June 2016 | Issue Brief

Understanding Medicaid Hospital Payments and the Impact of Recent Policy Changes

Peter Cunningham, Department of Health Behavior and Policy, Virginia Commonwealth University

Robin Rudowitz, Katherine Young, Rachel Garfield, and Julia Foutz, Kaiser Family Foundation

Executive Summary

Medicaid payments to hospitals and other providers play an important role in these providers’ finances, which

can affect beneficiaries’ access to care. Medicaid hospital payments include base payments set by states or

health plans and supplemental payments. Estimates of overall Medicaid payment to hospitals as a share of

costs vary but range from 90% to 107%. While base Medicaid payments are typically below cost, the use of

supplemental payments can increase payments above costs. Changes related to expanded coverage under the

Affordable Care Act (ACA) as well as other changes related to Medicaid supplemental payments could have

important implications for Medicaid payments to hospitals. This brief provides an overview of Medicaid

payments for hospitals and explores the implications of the ACA Medicaid expansion as well as payment policy

changes on hospital finances. Key findings include the following:

 Overall, hospitals have benefitted financially from the ACA coverage expansions and the increase in

Medicaid payments, especially in states that expanded Medicaid coverage. Analysis of the Medicare

Cost Report data for 2013 and 2014 shows overall declines in uncompensated care from $34.9 billion to

$28.9 billion in 2014 nationwide. Nearly all of this decline occurred in expansion states, where

uncompensated care costs were $10.8 billion in 2014, $5.7 billion or 35% less than in 2013.

 While hospitals expect to benefit financially from the Medicaid expansion, they expect some gains from

the reduction in uncompensated care to be offset by volume-generated increases in Medicaid payments

that may be lower than cost. The data is not reliable enough to support nationwide analysis of the

extent to which this has occurred, and the effect would vary across hospitals.

 Despite the decrease in uncompensated care, other changes to Medicaid payment policy (such as

required reductions to disproportionate share hospital (DSH) payments and policy changes to limit the

use of other supplemental payments) are likely to have a more substantial effect on Medicaid hospital

payment and overall hospital financial performance in the future. Ultimately the impact of reductions in

supplemental payments will depend on decisions by state governments to offset reductions with

increases to Medicaid base rates paid to hospitals.

Understanding Medicaid Hospital Payments and the Impact of Recent Policy Changes 2

Introduction

Medicaid payments to hospitals and other providers play an important role in these providers’ finances, which

can affect beneficiaries’ access to care. States have a great deal of discretion to set payment Medicaid rates for

hospitals and other providers. Like other public payers, Medicaid payments have historically been (on average)

below costs, resulting in payment shortfalls.1 However, hospital payment rates are often bolstered by additional

supplemental payments in the form of Disproportionate Share Hospital Payments (DSH) and other

supplemental payments. After accounting for these payments, many hospitals receive Medicaid payments that

may be in excess of cost. Understanding how much Medicaid pays hospitals is difficult because there is no

publicly available data source that provides reliable information to measure this nationally across all hospitals.

Different data sources use different definitions of what counts as payments and costs, so estimates are sensitive

to these data limitations.

Understanding the components of Medicaid payment to hospitals and how much Medicaid pays hospitals is

important given the many policy changes taking place. First, the Affordable Care Act (ACA) is leading to

changes in hospital payer mix, especially in states adopting the Medicaid expansion where studies have shown

a decline in self-pay discharges and a corresponding increase in Medicaid discharges.2,3,4 Second, the ACA calls

for reductions in DSH payments, and other federal policy changes are focused on limiting the use of

supplemental payments. These changes could have important implications for Medicaid payments to hospitals

at the same time that Medicaid is a growing share of hospital payer mix, especially among safety net hospitals

that serve a disproportionately high number of Medicaid and uninsured patients.

This brief provides an overview of how Medicaid pays hospitals and discusses changes related to the ACA and

supplemental payments that will have implications for hospital financing. It draws on existing literature and

published reports as well as information collected from semi-structured interviews with hospital associations

and federal agencies.5 Interviews focused on respondents’ perspectives of how hospitals were likely fare under

the ACA and changes in Medicaid payment policy. In addition, we used data from the 2013 and 2014 Medicare

cost reports to try to measure Medicaid payment and uncompensated care in 2013 and 2014.

Background

HOW DOES MEDICAID PAY HOSPITALS?

Hospital payment for a particular patient or service is usually different than the charge for that service (i.e.,

prices set by the hospital) or the cost to the hospital of providing the service (i.e., actual incurred expenses). In

Medicaid, payment rates, sometimes called the “base rate,” are set by state Medicaid agencies for specific

services used by patients. In addition, Medicaid also may make supplemental payments to hospitals (Figure 1).6

Base Payment. The base payment rates are reimbursed through fee-for-service or managed care

arrangements for services provided to Medicaid beneficiaries. States have wide discretion in setting these rates.

As discussed below, base rates are often not reflective of charges or costs for services.

Supplemental Payments. Supplemental payments are payments beyond the base rate that may or may not

be tied to specific services. States often use Upper Payment Limits (UPL), Intergovernmental Transfers (IGT),

provider taxes, or waivers to finance and direct supplemental payments. UPL rules allow states to make up the

Understanding Medicaid Hospital Payments and the Impact of Recent Policy Changes 3

difference between a reasonable estimate of what Medicare would pay and Medicaid payments (in aggregate

within a type and class of provider). IGTs or provider taxes are often used to generate the non-federal share for

Medicaid payments that are then redistributed to providers as additional Medicaid payments. In addition,

Medicaid Disproportionate Share Hospital (DSH) payments are made to hospitals serving high proportions of

Medicaid or low-income patients.

Nationally, all supplemental Medicaid payments combined amounted to 44 percent of Medicaid fee-for-service

payments to hospitals in 2014.7 Non-DSH supplemental payments (which includes UPL, IGT, and revenue

generated from provider taxes) alone accounted

for 15 percent of Medicaid fee-for-service

payments. Almost all states make Medicaid DSH

payments to hospitals, and most states also use

some other form of supplemental payments,

although both the amount of supplemental

payments and how they are distributed to

hospitals varies considerably across states.8

Supplemental payments as a proportion of total

Medicaid fee-for-service payments to hospitals

varies from a low of about 2 percent in North

Dakota, South Dakota, and Maine to more than

two-thirds in Vermont and Pennsylvania.9

HOW MUCH DOES MEDICAID PAY HOSPITALS?

Since payment rates are either negotiated (with health plans) or set by the federal government for Medicare or

state governments for Medicaid fee-for-service, payments that hospitals receive for patient care do not

necessarily reflect what hospitals charge for those services or the cost of providing those services;10 rather,

hospitals may receive payments above costs or below costs. Payments below costs would result in a “shortfall.”

Due to data challenges and differences in what is counted as a Medicaid cost and payment (see Appendix A),

estimates of Medicaid payments to hospitals vary. The American Hospital Association (AHA) estimated that

Medicaid payments to hospitals amounted to 90 percent of the costs of patient care in 2013, while Medicare

paid 88 percent of costs; by contrast, hospitals received considerable overpayment from private insurers,

amounting to 144 percent of costs.11,12 The most recent Medicaid and CHIP Payment and Access Commission

(MACPAC) report to Congress, based on the 2011 DSH audit reports, shows that DSH hospitals were paid an

average of 93 percent of total Medicaid costs, accounting for base Medicaid payments and non-DSH

supplemental payments. After DSH payments, hospitals received 107% of costs on average nationally but

ranged from 81 percent in the lowest paying state to 130 percent in the highest paying state.13 Our own analysis

of the Medicare Cost Reports finds that Medicaid payments covered 93% of costs in 2014.14 However, we find

great variation at the state or individual hospital level, indicating that hospitals may have very different

experiences of the extent to which Medicaid payment covers Medicaid costs.

Figure 1

*Includes UPL, IGT, provider taxes and 1115 Waiver payments. Note: Based on fee-for-service payments only. Data is for 2014. Source: Medicaid and CHIP Payment and Access Commission. MACStats, Section 3, Exhibit 2. Medicaid Supplemental Payments to Hospital Providers by State, FY 2014, https://www.macpac.gov/publication/medicaid-supplemental-payments-to-hospital- providers-by-state/. .

Medicaid payment to hospitals consists of base payments as well as supplemental payments.

$49.8 Billion

$24.2 Billion

$89.3 Billion

$15.2 Billion

Base Payment DSH Supplemental Payments

Non-DSH Supplemental Payments*

Total Hospital Payment

Understanding Medicaid Hospital Payments and the Impact of Recent Policy Changes 4

How has the Medicaid expansion affected hospital finances?

Expanded health insurance coverage through the ACA (both Medicaid and private insurance) is

having a major impact on hospital payer mix for many hospitals. A number of reports show

increases in Medicaid discharges and declines in uninsured or self-pay discharges for hospitals located in states

that implemented the Medicaid expansion. In contrast, hospitals located in states that did not expand Medicaid

are not seeing these large shifts in payer mix. 15, 16, 17

One report that examined the nation’s largest not-for-profit hospital system (Ascension Health) was able to

examine not only changes in discharges but also changes in hospital revenues and costs. Like other studies,

data from Ascension Health hospitals showed that hospitals in states that expanded Medicaid experienced

larger increases in Medicaid discharge volumes and patient revenue from 2013 to 2014 compared to hospitals

in states that did not expand Medicaid. Ascension hospitals in expansion states also observed a much larger

decrease in uninsured/self-pay volumes as well as charity care.18 Overall, Ascension Health hospitals in

Medicaid expansion states observed a $35 million decrease in charity care between 2013 and 2014, but they

also saw Medicaid shortfall amounts rise by $23 million, resulting in a net decrease of $12 million in the costs

of care to the poor.19 Shortfalls grew as a result of both increases in Medicaid volume and payment rate

changes in some states. Replicating the Ascension analysis for hospitals nationally is difficult due to limited

reliable data.

The cost of uncompensated care has declined among hospitals in Medicaid expansion states,

while such costs have remained flat among hospitals in states that did not expand Medicaid.

Analysis of the Medicare Cost Report data for 2013 and 2014 shows overall declines in uncompensated care. In

2013, total uncompensated care costs for hospitals (including charity care costs and bad debt) were $34.9

billion, with hospitals in expansion states

incurring about $16.7 billion and hospitals in

non-expansion states incurring about $18.1

billion.20 In 2014, uncompensated care fell to

$28.9 billion nationwide, a $6 billion or 17%

drop, with nearly all of the decrease occurring in

expansion states (where uncompensated care

costs were $11 billion in 2014, $5.8 billion or

35% less than the year before). In non-

expansion states, the change in uncompensated

care was nearly flat between 2013 and 2014,

dropping just 1% (or $0.2 billion) to $17.9

billion in 2014 (Figure 2).

Unfortunately, we are not able to quantify how much of the decrease in hospital uncompensated care costs was

offset by increases in Medicaid shortfall amounts, because such data are not reliable in the Medicare Cost

Reports (i.e. supplemental Medicaid payments are likely to be under-reported). While the experience of the

Ascension Health system suggests that rising Medicaid shortfalls are offsetting the potential financial benefit of

lower uncompensated care costs, this outcome is likely to vary substantially across hospitals.

Figure 2

Source: KCMU analysis of the Medicare Cost Reports, 2013 and 2014.

Hospitals in expansion states saw a reduction in uncompensated care costs from 2013 to 2014. $ in billions

$34.9

$16.7 $18.1

$28.9

$11.0

$17.9

A l l N o n -F e d eral A cu te C ar e H o sp i t al s

Ex p an si o n S t at es N o n -Ex p an si o n S t ates

Total Uncompensated Care Cost, 2013 Total Uncompensated Care Cost, 2014

Understanding Medicaid Hospital Payments and the Impact of Recent Policy Changes 5

Whether hospitals come out ahead financially under the ACA will depend on numerous factors

– many of which are unrelated to Medicaid. The ACA included a number of restrictions on Medicare

payments for hospitals and expanded coverage has also resulted in markets shifts and new competition.

Hospitals also may see shifts in patient acuity, Medicaid payment rate changes or other changes in Medicaid

payment policy. In addition, hospitals are constantly implementing strategies to increase revenue (e.g. diversify

payer mix) and reduce the costs of providing services. Many safety net hospitals are trying to diversify their

payer mix by changing their “safety net image” in the community, competing more aggressively for privately

insured patients, retaining the privately insured patients they already have, and expanding services beyond

inner city service areas where they are typically located.21 Thus, Medicaid expansion is just one of many factors

that will influence hospitals’ financial viability in the future.

Given this variation and difficulties with underlying data, better data are needed to capture how hospital

finances are faring under the ACA, and specifically how Medicaid revenues and shortfalls are changing.

Stakeholders interviewed for this project thought that the Medicaid expansion would be a financial benefit to

hospitals, but payment levels were a concern; however, these concerns were secondary to broader concerns

about upcoming and potential changes to Medicaid supplemental payments.

What payment policy changes could affect Medicaid hospital

payments?

Hospitals are facing several policy changes that may affect Medicaid payments. Over time, state budget

pressures have resulted in an increasing reliance on supplemental payments (versus base payments) to finance

Medicaid hospital services. However, a number of upcoming policy changes, including reductions in DSH

payments and limits on other supplemental payments, will restrict the use of supplemental payments. Federal

officials believe that reform of Medicaid supplemental payments is needed to make payment more transparent,

targeted, and consistent with delivery system reforms that reduce health care costs, and increase quality and

access to care. However, these policy changes are causing concern among hospitals that have long been

dependent on Medicaid revenue for their financial viability.22,23,24 In addition, payment changes are occurring

against the backdrop of coverage expansions under the ACA, which are affecting payer mix for some hospitals.

CHANGES IN BASE PAYMENT RATES

Changes in state reimbursement rates for hospitals have a big effect on Medicaid hospital financing, especially

for safety net hospitals that serve a large number of Medicaid patients. Each year, states must balance their

budgets, and consideration of Medicaid payment rates for providers and managed care organizations factor in

to these discussions. In general, increases in base rates have lagged behind increases in costs during economic

downturns as states often restrict (freeze or reduce) provider rates. Even as the economy has recovered, in

fiscal years 2015 and 2016, there were more states restricting (freezing or cutting) rates for Medicaid hospital

inpatient care than there were states increasing rates.25 While the economy is improving and resources are not

as scarce as during a recession, states balance the need to increase Medicaid payment rates to ensure provider

participation and access with overall budget decisions.

Understanding Medicaid Hospital Payments and the Impact of Recent Policy Changes 6

CHANGES IN MEDICAID DSH FUNDING

In 2014, federal DSH allotments totaled $11.7 billion.26 Under current law, DSH spending is limited by annual

federal allotments and individual hospital limits (hospitals cannot receive DSH payments in excess of

uncompensated care costs). The ACA calls for reductions in Medicaid DSH payments, originally scheduled to

begin in 2014 but delayed until 2018.27 These reductions will amount to $43 billion between 2018 and 2025;

reductions start at $2 billion in FY 2018 and increase to $8 billion by FY 2025. The ACA requires the Secretary

of HHS to develop a methodology to allocate the reductions that must take into account certain factors that

would allocate larger percentage reductions on states with the lowest percentages of uninsured individuals and

states that do not target DSH payments to hospitals with high levels of uncompensated care. It is unclear if or

how HHS will adjust the DSH reductions to account for the fact that some states may have higher uninsured

rates because they have opted to not implement the Medicaid expansion. MACPAC analysis shows that current

state DSH allocations are not tied to a hospital’s share of Medicaid and other low-income patients, its

uncompensated care burden, and its delivery of essential community services.28

In general, many hospitals and hospital associations are skeptical that the increase in patient revenue under

the ACA will make up for the loss of Medicaid DSH funds, although the impact will vary depending on

hospitals’ prior dependence on Medicaid DSH funding as well as federal and state government decisions on

how the remaining DSH funds will be distributed across states and hospitals. Safety net hospitals are

particularly vulnerable because of their high dependence on Medicaid DSH funds, high numbers of uninsured,

few privately insured or Medicare patients, and generally weaker financial condition.29 An analysis of California

concluded that reductions in DSH payments to the state’s public hospitals would not be fully offset by

increased revenue from paying patients due to the high number of people who would remain uninsured, low

Medicaid reimbursement rates, and the rising costs of care.30 Analyses by the New York City Health and

Hospitals Corporation also estimated that DSH cuts will put a strain on hospitals, possibly leading to

reductions in hospital medical staff and services.31

CHANGES IN OTHER SUPPLEMENTAL PAYMENTS

While states’ reliance on supplemental payments as a source of revenue for hospitals has increased, lack of data

and transparency on state’s use of supplemental payments makes federal oversight of these programs

difficult.32 Federal officials are working to reform how states use supplemental payments in managed care and

waivers, as well as the use of provider taxes.

Managed Care Rules. While UPL payments to hospitals have always been restricted to fee-for-service

payment only, some states have used pass-through mechanisms to direct supplemental payments to selected

hospitals through managed care plans. The Medicaid managed care rules originally proposed by the federal

government would have restricted states’ ability to direct supplemental payments to providers through

managed care plans.33 Under the Final Rule published in May 2016, these supplemental payments to hospitals

would be phased out over 10 years (2017-2027), by 10 percentage points each year. So, while still an area of

concerns, states and hospitals have more time to make rate adjustments over time.

DSRIP. The Delivery System Reform and Incentive Programs (DSRIP) allow states to use supplemental

payments for delivery system reforms in their Medicaid programs. These programs have been implemented

Understanding Medicaid Hospital Payments and the Impact of Recent Policy Changes 7

through Section 1115 waivers in eight states, including California, Texas, Massachusetts, New Jersey, New

Mexico, Kansas, and New York.34,35 Supplemental payments through DSRIP are being used to achieve

particular goals, such as improved quality, outcomes, access to care and population health. In most states with

DSRIP programs, public hospitals are contributing all or most of the non-federal share of funding for these

programs.36 The DSRIP programs are temporary, with the expectation that states and providers can transform

their delivery systems so that they are more efficient, less costly, have lower use of hospital inpatient care, and

more use of primary and preventive care. While these payments are included under broad waivers that are

budget neutral to the federal government, the amount of funding allocated for DSRIP programs is significant

($3.3 billion in California, $6.6 billion in Texas, $6.4 billion in New York)37, and the phase-out of this funding

will have implications for states and providers. In renewing California’s DSRIP program in December 2015,

funding is scheduled to phase down by 10% in year four and by 15% in year five.38

Safety Net Care Pools. Federal policy makers also have been focused on reforming the use of Medicaid

Section 1115 demonstration waivers to fund state uncompensated care pools in nine states. Officials laid out

the principles for which such funds were to be used, including: (1) funds should not pay for the costs that would

be covered in a Medicaid expansion; (2) they should support services provided to Medicaid beneficiaries and

low-income uninsured individuals, and; (3) provider payment should promote provider participation and

access, and should support plans in managing and coordinating care.39 To the extent that this funding has been

used to supplement Medicaid base rates for certain hospitals, changes to these funding streams will affect

hospital finances. The agreement to renew Florida’s Low Income Pool – which reduced funds for the pool –

included a $400 million increase in base rates to providers. In May 2016, Texas received a 15 month extension

of their waiver; the letter states that if CMS and the state cannot reach agreement during this extension period,

CMS expects that the Uncompensated Care pool will not be renewed at the end of 2017 and that DSRIP will

decrease by 25% each year starting in 2018.40

Provider Taxes. Provider taxes are an integral source of Medicaid financing governed by long-standing

regulations. Currently, all but one state (Alaska) reported a provider tax in FY 2015.41 Often provider taxes are

used to bolster Medicaid payment rates for hospitals; however, these taxes can also be used to support state

general revenues. In Connecticut, the state has been retaining more of the provider tax to address state budget

deficits instead of supporting hospitals.42 The state hospital association estimates that this has effectively

decreased overall Medicaid payments from 50 percent of costs to 41 percent.43 In addition to state decisions

about how to use funding from provider taxes, Congress is currently considering proposals to limit the use of

provider taxes. This action would restrict states’ flexibility to finance their share of Medicaid and could

therefore shift additional costs to states or result in program cuts. Since states use provider taxes differently,

limits would have different effects across states.

Understanding Medicaid Hospital Payments and the Impact of Recent Policy Changes 8

Conclusion

At this point, it is unclear how recent and upcoming policy changes in Medicaid will affect the financial viability

of hospitals. Early analysis of the Medicare Care Report data show national declines in uncompensated care,

especially in expansion states, although the data do not permit reliable estimates of trends in Medicaid

payment amounts. However, hospital margins are influenced by numerous factors, the health care and policy

environment is in flux, and some hospitals will be better able to adapt to these changes than others. There is

much concern from hospitals – especially safety net hospitals – about the decrease in Medicaid DSH funds and

other changes in supplemental payments that they have depended on for years. Most stakeholders from the

hospital industry that we talked to thought that even after accounting for increases in Medicaid shortfall, the

Medicaid expansion was a financial benefit, but changes to supplemental payments could have a much larger

negative effect on hospital finances. The overall impact of changes to supplemental payments also will depend

on how much states adjust base payment rates to compensate for changes to supplemental payments. Better

data and monitoring of the effects of coverage changes as well as policy changes related to the supplemental

payments will help to better evaluate hospitals financial well-being and the ability of safety net hospitals to

serve Medicaid and uninsured persons.

Understanding Medicaid Hospital Payments and the Impact of Recent Policy Changes 9

Appendix A: Measuring Medicaid Payments to Hospitals

No data source consistently collects information on Medicaid costs and payment, and different estimates of

Medicaid payment as a share of costs use different definitions of Medicaid costs and payments. Thus, estimates

of Medicaid payment as a percent of costs are sensitive to the specific data source and definitions used to make

the estimates. For example, when measuring Medicaid hospital payments, some data sources include

supplemental payments, while others do not. In some data sources, these payment streams are not identified,

making it difficult to understand what is and is not included. Further, in some cases, Medicaid costs may be

defined to include only costs for Medicaid-covered services, while in others, the definition may include unpaid

costs for services provided to Medicaid patients when Medicaid was not the primary payer—for example, costs

for Medicare-funded services provided to people dually eligible for both Medicaid and Medicare.

Three main sources of estimating Medicaid payment relative to costs are the Medicare cost reports, the DSH

Audit Reports and the American Hospital Association survey. These sources vary in the data they collect and

the definitions of costs and payments that they enable. Each of these data sources may underreport other

Medicaid supplemental payments, which may understate total Medicaid payments, and the data likely does not

net out provider contributions towards the non-federal share, which are necessary to calculate net Medicaid

payments and may contribute to overstating total Medicaid payments.

Medicare Cost Reports. The Medicare Cost Reports (MCR) are annual reports that all Medicare-certified

institutional providers are required to submit to Medicare. It is the only publicly available source of detailed

financial data for most of the acute care hospitals in the U.S. These reports contain provider information such

as facility characteristics, utilization data, cost and charges by cost center (in total and for Medicare), Medicare

settlement data, and financial statement data that are used as part of the annual settlement between the federal

government and the provider.44 These cost reports are designed to collect data necessary for Medicare

reimbursement and thus do not verify or require Medicaid data, leading to questions about how reliable these

data are for Medicaid payment analyses. Hospitals are not required to report DSH payments separately, but

DSH payments are included as Medicaid revenues in these reports, and the reports only include costs for

Medicaid-covered services.

Medicaid DSH Audit Reports. The Medicaid DSH audit reports are required annual reports that states

must submit to the federal government describing DSH payments made to each DSH hospital.45 In these

reports, hospitals explicitly report DSH payments. DSH audits also include unpaid costs for services provi