MEDICARE

Legislative 

Modifications Have 

Resulted in Payment 

Adjustments for Most 

Hospitals 

Report to Congressional Requesters

April 2013

GAO-13-334

United States Government Accountability Office

GAO
United States Government Accountability Office

Highlights of GAO-13-334, a report to 

congressional requesters

April 2013

MEDICARE

Legislative Modifications Have Resulted in Payment 

Adjustments for Most Hospitals 

Why GAO Did This Study

To help control the growth of hospital 

spending, give hospitals an incentive to 

provide care efficiently, and ensure 

beneficiary access, Congress created 

the IPPS in 1983. Yet, Congress can 

enhance Medicare payments to certain 

hospitals by changing the qualifying 

criteria for IPPS payment categories, 

creating and extending exceptions to 

IPPS rules, or by exempting certain 

types of hospitals from the IPPS. The 

Institute of Medicine and the Medicare 

Payment Advisory Commission have 

stated that such practices undermine 

the integrity of the IPPS.

GAO was asked to review legislation 

that altered payments to certain 

hospitals. In this report, GAO 

(1) identified provisions of law that 

enhanced Medicare payments for only 

a subset of hospitals and (2) examined 

the extent to which hospitals qualified 

for adjustments to the IPPS or 

exemptions from the IPPS in 2012.

To conduct this work, GAO reviewed 

provisions enacted from 1997 to 2012 

to identify those that adjusted 

payments to a subset of IPPS hospitals 

or exempted hospitals from the IPPS. 

GAO analyzed data to learn the 

number, location, and size of hospitals 

affected by these provisions and 

budgetary estimates for the first year of 

implementation, where available. GAO 

also analyzed 2012 data on 4,783 

general hospitals to determine the 

number and types of adjustments they 

received, the extent to which they 

qualified for multiple adjustments, and 

the number exempted from the IPPS.

The Department of Health and Human 

Services reviewed a draft of this report, 

and provided technical comments, 

which we incorporated as appropriate.

What GAO Found

Over time, Congress has modified how Medicare reimburses certain hospitals 

under the inpatient prospective payment system (IPPS), which pays hospitals a 

flat fee per stay, set in advance, with different amounts for each type of condition. 

GAO identified numerous statutory provisions that individually increased 

Medicare payments to a subset of hospitals. 

• Seven provisions enabled hospitals to be paid under a different geographic 

wage index, which is used to address variation in labor costs.

• Five provisions modified the classification criteria allowing IPPS hospitals to 

qualify for supplemental payments through the Medicare disproportionate 

share hospital (DSH) program or other types of special treatment.

• Three provisions created and modified criteria for classifying small rural 

providers as Critical Access Hospitals (CAH), which are exempt from IPPS 

and instead are paid under an alternative methodology.

In general, while such provisions were designed to affect only a subset of 

hospitals, nearly all of the 4,783 hospitals in GAO’s review qualified for an 

adjustment or exemption from the IPPS in 2012. About 91 percent were subject 

to an IPPS payment adjustment or were excluded from the IPPS entirely. Most 

hospitals, over 63 percent, qualified for at least one of four categories of 

increased payment, with DSH payments being the most common. Under the 

CAH program, 28 percent of hospitals were exempt from the IPPS. The 

remaining hospitals, 9 percent, received IPPS payments that were unadjusted for 

the modifications included in GAO’s review. Moreover, many IPPS hospitals 

qualified for multiple categories of payment adjustments. These findings suggest 

that the way Medicare currently pays hospitals may no longer ensure that the 

goals of the IPPS—cost control, efficiency, and access—are being met.

Inpatient Prospective Payment System (IPPS) Hospitals Qualifying for No, One, or Multiple 

Forms of Payment Adjustments, by Location, 2012

View GAO-13-334. For more information, 

contact James Cosgrove at (202) 512-7114 or 

cosgrovej@gao.gov.
Page i GAO-13-334 Hospital Payment Modifications

Letter 1 

Background 5

Numerous Statutory Provisions Have Resulted in Increased 

Medicare Payments to Certain Hospitals 11

IPPS Payment Adjustments or Exclusions Affected Nearly All 

Hospitals 27

Concluding Observations 31

Agency Comments 31

Appendix I Estimated Effect of Nationwide Budget Neutrality 

of Rural Floor on Hospital Payments by State, Fiscal 

Year 2012 and 2013 33

Appendix II Hospitals by Provider Type 35

Appendix III GAO Contact and Staff Acknowledgments 36

Table

Table 1: Inpatient Prospective Payment System (IPPS) Hospitals 

Qualifying for Additional Medicare Payments by Category 

and Location, 2012 29

Figures

Figure 1: Examples of Eligibility Criteria for Sole Community 

Hospitals 8

Figure 2: Examples of Eligibility Criteria for Rural Referral Centers 9

Figure 3: Eligibility Criteria for Medicare-Dependent Hospitals 10

Figure 4: Number of Hospitals Newly Designated as Critical Access 

Hospitals (CAH), 1998-2011 24

Figure 5: Percent of Each State’s Hospitals Designated as Critical 

Access Hospitals (CAH), June 2012 26

Figure 6: Inpatient Prospective Payment System (IPPS) Hospitals 

Qualifying for No, One, or Multiple Forms of Payment 

Adjustments, by Location, 2012 30

Contents 
Page ii GAO-13-334 Hospital Payment Modifications

Figure 7: Distribution of Inpatient Prospective Payment System 

(IPPS) Hospitals and Critical Access Hospitals (CAH), by 

Provider Type, 2012 35

Abbreviations

BBA Balanced Budget Act of 1997

BBRA Medicare, Medicaid, and SCHIP 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

CMS Centers for Medicare & Medicaid Services

DPP disproportionate patient percentage

DSH disproportionate share hospital

Flex Program Medicare Rural Hospital Flexibility program

HCERA Health Care and Education Reconciliation Act of 2010

HHS Department of Health and Human Services

IME indirect medical education

IOM Institute of Medicine

IPPS inpatient prospective payment system

MDH Medicare-dependent hospital

MedPAC Medicare Payment Advisory Commission

MMA Medicare Prescription Drug, Improvement, 

 and Modernization Act of 2003

MSA metropolitan statistical area

PPACA Patient Protection and Affordable Care Act of 2010

RRC rural referral center

SCH sole community hospital

the Board Medicare Geographic Classification Review Board

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Page 1 GAO-13-334 Hospital Payment Modifications

United States Government Accountability Office

Washington, DC 20548

April 17, 2013

The Honorable Tom Coburn, M.D.

Ranking Member

Committee on Homeland Security and Governmental Affairs

United States Senate

The Honorable Richard Burr

Ranking Member

Subcommittee on Primary Health and Aging

Committee on Health, Education, Labor and Pensions

United States Senate

In 2011, the Centers for Medicare & Medicaid Services (CMS)—the 

agency within the Department of Health and Human Services (HHS) that 

administers the Medicare program—paid hospitals about $147 billion for 

inpatient services provided to beneficiaries in fee-for-service Medicare, 

accounting for about one-quarter of all Medicare expenditures.1 To help 

control the growth of hospital spending, give hospitals an incentive to 

provide care efficiently, and ensure beneficiary access to care, Congress 

created the inpatient prospective payment system (IPPS) in 1983.2

Congress can enhance Medicare payments to certain hospitals by 

changing the qualifying criteria for IPPS payment categories, creating and 

extending exceptions to IPPS rules, or exempting certain hospitals from 

the IPPS altogether. Specifically, Congress may allow hospitals meeting 

Under 

this system, Medicare pays hospitals a flat fee per stay, set in advance, 

with different amounts for each type of condition. These payment rates 

are also influenced by such factors as the relative hourly wage in the area 

where the hospital is located and whether the hospital qualifies for 

additional payments. For hospitals not paid under IPPS, other Medicare 

payment methodologies apply.

 

1

Medicare Parts A and B are known as Medicare fee-for-service. Medicare Part A covers 

hospital and other inpatient stays. Medicare Part B is optional, and covers hospital 

outpatient, physician, and other services.

2

See Social Security Amendments of 1983, Pub. L. No. 98-21, § 601, 97 Stat. 65 (1983) 

(codified, as amended, at 42 U.S.C. § 1395ww). Medicare also pays hospitals for services 

provided to beneficiaries in outpatient departments under the outpatient prospective 

payment system, implemented in 2000.

 
 

Page 2 GAO-13-334 Hospital Payment Modifications

certain criteria to receive additional Medicare payments, and may revise 

some of the qualification criteria to enable more hospitals to benefit. For 

example, legislation has extended statutory provisions set to expire, or 

allowed certain hospitals to continue receiving additional payments after 

qualifying criteria have changed, through grandfathering. Often such 

efforts were intended to ensure beneficiary access to care or to help 

hospitals recruit and retain physicians and other medical professionals. 

However, some Medicare payment experts have expressed concerns 

about exceptions to the IPPS, extensions of certain provisions, and other 

forms of payment adjustments. They contend that such practices have a 

cumulative effect on the cost of the program, do not adequately target 

providers most in need, and undermine the integrity of the IPPS.3

In light of these issues, you asked us to review Medicare payment 

legislation that has benefited certain hospitals by creating new criteria or 

changing existing criteria for a hospital’s classification, or modifying 

payments for hospitals that fit a narrow profile. In this report, we 

(1) identify provisions of law that enhanced Medicare IPPS payments for 

only a subset of hospitals, and the characteristics of affected hospitals 

and budgetary estimates, if any; and (2) examine the extent to which 

hospitals qualified for adjustments to, or exemptions from, the IPPS in 

2012.

To address these issues, we limited our review to statutory provisions 

enacted since 1997 and to the class of short-term acute care general 

hospitals then paid under the IPPS.4

 

3

A. Bruce Steinwald, President, Bruce Steinwald Consulting, Congress Should Not Extend 

Expiring Exceptions to Medicare Payment Policies Without Compelling Evidence Based 

on Beneficiary Need, testimony before the Subcommittee on Health, Committee on Ways 

and Means, September 21, 2011; Institute of Medicine, Geographic Adjustment in 

Medicare Payment Phase I: Improving Accuracy (Washington, D.C.: September 2011); 

Institute of Medicine, Geographic Adjustment in Medicare Payment Phase II: Implications 

for Access, Quality, and Efficiency (Washington, D.C.: July 2012); and Medicare Payment 

Advisory Commission, Report to the Congress: Medicare and the Healthcare Delivery 

System (Washington, D.C.: June 2012).

We included in our review those 

provisions that subsequently adjusted payments to only a subset of IPPS 

hospitals or exempted hospitals from the IPPS during this period. The 

4

This scope excluded facilities not paid under the IPPS—psychiatric, rehabilitation, 

children’s, long-term care, and cancer hospitals, as well as religious nonmedical health 

care institutions. We also excluded Maryland hospitals because they too are subject to a 

separate payment methodology.
 

Page 3 GAO-13-334 Hospital Payment Modifications

provisions covered in our review may be ongoing, time-limited, or 

expired—as indicated. However, we excluded provisions that simply 

modified reimbursement to all hospitals in a previously established 

category of IPPS hospitals. We also excluded provisions that simply 

granted an extension of time to previously enacted payment rules.

To identify and describe statutory provisions within our scope, we 

interviewed CMS officials and health care policy researchers with 

expertise in the area of Medicare hospital payment systems. We also 

reviewed literature on Medicare’s hospital payment history and 

congressional committee and conference reports related to the statutory 

provisions identified.5

• Balanced Budget Act of 1997 (BBA);

This resulted in our review of provisions from the 

following laws:

• Medicare, Medicaid, and SCHIP Balanced Budget Refinement Act of 

1999 (BBRA);

• Medicare, Medicaid, and SCHIP Benefits Improvement and Protection 

Act of 2000 (BIPA);

• Medicare Prescription Drug, Improvement, and Modernization Act of 

2003 (MMA);

• Deficit Reduction Act of 2005;

• Tax Relief and Health Care Act of 2006;

• Medicare, Medicaid, and SCHIP Extension Act of 2007;

• Medicare Improvements for Patients and Providers Act of 2008;

• Patient Protection and Affordable Care Act (PPACA), as amended by 

the Health Care and Education Reconciliation Act of 2010 (HCERA);6

 

5

In this report, we describe statutory provisions within our scope that were identified 

through interviews with experts or literature review. Therefore, this list of provisions is not 

exhaustive.

6

In this report, references to PPACA include any amendments made by HCERA. 
 

Page 4 GAO-13-334 Hospital Payment Modifications

• Medicare and Medicaid Extenders Act of 2010;

• Temporary Payroll Tax Cut Continuation Act of 2011;

• Middle Class Tax Relief and Job Creation Act of 2012; and

• American Taxpayer Relief Act of 2012 (ATRA).

To determine characteristics of hospitals affected by these provisions, we 

analyzed data on the number, size, and location of hospitals using two 

sources: CMS’s fiscal year 1997 through 2013 impact files, as 

applicable,7 and the Flex Monitoring Team—a federally funded 

consortium of three rural health research centers.8 To report estimates of 

budgetary effects, we used data published by CMS and the 

Congressional Budget Office (CBO).9

To assess the extent to which hospitals qualified for a Medicare payment 

adjustment in 2012, we analyzed CMS and Flex Monitoring Team data on 

4,783 short-term acute care general hospitals, as of July 2012. These 

We generally reported data on the 

first year of a provision’s implementation, if available. Unless otherwise 

noted, however, data on affected hospitals and Medicare fee-for-service 

spending were projections issued prior to the implementation of the 

provisions rather than actual effects. In order to assess the reliability of 

the data we analyzed, we reviewed CMS’s documentation on the impact 

files, interviewed CMS officials familiar with the data, and compared 

impact file data to data in relevant federal register notices. We found 

these data sufficiently reliable for the purpose of this engagement.

 

7

CMS’s impact files provide hospital-level data the agency uses to estimate payment 

impacts of various policy changes in proposed and final rules published in the Federal 

Register. CMS usually prepares impact files in the summer preceding each federal fiscal 

year, based on the most recent data available at the time. Impact files include data on all 

Medicare acute care general hospitals. Because Maryland hospitals are not paid under 

the IPPS, we removed Maryland data from our analysis of the impact files.

8

The Flex Monitoring Team is comprised of rural health research centers at the 

Universities of Minnesota, North Carolina–Chapel Hill, and Southern Maine. These 

universities received a 5-year cooperative agreement award from the federal Office of 

Rural Health Policy to continue to monitor and evaluate rural hospital programs. To be 

consistent with other information in this report, we used June 30, 2012, data from the Flex 

Monitoring Team.

9

Given the purpose of these estimates, CMS’s projected budgetary impact data are not 

subsequently verified or compared to actual expenditures.
 

Page 5 GAO-13-334 Hospital Payment Modifications

data allowed us to report the number of hospitals that had their payments 

adjusted, the types of adjustments they received, and the extent to which 

they qualified for multiple adjustments.

We conducted this performance audit from June 2012 to March 2013 in 

accordance with generally accepted government auditing standards. 

Those standards require that we plan and perform the audit to obtain 

sufficient, appropriate evidence to provide a reasonable basis for our 

findings and conclusions based on our audit objectives. We believe that 

the evidence obtained provides a reasonable basis for our findings based 

on our audit objectives.

The IPPS provides incentives for hospitals to operate efficiently by paying 

a predetermined, standardized amount for an entire inpatient episode of a 

given type rather than the actual costs incurred in providing the care.

CMS calculates IPPS payments through a series of adjustments applied 

to separate national base payment rates covering operating and capital 

expenses.10 Specifically, the agency adjusts the base payment rates for 

patients in different diagnosis-related groups, assuming that cases falling 

into a particular grouping address similar clinical problems that are 

expected to require similar amounts of hospital services.11 CMS then 

applies an area wage index to account for geographic differences in labor 

costs. Finally, CMS determines whether supplemental Medicare 

payments or other types of special treatment, such as those provided to 

certain rural hospitals, are applicable.

CMS adjusts hospital payments under IPPS using the area wage index, 

to account for variation in labor costs across the country, as these costs 

are largely beyond any individual hospital’s ability to control. The wage 

 

10Medicare sets the base payment rates for the operating and capital costs that 

reasonably efficient hospitals are expected to incur in providing covered inpatient services.

Operating payments cover labor and supply costs and capital payments cover costs for 

depreciation, interest, rent, and property-related insurance and taxes. CMS updates these 

rates annually.

11Medicare categorizes all hospital inpatient care into medical-severity adjusted, 

diagnosis-related groupings. Inpatient episodes are first grouped by principal diagnosis 

and then subdivided by the nature of co-morbidities or complications, if any. Each 

grouping has a numeric weight, which signifies the average cost of stays assigned to that 

grouping relative to the average cost of other inpatient stays.

Background 

Area Wage Index
 

Page 6 GAO-13-334 Hospital Payment Modifications

index reflects how average hospital wages in each geographic area 

compare to average hospital wages nationally, set as 1.0. Thus, Medicare 

payment to a hospital in an area with lower wages is generally below the 

national average payment and the payment to a hospital in a higher wage 

area is generally above the national average. CMS considers each 

distinct urban area as a single labor market, but it considers all rural 

areas within a state as a single labor market and therefore assigns them 

the same wage index.12 If its wage index does not fully account for its 

relative labor costs, a hospital may qualify to be reclassified to a higher 

wage index area in order to receive higher Medicare payments. To 

request a reclassification to another geographic area, hospitals may apply 

to the Medicare Geographic Classification Review Board (the Board), an 

entity established by Congress. Among various criteria for reclassification, 

a hospital must demonstrate close proximity to the area for which it is 

seeking redesignation.

Medicare reimburses teaching hospitals and academic medical centers 

for both the direct and indirect costs of their residency training programs.

Direct graduate medical education payments cover the direct costs of 

resident training, such as salaries and benefits. The indirect medical 

education (IME) adjustment—a percentage add-on to IPPS rates—

reflects the higher patient care costs associated with resident education.

The size of the IME adjustment depends on the hospital’s teaching 

intensity, which is generally measured by a hospital’s number of residents 

per bed.

The Medicare disproportionate share hospital (DSH) adjustment generally 

provides supplemental payments to hospitals that treat a disproportionate 

number of low-income patients.13

 

12CMS uses definitions from the Office of Management and Budget to define its urban and 

rural areas. Core Based Statistical Areas are either metropolitan (population of at least 

50,000) or micropolitan (population of at least 10,000 and fewer than 50,000). In this 

report, we refer to both of these areas as “urban.” We refer to all nonurban areas as 

“rural.” 

To qualify for this payment adjustment, 

13See 42 U.S.C. § 1395ww(d)(5)(F).

Medical Education 

Payments

Medicare Disproportionate 

Share Hospitals 
 

Page 7 GAO-13-334 Hospital Payment Modifications

a hospital’s disproportionate patient percentage (DPP)14—the share of 

low-income patients treated by the hospital—must generally equal or 

exceed a specific threshold level determined by a statutory formula.15 The 

amount of Medicare DSH payment adjustment varies by hospital location 

and size.

Rural hospitals may qualify for special treatment in determining payment 

rates under IPPS, although some urban hospitals may also qualify, 

through three programs: sole community hospitals (SCH), rural referral 

centers (RRC), and Medicare-dependent hospitals (MDH).16

The SCH program provides payment adjustments to hospitals that are the 

only source of inpatient care in their community. To be designated as an 

SCH, a hospital must be located at least 35 miles from other like hospitals 

paid under the IPPS. Alternatively, if a hospital is located fewer than 

35 miles from the nearest hospital, it may qualify as an SCH if it is located 

In some 

cases, hospitals may qualify for more than one of these rural provider 

types, allowing them to receive multiple adjustments to their IPPS 

payment rates.

 

14The DPP is generally computed as the sum of the percentage of Medicare inpatient 

days attributable to patients entitled to both Medicare Part A and Supplemental Security 

Income (the federal program that provides cash benefits to eligible low-income individuals 

who are aged, blind, or disabled) and the percentage of total patient days attributable to 

patients eligible for Medicaid but not eligible for Medicare Part A.

15An alternative method for qualifying for the Medicare DSH adjustment applies to 

hospitals that are located in an urban area, have 100 or more beds, and can demonstrate 

that more than 30 percent of their total net inpatient care revenues come from state and 

local government sources for indigent care (other than Medicare and Medicaid). These 

hospitals are known as “Pickle” hospitals and qualify for a specific Medicare DSH 

adjustment.

16Federal law and regulations refer to “Medicare-dependent small rural hospitals”. In this 

report, we reference this category of rural providers as “Medicare-dependent hospitals” 

(MDH).

Types of Rural Providers 

under IPPS

Sole Community Hospitals
 

Page 8 GAO-13-334 Hospital Payment Modifications

in a rural area and meets additional criteria.17

Figure 1: Examples of Eligibility Criteria for Sole Community Hospitals

(See fig. 1.) Medicare pays 

each SCH on the basis of the applicable IPPS rate or the hospital’s 

updated historic cost per discharge, whichever provides the greater 

aggregate payment.

 

17See 42 U.S.C. § 1395ww(d)(5)(D)(iii), 42 C.F.R. § 412.92(a). A hospital may also qualify 

as an SCH if (1) it is located between 25 and 35 miles from another like hospital and 

meets additional criteria, such as having no more than 25 percent of Medicare 

beneficiaries in the service area being admitted to other like hospitals within 35 miles, (2) it 

is located between 15 and 25 miles from other like hospitals and because of local 

topography or prolonged severe weather conditions, other like hospitals are inaccessible 

for at least 30 days in each 2 out of 3 years, or (3) because of distance, posted speed, 

and predictable weather conditions, the travel time between the hospital and the nearest 

like hospital is at least 45 minutes.
 

Page 9 GAO-13-334 Hospital Payment Modifications

The RRC program supports high-volume rural hospitals that treat a large 

number of complicated cases. In general, a hospital is classified as an 

RRC if it meets certain location, size, and patient mix criteria,18 or meets 

alternative criteria.19

Figure 2: Examples of Eligibility Criteria for Rural Referral Centers

(See fig. 2.) Medicare provides RRCs with two 

payment enhancements: a higher DSH payment adjustment than other 

rural providers and an exemption from some of the applicable criteria for 

geographic reclassification so that they can be eligible for a higher wage 

index.

 

18See 42 U.S.C. § 1395ww(d)(5)(C)(i), (ii), 42 C.F.R. § 412.96. A hospital generally may 

qualify as an RRC if it is in a rural area and has at least 275 beds (subject to certain 

exceptions). A hospital may also qualify as an RRC if (1) it is located in a rural area, 

(2) the hospital demonstrates that at least 50 percent of its Medicare patients are referred 

from other hospitals or physicians not on the hospital’s staff, (3) at least 60 percent of the 

hospital’s Medicare patients live more than 25 miles from the hospital, and (4) at least 

60 percent of the hospital services are provided to Medicare patients living more than 

25 miles from the hospital.

19Alternatively, a hospital may also qualify as an RRC if it is located in a rural area and 

meets the following two criteria: (1) For discharges during the most recent fiscal year, its 

case-mix index is at least equal to the lower of the median for all urban hospitals nationally 

or the median for urban hospitals located in each region; and (2) its number of discharges 

is at least 5,000 or the median number of discharges for urban hospitals in the census 

region where the hospital is located. In addition, the hospital must meet at least one of the 

following three criteria: (1) More than 50 percent of its medical staff are specialists who 

meet certain conditions; (2) at least 60 percent of all its discharges are for individuals who 

live more than 25 miles from the hospital; or (3) at least 40 percent of all inpatients are 

referred from other hospitals or from physicians not on the hospital’s staff.

Rural Referral Centers
 

Page 10 GAO-13-334 Hospital Payment Modifications

The MDH classification allows small rural hospitals for which Medicare 

patients make up a significant percentage of inpatient days or discharges 

to receive adjustments to their IPPS rates. To qualify as an MDH, a 

hospital has to meet various criteria regarding location, size, and patient 

mix, as shown in figure 3. Specifically, MDHs have to be located in a rural 

area, have 100 or fewer beds, show that at least 60 percent of their 

inpatient days or discharges were for beneficiaries entitled to Medicare 

Part A, and not be classified as an SCH.20

Figure 3: Eligibility Criteria for Medicare-Dependent Hospitals

Among other adjustments, 

MDHs benefit from being paid their IPPS rate plus 75 percent of the 

amount by which the hospital’s updated historic cost per discharge 

exceeds the IPPS rate. Although the MDH program was originally 

enacted as a temporary program, it has been extended multiple times and 

is due to expire for discharges as of October 1, 2013.

The Institute of Medicine (IOM) and Medicare Payment Advisory 

Commission (MedPAC) recently evaluated the accuracy and adequacy of 

Medicare hospital payments. In the first of two reports, IOM—a unit of the 

National Academy of Sciences that addresses health policy—found that 

the methods CMS uses for determining how Medicare pays hospitals for 

the same services in different parts of the country did not accurately 

 

20See 42 U.S.C. § 1395ww(d)(5)(G)(iv), 42 C.F.R. § 412.108.

Medicare-Dependent Hospitals

Recent IPPS Reviews
 

Page 11 GAO-13-334 Hospital Payment Modifications

reflect regional differences in expenses.21 It noted, for instance, that the 

current reclassification process allows almost 40 percent of eligible 

hospitals to be paid according to a wage index from a labor market 

outside of their physical location. To improve payment accuracy, it 

recommended streamlining the sources and application of data used to 

make adjustments. In its 2012 report, MedPAC—an independent entity 

that advises Congress on issues affecting Medicare—reviewed the rural 

special payment adjustments.22 It found that in some cases the special 

adjustments did not adequately target isolated small rural providers.

MedPAC also reported that certain payment adjustments have 

overlapping purposes. It recommended using a more consistent targeted 

payment process to ensure that hospitals can continue to serve 

beneficiaries without unduly increasing Medicare program costs.23

We identified 16 statutory provisions enacted between 1997 and 2012 

that modified Medicare payment for inpatient services in a way that 

benefitted a subset of hospitals. These provisions allow hospitals to 

receive adjustments to their wage index, alter classification criteria for 

supplemental payments or other special treatment, or exclude hospitals 

from the IPPS. Most of the provisions we identified targeted rural 

hospitals for increased payment.24

 

21Institute of Medicine, Geographic Adjustment in Medicare Payment Phase I: Improving 

Accuracy. 

22Medicare Payment Advisory Commission, Report to the Congress: Medicare and the 

Healthcare Delivery System. 

23In addition, in a 2012 report on the effects of exceptions and adjustments to the wage 

index, CMS stated that modifications to the wage index have created or further 

exacerbated distortions in labor market values. See Department of Health and Human 

Services, Centers for Medicare & Medicaid Services, Report to Congress: Plan to Reform 

the Medicare Wage Index (Washington, D.C.: 2012). 

24Although a majority of the provisions we identified targeted rural hospitals, because rural 

hospitals tend to be smaller than urban hospitals, they are likely to receive 

correspondingly smaller payment increases.

Numerous Statutory 

Provisions Have 

Resulted in Increased 

Medicare Payments to 

Certain Hospitals
 

Page 12 GAO-13-334 Hospital Payment Modifications

We identified seven statutory provisions that have enabled hospitals to 

receive Medicare payment under a higher or nearby wage index. Some 

provisions moved hospitals in specific, named counties into different 

wage index areas, or set a minimum wage index for hospitals meeting 

certain criteria. Other provisions allow hospitals to reclassify from an 

urban to a rural area. Still others enable rural hospitals near urban areas 

to qualify for the higher wage index of the nearby area.

Section 4410 of BBA established a rural floor by requiring that the area 

wage index for a hospital in an urban area of a state could not be less

than the area wage indexes for hospitals in that state’s rural area. The 

provision applied to patient discharges beginning in fiscal year 1998, and 

specified that the implementation of the rural floor must be budget 

neutral—that is, any changes in the wage index for hospitals subject to 

the floor may not increase or decrease aggregate Medicare payments for 

the operating costs of inpatient services.25

In fiscal year 2009, CMS changed this policy and began phasing in a 

revised rural floor budget-neutrality adjustment that would be calculated

and applied on a state-by-state basis instead of on a nationwide basis. To 

do so, the agency blended the nationwide and state-by-state budget 

neutrality formulas for fiscal year 2009 and fiscal year 2010.

Initially, this upwards 

adjustment only applied in states with at least one rural IPPS hospital. 

The rural floor provision increased the wage index for hospitals in urban 

areas that had been paid under a lower wage index than the rural areas 

of that state. In order to compensate for the increased wage indexes of 

urban hospitals receiving the rural floor, CMS initially applied a nationwide 

budget-neutrality adjustment to account for the additional payment to 

these hospitals.

26

 

25BBA, Pub. L. No. 105-33, § 4410, 111 Stat. 251, 402-3 (1997) (codified, as amended, at 

42 U.S.C. § 1395ww note). A House of Representatives report accompanying the BBA 

stated that this provision addressed “an anomaly that exists with the way area wage 

indexes are applied which result in some urban hospitals being paid less than the average 

rural hospital in their states.” H.R. Rep. No. 105-149 at 1305.

As a result, 

within each state, some hospitals’ wage index increased, while other 

hospitals’ wage index decreased, in order to ensure that total Medicare 

payments to hospitals in that state remained the same.

26Medicare Program; Changes to the Hospital Inpatient Prospective Payment Systems 

and Fiscal Year 2009 Rates, 73 Fed. Reg. 48,434 (Aug. 19, 2008).

Some Provisions Have 

Enabled Hospitals to 

Qualify for a Different 

Wage Index

Rural Floor
 

Page 13 GAO-13-334 Hospital Payment Modifications

Section 3141 of PPACA reversed this policy by requiring that any 

adjustments to the wage index must be applied on a budget-neutral basis 

through a uniform national adjustment beginning in fiscal year 2011.27

• hospitals in seven states (Alaska, California, Colorado, Connecticut, 

Massachusetts, New Hampshire, and New Jersey) and Puerto Rico 

received increased hospital payments;

The application of the national budget-neutrality requirement has resulted 

in a transfer of Medicare payments from hospitals in states where no

hospitals qualified for the rural floor to hospitals in states where at least 

one hospital qualified for this adjustment. (For information on the impact 

of this provision by state, see app. I.) In fiscal year 2012, the effect of this 

PPACA provision was that

• hospitals in Massachusetts received the largest increase in 

payments—nearly $275 million—five times greater than New Jersey, 

the next largest recipient;

• to pay for the rural floor in these states, hospital payments in other 

states were adjusted downward by as much as 0.5 percent, with a 

median state reduction of $7.3 million; and

• hospitals in five states saw declines of over $20 million: New York 

($47.5 million), Texas ($34 million), Florida ($29 million), Illinois 

($26 million), and Michigan ($21 million).

Section 152 of BBRA reclassified hospitals in seven named counties or 

areas, deeming them to be located in specifically named large 

metropolitan areas, thus enabling them to qualify for the wage index of 

that area.28

 

27PPACA, Pub. L. No. 111-148, § 3141, 124 Stat. 119, 441 (2010) (codified, as amended, 

at 42 U.S.C. § 1395ww note).

This provision benefitted hospitals in these counties that

competed for labor with nearby hospitals in higher wage areas. The 

BBRA limited this reclassification to discharges during fiscal year 2000 

and fiscal year 2001. Hospitals in the following specified counties were 

reclassified:

28BBRA, Pub. L. No. 106-113, App. F, § 152, 113 Stat. 1501A-321, 334 (1999).

Specific County and Area 

Reclassifications (Expired) 
 

Page 14 GAO-13-334 Hospital Payment Modifications

• Iredell County, North Carolina, was deemed to be located in the 

Charlotte-Gastonia-Rock Hill, North Carolina-South Carolina 

metropolitan statistical area (MSA);

• Orange County, New York, was deemed to be part of the large urban 

area of New York, New York;29

• Lake County, Indiana, was deemed to be located in the Chicago, 

Illinois MSA;

• Lee County, Illinois, was deemed to be located in the Chicago, Illinois 

MSA; 

• Hamilton- Middletown, Ohio, was deemed to be located in the 

Cincinnati, Ohio-Kentucky-Indiana MSA;

• Brazoria County, Texas, was deemed to be located in the Houston, 

Texas MSA; and

• Chittenden County, Vermont, was deemed to be located in the 

Boston-Worcester-Lawrence-Lowell-Brockton, Massachusetts-New 

Hampshire MSA.

Section 401 of BBRA allowed certain urban hospitals, beginning 

January 1, 2000, to request to be reclassified as rural hospitals for 

payment purposes under the IPPS.30

 

29In explaining the reclassification of Iredell County and Orange County, a Senate 

committee report stated that Iredell County is still classified as rural for purposes of 

Medicare reimbursement, even though the county is almost completely surrounded by 

three MSAs. Orange County hospitals compete directly for personnel with neighboring 

counties that are reimbursed on the higher New York City wage index. More specifically, 

these hospitals receive reimbursement that is 26 percent less than neighboring counties 

solely based on the MSA to which it is classified. S. Rep. No. 106-199.

Generally, these hospitals may seek 

a lower wage index in a rural area in order to receive higher payments as 

a rural provider type, such as an SCH. According to CMS, the provision 

benefits hospitals that are within an urban area, but are isolated from the 

metropolitan core by distance or physical features. Under the BBRA 

provision, to qualify for this reclassification, a hospital must submit an 

application and meet one of the following criteria:

30BBRA, Pub. L. No. 106-113, App. F, § 401, 113 Stat. 1501A-321, 369 (codified, as 

amended, at 42 U.S.C. § 1395ww(d)(8)). 

Urban to Rural Reclassification
 

Page 15 GAO-13-334 Hospital Payment Modifications

• be located in a rural portion of an MSA or an area defined as rural by 

the state;

• be designated as a rural hospital by the state;

• would qualify as a rural, regional, or national referral center, or as an 

SCH if the hospital was located in a rural area; or

• meet other criteria established by CMS.

By fiscal year 2013, 46 urban hospitals, comprising 1.3 percent of IPPS 

hospitals, had been reclassified by CMS as rural under this provision. 

Seven states—California, Florida, Missouri, New York, Pennsylvania, 

Texas, and Virginia—had more than two qualifying hospitals.

Section 505 of MMA required that HHS establish a process, beginning in 

fiscal year 2005, by which the agency may increase the wage index for 

hospitals located in counties where potential employees commute to 

higher wage index areas.31

In the first year of implementation, fiscal year 2005,

The provision benefits hospitals located in 

counties where a higher than average percentage of hospital employees 

reside in that county but work in another county that has a higher wage 

index. Hospitals in qualifying counties receive an average of the 

differences between the higher and lower wage indexes, weighted by the 

percentage of hospital workers in the qualifying county who work in the 

higher-wage areas.

• the wage index increased for 555 eligible hospitals, representing 

nearly 14 percent of IPPS hospitals;

• eligible hospitals had an average of 140 beds;

• California, Texas, and Michigan had the most eligible hospitals with 

89, 44, and 40 hospitals, respectively;

 

31MMA, Pub. L. No. 108-173, § 505, 117 Stat. 2066, 2293 (2003) (codified, as amended, 

at 42 U.S.C. § 1395ww(d)(13)). The MMA imposed certain broad parameters for this 

provision, including limiting the adjustment determinations for 3-year periods and requiring 

HHS to impose criteria for the process, such as defining which counties may qualify and 

establishing thresholds of at least 10 percent for migration to higher wage index areas.

Outmigration Adjustment
 

Page 16 GAO-13-334 Hospital Payment Modifications

• Massachusetts, Michigan, and Connecticut had the most qualifying 

hospitals as a percentage of all hospitals in the state with 45, 31, and 

29 percent, respectively; and

• Utah, Minnesota, and Georgia benefited from the largest Medicare 

payment adjustment as a result of their qualifying status.

Section 508 of MMA required HHS to establish a process by January 1, 

2004, so that a hospital denied a request to be reclassified to the wage 

index of another area in its state could submit a onetime appeal to the 

Board.32

• 130 hospitals, or approximately 3 percent of all IPPS hospitals, 

qualified for this adjustment; and

The provision required the Board to grant appeals of and 

reclassify qualifying hospitals, defined as those hospitals that did not 

originally qualify for reclassification on the basis of distance or commuting 

requirements but met other criteria such as quality factors, as specified by 

HHS. The provision limited reclassifications to a three-year period for 

appeals filed by February 15, 2004. The provision also capped additional 

Medicare expenditures resulting from these reclassifications to 

$900 million over the initial 3-year period. We found that, in its first year of 

implementation,

• four states—Connecticut, Michigan, North Dakota, and 

Pennsylvania—had at least 10 qualifying hospitals each.

While originally enacted as a onetime and time-limited provision, 

Congress extended reclassifications made under this provision numerous 

times until they expired on March 31, 2012.

Section 10324 of PPACA established a hospital wage index floor 

adjustment, beginning with discharges as of fiscal year 2011, for hospitals 

located in frontier states.33

 

32MMA, Pub. L. No. 108-173, § 508, 117 Stat. at 2297 (codified, as amended, at 

42 U.S.C. § 1395ww note).

The provision defined a frontier state as one in 

which at least 50 percent of counties have a population of fewer than 

6 people per square mile and set the wage index in these areas at no 

lower than 1.0. In other words, while the wage index for all other states is 

33PPACA, Pub. L. No. 111-148, § 10324, 124 Stat. at 959 (codified, as amended, at 

42 U.S.C. § 1395ww(d)(3)(E)).

Onetime Appeal of Wage Index 

Reclassification by the Board 

(Expired)

Frontier States
 

Page 17 GAO-13-334 Hospital Payment Modifications

a ratio of the average hourly hospital wage in the area to the national 

average, if the wage index of a frontier state is lower than the national 

average—or less than 1.0—this provision adjusts the wage index to 1.0. 

Prior to implementation, CMS projected that

• five states would meet the criteria to be designated as a frontier state: 

Montana, Nevada, North Dakota, South Dakota, and Wyoming;

• 48 out of 82 IPPS hospitals in those states would be eligible for a 

modified wage index that is at least 1.0; and

• IPPS payments would increase by approximately $50 million in the 

first year.

We identified five statutory provisions that have affected the number of 

hospitals that qualify for IPPS supplemental payments or other types of 

special treatment. Most of these provisions modified the classification 

criteria for payment adjustments, thereby expanding the number of 

hospitals that qualify for higher payments.

Section 211 of BIPA revised the Medicare threshold criteria for DSH, 

resulting in an increased number of hospitals qualifying for a payment 

adjustment.34

• added 1,191 primarily rural and small urban hospitals to those already 

receiving a DSH adjustment; for example, 351 additional rural 

hospitals with fewer than 100 beds and 244 additional urban hospitals 

Effective for discharges as of April 1, 2001, this provision 

allowed hospitals, regardless of location and size, to receive a DSH 

adjustment with a DPP of 15 percent or greater. Originally, different types 

of hospitals qualified for a DSH adjustment on the basis of varying DPP 

thresholds. For instance, urban hospitals with 100 or more beds qualified 

for a DSH payment with a minimum DPP of 15 percent, whereas urban 

hospitals with fewer than 100 beds qualified for a DSH payment 

adjustment with a minimum DPP of 40 percent. CMS reported that this 

adjustment of the DPP qualifying threshold

 

34BIPA, Pub. L. No. 106-554, App. F, § 211, 114 Stat. 2763A-463, 483 (2000) (codified, 

as amended, at 42 U.S.C. § 1395ww(d)(5)(F)(v)). In addition, the provision also modified 

the DSH payment formulas for SCHs, RRCs, small rural hospitals, and urban hospitals 

with fewer than 100 beds.

Provisions Modifying 

Classification Criteria for 

IPPS Supplemental 

Payments or Other Types 

of Special Treatment

DSH Qualifying Criteria 
 

Page 18 GAO-13-334 Hospital Payment Modifications

with fewer than 100 beds started receiving a DSH adjustment after 

implementation;

• would increase Medicare spending by $60 million from fiscal year 

2001 through fiscal year 2002; and

• would not negatively affect any hospitals.

Section 402 of MMA modified the formulas used to calculate the DSH 

payment adjustment for certain hospitals, thereby increasing payments to 

these hospitals.35 Specifically, effective with discharges as of April 1, 

2004, the DSH adjustment formula used for large urban hospitals was 

applied to other types of hospitals, including SCHs, RRCs, other rural 

hospitals with fewer than 500 beds, and urban hospitals with fewer than 

100 beds.36 In addition, this provision capped this DSH payment 

adjustment at 12 percent of the hospital’s IPPS rate, while exempting 

RRCs from this cap.37

Section 406 of MMA established a new payment adjustment for lowvolume hospitals beginning in fiscal year 2005 that accounts for the 

higher costs per discharge at hospitals that admit a relatively small 

number of patients.

For instance, an urban hospital with fewer than 

100 beds that qualifies for a DSH payment adjustment of 18.1 percent is 

capped at the maximum 12 percent payment adjustment.

38

 

35MMA, Pub. L. No. 108-173, § 402, 117 Stat. at 2264 (codified, as amended, at 

42 U.S.C. § 1395ww(d)(5)(F)).

 To qualify, hospitals had to be located more than 

36Additional provisions have modified the Medicare DSH payment adjustment for all 

qualifying DSH hospitals, not a subset, and are, therefore, not included in our scope. For 

example, section 3133 of PPACA permanently reduces Medicare DSH payments by 

75 percent beginning in fiscal year 2014 and provides DSH hospitals with additional 

payments based on a formula that includes certain factors such as the hospital’s reduction 

in DSH funds, percentage change in the uninsured under 65 population, and 

uncompensated care provided by the hospital. 42 U.S.C. § 1395ww(r). According to CMS, 

this provision is estimated to save the Medicare program approximately $50 billion through 

fiscal year 2019.

37Section 5003 of the Deficit Reduction Act of 2005 also exempted MDHs from the 

12 percent cap, effective for discharges as of fiscal year 2007. Pub. L. No. 109-171, 

§ 5003(d), 120 Stat. 4, 31 (2006) (codified, as amended, at 42 U.S.C. 

§ 1395ww(d)(5)(F)(xiv)(II)).

38MMA, Pub. L. No. 108-173 § 406, 117 Stat. at 2269 (codified, as amended, at 42 U.S.C. 

§ 1395ww(d)(12)).

Low-Volume Adjustment
 

Page 19 GAO-13-334 Hospital Payment Modifications

25 miles from another hospital and have fewer than 800 total discharges 

annually. The provision required CMS to determine, on the basis of 

empirical data, applicable percentage increases, not to exceed 

25 percent, in payments for qualifying low-volume hospitals.39

• CBO estimated this provision would increase Medicare program 

expenditures by less than $50 million annually, and

CMS 

explained in issuing the final rule implementing this MMA provision that 

the agency analyzed data and determined that hospitals with fewer than 

200 discharges a year have sufficiently higher costs relative to payments 

to justify receiving a payment adjustment, but that hospitals with 200 to 

800 discharges a year did not. CMS provided the maximum 25 percent 

payment adjustment only to those qualifying hospitals that were located 

more than 25 miles from another hospital and had fewer than 200 

discharges in a given year. CMS reported that

• only three hospitals—one located in Florida and two located in South 

Dakota—received a low-volume payment adjustment in fiscal year 

2005. All were small (30 or fewer beds) rural hospitals classified as 

SCHs.

Section 3125, as amended by section 10314, of PPACA temporarily 

revised the qualifying criteria for a low-volume hospital designation 

making it easier for hospitals to receive the payment adjustment.40

Effective for fiscal year 2011 and fiscal year 2012,41

 

39The provision effectively gave CMS the authority to set the maximum number of 

discharges hospitals could have in a given year to receive a payment adjustment, as long 

as it was fewer than 800 total discharges.

this provision 

decreased the required distance from the nearest hospital from 25 miles 

to 15 miles. In addition, it changed the maximum number of annual 

discharges allowed from 800 total patients to 1,600 Medicare Part A 

beneficiaries. The provision also required that payment adjustments for 

qualifying low-volume hospitals be calculated using a continuous sliding 

40PPACA, Pub. L. No. 111-148. §§ 3125, 10314, 124 Stat. at 425, 944 (codified, as 

amended, at 42 U.S.C. § 1395ww(d)(12)).

41Section 605 of the American Taxpayer Relief Act of 2012 extended these payment 

adjustments through fiscal year 2013. Pub. L. No. 112-240, § 605, 126 Stat, 2313, 2349 

(2012) (to be codified at 42 U.S.C. § 1395ww(d)(12)). According to CBO, this provision 

was estimated to increase Medicare spending by $300 million in fiscal year 2013.
 

Page 20 GAO-13-334 Hospital Payment Modifications

scale, paying up to an additional 25 percent to hospitals with 200 or fewer 

annual Medicare Part A discharges.

As a result of these changes, both the number of hospitals receiving the 

low-volume payment adjustment and the estimated Medicare 

expenditures rose substantially. CMS reported that

• over the 2-year period, fiscal year 2011 and fiscal year 2012, the 

provision was estimated to cost Medicare approximately $880 million; 

and

• the number of hospitals that received a payment adjustment rose to 

approximately 645—or about 18 percent of IPPS hospitals—in fiscal 

year 2011 from 3 hospitals the year before.

We found that, in fiscal year 2011,

• at least 40 percent of IPPS hospitals in each of 6 states received a 

low-volume adjustment: Wyoming (67 percent), Vermont (50 percent), 

New Mexico (43 percent), Minnesota (42 percent), Alabama 

(41 percent), and Mississippi (41 percent); and

• recipient hospitals were relatively small,42

Section 212 of BIPA modified one aspect of the MDH classification 

criteria. Effective for cost reporting periods beginning April 1, 2001, it 

changed the data source used to determine whether at least 60 percent 

of a hospital’s discharges were Medicare beneficiaries. This provision 

allowed a hospital to base this determination on two of the three most 

recently audited fiscal year cost reporting periods.

predominately located in 

rural areas, and likely to also receive a DSH payment adjustment.

43

This provision did not initially have a significant effect on the number of 

qualifying hospitals or on Medicare payments. CMS estimated that a total 

of 139 hospitals—all of which had previously been designated as 

Prior to this change, 

discharge data were based on cost reporting periods beginning in 1987.

 

42These hospitals had an average bed size of 55, compared to a Medicare-wide IPPS 

hospital average bed size of 183.

43BIPA, Pub. L. No. 106-554, App. F, § 212, 114 Stat. at 2763A-485 (codified, as 

amended, at 42 U.S.C. § 1395ww(d)(5)(G)(iv)(IV)).

MDH Qualifying Criteria 
 

Page 21 GAO-13-334 Hospital Payment Modifications

MDHs—would qualify as an MDH using this revised data source. The 

agency further estimated that Medicare would spend an additional 

$10 million in the first year of implementation. It is likely that this provision 

had a greater effect on the number of hospitals qualifying for an MDH 

classification in later years because it allowed hospitals to use recent, 

rather than outdated, cost reports.

In 1997, Congress established the Critical Access Hospital (CAH) 

program, under which qualifying small rural hospitals are excluded from 

the IPPS and receive Medicare payment based on the reasonable costs 

of providing services.44 In effect, CAHs receive higher payments for 

providing services to Medicare beneficiaries than they would under the 

IPPS. Specifically, section 4201 of BBA allowed states to apply for 

approval to create a Medicare Rural Hospital Flexibility program (Flex 

Program), under which states must designate at least one hospital as a 

CAH.45

• type of organization: nonprofit or public hospital;

To be designated as a CAH, hospitals had to meet the following 

qualifying criteria:

• services: must provide 24-hour emergency services deemed 

necessary for ensuring access in each area served by the CAH;

• location: rural county or other rural area in states with approved Flex 

Programs;

• size: no more than 15 acute care inpatient beds;

• average inpatient stay: no more than 4 days (subject to certain 

exceptions)

• patient access: (a) located either more than 35 miles from the nearest 

hospital or CAH or more than 15 miles in areas with mountainous 

 

44BBA, Pub. L. No. 105-33, § 4201, 111 Stat. at 369 (codified, as amended, at 42 U.S.C. 

§§ 1395f(I), 1395i-4).

45CAHs are an outgrowth of the Medicare Assistance Facility Demonstration Project in 

Montana and the seven-state Essential Access Community Hospital/Rural Primary Care 

Hospital demonstration program established by Congress in 1989. The BBA replaced 

these initiatives in 1997 with the state-administered Flex Program.

Provisions Creating and 

Modifying Qualifying 

Criteria for CAHs
 

Page 22 GAO-13-334 Hospital Payment Modifications

terrain or only secondary roads, or (b) designated by the state as a 

necessary provider of health care services to residents in the area.

Prior to implementation, CMS reported that approximately 51 facilities in 

seven states—those participating in the demonstration program that 

preceded the CAH program—would be eligible to become CAHs. While 

the CAH program was expected to grow, CMS was not able to estimate 

reliably how many additional states would choose to participate or the 

potential cost of the CAH program to Medicare.

Section 403 of BBRA made a number of changes to qualifying criteria for 

the CAH program.46 First, the provision changed the inpatient length of 

stay requirement from a maximum of 4 days to an annual average of 

4 days. Second, the provision removed the requirement that eligible 

hospitals must be nonprofit or public, allowing for-profit hospitals to qualify 

as CAHs, if so approved by their state. Third, the provision permitted a 

state to designate as a CAH not only a currently operating hospital, but 

closed facilities or facilities that were previously hospitals but currently 

operate as a state-licensed health clinic or health center, if the facilities 

meet all other criteria.47

Section 405 of MMA made further changes to the CAH program, which 

included alterations to the qualifying criteria.

Data indicate that in the 2 years following the 

enactment of BBRA in 1999, 411 hospitals were newly designated as 

CAHs.

48

 

46BBRA, Pub. L. No. 106-113, App. F, § 403, 113 Stat. at 1501A-370 (codified, as 

amended, at 42 U.S.C. § 1395i-4(c)(2)). 

First, the provision 

permanently increased the bed limit for CAHs from 15 beds to 25 beds. 

Second, it allowed CAHs to establish separate inpatient rehabilitation or 

psychiatric care units with no more than 10 beds, with such services paid 

under the relevant prospective payment system (rather than the CAH 

47A House of Representatives committee report discussing this provision explained that it 

would strengthen and provide increased flexibility for the CAH program, and a Senate 

committee report added that the change to an annual 4 day length of stay average would 

provide increased flexibility and choice for rural health care delivery setting. The provision 

also eliminates increased administrative burdens for these providers. See H.R. Rep. 

No. 106-436 at 68, S. Rep. No. 106-199 at 27.

48See MMA, Pub. L. No. 108-173, § 405(e), (g), (h), 117 Stat. at 2266 (codified, as 

amended, at 42 U.S.C. § 1395i-4(c)(2), (h)). 
 

Page 23 GAO-13-334 Hospital Payment Modifications

reasonable cost basis).49

CBO estimated that these changes to the CAH program under this 

provision would increase Medicare program expenditures by 

approximately $100 million annually, according to CMS. Data show that in 

2004 and 2005, the 2 years following enactment of MMA, 422 new CAHs 

joined the program. However, the number of new CAH designations 

dropped sharply in 2006 with the elimination of the necessary provider 

designation. (See fig. 4.) 

Third, effective January 1, 2006, the provision 

eliminated the ability of a state to designate a hospital as a necessary 

provider, so that states could no longer waive the 35-mile distance 

requirement to designate a hospital as a CAH. However, the provision 

grandfathered all CAHs that had already received their CAH status by 

being designated as a necessary provider.

 

49In 2003, we reported that among the existing 620 CAHs at the time, 25 previously 

operated an inpatient rehabilitation or psychiatric care unit but had to close as part of 

becoming a CAH. In addition, we identified 683 rural hospitals as “potential CAHs” on the 

basis of their having an annual average of no more than 15 acute care patients per day.

About 14 percent (93) of these potential CAHs operated a rehabilitation or psychiatric care 

unit and about half of those 93 potential CAHs had a net loss on Medicare services, 

indicating that they might benefit from becoming a CAH. See GAO, Medicare: Modest 

Eligibility Expansion for Critical Access Hospital Program Should Be Considered, 

GAO-03-948 (Washington, D.C.: Sept. 19, 2003).
 

Page 24 GAO-13-334 Hospital Payment Modifications

Figure 4: Number of Hospitals Newly Designated as Critical Access Hospitals (CAH), 1998-2011

Note: A small number of hospitals were designated as CAHs prior to 1998. No new hospitals were 

designated as CAHs from January 1, 2012, through June 30, 2012.

The CAH program has grown to a total of 1,328 hospitals as of 2012.50

The majority of CAHs have the maximum 25 inpatient beds. In addition, 

CAHs are largely concentrated in the central states, although all but five 

states have at least one CAH.51

 

50According to MedPAC, the CAH payment system resulted in approximately $2 billion in 

higher payments to CAHs in 2010 than to hospitals receiving prospective payment for the 

same inpatient and outpatient services.

We found that the states with the largest 

percentage of hospitals designated as CAHs are North Dakota and 

Montana, with about 84 percent and 79 percent, respectively. (See fig. 5.) 

Furthermore, according to MedPAC, 17 percent of CAHs are 35 or more 

miles from the nearest hospital, 67 percent are between 15 miles and 

35 miles from the nearest hospital, and 16 percent of CAHs are fewer 

51Five states—Connecticut, Delaware, Maryland, New Jersey, and Rhode Island—do not 

participate in the Flex Program and, therefore, may not designate any hospitals in those 

states as CAHs. 
 

Page 25 GAO-13-334 Hospital Payment Modifications

than 15 miles from the nearest hospital.52 These data indicate that not all 

CAHs meet current qualifying criteria.53

 

52MedPAC, Report to the Congress: Medicare and the Healthcare Delivery System. 

53According to its fiscal year 2013 work plan, HHS’s Office of the Inspector General 

announced plans to review CAHs to profile variation in size, services, and distance from 

other hospitals, among other things.
 

Page 26 GAO-13-334 Hospital Payment Modifications

Figure 5: Percent of Each State’s Hospitals Designated as Critical Access Hospitals (CAH), June 2012
 

Page 27 GAO-13-334 Hospital Payment Modifications

Section 1109 of HCERA authorized $400 million in Medicare payments to 

qualifying hospitals in low-spending counties over 2 years, fiscal year 

2011 and fiscal year 2012.54

• CMS made payments to about 400 hospitals, which accounted for 

11 percent of all IPPS hospitals and approximately 8 percent of IPPS 

beds;

This provision defined qualifying hospitals as 

acute care hospitals located in a county that ranked within the lowest 

quartile of age, sex, and race adjusted spending per beneficiary enrolled 

in fee-for-service Medicare parts A and B. CMS allocated the additional 

payments to each qualifying hospital in proportion to its share of Medicare 

inpatient payments for all qualifying hospitals, based on fiscal year 2009 

IPPS payments for operating expenses. In implementing this provision,

• Medicare expenditures increased $150 million in fiscal year 2011 and 

$250 million in fiscal year 2012;

• on average, qualifying hospitals had 135 to 137 beds;

• half of qualifying hospitals were in urban areas and half were in rural 

areas; and

• states with the most hospitals receiving this payment were New York 

(50 hospitals), Wisconsin (40 hospitals), Virginia (31 hospitals), 

Oregon (21 hospitals), and Iowa (20 hospitals).

We found that, in 2012, payment adjustments to, or exclusions from, the 

IPPS affected nearly all of the 4,783 hospitals in our review.55

• 3,039 hospitals, or over 63 percent, qualified for at least one of the 

following four types of payment adjustments under the IPPS: a DSH 

Of these 

hospitals—IPPS hospitals and CAHs—91 percent were subject to a 

payment adjustment under the IPPS or were excluded from the IPPS 

entirely. Specifically,

 

54HCERA, Pub. L. No. 111-152, § 1109, 124 Stat. 1029, 1051 (codified, as amended, at 

42 U.S.C. § 1395ww note).

55For the number of hospitals qualifying for each rural provider type adjustment and as 

CAHs, see app. II.

Provision for Other Forms 

of Increased Medicare 

Payment (Expired)

IPPS Payment 

Adjustments or 

Exclusions Affected 

Nearly All Hospitals
 

Page 28 GAO-13-334 Hospital Payment Modifications

adjustment, an IME adjustment, a wage index adjustment, or a rural 

provider type adjustment for an RRC, SCH, or MDH designation;

• 1,328 hospitals, or about 28 percent, qualified as CAHs, excluding 

them from the IPPS; and

• 416 hospitals, or about 9 percent, received IPPS payments that were 

unadjusted for the modifications included in our review.

Among the 3,455 IPPS hospitals, the vast majority qualified for one of the 

four categories of upward payment adjustment in 2012. The DSH 

adjustment had the broadest reach, affecting payments to about 4 in 5 of 

IPPS hospitals. Nearly 1 in 3 hospitals qualified for an IME adjustment, 1 

in 3 qualified for a wage index adjustment, and almost 1 in 5 received a 

rural provider type adjustment. Each of these categories of increased 

payment benefited hospitals in both urban and rural areas. The DSH and 

IME adjustments applied mostly to urban hospitals’ payments, whereas 

the wage index adjustment was applied to more rural hospitals’ 

payments. Although rural provider type adjustments generally supported 

payment to rural hospitals, about 20 percent of recipients were urban 

hospitals.56 (See table 1.)

 

56According to CMS, urban hospitals may qualify for a rural provider type adjustment in 

one of three ways. An urban hospital may qualify as an SCH if it is located more than 

35 miles from other like hospitals (not including CAHs). A hospital may remain an SCH, 

MDH, or RRC through grandfathering if it is located in an area redesignated as urban after 

the hospital received its rural provider type designation. Finally, a hospital may apply for 

redesignation into a rural wage index area by meeting certain criteria.
 

Page 29 GAO-13-334 Hospital Payment Modifications

Table 1: Inpatient Prospective Payment System (IPPS) Hospitals Qualifying for Additional Medicare Payments by Category 

and Location, 2012

Categories of hospital payment adjustments

Hospitals by locationa Disproportionate 

share hospital (DSH)

Indirect medical 

education (IME) Wage index Rural provider typeb

Large urban area hospitals 999 581 210 16c

Other urban area hospitals 897 389 258 112c

Rural hospitals 859 61 559 519

Total 2,755 1,031 1,027 647

Source: GAO analysis of CMS data.

Notes: CMS made these estimates in July 2012 for payments in 2013. These types of increased 

payment are not mutually exclusive, so a hospital could qualify for more than one type of increased 

payment.

a

Large urban areas have a population of at least 1 million; other urban areas have a population of 

fewer than 1 million; all areas not defined as urban are considered rural. In July 2012, there were 

1,374 hospitals in large urban areas, 1,132 hospitals in other urban areas, and 949 hospitals in rural 

areas.

b

Data on rural provider types exclude Medicare-dependent hospitals (MDH) because at the time, the 

program was set to expire on September 30, 2012. However, the American Taxpayer Relief Act of 

2012 extended the program until October 1, 2013.

c

Hospitals may be included through grandfathering, reclassification from an urban wage index area to 

a rural wage index area, or modified access requirement (such as being located more than 35 miles 

from other like hospitals).

Among the 3,039 IPPS hospitals receiving additional payment, the 

majority qualified for more than one category of payment adjustment. In 

2012, roughly half of IPPS hospitals received two forms of adjustments 

and 13 percent qualified for three forms of adjustments. Two percent of 

IPPS hospitals qualified for four forms of adjustments, but no state had 

more than 10 hospitals qualifying for four forms of increased payment.

The remaining IPPS hospitals, almost a third of the total, qualified for a 

DSH adjustment alone. By location, we found that most hospitals in urban 

areas qualified for one or two forms of increased payment, whereas most 

hospitals in rural areas qualified for two or more forms of additional pay.

(See fig. 6.)

Of the 416 hospitals that did not qualify for IPPS payment adjustments, 

nearly all were in urban areas and were distributed across most states. 

Generally, they were substantially smaller than the average urban 

hospital, typically having 98 beds compared to 224 beds.
 

Page 30 GAO-13-334 Hospital Payment Modifications

Figure 6: Inpatient Prospective Payment System (IPPS) Hospitals Qualifying for No, 

One, or Multiple Forms of Payment Adjustments, by Location, 2012

Note: The number of IPPS hospitals totaled 3,455. CMS made these estimates in July 2012 for 

payments in 2013. Large urban areas have a population of at least 1 million. Other urban areas have 

a population of fewer than 1 million. The four forms of IPPS hospitals payment adjustments include 

wage index reclassification, indirect medical education (IME) payment, disproportionate share 

hospital (DSH) adjustment, or rural provider type adjustment.

The multiple types of adjustments to Medicare payments vary in their 

financial effect, and can substantially affect a hospital’s revenue. Take, for 

example, a beneficiary who undergoes coronary bypass surgery with 

angioplasty and has a major complication or comorbidity. When this 

surgery is performed at a teaching hospital in a large urban area that 

treats a high percentage of low-income patients, the total operating 

payment from Medicare comes to about $63,600.57

 

57The IPPS per-discharge payment is comprised of two parts: one that provides for 

operating expenses and another for capital expenses. This calculation is only for the 

operating payment.

Specifically, in fiscal 
 

Page 31 GAO-13-334 Hospital Payment Modifications

year 2013, the IPPS operating base rate for that case, adjusted for the 

local wage index, is approximately $41,500. Added to that amount is 

about $14,100 for IME and roughly $8,000 for Medicare DSH. Thus, the 

two payment adjustments increase the amount this hospital would receive 

for this discharge by more than 50 percent.

The IPPS streamlines how Medicare pays hospitals and gives hospitals 

an incentive to economize by paying a fixed amount, set in advance. Over 

time, however, numerous statutory provisions have been enacted that 

provide, grandfather, or extend additional payments to IPPS hospitals or 

exclude a substantial number of hospitals from the IPPS altogether. This 

piecemeal approach to modifying the original IPPS—a patchwork of 

individual “fixes”—has had the cumulative effect of most hospitals 

receiving modifications and add-ons to the basic payment formula that 

increase Medicare spending. In fact, over 90 percent of hospitals were 

subject to either IPPS payment adjustments or exemptions in 2012.

These changes address characteristics of the hospital market such as 

competition for labor, challenges to rural hospitals, and the need to 

support Medicare-participating hospitals in certain markets. In addition, 

organizations such as IOM and MedPAC have recently made 

recommendations to strengthen the data used in geographic adjustments, 

and to hone the targeting of rural special payment adjustments. Taken 

together, these findings and recommendations suggest that, 30 years 

after the IPPS was implemented, the way Medicare currently pays 

hospitals may no longer ensure that the goals of the payment system—

cost control, efficiency, and access—are being met.

HHS reviewed a draft of this report and did not have any general 

comments. The agency provided technical comments, which we 

incorporated where appropriate.

As we agreed with your offices, unless you publicly announce the 

contents of this report earlier, we plan no further distribution of it until 

30 days from its date. We will send copies of this report to the Secretary 

of Health and Human Services. The report will also be available at no 

charge on our website at http://www.gao.gov. 

Concluding 

Observations 

Agency Comments
 

Page 32 GAO-13-334 Hospital Payment Modifications

If you or your staffs have any questions about this report, please contact 

me at (202) 512-7114 or cosgrovej@gao.gov. Contact points for our 

Offices of Congressional Relations and Public Affairs may be found on 

the last page of this report. GAO staff who made key contributions to this 

report are listed in appendix III. 

James Cosgrove

Director, Health Care
Appendix I: Estimated Effect of Nationwide 

Budget Neutrality of Rural Floor on Hospital 

Payments by State, Fiscal Year 2012 and 2013

Page 33 GAO-13-334 Hospital Payment Modifications

Fiscal year 2012 Fiscal year 2013

State 

Number of 

hospitals

Number of 

hospitals 

receiving 

rural floor or 

imputed floor

Percent 

change in 

payments

Difference 

(in millions 

of dollars)

Number of 

hospitals

Number of 

hospitals 

receiving 

rural floor or 

imputed floor

Percent 

change in 

payments

Difference 

(in millions 

of dollars)

Massachusetts 61 60 8.7% $274.8 61 60 5.7% $188.0

California 308 100 0.2 20.3 311 180 0.9 98.5

Arizona 57 0 -0.5 -8.8 58 45 1.7 31.4

Connecticut 32 12 1.9 30.0 32 11 1.0 16.7

New Jersey 67 39 1.4 54.2 65 29 0.4 14.4

New Hampshire 13 9 1.5 6.3 13 9 2.1 10.0

Colorado 46 7 0.4 4.3 46 7 0.5 5.8

Alaska 6 4 1.7 2.3 6 4 1.5 2.3

Rhode Island 11 0 -0.6 -2.2 11 4 0.5 2.1

Puerto Rico 51 12 0.1 0.1 52 13 0.1 0.1

Wyoming 11 0 0.0 0.0 11 0 -0.1 -0.2

North Dakota 6 0 -0.3 -0.8 6 4 -0.2 -0.6

Montana 12 1 -0.3 -0.8 12 1 -0.3 -0.7

Vermont 6 0 -0.3 -0.6 6 0 -0.3 -0.7

South Dakota 19 0 -0.3 -0.9 18 0 -0.3 -0.8

Idaho 15 0 -0.4 -1.0 14 0 -0.3 -1.0

Hawaii 14 0 -0.4 -1.1 14 0 -0.4 -1.1

New Mexico 28 0 -0.3 -1.6 27 0 -0.3 -1.5

Utah 32 2 -0.4 -1.7 32 0 -0.4 -1.8

Delaware 5 0 -0.5 -2.0 6 0 -0.5 -2.1

Maine 20 0 -0.4 -2.1 20 0 -0.5 -2.4

Nebraska 23 0 -0.4 -2.4 23 0 -0.4 -2.5

Washington, DC 7 0 -0.5 -2.5 7 0 -0.5 -2.5

West Virginia 32 3 -0.3 -2.2 33 2 -0.3 -2.9

Nevada 24 0 -0.5 -3.7 24 4 -0.4 -3.2

Kansas 55 1 -0.4 -3.5 55 0 -0.4 -3.5

Oregon 33 3 -0.4 -3.5 33 0 -0.5 -4.1

Iowa 34 5 -0.3 -3.0 34 0 -0.4 -4.4

Wisconsin 64 2 -0.4 -6.4 65 8 -0.3 -5.0

Arkansas 47 0 -0.4 -5.0 45 0 -0.5 -5.2

Mississippi 64 0 -0.5 -5.6 66 0 -0.4 -5.5

Appendix I: Estimated Effect of Nationwide 

Budget Neutrality of Rural Floor on Hospital 

Payments by State, Fiscal Year 2012 and 2013
Appendix I: Estimated Effect of Nationwide 

Budget Neutrality of Rural Floor on Hospital 

Payments by State, Fiscal Year 2012 and 2013

Page 34 GAO-13-334 Hospital Payment Modifications

Fiscal year 2012 Fiscal year 2013

State 

Number of 

hospitals

Number of 

hospitals 

receiving 

rural floor or 

imputed floor

Percent 

change in 

payments

Difference 

(in millions 

of dollars)

Number of 

hospitals

Number of 

hospitals 

receiving 

rural floor or 

imputed floor

Percent 

change in 

payments

Difference 

(in millions 

of dollars)

Oklahoma 85 2 -0.4 -5.7 85 0 -0.4 -5.7

South Carolina 55 0 -0.4 -7.2 56 5 -0.3 -5.9

Washington 48 2 -0.4 -7.3 48 5 -0.3 -6.3

Louisiana 97 10 -0.5 -7.2 98 7 -0.4 -7.1

Tennessee 99 11 -0.3 -7.7 97 10 -0.3 -7.4

Alabama 95 6 -0.4 -7.5 96 3 -0.4 -8.2

Kentucky 65 1 -0.4 -8.5 65 0 -0.4 -8.4

Minnesota 51 0 -0.5 -8.1 51 0 -0.5 -8.6

Virginia 81 2 -0.4 -10.8 79 1 -0.4 -10.1

Missouri 80 4 -0.4 -10.5 76 2 -0.4 -10.9

Indiana 89 1 -0.5 -11.1 89 0 -0.5 -11.7

Georgia 108 0 -0.5 -13.0 108 0 -0.4 -12.7

Ohio 138 9 -0.4 -15.8 139 8 -0.4 -15.0

North Carolina 89 4 -0.4 -15.5 88 0 -0.4 -16.4

Pennsylvania 152 16 -0.4 -17.3 154 14 -0.4 -17.5

Michigan 100 0 -0.5 -21.4 96 0 -0.5 -21.2

Illinois 130 0 -0.5 -26.3 130 8 -0.5 -26.2

Florida 168 5 -0.4 -29.1 169 8 -0.4 -28.3

Texas 320 4 -0.5 -34.0 325 2 -0.4 -33.0

New York 170 2 -0.5 -47.5 168 0 -0.5 -46.8

Source: CMS.
Appendix II: Hospitals by Provider Type

Page 35 GAO-13-334 Hospital Payment Modifications

Figure 7: Distribution of Inpatient Prospective Payment System (IPPS) Hospitals 

and Critical Access Hospitals (CAH), by Provider Type, 2012

Appendix II: Hospitals by Provider Type 
Appendix III: GAO Contact and Staff 

Acknowledgments

Page 36 GAO-13-334 Hospital Payment Modifications

James Cosgrove, (202) 512-7114 or cosgrovej@gao.gov

In addition to the contact named above, Rosamond Katz, Assistant 

Director; Alexander Galuten; Katherine Perry; Kathryn Richter; and 

Hemi Tewarson made key contributions to this report.

Appendix III: GAO Contact and Staff 

Acknowledgments 

GAO Contact

Staff 

Acknowledgments 

(291057)
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