On June 14, St. Barnabas Corporation, the largest health system in New Jersey, agreed to pay the United States $265 million to settle allegations that it defrauded the Medicare program by inflating its charges. In its press release, the government stated simply that St. Barnabas had allegedly raised its charges to Medicare patients to obtain enhanced reimbursement. The complex legal and factual issues raised by these claims warrant closer examination, both by other hospitals that may be undergoing a similar investigation and by any entity that operates within a regulatory framework.

This issue arose in late 2002, when an investment analyst critiqued Tenet Healthcare Corporation's financial condition because of Tenet's dependency on Medicare reimbursements generally and its high level of Medicare "outlier payments" in particular. This analysis led the Centers for Medicare and Medicaid Services (CMS) to focus its attention on the functioning of its outlier reimbursement system. Shortly thereafter, CMS proclaimed that the system was being abused and it implemented changes to preclude the practices it believed were improper.

New Jersey was identified as one of the states where many hospitals had higher-than-average outlier reimbursements, and government investigators have been looking into whether New Jersey hospitals received excessive outlier payments based on sharp increases in their charges. Examining the outlier issue reveals that New Jersey hospitals complied with the system developed by CMS and that some unique conditions faced by New Jersey hospitals may have warranted the higher charge increases that resulted in higher outlier payments.

Every hospital sets published charges for each service it provides to patients. Outlier cases are Medicare cases in which "charges adjusted to cost" exceed a specified threshold. "Charges" are "adjusted to cost" by using the hospital's charges multiplied by the hospital cost-to-charge ratio, or CCR (i.e., the hospital's program costs divided by inpatient program charges).

The outlier payment is an additional Medicare payment that was first introduced in 1983 when Congress shifted Medicare reimbursement to a prospective payment system (PPS) in which hospitals receive a predetermined fee for each service. The outlier payment was designed to compensate hospitals for higher-cost cases that would not be fully reimbursed by the prospectively determined payment.

The Medicare statute authorizes outlier payments of no less than 5 percent and not more than 6 percent of total Medicare payments on a national basis. CMS estimates annually what the level of the outlier threshold must be in order to yield the proper percentage of outlier payments.

Until 2003, the data necessary to calculate each hospital's CCR were derived from the hospital's most recent "settled" Medicare cost report. A cost report is "settled" after CMS has fully audited it, usually two or three years after the report is filed. In adopting this standard, CMS rejected the suggestion that the CCR be taken from the most recent filed cost report.

CMS specifically rebuffed concerns raised by commenters that using the settled cost report would create a lag of three years between the costs and charges used to establish the CCR and the current charges to which the ratio is applied to calculate the approximate "cost" of each case. CMS also declined to regulate hospital charge increases, stating that it believed there were market forces sufficient to minimize the effects of any such increases. Thus, the three-year gap between the year on which CCRs were based and the year of the charges used to determine costs for outlier reimbursement was structurally fixed within CMS' regulations effective in 1989.

This gap permitted a prior year's higher CCR to be applied to the current year's increased charges, resulting in a higher estimate of costs that may exceed the outlier threshold. Thus, if the 1999 CCR was 0.5 (cost = $1; charges = $2), and charges in 2002 were raised from $2 to $4, the approximate cost derived by applying the CCR would be $2, regardless of any actual cost increase.

CMS used increases in the outlier threshold to attempt to limit the effect of charge increases. CMS raised the threshold approximately 200 percent from 1999 through 2003 as follows: FY 1999, $11,000; FY 2000, $14,050; FY 2001, $16,350; FY 2002, $21,025; and FY 2003, $33,560.

This created a chicken-and-egg reaction as hospitals raised charges to combat the effects of the elevated threshold.

While conceding that the government places no restriction on a hospital's setting of its own charges, the United States believes that charges must reasonably reflect the hospital's costs and that raising charges specifically to increase outlier reimbursement violates the purpose of the outlier provision, which was to compensate hospitals for extraordinarily costly cases.

Similar to cases involving tax issues, however, courts typically will not follow an agency's interpretation of the intent of Congress when it conflicts with the plain language of a statute or adds a condition that Congress did not impose:

It is not the role of the court to compensate for an apparent legislative oversight by effectively rewriting a law to comport with one of the perceived or presumed purposes motivating its enactment. Mertz v. Houston, 155 F. Supp.2d 415, 428 (E.D. Pa. 2001).

New Jersey hospitals have additional arguments regarding why it was necessary and appropriate for them to raise their charges during the 1999-2003 time period, such as:

Elimination of state rate-setting system. In May 1992, a U.S. District Court ruled that the surcharge used to finance New Jersey's regulated rate-setting system was pre-empted by federal law. United Wire, Metal Mach. Health & Welfare v. Morristown Mem. Hosp., 793 F.Supp. 524 (D. N.J. 1992). In response to this ruling, the New Jersey Legislature passed the Health Care Reform Act (HCRA), N.J.S.A. §§ 26:2H-18.70 et seq., the major components of which eliminated the state hospital rate-setting system and restructured the state's hospital charity care program. Passage of the HCRA resulted in a reduction of over 40 percent in the state charity care fund — from $700 million in 1992 to $300 million in 1997.

Hospital operating margins. As a result of this change (and other factors), New Jersey hospitals had significantly lower operating margins than the national average. In 1998, New Jersey hospitals' operating margins fell below zero, decreasing on average from 1.4 percent in 1996 to negative 1.3 percent. In 2004, New Jersey hospitals had a 1.0 percent aggregate operating margin.

Average hospital operating margins nationwide have ranged from 5.31 percent to 3.39 percent over the 1997-2004 time period. Industry analysts "recommend a minimum operating margin of 4.5 percent and suggest 5.5 percent as a goal." Bazzoli, Fred, "Survey: Hospital margins drop," Healthcare IT News (Feb. 6, 2006).

The difference between New Jersey and other parts of the country, according to the New Jersey Hospital Association (NJHA), is that New Jersey has "an older, sicker patient population, a highly-competitive and expensive labor market, reimbursement pressures from managed care companies, and the lack of any publicly-funded acute care hospitals to care for the uninsured." NJHA Press Release (Jan. 5, 2006), at www.njha.com/press/press.010506.aspx.

Length of stay. New Jersey has long been noted for its excess hospital bed capacity and high utilization of services — both of which have contributed to higher than average health-care costs. In each of 2002, 2003 and 2004, New Jersey had the longest average length of stay of any state except New York and Hawaii. Because Medicare pays through the PPS system on a per-discharge basis, having longer average lengths of stay penalizes New Jersey hospitals by providing them with lower reimbursement per day than other comparable hospitals for the same diagnosis. They also leave hospitals vulnerable to claim denials by commercial payers due to longer-than-average hospital stays.

Amounts owed to hospitals for years before 1993. In Dec. 1997, the New Jersey Superior Court granted summary judgment to the State of New Jersey in a lawsuit brought by the NJHA styled New Jersey Hospital Association v. State of New Jersey, Docket No. MER-L-2164-96 (Superior Court, Law Div.). The lawsuit concerned money hospitals believed to be owed as a result of the abrupt termination of the reconciliation process used under the old regulated rate-setting system.

NJHA claimed that the state had deprived the hospitals of approximately $1 billion. The court rejected the hospitals' claim, but did not refute the existence of the $1 billion owed to the hospitals. Rather, the court held that the new unregulated system permitted hospitals "to set their own rates to recover whatever costs they deem appropriate," and that hospitals could raise charges to recoup the damages claimed in the lawsuit.

The outlier issue demonstrates that compliance with a regulatory provision may not protect against claims of a violation of the regulatory scheme. New Jersey hospitals viewed by CMS as having improperly increased their outlier reimbursement have both legal and factual arguments at their disposal to refute these claims, however, sing New Jersey's unique health-care environment as a persuasive starting point.

Philip H. Lebowitz is a partner in the health law practice group at Duane Morris' Philadelphia office. He practices primarily in the area of health-care law and litigation, providing regulatory and general counseling to health-care providers, including hospitals, pharmaceutical and medical device companies, and physicians.

Reprinted with permission from New Jersey Law Journal, © ALM Media Properties LLC. All rights reserved.