Medicare’s home health care benefit enables certain beneficiaries with post-acute-care needs (such as recovery from joint replacement) and chronic conditions (such as congestive heart failure) to receive care in their homes. To qualify for home health care, beneficiaries must be homebound; require intermittent skilled nursing, or physical or speech therapy or occupational therapy on a continuing basis; be under the care of a physician; and have their home health care services furnished under a plan of care prescribed and periodically reviewed by a physician. If these conditions continue to be met, Medicare will pay for an unlimited number of episodes of care that can include skilled nursing care; physical, occupational, and speech therapy; medical social service; and home health aide visits. When a beneficiary begins receiving Medicare-covered home health care, all medical supplies except for durable medical equipment (DME) used by the patient are covered as part of the home health care. Beneficiaries using home health care are not required to pay any deductibles or copayments for these services and supplies. For beneficiaries who are not receiving Medicare-covered home health care, Medicare part B (supplementary medical insurance) covers certain medical supplies for those not hospitalized or not in another inpatient setting. Beneficiaries are responsible for a 20-percent copayment for all supplies and services. Medical supplies covered under part B are limited to the devices used to replace bladder and bowel function (such as catheters, ostomy bags, and irrigation and flushing equipment); supplies required for parenteral and enteral nutrition feeding (such as catheters, filters, and nutrient solutions) and tracheostomy care; and surgical wound dressings, if they are required for treatment of a wound caused by a surgical procedure or after the debridement of a wound. Such supplies must be ordered by a physician and be medically necessary. Medicare has coverage guidelines regarding the maximum number of each supply that is normally medically necessary per month (for example, the number of catheters or ostomy bags). On October 1, 2000, HCFA implemented the PPS for home health care. BBA stipulated that PPS payments cover all home health care services and supplies used to treat a beneficiary, including medical supplies, that were paid for on a reasonable cost basis at the time of enactment. Because DME was paid for on the basis of a fee schedule, it was not required to be included in the PPS and is paid for separately. The law also required HHAs to “consolidate” the billing and be paid for all Medicare-covered home health services and supplies provided to patients receiving home health care, even when they are furnished by an outside supplier under contract to the HHA. This all-inclusive payment gives HHAs an incentive to control the total costs of care provided during the episode, including the use of supplies. Under the home health PPS, HHAs that deliver care for less than the payment can profit. Conversely, HHAs will lose financially when their service costs are higher than the payment. Because patients who receive Medicare-covered home health care require differing amounts of care, a basic episode payment is adjusted based on the classification of each patient into one of 80 payment groups, called home health resource groups (HHRG). The classification is based on three dimensions of the patient—clinical condition, functional status, and expected use of services—that affect the total cost of the episode. Patients with similar total episode costs are grouped together: the use of nonroutine medical supplies contributes to, but does not determine, the payment group for any type of patient. The payment for each payment group is adjusted to reflect the average cost of providing services to patients in that group (as determined by the average time of the skilled nursing, home health aide, therapy, and other visits for the patients in the group) relative to the average cost of patients across all 80 payment groups. In fiscal year 2002, after adjusting for inflation, the basic episode payment was $2,274, with the payment adjusters resulting in payments for patients in the different HHRGs ranging from $1,197 to $6,393 per episode. The accuracy of the adjusted payments in reflecting the cost variation across patients depends on how well the payment groups distinguish among types of patients (and their episode costs) and how well the payment adjusters account for differences in total episode costs across the different payment groups. Shortcomings in either will result in some patients or payment groups being more financially attractive than others for HHAs to treat. We have reported that in the first 6 months of 2001 there was considerable variation in the relationship between payments and costs across payment groups. For example, the episode payments for 10 payment groups averaged about 1 percent above the average estimated episode cost, while for 10 other payment groups payments averaged almost twice the average episode cost. On average, episode payments were about 35 percent higher than the average estimated episode cost. Home health episode payments based on average costs may not be adequate for HHAs serving a disproportionate number of patients with high-cost nonroutine medical supply needs when a payment group includes few such patients. This is because if there are few high-cost patients in a payment group, their costs do not substantially increase the average cost for the group. In contrast, frequently provided high-cost services and supplies would boost average episode costs and, therefore, the payments based on them. HCFA’s efforts to refine the PPS, including a better accounting for nonroutine medical supply costs, began even before the PPS was implemented. For example, the agency considered excluding the costs of nonroutine medical supplies from the episode amount and paying for supplies covered under part B separately. HCFA concluded that it did not have the authority to exclude nonroutine medical supplies given the BBA requirement that all medical supplies be included in the episode payment. The agency also modified the HHRG patient classification system to better reflect the costs of high-cost patients with severe wounds, such as burns, after concerns were raised during the comment period on the proposed rule about the payments for these patients. Even with the revisions, HCFA officials acknowledged that the HHRGs may not adequately differentiate among home health patients, particularly those who need wound-care supplies, and that additional modifications might be needed. The agency plans to examine the payment groups and the payment adjusters using information on total episode costs, the visits provided during each episode, and patient diagnoses. CMS will use these analyses in determining if there are inadequacies in the payment groups or adjustments that require modifications to the PPS. HCFA used the total costs associated with furnishing home health care, including the costs of nonroutine medical supplies, to establish the average episode payment. HCFA estimated average total episode costs based on 1997 audited costs of a representative sample of HHAs and updated these costs for inflation each year through 2000—the beginning of the home health PPS. HCFA added an amount (based on 1998 data) to the episode payment rate to account for the separate payments that had been made to external suppliers for nonroutine medical supplies furnished directly to patients receiving home health care. HCFA estimated that the costs of all nonroutine medical supplies averaged about 2 percent of episode costs (or about $50 per episode). The adjusted payment associated with each payment group may not reflect the variation in the cost of the supplies used across the payment groups. When HCFA determined the payment adjustments for the payment groups, it did not have data on the cost or use of specific nonroutine medical supplies for different types of home health patients. Instead of considering the costs of nonroutine medical supplies in varying the payments across each of the payment groups, the agency used the average cost of staff time associated with the average number of visits. For some types of patients, such as those needing wound-care supplies and dressing changes, increasing payments in proportion to the cost of staff time is likely to result in an appropriate adjustment to total payments if wound-care supply costs are proportionately higher for patients receiving more costly staff time. However, some types of patients who have above-average nonroutine medical supply costs may not require more costly staff time. For example, staff may not need to spend extra time with patients who, prior to receiving home health care, managed their own ostomy care and will continue to do so. As a result, payments could be too low for these types of patients. In addition, the payment groups may not adequately distinguish among types of patients and their need for, and costs of, nonroutine medical supplies. Each payment group can include patients with widely varying clinical characteristics and nonroutine medical supply use. For example, the moderate clinical severity groups can include patients with diabetes and bowel ostomies, patients with stasis ulcers that are not healing, and patients with Parkinson’s disease—all of whom would be assigned to the same group even though their nonroutine medical supply costs could be quite different. These patients could be assigned to the same payment group, depending on their functional and service use characteristics. Although patients within a payment group have similar total episode costs, there could be subgroups of patients within a group who have above- average episode costs because of their nonroutine medical supply needs. Thus, patients requiring costly nonroutine medical supplies could have more difficulty gaining access to care, particularly since these patients are easy to identify prior to admission. As part of CMS’s review of the current PPS, the agency says it will try to evaluate whether the payment groups and adjustments appropriately account for variation in nonroutine medical supply costs across types of patients. CMS has noted that if supply costs vary significantly for different types of patients, the agency may modify the payment groups to account for supply cost differences as well as staffing. However, CMS continues to lack patient-specific data on the use and cost of specific nonroutine medical supplies needed to assess the variation in nonroutine medical supply costs across patients.