On the Way to Reform: Medicare Rate Updates Pack the Biggest Punch

Scott B. Clay, for HealthLeaders Media, July 20, 2009

These are heady days for the healthcare industry. The likelihood of national healthcare reform is greater than any time in recent history. There is a growing consensus that new payment models such as medical home and bundled payments will shape the industry towards a more "value based" purchasing model focused on managing chronic disease and improving preventive care. Demonstration projects and bold statewide initiatives, such as the one in Massachusetts are field testing the theories. There is no shortage of conjecture about which models will prevail and how health care providers should be prepared to succeed in the new landscape.

But amidst the dizzying array of healthcare reform proposals and revolutionary demonstration projects, let's be clear about one thing: over the next three years the financial performance and viability of hospitals and health systems will be more affected by one measure than any other: Medicare inpatient payment rate updates.

Remember the importance of annual Medicare updates
It is common knowledge that Medicare is the single largest payer source for hospitals nationwide. Nationally, over half of acute-care patient days are Medicare patients and more than 80% of hospital Medicare payments are for inpatients. As a percentage of revenues, hospitals are more dependent on Medicare than many other healthcare providers, including physicians and freestanding outpatient centers. So changes in Medicare payments, particularly inpatient payments, have the greatest single impact to hospital revenues.

There is no dispute that healthcare reform changes are important and will have a significant effect on hospitals. But these changes will take time to implement and ramp-up through national efforts. Many of the proposed changes will take several years or more to fully impact hospitals. In the meantime, the federal government will continue to manage expenditures by paying close attention to annual updates on the current system.

In its 2009 industry survey, HealthLeaders Media confirmed the importance of this issue. According to the respondents of the Finance Leader segment, "reimbursement cuts" are by far the trend that is expected to have the greatest impact on their organizations in the next three years. Furthermore, roughly 85 percent of respondents indicated that Medicare reimbursement was of "primary importance" to their revenue streams over the next three years?a far greater percentage than any other trend, including third-party payer negotiations.

A highly sensitive variable
Since Medicare represents such a large portion of hospital revenues, seemingly small changes can have a big impact. Historically, annual Medicare updates averaged around 3%, which was enough to offset 0% updates common for Medicaid programs as long as private insurers increased payments by an average of 4% or 5% annually. In other words, combined revenue inflation of 3.5% to 4% was sufficient to offset similar increases in expense inflation, with Medicare being heavily weighted in the revenue average. If net Medicare updates drop to 0% or worse for three years running, this alone could easily take a hospital from a 3% operating margin to a negative one. Even dropping Medicare updates to 2% annually can turn a 2% operating margin negative in three year's time unless expense inflation can be controlled. In the current economic climate, it is unlikely that commercial payers would agree to increases greater than those given in recent years, and Medicaid programs are more likely to reduce payments over the next three years than increase them, so additional cost shifting is not a likely solution.

Near term prospects
So, if Medicare reimbursement updates (particularly inpatient) serve as a cornerstone to short-term financial success, what are its prospects? In summary, the crystal ball does not paint a rosy picture.

The wake-up call came in the form of the 2010 inpatient prospective payment system proposed rule published in May. The proposed update included a market basket increase of only 2.1% and a behavioral offset of -1.9% for coding changes from the MS-DRG transition. Additional budget neutrality adjustments reduce the market basket update by another -0.7%, resulting in a total estimated reduction of -0.5% for 2010. The final rule (due August 1) could differ from the proposed rule, but even if 2010 payments are rescued, the longer term pressures to reduce Medicare costs remain.

One year of flat or slightly negative updates from Medicare would be difficult but not devastating for hospitals. However, included in the comments for the proposed 2010 update, CMS indicated a need for an additional 6.6% of negative adjustments over the next two years, resulting in a total three year reduction of 8.5%. Even with normal inflationary market basket updates, this would effectively wipe out payment rate increases for three years straight, and possibly result in a net three-year reduction in Medicare updates.

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