Hospitals are an important and significant provider of health care services to our nation. Nearly one-third of the total $3 trillion in health care spending in 2014 was attributed to hospital services. Three major payers comprise the bulk of our nation’s hospital spending: Medicare, Medicaid, and private health insurance companies: Medicare is a federal health program administered by CMS that provides health insurance coverage for seniors aged 65 and over, individuals with end-stage renal disease, and certain disabled persons. Medicaid is a joint federal-state health care program that provides health insurance coverage to low income and medically needy individuals. Medicaid is administered and operated by each state Medicaid program under CMS oversight. Within broad federal requirements, each state establishes provider payment rates, pays providers for services rendered, and determines the optional populations and benefits its Medicaid programs will cover beyond the mandatory populations and benefits states are required to cover. The federal government matches each state’s Medicaid expenditures for services according to the state’s federal medical assistance percentage. Private health insurance includes employer-sponsored coverage and coverage purchased by individuals from a private insurance carrier. Medicare, Medicaid, and private insurance covered over 80 percent of spending on hospital services in 2014. The remainder of the spending came from various other sources including other third party payers and programs and out-of-pocket spending by patients. Patient out-of-pocket spending includes deductibles, coinsurance, copayments, or payments for services not covered by insurance or that exceed coverage limits. Some patients receiving hospital services do not have health insurance coverage through public programs or private insurance; as a result, hospitals may provide care to these uninsured individuals for which the hospital may not receive compensation. Although the federal government has multiple funding streams to help offset these and other hospital uncompensated care costs, no standard definition of uncompensated care costs exists across federal programs. As a result, no standard federal estimate of total hospital uncompensated care costs is available. On the basis of its annual survey of hospitals, the American Hospital Association estimated that hospital uncompensated care costs totaled over $46 billion in 2013. Any estimate of these costs would vary depending upon the definition of uncompensated care used for the estimate. Definitions of uncompensated care costs may include the following: Uninsured patient costs. These include the costs of services provided to patients who do not have health insurance coverage and are unable to pay for the services they receive; these services are sometimes referred to as charity care and can include the cost of care provided to privately insured patients whose insurance did not cover the services provided. Bad debt. This includes cost-sharing for which patients are responsible for paying but have not paid—-for example, deductible and coinsurance amounts. Public payer payment shortfalls. These include the differences between payments from public payers such as Medicaid, and hospitals’ costs for the services provided to these payers’ beneficiaries. In fiscal years 2013 and 2014, the federal government made multiple types of payments to hospitals to help offset uncompensated care costs mainly through two programs—Medicare and Medicaid—totaling nearly $50 billion each year. Medicaid payments accounted for almost three- quarters of these payments in each year. Federal tax laws provided other benefits to qualifying non-profit hospitals through tax exemptions. In fiscal years 2013 and 2014, state Medicaid programs spent over $35 billion in each year for payments that helped hospitals offset their uncompensated care costs. Medicaid spending comprised three types of payments: disproportionate share hospital (DSH) payments, upper payment limit (UPL) payments, and uncompensated care payments made under section 1115 demonstrations. All three payment types are, for purposes of this report, considered to be supplemental payments, which are payments generally made separately from, and in addition to, states’ regular, claims-based payments to hospitals for Medicaid services provided to Medicaid beneficiaries. Supplemental payments are generally made as lump sum payments on a monthly, quarterly, or annual basis. Specifically Medicaid DSH payments. These are Medicaid payments that Congress established for hospitals serving large numbers of Medicaid and low-income individuals to help offset their uncompensated costs. Federal law requires states to make DSH payments to certain eligible hospitals and also limits DSH payment amounts to each hospital’s costs of providing uncompensated care, as defined under federal law and regulations governing Medicaid DSH payments. States have broad flexibility in deciding how to allocate these payments among eligible hospitals as long as any payment to an individual hospital does not exceed that hospital’s uncompensated costs of providing care to Medicaid beneficiaries and individuals without health insurance or other sources of third-party coverage for the service provided. State-specific limits also exist on the amount of federal funds available for Medicaid DSH payments. Medicaid UPL payments to hospitals. These are supplemental payments states make per the Medicaid UPL regulations. The UPL is a limit or ceiling on the amount of a state’s Medicaid payments for certain fee-for-service Medicaid services the federal government will match and is based on an estimate of what Medicare would pay for comparable services. States’ regular payments to hospitals for services rendered to Medicaid beneficiaries are often below the UPL. Consequently, most states make UPL supplemental payments to some hospitals that are in addition to the hospitals’ regular payments but do not exceed the UPL. Medicaid payments to individual hospitals are not limited to the hospitals’ costs of providing services, and UPL payments that states make have resulted in Medicaid payments that exceed hospital costs for Medicaid services, making funds available to the recipient hospitals for uncompensated care purposes. The UPL is not a hospital-specific limit but is applied in the aggregate across certain categories of providers, and states have some flexibility in deciding which hospitals will receive a UPL payment, and how to allocate UPL payments among hospitals. While UPL supplemental payments to providers are associated with particular types of services, whether the payments are intended to offset uncompensated care costs related to the provision of those services is generally not reported. Section 1115 demonstration uncompensated care payments. These are payments that some states make to hospitals specifically for uncompensated care costs in conjunction with demonstration and pilot projects for which they have received approval from the Secretary of Health and Human Services. Section 1115 of the Social Security Act authorizes the Secretary of Health and Human Services to waive certain federal Medicaid requirements and allow costs that would not otherwise be eligible for federal matching funds for experimental, pilot, or demonstration programs that, in the Secretary’s judgement, are likely to assist in promoting Medicaid objectives. Certain states have received approval to make supplemental payments for hospital uncompensated care in their Medicaid demonstrations. Supplemental payments states make under demonstrations are made according to the terms and conditions approved by the Secretary of HHS for each demonstration. In fiscal years 2013 and 2014, total Medicaid spending—state and federal funds—through the three types of payments exceeded $35 billion each year based on state Medicaid expenditure reports submitted to CMS. In fiscal year 2013, Medicaid DSH payments totaled $16.4 billion and combined UPL and section 1115 demonstration payments totaled $19 billion. In fiscal year 2014, Medicaid DSH payments totaled $18.1 billion and combined UPL and section 1115 payments totaled $17.5 billion. These payments could comprise a large proportion of payments that hospitals receive. For example, total Medicaid payments for hospital inpatient and outpatient services totaled over $88 billion in fiscal year 2013 and about $84 billion in fiscal year 2014. All of these Medicaid payments were eligible for federal matching funds; that is, the federal government provided funds for half or more of the payments, depending on the state. Medicare provided two types of payments that helped offset hospital uncompensated care costs in fiscal year 2013: DSH payments and bad debt payments. As required by PPACA starting in fiscal year 2014, Medicare DSH payments were reduced and a third type of payment— the Medicare UC payment—was established. Specifically Medicare DSH payments: These Medicare payments are required to be made to hospitals that serve a significantly disproportionate number of low-income patients. Congress established these payments to address concerns that these hospitals would have unreimbursed costs that would not be recognized under Medicare’s prospective payment system. Although these payments do not directly reimburse hospital uncompensated care costs, they are intended to help offset eligible hospitals’ unreimbursed cost of treating low-income patients. DSH payments are added on to Medicare’s base payment to hospitals for each Medicare patient discharge. In general, there are no national or hospital-specific limits on Medicare DSH payments. Under PPACA, starting in fiscal year 2014, Medicare DSH payments were reduced to 25 percent of the amount that would have been paid under prior law. PPACA requires that the remaining 75 percent of the amount that would have been paid as DSH payments is used to make a new type of payment, Medicare UC payments, discussed below. Bad debt payments: Hospitals are eligible to receive Medicare reimbursement for a portion of Medicare beneficiaries’ unpaid copayments and deductibles—known as bad debt—as long as the hospital makes a reasonable effort to collect the unpaid amounts. In general, Medicare bad debt payments to individual hospitals are limited to 65 percent of a hospital’s bad debt costs. The total amount of payments made by Medicare for bad debt is not capped and fluctuates as hospital bad debt increases or decreases. Bad debt payments are made as lump-sum supplemental payments and are not added on to Medicare base payments. Medicare UC payments: These payments, which were established under PPACA and required to be made starting in fiscal year 2014, are intended to help offset hospitals’ uncompensated care costs and are added on to Medicare’s base payment for each Medicare patient discharge. Hospitals that are eligible to receive Medicare DSH payments are automatically eligible to receive Medicare UC payments. These payments are made from an amount equal to 75 percent of what otherwise would have been paid as Medicare DSH after reducing this amount for changes in the percentage of individuals that are uninsured. In fiscal years 2013 and 2014, total Medicare spending through these payment types was over $14 billion each year. In comparison to Medicaid, Medicare spending through these payment types is a lower proportion of payments the program made to hospitals for services. Medicare payments to hospitals for inpatient and outpatient services totaled about $179 billion in 2013 and about $183 billion in 2014. As illustrated in figure 1, of the different types of Medicare payments that help offset hospital uncompensated care costs, DSH payments were the largest in fiscal year 2013 (over $12 billion); Medicare UC payments were the largest in fiscal year 2014 (over $9 billion); and bad debt payments were the smallest and relatively unchanged from one year to the next. In addition to payments from Medicaid and Medicare that offset hospital uncompensated care costs, federal tax law provides additional financial benefits to hospitals that qualify for tax-exempt status. Financial benefits for these qualifying nonprofit hospitals include exemptions from federal income taxes, eligibility for tax-exempt bond financing of capital projects, and tax-deductible contributions from donors (both individuals and corporations). To qualify for federal tax-exempt status, nonprofit hospitals must be organized and operated exclusively for charitable purposes. To meet this requirement, IRS requires that nonprofit hospitals meet its community benefit standard, a measure of which may include provision of uncompensated care. Hospitals are required to report the value of the community benefits they provide, including uncompensated care costs, in Schedule H of IRS Form 990. In tax year 2011, of the approximately 4,900 total hospitals nationwide, about half qualified for tax exempt status, and hospital uncompensated care accounted for about 56 percent of their total reported community benefit expenses. The exact amount of the financial benefits nonprofit hospitals receive from tax exemptions is not regularly tracked, but reported benefits are in the billions of dollars. For tax year 2002, the latest data available, the Joint Committee on Taxation (JCT) estimated that the financial benefits of federal tax exemption for nonprofit hospitals nationwide totaled about $6.1 billion. Using JCT’s methodology for estimating nonprofit hospital tax exemption, researchers estimated that for tax year 2011 the financial benefits of the federal tax exemption totaled about $13 billion. The basis for determining the different types of Medicaid and Medicare payments that help offset hospital uncompensated care costs varies somewhat by type of payment. However, the majority of the different payment types are based on similar factors—generally hospitals’ costs or workloads related to providing services to Medicaid, uninsured, or low- income Medicare patients, or some combination of these patients. Federal law and policy limit the amounts states may pay under the three types of payments that help offset hospitals’ uncompensated care costs. Within these limits, however, states generally may determine the hospitals that will receive these payments and the payment amounts. For example, Medicaid DSH payment limits are statutorily based on a calculation of a hospital’s uncompensated care costs of treating Medicaid and uninsured patients. Although this statutory formula does not apply to section 1115 demonstrations, CMS officials stated that they generally use the Medicaid DSH methodology in determining payment limits for Section 1115 uncompensated care payments. As such, DSH payments and uncompensated care demonstration payments are based, in part, on the cost of services provided to Medicaid and uninsured patients. The third payment type—UPL payments—is based on the difference between what the state Medicaid program pays for Medicaid services and the federal upper payment limit for payments for such services. Specifically Medicaid DSH payments. Federal law requires that states make Medicaid DSH payments to certain eligible hospitals but limits the amount of Medicaid DSH payments that states may make to individual hospitals. These limits are based on a hospital’s uncompensated care costs, which are defined by federal law and regulation to be the hospital’s uncompensated costs of providing care to Medicaid patients and uninsured patients. CMS relies on states and hospitals to calculate these uncompensated care costs using data from Hospital Cost Reports, their financial records, and state Medicaid agency data. In calculating their uncompensated care costs for Medicaid patients and uninsured patients, hospitals are required to include all payments received from Medicaid, including supplemental payments that are related to Medicaid services provided, as revenues that offset the costs of care. Since 2010, states have been required to submit independently certified audited reports annually on any hospital receiving Medicaid DSH payments. Medicaid section 1115 uncompensated care payments. Limits on the amount of these payments to individual hospitals are established based on a hospital’s uncompensated care costs, which are determined under the approved terms and conditions of a state’s demonstration. According to CMS officials, the agency requires that section 1115 hospital uncompensated care payments generally use similar methods to those used for Medicaid DSH payments to calculate hospital uncompensated care costs. States may include in their calculations additional costs typically not allowed for Medicaid DSH payments, subject to CMS approval. For example, some states include hospital uncompensated costs of physician services provided in a hospital. Medicaid UPL payments. Limits on the amount of these payments are established in the aggregate based on the difference between state Medicaid payments to hospitals for services rendered to Medicaid patients and the amount Medicare would have paid for similar services. Thus, the total amount of Medicaid UPL payments a state can make is based on services provided to Medicaid patients. The UPL is not a hospital-specific limit and states have flexibility in determining which hospitals to pay and the payment amounts. In fiscal year 2014, the bulk of state UPL payments were made to hospitals for inpatient and outpatient services. CMS makes Medicare DSH and Medicare UC payments to hospitals based on their workload, expressed as the number of days a hospital spends treating Medicaid and low-income Medicare patients (referred to as Medicaid patient days and low-income Medicare patient days, respectively). CMS also makes Medicare bad debt payments based on a certain percentage of the unpaid copayments and deductibles for Medicare beneficiaries. Specifically Medicare DSH payments. As required by statute, CMS determines Medicare DSH payments based on each hospital’s disproportionate patient percentage, which is calculated as the sum of two ratios: (Medicare low-income patient days / total Medicare days) + (Medicaid days / total hospital days). Hospitals qualify for Medicare DSH payments if their disproportionate patient percentage is above 15 percent, but actual Medicare DSH payments vary based upon hospitals’ characteristics, including their size and geographic location. The resulting payment amount is a percentage of the Medicare base payment calculated using a statutory formula that is then added to the base payment the hospital receives for each Medicare patient discharge. In fiscal year 2014, as required by PPACA, Medicare DSH payments were reduced to 25 percent of the amount that would have been paid under prior law. Overall, the number of Medicaid patient days was the largest factor in determining Medicare DSH payments in fiscal year 2014. Generally, the ratio that included Medicaid patient days accounted for about 70 percent of Medicare DSH payments in fiscal year 2014 while the ratio that included low-income Medicare beneficiaries treated accounted for the remaining 30 percent. Medicare UC payments. PPACA directed CMS to base these payments on hospital uncompensated care costs, including the costs of treating uninsured patients. However, CMS has discretion to choose the methods and data sources it uses to calculate these costs, and CMS has to date used data related to Medicaid and Medicare workload as a proxy for uncompensated care costs. For fiscal years 2014, 2015, and 2016, Medicare UC payments made to individual hospitals are based on a hospital’s days spent treating Medicaid patients and low-income Medicare beneficiaries rather than on a hospital’s actual uncompensated care costs. Specifically, an individual hospital’s Medicare UC payment is based on the hospital’s relative proportion of days spent treating Medicaid patients and low- income Medicare patients across all hospitals receiving UC payments nationally. Our analysis indicates that, under this formula, Medicaid patient days accounted for about 85 percent of Medicare UC payments, and low-income Medicare patient days accounted for the remaining 15 percent in fiscal year 2014. In other words, we found that the amount of a hospital’s Medicare UC payment is largely based on the hospital’s Medicaid patient workload. Medicare bad debt payments. CMS pays hospitals a certain percentage of the actual unpaid copayments and deductibles that hospitals expected to receive, but were unable to collect, from Medicare beneficiaries. In general, hospitals must demonstrate that they have made reasonable attempts to collect the bad debt—that is, the same type of efforts that they would make for non-Medicare patients. Medicare UC payments are not well aligned with hospital uncompensated care costs for two key reasons. First, Medicare UC payments are distributed to hospitals based largely on Medicaid patients treated and not on hospitals’ actual uncompensated care costs, which include the costs of treating uninsured patients. Second, CMS does not account for Medicaid payments made to hospitals that help offset uncompensated care costs, even though the bulk of Medicare UC payments are based on Medicaid patients treated. Medicare UC payments are not aligned with hospitals’ uncompensated care costs because CMS bases these payments mainly on hospitals’ historical Medicaid patient days rather than actual costs hospitals incurred treating uninsured patients. A 2015 report by HHS’s Office of the Assistant Secretary of Planning and Evaluation (ASPE) found that an increase in Medicaid coverage (which would result in a corresponding increase in Medicaid hospital patient days) was associated with a reduction in hospital uncompensated care costs. Distributing UC payments on the basis of Medicaid patient days will likely result in larger shares of Medicare UC payments directed towards hospitals where uncompensated care costs have likely declined. This is because hospitals located in states that expanded their Medicaid programs have higher proportions of Medicaid patient days and would therefore receive a larger share of Medicare UC payments. At the same time, uncompensated care costs in these hospitals may be declining due to a reduction in the number of uninsured individuals in the state. Conversely, hospitals in states that have not expanded Medicaid will continue to have relatively higher levels of uninsured individuals and thus higher uncompensated care costs, but these hospitals will likely have fewer Medicaid patient days and will thus receive a smaller share of Medicare UC payments under CMS’s current calculation. CMS officials acknowledged that using Medicaid patient days as a basis for Medicare UC payments could result in hospitals located in Medicaid expansion states receiving disproportionately higher payments. Officials stated that the effect of using Medicaid patient days rather than actual uncompensated care costs was somewhat mitigated because CMS had, for purposes of fiscal year 2014 Medicare UC payments, used data from fiscal years 2010 or 2011 to estimate hospitals’ proportions of Medicaid patient days—a time period before when most states expanded their Medicaid programs in response to PPACA. However, hospitals in states that had broader Medicaid eligibility requirements in 2010 or 2011 (and therefore higher numbers of Medicaid patient days) would receive higher payments than those in states with more restrictive requirements in those same years, despite potentially having to provide less uncompensated care. In addition, the hospitals in seven states that had expanded their Medicaid programs prior to 2014 may have also received higher Medicare UC payments through CMS’s use of Medicaid patient days to calculate Medicare UC payments. Directing a larger portion of the Medicare UC payments, which are intended to reimburse hospital uncompensated care costs, to hospitals where hospital uncompensated care is declining is not consistent with CMS’s role as an efficient payer of health care services. CMS has for several years considered options for defining and using hospital uncompensated care costs to make Medicare UC payments, but has not yet implemented plans to do so. In a May 2013 notice of proposed rulemaking, CMS stated that the definition of hospital uncompensated care costs for purposes of making Medicare UC payments could comprise charity care and bad debt costs (for both Medicare and non-Medicare patients), since these were commonly identified as sources of hospital uncompensated care by various stakeholders, including federal and state programs, and provider associations. CMS also identified a potential data source for actual hospital uncompensated care costs—an uncompensated care worksheet in the Hospital Cost Report—that is the only national data source for charity care and bad debt costs. CMS did not propose at the time to use this definition or the data in the uncompensated care worksheet because of concerns by certain stakeholders about the worksheet’s reliability. In an April 2016 proposed rule, CMS proposed transitioning away from using Medicaid days as the basis for UC payments, and instead using hospital uncompensated care costs from the uncompensated worksheet. Under the proposed rule, Medicare UC payments made in fiscal year 2020 would be entirely based on hospital uncompensated care costs, which CMS proposes to define as charity care and non-Medicare bad debt. In its proposed rule, CMS requested public comments on its proposed definition of hospital uncompensated care costs and use of the uncompensated care worksheet to determine these costs, among other things. Although the majority of Medicare UC payments to individual hospitals are based on Medicaid patient days, CMS does not adjust these payments to reflect payments hospitals receive from Medicaid. Hospitals could potentially receive significant amounts of payments that help offset uncompensated care costs from both the Medicare and Medicaid programs. A relatively large portion of the Medicare UC payments are determined in the Medicare UC formula by hospitals’ Medicaid patient days; similarly, a large portion of the Medicaid payments that help offset hospital uncompensated care costs are distributed, in part, on the basis of payment limits determined by those hospitals’ Medicaid workloads. We estimate, for example, that in fiscal year 2014 about $7.7 billion of Medicare UC payments to hospitals were based on Medicaid patient days and about $14.1 billion of Medicaid payments to hospitals were based on services provided to Medicaid patients. CMS officials told us that Medicare and Medicaid are separate programs administered under different statutory and regulatory rules under which hospitals can qualify for, and receive, both Medicare UC payments and Medicaid payments that help offset hospital uncompensated care costs. When determining hospital uncompensated care costs for purposes of Medicaid DSH payments, states are required to consider Medicare payments made on behalf of patients covered by both Medicare and Medicaid. While the law does not require CMS to take into account Medicaid payments that offset uninsured costs when calculating Medicare UC payments, CMS officials confirmed they have authority to consider such payments but have not taken steps to do so. Transitioning away from using Medicaid patient days and instead basing Medicare UC payments on data showing actual hospital uncompensated care costs, would result in a better alignment of Medicare UC payments with actual hospital uncompensated care costs. However, this change on its own would not be sufficient to account for the fact that hospitals eligible to receive UC payments may also be eligible for Medicaid DSH payments to offset these same costs. Although the Medicare and Medicaid programs define uncompensated care costs somewhat differently, a common and significant cost in their definitions is the uncompensated care costs for uninsured individuals. As a result, in determining Medicare UC payments, it is important that CMS, in fulfilling its role as an efficient payer of health care services, take into account the Medicaid payments eligible hospitals have received for these costs to ensure that Medicare UC payments are most effectively aligned with hospitals’ actual uncompensated care costs. Hospital uncompensated care costs are a longstanding concern that have the potential to weaken some hospitals’ financial stability and undermine their ability to provide care and serve their community. Recognizing the importance of financially stable hospitals, certain Medicare and Medicaid payments and federal tax laws were established to support hospitals providing uncompensated care. The amount of uncompensated care incurred by individual hospitals varies across the thousands of hospitals in our nation, including private for-profit, private nonprofit, and state and local government hospitals. The expansion of health insurance coverage as a result of PPACA has and will continue to alter the amount of uncompensated care incurred by hospitals. Hospitals in states and communities where the number of uninsured individuals has declined are likely to incur lower uncompensated care costs. In view of the changing landscape of hospital uncompensated care, Congress reduced the amount of federal support to offset hospital uncompensated care costs and also required federal spending to be aligned with hospitals’ uncompensated care costs. In particular, a large amount of existing federal funding was redirected to establish Medicare UC payments, which will decline as the number of uninsured individuals declines nationally. CMS was directed to distribute these payments on the basis of each hospital’s uncompensated care costs. While CMS was given flexibility to identify appropriate data for determining such costs, the agency’s use of Medicaid patient days as the basis for distributing Medicare UC payments to hospitals results in poor alignment of payments to hospital uncompensated care costs. Poor alignment results because relatively large shares of Medicare UC payment amounts will be distributed to hospitals where Medicaid expansion has lowered their uncompensated care costs. Particularly in view of the changing landscape of health care coverage, including some but not all states expanding Medicaid and the impact of such choices on hospital uncompensated care costs in different states, CMS has the responsibility to use the best data available to allocate payments based on hospitals’ actual uncompensated costs of providing care. In an April 2016 proposed rule, the agency announced that it is considering using hospitals’ actual uncompensated care costs as the sole basis for making Medicare UC payments by fiscal year 2020 Additional steps will be needed to ensure that Medicare UC payments are aligned with hospital uncompensated care costs, including taking into account Medicaid payments that hospitals receive for treating the uninsured. Neither the current poor alignment of Medicare UC payments with hospital uncompensated care costs nor the lack of accounting for reductions in hospital uncompensated care costs for uninsured patients resulting from Medicaid payments are consistent with Medicare’s role as a prudent payer of health care. To ensure efficient use of federal resources, we recommend that the Administrator of CMS take the following two actions: 1. Improve alignment of Medicare UC payments with hospital uncompensated care costs by basing these payments on hospital uncompensated care costs; and 2. Account for Medicaid payments a hospital has received that offset uncompensated care costs when determining hospital uncompensated care costs for the purposes of making Medicare UC payments to individual hospitals. We provided a draft of this report to the Secretary of Health and Human Services and the Commissioner of the Internal Revenue Service. We received written comments from HHS, which are reprinted in appendix I. In addition, HHS and IRS provided technical comments that we incorporated as appropriate. In its written comments, HHS concurred with both our recommendations. HHS concurred with our first recommendation to better align Medicare UC payments with hospitals’ actual uncompensated care costs, noting the April 2016 proposed rule that outlines a proposal to do so. HHS stated it would consider all stakeholder comments before issuing a final rule later this year. HHS also concurred with our second recommendation to account for hospitals’ Medicaid payments that offset uncompensated care costs when determining these costs for purposes of making Medicare UC payments. HHS agreed that it is important to align uncompensated care payments with actual uncompensated care costs and that doing so would help ensure that HHS is directing the payments to hospitals appropriately. HHS stated that the Department would continue to review the definition of uncompensated care as appropriate, particularly in the event it finalizes the proposal to begin using uncompensated care cost data to determine the distribution of these payments. Taking steps to better align these payments is important to improving the distribution of significant amounts of federal funds for hospital uncompensated care. As agreed with your offices, unless you publicly announce the contents of the report earlier, we plan no further distribution until 30 days from the report date. At that time, we will send copies of this report to the Secretary of Health and Human Services and other interested parties. In addition, the report is available at no charge on the GAO website at http://www.gao.gov. If you or your staffs have any questions about this report, please contact me at (202) 512-7114 or iritanik@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of the report. GAO staff that made key contributions to this report is listed in appendix II. In addition to the contact named above, Tim Bushfield, Assistant Director; Leonard Brown; Christine Davis; Iola D’Souza; Carolyn Fitzgerald, Sandra George; Peter Mann-King; and Laurie Pachter made key contributions to this report. Medicaid: Federal Guidance Needed to Address Concerns About Distribution of Supplemental Payments. GAO-16-108. Washington D.C.: February 5, 2016. Medicaid: Improving Transparency and Accountability of Supplemental Payments and State Financing Methods. GAO-16-195T. Washington D.C.: November 3, 2015. Medicaid: Additional Efforts Needed to Ensure that State Spending is Appropriately Matched with Federal Funds. GAO-16-53. Washington D.C.: October 16, 2015. Medicaid: Key Issues Facing the Program. GAO-15-667. Washington, D.C.: July 30, 2015 Medicare: Legislative Modifications Have Resulted in Payment Adjustments for Most Hospitals. GAO-13-334. Washington, D.C.: April 17, 2013. High-Risk Series: An Update. GAO-13-283. Washington, D.C.: February 2013. Medicaid: States Reported Billions More in Supplemental Payments in Recent Years. GAO-12-694. Washington, D.C.: July 20, 2012. High-Risk Series: An Update. GAO-11-278. Washington, D.C.: February 2011. Medicaid: Ongoing Federal Oversight of Payments to Offset Uncompensated Hospital Care Costs Is Warranted. GAO-10-69. Washington, D.C.: November 20, 2009. Nonprofit Hospitals: Variation in Standards and Guidance Limits Comparison of How Hospitals Meet Community Benefit Requirements. GAO-08-880. Washington, D.C.: September 12, 2008. Medicaid: CMS Needs More Information on the Billions of Dollars Spent on Supplemental Payments. GAO-08-614. Washington, D.C.: May 30, 2008. Medicaid: States’ Efforts to Maximize Federal Reimbursements Highlight Need for Improved Federal Oversight. GAO-05-836T. Washington, D.C.: June 28, 2005. Nonprofit, For-Profit and Government Hospitals: Uncompensated Care and Other Community Benefits. GAO-05-743T. Washington, D.C.: May 26, 2005.

Summary: Hospitals have historically incurred billions of dollars in costs for services provided to uninsured and other low-income individuals. The Patient Protection and Affordable Care Act (PPACA) offered ways for states to increase insurance levels including by expanding their Medicaid programs. In anticipation of the expected decline in the uninsured and uncompensated hospital costs, PPACA also reduced federal support for hospitals serving a disproportionate share of low-income and uninsured individuals and redirected some support to Medicare UC payments for hospital uncompensated care costs. GAO was asked to examine federal support for hospital uncompensated care. GAO examined (1) the key sources and amounts of federal support for hospital uncompensated care costs; (2) the basis for determining hospital uncompensated care payments made under Medicaid and Medicare; and (3) the extent to which Medicare UC payments align with hospital uncompensated care costs. GAO analyzed federal payment data for fiscal years 2013 and 2014, the most recent available, reviewed relevant laws and regulations, and interviewed CMS officials. Key sources of federal support for hospitals incurring costs for services provided to uninsured and other low-income individuals (uncompensated care costs) include multiple types of Medicaid and Medicare payments totaling about $50 billion annually. GAO's analysis shows that through Medicaid, a joint federal-state program for low-income individuals, states made three types of payments that helped offset uncompensated care in fiscal years 2013 and 2014 totaling over $35 billion annually. Medicare, a federal program for aged and certain disabled individuals, made two types of payments in 2013 and three in 2014—including a new type called Medicare Uncompensated Care (UC) payments—totaling over $14 billion annually. Federal tax law also provides tax benefits—estimated by researchers to be billions of dollars annually—to tax-exempt nonprofit hospitals that incur uncompensated care costs. The basis for determining these different types of Medicaid and Medicare payments varies somewhat by type of payment. As shown in the table, however, the payment types are based on similar factors—generally hospitals' costs or workloads related to providing services to Medicaid, uninsured, or low-income Medicare patients, or some combination of these. Medicare's UC payments are not well aligned with hospital uncompensated care costs for two reasons. First, payments are largely based on hospitals' Medicaid workload rather than actual hospital uncompensated care costs. Centers for Medicare & Medicaid Services (CMS) officials acknowledge this could result in payments not aligned with uncompensated costs, particularly in states that have expanded Medicaid resulting in fewer uninsured individuals and lower uncompensated costs. In an April 2016 proposed rule, the agency announced that it is considering using hospitals' actual uncompensated care costs as the basis for making Medicare UC payments. Second, CMS does not account for hospitals' Medicaid payments that offset uncompensated care costs when making Medicare UC payments, even though the bulk of Medicare's payments—about 85 percent or $7.7 billion in 2014—were made on the basis of hospitals' Medicaid workloads, for which hospitals may have also received Medicaid payments. CMS officials said that the Medicaid and Medicare programs are operated separately. Medicare UC payments that are not aligned with uncompensated care costs or adjusted to reflect Medicaid payments undermine CMS's efforts to efficiently pay for health care services. GAO recommends that CMS take two actions: (1) improve alignment of Medicare UC payments with hospital uncompensated care costs; and (2) account for Medicaid payments made when making Medicare UC payments to individual hospitals. In commenting on a draft of this report, HHS concurred with both recommendations.