I I 

Department of Health and Human Services -

OFFICE OF 

INSPECTOR GENERAL 

MEDICARE LOSSES ON 

HOSPITAL SALES 

JUNE GIBBS BROWN 

Inspector General 

JUNE1997 

OEI-03-9MO170 
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 Evaluationand 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 Philadelphia Regional Office prepared this report under the direction of 

Robert A. Vito, Regional Inspector General. Principal OEI staff included: 

REGION HEADQUARTERS 

Linda M. Ragone, Project Leader Stuart R. Wright, Program Specialist 

Linda Moscoe, Technical Support Staff 

To obtain copies of thisreport, please call the PhiladelphiaRegional Office at (800) 531-9562 
Department of Health and Human Services 

OFFICE OF 

INSPECTOR GENERAL 

MEDICARE LOSSES ON 

HOSPITAL SALES 

JUNE GIBBS BROWN 

Inspector General 

JUNE1997 

OEI-03-96-00170 
EXECUTIVE SUMMARY 

PURPOSE 

To quantify the financial impact of hospital sales on the Medicare program. 

BACKGROUND 

At the inception of the Medicare program, hospitals were allowed to include the 

depreciation of assets as an allowable capital-related cost in their annual Medicare 

cost reports. When a hospital undergoes change of ownership for reimbursement 

purposes, Medicare guidelines specify that the hospital can receive an adjustment to 

the facility’s final allowable or reimbursable costs based on the gain or loss on 

depreciated assets at the time of sale. This means that if a hospital’s depreciable 

assets (buildings and equipment) are purchased at higher than the net book value or 

“value on paper,” Medicare shares in the gain. If the hospital’s depreciable assets are 

purchased at less than the net book value, Medicare shares in the loss. Medicare’s 

share of the gain or loss is known as the depreciation adjustment. 

Recent increases in hospital sales have raised concerns about Medicare’s liability for 

depreciation adjustments. Our study was aimed at determining just how much 

Medicare had paid for depreciation adjustments in recent years. 

We requested information from two main sources: fiscal intermediaries and the 

Health Care Financing Administration’s regional offices. The scope of our study was 

acute care hospital changes of ownership that met Medicare requirements for a 

depreciation adjustment during Fiscal Years 1990 through 1996. 

FINDINGS 

Medicare lost $223 million and standk to lose another $289 million in depreciation 

adjustments forhospitals sold between 1990 and 1996. 

Fiscal intermediaries reported $453 million in losses and $56 million in gains for a net 

loss of $397 million on 229 hospitals sold between 1990 and 1996. Of the nearly $400 

million net loss reported, $223 million was from hospital sales where the final payment 

determination has been made. Another $174 million net loss to Medicare has been 

reported by hospitals but has yet to be settled by the program. We estimate that 

Medicare could pay out $115 million on an additional 88 hospital sales that have 

already occurred but for which no financial data was available. 

i 
Medicare could lose an estimated $53 million in depreciation adjustments for hospital 

sales expected in 1997. 

Although less than half of the fiscal intermediaries reported being aware of potential 

hospital sales in their respective areas, these intermediaries identified 41 expected 

hospital sales for 1997. We estimate that the potential liability to Medicare for these 

41 sales could reach $53 million. 

Net losses reported to the Medicare program have more than quadrupled between 1990 

and 1996. 

Net losses reported to the program have increased 322 percent from $29 million in 

1990 to $122 million in 1996. For every $1 that Medicare shared in gains, it paid out 

$8 in losses. While Medicare has shared in the loss for 161 hospital sales, in contrast, 

it has shared the gain for only 33 hospital sales. Since 1990, Medicare has shared in 

only one gain for every five losses resulting from depreciation adjustments. 

Medicare lluly be paying more than it should to hospitals sold at a loss during the 

transition period for capital prospective payments. 

The loss to the Federal Government from hospital sales may be greater than the half 

billion already identified through depreciation adjustments. Medicare may also be 

paying out more than it should for hospitals sold at a loss and paid under the capital 

prospective payment system. While Medicare recognizes a loss on assets for 

depreciation purposes, in most cases it makes no adjustment to a hospital’s capital 

payment methodology to account for the new lower value of the hospital. 

Losses jkom depreciation adjustments also impact the Medicaid program. 

Some Medicaid programs are calculating depreciation adjustments when hospitals are 

sold. Intermediaries could provide data on Medicaid depreciation adjustments for 

only 10 of the 229 sales transactions with Medicare depreciation adjustments. The 

Medicaid depreciation adjustments were all losses ranging from $18,000 to $10 million. 

The 10 sales represented a $16 million loss to the respective Medicaid programs. 

RECOMMENDATIONS 

Substantial amounts of money are being paid and will continue to be paid in the 

coming years for an accounting procedure established in the early years of the 

program. At the beginning of the 199Os, Medicare moved from cost-based 

reimbursement to a prospective payment system. We believe the policy allowing 

depreciation adjustments on hospital sales is an unnecessary holdover from the old 

cost-based reimbursement system that should be discontinued. 

ii 
We recommend that the Health Care Financing Administration: 

0 propose legislation to change Section 1861(v)(l)(O) of the Social Security Act 

to eliminate the requirement that Medicare make adjustments for gains or 

losses when hospitals undergo changes of ownership; 

0 propose a similar elimination of depreciation adjustments on hospital sales in 

the Medicaid program; and 

0 examine options for recalculating capital transition payments to hospitals 

undergoing changes of ownership for reimbursement purposes. 

AGENCY COMMENTS 

The HCFA concurred with our recommendations. The agency stated that proposed 

legislation entitled “Medicare and Medicaid Fraud, Abuse, and Waste Preventions 

Amendments of 1997” (Section 205) would use the net book value as the sales price 

for hospitals undergoing a change of ownership. This proposed change would 

eliminate the need for a depreciation adjustment. The agency also stated that if 

depreciation adjustments were eliminated in the Medicare program this change would 

also be reflected in the Medicaid program. After examining its options, HCFA 

believes that recalculating the capital transition payments for hospitals undergoing 

changes of ownership would be inappropriate and inadvisable at this time. While we 

recognize the complexity of the policy and administrative implications identified by 

HCFA, we continue to believe that capital payments to hospitals sold at a loss should 

be redetermined. 

*.. 

111 
TABLE OF CONTENTS 

PAGE 

EXECUTIVESUMMARY .......................................... i 

INTRODUCTION ................................................. 1 

FINDINGS ...................................................... 7 

� Medicare’s loss on depreciation adjustments ........................... 7 

� Loss on expected sales ........................................... 8 

0 Increase in net losses over time .................................... 9 

0 Prospective capital payments ..................................... 10 

� Medicaid’s loss on depreciation adjustments .......................... 11 

RECOMMENDATIONS ........................................... 12 

APPENDICES 

A: Explanation of Depreciation Adjustment Calculation .................. A - 1 

B: Health Care Financing Administration Comments .................... B - 1 
INTRODUCTION 

PURPOSE 

To quantify the financial impact of hospital sales on the Medicare program. 

BACKGROUND 

The Hospital Insurance program (Part A) pays for hospital, skilled nursing facility, 

home health, and hospice care for Medicare beneficiaries. Payments for inpatient 

hospital care comprised 70 percent of the $116 billion in Part A payments in 1995. 

Between 1990 and 1994, the number of inpatient short-stay hospital service discharges 

increased less than 10 percent; in contrast, expenditures for these services increased 

more than 30 percent. 

Medicare payments to most short-stay or acute care hospitals are made through a 

prospective payment system. For each Part A patient discharge, the hospital is paid 

based on a reimbursement equation that includes not only direct patient care costs but 

also capital costs such as the updating and acquiring of buildings and equipment. 

Prior to the phase-in of a prospective payment system for inpatient capital costs which 

began in October 1991, Medicare paid for capital costs on a reasonable cost basis as 

determined by a hospital’s annual cost report. 

Recent Increases in Hospital Mergers and Sales Activity 

In this era of cost-cutting and emphasis on managed care, hospitals are undertaking a 

number of consolidation measures to enhance their operations. The Public Citizen 

Health Research Group reported in its June 1996 Health Letter that transactions 

involving 447 community hospitals had been announced or completed in 1995. These 

hospital transactions included mergers, acquisitions, joint ventures, and leasing 

agreements. 

Medicare’s Handling of Hospital Ownership Changes 

The Health Care Financing Administration (HCFA) contracts with 54 fiscal 

intermediaries to process Medicare Part A inpatient hospital payments. The HCFA 

has provided guidance to these contractors on how to handle changes of hospital 

ownership, such as mergers or sales, in section 4500 of the Intermediary Manual. 

Guidelines for handling changes of ownership and disposal of assets are also 

delineated in sections 130 and 1500 of the Provider Reimbursement Manual. 

The fiscal intermediaries are responsible for performing the reimbursement analysis 

for a hospital change of ownership. Not all hospitals that undergo some type of 

change of ownership will have their reimbursement affected. The intermediary 

manual provides examples of what it considers a bona-fide sale or change of 

1 
ownership for reimbursement purposes. For the most part, a bona-fide sale would be 

defined as a sale between two unrelated parties (frequently called “arms-length 

transactions”). If a change of ownership is recognized for reimbursement, the fiscal 

intermediary will then calculate whether the transaction results in a gain or loss for the 

seller, and in what portion of the gain or loss the Medicare program will share. 

Gain or Loss on Depreciable Assets at the Bne of Hospital Sale 

Hospitals through the years were allowed to include the depreciation of assets as an 

allowable capital-related cost in their annual cost reports. When a hospital undergoes 

a bona-fide change of ownership for reimbursement purposes, Medicare guidelines 

specify that the hospital can receive an adjustment to the facility’s final allowable or 

reimbursable costs based on the gain or loss on depreciated assets at the time of sale. 

This means that if a hospital’s depreciable assets (buildings and equipment) are 

purchased at higher than the net book value or “value on paper,” Medicare shares in 

the gain. If the hospital’s depreciable assets are purchased at less than the net book 

value, Medicare shares in the loss. 

Calculating Medicare3 Share of the Gain or Loss 

As part of the audit or settlement of the final cost report, the fiscal intermediaries are 

responsible for reviewing the hospital’s gain or loss on sale for Medicare purposes. 

This settlement occurs after receiving the hospital’s terminating cost report along with 

other legal and financial documents having to do with the sale. The hospital must 

include in this documentation an allocation or distribution of the total sale price 

among all assets being sold. The guidelines allow for an independent appraisal expert 

to perform an appraisal to establish the value of the assets being sold. As outlined in 

section 4505.3 of the intermediary manual, HCFA considers this expert’s membership 

in one of several professional appraiser societies as providing reasonable assurance to 

the intermediary that the “appraisal results have been prepared in accordance with a 

code of ethics and professional standards.” 

Upon establishment of the sale or purchase prices for the depreciable assets, the 

intermediaries compare the purchase price to the current depreciated value of the 

assets (original value less depreciation taken in previous years) to determine the 

amount of gain or loss. Medicare’s share of this gain or loss is determined by the ratio 

of the hospital’s Medicare patient costs to all patient costs. A more detailed 

explanation and examples of depreciation adjustments are provided in Appendix A. 

HCFA Workgroup Reviews Medicare Policies for Changes of Ownership 

The HCFA’s Audit & Reimbursement Steering Committee convened an ad hoc 

Workgroup to review current guidelines for handling changes of ownership. The 

Workgroup consisted of both HCFA and fiscal intermediary staff. Its mission was to 

recommend to HCFA ways to “modify, update and expand program instructions 

considered necessary in order to provide current and complete guidance to fiscal 

2 
intermediaries and providers, regarding treatment of change of ownership transactions 

to determine appropriate Medicare reimbursement.” The group has transmitted its 

proposals back to the Steering Committee and they are now under review by HCFA. 

Prior to the release of this report, we provided the Office of the Secretary and HCFA 

with the results of our evaluation. 

MEiTHODOLOGY 

We requested information from two main sources: fiscal intermediaries and HCFA 

regional offices. The scope of our evaluation was acute care hospital changes of 

ownership (except bankruptcies) that met Medicare requirements for a depreciation 

adjustment during Fiscal Years 1990 through 1996. For the remainder of this report, 

we will refer to all of these types of ownership changes as hospital sales. 

Information Requested jkom Fiscal Intermediaries 

We surveyed all current fiscal intermediaries to determine their experiences with 

hospital changes of ownership. We requested that each intermediary complete an 

overview guide regarding hospitals sales that have transpired under their jurisdiction. 

This guide was developed to provide summary data on the number of hospital sale 

transactions triggering depreciation adjustments that occurred between 1990 and 1996. 

We sent requests to 44 organizations that represent all currently contracted fiscal 

intermediaries in the Medicare program. We received some form of response from all 

44 organizations. However, several intermediary organizations service multiple 

geographic areas and chose to break down their responses by those areas. As a result, 

our analysis was conducted on 54 separate fiscal intermediary responses received 

between August and December 1996. 

In addition to the overview guide, the intermediaries were asked to complete a fact 

sheet for each hospital sale where they had received either a terminating cost report 

or other financial documents from the hospital. We designed these fact sheets to 

collect detailed financial and descriptive data on each hospital sale. Much of the data 

requested on the fact sheet could be compiled from the hospital’s terminating cost 

report, sale or purchase agreement, and allocation of sales price documentation. 

The number of fact sheets returned by each fiscal intermediary and the thoroughness 

of data provided on the fact sheets were dependent upon: 1) the volume of hospital 

sales within the intermediary’s jurisdiction, and 2) the comprehensiveness and 

availability of information provided by hospitals to the intermediaries. Although we 

had follow-up telephone contacts with many fiscal intermediaries’ staff to clarify our 

information requests, we received some fact sheets that could not be utilized for 

analysis purposes. These fact sheets contained no financial data, were for hospital 

transactions that did not trigger a depreciation adjustment calculation, or were for 

other than acute care hospitals. The thoroughness of the financial data provided on 

the remaining fact sheets varied. However, every fact sheet used for our analysis had 

3 
to provide, at a minimum, financial data on Medicare’s share of the gain or loss on 

depreciable assets. We received 229 fact sheets that met this requirement for analysis. 

Information Requested jkom HCFA Regional mces 

We surveyed the 10 HCFA regional offices to collect data on hospital sales 

transactions that occurred between Fiscal Year 1990 and the beginning of Fiscal Year 

1997. The purpose of this was twofold -- we wanted to 1) verify the summary hospital 

sales information received from the fiscal intermediaries, and 2) gather regional office 

staff perspectives on the processing of hospital sales and their coordination with the 

intermediaries. We received responses from all the regional offices between 

November 1996 and January 1997. 

Calculating the Financial Impact of Hospital Sales on the Medicare Program 

We used the data reported from the fiscal intermediaries on the fact sheets to 

determine the impact of hospital sales with depreciation adjustments. For 171 of the 

229 hospital sales with depreciation adjustment data, these adjustments have been 

settled and are only subject to change if appealed by the hospital. After settlement of 

the cost report, hospitals have 180 days to appeal intermediary determinations. 

We identified 14 settled transactions with pending appeals concerning depreciation 

adjustments: four of these were for hospitals disputing the amount of gain they must 

share with Medicare, nine were for hospitals contesting that the loss shared by 

Medicare should be greater, and one hospital with a zero adjustment was arguing that 

a loss should have been recognized. We also identified nine transactions where 

intermediaries indicated that the opportunity to appeal had not yet expired. We 

included the adjustments for these 23 hospitals in our calculations because the figures 

do not represent an overstatement of Medicare impact. Indeed, if the appeals are 

decided in favor of the hospitals, the loss to Medicare would be even greater. 

For 58 hospital sales transactions, formal settlement of the terminating cost reports 

has not been completed; therefore, the depreciation adjustments reported are subject 

to redetermination by the fiscal intermediaries. These depreciation adjustments have 

been aggregated to determine the impact on the program. The monetary impact 

associated with these unsettled depreciation adjustments is identified in the findings. 

When we refer to the terms “net losses” or “overall impact” in this report, this refers to 

the dollar impact that results when aggregated depreciation loss adjustments are 

compared to aggregated depreciation gain adjustments. Depreciation adjustments for 

hospitals sold at a loss are presented in negative dollar figures in this report, since 

these represent Medicare outlays. Depreciation adjustments resulting from gains are 

presented as positive dollar figures, since these represent payments to the Medicare 

program. Although the hospital sales transactions that resulted in zero adjustments do 

not have a financial impact on Medicare, these transactions were included in the 

calculation of all hospital sale statistics. 

4 
Estimating the Financial Impact of Hospital Sales Where Depreciation Adjustments Have 

Yet To Be Reported 

To determine the financial impact of sales that have already occurred but for which no 

financial data is currently available, we aggregated the total number of sales 

transactions identified on the intermediary overview guides. In total, the 

intermediaries identified 317 hospital sales that would meet Medicare requirements for 

calculating a depreciation adjustment. We subtracted the number of sales with 

information on depreciation adjustments (229) from the 317 total sales. The 

difference between these two numbers (88) equals the number of sales without 

financial data available at this time. 

To estimate the depreciation adjustments for the 88 sales that have already occurred 

but for which no financial information is available, we utilized the depreciation 

adjustments reported on the fact sheets. We purposefully decided to include in our 

estimation analysis only the financial data from hospitals where the terminating cost 

report had been audited and settled by the intermediary. We believed this would 

provide a more conservative and accurate estimate of average depreciation 

adjustments. Financial data from 171 settled hospital cost reports was used for this 

analysis. 

We employed a three-step analysis to estimate the net financial impact of hospital 

sales without data. First, we determined the proportions of gain, loss, and zero 

adjustments that resulted from the 171 settled transactions. Sixty-nine percent of 

settled sales were recognized as losses to the Medicare program. Seventeen percent 

were gains and another 14 percent were zero adjustments. These three proportions 

were applied to the 88 sales without data to estimate how many transactions would fall 

into each of the three adjustment categories. Next, we grouped the 171 settled 

hospital sales by gain, loss, and zero adjustments and determined the average or mean 

depreciation adjustment for each category. We multiplied the mean statistic for each 

category by the number of sales without data we had estimated would fall into each of 

the three categories to quantify overall dollar amounts associated with gains, losses, 

and zero adjustments. Lastly, we compared the aggregate gain and loss depreciation 

adjustments to determine a net impact to Medicare. 

Estimating the Financial Impact of Potential Hospital Sales 

To determine the impact on Medicare from potential sales, we totaled the number of 

potential sales identified in the intermediary overview guides. We had asked both the 

intermediaries and HCFA regional offices to provide the number of potential sales 

they had reason to believe might occur in 1997; however, the potential sales data from 

the fiscal intermediaries and regional offices did not match. To prevent overinflating 

the data by combining or comparing the data, we chose to use only the potential sales 

data from the intermediaries. We selected the intermediary data since they had a 

higher response rate to the potential sales question than the regional offices. The 

fiscal intermediaries identified 41 potential sales. We computed the financial impact 

5 
of the 41 potential hospital sales identified using the three-step analysis described for 

hospital sales where depreciation adjustments have yet to be reported. 

6 
FINDINGS 

MEDICARE LOST $223 MILLION AND STANDS TO LOSE ANOTHER $289 

MILLION IN DEPRECIATION ADJUSTMENTS FOR HOSPITALS SOLD 

BETWEEN 1990 AND 1996. 

Over the last 7 years, a total of 317 hospital sales have occurred that met Medicare 

requirements for calculating a depreciation adjustment. These types of sales have 

more than doubled between Fiscal Years 1990 and 1995.’ The chart below provides 

a breakdown of the hospital sales by year. 

Hospital Sales with Depreciation Adjustments 

FiscalYears 1990 through 1996 

Fiscal intermediaries report $453 million in losses and $56 million in gains for a net loss 

of $397 million on 229 hospitals sold between I990 and 1996. Medicare has already 

paid out $223 million of the net loss. 

The fiscal intermediaries provided financial data on 229 hospital sales transactions that 

met Medicare requirements for a depreciation adjustment between Fiscal Years 1990 

and 1996. Of the nearly $400 million in net losses reported, $223 million was from 

171 hospital sales where the final payment determination has been made. The fiscal 

intermediaries have audited and settled these hospitals’ terminating cost reports. 

‘Fiscal year 1995 was the last complete year of hospital sales data collected from 

all fiscal intermediaries. 
Medicare has already paid out $270 million in losses and received $47 million in gains 

for these hospitals. 

Another $174 million net loss to Medicare has been reported by hospitals but has yet 

to be settled by the program. This figure is based on 58 hospital sales with reported 

gain adjustments of $9 million and reported loss adjustments of $183 million. These 

adjustments have been calculated and reported by hospitals but the intermediaries 

have yet to settle the terminating cost reports. 

Medicare could lose an estimated $115 million on another 88 hospital sales for which no 

financial data was available. 

The fiscal intermediaries reported that there were 317 hospital sales that met 

Medicare’s conditions for calculating a depreciation adjustment. However, for 88 of 

these transactions, the intermediaries could not provide us with data on the 

adjustment. Some of the intermediaries had not yet received any financial information 

on the sale from the hospitals. Others explained that they had received the 

information but had not yet reviewed it for accuracy. 

Using the financial data received from the 171 hospitals with depreciation adjustments 

finalized by the intermediaries, we calculated both the proportion of sales with gains 

and losses and the average of the resulting depreciation adjustments. Using the 

proportions calculated for the settled hospital sales, we estimate that of the 88 sales 

without data there would be 15 gain adjustments, 61 loss adjustments, and 12 zero 

adjustments. The average depreciation adjustment for settled hospitals sold at a loss 

was $2,291,078. For hospitals sold at a gain, the average depreciation adjustment was 

$1,629,629. By employing the estimated number of adjustments and the average gain 

and loss statistics, we estimate the 88 sales could result in a net loss to Medicare of 

$115 million. This figure is an approximation and is furnished to provide only an 

estimate of the impact on Medicare. The actual financial impact of these sales will 

not be known until the fiscal intermediaries audit the transactions and settle the final 

cost reports. 

MEDICARE COULD LOSE AN ESTIMATED $53 MILLION IN DEPRECIATION 

ADJUSTMENTS FOR HOSPITAL SALES EXPECTED IN 1997. 

It does not appear that the rate of hospital sales will significantly decrease in 1997. 

Although less than half of the fiscal intermediaries (24 of 54) reported being aware of 

potential sales in their respective areas, these intermediaries identified 41 expected 

hospital sales for 1997. 

Using the proportion of gains and losses and the average adjustments of previously 

settled hospital sales, we estimate that the potential liability to Medicare for these 41 

sales could reach $53 million. This estimate provides an indication of the possible 

impact that upcoming sales could have on Medicare. If all the expected sales do not 

occur, this could potentially reduce the estimated loss. Conversely, the impact on the 

8 
program could be even greater if additional hospitals not identified by the 

intermediaries undergo sales in 1997. 

NET LOSSES REPORTED TO THE MEDICARE PROGRAM HAVE MORE 

THAN QUADRUPLED BETWEEN 1990 AND 1996. 

When comparing Medicare’s share of gains and losses on reported hospital sales over 

the last 7 years, Medicare has never shown an overall gain in any year. Net losses 

reported to the program have increased 322 percent from $29 million in 1990 to $122 

million in 1996. For every $1 that Medicare shared in gains, it paid out $8 in losses. 

The table below provides the number of hospital sales with gain, loss, and zero 

adjustments by fiscal year. It also provides the payments associated with gains and 

losses for each year. 

YGII Number Total Gains Number Total Losses Numberof Overall Impact 

of Gains of LLxses Zeru on Medicare 

Adjustments Pragtam 

1990 5 $8,118,271 23 -$36,996,112 3 -$28,877,841 

1991 4 $7,401,497 21 -$49,405,907 7 -$42,004,410 

1992 8 $18,882,435 22 -$73,461,361 3 -$54,578,926 

1993 3 $2,771,716 26 -$43,978,492 7 -$41,206,776 

1994 9 $12,778,151 26 -$48,670,697 4 -$35,892,546 

199s 4 $6,054,598 24 -$78,456,929 9 -$72,402,331 

1996 0 $0 19 -$121,904,534 2 -$121,904,534 

Total 33 $56,006,668 161 -$452$X74,032 35 -$396,867,364 

FWde Medicare has shared in the loss for 161 hospital sales, in contrast, it has shared the 

gain for on& 33 hospital sales 

Seventy percent of the depreciation adjustments reported for hospital sales (161 of 

229) resulted in losses to the Medicare program. Fourteen percent of sales (33 of 

229) resulted in gains to the program. The ratio of Medicare losses to gains based on 

the data from the 229 hospital sales is 5 losses for every 1 gain. There were 35 

hospital sales where no gain or loss was recognized. The sales price allocated to 

depreciable assets for these hospitals was equal to the Medicare net book value of the 

assets. Therefore, the depreciation adjustment was zero since no gain or loss on 

depreciable assets was established. We have provided examples of how the three 

types of adjustments are determined by fiscal intermediaries in Appendix A. 

9 
MEDICARE MAY BE PAYING MORE THAN IT SHOULD TO HOSPITALS 

SOLD AT A LOSS DURING THE TRANSITION PERIOD FOR CAPITAL 

PROSPECLlVE PAYMENTS. 

The loss to the Federal Government from hospital sales may be greater than the half 

billion already identified through depreciation adjustments. Medicare may also be 

paying out more than it should for hospitals sold at a loss and paid under the capital 

prospective payment system. While Medicare recognizes a loss on assets for 

depreciation purposes, in most cases it makes no adjustment to a hospital’s capital 

prospective payment to account for the new lower value of the hospital. Under 

Medicare’s guidelines, most hospital buyers receive the same capital prospective 

payments as the previous owner. Section 2807.9 of the Provider Reimbursement 

Manual states that “if there is a change of ownership subsequent to the base period, 

the new owner receives capital payments under the same payment methodology and 

rates as the previous owner if the change in ownership results in a single surviving 

hospital.” 

For each Medicare patient discharge, hospitals receive a capital payment based on the 

methodology selected for the hospital at the beginning of the capital prospective 

payment transition. Hospitals receiving capital prospective payments during the 

transition period are paid under two methodologies: “fully prospective” and “hold 

harmless.” At the conclusion of a lo-year transition period, all hospitals will receive 

payments based solely on the national Federal rate. 

Nearly 60 percent of hospital sales reviewed (134 of 229) were reimbursed for capital 

costs based on a prospective payment methodology. More than 70 percent of the 

hospitals being paid prospectively (95 of 134) were sold at a loss. Twenty-eight 

percent of the hospital sales (63 of 229) occurred before Fiscal Year 1992, and thus 

were sold prior to the implementation of a prospective payment system for capital 

costs. 

Of the hospitals which received capital prospective payments and were sold at a loss, 

44 percent were paid under the fully prospective methodology. Fully prospective 

hospitals receive a combination of Federal and hospital-specific rates during the 

transition period. Since the hospital-specific rate is not recalculated when a hospital is 

sold at a loss, these hospitals have received and will continue to receive payments 

during the transition period based on a rate that was calculated when the hospitals’ 

depreciable assets had much higher values and thus higher associated depreciation 

costs. 

Fifty-five percent of hospitals sold at a loss and receiving capital prospective payments 

were reimbursed under the hold harmless methodology. Hold harmless hospitals 

receive either a blend of old and new capital payments or 100 percent of the Federal 

rate depending on which is higher. After a hold harmless hospital is sold, Medicare 

does not redetermine the hospital’s payment methodology to establish if the hold 

harmless distinction is still necessary. Therefore, the new owner of a hold harmless 

10 
hospital sold at a loss may continue to receive capital reimbursement based on a 

payment methodology that was determined by the previous owner’s above-average 

capital costs. The Medicare program continues hold harmless payments even though 

the hospital’s current depreciable asset value is now lower. 

We recognize that, without recalculating hospital-specific rates for each of the 

hospitals sold at a loss, there is no precise means to determine the financial impact on 

the program of continuing to make payments based on the previous owner’s 

methodology and rates. We also realize that not all hold harmless hospitals would 

lose that distinction, nor would all hospital-specific rates decrease dramatically if the 

payment methodologies for hospitals sold at a loss were recalculated based on present 

capital costs. However, the decrease in the value of depreciable assets and, 

consequently, the associated depreciation costs can be significant. More than half the 

hospitals sold at a loss (53 percent) had the value of their depreciable assets decrease 

by more than 50 percent. Thirty-five percent of hospitals sold at a loss had their 

depreciable asset value drop by more than 70 percent. 

LOSSES FROM DEPRECIATION ADJUSTMENTS ALSO IMPACT THE 

MEDICAID PROGRAM. 

The Federal Government does not mandate that State Medicaid programs use specific 

payment methodologies to determine hospital reimbursement. However, some State 

programs are calculating depreciation adjustments based on the guidelines established 

for Medicare when hospitals providing care to Medicaid recipients are sold. 

Several of the Medicare fiscal intermediaries performed some type of payment or 

audit function for State Medicaid programs. We asked these intermediaries if 

depreciation adjustments for hospital sales were made by these programs. Eleven 

intermediaries indicated that depreciation adjustments were calculated by State 

Medicaid programs. These intermediaries also reported that the Medicaid programs 

used the same rules and procedures as the Medicare program in calculating 

depreciation adjustments. 

Intermediaries could provide data on Medicaid depreciation adjustments for only 10 of 

the 229 sales transactions. All the depreciation adjustments resulted in losses to the 

Medicaid program. The individual hospital adjustments ranged from $18,000 to 

$10 million. These 10 sales represented a $16 million loss to the respective Medicaid 

programs. 

Since the majority of fiscal intermediaries do not serve as contractors to State 

Medicaid agencies, it is possible that other State Medicaid programs not represented 

in our review also follow Medicare policy and calculate depreciation adjustments on 

hospital sales. The impact of depreciation adjustments on the Medicaid program 

could conceivably be much greater than the $16 million in losses identified from only a 

small number of hospital sales. 

11 
RECOMMENDATIONS 

The Medicare program has already paid out hundreds of millions of dollars for 

depreciation adjustments associated with hospital sales. If the activity surrounding 

hospital sales continues to increase, the Medicare program could pay out even greater 

amounts in the coming years. 

We have provided evidence in this report that substantial amounts of money are being 

paid and will continue to be paid in the coming years for an accounting procedure 

established in the early years of the program. At the beginning of the 199Os, Medicare 

moved from cost-based reimbursement to a prospective payment system for hospitals. 

Since that time, Medicare has shared in only one gain for every five losses resulting 

from depreciation adjustments on hospital sales. We believe the policy allowing 

depreciation adjustments on hospital sales is an unnecessary holdover from the old 

cost-based reimbursement system that should be discontinued. 

In switching from a cost-based reimbursement methodology to the prospective 

payment system, the Medicare program recognized the need to constrain rising costs 

and promote cost effective decision-making in hospitals. Medicare’s sharing in gains 

and losses for hospital sales does not advance the goal the program set out to 

accomplish when implementing the prospective payment system. 

We recommend that the Health Care Financing Administration: 

0 propose legislation to change Section 1861(v)(l)(O) of the Social Security Act 

to eliminate the requirement that Medicare make adjustments for gains or 

losses when hospitals undergo changes of ownership; 

0 propose a similar elimination of depreciation adjustments on hospital sales in 

the Medicaid program; and 

0 examine options for recalculating capital transition payments to hospitals 

undergoing changes of ownership for reimbursement purposes. 

AGENCY COMMENT’S 

The HCFA concurred with our recommendations. The agency stated that proposed 

legislation entitled the “Medicare and Medicaid Fraud, Abuse, and Waste Preventions 

Amendments of 1997” (Section 205) would use the net book value as the sales price 

for hospitals undergoing a change of ownership. This proposed change would 

eliminate the need for a depreciation adjustment. The agency also stated that if 

depreciation adjustments were eliminated in the Medicare program this change would 

also be reflected in the Medicaid program. 

12 
The HCFA responded that after examining options for recalculating capital transition 

payments for hospitals undergoing changes of ownership, it believes that recalculating 

payments would be inappropriate and inadvisable at this time. The agency believes it 

would be contrary to the principle of administrative finality upon which the capital 

payment system was based. In addition, HCFA stated there would also be the 

potential for loss to the program since both hospitals sold at a gain and a loss would 

have their rates recalculated. The HCFA also advised that the recalculation would 

have a limited application period since the transition for capital prospective payments 

ends in 2001. The full text of HCFA’s comments are provided in Appendix B. 

We appreciate HCFA’s careful consideration of the issues concerning capital payments 

to hospitals undergoing changes of ownership. While we recognize the complexity of 

the policy and administrative implications identified by HCFA, we continue to believe 

that capital payments to hospitals sold at a loss should be redetermined. 

13 
APPENDIX A 

EXPLANATION OF DEPRECIATION ADJUSTMENT CALCULATION 

Before the fiscal intermediary can verify a depreciation adjustment, the hospital being 

sold sends a terminating cost report that documents a possible gain, loss, or zero 

adjustment on depreciable assets for the sale. The hospital should also provide the 

hospital sale or purchase agreement, an allocation of the sales price, and, if necessary, 

an independent appraisal that determines the fair market value of the hospital’s 

current assets. The intermediary reviews the terminating cost report and the 

additional documentation to ensure that they are correct and the calculations are fully 

supported. 

There are several key pieces of information that a fiscal intermediary must have to 

ensure a correct calculation. The hospital should provide to the intermediary the net 

sales price which includes cash and any other considerations plus any assumed 

liabilities. The allocation of the sales price provided should illustrate the types of 

assets being sold and the portion of the sales price allocated to them. At the present 

time, this allocation can include both depreciable and non-depreciable assets such as 

land, buildings, equipment, accounts receivable, medical records, inventory, and many 

other categories of assets. From this information, the fiscal intermediary should be 

able to verify the sales price allocated to depreciable assets. This figure is then 

compared to the net book value of all depreciable assets. The net book value is the 

original cost or value of an asset less any depreciation taken over the life of the asset. 

If the sales price allocated to depreciable assets is less than the net book value, there 

is a loss recognized on the sale of the assets. If the sales price is greater than the net 

book value of the depreciable assets, a gain is recognized. If the sales price allocated 

and the net book value of the depreciable assets are equal, then there is no gain or 

loss and the sale has been an even transaction and zero adjustment occurs. 

There are limits to the amount of money that Medicare can gain or lose during a 

hospital’s disposal of depreciable assets. The amount of gain is limited to the amount 

of depreciation for the asset previously included in allowable costs to the Medicare 

program through the years. The amount of loss is limited to the undepreciated basis 

of the asset (original value less any depreciation taken through the years) permitted 

under the program. 

Once the overall gain or loss on depreciable assets is calculated, the intermediary must 

determine Medicare’s share. This share is determined by multiplying the gain or loss 

by the hospital’s Medicare utilization during the years that the assets were in use. 

Medicare’s utilization is determined by comparing Medicare patients’ use of the 

hospital to use by non-Medicare patients. This can be a complicated procedure that 

can require going back through previous cost reports to determine overall Medicare 

utilization. 

A-l 
Three examples of depreciation adjustments are presented in this appendix. Example 

1 illustrates a depreciation adjustment resulting in a loss. Example 2 provides details 

on a gain and Example 3 shows a zero adjustment. These are simplified examples 

meant to illustrate how depreciation adjustments are calculated. The allocation of 

sales price can include many types of assets that are not included in these examples. 

We do not present the calculation for determining the Medicare utilization percentage 

in our examples. Instead, we assigned a Medicare utilization rate of 50 percent to 

determine Medicare’s share of the hospital sale. 

Example 1 - Medicare Loss on Sale 

Hospital net facility sales prices: $10,000,000 

(includes cash and any other considerations plus assumed liabilities) 

Allocation of the net sales price presented in table below: 

(includes both depreciable and non-depreciable assets such as buildings, 

equipment, accounts receivable, medical records, inventory, and other assets) 

DESCRIPTION OF ASSET DEPRECIABLE AMOUNT 

ASSET 

Land No $3,ooo,O~ 

Inventory No $2,000,000 

Buildings Yes $4,ooo,m 

Major Moveable Equipment Yes $l,~,~ 

TOTAL ALLOCATED NET SALES PRICE $10,000,000 

Sales price allocated to Medicare allowable depreciable assets: 

(determined from allocation above = 4,000,OOO + l,OOO,OOO) 

Net book value of depreciable assets at the date of sale: 

(determined from cost report: original value less depreciation already taken) 

Total amount of gain/loss on sale of depreciable assets: 

(sales price less net book value for depreciable assets = 5,000,OOO- 7,000,OOO) 

Medicare’s share of the total gain/loss on sale of allowable depreciable assets 

(total gain/loss on depreciable assets multiplied by Medicare utilization percentage 

including inpatient/outpatient and other components = -2,000,OOOx SO) 

LOSS TO MEDICARE = $ l,OOO,OOO 

A-2 
Example 2 - Medicare Gain on Sale 

Hospital net facility sales prices: $lO,OOO,OOO 

(includes cash and any other considerations plus assumed liabilities) 

Allocation of the net sales price presented in table below: 

(includes both depreciable and non-depreciable assets such as buildings, 

equipment, accounts receivable, medical records, inventory, and other assets) 

DESCRIPTION OF ASSET DEPRECIABLE AMOUNT 

ASSET 

Land No $1.000.000 .I I 

Inventory No $1,000,000 

Buildings Yes $5,ooO,~ 

Major Moveable Equipment Yes $3,ooo,ooo 

TOTAL ALLOCATED NET SALES PRICE $10,000,000 

Sales price allocated to Medicare allowable depreciable assets: 

(determined from allocation above = 5,000,OOO + 3,000,OOO) 

Net book value of depreciable assets at the date of sale: 

(determined from cost report: original value less depreciation already taken) 

Total amount of gain/loss on sale of depreciable assets: 

(sales price less net book value for depreciable assets = S,OOO,OOO- 7,000,OOO) 

Medicare’s share of the total gain/loss on sale of allowable depreciable assets 

(total gain/loss on depreciable assets multiplied by Medicare utilization percentage 

including inpatientloutpatient and other components = l,OOO,OOOx SO) 

GAIN TO MEDICARE = $500,000 

$8,~,~ 

$7,~,~ 

$1,ooo,ooo 

$ 5owoo 

A-3 
Example 3 - Medicare Zero Adjustment on Sale 

Hospital net facility sales prices: $lO,OOO,OOO 

(includes cash and any other considerations plus assumed liabilities) 

Allocation of the net sales price presented in table below: 

(includes both depreciable and non-depreciable assets such as buildings, 

equipment, accounts receivable, medical records, inventory, and other assets) 

DESCRIPTION OF ASSET REPRECIABLE AMUUNT 

ASSET 

Land No $2,000,000 

Inventory No $1,000,000 

Buildings Yes $4,oW~ 

Major Moveable Equipment Yes $3,ooo,~ 

TOTAL ALLOCATED ‘NET SALES PRICE $10,000,000 

Sales price allocated to Medicare allowable depreciable assets: $7,~,~ 

(determined from allocation above = 4,000,OOO + 3,000,OOO) 

Net book value of depreciable assets at the date of sale: $7,ooo,~ 

(determined from cost report: original value less depreciation already taken) 

Total amount of gain/loss on sale of depreciable assets: $ 0 

(sales price less net book value for depreciable assets = 7,000,OOO- 7,000,OOO) 

Medicare’s share of the total gain/loss on sale of allowable depreciable assets $ 0 

(total gainfloss on depreciable assets multiplied by Medicare utilization percentage 

including inpatient/outpatient and other components) 

NO GAIN OR LOSS TO MEDICARE = S 0 

A-4 
APPENDIX B 

HEALTH CARE FINANCING ADMININSTRATION C0MMEN”‘l-s 

B-l 
DtPARTMENT OF HEALTH & HUMAN SERVfClES Hoelth Cam Financinq Admimm Adminktntor 

Washingtan, DC. 20201 

DATE: JIN -3 @g 

TO: June Gibbs Brown 

Inspector General 

FROM: 

SUBJECT Oflciiceofhspect~r General (CM3) Ihfi Report “Medicare Losseson 

Hospital Saks,” (OEI43-9600170) 

ThankYOU forthe appartnnityio reviewand comment on this report. 

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