HHS Rule and the Future of Medicaid Hospital Cuts

The Department of Health and Human Services on May 15 released a highly anticipated proposed rule for allocating cuts to hospitals that handle a disproportionate share of uninsured patients. The cuts were included in the Affordable Care Act—called the ACA—as a way to compensate for the cost of expanded coverage. While the big news was that the department chose not to penalize states that have opted out of expanding Medicaid programs, the scale and scope of the proposed cuts ultimately will weigh on policymakers in all 50 states for years to come.

One of the key assumptions undergirding the ACA was that government would be able to spend less on reimbursing hospitals for uncompensated care as millions of Americans would have new coverage due to the expansion of Medicaid, the creation of health insurance subsidies and the adoption of the individual mandate. As a result, the department is scheduled to cut Medicaid payments to disproportionate share hospitals by more than $20 billion between 2014 and 2020.

A twist in the storyline, however, appeared when the Supreme Court ruled last summer that states have the option to expand their Medicaid programs. Following the ruling, many advocates for Medicaid expansion encouraged the department to use a formula for cuts to disproportionate share hospitals that would punish states that do not choose to expand their programs to push more states to expand.

The department instead chose to hew close to the original language of the statue and to base its formula on the number of uninsured individuals in a state—per Census Bureau calculations—combined with deeper cuts for those states that spread their disproportionate share hospital payments widely among state hospitals rather than concentrating them on hospitals with a higher volume of uninsured patients or higher utilization by Medicaid recipients.

The table summarizes how the first round of $500 million in cuts will be distributed according to the rule. This amount seems modest at first glance, but by 2018 the cuts will grow to $5 billion per year representing a 40 percent reduction over what the federal government would have spent on disproportionate share hospitals before the ACA was enacted.

Cuts of this magnitude ultimately will impact state decisions on both Medicaid expansion and program administration. According to the Kaiser Family Foundation, 20 states have indicated to date that they will not expand their Medicaid programs. For these states, the proposed schedule of cuts will likely have no near-term impact. As the cuts grow and their impact becomes clear on state hospitals, however, some states may revisit their expansion decisions.

For some states that chose to expand Medicaid despite considerable controversy, the Department of Health and Human Services rule may serve to reinforce their decision. Arkansas weighed its options carefully before ultimately choosing to cover the Medicaid expansion population through an innovative program using private insurance offered through the health exchange rather than direct Medicaid benefits. Given that Arkansas faces the steepest cuts to hospitals of any state, losing more than 7 percent of its disproportionate share hospital payments, many Arkansans will be reassured by their state’s decision.

The rule, however, may have its biggest impact on how states allocate hospital payments in the future. States can position themselves to receive a smaller share of scheduled cuts in future years by allocating the majority of their disproportionate share hospital payments to hospitals that have a high concentration of uninsured patients or Medicaid recipients. In Texas, the overwhelming majority of the state’s 2014 fiscal year disproportionate share hospital cut—$46.5 million out of $56 million—is driven by penalties for not concentrating payments on high volume and high utilization hospitals. As the size of the scheduled cuts grow, the pressure to change the way states distribute federal disproportionate share hospital payments undoubtedly will increase.