Build Back Better Would Reduce Disproportionate Share Hospital (DSH) Payments and Limit Uncompensated Care (UCC) Pools in Non-Expansion States

The Build Back Better Act (BBB) seeks to temporarily close the coverage gap for over 2 million uninsured people living in the 12 states that have not adopted the Medicaid expansion by allowing these individuals to purchase federally subsidized coverage on the Affordable Care Act (ACA) Marketplace through 2025. By filling the coverage gap, analysis finds uncompensated care (UCC) would decrease. Uncompensated care costs occur because, although people who are uninsured use less care than people with coverage, most who are uninsured have limited income or resources and cannot afford the high cost of medical care, if and when they do need and use care. To reflect expected decreases in UCC from filling the coverage gap and encourage holdout states to expand Medicaid, the BBB proposes reducing disproportionate share hospital (DSH) allotments by 12.5% starting in federal fiscal year (FFY) 2023 and places limits on Medicaid UCC pools for non-expansion states. This policy watch explains what these payments are, what changes have been tied to the ACA, and examines potential implications of changes included in the BBB.

What are DSH payments and UCC Pools?

Medicaid provides DSH payments to states to disperse to hospitals that serve a large number of Medicaid and low-income uninsured patients. These funds are intended to help offset hospital costs due to UCC of uninsured individuals and where Medicaid payments fall short of hospital costs, helping hospitals maintain financial stability. While states have considerable discretion in determining the amount of DSH payments to each DSH hospital, federal DSH funds are capped for the state and also capped at the facility level. Federal DSH allotments vary by state and totaled $13.0 billion in FFY 2021.

A number of states have also used Section 1115 waivers to create UCC pools to help providers finance funding shortfalls from uncompensated care. Funds in these pools go directly to health care providers and are not tied to costs for specific people and services, but more broadly are intended for hospital UCC.

How has the ACA affected DSH and UCC?

The ACA called for a reduction in federal DSH allotments starting in FFY 2014, but the cuts, $8 billion a year for four years, have been delayed several times and are currently set to take effect in FFY 2024. The reduction under the ACA was based on the assumption that health coverage would increase and therefore reduce UCC costs. The DSH Health Reform Reduction Methodology (DHRM) would be used to calculate allotment reductions for states, applying, for example, larger reductions to states with lower uninsured rates and states that do not target their payments to hospitals with more UCC costs or more Medicaid beneficiaries.

Although the post-ACA Obama administration began phasing down UCC pool funding in Section 1115 waivers, the Trump administration subsequently showed a willingness to continue such waivers. Following implementation of the ACA, the Obama administration sent letters notifying states that they could not use UCC pool funding to cover costs for individuals who could be covered under the Medicaid expansion, noting that states could instead lower UCC burdens by obtaining federal financing for covering expansion adults, with the federal government picking up 90% of the cost. However, the Trump administration did not continue this policy and approved increased UCC pool funding for two non-expansion states, Texas and Florida, in December 2017. The Trump administration subsequently approved 10-year renewals of both states’ waivers, including extended UCC funding, in January 2021. Currently, four non-expansion states have Section 1115 waivers with UCC pools (Florida, Kansas, Tennessee, and Texas), though elements of the Texas and Tennessee waivers are under review by CMS under the Biden Administration.

A large body of research finds that states that expanded Medicaid under the ACA have seen improvements in hospital financial performance, including decreased UCC costs. Studies find associations between Medicaid expansion and improvements in payer mix (declines in uninsured patients and increases in Medicaid-covered patients) and decreases in UCC costs overall and for specific types of hospitals, including those in rural areas. Studies also indicate that payer mix improvements and UCC declines in expansion states translated to improvements in hospital operating margins and other measures of financial performance, including decreased likelihood of hospital closure. However, a smaller number of studies suggests that these financial improvements may vary by hospital type and that UCC declines may have been partially offset by increases in unreimbursed Medicaid care and declines in commercial revenue.

What are potential implications of the DSH and UCC changes included in the BBB?

The BBB proposes to reduce DSH allotments by 12.5% in non-expansion states starting in FFY 2023 and places limits on Medicaid UCC pools for non-expansion states by excluding expenditures for the expansion population from federal assistance. Hospitals argue that DSH payments help address Medicaid shortfall (due to payment rates below costs) and provide financial stability on top of offsetting UCC costs; they further argue that the proposed reductions could hurt their ability to care for their patients. Hospitals also argue that they have faced financial instability during the COVID-19 pandemic, especially providers with low operating margins like many of those receiving DSH payments. Recent analysis shows that annual increases in hospital revenues from measures to close the coverage gap should more than offset the reduction in DSH allotments; however, the analysis did not account for the restrictions to UCC pool funding. Another analysis similarly finds improvements in hospital margins mostly due to reductions in UCC. The Congressional Budget Office (CBO) recently estimated that these provisions would decrease federal spending by $18 billion over the five-year period (2022-2026) and $35 billion over the ten-year period (2022-2031).

The BBB DSH cuts would be in addition to the ACA’s DSH reductions scheduled to go into effect in 2024, and in the current version of the bill, the additional cuts would remain in place after the provisions to close the coverage gap expire. However, states could adopt Medicaid expansion at any time and take advantage of the additional financial incentives in the American Rescue Plan Act (ARPA) that more than offset the state costs to expand for two years. BBB would also temporarily increase the federal share of costs for the Medicaid expansion from 90% to 93%. Further, even without federal legislation, the Biden administration could withdraw approved UCC pool Section 1115 waiver authorities or decline to renew or renegotiate these waivers as they expire. The net effects of the reductions relative to the new revenues from coverage remain in question both overall and for specific hospitals, but the debate highlights some of the trade-offs between DSH and UCC funding versus new coverage.