ongoing challenges that can disqualify some hospitals that otherwise should qualify for the discount. Moreover, significant compliance issues involving Medicare provider-based rules can arise as hospitals of all types determine which patients are eligible to receive the discounts. Hospital administrators and financial officers should be familiar with the program and keep abreast of ongoing changes in the 340B program and relevant Medicare reimbursement rules that affect a hospital's continued participation in the program.

Covered Hospitals

The 340B program's limited reach is driven, in part, by the statute's restrictive definition of "covered entity." To participate in the program as a covered entity for a current quarter, a hospital must meet each of the following criteria:

  • The hospital must be a governmental hospital, a public or private not-for-profit hospital with state or local formal governmental powers, or a private not-for-profit hospital that has a contract with state or local government to provide health services to low-income persons who are not enrolled in Medicare or Medicaid.
  • The hospital must be a "subsection (d) hospital," as defined in section 1886(d)(1)(B) of the Social Security Act.
  • The hospital must have had a DSH adjustment percentage of at least 11.75 percent for the most recent cost reporting period ending before the current calendar quarter.
  • The hospital must not obtain outpatient drugs through a group purchasing arrangement.

Ownership and operational requirements. The first criterion for hospital participation in the 340B program categorically excludes all proprietary hospitals. Not-for-profit hospitals are eligible for participation, but only if they are government hospitals or have a government contract to provide healthcare services to low-income patients who are not covered by Medicare or Medicaid.

Subsection (d) hospitals. Section 1886(d) of the Social Security Act is the statutory provision governing Medicare's original prospective payment system (PPS) for the operating costs of inpatient hospital services (42 U.S.C. § 1395ww[d]). Originally, the term subsection (d) hospital included any general acute care hospital except the types of hospitals that are exempt from the original PPS:  long-term care hospitals, rehabilitation hospitals, psychiatric hospitals, children's hospitals, and certain cancer hospitals. However, the scope of the program recently was extended to include children's hospitals. 

Critical access hospitals are also excluded from the 340B program, but for a slightly different reason. Critical access hospitals are reimbursed on reasonable cost basis (42 U.S.C. § 1395f[l]). They are excluded from the PPS, and they are not within the definition of a subsection (d) hospital because a critical access hospital, as defined in section 1861(mm)(1) of the  Social Security Act, is generally excluded from the Medicare statute's definition of a hospital (42 U.S.C. § 1395x(e), 1395x(mm)[1]).

Conversely, other types of rural hospitals-which in some cases may not be paid the standard PPS rate per discharge-should be eligible for the 340B program if they meet the other criteria. Sole community and Medicare-dependent hospitals, for example, are subject to special payment provisions under section 1886(d) of the Social Security Act. In short, these hospitals are paid the greater of either (1) the standard PPS rate per discharge, including add-on payments for DSH, indirect medical education, and outliers, or (2) the hospital-specific rate per discharge, which may be derived from any one of several alternative base periods (whichever produces the highest hospital-specific rate).

Though sole community and Medicare-dependent hospitals are subject to these special payment provisions, which may produce payment in excess of the standard amount that would be paid under the PPS, they are still subsection (d) hospitals. These hospitals, therefore, should be eligible to participate in the 340B program if the statute is construed and applied in accordance with its literal meaning.

However, it may not be universally understood and accepted that these rural hospitals are eligible for the 340B program. The Office of Pharmacy Affairs, which administers the program, usually describes the types of hospitals that may participate in the program as "DSH hospitals," perhaps suggesting that a hospital must qualify for, and receive, a Medicare DSH payment to participate in the 340B program. And, as noted above, sole community and Medicare-dependent hospitals may be paid on the basis of their hospital-specific rate and may not receive a DSH payment when the hospital-specific rate produces a greater Medicare payment. In addition, at least some members of Congress apparently do not believe that the current law permits a sole community or Medicare-dependent hospital to participate in the 340B program. Just last year, a bill was introduced in Congress to "expand" the 340B program to include sole community and Medicare-dependent hospitals as well as critical access hospitals and rural referral centers (the 340B Program Improvement and Integrity Act, H.R. 206). 

DSH adjustment percentage. Most rural hospitals, except critical access hospitals, are subsection (d) hospitals. However, until 2003, rural hospitals historically did not qualify for the 340B program because they generally could not establish a DSH adjustment percentage of at least 11.75 percent. As the term implies, the DSH adjustment percentage is the percentage add-on that is applied to the standard PPS rate paid for each discharge of a Medicare Part A beneficiary. As defined in section 1886(d)(5)(F)(vi) of the Social Security Act, this adjustment percentage is the end-product of a statutory formula that is based on a hospital's disproportionate patient percentage.

Prior to 2003 amendments to the Medicare DSH statute in the Medicare Prescription Drug, Improvement, and Modernization Act, most rural hospitals and small urban hospitals with less than 100 beds were required to have a higher disproportionate patient percentage than larger urban hospitals to qualify for the Medicare DSH payment (42 C.F.R. § 413.106[b]). Moreover, different formulas were used to calculate the disproportionate share adjustment percentage, and the adjustment percentage for many rural hospitals was capped by law at a percentage below 11.75 percent.

With the 2003 amendments to the Medicare DSH statute, however, all hospitals may now qualify for the Medicare DSH payment if the hospital's disproportionate patient percentage is at least 15 percent. The amendments also raised the DSH caps to a 12 percent limit for some rural hospitals and eliminated altogether for others. Thus, while rural hospitals typically were not able to qualify for the 340B program in the early years of the program, the 2003 amendments made it possible for rural hospitals that treat a substantial proportion of Medicaid and low-income Medicare patients to qualify for the 340B drug discount.

Children's hospitals. Section 6004 of the Deficit Reduction Act of 2005 made children's hospitals eligible to participate in the 340B program if they:

  • Are affiliated with state or local government
  • Provide a specified amount of indigent care
  • Do not acquire covered drugs through a group purchasing organization (GPO)

This year, the Health Resources and Services Administration (HRSA) published guidance establishing a process for children's hospitals to participate in the program (Federal Register, Sept. 1, 2009). This guidance details the specific requirements children's hospitals must meet:

  • It must establish that it is, in fact, a children's hospital as defined by Medicare and that it has a 3300 series Medicare provider number.
  • It must certify that it will abide by all the standard compliance requirements for a covered entity (e.g., prohibitions on resale of covered outpatient drugs and on duplicate discounts or rebates).
  • It must show that it is affiliated with a state or local government.
  • It must certify that it would qualify for Medicare DSH under the so-called "pickle" method or with a DSH adjustment percentage greater than 11.75 percent.
  • It must submit certification that it will not participate in a GPO for covered outpatient drugs as of the effective date of participation in the 340B program.

A children's hospital that has already filed an application with HRSA to participate in the program must apply again in accordance with September 2009 guidance. Because the portion of the Deficit Reduction Act allowing children's hospitals to participate in the 340B program became effective on Feb. 8, 2006, a qualifying children's hospital can receive discounts retroactive to that date, provided it can document that it meets the following requirements:

  • It must have been eligible as of the date requested for discounts.
  • It must not have purchased any covered drugs through a GPO.
  • It must be listed on the 340B Covered Entity Database by Sept. 1, 2010.
  • It must send, or have sent, a formal request for discounts to each manufacturer of the outpatient drugs sought within 30 days of having been listed on the database.
  • The drugs must have been purchased on or after Feb. 8, 2006.
  • The drugs must not have generated Medicaid discounts.
  • The drugs must not have been sold or transferred to a nonpatient.

Practically, these requirements may mean that children's hospitals will not obtain retroactive drug discounts.

The September 2009 guidance also provides that outpatient facilities of a children's hospital may be included in the 340B program if they are included on the facility's Medicare cost report or otherwise meet the Medicare "provider-based" rules, subject to audit by drug manufacturers.

Continuing Controversies

The computation of the DSH payment has been a source of continuing controversy between hospitals and the Centers for Medicare & Medicaid Services (CMS) virtually since the inception of the Medicare DSH payment in 1986. These disputes not only affect the Medicare DSH payment, but may also cause a hospital to lose the 340B discount to which it is lawfully entitled.

As mentioned previously, a hospital's eligibility to participate in the 340B drug discount program for the current calendar quarter is based, in part, on the hospital's disproportionate patient percentage for its most recently ended cost reporting period. To implement this provision, the Office of Pharmacy Affairs publishes a quarterly listing of hospitals' disproportionate patient percentages. To qualify for a discount, a hospital must not only apply to the Office of Pharmacy Affairs, but also must be listed by the Office of Pharmacy Affairs as currently having a DSH adjustment percentage of at least 11.75 percent.  

The percentages reflected on the quarterly listings are supplied to the Office of Pharmacy Affairs by CMS. In some instances, those percentages may be understated due to the application of a CMS payment policy or calculation that is contested by the hospital. The application of disputed Medicare DSH payment policies may dilute the Medicaid or Social Security Income (SSI) fractions-and thus cause a hospital to be disqualified for the 340B discount-by reducing the hospital's DSH adjustment percentage below the 11.75 percent qualification threshold. 

Although a hospital may appeal its DSH payment determination to the Provider Reimbursement Review Board (PRRB) and ultimately to federal court, the appeal process usually moves at a glacial pace. Ordinarily, it may be five to seven years after the fiscal year in question before a hospital has an appeal heard by the PRRB. And in the event that the PRRB rules against the hospital, or the administrator of CMS reverses a PRRB decision in favor of the hospital, further proceedings may be necessary in federal court, and the judicial review process may add years more to the process. 

The lengthy appeal process is particularly problematic for hospitals vis-à-vis the 340B program. For example, last year, the federal district court in Washington, D.C., issued a ruling requiring CMS to recalculate a hospital's SSI fraction from FY93 to FY96 to correct systemic errors and omissions in CMS's calculation of the SSI fraction (Baystate Medical Center v. Leavitt, 545 F. Supp. 2d 20, 22-23 [D.D.C. 2008]). The court's ruling reflects that some of those errors were discovered by the agency in 1995, but were not corrected or disclosed to affected hospitals until they were uncovered years later in litigation. Moreover, the errors in CMS's calculation tended uniformly to dilute the SSI fraction and thus resulted in a lower disproportionate patient percentage.

To the extent that the errors reflected systemic flaws in the agency's calculation of the SSI fractions for all hospitals in the country, they certainly had the potential to-and undoubtedly did-cause some hospitals not to qualify for the 340B drug discount that they otherwise would have been eligible to receive had the SSI fractions been calculated correctly. And, making matters worse for hospitals, the Office of Pharmacy Affairs apparently takes the position that hospitals not currently appearing on the quarterly listing may not qualify retroactively for the 340B discount based on subsequent corrections to its disproportionate share adjustment percentage (see www.hrsa.gov/opa/dsh.htm; see also Federal Register, May 1994).

Overcoming Obstacles to Participation

The 340B program provides an opportunity for hospitals to achieve significant cost savings on outpatient drugs. Ongoing disputes surrounding the Medicare DSH payment calculation, and potential misunderstandings of the Medicare provider-based reimbursement rules, pose obstacles to hospitals that wish to continue or gain participation in the program. Eligible hospitals should pay close attention not only to the rules specifically governing the 340B program, but also to these Medicare reimbursement rules, to ensure their continued access to drug discounts available under the program.


Christopher L. Keough, JD, is an attorney, healthcare practice group, King & Spalding, Washington, D.C., and a member of HFMA's Virginia Chapter (ckeough@kslaw.com).

Stephanie A. Webster, JD, is an attorney, healthcare practice group, King & Spalding, Washington, D.C., and a member of HFMA's Virginia Chapter (swebster@kslaw.com).

Publication Date: Sunday, November 01, 2009

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