Chad Mulvany

With the passage of landmark healthcare reform, a hospital financial leader's number one challenge is to become knowledgeable about the legislation and its likely impact on a hospital's bottom line.

At a Glance

  • Aspects of the recent landmark healthcare reform legislation likely to prove beneficial to hospitals include changes to insurance markets, malpractice reform demonstrations, and funding to help hospitals with high volumes of preventable readmissions.
  • Hospitals are likely to be adversely affected by scheduled payment cuts and the employer "free rider" penalty.
  • The legislation also poses transformational opportunities and challenges for hospitals, stemming from measures designed to change the care delivery system and provisions regarding hospitals' tax-exempt status and pricing transparency.

No one knows what the long-term impact of reform on hospitals will be. What is clear is that some provisions in the legislation will be good for providers, other will have a negative impact-and many will be transformational for the industry. Now that the legislation has become law, providers need to understand how the two bills that make up healthcare reform will impact their facilities.

Ratings agencies believe the long-term impact of reform will be neutral to negative for the industry over the long term. Increased coverage will reduce the cost of uncompensated care by an estimated $184.5 billion over 10 years, according to Bank of America Merrill Lynch (Managed Care, Health Care Facilities Overview, April 21, 2010). This effect, along with the effects of other provisions, will be good for the industry. However, there are a number of payment cuts to help pay for the expansion of coverage-the hospital share alone is an estimated $149 billion-and other provisions that will put significant pressure on hospitals.

The legislation also includes measures that will provide transformational opportunities to hospitals that can respond to the challenges of a shifting reimbursement system. Many of those transformations to the payment system have been issues that finance professionals have desired for some time. Finance professionals need to understand how the legislation is likely to impact their organizations specifically. From this knowledge, they can then develop and execute strategies to enhance the good, mitigate the bad, and take advantage of transformational opportunities.

The Good

There are a number of reforms that will be good for hospitals. Provisions such as changes to insurance markets, malpractice reform demonstrations, and funding to help hospitals with high volumes of preventable readmissions will increase revenue while reducing cost.

Insurance reform. Changes to the insurance market will expand coverage to 32 million people by increasing regulatory oversight of commercial insurers, using the tax code and subsidies to mandate coverage, and creating state-based exchanges to improve the accessibility, transparency, and efficiency of insurance markets.

Coverage expansion begins modestly on June 21, 2010, with the establishment of temporary state-based high-risk pools for individuals who have been uninsured for at least the previous six months. The program runs until 2014 and sets premiums at a standard rate that can vary by no more than a 4:1 ratio by age.

Six months after the passage of the law (Sept. 23, 2010), a number of measures impacting all insurance plans (including currently existing or "grandfathered" plans) go into effect. With these reforms, the plans will be prohibited from imposing lifetime benefit limits and unreasonable annual limits on coverage, and dependent children will be allowed to remain on their parents' policies until age 26.

The full impact of insurance reform will not be realized until Jan. 1, 2014, when the major coverage provisions begin. Insurers will be required to accept and renew every individual or employer applying for coverage regardless of health status or utilization, and to limit variance among premiums to a ratio of 3:1 based on family size, geography, actuarial value of policy, tobacco use, and age.

Exhibit 1


For insurance markets to continue functioning in the absence of experience rating, everyone must have insurance. To achieve this end, the legislation establishes an individual mandate, using the tax code to require that all legal residents enroll in qualified health plans (QHPs). Starting Jan. 1, 2014, those who don't-with limited exceptions-will face a penalty that increases over time.

Exhibit 2


To provide a marketplace for individuals and small businesses to purchase insurance, states will be required to establish health benefit exchanges as either government or not-for-profit entities using federal start-up funding. This provision will give states significant influence on the overall impact of healthcare reform.

The legislation also provides for four benefit categories for health insurance plan design-bronze, silver, gold, and platinum-based on the actuarial value of the plan. Under the minimum requirements of the individual mandate, insurers will be required to meet QHP certification criteria by offering a full range of services and charging the same premium for policies offered in and out of the state's exchange, and by providing at least one plan in the silver (reference package) and gold benefit tier.

The services that an insurer must offer to qualify as a QHP are:

  • Acute services (inpatient, outpatient, and emergency)
  • Rehabilitation services and devices
  • Mental health and substance abuse services
  • Prescription drug coverage
  • Maternity and newborn services
  • Pediatric services
  • Preventive and wellness services

Given the cost of insurance, the individual mandate isn't feasible without some individuals receiving financial assistance. The legislation therefore provides for individuals with incomes between 133 and 400 percent of the federal poverty level to receive such assistance in the form of refundable tax credits. These "affordability credits" are designed to help low- and middle-income individuals purchase insurance by limiting the cost to a percentage of income.

Exhibit 3


Subsidies also will be available for small businesses-defined as organizations with fewer than 25 FTEs with average wages of less than $50,000-in two phases. In phase one (2010-13), employers can receive up to 35 percent of their contribution as a tax credit toward the purchase of health insurance premiums. The credit is based on a sliding scale, with firms having fewer than 11 FTEs and average wages of $25,000 receiving the full credit. Phase two begins in 2014. Employers that purchase coverage through the state exchanges can receive a tax credit of up to 50 percent of their contribution for two years. The same sliding scale used in phase one will apply in phase two.

Malpractice demonstrations. Although most believe that sweeping malpractice reform could lead to substantial cost reductions, such an overhaul was not included in the reform package for a variety of political reasons. In a first step toward broader reform, however, the law provides the HHS secretary with $50 million over five years to fund demonstration projects. The funding will be used to explore alternative methods to resolve medical liability claims, such as health courts and early offer programs.

Funding for reducing preventable readmissions. Facilities with the highest readmission rates will be able to participate in a five-year Medicare pilot program designed to reduce readmissions. The pilot begins in 2011 and gives priority to small community hospitals, rural hospitals, and facilities caring for medically underserved populations. Participating facilities must target Medicare patients who are at high risk for readmission, using at least one evidence-based care transitional intervention, such as comprehensive medication reconciliation at discharge.

The Bad

The legislation also includes items that are unfavorable for hospitals. Payment cuts and the employer "free rider" penalty will place significant downward pressure on hospital bottom lines.

Payment cuts. Approximately one-half of the legislation's estimated $938 billion cost is financed through savings generated from the healthcare system. Of the cuts, hospitals shoulder $149 billon of the burden through reductions to market basket updates (MBUs) and Medicare and Medicaid payments to disproportionate share hospitals (DSH payments). Hospitals also will likely feel the effect of significant payment cuts targeted at other industry participants that play key roles in hospital value chains, including insurers, pharmaceutical manufacturers, and device companies.

The legislation places a downward adjustment for productivity that reduces hospital reimbursement by $112.6 billion over the next 10 years. There are two components to the reduction. The first is a "flat" reduction that began on Jan. 1, 2010, for outpatient prospective payment system (PPS) payments and on April 1, 2010, for inpatient PPS payments and continues until Dec. 31, 2019. The actual productivity-based adjustment, which is based on a 10-year moving average of changes in annual economywide, nonfarm, multifactor productivity, begins in 2012. Similar adjustments are made to the MBUs for PPS payments to rehabilitation, long-term care, psychiatric, and skilled nursing facilities.

Medicare DSH payments will be reduced by $22.1 billion over the next 10 years. As a result of recent findings of the Medicare Payment Advisory Commission (MedPAC) that only 25 percent of Medicare DSH payments are economically justified by the cost of providing indigent care, the legislation reduces DSH funding by 75 percent over current levels starting in 2014. Some of the savings will be used to create a new payment system to reimburse hospitals' indigent care cost. Payments will be allocated based on the hospitals percentage of the total uncompensated care delivered by all DSH hospitals.

Medicaid DSH allotments will also be reduced by $14 billion over 10 years starting in 2014. The reductions will be based on the number of uninsured in each state and how states allocate their DSH funding.

Exhibit 4


Much of the remaining savings used to fund reform will come from commercial insurers, pharmaceutical manufacturers, and device companies.

Insurers will see payments cut for their Medicare Advantage product lines by an estimated $136 billion over 10 years. This payment reduction combined with guaranteed issue-which will significantly reduce insurers' ability to manage claims expense-will put significant pressure on insurers' bottom lines. The result is likely to be a more difficult contract negotiation environment as payers attempt to hold the line on rate increases to improve their financial performance.

Pharmaceutical and device manufacturers will be subject to industry fees of approximately $80 billion and $20 billion, respectively, over 10 years. Supporters of this tax claim the cost will not be passed on to patients and hospitals. However, it is unlikely that pharmaceutical and device manufacturer shareholders will bear the brunt of this.

Employer provisions. Although employers won't be required to offer insurance to their employees, they will be subject to a free-rider penalty. Companies with 50 or more FTEs will face a penalty for employees receiving affordability credits. An employee may be eligible for credits if his or her income is less than 400 percent of the FPL and if the employer doesn't pay at least 60 percent of the actuarial value of a QHP or the offered QHP is unaffordable, exceeding 9.5 percent of the employee's income.

Employers that offer a QHP and contribute to any portion of the premium also must provide a free-choice voucher equal to the employers' premium contribution. An employee is eligible to receive a voucher, which can be used to purchase insurance in the state exchange, if the employer-provided coverage is between 8 and 9.8 percent of the employee's income.

Most hospitals provide their employees with insurance. However, they need to determine if coverage meets the benefit package requirements and whether it is affordable-as defined in the law-for all employees. It is important that hospitals understand the financial impact on the organization from not satisfying either of these requirements. Hospitals also will need to consider the impact of the free-rider penalty on nonaffiliated postacute care providers in the community, such as freestanding skilled nursing facilities and home health agencies, which will likely experience significant financial difficulties as a result of the free-rider provision.

The Transformational

Reform poses a number of transformational opportunities and challenges for providers. Although the majority of the transformational measures are designed to change the care delivery system, there are also provisions concerning tax-exempt status and pricing transparency.

Delivery system reforms. A frequent criticism of the U.S. healthcare system is that most payment systems reward volume with only minimal concern for outcomes. As a result, U.S. healthcare costs skyrocket while quality lags that in other developed countries. To correct this problem, the legislation has both short- and long-term measures designed to shift incentives in the payment system from volume- to value-based for Medicare and Medicaid.

In the near-term, the Centers for Medicare & Medicaid Services (CMS) will implement a value-based reimbursement mechanism and reduce Medicare payments to hospitals with high volumes of preventable readmissions and hospital-acquired conditions (HACs).

Hospital value-based purchasing goes into effect in FY13 and applies to all acute care inpatient PPS hospitals. The program would pay hospitals based on their performance on measures currently collected in the Medicare pay-for-reporting. The program is budget neutral and funded by reducing payments for all Medicare severity-adjusted diagnosis-related groups (MS-DRGS).

The secretary of the Department of Health and Human Services (HHS) will develop a method for assessing hospital performance. A facility that meets or exceeds the standard will be eligible to earn back the initially withheld funds. The payment will be based on either quality improvement relative to the prior year's results or attainment of a defined quality benchmark, whichever results in a higher payout. The payment adjustment will apply only to the relevant fiscal year and not impact DSH, independent medical education (IME), outlier, or low-volume adjustment payments.

Beginning in FY13, hospitals with higher-than-expected risk-adjusted 30-day readmission rates for heart attack, heart failure, and pneumonia will have all of their inpatient PPS payments reduced, resulting in an estimated payment reduction of $7.1 billion over 10 years. The list of conditions will be expanded in 2015 to include coronary obstructive pulmonary disease and several cardiac and vascular surgical procedures. CMS also will calculate and post all-payer readmissions rates for the selected conditions, but the legislation does not provide a timeline for this effort.

Similarly, in FY15, the legislation applies a financial penalty to hospitals with higher-than-expected risk-adjusted rates of HACs. Providers in the highest quartile will have all of their inpatient PPS payments reduced by 1 percent, saving Medicare an estimated $1.4 billion over 10 years. The program will use the conditions currently included in CMS's HAC inpatient PPS payment policy.

Over the longer term, the legislation has the potential to radically reshape the care delivery system. Pilots that test bundled payments and accountable care organizations (ACOs) can offer significant financial rewards to hospitals that can collaborate with physicians and postacute care providers to improve quality and lower cost.

A five-year national voluntary Medicare bundled payment pilot will begin in 2013. The bundled payment would cover services provided from three days prior to admission to 30 days post discharge for inpatient and outpatient care, physician services, post-acute care, and any other services deemed appropriate by the HHS secretary. An entity, comprised of a hospital, physician group, skilled nursing facility, and home health agency can apply to participate in the pilot.

Initially, the pilot will focus on 10 conditions, to be selected by the HHS secretary. These will include a mix of chronic and acute conditions, medical and surgical cases, and conditions where there is a significant opportunity to improve the quality of care while reducing spending and variation in readmissions and postacute care utilization. After Jan. 1, 2016, the HHS secretary will be able to expand the duration and scope of the pilot if it is determined that it decreases costs without reducing quality.

The legislation includes a similar Medicaid pilot that will involve up to eight states by Jan. 1, 2012.

Another long-term pilot tests the ability of ACOs to improve the quality of care by tying reimbursement to quality and cost measures. Groups of qualifying providers-including various configurations of physician practice groups, hospital-physician joint ventures, and hospitals employing physicians-will have the opportunity to form ACOs and share in any cost savings they achieve for Medicare.

To be eligible to participate, providers must agree to:

  • Become accountable for the overall care of their Medicare FFS beneficiaries
  • Participate for a minimum of three years
  • Have a legal structure enabling receipt and distribution of bonuses
  • Provide information on physicians practicing in the ACO
  • Have a management and leadership infrastructure in place
  • Define processes to promote evidenced-based medicine and patient engagement
  • Meet patient-centeredness criteria determined by the HHS secretary

The HHS secretary will set a minimum threshold of savings that an ACO must achieve to be eligible to earn incentive payments. Providers also must meet predefined quality thresholds for clinical processes and outcomes, patient and caregiver perspectives on care, and utilization and costs.

Tax-exempt status. For several years hospital tax-exempt status has been a hot-button issue on Capitol Hill. Beginning with tax years starting after March 23, 2010, the law requires hospitals to conduct a community health needs assessment, report annually to the IRS on how they're meeting identified community needs, create a financial assistance policy, and use "reasonable" efforts to determine if a patient qualifies for charity care.

Hospitals must conduct a community health needs assessment at least once every three years and adopt an implementation strategy to meet the identified needs. The assessment should include input from stakeholders who represent the broad interests of the community. Hospitals have until the end of their tax years that start after March 23, 2012, to complete the assessment; otherwise, they face a $50,000 fine.

Annually, hospitals must report to the IRS on how they're meeting identified community needs. This report must include a description of needs not being addressed and the reasons why, along with audited financial statements. The IRS will review information about a hospital's community benefit activities at least once every three years. The secretary of the Department of the Treasury will report annually to Congress on the levels of charity care, bad debt, and cost of community benefit activities undertaken by tax-exempt hospitals.

Each hospital is required to adopt, implement, and publicize a financial assistance policy. The policy must include eligibility criteria, the basis for determining amounts charged to patients receiving charity care, instructions for applying for assistance, and any actions that may be taken for nonpayment. Hospitals may not use gross charges when billing individuals who qualify for assistance but, instead, must bill "no more than the amounts billed to individuals who have coverage for such care."

Hospitals may not undertake extraordinary collections actions to collect from a patient without first making a "reasonable" effort to determine whether the individual is eligible for charity care. The Treasury secretary is authorized to provide guidance on what constitutes a reasonable effort.

Pricing transparency. Beginning in FFY11, hospitals must annually make public a list of hospital charges for all items and services, including charges for each Medicare MS-DRG. The HHS secretary is charged with developing guidelines for reporting.

Fortune Favors the Prepared

Louis Pasteur probably couldn't have imagined our current healthcare system, let alone sweeping reform, when he said, "Fortune favors the prepared mind." However, rarely has a quote been more apt for hospitals if they are going to mitigate the downside of reform while taking advantage of opportunities.

First, hospitals will need to understand the legislation. Given that the phrase "the Secretary shall" appears 1,045 times, it is crucial to follow CMS's proposed and final rulemaking process closely, because how the legislation is implemented will have a significant effect on its impact. With this understanding, hospitals will need to model both revenue and cost impacts on their bottom lines. As more becomes known through the rulemaking process, hospitals should revisit their assumptions and revise them to fine tune results.

Finally, hospitals should identify both areas of exposure and opportunity. For each area, the appropriate senior executive should be assigned to develop and execute a strategy that will mitigate negative impacts and leverage opportunities.

Chad Mulvany is a technical manager in HFMA's Washington, D.C., office and a member of HFMA's Virginia Chapter.

Publication Date: Tuesday, June 01, 2010

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