| June 2001 

e Congress: Medicare in Rural America 

06

ac.gov

REPOR

T TO THE CON

G RESS

Medicare in

Rural America
The Medicare Payment Advisory Commission (MedPAC) is an independent federal body

established by the Balanced Budget Act of 1997 (P.L. 105–33) to advise the U.S. Congress

on issues affecting the Medicare program. The Commission’s statutory mandate is quite

broad: In addition to advising the Congress on payments to health plans participating in the

MedicareChoice program and providers in Medicare’s traditional fee-for-service program,

MedPAC is also tasked with analyzing access to care, quality of care, and other issues

affecting Medicare.

The Commission’s 17 members bring diverse expertise in the financing and delivery of

health care services. Commissioners are appointed to three-year terms (subject to renewal) by

the Comptroller General and serve part time. Appointments are staggered; the terms of five

or six Commissioners expire each year. The Commission is supported by an executive

director and a staff of analysts, who typically have backgrounds in economics, health policy,

public health, or medicine.

MedPAC meets publicly to discuss policy issues and formulate its recommendations to the

Congress. In the course of these meetings, Commissioners consider the results of staff

research, presentations by policy experts, and comments from interested parties. (Meeting

transcripts are available at www.medpac.gov.) Commission members and staff also seek

input on Medicare issues through frequent meetings with individuals interested in the

program, including staff from congressional committees and the Health Care Financing

Administration, health care researchers, health care providers, and beneficiary advocates.

Two reports—issued in March and June each year—are the primary outlet for Commission

recommendations. This year the Commission’s June report is devoted to the subject of

Medicare in rural areas. Annual reports each March focus on payment policy. In addition to

these reports and others on subjects requested by the Congress, MedPAC advises the

Congress through other avenues, including comments on reports and proposed regulations

issued by the Secretary of the Department of Health and Human Services, testimony, and

briefings for congressional staff. 
JUNE 2001

REPORT TO THE CONGRESS

Medicare in

Rural America

1730 K Street, NW • Suite 800 • Washington, DC 20006

(202) 653-7220 • Fax: (202) 653-7238 • www.medpac.gov

The report was prepared with the assistance of many people. Their support was key as

the Commission considered policy issues and worked toward consensus on its

recommendations.

Despite a heavy workload, staff members of the Health Care Financing Administration

were particularly helpful during preparation of this report. We thank: Shawn Bishop,

Robert Braver, William Buczko, Deborah Chaney, Patti Espey, Marc Hartstein, Stephen

Heffler, Nora Kraemer, Ann Meadow, Steve Phillips, Leo Porter, John Shatto, Anne

Tayloe, Bob Wardwell, and David Worgo.

The Commission also received valuable insights and assistance from others—in

government, industry, and the research community—who generously offered their time

and knowledge. They include: Forrest Calico, Craig Caplan, Julia Christensen, Mark

Covall, Carmela Coyle, Kathleen Dalton, Beth Docteur, William Dombi, Brian

Ellsworth, Donna Farley, William Finerfrock, Randy Finneger, Sam Fleming, Sheila

Franco, Sylvia Gaudette, Kurt Gillis, George Greenberg, Kamal Hijjazi, Chris Hogan,

Ann Howard, Dana Karr, Kathleen McCann, Sharon McIlrath, Meredith Milet, Curt

Mueller, Keith Mueller, Dena Puskin, Janet Sutton, Henry Miller, Tom Morris, Thomas

Ricketts, Randy Randolph, Phil Salladay, Rebecca Slifkin, Joan Van Nostrand, and

Deborah Williams.

Once again, the programmers at Social and Scientific Systems provided highly capable

assistance to Commission staff. In particular, we appreciate the hard work of: Nancy

Allen, Valerie Aschenbach, Chris Brady, Daksha Damera, Dawn Ferragamo, Deborah

Johnson, John May, Carl Newman, Charles Thomson, Arlene Turner, and Dawn Wolfe.

Finally, the Commission wishes to thank Cynthia Pratt, Anne Brown Rodgers, and Nancy

E. Volkers for their help editing and producing this report.

Report to the Congress: Medicare in Rural America | June 2001 iii

Acknowledgments

Tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .vii

Figures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .xi

Executive summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .xiii

Chapters

1 Medicare and rural health care: overview and challenges 

for policymakers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1

What is rural? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5

Rural health care . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6

How rural markets differ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8

Medicare beneficiaries’ use of services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14

Potential implications for Medicare and other public policies . . . . . . . . . . . . . . .20

2 Rural beneficiaries’ access to care . . . . . . . . . . . . . . . . . . . . . . . . . . . .23

Assessing rural beneficiaries’ access to care . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26

Programs to address rural access problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33

3 Quality of care in rural areas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .39

Quality of care delivered to rural beneficiaries . . . . . . . . . . . . . . . . . . . . . . . . . . .42

Quality improvement and assurance in rural areas . . . . . . . . . . . . . . . . . . . . . . . .45

4 Improving payment for inpatient hospital care in rural 

areas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .53

A framework for considering rural payment provisions . . . . . . . . . . . . . . . . . . . .56

Financial performance of rural hospitals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .60

Policy options that do not target payments to specific cost factors . . . . . . . . . . .62

Specific problems and solution options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65

Inpatient psychiatric care . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .82

5 Assessing payment for outpatient hospital care in rural 

areas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .87

Paying for outpatient services in rural hospitals . . . . . . . . . . . . . . . . . . . . . . . . . .90

Applicability of the outpatient payment system to rural hospitals . . . . . . . . . . . .91

Limitations of the evidence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .98

Future policy options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .98

Report to the Congress: Medicare in Rural America | June 2001 v

Table of contents
6 Prospective payment for home health services in rural 

areas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .103

Evolving to the current system . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .106

Components of the prospective payment system . . . . . . . . . . . . . . . . . . . . . . . .106

Home health agency closures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .109

Need for better data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .110

7 Bringing Medicare+Choice to rural America . . . . . . . . . . . . . . . . .113

Little progress to date . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .116

Why are Medicare+Choice coordinated-care plans unlikely to enter rural 

areas? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .118

The private fee-for-service option . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .120

Other options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .121

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .122

8 Reviewing the estimated payment update for physician

services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .125

Updating payments for 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .128

Replacing the sustainable growth rate system . . . . . . . . . . . . . . . . . . . . . . . . . .130

Appendixes

A Clinically based indicators of access to care for Medicare beneficiaries . . . . .133

B Summary of Medicare’s special payment provisions for rural providers and 

criteria for qualification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .139

C Financial performance of rural hospitals and the value of special payment 

policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .145

D Commissioners’ voting on recommendations . . . . . . . . . . . . . . . . . . . . . . . . . .157

Acronyms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .163

More about MedPAC

Commission members . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .169

Commissioners’ biographies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .171

Commission staff . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .175

vi Table of contents
1 Medicare and rural health care: overview and challenges 

for policymakers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1

1-1 Percentage of rural hospital markets with selected characteristics, by region . . .11

1-2 Isolated and low-volume hospitals, by location . . . . . . . . . . . . . . . . . . . . . . . . . .14

1-3 Rural hospital diversification, by location . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14

1-4 Per capita use of services by beneficiaries in traditional Medicare, by type 

of service and location of county, 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19

2 Rural beneficiaries’ access to care . . . . . . . . . . . . . . . . . . . . . . . . . . . .23

2-1 Selected beneficiary characteristics, by location of county, 1999 . . . . . . . . . . . .28

2-2 Beneficiary satisfaction with care, by location of county, 1999 . . . . . . . . . . . . . .29

2-3 Beneficiary access to care, by location of county, 1999 . . . . . . . . . . . . . . . . . . . .31

2-4 Beneficiary insurance status, by location of county, 1999 . . . . . . . . . . . . . . . . . .32

3 Quality of care in rural areas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .39

3-1 Aggregate use of recommended services by beneficiaries in 1998–1999, 

by location of county . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .43

3-2 National health improvement clinical topics and performance indicators 

for the peer review organizations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .46

4 Improving payment for inpatient hospital care in 

rural areas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .53

4-1 Policy options for inpatient hospital care covered by the Medicare 

prospective payment system in rural areas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .57

4-2 Hospital financial performance, by urban and rural location, 1999 . . . . . . . . . . .60

4-3 Total value of Medicare special payment provisions for urban and rural 

hospitals, 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .61

4-4 Hospital financial performance, by urban and rural location, 1999 . . . . . . . . . . .61

4-5 Financial performance of hospitals, by discharge volume, 1999 . . . . . . . . . . . . .66

4-6 Distribution of low volume hospitals, by hospital type, 1997 . . . . . . . . . . . . . . .67

4-7 Impact on Medicare inpatient margins of implementing a low-volume 

adjustment with an access-related eligibility requirement . . . . . . . . . . . . . . . . . .69

4-8 Percentage change in wage index and prospective payment system payments

under selected policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .73

4-9 Hospitals sheltered by labor market average wage rate . . . . . . . . . . . . . . . . . . . .76

4-10 Hospitals affected by a wage index floor of 0.9, by financial status under

Medicare’s inpatient prospective payment system, fiscal year 1999 . . . . . . . . . .76

4-11 Impact on Medicare inpatient margins of phasing out teaching salaries 

and certified nurse anesthetists . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .77

Report to the Congress: Medicare in Rural America | June 2001 vii

Tables
4-12 Components of national labor share for hospital inpatient care . . . . . . . . . . . . . .79

4-13 Effect of wage index adjustment on labor share . . . . . . . . . . . . . . . . . . . . . . . . . .79

4-14 Urban and rural hospitals’ shares of low-income patient costs and 

disproportionate share payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .81

4-15 Impact on Medicare inpatient margins of raising the cap on disproportionate 

share payments to 10 percent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .81

4-16 Payment formulas required to implement MedPAC’s recommendation on

disproportionate share payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .82

4-17 Patient and psychiatric facility characteristics, by facility type and urban 

or rural location . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .83

4-18 Hospital-based units’ length of stay and cost per case . . . . . . . . . . . . . . . . . . . . .84

5 Assessing payment for outpatient hospital care in 

rural areas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .87

5-1 Medicare costs as percent of total hospital costs, 1999 . . . . . . . . . . . . . . . . . . . .91

5-2 Outpatient costs as percent of total Medicare costs, 1999 . . . . . . . . . . . . . . . . . .93

5-3 Medicare margins, by hospital type, 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .93

5-4 Outpatient service mix, urban and rural hospitals, 1999 . . . . . . . . . . . . . . . . . . . .95

5-5 Outpatient service mix, rural hospitals, 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . .96

5-6 Future policy options for outpatient payments to rural hospitals . . . . . . . . . . . . .99

6 Prospective payment for home health services in 

rural areas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .103

6-1 Total admissions to home health, by diagnosis, urban and rural agencies . . . .108

6-2 Home health visits and therapy visits, by location of patient’s county

of residence, 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .109

6-3 Home health visits, by location of patient’s county of residence

and location of agency, 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .109

6-4 Number of home health agencies, by ownership of facility, 1997 and 2001 . .110

7 Bringing MedicareChoice to rural America . . . . . . . . . . . . . . . .113

7-1 Percentage of beneficiaries with any MedicareChoice health maintenance

organization in their county in 2001, by location of county and 2000 

payment rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .117

7-2 For beneficiaries with a health maintenance organization available, 

prescription drug coverage and premiums in 2001, by location of county . . . .118

8 Reviewing the estimated payment update for physician 

services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .125

8-1 HCFA estimates of factors in sustainable growth rates, 2001–2002 . . . . . . . . .129

8-2 HCFA estimate of the update for physician services for 2002 . . . . . . . . . . . . .130

viii Tables
Appendixes 

A Clinically based indicators of access to care for Medicare 

beneficiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .133

A-1 Clinically based indicators of access to needed care for elderly Medicare

beneficiaries with certain diagnoses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .136

C Financial performance of rural hospitals and the value 

of special payment policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .145

C-1 Inpatient Medicare, overall Medicare, and total margins, by rural 

hospital groups, 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .149

C-2 Hospital Medicare inpatient margin and percent of hospitals with negative 

margin, by hospital location, 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .150

C-3 Hospitals in special payment policy groups, by urban and rural location, 

2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .150

C-4 Rural special payment groups: number receiving additional payments and 

value of payments, 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .151

C-5 Value of payment policies that affect both urban and rural hospitals: 

geographic reclassification, disproportionate share, and indirect medical 

education payments, 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .151

C-6 Value of special payment provisions for urban and rural hospitals, 2000 . . . . .152

C-7 Hospital total margin and percent of hospitals with negative margin, by 

hospital location, 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .155

Report to the Congress: Medicare in Rural America | June 2001 ix

1 Medicare and rural health care: overview and challenges 

for policymakers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1

1-1 Defining urban and rural . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5

1-2 Locations of rural hospitals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6

1-3 Definition of urban influence codes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7

1-4 Rural markets with small population base . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10

1-5 Rural markets with declining and aged populations . . . . . . . . . . . . . . . . . . . . . . .10

1-6 Rural markets with low income and high unemployment . . . . . . . . . . . . . . . . . .12

1-7 Rural markets with a disproportionate minority population . . . . . . . . . . . . . . . . .12

1-8 Isolated rural hospitals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13

1-9 Low-volume rural hospitals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13

1-10 Urban and rural beneficiaries use similar amounts of services, but use rates 

differ among regions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16

1-11 Counties with high and low use of services . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17

4 Improving payment for inpatient hospital care in rural 

areas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .53

4-1 Relationship between hospital discharge volume and costs per case, 1997 . . . . .66

4-2 Cumulative change in length of stay, by location of hospital (UIC), 

1990–1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .70

4-3 Distributions of hospital wage index values among urban and rural labor 

markets in fiscal year 2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .72

4-4 Hospital wage rates in low-wage areas are higher than expected . . . . . . . . . . . . .74

4-5 Medicare inpatient margins by wage index value, urban and rural 

hospitals, 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .75

4-6 Labor market areas for the hospital wage index . . . . . . . . . . . . . . . . . . . . . . . . . .78

5 Assessing payment for outpatient hospital care in 

rural areas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .87

5-1 Outpatient volume-cost relationship, 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .98

7 Bringing MedicareChoice to rural America . . . . . . . . . . . . . . . .113

7-1 2001 MedicareChoice payment rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .117

8 Reviewing the estimated payment update for physician 

services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .125

8-1 Medicare Economic Index, 1992–2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .129

Report to the Congress: Medicare in Rural America | June 2001 xi

Figures
Appendixes 

C Financial performance of rural hospitals and the value of 

special payment policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .145

C-1 Medicare inpatient hospital margin, by urban and rural location, 1990–1999 .148

C-2 Percent change in cost per case, urban and rural hospitals, 1991–1999 . . . . . .148

C-3 Percent change in length of stay, urban and rural hospitals, 1991–1999 . . . . . .149

C-4 Overall Medicare margin including graduate medical education, urban and 

rural hospitals, 1996–1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .153

C-5 Private payer and Medicaid payment-to-cost ratios, urban and rural hospitals, 

1992–1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .153

C-6 Medicare, Medicaid, and private-payer cost share, urban and rural hospitals, 

1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .154

C-7 Total margin, urban and rural hospitals, 1990–1999 . . . . . . . . . . . . . . . . . . . . .154

xii Figures
Executive summary

Medicare beneficiaries living in rural areas face many barriers to getting the medical care

they want and need. Some barriers relate to distance and population density, and others to

economic conditions—all may vary widely over the broad spectrum of conditions in rural

areas. Providers, especially specialists, are relatively scarce in rural areas and the

financial burden of obtaining care is often greater for rural than for urban beneficiaries

because they tend to have lower incomes and less supplemental insurance or access to

Medicare+Choice coordinated-care plans. 

Despite these barriers, rural Medicare beneficiaries do not seem to be measurably

disadvantaged compared with urban beneficiaries. The Commission’s analyses suggest

that they are about as likely to get needed care, just as satisfied with the care they receive,

and use about as much health care on average as their urban counterparts, albeit a slightly

different mix of services. Overall, rural beneficiaries and providers have adapted to and

often overcome barriers in rural areas, although not without some inconvenience and

cost. When necessary, beneficiaries travel to more urban areas for needed specialized care

and specialists travel to rural areas. 

However, not all barriers can be overcome. Many rural providers are experiencing

financial hardship, and providers may not be able to remain in markets in which

economic and demographic conditions are especially unfavorable. In those cases

Medicare may not be the sole, or even the principal, problem.

The fragility of the rural health care system calls for continued vigilance and special care

to ensure that Medicare policies do not weaken rural medicine inadvertently and that,

where appropriate, they reflect the special circumstances confronting rural beneficiaries

and providers. Following this path, we recommend a number of incremental changes in

Medicare that will improve the accuracy of Medicare payments by recognizing factors

such as the volume of services that affect the costs of providing care in rural areas.

Implementing these recommendations should improve the financial standing of many

rural providers. We also recommend changes that may improve access for some

financially disadvantaged beneficiaries and improve oversight of the quality of care. 

In the Balanced Budget Refinement Act of 1999, the Congress required the Medicare

Payment Advisory Commission to study and report on the adequacy and appropriateness

of Medicare’s payment policies for services furnished by various types of providers

located in rural areas. This report examines the Congress’ questions and how Medicare is

working for rural beneficiaries. Although we focus primarily on payment and other

policies in Medicare’s traditional program, we also examine issues affecting rural

beneficiaries’ access to health plans in the Medicare+Choice program.

Medicare and rural health care: overview and 

challenges for policymakers

Policymakers and rural health care advocates have long been concerned that Medicare

beneficiaries and others living in rural areas may not receive the care they need. The

geographic isolation, low population density, and poor economic conditions in many rural

areas impose economic hardships on providers and make it difficult to attract health

professionals. In Chapter 1 we describe those concerns, how market conditions vary

among rural areas, and how those variations affect rural providers and beneficiaries. Our

analyses confirm that some rural communities face adverse economic conditions that may

limit providers’ abilities to furnish needed services. Nevertheless, Medicare beneficiaries

in rural areas receive similar amounts of health services, on average, as do urban

beneficiaries. Although similar use rates do not guarantee that rural and urban

beneficiaries receive equally appropriate and effective care, this finding suggests that

Report to the Congress: Medicare in Rural America | June 2001 xv

Executive summary
major new Medicare policy interventions may not be needed to preserve rural

beneficiaries’ access to high-quality care. Some incremental changes may be helpful in

better adapting Medicare’s policies to rural market conditions. Because the stresses facing

rural providers often reflect broader market conditions, however, Medicare policy

changes alone may not be enough to resolve them fully.

Rural beneficiaries’ access to care

Promoting beneficiaries’ access to medically necessary health care of high quality is one

of the primary objectives of the Medicare program. Rural areas of the country are

believed to present more obstacles to beneficiaries’ access than more urban areas.

However, in Chapter 2 we show that on numerous measures, including satisfaction with

availability of providers, ease of getting care, and frequency of receiving needed care,

rural and urban beneficiaries appear strikingly similar. Although beneficiaries in the most

remote areas report somewhat greater barriers to accessing care, in general rural

beneficiaries do not appear to be singularly disadvantaged relative to urban beneficiaries.

Overall, rural beneficiaries’ greatest potential barrier to care appears to be the cost of

care, which may be related to the limited number of rural beneficiaries with supplemental

insurance. The Commission is concerned about this problem and recommends identifying

strategies to increase eligible rural beneficiaries’ participation in government cost-sharing

assistance programs. Interpreting the larger policy implications of these findings is

complex. Have the programs designed to address the availability of rural providers been

successful, or have the barriers to access in rural areas been overestimated and the

resourcefulness and adaptability of beneficiaries and providers underestimated? As these

issues are further examined, the findings suggest that policymakers should remain

vigilant in monitoring access issues in remote rural areas. 

Quality of care in rural areas

In the past, rural quality of care issues have received little attention in Medicare

policymaking. In Chapter 3, we present largely encouraging results on rural quality of

care, but also point to some problems with Medicare’s systems for improving and

safeguarding quality in rural areas. Quality of care, as measured by the use of

recommended services, is roughly comparable among rural counties of varying proximity

to metropolitan areas, as well as between rural and metropolitan areas. However, a

considerable proportion of beneficiaries in both rural and urban areas are not receiving

recommended services. Consequently, the Commission recommends strengthening

Medicare’s systems for influencing quality in rural areas by requiring the peer review

organizations to include rural populations and providers when carrying out their quality

improvement activities, and by surveying at least one-third of each facility type annually

to certify compliance with the conditions of participation in Medicare.

Improving payment for inpatient hospital 

care in rural areas

The financial status of rural hospitals continues to be a source of concern for

policymakers. Rural hospitals have had lower Medicare inpatient margins than urban

hospitals throughout the 1990s, and the gap has widened from less than a percentage

point in 1992 to 10 percentage points in 1999. This pattern applies not just to inpatient

care but across all major lines of Medicare business, with rural hospitals’ overall

Medicare margin dipping below zero. This growing imbalance in Medicare financial

performance has occurred despite special programs targeted to rural hospitals with

specific characteristics such as rural referral, Medicare dependent, critical access, and sole

community hospitals. Although some of the difference in performance may be within

hospitals’ control, the size of the gap suggests that the payment system does not

recognize factors that have a greater effect on the costs of rural hospitals, and perhaps

overemphasizes those with a greater effect on urban hospitals.

xvi Executive summary
In Chapter 4 we recommend addressing these problems by improving the existing

prospective payment system to match payments better to efficient providers’ costs, rather

than by moving further toward cost-based payment. We identify aspects of Medicare’s

prospective payment system for inpatient hospital care that tend to work against rural

hospitals and recommend several incremental improvements. First is to develop a

graduated adjustment to the rates used in the inpatient prospective payment system for

hospitals with low overall volumes of discharges. Second is to implement fully the policy

of excluding teaching physicians, residents, and certified registered nurse anesthetists

from the hospital wage index. Third is to reexamine the proportion of providers’ costs

assumed to reflect resources purchased in local markets in the wage index. The second

and third actions will raise the relative wage index values for most rural hospitals. We

also recommend raising the cap on the disproportionate share add-on a rural hospital can

receive from 5.25 percent to 10 percent. These first four recommendations would

improve the accuracy of the inpatient prospective payment system and better account for

differences in market circumstances among hospitals. Finally, we recommend requiring

that rural referral centers’ wages exceed the average wage in their area to qualify for

geographic reclassification. After these recommendations have gone into effect, the

results should be evaluated before additional steps are taken. 

The Congress also required the Commission to analyze unit costs at psychiatric facilities

that are exempt from the prospective payment system. We found that government-owned

facilities—which treat a more disabled beneficiary population and one that is more likely

to be involuntarily committed—are disadvantaged by the current payment system

because it does not recognize these differences in population characteristics. We also

found that rural hospital-based psychiatric units appear to have higher unit costs. We

recommend revising the current payment system’s target cap in a way that better

addresses differences among inpatient psychiatric facilities.

Assessing payment for outpatient hospital 

care in rural areas

Do rural hospitals face special circumstances that make the new outpatient prospective

payment system inappropriate for them? If rural hospitals have high costs for providing

outpatient services, the new payment system will not adequately cover their costs to

provide care because it pays rates based on median costs for all hospitals. In Chapter 5,

we evaluate whether special circumstances make it difficult for rural hospitals to keep

their costs below the prospective payment system rates. The available evidence suggests

that rural hospitals do face some unique circumstances, and may merit special

consideration. They rely more on Medicare and on outpatient services as sources of

revenue than do urban hospitals, increasing their exposure to the financial risks of

prospective payment. At the same time, they tend to have limited administrative capacity

and financial reserves, hence limited ability to manage financial risk. Finally, available

cost data suggest that rural hospitals have higher outpatient unit costs. Our analysis

suggests that in the short term, the existing hold-harmless policy—which provides

additional payments to rural hospitals with 100 or fewer beds that experience losses under

the outpatient prospective payment system—will provide financial support to rural

hospitals that need it. In the longer term, when better information on hospitals’

experience with the new payment system is available, other policies may be warranted. 

Prospective payment for home health services in rural areas

Should rural home health services be exempt from the new prospective payment system?

Rural health care advocates, among others, have suggested that the new payment system

may not adequately account for unique conditions in rural areas. Lack of experience with

the new system and other data limitations prevent a direct comparison of the costs in rural

and urban areas. However, we conclude in Chapter 6 that the components of the new

payment system should work equally well in rural and urban areas. Accordingly, we

Report to the Congress: Medicare in Rural America | June 2001 xvii
recommend that rural home health services not be exempt from the prospective payment

system. We also recommend that data collection be improved to assess whether any

higher costs associated with providing home health services in rural areas are adequately

taken into account.

Bringing Medicare+Choice to rural America

Why are Medicare+Choice benefit packages that include extras such as low cost sharing

and prescription drugs available to beneficiaries in some urban areas but not widely

available to those in rural areas? Despite efforts of the Congress to attract

Medicare+Choice managed-care plans to rural areas by revising the payment structure,

few such plans are available in rural areas, and the benefit packages they bring with them

are not as generous as those offered in some urban areas. In Chapter 7, we conclude that

the basic market characteristics shared by many rural areas—including a limited number

of providers and a dispersed population—will likely continue to frustrate those efforts

because they make it difficult for plans to generate sufficient efficiencies or provider

discounts to fund generous benefit packages. A non-network, private fee-for-service

option has become available in some rural areas, but (like other options discussed in the

chapter) it, too, is unlikely to generate efficiencies or provider discounts, and therefore

can only bring generous benefit packages to rural beneficiaries by inappropriately

increasing Medicare program costs.

Reviewing the estimated payment update for physician

services

Medicare payments for physician services are updated annually based on the sustainable

growth rate system, which is designed to control overall spending. Chapter 8 fulfills the

Commission’s mandate to review the Health Care Financing Administration’s (HCFA’s)

preliminary estimate of the update for 2002. The Commission concludes that the agency’s

current estimate of the update, 0.1 percent, appears reasonable. As required by law, the

agency will revise the estimate and issue a final update this fall. The Commission notes

that the final update for 2002 may be lower, perhaps significantly lower, than HCFA's

current estimate, which may raise concerns about the adequacy of payments and

beneficiary access to care. Such an update would limit physician spending for the first

time since enactment of the sustainable growth rate system and illustrates the

Commission's concern that updates under the system are not closely related to the cost of

providing physician services. Therefore, the Commission reiterates its recommendation to

replace the sustainable growth rate system with an update method that better accounts for

the cost of providing care, and that policymakers should consider alternatives to that

system if spending control is necessary. 

xviii Executive summary
Medicare and rural health care: 

overview and challenges 

for policymakers

CHAPTER1

olicymakers and rural health care advocates have long been concerned that Medicare beneficiaries and others living in rural areas

may not get all of the care they need. The geographic isolation, low

population density, and poor economic conditions in many rural

areas impose economic hardship on existing providers and make it difficult to attract health professionals. In this chapter we describe these concerns, how market conditions vary among rural areas, and how those variations affect rural

providers and beneficiaries. Our analyses confirm that some rural communities

face adverse economic conditions that may limit local providers’ abilities to furnish a broad array of needed services. Nevertheless, Medicare beneficiaries in rural areas receive similar amounts of health services, on average, as urban beneficiaries. Although similar use rates do not guarantee that rural and urban

beneficiaries receive equally appropriate and effective care, this finding suggests

that major new Medicare policy interventions may not be needed to preserve rural beneficiaries’ access to high-quality care. Some incremental changes may be

helpful in better adapting Medicare’s policies to rural market conditions. Because

the stresses affecting rural providers often reflect broader market conditions,

however, Medicare policy changes alone may not be enough to resolve them

fully.

CHAPTER

Medicare and rural health

care: overview and

challenges for policymakers

1

In this chapter

• What is rural?

• Rural health care

• How rural markets differ

• Medicare beneficiaries’ use of

services

• Potential implications for

Medicare and other public

policies

Report to the Congress: Medicare in Rural America | June 2001 3

P
In the Balanced Budget Refinement Act

of 1999 (BBRA), the Congress required

that the Medicare Payment Advisory

Commission (MedPAC) study and report

on several issues concerning Medicare’s

payment policies for rural providers. Two

of these studies focus on the adequacy and

appropriateness of payments to rural

providers under the new prospective

payment systems (PPSs) for hospital

outpatient department services and home

health care. Another study must evaluate

the effectiveness of various special

payment provisions for rural hospitals

under the hospital inpatient PPS and their

impact on beneficiaries’ access to services

and the quality of the care they receive.

Finally, a fourth study focuses on whether

low-volume hospital-based psychiatric

facilities located in rural areas have higher

costs per discharge than other inpatient

psychiatric providers.

These topics reflect several concerns

shared by rural policymakers, providers,

and health care advocates. One is concern

about the effects on rural providers of

Medicare policy changes enacted in the

Balanced Budget Act of 1997 (BBA).

This concern is largely driven by a

perception that the health care

infrastructure in many rural communities

is financially fragile and thus especially

sensitive to changes in Medicare’s

policies, even those that might have little

impact under other circumstances. In

addition, because rural health care

providers often account for a substantial

share of local employment and are viewed

as indispensable in attracting new

businesses to the local economy, increases

in their financial stresses are seen as

threatening the community’s survival.

Another widely shared concern is that

Medicare’s nationally determined policies

do not adapt appropriately to the diversity

of local conditions and needs in rural

areas. Some of this concern reflects a

judgment that Medicare’s payment

policies under the traditional program fail

to account adequately for local market

factors that affect rural providers’ costs

but are beyond their control. Questions are

also frequently raised about whether

Medicare’s administrative policies—

conditions of participation or billing rules,

for instance—make sufficient allowance

for rural providers’ limited administrative

capabilities.

Underlying these concerns are more

fundamental fears. The ever-rising

technological sophistication and expense

of modern medical care, coupled with

weak economic conditions in many rural

markets, challenges rural communities’

abilities to preserve delivery systems

capable of meeting their residents’ health

care needs. Medicare’s policies may

compound these difficulties in some rural

areas, resulting in financial pressure for

key providers and threatening access to

local services for Medicare beneficiaries

and other residents.

These concerns highlight important

questions for policymakers:

• Do rural and urban beneficiaries

receive similar amounts and mixes of

health services?

• Do rural beneficiaries have

appropriate access to high-quality

care under the traditional program?

• Are national quality standards (and

other uniform administrative

requirements) appropriate for rural

providers and plans?

• Do Medicare’s payments to rural

providers appropriately reflect

differences in market conditions?

• What might be done to improve rural

beneficiaries’ access to alternative

plans under the MedicareChoice

program?

We examine these questions in subsequent

chapters of this report. In addition, we

consider whether, and to what extent, the

issues confronting rural providers and

beneficiaries reflect limitations of

Medicare’s policies or problems beyond

its scope. Finally, we make

recommendations on how the Congress

and the Health Care Financing

Administration (HCFA) might respond to

the problems identified.

In this chapter, we examine the diversity

of conditions facing providers and

beneficiaries in rural markets, related

potential problems, and their implications

for Medicare and other policies. We begin

with a brief discussion of how rural areas

and markets are defined. Then we

describe key features of rural health care,

summarizing the types of adverse

conditions that rural providers and

beneficiaries may be facing. The next

section examines diversity among rural

markets, focusing on important economic

factors that may affect local demand for

and supply of health services. Then we

examine urban and rural beneficiaries’

service use patterns to see whether

differences in market conditions may be

affecting the quantity or mix of care they

receive. Finally, we consider the potential

implications of market diversity for

Medicare and other public policies.

Although preliminary, these analyses

support two conclusions. One is that

policymakers’ concerns are well

founded—many rural communities are

facing a variety of adverse market

conditions, including small and declining

populations, a disproportionate share of

aged residents, low household incomes,

high unemployment, and disproportionate

numbers of minority residents. Distinct

combinations of these factors may affect

local market demand for and supply of

health services in different regions, with

varying potential effects on beneficiaries’

and other residents’ access to high-quality

care. These factors reflect the diversity of

local markets, however, not the Medicare

program.

The other conclusion is that the available

evidence gives no indication that

Medicare beneficiaries living in rural

areas are facing widespread serious

problems. On average, they receive health

services that are similar in quantity and

scope to those consumed by their urban

counterparts. This does not mean that

rural beneficiaries (or urban ones either)

always get all of the care they need or the

most appropriate and effective care. But it

also does not suggest that they suffer from

widespread major deficiencies compared

with urban beneficiaries.

Nevertheless, Medicare has an obligation

to adjust its payment policies to

accommodate differences in market

4 Medicare and rural health care: overview and challenges for policymakers
conditions that would affect efficient

providers’ costs but are beyond their

control. Medicare has not always adapted

its policies appropriately, but necessary

changes in those policies are not large.

Adjustments are needed, not fundamental

changes in direction.

What is rural?

The U.S. Bureau of the Census (Census

Bureau) and the U.S. Office of

Management and Budget (OMB) have

developed definitions of urban and rural

areas (Ricketts et al. 1999). In both

systems, rural areas are defined by default,

as areas that are not urban. The Census

Bureau uses an expansive definition of

urban areas based on population size and

density. Urban areas include people,

territory, and housing units in places with

at least 2,500 people. Most urban

residents, however, live in “urbanized

areas” that include urban places with at

least 50,000 people and surrounding areas

with a population density of at least 1,000

people per square mile. Rural areas

encompass everything not included in

urban places.

OMB defines urban and rural areas based

on the population size and density of

counties. A metropolitan (urban) county

may have a large city and suburbs or it

may be a peripheral county that is

economically and socially integrated with

a city located in a nearby county. OMB

also defines metropolitan areas and

metropolitan statistical areas (MSAs),

which consist of one or more central and

well-integrated outlying counties; 868

U.S. counties were classified as

metropolitan in 1998. The remaining

2,273 counties were considered

nonmetropolitan (rural).

In 1990, the Census Bureau classified 24.8

percent of the population as rural, but

almost half of these people lived in OMBdefined metropolitan counties.1 Urban

areas often account for only a small

fraction of the total land area included in

metropolitan counties (Figure 1-1).

Similarly, about 10 percent of people

classified as urban lived in

nonmetropolitan counties; rural counties

sometimes include urban places.

Following the OMB definitions—rural

residents are those who live in

nonmetropolitan counties—would treat

about 20 percent of the population as rural.

Medicare uses MSAs and

nonmetropolitan counties in each state

(statewide rural areas) to set payment rates

for services furnished by facility

providers—for example, hospital inpatient

care, hospital outpatient services, or

skilled nursing care (see Chapter 4).2

Report to the Congress: Medicare in Rural America | June 2001 5

1 Comparable data from the 2000 census are not yet available.

2 Medicare uses a slightly modified version of OMB’s definitions, reflecting a variety of statutory provisions that treat certain nonmetropolitan counties as if they were part

of specified MSAs.

FIGURE

1-1 Defining urban and rural

Nonmetropolitan counties, 1999

Metropolitan counties, 1999

Urbanized areas, 1990

Alaska and Hawaii not to scale

Source: Analysis of U.S. census data by Cecil G. Sheps Center for Health Services Research, University of North Carolina at Chapel Hill.
6 Medicare and rural health care: overview and challenges for policymakers

FIGURE

1-2 Locations of rural hospitals

Alaska and Hawaii not to scale

Rural hospital

Note: Gray areas represent metropolitan counties, 1999.

Source: Analysis of hospital location data from HCFA by Cecil G. Sheps Center for Health Services Research, University of North Carolina at Chapel Hill.

HCFA uses these areas to classify

providers as urban or rural and to adjust

Medicare’s PPS payment rates to reflect

geographic differences in market prices

for labor inputs. This adjustment is based

on an input-price index that HCFA

calculates annually using MSAs and

statewide rural areas to define 325 urban

and 47 rural labor market areas. Rural

hospitals are located only in

nonmetropolitan counties; they are

relatively dense in the East, South, and

Midwest, but geographically dispersed in

the West (Figure 1-2).

To describe differences among urban and

rural areas, demographers have developed

other definitions that are intended to

capture nonmetropolitan counties’

isolation or degree of ruralness based on

their population density, whether they are

adjacent to an urban area, the population

of their largest town, or their total urban

population. Frontier counties, for

example, are considered the most isolated

rural counties because they have fewer

than seven people per square mile.

We often use urban influence codes

(UICs) in this report to examine

differences among rural areas. UIC codes

divide counties into nine categories—two

urban and seven rural (Ghelfi and Parker

1997). Urban categories are based on

whether counties are included in a large

MSA (with a population of 1 million or

more) or a small one (population of less

than 1 million). The seven categories for

nonmetropolitan counties reflect whether

or not a county is adjacent to an MSA and

the size of its largest town (Figure 1-3). In

this scheme, the most urbanized rural

counties are those adjacent to an MSA and

with a largest town of at least 10,000

people. The most rural counties

(completely rural) are those not adjacent

to an MSA and with a largest town of

fewer than 2,500 people.

Rural health care

The research and policy literature on rural

health care generally paints a gloomy

picture of medical practice in rural areas.

Furnishing health services in rural

communities often entails overcoming

multiple adverse conditions. Many rural

areas are isolated, with long distances (or

physical barriers, such as mountains or

rivers) between towns and cities; these

conditions are sometimes compounded by

poor roads and bad weather (Williamson

2001). Further, rural areas often have a

weak economic base with limited capacity

to support modern health care delivery

(Ricketts et al. 1999, Schur and Franco

1999, Rosenblatt 2001).

For the most part, the health care delivery

system is market driven. Given a weak

economic base, producing the full range

of health care services with today’s costly

technologies is impossible for rural

communities (Rosenblatt 2001). With

small populations and limited diagnostic

and therapeutic resources, few rural

communities can attract physician

specialists. In addition, many have

difficulty attracting and retaining primary

care physicians, well-trained support staff,

and other practitioners, such as dentists or
physical therapists. Rural counties account

for about 20 percent of the population, but

only about 10 percent of all active

physicians. 

The number of primary care physicians

engaged in patient care per 100,000

people generally is lower in more rural

counties (Rosenblatt and Hart 1999).

Although the supply of family physicians

and general practitioners is roughly even

across counties with different UIC codes,

internists, general surgeons, obstetriciangynecologists, and pediatricians tend to be

concentrated in counties that have one or

more towns with at least 10,000 people.

Some rural areas face chronic shortages of

health professionals and facilities. In

general, these areas have four

characteristics in common (Rosenblatt and

Hart 1999):

• sparse population,

• extreme and persistent poverty,

• a high proportion of racial or ethnic

minorities, and

• lack of physical and cultural

amenities.

Federal and state programs attempt to fill

the gaps in these areas with a combination

of direct service programs, subsidized or

cost-based payments to providers, and

subsidized health insurance for lowincome residents. These programs include

Community and Migrant Health Services,

the Indian Health Service, rural health

clinics (RHCs), the National Health

Service Corps, Medicaid, and the State

Children’s Health Insurance Program.

Rural practice also has been changing in

response to the increasing complexity of

medical technology and shifts in the

organization of care (Rosenblatt 2001).

The range of clinical practice once was

defined by the set of services a general

practitioner in solo practice could provide.

General practitioners in solo practice,

however, have been replaced by group

practices of two to five physicians, often

with support from other professionals,

such as nurse practitioners, physician’s

assistants, or nurse midwives. In addition,

many practices are now affiliated with

some form of rural practice network based

at a rural referral hospital or an urban

hospital.

Affiliation with a network may bring a

variety of benefits, such as administrative

support, purchasing efficiencies, or greater

access to capital. Increasingly, however,

decisions about health care organization,

administration, or payment are made by

referral partners, insurers, or state and

federal regulators who are not local and

therefore may be insensitive to or ignorant

of local needs.

Report to the Congress: Medicare in Rural America | June 2001 7

UIC 2

UIC 3 UIC 4 UIC 5 UIC 6

UIC 7 UIC 8 UIC 9

UIC 1

Does not include

a town with at 

least 2,500 people

Adjacent to

small MSA

Adjacent to

large MSA

Adjacent to

MSA

Not adjacent

to MSA In large MSA In small MSA

In MSA

(urban)

Not in MSA

(rural)

All

counties

Definition of urban influence codes FIGURE

1-3

Note: UIC (urban influence code, as defined by the U.S. Department of Agriculture), MSA (metropolitan statistical area, as defined by the U.S. Office of Management and Budget).

Source: Ghelfi and Parker (1997).

Includes a town 

with at least 

10,000 people

Includes a town 

with at least 

10,000 people

Includes a town 

with at least 

10,000 people

Does not include a 

town with at least 

10,000 people

Does not include a 

town with at least 

10,000 people

Includes a town 

with between 2,500 

and 10,000 people
How rural markets differ

Many rural communities face market

conditions that may depress demand or

supply, and potentially decrease access to

and use of health services among

beneficiaries and other residents.

Depending on the community, these

factors include:

• a small population,

• a declining and disproportionately

older population,

• low household incomes, relatively

high unemployment rates, and high

poverty rates,

• a high proportion of the population

lacking health insurance or with

limited coverage,

• physical isolation, with long

distances to urban centers for

specialty care, and

• weak or restrictive state policies (for

example, in Medicaid eligibility and

payment policies, or certificate of

need laws).

To explore further the diversity of

conditions among rural markets, we

contracted with the Cecil G. Sheps Center

for Health Services Research, University

of North Carolina at Chapel Hill, to analyze

data on population characteristics and

health care supply. Because the health care

delivery system in almost all rural markets

is centered around one or more hospitals,

we chose to use rural hospital markets

based on patient origin data as the focus for

this analysis (see text box).

Using hospital market definitions, the staff

of the Sheps Center calculated totals,

averages, or medians, as appropriate, for a

range of variables, including market

population, the percentage change in

population between 1990 and 1999,

proportions of the population by age

group or household income, or percentage

of the working-age population employed.

These measures were based on ZIP-code

level data purchased from Claritas

Corporation and derived mainly from the

1990 census or later surveys carried out

by the Census Bureau. The center staff

then displayed summaries of the various

measures in tables, charts, or maps.

Certain factors may affect beneficiaries’

and other residents’ access to nearby

health services through their effects on

service demand and financial outcomes

for local providers. For example, a

substantial proportion of rural hospitals

serve small markets. The potential

implications for service demand can be

illustrated by some rough calculations.

One-quarter of all rural hospital markets

include fewer than 11,900 people. Only

about 10 percent of the population—20

percent of Medicare beneficiaries—is

admitted for inpatient hospital care during

a year. If they provided all of the inpatient

care used by local residents, hospitals

serving markets with 12,000 people would

have about 1,200 admissions per year.

With an average length of stay of 6 days,

they would furnish 7,200 patient days per

year, with patients occupying about 20

beds each day, on average. Perhaps onehalf or more of patient stays, however,

would entail relatively sophisticated

services that require expensive equipment

and specialized staff that are not available

in small rural hospitals. These patients

would go to larger rural or urban

hospitals. Allowing for variability in

admissions and lengths of stay for the

remaining 600 patients, only about 10-15

8 Medicare and rural health care: overview and challenges for policymakers

Defining hospital markets and measuring market

factors

Urban and rural hospitals’

markets were defined by the 

staff of the Cecil G. Sheps

Center based on the ZIP codes of

origin—patients’ residences—for

their Medicare discharges. The staff

defined markets by selecting ZIP

codes in descending order of their

contributions to hospitals’ Medicare

discharges, adding new ones until the

cumulative area accounted for a preset

percentage of hospitals’ Medicare

volume. The objective was to include

all local ZIP codes that account for the

bulk of a hospital’s Medicare acute

inpatient care without including

remote areas that would have little

effect on measured market conditions.

Because many urban hospitals attract

a substantial portion of their patients

from surrounding rural areas, this goal

was achieved with a Medicare volume

threshold of 60 percent. Rural

hospitals, however, attract most of

their patients from nearby areas; thus,

the threshold for rural markets was set

at 80 percent.

This process produced hospitalspecific markets made up of one or

more ZIP codes. These markets are

not mutually exclusive; two hospitals

may draw substantial numbers of

patients from the same ZIP code.

Moreover, they are based on Medicare

beneficiaries’ observed use patterns,

which reflect the current size and

distribution of facilities, the health

care delivery roles they have chosen,

and beneficiaries’ travel capabilities

and preferences. Hospitals’

characteristics and their market

conditions are thus interrelated.

Although their size and service

capabilities generally reflect the size

and characteristics of the local

population, occasionally a large

hospital with broad service

capabilities may prosper in a rural

area because it can draw patients from

well beyond its local service area. The

equilibrium also can change; if the

supply or distribution of facilities

changes through entry, exit, or

conversion to some other use, the

market areas, their populations, and

other characteristics also would likely

change. Similarly, changes in the

number and mix of local industries

and employers also might change the

size and characteristics of the

population, potentially causing

providers to alter their size and

capabilities. beds would be needed in these small

hospitals to meet local demand for routine

inpatient care—even fewer if some

residents patronized other nearby hospitals

that also serve parts of the same market.

At this volume level, many hospitals

would experience serious financial stress

(see Chapter 4). The relatively high fixed

costs of operating a hospital must be

spread over few patients, raising the unit

cost of care. Economies of scale

associated with task specialization are not

available at low volume. Unit costs also

might be affected if—as advocates

assert—hospitals in small or declining

communities face higher costs in

attracting and retaining physicians and

other health professionals.3 Other things

being equal, higher unit costs resulting

from any of these factors would lower

hospitals’ Medicare inpatient margins and

their total margins.

The financial difficulties of operating at

low volume may be compounded by other

market factors, such as low household

incomes or a high proportion of the

population lacking health insurance.4

These factors are likely to affect

providers’ financial viability by further

reducing service volume or revenues for

non-Medicare patients, perhaps increasing

the burden of uncompensated care. Other

things being equal, these factors could

substantially reduce hospitals’ total

margins while having little effect on their

Medicare inpatient margins.

Changing population demographics—

particularly the emigration of working-age

residents—also likely affect the amount

and types of health facilities and

practitioners rural communities need, and

increase providers’ vulnerability to policy

changes in Medicare and state programs

such as Medicaid. Providers in small or

declining rural areas may be especially

vulnerable to Medicare policy changes

because program beneficiaries account for

a larger share of their overall service

volume and revenues compared with

providers in other rural and urban areas.

Further, these providers often derive a

large share of their revenues from services

furnished in settings—such as outpatient

departments, skilled nursing facilities

(SNFs), and home health agencies—that

have been most affected by recent

Medicare policy reforms.

Preliminary findings

Using the hospital market data, we

analyzed the variation in many of these

factors among market areas and

geographic regions. We also explored the

relationships between these market factors

and hospitals’ financial performance,

including their Medicare inpatient

margins and total margins. These analyses

have thus far only scratched the surface of

the complex relationships among the

various market factors and between those

factors and providers’ financial

performance. Nevertheless, our analyses

appear to support several preliminary

conclusions:

• Economic conditions vary widely

among rural markets.

• Rural markets in the West have

different sets of risk factors than

those in the East.5

• The main risk factors in the West

include combinations of markets with

small populations, declines in market

populations during the 1990s, and

populations with disproportionate

numbers of residents ages 65 or

older. These factors raise the

likelihood that providers will operate

at low volume, which adversely

affects providers’ unit costs,

Medicare inpatient margins, and total

margins.

• The main factors operating in the

East are more complicated, and how

they interact is still murky. Hospital

markets in the East often exhibit low

household income and high

unemployment rates. They also often

have high proportions of racial and

ethnic minorities. These factors

appear to affect providers’ total

margins more than their Medicare

inpatient margins, suggesting that

much of the market weakness may be

on the private side—perhaps

primarily reflecting large numbers of

people who lack health insurance.

Factors affecting hospital

markets in the West

Population is one of the major factors that

affects demand and supply in a market.

Market population declines sharply for

hospitals located in more rural counties

(across UIC categories). This relationship

holds across regions, but market

population levels are generally twice as

high in the East compared with the West,

which probably reflects differences in

population density across regions.

Hospital markets with small

populations—those with 11,900 or fewer

people, the bottom quartile of the

distribution of market population among

rural hospital markets—are concentrated

in the West, especially in the Plains states

(Figure 1-4). Only 6 percent of rural

markets in the East have small

populations, compared with 40 percent of

those in the West.

In addition to small populations, many

hospital markets in the West experienced

population declines during the 1990s—the

ZIP codes included in the market area lost

population between 1990 and 1999—and

also had disproportionate numbers of

residents ages 65 or older (Figure 1-5).6

Of the 471 hospital markets in the West

that have a small population base, 245 (52

Report to the Congress: Medicare in Rural America | June 2001 9

3 The wage and salary data hospitals report annually do not appear to support this claim (see Chapter 4). Another possibility is that small hospitals face lower productivity

and higher unit costs because they are unable to attract an efficient mix of staff given their mix of service outputs.

4 Unfortunately, we do not have ZIP code level information about the proportion of the population lacking health insurance.

5 The East and West regions are divided by the Mississippi river. The East includes New England, Middle Atlantic, South Atlantic, East South Central, and East North

Central Census divisions; the West includes West South Central, West North Central, Mountain, and Pacific divisions.

6 ZIP code population estimates for 1999, which were used in estimating the average annual change in population for each hospital market after 1990, were based on

population projections made by Claritas Corporation.
10 Medicare and rural health care: overview and challenges for policymakers

Alaska and Hawaii not to scale.

Rural markets with 

small population

All other rural markets 

FIGURE

1-4 Rural markets with small population base

Alaska and Hawaii not to scale.

FIGURE

1-5 Rural markets with declining and aged populations

Markets with declining and aged population

Markets with declining population only

All other rural markets

Note: Markets with small population had fewer than 11,900 residents in 1999. Gray areas represent metropolitan counties, 1999.

Source: Analysis of Claritas Corp. estimates based on 1990 census by Cecil G. Sheps Center for Health Services Research, University of North Carolina at Chapel Hill.

Note: Markets with declining population lost 0.1 percent of total population annually between 1990 and 1999. Markets with declining and aged population also had 20

percent or more aged 65 or older. Gray areas represent metropolitan counties, 1999.

Source: Analysis of Claritas Corp. estimates based on 1990 census by Cecil G. Sheps Center for Health Services Research, University of North Carolina at Chapel Hill.
percent) had population declines and 166

(35 percent) also had a high share of older

residents (Table 1-1).

Markets with declining populations also

occur in the East: along the Mississippi

river, in Appalachia, in Western New

York and Western Pennsylvania, and in

northern New England. These markets

usually include larger populations,

however, and they generally do not have a

disproportionate share of older residents.

Hospitals serving small markets tend to

have poor financial outcomes, especially

low total margins. Moreover, providers’

total margins tend to deteriorate where the

market population has been declining, and

worsen further where the population is

disproportionately 65 or older. Although

other mechanisms may be involved in

these relationships, a major one is that

providers facing these conditions are

highly likely to operate at low inpatient

volume. Two-thirds of the hospitals

serving small markets in the West have

fewer than 500 acute discharges per year.

Factors affecting hospital

markets in the East

Many rural hospital markets in the East

encompass populations with low

household incomes; about 45 percent of

all rural markets had median annual

incomes less than $28,100—the bottom

quartile of household income for all

hospital markets (urban and rural) in

1999. About 30 percent of all markets had

unemployment above 8.1 percent—the

top quartile of the distribution in 1999.

Finally, many hospital markets serve

populations that include concentrations of

racial or ethnic minorities.

Hospitals serving markets with any of

these characteristics tend to have aboveaverage financial performance under

Medicare’s inpatient PPS, but

substantially below-average overall

financial performance (total margins).

Moreover, high unemployment tends to

compound the effects associated with low

household income, resulting in much

lower total margins. These factors are

often accompanied by concentrations of

racial or ethnic minorities, which are also

associated with above-average financial

performance under the PPS but worse

overall financial outcomes.

Hospital markets with low household

incomes are located throughout the nation,

but those with low incomes and high

unemployment are concentrated in the

East, in the Mississippi valley,

Appalachia, and to a lesser extent near the

Canadian border (Figure 1-6). Hospital

markets with disproportionate minority

populations are located predominantly in

the South and Southeast (Figure 1-7).

How and why these factors affect

financial performance under Medicare’s

inpatient PPS and overall, however,

remains unclear.

Isolation and low volume

Rural health advocates have often cited

rural hospitals’ physical isolation as a

potential risk factor for financial pressures

that may threaten residents’ access to care.

The data, however, provide little evidence

to support this concern. Most isolated

rural hospitals—defined as those with no

other acute-care hospital within 25 air

miles—are located in the West (Figure

1-8).7 Financial performance under the

PPS, on average, is about the same for

isolated providers as for all others, and

they often have above-average total

margins. These outcomes probably reflect

to some extent the effects of Medicare’s

policies aimed at protecting isolated rural

hospitals (see Chapter 4).

In contrast, hospitals that produce few

inpatient discharges tend to have much

lower Medicare inpatient and total

margins than other providers. Lowvolume providers are located primarily in

the Midwest (Figure 1-9), but they are

generally not isolated. About 14 percent

of low-volume hospitals have another

acute-care hospital within 10-15 road

miles and half have another facility within

20-25 road miles (see Chapter 4). Finally,

isolated and low-volume providers have

little overlap across UIC categories (Table

1-2, see p. 14).

Report to the Congress: Medicare in Rural America | June 2001 11

Percentage of rural hospital markets with selected

characteristics, by region

Markets with

Market/hospital

All markets small population

characteristic All East West All East West

Small population 25.0% 6.0% 40.0% 100.0% 100.0% 100.0%

Declining population 24.3 14.6 32.1 49.6 28.3 52.1

Declining population and 

disproportionately aged 10.3 1.7 17.3 32.4 8.3 35.3

Low household income 44.7 45.5 44.1 48.7 65.0 46.7

High unemployment 30.2 35.1 26.2 21.1 55.0 17.0

Isolated location 18.5 7.3 27.6 34.3 18.3 36.3

Low volume 21.7 8.1 33.2 65.6 54.5 67.0

Note: East and West regions are divided by the Mississippi river; East includes New England, Middle Atlantic,

South Atlantic, East South Central, and East North Central census divisions, while West includes West South

Central, West North Central, Mountain, and Pacific divisions. Small population  fewer than 11,900

people; declining population  average annual population change from 1990 to 1999 of at least 0.1

percent; disproportionately aged  at least 20 percent of the population in the market ZIP codes is age 65

or older; low household income  median household income of the market area is $28,100; high

unemployment  percent of workforce that is not employed is greater than 8.1 percent; isolated location 

air-mile distance to nearest short-term acute care hospital is  25 miles; low volume  500 or fewer acute

inpatient discharges in 1997.

Source: Analysis of Claritas Corp. estimates based on 1990 census by Cecil G. Sheps Center for Health Services

Research, University of North Carolina at Chapel Hill.

TABLE

1-1

7 Air-mile distances are measured from the population center of a hospital’s ZIP code to the ZIP code population center for the nearest hospital.
12 Medicare and rural health care: overview and challenges for policymakers

Alaska and Hawaii not to scale.

FIGURE

1-6 Rural markets with low income and high unemployment

Low household income (lowest 25%) and

high unemployment (highest 25%)

Low household income only

All other rural markets

Alaska and Hawaii not to scale.

FIGURE

1-7 Rural markets with a disproportionate minority population

Minorities make up at least 30% of population

All other rural markets

Note: Markets with low household income had median household income of less than $28,100 in1999. Markets with low household income and high unemployment also had

more than 8.1 percent of resident workforce unemployed. Gray areas represent metropolitan counties, 1999.

Source: Analysis of Claritas Corp. estimates based on 1990 census by Cecil G. Sheps Center for Health Services Research, University of North Carolina at Chapel Hill.

Note: Markets with disproportionate minority population had 30 percent or more non-white or Hispanic in 1999. Gray areas represent metropolitan counties, 1999.

Source: Analysis of Claritas Corp. estimates based on 1990 census by Cecil G. Sheps Center for Health Services Research, University of North Carolina at Chapel Hill.
Report to the Congress: Medicare in Rural America | June 2001 13

Alaska and Hawaii not to scale.

FIGURE

1-8 Isolated rural hospitals

No acute-care hospital within 25 air miles

All other rural markets

Alaska and Hawaii not to scale.

FIGURE

1-9 Low-volume rural hospitals

500 or fewer acute-care discharges per year

All other rural hospitals

Note: Air-mile distances computed from population centers of hospitals’ ZIP codes. Includes all acute-care hospitals in HCFA files in 2000. Gray areas represent metropolitan

counties, 1999.

Source: Analysis of HCFA survey and certification data for 2000 by Cecil G. Sheps Center for Health Services Research, University of North Carolina at Chapel Hill.

Note: Gray areas represent metropolitan counties, 1999.

Source: Analysis of Medicare cost report data for 1998 by Cecil G. Sheps Center for Health Services Research, University of North Carolina at Chapel Hill.
Providers’ responses to

market conditions

Providers in different markets offer

different services (Table 1-3). Those in

the most urbanized counties are much

more likely than other rural hospitals to

have SNFs (rather than swing beds),

rehabilitation units, or psychiatric

facilities. Hospitals in the most rural

counties are much more likely to have

swing beds and nursing facilities for

long-term care; they are unlikely to have

SNFs, rehabilitation units, or psychiatric

units.

These data are consistent with findings

from MedPAC visits to rural providers in

2000. Many rural facilities were using

long-term care services and ambulatory

care (outpatient and rural health clinic

services) as their principal sources of

revenue. Without these revenue streams,

these hospitals probably would not be

financially viable.

Medicare beneficiaries’

use of services

Policymakers and rural health care

advocates have often argued that

beneficiaries and others living in rural

areas are disadvantaged in obtaining

needed care compared with their urban

counterparts. This claim is certainly

consistent with the weak market

conditions just described and parallel

suggestions in the literature that many

rural residents face substantial obstacles in

obtaining care, including low incomes,

lack of health insurance, limited local

health resources, and long travel distances

and times to reach sources of care

14 Medicare and rural health care: overview and challenges for policymakers

Isolated and low-volume hospitals, 

by location

Number of

Location of hospital (UIC) hospitals Isolated Low-volume Both

Adjacent to an MSA and includes a town 

with at least 10,000 people (3, 5) 349 9% 6% 1%

Not adjacent to an MSA but includes a town 

with at least 10,000 people (7) 314 20 10 3

Adjacent to an MSA but does not include a 

town with at least 10,000 people (4, 6) 623 13 23 4

Not adjacent to an MSA but includes a town 

with between 2,500 and 10,000 

people (8) 595 23 19 5

Not adjacent to an MSA and does not 

include a town with at least 2,500 

people (9) 271 28 59 21

All rural 2,152 18 22 6

Note: UIC (urban influence code, as defined by the U.S. Department of Agriculture), MSA (metropolitan statistical

area, as defined by the U.S. Office of Management and Budget).

Source: Analysis of HCFA survey and certification data for 2000 and Medicare cost report data for 1998 by Cecil

G. Sheps Center for Health Services Research, University of North Carolina at Chapel Hill.

TABLE

1-2

Rural hospital diversification, by location

Skilled

Swing nursing Nursing Any long- Rehabilitation Psychiatric Home Location of hospital (UIC) Hospitals beds facility facility term care unit unit health

Adjacent to an MSA and includes a town

with at least 10,000 people (3, 5) 363 30% 45% 9% 69% 16% 34% 30%

Not adjacent to an MSA but includes a

town with at least 10,000 people (7) 326 33 53 8 78 18 30 30

Adjacent to an MSA but does not include a

town with at least 10,000 people (4, 6) 625 65 32 11 82 3 13 28

Not adjacent to an MSA but includes a town

with between 2,500 and 10,000 people (8) 598 67 28 12 82 2 12 31

Not adjacent to an MSA and does not include

a town with at least 2,500 people (9) 271 90 26 20 95 1 7 27

All rural 2,183 59 35 12 81 6 18 30

Note: UIC (urban influence code, as defined by the U.S. Department of Agriculture), MSA (metropolitan statistical area, as defined by the U.S. Office of Management and

Budget). Counts and percentages based on sub-providers reported on hospitals’ Medicare cost reports for 1998.

Source: Analysis of HCFA data from hospitals’ Medicare cost reports for 1998 by Cecil G. Sheps Center for Health Services Research, University of North Carolina at Chapel Hill.

TABLE

1-3
(McConnel and Zetzman 1993, Edelman

and Menz 1996, Coburn and Bolda 1999,

Schur and Franco 1999).

To examine this issue, we compared the

use of health services by urban and rural

beneficiaries in Medicare’s traditional

program in 1999. We also compared the

proportions of beneficiaries using

services, services per user, and the mixes

of services used among urban and rural

areas and across geographic regions.

These analyses showed that:

• Urban and rural beneficiaries use

similar amounts of care, on average,

nationally and within each region.

• Beneficiaries’ per capita use of

services differs among regions, with

those in the South and the West

having the highest and lowest

average use, respectively.

• Washington, Arizona, and New

Hampshire have the highest

concentrations of counties with

unusually low use rates.

Report to the Congress: Medicare in Rural America | June 2001 15

Analytic methods 

To compare urban and rural

beneficiaries’ per capita service

use and the mix of services

used, we separated providers’ 1999

claims for a 5 percent sample of

beneficiaries into 11 service types:

short-term hospital inpatient,

rehabilitation hospital, long-term

hospital, psychiatric hospital, skilled

nursing facility (SNF), swing bed,

home health, physician, hospital

outpatient, ambulatory surgical center

(ASC), and rural health clinic (RHC).

The physical quantities of most

services, however, are not directly

comparable either within or across

service types. For example, outpatient

hip-replacement surgery uses more

resources than drawing blood for

laboratory tests, and neither is

equivalent to inpatient liver

transplantation.

To put all services on a common scale,

we measured the relative costliness of

each service as consistently as possible.

For most services paid under one of

Medicare’s prospective payment

systems—physician, short-term

hospital inpatient, hospital outpatient,

ASC, and SNF—we measured use as

the sum of the relative values for all

services received multiplied by the

national base payment amount. For

home health care, we applied the

median national payment rates in 1999

for the six home health visit types

specified in the Medicare interim

payment system. We calculated use of

swing-bed and specialty hospital

services (long-term, psychiatric, and

rehabilitation care) by adjusting the

payments Medicare made to providers

by the hospital wage indexes that apply

to the providers’ locations. For RHC

visits, we measured use as the number

of visits multiplied by the maximum

payment rate per visit in 1999 ($60.40).

These methods value all services as if

they were paid using national payment

rates. They provide fair relative

measures of service use if two

assumptions hold:

• Medicare’s relative values for

individual services within a service

type accurately reflect services’

relative costliness.

• The national base payment amounts

(conversion factors) accurately

measure the relative costliness of

services across service types.

After applying these methods,

beneficiaries’ total use is the sum of

measured use over all service types.

To explore differences in beneficiaries’

service use among types of rural areas

and across regions, we calculated

separate national average use rates for

counties grouped by urban influence

code (UIC) and for four Census

regions. To make the results easier to

interpret and ensure reasonably large

samples, we combined UIC groups

representing large and small

metropolitan statistical areas (MSAs)

and those adjacent to large and small

MSAs, leaving one urban and five rural

categories. Except for the most rural

UIC in the Northeast, all regional UIC

groups had at least 3,000 sample

beneficiaries.

To control for differences in

beneficiaries’ use of services associated

with systematic differences in health

status, we divided beneficiaries’ use

rates by their risk scores from the

hierarchical condition category (HCC)

risk adjustment model. These risk

scores represent beneficiaries’ expected

service use rates given their health

status, relative to that of the national

average beneficiary. Expected use is

based on the beneficiary’s risk

category, which reflects age, sex, and

diagnoses from hospital inpatient,

hospital outpatient, and physician visits

during the previous year, and on the

national average historical spending per

beneficiary in each risk category.

Urban beneficiaries in our sample had

higher average risk scores (worse

health) than rural ones. Because the

HCC model does not fully reflect

differences in health status, riskadjusted use rates probably overstate

urban beneficiaries’ service use.* Rural

beneficiaries’ risk-adjusted use rates

also may be overstated somewhat if

they use relatively few services given

their health status. 

* Urban beneficiaries’ use rates are also somewhat overstated because the population is limited to beneficiaries enrolled in the traditional program. Those

enrolled in the MedicareChoice program are excluded because MedicareChoice organizations generally do not submit claims. Excluding them, however,

overstates urban beneficiaries’ use rates because MedicareChoice enrollees are healthier than average (PPRC 1996, MedPAC 1998, MedPAC 2000).
• Although overall use rates are

similar, the mix of services varies;

rural beneficiaries use fewer

physician and post-acute care

services but more hospital outpatient

and inpatient services than do their

urban counterparts.

Use of services in urban and

rural areas

The per capita use rate in the urban UIC

is similar to rates in the five rural UICs,

both nationally and within regions

(Figure 1-10).8 This finding holds

whether or not we adjust for

beneficiaries’ health status.9 In contrast,

estimated use rates differ between

regions. Compared with the national

average, per capita service use is 6.0

percent higher in the South and 6.7

percent lower in the West.

16 Medicare and rural health care: overview and challenges for policymakers

8 Although differences in these use rates are statistically significant because we have large samples, they are not meaningful.

9 Without adjustment for health status, urban beneficiaries’ use rates range from 2.3 percent to 6.6 percent higher than the use rates in rural UICs; with adjustment, they

range from 0.7 percent higher to 4.8 percent lower.

5,073 5,059

Urban and rural beneficiaries use similar amounts

of services, but use rates differ among regions

3,600

900

UICs 1 and 2 UICs 3 and 5 UICs 4 and 6 UIC 7 UIC 8 UIC 9

Total use, per beneficiary

4,500

5,400

2,700

1,800

0

In an MSA Adjacent to an MSA Not adjacent to an MSA

FIGURE

1-10

National use rates

4,828 4,796 5,003 5,073 5,059 4,922

Regional use rates Region

Location of county (UIC) Nation Northeast South Midwest West

Urban, in an MSA (1, 2) 4,828 4,650 5,092 4,827 4,532

Adjacent to an MSA and includes a town

with at least 10,000 people (3, 5) 4,796* 4,396* 5,111 4,718 4,527

Not adjacent to an MSA but includes a

town with at least 10,000 people (7) 4,922* 4,339 5,395* 4,750 4,503

Adjacent to an MSA but does not include a

town with at least 10,000 people (4, 6) 5,003* 4,541 5,213* 4,867 4,480

Not adjacent to an MSA but includes a town

with between 2,500 and 10,000 people (8) 5,073* 4,601 5,469* 4,787 4,688

Not adjacent to an MSA and does not include

a town with at least 2,500 people (9) 5,059* 5,504 5,372* 4,815 4,586

All beneficiaries 4,864 4,627 5,156 4,813 4,537

Note: UIC (urban influence code, as defined by the U.S. Department of Agriculture), MSA (metropolitan statistical area, as defined by the U.S. Office of Management and

Budget). Use is the sum of services from 11 service types, evaluated at nationally standardized payment rates and adjusted for individual differences in health status. These

results include beneficiaries in traditional Medicare and exclude beneficiaries in MedicareChoice, who make up 21 percent of the Medicare population in urban counties

and 4 percent of the population in the five non-urban categories. Northeast includes New England and Middle Atlantic census divisions; South includes South Atlantic, East

South Central, and West South Central census divisions; Midwest includes East North Central and West North Central census divisions; West includes Mountain and

Pacific census divisions.

*Indicates statistically different from urban value in same region (5 percent level).

Source: MedPAC analysis of claims from 1999 for a 5 percent random sample of Medicare beneficiaries.
Report to the Congress: Medicare in Rural America | June 2001 17

We examined geographic differences in

use rates more closely by identifying

counties with unusually high or low use

rates.10 Louisiana, Texas, Florida, and

Mississippi have concentrations of highuse counties; Washington, Arizona, and

New Hampshire have disproportionate

numbers of low-use counties (Figure

1-11).

Unusually high or low rates do not

necessarily mean that beneficiaries are

receiving too much, too little, or an

inappropriate mix of care. A clinically

based analysis would be needed to

determine care appropriateness (see

Chapter 2). This analysis serves only to

identify counties that should be examined

more closely. Some of these counties, for

instance, have only a few beneficiaries in

our sample. Before undertaking a costly

clinical evaluation of their use rates, it

probably would be useful to re-estimate

use rates with a larger sample of 1999

claims or with claims from several years.

Interpreting use rates

Differences in use rates should be

interpreted cautiously. Beneficiaries in

areas with lower rates do not necessarily

have less access to care or receive less

appropriate care. The relatively low use

rates in the West thus might indicate that

beneficiaries living there have greater

access problems, but further analysis

would be necessary to rule out other

potential differences, such as providers’

practice patterns or beneficiaries’

10 High- and low-use counties have use rates that fall outside 95 percent confidence limits around the national average use rate, taking into account the number of sample

beneficiaries in the county.

Counties with high and low use of services

FIGURE

1-11

Low use

High use

Alaska and Hawaii not to scale

Note: High use includes counties with rates of service use more than two standard deviations above the national average. Low use includes counties more than two standard

deviations below the national average.

Source: MedPAC analysis of claims from 1999 for a 5 percent random sample of Medicare beneficiaries.
preferences and propensities to seek care.

Conversely, similar use rates do not imply

that all groups are equally well served.

Finally, use rate differences may or may

not be associated with differences in the

quality of health outcomes; outcomes

depend on the appropriateness and

technical quality—rather than the

amount—of the care received.

The mix of services used

Urban and rural beneficiaries use

somewhat different combinations of

services, on average. Per capita use of

physician services is 7 to 14 percent lower

in the rural UICs, compared with the

urban UIC (Table 1-4). Although rural

beneficiaries are about as likely as those

in urban areas to use physicians’ services,

rural users have fewer visits, on average,

than do urban ones. This result may

overstate the difference between urban

and rural beneficiaries’ behavior,

however, because the latter often receive

physician care in RHCs. After combining

physician and RHC services, per capita

use in the rural UICs is 3 to 6 percent

lower than that in the urban UIC.11

Conversely, per capita use of physicians’

services by urban beneficiaries may be

somewhat understated because residents

(physicians in training) furnish a

substantial volume of care in urban areas,

but claims for their services often are not

submitted.12

Beneficiaries in the rural UICs also use 5

to 15 percent less post-acute care (PAC),

which includes home health, SNF, swingbed, rehabilitation hospital, and long-term

hospital services. Rural beneficiaries’

lower PAC use is largely driven by lower

use of non-hospital PAC services (home

health and SNF), offset to some extent by

greater use of swing-bed services.

In contrast to physician and PAC services,

per capita use of hospital outpatient care is

14 to 28 percent higher in the rural UICs

because a higher proportion of rural

beneficiaries use at least one outpatient

service. Compared with urban

beneficiaries, those in rural areas may face

more obstacles in obtaining primary care

in physicians’ offices and thus receive a

greater proportion of primary care

services in outpatient departments. Rural

beneficiaries also may get some care from

physician specialists who periodically

visit rural outpatient departments. These

differences should be interpreted with

some caution, however; outpatient service

use may be generally understated because

of poor coding practices in 1999 before

prospective payment began in 2000.

Finally, use of hospital inpatient care per

beneficiary is 3 to 13 percent higher in the

rural UICs; rural beneficiaries are more

likely to be admitted for care at least once

and rural users have more admissions per

user.13 Rural areas are much less likely

than urban ones to have specialty

hospitals, such as long-term and

rehabilitation facilities, and they generally

have fewer SNFs and home health

agencies, which may increase use of

short-term and critical access hospitals.

Also, rural beneficiaries likely travel

greater distances, especially to obtain

specialized care. Consequently, physicians

may sometimes admit rural beneficiaries

for inpatient care in situations where they

would use outpatient care if the patient

lived closer to the hospital.

Validating our results

Our results suggesting that urban and rural

beneficiaries use similar amounts of care

might be viewed as somewhat contrary to

conventional wisdom. Consequently, we

attempted to validate them using two

approaches:

• We examined how well the use rates

track counties’ adjusted average per

capita cost (AAPCC) rates, which are

based on per capita program spending

in each county from 1990 to 1994,

and

• We compared our findings with those

reported in the literature on urban and

rural beneficiaries’ use of health

services.

Use rates and per capita

spending

To make fair comparisons, we removed

from the AAPCC rates the effects of

geographic differences in input prices,

indirect graduate medical education

payments, and disproportionate share

payments to hospitals because these factors

are external. We also compared use rates

and AAPCC rates without adjustments for

health status because they are adjusted with

different systems.

After these changes, the national average

adjusted AAPCC rate is 6.1 percent higher

for urban beneficiaries than for rural

beneficiaries. This is similar to the

differences in use rates (without

adjustment for health status), which

average 4.1 percent higher for urban

beneficiaries than for rural beneficiaries.

County AAPCC rates, however, explain

only half the cross-county variation in use

rates. We believe the correlation is

relatively low at the county level because:

• use rates may be somewhat unstable

because they are based on a single

year’s data and small samples in

some counties, while the AAPCC

rates are derived from five years of

data,14

• input-price adjusters for the AAPCC

rates poorly reflect input-price

differences between counties, and

18 Medicare and rural health care: overview and challenges for policymakers

11 Treating all RHC services as physician services may overstate the volume of physician care. RHC providers did not record service codes on more than half the claims in

our database. We assumed each uncoded claim represented a single physician visit.

12 Rural beneficiaries’ greater use of hospital outpatient care may exaggerate slightly measured discrepancies between urban and rural beneficiaries’ use of physician

services. Practice expense differentials tend to discount physician services furnished in outpatient settings compared with those furnished in physicians’ offices. Our

sensitivity analysis, however, suggests that this effect is probably quite small.

13 Hospital inpatient care includes inpatient services received in short-term and critical access hospitals.

14 From a regression of county use rates against AAPCC rates, unexplained errors in use rates are often very large for counties with small samples. Unexplained errors of

the same magnitude did not occur for counties with large samples.
• the AAPCC spending data are much

older (1990-1994) than are the use

rate data.

The discrepancies between county use

rates and AAPCCs caused by these

limitations are largely random at the

county level, so they likely cancel out

when rates are aggregated at the national

level.

Use rates in the literature

It is difficult to compare our total use rate

estimates to the literature because we

combined 11 service types and most other

studies examined no more than 3. In the

only comparable study, the Prospective

Payment Assessment Commission

(ProPAC 1996) had consistent results—

rural beneficiaries’ use of services was

approximately 2 percent higher than that

of their urban counterparts.

Moreover, our results for specific services

generally are consistent with those of other

published studies. The most frequently

analyzed service is physician care. Miller,

Holahan, and Welch (1995) measured use

of physician care with relative value units

(RVUs) from the physician fee schedule.

They compared the average RVUs of

services used by rural and urban

beneficiaries. This is similar to our method

of comparing the average of the RVUs

multiplied by the national conversion

factor in the physician fee schedule. They

found, as we have, that rural beneficiaries

use less physician care than those living in

urban areas.

Examining only annual physician visits

per person, Himes and Rutrough (1994)

found elderly rural residents had fewer

visits. If we count visits per beneficiary,

ignoring differences in service complexity

(RVUs), we find a similar result. In

contrast, McConnel and Zetzman (1993)

found urban and rural elderly do not differ

either in the percentage with at least one

physician visit or the annual number of

visits per person. Their results, however,

are based on a relatively small national

survey of 3,500 people age 70 and older,

including 1,102 rural residents.

Himes and Rutrough also found that nonfarm rural elderly have more hospital

inpatient stays per beneficiary, which is

consistent with our results. Conversely,

McConnel and Zetzman found that rural

elderly are not statistically more likely to

have at least one hospital stay. Although

the differences between urban and rural

beneficiaries’ admission rates are smaller

in our data, we have a much larger sample

(2 million beneficiaries) and thus greater

power to detect significant differences.

Our analysis of home health use is

consistent with Kenney (1993a, 1993b),

who found that urban beneficiaries were

Report to the Congress: Medicare in Rural America | June 2001 19

Per capita use of services by beneficiaries in traditional Medicare, 

by type of service and location of county, 1999

Location of county (UIC)

Adjacent to an MSA Not adjacent to an MSA

Service type

Physician 1,276 1,188* 1,186* 1,195* 1,139* 1,117*

PhysicianRHC 1,280 1,214* 1,246* 1,231* 1,212* 1,230*

Hospital outpatient 541 616* 625* 642* 664* 690*

Hospital inpatient 2,185 2,250* 2,363* 2,319* 2,473* 2,452*

Post acute** 684 602* 653* 628* 623* 593*

SNFhome health 502 461* 467* 478* 453* 426*

Swing beds 1 8* 24* 13* 30* 49*

Other 138 114 116 103 101 94

Total 4,828 4,796 5,003* 4,922* 5,073* 5,059*

Note: UIC (urban influence code, as defined by the U.S. Department of Agriculture), MSA (metropolitan statistical area, as defined by the U.S. Office of Management and

Budget), RHC (rural health clinic), SNF (skilled nursing facility). Hospital inpatient combines short-term and critical access hospitals. “Other” combines ambulatory surgical

center and psychiatric hospital services. Use is services evaluated at nationally standardized payment rates and adjusted for individual differences in health status. These

results include beneficiaries in traditional Medicare and exclude beneficiaries in MedicareChoice, who make up 21 percent of the Medicare population in urban counties

and 4 percent of the population in the five non-urban categories.

*Indicates statistically different from urban value (5 percent level).

**Post acute also includes two categories (not shown) for rehabilitation and long-term hospital services.

Source: MedPAC analysis of claims from 1999 for a 5 percent random sample of Medicare beneficiaries.

TABLE

1-4

Urban, in an

MSA (1, 2)

Includes a

town with at

least 10,000

people (3, 5)

Does not

include a

town with at

least 10,000

people (4, 6)

Includes a

town with at

least 10,000

people (7)

Includes a

town with

between 2,500

and 10,000

people (8)

Does not

include a

town with at

least 2,500

people (9)
more likely to use home health care. In

contrast, Rabiner (1995) found little

difference between urban and rural elderly

residents’ probabilities of using home

health services. However, she used data

from 1982-1984, and the home health

market has grown considerably since then.

Finally, our analysis of the use of SNF

services is not consistent with Dubay

(1993), who found rural beneficiaries are

more likely to use SNF services.

However, the SNF market has grown

substantially since the year of her data

(1987), so comparisons with our results

may not be meaningful.

Potential implications for

Medicare and other public

policies

Our findings support two conclusions.

First, although we cannot infer that

Medicare beneficiaries living in rural

areas always receive all of the care they

need, the available evidence does not

suggest that they have serious, widespread

or unique problems. On average, they

receive about the same amount of services

(but a somewhat different mix) as their

urban counterparts. Second, some rural

communities may have difficulty

sustaining the health care infrastructure

needed to meet their residents’ needs

because they are facing a combination of

one or more conditions, such as small and

declining populations, low household

incomes, high unemployment, or

disproportionate numbers of minority

residents. These conditions often make it

harder to attract and retain providers

because they limit the demand for

services, raise providers’ unit costs, or

reduce providers’ revenues by increasing

uncompensated care burdens.

Attempting to provide the full range of

modern medical services in all rural areas

with today’s costly technologies would

not be desirable, even if it were possible.

Given low levels of demand, providers

would operate at inefficient volumes,

raising costs and compromising service

quality.

Nevertheless, Medicare’s policies still

must adapt to accommodate differences in

market conditions that would affect

efficient providers’ costs but are beyond

their control (MedPAC 2001). This is

necessary to achieve Medicare’s

objectives of ensuring beneficiaries’

access to medically necessary acute care

of high quality and promoting efficient

production and distribution of acute care

products and services. Because Medicare

buys products and services from providers

who compete for resources in private

markets, it must establish payment rates

that approximate the prices that would

prevail in the long run given the

conditions in local health care markets.

The remaining chapters of this report

suggest a number of actions that we

believe policymakers in the Congress and

HCFA should take to better adapt

Medicare’s policies to conditions in rural

markets. In general, these policy changes

involve adjusting providers’ payment

rates to reflect how market conditions

affect their costs and revenues.

Even if Medicare’s payment rates

reasonably accommodate the diversity of

conditions in rural markets, however,

providers may not be able to cover their

fixed costs and may stop furnishing

certain kinds of care or exit the market.

Although Medicare often accounts for half

or more of rural providers’ revenues in

many markets, other payers still play

important roles. Thus, where market

conditions are weak, Medicare’s policies

can provide only part of the solution. 

20 Medicare and rural health care: overview and challenges for policymakers
References

Coburn AF, Bolda EJ. The rural elderly and long-term care, in Ricketts TC, ed., Rural

health in the United States. New York (NY), The Oxford University Press. 1999, p.

179–189.

Dubay L. Explaining urban-rural differences in the use of skilled nursing facility benefit,

Medical Care. February 1993, Vol. 31, No. 2, p. 111–129.

Edelman MA, Menz BL. Selected comparisons and implications of a national rural and

urban survey on health care access, demographics, and policy issues, Journal of Rural

Health. Summer 1996, Vol. 12, No. 3, p. 197–205.

Ghelfi LM, Parker TS. A county-level measure of urban influence, No. 9702.

Washington (DC), U.S. Department of Agriculture. February 1997.

Himes CL, Rutrough TS. Differences in use of health services by metropolitan and

nonmetropolitan elderly, Journal of Rural Health. Spring 1994, Vol. 10, No. 2, p. 80–88.

Kenney GM. Rural and urban differentials in Medicare home health use, Health Care

Financing Review. Summer 1993a, Vol. 14, No. 4, p. 39–57.

Kenney GM. Is access to home health care a problem in rural areas? American Journal of

Public Health. March 1993b, Vol. 83, No. 3, p. 412–414.

McConnel CE, Zetzman MR. Urban/rural differences in health service utilization by

elderly persons in the United States, Journal of Rural Health. Fall 1993, Vol. 9, No. 4, p.

270–280.

Medicare Payment Advisory Commission. Report to the Congress: Medicare payment

policy. Washington (DC), MedPAC. March 2001.

Medicare Payment Advisory Commission. Report to the Congress: improving risk

adjustment in Medicare. Washington (DC), MedPAC. November 2000.

Medicare Payment Advisory Commission. Report to the Congress: Medicare payment

policy, volume II: analytic papers. Washington (DC), MedPAC. March 1998.

Miller ME, Holahan J, Welch WP. Geographic variations in physician service utilization,

Medical Care Research and Review. June 1995, Vol. 52, No. 2, p. 252–278.

Physician Payment Review Commission. Annual report to the Congress. Washington

(DC), PPRC. June 1996.

Prospective Payment Assessment Commission. State variation in the resource costs of

treating aged Medicare beneficiaries, intramural report I-96-01. Washington (DC),

ProPAC. June 1996.

Rabiner DJ. Patterns and predictors of noninstitutional health care utilization by older

adults in rural and urban America, Journal of Rural Health. Fall 1995, Vol. 11, No. 4, p.

259–273.

Ricketts TC, Johnson-Webb KD, Randolph RK. Populations and places in rural America,

in Ricketts TC, ed., Rural health in the United States. New York (NY), The Oxford

University Press. 1999, p. 7–24.

Report to the Congress: Medicare in Rural America | June 2001 21
Rosenblatt RA. The health of rural people and the communities and environments in

which they live, in Geyman JP, Norris TE, Hart LG, eds., Textbook of rural medicine.

New York (NY), McGraw-Hill. 2001, p. 3–14.

Rosenblatt RA and Hart LG. Physicians and rural America, in Ricketts TC, ed., Rural

health in the United States. New York (NY), The Oxford University Press. 1999, p.

38–51.

Schur CL, Franco SJ. Access to health care, in Ricketts TC, ed., Rural health in the

United States. New York (NY), The Oxford University Press. 1999, p. 25–37.

Williamson HA. Emergency care, in Geyman JP, Norris TE, Hart LG, eds., Textbook of

rural medicine. New York (NY), McGraw-Hill. 2001, p. 93–101.

22 Medicare and rural health care: overview and challenges for policymakers
Rural beneficiaries’ access 

to care

CHAPTER 2
RECOMMENDATION

The Secretary should identify strategies to increase rural beneficiaries’ participation in government

programs that cover Medicare premiums and/or deductibles and coinsurance.

*YES: 13 • NO: 0 • NOT VOTING: 0 • ABSENT: 3

*COMMISSIONERS’ VOTING RESULTS
romoting beneficiaries’ access to health care is one of the primary

objectives of the Medicare program. Rural areas of the country

often have fewer providers and longer distances between beneficiaries and providers than do urban areas, potentially hindering

access to care. Research by the Medicare Payment Advisory Commission

(MedPAC) is largely reassuring. On numerous measures, including satisfaction

with availability of providers, ability to get care, and frequency of receiving

needed care, rural and urban beneficiaries appear strikingly similar, although beneficiaries in the most remote areas report somewhat greater barriers to accessing

care. Overall, rural beneficiaries’ greatest potential barrier to care appears to be

the high cost of care. The Commission is concerned about this problem and recommends that the Secretary identify strategies to increase eligible rural beneficiaries’ participation in government cost-sharing assistance programs.

Interpreting the larger policy implications of the Commission’s findings is complex. It is unclear whether programs designed to address perceived problems with

the availability of rural providers have been successful or not: The programs

could be imperfectly targeted or the magnitude of the barriers overestimated. At

the same time, MedPAC’s findings suggest that policymakers should be vigilant

in monitoring access issues in remote rural areas.

P

CHAPTER

Rural beneficiaries’ access 

to care

2

In this chapter

• Assessing rural beneficiaries’

access to care

• Programs to address rural

access problems

Report to the Congress: Medicare in Rural America | June 2001 25
For many years, policymakers have been

concerned that rural beneficiaries may

have difficulty accessing care. Perceived

barriers include long travel time between

beneficiaries and providers, fewer

available providers, the inability of some

rural beneficiaries to afford care, and the

inadequacy of supplemental insurance

coverage. In addition, many believe that

rural beneficiaries tend to have a greater

need for health services. Accordingly, the

purpose of this chapter is to uncover the

degree to which rural beneficiaries have

problems accessing care, discuss the

implications for Medicare policy, and

examine the Medicare programs intended,

in part, to increase rural beneficiaries’

access to care.

The Commission found that, on the

whole, rural beneficiaries are satisfied

with their access to care and the

availability of providers. In addition, they

are as likely as their urban counterparts to

avail themselves of needed services. Two

important exceptions emerged, however,

from an analysis of the Medicare Current

Beneficiary Survey (MCBS) (see text box)

and Medicare claims data. First,

beneficiaries living in the most remote

areas reported a greater degree of

difficulty accessing care than did other

rural and urban beneficiaries. Second,

rural beneficiaries expressed greater

concern about the cost of their care than

did their urban counterparts.

In considering the implications of these

findings, it is unclear whether limited

problems with access to care suggest that

programs to increase access have been

largely successful, not adequately targeted

to the most remote areas, or whether there

is a lack of underlying need for them.

However, given rural beneficiaries’

concern about the cost of their care, the

Commission recommends that the

Secretary identify strategies to improve

participation in government cost-sharing

assistance programs.

This chapter first explores the evidence on

rural beneficiaries’ experience in

accessing care. It notes that assessing

access to care is not straightforward and

presents survey and claims data to

describe the latest findings on availability

of providers and access to providers.

Access measures include beneficiaries’

own assessments, travel time, use of

services, out-of-pocket spending, and

availability of supplemental insurance.

The chapter then reviews the array of

Medicare programs created to improve

access to care for rural beneficiaries, and

explores some of the policy issues

concerning the Medicare incentive

payment (MIP) program for health

professionals in rural areas and coverage

of telemedicine services.

Assessing rural

beneficiaries’ access to

care

Analyzing whether rural beneficiaries

have adequate access to needed health

care is complicated by difficulties in

measuring access and evaluating its

adequacy. Because access is a

multidimensional concept, the

Commission relied on both subjective and

objective measures to evaluate it. The

available subjective measures reflect

beneficiaries’ satisfaction with availability

of and access to care, while the objective

measures capture information such as

travel time to providers, number of

providers in rural areas, and use of needed

care.

While the Commission concludes that

policymakers should be reassured about

the adequacy of rural beneficiaries’ access

to care, we recognize that our analysis is

constrained by survey data that were not

designed to reflect every problem in each

part of the country as well as a lack of

data on outcome measures for patients

with serious medical emergencies, such as

heart attacks. In addition, this analysis is

constrained by the lack of a definition—or

benchmark—of acceptable access to care.

26 Rural beneficiaries’ access to care

Using the Medicare Current Beneficiary Survey to

evaluate access

To evaluate access and 

satisfaction from the 

perspective of beneficiaries,

the Commission analyzed data from

the 1999 Access to Care files of the

Medicare Current Beneficiary Survey

(MCBS). Initially fielded in 1991, the

MCBS is a longitudinal survey of a

nationally representative sample of

Medicare beneficiaries.1

Each autumn, the Health Care

Financing Administration administers

the MCBS access to care

questionnaire to noninstitutionalized

beneficiaries. Questions address

beneficiaries’ ability to obtain care,

satisfaction with care, and usual

source of care. Beneficiaries ages 85

and older, those who are disabled and

under age 65, and those enrolled in

Medicare managed care are

oversampled to permit comparison of

these groups with their counterparts.

However, the sample underrepresents

populations in rural areas of Southern

states and frontier counties (areas with

fewer than six people per square

mile). The 1999 Access to Care file

includes data from 16,670

noninstitutionalized Medicare

beneficiaries.

Because the number of MCBS

respondents in two categories of

counties (those that were not adjacent

to a metropolitan area and contained a

population of less than 2,500 (urban

influence code 9) and those that were

adjacent to a large metropolitan area

and contained a city with a population

of greater than 10,000 (urban

influence code 3)) was insufficient to

permit reasonably precise statistical

testing, MedPAC combined these

county categories with others. This

grouping increases the proportion of

the population represented, allowing

sound statistical analysis. 

1 For additional information on the Medicare Current Beneficiary Survey and its history, see Adler

1994.
Without such a benchmark, how do we

know what degree of access to care is

adequate?

• Should adequacy of access for rural

beneficiaries be measured in

comparison with urban beneficiaries?

We compare rural beneficiaries’

responses to access questions to those

of urban beneficiaries, but different

responses with respect to travel times,

for example, may not necessarily

indicate a problem if rural

beneficiaries sought out urban

providers who demonstrated better

patient outcomes. Conversely, similar

responses do not rule out problems.

For example, although both rural and

urban beneficiaries express

satisfaction with their access to care,

many in each group do not receive

clinically appropriate care, such as

mammograms.

• Should adequacy be judged based

upon beneficiaries’ own assessments?

Survey results are by nature

subjective and influenced by

individuals’ frame of reference.

Beneficiaries’ opinions may or may

not be a valuable tool in assessing

adequacy of access.

• Should adequacy be defined by a

ratio of providers to beneficiaries or

by the existence of certain core

services within a certain radius? If so,

what is the appropriate radius? This

approach would address the

complicated and value-laden question

of what array of services should be

readily available to all beneficiaries.

Perhaps a rural environment dictates

a different standard of access. Just as

urban beneficiaries must cope with

more air pollution, perhaps rural

beneficiaries must cope with greater

travel time to health care services.

The Commission does not attempt to

answer these questions at this juncture,

but recognizes that they are inherent to

assessing the available data and research.

Findings on access to care 

Overall, rural and urban beneficiaries both

report high satisfaction with the

availability of providers and access to

care, although there is some variation. By

measures relating to satisfaction with the

availability of medical care and the ability

to get care, rural and urban beneficiaries

appear to have comparable access. By a

few measures, including reported

difficulty receiving care, rural

beneficiaries appear to have better access,

but by other measures—insurance

coverage, ability to pay, and travel time to

usual source of care—they appear to have

somewhat lower access.

MedPAC’s work also reveals that rural

areas differ from one another with respect

to a variety of access measures, depending

on proximity to a metropolitan area.

Beneficiaries who live in the most remote

areas appear to be more vulnerable to

access problems than other rural and

urban beneficiaries.2 These same

beneficiaries also report significantly

lower health status, income, and education

levels, which suggests a relatively higher

level of need among this population as

well.

We also found a relatively small

difference between rural and urban

beneficiaries in their use of needed health

care services, although remote rural

beneficiaries used needed services

somewhat less. According to an index that

equally weighted various clinical

indicators, beneficiaries in the most rural

areas received needed care about 71

percent of the time, compared with about

73 percent of the time for all other

beneficiaries. The alarming aspect of this

finding is that both urban and rural

beneficiaries fail to get needed care about

30 percent of the time.

The following section evaluates several

interrelated indicators of access to care:

• rural beneficiaries’ health care needs,

• the availability of providers and

services, and

• the accessibility of existing services,

which involves assessing barriers

such as travel time, use of needed

care, the affordability of care, and

supplemental insurance coverage.

Rural beneficiaries’ health care

needs

Rural beneficiaries appear to have

somewhat greater health care needs than

urban beneficiaries (Table 2-1).

• Self-reported health status. Overall,

rural beneficiaries report lower health

status than urban beneficiaries.

Thirty-three percent of beneficiaries

living in the most remote areas

reported fair or poor health status.

• Socioeconomic status. Rural

beneficiaries tend to have lower

socioeconomic status than do urban

beneficiaries, with the most rural

beneficiaries reporting the lowest.

With respect to income, 55 percent of

unmarried beneficiaries in remote

areas—but only 39 percent of

unmarried urban dwellers—reported

an annual income of less than

$10,000 per year. In addition, rural

beneficiaries, particularly those in

remote areas, are less likely to have

graduated from high school.

• Other health and mobility status

indicators. Rural beneficiaries are no

more likely than urban beneficiaries

to have at least one chronic condition

or need help with a functional

impairment.

Availability of services 

Rural beneficiaries—including those

living in remote rural areas—are generally

satisfied with the availability of care,

including specialty care. Ninety-four

percent of both rural and urban

beneficiaries described themselves as

satisfied or very satisfied with the

availability of medical care in general and

96 percent described themselves as

satisfied with the availability of specialist

care (Table 2-2).

Report to the Congress: Medicare in Rural America | June 2001 27

2 This analysis examined the data using the urban influence code (UIC) classification scheme developed by the Department of Agriculture, which segments the population

into nine categories based upon their proximity to urban areas. The most remote rural areas are not adjacent to a metropolitan area and do not include a town of at

least 10,000 people. See Chapter 1 for more detail.
The rural medical workforce differs from

the urban one. Rural areas have a higher

proportion of nonphysician providers and

a lower proportion of physician specialists

than urban areas. Rural hospitals tend to

be smaller, but there does not appear to be

a shortage of beds overall. With respect to

post-acute care, information on the

number of rural providers is unreliable but

data on use of services suggest that rural

beneficiaries use swing beds more often

and rehabilitation hospitals less often than

urban beneficiaries. Overall, however,

they use as many post-acute services as

urban beneficiaries.

28 Rural beneficiaries’ access to care

Selected beneficiary characteristics, 

by location of county, 1999

Rural

Adjacent to an MSA Not adjacent to an MSA

Characteristics

Age

65 12.1% 14.3%* 14.9% 12.9% 14.0% 16.1%

65-84 78.7 76.6* 75.7 78.3 75.5 75.4

859.2 9.1* 9.3 8.8 10.4 8.5

Female 56.2 55.3 57.5 53.9 55.3 54.4

Self-reported health status

Excellent or very good 42.6 37.9** 38.7 39.1 36.5 35.3**

Good 31.5 31.5** 31.6 30.3 34.5 31.3**

Fair or poor 25.9 30.6** 29.7 30.6 29.0 33.3**

Needs help with functional 

impairment 13.4 15.8 15.0 16.0 15.1 17.3

Presence of chronic conditions

None 22.2 20.7 22.0 20.1 17.5 21.7

One or two 50.7 50.6 51.5 49.6 50.8 50.7

Three or more 27.1 28.8 26.5 30.2 31.6 27.6

Income (not married)

Up to $10,000 38.7 49.1** 45.7** 49.3** 47.7 55.0*

$10,000 to $25,000 42.3 39.3** 43.6** 36.6** 43.5 34.3*

Greater than $25,000 18.9 11.7** 10.6** 14.1** 8.9 10.7*

Income (married)

Up to $10,000 8.0 11.4** 9.4* 10.5** 13.7 14.9*

$10,000 to $25,000 34.1 43.8** 46.0* 40.1** 43.9 47.2*

Greater than $25,000 57.9 44.8** 44.6* 49.4** 42.3 37.8*

Highest level of education

Less than high school 30.4 42.2** 41.0 38.8** 44.0* 49.3*

Completed high school 29.6 29.3** 29.5 30.4** 31.2* 25.8*

Beyond high school 40.0 28.5** 29.5 30.9** 24.9* 24.9*

Living arrangement

Lives alone 31.6 31.2** 31.2 29.4 31.7 34.0

Lives with spouse 51.0 55.2** 55.0 56.6 53.5 54.3

Lives with others, not 

spouse 17.4 13.6** 13.8 14.0 14.8 11.7

Note: UIC (urban influence code, as defined by the U.S. Department of Agriculture), MSA (metropolitan statistical area, as defined by the U.S. Office of Management and

Budget).

* Difference between urban and rural subgroups in their distribution is statistically significant at the 0.05 level. For characteristics with multiple dimensions, their difference is

in the distribution across dimensions.

** Difference between urban and rural subgroups in their distribution is statistically significant at the 0.01 level. For characteristics with multiple dimensions, their difference

is in the distribution across dimensions.

Source: MedPAC analysis of 1999 Medicare Current Beneficiary Survey Access to Care file.

TABLE

2-1

Urban, in an

MSA (UIC 1, 2)

Rural

total

Includes a

town with at

least 10,000

people 

(UIC 3, 5)

Includes a

town with at

least 10,000

people

(UIC 7)

Does not

include a town

with at least

10,000 people

(UIC 4, 6)

Does not

include a town

with at least

10,000 people

(UIC 8, 9)
A low density of providers in rural areas

does not necessarily mean that

beneficiaries are not receiving needed

care. As discussed in Chapter 1,

beneficiaries often travel to more urban

areas to receive certain types of care,

particularly specialized care. Travel is not

always a burdensome undertaking, as

some rural beneficiaries may be close to

urban counties that have a full

complement of services. For those who

lack transportation and are in more remote

areas, the sparseness of providers is a far

more significant barrier to care.

• Physicians. About 20 percent of the

U.S. population lives in rural areas,

but only 11 percent of physicians

practice in rural communities (AMA

1999). Primary care physicians are

more likely to practice in rural areas

than specialists: In 1999, 15 percent

of primary care physicians were in

rural areas (HRSA 2001), but only

10-12 percent of specialists were in

rural areas (AMA 1999). Data on the

ratio of generalists to residents also

reflect the disparity between rural and

urban areas, although the value of

this comparison is questionable given

concerns about physician oversupply

in urban areas.3

• Nurse practitioners and physician

assistants. 20 percent of nurse

practitioners and 23 percent of

physician assistants practice in rural

areas. Together they account for 23

percent of non-metropolitan primary

care practitioners, compared with 16

percent in metropolitan areas (HRSA

2001).

• Hospitals. In 1998, 20 percent of all

hospital beds were in rural hospitals

(Ricketts and Heaphy 1999), which is

consistent with the percent of the

population living in rural areas.

While there are fewer rural hospitals

today than 10 years ago, the impact

of hospital closures varied by

community. In addition, more than

350 critical access hospitals have

opened, either as new entities or

converted former full-service

hospitals, to meet the urgent health

care needs of rural beneficiaries.

• Rural health clinics. The number of

rural health clinics has grown from

483 in 1989 to 3,749 in 1998 (Farley

et al. 2001).4 Some policy analysts

have found that some of this growth

is the result of physician practices

Report to the Congress: Medicare in Rural America | June 2001 29

3 In 1998, urban counties with populations of more than 1,000,000 had an average of 91 generalist physicians per 100,000 residents and urban counties with

populations under 1,000,000 had an average of 75. In contrast, the average generalist-physician-to-population ratio in rural counties ranged from a low of 

39:100,000 in those categorized by UICs 4 and 9 to a high of 64:100,000 ratio in UIC 7 (Hart 2000).

4 This study counted the number of clinics operating at any time during 1998. This results in a larger estimate than counting the number of clinics operating at a single

point in time.

Beneficiary satisfaction with care, 

by location of county, 1999

Rural

Adjacent to an MSA Not adjacent to an MSA

Characteristics

Strongly agree/agree

Physician checks everything 93.9% 92.6% 92.4% 92.9% 95.7%* 90.3%

Great confidence in physician 94.7 94.8 94.5 94.6 95.7 95.1

Very satisfied/satisfied

Availability of medical care 93.6 93.6 94.3 93.0 94.9 92.9

Overall quality of care 96.0 96.0 95.4 96.3 96.4 96.2

Ease of getting to doctor 94.9 92.4 95.0 90.7** 94.6 90.3*

Costs of medical care 87.6 82.4* 83.3* 82.8** 82.7 79.6**

Specialist care 96.4 95.6 97.4 95.6 93.9 94.0

Note: UIC (urban influence code, as defined by the U.S. Department of Agriculture), MSA (metropolitan statistical area, as defined by the U.S. Office of Management and

Budget).

* Difference between urban and rural subgroups is statistically significant at the 0.05 level.

** Difference between urban and rural subgroups is statistically significant at the 0.01 level.

Source: MedPAC analysis of 1999 Medicare Current Beneficiary Survey Access to Care file.

TABLE

2-2

Urban, in an

MSA (UIC 1, 2)

Rural

total

Includes a

town with at

least 10,000

people 

(UIC 3, 5)

Includes a

town with at

least 10,000

people

(UIC 7)

Does not

include a town

with at least

10,000 people

(UIC 4, 6)

Does not

include a town

with at least

10,000 people

(UIC 8, 9)
redefining themselves as rural health

clinics (GAO 1996). The growth of

new clinics has slowed more recently

with payment changes enacted in the

Balanced Budget Act of 1997 (BBA).

• Home health. Counting the number

of home health agencies in rural areas

is not particularly meaningful, given

that the data reflect neither the

service areas of agencies (some are

statewide) nor branches of parent

agencies that may be located in rural

agencies. Data on the use of services

suggest that rural beneficiaries use

home health care less than urban

beneficiaries do, but rural

beneficiaries that do use home health

receive more visits than their urban

counterparts. However, rural

beneficiaries receive more home

health aide visits, while urban

beneficiaries receive more skilled

nursing and therapy visits (Sutton

1999).

• Skilled nursing facility and other

post-acute care. Because of

fluctuation in the number of swing

beds used for skilled nursing care and

the number of Medicare-certified

skilled nursing facility (SNF) beds,

an accurate count of SNF beds is not

possible. Use rate data are more

helpful in assessing availability of

post-acute care. Overall, rural

beneficiaries use the same amount of

SNF care (counting swing beds) but

less specialty care from long-term

care and rehabilitation hospitals,

which tend to be located in more

urban areas. Many rural beneficiaries

travel to other rural areas or

metropolitan areas for their SNF care,

but a greater percentage stay in their

own rural area for their SNF care.

Accessibility of care

In general, rural and urban beneficiaries

are satisfied with their access to care,

although beneficiaries in remote rural

areas report somewhat greater difficulty.

Data on other more objective measures—

such as travel time to providers, use of

necessary care, out-of-pocket costs, and

supplemental insurance—round out this

picture of access and raise some concerns.

With respect to beneficiaries’ assessment

of their access to care (Tables 2-2 and

2-3):

• Rural beneficiaries were somewhat

less likely than urban beneficiaries to

report trouble getting care in the past

year. Those who live in rural areas

containing towns of at least 10,000

people were half as likely as their

urban counterparts to report having

had such trouble.

• Rural beneficiaries are as likely as

urban beneficiaries to be satisfied or

very satisfied with the ease of getting

to the doctor. Although 90 percent of

rural beneficiaries in remote areas are

satisfied with their ease of getting to a

doctor, they are less satisfied than

their other rural and urban

counterparts.

• Rural and urban beneficiaries appear

similar in the percentage who lacked

a physician office visit during the

course of the year. More beneficiaries

in the most rural areas reported no

physician visit (31 percent compared

with 18 percent of urban

beneficiaries), but part of this

difference may reflect greater use of

rural health clinics, which may serve

as a substitute for physician office

visits.

Travel time to providers The difference

in travel times to providers between rural

and urban beneficiaries is not as great as

might be expected. About 8 percent of

rural beneficiaries and less than 4 percent

of urban ones report that they travel an

hour or more to get to their doctors.

Seventy-two percent of rural beneficiaries

and 81 percent of urban ones have a travel

time of under 30 minutes (Table 2-3).

The longer travel times for rural

beneficiaries are most troubling when

considering their ability to receive timely

emergency care. The quality of

emergency care is directly related to speed

of delivery. Research has shown that prehospital times averaged two times longer

in rural than urban areas (Esposito et al.

1995) and that rural patients with severe

injuries were seven times more likely to

die before arrival if the emergency

response time was greater than 30 minutes

(Grossman et al. 1997). Patients who die

at the scene or within 30 days are more

likely to have had slower emergency

response times and pre-hospital times than

those that survive (Morrisey et al. 1995).5

Use of necessary care MedPAC found

that rural beneficiaries were nearly as

likely as their urban counterparts to

receive necessary care. Direct Research

LLC analyzed claims data to determine

whether beneficiaries were receiving the

care they need, such as a physician visit

within four weeks of a heart attack (see

text box, p. 33). Findings indicate that

only those beneficiaries living in the most

rural areas were somewhat less likely to

get needed care. When comparing rural

and urban beneficiaries’ care for 46

clinical indicators, researchers found that

beneficiaries in the most rural areas

received needed care about 71 percent of

the time, on average, compared with 73

percent of the time for the average

beneficiary (see appendix A for a list of

clinical indicators). These findings are

reassuring in that potential obstacles to

seeking care, such as a greater sense of

self-sufficiency and less aggressive

referral patterns in rural areas, do not

result in lower use of services among rural

beneficiaries compared to urban

beneficiaries.6 These findings also suggest

that rural beneficiaries’ lower

self-reported health status, in relation to

urban beneficiaries, may also reflect

environmental and lifestyle factors.

However, these findings do raise the

30 Rural beneficiaries’ access to care

5 In this study, the mean response and pre-hospital times of patients who died were 12 and 63 minutes, respectively, compared with 8 and 39 minutes for patients who

survived.

6 Previous research has suggested less aggressive referral patterns in rural areas. One study of care for elderly patients with acute myocardial infarction showed that

patients who lived relatively near to a catheterization hospital were much more likely to be initially admitted to such a hospital and much more likely to undergo a

catheterization within seven days (McClellan et al. 1994).
concern that many rural and urban

beneficiaries are not receiving the care

they need.

Remote rural beneficiaries were somewhat

less likely to receive three types of care:

electrocardiograms (except during an

emergency room visit), timely follow-up

after hospital discharge, and

mammograms. In addition, rates of some

types of potentially avoidable care

(multiple emergency room visits for

angina, admissions for individuals with

known pulmonary disease) were higher in

remote areas. Rural beneficiaries did better

than their urban counterparts by some

measures, such as in the percentage who

obtained recommended services following

initial diagnosis of anemia (Hogan 2001).

Beneficiaries living in the most remote

rural areas that are also federally

designated Health Professional Shortage

Areas (HPSAs) appear to be particularly

vulnerable. For example, beneficiaries in

urban influence codes (UICs) 8 and 9,

which were also HPSAs, received needed

care about 67 percent and 68 percent of the

time, respectively, as calculated using the

index measure. However, one important

limitation of this analysis is the potential

for beneficiaries residing in rural HPSAs to

have obtained some of their outpatient care

in a rural health clinic. Such care would not

be fully captured in these measures

because approximately half of rural health

clinic claims lack procedure codes.7

Report to the Congress: Medicare in Rural America | June 2001 31

7 Visits to rural health clinics were captured for purposes of measuring the extent to which beneficiaries had at least one annual contact with the health system. However,

specific services furnished (such as retinal eye exams for diabetics) were not fully captured on claims.

Beneficiary access to care, by location of county, 1999

Rural

Adjacent to an MSA Not adjacent to an MSA

Characteristics

Had trouble getting care 4.0% 3.3%** 2.2%** 4.1% 2.0%** 4.1%

Delayed care due to cost 6.6 9.9 8.7 10.5** 11.3** 9.8**

No office visit this year1 18.3 20.2 16.1 20.5 12.4** 31.0**

Usual source of care

None 8.5 9.3** 7.2* 8.6** 11.7 12.4*

Doctor’s office or home 70.0 72.8** 69.5* 73.5** 80.7 71.2*

HMO 8.7 1.7** 0.3* 4.2** 0.0 0.4*

Other sites 12.9 16.2** 23.0* 13.7** 7.5 15.9*

Travel time

0-15 minutes 38.3 36.8** 36.5 31.8** 40.8 44.2*

15-30 minutes 42.4 35.0** 39.7 33.4** 35.5 30.0*

30-45 minutes 12.8 14.9** 14.7 18.5** 10.8 10.8*

45-60 minutes 3.0 5.3** 4.4 7.2** 3.6 4.0*

60 minutes 3.6 8.1** 4.6 9.1** 9.3 10.9*

Mode of transportation to doctor

Walking 3.1 2.1** 1.1* 3.1** 0.8 2.3

Driving 64.4 67.0** 69.0* 67.7** 67.1 61.9

Being driven 25.9 29.6** 28.3* 28.2** 30.1 33.7

Doctor comes to home 0.2 0.1** 0.1* 0.1** 0.0 0.0

Public transit 4.2 0.7** 0.5* 0.4** 1.2 1.1

Other 2.2 0.7** 0.9* 0.4** 0.7 1.0

Note: UIC (urban influence code, as defined by the U.S. Department of Agriculture), MSA (metropolitan statistical area, as defined by the U.S. Office of Management and

Budget), HMO (health maintenance organization).

1

Office visits only pertain to beneficiaries enrolled in traditional Medicare, and not MedicareChoice. The Medicare Current Beneficiary Survey bases office visits on

claims data, and providers do not submit claims for MedicareChoice enrollees.

* Difference between urban and rural subgroups in their distribution is statistically significant at the 0.05 level. For characteristics with multiple dimensions, their difference

is in the distribution across dimensions.

** Difference between urban and rural subgroups in their distribution is statistically significant at the 0.01 level. For characteristics with multiple dimensions, their difference

is in the distribution across dimensions.

Source: MedPAC analysis of 1999 Medicare Current Beneficiary Survey Access to Care file.

TABLE

2-3

Urban, in an

MSA (UIC 1, 2)

Rural

total

Includes a

town with at

least 10,000

people 

(UIC 3, 5)

Includes a

town with at

least 10,000

people

(UIC 7)

Does not

include a town

with at least

10,000 people

(UIC 4, 6)

Does not

include a town

with at least

10,000 people

(UIC 8, 9)
32 Rural beneficiaries’ access to care

Beneficiary insurance status, by location of county, 1999

Rural

Adjacent to an MSA Not adjacent to an MSA

Characteristics

Insurance (traditional Medicare only)

Private 74.1% 71.2% 73.0% 73.3% 67.0% 67.5%

Public 12.1 12.2 10.7 11.3 13.4 15.2

Medicare only 13.8 16.6 16.4 15.4 19.6 17.3

MedicareChoice 

enrollment 24.8 4.7* 3.3** 8.5** 1.7** 1.7**

Medicare buy-in assistance

QMB 5.6 6.3 5.9 5.5 7.0 8.1

SLMB 1.0 1.6 1.6 1.4 1.8 1.9

Medicaid 4.7 6.1 5.1 5.9 7.2 7.1

No assistance 88.7 86.0 87.4 87.3 84.0 82.9

Medicare enrollment

Parts A and B 94.9 96.8** 97.2** 96.3 98.4* 96.4**

Part A only 3.9 2.8** 2.6** 3.1 1.5* 3.5**

Part B only 1.2 0.3** 0.3** 0.6 0.1* 0.1**

Note: UIC (urban influence code, as defined by the U.S. Department of Agriculture), MSA (metropolitan statistical area, as defined by the U.S. Office of Management and

Budget), QMB (qualified Medicare beneficiary), SLMB (specified low-income Medicare beneficiary).

* Difference between urban and rural subgroups is statistically significant at the 0.05 level. For characteristics with multiple dimensions, their difference is in the distribution

across dimensions.

** Difference between urban and rural subgroups is statistically significant at the 0.01 level. For characteristics with multiple dimensions, their difference is in the distribution

across dimensions.

Source: MedPAC analysis of 1999 Medicare Current Beneficiary Survey Access to Care file.

TABLE

2-4

Urban, in an

MSA (UIC 1, 2)

Rural

total

Includes a

town with at

least 10,000

people 

(UIC 3, 5)

Includes a 

town with at

least 10,000

people

(UIC 7)

Does not

include a town

with at least

10,000 people

(UIC 4, 6)

Does not

include a town

with at least

10,000 people

(UIC 8, 9)

Out-of-pocket costs The greatest barrier

to care for rural beneficiaries appears to be

the cost of care. Beneficiaries in most

types of rural areas were found to be

significantly more likely (10-11 percent)

than their urban counterparts (7 percent)

to say that they delayed getting care in the

past year because of costs (Table 2-3). In

addition, rural beneficiaries (82 percent)

were less likely than urban ones (88

percent) to say that they were satisfied or

very satisfied with the cost of medical

care. According to a forthcoming AARP

Public Policy Institute analysis of 1995

MCBS cost and use data projected to

2000, rural beneficiaries spent an annual

average of $2,700 (23 percent of their

income) on health care services. In

contrast, urban beneficiaries spent $2,540

(18 percent of their income) (Caplan and

Gross, in prep.).

Rural and urban beneficiaries may differ

in their abilities to pay health care

expenses out of pocket, but the difference

is difficult to determine, as is the impact

any such difference may have on access.

Although rural beneficiaries have lower

incomes, the average cost of living is

often lower in rural areas. No good

adjusters have been identified for

evaluating the extent of real differences in

buying power. Some costs associated with

health care delivery, such as the Part

A and Part B deductible amounts, are

fixed nationally for all beneficiaries; other

costs, such as Medigap premiums, vary

locally.

Fixed deductibles and premiums are likely

to affect rural beneficiaries more than

urban ones. Furthermore, if rural

beneficiaries have less comprehensive

supplemental insurance coverage than

their urban counterparts do, out-of-pocket

costs may present greater barriers to

obtaining services. Possible policies to

address this problem include a flat

reduction in premiums or deductibles for

rural beneficiaries or linking cost-sharing

to measures of local Medicare spending or

beneficiary income. MedPAC will

continue to study out-of-pocket spending

differences between urban and rural

beneficiaries and model effects of

introducing variable cost-sharing.

Supplemental insurance Directly

related to rural beneficiaries’ concerns

about the cost of care is the lower

likelihood that they have supplemental

insurance coverage for Medicare’s costsharing requirements and services such as

prescription drugs not covered by

Medicare. The absence of supplemental
coverage is correlated with an increased

likelihood in delaying care and trouble

getting care (Table 2-4).8

Seventeen percent of fee-for-service rural

beneficiaries have no supplemental

coverage, compared with 14 percent of

urban beneficiaries.9 Although this

discrepancy may be in part related to

income, it is also directly related to fewer

MedicareChoice plans being available

to rural beneficiaries. These plans often

offer supplemental coverage. Only 5

percent of rural beneficiaries are enrolled

in MedicareChoice plans, compared

with 25 percent of urban beneficiaries (see

Chapter 7 for further discussion).

Beneficiaries may also have private

supplemental insurance, either through a

Medigap plan or an employer-sponsored

plan.

RECOMMENDATION

The Secretary should identify

strategies to increase rural

beneficiaries’ participation in

government programs that cover

Medicare premiums and/or

deductibles and coinsurance. 

Because rural beneficiaries have lower

incomes and are less likely to have

Medigap or employer-sponsored

coverage, they have greater need for

assistance to defray Medicare’s costsharing requirements. These requirements

have risen as a result of the design of the

newly implemented outpatient prospective

payment system. Accordingly, the

Commission recommends that the

Secretary identify strategies to increase

rural beneficiaries’ participation in the

government cost-sharing assistance

programs. The government programs that

cover Medicare premiums and/or costsharing include Medicaid, the qualified

Medicare beneficiary program and the

specified low-income beneficiary

program.

Programs to address

rural access problems

Many conditions in rural areas present

challenges to health care providers,

including low service volume, longer

travel times, difficulty in attracting

providers, and greater dependency on

Medicare patients and payments. In

acknowledgment of these challenges and

to increase beneficiary access to health

services, the Congress has enacted a

variety of programs to help rural facilities

and health care professionals. For other

services, such as ambulance and home

health care, no special programs exist, but

adjustments are made in the payment

method to recognize the nature of the rural

delivery system (see text box, p. 34, for a

discussion of the types of rural

adjustments for ambulance services).

Major programs are discussed below, with

a focus on the MIP. In addition, this

chapter discusses Medicare’s policy on

telemedicine and identifies issues relating

to its expansion.

Policymakers need to assess the need for

any changes in these programs, given the

Commission’s reassuring findings on

access to care as well as challenges to

delivering care in rural areas (see Chapter

4). The findings on access are not only

limited by the data but also are colored by

the effects of existing private initiatives,

public policies, and programs that have

been implemented in an effort to address

factors that may predispose rural

Medicare beneficiaries—and rural

Report to the Congress: Medicare in Rural America | June 2001 33

Using inpatient and outpatient claims to measure

use of necessary care

Medicare claims data for 

1998 and 1999 were used 

to measure whether

beneficiaries received 40 types of

necessary care as well as 6 indicators

of potentially avoidable emergency or

urgent care. “Necessary care” is

defined as a service, such as an annual

eye exam for diabetics, for which

expert clinicians judge that benefits

substantially outweigh risks and for

which failure to provide it would be

improper care. Indicators were

calculated for a sample of 240,000

elderly Medicare fee-for-service

beneficiaries, grouped by urban

influence code of their county of

residence.

The indicators were selected by a

multispecialty physician panel, but

should be interpreted with caution.

Physicians may disagree about

whether a particular service is

necessary. Also, the indicators reflect

the inherent uncertainty of claims

data, which may not identify each

service each time it is provided.

Finally, no specific cause should be

inferred when beneficiaries fail to

obtain needed care. Needed services

may not be provided for a number of

reasons, including problems accessing

the health care system, failure of

providers to perform or recommend

services, and/or failure of

beneficiaries to follow provider

recommendations to obtain care.

The indicators were developed as part

of the Access to Care for the Elderly

Project (ACE-PRO) by RAND. ACEPRO sought measures of care that

were both clinically meaningful and

could feasibly be calculated from

claims and administrative data. (For

more information on this project, see

Appendix A and Asch et al. 2000). 

8 In 1998, 7 percent of beneficiaries in the traditional Medicare program who lacked supplemental coverage had trouble obtaining care in the past year, compared with

2 percent of those with private supplemental coverage (MedPAC 2000). In addition, 21 percent of those without supplemental coverage said they had delayed seeking

care due to cost in the past year, compared with 4 percent of those privately covered. Nearly a quarter of those without supplemental coverage said they had no usual

source of care (compared with 7 percent of those privately covered) and 43 percent had no physician office visit in the past year (compared with 16 percent of those

privately covered).

9 In addition to the chi-square test analysis presented in Table 2-4, MedPAC performed a t-test analysis, which showed that the difference between rural and urban

beneficiaries’ likelihood to have supplemental insurance was statistically significant at the .05 level.
residents generally—to problems with

access to health care. Failure to find

access problems might reflect the success

of such efforts or suggest a lack of

underlying need for them.

Facility-based programs

Congress created two programs to

improve beneficiary access to hospital

services in rural areas (see Chapter 4 for a

discussion of related payment issues).

• Critical access hospitals. This

program is intended to ensure that

beneficiaries in isolated rural

communities have access to

emergency room services and limited

inpatient services. It is designed to

provide an adequate financial base

for facilities located in rural areas that

cannot support a full-service hospital.

• Sole community hospitals. The intent

of this policy is to maintain access to

needed health services for

beneficiaries in isolated communities.

This policy provides higher payments

to hospitals that are farther than 35

miles from the nearest hospital and

meet other criteria designed to

establish that they are the

community’s sole source of care. To

qualify, a hospital also must have

above-average costs in a base year for

the mix of patients it serves. In 2000,

640 hospitals were designated sole

community hospitals.

Rural health clinics

The rural heath clinic (RHC) program was

established in 1977 to encourage and

stabilize the provision of primary care

services in underserved rural areas

through the use of physicians, physician

assistants, nurse practitioners and certified

nurse midwives. RHCs must be located in

communities that are both rural (as

defined by the Bureau of the Census) and

underserved (a federally designated HPSA

or medically underserved area, or an area

designated by the state’s governor as

underserved).

To operate as an RHC, certain staffing

requirements and levels of service must be

maintained. A physician assistant, a nurse

practitioner, or a certified nurse midwife

must be on site and available to see

patients 50 percent of the time the clinic is

open. Nonphysician practitioners must be

supervised by a physician. Furthermore,

RHCs must directly provide diagnostic

and therapeutic services commonly

furnished in a physician’s office, as well

as basic laboratory services and other

tests. They must also make emergency

services available.

RHCs are paid using an all-inclusive rate.

Most of them are subject to a per-visit cap

($63.14 in 2001). Because of this payment

method, RHC claims generally do not

specify the services provided, making it

difficult to assess beneficiary use.10

Medicare incentive payment

program

Created in 1989, the MIP program pays

bonus payments to physicians who

practice in HPSAs in an effort to entice

more physicians to those areas. Although

the effectiveness of the program is

difficult to ascertain, a recent decline in

the bonus payments to physicians is cause

for concern. Several aspects of program

design have been identified as

compromising its effectiveness.11

34 Rural beneficiaries’ access to care

Payment policy issues for ambulance services 

in rural areas

A major concern of the 

Congress and Health Care 

Financing Administration

(HCFA) in formulating policy on

ambulance payment has been to take

into account the unique concerns of

rural areas. Ambulance suppliers

serving beneficiaries in rural areas

provide fewer services per year and

make longer trips than urban

suppliers, but have similar fixed costs

to maintain ambulance capacity for

emergency use and train personnel to

respond to the full range of

emergencies.

Medicare covers and pays for

ambulance services if other means of

transportation are contraindicated by

the beneficiary’s health condition.

Services are paid under Part B with 20

percent coinsurance. Medicare

currently pays for ambulance services

provided by facilities on a cost basis

and by independent, freestanding

suppliers on a reasonable charge

basis. The Balanced Budget Act of

1997 mandated the development of a

fee schedule for ambulance services,

but it has yet to be implemented as

HCFA tries to resolve some

outstanding policy issues.

Under the proposed rule, payment for

both ground and air services is

comprised of two components. First,

ground and air services are paid a base

rate adjusted for geographic cost

differences (using one of the measures

used to adjust physician payments).

For air ambulance services only, this

base payment is subject to a 50

percent add-on for beneficiaries

picked up in non-metropolitan areas.

The second component is a mileage

payment. For rural ground services, a

50 percent add-on payment is applied

to the first 17 miles traveled; for air

services, the add-on is applied to all

miles traveled.

These adjustments may be inadequate.

Applying the rural adjustment for all

services to beneficiaries in nonmetropolitan areas will not

appropriately target payments to

providers in isolated areas who

typically have very low volumes.

Also, the lack of a rural adjustment to

the base rate for ground ambulance

services may not adequately

compensate these providers for their

fixed costs.

10 This problem confounds some of the claims research assessing propensity to seek care, as noted earlier in this chapter.

11 RAND is expected to publish an evaluation of the MIP program later in 2001.
• MIP bonus payments may be

insufficient to attract physicians. The

bonus payments, calculated as 10

percent of the Medicare program

payment for physician services

(excluding beneficiary coinsurance),

may be too small to have a significant

influence on recruitment or retention

of primary care physicians (OIG

1994a, GAO 1999). In 1996, 75

percent of, or about 18,700,

participating rural physicians

received less than $1,520 in bonus

payments for the year. The low level

of payments may be attributable in

part to carriers being required to

review claims of physicians who

receive the largest bonus payments

(HCFA 1999). This policy may

discourage physicians from applying.

• MIP payments may be

inappropriately targeted for several

reasons. First, nurse practitioners and

physician assistants, who provide a

significant percent of primary care in

rural areas, are not eligible for bonus

payments. The MIP program may be

more effective in improving access to

primary care if these providers, in

addition to physicians, were eligible

for payments.

Second, the HPSA designation

system may overestimate the need for

primary care providers in some areas

(GAO 1995). The HPSA designation

is based only on the ratio of the

population to primary care physicians

(such as general and family medicine

practitioners). Specialists,

international medical graduates with

J-1 visas, National Health Service

Corps workers and nonphysician

providers who may render primary

care services are not included in the

calculation of the ratio. As part of a

larger effort to refine the HPSA

definition, the Health Resources and

Services Administration recently

proposed including nonphysician

providers and some previously

excluded categories of physicians in

the calculation of the ratio. This rule

was withdrawn but may be reissued

later this year.

Third, although specialists are not

counted for the purposes of HPSA

designation, they are eligible for

bonus payments. Such eligibility may

be appropriate because specialists

provide primary care, but excluding

them from the count for HPSA

designation means that an area could

qualify for HPSA status even if it had

an abundance of specialists.

Finally, although HPSA designations

are required to be updated annually,

only about one-third of the HPSAs

are actually reviewed each year

(Thornburg 2001). Therefore, some

existing HPSAs may no longer meet

the critical ratio threshold.

• Instability of the HPSA designation.

The inherent instability of the HPSA

designation may limit the

effectiveness of the MIP program for

recruitment and retention of

physicians in underserved areas (OIG

1994b, PPRC 1992). When shortage

areas are periodically reassessed as

required by law, an addition of even

one physician may reduce the

population-to-physician ratio enough

to disqualify an area. Although

withdrawal of a designation could be

a legitimate indication that an area is

self-sufficient, it may be that

retention of physicians in that

community is dependent on the

HPSA bonus payment. One option to

address this problem is to provide

bonus payments for an additional

three years in areas in which HPSA

status is withdrawn because of an

increase in physician supply.

Medicare payment for

telemedicine services

Telemedicine, the use of electronic

communication and information

technologies to provide or support clinical

care at a distance, offers the potential to

improve access to care in rural areas.12

Although telemedicine has been supported

by a number of federal and private grant

initiatives, many observers feel that

widespread dissemination for patient care

has been hampered by a lack of

reimbursement, provider and patient

acceptance, and infrastructure; the need

for physicians using telemedicine across

state lines to obtain medical licenses in

multiple states; and limited evidence of

clinical efficacy. Evidence on

telemedicine’s efficacy is limited because

research is often specific to the application

of a particular technology, such as

sonograms, and it is difficult to get

adequate sample size due to sparse rural

populations.

Although the Commission appreciates

telemedicine’s potential to improve rural

beneficiaries’ access to care, we believe

that the effects of recent legislative

changes and demonstration activity

warrant review to determine if and which

additional changes in Medicare policy are

needed. To assist policymakers in

evaluating whether change is needed, this

discussion provides an overview of

Medicare payment policy and identifies

several issues policymakers may want to

consider.

Medicare payment policy

Although Medicare payment for

telemedicine services has been limited in

the past, recent changes have expanded

coverage. Before the BBA, most

Medicare carriers paid the same fees for

certain services, such as the reading of

X-rays or pathology slides, regardless of

whether telecommunications services

were used. In addition, Medicare has

traditionally provided payment for several

services that expressly involve telemetry,

including the remote, real-time monitoring

of pacemakers and the reading of

electroencephalograms and

electrocardiograms.

The BBA allowed Medicare to pay for

interactive, real-time telemedicine

consultations among the patient and the

referring and consulting clinicians for the

first time. However, payment for

teleconsultation services applied only to

services involving the use of both

interactive audio and video that were

provided to beneficiaries living in rural

Report to the Congress: Medicare in Rural America | June 2001 35

12 There is no consensus on a single definition of telemedicine. Telemedicine and telehealth are sometimes referred to interchangeably.
HPSAs. Payment was split between the

consulting and referring clinicians in a 75-

25 percent ratio, and there was no separate

facility fee.

The Medicare, Medicaid, and SCHIP

Beneficiary Improvement and Protection

Act of 2000 (BIPA) eliminated many of

the restrictions imposed by the BBA. It

allows Medicare to pay for telemedicine

consultations in rural areas regardless of

HPSA designation, eliminates the feesplitting requirement so the consultant

receives the full Medicare payment,

provides a $20 facility fee to be annually

updated after 2002, and permits the use of

telemedicine in the delivery of home

health care. The legislation also allows

Medicare to pay for telemedicine

consultations provided through federally

funded projects in Alaska and Hawaii that

use store-and-forward technologies.

Does Medicare policy need to be

changed?

If policymakers are interested in

expanding the use of telemedicine to

improve access to care, two types of

coverage expansions could be explored:

coverage of asynchronous store-andforward technology for telemedicine

consultations and increased discretion to

substitute some in-person home health

visits with telemedicine. In asynchronous

store-and-forward technology, a

diagnostic test is performed on the patient

and then sent electronically to the

consulting physician for review at a later

time. Under either of these policy options,

policymakers must be careful that

telemedicine is appropriately used as a

substitute for traditional in-person care or

for necessary care that would not have

otherwise been received in a timely

manner.13

Expanded coverage for store-andforward technology Asynchronous

store-and-forward services surmount the

logistical and financial constraints

associated with the delivery of interactive,

real-time telemedicine services in rural

areas. These constraints include costs

associated with the use of high bandwidth,

interactive technologies, and coordination

of physicians’ schedules. One study found

that it could take up to 25 phone calls to

set up a meeting (IOM 1996). Store-andforward telemedicine services use lower

bandwidth and require less logistical

coordination between clinicians,

compared with real-time interactive

telemedicine services.

One concern about covering asynchronous

telemedicine is the potential for overuse.

The Health Care Financing

Administration has noted that coverage of

store-and-forward teleconsultations could

potentially result in a substantial increase

in the number of teleconsultations without

any relation to medical necessity

(Berenson 2000). The infrastructure

barriers that have so far precluded

widespread dissemination of telemedicine

may temper this potential at least initially,

however. A second concern is that—with

the exception of teledermatology—

available efficacy data are insufficient to

determine whether expanding Medicare’s

coverage for teleconsultations is clinically

warranted (AHRQ 2001). There are cost

implications related to limitations in the

data on clinical efficacy because clinicians

may be more inclined to verify a

telemedicine diagnosis with an in-person

diagnosis if the accuracy of the

telemedicine diagnosis is uncertain. On

the other hand, cost may not be a concern

if patients are faced with a choice of

receiving telemedicine services or

receiving no or inadequate care.

Expanded coverage for telemedicine

services used by home health

providers The BIPA prohibited the

substitution of telemedicine services for inperson visits under the new home health

prospective payment system. Although

substitution of telemedicine home health

care for in-person visits ordered by a

physician is often not appropriate, it may

be warranted under certain circumstances.

Preliminary evidence suggests that the use

of telemedicine in combination with inperson home health visits may improve

health outcomes and enhance quality of

care (Burgiss 2000, Johnson et al. 2000). 

36 Rural beneficiaries’ access to care

13 For instance, the Kentucky legislature explicitly excluded e-mails, faxes, and telephone calls from being considered “telemedicine.”
References

Adler GS. A profile of the Medicare Current Beneficiary Survey, Health Care Financing

Review. Summer 1994, Vol. 15, No. 4, p. 152–163.

Agency for Healthcare Research and Quality. Telemedicine for the Medicare population,

Evidence Report/Technology Assessment: Number 24. AHRQ Publication Number

01-E011, February 2001. Rockville, (MD), AHRQ. Available at

http://www.ahrq.gov/clinic/telemedsum.htm.

American Medical Association. Trends in the distribution of nonfederal physicians in

metropolitan and nonmetropolitan areas for selected years 1980-1997, Physician

characteristics and distribution in the US, 1999. Chicago, IL: American Medical

Association, 1999, p. 32.

Asch SM, Sloss EM, Hogan C, et al. Measuring underuse of necessary care among

elderly Medicare beneficiaries using inpatient and outpatient claims, JAMA. 2000, Vol.

284, p. 2374–2376.

Berenson R, Health Care Financing Administration. Hearing testimony before the Ways

and Means Subcommittee on Health: “Telehealth: A Cutting Edge Medical Tool for the

21st Century.” September 7, 2000.

Burgiss S. Hearing testimony before the Ways and Means Subcommittee on Health:

“Telehealth: A Cutting Edge Medical Tool for the 21st Century.” September 7, 2000.

Caplan C, Gross, D. AARP Public Policy Institute, Out-of-pocket health care spending by

rural Medicare beneficiaries age 65 and older. In preparation.

Esposito TJ, Maier RV, Rivara FP et al. The impact of variation in trauma care times:

urban versus rural, Prehospital and Disaster Medicine. July-September 1995, Vol. 10,

No.3, p. 161–166.

Farley DO, Inkelas M, Taylor P, Ashwood JS. Trends for rural health clinics and

federally qualified health centers serving rural Medicare beneficiaries during the 1990s.

RAND unrestricted draft series DRU-2540-HCFA. Santa Monica (CA), RAND. April

2001.

General Accounting Office. Physician shortage areas: Medicare incentive payments not

an effective approach to improve access. Washington (DC), GAO. February 1999.

General Accounting Office. Rural health clinics: Rising program expenditures not

focused on improving care in isolated areas, No. HEHS-97-24. Washington (DC), GAO.

November 1996.

General Accounting Office. Health care shortage areas: designations not a useful tool for

directing resources to the underserved. Washington (DC), GAO. September 1995.

Grossman, DC, Kim A, MacDonald SC, et al. Urban-rural differences in pre-hospital care

of major trauma, Journal of Trauma Injury, Infection, and Critical Care. April 1997, Vol.

42, No. 4, p. 723–729.

Hart, LG. Health care workforce supply in underserved rural areas of the United States.

Paper presented at the Fifth International Medical Workforce Conference, Sydney,

Australia, November 16–19, 2000.

Report to the Congress: Medicare in Rural America | June 2001 37
Health Care Financing Administration, Department of Health and Human Services.

Medicare Part B carriers manual, Part 3 claims process, Section 3350.7. Baltimore (MD),

HCFA. October 1999.

Health Resources and Services Administration, Department of Health and Human

Services. Unpublished data, 2001.

Hogan, C. Urban-rural differences in the use of needed services: analysis of the ACEPRO indicators using 1998/1999 data. Report to the Medicare Payment Advisory

Commission. Vienna (VA), Direct Research, LLC. April 19, 2001.

Institute of Medicine. Telemedicine. Washington (DC), National Academy Press. 1996.

Johnson B, Wheeler L, Deuser J, Sousa KH. Outcomes of the Kaiser Permanente TeleHome Health Research Project, Archives of Family Medicine. January 2000, Vol 9,

p. 40–45.

McClellan, M, McNeil BJ, and Newhouse JP. Does more intensive treatment of acute

myocardial infarction in the elderly reduce mortality? Journal of the American Medical

Association, September 21, 1994, Vol. 272, No. 11, p. 859-866.

Medicare Payment Advisory Commission. Report to the Congress: Medicare Payment

Policy. Washington (DC): MedPAC, March 2000.

Morrisey MA, Ohsfeldt RL, Johnson V, Treat R. Rural emergency medical services:

patients, destinations, times, and services, Journal of Rural Health. Fall 1995, Vol. 11,

No. 4, p. 286-294.

Office of Inspector General, Department of Health and Human Services, Medicare

incentive payments in the health professional shortage areas: do they promote access to

primary care? OEI-01-93-00050. Baltimore (MD), OIG. June 1994a.

Office of Inspector General, Department of Health and Human Services, Design flaws in

the Medicare Incentive Payment program: management advisory report. OEI-01-93-

00051. Baltimore (MD), OIG. June 1994b. 

Physician Payment Review Commission. Annual Report to Congress 1992. Washington

(DC), PPRC. 1992.

Ricketts, TC III, Heaphy P. Hospitals in rural America, in Rural Health in The United

States, TC Ricketts III, ed. New York (NY), Oxford University Press. 1999.

Sutton JP. Rural home health users: vulnerability to payment reform. Bethesda (MD),

Project HOPE. September 1999.

Thornburg JA, Health Resources and Services Administration. Letter to state primary

care offices. March 12, 2001.

38 Rural beneficiaries’ access to care
Quality of care in rural areas

CHAPTER3
RECOMMENDATIONS

3A The Secretary should require the peer review organizations to include rural populations and

providers when carrying out their quality improvement activities.

*YES: 14 • NO: 0 • NOT VOTING: 1 • ABSENT: 1

 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3B MedPAC reiterates its June 2000 recommendation that the Congress should require the

Secretary to survey at least one-third of each facility type annually to certify compliance with

the conditions of participation.

YES: 14 • NO: 0 • NOT VOTING: 0 • ABSENT: 2

*COMMISSIONERS’ VOTING RESULTS
lthough ensuring that beneficiaries have access to medically

necessary care of high quality is one of the primary objectives of the Medicare program, rural quality of care issues

have received little attention in Medicare policymaking.

MedPAC’s research on the quality of care in rural areas is largely encouraging.

As measured by the use of recommended services, quality of care is roughly comparable among rural counties of varying proximity to metropolitan areas, as well

as between rural and metropolitan areas. However, Medicare’s systems for improving and safeguarding quality could be strengthened to deal more effectively

with issues in rural areas. Improving care in rural areas is not an articulated task

on Medicare’s current quality improvement agenda; the Secretary should include

rural populations and providers when carrying out Medicare’s quality improvement activities. In addition, the Secretary should address a critical problem with

Medicare’s system for safeguarding rural care by requiring more frequent surveying of providers to ensure the care they deliver meets minimal standards for

quality and safety.

CHAPTER

Quality of care in rural areas

3

In this chapter

• Quality of care delivered to

rural beneficiaries

• Quality improvement and

assurance in rural areas

Report to the Congress: Medicare in Rural America | June 2001 41

A
One of the primary objectives of the

Medicare program is to ensure that

beneficiaries have access to medically

necessary care of high quality. Although

the Congress recently enacted special

payment programs to address the

adequacy of rural health care financing

and access to care, rural quality of care

issues have received less attention in

Medicare policymaking. Policymakers

also need to consider quality issues when

developing policy that affects rural health

care. Delivering quality care in rural

settings can be challenging, and

Medicare’s efforts to safeguard and

improve the quality of that care could be

improved. This chapter aims to assess the

quality of care delivered in rural settings,

discuss the implications of Medicare’s

systems to measure rural quality of care,

and examine Medicare’s programs

intended to safeguard and improve rural

beneficiaries’ access to quality care.

In the first section, we assess rural quality

of care by looking at whether beneficiaries

receive certain recommended services.

Use of recommended preventive, acute,

and chronic care is similar for

beneficiaries living in rural and

metropolitan (urban) areas, but large gaps

exist between the care that beneficiaries

should be receiving and what they

actually receive. Rural providers face

challenges in furnishing certain types of

high-tech procedures and therapies

because of low service volumes. By virtue

of their location, rural providers treat

fewer patients for many types of services

than do their non-rural counterparts.

Opportunities exist to improve the quality

of care furnished to rural and urban

beneficiaries by measuring the quality of

care.

In the second section, we examine how

Medicare influences the quality of care in

rural areas and find that quality

improvement activities performed by peer

review organizations do not give

sufficient attention to care furnished in

rural areas. Given research findings

suggesting that opportunities exist for

improving quality in rural areas, MedPAC

recommends that the Secretary require

peer review organizations to include rural

populations and providers when carrying

out quality improvement activities.

Next, we consider Medicare’s consumer

empowerment activities in the context of

rural health care. Readily available data

on the quality of care may be especially

useful for rural beneficiaries, who may

trade the convenience of obtaining care

from local providers for receiving

different or additional services furnished

by non-local providers.

Finally, we consider issues related to

Medicare’s quality assurance activities,

particularly in the use of performance

measures in providers’ conditions of

participation and the frequency of

surveying providers. Performance

measures represent a significant

opportunity to ensure the quality of care

furnished to beneficiaries. Nonetheless, the

Commission recognizes the burden that

collecting performance data may place on

small rural providers and believes that the

Secretary should consider this burden

when revising conditions of participation.

With respect to the frequency of surveying

providers to ensure they are meeting

conditions of participation, we find that

Medicare’s efforts to survey nonaccredited providers, including acute care

hospitals, are lacking. MedPAC reiterates

its recommendation of June 2000 that

Congress require the Secretary to survey at

least one-third of each facility type

annually to certify compliance with the

conditions of participation.

Quality of care delivered

to rural beneficiaries

To address the question of whether rural

beneficiaries have access to medically

necessary care of high quality, the

Commission reviewed available evidence

on the quality of care furnished to rural

beneficiaries, particularly the extent to

which differences exist among rural areas

based on their population size and

proximity to an urban area, as well as

between rural and urban areas. The

Commission also considered Medicare’s

efforts to improve quality by measuring

the care furnished to both rural and urban

beneficiaries.

Rural beneficiaries’ use of

recommended services

Clinical quality of care is often measured

by the extent to which beneficiaries

receive recommended acute, chronic, and

preventive services and the outcomes of

that care. Many performance indicators

currently used by Medicare represent

minimal standards of care recommended

by panels of expert clinicians, rather than

optimal practice patterns, and measure the

underuse of services considered clinically

appropriate. Underuse of services can

suggest a problem with quality, a lack of

availability of services or the presence of

barriers to obtaining services. Other ways

to examine quality include measuring the

overuse of services, such as when

beneficiaries receive too many diagnostic

procedures, and the misuse of services,

such as when beneficiaries are prescribed

multiple medications that should not be

given together. Underuse, overuse, and

misuse of services can result in treatment

complications and inefficient use of

resources.

A recent study commissioned by

MedPAC assessed whether differences

existed in the use of recommended

services in rural and urban areas in 1998-

1999 (Hogan 2001).1 This analysis uses

two types of indicators: those reflecting

minimum standards of recommended care

(necessary care indicators) and those

representing potentially avoidable

emergency or urgent care (avoidable

outcome indicators). The 40 necessary

care indicators measure the use of

preventive care and care for acute and

chronic conditions. The six avoidable

outcome indicators measure the

occurrence of avoidable outcomes for

42 Quality of care in rural areas

1 This analysis used Medicare claims and enrollment data for calendar years 1998 and 1999. Rural counties were classified using the urban influence code county

typology, developed by the Economic Research Service of the United States Department of Agriculture. Recommended care denotes care for which: 1) the benefits of

care outweigh the risks, 2) the benefits to the patient are likely and substantial, and 3) physicians judged that not recommending the care would be improper. The results

of this study are available upon request from MedPAC.
beneficiaries with diabetes, angina,

chronic obstructive lung disease,

pneumonia, congestive heart failure, or

gall stones. Appendix A lists these 46

indicators.

Results suggest that the provision of

recommended care and the occurrence of

potentially avoidable outcomes is roughly

comparable between rural and urban

beneficiaries. Using an index that equally

weighted each of the 46 indicators and

adjusted for differences in the age-sex mix

of the population, this study showed that

the average proportion of beneficiaries

who received necessary care ranged from

72 to 74 percent in counties with varying

degrees of ruralness (Table 3-1).

Beneficiaries living in remote rural

counties were somewhat less likely than

urban beneficiaries to receive three types of

care: electrocardiograms, except during

emergency room visits; timely follow-up

after hospital discharge; and

mammograms. In addition, some types of

potentially avoidable care (multiple

emergency room visits for angina,

admissions for beneficiaries with

pulmonary disease) were higher in remote

rural counties.

The data presented in Table 3-1 may

underestimate the use of recommended

care. All services provided during medical

encounters may not be reported in

Medicare’s claims system. For example,

eye exams delivered as part of routine

office visits would not be identified. In

addition, separate professional service

claims may not be generated for services

delivered by interns and residents.

Services for which Medicare denied

payment are not included in this analysis.

Finally, specific services furnished by

rural health clinics are not included in this

analysis. Notwithstanding, this analysis

does provide a quantitative sense of what

can be done to improve quality of care in

both rural and urban areas.

Although some of the differences found in

MedPAC’s study on the use of

recommended services may partly reflect

real differences in the quality of care,

some may also reflect barriers faced by

beneficiaries in accessing services.

Because the study was retrospective, it

was difficult to disentangle the effect of

barriers inhibiting access to care from

poor quality of care. Access can be more

difficult in rural areas because of

economic and transportation barriers. For

instance, a greater proportion of rural

beneficiaries have lower annual incomes,

lack private supplemental insurance, and

need to travel longer distances to seek

care, all of which have been linked to less

frequent use of certain types of services.

See Chapter 2 for an explanation of other

factors affecting rural beneficiaries’

access to care.

One important factor that may affect the

quality of care in rural areas is the low

patient service volume. A growing body

of evidence shows an association between

higher service volume furnished by acutecare hospitals and improved clinical

outcomes of care, particularly for hightech procedures and therapies. Most of the

studies focused on high-tech surgical

procedures, such as coronary artery

bypass graft surgery and coronary

angioplasty, rather than on other types of

interventions, but these studies also

assessed treatment of myocardial

infarction and acquired immunodeficiency

syndrome.2 Reasons for the positive

association between outcomes and

volume, first proposed by Luft et al.

(1979), include:

• the improved technique that results

from greater experience,

• the selective referral of patients to

high-volume providers, and

• treatment of sicker patients by lowvolume providers.

The findings from these studies on

inpatient care present a clear challenge for

rural providers, because by virtue of their

location in less populated areas, they treat

Report to the Congress: Medicare in Rural America | June 2001 43

Aggregate use of recommended services by

beneficiaries in 1998–1999, by location of county

Percentage of beneficiaries

Location of county (UIC) receiving recommended care

All counties 73.3

Urban, in an MSA (1, 2) 73.2

Rural

Adjacent to an MSA and includes a town with at least 

10,000 people (3, 5) 73.7

Adjacent to an MSA but does not include a town with 

at least 10,000 people (4, 6); 73.0

Not adjacent to an MSA but includes a town with 

at least 10,000 people (7) 74.0

Not adjacent to an MSA but includes a town with 

between 2,500 and 10,000 people (8) 71.4

Not adjacent to an MSA and does not include a town 

with at least 2,500 people (9) 71.5

Note: UIC (urban influence code, as defined by the U.S. Department of Agriculture), MSA (metropolitan statistical

area as defined by the U.S. Office of Management and Budget). These results are based on ordinary least

squares regression analyses, which estimated equally-weighted summary indices of the 46 performance

indicators, adjusted for differences in the age-sex mix of the population. Differences between counties in an

MSA and each rural county category are statistically significant (p 0.01) due to the large number of

observations present in the regression.

Source: Hogan 2001.

TABLE

3-1

2 A recent review of the literature in this area showed that the more generalizable of these studies assessed the volume/outcomes relationship for coronary artery bypass

graft surgery, pediatric cardiac surgery, carotid endarterectomy, abdominal aortic aneurysm repair, cancer surgery, percutaneous transluminal coronary angioplasty,

acute myocardial infarction, and acquired immunodeficiency syndrome (Halm 2000).
lower volumes of patients for many types

of services than do their non-rural

counterparts.

Although the gap in quality of care (as

measured by the use of recommended

services) between rural and urban settings

was less than we anticipated, MedPAC

remains concerned about the discrepancy

between the care both rural and urban

beneficiaries should receive and the care

they do receive. This gap exists for all

three types of care—preventive, acute,

and chronic. MedPAC’s finding that an

average of 73 percent of beneficiaries

receive recommended services suggests

the continued need to improve quality of

care for all beneficiaries. Other recent

studies confirm that beneficiaries do not

always receive the care related to the

initial evaluation, follow-up, and

monitoring of medical conditions that

meets professional standards. Jencks and

colleagues (2000) showed that in 1997-

1999, 69 percent (the median value) of

beneficiaries received recommended care,

as measured by 24 performance indicators

related to primary and secondary disease

prevention. Asch and colleagues (2000)

examined the provision of 37

recommended services during 1994-1996

and found that beneficiaries received 14 of

these services less than two-thirds of the

time. The results of these studies show

that Medicare beneficiaries, regardless of

whether they reside in rural or urban

areas, often do not get the care that

clinical experts considered to represent

minimal quality standard.

Rural beneficiaries’

satisfaction with care

Although measures of the clinical quality

of care consider the provision of necessary

services by health care providers,

satisfaction measures consider

beneficiaries’ perceptions and

expectations. Providers are increasingly

collecting and using information on

patient satisfaction to improve the quality

of care they deliver. This information can

reflect actual differences in quality of care

as well as differences in patient

perceptions and expectations.

MedPAC’s analysis of data from the 1999

Medicare Current Beneficiary Survey

(MCBS) shows that the majority of rural

and urban beneficiaries appear to be

satisfied with their care. For example:

• about 94 percent of both rural and

urban beneficiaries were very

satisfied or satisfied with the

availability of medical care,

• about 96 percent of both rural and

urban beneficiaries were very

satisfied or satisfied with the overall

quality of care, and

• about 96 percent of both rural and

urban beneficiaries were very

satisfied or satisfied with the care

they received from specialists.

Two aspects of satisfaction with care

significantly differed between rural and

urban beneficiaries—the ease of getting to

a doctor and believing their physician

“checks everything.” About 90 percent of

beneficiaries residing in rural counties

containing a town with fewer than 10,000

people reported being very satisfied or

satisfied with the ease of getting to a

doctor, 5 percentage points lower than

urban beneficiaries. This difference may

reflect the transportation barriers faced by

rural beneficiaries in using health care

services, including a lack of alternative

transportation services, such as van

services and taxis. At the same time, 96

percent of beneficiaries residing in rural

counties not adjacent to an MSA but

including a town with more than 10,000

people reported that they strongly agreed

or agreed that their physician “checks

everything,” 2 percentage points higher

than urban beneficiaries.

Improving efforts to

measure the quality of care

in rural settings

Opportunities exist to improve the quality

of care furnished to rural and urban

beneficiaries. One component of the

Health Care Financing Administration’s

(HCFA’s) national initiative to enhance

the quality of care provided to

beneficiaries is promoting efforts to

measure the quality of care, which the

agency believes is the essential foundation

for improving care (Jencks 1995).

HCFA’s goal is to create a system of

quality indicators that support

improvement across all Medicare services.

During the past decade, HCFA has

initiated a number of initiatives to

measure the quality of care furnished by

fee-for-service providers and managed

care plans. HCFA’s measurement

activities for traditional Medicare have

focused on developing clinical

performance measures to assess the care

provided by particular providers (skilled

nursing facilities, home health agencies,

and renal dialysis facilities). The agency is

extending its measurement activities to

assess inpatient care nationally and statewide for the following clinical areas: acute

myocardial infarction, heart failure,

stroke, and pneumonia (Jencks 2000).

HCFA’s measurement activities for

managed care organizations requires

health plans to collect information on the

use of recommended services and

beneficiaries’ functional status and

satisfaction with care.

As Medicare’s quality measurement

system continues to evolve, several issues

related to rural health care delivery should

be addressed. First, performance measures

that assess the delivery of health care in

rural areas should reflect the types of care

that are furnished in these areas. Second,

quality measurement systems should take

into account the low volume of services

furnished by small rural and urban

providers to ensure the validity of the

results. In addition, to the extent possible,

performance data should be adjusted for

factors (such as age and comorbidities)

known to affect them. Without

adjustment, data may not reflect the actual

performance of providers who treat

relatively more patients with lower health

and socioeconomic statuses. Finally, when

imposing new data collection and

reporting requirements, Medicare should

consider that small providers in both rural

and urban areas are less likely to have

technological support for monitoring and

tracking patient care and the resources to

acquire automated information

management systems, a key tool in quality

measurement systems.

44 Quality of care in rural areas
MedPAC is continuing to study issues

surrounding Medicare’s efforts to

measure quality of care. The Commission

is currently examining issues about

Medicare’s application of standards for

measuring, assuring, and improving care

among MedicareChoice (MC) and

fee-for-service providers. A report on the

Commission’s findings will be published

in December 2001, as required by the

Balanced Budget Refinement Act of

1999.

Quality improvement and

assurance in rural areas

Like other purchasers and health plans,

Medicare employs a variety of strategies

to influence quality. The program’s

quality assurance (QA) activities help to

ensure that health care providers have the

capacity to furnish safe care of adequate

quality. HCFA establishes health and

safety standards for providers and

suppliers that furnish care to Medicare

beneficiaries and enforces these standards

through its survey and certification efforts.

Two recent additions to Medicare’s

quality systems include its quality

improvement (QI) and consumer

empowerment activities. Quality

improvement—also known as continuous

quality improvement or total quality

management—has been adopted for use in

many industries and has recently begun to

influence health care industry practices

(Shortell et al. 1998). Medicare’s QI

activities aim to improve the average

quality of care furnished to beneficiaries

by helping providers assess their

performances, make changes, reassess

quality, and strive for continuous

improvements. Medicare’s consumer

empowerment activities provide

beneficiaries with information to help

them make more informed choices about

health plans and providers. Consumer

empowerment activities aim to improve

beneficiaries’ satisfaction with and

increase the value of the health care they

obtain.

Strengthening quality

improvement activities

Quality improvement efforts are based on

the notion that improving the average

quality of care furnished by providers is

an important goal that can be attained in a

blame-free environment. In 1992, HCFA

initiated the Health Care Quality

Improvement Program, under which

Medicare’s contractors, the peer review

organizations (PROs), worked with

participating providers to evaluate and

improve practice patterns. The program

has evolved over successive three-year

contracting cycles from a relatively

decentralized program under which each

state-based PRO chose quality

improvement targets, measures, and

measurement methods to the current

system, which requires the PROs to use

nationally standardized measures and

methods to assess and improve care

provided in six clinical priority areas

determined by HCFA. Medicare does not

require that hospitals, physicians, or any

other providers or health plans participate

in the PROs’ QI efforts. Instead, providers

may choose to participate because of an

interest in evaluating and improving the

quality of care furnished and because

participation may be used to satisfy

requirements of purchasers, state

regulatory authorities, or accrediting

bodies.

As currently designed and operated,

Medicare’s efforts to improve quality of

care may not be as effective as they could

be in addressing the quality of health care

in rural areas. The system is designed such

that the PROs have incentives to focus

their attention on large (usually urban)

providers.

Under the current contract (the so-called

sixth scope of work), the PROs are

responsible for completing three tasks to

improve the quality of care for Medicare

beneficiaries: national quality

improvement projects, local quality

improvement projects, and quality

improvement projects with MC plans.

PROs must meet the performance

standards for each of the tasks to be

eligible for the noncompetitive renewal of

their contracts.

The task on national quality improvement

requires the PROs to pursue QI activities

in six clinical areas—acute myocardial

infarction, breast cancer, diabetes, heart

failure, pneumonia, and stroke. The

Secretary selected these clinical areas

based on their public health importance

and the feasibility of measuring and

improving quality. The PROs must

analyze practice patterns, furnish

providers with performance data and

benchmark points of comparison, and use

interventions such as education, training,

and outreach to improve a state’s average

quality of care scores by a specified

amount over the contract cycle. HCFA

evaluates the success of each PRO’s

national QI activities by measuring the

organization’s combined improvement on

the 22 performance indicators (Table 3-2)

on a statewide basis.

The second task in the PROs’ current

scope of work requires them to perform

three types of local QI projects within

their state:

• projects designed to reduce

disparities between the care furnished

to beneficiaries who are members of

a targeted disadvantaged group and

all other beneficiaries residing in the

state;3

• projects in settings other than acutecare hospitals, such as nursing

homes, dialysis facilities, home

health agencies, or physicians’

offices; and

• projects in response to local interests

and needs.

HCFA evaluates the success of the PROs’

local efforts quantitatively and

qualitatively. For projects that use welldeveloped methods and quality indicators,

the agency uses the indicators to

determine the extent to which quality

improved. Other projects are evaluated by

measuring the amount of knowledge

gained through the experience of the

project.

Report to the Congress: Medicare in Rural America | June 2001 45

3 Targeted groups include African-Americans, Hispanics, American Indians and Alaskan Natives, Asians and Pacific Islanders, and Medicare beneficiaries who are dually

eligible for Medicaid benefits.
The third task in the PROs’ current scope

of work requires them to assist managed

care plans that want to develop QI

programs required as part of the Quality

Improvement System for Managed Care.

HCFA evaluates the success of the PROs’

managed care efforts by assessing changes

in statewide baselines over time and by

evaluating the amount of knowledge

gained through the experience of the

project.

The current contract does not preclude the

PROs from working with small rural and

small urban providers, but it does not

explicitly encourage them. PROs face

incentives to target their national quality

improvement efforts to large (usually

urban) providers, which offer the largest

potential for pay-off in terms of improving

statewide average performances if

improvement programs are successful.

Urban providers tend to be more

accessible, thereby reducing labor and

travel costs for PRO staff. Although the

PROs must perform local QI projects, the

current contract does not provide any

incentives for them to include rural

beneficiaries or providers. Rural

beneficiaries are not included as one of

the disadvantaged population groups in

the current scope of work, nor should they

be. Doing so might detract attention from

groups that have received demonstrably

poorer care compared with rural

populations. The PROs may include rural

providers in their local projects for

improving care in settings other than

acute-care hospitals or in response to local

interests and needs, but they are not

required to do so. In contrast to their

current contract, the PROs’ previous

contract (fifth scope of work) enabled

them to focus more attention on local and

state quality issues and populations

because their performance was evaluated

based on the number of projects

completed during the contract period.

RECOMMENDATION 3A

The Secretary should require the peer

review organizations to include rural

populations and providers when

carrying out their quality

improvement activities. 

Although MedPAC recommends that

PROs include a spectrum of rural

beneficiaries and providers in their QI

efforts, it is not the Commission’s intent

to shift the direction of national quality

improvement activities now articulated in

the Health Care Quality Improvement

Program. Instead, MedPAC believes

PROs should be encouraged to consider

rural settings under the next scope of

work, because rural providers have fewer

incentives to perform QI than do large

urban providers and previous QI activities

improved the quality of care among

certain rural providers.

Rural providers face less market pressure

to improve performance because they are

less likely to participate in managed care

plans or be part of purchasing coalitions’

efforts to address quality. Small rural

providers are also less likely to have their

own information systems for measuring

and improving quality than larger

providers, and often have fewer resources

to devote to QI. For these reasons, the QI

activities of the PROs could augment the

limited internal resources of small rural

providers.

46 Quality of care in rural areas

National health improvement clinical topics and

performance indicators for the peer review

organizations

Clinical topic Performance indicator

Acute myocardial infarction (inpatient) Early administration of aspirin

Aspirin at discharge

Early administration of beta blockers

Beta blockers at discharge

ACE inhibitor for low left ventricular ejection 

fraction at discharge

Time to initial reperfusion

Smoking cessation counseling during 

hospitalization

Heart failure (inpatient) Appropriate use of ACE inhibitors at discharge

Pneumonia (inpatient) Influenza vaccination or appropriate screening

Pneumococcal vaccination or appropriate 

screening

Blood culture before antibiotics are administered

Appropriate initial empiric antibiotic selection

Initial antibiotic dose within eight hours of hospital 

arrival

Pneumonia (outpatient) Influenza immunization

Pneumococcal immunization

Stroke (inpatient) Antithrombotic at discharge (acute stroke or 

transient ischemic attack)

Warfarin at discharge (atrial fibrillation)

Avoidance of sublingual nifedipine (acute stroke)

Diabetes (outpatient) Biennial retinal exam by an eye professional

Annual hemoglobin A1C testing

Biennial testing of lipid profile

Breast cancer (outpatient) Biennial screening mammography

Note: ACE (angiotensin converting enzyme). The above performance measures are used by the peer review

organizations in the national quality improvement activities set forth in their sixth scope of work. Data sources

for the performance indicators listed above include: 1) hospital medical records for acute myocardial

infarction, congestive heart failure, pneumonia, and stroke inpatient measures; 2) Medicare claims data for

breast cancer and diabetes measures; and 3) the Cener for Disease Control and Prevention’s Behavioral Risk

Factor Surveillance System for pneumonia outpatient measures. 

Source: HCFA 2001

TABLE

3-2
Further, several efforts under the PROs’

previous contract did succeed in

improving the quality of care among

certain rural providers. For example:

• The proportion of “ideal candidates”

with a confirmed acute myocardial

infarction who received

thrombolytics or percutaneous

transluminal coronary angioplasty

within 12 hours of hospital arrival

increased to 59 percent from 44

percent for small rural hospitals in

Oklahoma (AHQA 2001).

• The proportion of “ideal candidates”

with a confirmed acute myocardial

infarction who received daily aspirin

during hospitalization increased to 84

percent from 78 percent for small

rural hospitals in Oklahoma (AHQA

2001).

• Pneumococcal vaccination rates for

residents of long-term care facilities

in four rural Western states rose to 75

percent from 40 percent (Stevenson

et al. 2000).

• The proportion of ideal acute

myocardial infarction candidates in

Iowa who were prescribed aspirin at

discharge increased to 80 percent

from 63 percent (AHQA 2001).

To add rural health care to the list of

required performance improvements in

the PROs’ next (seventh) scope of work,

which is currently in development, the

Secretary could include rural health care

delivery as one of the local QI projects.

Alternatively, the Secretary could add a

separate rural health care delivery task.

It will be important for the Secretary to set

forth objectives in the PROs’ next scope

of work to guide them in performing QI

projects in rural settings. Specifically, the

Secretary will need to consider whether

rural health care QI efforts should focus

on national clinical topics (described in

Table 3-2) or whether individual PROs

should develop and implement rural QI

projects, based on the notion that the

organizations are best able to work with

local providers to identify specific quality

concerns. Many of the national indicators

are applicable to rural health care delivery,

as they focus on several conditions

relatively common among rural

beneficiaries—acute myocardial

infarction, diabetes, and pneumonia—and

several processes of care commonly

furnished in rural settings. The PROs’

local projects to reduce racial and ethnic

disparities in health require them to use

the nationally standardized quality

indicators. In contrast, the PROs’ local

projects to improve quality in non–acutecare hospital settings allow them to focus

on clinical topics and use quality

indicators other than those articulated in

Medicare’s national QI efforts.

When designing QI efforts for rural

settings, the PROs also will need to

consider issues specific to rural settings,

including the lower patient volume and

limited staff and resources. Low volume

leads to less precision in QI measurement

results because results can be swayed by

even a few extreme cases. Results of

quality measurement for rural providers

could appear more dire or more positive in

statistical calculations than may actually

be the case. In addition, small rural

providers often lack the resources to

devote staff time to quality improvement

and are less likely to have staff that focus

exclusively on such work. Lack of an

automated information infrastructure

means that collecting data is more time

and labor intensive.

By creating payment policies targeting

rural providers, such as the Medicare

Rural Hospital Flexibility Program, the

Congress has demonstrated its interest in

ensuring that rural beneficiaries have local

access to certain inpatient and ambulatory

services. In addition to ensuring access,

Medicare needs to continue efforts to

improve the quality of care for rural

beneficiaries. The gap between the care

that beneficiaries should receive and the

care they do receive creates substantial

opportunities for the PROs to improve

quality in both rural and urban settings.

Although it would be more efficient to

focus QI activities on large urban

providers (because such providers treat a

greater proportion of beneficiaries than do

rural providers), such an approach would

not be equitable. As a public program,

Medicare should seek to ensure

high–quality care for all beneficiaries,

regardless of where they live.

Finally, depending on the approach

decided upon by the Secretary, the PROs

may require additional funding to meet

their new responsibilities without

detracting from other QI efforts.

MedPAC’s recommendation is not meant

to divert funds from QI efforts in urban

areas to efforts in rural areas. Therefore,

when developing the next scope of work

for the PROs, the Secretary will need to

evaluate the budget impact of different

alternatives for including rural populations

and providers in PRO activities.

Improving consumer

empowerment activities

Medicare is increasingly releasing

information about the performance of

managed care and fee-for-service

providers to beneficiaries. In the late

1990s, HCFA established its “Medicare

Compare” site on the World Wide Web,

which offers basic comparative

information on the Medicare program,

managed care options, and the quality of

care furnished by skilled nursing facilities.

In 2000, the site was expanded to include

information about the quality of care

furnished by dialysis facilities.

Information is not yet available for other

providers, such as acute-care hospitals,

home health agencies, and physicians.

The assumption surrounding the release of

performance data is that consumers will

use the information to choose providers

that furnish high-quality care, and the

collective effect of those choices will give

providers an incentive to improve care

(Hibbard et al. 2000). Information may be

especially useful for rural beneficiaries

who may in some cases trade off the

convenience of obtaining care from local

providers to receive different or additional

services furnished by non-local providers.

MedPAC’s recent analysis of acute-care

hospital services shows that beneficiaries

residing in rural counties are more likely

to use hospitals outside their county of

residence compared with beneficiaries

residing in metropolitan counties.

Report to the Congress: Medicare in Rural America | June 2001 47
According to Buczko (1994), rural

beneficiaries who use non-local hospitals

do so primarily to seek specialized

services.

Although evidence is growing that

consumers want more information about

providers’ performance, it appears that the

release of performance information has

had only a limited impact on consumer

decision making (Marshall et al. 2000).

The primary audience for publicly

available performance data tends to be the

providers being measured, rather than

consumers (Goldfield et al. 1999).

Reasons for consumers’ lack of interest in

and use of performance data include

difficulty understanding the information,

lack of trust in the data, problems with

timely access to the information, and lack

of choice. In addition, evidence suggests

that consumers rate anecdotal evidence

from family and friends more highly than

they do systematic empirical evidence.

Medicare policymakers must have

reasonable expectations for both shortand long-term success of the informed

choice initiative in Medicare. The

initiative promises to improve

beneficiaries’ satisfaction with their care

by informing choice and fostering

appropriate decision-making, but

empowering beneficiaries as value-based

health care consumers is a long-term goal.

In the short term, significant obstacles

include limits in beneficiaries’ knowledge

of relevant health care concepts,

unfamiliarity with alternatives in health

care delivery, and uncertainty about how

to use comparative information in making

health care decisions. These problems

may subside as beneficiaries with more

experience making health care decisions

enter the program.

The Commission has previously

recognized the importance of furnishing

information on quality of care to help

beneficiaries compare providers in

traditional Medicare and MC enrollment

options. Specifically, MedPAC has

recommended that the Secretary develop

and disseminate consumer-oriented

information on quality of care to help

beneficiaries compare enrollment options

and providers (MedPAC 1999). Such

information should include both

geographic information on the quality of

care furnished to beneficiaries enrolled in

traditional Medicare and provider-specific

information on the quality of care

furnished by health care facilities and

practitioners participating in the MC

program.

When publishing facility-specific

information, HCFA should take steps to

ensure the validity of the information

reported and the comparisons made

between providers. As mentioned

previously, these steps include accounting

for the low volume of services furnished by

small providers in rural and urban settings

in calculating measurement results and

adjusting data for factors (such as age and

comorbidities) known to affect them.

Ensuring quality of care in

rural areas

Quality assurance—which aims to ensure

that health care providers have the

capacity to furnish safe care of good

quality—is another component of

Medicare’s system to influence quality.

Medicare’s QA for institutional providers

is essentially a regulatory process that

involves establishing conditions of

participation through a rulemaking

process and assessing provider

compliance with those conditions.4

Conditions of participation consist

primarily of structural requirements

believed to ensure the capacity of

providers to safely furnish high-quality

health care; however, most requirements

do not have a firm basis in evidence from

health services research and have not been

updated with changes in medical practices

and technologies (MedPAC 2000).

Compliance with conditions of

participation is assessed either through a

survey and certification process conducted

by state agencies under contract to HCFA,

or through a private accreditation process

that HCFA has determined to be

equivalent to its own.5

Last year, MedPAC reviewed Medicare’s

system for safeguarding and ensuring

health care quality and found problems

with the participation standards, the

process for certifying compliance with

those standards, the ability of HCFA to

enforce compliance, Medicare’s deeming

arrangements, and the limited information

available to consumers on certification

findings (MedPAC 2000). The

Commission set forth a series of

recommendations to the Congress and the

Secretary to address these problems by

updating standards more frequently,

funding the system adequately,

strengthening sanctions, and making other

changes. In addition, the Commission

considered the use of facility-specific

performance measures in Medicare’s QA

program and concluded that they represent

significant opportunities to improve the

program but need to be used

appropriately.

Additional assessment of the system in the

context of rural health care suggests that it

is particularly ineffective in assuring that

the care rural beneficiaries receive meets

minimum standards for quality and safety.

To assure that rural beneficiaries obtain

high-quality care, policymakers must take

steps to address weaknesses of the current

system.

Collecting performance data

from institutional providers

Medicare’s participation requirements,

like those of other public and private

oversight bodies, are beginning to move

away from structural proxies for quality

toward requirements to measure processes

and outcomes of care and to improve

quality. As part of its effort to set

performance standards, HCFA already

requires certain providers—including

home health agencies, long-term care

48 Quality of care in rural areas

4 Program regulations distinguish health care providers from health care suppliers. The former are generally subject to conditions of participation (sometimes called

requirements) and the latter to conditions of coverage. In this chapter, the term “provider” is used to refer both to providers (such as hospitals) and suppliers (such as

renal dialysis facilities).

5 Because the hospital accreditation program of the Joint Commission on Accreditation of Healthcare Organizations (JCAHO) is specified in law as satisfying Medicare

and Medicaid participation standards, JCAHO’s status is not dependent upon HCFA’s assessment of its accreditation standards and compliance assessment methods.
facilities, and dialysis facilities—to collect

performance data. The agency is

considering modifying the program’s

conditions of participation to require

reporting of standardized indicators,

attainment of specified (minimum)

performance levels, and improvement in

specified aspects of performance. HCFA

is also considering using performance

measures to determine the appropriate

frequency of site inspections, target

specific quality concerns in the course of

inspections, and monitor quality at

facilities between inspections.

Small health care providers in both rural

and urban areas face a number of

challenges in collecting performance data.

Because of resource constraints created by

the scale of their operations, small

providers may not be able to invest in

systems to support quality measurement.

Staffing shortages due to difficulties in

recruitment and retention also affect the

ability of small providers to measure

quality or collect data for quality

measurement. In addition, independent of

resource limitations, low service volume

makes quality measurement less precise.

Because of challenges faced by some

small providers in collecting performance

data, the Joint Commission on

Accreditation of Healthcare Organizations

(JCAHO) requirements for performance

measurement for acute-care hospitals,

behavioral health care providers, and

home health providers vary based on

service volume. For example, JCAHO

considers average daily census and the

number of outpatient visits per month in

its performance measurement

requirements for acute-care hospitals.6 In

contrast, performance measurement

requirements for long-term care facilities

do not differ based on service volume.

Despite the difficulties faced by small

providers in collecting performance data,

the Commission reiterates its belief that

performance measurement can help

ensure high-quality care for beneficiaries

(MedPAC 2000). Nonetheless, when

incorporating performance measures in

Medicare’s QA requirements, the

Secretary should consider the burden

associated with collecting data and take

steps to ensure that required items have an

explicit rationale and are needed for

quality assurance. In addition,

performance measures should reflect the

types of care delivered in rural settings.

Finally, when carrying out these activities,

the Secretary should seek input and

assistance from experts in rural and urban

health care.

Increasing the frequency of

surveying institutional providers

Medicare sets participation standards for

health care providers to ensure minimum

standards for the quality and safety of care

furnished to beneficiaries. Compliance

with these conditions of participation

occurs through the so-called survey and

certification program, by which state

agencies conduct on-site inspections of

health care providers. In addition, the

Secretary deems compliant with

Medicare’s standards providers who are

certified by certain private accrediting

bodies without having to submit to

additional review. State survey and

certification programs, which are partially

funded by the Department of Health and

Human Services, are the default quality

oversight mechanism for unaccredited

hospitals, as well as for other types of

providers for which deemed status is

unavailable or has not been attained.

Under current funding and legal

requirements, most facilities are surveyed

infrequently. Each year HCFA directs

state survey agencies to conduct

certification surveys on about 15 percent

of non-hospital, non-long-term care

facilities, which means an individual

facility is surveyed once every 7.5 years

(MacTaggart 1999).7 Only long-term care

facilities and home health agencies are

surveyed on a more regular basis due to

legal mandates requiring them to be

surveyed yearly and every three years,

respectively.

The infrequent surveying of institutional

providers affects rural providers

disproportionately. Rural providers are

more likely to use the survey and

certification program and less likely to be

accredited compared with urban

providers. As of 1996, less than 60

percent of rural hospitals were accredited

by JCAHO (Brasure et al. 1999). In

contrast, the vast majority of urban

providers are accredited. As mentioned

earlier, rural providers have fewer

incentives to seek accreditation because

purchasers and managed care plans have

less ability to be selective in rural areas. In

addition, rural hospitals do not pursue

accreditation because of the costs

associated with the process, which include

the fees to the oversight body and the

costs of preparing for the on-site

inspection.

In our June 2000 report to the Congress,

MedPAC recommended more frequent

surveys of all institutional providers. The

Commission repeats its recommendation

here specifically to address concerns

about infrequent surveys of rural

institutional providers.

RECOMMENDATION 3B

MedPAC reiterates its June 2000

recommendation that the Congress

should require the Secretary to

survey at least one-third of each

facility type annually to certify

compliance with the conditions of

participation.

Increasing the frequency of inspections

would require adequate levels of funding

for the Secretary to carry out these

Report to the Congress: Medicare in Rural America | June 2001 49

6 JCAHO’s current performance requirements for hospitals are as follows: 1) Hospitals having an average daily census of 10 or more and/or an average of 150 or more

monthly outpatient visits need to collect and transmit information on 6 inpatient performance measures to JCAHO on a quarterly basis; 2) Hospitals having an average

daily census of less than 10 and an average of 150 or more outpatient visits per month need to collect and transmit information on 6 ambulatory or inpatient

performance measures to JCAHO on a quarterly basis; 3) Hospitals having an average daily census of less than 10 and an average of 150 or less outpatient visits per

month are required to collect information on 6 performance measures, but are not required to transmit the data to JCAHO on a regular basis; rather, the data are

reviewed during on-site surveys (JCAHO 2001).

7 These facilities include non-accredited hospitals, renal dialysis facilities, hospices, ambulatory surgical centers, rural health clinics, physical therapy providers, portable

x-ray providers, and comprehensive outpatient rehabilitation facilities (HCFA 1998).
activities. MedPAC has previously

recommended that the Secretary request,

and the Congress appropriate, adequate

levels of funding for survey and

certification activities to enable HCFA

and state survey agencies to increase the

frequency of inspections and take other

steps to strengthen the quality oversight

process (MedPAC 2000). Others also

believe that funding for state survey and

certification responsibilities has been

inadequate for years (Morris 1999). 

Currently, HCFA seeks and obtains funds

for its survey and certification activities

through the normal appropriations

process. In our June 2000 report to the

Congress, MedPAC considered alternate

methods to fund HCFA’s survey and

certification activities, such as direct

funding through the Medicare trust funds

and user fees from entities seeking

Medicare certification. The Commission

concluded that the appropriations process

is the most straightforward way to assure

greater survey frequency. Switching the

funding method for these responsibilities

merely avoids addressing previous

inadequate funding levels.

Finally, although current funding levels

are problematic, MedPAC is also

concerned about the underlying substance

of the standards and the process for

applying those standards. Specifically, in

our June 2000 report, the Commission

identified problems with and made

recommendations about the content of

current participation standards, the ability

of HCFA to enforce compliance, and

Medicare’s deeming arrangements. 

50 Quality of care in rural areas
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Hogan C, Direct Research, LLC. Urban-rural differences in the use of needed services:

Analysis of the ACE-PRO indicators using 1998/1999 data. Report to the Medicare

Payment Advisory Commission. Vienna, (VA), Direct Research LLC. April 19, 2001.

Jencks SF, Cuerdon T, Burwen DR, et al. Quality of medical care delivered to Medicare

beneficiaries, JAMA. October 4, 2000, Vol. 284, No. 13, p. 1670–1676.

Jencks SF. Measuring quality of care under Medicare and Medicaid, Health Care

Financing Review. Summer 1995, Vol. 16, No. 4, p. 39–54.

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Available at http://www.jcaho.org/oryx_frm.html; accessed April 2001.

Luft HS, Bunker JP, Enthoven AC. Should operations be regionalized? The empirical

relation between surgical volume and mortality, New England Journal of Medicine. 1979,

Vol. 301, p. 1364–1369.

Report to the Congress: Medicare in Rural America | June 2001 51
52 Quality of care in rural areas

MacTaggart P, Health Care Financing Administration. Fiscal year 2000 state survey and

certification budget call letter. Washington (DC), HCFA. July 7, 1999.

Marshall MN, Shekelle PG, Leatherman S, Brook RH. The public release of performance

data, JAMA. April 12, 2000, Vol. 283, No. 14, p. 1866–1874.

Medicare Payment Advisory Commission, Report to the Congress: Selected Medicare

Issues. Washington (DC), MedPAC. June 2000.

Medicare Payment Advisory Commission, Report to the Congress: Selected Medicare

Issues. Washington (DC), MedPAC. June 1999.

Morris C, on behalf of the Association of Health Facility Survey Agencies. The nursing

home initiative: results at one year. Written statement to the Senate Special Committee on

Aging. June 30, 1999.

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improvement on clinical practice: what it will take to accelerate progress, Milbank

Quarterly. December 1998, Vol. 76, No. 4, p. 593–624.

Stevenson KB, McMahon JW, Harris J. Increasing pneumococcal vaccination rates

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Hospital Epidemiology. November 2000, Vol. 21, No. 11, p. 705–710.

52 Quality of care in rural areas
Improving payment for 

inpatient hospital care 

in rural areas

CHAPTER 4
RECOMMENDATIONS

4A The Congress should require that rural referral centers’ wages exceed the average wage in their

area to qualify for geographic reclassification, but these facilities should retain their waiver

from the proximity rule.

*YES: 13 • NO: 0 • NOT VOTING: 0 • ABSENT: 3

 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4B The Congress should require the Secretary to develop a graduated adjustment to the rates used

in the inpatient prospective payment system for hospitals with low overall volumes of

discharges. This adjustment should only apply to hospitals that are more than a specified

number of miles from another facility providing inpatient care, with appropriate exceptions for

topography or weather conditions.

YES: 13 • NO: 0 • NOT VOTING: 0 • ABSENT: 3

 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4C In fiscal year 2002, the Secretary should implement fully the policy of excluding from the

hospital wage index salaries and hours for teaching physicians, residents, and certified

registered nurse anesthetists.

YES: 14 • NO: 0 • NOT VOTING: 0 • ABSENT: 2

 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4D To ensure accurate input-price adjustments in Medicare’s prospective payment systems, the

Secretary should reevaluate current assumptions about the proportions of providers’ costs that

reflect resources purchased in local and national markets.

YES: 13 • NO: 0 • NOT VOTING: 1 • ABSENT: 2

 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4E The Congress should raise the cap on the disproportionate share add-on a rural hospital can

receive from 5.25 percent to 10 percent.

YES: 13 • NO: 0 • NOT VOTING: 0 • ABSENT: 3

 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4F The Congress should revise the target cap for inpatient psychiatric facilities in a way that better

addresses differences among them.

YES: 9 • NO: 0 • NOT VOTING: 0 • ABSENT: 7

*COMMISSIONERS’ VOTING RESULTS
ural hospitals have had lower Medicare inpatient margins than

urban hospitals throughout the 1990s, and the gap has been

widening. Less than a percentage point separated the margins

of the two groups in 1992, but the disparity grew to 10 percentage points by 1999. This pattern also applies across all major lines of

Medicare business, with rural hospitals’ overall Medicare margin dipping below

zero. This growing imbalance in Medicare financial performance has occurred

despite subsidies for rural hospitals that are almost as high as those for urban hospitals. Although some of the difference in performance may be within hospitals’

control, the size of the gap suggests that the payment system does not recognize

factors that have a greater effect on the costs of rural hospitals than they do on urban hospitals. In this chapter, we identify several problems in Medicare’s payment systems for inpatient hospital care that tend to work against rural hospitals

and recommend ways to match payments better to efficient provider costs while

improving the financial condition of many rural hospitals.

CHAPTER

Improving payment for

inpatient hospital care in 

rural areas

4

In this chapter

• A framework for considering

rural payment provisions

• Financial performance of rural

hospitals

• Policy options that do not

target payments to specific

cost factors

• Specific problems and solution

options

• Inpatient psychiatric care

Report to the Congress: Medicare in Rural America | June 2001 55

R
In response to the deteriorating financial

performance of many rural hospitals under

Medicare, as well as the large losses on

Medicare patients experienced by rural

hospitals that operate psychiatric units, the

Congress has asked the Medicare

Payment Advisory Commission

(MedPAC) to:

• review the adequacy and

appropriateness of Medicare’s current

payment policies for rural hospitals,

• analyze how the unit costs of rural

hospitals with psychiatric units vary

by the volume of services these

hospitals provide, and

• analyze the effect of low patient

volume on the financial status of

isolated rural providers.

This chapter responds to these

congressional mandates through a

comprehensive review of Medicare

payment policy for inpatient services in

rural areas.1 We begin by discussing a

framework for analyzing payments for

inpatient hospital services. Next, we

examine the financial performance of

rural and urban hospitals and compare the

value of Medicare’s current special

payment provisions for rural hospitals

with that of provisions targeted primarily

at urban hospitals. The remainder of the

chapter addresses four payment system

problems that rural hospitals face, options

the Commission considered for solving

each, and several recommendations.

A framework for

considering rural

payment provisions

A variety of factors contributes to the

difference in Medicare financial

performance between rural and urban

hospitals and to rural hospitals’ negative

margins across all lines of Medicare

business. We believe Medicare’s inpatient

payment system has four problems that

may inhibit the best possible distribution

of payments and that together play a

substantial role in rural hospitals’ lower

margins. We also believe that

improvements in the payment system to

solve these problems are feasible—some

immediately and some in the longer run.

The four are:

• failure to account directly for small

scale of operation,

• failure to account for longer lengths

of stay, that may result from limited

access to post-acute or follow-up

ambulatory care services,

• limitations in the measurement of

input prices (Medicare’s wage index

system), and

• unequal disproportionate share

(DSH) payments.

The first three issues concern systematic

differences between urban and rural

hospitals’ per unit costs arising from

factors that generally are beyond their

control. The fourth issue involves

differences among hospitals in the volume

of services they provide to low-income

patients, with treating poor patients

generally reducing hospitals’ revenue

rather than raising their costs. In each

case, Medicare’s payment system either

does not address the underlying

differences or appears to address them in a

way that works against rural hospitals. We

believe these four problems not only help

explain the difference in financial status

between rural and urban hospitals, but

also explain why this difference has

widened over the last decade.

In the broadest terms, our options for

improving Medicare’s payments to rural

hospitals are:

• expand cost-based (or even cost-plus)

payment to more hospitals, or

• make the prospective payment

system (PPS) more responsive to the

circumstances of rural hospitals.

Cost-based payment would make up for

any inaccuracies in the payment system,

but it would offer no incentive for

providers to operate efficiently—a key

goal of Medicare’s payment policy.2 In

addition, cost-based payment would not

allow hospitals to earn a margin to help

fund capital development or offset

uncompensated care.3 A cost-plus policy

would limit that problem, but would

exacerbate the lack of cost control.

In contrast, prospective payment gives

hospitals an incentive to control costs, but

the need to group patients in a PPS means

that a tolerable amount of variation in

costs among cases within each group can

be achieved only with a significant

volume of patients.4

In considering refinements to the PPS, we

again have two broad options:

• rely on programs that provide extra

payments to groups of rural hospitals

without targeting payments to

specific cost-influencing factors, or

• develop payment adjustments that

attempt to target payments more

accurately at the hospital-specific

level.

For hospitals covered by the inpatient

PPS, this chapter addresses 20 different

policy options (Table 4-1). Some are

mutually exclusive, but many could be

56 Improving payment for inpatient hospital care in rural areas

1 The Congress did not restrict the last of these studies—analysis of the effects of low volume on financial status—to hospital inpatient services. Chapter 5 discusses the

relationship of volume and per unit costs for hospital outpatient services.

2 We do not have a reliable way to quantify the efficient costs of providing services to Medicare patients, but the concept is still useful in guiding our assessment of

payment policy. Measuring the average costs of broad groups of hospitals while standardizing for differences in case mix and other cost-influencing factors can provide

useful input, however, and we use this approach throughout the chapter.

3 Although cost-based payment reimburses a hospital over time for its past capital expenditures, such payment does not adequately cover the effects of inflation or

technological advancement on the costs of plant and equipment. The only uncompensated care expenses a cost-based payment system would cover are Medicare copayments and deductibles that beneficiaries fail to pay.

4 Variation in costs among patients in a fixed-price system increases hospitals’ financial risk.
employed simultaneously. We considered

each option because it relies on an

existing Medicare program, has been

proposed by a leading industry group, or

showed promise in addressing one of the

four problem areas identified above. For

psychiatric facilities, we have considered

several options for reforming Medicare’s

per discharge payment limits, which

currently treat facilities in either urban or

rural areas and facilities that are either

free-standing or hospital-based as if they

provided the same types of care and faced

the same operating constraints.

Medicare has six payment provisions

designed to protect access to inpatient care

for Medicare beneficiaries in rural

communities by providing extra payments

to their hospitals. Some of these policies

have been extended on a limited basis to

urban hospitals as well (see box, page 58).

Four programs—rural referral, sole

community, small rural Medicaredependent, and critical access—can be

characterized as offering favorable

payment methods to defined groups of

rural hospitals based on criteria that do not

relate to specific cost factors that are

beyond hospitals’ control. The sole

community hospital program, for

example, requires only that hospitals be

isolated as evidence of their critical role in

maintaining access to care. Although

isolated hospitals are perhaps more likely

than others to suffer from problems such

as small scale of operation, isolation itself

does not have a systematic effect on unit

costs.

Medicare’s goal of matching payments to

efficient providers’ unit costs is best met

by accounting directly in the payment

system for factors that are generally

outside management control and that have

substantial and systematic cost effects. In

assessing rural hospitals’ needs, therefore,

we will first attempt to develop targeted

payment adjustments that reflect the most

important cost-determining factors, or,

where feasible, to improve the accuracy of

existing payment adjustments. Often this

will affect payments to all hospitals, not

just rural ones.

If successful, this approach may reduce or

even eliminate the need for some of our

current special payment provisions, and

we will review these existing programs to

determine whether and under what

conditions they might be phased out. If the

approach ultimately proves infeasible,

however, it may be necessary to consider

options, including cost-based or cost-plus

payment for select facilities, a blend of

cost-based and prospective payment, or

various types of subsidies or grant

programs. At this point, we still believe

that the Congress and the Health Care

Financing Administration (HCFA) can

modify the inpatient PPS to meet the

needs of most rural hospitals, and we are

not likely to know whether additional

alternatives are needed until a number of

system changes are implemented and their

impacts evaluated.

We must consider all of these policy

options in a broader context. Acute

inpatient care is only one of numerous

services a hospital may provide. Inpatient

Report to the Congress: Medicare in Rural America | June 2001 57

Policy options for inpatient hospital care covered 

by the Medicare prospective payment 

system in rural areas

Options that do not target payments to specific cost factors

• Maintain rural referral center program

• Maintain sole community hospital program

• Maintain small rural Medicare-dependent hospital program

• Maintain critical access hospital program

• Raise the rural base payment rate

Options that address specific problems in the payment system

Problem: Small scale of operation

• Implement a low-volume adjustment

• Add an access-related eligibility standard to the low-volume adjustment 

Problem: Longer lengths of stay, possibly resulting from limited access to post-acute care services

• Extend expanded transfer policy to all diagnosis related groups and return savings to 

base payments

• Apply the skilled nursing facility prospective payment system to swing beds

• Extend the expanded transfer policy to swing beds

Problem: Limitations in input price adjustment—

relating to occupational mix in the wage index

• Adjust for occupational mix (future)

• Implement a wage index floor

• Compress wage index values toward the mean

• Speed up the phase-out of teaching physician data

relating to labor markets used for the index wage

• Redefine labor markets (future)

• Continue to rely on geographic reclassification

relating to the labor share to which the wage index is applied

• Reduce the labor share

• Use hospital-specific labor shares

Problem: Unequal disproportionate share payments

• Use a broader definition of low-income share and consistent distribution formula (future)

• Raise the cap on disproportionate share payments

Source: MedPAC.

TABLE

4-1
58 Improving payment for inpatient hospital care in rural areas

Medicare’s current special payment provisions

Over the years, the Congress 

has enacted a variety of 

policies that provide special

payments to certain types of rural

hospitals. These policies are intended to

support rural hospitals that are

important or solitary sources of medical

services for Medicare beneficiaries.

Medicare has designated four groups of

hospitals to receive special Medicare

payments—rural referral, sole

community, small rural Medicaredependent, and critical access hospitals.

The program also has developed two

other focused payment policies for

rural hospitals: geographic

reclassification and swing beds (though

reclassification is not limited to rural

hospitals). This section describes each

program, the criteria to qualify, and the

special payments provided to qualified

hospitals. More information about each

program is available in Appendix B.

Geographically reclassified

hospitals

Geographic reclassification allows a

hospital to be paid under the wage

index, base rate, or both of another

area. Both urban and rural hospitals

may be reclassified. Hospitals apply

separately to receive another area’s

wage index or to receive the base rate

for large urban areas, which is 1.6

percent higher than the rate for other

urban and rural areas.a

To qualify, a hospital must demonstrate

that its area wage index and/or base

payment rate does not adequately

address the input costs it faces, and it

must prove proximity and similarity to

the area of reclassification. Proximity

may be based on distance or

employment patterns. Separate

similarity tests apply to reclassification

for wage index and base payment rate,

but the hospital must seek

reclassification to the same area for 

both. For wage index reclassification, a

rural hospital’s wages must be more

than 106 percent of the average for its

own area and at least 82 percent of the

average in the area to which it seeks

reassignment. For base rate

reclassification, a hospital must

demonstrate that its costs are closer to

the amount it would be paid if it were

reclassified than to the amount under its

current classification.

Rural referral centers

The rural referral center (RRC)

program was established to support

high-volume rural hospitals that treat a

large number of complicated cases and

function as regional or national referral

centers. In the first year of the program,

only rural hospitals with 500 or more

beds received special treatment as

referral centers. Congress subsequently

liberalized the definition, requiring that

rural hospitals either have 275 or more

beds available for use, or meet other

criteria relating to discharge volume,

case mix, specialty composition of

medical staff, source of inpatients, and

referral volume.

When the inpatient prospective payment

system (PPS) maintained separate rates

for urban and rural areas, RRCs were

paid the urban base payment rate.

Today, rural areas and urban areas of

fewer than 1 million people have the

same base payment rate, so RRCs

generally receive the same base

payment as any other rural facility.

However, they still receive preferential

treatment in two ways. First, RRCs must

meet less stringent standards for

geographic reclassification to another

wage index area; they do not have to

meet the proximity criteria, nor must

they show that their average wage

exceeds 106 percent of their actual

area’s average. Second, RRCs may

receive higher disproportionate share

(DSH) payments than small urban and

most other rural hospitals receive

(although their formula is still less

advantageous than that available to large

urban hospitals). Before the Medicare,

Medicaid, and SCHIP Benefits

Improvement and Protection Act of

2000 (BIPA), RRCs also could qualify

more easily for DSH payments than

other rural hospitals because of a

marginally lower eligibility

requirement.

Sole community hospitals 

The sole community hospital (SCH)

program was created to maintain access

to needed health services for

beneficiaries in isolated communities.

The SCH program provides higher

payments to hospitals that are

geographically isolated—and thus are

believed to play a critical role in

providing access to acute care—and

that had above-average costs in a base

year for the mix of patients they served.

To qualify as an SCH, a hospital must

be 35 road miles from the nearest

similar hospital, or meet other criteria

designed to establish that it is a

community’s sole source of care.

SCHs receive the higher of a per-case

payment based on their inpatient costs

per discharge updated from 1982, 1987,

or 1996 or PPS payment with more

liberal access to DSH payments.b A

hospital’s base year costs per discharge

are updated to the current year by the

PPS operating update factor and

adjusted to reflect its current case-mix

index (CMI). If the SCH receives the

PPS rate and qualifies for a DSH

adjustment, the adjustment is up to 10

percent rather than the maximum of

5.25 percent received by most other

rural hospitals. Further, SCHs are not

required to meet the proximity

requirement of geographic

reclassification.

(continued next page)

a A large urban area has a population of more than 1 million.

b The option for a 1996 base year was added by the Balanced Budget Refinement Act of 1999 and went into effect for fiscal year 2001.
Medicare’s current special payment provisions 

Report to the Congress: Medicare in Rural America | June 2001 59

c The CAH program replaced the essential access community hospital, rural primary care hospital, and Montana medical assistance facilities programs, which

had similar features.

(continued from prior page)

Small rural Medicare-dependent

hospitals

The small rural Medicare-dependent

hospital (MDH) program was created

to provide financial protection to

hospitals for which Medicare revenue

makes up a large share of total

revenues. These hospitals were

believed to be more vulnerable to

inadequate payments under the PPS

than otherwise similar rural facilities.

To qualify for MDH designation, a

facility must be located in a rural area,

have no more than 100 beds, not be

classified as a sole community hospital,

and have at least 60 percent of inpatient

days or discharges attributable to

Medicare patients.

Medicare-dependent hospitals are paid

similarly to sole community hospitals,

receiving the greater of the PPS rate or

base year costs from 1982 or 1987

trended forward. MDHs, however,

receive half of the difference between

PPS and cost-based payments when

their trended per case cost is higher,

and they do not receive the option of

1996 base-year costs. Also, MDHs do

not receive preferential treatment for

DSH payments or geographic

reclassification.

The MDH designation was originally

restricted to hospitals that qualified in

1987, but the BIPA added the option

for hospitals to qualify based on an

average of two of the last three years of

data. However, a Health Care

Financing Administration (HCFA)

analysis found that all hospitals eligible

under the new qualification rules were

already designated as MDHs.

Critical access hospitals 

The critical access hospital (CAH)

program was established by the

Balanced Budget Act of 1997 to ensure

that beneficiaries in isolated rural

communities had access to emergency

room and limited inpatient services,

including the capacity to stabilize

patients and arrange transport to an

appropriate larger hospital for complex

cases. The program is intended to

provide an adequate financial base for

facilities in rural areas that cannot

support a full-service hospital.c

To qualify for CAH designation, a

hospital must be located more than 35

miles from the nearest similar hospital

and have an average length of stay not

exceeding 4 days. A state governor

may also designate as a CAH a hospital

that does not meet the distance

requirement, subject to the Secretary’s

approval. A CAH must provide 24-

hour emergency care services and have

no more than 15 acute-care beds and 10

swing beds.

CAHs are paid their current Medicareallowable costs for inpatient and

outpatient services, and the BIPA

exempted their swing beds from the

skilled nursing facility (SNF) PPS.

CAHs that operate distinct-part SNFs

or home health agencies, however, are

subject to the PPSs for those services.

Full cost-based payment provides more

protection than the payment approach

of the SCH and MDH programs, which

limit the rate of growth in per-case

payments from a base year. Under the

SCH and MDH programs, a facility

could receive Medicare payments that

do not cover its costs of inpatient

services.

Swing beds 

A swing bed is a hospital bed that can

be used to provide either inpatient or

post-acute care. The swing bed

program is intended to enhance access

to post-acute care in rural communities.

It allows rural hospitals to provide SNF

services to Medicare patients and other

long-term care services to Medicaid

patients.

To qualify as a swing-bed provider, a

rural hospital must have fewer than 100

beds. If required by the state, the

hospital must have been granted a

certificate of need for the provision of

long-term care services.

Hospitals with swing beds are paid the

average Medicare rate per patient day

for routine services provided in

freestanding SNFs in their census

region. Ancillary services are

reimbursed on a reasonable cost basis,

with costs determined in a manner

comparable to that of all other ancillary

services provided by the hospital.

HCFA has proposed applying the SNF

PPS to swing beds in October 2001—

three years after the system’s

implementation. 

care commands a smaller share of

resources in rural than in urban hospitals,

and coordination of inpatient services with

ambulatory, post-acute, and long-term

care is critically important. In addition,

many of the problems we discuss for

inpatient services (small scale of operation

in particular) may also apply to the other

services that rural hospitals typically

furnish; consequently, some of the

potential solutions may have wider

applicability.

We must also recognize that isolated rural

communities face travel and resource

constraints. Health care must be delivered

locally, and some rural markets cannot

realistically generate the demand or attract

the human and capital resources needed to
operate a hospital—particularly one that

furnishes acute medical and surgical

services. This problem is no different for a

hospital than it would be for a community

college or shopping center, and Medicare

should not be the vehicle for funding

community development. Rather,

Medicare should pay for the efficient costs

of providing services to Medicare

beneficiaries, recognizing that such costs

may be higher (measured either per capita

or per unit of service) in communities that

are small but still capable of supporting

facility-based health services.

Financial performance of

rural hospitals

Medicare is the largest purchaser of health

services from hospitals and plays a larger

role for rural hospitals than for those in

urban areas. Although rural hospitals tend

to fare poorly under Medicare relative to

their urban counterparts, their total

margins—which incorporate all sources of

revenue—have been consistently higher.

To provide context for the policy options

explored in the chapter, this section

compares cost trends, Medicare margins

and total margins of rural hospitals with

those of urban facilities. The section also

examines the special payments provided

under Medicare to certain rural hospitals

and compares their value with that of the

special payments that tend to benefit

urban hospitals.5

Financial performance under

Medicare 

The Medicare inpatient margin is lower

for rural hospitals than urban hospitals due

to lower payments and relatively higher

cost growth.6 Differences in payment

levels have been relatively constant over

time; most DSH and indirect medical

education (IME) payments go to urban

hospitals and contribute substantially to

their higher margins. But the cumulative

change in costs per case between 1990

and 1999 was over 15 percentage points

higher for rural hospitals than for urban

ones; this has caused the gap in the

inpatient margin to grow steadily, to

nearly 10 percentage points (Table 4-2).

The current difference in inpatient

margins between rural and urban hospitals

appears to be due as much to higher rates

of cost growth for rural hospitals as to

inherent differences in payment policy.

Much of rural hospitals’ higher growth in

costs per case appears to have been caused

by smaller reductions in length of stay.

Since 1989, urban hospitals’ length of stay

declined 34 percent, compared with 25

percent for rural facilities. Although

additional analysis is needed, the larger

drop for urban hospitals may be due

largely to better access to providers of

post-acute and follow-up ambulatory care

in their service areas. Higher cost growth

in rural areas may also reflect a lack of

hospital competition and low levels of

managed care penetration.

The aggregate percent increase in

payments resulting from additional

payments to hospitals in Medicare’s

special rural programs, as well as from

geographic reclassification, DSH

payments, and IME payments, is fairly

close for urban and rural hospitals (Table

4-3). This has occurred despite the vast

disparity in terms of actual dollar outlays

through these payment provisions to urban

and rural hospitals. Changes in DSH

payment policy under the Medicare,

Medicaid and SCHIP Benefits

Improvement and Protection Act of 2000

(BIPA) will bring the total impact of

special payment provisions for rural

hospitals (9.7 percent) close to that for

urban hospitals (11.5 percent).

Similar to the inpatient margin, the overall

Medicare margin is lower for rural

hospitals than urban hospitals, and the gap

has widened each year from 1996 through

1999.7 In 1998 and 1999 this margin was

negative for rural hospitals and the

disparity between urban and rural

hospitals reached 10 percentage points.

This is due to lower inpatient margins as

well as relatively higher shares of

outpatient and post-acute care, which have

the lowest payments relative to costs.

Financial performance for all

sources of revenue

Total margins for the hospital industry as

a whole fell substantially in the late 1990s,

but rural hospitals’ total margins have not

declined as much as those of urban

hospitals.8 Reduced margins were due to

slower growth in Medicare payments,

continued pressure from managed care

organizations and other private payers,

losses from alternate lines of service and

divestiture of these ventures, and a return

in 1998 and 1999 to cost increases after an

60 Improving payment for inpatient hospital care in rural areas

Hospital financial

performance, by 

urban and rural location, 1999

Medicare Overall

Hospital inpatient Medicare Total

group margin margin margin

Urban 13.5% 6.9% 2.9%

Rural 4.1 2.9 4.7

Note: 1999 data are preliminary; the inpatient and

total (all sources of revenue) margins are based

on two-thirds of hospitals covered by

prospective payment, while the overall

Medicare margin is based on one-half of

hospitals covered by prospective payment.

Source: MedPAC analysis of Medicare Cost Report

data from HCFA.

TABLE

4-2

5 For a more detailed comparative analysis of financial performance, see Appendix C, which includes financial analyses for groups of rural hospitals over the last decade

as well as a full accounting of the value of Medicare’s special payments for rural and urban hospitals.

6 The inpatient margin is calculated (in percentage terms) as the difference between inpatient payments and Medicare-allowable inpatient costs (as derived from the cost

report each hospital submits to HCFA) divided by inpatient payments. The same general approach is used for the overall Medicare margin and the total margin.

7 The overall Medicare margin measures Medicare’s payments and associated costs for graduate medical education activities plus Medicare’s five largest hospital

services—inpatient care covered by the PPS, inpatient rehabilitation and psychiatric units, outpatient departments, hospital-based home health agencies, and hospitalbased skilled nursing facilities.

8 The total margin reflects all patient care services—those covered by all payers and uncompensated care—plus non-patient sources of revenue.
era of very low or negative cost growth.

Private-sector pressure and business losses

occurred most frequently for urban

hospitals, allowing rural hospitals to fare

relatively better during this period.

Rural hospitals’ total margins are higher

because their payments from private

payers exceed associated costs by far

more than those of urban hospitals. These

above-cost payments—more than 34

percent higher than costs throughout the

1990s—continue to offset lower Medicare

and Medicaid margins despite rural

hospitals having a smaller proportion of

private-sector business and higher cost

growth in recent years. Private-payer

payments to urban hospitals, in contrast,

have fallen from 132 percent of costs in

1995 to 114 percent in 1999.9 Privatepayer payments are higher in many rural

areas primarily because of limited hospital

competition and low levels of managed

care penetration.

A hospital survey jointly sponsored by

HCFA and MedPAC has found that the

total margin for all hospitals improved to

4.7 percent in fiscal year 2000, from 3.2

percent for 1999. A key factor in this

improvement appears to be better

negotiation with managed care

organizations and fewer one-time losses

from leaving alternate lines of business—

neither of which are applicable to most

rural hospitals. Thus, the increase in

2000—along with the drop in 1999—

appear to be primarily urban hospital

phenomena, and we expect that in 2000

the gap in total margin between urban and

rural hospitals will close somewhat.10

Financial performance by

degree of ruralness 

Hospitals located in the most isolated rural

areas tend to have substantially higher

Medicare inpatient margins than other

rural hospitals, and fewer have negative

margins (Table 4-4). This suggests that

the special payment programs that target

isolated hospitals have—on average—had

a positive effect. The overall Medicare

margin is also higher for the most isolated

rural hospitals relative to other rural

hospitals.

Although large urban hospitals and the

most isolated rural hospitals have the

highest Medicare inpatient margins, they

have the lowest total margins. Efforts to

increase Medicare payments to hospitals

in these areas may have had a favorable

impact, but they may not be enough to

make up for other market pressures. Large

urban hospitals face the most financial

pressure from uncompensated care and

managed care, while isolated rural

hospitals face pressures from low patient

volume and difficulty in attracting skilled

workers. These pressures underscore the

conclusion that the problems of these

hospitals extend to factors beyond

Medicare.

Report to the Congress: Medicare in Rural America | June 2001 61

Total value of

Medicare special

payment provisions

for urban and rural

hospitals, 2000

Additional

payments

Amount

(billions) Percent

Under previous policy

Urban hospitals $7.2 11.4%

Rural hospitals 0.8 8.0

With legislated increase in

disproportionate share payments

under the BIPA

Urban hospitals 11.5

Rural hospitals 9.7

Note: BIPA (Medicare, Medicaid, and SCHIP

Benefits Improvement and Protection Act of

2000). Additional payments refers to the

difference between what hospitals received

under prospective payment and what they

would have received without special payment

provisions. The BIPA lowered the

disproportionate share (DSH) eligibility

threshold and raised the DSH adjustment rate

for rural hospitals and urban hospitals with

fewer than 100 beds.

Source: MedPAC analysis of data from HCFA.

TABLE

4-3

Hospital financial performance, by 

urban and rural location, 1999

Medicare Overall

inpatient Medicare Total Hospital location (UIC) margin margin margin

Urban, in an MSA (1,2) 13.5% 6.9% 2.9%

Rural

Adjacent to an MSA and includes a town

with at least 10,000 people (3,5) 3.1 3.2 4.5

Adjacent to an MSA but does not include 

a town with at least 10,000 people (4,6) 6.0 2.2 3.9

Not adjacent to an MSA but includes a 

town with at least 2,500 people (7,8) 4.5 2.7 5.3

Not adjacent to an MSA and does not 

include a town with at least 2,500 

people (9) 8.4 0.1 0.4

Note: UIC (urban influence code, as defined by the U.S. Department of Agriculture). MSA (metropolitan statistical

area, as defined by the U.S. Office of Management and Budget). Data are preliminary; the inpatient and

total (all sources of revenue) margins are based on two-thirds of hospitals covered by prospective payment,

while the overall Medicare margin is based on one-half of hospitals covered by prospective payment.

Source: MedPAC analysis of Medicare Cost Report data from HCFA.

TABLE

4-4

9 Findings based on MedPAC analysis of data from the American Hospital Association Annual Survey of Hospitals.

10 The effect of stock market losses on non-operating revenue could mitigate these gains. However, the margins data cited reflect hospitals’ experience through September

2000, a period in which substantial equity losses had already occurred.
Policy options that do not

target payments to

specific cost factors

Medicare’s rural referral, sole community,

small rural Medicare-dependent, and

critical access hospital policies attempt to

address perceived financial hardship of

rural hospitals by providing financial

assistance to a group of hospitals without

targeting to a specific cost-increasing

factor that is beyond hospitals’ control.

One proposal for providing further

assistance to rural hospitals—raising the

rural base payment rate—also uses this

approach.

Current special payment

policies 

Rural hospitals in special payment groups

tend to have relatively higher inpatient

and overall Medicare margins, which

suggests that these policies have been

successful in raising payments for

qualifying hospitals. However, this does

not mean that the policies have targeted

special payments to the correct hospitals;

they may have included hospitals that do

not merit special payments or missed

hospitals that should receive them.

This section addresses the intent of the

current policies and how well they address

Medicare’s overarching goals of

preserving access to care for beneficiaries

and paying the efficient costs of providing

care. The critical access hospital (CAH)

program appears to play an important role

in preserving access to care and should

definitely be maintained. Funds expended

for the other three programs—rural

referral, sole community and small rural

Medicare-dependent—might in the long

run be better spent on payment

adjustments that target assistance to

factors that systematically increase the

costs or reduce the revenue of many rural

hospitals, as well as some urban facilities.

All existing programs must be maintained

in the short run, however, until new

payment policies have been implemented

and their effects evaluated.

Rural referral centers

The rural referral center (RRC) program

was intended to support high-volume rural

hospitals that treat complicated cases and

function as regional or national referral

centers. Because RRCs treat more

complex cases, it was presumed they

would compete with urban hospitals for

skilled staff, making their compensation

costs more like those of urban than rural

hospitals.

Many of the current RRCs do not reflect

the original intent of the policy. Some are

classified as RRCs when they no longer

are located in a rural area, do not meet the

bed size requirement, or no longer meet

criteria relating to case mix, discharge

volume, staffing, or referrals. Although

RRCs might have higher costs attributable

to treating more severely ill patients, these

costs are accounted for by the payment

system. The same holds true for costs

associated with teaching activities and

higher wages. After taking these factors

into account, we found that these

hospitals’ costs are not above average.

RRCs follow more lenient geographic

reclassification criteria than other

hospitals. Although their wages must be at

least 82 percent of those in the area to

which they seek assignment, they need not

be located within 35 miles of that area nor

have wages at least 106 percent of those in

their own area. Consequently, 80 percent

of RRCs are reclassified, compared with

13 percent of other rural hospitals.

Geographic reclassification appears

necessary in the short run to compensate

for the large rural labor areas Medicare

uses for application of the hospital wage

index.11 However, the exception from the

wage rate criteria granted to RRCs

appears overly broad. If these hospitals

employ a more expensive staff mix and

pay higher wages than other rural

hospitals in their states, their average

wage rate should exceed the 106 percent

threshold required for reclassification. In

such a case, a waiver from the rule would

not be necessary; otherwise, this benefit

may not be appropriate.

In fiscal year 2000, half of the 177 RRCs

reclassified to a new area had wages that

were not above 106 percent of the

statewide rural average; therefore, these

hospitals qualified for reclassification

solely because of their RRC status. Of

those reclassified, nearly one-quarter had

wages below the statewide rural average,

and thus were already receiving favorable

payments relative to their labor costs.

RECOMMENDATION 4A

The Congress should require that

rural referral centers’ wages exceed

the average wage in their area to

qualify for geographic

reclassification, but these facilities

should retain their waiver from the

proximity rule.

RRCs should maintain their waiver from

the 35-mile proximity rule at least until

labor markets are redefined and the wage

index is adjusted for differences in

occupational mix. RRCs are frequently

located close enough (although not

necessarily within 35 miles) to one or more

urban areas that, given their specialized

services, they might be expected to

compete with hospitals in those areas for

skilled personnel.

Sole community hospitals

The sole community hospital (SCH)

program has probably helped to preserve

access to care in isolated and sparsely

populated communities by targeting

hospitals that have higher-than-average

costs given their circumstances. Our

analysis documented these higher costs

after accounting for other factors that could

affect costs, such as low volume, case mix,

and teaching activity. The higher costs of

SCHs could be due to factors other than

scale, such as longer lengths of stay linked

to an inability to place patients into

appropriate post-acute care.

The SCH program, however, has two

distinct disadvantages. First, payments

based on hospital-specific costs do not

necessarily align payments to the efficient

cost of production. A hospital’s base-year

costs may have been relatively high given

its volume and case mix at the time,

62 Improving payment for inpatient hospital care in rural areas

11 This issue is discussed in greater detail later in the chapter.
reflecting inefficiency. In addition,

although adjusted for current-year case

mix, base-year costs do not relate a

hospital’s payment rate to its current

volume, which has a strong relationship

with underlying costs. A hospital’s base

rate for SCH payment reflects its volume

in the base year, but volume may have

increased—or more likely dropped—

significantly since then. In the Balanced

Budget Refinement Act of 1999 (BBRA),

the Congress allowed for more current

base-year costs by adding a 1996 baseyear option to the 1982 and 1987 options

previously in law, but this will quickly

become outdated as well.

Second, SCH policy is not linked to any

specific cost-raising factor and therefore

may not target the correct facilities. Some

relatively isolated hospitals are not SCHs

because the distance criterion (35 miles to

the nearest similar facility) is rather strict.

Conversely, not all isolated hospitals have

low volume or other factors outside their

control, and PPS payments may be

appropriate for these facilities. Finally, not

all SCHs are isolated; only 13 percent of

SCHs would meet even a liberalized

standard of 25 road miles from the nearest

PPS hospital or CAH.12

A set of PPS payment adjustments might

raise the payments of isolated rural

hospitals enough that few would continue

to benefit from a base payment trended

forward. However, we believe it will be

necessary to maintain the SCH program

until a new set of more targeted payment

adjustments is implemented and their

impact is known. Then the Congress and

HCFA could consider phasing out this

program if it appears to have become

redundant or only benefits facilities that

do not merit special payments. At that

point, continued extra payments to SCHs

might result from cost inefficiencies

implicitly supported by cost-based

payments, but could also be due to other

legitimate cost-raising factors. It will

likely take several years for all the

necessary policy changes to be fully

implemented, so the program should at the

least be kept in place on an interim basis,

and the need to maintain it permanently

cannot be ruled out.

Small rural Medicare-dependent

hospitals

The small rural Medicare-dependent

hospital (MDH) program is intended to

provide financial protection to hospitals

whose relatively large share of Medicare

patients may make them vulnerable to

inadequate payments under the PPS. The

MDH program probably has done less to

preserve access to care than the SCH

program has; we have found that MDHs

have lower-than-average costs (after

taking into account other factors reflected

in the payment system) and the highest

inpatient margins of all rural hospital

groups.

Like the SCH program, the MDH

program does not necessarily align

payments with efficient costs and

qualification is not linked to any specific

cost-raising factor. It appears that the

principal argument in favor of the MDH

program concerns the extra vulnerability

to Medicare payment policy of hospitals

with a greater dependence on Medicare.

This is not an insignificant consideration,

but we would prefer to develop a system

that recognizes the unique characteristics

and problems of rural hospitals so that

dependence on Medicare is not a factor.

As with the SCH program, the MDH

program should be reviewed after targeted

payment adjustments are implemented

and their impact is known. If the MDH

program becomes redundant or only

benefits facilities that do not merit special

payments, it could be phased out.

Critical access hospitals

The CAH program is designed to provide

an adequate financial base for facilities

located in isolated rural areas that cannot

support a full-service hospital. The

program has played a valuable role in

maintaining access to care for Medicare

beneficiaries, and appears to have actually

improved access to care. Some facilities

that closed before the program was

implemented have since reopened as

CAHs. Further, the cost-based payment

used for CAHs is probably appropriate

given their very low volume. However,

while cost-based payment may be justified

in preserving access in resourcechallenged communities, it does not

promote the efficient production of

services and thus should not be relied

upon more than necessary.

Growth in the number of CAHs has been

substantial over the last year. In April

2001, there were 375 CAHs, compared

with 219 in the fall of 2000. CAHs now

make up more than 17 percent of all rural

hospitals, and this number will almost

certainly increase. This rapid growth

reflects a number of factors, including

continued loss of volume and increased

unit costs in many rural hospitals, a BIPA

provision clarifying cost-based payment

to laboratory services for CAHs, and

hospitals’ efforts to avoid the effects of

the outpatient PPS.

CAHs are heavily concentrated in a small

number of states, especially in the Great

Plains region. As of March 2001, five

states—North Dakota, South Dakota,

Nebraska, Kansas, and Oklahoma—had

119 CAHs total; Nebraska alone had 44.

Conversely, California, Wyoming, and

Mississippi had one each, while Utah,

Arizona, and Alabama had none. Texas,

with the largest rural land mass of any

state besides Alaska and with among the

most hospitals of any state, had only nine

CAHs.

The rapid increase in the number of CAHs

has included some facilities that may fall

outside the intent of the program. For

example, the liberalized length of stay

requirement (from a maximum of four

days per admission to an average of four

days) may pave the way for some

hospitals to qualify for cost-based

payment without any change in

organization. In addition, some hospitals

that do not meet the 35-mile requirement

Report to the Congress: Medicare in Rural America | June 2001 63

12 Because CAHs are not considered full-service inpatient providers, HCFA does not count them as a similar facility in determining whether an applicant for the SCH

program meets the 35-mile requirement. As such, one hospital becoming a CAH might result in another hospital in the community becoming eligible for the SCH

program. This suggests that as the CAH program grows (at a rate of over 65 percent in the last year), so too could the number of SCHs. There are now more than 830

SCHs, 75 more than two years ago, and HCFA reports applications in 2001 that may raise that number further.
have been designated as CAHs by their

state governors, although this is done in

the context of a comprehensive state plan

(required by HCFA) for the delivery of

health care in each state’s rural areas.

The advantages to a hospital of cost-based

payments for inpatient, outpatient, and

swing-bed services could be substantial.

Very small rural hospitals—including

CAHs—provide a relatively greater

proportion of outpatient and post-acute

services. However, approximately one in

three CAHs operate rural health clinics in

place of outpatient departments, to take

advantage of full cost-based

reimbursement over Medicare’s former

policy of paying discounted costs for

outpatient services. These hospitals would

still receive the preferential payment for

their rural health clinics without CAH

status.

Despite the potential benefits, the CAH

program can limit a provider. Cost-based

payments may not be viable in the long

run because a CAH can never achieve a

positive margin for Medicare services to

help fund uncompensated care or capital

development. In effect, the only way a

CAH can generate above-cost revenues is

by finding ways to allocate more of its

overhead or ancillary costs to Medicare on

its cost report, behavior that we would not

want to encourage.

The requirements to qualify as a CAH can

also limit a hospital’s ability to offer a

range of services. The average length of

stay requirement may affect the ability to

provide psychiatric and rehabilitation

services, which tend to have longer-thanaverage lengths of stay and would be

included in calculation of the facility’s

average length of stay for CAH

qualification. The practical effect is to

make such units unlikely for CAHs,

possibly reflecting that these services

were not viewed as “critical” in the same

way that emergency room and basic

inpatient services were when the CAH

program was established.

By implementing PPS payment

adjustments targeted to small and isolated

rural hospitals—particularly a low-volume

adjustment, as discussed in the next

section—we may be able to make PPS

rates attractive enough to enable many

small hospitals to conclude that they need

not apply for CAH status. This would

minimize Medicare’s exposure to costbased payment. Under current law,

hospitals are not allowed to return to PPS

status once they have been designated

CAHs, but if targeted payment changes

that would affect them are implemented,

HCFA should consider (and Congress

could require) allowing CAHs to return to

PPS.13

An adjustment to inpatient payments

based on low volume may not work well

for many CAHs, in part because volume is

inherently unstable at low levels; below a

certain number of cases, the adjustment

required to ensure an adequate revenue

flow over time may be unappealing to

Medicare as a purchaser of such services.

In addition, the benefit to the hospital of

avoiding lower payments from the

outpatient PPS may be greater than the

value of the inpatient adjustment. For

these facilities, removal from the PPS

through the CAH program may be the

best option.

However, we believe the CAH program

should be restricted to its intended

purpose—ensuring that beneficiaries in

small and isolated rural communities have

access to emergency room services and

basic inpatient care, including

stabilization and transfer of complex

cases. Cost-based payment is appropriate

for that purpose, but should not be

extended to mainstream inpatient services

in larger communities. The higher

payments afforded by a set of targeted

PPS payment changes may be enough to

prevent this through incentives, but the

Congress and HCFA should also keep

growth of the program in check by

avoiding further liberalization of the

qualification criteria. The bed size, length

of stay and distance requirements, while

restrictive, help to target facilities that

play an important role in maintaining

access to care and yet are unable to

operate as full-service hospitals.

Raising the rural base

payment rate 

The inpatient PPS originally had separate

base payment rates for urban and rural

hospitals, but Congress began phasing out

the “rural differential” in the early 1990s.

Although the same base payment rate now

applies in rural areas and most of the

metropolitan statistical areas (MSAs) they

share borders with, hospitals in large

MSAs (those with more than 1 million

people) still have a 1.6 percent higher base

rate.

This differential, together with the IME

and DSH payments made to teaching

hospitals concentrated in large urban

areas, has contributed to a sizable gap in

Medicare inpatient margins by geographic

area. The 1999 margin in large urban

areas was 16.2 percent, compared with 9.0

percent in other urban areas and 4.1

percent in rural areas. The pattern for total

margins, however, is just the opposite: 2.2

percent for large urban, 4.1 percent for

other urban, and 4.7 percent for rural

areas.

The split in base payments has created

interest in raising the rate shared by rural

and other urban areas to the level of the

large urban rate, primarily as a method of

improving payments to rural facilities.

This could be done budget neutrally

through differential updates (as Congress

did previously in eliminating the rural

differential) or with new monies.

Arguments can be offered for and against

raising the rural (and other urban) base

rate. On the one hand, rural hospitals’

costs per discharge remain below those of

urban hospitals after controlling for other

factors accounted for in the payment

system (such as teaching activity and

wage levels). On the other hand, hospitals

in large urban areas do not have higher

costs than those in other urban areas.

Thus, implementing a single base

payment rate would have a mixed impact

in terms of matching payments to

underlying treatment costs across broad

groups of hospitals. One could argue that

there is an advantage to applying a single

64 Improving payment for inpatient hospital care in rural areas

13 It is important to remember that a hospital’s decision on whether to apply for or retain CAH status would consider outpatient and swing bed payments along with

inpatient payments. In addition, safety code issues might prevent some CAHs from returning to the PPS.
base payment rate to all hospitals and then

using targeted payment adjustments to

account for costs that differ

geographically and that are outside the

control of hospital managers. With one

base rate, the payment system would have

one less set of borders.

From a different perspective, raising the

rural base payment rate would not

necessarily offer the most accurate means

of targeting the payment change to

significant cost factors affecting rural

providers. Later in the chapter, we discuss

the option of extending Medicare’s

expanded transfer policy, which reduces

payments for cases with unusually short

lengths of stay, from 10 diagnosis related

groups (DRGs) to all DRGs and returning

the savings to the base payment rates.

Thus, we have two options that could

raise rural hospitals’ base payment rates

by similar amounts, but the methods of

funding are quite different:

• For eliminating the differential in

base payment rates, all hospitals in

large urban areas pay for the increase,

regardless of underlying costs or

financial performance.

• For extending the expanded transfer

policy, those hospitals (urban or

rural) that have been successful in

raising their inpatient margins by

reducing length of stay, at least partly

through good access to post-acute

care services, pay for the increase.

We believe that our recommendations for

targeted payment adjustments (discussed

in the next section) will make enough

progress in improving the accuracy of

inpatient payments (to the benefit of many

rural hospitals) that implementing a single

base payment rate should not be

necessary. Equalizing the base rate would

have major financial implications,

requiring either a large appropriation or an

extensive redistribution of payments. If

implemented with new monies, the

change would raise payments to rural and

other urban hospitals by 1.1 percent and

1.3 percent, respectively, and would

increase Medicare’s expenditures by

about $480 million per year. If done

budget neutrally, it would raise rural and

other urban hospitals’ payments by 0.5

percent and 0.7 percent, respectively, but

would reduce the payments of large urban

hospitals by 0.6 percent.

Specific problems and

solution options

This section discusses the four key

problems hospitals face with the Medicare

inpatient PPS—small scale of operation,

the treatment of length of stay, limitations

in input price adjustment, and unequal

disproportionate share payments—and

reviews potential solutions. We

recommend implementing a low-volume

adjustment, speeding up the phase-out of

certain categories of wages from the wage

index, investigating whether the labor

share used for the wage index should be

reduced, and raising the cap on rural

hospitals’ DSH payments.

Small scale of operation

Making Medicare payments approximate

an efficient provider’s costs requires

accounting for factors beyond providers’

control that may affect the costs of

furnishing services. Patient volume may

be one such factor, particularly in small

and isolated communities where some

providers cannot achieve the economies of

scale and service scope of their larger

counterparts and thus have higher per-case

costs. The current PPS rates do not

directly account for the relationship

between cost and volume, potentially

placing smaller providers at a financial

disadvantage relative to other facilities.14

The critical access, sole community, and

small rural Medicare-dependent programs

benefit many small and isolated hospitals,

even though these programs do not

directly address the small-scale issue.

Eligibility for these programs is not well

targeted to low-volume hospitals,

however, and payments are based at least

partially on hospital-specific costs, which

may reflect poor management and other

provider inefficiencies. A low-volume

adjustment could deal with these issues

more directly.

Effects of low volume on costs

To determine whether low-volume

hospitals have higher costs than other

hospitals, we examined the relationship

between total (all-payer) inpatient volume

and Medicare costs per discharge.15 Our

analysis shows a statistically significant

relationship between discharge volume

and costs per case, after controlling for

cost-related factors in the payment

system.16 The volume and cost

relationship is most pronounced for

facilities with fewer than 200 discharges

per year (Figure 4-1), which have per-case

costs that are more than 20 percent higher

than average. The relationship levels off

after about 500 discharges.

Low-volume hospitals account for only a

small fraction of acute care facilities; 2

percent of hospitals have fewer than 200

discharges and 11 percent have fewer than

500. The vast majority of these facilities,

85 percent, are in rural counties. The

question then arises: which facilities are

low volume and do other payment

programs targeted to rural providers

address the low-volume issue in another

way?

Relationship to current policy

Hospitals’ financial performance under

Medicare’s inpatient PPS, as well as

across all payers, is strongly related to

Report to the Congress: Medicare in Rural America | June 2001 65

14 The exception is that sole community and small rural Medicare-dependent hospitals with more than a 5 percent drop in total discharges from one period to the next

may apply for an adjustment to their payment rates to partially account for the potentially higher patient care costs associated with the drop in patient volume.

15 Although Medicare payments are intended to cover the costs of Medicare patients, a hospital’s total volume of service determines its unit costs of production.

16 A statistically significant relationship also was observed when controlling for both payment system factors (such as teaching activity, wage levels, and case mix) and

other factors that are thought to affect providers’ costs but not used to set payment rates. These include additional measures of hospital outputs (length of stay, outpatient

visits, and non-acute patient days), more detailed patient-mix data, provider characteristics, and market attributes.
inpatient volume: the Medicare inpatient

and total margins both rise as volume

increases (Table 4-5). The Medicare

inpatient margin is negative for hospitals

with 500 or fewer discharges and is

–16.4 percent for those with fewer than

200 discharges. This provides a strong

indication that the payment system is not

responding to the influence of scale on

provider payments. It would appear that

low-volume providers are disadvantaged

by rates based on average volume and

that current programs targeted to rural

providers are not protecting these

facilities, despite the fact that the average

margin of hospitals in these programs is

above that of other rural hospitals.

Our analysis shows that 64 percent of

hospitals with 500 or fewer discharges

receive special treatment through one of

the three current programs targeted to

small rural hospitals—sole community,

small rural Medicare-dependent, and

critical access (Table 4-6). Given this

result, we must ask how well these

programs compensate for the additional

costs low-volume providers incur,

particularly when we see most lowvolume providers with poor financial

performance.

The MDH program is not effective at

identifying low-volume hospitals. Only

15 percent of the hospitals with 500 or

fewer discharges are classified as MDHs,

and just half of these receive payments

based partially on hospital-specific rates

trended forward. This result is not

surprising, because the qualifying criteria

for the MDH program have nothing to do

with costs and hospitals do not need high

Medicare penetration to suffer from the

effects of small scale. In fact, our

analysis found that MDHs have lowerthan-average costs, after controlling for

other cost-influencing variables reflected

in the payment system.

For sole community hospitals, the picture

is murkier. The program covers 27

percent of hospitals with fewer than 500

discharges, but this limited coverage

results from the requirement that

hospitals must be more than 35 miles

from another facility (although some are

closer than this because they were

grandfathered into the program or meet

other criteria). Because any hospital

meeting the 35-mile test will qualify, the

SCH program by definition covers all

isolated low-volume hospitals. Whether

the payments hospitals receive under the

program are adequate or appropriate is

another issue.

66 Improving payment for inpatient hospital care in rural areas

40

30

35

25

20

15

10

5

0

5

10

0 200 100 300 400 500 600 700 800 900 1000

Total (all-payer) hospital discharges

Variation from mean (in percent)

Relationship between hospital discharge

volume and costs per case, 1997

Source: MedPAC analysis of data from HCFA.

FIGURE

4-1

Financial performance of hospitals, 

by discharge volume, 1999

Baseline Medicare inpatient Total

Percent of Percent of

hospitals with hospitals with

Total discharge volume Margin negative margin Margin negative margin

Up to 200 16.4% 66.7% 1.6% 64.1%

201 to 500 2.1 50.2 0.0 49.1

501 to 1,000 4.6 39.0 0.3 45.3

1,001 to 2,500 5.0 37.7 2.4 36.2

2,501 to 5,000 6.5 32.7 2.5 31.1

5,001 to 10,000 10.1 24.0 3.6 31.2

10,001 to 20,000 12.3 19.4 4.0 28.7

More than 20,000 17.4 7.4 2.8 26.4

Note: PPS (prospective payment system). The baseline margin is the actual 1999 margin adjusted to reflect the

change in disproportionate share payments enacted by the Medicare, Medicaid and SCHIP Benefits

Improvement and Protection Act of 2000. Analysis based on data from two-thirds of the hospitals covered by

prospective payment in 1999, which includes some that have since been designated critical access hospitals.

Source: MedPAC analysis of data from HCFA.

TABLE

4-5
The critical access hospital program

provides assistance to another 22 percent

of low-volume hospitals.17 A large

proportion of CAHs, 70 percent, are low

volume, in part because these hospitals by

definition are small and thus likely to have

a low number of discharges.

Overall, 37 percent of low-volume

hospitals are not covered by any of the

three existing programs; among those that

are, a substantial portion does not benefit

from hospital-specific payment rates. This

leaves a fairly large number of lowvolume providers without any special

treatment.

Another consideration is whether existing

programs target providers that may not

need assistance, at least as it relates to low

volume. Almost three-quarters of MDHs

and SCHs and one-third of CAHs have

discharge volumes above the level at

which low volume is expected to

significantly increase costs.

A final issue concerns the importance of

inpatient services to low-volume

providers. Revenue from acute-care

inpatient services generally makes up a

small portion of business; inpatient

revenues accounted for less than 40

percent of total revenues in 88 percent of

hospitals with fewer than 500 discharges,

compared with only 34 percent of highervolume facilities. Although acute inpatient

services do not appear to be a primary

focus, this does not necessarily diminish

the importance of a low-volume

adjustment for these services. Rather, it

suggests that attention should be paid to

the payment mechanisms Medicare uses

for the other services that small and

isolated hospitals provide to ensure an

adequate overall level of financial

performance.

Access considerations

The issue of a low-volume adjustment is

most critical for isolated hospitals, where

the facility is important for maintaining

beneficiaries’ access to care. Such

facilities, because of their market

circumstances, have little ability to grow

and take advantage of economies of scale

and scope realized by larger facilities.

Adjusting payments for a low-volume

facility that is near other facilities,

however, is not a priority because

beneficiaries’ access to care is less likely

to be affected.

Low-volume hospitals are more isolated

than higher-volume hospitals, but most

low-volume hospitals would not meet the

35-mile distance standard used for

designating sole community hospitals.

Just over half of low-volume hospitals are

more than 25 road miles from the nearest

hospital, and a relatively small proportion,

14 percent, have a potential competitor

within 15 miles.18

Low-volume adjustment

Medicare’s PPS payment rates do not

reflect the higher unit costs of low-volume

hospitals, placing these facilities at greater

financial risk. Many low-volume facilities

are not near another hospital, and

therefore may play an important role in

maintaining beneficiaries’ access to

patient care services. A low-volume

adjustment with a distance requirement

would allow Medicare payment rates to

reflect the higher costs of low-volume

facilities that are important to patient

access. 19

RECOMMENDATION 4B

The Congress should require the

Secretary to develop a graduated

adjustment to the rates used in the

inpatient prospective payment system

for hospitals with low overall

volumes of discharges. This

adjustment should only apply to

hospitals that are more than a

specified number of miles from

another facility providing inpatient

care, with appropriate exceptions for

topography or weather conditions. 

The Commission believes that a lowvolume adjustment would strengthen the

current inpatient PPS by aligning

payments better with efficient providers’

costs. The adjustment should reflect the

basic underlying relationship between

patient volume and costs per case,

avoiding cliffs (points in the formula

where a small change in volume would

produce a large change in payment) that

might provide inappropriate incentives.

Report to the Congress: Medicare in Rural America | June 2001 67

Distribution of low volume hospitals,

by hospital type, 1997

Share of Share of hospitals

hospitals within group with Share of with 500 or 500 or fewer

Hospital type all hospitals fewer discharges discharges

Urban 54% 14% 3%

Rural 46 86 21

Sole community 13 27 23

Medicare dependent 6 15 26

Critical access 4 22 70

Other rural 25 beds 1 7 58

Other rural 25-50 beds 7 15 25

Other rural  50 beds 15 1 1

Total 100 100 11

Source: MedPAC analysis of Medicare Cost Report data from HCFA.

TABLE

4-6

17 The number of low-volume hospitals benefitting from the critical access hospital program today is likely larger, as the number of CAHs has risen since we developed the

count used in this analysis.

18 A beneficiary-level analysis of how far patients in isolated communities must travel for care would provide a more direct measure of access than the distance from each

hospital to the nearest alternative facility. But investigating that approach was infeasible given our time frame for this project.

19 As discussed in Chapter 5, we also intend to consider a low-volume adjustment for Medicare outpatient payments.
To avoid problems with annual volume

variation and to encourage stability in the

level of the adjustment and provider

payment rates over time, the volume

adjustment should be set for an individual

facility based on a multi-year average

volume. The level of the adjustment

should be periodically reexamined to

reflect improvements made in the

inpatient PPS that might affect the

measured relationship between volume

and cost.20

The Medicare program would not

necessarily want to reward a low-volume

hospital with a payment adjustment if it

were close to other facilities; such

proximity could be one reason for the low

volume. In addition, extremely low

volumes may pose a quality-of-care risk,

and Medicare would not want to

encourage hospitals operating at such

levels unless necessary to maintain access

to care. Including a distance requirement

with a low-volume adjustment would

alleviate some of these concerns. Further,

as long as a distance criterion is in place,

there is no reason to restrict a low-volume

adjustment to rural hospitals.

The low-volume adjustment also could be

applied to hospitals that are closer than the

distance criterion by basing the

adjustment on the pooled volume for all

facilities falling within the distance limit.

If one other hospital were within the

distance limit, for example, the size of the

low-volume adjustment would be based

on the combined patient volume of both

facilities. In essence, the low-volume

adjustment would be set as if there were

only one hospital in the community.

The distance measure used is an important

issue. The standard used for sole

community hospitals (35 miles) would be

fairly restrictive; only about 21 percent of

low-volume providers would qualify. But

a distance standard set at a lenient level,

such as 5 miles, would likely help

providers in markets in which it is not

clear that the low-volume hospital is

essential to Medicare beneficiaries’ access

to care. A 15- or 20-mile standard might

provide a reasonable tradeoff for

including facilities that are important for

beneficiary access to care while excluding

facilities that markets cannot support

because of overcapacity.

To illustrate the financial impact of a lowvolume adjustment, we simulated an

adjustment that increases payments by up

to 25 percent and drops to zero for

hospitals with more than 500 discharges.

This formula, for example, would provide

a 20 percent increase in payments for

hospitals with 100 discharges and a 10

percent increase for those with 300

discharges.21

The low-volume adjustment would not

increase Medicare spending much, but

could provide payment increases—some

substantial—to roughly 10 percent of

hospitals. In our illustration, Medicare

inpatient payments would increase by $17

million a year with a 15-mile distance

standard (or by $22 million without such a

standard). For all hospitals with up to 200

discharges, payments would rise by 8

percent with the distance standard (or by

11 percent without), and for those with

201 to 500 discharges, these impacts

would be 4 percent and 5 percent,

respectively (Table 4-7).

This simulation suggests that a lowvolume adjustment could substantially

improve the Medicare inpatient margins

of many of these facilities, including a

number of sole community and Medicare

dependent hospitals. About one-quarter of

the low-volume hospitals currently paid

based on hospital-specific rates under the

SCH or MDH programs would benefit

from the volume-adjusted PPS over the

hospital-specific rate.

A low-volume adjustment probably would

enable some CAHs to come back into the

Medicare inpatient PPS (if these facilities

were allowed to reverse their CAH status),

because the adjusted base payment would

be more reflective of their underlying cost

structure. In addition, many hospitals

might decide not to become CAHs if a

low-volume adjustment were provided.

Treatment of length of stay

Providers with longer-than-average

inpatient stays generally have higher percase costs. Several factors can increase the

average length of an inpatient stay:

• less access to post-acute care,

• a sicker and older patient population,

• local practice patterns, and

• provider inefficiencies.

Our analysis confirms that costs per case

tend to rise as length of stay increases. In

addition, costs per case decline with

increases in the volume of non-acute

inpatient days in the facility. This latter

relationship may reflect provider

substitution of post-acute days for

inpatient days, potential economies of

scope, or departmental cost shifting from

acute inpatient to other settings, but we

cannot discriminate among these three

factors using currently available data.

Effects of post-acute care

availability on costs

Under a fixed per-case payment system,

hospitals are rewarded for sending

patients to post-acute care earlier in their

stays. Providers with post-acute care units

discharge patients to these units more

often and earlier than hospitals without

post-acute services (ProPAC 1996).

A shortage of ambulatory and post-acute

care resources may prevent rural hospitals

from discharging patients as early in the

episode of care as urban hospitals would.

Substitution of post-acute services

(including skilled nursing, rehabilitation,

and home care) for the latter days of

inpatient stays was one of the key factors

68 Improving payment for inpatient hospital care in rural areas

20 Examples of policy changes that could affect the cost and volume relationship include case-mix refinements (such as all patient refined diagnosis related groups, which

the Commission recommended in its March 2000 report) and an occupational mix adjustment to the wage index (discussed later in this chapter).

21 The payment adjustment we simulated produces a multiplier that is applied to the PPS base payment rate for a case, in a manner similar to how the indirect medical

education and disproportionate share adjustments are applied. Only hospitals with fewer than 500 discharges would have their payments adjusted. The low-volume

adjustment multiplier  [1.25 – (0.0005  d)] if d  500; otherwise, the multiplier  1.0, where d  total inpatient acute care discharges. We assumed that hospitals

must be located at least 15 miles from the closest similar hospital to qualify for the low-volume adjustment.
behind a 33 percent drop in Medicare’s

acute care length of stay since 1989. The

drop has been greater for urban than for

rural hospitals (34 percent compared with

25 percent through 1999), which may

have increased rural hospitals’ relative

unit costs. The smaller decline in length of

stay leads us to believe that rural hospitals

may have longer absolute lengths of stay,

given the mix of cases they receive.

The drop in length of stay has differed

sharply by the degree of isolation of rural

hospitals (Figure 4-2). The cumulative

drop in length of stay since 1990 for

hospitals in rural areas with no town of at

least 2,500 people, for instance, was 13

percent, compared with 24 percent for

hospitals in areas that are not adjacent to

an urban area but still include a sizeable

town and 33 percent for urban hospitals.

This smaller drop appears correlated to the

change in costs per case, which has been

much higher for the most isolated rural

hospitals, and likely reflects the lesser

availability of post-acute services in

isolated and sparsely populated

communities.

Relationship to current policy

Medicare’s transfer payment policy is

intended to recognize that when hospitals

discharge patients to another provider,

they may not provide the full course of

care implied by the DRG payment.

Transfer cases with shorter-than-average

stays, therefore, are counted as partial

cases and paid a graduated per diem.

Before the Balanced Budget Act of 1997

(BBA), a case was considered a transfer

only if the patient was discharged from

one PPS hospital and immediately

admitted to another PPS hospital. The

BBA expanded the transfer policy to

include patients in 10 DRGs who are

discharged to PPS-exempt facilities or

SNFs, and some cases discharged to home

health care.

The decision to transfer a patient to a postacute care setting should be based on

clinical rather than financial

considerations, and Medicare’s transfer

payment policy should lessen the

influence of payment policy on clinical

decision making (MedPAC 2000a).

Report to the Congress: Medicare in Rural America | June 2001 69

Impact on Medicare inpatient margins of implementing

a low-volume adjustment with an access-related

eligibility requirement

Baseline After policy change

Percent of Percent of

hospitals with Change in hospitals with

Hospital group Margin negative margin payments Margin negative margin

All hospitals 12.4% 31.7% 0.0% 12.4% 30.5%

Urban 13.6 25.4 0.0 13.6 25.2

Rural 5.8 38.9 0.1 5.7 36.6

Rural referral 6.0 32.2 0.0 6.0 32.2

Sole community 5.9 32.0 0.1 6.1 31.5

Small rural Medicaredependent 10.2 30.7 0.3 10.5 28.6

Critical access 4.2 66.9 2.5 2.1 53.2

Other rural 50 beds 6.9 38.9 0.3 7.2 36.8

Other rural 50 beds 4.0 40.9 0.0 4.1 40.9

Urban

Low-margin 7.3 97.3 0.0 7.3 96.4

Mid-margin 6.5 0.0 0.0 6.5 0.0

High-margin 23.6 0.0 0.0 23.6 0.0

Rural

Low-margin 8.3 91.0 0.2 8.1 85.7

Mid-margin 6.9 0.0 0.1 7.0 0.0

High-margin 22.7 0.0 0.1 22.8 0.0

Total discharge volume:

Up to 200 16.4 66.7 8.2 8.5 57.7

Remaining in PPS 15.7 58.7 5.1 10.0 54.3

Moved to CAH 17.7 80.0 13.2 5.3 64.0

201 to 500 2.1 39.0 3.8 1.6 38.4

Remaining in PPS 1.1 40.9 3.0 4.0 34.9

Moved to CAH 8.9 70.6 5.2 3.5 45.9

501 to 1,000 4.6 37.7 0.0 4.6 39.0

1,001 to 2,500 5.0 32.7 0.0 5.0 37.8

2,501 to 10,000 9.0 28.2 0.0 9.0 28.2

More than 10,000 14.8 15.9 0.0 14.8 15.9

Note: PPS (prospective payment system). CAH (critical access hospital). Baseline margin is the actual 1999 margin

adjusted to reflect the change in disproportionate share payments enacted by the Medicare, Medicaid, and

SCHIP Benefits Improvement and Protection Act of 2000. Analysis based on data from two-thirds of the

hospitals covered by prospective payment in 1999.

The critical access groups include hospitals that were designated CAHs in 1999 or after, and the results

estimate what the baseline margin and impact of the policy change would have been had they remained in

the PPS. Those becoming CAHs before filing their 1999 Medicare cost reports were excluded from the

analysis due to lack of data.

Low-margin is defined as having a Medicare inpatient margin below zero in 1999, which included 17

percent of urban and 30 percent of rural hospitals. High-margin defined as above 12 percent, which

included 27 percent of urban and 21 percent of rural hospitals.

The formula used for this simulation is detailed in footnote 21.

Source: MedPAC analysis of data from HCFA.

TABLE

4-7
However, because the current transfer

policy is limited to 10 DRGs and does not

apply to hospitals transferring patients to

swing beds, its incentives are not spread

over all cases that use post-acute care.

Expanding the transfer policy to cover all

DRGs and all post-acute settings—

including swing beds—and returning any

savings to the base payment rates might

provide a more equitable distribution of

payments and help payments reflect the

market circumstances faced by hospitals

without access to post-acute providers.

Payments for long-stay cases would

increase and payments for short-stay cases

transferred to post-acute settings would

fall. Hospitals with swing beds also would

no longer receive what is essentially a

partial double payment for care. If the

transfer policy was expanded to all DRGs

in a budget-neutral manner, rural hospitals

on average would benefit from the higher

base payments. Payments likely would

fall on average for urban hospitals, which

may have easier access to, and hence are

more likely to use, post-acute care

providers. The Commission will examine

the financial impact and other

implications of extending the transfer

policy to all DRGs in the coming year.

Hospital swing beds

The swing-bed program, established in

1980, allows rural hospitals with fewer

than 100 beds to use their beds

interchangeably to furnish either acute

care or skilled nursing services to

Medicare and Medicaid patients. The

program is aimed at increasing rural

beneficiaries’ access to skilled nursing

services by providing small hospitals with

a way to use their facilities more

efficiently than they would in operating a

SNF. Roughly two-thirds of rural

hospitals have approved swing beds, and

about one-quarter of hospitals with swing

beds also operate a SNF.

Hospitals that operate swing beds have a

financial advantage relative to other

hospitals because discharges made to

swing beds are not subject to the

expanded transfer policy. Hospitals

therefore receive the full DRG payment

for cases they transfer to swing beds. In

addition, discharges to swing beds

currently are exempt from the new PPS

for SNFs, although HCFA is scheduled to

start phasing in the SNF PPS for these

providers later this year.

The swing-bed policy allows an empty

hospital bed to be used for providing SNF

services and an empty SNF bed to be used

for providing acute care services. There is

limited rationale, however, for exempting

these providers from either the expanded

transfer policy or the SNF PPS. First, by

exempting these providers from the

expanded transfer policy, Medicare is

paying twice for the days that bridge acute

and skilled nursing care: once through the

DRG payment rate and again through the

swing bed payment for SNF care. Second,

patients transferred earlier to a swing bed

potentially face higher cost-sharing

requirements, because they may use more

SNF days and hence reach the 20-day

SNF copayment window earlier in their

spell of illness. To the extent that small

rural hospitals with swing beds face

financial difficulty because of their small

scale of operation, a low-volume

adjustment would be a more equitable

policy option than an exception from the

expanded transfer policy.

Although HCFA plans to phase in swingbed hospitals under the SNF PPS later this

year, the Commission is concerned about

bringing these stays under the PPS, which

has substantial problems. Once we are

sure that the case-mix system distributes

payments appropriately, there would be

no reason to continue paying differently

for swing-bed SNF care.

70 Improving payment for inpatient hospital care in rural areas

0

5

10

15

20

25

30

35

1990 1991 1992 1994 1993 1995 1996 1997 1998 1999

Prospective payment system year

Adjacent to an MSA but does not include a town with at least 10,000 people (4,6)

Not adjacent to an MSA but includes a town with at least 2,500 people (7,8)

Percent

Not adjacent to an MSA and does not include a town with at least 2,500 people (9)

Cumulative change in length of stay,

by location of hospital (UIC), 1990–1999

Note: UIC (urban influence code, as defined by the U.S. Department of Agriculture). MSA (metropolitan statistical

area, as defined by the U.S. Office of Management and Budget).

Source: MedPAC analysis of data from HCFA.

Urban, in an MSA (1,2)

Adjacent to an MSA and includes a town with at least 10,000 people (3,5)

FIGURE

4-2

Rural:
Limitations in input price

adjustment

Medicare’s prospective payment systems

for facility services—acute inpatient care,

outpatient services, ambulatory surgery,

skilled nursing care, and home health

services—include input-price adjustments

that raise or lower the payment rates to

reflect the hourly wages of health care

workers in each local market (see the box

below).22Currently, HCFA uses a single

measure of geographic differences in area

wage levels—the hospital wage index—

for this purpose. The wage index compares

the level of hospital hourly wages in each

labor market area with the national average

hospital hourly wage. Labor market areas

are based on groups of counties:

metropolitan statistical areas (MSAs)—as

defined by the U.S. Office of Management

and Budget—for urban labor markets, and

statewide rural areas, including all

nonmetropolitan counties in each state

(those excluded from any MSA) for rural

labor markets. HCFA annually calculates

the wage index using these labor markets

and the most recent data on wages, paid

hours of employment, and contract labor

spending and hours reported by hospitals

on their annual cost reports. The index

value for each labor market area is its

average hourly wage rate (for all paid hours

of hospital employment in the market area)

divided by the national average hourly

wage.

Only part of providers’ payments in each

setting is adjusted, depending on the

labor share. The labor share is HCFA’s

estimate of the proportion of facilities’

costs consisting of resources (inputs)

purchased in the local labor market and

thus affected by local wage rates. The

labor share in each setting generally

includes wages, fringe benefits, and

locally purchased labor-intensive inputs,

such as building maintenance and repair,

landscaping, and legal, accounting, or

consulting services.

Rural health care advocates,

policymakers, and providers have raised

concerns about the geographic

adjustment’s fairness, arguing that it

causes systematic underpayments to rural

facilities for services furnished to

beneficiaries. This section describes the

geographic adjustment’s objective, its

major problems, and potential solutions.

Purpose of the geographic

adjustment

The objective of the geographic

adjustment is to make Medicare’s

payment rates accurately reflect the costs

efficient providers would incur in

furnishing services to beneficiaries given

local market wages. Making accurate

adjustments for market wage differences

is important for two reasons. First, serious

problems could arise for beneficiaries and

taxpayers if Medicare’s payment rates

differ from efficient providers’ costs

(MedPAC 2001). Second, hospitals’

reported wage rates vary substantially

among labor market areas (HCFA 2000,

Dalton et al. 2000).

Whether and how well the adjustment

achieves its objective depends on the

accuracy of its components:

• Do the wage data reported by

hospitals accurately represent

differences in wage levels among

markets?

• Do the labor market areas identify

homogeneous labor markets?

• Does the share of the base payment

rates to which the adjustment is

applied reflect accurately the portion

of facilities’ costs affected by local

labor market conditions?

Without a geographic adjustment, the

payment rate for each service would be

the same nationwide. Consequently,

Medicare’s payment rates would be too

high in labor markets with relatively low

wage rates and providers in those markets

would face incentives to furnish too many

services. Payment rates would be too low

in labor markets with relatively high wage

rates, giving providers financial incentives

to produce too few services, stint on

services or inputs (especially labor), or

cease participating in Medicare. In

addition, health facilities would be unable

to compete for labor.

Report to the Congress: Medicare in Rural America | June 2001 71

How the wage index affects providers’

payment rates

Medicare’s payment rates for

most facility services are

based on a national base

payment amount adjusted to reflect

local market conditions. The national

base amount typically comprises two

components: a labor-related amount,

which reflects the labor share, and a

nonlabor amount. The Health Care

Financing Administration calculates

the adjusted payment rate for a labor

market area by multiplying the

national labor-related amount by the

wage index for the area to get its

wage-adjusted amount, and then

adding the nonlabor amount to the

wage-adjusted amount. In the acute

inpatient hospital prospective

payment system, for instance, the

national base operating payment

amount in fiscal year 2001 is $4,007

(excluding payments for capital costs)

for facilities located in rural and other

urban areas (small metropolitan

statistical areas). Based on a national

labor share of 71.1 percent, the laborrelated amount is $2,849 and the

nonlabor amount (representing 28.9

percent) is $1,158. As measured by

the wage index, hospital wage rates in

rural New York are 15 percent below

the national average. Thus, the local

base payment rate for a hospital

located in rural New York (wage

index 0.85) is $3,580 ([$2,849 

0.85] $1,158). For a case assigned

to a diagnosis related group with a

relative weight of 1.4 (roughly typical

for a rural hospital), a hospital in rural

New York would receive a total

operating payment of $5,012 ($3,580

1.4). 

22 In some instances, payment rates are also adjusted to reflect market differences in the level of nonlabor input prices. For example, portions of the payment rates in the

hospital acute inpatient PPS are adjusted to compensate for relatively high nonlabor input prices in Alaska and Hawaii. Other payment systems under development for

inpatient rehabilitation care, inpatient psychiatric services, and long-term hospital care also will include input-price adjustments.
The wage adjustment’s accuracy is

important because it strongly influences

payment rates among urban and rural

market areas. The hospital wage index

ranges from 0.7445 in rural Arkansas to

1.4983 in Oakland, California—25

percent below and 50 percent above the

national average, respectively. Given a

labor share of 71 percent, hospitals’

payment rates for acute inpatient care in

Oakland are 35 percent above the national

average compared with 18 percent below

the national average in rural Arkansas.

The wage adjustment has roughly similar

effects on payment rates for other facility

providers, although the strength of the

adjustment varies with the labor share

(which ranges from 50 percent for

hospital outpatient services to 78 percent

for skilled nursing care).

According to conventional wisdom, the

wage index is low in rural labor markets

and high in urban ones. Wage index

values among rural and urban labor

markets, however, exhibit wide

variability, with substantial overlap

(Figure 4-3). Some rural areas have wage

indexes above, and some urban areas have

indexes well below, the national average.

Problems with the geographic

adjustment

MedPAC and others have identified four

problems with the adjustment:

• The wage index may be distorted

because using aggregate wages and

hours in each labor market area

inappropriately raises the average

hourly wage where hospitals employ

a relatively costly mix of labor

categories and depresses it where

hospitals employ an inexpensive

labor mix. This is the so-called

occupational-mix problem.

• The market areas often encompass

distinct health care labor markets.

• The hospital wage and hour data are

four years old before they are used

for payment and may not capture

recent labor market trends.

• The labor share includes cost

components, such as computing

services, that may not be locally

purchased or affected by local labor

market conditions.

These problems may have important

consequences for some providers. In

response, some observers have suggested

limiting the range of the wage index

adjustment—or even eliminating it—on

the grounds that it misrepresents the labor

market conditions that rural hospitals face.

Some advocates even argue that providers

in low-wage markets really do not have

low wages. But this begs the question of

why hospitals in these areas annually

report low wage rates and attest to their

accuracy.

Some rural health care advocates have

proposed limiting the range of the

adjustment by establishing a floor under

the wage index, at 0.9 for instance.

Alternatively, the effects of the adjustment

could be reduced by compressing the

wage index—for example, by raising its

values to a fractional power, such as 0.8 or

0.9.23 These proposals would change the

wage index and payments under the

inpatient PPS, but in different ways (Table

4-8). A floor would raise the lower end of

the wage index distribution so that

hospitals (or other facility providers)

located in low-wage areas would be paid

as if the local wage index were the floor

value.24 A wage index floor set at 0.9, for

example, would raise the wage index in

34 of the 47 statewide rural labor markets,

thereby increasing PPS payments for 87

percent of all rural hospitals and 89

percent of Medicare discharges from rural

providers. A 0.9 floor also would increase

72 Improving payment for inpatient hospital care in rural areas

Distributions of hospital wage index values among

 urban and rural labor markets in fiscal year 2001

Note: Wage index intervals are deciles of wage index distribution across all labor markets in fiscal year 2001.

Source: MedPAC analysis of HCFA hospital wage index for fiscal year 2001.

32

28

24

20

8

4

0.74–0.81 0.82–0.85 0.86–0.87 0.88–0.89 0.90–0.91 0.92–0.95 0.96–0.97 0.98–1.03 1.04–1.11 1.12–1.50

Percent of labor market areas 36

40

16

12

0

Urban labor market areas

Rural labor market areas

Wage index intervals (deciles)

FIGURE

4-3

23 Applying a fractional power would increase wage index values lower than 1.0 and reduce values above 1.0.

24 Without a change in the law, HCFA would have to offset increases in payments for hospitals in low wage markets by reducing payments to all other hospitals. This

would be necessary to meet the current statutory budget neutrality requirement for changes in the wage index.
the wage index in 119 urban labor markets

(38 percent), raising PPS payments for 23

percent of all urban hospitals and about

the same percentage of discharges from

urban facilities.

Compressing the wage index would raise

low index values while reducing high

ones, thereby changing PPS inpatient

payments for virtually all rural and urban

providers. The percentage change in the

wage index (and payments) would be

greatest at the extremes of the distribution

and diminish for index values

approaching 1.0.

Whether either of these solutions might be

appropriate or desirable depends on the

overall performance of the current wage

index adjustment, including the nature,

size, and distribution of its errors among

labor market areas. Proposals to

implement a floor implicitly assume that

the wage index substantially understates

the level of market wage rates at the low

end and that the errors are

disproportionately larger for lower wage

index values. Proposals to compress the

wage index assume that it understates

wage levels at the low end and overstates

them at the high end, with the size of the

errors increasing disproportionately for

index values further from the national

average.

In general, we would expect health care

facilities’ wage rates to vary with the

overall wage scale paid by other

employers in the same market area, with

both reflecting the local cost of living. If

the hospital wage index grossly distorted

true market wage levels, we would expect

it to diverge substantially from an index

based on wage rates for all occupations

and industries. If the premise behind the

floor proposal were true, the divergence

would be entirely at the low end; the

hospital wage index would be further

below average than an overall index in

low-wage markets, with the size of the

discrepancies diminishing as index values

approach the floor value. If the premise

behind the compression proposal were

correct, the hospital wage index would be

lower at the low end and higher at the

high end than the overall index.

To examine these hypotheses, we created

an overall wage index using fiscal year

1997 wage data for all occupations and

industries by MSAs and statewide rural

areas.25 These data are based on Bureau of

Labor Statistics’ estimates of employment

and wages for workers in all industries

covered by state unemployment insurance

and unemployment compensation for

federal employees.

Consistent with our expectations, the

overall wage index and the hospital wage

index are positively correlated—the

estimated simple correlation (r) is 0.64,

which means that they have about 40

percent of their variation in common

(Figure 4-4). If both indexes were tracking

the same relative wage levels (or local

living costs) across labor markets, the

paired values would fall on a 45 degree

line from the origin. Under the floor

hypothesis, the dots should cluster below

the 45 degree line for hospital wage index

values below the floor, demonstrating that

the hospital wage index is understating

wage levels at the low end. If the

compression hypothesis were true, the

dots would cluster below the 45 degree

line at the low end and above it at the high

end—the index is exaggerating the

distribution at both ends—and the vertical

distance between the dots and the line

should diminish as the hospital wage

index approaches 1.0. The hospital wage

index, however, has a smaller range, with

higher values at the low end and lower

values at the high end, than the overall

wage index—as indicated by the

regression line (R2  0.4225).

Apparently, the geographic pattern of

variation in hospital wage rates is not

radically different than that for overall

wage rates based on all types of labor.

These results are not consistent with the

idea that the hospital wage index somehow

exaggerates the variation in market wage

levels—the premise of the compression

proposal. They are also inconsistent with

the idea that the hospital wage index

substantially understates market wage

levels in relatively low wage markets—the

hypothesis underlying the floor proposal.

Another way to evaluate the overall

performance of the wage index is to

examine its relationship to hospitals’

Medicare inpatient margins or paymentto-cost ratios for inpatient services. Other

things being equal, if the hospital wage

index were distorting market wage levels

and PPS payments as suggested by

proponents of the floor and compression

proposals, hospitals’ Medicare inpatient

margins would be directly related to the

wage indexes in their local labor markets;

hospitals in areas with low wage indexes

would have low or negative margins,

while those located in areas with high

Report to the Congress: Medicare in Rural America | June 2001 73

Percentage change in wage index and prospective

payment system payments under selected policies

Wage index PPS payments

Wage index Floor Compression Floor Compression

0.75 20.0% 5.9% 14.2% 4.2%

0.80 12.5 4.6 8.9 3.3

0.85 5.9 3.3 4.2 2.3

0.90 — 2.1 — 1.5

0.99 — 0.2 — 0.1

1.30 — 5.1 — 3.6

1.50 — 7.8 — 5.5

Note: PPS (prospective payment system). Floor set at wage index value  0.9. Compression wage index is defined

as HCFA wage index raised to the 0.8 power.

Source: MedPAC analysis of HCFA wage index.

TABLE

4-8

25 These data are posted on the web site for the Bureau of Economic Analysis, Department of Commerce.
wage indexes would have average or high

margins. Consistent with other recent

findings (Dalton et al. 2000), however,

hospitals’ Medicare inpatient margins do

not appear to be related to their local wage

index values (Figure 4-5).

Still, these analyses are not conclusive

because Medicare accounts for a high

proportion of hospitals’ revenues in many

rural markets and providers’ revenues

generally drive spending and costs. Some

rural facilities thus could exhibit relatively

low wage rates because Medicare’s

payments are low. This is an unlikely

outcome for many providers, however,

because most rural hospitals’ wage rates

are substantially lower than the average in

their labor markets (Table 4-9). This result

suggests that although some rural hospitals

may not be able to pay high wage rates, few

face this problem because the wage index

is too low. Instead, their financial weakness

generally stems from other sources, which

may include other limitations in

Medicare’s payment policies, or larger

problems, such as insufficient overall

market demand for their services or high

levels of uncompensated care.

Occupational mix in the wage

index

As discussed in our March 2001 report,

the computation and application of the

wage index raise concerns about the level

of payments to rural hospitals (MedPAC

2001). The current wage index confounds

differences in wage rates with differences

among areas in the occupational mix of

employment. In the early 1990s, staff at

the Prospective Payment Assessment

Commission (ProPAC) estimated that

occupational-mix differences probably

change the wage index, on average, by

plus or minus 2 percent (Williams, et al.

1990). Eliminating them generally would

raise the wage indexes for rural hospitals

in all regions except the Northeast.

Conversely, wage indexes would fall

somewhat for providers located in many

urban labor markets. The General

Accounting Office is conducting a study

using more recent data for California and

New York, and the results will be

available later this year.

In the BIPA, the Congress required HCFA

to implement an occupational-mix

adjustment to the wage index. To comply,

HCFA will have to revise the Medicare

cost reporting forms for hospital reporting

periods beginning in fiscal year 2001.

Consequently, an occupational-mix

adjusted wage index will not be available

until October 2004. Thus, at least three

years will pass before major

improvements in accuracy can be

achieved.

This timeline raises the issue of what

interim policies might be adopted to

mitigate the effects of the occupationalmix problem. Policymakers might

consider three options: establishing a

floor, compressing the wage index, or

accelerating implementation of the phaseout from the wage index of wages and

hours for teaching physicians, residents,

and certified registered nurse anesthetists

(CRNAs).

As mentioned earlier, imposing a wage

index floor would increase facilities’ PPS

payments in market areas with low

hospital wage rates. However, only raising

the wage index at the low end would be

inconsistent with the anticipated effects of

occupational-mix adjustment. Moreover, a

wage index floor would substantially

over-correct the wage index in areas with

the lowest wage indexes, which likely

would lead to potentially large payment

reductions and resistance to change when

direct occupational-mix adjustment

becomes possible. Further, benefits from

the floor would be arbitrary. For example,

if the floor were set at 0.9, hospitals in the

Iowa City MSA with a wage index of 0.96

would receive no benefit while those in

rural Iowa (at 0.8) would receive a 7

percent increase in payments. Hospitals in

markets with wage index values just

above the floor—for example, those in

Spartanburg-Anderson, SC (0.9003),

Hamilton-Middletown, OH (0.9061), or

Lewiston-Auburn, ME (0.9036)—would

not receive any benefit and likely would

argue that the floor should be set higher.

Even if the goal were to help rural

hospitals with poor financial performance

under Medicare’s inpatient PPS, a wage

index floor would raise the wage index

and PPS payments indiscriminately

(Table 4-10). We examined the effect of

a floor set at 0.9 on 3,226 hospitals that

74 Improving payment for inpatient hospital care in rural areas

1.9

1.7

1.8

1.6

1.5

1.4

1.3

1.2

1.1

1.0

0.9

0.8

0.7

0.6

0.6 0.8 0.9 0.7 1.0 1.1 1.2 1.3 1.5 1.7 1.4 1.6 1.8 1.9

All workers’ wages

Hospital workers’ wages

Note: Observations are average hourly wage rates for labor market areas defined by metropolitan statistical areas

 and statewide rural areas. 45	 line indicates perfect match between relative wage rates for hospital workers

 and those for all workers. R2 line shows that hospital workers’ wage rates are comparatively high in areas

 where all workers’ wages are low and comparatively low where all workers’ wages are high.

Hospital wage rates in low-wage

areas are higher than expected

R2  0.4225

FIGURE

4-4

Source: MedPAC analysis of HCFA hospital wage data for 1997 and all industries wage data 

 for 1997 from the Bureau of Economic analysis, Department of Commerce.

45	 line
total payments under the hospital

inpatient PPS would rise by roughly

$700 million per year.

Another option would be to adopt some

form of wage index compression. The

expected effects of occupational-mix

adjustment—raising the wage index at the

low end and reducing it at the high end—

are roughly consistent with those for wage

index compression. The premise behind

compression, however, is that

occupational-mix differences are strongly

positively related to the level of the wage

index—these differences exaggerate the

wage index smoothly at both ends, with

the extent of exaggeration rising

disproportionately the further the wage

level departs from the national average.

Occupational-mix differences are

undoubtedly positively related to

providers’ case mix and to their hourly

wage rates, but are likely to be highly

variable across markets because they

reflect the market composition of

hospitals by type and bed size. As a result,

occupational-mix differences are unlikely

to be smoothly related to the market wage

level. Wage rates might be understated by

6 percent in some low-wage rural markets

but by only 0.5 percent in others.

Similarly, wage levels may be overstated

by 2 percent in some high-wage markets

with many large teaching hospitals, but

only 0.5 percent in others that have fewer

large high-technology facilities. If this is

so, wage index compression would

overcorrect in some markets and

undercorrect in others. Thus, like a wage

index floor, compressing the wage index

would result in arbitrary changes in the

index and PPS payments, without

improving payment policies for rural

hospitals.

Another policy option would be to

accelerate the phase-out from the wage

index of compensation for teaching

physicians, residents, and CRNAs. This

phase-out is in its second year, so the

wage index reflects a 60 percent/40

percent blend of old and new wage

indexes; the old index includes wages and

hours for these three groups and the new

one does not. HCFA’s rationale for the

phase-out is that labor costs related to

Report to the Congress: Medicare in Rural America | June 2001 75

0

0.7 0.8 0.9 1.0 1.1 1.2 1.3 1.4 1.5 1.6

15

15

45

30

60

75

90

105

120

135

30

45

60

75

90

105

120

135

Medicare inpatient margins by wage index

 value, urban and rural hospitals, 1999

HCFA 2001 wage index

Margin (percent)

HCFA 2001 wage index

0

0.7 0.8 0.9 1.0 1.1 1.2 1.3 1.4 1.5 1.6

15

15

45

30

60

75

90

105

120

135

30

45

60

75

90

105

120

135

Margin (percent)

FIGURE 

4-5

Source: MedPAC analysis of data from HCFA.

Urban

Rural

have thus far reported Medicare inpatient

margin data for cost reporting periods

beginning during fiscal year 1999. The

floor would raise the wage index—and

inpatient payments—for 78 percent of

rural hospitals that had negative

Medicare inpatient margins in that year,

but it also would raise the index for 84

percent of those that had high Medicare

inpatient margins (greater than 12

percent). If a floor were implemented at

0.9, without the statutory budgetneutrality requirement that ordinarily

applies to changes in the wage index,
teaching activities are reimbursed through

direct graduate medical education (GME)

payments, not the inpatient PPS. 

Similarly, CRNA services generally are

paid under Medicare Part B, also outside

the inpatient PPS. HCFA’s impact

analysis suggests that changing the blend

from 80/20 to 60/40 in fiscal year 2001

raised the wage index about 0.1 percent in

rural areas and decreased it by a negligible

amount in urban areas.26 The effect of

completing the phase-out—eliminating

the old index and using only the new

one—might not be negligible for some

areas, but it would not be large in any case

(Table 4-11).

RECOMMENDATION 4C

In fiscal year 2002, the Secretary

should implement fully the policy of

excluding from the hospital wage

index salaries and hours for teaching

physicians, residents, and certified

registered nurse anesthetists.

Labor markets used for the

wage index

Earlier research by ProPAC and others

showed systematic differences in hospital

wage levels within many urban and rural

labor market areas (ProPAC 1991, DeLew

1992, Hendricks 1989, Schmitz and

Merrell 1987). MSAs and statewide rural

areas are frequently too large to capture

homogeneous labor markets for health

care workers (Figure 4-6). More recent

analysis suggests that statewide rural areas

typically contain three distinct markets

(Dalton et al. 2000).

Moreover, the political boundaries that

define current labor market areas often

arbitrarily separate facilities that

participate in the same labor market. For

instance, Coeur D’Alene in rural Idaho is

a short drive from Spokane, Washington,

but the rural Idaho wage index (0.8678) is

almost 18 percent lower than that for

Spokane (1.0513). As a result, some

hospitals can argue legitimately that a

nearby labor market area (and its wage

index) more accurately reflects their

market circumstances than the labor

market area in which they are physically

located.

To address this problem, the Congress

established a process enabling hospitals to

appeal their labor market assignments and

request reclassification. To qualify, rural

hospitals generally must:

• be located close to (within 15 miles)

the border of the area to which they

seek to be reassigned.

• demonstrate that they are

disadvantaged because their average

hourly wage rate is more than 106

percent (108 percent if urban) of the

average hourly wage in their actual

labor market location.

• demonstrate that their wage rates are

similar to those in the nearby area;

their average hourly wage must be at

least 82 percent (84 percent if urban)

of the average wage rate in the

adjacent area.

The Clinton Administration lowered the

criteria for rural hospital reclassifications

for fiscal year 2001. HCFA estimated that

about 50 rural hospitals would benefit

from this change. In fiscal year 2001, 490

hospitals (a little less than 10 percent of

all hospitals receiving PPS payments) are

reclassified for the wage index because

they met these or related criteria.

76 Improving payment for inpatient hospital care in rural areas

26 The estimated decrease was negligible even in the urban Middle Atlantic region, where we would expect the largest effects because of the high concentration of

teaching hospitals.

Hospitals sheltered by labor market 

average wage rate

Before geographic After geographic

reclassification reclassification

Percent Percent

Proportion difference Proportion difference Hospital type sheltered from average sheltered from average

All 62% 13% 67% 13%

Rural 64 15 73 14

Rural referral 31 6 76 9

Sole community 67 16 72 15

Other 68 15 73 15

Note: Sheltered hospitals are those with average hourly wages below the labor market average.

Source: MedPAC analysis of HCFA wage index.

TABLE

4-9

Hospitals affected by a wage index floor of 0.9, by

financial status under Medicare’s inpatient prospective 

payment system, fiscal year 1999

Low inpatient margin High inpatient margin

Percent of Percent Percent of Percent

Hospital Number low-margin change in Number high-margin change in

location affected hospitals wage index affected hospitals wage index

All hospitals 608 56% 9.0% 516 43% 10.4%

Urban 107 24 5.0 133 18 5.2

Rural 501 78 9.9 383 84 12.2

Note: Low inpatient margin defined as having a Medicare inpatient margin below zero in 1999. High inpatient

margin defined as having a Medicare inpatient margin above 12 percent in 1999.

Source: MedPAC analysis of HCFA wage index data and data from hospitals’ cost reports for fiscal year 1999.

TABLE

4-10
Although the geographic reclassification

process alleviates some problems, it also

creates new ones. First, the criteria for

reclassification are not completely

consistent with Medicare’s payment

policy goals. For instance, hospitals can

qualify for reclassification and receive

higher payments simply because they pay

high wage rates relative to the market

average, or because they have an

unusually costly occupational mix.

Reclassification thus can reward some

hospitals regardless of their efficiency,

giving them payment increases of 12

percent or more and a competitive

advantage over other hospitals in their

actual market area.

Another problem is that the payment

differentials at the edges of labor market

areas are not eliminated by

reclassification; instead they are shifted,

leaving different sets of hospitals affected.

Finally, reclassification can result in large

swings in hospitals’ payments if they fail

to qualify in any one year because of data

errors or changes in the wage index

calculation. However, the BIPA addressed

this problem to some degree by extending

the period for which reclassification

applies; hospitals that qualify can remain

reclassified (if they want to) for three

years.

Despite these problems, the geographic

reclassification policy ameliorates wage

index differentials at the boundaries of

labor market areas for some hospitals,

generally without imposing substantial

redistribution of payments on other

hospitals. After reclassification, the

hospitals remaining in the most populous

rural labor markets exhibit greater wage

rate homogeneity (Dalton et al. 2000).

Although reclassification is certainly

imperfect, it is probably worth retaining

until the underlying labor market

boundary problem can be solved.

Adopting an occupational-mix adjustment

may help somewhat, and occupationspecific wage data would enable HCFA to

evaluate alternative labor market

definitions. But major labor market

improvements are not likely in the near

future. Consequently, geographic

reclassification probably should be

retained for now.

Age of the wage index data

By the time the wage index is applied to

adjust payments, the underlying wage data

are four years old. In general, wage rates

have been increasing faster in rural areas

than in urban ones (the differential was

0.7 percent in 1995, 0.4 percent in 1996,

and 0.6 percent in 1997). Thus,

policymakers might conclude that using

old data delays justified increases in

payments for rural providers. Still, relative

wage levels across geographic areas

apparently have remained nearly constant

over time, although this finding might

change if local or regional scarcities of

medical professionals eventually affect

wages only in certain areas (Dalton et al.

2000).

Recently, many providers have indicated

that they are facing increased difficulties

finding adequate numbers of well-trained

nurses. These shortages, however, appear

Report to the Congress: Medicare in Rural America | June 2001 77

Impact on Medicare inpatient margins of phasing out

teaching salaries and certified nurse anesthetists

Baseline After policy change

Percent of Percent of

hospitals with Change in hospitals with

Hospital group Margin negative margin payments Margin negative margin

All hospitals 12.4% 30.2% 0.0% 12.4% 29.8%

Urban 13.6 25.3 0.1 13.5 25.0

Rural 5.8 36.3 0.3 6.0 39.7

Rural referral 6.0 32.2 0.5 6.3 28.7

Sole community 5.9 32.0 0.3 6.0 31.8

Small rural Medicaredependent 10.2 30.7 0.2 10.4 30.2

Critical access 4.2 66.7 0.2 4.1 66.1

Other rural 50 beds 6.9 38.9 0.2 7.0 38.9

Other rural 50 beds 4.0 40.9 0.2 4.3 40.9

Urban

Low-margin 7.3 97.3 0.2 7.1 93.7

Mid-margin 6.5 0.0 0.1 6.4 1.9

High-margin 23.6 0.0 0.1 23.9 0.0

Rural

Low-margin 8.3 90.3 0.3 7.8 88.6

Mid-margin 6.9 0.0 0.4 7.2 0.3

High-margin 22.7 0.0 0.2 22.8 0.0

Note: Baseline margin is the actual 1999 margin adjusted to reflect the change in disproportionate share payments

enacted by the Benefits Improvement and Protection Act of 2000. Analysis based on data from two-thirds of

the hospitals covered by prospective payment in 1999.

The critical access hospital (CAH) group includes hospitals that were designated CAHs in 1999 or after, and

the results estimate what the baseline margin and impact of the policy change would have been had they

remained in the PPS. Those becoming CAHs before filing their 1999 Medicare cost reports were excluded

from the analysis due to lack of data.

Low-margin is defined as having a Medicare inpatient margin below zero in 1999, which included 17

percent of urban and 30 percent of rural hospitals. High-margin defined as above 12 percent, which

included 27 percent of urban and 21 percent of rural hospitals.

Source: MedPAC analysis of data from HCFA.

TABLE

4-11
to be widespread across most markets and

thus do not raise immediate issues

regarding the accuracy of the wage index.

Rather, to the extent that all providers

must pay more (higher wage rates or

improved fringe benefits) or improve

working conditions to attract additional

nurses, the increase in input prices would

be reflected in the annual update to

Medicare’s inpatient PPS payment rates

through forecast changes in the HCFA

hospital market basket index—a measure

of inflation in the prices providers must

pay to buy inputs needed to produce care

(MedPAC 2001).

The four-year data lag comes from using

hospitals’ cost reports as the data

collection vehicle. This approach helps to

ensure reporting compliance and enables

important data quality improvements.

Moreover, because feasible alternative

approaches for obtaining accurate data are

not apparent, more timely data may never

be available.

Labor share used in geographic

adjustment

The labor share, which HCFA revises

periodically in updating the market basket

index, is an estimate of the national

average proportion of providers’ costs

associated with inputs that are directly or

indirectly affected by local market wage

levels.27 It is used to determine the portion

of the national PPS base payment rate to

which the wage index is applied. For

inpatient hospital services, the labor share

is 71.1 percent and includes wages and

salaries, fringe benefits, and other laborrelated costs that are intended to capture

spending for locally purchased inputs

(Table 4-12).

78 Improving payment for inpatient hospital care in rural areas

27 HCFA has established labor shares based on the weights for their market basket indexes for most facility PPSs, including those for hospital inpatient, skilled nursing,

rehabilitation, and home health services.

Labor market areas for the hospital wage index

FIGURE

4-6

Statewide rural areas (non-MSA)

Urban areas (MSA)

Alaska and Hawaii not to scale

Note: MSA (metropolitan statistical area, as defined by the U.S. Office of Management and Budget).
The definition of the labor share raises

several potential concerns:

• Rural and urban providers may use

different mixes of labor and capital.

• The costs included in the labor share

and those included in the wage index

do not match. The wage index

excludes contract labor costs for nonpatient care services, such as

purchased professional services,

computing, and laundry and dietary

services. These services are excluded

because it is difficult to separate labor

costs from overhead costs or

accurately assign labor hours for

contracted services.

• Some of the purchased laborintensive services included in the

labor share definition, such as

postage or non-medical professional

fees, likely are purchased in national

markets or are frequently available at

geographically uniform prices.

Some rural health care advocates and

providers have argued that the current

labor share overstates the proportion of

costs rural hospitals devote to labor and

other locally purchased inputs. The

proposed remedy—lowering the labor

share—would reduce the proportion of the

national base payment amount adjusted by

the wage index. Consequently, hospitals

located in low-wage markets (wage index

less than 1.0) would receive higher

payments, while those located in highwage markets would receive lower

payments. Overall, this policy change

would transfer payments from urban to

rural hospitals. Some urban hospitals

would benefit, however, because they are

located in markets with wage indexes

below 1.0, and some rural hospitals would

receive reduced payments because they

are located in market areas with wage

indexes above 1.0. Any decrease in

payments for areas with wage indexes

values above 1.0, however, would be

partly offset by a positive budgetneutrality adjustment.

Although the national average labor share

is 71.1 percent, the implied labor share—

the proportion of Medicare’s payment per

case that is associated with local labor and

related expenses—varies with the wage

index (Table 4-13). In a low-wage area,

multiplying the national labor-related

amount by a wage index less than 1.0

(0.75, for example) reduces the laborrelated portion of payments substantially

below the national average—to 64.9

percent in this example. Conversely, the

implied labor share is much higher than

the national average in labor markets with

relatively high wage rates. Consequently,

the labor share that applies to each

hospital’s payment is the local share after

wage index adjustment.

Differences in labor and non-labor shares

might be addressed by using providerspecific labor shares. However, this would

enable providers to manipulate their

payments by increasing or decreasing

wages and fringe benefits relative to other

costs. It would also give them

inappropriate incentives to purchase

certain services under contract rather than

produce them. Further, Medicare’s

payment rates in a market area would not

reflect the costs efficient providers would

incur to furnish care, but rather providers’

individual choices about production

methods, whether or not they were

efficient.

The labor share problem also could be

addressed by reexamining the national

labor share. The input categories included

in the labor share were originally selected

in 1983 when the hospital inpatient PPS

was adopted. Most of these inputs are still

largely purchased in local markets.

However, some categories, such as

postage, are likely purchased in national

markets and not influenced by local wage

levels. Still others (computer and data

processing services, for instance) may

include some inputs that are purchased in

national markets and some that are bought

in local ones. As a result, the national

Report to the Congress: Medicare in Rural America | June 2001 79

Components of

national labor share

for hospital inpatient care

Category Share

Total labor-related 71.1%

Wages and salaries 50.2

Employee benefits 11.2

Non-medical professional fees 2.1

Postage 0.3

All other labor-intensive 7.3

Note: All other labor-intensive includes business

services, computer processing, landscape and

horticultural services, building maintenance and

repair, laundry services, auto repair, payments

to membership organizations, appliance

repair, and indirect business taxes.

Source: HCFA analysis of hospital data from U.S.

Census, Bureau of Economic Analysis,

American Hospital Association, and Health

Care Provider Cost Report Information System

(HCRIS).

TABLE

4-12

Effect of wage index adjustment on labor share

Wage index value

1.0 0.75 1.5

Labor-related amount $2,849 $2,849 $2,849

Non-labor amount 1,158 1,158 1,158

Wage-adjusted amount 2,849 2,137 4,274

Local base payment 4,007 3,295 5,432

Local labor share 71.1% 64.9% 78.7%

Note: Wage adjusted amount  labor-related amount x wage index. Local base payment  wage-adjusted amount

non-labor amount. Local labor share  wage-adjusted amount / local base payment.

Source: MedPAC analysis of HCFA wage index.

TABLE

4-13
average labor share may be somewhat

lower than the current estimate of 71.1

percent.

RECOMMENDATION 4D

To ensure accurate input-price

adjustments in Medicare’s

prospective payment systems, the

Secretary should reevaluate current

assumptions about the proportions of

providers’ costs that reflect resources

purchased in local and national

markets.

Unequal payment formula

for disproportionate share

payments

Medicare’s DSH adjustment for hospital

inpatient services is designed to offset the

financial pressure of uncompensated care

and inadequate payments from Medicaid

and other indigent care programs.

However, despite improvement in the

DSH payment system implemented

through the BIPA, the current system still

provides substantially smaller payment

add-ons for rural facilities. In our March

2000 and March 2001 Reports, MedPAC

recommended a comprehensive reform of

the DSH adjustment that would apply a

consistent payment formula for all

hospitals. Medicare cannot implement this

reform for at least two years, however, so

the Commission recommends an interim

step that would help rural hospitals now

while providing a transition toward the

system we envision for the longer term.

Description of the

disproportionate share 

payment system

Medicare distributes DSH payments

through a hospital-specific percentage

add-on to the PPS base payment rate.

Consequently, a hospital’s DSH payments

are tied to its volume and mix of PPS

cases. The add-on for each case is

determined by a complex formula based

on the hospital’s share of low-income

patients, which is the sum of two ratios—

Medicaid patient days as a share of total

patient days, and patient days for

Medicare beneficiaries who receive

Supplemental Security Income (SSI) as a

percentage of total Medicare patient days.

The original justification for the DSH

adjustment presumed that poor patients

are more costly to treat, but ProPAC

adopted an alternative premise that had

evolved over time: to protect access to

care for Medicare beneficiaries, additional

funds should be provided to hospitals

whose viability might be threatened by

providing care to the poor. Although the

financial pressure from treating lowincome patients can include any extra

costs incurred, the primary threats are

underpayment or nonpayment. MedPAC

data have shown that Medicaid payments

are the lowest relative to costs of the

major payer groups, the payments of local

indigent care programs are usually even

lower, and uninsured patients generate the

least funding, even after accounting for

local operating subsidies.

Problems with the current

system and responses to date

The Commission believes that policy

changes are needed to ameliorate two key

problems inherent in the existing DSH

payment system:

• the current low-income share

measure does not include care to all

the poor, most notably omitting

uncompensated care, and

• the system has separate payment rates

for 10 specific hospital groups, with

the least favorable rates given to most

rural hospitals and urban facilities

with fewer than 100 beds.

The BIPA improved the equity of DSH

payments by applying the most liberal

current threshold (minimum low-income

share needed to qualify for a payment

adjustment) to all hospitals. We estimate

that this will make about 840 additional

rural hospitals (40 percent of all rural

facilities) eligible to receive DSH

payments. However, the BIPA caps the

DSH add-on a rural hospital can receive at

5.25 percent, except for those rural

hospitals already receiving higher

payments due to their SCH or RRC status.

Some large urban facilities currently

receive much higher adjustments.

In this year’s March report, the

Commission concluded that although the

BIPA significantly improved the equity of

DSH payments between rural and urban

hospitals, additional changes are still

needed. The only way to create true equity

between urban and rural hospitals is to use

the same distribution formula for all

hospitals (MedPAC 2001).

Additional changes needed

The changes we have recommended

cannot be implemented for two to three

years, while HCFA collects the necessary

low-income patient cost data. The BBRA

mandated this data collection effort for

hospital cost reporting periods beginning

in fiscal year 2001. In addition, the

Congress will have to legislate a new

distribution formula or provide guidelines

to HCFA for developing the formula.

One step to bridge the gap between the

BIPA provision and the system MedPAC

envisions when comprehensive lowincome share data become available

would be to raise the cap on the DSH addon a rural hospital can receive. Although

there is no right level for the cap, a cap of

10 percent would distribute DSH monies

roughly midway between the distribution

that BIPA will produce and the

distribution implied by urban and rural

hospitals’ cost shares for the largest two

groups of low-income patients. Rural

hospitals were responsible for 12.8

percent of the care provided to Medicaid

and uncompensated care patients

nationally in 1999 (Table 4-14). With the

DSH payment rules in effect through

2000, only 3.1 percent of payments went

to rural facilities; BIPA rules would

increase this proportion to 6.9 percent.

Raising the cap to 10 percent would lift

rural hospitals’ share of DSH payments to

9.8 percent.

This change would raise payments for

some rural hospitals with large lowincome populations that do not benefit

from the higher DSH payments available

to hospitals that qualify for the sole

community hospital and rural referral

center programs. In addition, if the

Congress chose to provide new funding to

implement the higher cap (which would

80 Improving payment for inpatient hospital care in rural areas
cost about $180 million per year), the

change would minimize the shift of

payments from urban to rural hospitals

that would occur when the program

implements a single distribution formula

for all hospitals two or three years down

the line. Finally, the 10 percent cap on

DSH payments for all rural hospitals

would match the cap currently in law for

SCHs, thus eliminating an unnecessary

discrepancy among rural hospital groups.

RECOMMENDATION 4E

The Congress should raise the cap on

the disproportionate share add-on a

rural hospital can receive from 5.25

percent to 10 percent.

A 10 percent cap on DSH payments with

new funding would increase rural

hospitals’ payments, on average, by 1.4

percent (Table 4-15). Hospitals that do not

have access to any of Medicare’s current

special payments for rural hospitals would

benefit the most; those with fewer than 50

beds would get a 1.9 percent increase and

larger facilities a 2.3 percent boost. If, in

light of the additional DSH funding

provided by the BIPA, the Congress

decided to implement the change by

redistributing the current funding, the

currently favored hospitals—those in

urban areas with more than 100 beds—

would absorb a 0.2 percent cut in their

DSH payments, and the gain to rural

facilities would be reduced to 1.2 percent.

Congress should not remove the DSH

payment cap altogether now, for two

reasons. First, it would inevitably result in

some hospitals receiving large increases in

their DSH payments, only to have their

payments cut again when uncompensated

care is brought into the low-income shares

used to distribute payments.

Eliminating the cap might also result in

unnecessarily large payment increases for

some rural hospitals, and the aggregate

increase in payments would be three times

that of our recommended approach. The

current DSH distribution formula is

graduated, offering a higher payment rate

for the mostly public, inner-city hospitals

with the largest low-income shares. This

was done in an attempt to compensate for

Report to the Congress: Medicare in Rural America | June 2001 81

Urban and rural hospitals’ shares of low-income

patient costs and disproportionate share payments

Share of disproportionate share payments

Share of Prior to 5.25 percent 10 percent Hospital group low-income costs the BIPA cap cap

Urban 87.2% 96.9% 93.1% 90.2%

Rural 12.8 3.1 6.9 9.8

Note: The 5.25 percent cap on the disproportionate share add-on was enacted by the Medicare, Medicaid and

SCHIP Benefits Improvement and Protection Act of 2000 (BIPA), and went into effect on April 1, 2001. Lowincome costs for this analysis include Medicaid and uncompensated care.

Source: MedPAC analysis of data from the American Hospital Association Annual Survey of Hospitals and HCFA.

TABLE

4-14

Impact on Medicare inpatient margins of raising the

cap on disproportionate share payments to 10 percent

Baseline After policy change

Percent of Percent of

hospitals with Change in hospitals with

Hospital group Margin negative margin payments Margin negative margin

All hospitals 12.4% 31.7% 0.2% 12.6% 30.1%

Urban 13.6 25.4 0.0 13.6 24.9

Rural 5.6 38.9 1.4 6.8 35.9

Rural referral 6.0 32.2 1.4 7.2 27.6

Sole community 5.9 32.0 0.3 6.3 30.5

Small rural Medicaredependent 10.2 30.7 0.9 11.0 29.1

Critical access 4.2 66.7 0.8 3.4 62.9

Other rural 50 beds 6.9 38.9 1.9 8.6 37.5

Other rural 50 beds 4.0 40.9 2.3 6.1 34.5

Urban

Low-margin 7.3 97.3 0.1 7.2 95.5

Mid-margin 6.5 0.0 0.0 6.5 0.0

High-margin 23.6 0.0 0.0 23.6 0.0

Rural

Low-margin 8.3 91.0 1.2 7.0 84.1

Mid-margin 6.9 0.0 1.2 8.0 0.0

High-margin 22.7 0.0 1.7 24.0 0.0

Note: Baseline margin is the actual 1999 margin adjusted to reflect the change in disproportionate share payments

enacted by the Medicare, Medicaid, and SCHIP Benefits Improvement and Protection Act of 2000. Analysis

based on data from two-thirds of the hospitals covered by prospective payment in 1999.

The critical access hospital (CAH) group includes hospitals that were designated CAHs in 1999 or after, and

the results estimate what the baseline margin and impact of the policy change would have been had they

remained in the prospective payment system. Those becoming CAHs before filing their 1999 Medicare cost

reports were excluded from the analysis due to lack of data.

Low-margin is defined as having a Medicare inpatient margin below zero in 1999, which included 17

percent of urban and 30 percent of rural hospitals. High-margin is defined as above 12 percent, which

included 27 percent of urban and 21 percent of rural hospitals.

Source: MedPAC analysis of data from HCFA.

TABLE

4-15
these hospitals’ unusually large

uncompensated care burdens and their low

Medicare penetration (often below 20

percent). Applying this formula in rural

areas, where small hospitals have much

higher Medicare penetration (often 80

percent or more), could result in windfalllevel payment adjustments. If Congress

approves revamping the DSH payment

system to bring uncompensated care into

the low-income share calculation, it can

avoid this problem by applying a single

formula to all hospitals without a

graduated rate structure.

It would be best to make DSH payment

add-ons up to 10 percent available to all

hospitals without taking away the higher

rates currently available to qualifying

rural referral centers and urban hospitals

of over 100 beds. Unfortunately, this

requires most of the overly complex

formulation in current law to be

maintained (Table 4-16).

Inpatient psychiatric care

Inpatient psychiatric facilities—

freestanding hospitals and hospital-based

units—specialize in treating patients with

mental illnesses who range in disability

from temporary disturbances to ongoing

psychotic states.28 They also provide

treatment for alcohol and drug-related

problems. These facilities are exempt

from the hospital inpatient PPS.

The BBA dramatically changed payment

for the 2,100 PPS-exempt psychiatric

facilities by requiring one target cap for all

facilities. Because rural psychiatric

facilities may be disproportionately

affected by the new payment method,

which could influence rural beneficiaries’

access to care, the Congress required

MedPAC to analyze the impact of patient

volume on rural facilities’ unit costs and

to determine whether special treatment

may be warranted.

We conclude that the single target cap is

problematic and recommend that it be

revised to account for differences in

patient characteristics. Governmentowned hospitals appear to treat a different

beneficiary population than do other

facilities and are disadvantaged by a

single cap. Although rural hospital-based

units do not appear to treat a

systematically different population, they

do have higher unit costs and further work

is needed to determine why. We also note

that while rural beneficiaries’ access to

some types of psychiatric care may be

affected by hospitals closing their PPSexempt psychiatric units to apply for CAH

status, CAHs are not precluded from

providing basic psychiatric services.

Finally, we provide policymakers with

preliminary information about two of the

challenges they face in designing a PPS

for inpatient psychiatric care.

Changes in payment

methods

The BBA created a single national

payment cap for PPS-exempt psychiatric

facilities. Before the BBA, these facilities

82 Improving payment for inpatient hospital care in rural areas

28 Inpatient psychiatric care is also provided in regular beds in acute hospitals, usually called “scatter beds.” In 1995, these patients represented 28 percent of

beneficiaries treated on an inpatient basis for psychiatric conditions (Cano et al. 1997). Medicare pays for patients in scatter beds under the hospital inpatient PPS.

Payment formulas required to implement MedPAC’s

recommendation on disproportionate share payments

Adjustment

Hospital group formula

Urban  100 beds and If DPP  15% to 20.2%:

Rural  500 beds 2.5% 0.65 (DPP—15%)

If DPP  20.2% or more:

5.88% 0.825 (DPP—20.2%)

Rural referral * If DPP  15% to 20.2%:

2.5% 0.65 (DPP—15%)

If DPP  20.2% to 25.2%:

5.88% 0.825 (DPP—20.2%)

If DPP  25.2% to 30%:

10%

If DPP  30%:

10% 0.6 (DPP-30%)

Urban 1-99 beds, If DPP  15% to 20.2%:

Sole community, and 2.5% 0.65 (DPP—15%)

Other rural 1-499 beds

If DPP  20.2% to 25.2:

5.88% 0.825 (DPP—20.2%)

If DPP  25.2%:

10%

Note: DPP (disproportionate patient percentage). *A rural referral center that is also a sole community hospital receives the larger disproportionate share

payment adjustment.

Source: MedPAC analysis.

TABLE

4-16
received a base operating payment for

each discharge equal to the lesser of their

current operating costs or a facilityspecific target, based on their historical

operating costs trended forward by an

inflation factor. The BBA required that a

facility’s target amount be capped at the

75th percentile of all target amounts

nationally. Psychiatric facilities are now

paid the least of their own costs, their own

target, or the national cap (which is

$11,364 per case for fiscal year 2001).29

Medicare beneficiaries may experience

difficulty in accessing care when payment

methods change because changes in

financial performance can affect facilities’

willingness to admit them or the quality of

care provided to them. In 1998, the first

post-BBA year, psychiatric facilities’

aggregate margin decreased by 5

percentage points from the previous year,

to –2.3 percent, reversing an earlier

upward trend. Exit of facilities from the

Medicare program also can be an

indicator of potential payment problems.

After years of increases, the number of

hospital-based units declined 14 percent

from 1999 to 2000. These trends could be

early warnings that beneficiaries needing

psychiatric care may experience access

problems.

Problems with the 

target cap

One target cap, based on national

averages, assumes that all PPS-exempt

psychiatric facilities have a similar mix of

cases. We found that government-owned

hospitals treat more costly beneficiaries

than other facility types; a single target

cap clearly disadvantages these hospitals.

Hospital-based units in rural areas have

higher costs than units in urban areas, but

we were unable to test the relationship

between those higher costs and patient

characteristics, volume, or allocation of

administrative costs of those facilities in

the time allowed. However, a single target

cap for all facilities appears inappropriate.

Historically, psychiatric facilities have

played different roles (Eselius 2000).

ProPAC (1992) found that psychiatric

providers were arrayed on a continuum of

patient complexity. PPS hospital scatter

beds fell at the low end of the continuum,

followed by hospital-based units and nongovernment hospitals, while governmentowned hospitals were at the high end.

ProPAC found that government-owned

hospitals had longer lengths of stay and

admitted higher proportions of disabled

beneficiaries and involuntarily committed

patients than other facility types.

(Disabled beneficiaries who use inpatient

psychiatric care are more likely to be

disabled because of mental illness.)

We compared PPS-exempt facility

types—government-owned freestanding

hospitals, other freestanding hospitals, and

hospital-based units—to determine

whether these historical differences are

still present. We also tested whether

different facility types have similar case

mixes. We found that government-owned

hospitals have patterns consistent with

historical data, but that patterns for other

hospitals and units may have changed.

Government-owned hospitals in both rural

and urban areas have lengths of stay twice

as long as other facility types, as well as

higher costs per case (Table 4-17).30 They

admit a larger proportion of disabled

Report to the Congress: Medicare in Rural America | June 2001 83

29 The labor-related portion of the cap is adjusted by the local wage index. The target cap also affects extra payments and future payments; annual updates to rates are

linked to the extent to which a facility’s costs exceed or fall below its target amount. The cap’s effect on extra payments and annual updates is small relative to its effect

on payment per case, but these additional effects can exacerbate poor financial performance for facilities with costs above the cap.

30 All psychiatric facilities’ costs have been standardized by removing the effects of geographic differences in wage levels.

Patient and psychiatric facility characteristics, by facility type and urban or rural location

Facility characteristics Patient characteristics

Average Average Average Average Number of Committed length of case-mix cost per percent

facilities Disabled involuntarily stay (days) index case over cap

Rural facilities

Government-owned 41 77% 22% 24 N/A $10,631 54%

Hospital-based 348 45 2 11 1.01 7,770 30

Freestanding 25 65 4 12 0.95 6,300 4

Urban facilities

Government-owned 119 81 20 26 N/A 9,560 54

Hospital-based 979 55 1 12 1.01 6,481 11

Freestanding 274 69 2 12 0.97 5,297 4

Note: Cost per case is standardized for wage index; cap for fiscal year 1998  $10,547. Length of stay and cost per case weighted by discharges. Case-mix index calculated

using all patient refined diagnosis related groups (APR-DRGs). N/A (not applicable); we were unable to calculate comparable case-mix index values for government-owned

hospitals.

Source: MedPAC analysis of fiscal year 1998 cost reports and 1997 MedPAR data from HCFA.

TABLE

4-17
84 Improving payment for inpatient hospital care in rural areas

Hospital-based units’ length of stay and cost per case

Average Average

Average Average standardized CPC for

Location of length of case-mix cost per case Percent facilities

hospital-based unit (UIC) Number stay index (CPC) over cap over cap

Urban, in an MSA (1,2) 979 12 1.01 $6,914 11% $13,842

Rural 348 11 1.01 8,424 30 13,776

Adjacent to an MSA and 

includes a town with at 

least 10,000 people (3,5) 107 11 1.01 7,654 21 13,021

Adjacent to an MSA but does 

not include a town with at 

least 10,000 people (4,6) 71 13 1.02 9,123 34 13,622

Not adjacent to an MSA but 

includes a town with at 

least 10,000 people (7) 87 9 0.99 6,791 14 12,989

Not adjacent to an MSA 

but includes a town with 

between 2,500 and 

10,000 people (8) 64 11 1.00 10,025 47 14,572

Not adajcent to an MSA

and does not include a 

town with at least 2,500 

people (9) 19 14 1.04 12,230 74 14,098

Note: UIC (urban influence code, as defined by the U.S. Department of Agriculture). MSA (metropolitan statistical area, as defined by the U.S. Office of Management and

Budget). Cost per case is standardized for wage index; cap for fiscal year 1998  $10,547. Length of stay and cost per case weighted by facilities. Case-mix index

calculated using all patient refined diagnosis related groups (APR-DRGs).

Source: MedPAC analysis of fiscal year 1998 cost reports and 1997 MedPAR data from HCFA.

TABLE

4-18

31 See Chapter 1 for more information on UICs.

beneficiaries and a much larger proportion

of Medicare patients who are involuntarily

committed. Consistent with this greater

patient complexity, government-owned

hospitals in both urban and rural areas had

the highest costs per case and more than

half of these hospitals had an average cost

per case above the target cap. The

hospitals with costs above the cap also

had average costs of almost double the

cap. We found that it was impossible to

compare case mix for government-owned

hospitals with that for other facility types

because their costs were so different.

Government-owned hospitals may have

higher costs in part because they cannot

refuse patients.

Other freestanding hospitals (not

government-owned) and hospital-based

units in both rural and urban areas have

similar lengths of stay—between 11 and

12 days. Urban freestanding hospitals

have a higher case-mix index than do their

rural counterparts, but costs per case are

higher in rural areas. Urban and rural

hospital-based units have an identical

case-mix index (1.01), but units in rural

areas have a higher cost per case and are

more likely to be over the target cap.

To examine differences in hospital-based

units’ case mix, lengths of stay, and costs

per case more closely, we used urban

influence codes (UICs).31 In general, as

hospital-based units become more rural,

cost per case increases (Table 4-18).

Average lengths of stay vary in rural

areas, from 9 to 14 days, but generally

increase as case mix increases. For

example, facilities in areas not adjacent to

an MSA but including a town with at least

10,000 people have the lowest case-mix

index, shortest average length of stay, and

lowest cost per case. Totally rural areas

(not adjacent to an MSA and not including

a town with at least 2,500 people) have

the highest case-mix index, longest

average length of stay, and highest cost

per case. However, in the two UICs with

an 11-day average length of stay, case mix

differs slightly but costs vary widely—the

area with a lower case-mix index has an

average cost per case 31 percent higher

than the area with the higher case mix.

As units become more rural, the

proportion with costs over the cap

generally increases. Almost three-fourths

of units in totally rural areas have costs

above the cap. However, the average cost

per case for hospital-based facilities above

the cap is similar, regardless of whether

they are urban or rural, and ranges from

$12,989 to $14,572.
Higher costs may be related to volume, or

rural PPS hospitals may allocate a greater

proportion of overhead to psychiatric

units. Rural units may also be more likely

to have management contracts. One

management company has reported to us

that its fees are $175,000 per year for a

10-bed unit, which could add an

additional $1,300 or more to the cost per

case. These contracts may be necessary

for rural hospitals to have PPS-exempt

psychiatric units; however, it will not be

possible to systematically identify

facilities with management contracts for

our future work on this issue because of

data limitations.

One target cap for all psychiatric facilities

is inappropriate. A single cap

disadvantages government-owned

freestanding hospitals and may

disadvantage rural hospital-based units as

well. The BBRA required HCFA to

develop a PPS for exempt psychiatric

facilities for implementation in October

2002. Revising the cap will provide a

stopgap in the event that the PPS is not in

effect by that time.

RECOMMENDATION 4F

The Congress should revise the target

cap for inpatient psychiatric facilities

in a way that better addresses

differences among them.

More knowledge about the reasons for

differences among facilities will be

needed to design more appropriate caps

because the major consequence of

introducing more than one target cap will

be to redistribute payments. For example,

if government-owned hospitals have their

own cap, the cap for other facilities will

be lower. The proportion of rural facilities

with costs above the cap may be even

greater with a separate cap for

government hospitals. Facilities with costs

per case above the new cap may discharge

patients prematurely or may refuse to

admit beneficiaries they believe to be

costly. HCFA’s current research on

psychiatric facilities will provide more

information on why differences exist.

Critical access hospitals and

psychiatric units

Another potential problem for beneficiary

access may result from hospitals closing

their PPS-exempt psychiatric units to

apply for CAH status. Psychiatric unit

beds and lengths of stay are included in

the CAH qualifying criteria (maximum 15

acute care inpatient beds and an average

length of stay of 96 hours).

On the one hand, closing a psychiatric unit

could affect rural beneficiaries’ access to

psychiatric care in specialized facilities

near their homes. On the other hand,

CAHs are not precluded from admitting,

stabilizing (through a scatter bed

approach), and transferring psychiatric

patients or providing treatment in a dayhospital program. PPS hospitals

frequently treat beneficiaries for

psychiatric conditions in scatter beds,

rather than in PPS-exempt specialty units

(Cano et al. 1997).

Challenges in designing a

prospective payment system

for inpatient psychiatric care

The BBRA required HCFA to develop a

PPS for psychiatric facilities. In the course

of our preliminary study of inpatient

psychiatric care, two issues emerged that

may complicate developing a PPS for

these facilities. Developers of other

prospective payment systems have faced

one of these challenges in the past, but the

other issue may be unique to psychiatric

facilities.

First, the data reported by psychiatric

facilities are inaccurate. Although patients

in PPS-exempt psychiatric facilities must

have a principal psychiatric diagnosis,

about 6 percent of the hospital-based

units’ stays had no psychiatric diagnosis.

In addition, facilities do not report

medical comorbidities, although

psychiatric patients frequently have them.

We believe these errors result from

facilities’ lack of attention to coding

diagnoses because their payment is

currently unaffected. Developers of other

PPSs have also encountered inaccurate

coding and found ways to compensate.

We were unable to use the same weights

to derive a case-mix index for government

owned hospitals that is comparable to the

index for other facility types because the

measured relative costliness for patients

with the same diagnosis was very

different. For example, patients with

schizophrenia treated in governmentowned hospitals have an average charge

as much as three times that of patients

treated in other facilities. This meant we

could not construct a valid measure of

case mix for both government-owned and

the other facility types. The inability to

construct one set of relative weights for all

patients could create problems in

designing a PPS. However, if the

differences in cost per case were

exclusively the result of much longer

lengths of stay, a per diem system could

mitigate the effect of those differences. 

Report to the Congress: Medicare in Rural America | June 2001 85
References

Cano C, Hennessy KD, Warren JL, et al. Medicare Part A utilization and expenditures for

psychiatric services: 1995, Health Care Financing Review. 1997, Vol. 18, No. 3, p.

177–193.

Dalton K, Slifkin R, Howard H. Rural hospital wages and the area wage index: 1990-

1997, Working paper No. 70. North Carolina Rural Health Research and Policy Analysis

Center, Cecil G. Sheps Center for Health Services Research, University of North Carolina

at Chapel Hill, November 20, 2000, available at

http://www.shepscenter.unc.edu/research_programs/rural_program.

DeLew N. Geographic classification of hospitals: alternative labor market areas, Health

Care Financing Review. 1992, Vol. 14, No. 2, p. 49–58.

Eselius L. Prospective payment for inpatient psychiatric services: a review of the

evidence and key issues. Cambridge (MA), Harvard Medical School Department of

Health Care Policy. October 6, 2000.

Health Care Financing Administration. Medicare program; changes to the hospital

inpatient prospective payment systems and fiscal year 2001 rates: final rule, Federal

Register, August 1, 2000, Vol. 65, No. 148, p. 47070–47071.

Hendricks A. Rural hospital wages, Health Care Financing Review. 1989, Vol. 11, No. 2,

p. 13–18.

Medicare Payment Advisory Commission. Report to the Congress: Medicare payment

policy. Washington (DC), MedPAC. March 2001.

Medicare Payment Advisory Commission. Report to the Congress: Selected Medicare

issues. Washington (DC), MedPAC. June 2000a.

Medicare Payment Advisory Commission. Report to the Congress: Medicare payment

policy. Washington (DC), MedPAC. March 2000b.

Prospective Payment Assessment Commission. Medicare and the American health care

system. Washington (DC), ProPAC. June 1996.

Prospective Payment Assessment Commission. Interim report on payment reform for

PPS-excluded facilities. Washington (DC), ProPAC. October 1992.

Prospective Payment Assessment Commission. Report and recommendations to the

Congress. Washington (DC), ProPAC. March 1991.

Schmitz R, Merrell K. Improving the definition of hospital labor market areas and wage

indexes. Contract No. T-31416922. Prepared for the Prospective Payment Assessment

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occupational mix. Technical report No. I-90-02. Washington (DC), ProPAC. June 1990.

86 Improving payment for inpatient hospital care in rural areas
Report to the Congress: Medicare in Rural America | June 2001 87
Assessing payment for 

outpatient hospital 

care in rural areas

CHAPTER 5
RECOMMENDATION

In the short term, no outpatient payment adjustments for rural hospitals are needed in addition to the

current hold-harmless provision. The Secretary should revisit outpatient payments to rural hospitals

when better information on hospitals’ experience with the payment system is available.

*YES: 14 • NO: 0 • NOT VOTING: 0 • ABSENT: 2

*COMMISSIONERS’ VOTING RESULTS
o rural hospitals face special circumstances that make the new

outpatient prospective payment system inappropriate for

them? Rural hospitals are concerned that the new payment

system will not adequately cover their costs to provide care

because it pays predetermined rates (based on median costs) for services provided

by all hospitals. In response to a Congressional mandate, MedPAC has evaluated

the extent to which special circumstances make it difficult for rural hospitals to keep

their costs below the prospective payment system rates. The available evidence

suggests that rural hospitals do face some unique circumstances and may merit

special consideration. For example, they rely more on Medicare and on outpatient

services as sources of revenue, increasing their exposure to the financial risks of

prospective payment. At the same time, rural hospitals tend to have limited

administrative capacity and financial reserves, leading to less ability to manage

financial risk. Finally, the available cost data indicate that rural hospitals have

higher outpatient unit costs. Our analysis suggests that in the short term, the existing

hold-harmless policy—which provides additional payments to rural hospitals with

100 or fewer beds that experience losses under the outpatient prospective payment

system—will provide financial support to rural hospitals that need it. In the longer

term, other policies may be warranted.

D

CHAPTER

Assessing payment for

outpatient hospital care in

rural areas

5

In this chapter

• Paying for outpatient services

in rural hospitals

• Applicability of the outpatient

payment system to rural

hospitals

• Limitations of the evidence

• Future policy options

Report to the Congress: Medicare in Rural America | June 2001 89
In August 2000, the Health Care

Financing Administration (HCFA)

implemented a prospective payment

system (PPS) for outpatient services. The

introduction of the outpatient PPS

generated considerable concern among

rural hospitals and their advocates because

it pays predetermined rates (based on

median costs) for services provided by all

hospitals. Special circumstances may

make it difficult for rural hospitals to keep

their costs below the PPS rates. This

chapter reviews the treatment of rural

hospitals under the outpatient PPS and

assesses the appropriateness of the

payment system for various types of rural

hospitals, including rural referral centers

(RRCs), small rural Medicare-dependent

hospitals (MDHs), sole community

hospitals (SCHs), other hospitals with 100

or fewer beds, and rural health clinics

(RHCs).

Paying for outpatient

services in rural hospitals 

Most rural hospitals will be paid under the

outpatient PPS, with the exception of

critical access hospitals (CAHs), Indian

Health Service hospitals, and hospitals in

Maryland subject to a waiver from the

inpatient PPS. Unlike under the inpatient

PPS, rural hospitals with special

designations (such as SCHs) are not

subject to special outpatient payment

rules.1 However, the Balanced Budget

Refinement Act of 1999 provided

transitional financial protection for all

small rural hospitals with 100 or fewer

beds by holding them harmless from

losses through calendar year 2003. Under

this policy, all hospitals must submit

claims and be paid the PPS rates;

however, hospitals that would have

received higher payments under the prePPS payment rules will receive an

additional payment to make up the

difference. The hold-harmless policy

limits losses for rural hospitals as they

adjust to the new system. More than 80

percent of rural hospitals are eligible for

the hold-harmless payments, including

almost all MDHs and SCHs but few

RRCs. Anecdotal reports suggest that

early implementation of the hold-harmless

provision has been variable, with HCFA

taking administrative steps to respond to

hospitals’ concerns (for more detail on the

calculation and implementation of holdharmless payments, see the text box

below).

90 Assessing payment for outpatient hospital care in rural areas

1 For a review of the special inpatient payment provisions for rural hospitals, see Chapter 4.

Implementing hold-harmless payments for small

rural hospitals

Rural hospitals with 100 or 

fewer beds will receive 

additional hold-harmless

payments if they suffer losses under

the outpatient prospective payment

system (PPS). Under this policy, all

hospitals must submit claims and be

paid the PPS rates. However, small

rural hospitals that would have

received higher payments under the

pre-PPS payment rules than they

actually receive under the outpatient

PPS will receive an additional

payment from the Health Care

Financing Administration (HCFA) to

make up the difference. Those

hospitals that keep costs below the

PPS rates will keep their gains.

By statute, the formula for

determining hold-harmless payments

(as well as other transitional corridor

payments) is the current year charges

reduced to costs and multiplied by a

payment-to-cost ratio. Also by statute,

both the cost-to-charge and paymentto-cost ratios used to calculate holdharmless payments are set by HCFA

based on 1996 cost reports

(exceptions were made in the

Medicare, Medicaid, and SCHIP

Benefits Improvement Act of 2000 for

hospitals without 1996 cost reports).

Although the final hold-harmless

payment amounts are determined

when hospitals’ cost reports are

settled, HCFA is making monthly

interim payments based on submitted

claims. Initial experience with the

interim payments has been mixed,

with HCFA taking administrative

steps to respond to hospitals’

concerns.

Anecdotal reports indicate that the

interim payments have been important

in protecting some rural hospitals’

cash flow, while others believe that

local fiscal intermediaries are not

implementing them in a uniform and

timely manner. In addition, given that

the interim payments are based on

submitted claims, they are affected by

problems and delays in claims

processing.

Concerns have also been raised

regarding the adequacy of the interim

payment amounts. For example, in

calculating interim payments, HCFA

pays only 85 percent of a hospital’s

estimated interim hold-harmless

amount to avoid the need to recoup

overpayments upon cost report

settlement. Final calculation of holdharmless payments will be done at

cost report settlement and any over- or

underpayments will be resolved.

Settlement times vary, but can take 18

months or more.

Some hospitals have also expressed

dissatisfaction with the cost-to-charge

ratios used to calculate the additional

payments; HCFA has instituted a

limited appeals process in response.

Finally, HCFA adopted a uniform 80

percent payment-to-cost ratio, rather

than a hospital-specific ratio, to

calculate interim payments as a way

to expedite the payment process.

Hospital-specific values will be used

for interim payments beginning in

July 2001 and to calculate final holdharmless payments when cost reports

are settled. Rural hospitals with more than 100 beds,

and virtually all other hospitals, may also

receive transitional payments through

2003 if they are paid less under the

outpatient PPS than they would have been

paid under pre-PPS payment rules;

however, they do not recoup the full

difference and the extent of additional

payment declines every year. Beginning

in 2004, virtually all hospitals will receive

only their outpatient PPS payments.2

Rural health clinics will, for the most part,

continue to be paid based on costs, subject

to certain per service limits, for their rural

health clinic services. For other services,

they are paid under the outpatient PPS

(see text box on RHCs, p. 92). Critical

access hospitals are paid on a reasonable

cost basis for outpatient services.

Applicability of the

outpatient payment

system to rural hospitals 

A prospective payment system pays all

hospitals predetermined rates (based on

median costs) for services. This payment

methodology provides an incentive for

hospitals to keep their costs below the

PPS rates and puts hospitals at financial

risk if their costs are above the PPS rates.

Rural hospitals may face circumstances

beyond their control that make them more

vulnerable than urban hospitals to the

financial risks associated with prospective

payment, such as dependence on

Medicare and outpatient services as

sources of revenue, limited administrative

capacity and financial reserves, a different

service mix, and higher outpatient unit

costs. Rural hospitals may also serve a

unique social role.

This chapter examines the available

evidence regarding the ability of rural

hospitals to adapt to the outpatient PPS.

We find some evidence that rural

hospitals are more vulnerable to the

financial risks inherent in the payment

system and may have fewer resources

available to manage those risks. However,

the evidence has serious limitations,

including a lack of systematic information

regarding hospitals’ experience with the

outpatient PPS to date, questions

regarding the completeness and reliability

of outpatient claims and cost data, and

difficulty obtaining recent cost data that

are linked to claims information.

Given those limitations and the

continuation of the hold-harmless

provision through 2003, MedPAC

recommends:

RECOMMENDATION

In the short term, no outpatient

payment adjustments for rural

hospitals are needed in addition to

the current hold-harmless provision.

The Secretary should revisit

outpatient payments to rural

hospitals when better information on

hospitals’ experience with the

payment system is available.

Under the Balanced Budget Act of 1997,

the Secretary has the authority to make

adjustments to the payment system for

specific classes of hospitals. In the final

rule governing the payment system,

HCFA indicated that it would monitor the

performance of small rural hospitals

during the early years of implementation

and assess whether additional adjustments

are needed after the hold-harmless

provision expires (HCFA 2000).

The rest of this section reviews the

evidence regarding rural hospitals’ ability

to adapt to the outpatient PPS. We then

discuss the limitations of the evidence and

outline future policy options for the

treatment of rural hospitals under the

outpatient PPS.

Dependence on Medicare

and outpatient revenues 

Medicare accounts for a larger share of

total business for rural hospitals than for

urban hospitals. Within Medicare, rural

hospitals also tend to provide a greater

share of outpatient services than urban

hospitals. In 1999, Medicare costs for

hospitals in rural areas made up 45.4

percent of total costs, compared with 34.0

percent for their urban counterparts. All

rural hospital groups had an average

Medicare share of at least 44.1 percent,

with a high of 51.0 percent for Medicaredependent hospitals (Table 5-1).

Similarly, outpatient costs made up 21.8

percent of total Medicare costs for rural

hospitals, but only 16.1 percent for urban

hospitals. For rural hospitals with 100 or

fewer beds, outpatient costs comprised

24.2 percent of Medicare costs (Table 5-2,

p. 93). Given their greater reliance on

Medicare and on outpatient services

within Medicare, rural hospitals have

more at stake than their urban counterparts

in the move to the outpatient PPS.

HCFA’s impact analysis of the outpatient

PPS suggests that rural hospitals are more

vulnerable to the financial risks of

prospective payment. While all hospitals

were estimated to gain an average of 0.2

percent in their outpatient payments

before any transitional payments, rural

hospitals were expected to lose an average

of 1.8 percent. Small rural hospitals were

projected to be more negatively affected,

with those under 50 beds (about 50

percent of rural hospitals) losing 8.5

percent and those with 50-99 beds losing

Report to the Congress: Medicare in Rural America | June 2001 91

Medicare costs as

percent of total

hospital costs, 1999

Medicare

Hospital type share

All hospitals 34.9%

Urban 34.0

Rural 45.4

Rural hospitals by bed size

1100 44.8

101 or more 45.9

Rural hospitals by type

Rural referral center 46.4

Sole community 44.1

Small rural Medicare-dependent 51.0

Other rural, 1100 beds 43.9

Other rural, 101 or more beds 44.6

Source: MedPAC analysis of American Hospital

Association annual survey data.

TABLE

5-1

2 The exceptions are cancer and children’s hospitals, which have permanent hold-harmless status. For a fuller description of the transitional corridor payments, see Chapter

2 in our June 2000 report.
92 Assessing payment for outpatient hospital care in rural areas

Applicability of the outpatient payment system to rural health clinics

T wo types of rural health clinics 

(RHCs) exist—free-standing 

clinics generally run by

physicians, and provider-based clinics

generally operated by a hospital. In 1998,

there were about 3,750 RHCs, of which

50 percent were provider-based (Farley

et al. 2001).3 The range of services

provided in RHCs builds on a primary

care base and includes routine diagnostic

and therapeutic services and basic

laboratory services. RHCs may also bill

for non-RHC services, such as X-rays or

other diagnostic and therapeutic services,

provided in the RHC.

Under the Medicare program, RHCs

are paid an all-inclusive rate, which

includes both professional and facility

costs, for their RHC services. RHCs are

paid based on their costs, up to a per

visit cap that is updated for inflation.

RHCs must also meet productivity

standards. Both free-standing and

provider-based clinics are subject to the

cap and productivity standards;

however, RHCs owned by hospitals

with less than 50 beds are exempt from

the payment cap (but not the

productivity standards) and are paid

based on their reasonable costs (the

Health Care Financing Administration

(HCFA) estimates that about 600

RHCs are part of hospitals with fewer

than 50 beds). Medicare reimburses

most RHCs subject to the cap at the

maximum level.

When HCFA implemented the

outpatient prospective payment system

(PPS), it changed the payment

mechanism for non-RHC services

provided in hospital-based RHCs.

Rather than billing these services as an

RHC and being paid on a cost basis,

RHCs that provide non-RHC services

are paid for them under the outpatient

PPS for the facility component. The

professional component of non-RHC

services is covered by the all-inclusive

rate.

The main advantage of making the

outpatient PPS apply to provider-based

RHCs for non-RHC services is that the

Medicare program pays the same

amount for the same service provided

by the same organization (the parent

hospital). It also eliminates the

incentive to shift costs and patients

receiving non-RHC services from the

outpatient department to the RHC,

which would exist if cost-based

reimbursement were continued in

RHCs.

Any difference in payment between the

outpatient department and the RHC

will create incentives to shift services

to the site of care with the highest

payment rate. The ability to act on

these incentives depends, in part, on the

proximity of the clinic to the main

hospital, as well as the facilities

available in the clinic and the impact of

shifting the site of service on both

physicians and patients. In 1995, about

one-third of RHCs were in the same

town as the parent hospital (Schoenman

et al. 1999).

Implementing the outpatient PPS in

RHCs also creates some problems. For

instance, the overlay of a second

payment system on what are often

small clinics staffed by one or two

providers creates an administrative

burden. This payment system also

creates a further inconsistency in how

the two types of RHCs—free-standing

and provider-based—are paid. Given

that the policy objective served and the

services provided in the two types of

clinics are similar, it may be

advantageous to equalize their

treatment.

In order to assess the applicability of

the outpatient PPS to provider-based

RHCs, a number of questions must be

answered:

• To what extent are these clinics

providing services outside the allinclusive rate? Do those services

overlap with the outpatient

department? If few non-RHC

services are provided, then the

administrative burden for providers

of complying with the outpatient

PPS may outweigh the benefits to

the program of having a uniform

payment system.

• Do the payment rates established by

the outpatient PPS adequately

reflect the efficient provision of care

in RHCs? The clinics may have

different cost structures than the

outpatient department, requiring a

separate payment rate.

• Does the outpatient PPS payment

for services covered by the allinclusive rate exceed the RHC

payment limit? If it does, hospitals

may decide to close their providerbased RHCs and integrate the

services into their outpatient

departments.

Unfortunately, data to answer these

questions do not currently exist. Due to

the per visit payment structure, RHC

claims contain little detailed

information regarding the services

performed. Cost reports are difficult to

obtain. HCFA is now gathering more

complete data on RHCs.

Given the limited information

available, it is difficult to evaluate the

applicability of the outpatient PPS to

these clinics. However, alternatives that

may be considered as more data are

gathered include establishing a distinct

PPS for all rural health clinic services,

or developing a separate payment

mechanism for non-RHC services,

based either on a fee schedule or costbased pass throughs with payment

limits. 

3 The methodology used in this study counts the number of clinics operating at any time during the year. This results in a larger estimate than counting the

number of clinics operating at a single point in time.
2.7 percent. After including the

transitional corridors and hold-harmless

payments, all hospital groups were

estimated to see increased outpatient

payments, with the average increase being

4.6 percent for all hospitals and 4.4

percent for rural hospitals (HCFA 2000).

Limited administrative

capacity and financial

reserves 

Limited administrative capacity and

financial reserves affect rural hospitals’

ability to adapt to the outpatient PPS in

both the short and long term. In the short

term, learning a new payment system and

ensuring proper billing entail a significant

administrative burden for all hospitals.

Small rural hospitals with limited staff are

likely to find the task even more difficult.

Payment depends on proper coding.

Therefore, hospitals with fewer resources

to devote to making this transition may

experience cash flow problems.

From a financial perspective, rural

hospitals tend to have lower reserves and

less access to financial markets.

Therefore, the cash-flow problems

associated with moving to a new payment

system may be more serious for them (the

transition has reportedly lengthened

processing times and increased the

number of rejected and returned claims).

Interim payments linked to the holdharmless provision partly mitigate cash

flow problems.

The transition to the new payment system

has also affected coinsurance. Rural

hospitals have reported anecdotally that

they are charging higher coinsurance rates

under the outpatient PPS than they used

to. Rural beneficiaries generally have

lower incomes and are less likely than

urban beneficiaries to have supplemental

coverage. If rural beneficiaries cannot

meet these increased coinsurance

obligations, access may be affected and

rural hospitals’ bad debt for outpatient

services may increase (for more

discussion of the potential impacts of the

outpatient PPS on access to high-quality

care in rural areas, see the text box, p. 

94).

Limited financial reserves may also

hamper rural hospitals’ ability to adapt to

the new payment system in the long term.

The outpatient PPS pays hospitals a fixed

amount per service delivered. If costs are

above the payment amount, hospitals must

absorb the losses; if costs are kept below

payments, hospitals keep the gains. The

outpatient PPS does include an outlier

payment; however, hospitals still bear

some of the costs associated with

outliers.4 With a large volume of services

and a diversified service line, a hospital

can offset losses on some services by

gains on others. However, the small size

and limited scope of many rural hospitals

make such cost-shifting less feasible.

Rural hospitals often lack access to

financial markets and other fund-raising

sources as well, such as support from local

governments and charities, trust funds and

other financial assets, and revenue sources

such as parking lots and cafeterias.

Report to the Congress: Medicare in Rural America | June 2001 93

Outpatient costs as

percent of total

Medicare costs, 1999

Outpatient Hospital type share

All hospitals 17.0%

Urban 16.1

Rural 21.8

Rural hospitals by bed size

1100 24.2

101 or more 19.8

Rural hospitals by type

Rural referral center 19.9

Sole community 23.9

Small rural Medicare-dependent 24.0

Other rural, 1100 beds 23.8

Other rural, 101 or more beds 19.9

Note: Total Medicare costs include operating and

capital costs for inpatient, outpatient, home

health, skilled nursing facility, and exempt unit

services, as well as graduate medical

education and Medicare bad debt. Based on

a sample that includes about one-half of

hospitals covered by prospective payment.

Source: MedPAC analysis of Medicare cost reports.

TABLE

5-2

4 HCFA currently assesses outliers at the claim level. Costs must exceed the payment rate by a factor of 2.5. Hospitals are then reimbursed 75 percent of costs above the

threshold. The outlier provision is budget neutral, with a limit on outlier payments of 2 percent of total outpatient program payments.

Medicare margins, by hospital type, 1999

Hospital type Outpatient margin Overall Medicare margin

All hospitals 15.3% 5.6%

Urban 15.1 6.8

Rural 15.8 2.9

Rural hospitals by bed size

1100 17.3 4.1

101 or more 14.0 1.5

Rural hospitals by type

Rural referral center 13.7 1.3

Sole community 14.1 2.7

Small rural Medicare-dependent 20.4 1.3

Other rural, 1100 beds 18.8 5.9

Other rural, 101 or more beds 16.1 3.7

Note: Overall Medicare margin includes operating and capital payments and costs for inpatient, outpatient, home

health, skilled nursing facility, and exempt unit services, as well as graduate medical education and Medicare

bad debt. Overall Medicare margin is based on a sample of about one-half of hospitals covered by

prospective payment. Outpatient margin is based on a sample of about two-thirds of hospitals covered by

prospective payment.

Source: MedPAC analysis of Medicare cost reports.

TABLE

5-3
Rural hospitals’ financial position is

reflected in their margins.5 Even before

the introduction of the outpatient PPS,

rural hospitals had lower Medicare

outpatient margins than did their urban

counterparts (Table 5-3, p. 93). 

Medicare-dependent hospitals had the

lowest outpatient margin for 1999: –20.4

percent. Among rural hospitals, those with

fewer beds had lower margins.

Interpreting outpatient margins can be

difficult, and the numbers presented here

understate outpatient financial

performance. Previous payment policy,

which paid for most outpatient services

based on costs while inpatient services

were paid under a PPS, provided an

incentive to over-allocate fixed costs to

outpatient services. In part to counteract

this trend, previous payment system rules

set payments below reported costs,

leading to negative outpatient margins for

all hospitals. However, among urban

hospitals a high, positive inpatient margin

generally translates into a positive overall

Medicare margin. For rural hospitals,

overall Medicare margins are, on average,

negative.

Different service mix 

Rural hospitals tend to provide a different

mix of services than do their urban

counterparts. The service-mix index is an

average of the relative weights for the

outpatient PPS services provided in a

hospital and is analogous to the case-mix

index for inpatient care. This index

provides a global measure of the resource

intensity of the services provided, with a

larger number indicating a more resourceintensive, and generally more complex,

service mix. According to MedPAC

analysis, the average outpatient servicemix index in 1996 was 2.19 for all

hospitals, 2.38 for urban hospitals, and

1.95 for rural hospitals.

The impact of differences in service mix

on various types of rural hospitals will

depend on the adequacy of the payment

rates by type of service. If payments are

adequate to cover costs for all services,

there will be no differential impact by

hospital type due to service mix

differences. If, however, the payment-tocost ratio varies among the services

provided, different types of hospitals may

do better or worse under the outpatient

PPS due to underlying differences in the

services provided.

The outpatient PPS covers a broad and

diffuse array of services, from office visits

and X-rays to advanced imaging and

significant operations. Tables 5-4 (p. 95)

and 5-5 (p. 96) provide a classification

scheme that allows a better understanding

of the types of services covered and the

differences in service mix summarized by

the service-mix index. The volume of

outpatient services provided by various

types of hospitals is grouped into five

broad categories for comparison:

evaluation and management, procedures,

imaging, testing, and other services. The

categories are based on HCFA’s

Berenson-Eggers Type of Service

classification system, modified to better

94 Assessing payment for outpatient hospital care in rural areas

Potential impacts of the outpatient payment system

on access to quality care in rural areas

The implementation of a

prospective payment system

(PPS) for outpatient services in

August 2000 marked a dramatic

departure from previous payment

policy and was greeted with

considerable concern by hospitals. To

get early perspectives on the possible

consequences of the new payment

system for Medicare beneficiaries’

access to quality care, and to have

timely knowledge of any significant

access or quality problems, MedPAC

contracted with the Center for Health

Policy Studies to conduct structured

interviews with key informants. The

interviews included 82 individuals

from hospitals, trade associations,

government, research firms,

beneficiary organizations, and payers.

Of those interviewed, eight were rural

hospital administrators from hospitals

ranging in size from 50 to 300 beds (4

had 100 or fewer).

Rural hospital administrators reported

few short-term access and quality

concerns, although they felt burdened

by the new billing and coding

requirements of the outpatient PPS.

On a financial front, they reported that

the interim hold-harmless payments

have been important to ensure cash

flow. In addition, most reported an

increase in coinsurance liability for

their patients, which may present an

access problem for beneficiaries and

increase rural hospitals’ bad debt if

beneficiaries cannot pay.

In the long term, respondents felt that

rural hospitals may be forced to

reduce the scope of services offered

due to reimbursement levels below

their costs, although only one hospital

reported already changing services

due to the payment system. The low

volume of services provided by rural

hospitals can result in higher unit

costs than those of the average

hospital (payment rates, however, are

set at a national level). Services of

particular concern to some hospitals

were radiology and emergency

services. A decrease in services

offered by rural hospitals may not

cause an access problem for

beneficiaries if the services are

available at other sites, such as

physicians’ offices or ambulatory

surgical centers. However, these

substitute sites many not be available

locally, especially in small

communities. Therefore, shifts of

services to substitute sites may

increase travel times for beneficiaries,

which could affect access. Finally,

some respondents suggested that the

introduction of the outpatient PPS

would encourage more conversion to

critical access hospital (CAH) status,

as CAHs are exempt from the

payment system. 

5 Margins are calculated (in percentage terms) as the difference between payments and costs divided by payments.
reflect services provided in the outpatient

setting. As expected, rural hospitals tend

to provide more basic services, including

emergency services, and fewer services

that require advanced technology. In

general, the differences among rural

hospitals are greater than those between

urban and rural hospitals.

Outpatient services in rural hospitals

include a somewhat greater share of

evaluation and management services, such

as physician visits (25.8 percent of all

Report to the Congress: Medicare in Rural America | June 2001 95

services), than in urban hospitals (24.3

percent) (Table 5-4). Within evaluation

and management, emergency visits make

up a larger share of rural hospitals’ total

volume (8.5 percent versus 7.4 percent).

On the other hand, rural hospitals’

outpatient departments have a

substantially lower proportion of

procedures (15.8 percent versus 19.8

percent for urban hospitals), particularly

major procedures such as coronary

angioplasty, breast surgery, and

orthopedic surgery. Radiation therapy

comprises a larger share of urban

outpatient volume (7.5 percent) than rural

(4.0 percent). Rural hospitals have a

greater proportion of imaging services, but

they are slightly more concentrated in

standard imaging such as X-ray than in

advanced imaging such as computerized

axial tomography or magnetic resonance

imaging. Rural hospitals’ service mix

includes a lower share of tests, including

fewer lab and pathology services.

Outpatient service mix, urban and rural hospitals, 1999

Percent of volume by type of hospital

Rural

101 or

All Rural more

Service category hospitals Urban Rural 1–100 beds beds

Evaluation and management 24.6% 24.3% 25.8% 28.3% 22.7%

Clinic/office visits 16.6 16.5 17.0 18.2 15.4

Emergency/critical care 7.6 7.4 8.5 9.8 6.8

Consultations 0.4 0.4 0.3 0.3 0.4

Procedures 18.8 19.8 15.8 12.8 19.5

Major procedures 1.3 1.5 0.7 0.4 1.1

Minor and ambulatory procedures 7.0 6.8 7.4 8.1 6.4

Eye procedures and ophthalmology services 1.4 1.4 1.3 1.3 1.4

Endoscopy 2.5 2.5 2.4 2.3 2.5

Radiation therapy 6.7 7.5 4.0 0.7 8.2

Imaging 30.4 29.5 33.4 34.4 32.0

Standard imaging 19.4 18.5 22.4 24.0 20.4

Advanced imaging 5.2 5.2 5.1 4.6 5.8

Echography 4.8 4.7 5.3 5.6 5.0

Other imaging 1.0 1.2 0.6 0.3 0.9

Testing 18.1 18.4 17.1 16.2 18.3

Lab tests and pathology services 7.6 8.1 5.7 4.4 7.4

Cardiology tests (EKG, stress tests) 6.8 6.5 7.7 8.2 7.0

Other tests 3.8 3.8 3.7 3.6 3.9

Other services 8.1 8.1 7.9 8.2 7.5

Psychiatric services 2.8 3.1 1.6 1.7 1.5

Other specialist services 2.3 2.1 2.8 3.2 2.4

Chemotherapy 2.2 2.1 2.4 2.2 2.7

All other services 0.8 0.7 1.0 1.1 0.8

Note: EKG (electrocardiogram). Major procedures include services such as breast surgery, coronary angioplasty, pace-maker insertion, and orthopedic surgery. Minor and

ambulatory procedures include services such as hernia repair, lithotripsy, and skin/musculoskeletal procedures. Rural hospitals are located in non-metropolitan areas, as

defined by the U.S. Office of Management and Budget.

Source: MedPAC analysis of 5 percent sample of 1999 outpatient claims and HCFA’s Berenson-Eggers Type of service classification scheme.

TABLE

5-4
The differences noted above are more

pronounced among smaller rural hospitals,

SCHs, and MDHs (Table 5-5). The profile

of services delivered by RRCs and larger

rural hospitals (101 or more beds) is

generally closer to that of urban hospitals.

For example, 9.8 percent of the services

delivered by SCHs were emergency visits

or critical care services, compared with

6.4 percent for RRCs. Similarly,

procedures make up 20.5 percent of the

volume for RRCs, but only 14.2 percent

for SCHs and 13.3 percent for MDHs.

Among the rural hospitals, radiation

therapy comprises a fairly high percentage

of total volume for RRCs (9.1 percent),

but almost none for SCHs (1.7 percent) or

MDHs (0.4 percent).

On balance, rural hospitals have a lowerintensity service mix and a greater

proportion of emergency services. If the

payments rates for these services are

adequate, then the differences in service

mix should not lead to differences in

financial performance. Given the newness

of the outpatient PPS, there is no solid

evidence regarding services that may be

more or less adequately reimbursed.

However, comments on the payment

system by various industry groups and

reports in the trade press have suggested

some potential issues. For example,

payment rates for clinic visits may not be

accurate due to previous coding practices

(at many hospitals, all visits were coded at

the lowest level). There is also concern

about the lack of a separate payment for

observation services, where beneficiaries

coming to the emergency department are

not admitted or discharged immediately,

but monitored for a period of time. This

96 Assessing payment for outpatient hospital care in rural areas

Outpatient service mix, rural hospitals, 1999

Percent of volume by type of hospital

Small Other

Rural rural Other rural, 101

referral Sole Medicare- rural, or more

Service category center community dependent 1–100 beds beds

Evaluation and management 22.4% 25.4% 26.3% 30.9% 24.5%

Clinic/office visits 15.7 15.4 16.5 20.5 16.3

Emergency/critical care 6.4 9.8 9.4 10.1 7.6

Consultations 0.3 0.2 0.5 0.2 0.6

Procedures 20.5 14.2 13.3 12.1 14.9

Major procedures 1.2 0.5 0.3 0.4 0.7

Minor and ambulatory procedures 6.2 8.4 9.3 7.6 6.8

Eye procedures and ophthalmology services 1.4 1.4 1.0 1.2 1.5

Endoscopy 2.5 2.3 2.2 2.2 2.5

Radiation therapy 9.1 1.7 0.4 0.6 3.5

Imaging 30.7 35.7 34.5 33.8 35.1

Standard imaging 19.1 24.6 24.5 23.7 23.5

Advanced imaging 5.7 4.9 4.2 4.4 6.0

Echography 5.0 5.8 5.6 5.4 5.0

Other imaging 1.0 0.4 0.3 0.3 0.6

Testing 18.1 17.6 16.3 15.3 18.3

Lab tests and pathology services 7.4 5.3 4.6 3.9 7.1

Cardiology tests (EKG, stress tests) 6.6 8.2 8.2 8.3 8.0

Other tests 4.1 4.1 3.6 3.1 3.2

Other services 8.2 7.1 9.5 7.9 7.2

Psychiatric services 2.1 0.8 1.2 2.1 1.2

Other specialist services 2.5 3.0 4.0 3.0 2.5

Chemotherapy 2.8 2.3 2.0 2.0 2.8

All other services 0.8 1.0 2.2 0.9 0.7

Note: EKG (electrocardiogram). Major procedures include services such as breast surgery, coronary angioplasty, pace-maker insertion, and orthopedic surgery. Minor and

ambulatory procedures include services such as hernia repair, lithotripsy, and skin/musculoskeletal procedures.

Source: MedPAC analysis of 5 percent sample of 1999 outpatient claims and HCFA’s Berenson-Eggers Type of Service classification scheme.

TABLE

5-5
may lead to inadequate payment for

emergency department services.

Experience under the outpatient PPS will

allow for a better understanding of the

accuracy of the payment system with

regard to specific types of service.

Higher unit costs 

Economic theory postulates that low

volume leads to higher unit costs due to a

lack of scale and scope efficiencies. Scale

economies arise when fixed capital and

other resources, such as a magnetic

resonance imaging (MRI) machine, can be

used for a greater number of patients,

leading to lower costs per service. Scope

efficiencies arise when fixed capital and

other resources can be used across service

lines. In this case, the MRI machine is

used for both inpatients and outpatients,

again leading to lower costs per service.

Rural hospitals generally have lower

service volumes and higher unit costs.

Based on 1996 claims data and associated

cost reports, the wage index and service

mix adjusted cost per service is $61 for all

hospitals, $59 for urban hospitals, and $66

for rural hospitals. Thus, rural hospitals

have an adjusted unit cost that is 8.2

percent higher than the average. Among

rural hospital types, the highest adjusted

costs per service are found among SCHs

($69) and MDHs ($67).

To address the volume-cost relationship,

we conducted regression analyses to

determine whether smaller hospitals have

higher unit costs after adjusting for the

components of the payment system that

affect a hospital’s payment rates: wage

index and case mix.6

The results must be interpreted cautiously

due to data constraints. Given the

difficulties in matching costs to outpatient

PPS services, we have chosen to use

HCFA’s estimates of 1996 costs that

formed the basis for the payment system.

There are limitations to the data, including

probable undercoding of claims by

hospitals (which understates volume of

services), difficulties in matching the

Medicare cost reports to the outpatient

claims, and the age of the data. However,

these data are the best available, given that

they rely on 100 percent of claims. In

addition, these data issues are not likely to

have improved substantially since 1996

and would not, therefore, be addressed by

the use of more recent data. More recent

data would be desirable, however, if the

volume-cost relationship has changed

since 1996. Using only one year of data

may lead to bias toward showing

economies of scale in the estimation of the

volume-cost relationship due to transitory

shifts in volume, which are more common

at low levels.7 Finally, a multi-product

cost function including all of a hospital’s

service lines (inpatient, outpatient, home

health, and so on) would better account

for economies of scope.

As shown in Figure 5-1 (p. 98), lowvolume hospitals did have higher adjusted

costs per service; this relationship was

found to be statistically significant.8

Those at the lowest volume levels (less

than 2,000 services per year) exhibited

unit costs more than 15 percent higher

than the mean adjusted cost per service.

Adjusted unit costs approached the mean

value at a volume of about 7,000 services

per year, and then fell below it. Thirtyeight percent of sample hospitals reported

service volumes below 7,000. Of those, 72

percent were rural. The median volume

for sample hospitals was about 10,400

services per year and the mean was

17,800. Most of the low-volume hospitals

(defined as 7,000 or fewer services per

year) are now subject to special outpatient

payment provisions, with 63 percent

covered by the hold-harmless provision

and 8 percent part of the CAH program.9

Among all rural hospitals in the sample,

61 percent are low-volume. When looking

at the rural hospital types, 81 percent of

MDHs, 65 percent of SCHs, and 97

percent of CAHs are low-volume. For

other rural hospitals with 100 or fewer

beds, the number is 67 percent. No RRCs

are low-volume.

The volume-cost relationship held across

all hospitals. In considering hospital types,

urban hospitals, rural hospitals with more

than 100 beds, and RRCs did not have

significantly different adjusted unit costs

from one another. However, two groups

of particular interest in looking at rural

hospitals did show adjusted unit cost

differences: rural hospitals with 100 or

fewer beds, which benefit from the hold

harmless provision, and CAHs, which are

exempt from the outpatient PPS.10

At any volume, rural hospitals with 100 or

fewer beds had adjusted unit costs that

were about 2 percent higher than those of

urban and larger rural hospitals (Figure

5-1). This finding supports the need for

the existing hold-harmless policy,

although the size of the effect suggests

that these hospitals may be able to adapt

to the PPS rates in the future. For

hospitals that have converted to CAH

status (as of September 2000), adjusted

Report to the Congress: Medicare in Rural America | June 2001 97

6 The sample included 4,784 hospitals. We excluded long-term, psychiatric, rehabilitation, cancer, and children’s hospitals from the analysis because we considered

them to be poor comparators to rural hospitals and because they seemed to have greater data problems. In addition, hospitals reporting fewer than 100 units were

excluded for reasons of data reliability. One high-volume hospital was also excluded as an outlier.

7 The bias is in the direction of showing economies of scale because one year of lower-than-average volume compared with average fixed costs will result in a higher unit

cost at low volumes than would be obtained in a steady state. Conversely, one year of higher-than-average volume compared with average fixed costs will result in a

lower unit cost at high volumes than would be obtained in a steady state.

8 These results are from a payment model that included only volume measures (cubic expansion of the natural log of outpatient units), hold-harmless status, and CAH

status as explanatory variables. The dependent variable was the natural log of adjusted unit costs. All explanatory variables in the model were statistically significant (p

0.05). The R2 value was 0.22. Additional modeling that included other hospital and market characteristics thought to affect costs resulted in a similar volume-cost

relationship. 

9 This percentage is likely to grow as the CAH program expands. The CAH classification used in this analysis dates from September 2000.

10 To compare this grouping with other rural hospitals designations, it is important to remember that most MDHs and SCHs have 100 or fewer beds while most RRCs have

more than 100 beds.
unit costs were about 7 percent higher

than those of urban and larger rural

hospitals in 1996 (Figure 5-1). This

finding suggests that hospitals with high

costs have chosen to become CAHs. It

also suggests that CAHs would have

difficulty operating under the outpatient

PPS without special protections.11

Unique social role 

Some have argued that as a matter of

public policy, we may wish to

accommodate higher costs in rural

hospitals both to preserve access and

because they serve other important

functions. For example, these hospitals

may be the only sources of emergency

services in small isolated areas. In

addition, they may be major employers in

local markets. Finally, the presence of

medical services may be part of an

economic development strategy to attract

and retain other businesses.

Limitations of the

evidence 

The evidence we have presented suggests

that rural hospitals, and particularly small

rural hospitals, may have higher costs, be

more vulnerable to the financial risks

inherent in prospective payment, and be

less able to adapt to the new payment

system. However, assessment of the

applicability of the outpatient PPS to rural

hospitals is hampered by a lack of

experience and data from service

provision under the payment system.

Some questions can only be answered

using claims, cost reports, and other

evidence from hospitals operating under

the system. These questions include:

• Do payment-to-cost ratios vary by the

type of service provided? If so, has

this negatively affected rural

providers? Could changes to payment

rates for specific services address the

problem?

• Do the adjusted unit costs of rural

hospitals continue to be higher under

the outpatient PPS?

• Have most rural hospitals received

hold-harmless payments, indicating

that their PPS payments are below

the pre-PPS levels?

• How have outpatient margins

changed under the new payment

system? Is there evidence of

increased financial pressure?

• Do we have evidence of impaired

access to outpatient services in rural

hospitals that can be attributed to the

new payment system?

In addition, issues regarding the age and

reliability of the 1996 data to assess the

relationship between outpatient costs and

volume limit our ability to draw policy

conclusions.

Further analysis and data from

implementation experience may show that

rural hospitals can adapt to the outpatient

PPS, or it may reveal systemic problems.

In the meantime, the current policy of

having a hold-harmless provision for rural

hospitals with 100 or fewer beds protects

more than 80 percent of rural hospitals,

and all of the small rural hospitals that

appear to be most vulnerable, through

2003. This provides time to gather data

and conduct further analyses that will

better inform future policy decisions

regarding the treatment of rural hospitals

under the outpatient PPS.

Future policy options 

If additional data and experience under the

PPS show that rural hospitals face special

circumstances beyond their control that

make it more difficult for them to cover

their costs under the outpatient PPS, then

the payment system should recognize

those circumstances and make appropriate

accommodations. If, however, rural

98 Assessing payment for outpatient hospital care in rural areas

0.6

0.5

0.4

0.3

0.2

0.1

0

0.1

0 4,000 2,000 6,000 8,000 10,000

Volume (services)

Adjusted unit costs relative to the mean

Outpatient volume-cost relationship,

1996

Source: MedPAC analysis of 1996 outpatient cost data from HCFA and outpatient prospective payment

 system impact file.

Note: Volume is truncated at 10,000 services. The actual range of values was 100 to 250,000. Small rural

 hospitals have 100 or fewer beds. Large rural hospitals have 101 or more beds.

FIGURE

5-1

critical access

small rural

urban/large rural

11 Given data limitations, the point estimates noted here should be considered notional rather than definitive.
hospitals are found to have adapted to

outpatient prospective payment without

compromising access and quality, no

adjustments would be needed.

Five policy alternatives are presented in

Table 5-6 and discussed below. The ideal

policy would contain financial incentives

to control costs, be administratively

feasible, and target additional payments

only to those hospitals that truly need

them. The extent to which each alternative

has these three characteristics provides

one framework for judging which might

be most appropriate. Adopting any one of

these policies would require difficult

decisions regarding exact design

specifications and identification of the

facilities to benefit.

One policy that is not discussed here, but

which would affect outpatient payments to

rural hospitals, is a change in the wage

index, which is discussed in Chapter 4. It

is likely that any change would apply to

both payment systems, as the outpatient

PPS uses the same wage index as the

inpatient PPS, with 60 percent of the

payment amount adjusted for geographic

variations in input prices. Future

consideration of outpatient payment

adjustments for rural hospitals must also

take into account the extent to which

hospitals have become CAHs, which are

exempt from the outpatient PPS.

If and when specific policies are designed,

it would be more appropriate to base

eligibility on outpatient criteria (such as

volume or payment-to-cost ratios) rather

than inpatient criteria. Given the trend of

diversification away from inpatient

services in rural hospitals, it is not clear

that the number of beds or other inpatient

measures are good proxies for outpatient

characteristics. However, more work

needs to be done to assess the validity and

reliability of various outpatient measures.

No change from existing

policy 

Under existing policy, small rural

hospitals will receive hold-harmless

payments through 2003, and then will be

treated no differently than other hospitals

under the payment system (unless they are

CAHs).

This policy assumes that rural hospitals

will be able to adapt to the outpatient PPS.

It would provide the same efficiency

incentives for all hospitals and allow for a

single administrative system. If future

research shows that rural hospitals

perform adequately under the PPS, this

option should be pursued. It should be

noted, however, that the transition to the

full fee schedule is abrupt for small rural

hospitals. A more gradual transition for

rural hospitals, phasing out the holdharmless payments over two to three years

beyond 2003, might be considered.

Separate conversion factor 

A separate conversion factor would pay

rural hospitals, or certain types of rural

hospitals, more for all outpatient services

delivered. The design of the policy could

take into account such factors as

geographic isolation (using measures such

as the urban influence codes) or size

(using measures such as outpatient

volume or number of beds).

This policy would recognize structural

differences that make delivering

outpatient services uniformly more

expensive for rural hospitals, if they exist.

It would maintain incentives for efficiency

by maintaining the structure of the

outpatient PPS, but pay relatively more

Report to the Congress: Medicare in Rural America | June 2001 99

Future policy options for outpatient payments to rural hospitals

Incentives for Administrative 

Policy efficiency feasibility Targeting

TABLE

5-6

Maintain current policy

Adopt separate conversion factor for rural

hospitals or some subgroup

Make a low-volume adjustment for all hospitals

Extend the current hold-harmless provision for

small rural hospitals or some subgroup

Return to cost-based payment for rural hospitals or

some subgroup

Rural hospitals have same

incentives as others

Incentives for efficiency are

maintained, but rural hospitals

have higher ceiling

Incentives for efficiency are

maintained, but low-volume

hospitals have higher ceiling

Incentives for efficiency are

maintained, with some

potential for inefficiency

Incentives for efficiency are not

maintained

Same system for all hospitals

Same system for all hospitals

Introduces interim payment and

settlement issues

Introduces interim payment and

settlement issues

New system that introduces

settlement and cost allocation

issues

No hospitals receive additional

payments

Additional payments are not

targeted within group

Additional payments are

targeted to low-volume

hospitals

Additional payments are

targeted to hospitals with losses

Additional payments are not

targeted within group
per service (due to differences in the wage

index, the absolute payments may still be

lower in rural areas). By maintaining the

structure of the outpatient PPS, a separate

conversion factor also allows HCFA and

its fiscal intermediaries to maintain one

billing system. There would be no need

for special adjustments or settlements.

However, a separate conversion factor

may not be needed for all rural hospitals,

such as those in peri-urban areas or those

that are larger. In addition to recognizing

legitimately higher costs, this approach

may also reward inefficiency. Any policy

that provides additional payments should

be designed in a way that does not

subsidize excess capacity. This could be

achieved by including a distance criterion

or other measure that limits additional

payments for hospitals that are too close

to the nearest similar facility.

Low-volume adjustment 

A low-volume adjustment would pay

more per service for hospitals that provide

fewer outpatient services in recognition of

the limited scale and scope economies

possible at lower output levels. The

adjustment could have a graduated design,

such that additional payments decline as

volume increases.

If the underlying cause of high unit costs

for rural hospitals is low volume, then a

low-volume adjustment may address the

problem. MedPAC’s cost function

analysis presented above does indicate a

volume-cost relationship that results in

higher-than-average unit costs for those at

the lowest volumes. Assuming that the

adjustments are made to the conversion

factor for low-volume hospitals, HCFA

and the fiscal intermediaries can maintain

a single billing system across hospitals.

However, this approach may provide

additional payments to low-volume

hospitals that can keep costs below the

PPS rate. It may also provide an incentive

to decrease volume, although an

appropriately graduated design could

minimize this problem. In addition, a lowvolume adjustment provides no incentives

to rationalize care and close hospitals that

may not be needed. Including a distance

criterion or other measure, however, could

protect against subsidizing excess

capacity. Finally, this approach may

require end-of-year settlements and

adjustments to verify volume and settle

accounts.

Extended hold-harmless

provision

An extended hold-harmless provision

would continue the current policy of

ensuring that small rural hospitals are paid

at least as much under the outpatient PPS

as they were under previous payment

policy. Alternatively, the target group

could be based on outpatient measures,

such as volume, or include factors such as

geographic isolation.

By providing additional payments only

when hospitals cannot keep costs below

the PPS rate, this policy maintains some

incentives for efficiency and targets those

most in need of help. If hospitals can keep

costs below the PPS rate, they keep the

gains. In addition, the policy allows

HCFA and fiscal intermediaries to

maintain a single billing system.

However, this approach assumes that the

hospital-specific 1996 payment-to-cost

ratios on which the hold-harmless

payments are based were appropriate. It

also perpetuates differences in payments

among hospitals that existed in 1996. An

extended hold-harmless provision allows

for some inefficiency, albeit with a limit

on the amount of additional payment. It

may subsidize excess capacity without the

inclusion of a distance criterion or similar

measure. Finally, as under the current

policy, the extended hold-harmless

provision would require end-of-year

settlements and adjustments.

Cost-based payment 

Some proponents have argued that due to

the unique characteristics of rural

hospitals, prospective payment carries too

many risks and payment should be made

on a cost or cost-plus basis.

This approach to paying hospitals ensures

that hospitals can continue to operate.

However, it includes no incentives for

efficiency, and, as we saw in the 1970s

and 1980s, it can lead to dramatic

increases in expenditures. In addition,

cost-based payment can lead to

substantially different payments for the

same service provided in different

hospitals in the same area. Finally,

because the outpatient PPS has already

been implemented, a return to cost-based

payment would require a new billing

system. We would also return to a system

in which payments for an individual

service cannot be accurately measured. 

100 Assessing payment for outpatient hospital care in rural areas
References

Farley DO, Inkelas M, Taylor P, Ashwood JS. Trends for rural health clinics and

federally qualified health centers serving rural Medicare beneficiaries during the 1990s.

RAND unrestricted draft series DRU-2540-HCFA. Santa Monica (CA), RAND. April

2001.

Health Care Financing Administration, Department of Health and Human Services.

Medicare program prospective payment system for hospital outpatient services; final rule.

Federal Register. April 7, 2000, Vol. 65, No. 68, p. 18433-18820.

Schoenman JA, Cheng MC, Evans WN, et al. Do hospital-based rural health clinics

improve the performance of the parent hospital? Bethesda (MD), Project HOPE Walsh

Center for Rural Health Analysis. March 22, 1999.

Report to the Congress: Medicare in Rural America | June 2001 101

Prospective payment for home 

health services in rural areas

CHAPTER 6
RECOMMENDATIONS

6A The Congress should not exempt rural home health services from the prospective payment

system.

*YES: 13 • NO: 1 • NOT VOTING: 0 • ABSENT: 2

 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6B The Secretary should study a sample of home health providers:

• to evaluate the impact of prospective payment on home health in rural areas,

• to evaluate costs that may affect the adequacy of prospective payments, and

• to find ways to improve all cost reports.

YES: 13 • NO: 0 • NOT VOTING: 0 • ABSENT: 3

*COMMISSIONERS’ VOTING RESULTS
hould rural home health services be exempt from the new prospective payment system? Rural health care advocates, among others,

have suggested that the new payment system may not adequately account for unique conditions in rural areas. Lack of experience with

the new system and other data limitations prevent a direct comparison of the costs

in rural and urban areas. However, our analysis concludes that the components of

the new payment system should work equally well in rural and urban areas.

Accordingly, we recommend that rural home health services not be exempt from

the prospective payment system. We also recommend that data collection be improved to assess whether any higher costs associated with providing care in rural

areas are adequately taken into account.

CHAPTER

Prospective payment for

home health services in 

rural areas

6

In this chapter

• Evolving to the current system

• Components of the

prospective payment system

• Home health agency closures

• Need for better data

Report to the Congress: Medicare in Rural America | June 2001 105

S
The Balanced Budget Refinement Act of

1999 (BBRA) mandated that MedPAC

examine whether rural areas should be

exempt from the prospective payment

system (PPS) for home health services.

Advocates and policymakers have been

concerned that the PPS does not

adequately account for the costs

associated with providing care in rural

areas. They also have been concerned

about the effects of closures of home

health agencies in rural areas. The new

system has not been in place long enough

to assess its impact using claims and other

administrative data from the PPS, but

historical differences in the use of home

health care in urban and rural areas

provide no reason to think that rural areas

would be affected differently by the

components of the PPS. The Commission

concludes that the new PPS should work

equally well in both urban and rural

settings and that closures of home health

agencies have not affected access to home

health services for rural beneficiaries.

Evolving to the current

system 

Rapid growth in home health spending in

the early 1990s gave impetus to

substantial changes in the home health

payment system. Before 1998, home

health was paid under a cost-based system

with little incentive for efficiency;

Medicare spending for home health grew

to $17.5 billion in 1997, compared with

$7 billion in 1992. The Balanced Budget

Act of 1997 (BBA) required the Health

Care Financing Administration (HCFA) to

develop a prospective payment system to

replace the cost-based system and control

spending.

Also as required under the BBA, HCFA

began an interim payment system (IPS) in

1997 as a transition to prospective

payment. The IPS paid agencies based on

their costs, subject to aggregate limits on

per-visit or per-beneficiary costs. It was

assumed that agencies would serve both

low- and high-cost beneficiaries to keep

costs under the limits. However, some

evidence suggests that beneficiaries with

needs for high-intensity or chronic care

may have had difficulties in obtaining

care. Some agencies reported that they no

longer accepted, or were more likely to

discharge earlier, patients whose care they

expected to be expensive (Stoner et al.

1999). After 1997, spending fell further

than anticipated; by 1999, Medicare

spending for home health had fallen to

$9.7 billion.

The PPS replaced the IPS in October

2000. Though movement from the IPS to

the PPS has generally been viewed as a

positive step, advocates and policymakers

have been concerned about access to

home health services. The Medicare,

Medicaid, and SCHIP Benefits

Improvement and Protection Act of 2000

(BIPA) increased payments for home

health care by restoring the full market

basket update to the base payment amount

in 2001 and by delaying for one year a

scheduled 15 percent reduction in

Medicare home health spending.

To protect rural areas, the BIPA also

increased payments for home health

services in rural areas by 10 percent for a

two-year period beginning April 1, 2001.1

Because the 10 percent increase is not

subject to the budget neutrality provision

that applies to the PPS generally, it

provides new funding. Home health care

provided by either urban or rural home

health agencies to beneficiaries living in

non-metropolitan areas is eligible for this

rate increase.

Components of the

prospective payment

system

Four components make up the PPS: the

unit of payment, the base payment

amount, the case-mix adjustment, and the

wage index adjustment. Adjustments for

several other special circumstances, such

as outliers, can also modify the payment.

We examined the components of the PPS

to determine whether the system can be

applied in rural areas as well as it can in

urban ones. We assessed whether, for

rural areas:

• the unit of payment is appropriate,

• the base payment adequately

accounts for the efficient costs of

providing care, and

• the case-mix adjustment captures the

relative resource needs of

beneficiaries.

We do not discuss the wage index in this

chapter. The PPS payment comprises a

labor and non-labor portion; the labor

portion—77 percent—is adjusted by the

hospital wage index to account for

geographic differences in the cost of

labor-related inputs to home health

services. The index might not accurately

reflect the cost of labor for home health

providers, however, because HCFA’s

method for calculating the wage index

does not discriminate between differences

in labor costs due to differences in price

and those differences due to the mix of

inputs. This problem, which affects wage

adjustments for all providers, is addressed

in more detail in Chapter 4 and in the

Commission’s March 2001 report to the

Congress (MedPAC 2001).

Unit of payment

An appropriate unit of payment for home

health services should be short enough for

reliable predictions of resource use over

its span and long enough to allow

agencies to manage care effectively within

an episode of care. Under the home health

PPS, the unit of payment is a 60-day

episode of care that includes five or more

home health visits. The 60-day episode

was chosen after HCFA tested two lengths

for the unit of payment: one visit and a

120-day episode.

One visit was deemed too small a unit for

the home health prospective payment

system. An evaluation of HCFA’s

106 Prospective payment for home health services in rural areas

1 For most services provided in facilities, the location of the facility providing the service determines the local area adjustment to payment. For home health services, the

local area adjustment is determined by the location of the beneficiary receiving the service.
demonstration of prospective per-visit

payments found no compelling evidence

of an impact on agency cost per visit or

the volume of home health services

(Phillips et al. 1994). Agencies shortened

the length of visits without harming

quality of care, but there was no

significant change in the management of

care (Bishop et al. 1996). The system did

not control costs.

A 120-day episode was more effective

than one visit in controlling costs but was

deemed too long. Under HCFA’s

demonstration of prospective 120-day

episodes of care, cost per episode declined

without an increase in the use of other

Medicare services. Agencies reported

improvements in their management of the

care within the episode, decreasing total

volume of care without a negative impact

on quality or outcomes. However, most

beneficiaries were discharged weeks or

months before the end of the 120-day

episode; about 60 percent were discharged

in 60 or fewer days. Furthermore, the 120-

day episode did not match the periods

already established for key administrative

tasks for the home health agencies:

agencies develop plans of care for 60-day

periods and physicians must re-certify the

need for home health services every two

months.

The 60-day episode was selected to meet

the cost control objectives of the Congress

while coordinating with administrative

time frames. Agencies might change visit

lengths, but we would not expect this to

harm the quality of care. Key management

improvements used under the 120-day

episode—such as better review of the

initial plan of treatment, tailoring care by

diagnosis, and focusing on patient

rehabilitation—are also expected under

60-day episodes. Sixty-day episodes also

correspond more closely to most observed

lengths of stay under HCFA’s

demonstration. Thus, shortening the

episode length from 120 days to 60 days

relieves some cash flow pressure by

reducing the lag between rendering

services, closing the claim, and receiving

full reimbursement.2

None of the strengths or weaknesses of

the unit of payment’s duration is unique to

urban or rural home health. Agencies in

both urban and rural areas can use the

flexibility of episode payment to change

the management of care. Historically,

rural agencies have had significantly

longer lengths of stay than urban ones

(Goldberg and Schmitz 1994). But

because beneficiaries may receive an

unlimited number of episodes of care—as

long as they remain eligible for home

health care—differences in length of stay

should not be a problem. Further, outlier

payments are made for cases with very

high costs within a 60-day episode. As

PPS data become available, the volume of

care within urban and rural patients’

episodes should be monitored.

Amount of base payment

An appropriate base payment amount

should cover the costs that an efficient

provider would incur in providing care.

For each episode of care, the PPS base

payment amount includes costs of visits,

supplies, outpatient therapy that was not

previously considered as part of the home

health benefit, and patient assessment. If

rural providers faced higher costs per

episode than the national average because

of circumstances beyond their control,

then the base payment would not be

adequate for the beneficiaries they serve.

We found two factors that could

differentiate the costs of providing care in

urban and rural areas: travel and volume

of services. Traveling to serve sparse or

remote populations may increase the costs

of providing services to rural

beneficiaries. Rural providers also may be

at a cost disadvantage if their low volume

of services provided does not permit them

to spread fixed costs over a large number

of episodes.

Examining travel costs is difficult because

the data reported to HCFA are unreliable

and the calculation of travel costs varies

from agency to agency. We have been

advised against the use of these data by

several researchers, including those at

HCFA.

Moreover, some urban home health

agencies (HHAs) may face higher-thanaverage travel costs as well. Some urban

agencies may incur costs for safety

measures such as escorts to serve unsafe

neighborhoods. The need for safety

measures could reasonably be considered

part of the cost of travel in an urban area

and could be as significant a cost factor as

distance is in a rural area.

Rural areas have small, sometimes sparse

populations, so that many rural HHAs

operate at low volumes. More than 50

percent of agencies in the most rural

counties delivered fewer than 5,000 visits

in a year (Franco and Leon 2000); only 20

percent of urban home health agencies

had volumes that low. Most urban HHAs

delivered between 5,000 and 30,000

visits, and 30 percent delivered more than

30,000 visits annually. In contrast, only 12

percent of HHAs in the most rural

counties delivered more than 30,000

visits. Because rural HHAs generally

deliver fewer visits than their urban

counterparts, their low volume could lead

to higher per episode costs.

Differences in costs also could arise if

small agencies lack the sophisticated

management and patient care procedures

of larger agencies (Goldberg and Schmitz

1994). Small agencies may not have

access to the same range of professionals

to manage specific tasks, such as a wound

care specialist or a therapist dedicated to

patient assessment. Small agencies also

may not be able to invest in new

technologies, which could also lower

costs. If small agencies cannot make the

same changes in the management of care

that large agencies can, then even efficient

small providers may have higher per-unit

costs than larger ones. This is not unique

to rural areas; low-volume agencies in

urban areas may face the same cost

disadvantages.

Report to the Congress: Medicare in Rural America | June 2001 107

2 Agencies are not fully reimbursed for a unit of care until the entire episode has elapsed. Because any unit of payment longer than one visit would delay the close of the

claim for some beneficiaries whose length of stay is less than the episode length, HCFA has also split the payment so that much of the total episode payment is available

before the entire episode has elapsed.
The case-mix adjustment

An appropriate case-mix system should

account for predictable differences in

costs due to the characteristics of the

patients. The case-mix system for the

home health PPS might not account

adequately for rural costs because

payments are based in part on the services

that patients use. Urban and rural home

health patients receive different services

even though their diagnoses and

functional limitations are similar.

In the home health PPS, an 80-category

case-mix classification system adjusts the

base payment rate. The categories—called

home health resource groups or

HHRGs—are based on three factors:

patients’ clinical status, functional status,

and use of services. Patients’ clinical

status largely depends on their diagnosis.

Functional status depends on their ability

to perform a select set of activities of daily

living. Service use is determined by

discharge from a hospital or post-acute

care facility before the home health

episode and/or the receipt of at least 10

therapy visits during the episode.

According to recent claims data, urban

and rural providers treat a clinically

similar mix of patients. For five high-cost

and common diagnoses—Alzheimer’s

disease, congestive heart failure, diabetes,

stroke, and wound—the proportion of

admissions by diagnosis was the same for

urban and rural agencies under cost-based

reimbursement in 1997 (Table 6-1).

Although the proportion of admissions by

diagnosis changed after the

implementation of the IPS in 1998, the

rural and urban proportions were still

similar to each other.

Home health patients in urban and rural

areas had similar functional status as well

(Schlenker et al. 2000). Although upon

admission, rural patients were somewhat

more limited in function than urban ones,

similarities appeared in a cross-sectional

sample. The admission sample included

more post-acute, short-stay patients than

did a cross-sectional sample that included

all patients receiving home health services

at a given point in time. Cross-sectional

samples showed no significant difference

in either individual or aggregate measures

of patient’s ability to bathe, eat, and

perform other activities of daily living.

Despite similarities in diagnoses and

functional status, rural and urban patients

have different service use. Service use is

both the total number of visits and the mix

of therapy visits (physical, occupational,

or speech therapy) and non-therapy visits

(home health aide, skilled nurse, or

medical social worker). In 1999, under the

interim cost-based system, rural patients

of home health received more total visits

than their urban counterparts but fewer

rural patients received therapy visits

(Table 6-2).

The difference between rural and urban

therapy use is in the number of therapy

patients per home health patient, not in the

amount of therapy used. Though rural

home health patients were less likely to

receive therapy than urban ones, those

who received therapy used the same

amount of therapy as urban patients

(Sutton 1999). Given that rural and urban

home health patients are functionally and

clinically similar, it appears that some

rural beneficiaries who would receive

therapy if they were in an urban area do

not receive any therapy in a rural area.

The population of rural therapy patients

might include only those with moderate or

heavy therapy needs while the population

of urban therapy patients includes those

with light therapy needs. If this were the

case, we would expect average rural

therapy use per therapy patient to be

higher than urban use, but we instead

observe that rural therapy use per therapy

patient is the same as urban. Therapy use

per home health patient is lower in rural

areas but the number of total visits per

patient (therapy and non-therapy) is

higher. Because rural home health patients

use less therapy but more visits than their

diagnostically and clinically similar urban

counterparts, the HHRGs may not account

adequately for the non-therapy costs of

caring for some rural home health users.

(For further discussion of rural use rates,

see Chapter 1.)

The use of therapy can substantially

increase the total reimbursement for an

episode. For example, if the only

difference between an urban and a rural

patient with moderate clinical and

functional conditions is the receipt of 10

hours of therapy, then the case-mixed base

payment would be twice as high for the

urban beneficiary who received therapy.

Limited data from a model that was used

to develop the case-mix adjustment

suggest that rural agencies will not be

disadvantaged by the case-mix system

(Goldberg et al. 1999). This research

included data from 26 rural agencies in 8

states under the IPS in 1997 and 1998.

Clinical status, functional status, and

108 Prospective payment for home health services in rural areas

Total admissions to home health, by diagnosis, urban

and rural agencies

1997 1998

Diagnosis Urban Rural Urban Rural

Alzheimer’s disease 2% 2% 2% 2%

Congestive heart failure 16 18 17 18

Diabetes 21 22 21 22

Stroke 10 10 10 10

Wound 11 10 6 5

Note: Rural home health agencies are located in non-metropolitan areas, as defined by the U.S. Office of

Management and Budget.

Source: MedPAC analysis of the 1997 and 1998 HCFA standard analytic file claims data

TABLE

6-1
service use were measured, and episodes

were constructed. In the model, resource

use by HHRG tended to be slightly

overstated for rural agencies. However,

more than half of the HHRGs contained

fewer than 50 cases. The small number of

cases in many HHRGs coupled with the

narrow sample of rural agencies suggests

caution in generalizing the results to all

HHRGs for all agencies in rural areas.

In any case, patterns of care observed

before the implementation of the PPS may

not predict use under prospective

payment. Incentives in the PPS are likely

to change the mix of services provided by

HHAs. The home health service mix has

changed in recent years: 20 percent more

home health users received therapy

services in 1999 than in 1996 (GAO

2000).

Home health agency

closures

Many of those who seek to protect access

to home health in rural areas cite agency

closures as a source of their concern.

Fewer HHAs serve Medicare beneficiaries

now than in 1997. However, closures

were more prominent in urban areas; the

number of HHAs fell by 14 percent in

urban areas between October 1997 and

January 1999, compared with a 9 percent

decrease in rural areas.

Counting the number of Medicare HHAs

may be misleading because HCFA tracks

parent agencies, not branches. For

example, in a recent study, the General

Accounting Office (GAO) interviewed

more than 100 stakeholders in 34 rural

counties that had experienced closures and

found as many as 3 HHAs in counties that

HCFA data identified as having none

(GAO 1999). HHAs that remained had

changed their practice patterns in response

to the IPS. Some reported that they

screened for potentially complex or

chronic patients, which may have created

difficulties and delays for placing some

beneficiaries in care. Nonetheless, GAO

found that despite closures and changes in

practice patterns, access generally was not

impaired. Even in counties where HCFA

data indicated that the sole HHA had

closed, hospital discharge planners and

managers of nearby HHAs concluded that

access was not a problem because branch

agencies or agencies in neighboring

counties were still providing services.

MedPAC’s examination of home health

use in 1999 also shows that many patients

in rural areas did not rely upon agencies in

rural areas to provide service (Table 6-3).

For example, urban HHAs provided onethird of all visits to beneficiaries in rural

counties adjacent to an urban county.

Urban HHAs even provided 10 percent of

Report to the Congress: Medicare in Rural America | June 2001 109

Home health visits and therapy visits, by location of

patient’s county of residence, 1999

Therapy visits as Annual total percent of all Location of county (UIC) visits per patient home health visits

Urban, in an MSA (1, 2) 37.5 18%

Rural

Adjacent to an MSA and includes a town

with at least 10,000 people (3, 5) 41.3 14

Adjacent to an MSA but does not include

a town with at least 10,000 people (4, 6) 42.4 13

Not adjacent to an MSA but includes a town 

with at least 10,000 people (7) 41.2 13

Not adjacent to an MSA but includes a town

with between 2,500 and 10,000 people (8) 43.9 11

Not adjacent to an MSA and does not include

a town with at least 2,500 people (9) 43.8 12

All counties 38.8 17

Note: UIC (urban influence code, as defined by the U.S. Department of Agriculture), MSA (metropolitan statistical

area, as defined by the U.S. Office of Management and Budget).

Source: MedPAC analysis of the 1999 HCFA standard analytical file claims data

TABLE

6-2

Home health visits, by location of patient’s county of

residence and location of agency, 1999

Location of agency

Location of patient’s county of residence (UIC) Rural MSA

Urban, in an MSA (1, 2) 3% 97%

Rural

Adjacent to an MSA (3, 4, 5, 6) 67 33

Not adjacent to an MSA but includes

a town with at least 2,500 people (7, 8) 90 10

Not adjacent to an MSA and does not

include a town with at least 2,500 people (9) 90 10

Note: UIC (urban influence code, as defined by the U.S. Department of Agriculture), MSA (metropolitan statistical

area, as defined by the United States Office of Management and Budget).

Source: MedPAC analysis of the 1999 HCFA standard analytical file claims data

TABLE

6-3
all visits delivered in the most rural areas.

Thus, the effects of rural agency closures

might have been mitigated by the

availability of care from agencies outside

of the rural area for some rural

beneficiaries.

One reason that national closures affected

rural areas less than urban areas is that

patients in rural areas rely more on

government and voluntary agencies and

less on freestanding agencies than their

urban counterparts. Between 1997 and

2001, more than 70 percent of the

agencies that closed were freestanding

(Table 6-4).

Some observers have suggested that

having only a small number of agencies

per Medicare beneficiary in an area may

impair access, but there is no evidence to

suggest that this is a meaningful measure

of access. Furthermore, the national

distribution of HHAs does not suggest

that rural areas are at a disadvantage;

about one-third of all HHAs but only onefourth of beneficiaries are located outside

of urban areas (Franco and Leon 2000).

RECOMMENDATION 6A

The Congress should not exempt rural

home health services from the

prospective payment system.

No component of the PPS—unit of

payment, amount of base payment, or case

mix adjustment—should be less adequate

for rural home health services than for

urban. The current payment system,

especially with the 10 percent increase in

payments provided under the BIPA,

should ensure adequate payment and

allow assessment of the impact of the PPS

and whether any changes may be

appropriate.

Need for better data

Significant data limitations restrict our

ability to fully assess differences in the

costs of providing care to urban and rural

patients. Chief among these limitations is

the lack of data under the new payment

system. According to HCFA, cost report

data from the PPS will not be available

before September 2003. However, while

cost report data will be essential for

assessing and maintaining adequate

payments under the PPS, their quality may

decline unless some improvements are

made.

Home health intermediaries—the

organizations that process claims—report

challenges for cost reporting. Many HHAs

are small and lack staff to dedicate to cost

reporting. Further, definitions of key costs,

how to document them, and how to allocate

them are unclear. Costs not directly related

to patient care—such as costs for travel or

for providing escorts to employees who see

clients in unsafe neighborhoods—seem to

be especially difficult to allocate. The

intermediaries with whom we spoke

believed that declining budgets for

education and audits also will contribute to

problems with the quality of cost data.

The quality of cost data may decline

further under PPS because the new system

moves payment away from agencies’

reported costs toward a nationally

determined prospective rate. Because

agencies’ payments are no longer tied to

their reported costs, the incentive to report

their own costs accurately has been

reduced.

Reliable cost data are important in a PPS

to assess the adequacy of payments. Cost

report data will be needed not only to

assess the payment system’s ability to

account for potential differences between

urban and rural home health but also to

ensure that the system reflects appropriate

changes in costs. Given the need for

accurate cost report data, we recommend

that:

RECOMMENDATION 6B

The Secretary should study a sample

of home health providers:

• to evaluate the impact of

prospective payment on home

health in rural areas,

• to evaluate costs that may affect

the adequacy of prospective

payments, and

• to find ways to improve all cost

reports.

Offsetting a potential decline in the

quality of cost data by increasing the audit

rate could require substantial new

resources and the development of new and

meaningful penalties for inaccurate data.

However, it may be difficult to generate

sufficient incentives to report accurate

data through increasing audits without

burdening providers and making

Medicare’s relationship with them

unacceptably punitive. Furthermore, to the

extent that cost data are inaccurate due to

a lack of clear definitions and

requirements, penalizing providers who

attempt to comply would be inappropriate.

110 Prospective payment for home health services in rural areas

Number of home health agencies, by ownership

of facility, 1997 and 2001

Ownership 1997 2001 Percent change

Total 10,498 7,121 32%

Visiting nurse association 556 432 22

Government and voluntary 1,192 950 20

Hospital-based 2,695 2,138 21

SNF-based 199 150 25

Freestanding, other 5,856 3,451 41

Note: SNF (skilled nursing facility)

Source: HCFA, Medicare Decision Support System, Office of Strategic Planning

TABLE

6-4
Instead, HCFA could create a pool of

providers, perhaps similar to the group

whose cost reports were thoroughly

audited and used to make the PPS. With

some statistical adjustment, that group

constituted a nationally representative

sample of agencies. It may be desirable to

increase the number of rural providers in

the pool to enable distinctions among rural

areas, especially to examine isolated rural

providers. It may also be desirable to

focus attention on travel costs in both

rural and urban settings.

New and substantial resources would be

needed to support continuing,

comprehensive audits of cost reports from

the pool. An incentive for agencies to join

the highly audited group may be needed if

the group is composed of volunteers.

However, such additional spending may

be worthwhile if it produces timely and

accurate cost data and reveals ways to

target resources for improving the quality

of all home health cost data from all

agencies. Input from members of the

group could also inform efforts to clarify

and streamline the cost reports or to

consider the incorporation of new costs,

such as the use of telehealth.

Devoting resources to the improvement of

cost data should not be allowed to

decrease the attention given to utilization

data. Utilization data will continue to be

important for monitoring access to home

health services. 

Report to the Congress: Medicare in Rural America | June 2001 111
References

Bishop CE, Brown RS, Phillips B, Ritter G, Skwara KC. The home health visit: an

appropriate unit for Medicare payment? Health Affairs. Winter 1996, p. 145–155.

Franco S, Leon J. Rural home health agencies: the impact of the balanced budget act. The

Project HOPE Walsh Center for Rural Health Analysis. Washington (DC), February

2000.

General Accounting Office. Medicare home health agencies: closures continue, with little

evidence beneficiary access is impaired, No. HEHS-99-120. Washington (DC), GAO.

May 1999.

General Accounting Office. Medicare home health care: prospective payment system

could reverse recent declines in spending, No. HEHS-00-176. Washington (DC), GAO.

September 2000.

Goldberg HB, Delary D, Schmitz RJ, et al. Case-mix adjustment for a national home

health prospective payment system: second interim report. Cambridge (MA), Abt

Associates. September 24, 1999.

Goldberg HB, Schmitz RJ. Contemplating home health PPS: current patterns of Medicare

service use, Health Care Financing Review. Fall 1994, Vol. 16, No. 1, p. 109–130.

Medicare Payment Advisory Commission. Report to the Congress: Medicare payment

policy. Washington (DC), MedPAC. March 2001.

Phillips BR, Brown RS, Bishop CE, Klein AC, Ritter GA, Schore JL, Skwara KC,

Thornton CV. Do preset per visit payment rates affect home health agency behavior?

Health Care Financing Review. Fall 1994, Vol. 16, No. 1, p. 91–107.

Schlenker RE, Powell MC, Goodrich GK, Kaehny MM. Quality of home health care: a

rural-urban comparison. Center for Health Services and Policy Research. Denver (CO),

November 2000.

Stoner D, Goldberg HB, McCallum-Keeler G, Robinson C. Medicare Payment Advisory

Commission (MedPAC) home health agency survey, 1999. Cambridge (MA), Abt

Associates. 1999.

Sutton JP. Rural home health users: vulnerability to payment reform. The Project HOPE

Walsh Center for Rural Health Analysis. Washington (DC), September 1999.

112 Prospective payment for home health services in rural areas
Bringing MedicareChoice

to rural America

CHAPTER 7

hy are MedicareChoice benefit packages that include

extras such as low cost sharing and prescription drugs

available to beneficiaries in some urban areas but not

widely available to those in rural areas? Despite efforts

of the Congress to attract MedicareChoice managed-care plans to rural areas by

revising the payment structure, there are still few managed-care plans available

in rural areas, and the benefit packages they bring are not as generous as those offered in some urban areas. The basic market characteristics shared by many rural

areas—including a limited number of providers and a dispersed population—will

likely continue to frustrate these efforts. A non-network, private fee-for-service

option has become available in some rural areas but, like other options discussed

in this chapter, is not likely to generate sufficient efficiencies or provider discounts to bring generous benefit packages to rural beneficiaries without increasing Medicare program costs.

W

CHAPTER

Bringing MedicareChoice 

to rural America

7

In this chapter

• Little progress to date

• Why are MedicareChoice

coordinated-care plans

unlikely to enter rural areas?

• The private fee-for-service

option

• Other options

• Conclusion

Report to the Congress: Medicare in Rural America | June 2001 115
Rural Medicare beneficiaries and their

representatives in the Congress want to

bring to rural areas the generous benefits

packages (including prescription drug

coverage and low cost sharing) and low

premiums enjoyed by beneficiaries in

some urban areas who have enrolled in

Medicare managed-care plans. Two

features of the MedicareChoice (MC)

program enacted as part of the Balanced

Budget Act of 1997 (BBA) were designed

to bring such packages to rural areas (see

text box). First, payments in lower-paid

areas—which includes most rural areas—

were increased by creating a floor rate,

which has been increased substantially in

subsequent legislation and is $475 per

month today. Second, plans other than

health maintenance organizations (HMOs)

were allowed to participate in the

program.

Little progress to date

Thus far, MC plans offering generous

benefit packages at little or no cost to

beneficiaries have not entered rural areas.

In this chapter, we explain why

coordinated-care plans (plans offered by

HMOs, preferred provider organizations,

or provider sponsored organizations) are

unlikely to enter rural areas under most

conditions and, if they did, why they

would be unlikely to garner the

efficiencies and provider discounts

necessary to fund generous benefit

packages. We also discuss the only other

option in the MC program that is

currently available to beneficiaries—a

private fee-for-service plan. This type of

plan is becoming more widely available in

rural areas and presents some unique

policy challenges for the Medicare

program when combined with the

increased floor payment rates resulting

from recent legislation. Finally, we briefly

describe some other options for bringing

more benefits to rural areas at low cost to

beneficiaries.

HMO availability for

Medicare beneficiaries

Although the MC program allows

several kinds of coordinated care plans to

be offered, only MC HMOs (and one

MC provider sponsored organization

plan, which is included in the analysis) are

offered. Because MC HMOs have

provided the generous benefits in some

urban areas that are desired in rural areas,

it is important to understand what

determines their availability.

The availability of MC HMOs varies

over two dimensions (Table 7-1). First,

availability decreases as the degree of

urban influence decreases. As one moves

from a metropolitan statistical area (MSA)

containing more than 1 million people to

rural areas not adjacent to an MSA, the

availability of MC HMO plans

decreases for any given level of payment.

For example, 48 percent of beneficiaries

living in large MSAs with a payment rate

at the floor level of $401.61 for 2000 had

at least one MC HMO plan available,

compared with only 4 percent of

beneficiaries in the most rural counties.

(In rural counties, the plan is usually an

extension of an urban-based HMO; only

two plans have completely rural service

areas.) Second, availability increases with

payment level at all degrees of urban

influence except for the most rural

(possibly because there are very few

counties in this category with payment

rates above the floor). For example, in

MSAs with a population of less than 1

million, availability increases from 21

percent for counties at the floor level to 94

percent for counties at the highest

payment level.

For most of rural America, the MC 

payment rate is at the floor (Figure 7-1).

Even though the floor represented an

increase of over 100 percent from 1997

fee-for-service spending for some counties,

116 Bringing MedicareChoice to rural America

The MedicareChoice program

The MedicareChoice (MC)

program was created by the

Balanced Budget Act of 1997.

It allows private-sector organizations

to provide medical coverage to

Medicare beneficiaries in exchange

for a monthly payment from the

Medicare program. The MC

program replaced the risk-health

maintenance organization (risk-HMO)

program established under the Tax

Equity and Fiscal Responsibility Act

of 1982 and substantially changed the

existing payment provisions. The link

between capitation payments to plans

and local fee-for-service spending in

the traditional Medicare program was

loosened by moving toward a blend of

local and national spending. Payments

were to be the maximum of: the

blended rate, a floor rate, or a 2

percent minimum increase from the

previous year’s rate. The intent was to

decrease the disparity in payment

rates between different markets. The

MC program also added non-HMO

options, including preferred provider

organization plans, provider

sponsored organization plans, private

fee-for-service plans, and highdeductible plans with medical savings

accounts. Its intent was to create more

options for more beneficiaries in more

areas, including rural areas and lowerpaid urban areas.

In continued efforts to increase the

availability of MC plans, the

Balanced Budget Refinement Act of

1999 created bonus payments for

plans that enter counties in which no

other MC plan is operating. Such

plans receive a 5 percent bonus for the

first year and a 3 percent bonus during

the second year. The Medicare,

Medicaid, and SCHIP Benefits

Improvement and Protection Act of

2000 then increased monthly floor

payments to the current $475 and

introduced a new floor of $525 a

month for counties in metropolitan

statistical areas with populations

greater than 250,000.Report to the Congress: Medicare in Rural America | June 2001 117

Percentage of beneficiaries with any MedicareChoice health 

maintenance organization in their county in 2001, 

by location of county and 2000 payment rate

MedicareChoice 2000 monthly payment rate

Beneficiaries $401.61 $401.62- $450.00-

Location of county (UIC) (millions) (floor) $449.99 $549.99 $550All

In an MSA that includes at least

one million people (1) 17.6 48% 76% 88% 100% 94%

In an MSA that does not include

at least one million people (2) 12.3 21 37 65 94 57

Adjacent to an MSA and includes a town 

with at least 10,000 people (3,5) 2.4 14 23 38 41 28

Adjacent to an MSA but does not include 

a town with at least 10,000 people (4,6) 2.8 11 11 23 38 16

Not adjacent to an MSA (7,8,9) 4.2 4 3 11 1 5

Note: UIC (urban influence code, as defined by the U.S. Department of Agriculture), MSA (metropolitan statistical area, as defined by the U.S. Office of Management and

Budget).

Source: MedPAC analysis of Medicare Compare data from HCFA website, February 2001.

TABLE

7-1

2001 Medicare+Choice payment rates

FIGURE

7-1

Alaska and Hawaii not to scale

$475 floor

$525 floor

Non-floor
118 Bringing MedicareChoice to rural America

only 4 percent of beneficiaries in rural floor

counties not adjacent to an MSA had an

MC HMO available in 2000. The effect

on availability of MC HMOs from the

latest increase in the floor, to $475 per

month, has been limited thus far.

Lack of generous benefit

packages

Where MC HMOs are available in rural

areas, they do not provide the generous

benefit packages and low premiums that

accompany MC HMOs in some urban

areas (Table 7-2).

The pattern of benefits shows the same

trend as plan availability. Even when we

only look at beneficiaries who have a

MC HMO available, the more rural the

area the less likely beneficiaries are to

have generous benefit packages. For

example, zero-premium plans, available to

70 percent of beneficiaries in large MSAs

who have plans they can join, are only

available to 6 percent of the small number

of beneficiaries in the most rural areas

who have HMOs they can join.

The enrollment picture reflects this lack of

benefits in rural areas, even where MC

HMOs are available. Only about 5 percent

of those beneficiaries living in rural areas

not adjacent to MSAs who could join are

members of MC HMOs—about 11,000

beneficiaries. In large MSAs, over 25

percent of eligible beneficiaries join. The

lower enrollment rate in rural areas may

reflect the paucity of benefit packages

HMOs offer and the higher premiums

they charge. It could also reflect the

difficulty of marketing in rural areas and

the lack of established plans. For MC

HMOs to successfully market themselves

to beneficiaries, they must offer enough

extra benefits to make it worthwhile for

beneficiaries to give up free choice of

providers—which is difficult to do in

most rural areas.

Although the generous packages offered

by MC HMOs in urban areas in the past

may not be as generous today (for

example, 75 percent of urban beneficiaries

had access to zero-premium plans in 1999,

versus 50 percent in 2001), the underlying

problem of equity that the BBA and other

legislation have sought to rectify remains;

beneficiaries in some urban areas have

access to MC HMOs that make extra

benefits available for small or no

premiums, and beneficiaries in rural areas

generally do not.

Why are

MedicareChoice

coordinated-care plans

unlikely to enter rural

areas?

Three factors make it unlikely that MC

coordinated-care plans, which depend on

networks of participating providers, will

enter rural areas: the difficulty and

economics of forming provider networks,

the characteristics of the beneficiary

population, and patterns of health care use

in an area. In addition, the relation of the

rates the MC program pays plans to feefor-service spending in the traditional

Medicare program must be considered,

because for an MC plan to succeed it

has to provide some beneficiaries a

preferable alternative to the traditional

program and available supplemental

(medigap) arrangements.

Network formation

Any network managed care plan

considering entering a health care market

must determine whether enough providers

are available to form a network that will

meet regulatory guidelines (such as

distance and time to closest provider, 24-

hour coverage, and the range of medically

necessary services offered in network),

respond to consumer preferences, and

participate on economic terms acceptable

to the plan.

Forming networks that meet state (or in

the case of MC plans, Health Care

Financing Administration) regulations is

difficult in some areas. For example, in

rural areas not adjacent to metropolitan

areas, there are fewer than 6 primary care

physicians per 10,000 people (Geyman et

al. 2001). Meeting local consumer

preferences may be a problem for urban

plans wanting to extend service to

bordering rural areas. Urban-based

providers might not be acceptable to some

rural beneficiaries who want to use their

local providers.

Networks in urban areas are often formed

using intermediate entities, such as

independent practice associations or large

For beneficiaries with a health maintenance

organization available, prescription drug

coverage and premiums in 2001, 

by location of county

Percent of beneficiaries with

Average Prescription monthly

drug plan Zero premium minimum

Location of county (UIC) available plan available premium

In an MSA that includes at least

one million people (1) %91% %70% $12

In an MSA that does not include

at least one million people (2) 73 50 24

Adjacent to an MSA and includes a town 

with at least 10,000 people (3,5) 59 36 30

Adjacent to an MSA but does not include 

a town with at least 10,000 people (4,6) 58 22 33

Not adjacent to an MSA (7,8,9) 64 6 40

Note: UIC (urban influence code, as defined by the U.S. Department of Agriculture), MSA (metropolitan statistical

area, as defined by the U.S. Office of Management and Budget).

Source: MedPAC analysis of Medicare Compare data from HCFA website, February 2001.

TABLE

7-2
group practices (Mathematica 2000).

These entities, which can accept risk in

the form of capitated payments and help

the plans manage care, are not as

commonly available in rural areas as in

urban areas. As a result, HMOs in rural

areas commonly use fee-for-service to

reimburse physicians rather than capitated

payments, making it more difficult to

manage care so that it can be delivered

more efficiently (Christianson et al. 1997).

In addition, if providers are not already

organized, networks may have to be built

provider by provider, which can increase

the cost and effort to enter a market.

In areas with a sufficient supply of

providers to generate competition,

managed care plans can sometimes

negotiate discounted prices for services by

proffering higher patient volumes in

exchange for lower prices. Rural areas

however, often have few providers. In

many counties there is only one hospital,

which will have little incentive to

negotiate discounted rates with an MC

plan because it will serve all the patients

anyway at Medicare fee-for-service rates.

This point is illustrated by private

payments to rural hospitals. In 1999,

private payments were 134 percent of

costs for rural hospitals, compared with

113 percent of costs in urban settings,

where more provider competition exists

(MedPAC 2001).

The same logic applies to physicians. In

counties with few physicians it is unlikely

that managed care plans could deliver a

significantly higher volume of patients

than the physicians are already seeing, or

that those physicians would accept lower

payment even if a higher volume of

patients was delivered.1

In rural areas, forming economically

feasible networks that have adequate

access is not just a problem for HMOs

operating in Medicare. In the Medicaid

program, in which membership in

managed care can be made mandatory,

HMOs are not common in rural areas.2 In

commercial plans, HMO penetration

decreases as distance from urban areas

increases. In the Federal Employees

Health Benefits program (FEHB), HMOs

are not available in many rural areas; in

eight predominately rural states there are

no HMOs available in any county (OPM

2000).3

Population characteristics

Two characteristics of rural populations

influence the entry of managed care plans:

density and income. Rural areas have low

population density, which makes it

difficult to enroll a large number of

members in a compact geographic area. A

large membership is attractive to managed

care plans because it enables plans to

spread their fixed costs. For plans to attain

large membership levels where population

density is low, they either must cover

large geographic areas (with all the

complication and cost that entails for

network formation) or extend coverage

from a higher-density area. A large

membership also absorbs the risk of some

members having large expenses. If the

plan population is too small, the insurance

risk, or the cost of defraying it through

reinsurance, becomes very high.

Medicare beneficiaries in rural areas have

lower incomes than those in urban areas.

Although lower-income beneficiaries

might want to join plans with lower cost

sharing than traditional Medicare, they

might not be able to pay premiums to do

it. Evidence suggests that higher incomes

in rural areas are linked to higher

Medicare managed care penetration

(Moscovice et al. 1997), possibly because

plans often charge premiums in rural areas

(Table 7-2). If premiums were lowered or

eliminated this relationship might change.

Finally, the presence of large employers is

often associated with managed care

success because they provide ease of

marketing and a source of money for

premiums. Most rural areas do not have

large employers or associated retiree

populations. A dispersed, relatively lowincome population with no ready source

for marketing organization or premium

support is unlikely to encourage managed

care entry.

Use of health care

Higher use of health care under fee-forservice allows coordinated care plans

more scope to realize efficiency gains

from either decreasing the amount or

changing the mix of health care provided.

There is no evidence of widespread high

use in rural areas (see analysis of use rates

in Chapter 1); hence, plans have less

opportunity for efficiency gains and little

incentive to enter those areas. In addition,

in counties where beneficiaries underuse

care (due to, for example, low beneficiary

income and little supplemental coverage),

pent-up demand may lead to an initial

spike and a permanent increase in use

when beneficiaries switch from traditional

fee-for-service to MC HMOs with

lower cost sharing for services. This

increase in use has contributed to the

withdrawal of some MC HMOs from

rural areas in the past and has discouraged

the entry of others, according to an expert

panel on the MC program convened by

MedPAC.4

Report to the Congress: Medicare in Rural America | June 2001 119

1 On average, rural physicians work longer hours and see more patients than those in urban areas do (Geyman et al. 2001).

2 In Medicaid, primary care case management (PCCM) is the prevalent mode of managed care in rural areas—over 60 percent of rural counties participating in Medicaid

managed care used PCCM in 1997 (Slifkin et al. 1998). Primary care case management pays primary care providers a small amount per member per month in addition

to any charges for patient encounters, which are reimbursed under fee-for-service rules. Where a choice is available between capitated plans and PCCM, Medicaid

recipients overwhelmingly choose PCCM: for example, 61 percent chose PCCM in Iowa and 98 percent chose PCCM in Virginia (Felt-Lisk et al. 1999). The primary

care case management model would, however, be unlikely to generate generous extra benefits for Medicare beneficiaries. There are no provider discounts and there is

no mechanism to directly reward the primary care provider for efficiency gains; hence, the provider could not translate them to increased benefits for beneficiaries.

3 States without FEHB program HMOs are Alaska, Arkansas, Maine, Montana, Nebraska, New Hampshire, South Dakota, and Wyoming. In other states, such as Idaho,

Louisiana, Mississippi, Utah, and Vermont, FEHB program HMOs are available only in a few counties.

4 MedPAC expert panel on MC plan participation and withdrawals, August 31, 1999.
The relation of

MedicareChoice payment

rates to fee-for-service

spending

We have seen that several factors

discourage network managed care plans

from entering rural areas. For MC

HMOs in particular, the relation of MC

payment rates to spending in traditional

Medicare is also important. The

Commission looked first at MC HMO

entry under conditions where MC

payment rates are essentially equal to riskadjusted Medicare spending on

beneficiaries in the traditional fee-forservice program. We then looked at the

situation in rural areas today, where MC

payment rates are frequently much higher

than expected spending in traditional feefor-service.

If MedicareChoice payments

are similar to fee-for-service

spending

As discussed in our March 2001 report,

the Commission believes that payments to

MC plans should not stray far from riskadjusted Medicare fee-for-service (FFS)

spending in a local market area because

the market distortions that will result from

disparate payments are bad for the

program and beneficiaries.5 However, if

payments in rural areas are close to FFS

spending, coordinated-care plans will not

enter rural areas because efficiency gains

will not outweigh the plan’s additional

marketing and administrative costs. In

high-use, high-payment areas, managed

care plans can be more efficient than FFS

if they can decrease the use of health care

or change the mix of services. Plans also

may be able to use their market power to

extract provider discounts. The literature

shows no evidence of overuse of health

care in rural areas, so it is unlikely that use

can be substantially decreased and there

may be fewer opportunities to shift care to

lower-cost settings. In addition, if there is

no competition among providers, no

provider discounts can be expected by

managed care firms. If no efficiency will

be gained nor discounts extracted, no

revenue will be available to fund extra

benefits. (Assuming that payments are

fully risk adjusted, there is no advantage

from favorable selection either.) If a plan

cannot offer extra benefits (or even cover

its administrative and marketing costs) it

will not attract customers and will either

not enter a market, or not stay in a market

if it does enter.

If MedicareChoice payments

are greater than fee-for-service

spending

As we recommended in our March 2001

report, the variation in FFS spending that

exists among different parts of the country

and whether it is justified should be

investigated in its own right, and not

addressed through the MC program.

However, MC payments have been

adjusted to decrease payment variation

between market areas by substantially

increasing payments to rural areas. Thus

far, increasing payments to MC plans in

rural areas has not stimulated widespread

entry of coordinated care MC plans, for

the reasons stated above. In areas where

the non-payment barriers to entry are not

as compelling—a commercial network of

providers exists, a strong rural providerbased plan is operating, a large local

employer supports a managed care plan

for its workers and wants its retirees to

have access, or MC plans exist in

neighboring urban areas—some entry

might eventually be anticipated from

higher payments. But in general, the nonpayment factors that make it difficult for

managed care to succeed in rural areas

will not be overcome through reasonable

payment increases and increased benefits

will not result. This has been amply

illustrated by the fact that the number of

MC HMOs in rural areas has not grown

despite substantial increases in payment.

Increasing payments, however, has given

rise to a new type of plan—the private

fee-for-service (PFFS) plan.

The private fee-for-service

option

In an MC PFFS plan, the plan takes on

the full risk for beneficiaries’ health care

expenses and in turn receives a monthly

payment from the Medicare program just

like any other MC plan. There is no

requirement for management of care or

for a network of providers. Although the

details may vary by plan, under the plan

currently offered the providers are

intended to be the same as under

traditional FFS and will initially be paid

the same rates.6 Under this arrangement,

the only gains in efficiency might arise

from beneficiary behavior changing

because of differences in cost sharing.

(Because payments are not yet fully risk

adjusted, there may also be gains or losses

from risk selection.) If the use of care is

the same as in traditional Medicare, then

for the plan to provide benefits beyond

those in traditional Medicare, either the

MC payment must exceed average FFS

spending by an amount greater than the

sum of the plan’s marketing and

administrative costs and profit or the plan

must charge a premium for the extra

benefits.7

If MC payments were substantially

equal to risk-adjusted spending in

traditional Medicare, PFFS plans could

provide a desirable option to some

beneficiaries without presenting a

120 Bringing MedicareChoice to rural America

5 If payments to the MC sector diverge significantly from spending in the FFS sector, beneficiaries will have reason to migrate to the higher-cost sector if the higher

spending is translated into additional benefits. This could result in higher total spending by the Medicare program as a whole. Where payments diverge such that MC

payments are far below FFS spending, MC plans may leave the program, providing less choice for beneficiaries and leaving them less well off. The Commission

recommended that “the Medicare program be financially neutral as to whether beneficiaries enroll in MedicareChoice plans or in the traditional Medicare program.

Therefore, Congress should make Medicare payments for beneficiaries in the two sectors of a local market substantially equal, after accounting for risk.” (MedPAC

2001)

6 Providers are informed that their patient is covered under the PFFS plan and what the terms of reimbursement are. Because they will be paid the same as under

traditional Medicare, it is anticipated that they will agree to provide services. This willingness has not yet been demonstrated on a wide scale.

7 The original impetus for the PFFS option was to provide benefits not normally available through Medicare even if beneficiaries had to pay the additional cost. This was in

response to the fear that as Medicare budgets became more constrained, certain services—particularly for those near the end of life—would be curtailed.
financial quandary for the Medicare

program. Where MC payments are

substantially higher than spending in

traditional Medicare, however (as is the

case in some floor payment counties),

Medicare spending will be increased if an

MC option is chosen. For example, in

more than 300 rural counties we estimate

the 2001 floor payment rate of $475 a

month exceeds the spending for the

average beneficiary in traditional

Medicare in those counties by at least

$130 a month, a minimum increase of

almost 40 percent.

In some of those counties, the difference

between the floor payment and traditional

Medicare spending is greater than the

premium for a medigap plan that covers

most cost sharing for Medicare-covered

benefits. Hence, paying an MC PFFS

plan at the floor rate in some rural

counties would not appear to be paying

the cost of an efficient provider—the basic

axiom of Medicare payment policy.

Paying PFFS plans at the floor rate is an

expensive way to get extra benefits for

Medicare beneficiaries in some counties.

Other options 

Like its predecessor the Medicare riskHMO program, the MC program

continues to require that plans absorb all

risk for the cost of beneficiaries’ health

care. This basic tenet of the program could

be rethought. One could argue that the

Medicare program itself can more

efficiently absorb the risk for health care

in areas where few beneficiaries are

available to spread the risk. This would be

of particular importance in rural areas for

provider-based plans (which could be

HMOs, provider-sponsored organizations,

or preferred-provider organizations)

where even a plan that enrolled all the

local beneficiaries might still have too few

enrollees to properly spread the risk of

random high-cost occurrences, probably

necessitating the purchase of reinsurance

with its attendant costs. Larger plans

might ameliorate this problem by covering

broader geographic areas, although they

would then have commensurately more

severe network formation problems and

costs.

Alternatively, the Medicare program

could absorb all the risk and pay plans on

a cost basis (as it does for a small number

of plans already), or absorb part of the risk

and either pay plans a partial capitation

amount and some additional amount for

each service or pay a split capitation, in

which the plan takes on the risk for some

services and the program keeps the risk

for other services. Each of these

approaches has advantages and

disadvantages.

Cost HMOs

One way to extend HMOs to rural areas

might be to reconsider the cost HMO

model. Cost HMOs were the original use

of HMOs in the Medicare program and

provided a way for beneficiaries who had

been in HMOs before they were eligible

for Medicare to continue their

membership. Under current law, new cost

HMOs can no longer be formed and

existing cost HMOs must cease operation

by 2004. There are 21 cost HMOs open to

new members and 10 that no longer

accept new members.

The Medicare program pays an HMO’s

cost for providing basic Medicare

benefits, less the actuarial value of

traditional FFS cost sharing. If a

beneficiary goes to a non-network

provider, the beneficiary pays his

coinsurance and the Medicare program

pays its usual FFS rate. Cost HMOs must

charge premiums for benefits beyond the

basic Medicare benefit, unlike MC

plans which can offer free extra benefits if

payment rates are high enough and

efficiencies can be realized. Therefore,

they cannot bring the generous benefit

packages with low or no premiums

desired in rural areas. In addition,

experience to date with the cost program

suggests that it is more expensive for the

Medicare program than is traditional FFS

(although not necessarily more expensive

than the MC floor payment), so it is not

clear that expanding it would be a good

solution even if it were desirable (Sing et

al. 1996). Although cost HMOs do differ

from MC plans, they too are unlikely to

be a major part of a solution for rural

areas.

Partial capitation

Under partial capitation, a plan would be

paid less than the full capitation payment

but would receive an additional payment

for each service rendered. The additional

payment would be less than the normal

fee-for-service amount such that the total

received by the plan would approximate

the total capitated payment. Partial

capitation has two important benefits.

First, it would decrease the risk to plans

because they would be reimbursed more

for enrollees who use more health care

services. Second, partial capitation

decreases incentives to stint on services

and hence perhaps increases the services

enrollees receive. In rural settings, the

primary benefit would be the decreased

risk held by the plan, which might make it

more feasible to offer plans in places with

little potential enrollment. However, the

decreased risk would be accompanied by

a decrease in the capitation payment,

making less money available to provide

increased benefits even if efficiency gains

could be achieved. It is unlikely that the

decreased risk could overcome the other

factors that discourage managed care

participation in rural areas.

Split capitation 

Under split capitation, a plan would only

bear risk for those services under its

control. For example, multi-specialty

group practices (to the extent they are

available in rural areas) could take full

risk for all physician services and no risk

for hospital inpatient services. However, it

is difficult to see how this could generate

a surplus from efficiency that could be

used to fund significant additional

benefits. Successful Medicaid plans in

rural areas that are sponsored by primary

care providers depend on limiting referrals

to specialists and inpatient admissions to

generate surpluses. If plans were not at

risk for those services, they could not keep

any surpluses generated. Analogously, in

Medicare under split capitation there

would be little opportunity for efficiency

gains by group practices if they were

limited to decreasing physician use. The

incentive for a group practice to form such

a plan would be even less if the group

would have benefitted from additional use

Report to the Congress: Medicare in Rural America | June 2001 121
of services under traditional FFS because

they are the sole providers for that area. In

addition, split capitation raises the

problem of providers unbundling services

and moving the site of service to a venue

for which they do not hold risk. For

example, a group practice could move a

procedure to an outpatient from an office

setting.

Conclusion

If the sources of benefits accompanying

MC HMOs in urban areas are efficiency

gains and provider discounts, it is unlikely

they can be replicated in rural areas

through MC coordinated care plans. If

favorable selection is a source as well,

proper risk adjustment of payment would

preclude that avenue in urban as well as in

rural areas. The more likely MC vehicle

for choice in rural areas is the PFFS or

other non-network type of plan. The

danger for the program, assuming

payment floors persist, is that such a plan

will cost the program more without

proportional increases in benefits for

beneficiaries, because of funds needed for

marketing and administrative expenses

and profits. If several non–managed-care

plans compete, profit levels may be

trimmed but the administrative and

marketing expenses will remain. If the

Congress wants more generous benefit

packages in rural areas it should address

the issue directly, and if a more generous

benefit package is made available in rural

areas by legislation it must be made

available in all areas. Given appropriate

risk adjustment, the only sources of

savings that can be translated into

additional benefits are efficiency gains

and provider discounts. Because these

sources are not generally available in rural

areas, rural beneficiaries are unlikely to

see more generous benefits without an

explicit or implicit subsidy. 

122 Bringing MedicareChoice to rural America
References

Christianson J, Wellever A, Hamer R, et al. HMO financial arrangements with rural

physicians, Journal of Rural Health. 1997, Vol. 13, No. 3, p. 240–252.

Felt-Lisk S, Silberman P, Hoag S, et al. Medicaid managed care in rural areas: a ten-state

follow-up study, Health Affairs. March/April 1999, Vol. 18, No. 2, p. 238–245.

Geyman JP, Norris TE, Hart LG. Textbook of rural medicine. New York (NY), McGrawHill. 2001.

Mathematica Policy Research, Incorporated. Health plans’ selection and payment of

health care providers, 1999. Washington (DC), MPR, Inc. Report to Medicare Payment

Advisory Commission No. 00-2. May 2000.

Medicare Payment Advisory Commission. Report to the Congress: Medicare Payment

Policy. Washington (DC), MedPAC. March 2001.

Moscovice I, Casey M, Krein S. Rural managed care: patterns and prospects.

Minneapolis (MN), Rural Health Research Center, University of Minnesota. 1997.

Office of Personnel Management, The 2001 guide to federal employees health benefits

plans, Washington (DC), OPM. November 2000.

Sing M, Hill SC, Brown RS, et al. The consequences of paying Medicare HMOs and

health care prepayment plans their costs. Princeton (NJ), Mathematica Policy Research,

Inc. 1996.

Slifkin R, Hoag S, Silberman P, et al. Medicaid managed care programs in rural areas: a

fifty-state overview, Health Affairs. November/December 1998, Vol. 17, No. 6, p.

217–227.

Report to the Congress: Medicare in Rural America | June 2001 123

Reviewing the estimated payment 

update for physician services

CHAPTER 8

edicare payments for physician services are updated annually based on the so-called sustainable growth rate

system, which is designed to control overall spending.

The Medicare Payment Advisory Commission

(MedPAC) believes this system fails to account adequately for changes in the

cost of physician services and that policymakers should consider alternatives to

the system if policies to control spending are necessary. Accordingly, the

Commission recommends replacing the sustainable growth rate system with an

update method that better accounts for the cost of providing care. In the meantime, this chapter fulfills MedPAC’s requirement to review the Health Care

Financing Administration’s (HCFA’s) preliminary estimate of the update for

2002. Based on this review, the Commission concludes that this estimate of the

update appears reasonable. The Commission notes that the update for 2002 may

ultimately be lower—perhaps significantly lower—than HCFA’s estimate of

0.1 percent, which could raise concerns about the adequacy of payments and

beneficiary access to care. Such an update would limit physician spending for the

first time since enactment of the sustainable growth rate system, and it also illustrates the Commission’s concern that updates under the system are not closely related to the cost of providing physician services.

M

CHAPTER

Reviewing the estimated

payment update for 

physician services

8

In this chapter

• Updating payments for 2002

• Replacing the sustainable

growth rate system

Report to the Congress: Medicare in Rural America | June 2001 127
Medicare’s payments for physician

services are made according to a fee

schedule that assigns relative weights to

services, reflecting resource requirements.

These weights are adjusted for geographic

differences in practice costs and

multiplied by a dollar amount—the

conversion factor—to determine

payments. The conversion factor is

updated annually, based on a formula

designed to control overall spending over

time while accounting for some of the

factors that affect the cost of providing

care.

Calculating the update to the conversion

factor is a two-step process. First, HCFA

must estimate the sustainable growth rate

(SGR), which is the target rate of growth

in spending for physician services and is

based on a formula defined in law. The

SGR is a function of projected changes in:

• input prices for physician services,1

• enrollment in traditional Medicare,

• real gross domestic product (GDP)

per capita, and

• spending attributable to changes in

law and regulations.

Second, HCFA calculates the update to

the conversion factor. This update is a

function of:

• the change in input prices for

physician services,2

• a legislative adjustment required by

the Balanced Budget Refinement Act

of 1999 (BBRA),3

• an adjustment to account for expected

changes in physician behavior in

response to payment changes,4 and

• an adjustment factor that increases or

decreases the update as needed to

align actual spending with target

spending determined by the SGR.5

Updating payments for

2002

Under the BBRA, the Secretary is

required to make publicly available, by

March 1 of each year, an estimate of the

SGR and conversion factor update for the

succeeding year.

HCFA’s estimate of the SGR for 2002 is

6.0 percent (Miller 2001b). As discussed

below, this estimate appears reasonable,

but it is based on limited data. When reestimating the SGR this fall, HCFA’s use

of more complete data will be important.

HCFA then calculated a preliminary

update for 2002 of 0.1 percent. Pending

re-estimation of the SGR and the

collection of data necessary to calculate

the update, this preliminary estimate also

appears reasonable.

Estimate of the sustainable

growth rate for 2002 

HCFA’s preliminary estimate of the SGR

for 2002 of 6.0 percent is based on

estimates of a change in input prices for

physician services of 1.5 percent, growth

in traditional Medicare enrollment of 0.4

percent, growth in real GDP per capita of

2.4 percent, and growth in spending due to

law and regulations of 1.5 percent (Table

8-1). This estimate of the SGR for 2002 is

lower than HCFA’s current estimate of

the SGR for 2001, which is 7.0 percent

(HCFA 2001). The two SGRs are

different largely because HCFA projects

less growth in traditional Medicare

enrollment in 2002 than in 2001.

Change in input prices 

By law, the change in input prices in the

SGR is a weighted average of the

expected changes in input prices for

physician services and laboratory services.

HCFA’s estimate of this factor is based in

part on the Medicare Economic Index

(MEI), which is 1.8 percent. The estimate

also accounts for changes in payment

rates for laboratory services; under the

Balanced Budget Act of 1997, these rates

will not change in 2002.

A change in input prices of 1.8 percent is

slightly lower than in recent years (HCFA

2001). Since 1992, when the physician fee

schedule was introduced, the MEI has

ranged from 2.0 percent to 3.2 percent

(Figure 8-1). One reason for the drop in

the MEI is that growth in input prices is

expected to slow generally in 2002

(Standard and Poor’s DRI 2000). Also,

the Bureau of Economic Analysis has

revised its methods for calculating

productivity growth. (Measures of labor

inputs in the MEI are adjusted downward

for productivity growth.) This change has

shifted estimates of productivity growth

upward and reduced estimates of the

change in prices for labor inputs measured

by the MEI.6

128 Reviewing the estimated payment update for physician services

1 For purposes of the SGR, physician services include services commonly performed by a physician or in a physician’s office. In addition to services paid under the

physician fee schedule, these services include diagnostic laboratory tests. To estimate this factor, HCFA uses a weighted average of the Medicare Economic Index (MEI),

a measure of changes in input prices for physician services, and the change in payment rates for laboratory services legislated by the Congress. Unlike input price

indexes for other services, HCFA adjusts the Medicare Economic Index for growth in the productivity of labor inputs used to provide physician services.

2 For purposes of the update, physician services include only those services paid for under the physician fee schedule.

3 This adjustment maintains the budget neutrality of a technical change introduced to avoid volatility in the conversion factor.

4 The behavioral response adjustment is based on a HCFA assumption that physicians will increase the volume of services to offset a portion of revenue reductions

associated with implementation of resource-based practice expense payments (HCFA 1998).

5 The update adjustment factor has two components that account for the difference between target and actual spending. The first component is an adjustment for the

difference between target and actual spending in the year before the update occurs, or 2001 in the case of the update for 2002. The second component is an

adjustment for the cumulative difference between target and actual spending since April 1996. By law, the first component is weighted to be the most important

component of the update adjustment factor.

6 See Chapter 2 of MedPAC’s March 2001 report to the Congress for further discussion of MEI issues.
Growth in traditional Medicare

enrollment 

HCFA’s forecast of growth in total

Medicare Part B enrollment for 2002 is

0.9 percent. Net of growth in

MedicareChoice (MC) enrollment,

Part B enrollment for beneficiaries in

traditional Medicare is expected to grow 

by 0.4 percent.

The forecast growth rate for MC

enrollment of 3.4 percent may be too high

or too low. On one hand, for the year

ending February 1, 2001, average monthly

enrollment in MC plans fell by 1.5

percent over the previous year, including a

10 percent drop in January. On the other

hand, implementation of the Medicare,

Medicaid, and SCHIP Benefits

Improvement and Protection Act of 2000

(BIPA) could lead to higher MC

enrollment because the law increased

MC payment rates.7

It is too early to analyze the BIPA’s effects

on MC enrollment, but further

information on enrollment in MC for

2002 will be available this summer when

MC plans notify HCFA about their

contracting plans. This information,

combined with additional data on MC

enrollment in 2001, will help HCFA revisit

its estimates of enrollment growth before

publishing the final update for 2002.

Growth in real gross domestic

product per capita 

HCFA’s estimate of growth in real GDP

per capita of 2.4 percent is based on the

President’s budget proposal for fiscal year

2002. This estimate is consistent with the

forecast of real GDP growth for 2002

from the Congressional Budget Office

(CBO 2001). The estimate assumes an

end to the current economic slowdown

and a rebound by next year.

Growth in spending due to law

and regulations 

For the 2002 update, the factor that

accounts for changes in law and

regulations reflects provisions in the BIPA

that established or increased Medicare

Part B coverage for Pap smears, pelvic

examinations, glaucoma examinations,

colonoscopy, and mammography. The

law also established coverage for medical

nutrition therapy services for certain

beneficiaries with diabetes or renal

disease and included other provisions that

will lead to greater spending.

Estimate of the update 

for 2002 

HCFA’s estimate of the 2002 update to

payments for physician services is 0.1

percent (Miller 2001a). This estimate is

based on reasonable estimates of the

factors in the statutory formula (Table 8-2,

see page 130), but it is lower than the

estimated change in input prices for

physician services.

Specifically, the change in input prices of

1.8 percent is the estimate of the MEI

discussed above. The update adjustment

factor of 1.5 percent would reduce the

update because estimated spending for

physician services is greater than the

target determined by the SGR. The

legislative adjustment of 0.2 percent is

required under the BBRA. Finally, the

volume and intensity adjustment of 0.2

Report to the Congress: Medicare in Rural America | June 2001 129

7 For further information on MC payment rates, see p. 113 of MedPAC’s March 2001 report to the Congress.

HCFA estimates of

factors in sustainable 

growth rates, 

2001-2002

Factor 2001 2002

Change in input prices 1.9% 1.5%

Growth in traditional 

Medicare enrollment 2.9 0.4

Growth in real GDP per 

capita 1.5 2.4

Growth in spending due to 

law and regulations 0.5 1.5

Sustainable growth rate 7.0 6.0

Note: GDP (gross domestic product). The sustainable

growth rate is a function of the four factors

shown.

Source: HCFA estimates.

TABLE

8-1

2.4

3.2

2.7

2.3

2.1 2.0 2.0

2.2 2.3 2.4

2.1

1.8

Percent

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

(estimate)

2.5

2.0

1.5

1.0

0.5

0.0

3.0

3.5

FIGURE

8-1 Medicare Economic Index, 1992–2002

Source: HCFA.
percent is based on a HCFA assumption

that physicians will provide more services

to offset lower payments associated with

implementation of resource-based practice

expense payments to physicians.

The estimate of the update adjustment

factor is negative because HCFA’s

estimates of actual spending for physician

services are greater than the target

determined by the SGR. This difference

means that HCFA’s estimates include

growth in real GDP per capita that is less

than growth in the volume and intensity of

physician services per beneficiary.

Without further analysis, reasons for this

difference are unclear, but HCFA’s

estimates assume that volume growth per

beneficiary started to exceed growth in

real GDP per capita in 2000 and that the

difference will widen in 2001.8

An update less than the estimated change

in input prices may raise concerns about

the adequacy of payments and beneficiary

access to care, but it is unclear whether

the update HCFA has estimated would

lead to access problems. The updates for

2000 and 2001 (of 5.4 percent and 4.5

percent, respectively) were somewhat

generous in that they were higher than the

estimated change in input prices.

However, if the final update for 2002

published this fall is substantially lower

than HCFA’s estimate, it may affect

access.

An update lower than HCFA’s estimate is

possible for two reasons. First, the current

economic slowdown may lead to lower

growth in real GDP than HCFA estimates,

lowering the SGR for 2001. Second,

volume growth may be higher than HCFA

expects, raising the estimate of actual

spending for 2001. Such changes in target

and actual spending would have a direct

effect on the update because the difference

between target and actual spending in

2001 is the most important component of

the update adjustment factor for next year.

Replacing the sustainable

growth rate system 

Regardless of whether HCFA’s estimate

of the 2002 update under the SGR system

is technically reasonable, MedPAC has

concluded that the SGR system is not an

appropriate method for updating payments

for physician services (MedPAC 2001).

Accordingly, the Commission has

recommended that the Congress replace

the SGR system with an annual update

based on factors influencing the unit costs

of efficiently providing physician

services.

MedPAC’s recommendation would

correct three problems. First, although the

SGR system accounts for changes in input

prices, it fails to account for other factors

affecting the cost of providing physician

services, such as scientific and

technological advances and new federal

regulations. Second, it is difficult to set an

appropriate expenditure target with the

SGR system because spending for

physician services is influenced by many

factors not explicitly addressed, including

shifts of services among settings and the

diffusion of technology. The SGR system

attempts to sidestep this problem with an

expenditure target based on growth in real

GDP, but such a target helps ensure that

spending is affordable without necessarily

accounting for changes in beneficiaries’

needs for care. Third, enforcing the

expenditure target is problematic. An

individual physician reducing volume in

response to incentives provided by the

SGR system would not realize a

proportional increase in payments.

Instead, the increase in payments would

be distributed among all physicians

providing services to Medicare

beneficiaries.

These problems with the SGR system can

have serious consequences. Updates under

the SGR system will nearly always lead to

payments that diverge from costs because

actual spending is unlikely to be the same

as the target. When this occurs, payments

will either be too low, potentially

jeopardizing beneficiary access to care, or

too high, making spending higher than

necessary. Also, the SGR system only

applies to services paid under the

physician fee schedule, including services

provided in physicians’ offices. It does not

apply to facility payments, such as

payments to hospital outpatient

departments and ambulatory surgical

centers. Because physicians can provide

many services in their offices or in

facilities, updates constrained by an

expenditure target that apply only to one

setting could create financial incentives

that inappropriately influence clinical

decisions about where services are

provided.

Given these problems with the SGR

system, the Commission has

recommended that the Congress consider

a new approach to updating payments for

physician services that more fully

accounts for changes in the unit costs of

providing those services. In considering

updates of other Medicare payments,

MedPAC uses an update framework that

addresses both the appropriateness of the

current level of payment and changes in

130 Reviewing the estimated payment update for physician services

HCFA estimate of 

the update for

physician services

for 2002

Factor Percentage

Change in input prices 1.8%

Update adjustment factor 1.5

Legislative adjustment 0.2

Volume and intensity adjustment 0.2

Update 0.1

Note: The update is a function of the four factors

shown.

Source: HCFA estimates.

TABLE

8-2

8 HCFA warns that the estimates of actual spending may change because data the agency used to calculate the preliminary estimate of the update for 2002 were based

only on complete claims through the second quarter of 2000.
costs expected to occur during the coming year. The Commission believes elements of

this framework could provide a promising basis for developing a new approach for

updating payments to physicians. 

References

Congressional Budget Office. The budget and economic outlook: fiscal years 2002–2011.

Washington (DC), Government Printing Office. January 2001.

Health Care Financing Administration. Estimated sustainable growth rate and conversion

factor for Medicare payments to physicians in 2002. March 19, 2001, available at

http://www.hcfa.gov/pubforms/actuary/SGR/sgr2002.pdf.

Health Care Financing Administration. Estimated volume-and-intensity response to a

price change for physicians’ services. August 13, 1998, available at

http://www.hcfa.gov/pubforms/behavoff/.

Medicare Payment Advisory Commission. Report to the Congress: Medicare payment

policy. Washington (DC), MedPAC. March 2001.

Miller ME, Health Care Financing Administration. Letter to Gail R. Wilensky, Medicare

Payment Advisory Commission. March 9, 2001a.

Miller ME, Health Care Financing Administration. Letter to Gail R. Wilensky, Medicare

Payment Advisory Commission. March 1, 2001b.

Standard and Poor’s DRI. Health care cost review. Lexington (MA), The McGraw-Hill

Companies. Fourth quarter 2000.

Report to the Congress: Medicare in Rural America | June 2001 131

Clinically based indicators of 

access to care for 

Medicare beneficiaries

APPENDIX A

Ensuring beneficiaries’ access to

necessary medical care is a primary goal

of the Medicare program. Some policy

experts fear that beneficiaries residing in

certain rural areas may have more

difficulty getting needed services and

quality care as compared with their urban

counterparts (see Chapters 2 and 3). To

address these issues, MedPAC contracted

with Direct Research LLC for a study

using clinically based measures of access

to care. As reported in Chapter 2, except

for residents of the most remote rural

areas, MedPAC found that rural

beneficiaries were nearly as likely as their

urban counterparts to receive necessary

care.

The clinically based indicators of needed

care (Table A-1, see page 136) used by

Direct Research LLC were developed by a

APPENDIX

Clinically based indicators of

access to care for Medicare

beneficiaries

A

Report to the Congress: Medicare in Rural America | June 2001 135

research team at RAND as part of a

project which was funded by MedPAC’s

predecessor, the Physician Payment

Review Commission (PPRC 1995, PPRC

1997). RAND designed these indicators to

reflect basic clinical standards of care for

common medical diagnoses. Necessary

care was defined as care for which (1) the

benefits of care outweigh the risks, (2) the

benefits to the patient are likely and

substantial, and (3) physicians have

judged that not recommending the care

would be improper (Asch et al. 2000). For

the indicators, RAND selected medical

conditions that had a high prevalence or

incidence among the elderly population,

for which effective medical treatment was

available, and that were readily

identifiable from diagnoses coded on

claims forms.

RAND developed two types of measures:

those reflecting minimum standards of

acceptable care for certain diagnoses and

those representing potentially avoidable

outcomes. Therefore, measures do not

necessarily document optimal care, but

rather define the minimally acceptable

care or services for certain diseases.

Measures of potentially avoidable care

include use of emergency services or

hospitalizations that might have been

averted had patients received better

outpatient disease management and

treatment. Because these measures can be

derived from claims and administrative

data, they provide a relatively inexpensive

and easy method to monitor underuse of

medical services by Medicare

beneficiaries.
136 Clinically based indicators of access to care for Medicare beneficiaries

Clinically based indicators of access to needed care for elderly 

Medicare beneficiaries with certain diagnoses

Anemia

For patients with iron deficiency anemia: gastrointestinal workup

Hematocrit/hemoglobin between one and six months following initial diagnosis of anemia

Breast cancer

For patients with breast cancer and eventual mastectomy: interval from biopsy to definitive therapy (surgery delay time) should be less than three months

Visit every six months for breast cancer patients who have undergone mastectomy and cytotoxic chemotherapy

Mammography every year for patients with a history of breast cancer

At initial diagnosis of breast cancer, mammogram

At initial diagnosis of breast cancer, chest X-ray

Visit every year for breast cancer patients who have undergone mastectomy without cytotoxic chemotherapy

Diabetes

Glycosolated hemoglobin or fructosamine every six months for patients with diabetes

Eye exam every year for patients with diabetes

Visit within four weeks following discharge of patients hospitalized with diabetes

Visit every six months for patients with diabetes

Gastrointestinal bleeding

Visit within four weeks following discharge of patients hospitalized with gastrointestinal bleeding

Hematocrit within four weeks following discharge of patients hospitalized with gastrointestinal bleeding

Follow-up visit within four weeks of initial diagnosis of gastrointestinal bleeding

Heart and circulatory system

Visit within four weeks following discharge of patients hospitalized with myocardial infarction (MI) or heart attack

Cholesterol test every six months for patients hospitalized with MI who have an elevated cholesterol level

Electrocardiogram (EKG) during emergency department visit for unstable angina

Visit within four weeks following discharge of patients hospitalized with unstable angina

Visit every six months for patients with stable angina

Follow-up visit or hospitalization within one week of initial diagnosis of unstable angina

Chest X-ray within three months of initial diagnosis of congestive heart failure (CHF)

Visit within four weeks following discharge of patients hospitalized for CHF

EKG within three months of initial diagnosis of CHF

Visit every six months for patients with CHF

Visit within four weeks following discharge of patients hospitalized with malignant or otherwise severe high blood pressure

Pulmonary system

Visit every six months for patients with chronic obstructive pulmonary disease (COPD)

Stroke

EKG within two days of initial diagnosis of transient ischemic attack (TIA)

For TIA patients with eventual carotid endarterectomy: interval between carotid imaging and endarterectomy less than two months

Visit within four weeks following discharge of patients hospitalized for TIA

Visit every year for patients with diagnosis of TIA

For patients hospitalized for carotid territory stroke: carotid imaging within two weeks of initial diagnosis

For cerebral vascular accident (CVA) patients with eventual carotid endarterectomy: interval between carotid imaging and endarterectomy less than two

months

Visit within four weeks of discharge of patients hospitalized with CVA

Continued on next page

TABLE

A-1
Report to the Congress: Medicare in Rural America | June 2001 137

Clinically based indicators of access to needed care for elderly 

Medicare beneficiaries with certain diagnoses

Continued from previous page

Avoidable outcomes

Among patients with angina, three or more emergency department visits for heart-related diagnoses in one year

Among patients with gall stones, diagnosis of perforated gallbladder

Among patients with COPD, subsequent admission for respiratory diagnosis

Nonelective admission for CHF

Among patients with diabetes, admission for diabetic coma

Among patients with pneumonia, diagnosis of lung abscess or empyema

Preventive care

Visit every year

Assessment of visual impairment every two years

Mammography every two years in female patients

Other

Cholecystectomy (open or laparoscopic) for patients with gall stones and inflammation of the gall bladder, bile duct and/or pancreas

Arthroplasty or internal fixation of hip during hospital stay for broken hip

Visit within two weeks following discharge of patients hospitalized for depression

Note: A visit may be with a physician or a nonphysician provider, including a nurse practitioner or a physician assistant.

Source: Hogan (2001).

TABLE

A-1
References

Asch SM, Sloss EM, Hogan C, et al. Measuring underuse of necessary care among

elderly Medicare beneficiaries using inpatient and outpatient claims, Journal of the

American Medical Association. November 8, 2000, Vol. 284, No. 18, p. 2325–2376.

Hogan C, Direct Research LLC. Urban-rural differences in the use of needed services:

analysis of the ACE-PRO indicators using 1998/1999 data. Report to the Medicare

Payment Advisory Commission. April 19, 2001.

Physician Payment Review Commission, Monitoring access of Medicare beneficiaries.

Washington (DC), PPRC. 1997.

Physician Payment Review Commission, Monitoring access of Medicare beneficiaries.

Washington (DC), PPRC. 1995.

138 Clinically based indicators of access to care for Medicare beneficiaries
Summary of Medicare’s special 

payment provisions for rural 

providers and criteria 

for qualification

APPENDIX B

This appendix summarizes Medicare’s

special payment provisions and the

criteria for qualification for the following

groups of rural hospitals:

• Geographically reclassified hospitals

• Sole community hospitals

• Small rural Medicare-dependent

hospitals

• Critical access hospitals

• Rural referral centers

• Hospital swing beds

Geographically

reclassified hospitals 

Hospitals that believe their area wage

index or base payment rate does not

adequately address the costs they face

may apply separately to be reclassified for

payment purposes. Both rural and urban

hospitals have applied for reclassification

into rural, other urban, and large urban

areas.1

APPENDIX

Summary of Medicare’s special

payment provisions for rural

providers and criteria 

for qualification

B

Report to the Congress: Medicare in Rural America | June 2001 141

Criteria to qualify

Hospitals may qualify for reclassification

in one of three ways:

1. They must prove proximity and

similarity to the area of

reclassification. Proximity may be

based on distance (no more than 15

miles away for an urban hospital and

35 miles for a rural hospital) or

employment patterns (at least 50

percent of the hospital’s employees

reside in the area). Separate similarity

tests apply to reclassification for wage

index and base payment amount, and

a hospital seeking reclassification for

both must choose the same area.

• For wage index reclassification, a

hospital’s wages must be more

than 106 percent (108 percent for

urban facilities) of the local area

wage index, as well as at least 82

percent (84 percent for urban

facilities) of the wage index in the

area of reclassification.

• For base payment reclassification,

a hospital must demonstrate that

its average case-mix-adjusted cost

per discharge is more than its

current rate plus 75 percent of the

difference between that rate and

the rate it would receive if it were

reclassified.

2. Different rules apply to rural referral

centers (RRCs) and sole community

hospitals (SCHs).

• RRCs and SCHs do not have to

demonstrate proximity to the area

to which they seek redesignation.

• RRCs also do not have to meet the

106 percent criterion for average

hourly wage.

• An RRC or SCH that qualifies for

reclassification to an urban area is

assigned to the area closest to the

hospital.

3. All hospitals in a county can apply for

group reclassification. For hospitals in

a rural county seeking urban

redesignation, the county must be

adjacent to the metropolitan area to

which the hospitals seek to be

assigned. The hospitals must

demonstrate that the rural county in

which they are located currently

meets the similarity criteria.

1 A large urban area is defined as an urban area with a population of at least one million.
Payment provisions

A reclassified hospital receives the wage

index, base payment rate, or both of the

area to which it has been assigned.

Sole community hospitals

The intent of the SCH program, started in

1983, is to maintain access to needed

health services for Medicare beneficiaries

by providing financial assistance to

hospitals that are geographically isolated.

Criteria to qualify

A hospital seeking SCH status must meet

one of the following criteria:

1. It must be 35 miles from a like

hospital.

2. It must be between 25 and 35 miles

from a like hospital and meet one of

the following criteria:

• No more than 25 percent of all

inpatients or 25 percent of

inpatient Medicare beneficiaries in

its service area may be admitted to

other like hospitals within 35

miles.

• It must have fewer than 50 beds

and would have met the above

criteria, except that some patients

or residents had to seek care

outside the service area because

necessary specialty services were

unavailable.

• Nearby like hospitals must be

inaccessible for at least 30 days in

2 out of 3 years because of local

topography or periods of

prolonged severe weather

conditions.

3. It must be between 15 and 25 miles

from a like hospital but because of

local topography or periods of

prolonged severe weather conditions,

nearby like hospitals are inaccessible

for at least 30 days in 2 out of 3 years.

4. Because of distance, posted speed

limits, and predictable weather

conditions, the travel time between

the hospital and the nearest like

hospital must be at least 45 minutes.

Payment provisions

Sole community hospitals benefit from

four provisions. First, they are paid the

highest of four amounts for Medicare

inpatient services: the current prospective

payment system (PPS) rate, or base year

costs per discharge from 1982, 1987, or

1996 updated to the current year. The

1996 base went into effect in fiscal year

2001, and will be phased in between 2001

and 2004 in four 25 percentage-point

increments.

Second, an SCH that receives the PPS rate

and qualifies for a disproportionate share

hospital (DSH) payment receives up to a

10 percent adjustment, rather than the

maximum of 5.25 percent received by

other rural hospitals.2

Third, SCHs need not meet the proximity

requirement of geographic

reclassification, which could facilitate

approval for reclassification to a region

with a higher wage index, base payment

rate, or both.

Finally, if an SCH experiences a decrease

of more than 5 percent in total number of

inpatient cases due to circumstances

beyond its control, it is eligible to receive

payments necessary to fully compensate it

for fixed costs.

Small rural Medicaredependent hospitals

The Medicare-dependent hospital (MDH)

program, established in 1987, is intended

to support small rural hospitals for which

Medicare patients make up a significant

percentage of inpatient days or discharges.

This greater dependence on Medicare may

make these hospitals more financially

vulnerable to prospective payment, and

the MDH designation is designed to

reduce this risk.

Criteria to qualify

A hospital qualifies for the MDH program

by meeting all of the following criteria:

1. It is located in a rural area.

2. It has no more than 100 beds.

3. It is not classified as an SCH.

4. It has at least 60 percent of inpatient

days or discharges covered by

Medicare.

Payment provisions

Medicare-dependent hospitals benefit

from two provisions. First, they are paid

for inpatient services the sum of the PPS

payment rate plus half of the amount by

which the highest of hospital-specific base

year costs per discharge for Medicare

patients from 1982 or 1987 (updated to

the current year) exceeds the PPS rate.

Second, an MDH with a caseload that

falls by more than 5 percent (due to

circumstances beyond its control) may

receive payments necessary to fully

compensate it for fixed costs.

Critical access hospitals

The critical access hospital (CAH)

program, established in 1997, is intended

to support limited-service hospitals

located in rural areas that cannot support a

full-service hospital. The CAH program

replaced the essential access community

hospital (EACH), rural primary care

hospital (RPCH), and Montana medical

assistance facilities (MAF) programs,

which had similar features. Before the

Balanced Budget Refinement Act of 1999

(BBRA), the CAH program was limited to

public and non-profit private hospitals.

Criteria to qualify

A hospital may qualify for the CAH

program in one of three ways:

1. It meets the following criteria:

• It is located in a rural area.

142 Summary of Medicare’s special payment provisions for rural providers and criteria for qualification

2 Hospitals that receive cost-based payment for Medicare inpatient services do not receive payment adjustments available under the PPS (DSH, indirect medical education,

outlier payments, etc.). This applies to hospitals certified as sole community, critical access, or Medicare-dependent.
• It is more than 35 road miles (or,

in the case of mountainous terrain

or in areas with only secondary

roads available, 15 miles) from a

similar hospital.

• It provides 24-hour emergency

care services.

• It has no more than 15 acute care

beds (or 25 in limited cases,

including up to 10 swing beds).

• It has stays averaging no more

than 96 hours per patient. (The

Balanced Budget Act of 1997

(BBA) mandated a length-of-stay

maximum of 96 hours; the BBRA

changed this to a 96-hour average

length of stay.)

2. It is certified by the state as being a

necessary provider of health care

services to residents in the area.

Hospitals cannot apply for

designation as a CAH unless their

state has developed or is in the

process of developing a “rural health

plan,” which is submitted to the

Health Care Financing

Administration (HCFA) for review

and approval.

3. It was previously certified under the

RPHC or MAF programs.

Payment provisions 

Critical access hospitals are reimbursed by

Medicare for both inpatient and outpatient

services on the basis of their current

Medicare-allowable costs. They are

exempt from the inpatient and outpatient

PPSs, but are subject to the home health

and skilled nursing facility (SNF) systems.

CAH swing beds are exempt from the

SNF PPS.

Rural referral centers

The RRC program, established in 1983, is

intended to support high-volume hospitals

that treat a large number of complicated

cases and function as regional or national

referral centers. RRC designation is

intended to support the greater intensity

and costs these facilities may have.

Criteria to qualify

A rural hospital must meet one of three

criteria to qualify:

1. It has at least 275 beds.

2. It demonstrates that:

• at least 50 percent of its Medicare

patients are referred from other

hospitals or from physicians not

on the hospital staff,

• at least 60 percent of its Medicare

patients live more than 25 miles

away, and

• at least 60 percent of the Medicare

services it furnishes are provided

to beneficiaries who live more

than 25 miles away.

3. It demonstrates that it:

• has a case-mix index value greater

than or equal to the median for all

urban hospitals in the same census

region, and

• has at least 5,000 discharges per

year (3,000 for osteopathic

hospitals) or at least the median

number of discharges for urban

hospitals in the same region, and

meets at least one of the following

three criteria:

a. more than 50 percent of its

medical staff are specialists,

b. at least 60 percent of its

discharges are for inpatients

who reside more than 25

miles away, and

c. at least 40 percent of its

inpatients are referred from

other hospitals or from

physicians not on the

hospital’s staff.

Payment provisions

Under the original PPS legislation, RRCs

received the urban rather than rural base

payment rate, adjusted by their area wage

index. When the rural and “other urban”

payments were combined in 1994, this

preferential payment policy was

eliminated for most RRCs. A few still

qualify for the large urban base payment

rate, which is 1.6 percent higher than the

combined rural/other urban rate. 

The RRC program offers two other

special payment provisions. First,

qualifying RRCs receive a higher DSH

adjustment than do other rural hospitals.

Most rural hospitals’ DSH add-ons are

capped at 5.25 percent, but RRCs receive

an additional 0.6 percent adjustment for

every percentage point that their

disproportionate patient percentage

exceeds 30.3 Second, RRCs are exempt

from two of three criteria for geographic

reclassification: an RRC need not

demonstrate proximity to the area to

which it seeks redesignation or that its

wages exceed 106 percent of the average

for its actual area.

Hospital swing beds 

The hospital swing bed program,

established in 1980, is intended to

enhance access to long-term care in rural

communities. The swing-bed provisions

allow rural hospitals to provide long-term

care services to Medicare and Medicaid

patients without establishing a separate

unit.

Criteria to qualify

To qualify, a hospital must meet the

following criteria:

1. It has fewer than 100 beds and is

located in a rural area.

2. It has been granted a certificate of

need (if required by the state) for the

provision of long-term care services.

3. It has not had a swing-bed approval

terminated within the two years

before its application.

Report to the Congress: Medicare in Rural America | June 2001 143

3 The disproportionate patient percentage (DPP) is defined as the ratio of Medicare Supplemental Security Income days to total Medicare days plus the ratio of Medicaid

days to total days. To qualify for DSH payments, a hospital’s DPP must be at least 15. 
If the hospital has more than 49 beds and

was approved as a swing-bed hospital

after March 1988, it must have an

agreement with each Medicareparticipating SNF located in the hospital’s

geographic region requiring it be notified

when beds suitable for post-acute care

placement will be open, and generally

must transfer patients within five days

after determining that a SNF bed is

available.

Payment provisions 

Hospitals with swing beds are paid the

average Medicare rate per patient day for

routine services provided in freestanding

SNFs in their census region. Ancillary

services are reimbursed on a reasonable

cost basis, where costs are determined in a

manner comparable to that of all other

ancillary services provided by the

hospital. For swing-bed hospitals with

more than 49 beds, the number of SNF

patient days in each cost reporting period

is required to be less than 15 percent of

the hospital’s available bed days. The

BBA did not include swing-bed hospitals

in the SNF PPS, but required HCFA to

develop a transition to the SNF PPS for

swing-bed hospitals.

144 Summary of Medicare’s special payment provisions for rural providers and criteria for qualification
Financial performance of rural 

hospitals and the value of 

special payment policies

APPENDIX C

This section provides a detailed analysis

of hospital financial performance to

accompany the discussion of Medicare

inpatient payment policy in Chapter 4.

These analyses compare the performance

of rural hospitals—including distinct

groups of rural hospitals created by

Medicare payment policy as well as by

degree of ruralness—with that of urban

ones.1 In general, rural hospitals have

lower Medicare margins but higher total

margins than their urban counterparts.

This appendix begins with an analysis of

financial performance under Medicare and

then expands to trends in other sources of

patient revenue (private payers and

Medicaid, as well as uncompensated care)

and finally to total margins (reflecting all

payers and non-patient care revenue).

Financial performance

under Medicare

Medicare is the largest purchaser of health

services from hospitals, and Medicare

plays a larger role in rural areas than in

urban areas. This makes financial

performance under Medicare relatively

more important for rural hospitals. In this

section, we examine the trend in inpatient

margins, the impact of special payment

provisions for certain rural hospitals

compared with other special payments

Medicare makes primarily to urban

hospitals, and the overall Medicare

margin, which includes hospitals’ five

largest lines of Medicare business.

Medicare inpatient margin 

In the early 1990s, the Medicare inpatient

margin was negative for both urban and

rural hospitals, but the difference between

the two groups was slight.2 Through the

1990s, urban hospitals had higher inpatient

margins than rural hospitals, and the gap

has widened in recent years (Figure C-1).

In 1999, the urban margin fell to 13.5

percent after reaching an all-time high of

18 percent in 1997, while the margin for

rural hospitals dropped to 4.1 percent after

peaking at 10 percent in 1996.

The Medicare inpatient margin is lower

for rural hospitals than urban hospitals due

to lower payments and relatively higher

APPENDIX

Financial performance of

rural hospitals and the value

of special payment policies

C

Report to the Congress: Medicare in Rural America | June 2001 147

cost growth. Differences in payment

levels have been relatively constant over

time because most indirect medical

education (IME) and disproportionate

share (DSH) payments go to urban

hospitals and contribute substantially to

their higher margins.3 Accompanying this,

rural hospitals have had higher cost

increases throughout the 1990s. Between

1990 and 1999, rural hospitals’ cost

increases have consistently been 1 to 2

percentage points higher than those of

urban hospitals, and the cumulative

change in cost per case was nearly 30

percent for rural hospitals and just 14

percent for urban hospitals (Figure C-2).

This has caused the gap in the inpatient

margin to grow steadily, to nearly 10

percentage points in 1999. This suggests

that the difference in inpatient margins

between rural and urban hospitals is due

more to higher rates of cost growth for

rural hospitals than inherent differences in

payment policy.

Although cost growth slowed for all

hospitals in the mid-1990s, it has begun to

increase in recent years. The effect of

differences in cost growth was most

1 For an overview of the special payment policies for rural hospitals, see Appendix B and the text box in Chapter 4.

2 The inpatient margin is calculated (in percentage terms) as the difference between inpatient payments and Medicare-allowable costs (as derived from costs reported by

hospitals to the Health Care Financing Administration) divided by inpatient payments. The same general approach is used for the overall Medicare margin and the total

margin.

3 The impact of both IME and DSH payments on total prospective payment system payments to urban and rural hospitals is estimated in the section on the value of

Medicare’s special payment provisions.
striking in 1997, when rural hospital

inpatient margins fell while those of urban

hospitals continued to increase. In 1999,

rural hospital costs increased 3.7 percent

and urban hospital costs 2.6 percent, the

highest rate since 1993 for either group.

Much of rural hospitals’ higher growth in

costs per case appears to have been caused

by smaller reductions in length of stay.

Through the 1990s, urban hospitals’

length of stay declined 32 percent,

compared with 24 percent for rural

facilities. The larger drop for urban

hospitals is perhaps due to better access to

providers of post-acute and follow-up

ambulatory care in their service areas.

After considerably larger reductions for

urban hospitals in each year from 1993 to

1996, the decline in length of stay has

slowed in recent years for both urban and

rural hospitals, to less than 2 percent for

both groups in 1999 (Figure C-3).

The trend in unit costs is closely related to

the trend in volume of services. Overall,

admissions to community hospitals have

grown by 3.9 percent over the last

decade.4 Although this rate of increase has

not kept pace with population growth, the

industry as a whole has improved its

ability to realize efficiency gains related to

scale of operation. But the cumulative

increase has been only 2.6 percent for

rural hospitals, compared with 4.1 percent

for urban facilities, which suggests that

rural hospitals’ problems of scale have

worsened relative to their urban

counterparts.

Rural hospitals that receive special

payments under Medicare—rural referral

centers (RRCs), sole community hospitals

(SCHs), and small rural Medicaredependent hospitals (MDHs)—have

higher inpatient margins than other rural

hospitals (Table C-1). At 7.7 percent, the

margin for MDHs is more than four times

that of rural hospitals with more than 50

beds that have not qualified for any of

Medicare’s special payment provisions.

148 Financial performance of rural hospitals and the value of special payment policies

Note: Data for 1999 are preliminary, based on two-thirds of all hospitals covered by prospective payment.

Margins for all years are based on Medicare-allowable costs.

Medicare inpatient hospital margin, 

by urban and rural location, 1990–1999

Source: MedPAC analysis of Medicare Cost Report data from HCFA.

20

15

10

5

0

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Margin (percent) 5

Urban Rural

Prospective payment system year

1.2

3.7 3.7

1.4

0.5

0.6

6.1

9.5

5.5

4.1

10.3

2.2

0.8

1.6

6.4

11.8

16.8

18.0

14.8

13.5

FIGURE

C-1

10

8

6

4

2

0

2

1991 1992 1993 1994 1995 1996 1997 1998 1999

Prospective payment system year

Urban

Percent change

Percent change in cost per case, urban

and rural hospitals, 1991–1999

Note: Data for 1999 are preliminary, based on two-thirds of all hospitals covered by prospective payment.

Source: MedPAC analysis of Medicare Cost Report data from HCFA.

FIGURE

C-2

Rural

4 This analysis was based on data from the American Hospital Association’s Annual Survey of Hospitals, with hospitals segregated according to the urban/rural

designation of their county in 1999.
Hospitals located in the most isolated rural

areas have the highest inpatient margins of

all rural hospitals, and fewer had negative

margins (Table C-2). Other rural hospitals

in areas adjacent to urban areas, or not

adjacent but containing a town, have

lower margins and a greater share have

negative margins than either urban

hospitals or the most isolated rural

hospitals. That the most rural hospitals

have a Medicare inpatient margin

exceeding 8 percent suggests that the

existing special payment policies that seek

to target isolated hospitals have indeed

had a positive effect—on average—for

these hospitals.

Value of Medicare’s special

payment provisions 

Over the years, the Congress has

responded to perceived problems of rural

hospitals by enacting a number of policies

that provide special payments to certain

rural facilities. We have measured the

payment value of these provisions and

their proportional impact on Medicare

inpatient payments for the hospitals that

qualify.5 This analysis provides insight

into the number of facilities that benefit

from special payments, shows which

benefits the facilities receive, and also

provides a sense of scale by analyzing

other policies that tend to benefit urban

hospitals over their rural counterparts.

We analyzed the following payment

policies:

• sole community hospitals

• small rural Medicare-dependent

hospitals

• rural referral centers

• critical access hospitals

• disproportionate share payments

• geographic reclassification

• indirect medical education payments

in excess of the cost impact of

teaching

Table C-3 shows the number of hospitals

in each special payment group (a hospital

can be in more than one of these groups).

Although the first four policies are

technically restricted to rural hospitals, all

except the Medicare-dependent program

allow a hospital to keep its group

designation—and the resulting additional

payment—if its county becomes urban.

All hospitals may qualify for DSH and

IME payments and geographic

reclassification, but substantially more

urban hospitals receive DSH and IME

payments, while more rural hospitals are

reclassified.

Not all rural hospitals in a special

payment group receive the special

payments for which they are eligible, for

instance because prospective payment

system (PPS) payments are higher, or they

do not meet the DSH eligibility threshold.

Table C-4 shows the number of hospitals

in each group that receive special

payments, the type of special payment

received, and the resulting increase in PPS

payments.

Report to the Congress: Medicare in Rural America | June 2001 149

2

0

2

4

6

8

10

1991 1992 1993 1994 1995 1996 1997 1998 1999

Prospective payment system year

Urban

Percent change

Percent change in length of stay, urban

and rural hospitals, 1991–1999

Note: Data for 1999 are preliminary, based on two-thirds of all hospitals covered by prospective payment.

Source: MedPAC analysis of Medicare Cost Report data from HCFA.

Rural

FIGURE

C-3

5 The value of special payments was estimated for hospital cost reporting periods beginning in fiscal year 2000.

Inpatient Medicare, overall Medicare, and total 

margins, by rural hospital groups, 1999

Medicare Overall

Hospital inpatient Medicare Total

group margin margin margin

Rural referral centers 4.5 1.3 7.4

Sole community hospitals 4.9 2.7 3.0

Medicare-dependent hospitals 7.7 1.3 2.5

Other rural  50 beds 3.1 5.6 1.5

Other rural  50 beds 1.7 5.0 3.8

Note: Inpatient and overall Medicare data are based on Medicare-allowable costs. Data are preliminary; the

inpatient and total (all sources of revenue) margins are based on a sample of about two-thirds of hospitals

covered by prospective payment, while the overall Medicare margin is based on about one-half of hospitals

covered by prospective payment.

Source: MedPAC analysis of Medicare Cost Report data from HCFA.

TABLE

C-1
relative to what they would have received

under the PPS.6 As of 2001, these

hospitals have the additional prospect of

receiving 1996 base year costs trended

forward, in addition to the 1982 and 1987

base-year options previously available.

We estimate that an additional 43

hospitals will benefit from this option,

increasing total SCH cost-based outlays

by $54 million.

In comparison, in 2000 approximately 40

percent of Medicare-dependent hospitals

qualified for base-year costs trended

forward, which raised their payments by

$31 million, or 4.3 percent.

The chief benefit enjoyed by RRCs was

easier reclassification. In 2000,

approximately 80 percent of RRCs were

reclassified, which increases their PPS

payments by $217 million, or 7.2 percent.

Less than a third of RRCs received

additional DSH payments of $30 million,

which increased their PPS payments by

0.7 percent.

Cost-based reimbursement for critical

access hospitals (that is, the amount of

payment above what the PPS would

otherwise provide) resulted in a relatively

modest increase in Medicare outlays

compared with other special payment

policies—$18 million in fiscal year 2000,

which raised their payments by 10

percent. However, as of April 2001, 375

hospitals have received approval for CAH

status, compared with the 216 used in this

analysis, and this increase—as well as

additional payments for cost-reimbursed

outpatient services—will raise the

payment estimate substantially.

Payment policies that provide additional

payments to both urban and rural

hospitals—geographic reclassification,

DSH payments, and IME payments in

excess of the estimated costs associated

with operating an approved residency

program—have a much greater impact in

terms of increased payments than do rural

hospital policies (Table C-5).

150 Financial performance of rural hospitals and the value of special payment policies

Hospital Medicare inpatient margin and percent of

hospitals with negative margin, by hospital location,

1999

Medicare Percent with

Hospital inpatient negative

location (UIC) margin margin

Urban, in an MSA (1,2) 13.5% 26.1%

Rural

Adjacent to an MSA and includes a town

with at least 10,000 people (3,5) 3.1 42.5

Adjacent to an MSA but does not include 

a town with at least 10,000 people (4,6) 6.0 43.3

Not adjacent to an MSA but includes a town

with at least 2,500 people (7,8) 4.5 43.5

Not adjacent to an MSA and does not 

include a town with at least 2,500 people (9) 8.4 36.0

Note: UIC (urban influence code, as defined by the U.S. Department of Agriculture). MSA (metropolitan statistical

area, as defined by the U.S. Office of Management and Budget). Data are based on Medicare-allowable

costs. Data are preliminary, based on two-thirds of hospitals covered by prospective payment.

Source: MedPAC analysis of Medicare Cost Report data from HCFA.

TABLE

C-2

Hospitals in special payment policy groups, by urban

and rural location, 2000

Rural Urban All

Policy hospitals hospitals hospitals

All hospitals 2,128 2,722 4,850

Sole community hospitals 597 43 640

Rural referral centers 169 6 175

Sole community and rural referral 56 1 57

Small rural Medicare-dependent hospitals 299 0 299

Critical access hospitals 216 3 219

Geographic reclassification 408 83 491

Disproportionate share 339 1,440 1,779

Indirect medical education 69 1,038 1,107

Note: The number of sole community hospitals has grown to 833 and the number of critical access hospitals to 375

as of April 2001. The changes in qualifying criteria for disproportionate share payments enacted by the

Medicare, Medicaid and SCHIP Benefits Improvement and Protection Act of 2000 are expected to make

840 additional rural hospitals eligible for this payment adjustment.

Source: MedPAC analysis of data from HCFA.

TABLE

C-3

6 Health Care Financing Administration staff report that the number of SCHs has risen by 75 since the count used for this analysis was developed, which means that the

total payments to these hospitals will also increase.

SCHs are eligible for the higher of costs in

a specific base year trended forward or

PPS payments with potentially higher

DSH payments. About half of SCHs

qualify for payments based on base-year

costs, and about one-quarter receive extra

DSH payments. SCH payments linked to

base-year costs represent the largest single

benefit to rural hospitals. In 2000, the

extra payments due to this benefit totaled

$248 million, which raised the payments

of qualifying hospitals by 8.1 percent
Geographic reclassification is the only one

of these policies that tends to benefit rural

hospitals more than urban hospitals. In

2000, 408 rural hospitals were

reclassified, which increased their

payments by $299 million (a 7 percent

increase in PPS payments). Only 83 urban

hospitals were reclassified, increasing

their payments by $124 million, or 5.1

percent of PPS payments. Of the

reclassified rural hospitals, approximately

one-third were RRCs, and more than half

of the total increase in payments from

reclassification went to these facilities.

Because reclassification is implemented in

a budget-neutral fashion through

reductions in the PPS base payments, all

hospitals—even those that are

reclassified—pay to some extent. The

losses due to reclassification are skewed

toward urban hospitals. Among hospitals

not reclassified, payments to urban

hospitals were reduced by $400 million

and payments to rural hospitals were

reduced by $23 million. In percentage

terms, these reductions in total PPS

payments were fairly close for nonreclassified urban and rural hospitals, at

–0.6 and –0.4 percent, respectively.

Although rural hospitals are eligible to

receive DSH and IME payments under

Medicare, most of these payments go to

urban hospitals. This has contributed to an

inpatient margin for urban hospitals that is

consistently higher than that of their rural

counterparts. More than half of all urban

hospitals qualified for DSH payments in

2000, compared with less than 20 percent

of rural hospitals. This difference existed

in part because the eligibility standard was

higher for rural hospitals. The Medicare,

Medicaid, and SCHIP Benefits

Improvement and Protection Act of 2000

(BIPA) equalized this standard, which we

estimate will allow 840 additional rural

hospitals—about 40 percent of the total—

to receive DSH payments. Urban hospitals

collected more than $4.7 billion in DSH

payments in 2000, increasing their PPS

payments by 11.5 percent. In contrast,

rural hospitals collected $78 million,

which increased their payments by 2.7

percent.

Report to the Congress: Medicare in Rural America | June 2001 151

Rural special payment groups: number receiving

additional payments and value of payments, 2000

Number of

Increase in payments

Hospital group hospitals Amount (millions) Percent

Sole community hospitals

Base year costs trended forward 337 $248 8.1%

Favorable DSH formula 151 43 1.3

Rural referral centers

Reclassification 179 217 7.2

Favorable DSH formula 52 30 0.7

Medicare dependent hospitals 129 31 4.3

Critical access hospitals 219 18 10.0

Note: DSH (disproportionate share hospital). Hospitals that are both sole community hospitals and rural referral

centers are included in the group for which they received payment. Twenty-seven of 56 SCH/RRC hospitals

received base-year costs trended forward. DSH payments exceed what a hospital would have received

without preferential treatment.

Source: MedPAC analysis of data from HCFA.

TABLE

C-4

Value of payment policies that affect both urban and

rural hospitals: geographic reclassification,

disproportionate share, and indirect 

medical education payments, 2000

Number of

Change in payments

Hospital group hospitals Amount (millions) Percent

Reclassified hospitals

Urban 83 $124 5.1%

Rural 408 299 7.0

Non-reclassified hospitals

Urban 2,639 396 0.6

Rural 1,720 23 0.4

Disproportionate share

Urban 1,431 4,711 11.5

Rural 339 78 2.7

Indirect medical education

Urban 1,038 2,313 5.5

Rural 69 34 2.8

Note: Change in payments refers to the difference between what hospitals would receive under prospective

payment and what they would receive without the special payment policy. Indirect medical education

payments are measured as the amount of payment in excess of MedPAC’s estimate of the costs associated

with operating an approved residency program. The total disproportionate share payments shown are net of

all special disproportionate share payments to special rural groups, which came to roughly $81 million.

Source: MedPAC analysis of data from HCFA.

TABLE

C-5
The next largest source of special

payments to urban hospitals is IME

payments to teaching hospitals, measured

as the level of payments above our

estimate of the cost impact of teaching for

hospitals with residents. The IME

adjustment in 2000 was 6.5 percent for

every 10 percent increment in the

resident-to-bed ratio, but we estimate the

empirical costs of teaching to be about 3.2

percent. The excess payments this

difference creates are heavily skewed

toward urban hospitals. In 2000, more

than 1,000 urban hospitals shared $2.3

billion in IME payments above the costs

of teaching, compared with 69 rural

hospitals that received just $34 million.

This excess increased urban hospital

payments by 5.5 percent, compared with

2.8 percent for rural facilities.

The percentage increase in total payments

resulting from these special payment

provisions is fairly close for urban and

rural hospitals, despite the disparity in

terms of actual dollar outlays (Table C-6).

Urban hospitals received almost $7.2

billion in special payments, which

increased their payments 11.4 percent.

Rural hospitals received about $800

million, which increased their payments

8.3 percent. The lower standard to qualify

for DSH payments granted under the

BIPA for all rural hospitals, as well as

urban hospitals with fewer than 100 beds,

will increase total rural payments by 1.4

percent and urban payments by 0.1

percent. This will bring the total impact of

special payment provisions to 9.7 percent

for rural hospitals, a level nearly

comparable to the urban hospital level of

11.5 percent.

Overall Medicare margin 

The overall Medicare margin

encompasses the five largest lines of

hospital service to Medicare

beneficiaries—inpatient, outpatient, home

health, skilled nursing, and psychiatric

and rehabilitation units. This margin also

includes payments and costs for graduate

medical education and Medicare bad debt.

The overall Medicare margin plays an

important role in our research concerning

rural hospitals. When implementation is

complete and data are available, this

margin will be especially useful in

illustrating the performance of rural

hospitals under the new PPSs for

outpatient departments, home health

agencies, and skilled nursing facility units.

The appropriateness of the outpatient and

home health PPSs for rural hospitals was

of particular concern to the Congress in

the BBRA.

The overall Medicare margin reflects the

relative payment and cost shares of each

component of services provided to

Medicare beneficiaries. In 1999, hospitals’

inpatient margins were sufficiently high

and the share of payments accounted for

by inpatient services large enough (almost

75 percent) that even though Medicare

margins for all other services were

negative, the overall Medicare margin was

5.6 percent.

Rural hospitals have had lower overall

Medicare margins than urban hospitals

and the gap has widened in each of the

years for which we have data. In 1998,

when some BBA payment policies went

into effect, the rural hospital overall

Medicare margin fell 6 percentage points,

to –2.1 percent (Figure C-4). In 1999, the

overall Medicare margin fell again for

both urban and rural hospitals, and the

disparity between urban and rural

hospitals increased to nearly 10

percentage points—the same gap found in

the inpatient margin.

The considerably lower overall Medicare

margin for rural hospitals reflects a variety

of factors. Rural hospitals tend to provide

relatively more outpatient and post-acute

care, and relatively less inpatient care.

About 66 percent of rural hospitals’

Medicare costs are accounted for by

inpatient services, compared with 73

percent for urban hospitals. Therefore,

low Medicare payments (relative to costs)

for outpatient services are not as easily

compensated by inpatient payments. The

152 Financial performance of rural hospitals and the value of special payment policies

Value of special

payment provisions

for urban and rural hospitals,

2000

Additional payments

Amount

(millions) Percent

Under previous policy

Urban hospitals $7,188 11.4%

Rural hospitals 783 8.3

With legislated increase in

disproportionate share payments

under the BIPA

Urban hospitals 11.5

Rural hospitals 9.7

Note: Additional payments refer to the difference

between what hospitals received under

prospective payment and what they would

have received without special payment

provisions. The Medicare, Medicaid, and

SCHIP Benefits Improvement and Protection Act

of 2000 (BIPA) lowered the disproportionate

share (DSH) eligibility threshold and raised the

DSH adjustment rate for rural hospitals and

urban hospitals with fewer than 100 beds.

Source: MedPAC analysis of data from HCFA .

TABLE

C-6

7 A 1993 Prospective Payment Assessment Commission study found that outpatient costs were overstated by at least 8 percent.

lower margin associated with Medicare

outpatient services, however, is partly a

vestige of hospital accounting practices.

Until recently, hospitals were paid for

outpatient services on a cost basis, which

created a strong incentive for providers to

disproportionately allocate overhead and

ancillary costs to outpatient services.7

The overall Medicare margin of every

rural hospital group—regardless of special

payment status—fell below zero in 1998

and declined again in 1999. However,

hospitals in special payment groups have

fared much better than other rural

hospitals (Table C-1). In 1999, overall

Medicare margins were –1.3 percent for

RRCs and Medicare-dependent hospitals,

–2.7 percent for SCHs, –5.0 percent for

other rural hospitals with 50 or more beds,

and –5.6 percent for other rural hospitals

with less than 50 beds.
Financial performance for

all sources of revenue

The total margin is a comprehensive

measure of hospital financial

performance, encompassing payments and

costs from all payers, non-patient services,

and non-operating revenue. The total

margin for the hospital industry as a

whole fell substantially in the late 1990s,

reflecting slower growth in Medicare

payments, continued pressure from

managed care organizations and other

private payers, losses from alternate lines

of service (and divestiture of these

ventures), and a return in 1998 and 1999

to cost increases after an era of very low

or negative cost growth. These factors

affected rural hospitals to a lesser degree,

however, and their total margins have not

declined as much as those of urban

hospitals.

Urban hospitals in recent years have

tended to fare slightly better on Medicaid

payments than rural hospitals, probably

because of a slower rate of cost growth.

The ratio of Medicaid payments to costs

for urban hospitals grew relative to the

ratio for rural hospitals in 1998, but

Medicaid payments remained below costs

(Figure C-5).

While Medicare and Medicaid margins

have been lower for rural hospitals

relative to urban hospitals, the privatepayer margin for rural hospitals has been

consistently higher throughout the 1990s.

Payments relative to costs from private

payers have fallen for urban hospitals,

while payments to rural hospitals have

remained above 134 percent of costs,

despite rural hospitals’ higher cost growth

in recent years (Figure C-5). Higher

private-sector payments in rural areas

reflect the lack of hospital competition

and low levels of managed care

penetration in rural areas.

Rural hospitals are more dependent than

urban hospitals on Medicare and have less

private-sector business; therefore,

Report to the Congress: Medicare in Rural America | June 2001 153

Note: Data for 1999 are preliminary, based on 50 percent of all hospitals covered by prospective payment.

Margins for all years are based on Medicare-allowable costs.

Overall Medicare margin including 

graduate medical education, urban

and rural hospitals, 1996–1999

Source: MedPAC analysis of Medicare Cost Report data from HCFA.

20

15

10

5

0

1996 1997 1998 1999

Margin (percent) 5

Urban Rural

Prospective payment system year

10.7

5.0

11.5

4.1

7.4

2.1

6.9

2.9

FIGURE

C-4

145

140

135

130

125

120

115

110

105

100

95

90

85

1992 1993 1994 1995 1996 1997 1998 1999

Prospective payment system year

Percent

Rural private payers

Rural Medicaid

Private payer and Medicaid payment-tocost ratios, urban and rural hospitals,

1992–1999

Source: MedPAC analysis of data from the American Hospital Association Annual Survey of Hospitals.

Urban private payers

Urban Medicaid

FIGURE

C-5
although rural hospitals have much 

higher private-payer payment-to-cost

ratios, they have less private-payer

revenue (Figure C-6). Despite the smaller

share of private payer business, however,

private-sector payments on average were

still high enough to produce consistently

higher total margins for rural hospitals.

This outcome was aided by rural

hospitals’ modestly lower uncompensated

care losses, net of applicable tax 

subsidies.

Margins for both urban and rural hospitals

grew steadily through the mid-1990s, but

began to fall in 1997 and fell steeply in

1998 (Figure C-7). In 1999, rural hospital

margins remained flat while urban

hospital margins continued to decline.

This difference appears attributable to

differences in market conditions and

business practices.

First, urban hospitals continued to

experience substantial declines in their

payments from private payers, which was

not much of a factor in rural areas.

Second, rural hospitals probably took

smaller one-time write-offs from divesting

alternative lines of business—such as

hospital-owned managed care plans and

physician practices—because they had not

dedicated as many resources to these

pursuits. Finally, rural hospitals reduced

their Medicare home health services at a

rate double that of urban hospitals.

There were signs of substantial

improvement in hospital financial

performance in fiscal year 2000. Data

from the National Hospital Indicators

Survey (NHIS, jointly sponsored by

HCFA and MedPAC) show that the total

margin climbed from 3.2 percent for fiscal

year 1999 to 4.7 percent for fiscal year

2000. A key factor in this improvement

appears to be better negotiation with

managed care and fewer one-time losses

from leaving alternate lines of business—

neither of which is applicable to most

154 Financial performance of rural hospitals and the value of special payment policies

Medicare, Medicaid, and private-payer cost

share, urban and rural hospitals, 1999

Source: MedPAC analysis of data from the American Hospital Association Annual Survey of Hospitals.

5

10

15

20

25

30

35

40

45

50

0

Medicare Private payers Medicaid Uncompensated care

Percent of total costs 5

Urban Rural

FIGURE

C-6

34.0

45.4 43.6

35.5

11.2 10.8

6.5 5.2

Note: Data for 1999 are preliminary, based on two-thirds of all hospitals covered by prospective payment.

Total margin, urban and rural hospitals,

1990–1999

Source: MedPAC analysis of Medicare Cost Report data from HCFA.

10

8

4

2

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Margin (percent)

9

5

6

7

3

1

0

Urban Rural

Prospective payment system year

3.5

4.6

4.3

5.2

4.3

5.3

4.3

5.2

4.9

5.6 5.6

6.6

5.9

7.1

5.8

6.6

4.1

4.7

2.9

4.7

FIGURE

C-7
hospitals and other rural hospitals with

fewer than 50 beds have the greatest

proportions with negative margins: 42 and

40 percent, respectively. However, more

than 40 percent of hospitals in large urban

areas also have negative margins, despite

an aggregate Medicare inpatient margin in

these areas of 16 percent.

Although rural hospitals generally have

higher total margins, the most isolated

rural hospitals have the lowest margin—at

–0.4 percent—of any of the five

geographic areas defined by degree of

ruralness (Table C-7). There is an inverse

relationship between the Medicare

inpatient margin and total margin 

that is consistent along this spectrum.

Urban hospitals and isolated rural

hospitals have the highest inpatient

margins and the lowest total margins. This

suggests that although efforts to increase

Medicare payments to hospitals in these

areas have had a favorable impact, they

have not offset other market pressures.

Large urban hospitals face the most

financial pressure from uncompensated

care and managed care, but the most

isolated rural hospitals face pressures

from low patient volume and difficulty in

attracting skilled workers. These factors

underscore that the financial problems of

urban and extremely rural hospitals go

well beyond Medicare. 

Report to the Congress: Medicare in Rural America | June 2001 155

Hospital total margin and percent of hospitals with

negative margin, by hospital location, 1999

Percent with

Hospital Total negative

location (UIC) margin margin

Urban, in an MSA (1, 2) 2.9% 36.8%

Rural

Adjacent to an MSA and includes a town

with at least 10,000 people (3,5) 4.5 27.5

Adjacent to an MSA but does not include a

town with at least 10,000 people (4,6) 3.9 35.8

Not adjacent to an MSA but includes a 

town with at least 2,500 people (7,8) 5.3 30.2

Not adjacent to an MSA and does not include

a town with at least 2,500 people (9) 0.4 53.5

Note: UIC (urban influence code, as defined by the U.S. Department of Agriculture). MSA (metropolitan statistical

area, as defined by the U.S. Office of Management and Budget). Data are based on Medicare-allowable

costs from the Medicare Cost Report. Data are preliminary, based on two-thirds of hospitals covered by

prospective payment.

Source: MedPAC analysis of Medicare Cost Report data from HCFA.

TABLE

C-7

8 A percentile margin is defined as the total margin at that point in the distribution. For example, the 10th percentile margin is higher than 10 percent of other margins and

lower than 90 percent of other margins.

rural hospitals. Thus, both the drop in

1999 and the increase in 2000 appear to

be urban hospital phenomena. The effect

of stock market losses on non-operating

revenue in 2000 (and pehaps 2001) could

mitigate these gains. However, the fiscal

year 2000 NHIS margins reflect data

through September 2000, a period of

substantial equity losses.

Rural hospitals tend to have a somewhat

more favorable distribution of total

margins than urban hospitals. In 1999, 37

percent of urban hospitals had negative

total margins, compared with 34 percent

of rural hospitals. The 10th percentile

margin (as well as the 25th and 50th ) for

rural hospitals is also higher.8 Among

rural hospital groups, Medicare-dependent

Commissioners’ voting 

on recommendations

APPENDIX D

In the Medicare, Medicaid, and SCHIP Benefits Improvement and Protection Act of 2000 (BIPA), the Congress required MedPAC to

call for individual Commissioner votes on each recommendation, and to document the voting record in its report. The information below

satisfies that mandate.

Chapter 1: Medicare and rural health care: overview and challenges for policymakers

No recommendations

Chapter 2: Rural beneficiaries’ access to care 

The Secretary should identify strategies to increase rural beneficiaries’ participation in government programs that cover Medicare

premiums and/or deductibles and coinsurance.

Yes: Braun, Hackbarth, Loop, Nelson, Newhouse, Newport, Raphael, Reischauer, Rosenblatt, Rowe, Stowers, Wakefield,

Wilensky

Absent: DeBusk, Johnson, Smith

Chapter 3: Quality of care in rural areas 

3A The Secretary should require the peer review organizations to include rural populations and providers when carrying out their

quality improvement activities.

Yes: Braun, DeBusk, Hackbarth, Loop, Nelson, Newhouse, Newport, Raphael, Reischauer, Rosenblatt, Rowe, Stowers,

Wakefield, Wilensky

Absent: Johnson

Not Voting: Smith 

3B MedPAC reiterates its June 2000 recommendation that the Congress should require the Secretary to survey at least one-third of each

facility type annually to certify compliance with the conditions of participation.

Yes: Braun, DeBusk, Hackbarth, Loop, Nelson, Newhouse, Newport, Raphael, Reischauer, Rosenblatt, Smith, Stowers,

Wakefield, Wilensky

Absent: Johnson, Rowe

APPENDIX

Commissioners’ voting 

on recommendations

D

Report to the Congress: Medicare in Rural America | June 2001 159
Chapter 4: Improving payment for inpatient hospital care in rural areas 

4A The Congress should require that rural referral centers’ wages exceed the average wage in their area to qualify for geographic

reclassification, but these facilities should retain their waiver from the proximity rule.

Yes: Braun, DeBusk, Hackbarth, Loop, Nelson, Newport, Raphael, Rosenblatt, Rowe, Smith, Stowers, Wakefield, Wilensky

Absent: Johnson, Newhouse, Reischauer

4B The Congress should require the Secretary to develop a graduated adjustment to the rates used in the inpatient prospective payment

system for hospitals with low overall volumes of discharges. This adjustment should only apply to hospitals that are more than a

specified number of miles from another facility providing inpatient care, with appropriate exceptions for topography or weather

conditions.

Yes: Braun, Hackbarth, Loop, Nelson, Newport, Raphael, Reischauer, Rosenblatt, Rowe, Smith, Stowers, Wakefield,

Wilensky

Absent: DeBusk, Johnson, Newhouse

4C In fiscal year 2002, the Secretary should implement fully the policy of excluding from the hospital wage index salaries and hours for

teaching physicians, residents, and certified registered nurse anesthetists.

Yes: Braun, DeBusk, Hackbarth, Loop, Nelson, Newport, Raphael, Reischauer, Rosenblatt, Rowe, Smith, Stowers,

Wakefield, Wilensky

Absent: Johnson, Newhouse 

4D To ensure accurate input-price adjustments in Medicare’s prospective payment systems, the Secretary should reevaluate current

assumptions about the proportions of providers’ costs that reflect resources purchased in local and national markets.

Yes: Braun, DeBusk, Hackbarth, Loop, Nelson, Newport, Reischauer, Rosenblatt, Rowe, Smith, Stowers, Wakefield,

Wilensky

Absent: Johnson, Newhouse

Not Voting: Raphael

4E The Congress should raise the cap on the disproportionate share add-on a rural hospital can receive from 5.25 percent to 10 percent.

Yes: Braun, Hackbarth, Loop, Nelson, Newport, Raphael, Reischauer, Rosenblatt, Rowe, Smith, Stowers, Wakefield,

Wilensky

Absent: DeBusk, Johnson, Newhouse

4F The Congress should revise the target cap for inpatient psychiatric facilities in a way that better addresses differences among them.

Yes: Braun, DeBusk, Hackbarth, Nelson, Newport, Reischauer, Rosenblatt, Stowers, Wilensky

Absent: Johnson, Loop, Newhouse, Raphael, Rowe, Smith, Wakefield 

Chapter 5: Assessing payment for outpatient hospital care in rural areas 

In the short term, no outpatient payment adjustments for rural hospitals are needed in addition to the current hold-harmless provision.

The Secretary should revisit outpatient payments to rural hospitals when better information on hospitals’ experience with the payment

system is available.

Yes: Braun, DeBusk, Hackbarth, Loop, Nelson, Newhouse, Newport, Raphael, Reischauer, Rosenblatt, Rowe, Stowers,

Wakefield, Wilensky

Absent: Johnson, Smith

160 Commissioners’ voting on recommendations
Chapter 6: Prospective payment for home health services in rural areas

6A The Congress should not exempt rural home health services from the prospective payment system. 

Yes: Braun, DeBusk, Hackbarth, Loop, Nelson, Newport, Raphael, Reischauer, Rosenblatt, Rowe, Smith, Stowers, Wilensky

No: Wakefield

Absent Johnson, Newhouse

6B The Secretary should study a sample of home health providers: to evaluate the impact of prospective payment on home health in

rural areas; to evaluate costs that may affect the adequacy of prospective payments; and to find ways to improve all cost reports.

Yes: Braun, Hackbarth, Loop, Nelson, Newhouse, Newport, Raphael, Reischauer, Rosenblatt, Rowe, Stowers, Wakefield,

Wilensky

Absent: DeBusk, Johnson, Smith 

Chapter 7: Bringing MedicareChoice to rural America 

No recommendations

Chapter 8: Reviewing the estimated payment update for physician services 

No recommendations

Report to the Congress: Medicare in Rural America | June 2001 161

Acronyms

Report to the Congress: Medicare in Rural America | June 2001 165

AAPCC adjusted average per capita cost

ACE angiotensin converting enzyme

ACE-PRO Access to Care for the Elderly Project

AHRQ Agency for Healthcare Research and Quality

AMA American Medical Association

APR-DRG all patient refined diagnosis related group

ASC ambulatory surgical center

BBA Balanced Budget Act of 1997

BBRA Balanced Budget Refinement Act of 1999

BIPA Medicare, Medicaid, and SCHIP Benefits Improvement and Protection

Act of 2000

CAH critical access hospital

CBO Congressional Budget Office

CHF congestive heart failure

CMI case-mix index

COPD chronic obstructive pulmonary disease

CRNA certified registered nurse anesthetist

CVA cerebral vascular accident

DPP disproportionate patient percentage

DRG diagnosis related group

DSH disproportionate share hospital

EACH essential access community hospital

EKG electrocardiogram

FEHB Federal Employees Health Benefits

FFS fee-for-service

GAO General Accounting Office

GDP gross domestic product

GME graduate medical education

HCC hierarchical condition category

HCFA Health Care Financing Administration

HCRIS Hospital Cost Report Information System

HHA home health agency

HHRG home health resource group

HMO health maintenance organization

HPSA health professional shortage area

HRSA Health Resources and Services Administration

IME indirect medical education

IPS interim payment system

JCAHO Joint Commission on Accreditation of Healthcare Organizations

MC MedicareChoice

MCBS Medicare Current Beneficiary Survey

MDH small rural Medicare-dependent hospital

Acronyms
MedPAC Medicare Payment Advisory Commission

MEI Medicare Economic Index

MI myocardial infarction

MIP Medicare incentive payment

MRI magnetic resonance imaging

MSA metropolitan statistical area

NHIS National Hospital Indicators Survey

OIG Office of Inspector General

OMB U.S. Office of Management and Budget

PAC post-acute care

PFFS private fee-for-service

PPRC Physician Payment Review Commission

PPS prospective payment system

PCCM primary care case management

PRO peer review organization

ProPAC Prospective Payment Assessment Commission

QA quality assurance

QI quality improvement

QMB qualified Medicare beneficiary

RHC rural health clinic

RPCH rural primary care hospital

RRC rural referral center

RVU relative value unit

SCH sole community hospital

SCHIP State Children’s Health Insurance Program

SGR sustainable growth rate

SLMB specified low-income Medicare beneficiary

SNF skilled nursing facility

SSI Supplemental Security Income

TIA transient ischemic attack

UIC urban influence code

166 Acronyms
More about MedPAC

Report to the Congress: Medicare in Rural America | June 2001 169

Commission members

Gail R. Wilensky, Ph.D., chair

Project HOPE

Center for Health Affairs

Bethesda, MD

Joseph P. Newhouse, Ph.D., vice chair

Harvard University

Boston, MA

Term expires April 2002

Beatrice S. Braun, M.D.

AARP, Board of Directors

Spring Hill, FL

Floyd D. Loop, M.D.

The Cleveland Clinic Foundation

Cleveland, OH

Janet G. Newport

PacifiCare Health Systems

Santa Ana, CA

Carol Raphael

Visiting Nurse Service of New York

New York, NY

Mary K. Wakefield, Ph.D., R.N.

College of Nursing and Health Science

George Mason University

Fairfax, VA

Term expires April 2003

Autry O.V. “Pete” DeBusk

DeRoyal

Powell, TN

Glenn M. Hackbarth, J.D.

Independent consultant

Bend, OR

Alan R. Nelson, M.D.

American College of PhysiciansAmerican Society of Internal Medicine

Washington, DC

Robert D. Reischauer, Ph.D.

The Urban Institute

Washington, DC

David A. Smith

AFL-CIO

Washington, DC

Ray E. Stowers, D.O.

Oklahoma State University College of

Osteopathic Medicine

Tulsa, OK

Term expired April 2001

Spencer Johnson

Michigan Health and Hospital

Association

Lansing, MI

Joseph P. Newhouse, Ph.D.

Alice Rosenblatt, F.S.A.,

M.A.A.A.

WellPoint Health Networks

Thousand Oaks, CA

John W. Rowe, M.D.

Aetna Inc.

Hartford, CT

Gail R. Wilensky, Ph.D.

Commissioners’ biographies

Beatrice S. Braun, M.D., is a member of the board of directors of AARP. She is also

a member of the State Advisory Council for the Florida Department of Elder Affairs and

serves on the board of directors for the Mid-Florida Area Agency on Aging. Dr. Braun

founded and, until her retirement in 1989, directed a day treatment program at St.

Vincent’s Hospital in Harrison, New York, for people with severe and persistent mental

illness. She is a past president of the American Association for Partial Hospitalization.

She also had a private practice in psychiatry for 16 years and was named a fellow of the

American Psychiatric Association. Before her psychiatric specialization, Dr. Braun

served for 17 years as a family physician and missionary in South Korea.

Autry O.V. “Pete” DeBusk is chairman, CEO and founder of DeRoyal, a global

supplier of medical products and services in the acute care, patient care, wound care, and

OEM (original equipment manufacturing) markets. Mr. DeBusk formed his first

company in 1970 with a patent he received on an orthopedic product. Later, in 1976, he

consolidated his many product lines into one company, DeRoyal Industries. A member of

several community organizations, Mr. DeBusk is also chairman of the Board of Trustees

at Lincoln Memorial University in Harrogate, Tennessee. As an innovative leader in the

medical industry, he received a prestigious award from Duke University in 2000

recognizing “his original contributions to orthopedic surgery.” He received his B.S.

degree from Lincoln Memorial University and attended graduate school at the University

of Georgia.

Glenn M. Hackbarth, J.D., is an independent consultant living in Bend, Oregon. He

has experience as a healthcare executive, government official, and policy analyst. He was

chief executive officer and one of the founders of Harvard Vanguard Medical Associates,

a multispecialty group practice in Boston that serves as a major teaching affiliate of

Harvard Medical School. Harvard Vanguard was created from the staff-model delivery

system that was the original core of Harvard Community Health Plan. Mr. Hackbarth

previously served as senior vice president of Harvard Community Health Plan. From

1981 to 1988, Mr. Hackbarth held positions at the U.S. Department of Health and Human

Services, including deputy administrator of the Health Care Financing Administration.

Mr. Hackbarth received his B.A. from Penn State University and his M.A. and J.D.

degrees from Duke University.

Spencer Johnson is president of the Michigan Health and Hospital Association, the

principal statewide advocate for hospitals, health systems, and other health care providers

committed to improving community health status in Michigan. Before assuming this

position in early 1985, Mr. Johnson was executive vice president of the Hospital

Association of New York State. Before that, he was involved in the development of

federal health policy and legislation as associate director of the Domestic Council at the

White House during the Ford Administration and as a professional staff member of the

U.S. Senate and the House of Representatives. He has served on the Prospective Payment

Assessment Commission and is a board member of both Blue Cross Blue Shield of

Michigan and the MHA Insurance Company. Mr. Johnson holds a master’s degree in

public administration from Cornell University and a bachelor’s degree in journalism from

St. Bonaventure University.

Report to the Congress: Medicare in Rural America | June 2001 171
Floyd D. Loop, M.D., has served since 1989 as chief executive officer and chairman of

the Board of Governors of The Cleveland Clinic Foundation. In the past 10 years, the

Cleveland Clinic has developed a regional health care delivery system of clinics and

acquired hospitals. Dr. Loop has practiced thoracic and cardiovascular surgery for 30

years and from 1975 to 1989 served as chairman of this department at the Cleveland

Clinic. As a practicing surgeon, Dr. Loop and his colleagues have made numerous

contributions to cardiac surgery, including extensive writings on internal thoracic artery

grafting, reoperations, myocardial protection, and long-term results. He is a former editor

of Seminars in Thoracic and Cardiovascular Surgery and has served on the editorial

boards of 15 specialty journals in surgery and cardiology. Dr. Loop is the author of more

than 300 articles on surgery. He chaired the Residency Review Committee for Thoracic

Surgery and has been president of the American Association for Thoracic Surgery. He

received a medical degree from George Washington University and completed surgical

residencies at George Washington University and the Cleveland Clinic.

Alan R. Nelson, M.D., is an internist-endocrinologist who was in private practice in

Salt Lake City until becoming chief executive officer of the American Society of Internal

Medicine (ASIM) in 1992. Following the merger of ASIM with the American College of

Physicians (ACP) in 1998, Dr. Nelson headed the Washington Office of ACP-ASIM

until his semi-retirement in January 2000. He currently serves as special advisor to the

EVP/CEO of the College. Dr. Nelson also serves on the Board of Trustees of

Intermountain HealthCare, a large integrated health system headquartered in Salt Lake

City. A member of the prestigious Institute of Medicine of the National Academy of

Sciences (IOM), he serves on the IOM Roundtable on Environmental Health Sciences

Research and Medicine, and is co-chair of the Workshop Planning Group on the

Environment and Cancer. Dr. Nelson, who grew up in Logan, Utah and attended Utah

State University, received his M.D. degree from Northwestern University. 

Joseph P. Newhouse, Ph.D., is vice chair of the Commission. He is the John D.

MacArthur Professor of Health Policy and Management at Harvard University and

director of Harvard’s Division of Health Policy Research and Education. At Harvard

since 1988, Dr. Newhouse was previously a senior corporate fellow and head of the

economics department at RAND. He has conducted research in health care financing,

economics, and policy, and was the principal investigator for the RAND Health

Insurance Experiment. Recipient of several professional awards, he is a member of the

Institute of Medicine, a former chair of the Prospective Payment Assessment

Commission, and a former member of the Physician Payment Review Commission. He is

also a past president of the Association for Health Services Research and has been

elected to the American Academy of Arts and Sciences. Dr. Newhouse is editor of the

Journal of Health Economics. He received a B.A. from Harvard College and a Ph.D. in

economics from Harvard University.

Janet G. Newport is corporate vice president of public policy for PacifiCare Health

Systems (PHS), Inc. The Corporate Public Policy Department is responsible for PHS’

policy development and strategic response on health care issues, support of the entity’s

Ethics and Integrity (Compliance) Program, and acts as the Company liaison with key

government agencies and Congress. Ms. Newport serves on several American

Association of Health Plans technical and advisory committees and is an industry

representative on the Health Care Financing Administration’s Medicare Council. She has

also served as an industry representative on internal HCFA technical committees. She has

more than 25 years of public affairs experience, including over 10 years directing the

Washington, D.C., office of another major Medicare risk contractor. Ms. Newport

received a political science degree from American University.

172 Commissioners’ biographies
Carol Raphael is president and chief executive officer of the Visiting Nurse Service

(VNS) of New York, the largest voluntary home health care organization in the United

States. Her responsibilities include managing its post-acute, long-term care, maternal and

child health, high-tech, rehabilitation, hospice, mental health and public health programs

and its Centers of Excellence in cardiopulmonary, diabetes, asthma, and cancer care.

Under Ms. Raphael’s leadership, VNS created VNS Choice, a Medicaid Managed LongTerm Care Health Plan and the Medicare Community Nursing Organization. Ms.

Raphael also developed the VNS Center for Home Care Policy and Research, which

conducts policy-relevant research focusing on the management, cost, quality, and

outcomes of home- and community-based services. Before joining VNS, Ms. Raphael

worked for nine years at the New York City Human Resources Administration, leaving

as executive deputy commissioner of the Income and Medical Assistance Administration.

Ms. Raphael has served on several Robert Wood Johnson Foundation advisory

committees and New York State panels, including the New York State Hospital Review

and Planning Council. She has an M.P.A. from Harvard University’s Kennedy School of

Government.

Robert D. Reischauer, Ph.D., is president of The Urban Institute. Previously, he was

a senior fellow with the Brookings Institution and from 1989 to 1995 was the director of

the Congressional Budget Office. Dr. Reischauer currently serves on the boards of the

Academy of Political Sciences, the Center on Budget and Policy Priorities, and the

Committee for a Responsible Federal Budget. He also serves on the editorial board of

Health Affairs, chairs the National Academy of Social Insurance’s project on

Restructuring Medicare for the Long-Term, and is a member of the Institute of Medicine

and the Medicare Competitive Pricing Advisory Commission. Dr. Reischauer received

his A.B. degree from Harvard College and his M.I.A. and Ph.D. from Columbia

University.

Alice Rosenblatt, F.S.A., M.A.A.A., is chief actuary and senior vice president of

Merger and Acquisition Integration at WellPoint Health Networks. Before joining

WellPoint in 1996, she was a principal at Coopers & Lybrand LLP, where she consulted

with insurers, health plans, providers, and employers. She is a former senior vice

president and chief actuary of Blue Cross Blue Shield of Massachusetts and Blue Cross

of California. Other positions include work for The New England and William M.

Mercer, Inc. Ms. Rosenblatt has served on the Board of Governors of the Society of

Actuaries and the American Academy of Actuaries. She previously chaired the

Academy’s federal health committee and work group on risk adjustment. Ms. Rosenblatt

has testified on risk adjustment before subcommittees of the Committee on Ways and

Means and the Committee on Commerce of the U.S. House of Representatives. She has a

B.S. and an M.A. in mathematics from City College of New York and the City

University of New York, respectively.

John W. Rowe, M.D., is president and CEO of Aetna US Inc., the nation’s largest

healthcare insurer. Prior to joining Aetna, Dr. Rowe served as president and chief

executive officer of Mount Sinai NYU Health. Prior to the Mount Sinai NYU Health

merger, Dr. Rowe was president of The Mount Sinai Hospital and the Mount Sinai

School of Medicine in New York City, where he currently is a professor of medicine and

geriatrics. Before joining Mount Sinai in1988, Dr. Rowe was a professor of medicine and

the founding director of the Division on Aging at Harvard Medical School and chief of

gerontology at Boston’s Beth Israel Hospital. He has authored over 200 scientific

publications, mostly on the physiology of the aging process, and a leading textbook of

geriatric medicine. Dr. Rowe was director of the MacArthur Foundation Research

Network on Successful Aging and is co-author, with Robert Kahn, Ph.D., of Successful

Aging (Pantheon, 1998). He served on the Board of Governors of the American Board of

Internal Medicine and as president of the Gerontological Society of America, and is a

member of the Institute of Medicine of the National Academy of Sciences.

Report to the Congress: Medicare in Rural America | June 2001 173
David A. Smith is director of the Public Policy Department, AFL-CIO. The

department’s work covers a wide range of domestic and international concerns with a

special emphasis on economics. Prior to joining the AFL-CIO, Mr. Smith served as

senior deputy budget director and as Commissioner of Economic Development for the

City of New York. Mr. Smith spent most of the 1980’s in Washington as an aide to

Senator Edward M. Kennedy and as a senior economist at the Joint Economic

Committee. Mr. Smith has taught economics and public policy at the University of

Massachusetts and the New School for Social Research, and is a senior fellow at the

Century Foundation. Mr. Smith is a member of the Board of Directors of the National

Bureau of Economic Research, a member of the Board of Directors of Public Campaign,

a fellow of the National Academy of Social Insurance, a member of the Treasury

Department’s Advisory Committee on the International Monetary Fund, and a member of

the Advisory Committee to the Export-Import Bank. He attended Tufts University and

received a M.Ed. from Harvard University.

Ray E. Stowers, D.O., is the director of rural health in the Department of Family

Medicine at Oklahoma State University College of Osteopathic Medicine and was in

private rural practice for 25 years at Family Medicine Clinics, Inc. in Medford,

Oklahoma. He is a member of the National Rural Health Association. Dr. Stowers is

second vice president of the American Osteopathic Association and has served that

organization in many capacities, including several related to physician coding and

reimbursement issues. He has been on the Physician Payment Review Commission and

was a founding member of the American Medical Association’s Relative Value Update

Committee. Dr. Stowers received his B.S. and B.A. degrees from Phillips University in

Oklahoma and his D.O. from the University of Health Sciences College of Osteopathic

Medicine in Kansas City, Missouri.

Mary K. Wakefield, PhD., has served since 1996 as professor and director of the

Center for Health Policy, Research, and Ethics at George Mason University, working on

policy analysis, research, and educational initiatives. Dr. Wakefield held administrative

and legislative staff positions in the U.S. Senate before assuming her current position.

She has served on many public and private health-related advisory boards. From 1997

through 1998, she was on President Clinton’s Advisory Commission on Consumer

Protection and Quality in the Health Care Industry. In September 1998, Dr. Wakefield

was appointed to the Institute of Medicine’s Committee on Quality Health Care in

America. She was a Kodak Fellow in the Program for Senior Managers in Government at

the John F. Kennedy School of Government, Harvard University, and is a fellow in the

American Academy of Nursing. Dr. Wakefield received her B.S. in nursing from the

University of Mary, Bismarck, North Dakota, and her M.S. and Ph.D. from the

University of Texas at Austin.

Gail R. Wilensky, Ph. D., is chair of the Commission. She is the John M. Olin senior

fellow at Project HOPE, where she analyzes and develops policies relating to health care

reform and ongoing changes in the medical marketplace. She also frequently advises

members of the Congress and others on the policies and politics of health care reform.

Former chair of Physician Payment Review Commission, Dr. Wilensky has held several

posts in the executive branch, most recently as deputy assistant to the President for policy

development during the Bush Administration (1992) and, before that, as administrator of

the Health Care Financing Administration (1990-1992). Recipient of numerous

professional awards, she is a member of the Institute of Medicine, a trustee of the

Combined Benefits Fund of the United Mine Workers of America, and a governor for the

Research Triangle Institute. In addition to serving on many other professional committees

and corporate boards, Dr. Wilensky is a well-known speaker who has published widely

on health policy, economics, and financing. She received a B.A. in psychology and a

Ph.D. in economics from the University of Michigan.

174 Commissioners’ biographies
Report to the Congress: Medicare in Rural America | June 2001 175

Commission staff

Murray N. Ross, Ph.D.

Executive director

Lu Zawistowich, Sc.D.

Deputy director

Jennifer Jenson, M.P.H., M.P.P.

Special assistant to the executive director

Helaine I. Fingold, J.D.

General counsel

Research directors

Jack Ashby, M.H.A.

Scott Harrison, Ph.D.

Kevin J. Hayes, Ph.D.

Sally Kaplan, Ph.D.

Julian H. Pettengill, M.A.

Analysts

Sharon L. Bee, M.S.

David V. Glass, M.S.

Janet C. Goldberg, M.P.H.

Timothy F. Greene, M.B.A.

Jesse Patrice Kerns, M.P.P.

Craig K. Lisk, M.S.

Mary B. Mazanec, M.D., J.D.

Anne Mutti, M.P.A.

Nancy Ray, M.S.

Susanne Seagrave, Ph.D.

Deborah Walter, M.P.A.

Chantal Worzala, Ph.D.

Daniel Zabinski, Ph.D.

Administrative support

Reda H. Broadnax, B.S.

Wylene Carlyle

Diane E. Ellison

Plinie (Ann) Johnson

Cheron McCrae

Dominic F. Taylor, B.S.

Cynthia Wilson

| June 2001 

 Congress: Medicare in Rural America 

06

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