March 22, 2006Client Alert

Deficit Reduction Act of 2005 Addresses Various Health Care Issues

On February 8, 2006, President Bush signed the Deficit Reduction Act of 2005 (the "DRA")1 into law. The DRA significantly modifies several Medicare and Medicaid provisions, including but not limited to those relating to specialty hospitals, gainsharing programs, and outpatient therapy caps.

Specialty Hospitals

The DRA extends the specialty hospital moratorium to later this year. To fully understand the DRA's impact in this area, some background is required.


Unless an exception applies, the federal Ethics in Patient Referrals Act, commonly known as the Stark Law, prohibits referrals of certain designated health services payable under Medicare or Medicaid to entities in which a physician (or the physician's family member) has a financial relationship.2 One exception from the Stark Law's prohibition excludes certain investment interests in hospitals.3 Under this exception, ownership or investment in a whole hospital (as opposed to a mere unit, subdivision or department of a hospital) is exempted from the Stark Law's referral prohibition if the referring physician is authorized to perform services at the hospital.4

In recent years, physicians have increasingly invested in "specialty hospitals". Specialty hospitals include those that specialize in cardiac, orthopedic, or surgical procedures.5 Debate has surrounded these investments, because some believe that such physician investments constitute an unintended loophole in the Stark Law's whole hospital exception.6

In response to the specialty hospital debate, Congress incorporated a provision into the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the "MMA") that imposed an 18-month moratorium, beginning on December 8, 2003 and ending on June 8, 2005, on the application of the Stark Law whole hospital exception to physician investments in specialty hospitals.7 This moratorium applied to physician investments in all but "grandfathered" entities.8 On May 12, 2005, the Centers for Medicare and Medicaid Services ("CMS") administratively continued the specialty hospital moratorium beyond its statutory expiration by implementing a freeze on the issuance of provider numbers to specialty hospitals until January 2006.9

The DRA's Impact on the Specialty Hospital Moratorium

The DRA continues the administrative suspension on enrollment of, and issuance of new provider numbers for, new specialty hospitals until the earlier of the date that CMS submits its final report, described below, or August 8, 2006.

Under the DRA, CMS must provide a report that addresses perceived problems relating to specialty hospitals. The report must provide a strategic plan addressing the following issues arising from physician investments in specialty hospitals:

  • proportionality of investment return;
  • bona fide investment;
  • annual disclosure of investment information;
  • provision of care to Medicaid beneficiaries and charity care patients; and
  • appropriate enforcement.

An interim CMS report on specialty hospitals is due on or before May 8, 2006, and the final report is due no later than August 8, 2006. If CMS fails to submit the final report by August 8, 2006, then the suspension on specialty hospital enrollment will be automatically extended until October 8, 2006, at which point it will expire.

Medicare Gainsharing Projects

The DRA authorizes certain gainsharing demonstration projects to test and evaluate gainsharing arrangements between hospitals and physicians.10

Generally speaking, gainsharing is a program in which a hospital pays physicians a portion of certain cost savings achieved by the hospital as a result of the physicians' efforts to reduce costs and increase efficiencies. The Office of Inspector General of the Department of Health and Human Services (the "OIG") has historically found gainsharing arrangements problematic, and has indicated that such arrangements may implicate the Stark Law, the Anti-Kickback Statute11 and the Civil Monetary Penalty Law.12, 13

However, last year the OIG approved six gainsharing programs on a case-by-case basis, through its advisory opinion process.14 The OIG's approval of these programs was based on the incorporation of several safeguards.15 The DRA will allow limited gainsharing arrangements that participate in certain demonstration projects specifically authorized by CMS, while allowing Congress additional time to consider whether changes to the Stark Law in this area are advisable.

The aim of the demonstration projects is to monitor the utilization of inpatient hospital resources and physician services, in order to improve the quality and efficiency of care provided to Medicare beneficiaries and develop improved hospital performance, with sharing of the resulting cost savings between the hospital and physicians. Under the DRA, CMS is authorized to permit gainsharing demonstration arrangements at up to six sites, based on proposals submitted to CMS.

The demonstration projects are permitted under the following conditions:

  • a demonstration project must involve an arrangement between a hospital and a physician under which the hospital provides remuneration to the physician that represents solely a share of the savings incurred directly as a result of collaborative efforts between the hospital and the physician;
  • a demonstration project must be submitted to CMS prior to the implementation of the project and conducted pursuant to a written agreement that defines how the project will achieve improvements in quality and efficiency;
  • the project must include a notification process to inform patients who are treated in a hospital participating in the project of the hospital's participation;
  • the project must provide measures to ensure that the quality and efficiency of the care provided to patients participating in the project is continuously monitored to ensure that such quality and efficiency is maintained or improved;
  • the elements of the demonstration project must be reviewed by an organization that is not affiliated with a hospital or the physician participating in the project; and
  • the project must not be structured in a manner that awards physicians for participating in the project on the basis of the volume or value of referrals to the hospital.

CMS must solicit applications for demonstration projects by May 9, 2006, and is required to approve projects no later than November 1, 2006.

Exceptions to Outpatient Therapy Caps

The DRA also provides for an exception to certain caps imposed by the Medicare and Medicaid programs on benefits for outpatient physical therapy, speech-language pathology and occupational therapy services furnished by providers other than hospitals. The DRA requires CMS to waive the caps for therapy services that are determined to be medically necessary. CMS recently announced the exception process that will be followed by its claims processing contractors.16

Medicare and Medicaid impose a combined cap of $1,740 on benefits for physical therapy and speech-language pathology services furnished in 2006, with a separate $1,740 cap for 2006 occupational therapy services.17 Under the new exception process, CMS claims processing contractors will automatically waive the otherwise applicable cap for any therapy services provided to treat: (a) any one or more of certain named conditions, such as joint replacements, multiple sclerosis or muscular dystrophy; or (b) any other condition, when the patient has an underlying condition that makes treatment of the case more complex, such as diabetes, Parkinson's disease, pneumonia or heart failure. Because they directly and significantly impact medical necessity, the presence of any named condition or complexity automatically establishes the medical necessity of therapy. Consequently, as long as appropriate documentation of the applicable condition or complexity is furnished to the claims processing contractor, the contractor will waive the cap and provide benefits for therapy services without requiring any specific request for a waiver.

Automatic exception from the therapy caps will also be made for certain clinically complex situations, such as where the patient was recently discharged from a hospital or skilled nursing facility, where the patient has a generalized musculoskeletal condition or a mental or cognitive disorder that will directly and significantly impact the recovery rate, or where the patient requires additional therapy so that he or she can return to his or her place of residence. Although waiver of the caps is also automatic in these cases, when submitting its claim to a claims processing contractor, a provider must include documentation of the facts and circumstances that substantiate medical necessity and waiver of the cap.

A provider (or beneficiary) can request that a claims processing contractor make a manual exception to the caps to permit a specific number of additional therapy visits, not to exceed 15 additional days of treatment, even when one of the enumerated conditions or complexities is not present, if it is believed that services furnished in excess of the cap are medically necessary. To do so, the provider (or beneficiary) must submit a written request to the claims processing contractor along with documentation to substantiate the medical necessity of the additional services. The contractor will review the request and must make a decision within 10 business days. If the contractor fails to make its determination within the ten-day period, the additional 15 days of treatment are deemed medically necessary, and benefits will be provided for that treatment notwithstanding the caps.

Ownership of Durable Medical Equipment Reimbursed by Medicare

Under the DRA, so-called "capped rental" items newly rented on or after January 1, 2006 may be rented for up to 13 months.18 In the case of a power-driven wheelchair, the beneficiary is afforded the option of purchasing the wheelchair on a lump-sum basis at the time the beneficiary is supplied with the wheelchair.19 In any case, after the end of any rental period, title to the durable medical equipment transfers to the Medicare beneficiary. Medicare shall continue to pay for the "reasonable and necessary" maintenance and service of such equipment after the expiration of the rental period.

Medicare Payments for Oxygen Equipment

The DRA imposes a 36-month limit on the amount of time that oxygen equipment (including portable oxygen equipment) may be rented.20 After the three-year rental period, title of the oxygen equipment is transferred to the Medicare beneficiary, and Medicare is required to pay for reasonable and necessary service and maintenance.

Hospital Quality Improvement

Hospitals that submit quality of care data selected by the Secretary of Health and Human Services ("Secretary") are entitled to receive annual increases in their payments for inpatient services in the full amount of the increase in the hospital market basket.21 Currently, hospitals that do not participate receive a lesser increase in Medicare payment, equal to the market basket minus 0.4%.22 The DRA increases the penalty for hospitals that do not submit the selected quality data. For fiscal year 2007 and thereafter, the reduction for hospitals that do not participate will be increased to 2%.23 In 2007, CMS is also required to expand the set of measures determined to be appropriate for the measurement of the quality of care furnished by hospitals.

Extended Phase-In of the Inpatient Rehabilitation Facility Classification Criteria

The DRA also codifies and makes certain changes to the "75 Percent Rule," described below.

Obtaining classification as an inpatient rehabilitation facility ("IRF") can be advantageous for a hospital because IRFs receive enhanced Medicare reimbursement in comparison to regular acute care hospitals.24 One of CMS's criteria for IRF classification, commonly known as the "75 Percent Rule," requires that a certain percentage of a facility's patients fall into specified diagnostic categories.25 CMS has published a phase-in schedule for that rule, with the percentage of an IRF's patients who must satisfy the above requirement increasing annually, until the 75% threshold is reached.26

The DRA codifies the "75 Percent Rule," and adds another year to the phase-in period in which the Rule will be fully implemented. Specifically, the 60% threshold currently in use to determine whether a hospital or hospital unit is an IRF will remain in effect until June 30, 2007. The threshold will increase to 65% on July 1, 2007, and again to 75% on July 1, 2008.

Payment for Physicians' Services

The DRA will eliminate the 4.4% reduction in payments for physicians' services which went into effect January 1, 2006.27 Under the DRA, payment for physicians' services for 2006 will instead remain frozen at the 2005 level.

January or February 2006 claims for physicians' services that have already been paid will be reprocessed without resubmission; CMS expects reprocessing to be completed by July 1, 2006. In addition, because the higher payment rates for physicians' services may affect a physician's decision to participate in Medicare, CMS is offering a second 45-day participation enrollment period beginning February 15, 2006, to allow physicians to change their participation decision, should they so desire.

Reduction in Payments to Skilled Nursing Facilities

The DRA calls for a 30% reduction in Medicare reimbursement payments to skilled nursing facilities for bad debt resulting from failure of Medicare beneficiaries (other than those beneficiaries who are dually eligible for both Medicare and Medicaid) to pay coinsurance.28 According to CMS, this reduction will be implemented through revised cost report instructions.29

Adjustments in Payments for Imaging Services

The DRA limits reimbursement for the technical component of certain imaging services. Specifically, under the DRA, payment for the technical component of an imaging service furnished in a physician's office on or after January 1, 2007 will be reduced to the lesser of the amount established under the prospective payment system for hospital outpatient department services or the physician fee schedule amount.30 This adjustment applies to imaging and computer-assisted imaging services, including X-ray, ultrasound, nuclear medicine, magnetic resonance imaging, computed tomography, and fluoroscopy, but it does not apply to diagnostic and screening mammography.

Limitation on Payments for Procedures in Ambulatory Surgical Centers

The DRA also limits payment for certain procedures performed in ambulatory surgical centers ("ASCs"). Effective January 1, 2007, payment for ASC services will be reduced to the lesser of the hospital outpatient department rate or the standard overhead amount for the ASC service.31

Increase to Composite Rate Component for Dialysis Services

Effective January 1, 2006, the DRA increases payments for dialysis services by 1.6% above the rates paid for services furnished on December 31, 2005.32 January or February 2006 claims that have already been paid will be reprocessed; CMS expects reprocessing to be completed by July 1, 2006.

Home Health Payments

The DRA eliminates the 2.8% increase to home health agency rates that went into effect January 1, 2006.33 Under the DRA, home health agencies will receive payments for services provided in 2006 at the 2005 rates.

However, the DRA reestablishes a 5% add-on to payments for home health services provided to beneficiaries in rural areas.34 The add-on payment originally expired on April 1, 2005, but the DRA will continue the add-on payment for rural home health services provided on or between January 1, 2006 and January 1, 2007. This payment aims to support access to home health services in rural areas.

Payments for Services at Federally Qualified Health Centers

Effective January 1, 2006, the DRA allows federally qualified health centers ("FQHCs") to receive Medicare reimbursement for delivery of diabetes

self-management training and medical nutrition therapy to beneficiaries with diabetes or renal disease.35 The DRA also eliminates restrictions on receipt of grants from the Health Care for the Homeless program36 by expanding the definition of FQHC to include recipients of such grants.37


Under the DRA, every entity that receives at least $5 million in Medicaid payments annually is required to establish fraud and abuse policies, describing in detail the Federal False Claims Act and the entity's procedures for detecting and preventing fraud, waste, and abuse.38 CMS has recommended that entities participating in Medicare and Medicaid adopt such policies for a number of years. But this is the first time such policies have ever been mandated. The required policies must be in place by January 1, 2007 and must be available to all of an entity's employees, agents and contractors. An entity's employee handbooks must include discussions of federal fraud and abuse laws and whistleblower protection, as well as the entity's fraud and abuse policies. Compliance with these requirements will be a condition of Medicaid payment. Accordingly, an entity that does not comply is not entitled to submit Medicaid claims without facing potential liability for submission of false claims.


The DRA has wide-reaching implications affecting virtually all aspects of the health care industry. While decreasing reimbursement for certain providers, the DRA presents opportunities for others to increase their margins. In any case, it is incumbent upon all providers and suppliers to address the effects of the DRA in the future.

For more information, please contact Jessica A. Von Bommel at 414.223.2508, or

1 Deficit Reduction Act of 2005, Pub. Law 109-171 (2006) [hereinafter DRA].
2 See 42 U.S.C. § 1395nn.
3 42 U.S.C. § 1395nn(d)(3).
4 42 U.S.C. § 1395nn(d)(3)(A).
5 Medicare Prescription Drug, Improvement and Modernization Act of 2003, Pub. L. No. 108-173 [hereinafter MMA], § 507(a)(1)(B), 117 STAT. 2066, 2295-96 (Dec. 8, 2003) (defining "specialty hospital").
6 Stuart Guterman, Specialty Hospitals: A Problem or a Symptom?, HEALTH AFFAIRS, 25, no. 1 (Jan. 2006).
7 MMA § 507.
8 "Grandfathered" entities are those that the Secretary of Health and Human Services determines to be in operation or under development as of November 18, 2003 and for which (i) the number of physician investors has not increased since that date, (ii) the specialized services furnished by the hospital have not changed, and (iii) any increase in the number of beds has occurred only on the main campus of the hospital and does not exceed the greater of five beds or fifty percent of the beds in the hospital as of that date. MMA § 507(a)(1)(B).
9 CMS, Hospitals - Suspension of Processing New Provider Enrollment Applications (CMS 855A) for Specialty Hospitals, at (June 9, 2005).
10 DRA § 5007(a).
11 42 U.S.C. § 1320a-7b(b).
12 42 U.S.C. § 1320a-7a.
13 See, e.g., OIG Special Advisory Bulletin, Gainsharing Arrangements and CMPs for Hospital Payments to Physicians to Reduce or Limit Services to Beneficiaries, at (July 1999).
14 OIG Advisory Opinions 05-01, 05-02, 05-03, 05-04, 05-05, and 05-06, at (2005).
15 The safeguards considered by the OIG included, among others: (i) the specific cost-saving actions and resulting savings were transparent; (ii) the parties requesting the Advisory Opinions offered credible medical support for the position that implementation of the recommendations would not adversely affect patient care; (iii) the requesting parties would disclose their involvement in the gainsharing arrangement to patients; and (iv) the financial incentives would be reasonably limited in duration and amount.
16 CMS, Outpatient Therapy Caps: Exceptions Process Required by the DRA, at (Feb. 15, 2006).
17 Id.
18 DRA § 5101(a)(1)(A)(i)(I). Prior to passage of the DRA, capped rental items could be rented for up to 15 months. 42 C.F.R. § 414(d)(2)(i).
19 DRA § 5101(a)(1)(A)(iii).
20 DRA § 5101(b)(1). Prior to passage of the DRA, oxygen equipment could be rented for an indefinite period. 42 U.S.C. § 1395m(a)(5).
21 The hospital market basket is an index used by Medicare to update cost and payment levels for various hospital services. It reflects price inflation facing hospitals in providing medical care. CMS, Market Basket Definitions and General Information, at Stats/downloads/info.pdf (last visited March 13, 2006).
22 MMA § 501(b).
23 DRA § 5001(a).
24 42 C.F.R. § 412.23(b).
25 The 13 diagnostic categories are: (1) stroke, (2) spinal cord injury, (3) congenital deformity, (4) amputation, (5) major multiple trauma, (6) fracture of femur, (7) brain injury, (8) neurological disorders, (9) burns, (10) active, polyarthricular rheumatoid arthritis, psoriatic arthritis, and seronegative arthropathies, (11) systemic vasculidities with joint inflammation, (12) severe/advanced osteoarthritis involving two or more major weight-bearing joints, and (13) knee or hip joint replacement, with one or more of the following circumstances applying: (i) the patient underwent bilateral knee or bilateral hip joint replacement surgery during acute hospitalization, (ii) the patient is extremely obese with a Body Mass Index of at least 50 at time of admission to inpatient rehabilitation hospital, or (iii) the patient is age 85 or older at the time of admission. 42 C.F.R. § 412.23(b)(2).
26 Id.
27 DRA § 5104(a)(2).
28 DRA § 5004.
29 See CMS, Payment Provisions in the Original Medicare Program Immediately Affected by the Deficit Reduction Act, at (Feb. 10, 2006).
30 DRA § 5102(b).
31 DRA § 5103.
32 DRA § 5106.
33 DRA § 5201(a).
34 DRA § 5201(b).

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