Chapter Three

Rate Setting Process and Impact on Reimbursement

A major focus of the program review committee's study on nursing home Medicaid reimbursement is whether Connecticut's current rate-setting system adequately recognizes costs incurred by nursing homes in providing care to Medicaid beneficiaries. As noted in Chapter One, high increases in average Medicaid nursing home payments during the late 1980s and early 1990s led to significant changes in Connecticut's reimbursement methodology in 1991. The revised methodology included several cost containment components in order to limit growth of Medicaid expenditures. This chapter describes the rate-setting process, analyzes the impact of the cost containment provisions on nursing home rates, and presents findings and recommendations related to they system.

Under Connecticut's Medicaid program, payment rates for nursing facilities are set on a cost-based, prospective basis and determined annually. By December 31 of each year, facilities are required to submit detailed cost reports for the preceding period of October 1 through September 30. Although reports are submitted annually, DSS is only required to rebase⁵ costs every two to four years. Thus, costs reported in a year selected for rebasing costs are used to establish rates for multiple years (except for annual reimbursement amounts for fair rent). However, the department is not required to use the most recently submitted cost report when it rebases costs. Figure III-1 identifies the cost report years used to rebase costs and the subsequent rate years affected.

Nursing home rates are set by DSS, in conjunction with a subcontractor, for the period from July 1 through June 30. Figure III-2 illustrates the rate-setting process used to establish Medicaid per-diem rates. Only expenses allowed under federal and state regulations are considered in setting Medicaid rates.

Built into the rate-setting process are several cost containment features that promote efficiency and protect against uncontrolled Medicaid expenditures. Major rate-setting system components include:

• rebasing nursing home costs to set Medicaid rates every two to four years rather than annually;
• arraying nursing home expenditures into five categories;
• limiting allowable costs to a certain percentage of median costs in three of the cost categories;
• providing an efficiency allowance to facilities with low costs in the indirect and administrative categories;

• using an occupancy standard of 95 percent to calculate rates;
• applying an inflation index - the Regional Consumer Price Index (CPI) in Health Care Costs and its projected value to inflate costs from the cost year to the rate year (although in some years the legislature has lowered the index by requiring specific percentages be subtracted from it); and
• the dominant provision, that supercedes all others, caps facilities' per-diem Medicaid rate increases from year to year to specified statutory percentages (i.e., applying a stop gain/stop loss percent to the prior year's rate).

A description of the five cost categories considered in the rate calculation is shown in Table III-1.

Allowable Cost Maximums

Costs for all residents are arrayed into the five categories shown in Table III-1 and allowable costs for each category - as defined by statute and regulation - are determined. Facilities' allowable costs are then limited to maximums established as percentages at or above median costs in the direct, indirect, and administrative and general categories. Cost ceilings for each category are specified by year under the statute as shown in Table III-2.

The reimbursement system contains costs by establishing cost ceilings -- expenditures that fall above the maximums are disallowed and those costs are excluded from the rate calculation. There is no limit on capital costs, and fair rent is calculated using the most recent cost report and a different formula.

Source: LPR&IC Analysis.

Figure III-3 shows the percent each cost component accounted toward total Medicaid allowable expenses ($1,777,589,503) in Cost Year 2000. The Direct care category comprised 52 percent of total expenses, while Indirect Care accounted for 25 percent. These two components, which are mostly staffing costs, make up more than 75 percent of the total allowed costs. Property costs accounted for about 6 percent of total allowable expenses, and capital costs only about 2 percent.

Analysis of Effects of Allowable Cost Maximums

Based on cost reports submitted by facilities for 1996 and 2000 (years in which costs were rebased), and applying the allowable cost ceilings identified in the table above, Table III-3 shows almost all facilities would have had direct care costs fully allowed if a stop gain provision were not applied. Over three-quarters of facilities would have indirect care costs fully allowed. Since the administrative and general cost category is set at the median, half of the facilities have costs allowed, while half are disallowed. However, not all facilities with allowable costs are actually reimbursed based on those costs because the overriding feature of the rate-setting system is the stop gain/stop loss on the prior year's rate. Thus, even though facilities may be below the maximum ceilings in any of the cost categories, once the stop gain provision is applied to the computed rate, allowable costs may not be reimbursed if those costs grew at a faster rate than the stop gain.

Stop Gain/Stop Loss Provisions in Statute

The stop gain/stop loss provision limits rate changes to statutorily specified percentages (shown in Table III-4), even when facilities' costs are below the maximum allowed. In the mid-1990s the stop gain was high, but since FY 00 a flat percent increase has been given to all facilities regardless of their reported costs.

Thus, as shown in Figure III-4, the rate computed based on the major components of the system (i.e., allowable cost ceilings, efficiency incentives, occupancy standards, CPI inflation, and fair rent) can differ from the actual rate issued to a facility because of stop gain/stop loss limits that are applied. Once the stop gain is applied to a facility's rate for multiple years, the cumulative effect of the loss is even greater, weakening the relationship between a facility's costs and the rate it receives.

What is the Effect of the Stop Gain/StopLoss?

To develop rates for FY 99, DSS used the 1996 cost report with allowable costs inflated forward with stop gain applied. Committee staff used the calculated rate (i.e., no stop gain applied) for FY 99 and compared it to the actual rate issued by DSS to analyze the impact of the stop gain provision on reimbursement.

The actual rate issued to facilities for FY 99 multiplied by Medicaid days totaled $901.1 million - $28.7 million more would have been paid by the department if the stop gain of 1 percent were not applied and the system-computed rate were given. Table III-5 shows based on the 314 licenses issued to facilities, 188 facilities (60 percent) fared worse because of the stop gain - the annual loss in Medicaid revenue ranged from $1,200 to over $1 million. Fifty-two licensed facilities fared better because of the stop gain provision and 34 showed no impact.

The same comparison was also done for rates issued for FY 02 based on 2000 Cost Reports (shown in Table III-6). Based on 314 licenses issued to facilities, 152 facilities fared worse because of the stop gain - the annual loss in revenue ranged from $5,871 to almost $1.3 million. Fifty-eight facilities fared better because of the stop gain - the annual gain in revenue ranged from $9,743 - $2,097,189. Total net loss for facilities is $27.5 million.

What Would the Impact Be if Costs Were Rebased Annually?

The committee also compared the effect on reimbursement if nursing home costs were rebased annually, rather than adjusting cost ceilings using the inflation index. As noted above, rebasing of costs occurs only every two to four years, and the effects of rebasing are muted because of stop gain/stop loss.

Table III-7 compares actual per diem cost ceilings to hypothetical rebased ceilings. Actual ceilings for FY 99 are based on Cost Year 96 and inflated forward using the CPI inflation factor used by DSS. Hypothetical rebased ceilings recalculate the upper limits using reported costs for Cost Year 99. Actual cost ceilings for FY 00 are based on actual FY 99 ceilings inflated forward using the 1 percent increase facilities were given for FY 00. Hypothetical rebased ceilings were calculated using reported costs for Cost Year 2000.

Table III-7 shows per diem allowable costs would be much higher if costs were rebased more frequently - for example, if all facilities were at the ceilings and there were an average of 20,000 Medicaid residents, rebasing costs would have about a $51 million dollar impact in FY 00.

Findings and Recommendations

Although the committee believes cost-containment features should play a major role in the rate-setting process, homes also must be adequately reimbursed based on reasonable costs. In recent years, the rate-setting system has been superceded by a single system component -- the stop gain provision. Furthermore, since FY 99, the stop gain provision has evolved into a flat percent increase with specific percent increases established through the state budget process and applied to all facilities' prior year's rates.

The program review committee finds adoption of flat percent increases for rate reimbursement has eliminated the relationship between facilities' allowed costs and the Medicaid rate ultimately issued. Under Connecticut's rate-setting system, facilities submit cost reports, and a two-step process determines allowable costs to compute rates. First, DSS excludes costs not allowed under the Medicaid program, and then disallows costs above the cost ceilings in three of the five categories (direct care, indirect care, and administrative and general) in which costs are arrayed. The costs are then used to calculate per diem Medicaid rates. However, since FY 00, the stop gain provision has made this calculation pointless, since a flat rate increase percentage is merely applied to the prior year's rate to yield the new per diem issued to a facility. In other words, the rate ultimately established has no connection to the costs submitted by the facility.

As noted earlier in this chapter, nursing home costs have risen due to increases in expenses, not because nursing home admissions are increasing. Under the current system of flat rate increases, these expenses are not being examined and linked to rate reimbursement. In the opinion of the committee, flat rate increases have had a negative financial impact on facilities. That is evidenced by:

• committee findings indicating a shortfall of $27.5 million between the computed rate and the issued rate for FY 02;
• the existence of a shadow rate system - 45 percent of facilities received approval of interim rates requests since 1998, and 20 percent are on an interim rate at any given time; and
• findings in a national study showing the average disparity between Medicaid rates and allowable Medicaid per-resident-day costs is almost $9.00.

The committee finds application of a flat increase has also had an adverse effect on fair reimbursement rates. Further, the flat percentage increases are fundamentally unfair because:

• facilities with higher rates in 1992 receive higher increases because the cumulative effect of year-to-year percentage increases is applied to a higher base each year; and
• as was pointed out earlier in this chapter, lower-cost facilities have received $6.00 less in per diem rate increases since FY 92 than higher paid facilities.

However, in any discussion involving adequate Medicaid reimbursement in Connecticut, it is important to remember interim rate increases have become so common, that case-by-case review has replaced a systemic approach to rate setting (see Chapter Five). Further, the impact of interim rate approvals on costs shows rates have actually risen more than the stop gain percent increases, even in the last year. For example, the average weighted daily Medicaid rate in FY 01 was $158.64 and grew to $164.64 in FY 02 - an increase of 3.8 percent, although the stop gain percent was 2.5 percent. Thus, cost containment approaches intended for the entire system lose their effectiveness when the measures are waived for the high percentage of facilities on interim rates or special adjustments.

Inflation

The committee finds comparing nursing home cost and rate increases to measures of inflation produce rather confusing, and often conflicting, results. First, as discussed in Chapter Two, Medicaid costs have more than doubled between FY 89 and FY 01. At the same time, the number of Medicaid residents increased only about 28 percent during the same time period, and, since FY 98, the number has actually dropped slightly. Thus, the committee finds recent increases in nursing home Medicaid expenditures have more to do with rising costs than greater volume of Medicaid residents.

Recent increases in Medicaid reimbursement to nursing homes have been higher than inflation -- since FY 96, they have risen from $841 million to $1.03 billion - a total increase of 22.5 percent, or an average of 4.6 percent a year, while inflation by most measures, has been less 3 percent per year. In addition, average overall rates, including interim rates, also increased (by 22.2 percent) since FY 96, or an average of 4.4 percent a year.

Table III-8 shows increases in several categories related to nursing home financing and illustrates the variation in percentage growth depending on which measure is examined. For example, nursing home costs between 1999 and 2000 grew more than 7 percent; Medicaid reimbursement for FY 2001 increased by 4.7 percent, both higher than the 3.2 percent inflation rate⁶. However, the flat rate increase established through the budget process for FY 01 was 2 percent, lower than inflation. Thus, because of interim and special rate adjustments, rates actually increased more than provided for by the budget, however the increase still didn't match inflation.

The committee concludes that Medicaid reimbursement, and overall rate increases including adjustments, are higher than inflation due to several factors.

• First, the Wage Enhancement Act funding, which added 7.5 percent to FY 00 rates over FY 99, is included in the increases above. However, the legislation targeted funds to increase staffing, wages and benefits, and not on other expenses at a facility, like utilities or insurance. Further, because the enhancement formula was based on a facility's FY 98 wage and benefit costs, those facilities already paying higher wages received a greater enhancement allotment. Thus, facilities indicate that the Enhancement Act further widened the gap between higher-rate and lower-rate facilities, and secondly, added to all facilities wage costs rather than helping to address inflation.
• Secondly, a great number of facilities had rates adjusted through interim rates or special adjustments -- about 50 facilities a year (20 percent) have their rates adjusted. These adjustments raise only some facilities' rates, but drive the statewide average rates higher. However, facilities without special rates are not receiving the high percentage increases.
• Thirdly, measuring rate increases alone does not account for other system factors that also drive costs. For example, between 1995 and 2001, there have been about 3,800 bed conversions from the lower-cost RHNS beds to the higher-cost CCNH level. This increases costs to the system more than would be attributable to rate increases alone.
• Lastly, facilities' property costs are readjusted each year to establish their rates. Those increases can be greater than the flat percentage increase in overall rates.

The committee also finds that if facility costs were adjusted annually using inflation increases⁷, many facilities would have received higher reimbursement amounts. For example, the committee found for Cost Year 2000, 33 facilities were not reimbursed for $8.1 million in direct care costs (nurses and aides) that would have been paid if facilities' costs had been adjusted for inflation. Lack of inflation adjustments on administrative and general costs (A&G) had an even greater impact -- 189 facilities incurred about $32.6 million in A&G costs that were not reimbursed, because no inflation index was applied.

The committee does not suggest a return to a system where facilities are reimbursed for all their costs each year. That system, in effect prior to 1991, yielded annual increases of about 15 percent a year. However, the committee believes with more frequent rebasing and a simpler and more appropriate inflation index applied annually (without statutory subtractions from the index) for years between rebasing costs should more adequately pay facilities for their expenses.

Rebasing nursing home costs. Rebasing nursing home costs assesses and updates the actual costs of operating a nursing home and reflects those costs in computing the nursing home's Medicaid rate. Currently, the DSS commissioner is given discretion in determining when to rebase nursing home costs, with the statute requiring only that this occur no more frequently than every two years and no less frequently than every four years. In addition, the statute does not require the most recently submitted cost report to be used by DSS in years that costs are rebased.

A primary reason for recalculating nursing home rates is to update facilities' allowable costs with their expenses. Thus, infrequent rebasing limits costs by preventing facilities with low reimbursement rates from making significant improvements in staffing or operations, by capping rates at the prior year's rate plus some inflation factor - even if costs remain below established cost ceilings. In addition, inflating costs forward for too many years ignores valid reasons for cost increases -- such as increasing direct care staffing in response to changes in resident acuity.

The statute currently requires costs to be rebased between every two to four years. The Department of Social Services rebased in 1996 and although, in theory DSS used 2000 cost reports to rebase nursing home rates for FY 02, in actuality, facilities received the same flat rate increase. Furthermore, after a review of the statute, the committee finds no evidence the stop gain provision (C.G.S. Sec. 17b-340(4)) takes precedence over C.G.S. 17b-340(8) which requires rebasing every two or four years.

In addition, the committee believes rebasing should be done according to an established schedule so the link between nursing home costs and Medicaid reimbursement is maintained. The statute also needs to be clarified to ensure the most recently submitted cost report is used in the rebasing calculation.

As will be discussed in Chapter Five, the key to containing nursing home costs is not to erode the industry's reimbursement rates, but to determine the adequate number of beds by area, and fund only that number. Inflationary pressures affect the costs of operating nursing homes. Providing inadequate inflationary increases and rebasing costs less frequently impact the industry's ability to attract qualified staff, and, without reducing the size of the industry, will eventually pose a serious threat to the quality of resident care as inflation forces homes to reduce spending on critical needs.

The program review committee believes several fundamental changes to the Medicaid reimbursement system are warranted -- eliminating the trend of providing flat rate increases that are not related to facilities' costs; using a more appropriate inflation index to adjust costs and rates; establishing a fixed schedule for rebasing nursing home costs; and adopting a simplified case-mix approach linking case-mix levels to direct care costs -- will all serve to improve the system. Therefore the committee recommends:

For FY 03-04, nursing home Medicaid rates should be calculated according to the statutory system currently in place with the following modifications:

1. In years that nursing home costs are not rebased, rates should be adjusted using the Skilled Nursing Facility (SNF) Market Basket index annual (third quarter to third quarter) increase in inflation;

2. C.G.S. 17b-340(7) shall be amended to repeal the use of the Regional Data Resources Incorporated McGraw-Hill Health Care Costs: Consumer Price Index (all urban) - All Items as the inflation index used to adjust nursing home costs. For years in which costs are rebased, the SNF Market basket index shall be used to inflate costs for the time period currently required in statute, mid-point of the cost year to mid-point of the rate year.

3. C.G.S. 17b-340(8) shall be amended to require nursing home costs be rebased every three years, notwithstanding C.G.S. 17b-340(4) that limits nursing home rate increases to specified percent increases or decreases.

4. A case-mix system shall be adopted and implemented beginning in the FY 04 rate year. (See Chapter Four).

In addition, a review by the committee finds the regulations used by the Department of Social Services to establish Medicaid nursing home rates have never been modified to reflect revisions to the reimbursement methodology under Public Act 91-8. The existing regulations were adopted in 1983 and have little relationship to the current system, including its financial reporting or auditing requirements. To remedy this, the program review committee recommends:

The commissioner of DSS shall amend its regulations regarding nursing homes Medicaid reimbursement as described in C.G.S. sec. 17b-340.

The committee believes the modifications to the rate-setting system will improve Medicaid rate reimbursement to nursing homes in several ways. It will link the stop gain or capping provision to an inflation index that most accurately reflects annual increases in costs to the nursing home industry. It begins to reestablish a connection between facilities' actual costs and their fair reimbursement through rebasing every three years. Further, the recommendation weights a facility's direct care costs by its case-mix index (in Chapter Four), and reimbursement is based on the association of staffing costs and the needs of the facility's residents.

The recommendation clearly recognizes the need for cost containment, with rate increases linked to inflation and lowered cost ceilings based on case mix. The committee believes these measures promote a more adequate and equitable system for spending finite resources by more appropriately funding facilities that need it based on the level of care their residents require. Updating nursing home costs on a predictable schedule and employing realistic caps on costs should alleviate some of the financial pressures experienced by nursing homes while maintaining valid cost containment features.

⁵ Rebasing is an element of the reimbursement system that periodically assesses and updates the actual costs of operating a nursing home and reflects those costs in computation of the NH's Medicaid rate. A cost year is selected as a base year and allowable costs are established; those costs are inflated forward from that base cost year to the appropriate rate year(s). See Figure III-1.

⁶ Inflation index used is the SNF market basket index used by Medicare to set prospective payments for nursing homes as forecasted for FFY 2001, published in the Federal Register, July 31, 2000.

⁷ The committee used the inflation adjustment that is hypothetically built into the rate system to adjust rates-- the CPI increases in health care costs for the Northeast inflated forward from the last year in which costs were rebased (1996) to the current rate year (2000)

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