While the 75 percent rule has been in effect in one form or another for over two decades, the current payment system and review procedures for IRFs went into effect in recent years. The Social Security Amendments of 1983 changed the Medicare hospital payment system from a cost-based retrospective reimbursement system to a prospective system known as the inpatient prospective payment system (IPPS), under which hospitals receive a per discharge payment for a diagnosis-related group (DRG). However, the amendments excluded “rehabilitation hospitals,” and so IRFs continued to be paid under a reasonable-cost-based retrospective system. Before the IPPS was implemented, CMS consulted with the Joint Commission on Accreditation of Healthcare Organizations (JCAHO) and other accrediting organizations to determine how to classify IRFs, that is, distinguish them from other facilities for payment purposes. The 75 percent rule was established for that purpose in 1983. To develop the original list of conditions in the 75 percent rule, CMS relied, in part, on information from the American Academy of Physical Medicine and Rehabilitation, the American Congress of Rehabilitation Medicine, the National Association of Rehabilitation Facilities, and the American Hospital Association. According to CMS, the conditions on the list accounted for approximately 75 percent of the admissions to IRFs when the original list was developed. In January 2002 a prospective payment system (PPS) was implemented for IRFs—known as the inpatient rehabilitation facility prospective payment system (IRF PPS). On June 7, 2002, CMS suspended the enforcement of the 75 percent rule after its study of FIs, which have responsibility under contract with CMS for verifying compliance with the rule, revealed that they were using inconsistent methods to determine whether an IRF was in compliance and that in some cases IRFs were not being reviewed for compliance at all. Specifically, CMS found that only 20 of the 29 FIs conducted reviews for IRF compliance with the 75 percent rule and that the FIs that did these reviews used different methods and data sources. In 2004, CMS standardized the verification process that the FIs were to use to determine if an IRF met the classification criteria, including how to determine whether a patient is considered to have 1 of the 13 conditions. When the final rule was made effective on July 1, 2004, a transition period was established for IRFs to meet the requirements of the rule. In addition to lowering and then increasing the threshold, the transition period allows a patient to be counted toward the required threshold if the patient is admitted for either a primary or comorbid condition on the list in the rule. But at the end of the transition period, a patient cannot be counted toward the required threshold on the basis of a comorbidity on the list in the rule. The requirements of the transition period are as follows: July 1, 2004, to June 30, 2005: 50 percent threshold, counting comorbidities July 1, 2005, to June 30, 2006: 60 percent threshold, counting comorbidities July 1, 2006, to June 30, 2007: 65 percent threshold, counting comorbidities Effective July 1, 2007, the threshold will be 75 percent, not counting comorbidities. During the 3-year transition period, CMS plans to analyze claims and patient assessment data to evaluate if and how the 75 percent threshold should be modified. In addition, the agency has announced its willingness to consider alternative policy proposals to the 75 percent rule submitted during this period. In the past, CMS has declined requests to modify the rule’s threshold or list of conditions, citing a lack of supporting or objective data from the clinical community. However, in the final rule, the agency solicited “objective data or evidence from well-designed research studies” that would support a change in the rule’s 75 percent threshold or list of conditions. Also, because of the relative absence of clinical research studies in the peer-reviewed medical literature, CMS contracted with NIH to convene one meeting of a research panel to review the current medical literature and identify priorities for conducting studies on inpatient rehabilitation. Beginning in January 2002, CMS implemented the IRF PPS to pay IRFs on a per-discharge basis. Payment is contingent on an IRF’s completing a patient assessment after admission and transmitting the resulting data to CMS. The Inpatient Rehabilitation Facility—Patient Assessment Instrument (IRF-PAI) includes identification of an impairment group code that identifies the impairment group, or the condition that requires admission to rehabilitation. The patient’s comorbidities are also recorded on the IRF-PAI. The impairment group code is combined with other information on the IRF-PAI to classify the patient into 1 of 100 case-mix groups (CMG). Patients are assigned to a CMG based on the impairment group code, age, and levels of functional and cognitive impairment. The CMG determines the payment the IRF will receive for a patient. Each CMG is weighted to account for the relative difference in resource use across all CMGs. Within each CMG, the weighting factors are “tiered” based on the estimated effect of comorbidities. Each CMG has four payment tiers reflecting the level of comorbidities. CMS contracts with FIs, the entities that conduct compliance reviews, to conduct reviews for medical necessity to determine whether an individual admission to an IRF was covered under Medicare. FIs were specifically authorized to conduct reviews for medical necessity for inpatient rehabilitation services beginning in April 2002. According to the Medicare Benefit Policy Manual, two basic requirements must be met if inpatient hospital stays for rehabilitation services are to be covered: (1) the services must be reasonable and necessary, and (2) it must be reasonable and necessary to furnish the care on an inpatient hospital basis, rather than in a less intensive facility, such as a SNF, or on an outpatient basis. Determinations of whether hospital stays for rehabilitation services are reasonable and necessary must be based on an assessment of each beneficiary’s individual care needs. Fewer than half of all IRF Medicare patients in fiscal year 2003 were admitted for conditions on the list in the 75 percent rule. The patients admitted in 2003 had a variety of conditions, not all of which were on the list in the rule. Nearly half of the patients admitted for conditions not on the list were admitted for orthopedic conditions. The largest group of patients admitted for orthopedic conditions not on the list were admitted for joint replacements that did not meet the list’s specific criteria for joint replacement. Relatively few of these patients had comorbid conditions that suggested a possible need for the intensive level of rehabilitation provided in IRFs. Additionally, we found that based on the fiscal year 2003 data few IRFs were able to meet a 75 percent threshold. Medicare patients were admitted to IRFs in fiscal year 2003 with a variety of conditions, as defined by the impairment group codes we analyzed. Forty-two percent of the 506,662 Medicare patients admitted to IRFs in 2003 were admitted with orthopedic conditions, representing the largest category of patients. Figure 1 shows the distribution of all the conditions, based on impairment group codes, for which patients were admitted to IRFs in fiscal year 2003. The largest impairment group consisted of patients admitted for joint replacement. Fewer than half of the Medicare patients (222,316 of the 506,662 patients) admitted in fiscal year 2003 were admitted for a primary condition that was on the list in the 75 percent rule. Using the impairment group codes assigned to these patients at the time of their admission, we determined that in fiscal year 2003 less than 44 percent of IRF admissions had a primary condition that was on the list in the rule. However, when comorbid conditions that were on the list were counted—as they would be during the transition period—the number of patients having a listed condition rose to 311,740 (62 percent) of IRF patients in that year. (See table 1.) The amount of increase that occurred when comorbid conditions were counted varied by impairment group. For some impairment groups, the percentage of patients who had a condition on the list in the rule substantially increased when comorbidities were counted. For example, the percentage of joint replacement patients having a listed condition increased from 13 percent to 51 percent by virtue of their comorbidities. The comorbidity that qualified over 90 percent of this group was some form of arthritis. In contrast, the increase was lower for patients in the medically complex, cardiac, debility, pain syndrome, and pulmonary disorder impairment groups, increasing between 14 percentage points and 22 percentage points. The comorbidity that qualified about one-third of cardiac and debility patients was stroke, and the comorbidity that qualified over one-third of pulmonary patients was a neurological condition. Almost half of the 194,922 IRF Medicare patients that did not have a condition on the list in the rule, either as a primary condition or as a comorbid condition, were admitted for orthopedic conditions. (See fig. 2.) The single largest group of patients who did not have a condition on the list were the joint replacement patients whose condition did not meet the list’s specific criteria for joint replacements. Over 30 percent of patients who did not have a condition on the list had been admitted to IRFs for joint replacement, with another 15 percent having been admitted for “other orthopedic,” that is, any orthopedic condition other than hip fractures or joint replacements. The next largest group, cardiac patients, represented 12 percent. Although some joint replacement patients may need the level of services of an IRF, such as those who have a comorbid condition that significantly affects their level of function, our analysis of the case-mix groups used for payment purposes suggests that relatively few of the Medicare joint replacement patients currently admitted by IRFs fit this description. In particular, 87 percent of joint replacement patients admitted in fiscal year 2003 had unilateral procedures and were less than 85 years of age, and thus did not fit the criteria for joint replacement on the list in the rule based on their primary condition. Of the joint replacement patients who did not fit the criteria based on their primary condition, over 84 percent were in a payment tier with no comorbidities that affected costs.