Medicare payment policies for technical pathology services have changed over the years as new payment systems for hospital and physician services have been implemented and modified. Beginning with the implementation of the hospital inpatient PPS on October 1, 1983, through the implementation of the Medicare physician fee schedule (MPFS) on January 1, 1992, and the outpatient PPS on August 1, 2000, payment for technical pathology services changed as fixed, predetermined payment replaced reasonable cost or charge-based reimbursement for Medicare services. Under the inpatient PPS, each inpatient stay is classifed into a diagnosis- related group (DRG) based primarily on the patient’s condition. Each DRG has a payment weight assigned to it that reflects the relative cost of inpatient treatment for a patient in that group compared with that for the average Medicare inpatient. Included in the costs of each DRG are nonphysician services provided to inpatients by the hospital and its outside suppliers. A hospital receives a DRG payment from Medicare and a deductible amount from a beneficiary for each inpatient benefit period.Each year, the DRG weights are recalibrated to account for changes in resource use, and the payment rate is adjusted by an update factor to account for changes in market conditions, practice patterns, and technology. Medicare separately pays physicians, including pathologists, and certain other professionals for the direct services they provide to inpatients. When developing the inpatient PPS in the early 1980s, HCFA determined that technical pathology services outsourced to laboratories were an integral part of the professional services provided by the laboratories’ pathologists, not separate nonphysician services. Based on that determination, the payment for technical pathology services provided by laboratories was included in the larger payment to the laboratories and not included in the PPS payments. In 1992, HCFA implemented the MPFS, which created distinct payments for the professional and technical components of most diagnostic services, including pathology services. Although the MPFS included a distinct payment to laboratories for technical pathology services, HCFA did not revise its policy to prohibit laboratories from continuing to receive the separate Medicare payment for outsourced technical pathology services provided to inpatients. Under the MPFS, beneficiaries are responsible for a copayment equal to 20 percent of the payment for physician services, including technical pathology services. Thus, inpatient beneficiaries whose technical pathology services were outsourced by a hospital to a laboratory that received direct payment from Medicare were responsible for a copayment, while other inpatients were not. On July 22, 1999, HCFA proposed ending Medicare payments under the MPFS to laboratories for technical pathology services provided to hospital inpatients on or after January 1, 2000. Under the proposal, laboratories, like suppliers of other nonphysician services, would have to seek payment from hospitals for technical pathology services provided to hospital inpatients. HCFA’s rationale for its proposed rule was that payment for technical pathology services provided to beneficiaries was already included in the inpatient PPS. When implementing the inpatient PPS, HCFA established separate payment rates for rural and urban hospitals based on data from hospitals’ cost reports submitted to the agency. Hospitals that performed their own technical pathology services included such costs in their cost reports, while hospitals outsourcing these services did not. According to HCFA, urban hospitals generally performed such services, and in part, their higher rates reflected that. Consequently, in HCFA’s view, when the separate rural rate was eliminated in 1995 and rural hospitals began receiving the higher rate paid to most urban hospitals, the cost of technical pathology services was included in that payment. Thus, HCFA concluded that when a laboratory received payment from Medicare for technical pathology services provided to a hospital inpatient, Medicare was paying twice for the same service—once to the hospital as part of the PPS payment and once to the laboratory through the MPFS. A second reason HCFA cited to support its proposed rule was concern that hospital outsourcing arrangements with laboratories to provide technical pathology services would proliferate if hospitals realized these arrangements would reduce their costs without any reduction in their inpatient PPS payments. After considering comments from the hospital industry and laboratories, which stated, in part, that they would need additional time to renegotiate their agreements, in the final rule, HCFA delayed implementation of the policy until January 1, 2001. In December 2000, the Congress enacted provisions in BIPA that stated that laboratories furnishing technical pathology services to hospital patients under agreements with hospitals as of the publication date of the HCFA proposed rule could continue to receive payment directly from Medicare for these services until January 1, 2003. Because the outpatient PPS was implemented in August 2000, the provisions applied to services provided to outpatients as well as inpatients. The outpatient PPS pays hospitals a predetermined amount per service similar to a fee schedule. All services paid under the outpatient PPS, including technical pathology services, are classified into groups called ambulatory payment classifications (APC). Like inpatient DRGs, the relative weights of the APCs are adjusted annually by recalibration and the payment rates by an update factor to account for changes in resource use, technology, practice cost, and service delivery. When the outpatient PPS was implemented, beneficiary copayments for a service were generally 20 percent of the hospitals’ median charges for that service in 1996, updated to 1999. Therefore, the beneficiary cost-sharing obligation as a percentage of APC payment rates varies by service. Because the median charges were often higher than the APC payment rates implemented with the outpatient PPS, beneficiary copayments were frequently as high or higher than 50 percent of the total APC payment amount. The Balanced Budget Act of 1997 established a mechanism to gradually decrease the cost-sharing percentages for all APCs to 20 percent over time. The copayments that beneficiaries are responsible for paying under the outpatient PPS for technical pathology services that are furnished directly by hospitals are roughly comparable to the copayments that beneficiaries are responsible for paying laboratories under the MPFS when services are outsourced. The outpatient PPS payment rates for technical pathology services are significantly lower than the corresponding MPFS payment rates, but outpatient PPS copayments represent a higher percentage of the payment for technical pathology services than MPFS copayments. If the BIPA provisions are not reinstated and CMS terminates direct payments to laboratories, hospitals would have to negotiate payment amounts with laboratories to pay them directly for services delivered to inpatient and outpatient beneficiaries or begin to supply these services themselves. While the hospitals would not experience any direct adjustments to their inpatient DRG payments, over time, hospital costs of paying laboratories for technical pathology services would be reflected in the DRG weights, as the annual recalibration accounts for changes in the costs of delivering services. For services delivered to outpatients, hospitals would bill Medicare under the outpatient PPS for technical pathology services and, therefore, would recover additional revenue even if they continued to outsource these services to laboratories. Inpatient beneficiaries of hospitals that outsource technical pathology services would no longer be responsible for additional copayments to the laboratories. Outpatient beneficiaries would no longer be responsible for copayments to laboratories under the MPFS, but instead would be responsible for copayments to the hospitals where they received their services under the outpatient PPS. CAHs, which as of March 2003 constituted 15 percent of all hospitals and 31 percent of rural hospitals, would not be affected by the termination of direct laboratory payments. CAHs are not paid under the inpatient and outpatient PPS, but instead are paid based on their reasonable costs of providing services. Currently, CAHs receive no payment from Medicare for technical pathology services outsourced to laboratories that directly bill Medicare because CAHs incur no costs in the delivery of those services. If direct laboratory payments are terminated, CAHs would be reimbursed by Medicare for their costs of paying laboratories to perform technical pathology services, and outpatient beneficiaries who currently are responsible for paying 20 percent of the payment for their technical pathology services to the laboratories under the MPFS would instead be responsible for paying 20 percent of the CAHs’ customary charges. See table 1 for a description of Medicare payments to outsourcing PPS hospitals and CAHs, and table 2 for a description of beneficiary cost- sharing obligations at outsourcing PPS hospitals and CAHs, under current policy and if direct payment to laboratories is terminated. We estimate that in 2001, 4,773 PPS hospitals and CAHs, representing 95 percent of all such facilities, outsourced at least some technical pathology services to laboratories that received direct payment from Medicare for those services (see table 3). However, most hospitals outsourced a small number of these services to laboratories. In 2001, approximately 1.4 million technical pathology services were outsourced, and the median number of outsourced services per hospital was 81. Approximately 68 percent of all hospitals outsourced 200 or fewer technical pathology services, and only 6 percent outsourced more than 1,000 services. Outsourcing hospitals consisted of 2,428 urban PPS facilities and 1,651 rural PPS facilities, representing 95 percent and 97 percent of urban and rural PPS hospitals in 2001, respectively, and 694 CAHs. Among hospitals outsourcing technical pathology services, urban hospitals, including CAHs, outsourced a median of 97 services and 64 percent of all services, and rural hospitals, including CAHs, outsourced a median of 61 services and 36 percent of all services. Almost twice as many services were delivered to outpatient beneficiaries compared to inpatient beneficiaries, as outpatient services accounted for approximately 64 percent of all outsourced services. If laboratories had not received direct payment for services for hospital patients, we estimate that Medicare spending would have been $42 million less in 2001, with $18 million and $24 million in savings for inpatient and outpatient services, respectively, and overall beneficiary cost sharing would have been reduced by $2 million. In 2001, payments to laboratories providing technical pathology services to beneficiaries who were hospital patients equaled over $63 million, including Medicare payments of about $51 million ($18 million for inpatient services and $33 million for outpatient services) and beneficiary copayments of almost $13 million ($5 million for inpatient services and $8 million for outpatient services). Paying laboratories to provide technical pathology services is unlikely to impose a large financial burden on most hospitals. However, the extent to which an individual hospital’s costs and a laboratory’s revenues would change if direct payment to laboratories is terminated would depend on the rates negotiated by that hospital and laboratory. If payment to the laboratory is made at the MPFS rate, a PPS hospital outsourcing the median number of technical pathology services would incur an additional cost of approximately $2,900. Additionally, there would be no financial impact on CAHs if direct laboratory payment is terminated because they would be reimbursed for their reasonable costs of outsourcing technical pathology services. In 2001, estimated payments to laboratories providing technical pathology services to hospital patients totaled over $63 million, including Medicare payments of about $51 million and beneficiary copayments of almost $13 million (see table 4). For services provided to inpatients, total laboratory payments equaled approximately $23 million, with $18 million from Medicare and $5 million from beneficiaries. For services provided to outpatients, total laboratory payments equaled approximately $41 million, including $33 million from Medicare and $8 million from beneficiaries. If laboratories had not received direct payment for services for hospital patients, we estimate that Medicare spending would have been $42 million less in 2001 (see table 5). The $18 million in inpatient savings would have resulted from Medicare discontinuing payments for technical pathology services to laboratories under the MPFS, while making no additional payments to PPS hospitals for inpatient services. For outpatient services, Medicare would not have paid laboratories directly, but would have paid PPS hospitals under the outpatient PPS. If direct payment to laboratories had been terminated, Medicare would have paid PPS hospitals an estimated $9 million under the outpatient PPS in 2001 for technical pathology services, thus saving $24 million. If laboratories had not received direct payment for services for hospital patients, Medicare beneficiaries would have been relieved of approximately $2 million in cost-sharing obligations (see table 6). In 2001, inpatients at hospitals that outsourced services were responsible for paying laboratories approximately $5 million in copayments under the MPFS. If direct payment to laboratories is terminated, inpatients would make no copayments to laboratories for technical pathology services. We estimate that the cost-sharing obligation of outpatients at PPS hospitals would have increased by $3 million to approximately $11 million under the outpatient PPS if laboratories had not received direct payment, compared to an estimated cost sharing of $8 million under the MPFS. However, outpatients’ cost-sharing obligations for technical pathology services under the outpatient PPS gradually will decline, as mandated by the law. As the percentage declines, beneficiary copayments for technical pathology services under the outpatient PPS should become lower than under the MPFS, as long as payments for these services generally remain lower under the outpatient PPS than the MPFS. If outsourcing hospitals agree to pay laboratories the rates the laboratories currently receive under the MPFS for technical pathology services, these amounts are unlikely to impose a large financial burden on most hospitals. In 2001, a PPS hospital outsourcing the median number of services outsourced by PPS hospitals, 94, would have incurred additional costs of approximately $2,900 in paying a laboratory for technical pathology services, representing a small fraction of hospitals’ annual Medicare revenues. A PPS hospital outsourcing 1,283 services annually—the 95th percentile of outsourced technical pathology service volume in our analysis—would have incurred an additional annual cost of just under $40,000. There would be no financial impact from terminating direct laboratory payments for rural hospitals that are or become CAHs, as CAHs would recover from Medicare their reasonable costs of outsourcing technical pathology services. The extent to which a hospital’s costs and a laboratory’s revenues would change if direct laboratory payments are terminated would depend on the rates negotiated between the two parties. Hospitals’ costs would increase because they would begin paying the laboratories for technical pathology services; laboratories’ revenues would decline if hospitals pay lower rates for the technical pathology services than Medicare currently pays laboratories under the MPFS. Because larger hospitals and those located in urban areas have more purchasing power and may have multiple laboratories from which to choose, these hospitals are likely to fare better than smaller hospitals and those in rural areas. Laboratory officials we spoke with voiced concern that some hospitals would insist that laboratories furnish technical pathology services at no charge or at extremely low rates in exchange for hospitals referring other business to the laboratories and their pathologists. However, these officials also indicated that their laboratories would not perform technical pathology services at no charge or for very low rates. Furthermore, hospitals might be deterred from requesting low rates because of concerns that such arrangements might violate applicable fraud and abuse laws. Although hospitals and laboratories would face new billing costs—both one-time and ongoing—if direct payments to laboratories are terminated, such changes generally would impose a modest additional cost. We spoke with officials from hospitals and laboratories that already have billing arrangements for these services, and they did not report to us that these costs were burdensome. Beneficiaries’ Access Medicare beneficiaries’ access to pathology services is unlikely to be Likely Would Be Unaffected disrupted if direct payments to laboratories are terminated because hospitals are unlikely to limit surgical services, including those requiring pathology services. In addition, hospitals would likely continue to outsource technical pathology services to laboratories because this would generally be less costly than performing these services themselves. Limiting Surgeries Unlikely Representatives of outsourcing hospitals with whom we spoke indicated that their hospitals would not eliminate or restrict surgical procedures if direct payment to laboratories is terminated. Because a large percentage of hospital-based surgeries require pathology services, hospitals would lose an important source of revenue if they restricted surgeries to those not requiring such services. Outsourcing hospitals stated that they could not afford this revenue loss. Rural hospitals, which are often the sole hospitals in their geographic areas, expressed the added concern that eliminating surgical procedures would reduce their communities’ access to medical services. If direct payment to laboratories is terminated, representatives from hospitals that do not maintain pathology laboratories and outsource technical pathology services to laboratories said they would continue to outsource technical pathology services. Few such hospitals have a sufficiently large volume of technical pathology services to make it cost effective to perform such services themselves. For most hospitals, the equipment and personnel expenses associated with maintaining their own pathology laboratories would likely exceed the cost of outsourcing the technical pathology services to laboratories. Hospital officials also stated that they have had difficulty recruiting histotechnicians, and it therefore would be difficult to staff new, or expand existing, pathology laboratories. Termination of direct laboratory payments generally would reduce Medicare expenditures and beneficiary cost-sharing obligations for technical pathology services while having little effect on beneficiaries’ access to these services. While termination of direct laboratory payments would impose a small financial burden on outsourcing PPS hospitals, this change would have no impact on CAHs. As the relative payment weights of services provided under the inpatient and outpatient PPS are adjusted annually, any increased costs hospitals incur to pay laboratories for technical pathology services will, over time, be reflected in the inpatient and outpatient PPS payments. Termination of direct laboratory payments also would eliminate the inequity between beneficiary cost-sharing obligations at different hospitals. In addition, continuing direct laboratory payments is an inappropriate means for providing financial assistance to hospitals. Hospitals, in receiving fixed payment amounts under a PPS and paying suppliers of nonphysician services provided to a Medicare patient from such fixed amounts, have an incentive to provide health care services efficiently. Permitting hospitals to outsource technical pathology services and have laboratories seek payment from Medicare eliminates the incentive for the efficient provision of these services and leads to potential Medicare double payments. We suggest that the Congress may wish to consider not reinstating the provisions that allow laboratories to receive direct payment from Medicare for providing technical pathology services to hospital patients. We recommend that the Administrator of CMS terminate the policy of permitting laboratories to receive payment from Medicare for technical pathology services provided to hospital patients. In commenting on a draft of this report, CMS stated that it is important that payment policy encourage efficiencies in the provision of technical pathology services. CMS stated that it would carefully consider our recommendation and noted that the Congress is currently considering this issue. CMS further stated that it would want to ensure that implementation of the recommendation does not adversely affect rural hospitals. As we noted in the draft report, permitting laboratories to receive payment directly from Medicare for technical pathology services is not an appropriate or efficient mechanism for providing financial assistance to hospitals, as it is contradictory to the objectives of a PPS. In addition, because the median number of technical pathology services annually outsourced by rural hospitals was low, we do not believe that paying laboratories directly for these services will place a significant financial burden on these hospitals. CMS’s written comments are reprinted in appendix II. The agency also provided technical comments, which we incorporated where appropriate. We received oral comments on a draft of this report from the American Hospital Association (AHA), the College of American Pathologists (CAP), and the National Rural Health Association (NRHA). These organizations disagreed with our conclusions, matter for congressional consideration, and recommendation and suggested that direct laboratory payments should continue. Generally, all three organizations expressed concerns about rural hospitals. AHA and NRHA expressed the concern that termination of direct laboratory payments would place a financial burden on rural hospitals, and CAP expressed concern that hospitals, including CAHs, and laboratories would experience an increased administrative burden in changing their current billing practices. CAP also raised a question about whether hospitals and laboratories would be able to successfully negotiate new payment arrangements for outsourced technical pathology services; if not, in its view, beneficiaries’ access to services could be jeopardized. As we noted in the draft report, hospital officials we spoke with, including those from rural hospitals, stated they would continue to offer technical pathology services as a part of their surgical services if they had to pay laboratories directly for technical pathology services. These officials stated that they would not consider eliminating surgeries if they had to enter new, or modify existing, arrangements with laboratories to provide technical pathology services. We acknowledge that modifying their billing practices will impose costs on hospitals and laboratories; however, officials from hospitals and laboratories that already have billing arrangements for technical pathology services did not report to us that these costs were burdensome. We are sending a copy of this report to the Administrator of CMS and appropriate congressional committees. The report is available at no charge on GAO’s Web site at http://www.gao.gov. We will also make copies available to others on request. If you or your staffs have any questions, please call me at (202) 512-7119 or Nancy A. Edwards at (202) 512-3340. Other major contributors to this report include Beth Cameron Feldpush, Jessica Lind, and Paul M. Thomas. In conducting this study, we analyzed Medicare claims and provider data obtained from the Centers for Medicare & Medicaid Services (CMS). We interviewed officials at CMS, the Congressional Budget Office, and the Department of Health and Human Services Office of Inspector General. We also interviewed industry representatives from the American Hospital Association, College of American Pathologists, and National Rural Health Association, as well as representatives of individual hospitals and laboratories and a pathology practice management consulting company. Finally, we conducted a site visit of a laboratory and one of the rural hospitals to which it provides pathology services. As there is no list of covered hospitals and the laboratories to which they outsource technical pathology services, we used 2001 Medicare claims data, the most recent year for which data are available, for our analysis. We received the data files directly from CMS. These data reflect the set of claims submitted to and paid by CMS for services performed in 2001. We performed our own initial analyses to check the reliability of the data. We estimated the number of hospitals outsourcing technical pathology services to laboratories that directly billed Medicare and the volume of and payments for these services. To do so, we matched Medicare laboratory claims with claims submitted by prospective payment system (PPS) hospitals and critical access hospitals (CAH). We assumed that a laboratory’s service was related to a hospital inpatient admission or outpatient encounter if the date of service on the laboratory’s claim was (1) during an inpatient’s stay at a hospital, within 3 days prior to the inpatient’s admission, or after the inpatient’s discharge or (2) on the day of or within 3 days after an outpatient surgical procedure at a hospital. We included in our list of total hospitals only those hospitals listed in the CMS Provider of Services (POS) file and characterized outsourcing hospitals as urban or rural according to their designation in the POS file. To identify hospitals outsourcing technical pathology services that have converted to CAHs, we matched each hospital’s Medicare provider number to the list of CAHs maintained by the North Carolina Rural Health Research and Policy Analysis Center at the University of North Carolina as of March 2003. To estimate Medicare payments and beneficiary copayments to laboratories for technical pathology services in 2001, we first calculated the claims frequency for each type of technical pathology service in our file of matched laboratory and hospital claims. We estimated the Medicare payment amount for each type of technical pathology service as 80 percent of the Medicare physician fee schedule (MPFS) national standard payment rate for that service and beneficiary cost sharing as the remaining 20 percent, and then we multiplied the claims frequency by the estimated Medicare and beneficiary cost-sharing amounts to calculate total laboratory payments. We performed similar calculations to find payments for inpatient and outpatient claims exclusively. To estimate 2001 Medicare outpatient PPS payments and beneficiary cost sharing to PPS hospitals if laboratories had not received direct payments, we multiplied the 2001 outpatient PPS Medicare payment rate and beneficiary copayment amount for each type of technical pathology service by the frequency of each type of technical pathology service in the outpatient claims. To estimate the cost difference to PPS hospitals of paying laboratories to perform technical pathology services, we first calculated a weighted average payment rate for technical pathology services for 2001 by multiplying the 2001 national standard MPFS payment rate by the frequency percentage of each type of technical pathology service among PPS hospitals and summing the payments for all services. We multiplied the median and 95th percentile volume of services outsourced by PPS hospitals by the estimated weighted average laboratory payment. We then calculated a weighted outpatient PPS payment rate, including beneficiary copayments, for technical pathology services in 2001 as described above for calculating the weighted average MPFS payment rate. Because approximately 63 percent of technical pathology services provided to patients of PPS hospitals were provided to outpatients, we estimated the number of outpatient services by multiplying the median and 95th percentile volumes by 63 percent. We then multiplied the estimated number of outpatient services by the estimated weighted average outpatient PPS payment rate, and subtracted this amount from the weighted average laboratory payment. We interviewed representatives of four Medicare carriers and four state hospitals associations. In addition, we spoke with representatives from 19 hospitals and 13 laboratories from a sample of eight geographically diverse states—Colorado, Florida, Iowa, North Dakota, Pennsylvania, Tennessee, South Dakota, and Washington—and an additional 2 laboratories in Oklahoma. We selected several states in the South, Southeast, and Midwest where, according to CMS officials, outsourcing arrangements for technical pathology services were believed to be fairly common. We interviewed officials from urban and rural hospitals and hospitals and laboratories with different types of outsourcing arrangements, including a hospital that outsources only complex and infrequently performed services and a hospital that currently pays its laboratory for technical pathology services.

Summary: In 1999, the Health Care Financing Administration, now called the Centers for Medicare & Medicaid Services (CMS), proposed terminating an exception to a payment rule that had permitted laboratories to receive direct payment from Medicare when providing technical pathology services that had been outsourced by certain hospitals. The Congress enacted provisions in the Medicare, Medicaid, and SCHIP Benefits Improvement and Protection Act of 2000 (BIPA) to delay the termination. The BIPA provisions directed GAO to report on the number of outsourcing hospitals and their service volumes and the effect of the termination of direct laboratory payments on hospitals and laboratories, as well as on access to technical pathology services by Medicare beneficiaries. GAO analyzed Medicare inpatient and outpatient hospital and laboratory claims data from 2001 to develop its estimates. In 2001, approximately 95 percent of all Medicare prospective payment system (PPS) hospitals--hospitals that are paid predetermined fixed amounts for services--and critical access hospitals (CAH), which receive reimbursement from Medicare based on their reasonable costs, outsourced some technical pathology services to laboratories that received direct payment for those services. However, the median number of outsourced services per hospital was small--81. If laboratories had not received direct payments for services for hospital patients, GAO estimates that Medicare spending would have been $42 million less in 2001, and beneficiary cost sharing obligations for inpatient and outpatient services would have been reduced by $2 million. Most hospitals are unlikely to experience a financial burden from paying laboratories to provide technical pathology services. If payment to the laboratory is made at the current rate, a PPS hospital outsourcing the median number of technical pathology services outsourced by PPS hospitals, 94, would incur an additional annual cost of approximately $2,900. There would be no financial impact for the 31 percent of rural hospitals that are CAHs, as they would receive Medicare reimbursement for their additional costs. Medicare beneficiaries' access to pathology services would likely be unaffected if direct laboratory payments are terminated. Hospital officials stated they were unlikely to limit surgical services, including those requiring pathology services, because limiting these services would result in a loss of revenue and could restrict access to services for their communities.