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Toward a High Performance Health Care System for Vulnerable Populations: Funding for Safety-Net Hospitals

High-performance health systems must be capable of meeting the needs of vulnerable populations, who are at disproportionately greater risk for receiving inferior care and experiencing poorer health outcomes than other groups. The Commonwealth Fund Commission on a High Performance Health System has identified equity as a core goal of a high-performance health system and has proposed a three-part strategy to reduce the health care divide between vulnerable Americans—low-income families, those without health insurance, and racial and ethnic minorities—and the rest of society. First, ensure that health coverage provides adequate access and financial protection; second, coordinate care delivery with other community resources, including public health services; and finally, strengthen the safety-net delivery system serving these populations. Safety-net hospitals are central to these delivery systems and as such play a critical role in achieving high-performance health care for vulnerable populations. These hospitals serve disproportionately large numbers of low-income patients, both insured and uninsured, and rely disproportionately on Medicaid and disproportionate share hospital (DSH) payments to sustain their operations and public funds to underwrite their capital needs. Both the financial pressures induced by dependence on these funding streams, as well as the anticipated changes in these streams due to the expected influx of Medicaid patients and reduction of DSH payments under health reform, pose challenges to the short- and long-term viability of safety-net hospitals. This report examines the funding streams on which safety-net hospitals most rely and suggests strategies to better target financial resources to these hospitals—not simply to sustain them but to stimulate and reward high performance. To address the complex health needs of vulnerable patients, safety-net hospitals must be able to provide high-quality, cost-effective care. Accordingly, the funding proposals that follow incorporate requirements of transparency and accountability.

The Distinguishing Features of Safety-Net Hospitals
Researchers and policymakers have used a range of factors to identify safety-net hospitals, all of which focus on hospitals that serve large numbers of low-income, medically vulnerable patients. These factors generally include the hospital’s percentage of Medicaid patients, its uncompensated care burden, and the socioeconomic status of its patients. Occasionally, the hospital’s financial condition is taken into account, as is the provision of selected services (e.g., trauma, burn, and neonatal intensive care).

The definition of safety-net hospital is important for several reasons. First, it indicates the hospitals to which federal and state resources should be targeted. In addition, it highlights the revenue streams most relevant to the financial health of safety-net hospitals and informs how these funding streams might best be configured and allocated among institutions. The ultimate goal is to ensure that low-income and medically vulnerable patients have timely access to care that is cost-effective and produces quality outcomes. In short, the challenge policymakers face is threefold: to identify safety-net hospitals, appropriately target and allocate key funding streams among these hospitals, and ensure accountability for quality and efficiency.

While policymakers and researchers do not agree on the exact determinants of safety-net hospital status, there is general agreement that Medicaid payments and Medicare and Medicaid DSH funding are all critical revenue streams. By definition, safety-net hospitals typically have disproportionately high percentages of Medicaid patients. However, a given hospital’s Medicaid mix may fall along a continuum, and the baseline varies between states and local areas based on a state’s Medicaid policies and the socioeconomic status of the community served by the hospital. Safety-net hospitals also serve larger numbers of uninsured and underinsured patients, resulting in larger uncompensated care burdens, reflected in their reliance on DSH payments. That said, some safety-net hospitals, most notably academic medical centers, have a greater percentage of privately insured patients and a greater ability to cross-subsidize Medicaid and uninsured losses.

Medicaid Payment Policies
Medicaid is becoming an increasingly important revenue stream at safety-net hospitals. As unemployment and poverty rates have risen, the number of Americans depending on Medicaid coverage and the number of uninsured Americans have likewise risen. When the Patient Protection and Affordable Care Act (Affordable Care Act) expands Medicaid to cover more than 52 million Americans, up from 35 million, Medicaid will become the nation’s largest insurer. Massachusetts’s health care reform experience suggests that under reform, Medicaid patients will continue to rely disproportionately on safety-net providers. With Medicaid constituting anywhere from 25 percent to well over 50 percent of the revenue of safety-net hospitals, states’ Medicaid payment policies are a key determinant of the financial health of these institutions. In many, perhaps most, states, Medicaid payment rates are low and too often encourage costly inpatient services
over more cost-effective outpatient services. With Medicaid the largest or second-largest item in a state budget, states are cutting Medicaid rates further in their efforts to balance their budgets.

The Affordable Care Act’s expansion of Medicaid, coupled with its focus on cost containment and improved health outcomes, has triggered a focus on Medicaid payment levels and methodologies. State budget cuts and across-the-board rate cuts have focused attention on the adequacy of Medicaid payment rates and most particularly the relationship between payment rates and access to care. The challenge will be to channel this attention on Medicaid payment policies into sound decisions that ensure that Medicaid beneficiaries have timely access to quality, cost-effective care. At a minimum, that means rational payment methods and reasonable payment levels that support hospitals that provide value. This goal is not limited to payments to providers that serve the largest numbers of Medicaid patients. However, sound payment policies, most especially adequate payment levels, are core to the ability of these providers to deliver quality services to vulnerable populations.

Given current budget constraints, it is unlikely that states will be in a position to raise Medicaid payment levels for all services and for all providers. Therefore, targeting selective investment to enhance rates paid to safety-net hospitals that are most dependent on Medicaid revenue may be necessary. If linked to performance, this offers the best opportunity to improve care and preserve access for low-income patients and communities. At the outset, it must be acknowledged that targeting enhanced Medicaid payments to hospitals based on their safety-net status is far from ideal. However, a strategy that ties payment to performance and performance improvement offers a way to address quality and access concerns in an environment in which state Medicaid rates are otherwise low and state resources limited. If the investment is transparent and linked to quality measures, targeting can advance three important policy goals: sustaining safety-net hospitals; supporting delivery system reform at safety-net hospitals; and ensuring that vulnerable populations have access to high-quality, coordinated, and efficient care. Notably, this strategy presumes that a state’s underlying payment methods and purchasing strategies are designed to promote value. With these principles in mind, the Commission recommends:

  • In states where Medicaid hospital rates are below the cost of efficiently delivered care, states should increase Medicaid rates paid to hospitals with the highest share of Medicaid patients and lowest share of privately insured as a share of all their patients, contingent on meeting quality targets and delivering high-quality, accessible, cost-effective care. Because there is no clear demarcation as to when safety-net status begins, it is recommended that states consider the degree to which these rate increases accomplish the goals of preserving access to care for low-income populations and encouraging improved performance on indicators of quality and efficiency. This additional investment should be structured consistently with the overarching goals of transparency and accountability.
  • In making targeted investments in Medicaid payments, states should consider the relationship between inpatient and outpatient services, incentivizing the delivery of care in the most appropriate and efficient setting and supporting clinical integration across hospitals and community-based settings. 
  •  States should invest in reimbursement rates for services where there is insufficient capacity to meet the needs of Medicaid beneficiaries and where increased Medicaid payments may enhance access.

This report focuses on states’ Medicaid fee-for-service payment policies, although states are increasingly shifting Medicaid enrollees into managed care plans and other capitated payment and delivery models, where safety-net hospitals are reimbursed by a health plan or similar entity rather than directly by the state. However, even in state Medicaid programs with considerable managed care penetration, fee-for-service payment levels and methods remain important for several reasons. First, states continue to carve out beneficiaries with complex conditions and some services required by complex populations (e.g., behavioral health and substance abuse services) from managed care. Second, states’ managed care premiums as well as plan provider rates are often built on or are informed by state fee-for-service payment policies. Third, sound Medicaid fee-for-service payment policies are an essential first step in building a pathway by which states and the federal government can ensure that safety-net hospitals have access to the revenue they need to deliver high-quality, coordinated, and efficient care and that vulnerable populations have access to the services they need. Notably, as states move additional Medicaid populations into managed care plans (or accountable care organizations), they are borrowing fee-for-service strategies to require or enable managed care plans to target additional payments to providers that advance priorities such as service to the uninsured or meeting patient-centered medical home standards.

Medicaid and Medicare Disproportionate Share Hospital Payments
Along with Medicaid, safety-net hospitals also rely on Medicaid and Medicare DSH payments, although neither funding stream is currently well targeted to hospitals providing the largest percentage of uncompensated care to low-income patients. DSH payments have traditionally been viewed as at least partially offsetting uncompensated care costs, low Medicaid reimbursement rates, and the added costs of serving large numbers of low-income patients. Under federal health reform, with more patients having access to health insurance coverage, Medicaid and Medicare DSH payments will be dramatically reduced starting in 2014. How states and the federal government target the remaining DSH dollars will have significant implications for safety-net hospitals that continue to serve the remaining uninsured—undocumented immigrants and individuals for whom insurance remains unaffordable—as well as some number of underinsured patients. Defining “underinsured” post-reform will require consideration of the law’s affordability standards and minimum essential coverage requirements. With the recent Department of Health and Human Services (HHS) announcement that until at least 2016, states will have considerable discretion in defining the essential health benefits, a national definition of underinsured may be difficult.

The Commission recommends that the remaining Medicaid DSH dollars be targeted first to hospitals that serve uninsured patients, valued on a unit-of-service basis multiplied by the applicable Medicaid rate or some percentage thereof, thereby ensuring transparency and accountability for DSH spending. Any remaining DSH funds could be spent on treatment of underinsured patients, but this would first require consideration of the definition of underinsured after implementation of federal health care reform. Finally, with respect to state dollars formerly spent on DSH, the Commission recommends investing them in Medicaid payment rates to sustain a high-performance health care system for vulnerable populations.

Under the Affordable Care Act, Medicare DSH will be cut by 75 percent in 2014. This reduction eliminates the portion of Medicare DSH spending the Medicare Payment Advisory Commission found was not empirically justified by the higher patient costs associated with low-income patients. The amount cut from Medicare DSH will be pooled and reduced somewhat to account for the anticipated decrease in uninsured patients. Hospitals will then receive a share of the new pool commensurate with their share of total uncompensated care provided by acute care hospitals nationally. In distributing this money, the Commission recommends that the HHS secretary give first priority to the uncompensated costs of care for uninsured patients. Thereafter, Medicare DSH payments could be applied to uncompensated costs of underinsured patients, with the same caveat as noted above with respect to Medicaid DSH.

The reductions and reconfiguration of both Medicare and Medicaid DSH spending require federal and state governments to consider anew the definitions of uninsured and underinsured patients after implementation of federal reform and how best to target DSH spending to support the cost of services provided such patients.

Capital Funding
Emerging payment and delivery system reforms are requiring hospitals to demonstrate quality and efficiency and reconfigure their care models accordingly. Safety-net hospitals must change how they deliver and finance care to survive in this new landscape. But adapting requires significant upfront investments of both human and financial capital, neither of which is readily available to many safety-net facilities. Many of these hospitals are already stretched to their limits and have little ability to raise additional funds or increase their revenues from private payers, and thus may be unable to invest the staff or funds needed to evolve. Access to capital is, therefore, a critical issue. Where operating margins are not large enough to demonstrate creditworthiness, safety-net hospitals will have limited access to capital. To the extent that Medicaid payments are adequate and DSH dollars strategically targeted, operating margins may improve. In many instances this will not be the case and alternative mechanisms to provide capital access for safety-net hospitals will be critical. One potential yet limited funding stream is the Health Care Innovation Challenge, under which the new Innovation Center at the Centers for Medicare and Medicaid Services (CMS) will award up to $1 billion in grants to providers, payers, and local government to fund new models of care delivery that provide better health, improved care, and lower costs to people enrolled in Medicaid, the Children’s Health Insurance Program, and Medicare. Another broader source of funding for safety-net hospitals are Medicaid waivers under Section 1115 of the Social Security Act. These waivers enable federal and state governments to target financial support for high-priority capital projects and system restructuring at safety-net hospitals. Both California and New York have secured federal waiver funding for such initiatives, and their experiences are instructive. The Commission recommends that states consider using waiver funding to support essential investments at safety-net hospitals, especially those that support the development of accountable care systems at these facilities.

Publication Details



D. Bachrach, L. Braslow, and A. Karl, Toward a High Performance Health Care System for Vulnerable Populations: Funding for Safety-Net Hospitals, The Commonwealth Fund, March 2012.