Department of Health and Human Services 
OFFICE OF 
INSPECTOR GENERAL 
HOSPITAL OWNERSHIP OF 
PHYSICIAN PRACTICES 
JUNE GIBBS BROWN 
Inspector General 
SEPTEMBER 1999 
OEI-05-98-00110  OFFICE OF INSPECTOR GENERAL 
The mission of the Office of Inspector General (OIG), as mandated by Public Law 95-452, is to 
protect the integrity of the Department of Health and Human Services programs as well as the 
health and welfare of beneficiaries served by them.  This statutory mission is carried out through a 
nationwide program of audits, investigations, inspections, sanctions, and fraud alerts.  The 
Inspector General informs the Secretary of program and management problems and recommends 
legislative, regulatory, and operational approaches to correct them. 
Office of Evaluation and Inspections 
The Office of Evaluation and Inspections (OEI) is one of several components of the Office of 
Inspector General.  It conducts short-term management and program evaluations (called 
inspections) that focus on issues of concern to the Department, the Congress, and the public.  The 
inspection reports provide findings and recommendations on the efficiency, vulnerability, and 
effectiveness of departmental programs. 
OEI's Chicago office  prepared this report under the direction of William C. Moran, Regional 
Inspector General and Natalie Coen, Deputy Regional Inspector General.  Principal OEI staff 
included: 
REGION  HEADQUARTERS 
Thomas Komaniecki, Project Leader  Jennifer Antico, Program Specialist 
Suzanne Johnson  EXECUTIVE  SUMMARY 
PURPOSE 
To examine the potential impact on the Medicare program and beneficiaries and the 
inherent fiscal vulnerabilities that exist from hospital ownership of physician practices. 
BACKGROUND 
As part of the changing healthcare market, hospitals as well as other entities have been 
purchasing physician practices.  An outcome of these purchases is the ability of hospitals 
to obtain reimbursement for services provided in these practices.  While hospitals have 
historically operated outpatient clinics on their campuses, many of the newly acquired 
practices are located in different cities or States and not on the hospital grounds.  The 
location and operation of these clinics raise questions regarding the payment mechanism 
Medicare should use for the services provided by these purchased practices. 
Hospitals have two options regarding how to account for their purchased physician 
practices.  They can treat them as free-standing or as part of the hospital, referred to as 
provider-based.  If a hospital treats the physician practice as part of the hospital, then the 
hospital can include the operating costs of the practice in the hospitals cost report. 
Medicare reimburses hospitals using interim payments which are reconciled with the 
hospitals actual costs at the end of the cost reporting period.  The payments for these 
provider-based services are typically higher than the payment for services provided in a 
free-standing physician office. 
If the hospital elects to treat the physician practice as free-standing, payments are made by 
the Medicare carrier using the Physician Fee Schedule.  If the hospital provides any type of 
service to the practice, the hospital should establish a nonreimbursable cost center in its 
cost report to capture and exclude the costs associated with the practice. 
Medicare needs to be aware of hospital purchases of physician practices and how these 
hospitals are accounting for and treating them in their cost reports.  This information is 
needed to ensure that appropriate payments have been made. 
FINDINGS 
Hospitals are purchasing and operating physician practices in significant 
numbers 
Based on our review, we estimate that 62 percent of for-profit and not-for-profit general, 
short-term hospitals purchased or owned a physician practice. 
1 
Hospital Ownership of Physician Practices  OEI-05-98-00110  Fiscal intermediaries are frequently unaware of hospital ownership of physician 
practices 
Of the hospitals we identified as owning physician practices, fiscal intermediaries (FIs) 
knew about the ownership 50 percent of the time.  This lack of knowledge could lead to 
the inability of the FIs to ensure that physician practices are properly accounted for in 
hospital cost reports. 
Lack of knowledge of hospital ownership of physician practices presents a fiscal 
vulnerability to the Medicare program 
If a hospital chooses to handle a practice as provider-based and the practice meets the 
criteria for provider-based status, then Medicare requires the hospital to report the costs 
and charges of the practice as reimbursable services in the cost report.  However, if a 
hospital fails to seek provider-based status for their practice, but claims the costs for the 
practice in the cost report, Medicare could be paying excessive amounts for services 
provided in the practice. 
If the hospital elects to treat the physician practice as free-standing, the hospital excludes 
the costs of operating the practice from Medicare reimbursement through the cost report. 
Medicare requires the hospital to report the costs of operating the practices but must 
indicate that they are nonallowable costs.  If a hospital fails to do so and the FI fails to 
detect the error, a substantial amount of Medicare reimbursement could be in question. 
Most likely the FI would never discover these situations unless the FI conducted a full 
scale audit.  Few hospitals are subject to full scale audits.  The net result is that potentially 
overhead and operating costs for these purchased practices are paid twice or hospitals are 
receiving reimbursement for practices that do not meet the provider-based criteria. 
Current HCFA efforts begin to address this issue, but may not go far enough 
The Health Care Financing Administration (HCFA) has taken some steps to gather 
information about hospital purchase of physician practices although the steps are limited. 
Effective June 1998, hospitals were required to report to the FIs any current purchase of 
physician practices.  They are not required to report past purchases. 
Also, in December 1997, HCFA published proposed regulations changing the conditions 
of participation for hospitals.  As part of the proposed regulations, HCFA would require 
that hospitals report purchases of physician practices if a hospital plans on seeking 
provider-based status for the practice.  However, the regulations do not require that a 
hospital report a purchase of a physician practice if it elects to treat the practice as free-
standing. 
2 
Hospital Ownership of Physician Practices  OEI-05-98-00110  Provider-based status increases beneficiary coinsurance with questionable 
benefit to Medicare and its beneficiaries 
The provider-based designation allows hospitals to shift costs to facilities subject to cost-
based reimbursement.  A provider-based designation results in increased Medicare 
payment with no apparent benefit for Medicare or the beneficiary.  In addition, a 
beneficiarys coinsurance is higher for services furnished in provider-based physician 
practices than for services provided in free-standing physician practices. 
If a hospital elects to treat a practice as provider-based, then a beneficiary is responsible 
for 20 percent of the hospital charges as well as 20 percent of the reduced Physician Fee 
Schedule for the physicians services.  These payments are often two to three times greater 
than the coinsurance for services provided by a free-standing practice.  If beneficiaries are 
being treated in facilities that do not meet the provider-based criteria, but hospitals are 
billing as if they did, then beneficiaries are paying excessive coinsurance amounts. 
Proposed regulations will change the methodology used to compute a beneficiarys 
coinsurance.  However, for some outpatient services, this process may be lengthy and 
beneficiaries will be subject to artificially high coinsurance rates for the duration. 
RECOMMENDATIONS 
Provider-based status for hospital owned physician practices has a significant impact on 
both Medicare and its beneficiaries.  At issue is whether the site, or ownership of the site, 
where the service is rendered should dictate a higher payment amount by the Medicare 
program and the beneficiary. 
We recommend that HCFA change its policy and eliminate the provider-based 
designation for hospital owned physician practices. 
The HCFA should require that hospitals treat all purchased physician practices and those 
they currently own, as free-standing entities.  The HCFA could make exceptions for long-
standing clinics located on contiguous hospital campuses.  Monitoring of hospital 
compliance will be necessary.  Procedures will need to be developed to ensure that 
hospitals are not billing for services provided by these entities and receiving payments 
other than under the Physician Fee Schedule. 
Under the proposed outpatient prospective payment system, hospitals may continue to 
have an incentive to treat acquired physician practices as provider-based, since some rates 
may result in higher payment for services performed in provider-based facilities versus 
payment for those same services performed in free-standing facilities. 
3 
Hospital Ownership of Physician Practices  OEI-05-98-00110  We recommend that HCFA require hospitals to report all purchases of physician 
practices or clinics and declare how the costs associated with the operation of 
these entities are handled in hospital cost reports. 
Regardless of whether HCFA eliminates provider-based status, it will continue to be 
important that fiscal intermediaries be aware of current and past purchases of physician 
practices. 
We offer solutions on how HCFA can implement this recommendation.  We believe 
hospital purchases of physician practices are wide spread.  Currently, neither HCFA nor its 
fiscal intermediaries have a good handle on whether hospitals are handling the operating 
costs associated with these purchases correctly in the cost reports. 
We recommend that HCFA seek legislation to sanction hospitals for failure to 
report the ownership of physician practices. 
Hospitals failing to inform HCFA or its fiscal intermediaries of the ownership and 
purchase of physician office practices, regardless of whether these physician offices are 
provider-based, free-standing or were past purchases, should be sanctioned. 
AGENCY COMMENTS 
We requested and received comments from the Health Care Financing Administration. 
Their comments are included in Appendix B.  The HCFA concurred with two of our three 
recommendations.  They did not concur with our recommendation to change its policy and 
eliminate provider-based designation for hospital owned physician practices. 
The HCFA recognizes that the current system may result in abuse of Medicare's payment 
system in some cases.  They state that it would be difficult to construct rules that 
differentiate physician practices from outpatient clinics to include one and exclude the 
other from designation as provider-based.  In the long run, HCFA believes the most 
effective alternative to avoid abuse of the payment system is to move further toward the 
elimination of the differences in payments across sites that make advantageous the 
designation of physician practices as provider-based. 
We appreciate HCFAs positive response to our report.  We agree with their long-term 
plans of eliminating differences in payments for similar services across sites.  However, we 
are uncertain whether the current set of provider-based standards, as well as the proposed 
set of regulations, can adequately safeguard Medicares payment system.  We are 
currently examining the process of designating facilities as provider-based.  We hope that 
the results of this additional work will be helpful in resolving the problems that remain 
with the current system. 
4 
Hospital Ownership of Physician Practices  OEI-05-98-00110  TABLE  OF  CONTENTS 
EXECUTIVE SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

INTRODUCTION  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

FINDINGS

Hospitals Purchasing Physician Practices  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Medicare Unaware of Many of These Purchases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  9

Medicare Program Vulnerable to Erroneous and Excess Payments . . . . . . . . . . . . . . . .  10

HCFA Efforts May Not Be Enough . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Provider-Based Increases Beneficiary Costs With Questionable Benefit  . . . . . . . . . . . .  12

RECOMMENDATIONS  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  15

AGENCY COMMENTS  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  18

APPENDICES

HCFA Program Memorandum . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

Agency Comments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

5 
Hospital Ownership of Physician Practices  OEI-05-98-00110  INTRODUCTION 
PURPOSE 
To examine the potential impact on the Medicare program and beneficiaries and the 
inherent fiscal vulnerabilities that exist from hospital ownership of physician practices. 
BACKGROUND 
As part of the changing healthcare market, hospitals, as well as, other entities have been 
purchasing physician practices.  For hospitals, one of the major reasons to purchase 
physician practices is to establish physician networks to compete with managed care 
products being offered by insurance companies.  An outcome of these purchases is the 
ability for hospitals to obtain reimbursement for services provided in these practices. 
While hospitals have historically operated outpatient clinics located on their campuses, 
many of the newly acquired practices are not located on the hospital grounds.  Some of 
these newly acquired practices are located in different cities or States.  The location and 
operation of these clinics raise questions regarding the payment methods Medicare should 
use for the services provided by these purchased practices. 
Medicare Reimbursement Options 
It is the Health Care Financing Administrations (HCFAs) policy that a hospital may treat 
an acquired physician practice as either provider-based or free-standing.  The hospitals 
decision on how to treat the practice will affect the amount of payment received by the 
hospital for physician services rendered in the practice. 
Option one is to treat the facility as provider-based.  In essence, the hospital treats the 
purchased physician practice as if it were a hospital outpatient department.  If the hospital 
wishes to treat the practice as provider-based, the hospital must submit an application to 
HCFA requesting provider-based status.  The HCFA has established eight criteria that a 
physician practice must meet before HCFA grants provider-based status.1  These criteria 
deal with such issues as:  the physical location of the entity, the patient population served, 
and the type of control and governance exhibited by the hospital over the practice.  (See 
Appendix A for the list of criteria.) 
Once HCFA grants provider-based status, the hospital may receive reimbursement for 
services provided in the purchased facility using the reasonable cost reimbursement 
method.  This is the same payment method used for services provided in hospital 
outpatient departments.  Reimbursement for services in a provider-based practice, as well 
1	
The Office of Inspector General is currently working on a report that examines how HCFA approves 
provider-based status. 
6 
Hospital Ownership of Physician Practices  OEI-05-98-00110  as in a hospital outpatient department, generally include both a facility payment and a 
payment for the service or procedure performed.  Under the reasonable cost 
reimbursement method, Medicare reimburses hospitals for either the costs or charges for 
services2 provided by hospital outpatient departments or provider-based physician 
practices, whichever is lower.  Medicare reimburses hospitals using interim payments 
which are reconciled with the hospitals actual costs at the end of the cost reporting 
period.  To determine the costs of providing services, Medicare requires hospitals to file 
an annual cost report.  Included in this cost report are all the overhead and operating costs 
associated with operating the hospital as well as any physician practices the hospital owns. 
In addition, the hospital can also submit a separate claim to the Medicare carrier for the 
physicians  professional services.  Medicare pays for these services using the Physician 
Fee Schedule.3  If the hospital properly codes the claim as provider-based, the Medicare 
carrier adjusts the amount paid for the practices operating and overhead costs which have 
already been paid by the fiscal intermediary (FI) through the cost report.  If the hospital 
does not properly code these claims, Medicare will erroneously pay overhead costs twice. 
The combined payments for these provider-based services are typically higher than the 
payment for services provided in a free-standing physician office. 
Option two is to treat the facility as free-standing.  If the hospital treats the purchased 
practice as a free-standing practice, then it does not have to meet any of HCFAs criteria 
for provider-based status.  The hospital submits claims for services provided in the free-
standing practice to the Medicare carrier which pays these claims under the Physician Fee 
Schedule. 
The Physician Fee Schedule payment includes portions for both the physicians 
professional  service as well as for the costs incurred in operating a physicians office.  If a 
hospital provides any services to the free-standing practice, the hospital must establish a 
nonallowable cost center on their cost report that captures any costs 4 associated with 
operating the purchased physician practice. 
2	
The Congress has legislated a number of different payment methods for specific types of hospital outpatient 
services. The methods include a fee schedules for clinic laboratory services and payments based on blends 
of hospital costs and the rates paid in other ambulatory settings. Nevertheless, payment for services 
performed in a hospital outpatient setting remains largely cost-based. 
3	
The Physician Fee Schedule consists of three main components, the physicians work, the practice expense 
and the malpractice insurance expenses. Physicians are paid under this fee schedule regardless of setting. 
The physician work and malpractice expense components are constants, irrespective of the setting in which 
the service is performed. However, for some services, the practice expense component is reduced by 50 
percent when these services are provided outside the physician office setting. This is done because it is 
assumed that the practice expense component reflects the operating costs of the physicians office. When 
these services are performed in a hospital outpatient department or provider-based physician office, the 
physician office operating costs are subsumed in the facility payment. 
4	
Examples of costs that hospitals should include in the nonreimbursable cost center are administrative 
services, medical records and maintenance. 
7 
Hospital Ownership of Physician Practices  OEI-05-98-00110  These nonallowable costs are not reimbursable by Medicare because the Medicare carrier 
has already paid the hospital using the Physician Fee Schedule.  The overall effect of 
nonallowable cost centers on a hospital cost report is to lower the outpatient costs claimed 
by the hospital.  However, if the hospital does not identify the costs associated with 
operating a physicians practice as nonallowable then Medicare will reimburse the hospital 
twice. 
METHODOLOGY 
To examine the potential impact of hospital purchases of physician practices on the 
Medicare program, we selected a stratified random sample of 100 for-profit and 100 not-
for-profit general, short-term hospitals.5  We did not contact the sampled hospitals directly 
to question them regarding their purchase of physician practices.  Rather, we identified 
whether the hospitals purchased practices through other means. 
For our sampled hospitals, we used the following methods to determine whether there 
appeared to be an affiliation between our sampled hospitals and physician practices: 
<  An Internet search for any sites that discussed or showed the appearance of 
physician practices purchased or operated by our sampled hospitals. 
<  A phone book search of listings looking for physician practices that are advertising 
using logos, symbols or the names of our sampled hospitals. 
<  A request to the fiscal intermediaries for any information regarding the purchase or 
ownership of a physician practice by our sampled hospitals. 
<	 A request to the HCFA regional office for any information they may have 
concerning the purchase or ownership of a physician practice by our sampled 
hospitals. 
<	 A search of the American Hospital Associations (AHAs) data regarding hospital 
ownership of physician practices. 
We conducted our review in accordance with the Quality Standards for Inspections issued 
by the Presidents Council on Integrity and Efficiency. 
5	 We obtained a list of hospitals from HCFAs Online Survey and Certification Reporting System. 
The list contained 6,164 hospitals. We selected only general, short-term hospitals leaving us 
with a list of 5,093 hospitals. After further discussion, we decided to limit our analysis to not-
for-profit and for-profit hospitals, excluding government owned hospitals. We selected our 
sample from this list of 3,610 hospitals. 
8 
Hospital Ownership of Physician Practices  OEI-05-98-00110  FINDINGS 
Hospitals are purchasing and operating physician practices in significant 
numbers 
Based on our review of the Internet, phone book listings and information from the fiscal 
intermediaries, we estimate that 62 percent6 of for-profit and not-for-profit general, short-
term hospitals purchased or owned a physician practice.  Using only AHA data gathered in 
1996, our estimate decreases to 51 percent.7 
Other information also indicates that ownership of physician practices by hospitals is 
significant.  According to the Health Care Advisory Board, a group that serves chief 
executives and senior administrators of more than 1,400 hospitals and health systems, the 
number of physician practices owned or managed by a hospital rose from 4,126 practices 
in 1993 to 11,234 practices in 1995, an increase of 172 percent.  In another study, the 
Center for Healthcare Industry Performance Studies surveyed hospitals, insurance 
companies, physician management companies and others about recent purchases of 
physician practices.  Based on the results of their survey, hospitals were responsible for 83 
percent of the purchased practices they reviewed. 
Fiscal intermediaries are frequently unaware of hospital ownership of physician 
practices 
Of the hospitals we identified as owning physician practices, the FIs knew about the 
ownership about 50 percent of the time.  This lack of knowledge could lead to the inability 
of the FIs to ensure that hospitals are accounting for physician practices properly in 
hospital cost reports, resulting in excessive Medicare reimbursement.  This vulnerability is 
discussed in our next finding. 
At the time we were conducting our study, there was no requirement for hospitals to 
report to HCFA or the FIs the purchase of physician practices unless the hospital was 
requesting provider-based status for these practices. 
In 1998, HCFA reports that few hospitals requested provider-based status.  These 
situations are known to the FIs.  Other ways fiscal intermediaries became aware of 
hospital owned physician practices were through a review of hospital marketing materials, 
newspaper articles or by word of mouth.  In other cases, the FIs became aware of the 
ownership of a physician practice(s) while auditing the hospital cost report for other 
reasons or through beneficiary complaints. 
6  6.48 at a 90 percent confidence level 
7  6.71 at a 90 percent confidence level 
9 
Hospital Ownership of Physician Practices  OEI-05-98-00110  Lack of knowledge of hospital ownership of physician practices presents a fiscal 
vulnerability to the Medicare program 
Fiscal intermediaries are often unaware of hospital owned physician practices and this 
handicaps their ability to ensure that hospitals have appropriately handled the costs 
associated with these practices in hospital cost reports.  While we could not estimate the 
extent of inappropriate Medicare reimbursement caused by FIs being unaware of the 
purchase and ownership of physician practices, the potential amounts paid inappropriately 
could be substantial.  Medicare losses can occur whenever hospitals, intentionally or not, 
inappropriately claim Medicare reimbursement for the operating costs of provider-based 
practices when their physician practices are, in reality, free-standing. 
Provider-based cost report vulnerabilities 
If a hospital chooses to handle a practice as provider-based and the practice meets the 
criteria for provider-based status, then Medicare requires the hospital to report the costs 
and charges of the practice as reimbursable services in the cost report to receive Medicare 
payment.  However, if a hospital fails to seek provider-based status for their practice but 
claims the costs for the practice in the cost report, Medicare could be paying excessive 
amounts for services provided in the practice. 
For example, Medicare reimbursed hospitals approximately $548 million for outpatient 
clinic services in Fiscal Year 1996.  In some cases, hospitals may have included operating 
costs for physician practices that they purchased even though these practices do not meet 
the eight criteria for provider-based status.  In these cases, some portion of the $548 
million could have been reimbursed inappropriately.  We do not mean to infer that the 
services provided in these situations were inappropriate, only that the method used to 
reimburse the hospital may have caused Medicare to pay more than it should. 
Free-standing cost report vulnerabilities 
If the hospital elects to treat the physician practice as free-standing, the hospital excludes 
the costs of operating the practice from Medicare reimbursement through the cost report. 
Medicare requires the hospital to report the costs of operating the practices but must 
indicate that they are nonallowable costs.  If a hospital fails to do so and the FI fails to 
catch the mistake, a substantial amount of Medicare reimbursement could be in question. 
For example, one hospital in our sample reported $903,658 in nonallowable costs for 
physician practices it owns.  Using this amount for all hospitals that we believed owned 
physician practices but were unknown to the FIs, the potential amount that hospitals 
should have excluded from their reimbursable costs was $726 million. 
10 
Hospital Ownership of Physician Practices  OEI-05-98-00110  If the $726 million was not excluded from total costs, Medicare would have reimbursed 
$86.4 million8 inappropriately.  This is not an estimate of program losses, but rather an 
example of the potential extent of the problem that could exist if FIs are unaware of 
hospital purchase and ownership of physician practices. 
Difficulty in discovering these vulnerabilities 
Most likely the FI would never discover these situations unless the FI conducted a full 
scale audit.  Few hospitals are subject to full scale audits, possibly because the funding to 
conduct such audits may be prohibitive.  The net result is that potentially overhead and 
operating costs for these purchased practices are paid twice or hospitals are receiving 
reimbursement for practices that do not meet the provider-based criteria. 
The possibility exists that Medicare carriers may also be making excess payments for 
physician office services they believe are being provided in a free-standing facility, when in 
fact these services are being performed in a provider-based facility.  Medicare carriers may 
be reimbursing physicians for office operating costs that have already been paid by the FI 
through interim payments. 
In the future, HCFA is changing Medicares payment method for outpatient services to 
that of a prospective payment system (similar to the way Medicare pays for hospital 
inpatient services).  However, this does not remove the need for the fiscal intermediaries 
to be aware of hospital owned physician practices.  The implementation of this new 
payment method would highlight the different payment rates between settings.  As a 
result, decisions about where to provide services may become more dependent on which 
setting is more profitable, rather than which setting is most clinically appropriate.  Thus, 
hospitals may continue to have an incentive to acquire and treat physician practices as 
provider-based. 
Current HCFA efforts begin to address this issue, but may not go far enough 
The HCFA is committed to gathering information about hospital purchase of physician 
practices.  Through four separate actions, HCFA is beginning to collect information that 
may assist the fiscal intermediaries in determining whether hospitals are accounting for 
physician practices appropriately in their cost reports.  Unfortunately, these efforts may 
fall short as they will not ensure that FIs are aware of hospitals past and present 
purchases of physician practices or how hospitals are treating the operating costs of these 
practices in their cost reports. 
8	 Using Sudaan, a statistical package that accounts for stratified samples, we estimated that $726 
million would represent the amount of money that should have been excluded from those hospital 
cost reports where the FI appeared to be unaware of the ownership of physician practices. We 
then estimated, using Fiscal Year (FY) 1996's Hospital Minimum Data Set, the percent of 
Medicare costs to Medicare charges for outpatient clinics. According to our calculations, this 
amounted to 11.9 percent. We then multiplied the $726 million by 11.9 percent to arrive at 
$86.4 million. 
11 
Hospital Ownership of Physician Practices  OEI-05-98-00110  In May 1998, HCFA issued a program memorandum requiring hospitals, as part of the 
Provider Cost Report Reimbursement Questionnaire submitted with the annual cost 
report, to answer questions about whether the facility purchased a physicians practice. 
This was effective for cost reporting periods ending on or after June 30, 1998.  The 
questions specifically target purchases for the cost reporting year being filed.  It does not 
ask about practices that the hospital may have purchased in years prior to the current cost 
report year. 
Entities, such as hospitals and physician practices, applying for a Medicare provider 
number must complete a  provider enrollment application (HCFA 855).  This form also 
solicits ownership information and providers may use this form, or some other means, to 
inform HCFA and its contractors of a change in ownership.  Again,  this document does 
not request information about past purchases. 
In December 1997, HCFA published proposed regulations changing the conditions of 
participation for hospitals.  As part of the proposed regulations, HCFA would require that 
hospitals report purchases of physician practices if they plan on seeking provider-based 
status for these practices. 
Currently, HCFA uses eight criteria to determine whether a practice can be considered 
provider-based.  These criteria are contained in a program memorandum published in 
August 1996 and again in May 1998.  (See Appendix A for a list of the criteria.)  As part 
of the proposed regulations for Outpatient Prospective Payment, HCFA proposes to set in 
regulation the criteria that facilities must meet to be considered part of the hospital for 
cost reporting purposes.  Again, it will only require hospitals to notify HCFA if the 
hospital plans on seeking provider-based status for the physician practices. 
The proposed regulations for Outpatient Prospective Payment also do not require a 
hospital to report the purchase of a physician practice if it elects to treat the practice as 
free-standing.  The HCFA has acknowledged the vulnerability free-standing entities can 
present in its proposed regulations.  To address this vulnerability, providers will be 
required ...to develop detailed work papers showing the exact cost of the services, 
including overhead, provided to or by the free-standing entity and show those carved out 
costs as non-reimbursable cost centers in the providers trial balance.  This should help 
alert FIs to hospitals ownership and purchase of physician practices as long as the scope 
of the FI audit includes a review of this information. 
Many, but not all, of the vulnerabilities mentioned in this report will be alleviated with 
passaged of the proposed outpatient prospective payment system regulations and if HCFA 
is able to enforce its provider-based policies, with respect to hospital purchased physician 
practices.  Such will not be the case, however, if hospitals fail to:  (1) report their 
physician practice purchases to the fiscal intermediaries, and (2) inappropriately claim 
overhead expenses for free-standing facilities in their cost report. 
12 
Hospital Ownership of Physician Practices  OEI-05-98-00110  Provider-based status increases beneficiary coinsurance with questionable 
benefit to Medicare and its beneficiaries 
The current system that provides for provider-based entities came about as a policy 
decision by HCFA to accommodate the integration of the financial operations of merging 
health care delivery systems, such as hospitals and clinics.  Prior to the inpatient 
prospective payment system, hospitals could achieve greater economies of scale in 
overhead costs, thus provider-based designation was beneficial to both the Medicare 
program and hospitals.  However, as hospitals looked for ways to increase Medicare 
revenues, they established provider-based facilities that were one of the few remaining 
methods hospitals could use to receive cost-based reimbursement.  These cost-based 
facilities, such as outpatient clinics and physician practices, shifted costs to increase 
Medicare payments with no commensurate benefit to the Medicare program or its 
beneficiaries.9 
The coinsurance paid by Medicare beneficiaries for services provided by provider-based 
physician practices are higher than for services provided in free-standing physician 
practices.  A beneficiarys coinsurance can vary substantially depending on how hospitals 
handle the physician practices they own.  If a hospital treats a practice as free-standing, 
then a beneficiary is responsible for 20 percent of the full Physician Fee Schedule. 
However, if a hospital elects to treat a practice as provider-based then a beneficiary is 
responsible for 20 percent of the hospital charges as well as 20 percent of the reduced 
Physician Fee Schedule for the physicians services.  The example in Table 1 demonstrates 
the impact on the beneficiary if a hospital elects to treat a practice as provider-based. 
Table 1 
Example Of Impact To Beneficiary Coinsurance By Type Of Facility 
Patient Diagnosis and Procedure Performed:  Male, age 70, is diagnosed 
with diabetes and leg ulcers.  Procedure performed is debridement of ulcer. 
Beneficiary Coinsurance 
Service 
Billing Provider  Description  Provider- Free-
Based  Standing 
Facility  Facility 
Clinic & 
Hospital  Treatment Room  $  52.05  NONE 
Office Visit  $  8.83  $  10.99 
Physician 
Debridement  $  10.93  $  13.66 
TOTAL BENEFICIARY PAYMENT  $  71.81  $  24.65 
9 
Federal Register, Vol. 63, No 173, September 8, 1998, pg. 47,588. 
13 
Hospital Ownership of Physician Practices  OEI-05-98-00110  In the example in Table 1, the beneficiary would incur a $71.81 coinsurance payment if the 
procedure is performed in a physicians office with provider-based status, as opposed to a 
$24.65 coinsurance payment if the same procedure is performed in a free-standing 
physicians office.  The beneficiary in this example would have paid $47.16 more because 
the procedure was performed in a provider-based physician practice.  It is likely that these 
same services could have been provided to the beneficiary in a free-standing physicians 
office with no adverse effects to the beneficiary.  This situation also raises questions on 
why different payment methods should apply to the same services. 
Medicare has recognized the unfair financial burden placed on beneficiaries when services 
are provided in a provider-based facility versus one that is free-standing.  Proposed 
regulations for the outpatient prospective payment system, published in September 1998, 
changes the methodology for computing beneficiary coinsurance for hospital outpatient 
services.  Currently, for some outpatient services, the beneficiary coinsurance equals 50 
percent or more of the total Medicare payments to hospitals.10  These proposed 
regulations will eventually transition the current beneficiary coinsurance to 20 percent of 
the prospective payment rate, rather than 20 percent of charges.  However, for some 
outpatient services, this process may be lengthy and beneficiaries will be subject to 
artificially high coinsurance rates for the duration. 
10	 Medicare payments to provider-based facilities are affected by the amount of coinsurance they 
collect from beneficiaries. The greater the provider-based facility charge to the patient the 
greater the patient coinsurance and the lower the Medicare payment. 
14 
Hospital Ownership of Physician Practices  OEI-05-98-00110  RECOMMENDATIONS 
Provider-based status for hospital owned physician practices has a significant impact on 
both Medicare and its beneficiaries.  At issue is whether the site, or ownership of the site, 
where the service is rendered should dictate a higher payment amount by the Medicare 
program and the beneficiary. 
Prospective payment for outpatient services will highlight for hospitals the different 
payment rates between service settings.  Outpatient prospective payment rates may result 
in higher aggregate payments for some services performed in provider-based facilities 
versus payment for those same services performed in free-standing facilities. 
We recommend that HCFA change its policy and eliminate the provider-based 
designation for hospital owned physician practices. 
The HCFA should require that hospitals treat all purchased physician practices and those 
they currently own, as free-standing entities.  This would financially benefit Medicare 
beneficiaries by eliminating the coinsurance inequities they are currently experiencing 
when they receive services in provider-based, rather than free-standing, facilities. 
The Medicare Payment Advisory Commission in a March 1998 report expressed its 
concerns about the effects of inappropriate payment levels that, if too low, would restrict 
beneficiary access to care or prompt shifts of the site of services for financial rather than 
clinical reasons.  On the other hand, they also expressed concern that if the rates are too 
high this would result in an increase in the volume of outpatient services that is unrelated 
to patient needs.  They were also concerned regarding the impact on service delivery when 
Medicare pays different amounts based on the site of service.  They believe that HCFA 
should move to a payment method that pays the same for the service provided regardless 
of the setting in which the service is performed. 
The HCFA could make exceptions to their policy, but only if the hospital is able to 
demonstrate to the FI that the purchased physician practice is part of the hospital campus. 
The physician practice site is part of the hospital campus if it is located at contiguous 
buildings on the same campus and under common direction.  The burden of proof to this 
fact should be born by the hospital. 
We recognize that enforcement may be difficult.  Because FIs perform a very limited 
number of hospital cost report audits on an annual basis, they must rely on the hospital, or 
happenstance, for information about hospital ownership of physician office practices. 
Therefore, monitoring of hospital compliance will be necessary.  Even under prospective 
payment, procedures will need to be developed to ensure that hospitals are not billing for 
services provided by these entities and receiving payments other than under the Physician 
Fee Schedule. 
15 
Hospital Ownership of Physician Practices  OEI-05-98-00110  We recommend that HCFA require hospitals to report all purchases of physician 
practices or clinics and declare how the costs associated with the operation of 
these entities are handled in hospital cost reports. 
Regardless of whether HCFA eliminates provider-based status, it will continue to be 
important that fiscal intermediaries be aware of current and past purchases of physician 
practices. 
We offer the following solutions to implement this recommendation: 
1.	 Clarify the language on the Provider Cost Report Reimbursement Questionnaire 
to require hospitals to report the purchase of physician practices, including past 
purchases and those purchased by hospital subsidiaries. 
2.	 Include in any proposed regulations requiring the reporting of hospital ownership 
of physician practices the reporting of past purchases and a declaration of whether 
these practices have been treated as provider-based or free-standing in the 
hospitals cost reports. 
3.	 Conduct hospital surveys, using Medicare Integrity Program funds from the Health 
Insurance Portability and Accountability Act, to determine whether physician 
practices owned by hospitals are handled correctly in the cost report. 
4.	 Direct the fiscal intermediaries to conduct focused audits of the hospitals we 
identified as having an ownership interest in physician practices of which the FIs 
were unaware. 
5.	 Include the issue of hospital ownership of physician practices in the Quality Audit 
Program, the oversight program HCFA implemented to ensure that FIs are 
appropriately reviewing cost reports and correctly reimbursing hospitals. 
This recommendation offers options on how to identify and ensure that hospitals are 
correctly handling the costs associated with the operation of physician practices.  We 
recognize that HCFA is proposing regulations that will require hospitals to keep detailed 
work papers identifying the free-standing entities as non-reimbursable cost centers.  This 
should help FIs identify cost associated with hospital purchased physician practices. 
We recommend that HCFA seek legislation to be able to sanction hospitals for 
failure to report the ownership of physician practices. 
Hospitals failing to inform HCFA or its fiscal intermediaries of the ownership or purchase 
of physician office practices, regardless of whether or not these physician offices are 
provider-based or free-standing, or were purchased in the past, should be sanctioned. 
16 
Hospital Ownership of Physician Practices  OEI-05-98-00110  Continuing work 
Equally as important as ensuring that FIs handle correctly the costs from the operation of 
these physician practices and reimburse appropriately, is the process that HCFA uses to 
determine if a physician practice meets the provider-based criteria.  This issue is currently 
under review by the Office of Inspector General. 
An additional area we plan to review includes whether physician services provided in 
provider-based facilities are appropriately billed to Medicare.  We also plan to compare 
the payment for services performed in provider-based settings with those performed in 
free-standing settings.  We will compare these payment rates to those proposed in the 
outpatient prospective payment regulations to determine which payment rates are higher. 
17 
Hospital Ownership of Physician Practices  OEI-05-98-00110  AGENCY  COMMENTS 
We requested and received comments from the Health Care Financing Administration. 
Their comments are included in Appendix B.  The HCFA concurred with two of our three 
recommendations.  They did not concur with our recommendation to change its policy and 
eliminate provider-based designation for hospital owned physician practices. 
The HCFA recognizes that the current system may result in abuse of Medicare's payment 
system in some cases.  They state that it would be difficult to construct rules that 
differentiate physician practices from outpatient clinics to include one and exclude the 
other from designation as provider-based.  In the long run, HCFA believes the most 
effective alternative to avoid abuse of the payment system is to move further toward the 
elimination of the differences in payments across sites that make advantageous the 
designation of physician practices as provider-based. 
We appreciate HCFAs positive response to our report.  We agree with their long-term 
plans of eliminating differences in payments for similar services across sites.  However, we 
are uncertain whether the current set of provider-based standards, as well as the proposed 
set of regulations, can adequately safeguard Medicares payment system.  We are 
currently examining the process of designating facilities as provider-based.  We hope that 
the results of this additional work will be helpful in resolving the problems that remain 
with the current system. 
18 
Hospital Ownership of Physician Practices  OEI-05-98-00110  APPENDIX A 
Provider-Based Criteria

Program Memorandum (Intermediaries), HCFA Pub. 60A, Transmittal No. A-96-7 August 1, 
1996 
Reissued as Transmittal N. A-98-15, (May 1, 1998) 
SUBJECT: Policy Clarification: Provider-Based Designation 
PURPOSE: 
The purpose of this program memorandum (PM) is to consolidate and clarify the Health Care 
Financing Administrations (HCFAs) policy regarding provider-based and free-standing 
designation decisions. The various elements of this policy have been issued previously in 
regulations, program manuals, and letters to HCFA regional offices (ROs) or providers. This 
policy applies to all such designation decisions regarding any provider of services under Medicare, 
including physicians practices or clinics that state they are part of a provider. 
BACKGROUND: 
The term or designation provider-based is an outgrowth of the Medicare cost reimbursement 
system. The main purpose of the provider or facility-based designation is to accommodate the 
appropriate accounting and allocation of costs where there is more than one type of provider 
activity taking place within the same facility/organization, e.g., a hospital-based skilled nursing 
facility. This cost allocation and cost reimbursement more often than not results in Medicare 
program payments that exceed what would have been paid for if the same services were rendered 
by a free-standing entity. 
With the growth of integrated delivery systems, HCFA has received numerous requests from 
entities requesting provider-based status. These requests, if approved, increase the portion of the 
facilitys general and administrative costs that are supported by the Medicare program with no 
commensurate benefit to Medicare and its beneficiaries. Therefore, it is critical that HCFA 
designate only those entities that are unquestionably qualified as provider-based. 
For example, some hospitals are purchasing physicians clinics and multiple clinics in areas far 
from the licensed hospital and designating the clinics as outpatient departments of the hospital. 
If Medicare were to approve such designation as an outpatient department the hospital would 
then be allowed to increase Medicare payments by shifting overhead costs to the outpatient 
department and by increasing payments for indirect medical education. In addition to the 
payment impact, the Medicare coverage of incident-to services would also be affected if a 
physicians office is redesignated as a hospital outpatient department. 
Medicare beneficiaries are also subject to an increased financial liability. In the example above of a 
hospital acquired physician practice, the beneficiary pays the usual deductible and co-insurance for 
physician services which are capped by the physician fee schedule. He is also responsible for a 
19 
Hospital Ownership of Physician Practices  OEI-05-98-00110  APPENDIX A 
Provider-Based Criteria

second deductible and co-insurance for a clinic visit or facility fee to the hospital. 
These charges are not subject to the Medicare allowable charge or limiting charge restrictions of a 
physicians office. 
Moreover, it should be noted that it is the intent of existing statutory and regulatory criteria for 
Medicare to operate as a prudent purchaser of services that enhance the care of beneficiaries. 
Medicare must comply with Congressional intent as reflected in 1861(v)(1)(A) of the Social 
Security Act to pay only for those costs that are necessary for the efficient delivery of needed 
health services. The statute at 1861(v)(1)(A) also provides general and specific criteria for 
developing payment rules to carry out the basic intent of the law as well as provisions when 
aggregate reimbursement produced by existing methodologies proves to be inadequate or 
excessive. 
POLICY STATEMENT: 
It is HCFAs policy that the following applicable requirements must be met before an entity can be 
designated as part of a provider for 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 (e.g. 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 (i.e., common governance) by the 
provider where it is based, as evidenced by the following: 
!	 The entity is subject to common bylaws and operating decisions of the governing body of 
the provider where it is based; 
!	 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 
!	 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 
20 
Hospital Ownership of Physician Practices  OEI-05-98-00110  APPENDIX A 
Provider-Based Criteria

located, as evidenced by the following: 
!	 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 
!	 Administrative functions of the entity, e.g., 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: 
!	 Professional staff of the provider-based entity have clinical privileges in the provider where 
it is based; 
!	 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; 
!	 All medical staff committees or other professional committees at the provider where the 
entity is based are responsible for all medical activities in the provider-based entity; 
!	 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; 
!	 Patients treated at the provider-based entity are considered patients of the provider and 
have full access to all provider services; and 
!	 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 (e.g., 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: 
!	 The entity and the provider where it is based have an agreement for the sharing of income 
and expenses; and 
21 
Hospital Ownership of Physician Practices  OEI-05-98-00110  APPENDIX A 
Provider-Based Criteria

!	 The entity reports its cost in the cost report of the provider where it is based using the 
same accounting system for the same cost reporting period as the provider where it is 
based. 
DETERMINATIONS: 
Determinations concerning whether an entity is provider-based (e.g., common licensure, 
governance, professional supervision criteria, reimbursement and accounting information) will be 
made by the appropriate HCFA RO components, i.e., the RO Division of Health Standards and 
Quality and the RO Division of Medicare with the assistance of the State survey agencies 
and the fiscal intermediary. 
Please note that the issuance of this clarifying instruction may result in identification of previous 
provider-based decisions that would not be in accordance with the criteria described in this PM. 
In those instances, the ROs are not precluded from taking a corrective action on such erroneous 
designation/determinations. However, any corrective action is to be applied prospectively. 
This PM may be discarded after JULY 31, 1997. 
For further information, please contact David Goldberg at (410) 786-4512. 
22 
Hospital Ownership of Physician Practices  OEI-05-98-00110  APPENDIX B 
Agency Comments

23 
Hospital Ownership of Physician Practices  OEI-05-98-00110  APPENDIX B 
Agency Comments

24 
Hospital Ownership of Physician Practices  OEI-05-98-00110