[Federal Register: September 8, 1998 (Volume 63, Number 173)]
[Proposed Rules]
[Page 47551-47600]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr08se98-34]


[[Page 47551]]

_______________________________________________________________________

Part II

Department of Health and Human Services

_______________________________________________________________________

Health Care Financing Administration

Office of Inspector General

_______________________________________________________________________

42 CFR Part 409, et al.

Medicare Program; Prospective Payment System for Hospital Outpatient
Services; Proposed Rules

[[Page 47552]]

DEPARTMENT OF HEALTH AND HUMAN SERVICES

Health Care Financing Administration
Office of Inspector General

42 CFR Parts 409, 410, 411, 412, 413, 419, 489, 498, and 1003

[HCFA-1005-P]
RIN 0938-AI56


Medicare Program; Prospective Payment System for Hospital
Outpatient Services

AGENCY: Health Care Financing Administration (HCFA), HHS, and Office of
Inspector General (OIG), HHS.

ACTION: Proposed rule.

-----------------------------------------------------------------------

SUMMARY: As required by sections 4521, 4522, and 4523 of the Balanced
Budget Act of 1997, this proposed rule would eliminate the formula-
driven overpayment for certain outpatient hospital services, extend
reductions in payment for costs of hospital outpatient services, and
establish in regulations a prospective payment system for hospital
outpatient services (and for Medicare Part B services furnished to
inpatients who have no Part A coverage). The prospective payment system
would simplify our current payment system and apply to all hospitals,
including those that are excluded from the inpatient prospective
payment system. The Balanced Budget Act provides for implementation of
the prospective payment system effective January 1, 1999, but delays
application of the system to cancer hospitals until January 1, 2000.
The hospital outpatient prospective payment system would also apply to
partial hospitalization services furnished by community mental health
centers.
    Although the statutory effective date for the outpatient
prospective payment system is January 1, 1999, implementation of the
new system will have to be delayed because of year 2000 systems
concerns. The demands on intermediary bill processing systems and HCFA
internal systems to become compliant for the year 2000 preclude making
the major systems changes that are required to implement the
prospective payment system. The outpatient prospective payment system
will be implemented for all hospitals and community mental health
centers as soon as possible after January 1, 2000, and a notice of the
anticipated implementation date will be published in the Federal
Register at least 90 days in advance.
    This document also proposes new requirements for provider
departments and provider-based entities. These proposed changes, as
revised based on our consideration of public comments, will be
effective 30 days after publication of a final rule.
    This proposed rule would also implement section 9343(c) of the
Omnibus Budget Reconciliation Act of 1986, which prohibits Medicare
payment for nonphysician services furnished to a hospital outpatient by
a provider or supplier other than a hospital, unless the services are
furnished under an arrangement with the hospital. This section also
authorizes the Department of Health and Human Services' Office of
Inspector General to impose a civil money penalty, not to exceed
$10,000, against any individual or entity who knowingly and willfully
presents a bill for non-physician or other bundled services not
provided directly or under such an arrangement.
    This proposed rule also addresses the requirements for designating
certain entities as provider-based or as a department of a hospital.

DATES: Comments will be considered if we receive them at the
appropriate address, as provided below, no later than 5 p.m. on
November 9, 1998.

ADDRESSES: Mail written comments (1 original and 3 copies) to the
following address: Health Care Financing Administration, Department of
Health and Human Services, Attention: HCFA-1005-P, P.O. Box 26688,
Baltimore, MD 21207-0488.
    If you prefer, you may deliver your written comments (1 original
and 3 copies) to one of the following addresses:

Room 309-G, Hubert H. Humphrey Building, 200 Independence Avenue, SW.,
Washington, DC 20201, or
Room C5-09-26, 7500 Security Boulevard, Baltimore, MD 21244-1850.

    Because of staffing and resource limitations, we cannot accept
comments by facsimile (FAX) transmission. In commenting, please refer
to file code HCFA-1005-P. Comments received timely will be available
for public inspection as they are received, generally beginning
approximately 3 weeks after publication of a document, in Room 309-G of
the Department's offices at 200 Independence Avenue, SW., Washington,
DC, on Monday through Friday of each week from 8:30 a.m. to 5 p.m.
(phone: (202) 690-7890).
    Copies: To order copies of the Federal Register containing this
document, send your request to: New Orders, Superintendent of
Documents, P.O. Box 371954, Pittsburgh, PA 15250-7954. Specify the date
of the issue requested and enclose a check or money order payable to
the Superintendent of Documents, or enclose your Visa or Master Card
number and expiration date. Credit card orders can also be placed by
calling the order desk at (202) 512-1800 or by faxing to (202) 512-
2250. The cost for each copy is $8. As an alternative, you can view and
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libraries throughout the country that receive the Federal Register.
    This Federal Register document is also available from the Federal
Register online database through GPO Access, a service of the U.S.
Government Printing Office. Free public access is available on a Wide
Area Information Server (WAIS) through the Internet and via
asynchronous dial-in. Internet users can access the database by using
the World Wide Web; the Superintendent of Documents home page address
is
http://www.access.gpo.gov/nara/index.html, by using local WAIS client
software, or by telnet to swais.access.gpo.gov, then login as guest (no
password required). Dial-in users should use communications software
and modem to call 202-512-1661; type swais, then login as guest (no
password required).

FOR FURTHER INFORMATION CONTACT:
Janet Wellham, (410) 786-4510 (for general information). Joel Schaer
(OIG), (202) 619-0089 (for information concerning civil money
penalties).
Kitty Ahern, (410) 786-4515 (for information related to the
classification of services into ambulatory payment classification (APC)
groups).
Suzanne Letsch (410) 786-4558 (for information related to volume
control measures and updates).
George Morey (410) 786-4653 (for information related to the
determination of provider-based status).
Janet Samen (410) 786-9161 (for information on the application of APCs
to community mental health centers).

SUPPLEMENTARY INFORMATION: To assist readers in referencing sections
contained in this document, we are providing the following table of
contents.

Table of Contents

I. Background

[[Page 47553]]

II. Elimination of Formula-Driven Overpayment
III. Extension of Cost Reductions
IV. Prohibition Against Unbundling of Hospital Outpatient Services
    A. Background
    B. Previous Medicare Regulations Affecting Bundling
    C. Office of Inspector General (OIG) Civil Money Penalty
Authority
    D. Proposed Regulations Published August 5, 1988
    1. Bundling of Hospital Outpatient Services
    2. Civil Money Penalties for Unbundling Hospital Outpatient
Services
    E. Revised Proposed Regulations on Bundling of Hospital Services
V. Hospital Outpatient Prospective Payment System (PPS)
    A. Scope of Services Within the Outpatient PPS
    1. Services Excluded from the Hospital Outpatient PPS
    2. Services Included Within the Scope of the Hospital Outpatient
PPS
    a. Services for Patients Who Have Exhausted Their Part A
Benefits
    b. Partial Hospitalization Services
    c. Services Designated by the Secretary
    3. Hospital Outpatient PPS Payment Indicators
    B. Description of the Ambulatory Payment Classification (APC)
Groups
    1. Setting Payment Rates Based on Groups of Services Rather than
on Individual Services
    2. How the Groups Were Constructed
    3. Packaging Under the Groups
    4. Treatment of Clinic and Emergency Visits
    5. Treatment of Partial Hospitalization Services
    6. Comments on Specific APCs
    7. Discounting of Surgical Procedures
    a. Reduced Payment for Multiple Procedures
    b. Discounted Payment for Terminated Procedures
    8. Inpatient Care
    C. Calculation of Group Weights and Rates
    1. Group Weights
    2. Conversion Factor
    a. Calculating Aggregate Calendar Year 1996 Medicare and
Beneficiary Payments for Hospital Outpatient Services (Current Law)
    b. Sum of the Relative Weights
    D. Calculation of Medicare Payment Amount and Copayment Amount
    1. Introduction
    2. Determination of Unadjusted Copayment Amount, Program Payment
Percentage, and Copayment Percentage
    3. Calculation of Medicare Payment Amount and Beneficiary
Copayment Amount
    4. Hospital Election to Offer Reduced Copayment
    E. Adjustment for Area Wage Differences
    1. Proposed Wage Index
    2. Labor-Related Portion of Hospital Outpatient Department PPS
Payment Rates
    3. Adjustment of Hospital Outpatient Department PPS Payment and
Copayment Amounts for Geographic Wage Variations
    F. Claims Submission and Processing
    G. Updates
    1. Revisions to Weights and the Wage and Other Adjustments
    2. Revisions to APC Groups
    3. Annual Update to Conversion Factor
    H. Outlier Payments
    I. Adjustments for Specific Classes of Hospitals
    J. Volume Control Measures
    K. Prohibition Against Administrative or Judicial Review
VI. Hospital Outpatient Departments and Provider-Based Entities
    A. Background
    B. Effects on Medicare
    C. Relationship of the ``Provider-Based'' Proposals to
Prospective Payment for Outpatient Hospital Services and Effective
Date of ``Provider-Based'' Proposals
    D. Basis for Current Provider-Based Policy
    E. Provisions of this Proposed Rule
    F. Requirements for Payment
    1. Prerequisites for Payment for Outpatient Hospital Services
and Supplies Incident to Physician Services
    2. Prerequisites for Payment for Hospital or Critical Access
Hospital Diagnostic Services Furnished to Outpatients
    3. Payment for Ambulatory Surgical Services
VII. MedPAC Recommendations
VIII. Collection of Information Requirements
IX. Response to Comments
X. Regulatory Impact Analysis
    A. Introduction
    B. Estimated Impact on Medicare Program
    C. Objectives
    D. Limitations of Our Analysis
    E. Hospitals Included In and Excluded From the Prospective
Payment System
    F. Quantitative Impact Analysis of the Proposed Policy Changes
Under the Prospective Payment System for Operating Costs and Capital
Costs
    G. Estimated Impact of the New APC System
XI. Delay in Implementation
Regulations Text
Addenda
Addendum A--List of Proposed Hospital Outpatient Ambulatory Payment
Classes with Status Indicators, Relative Weights, Payment Rates, and
Coinsurance Amounts
Addendum B--Proposed Hospital Outpatient Department (HOPD) Payment
Status by HCPCS and Related Information
Addendum C--Proposed Hospital Outpatient Payment for Procedures by
APC
Addendum D--Summary of Medical APCs
Addendum E--Major Diagnostic Categories
Addendum F--ICD-9 Codes with Major Diagnostic Categories (MDCs) for
Payment of Medical Visits under the Hospital Outpatient PPS
Addendum G--CPT Codes Which Will Be Paid Only As Inpatient
Procedures
Addendum H--Status Indicators
Addendum I--Service Mix Indices by Hospital
Addendum J--Wage Index for Urban Areas
Addendum K--Wage Index for Rural Areas
Addendum L--Wage Index for Hospitals That Are Reclassified

    In addition, because there are many terms to which we refer by
acronym in this rule, we are listing these acronyms and their
corresponding terms in alphabetical order below:

APC  Ambulatory payment classification
APG  Ambulatory patient group
ASC  Ambulatory surgical center
BBA  Balanced Budget Act of 1997
CAH  Critical access hospital
CCI  [HCFA's] Correct Coding Initiative
CCR  Cost center specific cost-to-charge ratio
CHAMPUS  Civilian Health and Medical Program of the Uniformed
Services
CMHC  Community mental health center
CMP  Civil money penalty
CORF  Comprehensive outpatient rehabilitation facility
CPT  [Physicians'] Current Procedural Terminology, 4th Edition,
1998, copyrighted by the American Medical Association
DME  Durable medical equipment
DMEPOS  DME, orthotics, prosthetics, prosthetic devices, prosthetic
implants and supplies
DRG  Diagnosis-related group
EACH  Essential access community hospital
ESRD  End-stage renal disease
FDO  Formula-driven overpayment
FQHC  Federally qualified health center
HCPCS  HCFA Common Procedure Coding System
HHA  Home health agency
ICD-9-CM  International Classification of Diseases, Ninth Edition,
Clinical Modification
IME  Indirect medical education
IOL  Intraocular lens
MDC  Major diagnostic category
MDH  Medicare dependent hospital
MedPAC  Medicare Payment Advisory Commission
MSA  Metropolitan statistical area
NECMA  New England County Metropolitan Area
OBRA  Omnibus Budget Reconciliation Act
PPS  Prospective payment system
RHC  Rural health clinic
RPCH  Rural primary care hospital
RRC  Rural referral center
SCH  Sole community hospital
SGR  Sustainable growth rate
SNF  Skilled nursing facility
TEFRA  Tax Equity and Fiscal Responsibility Act of 1982

I. Background

    As the Medicare statute was originally enacted, Medicare payment
for hospital services (inpatient and outpatient) was based on hospital-
specific reasonable costs attributable to serving Medicare
beneficiaries. Later, the law was amended to limit payment to the
lesser of a hospital's reasonable costs or to its customary charges. In
1983, section 601 of the Social Security Amendments of 1983 (Public Law
98-21) completely revised the cost-based payment system for most
hospital inpatient services by enacting section 1886(d) of the Social

[[Page 47554]]

Security Act (the Act). This section provided for a prospective payment
system (PPS) for acute inpatient hospital stays, effective with
hospital cost reporting periods beginning on or after October 1, 1983.
    Although payment for most inpatient services became subject to a
PPS, hospital outpatient services continued to be paid based on
hospital-specific costs, which provided little incentive for hospital
efficiency for outpatient services. At the same time, advances in
medical technology and changes in practice patterns were bringing about
a shift in the site of medical care from the inpatient to the
outpatient setting. During the 1980s, the Congress took steps to
control the escalating costs of providing outpatient care. The Congress
amended the statute to implement across-the-board reductions of 5.8
percent and 10 percent to the amounts otherwise payable for hospital
operating costs and capital costs, respectively, and legislated a
number of different payment methods for specific types of hospital
outpatient services. These methods included fee schedules for clinical
diagnostic laboratory tests, orthotics, prosthetics, and durable
medical equipment (DME); composite rate payment for dialysis for
persons with end-stage renal disease (ESRD); and payments based on
blends of hospital costs and the rates paid in other ambulatory
settings such as separately certified ambulatory surgical centers
(ASCs) or physician offices for certain surgery, radiology, and other
diagnostic procedures. Nevertheless, Medicare payment for services
performed in the hospital outpatient setting remains largely cost-
based.
    In section 9343(f) of the Omnibus Budget Reconciliation Act of 1986
(OBRA 1986) (Public Law 99-509) and in section 4151(b)(2) of the
Omnibus Budget Reconciliation Act of 1990 (Public Law 101-508), the
Congress required the Secretary to develop a proposal to replace the
current hospital outpatient payment system with a PPS and to submit a
report to the Congress on the proposed system. In OBRA 1986, the
Congress paved the way for development of a PPS, under section 9343(g),
by requiring fiscal intermediaries to require hospitals to report
claims for services under the HCFA Common Procedure Coding System
(HCPCS), and, under section 9343(c), by extending the prohibition
against unbundling of hospital services under section 1862(a)(14) of
the Act to include outpatient services as well as inpatient services.
HCPCS coding enabled us to determine what specific procedures and
services were being billed, while the extension of the prohibition
against unbundling ensured that all nonpractitioner services provided
to hospital outpatients would be billed only by the hospital, not by an
outside supplier, and, therefore, would be reported on hospital bills
and captured in the hospital outpatient data that could be used to
develop an outpatient PPS.
    Section 1866(g) of the Act, as added by section 9343(c) of OBRA
1986, and amended by section 4085(i)(17) of the Omnibus Budget
Reconciliation Act of 1987 (OBRA 1987) (Public Law 100-203), also
authorizes the Department of Health and Human Services' Office of
Inspector General to impose a civil money penalty (CMP), not to exceed
$2,000, against any individual or entity who knowingly and willfully
presents a bill in violation of an arrangement (as defined in section
1861(w)(1) of the Act).
    A proposed rule to implement section 9343(c) was published in the
Federal Register on August 5, 1988. However, those regulations were
never published as a final rule, so we are including them in this
regulation and will implement them as part of the final regulation
implementing the hospital outpatient PPS.
    The Secretary submitted a Report to Congress on March 17, 1995. The
report summarized the research HCFA conducted in searching for a way to
classify outpatient services for purposes of developing an outpatient
PPS. The report cited Ambulatory Patient Groups (APGs), developed by
3M-Health Information Systems under a cooperative grant with HCFA, as
the most promising classification system for grouping outpatient
services and recommended that APG-like groups be used in designing a
hospital outpatient PPS.
    The report also presented a number of options that could be used,
once a PPS was in place, for addressing the issue of rapidly growing
beneficiary copayment. As a separate issue, we recommended that the
Congress amend the provisions of the law pertaining to the blended
payment methods for ASC surgery, radiology, and other diagnostic
services to correct an anomaly that resulted in a less than full
recognition of the amount paid by the beneficiary in calculating
program payment (referred to as the formula-driven overpayment).
    The Balanced Budget Act of 1997 (BBA) (Public Law 105-33), enacted
on August 5, 1997, contains a number of provisions that affect Medicare
payment for hospital outpatient services. The purpose of this proposed
rule is to implement sections 4521, 4522, and 4523 of the BBA and
section 9343(c) of OBRA 1986. Section 4521 of the BBA eliminates the
formula-driven overpayment effective for services furnished on or after
October 1, 1997. Because of the October 1, 1997 effective date, HCFA
has already taken action to implement this provision. Section 4522
extends the current cost reductions of 5.8 percent and 10 percent
(applicable to hospital outpatient operating costs and hospital capital
costs, respectively) through and including December 31, 1999.
    Section 4523 of the BBA amends section 1833 of the Act by adding
subsection (t), which provides for implementation of a PPS for most
hospitals for outpatient services furnished on or after January 1, 1999
and for cancer hospitals that are excluded from inpatient PPS for
services furnished on or after January 1, 2000. We note that while the
statutory effective date for the outpatient PPS is January 1, 1999,
implementation of the new payment system will have to be delayed
because of year 2000 systems concerns. The demands on intermediary bill
processing systems and HCFA internal systems to become compliant for
the year 2000 preclude making the major systems changes that are
required to implement the PPS. See Section XI of this preamble (``Delay
in Implementation'') for a more detailed explanation of the reasons for
delay. The outpatient PPS will be implemented as soon as possible after
January 1, 2000. A notice of the anticipated implementation date will
be published in the Federal Register at least 90 days in advance. The
rates that will go into effect on the implementation date will apply to
all hospitals including cancer hospitals described in section
1886(d)(1)(B)(v) of the Act. The rates will be based on the rates that
would have been in effect January 1, 1999 updated by the rate of
increase in the hospital market basket minus one percentage point.
    Section 1833(t)(1)(B) of the Act authorizes the Secretary to
designate the hospital outpatient services that would be paid under the
PPS. Section 1833(t)(1)(B) also requires that the outpatient PPS
include inpatient services covered under Part B for beneficiaries who
are entitled to Part A benefits but who have exhausted their Part A
benefits or otherwise are not in a covered Part A stay. However,
section 1833(t)(1)(B) specifically excludes as covered services under
the outpatient PPS ambulance services and physical and occupational
therapy, and speech-language pathology services, for which separate fee
schedules are required by

[[Page 47555]]

statute. (See section 4531 of the BBA for amendments pertaining to
ambulance services and section 4541 for amendments pertaining to
outpatient rehabilitation services.)
    Section 1833(t)(2) of the Act stipulates certain requirements for
the hospital outpatient PPS. The Secretary is required to develop a
classification system for covered outpatient services which may consist
of groups arranged so that the services within each group are
comparable clinically and with respect to the use of resources. In
addition, this section specifies data requirements for establishing
relative payment weights, which are to be based on median hospital
costs determined by data from the most recent available cost reports;
requires that the portion of the Medicare payment and the beneficiary
copayment that are attributable to labor and labor-related costs be
adjusted for geographic wage differences; and authorizes the
establishment of other adjustments, such as outlier adjustments or
adjustments for certain classes of hospitals, that are necessary to
ensure equitable payments. All adjustments are required to be made in a
budget neutral manner. This section concludes with the requirement that
a control on unnecessary increases in the volume of covered services be
established.
    Section 1833(t)(3) provides for a new method of calculating
beneficiary copayment. It freezes beneficiary copayment at 20 percent
of the national median charges for covered services (or group of
covered services) furnished during 1996 and updated to 1999 using the
Secretary's estimated charge growth from 1996 to 1999. This section
specifies how beneficiary deductibles are to be treated in calculating
the Medicare payment and beneficiary copayment amounts and requires
that rules be established regarding determination of copayment amounts
for covered services that were not furnished in 1996. Further, it
prescribes the formula for calculating the initial conversion factor
used to determine Medicare payment amounts for 1999 and the method for
updating the conversion factor in subsequent years.
    Sections 1833(t)(4) and (t)(5) describe the basis for determining
the Medicare payment amount and the beneficiary copayment amount for
services covered under the outpatient PPS. The latter section requires
the Secretary to establish a procedure whereby hospitals may
voluntarily elect to reduce beneficiary copayment for some or all
covered services to an amount not less than 20 percent of the Medicare
payment amount. Hospitals are further allowed to advertise any such
reductions of copayment amounts. Section 4451 of the BBA added section
1861(v)(1)(T) to the Act, which stipulates that bad debts will not be
recognized on any copayment the hospital elects to reduce.
    Section 1833(t)(6) authorizes periodic review and revision of the
payment groups, relative payment weights, wage index, and conversion
factor.
    Section 1833(t)(7) describes how payment is to be made for
ambulance services, which are specifically excluded from the outpatient
PPS under section 1833(t)(1)(B).
    Section 1833(t)(8) provides that the Secretary may establish a
separate conversion factor for determining services furnished by cancer
hospitals excluded from inpatient PPS under this PPS.
    Section 1833(t)(9) prohibits administrative or judicial review of
the PPS classification system, the groups, relative payment weights,
adjustment factors, other adjustments, calculation of base amounts,
periodic adjustments, and the establishment of a separate conversion
factor for those cancer hospitals excluded from inpatient PPS.
    Section 4523(d) of the BBA amends section 1833(a)(2)(B) of the Act
to require payment under the PPS for some services described in section
1832(a)(2) that are currently paid on a cost basis and furnished by
providers of services such as comprehensive outpatient rehabilitation
facilities (CORFs), home health agencies (HHAs), hospices, and
community mental health centers (CMHCs). This amendment requires that
partial hospitalization services furnished by CMHCs beginning January
1, 1999 be paid under the PPS. As noted earlier, implementation of the
PPS will be delayed. Implementation will occur as soon as possible
after January 1, 2000.

II. Elimination of Formula-Driven Overpayment

    Before enactment of section 4521 of the BBA, under the blended
payment formulas for ASC procedures, radiology, and other diagnostic
services, the ASC or physician fee schedule portion of the blends was
calculated as if the beneficiary paid 20 percent of the ASC rate or
physician fee schedule amount instead of the actual amount paid, which
was 20 percent of the hospital's billed charges. Section 4521 corrects
this anomaly by changing the blended calculations so that all amounts
paid by the beneficiary are subtracted from the total payment in
determining the amount due from the program. Effective for services
furnished on or after October 1, 1997, payment for surgery, radiology,
and other diagnostic services under blended payment methods will be
calculated by subtracting the full amount of copayment due from the
beneficiary (based on 20 percent of the hospital's billed charges).

 III. Extension of Cost Reductions

    Section 1861(v)(1)(S)(ii) of the Act requires that the amounts
otherwise payable for hospital outpatient operating costs and capital
costs be reduced by 5.8 percent and 10 percent, respectively. These
reductions were scheduled to sunset at the end of fiscal year 1998, but
section 4522 of the BBA extended the reductions through December 31,
1999.

IV. Prohibition Against Unbundling of Hospital Outpatient Services

A. Background

    The Social Security Amendments of 1965 (Public Law 89-97), enacted
on July 30, 1965, established title XVIII of the Act, which authorized
the establishment of the Medicare program to pay part of the costs of
health care services furnished to eligible beneficiaries. Part A of the
program (Hospital Insurance) provides basic health insurance protection
against the costs of inpatient or home health care. Part B of the
program (Supplementary Medical Insurance) provides voluntary
supplementary insurance covering most physician services and certain
other items and services not covered under Part A, including hospital
outpatient services.
    Before the enactment of Public Law 98-21 on April 7, 1983, which
established the Medicare PPS for inpatient hospital services,
nonphysician services furnished to Medicare beneficiaries who were
hospital patients were generally billed by the hospitals. Under certain
circumstances, however, Part B of the Medicare statute permitted
payments to be made to an outside supplier or another provider for
certain nonphysician services otherwise covered by Medicare Part B that
were furnished to a hospital patient. When payments were made under
these circumstances, some nonphysician services were billed as hospital
services in one hospital and billed by an outside supplier in another.
The practice of billing by suppliers outside the hospital for these
services has been referred to in the legislative history as the
``unbundling'' of hospital services.
    Since the enactment of Public Law 98-21 and the publication of
implementing regulations on September 1, 1983 (48 FR 39752), the
Medicare program has required that nonphysician

[[Page 47556]]

services furnished to hospital inpatients be covered and paid for under
Medicare as hospital services. This practice of covering nonphysician
services furnished to hospital inpatients by an outside supplier as
hospital services is referred to as ``bundling.'' Under the PPS for
inpatient hospital services, a single predetermined payment is made for
a case based on the diagnosis-related group (DRG) to which the case is
assigned. Bundling ensures that the DRG payments to all hospitals cover
a comparable ``bundle'' of services related to the hospital stay.
    Specifically, Public Law 98-21 added section 1862(a)(14) to the Act
to prohibit payment for services (other than physician services)
furnished to an inpatient of a hospital by an entity other than the
hospital, unless the services are furnished under an arrangement (as
defined in section 1861(w)(1) of the Act). (Section 1861(w)(1) of the
Act specifies that the term ``arrangements'' is limited to arrangements
under which receipt of payment by the hospital or other provider for
Medicare-covered services to an individual discharges the liability of
the individual or any other person to pay for the services.) Public Law
98-21 also added section 1866(a)(1)(H) to the Act to provide that a
hospital is eligible to participate in the Medicare program only if the
hospital agrees to furnish to inpatients either directly or under an
arrangement all Medicare-covered items and services, other than
physician services.
    Regardless of whether the hospital furnishes the services directly
or arranges for furnishing the services, the hospital assumes financial
responsibility for the services. The Medicare program makes payment
only to hospitals and not to other providers or suppliers that furnish
inpatient services on behalf of the hospitals.
    In Public Law 98-21, the Congress addressed only nonphysician
services furnished to Medicare beneficiaries who are hospital
inpatients. The Congress did not address at that time nonphysician
services furnished to Medicare beneficiaries who are hospital
outpatients, for which payment is made, usually on a cost basis, under
Part B of Medicare. Thus, services to hospital outpatients continued to
be unbundled in some hospitals. Subsequently, in section 9343(c) of
OBRA 1986, the Congress extended the bundling provision to all
nonphysician services furnished to hospital ``patients,'' thus also
including nonphysician services furnished to Medicare beneficiaries who
are hospital outpatients.
    Sections 9343(c)(1) and (c)(2) of OBRA 1986 amended sections
1862(a)(14) and 1866(a)(1)(H) of the Act, respectively. As revised,
section 1862(a)(14) of the Act prohibits payment for nonphysician
services furnished to hospital patients (inpatients and outpatients),
unless the services are furnished by the hospital, either directly or
under an arrangement (as defined in section 1861(w)(1) of the Act). As
revised, section 1866(a)(1)(H) of the Act requires each Medicare-
participating hospital to agree to furnish directly all covered
nonphysician services required by its patients (inpatients and
outpatients) or to have the services furnished under an arrangement (as
defined in section 1861(w)(1) of the Act). Section 9338(a)(3) of OBRA
1986 affected implementation of the bundling mandate by amending
section 1861(s)(2)(K) of the Act to permit services of physician
assistants to be covered and billed separately.
    Bundling of outpatient hospital services was required in order to
provide a basis for implementing another provision of OBRA 1986, which
required the development of a prospective payment methodology for
outpatient hospital services. Section 9343(f) of OBRA 1986 amended
section 1135 of the Act to require the Secretary to submit to the
Congress by April 1, 1988, an interim report concerning development of
a fully prospective payment system for ambulatory surgery. The
legislation also specified that a final report was due to the Congress
no later than April 1, 1989, with recommendations concerning
implementation of a fully prospective payment mechanism for ambulatory
surgery services by October 1, 1989. We released an interim report in
June of 1988 and the final report in September of 1990. The final
report summarized our research findings relating to hospital outpatient
prospective payment and did not contain specific recommendations
regarding a PPS for ambulatory surgical services. Later, in section
4151(b)(2) of OBRA 1990, the Congress expanded its earlier request and
required HCFA to develop a PPS that included all hospital outpatient
services. That legislation also directed us to submit a report to the
Congress concerning this proposal. We submitted a report to the
Congress on March 17, 1995.
    In order for us to be able to develop a PPS for hospital outpatient
services, it was necessary to have available clear and consistent rules
about the range of services that would be included in this payment
system. Previous policies on coverage of hospital outpatient services
permitted services to be unbundled and thus allowed providers to vary
their practices concerning the furnishing of services. The Congress
recognized the inconsistencies of the current payment system and
required bundling as a first step toward payment reform.

B. Previous Medicare Regulations Affecting Bundling

    Previous regulations set forth at 42 CFR 405.310(m) concerning
noncoverage of certain services furnished to hospital inpatients
(redesignated as Sec. 411.15(m)) implemented the statutory requirement
for bundling of inpatient hospital services. They excluded from
coverage nonphysician services furnished to hospital inpatients by an
entity other than the hospital, unless the services were furnished
under an arrangement. The exclusion from coverage in effect at that
time did not apply to physician services that met the conditions for
payment for physician services to provider patients in Sec. 405.550(b)
(redesignated as Sec. 415.102(a)), or services of anesthetists employed
by physicians that met the conditions for payment in Sec. 405.553(b)(4)
concerning reasonable charges for anesthesiology services furnished by
the anesthesiologist or by an anesthetist employed by the
anesthesiologist. (The regulation is now deleted as the payment
structure for anesthesiologists has changed.) The exception for
physician services is required by section 1862(a)(14) of the Act.
Services of physician-employed anesthetists were exempted from bundling
as an administrative measure to prevent disruption of long-standing
physician-anesthetist team relationships. However, in a final rule
published on May 26, 1993 (58 FR 30630), the regulations set forth at
Sec. 411.15(m) and Sec. 489.20(d) were revised to reflect the statutory
exclusion of certified registered nurse anesthetist (CRNA) services
(including services of anesthesiologist assistants), physician
assistant services, certified nurse midwife services, and qualified
psychologist services from the inpatient bundling requirement. Section
411.15(m) concerns services to hospital inpatients excluded from
coverage, and Sec. 489.20(d) concerns a provider agreement in the case
of a hospital or critical access hospital (CAH) to furnish directly or
make arrangements for Medicare-covered services to inpatients of a
hospital or a CAH.

C. Office of Inspector General (OIG) Civil Money Penalty Authority

    In order to prevent the unbundling of nonphysician hospital
services, section 9343(c)(3) of OBRA 1986 amended section 1866 of the
Act by adding a new paragraph (g). Specifically, this

[[Page 47557]]

authority provided for the imposition of a civil money penalty (CMP),
not to exceed $2,000, against any person who knowingly and willfully
presents, or causes to be presented, a bill or request for payment for
a hospital outpatient service under Part B of Medicare that violates
the requirement for billing under arrangements specified in section
1866(a)(1)(H) of the Act. Section 1866(g) was further amended by
section 4085(i)(17) of OBRA 1987. Section 4085(i)(17) of OBRA 1987
deleted all references to hospital outpatient services under Part B of
Medicare and authorized imposition of a CMP when arrangements should
have been made but were not. Section 1866(g) of the Act authorizes
imposition of a CMP against any person who knowingly and willfully
presents, or causes to be presented, a bill or request for payment
inconsistent with an arrangement under section 1866(a)(1)(H) or in
violation of the requirement for an arrangement. The result of this
amendment is that the CMP is now applicable for all services furnished
to hospital patients, whether paid for under Medicare Part A or B. The
statute also requires that a CMP be imposed in the same manner as other
CMPs are imposed under section 1128A of the Act. Section 231(c) of the
Health Insurance Portability and Accountability Act of 1996 (Public Law
104-191) revised section 1128A of the Act to increase the CMP maximum
amount for each false claim or prohibited practice from $2,000 to
$10,000. Implementing regulations for this authority are set forth in
42 CFR parts 1003 and 1005.
    To implement the provisions of section 9343(c) of OBRA 1986, we
published a proposed rule in the Federal Register on August 5, 1988 (53
FR 29486). Those regulations have not been published in final, but we
are proposing revised implementing regulations as part of this
regulation.

D. Proposed Regulations Published August 5, 1988

1. Bundling of Hospital Outpatient Services
    We proposed to implement the requirement for bundling of outpatient
hospital services by amending then existing Medicare regulations
(Sec. 405.310 concerning particular services excluded from coverage,
and part 410 concerning supplementary medical insurance benefits) to
exclude coverage of any services that are furnished in a hospital to an
outpatient of the hospital by an entity other than the hospital during
or as a result of an encounter in the hospital, unless the services are
furnished under an arrangement. In addition, we proposed to require
bundling of those diagnostic procedures or tests (for example, magnetic
resonance imaging procedures) that are furnished outside the hospital
by an entity other than the hospital but are ordered during an
encounter in the hospital with the patient or as a result of such an
encounter.
    In the proposed rule, in Sec. 405.310(n)(1) concerning definitions
of services to hospital outpatients excluded from coverage (now
redesignated as Sec. 411.15(m)), we defined a hospital outpatient as an
individual who is not an inpatient of the hospital but who is
registered as an outpatient.
    We proposed to define, in Sec. 410.2 (``Definitions''), the term
``encounter'' as a direct personal contact between a patient and a
physician, or other person who is authorized by State licensure law
and, where applicable, by hospital staff bylaws, to order or furnish
services for the patient for the purpose of diagnosis or treatment of
the patient. The use of the ``encounter'' as a basis for identifying
the services to be bundled is not specifically required by OBRA 1986
but is needed in order to implement the bundling requirement in a
uniform and equitable manner, as explained further in section III. of
the preamble of the August 5, 1988 proposed rule (53 FR 29489).
    As in the case of services to hospital inpatients, physician
services that meet the conditions for payment for services of
physicians to provider patients in Sec. 415.102(a) would not be bundled
under our proposal. (The exception for physician services is required
by section 1862(a)(14) of the Act.) We also proposed, as an
administrative measure, to exempt from outpatient bundling the services
of physician-employed anesthetists that meet the conditions for payment
for services furnished by an anesthesiologist or by an anesthetist
employed by the anesthesiologist in Sec. 405.553(b)(4). These services
were exempted from bundling to prevent disruption of long-standing
physician-anesthetist team relationships. We also proposed to exempt
physician assistant services as defined in section 1861(s)(2)(K)(i) of
the Act from inpatient and outpatient bundling. We proposed this change
to help accomplish the objective of section 1861(s)(2)(K)(i) of the
Act, as amended by section 9338(a)(3) of OBRA 1986, which permits
physician assistant services to be covered and to be billed separately.
As noted earlier, we have made the changes in the types of services
excluded from bundling of inpatient services in the May 1993 final rule
(58 FR 30630).
    We also proposed to revise the regulations set forth at
Sec. 489.20, which describe the basic commitments included in the
provider agreement. They would require a hospital that furnishes
services to a beneficiary who is not currently an inpatient of a
hospital but who is registered by the hospital as an outpatient to
agree either to furnish directly or to make arrangements (in accordance
with section 1861(w)(1) of the Act) for all items and services for
which bundling is required under the proposed revision described above,
and for which the beneficiary is entitled to have payment made under
Medicare.
    We proposed in the August 5, 1988 proposed rule that if a Medicare
outpatient is referred to another provider or supplier for further
diagnostic testing or other diagnostic services as a result of an
encounter that occurs in the hospital, the hospital would be
responsible for arranging with the other entity for the furnishing of
services. (We have now changed our view on bundling of these services
as discussed in the following section IV.E.) Also, the hospital would
be responsible for furnishing or arranging for the furnishing of
prostheses and prosthetic devices (other than dental) that replace all
or part of an internal body organ (for example, intraocular lenses
(IOLs)) and are implanted or fitted during an encounter. For example,
in the absence of a bundling provision, the physician who implants an
IOL during surgery performed on an outpatient of a hospital also could
be the supplier of the IOL and could bill Medicare under Part B for it.
As proposed in our August 1988 rule, this practice would be prohibited,
and the hospital would have to furnish the IOL, either directly or
under an arrangement (that is, would have to pay for the lens). The
same policies would apply to other items and services, such as
artificial limbs, knees, and hips; orthotics; equipment and supplies
covered under the prosthetic device benefit; and services incident to
physician services. Thus, hospitals would be required to assume
financial liability for prostheses and prosthetic devices (which are
regarded as ``services'' for Medicare coverage purposes) and for other
services furnished by an outside entity to their outpatients, and the
practice of unbundling these services would be prohibited.
    Sometimes a hospital may furnish an item or service for which a
patient will have a continuing need. For example, a hospital may
furnish a DME item such as a wheelchair. When this situation occurs,
the proposed rule required that

[[Page 47558]]

the hospital would be responsible for bundling the items and services
it furnishes on-site. In adopting the view that these types of items
are subject to bundling, we did not discount the patient's continuing
need for them after leaving the hospital. However, the bundling
provisions in sections 1862(a)(14) and 1866(a)(1)(H) of the Act
prohibit unbundling of services to an individual who is a patient of a
hospital and do not provide any specific exception to these provisions
for DME. Therefore, we did not believe it would be appropriate to
exclude DME from bundling when it was furnished to a hospital patient.
(We have now changed our previous position on bundling of DME as
discussed in section IV.E.)
2. Civil Money Penalties for Unbundling Hospital Outpatient Services
    In order to implement section 1866(g) of the Act, in our August 5,
1988 proposed rule, we proposed that the OIG would impose a CMP against
any person who knowingly and willfully presents, or causes to be
presented, a bill or request for payment for a hospital outpatient
service under Part B of Medicare that violates the billing arrangement
under section 1866(a)(1)(H) of the Act or the requirement for an
arrangement. The amount of the CMP was to be limited to $2,000 for each
improper bill or request, even if the bill or request included more
than one item or service. However, in accordance with the Health
Insurance Portability and Accountability Act of 1996, which increased
the minimum penalty amount to $10,000, the increased amount will now be
reflected in the regulations.

E. Revised Proposed Regulations on Bundling of Hospital Services

    This proposed rule incorporates most of the provisions of the
August 5, 1988 proposed rule. The following describes how the
regulations published in this proposed rule to implement the rebundling
of outpatient hospital services differ from the regulations we proposed
and published on August 5, 1988:
    <bullet> We are not including any of the changes in the regulations
relating to payment for physician laboratory services (Secs. 405.555(a)
through (c), and 405.556(c) of the August 5, 1988 proposed rule),
because these regulations were deleted as a result of publication of
regulations to implement the Medicare physician fee schedule published
on November 25, 1991 (56 FR 59502).
    <bullet> We are revising Sec. 409.10(b), which describes services
that are not included in the definition of ``hospital inpatient or
inpatient CAH services'' to include all of the services that are now
exceptions from the bundling rule under section 1862(a)(14) of the Act.
Section 4511 of the BBA revised sections 1862(a)(14) and 1866(a)(1)(H)
of the Act to exclude services of nurse practitioners and clinical
nurse specialists described in section 1861(s)(2)(K) of the Act from
the bundling requirement.
    <bullet> As previously indicated, proposed Sec. 410.2 had been
revised in the earlier proposed rule to include a definition of an
``encounter.'' The definition of an encounter is expanded to include
encounters in a CAH. That section is further amended to include a
definition of an ``outpatient'' as a person who has not been admitted
as an inpatient but who is registered on the hospital or CAH records as
an outpatient and receives services (rather than supplies alone)
directly from the hospital or CAH. The revision to include CAHs in
these definitions is made to comply with sections 1862(a)(14) and
1866(a)(1)(H) of the Act, which require that CAHs be treated as
hospitals for purposes of the bundling provisions. (The BBA eliminated
rural primary care hospitals (RPCHs) and created CAHs. The Congress
intended, under section 4201(c) of the BBA, that CAHs be subject to the
same Medicare requirements to which RPCHs were subject.)
    <bullet> The revision to Sec. 410.27 is the same as in the earlier
proposed rule except that the revision is now designated as paragraph
(e) instead of paragraph (c).
    <bullet> We are removing paragraph (a)(4) of Sec. 410.28
(``Hospital or CAH diagnostic services furnished to outpatients:
Conditions'') to reflect a change made by section 4085(i)(11) of OBRA
1987 regarding provisions of diagnostic services furnished to
outpatients.
    <bullet> Proposed Sec. 410.30 (redesignated as Sec. 416.39 in this
proposed rule) is being significantly revised. In Sec. 410.30(a) and
(b) (now Sec. 410.39 (a) and (b) of regulations published on August 5,
1988, we proposed to require the hospital to furnish directly or under
arrangements all services furnished to its outpatients during an
encounter as well as any diagnostic services furnished outside the
hospital that were ordered during or as a result of an encounter in the
hospital. In this rule, we are not extending the bundling requirements
to include diagnostic services ordered during an encounter in the
hospital that are furnished outside the hospital. Thus, the hospital
will not be required to furnish such diagnostic services directly or
under arrangements. We are proposing a more limited approach to
bundling because the PPS we are proposing involves less ``packaging''
than we anticipated when we published the August 1988 proposed
regulations. At that time, we believed that a PPS payment for a
surgical procedure was likely to include preoperative tests and that
payment for a clinic visit was likely to include the ancillary services
(for example, laboratory tests and x-rays) that were needed to make a
diagnosis. Therefore, by requiring bundling of off-site diagnostic
tests that were ordered during an outpatient encounter at the hospital,
we believed we could ensure that: (1) We had sufficient data to set
payment rates that included the ancillary tests, and (2) once the
system was implemented, the bundling rules would prevent any
duplication of program payments. That is, a service packaged into a PPS
payment to the hospital could not also be billed to the program as an
ancillary test by an outside entity.
    As noted above, the PPS we are proposing now does not include
extensive packaging; therefore, the payment for related diagnostic
tests is not included in the payments under the ambulatory payment
classification (APC) groups for surgical procedures, clinic visits,
emergency room visits, etc. Any diagnostic tests that are furnished
will result in a separate payment. The program will pay the entity that
actually furnishes the service--the hospital, if the service is
provided directly or under arrangements made by the hospital; or
another Medicare recognized entity, if the patient leaves the hospital
and obtains the service elsewhere. Because diagnostic tests are not
being packaged into another hospital service, we no longer need to
require that a hospital furnish directly or under arrangements the
services ordered during, or as a result of, an encounter, but furnished
outside the hospital. If the PPS is changed in future years to require
a more packaged approach to payment, the bundling regulations will be
revised. Proposed Sec. 410.30 (now Sec. 410.39) is also revised to
require that the bundling rules apply to CAHs, and the list of services
that are excepted from the bundling requirements, in Sec. 410.30(b)
(now Sec. 410.39(b)) (previously designated in the August 5, 1988,
proposed rule as Sec. 410.30(c)), is expanded to include all of the
services that are currently excepted under section 1862(a)(14) of the
Act.
    <bullet> We are revising Sec. 411.15(m) (previously designated as
Sec. 405.310(m)) significantly. We are eliminating proposed
Sec. 405.310(n). That section, which had described the hospital

[[Page 47559]]

outpatient services that were excluded from coverage if not furnished
directly or under arrangements, has been revised so that we will not
require that hospitals bundle diagnostic services ordered during or as
a result of an encounter in the hospital if furnished outside the
hospital. The requirements of that section have been incorporated into
Sec. 411.15(m)(1). We are revising Sec. 411.15(m)(2), which describes
the services that are exceptions to the bundling rule, to include all
of the services that are now exceptions under section 1862(a)(14) of
the Act. We are further revising Sec. 411.15(m)(3), ``Scope of
exclusion,'' to delete the reference to DME as a service that must be
bundled. DME is defined under section 1861(n) of the Act as equipment
used in the patient's home or in another institution used as his home
other than a hospital or skilled nursing facility (SNF). By definition,
DME is not something that is provided for use in the hospital setting.
Therefore, we do not believe that the DME benefit provides for any item
or service that is expected to be used by the patient while in the
hospital as an inpatient or outpatient. Section 1862(a)(14) of the Act
requires the hospital to provide directly or under arrangements
services furnished to the patients of a hospital or CAH. We did not
provide an exception for DME in our earlier proposed rule, because the
bundling requirements under sections 1862(a)(14) and 1866(a)(1)(H) of
the Act did not provide an exception for DME. However, we now believe
that a statutory exception is not required because the bundling
requirements apply to the services a hospital furnishes to its
patients, and DME is not a hospital service. The covered Part B benefit
for DME as described under section 1861(n) of the Act is intended for
equipment used in the home, so a hospital that furnishes DME to its
patients is not providing a hospital service to its patients, but is
acting in the capacity of a supplier of DME, not a provider of hospital
services. For these reasons, we will not require bundling of DME for
hospital patients.
    <bullet> Section 412.50 was not amended in the earlier proposed
rule, but we are revising it in this rule to specify that hospital
inpatient services do not include the services that are exceptions to
the bundling requirements under section 1862(a)(14) of the Act.
    <bullet> We are revising proposed Sec. 489.20(d) to incorporate as
exceptions to the bundling requirements all of the services that are
now exceptions under section 1866(a)(1)(H) of the Act.
    <bullet> In addition to minor wording changes in introductory
paragraph (b), proposed Sec. 1003.102 remains the same as in the August
5, 1988 proposed rule, with the exception that the revision is now
designated as paragraph (b)(14) rather than as paragraph (b)(4), as
originally indicated in the August 5, 1988 proposed rule. Paragraphs
(b)(11) through (b)(13) of Sec. 1003.102 are being reserved. We are
also amending Sec. 1003.103(a) to indicate, in accordance with section
231(c) of the Health Insurance Portability and Accountability Act, that
the maximum CMP for each improper bill or request has been increased to
$10,000.
    <bullet> We are also amending Sec. 1003.105 (Exclusion from
participation in Medicare and State health care programs) by revising
paragraph (a)(1)(i) to reflect that this basis for imposition of a CMP
is also a basis for an exclusion from participation in Medicare and the
State health care programs.

V. Hospital Outpatient Prospective Payment System (PPS)

    In this proposed rule, we delineate the services that are covered
under the hospital outpatient prospective payment system (PPS) that we
are required to establish under section 1833(t) of the Act. We also
propose Medicare payment rates when those services are ordered or
furnished for diagnosis or treatment of a Medicare beneficiary who is
registered on hospital records as an outpatient, and who receives
services directly from the hospital.
    In this section, we explain the framework for the hospital
outpatient PPS. This framework rests on Medicare's definition of an
outpatient, which we discuss in section IV.E, above, and on Medicare's
definition of what constitutes a hospital outpatient department or
clinic. In section VI., below, we address requirements to define and
distinguish among the various sites where services that are covered
under the hospital outpatient PPS could be furnished. For example, a
service furnished at an outpatient department or clinic located within
a hospital can also be furnished at a ``provider-based'' entity, at a
site away from a hospital that functions as though it were a department
within the hospital, at an ASC, and at a physician office. Under the
statute as it is currently written, in order to determine whether
Medicare makes payment for a service under the hospital outpatient PPS
that is the subject of this proposed rule or under another provision of
Medicare Part B, such as the ASC benefit or the physician fee schedule,
it is essential to clarify exactly where and under what conditions the
service was furnished.
    This PPS will apply to covered hospital outpatient services
furnished by any hospital participating in the Medicare program, except
for those hospitals discussed below. Partial hospitalization services
in community mental health centers (CMHCs) will also be paid under this
PPS.
    The cancer hospitals that are excluded from inpatient PPS will be
paid under hospital outpatient PPS. Although the BBA provides for a
separate conversion factor if necessary, we intend to pay cancer
hospitals using the same conversion factor and rates as all other
hospitals. Certain hospitals in Maryland furnish services that are
exempt from this system because they qualify under section 1814(b)(3)
of the Act for payment under the State's payment system. Such excluded
services are limited to the services paid under the State's payment
system as described in section 1814(b)(3) of the Act. Any other
outpatient services furnished by the hospital will be paid under the
outpatient PPS. Critical access hospitals are excluded from the
outpatient PPS because they are paid under a reasonable cost based
system, as required under section 1834(g) of the Act. All other
participating hospitals will be paid under hospital outpatient PPS.
    Distinct parts of hospitals that are excluded under inpatient PPS
will be included in the outpatient PPS, to the extent that outpatient
services are furnished by the hospital. For example, a hospital with an
excluded inpatient psychiatric unit will have payment made under this
PPS for outpatient psychiatric services including to inpatients who are
not in a covered Part A stay.

A. Scope of Services Within the Outpatient PPS

    Section 1833(t)(1)(B)(i) of the Act gives the Secretary the
authority to designate which services are to be covered under the
hospital outpatient PPS. In this section, we indicate the types of
services for which we are proposing to make payment under the hospital
outpatient PPS and the types of services we are proposing to exclude
from the scope of the hospital outpatient PPS.
    Section 1833(t)(2)(A) of the Act requires the Secretary to develop
a classification system for the services that she designates are
covered under the hospital outpatient PPS. Section 1833(t)(2)(B) of the
Act allows the Secretary to classify covered outpatient services by
groups so that the services within each are comparable clinically and
with respect to the use of resources.

[[Page 47560]]

We refer to the hospital outpatient PPS classification system that we
have developed as the Ambulatory Payment Classification (APC) system.
The APC system consists of 346 groups of services that are covered
under the hospital outpatient PPS.
    In section V.B., below, we explain how we assigned services and
procedures to APC groups and in sections V.C. and V.D., below, we
explain how we used the APC groups to determine hospital outpatient PPS
payment rates.
1. Services Excluded From the Hospital Outpatient PPS
    Section 1833(t)(1)(B)(iii) of the Act excludes the following from
payment under the hospital outpatient PPS: ambulance services, physical
and occupational therapy, and speech-language pathology services. These
services will be paid under fee schedules in all settings.
    Section 1833(t)(1)(B)(i) of the Act gives the Secretary the
authority to designate which hospital outpatient services are covered
under the outpatient PPS. In considering which services to include
under the outpatient PPS, we wanted to ensure that all hospital
outpatient services are paid under a prospectively determined amount.
Some hospital outpatient services (for example, clinical diagnostic
laboratory services, orthotics and prosthetics, ESRD dialysis services)
are currently paid based on fee schedules or other prospective rates.
Payments under these fee schedules apply not only to hospital
outpatient services, but the same or very similar payment rates apply
across a number of sites of ambulatory care. Such similar payments
across various settings creates a level playing field where HCFA pays
virtually the same payment for the same service, without regard to
where the service is furnished. So that we do not disrupt an existing
level playing field, we propose to exclude from our PPS, hospital
outpatient services that are currently paid prospectively determined
rates that are the same rates paid in other settings.
    We are proposing to exclude from the hospital outpatient PPS the
following:
    a. Certain services already paid for under fee schedules or other
payment systems including, but not limited to, services for patients
with ESRD that are paid for under the ESRD composite rate; laboratory
services paid under the clinical diagnostic laboratory fee schedule;
and DME, orthotics, prosthetics, prosthetic devices, prosthetic
implants and supplies (DMEPOS) paid for under the DMEPOS fee schedule
when the hospital is acting as a supplier of these items. An item such
as crutches or a walker that is given to the patient to take home, but
that may also be used while the patient is at the hospital, would be
billed to the DME regional carrier rather than being paid for under the
hospital outpatient PPS.
    b. Hospital outpatient services furnished to inpatients of an SNF
regardless of whether the person is in a Part A covered stay and
furnished pursuant to the resident assessment or comprehensive care
plan and that are covered under the SNF PPS, furnished ``under
arrangements'' and billable only by the SNF.
    c. Services and procedures that require inpatient care.
    MedPAC Recommendation: In its March 1998 report to the Congress,
the Medicare Payment Advisory Commission (MedPAC) recommends that costs
associated with allied health professions training, such as nursing
schools and paramedical education, be excluded from the calculation of
the relative weights and the conversion factor used to set outpatient
PPS payment rates. MedPAC further recommends that Medicare make
separate payment for these costs, consistent with the manner in which
Medicare pays for allied health professions training costs under the
inpatient PPS.
    Response: We agree with MedPAC's recommendation. We did not include
costs associated with allied health professions training in the
calculation of outpatient PPS relative weights and conversion factors.
We propose to pay hospitals that have allied health professions
training programs on a cost-pass-through basis similar to the way we
treat these costs under the hospital inpatient PPS.
2. Services Included Within the Scope of the Hospital Outpatient PPS

a. Services for Patients Who Have Exhausted Their Part A Benefits

    Section 1833(t)(1)(B)(ii) of the Act provides for Medicare payment
under the hospital outpatient PPS for certain services furnished to
inpatients who have exhausted Part A benefits or otherwise are not in a
covered Part A stay. Examples of services covered under this provision
include diagnostic x-rays and certain other diagnostic services and
radiation therapy covered under section 1832 of the Act.

b. Partial Hospitalization Services

    Section 1833(a)(2)(B) of the Act provides that partial
hospitalization services furnished in CMHCs be paid for under the
hospital outpatient PPS. Partial hospitalization is a distinct and
organized intensive psychiatric outpatient day treatment program,
designed to provide patients with profound and disabling mental health
conditions an individualized, coordinated, comprehensive, and
multidisciplinary treatment program.

c. Services Designated by the Secretary

    Under the authority established by the statute at section
1833(t)(1)(B)(i), we further are proposing to include within the scope
of services for which payment is made under the hospital outpatient PPS
the following:
    <bullet> Services that are included within the outpatient PPS
system are all hospital outpatient services that have not been
identified for exclusion as described in section V.A.1., above. Among
the types of services that we have classified into APC groups for
payment under the hospital outpatient PPS are the following: surgical
procedures; radiology, including radiation therapy; clinic visits;
emergency department visits; diagnostic services and other diagnostic
tests; partial hospitalization for the mentally ill; surgical
pathology; cancer chemotherapy.
    <bullet> Services furnished to SNF inpatients that are not packaged
into SNF consolidated billing precisely because they are services that
are commonly furnished by hospital outpatient departments and that SNFs
would not be able to provide, such as CT scans, magnetic resonance
imaging, or ambulatory surgery requiring the use of an operating room.
    <bullet> Supplies such as surgical dressings that can be used
during surgery or other treatments in the hospital outpatient setting
that are also on the DMEPOS fee schedule. Payment for such supplies,
when they are used in the hospital, is packaged into the APC payment
rate for the procedure or service with which the items are associated.
    <bullet> Certain preventive services furnished to healthy persons,
such as colorectal cancer screening.
    Section 4523(d)(3) of the BBA provides that we will make Part B
payment for certain medical and other health services, when furnished
by a provider of services or by others under arrangement with a
provider of services, under the outpatient PPS, if we would otherwise
pay those providers on a reasonable cost basis for those services.
Specifically, we are proposing that we would pay for the following
medical and other health services under the

[[Page 47561]]

outpatient PPS when furnished by a provider of services:
    <bullet> Antigens (as defined in 1861(s)(2)(G) of the Act);
    <bullet> Splints and casts (1861(s)(5));
    <bullet> Pneumococcal vaccine, influenza vaccine, hepatitis B
vaccine (1861(s)(10)).
    We make Part B payment for the above services under the outpatient
PPS when those services are provided by a CORF, HHA, or hospice
program. However, this provision does not apply to services, furnished
by a CORF, that fall within the definition of CORF services at section
1861(cc)(1) of the Act. It also does not apply to services furnished by
a hospice within the scope of the hospice benefit. Nor does it apply to
services furnished by HHAs to individuals under an HHA plan of
treatment within the scope of the home health benefit.
3. Hospital Outpatient PPS Payment Indicators
    Column B in Addendum B indicates the payment status of each HCPCS
code. Addendum B displays all HCPCS codes, including those incidental
services that are packaged into APC payment rates. Addendum G
identifies inpatient services not payable under outpatient PPS.
    <bullet> We use ``A'' to indicate services that are paid under some
other method such as the DMEPOS fee schedule or the physician fee
schedule.
    <bullet> We use ``E'' to indicate services for which payment is not
allowed under the hospital outpatient PPS or is not covered by
Medicare.
    <bullet> We use ``C'' to indicate inpatient services that are not
payable under the outpatient PPS.
    <bullet> We use ``N'' to indicate services that are incidental,
with payment packaged into another service or APC group.
    <bullet> We use ``P'' to indicate services that are paid only in
partial hospitalization programs.
    <bullet> We use ``S'' to indicate significant procedures for which
payment is allowed under the hospital outpatient PPS but to which the
multiple procedure reduction does not apply.
    <bullet> We use ``T'' to indicate surgical services for which
payment is allowed under the hospital outpatient PPS. Services with a
payment indicator ``T'' are the only services to which the multiple
procedure payment reduction applies.
    <bullet> We use ``V'' to indicate medical visits for which payment
is allowed under the hospital outpatient PPS. Providers must use ICD-9-
CM (International Classification of Diseases, Ninth Edition, Clinical
Modification) codes to determine the level of payment for services with
a payment indicator ``V''.
    <bullet> We use ``X'' to indicate ancillary services for which
payment is allowed under the hospital outpatient PPS.
    The table below lists all of the outpatient PPS indicators and what
they designate.

                                                                    Status Indicators
                                 [How Medicare Pays for Various Services When They Are Billed for Hospital Outpatients]
--------------------------------------------------------------------------------------------------------------------------------------------------------
               Indicator                             Service                                                  Status
--------------------------------------------------------------------------------------------------------------------------------------------------------
A.....................................  Pulmonary Rehabilitation;         Non-paid.
                                         Clinical Trial.
C.....................................  Inpatient Procedures............  Bill as Inpatient.
A.....................................  Durable Medical Equipment,        DMEPOS Fee Schedule.
                                         Prosthetics and Orthotics.
E.....................................  Non-covered Items and Services..  Non-paid.
A.....................................  Physical, Occupational and        Rehab Fee Schedule.
                                         Speech Therapy.
A.....................................  Ambulance.......................  Ambulance Fee Schedule.
A.....................................  EPO for ESRD patients...........  National Rate.
A.....................................  Clinical Diagnostic Laboratory    Lab Fee Schedule.
                                         Services.
A.....................................  Physician Services for ESRD       Bill to carrier.
                                         patients.
A.....................................  Screening Mammography...........  Lower of Charge or National Rate.
N.....................................  Incidental Services, packaged     Packaged; no additional payment allowed.
                                         into APC Rate.
P.....................................  Partial Hospitalization Services  Paid per diem.
S.....................................  Significant Procedure, not        Paid under hospital outpatient PPS (APC rate).
                                         reduced when multiple.
T.....................................  Significant Procedure, multiple   Paid under hospital outpatient PPS (APC rate).
                                         procedure reduction applies.
V.....................................  Visit to Clinic or Emergency      Paid under hospital outpatient PPS (APC rate).
                                         Department.
X.....................................  Ancillary Service...............  Paid under hospital outpatient PPS (APC rate).
--------------------------------------------------------------------------------------------------------------------------------------------------------

B. Description of the Ambulatory Payment Classification (APC) Groups

    In response to OBRA 1986 and OBRA 1990 requirements to develop a
hospital outpatient PPS, we examined systems that were in place or
under development, and we entered into a cooperative agreement with 3M-
Health Information Systems to develop a classification system for
outpatient services. The results of our review of existing systems are
outlined in a Report to Congress dated March 17, 1995. The report
identified the Ambulatory Patient Groups (APGs), which were developed
by 3M-Health Information Systems, as the most promising classification
system, and we recommended that APG-like groups be used as the basis
for the hospital outpatient PPS. Soon after the report was submitted to
the Congress, 3M-Health Information Systems released an updated version
(known as Version 2.0) of the APGs. Since the release of Version 2.0,
HCFA has revised the APGs based on more recent Medicare data. These
revisions constitute what we are calling the Ambulatory Payment
Classification (APC) system or groups that are proposed in this rule.
Services within the APC system are identified by HCPCS codes and
descriptions.
1. Setting Payment Rates Based on Groups of Services Rather Than on
Individual Services
    MedPAC Recommendation: In its March 1998 report to the Congress
entitled ``Report to the Congress: Medicare Payment Policy,'' MedPAC
recommends that payment rates under the hospital outpatient PPS be
based upon relative weights for each individual service rather than
upon groups of similar services to help ensure consistent payments
across ambulatory settings. MedPAC gives several reasons to support
this recommendation:
    <bullet> If services in a group are not homogeneous, a single
payment rate for

[[Page 47562]]

all services in the group would not be accurate.
    <bullet> Hospitals whose case mix includes a greater than average
volume of higher-cost procedures in a group with a payment rate based
on median costs for all procedures in the group could face losses and
would have a financial incentive to provide only the lower-cost
procedures within a group and to avoid the higher-cost procedures.
    <bullet> Grouping services creates considerable administrative
burdens and problems related to data consistency, provider education,
the need for extensive technical assistance, and modification of claims
processing systems.
    <bullet> If costs for services in a group change at different
rates, the price for the group may become distorted over time,
necessitating periodic rebasing of group weights.
    <bullet> Using groups to set rates for services under the hospital
outpatient PPS moves away from standardizing payment systems across
ambulatory settings.
    Response: We have carefully reviewed MedPAC's concerns about using
groups of services rather than individual services as the basis for
setting weights under the hospital outpatient PPS, and we believe that
we have addressed most of these concerns in our approach to ratesetting
using APC groups.
    Section 1833(t)(2)(A) of the Act requires the Secretary to develop
a classification system for covered outpatient services. Section
1833(t)(2)(B) provides that this classification system may be composed
of groups, so that services within each group are comparable clinically
and with respect to the use of resources. The statute refers to ``each
such service (or group of services),'' implying that we may choose or
not choose to group services. We have chosen to set rates for groups of
similar services rather than setting rates for individual services for
several reasons:
    <bullet> The composition of the APC groups is based on two
premises: the procedures within each group must be similar clinically,
and the procedures must be similar in terms of resource costs. As we
explain below, we used 3M's APGs as a starting point, but we have
subsequently made changes to most of the 3M groups, taking into account
1996 outpatient claims data; data collected in a 1994 survey of ASC
costs and charges; data collected in 1995 and 1996 to establish
resource-based practice expense relative values under the Medicare
physician fee schedule; comments on surgical groupings following an ASC
town meeting held at HCFA in July 1996 at which participants reviewed
3M's Version 2.0 surgical APGs for consistency in terms of clinical
characteristics and resource costs; and the medical judgment of HCFA's
medical advisors. Further, we invite comments on the composition of all
the APC groups that are presented in this proposed rule and whether
readers believe that further refinements are needed. We request that
commenters support their recommendations for changes in the APC groups
with data regarding resource costs (time, supplies, equipment, labor
requirements) as well as clinical arguments.
    We have also solicited comments on the same surgical APC groups
that are proposed in this rule as part of a proposed rule entitled
``Update of Ratesetting Methodology, Payment Rates, Payment Policies,
and the List of Covered Surgical Procedures for Ambulatory Surgical
Centers Effective October 1, 1998'' (HCFA-1885-P), published in the
Federal Register June 12, 1998 (63 FR 32290). We intend to coordinate
our review of all comments submitted timely during the comment period
for the hospital outpatient PPS proposed rule and the ASC proposed
rule. Any subsequent changes to the APC groups will be used by both
payment systems when we set their respective final rates. We have a
high level of confidence in the homogeneity of the APC groups that will
emerge from this exhaustive review process.
    <bullet> We have found that, in this context, setting weights at a
single code level suggests a level of precision that is often not
warranted due either to low procedure volume or questionable cost data.
    <bullet> Of the 10,500 codes in the HCPCS, over 5,000 describe
services that are covered under the hospital outpatient PPS. However,
an examination of outpatient claims data for 1997 reveals that as few
as 100 HCPCS codes account for more than a third of all coded services
billed during that year. MedPAC states in its report to the Congress
that its analysis of physician claims for 1996 revealed that more than
90 percent of hospital outpatient volume was accounted for by 300 high
volume services. Because so many codes were billed infrequently or not
at all, we found ratesetting to be facilitated by grouping together the
data that were available for codes that are similar clinically. We
disagree with MedPAC's suggestion that we establish payment groups
composed only of low-volume procedures. If we were to establish such
groups, we would either have to except these groups from the principle
of clinical consistency that applies to other APC groups or greatly
increase the number of APC groups within the outpatient PPS. And, this
approach does not solve the problem of how to establish weights for
procedures, whether they are taken individually or in groups, for which
we have inadequate cost data. Placing low Medicare volume procedures in
APC groups with which they are similar clinically and in terms of
resource consumption does not affect the weight established for the
group to any appreciable extent because the weight derives from the
higher volume procedures within the group.
    <bullet> Grouping closely related services, and paying the median
cost of the group, discourages the upcoding that occurs when individual
services that are similar have disparate median costs.
    <bullet> Using APC groups to set outpatient weights is consistent
with the ratesetting method we are proposing for ASCs. In a proposed
rule entitled ``Update of Ratesetting Methodology, Payment Rates,
Payment Policies, and the List of Covered Surgical Procedures for
Ambulatory Surgical Centers Effective October 1, 1998'' (HCFA-1885-P),
published in the Federal Register June 12, 1998 (63 FR 32290), we
propose payment rates for surgical procedures performed in Medicare-
approved ASCs using APC surgical groups proposed in this rule.
    <bullet> Payment rates for new or redefined services can be more
reliably established by assigning codes for these services to an
existing group of several codes that share characteristics with the new
code rather than trying to match it to an equivalent single procedure
for which we may or may not have reliable cost data.
    <bullet> Our experience basing ASC payment rates on groups of codes
has proved to be no more burdensome administratively than has our
experience with setting weights on a single code basis under the
Medicare physician fee schedule. Under the outpatient PPS, with weights
set by APC groups, hospitals will continue to use the same HCPCS coding
and the same claims forms that they use currently. Any burdens on HCFA
or on hospitals necessitating additional technical assistance or
systems changes are more a function of implementing an entirely new
payment system than of our setting weights on the basis of groups of
services instead of on the basis of single procedures or services.
    We invite comments on our setting rates on the basis of groups of
services rather than on individual codes.

[[Page 47563]]

2. How the Groups Were Constructed
    3M created APGs by combining procedure codes and diagnosis codes
into groups that were clinically related (such as all codes for repair
of fractured legs) and analyzing claims data to determine if the codes
that were clinically similar also used resources in similar ways (for
example, surgical repair would likely be more resource intensive than
closed manipulation and casting). The resources that were examined were
based on a 3-month sample of all Medicare claims for outpatient
services. The sample of nearly 15 million claims was selected from
claims paid in 1992 with the charges on each claim matched to
departmental cost-to-charge ratios from the hospital that provided the
services. The costs that were calculated using billed charges and
department cost-to-charge ratios included direct costs, as well as the
overhead for performing the services. The APGs were clustered into
significant procedures (both surgical and nonsurgical), medical visits
(in both clinics and emergency departments), and ancillary services.
Other groups captured incidental services (those that would not be paid
separately) and procedures for which no payment is made, such as
services specifically excluded from Medicare payment by statute.
    Our Report to Congress recommended the use of APG-like groups for a
hospital outpatient prospective payment system. When the time came to
update payment groups for ASCs, which already were paid under a PPS, we
decided to propose the use of APG-like groups. The ASC industry was
accustomed to eight payment groups, with rates ranging from about $300
to about $900 in roughly $75 increments, without clinical coherence.
While interested in our proposal, the ASCs were concerned about
perceived misclassifications, with groups containing codes they
believed represented divergent resources. To accommodate these
concerns, we regrouped many surgical codes, creating more levels within
some ranges of groups and otherwise changing 3M's system. We also found
it necessary to change the medical APGs. The medical visit groups,
which under the APGs were grouped based on the patient's diagnosis,
were clearly distinct when laboratory services and plain film x-rays
were packaged in, but were much less distinct when those ancillary
services related to the visit were not packaged, as will be the case
initially under our system. We therefore investigated other approaches
to categorizing medical visits that would result in clearly defined
payment groups without extensive packaging. We discuss these approaches
in section V.B.4., below.
    This process of revising 3M's APGs resulted in the development of
the set of 346 mutually-exclusive and exhaustive service categories
called ambulatory payment classification groups or APCs. The weights of
the groups proposed in this rule are based on new data, as required by
the BBA. We matched the database of 98 million hospital outpatient
claims paid in 1996 to the most recent available cost reports for each
hospital, and constructed the groups using these cost data. We defined
each outpatient service under the PPS by a HCPCS code and classified it
either into one of the APC groups for which an outpatient PPS payment
rate is established or into a non-payment category of services that are
excluded from the outpatient PPS. A weight is associated with each APC
group. See section V.C. of this rule for details on how we calculated
the weights. Procedures and services assigned a non-payment
classification include services that can be provided only on an
inpatient basis; codes or services that are not covered by Medicare;
and procedures and services paid under fee schedules or other payment
method.
3. Packaging Under the Groups
    Packaged services are those that are recognized as contributing to
the cost of the services in an APC, but that we do not pay for
separately. Under the APC system, packaged services include the
operating room, recovery room, anesthesia, medical/surgical supplies,
pharmaceuticals, observation, blood, intraocular lenses, casts and
splints, donor tissue, and various incidental services such as
venipuncture. We ``packaged'' the services (and their costs) within the
APC group of procedures with which they were delivered in the base
year. Below is a list of the hospital revenue centers from which we
derived costs that were packaged within the APC groups. For example, a
given surgical procedure would have a cost for the use of the operating
and recovery rooms in every case. However, supply costs might vary,
with some patients requiring special drains and dressings and others
needing minimal dressings. The average packaged cost for supplies might
represent, for example, $200 for the former group 40 percent of the
time, and $150 for the rest. Thus, the APC would include $170 for
supplies. Similarly, only a few cases would have included observation
in the base year, but each case in the group would include a small
amount for the times we associated observation with the cases in the
group.
    We have packaged the cost of pharmaceuticals and biologicals within
APC groups. We did this because we believe drugs are usually provided
in connection with some other treatment or procedure. We have captured
aggregate cost data on all drugs that were billed with HCPCS codes and
those billed with revenue center codes, whether or not a HCPCS was
entered. Thus, historical patterns of drug use are captured within the
APC groups with which the drugs were billed during the base year. The
only separate drug groups we have created are for chemotherapeutic
agents, because those were separately identified in 3M's APG system.
Because we intended to use an APG-like system, we required detailed
coding of chemotherapeutic agents in order to be able to capture the
costs of the specific drugs. We did not require HCPCS coding of other
drugs, so we cannot specifically identify costs of non-chemotherapy
drugs. We understand, however, that some rarely-used drugs are both
expensive and used in only a few hospitals. In those instances, APC
payment rates may not adequately represent costs for hospitals that
treat patients who require infusions of very costly drugs or
biologicals. Because we do not have bills that were coded to identify
these high-cost drugs individually, we cannot evaluate the impact of
paying separately for high-cost drugs. We could require HCPCS coding of
all drugs or certain categories of drugs in order to gather the data,
but we know hospitals could find such a requirement burdensome. We
solicit comments on this issue.
    Currently, drugs that can be self-administered are not covered
under Part B of Medicare (with certain specific exemptions for blood-
clotting factors, immunosuppresives, erythropoietin for dialysis
patients, and certain oral chemotherapeutic agents and antiemetics).
This presents problems in the outpatient hospital setting because even
a pain killer given to a groggy patient postoperatively would not be
covered. The only way such drugs can be paid for is for the hospital to
bill the beneficiary. In many cases, the hospital does not, both
because keeping track of such small charges for billing purposes is
burdensome and because beneficiaries would not understand why they are
being asked to pay for, for example, pain medication that was clearly
related to the procedure they had undergone.
    We propose to allow hospitals to provide drugs to patients without
requiring that the hospital bill the

[[Page 47564]]

patient, and without Medicare's paying the hospital. Normally,
hospitals are not allowed to waive such billing, since not charging a
patient could be seen as an inducement to the patient to use other
services at the hospital, for which the hospital would be paid.
However, if the benefit is not advertised, we believe that provision of
the self-administered drugs at no charge to the beneficiary need not
constitute an inducement in violation of the anti-kickback rules. The
hospital may not advertise this to the public or in any other way
induce patients to use the hospital's service in return for forgoing
payment.
    Recommendation: MedPAC recommends that the unit of payment under
the outpatient PPS be the individual service or procedure that is
furnished and that payment for services and supplies integral to the
individual service or procedure be bundled within that single unit of
payment.
    Response: We agree both with MedPAC's recommendation regarding what
should constitute the unit of payment under the outpatient PPS, and
with MedPAC's recommendation regarding the ``bundling'' of payment,
which we call ``packaging,'' for supplies and services that are
integral to the individual service or procedure that constitutes the
unit of payment. All services and procedures for which payment is to be
made under the outpatient PPS are identified by HCPCS codes and
descriptions. This approach of identifying individual services by HCPCS
as the unit for payment parallels the unit for payment under both the
Medicare physician fee schedule and the ASC facility services benefit.
In addition, as we explain above, the payment amount for each HCPCS
code is a packaged payment that takes into account the costs associated
with services and supplies that are integral to the primary HCPCS-coded
service or procedure and that are furnished at the same time and in the
same place as the primary service or procedure. Because we modeled the
outpatient PPS package of services for surgical procedures on the
package of services that is the basis for payments for facility
services furnished by Medicare approved ASCs, the definition of
packaging will become standardized across both settings upon
implementation of the outpatient PPS.
    MedPAC cites as a disadvantage of using individual services or
procedures as the unit for payment the limited options that are
available to control the volume of unnecessary ancillary services. We
discuss in section V.J. how we intend to address volume control under
the outpatient PPS. While a broader definition of packaging that
includes related ancillaries such as diagnostic x-rays and other
diagnostic tests that are furnished in other settings or at a different
time than the primary service or procedures may have potential benefits
not realized by the more limited packaging that we are using, we are
concerned that applying different definitions of packaging to payments
for the same primary service furnished in different settings would
defeat the goal of establishing a unified payment structure across
sites. One component of achieving this goal is to employ a consistent
definition of packaging across all sites of ambulatory services. We
solicit comments on the packaging options and the implications for
ratesetting and volume control of using the same or different
definitions of packaging across different settings.
    The following table identifies by revenue code the services and
items that are packaged into the various categories of APC groups
(surgery, radiology, other diagnostic, medical visits, and all other
APC groups).

                   Packaged Services by Revenue Center
------------------------------------------------------------------------

------------------------------------------------------------------------
                                 SURGERY
------------------------------------------------------------------------
250....................................  PHARMACY.
251....................................  GENERIC.
252....................................  NONGENERIC.
257....................................  NONPRESCRIPTION DRUGS.
258....................................  IV SOLUTIONS.
259....................................  OTHER.
270....................................  M&S SUPPLIES.
271....................................  NONSTERILE SUPPLIES.
272....................................  STERILE SUPPLIES.
360....................................  OPERATING ROOM.
361....................................  MINOR SURGERY.
369....................................  OTHER.
370....................................  ANESTHESIA.
379....................................  OTHER.
380....................................  ``BLOOD, GENERAL CLASS''.
381....................................  PACKED RED CELLS.
382....................................  WHOLE BLOOD.
383....................................  PLASMA.
384....................................  PLATELETS.
385....................................  LEUCOCYTES.
386....................................  OTHER COMPONENTS.
387....................................  OTHER DERIVATIVES.
389....................................  OTHER BLOOD.
390....................................  BLOOD STORAGE AND PROCESSING.
391....................................  BLOOD ADMINISTRATION.
399....................................  OTHER BLOOD PROC/STORAGE.
490....................................  ``AMBULATORY SURGERY, GENERAL
                                          CLASS''.
491....................................  OTHER AMBULATORY SURGICAL CARE.
630....................................  DRUGS REQUIRING ID.
631....................................  SINGLE SOURCE DRUG.
632....................................  MULTIPLE SOURCE DRUG.
636....................................  DRUGS REQUIRING DETAILED
                                          CODING.
700....................................  CAST ROOM.
709....................................  OTHER.
710....................................  RECOVERY ROOM.
719....................................  OTHER.
720....................................  LABOR ROOM.
721....................................  LABOR.
722....................................  DELIVERY.
723....................................  CIRCUMCISION.
724....................................  BIRTHING CENTER.
729....................................  OTHER.
750....................................  GASTROINTESTINAL.
759....................................  OTHER.
760....................................  OBSERVATION ROOM.
761....................................  TREATMENT ROOM.
762....................................  OBSERVATION ROOM.
769....................................  OTHER TREATMENT ROOM.
890....................................  OTHER DONOR BANK.
891....................................  BONE.
892....................................  ORGAN.
893....................................  SKIN.
899....................................  OTHER.
920....................................  ``OTHER DIAGNOSTIC SERVICES,
                                          GENERAL CLASS''.
929....................................  OTHER DIAGNOSTIC SERVICES.
940....................................  ``OTHER THERAPEUTIC SERVICES,
                                          GENERAL CLASS''.
949....................................  OTHER THERAPEUTIC SERVICES.
------------------------------------------------------------------------
                              MEDICAL VISIT
------------------------------------------------------------------------
250....................................  PHARMACY.
251....................................  GENERIC.
252....................................  NONGENERIC.
257....................................  NONPRESCRIPTION DRUGS.
258....................................  IV SOLUTIONS.
259....................................  OTHER.
270....................................  M&S SUPPLIES.
271....................................  NONSTERILE SUPPLIES.
272....................................  STERILE SUPPLIES.
279....................................  OTHER.
380....................................  ``BLOOD, GENERAL CLASS''.
381....................................  PACKED RED CELLS.
382....................................  WHOLE BLOOD.
383....................................  PLASMA.
384....................................  PLATELETS.
385....................................  LEUCOCYTES.
386....................................  OTHER COMPONENTS.
387....................................  OTHER DERIVATIVES.
389....................................  OTHER BLOOD.
390....................................  BLOOD STORAGE AND PROCESSING.
391....................................  BLOOD ADMINISTRATION.
399....................................  OTHER BLOOD PROC/STORAGE.
630....................................  DRUGS REQUIRING ID.
631....................................  SINGLE SOURCE DRUG.
632....................................  MULTIPLE SOURCE DRUG.
636....................................  DRUGS REQUIRING DETAILED
                                          CODING.
762....................................  OBSERVATION ROOM.
------------------------------------------------------------------------
                               DIAGNOSTIC
------------------------------------------------------------------------
250....................................  PHARMACY.
251....................................  GENERIC.
252....................................  NONGENERIC.
254....................................  INCIDENT TO OTHER DIAGNOSTIC.
257....................................  NONPRESCRIPTION DRUGS.
258....................................  IV SOLUTIONS.
259....................................  OTHER.
270....................................  M&S SUPPLIES.
271....................................  NONSTERILE SUPPLIES.
272....................................  STERILE SUPPLIES.
360....................................  OPERATING ROOM.
361....................................  MINOR SURGERY.
369....................................  OTHER.
370....................................  ANESTHESIA.
372....................................  INCIDENT TO OTHER DIAGNOSTIC.
379....................................  OTHER.
380....................................  ``BLOOD, GENERAL CLASS''.
381....................................  PACKED RED CELLS.
382....................................  WHOLE BLOOD.
383....................................  PLASMA.
384....................................  PLATELETS.
385....................................  LEUCOCYTES.
386....................................  OTHER COMPONENTS.
387....................................  OTHER DERIVATIVES.
389....................................  OTHER BLOOD.
390....................................  BLOOD STORAGE AND PROCESSING.
391....................................  BLOOD ADMINISTRATION.
399....................................  OTHER BLOOD PROC/STORAGE.

[[Page 47565]]


450....................................  ER.
459....................................  OTHER.
622....................................  INCIDENT TO OTHER DIAGNOSTIC.
630....................................  DRUGS REQUIRING ID.
631....................................  SINGLE SOURCE DRUG.
632....................................  MULTIPLE SOURCE DRUG.
636....................................  DRUGS REQUIRING DETAILED
                                          CODING.
710....................................  RECOVERY ROOM.
719....................................  OTHER.
762....................................  OBSERVATION ROOM.
------------------------------------------------------------------------
                                RADIOLOGY
------------------------------------------------------------------------
250....................................  PHARMACY.
251....................................  GENERIC.
252....................................  NONGENERIC.
255....................................  INCIDENT TO RADIOLOGY.
257....................................  NON-PRESCRIPTION DRUGS.
258....................................  IV SOLUTIONS.
259....................................  OTHER.
270....................................  M&S SUPPLIES.
271....................................  NONSTERILE SUPPLIES.
272....................................  STERILE SUPPLIES.
360....................................  OPERATING ROOM.
361....................................  MINOR SURGERY.
369....................................  OTHER.
370....................................  ANESTHESIA.
371....................................  ANESTHESIA INCIDENT TO
                                          RADIOLOGY.
379....................................  OTHER.
380....................................  ``BLOOD, GENERAL CLASS''.
381....................................  PACKED RED CELLS.
382....................................  WHOLE BLOOD.
383....................................  PLASMA.
384....................................  PLATELETS.
385....................................  LEUCOCYTES.
386....................................  OTHER COMPONENTS.
387....................................  OTHER DERIVATIVES.
389....................................  OTHER BLOOD.
390....................................  BLOOD STORAGE AND PROCESSING.
391....................................  BLOOD ADMINISTRATION.
399....................................  OTHER BLOOD PROC/STORAGE.
621....................................  SUPPLIES INCIDENT TO RADIOLOGY.
630....................................  DRUGS REQUIRING ID.
631....................................  SINGLE SOURCE DRUG.
632....................................  MULTIPLE SOURCE DRUG.
636....................................  DRUGS REQUIRING DETAILED
                                          CODING.
710....................................  RECOVERY ROOM.
719....................................  OTHER.
762....................................  OBSERVATION ROOM.
------------------------------------------------------------------------
                           ALL OTHER APC GROUPS
------------------------------------------------------------------------
250....................................  PHARMACY.
251....................................  GENERIC.
252....................................  NONGENERIC.
257....................................  NONPRESCRIPTION DRUGS.
258....................................  IV SOLUTIONS.
259....................................  OTHER.
270....................................  M&S SUPPLIES.
271....................................  NONSTERILE SUPPLIES.
272....................................  STERILE SUPPLIES.
279....................................  OTHER.
380....................................  ``BLOOD, GENERAL CLASS''.
381....................................  PACKED RED CELLS.
382....................................  WHOLE BLOOD.
383....................................  PLASMA.
384....................................  PLATELETS.
385....................................  LEUCOCYTES.
386....................................  OTHER COMPONENTS.
387....................................  OTHER DERIVATIVES.
389....................................  OTHER BLOOD.
390....................................  BLOOD STORAGE AND PROCESSING.
391....................................  BLOOD ADMINISTRATION.
399....................................  OTHER BLOOD PROC/STORAGE.
630....................................  DRUGS REQUIRING ID.
631....................................  SINGLE SOURCE DRUG.
632....................................  MULTIPLE SOURCE DRUG.
636....................................  DRUGS REQUIRING DETAILED
                                          CODING.
762....................................  OBSERVATION ROOM.
------------------------------------------------------------------------

4. Treatment of Clinic and Emergency Visits
    The major issue we face in determining payment for clinic and
emergency room visits is whether to include diagnosis as well as
Physicians' Current Procedural Terminology (CPT) codes in setting
payment rates. We solicit comments on the approaches that we discuss
below and on other possible alternatives.
    Determining payment for clinic and emergency room visits requires a
variety of considerations and trade-offs. These include:
    <bullet> The impact of packaging on setting payment rates (for
example, the more packaging, the greater the difference among APC
payments; however, we are not proposing a fully packaged system
initially, which reduces payment differences and may necessitate
additional policies to increase differences across payment groups);
    <bullet> How to code visits in a manner that recognizes variations
in service intensity and levels of resource consumption (for example,
how to pay more for visits that cost more);
    <bullet> How to keep the system administratively manageable (for
payment purposes, we assign 31 CPT codes that describe different levels
of evaluation and management services to 7 APC groups);
    <bullet> How to define critical care in terms of facility as
opposed to physician inputs (for example, what is an appropriate
facility payment for critical care when critical care CPT codes are
currently determined to reflect physician inputs);
    <bullet> Data problems associated with identifying costs from
claims that list multiple services (for example, the data analysis we
have conducted so far reflects only data from claims for single visits;
we are analyzing data from multiple visit claims to glean additional
information relevant to these policies);
    <bullet> How to move toward greater uniformity of payments across
ambulatory settings so as to remove payment as an incentive for
determining site of service (for example, the trade-off that could
result if, by enhancing differentiation of payments for services within
the hospital outpatient setting, we were to increase payment
differences across settings for services that are provided in both
hospital outpatient departments and physician offices).
    Given the range of issues surrounding payments for clinic and
emergency room visits, we are continuing to weigh different options. We
are concerned that using diagnosis coding to set rates for hospital
outpatient clinic visits could increase disparities in payment
methodology between outpatient departments and physician offices, for
which a new system of resource based practice costs is just now being
proposed. (These concerns do not extend as much to emergent and
critical care, which are not routinely furnished in physician office
settings.) Diagnostic coding has not been used in the past to adjust
payments in the physician office setting and there is no general
evidence that practice expense (or work) in physician office settings
varies by the patient's diagnosis. Moreover, because patients in the
hospital outpatient department can be shifted easily to alternative
outpatient settings, adjustment of facility costs to take diagnosis
into account in one setting but not others may create incentives to
shift patients among ambulatory settings in unknown ways.

Coding Visits

    We have considered several approaches to setting prospective
payment rates for hospital clinic and emergency visits. We reviewed the
medical visit groups in 3M's version 2.0 of APGs that are based solely
on ICD-9 diagnosis codes, with 80 APGs providing several groups for
each body system; we analyzed the effect on ratesetting of defining
clinic and emergency visits solely by CPT code; and, we analyzed the
effect of using a matrix that combines patient diagnosis with a CPT
code to describe the nature of the outpatient encounter. We discuss
these various approaches in more detail here and some of the advantages
and disadvantages of each. Again, we solicit comments on these
approaches to setting payment rates for clinic and emergency room
visits as well as comments on alternative approaches that are not
mentioned here.

Approach 1: Using Diagnosis Codes Only

    3M's approach of using only ICD-9 diagnosis codes with extensive
packaging results in a wide range of group payment rates. The group
that pays the most is almost 13 times as costly as the lowest-paid
group. However, when we removed minor laboratory tests, x-rays, and
certain other minor procedures that had been packaged into 3M's medical
visit APGs in order to conform with the packaging that we propose in
this proposed rule,

[[Page 47566]]

the difference between the highest and the lowest paid group dropped to
not quite five times. (Fully packaged APGs are sufficiently
differentiated for payment purposes, while partially packaged APGs are
not; therefore, if we were to move to a fully packaged system, we would
re-evaluate approaches using diagnosis.)
    We also found that grouping clinic and emergency visits solely on
the basis of diagnoses tends to result in visits that require major
resources for critical cases clustering together with less resource-
intensive follow-up visits after the crisis has passed.

Approach 2: Using CPT Codes Only

    The APC groups that we propose in this proposed rule as the basis
for setting rates for surgical services consist solely of CPT codes. We
looked at using only CPT codes to establish payment groups for
outpatient clinic and emergency room visits, but we found that the
variation between the most costly and the least costly encounter was
quite flat, with the former only 4.5 times greater than the latter.
When basing payment on CPT codes alone, the range reflects hospitals'
billing patterns in increasing level of intensity, but cases at the
margin are overwhelmed by the numbers of visits billed so that
individual cases with low or high costs are not discernible. Also,
billing patterns reflect standard bills, not the resources used in any
particular case.

Approach 3: CPT and Diagnosis Hybrid

    We looked at another approach that bases payment rates on a hybrid
of CPT codes and patient diagnoses. We first assigned 31 CPT codes that
describe physician encounters with patients in the outpatient setting
to seven APC groups: three for clinic visits, three for emergency
department visits, and one for critical care. We also collapsed
approximately 12,000 ICD-9 codes into 20 major diagnostic categories
(MDCs), arranged generally by body system. Classifying services in this
fashion produces a more manageable number of groups, and results in a
matrix of 121 CPT/diagnosis combinations, in which the most costly
combination is more than 10 times as costly as the least.
    Our grouping of evaluation and management CPT codes was based on
several factors. As we note above, we grouped 31 CPT codes that
represent different levels of physician ``evaluation and management''
of patients into seven APC groups. (For a more complete discussion,
refer to the evaluation and management services guidelines in
Physicians' Current Procedural Terminology 1998 edition (CPT '98)
published by the American Medical Association.) CPT codes are more
descriptive of physician effort than of facility use, and our cost data
showed little difference between level 1 and level 2 visits or between
level 4 and level 5 visits. Therefore, we elected to combine some of
the CPT codes into a single group, for example, the two least intensive
outpatient visit codes, 99201 and 99202, are both in APC 911, which is
the lowest level of clinic visits, etc. Grouping CPT codes together in
this fashion reduces administrative burden, and our data analysis shows
only small additional cost differences among the complete set of CPT
medical visit codes. Moreover, we found that grouping CPT codes in this
fashion evens out certain anomalies that arise when an emergency
department furnishes services that would not typically be thought of as
emergency care, such as suture removal, or treatment of a skin disease.
Even though suture removal or treatment of conditions such as impetigo,
conjunctivitis, etc. is performed in emergency departments, these types
of services are more appropriately furnished at a clinic because they
do not require the more elaborate resources of the emergency
department. Assigning codes to APC groups would allow us to set payment
for care of patients with minor problems in the emergency department at
a level equivalent to payment for the same care when it is furnished at
a clinic. We welcome comments on payment for services that do not
require emergency room use.
    Using a matrix of evaluation and management codes with patient
diagnosis would offset the disadvantages noted above of grouping solely
by CPT code (too little payment variation) or solely by patient
diagnosis (reduced payment variation and commingling of resource
intensive and non-resource intensive visits). Defining a clinic or
emergency visit APC in terms of both CPT code and diagnosis, even when
grouping codes to provide a manageable number of groups, would better
recognize the facility resources consumed in providing emergency and
critical care visits. Many such visits, of course, cluster around the
same dollar amount, but this is expected because many visits involve
typical care and standard resources. The cases that represent care at
higher or lower levels of intensity appear to represent real
differences in resource consumption. We used the CPT/patient diagnosis
hybrid to model impacts. We do not believe that payment to individual
hospitals would be significantly affected, whether we base payment
rates on groups of CPT codes only or on groups that combine CPT codes
and patient diagnosis.
    Using a matrix that combines CPT codes with patient diagnosis to
set payment rates for clinic and emergency department visits would also
improve the coding of diagnoses in the hospital outpatient setting
generally. Such improved diagnosis coding is critical to evaluating
future degrees of packaging in the APC system, and we have already
noted that more packaging tends to increase the measured cost
differences across APC groups.
    However, as we discussed earlier, there are also problems with
using a matrix that includes diagnosis codes for hospital outpatient
visits. We are concerned about the effect of using a method to pay for
clinic visits in the hospital outpatient setting that is at variance
with the method we use to pay for the same service in a physician
office. A possible alternative to using diagnosis codes as an indicator
of resource consumption in connection with medical visits in hospital
outpatient departments is to create a uniform fee schedule for
physician visits across all ambulatory settings, paying the site at
which the service is furnished the physician practice expense component
as a ``facility fee.'' However, the latter option would require
legislation and a possible reallocation of the overhead currently
associated with medical visits in the outpatient department to other
outpatient services. Given the complexity of these issues, it may not
be desirable to introduce additional differences, such as diagnosis,
among payments in medical visits at this time. We invite public comment
on all of the issues raised in the discussion in this section. In
addition, after this rule is published, we will be reexamining our
outpatient database and extending our analysis to multiple visit data.
We will incorporate the findings of these additional analyses into our
final decision.

Hypothetical Case Using the Hybrid

    The following is a hypothetical case presented to illustrate how
payment would be determined using the CPT code/diagnosis code hybrid. A
new patient, an elderly woman who has recently come to live with her
family in the area, presents to the primary care clinic complaining of
fatigue, shortness of breath, swollen ankles, and loss of vision. The
physician spends 45 minutes eliciting the patient's medical, family,
and social history and performing an extensive physical examination.
Suspecting cataracts as the

[[Page 47567]]

cause of her loss of vision, the physician suggests she make an
appointment in the eye clinic. Suspecting congestive heart failure as
the cause of her other symptoms, but also suspicious of coexisting
diabetes and hypertension, the physician orders laboratory tests and an
electrocardiogram (ECG) to be performed that day, and schedules an
appointment in the cardiovascular clinic for a later date. If payment
to the hospital were to be made on the basis of a CPT code/ICD-9 code
matrix, the hospital's claim for services furnished in connection with
this visit would identify the following information: CPT code 99204,
comprehensive outpatient visit, new patient, and ICD-9 diagnosis code
401.1, benign hypertension. Payment would be determined by mapping CPT
code 99204 to APC group 915, levels 4 and 5 clinic visit, and ICD-9
code 4011 to MDC 36, cardiovascular system diseases. Payment would be
the rate established for the resulting hybrid group identifier, 91536.
Addendum A lists the payment rates for the proposed hospital clinic and
emergency room payment groups. Separate payment would be made under the
clinical diagnostic laboratory fee schedule for the laboratory work;
the ECG would be paid for separately on the basis of the payment rate
established for APC 950.
    Several months later, the same patient, who now is known to have
congestive heart failure, returns to the primary care clinic
complaining of a cough and runny nose. The physician, having determined
that the symptoms are due to a virus, recommends using a humidifier and
drinking extra fluids. The hospital would code this visit with CPT code
99212 (problem-focused outpatient visit, established patient) and with
ICD-9 diagnosis code 460 (acute nasopharyngitis, or common cold). This
combination, in turn, would map to APC 911, levels 1 and 2 clinic
visit, plus MDC 31, ear, nose, mouth and throat diseases, and payment
for this patient's second visit to the hospital clinic would be based
on the rate established for hybrid group 91131.

Payment for Screening Services

    Every patient who presents to an emergency department and requests
(or has requested on his or her behalf) a screening must be screened in
accordance with section 1867(a) of the Act. If the physician or other
hospital staff who performs the screening determines that no medical
emergency exists, the patient can be referred to one of the hospital's
clinics or to another provider such as a physician office for further
treatment, or the emergency department personnel can decide to treat
the patient in the emergency department. We propose to create a HCPCS
code to be used to bill the screening. Payment for this new code will
be low because no treatment is included in the screening. Payment for
the screening APC is made only when no additional services are
furnished by the emergency department. If non-emergency treatment is
furnished, the appropriate emergency room visit should be billed, and
not the screening. Similarly, if the screening reveals that an
emergency does exist and treatment is instituted immediately, the
screening should not be billed; the screening is subsumed into the
further treatment. If an emergency room physician feels the need to
consult with another physician before deciding whether the patient
needs emergency treatment, the consultation is part of the original
screening, and the hospital should bill for only one screening visit,
if a bill for screening is appropriate, as described above.

Payment for Critical Care

    We propose to have hospitals use CPT code 99291 to bill for
outpatient encounters in which critical care services are furnished. We
use the CPT definition of ``critical care,'' which is the evaluation
and management of the unstable critically ill or injured patient who
requires the constant attendance of a physician. Under the outpatient
PPS, we would allow the hospital to use CPT 99291 in place of, but not
in addition to, a code for a medical visit or for an emergency
department service. However, the entire duration of the hospital
outpatient department's critical care services for an individual
patient is represented by CPT 99291, and we would not allow the
facility to use CPT 99292 to bill for critical care services extended
in 30-minute increments, as would the attending physician. (We have
packaged the costs associated with subsequent hours of critical care
billing into the APG group of services with which the critical care
hours were billed in the base year.) If other services, such as
surgery, x-rays, or cardiopulmonary resuscitation, are furnished on the
same day as the critical care services, we would allow the hospital to
bill for them separately.
    We expect that the numbering scheme proposed in this rule to
distinguish clinic and emergency room visits would be changed in the
final rule. Although we believe the 5-digit identifier used in this
proposal makes it easier to see the relationship between the CPT code
for the level of the visit and the ICD-9-CM code for the diagnosis, for
claims processing purposes, we would have to replace 5-digit
identifiers with 3-digit ones.
5. Treatment of Partial Hospitalization Services
    In accordance with section 1861(ff) of the Act, partial
hospitalization services may be furnished only by a hospital to its
outpatients or by a community mental health center (CMHC). We published
an interim final rule on February 11, 1994 (59 FR 6570) to establish
coverage criteria and payment requirements for partial hospitalization
programs. In that rule, we indicated that physician services and
certain nonphysician practitioner services are not considered to be
partial hospitalization services. Payment for these services is outside
the scope of this proposed rule.
    The partial hospitalization program of services is organized and
furnished similarly, whether the program is administered by a hospital
or by a CMHC. Section 1833(a)(2)(B) of the Act requires that payment
for CMHC partial hospitalization services be based on the hospital
outpatient PPS. Thus, the methodology we are proposing would apply to
hospital outpatient and to CMHC partial hospitalization programs. The
current rules governing CMHC payment appear in 42 CFR part 413. This
proposed rule would amend Sec. 413.1 to indicate that payment for
partial hospitalization services furnished by CMHCs is made in
accordance with the hospital outpatient prospective payment system
described in part 419 of this chapter.
    Patients eligible for the Medicare partial hospitalization benefit
comprise two groups: patients who have been discharged from a
psychiatric hospital for whom partial hospitalization services are
provided in lieu of continued inpatient treatment; and patients who
exhibit disabling psychiatric/psychological symptoms as a result of an
acute exacerbation of a severe and persistent mental illness for whom
the partial hospitalization services are provided in lieu of admission
to an inpatient psychiatric hospital.
    As required by section 1835(a)(2) of the Act, admission to a
partial hospitalization program is limited to patients whose physicians
certify that: (1) the individual would require inpatient psychiatric
care in the absence of partial hospitalization services; (2) an
individualized, written plan of care has been established by a
physician and is reviewed periodically by a physician; and (3) the
patient is or was under the care of a physician. This certification
would be made when the physician

[[Page 47568]]

believes that the course of the patient's current episode of illness
would result in psychiatric hospitalization if the partial
hospitalization services are not substituted.
    The acute psychiatric condition being treated by a partial
hospitalization program must require intensive active treatment,
including a combination of medical and nursing interventions,
individual and group psychotherapy, occupational therapy, family
counseling, and various adjunctive therapeutic activities that are not
primarily recreational or diversionary. The patient's degree of
impairment must be severe enough to require a multidisciplinary
structured day program, but not so severe that patients are incapable
of participating in and benefitting from an active treatment program.
Patients must require partial hospitalization services at levels of
intensity and frequency comparable to patients in an inpatient setting
for similar psychiatric illnesses. In addition, the patient must have
an adequate community-based network to support the patient outside the
partial hospitalization program.
    Typically, patients admitted to a partial hospitalization program
initially require full-time participation in order to provide crisis
stabilization, that is, 6 hours of programming for 5 days per week. In
some cases, the patient may ultimately require inpatient psychiatric
care despite the partial hospitalization services. However, in most
cases, as the patient's symptoms diminish and functional goals are
achieved, the frequency of attendance is reduced to 4 days and, later,
to 3 days. Once the patient's participation drops to this level, the
need for partial hospitalization services in lieu of inpatient
psychiatric care is not generally indicated and the patient would be
discharged to a lower level of outpatient psychiatric care.
    Under the current reasonable cost payment system, providers report
the total number of units for each partial hospitalization service
furnished during the billing period. As noted earlier, hospitals are
also required to report claims for services using HCPCS codes. Payment
for the additional overhead cost of supportive staff and recordkeeping
for a comprehensive day program of services would be built into the
provider's charge structure for covered partial hospitalization
services and paid through the cost report settlement process.
    Because a day of care is the unit that defines the structure and
scheduling of partial hospitalization services, we believe that a per
diem payment for partial hospitalization services is a more appropriate
methodology than billing for each component of a partial
hospitalization program. A packaged, per diem approach is used by other
governmental and private payers when paying for partial hospitalization
services. In order to determine the median cost for the partial
hospitalization APC group, we analyzed the components reported for each
partial hospitalization service over the course of a billing period and
established a per diem payment rate. This analysis resulted in an APC
payment rate of $208.25 per day, of which $46.78 is the beneficiary's
copayment.
    As noted above, partial hospitalization providers currently report
the total number of units for each service billed. We have revised the
billing instructions to require CMHCs to report HCPCS codes and to
require hospitals and CMHCs to report the date of each service,
effective October 1, 1998. We welcome information from the public to
assist us in refining the median cost for a day of partial
hospitalization. We are particularly interested in information
concerning the mix of services that constitute a typical partial
hospitalization day.
    We have not established a group to represent a half-day of partial
hospitalization, although we are aware that other governmental and
private payers have adopted both a full and half-day rate for partial
hospitalization. For example, CHAMPUS (Civilian Health and Medical
Program of the Uniformed Services) recognizes a day with at least 6
hours of programming as a full day, while days with at least 3
programmed hours, but less than 6, are paid a per diem rate equal to 75
percent of the full day rate. However, the CHAMPUS per diem is not tied
to the cost of certain covered services, but rather to the number of
programmed hours the patient attends. As noted above, we will begin to
collect information October 1, 1998, regarding which services are
furnished each day. Once we have analyzed this information, we will be
able to determine the extent to which half-days are used typically in
partial hospitalization treatment planning. We are interested in public
comments regarding whether we should establish a half-day partial
hospitalization group.
    We have also decided not to propose a minimum number of hours or
units of covered services that constitute a partial hospitalization day
at this time. However, we are concerned that a low frequency of
participation, either very few days per week or few covered services
per day, indicate that the partial hospitalization program is no longer
reasonable and necessary and the patient could be managed in a less
intensive level of outpatient treatment or periodic office visits.
Fiscal intermediaries in performing medical review of claims will
continue to make decisions regarding whether the services furnished a
patient are covered and payable as partial hospitalization services. As
noted above, CHAMPUS has established a minimum of 3 hours of service
for payment of their partial hospitalization per diem amount. We are
specifically requesting public comment on adopting a minimum number of
services for Medicare payment purposes.
    We note that many other payers have established an annual limit on
the number of covered partial hospitalization days. There is currently
no duration limit on the Medicare partial hospitalization benefit.
Rather, in order to be covered by Medicare, partial hospitalization
services must be reasonably expected to improve or maintain the
patient's condition and to prevent relapse or hospitalization. For most
psychiatric patients, particularly those with long term, chronic
conditions, control of symptoms and maintenance of a functional level
to avoid hospitalization is an acceptable expectation of improvement.
It is not necessary for a course of partial hospitalization services to
have, as its goal, restoration of the patient to the level of
functioning exhibited prior to the onset of the illness. Some patients
may undergo a course of treatment that increases their level of
functioning but then reach a point where further significant
improvement is not expected. Continued coverage after this point may be
dependent upon evidence that the patient is not able to maintain
stability with less intensive treatment. Although we are not proposing
a duration standard for partial hospitalization at this time, we are
concerned that there is significant variation in duration of treatment.
We solicit data that show treatment duration from providers of partial
hospitalization services. We are also considering specifying a
timeframe for periodic physician recertification of need for partial
hospitalization services as a method to ensure that a patient's
individual needs continue to require the intensity of a partial
hospitalization program.
    Finally, we are concerned about the impact of establishing a per
diem payment for partial hospitalization on the provision of other
outpatient mental health services. Patients should be

[[Page 47569]]

referred to the outpatient mental health treatment program that best
suits their individual needs. Partial hospitalization programs differ
from other outpatient mental health treatment programs in the intensity
of the program, the frequency of participation, and the patient's need
for a comprehensive structured program of services. Upon discharge from
a partial hospitalization program, a patient's symptoms and level of
functioning will have stabilized to the point that the intensity of a
partial hospitalization program is no longer necessary. We are
concerned that providing a per diem payment for partial hospitalization
services may discourage timely discharge. For this reason, medical
review by fiscal intermediaries will continue to focus on patients'
initial and continued eligibility for partial hospitalization services.
    As noted previously, once we have complete encounter data on which
to base the per diem partial hospitalization rate, the per diem will
represent the median cost of services furnished on a typical day. As
such, it will not be based on the cost of each service furnished on a
particular day. Since partial hospitalization represents the most
intensive outpatient program and we will have established the median
cost of furnishing a day of partial hospitalization services, it does
not seem appropriate to pay more for other, less intensive outpatient
psychiatric programs. For this reason, we are specifically requesting
public comment on establishing a limit on routine outpatient mental
health services furnished on a given day to equal the partial
hospitalization per diem amount.
6. Comments on Specific APCs
    APCs 061-064. We created separate (that is, unpackaged) groups for
various chemotherapeutic agents because we believed that some agents
had high costs that would not be recognized if those drugs were
packaged into the median cost for the chemotherapy administration. We
solicit comment on whether to package these costs into the chemotherapy
delivery codes in the final rule. We request that commenters identify
high-cost chemotherapeutic agents that would not be adequately
recognized if packaged or that may require a separate payment or higher
payment grouping.
    APC 226: This group represents the facility costs for making custom
maxillofacial prosthetics. There are few claims, and the median cost is
very low compared to the practice expenses associated with these claims
on the Medicare physician fee schedule. We assume poor coding accounts
for the anomalous cost. However, it may be that these services are not
performed in hospital outpatient departments; they may actually be
performed by maxillofacial surgeons in their offices or by dental
laboratories. We welcome comments on whether these services are
actually provided in the outpatient hospital setting and the resources
involved.
    APC 317 (Cochlear device implantation): The few claims in our
database for this procedure have such disparate costs that we are
uncertain of the appropriate assignment of the surgery. The device is
paid for from the DMEPOS fee schedule. We solicit comments on whether
the implant procedure itself resembles procedures in another APC group
to which it could be appropriately assigned.
    APCs with a status indicator of ``V'': The groups that represent
medical visits in clinics and emergency departments are based on a
matrix, with intensity represented by six levels of CPT codes combined
with 20 categories of ICD-9 codes indicating diagnosis or condition.
Although current instructions require hospitals to use a CPT code to
bill for medical visits, we permit hospitals to bill for all medical
visits under a single code (99201) unless a hospital chooses to be more
specific. In 1997, our data show code 99201 accounting for 22 percent
of all medical visits billed, which we surmise is an overstatement of
the incidence of the lowest level clinic visit. With the implementation
of the hospital outpatient PPS, we will require hospitals to begin
coding medical visits with greater specificity. As a result, we expect
to see an increase in the relative incidence of higher level medical
visits and emergency visits and a proportional decrease in the relative
incidence of the lowest level clinic visit. We will monitor claims by
provider for unexplained increases in the total number of visits or in
the proportion of visits billed at the highest levels. Use of HCPCS
codes should conform with the CPT clinical examples of cases in each
code level.
    Because the layout of the outpatient claim form does not allow a
HCPCS code to be linked to more than one ICD-9-CM code, the form
properly accounts for only one medical visit per claim. When two or
more medical visits occur on the same day for different diagnoses, a
separate claim would be created for each visit, showing the appropriate
level of CPT code and the related diagnosis. We would expect this to
occur only in those hospitals that operate many outpatient clinics
dedicated to various conditions, such as a diabetes clinic, arthritis
clinic, etc. Clinics in which a patient is seen for one or a number of
conditions by one health care professional, such as in a primary care
clinic, would bill for only one clinic visit for that encounter.
    A medical visit would not be billed simply because a patient has
presented to a hospital for a service such as chemotherapy, cardiac
rehabilitation, an x-ray, etc.
    We propose not to pay for a medical visit that takes place on the
same date of service as a scheduled outpatient surgery. Registration of
the patient, taking of vital signs, insertion of an IV, preparation for
surgery, etc., are packaged into and paid for as part of the APC group
to which the surgical procedure or service is classified.
    In cases where a surgical procedure or service is performed as the
immediate result of an outpatient visit (such as the removal of skin
lesions following a visit to a dermatology clinic) or from an emergency
department visit, the visit would be billed with a modifier -25,
indicating that a separately identifiable evaluation and management
service was furnished.
    APCs 667 and 668: These groups, for cataract surgery without and
with insertion of an IOL, should require different resources, because
667 should not include the cost of an IOL. Because the median costs of
the two groups are identical, we assume that hospitals were not
correctly coding some cases. Therefore, we have reduced the median cost
of 667 by $200 to reflect the resources associated with an IOL. We
arrived at this figure by allowing the $150 that was allowed for an IOL
as the ASC portion of the blended amount formerly paid, and by assuming
that the recognition of hospitals' costs under the blend would result
in the hospital IOL ``allowance'' being higher than the ASC's. This
reduction will have a very small overall effect, because the services
in APC 668 were billed more than 225 times as often as those in APC
667. This also leads us to believe that the data we have for the
services in APC 668 are more likely to represent accurate information.
    APC 670: This group packages payment for the acquisition costs of
corneal tissue with the payment for the corneal transplant surgery. It
has been brought to our attention that the costs of acquiring corneal
tissue vary widely from one locality to another, so that packaging may
not be a reasonable way to handle these costs. We are specifically
soliciting comments on the issue of packaging corneal tissue costs. We
are also soliciting suggestions for alternate ways to pay for corneal
tissue, if the comments and supporting data we

[[Page 47570]]

receive indicate that packaging is not an appropriate way to treat
these costs.
    APCs 761 and 762, and 791 and 792: These groups are anomalous,
because the group entitled ``Complex'' in each case has a lower weight
than the one entitled ``Standard.'' This has to do with the cost of the
procedure itself compared to the cost of the radionuclide involved. We
are working with the Society for Nuclear Medicine to correct these
anomalies.
    APCs 902 and 903: We had very few bills for the vaccines in these
groups (902 includes polio vaccine and DPT; 903 includes vaccines for
rabies and plague). We are considering combining the two groups. We
solicit comments on vaccine costs to supplement our data.
    APCs 091 and 91191: Brief psychotherapy encounters can be
identified by either a CPT code (as in APC 091) or a low- or mid-level
visit with a psychiatric diagnosis (APC 91191). We determined the
median costs for these bills taken together, because we believe that
there are no differences in the facility resources used in these
instances. In the case of other psychiatric encounters, we believe that
clinic services at the highest level should be the equivalent of an
extended psychotherapy encounter. Mid- and high-level emergency room
encounters should be billed by evaluation and management CPT codes and
psychiatric diagnoses.
    APC 921: Although the addenda refer to this APC, in fact diabetic
education services will be paid under the physician fee schedule, which
will establish rates for one-on-one sessions and group sessions. The
addenda will be corrected in the final rule. (A proposed rule titled
``Medicare Program; Expanded Coverage for Diabetes Outpatient Self-
Management Training Services'' is under development.)
    APCs 981 and 982: These groups represent nerve and muscle tests. We
are continuing to evaluate whether these two groups should be combined
in the final rule, because there is very little distinction between
them in our cost data.
    We are still examining ways to pay for drugs outside the composite
rate for ESRD patients, and the services to be paid under our system in
CORFs, HHAs, and hospices. These will be APCs, based on services that
are packaged in our system.
7. Discounting of Surgical Procedures
    Under hospital outpatient PPS, we will discount payment amounts
when more than one procedure is performed during a single operative
session or when a surgical procedure is terminated prior to completion.
The discount policy explained below is consistent with Medicare policy
and regulations governing payment for physician and ASC surgical
services.

a. Reduced Payment for Multiple Procedures

    When more than one surgical procedure (defined as those HCPCS codes
in APC groups with status ``T'') is performed during a single operative
session, we propose that the full Medicare payment amount and
beneficiary copayment amount would be paid for the procedure having the
highest APC payment rate. Fifty percent of the normal Medicare payment
amount and beneficiary copayment amount would be paid for all other
procedures performed during the same operative session to reflect the
savings associated with having to prepare the patient only once and the
incremental costs associated with anesthesia, operating and recovery
room use, and other services required for the second and subsequent
procedures.

b. Discounted Payment for Terminated Procedures

    Under outpatient PPS, the hospital will use modifiers to indicate
procedures that are terminated prior to completion. Modifier-52
(Reduced Services) is used to identify a procedure that is terminated
after the patient has been prepared for surgery, including sedation
when provided, and taken to the room where the procedure is to be
performed, but before anesthesia is induced (for example, local,
regional block(s), or general anesthesia). Fifty percent of the normal
Medicare payment amount and beneficiary copayment amount would be paid
for a procedure terminated before anesthesia is induced.
    Modifier-53 (Discontinued Procedure) is used to indicate that a
surgical procedure was started but discontinued after the induction of
anesthesia (for example, local, regional block, or general anesthesia),
or after the procedure was started (incision made, intubation begun,
scope inserted) due to extenuating circumstances or circumstances that
threatened the well-being of the patient. To recognize the costs
incurred by the hospital to prepare the patient for surgery and the
resources expended in the operating room and recovery room, the full
Medicare payment amount and beneficiary copayment amount would be paid
for a procedure that was started but discontinued after the induction
of anesthesia or after the procedure was started, as indicated by a
modifier-53.
    The elective cancellation of procedures would not be reported. If
multiple procedures were planned, only the procedure actually initiated
would be billed. A pattern of canceled procedures will prompt medical
review of the reasons for cancellation and may trigger review of the
appropriateness of patient selection for outpatient surgery.
8. Inpatient Care
    In recent years, the distinction between inpatient and outpatient
care has been blurred by the retention of outpatients in the hospital
overnight, sometimes for many days in a row. Medicare paid for
observation services while the hospital determined whether an
outpatient needed admission for further treatment. Frequently, the
patients did not understand that they were not inpatients until they
were billed for 20 percent of outpatient charges as copayment. In
November 1996, we put in place a policy limiting outpatient observation
services to a maximum of 48 hours. We made clear at that time that
observation was not a means to make it possible to perform inpatient
surgery on an outpatient basis, nor was it appropriate to retain
chemotherapy patients in long-term observation. Because observation is
not provided as the sole service a patient receives, we packaged costs
associated with observation into the median costs for the services, for
example, surgery or chemotherapy, with which they were furnished in
1996.
    There are procedures that, by their nature, require inpatient care.
Open abdominal surgery requires a postoperative recovery period, for
example, to ensure that bowel function resumes. Certain major surgeries
require monitoring in an intensive care unit until the patient's
neurological or other function returns. Yet other surgeries involve
large or delicate surgical wounds that require monitoring, skilled
dressing changes, and fluid replacement. These procedures obviously
require inpatient care, and performing them on an outpatient basis
would clearly jeopardize patient health and safety. Other procedures
are not as clearly defined as inpatient, but we have classified them as
inpatient because they are performed on an inpatient basis virtually
all the time for the Medicare population, either because of the
invasive nature of the procedures, the need for postoperative care, or
the underlying physical condition of the patient who would require such
surgery. These procedures are not classified in an outpatient APC
group, and no payment is provided for these procedures under the
hospital

[[Page 47571]]

outpatient PPS. We will deny payment for claims that are submitted for
these procedures furnished as outpatient services because performing
these procedures on an outpatient basis is not safe or appropriate, and
therefore not reasonable and necessary under Medicare rules. Because we
base these denials on the exclusion in section 1862(a)(1)(A) of the Act
and in Sec. 411.15(k)(1), beneficiaries may be protected from liability
by the limitation on liability provision of section 1879 of the Act.
    The procedures that we consider appropriate and safe only in an
inpatient setting and for which we are excluding payment under the
hospital outpatient PPS are listed in Addendum H to enable hospitals to
make appropriate site of care decisions. This list represents national
Medicare policy and is binding on fiscal intermediaries and peer review
organizations, as well as on hospitals and Medicare participating ASCs.
    We acknowledge that we have classified in outpatient APC groups
some procedures that may seem closely related to procedures that we are
excluding from the outpatient PPS on the basis of their status as
inpatient procedures. We expect that when the former are performed in
the outpatient setting, they will be only the simplest, least intense
cases. The fact that a service is included in an APC group under the
hospital outpatient PPS should not be construed to mean that the
procedure may only be performed in an outpatient setting. In every
case, we expect the surgeon and the hospital to assess the risk to the
individual patient and to act in that patient's best interests.

C. Calculation of Group Weights and Rates

1. Group Weights
    Section 1833(t)(2)(C) of the Act requires the Secretary to develop
relative payment weights for covered groups of hospital outpatient
services. The statute requires that such weights be developed using
1996 hospital outpatient claims and the most recent available hospital
cost reports. We are required to base these weights on median hospital
costs. In constructing the database to model the outpatient PPS
proposal, we used a universe of approximately 98 million calendar year
1996 final action claims for hospital outpatient department services
received through June 1997 to match to the most recent hospital cost
reports available.
    To derive weights based on median hospital costs for services in
the hospital outpatient APC groups, we needed to convert billed charges
to costs and aggregate them to the procedure or visit level. To do
this, we first identified the cost-to-charge ratio that was specific to
each hospital's cost centers (``cost center specific cost-to-charge
ratios'' or CCRs). We then developed a crosswalk to match the
hospital's CCRs to revenue centers used on the hospital's 1996
outpatient bills. The CCRs included operating and capital costs but
excluded costs associated with direct graduate medical education and
allied health education. (Medicare payment for direct graduate medical
education is made as a pass-through under the inpatient PPS and
includes the costs associated with approved educational activities for
residents assigned to the hospital's outpatient department. We discuss
in elsewhere in this proposed rule how we would make payment for allied
health education.)
    Our next task was to identify each hospital's most recent available
cost report from which to determine the hospital's CCRs. Because there
is generally a 2-year lag between claims adjudication and cost report
filing, the most recent cost reports that we could expect to be
available to associate with calendar year 1996 claims were those from
PPS-12 (cost reporting periods beginning on or after October 1, 1994
and before October 1, 1995). We searched the PPS-12 period first to
match the 1996 final action claims to a cost report. If we achieved a
match, no other action was needed. However, if no match was found, we
next searched for a cost report in the PPS-11 period and subsequently
in the PPS-10 period, if necessary.
    If the most recent available cost report that we used for a
provider was one that had been submitted but not settled, we calculated
an adjustment factor to adjust for the differences that exist between
settled and ``as submitted'' cost reports. We determined the adjustment
factor by dividing the outpatient department cost-to-charge ratio from
the hospital's most recent settled cost report by the outpatient
department cost-to-charge ratio from the hospital's ``as submitted''
cost report for the same period. We used the resulting ratio to adjust
each of the CCRs in the hospital's most recent ``as submitted'' cost
report. We repeated this process for every hospital for which the most
recent available cost report was a cost report that had not been
settled.
    The Office of Inspector General (OIG) is concerned that the cost
reports we are using may reflect some unallowable costs. Therefore, the
OIG, in conjunction with HCFA, is proposing to examine the extent to
which the cost reports used reflect costs that were inappropriately
allowed. If this examination reveals excessive inappropriate costs, we
would address this issue in a future proposed rule, or perhaps seek
legislation to adjust future payment rates downward.
    When this process was completed, we were able to match revenue
centers from approximately 83 million claims to CCRs of approximately
5,600 hospitals. We excluded from the crosswalk approximately 15
million claims in which the bill type denoted services that would not
be covered under the PPS, for example, bill type 72X for dialysis
services for patients with ESRD. The table below shows the three cost
reporting periods we used and the percentage of the cost reports within
each PPS period with which we were able to match 1996 claims. The most
recent cost reports available to us were from the hospital inpatient
PPS-12 period, and 95.8 percent of the most recent cost reports
available to us matched the 1996 claims that we are required to use as
the basis for establishing relative payment weights for the APC groups
in the outpatient PPS.

------------------------------------------------------------------------
                                                              Percentage
                                                                of cost
                      Reporting period                          reports
                                                                matched
------------------------------------------------------------------------
PPS-12 (cost reporting period beginning on or after 10/1/94
 and before 10/1/95)........................................        95.8
PPS-11 (cost reporting period beginning on or after 10/1/93
 and before 10/1/94)........................................         3.7
PPS-10 (cost reporting period beginning on or after 10/1/92
 and before 10/1/93)........................................         0.5
                                                             -----------
                                                                   100.0
------------------------------------------------------------------------

    We next separated the estimated 83 million claims that we had
matched with a cost report into two distinct groups: single-procedure
claims and multiple-procedure claims. Single-procedure claims are those
for which the HCPCS to be grouped to an APC is the only code that
appears on the bill, other than laboratory and incidentals such as
venipuncture. Multi-procedure claims included more than one HCPCS code
that could be mapped to an APC. There were approximately 37 million
single-procedure claims and 46 million multiple-procedure claims.
    To calculate median costs for services within an APC, we used only
the single-procedure bills. (Of the roughly 37 million single-procedure
claims, about 11 million were excluded from the conversion process
largely because the only HCPCS codes reported on the claims were for
laboratory procedures.)

[[Page 47572]]

This approach was taken because of our inability to specifically
allocate charges or costs for packaged items and services such as
anesthesia, recovery room, drugs, or supplies to a particular procedure
when more than one significant procedure or medical visit was billed on
a claim. Use of the single-procedure bills minimizes the risk of
improperly assigning costs to the wrong procedure or visit. Although
single-procedure/visit bills were used for determining APC relative
payment weights, the multiple-procedure bills were used in the service
mix calculations, regressions, and impact analyses.
    For each single-procedure claim, we calculated a cost for every
billed line item charge by multiplying each revenue center charge by
the appropriate hospital-specific CCR. If the appropriate cost center
did not exist for a given hospital, we crosswalked the revenue center
to a secondary cost center when possible, or to the hospital's overall
cost-to-charge ratio for outpatient department services. We excluded
from this calculation all charges associated with HCPCS codes
previously defined as noncovered under this PPS, for example,
laboratory, ambulance, and therapy services.
    To calculate the per-procedure or per-visit costs, we used the
charges shown in the revenue centers that contained items integral to
performing the procedure or visit. These included those items that we
previously discussed as being subject to our proposed packaging
provision. For example, in calculating the surgical procedure cost, we
included charges for the operating room, treatment rooms, recovery,
observation, medical and surgical supplies, blood, pharmacy,
anesthesia, cast and splints, and donor tissue, bone, and organ. For
medical visit cost estimates, we included charges for items such as
medical and surgical supplies, drugs, observation, and blood. A
complete listing of the revenue centers we used is included elsewhere
in this preamble.
    To standardize costs for geographic wage variation, we divided the
labor-related portion of the operating and capital costs for each
billed item by the hospital inpatient prospective payment system wage
index published in the Federal Register on May 8, 1998 (63 FR 25575).
We used 60 percent to represent our estimate of that portion of costs
attributable, on average, to labor, but this factor is sensitive to
other payment adjustments. Therefore, we will restandardize costs in
the final rule using FY 1999 hospital inpatient PPS wage index values
and the final labor market share value. A more detailed discussion of
wage index adjustments is found below (section V.E. of this document).
    We then added the standardized labor-related cost to the non-labor-
related cost component for each billed item to derive the total
standardized cost for each procedure or medical visit. We trimmed
standardized procedure and visit costs to remove extremely unusual
costs that appeared to be errors in the data. The trimming methodology
is analogous to that used in calculating the DRG weights for the
inpatient PPS: any bills with costs outside of 3 standard deviations
from the geometric mean were eliminated. The geometric mean and the
associated standard deviation are used because the distribution of
costs more closely resembles a lognormal distribution than a normal
distribution: there are no negative costs, and the average cost is
greater than the median cost. Using the geometric mean has the effect
of minimizing the impact of the most unusual bills in the determination
of the mean. The geometric mean is calculated by taking the mean of the
natural logarithm cost. Since the distribution of the natural
logarithms of a set of numbers is more compact than the distribution of
the numbers themselves, bills with extreme costs do not appear as
extreme as they would if non-logged costs were examined. This ensures
that only the most unusual data will be removed from the calculation.
    After we trimmed the procedure and visit level costs, we mapped
each procedure or visit cost to its assigned APC. We calculated the
median cost for each APC weighted by procedure volume.
    Using these median APC costs, we then calculated the relative
payment weights for each APC. We decided to scale all the relative
payment weights to APC 91336, a mid-level clinic visit for
cardiovascular services because it is one of the most frequently
performed services. This approach is consistent with that used in
developing relative value units for the Medicare physician fee
schedule. By assigning APC 91336 a relative payment weight of ``1.0,''
hospitals can easily compare the relative relationship of one APC to
another. Next, we divided the median cost for each APC by the median
cost for APC 91336 to derive the relative payment weight for each APC.
2. Conversion Factor
    Section 1833(t)(3)(C)(i) of the Act requires that we establish a
conversion factor for 1999 to determine the Medicare amounts for each
covered group of services. The statute mandates that the conversion
factor be established on the basis of the weights and aggregate
projected utilization for 1999 and based on the base amount of payments
described in section 1833(t)(3)(A) of the Act. Such base amount is
calculated for the services included in the outpatient PPS, as an
estimate of the sum of (1) total payments that would be payable from
the Trust Fund under the current (non-PPS) payment system in 1999 plus
(2) the beneficiary copayments that would have been made under the new
(PPS) system in 1999. Section 1833(t)(3)(C)(ii) of the Act further
requires that the Medicare amount take into account all appropriate
adjustments.
    Although section 1833(t)(2)(C) of the Act requires us to project
utilization for hospital outpatient services, we were unable to project
precisely increases in the volume and intensity of services because we
were not able to quantify some of the factors that affect utilization.
For instance, we would anticipate that Medicare beneficiaries that
choose to migrate to managed care plans may be healthier than those who
choose to stay in fee-for-service plans. Thus, we could assume a
decrease in the volume of services but an increase in the intensity of
services furnished for Medicare beneficiaries enrolled in fee-for-
service plans. Another factor that we believe will affect future
utilization is the incentive to code HCPCS accurately to receive
payment. Currently, hospitals are paid for the majority of the
outpatient services they furnish on a cost basis. Claims without a
HCPCS or an invalid HCPCS are not always rejected. In contrast, under
the new PPS, hospitals would be required to use HCPCS codes and, for
medical visits and emergency room services, ICD-9 codes, in order to
receive payment. We expect that frequencies may increase as a result of
the coding requirements. All in all, these are factors we believe will
affect the reporting of volume and intensity of services, but we were
not able to quantify these assumptions individually to project 1999
utilization. Therefore, we used what we believe to be a more reliable
and valid approach to computing the conversion factor under the
methodology described below.

Setting the Rates

    In order to convert the relative weights determined for each APC
(see previous section) into payment rates, we calculated a conversion
factor that would result in payments to hospitals under the PPS in 1999
equaling the total projected payment specified in section 1833(t)(3)(A)
of the Act. The prospective payment rate set for each APC is

[[Page 47573]]

calculated by multiplying the APC's relative weight by a conversion
factor. We computed the conversion factor by first adding together for
calendar year 1996 the aggregate Medicare hospital outpatient payments
paid under the current cost-based payment system (referred to in this
section as current law payments) plus the estimated beneficiary
copayment amounts that would be paid under the outpatient PPS for the
same services. We then divided that amount by the sum of the relative
weights for all APCs under the hospital outpatient PPS. The methodology
we followed to determine current law Medicare hospital outpatient
payments and beneficiary copayments is discussed in section V.C.2.a.,
below, which is followed in section V.C.2.b. by a discussion of the sum
of the relative weights.

a. Calculating Aggregate Calendar Year 1996 Medicare and Beneficiary
Payments for Hospital Outpatient Services (Current Law)

    First, to calculate Medicare hospital outpatient payment amounts
under current law (that is, before PPS), we identified calendar year
1996 single and multiple procedure bills for all the services that we
will recognize under the outpatient PPS. As we identified services that
will be paid under the outpatient PPS, we eliminated invalid or
noncovered HCPCS codes.
    Hospital payments include both operating and capital costs for the
HCPCS coded services for which payment is to be made under the
outpatient PPS. We summed both of these types of costs by HCPCS at the
provider level. Summarizing the data in this manner allows us to
simulate provider payment on an aggregate basis. We then applied the
legislated capital cost reductions of 10 percent and operating cost
reductions of 5.8 percent, as required by section 4522 of the BBA.
    We determined for each HCPCS code the applicable payment
methodology under current law. We then calculated current law payment
for procedures in the baseline using one of the following equations, as
appropriate:
    <bullet> For radiology procedures paid for under the radiology fee
schedule, payment is determined in the aggregate for each provider as
the lower of cost, charge, or blended amount. The radiology blended
amount is determined by the following equation:

(0.42  x  lower of cost or charge minus beneficiary copayment) + (0.58
x  ((0.62  x  global physician fee schedule amount)-beneficiary
copayment))

    <bullet> For surgical procedures for which Medicare pays an ASC
facility fee, payment is determined in the aggregate for each provider
as the lower of the cost, charge, or blended amount. The ASC blended
amount is determined by the following equation:

(0.42  x  lower of cost or charge minus beneficiary copayment) + (0.58
x  (ASC payment rate-beneficiary copayment))

    <bullet> For diagnostic procedures paid under the diagnostic fee
schedule, payment is determined in the aggregate for each provider as
the lower of cost, charge, or blended amount. The blended amount is
determined by the following equation:

(0.50  x  lower of cost or charge minus beneficiary copayment) + (0.50
x  ((0.42  x  global physician fee schedule amount)-beneficiary
copayment))

    For all other covered services not subject to one of the blended
payment method categories, payment is determined to be the lower of
costs or charges less beneficiary copayment. Because the formula-driven
overpayment (FDO) was corrected beginning October 1, 1997, the blended
equations eliminate FDO.
    We then determined each provider payment. We summed the aggregate
amounts computed for each of the four types of payment methodologies
discussed above to determine the Medicare payment amount for each
provider. In addition, we also determined the amount of the beneficiary
copayment for each provider using the beneficiary copayment amounts
that would be paid under the PPS. Summing both the Medicare payment and
the beneficiary copayment amounts at the provider level is necessary in
order to determine the impact of the outpatient PPS on individual
hospitals. In addition to calculating provider payments under the
current law and PPS payment systems, we calculated the aggregate
Medicare payments under the current system and beneficiary copayments
under the PPS for all hospitals for services that are within the scope
of the outpatient PPS. The total amount reflects the amount hospitals
would be paid under the PPS in accordance with section 1833(t)(3)(A) of
the Act and is the numerator in the equation for calculating the
unadjusted conversion factor.

b. Sum of the Relative Weights

    Next we summed the relative weights. Specifically, we multiplied
the volume of procedures or visits (excluding the volume of packaged
services) for each group by the relative weights for each group. We
then calculated the conversion factor by dividing the sum of the volume
multiplied by the relative weights for each APC into the total payment
explained above, including both Medicare payment and beneficiary
copayment. The calendar year 1996 conversion factor is $46.32. To trend
forward the 1996 conversion factor to 1999, HCFA's Office of the
Actuary estimated an update factor of 1.0939. The update factor
represents the estimated per service increase in outpatient Medicare
payments and beneficiary copayment between 1996 and 1999 net of changes
in the volume and intensity of services. Medicare payments per service
were increased by projected CPI-medical items for cost-based services
and for blend services mandated updates. Beneficiary copayments were
increased by projected increases in CPI-outpatient charges. In
estimating the update factor, HCFA's Office of the Actuary assumed that
using the national median of the charges for PPS services to establish
the unadjusted copayment amount would result in beneficiaries paying
6.9 percent less in coinsurance payments in 1999 than what they would
have been expected to pay otherwise, which would create an incentive
for a behavioral offset by hospitals of 10 percent of the coinsurance
reduction. It was assumed that 45 percent of this offset would apply to
the services subject to the PPS and, therefore, would be included in
setting the 1999 conversion factor. The remaining 55 percent of the
offset would be reflected in expenditures for non-PPS services with
both the beneficiary and Medicare absorbing this impact. The adjusted
1999 conversion factor is $50.67.

D. Calculation of Medicare Payment Amount and Copayment Amount

1. Introduction
    In the previous section, section V.C, we explain how we determined
national prospective payment rates, standardized for area wage
variations, for the APC groups. In this section, we explain how we are
proposing to calculate Medicare program payment amounts and beneficiary
copayment amounts for each APC group.
    Under the statutory provision currently in effect, copayment for
hospital outpatient department services is based on 20 percent of the
hospital's billed charges. Because most hospital outpatient services
have been paid, at least in part, on the basis of retrospectively
calculated cost, Medicare payment amounts for most

[[Page 47574]]

hospital outpatient services are not known at the time the services are
furnished. For that reason, coinsurance could not be based on 20
percent of the payment amount. Accordingly, the statute required that
copayment be based on 20 percent of charges. Because charges for
hospital outpatient services have increased faster than costs for those
services, beneficiaries' copayments of 20 percent of charges have, for
some services, accounted for 50 percent or more of the total (Medicare
program plus beneficiary) payments to the hospitals. Because of
extensive secondary insurance coverage, a large share of the copayments
made to hospitals is not direct out-of-pocket expenditures by the
beneficiaries. There has, however, been concern that premiums for
Medigap policies may be affected by the growing copayment liability. In
addition, copayments most directly affect those beneficiaries who do
not have supplemental insurance. This group of beneficiaries cannot
afford to purchase supplemental insurance, and high copayment rates can
be a hardship for those needing services. The outpatient PPS created by
section 4523 of the BBA, which added section 1833(t) to the Act,
includes a mechanism that is designed to eventually achieve a
beneficiary copayment level equal to 20 percent of the prospectively
determined payment rate that has been established for the service.
    MedPAC Comment: In its March 1998 report to the Congress, MedPAC
expresses concern about the inequity represented by the current level
of beneficiary copayment liability, which generally exceeds 20 percent
of the total payment to hospitals for outpatient services. MedPAC,
recognizing that immediate beneficiary copayment reductions to 20
percent of payments made to hospitals would result either in
unacceptable increases in program outlays and/or unacceptable
reductions in payments to hospitals, agrees with the need for a phased-
in approach to the copayment reductions. However, MedPAC recommends
that the Congress specify a shorter timeframe than that which results
from the provisions of the BBA to phase in fully the appropriate
beneficiary copayment contribution of 20 percent for hospital
outpatient services paid for under the outpatient PPS.
    Response: While we do not disagree with MedPAC's recommendation
with respect to beneficiary copayment, because of the budgetary
implications and the existing statutory requirements resulting from the
BBA, implementation of this recommendation would ultimately require
action by the Congress.
    The next sections describe the steps that we followed in accordance
with statutory requirements to determine the beneficiary copayment
amount and the Medicare program payment amount for services paid for
under the hospital outpatient PPS.
2. Determination of Unadjusted Copayment Amount, Program Payment
Percentage, and Copayment Percentage
    In order to calculate program payment amounts and beneficiary
copayment amounts, we first determined for each APC group two base
amounts, in accordance with statutory provisions:
    <bullet> An unadjusted copayment amount, described in section
1833(t)(3)(B) of the Act.
    <bullet> The ``pre-deductible payment percentage,'' which we call
the program payment percentage, described in section 1833(t)(3)(E).
    The steps that we followed to calculate these two base amounts for
each APC group are explained below.
    (a) Calculate the unadjusted copayment amount for each APC group.
    (i) Determine the national median of the charges billed in 1996 for
the services that constitute the APC group after standardizing charges
for geographic variations attributable to labor costs. (To make the
labor adjustment, we divided the portion of each charge that we
estimated was attributable to labor costs (60 percent) by the
provider's hospital inpatient wage index value, and we added the result
to the non-labor portion of the charge (40 percent). Section V.F.
provides a detailed discussion of the adjustments made within the
outpatient PPS to offset regional differences in labor costs.)
    (ii) Update charge values to projected 1999 levels by multiplying
the 1996 median charge for the APC group by 29.2 percent, which the
HCFA Office of the Actuary estimates to be the rate of growth of
charges between 1996 and 1999.
    (iii) Multiply the estimated 1999 national median charge for the
APC group by 20 percent, which becomes the unadjusted copayment amount
for the APC group. The unadjusted copayment amount is frozen at the
1999 level until such time as the program payment percentage (see
below) equals or exceeds 80 percent (section 1833(t)(3)(B)(ii) of the
Act).
    (b) Calculate the program payment percentage (pre-deductible
payment percentage). In this proposed rule, we use the term program
payment percentage to replace the term ``pre-deductible payment
percentage,'' which is referred to in section 1833(t)(3)(E) of the Act.
The program payment percentage is calculated annually for each APC
group, until the value of the program payment percentage equals 80
percent. To determine the program payment percentage for each APC
group, we followed these steps:
    (i) Subtract the APC group's unadjusted copayment amount from the
payment rate set for the APC group;
    (ii) Divide the difference [(APC payment rate) minus (unadjusted
copayment amount)] by the APC payment rate, and multiply by 100. The
resulting percentage is the program payment percentage.
    Calculation of the program payment percentage allows us to
determine a ``copayment percentage,'' which equals the difference
between the program payment percentage and 100 percent. As the program
payment percentage for an APC group approaches 80 percent due to annual
market basket increases of the APC payment rates, the copayment
percentage, conversely, approaches 20 percent, which is ultimately the
target copayment percentage for all services paid for under the
hospital outpatient PPS. When the copayment percentage equals 20
percent of the APC payment rate, we consider the copayment amount for
that APC to be fully phased in at the standard Medicare copayment
level, as we explain in the next section.
3. Calculation of Medicare Payment Amount and Beneficiary Copayment
Amount
    a. Calculate the Medicare payment amount. A Medicare payment amount
is calculated for every APC group. The Medicare payment amount takes
into account wage index and other applicable adjustments and applicable
beneficiary deductible amounts. The Medicare payment amount calculated
for an APC group applies to all the services that are classified within
that APC group. The Medicare payment amount for a specific service
classified to an APC group under the outpatient PPS is calculated as
follows:
    (i) Apply to the national payment rate that is set annually for
each APC group the appropriate wage index adjustment (see section V.E.
for a discussion of how national APC rates are to be adjusted for
geographic wage differences) and any other adjustments applicable to
the provider;
    (ii) Subtract from the adjusted APC group payment rate the amount
of any applicable deductible as provided under Sec. 410.160; and
    (iii) Multiply the adjusted APC group payment rate, from which the
applicable

[[Page 47575]]

deductible has been subtracted, by the program payment percentage
determined for the APC group or 80 percent, whichever is lower. The
result is the Medicare payment amount.
    b. Calculate the copayment amount.
    A copayment amount is calculated annually for each APC group. The
copayment amount calculated for an APC group applies to all the
services that are classified within the APC group. The copayment amount
for an APC is calculated as follows:

    Subtract the APC group's Medicare payment amount from the
adjusted APC group payment rate less deductible, for example,
COPAYMENT AMOUNT equals [(adjusted APC group payment rate less
deductible) minus (APC group Medicare payment amount). The resulting
difference is the beneficiary copayment amount.

    Again, as soon as the Medicare program payment percentage of an
adjusted APC payment rate less deductible equals or exceeds 80 percent,
we set the copayment amount at 20 percent of the adjusted APC group
payment rate, and we consider the standard Medicare 20 percent
copayment level to be fully phased in for that APC group (section
1833(t)(3)(B)(ii) of the Act). Thereafter, for those APC groups whose
program payment percentage has become 80 percent of the APC payment
rate (and whose copayment percentage is 20 percent), the unadjusted
copayment amount for the APC ceases to be frozen at the 1999 level. The
copayment amount for the APC group is permanently established at 20
percent of the adjusted APC group payment rate. Because the copayment
amount is now tied directly to the APC payment rate, the copayment
dollar amount increases as annual updates increase the APC group
payment rate.
    For example, assume that the wage-adjusted payment rate for an APC
is $300; the program payment percentage for the APC group is 60
percent; the wage-adjusted copayment amount for the APC group is $120;
and the beneficiary has not yet satisfied any portion of his or her
annual $100 deductible.

(A) Adjusted APC payment rate: $300
(B) Subtract the applicable deductible: $300 - $100 = $200
(C) Multiply the remainder by the program payment percentage to
determine the Medicare payment amount: 0.6  x  $200 = $120
(D) Subtract the Medicare payment amount from the adjusted APC payment
rate less deductible to determine the copayment amount: $200 - $120 =
$80

    In this case, the beneficiary pays a deductible of $100 and an $80
copayment. The program also pays $120, for a total payment to the
hospital of $300. Applying the program payment percentage ensures that
the program and the beneficiary pay the same proportion of payment that
they would have paid if no deductible were taken.
    In the event that the annual deductible has already been satisfied,
the calculation runs as follows:

(A) Adjusted APC payment rate: $300
(B) Subtract the applicable deductible: N/A
(C) Multiply by the program payment percentage to determine the
Medicare payment amount: 0.6  x  $300 = $180
(D) Subtract the Medicare payment amount from the adjusted APC payment
rate less deductible to determine the copayment amount: $300 - $180 =
$120

    In this case, the beneficiary makes a $120 copayment. The program
also pays $180, for a total payment to the hospital of $300.
4. Hospital Election To Offer Reduced Copayment
    The transition to the standard Medicare copayment rate (20 percent
of the wage-adjusted APC payment rate) will obviously be gradual. For
those APC groups for which copayment is currently a relatively high
proportion of the total payment, the process will be correspondingly
lengthy. Therefore, the Act offers hospitals the option of electing to
reduce copayment amounts and allows the hospital to advertise these
reduced rates. In this section, we discuss the procedure by which
hospitals can elect to offer a reduced copayment amount, and the effect
of such election on calculation of the program payment and beneficiary
copayment.
    Section 1833(t)(5)(B) of the Act requires the Secretary to
establish a procedure under which a hospital, before the beginning of a
year, may elect to reduce the copayment amount otherwise established
for some or all hospital outpatient department services to an amount
that is not less than 20 percent of the hospital outpatient prospective
payment amount. The statute further provides that the election of a
reduced copayment amount will apply without change for the entire year,
and that the hospital may advertise its reduced copayment levels.
Section 1833(t)(5)(C) of the Act provides that deductibles cannot be
waived. Finally, section 1861(v)(1)(T) of the Act (as established by
section 4451 of the BBA) provides that no reduction in copayment
elected by the hospital under section 1833(t)(5)(B) may be treated as a
bad debt.
    In this rule, we are proposing that a hospital may make the
election to reduce copayments on a calendar year basis. The hospital
must notify its fiscal intermediary of its election to reduce
copayments no later than 90 days prior to the start of the calendar
year. This 90-day notification requirement is necessary in order to
give the intermediaries sufficient time to make the systems changes
required to implement the hospital's election. The hospital's
notification must be in writing. It must specifically identify the APC
groups to which the hospital's election will apply and the copayment
level (within the limits identified below) that the hospital has
selected for each group. The election of reduced copayment must remain
in effect unchanged during the year for which the election was made.
The hospital may advertise and otherwise disseminate information
concerning the reduced level of copayment that it has elected.
    We also are proposing that a hospital may elect to reduce the
copayment amount for any or all APC groups. A hospital may not elect to
reduce the copayment amount for some, but not all, services within the
same APC group.
    A hospital may not elect for an APC group a copayment amount that
is less than 20 percent of the adjusted APC payment rate for that
hospital. In determining whether to make such an election, hospitals
should note that the national copayment amount under this system, based
on 20 percent of national median charges for each APC, may yield
copayment amounts that are significantly higher or lower than the
copayment that the hospital has previously collected. This is because
the median of the national charges for an APC group, from which the
copayment amount is ultimately derived, may be higher or lower than the
hospital's historic charges. We, therefore, advise that hospitals, in
determining whether to exercise the option of electing lower copayment
and the level at which to make the election, carefully study the annual
copayment amounts for each APC group in relation to the copayment
amount that the hospital has previously collected.
    Calculation of copayment amounts on the basis of a hospital's
election of reduced copayment for the most part follows the formula
described previously. For example, assume that the adjusted APC payment
rate is $300; the program payment percentage for the

[[Page 47576]]

APC group is 60 percent; the hospital has elected a $60 adjusted
reduced copayment amount for the APC group; and the beneficiary has not
satisfied the annual deductible.

(A) Adjusted APC payment rate: $300
(B) Subtract the applicable deductible: $300 - $100 = $200
(C) Multiply by the program payment percentage to determine the
Medicare payment amount: 0.6  x  $200 = $120
(D) Beneficiary's copayment is the difference between the APC payment
rate reduced by any deductible amount and the Medicare payment amount,
but not to exceed the adjusted reduced copayment amount: $200 - $120 =
$80 (limited to $60 because of the hospital-elected reduced copayment
amount)

    In this case, Medicare makes its regular payment of $120, but the
beneficiary pays a $100 deductible and a reduced copayment amount of
$60, for a total payment to the hospital of $280 instead of the $300
that the hospital would have received if it had not made its election.

E. Adjustment for Area Wage Differences

1. Proposed Wage Index
    Section 1833(t)(2)(D) of the Act requires that, as part of the
methodology for determining prospective payments to hospitals for
outpatient services, the Secretary must determine a wage adjustment
factor to adjust the portion of payment and copayment attributable to
labor-related costs for relative differences in labor and labor-related
costs across geographic regions in a budget-neutral manner.
    To determine which wage adjustment factor to incorporate into the
hospital outpatient department PPS, we considered several options. One
choice would be to use a wage index specific to hospital outpatient
department labor costs. However, the Congress did not require us to nor
did we have either the time or resources necessary to construct a
hospital-outpatient-department-specific wage index.
    We next considered the hospital inpatient PPS wage index that HCFA
maintains under the Medicare program. The hospital inpatient PPS wage
index is well established, and it is constructed specifically for the
purpose of ``reflecting the relative hospital wage level in the
geographic area of the hospital compared to the national average
hospital wage level'' (section 1886(d)(3)(E) of the Act), a requirement
that is analogous to that set forth under the hospital outpatient
department PPS in section 1833(t)(2)(D) of the Act. The data upon which
the hospital inpatient PPS wage index is based are collected from
Medicare cost reports, and the wage index is updated annually. Any
changes in hospital inpatient PPS wage index values must be made in
such a manner as to assure budget neutrality (section 1886(d)(3)(E) of
the Act). The hospital inpatient PPS wage index for fiscal year 1998
reflects the following:
    <bullet> Total salaries and hours from short-term, acute care
hospitals.
    <bullet> Home office costs and hours.
    <bullet> Fringe benefits associated with hospital and home office
salaries.
    <bullet> Direct patient care contract labor costs and hours.
    <bullet> The exclusion of salaries and hours for nonhospital type
services such as SNF services, home health services, or other
subprovider components that are not subject to the PPS.
    A detailed description of the fiscal year 1999 hospital inpatient
PPS wage index is contained in the proposed rule entitled ``Changes to
the Hospital Inpatient Prospective Payment Systems and Fiscal Year 1999
Rates (HCFA-1003-P)'' published in the Federal Register on May 8, 1998
(63 FR 25575).
    We decided that using the hospital inpatient PPS wage index as the
source of an adjustment factor for geographic wage differences for the
hospital outpatient department PPS was both reasonable and logical,
given the inseparable, subordinate status of the outpatient department
within the hospital overall. We then had to determine which version of
the hospital inpatient PPS wage index to use. There are several
possible wage indices that can be developed from the basic wage and
salary data taken from hospital cost reports, depending on changes that
are applied to the data. One modification takes into account the effect
of hospital redesignation under 1886(d)(8)(B) of the Act and hospital
reclassification under 1886(d)(10). A second modification results from
assigning to an urban hospital the statewide rural wage index value for
the State in which that hospital is located when the wage index of the
urban hospital would otherwise be lower than the statewide rural wage
index value (the ``floor''). (In fiscal year 1998, this particular
``hold harmless'' provision affected 128 hospitals in 32 metropolitan
statistical areas (MSAs).) Given the choice between the wage index that
we use under the hospital inpatient PPS, which reflects
reclassification and other changes, and a wage index that does not
incorporate these changes, we are proposing to adopt the wage index
that is used to determine payments to hospitals under the hospital
inpatient PPS to adjust for relative differences in labor and labor-
related costs across geographic areas under the hospital outpatient
department PPS. We note that hospital outpatient department services do
not fall under the category of either ``nonhospital type services'' or
of ``other subprovider components,'' which are excluded from
consideration in developing the hospital inpatient PPS wage index. We
also note that because hospital staff frequently provide services in
both the inpatient and outpatient departments, labor costs associated
with hospital outpatient department services are generally reflected in
the hospital wage and salary data that are the basis of the hospital
inpatient PPS wage index.
    By statute, we implement the annual updates of the hospital
inpatient PPS on a fiscal year basis. However, updates to the hospital
outpatient department PPS will be made on a calendar year basis. We are
proposing to update the wage index values used to calculate hospital
outpatient department PPS Medicare payment and beneficiary copayment
amounts on a calendar year basis. In other words, the hospital
inpatient PPS wage index values that are updated annually on October 1
will be implemented for the hospital outpatient department PPS on the
January 1 immediately following. We are proposing this schedule so that
wage index changes are implemented concurrently with any other
revisions, such as changes in the APC groups resulting from new or
deleted CPT codes, that are implemented on a calendar year basis.
2. Labor-Related Portion of Hospital Outpatient Department PPS Payment
Rates
    In calculating payments to hospitals under the hospital inpatient
PPS, the labor-related portion of expenses within the standardized
amounts used to establish the prospective payment rates is multiplied
by the hospital wage index value to offset regional wage differences.
The fiscal year 1998 labor-related portion under the hospital inpatient
PPS is 71.1 percent. The manner in which this portion was calculated is
explained in detail in the August 29, 1997 Federal Register (62 FR
45993). We note that compensation for wages, salaries, and employee
benefits accounts for 61.4 percent of expenses, with the other 9.7
percent attributable to professional fees, postal services, and all
other labor-intensive services, as explained in the August 29, 1997
Federal Register (62 FR 45995).

[[Page 47577]]

    Current ASC payment rates are standardized for regional wage
differences, and carriers adjust the base rates to calculate payments
to individual facilities by multiplying the labor-related portion of
the base rate by the appropriate hospital inpatient PPS wage index
factor. The labor-related portion of current ASC payment rates is 34.45
percent based on 1986 ASC survey data.
    Because of the sequence of steps that we followed to construct the
hospital outpatient department services PPS database, we had to
estimate the percentage of hospital outpatient department costs
attributable to labor in order to standardize hospital outpatient
department costs for geographic wage differences. We decided that 60
percent represented a reasonable estimate of outpatient costs
attributable to labor, as it falls between the hospital inpatient PPS
operating cost labor factor of 71.1 percent and the ASC labor factor of
34.45 percent and is within a percentage point of the labor-related
costs under the hospital inpatient operating cost PPS attributed
directly to wages, salaries, and employee benefits (61.4 percent) under
the rebased 1992 hospital market basket that was used to develop the
fiscal year 1997 update factor for inpatient PPS rates (published
August 30, 1996 at 61 FR 46187). In addition to considering what
percentage of costs is attributed to labor by other payment systems, we
considered health care market factors such as the shift of more complex
services from the inpatient to the outpatient setting, which could
influence labor intensity and costs, and 60 percent seemed appropriate.
(As we explain in section V.I. below, regression analysis confirmed the
labor percentage to be 60 percent.) We calculated 60 percent of each
hospital's total operating and capital costs. We then divided that
amount by the provider's 1996 hospital inpatient PPS wage index value
to standardize differences in costs that are attributable to geographic
wage differences. The total cost of performing a procedure/visit,
therefore, includes wage-standardized operating and capital costs, as
well as bundled ancillary costs (that is, operating room time, medical/
surgical supplies, pharmaceuticals, anesthesia, recovery room,
observation, biologicals, etc.) and minor ancillary procedures (for
example, venipuncture), as explained in greater detail in section V.C.
    The final hospital outpatient department PPS payment rates that
would have been effective January 1, 1999 may differ slightly from
those proposed in this rule because we intend to adjust APC payment
rates using the fiscal year 1999 hospital inpatient PPS wage index
values that are implemented October 1, 1998. The hospital inpatient PPS
wage index values proposed for fiscal year 1999 are in the Federal
Register proposed rule published May 8, 1998 entitled ``Changes to the
Hospital Inpatient Prospective Payment Systems and Fiscal Year 1999
Rates (HCFA-1003-P)'' (63 FR 25575).
    We are proposing to use the annually updated hospital inpatient PPS
wage index values to adjust both program payment and copayment amounts
for area wage variations, as we explain below.
3. Adjustment of Hospital Outpatient Department PPS Payment and
Copayment Amounts for Geographic Wage Variations
    To adjust the APC payment rates and beneficiary copayment rates for
outpatient services for geographic wage variations, we are proposing to
use the same labor-related percentage (60 percent) that we used
initially to standardize costs for geographic wage differences. When
intermediaries calculate actual payment amounts, they will multiply the
prospectively determined APC payment rate and copayment amount by that
labor-related percentage to determine the labor-related portion of the
base payment and copayment rates that is to be adjusted using the
appropriate wage index factor. That labor-related portion will then be
multiplied by the hospital's inpatient PPS wage index factor, and the
resulting wage-adjusted labor-related portion will be added to the non-
labor-related portion, resulting in wage-adjusted payment and copayment
rates. The wage-adjusted copayment amount is then subtracted from the
wage-adjusted APC payment rate, and the result is the Medicare payment
amount for the service or procedure. Note that even if a hospital
elects to discount the copayment, the full copayment amount is assumed
for purposes of determining Medicare program payments. (See section
V.D. for a discussion of how Medicare program payments are calculated
when the Part B deductible applies.)
    The following is an example of how an intermediary would calculate
the Medicare payment for a surgical procedure with a hypothetical APC
payment rate of $300 that is performed in the outpatient department of
a hospital located in Heartland, USA. The copayment amount for the
procedure is $105. The hospital inpatient PPS wage index value for
hospitals located in Heartland, USA is 1.0234. The labor-related
portion of the base payment rate is $180 ($300  x  60 percent), and the
non-labor-related portion of the base payment rate is $120 ($300  x  40
percent). The labor-related portion of the base copayment rate is $72
($120  x  60 percent), and the non-labor-related portion of the base
copayment rate is $48 ($120  x  40 percent). It is assumed that the
beneficiary deductible has been met.

Wage-Adjusted Base Payment Rate (rounded to nearest dollar):
    = ($180  x  1.0234) + $120
    = $184 + $120
    = $304
Wage-Adjusted Base Copayment Rate (rounded to nearest dollar):
    = ($72  x  1.0234) + $48
    = $74 + $48
    = $122
Calculate Medicare Program Payment Amount:
    $304 - $122 = $182

F. Claims Submission and Processing

    Hospitals will receive detailed instructions on claims submission
over the coming year. This section provides a brief overview of the
process.
    In order for APCs to properly capture services furnished, hospitals
must assign HCPCS codes to services. Revenue center codes will capture
only packaged services (operating and recovery room, pharmaceuticals,
medical/surgical supplies, etc.). Correct assignment of codes requires
an understanding of the differences among surgical procedures, a
knowledge of the extent of effort expended in a clinic visit, etc. We
believe that many hospitals currently have surgical records coded using
HCPCS in the medical records department. However, many hospital coders
are much more familiar with the ICD-9-CM system of classification than
they are with HCPCS. Among the sources of education available to update
skills, hospitals may want to explore in-service education from a
credentialed coder with experience in billing for physicians' and
surgeons' services, classes available from local hospital associations
or medical record associations, formal classes in local colleges, etc.
    Coding conventions in the outpatient setting differ slightly from
those in use in inpatient settings. The diagnosis identified on the
claim need not be the ``principal'' diagnosis, as required under DRGs.
Instead the diagnosis is the reason for the visit as identified at the
time of the visit. It is not necessary to wait to submit the claim
until laboratory or x-ray results are known, in an effort to more
clearly identify the diagnosis. In billing for clinic and emergency

[[Page 47578]]

department visits, the diagnosis should relate to the reason for the
visit. A patient who attends several different clinics in one day
should have separate claims submitted for each clinic visit, since at
this time only one diagnosis can be associated with each claim. We will
seek a change to the UB-92 allowing diagnoses to be identified by
number, so that each line item can have a diagnosis associated with it.
    Another difference from inpatient reporting is that the DRG GROUPER
can take every procedure coded and identify the one highest in the
surgical hierarchy applicable to the diagnosis, then ignore those that
do not affect the DRG. The HCPCS codes, however, are both more numerous
and very specific and should be used appropriately, since each code
will trigger a payment.
    We propose to apply to hospital outpatient claims HCFA's Correct
Coding Initiative (CCI). One of the purposes of the CCI is to ensure
that the most comprehensive of a group of codes is billed instead of
the component parts. For example, G0001 (routine venipuncture) is a
component part of 36430 (transfusion of blood or blood components) and
should not be separately billed. Similarly, 94760 (pulse oximetry)
should not be billed with surgical procedures for which it is a common
monitoring technique. In 1997, hospital outpatient claims showed it
more than 10,000 times with 45378 (diagnostic colonoscopy). The CCI
also checks for mutually-exclusive code pairs. For example, 93797
(cardiac rehabilitation without ECG monitoring) should not be billed
simultaneously with 93798 (cardiac rehabilitation with ECG monitoring),
which happened nearly 12,000 times in 1997 hospital outpatient claims.
We propose to use the CCI edits to ensure that only appropriate codes
are grouped and priced.
    Carriers have used CCI as an editing tool since January 1996, and
have discovered that the vast majority of edits are rarely triggered.
However, as shown in the examples above, hospitals' coding patterns
could result in inappropriate payments unless such edits are applied.
Under the cost reimbursement system, these types of errors did not
ultimately result in higher payments to the hospitals; nor did
providing wrong numbers in the units field (for example, repeating the
revenue code). Again, under this PPS, each unit billed will trigger a
payment. Thus, we have created a second set of edits limiting the
number of units allowed for each HCPCS code. For example, only ``1''
will be accepted in the units field for cataract surgery, but for most
services the edit allows for the procedure to be performed a number of
times in a day, with an upper limit to reduce obvious errors. Of
course, hospitals should report only the actual number of times a
procedure was performed, keeping in mind that CPT and HCPCS definitions
sometimes specify the units. For example, code 11720 is for debridement
of nail(s) by any method; one to five. This code should be reported
only once for any number of nails debrided between one and five,
inclusive. If more than five nails are debrided, the appropriate code
is 11721, debridement of nail(s) by any method; six or more, billed
only once in place of 11720.
    We propose to require that hospital outpatient and CMHC bills that
span more than one day indicate the date of the service for each line
item on the bill. Line item dates of service are needed in order to
implement the CCI and the units' edits, both of which are applied based
on services furnished on the same date.
    Further information on billing line item dates of service, using
HCPCS to code all claims, and editing will be provided by instructions.

G. Updates

1. Revisions to Weights and the Wage and Other Adjustments
    Section 1833(t)(6)(A) of the Act gives the Secretary authority to
periodically review and update the APC groups, the relative payment
weights, and the wage and the other adjustments that are components of
the outpatient PPS, to take into account changes in medical practice,
changes in technology, the addition of new services, new cost data, and
other relevant information and factors.
    We explained above that we intend to update the wage index values
used to calculate program payment and copayment amounts on a calendar
year basis, adopting effective for services furnished each January 1
the wage index value established for a hospital under the inpatient PPS
the previous October 1.
    Recalibration of the APC group weights is another type of revision
provided for under the statutory review authority. We define
recalibration as the updating of all the APC group weights based on
more recent information. We do not intend to make this type of update
on an annual basis. For example, we are required to rebase ASC payment
rates using survey data that are collected every 5 years. At this time,
we would like to solicit comments on how frequently to recalibrate the
hospital outpatient APC weights and on the method and data that should
be used.
    Section 1833(t)(6)(B) of the Act requires that all revisions to APC
groupings, weights, and other adjustments be made in a budget-neutral
manner. Adjustments made for a particular year may not cause the
estimated amount of expenditures under the outpatient PPS to increase
or decrease from the expenditures that we estimate would have been made
under the outpatient PPS without any updates or revisions.
2. Revisions to APC Groups
    It is our intent to use the same APC surgical groups in the payment
systems both for hospital outpatient services and for surgical services
furnished by Medicare-approved ASCs. A discussion of the use of APC
groups to set payment rates for Medicare-approved ASCs can be found in
the proposed rule entitled ``Update of Ratesetting Methodology, Payment
Rates, Payment Policies, and the List of Covered Surgical Procedures
for Ambulatory Surgical Centers Effective October 1, 1998'' (HCFA-1885-
P) that was published in the Federal Register June 12, 1998 (63 FR
32290). In order to maintain comparability of the APC groups across
both settings, we are proposing to coordinate our review of comments on
the composition of the APC groups that are submitted during the public
comment period following publication of both this proposed rule and the
ASC proposed rule. We are further proposing to coordinate any
adjustments to the composition of the APC surgical groups that may
result from our analysis of both sets of comments to ensure that the
final APC surgical groups not only reflect and take into account both
sets of comments, but also remain comparable for ASCs and hospital
outpatient departments to the maximum extent possible within the
constraints imposed by statutory and regulatory requirements.
    Thereafter, we expect the composition of all the APC groups to
remain essentially intact from one year to the next with the exception
of the few changes that may be necessary as a consequence of annual
revisions to HCPCS and ICD-9 codes. We do not plan to routinely
reclassify services and procedures from one APC to another. HCFA will
make these changes based on evidence that a reassignment would improve
the group(s) either clinically or with respect to resource consumption.
All changes in APC groups must be budget neutral, and changes in APC
groups will only be made through notice and comment when we implement
the annual outpatient PPS update.

[[Page 47579]]

    We are proposing to follow certain conventions when, as a result of
annual HCPCS and ICD-9 revisions, we add new services to the hospital
outpatient PPS. As part of the notice and comment process accompanying
the annual update of the outpatient PPS, we shall propose the
assignment of a newly created code to the existing APC that, in the
judgment of our medical advisors, is the most similar clinically and in
terms of resource requirements to the new service. Because a new
service will not have any charge history or cost data associated with
it, classification of a new service to an existing APC group will not
alter the APC payment rate, relative weight, and program payment and
copayment amounts that have been established for that APC group. The
new service will assume the same payment rate, relative weight, and
program and copayment amounts that have been established for the APC
group to which it is classified.
    If the annual revision of HCPCS or ICD-9 result in the deletion of
a code or service that is classified in an APC group under the
outpatient PPS, we shall remove that service from the APC group and
discontinue paying for the service under the outpatient PPS. When a CPT
code that contributed cost data to our 1996 database is deleted, we
will continue to use the cost data in the APC. This in fact did occur
in the psychotherapy set of codes. The codes that were in effect in
1996 have been replaced. If we did not capture these data from those
codes, we would not be able to assign a weight to brief psychotherapy
visits. As long as the new codes belong in the same APC, in terms of
clinical coherence and related resource use, the data are relevant. If
the code that contributed data to the 1996 database were revised so
that it no longer belonged in the APC to which it was originally
assigned, the revised code would be placed in an APC that better
matched the new description. As in the case of an entirely new code, no
cost data would be available for the revised code, so it would be
assigned the weight, program payment rate, and copayment rate of the
codes in the new APC. We will not create an APC for an entirely new
code, but will assign it for at least 2 years to an existing group
while accumulating data on its costs relative to the other codes in the
APC.
    When we do reclassify a service from one APC group to another, the
reclassification will affect the payment rate, the weight, and the
payment and copayment amounts for both of the ``donor'' APC group and
the ``receiving'' APC group if the service that is reclassified was
recognized in 1996 and is reflected in our database. As a result of
reclassifying a service that was recognized in 1996 and is reflected in
our database, we shall recalculate the payment rate, the weight, and
the payment and copayment amounts for both the ``donor'' APC group and
the APC group to which the service is reassigned. If the service that
is reclassified was not recognized in 1996 and is therefore not
reflected in our database, we shall treat it in the same manner that we
treat the addition of altogether new services and the removal of
services that are deleted from HCPCS and ICD-9, that is, reclassifying
the code will have no effect on the payment rate, relative weight, and
payment and copayment amounts for either the donor APC or the receiving
APC, and the reclassified code will assume the payment rate, relative
weight, and payment and copayment amounts of the APC to which the
service is reclassified.
3. Annual Update to Conversion Factor
    Section 1833(t)(3)(C)(ii) of the Act requires us to update annually
the conversion factor used to determine APC payment rates. Section
1833(t)(3)(C)(iii) of the Act provides that the update be equal to the
hospital inpatient market basket percentage increase applicable to
hospital discharges under section 1886(b)(3)(B)(iii) of the Act,
reduced by one percentage point for the years 2000, 2001, and 2002. We
also have the option (under section 1833(t)(3)(C)(iii)) of developing a
market basket that is specific to hospital outpatient services. We are
considering this option, and we solicit comments on possible sources of
data that are suitable for constructing a market basket specific to
hospital outpatient services.

H. Outlier Payments

    Section 1833(t)(2)(E) of the Act requires us to establish in a
budget-neutral manner other adjustments that we determine are necessary
to ensure equitable payments, such as outlier adjustments or
adjustments for certain classes of hospitals. We considered several
factors to evaluate the necessity of an outlier adjustment policy.
    The most relevant factor is that the proposed system has minimal
packaging. Unlike the DRG system for inpatient services, where a
patient can be classified into only one payment group during an
inpatient stay, payment can be made for a number of APC groups for a
given patient on a given day. If multiple services are delivered,
payments will be made for multiple APCs. Because a hospital will
receive payment for each service furnished, we believe this greatly
reduces the need for an outlier adjustment.
    Another relevant factor is that critical care services have been
isolated into their own APC. Payment for the critical care APC is based
on median hospital costs of critical care services. Therefore, payments
for this group will reflect the intensity and associated higher costs
of this type of medical care.
    Even if critical care is not delivered, higher payment will be made
for more serious cases. Payments for medical visits to the emergency
room will be made at three incremental levels of intensity, and
additional payments will be made for any other laboratory work, x-rays,
or surgical interventions resulting from the visit.
    Upon consideration of the above factors, we do not believe that an
outlier adjustment is necessary to ensure equitable payments.

I. Adjustments for Specific Classes of Hospitals

    As part of the analysis to determine whether payment adjustments
would be proposed for the outpatient prospective payment system, we
conducted extensive regression analysis of the relationship between
outpatient hospital costs (calculated as hospital outpatient operating
and capital cost per unit) and several factors that affect costs. The
latter included variables used in estimating similar models for the
inpatient PPS, as well as several variables unique to hospital
outpatient departments. We considered all costs and services for each
hospital relevant to the proposed payment system. Ultimately, we
decided not to propose any adjustments to the Federal payment other
than the wage index used to adjust for local variation in labor costs
at this time. While this reflects a difference in policy relative to
inpatient PPS, the proposed outpatient PPS is fundamentally different.
Specifically, the outpatient system has limited packaging, so
variations in costs are limited to the resources used to produce a
single procedure. Cost variations in the inpatient system, however,
also can be attributed to variation in the intensity of services
bundled under a single rate. Therefore, variations in outpatient cost
per unit among hospitals are expected to be small relative to the
variations in inpatient cost per discharge that have been estimated in
the past.
    We began our analysis by examining the distribution of service mix
and cost per unit (or cost per service) among various types of
hospitals. This analysis revealed some extreme values of cost per unit
among types of hospitals, especially major teaching hospitals,

[[Page 47580]]

hospitals with trauma centers, and eye and ear hospitals. These costs
were 200 percent to 400 percent higher than the average cost per unit
for all hospitals. Because costs are measured on a per unit basis,
values of this magnitude suggested problems both with identifying
procedure codes and properly entering the correct unit of measurement
(times performed, minutes of treatment, etc.). Under the current
payment system, hospitals will be fully reimbursed for their services
even if claims do not contain all the procedure codes that would be
associated with revenue centers billed. A consistent practice of such
under-coding would lead to very high costs associated with a single
unit.
    The presence of these extreme values also suggested that a few
hospitals could unduly influence the distribution of hospital
outpatient cost per unit in our regression analysis. Individual bills
were not edited for extreme unit costs. However, even removing cost
outliers at the bill-level might not have eliminated these extreme
variations at the hospital level. A single under-coded bill might not
meet outlier thresholds, but the combined effects of coding differences
on all of a hospital's bills could create much higher or lower unit
costs.
    In light of the lack of trimming for outlier/error costs at the
bill level, the possibility of outlier hospitals skewing the
distribution of cost per unit, and the hospital-level analysis for
payment adjustments argued for an edit on cost per unit at the hospital
level. The distribution of cost per unit more closely resembles a
lognormal distribution than a normal distribution; there are no
negative costs and the average cost is greater than the median cost. We
identified outliers using the mean and standard deviation of the
natural logarithm of cost per unit. Taking the natural logarithm of any
variable compresses the distribution and minimizes the impact of the
most unusual bills in the determination of the mean. The compressed
distribution also makes it more difficult to identify outliers.
    We removed 83 hospitals through an edit of three standard
deviations from the mean of the logged unit costs: 51 hospitals with a
logged cost per unit exceeding three standard deviations above the mean
and 32 hospitals with a logged cost per unit less than three standard
deviations below the mean. Removing outlier hospitals greatly improved
the distribution of unit costs among types of hospitals. The exempted
Maryland hospitals were also excluded from the analysis. However, we
included the 10 cancer hospitals. After we removed the 54 exempted
Maryland hospitals, outlier hospitals, and hospitals for which we could
not identify payment variables, we were left with 5,419 hospitals for
analysis. Our regression analyses use this set of hospitals.
    A variety of regression models have become the standard of practice
for examining hospital cost variation and analyzing potential payment
adjustments. We looked at two standard models: fully specified
explanatory models to examine the impact of all relevant factors that
might potentially affect outpatient hospital cost per unit and payment
models that examine the impacts of those factors used to determine
payment rates. The payment models standardize the dependent variable,
hospital outpatient cost per unit, by service mix to capture the
relationship between the APC weights and payment under the PPS, rather
than a statistical relationship between service mix and costs. Both
unweighted regressions and regressions weighted by volume were
examined. All regressions employed a double log or semi-log
specification. References to logs throughout this discussion refer to
the natural logarithm, and the geometric mean is the mean of the
natural logarithm of values. Our dependent variable was total hospital
outpatient cost per unit.
    We used payment variables from the inpatient prospective payment
system, including disproportionate share patient percentage, both
capital and operating teaching variables (resident to average daily
census and resident to bed ratios respectively), and dummy variables to
account for location in a rural, large urban, and other urban area. We
also looked at a modified teaching variable that reflects outpatient
volume, several dummy variables unique to outpatient departments, such
as the presence of a trauma unit, and the difference in costs among
various types of TEFRA hospitals and cancer hospitals. A discussion of
the major payment variables and our findings appears below.

Service Mix Index

    Using APC weights and the number of services provided in each APC,
we calculated an average APC weight, or service mix, for each hospital.
We also calculated a ``discounted'' service mix that considers the
reduced weight for additional surgical procedures performed at the same
time, which is consistent with the proposed payment system. The
national average service mix is 1.43, and the national average service
mix discounted for multiple procedures is 1.45. The differences between
the two are negligible due to the low volume of services subject to
discounting, and they proved almost interchangeable in the adjustment
regressions. We did use the discounted service mix for our regressions
because it reflects the proposed policy.
    Since APC weights are calculated from costs, we would expect
approximately a one to one, or proportional, relationship between
service mix and hospital outpatient cost per unit. That is, we expect
the coefficient of the service mix to be one in a regression of
outpatient cost per unit on the service mix. However, initial payment
regressions of hospital outpatient cost per unit on service mix and the
wage index revealed a coefficient of 0.68, suggesting that the
calculated service mix increases faster than cost per unit; a 10
percent increase in the service mix is associated with a 6.8 percent
increase in costs.
    This estimated relationship prompted a preliminary analysis of the
relationship between geometric means and median cost per unit within
each APC. If per unit cost within APCs is distributed log normally, the
median and the geometric mean are equivalent. However, if the
distribution of costs within APCs is skewed, then the median may differ
from the geometric mean. Because the dependent variable in the
regression models is the natural log of hospital outpatient cost per
unit, a systematic difference between the geometric mean of cost per
unit and median cost per unit could explain the lack of one to one
relationship between hospital service mix and hospital cost per
service. Weighting the regression equation by the volume of services,
essentially giving greater weight to the relationship between service
mix and unit costs for hospitals with a higher volume of services,
increases the relationship to 7.5 percent. Higher volume hospitals tend
to have a higher service mix and higher service costs.
    A limited analysis of unit costs for selected APCs demonstrated
that, in general, in APCs with low relative weights, median hospital
cost per unit is lower than the geometric mean of logged hospital cost
per unit, and, in APCs with high relative weights, median hospital cost
per unit is generally higher than the geometric mean. This would lead
to a greater spread in a hospital's service mix than appears in their
actual cost per unit, and would provide an explanation for the less
than proportional relationship that was estimated to exist between
service mix and cost per unit. A regression of cost per unit on a
service mix derived from weights based on the geometric

[[Page 47581]]

mean and the wage index demonstrated better correlation; a 10 percent
increase in service mix led to a 7.7 percent increase in cost per unit.
Weighting this regression equation by the volume of services increases
the relationship to 9.1 percent, suggesting that the higher service mix
of higher volume hospitals better tracks those hospitals' cost per
unit.

Labor Share

    The coefficient of the hospital wage index is the estimated
percentage change in costs attributable to a 1 percent increase in the
wage index. This coefficient provides an estimate of the share of
outpatient hospital unit costs that are attributable to labor.
Depending on the model specification, the coefficient ranged from 0.51
to 0.68 reflecting a labor share between 50 and 70 percent. The
coefficient from a fully specified payment regression of the hospital
cost per unit standardized for the service mix on the wage index,
disproportionate share patient percentage, modified teaching, rural,
and urban variables is approximately 0.60, suggesting a labor share of
60 percent. Even though we ultimately decided that we would not propose
additional adjustments, we believe that the coefficient from this
specification provides the best estimate of the labor share for the
proposed system. This judgment was based on a policy to use a labor
share that reflected the relationship between the wage index and costs,
rather than the effects of correlated factors. The explanatory
regression model that has a dependent variable of unstandardized
hospital outpatient cost per unit also implies a labor share of 60
percent across most specifications.

Teaching Intensity and Disproportionate Share Patient Percentage

    For the inpatient PPS, the intensity of teaching programs has
typically been measured by the resident to bed ratio or resident to
average daily census ratio. Early in our regression analysis, we used
resident to the average daily census of inpatient days, the teaching
variable from inpatient capital PPS. The results suggested that costs
increase somewhat with the size of the teaching program (p<0.05).
However, we believed that this ratio could not adequately represent
teaching hospitals with large outpatient departments relative to the
size of their inpatient operations. We modified the resident to average
daily census variable to reflect the ratio of residents to combined
inpatient and outpatient utilization. To accomplish this, we calculated
the ratio of inpatient costs per day to outpatient costs per unit for
each hospital, and we used this ratio to convert hospital services into
inpatient day equivalents. We combined both inpatient days and
outpatient day equivalents to get a ratio of residents to inpatient and
outpatient days. Since we cannot, at this time, allocate residents to
inpatient and outpatient settings, we could not estimate a teaching
variable based on residents to outpatient volume alone.
    We created the disproportionate share patient percentage variable
by adding the percentage of inpatient days attributable to Medicaid
patients to the percentage of Medicare patients receiving Supplemental
Security Income. In most regression specifications, the
disproportionate share percentage was positive, small in magnitude, and
significant (p<0.05). These coefficients imply that a hospital with a
40 percent disproportionate share percentage would be approximately 4.5
percent [calculated (<INF>e(<SUP>DSHP*0.11</SUP></INF>-1)*100] more
costly than hospitals without any low-income patients. Teaching
intensity variables were not significant in un-weighted regressions
(p>0.05). However, they were positive and significant in regressions
weighted by number of services. The teaching coefficient implies that a
hospital with a resident to combined inpatient and outpatient ``days''
ratio of 0.35 would be 2.4 percent [calculated
((1+IME)<SUP>0.08-</SUP>1)*100] more costly than hospitals with no
residents.
    We also estimated several regression specifications to determine if
there were thresholds for the estimated impacts of teaching and
disproportionate share patient percentage on costs. We determined that
positive and significant estimated differences do not occur for
hospitals whose disproportionate share percentage is less than 0.40.
Significant effects for the teaching variable do not occur for
hospitals whose ratio of residents to inpatient and outpatient days is
less than 0.32. We used these results to estimate a new
disproportionate share patient percentage based on a 0.30 threshold and
a ratio of residents to inpatient and outpatient ``days'' based on a
0.28 threshold. We chose these thresholds by identifying the point at
which the relationship between the unit costs and the teaching
intensity or disproportionate share patient percentage becomes positive
rather than significant because of the lack of significance associated
with the teaching variable and because the small coefficient for the
disproportionate share variable led to intermittent significance for
higher values. We subtracted these thresholds from the original
variable to create new teaching and disproportionate share patient
percentage variables. Subtracting the threshold removes the effect of
values that are not significantly related to cost per unit and
eliminates the sudden increase (notch effect) in the disproportionate
share patient percentage and teaching variable at the threshold level.
The new variables suggest that a hospital with a disproportionate share
patient percentage 10 points higher than the 30 percent threshold is
approximately 2.3 percent more costly [calculated
(<INF>e<SUP>DSHP*0.23</SUP></INF>-1)*100] and that a hospital with a
ratio of residents to inpatient and outpatient utilization 0.07 higher
than the 0.28 threshold is approximately 0.75 percent more costly
[calculated ((1+IME)<SUP>0.11</SUP>-1)*100].

Urban and Rural Location

    We also estimated difference in hospital outpatient costs between
rural, large urban, and other urban areas. In almost all of the
regression models, both explanatory and payment, the rural dummy
variable was positive and significant (p<0.05). Rural hospitals had
approximately 8 percent higher standardized unit costs than urban
hospitals. In all of the regression models, large urban hospitals were
not significantly different from other urban hospitals.

TEFRA and Cancer Hospitals

    We also found that some types of TEFRA hospitals (long-term care,
children's, and psychiatric) and the ten cancer hospitals have
significantly (p<0.05) higher unit costs standardized for service mix.
Cancer, children's, and long term care hospitals demonstrated
standardized unit costs that were at least 20 percent higher than other
hospitals. We believe that these significantly higher costs largely can
be attributed to under-coding because proper coding is not required for
the payment of many services under the current system, especially
medical visits. Poor coding would affect calculations of both service
mix and cost per unit.

Estimated Payments

    The appropriateness of potential payment adjustments must be based
on both cost effects estimated by regression analysis and other factors
including simulated payment impacts. We simulated the impact of the
proposed system on hospitals by calculating the percentage difference
between payments made under current law and payments

[[Page 47582]]

under the proposed system (column 3). Section X. contains a more
complete table that considers the impact of proposed payments on
additional classes of hospitals, including TEFRA and cancer hospitals.
Although Column 3 represents the net effect of the new PPS on
hospitals, we thought it was necessary to show the impacts on hospitals
of simply changing the payment system without including the effects of
the overall reduced payment to hospitals because the PPS system is not
budget neutral to current payment. To reiterate, the conversion factor
is set by summing Medicare payments under the current system and
beneficiary copayment under the new system and dividing by the sum of
the relative weights. Beneficiary copayments under the new system will
reduce overall payments to most hospitals because 20 percent of the
median group charges is less than 20 percent of actual charges.
Therefore, we simulated the impacts as though the conversion factor
were set as if the system were to be budget neutral. Column 4
demonstrates the distributional impacts resulting from implementing the
new system after eliminating the overall reduction in payment most
hospitals will experience due to the effect of the methodology used to
set the conversion factor. We believe the column 4 percentage
differences are what we should examine since any adjustment we would
consider should correct for inequities caused by moving to a PPS (not
the legislated reduction in total payment). Therefore, we based our
decision about adjustments on these percentage differences rather than
percentages combining the PPS and the overall reduction in coinsurance
amounts required by law. We also estimated payment to cost ratios
associated with the new payment methods and the percent change in total
Medicare payments. All simulations used a labor share of 60 percent.
The table below shows the results of two simulations. The first
contains only the wage index adjustment to the APC rates. The second
also includes the threshold adjustments for disproportionate share
patient percentage and teaching intensity discussed above.

BILLING CODE 4120-01-P

[[Page 47583]]

[GRAPHIC] [TIFF OMITTED] TP08SE98.000

[[Page 47584]]

[GRAPHIC] [TIFF OMITTED] TP08SE98.001

BILLING CODE 4120-01-C

[[Page 47585]]

    Based on our analyses, we are not proposing to make adjustments to
the outpatient payment rates for disproportionate share patient
percentage and teaching intensity and rural location for the following
reasons.
    1. Estimated effects of teaching intensity and disproportionate
share patient percentage on costs were small and, in some cases, not
statistically significant.
    2. Payment impacts without such adjustments do not vary
considerably, the largest being a reduction of 5.8 percent for major
teaching hospitals. These impacts should also be evaluated in terms of
the overall effect on Medicare payments since on average, outpatient
services account for 10 percent of hospitals' Medicare payments. For
example, the associated reduction of total Medicare payments for major
teaching hospitals would be about 1 percent.
    3. With the threshold adjustments we considered, estimated payment
reductions for rural hospitals would be 1.9 percent under the proposed
system, rather than 1.5 percent. These hospitals also receive a greater
percent of their Medicare income (14.7 percent) from providing
outpatient services. Similarly, payment reductions for low-volume rural
hospitals would be 13.9 percent of current payments, rather than 13.7
percent, and these hospitals also earn a greater percentage of their
Medicare income (18.2 percent) from providing outpatient services.
Because of these potential shifts in payments, any adjustment should be
based on stronger analytic results than those found with the current
data.
    4. We also believe the issue of payment adjustments should be
reexamined using data from initial years of the implemented system
because current cost calculations and relationships among key factors
and costs probably are affected by variation in coding patterns.
    5. HCFA is working towards standardizing payment across all sites
of service. Fewer adjustments to the outpatient PPS would allow HCFA to
move ahead more quickly with this approach.
    6. We believe that we should further analyze the impact of basing
APC weight calculations on the median rather than the geometric mean
because better correlation between costs and service mix would impact
the size of adjustments.
    Although the payment simulations show potentially large percentage
losses and low payment to cost ratios for low-volume hospitals, we are
not proposing an adjustment for volume. The low-volume hospitals get a
much greater percent of their Medicare income from the provision of
outpatient services than the average, and total Medicare payments would
drop by 3.1 percent for rural low-volume hospitals and 1.8 percent for
urban low-volume hospitals. Low-volume hospitals have higher than
average standardized unit costs, which may be attributable to economies
of scale, under-coding, or cost allocations to the outpatient
departments that are not volume related. However, an adjustment to the
rates based on volume alone might reward inefficiency and create
adverse incentives such as a reduction in services in order to increase
payment rates. Moreover, these hospitals do not comprise a large enough
proportion of other hospital types to substantially benefit from other
adjustments (for example, teaching or disproportionate share).
    We are particularly concerned about the potential impact of the
outpatient PPS on low-volume rural hospitals that are sole community
hospitals or Medicare-dependent hospitals. Approximately 60 percent of
the rural hospitals furnishing fewer than 5,000 visits fall into these
categories. We are investigating the reasons for their higher costs and
are assessing whether a temporary adjustment is needed to moderate the
impact of moving to an outpatient PPS. One option we are considering
would be to phase-in the outpatient PPS for low-volume Medicare-
dependent and sole community hospitals by paying a portion of the
payment based on PPS rates and a portion based on the current payment
system. For example, payment could be based on 75 percent of payments
under the current system and 25 percent on PPS rates in the first year,
50 percent current system payments and 50 percent PPS rates in the
second year, 25 percent current system payments and 75 percent PPS
rates in the third year, and completely on PPS rates in subsequent
years. Another option we are considering would phase-in outpatient PPS
if a low-volume sole community hospital or Medicare-dependent hospital
has a negative Medicare margin for outpatient services. For example,
payment could be based on the amount payable under outpatient PPS plus
a percentage of the difference between those amounts and the amounts
payable under the current system. The percentage of the difference that
would be payable could phase down, for example, 75 percent in year one
of implementation, 50 percent in year 2, 25 percent in year 3, and no
adjustment in year 4 and subsequent years. We solicit comment on this
and other alternatives we might consider. By statute, any adjustment
would have to be budget neutral.
    We also are not proposing adjustments for cancer or TEFRA hospitals
at this time. We believe that claims from cancer and TEFRA hospitals
have been under-coded for many of the services cancer hospitals provide
due to the lack of payment incentives for proper coding of these
services under the current system. Further analysis will be conducted
to determine if current coding practices explain the negative impact.
If we determine that cancer hospitals would be unduly harmed because of
the new outpatient PPS, we will consider whether an adjustment or
perhaps a transition period is needed to moderate the impact. By
statute, any adjustment would have to be budget neutral.
    We do not believe that this action will restrict beneficiary access
because other hospitals provide many of the same services provided at
TEFRA hospitals. In addition, children's and free-standing psychiatric
hospitals are less dependent than other hospitals on Medicare revenues.
Finally, the remaining classes of TEFRA hospitals, rehabilitation and
long-term care, lose a much smaller percentage of their total Medicare
income, 3.7 and 3.5 percent respectively than the average for all
facilities.
    We are not proposing adjustments for any eye and ear or trauma
hospitals because payment simulations demonstrated an increase in
payments under the proposed PPS. We will assess the need for additional
adjustments and make any appropriate changes as data become available
under the new system.

J. Volume Control Measures

    Section 1833(t)(2)(F) of the Act requires us to develop a method
for controlling unnecessary increases in the volume of covered
outpatient department services, including partial hospitalization
services in CMHCs. If the volume of services paid for increases beyond
amounts established through methodologies determined in section
1833(t)(2)(F), section 1833(t)(6)(C) provides that the update to the
conversion factor may be adjusted. MedPAC recommends in its report to
the Congress that we implement an expenditure cap to help control
spending for hospital outpatient services and that we monitor hospital
outpatient volume to ensure that access to services and quality of care
are not reduced under a cap.
    In this proposed rule, we are proposing a volume control measure
for services furnished in CY 2000. In the

[[Page 47586]]

proposed rule for rates that would be effective in CY 2001, we plan to
propose an appropriate method for determining expenditure targets for
services furnished in CY 2001 and subsequent years, following
completion of further analysis of how that target should be computed.
Later in this section, we discuss several possible approaches for
controlling the volume of hospital outpatient services furnished in CY
2001 and subsequent years.
    Pursuant to section 1833(t)(2)(F) and consistent with section
1833(t)(6)(C), we are proposing to update the target amount specified
under section 1833(t)(3)(A) for CY 1999 as an expenditure target for
services furnished in CY 2000. We will update the CY 1999 target for
inflation (based on the projected change in the hospital market basket
minus one percentage point) and estimated changes in the volume and
intensity of hospital outpatient services and estimated Part B fee-for-
service changes in enrollment. If volume exceeds the target for CY
2000, we are proposing to adjust the update to the conversion factor
for CY 2002. We will compare the CY 2000 target to an estimate of CY
2000 actual payments to hospitals. (HCFA's Office of the Actuary will
determine the CY 2000 actual payments using the best available data.)
If unnecessary volume increases, as reflected by expenditure levels,
cause payments to exceed the target, we will determine the percentage
by which the target is exceeded, and adjust the CY 2002 update to the
conversion factor by the same percentage.
    In conjunction with the Office of Inspector General, we are
proposing to do further work to assure that only payments made in
accordance with existing Medicare law and regulations were used in the
calculation of the target amount. If this work reveals that adjustments
to the target amount and expenditure ceiling are warranted, we will
address this issue in a future rule.
    When the inpatient PPS was implemented, the packaging of all
services provided during an admission under a single rate was the
primary method of volume control. This method was appropriate because
the concern was the intensity of services per admission, rather than
the number of admissions, which was generally stable. For outpatient
department services, there has been rapid growth in the intensity of
ancillary services per procedure. We believe that greater packaging of
these services might provide volume control. However, because the
hospital outpatient PPS will not initially include a significant degree
of packaging, we are examining a number of mechanisms to control
unnecessary increases, as reflected by expenditure levels, in the
volume of covered outpatient department services. The volume of
services is a significant concern, particularly during the first few
years of the outpatient PPS, because of the possible incentives under
PPS to increase utilization.
    Although the updated target amount provides a basis against which
we can measure year 2000 actual payments, we need to develop an
approach for establishing a volume control measure for years 2001 and
beyond. Because of the complexities involved in developing such a
system, we do not plan to propose a method for future years (2001 and
beyond) until we issue our notice of proposed rulemaking for CY 2001,
but we want to open a discussion now, so that we can obtain comments
that we can use in developing a proposal.
    One possible mechanism to control unnecessary increases in the
volume of outpatient services paid for under the outpatient PPS is to
expand the sustainable growth rate (SGR) system for physician services,
which is required under section 1848(d)(3) of the Act, as amended by
section 4502 of the BBA, to take into account hospital outpatient
services. Physicians typically are responsible for ordering medical
services and are thus responsible for determining a substantial portion
of hospital outpatient volume. Expanding the SGR system for physician
services to include hospital outpatient services would provide added
incentives for physicians to evaluate the necessity of orders for
hospital outpatient services.
    A second possible mechanism would be to expand the SGR system for
physician services to include all ambulatory services, for example,
services in hospital outpatient departments and ASCs, and to use this
expanded SGR system to establish updates for the ambulatory facility
payments as well as for physician fee schedule updates. This method
would spread volume control incentives more evenly across the
ambulatory sector. It would more closely align physician and facility
incentives and be less sensitive than a hospital-outpatient-department-
only SGR to shifts in site of service.
    A third approach to controlling unnecessary growth in the volume of
hospital outpatient services is to modify the physician SGR method and
incorporate it into the hospital outpatient department payment system.
That is, as in the physician payment context, an SGR value for hospital
outpatient services would be calculated and payment updates for these
services would be reduced if volume increases result in expenditures
above target levels.
    We believe the third option of linking updates of the outpatient
department conversion factor to an SGR system is the most feasible
approach to take initially. Additional study, analysis, and possible
legislative modification would be necessary before we could consider
implementing either of the first two options discussed above. We
acknowledge that, to the extent that hospital outpatient volume is
physician driven, an outpatient SGR could arguably be viewed as
unnecessarily and unfairly penalizing facilities. Moreover, because
sites of ambulatory care are relatively interchangeable with respect to
the delivery of outpatient services, setting appropriate targets for
hospital outpatient departments alone could be difficult. However, an
outpatient SGR system would parallel the SGR system created for
physician services under section 4502 of the BBA. Physician volume
issues have been extensively analyzed by MedPAC, and the SGR system for
physicians has evolved as a feasible method for volume control. Many
outpatient PPS issues are similar to physician issues because changes
in technology and places of service can affect expenditures for both
hospital outpatient departments and physicians.
    The outpatient SGR system would base volume and intensity growth
allowances for services under the outpatient PPS on the growth in the
general economy. Other factors in determining the target rate of growth
include medical inflation, changes in enrollment, and changes in
spending due to changes in the law or regulations. The outpatient SGR
would be calculated as the product of--
    (1) The annual update to the conversion factor (described in
section V.G.3. of this preamble), which is the outpatient market basket
percentage increase reduced by one percentage point for the years 2000,
2001, and 2002.
    (2) The percentage increase or decrease in Part B enrollees
(excluding those enrolled in Medicare+Choice) from one year to the
next;
    (3) The projected growth in the real gross domestic product per
capita (or real gross domestic product per capita plus an appropriate
factor for recent outpatient department services growth) from the
previous year to the year involved; and
    (4) The percentage change in spending for outpatient department
services resulting from changes in law and regulations from one year to
the next.

[[Page 47587]]

    This growth rate system would be used in setting annual updates to
the conversion factor for hospital outpatient services. Pursuant to
section 1833(t)(2)(F) of the Act, and consistent with section
1833(t)(6)(C), we would lower the annual update to the conversion
factor for a given year if volume increases cause expenditures to
exceed the target amount in a previous year. While we think using an
outpatient department SGR is the most feasible option in the short
term, in the long term we would like to develop a more integrated
approach that addresses physicians and ASCs, as well as outpatient
departments. In addition to requesting comments on our proposed volume
control measure for services furnished in CY 2000, we specifically
solicit comments on the appropriateness of applying the SGR method
directly to payments made under the outpatient PPS for future years. We
also welcome comments on the development of a long-term integrated
system that we would consider as we develop possible future proposals.
In our final rule, we will respond to comments on our proposed volume
control measure for services furnished in CY 2000. We do not intend to
respond to comments concerning the development of an SGR system for
services furnished after CY 2000, an integrated system, or any other
approach. However, we will use any comments we receive in developing a
proposal we will make next year for volume control measures to be
applied to services furnished after CY 2000.

K. Prohibition Against Administrative or Judicial Review

    Section 1833(t)(9) of the Act prohibits administrative or judicial
review of the PPS classification system, the groups, relative payment
weights, adjustment factors, other adjustments, volume control methods,
calculation of base amounts, periodic control methods, periodic
adjustments, and the establishment of a separate conversion factor for
cancer hospitals.

VI. Hospital Outpatient Clinics and Other Provider-Based Entities

A. Background

    The Medicare law (section 1861(u) of the Act) lists the types of
facilities that are regarded as providers of services, but does not use
or define the term ``provider-based.'' However, from the beginning of
the Medicare program, some providers, which are referred to in this
section as ``main providers,'' have owned and operated other
facilities, such as SNFs or HHAs, that were administered financially
and clinically by the main provider. The subordinate facilities may
have been located on the main provider campus or may have been located
away from the main provider. In order to accommodate the financial
integration of the two facilities without creating an administrative
burden, we have permitted the subordinate facility to be considered
provider-based. The determination of provider-based status allowed the
main provider to achieve certain economies of scale. To the extent that
overhead costs of the main provider, such as administrative, general,
housekeeping, etc. were shared by the subsidiary facility, these costs
were allowed to flow to the subordinate facility through the cost
allocation process in the cost report. This was considered appropriate
because these facilities were also operationally integrated, and the
provider-based facility was sharing the overhead costs and revenue
producing services controlled by the main provider.
    Before implementation of the hospital inpatient PPS in 1983, there
was little incentive for providers to affiliate with one another merely
to increase Medicare revenues or to misrepresent themselves as being
provider-based, since at that time each provider was paid primarily on
a retrospective, cost-based system. At that time, it was in the best
interest of both the Medicare program and the providers to allow the
subordinate facilities to claim provider-based status, because the main
providers achieved certain economies, primarily on overhead costs, due
to the low incremental nature of the additional costs incurred. For
example, the billing department of a main provider could usually
accommodate the additional workload associated with a provider-based
facility by hiring an additional billing clerk, instead of incurring
the cost of a separate billing department for the provider-based
facility. This economy of scale would usually extend to the other
overhead costs incurred by the main provider, because the free-standing
facility was generally more costly to maintain than one that was
provider-based. This was due primarily to the savings on overhead costs
that were accomplished by the merging of the free-standing facility
into the main provider and having it integrated with the main provider.
Although there were several limited guidelines outlining the conditions
for certain provider-based situations, we devoted few resources to
reviewing provider compliance, because there was little incentive for
providers to use this designation inappropriately.
    Since 1983, the number of provider-based facilities has increased
significantly. For example, in July of 1982, there were 481 provider-
based HHAs as compared with 2,577 provider-based HHAs in October of
1996. This was an increase of 435.75 percent in the 13 years since the
PPS was established. In addition, many hospitals now have a large
number of outpatient clinics, often located at various sites.
    We believe the growth in the number of facilities and organizations
claiming to be provider-based has occurred for several reasons. First,
the PPS established payment rates using base year costs that included
provider overhead. Health care providers, looking for ways to increase
their Medicare revenues, realized that if they established provider-
based facilities or organizations that were still subject to the
reasonable cost principles, they would then be able to shift some of
the overhead from the hospital inpatient operating costs to these
provider-based facilities or organizations. The PPS main provider would
be paid a PPS payment that was intended to cover overhead costs, as
well as being reimbursed on a reasonable cost basis based on Medicare's
share of the overhead costs for the services furnished by the provider-
based facility or organization. A main provider that is excluded from
PPS and subject to the rate-of-increase limits would also benefit from
shifting its overhead to the subordinate provider-based facility or
organization. This cost shifting would enable it to increase its
payment by being paid for the Medicare share of the diverted overhead
on a cost-based methodology, as well as bringing its costs below the
rate-of-increase limit. The main provider could then share in the
incentive payment by having its costs come in below the target rate.
    More recently, other factors have combined to create incentives for
providers to affiliate with one another and to acquire control of
nonprovider treatment settings, such as physician offices. Integrated
delivery systems offer a wide variety of health care services and can
assume responsibility for entire episodes of a patient's illness. These
systems are attractive to patients, who seek continuity of care, and to
businesses seeking a single source of health services for their
employees. The resulting growth in the number of patients enrolled by
these integrated delivery systems has created a powerful incentive for
affiliations. In addition, hospitals rely on referrals from physicians
to assure a steady stream of patients, and they have begun to purchase
physician practices and integrate them into their outpatient
operations. This trend also has created

[[Page 47588]]

incentives for hospitals to affiliate with physician practices.

B. Effects on Medicare

    For several reasons, it is essential that we ensure that decisions
regarding provider-based status are made appropriately, and that
facilities or organizations are not recognized as provider-based unless
they are in fact integral and subordinate parts of the main provider.
As noted earlier, in cases where main providers are paid under the PPS
and subordinate facilities or organizations are paid under the
reasonable cost reimbursement method (section 1861(v)(1)(A) of the Act
and 42 CFR part 413), a provider-based determination could allow the
main provider to shift overhead costs to cost centers that are paid on
a cost basis and thereby increase Medicare payments with no
commensurate benefit to the Medicare program or its beneficiaries.
    Payments for services furnished in a hospital outpatient clinic
generally include both a facility payment and payment for the
professional services of a physician. The combined payments are
typically higher than the payment for comparable services furnished in
a physician office, where a separate facility fee is not payable. In
many cases, there is also an increase in beneficiaries' out-of-pocket
expenses compared to services furnished in a physician office. For
example, when a beneficiary is treated in a physician office, the only
payment made is Part B payment to the physician for his or her
professional services, under the physician fee schedule. The single
payment made under the physician fee schedule pays for the physician's
work and includes a component for practice expense. The beneficiary's
coinsurance is based on 20 percent of the physician fee schedule
amount. However, if the same service is furnished in a hospital
outpatient clinic, Medicare Part B payment for a facility fee is also
made to the hospital, in addition to the physician's payment (which may
include a smaller practice expense component). Thus, for the same
visit, the beneficiary is also subject to the Part B coinsurance for
the hospital's facility fee. Beneficiaries are responsible for
coinsurance based on 20 percent of the hospital's charges (or, the
applicable coinsurance amounts under the hospital outpatient PPS).
    Provider-based status also raises issues of Medicare coverage.
Generally, the services of nonphysician staff furnished in a physician
office are covered only as services ``incident to'' the professional
services of a physician under section 1861(s)(2)(A) of the Act. This
means that a physician must be available on the premises when the
service is furnished, in order to provide direct supervision of that
service. In hospital outpatient departments, however, we presume that
the ``incident to'' requirements are met with respect to hospital
services incident to physician services to outpatients (section
1861(s)(2)(B)). The policy assumed the outpatient department was co-
located on the hospital premises and staff physicians would be
available nearby to provide necessary oversight. It is possible that a
hospital outpatient clinic may not be in the immediate vicinity of the
hospital and may furnish nonphysician services without actually
providing for direct physician supervision of those services. We do not
believe that such services should be presumed to meet applicable
``incident to'' requirements. As explained below, it could also present
a health and safety risk at a time when the office is staffed with
nonphysician personnel who are furnishing medical care with no
physician present and available to attend to any unexpected emergency
situation that may arise.
    Provider-based status for a facility or organization can have other
implications for the health and safety of its patients. Hospital
outpatient facilities are subject to the Medicare conditions of
participation in 42 CFR part 482, including specific requirements
covering such crucial areas as adequacy of physician care (Sec. 482.22,
``Conditions of participation: Medical staff''), and the safety of the
physical environment, including compliance with fire safety
requirements (Sec. 482.41, ``Conditions of participation: Physical
environment''). Beneficiaries have the right to expect that any
outpatient department of a hospital meets applicable conditions of
participation and that the facility is capable of providing care
commensurate with the general level of care furnished in a hospital
outpatient department that is co-located with the inpatient setting.
However, the facility claimed as an outpatient department may not have
been surveyed for compliance with the conditions of participation and,
in some cases, we may not even have been notified of its existence.
    The BBA includes several new provisions that can be implemented
appropriately only if clear distinctions are made between free-standing
and provider-based facilities. Section 4205(a)(1) of the BBA amended
section 1833(f) of the Act to extend the per-visit payment limit for
rural health clinics (RHCs), which previously applied only to free-
standing RHCs, to most provider-based RHCs as well. (The law provides
that the limit does not apply to RHCs located in hospitals with less
than 50 beds.)
    Section 4541 of the BBA amended section 1833 of the Act to
establish a prospective system of payment for outpatient physical
therapy services (including outpatient speech-language pathology
services) and outpatient occupational therapy services furnished after
1998, and to establish a $1,500 annual limit on the amount of payment
for such services to each beneficiary. Under sections 1833(g)(1) and
(g)(2) of the Act, however, that limit does not apply to services
furnished in hospital outpatient departments. Moreover, as explained
later in this section of the preamble, there are differences in payment
for ambulatory surgical services, depending on whether the services are
furnished in a hospital, by an approved ASC, or in a physician office.
Further, higher composite rate payments are made to hospital-based ESRD
facilities than to free-standing ESRD facilities. Thus, it is essential
that we have clear rules for identifying provider-based facilities.

C. Relationship of the ``Provider-Based'' Proposals to Prospective
Payment for Outpatient Hospital Services and Effective Date of
``Provider-Based'' Proposals

    Although the proposed regulations set forth in new Sec. 413.65 and
in the amendment to Sec. 413.24 relate to providers generally, their
implementation is crucial to successful implementation of a PPS for
outpatient hospital services. No outpatient PPS can succeed if it does
not clearly define the services to which it applies. Experience
suggests that under the existing policies defining provider-based
status, many ambulatory services may be characterized either as
physician office services or as services of hospital outpatient
departments or clinics or an ASC, depending on the financial incentives
involved. Thus, we are publishing these proposed rules to permit
clearer distinctions to be made between various types of services, and
to ensure that services paid for under the outpatient PPS are of the
same type as those included in the data on which the system is based.
    As explained in the previous section of this preamble, it is
essential that provider-based decisions be made appropriately in all
cases, not just those involving outpatient hospital services paid for
under a PPS. Therefore, the effective date of these proposals will not
be delayed until after an outpatient PPS is in effect. On the contrary,
we plan to

[[Page 47589]]

implement proposed Secs. 413.24(d)(6)(i) and (ii), 413.65, 489.24(b),
and 498.3, as revised based on our consideration of public comments,
with respect to services furnished on or after 30 days following
publication of a final rule.

D. Basis for Current Provider-Based Policy

    Although there is no direct statutory requirement to maintain
explicit criteria for determination as to provider-based status, there
are statutory references acknowledging the existence of this payment
outcome. For example, section 1881(b) of the Act provides for separate
payment rates for hospital-based (ESRD) facilities.
    There is currently no general definition of ``provider-based
facility'' in the CFR. However, various sections of the CFR do contain
provisions for recognition of specific types of entities as provider-
based.
    Section 405.2462(a) authorizes payment for RHCs and Federally
qualified health centers (FQHCs) as provider-based, if:
    (1) The clinic or center is an integral and subordinate part of a
hospital, SNF, or HHA participating in Medicare, (that is, a provider
of services); and
    (2) The clinic or center is operated with other departments of the
provider under common licensure, governance, and professional
supervision.
    Definitions of hospital-based HHAs and SNFs were published in final
notices on cost limits for HHAs and SNFs, in the June 5, 1980 (45 FR
38014) and September 4, 1980 (45 FR 58699) issues of the Federal
Register, respectively. These criteria were identical to one another
and were similar to the RHC and FQHC definition but they provided
considerably more detail in their description of common governance.
    Further, we have provided additional detail regarding the factors
to be considered in making determinations regarding provider-based
status in our manuals. The Medicare Regional Office Manual at section
6860 provides a list of criteria that should be considered in making a
determination regarding provider-based status for clinics. Also,
section 2186 of the State Operations Manual provides direction
regarding provider-based designation for HHAs.
    Program Memorandum A-96-7, published on August 27, 1996, pulled
together the instructions previously manualized for specific entity
types into a general instruction for the designation of provider-based
status to all facilities or organizations. In developing this Program
Memorandum, we took information from the State Operations Manual
(sections 2024, 2186, and 2242), the Regional Office Manual (section
1060, 2020 and 6865), and Secs. 405.2462 and 413.170 of the CFR.
    Under the policy we set forth in Program Memorandum A-96-7, the
following applicable requirements must be met before an entity can be
designated as provider-based for Medicare payment purposes:
    1. The entity is physically located in close proximity of the
provider where it is based, and both facilities serve the same patient
population (for example, from the same service, or catchment area);
    2. The entity is an integral and subordinate part of the provider
where it is based, and as such, is operated with other departments of
that provider under common licensure (except in situations where the
State separately licenses the provider-based entity);
    3. The entity is included under the accreditation of the provider
where it is based (if the provider is accredited by a national
accrediting body) and the accrediting body recognizes the entity as
part of the provider;
    4. The entity is operated under common ownership and control (that
is, common governance) by the provider where it is based, as evidenced
by the following:
    <bullet> The entity is subject to common bylaws and operating
decisions of the governing body of the provider where it is based;
    <bullet> The provider has final responsibility for administrative
decisions, final approval for personnel actions, and final approval for
medical staff appointments in the provider-based entity; and
    <bullet> The entity functions as a department of the provider where
it is based with significant common resource usage of buildings,
equipment, and service personnel on a daily basis.
    5. The entity director is under the direct day-to-day supervision
of the provider where it is located, as evidenced by the following:
    <bullet> The entity director or individual responsible for day-to-
day operations at the entity maintains a daily reporting relationship
and is accountable to the Chief Executive Officer of the provider and
reports through that individual to the governing body of the provider
where the entity is based; and
    <bullet> Administrative functions of the entity, for example,
records, billing, laundry, housekeeping and purchasing are integrated
with those of the provider where the entity is based.
    6. Clinical services of the entity and the provider where it is
located are integrated as evidenced by the following:
    <bullet> Professional staff of the provider-based entity have
clinical privileges in the provider where it is based;
    <bullet> The medical director of the entity (if the entity has a
medical director) maintains a day-to-day reporting relationship to the
chief medical officer or other similar official of the provider where
it is based;
    <bullet> All medical staff committees or the professional
committees at the provider where the entity is based are responsible
for all medical activities in the provider-based entity;
    <bullet> Medical records for patients treated in the provider-based
entity are integrated into the unified records system of the provider
where the entity is based;
    <bullet> Patients treated at the provider-based entity are
considered patients of the provider and have full access to all
provider services; and
    <bullet> Patient services provided in the entity are integrated
into corresponding inpatient and/or outpatient services, as
appropriate, by the provider where it is based.
    7. The entity is held out to the public as part of the provider
where it is based (for example, patients know they are entering the
provider and will be billed accordingly).
    8. The entity and the provider where it is based are financially
integrated as evidenced by the following:
    <bullet> The entity and the provider where it is based have an
agreement for the sharing of income and expenses, and
    <bullet> The entity reports its cost in the cost report of the
provider where it is based using the same accounting system and the
same cost reporting period as the provider where it is based.
    Our policy will continue to follow the principles we articulated in
Program Memorandum A-96-7 until 30 days after this rule is published as
final in the Federal Register. After that date, we will apply the
policies set forth in the final regulations.

E. Provisions of This Proposed Rule

    This proposed rule would add a new Sec. 413.65, stating the
appropriate definitions of, and the general requirements for, the
determination of ``provider-based'' status. In paragraph (a), we are
proposing to define the following terms for purposes of this section:
department of a provider, free-standing facility, main provider,
provider-based entity, and provider-based status. The definitions used
are as follows.
    Department of a provider means a facility or organization or clinic
that is

[[Page 47590]]

either created by, or acquired by, a main provider for the purpose of
furnishing health care services under the name, ownership, and
financial and administrative control of the main provider in accordance
with the provisions of proposed Sec. 413.65. A department of a provider
is not licensed or certified to provide services in its own right, and
Medicare conditions of participation do not apply to the department as
an independent entity. The term ``department of a provider'' does not
include an RHC or FQHC; however, an RHC or FQHC could qualify as a
provider-based entity.
    Free-standing facility means an entity that furnishes health care
services to Medicare beneficiaries, and that is not integrated with any
other entity as a main provider, a department of a provider, or a
provider-based entity.
    Main provider means a provider that either creates or acquires
ownership of another entity to deliver additional health care services
under its name, ownership, and financial and administrative control.
    Provider-based entity means a provider, or an RHC or FQHC as
defined in Sec. 405.2401(b), that is either created by, or acquired by,
a main provider for the purpose of furnishing health care services
under the name, ownership, and administrative and financial control of
the main provider in accordance with the provisions of proposed
Sec. 413.65. A provider-based entity is certified to provide services
in its own right.
    Provider-based status means the relationship between a main
provider and a provider-based entity, or a department of a provider,
that is in compliance with the provisions of proposed Sec. 413.65.
    We are proposing to state explicitly, in new paragraph (b), that a
facility or organization is not entitled to be treated as provider-
based simply because it or the provider believe it to be provider-
based. We also would state that, if a facility or organization seeking
provider-based status is located off the campus of a provider, or
inclusion of the costs of the facility or organization on the
provider's cost report would increase the total costs on that report by
at least 5 percent, HCFA will not treat the facility or organization as
provider-based for purposes of billing or cost reporting unless the
provider has contacted HCFA and obtained a determination of provider-
based status. This means that we would not accept billings from the
facility or organization as if it were provider-based, and the provider
will not be permitted to include costs of the facility or organization
on its cost report, unless the acquisition or creation of the facility
or organization has been reported to us and we have determined that it
is either a department of a provider or a provider-based entity.
Further, a facility not located on the campus of a hospital and used as
a site of physician services of the kind ordinarily furnished in
physician offices will be presumed to be a free-standing facility
unless it is determined by HCFA to have provider-based status. For
example, a physician office practice purchased by a main provider would
not qualify for provider-based status unless it meets all applicable
criteria in proposed Sec. 413.65.
    We are proposing to require, in new paragraph (c), that a main
provider that acquires a facility or organization for which it wishes
to claim provider-based status must report its acquisition of the
facility or organization to HCFA and furnish all information needed for
a determination as to whether the facility or organization meets the
criteria in this section for provider-based status. A main provider
that has had one or more facilities or organizations determined to have
provider-based status also must report to HCFA any material change in
the relationship between it and any department or provider-based
entity, such as a change in ownership of the entity or entry into a new
or different management contract, that could affect the provider-based
status of the department or entity.
    In new paragraph (d), we propose the requirements for a
determination of ``provider-based status.'' In paragraph (d)(1), we
would set forth licensure requirements for facilities or organizations
seeking provider-based status. Any facility or organization seeking to
be a department of a provider would have to be operated under the same
license as the main provider. We note that if a State's licensure laws
establish restrictions on the type or location of facilities or
organizations that can be licensed as part of a provider, we would
defer to those restrictions in determining whether a particular
facility is a department of the provider. For example, if the hospital
licensure laws of a particular State precluded facilities located more
than 5 miles from a hospital from being licensed as part of the
hospital, we also would not consider those facilities to be a part of
the hospital. Provider-based entities would not have to be operated
under the same license as the main provider, since in most cases we
expect that they would be separately licensed by the State. To take
account of possible State-by-State differences in licensure, however,
we would require only that a prospective provider-based entity be
licensed in accordance with the law of the State in which it is
located.
    In addition, if a State health facilities' cost review commission,
or other agency that has authority to regulate the rates charged by
hospitals or other providers in a State, finds that a particular
facility or organization is not part of a provider, we also would
determine that the facility or organization does not have provider-
based status. We believe it would be inappropriate for a facility or
organization to be considered free-standing for State ratesetting
purposes, but provider-based status under Medicare.
    In paragraph (d)(2), we would require that a facility or
organization be under the ownership and control of the main provider.
In particular, we would require that the facility or organization be
100 percent owned by the provider, that the main provider and a
facility or organization seeking provider-based status have the same
governing body, and that the facility or organization be operated under
the same organizational documents as the main provider. For example,
the facility seeking provider-based status would have to be subject to
the bylaws and operating decisions of the governing body of the main
provider. In addition, we would require that the main provider have
final responsibility for administrative decisions, final approval for
outside contracts, final responsibility for personnel policies, and
final approval for medical staff appointments in the department or
entity.
    In paragraph (d)(3), with respect to administration and direct
supervision of the main provider, we are proposing to require that a
facility or organization seeking provider-based status have a reporting
relationship to the main provider that is characterized by the same
frequency, intensity, and level of accountability that exists in the
relationship between the main provider and one of its departments. As
evidence of this relationship, we would look to whether the facility is
under the direct supervision of the provider where it is located,
whether it is operated under the same monitoring and oversight as any
other department of the provider, and is operated as any other
department with respect to supervision and accountability. We would
expect the director or individual responsible for daily operations at
the facility or organization to maintain a day-to-day reporting
relationship with a manager at the main provider and to be accountable
to the main provider's governing body in the same manner as any
department head of the provider. We also would require integration of
certain

[[Page 47591]]

administrative functions, in particular, billing services, records,
human resources, payroll, employee benefit package, salary structure,
and purchasing services. Either the same employee or group of employees
would have to handle these administrative functions for both the
facility or organization and the main provider, or the administrative
functions for the entity and the main provider would have to be
contracted out under the same contractual agreement, or be handled
under different contract agreements, with the entity's contract being
managed by the main provider's billing department.
    In paragraph (d)(4), we are proposing that a facility or
organization seeking provider-based status and the main provider share
integrated clinical services, as evidenced by privileging of the
professional staff of the department or entity at the main provider,
and the main provider's maintenance of the same monitoring and
oversight of the department or entity as of other departments. Also,
the medical director of the department or entity must maintain a day-
to-day reporting relationship with the chief medical officer (or
equivalent) of the main provider, and be under the same supervision as
any other director of the main provider. We also would expect medical
staff committees or other professional committees of the main provider
to be responsible for medical activities in the department or entity,
including quality assurance, utilization review, and the coordination
and integration of services. We also would expect medical records to be
integrated into a unified retrieval system. We would expect that
inpatient and outpatient services of the facility or organization and
the main provider be integrated and that patients treated at the
facility or organization who require further care have full access to
all services of the main provider, including all inpatient or
outpatient services of the main provider.
    In paragraph (d)(5), we would require that the proposed department
or entity and the main provider be fully financially integrated within
the main provider's financial system, as evidenced by the sharing of
income and expenses. The department's or entity's costs should be
reported in a cost center of the provider, and the department's or
entity's financial status should be incorporated into, and readily
identifiable in, the main provider's trial balance.
    In paragraph (d)(6), we would require that the main provider and
the facility seeking status as a department of the provider be held out
to the public as a single entity, so that when patients enter the
department they are aware that they are entering the provider and will
be billed accordingly. (This requirement would not apply to a provider-
based entity that is itself a provider, such as a SNF.)
    In paragraph (d)(7), we would require that the department of a
provider or provider-based entity and the main provider be located on
the same campus. Alternatively, the main provider and facility seeking
provider-based status must demonstrate that they serve the same patient
population. The department or entity and the main provider would be
required to demonstrate that they serve the same patient population by
submitting patient lists and/or demographic data showing that a high
percentage of the patients of both come from the same geographic area,
or that patients of the entity also receive a preponderance of services
from the main provider. We would specify that a facility or
organization is not considered to be in the ``immediate vicinity'' of
the main provider if it is located in a different State than the main
provider. We welcome comments as to whether an exception should be made
for areas where a single metropolitan area may include two or more
States.
    New paragraph (e) would specifically prohibit the approval of
provider-based status for any proposed department or entity that is
owned by two or more providers engaged in a joint venture. Some
hospitals, under joint venture arrangements, are jointly purchasing or
jointly creating free-standing facilities. Although the facility or
organization is operated by two or more hospitals, the dominant
hospital claims the free-standing facility or organization as a
department or provider-based entity. This is clearly unallowable,
because the facility or organization is owned by more than one
hospital, and in its own right must be considered as free-standing,
subject to all of the rules and certifications that govern that type of
operation.
    In proposed paragraph (f), we would state that facilities or
organizations operated under management contracts will be considered
provider-based only if specific requirements for staff employment,
administrative functions, day-to-day control of operations, and holding
of the management contract by the provider itself rather than by a
parent organization are met. Generally, we believe it would be
difficult for any facility or organization operated under a management
contract to provide all services to be able to demonstrate the degree
of integration with a provider that would be needed to qualify for
provider-based status. Thus, we are proposing to adopt these
requirements, which are designed to ensure that we treat a facility or
organization under a management contract as provider-based only if it
clearly is operated by the provider, not by the management company or
by a common parent organization.
    In proposed paragraph (g), we would specify nine obligations of
hospital outpatient departments and hospital-based entities. These
obligations are spelled out in detail to help us ensure that facilities
seeking recognition as hospital outpatient departments or hospital-
based entities are in fact what they represent themselves as being, and
are not simply the private offices of individual physicians or of
physicians in group practices. The obligations are--

--In the case of hospital outpatient departments located off the main
provider campus, compliance with the anti-dumping requirements in
Secs. 489.20 (l), (m), (q), and (r) and 489.24. If any individual comes
to any hospital-based entity (including an RHC) located on the main
hospital campus and a request is made on the individual's behalf for
examination or treatment of a medical condition, as described in
Sec. 489.24, the hospital must comply with the anti-dumping
requirements in Sec. 489.24. We would also revise Sec. 489.24(b) to
clarify that for purposes of the anti-dumping rules set forth in that
section, hospital property means the entire main hospital campus,
including the parking lot, sidewalk, and driveway, as well as any
facility or organization that is located off the main hospital campus
but has been determined under Sec. 413.65 to be a department of the
hospital.
--Billing of physician services in hospital outpatient departments or
hospital-based entities (other than RHCs) with the correct site-of-
service indicator, so that applicable site-of-service reductions to
physician and practitioner payment amounts can be applied;
--In the case of hospital outpatient departments, compliance with all
the terms of the provider agreement;
--Compliance by physician staff with the nondiscrimination provisions
in Sec. 489.10(b) of this chapter;
--In the case of hospital outpatient departments (other than RHCs),
representation to other payers as an outpatient department of the
hospital, and treatment of all patients, for billing purposes, as
hospital outpatients;

[[Page 47592]]

--In the case of hospital outpatient departments or hospital-based
entities, compliance with the payment window provisions applicable
under Sec. 412.2(c)(5) (for PPS hospitals) or Sec. 413.40(c)(2) (for
PPS-excluded hospitals);
--In the case of hospital outpatient departments or hospital-based
entities (other than RHCs), notice to each beneficiary treated that he
or she will be liable for coinsurance for a facility visit as well as
for the physician service; and
--In the case of hospital outpatient departments, compliance with
applicable Medicare hospital conditions of participation for hospitals
in part 482 of this chapter.

    We would also preclude any facility or organization that furnishes
all services under arrangements from qualifying as provider-based. We
believe the provision of services under arrangement was intended to be
allowed only to a limited extent, in situations where cost-
effectiveness or clinical considerations, or both, necessitate the
provision of services by someone other than the provider's own staff.
The ``under arrangement'' provision in section 1861(w)(1) of the Act
and Sec. 409.3 is not intended to allow a facility merely to act as a
billing agent for another. We are concerned that this would be the case
if all services at a facility or organization seeking provider-based
status were furnished under arrangement. We believe use of arranged-for
services could, if not limited, become a means of circumventing the
provider-based requirements. We are proposing in paragraph (g)(10) that
a facility or organization may not qualify for provider-based status if
all of the services furnished at the facility are furnished under
arrangements. We note that this approach is consistent with existing
policy under which a hospital outpatient is expected to receive
services, rather than supplies, directly from the hospital.
    Proposed paragraph (h) states that if we learn of a provider that
has inappropriately treated a facility or organization as provider-
based, before obtaining our determination of provider-based status, we
would reconsider all payments to that main provider for periods subject
to reopening, investigate, and determine whether the designation was
appropriate. If we find it was not provider-based, we will recover all
payments in excess of those payments that should have been made in the
absence of the provider-based status. As explained further below,
however, recovery will not be made for any period prior to the
effective date of this rule if during all of that period the management
of the facility or organization made a good-faith effort to operate it
as a department of a provider or provider-based entity.
    In proposed paragraph (i), we would detail the application of the
principles in paragraph (h) to situations involving inappropriate
billing for services furnished in a physician office or other facility
or organization as if they had been furnished in a hospital outpatient
or other department of a provider or in a provider-based entity.
Generally, when such cases of inappropriate billing are found, we will
recover any overpayments as described in the preceding paragraph. Under
certain circumstances, however, we will determine that the management
of a facility or organization has made a good faith effort to operate
it as a department of a provider or a provider-based entity and will
not recover past payments. We would take this action if we determine
that the requirements regarding licensure and public awareness in
paragraphs (d)(1) and (d)(6) are met, all facility services were billed
as if they had been furnished by a department of the main provider or a
provider-based entity of the main provider, and all professional
services of physicians and other practitioners were billed with the
correct site-of-service indicator, as described in paragraph (g)(4).
    We are also proposing to add a new paragraph (j) that would allow
HCFA to review past determinations. If we find that a designation was
in error, and the facility or organization in question does not meet
the requirements of this section, we will notify the main provider that
the provider-based status will cease as of the first day of the next
cost report period following notification of the redetermination.
    In addition, we are proposing to add to Sec. 413.24(d) new
paragraphs (6)(i) and (6)(ii) to clarify that main providers, in
completing their Medicare cost reports, may not allocate overhead costs
to the provider-based or other cost centers that incur similar costs
directly through management contracts or other arrangements. These
changes are needed to prevent mis-allocation of management costs, which
would result in excessive payment to those types of providers paid on a
reasonable cost basis.
    As the number of affiliation agreements among various entities has
increased, there has been a noticeable shift in the way the HHAs and
clinics have been managed, resulting in increased Medicare payments.
Today, there are many management companies that enter into contracts
with main providers to manage their provider-based entities, and the
costs of these management services are being directly assigned to the
department or provider-based entity receiving the service. The
contracts typically call for the management company to provide the
billing and accounting services, and to procure services, such as
housekeeping, laundry and linen, to enable the department or provider-
based entity to operate away from the campus and supervision of the
main provider, even though these management companies must report to
the board of the main provider. In addition to directly assigning these
costs to the department or provider-based entity, the main provider,
through the cost report, is still allocating overhead costs to the
department or provider-based entity, even though these services are
being performed through the management contract and not through the
main provider. Under these circumstances, the provider could be paid
three times for the same overhead cost. The first payment would be made
through the PPS payment, which reflects overhead cost. The second
payment would come through the cost of the management contract, and the
third would come through the allocation of a share of the main
provider's overhead cost to the department or provider-based entity.
Our proposed changes to Sec. 413.24 are needed to prevent this result.
    To provide an administrative appeals process for entities that have
been denied provider-based status, we are proposing to revise the
regulations on provider appeals at Sec. 498.3. As revised, these rules
would specify that a provider seeking a determination that a facility
or an organization is a department of the provider or a provider-based
entity under proposed Sec. 413.65 will be included in the definition of
``prospective provider'' for purposes of part 498, and will be afforded
the same appeal rights as a prospective provider, such as a hospital or
SNF, that has been found by HCFA not to qualify for participation as a
provider. We believe it is in the best interest of both HCFA and health
care organizations to have an explicit procedure for handling these
appeals.

F. Requirements for Payment

    The following discussion sets out the requirements that must be met
to allow us to make payment under the outpatient PPS for various
services.

[[Page 47593]]

1. Prerequisites for Payment for Outpatient Hospital Services and
Supplies Incident to Physician Services
    Medicare Part B benefits include payment for services and supplies
that are furnished incident to the professional services of a
physician. Medicare makes payment for services and supplies furnished
in physician offices that are incident to a professional service of a
physician under the provisions of the Medicare physician fee schedule
(section 1848 and section 1861(s)(2)(A) of the Act; 42 CFR part 414).
Payment for the ``incident to'' services furnished in physician offices
is generally included within the fee for the physician services.
Medicare also makes payment for hospital services and supplies that are
incident to a physician service furnished to outpatients (section
1861(s)(2)(B) of the Act). Payment for ``incident to'' services
furnished to hospital outpatients is in addition to payment for the
professional services of a physician. The place where ``incident to''
services are furnished determines how Medicare pays for them.
    We are proposing to add to the regulations certain prerequisites
that the hospital must fulfill before it can receive Medicare payment
under section 1861(s)(2)(B) of the Act for services and supplies
furnished ``incident to'' physician services at a site that is off the
premises of the main hospital complex. These prerequisites are intended
to adapt our current policy regarding payment for ``incident to''
services furnished to hospital outpatients to address the special
circumstances presented by a hospital outpatient department or clinic
that is not co-located on the hospital campus or within a short
distance of the hospital and that HCFA has designated is a department
of the hospital or ``provider-based.''
    The first prerequisite is that the office/clinic meet the
responsibilities and criteria incumbent upon a provider-based entity as
defined in Sec. 413.65(g). We are proposing this requirement because
the fact that a hospital owns and/or operates a clinic does not
automatically make that clinic an integral, subordinate part of the
hospital. If the clinic does not conform with the responsibilities and
criteria at Sec. 413.65(g), that clinic would be paid as a physician
office, and Medicare payment for services furnished at that site would
be made accordingly.
    The second prerequisite is that the hospital seek an official
determination from HCFA that the provider-based designation applies to
the proposed off-site hospital outpatient department/clinic as required
by Sec. 413.65(d). The authority to determine whether or not an entity
has provider-based status rests solely with HCFA. The criteria and
obligations that are a prerequisite of a provider-based hospital
outpatient designation are discussed earlier in this section.
    Current regulations require that, in order to be paid for as
``incident to'' services, outpatient hospital services and supplies are
to be furnished as an integral though incidental part of a physician
service (Sec. 410.27(a)(1)(ii)). In addition, as a matter of policy, we
require that the services and supplies be furnished on a physician's
order by hospital personnel and under a physician's supervision
(Intermediary Manual, section 3112.4(A)). When ``incident to'' services
are furnished on hospital premises, we assume the physician supervision
requirement to be met because staff physicians would be present nearby
within the hospital. We also allow staff in a department of the
hospital other than that of the ordering physician to supervise the
services. We equate the location of the hospital outpatient department
or hospital clinic within the hospital's walls, or their co-location on
the same campus, with being ``on the hospital premises,'' and we assume
physician supervision is always at hand. In the interests of
beneficiary health and safety, we do not believe it is reasonable,
safe, or appropriate to extend these assumptions to a hospital
outpatient department or hospital clinic that is located off-site and
that is not on the hospital premises, even if that outpatient
department or clinic is accorded provider-based status. Therefore, we
are proposing as the third prerequisite for a hospital to receive
payment for ``incident to'' services under section 1861(s)(2)(B) of the
Act, when these services are furnished at a hospital outpatient
department or clinic that HCFA designates as provider-based: that the
``incident to'' services and supplies always be furnished under the
direct supervision of a physician.
    Unless the three prerequisites are met, we are proposing to
continue to regard a clinic, even if it is owned or operated by a
hospital, as a physician office or physician clinic for Medicare
payment purposes. Payment for services and supplies incident to
physician services that are furnished to Medicare beneficiaries at that
site would only be paid in accordance with section 1848 and section
1861(s)(2)(A) of the Act, and payment would be subject to Medicare
physician fee schedule payment policies and regulations (part 410; part
414).
2. Prerequisites for Payment for Hospital or Critical Access Hospital
Diagnostic Services Furnished to Outpatients
    Prerequisites for payment for diagnostic services furnished to
hospital outpatients are addressed in Sec. 410.28. We are proposing to
add a new paragraph to the regulation that would require, at a minimum,
a general level of physician supervision, and in some cases, direct or
personal physician supervision, when diagnostic x-ray tests and other
diagnostic tests are furnished at a hospital outpatient department or
clinic that HCFA has determined meets the criteria and obligations of a
provider-based entity in accordance with Sec. 413.65. The definitions
of general, direct, and personal supervision are contained in
Sec. 410.32. Although the levels of supervision defined in Sec. 410.32
apply specifically to diagnostic x-ray and other tests that are payable
under the Medicare physician fee schedule, we believe the same levels
of supervision are equally relevant and reasonable and necessary to
ensure that beneficiary health and safety are protected and that
diagnostic x-ray and other diagnostic tests are safe and effective when
they are furnished at a hospital outpatient department or clinic that
HCFA has designated to be provider-based.
    We are also proposing to exclude from the supervision requirement
in provider-based outpatient settings the same three types of
diagnostic tests that are excluded from the supervision requirement
under the physician fee schedule:
    <bullet> Diagnostic mammography procedures, which are regulated by
the Food and Drug Administration.
    <bullet> Diagnostic tests personally furnished by a ``qualified
audiologist'' as defined in section 1861(ll)(3) of the Act. These
include ``audiology services'' as defined in section 1861(ll)(2) of the
Act. We exclude these diagnostic tests from the physician supervision
requirement because the Congress has defined these services without
requiring physician supervision of their performance.
    <bullet> Diagnostic psychological testing services personally
performed by a qualified psychologist practicing independently of an
institution, agency, or physician office as currently defined in
section 2070.2 of the Medicare Carriers Manual (HCFA Pub. 14-3). These
services are distinguished from services of a clinical psychologist,
which are covered under section 1861(ii) of the Act, rather than
section 1861(s)(3).

[[Page 47594]]

    We are proposing to coordinate changes to the physician supervision
requirements for diagnostic tests performed in outpatient settings that
HCFA has designated to be provider-based with changes made to these
requirements under the Medicare physician fee schedule. Refer to the
final rule governing the 1998 physician fee schedule that was published
in the October 31, 1997 Federal Register (``Medicare Program; Revisions
to Payment Policies and Adjustments to the Relative Value Units Under
the Physician Fee Schedule, Other Part B Payment Policies, and
Establishment of the Clinical Psychologist Fee Schedule for Calendar
Year 1998'' (BPD-884-FC) (62 FR 59048)) for a full discussion.
Implementing instructions for physician supervision of diagnostic tests
are being developed. We note that these implementing instructions will
contain revisions in the supervision levels required for many
ultrasound services, stress tests, and some other services.
    When diagnostic x-rays and other diagnostic tests are performed at
a hospital-owned and/or operated office or clinic that is off-site and
that HCFA does not designate as provider-based, we are proposing to pay
for these services under the provisions of the Medicare physician fee
schedule and the requirements of Sec. 410.32 or under the provisions of
Sec. 410.33, if applicable.
    3. Payment for Ambulatory Surgical Services
    Upon implementation of the hospital outpatient PPS, Medicare
payment for resource costs incurred in connection with performing
ambulatory surgical procedures would be made either under the
provisions of the hospital outpatient PPS; or, under the benefit
established at section 1832(a)(2)(F) of the Act for facility services
furnished by an approved ASC in connection with surgical procedures
specified by the Secretary; or, under the physician fee schedule as
established under section 1848 of the Act.
    When ambulatory surgery is performed at the hospital on Medicare
beneficiaries who are registered at the hospital as outpatients,
Medicare would allow payment under the outpatient PPS, as explained in
this proposed rule. However, Medicare would make payment under the
outpatient PPS for surgical procedures performed at an off-site clinic
that the hospital owns and operates and for which it submits claims
only if the off-site clinic has been designated by HCFA as a department
of the hospital in accordance with proposed Sec. 413.65.
    Alternatively, if the hospital-owned off-site facility is certified
or accredited in accordance with ASC conditions of coverage and the
requirements at part 416, Medicare would make payment for covered
surgical procedures performed at the off-site facility under the ASC
benefit.
    However, for Medicare payment purposes, we consider an off-site
office, clinic, organization, or facility that is owned and operated by
a hospital but that does not meet the requirements at proposed
Sec. 413.65 or in part 416, to be a physician office or clinic, and
Medicare payment for surgical procedures performed at that site would
be limited to what Medicare allows for physician services furnished in
connection with the surgical procedure under the Medicare physician fee
schedule.

VII. MedPAC Recommendations

    We reviewed the March 1998 report submitted by MedPAC to the
Congress and gave its recommendations careful consideration in
establishing the framework for the outpatient PPS that is the subject
of this proposed rule. We responded earlier to several MedPAC
recommendations that pertained directly to specific features of the
outpatient PPS. In this section, we address the more general MedPAC
recommendations on hospital outpatient payment policies.
    Recommendation: MedPAC expresses its concern about the effects of
inappropriate payment levels that could, if they are too low, restrict
beneficiary access to care or prompt shifts of services for financial
rather than clinical reasons, or that could, if they are too high,
stimulate growth in the volume of outpatient services that is unrelated
to patient needs. MedPAC states that the initial level of payment
established in the BBA is a reasonable starting point for the
outpatient PPS, but recommends that the Secretary monitor access to
hospital outpatient services to ensure that the aggregate level of
payment under the outpatient PPS is appropriate.
    Response: We agree with MedPAC that monitoring service patterns not
only in hospital outpatient departments but across all ambulatory
settings subsequent to implementation of the outpatient PPS is
essential in order to detect sudden changes and to identify variant
trends in where services are being furnished to Medicare beneficiaries.
As is MedPAC, we too are aware of how vividly any differences in
payment for services furnished in different ambulatory settings will be
revealed once the outpatient PPS is implemented, and we expect that
these differences will, not surprisingly, precipitate shifts in
services from one setting to another. It is the recognition of this
likely outcome that makes it all the more urgent that we resolve the
dilemma posed by two conflicting policy determinations raised by
MedPAC: whether to set Medicare payments to reflect the cost of
providing a service regardless of where the service is furnished or
whether to set Medicare payments to acknowledge that the site where a
service is furnished could affect the cost of furnishing the service.
As we discuss below, we clearly are inclined toward a position that
Medicare should determine payment on the basis of the service that is
furnished rather on the setting where that service is furnished, but
there are many factors still to be considered before making such a
determination final. In the meantime, we believe that the adjustments
provided for under the outpatient PPS will contribute to ensuring that
Medicare is paying adequately for services, especially in areas where a
hospital is the only provider of services to which beneficiaries have
access. We particularly welcome comments and suggestions regarding
methods by which we can enhance our monitoring of service delivery
patterns to ensure that the outpatient PPS is not adversely affecting
beneficiary access to hospital outpatient care in accordance with
MedPAC's recommendation. We agree with MedPAC's concern that payment
levels under the outpatient PPS be sufficient to support the provision
of services, especially in areas where a hospital is the only provider
of such services, but that payment levels under the outpatient PPS not
exceed payments for the same services at other ambulatory sites to such
a degree as to cause shifts in where services are provided for
financial rather than clinical reasons.
    Recommendation: MedPAC recommends that HCFA continue to investigate
service classification systems that could be applied consistently to
all ambulatory care settings. In its 1998 report to Congress, MedPAC
expresses concern about the impact on service delivery of paying
different amounts for the same service based on where the service is
furnished. MedPAC appears to favor Medicare ambulatory care payment
systems that are standardized across hospital outpatient, physician
office, and ASC settings. MedPAC equates ``standardized'' with
``policies that are comparable for the same service, regardless of
setting,'' (p. 83) and ``* * * consistency of payment across all
ambulatory settings'' (p. 84).
    Response: In principle, we agree that establishing Medicare payment

[[Page 47595]]

uniformity across ambulatory care settings is important. We have, to
the extent permitted by the statute, incorporated into the outpatient
PPS elements of Medicare payment policy for ASCs and for physician
services.
    Upon implementation of the outpatient PPS, the same unit of payment
(HCPCS codes and descriptors) will be used for all three settings.
Packaging under the outpatient PPS parallels that for ASCs. At least
initially, volume control under the outpatient PPS parallels that which
is applied to physician services. The policy for discounting multiple
procedures will be comparable under the outpatient PPS, the ASC
benefit, and the physician fee schedule. APC groups will be used to set
rates for ASC payments and for hospital outpatient surgical services,
and we propose to pay for the same surgical procedures in both
settings. Notwithstanding these similarities, payment rates for most
procedures will not be the same for ASCs and under the outpatient PPS.
We use different data and methods to set rates for ASC services, for
physician services, and for hospital outpatient services. The latter is
attributable primarily to the fact that the statute sets forth criteria
that are to be considered when setting payment mechanisms that are
specific to each site of service.
    Several fundamental issues must be addressed before we achieve the
goal of making consistent payment for the same service across all
ambulatory sites of service. First, consensus must be reached on what
constitutes ``consistent payment.'' Even MedPAC equivocates on this
point, noting that while it believes that ``Medicare's payment should
reflect the cost of efficiently providing a service, regardless of
where it is delivered * * * (b)ecause of access or quality concerns * *
* it may be appropriate to continue to pay different amounts for the
same service, depending on the setting in which it is furnished.'' Does
``consistent'' or ``comparable'' payment mean the same payment for a
service regardless of setting? Or would consistency be achieved by
using the same group weights for hospital outpatient and ASC payment
rates even though we used site-specific conversion factors, resulting
in different payment rates? Should we use ASC groups as the basis for
setting payments for physician services? Is there a single index that
is appropriate to standardize variations in costs attributable solely
to geographical differences? And which legislative changes would be
required to standardize payment for services across ambulatory
settings? These are but a few of the issues and options that we and
stakeholders across the spectrum of ambulatory care must thoroughly
examine and analyze as we move towards standardizing payments across
ambulatory sites of service. We solicit comments on this issue, on
options to be considered in restructuring Medicare payment provisions
towards the goal of establishing payment uniformity across ambulatory
sites, and on strategies for achieving consensus on the definition of
both goals and the means of attaining them.

VIII. Collection of Information Requirements

    Under the Paperwork Reduction Act of 1995, we are required to
provide 60-day notice in the Federal Register and solicit public
comment before a collection of information requirement is submitted to
the Office of Management and Budget (OMB) for review and approval. In
order to fairly evaluate whether an information collection should be
approved by OMB, section 3506(c)(2)(A) of the Paperwork Reduction Act
of 1995 requires that we solicit comment on the following issues:
    <bullet> The need for the information collection and its usefulness
in carrying out the proper functions of our agency.
    <bullet> The accuracy of our estimate of the information collection
burden.
    <bullet> The quality, utility, and clarity of the information to be
collected.
    <bullet> Recommendations to minimize the information collection
burden on the affected public, including automated collection
techniques.
    We are soliciting public comment on each of these issues for the
provisions summarized below that contain information collection
requirements:

Section 413.65  Requirements for a Determination That a Facility or an
Organization is a Department of a Provider or a Provider-Based Entity

    Section 413.65(c)(1) and (c)(2) states that a main provider that
acquires a facility or organization for which it wishes to claim
provider-based status, including any physician offices that a hospital
wishes to operate as a hospital outpatient department or clinic, must
report its acquisition of the facility or organization to HCFA and must
furnish all information needed for a determination as to whether the
facility or organization meets the requirements in paragraph (d) of
this section for provider-based status. This requirement applies,
however, only if the facility or organization is located off the campus
of the provider, or inclusion of the costs of the facility or
organization on the provider's cost report would increase the total
costs on the report by at least 5 percent. Furthermore, a main provider
that has had one or more entities considered provider-based also must
report to HCFA any material change in the relationship between it and
any provider-based facility or organization, such as a change in
ownership of the facility or organization or entry into a new or
different management contract that could affect the provider-based
status of the facility or organization.
    The burden associated with this requirement is the time for the
main provider to report its acquisition to HCFA, furnish all
information needed for a determination, report to HCFA any material
change in the relationship between it and any provider-based facility
or organization, such as a change in ownership of the facility or
organization or entry into a new or different management contract that
could affect the provider-based status of the facility or organization.
It is estimated that 105 main providers will take 10 hours for a total
of 1,050 hours.

Section 419.42  Hospital Election To Reduce Copayment

    Section 419.42(b) and (c) states that a hospital must notify its
fiscal intermediary of its election to reduce copayments no later than
90 days prior to the start of the calendar year. The hospital's
election must be properly documented. It must specifically identify the
ambulatory payment classification to which it applies and the copayment
level (within the limits identified below) that the hospital has
selected for each group.
    The burden associated with these requirements is the time it takes
a hospital to compile, review, and analyze data for both revenues and
copayments; prepare and present the data to the hospital board; make a
business decision as to whether the hospital would elect to reduce
copayments; and then notify its fiscal intermediary of its election. A
hospital would notify its fiscal intermediary of its election to reduce
copayments only if there were other providers, in close proximity, that
would attract a majority of the hospital's business if they did not
reduce their copayments. Since hospitals do not want to lose money by
absorbing copayments, we anticipate that this requirement will affect
750 hospitals and take them 10 hours each for a total of 7,500 hours.
    Section 419.42(e) states that the hospital may advertise and
otherwise disseminate information concerning the reduced level(s) of
coinsurance that it has elected.

[[Page 47596]]

    The burden associated with this requirement is the time for the
hospital to disseminate information concerning its coinsurance
election. It is estimated that 750 hospitals will each take 10 hours
annually to disseminate this information via newsletters and
information sessions at senior citizen centers for a total of 7,500
hours.
    While the information collection requirements listed below are
subject to the Paperwork Reduction Act, the burden associated with
these requirements is captured under Sec. 413.65(c)(1) and (c)(2).
    Section 413.65(b)(2) states that a provider or a facility or
organization must contact HCFA and the facility or organization must be
determined by HCFA to be provider-based before the main provider begins
billing for services of the facility or organization as if they were
furnished by a department of the provider-based entity, or before it
includes costs of those services on its cost report.
    Section 413.65(d)(7)(i) requires that the facility or organization
demonstrates a high level of integration with the main provider by
showing that it meets all of the other provider-based criteria, and
demonstrates that it serves the same patient population as the main
provider, either by submitting records such as common patient lists
and/or demographic data showing that a high percentage of patients of
both the main provider and the applicant entity come from the same
geographic area, or by submitting data substantiating that the patients
served by the entity also receive services from the main provider (for
example, the patients of an RHC receive inpatient hospital services
from the main provider).
    While the information collection requirements listed below are
subject to the Paperwork Reduction Act, we believe the burden
associated with these requirements is not subject to the Act, as
defined by 5 CFR 1320.3(b)(2), because the time, effort, and financial
resources necessary to comply with these requirements would be incurred
by persons in the normal course of their activities.
    Section 413.65(g)(7) states that when a Medicare beneficiary is
treated in a hospital outpatient department or hospital-based entity,
the hospital has a duty to notify the beneficiary, prior to the
delivery of services, of the beneficiary's potential financial
liability (that is, a coinsurance liability for a facility visit as
well as for the physician service).
    We believe the information collection requirement below is exempt
from the Paperwork Reduction Act, as defined by 5 CFR 1320.4(a)(2),
since this activity is pursuant to the conduct of an investigation or
audit against specific individuals or entities.
    Section 413.65(i)(1) states that if HCFA determines that a provider
has been inappropriately billing Medicare for services furnished in a
physician office or other facility or organization as if they had been
furnished in a hospital outpatient department or other department of a
provider or in a provider-based entity, HCFA stops all payments to the
provider for outpatient services until the provider can demonstrate
which payments are proper.
    The table below indicates the annual number of responses for each
regulation section in this proposed rule containing information
collection requirements, the average burden per response in minutes or
hours, and the total annual burden hours.

                                             Estimated Annual Burden
----------------------------------------------------------------------------------------------------------------
                                                                                      Average
                                                                                    burden per     Annual burden
                           CFR section                               Responses       response          hours
                                                                                      (hours)
----------------------------------------------------------------------------------------------------------------
413.65(c)(1) and (c)(2).........................................             105              10           1,050
419.42(b) and (d)...............................................             750              10           7,500
419.42(f).......................................................             750              10           7,500
                                                                 -----------------------------------------------
    Total.......................................................                                          16,050
----------------------------------------------------------------------------------------------------------------

    We have submitted a copy of this proposed rule to OMB for its
review of the information collection requirements. These requirements
are not effective until they have been approved by OMB. A notice will
be published in the Federal Register when approval is obtained.
    If you comment on any of these information collection and record
keeping requirements, please mail copies directly to the following:

Health Care Financing Administration, Office of Information Services,
Information Technology Investment Management Group, Division of HCFA
Enterprise Standards, Room C2-26-17, 7500 Security Boulevard,
Baltimore, MD 21244-1850, Attn: Louis Blank HCFA-1005-P, Fax number:
(410) 786-1415 and,
Office of Information and Regulatory Affairs, Office of Management and
Budget, Room 10235, New Executive Office Building, Washington, DC
20503, Attn.: Allison Herron Eydt, HCFA Desk Officer, Fax numbers:
(202) 395-6974 or (202) 395-5167.

IX. Response to Comments

    Because of the large number of items of correspondence we normally
receive on Federal Register documents published for comment, we are not
able to acknowledge or respond to them individually. We will consider
all comments we receive by the date and time specified in the ``DATES''
section of this preamble, and, if we proceed with a subsequent
document, we will respond to the comments in the preamble to that
document.

X. Regulatory Impact Analysis

A. Introduction

    We have examined the impacts of this proposed rule as required by
Executive Order 12866, the Unfunded Mandates Reform Act of 1995, and
the Regulatory Flexibility Act (RFA) (Public Law 96-354). Executive
Order 12866 directs agencies to assess all costs and benefits of
available regulatory alternatives and, when regulation is necessary, to
select regulatory approaches that maximize net benefits (including
potential economic, environmental, public health and safety effects,
distributive impacts, and equity). A regulatory impact analysis (RIA)
must be prepared for major rules with economically significant effects
($100 million or more annually). Because the projected savings
resulting from this proposed rule are

[[Page 47597]]

expected to exceed $100 million, it is considered a major rule.
    The Unfunded Mandates Reform Act of 1995 also requires (in section
202) that agencies prepare an assessment of anticipated costs and
benefits for any rule that may result in an annual expenditure by
State, local, or tribal governments, in the aggregate, or by the
private sector, of $100 million. This proposed rule does not mandate
any requirements for State, local, or tribal governments. However, our
estimations indicate that the loss of income to the private sector as a
result of this rule should exceed $300 million total to all hospitals.
    We generally prepare a regulatory flexibility analysis that is
consistent with the RFA (5 U.S.C. 601 through 612), unless we certify
that a proposed rule would not have a significant economic impact on a
substantial number of small entities. For purposes of the RFA, we
consider all hospitals to be small entities.
    Also, section 1102(b) of the Social Security Act requires us to
prepare a regulatory impact analysis for any proposed rule that may
have a significant impact on the operations of a substantial number of
small rural hospitals. Such an analysis must conform to the provisions
of section 603 of the RFA. With the exception of hospitals located in
certain New England counties, for purposes of section 1102(b) of the
Act, we define a small rural hospital as a hospital with fewer than 100
beds that is located outside of a Metropolitan Statistical Area (MSA)
or New England County Metropolitan Area (NECMA). Section 601(g) of the
Social Security Amendments of 1983 (Public Law 98-21) designated
hospitals in certain New England counties as belonging to the adjacent
NECMA. Thus, for purposes of the proposed prospective payment system,
we classify these hospitals as urban hospitals.

B. Estimated Impact on Medicare Program

    According to HCFA's Office of the Actuary, the benefit impacts of
the hospital outpatient PPS (including elimination of the formula-
driven overpayment (FDO) effective as of October 1, 1997, extension of
the 10 percent reduction in payments for hospital outpatient capital
cost and the 5.8 percent reduction for outpatient services paid on a
cost basis through CY 1999, and the implementation of a PPS for
hospital outpatient services on January 1, 1999 would be as follows:

------------------------------------------------------------------------
                                                            Impact  ($
                       Fiscal year                           millions)
------------------------------------------------------------------------
1998....................................................            -940
1999....................................................           -1650
2000....................................................           -1330
2001....................................................           -1070
2002....................................................            -990
2003....................................................            -680
------------------------------------------------------------------------

The use of the national median of the charges for PPS services to
establish the unadjusted copayment amount would have resulted in the
beneficiaries paying 6.9 percent less in coinsurance payments in 1999
than what they would have been expected to pay otherwise. It was
assumed that there would have been a behavioral offset by the hospitals
of 10 percent of the coinsurance reduction. It was assumed that 45
percent of this offset would apply to the services subject to the PPS
and, therefore, would have been included in setting the 1999 conversion
factor. The remaining 55 percent of the offset would be reflected in
expenditures for non-PPS services with both the beneficiary and
Medicare absorbing this impact. With the delay in implementation of the
outpatient PPS, the behavioral offset will not occur in 1999, and,
therefore, there will be slightly higher program savings.

C. Objectives

    The primary objective of the proposed prospective payment system is
to simplify the payment system while at the same time ensuring that
payments are sufficient to adequately compensate hospitals for their
legitimate costs. In addition, we share national goals of deficit
reduction and restraints on government spending in general.
    We believe the proposed changes would further each of these goals
while maintaining the financial viability of the hospital industry and
ensuring access to high quality health care for Medicare beneficiaries.
We expect that these proposed changes would ensure that the outcomes of
this payment system are reasonable and equitable while avoiding or
minimizing unintended adverse consequences.

D. Limitations of our Analysis

    The following quantitative analysis presents the projected effects
of our proposed policy changes, as well as statutory changes, on
various hospital groups. We use the best data available; in addition,
we do not make adjustments for future changes in such variables as
volume and intensity. As we have done in previous proposed rules, we
are soliciting comments and information about the anticipated effects
of these changes on hospitals and our methodology for estimating them.

E. Hospitals Included in and Excluded From the Prospective Payment
System

    The outpatient prospective payment system encompasses nearly all
hospitals that participate in the Medicare program. However, those
services furnished by Maryland hospitals that are paid under a cost
containment waiver in accordance with section 1814(b)(3) of the Act are
excluded from the PPS. Critical access hospitals (CAHs) are also
excluded and are paid at cost under section 1834(g).

F. Quantitative Impact Analysis of the Proposed Policy Changes Under
the Prospective Payment System for Operating Costs and Capital Costs

Basis and Methodology of Estimates
    The data used in developing the quantitative analyses presented
below are taken from the CY 1996 cost and charge data and the most
current provider-specific file that is used for payment purposes. Our
analysis has several qualifications. First, we draw upon various
sources for the data used to categorize hospitals in the tables. In
some cases, there is a fair degree of variation in the data from
different sources. We have attempted to construct these variables with
the best available source overall. For individual hospitals, however,
some miscategorizations are possible.
    Using CY 1996 cost and charge data, we simulated payments using the
current and proposed payment methodologies. We used both single and
multiple bills to calculate current and proposed Medicare and
beneficiary hospital outpatient payment amounts. Both current and
proposed payment estimates include operating and capital costs. The
exempted Maryland hospitals were excluded from the simulations;
however, we included the 10 cancer hospitals that will be paid under
the proposed system.
    We also trimmed outlier hospitals from the impact analysis because
we had indications that hospitals with extreme unit costs would not
allow us to assess the impacts among the various classes of hospitals
accurately. First, we identified all the outlier hospitals by using an
edit of three standard deviations from the mean of the logged unit
costs. Trimming the data in this manner ensures that only the hospitals
with extremely high and low costs are eliminated from the impacts. In
doing this, we removed 83 hospitals of which 32 hospitals had extremely
low unit costs and 51 hospitals had extremely

[[Page 47598]]

high unit costs. We conducted a thorough analysis of these hospitals to
ensure that we did not remove any particular type of hospital (for
example, teaching hospitals) that would further harm the integrity of
the data. We speculate many of these hospitals are not coding
accurately, and we will continue to perform further analysis in this
area after implementation of the new APC system.
    After removing the 54 exempted Maryland hospitals, outlier
hospitals, and hospitals for which we could not identify payment
variables, we included 5,419 hospitals in our analysis. The impact
analysis focuses on this set of hospitals. The table below demonstrates
the results of our analysis. The table categorizes hospitals by various
geographic and special payment consideration groups to illustrate the
varying impacts on different types of hospitals. The first column
represents the number of hospitals in each category. The second column
is the hospitals' Medicare outpatient payments as a percentage of the
hospitals' total Medicare payment. The third column shows the
percentage change in Medicare outpatient payments comparing the current
and proposed payment systems. The fourth column shows the change in
total Medicare payments, resulting from implementing the PPS for
outpatient services.
    The top row of the table shows the overall impact on the 5,419
hospitals included in the analysis. We included as much of the data as
possible to the extent that we were able to capture all the provider
information necessary to determine payment. Further, our estimates
include the same set of services for both current and proposed APC
payments so that we could determine the impact as accurately as
possible. Since payment under the proposed APC system can only be
determined if bills are accurately coded, the data upon which the
impacts were developed do not reflect all CY 1996 hospital outpatient
services, but only those that were coded using valid HCPCS.
    The second row identifies the hospitals in our analysis with the
exception of psychiatric, long-term care, children, and rehabilitation
hospitals, which account for 4,864 hospitals.
    The next four rows of the table contain hospitals categorized
according to their geographic location (all urban, which is further
divided into large urban and other urban, or rural). There are 2,677
hospitals located in urban areas (MSAs or NECMAs) included in our
analysis. Among these, there are 1,516 hospitals located in large urban
areas (populations over 1 million), and 1,161 hospitals in other urban
areas (populations of 1 million or fewer). In addition, there are 2,187
hospitals in rural areas. The next two groupings are by bed-size
categories, shown separately for urban and rural hospitals. The next
category includes the volume of outpatient services, also shown
separately for urban and rural hospitals. The final groupings by
geographic location are by census divisions, also shown separately for
urban and rural hospitals.
    The next three groupings examine the impacts of the proposed
changes on hospitals grouped by whether or not they have residency
programs (teaching hospitals that receive an indirect medical education
(IME) adjustment), receive disproportionate share hospital (DSH)
payments, or some combination of these two adjustments. There are 3,847
non-teaching hospitals in our analysis, 766 teaching hospitals with
fewer than 100 residents, and 250 teaching hospitals with 100 or more
residents.
    In the DSH categories, hospitals are grouped according to their DSH
payment status. The next category groups hospitals considered urban
after geographic reclassification, in terms of whether they receive the
IME adjustment, the DSH adjustment, both, or neither. The next five
rows examine the impacts of the proposed changes on rural hospitals by
special payment groups (rural referral centers (RRCs), sole community
hospitals/essential access community hospitals (SCHs/EACHs), Medicare
dependent hospitals (MDHs), and SCHs and RRCs), as well as rural
hospitals not receiving a special payment designation. The RRCs (168),
SCH/EACHs (625), MDHs (365), and SCH and RRCs (55) shown here were not
reclassified for purposes of the standardized amount.
    The next grouping is based on type of ownership. These data are
taken primarily from the FY 1995 Medicare cost report files, if
available (otherwise, FY 1994 data are used).
    The next groupings are the specialty hospitals. The first set
includes the categorizations of eye and ear hospitals and trauma
hospitals (hospitals having a level one trauma center) and cancer
hospitals. The final groupings are the TEFRA hospitals, specifically
rehabilitation, psychiatric, long-term care, and children hospitals.

G. Estimated Impact of the New APC System

    Column 3 compares our estimate of payments, incorporating statutory
and policy changes reflected in this proposed rule for CY 1996, to our
estimate of payments in CY 1996 under the current payment system.
Percent differences between current and proposed payment reflect the
combined impact of a proportionally equal reduction in payments due to
the calculation of the conversion factor and distributional differences
attributable to variation in cost and charge structures among
hospitals. The methodology described in section 1833(t)(3)(C) of the
Act outlining the calculation of the conversion factor reduces payment
to hospitals overall by 3.8 percent relative to current law. As noted,
section 1833(t)(3)(C) of the Act requires us to set the conversion
factor so that total 1999 payments to hospitals under the proposed PPS
system equal Medicare payment amounts as calculated under the current
payment system plus beneficiary copayments as calculated under the
proposed system (20 percent of the APC median charge or, at minimum, 20
percent of the APC rate). The 3.8 percent loss implies that the
difference between the median and charges higher than the median was
proportionally larger than the difference between the median and
charges lower than the median. Because this reduction is incorporated
into the conversion factor, the 3.8 percent is distributed among
hospitals proportional to their total payments. After removing the
effect of the conversion factor calculation on total payments, the
remaining percent differences demonstrate the redistribution of
payments among hospitals and can be attributed to variation in both
costs and charge structures. Variation in costs among hospitals results
in differences between current and proposed Medicare payments, and
variation in charge structures results in differences between current
and proposed beneficiary copayment.
    Redistributions may also occur as a result of current payment
methods. Total Medicare outpatient payments are less than reported
total costs because (in addition to the 5.8 and 10 percent reductions
for operating and capital costs) the blended payment methods applicable
to many surgical and diagnostic services often result in payments that
are less than reported costs. Other services such as medical visits,
chemotherapy services, partial hospitalization services, and non-ASC
approved surgeries are paid based on hospital costs. The new system
redistributes the current total Medicare payments, based in part on
cost-based payments and in part on blended

[[Page 47599]]

payment amounts, across all services. Hospitals, in the aggregate, will
receive proportionately less for services that are currently paid based
on costs and more for services that had been paid under blended payment
methods.
    The impact on TEFRA hospitals is shown separately at the end of the
table; however, these hospitals were not included in determining the
impact on any of the other categories (for example, geographic
location, bed size, volume, etc.). These hospitals demonstrated a very
low service mix, but an average unit cost that is only somewhat smaller
than the national average. We believe that billing practices may
account for this phenomenon. Some TEFRA hospitals appear to under-code
HCPCS and units. This may be because correct coding is not required for
payment or because they bill an all-inclusive rate. Undercoding or
billing an all-inclusive rate could account for their low volume, low
service mix, and almost average cost per unit. We expect that once
these hospitals begin to code HCPCS according to the new payment
system, new payments will better reflect current payments.
    In general, differences among hospital classifications for short-
term acute care hospitals were relatively small. That is, payments
under the proposed outpatient system were within a few percentage
points of payments made under current law. The following discussion
highlights some of the variation in payments among hospital
classifications.
    Based on comparing current and proposed payment estimates, minor
teaching hospitals lose 1.8 percent, while major teaching hospitals
experience a reduction of 9.4 percent. Non-teaching hospitals
experience a decrease of 3.1 percent. However, major teaching hospitals
gain less of their total Medicare income (9.2 percent) from outpatient
services than the national average (10 percent). This results in a less
than 1 percent loss in their total Medicare income.
    Hospitals with a high percentage of low income patients
(disproportionate share patient percentage <ls-thn-eq> 0.35) appear to
experience payment reductions of 6.8 percent relative to current law.
These hospitals have lower than average volume, and, like major
teaching hospitals, they receive a smaller than average percent of
their Medicare income from outpatient services.
    Rural hospitals would lose about 5.2 percent and large urban
hospitals would lose about 5.0 percent under the new system while other
urban hospitals would lose 0.9 percent. These small differences
illustrate fairly equitable payment among these geographical settings.
However, rural hospitals get a greater percentage of their Medicare
income (14.7 percent) from outpatient services compared to the national
average of 10 percent.
    Low-volume hospitals appear to lose a large percentage of their
payments under the new payment system (17 percent for rural and 15.6
percent for urban hospitals with less than 5,000 units of service). We
believe several factors are contributing to this outcome, including
undercoding, lack of economies of scale, and underpayment due to the
reliance on the median instead of the geometric mean in the calculation
of APC weights. The majority of these hospitals (about 75 percent) are
rural. These hospitals also have a service mix (1.03) lower than the
national average (1.45) and higher than average hospital cost per unit
standardized for service mix. For these small hospitals, some of the
higher standardized unit costs could be attributed to economies of
scale. These low-volume rural hospitals also receive a greater
percentage of their Medicare income (18.2 percent) from outpatient
services than the average. SCHs and MDHs comprise about 60 percent of
these low-volume rural hospitals.
    As discussed previously in section V.I, the Adjustments section, we
are particularly concerned about the potential impact on the
approximately 60 percent of low-volume rural hospitals that are sole
community hospitals or Medicare-dependent hospitals. As previously
discussed, one option would be to phase-in the outpatient PPS for low-
volume Medicare-dependent and sole community hospitals by paying a
portion of the payment based on PPS rates and a portion based on the
current payment system. For example, payment could be based on 75
percent of payments under the current system and 25 percent on PPS
rates in the first year, 50 percent current system payments and 50
percent PPS rates in the second year, 25 percent current system
payments and 75 percent PPS rates in the third year, and completely on
PPS rates in subsequent years. If such an approach were adopted, the
impact on Medicare outpatient payment for these hospitals would be as
follows:

     Estimated Impact of a Transition Policy on Medicare Outpatient Payments for Medicare-Dependent and Sole
                                               Community Hospitals
                                                  [In percent]
----------------------------------------------------------------------------------------------------------------
                                                      Year 1          Year 2          Year 3          Year 4
----------------------------------------------------------------------------------------------------------------
MDH.............................................            -2.1            -4.3            -6.4            -8.5
SCH.............................................            -1.7            -3.3            -5.0            -6.7
SCH/RRC.........................................            -0.5            -1.0            -1.6            -2.1
----------------------------------------------------------------------------------------------------------------

    Another option discussed earlier in the adjustments section would
phase-in outpatient PPS if a low-volume sole community or Medicare-
dependent hospital has a negative Medicare margin for outpatient
services. For example, payment could be based on the amount payable
under outpatient PPS plus a percentage of the difference between those
amounts and the amounts payable under the current system. The
percentage of the difference that would be payable could phase down,
for example, 75 percent in the first year, 50 percent in the second
year, 25 percent in the third year, and no additional payment in
subsequent years. We solicit comments on these and other alternatives
we could consider.
    As noted above, rural hospitals lose a larger percent of their
payments than urban hospitals. Among the census divisions, rural New
England hospitals experience the largest negative payment impact of
13.6 percent. This could be attributed to higher non-labor costs in New
England. West North Central hospitals also would experience a 7.7
percent payment loss.
    Urban census division breakouts reveal that Middle Atlantic urban
hospitals lose 11.3 percent of payments while the other urban census
regions gain or lose modestly.
    Hospitals located in Puerto Rico gain because of the change in the
beneficiary copayment. Previously these hospitals received 20 percent
of their charges from the beneficiary, whereas under the

[[Page 47600]]

new PPS they would receive 20 percent of the APC median charge or, at
minimum, they would receive 20 percent of the payment rate. Hospitals
in Puerto Rico gain under the new proposed system because 20 percent of
their charges are lower than 20 percent of the APC median charges or 20
percent of the rates.
    Among special categories of rural hospitals, MDHs and SCHs/EACHs
would experience decreases of 8.5 and 6.7 percent, respectively. Some
of this decrease may be attributed to the impact on low-volume rural
hospitals.
    Cancer hospitals experience a 29.2 percent loss. Several factors
may contribute to this loss. Under-coding could be a factor
contributing to the percentage loss. In addition, the current
requirements for batch billing of services such as chemotherapy and
radiation therapy and the fact that we used only single procedure bills
to calculate group weights may also have contributed to the impact on
these hospitals. Further analysis will be conducted to determine if
current coding practices explain the negative impact. We will be
verifying the accuracy of the rates for these types of procedures.
Specifically, the APC weights were calculated using single bill
procedures. Using single bill procedures to compute a weight for
services which are not typically billed as a single procedure could
result in rates that are not accurate for these services. We will
verify the accuracy of the rates for these types of procedures by
analyzing the costs from the multiple bills. If further analysis
reveals that cancer hospitals would be unduly harmed because of the new
outpatient PPS, we will consider whether an adjustment or perhaps a
transition period is needed to moderate the impact. By statute, any
adjustment would have to be budget neutral. Until further analysis can
be conducted we are not proposing an adjustment for cancer hospitals.
    In accordance with the provisions of Executive Order 12866, this
regulation was reviewed by the Office of Management and Budget.

BILLING CODE 4120-01-P

[[Continued on page 47601]]