By Martha Heberlein

Anticipating that declines in the number of uninsured people would reduce the costs of uncompensated care, the Affordable Care Act cut Disproportionate Share Hospital (DSH) payments to hospitals that serve large numbers of low-income individuals. On Monday, CMS released a proposed rule that begins to explain how these reductions will be implemented.

While the statute requires reductions in FY 2014 through FY 2020, the rule includes the proposed methodology for just the first two years, allowing CMS to revisit the methodology before the more substantial cuts occur in 2017. Overall, DSH will be reduced by $18.1 billion, but these cuts are back-loaded. In FY 2014, DSH payments are reduced by $500 million; in each of FY 2015 and 2016 they are reduced by $600 million. In 2017, the size of the reduction jumps to $1.8 billion.

The rule establishes separate DSH reduction “pools” for low-DSH states (those for which DSH expenditures are between 0% and 3% of annual Medicaid expenditures) and other states. It then creates a pretty complex formula for distributing the reductions in each pool that takes into account the percentage of the uninsured in a state, as well as whether states are targeting DSH payments well to hospitals with high volumes of Medicaid patients and the uninsured. The approach also protects DSH allotments that have been used in Section 1115 waivers that expanded coverage.

While only illustrative (note the asterisks!), Table 1 shows the values associated with these various reduction factors and the FY 2014 reduced allotments by state. Others are running the numbers on what this might mean in states and it is very likely that these numbers will change, so stay tuned.

CMS decided not to factor into the formula whether or not states have chosen to expand Medicaid. It’s hard to see how, under any scenario, they could have, as the data on the number of uninsured will not yet be available.

The bottom line, though, is that hospitals that operate in states that do no expand Medicaid will be far worse off than hospitals in states that do because while all states face DSH cuts, hospitals in states that do expand will see a substantial increase in federal dollars for the newly covered offsetting the loss. Yet another unintended consequence of the Supreme Court ruling that passed the decision to states.

The proposed rule is the tip of the iceberg with respect to DSH cuts – just the first two years in which they are relatively small. For states that are dragging their feet on the Medicaid expansion this rule should be a wake up call to remind them that these cuts are coming and they will get more devastating as years go by.