Skilled Nursing Facilities: Medicare Payments Need to Better Account for Nontherapy Ancillary Cost Variation

Published by the Government Accountability Office on 1999-09-30.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                  United States General Accounting Office

GAO               Report to the Chairman, Subcommittee
                  on Health, Committee on Ways and
                  Means, House of Representatives

September 1999
                  SKILLED NURSING
                  Medicare Payments
                  Need to Better Account
                  for Nontherapy
                  Ancillary Cost

      United States
GAO   General Accounting Office
      Washington, D.C. 20548

      Health, Education, and
      Human Services Division


      September 30, 1999

      The Honorable William M. Thomas
      Subcommittee on Health
      Committee on Ways and Means
      House of Representatives

      Dear Mr. Chairman:

      Over the last decade, Medicare payments for skilled nursing facility (SNF)
      services have increased dramatically, with spending rising on average over
      23 percent per year between 1990 and 1996. To curb this growth, the
      Balanced Budget Act of 1997 (BBA) replaced Medicare’s existing cost-based
      payment methodology with a prospective payment system (PPS).1 PPS
      payments for SNFs—which provides facilities an all-inclusive daily
      payment, adjusted for the complexity and expected care needs of each
      patient—began being phased in on July 1, 1998.2

      Concerns have been raised about whether the rates under the new
      payment system account for disparate patient costs, particularly high or
      low nontherapy ancillary service costs, which include drugs, laboratory
      tests, radiology procedures, respiratory therapy, medical supplies,
      intravenous therapy, and other nonroutine services. These concerns have
      prompted legislative proposals to raise SNF PPS payments for all or some
      types of patients. In this context, you asked us to (1) assess whether the
      SNF payment rates incorporate the costs of nontherapy ancillary services
      and (2) analyze the PPS design and nontherapy ancillary cost variation to
      assess whether payments are distributed appropriately.

      To complete this study, we reviewed the provisions of BBA and the Health
      Care Financing Administration’s (HCFA) interim rule and final rule on the
      prospective payment system and consolidated billing for SNFs, which took
      effect on July 1, 1998, to determine the extent to which nontherapy
      ancillary cost variation was accounted for in the payment rates. We also
      analyzed provider cost reports from fiscal year 1995 (the most recent
      available data) to estimate the average costs per day, the components of

       P.L. 105-33, section 4432(a).
       There is a 3-year transition to the new payment system during which payments are a blend of
      facility-specific and national average per diem rates. In the first year, payments are 75-percent
      facility-specific; 50-percent facility-specific in the second year; and 25-percent facility-specific in the
      third. The facility-specific portion is based on each facility’s updated 1995 costs. SNFs are being
      phased in according to the start of their fiscal year.

      Page 1                                           GAO/HEHS-99-185 SNF Nontherapy Ancillary Costs

                   daily costs, and the variations in costs across Medicare-certified SNFs. We
                   conducted our work between December 1998 and August 1999 in
                   accordance with generally accepted government auditing standards. (For a
                   detailed discussion of our scope and methodology, see app. I.)

                   SNF PPS rates were calculated using the full historical costs of nontherapy
Results in Brief   ancillary services, updated for inflation. Costs associated with
                   unnecessary care and improperly billed services may have boosted these
                   historical costs above what was warranted, resulting in generous PPS
                   payment rates. However, BBA explicitly reduced payments by not
                   accounting for total cost increases, raising concerns about whether the
                   adjustment process adequately accounts for cost increases that occurred
                   between the base-year and the first PPS payment year. Although the
                   case-mix adjustments to payments for each patient under PPS are intended
                   to account for changes in costs due to shifts in the mix of treatments,
                   evidence indicates that for some types of patients, these adjustments may
                   not be adequate. A full audit of SNF base-year and current costs and
                   medical reviews of service provision would be needed to establish the
                   actual relationship between the current costs of medically appropriate
                   care and payments.

                   Nontherapy ancillary costs were not used to develop the payment
                   adjusters that raise or lower the average payment to account for resource
                   need differences across patients. As a result, per diem payments may not
                   be adequate for types of patients who are likely to incur high nontherapy
                   ancillary costs or may be excessive for those groups of patients with low
                   expected nontherapy ancillary costs. In 1995, nontherapy ancillary service
                   costs comprised 16 percent of total daily SNF costs, indicating that failure
                   to adequately account for nontherapy ancillary cost variation could result
                   in substantial under- or overpayments. This potential misallocation could
                   contribute to beneficiary access problems if certain patients are identified
                   prior to SNF admission as requiring nontherapy ancillary costs higher than
                   the PPS rate.

                   HCFA is investigating possible refinements to PPS that could address these
                   problems. In the meantime, increasing SNF payments will not improve the
                   allocation of the payments but will only increase program outlays and
                   possible overpayments to certain facilities.

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                          Medicare covers up to 100 days of care in a SNF for beneficiaries who need
Background                skilled nursing or rehabilitative care on a daily basis following a hospital
                          stay of at least 3 days. Medicare pays for routine services, such as room
                          and board, skilled nursing care, social services, and supplies and
                          equipment. It also pays for ancillary services, including physical,
                          occupational, respiratory, and speech therapies; laboratory services;
                          radiology procedures; and drugs.

Cost-Based                Prior to the implementation of PPS, Medicare paid SNFs on a reasonable
Reimbursement Had Few     cost basis. Routine nursing and room and board costs were paid up to
Incentives to Constrain   specified limits, with higher limits applied to hospital-based SNFs than to
                          freestanding ones. New providers were exempt from the cost limits for up
Costs                     to their first 4 years of operation. In addition, providers that demonstrated
                          higher than average costs as a consequence of atypical patients or patterns
                          of care could be granted exceptions to the routine cost limits.

                          Unlike payments for routine costs, payments for ancillary (therapy and
                          nontherapy) costs were not subject to limits. Services had to meet medical
                          necessity criteria, but there was little Medicare review of their use. As a
                          result, facilities had few incentives to constrain costs or to restrict
                          ancillary service provision to only necessary services—increases in
                          ancillary service costs increased payments. In fact, payments for ancillary
                          services increased 17 to 20 percent annually between 1992 and 1995,
                          compared with 5 to 7 percent for routine services.

                          Despite the growth in Medicare expenditures, funding for program
                          safeguards decreased by 50 percent between 1989 and 1995. Limited
                          auditing of cost reports and medical review of claims raised concerns that
                          ancillary cost growth was not entirely due to increases in the service needs
                          of Medicare beneficiaries.

PPS Implemented to        To curb the rise in Medicare SNF spending, BBA required HCFA to implement
Control Spending          a PPS for SNFs. HCFA designed an all-inclusive per diem payment approach
                          to replace the cost-based reimbursement methodology (see app. II). The
                          per diem payment, which is adjusted for differences in the resource needs
                          of patients and for geographic differences in labor costs, covers all
                          routine, ancillary, and capital costs incurred in treating a SNF patient.

                          The per diem rate has three components—one for nursing (nursing care,
                          social services, and nontherapy ancillary services), one for therapies

                          Page 3                            GAO/HEHS-99-185 SNF Nontherapy Ancillary Costs

(physical, occupational, and speech), and a non-case-mix services
component (for example, capital, maintenance, dietary)—that are totaled
to determine the overall payment. The nursing and therapy components
are adjusted upward for patients who are expected to be more
resource-intensive—and thus more costly to care for—or downward for
patients who are expected to be less resource intensive than average. The
non-case-mix component covers costs that are assumed to be uniform
across all patients and, therefore, is not adjusted.

The adjustments of nursing and therapy payments are based on a case-mix
classification system—Resource Utilization Group, version III, or
RUG-III—developed by HCFA contractors. The system comprises 44 distinct
patient groups distinguished by patient clinical condition, functional
status, and expected use of certain types of services. Each case-mix group
has a corresponding “nursing relative weight” that reflects the costliness of
providing services to patients in that group relative to the average
costliness of patients across all groups. Of the 44 RUG-III groups, 14
describe patients who require substantial therapy services and have an
associated “therapy relative weight.” The remaining case-mix groups are
assumed to require a minimal amount of therapy services and are paid a
fixed non-case-mix therapy payment. The payment for each day of care for
a patient is the sum of three parts—the nursing component (the product of
the nursing base rate and the nursing relative weight for the appropriate
RUG-III group), the therapy component (the product of the therapy base
rate and the appropriate relative weight or a flat amount, depending on the
RUG-III category), and the non-case-mix amount (see fig. 1). (App. II
contains a more complete discussion of the payment amount calculation.)

Page 4                            GAO/HEHS-99-185 SNF Nontherapy Ancillary Costs

Figure 1: Overview of SNF PPS Rate

                                     HCFA  used 1995-reported SNF costs, including those for nontherapy
Average SNF                          ancillary services, as the basis for the 1999 base payments under PPS. Given
Payments Include                     the lack of incentives under the prior payment approach to control
Historical Nontherapy                ancillary costs, the 1995 costs may be higher than warranted due to
                                     inefficient service provision, the costs of unnecessary care, and improper
Ancillary Costs                      billings. On the other hand, some contend that the method for updating the
                                     1995 costs to 1999 levels underestimated appropriate cost increases over
                                     that period. Without a systematic review of SNF costs, service provision,
                                     and payments, it is not possible to determine the appropriateness of the
                                     resulting 1999 base rates.

                                     The base PPS payment amounts include (1) the per diem routine, ancillary,
                                     and capital costs reported by SNFs in fiscal year 1995 and (2) an estimate of
                                     the per diem average amount paid during that year for ancillary services
                                     furnished to SNF patients by external providers (such as outside
                                     laboratories.) The 1995 nontherapy ancillary costs were thus fully included
                                     in the calculation of the base rates. Total costs were updated for inflation

                                     Page 5                            GAO/HEHS-99-185 SNF Nontherapy Ancillary Costs

between the 1995 base year and 1999 by the SNF market-basket index
minus 1 percent, as required by BBA.3

There is evidence that base year spending was higher than it should have
been due to unwarranted growth in ancillary expenditures and
unnecessary costs or inappropriate billing for services, which was
undetected because of minimal program oversight. We have reported that
it is likely that the base year costs include too many services and that the
costs per service were inappropriately high.4 Likewise, in its review of the
SNF PPS, the Department of Health and Human Services’ (HHS) Office of the
Inspector General (OIG) noted that the rate-setting process did not
adequately exclude costs for medically unnecessary care or the amount of
improper SNF payments.5 Due to these factors, the level of overpayments is
not known.

The adequacy of the method of updating the 1995 costs to 1999 costs has
been called into question. Some contend that actual SNF costs rose faster
than the inflation adjuster because SNFs were treating more complex
patients and providing more intensive treatments. Some of this increase,
however, will be accounted for by the case-mix adjustment to the
payments. To the extent that higher costs are due to a different mix of
patients than is measured by the case-mix adjustment method, the national
portion of the payments will be higher.6 Reflecting congressional concerns
about excessive cost increases due to inefficient or inappropriate service
provision under cost-based payments, BBA explicitly reduces SNF per diem
payments by requiring the use of an inflation adjuster that is less than the
expected increase in SNF costs, as measured by the market-basket index.

Additional information is required to determine the adequacy and
appropriateness of payments. Thoroughly audited Medicare cost reports,
patient assessment data, and beneficiary claims are needed to establish
the appropriateness of facility costs, and medical reviews of services
provided to Medicare beneficiaries would determine if any unnecessary
care had been provided. Together, this information would provide a

 The market-basket index measures the annual change in the prices of goods and services providers
use in producing health care services.
Balanced Budget Act: Any Proposed Fee-for-Service Payment Modifications Need Thorough
Evaluation (GAO/T-HEHS-99-139, June 10, 1999).
 OIG, Review of the Health Care Financing Administration’s Development of a Prospective Payment
System for Skilled Nursing Facilities, A-14-98-00350 (Washington, D.C.: HHS).
 During the transition, the facility portion of the payment is not case-mix adjusted because it already
includes facility-specific costs.

Page 6                                         GAO/HEHS-99-185 SNF Nontherapy Ancillary Costs

                      clearer picture of what Medicare should be paying for services and could
                      be used to identify and assess the appropriateness of any cost growth that
                      remains unaccounted for by the inflation adjuster or the case-mix
                      adjustment to payments.

                      The SNF case-mix-adjustment system does not directly account for the
PPS Case-Mix          variation in nontherapy ancillary costs across patients because only
Adjustments May Not   variations in nursing time were used to establish the relative weights for
Appropriately         the case-mix groups. As a result, SNF payments may not vary consistently
                      with the expected variation in patient costs. This could disadvantage those
Distribute SNF        facilities that treat many patients with high nontherapy ancillary costs and
Payments              may create access problems for patients who are identified as having high
                      nontherapy ancillary needs prior to admission. The dollars at stake are
                      substantial. In 1995, Medicare nontherapy ancillary costs accounted for
                      16 percent ($45) of the daily costs of care. To the extent that payments do
                      not adequately reflect nontherapy ancillary costs, some SNFs could receive
                      substantial overpayments relative to the expected costs of their mix of
                      patients, while others could be underpaid.

                      In order to assess the adequacy of the payments for nontherapy ancillary
                      costs across the different case-mix categories, average patient-level costs
                      and average payments would need to be compared. These data are not yet
                      available.7 However, facility-level data indicate that there is a ninefold
                      variation in average nontherapy ancillary costs per day. By comparison,
                      the relative weights used to adjust payments for these costs only allow
                      payments to vary by about two and a half times—suggesting that PPS could
                      be overpaying some facilities and underpaying others. Further, by
                      comparing the range in potential payments for nontherapy ancillary costs
                      to facilities’ costs, we found that two-thirds of the SNFs had reported costs
                      either below or above that range. This also indicates that there could be
                      substantial over- or underpayments under PPS to certain facilities.

                        Until data are available, many elements required to classify patients into the 44 RUG-III groups—such
                      as the frequency and duration of therapies, the number of physician visits or order changes, and
                      activities of daily living—cannot be reproduced using existing claims information.

                      Page 7                                        GAO/HEHS-99-185 SNF Nontherapy Ancillary Costs

Classification System’s    The RUG-III classification system groups similar types of patients based on
Relative Weights Not       their expected level of resource use.8 To adjust payments, each group is
Likely to Adequately       assigned two weights: one based on the average cost of providing nursing
                           services to the patients in the group relative to overall patient averages
Account for Patient Cost   and the other based on relative therapy costs. Although total nontherapy
Variation                  ancillary costs were included in the base nursing rate, these costs were not
                           considered in the calculation of the nursing relative weights. Rather,
                           nursing time was used to develop the relative weights. If nontherapy
                           ancillary costs are correlated with nursing time, the nursing weights will
                           appropriately distribute payments according to patients’ nontherapy
                           ancillary resource needs. If this is not the case, the payments for some
                           groups of patients will be too high and for others, too low.

                           According to HCFA, it incorporated nontherapy ancillary costs into the
                           nursing base rate because its analysis showed that patients in the RUG-III
                           categories with high nursing relative weights tend to have high nontherapy
                           ancillary charges. However, this does not necessarily mean that weights
                           based only on nursing time are adequate to distribute payments for
                           nontherapy ancillary services. At the time the classification system was
                           developed, nontherapy ancillary costs did not comprise a substantial share
                           of SNF costs9—they now do, averaging approximately 16 percent of SNF per
                           diem costs in 1995.10 Thus, if the relative weights do not adequately
                           account for these costs, the total per diem payment may not be
                           appropriate. For example, some patients requiring relatively limited
                           nursing time might have costly nontherapy ancillary needs, such as the
                           administration of expensive drugs. Without other service needs that would
                           place these patients in higher weighted groups, they would get assigned to
                           case-mix groups with lower relative weights that may not fully reflect their
                           high nontherapy ancillary costs. If nursing homes identify these patients
                           and choose not to admit them, the patients may need to stay in a hospital
                           longer to receive the care they need. Our work and work conducted by
                           HHS’ OIG found that some patients who require extensive services are more

                            The need for certain nontherapy ancillary services, such as chemotherapy, radiation therapy, and
                           parenteral feeding, are used to classify patients into some case-mix groups. The costs of these
                           nontherapy ancillary services, however, are not used in calculating the relative weights for these
                           case-mix groups.
                            For example, pharmacy costs, the largest, was 5 percent of nursing costs. See Brant E. Fries, Don P.
                           Schneider, and others, “Refining a Case-Mix Measure for Nursing Homes: Resource Utilization Groups
                           (RUG-III),” Medical Care, Vol. 32, No. 7 (1994), pp. 668-85.
                            PPS provides incentives for SNFs to lower their provision of nontherapy ancillary services and to
                           negotiate lower prices paid for them. As a result, the share of total costs that are attributable to
                           nontherapy services may have declined since 1995.

                           Page 8                                        GAO/HEHS-99-185 SNF Nontherapy Ancillary Costs

                            difficult to place.11 Conversely, payments may be too high for patients with
                            relatively low nontherapy ancillary use. For example, an unstable patient
                            may require significant amounts of nursing time for monitoring but may
                            not be receiving treatments involving many nontherapy ancillary

                            HCFA has acknowledged concerns about whether the case-mix adjustment
                            method appropriately accounts for nontherapy ancillary cost variation and
                            is sponsoring research to determine if the accuracy of the rates could be
                            improved by refining the RUG-III system to explicitly incorporate
                            nontherapy ancillary services. HCFA also is investigating whether relative
                            weights based on ancillary charges, rather than the current weights based
                            on nursing time, would be more appropriate for adjusting the nontherapy
                            ancillary component of the payment amount. It anticipates completing
                            these research projects by January 1, 2000. Any payment system
                            refinements resulting from these projects would be implemented starting
                            October 1, 2000, before the transition to the full PPS is complete.

Nontherapy Ancillary Cost   Measuring the effect of omitting nontherapy ancillary costs in computing
Variation Wider Than        the RUG-III relative weights on patients and facilities requires data on
Range in PPS Payments       patient characteristics not currently available.12 However, our analysis of
                            facility-level information revealed that two-thirds of facilities have average
                            nontherapy ancillary costs that are outside of the range of potential PPS
                            payments. This means that many facilities could be over- or underpaid.

                            According to our analysis, nontherapy ancillary costs averaged about $45
                            per day in 1995 (see table 1).13 Although for the majority of SNFs, these
                            costs averaged below $40, the most expensive providers of these services
                            (the top 10 percent) had daily costs of $95 or more, while the least
                            expensive providers (the bottom 10 percent) had costs below $11. (See
                            app. III for a more complete presentation of facility cost variation.) Thus,
                            facilities with the highest nontherapy ancillary costs were nine times more
                            expensive than the bottom 10 percent of facilities. Patient-level costs
                            could vary considerably more than these facility averages.

                             OIG, Office of Evaluation and Inspections, Early Effects of the Prospective Payment System on
                            Access to Skilled Nursing Facilities, OEI-02-99-00400 (Washington, D.C.: HHS, Aug. 1999).
                             In developing the payment rates and the relative weights, HCFA did not have a national sample of
                            patient-level data to classify patients into the RUG-III groupings. Instead, it used available claims data
                            and decision rules to group patients into 10 broad categories, using a model known as the MedPAR
                             App. III shows the average costs and the distribution of costs for the major nontherapy ancillary

                            Page 9                                          GAO/HEHS-99-185 SNF Nontherapy Ancillary Costs

Table 1: Average Daily SNF Reported
Costs for Medicare Patients, 1995                                                                    Average per-day
                                       Cost category                                                           costs            Percent of total
                                       Nontherapy ancillary services                                                  $45                        16%
                                       Therapy servicesa                                                               78                        28
                                       Routine                                                                        153                        56
                                       Total                                                                        $276                       100%
                                        Therapy costs include speech, occupational, and physical therapy.
                                           Routine costs include room and board, nursing, and other costs.

                                       Source: GAO analysis of 1995 SNF Medicare cost reports.

                                       By contrast, PPS payments for nontherapy ancillary services will range
                                       from about $35 to almost $80 per day, depending on the RUG-III category of
                                       the patient.14 A comparison of reported costs to the possible range in
                                       payments indicates that two-thirds of the SNFs had average daily
                                       nontherapy ancillary costs either below or above the range of potential
                                       payments established in PPS (see table 2). This may be an underestimate of
                                       the proportion of patient days that would be under- or overpaid because
                                       each facility treats patients across a range of the RUG-III categories.
                                       Therefore, these facility averages may mask the extreme payment and cost
                                       variation across patient days.

Table 2: Facility-Level Nontherapy
Ancillary Reported Costs Compared to                                                                         Number of
Estimated PPS Payment Range, 1995      Nontherapy ancillary costs                                             facilities                  Percent
                                       Costs less than estimated payment range                                     5,291                         53%
                                       Costs within payment range                                                  3,185                         32
                                       Costs above estimated payment range                                         1,539                         15
                                       Total                                                                      10,015                       100%
                                       Source: GAO analysis of 1995 SNF Medicare cost reports.

                                       Total Medicare payments for all SNFs are likely to be adequate, if not
Conclusions                            generous, to cover the costs of nontherapy ancillary services. However,
                                       the PPS case-mix adjustment method may not appropriately account for the
                                       variation in the nontherapy ancillary costs and thus may not correctly

                                         Nontherapy ancillary costs account for approximately 43 percent of the nursing base rate. Therefore,
                                       the nontherapy ancillary portion of the nursing rate is $47 for urban facilities (43 percent of
                                       $109.48) and $45 for rural facilities (43 percent of $104.88.) The range in the weights for urban facilities
                                       is ($47 x .75) to ($47 x 1.7); the range for rural facilities is ($45 x .75) to ($45 x 1.7). We examined this
                                       variation only for the 26 RUG-III patient groups that account for most Medicare-covered stays.

                                       Page 10                                         GAO/HEHS-99-185 SNF Nontherapy Ancillary Costs

                  raise or lower payments across the patient groups to reflect expected
                  differences in nontherapy ancillary needs. Therefore, Medicare payments
                  for certain patient groups may be too high or too low, relative to the
                  average. Any assessment of the adequacy of total Medicare payments to
                  any SNF, however, would need to consider total Medicare costs and
                  payments over the entire year.

                  HCFA is aware of the concern about this issue. It has commissioned
                  research to assess the extent of any payment distributional problem and
                  evaluate the possibility of refining the RUG-III classification system and
                  weights to explicitly account for nontherapy ancillary cost variation.
                  These refinements will become even more important as the 3-year
                  transition to fully prospective rates proceeds.

                  In the meantime, increasing SNF payments for all or some RUG-III groups
                  will not address the allocation problem. It would simply add costs to the
                  program and increase overpayments without improving the distribution of
                  payments across patient categories and SNFs. Rather, as a first step, the
                  extent of any maldistribution of SNF payments across case-mix groups
                  needs to be assessed. If any distributional problems are identified, the
                  RUG-III relative weights would have to be recalculated to better target
                  payments to the case-mix groups that contain patients with high expected
                  nontherapy ancillary needs.

                  In written comments on a draft of this report, HCFA shared GAO’s concerns
Agency Comments   for PPS’ potential effects on medically complex patients under the SNF PPS.
                  HCFA noted that it is expediting research that will allow it to refine the
                  payment system for nontherapy ancillary services and affirmed its
                  commitment to assessing potential changes that could affect quality of
                  care and access to skilled nursing care for Medicare beneficiaries.

                  HCFA  also provided technical comments, which we incorporated where
                  appropriate. Among these, HCFA stressed two important advantages of a
                  PPS. First, under PPS, SNFs receive an all-inclusive per diem payment, which
                  is fungible among the various services provided to SNF patients. SNFs do
                  not receive separate payments for nontherapy ancillary services. Second,
                  because of the all-inclusive nature of the payment, SNFs are encouraged to
                  provide services in an efficient manner. Providers may choose to provide
                  fewer nontherapy ancillary services and to negotiate lower prices paid for
                  them. Because our sample was based on 1995 costs, any reductions in

                  Page 11                           GAO/HEHS-99-185 SNF Nontherapy Ancillary Costs

ancillary pricing or utilization will not be reflected in these data. HCFA’s
letter is reprinted as appendix IV.

We are sending copies of this report to Nancy-Ann Min DeParle,
Administrator of HCFA; appropriate congressional committees; and other
interested parties. We will also make copies available to others upon

If you or your staff have any questions, please call me or Laura Dummit,
Associate Director, at (202) 512-7114. Other major contributors include
Carol Carter, Jennifer DuLac, Daniel Lee, and Dana Kelley.

Sincerely yours,

William J. Scanlon
Director, Health Financing and
  Public Health Issues

Page 12                            GAO/HEHS-99-185 SNF Nontherapy Ancillary Costs
Page 13   GAO/HEHS-99-185 SNF Nontherapy Ancillary Costs

Letter                                                                                                1

Appendix I                                                                                           16

Scope and
Appendix II                                                                                          17

Prospective Payment
System Rate
Appendix III                                                                                         20

Types of and Variation
in Nontherapy
Ancillary Service
Costs, 1995
Appendix III                                                                                         22

Comments From the
Health Care Financing
Tables                   Table 1: Average Daily SNF Reported Costs for Medicare                      10
                           Patients, 1995
                         Table 2: Facility-Level Nontherapy Ancillary Reported Costs                 10
                           Compared to Estimated PPS Payment Range, 1995
                         Table II.1: RUG-III Groups                                                  17
                         Table II.2: PPS Rate Calculations for Urban SNFs for the Upper              19
                           26 Case-Mix Groups
                         Table III.1: Distribution of Daily Nontherapy Ancillary Costs by            20
                           Cost Center, 1995
                         Table III.2: Per Diem Nontherapy Ancillary Costs, By Percentile,            21

                         Page 14                          GAO/HEHS-99-185 SNF Nontherapy Ancillary Costs

         Table III.3: Daily Nontherapy Ancillary Costs, Range Across                 21
           Facilities, 1995

Figure   Figure 1: Overview of SNF PPS Rate Calculation                               5


         BBA        Balanced Budget Act of 1997
         HCFA       Health Care Financing Administration
         HHS        Department of Health and Human Services
         MDS        Minimum Data Set
         OIG        Office of the Inspector General
         PPS        prospective payment system
         RUG        Resource Utilization Group
         SNF        skilled nursing facility

         Page 15                          GAO/HEHS-99-185 SNF Nontherapy Ancillary Costs
Appendix I

Scope and Methodology

             To determine how HCFA incorporated nontherapy ancillary costs into the
             SNF PPS, we reviewed (1) the provisions of the Balanced Budget Act of 1997
             that mandated the new SNF PPS; (2) the SNF PPS interim rule, which took
             effect on July 1, 1998; (3) the SNF PPS final rule, which took effect
             September 30, 1999; and (4) associated research concerning SNF payment
             policies. We also discussed HCFA’s implementation of the SNF PPS with
             officials at its Division of Inpatient Post Acute Care.

             To determine the variation in SNF costs, we analyzed the 1995 SNF
             Minimum Data Set (MDS), which contains cost, financial, and other
             statistical information for Medicare-certified SNFs from the Medicare cost
             report. We used fiscal year 1995 data because they were the most
             complete data available at the time of our analysis. Based on input from
             HCFA officials, we calculated per diem ancillary (therapy and nontherapy),
             routine, and total costs for each facility.15 To control for regional wage
             differences, we adjusted costs for wage differences across geographic
             areas according to the methodology prescribed in the regulations.16
             Finally, based on input from HCFA officials, examinations of the
             regulations, and our own determinations, we excluded SNFs that met any
             of the following conditions: (1) cost report periods less then 10 months or
             greater than 13 months, (2) low or no Medicare utilization, (3) extremely
             high or low routine or ancillary costs,17 or (4) no identifiable wage index.
             These conditions reduced the analytic file from 12,276 to 10,015 facilities.

             Due to data limitations, we could not examine SNF costs by case-mix
             group. The RUG-III classification system uses variables that were not in the
             1995 cost report or claims files. Therefore, we focused our analysis on
             average per diem costs at the facility level. Although this limited our ability
             to examine the impact of the payment system under the new provisions,
             comparisons were adequate to establish a potential problem with the
             distribution of payments under PPS.

              Ancillary costs are costs for specialized services that are directly identifiable to individual patients.
             Therapy-ancillary costs include speech, occupational, and physical therapy costs. Nontherapy ancillary
             costs are all other ancillary cost categories, including drugs, medical supplies, labs, and X rays.
             Routine costs include regular room, dietary, nursing, and other services for which a separate charge is
             not made. All costs are after the allocation of overhead expenses.
               64 Fed. Reg. 41, 643-41, 683 (1999) (to be codified at 52 C.F.R. 409, 411, 413, 489).
              We excluded SNFs with no ancillary or routine costs and excluded SNFs whose routine or ancillary
             costs were within the top or bottom 0.25 percent for each group of hospital-based and freestanding
             SNFs. We chose this approach over HCFA’s typical approach of excluding values equal to the mean
             plus three standard deviations or minus three standard deviations since it would have eliminated many
             of the high-cost providers without eliminating any of the extremely low-cost providers. Because many
             of the high-cost providers were hospital based, HCFA’s approach would have eliminated a
             disproportionate number of hospital-based SNFs.

             Page 16                                          GAO/HEHS-99-185 SNF Nontherapy Ancillary Costs
Appendix II

Medicare’s Prospective Payment System
Rate Calculation

                             Under PPS, SNFs are paid for their Medicare patients on a per diem basis.
                             Each patient is grouped into 1 of 44 RUG-III categories based on their
                             clinical condition, functional status, and expected use of certain services
                             (see table II.1). A base payment is adjusted for each RUG-III category to
                             account for the nursing and therapy costs associated with treating the
                             average patient in that group.

Table II.1: RUG-III Groups
                             Service                Clinical condition/need                                                of groups
                             Rehabilitation         Patients who require rehabilitation in one of five groups
                                                    based on the number of therapy minutes per week:
                                                    — Ultra: 720 or more therapy minutes per week
                                                    — Very high: 500 to 719 therapy minutes per week
                                                    — High: 325 to 499 therapy minutes per week
                                                    — Medium: 150 to 324 therapy minutes per week
                                                    — Low: 45 to 149 therapy minutes per week                                       14
                             Extensive              Patients who require intravenous feeding or medications,
                             services               suctioning, tracheostomy care, or are on a
                                                    ventilator/respirator                                                               3
                             Special care           Patients with cerebral palsy; quadraplegia; multiple
                                                    sclerosis; pressure ulcers; fever with vomiting, weight
                                                    loss, or dehydration; tube feeding and aphrasia; or
                                                    receiving radiation therapy.                                                        3
                             Clinically complex Patients with burns, coma, septicemia, pneumonia,
                                                internal bleeding, chemotherapy, wounds, kidney failure,
                                                urinary tract infections, oxygen, or transfusions                                       6
                             Impaired               Patients with poor cognitive performance
                             cognition                                                                                                  4
                             Behavior               Patients with behavior symptoms such as wandering,
                             problems               hallucinations, or physical or verbal abuse of others
                                                    (unless other condition would place patient in other
                                                    category)                                                                           4
                             Reduced                No special clinical conditions; RUG groups based solely
                             physical function      on patient ability to perform activities of daily living                        10

                             Each payment has three components to cover different types of costs:
                             nursing, therapy, and other services.18 The nursing component is
                             calculated by multiplying the nursing weight assigned to each RUG-III
                             category by the nursing base rate ($109.48 for urban facilities in 1998). The
                             nursing weight reflects nursing, social services, and nontherapy ancillary
                             resources necessary for providing care to the average patient within the
                             associated RUG-III category. For the 26 RUG-III groups that will cover the

                               The labor-related portion of the rate is adjusted by the hospital wage index to reflect the wage level
                             in each SNF’s market area.

                             Page 17                                        GAO/HEHS-99-185 SNF Nontherapy Ancillary Costs
Appendix II
Medicare’s Prospective Payment System
Rate Calculation

majority of Medicare patients, the nursing weight ranges from 0.75 to 1.7.19

The costs of nontherapy ancillary services are included in the nursing
component of the payment amount. Consequently, the nursing weights
determine the payment range for nontherapy ancillary services. The
nursing payment component, which covers nursing, social service, and
nontherapy ancillary costs, ranges from $82.11 to $186.12 for urban
facilities, depending on the RUG-III category, and $78.66 to $178.30 for rural

The therapy component consists of either a therapy case-mix amount or a
therapy non-case-mix amount, depending on the RUG-III category and the
amount of therapy resources required. For high-therapy-use groups, the
therapy case-mix amount is calculated by multiplying the therapy weight
by the therapy base amount ($82.67 for urban facilities in 1998). The
therapy weight reflects resources necessary to provide physical therapy,
speech therapy, or occupational therapy to the average patient within the
associated RUG-III group. Patients who require minimal therapy services
receive the therapy non-case-mix amount. This fixed amount reflects costs
incurred to provide lower levels of therapy services.

The non-case-mix component is a fixed amount assigned to all RUG-III
groups. This amount covers administrative, overhead, and other general
patient care costs.

Table II.2 shows the PPS rate calculations for urban SNFs for the upper 26
case-mix groups.

   Patients classified into 1 of the upper 26 RUG-III categories are deemed to be eligible for Medicare
coverage. Patients classified into 1 of the lower 18 RUG-III categories are reviewed on a case-by-case
basis to determine Medicare eligibility.

Page 18                                        GAO/HEHS-99-185 SNF Nontherapy Ancillary Costs
                                         Appendix II
                                         Medicare’s Prospective Payment System
                                         Rate Calculation

Table II.2: PPS Rate Calculations for Urban SNFs for the Upper 26 Case-Mix Groups
                                  Nursing componenta                Therapy componentb                            Non-case-
                                 Relative   Weight x                Relative   Weight x            Non-case-        mix               Total
RUG-III category (code)           weight base rate (A)               weight base rate (B)            mix (C)                 (D)    (A+B+C+D)
Ultra C (RUC)                        1.30          $142.32              2.25         $186.01                            $55.88          $384.21
Ultra B (RUB)                        0.95            104.01             2.25           186.01                             55.88           345.90
Ultra A (RUA)                        0.78             85.39             2.25           186.01                             55.88           327.28
Very high C (RVC)                    1.13            123.71             1.41           116.56                             55.88           296.15
Very high B (RVB)                    1.04            113.86             1.41           116.56                             55.88           286.30
Very high A (RVA)                    0.81             88.68             1.41           116.56                             55.88           261.12
High C (RHC)                         1.26            137.94             0.94            77.71                             55.88           271.53
High B (RHB)                         1.06            116.05             0.94            77.71                             55.88           249.64
High A (RHA)                         0.87             95.25             0.94            77.71                             55.88           228.84
Medium C (RMC)                       1.35            147.80             0.77            63.66                             55.88           267.34
Medium B (RMB)                       1.09            119.33             0.77            63.66                             55.88           238.87
Medium A (RMA)                       0.96            105.10             0.77            63.66                             55.88           224.64
Low B (RLB)                          1.11            121.52             0.43            35.55                             55.88           212.95
Low A (RLA)                          0.80             87.58             0.43            35.55                             55.88           179.01
Extensive services
Level 3 (SE3)                        1.70            186.12                                            $10.91             55.88           252.91
Level 2 (SE2)                        1.39            152.18                                              10.91            55.88           218.97
Level 1 (SE1)                        1.17            128.09                                              10.91            55.88           194.88
Special care
Level C (SSC)                        1.13            123.71                                              10.91            55.88           190.50
Level B (SSB)                        1.05            114.95                                              10.91            55.88           181.74
Level A (SSA)                        1.01            110.57                                              10.91            55.88           177.36
Clinically complex
ADL high, with depression
(CC2)                                1.12            122.62                                              10.91            55.88           189.41
ADL high, without depression
(CC1)                                0.99            108.39                                              10.91            55.88           175.18
ADL medium, with depression
(CB2)                                0.91             99.63                                              10.91            55.88           166.42
ADL medium, without
depression (CB1)                     0.84             91.96                                              10.91            55.88           158.75
ADL low, with depression (CA2)       0.83             90.87                                              10.91            55.88           157.66
ADL low, without depression
(CA1)                                0.75             82.11                                              10.91            55.88           148.90
                                            The urban SNF base rate for nursing is $109.48; the rural SNF nursing base rate is $104.88.
                                             The urban SNF base rate for therapy is $82.67; the rural SNF base rate for therapy is $95.51.

                                         Page 19                                         GAO/HEHS-99-185 SNF Nontherapy Ancillary Costs
Appendix III

Types of and Variation in Nontherapy
Ancillary Service Costs, 1995

                                     Drug and medical supply costs accounted for the highest shares of
                                     nontherapy ancillary service spending in 1995 (see table III.1). Drugs were
                                     the most commonly provided service and were also the most expensive
                                     service on average. Virtually all (99 percent) of the SNFs in 1995 had
                                     reported drug costs, averaging almost $20 per day, and making up over
                                     half (58 percent) of all nontherapy ancillary costs. Ten percent of facilities
                                     had drug costs of $37 per day or more. Medical supplies were the next
                                     most common service (supplied in 90 percent of the SNFs) and made up
                                     about 18 percent of total nontherapy ancillary costs, or $9 per day. Again,
                                     the top 10 percent of facilities had costs well above that, at $22 or more
                                     per day.

Table III.1: Distribution of Daily
Nontherapy Ancillary Costs by Cost                                                Range of costs
Center, 1995                         Nontherapy ancillary                10th                              90th      Percent of SNFs
                                     service                        percentile            Mean        percentile      reporting costs
                                     Drugs                                   $7             $20                $37                99%
                                     Medical supplies                         0                9                22                90
                                     Oxygen therapy                           0                8                26                54
                                     Labs                                     0                2                10                26
                                     All other cost centersa                  0                2                7                 42
                                     Intravenous therapy                      0                2                4                 22
                                     Radiology                                0                1                5                 32
                                     Electrocardiology, dental, and other nontherapy ancillary cost centers.

                                     Source: GAO analysis of 1995 SNF Medicare cost reports.

                                     Facility-level nontherapy ancillary costs ranged from less than $11 at the
                                     10th percentile to $95 or greater at the 90th percentile (see table III.2).
                                     Although most of the facilities in our sample had average daily nontherapy
                                     ancillary costs below $40, 8 percent of facilities had costs that exceeded
                                     $101 per day. The type of institution may explain some of the variation in
                                     daily nontherapy ancillary costs, as seen in table III.3. For 67 percent of
                                     freestanding SNFs, these costs were $40 or less. However, only 25 percent
                                     of hospital-based SNFs had daily nontherapy ancillary costs of $40 or less.

                                     Page 20                                       GAO/HEHS-99-185 SNF Nontherapy Ancillary Costs
                                          Appendix III
                                          Types of and Variation in Nontherapy
                                          Ancillary Service Costs, 1995

Table III.2: Per Diem Nontherapy
Ancillary Costs, by Percentile, 1995      Percentile                                                                        Daily cost
                                          1st                                                                                       $2
                                          5th                                                                                        7
                                          10th                                                                                      10
                                          25th                                                                                      18
                                          50th (median)                                                                             33
                                          75th                                                                                      60
                                          90th                                                                                      95
                                          95th                                                                                     123
                                          99th                                                                                     181
                                          Source: GAO Analysis of 1995 SNF Medicare cost reports.

Table III.3: Daily Nontherapy Ancillary
Costs, Range Across Facilities, 1995      Average daily             Number of facilities, by type                          Cumulative
                                          nontherapy ancillary                Hospital-                      Percent of     percent of
                                          cost                Freestanding       based          Total         facilities     facilities
                                          $0-10                          1,012            104        1,116           11%            11%
                                          11-20                          1,888            123        2,011           20             31
                                          21-30                          1,558             94        1,652           16             48
                                          31-40                          1,147            105        1,252           13             60
                                          41-50                            781            100         881             9             69
                                          51-60                            548            110         658             7             76
                                          61-70                            399            150         549             5             81
                                          71-80                            290            140         430             4             85
                                          81-90                            203            141         344             3             89
                                          91-100                           148            128         276             3             92
                                          101+                             349            497         846             8            100
                                          Total                          8,323          1,692       10,015          100%           100%

                                          Page 21                                   GAO/HEHS-99-185 SNF Nontherapy Ancillary Costs
Appendix III

Comments From the Health Care Financing

               Page 22    GAO/HEHS-99-185 SNF Nontherapy Ancillary Costs
           Appendix III
           Comments From the Health Care Financing

(101791)   Page 23                              GAO/HEHS-99-185 SNF Nontherapy Ancillary Costs
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