Physician-Owned Hospitals

Background:  The past few years have seen the significant growth of so-called specialty hospitals.  These facilities, which generally concentrate on one medical practice area (often cardiac or orthopedic care), are often able to provide higher-quality care than general hospitals due to their focused mission.  Critics of specialty hospitals claim that, by “cherry-picking” the best—and therefore most lucrative—candidates for surgical procedures, they siphon off revenues from general and community hospitals, threatening their future viability.

The ownership arrangements of many specialty hospitals have also been questioned.  While federal law against physician self-referral prohibits doctors from holding an ownership stake in a particular department of a hospital facility, the “whole hospital” exemption permits physicians to hold an ownership stake in an entire facility.  Because many specialty hospitals are physician-owned in whole or in part, some critics believe that physicians owning a stake in a specialty hospital may be inclined to perform additional tests and procedures on patients due to a stronger profit motive.

Legislative History:  Congressional action on specialty hospitals over the past several years has focused on the “whole hospital” exemption and the issue of physician self-referral.  In December 2003, Section 507 of the Medicare Modernization Act (P.L. 108-173) placed an 18-month moratorium on physician self-referrals to any new specialty hospital and ordered reports to Congress regarding the issue.  Upon expiration of the moratorium in June 2005, the Centers for Medicare and Medicaid Services (CMS) issued a further suspension in the processing of Medicare enrollment applications for specialty hospitals, pending a CMS review.

In February 2006, Section 5006 of the Deficit Reduction Act (P.L. 109-171) extended the CMS suspension of applications for new specialty hospitals until CMS submitted a report to Congress.  The report, issued in August 2006, summarized the earlier reports on specialty hospitals and outlined a strategic plan for examining the issues raised.  Although the report included no legislative recommendations, CMS did subsequently issue regulations in August 2007 requiring all hospitals, not just specialty hospitals, to notify patients of their physician ownership arrangements beginning in Fiscal Year 2008.

In July 2007, Section 651 of H.R. 3162, the Children’s Health and Medicare Protection (CHAMP) Act, proposed several modifications to the “whole hospital” exemption for physician self-referral.  Most notably, the bill applied the exemption only to those facilities with Medicare provider agreements in place prior to July 2007—excluding new specialty hospitals or other facilities, including those currently under construction, from protection under the self-referral statute—and prohibited existing facilities from expanding their number of operating rooms or beds.  While the bill passed the House by a 225-204 vote, the Senate has yet to take up the measure.

Quality of Care:  Many public and private studies that have examined the specialty hospital issue have compared the quality of care and patient outcomes for both specialty and general hospitals.  Most studies have found that specialty hospitals perform no worse than general hospitals with respect to patient outcomes, and many studies have found measurable performance improvements.  The independent quality review firm HealthGrades found that specialty hospitals constitute a disproportionate share of the highest-quality facilities among the top tier of facilities it surveyed.[1]

The focus on improved quality control comes at a time when the impact of medical errors and hospital-acquired infections has risen to greater prominence.  The landmark 1999 Institute of Medicine study To Err Is Human estimated that between 44,000 and 98,000 Americans die annually in hospitals due to preventable medical errors, creating a total economic cost of as much as $29 billion.[2]  A November 2006 report utilizing data from a new infection-reporting regime in Pennsylvania found 19,154 cases of hospital-acquired infections in 2005 alone, representing an infection incident rate of more than 1 in 100 hospitalizations, and average costs for patients who developed infections nearly six times higher than those who did not ($185,260 vs. $31,389).[3]

For this reason, many specialty hospitals include their physician-owners in all aspects of the planning, design, and implementation of the facility and its treatment delivery systems, so as to minimize the possibility of preventable errors and the spread of infection.  Additionally, regular performance of surgical procedures in specialized settings permits physicians and medical staff to develop expertise and innovative techniques that improve the quality of care delivered.  For instance, physicians in one cardiac specialty hospital developed new procedures to recognize and treat irregular heartbeats following surgery; the new protocol reduced incidence of this dangerous symptom by two-thirds.[4]

Although some critics of specialty hospitals cite concerns about “cherry-picking”—whereby physician-owned facilities attract comparatively healthy patients, leaving general hospitals to treat the sickest cases—reports such as the HealthGrades study have quantified the better care provided by many specialty hospitals on a risk-adjusted basis that controls for patients’ varied health status.  Some specialty hospitals have been found to have patients sicker than average when compared to Medicare claims data are used to compare patients in specialty hospitals and general hospitals.[5]  Moreover, to the extent that specialty hospitals may wish to pick the “easiest” cases, such changes can be resolved by reforms currently being implemented by CMS to reform Medicare’s diagnosis-related group (DRG) classification system and adjust reimbursements to more closely reflect health status upon admission.

Financial Arrangements:  Much of the criticism surrounding specialty hospitals has focused on the potential conflict-of-interest associated with physician ownership, and specifically whether an ownership stake motivates physicians to increase the number and scope of tests and procedures performed, increasing patient costs.  In scoring the additional restrictions proposed by Section 651 of the CHAMP Act, the Congressional Budget Office (CBO) asserted that Medicare spends more for outpatient services for patients treated in specialty hospitals than for treatments provided in other facilities.  Based on this assumption and related changes in reimbursements, CBO estimated that the CHAMP Act’s proposed restrictions on specialty hospitals would generate $3.5 billion in savings to the federal government over a ten-year period by diverting patient care to general and community hospitals.

However, the CBO score did not take into account any potential savings due to differential rates of medical errors and acquired infections when comparing costs in specialty and general hospitals.  One study noted that the nearly 9,000 infections acquired by Medicare and Medicaid recipients hospitals during 2004 cost taxpayers nearly $1.4 billion in added costs in Pennsylvania alone—and the study also noted that hospital-acquired infections, and thus the costs associated with them, were likely to be underreported during the report’s time frame.[6]  Given the existing studies documenting better patient outcomes and lower infection rates in physician-owned facilities, reduced costs to the federal government from an expansion of specialty hospitals could well exceed the $3.5 billion in purported savings CBO attributes to lower utilization rates by general hospitals.

In addition, some critics of the ownership arrangements of specialty hospitals have failed to acknowledge the implications of the vast growth of hospital-owned physician networks in the past two decades.  While a 2005 CMS report to Congress noted that “we did not see clear, consistent patterns of preference for referring to specialty hospitals among physician owners relative to their peers,” it also added that “physicians in general are constrained in where they refer patients by several factors.”[7]  Physicians working for networks affiliated with a particular community hospital may be contractually obligated to refer their patients to that hospital.  When viewed from this prism, the significant growth—from 24% in 1983 to 39% in 2001—of physicians directly employed by hospitals or other medical centers is likely to have had a greater impact on physician referral patterns than the growth of approximately 200 specialty hospitals when compared to 60,000 hospitals nationwide.[8]

Conclusion:  The benefits of increased specialization have been examined and analyzed by economists for more than two centuries.  In his seminal work The Wealth of Nations, Adam Smith highlighted the benefits of a division of labor to focus on discrete tasks as providing the greatest possible improvement in productivity, and thus economic growth, for all individuals.  In health care, specialization can increase productivity gains, which are the key to controlling the rise of health care costs without relying on heavy-handed rationing of care.  The growth of specialty hospitals—which focus on performing discrete groups of surgical procedures well, improving quality and thus reducing costs—is consonant with the theories which Smith and his adherents used to expound open markets and free trade worldwide.

Amidst spiraling costs and uneven quality, the health sector warrants more competition, not less: new entrants to introduce innovative techniques and practices improving the quality of care; greater transparency of both price and quality information, so patients can make rational choices about the nature of their treatment options; and a funding system that reduces where possible the distortionary effects of third-party payment and empowers consumers to take control of their health.  Viewed from this perspective, opposition to undue and onerous restrictions on the specialty hospitals that have driven innovation within health care may strike many conservatives as a return to first principles.


[1] Cited in David Whelan, “Bad Medicine,” Fortune 10 March 2008, available online at (accessed March 1, 2008).

[2] Institute of Medicine, To Err Is Human: Building a Safer Health System, summary available online at (accessed March 1, 2008).

[3] Pennsylvania Health Care Cost Containment Council, Hospital Acquired Infections in Pennsylvania, available online at (accessed March 1, 2008).

[4] Regina Herzlinger and Peter Stavros, “MedCath Corporation (A),” Harvard Business School Case No. 303-041, rev. August 2006, p. 10.

[5] Regina Herzlinger and Peter Stavros, “MedCath Corporation (C),” Harvard Business School Case No. 305-097, rev. May 2006, p. 1.

[6] Pennsylvania Health Care Cost Containment Council, Reducing Hospital-Acquired Infections: The Business Case (Issue Brief No. 8, November 2005), available online at (accessed March 1, 2008).

[7] Department of Health and Human Services, “Study of Physician Owned Specialty Hospitals Required in Section 507(c)(2) of the Medicare Modernization Act of 2003,” available online at (accessed March 1, 2008).

[8] Kaiser Family Foundation, Trends and Indicators in the Health Care Marketplace, Section Five, available online at (accessed March 3, 2008) ; Whelan, “Bad Medicine.”

Top Ten Conservative Concerns with H.R. 1424, Mental Health Parity Act

  1. Increases Health Insurance Costs. CBO estimates that H.R. 1424 would impose mandates on private insurance companies totaling $3 billion annually by 2012.  These costs will ultimately be borne by employers offering health insurance and employees seeking to obtain coverage.
  2. Increases Costs for Business Due to Private-Sector Mandates. The bill contains multiple new federal mandates on the private sector, affecting the design and structure of health insurance plans.   The bill also increases the threshold level at which employers suffering increased claim costs as a result of implementing the new federal mandates can claim an exemption from the provisions of H.R. 1424.
  3. Decreases Mental Health Coverage. While the bill imposes several new federal mandates on those employers who choose to offer mental health coverage, there is nothing in H.R. 1424 that would require plans to cover these conditions.  Thus H.R. 1424 could have the perverse effect of actually decreasing mental health coverage, by encouraging employers frustrated with the bill’s onerous burdens to drop mental health insurance altogether.
  4. Increases the Number of Uninsured. By increasing the cost of health insurance, H.R. 1424 will lead directly to an increase in the number of uninsured Americans.  In addition, some employers could decide to drop group health insurance coverage altogether rather than face a potentially conflicting array of state mandates and regulations to which they could be subjected under H.R. 1424.
  5. Erodes Federal Pre-emption for Employers. While H.R. 1424 does pre-empt state laws that conflict with the bill, it also explicitly permits additional state laws that provide more stringent consumer protections.  This provision could undo three decades of strict federal pre-emption for group health plans, creating a patchwork of laws across all 50 states with which large employers would have to comply.
  6. Codification of Treatment Mandate for Health Plans. H.R. 1424 would incorporate into federal law the Diagnostic and Statistical Manual of Mental Disorders (DSM-IV) classification definitions as the parameter of mental health treatment for health plans.  The broad parameters included in the DSM-IV categories will obligate employers to cover “disorders” such as “jet lag” and “caffeine intoxication.”
  7. Intergovernmental Mandate. The bill would pre-empt state laws governing mental health coverage that conflict with the bill—but would not pre-empt laws providing more stringent consumer protections for employees.  Additionally, CBO notes that some state and local governments would face increased costs for health insurance provided to their employees.
  8. Violation of UMRA. CBO estimates that the costs of the mandates to the private sector in the bill would be at least $1.3 billion in 2008, rising to $3 billion in 2012 and thus exceed the annual threshold established in the Unfunded Mandates Reform Act or UMRA ($131 million in FY2007, adjusted annually for inflation).
  9. Lack of Conscience Clause. H.R. 1424 would mandate that employers offering mental health benefits cover all diagnoses under DSM-IV.  The bill does not include an exemption for groups to exclude coverage of mental disorders, particularly psycho-sexual disorders, for which they have religious or moral objections.
  10. Lack of Medical Management Tools. H.R. 1424 does not include language permitting group health plans to negotiate separate reimbursement rates or provider payment rates and delivery service systems for different benefits.  These tools would empower plans to utilize medical management practices in order to reduce claim costs.

Weekly Newsletter: March 3, 2008

Mental Health Parity Scheduled for Wednesday Vote

The House Democrat leadership announced last week that the House would be voting Wednesday on a mental health bill (H.R. 1424) sponsored by Rep. Patrick Kennedy (D-RI). Some conservatives may have strong concerns about both the principle behind the legislation—a costly federal mandate that will raise the health insurance premiums and increase the number of uninsured Americans—as well as the way in which the expansive House language would mandate coverage for “mental disorders” such as caffeine addiction and jet leg.

In addition, the ways in which Democrats intend to finance its $4 billion price tag may also cause conservatives concern. News reports indicate that the bill will be funded by placing further restrictions on physician-owned specialty hospitals—hindering the development of a new source of consumer choice, and medical innovation, in health care—and increasing the amount of rebates pharmaceutical manufacturers offering products to Medicaid beneficiaries must pay the federal government—which may lead some drug companies to end their participation in Medicaid altogether.

The RSC will be monitoring this legislation as it makes its way to the House floor, and will be weighing in during the process to express conservatives’ concerns.

A Top Ten list of conservative concerns about H.R. 1424 can be found here.

SCHIP Policy Brief Released

Last week the RSC released a policy brief analyzing the proposals in President Bush’s Fiscal Year 2009 budget that would effect the State Children’s Health Insurance Program (SCHIP). The brief was released prior to a House Energy and Commerce subcommittee hearing where several state Governors testified in opposition to guidance issued by the Administration that would ensure federal funds are targeted towards the low-income children for whom the SCHIP program was created.

While most conservatives support the Administration’s focus on low-income children, the significant increase in its SCHIP funding request when compared to last year—enough to fund an expansion of program participants—may give some conservatives concern.

The RSC Policy Brief can be found here.

GAO Issues Report on Medicare Advantage

Last week the Government Accountability Office released a report regarding the benefits provided by Medicare Advantage plans. The report highlighted how Medicare Advantage provides enhanced benefits and lower premiums to beneficiaries than traditional fee-for-service Medicare. Specifically, the study noted that nearly 70% of rebate payments provided to plans go directly toward reduced cost sharing for beneficiaries, with the remainder providing additional benefits and lower overall premiums.

While the GAO study generated headlines because it found that some plans in some situations may generate higher cost-sharing for beneficiaries, the true story remains the way in which private plans provide quality benefits and reduce costs for seniors, particularly low-income beneficiaries. If Congressional Democrats wish to object to so-called overpayments to Medicare Advantage plans, they should enact reforms allowing traditional Medicare to compete on a “level playing field” with private plans—which would generate downward pressure on health care costs and help Medicare remain financially viable.

Read the report here.

Article of Note: “One Cheer for the New York Times

Last week, the editorial board of the New York Times weighed in with its verdict on the President’s plan to address the funding warning issued by the Medicare trustees. The paper’s writers agree that Medicare’s funding mechanism needs reform, and think that the additional means-testing in the President’s proposal contains merit. However, the editorial also criticizes proposals for reform of medical liability laws, noting that Congress should instead “reduce the lavish and unjustified subsidies” provided to insurance plans offering Medicare Advantage coverage—or take the “sensible step” of letting the President’s tax relief expire.

While the Times’ writers at least acknowledged what some Congressional Democrats have not—namely, that Medicare needs serious reform if it is to remain financially viable—giving millions of Americans a tax increase will not resolve a problem caused by skyrocketing spending on health care. Nor will causing more than eight million Americans to lose the additional health benefits offered by Medicare Advantage plans improve the health of America’s seniors.

A better solution would transform Medicare into a health insurance system similar to that provided to Members of Congress, where beneficiaries receive a defined contribution from Medicare to select a plan of their choosing. That and other similar ideas for comprehensive reform—and not the tax increases and benefit cuts advocated by the Times—could finally begin to bring down health care costs and ensure Medicare’s long-term solvency.

Read the article here: New York Times: “Constraining the Medicare Debate

Weekly Newsletter: February 15, 2008

  • Medicare Trigger Legislation Submitted

    This week the President formally submitted to Congress legislation to reform Medicare, as required by Title VIII of the Medicare Modernization Act (MMA). The so-called trigger provisions of Title VIII—inserted into MMA five years ago at the behest of RSC members—requires the President to submit legislative remedies when the Medicare trustees certify that Medicare expenditures are consuming a growing portion of general budget revenues, and provides a mechanism for both Houses of Congress to demand an up-or-down vote on a solution to Medicare’s funding woes.

    The President’s proposal to Congress includes three planks: value-based purchasing (also known as “pay-for-performance”), medical liability reform, and a means-tested premium for Medicare Part D, similar to the means-tested Part B premium incorporated into MMA. These proposals follow on the heels of the President’s Fiscal Year 2009 budget submission to Congress, which proposed $178 billion in savings over the next five years, largely through adjustments to provider reimbursement rates (see below).

    Although some conservatives may have concerns over the significant intrusion into doctor-patient relationships that pay-for-performance could create, it is worth noting that the President has put forward two distinct proposals for Medicare reform in as many weeks. While some conservatives will look to more comprehensive measures—re-structuring of Medicare cost-sharing, and Medicare’s eventual conversion into a health care system similar to that provided to Members of Congress—many view the measures advanced by the Administration, and supported by the Republican leadership in Congress, as a positive first step in the cause of comprehensive entitlement reform.

    When it comes to entitlement reform, the cost of inaction is great: the Government Accountability Office estimates that each year Congress does not act to reform Social Security and Medicare, their unfunded liability to the federal government grows by $2 trillion. Congress needs to act—and act now—on comprehensive reforms to Medicare.

    To learn more about the trigger, read the RSC policy briefs on this issue.

    Analysis of Fiscal Year 2009 Budget Proposals

    Last week the Administration put forward its Fiscal Year 2009 budget, which contained several key health-related proposals. The President’s budget suggested generating $178 billion in savings from Medicare over the next five years, slowing its projected rate of growth from 7.2% to 5.0% and saving beneficiaries $6.2 billion in Part B premiums over five years. The budget also proposed $14 billion in savings from Medicaid, but more than offset these savings by proposing a $19 billion expansion of the State Children’s Health Insurance Program (SCHIP).

    The RSC prepared a policy brief highlighting the President’s health care proposals.

    Articles of Note

    Two articles in the past week dissected the ongoing debate between Democrat Presidential contenders over a mandate for individual coverage, while providing all the proof needed that such a mandate would likely prove ineffective. While Politico noted Sen. Hillary Clinton’s “winner-take-all” approach to universal coverage and an individual mandate, the Wall Street Journal provided insights as to why most conservatives view mandates as both unnecessary and unworkable:

    Census Department data indicate that more than one-third of the uninsured—over 17.7 million Americans—come from families with annual incomes over $50,000, raising questions as to how many of the uninsured cannot afford to buy insurance and how many do not wish to purchase insurance, because costly state regulations have inflated premiums.

  • Massachusetts has already exempted 20% of its uninsured population from its “universal” individual mandate—a number which is likely to climb in future years, as the cost of overregulated health insurance products in the state skyrockets.
  • Hawaii has incorporated a “pay-or-play” mandate—requiring most employers to subsidize their workers’ health insurance—for more than three decades, yet Hawaii still has more than 100,000 uninsured individuals—even though employers cannot easily relocate their businesses to other states in order to avoid paying the higher health costs associated with the mandate.

    As the Journal points out, enforcing a mandate will require both harsh government penalties—Sen. Clinton has suggested garnishing workers’ wages—and a new federal bureaucracy to enforce them.

    Read the articles here: Politico: “Mandate vs. Incentive

The Wall Street Journal: “The Wages of HillaryCare” (subscription required)

Legislative Bulletin: H.R. 4848, Mental Health Parity Extension

Order of Business:  The bill is scheduled to be considered on Wednesday, February 6, 2008, under a motion to suspend the rules and pass the bill.

Summary:   H.R. 4848 would extend through December 31, 2008 certain provisions relating to mental health parity coverage that previously expired on December 31, 2007.

Specifically, the bill would reinstitute federal mandates first included in the Mental Health Parity Act of 1996, and extended in subsequent legislation, requiring that annual and lifetime limits on coverage for mental health treatments equal similar limits for physical illnesses.  Group health plans failing to meet the requirements of the Mental Health Parity Act would be subject to an excise tax; however, employers with fewer than 50 employees would be exempt from the federal requirements.

H.R. 4848 would also include Medicare provider payments in the Federal Payment Levy System, which imposes a 15% levy on contractors to recover outstanding federal tax debt.  A 2004 Government Accountability Office study determined that 21,000 Medicare providers owed more than $1.3 billion in back taxes, in part because payments under Medicare Parts A and B are currently exempt from participation in the Federal Payment Levy System.  H.R. 4848 would extend the Federal Payment Levy system to Medicare Part A and B claims over a three-year period ending on September 30, 2011.

Finally, H.R. 4848 would deposit additional savings in the Physician Assistance and Quality Initiative Fund, which is used by the Centers for Medicare and Medicaid Services (CMS) to finance physician payment and quality improvement initiatives.

Possible Conservative Concerns:  Some conservatives may be concerned that the bill would raise the cost of health insurance by re-imposing a lapsed federal mandate on individual and group health plans.  Some conservatives may also be concerned that the bill could lead to further action on full mental health parity legislation (H.R. 1424; S. 558) being considered in the 110th Congress, further inflating health insurance premiums nationwide.

Committee Action:  H.R. 4848 was introduced on December 19, 2007 and was referred to the House Committee on Energy and Commerce, and in addition to the Committees on Ways and Means and Education and Labor, where no further action was taken.

Cost to Taxpayers:  However, H.R. 4848 would reduce federal revenues by $25 million over ten years by increasing the cost of health insurance, thus leading employees with group coverage to exclude more of their income from federal income and payroll taxes.  The bill would offset that foregone revenue through the extension of Part A and B Medicare payments to the Federal Payment Levy System as described above, saving a total of $374 million over ten years.  The bill diverts the additional revenue generated in excess of the foregone income and payroll taxes ($349 million over ten years) to the Physician Assistance and Quality Improvement Fund.

Does the Bill Expand the Size and Scope of the Federal Government?  No.

Does the Bill Contain Any New State-Government, Local-Government, or Private-Sector Mandates?  Yes, the bill reinstitutes federal mandates on individual and group health insurance plans regarding the design of their benefit plans.

Does the Bill Comply with House Rules Regarding Earmarks/Limited Tax Benefits/Limited Tariff Benefits?:  A Committee report designating compliance with clause 9 of rule XXI is unavailable.

Constitutional Authority:  A Committee report citing Constitutional authority is unavailable.

Legislative Bulletin: H.R. 3963, Children’s Health Insurnace Program Reauthorization Act

Order of Business:  Today the House will consider the President’s second veto of SCHIP legislation, H.R. 3963.  This bill passed the House by a vote of 265-142 on October 25, 2007, and was vetoed by President Bush on December 12, 2007.  On December 12, 2007, the House by a 211-180 vote postponed consideration of the President’s veto until today.

An earlier version of SCHIP legislation, H.R. 976, was vetoed by President Bush on October 3, 2007.  This bill was originally passed in the House by a vote of 265-159 on September 25, 2007.  On October 18, 2007, the House sustained the President’s veto of H.R. 976 by a vote of 273–156 (needing 2/3 to override a veto).

On December 19, 2007, the House passed by a 411—3 margin S. 2499, which was signed into law by President Bush on December 29, 2007.  This legislation reauthorized the SCHIP program through March 2009, and included $800 million in additional funding to ensure that all states would have sufficient funds to cover existing populations through the 18 months of the authorization.

Summary:  H.R. 3963 reauthorizes and significantly expands the State Children’s Health Insurance Program (SCHIP), while increasing cigarette taxes to supposedly offset the bill’s costs.  The legislation follows closely the recently-vetoed version of SCHIP reauthorization.  Highlights of the revised legislation are as follows:

Cost:  H.R. 3963 provides $35.4 billion over five years and $71.5 billion over ten years in new mandatory spending—this spending is on top of the $25 billion over five years that would result from a straight extension of the program.

The new spending is partially offset by increasing taxes on tobacco products (see below).  However, this CBO score overlooks a major gimmick which the bill employs to lower its costs.  The bill dramatically lowers the SCHIP funding in the fifth year by 84%, from $13.75 billion in the first six months to $1.15 billion.  In all likelihood, such a reduction would not actually take effect, which would make this a gimmick to generate unrealistic savings in order to comply with PAYGO rules.  To that end, H.R. 976 is technically compliant with PAYGO.

Block Grant:  Under current law, a federal block grant is awarded to states, and from the total annual appropriation, every state is allotted a portion for the year according to a statutory formula.  The bill extends the SCHIP block grants from FY 2008-12.  In addition, the bill also creates a new Child Enrollment Contingency Fund capped at 20% of the total annual appropriation, for states that exhaust their allotment by expanding coverage, and Performance Bonus Payments comprised of a $3 million lump sum in FY 2008 plus unspent SCHIP funds in future years.

Expansion to Higher Incomes:  Under current law, states can cover families earning up to 200% of the Federal Poverty Level (FPL) or $41,300 for a family of four in 2007 or those at 50% above Medicaid eligibility.  However, states have been able to “disregard” income with regard to eligibility for the program, meaning they can purposefully ignore various types of income in an effort to expand eligibility.  For instance, New Jersey covers up to 350% of FPL by disregarding any income from 200-350%, allowing them to cover beyond 200% with the enhanced federal matching funds that SCHIP provides.

H.R. 3963 increases the eligibility limit to 300% of FPL or $61,950 for a family of four but also continues the current authority for states to define and disregard income.  States which extend coverage beyond 300% of FPL would receive the lower Medicaid match rate.  The bill limits states from expanding their programs above 300% of FPL through an income disregard whereby they block “income that is not determined by type or expense or type of income.”  However, a state could get around this restriction in a host of ways by disregarding specific types of income, such as income paid for rent or transportation or food.  Practically speaking, H.R. 3963 still places no limit on SCHIP eligibility since states can still manipulate the definition of income to expand coverage, and CMS is limited in its ability to reject such determinations. [New Jersey would be grandfathered from this limitation until 2010, but they would then have to ensure that they are in the top ten of states with the highest coverage rate for low-income children.]

Furthermore, Section 116 overturns CMS’ current policy of requiring states to ensure that 95% of the eligible children in their state below 250% of FPL are enrolled before expanding coverage to higher incomes.  As a result, some conservatives may be concerned that this does not adequately ensure that SCHIP funding targets truly low-income children.

Unlike past legislation, the bill would not grandfather New York’s proposed plan (seeking to cover 400% of FPL or $82,600 for a family of four).  However, New York could merely use specific income disregards to effectively cover up to 400% of FPL.  Some conservatives may be concerned that a family with an income of $82,600 will still potentially be eligible for SCHIP funding after this bill is enacted.

Childless Adults:  The earlier bill phased adults off of the program within two years.  H.R. 3963 would remove childless adults from the program (all would be off by 2009), while allowing parents of eligible SCHIP kids to continue receiving healthcare under SCHIP.  According to CBO estimates, there will still be approximately 700,000 (roughly 10% of total SCHIP enrollees) adults (parents of eligible kids and pregnant women) enrolled in SCHIP by 2012.

H.R. 3963 states that no new waivers for non-pregnant childless adults will be granted to states, and any currently existing waivers will be extended through FY 2008 (terminating such waivers at the end of FY 2008).  H.R. 3963 states that any current state waiver for non-pregnant childless adults which expires before January 1, 2009 may be extended until December 31, 2008 to retain all currently covered non-pregnant childless adults on the program until the end of FY 2008.  The bill extends enhanced FMAP to apply to such waivers through December 31, 2008.

H.R. 3963 grants states the opportunity to apply for a Medicaid waiver for non-pregnant childless adults by September 30, 2008, for those whose SCHIP coverage will end December 31, 2008, and requires that the Secretary approve such waivers within 90 days or the application is automatically deemed approved.

Parents:  The bill provides a two year transition period and automatic extension at the state’s discretion through FY 2009 for the currently covered parents of SCHIP eligible/covered kids, and states that no new waivers be granted or renewed to states to cover the parents of SCHIP kids if such waivers do not currently exist.  Similar to what would be done with non-pregnant childless adults, H.R. 3963 states that any current state waiver for parents of SCHIP kids which expires before October 1, 2009 may be extended until September 30, 2009 to retain all currently covered parents on the program until the end of FY 2009.  The bill states that the enhanced FMAP shall apply to these expenditures under an existing waiver for parents of eligible SCHIP kids during FY 2008 and 2009.

H.R. 3963 requires that any state which provides coverage under a currently existing waiver for a parent of an SCHIP child may continue to provide such coverage through FY 2010, 2011, or 2012, but such coverage must be paid for by a block grant funded from the state allotment.  If the state makes the decision to continue the coverage of parents through 2012, the Secretary may set aside for the state for each fiscal year an amount equivalent to the federal share of 110% of the state’s projected expenditures under currently existing waivers.  The Secretary will then pay out such funds quarterly to the state.  States that enhanced FMAP only applies in fiscal year 2010 for states with “significant child outreach or that achieve child coverage benchmarks.”

In addition, H.R. 3963 retains the statement from H.R. 976 that states there shall be no increase in income eligibility level for covered parents (i.e. no expenditures for providing child health assistance or health benefits coverage to a parent of a “targeted low-income child” whose family income exceeds the income eligibility level applied under the applicable existing waiver).

Private Insurance Crowd-Out:  According to CBO, under H.R. 3963, 2 million children will still shift from receiving private health insurance to government health insurance.  This means that they may get worse health care service and become increasingly dependent on the federal government.  In addition, as H.R. 3963 begins to reduce SCHIP funding in 2012 (if such a reduction is actually intended, see above), some have noted that states may shift these children made newly eligible for a government program into Medicaid.  This phenomenon takes place despite a provision in H.R. 3963 to offer a premium assistance subsidy under SCHIP for employer-sponsored coverage.  A qualifying employer-sponsored plan would have to contribute at least 40 percent of the cost of any premium toward coverage.  The bill includes new language requiring the Secretary, in consultation with the states, to measure crowd-out and to develop best practices designed to limit it.  States would then be required to limit SCHIP crowd-out and incorporate those best practices.  However, many conservatives are likely to be concerned that this language is not enough of protection when CBO maintains that two million will lose their health insurance under this bill.

Legal Immigrants and Citizenship Certification:  H.R. 3963 states that “nothing in this Act allows Federal payment for individuals who are not legal residents.”  However, the bill weakens existing law by removing the documentation requests under the Deficit Reduction Act (DRA), specifically the burden that citizens and nationals provide documentation proving their citizenship in order to be covered under Medicaid and SCHIP.  Instead, the bill would require that a name and Social Security number be provided as documentation of legal status to acquire coverage and that those names and Social Security numbers be submitted to the Secretary to be checked for validity.  If a state is notified that a name and Social Security number do not match, the state must contact the individual and request that within 90 days the individual present satisfactory documentation to prove legal status.  During this time, coverage for the individual continues.  If the individual does not provide documentation within 90 days, he is “disenrolled” from the program but maintains coverage for another 30 days (after the 90 days given to come up with proper documentation), giving the individual up to four months of coverage on a false identity.

It is unclear what substantive changes were made to the vetoed bill beyond the cosmetic, with regard to citizenship certification.  Some conservatives may be concerned that a Social Security number and name are not enough for a proof of citizenship and that more documents should be required to determine eligibility.  For instance, according to a recent letter from Social Security Administration Commissioner Michael Astrue, a Social Security number would not keep someone from fraudulently receiving coverage under Medicaid or SCHIP (if they claimed they were someone they were not).  Thus, this bill may allow illegal aliens the opportunity to enroll falsely in Medicaid or SCHIP and retain coverage for an undetermined amount of time before they are disenrolled for lack of proper identification.

Tax Increase:  H.R. 3963 increases the cigarette tax by 61 cents to $1 per pack, and the cigar tax up to $3 per cigar, supposedly generating $35.5 billion over five years and $71.1 billion over ten years.  It is important to note that this is a substantial tax increase on low-income individuals in order to pay for an expansion of SCHIP to higher income levels, which it was not initially designed for.  In addition, this revenue source is constantly declining as fewer and fewer individuals smoke, and since placing a tax on cigarettes will likely deter sales, some have questioned the efficacy of the offset.  According to a study by the Heritage Foundation, “To produce the revenues that Congress needs to fund SCHIP expansion through such a tax would require 22.4 million new smokers by 2017.”  The bill also changes the timing for some corporate estimate tax payments.

Encourages Spending:  H.R. 3963 shortens from three to two years the amount of time a state has to spend its annual SCHIP allotment.  Under current law, states are given three years to spend each year’s original allotment, and at the end of the three-year period, any unused funds are redistributed to states that have exhausted their allotment or created a “shortfall,” i.e. making commitments beyond the funding it has available.  In addition, the bill establishes a process through which any unspent funds would be redistributed to any states with a shortfall.  Some conservatives may be concerned that this process provides incentives both for states to spend their allotment quickly and to extend their programs beyond their regular allotments into shortfall, so as to be relieved by the unspent funds of other states or the new Contingency Fund.

Other Provisions:

  • Disregarding of Pension Contributions as Income.  The bill disregards “extraordinary employer pensions” as income.  According to CMS, only one state would fall into this category—Michigan, due to the auto manufacturers.  Some conservatives may view this as an authorizing earmark.
  •  Name Change.  H.R. 3963 renames the program the “Children’s Health Insurance Program.”
  • Medicaid Disproportionate Share Hospital (DSH) Allotment for TN and HI.  The bill sets the DSH allotments for Tennessee at $30 million a year beginning in FY 2008, and sets the DSH allotment increases for Hawaii, beginning in FY 2009 and thereafter, as the allotments for low DSH states.  Some conservatives may view these provisions as authorizing earmarks.
  • Premium Assistance and Health Savings Accounts.  The bill streamlines procedures for states to provide premium assistance subsidies for children eligible to enroll in employer-sponsored coverage, rather than placing such children in a state-sponsored SCHIP program.  However, all high-deductible health insurance plans and Health Savings Accounts (HSAs) would be ineligible for premium assistance, even if employers and/or states chose to make cash contributions to the HSA up to the full amount of the plan’s high deductible.  Some conservatives may be concerned that these restrictions would undermine the recent growth of HSAs and consumer-driven health care plans.

Does the Bill Expand the Size and Scope of the Federal Government?:  Yes, the bill would expand the SCHIP program by $35 billion over five years and loosen the program’s eligibility requirements.

Does the Bill Contain Any New State-Government, Local-Government, or Private-Sector Mandates?:  A detailed CBO cost estimate with such information is not available.

Medicare Funding Warning

Background:  Enactment of a prescription drug benefit as part of Medicare proved controversial to certain segments of the conservative community.  While President Bush and a Republican Congress campaigned in 2000 and 2002 on a promise to extend prescription drug coverage to American seniors, some conservatives retained concerns about a significant expansion of government-financed entitlement spending, even though the benefit itself would be delivered through the private sector.  While conservatives generally admired proposals such as Health Savings Accounts (HSAs) and other similar innovations designed to control the growth of health care spending, the size of the prescription drug benefit ultimately enacted—$400 billion in spending over ten years, and nearly $8 trillion in unfunded liabilities over 75 years—prompted calls for more comprehensive reforms to Medicare than those included in the Medicare Modernization Act (MMA).

At the behest of the Republican Study Committee, the funding warning mechanism was included as one device to help alleviate conservatives’ concerns about Medicare’s long-term solvency and ensure that Medicare’s claims on general budgetary revenues would not overwhelm either other federal budgetary priorities or the national debt.  By providing “fast-track” procedures for considering bills to improve the program’s solvency, the Medicare trigger also provides conservatives with another opportunity to examine more fundamental reforms to the way seniors’ health care is financed and delivered.

Funding Warning Defined:  Section 801 of the Medicare Modernization Act provides that a funding warning will be issued if two consecutive annual reports by the Medicare trustees determine that general revenue Medicare spending—that is, Medicare spending not financed by payroll taxes, or by beneficiary premiums and co-payments—will exceed 45% of total Medicare outlays for the current fiscal year, or any of the following six fiscal years.  The April 2006 trustees report noted that Medicare outlays minus dedicated revenues were expected to exceed 45% of total outlays in 2012, and the April 2007 report concluded that Medicare outlays minus dedicated revenues are expected to exceed 45% of total outlays in 2013.  Thus, two consecutive trustees reports have indicated that Medicare will be deriving excess revenues from the general fund within the next seven years—triggering the expedited procedures provided as part of MMA.

Democrats have argued that the 45% measure for excess general revenue Medicare spending is “an artificial and misleading measure of Medicare’s fiscal health,” and Section 902 of the Children’s Health and Medicare Protection Act (H.R. 3162)—considered and passed by the House in July—would have repealed the excess funding warning mechanism entirely.[1]  However, the Medicare trustees report indicates that the percentage of Medicare spending taken from general revenues—which to date has never exceeded 45%—“is projected to continue growing throughout the 75-year period, reaching 63% of total outlays in 2031 and 73% in 2081.”[2]  With trustees noting that the Medicare trust funds require an additional $40.9 trillion in funding over the next 75 years to meet current obligations, most conservatives would argue that repealing the trigger provisions—which all Republicans on the House Ways and Means Committee opposed in mark-up last year—would not represent sound fiscal policy.[3]

Expedited Procedures:  Sections 802 through 804 of MMA describe the expedited procedures by which the President and Congress will address the Medicare funding warning triggered by the April 2007 trustees report.  The process outlined in the statute includes the following steps:

  • Within 15 days of submitting his next budget to Congress, the President will also propose legislation to respond to the warning.  As the President’s Fiscal Year 2009 budget is expected to be released on February 4, 2008, the Medicare legislation should be received by the end of February.
  • Party leaders in both the House and Senate will introduce the President’s legislation within three legislative days of its submission, and the legislation shall be referred to the relevant Committees (Ways and Means and Energy and Commerce in the House, Finance in the Senate).
  • Committees in both the House and Senate shall report Medicare funding legislation to the floor of each chamber by June 30; if they do not, the relevant Committees may be discharged from consideration under special procedures.
  • In the House, one-fifth of the membership (87 Members) can move to discharge the President’s Medicare funding legislation, or any other legislation that remedies the Medicare funding warning, after July 30.  In the event that the motion to discharge is successful, the Medicare funding legislation shall be considered by the full House within three legislative days under procedures established in statute.
  • In the Senate, any Senator may move to discharge Medicare funding legislation after June 30, and such a motion will be considered under strict time limits precluding a filibuster.

In general, these special procedures seek to ensure that Members in both chambers have the opportunity for an up-or-down vote on whether or not Congress should consider legislation to remedy Medicare’s funding deficiencies.

Conclusion: The Medicare funding warning issued by the trustees last year provides an opportunity to re-assess the program’s structure and finance.  While competition among drug companies has ensured that expenditures for the MMA’s prescription drug benefit remain below the bill’s original estimates, introduction of pharmaceutical coverage has dramatically increased the overall growth of health care costs within the Medicare program, leading to the trustees’ funding warning.  The confluence of these two events should prompt Congress to consider the ways in which competition could be used to reduce the growth of overall Medicare costs, similar to the way in which the market for pharmaceutical coverage reduced the estimated cost of the Part D prescription drug benefit.

It remains to be seen whether the Administration will propose legislation that would constitute fundamental reform—either a mechanism to adjust benefits automatically in the case of funding shortfalls, or to inject greater competition into Medicare through a premium support program that would level the playing field between traditional Medicare and private insurance coverage.  Regardless, the Medicare funding warning being triggered this year affords Congress an opportunity to re-think and re-consider some of the drawbacks of the original MMA and put forth constructive alternatives to ensure Medicare’s long-term fiscal stability.

[1] House Report 110-284, p. 249.

[2] “2007 Annual Report of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplemental Medical Insurance Trust Funds,” available at (accessed January 20, 2008), p. 37.

[3] Ibid., pp. 190-91; House Report 110-284, p 278.