The Future of Medicare Outlier Payments: A Change May be on the Horizon

After Medicare’s implementation of the Prospective Payment System (PPS) for hospital inpatient care, the common misconception is Medicare cost report’s importance has been reduced to the reporting of Medicare wage index, disproportionate share, bad debts, and other areas of additional reimbursement; however, as noted by one of our clients, the calculated cost of care (cost to charge ratios), continue to have a significant reimbursement impact on PPS hospitals.

As background, Section 1886(d)(5)(A) of the act provides for Medicare payments to Medicare-participating hospitals in addition to the basic prospective payments for cases incurring extraordinarily high costs. To qualify for outlier payments, a case must have costs above a fixed-loss cost threshold amount (a dollar amount by which the costs of a case must exceed payments in order to qualify for outliers). The actual determination of whether a case qualifies for outlier payments takes into account both operating, capital costs, and diagnosed-related group or DRG payments. That is, the combined operating and capital costs of a case must exceed the fixed loss outlier threshold to qualify for an outlier payment. The operating and capital costs are computed separately by multiplying the total covered charges by the operating and capital cost-to-charge ratios. The estimated operating and capital costs are compared with the fixed-loss threshold after dividing that threshold into an operating portion and a capital portion (by first summing the operating and capital ratios and then determining the proportion of that total comprised by the operating and capital ratios and applying these percentages to the fixed-loss threshold). The thresholds are also adjusted by the area wage index (and capital geographic adjustment factor) before being compared to the operating and capital costs of the case. Finally, the outlier payment is based on a marginal cost factor equal to 80 percent of the combined operating and capital costs in excess of the fixed-loss threshold (90 percent for burn DRGs). For discharges occurring on or after August 8, 2003, any reconciliation of outlier payments will be based on operating and capital cost-to-charge ratios calculated based on a ratio of costs to charges computed from the relevant cost report and charge data determined at the time the cost report, coinciding with the discharge, is settled.

Prior to reconciliation, the cost-to-charge ratios are based on the most recently settled or tentative cost report. For the hospital referenced above, a change of ownership had occurred in between the most recently settled cost reporting year and the applicable cost reporting year; in addition, new ownership implemented a significant price increase. Expenses incurred by the hospital during the cost reporting year increased marginally due to an increase in patient volume. However, total charges increased exponentially due to the increased volume and significant price increase, i.e., the cost of providing a service increased from $1,000 to $1,200 and the corresponding charges for that service increased from $2,000 to $5,000; as a result, the calculated cost-to-charge ratio decreased from 0.500 to 0.240 – a decrease of 0.260.

The Centers for Medicare & Medicaid Services (CMS) require its Medicare administrative contractors to reconcile outlier payments by using information from the updated current cost-reporting period, but only if the cost report meets the following criteria: the actual cost-to-charge ratio (CCR) is found to be plus or minus ten percentage points from the CCR applied during the payment period (10-percentage-point threshold), and the outlier payments in that cost reporting period exceed $500,000.

As both criteria were met for our client’s Medicare cost report, the Medicare administrative contractor completed an outlier reconciliation, resulting in a calculated overpayment in excess of $3 million!

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A review conducted by the Office of Inspector General (OIG) in 2019 used claims data and cost reports for a four-year period to recalculate outlier payments based on the actual CCRs of 60 hospitals that had received $3.5 billion in outlier payments and analyzed the CCRs of 912 hospitals that received $11.2 billion in outlier payments. The purpose of the review was to estimate the potential costs to Medicare Administrative Contractors (MACs), as well as the potential return on investment, by reconciling the 236 cost reports that did not meet the 10-percentage-point threshold.

From fiscal years 2011 through 2014, CMS paid the 60 hospitals a net of $502 million more in outlier payments than the hospitals would have been paid if their outlier payments had been reconciled. Specifically, CMS paid 53 hospitals $541 million more than they would have been paid and seven hospitals $39 million less than they would have been paid over the four-year period. CMS did not detect or recover these excessive outlier payments because the 236 associated cost reports did not meet the 10-percentage-point threshold for reconciliation.

The cost reports associated with these outlier payments did not meet CMS's 10-percentage-point threshold for reconciliation because when hospitals increased their charges at a rate higher than the rate of cost increases, this usually resulted in only a small percentage point change in their CCRs. Of the 236 cost reports of 60 hospitals that the OIG reconciled, 216 (92 percent) had a change of less than five percentage points in their CCRs. In addition, 34 of the 60 hospitals received excessive outlier payments each of the four years in our 4-year period. Of the 3,627 cost reports that the OIG did not reconcile, but for which we determined the differences between CCRs used at the time of claim payments and the actual CCRs, 3,417 (94 percent) had a change of less than five percentage points in their CCRs. CMS set the 10-percentage point threshold because it believed that the threshold would appropriately capture those hospitals whose outlier payments would be substantially inaccurate when the hospital uses the ratio from the contemporaneous cost-reporting period. Based on the estimated time and costs that the OIG received from seven MACs, the OIG estimates that the administrative burden on the MACs to reconcile the 236 cost reports that did not meet the 10-percentage-point threshold would be a minimum of $47,200 and a maximum of $1.7 million for four years, or a minimum of $11,800 and a maximum of $425,000 per year.

Upon concluding the review, the OIG recommended that CMS require reconciliation of all hospital cost reports with outlier payments during a cost-reporting period. If this had been in effect for the 60 hospitals in the review, CMS would have saved approximately $125 million per year. In written comments on the draft report, CMS concurred with the recommendation and stated that it is evaluating the current outlier reconciliation criteria and will consider whether to propose any appropriate modifications to the outlier reconciliation policy in future rule-making.

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In the event that CMS moves forward with the OIG recommendations, hospitals will be forced to focus more attention on the fluctuation of cost-to-charge ratios between cost reporting years and determine the potential liability associated with Medicare outlier payments received.

Jesse Parker, CPA

Director, Reimbursement

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