OIG: CMS Should Remove IPPS New Hospital Capital Cost Exemption

August 19, 2021 - A recent Office of Inspector General (OIG) audit recommended that CMS remove the inpatient prospective payment system (IPPS) new hospital capital cost exemption, which in recent years resulted in new hospitals being paid three times more than hospitals that were paid for capital costs under IPPS.

OIG’s audit found that Medicare could have saved $283 million between 2012 and 2018 for capital costs if the hospitals had been paid through IPPS. OIG reasoned that the exemption’s benefits do not outweigh the hefty Medicare costs.

“The stated rationale for this IPPS exemption is that new hospitals may not have adequate Medicare utilization in those initial [two] years and may have incurred significant startup costs,” the report explained.

Current Medicare regulations say that payments for capital costs must be made through the IPPS payment methodology. Capital costs include leases, insurance, taxes, depreciation, and interest expense.

But all these costs tend to be larger for new hospitals that may require additional capital to kickstart their operations. As a result, CMS established an exemption in 1991 that it extended indefinitely in 2002.

Along with being exempt from the capital IPPS, Medicare pays new hospitals 85 percent of their reasonable capital costs for their first two years of operation.

CMS validated the exemption by asserting that newer hospitals may have lower Medicare utilization, less capital reserves, and additional startup costs. Following this logic, the exemption would give hospitals a buffer to get operations running.

But OIG’s review of cost report data from new hospitals between 2012 and 2018 revealed that average Medicare-related capital costs were merely three percent higher in the first two years of operation compared to the following two years of operation. In addition, average Medicare utilization was 15 percent lower compared to the subsequent two years.

Further, over half of the new hospitals were parts of major hospital chains that likely had the capital reserves to get the new hospitals up and running without suffering financially. OIG argued that these analyses negate CMS’s rationale for continuing the exemption.

“Although new hospitals incur slightly higher capital costs and have somewhat lower Medicare utilization during their first 2 years of operation than they do in the subsequent 2 years, these differences are not so significant as to justify capital payments that are triple what they would have been paid through the IPPS,” the audit report explained.

“If CMS determines that new hospitals require increased payment for capital costs, it could make payment adjustments or supplemental payments within the framework of the IPPS. Such payments would not be based solely on cost and would still allow CMS to realize significant cost savings. By using the IPPS for new hospitals in lieu of cost reimbursement, CMS could create incentives for hospitals to operate more efficiently.”

OIG recommended that CMS review its report and possibly alter its regulations to require new hospitals to have Medicare capital costs paid through IPPS with optional payment adjustments. In response, CMS agreed with the recommendations and said that it would review the findings to determine whether a new payment methodology should be considered in upcoming rulemaking.