Report to Congressional Committees

United States General Accounting Office 

GAO 

December 2002 SKILLED NURSING 

FACILITIES 

Medicare Payments 

Exceed Costs for Most 

but Not All Facilities 

GAO-03-183 
Page i GAO-03-183 Medicare Skilled Nursing Facility Payments 

Letter 1

Results in Brief 2 

Background 4 

Medicare Payments Considerably Higher than Costs for Most 

Freestanding SNFs, Thereby Improving Their Overall Financial 

Performance 10 

Reported Medicare Costs of Hospital-Based SNFs Substantially 

Exceeded Medicare Payments 16 

Concluding Observations 20 

Agency and Other Comments and Our Evaluation 21 

Appendix I Methodology for Calculating and Analyzing SNF 

Margins 25 

Appendix II Medicare Margins of Freestanding SNFs by Selected 

Characteristics, 1999 and 2000 29 

Appendix III Comments from the Centers for Medicare & Medicaid 

Services 30 

Appendix IV GAO Contacts and Staff Acknowledgments 31 

GAO Contacts 31 

Acknowledgments 31 

Related GAO Products 32 

Tables 

Table 1: Freestanding and Hospital-Based SNFs by Type of 

Ownership, 1999 5 

Table 2: Freestanding SNFs' Median Medicare Per Diem Payments 

and Costs, 1997-2000 11 

Contents 
Page ii GAO-03-183 Medicare Skilled Nursing Facility Payments 

Table 3: Median Medicare Margins for Freestanding SNFs by Type 

of Ownership, 1999 and 2000 12 

Table 4: Median Medicare Margins for Freestanding SNFs by 

Occupancy Rate, 1999 13 

Table 5: Median Margins for Freestanding SNFs, 1999 and 2000 14 

Table 6: Median Total Margins for Freestanding SNFs by Medicaid 

Share of Patient Days, 1999 15 

Table 7: Median Total Margins for Freestanding SNFs by Type of 

Ownership, 1999 and 2000 15 

Table 8: Hospital-Based SNFs' Median Medicare Per Diem 

Payments and Costs, 1997-1999 17 

Table 9: Therapies, Special Treatments, and Nursing in HospitalBased and Freestanding SNFs, 1999 19 

Table 10: Distribution of Freestanding SNFs for Which Margins 

Were Calculated, 1999 and 2000 28 

Abbreviations 

AAHSA American Association of Homes and Services for the Aging 

AHCA American Health Care Association 

AHA American Hospital Association 

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 

CMS Centers for Medicare & Medicaid Services 

HCFA Health Care Financing Administration 

IV intravenous 

MDS minimum data set 

MedPAC Medicare Payment Advisory Commission 

OACT Office of the Actuary 

OIG Office of Inspector General 

OSCAR Online Survey Certification and Reporting System 

PPS prospective payment system 

RN registered nurse 

RUG resource utilization group 

SNF skilled nursing facility 
Page 1 GAO-03-183 Medicare Skilled Nursing Facility Payments 

December 31, 2002 

The Honorable Max Baucus 

Chairman 

The Honorable Charles E. Grassley 

Ranking Minority Member 

Committee on Finance 

United States Senate 

The Honorable William M. Thomas 

Chairman 

The Honorable Charles B. Rangel 

Ranking Minority Member 

Committee on Ways and Means 

House of Representatives 

From the mid-1980s through 1997, Medicare's spending for skilled nursing 

facility (SNF) care rose at an average annual rate of 30 percent, making it 

one of the fastest growing components of the Medicare program. During 

this period, Medicare paid SNFs based on their reported costs of 

delivering care, subject to certain limits that were higher for hospitalbased SNFs than for freestanding SNFs.1

 Growth in the number of services 

provided to an increasing number of patients resulted in Medicare 

spending for SNF care reaching $13 billion in 1997. In response, the 

Congress established in the Balanced Budget Act of 1997 (BBA) a SNF 

prospective payment system (PPS) under which SNFs receive a fixed 

payment that covers almost all services provided during each day of a 

Medicare-covered stay.2

With the implementation of the PPS, providers stated that the payments 

were inadequate, threatening their financial viability and their ability to 

serve beneficiaries. The Congress subsequently modified the PPS with 

several temporary payment increases. Some of these increases expired on 

October 1, 2002, and provider representatives have said that they should 

be restored due to payment shortfalls from other payers. These 

 1

A freestanding SNF is a nursing home that provides skilled nursing care and is not 

attached to a hospital. A hospital-based SNF is a unit of an acute care hospital. 

2

Pub. L. No. 105-33, § 4432(a), 111 Stat. 251, 414 (codified at 42 U.S.C. § 1395yy(e)). 

United States General Accounting Office 

Washington, DC 20548 
Page 2 GAO-03-183 Medicare Skilled Nursing Facility Payments 

representatives are mainly concerned about Medicaid, a joint federal-state 

program for certain low-income individuals. According to this argument, 

when Medicaid payments do not cover the costs of Medicaid patients, 

higher payments are needed from Medicare to offset current or anticipated 

financial difficulties. 

The Medicare, Medicaid, and SCHIP Benefits Improvement and Protection 

Act of 2000 (BIPA) directed us to examine the adequacy of Medicare 

payments for SNFs and the extent to which Medicare revenues contribute 

to SNFs' financial viability.3

 This report addresses (1) the relationship 

between Medicare SNF payments and the costs of treating Medicare 

patients in freestanding SNFs, as well as the effect of Medicare SNF 

payments on the financial condition of these facilities, and (2) the 

relationship between Medicare SNF payments and the costs of treating 

patients in hospital-based SNFs, as well as the factors that may account 

for cost differences between hospital-based and freestanding SNFs. To 

address these issues, we analyzed 1997 through 2000 SNF Medicare cost 

reports, which are the financial documents that facilities submit annually 

to receive payment from Medicare.4

 We supplemented the cost report data 

with admissions data from Medicare claims, data on facility characteristics 

from the Online Survey Certification and Reporting System (OSCAR) 

maintained by the Centers for Medicare & Medicaid Services (CMS), and 

data on patient services from CMS's nursing home minimum data set 

(MDS). We did not verify these data, but we excluded a SNF from our 

analysis if one or more of its reported data items likely represented data 

entry or other reporting errors. We also interviewed representatives of the 

SNF industry. (See app. I for a more complete discussion of our methods.) 

We performed our work from October 2001 through December 2002 in 

accordance with generally accepted government auditing standards. 

Under the PPS, most freestanding SNFs' Medicare payments substantially 

exceeded the costs of caring for Medicare patients, contributing to 

facilities' overall positive financial condition. In 1999, the first full year 

under the PPS, the median freestanding SNF Medicare margin—a measure 

that compares Medicare payments with Medicare costs—was slightly over 

 3

Pub. L. No. 106-554, App. F, § 311(d), 114 Stat. 2763A-463, 2763A-498. 

4

Hospital-based facilities' 2000 cost reports as well as more recent cost reports for all SNFs 

were not available when we did our analysis. 

Results in Brief 
Page 3 GAO-03-183 Medicare Skilled Nursing Facility Payments 

8 percent.5 By 2000, when the temporary payment increases authorized by 

the Congress started to take effect, the median Medicare margin had risen 

to almost 19 percent. However, nearly one-quarter of SNFs in 2000 had 

Medicare margins exceeding 30 percent, while about one-fifth had 

negative Medicare margins; that is, the payments they received from 

Medicare did not cover their costs of providing care. Medicare margins 

were higher for freestanding SNFs affiliated with large, for-profit nursing 

home chains and for those with high occupancy. The median SNF total 

margin—which reflects total revenues and costs across all patients—was 

1.3 percent in 1999 and 1.8 percent in 2000. A SNF's total margin tended to 

be higher when its Medicare margin was higher despite the fact that, in 

most SNFs, Medicare's share of patient days was small. The total margins 

for freestanding SNFs tended to be lower when a higher proportion of a 

SNF's patients had their care paid for by Medicaid. 

Unlike freestanding SNFs, about 90 percent of hospital-based SNFs 

reported significantly negative Medicare margins after Medicare's new 

SNF payment system was launched. The median hospital-based SNF 

Medicare margin was –53 percent in 1999. Under the PPS, per diem 

payments to hospital-based SNFs dropped considerably, reflecting the 

change from payments based on a facility's own costs to fixed payments 

based on average costs for all facilities. At the same time, hospital-based 

SNFs' reported per diem costs rose from 1997 through 1999. This is in 

contrast to the experience of freestanding SNFs, which had lower per 

diem Medicare costs than hospital-based SNFs prior to the PPS and 

reduced their costs further after the shift to the PPS. The higher Medicare 

costs reported by hospital-based SNFs may stem in part from differences 

in services provided to patients. The higher costs may also reflect the 

historical allocation of overhead costs to the SNF from the hospital, an 

accounting practice that, while consistent with the payment incentives 

under the prior cost-based reimbursement system, means that hospitalbased SNFs' reported costs should be treated cautiously. 

We received written comments from CMS stating that our findings are 

consistent with a recent analysis conducted by MedPAC and other 

 5

The Medicare margin is the difference between Medicare payments and Medicare costs, 

divided by Medicare payments, expressed as a percentage. We computed Medicare margins 

for SNFs using methods similar to those developed by the Medicare Payment Advisory 

Commission (MedPAC) and CMS's Office of the Actuary (OACT). These methods assume 

that the average routine costs per day of Medicare patients are equal to the average routine 

costs per day of all patients in the SNF. (See app. I.) 
Page 4 GAO-03-183 Medicare Skilled Nursing Facility Payments 

analyses of Medicare margins. CMS noted that this report supports its 

position that Medicare SNF payment rates are more than adequate to 

cover the cost of services provided to Medicare beneficiaries. CMS's 

comments are reprinted in appendix III. 

About 15,000 SNFs provide care for patients who are temporarily or 

permanently unable to care for themselves, but who do not require the 

level of care furnished in an acute care hospital. SNFs provide a variety of 

services to patients, including nursing care; physical, occupational, 

respiratory, and speech therapy; and medical social services. Medicare 

covers these SNF services for Medicare beneficiaries who have recently 

been discharged from a stay in an acute care hospital lasting at least 3 days 

and who need daily skilled care. In addition, many of these facilities 

provide long-term care, mostly to Medicaid or private paying patients. 

(Over 2,200 nursing homes are not SNFs and treat Medicaid but not 

Medicare patients.) A SNF must meet federal standards to participate in 

the Medicare or Medicaid program. About 85 percent of SNFs, or roughly 

13,000, are freestanding and three-quarters of these are for-profit entities. 

Nearly half of freestanding SNFs are owned by for-profit chains—

corporations operating multiple facilities. Hospital-based SNFs, which 

number about 1,900, are usually part of not-for-profit acute care hospitals. 

(See table 1.) 

In 2000, Medicare SNF expenditures were $13 billion for services provided 

to 1.4 million Medicare patients. About two-thirds of these patients 

received care in freestanding SNFs and the remaining one-third received 

care in hospital-based SNFs. On any given day, about 10 percent of 

freestanding SNFs' residents were Medicare beneficiaries.6

 Most other 

patients cared for in a freestanding SNF were longer-stay patients 

receiving nursing or long-term care, which generally is paid for by 

Medicaid or by the patients themselves. Medicare patients account for a 

larger share of patients in hospital-based SNFs compared to freestanding 

SNFs. About 56 percent of patients in hospital-based SNFs are Medicare 

patients. 

 6

The 10 percent refers to SNF patients whose care is covered by Medicare. It excludes 

Medicare beneficiaries who are long-stay patients receiving long-term care or nursing care 

that Medicare does not cover. In this report, Medicare patients refers to Medicare 

beneficiaries who receive Medicare-covered SNF care. 

Background 
Page 5 GAO-03-183 Medicare Skilled Nursing Facility Payments 

Table 1: Freestanding and Hospital-Based SNFs by Type of Ownership, 1999a

Numbers in percent 

Type of ownership Freestanding SNFs Hospital-based SNFs

For-profit: 

 10 largest chainsb 20 1

 Smaller chains 29 9

 Independents 26 6

 All for-profit 75 16

Not-for-profit 22 65

Governmentc 3 19

Total 100 100

Source: GAO analysis of OSCAR data and of CMS data based on "Top 50 Nursing Facility Chains," 

Provider, July 1999. 

a

Year refers to each SNF's cost reporting year, which corresponds to its fiscal year that begins during 

the federal fiscal year. 

b

Chain size is measured by the total number of beds in the chain's SNFs. This number is selfreported. 

c

Primarily facilities operated by counties or cities. 

During most of the 1990s, Medicare spending for SNF care grew much 

more rapidly than spending for most other Medicare services. Under the 

cost-based reimbursement system then in effect, Medicare paid SNFs' 

costs for routine care (room and board and routine nursing) up to a 

specified limit, with higher limits applied to hospital-based SNFs than to 

freestanding SNFs. New providers were exempt from the routine-care cost 

limits for their first 4 years, and all providers could be granted exemptions 

to the limits by demonstrating that their higher costs were due to atypical 

patients or patterns of care. Unlike routine-care costs, payments for 

ancillary services such as therapy were not subject to cost limits, giving 

facilities few incentives to control those costs. 

The Congress, in the BBA, directed the Health Care Financing 

Administration (HCFA)7

 to replace the cost-based reimbursement system 

with a PPS. The PPS is designed to give SNFs incentives to furnish only 

necessary services and to deliver those services efficiently by allowing 

facilities to retain any excess of Medicare payments over costs, but 

 7

On July 1, 2001, the Secretary of Health and Human Services changed the name of HCFA 

to CMS. In this report, we will continue to refer to HCFA where our findings apply to the 

organizational structure and operations associated with that name. 

Medicare Payment for SNF 

Care 
Page 6 GAO-03-183 Medicare Skilled Nursing Facility Payments 

requiring them to absorb any costs that are greater than payments. Under 

the PPS, SNFs receive a per diem payment, adjusted for geographic 

differences in labor costs and for differences in the resource needs of 

patients. Adjustments for patients' resource needs are based on a patient 

classification system, resource utilization group (RUG), version III. This 

system assigns patients to 1 of 44 payment groups or RUGs, based on their 

clinical condition, functional status, and use or expected use of certain 

types of services. With few exceptions, the payment covers all routine, 

therapy, and nursing costs incurred in treating patients. 

Although we have reported that total SNF PPS payments are likely to be 

adequate, we, MedPAC, and others have raised concerns that the Medicare 

payments for certain types of patients may be too low because of 

inadequacies with the patient classification system.8

 The patient 

classification system may not sufficiently reflect the greater resource 

needs of those patients who require multiple kinds of health care services, 

such as drugs, laboratory services, and imaging.9

 In response to BIPA's 

requirement that CMS report on alternatives to the RUG patient 

classification system by January 1, 2005, CMS has sponsored research to 

determine the feasibility of refinements as well as alternatives to the RUG 

system. 

After the implementation of the SNF PPS, some SNF representatives 

claimed that Medicare payments were inadequate and contributed to 

SNFs' poor financial performance. The Congress responded to provider 

concerns about the adequacy of SNF payments by making several 

temporary modifications to the PPS payment rates. Two of these changes, 

which applied to all Medicare SNF patients and represented about 

$1.4 billion in annual payments, expired on October 1, 2002: 

 8

U. S. General Accounting Office, Skilled Nursing Facilities: Medicare Payment Changes 

Require Provider Adjustments but Maintain Access, GAO/HEHS-00-23 (Washington, D.C.: 

Dec. 14, 1999); Medicare Payment Advisory Commission, Report to the Congress: Medicare 

Payment Policy (Washington, D.C.: March 1999); Korbin Liu, Jennie Harvell, and Barbara 

Gage, Post-Acute Care Issues for Medicare: Interviews with Provider and Consumer 

Groups, and Researchers and Policy Analysts (Washington, D.C.: May 2000), 

http:www.hhs.gov/aspe.hhs.gov/search/daltcp/Reports/pacissue.htm (downloaded 

August 1, 2002). 

9

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

Policy (Washington, D.C.: March 2001).
Page 7 GAO-03-183 Medicare Skilled Nursing Facility Payments 

• an increase provided by the Medicare, Medicaid, and SCHIP Balanced 

Budget Refinement Act of 1999 (BBRA) of 4 percent in the payment rate 

for all RUGs for fiscal years 2001 and 2002;10 and 

• an increase provided by BIPA of 16.66 percent in the nursing component 

of the payment rate for all RUGs for April through September 2001 and 

fiscal year 2002.11

Two additional changes were enacted for selected types of Medicare 

patients. These changes, which affect 26 of the 44 RUGs and total about 

$1 billion per year, will remain in effect until CMS refines the patient 

classification system. CMS has announced that, although it is examining 

possible refinements, the system will not be changed for the 2003 payment 

year. The two payment changes are: 

• an increase provided by BBRA of 20 percent in the payment rate for 15 

RUGs, including those for extensive services, special care, clinically 

complex care, and certain rehabilitation services;12 and 

• an increase provided by BIPA of 6.7 percent in the payment rate for 14 

rehabilitation RUGs.13 This redirected the funds from the 3 rehabilitation 

RUGs that had received the 20 percent BBRA increase and applied these 

funds to all 14 rehabilitation RUGs. As a result of this redirection of funds, 

aggregate payments did not increase. 

Prior to October 1, 2002, when two of these temporary payment increases 

expired, some SNF representatives stated that Medicare payments were 

adequate, although they said inadequate Medicaid payments compromised 

SNF financial viability. Following the expiration of these two temporary 

Medicare payment increases, provider organizations have again expressed 

concern that Medicare payments are now not adequate. 

Other legislative provisions also affected Medicare payments to SNFs. A 

key provision was the 3-year phased transition to the PPS that the BBA 

established. Under this transition, which began in 1998, SNFs were paid a 

 10Pub. L. No. 106-113, App. F, § 101(d), 113 Stat. 1501A-321, 1501A-324. 

11BIPA § 312(a). This increase raised the overall payment rate from 4 to 12 percent, 

depending on the RUG. See U.S. General Accounting Office, Skilled Nursing Facilities: 

Available Data Show Average Nursing Staff Time Changed Little after Medicare 

Payment Increase, GAO-03-176 (Washington, D.C.: Nov. 13, 2002). 

12BBRA § 101. 

13BIPA § 314. 
Page 8 GAO-03-183 Medicare Skilled Nursing Facility Payments 

blend of facility-specific rates, based on each SNF's 1995 costs, and the 

PPS rate. BBRA allowed SNFs to receive the full PPS rate for cost 

reporting periods beginning on or after January 1, 2000.14 This provision 

permitted SNFs that were advantaged by the PPS rate to be paid under it, 

while SNFs that were disadvantaged by the new rate could transition to it 

on the original 3-year schedule. 

Medicare-covered SNF use quadrupled from 1985 to 1997, rising from 10 

SNF users per 1,000 Medicare fee-for-service beneficiaries to 41 users.15 A 

variety of factors contributed to this increase: 

• In 1983, Medicare began paying hospitals a fixed rate per stay as an 

incentive to control costs. Hospitals responded as expected and, to reduce 

costs by cutting the length of hospital stays, transferred patients more 

quickly to SNFs and other post-acute care settings. 

• In 1988, clarification of Medicare coverage guidelines allowed more 

beneficiaries to qualify for SNF services. 

• From 1990 through 1996 the number of freestanding SNFs increased 49 

percent, while hospital-based SNFs increased 82 percent. This growth in 

providers was encouraged by Medicare payment policies, which did not 

subject new SNFs to payment limits for their first 4 years of operation, and 

by the growth in payments. From 1990 through 1996, the average Medicare 

payment per SNF day of care climbed from $98 to $292.16

During this period prior to the implementation of the SNF PPS, hospitals 

that had SNFs were particularly advantaged by transferring acute care 

patients sooner to their own SNFs. Transfers enabled these hospitals to 

reduce their acute care costs and increase their SNF revenues. To help 

ensure that Medicare did not overpay for services at the end of an acute 

episode of care, the Congress required HCFA to reduce hospital payments 

for patients transferred to post-acute care after a shorter-than-average 

 14BBRA § 102. 

15Beneficiaries enrolled in managed care plans are excluded from the calculation. 

16Prospective Payment Assessment Commission, Medicare and the American Health Care 

System, Report to the Congress (Washington, D.C.: June 1997), p. 107. 

Use of Medicare-Covered 

SNF Care 
Page 9 GAO-03-183 Medicare Skilled Nursing Facility Payments 

hospital stay.17 In fiscal year 1999 HCFA implemented this policy for 10 

types18 of patients with high use of post-acute care. 

The reduction in hospital payment for patients transferred to post-acute 

care lessened the incentive for hospitals to shorten the stays of these 

patients. Following this change, SNF admissions per 1,000 hospital 

discharges decreased by 4 percent from 1996 to 2000. After adjusting for 

differences in patients' clinical conditions,19 the number of admissions was 

only 2 percent lower in 2000 than in 1996, indicating that part of the 

decline was due to reduced need for SNF care. However, if the 10 types of 

patients affected by the change in hospital payment for transfers are 

excluded, SNF admissions were the same in 2000 as in 1996. This suggests 

that some of the observed decline in SNF admissions may be due to the 

change in payment policy for hospital transfers. 

Despite this observed decline in SNF admissions, the evidence does not 

suggest major problems with beneficiary access to SNF care. Beginning in 

1999, the Department of Health and Human Services' Office of Inspector 

General (OIG) has examined SNF access in several surveys of hospital 

discharge planners to determine whether they are able to place their 

Medicare patients who need care in SNFs.20 These surveys have found that 

planners can place most patients needing care. In the most recent OIG 

survey, about three-quarters of discharge planners reported that they were 

able to place all patients. However, some planners reported delays in 

placing patients with particular medical conditions or service needs, 

resulting in these patients continuing to receive care in the hospital rather 

 17BBA § 4407. Without this provision, Medicare would pay hospitals a fixed amount per 

stay—whether the patient had an average or shorter-than-average hospital stay. In addition, 

Medicare would pay SNFs for each day of SNF care, even if—prior to the change in 

hospital payment—some of this care would have been provided in the hospital. 

18"Types" refers to diagnosis-related groups (DRG), a classification scheme that groups 

acute care hospital patients according to diagnosis, type of treatment, age, and other 

criteria. 

19"Patients' clinical conditions" refers to DRGs. 

20Department of Health and Human Services, Office of Inspector General, Medicare 

Beneficiary Access to Skilled Nursing Facilities: 2001, OEI-02-01-00160 (July 2001); 

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

Beneficiary Access to Skilled Nursing Facilities: 2000, OEI-02-00-00330 (September 2000); 

and Department of Health and Human Services, Office of Inspector General, Early Effects 

of the Prospective Payment System on Access to Skilled Nursing Facilities, OEI-02-99-

00400 (August 1999). 
Page 10 GAO-03-183 Medicare Skilled Nursing Facility Payments 

than in a SNF. Patients who took longer to place included those who 

needed intravenous (IV) antibiotics or expensive drugs, as well as those 

who were ventilator-dependent or who required dialysis or wound care. 

In the first 2 full years under the PPS, Medicare payments more than 

covered Medicare costs for most freestanding SNFs, although their 

experiences varied widely. Many SNFs had very high Medicare margins, 

particularly in 2000, although in both years a minority of SNFs had 

negative Medicare margins—payments from Medicare did not cover their 

costs of serving Medicare patients. The median Medicare margin for SNFs 

that were owned by large nursing home chains and for those SNFs with 

high occupancy was much higher than the overall median Medicare 

margin for all SNFs. SNFs' Medicare margins were sufficiently high that, 

while Medicare's share of most SNFs' total patient days was relatively 

small, SNFs with higher Medicare margins generally had higher total 

margins, which reflect all SNF revenues and costs. For-profit facilities 

generally had higher total margins, as did facilities owned by large chains. 

SNFs with higher proportions of Medicaid patients generally had lower 

total margins. 

For their first 2 years under PPS, most freestanding SNFs reported positive 

Medicare margins, meaning that their payments more than covered their 

costs.21 In 1999, the median facility had a Medicare margin exceeding 8 

percent, and over one-tenth had margins of 30 percent or more. By 2000, 

the median Medicare margin for freestanding SNFs had risen to nearly 19 

percent,22 and almost one-quarter of SNFs had Medicare margins of 30 

percent or more. These positive margins resulted largely from SNFs 

reducing their costs. Although Medicare payments per day were 8 percent 

lower in 1999 than in 1997, for the median facility these lower payments 

 21In aggregate, Medicare payments to freestanding SNFs exceeded Medicare costs by 11 

percent in 1999 and by 24 percent in 2000. 

22We computed Medicare margins for SNFs using methods similar to those developed by 

MedPAC and CMS's OACT. These methods assume that average nursing costs are the same 

for Medicare and other patients. A more refined measure of costs would reflect the 

difference in nursing needs between Medicare patients and other patients in the facility. We 

tested such a refinement but could not calculate it for all SNFs due to incomplete data. 

Using available data, we estimated that the median Medicare margin in 2000, based on a 

more refined measure of costs, would have been between 0.6 and 1.6 percentage points 

lower than that reported here. (See app. I.) 

Medicare Payments 

Considerably Higher 

than Costs for Most 

Freestanding SNFs, 

Thereby Improving 

Their Overall 

Financial 

Performance 

Medicare Margins 

Generally High, 

Particularly in 2000 and for 

SNFs in Large For-Profit 

Chains and Those with 

High Occupancy 
Page 11 GAO-03-183 Medicare Skilled Nursing Facility Payments 

were more than offset by lower costs. (See table 2.) From 1999 through 

2000, costs had again declined, although by a smaller amount. At the same 

time, payments increased, as the temporary increases authorized by the 

Congress began to be implemented.23

Table 2: Freestanding SNFs' Median Medicare Per Diem Payments and Costs, 1997-

2000 

In dollars 

Yeara

1997 1998 1999 2000

Medicare payments per day 264 270 243 269

Medicare costs per day 273 279 224 220

Source: GAO analysis of Medicare cost report data. 

a

Year refers to each SNF's cost reporting year, which corresponds to its fiscal year that begins during 

the federal fiscal year. 

Although most freestanding SNFs had positive Medicare margins, for a 

minority of SNFs, Medicare payments did not cover Medicare costs. In 

1999, more than one-third of freestanding facilities reported negative 

Medicare margins, with one-tenth reporting margins that were –30 percent 

or less.24 By 2000, the number of facilities with negative margins had 

declined substantially: about 19 percent had margins that were less than 

zero, and 4 percent had margins of –30 percent or less. 

Freestanding SNFs' Medicare margins differed by type of ownership. Forprofit SNFs—particularly those associated with the largest chains—had 

positive Medicare margins in both 1999 and 2000 that were higher than 

those of both not-for-profit and government-operated SNFs.25 In 1999, 

median margins for not-for-profit and government-operated SNFs were 

 23The impact of the temporary increases on 2000 payments depended both on the effective 

date in the law and on the start date of each SNF's fiscal year. The 4 percent across-theboard increase was in effect for the entire year for all facilities. The 20 percent temporary 

increase in payments for 15 RUGs was in effect for part of 2000 for most facilities. The 

other two increases—the increase in the nursing component and the increase for 

rehabilitation RUGs—had a smaller effect in the 2000 cost reporting year: 16 percent of 

SNFs were affected for part of the year. 

24That is, Medicare payments fell short of costs by at least 30 percent. 

25This relationship held true even after accounting for other factors. (See app. I.) 
Page 12 GAO-03-183 Medicare Skilled Nursing Facility Payments 

negative, while in 2000 the median margins for all types of freestanding 

SNFs were positive. (See table 3.) 

Table 3: Median Medicare Margins for Freestanding SNFs by Type of Ownership, 

1999 and 2000 

Numbers in percent 

1999a

 2000a

For-profit: 

 10 largest chainsb 18.2 25.2

 Smaller chains 7.6 16.8

 Independents 6.6 17.7

 All for-profit 11.7 20.4

Not-for-profit -1.4 11.1

Governmentc -13.9 8.2

All freestanding SNFs 8.4 18.9

Source: GAO analysis of Medicare cost report data, OSCAR data, and CMS data based on "Top 50 

Nursing Facility Chains," Provider, July 1999. 

a

Year refers to each SNF's cost reporting year, which corresponds to its fiscal year that begins during 

the federal fiscal year. 

b

Chain size is measured by the total number of beds in the chain's SNFs. This number is selfreported. 

c

Primarily facilities operated by counties or cities. 

Medicare margins also varied with occupancy.26 Higher occupancy resulted 

in higher margins. For example, in 1999, freestanding SNFs with 

occupancy rates27 of 90 percent or more had a median margin of 10.2 

percent, while SNFs with occupancy rates below 70 percent had a median 

margin of 0.6 percent. (See table 4.) These results are not surprising, 

because higher occupancy reduces per diem costs, as fixed costs are 

spread across more patient days. 

 26Other factors associated with higher Medicare margins included urban location, while 

factors associated with lower margins included having a small number of Medicare SNF 

patient days per year. 

27The occupancy rate is based on all beds in the facility, regardless of whether they were 

occupied by Medicare patients or other patients. 
Page 13 GAO-03-183 Medicare Skilled Nursing Facility Payments 

Table 4: Median Medicare Margins for Freestanding SNFs by Occupancy Rate, 1999a

Numbers in percent 

Occupancy rateb Share of SNFs Medicare margin

Less than 70 percent 11 0.6

70 to 79 percent 13 6.1

80 to 89 percent 28 8.3

90 to 100 percent 48 10.2

Source: GAO analysis of Medicare cost report data. 

a

Year refers to each SNF's cost reporting year, which corresponds to its fiscal year that begins during 

the federal fiscal year. 

b

The occupancy rate is based on all beds in the facility, regardless of whether they were occupied by 

Medicare patients or other patients. 

Despite the expiration of two temporary Medicare payment increases and 

the completed transition from payments based on a facility's own costs to 

PPS rates, SNFs' positive Medicare margins are likely to continue. 

MedPAC has estimated that freestanding SNFs' aggregate Medicare margin 

for 2002 would be 9.4 percent, excluding for the entire year the temporary 

payment increases that expired on October 1, 2002, and assuming that all 

facilities had completed the transition to the PPS.28

Although most freestanding SNFs had positive Medicare margins, most 

had few Medicare patients and Medicare accounted for a small share of 

their revenue. In 1999, the median SNF had about six Medicare patients 

each day and received about 13 percent of its revenue from Medicare. By 

contrast, the care for about two-thirds of patients was paid for by 

Medicaid with the remainder generally paid for by the patients themselves. 

Despite Medicare's small share of most freestanding SNFs' patients, 

Medicare contributed substantially to these facilities' total margins, 

because Medicare payments were much higher than costs. In general, 

 28In its estimate, MedPAC updated 1999 costs and payments through 2002 for inflation and 

used payment policies expected to be in effect in 2003: temporary payment increases due 

to expire on October 1, 2002, were excluded and all facilities were assumed to be paid 

entirely under the PPS. MedPAC included the temporary payment increases that will be in 

effect in 2003 and will not expire until the patient classification system is refined. It 

estimated the margin using aggregate Medicare SNF payments and aggregate Medicare SNF 

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

Payment Policy (Washington, D.C.: March 2002). 

Despite Medicare's Small 

Share of Patients, 

Medicare Margins 

Significantly Affected 

Freestanding SNFs' Total 

Margins 
Page 14 GAO-03-183 Medicare Skilled Nursing Facility Payments 

facilities with higher Medicare margins had higher total margins. 

Moreover, in 1999 and 2000, the median total margin would have been 

negative without Medicare; for example, in 2000, it would have been –1.2 

percent. With Medicare, the actual median total margin was 1.8 percent. 

(See table 5.) 

Table 5: Median Margins for Freestanding SNFs, 1999 and 2000 

Numbers in percent 

1999a

2000a

Medicare margin 8.4 18.9

Total margin 1.3 1.8

Total margin without Medicare -0.1 -1.2

Source: GAO analysis of Medicare cost report data. 

a

Year refers to each SNF's cost reporting year, which corresponds to its fiscal year that begins during 

the federal fiscal year. 

Medicaid's share of freestanding SNFs' residents influenced facilities' 

overall profitability. The larger Medicaid's share of a SNF's patient days, 

the smaller its total margin.29 (See table 6.) For-profit status and ownership 

by a chain also affected freestanding SNFs' total margins. For-profit 

facilities showed higher median total margins than not-for-profit and 

government-operated facilities, and large chains displayed the highest total 

margins. (See table 7.) 

 29Our statistical analysis of SNF total margins showed that the Medicaid share of patient 

days remains significant after accounting for SNF characteristics, including for-profit 

status. 

Freestanding SNFs' Total 

Margins Varied by 

Medicaid Share of 

Residents and Type of 

Ownership 
Page 15 GAO-03-183 Medicare Skilled Nursing Facility Payments 

Table 6: Median Total Margins for Freestanding SNFs by Medicaid Share of Patient 

Days, 1999a

Numbers in percent 

Medicaid share of patientsb Total margins

Less than 56 percent 2.2

56 to 69 percent 1.8

70 to 79 percent 1.0

80 percent and above 0.6

Source: GAO analysis of Medicare cost report data. 

a

Year refers to each SNF's cost reporting year, which corresponds to its fiscal year that begins during 

the federal fiscal year. 

b

Each group contains roughly one-quarter of all freestanding SNFs. 

Table 7: Median Total Margins for Freestanding SNFs by Type of Ownership, 1999 

and 2000 

Numbers in percent 

1999a2000a

For-profit: 

 10 largest chainsb 2.7 3.8

 Smaller chains 0.6 1.5

 Independents 1.8 1.8

 All for-profit 1.6 2.2

Not-for-profit 0.6 0.3

Governmentc 0.3 0.6

All freestanding SNFs 1.3 1.8

Source: GAO analysis of Medicare cost report data, OSCAR data, and CMS data based on "Top 50 

Nursing Facility Chains," Provider, July 1999. 

a

Year refers to each SNF's cost reporting year, which corresponds to its fiscal year that begins during 

the federal fiscal year. 

b

Chain size is measured by the total number of beds in the chain's SNFs. This number is selfreported. 

c

Primarily facilities operated by counties or cities. 

Many other factors were also related to differences in freestanding SNFs' 

total margins. Factors contributing to high total margins included high 

occupancy and location in a rural area. Factors associated with low total 

margins were a high concentration of SNFs in a geographic area, and 

location in a state with relatively high average wages for nursing staff. 
Page 16 GAO-03-183 Medicare Skilled Nursing Facility Payments 

In contrast to freestanding SNFs, hospital-based SNFs reported very 

negative Medicare margins after the introduction of the PPS. These low 

margins reflected a substantial decline in Medicare payments to hospitalbased SNFs under the PPS as well as hospital-based SNFs' weak response 

to PPS incentives to reduce costs. Differences in services between 

hospital-based SNFs and freestanding SNFs could have resulted in higher 

costs for hospital-based SNFs that may not have been fully accounted for 

by the patient classification system in the PPS. The negative margins 

reported by hospital-based SNFs were also due in part to their high costs 

per day, which may reflect the historical allocation of hospitals' overhead 

to their SNF units. 

In 1999, about 90 percent of all hospital-based SNFs reported Medicare 

costs exceeding Medicare payments, and the median hospital-based SNF 

posted Medicare margins of –53 percent.30 While insufficient data were 

available to compute margins for hospital-based SNFs for 2000, their 

margins likely improved with the payment increases, but remained 

significantly negative.31 Only a small minority—about 10 percent—reported 

positive margins in 1999. These more successful hospital-based SNFs 

generally had high occupancy and did not rely heavily on Medicare 

payments. 

The explanation of these low margins lies partly in the large decline in 

Medicare per diem payments that followed the shift to the PPS. Prior to 

the PPS, Medicare's payments to SNFs were based on each facility's own 

costs. This led to higher payments for hospital-based SNFs: a median of 

$378 per day for hospital-based SNFs in 1997 (see table 8), compared to a 

median of $264 for freestanding SNFs. 

 30In aggregate, Medicare costs of hospital-based SNFs exceeded their Medicare payments 

by 55 percent. 

31We were not able to calculate margins for 2000 because most hospitals' cost reports were 

not yet available when we performed our work. 

Reported Medicare 

Costs of HospitalBased SNFs 

Substantially 

Exceeded Medicare 

Payments 

Unlike Freestanding SNFs, 

Most Hospital-Based SNFs 

Had Very Negative 

Medicare Margins 
Page 17 GAO-03-183 Medicare Skilled Nursing Facility Payments 

Table 8: Hospital-Based SNFs' Median Medicare Per Diem Payments and Costs, 

1997-1999 

In dollars 

Yeara

1997 1998 1999

Medicare payments per day 378 347 281

Medicare costs per day 461 484 490

Source: GAO analysis of Medicare cost report data. 

a

Year refers to each SNF's cost reporting year, which corresponds to its fiscal year that begins during 

the federal fiscal year. 

In the first year of the PPS, hospital-based SNFs, unlike their freestanding 

counterparts, did not respond to the incentives in the PPS by reducing 

costs: compared to 1997, hospital-based SNFs' costs in 1999 were higher 

by $29 per day.32 By contrast, freestanding SNFs reduced costs by $49 per 

day. As a result, per diem costs continued to be substantially higher in 

hospital-based facilities than in freestanding SNFs—more than twice as 

high in 1999. 

Some differences in costs between hospital-based and freestanding SNFs 

may also reflect differences in services in the two settings. Although 

patients in hospital-based SNFs had received less therapy as of their initial 

Medicare assessment than patients in freestanding SNFs (and slightly 

more as of their second assessment),33 they were more likely to receive 

other kinds of services, including IV medications, oxygen therapy, and 

transfusions. Hospital-based SNFs also gave significantly more nursing 

care, as measured by the ratio of nurses to patients. However, when 

patients' resource needs were measured by RUGs, patients in the two 

 32Nearly one-quarter of hospital-based SNFs closed after the implementation of the PPS. 

These closures accounted for 4 percent of all Medicare-covered SNF days in 1997 and 22 

percent of Medicare-covered SNF days provided by hospital-based SNFs. Hospital-based 

SNFs that opened after 1995 were more likely to close than those that had been in business 

longer. 

33SNFs document the amount of therapy a patient has received in the last 7 days at an initial 

assessment (often called the 5-day assessment) and again at a second assessment (often 

called the 14-day assessment). The amount of therapy documented includes only therapies 

provided in the SNF; if the initial assessment occurs on the fifth or sixth day, then only 5 or 

6 days of therapy are documented. Therapy includes physical, occupational, and speech 

therapy. 

Differences in Services and 

Accounting Practices May 

Contribute to Cost 

Differences between 

Hospital-Based and 

Freestanding SNFs 
Page 18 GAO-03-183 Medicare Skilled Nursing Facility Payments 

settings appeared identical, suggesting that their service needs should be 

comparable. Consequently, the observed differences in the treatments that 

patients received may suggest that the RUGs do not fully measure 

differences in patients' conditions and could account for part of the cost 

difference between hospital-based and freestanding SNFs.34 (See table 9.) 

 34A study by Abt Associates found that hospital-based SNFs have significantly higher perpatient costs than freestanding SNFs after controlling for various factors, but could not 

explain why. Abt Associates, Inc., Why Are Hospital-Based Nursing Homes So Expensive? 

The Relative Importance of Acuity and Treatment Setting, Health Services and 

Evaluation (HSRE) Working Paper No. 3 (Cambridge, Massachusetts: February 2001). 
Page 19 GAO-03-183 Medicare Skilled Nursing Facility Payments 

Table 9: Therapies, Special Treatments, and Nursing in Hospital-Based and 

Freestanding SNFs, 1999 

Hospitalbased Freestanding

Average therapy per patient, minutesa 

 Measured at initial Medicare assessment 337 369

 Measured at second Medicare assessment 446 440

Patients receiving special treatments, percentageb

 IV medication 57 37

 Intake/output 70 53

 Monitoring acute medical condition 62 57

 Ostomy care 3 6

 Oxygen therapy 38 28

 Suctioning 4 3

 Tracheotomy care 1 1

 Transfusions 8 4

Average nurse staffing ratioc

 Average registered nurse (RN) hours per patient day 1.81 0.37

 Average total nurse hours (RN, licensed practical 

 nurse, aide) per patient day 5.57 3.12

Source: GAO analysis of MDS data and OSCAR data. 

Note: Entries are not adjusted for differences in patients' clinical conditions between hospital-based 

and freestanding SNFs. Their RUG scores are similar. 

a

SNFs document the amount of therapy a patient has received in the last 7 days at an initial 

assessment (often called the 5-day assessment) and again at a second assessment (often called the 

14-day assessment). The amount of therapy documented includes only therapies provided in the 

SNF; if the initial assessment occurs on the fifth or sixth day, then only 5 or 6 days of therapy are 

documented. Therapy includes physical, occupational, and speech therapy. Patients who were 

receiving chemotherapy, dialysis, IV medications, oxygen therapy, radiation, or ventilator or 

respiratory care were excluded from the analysis of therapy. 

b

Based on the initial Medicare assessment. Similar results were obtained using the second 

assessment. 

c

These staffing ratios are based on SNFs' overall direct nursing care staff and the total number of 

patients. These ratios are facility-wide rather than ratios specific to Medicare patients. 

Part of the cost differential between hospital-based and freestanding SNFs 

may reflect accounting practices that increase reported costs for 

individual units of the hospital, such as SNFs, that had been paid on the 

basis of these reported costs. MedPAC "believe[s] a significant portion of 

the negative [hospital-based] SNF margin reflects the allocation of hospital 
Page 20 GAO-03-183 Medicare Skilled Nursing Facility Payments 

overhead costs to cost-reimbursed units."35 Prior to the SNF PPS, but after 

Medicare had implemented its per case PPS for acute inpatient hospital 

care, hospitals had an incentive to allocate administrative and capital costs 

to cost-reimbursed units, including SNFs, potentially raising reported 

costs for these units. (Capital as a share of Medicare per diem costs for 

hospital-based SNFs was about 96 percent higher than it was for 

freestanding SNFs in 1999.) Now that SNFs are paid a fixed rate, this 

incentive no longer exists—but neither is there an incentive to change 

historical cost allocations. In fact, capital as a share of Medicare costs for 

hospital-based SNFs has changed little since before PPS. In light of these 

accounting issues, reported costs of hospital-based SNFs, as well as 

margins calculated from these costs, should be treated cautiously.36

Our analysis shows that the Medicare PPS generally pays SNFs adequately 

for the services that beneficiaries receive. Freestanding SNFs, which treat 

most Medicare SNF patients, generally received Medicare payments that 

exceeded their costs, often by considerable amounts. Most hospital-based 

SNFs reported costs that were greatly in excess of Medicare payments, but 

these hospital-based SNFs did not respond to the incentives in the PPS by 

reducing costs. Some of their high costs may also be due to differences in 

patients that lead to higher resource use and that are not captured by the 

payment system. This problem could be addressed through refinements to 

the patient classification system, which CMS is currently studying. 

Concerns about the financial conditions of some nursing homes have led 

to interest in using Medicare payment policy to offset current or 

anticipated financial difficulties. Whatever the merits of the case for aiding 

these facilities, an across-the-board increase in Medicare payments, such 

as the restoration of the expired temporary increases, would be 

particularly inefficient. An across-the-board increase would go to all 

providers of Medicare SNF care, even those for which Medicare's current 

 35See Medicare Payment Advisory Commission, Report to the Congress: Medicare Payment 

Policy (Washington, D.C.: March 2001), p. 67. 

36In addition to the differences in per diem cost, the average length of stay in hospital-based 

SNFs was less than half that in freestanding facilities. It is uncertain whether the difference 

in length of stay resulted from differences in patients, effectiveness of treatment, or other 

factors. For analysis of selected differences in outcomes, see DataPRO Team, Skilled 

Nursing Facilities Prospective Payment System, Findings from Rehospitalization 

Transfer within 30 Days Analysis: Summary and Selected Results, Ad Hoc Report E 

(Washington, D.C.: June 2002). 

Concluding 

Observations 
Page 21 GAO-03-183 Medicare Skilled Nursing Facility Payments 

payments already greatly exceed costs and which are not experiencing any 

financial difficulty. Such an increase could also not take account of 

differences in the adequacy of revenues from other payers, especially the 

state Medicaid programs. Moreover, over 2000 nursing homes would not 

get any increase, because they do not participate in Medicare. 

We received written comments on a draft of this report from CMS (see 

app. III) and oral comments from the American Association of Homes and 

Services for the Aging (AAHSA), which represents not-for-profit nursing 

facilities; the American Health Care Association (AHCA), which represents 

for-profit and not-for-profit nursing facilities; and the American Hospital 

Association (AHA), which represents hospitals. We incorporated their 

comments as appropriate. Industry representatives agreed with our basic 

findings concerning SNF margins and several stated that it was a good 

report. 

CMS noted that our findings are consistent with a recent analysis 

conducted by MedPAC and other analyses of Medicare margins. CMS 

stated that the report supports its position that Medicare SNF payment 

rates are more than adequate to cover the cost of services provided to 

Medicare beneficiaries. 

Representatives of AHCA and AAHSA who reviewed the draft report were 

concerned that the report does not address the issue of Medicaid 

payments being too low and the role they play in SNFs' financial viability. 

AHCA also objected to the prominence given to differences in payments 

by type of ownership, which they believe is a less important factor than 

occupancy and Medicare percentage of total SNF days in explaining SNF 

total margins. They characterized as misleading the 30 percent annual 

growth rate in Medicare SNF expenditures that we reported for 1985 

through 1997, stating that spending growth was driven by growth in 

utilization. 

Both the AHCA and AHA representatives commented on our findings 

concerning the differences between freestanding and hospital-based SNFs. 

AHCA stated that any differences in services between hospital-based and 

freestanding SNFs are due to differences in patients' clinical conditions. 

The AHA representatives objected to our statement that the higher per 

diem costs of hospital-based SNFs could be partly due to the historical 

patterns of allocating overhead and other costs to the SNF. They stated 

Agency and Other 

Comments and Our 

Evaluation 

CMS 

Industry Associations 
Page 22 GAO-03-183 Medicare Skilled Nursing Facility Payments 

that hospital cost accounting systems are constantly changing as hospitals 

add and drop services, and that the cost allocation issue in general is an 

artifact of the 15 years of operation of Medicare's inpatient PPS. According 

to AHA, hospitals were already operating at an efficient level when the 

SNF PPS was implemented and therefore had fewer excess costs to trim. 

The AHA representatives also noted the shorter average length of stay of 

hospital-based SNFs and suggested that reporting costs on a per case 

basis, which reflects this shorter length of stay, rather than on a per diem 

basis, would show that hospital-based SNFs are less costly than 

freestanding SNFs. 

Both AAHSA and AHA addressed possible changes to the PPS. The AAHSA 

representative stressed that Medicare payments are inadequate for 

patients who need medically complex nonrehabilitation ancillary services. 

She stated that the report should include language suggesting that the 

patient classification system should be changed to better reflect patient 

characteristics. Regarding our concluding observations, AHA inferred 

from our discussion of across-the-board increases in payment rates that 

we would favor targeted increases. 

Regarding payments, we accounted for Medicaid payments in our analysis 

of total margins but were unable to conduct a separate analysis of 

Medicaid payment adequacy for nursing homes because of the lack of 

suitable data. Isolating the impact of Medicaid payments was not possible 

because the Medicare cost reports do not report Medicaid payments or 

costs separately and because there is no source of Medicaid financial data 

collected on a consistent and ongoing basis across all facilities and states. 

Although occupancy and Medicare percentage of total SNF days were 

important factors in explaining differences in total margins, we found that 

after accounting for these factors, type of ownership remained a 

significant factor. We agree that utilization growth was a key factor in the 

rise in Medicare SNF spending, as this report states. Nonetheless, the rapid 

growth in spending, which we characterized correctly, provided the 

impetus for enactment of the SNF PPS. 

With regard to differences between freestanding and hospital-based SNFs, 

our analyses reported in the draft show that the average RUG score, a 

measure of patients' clinical conditions, is nearly the same for both. We 

acknowledged, moreover, that the RUG system may not adequately 

account for differences across patients. As we stated in the draft, the 

higher costs of hospital-based SNFs are consistent with historical patterns 

of allocating overhead costs to SNF units. Whatever changes are occurring 

Our Response 
Page 23 GAO-03-183 Medicare Skilled Nursing Facility Payments 

in hospital cost accounting, hospitals have had no incentive to change 

their historical cost allocations since the implementation of the SNF PPS. 

Moreover, we found no evidence to suggest that they had done so. For 

example, as we stated in the draft, capital costs expressed as a share of 

Medicare per diem costs have not changed. Although AHA representatives 

said that hospitals were more efficient and consequently had less 

flexibility to reduce costs after the implementation of the SNF PPS, they 

did not offer evidence to reconcile this view with hospital-based SNFs' 

higher costs. Hospitals' efficiency may have improved on the inpatient side 

as a result of the hospital PPS, but this would not necessarily improve the 

efficiency of hospital-based SNFs. Although we agree that hospital-based 

SNFs are less costly than freestanding SNFs on a per case basis, we did 

not present this measure because payments under the SNF PPS are not 

made on a per case basis. 

Regarding possible changes in the PPS, we have previously acknowledged 

that the current patient classification system may not adequately recognize 

the greater resource needs of some patients.37 We support CMS's 

sponsorship of research to investigate improvements in the system. Our 

analysis does not support an increase in Medicare payment rates. Instead, 

it would be preferable to refine the patient classification system 

underlying the SNF PPS, if necessary redistributing money to ensure that 

payments vary appropriately to reflect patient resource needs. 

We are sending copies of this report to the Administrator of CMS, 

appropriate congressional committees, and other interested parties. We 

will also provide copies to others upon request. In addition, the report is 

available at no charge on the GAO Web site at http://www.gao.gov. 

 37See U.S. General Accounting Office, Skilled Nursing Facilities: Medicare Payment 

Changes Require Provider Adjustments but Maintain Access, GAO/HEHS-00-23

(Washington, D.C.: Dec. 14, 1999). 
Page 24 GAO-03-183 Medicare Skilled Nursing Facility Payments 

If you or your staffs have any questions, please call me at (202) 512-7114. 

Other GAO contacts and staff acknowledgements are listed in appendix IV. 

Laura A. Dummit 

Director, Health Care—Medicare Payment Issues 
Appendix I: Methodology for Calculating and 

Analyzing SNF Margins 

Page 25 GAO-03-183 Medicare Skilled Nursing Facility Payments 

This appendix describes the data and methods used to calculate margins 

for SNFs as well the analyses of factors affecting margins. 

In general, a SNF margin is the difference between its payments and its 

costs, divided by payments; this ratio is expressed as a percentage. Using 

this definition, a total margin for a SNF is based on the difference between 

its total payments—derived from all payers—and its total costs. A 

Medicare margin for a SNF is based on the difference between its 

Medicare payments and its reported costs of serving Medicare patients.1

We report the median margins for freestanding and hospital-based SNFs, 

as well as for subgroups (for example, not-for-profit freestanding SNFs).2

We computed Medicare and total margins for freestanding and hospitalbased SNFs using methods similar to those developed by MedPAC and 

CMS's Office of the Actuary (OACT). Our primary data sources for SNF 

payments and costs used in calculating Medicare and total margins were 

the 1997 through 2000 Medicare SNF cost report files maintained by CMS.3

Our methods differed slightly from those used by MedPAC and OACT with 

respect to the definition of outliers and the application of an adjustment to 

Medicare costs. 

Definition of outliers. The data for some SNFs must be excluded from the 

analysis because they result in outliers—implausibly high or low margins 

that suggest data error. To identify outliers, MedPAC uses a method based 

on percentiles. We used a standard statistical distribution (lognormal) and 

removed SNFs where margins were plus or minus 3 standard deviations or 

more from the mean. We used this method because it improved our ability 

to detect and eliminate extreme values. 

Application of cost adjustment. MedPAC adjusted 1999 cost data for 

freestanding SNFs that, after the implementation of the SNF PPS, changed 

 1

The definition of Medicare costs excludes nonallowable costs such as patients' telephones 

and personal laundry services. 

2

MedPAC primarily reports revenue-weighted, or aggregate, margins. These are calculated 

by summing the revenues of all providers in a group (for example, freestanding SNFs) and 

separately summing these providers' costs. Using these sums, a margin is calculated for the 

group. Reporting revenue-weighted margins is consistent with MedPAC's focus on the 

adequacy of Medicare's aggregate payments for SNF care. 

3

Each annual cost report file contains data for SNFs' cost reporting periods beginning on or 

after the start date of the relevant federal fiscal year. 

Appendix I: Methodology for Calculating and 

Analyzing SNF Margins 

Data and Methods Used in 

Calculating Margins 
Appendix I: Methodology for Calculating and 

Analyzing SNF Margins 

Page 26 GAO-03-183 Medicare Skilled Nursing Facility Payments 

from certifying a portion of their beds for use by Medicare patients to 

certifying all or most their beds for Medicare patients. This increase in 

certified beds resulted in the average cost per day reflecting the cost 

experience of a broader range of patients, many of whom may not have 

received skilled care. The adjustment made data more comparable over 

time by making costs for 1999 more similar to costs in 1997 and 1998, 

which were based on a larger share of patients needing a SNF level of 

care. 

To better ensure comparability of cost data across time, we made an 

adjustment similar to MedPAC's. Following MedPAC's approach, we 

identified freestanding SNFs for which this adjustment should be made by 

examining the change between years in the number of Medicare-certified 

beds. If the number of certified beds increased 50 percent or more, over 90 

percent of the SNF's beds were Medicare-certified, and certain other 

conditions were met, MedPAC adjusted the SNF's routine costs. We used 

similar criteria: If a SNF had over 90 percent of its beds certified as 

Medicare and if, in addition, this percentage had changed by more than 30 

percentage points from 1998, we adjusted the SNF's routine costs. The 

adjustment raised or lowered routine costs based on the pre-PPS ratio of 

Medicare SNF routine costs per day to the entire facility's routine costs 

per day. We applied this adjustment in both 1999 and 2000. We found that 

our criteria identified about 10 percent of SNFs in 1999 and 18 percent in 

2000 for which the adjustment was appropriate. Without the adjustment, 

the median Medicare margin for freestanding SNFs in 1999 would have 

been 10.2 percent rather than 8.4 percent, and the median Medicare 

margin in 2000 would have been 21.7 percent rather than 18.9 percent. 

A more refined measure of the routine costs attributable to Medicare 

patients in all SNFs would reflect the difference in nursing needs between 

Medicare patients and other patients in the facility. To test the impact of 

such an adjustment, we used patient-specific data on services from CMS's 

nursing home minimum data set (MDS) to approximate the difference in 

nursing needs between Medicare patients and other patients for each SNF. 

Using this estimate, we adjusted the portion of total facility routine costs 

attributable to employee wages and benefits, which we used as a proxy for 

nursing costs. Based on this analysis, we estimate that using a more 

refined measure of Medicare costs would likely have reduced the median 

Medicare margin we reported for freestanding SNFs by between 0.6 and 

1.6 percentage points. This adjustment would not affect SNF total costs or 

total margins. 

Refining the Measurement 

of Medicare Costs 
Appendix I: Methodology for Calculating and 

Analyzing SNF Margins 

Page 27 GAO-03-183 Medicare Skilled Nursing Facility Payments 

The SNF cost report files we used to calculate 1999 and 2000 Medicare 

margins were the most current files as of May 2, 2002. The 1999 and 2000 

files differed with respect to their completeness. The 1999 file was over 97 

percent complete, while the 2000 file was 80 percent complete.4

 After 

excluding freestanding SNFs that had outliers or lacked key data, 

including data necessary to adjust routine costs, 7,805 facilities were 

available for analysis in 1999 and 6,975 facilities in 2000. After exclusions, 

1,506 hospital-based SNFs were available for analysis in 1999. The 2000 file 

contained very few records for hospital-based SNFs; as a result, we could 

not reliably calculate and report 2000 margins for these providers. Table 

10 shows that the distribution of freestanding SNFs is similar in both years 

for type of ownership, location (urban versus rural), and census region. 

Compared to the 1999 file, the 2000 file has more SNFs that provide 4,000 

or more days of care to Medicare beneficiaries and correspondingly fewer 

that provide less than 1,500 days of care. 

 4

A large proportion of these cost reports—36 percent in 1999 and 63 percent in 2000—are 

"as submitted," meaning that, although they have passed initial automated checks and edits, 

final payment has not been made. 

Characteristics of the Files 

Used to Calculate Margins 
Appendix I: Methodology for Calculating and 

Analyzing SNF Margins 

Page 28 GAO-03-183 Medicare Skilled Nursing Facility Payments 

Table 10: Distribution of Freestanding SNFs for Which Margins Were Calculated, 

1999 and 2000 

Numbers in percent 

 Yeara

 1999b2000c

Type of ownership For-profit 79 80

 Not-for-profit 18 17

 Government 3 3

Location Urban 63 63

 Rural 37 37

Census region Northeast 15 14

 South 34 35

 Midwest 33 33

 West 18 18

Medicare days Under 1,500 32 29

 1,500 – 2,499 23 22

 2,500 – 3,999 22 23

 4,000 or more 23 26

Source: GAO analysis of Medicare cost report data. 

a

Year refers to each SNF's cost reporting year, which corresponds to its fiscal year that begins during 

the federal fiscal year. 

b

Based on 7,805 facilities, after excluding SNFs that lacked key data or were outliers. 

c

Based on 6,975 facilities, after excluding SNFs that lacked key data or were outliers. 

To account quantitatively for factors that potentially influence SNF 

margins, we analyzed SNF margins using multiple regression. This 

statistical technique accounts for variation in margins by estimating the 

separate contribution of each of several explanatory factors included in 

the analysis, while controlling for the effect of all other included factors. 

For freestanding SNFs, we estimated separate regressions for Medicare 

margins and for total margins. Each regression included contextual 

factors, such as the number of SNFs in a geographic area and the state in 

which the SNF was located, and individual factors, such as each SNF's 

proportion of Medicaid patients, its occupancy rate, and whether it was 

for-profit. We report only results that are statistically significant. 

Methods for Analysis of 

Factors Affecting SNF 

Margins 
Appendix II: Medicare Margins of 

Freestanding SNFs by Selected 

Characteristics, 1999 and 2000 

Page 29 GAO-03-183 Medicare Skilled Nursing Facility Payments 

Numbers in percent 

 Yeara

1999b

2000c

Type of ownership For-profit 11.7 20.4

 Not-for-profit -1.4 11.1

 Government -13.9 8.2

Location Urban 10.7 19.4

 Rural 5.2 18.0

Census region Northeast 4.3 15.7

 South 11.6 19.8

 Midwest 4.6 17.7

 West 15.3 21.0

Medicare days Under 1,500 3.2 16.1

 1,500 – 2,499 8.0 18.9

 2,500 – 3,999 10.0 19.4

 4,000 or more 12.8 20.2

Source: GAO analysis of Medicare cost report data. 

a

Year refers to each SNF's cost reporting year, which corresponds to its fiscal year that begins during the federal 

fiscal year. 

b

Based on 7,805 facilities, after excluding SNFs that lacked key data or were outliers. 

c

Based on 6,975 facilities, after excluding SNFs that lacked key data or were outliers. 

Appendix II: Medicare Margins of 

Freestanding SNFs by Selected 

Characteristics, 1999 and 2000 
Appendix III: Comments from the Centers for 

Medicare & Medicaid Services 

Page 30 GAO-03-183 Medicare Skilled Nursing Facility Payments 

Appendix III: Comments from the Centers for 

Medicare & Medicaid Services 
Appendix IV: GAO Contacts and Staff 

Acknowledgments 

Page 31 GAO-03-183 Medicare Skilled Nursing Facility Payments 

Jonathan Ratner, (202) 512-7107 

Phyllis Thorburn, (202) 512-7012 

Contributors to this report were Dae Park and Eric Wedum. 

Appendix IV: GAO Contacts and Staff 

Acknowledgments 

GAO Contacts 

Acknowledgments 
Related GAO Products 

Page 32 GAO-03-183 Medicare Skilled Nursing Facility Payments 

Skilled Nursing Facilities: Available Data Show Average Nursing Staff 

Time Changed Little after Medicare Payment Increase. GAO-03-176. 

Washington, D.C.: November 13, 2002. 

Skilled Nursing Facilities: Providers Have Responded to Medicare 

Payment System by Changing Practices. GAO-02-841. Washington, D.C.: 

August 23, 2002. 

Nursing Homes: Quality of Care More Related to Staffing than Spending. 

GAO-02-431R. Washington, D.C.: June 13, 2002. 

Skilled Nursing Facilities: Services Excluded from Medicare's Daily Rate 

Need to be Reevaluated. GAO-01-816. Washington, D.C.: August 22, 2001. 

Nursing Homes: Aggregate Medicare Payments Are Adequate Despite 

Bankruptcies. GAO/T-HEHS-00-192. Washington, D.C.: September 5, 2000. 

Skilled Nursing Facilities: Medicare Payment Changes Require Provider 

Adjustments but Maintain Access. GAO/HEHS-00-23. Washington, D.C.: 

December 14, 1999. 

Skilled Nursing Facilities: Medicare Payments Need to Better Account 

for Nontherapy Ancillary Cost Variation. GAO/HEHS-99-185. 

Washington, D.C.: September 30, 1999. 

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