United States: Proposed Self-Referral Ban Casts Chill on Specialty Hospitals

With less than month before the June 8, 2005, expiration of the specialty hospital moratorium, Senators Grassley (R-IA) and Baucus (D-MT), Chairman and ranking Democrat on the Senate Finance Committee, respectively, introduced a bill on May 11, 2005 that would permanently extend and substantially expand the current self-referral ban. The legislation, dubbed the Hospital Fair Competition Act of 2005, might not be the silver bullet sought by opponents of physician-owned specialty hospitals. The bill leaves unaddressed several loopholes that have enabled developers of physician-owned hospitals to proceed with plans for new facilities, even during the moratorium period, and includes several changes likely to be troubling to general acute care hospitals. Moreover, the future of the Grassley-Baucus bill remains uncertain after both the Administration and a key House Republican announced opposition to a permanent ban on physician-owned specialty hospitals.

Under the self-referral proscription, commonly known as the "Stark Law," a physician may not make a referral to an entity for the furnishing of designated health services that may be covered by Medicare if the physician (or an immediate family member of the physician) has a financial relationship (including a direct or indirect ownership or investment interest) with the entity, unless an exception applies. Violators are subject to repayment, civil monetary penalties of up to $15,000 for each prohibited referral, and up to $100,000 for deliberate circumvention schemes, as well as exclusion from the Medicare and Medicaid programs.

Two exceptions to this general prohibition have been exploited to legitimize physician ownership in specialty hospitals. The first, commonly referred to as the "whole hospital exception," permits a physician with an ownership interest in a hospital to make referrals to that hospital, provided the referring physician is authorized to perform services at the hospital, and the physician’s ownership or investment interest is in the entire hospital, and not merely in a distinct part or department of the hospital. The second, called the "rural exception," likewise permits a physician with an ownership interest in a hospital to make referrals to that hospital, provided the entity is located in a rural area and it furnishes "substantially all" of the designated health services to individuals residing in the rural area.

Section 507 of the Medicare Modernization Act of 2003 (MMA) amended both exceptions by excluding referrals to "specialty hospitals" for the 18-month period beginning December 8, 2003, the date on which the legislation was enacted. The 18-month moratorium was intended to give Congress more time to further study and debate the matter. While Congress has done both, no clear consensus on how to proceed has yet emerged, the 18-month moratorium period is set to lapse on June 8, 2005.

On one side of the debate are Senators Grassley and Baucus, who believe that physicians should not be permitted to own and refer cases to specialty hospitals. To halt further development of physician-owned specialty hospitals, the two Senators now are proposing to amend the Stark Law in several ways. First, and perhaps most significantly, their bill would permanently render referrals to specialty hospitals ineligible for the whole hospital and rural exceptions.

They also would amend the grandfather protection extended by the MMA that allowed certain physician-owned specialty hospitals in operation or under development before November 18, 2003, to continue to function. In such cases, these hospitals could continue to operate, provided they meet certain requirements intended to limit their growth or expansion. Specifically, hospitals qualifying for the grandfather could not increase the number of physician investors, change the categories of services furnished by the hospital, or increase the number of beds beyond prescribed limits. The new bill would additionally prohibit grandfathered facilities from increasing their overall investment by physicians in the hospital beyond the amount held on June 8, 2005, and prevent individual physician-owners from increasing their individual ownership stake beyond that held on June 8, 2005. The bill likewise would prohibit grandfathered specialty hospitals from increasing the number of operating rooms and beds after June 8, 2005.

The Senators’ firm stand is supported by the American Hospital Association and Federation of American Hospitals (FAH) , among other trade associations, as well as scores of legislators in both the House and Senate, many of whom have signed on to various letters and statements urging more restrictions. However, several key players in the debate have withheld support or openly opposed a permanent ban.

The MMA required the Medicare Payment Advisory Commission (MedPAC) and Centers for Medicare and Medicaid Services (CMS) to study, among other things, the differences in the costs of care, referral patterns, payor mix and quality of care between physician-owned specialty hospitals and full-service community hospitals. MedPAC issued its report in March 2005. The Commission was unable to find ample evidence to support a permanent ban, but found enough disparity in key indicators to support extending the moratorium temporarily, through December 31, 2006, to allow more time to study these facilities.

CMS issued its report the day after the Grassley-Baucus bill was introduced. The Administration refused to recommend that the moratorium be formally extended, but did announce steps that will informally perpetuate the moratorium, at least for six months. CMS Administrator, Dr. Mark McClellan, told the House Energy & Commerce Committee that CMS will instruct its fiscal intermediaries to refrain from processing participation applications from specialty hospitals until the Agency can complete a comprehensive review of its procedures for approving new hospital applications. The Administrator also announced that the Agency may revoke provider agreements from some specialty hospitals that fail to satisfy a long-standing Medicare condition of participation that hospitals be predominantly engaged in furnishing services to inpatients. If CMS determines that a participating hospital is not primarily engaged in inpatient care, the hospital may have its provider agreement terminated. The Administrator gave little clue as to how CMS would measure whether a hospital is primarily engaged in inpatient care.

As a long-term remedy, CMS further proposed to address perceived disparities by adjusting payment rates for certain inpatient hospital services, such as cardiac, orthopedic, and surgical services, that are alleged to be overpaid and that may create incentives for physicians to form specialty hospitals, and payment rates for ambulatory surgical centers, which are perceived to be too low, and likewise encourage physicians to form specialty hospitals to receive higher hospital reimbursements. CMS’s proposed payment reforms, as well as similar provisions in the Grassley-Baucus legislation that also would direct Medicare inpatient service payment refinements, would apply to general and specialty hospitals alike. To the extent general acute care hospitals see these changes as cutting into their margins, their enthusiasm for the Grassley-Baucus bill may diminish.

Also now standing in the way of a permanent ban is Representative Joe Barton (R-TX), Chairman of the House Energy & Commerce Committee, stated that he will take up the mantle of his predecessor, former Committee Chairman Billy Tauzin, and oppose efforts to extend the ban. The Grassley/Baucus and Barton stand-off now focuses attention on Representative Bill Thomas (R-CA), Chairman of the powerful House Ways & Means Committee and an influential voice in all matters Medicare, to arbitrate the matter. To date, Mr. Thomas has assiduously avoided staking out a position on whether to extend the moratorium, although he has historically regarded the Stark Law as cumbersome and overly broad, and he opposed the outright ban on physician ownership of specialty hospitals approved by the Senate during consideration of the MMA in 2003.

There is little chance that Congress will act to extend the moratorium by the June 8, 2005 expiration date. Nonetheless, recent activity will likely will buy opponents of physician-owned specialty hospitals more time to advance a bill. Senators Grassley and Baucus put the specialty hospital community on notice that any legislation that does advance this year likely will apply retroactively to June 8, 2005. Their warning shot was no doubt intended to shake the confidence of would-be investors and put any pending development plans on hold until Congress can take action.

The Grassley-Baucus measure may not be the panacea opponents of specialty hospitals seek. Surprisingly, the Hospital Fair Competition Act does not attempt to address some of the most major shortcomings of the existing specialty hospital referral ban, and may leave ample loopholes to enable further development.

For example, the Grassley-Baucus bill does not clarify the definition of a specialty hospital. The MMA ban defines the term "specialty hospital" as a hospital that is "primarily or exclusively" engaged in the care and treatment of patients with a cardiac or orthopedic condition, or patients receiving a surgical procedure. To date, despite several attempts to clarify other aspects of the law, CMS has not further defined what it means to be a specialty hospital. As such, it remains unclear what it means to be "primarily" engaged in furnishing services in one of the defined categories. The term is not defined in either the MMA or regulations, and there presently is no legislative, administrative or judicial guidance clarifying this question. Moreover, the term "primarily" is not a term of art that carries an implied definition. As such, it is not clear whether "primarily" means 33 percent, 50 percent, 66 percent or some other threshold.

It also is unclear what the basis is for determining the extent to which a hospital is engaged in treating or caring for a category. In other words, what units would be used to measure "primarily" engaged? It remains unclear whether the term would be defined based on revenues or case volume, or something else altogether. Moreover, it is not clear whether it is to be based on Medicare cases alone (since the Stark Law applies only to this program), or all patients.

Would-be investors can look at several studies conducted by federal authorities for some guidance on this matter. The U.S. Government Accountability Office (GAO) issued several reports regarding specialty hospitals in which they defined a specialty hospital as a hospital in which two-thirds or more of its inpatient claims were in one or two major diagnosis categories, or two-thirds or more of its inpatient claims were for surgical diagnosis-related groups. MedPAC took a more liberal view by defining a specialty hospital as having 45 percent of its Medicare discharges in the heart or orthopedic major diagnosis category (MDC) or being from surgical diagnosis-related groups (DRGs). It is questionable whether 45 percent would constitute "primarily engaged in" for purposes of the definition. CMS generally followed the MedPAC report criteria, but with an additional requirement that cardiac and orthopedic hospitals perform at least five major procedures. To be considered a cardiac specialty hospital, 45 percent or more of a hospital’s Medicare cases must have been in the MDC 5, Diseases and Disorders of the Circulatory System. Orthopedic hospitals must have had 45 percent of their cases in MDC 8, Diseases and Disorders of the Musculoskeletal System and Connective Tissue. For surgery hospitals, 45 percent or more of their discharges must have involved a surgical procedure.

Nonetheless, the definitions established for purposes of these reports do not carry the force of law. Absent binding legal clarification, CMS could have a tough time labeling certain physician-owned hospitals as specialty hospitals in the face of these ambiguities. A hospital that specializes in orthopedic procedures, but also provides a considerable amount of diagnostic imaging and lab services, may not be considered a "specialty hospital." If not, it would not be subject to the self-referral ban. Physician owners could continue to have an ownership interest in the hospital and make referrals to it so long as the conditions of the whole hospital or rural exceptions are satisfied. Developers may continue to exploit these and other ambiguities by diversifying services sufficiently to avoid falling within the ambit of the law.

Additionally, the Grassley-Baucus legislation seems to lay to rest the larger threat that the whole hospital exception would be eliminated out-right. Opponents of specialty hospitals have urged Congress to eliminate the whole hospital exception in its entirety, and therefore preclude any physician investment in hospitals. Senators Grassley and Baucus have apparently declined to take such a drastic step, at least for the time being.

The two Senators have also apparently rejected suggested changes presented earlier this year by the FAH, which urged that the whole hospital exception be amended to apply only to ownership or investment in a full-service hospital. FAH defines the term "full-service hospital" as a hospital that has a comprehensive and fully functional emergency department and that furnishes a broad range of vital health services.

The preemptive strike by Senators Grassley and Baucus, and statements by Dr. McClellan, will no doubt cut the legs out from under what could have been a flurry of development activity beginning June 8, 2005, when the current moratorium expires. Nonetheless, astute developers of specialty hospitals may look at the legislation as the high-water mark for their opponents, and see ample opportunity within the shortcomings of the proposed legislation and administrative action to proceed with development plans after an appropriate cooling-off period.

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