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CMS’s hospital inpatient regulation proposes the use of novel methods to calculate 2023 payment rates

This week, our In Focus section reviews the policy changes included in the Centers for Medicare & Medicaid Services’ (CMS) Fiscal Year (FY) 2023 Medicare Hospital Inpatient Prospective Payment System (IPPS) and Long-Term Acute Care Hospital (LTCH) Proposed Rule (CMS-1771-P). This year’s IPPS Proposed Rule includes several important policy changes that will alter hospital margins and change administrative procedures, beginning as soon as October 1, 2022.

HMA continues to monitor legislative and regulatory developments that will impact the hospital sector. For more information or questions about the policies described below, please contact Zach Gaumer ([email protected]), Amy Bassano ([email protected]), Andrea Maresca ([email protected]) or Clare Mamerow ([email protected]).

Key provisions of the FY 2023 Hospital IPPS and LTCH Proposed Rule

On April 18, 2022, CMS released the FY 2023 IPPS and LTCH Final Rule (CMS-1771-P). For FY 2023, CMS proposed to make modifications to several hospital inpatient payment policies. We highlight six payment specific 2023 payment policies that are among the most impactful for Medicare beneficiaries, hospitals and health systems, payors, and manufacturers: the annual inpatient market basket update and economy-wide inflation, the methodology used to calculated the weights of Medicare severity adjusted diagnosis related groups (MS-DRG), disproportional share hospital (DSH) payments, hospital wage index adjustments, and new technology add-on payments (NTAP). Stakeholders will have until June 17, 2022 to submit comments to CMS on the contents of this regulation, including several specific areas where CMS requests input.

1. Market basket update

Proposed Rule: Overall CMS’s Medicare 2023 Hospital Inpatient Proposed Rule will increase payments to acute care hospitals by an estimated $1.6 billion from 2022 to 2023; however, recent trends in economy-wide inflation may alter this estimate by the time the agency releases the Final Rule version of this regulation in August 2022. The primary driver of the estimated $1.6 billion increase in inpatient payments to hospitals is CMS’s proposed 3.2 percent increase in the annual update to inpatient operating payment rates.

HMA analysis: CMS’s 3.2 percent increase is largely based on an estimate of the rate of increase in the cost of a standard basket of hospital goods, the hospital market basket. For this Proposed Rule, data from the third quarter of 2021 was used to calculate this rate of increase. Importantly, for the FY 2023 Final Rule, CMS is likely to use data through the first quarter of 2022, which we know to include growth in economy-wide inflation. As a result, we anticipate the proposed 3.2 percent increase in the annual update to inpatient rates may increase by the time rates are finalized later in the year due to inflation, and with that the estimated increase in total Medicare inpatient payments to acute care hospitals is likely to be higher than $1.6 billion. For beneficiaries, increasing payment rates will eventually lead to a higher standard Medicare inpatient deductible and increased beneficiary out-of-pocket costs for many other services. For hospitals and health systems, payors, and manufacturers we will be watching to see if Medicare payment rates increase consistently with real-time inflation.

2. MS-DRG weights:

Proposed Rule: To set MS-DRG weights for FY 2023 inpatient cases, CMS proposed to use FY 2021 data with modifications to account for anticipated changes in COVID hospitalization rates. Contrary to the agency’s typical methodology of using all claims in a given year to calculate MS-DRG weights, CMS proposed to calculate weights by averaging weights derived from two separate calculations: 1) weights using all FY 2021 claims excluding COVID claims and 2) weights using all FY 2021 claims including COVID claims. Importantly, relative to the typical CMS methodology for setting MS-DRG weights, the proposal to control for COVID claims is designed to reduce the overall variability in DRG-level weights and in payment rates from 2022 to 2023. Further, CMS proposed to implement a permanent 10-percent cap on the reduction in any individual MS-DRG’s relative weight in a given fiscal year. CMS requested comments on the proposed 10-percent cap policy and whether the modified rate setting methodology is more accurate than simply using FY 2021 claims through the usual rate setting methodology.

HMA analysis: Our analysis of the new MS-DRG weight methodology confirms that the new methodology reduces the variability in weight changes from 2022 to 2023, relative to the typical MS-DRG weight methodology.  Absent the use of CMS’s novel methodology for setting rates, the variability in MS-DRG weights from 2022 to 2023 will be more significant. Despite the use of the novel methodology, HMA’s own analysis of the data identified large changes in the weights (and payment rates) for many MS-DRGs in 2023. Specifically, we observe large increases in the weights of medical MS-DRGs likely to include COVID cases (e.g., sepsis cases) and large decreases in the weights of surgical cases with relatively short lengths of stay. Given the extent of changes occurring for many MS-DRGs in 2023, hospitals, payers, and manufacturers will need to be aware of the proposed impact to specific inpatient MS-DRGs that affect their business.

3. Disproportionate Share Hospital (DSH) and Uncompensated Care (UC) payments

Proposed Rule: CMS proposed to reduce DSH and UC payments by $0.8 billion from 2022 to 2023, with most of this decline coming from reductions in UC payments. Further, CMS proposed to use two years of pre-COVID hospital cost report data to calculate the UC portion of these payments. In addition, CMS proposed to add hospital inpatient days attributed to patients associated with Medicaid section 1115 demonstrations within the calculation of total Medicaid days and therefore the calculation of hospital-level Medicare disproportionate share hospital (DSH) payments.

HMA analysis: Our analysis of the two DSH-related proposals highlighted above finds that the proposed reductions in DSH and uncompensated care payments will have a differential impact on hospitals nationwide, with some increasing DSH and UC payments and others losing DSH and UC payments. Hospitals serving larger shares of Medicaid patients are likely to benefit, while those with small or declining shares are likely to see declining DSH and UC payments.

CMS’s proposal to begin to count patients participating in section 1115 demonstrations in the calculation of DSH share will be a welcome change for hospitals and health systems, as this has the potential to increase DSH payments to individual hospitals. However, this change is complicated by the fact that many hospitals do not track patients participating in  section 1115 demonstrations. Therefore, it will take hospitals and health systems time to begin tracking these data and recording it within their hospital cost reports. In addition, this policy change will have a differential impact by state because of the variation in the scope of benefits and populations states cover in their section 1115 demonstrations. CMS proposed to define patients associated with section 1115 demonstrations as those who either receive health insurance or those who receive premium assistance from a state program to purchase health insurance which provides essential health benefits (EHB) and the assistance amounts to at least 90 percent of the cost of the health insurance. CMS proposed to exclude from this policy patients who use premium assistance to buy health insurance that does not provide EHB or for whom the premium assistance provided by the demonstration accounts for less than 90 percent of the cost of the health insurance. Further, hospitals that receive direct reimbursement for under- or uninsured patients through uncompensated care or similar pools under Section 1115 demonstration programs, will not be permitted to include patient days associated with these programs in the calculation of DSH share.

For beneficiaries, these policy changes will have a minimal direct impact. For hospitals and health systems, the DSH and UC payment declines could be large for some individual hospitals. In addition, to benefit from the Section 1115 demonstration policy proposal hospitals will need to begin tracking patients involved with these programs as soon as possible. Further, this policy could create downstream implications for reporting and transparency around Medicaid supplemental payments while also exacerbating tensions in states with a heavy reliance on uncompensated care pools in lieu of expanding Medicaid coverage.

4. Hospital Wage Index Adjustments:

Proposed Rule: CMS proposed a permanent 5-percent cap on any year-over-year decrease in an individual hospital’s geographic wage index, regardless of the circumstances causing the decline. Further, CMS proposed to implement this policy on a budget neutral basis.

HMA analysis: CMS’s wage index cap policy has been considered in past regulatory cycles, but the impetus for proposing this policy in FY 2023 likely associated with the difficulty hospitals have had over the last two years with staffing costs and staffing availability. The data used to set individual hospital wage indexes is impacted by volatility in staffing levels and the wages paid to hospital staff. CMS’s proposed 5-percent cap policy will moderate the volatility of these data and changes to individual hospital wage index calculations. For hospitals and health systems, this wage index 5-percent cap policy will protect them from large decreases in their wage index and therefore changes in the payments they receive from the Medicare program. Further, because CMS proposed to implement this policy on a budget neutral basis, any additional costs of this policy will be paid for across all hospitals.

5. New technology add-on payments (NTAP):

Proposed Rule: CMS continues to receive a large number of NTAP applications.  The agency proposed to continue NTAP payments for 15 drug and device technologies in FY 2023 which received an NTAP for FY 2022.  In addition, CMS proposed to consider the applications of 26 other drug and device technologies for possible NTAPs. CMS also proposed to discontinue NTAPs for 13 technologies in FY 2023 which had been given a special 1-year NTAP coverage extension for FY 2022.  CMS proposed to use National Drug Codes (NDCs) to identify drugs receiving NTAP payments starting in FY 2023.  In addition, CMS proposed to post, on a publicly accessible website, all NTAP applications (minus pricing and volume estimates) starting in FY 2024.  Both of these proposals aim to streamline the application submission and review process.

HMA Analysis: CMS continues to expand the use of the NTAP program to foster innovation within the Medicare program while also proposing changes to reduce CMS’ administrative burden in maintaining the program.

6. Outlier payments:

Proposed Rule: CMS proposed to modify the methodology for calculating payments on outlier cases within the IPPS to account for data uniquely impacted by COVID-19 and the public health emergency. The agency proposes to compute the outlier level at which cases become outlier cases, referred to as the fixed loss amount (FLA) by using data from pre-COVID years (2018 and 2019) instead of their typical method of using more recently available data.

HMA analysis: As a result of using the new methodology, the inpatient outlier FLA will increase significantly, but not as significantly as it would have if CMS had used their typical methodology which would have relied on more recent years of data from the 2020 and 2021. If finalized as proposed, we anticipate a decrease in the number of outlier cases and outlier-related spending for hospitals from 2022 to 2023. Hospitals and health systems will need to closely monitor the level at which CMS finalizes the FLA within the Final Rule.

Other important proposals introduced in the FY 2023 Medicare Hospital IPPS Proposed Rule include:

  • A proposal to establish the criteria for a new “Birthing Friendly” (or maternity) hospital designation,
  • A proposal to continue to suppress data impacted by COVID-19 and the public health emergency which is used within several quality-related hospital payment programs;
  • A solicitation for feedback from stakeholders on ways to advance health equity and key considerations to improve data collection for measuring and analyzing disparities;
  • A proposal to modify how resident FTEs above the cap are counted within the Graduate Medical Education payment program; and
  • A request for information on potential mechanisms to address issues related to rare diseases with low volumes in the MS-DRG structure.

Meet the HMA blog contributors

Zach Gaumer

Zach Gaumer

Managing Principal
Washington, DC
Amy Bassano

Amy Bassano

Managing Director, Medicare
Washington, DC
Andrea Maresca

Andrea Maresca, MPH

Managing Director, Information Services
Washington, DC
Clare Mamerow

Clare Mamerow

Washington, DC