Department of Health and Human Services 

OFFICE OF 

INSPECTOR GENERAL 

JUNE GIBBS BROWN 

Inspector General 

SEPTEMBER 1999 

OEI-05-98-00110 

HOSPITAL OWNERSHIP OF 

PHYSICIAN PRACTICES 
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 hospital’s cost report. 

Medicare reimburses hospitals using interim payments which are reconciled with the 

hospital’s 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. 

Hospital Ownership of Physician Practices 1 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 FI’s 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 freestanding. 

Hospital Ownership of Physician Practices 2 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 costbased reimbursement. A provider-based designation results in increased Medicare 

payment with no apparent benefit for Medicare or the beneficiary. In addition, a 

beneficiary’s 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 physician’s 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 beneficiary’s 

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 longstanding 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. 

Hospital Ownership of Physician Practices 3 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 HCFA’s 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 Medicare’s 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. 

Hospital Ownership of Physician Practices 4 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

Hospital Ownership of Physician Practices 5 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 Administration’s (HCFA’s) policy that a hospital may treat 

an acquired physician practice as either provider-based or free-standing. The hospital’s 

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. 

Hospital Ownership of Physician Practices 6 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 hospital’s 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 

physician’s 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 practice’s 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 HCFA’s criteria 

for provider-based status. The hospital submits claims for services provided in the freestanding practice to the Medicare carrier which pays these claims under the Physician Fee 

Schedule. 

The Physician Fee Schedule payment includes portions for both the physician’s 

professional service as well as for the costs incurred in operating a physician’s 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 physician’s 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 physician’s 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. 

Hospital Ownership of Physician Practices 7 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 physician’s 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 notfor-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 Association’s (AHA’s) data regarding hospital 

ownership of physician practices. 

We conducted our review in accordance with the Quality Standards for Inspections issued 

by the President’s Council on Integrity and Efficiency. 

5 We obtained a list of hospitals from HCFA’s 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 notfor-profit and for-profit hospitals, excluding government owned hospitals. We selected our 

sample from this list of 3,610 hospitals. 

Hospital Ownership of Physician Practices 8 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, shortterm 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 

Hospital Ownership of Physician Practices 9 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. 

Hospital Ownership of Physician Practices 10 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 Medicare’s 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. 

Hospital Ownership of Physician Practices 11 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 physician’s 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 provider’s 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. 

Hospital Ownership of Physician Practices 12 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 beneficiary’s 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 physician’s 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: 

with diabetes and leg ulcers. 

Billing Provider Description 

Service 

Beneficiary Coinsurance 

Provider- FreeBased Standing 

Facility Facility 

Hospital Treatment Room $ NONE 

Clinic & 

Physician 

Office Visit $ $ 

Debridement $ $ 

TOTAL BENEFICIARY PAYMENT $ $ 

Male, age 70, is diagnosed 

Procedure performed is debridement of ulcer. 

52.05 

8.83 10.99 

10.93 13.66 

71.81 24.65 

9 Federal Register, Vol. 63, No 173, September 8, 1998, pg. 47,588. 

Hospital Ownership of Physician Practices 13 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 physician’s office with provider-based status, as opposed to a 

$24.65 coinsurance payment if the same procedure is performed in a free-standing 

physician’s 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 physician’s 

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. 

Hospital Ownership of Physician Practices 14 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. 

Hospital Ownership of Physician Practices 15 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 

hospital’s 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. 

Hospital Ownership of Physician Practices 16 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. 

Hospital Ownership of Physician Practices 17 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 HCFA’s 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 Medicare’s 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. 

Hospital Ownership of Physician Practices 18 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 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 

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 

Hospital Ownership of Physician Practices 19 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 

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; 

! 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 

Hospital Ownership of Physician Practices 20 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 

Hospital Ownership of Physician Practices 21 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. 

Hospital Ownership of Physician Practices 22 OEI-05-98-00110 
APPENDIX B 

Agency Comments

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

Agency Comments

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