Department of Health and Human Services 

OFFICE OF 

INSPECTOR GENERAL 

JUNE GIBBS BROWN 

Inspector General 

AUGUST 2000 

OEI-04-97-00090 

HCFA Management of Provider-Based 

Reimbursement to Hospitals 
OFFICE OF INSPECTOR GENERAL 

The mission of the Office of Inspector General (OIG), as mandated by Public Law 95-452, and 

amended by Public Law 100-504, 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 Atlanta office prepared this report under the direction of Jesse J. Flowers, Regional 

Inspector General and Christopher Koehler, Deputy Regional Inspector General. Principal OEI 

staff included: 

Joe Townsel, Project Leader 

Jennifer Antico, Program Specialist 

Dwayne Grant, Program Analyst 

Janet Miller, Program Analyst 

To obtain copies of this report, please call the Atlanta Regional Office at 404-562-7723. Reports 

are also available on the World Wide Web at our home page address: 

http://www.dhhs.gov/oig/oei 
TABLE OF CONTENTS 

EXECUTIVE SUMMARY ............................................... 1

INTRODUCTION ..................................................... 4

FINDINGS

Process inconsistently applied ......................................... 8

Data systems inadequate ........................................... 11

Improper Medicare payments ....................................... 13

CONCLUSION AND RECOMMENDATIONS ............................... 17

APPENDIX A ....................................................... 20

APPENDIX B ....................................................... 24

APPENDIX C ....................................................... 25

Provider-Based Reimbursement to Hospitals OEI-04-97-00090 
EXECUTIVE SUMMARY 

PURPOSE 

To describe Health Care Financing Administration management of provider-based status 

for hospital owned entities. 

BACKGROUND 

Hospitals often purchase entities such as physician practices and nursing facilities. Under 

Medicare, such hospitals can account for their entities as free-standing or as part of the 

hospital. The latter arrangement is called “provider-based” status. In its program 

guidance, HCFA stated that provider-based status for hospital owned entities would 

increase costs for Medicare and its beneficiaries with no commensurate benefits. 

Therefore, the guidance stated that it is critical to designate only unquestionably qualified 

entities for provider-based status. 

FINDINGS 

Regional offices do not consistently follow HCFA processes for review and approval 

of provider-based status 

The HCFA regions use different processes and standards, and require varying levels of 

documentation for approving provider-based status for hospital owned entities. For 

example, some regions accept hospital self-attestation that their entities meet HCFA 

criteria for provider-based status. Others, however, do a detailed review to ascertain 

qualifications for the status. Some regions obtain assistance from HCFA intermediaries 

and State licensure agencies, as required, and others do not. The inconsistencies occur 

both within and among regional offices. 

HCFA data systems are inadequate for managing hospital use of provider-based 

status 

Neither HCFA headquarters nor regional offices could furnish reliable data showing 

hospital requests or approvals for provider-based status. More importantly, HCFA could 

not determine, from existing data systems, which hospitals were improperly claiming the 

status and billing Medicare under the higher cost provider-based rules. Such basic data is 

essential for assuring that only qualified hospital owned entities are approved, and for 

identifying unqualified hospitals that bill Medicare under the provider-based rules. 

Provider-Based Reimbursement to Hospitals 1 OEI-04-97-00090 
<

Hospitals often bill for reimbursement under the provider-based rules without 

HCFA approval 

Hospitals often simply assume provider-based status for their off-site entities and bill 

Medicare without getting HCFA approval. Such practices are improper, but they often go 

undetected for several years. Further, when detected, HCFA policy guidance is widely 

interpreted as allowing only prospective payment corrections. Finally, no penalties are 

levied on hospitals who engage in the improper practice. 

CONCLUSION AND RECOMMENDATIONS 

HCFA management of its provider-based determination process provides little or no 

assurance that only qualified hospital owned entities are approved. Qualified 

hospitals benefit from provider-based designations for their off-site entities because they 

can shift overhead costs to them and receive higher Medicare reimbursement. HCFA 

recognized that provider-based designations for qualified hospital owned entities would 

increase costs for Medicare and its beneficiaries, with no commensurate benefits -- as 

compared to free-standing arrangements. However, the costs are unnecessarily further 

increased when unqualified hospital owned entities bill Medicare under the financially 

advantageous provider-based rules. 

However, to assure that only qualified hospital entities receive provider-based status 

would likely require considerable resources by HCFA, its intermediaries, and State 

licensure agencies. This possibility, combined with the increased cost of qualified and 

unqualified hospitals, and no commensurate benefits for Medicare and its beneficiaries, 

raises serious questions about the merits of continuing the provider-based option for 

hospital owned entities. 

Therefore, as recommended in our prior OIG report on physician practices, we 

recommend that HCFA eliminate provider-based status as an accounting option for 

all types of hospital owned entities. 

If HCFA chooses to continue the use of provider-based status, it should 

< Impose severe and substantial penalties, as recommended in our prior report, 

when hospitals bill Medicare for unqualified medical entities they own. 

< Revise and clarify its program policy and procedures. 

< Develop reliable data systems for program management. 

< Require that all hospitals claiming provider-based status reapply for that 

status. 

Provider-Based Reimbursement to Hospitals 2 OEI-04-97-00090 
AGENCY COMMENTS 

The Health Care Financing Administration commented on our draft report. The full text of those 

comments are shown in appendix C. 

In brief, HCFA did not agree with the recommendation to eliminate the provider-based program. 

Instead, HCFA supported our alternative recommendation to establish reliable systems to improve 

its management of the provider-based program. To that end, HCFA has initiated various actions, 

including revising regulations and procedures, implementing management data and control 

systems, and providing training for staff responsible for program administration and control. 

The HCFA expressed concern about the administrative burden of full implementation of our 

recommendation to require all hospitals claiming provider-based status to reapply so that HCFA 

could assure they qualified for the benefit. Instead, HCFA plans a less burdensome, alternative 

approach to resolving that problem. Specifically, HCFA plans to assure that all new applicants 

qualify for the benefit. Further, when a complaint or other evidence indicates that an existing 

provider-based arrangement does not meet requirements, HCFA plans to reassess the hospital’s 

qualifications for the benefit at that time. 

While we believe that HCFA’s planned corrective action will significantly strengthen their future 

management of the Medicare provider-based reimbursement provision, we are concerned that 

some problems described in our report will continue. Specifically, existing non-qualified hospitals 

will continue to bill Medicare under the cost advantageous provider-based rules until they are 

caught. 

Therefore, we continue to believe that it is appropriate to require all hospitals to reapply. We 

recognized that there would be administrative costs associated with this requirement. However, 

we believe that such costs would be more than off-set by savings accruing from termination of 

inappropriate billings to the program. 

Provider-Based Reimbursement to Hospitals 3 OEI-04-97-00090 
INTRODUCTION 

PURPOSE 

To describe Health Care Financing Administration management of provider-based status 

for hospital owned entities. 

BACKGROUND 

Provider-based status for hospital reimbursement 

Hospitals often purchase a variety of other medical entities such as physician practices, 

nursing facilities and home health agencies. Under Medicare, hospitals can account for 

medical entities they own as either free-standing or as part of the hospital. If a hospital 

accounts for an entity as part of the hospital, it is referred to as a “provider-based” 

arrangement. This is a cost accounting and allocation mechanism which requires Health 

Care Financing Administration (HCFA) approval. 

Benefits of provider-based status for the Medicare program and its beneficiaries 

Prior to 2000, HCFA has recognized that provider-based status for hospitals has no 

benefit for Medicare or its beneficiaries. According to HCFA program guidance1, 

provider-based status actually increases the portion of a hospital’s general and 

administrative costs that are supported by Medicare, with no commensurate benefit to 

Medicare or its beneficiaries. The guidance further showed that Medicare payments for 

services in provider-based entities exceed what Medicare would have paid under freestanding status. 

Medicare payments are higher largely because of the increased general and administrative 

costs supported by Medicare under provider-based rules. Hospitals can include such costs 

as reimbursable in their Medicare cost reports. Medicare reimburses such hospitals on an 

interim basis and reconciles the cost reports at the end of the reporting period. That 

reimbursement is under Part A of the program. Hospitals may also receive other 

reimbursement under Part B, such as clinical laboratory services. 

Hospitals must exclude from their Medicare cost reports any overhead and administrative 

costs associated with services at their free-standing entities. Such costs associated with its 

free-standing entities must be shown as non-reimbursable on hospital cost reports to 

Medicare. 

1

Program Memoranda A-96-7 dated August 1, 1996; A-98-15 dated May 1, 1998; and A-99-24 dated May 1, 1999 

(see Appendix A) 

Provider-Based Reimbursement to Hospitals 4 OEI-04-97-00090 
Likewise, as documented in our September 1999 OIG report2

, provider-based status often 

increases coinsurance costs for Medicare beneficiaries. 

Prevalence of provider-based status 

Our September 1999 OIG report showed that HCFA and its Medicare contractors have 

little specific knowledge on the extent that provider-based designations have been 

requested and approved. The report showed, however, that hospitals are acquiring 

physician practices in significant numbers. While HCFA program guidance issued in 1996, 

1998, and 1999 did not specify the prevalence, it showed that HCFA receives numerous 

requests from hospitals for provider-based status for their off-site entities. 

Approval of provider-based status 

Considering the increased costs and absence of any recognized benefit to Medicare and its 

beneficiaries, HCFA declared in its program guidance that it is critical to designate only 

entities that are unquestionably qualified for provider-based status. 

To this end, hospitals must request provider-based status from HCFA for entities they 

own. Only after receiving HCFA approval may a hospital legitimately claim providerbased status and bill Medicare for services provided in their off-site entities. The review 

and determination process calls for a written request, which specifies that an entity meets 

eight criteria published by HCFA in program policy guidance (see Appendix A). 

HCFA’s program guidance does not provide specific and detailed instructions or formats 

for requesting, approving, and disapproving provider-based status. It requires regional 

offices to make provider-based determinations with assistance from intermediaries and 

State licensure agencies. Typically, hospitals should submit requests to their intermediary, 

which remands the requests to HCFA for a determination. The program guidance does 

not specify the level of information needed from hospitals, types of assistance needed from 

intermediaries, or the depth of analysis. 

On April 7, 2000, HCFA issued final regulations3 which could affect the process for 

granting provider-based status for hospital owned entities. The regulations, prompted by 

an upcoming prospective payment system for hospital outpatient services, emphasize the 

fiscal impact of provider-based status on Medicare. They also present regulatory 

definitions for provider-based status, provider-based entities, and other terms. Further, 

the new regulations require a hospital to report its acquisitions to HCFA if the hospital 

wishes to obtain provider-based status for them. Finally, the April regulations revise the 

wording on whether or not Medicare and its beneficiaries benefit from provider-based 

designations. However, our review of the revised wording showed it makes no 

substantive changes that indicate an intended benefit to Medicare and its beneficiaries. 

The regulations appear, however, to enhance HCFA’s control over which hospital owned 

entities receive approval to bill Medicare under the provider-based cost rules. 

2

Hospital Ownership of Physician Practices (OEI-05-98-00110) 

3

The regulations were published with a 60-day comment period. They are to be effective July 1, 2000. However, the 

specific provisions on provider-based status are not effective until October 10, 2000. 

Provider-Based Reimbursement to Hospitals 5 OEI-04-97-00090 
METHODOLOGY

This report describes HCFA’s management and oversight process4 for assuring that only 

qualified hospital owned entities are approved for provider-based status as intended. 

Our scope included HCFA headquarters, all HCFA regional offices, all fiscal 

intermediaries, and all State licensure agencies. We collected and analyzed data from 

February 1998 through January 1999. Where needed, we verified data through September 

1999. At each location we reviewed policies, procedures, and practices for providerbased determinations, including HCFA’s eight criteria. (See Appendix A.) 

Our data collection methods included a combination of written surveys, personal 

interviews, and document searches. We used standardized survey questionnaires for 

collecting information on policies, procedures, and practices. We provided our 

questionnaires to HCFA regional offices and intermediaries by electronic mail, and to the 

State agencies by traditional mail. Table 1 shows the response rates to our questionnaire. 

Table 1

Agency Response

Agency Type Responses — Percent of Universe 

HCFA regional offices 10 of 10 (100%) 

State licensure survey agencies 

(50 States, District of Columbia, and Puerto Rico) 

44 of 52 (85%) 

Medicare fiscal intermediaries 39 of 39 (100%) 

In addition to the mail questionnaire, we made on-site inspections at three selected 

regional offices, three State agencies, and five intermediaries. Using our standardized 

questionnaire, we interviewed staff and officials at each site to determine what policies, 

procedures, guidance, and practices were actually followed in approving and disapproving 

provider-based status. At each location, we also reviewed and analyzed documentation on 

criteria, guidance, procedures, and practices for approving provider-based entities. 

Appendix B shows the specific locations of our on-site inspections. 

Further, we analyzed 85 sample case files showing HCFA decisions on provider-based 

status for hospital owned entities. We obtained 70 files from intermediaries and 15 from 

HCFA regional offices. We reviewed the case files to identify what procedures were 

actually used and what resulted from reviewing, approving, and disapproving requests. 

Our selection of the 85 case files was based almost entirely on availability of records. To 

illustrate, we requested 5 sample case files from each of the 39 Medicare intermediaries. 

4

This report frequently refers to HCFA’s provider-based process. That term encompasses HCFA’s policy, 

instructions, protocol, practices, and procedures for reviewing, approving, disapproving, and tracking provider-based status for 

hospital owned entities. 

Provider-Based Reimbursement to Hospitals 6 OEI-04-97-00090 
- - - - - - - - - - - - -

To avoid anomalies, we requested files that documented typical determinations of 

provider-based or free-standing status. If each intermediary had provided our requested 

five cases, we would have reviewed a total of 195 cases. However, only 15 intermediaries 

could provide cases for our review. They provided a total of 70 cases. Twelve of those 

intermediaries provided at least the 5 case files we requested. 

We also requested one case file from each HCFA regional office. In response, we 

received 15 cases -- 1 case each from 6 regions, 2 cases from 1 region, 3 cases from 1 

region, and 4 cases from 1 region. One region provided no case files. 

We integrated and compared information and data from HCFA, its intermediaries, States, 

and our case file review. The information and data, however, was scarce, incomplete, and 

often inconsistent. Accordingly, because of our concerns about data reliability we did not 

project the results of our survey and case file analysis. We used dBASE, excel, and 

manual worksheets as tools to help aggregate and analyze the data obtained. 

We conducted this inspection in accordance with the Quality Standards for Inspections 

issued by the President’s Council on Integrity and Efficiency. 

Provider-Based Reimbursement to Hospitals 7 OEI-04-97-00090 
FINDINGS 

Regional offices do not consistently follow HCFA processes 

for approving provider-based status 

According to HCFA program guidance, its regional offices have responsibility for 

determining whether or not hospital owned entities qualify for provider-based status. In 

approving entities for provider-based status, HCFA regional offices are required to obtain 

assistance from Medicare intermediaries and State licensure agencies. 

In practice, however, HCFA regions do not consistently carry out their responsibilities for 

approving provider-based status for hospital owned medical entities. The regions were 

inconsistent in applying criteria for provider-based status, using fiscal intermediary and 

State assistance, and documenting decisions. The inconsistencies occurred not only 

among regions, but within the same region. 

The most common reason HCFA regional, intermediary, and State staffs gave for 

inconsistent application of the review process was that it is not clear. They said their 

respective roles and HCFAs eight criteria are not clear. 

The level and extent of review varies considerably within and among HCFA 

regions 

Overall, our survey responses, interviews, documents searches, and case analysis showed 

that some HCFA regions perform a detailed, documented analysis in approving providerbased status for hospital owned entities. Others perform only a minimal review and do not 

document the basis for their decision. 

Variation within the same region: In 1997, one HCFA region approved a hospital 

request for provider-based status for one of its entities. The approval was given only after 

a thorough review of the request and supporting documentation from the hospital. HCFA 

regional staff reviewed both the operations of the hospital and its entity. The regional 

office required the hospital to submit a detailed request along with supporting 

documentation addressing each of the eight HCFA criteria. For each of the eight criteria, 

the intermediary indicated compliance or noncompliance for provider-based status. 

Further, the hospital’s request for provider-based status was signed by its Certified Public 

Accountant. 

In 1998, this same region approved another hospital request for provider-based status for 

one of its entities. However, in this instance the approval was given after only minimal 

review. The hospital’s request consisted of a simple one and one-third page, unsigned 

memorandum. Generally, the support was an assertion by the hospital that its entity met 

HCFA criteria. For four of the eight criteria, the hospital’s assertion consisted of a single 

sentence statement. No additional support was furnished by the hospital, or requested by 

HCFA regional office staff. 

Provider-Based Reimbursement to Hospitals 8 OEI-04-97-00090 
Variation among regions: In 1998, another HCFA region approved a hospital request 

for provider-based status for seven off-site entities. In this example, the HCFA region 

gave approval after an extensive review of supporting documentation. The hospital 

submitted over 1,000 pages of supporting documentation before obtaining approval. 

Further, the case files show that HCFA and intermediary staff made considerable inquiries 

into the qualifications of the seven entities. To illustrate, the distance of each entity from 

the acquiring hospital was checked thoroughly and plotted on a map to assure compliance 

with HCFA criteria on proximity. Further, HCFA regional staff even required 

documentary evidence that each of the entities was accredited as claimed by the hospital. 

Conversely, another region advised us that there is no requirement for establishing specific 

provider adherence to the provider-based approval process. This region relies mainly on 

self-attestation statements from hospitals as evidence that their entities qualify for 

provider-based status. 

Similarly, an intermediary in another region described the process as primarily the 

hospital’s self-attestation that their entities qualify for the status. 

HCFA regions do not always use fiscal intermediaries and State licensure 

agencies in approving provider-based status 

The extent to which HCFA regional offices use assistance from Medicare intermediaries 

and State licensure agencies varied. Use of those important sources by HCFA in 

approving or disapproving provider-based status ranges from consistent involvement to 

total exclusion. 

HCFA fiscal intermediaries: As HCFA contractors for Medicare reimbursement, the 

intermediaries are well positioned to contribute important information to HCFA regional 

offices for determining whether hospital owned entities are unquestionably qualified for 

provider-based status. They have routine interaction with hospitals on a wide range of 

Medicare issues that provide a sound understanding of hospital operations, including those 

of off-site entities. This knowledge is frequently reinforced and enhanced as a result of 

reviewing hospital cost reports and conducting routine audits. 

At the time of our inspection, HCFA used 39 fiscal intermediaries to pay Medicare claims 

for Part A medical services. Despite HCFA program memoranda requiring their 

assistance in approving provider-based status for hospital owned entities, 16 

intermediaries reported not being involved in the approval process. 

Additionally, 13 of the remaining 23 intermediaries that did have a role in the approval 

process said that their role was not clear and inconsistently carried out. 

Staff at one intermediary specifically described three different practices by three HCFA 

regions for using the intermediaries to help determine if hospital owned entities qualified 

for provider-based status. The intermediary serves medical providers in each of the three 

different HCFA regions. 

Provider-Based Reimbursement to Hospitals 9 OEI-04-97-00090 
--

--

--

The first HCFA regional office typically approved newly licensed entities as freestanding, and instructed the owning hospital to request provider-based status from 

the intermediary. 

The second regional office approved hospital owned entities for provider-based 

status contingent on the intermediary review and finding. 

The third regional office approved hospital owned entities for provider-based 

status without any consideration of the intermediary. 

State licensure agencies: State licensure agencies routinely review hospitals and various 

other types of medical facilities for licensing and Medicare certification purposes. These 

functions frequently involve on-site inspections of hospitals and entities they own. 

Therefore, State agencies are well positioned to assist HCFA in making provider-based 

determinations. 

However, HCFA regional offices frequently do not use the assistance of States. For 

example, only 20 of the 44 State agencies that responded to our questions said they make 

on-site reviews of hospital owned entities in support of HCFA determinations. Of those 

agencies, 16 said they made recommendations to HCFA or its intermediaries for approval 

or disapproval for provider-based status. Staff in 3 State agencies that do not make site 

visits also said they make a recommendation, but it is based on their general knowledge of 

the hospitals. One of the 19 States that make recommendations told us they recently 

discontinued their involvement in the approval process because HCFA told them to do so. 

Of the 44 State agencies, 15 said their responsibilities in the approval process is unclear. 

Many of the remaining 29 States did not provide clear information on their role. 

Provider-based decisions are not always documented 

The HCFA regions and intermediaries often do not document their decisions for or against

provider-based status, and the basis for those decisions. At least one region had issued

guidance to intermediaries requiring them to document provider-based decisions. That

region required intermediaries to document, at a minimum, that they had applied each of

HCFAs eight criteria in determining provider-based status for hospital owned entities. 

The region allowed flexibility to do so in a checklist, summary, or other method. 

However, many of the files we reviewed contained no such documentation.

To illustrate, our analysis showed that of the 85 case files we reviewed, HCFA regions

determined that 55 entities (65 percent) were qualified for provider-based status, and 20

(23 percent) were free-standing. Files for five cases contained inadequate documentation

to determine if HCFA had approved or disapproved the application. The remaining five

cases were incorrectly provided to us. They were for provider enrollment and change of

ownership rather than determinations of provider-based status, as we had requested.

Of the 75 case files that showed the approval or disapproval decision, 26 contained clear

documentation for the basis of the decisions. About half of the 26 decisions were for

provider-based status and half were for free-standing status. The files for 15 of the 75

Provider-Based Reimbursement to Hospitals 10 OEI-04-97-00090 
--

--

--

--

determinations contained only minimal documentation, but we could ascertain that a 

decision had been made. On the other hand, the files for the remaining 34 determinations 

did not contain supporting documentation for the decision. Documentation was either 

missing altogether from the case files, or insufficient to determine how the decisions were 

reached. HCFA regional offices, however, had approved a clear majority (28) of those 34 

cases for provider-based status. 

HCFA data systems are inadequate for managing the 

provider-based review process 

Neither HCFA headquarters nor regional offices could furnish reliable data on providerbased determinations. For example, from the data HCFA provided, we could not 

ascertain the number of 

hospitals requesting provider-based status, 

hospitals that had been approved for provider-based status, 

hospitals that had been rejected or disapproved for provider-based status, 

and 

hospitals that simply billed Medicare under the provider-based rules 

without notifying HCFA. 

Timely availability of such basic data is essential for sound program management. 

Without it, HCFA is unable to provide needed program oversight to assure appropriate 

costs and impacts for the Medicare Trust Funds and beneficiaries. Further, without basic 

data showing approvals of hospitals for provider-based status, HCFA’s fiscal 

intermediaries can not assure that off-site entities are properly accounted for in hospital 

cost reports. Finally, without such basic management data, HCFA is highly vulnerable to 

improper Medicare Trust Fund reimbursements. 

HCFA can not identify hospitals that have requested and been approved for 

provider-based status 

HCFA program guidance does not fix responsibility on which organization (HCFA central

office, its regions, its fiscal intermediaries, or State licensure agencies) should maintain

records on provider-based determinations. Our inspection showed that none of the

organizations maintained complete and accurate records. Therefore, HCFA does not have

such basic data as which hospitals have requested and been approved for provider-based

status. 

First, HCFA headquarters does not maintain a data base or other record-keeping system

showing which hospitals have properly applied for and received approval for providerbased status for entities they own. 

Second, data bases at HCFA regional offices either do not exist, or they are clearly

incomplete. For example, of the 10 HCFA regional offices, only 2 had data bases that

Provider-Based Reimbursement to Hospitals 11 OEI-04-97-00090 
listed hospitals which had requested provider-based status for off-site entities. Another 

regional office could only manually retrieve copies of some of their provider-based 

determination notices. The staff in this region told us they were unable to identify all 

provider-based determinations. 

Third, such data is not consistently maintained by HCFA fiscal intermediaries. Only 11 of 

the 39 intermediaries told us that they have a data base or other record-keeping system 

from which provider-based entities can be identified. Typically, the other intermediaries 

relied on manual searches of their files, or less reliable methods such as the knowledge or 

recollections of various staff persons. For example, we requested 5 case files for CY 1997 

from each of the 39 intermediaries. Out of a possible 195 files, we received 70 from 15 

intermediaries. Generally, the missing cases were not maintained or were not accounted 

for by intermediaries. For example, eight intermediaries could furnish no case files, 

although they told us that they had assisted HCFA with 16 determinations. Another 5 

intermediaries furnished 11 files, but said they actually assisted HCFA in 13 decisions. 

Finally, State licensure agencies do not maintain data on hospitals that have requested or 

obtained provider-based status for their off-site entities. Of the 44 State agencies that 

responded to our survey, only 4 told us they have a data base from which they can retrieve 

information on provider-based status. Of those four agencies, none could provide us with 

case-specific data. For example, we could not always determine, from the State provided 

data, if hospital owned entities had been approved for provider-based status. In instances 

where approval was clear, we could not ascertain when it occurred. 

HCFA efforts to identify hospitals that bill for provider-based reimbursement for 

off-site entities have generally been unsuccessful 

Staff in 7 of the 10 HCFA regional offices said they had tried several ways to identify 

hospitals that bill for provider-based entities. Four of the seven had specifically directed 

intermediaries to identify hospitals that are billing for provider-based reimbursements for 

off-site entities. They said that they had been generally unsuccessful. 

Staff in 3 of the 10 regions gave various reasons for not attempting to identify hospitals 

that were billing for provider-based reimbursement for their entities. For example, two 

regions said HCFA had not mandated or funded initiatives for this purpose and another 

said they had no consistent way of collecting such information. 

Likewise, HCFA intermediaries have been generally unsuccessful in identifying hospitals 

that are claiming provider-based status for their entities. Of the 39 intermediaries, only 18 

said they had taken specific action to determine which hospitals are claiming providerbased status for their off-site entities rather than free-standing status. However, they 

reported generally unsuccessful results. For example, some of the intermediaries had 

surveyed hospitals in their jurisdiction, but only a few responded. Of those that 

responded, their responses were often nonspecific. Some intermediaries sent inspection 

teams to the hospitals. However, even these intermediaries could not provide a complete 

listing of hospitals in their jurisdictions that were claiming provider-based reimbursement 

for their off-site entities. 

Provider-Based Reimbursement to Hospitals 12 OEI-04-97-00090 
Hospitals often bill for provider-based Medicare 

reimbursement without approval 

Overall, the system for approving provider-based arrangements for hospital owned entities 

does not work very well. As a result, Medicare incurs excessive costs. Because data 

systems were incomplete or nonexistent, we were unable to quantify the excessive costs. 

However, data from certain regions and intermediaries suggest that those costs could be 

substantial. 

Hospitals are required to obtain HCFA approval before billing for Medicare 

reimbursement under the provider-based accounting rules. However, in practice, many 

HCFA and intermediary staff stated that hospitals do not obtain approval from HCFA. 

They said hospitals simply assume provider-based status for their entities and bill Medicare 

accordingly. Such billing is inappropriate. In some instances, HCFA intermediaries do 

not detect that the hospitals are billing Medicare under the higher cost provider-based 

rules until after several years have elapsed. Further, when improper payments are made 

under the provider-based rules, intermediaries reported to us that they typically make only 

prospective corrections. 

The number of improperly designated medical entities is unknown, but may be 

substantial 

Numerous intermediary staff told us that hospitals frequently bill Medicare under the 

provider-based rules without HCFA approval. Intermediary staff also said that, in many 

such instances, the hospital owned entities do not meet HCFA criteria. Neither HCFA nor 

its intermediaries had data or information showing the extent of this practice nationally. 

However, the examples below indicate that the practice may be extensive. 

Data at one intermediary showed that 213 hospital owned entities claimed provider-based 

status during 1997 and early 1998. The hospitals had properly requested provider-based 

status for only 5 of those. The hospitals had, without HCFA approval, assumed providerbased status for the remaining 208 entities and billed Medicare under the provider-based 

rules. 

After learning about the 208 designations through its hospital audits, the intermediary and 

HCFA staff reviewed and approved 185 of them for provider-based status. The HCFA 

regional office disapproved the remaining 28. Therefore, 14 percent of the entities for 

which hospitals had improperly assumed provider-based status were unqualified for 

Medicare reimbursement under the provider-based rules. 

Likewise, data provided by another intermediary showed that 58 entities claimed providerbased status during 1997 and early 1998. Only 2 of the 58 had been properly requested in 

advance. The remaining 56 were assumed by hospitals without approval. Subsequently, 

HCFA disapproved 45 of the 56 entities for which hospitals had improperly assumed 

provider-based status. Therefore, 80 percent of the entities for which hospitals merely 

assumed provider-based status in this State were unqualified for reimbursement under the 

provider-based rules. 

Provider-Based Reimbursement to Hospitals 13 OEI-04-97-00090 
Additionally, after learning of these improperly assumed designations, the intermediary 

referred 6 of the 56 entities for Medicare program integrity investigations. The referrals 

were based on failure to meet an essential Medicare program requirement for off-site 

entities. As of September 1999, the intermediary was in the process of determining 

overpayments made in connection with those cases. 

In another HCFA region, a fiscal intermediary initiated a comprehensive effort to identify 

hospital owned entities that billed Medicare under the provider-based rules. According to 

intermediary staff, this review disclosed numerous hospitals that were reimbursed under 

the provider-based rules, but should have been reimbursed under the less costly freestanding rules. The intermediary could not furnish specific numbers. 

A fiscal intermediary in another region conducted a similar review of provider-based 

entities owned by 23 hospitals in one State. That intermediary found one entity that was 

receiving Medicare reimbursement under the provider-based rules, but should have been 

receiving it under the free-standing rules. 

Improperly designated medical entities and the resulting incorrect Medicare 

payments may go undetected for years 

When a hospital improperly assumes provider-based status for an unqualified entity, it may 

collect improper Medicare payments until the intermediary learns of, and corrects the 

improper designation. The intermediary typically learns of such improperly designated 

entities after the fact through its audit process. 

In some instances, the audit process may not disclose improperly designated providerbased status and improper billings for hospital owned entities for years. For example, our 

review of case files for 50 hospital owned entities from one intermediary showed that at 

least 4 had been improperly billing Medicare under the financially advantageous providerbased rules for between 4 and 6 years. 

The cost of improperly designated provider-based entities is unknown, but could 

be substantial 

Because of the absence of complete, reliable records, we did not determine the extent of 

improper payments for unqualified entities. HCFA, its intermediaries, and States had no 

reliable data for comparing the costs of operating hospital owned entities under providerbased rules versus operating them under the rules for free-standing entities. 

However, one HCFA region provided an estimate by one hospital that gives an indication 

of the financially advantageous reimbursement under the provider-based rules as compared 

to free-standing rules. 

In this example, HCFA determined that a hospital owned medical entity was actually a 

free-standing entity rather than a provider-based entity. Therefore, the hospital was not 

allowed to claim Medicare reimbursement under the provider-based rules. Instead, it had 

to claim reimbursement under the free-standing rules. The hospital appealed HCFA’s 

decision. In its appeal, the hospital estimated that HCFA’s denial had cost it $440,000 

over an 8-month period. That estimate was the difference between Medicare Part B 

Provider-Based Reimbursement to Hospitals 14 OEI-04-97-00090 
reimbursement to the entity as a free-standing entity and what Medicare would have 

reimbursed had the entity been classified under the provider-based accounting rules. 

To the extent that the estimate by that hospital is reliable, the excessive cost for numerous 

unqualified hospital owned entities billing under the provider-based rules would be 

considerable. As shown above, hospitals often improperly bill Medicare for providerbased status, and incorrect payments may be undetected for years. 

Retroactive adjustments of improper payments for provider-based status are 

typically not made 

Staff at all HCFA regional offices, most intermediaries, and most State licensure agencies 

told us that controls are needed to prevent hospitals from improperly billing Medicare for 

entities that do not qualify for provider-based status. As shown earlier, hospitals often 

improperly assume provider-based status for their entities and bill Medicare under the 

more costly provider-based rules. HCFA does not have authority to impose penalties on 

such hospitals. Further, when HCFA learns of such improper payments, it typically does 

not retroactively adjust Medicare reimbursements. As a result, hospitals have little or no 

incentive to assure that their entities are unquestionably qualified for the financially 

advantageous reimbursements under provider-based status. 

The majority of Medicare intermediaries typically do not make retroactive adjustments of 

Medicare payments when they find that a hospital has been improperly reimbursed under 

the provider-based rules. Those improper payments occur because the hospital should 

have been reimbursed under the less costly free-standing rules. We asked the 39 

intermediaries if they make retroactive adjustments when they discover through audits or 

other means that a hospital had been improperly reimbursed. Of the 39 intermediaries, 30 

answered our question. Of those 30 intermediaries, 21 said they do not make retroactive 

adjustments, and only 9 said they make such adjustments. 

Data on provider-based status was incomplete and our attempts to ascertain the impact of 

not retroactively adjusting for improper Medicare payments was unsuccessful. However, 

the impact could be significant based on anecdotal examples provided by a few of the 21 

intermediaries that clearly stated they do not retroactively adjustment payments. To 

illustrate, 3 of the 21 intermediaries told us they did not retroactively adjust Medicare 

payments to numerous hospitals for 68 hospital owned entities. Through the audit 

process, the intermediaries learned that the hospitals had billed under the provider-based 

rules for the 68 entities, but should have billed under the free-standing rules. 

Partly, this problem stems from a lack of consistent understanding among HCFA regions 

and intermediaries on what HCFA program guidance is relative to retroactive adjustments. 

The following examples illustrate the widely divergent views on HCFA program guidance 

relative to retroactive adjustments of payments for hospital owned entities. Three 

intermediaries interpreted HCFA guidance to mean no adjustment even though the 

hospitals had billed Medicare under the provider-based rules without HCFA approval. 

Similarly, one HCFA regional office staff said they were not familiar with authority to 

make a retroactive adjustment. 

Provider-Based Reimbursement to Hospitals 15 OEI-04-97-00090 
Conversely, another HCFA regional office interpreted the guidance to allow a retroactive 

adjustment unless HCFA had previously made an incorrect determination of providerbased status. If HCFA had made the improper determination, the region felt it could not 

make a retroactive adjustment. This interpretation precludes retroactive adjusted 

payments when a hospital improperly assumes provider-based status. As shown earlier in 

this report, hospitals often do not ask HCFA for a determination. They simply assume 

provider-based status and bill Medicare accordingly. 

In its new regulations which could revise the provider-based rules, HCFA has included 

language on retroactive adjustments or recovery of overpayments. However, staff at 

several intermediaries said that reclassifying costs and correcting cost reports, as a means 

of adjusting for improper payments, was an over-simplification of the problem. Those 

intermediaries and many others stated that the more significant problems are inadequate 

controls for assuring consistent, accurate determinations of provider-based status, and 

inadequate safeguards to prevent hospitals from improperly billing Medicare for 

unqualified off-site entities. 

Provider-Based Reimbursement to Hospitals 16 OEI-04-97-00090 
CONCLUSION AND RECOMMENDATIONS 

HCFA management of the process for granting provider-based status gives little or 

no assurance that only qualified hospital owned entities are approved. The process 

often results in hospitals improperly billing Medicare for off-site entities that are not 

qualified for reimbursement under the higher cost provider-based rules. Further, when 

HCFA identifies improper Medicare reimbursements for unqualified hospital owned 

entities, it typically does not make retroactive adjustments. The extent of improperly 

designated provider-based entities and the resulting improper Medicare reimbursements is 

not readily determinable because of inadequate data systems. However, opinions from 

HCFA, fiscal intermediary, and State staffs, plus the limited data they could provide 

suggested that improper Medicare reimbursements are substantial. 

In establishing procedures for granting provider-based status, HCFA recognized that the 

costs to both Medicare and its beneficiaries would be greater, with no commensurate 

benefits. However, hospitals benefit from the provider-based arrangement because they 

are allowed to shift overhead costs to their provider-based entities and receive higher 

Medicare reimbursement. For these reasons, in establishing procedures for granting 

provider-based status, HCFA stressed the importance of assuring that only unquestionably 

qualified hospital entities are approved. 

Implementing needed systems for properly managing the provider-based provision would 

likely require considerable resource investments by HCFA, its fiscal intermediaries, and 

States. Considering this possibility, the recognized increased costs of the provider-based 

status for qualified and unqualified hospitals, and the absence of any commensurate benefit 

for Medicare and its beneficiaries, we question the merits of any additional expenditures 

on provider-based status for hospital owned entities. 

Because of such concerns, we recommended in our September 1999 OIG report5 that 

HCFA eliminate provider-based status as an option for physician practices. Our current 

inspection showed that the same concerns are applicable for all types of hospital owned 

entities, including physician practices, home health agencies, nursing homes, and others. 

Therefore, expanding on our prior recommendation, 

we recommend that HCFA eliminate provider-based status as an accounting 

option for all types of hospital owned entities. 

If HCFA chooses to continue use of the provider-based option for hospital owned entities, 

it should 

< Impose severe and substantial penalties, as recommended in our prior report, 

when hospitals bill Medicare for unqualified medical entities they own. 

Penalties should provide an incentive for hospitals to request HCFA approval, as 

5

Hospital Ownership of Physician Practices (OEI-05-98-00110) 

Provider-Based Reimbursement to Hospitals 17 OEI-04-97-00090 
required, before billing Medicare under provider-based rules. Penalties would 

reduce the incentive for hospitals to bill Medicare for unqualified entities. 

< Revise and clarify its program policy and procedures. HCFA guidance should 

better define processes for requesting, approving, tracking, and evaluating 

provider-based status. Procedural guidance is needed to assure that HCFA 

regions, fiscal intermediaries, States, and hospitals understand eligibility criteria for 

provider-based status, and their respective roles in the approval process. Further, 

such clarification is needed to assure consistent application of eligibility criteria by 

HCFA regions, fiscal intermediaries, and States. The need for a consistent process 

related to recovery or non-recovery of reimbursement improperly claimed by 

hospitals is yet another reason clarification of policy and procedures would be 

beneficial. 

< Develop reliable data systems for program management. At a minimum, data 

systems should identify hospitals that request provider-based status, hospitals that 

are approved, and those that simply assume the status without approval and bill 

Medicare inappropriately. Further, HCFA needs such basic data to evaluate the 

cost of provider-based arrangements versus the cost for free-standing medical 

entities. 

< Require that all hospitals claiming provider-based status reapply for that 

status. Reapplication could be done on a one-time or periodic basis. It would 

give HCFA valuable information on which hospitals are being reimbursed under 

the financially advantageous provider-based rules. It would also allow HCFA an 

opportunity to assure that only unquestionably qualified hospitals are approved. 

Further, if HCFA establishes serious intent to control approval based on its eight 

criteria, some unqualified hospitals might not reapply. Finally, this option would 

give HCFA an opportunity to establish reliable baseline data for program 

management. 

AGENCY COMMENTS 

The Health Care Financing Administration commented on our draft report. The full text of those 

comments are shown in appendix C. 

In brief, HCFA did not agree with the recommendation to eliminate the provider-based program. 

Instead, HCFA supported our alternative recommendation to establish reliable systems to improve 

its management of the provider-based program. To that end, HCFA has initiated various actions, 

including revising regulations and procedures, implementing management data and control 

systems, and providing training for staff responsible for program administration and control. 

The HCFA expressed concern about the administrative burden of full implementation of our 

recommendation to require all hospitals claiming provider-based status to reapply so that HCFA 

could assure they qualified for the benefit. Instead, HCFA plans a less burdensome, alternative 

approach to resolving that problem. Specifically, HCFA plans to assure that all new applicants 

qualify for the benefit. Further, when a complaint or other evidence indicates that an existing 

Provider-Based Reimbursement to Hospitals 18 OEI-04-97-00090 
provider-based arrangement does not meet requirements, HCFA plans to reassess the hospital’s 

qualifications for the benefit at that time. 

While we believe that HCFA’s planned corrective action will significantly strengthen their future 

management of the Medicare provider-based reimbursement provision, we are concerned that 

some problems described in our report will continue. Specifically, existing non-qualified hospitals 

will continue to bill Medicare under the cost advantageous provider-based rules until they are 

caught. 

Therefore, we continue to believe that it is appropriate to require all hospitals to reapply. We 

recognized that there would be administrative costs associated with this requirement. However, 

we believe that such costs would be more than off-set by savings accruing from termination of 

inappropriate billings to the program. 

Provider-Based Reimbursement to Hospitals 19 OEI-04-97-00090 
APPENDIX A 

Provider-Based Criteria

Program Memorandum (Intermediaries), HCFA Pub. 60A, Transmittal No. A-99-24 

May 1999 

This Program Memorandum re-issues Program Memorandum A-98-15, dated May 1998. 

The only change is the discard date and contact person; all other material remains the 

same. 

This Program Memorandum re-issues Program Memorandum A-96-7. 

SUBJECT: Policy Clarification: Provider-Based Designation 

PURPOSE: 

The purpose of this program memorandum (PM) is to consolidate and clarify the Health Care 

Financing Administration’s (HCFA’s) 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 physician’s 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 

facility’s 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 

Provider-Based Reimbursement to Hospitals 20 OEI-04-97-00090 
APPENDIX A 

Provider-Based Criteria

payment impact, the Medicare coverage of “incident-to” services would also be affected if a 

physician’s 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 

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 

physician’s 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 HCFA’s 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; 

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APPENDIX A 

Provider-Based Criteria

! 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 

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. 

Provider-Based Reimbursement to Hospitals 22 OEI-04-97-00090 
APPENDIX A 

Provider-Based Criteria

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 

! 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 Program Memorandum may be discarded May 31, 2000. 

For further information, please contact George Morey at (410) 786-4653. 

Provider-Based Reimbursement to Hospitals 23 OEI-04-97-00090 
APPENDIX B 

Locations of On-Site Inspections

We surveyed all HCFA regional offices, State agencies, and intermediaries. We also 

selected a limited sample for on-site inspections. We selected sites on the basis of 

accessibility. The table below identifies those selected. 

On-Site Inspections 

Site HCFA Region Location 

HCFA Regional Office IV Atlanta, Georgia 

HCFA Regional Office VII Kansas City, Missouri 

HCFA Regional Office X Seattle, Washington 

Medicare Intermediary III Baltimore, Maryland 

Medicare Intermediary III Richmond, Virginia 

Medicare Intermediary IV Birmingham, Alabama 

Medicare Intermediary IV Columbus, Georgia 

Medicare Intermediary IV Durham, North Carolina 

State Licensure Agency III Baltimore, Maryland 

State Licensure Agency III Richmond, Virginia 

State Licensure Agency IV Raleigh, North Carolina 

Provider-Based Reimbursement to Hospitals 24 OEI-04-97-00090 
APPENDIX C 

Agency Comments

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