OIG: Medicare paid new hospitals 3 times more than older facilities for capital costs

A sticky note says Medicare on top of a pile of money
The Office of Inspector General recommended the Centers for Medicare & Medicaid Services consider removing the separate payment methodology to achieve "significant" cost and potentially incentivize more efficient operations among new hospitals. CMS Administrator Chiquita Brooks-LaSure agreed with the recommendation. (Getty/Steve Dunning)

Medicare has been paying new hospitals three times the amount these facilities would have received if their capital costs were handled through the standard Inpatient Prospective Payment System (IPPS), according to a recent Office of Inspector General (OIG) audit.

Over a nine-year study period, the program paid 112 new facilities an extra $283 million, about $1.3 million each, to cover their one-time startup cost—despite the fact that more than half were part of chain organizations that could have capital reserves in place to cover those costs, the OIG wrote (PDF).

The payments come from an exemption to Medicare’s IPPS established in the early 1990s that allows hospitals in their first two years of operation to be paid 85% of their Medicare-related capital costs (e.g., leases, interest expense or insurance that are depreciated).

The exemption was hashed out and extended by the Centers for Medicare & Medicaid Services (CMS) due to concerns that new hospitals would incur significant startup costs, have lower Medicare utilization and no opportunity to build up capital reserves, OIG wrote.

These findings, however, give CMS reason to explore whether new hospitals still require a separate approach to capital cost payments. The watchdog wrote that CMS should review the data and gauge whether it should instead require capital cost payments through IPPS with payment adjustments or supplements “if necessary.”

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“CMS concurs with this recommendation,” CMS Administrator Chiquita Brooks-LaSure wrote in a comment letter included alongside the published OIG report. “CMS will further review the OIG’s findings and determine whether any modifications to the capital payment methodology for new hospitals should be proposed in future notice-and-comment rulemaking.”

The OIG’s audit reviewed more than $423 million in capital costs paid by Medicare to 112 new hospitals during the fiscal years 2012 through 2018.

The office calculated what the IPPS payments to each hospital would have been using data reported to CMS and compared these to the “reasonable cost” payments each hospital received. Additionally, the OIG reviewed actual costs and utilization for a subset of 35 new hospitals.

The audit “identified significant potential cost savings” for the program should the reasonable costs payments be done away with in favor of standard IPPS payments, the OIG wrote. The new hospitals had received just over three times more under the reasonable cost methodology, or an average $1.27 million more per cost report than they would have under the IPPS.

When comparing the sample subset’s first two years of operation to the following two years, the OIG saw that average Medicare-related capital costs were just 3% higher during the opening two years while average Medicare utilization was 15% lower, the office wrote.

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“Although new hospitals incur slightly higher capital costs and have somewhat lower Medicare utilization during their first two years of operation than they do in the subsequent two years, these differences are not so significant as to justify capital payments that are triple what they would have been paid through the IPPS,” the OIG wrote.

CMS’ remaining concern for new hospitals’ capital payments was also largely offset by their ownership. Across the 112-hospital sample, 59% were part of chain organizations “that might have been able to provide reserve capital to their new hospitals if needed,” the watchdog said.

Switching over to capital payments through IPPS with conditional adjustments or supplements would allow CMS “to realize significant cost savings” and potentially optimize these hospitals’ initial investments.

 “By using the IPPS for new hospitals in lieu of cost reimbursement, CMS could create incentives for hospitals to operate more efficiently,” the OIG concluded.