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Medicare Disproportionate Share (DSH) Payments

Many Medicare beneficiaries and other patients rely on hospitals for their care, especially teaching hospitals that serve large low-income populations. These hospitals often face substantial financial pressure: they may provide significant amounts of care to the poor and lack the surplus revenue needed to underwrite the costs associated with the provision of services.

Maintaining access to hospital care has been an important objective of the Medicare program. As the program transitioned from cost-based reimbursement to a prospective system, Medicare added a special payment adjustment to its prospective payment system (PPS) for hospitals that serve large populations of low-income patients.

Purpose of the DSH Payment

The original rationale for the Medicare Disproportionate Share (DSH) payment adjustment was to compensate hospitals for the higher operating costs they incur in treating a large share of low-income patients. Low-income Medicare patients tend to be sicker and more costly to treat than other Medicare patients with the same diagnosis. Higher costs also result from the need for additional staffing and services, such as translators and social workers, to care for low-income patients.

Over time, however, a second justification for the DSH adjustment emerged. Many policy makers now view the purpose of DSH payments more broadly. Most agree that DSH funds preserve access to care for Medicare and low-income populations by financially assisting the hospitals they use.


The origin of the DSH adjustment is rooted in legislation passed in 1982. However, an explicit adjustment to the Medicare PPS was not adopted until May 1986, two years after prospective payment began. In the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Congress directed the Secretary of Health and Human Services to study the extent to which the TEFRA hospital rates should be adjusted for the extra costs incurred by hospitals in treating low-income patients. The original legislation that created the Medicare PPS in 1983 did not include a DSH payment adjustment, but one year later, in the Deficit Reduction Act of 1984, Congress directed the Secretary to define and identify DSH hospitals.

Several studies conducted by the Health Care Financing Administration (HCFA) and others showed a relationship between higher Medicare costs per case and the percentage of a hospital's patients covered by Medicare or Medicaid. However, a 1985 HCFA study found no evidence that a higher proportion of Medicare patients contributed to higher operating costs. HCFA did find that the proportion of Medicaid patients treated by a hospital was significantly and positively related to higher operating costs. Several other studies supported these results.

A study by the Congressional Budget Office in late 1984 showed that certain groups of hospitals with relatively large shares of Medicaid patients would be affected more adversely, on average, under the Medicare PPS than would other hospitals. The effect would be concentrated in big city, urban areas and especially in hospitals with more than 100 beds. CBO did not find evidence to support a DSH adjustment for urban hospitals with fewer than 100 beds or for rural hospitals.

In April 1986, with the passage of the Consolidated Omnibus Reconciliation Act of 1985 (COBRA) (P.L. 99-272), Congress mandated an explicit adjustment for hospitals that serve a large share of low-income patients. It was incorporated into the PPS in May 1986 and was set to expire on October 1, 1988. The creation of the DSH adjustment required no new money. Funding was obtained by lowering the basic DRG rate paid to all hospitals, and by decreasing the level of the indirect medical education (IME) adjustment by 0.6 percentage point (from 8.7 to 8.1 percent) in recognition that teaching hospitals would receive a large proportion of DSH payments.

By 1990, CBO analysis of more recent 1987 data, in contrast to the 1981 data used earlier, showed that the higher cost differences associated with serving the poor had disappeared. Except for urban hospitals with more than 100 beds, CBO concluded there was little evidence of a need for a DSH adjustment. However, CBO noted a second justification for DSH payments. Over time, Congress had become increasingly concerned that certain hospitals were at risk of closing and began to view the DSH payment as a mechanism for mitigating the financial distress that some hospitals experienced in serving the poor.

The DSH adjustment has been modified repeatedly. Each time, Congress has added money to the adjustment for specific categories of hospitals. Legislation passed in 1990 (P.L. 101-508) added the most money to the adjustment, about $1 billion over a five-year period, through changes in the DSH formulae. Congress also repealed the sunset provision for the adjustment, making it a permanent part of the PPS.

In recent years, DSH payments have grown rapidly, from $1.1 billion in 1989 to $4.5 billion in 1997. DSH payments accounted for about 6 percent of total PPS operating payments to all hospitals in 1997. In 1997, about 40 percent of all PPS hospitals were eligible for DSH payments, but DSH payments are concentrated in relatively few hospitals. More than 95 percent of all DSH payments go to urban hospitals, and about 250 hospitals receive one-half of all DSH payments. Teaching hospitals received $3 billion in DSH payments in 1997, or about two-thirds of all DSH payments.

The Balanced Budget Act (BBA) of 1997 (P.L. 105-33) reduced DSH payments by 5 percent, with the reduction to be implemented in 1 percentage point increments between fiscal years 1998 and 2002. The legislation required the Health Care Financing Administration (HCFA) to recommend a new payment formula for DSH that treats hospitals equitably (see methodology below). The report, required by August 5, 1998, is overdue. The Medicare Payment Advisory Commission (MedPAC) will comment on HCFA's recommendations. In its March 1998 report to the Congress, MedPAC made its own recommendations on the structure of the adjustment. The National Bipartisan Commission on the Future of Medicare has interpreted its mission to ensure the long-term solvency of the Medicare program to include an examination of the appropriate role of the Medicare in making DSH payments.

DSH Payment Methodology

The DSH payment is calculated as a percentage add-on to the basic DRG payment. The amount of DSH payment a hospital receives is determined by a complex formula and each hospital's DSH percentage. The hospital's DSH percentage is derived as the sum of two ratios: the proportion of all Medicare days that are attributable to beneficiaries of Supplemental Security Income (SSI), a cash benefit program for aged and disabled people, and the proportion of all patient days for which Medicaid is the primary payer. There are ten different formulae, depending primarily on urban or rural location and hospital size.

A hospital must have a minimum DSH percentage, which differs across hospital groups, to qualify for DSH payments. Urban hospitals with more than 100 beds have a lower threshold than hospitals in rural areas with less than 100 beds. There are two formulae for large hospitals in urban areas. After a specified DSH percentage threshold is exceeded, a more generous formula is applied, targeting payments to hospitals who are at the high end of service to low-income poor.

For some time, policy makers have been concerned about the accuracy of the underlying measure of care to the poor and how the payments are targeted to certain types of hospitals. Many believe that a broader measure of care to the poor, one that includes uncompensated care, is needed to target payments more accurately to those hospitals most in need. In addition, many policy makers believe DSH payments should be concentrated in hospitals with the largest low-income shares by establishing a single minimum threshold for the low-income share that a hospital must have before payment is made.

The BBA of 1997 required the Secretary to submit a report to Congress on a new formula for making DSH payments more equitably. HHS must include Medicaid and Medicare SSI patients in any new low-income share measure that is developed, and the Secretary is authorized to collect any data needed to implement the new formula. The Secretary also is required to establish a single threshold for all hospitals.

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