The Centers for Medicare and Medicaid Services (CMS) recently released a proposed rule addressing the treatment of third-party payments when calculating uncompensated care costs for the Medicaid disproportionate share hospital (DSH) formula (Proposed Rule). While CMS maintains the Proposed Rule merely clarifies longstanding policy, industry stakeholders submitting comments prior to the September 14 deadline disagree, saying it would substantively modify the Medicaid DSH formula methodology. The new CMS policy is also the subject of litigation in two federal district courts – New Hampshire and the District of Columbia.

The issue raised by the plaintiffs in both cases involves the 2010 publication of answers to two Frequently Asked Questions (FAQs), #33 and #34. FAQ #33 involves commercial third-party payments. It defines Medicaid-eligible patients with private commercial insurance coverage as “dual eligible,” and requires the inclusion of private third-party payments in the calculation of the hospital-specific limit, when there is no Medicaid claim or payment made on behalf of a Medicaid-eligible patient. FAQ #34 addresses dual-eligible patients and the inclusion of Medicare payments in this same manner. During the DSH audits and the finalization of these audits, CMS has required that any amounts paid during the 2011 cost reporting year be recouped in the 2014 audit. The agency has also threatened to deny federal financial participation to states that fail to enforce the FAQs.

The policy change was first identified by children’s hospitals in Texas and Washington when the entirety of their DSH payments was eliminated, or when they were completely shut out of their state’s DSH program. Medicaid covers children who are significantly premature or whose length of stay is extensive or illness is particularly severe, regardless of insurance status. When private coverage is present, the impacted hospitals do not bill or collect for their care, even though they are technically categorized as Medicaid-eligible. The DSH formula approach identified first in FAQ #33 would include payments made by the commercial insurers at the rate negotiated in the contract with the hospital and not at a rate that Medicaid would have paid, had Medicaid actually paid the claim. The inclusion of these revenues in calculating the Medicaid shortfall part of the uncompensated care formula has a significant adverse impact on these hospitals.

The plaintiffs assert that the policies advanced by CMS conflict with the unambiguous language of the governing statute, 42 U.S.C. § 1396r-4(g)(1)(A), are being implemented without appropriate notice and comment, and are therefore illegal and void under the Administrative Procedures Act. The District of Columbia and New Hampshire district courts agreed and have temporarily enjoined CMS from “enforcing, applying, or implementing” the policies. Commenters to the Proposed Rule, including the American Hospital Association, the Children’s Hospital Association and several state hospital associations, have all expressed indignation at CMS’s apparent attempt to circumvent the determinations of two federal district courts.

Both lawsuits await final determination, with all permanent injunction arguments having been completed. The courts will determine the final application of the Proposed Rule on two issues: (1) whether CMS inappropriately applied the FAQs without first complying with the proper notice and comment required for issuing a substantive rule under the Administrative Procedures Act, and (2) whether the policy would be upheld as authorized under the applicable statute.