Medicare Program; Inpatient Psychiatric Facilities Prospective Payment System Payment Update for Rate Year Beginning July 1, 2006 (RY 2007), 3616-3752 [06-488]

Agencies

• Centers for Medicare & Medicaid Services
• DEPARTMENT OF HEALTH AND HUMAN SERVICES

[Federal Register Volume 71, Number 14 (Monday, January 23, 2006)]
[Proposed Rules]
[Pages 3616-3752]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 06-48]



[[Page 3615]]

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Part II





Department of Health and Human Services





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Centers for Medicare & Medicaid Services



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42 CFR Parts 412 and 424



Medicare Program; Inpatient Psychiatric Facilities Prospective Payment 
System Payment Update for Rate Year Beginning July 1, 2006 (RY 2007); 
Proposed Rule

Federal Register / Vol. 71, No. 14 / Monday, January 23, 2006 / 
Proposed Rules

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DEPARTMENT OF HEALTH AND HUMAN SERVICES

Centers for Medicare & Medicaid Services

42 CFR Parts 412 and 424

[CMS-1306-P]


Medicare Program; Inpatient Psychiatric Facilities Prospective 
Payment System Payment Update for Rate Year Beginning July 1, 2006 (RY 
2007)

AGENCY: Centers for Medicare & Medicaid Services (CMS), HHS.

ACTION: Proposed rule.

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SUMMARY: This proposed rule would update the prospective payment rates 
for Medicare inpatient hospital services provided by inpatient 
psychiatric facilities (IPFs). These changes are applicable to IPF 
discharges occurring during the rate year beginning July 1, 2006 
through June 30, 2007. We are proposing to adopt the new Office of 
Management and Budget (OMB) labor market area definitions for the 
purpose of geographic classification and the wage index. In addition, 
we are proposing other new polices and making changes to existing 
policies.

DATES: We will consider comments if we receive them at the appropriate 
address provided below, no later than 5 p.m. on March 14, 2006.

ADDRESSES: In commenting, please refer to file code CMS-1306-P. Because 
of staff and resource limitations, we cannot accept comments by 
facsimile (FAX) transmission.
    You may submit comments in one of three ways (no duplicates, 
please):
    1. Electronically. You may submit electronic comments on specific 
issues in this regulation to https://www.cms.hhs.gov/eRulemaking. 
(Attachments should be in Microsoft Word, WordPerfect, or Excel; 
however, we prefer Microsoft Word.)
    2. By mail. You may mail written comments (one original and two 
copies) to the following address ONLY: Centers for Medicare & Medicaid 
Services, Department of Health and Human Services, Attention: CMS-1306-
P, P.O. Box 8010, Baltimore, MD 21244.
    Please allow sufficient time for mailed comments to be received 
before the close of the comment period.
    3. By hand or courier. If you prefer, you may deliver (by hand or 
courier) your written comments (one original and two copies) before the 
close of the comment period to one of the following addresses. If you 
intend to deliver your comments to the Baltimore address, please call 
telephone number (410) 786-9994 in advance to schedule your arrival 
with one of our staff members. Room 445-G, Hubert H. Humphrey Building, 
200 Independence Avenue, SW., Washington, DC 20201; or 7500 Security 
Boulevard, Baltimore, MD 21244-1850.
    (Because access to the interior of the Humphrey Building is not 
readily available to persons without Federal Government identification, 
commenters are encouraged to leave their comments in the CMS drop slots 
located in the main lobby of the building. A stamp-in clock is 
available for persons wishing to retain a proof of filing by stamping 
in and retaining an extra copy of the comments being filed.)
    Comments mailed to the addresses indicated as appropriate for hand 
or courier delivery may be delayed and received after the comment 
period.
    Submission of comments on paperwork requirements. You may submit 
comments on this document's paperwork requirements by mailing your 
comments to the addresses provided at the end of the ``Collection of 
Information Requirements'' section in this document.
    For information on viewing public comments, see the beginning of 
the SUPPLEMENTARY INFORMATION section.

FOR FURTHER INFORMATION CONTACT: Janet Samen, (410) 786-4533 for 
general information. Mary Lee Seifert, (410) 786-0030 for information 
regarding the market basket and labor-related share. Theresa Bean, 
(410) 786-2287 for impact. Matthew Quarrick, (410) 786-9867 for wage 
index.

SUPPLEMENTARY INFORMATION:
    Submitting Comments: We welcome comments from the public on all 
issues set forth in this rule to assist us in fully considering issues 
and developing policies. You can assist us by referencing the file code 
CMS-1306-P and the specific ``issue identifier'' that precedes the 
section on which you choose to comment.
    Inspection of Public Comments: All comments received before the 
close of the comment period are available for viewing by the public, 
including any personally identifiable or confidential business 
information that is included in a comment. CMS posts all electronic 
comments received before the close of the comment period on its public 
Web site as soon as possible after they have been received. Hard copy 
comments received timely will be available for public inspection as 
they are received, generally beginning approximately 3 weeks after 
publication of a document, at the headquarters of the Centers for 
Medicare & Medicaid Services, 7500 Security Boulevard, Baltimore, 
Maryland 21244, Monday through Friday of each week from 8:30 a.m. to 4 
p.m. To schedule an appointment to view public comments, phone 1-800-
743-3951.

Table of Contents

I. Background
    A. General and Legislative History
    B. Overview of the Establishment of the IPF PPS
    C. Applicability of the IPF PPS
II. Overview for Updating the IPF PPS
    A. Requirements for Updating the IPF PPS
    B. Proposed Updates to the IPF PPS
    C. Transition Period for Implementation of the IPF PPS
III. Proposed Updates to the IPF PPS for Rate Year beginning July 1, 
2006
    A. Calculation of the Average Per Diem Cost
    B. Determining the Standardized Budget-Neutral Federal Per Diem 
Rate
    1. Standardization of the Federal Per Diem Base Rate
    2. Calculation of the Budget Neutrality Adjustment
    a. Outlier Adjustment
    b. Stop-Loss Provision Adjustment
    c. Behavioral Offset
    3. Revision of Standardization Factor
    C. Update of the Federal Per Diem Base Rate
    1. Market Basket for IPFs Reimbursed under the IPF PPS
    a. Proposed IPF Market Basket Index
    b. Overview of the Proposed RPL Market Basket
    2. Proposed Methodology for Operating Portion of the RPL Market 
Basket
    3. Proposed Methodology for Capital Portion of the RPL Market 
Basket
    4. Proposed Labor-Related Share
IV. Update of the IPF PPS Adjustment Factors
    A. Overview of the IPF PPS Adjustment Factors
    B. Proposed Patient-Level Adjustments
    1. Proposed Adjustment for DRG Assignment
    2. Proposed Payment for Comorbid Conditions
    3. Proposed Patient Age Adjustment
    4. Proposed Variable Per Diem Adjustment
    C. Facility-Level Adjustments
    1. Wage Index Adjustment
    a. Proposed Revisions of the IPF PPS Geographic Classifications
    b. Current IPF PPS Labor Market Areas Based on MSAs
    c. Core-Based Statistical Areas
    d. Proposed Revision of the IPF PPS Labor Market Areas
    i. New England MSAs
    ii. Metropolitan Divisions
    iii. Micropolitan Areas
    e. Implementation of the Proposed Revised Labor Market Area 
under the IPF PPS
    f. Wage Index Budget Neutrality
    1. Proposed Adjustment for Rural Location
    2. Proposed Teaching Adjustment

[[Page 3617]]

    3. Proposed Cost of Living Adjustment for IPFs Located in Alaska 
and Hawaii
    4. Proposed Adjustment for IPFs with a Qualifying Emergency 
Department
    a. Proposed New Source of Admission Code to Implement the ED 
Adjustment
    b. Applicability of the ED Adjustment to IPFs in Critical Access 
Hospitals
    D. Other Payment Adjustments and Policies
    1. Outlier Payments
    a. Proposed Update to the Outlier Fixed Dollar Loss Amount
    b. Proposed Statistical Accuracy of Cost-to-Charge Ratio
    2. Proposed Stop-loss Provision
    3. Patients who Receive Electroconvulsive Therapy
    4. Physician Certification and Recertification Requirements
    5. Provisions of Therapeutic Recreation in IPFs
    6. Same Day Transfers
V. Provisions of the Proposed Rule
VI. Collection of Information Requirements
VII. Regulatory Impact Analysis

Acronyms

    Because of the many terms to which we refer by acronym in this 
proposed rule, we are listing the acronyms used and their corresponding 
terms in alphabetical order below:

BBA Balanced Budget Act of 1997, (Pub. L. 105-33)
BBRA Medicare, Medicaid and SCHIP [State Children's Health Insurance 
Program] Balanced Budget Refinement Act of 1999, (Pub. L. 106-113)
BIPA Medicare, Medicaid, and SCHIP [State Children's Health Insurance 
Program] Benefits Improvement and Protection Act of 2000, (Pub. L. 106-
554)
CBSA Core-Based Statistical Areas
CCR Cost-to-charge ratio
CMS Centers for Medicare & Medicaid Services
CMSA Consolidated Metropolitan Statistical Area
DSM-IV-TR Diagnostic and Statistical Manual of Mental Disorders Fourth 
Edition--Text Revision
DRGs Diagnosis-related groups
FY Federal fiscal year
HCRIS Hospital Cost Report Information System
ICD-9-CM International Classification of Diseases, 9th Revision, 
Clinical Modification
IPFs Inpatient psychiatric facilities
IRFs Inpatient rehabilitation facilities
LTCHs Long-term care hospitals
MedPAR Medicare provider analysis and review file
MMA Medicare Prescription Drug, Improvement and Modernization Act of 
2003, (Pub. L. 108-173)
MSA Metropolitan Statistical Area
NECMA New England County Metropolitan Area
OMB Office of Management and Budget
PIP Periodic interim payments
RY Rate Year (July 1 through June 30)
TEFRA Tax Equity and Fiscal Responsibility Act of 1982, (Pub. L. 97-
248)

I. Background

[If you choose to comment on issues in this section, please include the 
caption ``BACKGROUND'' at the beginning of your comments.]

A. General and Legislative History

    The Congress directed implementation of a prospective payment 
system (PPS) for acute care hospitals with the enactment of Public Law 
98-21. Section 601 of the Social Security Amendments of 1983 (Pub. L. 
98-21) added a new section 1886(d) to the Social Security Act (the Act) 
that replaced the reasonable cost-based payment system for most 
hospital inpatient services with a PPS.
    Although most hospital inpatient services became subject to the 
PPS, certain hospitals, including IPFs, inpatient rehabilitation 
facilities (IRFs), long term care hospitals (LTCHs), and children's 
hospitals were excluded from the PPS for acute care hospitals. These 
hospitals and units were paid their reasonable costs for inpatient 
services, subject to a per discharge limitation or target amount under 
the authority of the Tax Equity and Fiscal Responsibility Act of 1982 
(TEFRA), Public Law 97-248. The regulations implementing the TEFRA 
(reasonable cost-based) payment provisions are located at 42 CFR part 
413. Cancer hospitals were added to the list of excluded hospitals by 
section 6004(a) of the Omnibus Budget Reconciliation Act of 1989, (Pub. 
L. 101-239).
    The Congress enacted various provisions in the Balanced Budget Act 
of 1997 (BBA) (Pub. L. 105-33), the Medicare, Medicaid, and SCHIP 
(State Children's Health Insurance Program) Balanced Budget Refinement 
Act of 1999 (BBRA) (Pub. L. 106-113), and the Medicare, Medicaid, and 
SCHIP Benefits Improvement and Protection Act of 2000 (BIPA) (Pub. L. 
106-554) to replace the reasonable cost-based method of reimbursement 
with a PPS for IRFs, LTCHs, and IPFs. Section 124 of the BBRA required 
implementation of the IPF PPS.
    Section 124 of the BBRA mandated that the Secretary--(1) develop a 
per diem PPS for inpatient hospital services furnished in psychiatric 
hospitals and psychiatric units; (2) include in the PPS an adequate 
patient classification system that reflects the differences in patient 
resource use and costs among psychiatric hospitals and psychiatric 
units; (3) maintain budget neutrality; (4) permit the Secretary to 
require psychiatric hospitals and psychiatric units to submit 
information necessary for the development of the PPS; and (5) submit a 
report to the Congress describing the development of the PPS. Section 
124 of the BBRA also required that the IPF PPS be implemented for cost 
reporting periods beginning on or after October 1, 2002.
    Section 405(g)(2) of the Medicare Prescription Drug, Improvement, 
and Modernization Act of 2003 (MMA) (Pub. L. 108-173) extended the IPF 
PPS to distinct part psychiatric units of critical access hospitals 
(CAHs).

B. Overview of the Establishment of the IPF PPS

    On November 28, 2003, we published a proposed rule in the Federal 
Register (68 FR 66920) that proposed to implement section 124 of the 
BBRA. In the November 15, 2004 Federal Register (69 FR 66922) our final 
rule implemented the IPF PPS for cost reporting periods beginning on or 
after January 1, 2005. Although section 124 of the BBRA directed that 
the IPF PPS be implemented for cost reporting periods beginning on or 
after October 1, 2002, we explained in the proposed and final rules 
that the creation of a PPS requires an extraordinary amount of lead-
time to create a completely new payment system and that we were unable 
to perform the analysis required in time for an October 1, 2002 
implementation, to ensure that a system based on CMS administrative 
data would fulfill the statutory mandate of section 124 of the BBRA. We 
explained that despite our best efforts, we could not engage in notice 
and comment rulemaking and achieve implementation of the IPF PPS by 
October 1, 2002.
    The November 2004 final rule (hereinafter referred to as the IPF 
PPS final rule) established regulations for the IPF PPS under 42 CFR 
412, subpart N.
    The IPF PPS established the Federal per diem base rate for each 
patient day in an IPF derived from the national average daily routine 
operating, ancillary, and capital costs in IPFs in FY 2002. The average 
per diem cost was updated to the midpoint of the first year under the 
IPF PPS, standardized to account for the overall positive effects of 
the IPF PPS payment adjustments, and adjusted for budget neutrality. 
The Federal per diem payment under the IPF PPS is comprised of the 
Federal per diem base rate described above and certain patient and 
facility payment adjustments that were found in the regression analysis 
to be associated with

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statistically significant per diem cost differences (see 69 FR 66933 
through 66936 for a description of the regression analysis). The 
patient-level adjustments include age, DRG assignment, comorbidities, 
and variable per diem adjustments to reflect the higher cost incurred 
in the early days of a psychiatric stay. Facility-level adjustments 
include adjustments for the IPF's wage index, rural location, teaching 
status, a cost of living adjustment for IPFs located in Alaska and 
Hawaii, and presence of a qualifying emergency department (ED). The IPF 
PPS provides additional payments for outlier cases, stop-loss 
protection which is applicable only during the IPF PPS transition 
period, includes special payment provisions for interrupted stays, and 
a per treatment adjustment for patients who undergo electroconvulsive 
therapy (ECT). We refer readers to the IPF PPS final rule for a 
comprehensive discussion of the research and data that supported the 
establishment of the IPF PPS.
    On April 1, 2005, we published a correction to the IPF PPS final 
rule in the Federal Register (70 FR 16724). Any reference to the IPF 
PPS final rule in this proposed rule includes the provisions in the 
correction notice. We established a CMS website that contains useful 
information regarding the IPF PPS including the proposed rule, final 
rule, and the correction notice. The website URL is https://
www.cms.hhs.gov/InpatientPsychFacilPPS/ and may be accessed to download 
or view publications and other information pertinent to the IPF PPS.

C. Applicability of the IPF PPS

    The IPF PPS is applicable to freestanding psychiatric hospitals, 
including government-operated psychiatric hospitals, and distinct part 
psychiatric units of acute care hospitals and CAHs.
    The regulations at Sec.  412.402 define an IPF as a hospital that 
meets the requirements specified in Sec.  412.22, Sec.  412.23(a), 
Sec.  482.60, Sec.  482.61, and Sec.  482.62, and units that meet the 
requirements specified in Sec.  412.22, Sec.  412.25, and Sec.  412.27.
    However, the following hospitals are paid under a special payment 
provision, as described in Sec.  412.22(c) and, therefore, are not 
subject to the IPF PPS rules:
     Veterans Administration hospitals.
     Hospitals that are reimbursed under State cost control 
systems approved under 42 CFR part 403.
     Hospitals that are reimbursed in accordance with 
demonstration projects specified in section 402(a) of Public Law 90-248 
(42 U.S.C. 1395b-1) or section 222(a) of Public Law 92-603 (42 U.S.C. 
1395b-1(note)).
     Non-participating hospitals furnishing emergency services 
to Medicare beneficiaries.

II. Overview for Updating the IPF PPS

[If you choose to comment on issues in this section, please include the 
caption ``OVERVIEW FOR UPDATING THE IPF PPS'' at the beginning of your 
comments.]

A. Requirements for Updating the IPF PPS

    Section 124 of the BBRA does not specify an update strategy for the 
IPF PPS and is broadly written to give the Secretary discretion in 
establishing an update methodology. Therefore, we reviewed the update 
approach used in other hospital PPSs (specifically, the IRF and LTCH 
PPS update methodologies). As a result of this analysis, we stated in 
the IPF PPS final rule (69 FR 66966) that we would implement the IPF 
PPS using the following update strategy--(1) calculate the final 
Federal per diem base rate to be budget neutral for the 18-month period 
(that is, January 1, 2005 through June 30, 2006); (2) use a July 1 
through June 30 annual update cycle; and (3) allow the IPF PPS first 
update to be effective for discharges July 1, 2006 through June 30, 
2007. In this proposed rule, we are proposing updates to the IPF PPS 
for the period of July 1, 2006 through June 30, 2007.
    As explained in the IPF PPS final rule, we believe it is important 
to delay updating the adjustment factors derived from the regression 
analysis until we have IPF PPS data that include as much information as 
possible regarding the patient-level characteristics of the population 
that each IPF serves. For this reason, we do not intend to update the 
regression analysis and recalculate the Federal per diem base rate 
until we have analyzed 1 year of IPF PPS claims and cost report data 
(that is, no earlier than FY 2008). Until that analysis is complete, we 
stated our intention to publish a notice in the Federal Register each 
spring to update the IPF PPS as specified in Sec.  412.428 to include:
     A description of the methodology and data used to 
calculate the updated Federal per diem base payment amount.
     The rate of increase factor as described in Sec.  
412.424(a)(2)(iii), which is based on the excluded hospital with 
capital market basket under the update methodology of 1886(b)(3)(B)(ii) 
of the Act for each year.
     The best available hospital wage index and information 
regarding whether an adjustment to the Federal per diem base rate is 
needed to maintain budget neutrality.
     Updates to the fixed dollar loss amount in order to 
maintain the appropriate outlier percentage.
     Describe the ICD-9-CM coding and DRG classification 
changes discussed in the annual update to the hospital inpatient 
prospective payment system regulations.
     Update the ECT adjustment by a factor specified by CMS.

B. Proposed Updates to the IPF PPS

    As discussed above, we intended to publish a notice in the Federal 
Register in the spring of 2006 that would announce the updates to the 
IPF PPS in accordance with Sec.  412.428 rather than update through 
rulemaking (69 FR 66966). However, since the implementation of the IPF 
PPS, a new market basket index was announced in the August 2005 IPPS 
final rule. We believe that this new market basket should be 
implemented in the IPF PPS as well in order to update the system using 
the best data available. Therefore, rather than publish a notice to 
update the IPF PPS in 2006, we are proposing changes in this proposed 
rule to give interested parties the opportunity to comment.
    Furthermore, we indicated in the IPF PPS final rule (69 FR 66952) 
that we were not adopting the new labor market definitions developed by 
the OMB and adopted under the IPPS. Rather, we explained that we 
intended to use the metropolitan statistical areas (MSAs) developed by 
OMB in 1993 for the wage index under the IPF PPS. At the time we 
published the proposed IPF PPS rule, the 2003 MSA definitions had not 
been implemented for any Medicare programs. In addition, we indicated 
that we believe that the adoption of the new labor market area 
definitions may have a significant impact on the wage index applied to 
IPFs and associated payments and that we would assess the implications 
of the new MSA definitions on IPFs before proposing to adopt them.
    We believe that IPFs should be afforded an opportunity to comment 
on the use of the new labor market definitions before we adopt them 
under the IPF PPS. For this reason also, we are publishing this 
proposed rule, rather than a notice, in order to give interested 
parties an opportunity to comment on the new labor market definitions 
(see section III.C.1. of this proposed rule).

[[Page 3619]]

C. Transition Period for Implementation of the IPF PPS

    In the IPF PPS final rule, we established Sec.  412.426 to provide 
for a 3-year transition period from reasonable cost-based reimbursement 
to full prospective payment for IPFs. New IPFs are paid 100 percent of 
the Federal per diem rate. However, for those IPFs that are 
transitioning to a new system, during the 3-year period as specified in 
the IPF PPS final rule, payment is based on an increasing percentage of 
the PPS payment and a decreasing percentage of each IPF's facility-
specific TEFRA reimbursement rate. The blend percentages are as 
follows:

                              Table 1.--IPF PPS Final Rule Transition Blend Factors
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                                                                                                      IPF PPS
                Transition year                 Cost reporting periods beginning    TEFRA rate     Federal rate
                                                           on or after              percentage      percentage
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1.............................................  January 1, 2005.................              75              25
2.............................................  January 1, 2006.................              50              50
3.............................................  January 1, 2007.................              25              75
                                                January 1, 2008.................               0             100
----------------------------------------------------------------------------------------------------------------

    Changes to the blend percentages occur at the beginning of an IPF's 
cost reporting period. As a result, for discharges occurring during IPF 
cost reporting periods beginning in CY 2006, IPFs would receive a 
blended payment consisting of 50 percent of the facility-specific TEFRA 
payment and 50 percent of the IPF PPS payment amount. However, 
regardless of when an IPF's cost reporting year begins, the payment 
update we are proposing would be effective for discharges occurring on 
or after July 1, 2006 through June 30, 2007. We are not proposing any 
changes to the transition approach established in the IPF PPS final 
rule.

III. Proposed Updates to the IPF PPS for Rate Year beginning July 1, 
2006

    The IPF PPS is based on a standardized Federal per diem base rate 
calculated from IPF average per diem costs and adjusted for budget-
neutrality in the implementation year. The Federal per diem base rate 
is used as the standard payment per day under the IPF PPS and is 
adjusted by the applicable wage index factor and the patient-level and 
facility-level adjustments that are applicable to the IPF stay.
    The following is an explanation of how we calculated the Federal 
per diem base rate and the standardization and budget neutrality 
factors as described in the IPF PPS final rule.

A. Calculation of the Average Per Diem Cost

[If you choose to comment on issues in this section, please include the 
caption ``PER DIEM COST'' at the beginning of your comments.]

    As indicated in the IPF PPS final rule, to calculate the Federal 
per diem base rate, we estimated the average cost per day for--(1) 
routine services from FY 2002 cost reports (supplemented with FY 2001 
cost reports if the FY 2002 cost report was missing); and (2) ancillary 
services using data from the FY 2002 Medicare claims and corresponding 
data from facility cost reports.
    For routine services, the per diem operating and capital costs were 
used to develop the average per diem cost amount. The per diem routine 
costs were obtained from each facility's Medicare cost report. To 
estimate the costs for routine services included in the Federal per 
diem base rate calculation, we added the total routine costs (including 
costs for capital) submitted on the cost report for each provider and 
divided it by the total Medicare days.
    Some average routine costs per day were determined to be aberrant, 
that is, the costs were extraordinarily high or low and most likely 
contained data errors. We provided a detailed discussion in the IPF PPS 
final rule (69 FR 66926 through 66927) of the method used to trim 
extraordinarily high or low cost values from the per diem rate 
development file in order to improve the accuracy of our results. For 
ancillary services, we calculated the costs by converting charges from 
the FY 2002 Medicare claims into costs using facility-specific, cost-
center specific cost-to-charge ratios obtained from each provider's 
applicable cost reports. We matched each provider's departmental cost-
to-charge ratios from their Medicare cost report to each charge on 
their claims reported in the MedPAR file. Multiplying the total charges 
for each type of ancillary service by the corresponding cost-to-charge 
ratio provided an estimate of the costs for all ancillary services 
received by the patient during the stay. We determined the average 
ancillary amount per day by dividing the total ancillary costs for all 
stays by the total number of covered Medicare days.
    Adding the average ancillary costs per day and the average routine 
costs per day including capital costs provided the estimated average 
per diem cost for each patient day of inpatient psychiatric care in FY 
2002.

B. Determining the Standardized Budget-Neutral Federal Per Diem Base 
Rate

[If you choose to comment on issues in this section, please include the 
caption ``BUDGET NEUTRAL BASE RATE'' at the beginning of your 
comments.]

    Section 124(a)(1) of the BBRA requires that the implementing IPF 
PPS be budget neutral. In other words, the amount of total payments 
under the IPF PPS, including any payment adjustments, must be projected 
to be equal to the amount of total payments that would have been made 
if the IPF PPS were not implemented. Therefore, in the IPF PPS final 
rule, we calculated the budget-neutrality factor by setting the total 
estimated IPF PPS payments to be equal to the total estimated payments 
that would have been made under the TEFRA methodology had the IPF PPS 
not been implemented. The IPF PPS final rule includes a step-by-step 
description of the methodology we used to estimate payments under the 
TEFRA payment system (69 FR 66930). For the IPF PPS methodology, we 
calculated the final Federal per diem base rate to be budget neutral 
during the implementation period under the IPF PPS using a July 1 
update cycle. Thus, the implementation period for the IPF PPS is the 
18-month period January 1, 2005 through June 30, 2006.
    We updated the average cost per day to the midpoint of the IPF PPS 
implementation period (that is, October 1, 2005). We used the most 
recent projection of the full percentage increase in the 1997-based 
excluded hospital with capital market basket index for FY 2003 and 
later in accordance with Sec.  413.40(c)(3)(viii). The updated average 
cost per day of $724.43 was used in the payment model to

[[Page 3620]]

establish the budget neutrality adjustment.
1. Standardization of the Federal Per Diem Base Rate
    In the IPF PPS final rule, we standardized the IPF PPS Federal per 
diem base rate in order to account for the overall positive effects of 
the IPF PPS payment adjustment factors. To standardize the IPF PPS 
payments, we compared the IPF PPS payment amounts calculated from the 
psychiatric stays in the FY 2002 MedPAR file to the projected TEFRA 
payments from the FY 2002 cost report file updated to the midpoint of 
the IPF PPS implementation period (that is October 2005). The 
standardization factor was calculated by dividing total estimated 
payments under the TEFRA payment system by estimated payments under the 
IPF PPS. The standardization factor was calculated to be 0.8367. As a 
result, in the IPF PPS final rule, the $724.43 average cost per day was 
reduced by 16.33 percent (100 percent minus 83.67 percent).
2. Calculation of the Budget Neutrality Adjustment
    To compute the budget neutrality adjustment for the IPF PPS, we 
separately identified each component of the adjustment, that is, the 
outlier adjustment, stop-loss adjustment, and behavioral offset.
a. Outlier Adjustment
    Since the IPF PPS payment amount for each IPF includes applicable 
outlier amounts, we reduced the standardized Federal per diem base rate 
to account for aggregate IPF PPS payments estimated to be made as 
outlier payments. The appropriate outlier amount was determined by 
comparing the adjusted prospective payment for the entire stay to the 
computed cost per case. If costs were above the prospective payment 
plus the adjusted fixed dollar loss threshold amount, an outlier 
payment was computed using the applicable risk-sharing percentages, as 
explained in greater detail in section IV.D.1 of this proposed rule. 
The outlier amount was computed for all stays, and the total outlier 
amount was added to the final IPF PPS payment. The outlier adjustment 
was calculated to be 2 percent. As a result, the standardized Federal 
per diem base rate was reduced by 2 percent to account for projected 
outlier payments.
b. Stop-Loss Provision Adjustment
    As explained in the IPF PPS final rule, we provide a stop-loss 
payment to ensure that an IPF's total PPS payments are no less than a 
minimum percentage of their TEFRA payment, had the IPF PPS not been 
implemented. We reduced the standardized Federal per diem base rate by 
the percentage of aggregate IPF PPS payments estimated to be made for 
stop-loss payments.
    The stop-loss payment amount was determined by comparing aggregate 
prospective payments that the provider would receive under the IPF PPS 
to aggregate TEFRA payments that the provider would have otherwise 
received without implementation of the IPF PPS. If an IPF's aggregate 
IPF PPS payments are less than 70 percent of its aggregate payments 
under TEFRA, a stop-loss payment was computed for that IPF. The stop-
loss payment amounts were computed for those IPFs that were projected 
to receive the payments, and the total amount was added to the final 
IPF PPS payment amount. As a result, the standardized Federal per diem 
base rate was reduced by 0.39 percent in order to maintain budget 
neutrality in the IPF PPS.
c. Behavioral Offset
    As explained in the IPF PPS final rule, implementation of the IPF 
PPS may result in certain changes in IPF practices especially with 
respect to coding for comorbid medical conditions. As a result, 
Medicare may incur higher payments than assumed in our calculations. 
Accounting for these effects through an adjustment is commonly known as 
a behavioral offset.
    Based on accepted actuarial practices and consistent with the 
assumptions made in other prospective payment systems, we assumed in 
determining the behavioral offset that IPFs would regain 15 percent of 
potential ``losses'' and augment payment increases by 5 percent. We 
applied this actuarial assumption, which is based on our historical 
experience with new payment systems, to the estimated ``losses'' and 
``gains'' among the IPFs. The behavioral offset for the IPF PPS was 
calculated to be 2.66 percent. As a result, we reduced the standardized 
Federal per diem base rate by 2.66 percent to maintain budget 
neutrality.
    To summarize, the $724.43 updated average per diem cost was reduced 
by 16.33 percent to account for standardization to projected TEFRA per 
diem payments for the implementation period, by 2 percent to account 
for outlier payments, by 0.39 percent to account for stop-loss 
payments, and by 2.66 percent reduction to account for the behavioral 
offset. The final standardized budget-neutral Federal per diem base 
rate for the IPF PPS implementation year was calculated to be $575.95. 
We discuss the Federal per diem base rate for RY 2007 in section III 
B.3. of this proposed rule.
3. Revision of Standardization Factor
    In reviewing the methodology used to simulate the IPF PPS payments 
used for the IPF PPS final rule, we discovered that the computer code 
incorrectly assigned non-teaching status to most teaching facilities. 
As a result, total IPF PPS payments were underestimated by about 1.36 
percent. The IPF PPS estimated payment total was used in calculating 
the IPF PPS standardization factor. The standardization factor 
indicates the proportion by which the IPF PPS per diem payment rate and 
the ECT rate must be reduced in order to make total IPF PPS payments 
equal to estimated total TEFRA payments assuming IPFs continued to be 
paid solely under TEFRA for the first PPS payment year. The 
standardization factor is calculated as the ratio of estimated total 
TEFRA payments to estimated total IPF PPS payments assuming no 
reduction to the per diem and ECT payment rates. Since the IPF PPS 
payment total should have been larger than the estimated figure, the 
standardization factor should have been smaller (0.8254 vs. 0.8367). In 
turn, the per diem rate and the ECT rate should have been reduced by 
0.8254 instead of 0.8367.
    To resolve this issue, we are proposing to amend the Federal per 
diem base rate prospectively. Using the standardization factor of 
0.8254, the base rate should have been $568.17 for the implementation 
year of the IPF PPS. It is this base rate that we propose to update 
using the market basket rate of increase of 4.5 percent and the budget-
neutral wage index factor of 1.00156 (as discussed in section IV.C.1.f. 
of this proposed rule). Applying these factors yields a proposed 
Federal per diem base rate of $594.66 for the rate year (RY) beginning 
July 1, 2006 through June 30, 2007.

C. Update of the Federal Per Diem Base Rate

[If you choose to comment on issues in this section, please include the 
caption ``UPDATE ON PER DIEM BASE RATE'' at the beginning of your 
comments.]
1. Market Basket for IPFs Reimbursed under the IPF PPS
a. Proposed IPF Market Basket Index
    The market basket index used to develop the IPF PPS is the excluded 
hospital with capital market basket. This market basket was based on 
1997 Medicare cost report data and includes data for Medicare 
participating IPFs,

[[Page 3621]]

IRFs, LTCHs, cancer, and children's hospitals.
    We are presently unable to create a separate market basket 
specifically for psychiatric hospitals due to the small number of 
facilities and the limited data that are provided (for instance, 
approximately 4 percent of psychiatric facilities reported contract 
labor cost data for 2002). However, since all IRFs, LTCHs, and IPFs are 
now paid under a PPS, we are proposing to update PPS payments made 
under the IRF PPS, the LTCH PPS, and the IPF PPS, in their respective 
Federal Register updates, using a market basket reflecting the 
operating and capital cost structures for IRFs, IPFs, and LTCHs, 
hereafter referred to as the RPL (rehabilitation, psychiatric, long-
term care) market basket. We are excluding children's and cancer 
hospitals from the RPL market basket because their payments are based 
entirely on reasonable costs subject to rate-of-increase limits 
established under the authority of section 1886(b) of the Act, which is 
implemented in Sec.  413.40 of the regulations. They are not reimbursed 
under a PPS. Also, the FY 2002 cost structures for children's and 
cancer hospitals are noticeably different than the cost structures of 
the IRFs, IPFs, and LTCHs.
    The services offered in IRFs, IPFs, and LTCHs are typically more 
labor-intensive than those offered in cancer and children's hospitals. 
Therefore, the compensation cost weights for IRFs, IPFs, and LTCHs are 
larger than those in cancer and children's hospitals. In addition, the 
depreciation cost weights for IRFs, IPFs, and LTCHs are noticeably 
smaller than those for children's and cancer hospitals.
    In the following discussion, we provide an overview on the market 
basket and describe the methodologies we propose to use for purposes of 
determining the operating and capital portions of the proposed FY 2002-
based RPL market basket.
b. Overview of the Proposed RPL Market Basket
    The proposed RPL market basket is a fixed weight, Laspeyres-type 
price index that is constructed in three steps. First, a base period is 
selected (in this case, FY 2002) and total base period expenditures are 
estimated for a set of mutually exclusive and exhaustive spending 
categories based upon type of expenditure. Then the proportion of total 
costs that each category represents is determined. These proportions 
are called cost or expenditure weights. Second, each expenditure 
category is matched to an appropriate price or wage variable, referred 
to as a price proxy. In nearly every instance, these price proxies are 
price levels derived from publicly available statistical series that 
are published on a consistent schedule, preferably at least on a 
quarterly basis.
    Finally, the expenditure weight for each cost category is 
multiplied by the level of its respective price proxy for a given 
period. The sum of these products (that is, the expenditure weights 
multiplied by their price levels) for all cost categories yields the 
composite index level of the market basket in a given period. Repeating 
this step for other periods produces a series of market basket levels 
over time. Dividing an index level for a given period by an index level 
for an earlier period produces a rate of growth in the input price 
index over that time period.
    A market basket is described as a fixed-weight index because it 
answers the question of how much it would cost, at another time, to 
purchase the same mix of goods and services purchased to provide 
hospital services in a base period. The effects on total expenditures 
resulting from changes in the quantity or mix of goods and services 
(intensity) purchased subsequent to the base period are not measured. 
In this manner, the market basket measures only pure price change. Only 
when the index is rebased would the quantity and intensity effects be 
captured in the cost weights. Therefore, we rebase the market basket 
periodically so that cost weights reflect changes in the mix of goods 
and services that hospitals purchase (hospital inputs) to furnish 
patient care between base periods.
    The terms rebasing and revising, while often used interchangeably, 
actually denote different activities. Rebasing means moving the base 
year for the structure of costs of an input price index (for example, 
shifting the base year cost structure from FY 1997 to FY 2002). 
Revising means changing data sources, methodology, or price proxies 
used in the input price index. We propose to rebase and revise the 
market basket used to update the IPF PPS.
2. Proposed Methodology for Operating Portion of the RPL Market Basket
    The operating portion of the proposed FY 2002-based RPL market 
basket consists of several major cost categories derived from the FY 
2002 Medicare cost reports for IRFs, IPFs, and LTCHs: wages, drugs, 
professional liability insurance, and a residual. We choose to use FY 
2002 as the base year because we believe this is the most recent, 
complete year of Medicare cost report data and is consistent with the 
data year on which the IPF PPS is based. Due to insufficient Medicare 
cost report data for IRFs, IPFs, and LTCHs, we propose to develop cost 
weights for benefits, contract labor, and blood and blood products 
using the FY 2002-based IPPS market basket (70 FR 23384), which we 
explain in more detail later in this section. For example, less than 30 
percent of IRFs, IPFs, and LTCHs reported benefit cost data in FY 2002. 
We have noticed an increase in cost data for these expense categories 
over the last 4 years. The next time we rebase the RPL market basket 
there may be sufficient IRFs, IPFs, and LTCHs cost report data to 
develop the weights for these expenditure categories.
    Since the cost weights for the RPL market basket are based on 
facility costs, we are proposing to limit our sample to hospitals with 
a Medicare average length of stay (LOS) within a comparable range of 
the total facility average LOS. We believe this provides a more 
accurate reflection of the structure of costs for Medicare covered 
days. Our goal is to measure cost shares that are reflective of case 
mix and practice patterns associated with providing services to 
Medicare beneficiaries.
    We propose to use those cost reports for IRFs and LTCHs whose 
Medicare average LOS is within 15 percent (that is, 15 percent higher 
or lower) of the total facility average LOS for the hospital. This is 
the same edit applied to the FY 1992-based and FY 1997-based excluded 
hospital with capital market basket. We are proposing 15 percent 
because it includes those LTCHs and IRFs whose Medicare LOS is within 
approximately 5 days of the facility LOS.
    However, we are proposing to use a less stringent measure of 
Medicare LOS for IPFs whose average LOS is within 30 or 50 percent 
(depending on the total facility average LOS) of the total facility 
average LOS. Using this less stringent edit allows us to increase our 
sample size by over 150 cost reports and produce a cost weight more 
consistent with the overall facility. The edit we applied to IPFs when 
developing the FY 1997-based excluded hospital with capital market 
basket was based on the best available data at the time.
    The detailed cost categories under the residual (that is, the 
remaining portion of the market basket after excluding wages and 
salaries, drugs, and professional liability cost weights) are derived 
from the FY 2002-based IPPS market basket and the 1997 Benchmark Input-
Output (I-O) Tables published by the Bureau of Economic Analysis, U.S. 
Department of Commerce. The FY 2002-based IPPS market basket was 
developed using FY 2002 Medicare hospital cost reports with the most

[[Page 3622]]

recent and detailed cost data (see the IPPS final rule in the August 
12, 2005 Federal Register (70 FR 47388)). The 1997 Benchmark I-O is the 
most recent, comprehensive source of cost data for all hospitals. The 
proposed RPL cost weights for benefits, contract labor, and blood and 
blood products were derived using the FY 2002-based IPPS market basket. 
For example, the ratio of the benefit cost weight to the wages and 
salaries cost weight in the FY 2002-based IPPS market basket was 
applied to the RPL wages and salaries cost weight to derive a benefit 
cost weight for the RPL market basket. The remaining proposed RPL 
operating cost categories were derived using the 1997 Benchmark I-O 
Tables, aged to 2002 using relative price changes. (The methodology we 
used to age the data involves applying the annual price changes from 
the price proxies to the appropriate cost categories. We repeat this 
practice for each year.) Therefore, using this methodology, roughly 59 
percent of the proposed RPL market basket is accounted for by wages, 
drugs, and professional liability insurance data from FY 2002 Medicare 
cost report data for IRFs, LTCHs, and IPFs.
    Table 2 below sets forth the complete proposed 2002-based RPL 
market basket including cost categories, weights, and price proxies. 
For comparison purposes, the corresponding FY 1997-based excluded 
hospital with capital market basket is listed as well.
    Wages and salaries are 52.895 percent of total costs in the 
proposed FY 2002-based RPL market basket compared to 47.335 percent for 
the FY 1997-based excluded hospital with capital market basket. 
Employee benefits are 12.982 percent in the proposed FY 2002-based RPL 
market basket compared to 10.244 percent for the FY 1997-based excluded 
hospital with capital market basket. As a result, compensation costs 
(wages and salaries plus employee benefits) for the proposed FY 2002-
based RPL market basket are 65.877 percent of costs compared to 57.579 
percent for the FY 1997-based excluded hospital with capital market 
basket. Of the 8 percentage-point difference between the compensation 
shares, approximately 3 percentage points are due to the proposed new 
base year (FY 2002 instead of FY 1997), 3 percentage points are due to 
revised length of stay edit, and the remaining 2 percentage points are 
due to the proposed exclusion of other hospitals (that is, only 
including IPFs, IRFs, and LTCHs in the market basket).
    Following the table is a summary outlining the choice of the 
proxies we propose to use for the operating portion of the market 
basket. The price proxies for the capital portion are described in more 
detail in the capital methodology section (see section III.C.3 of this 
proposed rule).

   Table 2.--Proposed FY 2002-Based RPL Market Basket Cost Categories, Weights, and Proxies With FY 1997-Based
                        Excluded Hospital With Capital Market Basket Used for Comparison
----------------------------------------------------------------------------------------------------------------
                                              FY 1997-based
                                                excluded       Proposed FY
             Expense categories               hospital with  2002-based RPL   Proposed FY 2002 RPL market basket
                                             capital market   market basket             price proxies
                                                 basket
----------------------------------------------------------------------------------------------------------------
Total......................................         100.000         100.000  ...................................
Compensation...............................          57.579          65.877  ...................................
    Wages and Salaries*....................          47.335          52.895  ECI-Wages and Salaries, Civilian
                                                                              Hospital Workers.
    Employee Benefits*.....................          10.244          12.982  ECI-Benefits, Civilian Hospital
                                                                              Workers.
    Professional Fees, Non-Medical.........           4.423           2.892  ECI-Compensation for Professional,
                                                                              Specialty & Technical Workers.
Utilities..................................           1.180           0.656  ...................................
    Electricity............................           0.726           0.351  PPI-Commercial Electric Power.
    Fuel Oil, Coal, etc....................           0.248           0.108  PPI-Refined Petroleum Products.
    Water and Sewage.......................           0.206           0.197  CPI-U--Water & Sewage Maintenance.
Professional Liability Insurance...........           0.733           1.161  CMS Professional Liability Premium
                                                                              Index.
All Other Products and Services............          27.117          19.265  ...................................
All Other Products.........................          17.914          13.323  ...................................
Pharmaceuticals............................           6.318           5.103  PPI Prescription Drugs.
    Food: Direct Purchase..................           1.122           0.873  PPI Processed Foods & Feeds.
    Food: Contract Service.................           1.043           0.620  CPI-U Food Away From Home.
    Chemicals..............................           2.133           1.100  PPI Industrial Chemicals.
    Blood and Blood Products**.............           0.748  ..............  ...................................
    Medical Instruments....................           1.795           1.014  PPI Medical Instruments &
                                                                              Equipment.
    Photographic Supplies..................           0.167           0.096  PPI Photographic Supplies.
    Rubber and Plastics....................           1.366           1.052  PPI Rubber & Plastic Products.
    Paper Products.........................           1.110           1.000  PPI Converted Paper & Paperboard
                                                                              Products.
    Apparel................................           0.478           0.207  PPI Apparel.
    Machinery and Equipment................           0.852           0.297  PPI Machinery & Equipment.
    Miscellaneous..........................           0.783           1.963  PPI Finished Goods less Food &
                                                                              Energy.
All Other Services.........................           9.203           5.942  ...................................
    Telephone..............................           0.348           0.240  CPI-U Telephone Services.
    Postage................................           0.702           0.682  CPI-U Postage.
All Other: Labor Intensive.................           4.453           2.219  ECI-Compensation for Intensive
                                                                              Private Service Occupations.
All Other: Non-labor Intensive.............           3.700           2.800  CPI-U All Items.
Capital-Related Costs......................           8.968          10.149  ...................................
    Depreciation...........................           5.586           6.186  ...................................
    Fixed Assets...........................           3.503           4.250  Boeckh Institutional Construction
                                                                              23-year useful life.
    Movable Equipment......................           2.083           1.937  WPI Machinery & Equipment 11-year
                                                                              useful life.
Interest Costs.............................           2.682           2.775  ...................................
    Nonprofit..............................           2.280           2.081  Average yield on domestic municipal
                                                                              bonds (Bond Buyer 20 bonds)
                                                                              vintage- weighted (23 years).

[[Page 3623]]

 
    For Profit.............................           0.402           0.694  Average yield on Moody's Aaa bonds
                                                                              vintage weighted (23 years).
Other Capital-Related Costs................           0.699           1.187  CPI-U Residential Rent.
----------------------------------------------------------------------------------------------------------------
* Labor-related.
** Blood and blood-related products is included in miscellaneous products.
Note: Due to rounding, weights may not sum to total.

    Below we provide the proxies that we are proposing to use for the 
FY 2002-based RPL market basket. With the exception of the Professional 
Liability proxy, all the proposed price proxies for the operating 
portion of the proposed RPL market basket are based on Bureau of Labor 
Statistics (BLS) data and are grouped into one of the following BLS 
categories:
     Producer Price Indexes--Producer Price Indexes (PPIs) 
measure price changes for goods sold in other than retail markets. PPIs 
are preferable price proxies for goods that hospitals purchase as 
inputs in producing their outputs because the PPIs better reflect the 
prices faced by hospitals. For example, we use a special PPI for 
prescription drugs, rather than the Consumer Price Index (CPI) for 
prescription drugs because hospitals generally purchase drugs directly 
from the wholesaler. The PPIs that we use measure price change at the 
final stage of production.
     Consumer Price Indexes--Consumer Price Indexes (CPIs) 
measure change in the prices of final goods and services bought by the 
typical consumer. Because they may not represent the price faced by a 
producer, we use CPIs only if an appropriate PPI is not available, or 
if the expenditures are more similar to those of retail consumers in 
general rather than purchases at the wholesale level. For example, the 
CPI for food purchases away from home is used as a proxy for contracted 
food services.
     Employment Cost Indexes--Employment Cost Indexes (ECIs) 
measure the rate of change in employee wage rates and employer costs 
for employee benefits per hour worked. These indexes are fixed-weight 
indexes and strictly measure the change in wage rates and employee 
benefits per hour. Appropriately, they are not affected by shifts in 
employment mix.
    We evaluated the price proxies using the criteria of reliability, 
timeliness, availability, and relevance. Reliability indicates that the 
index is based on valid statistical methods and has low sampling 
variability. Timeliness implies that the proxy is published regularly, 
preferably at least once a quarter. Availability means that the proxy 
is publicly available. Finally, relevance means that the proxy is 
applicable and representative of the cost category weight to which it 
is applied. The CPIs, PPIs, and ECIs selected by us to be proposed in 
this regulation meet these criteria.
    We note that the proxies are the same as those used for the FY 
1997-based excluded hospital with capital market basket. Because these 
proxies meet our criteria of reliability, timeliness, availability, and 
relevance, we believe they continue to be the best measure of price 
changes for the cost categories. For further discussion on the FY 1997-
based excluded hospital with capital market basket, see the IPPS final 
rule published in the Federal Register on August 1, 2002 (67 FR at 
50042).

Wages and Salaries

    For measuring the price growth of wages in the proposed FY 2002-
based RPL market basket, we propose to use the ECI for wages and 
salaries for civilian hospital workers as the proxy for wages in the 
RPL market basket.
Employee Benefits
    The proposed FY 2002-based RPL market basket uses the ECI for 
employee benefits for civilian hospital workers.

Nonmedical Professional Fees

    The ECI for compensation for professional and technical workers in 
private industry would be applied to this category since it includes 
occupations such as management and consulting, legal, accounting, and 
engineering services.

Fuel, Oil, and Gasoline

    The percentage change in the price of gas fuels as measured by the 
PPI (Commodity Code 0552) would be applied to this component.

Electricity

    The percentage change in the price of commercial electric power as 
measured by the PPI (Commodity Code 0542) would be applied to 
this component.
Water and Sewage
    The percentage change in the price of water and sewage maintenance 
as measured by the Consumer Price Index (CPI) for all urban consumers 
(CPI Code CUUR0000SEHG01) would be applied to this component.

Professional Liability Insurance

    The proposed FY 2002-based RPL market basket would use the 
percentage change in hospital professional liability insurance (PLI) 
premiums as estimated by the CMS Hospital Professional Liability Index 
for the proxy of this category. In the FY 1997-based excluded hospital 
with capital market basket, the same proxy was used.
    We continue to research options for improving our proxy for 
professional liability insurance. This research includes exploring 
various options for expanding our current survey, including the 
identification of another entity that would be willing to work with us 
to collect more complete and comprehensive data. We are also exploring 
other options such as third party or industry data that might assist us 
in creating a more precise measure of PLI premiums. At this time we 
have not identified a preferred option, therefore no change is proposed 
for the proxy in this proposed rule.

Pharmaceuticals

    The percentage change in the price of prescription drugs as 
measured by the PPI (PPI Code PPI32541DRX) would be used as a 
proxy for this cost category. This is a special index produced by BLS 
as a proxy in the 1997-based excluded hospital with capital market 
basket.

[[Page 3624]]

Food, Direct Purchases

    The percentage change in the price of processed foods and feeds as 
measured by the PPI (Commodity Code 02) would be applied to 
this component.

Food, Contract Service

    The percentage change in the price of food purchased away from home 
as measured by the CPI for all urban consumers (CPI Code 
CUUR0000SEFV) would be applied to this component.

Chemicals

    The percentage change in the price of industrial chemical products 
as measured by the PPI (Commodity Code 061) would be applied 
to this component. While the chemicals hospitals purchase include 
industrial as well as other types of chemicals, the industrial 
chemicals component constitutes the largest proportion by far. Thus we 
believe that Commodity Code 061 is the appropriate proxy.

Medical Instruments

    The percentage change in the price of medical and surgical 
instruments as measured by the PPI (Commodity Code 1562) would 
be applied to this component.

Photographic Supplies

    The percentage change in the price of photographic supplies as 
measured by the PPI Commodity Code 1542) would be applied to 
this component.

Rubber and Plastics

    The percentage change in the price of rubber and plastic products 
as measured by the PPI (Commodity Code 07) would be applied to 
this component.

Paper Products

    The percentage change in the price of converted paper and 
paperboard products as measured by the PPI (Commodity Code 
0915) would be applied to this component.

Apparel

    The percentage change in the price of apparel as measured by the 
PPI (Commodity Code 381) would be applied to this component.

Machinery and Equipment

    The percentage change in the price of machinery and equipment as 
measured by the PPI (Commodity Code 11) would be applied to 
this component.

Miscellaneous Products

    The percentage change in the price of all finished goods less food 
and energy as measured by the PPI (Commodity Code SOP3500) 
would be applied to this component. Using this index would remove the 
double-counting of food and energy prices, which are captured elsewhere 
in the market basket. The weight for this cost category is higher, in 
part, than in the 1997-based index because the weight for blood and 
blood products (1.188) is added to it. In the 1997-based excluded 
hospital with capital market basket, we included a separate cost 
category for blood and blood products, using the BLS PPI for blood and 
derivatives as a price proxy. A review of recent trends in the PPI for 
blood and derivatives suggests that its movements may not be consistent 
with the trends in blood costs faced by hospitals. While this proxy did 
not match exactly with the product hospitals are buying, its trend over 
time appears to be reflective of the historical price changes of blood 
purchased by hospitals. However, an apparent divergence over recent 
years led us to reevaluate whether the PPI for blood and derivatives 
was an appropriate measure of the changing price of blood. We ran test 
market baskets classifying blood in three separate cost categories: 
blood and blood products, contained within chemicals as was done for 
the 1992-based excluded hospital with capital market basket, and within 
miscellaneous products. These categories use as proxies the following 
PPIs: The PPI for blood and blood products, the PPI for chemicals, and 
the PPI for finished goods less food and energy, respectively. Of these 
three proxies, the PPI for finished goods less food and energy moved 
most like the recent blood cost and price trends. In addition, the 
impact on the overall market basket by using different proxies for 
blood was negligible, mostly due to the relatively small weight for 
blood in the market basket.
    Therefore, we are proposing to use the PPI for finished goods less 
food and energy for the blood proxy because we believe it more 
appropriately proxies the price changes (not quantities or required 
tests) associated with blood purchased by hospitals. We will continue 
to evaluate this proxy for its appropriateness and will explore the 
development of alternative price indexes to proxy the price changes 
associated with this cost.

Telephone

    The percentage change in the price of telephone services as 
measured by the CPI for all urban consumers (CPI Code 
CUUR0000SEED) would be applied to this component.

Postage

    The percentage change in the price of postage as measured by the 
CPI for all urban consumers (CPI Code CUUR0000SEEC01) would be 
applied to this component.

All Other Services, Labor Intensive

    The percentage change in the ECI for compensation paid to service 
workers employed in private industry would be applied to this 
component.

All Other Services, Nonlabor Intensive

    The percentage change in the all items component of the CPI for all 
urban consumers (CPI Code  CUUR0000SA0) would be applied to 
this component.
3. Proposed Methodology for Capital Portion of the RPL Market Basket
    Unlike for the operating costs of the proposed FY 2002-based RPL 
market basket, we did not have IRF, IPF, and LTCH FY 2002 Medicare cost 
report data for the capital cost weights, due to a change in the FY 
2002 reporting requirements. Rather, we used these hospitals' 
expenditure data for the capital cost categories of depreciation, 
interest, and other capital expenses for FY 2001, and aged the data to 
a FY 2002 base year using relevant price proxies.
    We calculated weights for the proposed RPL market basket capital 
costs using the same set of Medicare cost reports used to develop the 
operating share for IRFs, IPFs, and LTCHs. The resulting proposed 
capital weight for the FY 2002 base year is 10.149 percent. This is 
based on FY 2001 Medicare cost report data for IRFs, IPFs, and LTCHs, 
aged to FY 2002 using relevant price proxies.
    Lease expenses are not a separate cost category in the market 
basket, but are distributed among the cost categories of depreciation, 
interest, and other, reflecting the assumption that the underlying cost 
structure of leases is similar to capital costs in general. We assumed 
10 percent of lease expenses are overhead and assigned them to the 
other c