[Federal Register: August 30, 1996 (Rules and Regulations)] [Page 46316-46328] 
From the Federal Register Online via GPO Access [wais.access.gpo.gov] [[pp. 46316-46328]] 
Medicare Program; Changes to the Hospital Inpatient Prospective 
Payment Systems and Fiscal Year 1997 Rates [[Continued from page 46315]]  
VII. Impact of Changes in the Capital Prospective Payment System A. General Considerations 
We now have data that were unavailable in previous impact analyses for the capital 
prospective payment system. Specifically, we have cost report data for the third 
year of the capital prospective payment system (cost reports beginning in FY 1994) 
available through the June 1996 update of the Hospital Cost Report Information 
System (HCRIS). We also have updated information on the projected aggregate amount 
of obligated capital approved by the fiscal intermediaries. However, our impact 
analysis of payment changes for capital-related costs is still limited by the 
lack of hospital-specific data on several items. These are the hospital's projected 
new capital costs for each year, its projected old capital costs for each year, 
and the actual amounts of obligated capital that will be put in use for patient 
care and recognized as Medicare old capital costs in each year. 
The lack of such information affects our impact analysis in several ways. Specifically, 
major investment in hospital capital assets (for example in building and major 
fixed equipment) occurs at irregular intervals. As a result, there can be significant 
variation in the growth rates of Medicare capital-related costs 
per case among hospitals. We do not have the necessary hospital-specific budget 
data to project the hospital capital growth rate for individual hospitals. Moreover, 
our policy of recognizing certain obligated capital as old capital makes it difficult 
to project future capital-related costs for individual hospitals. Under Sec. 412.302(c), 
a hospital is required to notify its intermediary that it has obligated capital 
by the later of October 1, 1992, or 90 days after the beginning of the hospital's 
first cost reporting period under the capital prospective payment system. The 
intermediary must then notify the hospital of its determination whether the criteria 
for recognition of obligated capital have been met by the later of the end of 
the hospital's first cost reporting period subject to the capital prospective 
payment system or 9 months after the receipt of the hospital's notification. The 
amount that is recognized as old capital is limited to the lesser of the actual 
allowable costs when the asset is [[Page 46315]] put in use for patient care or 
the estimated costs of the capital expenditure at the time it was obligated. We 
have substantial information regarding intermediary determinations of projected 
aggregate obligated capital amounts. However, we still do not know when these 
projects will actually be put into use for patient care, the actual amount that 
will be recognized as obligated capital when the project is put into use, or the 

Medicare share of the recognized costs. Therefore, we do not 
know actual obligated capital commitments for purposes of the FY 1997 capital 
cost projections. We discuss in Appendix B the assumptions and computations we 
employ to generate the amount of obligated capital commitments for use in the 
FY 1997 capital cost projections. In Table III of this appendix, we present the 
redistributive effects that are expected to occur between "hold-harmless" hospitals 
and "fully prospective" hospitals in FY 1997. In addition, we have integrated 
sufficient hospital-specific information into our actuarial model to project the 
impact of the FY 1997 capital payment policies by the standard prospective payment 
system hospital groupings. We caution that while we now have actual information 
on the effects of the transition payment methodology and interim payments under 
the capital prospective payment system and cost report data for most hospitals, 
we need to randomly generate numbers for the change in old capital costs, new 
capital costs for each year, and obligated amounts that will be put in use for 
patient care services and recognized as old capital each year. We continue to 
be unable to predict accurately FY 1997 capital costs for individual hospitals, 
but with the more recent data on the experience to date under the capital prospective 
payment system, there is adequate information to estimate the aggregate impact 
on most hospital groupings. We present the transition payment methodology by hospital 
grouping in Table IV. In Table V we present the results of the cross-sectional 
analysis using the results of our actuarial model. This table presents the aggregate 
impact of the FY 1997 payment policies. B. Projected Impact Based on the FY 1997 
Actuarial Model 1. Assumptions In this impact analysis, we model dynamically the 
impact of the capital prospective payment system from FY 1996 to FY 1997 using 
a capital acquisition model. The FY 1997 model, described in Appendix B of this 
final rule, integrates actual data from individual hospitals with randomly generated 
capital cost amounts. We have capital cost data from cost reports beginning in 
FY 1989 through FY 1994 received through the June 1996 update of the Hospital 
Cost Reporting Information System (HCRIS), interim payment data for hospitals 
already receiving capital prospective payments through PRICER, and data reported 
by the intermediaries that include the hospital-specific rate determinations that 
have been made through July 1, 1996 in the Provider-Specific file. We used this 
data to determine the FY 1997 capital rates. However, we do not have individual 
hospital data on old capital changes, new capital formation, and actual obligated 
capital costs. We have data on costs for capital in use in FY 1994, and we age 
that capital by a formula described in Appendix B. We therefore need to randomly 
generate only new capital acquisitions for any year after FY 1994. All Federal 
rate payment parameters are assigned to the applicable hospital. For purposes 
of this impact analysis, the FY 1997 actuarial model includes the following assumptions: 
<bullet> Medicare inpatient capital costs per discharge 
will increase at the following rates during these periods: Average Percentage 
Increase in Capital ------------------------------------------------------------------------ 
Costs per Fiscal year discharge ------------------------------------------------------------------------ 
1995....................................................... -0.53 1996....................................................... 
5.06 1997....................................................... 5.21 ------------------------------------------------------------------------ 
<bullet> The Medicare case-mix index will increase by 1.4 
percent in FY 1996 and 1.6 percent in FY 1997. <bullet> The Federal capital 
rate as well as the hospital-specific rate is updated in FY 1996 by an analytical 
framework that considers changes in the prices associated with capital-related 
costs, and adjustments to account for forecast error, changes in the case-mix 
index, allowable changes in intensity, and other factors. The FY 1997 update factor 
is .7 percent. (see Addendum, Part III). 2. Results We have used the actuarial 
model to estimate the change in payment for capital-related costs from FY 1996 
to FY 1997. Table III shows the effect of the capital prospective payment system 
on low capital cost hospitals and high capital cost hospitals. We consider a hospital 
to be a low capital cost hospital if, based on a comparison of its initial hospital-specific 
rate and the applicable Federal rate, it will be paid under the fully prospective 
payment methodology. A high capital cost hospital is a hospital that, based on 
its initial hospital-specific rate, will be paid under the hold-harmless payment 
methodology. Based on our actuarial model, the breakdown of hospitals is as follows: 
Capital Transition Payment Methodology ---------------------------------------------------------------------------------------------------------------- 
FY 1997 FY 1997 Percent of FY 1997 percent of percent of Type of hospital hospitals 
percent of capital capital discharges costs payments ---------------------------------------------------------------------------------------------------------------- 
Low Cost Hospital........................................... 66 62 52 56 High 
Cost Hospital.......................................... 34 38 48 44 ---------------------------------------------------------------------------------------------------------------- 
A low capital cost hospital may request to have its hospital- specific rate redetermined 
based on old capital costs in the current year, through the later of the hospital's 
cost reporting period beginning in FY 1994 or the first cost reporting period 
beginning after obligated capital comes into use (within the limits established 
in Sec. 412.302(e) for putting obligated capital in use for patient care). If 
the redetermined hospital-specific rate is greater than the adjusted Federal rate, 
these hospitals will be paid under the hold-harmless payment methodology. Regardless 
of whether the hospital became a hold- harmless payment hospital as a result of 
a redetermination, we have continued to show these hospitals as low capital cost 
hospitals in Table III. Assuming no behavioral changes in capital expenditures, 
Table III displays the percentage change in payments from [[Page 46316]] FY 1996 
to FY 1997 using the above described actuarial model. Table III.--Impact of Final 
Changes for FY 1997 on Payments Per Discharge FY 1996 payments per discharge -------------------------------------------------------------------------------------------------------------------------------------------------------- 
Adjusted Average Hospital Hold Number of Discharges federal federal specific harmless 
Exceptions Total hospitals payment percent payment payment payment payment -------------------------------------------------------------------------------------------------------------------------------------------------------- 
Low Cost Hospitals.............................. 3,363 6,868,405 $411.84 54.85 
$200.68 $15.75 $18.28 $646.55 Fully Prospective........................... 1,548 
3,287,821 375.12 50.00 237.10 ........... 11.40 623.62 Rebase--Fully Prospective................... 
1,483 2,743,898 371.61 50.00 218.24 ........... 27.88 617.74 Rebase--100% Federal 
Rate................... 228 643,922 793.64 100.00 ........... ........... 0.25 
793.89 Rebase--Hold Harmless....................... 104 192,764 335.30 46.49 ........... 
561.32 59.11 955.72 High Cost Hospitals............................. 1,741 4,288,642 
668.50 86.23 ........... 145.12 19.59 833.21 100% Federal Rate........................... 
1,135 3,010,570 785.30 100.00 ........... ........... 2.23 787.53 Hold Harmless............................... 
606 1,278,072 393.38 52.33 ........... 486.95 60.48 940.81 Total Hospitals......................... 
5,104 11,157,046 510.50 67.15 123.54 65.48 18.78 718.30 -------------------------------------------------------------------------------------------------------------------------------------------------------- 
FY 1997 payments per discharge -------------------------------------------------------------------------------------------------------------------------------------------------------- 
Adjusted Average Hospital Hold Number of Discharges federal federal specific harmless 
Exceptions Total Percent hospitals payment percent payment payment payment payment 
change -------------------------------------------------------------------------------------------------------------------------------------------------------- 
Low Cost Hospitals................. 3,363 7,056,653 $471.51 63.97 $157.25 $12.43 
$40.25 $681.44 5.40 Fully Prospective.............. 1,548 3,377,933 441.20 60.00 
185.78 ........... 30.53 657.51 5.43 Rebase--Fully Prospective...... 1,483 2,819,103 
438.15 60.00 171.01 ........... 54.23 663.39 7.39 Rebase--100% Federal Rate...... 
238 677,500 778.75 100.00 ........... ........... 2.63 781.38 -1.58 Rebase--Hold 
Harmless.......... 94 182,117 407.13 56.47 ........... 481.80 144.04 1,032.97 
8.08 High Cost Hospitals................ 1,741 4,406,184 694.20 89.74 ........... 
117.32 49.69 861.21 3.36 100% Federal Rate.............. 1,173 3,160,803 779.30 
100.00 ........... ........... 11.40 790.70 0.40 Hold Harmless.................. 
568 1,245,382 478.21 63.00 ........... 415.08 146.89 1,040.17 10.56 Total Hospitals............ 
5,104 11,462,838 557.11 74.17 96.80 52.75 43.88 750.54 4.49 -------------------------------------------------------------------------------------------------------------------------------------------------------- 
Under section 1886(g)(1)(A) of the Act, aggregate payments under the capital prospective 
payment system for FY 1992 through 1995 respectively, were projected to equal 
90 percent of payments that would have been payable on a reasonable cost basis 
in each year. With the expiration of the capital budget neutrality provision, 
we now estimate that there was an aggregate 27.50 percent increase in FY 1996 

Medicare capital payments over the FY 1995 payments. We estimate 
aggregate Medicare capital payments will increase by 6.77 percent 
in FY 1997. We project that low capital cost hospitals paid under the fully prospective 
payment methodology will experience an average increase in payments per case of 
4.75 percent, and high capital cost hospitals will experience an average increase 
of 2.86 percent. For hospitals paid under the fully prospective payment methodology, 
the Federal rate payment percentage will increase from 50 percent to 60 percent 
and the hospital-specific rate payment percentage will decrease from 50 to 40 
percent in FY 1997. The Federal rate payment percentage for hospitals paid under 
the hold-harmless payment methodology is based on the hospital's ratio of new 
capital costs to total capital costs. The average Federal rate payment percentage 
for hospitals receiving a hold-harmless payment for old capital will increase 
from 52.33 percent to 62.81 percent. (We estimate the percentage of hold-harmless 
hospitals paid based on 100 percent of the Federal rate will increase from 65.8 
percent to 67.8 percent.) We expect that the average hospital-specific rate payment 
per discharge will decrease from $123.54 in FY 1996 to $96.10 in FY 1997. This 
is partly due to the 4.32 percent decrease in the FY 1997 hospital-specific rate 
compared to FY 1996. We proposed no changes in our exceptions policies for FY 
1997. As a result, the minimum payment levels will be: <bullet> 90 percent 
for sole community hospitals; <bullet> 80 percent for urban hospitals with 
100 or more beds and a disproportionate share patient percentage of 20.2 percent 
or more; or, <bullet> 70 percent for all other hospitals. We estimate that 
exceptions payments will increase from 2.61 percent of total capital payments 
in FY 1996 to 5.97 percent of payments in FY 1997. The number and amount of exceptions 
payments is expected to increase throughout the transition period. The projected 
distribution of the payments is shown in the table below: Estimated FY 1997 Exceptions 
Payments ------------------------------------------------------------------------ 
Percent of Type of hospital Number of exceptions hospitals payments ------------------------------------------------------------------------ 
Low Capital Cost.............................. 464 57 High Capital Cost............................. 
348 43 ------------------------- Total......................................... 
812 100 ------------------------------------------------------------------------ 
C. Cross-Sectional Comparison of Capital Prospective Payment Methodologies Table 
IV presents a cross-sectional summary of hospital groupings by capital prospective 
payment methodology. This distribution is generated by our actuarial model. [[Page 
46317]] Table IV.--Distribution by Method of Payment (Hold-Harmless/Fully Prospective) 
of Hospitals Receiving Capital Payments ---------------------------------------------------------------------------------------------------------------- 
(2) Hold-harmless -------------------------- (3) (1) Total Percentage Percentage 
No. of paid hold- Percentage paid fully hospitals harmless paid fully prospective 
(A) federal (B) rate ---------------------------------------------------------------------------------------------------------------- 
By Geographic Location: All hospitals........................................... 
5,104 13.0 27.6 59.4 Large urban areas (populations over 1 million).......... 
1,584 15.3 34.8 49.9 Other urban areas (populations of 1 million or fewer)... 
1,275 15.8 32.9 51.3 Rural areas............................................. 
2,245 9.7 19.6 70.7 Urban hospitals......................................... 2,859 
15.5 34.0 50.5 0-99 beds........................................... 697 16.4 27.4 
56.2 100-199 beds........................................ 941 19.2 36.9 43.9 200-299 
beds........................................ 576 14.4 36.6 49.0 300-499 beds........................................ 
478 10.3 34.5 55.2 500 or more beds.................................... 167 10.2 
34.1 55.7 Rural hospitals......................................... 2,245 9.7 19.6 
70.7 0-49 beds........................................... 1,175 7.0 14.6 78.5 
50-99 beds.......................................... 656 12.5 21.6 65.9 100-149 
beds........................................ 241 13.7 30.7 55.6 150-199 beds........................................ 
98 15.3 22.4 62.2 200 or more beds.................................... 75 8.0 
41.3 50.7 By Region: Urban by Region......................................... 
2,859 15.5 34.0 50.5 New England......................................... 160 
6.9 25.0 68.1 Middle Atlantic..................................... 434 10.1 29.7 
60.1 South Atlantic...................................... 418 20.1 40.2 39.7 East 
North Central.................................. 480 9.6 30.0 60.4 East South Central.................................. 
162 22.8 34.6 42.6 West North Central.................................. 190 18.4 
27.4 54.2 West South Central.................................. 367 27.8 46.0 26.2 
Mountain............................................ 126 15.9 42.1 42.1 Pacific............................................. 
474 12.7 31.2 56.1 Puerto Rico......................................... 48 10.4 
25.0 64.6 Rural by Region......................................... 2,245 9.7 19.6 
70.7 New England......................................... 53 7.5 15.1 77.4 Middle 
Atlantic..................................... 84 10.7 15.5 73.8 South Atlantic...................................... 
297 11.8 25.6 62.6 East North Central.................................. 304 10.2 
11.8 78.0 East South Central.................................. 278 9.7 31.3 59.0 
West North Central.................................. 525 7.0 15.2 77.7 West South 
Central.................................. 347 9.2 24.8 66.0 Mountain............................................ 
211 12.3 15.2 72.5 Pacific............................................. 141 11.3 
15.6 73.0 Large urban areas (populations over 1 million).......... 1,779 15.2 
34.5 50.4 Other urban areas (populations over 1 million or fewer). 1,180 15.8 
32.2 51.9 Rural areas............................................. 2,145 9.6 19.5 
71.0 Teaching Status: Non-teaching........................................ 4,019 
13.5 26.6 59.8 Fewer than 100 Residents............................ 850 11.3 32.4 
56.4 100 or more Residents............................... 235 9.4 27.7 63.0 Disproportionate 
share hospitals (DSH): Non-DSH............................................. 3,178 
12.3 24.0 63.7 Urban DSH: 100 or more beds................................ 1,409 
15.4 36.1 48.5 Less than 100 beds.............................. 100 17.0 23.0 
60.0 Rural DSH: Sole Community (SCH/EACH)....................... 156 11.5 18.6 
69.9 Referral Center (RRC/EACH)...................... 27 7.4 37.0 55.6 Other Rural: 
100 or more beds............................ 83 8.4 45.8 45.8 Less than 100 beds.......................... 
151 7.3 25.8 66.9 Urban teaching and DSH: Both teaching and DSH............................... 
692 11.1 32.2 56.6 Teaching and no DSH................................. 339 11.2 
29.8 59.0 No teaching and DSH................................. 817 19.2 37.7 43.1 
No teaching and no DSH.............................. 1,111 16.7 32.5 50.9 Rural 
Hospital Types: Non special status hospitals........................ 1,372 7.7 
19.5 72.8 RRC/EACH............................................ 90 10.0 34.4 55.6 
SCH/EACH............................................ 645 13.3 17.2 69.5 [[Page 
46318]] SCH, RRC and EACH................................... 38 13.2 21.1 65.8 
Type of Ownership: Voluntary........................................... 2,951 
12.3 27.6 60.1 Proprietary......................................... 696 23.4 46.7 
29.9 Government.......................................... 1,366 8.7 17.6 73.7 
Medicare Utilization as a Percent of Inpatient Days: 0-25................................................ 
258 15.1 25.2 59.7 25-50............................................... 1,284 
14.5 33.4 52.1 50-65............................................... 2,097 12.9 
28.0 59.1 Over 65............................................. 1,374 10.8 21.6 
67.5 ---------------------------------------------------------------------------------------------------------------- 
As we explain in Appendix B, we were not able to determine a hospital-specific 
rate for 25 of the 5,129 hospitals in our data base. Consequently, the payment 
methodology distribution is based on 5,104 hospitals. This data should be fully 
representative of the payment methodologies that will be applicable to hospitals. 
The cross-sectional distribution of hospital by payment methodology is presented 
by: (1) geographic location, (2) region, and (3) payment classification. This 
provides an indication of the percentage of hospitals within a particular hospital 
grouping that will be paid under the fully prospective payment methodology and 
under the hold-harmless methodology. The percentage of hospitals paid fully Federal 
(100 percent of the Federal rate) as hold-harmless hospitals is expected to increase 
to 27.5 percent in FY 1997. Table IV indicates that 59.4 percent of hospitals 
are paid under the fully prospective payment methodology. (This figure, unlike 
the figure of 66 percent for low cost capital hospitals in the previous section, 
takes account of the effects of redeterminations. In other words, this figure 
does not include low cost hospitals that, following a hospital-specific rate redetermination, 
are now paid under the hold- harmless methodology.) As expected, a relatively 
higher percentage of rural and governmental hospitals (70.7 percent and 73.7 percent, 
respectively by payment classification) are being paid under the fully prospective 
methodology. This is a reflection of their lower than average capital costs per 
case. In contrast, only 29.9 percent of proprietary hospitals are being paid under 
the fully prospective methodology. This is a reflection of their higher than average 
capital costs per case. (We found at the time of the August 30, 1991 final rule 
(56 FR 43430) that 62.7 percent of proprietary hospitals had a capital cost per 
case above the national average cost per case.) D. Cross-Sectional Analysis of 
Changes in Aggregate Payments We used our FY 1997 actuarial model to estimate 
the potential impact of our changes for FY 1997 on total capital payments per 
case, using a universe of 5,104 hospitals. The individual hospital payment parameters 
are taken from the best available data, including: the July 1, 1996 update to 
the Provider-Specific file, cost report data, and audit information supplied by 
intermediaries. Table V presents estimates of payments per case under our model 
for FY 1996 and FY 1997 (columns 2 and 3). Column 4 shows the total percentage 
change in payments from FY 1996 to FY 1997. Column 5 presents the percentage change 
in payments that can be attributed to Federal rate changes alone. Federal rate 
changes represented in Column 5 include the 4.99 percent decrease in the Federal 
rate, a 1.6 percent increase in case mix, changes in the adjustments to the Federal 
rate (for example, the effect of the new hospital wage index on the geographic 
adjustment factor), and reclassifications by the Medicare Geographic 
Classification Review Board. Column 4 includes the effects of the Federal rate 
changes represented in column 3. Column 4 also reflects the effects of all other 
changes, including: the change from 50 percent to 60 percent in the portion of 
the Federal rate for fully prospective hospitals, the hospital-specific rate update, 
changes in the proportion of new to total capital for hold-harmless hospitals, 
changes in old capital (for example, obligated capital put in use), hospital-specific 
rate redeterminations, and exceptions. The comparisons are provided by: (1) geographic 
location and (2) payment classification and payment region. The simulation results 
show that, on average, capital payments per case can be expected to increase 3.9 
percent in FY 1997. The results show that the effect of the Federal rate changes 
alone is to decrease payments by 1.3 percent. The decrease attributable to the 
Federal rate changes is more than offset by a 5.2 percent increase attributable 
to the effects of all other changes. Our comparison by geographic location shows 
that overall, urban hospitals will gain slightly less than rural hospitals from 
the final rule changes (increases of 3.8 percent and 4.7 percent, respectively). 
Payments per case for urban hospitals will decrease at about the same rate as 
payments per case for rural hospitals (1.2 percent and 1.7 percent, respectively) 
from the Federal rate changes alone. Urban hospitals will gain slightly less than 
rural hospitals (5.0 percent compared to 6.4 percent) from the effects of all 
other changes. By region, there is relatively little variation compared to some 
previous years. All regions are estimated to receive increases in total capital 
payments per case. Changes by region vary from a low of 2.1 percent increase (rural 
hospitals of the West South Central region) to a high of 15.2 percent increase 
(rural hospitals of the New England region). By type of ownership, government 
hospitals are projected to have the largest rate of increase (5.1 percent, -1.5 
percent due to Federal rate changes and a 6.6 percent positive offset from the 
effects of all other changes). Payments to voluntary hospitals will increase 3.8 
percent (a 1.3 percent decrease due to Federal rate changes and a 5.1 percent 
[[Page 46319]] positive offset from the effects of all other changes) and payments 
to proprietary hospitals will increase 3.4 percent (a 0.9 percent decrease due 
to Federal rate changes and a 4.3 percent positive offset from the effects of 
all other changes). Section 1886(d)(10) of the Act established the Medicare 

Geographic Classification Review Board (MGCRB). Hospitals may apply for reclassification 
for purposes of the standardized amount, wage index, or both. Although the Federal 
capital rate is not affected, a hospital's geographic classification for purposes 
of the operating standardized amount does affect a hospital's capital payments 
as a result of the large urban adjustment factor and the disproportionate share 
adjustment for urban hospitals with 100 or more beds. Reclassification for wage 
index purposes affects the geographic adjustment factor since that factor is constructed 
from the hospital wage index. To present the effects of the hospitals being reclassified 
for FY 1997 compared to the effects of reclassification for FY 1996, we show the 
average payment percentage increase for hospitals reclassified in each fiscal 
year and in total. For FY 1997 reclassifications, we indicate those hospitals 
reclassified for standardized amount purposes only, for wage index purposes only, 
and for both purposes. The reclassified groups are compared to all other nonreclassified 
hospitals. These categories are further identified by urban and rural designation. 
Hospitals reclassified for FY 1997 as a whole are projected to experience a 4.5 
percent increase in payments (a 0.8 percent decrease attributable to Federal rate 
changes and a 5.3 percent positive offset attributable to the effects of all other 
changes). Payments to nonreclassified hospitals will increase slightly less (3.9 
percent) than reclassified hospitals (4.5 percent). Payments to nonreclassified 
hospitals will decrease slightly more than reclassified hospitals from the Federal 
rate changes (1.3 percent compared to 0.8 percent), but they will gain about the 
same from the effects of all other changes (5.2 percent compared to 5.3 percent). 
Table V.--Comparison Of Total Payments Per Case [FY 1996 Payments Compared to 
FY 1997 Payments] ---------------------------------------------------------------------------------------------------------------- 
Average FY Average FY Portion Number of 1996 1997 attibutable hospitals payments/ 
payments/ All changes to federal case case rate change ---------------------------------------------------------------------------------------------------------------- 
By Geographic Location: All hospitals.............................. 5,104 718 
746 3.9 -1.3 Large urban areas (populations over 1 million).................................. 
1,584 823 852 3.6 -1.2 Other urban areas (populations of 1 million of fewer)................................. 
1,275 715 745 4.1 -1.1 Rural areas................................ 2,245 478 501 
4.7 -1.7 Urban hospitals............................ 2,859 776 806 3.8 -1.2 0-99 
beds.............................. 697 566 589 4.0 -1.3 100-199 beds........................... 
941 705 732 3.7 -1.3 200-299 beds........................... 576 744 774 4.0 -1.3 
300-499 beds........................... 478 801 830 3.7 -1.2 500 or more beds....................... 
167 944 980 3.8 -0.9 Rural hospitals............................ 2,245 478 501 
4.7 -1.7 0-49 beds.............................. 1,175 367 385 5.0 -2.0 50-99 
beds............................. 656 447 468 4.8 -1.6 100-149 beds........................... 
241 511 532 4.2 -1.7 150-199 beds........................... 98 511 540 5.6 -1.4 
200 or more beds....................... 75 612 638 4.3 -2.0 By Region: Urban by 
Region............................ 2,859 776 806 3.8 -1.2 New England............................ 
160 784 817 4.3 -1.9 Middle Atlantic........................ 434 813 848 4.2 -1.2 
South Atlantic......................... 418 780 814 4.3 -1.1 East North Central..................... 
480 727 749 3.1 -1.2 East South Central..................... 162 707 733 3.7 -0.8 
West North Central..................... 190 772 809 4.8 -1.0 West South Central..................... 
367 796 823 3.4 -0.4 Mountain............................... 126 775 797 2.7 -1.5 
Pacific................................ 474 855 883 3.3 -1.7 Puerto Rico............................ 
48 305 326 6.8 -0.4 Rural by Region............................ 2,245 478 501 
4.7 -1.7 New England............................ 53 606 698 15.2 -2.3 Middle Atlantic........................ 
84 497 525 5.6 -2.7 South Atlantic......................... 297 498 511 2.8 -2.0 
East North Central..................... 304 482 510 5.9 -1.3 East South Central..................... 
278 446 463 3.8 -1.8 West North Central..................... 525 454 477 5.2 -1.7 
West South Central..................... 347 440 449 2.1 -1.3 Mountain............................... 
211 504 534 6.1 -0.8 Pacific................................ 141 555 587 5.9 -1.3 
By Payment Classification: All hospitals.............................. 5,104 718 
746 3.9 -1.3 Large urban areas (populations over 1 million).................................. 
1,779 807 836 3.6 -1.2 Other urban areas (populations of 1 million of fewer)................................. 
1,180 715 746 4.2 -1.1 Rural areas................................ 2,145 472 494 
4.7 -1.8 [[Page 46320]] Teaching Status: Non-teaching........................... 
4,019 622 645 3.8 -1.3 Fewer than 100 Residents............... 850 757 787 3.9 
-1.2 100 or more Residents.................. 235 1,034 1,079 4.3 -1.2 Urban DSH: 
100 or more beds................... 1,409 813 843 3.7 -1.2 Less than 100 beds................. 
100 576 607 5.4 -1.2 Rural DSH: Sole Community (SCH/EACH).......... 156 449 486 
8.1 -1.5 Referral Center (RRC/EACH)......... 27 533 541 1.5 -1.0 Other Rural: 
100 or more beds............... 83 488 504 3.3 -2.5 Less than 100 beds............. 
151 367 379 3.3 -2.2 Urban teaching and DSH: Both teaching and DSH.................. 
692 879 911 3.6 -1.2 Teaching and no DHS.................... 339 786 821 4.5 -1.1 
No teaching and DSH........................ 817 710 737 3.9 -1.2 No teaching and 
no DSH..................... 1,111 673 697 3.6 -1.1 Rural Hospital Types: Non special 
status hospitals............... 1,372 439 458 4.2 -2.2 RRC/EACH................................... 
90 559 573 2.6 -1.1 SCH/EACH................................... 645 470 502 6.8 
-1.6 SCH, RRC and EACH.......................... 38 582 6.5 5.7 -1.4 Hospitals 
Reclassified by the Medicare Geographic Classification Review 
Board: Reclassification Status During FY96 and FY97: Reclassified During Both 
FY96 and FY97. 379 662 685 3.5 -1.5 Reclassified During FY97 Only.............. 
98 673 732 8.7 2.0 Reclassified During FY96 Only.............. 230 652 661 1.4 
-3.9 FY 97 Reclassifications: All Reclassified Hospitals............. 477 664 
694 4.5 -0.8 All Nonreclassified Hospitals.......... 4,600 726 754 3.9 -1.3 All 
Urban Reclassified Hospitals....... 159 756 782 3.5 -1.0 Urban Nonreclassified 
Hospitals........ 2,700 778 808 3.8 -1.2 All Reclassified Rural Hospitals....... 
318 570 604 5.9 -0.7 Rural Nonreclassified Hospitals........ 1,900 442 460 4.1 
-2.2 Other Reclassified Hospitals (Section 1886 (D)(8)(B))................................ 
27 541 561 3.7 -1.8 Type of Ownership: Voluntary.................................. 
2,951 731 760 3.8 -1.3 Proprietary................................ 696 751 777 
3.4 -0.9 Government................................. 1,366 625 657 5.1 -1.5 Medicare 
Utilization as a Percent of Inpatient Days: 0-25....................................... 
258 797 830 4.1 -2.0 25-50...................................... 1,284 843 875 
3.9 -1.2 50-60...................................... 2,097 676 703 4.0 -1.2 Over 
65.................................... 1,374 603 627 4.0 -1.3 ----------------------------------------------------------------------------------------------------------------  
Go to Top 
 Appendix B: Technical Appendix on the Capital 
Acquisition Model and Required Adjustments Under section 1886(g)(1)(A) of the 
Act, we set capital prospective payment rates for FY 1992 through FY 1995 so that 
aggregate prospective payments for capital costs were projected to be 10 percent 
lower than the amount that would have been payable on a reasonable cost basis 
for capital-related costs in that year. To implement this requirement, we developed 
the capital acquisition model to determine the budget neutrality adjustment factor. 
Even though the budget neutrality requirement expires effective with FY 1996, 
we must continue to determine the recalibration and geographic reclassification 
budget neutrality adjustment factor, and the reduction in the Federal and hospital-specific 
rates for exceptions payments. We continue to use the capital acquisition model 
to determine these factors. The following data are used in the capital acquisition 
model for FY 1997: the June 30, 1996 update of the cost reports for PPS-IX (cost 
reporting periods beginning in FY 1992), PPS-X (cost reporting periods beginning 
in FY 1993) and PPS-XI (cost reporting periods beginning in FY 1994), the July 
1, 1996 update of the provider-specific file, and the March 1994 update of the 
intermediary audit file. The available data still lack certain items that were 
required for the determination of budget neutrality, including each hospital's 
projected new capital costs for each year, its projected old capital costs for 
each year, and the projected obligated capital amounts that will be put in use 
for patient care services and recognized as old capital each year. Since hospitals 
under alternative payment system waivers (that is, hospitals in Maryland) are 
currently excluded from the capital prospective [[Page 46321]] payment system, 
we excluded these hospitals from our model. We then developed FY 1992, FY 1993, 
FY 1994, FY 1995, and FY 1996 hospital-specific rates using the provider-specific 
file, the intermediary audit file, and, when available, cost reports. (We used 
the cumulative provider-specific file, which includes all updates to each hospital's 
records, and chose the latest record for each fiscal year.) We checked the consistency 
between the provider-specific file and the intermediary audit file. We also ensured 
that the FY 1993 increase in the hospital-specific rate was at least 0.62 percent 
(the net FY 1993 update), that the FY 1994 hospital-specific rate was at least 
as large as the FY 1993 hospital-specific rate decreased by 2.16 percent (the 
net FY 1994 update), that the FY 1995 increase in the hospital-specific rate was 
at least 0.05 percent (the net FY 1995 update), and that the FY 1996 increase 
in the hospital-specific rate was at least 21.10 percent (the net FY 1996 update). 
We were able to match hospitals to the files as shown in the following table. 
------------------------------------------------------------------------ Number 
of Source hospitals ------------------------------------------------------------------------ 
Provider-Specific File Only................................ 99 Provider-Specific 
and Audit File........................... 5029 Other...................................................... 
1 ------------ Total................................................ 5129 ------------------------------------------------------------------------ 
Sixty-six of these hospitals had unusable or missing data. We were able to backfill 
a hospital-specific rate for 41 of these hospitals from the cost reports as shown 
in the following table. ------------------------------------------------------------------------ 
Number of Source hospitals ------------------------------------------------------------------------ 
PPS-VII Cost Reports....................................... 1 PPS-VIII Cost Reports...................................... 
2 PPS-IX Cost Reports........................................ 3 PPS-X Cost Reports......................................... 
7 PPS-XI Cost Reports........................................ 28 ------------ 
Total................................................ 41 ------------------------------------------------------------------------ 
We did not have data for 25 hospitals, and had to eliminate them from the capital 
analysis. These hospitals likely are new hospitals or hospitals with very few 
Medicare admissions. This leaves us with 5104 hospitals and should 
not affect the precision of the required adjustment factors. Next, we determined 
old and new capital amounts for FY 1992 using the PPS-IX cost reports as the first 
source of data. For FY 1993 amounts, we used PPS-IX and PPS-X cost reports as 
the first source of data, weighting each cost report by the number of days in 
FY 1993. For FY 1994 amounts, we used PPS-X and PPS-XI cost reports as the first 
source of data, weighting each cost report by the number of days in FY 1994. We 
were able to match 5,049 PPS-IX cost reports, 5,064 PPS-X cost reports, and 4,924 
PPS-XI cost reports. In cases where cost reports could not be matched, we used 
the provider-specific file for old capital information. Even in cases where a 
cost report was available, the breakout of old and new capital was not always 
available. In these cases, we used the old capital amounts and new capital ratios 
from the provider-specific file. If these were missing, we derived the old capital 
amount from the hospital-specific rate. Finally, we used the intermediary audit 
file to develop obligated capital amounts. Since the obligated amounts are aggregate 
projected amounts, we computed a Medicare capital cost per admission 
associated with these amounts. We adjusted the aggregate amounts by the following 
factors: (1) Medicare inpatient share of capital. This was derived 
from cost reports and was limited to the Medicare share of total 
inpatient days. It was necessary to limit the Medicare share 
because of data integrity problems. Medicare share of inpatient 
days is a reasonably good proxy for allocating capital. However, it may be understated 
if Medicare utilization is high, and may be overstated because 
it does not reflect the outpatient share of capital. (2) Capitalization factor. 
This factor allocates the aggregate amount of obligated capital to depreciation 
and interest amounts. Consistent with the assumptions in the capital input price 
index, we used a 25-year life for fixed capital and a 10-year life for movable 
capital, and an average projected interest rate of 6.7 percent. We also assumed 
that fixed capital acquisitions are about one-half of total capital. In conjunction 
with the useful life and interest rate assumptions, the resulting capitalized 
fixed capital is about one-half of total capitalization. This is consistent with 
the allocations between fixed and movable capital found on the cost reports. The 
ratio we developed is 0.137, which produces the first year capitalization based 
on the aggregate amount. (3) A divisor of Medicare admissions 
to derive the capital costs per discharge amount. Since we must project capital 
amounts for each hospital, we continued to use a Monte Carlo simulation to develop 
these amounts. (This model is described in detail in the August 30, 1991 final 
rule (56 FR 43517).) The Monte Carlo simulation is now used only to project capital 
costs per discharge amounts for each hospital. We analyzed the distributions of 
capital increases, and noted a slightly negative correlation between the dollar 
level of capital cost per admission, and the rate of increase in capital. To determine 
the rate of increase in capital cost per admission, we multiplied the lesser of 
$3,000 or the capital cost per admission by .00006 and subtracted this result 
from 1.2. (Increases for capital levels over $3,000 were not influenced by the 
level of capital, so this part of the calculation was capped at $3,000.) We selected 
a random number from the normal distribution, multiplied it by 0.17 (the standard 
deviation) and added it to -0.04 (the mean) and then added 1 to create a multiplier. 
This random result was multiplied by the previous result to assign a rate of increase 
factor which was multiplied by the prior year's capital per discharge amount to 
develop a capital per discharge amount for the projected year. To model a projected 
year, we used the old and new capital for the prior year multiplied by 0.85 (aging 
factor). The 0.85 aging factor is the average of changes in capital over its life 
due to the gradual decrease in interest payments and the retirement of fully depreciated 
capital. The aged new and old capital is subtracted from the projected capital 
described in the previous paragraph. The difference represents newly acquired 
capital. If the hospital has obligated capital, any increase in "old" capital 
up to the total amount of obligated capital in FY 1993 and FY 1994 is assigned 
to obligated capital. Any remaining obligated capital is assigned to FY 1995 up 
to the amount of the modeled increase in capital for FY 1995. Even though obligated 
capital must be put in use for patient care by October 1, 1994, the use of the 
obligated capital may have started late in FY 1994 with only part of the "first 
year" depreciation and interest realized in FY 1994. The remainder of the "first 
year" depreciation and interest would be realized in FY 1995. With the exception 
of certain hospitals about whom we have information to the contrary, we assume 
that hospitals would meet the expiration dates provided under the obligated capital 
provision. Hence, no obligated capital is assigned to years FY 1996 and later. 
Once obligated capital is assigned, it is included with the "old" capital and 
is capitalized into future years as part of "old" capital. The on-line obligated 
amounts are added to old capital and subtracted from the newly acquired capital 
to yield residual newly acquired capital, which is then added to new capital. 
The residual newly [[Page 46322]] acquired capital is never permitted to be less 
than zero. Next, we computed the average total capital cost per discharge from 
the capital costs that were generated by the model and compared the results to 
total capital costs per discharge that we had projected independently of the model. 
We adjusted the newly acquired capital amounts proportionately, so that the total 
capital costs per discharge generated by the model match the independently projected 
capital costs per discharge. Once each hospital's capital-related costs are generated, 
the model projects capital payments. We use the actual payment parameters (for 
example, the case-mix index and the geographic adjustment factor) that are applicable 
to the specific hospital. To project capital payments, the model first assigns 
the applicable payment methodology (fully prospective or hold-harmless) to the 
hospital. If available, the model uses the payment methodology indicated in the 
PPS-IX cost reports or the provider-specific file. Otherwise, the model determines 
the methodology by comparing the hospital's FY 1992 hospital-specific rate to 
the adjusted Federal rate applicable to the hospital. The model simulates Federal 
rate payments using the assigned payment parameters and hospital-specific estimated 
outlier payments. The case-mix index for a hospital is derived from the FY 1995 
MedPAR file using the FY 1997 DRG relative weights published in this final rule. 
The case-mix index is increased each year after FY 1995 based on analysis of past 
experiences in case-mix increases. We analyzed the case-mix increases for the 
recent past and found that case-mix increases have decelerated to about 1.53 percent 
in FY 1992, 0.80 percent in FY 1993, and 0.75 percent in FY 1994. It appears that 
the case-mix increase for FY 1995 accelerated to around 1.6 percent. Early indications 
show that FY 1996 case-mix is increasing at FY 1995 level, that is, approximately 
1.6 percent. Thus, it appears that the deceleration of case-mix increases in FY 
1993 and FY 1994 were anamolous, rather than the beginning of a trend. Therefore, 
in the model we are using the recent experience and have used a case-mix increase 
of 1.6 percent in FY 1995 and a projected case-mix increase of 1.6 percent in 
both FY 1996 and FY 1997. (Since we are using FY 1995 cases for our analysis, 
the FY 1995 increase in case mix has no effect on projected capital payments.) 
Changes in geographic classification and revisions to the hospital wage data used 
to establish the hospital wage index affect the geographic adjustment factor. 
Changes in the DRG classification system and the relative weights affect the case-mix 
index. Section 1886(g)(1)(A) of the Act requires that, for discharges occurring 
after September 30, 1993, the unadjusted standard Federal rate be reduced by 7.4 
percent. Consequently, the model reduces the unadjusted standard Federal rate 
by 7.4 percent effective in FY 1994. Since budget neutrality expires effective 
with FY 1996, this adjustment affects the adjusted Federal rate starting in FY 
1996. Section 412.308(c)(4)(ii) requires that the estimated aggregate payments 
for the fiscal year, based on the Federal rate after any changes resulting from 
DRG reclassifications and recalibration and the geographic adjustment factor, 
equal the estimated aggregate payments based on the Federal rate that would have 
been made without such changes. For FY 1996, the budget neutrality adjustment 
factor was 1.0025. To determine the factor for FY 1997, we first determined the 
portion of the Federal rate that would be paid for each hospital in FY 1997 based 
on its applicable payment methodology. Using our model, we then compared estimated 
aggregate Federal rate payments based on the FY 1996 DRG relative weights and 
the FY 1996 geographic adjustment factor to estimated aggregate Federal rate payments 
based on the FY 1997 relative weights and the FY 1997 geographic adjustment factor. 
In making the comparison, we held the FY 1997 Federal rate portion constant and 
set the other budget neutrality adjustment factor and the exceptions reduction 
factor to 1.00. We determined that to achieve budget neutrality for the changes 
in the geographic adjustment factor and DRG classifications and relative weights, 
an incremental budget neutrality adjustment of 0.9987 for FY 1997 should be applied 
to the previous cumulative FY 1996 adjustment of 1.0025 (the product of the FY 
1993 incremental adjustment of 0.9980, the FY 1994 incremental adjustment of 1.0053, 
the FY 1995 incremental adjustment of 0.9998, and the FY 1996 incremental adjustment 
of 0.9994), yielding a cumulative adjustment of 1.0012 through FY 1997. The methodology 
used to determine the recalibration and geographic (DRG/GAF) budget neutrality 
adjustment factor is similar to that used in establishing budget neutrality adjustments 
under the prospective payment system for operating costs. One difference is that 
under the operating prospective payment system, the budget neutrality adjustments 
for the effect of geographic reclassifications are determined separately from 
the effects of other changes in the hospital wage index and the DRG relative weights. 
Under the capital prospective payment system, there is a single DRG/GAF budget 
neutrality adjustment factor for changes in the geographic adjustment factor (including 
geographic reclassification) and the DRG relative weights. In addition, there 
is no adjustment for the effects that geographic reclassification has on the other 
payment parameters, such as the payments for serving low income patients or the 
large urban add-on. In addition to computing the DRG/GAF budget neutrality adjustment 
factor, we used the model to simulate total payments under the prospective payment 
system. Additional payments under the exceptions process are accounted for through 
a reduction in the Federal and hospital-specific rates. Therefore, we used the 
model to calculate the exceptions reduction factor. This exceptions reduction 
factor ensures that aggregate payments under the capital prospective payment system, 
including exceptions payments, are projected to equal the aggregate payments that 
would have been made under the capital prospective payment system without an exceptions 
process. Since changes in the level of the payment rates change the level of payments 
under the exceptions process, the exceptions reduction factor must be determined 
through iteration. In the August 30, 1991 final rule (56 FR 43517), we indicated 
that we would publish each year the estimated payment factors generated by the 
model to determine payments for the next 5 years. The table below provides the 

actual factors for FY 1992, FY 1993, FY 1994, FY 1995, FY 1996, the final FY 1997 
factor, and the estimated factors that would be applicable through FY 2001. We 
caution that, except with respect to FY 1992, FY 1993, FY 1994, FY 1995, FY 1996 
and FY 1997, these are estimates only, and are subject to revisions resulting 
from continued methodological refinements, more recent data, and any payment policy 
changes that may occur. In this regard, we note that in making these projections 
we have assumed that the cumulative DRG/GAF adjustment factor will remain at 1.0012 
for FY 1997 and later because we do not have sufficient information to estimate 
the change that will occur in the factor for years after FY 1997. The projections 
are as follows: [[Page 46323]] ---------------------------------------------------------------------------------------------------------------- 
Federal Update Exceptions Budget rate (after Fiscal year factor reduction neutrality 
outlier) factor factor reduction) ---------------------------------------------------------------------------------------------------------------- 
1992........................................................ N/A 0.9813 0.9602 
415.59 1993........................................................ 6.07 .9756 
.9162 \1\ 417.29 1994........................................................ 
3.04 .9485 .8947 \2\ 378.34 1995........................................................ 
3.44 .9734 .8432 \3\ 376.83 1996........................................................ 
1.20 .9849 N/A \4\ 461.96 1997........................................................ 
0.70 .9358 N/A \5\ 438.92 1998........................................................ 
1.20 .9121 N/A 432.94 1999........................................................ 
1.20 .9206 N/A 442.22 2000........................................................ 
1.30 9148 N/A 445.15 2001........................................................ 
1.30 \6\ N/A N/A 492.93 ---------------------------------------------------------------------------------------------------------------- 
\1\ Note: Includes the DRG/GAF adjustment factor of 0.9980 and the change in the 
outlier adjustment from 0.9497 in FY 1992 to 0.9496 in FY 1993. \2\ Note: Includes 
the 7.4 percent reduction in the unadjusted standard Federal rate. Also includes 
the DRG/GAF adjustment factor of 1.0033 and the change in the outlier adjustment 
from 0.9496 in FY 1993 to 0.9454 in FY 1994. \3\ Note: Includes the DRG/GAF adjustment 
factor of 1.0031 and the change in the outlier adjustment from 0.9454 in FY 1994 
to 0.9414 in FY 1995. \4\ Note: Includes the transfer adjustment of .9972. Also 
includes the DRG/GAF adjustment factor of 1.0025 and the change in the outlier 
adjustment from 0.9414 in FY 1995 to 0.9536 in FY 1996. \5\ Note: Includes the 
DRG/GAF adjustment factor of 1.0012 and the change in the outlier adjustment from 
0.9536 in FY 1996 to 0.9481 in FY 1997. Future adjustments are, for purposes of 
this projection, assumed to remain at the same level. \6\ Note: We are unable 
to estimate exceptions payments for the year under the special exceptions provision 
(Sec. 412.348(g) of the regulations) because the regular exceptions provision 
(Sec. 412.348(e)) expires. 
Go to Top
 Appendix C: Rebased Market Basket Data Sources 
I. Data Sources Used to Determine the Market Basket Relative Weights and Choice 
of Price Proxy Variables for the Operating Hospital Input Price Indexes As discussed 
in section IV of the preamble to this final rule, we are rebasing and revising 
the hospital market baskets. This appendix describes the technical features of 
the 1992-based indexes that we are implementing in this rule. For both the prospective 
payment and excluded hospital market baskets, the differences between the 1992- 
based market basket and the previous 1987-based market basket are noted. In the 
September 4, 1990 final rule (55 FR 36170), we discussed in detail the 1987-based 
hospital market baskets. We present this description of the hospital operating 
market baskets in three steps: <bullet> A synopsis of the structural differences 
between the 1987- based market baskets and the proposed 1992-based market baskets. 

<bullet> A description of the methodology used to develop the cost category 
weights in the 1992-based market baskets, making note of the differences from 
the methodology used to develop the 1987-based market baskets. <bullet> 
A description of the data sources used to measure price change for each component 
of the 1992-based market baskets, making note of the differences from the price 
proxies used in the 1987-based hospital market baskets. A. Synopsis of Structural 
Changes Adopted in the Rebased 1992 Operating Hospital Market Baskets. Three major 
structural differences exist between the 1987-based and the 1992-based operating 
hospital market baskets. <bullet> The 1992-based hospital market baskets 
are based on more recent hospital expenditure data. The 1987-based market baskets 
contained skeletal cost shares that were derived from the 1987 cost data from 
the 1988 Annual Survey of the American Hospital Association (AHA). The 1992-based 
market baskets use data from the hospital cost reports for cost reporting periods 
beginning on or after October 1, 1991 and before October 1, 1992. <bullet> 
Some cost categories have been combined, namely Fuel, Oil, Coal, and Other Fuel 
with Motor Gasoline, and Blood Services with Chemicals. These category mergers 
reflect the Bureau of Economic Analysis (BEA) reclassification decisions in the 
1987 update of the BEA Input-Output Tables. <bullet> In the 1992-based market 
basket, the sample of excluded hospitals is restricted to more closely reflect 
the average Medicare length of stay in excluded hospitals. We 
have used cost report data for excluded hospitals from only those hospitals in 
which the average length of stay of Medicare patients in the 
hospital is within 15 percent of the average length of stay of all patients in 
the hospital to more accurately reflect the structure of costs for Medicare 

cases. This is a change from the FY 1987-based market basket, for which data from 
all excluded hospitals were used. B. Methodology for Developing the Cost Category 
Weights. Cost category weights for the 1992-based market baskets were developed 
in four stages. First, base weights for three (Wages and Salaries, Employee Benefits, 
Pharmaceuticals) of the six main categories were derived from the 1992 Medicare 
cost reports for operating costs. Second, the weight for Nonmedical Professional 
Fees was developed by subtracting Medical Professional Fees reported in the Hospital 
Cost Report Information System (HCRIS) file from AHA Annual Survey Total Professional 
Fees to obtain Nonmedical Professional Fees, and the weight for Professional Liability 
Insurance was developed using 1989 HCRIS data trended forward to 1992, using the 
relative importance values in the previous market baskets. Third, the sum of Wages 
and Salaries, Employee Benefits, Pharmaceuticals, Nonmedical Professional Fees, 
and Professional Liability Insurance was subtracted from total expenses to obtain 
All Other Expenses. Finally, the weight for All Other Expenses was divided into 
subcategories using cost shares from the 1987 Input-Output Table for the hospital 
industry, produced by the U.S. Department of Commerce, Bureau of Economic Analysis, 
aged to 1992 using price changes. As of this writing the Department of Commerce 
has not released final 1992 cost data. Therefore we plan to incorporate these 
data into the FY 1998 proposed rule. Below, we describe the source of the six 
main category weights and their subcategories in the 1992-based market [[Page 
46324]] baskets. We make note of the differences between the methodologies used 
to develop the 1987-based and the 1992-based market baskets. 1. Wages and Salaries 
The cost weight for the Wages and Salaries category was derived using the 1992 
Medicare cost reports. Contract Labor, which is also derived 
from the 1992 Medicare cost reports, is split between the Wages 
and Salaries and Employee Benefits cost categories, using the relationship for 
employed workers. Examples of Contract Labor are registered nurses and workers 
in hospital food service or security who are employed and paid by firms that contract 
for their work with the hospital. The Wages and Salaries cost category was disaggregated 
into nine occupational subcategories (professional and technical, managers and 
administration, sales, clerical, craft and kindred, operatives excluding transport, 
transport equipment operatives, nonfarm laborers and service workers) to reflect 
the mix of occupational inputs used by hospitals. The Contract Labor wages and 
salaries component was allocated proportionally to Professional-Technical and 
Service occupations. The 1987-based weights were developed from the 1987 Current 
Population Survey, while the 1992-based weights were developed from the 1992 Current 
Population Survey. 2. Employee Benefits The cost weight for the employee benefits 
category was derived from the 1992 cost reports. Like wages and salaries, the 
employee benefit weight in each 1992-based market basket is a composite of nine 
labor subcategories. The employee benefits categories in the 1987-based market 
baskets were developed from the 1987 AHA Annual Survey and used the 1987 Current 
Population Survey. In 1987 Contract Labor's implied fringe benefits were allocated 
proportionally to Professional and Technical occupations, while in 1992 they were 
allocated to Professional-Technical and Service occupations. 3. Nonmedical Professional 
Fees The cost weight for the nonmedical professional fees category was derived 
from the 1992 Medicare Cost Reports and AHA Annual Survey data. 
Total professional fees were split into the subcategories medical and other (nonmedical) 
fees using AHA Total Professional Fees minus HCRIS Medical Professional Fees to 
equal Nonmedical Professional Fees. The 1987-based nonmedical professional fees 
cost category was derived from the 1987 AHA Annual Survey and American Medical 
Association (AMA) data. It was split into the subcategories medical and other 
fees using data derived from the American Medical Association. The medical professional 
fees category is excluded from the hospital market basket since it is paid under 
Medicare Part B. 4. Professional Liability Insurance The 1987-based 
market baskets have weights for professional liability insurance that were derived 
from the June 30 and December 31, 1987 HAS/Monitrend surveys. The cost weight 
for the 1992-based professional liability insurance category was derived from 
1989 HCRIS cost shares trended to 1992 using the change in the relative importance 
factor for professional liability insurance (malpractice) from the previous 1987-based 
prospective payment hospital and excluded hospital market baskets. 5. Utilities 
For the 1987-based market baskets, the cost weight for utilities was derived by 
extrapolating the 1985 AHA Annual Survey utilities cost weight forward to 1987 
using the rate of growth in the HAS/Monitrend cost weight for utilities between 
1985 and 1987. The 1987 Utility subcategory weights were aged from their 1982-based 
index subcategory weights using price changes from 1982 to 1987. The 1992-based 
market basket cost weights for the subcategories (fuel, oil and gasoline; electricity; 
natural gas; and water and sewage) were derived from the Bureau of Economic Analysis' 
1987 Input-Output table for the hospital industry, aged forward to 1992 by price 
changes and summed to a weight for utilities. 6. All Other Goods and Services 
The all other goods and services category has more subcategories than any other 
market basket category. Goods found in this category include: direct service food, 
contract service food, pharmaceuticals, chemicals, medical instruments, photo 
supplies, rubber and plastics, paper products, apparel, machinery and equipment 
and miscellaneous products. Services found in this category include: business 
services, computer services, transportation and shipping, telephone, postage, 
other labor-intensive services, and other nonlabor-intensive services. The share 
for pharmaceuticals was derived from the 1992 Medicare cost reports. 
Relative shares for the other subcategories were derived from the 1987 Bureau 
of Economic Analysis' Input-Output table for the hospital industry and were aged 
forward to 1992 using price changes. C. Price Proxies Used To Measure Cost Category 
Growth 1. Wages and Salaries For measuring price growth in the 1992-based market 
basket, 10 price proxies are applied to the 9 occupational subcategories within 
the wages and salaries component. As in the 1987-based market basket, the professional 
and technical subcategory was split in half. An Employee Cost Index (ECI) for 
hourly wages paid to civilian hospital workers was applied to one half. An ECI 
of hourly wages and salaries paid to professional and technical workers in private 
industry was applied to the other half of the professional and technical component. 
The other eight occupations subcategories of the wages and salaries component 
were proxied using ECIs for wages and salaries for private industry workers in 
their respective occupational categories. 2. Employee Benefits The 1992-based 
hospital market baskets use occupation-specific ECIs for employee benefits. The 
distribution of weights and price proxies is the same as for wages and salaries 
discussed above, but occupation- specific employee benefit ECIs replace occupation-specific 
wages and salaries ECIs. The components are summed into a composite index, just 
as was done for the 1987-based market basket. 3. Nonmedical Professional Fees 
The ECI for compensation for professional and technical workers in private industry 
is applied to this category. This is a revision from the 1987-based market basket 
in which the ECI for wages and salaries for professional and technical workers 
in private industry was used. 4. Fuel, Oil, and Gasoline The percentage change 
in the price of refined petroleum products as measured by the Producer Price Index 
(PPI) (Commodity Code #057) was applied to this component. This is a revision 
from the 1987-based indexes in which the PPIs for Light Fuel Oil (Commodity Code 
#0573) and Gasoline (Commodity Code #0571) were used. 5. Electricity The percentage 
change in the price of commercial electric power as measured by the PPI (Commodity 
Code #0542) was applied to this component. This is a revision from the 1987-based 
indexes in [[Page 46325]] which the PPI for industrial power (Commodity Code #0543) 
was used. 6. Natural Gas The percentage change in the price of gas fuels as measured 
by the PPI (Commodity Code #0552) was applied to this component. This is a revision 
from the 1987-based indexes in which the PPI for Natural Gas (Commodity Code #0531) 
was used. 7. Water and Sewerage The percentage change in the price of water and 
sewerage maintenance as measured by the Consumer Price Index (CPI) for all urban 
consumers was applied to this component. The same price measure was used in the 
1987-based market baskets. 8. Professional Liability Insurance The percentage 
change in the hospital professional liability insurance price as estimated by 
hospital industry professional liability insurance premium increase was applied 
to this component. The same price measure was used in the 1987-based market baskets. 
9. Pharmaceuticals The percentage change in the price of ethical preparations 
as measured by the PPI (Commodity Code #0635) was applied to this variable. The 
same price measure was used in the 1987-based market baskets. 10. Food, Direct 
Purchases The percentage change in the price of processed foods and feeds as measured 
by the PPI (Commodity Code #02) was applied to this component. The same price 
measure was used in the 1987-based market baskets. 11. Food, Contract Services 
The percentage change in the price of food purchased away from home as measured 
by the CPI for all urban consumers was applied to this component. The same price 
measure was used in the 1987-based market baskets. 12. Chemicals The percentage 
change in the price of industrial chemical products as measured by the PPI (Commodity 
Code #061) was applied to this component. The same price measure was used in the 
1987-based market baskets. 13. Surgical and Medical Equipment The percentage change 
in the price of medical and surgical instruments as measured by the PPI (Commodity 
Code #1562) was applied to this component. The same price measure was used in 
the 1987-based market baskets. 14. Photographic Supplies The percentage change 
in the price of photographic supplies as measured by the PPI (Commodity Code #1542) 
was applied to this component. The same price measure was used in the 1987-based 
market baskets. 15. Rubber and Plastics The percentage change in the price of 
rubber and plastic products as measured by the PPI (Commodity Code #07) was applied 
to this component. The same price measure was used in the 1987-based market baskets. 
16. Paper Products The percentage change in the price of converted paper and paperboard 
products as measured by the PPI (Commodity Code #0915) was used. This is a revision 
from the 1987-based indexes in which a weighted average of the percentage change 
in the price of converted paper and paperboard products and the percentage change 
in the price of paper excluding newsprint and packaging paper (Commodity Code 
#091301) was used. 17. Apparel The percentage change in the price of apparel as 
measured by the PPI (Commodity Code #381) was applied to this component. This 
is a revision from the 1987-based indexes in which the PPI for textile house furnishings 
(Commodity Code #0382) was used. 18. Minor Machinery and Equipment The percentage 
change in the price of machinery and equipment as measured by the PPI (Commodity 
Code #11) was applied to this component. The same price measure was used in the 
1987-based market baskets. 19. Miscellaneous Products The percentage change in 
the price of all finished goods as measured by the PPI was applied to this component. 
The same price measure was used in the 1987-based market baskets. 20. Business 
Services The ECI for compensation for workers in the business services industry 
was applied to this component. This is a revision from the 1987-based indexes 
in which the percentage change in the AHE for wages and salaries for production 
and nonsupervisory workers in the business services industry as measured by the 
Bureau of Labor Statistics (SIC Code 73) was used. 21. Computer and Data Processing 
Services The percentage change in the AHE of production and nonsupervisory workers 
engaged in firms furnishing computer data processing services (SIC Code 737) was 
applied to this component. The same price measure was used in the 1987-based market 
baskets. 22. Transportation and Shipping The percentage change in the transportation 
component of the CPI for all urban consumers was applied to this component. The 
same price measure was used in the 1987-based market baskets. 23. Telephone The 
percentage change in the price of telephone services as measured by the CPI for 
all urban consumers was applied to this component. The same price measure was 
used in the 1987-based market baskets. 24. Postage The percentage change in the 
price of postage as measured by the CPI for all urban consumers was applied to 
this component. The same price measure was used in the 1987-based market baskets. 
25. All Other Services, Labor Intensive The percentage change in the ECI for compensation 
paid to service workers employed in private industry was applied to this component. 
This is a revision from the 1987-based indexes in which the ECI for wages and 
salaries paid to service workers employed in private industry was used. 26. All 
Other Services, Nonlabor Intensive The percentage change in the all-items component 
of the CPI for all urban consumers was applied to this component. The same price 
measure was used in the 1987-based market baskets. For further discussion of the 
rationale for choosing specific price proxies, we refer the reader to the September 
3, 1986 final rule (51 FR 31582). 

Go to Top 
 II. Data Sources Used to Determine the Cost 
Category Weights and Vintage Weights, and Choices of Price Proxy Variables for 
the Hospital Capital Input Price Index In the preamble to this final rule, we 
discuss the rebasing of the capital input price index (CIPI). This appendix describes 
certain technical features of the 1992-based index, as well as differences between 
the 1992-based CIPI and the 1987-based CIPI. We discussed [[Page 46326]] the 1987-based 
CIPI in the September 1, 1995 final rule (60 FR 45817.) This discussion has the 
following three parts: <bullet> A synopsis of the differences between the 
1987-based CIPI and the 1992-based CIPI. <bullet> A description of the methodology 
used to develop the cost category weights and vintage weights in the 1992-based 
CIPI, making note of the differences from the methodology used to develop the 
1987- based CIPI. <bullet> A description of the data sources used to measure 
price change for each component of the 1992-based CIPI, making note of the differences 
from the price proxies used in the 1987-based CIPI. A. Synopsis of Changes Adopted 
in the Rebased 1992 CIPI We made no structural changes in the 1992-based CIPI. 
The only major change is the use of more recent hospital capital expenditure data. 
The 1987-based CIPI contained cost category weights that were derived from 1987 
Medicare cost report data and the 1987 Annual Survey of the AHA. 
The 1992-based CIPI uses data from the hospital Medicare cost 
reports for cost periods beginning between October 1, 1991 and September 30, 1992. 
The 1992-based CIPI also uses data from the 1992 Annual Survey of the AHA. The 
1987-based CIPI contained vintage weights that were derived from 1987 Medicare 

cost report data, the 1963-1987 Panel Survey of the AHA, and the 1980-1989 Securities 
Data Corporation data on hospital bonds. The 1992-based CIPI uses data from the 
1992 Medicare cost reports, the 1963-1992 Panel Survey of the 
AHA, and 1980-1992 Securities Data Corporation data on hospital bonds. B. Methodology 
for Developing Cost Category Weights and Vintage Weights for the 1992-based CIPI 
There are five cost categories in the CIPI: Building and fixed equipment depreciation, 
movable equipment depreciation, capital-related interest expense from government/nonprofit 
debt instruments, capital- related interest expense from for-profit debt instruments, 
and other capital-related expenses, such as taxes and insurance. The methodology 
for developing each of these cost category weights is described below: 1. Building 
and Fixed Equipment Depreciation The 1992-based cost weight for building and fixed 
equipment depreciation was derived using the 1992 Medicare cost 
reports. The proportion of lease expenses attributable to building and fixed equipment 
was included in the cost weight based on the proportion of overall capital expenses 
allocated to building and fixed equipment depreciation. The 1987-based weight 
was developed from the 1987 Medicare cost reports and the 1987 
AHA Annual Survey. 2. Movable Equipment Depreciation The 1992-based cost weight 
for movable equipment depreciation was derived using the 1992 Medicare 
Cost Reports. The proportion of lease expenses attributable to movable equipment 
was included in the cost weight based on the proportion of overall capital expenses 
allocated to movable equipment depreciation. The 1987-based weight was developed 
from the 1987 Medicare cost reports and the 1987 AHA Annual Survey. 
3. Government/Nonprofit Interest The 1992-based cost weight for government/nonprofit 
interest was derived using the 1992 AHA Annual Survey data. The government/nonprofit 
interest is 85 percent of total interest, reflecting the relative debts of the 
government/nonprofit hospital sector and the for-profit hospital sector. The proportion 
of lease expenses attributable to government/ nonprofit interest was included 
in the cost weight based on the proportion of overall capital expenses allocated 
to government/non- profit interest expense. The 1987-based weight was developed 
from the 1987 AHA Annual Survey. 4. For-Profit Interest The 1992-based cost weight 
of for-profit interest was derived using the 1992 AHA Annual Survey data. The 
for-profit interest is 15 percent of total interest, reflecting the relative debts 
of the government/ nonprofit hospital sector and the for-profit hospital sector. 
The proportion of lease expenses attributable to for-profit interest was included 
in the cost weight based on the proportion of overall capital expenses allocated 
to for-profit interest expense. The 1987-based weight was developed from the 1987 
AHA Annual Survey. 5. Other Capital-Related Expenses The 1992-based cost weight 
for other capital-related expenses was derived using 1992 Medicare 

cost reports. The proportion of lease expenses attributable to other capital-related 
expenses was included in the cost weight based on the proportion of overall capital 
expenses allocated to other capital-related expenses. The 1987-based weight was 
developed from the 1987 Medicare cost reports and the 1987 Capital 
Expenditure Survey. 6. There are three sets of vintage weights in the CIPI Building 
and fixed equipment depreciation, movable equipment depreciation, and interest 
expense. The methodology for developing each of these vintage weights is described 
below. a. Building and Fixed Equipment: The 1992-based building and fixed equipment 
vintage weights were derived from the 1992 Medicare cost reports 
and the 1963-1992 AHA Panel Survey. The 1987-based weights were developed from 
the 1987 Medicare cost reports and the 1963-1987 AHA Panel Survey. 
b. Movable Equipment: The 1992-based movable equipment vintage weights were derived 
from the 1992 Medicare cost reports and the 1963- 1992 AHA Panel 
Survey. The 1987-based weights were developed from the 1987 Medicare 
cost reports and the 1963-1987 AHA Panel Survey. c. Capital-Related Interest: 
The 1992-based movable equipment vintage weights were derived from the 1980-1992 
Securities Data Corporation data on hospital bonds and the 1963-1992 AHA Panel 
Survey. The 1987-based weights were developed from the 1980-1989 Securities Data 
Corporation data on hospital bonds and the 1963-1987 AHA Panel Survey. C. Price 
Proxies Used to Measure Cost Category Growth in the CIPI 1. Building and Fixed 
Equipment Depreciation The percentage change in the vintage-weighted price of 
building and fixed equipment depreciation as measured by the Boeckh institutional 
construction index was applied to this category in the 1992-based CIPI. The same 
price proxy was used in the 1987-based CIPI. 2. Movable Equipment Depreciation 
The percentage change in the vintage-weighted price of movable equipment depreciation 
as measured by the Producer Price Index (PPI) for machinery and equipment was 
applied to this category in the 1992- based CIPI. The same price proxy was used 
in the 1987-based CIPI. 3. Government/Nonprofit Interest Expense The percentage 
change in the vintage-weighted price of government/ nonprofit interest expense 
as measured by the Average yield on Domestic Municipal Bonds from the Bond Buyer 
index of 20 bonds was applied to this category in [[Page 46327]] the 1992-based 
CIPI. The same price proxy was used in the 1987-based CIPI. 4. For-Profit Interest 
Expense The percentage change in the vintage-weighted price of for-profit interest 
expense as measured by the Average yield on Moody's Aaa Bonds was applied to this 
category in the 1992-based CIPI. The same price proxy was used in the 1987-based 
CIPI. 5. Other Capital-Related Expenses The percentage change in the price of 
other capital-related expenses as measured by the CPI for all urban consumers 
for residential rent was applied to this category in the 1992-based CIPI. The 
same price proxy was used in the 1987-based CIPI. We provided more detailed discussion 
of the rationale for the choice of these price proxies in the June 2, 1995 proposed 
rule (60 FR 29227) and in the September 1, 1995 final rule (60 FR 45815). 
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 Appendix D: Recommendation of Update Factors 
for Operating Cost Rates of Payment for Inpatient Hospital Services I. Background 
Several provisions of the Social Security Act (the Act) address the setting of 
update factors for inpatient services furnished in FY 1997 by hospitals subject 
to the prospective payment system and those excluded from the prospective payment 
system. Section 1886(b)(3)(B)(i)(XII) of the Act sets the FY 1997 percentage increase 
in the operating cost standardized amounts equal to the rate of increase in the 
hospital market basket minus 0.5 percentage points for prospective payment hospitals 
in all areas. Section 1886(b)(3)(B)(iv) of the Act sets the FY 1997 percentage 
increase in the hospital- specific rates applicable to sole community hospitals 
equal to the rate set forth in section 1886(b)(3)(B)(i) of the Act, that is, the 
same update factor as all other hospitals subject to the prospective payment system, 
or the rate of increase in the market basket minus 0.5 percentage points. Section 
1886(b)(3)(B)(ii) of the Act sets the FY 1997 percentage increase in the rate 
of increase limits for hospitals excluded from the prospective payment system 
equal to the rate of increase in the excluded hospital market basket minus the 
applicable reduction or, in the case of a hospital in a fiscal year for which 
the hospital's update adjustment percentage is at least 10 percent, the excluded 
hospital market basket percentage increase. Under section 1886(b)(3)(B)(v) of 
the Act, a hospital's update adjustment percentage increase for FY 1997 is the 
percentage increase by which the hospital's allowable operating costs of inpatient 
hospital services recognized under this title for the cost reporting period beginning 
in FY 1990 exceed the hospital's target amount for such cost reporting period, 
increased for each fiscal year (beginning with FY 1994) by the sum of any of the 
hospital's applicable reductions for previous years. The applicable reduction 
with respect to a hospital for FY 1997 is the lesser of 1 percentage point or 
the percentage point difference between 10 percent and the hospital's update adjustment 
percentage for FY 1997. In accordance with section 1886(d)(3)(A) of the Act, we 
are updating the standardized amounts, the hospital-specific rates, and the rate-of-increase 
limits for hospitals excluded for the prospective payment system as provided in 
section 1886(b)(3)(B) of the Act. Based on the second quarter 1996 forecast of 
the FY 1997 rebased market basket increase of 2.5 percent for hospitals subject 
to the prospective payment system, the updates in the standardized amounts are 
2.0 percent for hospitals in both large urban and other areas. The update in the 
hospital-specific rate applicable to sole community hospitals is 2.0 percent (that 
is, the market basket rate of increase of 2.5 percent minus 0.5 percentage points). 
The update for hospitals excluded from the prospective payment system is based 
on the percentage increase in the excluded hospital market basket (currently estimated 
at 2.5 percent) minus the applicable reduction factor. The applicable reduction 
factor is the lesser of 1 percentage point or the percentage point difference 
between 10 percent and the hospital's update adjustment percentage. Therefore, 
for excluded hospitals, the hospital- specific update can vary between 1.5 and 
2.5 percent. Sections 1886(e)(2)(A) and (3)(A) of the Act require that the Prospective 
Payment Assessment Commission (ProPAC) recommend to the Congress by March 1 of 
each year an update factor that takes into account changes in the market basket 
rate of increase index, hospital productivity, technological and scientific advances, 
the quality of health care provided in hospitals, and long-term cost effectiveness 
in the provision of inpatient hospital services. Section 1886(e)(4) of the Act 
requires that the Secretary, taking into consideration the recommendations of 
ProPAC, recommend update factors for each fiscal year that take into account the 
amounts necessary for the efficient and effective delivery of medically appropriate 
and necessary care of high quality. Under section 1886(e)(5) of the Act, we published 
the FY 1996 update factors recommended under section 1886(e)(4) of the Act as 
Appendix E of the May 31, 1996 final rule (61 FR 27591). 
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 II. Secretary's Final Recommendation for 
Updating the Prospective Payment System Standardized Amounts We did not receive 
any public comments concerning our proposed recommendation. Therefore, our final 
recommendation will be the same as our proposed recommendation. That is, we are 
recommending that the standardized amounts be increased by an amount equal to 
the market basket rate of increase minus 1.5 percentage points for hospitals located 
in large urban and other areas. We are also recommending an update of the market 
basket rate of increase minus 1.5 percentage points to the hospital-specific rate 
for sole community hospitals. These figures are consistent with the President's 
budget recommendation. In recommending these increases, we have followed section 
1886(e)(4) of the Act, which requires that we take into account the amounts necessary 
for the efficient and effective delivery of medically appropriate and necessary 
care of high quality. In addition, as required by section 1886(e)(4) of the Act, 
we have taken into consideration the recommendations of ProPAC. We believe our 
analyses, which measure changes in hospital productivity, scientific and technological 
advances, practice pattern changes, and changes in case mix, support our recommendations. 
These figures are consistent with the President's FY 1997 budget recommendation, 
which continues the reductions imposed by section 13501 of the Omnibus Budget 
Reconciliation Act of 1993 (Public Law 103-66), that is, reductions in the hospital 
market basket of 2.5 percentage points for FYs 1994 and 1995 and 2.0 percentage 
points for FY 1996. We believe these recommended changes in the update factor 
would ensure that Medicare acts as a prudent purchaser and provide 
incentives to hospitals for increased efficiency, thereby contributing to the 
solvency of the Medicare Part A Trust Fund. When the President's 
budget was submitted, the market basket rate of increase was projected at 3.6 
percent. As noted above, our final recommendation is based on the most recent 
forecast of the rebased market basket. (See section IV of the [[Page 46328]] preamble 
to this final rule for a detailed discussion of the market basket.) 
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 III. Secretary's Final Recommendation for 
Updating the Rate-of-Increase Limits for Excluded Hospitals and Units Our final 
recommendation is that hospitals and hospital units excluded from the prospective 
payment system receive an update equal to percentage increase in the rebased market 
basket that measures input price increases for services furnished by excluded 
hospitals minus 1.5 percentage points. Thus, given the current estimate of the 
change in the market basket rate of increase for excluded hospitals of 2.5 percent 
(compared with the earlier estimate of 2.7 percent used in the proposed rule), 
our final recommendation is for an update of 1.0 percent. This recommendation 
is consistent with the President's budget, acknowledging that the market basket 
rate of increase for these hospitals was forecast at 3.6 percent at the time the 
budget was submitted. [FR Doc. 96-22145 Filed 8-28-96; 8:45 am] BILLING CODE 4120-03-P 
 

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