Medicare Reform -- Balanced Budget Act of 1997

The Balanced Budget Act of 1997 made a number of significant changes in the Medicare program. These changes are, of course, significant to the providers affected by them and generally mean lower potential revenues from the Medicare program. Also significant is their long-term effect on the average per capita cost of the program, which is the basis for paying capitation to Medicare risk contractors. IF the changes succeed in reducing the cost of Medicare, AAPCC growth will slow, and the profitability of Medicare risk contracts will be affected.

There are two generic types of reimbursement programs used by Medicare. Under a retrospective cost system, providers are paid after the services are provided based upon approved reasonable costs. Under a prospective system, a uniform rate is established in advance of the services being provided. Many of the changes adopt new prospective payment systems for various Medicare facilities and services, designed to halt manipulation of treatment venues and provision of unnecessary services by providers.

Acute Care Hospitals

Rates paid under the Prospective Payment System (PPS), which pays a fixed fee per discharge diagnosis (DRG), will be held constant in 1998 and reduced from otherwise payable levels in 1999 through 2002. In 1999, the increases will be limited to the "Market Basket" level less 1.9%; in 2000, less 1.8% and in 2001 and 2002, less 1.1%.

Reductions in the payments for capital expenditures will be reduced by 17.7%. Another significant change may well impact the number of acquisitions of hospitals by such chains as Columbia and Tenet. Under present law, acquirers of hospitals may claim a 'step-up' in basis for the cost of fixed assets in their Medicare reimbursement. Many had come to believe that this provision was, in effect, financing the takeover of nonprofit hospitals by the for-profits. Effective for ownership changes after 12/1/97, basis step-up will no longer be permitted, and historical cost less depreciation as of 8/11/97 will serve as the measurement.

Disproportionate share hospitals (DSH) - those with an excess of low income patients - will receive reimbursement cutbacks under the DSH adjustment provisions of 1% in 1998, 2% in 1999, 3% in 2000, 4% in 2001 and 5% in 2002.

Under present law, PPS hospitals which have cases that exceed the cost implicit in the regular DRG payments receive so-called cost outlier payments. The present payments include add-ons for indirect medical education costs (IME) typically received by teaching hospitals as well as DSH costs; the IME will be eliminated. Length of stay outlier payments - where the days spent in the hospital by a patient exceed the mean for a particular DRG grouping - are scheduled to expire at the beginning of FY98.

Acute care hospitals are generally paid under the PPS described above. Sub-acute care facilities are paid on a per diem basis. As a result of this mixed incentive payment system, it has become increasingly common for acute care hospitals to discharge patients to sub-acute facilities, where the billing process can begin again. As of FY99, HHS is to identify 10 DRGs where this practice has been abused. In these ten DRGs, the discharge to sub acute care will instead be treated as a transfer, preventing the re-start of the billing process. Reimbursement in these cases will be limited to 50% of the DRG payment plus 50% of the per diem payment. It is anticipated that the results of a study of these 10 DRGs will be expanded to most if not all of the others.

Hospital Outpatient Departments

These services are generally covered by Part B of Medicare. HHS is directed to develop a prospective payment system for these services, effective 1/1/99. In effect, a series of "DRGs" will be developed for hospital outpatient services, reducing the incentives for overutilization and the common practice of shifting reimbursable costs from inpatient to outpatient settings to enhance reimbursement.

The current 10% reduction in payments for outpatient capitals costs will be extended through FY 2000.

Outpatient Rehab Services

As is the case throughout much of the 1997 changes, Medicare will adopt a Prospective Payment System for these Part B services, to be implemented January of 1999. The underlying reason for this change is similar to that described above for discharges to subacute care - the mix of the DRG-based PPS for inpatient acute care with retrospective cost per diem based systems for other services creates a perverse pattern of financial incentives which is costing the Medicare program money.

Outpatient rehab services include physical therapy, occupational therapy and speech therapy. After a transition year in 1998, hospitals will be paid in 1999 at 80% of the PPS rate with a 20% patient co-pay. Medicare assignment will be mandatory and there will be an annual limit of $1,500 for physical therapy and speech therapy with a separate $1,500 for occupational therapy outside of a hospital OPD.

Skilled Nursing Facilities (SNFs)

SNFs are presently paid under a retrospective cost system. Nursing, room and board and similar facility expenses are paid on a per diem basis determined based upon submission of cost reports. Ancillary services such as pathology, physical therapy, occupational therapy and speech therapy are paid based upon utilization and a fee schedule.

Once again, a prospective payment system to be developed which will have a federal per diem rate for covered SNF services under both parts A & B, excluding physician and physician extender costs, but including physical therapy, occupational therapy and speech therapy, these latter three being a traditional area for revenue enhancement in SNF settings.

During a three year transition from 7/1/98, SNFs will be paid a blend of their own facility rate, based on FY 95 costs, and the federal rate, as follows:

Year 1 75% Facility Specific 25% Federal Rate
Year 2 50% Facility Specific 50% Federal Rate
Year 2 25% Facility Specific 75% Federal Rate

There is a specific prohibition in the legislation against judicial review of the federal per diem rates.

Rehabilitation Hospitals

A prospective payment system will likewise be developed by October 1, 2000 for rehabilitation hospitals, with a three year transition as follows:

Year 1 67% Facility Specific 33% Federal Rate
Year 2 33% Facility Specific 67% Federal Rate
Year 2 0% Facility Specific 100% Federal Rate

Other Part B Changes

Durable medical equipment, Parenteral and enteral nutrients, etc.

There will be no inflation update in the reimbursement for these items during the years 1998 through 2002.

Oxygen and equipment

The monthly payment will be reduced by 25% in 1998 and another 5% in 1999, where it is scheduled to be frozen permanently.

Clinical laboratory tests

There is an outright reduction in reimbursement of 2% in addition to no inflation update during the years 1998 through 2002.


Presently, Medicare pays physicians under the Resource-based Relative Value Scale where each CPT code is assigned a certain number of relative value units (RVUs). These RVUs are then multiplied by a conversion factor, of which there were three: One for surgery, one for primary care and one for other nonsurgical services. The Act substitutes a single conversion factor based upon the present, updated, primary care factor. The effect, as seen below, is a cutback in reimbursement for surgical services. Anesthesia services will be paid at a conversion factor equal to 46% of the factor applied to other services.

Changes by specialty:


Radiation Oncology +8.4%
Psychiatry +8.2%
Radiology +8.2%
Pathology +8.0%
Heme/Oncology +8.0%
Neurology +7.9%
Pulmonology +7.7%
Rheumatology +7.2%
Gastroenterology +7.1%
Internal Medicine +7.0%
Family Practice +6.4%
Cardiology +6.4%
General Practice +6.0%
Nephrology +4.7%
Clinics +4.4%
Emergency Medicine +3.2%
Anesthesiology +2.1%
Obstetrics/Gyn +0.6%
Otolaryngology +0.5%
General Surgery +2.3%
Vascular Surgery +2.6%
Urology +2.9%


Orthopedic Surgery -4.0%
Dermatology -4.6%
Plastic Surgery -5.3%
Ophthalmology -5.8%
Neurosurgery -5.9%
Thoracic Surgery -7.2%
Cardiac Surgery -8.8%

The Act delays scheduled 1998 changes in allocating RVUs to the various CPT codes. The allocations are based in part on studies conducted by Medicare of the expenses associated with each specialties' services. In 1999, a four year transition to the new allocations will commence, with 25% of the practice expense factor based upon the new rules and 75% based on the old rules, until the system is fully phased in by 2002.

Medicare will now pay for the services of physician extenders, including physician assistants, nurse practitioners and clinical nurse specialists, generally at a rate equal to 85% of the physician fee.

New Coverages

Screening mammography is covered for all women over the age of 39 and the annual Medicare $100 deductible is waived, effective 1/1/98.

Effective 1/1/98, screening pap smears and pelvic exams are covered every three years. If a woman is deemed to be at high risk for cervical or vaginal cancer, annual testing is authorized. The annual Medicare $100 deductible is waived.

Effective 1/1/2000, prostate cancer screening is covered, including a digital rectal exam, prostate specific antigen test, and after 2002, any other method the Secretary of HHS finds appropriate.

Generally effective 1/1/98, a broad range of colorectal cancer screening tests are covered, including annual fecal occult blood tests for those over 50, screening double contrast barium enemas, quadrennial flexible sigmoidoscopy, biennial colonoscopy for high risk individuals, and any other method the Secretary of HHS finds appropriate.

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    Mark O. Dietrich
    last revised July 10, 2000
    Copyright Mark O. Dietrich, Dietrich & Wilson 2000 all rights reserved