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All Eyes on DSH Payment Cuts: The Future of DSH Payments in Healthcare Reform

Healthcare reform, with its potential to reduce levels of uncompensated care, may seem like a way for hospitals to increase their bottom lines. However, the Patient Protection and Affordable Care Act (PPACA) decreases Medicare and Medicaid Disproportionate Share Hospital (DSH) payments — adjustments made to hospitals that serve a higher-than-average number of low-income patients. That, coupled with customary CMS cuts, could further erode revenue for facilities in states with their own support funding for uninsured patients.


History of DSH payments

For almost 25 years, the Medicare/Medicaid program has classified hospitals that treat large numbers of low-income patients as DSH program facilities and, as such, offered higher payments for treatment. The government determines whether a hospital qualifies for DSH payments using a series of formulas that consider the ratio of Medicaid patient days to total patient days, and the ratio of patient days for Medicare beneficiaries receiving Supplemental Security Income to total Medicare patient days.[1]


DSH payments, which in 2009 reached $10.1 billion and $11.3 billion for Medicare and Medicaid respectfully, started as a way to compensate hospitals for what government officials believed were the higher costs associated with treating low-income patients.[2] As CMS payment cuts became increasingly common, DSH payments have become an unconventional way to reimburse hospitals for costs related to uncompensated care. In its March 2007 report to Congress, the Medicare Payment Advisory Commission (MedPAC) suggested that DSH payments were being used inappropriately. "Many have viewed the DSH adjustment as helping hospitals with their uncompensated care rather than offsetting the cost impact of treating low-income patients," the report stated. "However, we found little evidence of a relationship between the DSH payments hospitals receive and the amount of uncompensated care they provide."


Congress integrated recommendations from MedPAC into both the House and Senate healthcare reform proposals. That could mean closer scrutiny of hospital eligibility and possible reductions in DSH payments.

What Health Reform includes

As stated above, the unconsolidated Senate and House versions of health care reform each incorporate proposed changes to Medicare and Medicaid DSH payments. To get past these differences, the House passed the "Health Care and Education Reconciliation Act of 2010" and the PPACA. President Obama signed both into law in late March. Here's what they say:

Medicare: DSH payments will decrease by 25 percent in fiscal year 2014. However, these payments will be subsequently adjusted based on the overall percentage of uninsured in the total patient population and the amount of uncompensated care provided compared to each respective rate in 2012. The adjustments set by the Department of Health and Human Services will not be open for challenge or review by administration or judicial proceedings. The estimated total reduction amount set forth in the law is $21 billion over 10 years.


Medicaid: DSH payments will decrease by $14.1 billion between 2014 and 2020. The reduction per year will be more heavily weighted towards the end of the decade. DSH payment cuts will be split among states based on the overall size of DSH participation per state. Exactly how payment cuts will break down has yet to be determined.


Hospital support

Three major hospital associations — the American Hospital Association, the Federation of American Hospitals and the Catholic Health Association — have offered to contribute approximately $155 billion over 10 years to help pay for the U.S. healthcare overhaul.


Significant savings — approximately $100 billion — could come through lower-than-expected Medicare and Medicaid payments to hospitals. Slowly reducing the subsidies paid to hospitals to care for the uninsured could generate close to $40 billion in savings.[3]


Effect of DSH uncertainty on hospital value

In evaluating the Fair Market Value (FMV) or calculating the market (sales) price of a certain hospital, it's important to consider how the healthcare reform proposals, including decreases in uncompensated care and in future DSH payments, will affect that facility (As mentioned above, many of the DSH cuts align with uninsured levels.). For example, "unless Congress acts to extend the American Recovery and Reinvestment Act, DSH allotments through Fiscal Year 2011," the National Association of Public Hospitals and Health Systems writes in May 2010, "DSH payments to safety-net hospitals will be cut by hundreds of millions of dollars in October 2010, putting vulnerable patients' access to care and the availability of essential community services at risk."[4]


Generally accepted valuation practice requires consideration of all relevant approaches to value. Performing a valuation analysis includes one of three generally accepted methodologies:


1. Cost approach. This approach looks at the overall dollars it would take to replicate a comparable group of assets or a business with the same level of utility.


This is most often used for situations in which a hospital's projected earnings or cash flows yield a smaller value than that of the tangible and identifiable intangible assets. Tangible assets include equipment and net working capital. Identifiable intangible assets include items such as Certificates of Need and trade names. In the context of the cost approach, identifiable intangible assets may have value when transferable and separately marketable. The buildup methodology is most commonly used when applying the cost approach.


Using this methodology, the valuator adjusts the balance sheet or the book value of the portfolio of tangible and intangible assets to represent the value of the assets in place and in use, or perhaps, in orderly liquidation. This process may, in practice, use all three approaches to value.


If the total indicated value equals less than that shown by the market approach or income approach, the valuation opinion should not place any reliance or weighting on the cost-approach result. However, if the total indicated value from the cost approach exceeds the indicated values from the market approach and the income approach, the valuation opinion may rely solely on the cost approach indicated value.


2. Market approach. This approach compares the value of the subject asset to that of similar businesses traded in a free and open market. To estimate value, adjust the market value of the similar assets or businesses for qualitative and quantitative differences.


This approach typically considers the market value of invested capital (MVIC) multiples of revenues and of earnings before interest, taxes, depreciation, and amortization (EBITDA). Though EBITDA often becomes a proxy for cash flows and MVIC/EBITDA multiples are the most common measurements used in the hospital and other healthcare sectors, be cautious when considering this simple application; historical or even projected EBITDA may not represent long-term, sustainable cash flows, especially given the changing reimbursement environment.


3. Income approach. This approach analyzes historical financial information to estimate the future level of cash flow generated by an asset or group of assets. The present value of these future cash flows represents value to an investor.


The income approach most commonly takes the form of discounted cash-flow methodology, which bases the total value of a business on its projected cash flows, discounted back to present worth at the investors' required rate of return or discount rate. Cash flow equals net income plus depreciation and amortization, minus capital expenditures and incremental working capital.


As for any business, volumes, pricing (or reimbursement levels in the healthcare world) and operating expense levels drive net income for hospitals. In the current environment, remember to consider the effect of future DSH reimbursement trends. Finally, avoid the temptation to look at each input in isolation, without considering how assumptions about one affect the others.


What to do now?

In the current atmosphere and given the healthcare reform legislation, we are often asked, how is hospital value affected? The short answer is, "It depends." A comprehensive valuation analysis that takes into account the specific facts and circumstances of the subject hospital, performed by an independent third party, may be the best place to start.


Contact Mr. Kickirillo at vincek@vmghealth.com. Contact Mr. Rolfe at rolfe@vmghealth.com. Learn more about VMG Health.

[1] "Acute Inpatient PPS: Disproportionate Share Hospital," Center for Medicare & Medicaid Services.

[2] "DSH Allotment for Fiscal Year 2009", Health and Human Services.

[3] H.R.4872, Health Care and Education Affordability Reconciliation Act of 2010.

[4] "Our View," May 2010, National Association of Public Hospitals and Health Systems.

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