Medicare Program; Changes to the Hospital Inpatient Prospective Payment Systems and Fiscal Year 2007 Rates; Fiscal Year 2007 Occupational Mix Adjustment to Wage Index; Health Care Infrastructure Improvement Program; Selection Criteria of Loan Program for Qualifying Hospitals Engaged in Cancer-Related Health Care and Forgiveness of Indebtedness; and Exclusion of Vendor Purchases Made Under the Competitive Acquisition Program (CAP) for Outpatient Drugs and Biologicals Under Part B for the Purpose of Calculating the Average Sales Price (ASP)

Federal RegisterAug 18, 2006

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DEPARTMENT OF HEALTH AND HUMAN SERVICES

Centers for Medicare & Medicaid Services

42 CFR Parts 409, 410, 412, 413, 414, 424, 485, 489, and 505

[CMS-1488-F; CMS-1287-F; CMS-1320-F; and CMS-1325-IFC4]

RINs 0938-AO12; 0938-AO03; 0938-AN93; and 0938-AN58

Medicare Program; Changes to the Hospital Inpatient Prospective Payment Systems and Fiscal Year 2007 Rates; Fiscal Year 2007 Occupational Mix Adjustment to Wage Index; Health Care Infrastructure Improvement Program; Selection Criteria of Loan Program for Qualifying Hospitals Engaged in Cancer-Related Health Care and Forgiveness of Indebtedness; and Exclusion of Vendor Purchases Made Under the Competitive Acquisition Program (CAP) for Outpatient Drugs and Biologicals Under Part B for the Purpose of Calculating the Average Sales Price (ASP)

AGENCY:

Centers for Medicare and Medicaid Services (CMS), HHS.

ACTION:

Final rules and interim final rule with comment period.

SUMMARY:

We are revising the Medicare hospital inpatient prospective payment systems (IPPS) for operating and capital-related costs to implement changes arising from our continuing experience with these systems, and to implement a number of changes made by the Deficit Reduction Act of 2005 (Pub. L. 109-171). In addition, in the Addendum to this final rule, we describe the changes to the amounts and factors used to determine the rates for Medicare hospital inpatient services for operating costs and capital-related costs. We also are setting forth rate-of-increase limits as well as policy changes for hospitals and hospital units excluded from the IPPS that are paid in full or in part on a reasonable cost basis subject to these limits. These changes are applicable to discharges occurring on or after October 1, 2006.

In this final rule, we discuss public comments we received on our proposals to refine the diagnosis-related group (DRG) system under the IPPS to better recognize severity of illness among patients—to use a hospital-specific relative value (HSRV) cost center weighting methodology to adjust DRG relative weights; and to implement consolidated severity-adjusted DRGs or alternative severity adjustment methods.

Among the other policy changes that we are making are those changes related to: limited revisions of the reclassification of cases to DRGs; the long-term care (LTC)-DRGs and relative weights; the wage data, including the occupational mix data, used to compute the wage index; applications for new technologies and medical services add-on payments; payments to hospitals for the direct and indirect costs of graduate medical education; submission of hospital quality data; payments to sole community hospitals and Medicare-dependent, small rural hospitals; and provisions governing emergency services under the Emergency Medical Treatment and Labor Act of 1986 (EMTALA).

We are responding to requested public comments on a number of other issues that include performance-based hospital payments for services and health information technology, as well as how to improve health data transparency for consumers.

In addition, we are responding to public comments received on a proposed rule issued in the

Federal Register

on May 17, 2006 that proposed to revise the methodology for calculating the occupational mix adjustment to the wage index for the FY 2007 hospital inpatient prospective payment system by applying an adjustment to 100 percent of the wage index using new 2006 occupational mix survey data collected from hospitals.

We are finalizing two policy documents published in the

Federal Register

relating to the implementation of the Health Care Infrastructure Improvement Program, a hospital loan program for cancer research, established under the Medicare Prescription Drug, Improvement, and Modernization Act of 2003.

This final rule also revises the definition of the term “unit” to specify the exclusion of units of drugs sold to approved Medicare Competitive Acquisition Program (CAP) vendors for use under the CAP from average sales price (ASP) calculations for a period of up to 3 years, at which time we will reevaluate our policy.

DATES:

Effective Dates:

The provisions of these final rules are effective on October 1, 2006, with the exception of the provisions in § 412.8, § 414.802, and the procedures for withdrawing or terminating reclassifications established in section III.H.4. of the preamble. The provisions of § 412.8, § 414.802, and the procedures for withdrawing or terminating reclassifications established in section II.H.4. of the preamble are effective August 18, 2006. This rule is a major rule as defined in 5 U.S.C. 804(2). Pursuant to 5 U.S.C. 801(a)(1)(A), we are submitting a report to the Congress on this rule on August 1, 2006.

Comment Date:

We will consider comments on the exclusion of CAP drugs from the ASP calculation (§ 414.802) as discussed in section XII. of the preamble of this final rule, if we receive them at one of the addresses provided below, no later than 5 p.m. on October 2, 2006.

ADDRESSES:

In commenting, on section XII. of this rule, please refer to file code CMS-1325-IFC4.

Because of staff and resource limitations, we cannot accept comments by facsimile (FAX) transmission.

You may submit comments in one of four ways (no duplicates, please):

Electronically

. You may submit electronic comments on specific issues in this regulation to

http://www.cms.hhs.gov/eRulemaking.

Click on the link “Submit electronic comments on CMS regulations with an open comment period.” (Attachments should be in Microsoft Word, WordPerfect, or Excel; however, we prefer Microsoft Word.)

By regular mail.

You may mail written comments (one original and two copies) to the following address ONLY: Centers for Medicare & Medicaid Services, Department of Health and Human Services, Attention: CMS-1325-IFC4, P.O. Box 8011, Baltimore, MD 21244-1850.

Please allow sufficient time for mailed comments to be received before the close of the comment period.

By express or overnight mail.

You may send written comments (one original and two copies) to the following address ONLY: Centers for Medicare & Medicaid Services, Department of Health and Human Services, Attention: CMS-1325-IFC4, Mail Stop C4-26-05, 7500 Security Boulevard, Baltimore, MD 21244-1850.

By hand or courier.

If you prefer, you may deliver (by hand or courier) your written comments (one original and two copies) before the close of the comment period to one of the following addresses. If you intend to deliver your comments to the Baltimore address, please call telephone number (410) 786-7195 in advance to schedule your arrival with one of our staff members. Room 445-G, Hubert H. Humphrey Building, 200 Independence Avenue, SW., Washington, DC 20201; or 7500 Security Boulevard, Baltimore, MD 21244-1850.

(Because access to the interior of the HHH Building is not readily available to

persons without Federal Government identification, commenters are encouraged to leave their comments in the CMS drop slots located in the main lobby of the building. A stamp-in clock is available for persons wishing to retain a proof of filing by stamping in and retaining an extra copy of the comments being filed.)

Comments mailed to the addresses indicated as appropriate for hand or courier delivery may be delayed and received after the comment period.

For information on viewing public comments, see the beginning of the

SUPPLEMENTARY INFORMATION

section.

FOR FURTHER INFORMATION CONTACT:

Marc Hartstein, (410) 786-4548, Operating Prospective Payment, Diagnosis-Related Groups (DRGs), Wage Index, Occupational Mix Adjustment, New Medical Services and Technology Add-On Payments, Hospital Geographic Reclassifications, Sole Community Hospital, Disproportionate Share Hospital, and Medicare-Dependent, Small Rural Hospital Issues.

Tzvi Hefter, (410) 786-4487, Capital Prospective Payment, Excluded Hospitals, Graduate Medical Education, Critical Access Hospitals, Long-Term Care (LTC)-DRGs, and Terms of Hospital Loans under Health Care Infrastructure Improvement Program Issues.

Siddhartha Mazumdar, (410) 786-6673, Rural Community Hospital Demonstration Issues.

Sheila Blackstock, (410) 786-3502, Quality Data for Annual Payment Update Issues.

Thomas Valuck, (410) 786-7479, Hospital Value-Based Purchasing Issues.

Frederick Grabau, (410) 786-0206, Services in Foreign Hospitals Issues.

Brian Reitz, (410) 786-5001, Obsolete Paper Claims Forms Issues.

Melinda Jones, (410) 786-7069, Loan Forgiveness Criteria for Health Care Infrastructure Improvement Program.

Corinne Axelrod, (410) 786-5620, Competitive Acquisition Program (CAP) for Part B Drugs Issues.

Angela Mason, (410) 786-7452, Payment for Covered Outpatient Drugs and Biologicals Issues.

Submitting Comments:

We welcome comments from the public on all issues set forth in this rule to assist us in fully considering issues and developing policies. You can assist us by referencing the file code CMS-1325-IFC4 and the specific “issue identifier” that precedes the section on which you choose to comment.

Inspection of Public Comments:

All comments received before the close of the comment period are available for viewing by the public, including any personally identifiable or confidential business information that is included in a comment. We post all comments received before the close of the comment period on a public Web site as soon as possible after they are received:

http://www.cms.hhs.gov/eRulemaking.

Clink on the link “Electronic Comments on CMS Regulations” on that Web site to view public comments.

Comments received timely will also be available for public inspection as they are received, generally beginning approximately 3 weeks after publication of a document, at the headquarters of the Centers for Medicare & Medicaid Services, 7500 Security Boulevard, Baltimore, Maryland 21244, Monday through Friday of each week from 8:30 a.m. to 4 p.m. To schedule an appointment to view public comments, phone 1-800-743-3951.

Electronic Access

This

Federal Register

document is also available from the

Federal Register

online database through

GPO Access,

a service of the U.S. Government Printing Office. Free public access is available on a Wide Area Information Server (WAIS) through the Internet and via asynchronous dial-in. Internet users can access the database by using the World Wide Web; the Superintendent of Documents' home page address is

http://www.gpoaccess.gov/,

by using local WAIS client software, or by telnet to

swais.access.gpo.gov,

then login as guest (no password required). Dial-in users should use communications software and modem to call (202) 512-1661; type swais, then login as guest (no password required).

Acronyms

AHA American Hospital Association

AHIMA American Health Information Management Association

AHRO Agency for Health Care Research and Quality

AMI Acute myocardial infarction

AOA American Osteopathic Association

APR DRG All Patient Refined Diagnosis-Related Group System

ASC Ambulatory surgical center

ASP Average sales price

AWP Average wholesale price

BBA Balanced Budget Act of 1997, Pub. L. 105-33

BBRA Medicare, Medicaid, and SCHIP [State Children's Health Insurance Program] Balanced Budget Refinement Act of 1999, Pub. L. 106-113

BIPA Medicare, Medicaid, and SCHIP [State Children's Health Insurance Program] Benefits Improvement and Protection Act of 2000, Pub. L. 106-554

BLS Bureau of Labor Statistics

AH Critical access hospital

AP Competitive Acquisition Program

CART CMS Abstraction & Reporting Tool

CBSAs Core-based statistical areas

CC Complication or comorbidity

CDAC Clinical Data Abstraction Center

CIPI Capital input price index

CPI Consumer price index

CMI Case-mix index

CMS Centers for Medicare & Medicaid Services

CMSA Consolidated Metropolitan Statistical Area

COBRA Consolidated Omnibus Reconciliation Act of 1985, Pub. L. 99-272

CPI Consumer price index

CRNA Certified registered nurse anesthetist

CY Calendar year

DRA Deficit Reduction Act of 2005, Pub. L. 109-171

DRG Diagnosis-related group

DSH Disproportionate share hospital

ECI Employment cost index

EMR Electronic medical record

EMTALA Emergency Medical Treatment and Labor Act of 1986, Pub. L. 99-272

FDA Food and Drug Administration

FFY Federal fiscal year

FIPS Federal information processing standards

FQHC Federally qualified health center

FTE Full-time equivalent

FY Fiscal year

GAAP Generally Accepted Accounting Principles

GAF Geographic Adjustment Factor

GME Graduate medical education

HCAHPS Hospital Consumer Assessment of Healthcare Providers and Systems

HCFA Health Care Financing Administration

HCRIS Hospital Cost Report Information System

HHA Home health agency

HHS Department of Health and Human Services

HIC Health insurance card

HIPAA Health Insurance Portability and Accountability Act of 1996, Pub. L. 104-191

HIPC Health Information Policy Council

HIS Health information system

HIT Health information technology

HMO Health maintenance organization

HSA Health savings account

HSCRC Maryland Health Services Cost Review Commission

HSRV Hospital-specific relative value

HSRVcc Hospital-specific relative value cost center

HQA Hospital Quality Alliance

HQI Hospital Quality Initiative

HwH Hospital-within-a-hospital

ICD-9-CM International Classification of Diseases, Ninth Revision, Clinical Modification

ICD-10-PCS International Classification of Diseases, Tenth Edition, Procedure Coding System

ICU Intensive care unit

IHS Indian Health Service

IME Indirect medical education

IOM Institute of Medicine

IPF Inpatient psychiatric facility

IPPS Acute care hospital inpatient prospective payment system

IRF Inpatient rehabilitation facility

IRP Initial residency period

JCAHO Joint Commission on Accreditation of Healthcare Organizations

LAMCs Large area metropolitan counties

LTC-DRG Long-term care diagnosis-related group

LTCH Long-term care hospital

MCE Medicare Code Editor

MCO Managed care organization

MCV Major cardiovascular condition

MDC Major diagnostic category

MDH Medicare-dependent, small rural hospital

MedPAC Medicare Payment Advisory Commission

MedPAR Medicare Provider Analysis and Review File

MEI Medicare Economic Index

MGCRB Medicare Geographic Classification Review Board

MMA Medicare Prescription Drug, Improvement, and Modernization Act of 2003, Pub. L. 108-173

MRHFP Medicare Rural Hospital Flexibility Program

MSA Metropolitan Statistical Area

NAICS North American Industrial Classification System

NCD National coverage determination

NCHS National Center for Health Statistics

NCQA National Committee for Quality Assurance

NCVHS National Committee on Vital and Health Statistics

NECMA New England County Metropolitan Areas

NICU Neonatal intensive care unit

NQF National Quality Forum

NTIS National Technical Information Service

NVHRI National Voluntary Hospital Reporting Initiative

OES Occupational employment statistics

OIG Office of the Inspector General

OMB Executive Office of Management and Budget

O.R. Operating room

OSCAR Online Survey Certification and Reporting (System)

PRM Provider Reimbursement Manual

PPI Producer price index

PMSAs Primary metropolitan statistical areas

PPS Prospective payment system

PRA Per resident amount

ProPAC Prospective Payment Assessment Commission

PRRB Provider Reimbursement Review Board

PS&R Provider Statistical and Reimbursement (System)

QIG Quality Improvement Group, CMS

QIO Quality Improvement Organization

RHC Rural health clinic

RHQDAPU Reporting hospital quality data for annual payment update

RNHCI Religious Nonmedical Health Care Institution

RRC Rural referral center

RUCAs Rural-urban commuting area codes

RY Rate year

SAF Standard Analytic File

SCH Sole community hospital

SFY State fiscal year

SIC Standard Industrial Classification

SNF Skilled nursing facility

SOCs Standard occupational classifications

SOM State Operations Manual

SSA Social Security Administration

SSI Supplemental Security Income

TAG Technical Advisory Group

TEFRA Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. 97-248

UHDDS Uniform hospital discharge data set

Table of Contents

I. Background

A. Summary

1. Acute Care Hospital Inpatient Prospective Payment System (IPPS)

2. Hospitals and Hospital Units Excluded from the IPPS

a. Inpatient Rehabilitation Facilities (IRFs)

b. Long-Term Care Hospitals (LTCHs)

c. Inpatient Psychiatric Facilities (IPFs)

3. Critical Access Hospitals (CAHs)

4. Payments for Graduate Medical Education (GME)

B. Provisions of the Deficit Reduction Act of 2005 (DRA)

C. Summary of the Provisions of the FY 2007 IPPS and FY 2007 Occupational Mix Adjustment to the Wage Index Proposed Rules

1. DRG Reclassifications and Recalibrations of Relative Weights

2. Changes to the Hospital Wage Index

3. Other Decisions and Changes to the IPPS for Operating Costs, GME Costs, and Promoting Hospitals’ Effective Use of Health Information Technology

4. Changes to the PPS for Capital-Related Costs

5. Changes for Hospitals and Hospital Units Excluded from the IPPS

6. Payments for Services Furnished Outside the United States

7. Payment for Blood Clotting Factor Administered to Inpatients with Hemophilia

8. Limitation on Payments to Skilled Nursing Facilities for Bad Debt

9. Determining Prospective Payment Operating and Capital Rates and Rate-of-Increase Limits

10. Impact Analysis

11. Recommendation of Update Factors for Operating Cost Rates of Payment for Inpatient Hospital Services

12. Discussion of Medicare Payment Advisory Commission Recommendations

13. Appendix C and Appendix D

D. Public Comments Received in Response to the FY 2007 IPPS and FY 2007 Occupational Mix Adjustment to the Wage Index Proposed Rules

E. Interim Final Rule on Selection Criteria of Loan Program for Qualifying Hospitals Engaged in Cancer-Related Health Care

F. Proposed Rule on Forgiveness of Indebtedness under the Health Care Infrastructure Improvement Program

G. Interim Final Rule on the Exclusion of Vendor Purchases Made Under the Competitive Acquisition Program for Part B Outpatient Drugs and Biologicals for the Purpose of Calculating the Average Sales Price

II. Changes to DRG Classifications and Relative Weights

A. Background

B. DRG Reclassifications

1. General

2. Yearly Review for Making DRG Changes

C. Revisions to the DRG System Used Under the IPPS

1. MedPAC Recommendations

2. Refinement of the Relative Weight Calculation

3. Refinement of DRGs Based on Severity of Illness

a. Comparison of the CMS DRG System and the APR DRG System

b. CS DRGs for Use in the IPPS

c. Changes to CMI from a New DRG System

4. Effect of CS DRGs on the Outlier Threshold

5. Impact of Refinement of DRG System on Payments

6. Conclusions

7. Severity Refinement to CMS DRGs

a. MDC 1 (Diseases and Disorders of the Nervous System)

b. MDC 4 (Diseases and Disorders of the Respiratory System): Respiratory System Diagnosis with Ventilator Support

c. MDC 6 (Diseases and Disorders of the Digestive System)

d. MDC 11 (Diseases and Disorders of the Kidney and Urinary Tract): Major Bladder Procedures

e. MDC 16 (Diseases and Disorders of the Blood and Blood Forming Organs and Immunological Disorders): Major Hematological and Immunological Diagnoses

f. MDC 18 (Infectious and Parasitic Diseases (Systemic or Unspecified Sites)): O.R. Procedure for Patients with Infectious and Parasitic Diseases

g. Severe Sepsis

D. Changes to Specific DRG Classifications

1. Pre-MDCs

a. Heart Transplant or Implant of Heart Assist System: Addition of Procedure to DRG 103

b. Pancreas Transplants

2. MDC 1 (Diseases and Disorders of the Nervous System)

a. Implantation of Intracranial Neurostimulator System for Deep Brain Stimulation (DBS)

b. Carotid Artery Stents

3. MDC 5 (Diseases and Disorders of the Circulatory System)

a. Insertion of Epicardial Leads for Defibrillator Devices

b. Application of Major Cardiovascular Diagnoses (MCVs) List to Defibrillator DRGs

4. MDC 8 (Diseases and Disorders of the Musculoskeletal System and Connective Tissue)

a. Hip and Knee Replacements

b. Spinal Fusion

c. CHARITE

Spinal Disc Replacement Device

5. MDC 18 (Infectious and Parasitic Diseases (Systemic or Unspecified Sites)): Severe Sepsis

6. Medicare Code Editor (MCE) Changes

a. Edit: Newborn Diagnoses

b. Edit: Diagnoses for Pediatric—Age 0-17 Years Old

c. Edit: Maternity Diagnoses—Age 12 through 55

d. Edit: Diagnoses Allowed for Females Only

e. Edit: Diagnoses Allowed for Males Only

f. Edit: Procedures Allowed for Females Only

g. Edit: Manifestations Not Allowed as Principal Diagnosis

h. Edit: Nonspecific Principal Diagnosis

i. Edit: Unacceptable Principal Diagnosis

j. Edit: Nonspecific O.R. Procedures

k. Edit: Noncovered Procedures

l. Edit: Bilateral Procedure

7. Surgical Hierarchies

8. Refinement of Complications and Comorbidities (CC) List

a. Background

b. Comprehensive Review of the CC List

c. CC Exclusions List for FY 2007

9. Review of Procedure Codes in DRGs 468, 476, and 477

a. Moving Procedure Codes from DRG 468 or DRG 477 to MDCs

b. Reassignment of Procedures among DRGs 468, 476, and 477

c. Adding Diagnosis or Procedure Codes to MDCs

10. Changes to the ICD-9-CM Coding System

11. Other Issues

a. Chronic Kidney Disease

b. Bronchial Valve

c. Female Reproductive System Reconstruction Procedures

d. Devices That are Replaced Without Cost or Where Credit for a Replaced Device is Furnished to the Hospital

E. Recalibration of DRG Weights

F. LTC-DRG Reclassifications and Relative Weights for LTCHs for FY 2007

1. Background

2. Changes in the LTC-DRG Classifications

a. Background

b. Patient Classifications into DRGs

3. Development of the FY 2007 LTC-DRG Relative Weights

a. General Overview of Development of the LTC-DRG Relative Weights

b. Data

c. Hospital-Specific Relative Value Methodology

d. Low-Volume LTC-DRGs

4. Steps for Determining the FY 2007 LTC-DRG Relative Weights

5. Summary of Public Comments and Departmental Responses

G. Add-On Payments for New Services and Technologies

1. Background

2. Public Input Before Publication of a Notice of Proposed Rulemaking on Add-On Payments

3. FY 2007 Status of Technologies Approved for FY 2006 Add-On Payments

a. Kinetra® Implantable Neurostimulator (Kinetra®) for Deep Brain Stimulation

b. Endovascular Graft Repair of the Thoracic Aorta

c. Restore® Rechargeable Implantable Neurostimulator

4. FY 2007 Applications for New Technology Add-On Payments

a. C-Port® Distal Anastomosis System

b. NovoSeven® for Intracerebral Hemorrhage

c. X STOP Interspinous Process Decompression System

5. Interim and Final Cost Threshold Tables Due to Changes to Wage Index and Budget Neutrality Factors

III. Changes to the Hospital Wage Index

A. Background

B. Core-Based Statistical Areas for the Hospital Wage Index

C. Occupational Mix Adjustment to the FY 2007 Wage Index

1. Development of Data for the FY 2007 Occupational Mix Adjustment

2. Timeline for the Collection, Review, and Correction of the Occupational Mix Data

3. Calculation of the Occupational Mix Adjustment

D. Worksheet S-3 Wage Data for the FY 2007 Wage Index Update

E. Verification of Worksheet S-3 Wage Data

F. Computation of the FY 2007 Unadjusted Wage Index

G. Implementation of the FY 2007 Occupational Mix Adjustment to the Wage Index

H. Revisions to the Wage Index Based on Hospital Redesignations

1. General

2. Effects of Reclassification/Redesignation

3. FY 2007 MGCRB Reclassifications

4. Procedures for Hospitals Applying for Reclassification Effective in FY 2008 and Reinstating Reclassifications in FY 2008

5. FY 2007 Redesignations Under Section 1886(d)(8)(B) of the Act

6. Reclassifications Under Section 508 of Pub. L. 108-173

7. Wage Indices for Reclassified Hospitals and Reclassification Budget Neutrality Factor

I. FY 2007 Wage Index Adjustment Based on Commuting Patterns of Hospital Employees

J. Process for Requests for Wage Index Data Corrections

K. Labor-Related Share for the Wage Index for FY 2007

L. Proxy for the Hospital Market Basket

IV. Other Decisions and Changes to the IPPS for Operating Costs and GME Costs

A. Reporting of Hospital Quality Data for Annual Hospital Payment Update

1. Background

2. New Procedures for Hospital Reporting of Quality Data

a. Two Percentage Point Reduction

b. New Procedures

c. Expanded Quality Measures

d. HCAHPS® Survey

e. Data Submission

f. RHQDAPU Program Withdrawal and Chart Validation Requirements

g. Data Validation and Attestation

h. Public Display and Reconsideration Procedures

i. Conclusion

3. Electronic Medical Records

B. Value-Based Purchasing

1. Introduction

2. Premier Hospital Quality Incentive Demonstration

3. RHQDAPU Program

a. Section 501(b) of Pub. L. 108-173 (MMA)

b. Section 5001(a) of Pub. L. 109-171 (DRA)

4. Plan for Implementing Hospital Value-Based Purchasing Beginning with FY 2009

a. Measure Development and Refinement

b. Data Infrastructure

c. Incentive Methodology

d. Public Reporting

5. Considerations Related to Certain Conditions, Including Hospital-Acquired Infections

6. Promoting Effective Use of Health Information Technology

C. Sole Community Hospitals (SCHs) and Medicare-Dependent, Small Rural Hospitals (MDHs)

1. Background

2. Volume Decrease Adjustment for SCHs and MDHs

a. HAS/Monitrend Data

b. HAS/Monitrend Data Book Replacement Alternative

3. Mandatory Reporting Requirements for Any Changes in the Circumstances Under Which a Hospital Was Designated as an SCH or MDH

4. Payment Changes for MDHs under the DRA of 2005

a. Background

b. Regulation Changes

5. Technical Change

D. Rural Referral Centers

1. Case-Mix Index

2. Discharges

E. Indirect Medical Education (IME) Adjustment

1. Background

2. IME Adjustment Factor for FY 2007

3. Technical Change to Revise Cross-Reference

F. Payment Adjustment for Disproportionate Share Hospitals (DSHs)

1. Background

2. Technical Corrections

3. Reinstatement of Inadvertently Deleted Provisions on DSH Payment Adjustment Factors

4. Enhanced DSH Adjustment for MDHs

G. Geographic Reclassifications

1. Background

2. Reclassifications under Section 508 of Pub. L. 108-173

3. Multicampus Hospitals

4. Urban Group Hospital Reclassifications

5. Effect of Change of Ownership on Urban County Group Reclassifications

6. Requested Reclassification for Hospitals Located in a Single Hospital MSA Surrounded by Rural Counties

7. Special Adjustment for the Hospital Group Reclassification Denied on the Basis of Incomplete CSA Listing

H. Payment for Direct Graduate Medical Education

1. Background

2. Determination of Weighted Average Per Resident Amounts (PRAs) for Merged Teaching Hospitals

3. Determination of Per Resident Amounts (PRAs) for New Teaching Hospitals

4. Requirements for Counting and Appropriate Documentation of FTE Residents: Clarification

5. Resident Time Spent in Nonpatient Care Activities as Part of Approved Residency Programs

6. Medicare GME Affiliated Groups: Technical Changes to Regulations

I. Payment for the Costs of Nursing and Allied Health Education Activities: Clarification

J. Hospital Emergency Services under EMTALA

1. Background

2. Role of the EMTALA Technical Advisory Group (TAG)

3. Definition of “Labor”

4. Application of EMTALA Requirements to Hospitals Without Dedicated Emergency Departments

5. Clarification of Reference to “Referral Centers”

K. Other Technical Changes

1. Cross-Reference Correction in Regulations on Limitations on Beneficiary Charges

2. Cross-Reference Corrections in Regulations on Payment Denials Based on Admissions and Quality Reviews

3. Cross-Reference Correction in Regulations on Outlier Payments

4. Removing References to Two Paper Claims Forms

L. Rural Community Hospital Demonstration Program

M. Health Care Information Transparency Initiative

V. Changes to the PPS for Capital-Related Costs

A. Background

B. Treatment of Certain Urban Hospitals Reclassified as Rural Hospitals Under § 412.103

C. Other Technical Corrections Relating to the Capital PPS Geographic Adjustment Factors

VI. Changes for Hospitals and Hospital Units Excluded from the IPPS

A. Payments to Excluded Hospitals and Hospital Units

1. Payments to Existing Excluded and New Hospitals and Hospital Units

2. Separate PPS for IRFs

3. Separate PPS for LTCHs

4. Separate PPS for IPFs

5. Grandfathering of Hospitals-Within-Hospitals (HwHs) and Satellite Facilities

6. Changes to the Methodology for Determining LTCH Cost-to-Charge Ratios (CCRs) and the Reconciliation of High-Cost and Short-Stay Outlier Payments under the LTCH PPS

a. Background

b. High-Cost Outliers

c. Short-Stay Outliers

d. CCR Ceiling

e. Statewide Average CCRs

f. Data Used to Determine a CCR

g. Reconciliation of Outlier Payments Upon Cost report Settlement

7. Technical Corrections Relating to LTCHs

8. Cross-Reference Correction in Authority Citations for 42 CFR 412 and 413

9. Report of Adjustment (Exceptions) Payments

B. Critical Access Hospitals (CAHs)

1. Background

2. Sunset of Designation of CAHs as Necessary Providers: Technical Correction

VII. Payment for Services Furnished Outside the United States

A. Background

B. Proposed Clarification of Regulations

VIII. Payment for Blood Clotting Factor Administered to Inpatients with Hemophilia

IX. Limitation on Payments to Skilled Nursing Facilities for Bad Debt

A. Background

B. Changes Made by Section 5004 of Pub. L. 109-171

C. Proposed Regulation Changes

X. MedPAC Recommendations

XI. Health Care Infrastructure Improvement Program: Selection Criteria for Loan Program for Qualifying Hospitals Engaged in Cancer-Related Health Care and Forgiveness of Indebtedness

A. Background

B. Issuance of an Interim Final Rule with Comment Period and a Proposed Regulation

C. Provisions of the Interim Final Rule With Comment Period

1. Loan Qualifying Criteria

2. Selection Criteria

3. Terms of the Loan

4. Public Comments Received on the Interim Final Rule With Comment Period

5. Provisions of this Final Rule

D. Proposed Rule on Forgiveness of Indebtedness

1. Conditions for Loan Forgiveness

2. Plan Criteria for Meeting the Conditions for Loan Forgiveness

3. Public Comments Received on the Proposed Rule and Our Responses

4. Provisions of the Final Rule

E. Statutory Requirements for Issuance of Regulations

XII. Exclusion of Vendor Purchases Made Under the Competitive Acquisition Program (CAP) for Outpatient Drugs and Biologicals Under Part B for the Purpose of Calculating the Average Sales Price (ASP)

A. Background

1. Average Sales Price (ASP)

2. Competitive Acquisition Program (CAP)

3. Regulatory History

B. Regulation Change

XIII. Other Required Information

A. Requests for Data from the Public

B. Collection of Information Requirements

C. Waiver of Proposed Rulemaking and Delay in the Effective Date

D. Response to Comments

Regulation Text

Addendum—Schedule of Tentative Standardized Amounts, Tentative Update Factors and Rate-of-Increase Percentages Effective With Cost Reporting Periods Beginning On or After October 1, 2006

I. Summary and Background

II. Changes to Prospective Payment Rates for Hospital Inpatient Operating Costs

A. Calculation of the Tentative Adjusted Standardized Amount

1. Standardization of Base-Year Costs or Target Amounts

2. Computing the Tentative Average Standardized Amount

3. Updating the Tentative Average Standardized Amount

4. Other Adjustments to the Average Standardized Amount

a. Recalibration of DRG Weights and Updated Wage Index—Budget Neutrality Adjustment

b. Reclassified Hospitals—Tentative Budget Neutrality Adjustment

c. Outliers

d. Tentative Rural Community Hospital Demonstration Program Adjustment (Section 410A of Pub. L. 108-173)

5. Tentative FY 2007 Standardized Amount

B. Tentative Adjustments for Area Wage Levels and Cost-of-Living

1. Tentative Adjustment for Area Wage Levels

2. Final Adjustment for Cost-of-Living in Alaska and Hawaii

C. DRG Relative Weights

D. Calculation of the Prospective Payment Rates

1. Federal Rate

2. Hospital-Specific Rate (Applicable Only to SCHs and MDHs)

a. Calculation of Hospital-Specific Rate

b. Updating the FY 1982, FY 1987, FY 1996, and FY 2002 Hospital-Specific Rates for FY 2007

3. General Formula for Calculation of Prospective Payment Rates for Hospitals Located in Puerto Rico Beginning On or After October 1, 2006, and Before October 1, 2007

a. Puerto Rico Rate

b. National Rate

III. Changes to Payment Rates for Acute Care Hospital Inpatient Capital-Related Costs for FY 2007

A. Determination of Federal Hospital Inpatient Capital-Related Prospective Payment Rate Update

1. Projected Capital Standard Federal Rate Update

a. Description of the Update Framework

b. Comparison of CMS and MedPAC Update Recommendation

2. Outlier Payment Adjustment Factor

3. Budget Neutrality Adjustment Factor for Changes in DRG Classifications and Weights and the GAF

4. Exceptions Payment Adjustment Factor

5. Capital Standard Federal Rate for FY 2007

6. Special Capital Rate for Puerto Rico Hospitals

B. Calculation of the Inpatient Capital-Related Prospective Payments for FY 2007

C. Capital Input Price Index

1. Background

2. Forecast of the CIPI for FY 2007

IV. Payment Rates for Excluded Hospitals and Hospital Units: Rate-of-Increase Percentages

A. Payments to Existing Excluded Hospitals and Units

B. New Excluded Hospitals and Units

V. Payment for Blood Clotting Factor Administered to Inpatients with Hemophilia

Tables

The following tables are included as part of this final rule:

Table 1A—National Adjusted Operating Standardized Amounts, Labor/Nonlabor (69.7 Percent Labor Share/30.3 Percent Nonlabor Share If Wage Index Is Greater Than 1) (Tentative)

Table 1B—National Adjusted Operating Standardized Amounts, Labor/Nonlabor (62 Percent Labor Share/38 Percent Nonlabor Share If Wage Index Is Less Than or Equal to 1) (Tentative)

Table 1C—Adjusted Operating Standardized Amounts for Puerto Rico, Labor/Nonlabor (Tentative)

Table 1D—Capital Standard Federal Payment Rate (Tentative)

Table 4J—Out-Migration Wage Adjustment—FY 2007 (Tentative)

Table 5—List of Diagnosis-Related Groups (DRGs), Relative Weighting Factors, and Geometric and Arithmetic Mean Length of Stay (LOS) (Tentative)

Table 6A—New Diagnosis Codes

Table 6B—New Procedure Codes

Table 6C—Invalid Diagnosis Codes

Table 6D—Invalid Procedure Codes

Table 6E—Revised Diagnosis Code Titles

Table 6F—Revised Procedure Code Titles

Table 6G—Additions to the CC Exclusions List

Table 6H—Deletions from the CC Exclusions List

Table 7A—Medicare Prospective Payment System Selected Percentile Lengths of Stay: FY 2005 MedPAR Update March 2006 GROUPER V23.0

Table 7B—Medicare Prospective Payment System Selected Percentile Lengths of Stay: FY 2005 MedPAR Update March 2006 GROUPER V24.0

Table 8A—Statewide Average Operating Cost-to-Charge Ratios—July 2006

Table 8B—Statewide Average Capital Cost-to-Charge Ratios—July 2006

Table 8C— Statewide Average Total Cost-to-Charge Ratios for LTCHs—July 2006

Table 9A—Hospital Reclassifications and Redesignations by Individual Hospital and CBSA for FY 2007 (Tentative)

Table 9B—Hospital Reclassifications and Redesignation by Individual Hospital Under Section 508 of Pub. L. 108-173 for FY 2007 (Tentative)

Table 9C—Hospitals Redesignated as Rural under Section 1886(d)(8)(E) of the Act for FY 2007 (Tentative)

Table 10—Geometric Mean Plus the Lesser of .75 of the National Adjusted Operating Standardized Payment Amount (Increased to Reflect the Difference Between Costs and Charges) or .75 of One Standard Deviation of Mean Charges by Diagnosis-Related Group (DRG)—July 2006 (Tentative)

Table 11—FY 2007 LTC-DRGs, Relative Weights, Geometric Average Length of Stay, and

5/6

ths of the Geometric Average Length of Stay

Appendix A—Regulatory Impact Analysis

I. Overall Impact

II. Objectives

III. Limitations on Our Analysis

IV. Hospitals Included In and Excluded From the IPPS

V. Effects on Excluded Hospitals and Hospital Units

VI. Quantitative Effects of the Policy Changes Under the IPPS for Operating Costs

A. Basis and Methodology of Estimates

B. Analysis of Table I

C. Effects on the Hospitals that Failed the Quality Data Submission Process (Column 2)

D. Effects of the DRA Provision Related to MDHs (Column 3)

E. Effects of the Changes to the DRG Reclassifications and Relative Cost-Based Weights (Column 4)

F. Effects of Wage Index Changes (Column 5)

G. Combined Effects of DRG and Wage Index Changes, Including Budget Neutrality Adjustment (Column 6)

H. Effects of the 3-Year Provision Allowing Urban Hospitals that Were Converted to Rural as a Result of the FY 2005 Labor Market Area Changes to Maintain the Wage Index of the Urban Labor Market Area in Which They Were Formerly Located (Column 7)

I. Effects of MGCRB Reclassifications (Column 8)

J. Effects of the Wage Index Adjustment for Out-Migration (Column 9)

K. Effects of All Changes (Column 10)

L. Effects of Policy on Payment Adjustments for Low-Volume Hospitals

M. Impact Analysis of Table II

VII. Effects of Other Policy Changes

A. Effects of LTC-DRG Reclassifications and Relative Weights for LTCHs

B. Effects of New Technology Add-On Payments

C. Effects of Requirements for Hospital Reporting of Quality Data for Annual Hospital Payment Update

D. Effects of Other Policy Changes Affecting Sole Community Hospitals (SCHs) and Medicare-Dependent, Small Rural Hospitals (MDHs)

E. Effects of Policy on Payment for Direct Costs of Graduate Medical Education

1. Determination of Weighted Average GME PRAs for Merged Teaching Hospitals

2. Determination of PRAs for New Teaching Hospitals

3. Requirements for Counting and Appropriate Documentation of FTE Residents

4. Resident Time Spent in Nonpatient Care Activities as Part of an Approved Residency Program

F. Effects of Policy Changes Relating to Emergency Services under EMTALA

G. Effects of Policy on Rural Community Hospital Demonstration Program

H. Effects of Policy on Hospitals-within-Hospitals and Satellite Facilities

I. Effects of Policy Changes to the Methodology for Determining LTCH CCRs and the Reconciliation of LTCH PPS Outlier Payments

J. Effects of Policy on Payment for Services Furnished Outside the United States

K. Effects of Final Policy on Limitation on Payments to SNFs

L. Effects of Policy on CAP for Outpatient Drugs and Biologicals under Part B for the Purpose of Calculating the ASP

VIII. Impact of Changes in the Capital PPS

A. General Considerations

B. Results

IX. Impact of Changes Relating to the Loan Program for Capital Cost under the Health Care Infrastructure Improvement Program

A. Effects on Hospitals

B. Effects on the Medicare and Medicaid Programs

X. Alternatives Considered

XI. Overall Conclusion

XII. Accounting Statement

XIII. Executive Order 12866

Appendix B—Recommendation of Update Factors for Operating Cost Rates of Payment for Inpatient Hospital Services

I. Background

II. Secretary's Final Recommendation for Updating the Prospective Payment System Standardized Amounts

III. Secretary's Final Recommendation for Updating the Rate-of-Increase Limits for Excluded Hospitals and Hospital Units

IV. Secretary's Recommendation for Updating the Capital Prospective Payment Amounts

I. Background

A. Summary

1. Acute Care Hospital Inpatient Prospective Payment System (IPPS)

Section 1886(d) of the Social Security Act (the Act) sets forth a system of payment for the operating costs of acute care hospital inpatient stays under Medicare Part A (Hospital Insurance) based on prospectively set rates. Section 1886(g) of the Act requires the Secretary to pay for the capital-related costs of hospital inpatient stays under a prospective payment system (PPS). Under these PPSs, Medicare payment for hospital inpatient operating and capital-related costs is made at

predetermined, specific rates for each hospital discharge. Discharges are classified according to a list of diagnosis-related groups (DRGs).

The base payment rate is comprised of a standardized amount that is divided into a labor-related share and a nonlabor-related share. The labor-related share is adjusted by the wage index applicable to the area where the hospital is located; and if the hospital is located in Alaska or Hawaii, the nonlabor-related share is adjusted by a cost-of-living adjustment factor. This base payment rate is multiplied by the DRG relative weight.

If the hospital treats a high percentage of low-income patients, it receives a percentage add-on payment applied to the DRG-adjusted base payment rate. This add-on payment, known as the disproportionate share hospital (DSH) adjustment, provides for a percentage increase in Medicare payments to hospitals that qualify under either of two statutory formulas designed to identify hospitals that serve a disproportionate share of low-income patients. For qualifying hospitals, the amount of this adjustment may vary based on the outcome of the statutory calculations.

If the hospital is an approved teaching hospital, it receives a percentage add-on payment for each case paid under the IPPS, known as the indirect medical education (IME) adjustment. This percentage varies, depending on the ratio of residents to beds.

Additional payments may be made for cases that involve new technologies or medical services that have been approved for special add-on payments. To qualify, a new technology or medical service must demonstrate that it is a substantial clinical improvement over technologies or services otherwise available, and that, absent an add-on payment, it would be inadequately paid under the regular DRG payment.

The costs incurred by the hospital for a case are evaluated to determine whether the hospital is eligible for an additional payment as an outlier case. This additional payment is designed to protect the hospital from large financial losses due to unusually expensive cases. Any outlier payment due is added to the DRG-adjusted base payment rate, plus any DSH, IME, and new technology or medical service add-on adjustments.

Although payments to most hospitals under the IPPS are made on the basis of the standardized amounts, some categories of hospitals are paid the higher of a hospital-specific rate based on their costs in a base year (the higher of FY 1982, FY 1987, FY 1996, or FY 2002) or the IPPS rate based on the standardized amount. For example, sole community hospitals (SCHs) are the sole source of care in their areas, and Medicare-dependent, small rural hospitals (MDHs) are a major source of care for Medicare beneficiaries in their areas. Both of these categories of hospitals are afforded special payment protection in order to maintain access to services for beneficiaries. (Through FY 2007, an MDH receives the IPPS rate plus 50 percent of the difference between the IPPS rate and its hospital-specific rate if the hospital-specific rate is higher than the IPPS rate. In addition, an MDH may not use FY 1996 as its base year for the hospital-specific rate. As discussed below, for discharges occurring on or after October 1, 2007, but before October 1, 2011, an MDH will receive the IPPS rate plus 75 percent of the difference between the IPPS rate and its hospital-specific rate, if the hospital-specific rate is higher than the IPPS rate.)

Section 1886(g) of the Act requires the Secretary to pay for the capital-related costs of inpatient hospital services “in accordance with a prospective payment system established by the Secretary.” The basic methodology for determining capital prospective payments is set forth in our regulations at 42 CFR 412.308 and 412.312. Under the capital PPS, payments are adjusted by the same DRG for the case as they are under the operating IPPS. Capital PPS payments are also adjusted for IME and DSH, similar to the adjustments made under the operating IPPS. In addition, hospitals may receive outlier payments for those cases that have unusually high costs.

The existing regulations governing payments to hospitals under the IPPS are located in 42 CFR Part 412, Subparts A through M.

2. Hospitals and Hospital Units Excluded From the IPPS

Under section 1886(d)(1)(B) of the Act, as amended, certain specialty hospitals and hospital units are excluded from the IPPS. These hospitals and units are: inpatient rehabilitation hospitals and units (commonly referred to as inpatient rehabilitation facilities (IRFs); long-term care hospitals (LTCHs); inpatient psychiatric hospitals and units (commonly referred to as inpatient psychiatric facilities (IPFs); children's hospitals; and cancer hospitals. Religious nonmedical health care institutions (RNHCIs) are also excluded from the IPPS. Various sections of the Balanced Budget Act of 1997 (Pub. L. 105-33), the Medicare, Medicaid and SCHIP [State Children's Health Insurance Program] Balanced Budget Refinement Act of 1999 (Pub. L. 106-113), and the Medicare, Medicaid, and SCHIP Benefits Improvement and Protection Act of 2000 (Pub. L. 106-554) provide for the implementation of PPSs for IRFs, LTCHs, and IPFs, as discussed below. Children's hospitals, cancer hospitals, and RNHCIs continue to be paid solely under a reasonable cost-based system.

The existing regulations governing payments to excluded hospitals and hospital units are located in 42 CFR Parts 412 and 413.

a. Inpatient Rehabilitation Facilities (IRFs)

Under section 1886(j) of the Act, IRFs have been transitioned from payment based on a blend of reasonable cost reimbursement and the adjusted IRF Federal prospective payment rate for cost reporting periods beginning on or after January 1, 2002, through September 30, 2002, to payment at 100 percent of the Federal rate effective for cost reporting periods beginning on or after October 1, 2002. IRFs subject to the blend were also permitted to elect payment based on 100 percent of the Federal rate. The existing regulations governing payments under the IRF PPS are located in 42 CFR Part 412, Subpart P.

b. Long-Term Care Hospitals (LTCHs)

Under the authority of sections 123(a) and (c) of Pub. L. 106-113 and section 307(b)(1) of Pub. L. 106-554, LTCHs that do not meet the definition of “new” under § 412.23(e)(4) are being transitioned from being paid for inpatient hospital services based on a blend of reasonable cost-based reimbursement under section 1886(b) of the Act to 100 percent of the Federal rate during a 5-year period with cost reporting periods beginning on or after October 1, 2002. Those LTCHs that do not meet the definition of “new” may elect to be paid based on 100 percent of the Federal prospective payment rate instead of a blended payment in any year during the 5-year transition. For cost reporting periods beginning on or after October 1, 2006, LTCHs will be paid 100 percent of the Federal rate. The existing regulations governing payment under the LTCH PPS are located in 42 CFR Part 412, Subpart O.

c. Inpatient Psychiatric Facilities (IPFs)

Under the authority of sections 124(a) and (c) of Pub. L. 106-113, IPFs are paid under the IPF PPS. Under the IPF PPS, some IPFs are transitioning from being paid for inpatient hospital services based on a blend of reasonable cost-based payment to a Federal per diem

payment rate, effective for cost reporting periods beginning on or after January 1, 2005 (November 15, 2004 IPF PPS final rule (69 FR 66922) and May 9, 2006 IPF PPS final rule (71 FR 27040)). For cost reporting periods beginning on or after January 1, 2008, all IPFs will be paid 100 percent of the Federal per diem payment amount. The existing regulations governing payment under the IPF PPS are located in 42 CFR 412, Subpart N.

3. Critical Access Hospitals (CAHs)

Under sections 1814, 1820, and 1834(g) of the Act, payments are made to critical access hospitals (CAHs) (that is, rural hospitals or facilities that meet certain statutory requirements) for inpatient and outpatient services based on 101 percent of reasonable cost. Reasonable cost is determined under the provisions of section 1861(v)(1)(A) of the Act and existing regulations under 42 CFR Parts 413 and 415.

4. Payments for Graduate Medical Education (GME)

Under section 1886(a)(4) of the Act, costs of approved educational activities are excluded from the operating costs of inpatient hospital services. Hospitals with approved graduate medical education (GME) programs are paid for the direct costs of GME in accordance with section 1886(h) of the Act; the amount of payment for direct GME costs for a cost reporting period is based on the hospital's number of residents in that period and the hospital's costs per resident in a base year. The existing regulations governing payments to the various types of hospitals are located in 42 CFR Part 413.

B. Provisions of the Deficit Reduction Act of 2005 (DRA)

On February 8, 2006, the Deficit Reduction Act of 2005 (DRA), Pub. L. 109-171, was enacted. Pub. L. 109-171 made a number of changes to the Act relating to prospective payments to hospitals and other providers for inpatient services. This final rule implements amendments made by the following sections of Pub. L. 109-171:

• Section 5001(a), which, effective for FY 2007 and subsequent years, allows for expansion of the requirements for hospital quality data reporting.

• Section 5003, which makes several changes to the MDH program. It extends special payment provisions, requires MDHs to use FY 2002 as their base year for determining whether use of their hospital-specific rate enhances payment (but permits them to continue to use either their 1982 or 1987 hospital-specific rate if using either of those rates results in higher payments), and removes the application of the 12-percent cap on the DSH payment adjustment factor for MDHs.

• Section 5004, which reduces certain allowable SNF bad debt payments by 30 percent. Payments for the bad debts of full-benefit, dual eligible individuals are not reduced.

In this final rule, we also discuss the provisions of section 5001(b) of Pub. L. 109-171, which require us to develop a plan to implement, beginning with FY 2009, a value-based purchasing plan for section 1886(d) hospitals and summarize the public comments received in response to our invitation for public comments. This discussion also includes the provisions of section 5001(c) of Pub. L. 109-171, which requires a quality adjustment in DRG payments for certain hospital-acquired conditions, effective for FY 2008.

C. Summary of the Provisions of the FY 2007 IPPS and FY 2007 Occupational Mix Adjustment to the Wage Index Proposed Rules

In the FY 2007 IPPS proposed rule, we set forth proposed changes to the Medicare IPPS for operating costs and for capital-related costs in FY 2007. We also set forth proposed changes relating to payments for GME costs, payments to certain hospitals and units that continue to be excluded from the IPPS and paid on a reasonable cost basis, and payments for SCHs and MDHs. The changes were proposed to be effective for discharges occurring on or after October 1, 2006, unless otherwise noted.

After publication of the FY 2007 IPPS proposed rule, the United States Court of Appeals for the Second Circuit issued a decision in the Bellevue case that caused us to modify our proposals on the implementation of the occupational mix adjustment. As a result, we published a second proposed rule in the May 17, 2006

Federal Register

that superseded the occupational mix proposals that had been made in the FY 2007 IPPS proposed rule (published April 25, 2006). The following is a summary of the major changes that we proposed to make and the issues that we addressed in the FY 2007 IPPS and FY 2007 Occupational Mix Adjustment to the Wage Index proposed rules:

1. DRG Reclassifications and Recalibrations of Relative Weights

As required by section 1886(d)(4)(C) of the Act, we proposed limited annual revisions to the DRG classifications structure. In this section, we responded to several recommendations made by MedPAC intended to improve the DRG system. We also proposed to use, for FY 2007, hospital-specific relative values (HSRVs) for 10 cost centers to compute DRG relative weights. In addition, we proposed to use consolidated severity-adjusted DRGs or alternative severity adjustment methods in FY 2008 (if not earlier).

We presented our reevaluation of certain FY 2006 applicants for add-on payments for high-cost new medical services and technologies, and our analysis of FY 2007 applicants (including public input, as directed by Pub. L. 108-173, obtained in a town hall meeting).

We proposed the annual update of the long-term care diagnosis-related group (LTC-DRG) classifications and relative weights for use under the LTCH PPS for FY 2007.

2. Changes to the Hospital Wage Index

We proposed revisions to the wage index and the annual update of the wage data. Specific issues addressed include the following:

• The FY 2007 wage index update, using wage data from cost reporting periods that began during FY 2003.

• The FY 2007 occupational mix adjustment to the wage index (discussed inthe May 17, 2006 proposed rule).

• The revisions to the wage index based on hospital redesignations and reclassifications.

• The adjustment to the wage index for FY 2007 based on commuting patterns of hospital employees who reside in a county and work in a different area with a higher wage index.

• The timetable for reviewing and verifying the wage data that will be in effect for the proposed FY 2007 wage index.

• The special timetable that will apply in FY 2007 in order to allow us to make presumptive reclassification withdrawal or termination decisions on behalf of affected hospitals which will then become final unless reversed or modified by the affected hospitals in accordance with CMS procedural rules.

• The labor-related share for the FY 2007 wage index, including the labor-related share for Puerto Rico.

3. Other Decisions and Changes to the IPPS for Operating Costs, GME Costs, and Promoting Hospitals' Effective Use of Health Information Technology

In the proposed rule, we discussed a number of provisions of the regulations in 42 CFR Parts 412 and 413 and related proposed changes, including the following:

• The reporting of hospital quality data as a condition for receiving the full annual payment update increase.

• Changes in payments to SCHs and MDHs.

• Updated national and regional case-mix values and discharges for purposes of determining rural referral center status.

• The statutorily-required IME adjustment factor for FY 2007.

• Changes relating to hospitals' geographic classifications, including reclassifications under section 508 of Pub. L. 108-173, multicampus hospitals, urban group hospital reclassification and the effect of change in ownership on urban county group reclassifications.

• Changes and clarifications relating to GME that address determining the per resident amounts (PRAs) for merged hospitals and new teaching hospitals, counting and appropriate documentation of FTE residents, and counting of resident time spent in nonpatient care activities as part of approved residency programs.

• Changes relating to payment for costs of nursing and allied health education programs.

• Changes relating to requirements for emergency services for hospitals under EMTALA.

• Discussion of the third year of implementation of the Rural Community Hospital Demonstration Program.

We also invited comments on promoting hospitals' effective use of health information technology.

4. Changes to the PPS for Capital-Related Costs

In the proposed rule, we discussed the payment policy requirements for capital-related costs and capital payments to hospitals and proposed several technical corrections to the regulations.

5. Changes for Hospitals and Hospital Units Excluded From the IPPS

In the proposed rule, we discussed payments made to excluded hospitals and hospital units, proposed policy changes regarding decreases in square footage or decreases in the number of beds of the “grandfathering” HwHs and satellite facilities, and proposed changes to the methodology for determining LTCH CCRs and the reconciliation of high-cost and short-stay outlier payments under the LTCH PPS. In addition, we proposed a technical change relating to the designation of CAHs as necessary providers.

6. Payments for Services Furnished Outside the United States

In the proposed rule, we set forth proposed changes to clarify what is considered “outside the United States” for Medicare payment purposes.

7. Payment for Blood Clotting Factor Administered to Inpatients With Hemophilia

In the proposed rule, we discussed the proposed changes in payment for blood clotting factor administered to Medicare beneficiaries with hemophilia for FY 2007.

8. Limitation on Payments to Skilled Nursing Facilities for Bad Debt

In the proposed rule, we proposed to implement section 5004 of Pub. L. 109-171 relating to reduction in payments to SNFs for bad debt.

9. Determining Prospective Payment Operating and Capital Rates and Rate-of-Increase Limits

In the Addendum to the proposed rule, we set forth proposed changes to the amounts and factors for determining the FY 2007 prospective payment rates for operating costs and capital-related costs. We also proposed to establish the threshold amounts for outlier cases. In addition, we addressed the proposed update factors for determining the rate-of-increase limits for cost reporting periods beginning in FY 2007 for hospitals and hospital units excluded from the PPS.

10. Impact Analysis

In Appendix A of the proposed rule, we set forth an analysis of the impact that the proposed changes would have on affected hospitals.

11. Recommendation of Update Factors for Operating Cost Rates of Payment for Inpatient Hospital Services

In Appendix B of the proposed rule, as required by sections 1886(e)(4) and (e)(5) of the Act, we provided our recommendations of the appropriate percentage changes for FY 2007 for the following:

• A single average standardized amount for all areas for hospital inpatient services paid under the IPPS for operating costs (and hospital-specific rates applicable to SCHs and MDHs).

• Target rate-of-increase limits to the allowable operating costs of hospital inpatient services furnished by hospitals and hospital units excluded from the IPPS.

12. Discussion of Medicare Payment Advisory Commission Recommendations

Under section 1805(b) of the Act, MedPAC is required to submit a report to the Congress, no later than March 1 of each year, in which MedPAC reviews and makes recommendations on Medicare payment policies. MedPAC's March 2006 recommendation concerning hospital inpatient payment policies addressed the update factor for inpatient hospital operating costs and capital-related costs under the IPPS and for hospitals and distinct part hospital units excluded from the IPPS. This recommendation was addressed in Appendix B of the proposed rule. For further information relating specifically to the MedPAC reports or to obtain a copy of the reports, contact MedPAC at (202) 220-3700 or visit MedPAC's Web site at:

www.medpac.gov

13. Appendix C and Appendix D

In Appendix C of the proposed rule, we listed the combinations of the consolidated severity-adjusted DRGs that we proposed to implement on FY 2008 (if not earlier), as discussed in section II.C. of the preamble of the proposed rule. In Appendix D of the proposed rule, we provided a crosswalk of the proposed consolidated severity-adjusted DRG system to the respective All Patient Related Diagnosis-Related Group (APR DRG) system.

D. Public Comments Received in Response to the FY 2007 IPPS and FY 2007 Occupational Mix Adjustment to the Wage Index Proposed Rules

We received over 2,300 timely items of correspondence containing multiple comments on the FY 2007 IPPS proposed rule. We also received over 100 timely items of correspondence on the FY 2007 Occupational Mix Adjustment to the Wage Index proposed rule. Summaries of the public comments and our responses to those comments are set forth under the appropriate heading.

E. Interim Final Rule on Selection Criteria of Loan Program for Qualifying Hospitals Engaged in Cancer-Related Health Care

On September 30, 2005, we published in the

Federal Register

(70 FR 57368) an interim final rule with comment period (CMS-1287-IFC) that set forth the criteria for implementing a loan program for qualifying hospitals engaged in research in the causes, prevention, and treatment of cancer, as specified in section 1016 of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (Pub. L. 108-173). Specifically, this interim final rule established a loan application process by which qualifying hospitals, including specified entities, may apply for a loan for the capital costs of health care infrastructure improvement projects. The interim final rule was effective on November 29, 2005.

We received seven timely items of correspondence on the interim final

rule. In section XI. of the preamble to this final rule, we are finalizing this interim final rule with comment period. In that section, we discuss the provisions of the program, the public comments received, our responses to those comments, and the final policy.

F. Proposed Rule on Forgiveness of Indebtedness under the Health Care Infrastructure Improvement Program

On September 30, 2005, we published in the

Federal Register

(70 FR 57376) a proposed rule (CMS-1320-P) to establish the loan forgiveness criteria for qualifying hospitals who receive loans under the Health Care Infrastructure Improvement Program that was established under section 1016 of Pub. L. 108-173.

We received one timely item of correspondence on this proposed rule. We address the provisions of the proposed rule, a summary of the public comments received and our responses, and the provisions of the final rule in section XI. of the preamble of this final rule.

In November 21, 2005

Federal Register

(70 FR 70748), we published an interim final rule with comment period (CMS-1325-IFC3) to clarify and solicit comments on the relationship between drugs supplied under the CAP for Part B Drugs and Biologicals and the calculation of the ASP.

We did not receive any timely items of correspondence on this interim final rule with comment period. We summarize the provisions of the July 6, 2005 and the November 21, 2005 interim final rules and the current interim final provisions in section XII. of the preamble of this final rule.

II. Changes to DRG Classifications and Relative Weights

A. Background

Section 1886(d) of the Act specifies that the Secretary shall establish a classification system (referred to as DRGs) for inpatient discharges and adjust payments under the IPPS based on appropriate weighting factors assigned to each DRG. Therefore, under the IPPS, we pay for inpatient hospital services on a rate per discharge basis that varies according to the DRG to which a beneficiary's stay is assigned. The formula used to calculate payment for a specific case multiplies an individual hospital's payment rate per case by the weight of the DRG to which the case is assigned. Each DRG weight represents the average resources required to care for cases in that particular DRG, relative to the average resources used to treat cases in all DRGs.

Congress recognized that it would be necessary to recalculate the DRG relative weights periodically to account for changes in resource consumption. Accordingly, section 1886(d)(4)(C) of the Act requires that the Secretary adjust the DRG classifications and relative weights at least annually. These adjustments are made to reflect changes in treatment patterns, technology, and any other factors that may change the relative use of hospital resources.

B. DRG Reclassifications

1. General

As discussed in section II.D. of the preamble to the FY 2007 IPPS proposed rule (71 FR 24030), for FY 2007, we are making only limited changes to the current DRG classifications that will be applicable to discharges occurring on or after October 1, 2006. We are limiting our changes because, as discussed in detail in section II.C. of the preamble to the proposed rule and to this final rule, we are focusing our efforts on addressing the recommendations made last year by MedPAC to refine the entire CMS DRG system by taking into account severity of illness and applying hospital-specific relative value (HSRV) weights to DRGs.

Currently, cases are classified into CMS DRGs for payment under the IPPS based on the principal diagnosis, up to eight additional diagnoses, and up to six procedures performed during the stay. In a small number of DRGs, classification is also based on the age, sex, and discharge status of the patient. The diagnosis and procedure information is reported by the hospital using codes from the International Classification of Diseases, Ninth Revision, Clinical Modification (ICD-9-CM).

The process of forming the DRGs was begun by dividing all possible principal diagnoses into mutually exclusive principal diagnosis areas, referred to as Major Diagnostic Categories (MDCs). The MDCs were formed by physician panels as the first step toward ensuring that the DRGs would be clinically coherent. The diagnoses in each MDC correspond to a single organ system or etiology and, in general, are associated with a particular medical specialty. Thus, in order to maintain the requirement of clinical coherence, no final DRG could contain patients in different MDCs. Most MDCs are based on a particular organ system of the body. For example, MDC 6 is Diseases and Disorders of the Digestive System. This approach is used because clinical care is generally organized in accordance with the organ system affected. However, some MDCs are not constructed on this basis because they involve multiple organ systems (for example, MDC 22 (Burns)). For FY 2006, cases are assigned to one of 526 DRGs in 25 MDCs. The table below lists the 25 MDCs.

Major Diagnostic Categories (MDCs)

Diseases and Disorders of the Nervous System.

Diseases and Disorders of the Eye.

Diseases and Disorders of the Ear, Nose, Mouth, and Throat.

Diseases and Disorders of the Respiratory System.

Diseases and Disorders of the Circulatory System.

Diseases and Disorders of the Digestive System.

Diseases and Disorders of the Hepatobiliary System and Pancreas.

Diseases and Disorders of the Musculoskeletal System and Connective Tissue.

Diseases and Disorders of the Skin, Subcutaneous Tissue and Breast.

Endocrine, Nutritional and Metabolic Diseases and Disorders.

Diseases and Disorders of the Kidney and Urinary Tract.

Diseases and Disorders of the Male Reproductive System.

Diseases and Disorders of the Female Reproductive System.

Pregnancy, Childbirth, and the Puerperium.

Newborns and Other Neonates with Conditions Originating in the Perinatal Period.

Diseases and Disorders of the Blood and Blood Forming Organs and Immunological Disorders.

Myeloproliferative Diseases and Disorders and Poorly Differentiated Neoplasms.

Infectious and Parasitic Diseases (Systemic or Unspecified Sites).

Mental Diseases and Disorders.

Alcohol/Drug Use and Alcohol/Drug Induced Organic Mental Disorders.

Injuries, Poisonings, and Toxic Effects of Drugs.

Burns.

Factors Influencing Health Status and Other Contacts with Health Services.

Multiple Significant Trauma.

Human Immunodeficiency Virus Infections.

In general, cases are assigned to an MDC based on the patient's principal diagnosis before assignment to a DRG. However, for FY 2006, there are nine DRGs to which cases are directly assigned on the basis of ICD-9-CM procedure codes. These DRGs are for heart transplant or implant of heart assist systems, liver and/or intestinal transplants, bone marrow transplants, lung transplants, simultaneous pancreas/kidney transplants, pancreas transplants, and for tracheostomies. Cases are assigned to these DRGs before they are classified to an MDC. The table below lists the nine current pre-MDCs.

Pre-Major Diagnostic Categories (Pre-MDCs)

DRG 103

Heart Transplant or Implant of Heart Assist System.

DRG 480

Liver Transplant and/or Intestinal Transplant.

DRG 481

Bone Marrow Transplant.

DRG 482

Tracheostomy for Face, Mouth, and Neck Diagnoses.

DRG 495

Lung Transplant.

DRG 512

Simultaneous Pancreas/Kidney Transplant.

DRG 513

Pancreas Transplant.

DRG 541

ECMO or Tracheostomy with Mechanical Ventilation 96+ Hours or Principal Diagnosis Except for Face, Mouth, and Neck Diagnosis with Major O.R.

DRG 542

Tracheostomy with Mechanical Ventilation 96+ Hours or Principal Diagnosis Except for Face, Mouth, and Neck Diagnosis without Major O.R.

Once the MDCs were defined, each MDC was evaluated to identify those additional patient characteristics that would have a consistent effect on the consumption of hospital resources. Because the presence of a surgical procedure that required the use of the operating room would have a significant effect on the type of hospital resources used by a patient, most MDCs were initially divided into surgical DRGs and medical DRGs. Surgical DRGs are based on a hierarchy that orders operating room (O.R.) procedures or groups of O.R. procedures by resource intensity. Medical DRGs generally are differentiated on the basis of diagnosis and age (0 to 17 years of age or greater than 17 years of age). Some surgical and medical DRGs are further differentiated based on the presence or absence of a complication or a comorbidity (CC).

Generally, nonsurgical procedures and minor surgical procedures that are not usually performed in an operating room are not treated as O.R. procedures. However, there are a few non-O.R. procedures that do affect DRG assignment for certain principal diagnoses. An example is extracorporeal shock wave lithotripsy for patients with a principal diagnosis of urinary stones.

Once the medical and surgical classes for an MDC were formed, each class of diagnoses was evaluated to determine if complications, comorbidities, or the patient's age would consistently affect the consumption of hospital resources. Physician panels classified each diagnosis code based on whether the diagnosis, when present as a secondary condition, would be considered a substantial CC. A substantial CC was defined as a condition which, because of its presence with a specific principal diagnosis, would cause an increase in the length of stay by at least one day in at least 75 percent of the patients. Each medical and surgical class within an MDC was tested to determine if the presence of any substantial CC would consistently affect the consumption of hospital resources.

A patient's diagnosis, procedure, discharge status, and demographic information is fed into the Medicare claims processing systems and subjected to a series of automated screens called the Medicare Code Editor (MCE). The MCE screens are designed to identify cases that require further review before classification into a DRG.

After patient information is screened through the MCE and any further development of the claim is conducted, the cases are classified into the appropriate DRG by the Medicare GROUPER software program. The GROUPER program was developed as a means of classifying each case into a DRG on the basis of the diagnosis and procedure codes and, for a limited number of DRGs, demographic information (that is, sex, age, and discharge status).

After cases are screened through the MCE and assigned to a DRG by the GROUPER, the PRICER software calculates a base DRG payment. The PRICER calculates the payment for each case covered by the IPPS based on the DRG relative weight and additional factors associated with each hospital, such as IME and DSH adjustments. These additional factors increase the payment amount to hospitals above the base DRG payment.

The records for all Medicare hospital inpatient discharges are maintained in the Medicare Provider Analysis and Review (MedPAR) file. The data in this file are used to evaluate possible DRG classification changes and to recalibrate the DRG weights. However, in the July 30, 1999 IPPS final rule (64 FR 41500), we discussed a process for considering non-MedPAR data in the recalibration process. In order for us to consider using particular non-MedPAR data, we must have sufficient time to evaluate and test the data. The time necessary to do so depends upon the nature and quality of the non-MedPAR data submitted. Generally, however, a significant sample of the non-MedPAR

data should be submitted by mid-October for consideration in conjunction with the next year's proposed rule. This allows us time to test the data and make a preliminary assessment as to the feasibility of using the data. Subsequently, a complete database should be submitted by early December for consideration in conjunction with the next year's proposed rule.

In the FY 2007 IPPS proposed rule, we proposed limited changes to the DRG classification system for FY 2007 for the FY 2007 GROUPER, Version 24.0 and to the methodology used to recalibrate the DRG weights. The changes we proposed, the public comments we received concerning the proposed changes, the final DRG changes, and the methodology used to calculate the DRG weights are set forth below. The changes we are implementing in this final rule will be reflected in the FY 2007 GROUPER, Version 24.0, and are effective for discharges occurring on or after October 1, 2006. Unless otherwise noted in this final rule, our DRG analysis is based on data from the March 2006 update of the FY 2005 MedPAR file, which contains hospital bills received through March 31, 2006, for discharges occurring in FY 2005.

2. Yearly Review for Making DRG Changes

Many of the changes to the DRG classifications are the result of specific issues brought to our attention by interested parties. We encourage individuals with concerns about DRG classifications to bring those concerns to our attention in a timely manner so they can be carefully considered for possible inclusion in the annual proposed rule Therefore, similar to the timetable for interested parties to submit non-MedPAR data for consideration in the DRG recalibration process, concerns about DRG classification issues should be brought to our attention no later than early December in order to be considered and possibly included in the next annual proposed rule updating the IPPS.

The actual process of forming the DRGs was, and continues to be, highly iterative, involving a combination of statistical results from test data combined with clinical judgment. For purposes of this final rule, in deciding whether to create a separate DRG, we consider whether the resource consumption and clinical characteristics of the patients with a given set of conditions are significantly different than the remaining patients in the existing DRG. We evaluate patient care costs using average charges and lengths of stay as proxies for costs and rely on the judgment of our medical officers to decide whether patients are clinically distinct or similar to other patients in the DRG. In evaluating resource costs, we consider both the absolute and percentage differences in average charges between the cases we are selecting for review and the remainder of cases in the DRG. We also consider variation in charges within these groups; that is, whether observed average differences are consistent across patients or attributable to cases that are extreme in terms of charges or length of stay, or both. Further, we also consider the number of patients who will have a given set of characteristics and generally prefer not to create a new DRG unless it will include a substantial number of cases.

C. Revisions to the DRG System Used Under the IPPS

1. MedPAC Recommendations

In the FY 2006 IPPS final rule, we discussed a number of recommendations made by MedPAC regarding revisions to the DRG system used under the IPPS (70 FR 47473 through 47482).

In Recommendation 1-3 in the 2005 Report to Congress on Physician-Owned Specialty Hospitals, MedPAC recommended that CMS refine the current DRGs to more fully capture differences in severity of illness among patients, including:

• Base the DRG relative weights on the estimated cost of providing care.

• Base the weights on the national average of the hospital-specific relative values (HSRVs) for each DRG (using hospital-specific costs to derive the HSRVs).

• Adjust the DRG relative weights to account for differences in the prevalence of high-cost outlier cases.

• Implement the case-mix measurement and outlier policies over a transitional period.

As we noted in the FY 2006 IPPS final rule, we had insufficient time to complete a thorough evaluation of these recommendations for full implementation in FY 2006. However, we did adopt severity-weighted cardiac DRGs in FY 2006 to address public comments on this issue and the specific concerns of MedPAC regarding cardiac surgery DRGs. We also indicated that we planned to further consider all of MedPAC's recommendations and thoroughly analyze options and their impacts on the various types of hospitals in the FY 2007 IPPS proposed rule. Following the publication of the FY 2006 IPPS final rule, we contracted with 3M Health Information Systems to assist us in performing this analysis.

Beginning with MedPAC's relative weight recommendations, we analyzed MedPAC's recommendations to move to a cost-based HSRV weighting methodology. In performing this portion of the analysis, we studied hospital cost report data, departmental cost-to-charge ratios (CCRs), MedPAR claims data, and HSRV weighting methodology. Our intention in undertaking this portion of the analysis was to find an administratively feasible approach to improving the accuracy of the DRG weights. As we described in the proposed rule, we believe some changes can be made to MedPAC's methodology for determining the relative weights that will make it more feasible to replicate on an annual basis but will result in similar impacts.

In conjunction with analyzing MedPAC's relative weight recommendations, we looked at refining the current DRG system to better recognize severity of illness. Starting with the APR DRG GROUPER used by MedPAC in its analysis, we studied Medicare claims data. Based on this analysis, we developed a CS DRG GROUPER that we believe could be a better alternative for recognizing severity of illness among the Medicare population. We note that MedPAC's recommendations with regard to revising the DRGs to better recognize severity of illness may have implications for the outlier threshold, the measurement of real case-mix versus apparent case-mix, and the IME and the DSH adjustments. We discuss these implications in more detail in the following sections.

As we present below, we believe that the recommendations made by MedPAC, or some variants of them, have significant promise to improve the accuracy of the payment rates in the IPPS. We agree with MedPAC about exploring possible refinements to our payment methodology even in the absence of concerns about the proliferation of specialty hospitals. In the FY 2006 final rule, we indicated that until we had completed further analysis of the options and their effects, we could not predict the extent to which changing to APR DRGs would provide payment equity between specialty and general hospitals. In fact, we cautioned that any system that groups cases will always present some opportunities for providers to specialize in cases they believe to have higher margins. We believe that improving payment accuracy should reduce these opportunities and potentially reduce the

incentives that Medicare payments may provide for the further development of specialty hospitals.

We considered MedPAC's recommendation to adjust the relative weights to account for differences in the prevalence of outlier cases. However, we placed most of our attention and resources on the recommendations related to refinement of the current DRGs to more fully capture differences in severity of illness among patients, as we do not have the statutory authority to make the specific changes to our outlier policy that MedPAC recommended. While we have not made MedPAC's recommendation regarding outliers a central focus of our analysis, we do intend to examine this issue in more detail in the future. In sections II.C.2. through C.6. of the FY 2007 proposed rule, we discussed a number of issues related to the MedPAC recommendations. We also presented our analysis and specific proposals for FY 2007 and FY 2008 including their estimated impacts. In this final rule, we present the public comments received on the proposed rule, our responses to those comments, our final decisions for FY 2007 and our intended actions for FY 2008.

2. Refinement of the Relative Weight Calculation

MedPAC made two recommendations with respect to the DRG relative weight calculation. First, MedPAC recommended that CMS base the DRG relative weights on the estimated cost of providing care. Second, MedPAC recommended that CMS base the weights on the national average of hospitals' relative values in each DRG. Because both of these recommendations address the relative weight calculation, we are addressing them together. The work we have done to address these recommendations was discussed in detail in the proposed rule (71 FR 24006-24011).

MedPAC recommended that CMS replace its charge-based relative weight methodology with cost-based weights, as it believed that the charge-based relative weight methodology that CMS has utilized since 1985 has introduced bias into the weights due to differential markups for ancillary services among the DRGs. In analyzing claims data, it is evident to us that some hospital types (for example, teaching hospitals) are systematically more expensive overall than the average hospital and certain case types are more commonly treated at these more expensive facilities. Higher average charges for cases that are treated at more expensive hospitals may result in higher weights for these types of cases. MedPAC suggested a hospital-specific relative value (HSRV) methodology which MedPAC believed would reduce the effect of cost differences among hospitals that may be present in the national relative weights due to differences in case-mix adjusted costs.

Under the HSRV methodology recommended by MedPAC, charges are standardized for each provider by converting its charges for each case to hospital-specific relative charge values and then adjusting those values for the hospital's case-mix. The first step in this process involves dividing the charge for each case at the hospital by the average charge for all cases at the hospital in which the case was treated. The hospital-specific relative charge value, by definition, averages 1.0 for each hospital. The resulting ratio is then multiplied by the hospital's case-mix index (CMI). In this way, each hospital's relative charge value is adjusted by its case-mix to an average that reflects the complexity of the cases it treats relative to the complexity of the cases treated by all other hospitals. We discuss this issue in further detail below.

Our analysis of departmental-level CCRs from the Medicare cost report data has shown that charges for routine days, intensive care days, and various ancillary services are not marked up by a consistent amount. For example, the markup amounts for cardiology services are higher than average. Because charges are the current basis for the DRG relative weights, the practice of differential markups can lead to bias in the DRG weights because various DRGs use, on average, more or less of particular ancillary services. MedPAC believes that the bias in the national DRG relative weights that may arise as a result of differential markups across various cost centers can be removed by moving from charge-based to cost-based weights. Based on the analysis we have conducted, we agree that it is appropriate to adjust the DRG relative weights to account for the differences in charge markups across cost centers.

In the proposed rule, we indicated several concerns about the methodology used by MedPAC. MedPAC's methodology to reduce hospital charges to cost is administratively burdensome, not only to develop, but also to maintain. First, MedPAC developed CCRs for individual hospitals at the most detailed department level. Specifically, in calculating costs as the basis for the relative weights, MedPAC applied hospital-specific CCRs from each provider's cost report to the line item charges on the claims that the hospital submitted during the same time period. This methodology required matching cost report data to claims data, and because cost report data take longer to compile and file, the method necessitates using older claims data to set relative weights. The most recent complete set of Medicare cost reports available to us is from FY 2003. Thus, if we were to model the exact approach used by MedPAC and use claims data for a matching year, we would be using claims data from FY 2003 instead of using FY 2005 claims data, as we would if we were to continue with our current methodology. In addition, MedPAC's hospital-specific approach required detailed cost center distinctions for each hospital that are difficult to define, map, and apply. This approach also required the use of the Standard Analytic File (SAF) because MedPAR data that we currently use to set DRG weights did not have the necessary level of detail. Using the SAF increases processing time and adds further complexity to the process of setting the relative weights.

Second, because MedPAC applied these CCRs at the individual claim level, missing or invalid data resulted in MedPAC deleting a large number of claims (approximately 10 percent) from the relative weight calculation. Lastly, MedPAC acknowledged that its method was too difficult to replicate on an annual basis and suggested that the weights be recalculated once every 5 years with other adjustments based on charges during the intervening years.

As we explained in the FY 2007 IPPS proposed rule, we developed an alternative to MedPAC's approach that we believe achieves similar results in a more administratively feasible manner. This method involves developing hospital-specific charge relative weights at the cost center level and then scaling the weights to costs using the national cost center charge ratios developed from the cost report data. After studying Medicare cost report data, we established 10 cost center categories based upon broad hospital accounting definitions. In our cost center categories, there are 8 ancillary cost groups in addition to routine day costs and intensive care day costs, and each category represents at least 5 percent of the charges in the claims data. The specific cost report lines that contribute to each category and the corresponding charge lines from the MedPAR claims data are itemized in Table A below.

In the proposed rule, we stated that this alternative approach, which we labeled as the HSRV cost center (HSRVcc) methodology, has several advantages. First, the use of national average rather than hospital-specific CCRs avoids the complexity

encountered with cost center CCRs at the hospital level and allows us to retain more data for use in the relative weight calculation. In addition, the methodology eliminates the need to match claims to the time period of the CCRs, resulting in the ability to use more timely claims data. Furthermore, the alternative approach makes it more feasible to update the relative weights annually using a single methodology. We do not have to replicate the methodology once every 5 years and make adjustments based on changes in charges in the intervening years. The HSRVcc methodology is described in detail in the proposed rule (71 FR 24008 through 24011).

Comment:

Several commenters supported CMS' effort to restructure the DRG relative weights based on cost. They stated that using charges as a proxy for hospital costs in determining resource utilization under the current system is inappropriate and encouraged CMS to implement a cost-based system consistent with the agency's original intent without delay.

Response:

We appreciate the commenters' support of our proposal to implement a cost-based weighting methodology. We believe that adopting cost-based weights will result in significant improvements to Medicare's IPPS payments. MedPAC concluded after an extensive analysis of Medicare hospital inpatient claims and cost data that the IPPS payment rates are badly distorted, resulting in Medicare paying too much for some types of patients and too little for others. As indicated below, we are making some modifications to our proposals in response to the public comments. However, we are adopting a system of cost-based weights for FY 2007 to address the concerns raised by MedPAC. As a result, all hospitals, including specialty hospitals, will be paid more appropriately. In addition, based on our analysis, we concur with MedPAC that the current DRG system needs to be changed to better account for severity of illness among patients. This issue is discussed in more detail in the next section of this final rule.

Comment:

A majority of commenters supported CMS' efforts to improve the accuracy of the DRG weights, and better reflect variations in patients' severity of illness. However, many commenters viewed the HSRVcc proposal as flawed from both a methodological and policy perspective, and believed the proposal to implement cost-based weights should be delayed for at least a year. They believed that CMS needs to further consider a number of issues raised in the public comments before such sweeping changes are implemented. In addition, the commenters indicated that CMS needs to provide hospitals with more lead-time before implementing changes so they can budget accurately. They urged CMS to use the current standardized charge-based approach in FY 2007 until these issues can be addressed. At a minimum, they believed CMS should address what were characterized as methodological flaws and publish revised relative weights along with hospital impacts for public comment prior to implementation.

Response:

We appreciate the commenters' concerns with regard to a rapid and full implementation of the changes we proposed to the relative weight methodology. However, based on our analysis and study of the MedPAC recommendations that we presented in our proposed rule, it has come to our attention that differential markups between routine and ancillary cost centers have introduced significant bias into the relative weights. In order to reduce the bias in weights and make more appropriate payments under the IPPS, we believe it is necessary to initiate the transition to a cost-based relative weight methodology in FY 2007. However, we have considered the commenters' requests to further review the HSRV methodology. Therefore, in this final rule, we are not adopting our proposal to standardize charges using the HSRV methodology. However, we are adopting our proposal to reduce charges to estimated costs prior to setting DRG weights. We will undertake further analysis of the HSRV methodology during the next year. Based on this analysis, we will consider proposing further changes to adopt the HSRV methodology for FY 2008.

Comment:

Many commenters disagreed with CMS' assertion that the more administratively feasible HSRVcc approach achieves similar results to the MedPAC methodology. While they supported CMS' efforts to ensure the DRG weights are updated annually to reflect the most recent trends in inpatient care, they expressed concern with the specifics of the HSRVcc methodology.

First, they noted that CMS stated in the proposed rule that organ acquisition costs were eliminated from hospital charges before the HSRVcc weights were calculated. However, it had come to their attention that organ acquisition charges were actually included in the calculation of DRG weights under the proposed methodology. They stated that organ acquisition is reimbursed by Medicare on a cost basis and should not be included in the weight calculation. Furthermore, the commenters asserted that the inclusion of organ acquisition charges improperly overstated the transplant DRG HSRVcc weights. Commenters recommended that CMS remove the organ acquisition charges from the computation of the DRG weights if the HSRVcc methodology is to be adopted.

Second, commenters believe CMS made questionable methodological decisions when calculating the national CCRs. Under the proposed methodology, CMS calculated hospital-weighted rather than charge-weighted CCRs for each of the 10 cost centers used to scale the charge-based weights. Because the averages are unweighted, the commenters stated that the CCRs do not account for the differential contribution of each hospital to total charges. The commenters asserted that, mathematically, the only correct way to get from total hospital charges to total hospital costs is to use a charge-weighted average of hospital CCRs. Failure to use charge-weighted averages overestimates routine and ICU costs and underestimates ancillary costs, which ultimately exaggerates the shift in payments, according to the commenters. Therefore, commenters believed CMS should recalculate the mean national CCRs using a charge-weighted method.

Third, commenters believed CMS applied questionable trimming criteria in computing the cost center CCRs. They stated that trimming the cost center CCRs at 1.96 standard deviations (rather than 3 standard deviations) from the geometric mean inappropriately excluded over 200 large hospitals that account for 25 percent of routine accommodation charges. They noted that the CCRs for these hospitals appear to be predominantly correct. In addition, the commenters noted that CMS applied the CCRs to the charge data for hospitals that were excluded from the national average CCR calculation. Thus, the commenters argued there is a significant mismatch between the hospital data that was included in the CCR and HSRVcc calculations. These commenters recommended that CMS exclude hospital data from the CCRs if it is more than 3 standard deviations (rather than 1.96) from the mean CCR. Many commenters characterized these methodological decisions as errors and indicated that their combined impact is significant. If CMS is to use the HSRVcc methodology, the commenters indicated that these issues should be addressed.

A few commenters stated that we made incorrect assumptions that may have resulted in new distortions to the relative weights. Specifically, the commenters stated that we were incorrect in applying the same CCR

across all hospitals for a given cost center and applying the same percent mix of services by cost center to all DRGs. The commenters recommended that we first convert charges to costs for each hospital and DRG, and then compute hospital-specific relative values. They stated that the reversal of the calculations in the HSRVcc methodology accommodates cost center mix and charge markup differences across hospitals and across DRGs.

Many commenters argued that the hospital-specific relative value methodology is unnecessary and compresses the DRG weights. Commenters cited past research indicating that HSRV has a disproportionate impact on certain types of hospitals and types of care, and reduces the range of DRG weights between the lowest and highest weight DRGs.

Commenters noted that the HSRV methodology “produces more compressed DRG weights” than the existing standardization methodology and that “the greater compression of the HSRV weights is counter balanced by the fact that more high-weighted cases qualify as [high cost] outlier cases.” A few commenters expressed concern that adopting MedPAC's recommendation to exclude high-cost outliers in addition to statistical outliers from the computation of the DRG weights so that the weights reflect the average cost only of inlier cases would compound the DRG weight compression caused by the HSRV methodology because high-cost outlier cases occur most frequently in high-weighted DRGs. The commenters indicated that the finding raises the concern of patient access to care for services in higher cost DRGs.

Carter, Grace “How recalibration method, pricing, and coding affect DRG weights,” Health Care Financing Review, Winter 1992.

Commenters also believed that the HSRV methodology fails to take into account legitimate variation in costs that occur between hospitals. Therefore, any hospital-level variation in cost that is not explained by the IPPS case mix index is simply ignored, according to the commenters. To the extent that certain services are provided most frequently in hospitals with higher than average cost, the commenters believed that the HSRV methodology will result in inappropriately lower DRG weights for these services.

Therefore, commenters strongly recommended that the HSRV methodology be eliminated in favor of the cost-based weighting methodology adopted under the OPPS. They stated that the main difference between these two approaches is the treatment of cost variation that is not otherwise explained with IPPS payment factors. In the standardization approach employed by OPPS, any variation in hospital costs that is not explained by CMS payment factors affects the calibration of DRG weights. They stated that the HSRV approach proposed by CMS, by contrast, ignores any hospital level variation in charges that is not explained by the case mix index. Many commenters added that CMS could propose to remove other sources of cost variation beyond its current practice of standardizing for wage index, DSH, and IME. They believed a factor-specific approach to standardization would lead to more precise and valid adjustments than those recognized under the HSRV methodology, which eliminates all sources of charge variation irrespective of whether there are legitimate differences among hospitals in costs that are not taken into account in the payment system.

Response:

In preparing the FY 2007 relative weights, the costs of organ acquisition were inadvertently included in the relative weight for the calculation of “other services.” The costs of organ acquisition are paid by Medicare on a cost basis and should not be included in setting the IPPS relative weights. These costs have been excluded from the IPPS relative weights calculated for this final rule.

In response to the concerns expressed regarding the CCR calculation, we proposed to establish the geometric mean CCRs using a hospital-weighted methodology because we believed that it served as an acceptable measure of central tendency. In addition, we proposed to trim the CCRs on the basis of 1.96 standard deviations since we were using national averages and thought a more stringent statistical trim would be appropriate. In response to comments, however, we have reconsidered our approach and have implemented the 3 standard deviation statistical trim supported by commenters. Further, we are also adopting the charge-weighted method of calculating CCRs, as we now believe it may be more appropriate to apply CCRs based on aggregate costs and charges among hospitals to the charges that are aggregated by DRG and used to set the relative weights.

Although commenters asserted that the HSRV methodology exacerbates the effect of charge compression on the relative weights, we have not had sufficient time between the close of the comment period and the publication of this final rule to analyze this assertion. Therefore, in response to comments (and as stated above), we are postponing the implementation of the HSRV methodology until we can study this comment further. Instead, as suggested by many commenters, we are using an approach to calculating the IPPS relative weights that is more similar to the approach used in the OPPS. That is, rather than using a hospital-specific relative weighting methodology, we are standardizing charges to remove relevant payment factor adjustments and then adjusting those charges to costs using national cost center CCRs. As we stated in the proposed rule, it is not administratively feasible to adjust charges to cost using hospital-specific cost to charge ratios. Therefore, while we are standardizing charges for the IPPS cost-based weights using a similar process to the OPPS, we are still utilizing national average CCRs to determine cost. Specifically, we are standardizing the charges for each DRG by cost center to remove differences in wage index, indirect medical education and disproportionate share adjustments and are then reducing the standardized charges to cost using the national average CCRs. The relative weights we are adopting in this final rule are calculated based on the average total cost for a DRG in relation to the national average total cost.

Comment:

Many commenters expressed concern that CMS collapsed the full set of at least 37 cost centers into only 10. They believed this approach eliminates detail that is available on the cost report. The commenters requested that CMS elaborate on the process it went through to derive the 10 cost centers used to calculate the HSRVcc weights. Some commenters stated CMS should use all 37 cost centers that are used in calculating the OPPS relative weights for the IPPS. Other commenters suggested that CMS expand the number of cost centers used in the calculation. MedPAC found that the CCRs within the proposed 10 cost centers varied significantly in some areas and recommended that CMS expand the number to 13 by distinguishing anesthesia and labor and delivery from the operating room cost center and distinguishing inhalation therapy from the therapy services cost center. Several commenters supported MedPAC's recommendation. Further, MedPAC recommended that the CCRs be based on Medicare-specific costs and charges rather than on the costs and charges for the entire facility. Some commenters advocated that a separate cost center be added for implantable devices. They believed this additional cost center would better identify the mark-up for high cost technological devices than

using the average for all supplies and equipment.

Several commenters encouraged CMS to specifically incorporate nursing costs into the weighting methodology. They stated that nursing care represents approximately 30 percent of all hospital expenditures and nearly half of all direct care costs and have been essentially ignored in the payment formula. Specifically, these commenters urged CMS to create a unique Nursing Cost Center that identifies the inpatient direct and indirect costs for registered nurses, licensed practical nurses, and unlicensed assistive personnel. They defined direct nursing costs as those associated with licensed and assistive nursing personnel assigned to care for an individual patient. Indirect nursing costs are all other salary and benefits related to licensed and assistive nursing personnel not directly assigned to care for individual patients. They suggested that the routine and intensive care cost centers in the proposed HSRVcc methodology be replaced with a nursing cost center and a separate facility cost center to identify the non-nursing cost component of care. They urged CMS to set aside funds to study and implement the above recommendation using methodologically sound research and demonstration projects.

Response:

As we stated in the proposed rule, we established 10 cost center categories based upon broad hospital accounting definitions. These 10 cost center categories consist of 8 ancillary cost groups, a routine days cost group, and an intensive care days cost group. These cost centers were selected because each category represents at least 5 percent of the charges in the claims data.

We thoroughly reviewed the comments advocating that we expand the number of cost centers used in the calculation. We currently use the MedPAR data set for charge detail. The MedPAR file does not provide enough granularity in the charge detail to support 37 different cost centers. In addition, in the proposed methodology, we eliminated claims for providers that did not have costs greater than zero for at least 8 of the 10 cost centers. At least 96 percent of the providers in the MedPAR file had charges for at least 8 of the 10 cost centers. We believe that if we were to expand to the full set of 37 cost centers outlined in the cost report, we would eliminate a greater number of claims in the calculation of the DRG relative weights.

While we do not believe expanding to 37 cost centers is feasible, we agree with MedPAC that we may have consolidated a few revenue centers that have significantly different CCRs. Upon further examination of the data, in this final rule, we are expanding the number of cost centers from 10 to 13 by creating separate cost centers for anesthesia, labor and delivery, and inhalation therapy. We also agree with MedPAC that it would be more appropriate to set the CCRs based on Medicare-specific charges and costs rather than on the costs and charges for the entire facility. Therefore, in this final rule, we are modifying our CCR calculations to incorporate Medicare-specific charge data from Worksheet D Part 4 in addition to the cost and charge data from Worksheet C Part I that we used in the proposed rule.

Other commenters suggested that we also create separate cost centers for implantable devices and nursing. As noted in the comments, the MedPAR file does not contain the necessary detail to identify a separate cost center for implantable devices or nursing. In addition, we did not have enough time to evaluate whether it would be reasonable to utilize a nursing cost center in the methodology in the future. However, we anticipate undertaking further analysis of the relative weight methodology over the next year in conjunction with the research we are doing on charge compression to determine if additional cost centers are necessary.

Comment:

Commenters, referring to Table A, “Charge Line Items from MedPAR Included in Cost Center Charge Group,” noted that MedPAR charge descriptions do not match the Form CMS-2552-96 Cost Center description(s) for several cost centers. For example:

(a) MedPAR lists (18) Lithotripsy Charges where the cost reporting form lists Radioisotopes;

(b) MedPAR lists (6) Other Services where the cost reporting form lists Whole Blood and Packed Red Blood Cells;

(d) MedPAR lists (16) Blood Administration Charges where the cost reporting form lists ASC (Non-Distinct Part);

(e) MedPAR lists (24) Outpatient Services Charges where the cost reporting form lists Emergency;

(f) MedPAR lists (25) Emergency Room Charges where the cost reporting form lists Ambulance Services;

(g) MedPAR lists (26) Ambulance Charges where the cost reporting form lists Renal Dialysis;

(h) MedPAR lists (29) ESRD Revenue Setting Charges where the cost reporting form lists Clinic;

(i) MedPAR lists (30) Clinic Visit Charges where the cost reporting form lists Other Outpatient Services, Other Ancillary, Home Program Dialysis and Ambulance Services;

(j) Ambulance Services appear to be included twice, once in (30) Clinic Visit Charges and once in (25) Emergency Room Charges;

(k) Lithotripsy is included in Radiology Services;

(l) Line 62 “Observation Beds” is not reflected separately in Table A; and

(m) Line 68 “Other reimbursement” of the cost report is not listed in Table A.

In addition, commenters were unclear as to whether CMS accounted for subscripted lines in the cost report when calculating CCRs. The commenters noted that subscripted lines did not appear in Table A. Commenters believed this inconsistency in reporting may lead to distorted DRG weights. Therefore, commenters recommended that CMS examine this issue thoroughly before implementing cost-based weights. Several commenters requested that CMS publish a crosswalk of the revenue codes that are used for each MedPAR charge data group and require intermediaries to review cost report data to ensure that providers have reported data consistent with the mapping to the MedPAR data.

Response:

We wish to clarify to the commenters that the charge description titles shown in the MedPAR charge description column in Table A were not meant to also be interpreted as the title for each of the cost report line items. That is, we were simply using Table A to illustrate the MedPAR charge groups and the cost report line numbers that were used to create the 10 proposed cost centers. To alleviate this confusion, we are revising Table A to show both the MedPAR charge titles and the titles of the cost report line items. In response to comments (j) and (l), we note that the cost report line item number 65 for ambulance was inadvertently listed twice in the proposed rule; line item 62, observation beds, was used in establishing the CCR for the other services category. Line 65 for ambulance was only used once in the actual other services CCR calculation. Line item 62 should have appeared in the “other services” cost center grouping printed in Table A in the proposed rule. We have corrected this error in the final version of Table A. In addition, in regards to comment (k) above, we have moved the lithotripsy charges from MedPAR to the “other services” cost center grouping and we have also

revised the CCR for “other services” to include the cost report line item 43 for radioisotopes, which was formerly included in the radiology CCR.

In response to the commenters’ question regarding the inclusion of subscripted lines, when we calculated the CCRs for the proposed rule and subsequently for this final rule, we relied on a HCRIS data set that contains rolled-up cost report fields such that line items which are subscripted contain the total value for the line item and any subscripted lines below. Therefore, most subscripted lines were included in the proposed rule CCRs and continue to be included in the final rule CCR calculations. However, some subscripted line items are not rolled up and continue to have their own field on the HCRIS data set that we used to calculate the CCRs. Therefore, we are now including the cost report line item 6201 for observation beds, the cost report line item 6350 for Rural Health clinics and the cost report line item 6360 for Federally Qualified Health clinics in the other services CCR. Cost report line items 6350 and 6360 are only reported by provider-based Rural Health clinics and Federally Qualified Health clinics and are necessary in order to identify all incurred costs applicable to furnishing an observation bed prior to a decision to admit a patient to the hospital. Further, we are now including the cost report line item 68 for other reimbursement in the other services CCR, and we are including professional services charges from MedPAR in the other services charge grouping. In response to the commenters’ requests that we show the revenue codes that comprise the MedPAR charges, we have also inserted an additional column in Table A that lists the revenue codes MedPAR groups into each charge field that we are using in the final 13 cost centers. The final version of Table A appears below:

BILLING CODE 4120-01-P

ER18AU06.000

ER18AU06.001

ER18AU06.002

ER18AU06.003

ER18AU06.004

ER18AU06.005

Comment:

Many commenters warned that the redistribution of payments from the surgical to the medical DRGs under the proposed methodology may create unintended consequences. Several of these commenters stated that this redistribution poses a threat to patients' access to the latest medical advances and highest quality care. They feared that hospitals will invest less in new medical technologies because Medicare would not pay sufficiently for the DRGs that use them. Another commenter stated that the increased reimbursement for psychiatric DRGs may create an incentive for IPFs to decertify and become inpatient units.

Response:

We appreciate the commenters' concern that payment redistribution may create the potential for unintended consequences. However, we wish to emphasize that the redistribution of payments among DRGs is necessary to improve payment accuracy and eliminate the distortions in the current IPPS payment rates. Under the methodology in this final rule, we will increase payment for relatively underpaid cases and reduce payment for relatively overpaid cases.

We are adopting a methodology that will realign payments with costs to pay more appropriately for services rendered by hospitals. Therefore, we do not believe altering the DRG relative weighting methodology will affect patients' access to quality medical care. Patients should have continued and uninterrupted access to new, innovative technologies.

We have analyzed the impact of the increased reimbursement for psychiatric DRGs in response to the commenter's concern that increased reimbursement may provide incentives for IPFs to decertify their units and be paid under the IPPS. Because of the differences in payment between the IPPS and the IPF PPS, we do not believe that the DRG relative weights we are adopting in this final rule will provide increased incentive for IPFs to decertify units. Whereas under the IPF PPS, hospitals receive a daily base rate and adjustments to account for certain patient and facility characteristics, hospitals paid under the IPPS are paid a specified amount based on the DRG for the same cases, regardless of the length of the hospital stay. Our analysis suggests that even though the average payment per day (total payment divided by average length of stay) for the psychiatric DRGs in the IPPS proposed rule may be higher than under the IPF PPS, the total average payment per episode of care remains lower (product of the average IPF payment per day and the average length of stay). Thus, because payments per episode of care remain lower under the IPPS than under the IPF PPS, we are not concerned that IPFs will decertify to get paid using the IPPS. In addition, as indicated above, we are making some modifications to our methodology in response to the public comments. Based on these changes, the increase in the relative weights for the psychiatric DRGs presented in this final rule will not be as significant as those contained in the proposed rule.

Comment:

Commenters expressed concern that because hospitals often allocate charges on the cost reports differently than charges on the claims, the cost-center level CCRs are calculated based on a different set of charges than the charges on the claims to which the CCRs are later applied. Commenters expressed concern that Medicare cost report data are not detailed enough or consistently reported accurately to determine costs accurately at a DRG level since such data lack specific cost data on individual items and services. They reiterated that the Medicare cost reports, which serve as the primary source of data under the proposed system, were not designed to be used in a prospective payment system and have not been used to establish hospital rates for inpatient services for some time. They noted several limitations in using the cost reports to derive estimated costs utilized in the DRG relative weight calculations that should be carefully examined and addressed before moving forward with the proposed system of hospital-specific cost weights.

First, the commenters believed that CMS should address cost report accuracy. The commenters stated that because the cost reports have only been used for payment in limited circumstances (DSH, IME, outlier policy), hospitals have had little incentive to report accurately and completely for the services provided to Medicare beneficiaries. In addition, they claimed the cost reports do not contain the level of detail necessary to accurately determine costs at the DRG level. Instead, the cost report provides payments, costs, and some reimbursement totals by department or cost center. The commenters also advised that CMS perform additional auditing of the cost reports to ensure accuracy. The commenters were concerned that if CMS implements a cost-based weighting methodology, the DRG weights will be based on largely un-audited cost reports since approximately 15 percent of hospital cost reports are audited each year. They noted that MedPAC estimated that a full-scale audit could require 1,000 to 2,000 hours from a fiscal intermediary,

as well as additional time and resources from the hospital. In addition, a few commenters stated that CMS should only use final settled cost report data, not as-submitted data, in calculating DRG weights.

Second, some commenters contended that CMS should evaluate the overall timeliness of cost report data. They stated that cost report data used to recalibrate the DRG weights are outdated and significantly older than the charge-based data currently used to determine DRG weights under the IPPS. Under the proposed methodology, CMS used hospital claims data from FY 2005 and hospital cost reports from FY 2003. The commenters were concerned that because a lag between the cost report year and the payment year exists, the proposed methodology would rely on older data that does not reflect the costs of many newer technologies. The commenters supported an approach that uses more recent claims and cost report data and also urge CMS to explore options for using alternative data sources that include current information on the costs of inpatient care.

Third, the commenters stated that CMS should examine the comparability of cost reports due to variability in how hospitals allocate costs. Commenters explained that a cost allocation methodology must be used to estimate the cost of individual items and services from the aggregate costs reported for each cost-center on the cost-report. They stated that the proposed methodology assumes that all hospitals consistently allocate costs to the same cost centers. However, hospitals may have inconsistent cost accounting practices or use different cost allocation methods (for example, utilization or square-footage) according to the commenters. The commenters suggested these factors and the compression of charges both within and across cost-centers, limits the usefulness of cost report data to accurately estimate costs. According to the commenters, each hospital uses its own method to allocate costs among cost centers, often resulting in cost assignments that do not reflect the departments to which charges are assigned in the MedPAR data. For example, some commenters indicated that they included cardiac catheterization in lines other than 53 and 54 that group to the cardiac cost center. In addition, several commenters noted that hospitals report medical supply costs inconsistently. While some report them in the supply cost center, others report the medical supply cost in the cost center for the procedure in which the device was used (that is, medical supplies specific to the Emergency Room are included in line 61 of the cost report). The commenters suggested that more specific cost report instructions may be necessary to ensure that hospitals report the information correctly and consistently. Some commenters believed that cost report data were not intended or designed to be used to develop accurate payment rates and suggested developing a proxy to more accurately allocate costs at the DRG level, such as collecting data from hospitals that utilize “sophisticated cost accounting tools that provide more accurate allocation of costs.”

Some commenters also recommended that CMS convene an expert panel to explore ways to address the current limitations of the cost report. They stated that this effort should identify methods to better use or improve hospital cost reports for use in setting the inpatient and outpatient relative weights. The expert panel should aim to identify changes to the cost report that reduce the net information burden on hospitals, while improving overall payment accuracy. The panel should report its recommendations by April 2007 to enable CMS enough time to consider the recommendations in setting the relative weights for FY 2008. Other commenters advocated that CMS initiate a national project to correct any misalignments between cost and charges in cost reports and on the MedPAR claims. Other commenters suggested that CMS postpone the adoption of the proposed HSRVcc methodology until such time that providers improve the accuracy of the source data used in the determination of the DRG weights.

Response:

With respect to the commenters' recommendation regarding the reporting of costs and charges for services, CMS requires hospitals to report their costs and charges through the cost report with sufficient specificity to support CMS' use of cost report data for monitoring and payment. Within generally accepted principles of cost accounting, CMS allows providers flexibility to accommodate the unique attributes of each institution's accounting systems. For example, providers must match the generally intended meaning of the line-item cost centers, both standard and non-standard, to the unique configuration of department and service categories used by each hospital's accounting system. Also, while the cost report provides a recommended basis of allocation for the general service cost centers, a provider is permitted, within specified guidelines, to use an alternative basis for a general service cost if it can support to its intermediary that the alternative is more accurate than the recommended basis. This approach creates internal consistency between a hospital's accounting system and the cost report but cannot guarantee the precise comparability of costs and charges for individual cost centers across institutions.

However, we believe that achieving greater uniformity by, for example, specifying the exact components of individual cost centers, would be very burdensome for hospitals and auditors. Hospitals would need to tailor their internal accounting systems to reflect a national definition of a cost center. It is not clear that the marginal improvement in precision created here is worth the additional administrative burden. The current hospital practice of matching costs to the generally intended meaning of a cost center ensures that most services in the cost center will be comparable across providers, even if the precise composition of a cost center among hospitals differs. Further, every hospital provides a different mix of services. Even if CMS specified the components of each cost center, costs and charges on the cost report would continue to reflect each hospital's mix of services. At the same time, internal consistency is very important to the IPPS. Costs are estimated on claims by matching CCRs for a given hospital to their own claims data through a cost center-to-revenue code crosswalk.

Despite the concerns raised in the comments, we believe that costs and charges are reported through the cost report with sufficient specificity to support CMS' use of cost report data to develop cost-based weights. The information we obtained from the cost report on the differing level of charge markups occurring between routine and ancillary hospital departments supports MedPAC's conclusions that the most profitable DRGs that are leading to the development of specialty hospitals are those that require a lot of ancillary services with high markups and low CCRs. To the extent that charge markups vary significantly between the various routine and ancillary hospital departments, we believe that there is a need to adjust charges to cost prior to setting the relative weights. We will continue to rely on the cost report to establish the CCRs that we are finalizing to use to adjust the DRG charges to costs.

However, we continue to be interested in receiving suggestions on ways that hospitals can uniformly and consistently report charges and costs related to all cost centers that also acknowledge the ubiquitous tradeoff between greater precision in developing CCRs and administrative burden

coupled with reduced flexibility in hospital accounting practices. Another issue to consider is the potential changes to the relative weights from undertaking efforts of this magnitude that will be costly for both CMS, its fiscal intermediaries and costly and burdensome to hospitals. Although we are not modifying the cost report or our cost report instructions at this time, we would be open to making improvements in the future.

Comment:

Several commenters applauded CMS' efforts to find “an administratively feasible approach to improving the accuracy of the DRG weights.” However, they expressed serious concerns about whether the proposed approach achieves that goal. Many commenters asserted that CMS proposes to move to a new cost-based methodology without offering any evidence that the proposed method actually improves payment accuracy.

A few commenters submitted analyses that suggest that the impact of the proposed HSRVcc methodology is substantially different than the MedPAC recommendations, and may even decrease payment accuracy relative to the charge-based weights. A few commenters specifically noted that cardiac procedures are more adversely impacted by the HSRVcc methodology. The proposed methodology reduces relative weights for the three major implantable cardioverter defibrillator (ICD) DRGs (515, 535, and 536) by 25 percent or more. While these proposed reductions imply that the weights based on the existing charge-based methodology overstate the costs of ICD procedures and therefore overpay them, the commenters presented analyses suggesting that these cases are actually underpaid. One such analysis by MedPAC, in its report on physician-owned specialty hospitals, found ICD procedures to have “lower marginal” profitability or “possibly a loss” for hospitals, based on calculation of payment-to-cost ratios and surveys of specialty hospitals. They also indicated that CMS, in approving cardiac resynchronization therapy defibrillators (CRT-D) for new technology add-on payments, found the device to be inadequately paid and granted the add-on payments to defray the costs of the therapy. Given that payment rates under the charge-based weights appear to be inadequate in many of the cardiovascular DRGs, the commenters believed the severe reductions resulting from the proposed HSRVcc methodology appear to be unjustified and provide ample reason to believe that the proposed methodology does not accomplish the goal of improving payment accuracy.

These commenters emphasized that while measuring improved payment accuracy is difficult, the large degree to which the weights fluctuate given the methodological changes alone indicates the need for further analysis and study. The commenters believed CMS should publish reliable indicators that demonstrate how the goal of payment accuracy is achieved. One commenter requested that CMS produce and publish estimates of payment-to-cost ratios and the relative profitability by DRG to determine the effectiveness of different weight-setting and patient classification methodologies in improving overall payment accuracy. The commenter emphasized that such estimates must be adjusted to account for the cost of providing services that include high-technology devices that are understated in the cost reports. Another commenter recommended that CMS construct a process to test the sensitivity of weights to various methodological assumptions and publicly share the results, including: a comparison of the CMS weights to MedPAC's HSRV cost approach; a comparison of CMS weights to an approach using standardized costs (as opposed to HSRV); comparison of CMS weights to weights calculated by estimating costs at the claim level using the 10 cost center approach; evaluation of other alternative methodologies for estimating costs; and an evaluation of the stability of weights over time.

Response:

We appreciate the commenters concerns regarding the HSRVcc relative weight setting methodology we proposed and the large change in the relative weights that result from the application of this methodology. As we stated in the FY 2006 IPPS final rule, given the potential for significant redistribution in payments, the MedPAC recommendations should be studied extensively before any broad fundamental changes are made to the current system. In the proposed rule, we provided the results of such an extensive analysis and concluded that changes can be made to the relative weight methodology and the DRG system to improve payment accuracy. Although we agree that adopting a methodology that results in large changes in payment should not be adopted without careful study, we do not believe that the mere presence of such significant impacts invalidates the methodology. On the contrary, we believe large payment impacts may suggest there is a significant degree of distortion present in the current payment system. In our view, we believe that the changes to the IPPS should be evaluated based on whether they represent an improvement to the current system. MedPAC has studied the IPPS extensively and found that improvement can be found in payment accuracy from adopting its recommendations that are similar to those we proposed.

Medicare Payment Advisory Commission: Report to Congress on Physician-Owned Specialty Hospitals, March 2005, p. 37-38.

While we acknowledge the need for further study and evaluation of the HSRVcc methodology, we continue to believe that the differential markups among departmental CCRs have introduced distortion into the charge-based relative weights. We note that MedPAC found that “the current payment system encourages community hospitals to allocate capital to profitable services such as cardiology and stimulates the formation of specialty hospitals that often focus on providing profitable services and tend to care for low-severity patients.”

The information we obtained from the cost reports on the differing level of charge markups occurring between routine and ancillary hospital departments supports MedPAC's conclusions that the most profitable DRGs that are leading to the development of cardiac specialty hospitals are those that require a lot of ancillary services with high markups and low CCRs. We note that the proposed rule showed that these hospitals are almost exclusively affected by changes to the relative weight methodology providing further evidence of bias and distortion in the relative weights by setting them using hospital charges. To the extent that charge markups vary significantly between the various routine and ancillary hospital departments, we believe that there is a need to adjust charges to cost prior to setting the relative weights. Although it suggested refinements to CMS' proposal (all of which we have adopted in this final rule), we note that MedPAC found that the CMS proposals made great strides toward achieving the goal of improvements in payment accuracy.

Therefore, as discussed in section II. C., we are using the national average CCRs to adjust the cost center charges for each DRG to cost prior to setting the relative weights. While we acknowledge that no payment methodology can be perfect because DRG-specific costs cannot be determined, we believe the cost-based methodology we are finalizing in this rule represents a significant

improvement over the current charge-based methodology for all of the reasons we specified above. Under the cost-based methodology in this final rule, we will increase payment for relatively underpaid cases and reduce payment for relatively overpaid cases. We believe this reform is badly needed to reduce the bias in the weights and make more appropriate payments for both medical and surgical DRGs.

Hackbarth, Glenn, MedPAC Comments on the IPS Rule, June 12, 2006, page 2.

Hackbarth, Glenn, MedPAC Comments on the IPPS Rule, June 12, 2006, page 2.

In order to mitigate the impact of the changes in the relative weights, we are implementing the new cost-based weight methodology in a 3-year transition, where the weights in the first year will be set based on 33 percent of the cost-based weight and 67 percent of the charge based weight. We will continue to study the HSRVcc methodology, the potential effects of charge compression and ways in which we can better account for severity of illness within the DRG system in the coming year.

With respect to the changes in the new patient classification system, the proposed rule noted that we modeled the CS DRGs and observed a 12-percent increase in the explanatory power (or R-quare statistic) of the DRG system to explain hospital charges. That is, we found more uniformity among hospital total charges within the CS DRGs than we did with Medicare's current DRG system (71 FR 24027). Thus, we believe that there is clear evidence that improvements can be made to the current DRG system that will reduce heterogeneity among patients within a given DRG. While this statistic indicates that the current CMS DRG system can be refined to improve payment accuracy, we agree that it does not necessarily mean we should adopt the system we proposed. For a variety of reasons explained further below, we believe that a number of factors must be considered in deciding how to revise the DRG system to better recognize severity of illness.

Comment:

One commenter asserted that CMS published incorrect and deficient information about the HSRVcc methodology, its impact on hospitals, and the underlying data utilized in developing the proposed rule. Specifically, the commenter believed the HSRVcc methodology was flawed and therefore stated that the published impacts were inaccurate. The commenter believed that we failed to comply with the Federal Data Quality Act, and OMB, HHS, and CMS Guidelines which address the quality of the data used for policy development, in particular, meeting standards of utility, objectivity, integrity, and transparency and reproducibility. Because the commenter believed that we have violated these data quality standards, the public was deprived of the opportunity to submit meaningful comments, as required by the Administrative Procedure Act (APA). The commenter urged CMS to take the appropriate steps that would result in the withdrawal of the FY 2007 IPPS proposed rule and the publication of a new proposed rule.

Response:

We disagree with the commenter's claims that the data utilized in the development of the FY 2007 IPPS proposed rule were materially flawed, did not comply with the Federal Data Quality Act, and did not meet established OMB, Department and CMS guidelines for data quality. The data sources used in estimating the payment impacts from policy changes proposed in the FY 2007 IPPS proposed rule were the HCRIS files that contain Medicare cost report data, the MedPAR files that contain Medicare claims data, the OSCAR database, and the PSF (which is maintained by the fiscal intermediaries and used in paying Medicare claims). These are the best and most reliable data sources available to CMS for modeling the impacts of policy changes. We note that these same databases are used in modeling payment impacts under the LTCH PPS, the OPPS, the IRF PPS, and the IPF PPS, as well as other payment systems. We also note that the comment period to the FY 2007 IPPS proposed rule provided commenters with an opportunity to bring to our attention specific examples of incorrect or inaccurate data. In addition to our posting the impact files from the FY 2007 IPPS proposed rule on the CMS Web site, as always, commenters had access to the same CMS data files that we utilized through communication with our Office of Information Services (OIS).

The fact that the data we used in the development of the FY 2007 IPPS proposed rule were available and transparent to the public was attested by the detailed data analyses included with a significant number of the public comments we received on the FY 2007 IPPS proposed rule. Therefore, for the reasons stated above, we disagree with the commenter's assertion that the data used by CMS in the FY 2007 IPPS proposed rule does not meet the transparency and reproducibility standards. As is the case with any change in policy, we do not base policy decisions on mere assumptions, but rather we analyze the relevant data and any comments submitted in response to a proposed rule.

Comment:

One commenter stated that it was unclear whether the weights published for CS DRGs included using the transfer-adjusted charges prior to calculating weights.

Response:

We used the hospital's charge on the claim in the HSRVcc methodology. We presume the commenter is asking whether we adjusted the number of cases in setting the relative weights to reflect early transfer to either a post-acute or other acute care setting. We did use transfer-adjusted case counts when we applied the HSRVcc methodology for the relative weights that were shown in Table 5 of the IPPS proposed rule (71 FR 24272) and the “Consolidated severity adjusted DRG HSRVcc relative weights” provided on the CMS Web site at:

http://www.cms.hhs.gov/AcuteInpatientPPS/FFD/list.asp#TopOfPage

. The case mix index that we use to iterate the proposed FY 2007 HSRVcc weights did not reflect a transfer-adjusted case count. That is, we used the sum of all the case weights divided by the total number of cases unadjusted for transfers to post-acute or other acute care settings.

Comment:

Many commenters stated that once a cost-based system is implemented, CMS should provide at least a three-year transition. They stated that a three-year transition is consistent with MedPAC's recommendation to implement the changes to the weights and DRG system over a transitional period. Commenters recommended that payments be made based on a blend of charge and cost-based weights culminating with full cost-based weights at the completion of the transition period.

Response:

We have in the past provided for transition periods when adopting changes that have significant payment implications. Given the significant payment impacts upon some hospitals because of these changes to the DRG weighting methodology, we considered options to transition to cost-based weights. We believe the potential payment effects from the changes to the DRG relative weights can be mitigated by adopting a 3-year transition of the relative weights. During the first year of the transition, the relative weights will be based on a blend of 33 percent of the cost-based weights and 67 percent of the charge weights. In the second year of the transition, the relative weights will be based on a blend of 33 percent of the charge weights and 67 percent of the cost-based weights. In the third year of the transition, the relative weights will be based on 100 percent of the cost-based weights.

Comment:

One commenter asserted that the proposed changes to improve

payment accuracy and to provide payment equity between specialty and general hospitals do not address many of the differences between specialty and full-service hospitals. The commenter stated that hospitals should be reimbursed for the additional services that are required to operate a full-service hospital which are often unnecessary in a specialty hospital setting. The commenter acknowledged that CMS already provides some support to hospitals that serve a high percentage of Medicaid patients through disproportionate share payments. However, the commenter suggested that CMS also make add-on payments to the base DRG payment for expenses such as: operation of a full-service, 24-hour emergency department; operation of a trauma service, a burn unit, or other high cost medically necessary services; sponsoring ground and helicopter ambulance services; operation of 24-hour diagnostic services; provision of round the clock nursing services; and provision of other support services such as clinical pharmacists, nutritionists, case managers, and medical social workers. The commenter believed these add-on payments will encourage hospitals to maintain these services rather than promote specialty hospitals that may be able to operate at a lesser cost without some or all of these services.

Response:

Medicare does pay for all of these services through either the IPPS or OPPS payment. We disagree that add-on payments are necessary for services that are commonly provided at many hospitals. The costs of these services will be incorporated in the IPPS or OPPS relative weights. Rather, we continue to believe that Medicare's IPPS payment system needs to be changed to make more equitable payment across all hospitals and decrease the incentive to profit from patient and DRG selection.

Comment:

A few commenters stated that although the DRG payment changes proposed by CMS seek to address the proliferation of physician-owned, limited service hospitals in response to recommendations by MedPAC, they do not believe that these payment changes alone will remove the inappropriate incentives created by physician self-referral to limited-service hospitals. They stated that physicians will still have the ability and incentive to refer financially attractive patients to facilities they own, avoid serving low-income patients, and encourage utilization of profitable services. The commenters urged CMS to examine the investment structures of physician-owned, limited service hospitals and to continue the moratorium on issuing new provider numbers to physician-owned, limited service hospitals until the agency's strategic plan has been developed and the Congress has had the opportunity to consider the agency's final report on the topic.

Response:

We are in the process of completing the Final Report to Congress and the Strategic and Implementing Plan on Specialty Hospitals, as required by section 5006 of the DRA. Section 5006 of the DRA requires us to consider, among other things, issues of bona fide investment and proportionality of investment with respect to physician investment in specialty (that is, cardiac, orthopedic or surgical) hospitals. Section 5006 of the DRA also provides that the suspension on enrollment of new specialty hospitals that we administratively instituted on June 9, 2005, shall expire upon the date we issue the final report, or, if the report is issued after August 8, 2006, it shall expire on October 8, 2006. We note that Congress has provided for a date certain for the end of the suspension on enrollment of new specialty hospitals. Furthermore, we have not identified a need at this time to continue the suspension beyond that date.

Comment:

Many commenters stated that CMS's proposed HSRVcc methodology presented in the FY 2007 IPPS proposed rule failed to address issues of “charge compression.” The commenters explained that “charge compression” describes the common billing practice of hospitals applying higher percentage markups on lower cost items and lower percentage markups on higher cost items. The commenters noted that MedPAC explained that hospitals may reduce the mark-ups for higher-cost items to avoid “sticker shock.”

As discussed below, many commenters believed that, to the extent “charge compression” exists, the proposed HSRVcc methodology would lead to systematic differences between estimates of costs and Medicare's payments. Therefore, the commenters believed that the proposal failed to accomplish CMS's stated goal of setting the DRG weights based on accurate cost determinations. If the proposed methodology is implemented, several commenters believed hospitals that perform a large volume of procedures requiring relatively costly supplies/procedures would be severely and unfairly penalized through inappropriately reduced Medicare DRG payments. The treatments they provide would be less likely to be provided, and consequently, Medicare beneficiaries’ access to care may be diminished. Therefore, the commenters stated that if CMS adopts a cost-based DRG weighting methodology, a more accurate measure of determining hospitals’ actual costs must be developed.

Medicare Payment Advisory Commission, “Meeting Brief: Study of Hospital Charge-Setting Practices, ” September 9-10, 2004.

Many commenters believed that “charge compression” is a concern because the proposed HSRVcc methodology uses a single CCR for a variety of items and services in a department. Specifically, under the proposed HSRVcc methodology, we proposed to aggregate hospital-level departmental charges into 10 cost centers for each DRG, and then apply national average cost-center level CCRs to determine estimated costs. The commenters asserted that because most hospitals do not apply the same uniform percentage mark-up when setting the charges of each item in the department, the proposed HSRVcc methodology underestimates the cost of relatively more expensive items (particularly devices and implants) and overestimates the cost of relatively less expensive items. The commenters believed that the use of a single CCR for a variety of different items results in a systematic distortion of the estimated costs, and consequently the DRG relative weights that are used in determining the IPPS payment rates. Specifically, many commenters stated that the HSRVcc methodology has a disproportionate adverse impact on DRGs that include implantable technologies and devices, and in some cases would result in Medicare reimbursement that is less than the actual cost of the device.

Some commenters discussed cost data research that has been performed since the implementation of the OPPS to determine the causes and effects of “charge compression.” The commenters asserted that OPPS payment rates are also affected by charge compression. Specifically, one commenter recently commissioned research to investigate whether Medicare claims data provided statistical evidence of “charge compression.” (This research was summarized in an executive summary by Christopher Hogan of Direct Research, LLC. entitled “A Proposed Solution for Charge Compression.”) Many other commenters cited this recent research in their own comments, and recommended that the results of this research be used to develop an adjustment under the proposed HSRVcc methodology to account for “charge compression.” This analysis utilized the detailed coding of charges for supplies by revenue center on the Medicare claims data in the Standard Analytical Files (SAF) to divide the single cost-

center CCR for “supplies and equipment” used under the proposed HSRVcc methodology into separate cost-center CCRs for 5 supplies subcategories (general supplies; implantables; sterile supplies; pacemakers and defibrillators; and all other supplies) based on a “strong statistical association between mix of charges for supplies (by revenue center) in a hospital and the [overall] supplies CCR in a hospital.” Using these data from all hospitals, a regression analysis yielded a single “set of CCR adjustments reflecting national average CCRs for [each of] the [five supplies] sub-categories.” This national-average set of adjustments is applied to each hospital (and combined with each hospital's actual supplies CCR) to determine an adjusted estimate of cost on each hospital's claim in the MedPAR file. The results of this research showed that this variation in CCRs across the supplies subcategories would result in weights for some DRGs being significantly different than under the HSRVcc methodology. In particular, the methodology advocated by Hogan would increase the relative weights “for DRGs with substantial charges in the implantable devices and pacemaker/defibrillator revenue centers.”

The commenters pointed out that the results of this research are consistent with previous analyses demonstrating “charge compression” in hospitals’ billing patterns. The commenters also noted that this research was conducted exclusively on Medicare claims data, without supplementation with any external data. The commenters believed that this research demonstrates that an adjustment for “charge compression” is possible. They further asserted that the research provides a solid analytical basis for a specific adjustment. The commenters advocated that we use the coefficients from this regression analysis to develop a “data-driven” adjustment to the CCRs for the supplies and equipment to address the distortion caused by “charge compression.”

Another commenter supported the idea of a “charge compression” adjustment but suggested that CMS should ensure appropriate stakeholder involvement before applying such a policy. Other commenters also advocated for the use of data from the SAF to analyze the relationship between costs and charges for non-implantable supplies and equipment to determine whether an adjustment to the medical-surgical supplies cost center on the MedPAR files to account for “charge compression” is also warranted.

As a result of the concerns discussed above, many commenters stated that any change toward a cost-based DRG weighting methodology under the IPPS must address the distortion caused by “charge compression” and must ensure that the methodology utilizes accurate cost determinations. Consequently, some commenters requested a delay in the implementation of the cost-based DRG weighting methodology until an adjustment for “charge compression” can be incorporated. In addition, some commenters stated that such an adjustment should also be used to address “charge compression” under the OPPS. Several commenters recommended that, in addition to including an adjustment for “charge compression,” the methodology for determining the cost-based DRG relative weights be developed without employing the HSRV methodology. However, a few other commenters endorsed the proposed HSRVcc methodology, stating that the “HSRVcc methodology more closely represents the cost of providing services than the current charge-based system.”

Several commenters referenced various research studies on this issue undertaken over the past 5 to 6 years. These commenters asserted that the research supports the existence of “charge compression” and its systemic distortion in payment rates. The commenters also stated that “although evidence of the effect of charge compression is not new,” research that could support an adjustment to offset charge compression was not available. However, according to the commenters, “research just completed now presents a solution.”

Response:

We appreciate the commenters’ concerns regarding charge compression and its impact on the relative weight calculations under the proposed HSRVcc methodology. We are interested in further studying the analytic technique suggested in the comments of using a regression analysis to identify adjustments that could be made to the CCRs to account for charge compression. We note that the Hogan study's regression model was only applied to expensive medical supplies and devices and was not applied uniformly to develop potential adjustments that could be made to costs and charges across all revenue and cost centers that could potentially be subject to charge compression. If such a model were to be applied, we believe further analysis would have to be undertaken to determine whether it should apply to all costs and revenue centers. At this time, we intend to research whether a rigorous model should allow an adjustment for “charge compression” to the extent it exists. Accordingly, we have engaged a contractor to undertake a study on charge compression and review the statistical models provided to us by the commenters. To the extent that we find “charge compression” exists, we will further study potential models that could adjust for it so we can develop more accurate systems of cost-based weights to better reflect the relative costs of the different types of services provided under the IPPS. As suggested in the comments, we plan to fully involve appropriate stakeholders in future analysis of this issue to the extent feasible. Before implementing such an adjustment, we would fully describe our analysis and a potential proposed adjustment as part of the IPPS proposed rule for FY 2008.

Further, we intend to use the charge compression study that we will conduct over the next year as an opportunity to better understand the costs of medical devices. The United States faces a dilemna in health care. Although the rate-of-increase in health care spending slowed last year, costs are still growing at an unsustainable rate. One reason health care costs are rising so quickly is that most consumers of health care are frequently not aware of the actual cost of their care due to lack of transparency. We believe that cost, quality, and patient satisfaction information should be available across the spectrum of care.

Transparency of device pricing is a key aspect of consumer understanding of the cost of health care. We believe that the enhanced understanding of device pricing that will be brought about as part of our charge compression study will help accelerate the public release, in a consumer friendly fashion, of pricing information of medical devices. The public release of device pricing will help augment our overall efforts to empower consumers with better information on the health care they require.

In addition, we note that in order to mitigate the impact of adopting a revised methodology for calculating DRG weights, we are standardizing charges for MedPAR claims using the same methodology we have used in past years, rather than using the HSRV methodology. However, as discussed in detail in section II.E. of this preamble to the final rule, we are adopting our proposal to adjust charges to account for costs prior to establishing DRG weights. However, we anticipate undertaking further analysis of the hospital-specific methodology over the next year in conjunction with the research we are doing on charge compression. If our analysis suggests that an adjustment for charge compression should be applied and/or that the hospital-specific methodology will result in relative

weights that more closely approximate the relative costs of care, we will propose further changes for FY 2008. In the interim, we are further mitigating the potential payment effects from the changes to the DRG relative weights by adopting a 3-year transition of the relative weights. During the first year of the transition, the relative weights will be based on a blend of 33 percent of the cost-based weights and 67 percent of the charge weights. In the second year of the transition, the relative weights will be based on a blend of 33 percent of the charge weights and 67 percent of the cost-based weights. In the third year of the transition, the relative weights will be based on 100 percent of the cost-based weights.

3. Refinement of DRGs Based on Severity of Illness

For purposes of the following discussions, the term “CMS DRGs” means the DRG system we currently use under the IPPS; the term “APR DRGs” means the severity DRG system designed by 3M Health Information Systems that currently is used by the State of Maryland; and the term “consolidated severity-adjusted DRGs (CS DRGs)” means the DRG system based on a consolidated version of the APR DRGs (as described in detail below). We discussed the CS DRGs in the FY 2007 IPPS proposed rule and solicited public comments on whether there are alternative DRG systems that could result in better recognition of severity than the CS DRGs we were proposing. As we made clear in the proposed rule, there are still further changes that are important to make to the CS DRG system before it is ready for adoption. In the remainder of this final rule, “CS DRGs” refers to the DRG system we analyzed and proposed for adoption in FY 2008. However, as we indicate below, we received a number of public comments about the proposed CS DRGs, potential alternatives, and a number of other issues related to our proposal. Below we summarize those comments, respond to the comments, and present our plans for adopting a severity-adjusted DRG system for FY 2008.

In the FY 2006 IPPS final rule (70 FR 47474), we stated that we would consider making changes to the CMS DRGs to better reflect severity of illness among patients. We indicated that we would conduct a comprehensive review of the CC list as well as consider the possibility of using the APR DRGs for FY 2007. We did not adopt APR DRGs for FY 2006 because such an adoption would represent a significant undertaking that could have a substantial effect on all hospitals. There was insufficient time between the release of the MedPAC report in March 2005 and the publication of the FY 2006 IPPS final rule for us to analyze fully a change of this magnitude. Instead, we adopted a more limited policy by implementing severity-adjusted cardiac DRGs.

After publication of the FY 2006 IPPS final rule, CMS contracted with 3M Health Information Systems to further analyze the MedPAC recommendations in support of our consideration of possible changes to the IPPS for FY 2007. Under one task of this contract, 3M Health Information Systems analyzed the feasibility of using a revised DRG system under the IPPS that is modeled on the APR DRGs Version 23 to better recognize severity of illness. The APR DRGs have been used successfully as the basis of Belgium's hospital prospective global budgeting system since 2002. The State of Maryland began using APR DRGs as the basis of its all-payer hospital payment system in July 2005. More than a third of the hospitals in the United States are already using APR DRG software to analyze comparative hospital performance. Many major health information system vendors have integrated this system into their products. Several State agencies utilize the APR DRGs for the public dissemination of comparative hospital performance reports. APR DRGs have been widely applied in policy and health services research. In addition to being used in research by MedPAC, the APR DRGs also contain a separate measure of risk of mortality that is used in the Quality Indicators of the Agency for Healthcare Research and Quality, the Premier Hospital Quality Incentive Demonstration discussed in section IV.B. of this preamble, and the Joint Commission on Accreditation of Healthcare Organizations (JCAHO) hospital accreditation survey process (Shared Visions-New Pathways).

Below we present a comparison of the CMS DRG system and the APR DRG system.

a. Comparison of the CMS DRG System and the APR DRG System

The CMS DRG and APR DRG systems have

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