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Statement of Need: As the Medicare statute was originally enacted, Medicare payment for hospital services (inpatient and outpatient) was based on hospital-specific reasonable costs attributable to serving Medicare beneficiaries. The law was later amended to limit payment to the lesser of a hospital's reasonable costs or to its customary charges. In 1983, section 601 of the Social Security Amendments of 1983 (Public Law 98-21) completely revised the cost-based payment system for most hospital inpatient services by enacting section 1886(d) of the Social Security Act (the Act). This section provided for a PPS for acute inpatient hospital stays, effective with hospital cost reporting periods beginning on or after October 1, 1983. Although payment for most inpatient services became subject to PPS, hospital outpatient services continue to be paid based on hospital-specific costs which provided little incentive for hospital efficiency for outpatient services. At the same time, advances in medical technology and changes in practice patterns were bringing about a shift in the site of medical care from the inpatient to the outpatient setting. During the 1980's, the Congress took steps to control the escalating costs of providing outpatient care. The Congress amended the statute to implement across-the-board reductions of 5.8 percent and 10 percent to the amounts otherwise payable for hospital operating costs and capital costs, respectively, and legislated a number of different payment methods for specific types of hospital outpatient services. These methods included fee schedules for clinical diagnostic laboratory tests, orthotics, prosthetics, and durable medical equipment (DME); composite rate payment for dialysis for persons with end-stage renal disease; and payments based on blends of hospital costs in the rates paid in other ambulatory settings, such as separately certified ambulatory surgical centers (ASCs) or physician offices for certain surgery, radiology, and other diagnostic procedures. Nevertheless, Medicare payment for services performed in the hospital outpatient setting remains largely cost-based.

Summary of the Legal Basis: In section 9343 of the Omnibus Budget Reconciliation Act of 1986 (OBRA 1986) (Public Law 99-509) and in section 4151(b)(2) of the Omnibus Budget Reconciliation Act of 1990 (Public Law 101-508), the Congress required the Secretary to develop a proposal to replace the current hospital outpatient payment system with a PPS and to submit a report to Congress on the system. In section 9343 of OBRA 1986, the Congress paved the way for development of a PPS by requiring hospitals to report claims for services under the HCFA Common Procedure Coding System (HCPCS), and by extending the prohibition against unbundling of hospital services under section 1862(a)(14) of the Social Security Act (the Act) to include outpatient services as well as inpatient services. HCPCS coding enabled us to determine what specific procedures and services were being billed, while the extension of the prohibition against unbundling ensured that all non-practitioner services provided to hospital outpatients would be billed only by the hospital not by an outside supplier, and therefore, would be reported on hospital bills and captured in the hospital outpatient data used in developing an outpatient PPS. The Secretary submitted a report to Congress on March 17, 1995. The report summarized the research HCFA conducted in searching for a way to classify outpatient services for purposes of developing an outpatient PPS. The report cited Ambulatory Patient Groups (APGs), developed by 3M-Health Information Systems under a cooperative grant with HCFA, as the most promising classification system for grouping outpatient services and recommended that the APG-like groups be used in designing a hospital outpatient PPS. The report also presented a number of options that could be used, once the PPS was in place, for addressing the issue of rapidly growing beneficiary copayment. As a separate issue we recommended that the Congress amend the provisions of the law pertaining to the blended payment methods for ASC surgery, radiology, and other diagnostic services to correct an anomaly that resulted in a less than full recognition of the amount paid by the beneficiary in calculating program payment (referred to as the formula-driven overpayment). The Balanced Budget Act of 1997 (BBA) (Public Law 105-33), enacted on August 5, 1997, contains a number of provisions that affect Medicare payment for hospital outpatient services. The purpose of this rule is to implement sections 4521, 4522, and 4523 of the BBA. Section 4521 of the BBA eliminates the formula-driven overpayment, effective for services furnished on or after October 1, 1997. Section 4522 extends the current cost reduction of 5.8% and 10% (applicable to hospital outpatient operating cost and hospital capital costs, respectively) through December 31, 1999. Section 4523 provides for implementation of a PPS for hospital outpatient services (and for part B services furnished to inpatients who have no part A coverage) furnished on or after January 1, 1999. This system will also apply to partial hospitalization services furnished by community mental health centers. Section 4523 also requires a new method for calculating beneficiary copayments for the hospital outpatient services included under the PPS. This rule would also implement section 9343(c) of the Omnibus Reconciliation Act of 1986, which prohibits Medicare payment for non-physician services furnished to a hospital outpatient by a provider or supplier other than a hospital, unless the services are furnished under an arrangement with a hospital. This section also authorizes HHS's Office of Inspector General to impose a civil money penalty against any individual or entity who knowingly or willfully presents a bill for non-physician or other bundled services not provided directly or under such an arrangement. The Secretary has the authority under the BBA to determine which services are included (with the exception of ambulance services and physical, occupational, and speech therapies, for which fee schedules are being separately created). We will continue to pay for laboratory services and for orthotics and prosthetics on their prospective fee schedules, and for chronic dialysis using the composite rate.

Alternatives: If this final rule were not published, we would not implement the Balanced Budget Act of 1997 provision mandating a prospective payment system for hospital outpatient services. In addition, there would be no relief for beneficiaries from the large coinsurance burdens that they have been bearing for outpatient services.

Anticipated Costs and Benefits: The primary benefit of this rule is the elimination of a cost-based system, which provides little incentive for hospital efficiency for outpatient services. In addition, the regulation will provide considerable relief over time to beneficiaries from high coinsurance payments under the current system. Finally, the rules governing provider-based status will alleviate an important area of program abuse.