The Medicare Prescription Drug, Improvement, and Modernization Act of 2003, or the 2003 Act, which was signed into law on December 8, 2003 made a number of significant changes to the Medicare program.  In addition to a highly publicized prescription drug benefit that is intended to provide direct relief to Medicare beneficiaries, the 2003 Act provides a number of direct benefits to hospitals including, but not limited to: a provision for an update factor for federal fiscal year 2004 that is the full market basket;  a permanent increase in the base payment rate for rural and small urban hospitals of 1.6% up to the large urban payment rate; the cap on disproportionate share payments for rural and small urban hospitals, as of April 1, 2004, was increased to 12.0% of total inpatient payments; extension until January 1, 2006 of the hold harmless provisions for small rural hospitals and sole community hospitals under the Outpatient Department reform provisions of the 2003 Act; and  establishment of a physician incentive program for primary care and certain specialty physicians who provide services to individuals in areas having the fewest physicians available to serve Medicare beneficiaries, among others.  In addition,for federal fiscal years 2005, 2006 and 2007, hospitals will receive full market basket updates if they provide the Center for Medicare and Medicaid Services with specific quality data relating to the quality of services provided. We intend to comply with this requirement and believe that the 2003 Act will continue to have a positive impact on our financial operations.

          In addition to the DRG and capital payments, our hospitals may qualify for and receive “outlier” payments.  Outlier payments are made for those inpatient discharges where the total cost of care (as determined by using the gross charges adjusted by the hospital’s cost-to-charge ratio) exceeds the total DRG payment plus a fixed threshold amount.  In determining the cost-to-charge ratio, Medicare uses the latest of either a hospital’s most recently submitted or most recently settled cost report. The threshold amount used in the outlier computation for federal fiscal years 2004 and 2003 was $31,000 and $33,560, respectively. The amount for federal fiscal year 2005 is $25,800. Approximately 2.5% of our Medicare inpatient payments were from outliers in fiscal 2004 compared to 3.8% in fiscal 2003.

          Medicare fiscal intermediaries have been given specific criteria for identifying hospitals that may have received inappropriately high outlier payments.  The intermediaries are authorized to recover overpayments, including interest, if the actual cost of the DRG stay (which was reflected in the settled cost report) was less than claimed, or if there were indications of abuse.  In order to avoid overpayment or underpayment of outlier cases, hospitals may request changes to their cost-to-charge ratio in much the same way that an individual taxpayer can adjust the amount of withholding from income.

          Each state is responsible for administering its own Medicaid program and payment rates and methodologies as well as covered services, all of which vary from state to state. Approximately 50% of Medicaid funding comes from the federal government, with the balance shared by state and local governments. The most common payment methodologies include prospective payment systems and programs that negotiate payment rates with individual hospitals.  Generally, Medicaid payments are less than Medicare payments and are often less than a hospital’s cost of services.  In 1991 Congress passed legislation limiting the states’ use of provider-specific taxes, donated funds to bolster the states’ share and obtained increased federal Medicaid matching funds.  Certain states in which we operate adopted broad-based provider taxes to fund their Medicaid programs in response to the 1991 legislation. 

          Hospitals that have an unusually large number of low-income patients (i.e., those with a Medicaid utilization rate of at least one standard deviation above the mean Medicaid utilization, or having a low income patient utilization rate exceeding 25%) are eligible to receive a disproportionate share adjustment.  Congress has also established a national limit on disproportionate share hospital adjustments.  Although this legislation and the resulting state broad-based provider taxes have affected the payments we receive under the Medicaid program, to date the net impact has not materially adversely affected us.

          Given increasing budget deficits, the federal government and many states are currently considering additional ways in which to limit increases in levels of Medicaid funding, which could also adversely affect future levels of Medicaid payments received by our hospitals.  In addition, the uncertainty and fiscal pressures placed upon the federal government as a result of, among other things, the ongoing military engagement in Iraq, the War on Terrorism, economic recovery stimulus packages, and the deficit in general may affect the availability of federal funds to provide additional relief in the future.

          Because we cannot predict what action the federal government or the states will eventually take under existing and future legislation, we are unable to assess the effect any such legislation might have on our business.  Like Medicare funding, Medicaid funding may also be affected by health care reform legislation, and it is impossible to predict the effect future legislation could have on our business.

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