Disproportionate share hospital payments

Medicaid disproportionate share hospital (DSH) payments are statutorily required payments intended to offset hospitals’ uncompensated care costs to improve access for Medicaid and uninsured patients as well as the financial stability of safety-net hospitals. In fiscal year (FY) 2021, Medicaid made a total of $18.9 billion in DSH payments ($8.1 billion in state funds and $10.8 billion in federal funds).¹

In the Protecting Access to Medicare Act of 2014 (P.L. 113-93) Congress directed MACPAC to publish an initial Report to Congress on Medicaid Disproportionate Share Hospital Payments in February 2016 and update it annually in March. Congress specifically asked MACPAC to compare the relationship of state DSH allotments to (1) changes in the number of uninsured individuals, (2) amounts and sources of hospitals’ uncompensated care costs, and (3) the number of hospitals with high levels of uncompensated care that also provide access to essential community services for low-income, uninsured, and vulnerable populations.

Read MACPAC’s first DSH report to Congress here, and MACPAC’s 2023 update here. MACPAC’s June 2023 report made recommendations that would automatically adjust DSH allotments so that total DSH funding does not change when there are changes in the federal medical assistance percentage (FMAP). MACPAC’s March 2019 report made recommendations related to allotment reductions scheduled to take effect in FY 2020 and MACPAC’s June 2019 report made recommendations on how to calculate Medicaid shortfall for Medicaid beneficiaries for whom Medicaid is not the primary payer. MACPAC’s Medicaid shortfall recommendation was implemented for most hospitals as part of the Consolidated Appropriations Act, 2021 (P.L. 116-260).

MACPAC’s March 2017 report analyzes several approaches to improve the targeting of DSH payments to hospitals, which is available here. You also can find data on DSH and other supplemental payments by state in MACPAC’s issue brief on base and supplemental payments to hospitals here and profiles of DSH hospitals here.

Evolution of DSH payment policy

States began making Medicaid DSH payments in 1981, when Medicaid hospital payments were delinked from Medicare payment levels. Beginning with Medicaid’s enactment in 1965, states were required to pay hospitals’ reasonable costs, and to comply with this requirement, states mirrored Medicare’s hospital payment policies. As states were given broader discretion over hospital payment, Congress became concerned that this shift might threaten hospitals serving large numbers of Medicaid beneficiaries and the uninsured. In response, legislation enacted in 1981 required states to “take into account” the situation of hospitals serving a disproportionate share of low-income patients when designing payment systems (§1902(a)(13)(A)(iv) of the Social Security Act (the Act)). For further discussion of the evolution of Medicaid hospital payment policy, see Examining Medicaid Payment Policy from MACPAC’s March 2011 report.

Limits on DSH allotments and payments

When Congress first required states to make DSH payments, the total amount of payments that states could make was left open-ended; however, states were slow to make DSH payments. DSH payments increased significantly in the 1990s due to a series of hospital payment policy changes starting in 1985. In the Omnibus Budget Reconciliation Act (OBRA) of 1986 (P.L. 99-509), Congress clarified that Medicaid’s hospital payment limitations did not apply to DSH, and OBRA 1987 (P.L. 100-203) required states to submit state plan amendments authorizing DSH payments. At about the same time, a 1985 federal regulation permitted states to use both public and private donations as sources of non-federal Medicaid financing and 1987 policy guidance indicated that taxes that were imposed on only Medicaid providers could also be used to finance Medicaid (Federal Register 1987). This combination of unlimited DSH payments and financing flexibility was soon followed by significant growth in DSH spending and, from 1990 to 1992, the total amount of DSH payments increased from $1.3 billion to $17.7 billion (Urban Institute 1998).

As DSH spending increased, federal policymakers grew concerned over both the level of DSH spending and the possibility that some states were misusing DSH funds by making large DSH payments to state and local government-owned hospitals, which then transferred the payment back to the state and used other purposes. Congress acted to address these concerns by first enacting national and state-specific caps on the DSH funds that could be allocated to hospitals (Medicaid Voluntary Contribution and Provider-Specific Tax Amendments of 1991, P.L. 102-234), and then creating hospital-specific limits equal to the actual cost of uncompensated care for hospital services provided to Medicaid enrollees and uninsured individuals (OBRA 1993, P.L. 103-166).²

State-specific DSH allotments. The caps on the federal DSH funds that are available to each state are referred to as allotments, and the amount of each state’s allotment is calculated according to statutory requirements and published annually in the Federal Register. Allotments were initially established for FY 1993 and were generally based on state 1992 DSH spending. Currently, each state allotment is based on the higher of its fiscal year (FY) 2004 allotment, or the prior fiscal year’s allotment increased by the change in the Consumer Price Index for All Urban Consumers from the prior year (Federal Register 2014). ⁴ Also, each state allotment can be no more than the greater of the prior year’s allotment or 12 percent of its total Medicaid medical assistance expenditures during the fiscal year (§1923(f)(3)(B) of the Act).

The distribution of allotments across states today largely reflects the patterns of states’ DSH spending in 1992, before federal limits were established.

Hospital-specific DSH payment limits. Federal statute also limits the amount of DSH payments that a state can make to any single hospital. In general, DSH payments cannot exceed a hospital’s cost of providing uncompensated care.⁵That is, DSH payments are limited to the cost of inpatient and outpatient services to patients for whom Medicaid is the primary payer and uninsured patients minus payments received from Medicaid (including supplemental payments) and from uninsured individuals.⁶

State DSH Policies

States have broad flexibility in both determining which hospitals receive DSH payments and in how the payments are calculated. However, states must make DSH payments to deemed DSH hospitals, which must meet one of two criteria specified in federal statute:

the hospital has a Medicaid utilization at least one standard deviation above the mean for hospitals in the state that receive Medicaid payments, or
the hospital has a low-income inpatient utilization in excess of 25 percent.⁷

States may designate other hospitals to receive DSH payments as long as they have a Medicaid utilization rate of at least 1 percent and, with certain exceptions, at least two obstetricians with staff privileges that treat Medicaid enrollees. As a result, states may designate a wide range of hospitals as DSH hospitals, as long as those meeting the specified minimum criteria are included. Accordingly, hospitals that receive DSH funds vary substantially among states, with some providing DSH payments to nearly all of their hospitals and other states providing DSH payments to one or two hospitals.

Federal statute also limits the amount of DSH payments that each state can make to institutions for mental diseases or other mental health facilities. However, states have broad flexibility within these requirements in determining the amount of DSH payments that are made to each provider.

States’ DSH payment methodologies are specified within their Medicaid state plans. Federal statute requires that minimum payments to DSH hospitals must be determined using one of the following methodologies:

the Medicare DSH adjustment methodology,
a methodology that increases DSH payments in proportion to the extent that a hospital’s Medicaid utilization exceeds one standard deviation above the mean; and
a methodology that varies by hospital type and that applies equally to all hospitals of each type and is reasonably related to Medicaid and low-income utilization.

Temporary changes in DSH allotments since 2009

During periods of economic uncertainty, Congress may provide temporary enhancements to the Medicaid FMAP and the State Children’s Health Insurance Program (CHIP) enhanced FMAP. These FMAP increases effectively reduce total DSH spending as federal spending remains capped while state contribution to DSH spending decreases.

Since 2009, there have been two federal provisions that adjusted federal DSH allotments when Congress provides a temporary FMAP increase:

In February 2009, Congress enacted the American Recovery and Reinvestment Act (ARRA, P.L. 111-5), providing a flat 6.2 percentage point FMAP increase. ARRA excluded DSH payments from this increase and separately increased DSH allotments for FYs 2009 and 2010 (Congressional Research Service 2016).⁸
Families First Coronavirus Response Act (FFCRA, P.L. 116-127) provided a temporary enhancement to the Medicaid federal match from January 1, 2020 until the end of the COVID-19 public health emergency, which lowered the total amount of DSH available to providers.
American Rescue Plan Act of 2021 (ARPA, P.L. 117-2) changed the basis of DSH allotments from the federal funding to total funding and continued the enhanced federal match for DSH payments. This ensured that total DSH funding would not decline during the public health emergency.

DSH Reporting and Audits

In 2003, Congress added statutory requirements for states to submit annual reports and, separately, to submit an annual independent certified audit of their DSH payments Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA, P.L. 108-173). For each DSH hospital, the annual reports are required to include, for example, the hospital-specific DSH limit, the Medicaid inpatient utilization rate, the low-income utilization rate, state-defined DSH qualification criteria, and Medicaid payments (including fee-for-service, managed care, and non-DSH supplemental payments) (§1923(j) of the Act and 42 CFR 447.299). The annual independent audits must certify that each DSH hospital qualifies for payment, DSH payments do not exceed allowable uncompensated care costs, and that the hospital accurately reported payments, spending, and utilization for the purpose of DSH payment methodology.

The first set of DSH reports were submitted in 2010 and covered state plan rate years (SPRYs) 2005 to 2007. SPRYs 2005 to 2010 were deemed transition years to allow the Centers for Medicare & Medicaid Services (CMS), states, hospitals, and auditors time to develop and refine their procedures without financial penalties. Beginning with the reports for SPRY 2011, which were submitted in 2014, DSH payments that exceed hospital specific limits are considered overpayments and states are required to return the federal share or, if specified in the state plan, redistribute it to other hospitals that are below their limits (CMS 2019).

Medicaid DSH Allotment Reductions

Federal statute. Under the Patient Protection and Affordable Care Act of 2010 (ACA, P.L. 111-148, as amended), Congress would have reduced federal DSH allotments beginning in 2014, to account for the decrease in uncompensated care anticipated under health insurance coverage expansion. However, several pieces of legislation have been enacted since 2010 that delayed the ACA’s Medicaid DSH reduction schedule:

the Middle Class Tax Relief and Job Creation Act of 2012 (P.L. 112-96), enacted on February 22, 2012, extended the reductions to FY 2021.
the American Taxpayer Relief Act of 2012 (P.L. 112-240), enacted on January 2, 2013, extended the reductions to FY 2022.
the Bipartisan Budget Act of 2013 (P.L. 113-67), enacted on December 26, 2013, delayed the onset of reductions until FY 2016 by eliminating the FY 2014 reduction and adding the FY 2015 reduction to that for FY 2016; also extended the reductions to FY 2023.
the Protecting Access to Medicare Act of 2014 (P.L. 113-93), enacted April 1, 2014, eliminated the FY 2016 reduction, thus delaying the reductions until FY 2017; also adjusted amounts of reductions in future years and extended them to FY 2024.
the Medicare Access and CHIP Reauthorization Act of 2015 (P.L. 114-10), enacted on April 16, 2015, eliminated the FY 2017 reduction, which delayed the reductions until FY 2018, adjusted amounts of reductions in future years, and extended them to FY 2025.
the Bipartisan Budget Act of 2018 (P.L. 115-123) eliminated DSH allotment reductions for FY 2018 and FY 2019 and increased the amount of reductions scheduled for FYs 2021–2023.
the Further Consolidated Appropriations Act, 2020 (P.L. 116-94) delayed the implementation of the FY 2020 reductions until May 23, 2020.
the Coronavirus Aid, Relief, and Economic Security Act of 2020 (P.L. 116-136) eliminated the reduction scheduled for FY 2020. The Act also reduces the amount of reduction scheduled for FY 2021 by half and delayed implementation of reductions until December 1, 2020.
the Consolidated Appropriations Act, 2021 (P.L. 116-260) delayed implementation of reductions until FY 2024.

As a result, the current schedule and amounts for the Medicaid DSH reductions are as follows:

$8.0 billion in FY 2024;
$8.0 billion in FY 2025;
$8.0 billion in FY 2026; and
$8.0 billion in FY 2027.

The statute requires the Secretary of Health and Human Services to develop a methodology that:

imposes the largest reductions on states that have the lowest percentages of uninsured individuals or do not target DSH payments on hospitals with high volumes of Medicaid inpatients or uncompensated care;
imposes smaller percentage reductions on low DSH states;⁹and
takes accounts for the extent to which DSH funds were used to expand coverage through a demonstration under Section 1115 of the Social Security Act.

On September 25, 2019, CMS issued a final rule for distributing reductions among states, which is similar to the methodology proposed in 2017. However, even after DSH allotment reductions, DSH allotments will continue to vary widely by state. MACPAC’s analyses have found that the methodology does not meaningfully improve the relationship between DSH allotments and levels of hospital uncompensated care or any other factor that Congress asked MACPAC to consider.

Notes

¹DSH spending in FY 2018 includes spending funded from prior year allotments. Total DSH spending includes an estimate of the portion of California’s Section 1115 waiver spending that based on the state’s DSH allotment.

² In a 1994 letter to state Medicaid Directors, CMS (then HCFA) instructed states that the cost of “hospital services” includes both inpatient and outpatient costs.

³ The methodology described here applies to most states, although there are some notable exceptions. Hawaii and Tennessee each have specific methodology outlined in the Medicaid statute.

⁴Total annual uncompensated care costs are defined in federal regulation as “the total cost of care for furnishing inpatient hospital and outpatient hospital services to Medicaid eligible individuals and to individuals with no source of third party coverage for the hospital services they receive less the sum of regular Medicaid FFS rate payments, Medicaid managed care organization payments, supplemental or enhanced Medicaid payments, uninsured revenues, and Section 1011 payments for inpatient and outpatient hospital services” (42 CFR 447.299).

⁵For California public hospitals, the limit is 175 percent of uncompensated costs.

⁶ The Consolidated Appropriations Act, 2021 (P.L. 116-260) made changes to the DSH definition of Medicaid shortfall and excludes enrollees who receive principal coverage through a third party (private or Medicare) from calculations of Medicaid shortfall. The law also exempts the top 3 percent of hospitals that treat a high number and share of patients who are eligible for Medicare and receive Supplemental Security Income from this change.

⁷ The formulas for calculating Medicaid utilization and low-income utilization are defined under Section 1923(b) of the Social Security Act.

⁸ ARRA did not increase Hawaii and Tennessee’s FYs 2009 and 2010 DSH allotments.

⁹ A low-DSH state is a state that had FY 2000 DSH expenditures that were greater than 0 percent but less than 3 percent of its total Medicaid medical assistance expenditures (i.e., including federal and state expenditures and excluding expenditures for administrative activities).