[Federal Register Volume 65, Number 196 (Tuesday, October 10, 2000)]
[Proposed Rules]
[Pages 60151-60159]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-25935]



[[Page 60151]]

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DEPARTMENT OF HEALTH AND HUMAN SERVICES

Health Care Financing Administration

42 CFR Part 447

[HCFA-2071-P]
RIN 0938-AK12


Medicaid Program; Revision to Medicaid Upper Payment Limit 
Requirements for Hospital Services, Nursing Facility Services, 
Intermediate Care Facility Services for the Mentally Retarded, and 
Clinic Services

AGENCY: Health Care Financing Administration (HCFA), HHS.

ACTION: Proposed rule.

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SUMMARY: This proposed rule would modify Medicaid upper payment limits 
for inpatient hospital services, outpatient hospital services, nursing 
facility services, intermediate care facility services for the mentally 
retarded, and clinic services. For each type of Medicaid inpatient 
service, current regulations place an upper limit on overall aggregate 
payments to all facilities and a separate aggregate upper limit on 
payments made to State-operated facilities. This proposed rule would 
establish a third aggregate upper limit that would apply to payments 
made to all other types of government facilities that are not State-
owned or operated facilities.
    With respect to outpatient hospital and clinic services, current 
regulations place a single upper limit on aggregate payments made to 
all facilities. For these services, this proposed rule would establish 
a separate aggregate upper limit on payments made to State-owned or 
operated facilities and an aggregate upper limit on payments made to 
all other government-owned or operated facilities.
    These proposed upper limits are necessary to ensure State Medicaid 
payment systems promote economy and efficiency, while recognizing the 
higher cost of inpatient and outpatient services in public hospitals. 
In addition, to ensure continued access to care and the ability to 
adjust to proposed changes, the proposed rule includes a transition for 
States with approved State plan amendments.

DATES: We will consider comments if we receive them at the appropriate 
address, as provided below, no later than 5 p.m. on November 9, 2000.

ADDRESSES: Mail written comments (1 original and 3 copies) to the 
following address ONLY: Health Care Financing Administration, 
Department of Health and Human Services, Attention: HCFA-2071-P, P.O. 
Box 8010, Baltimore, MD 21244-8010.
    Because comments must be received by the date specified above, 
please allow sufficient time for mailed comments to be timely received 
in the event of delivery delays.
    If you prefer, you may deliver your written comments (1 original 
and 3 copies) to one of the following addresses: Room 443-G, Hubert H. 
Humphrey Building, 200 Independence Avenue, SW., Washington, DC 20201, 
or Room C5-14-03, 7500 Security Boulevard, Baltimore, MD 21244-1850.
    Comments mailed to the two above addresses may be delayed and 
received too late to be considered.

FOR FURTHER INFORMATION CONTACT: Robert Weaver, (410) 786-5914--Nursing 
facility services and intermediate care facility services for the 
mentally retarded.
    Larry Reed, (410) 786-3325--Inpatient and outpatient hospital 
services and clinic services.

SUPPLEMENTARY INFORMATION: Because of staff and resource limitations, 
we cannot accept comments by facsimile (FAX) transmission. In 
commenting, please refer to file code HCFA-2071-P. Comments received 
timely will be available for public inspection as they are received, 
generally beginning approximately 3 weeks after publication of a 
document, in Room 443-G of the Department's office at 200 Independence 
Avenue, SW., Washington, DC, on Monday through Friday of each week from 
8:30 to 5 p.m. (phone: (202) 690-7890).
    This Federal Register document is also available from the Federal 
Register online database through GPO Access, a service of the U.S. 
Government Printing Office. The Website address is: http://www.access.gpo.gov/nara/index.html.

I. Statutory and Regulatory Framework

    Title XIX of the Social Security Act (the Act) authorizes Federal 
grants to States for Medicaid programs that provide medical assistance 
to low-income families, elderly and persons with disabilities. Each 
State Medicaid program is administered by the State in accordance with 
an approved State plan. While the State has considerable flexibility in 
designing its State plan and operating its Medicaid program, it must 
comply with Federal requirements specified in the Medicaid statute, 
regulation and program guidance. Additionally, the plan must be 
approved by the Secretary, who has delegated this authority to HCFA.
    Section 1902(a)(30) of the Act requires a State plan to meet 
certain requirements in setting payment amounts to obtain Medicaid care 
and services. One of these requirements is that payment for care and 
services under an approved State Medicaid plan be consistent with 
efficiency, economy, and quality of care. This provision provides 
authority for specific upper payment limits (UPL) set forth in Federal 
regulations in 42 CFR part 447 relating to different types of Medicaid 
covered services. With respect to inpatient hospital services, nursing 
facility (NF) services and intermediate care facility services for the 
mentally retarded (ICF/MR), upper payment limits are set forth in 
regulations at Sec. 447.272, ``Application of upper payment limits.'' 
This provision limits overall aggregate State payments and aggregate 
payments to State-operated providers. With respect to outpatient 
hospital services and clinic services, upper payment limits are set 
forth in regulations at Sec. 447.321, ``Outpatient hospital services 
and clinic services: Upper limits of payment.''
    These regulations stipulate that aggregate State payments for 
services provided by each group of health care facilities, that is, 
inpatient hospital and outpatient hospital services, NF services, ICF/
MR services, and clinic services may not exceed a reasonable estimate 
of the amount the State would have paid under Medicare payment 
principles. Under Secs. 447.257, ``FFP: Conditions relating to 
institutional reimbursement,'' and 447.304, ``Adherence to upper 
limits; FFP, paragraph (c),'' FFP is not available for State 
expenditures that exceed the applicable upper payment limit.
    The statute also permits States some flexibility to use local 
government resources. Under section 1902(a)(2) of the Act, States may 
fund up to 60 percent of the non-Federal share of Medicaid expenditures 
with local government funds. Section 1903(w)(6) of the Act specifically 
limits the Secretary's ability to place restrictions on a State's use 
of certain funds transferred to it from a local unit of government 
subject to the requirements in section 1902(a)(2) of the Act.

II. Background

    Before 1981, States were required to pay rates for hospital and 
long term care services that were directly related to cost 
reimbursement. To obtain approval from HCFA, many States set rates 
using Medicare reasonable cost payment principles.
    In 1980 and 1981, the Congress enacted legislation, at section 962 
of the Omnibus Reconciliation Act of 1980 (OBRA `80), Pub. L. 96-499 
and section

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2173 of the Omnibus Budget Reconciliation Act of 1981 (OBRA `81), Pub. 
L. 97-35, collectively known as the ``Boren Amendment'' that amended 
section 1902(a)(13) of the Act to give States flexibility to deviate 
from Medicare's cost payment principles in setting payment rates for 
hospital and long term care services.
    The Boren Amendment was primarily considered a floor on State 
spending because it required States to set rates that would meet the 
costs incurred by efficiently and economically operated facilities. 
However, the Boren Amendment also supported upper payment limits on 
overall rates. In legislative history, the Congress directed the 
Secretary to maintain ceiling requirements that limited State payments 
in the aggregate from exceeding Medicare payment levels. The Senate 
Finance Committee report on the legislation states that ``the Secretary 
would be expected to continue to apply current regulations that require 
that payments made under State plans do not exceed amounts that would 
be determined under Medicare principles of reimbursement.'' S. Rep. No. 
96-471, 96 Cong., 1st Sess. 1979.
    In 1986, the Congress affirmed the use of upper limits on payments 
for inpatient hospital services, NF services and intermediate care 
facility (ICF) (now ICF/MR) services. Section 9433 of the Omnibus 
Budget Reconciliation Act of 1986 (Pub. L. 99-509) titled ``A 
Clarification of State Flexibility for State Medicaid Payment Systems 
for Inpatient Services'' precluded the Secretary from placing limits on 
State disproportionate share hospital (DSH) payments but maintained the 
application of limits on regular inpatient payment rates.
    The current upper limits were last changed in a final rule in the 
Federal Register (52 FR 28141) on July 28, 1987 that addressed the 
application of the upper payment limit to States that had multiple 
payment rates for the same class of services. This rule addressed the 
differential rate issue in the context of State-operated facilities 
because several audits had revealed that the circumstances of State-
operated facilities resulted in a lack of incentives to curb excessive 
payments. A high volume of uninsured patients will increase the costs 
of providing services in State-owned or operated facilities. These 
costs, in turn, are passed on to the State. To offset those higher 
costs, States established payment methodologies which paid State-owned 
or operated facilities at a higher rate than privately-operated 
facilities. Higher Medicaid payments to State-owned or operated 
facilities allowed States to obtain additional Federal Medicaid dollars 
to cover costs formerly met entirely by State dollars. To ensure 
payments to State-operated facilities would be consistent with 
efficiency and economy, the final rule applied the Medicare upper limit 
test to State-operated facilities separate from other facilities. 
However, the final rule did not create a separate upper payment limit 
for other government facilities, allowing their payments to count 
toward the same aggregate upper payment limit as private facilities.
    Section 4711 of the Balanced Budget Act of 1997 (BBA)(Pub. L. 105-
33) amended section 1902(a)(13) of the Act to increase State 
flexibility in rate setting by replacing the substantive requirements 
of the Boren amendment with a new public process. Under section 4711 of 
the BBA, States have flexibility to target rate increases to particular 
types of facilities so long as the rates are established in accordance 
with the new public process requirements.

III. Provisions of the Proposed Regulations

A. Description of the Problem

    It has become apparent that the current regulation creates a 
financial incentive for States to overpay non-State-operated government 
facilities because States, counties, cities and/or public providers 
can, through this practice, lower current State or local spending and/
or gain extra Federal matching payments. This practice is not 
consistent with Medicaid statute and has contributed to rapidly growing 
Medicaid spending.
    The incentive and ability for States to pay excessive rates to non-
State government-owned or operated Medicaid providers can be explained 
as follows. As stated previously, the current aggregate upper payment 
limit is applied to both private and non-State government-owned or 
operated facilities. By developing a payment methodology that sets 
rates for proprietary and nonprofit facilities at lower levels, States 
can set rates for county or city facilities at substantially higher 
levels and still comply with the current aggregate upper payment limit. 
The Federal government matches these higher payment rates to public 
facilities. Because these facilities are public entities, funds to 
cover the State share may be transferred from those facilities (or the 
local government units that operate them) to the State, thus generating 
increased Federal funding with no net increase in State expenditures. 
This is not consistent with the intent of statutory requirements that 
Medicaid payments be economical and efficient.
    On July 26, 2000, the Director of the Center for Medicaid and State 
Operations sent a letter to all State Medicaid Directors notifying them 
that ``the Administration is developing a proposal to ensure that 
Medicaid payments meet the statutory definition of efficiency and 
economy'' and that we would issue a proposed rule to address this 
problem. The Office of the Inspector General (OIG) and the General 
Accounting Office (GAO) have begun to monitor States with State plans 
that permit these types of payments. Both the GAO and OIG testified on 
the scope of the financing practices, their impact on State and Federal 
spending, and on the resultant uses of increased Federal funds. 
Preliminary results of OIG's work to date are described below.
    To date, the OIG has substantially completed reviews in three 
States and is continuing reviews in three additional States. Although 
the specifics of the enhanced payment programs and associated financing 
mechanisms differed somewhat in the three States they have reviewed 
thus far, they have found that the payment programs share some common 
characteristics. These similarities are included below:
    <bullet> The States did not base the enhanced payments on the 
actual cost of providing services or increasing the quality of care to 
the Medicaid residents of the targeted nursing facilities.
    <bullet> The counties involved in the enhanced payment process used 
little or none of the enhanced payments to provide services to Medicaid 
residents. Instead, the counties returned these funds to their original 
source. That is, the funds were returned to the State's general funds 
or used to repay loans that were made to initiate the transaction, or 
both.
    <bullet> The States were clear winners in that they were able to 
reduce their share of Medicaid costs and cause the Federal government 
to pay significantly more than it should for the same volume and level 
of Medicaid services. The Federal share of the enhanced funding went 
into State accounts and, in some cases, could be used for any purpose.
    <bullet> Some States effectively recycled the Federal funds 
received from these enhanced payments to generate additional Federal 
matching funds.
    Similarly, the GAO testified that current arrangements violate the 
basic integrity of Medicaid as a joint Federal/State program. By taking 
advantage of a technicality, these financing schemes allow States, in 
effect, to replace State

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Medicaid dollars with Federal Medicaid dollars.

B. Application of the Upper Payment Limit

    To address these problems, we are proposing to revise the 
regulations at Secs. 447.272, ``Application of upper payment limits,'' 
and 447.321, ``Outpatient hospital services and clinic services: Upper 
limits of payment,'' to establish separate upper payment limits for 
non-State government-owned or operated facilities. This approach is 
consistent with the last regulatory change which created separate upper 
payment limits for State-operated facilities. While the proposal would 
still allow for flexibility in payment methodologies, it prevents 
States from setting rates to public facilities well in excess of the 
average upper payment limit and the actual cost of providing Medicaid 
covered services to eligible individuals. This change is necessary to 
ensure that the Medicaid regulations conform to Medicaid statutory 
requirements that promote efficiency and economy.
    The upper payment limit requirements for Medicaid inpatient 
hospital services, NF services and ICF/MR services are set forth in 
regulations at Sec. 447.272. Paragraph (a) of this section provides 
that aggregate payments by an agency to each group of health care 
facilities (that is, hospitals, nursing facilities and ICFs for the 
mentally retarded (ICFs/MR)), may not exceed a reasonable estimate of 
what would have been paid for those services under Medicare payment 
principles. Paragraph (a) provides an exception to specify that 
disproportionate share hospital payments are not counted toward the 
general limit. We would amend paragraph (a) to specify that an 
exception also applies for payments made to non-State-owned or operated 
public hospitals under paragraph (b)(2) of this section.
    Paragraph (b) of this section currently limits aggregate payment to 
State-operated facilities in each class of service. We would revise 
Sec. 447.272(b) to establish an additional upper payment limit that 
would apply to payments made to all other types of government 
facilities. To establish this new upper payment limit, we propose to 
make the following changes to Sec. 447.272(b).
    Specifically, we propose to revise paragraph (b) of this section to 
specify that payments made to each type of government-owned or operated 
health care facility (that is, inpatient hospital, NF, ICF/MR) may not 
exceed the specified allowable limits. Proposed paragraph (b)(1) would 
continue the limitation on aggregate payments made to State-owned or 
operated facilities from exceeding a reasonable estimate of what would 
have been paid using Medicare payment principles. In addition, we 
propose to add a new paragraph (b)(2) that would impose an aggregate 
upper limit restriction on payments for services furnished by all other 
government-owned or operated facilities (other than Indian Health 
Service (IHS) facilities and tribal facilities funded through Pub. L. 
93-638) that are not State-owned or operated. (Although we invite 
specific comments, we excluded IHS facilities because we believe there 
is little incentive for States to pay enhanced rates to these 
facilities. Rates to these facilities are generally set by the State in 
accordance with rates published by the Federal government.) Under 
paragraph (b)(2), we would specify that aggregate payments to NFs IFCs/
MR may not exceed a reasonable estimate of what would have been paid 
for those services under Medicare payment principles. We would also 
specify that aggregate payment to non-State-owned or operated public 
hospitals may not exceed 150 percent of a reasonable estimate of what 
would have been paid for those services under Medicare payment 
principles.
    We are proposing a higher upper payment limit for services in non-
State-owned or operated public hospitals operated by governmental 
entities other than the State itself because we believe that allowing 
higher Medicaid payments will fully reflect the value of public 
hospitals' services to Medicaid and the populations it serves. Public 
hospitals are established to ensure access to needed care in 
underserved areas, and often provide a range of care not readily 
available in the community, including expensive specialized services, 
such as trauma and burn care and outpatient tuberculosis services. They 
also provide a significant proportion of the uncompensated care in the 
nation.
    The size and scale of public hospitals create extreme stresses and 
uncertainties, especially given their dependence on public funding 
sources. We are concerned that these stresses may threaten the ability 
of these public hospitals to fulfill their mission and fully serve the 
Medicaid population. As such, we are proposing a higher UPL for these 
facilities. Specifically, this higher aggregate UPL would allow States 
to pay non-State-owned or operated public hospitals up to 150 percent 
of the amount that would have been paid for inpatient and outpatient 
services using Medicare payment principles.
    We also recognize that, in some instances, these public hospitals 
may be required by State or local governments to transfer back a 
portion of payments that they receive under Medicaid. This practice 
raises serious concerns about whether the purposes of the higher 
payment limits being proposed for public hospitals will be met. To 
ensure that higher payment levels will assist in ensuring the stability 
of public hospitals as a vital link in the resources available for care 
to Medicaid beneficiaries, we intend to require in our final rule that 
payments made to public hospitals under this provision be separately 
identified and reported to HCFA. We request comment on the most 
suitable ways of reporting and accounting for these payments. In 
addition, we are soliciting comments on whether the 150 percent limit 
is appropriate.
    For outpatient hospital services and clinic services, the current 
upper payment limit is in regulations at Sec. 447.321. This limit 
precludes FFP on aggregate payments for outpatient hospital services 
and clinic services that exceed the amount that would be payable to all 
providers (State-owned or operated, other government-owned or operated, 
and private) under comparable circumstances under Medicare. Unlike 
other classes of services subject to the upper payment limit, there is 
no separate limit for State-owned or operated facilities. We propose to 
amend Sec. 447.321 to establish additional upper payment limits that 
would apply to aggregate payments for Medicaid services furnished by 
State-owned or operated and all other government-owned or operated 
facilities.
    We propose to move the current provisions under paragraph (a) of 
this section, as discussed below, to Sec. 447.304 and add a new 
paragraph (a) to conform the language in this section to the language 
in Sec. 447.272, for purposes of consistency within the Medicaid 
regulations. We would provide in Sec. 447.321(a) that aggregate 
payments by an agency to each group of health care facilities (that is, 
outpatient hospitals and clinics) may not exceed a reasonable estimate 
of what would have been paid for each of those services under Medicare 
payment principles. We would also specify that an exception applies for 
payments made to non-State-owned or operated public hospitals under 
paragraph (b)(2) of this section. Consistent with the changes to 
Sec. 447.272, we propose to establish separate upper payment limits for 
Medicaid services furnished by--(1) State-owned or operated facilities; 
and (2) all other government-owned or

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operated facilities that are not State-owned or operated. In 
Sec. 447.321, proposed paragraph (b)(1) would establish the upper 
payment limit for Medicaid services furnished by State-owned or 
operated facilities. Like the current UPL for inpatient hospital 
services, aggregate Medicaid payments for outpatient services or clinic 
services furnished by State facilities would be limited to a reasonable 
estimate of what would have been paid under Medicare reimbursement 
principles.
    Proposed paragraph (b)(2) would establish a similar aggregate upper 
limit restriction for Medicaid services furnished by all other 
government providers that are not State-owned or operated except that 
the payment maximum for outpatient services would be set at 150 percent 
of what would have been paid using Medicare payment principles. See the 
earlier discussion of our rationale for the higher limit to these 
public hospitals. Under the proposed limits in Secs. 447.272 and 
447.321, States would have flexibility to consider either Medicare 
principles of reasonable cost reimbursement or a Medicare prospective 
payment system if available, to estimate the Medicare payment amount 
for Medicaid services.
    In addition, we are moving the language regarding prohibition for 
FFP currently found in Sec. 447.321(a) to Sec. 447.304, ``Adherence to 
upper limits; FFP,'' paragraph (c). The provision in Sec. 447.304(c) 
currently specifies that FFP is available for State expenditures that 
do not exceed upper limits. We propose to revise this section to 
specify that FFP is not available for payment that exceeds the upper 
limits specified in subpart F. This revision would conform to our 
approach in Sec. 447.257.

C. Transition Periods for States That Have Approved Rate Enhancement 
Payment Arrangements

    We recognize that the new upper payment limits we are proposing may 
disrupt State budget arrangements for States with approved enhanced 
plan amendments. Therefore, we are proposing a transition policy for 
States with approved rate enhancement amendments that would be affected 
by the proposed UPLs. We refer to these amendments as noncompliant 
because they result in payments that exceed the maximum amount 
allowable under the new UPLs. We are proposing two transition periods 
and are soliciting comments on the material elements of these 
transition periods, including the starting point for the phase-out, the 
percentage reduction each year, and whether a longer or shorter period 
would be appropriate.
    1. Transition period for noncompliant approved State plan 
amendments effective on or after October 1, 1999.
    For noncompliant approved State plan amendments with an effective 
date on or after October 1,1999, we are proposing a transition period 
that would end on September 30, 2002. Because these programs are 
relatively new (in fact, some may be deemed approved during the comment 
period for this proposed rule), States are not likely to have developed 
the same level of reliance on the enhanced payments addressed in this 
proposed rule as States with older programs. Additionally, during the 
review period for these amendments, we have been informing States of 
our intent to curtail this practice and advising them not to rely on 
the continuation of this funding. For these reasons, we believe a short 
transition period is appropriate.
    2. Transition period for noncompliant approved State plan 
amendments effective before October 1, 1999.
    For noncompliant approved State plan amendments with an effective 
date before October 1, 1999, we are proposing a 3-year transition 
period beginning in the State FY that begins calendar year 2002.
    We propose to implement the reductions on a State Fiscal Year (FY) 
basis starting with the first full State FY that begins in calendar 
year 2002. Specifically, the transition generally consists of reducing 
aggregate payments with the proposed classes to the proposed UPLs in 
increments, with the proposed UPL becoming fully effective in the first 
State FY beginning in Calendar Year 2005. In the first year of 
implementation, States would have to reduce the aggregate payments 
above the new UPL by 25 percent. In the second year, the amount of 
excess aggregate payments must be reduced by 50 percent and in the 
third year by 75 percent. By the first day of the fourth year, State 
payments would have to be in compliance with the new UPL policy.
    We are proposing to use State FY 2000 as the base period to 
determine the excess payment that must be phased down. To compute the 
dollar amount of the excess, States would be required to compare State 
FY 2000 payments paid to the current class of providers to the maximum 
aggregate payments for its new class of providers (that is, State-owned 
or operated and other government-owned or operated) under the proposed 
UPL for State FY 2000. The difference is considered the excess payment 
that must be phased out over the transition period.
    The table below illustrates the transition policy. In this example, 
State FY 2000 payments for nursing facility services provided by other 
government-owned or operated providers are $300 million and new UPL is 
$100 million. The amount in excess of the upper payment limit, $200 
million, must be reduced in successive State FYs by 25 percent, 50 
percent and 75 percent respectively. The steps to calculate the maximum 
allowable payment during this transition period are as follows:
    <bullet> Subtract the amount that would have been allowed under the 
new UPL for State FY 2000 services from the State FY 2000 payment.
    <bullet> Multiply that difference by the phase down rate.
    <bullet> Add to that result, the new UPL for Medicaid services 
furnished on or after State FY 2000.
    At the end of the transition period, State payments would have to 
be in full compliance with the new upper payment limit.

[[Page 60155]]



     Table--Illustrative Example of Transition \1\ Other Government-Owned or Operated Nursing Home Providers
                                              [Dollars in millions]
----------------------------------------------------------------------------------------------------------------
                                                               SFY 2003*     SFY 2004     SFY 2005     SFY 2006
----------------------------------------------------------------------------------------------------------------
Excess Payment in SFY 2000 \2\..............................          200          200          200          200
Phase-out rate (in percent).................................          25%          50%          75%         100%
Maximum allowable excess....................................          150          100           50            0
New UPL \3\.................................................          105          110          115          120
Transition UPL..............................................          255          210          165         120
----------------------------------------------------------------------------------------------------------------
* Assumes that the SFY 2003 begins on July 1, 2002.
\1\ State FY 2001 and State FY 2002 payments would not be subject to this proposed rule because it assumes that
  the transition period begins in State FY 2003.
\2\ The $200 million excess payment is derived by subtracting the new aggregate UPL for State FY 2000 services
  provided by other government-owned or operated providers from the actual FY 2000 payment made to these
  providers.
\3\ Assumes $5 million annual growth in the program.

    To implement these provisions, we propose to make further revisions 
to Secs. 447.272 and 447.321 to include regulations that establish 
transition periods for States that will be affected by the new upper 
payment limits that we are proposing.
    Specifically, Sec. 447.272 sets forth the rules regarding the 
application of the upper payment limit requirements for Medicaid 
inpatient hospital services, NF services and ICF/MR services. We 
propose to revise Sec. 447.272(b) to establish a shorter-term 
transition period and a 3-year transition period. Specifically, 
proposed paragraph (b)(2)(i) of this section would specify that 
noncompliant State plan amendments effective on or after October 1, 
1999 and approved before the effective date of the final rule have 
until September 30, 2002 to come into compliance with the requirements 
of the new upper payment limits. Proposed paragraph (b)(2)(ii) of this 
section would specify that noncompliant approved State plan amendments 
effective before October 1, 1999 are allowed a 3-year transition period 
beginning in the State FY that begins in calendar year 2002. Paragraph 
(b)(2) of this section refers to payments made to those other 
government-owned or operated facilities that are not State-owned or 
operated.
    Section 447.321 sets forth rules regarding the application of the 
upper payment limit requirements for Medicaid outpatient hospital 
services and clinic services. We are proposing similar revisions to 
Sec. 447.321(b) to include our proposed transition periods. We apply 
these transition periods to States for payments made to State-owned or 
operated facilities and other government-owned or operated facilities 
described in proposed paragraphs (b)(1) and (b)(2) of this section. 
Specifically, proposed paragraphs (b)(1)(i) and (b)(1)(ii) of this 
section would specify the requirements for the short-term and the 3-
year transition periods for State-owned or operated facilities. 
Proposed paragraphs (b)(2)(i) and (b)(2)(ii) of this section would set 
forth the short-term and the 3-year transition periods for all other 
government-owned or operated facilities.
    To the extent this regulation alters allowable Medicaid 
expenditures in a State with a section 1115 title XIX waiver, the 
estimates of the expected cost to the Federal government without the 
waiver will be adjusted (upward or downward) to accurately reflect 
these changes in allowable Medicaid expenditures. These adjustments are 
consistent with current section 1115 waiver budget neutrality policy.

IV. Response to Comments

    Because of the large number of items of correspondence we normally 
receive on Federal Register documents published for comment, we are not 
able to acknowledge or respond to them individually. We will consider 
all comments we receive by the date and time specified in the DATES 
section of this preamble, and, if we proceed with a subsequent 
document, we will respond to the major comments in the preamble to that 
document.

V. Regulatory Impact Analysis

A. Introduction

    We have examined the impact of this rule as required by Executive 
Order (EO) 12866, the Unfunded Mandates Act of 1995, and the Regulatory 
Flexibility Act (RFA) (Pub. L. 96-354). Executive Order 12866 directs 
agencies to assess all costs and benefits of available regulatory 
alternatives and, if regulation is necessary, to select regulatory 
approaches that maximize net benefits (including potential economic, 
environmental, public health and safety effects, distributive impacts, 
and equity). A regulatory impact analysis (RIA) must be prepared for 
major rules with economically significant effects ($100 million or more 
in any one year).

B. Overall Impact

    We are unable to provide a specific dollar estimate of the economic 
impact this proposed regulation will have on State and local 
governments and Medicaid participating health care facilities due to 
data limitations and State behavioral responses. This proposed 
regulation does not reduce the overall aggregate amount States can 
spend on Medicaid services or place a fixed ceiling on the amount of 
State spending that will be eligible for Federal matching dollars. 
Under the proposed limitations, States will be able to set reasonable 
rates as determined under Medicare payment principles for Medicaid 
services furnished by public providers to eligible individuals. The 
amount of spending permitted under the proposed limits will vary 
directly with the amount of Medicaid services furnished by public 
providers to eligible individuals. While the proposed regulation does 
not affect the overall aggregate amount States can spend, by setting an 
upper payment limit for government providers, it may impact how States 
distribute available funding to participating health care facilities.
    We have identified 28 States with approved and/or pending rate 
proposals that target enhanced Medicaid payments to hospital and 
nursing service providers that are owned or operated by county or local 
governments. There are 17 States with approved State plan amendments or 
waivers and 7 States with pending plan amendments. In addition, there 
are 4 States that have both approved and pending plan amendments. We 
estimate that these proposals currently account for approximately $3.7 
billion in Federal spending annually. This estimate is based on State 
reported Federal fiscal information submitted with State plan 
amendments and State expenditure

[[Page 60156]]

information where available. It may be understated or overstated to the 
degree that actual State expenditures would vary from the estimates 
included with State plan submissions. For example, a State could 
include a provision in its State Medicaid plan that would enable it to 
spend up to allowable amounts by making additional payments to 
designated providers. Under this scenario, if the upper payment 
limitation permitted the State to spend an additional $200 million, the 
actual annual expenditure could vary from zero to $200 million 
depending upon the State's willingness to finance its share of the 
payment. In the final rule, we may revise our estimate of $3.7 billion 
in Federal spending to reflect findings reported by the OIG and the 
GAO.
    Of this $3.7 billion in spending, we do not have sufficient 
information to permit us to quantify accurately the amount of payments 
to State and local government providers that may exceed the proposed 
upper payment limits. In addition, because some States may be using the 
Federal share of enhanced payments in a manner that allows some funds 
to be re-invested in Medicaid (and thereby drawing down additional 
FFP), the potential impact may extend to other Medicaid services not 
reflected in the above spending. Because we believe that the potential 
impact will exceed $100 million, we consider this proposed rule to be a 
major rule.
    We are seeking information to help us quantify the impact of this 
proposed rule. We invite comments on how the proposed rule may affect 
State Medicaid programs and other State programs. In particular, we 
seek information to help us quantify the fiscal impact of this proposed 
rule (also taking into account the proposed transition periods and 
higher UPLs for non-State-owned or operated public hospitals) on State 
Medicaid programs and other State programs.

C. Impact on Small Entities and Rural Hospitals

    The Regulatory Flexibility Act requires agencies to analyze options 
for regulatory relief of small entities. For purposes of the RFA, small 
entities include small businesses, nonprofit organizations and 
government agencies. Most hospitals and most other providers and 
suppliers are small entities, either by nonprofit status or by having 
revenues of $5 million or less annually. For purposes of the RFA, all 
hospitals, nursing facilities, intermediate care facilities for the 
mentally retarded, and clinics are considered to be small entities. 
Individuals and States are not included in the definition of a small 
entity.
    In addition, section 1102(b) of the Act requires us to prepare a 
regulatory impact analysis if a rule may have a significant impact on 
the operations of a substantial number of small rural hospitals. This 
analysis must conform to the provisions of section 603 of the RFA. For 
purposes of section 1102(b) of the Act, we define a small rural 
hospital as a hospital that is located outside of a Metropolitan 
Statistical Area and has fewer than 50 beds.
    The chart below indicates the type and number of providers 
potentially affected by this regulation in all 50 States and the 
District of Columbia. We included facilities in all 50 States because 
although every State is not currently making enhanced payments to 
government non-State-owned or operated facilities, this rule will 
prevent new proposals from all States in the future. We do not believe 
any States have payment arrangements with providers of ICF/MR services 
or clinic services that will be affected by this regulation and 
therefore we did not include those providers in the chart below.

                                Potentially Affected Providers by Number and Type
----------------------------------------------------------------------------------------------------------------
                                                               Government state-   Government non-
                        Provider type                               owned or        state-owned or      Total
                                                                    operated           operated
----------------------------------------------------------------------------------------------------------------
Nursing Facilities...........................................            \1\ N/A                892          892
Hospitals....................................................                254              1,275       1,529
----------------------------------------------------------------------------------------------------------------
\1\ These facilities are already subject to a separate aggregate UPL and will not be affected by the final rule.

    As explained earlier in the preamble, it is very difficult to 
predict how States will respond to the proposed rule and consequently 
how State decisions will impact Medicaid providers. Each State makes 
its own budgetary and rate setting decisions. Since we do not collect 
information about the specific services that providers use Medicaid 
payments to support, we cannot determine how potential payment rate 
adjustments will affect providers or the patients they serve. Under the 
proposed UPLs, States would continue to be able to set rates that 
provide fair compensation for Medicaid services furnished to Medicaid 
patients. Hospitals that are owned or operated by local governments may 
benefit from the higher UPLs we are proposing for inpatient and 
outpatient services. Additionally, if these hospitals furnish services 
to indigent patients, they may qualify as a DSH and qualify for funding 
under a State's program. With respect to small entities that are not 
government-owned or operated, the proposed UPLs do not apply to them 
and therefore, they should not be impacted.
    With respect to the impact on small rural hospitals, we do not 
believe the proposed rule will have a significant overall impact on 
rural hospitals. With respect to Medicaid services furnished by rural 
hospitals, the proposed upper payment limits do not interfere with 
States setting rates that result in fair compensation. Additionally, 
rural hospitals that are owned or operated by local governments should 
be able to benefit from the higher UPLs we are proposing for inpatient 
and outpatient hospital services. Finally, if a rural hospital provides 
services to indigent patients, they may qualify as a DSH and qualify 
for funding under a State's DSH payment program.
    We invite public comment on the possible effects this proposed rule 
may have on small entities in general and on small rural hospitals in 
particular.

D. Alternatives Considered

    Section 1902(a)(30) of the Act requires in part that Medicaid 
service payments be consistent with efficiency and economy. In addition 
to the interpretation we are proposing in this proposed rule, we 
considered several other alternatives to ensure Medicaid service 
payments are consistent with economy and efficiency. In this section, 
we will explain these other alternatives and why we did not select 
them.
    1. Facility-Specific Upper Payment Limit. Under this option, 
Medicaid spending would be limited on a provider-specific application 
of Medicare payment principles. FFP

[[Page 60157]]

would not be available on the amount of Medicaid service payment in 
excess of what a provider would have been paid using Medicare payment 
principles.
    These limits would be applied to all institutions, or just to 
public institutions where the incentives for over-payment are 
significant. While a facility-specific limitation may be the most 
effective method to ensure State service payments are consistent with 
economy and efficiency, when balanced against the additional 
administrative requirements on States and the congressional intent for 
States to have flexibility in rate setting, we are not sure that the 
increased amount of cost efficiency, if any, justifies this approach as 
a viable option.
    2. Government-owned or Operated Upper Payment Limit. This proposal 
would limit, in the aggregate, the amount of payment States can make to 
public providers. Under this proposal, State and local government 
providers would be grouped together and payments to them as a group 
could not exceed an aggregate limit. The aggregate limit would continue 
to be based on Medicare payment principles. This option, relative to 
upper payment limitations we are proposing, would have allowed States 
to exercise more flexibility granted to them in the rate setting 
process. While this option permits more flexibility, we believe the 
aggregation of Medicaid service payments by all types of government 
providers would have the unintended consequence of reopening 
differential rate issues between State facilities and other types of 
government facilities.
    3. Intergovernmental Transfers (IGTs). Because in many cases we 
believe there is a connection between excessive payments and IGTs, we 
gave consideration to formulating policy with respect to them. 
Generally, States have genuine incentive to set Medicaid service rates 
at levels consistent with economy and efficiency since they share the 
financial burden with the Federal government. As explained in section 
III of the preamble, the use of IGTs to move funds between government 
entities makes it possible to generate enhanced Federal matching 
payment. However, we did not pursue this alternative because we 
recognize that States, counties, and cities have developed their own 
unique arrangements for sharing in Medicaid costs. Furthermore, there 
are statutory limitations placed on the Secretary which limit the 
authority to place restrictions on IGTs.
    4. ``Grandfathering'' existing arrangement. Under this proposal, we 
would not approve any new plan amendments after the effective date of 
the final rule. This would permit States that are currently making 
excessive payments to local government facilities to continue making 
such payments indefinitely. Allowing some States to permanently 
continue making excessive payments solely because they were approved 
before this rule is published and effective appears to be arbitrary, 
capricious, and inconsistent with our administrative authority.
    We invite comment on these alternatives we considered and on other 
possible approaches for achieving our objective to ensure Medicaid 
service payments are consistent with efficiency and economy. We 
specifically invite comment on alternative means of setting the maximum 
amount that may be paid to public hospitals that have traditionally 
provided ``safety-net'' care and services to underserved communities 
and individuals who are uninsured. We request information regarding the 
mechanisms used to finance these hospitals under current regulations, 
as well as proposals for a means of curbing excessive payments while 
allowing States the flexibility to recognize higher costs faced by 
these hospitals.

E. The Unfunded Mandates Act

    The Unfunded Mandates Reform Act of 1995 also requires (in section 
202) that agencies perform an assessment of anticipated costs and 
benefits before proposing any rule that may result in a mandated 
expenditure in any one year by State, local, or Tribal governments, in 
the aggregate, or by the private sector, of $100 million. Absent FFP, 
we do not believe States will continue to set excessive payment rates 
for Medicaid services furnished by government providers. Generally, 
discontinuing an expenditure should not result in new costs, unless the 
State has to fund the portion of the expenditure that is no longer 
Federally funded with all State and local dollars. There are no Federal 
requirements under the Medicaid statute that mandate States to make 
these type of payments to Medicaid public providers and therefore we do 
not believe the proposed limits have any unfunded mandate implications.

F. Federalism

    Executive Order 13132 establishes certain requirements that an 
agency must meet when it promulgates a proposed rule (and subsequent 
final rule) that imposes substantial direct compliance costs on State 
and local governments, preempts State law, or otherwise has Federalism 
implications.
    In developing the interpretative policies set forth in this 
proposed rule, we met with interested parties and listened to their 
ideas and concerns. These discussions were held with members of 
Congress and their staff. We also met with various associations 
representing State and local governments including the National 
Governors' Association, the National Conference of State Legislatures, 
and the National Association of State Medicaid Directors. In addition, 
we met with many hospital associations, advocacy groups, labor 
organizations, and numerous other interested parties. We do not believe 
this proposed rule in any way imposes substantial direct compliance 
costs on State and local governments or preempts or supersedes State or 
local law.
    The financial implications of this proposed rule are highly 
uncertain for the reasons we have previously indicated. We anticipate 
that many State Medicaid programs will be unaffected by the upper 
payment limits we are proposing. With respect to affected States, to 
some degree we will be limiting flexibility in the management of their 
Medicaid programs. If these States wish to continue to make payments in 
excess of the proposed limits, they will have to fund the amount in 
excess with only State and local resources. In the absence of FFP, we 
anticipate States will reinvest these resources to support other 
Medicaid activities to take advantage of and maintain Federal 
resources. Should States realign their payment systems or divert State 
matching dollars to support other Medicaid activities, the total amount 
of available Federal funds should remain unchanged.

G. Executive Order 12866

    In accordance with the provisions of Executive Order 12866, this 
regulation was reviewed by the Office of Management and Budget.

List of Subjects in 42 CFR Part 447

    Accounting, Administrative practice and procedure, Drugs, Grant 
programs--health, Health facilities, Health professions, Medicaid, 
Reporting and recordkeeping requirements, Rural areas.
    For the reasons set forth in the preamble, 42 CFR part 447 is 
proposed to be amended as follows:

PART 447--PAYMENTS FOR SERVICES

    1. The authority citation for part 447 continues to read as 
follows:


[[Page 60158]]


    Authority: Sec. 1102 of the Social Security Act (42 U.S.C. 
1302).

    2. In Sec. 447.272 revise paragraphs (a) and (b) to read as 
follows:


Sec. 447.272  Application of upper payment limits.

    (a) General rule. Except as provided in paragraphs (b)(2) and (c) 
of this section, aggregate payments by an agency to each group of 
health care facilities (that is, hospitals, nursing facilities and ICFs 
for the mentally retarded (ICFs/MR)), may not exceed a reasonable 
estimate of what would have been paid for those services under Medicare 
payment principles.
    (b) Government-owned or operated facilities. In addition to being 
subject to the requirements in paragraph (a) of this section, payments 
by an agency to each group of government-owned or operated health care 
facilities (that is, hospitals, nursing facilities and ICFs for the 
mentally retarded (ICFs/MR)), may not exceed the limits specified in 
paragraph (b)(1) or (b)(2) of this section.
    (1) State-owned or operated facilities. Aggregate payments to 
State-owned or operated facilities may not exceed a reasonable estimate 
of what would have been paid for those services under Medicare payment 
principles.
    (2) Other government-owned or operated facilities. Except for 
public hospitals, aggregate payments to all other government-owned or 
operated facilities (other than Indian Health Services facilities (IHS) 
and tribal facilities funded through Pub. L. 93-638) may not exceed a 
reasonable estimate of what would have been paid for those services 
under Medicare payment principles. Payment to non-State-owned or 
operated public hospitals may not exceed 150 percent of a reasonable 
estimate of what would have been paid for those services under Medicare 
payment principles, except as provided below.
    (i) Transition period for noncompliant State plan amendments 
effective on or after October 1, 1999 and approved before the effective 
date of the final rule. Enhanced payment arrangements with an effective 
date on or after October 1, 1999 and approved before the effective date 
of the final rule must come into compliance by September 30, 2002.
    (ii) Transition period for noncompliant approved State plan 
amendments effective before October 1, 1999. A 3-year transition period 
applies to approved State payment arrangements with an effective date 
before October 1, 1999. During the 3 successive State fiscal years 
beginning in State FY 2003, State payments must comply with the 
excessive payment phase down payment reduction schedule.
    (iii) State payments may not exceed the lower of the base State FY 
2000 payments or the following limits:

State FY 2003 UPL + .75x
State FY 2004 UPL + .50x
State FY 2005 UPL + .25x
UPL = Upper Payment Limit.
X = Payments to local government providers less the UPL described in 
Sec. 447.272(b)(2) for services furnished in State FY 2000.

    3. In Sec. 447.304, revise paragraph (c) and remove the note to 
read as follows:


Sec. 447.304  Adherence to upper limits; FFP.

* * * * *
    (c) FFP is not available for a State's expenditures for services 
that are in excess of the amounts allowable under this subpart.
    4. Section 447.321 is revised to read as follows:


Sec. 447.321  Outpatient hospital services or clinic services: 
Application of upper payment limits.

    (a) General rule. Except as provided in paragraph (b)(2) of this 
section, aggregate payments by an agency to each group of health care 
facilities, (that is, outpatient hospitals or clinics) may not exceed a 
reasonable estimate of what would have been paid for each of those 
services under Medicare payment principles.
    (b) Government-owned or operated facilities. In addition to being 
subject to the requirements in paragraph (a) of this section, payments 
by an agency to each group of government-owned or operated health care 
facilities, (that is, outpatient hospitals or clinics) may not exceed 
the limits specified in paragraph (b)(1) or (b)(2) of this section.
    (1) State-owned or operated facilities. Aggregate payments to 
State-owned or operated facilities may not exceed a reasonable estimate 
of what would have been paid for those services under Medicare payment 
principles, except as provided below.
    (i) Transition period for noncompliant State plan amendments 
effective on or after October 1, 1999 and approved before the effective 
date of the final rule. Enhanced payment arrangements with an effective 
date on or after October 1, 1999 and approved before the effective date 
of the final rule must come into compliance by September 30, 2002.
    (ii) Three-year phase down transition period for noncompliant 
approved State plan amendments effective before October 1, 1999. A 3-
year transition period applies to approved State payment arrangements 
with an effective date before October 1, 1999. During the 3 successive 
State fiscal years beginning in State FY 2003, State payments must 
comply with the excessive payment phase down payment reduction 
schedule.
    (iii) State payments may not exceed the lower of the base State FY 
2000 payments or the following limits:

State FY 2003 UPL + .75X
State FY 2004 UPL + .50x
State FY 2005 UPL + .25x
State FY 2006 UPL
UPL = Upper Payment Limit
X = Payments to local government providers and State-owned or 
operated providers less the applicable UPL described in 
Sec. 447.321(b) for services furnished in State FY 2000.

    (2) Other government-owned or operated facilities. Except for 
public hospitals, aggregate payments to all other government-owned or 
operated facilities (other than Indian Health Services facilities (IHS) 
and tribal facilities funded through Pub. L. 93-638) may not exceed a 
reasonable estimate of what would have been paid for those services 
under Medicare payment principles. Payment to non-State-owned or 
operated public hospitals may not exceed 150 percent of a reasonable 
estimate of what would have been paid for those services under Medicare 
payment principles, except as provided below.
    (i) Transition period for noncompliant State plan amendments 
effective on or after October 1, 1999 and approved before the effective 
date of the final rule. Enhanced payment arrangements with an effective 
date on or after October 1, 1999 and approved before the effective date 
of the final rule must come into compliance by September 30, 2002.
    (ii) Three-year phase down transition period for noncompliant 
approved State plan amendments effective before October 1, 1999. A 3-
year transition period applies to approved State payment arrangements 
with an effective date before October 1, 1999. During the 3 successive 
State fiscal years beginning in State FY 2003, State payments must 
comply with the excessive payment phase down payment reduction 
schedule.
    (iii) State payments may not exceed the lower of the base State FY 
2000 payments or the following limits:

State FY 2003 UPL + .75X
State FY 2004 UPL + .50x
State FY 2005 UPL + .25x
State FY 2006 UPL
UPL = Upper Payment Limit
X = Payments to local government providers and State-owned or 
operated providers less the UPL described in Sec. 447.321(b)(1) for 
services furnished in State FY 2000.

(Catalog of Federal Domestic Assistance Program No. 93.778, Medical 
Assistance Program)

[[Page 60159]]

    Dated: October 3, 2000.
Michael M. Hash,
Acting, Administrator, Health Care Financing Administration.
    Approved: October 4, 2000.
Donna E. Shalala,
Secretary.
[FR Doc. 00-25935 Filed 10-5-00; 1:00 pm]
BILLING CODE 4120-01-P