Executive Summary

As of November, 2003, 834 small rural hospitals have converted to Critical Access Hospital (CAH) status. A primary benefit of converting to CAH status is to receive cost-based payments (rather than prospective payments) from Medicare. The small rural hospitals that converted in FY 1999 experienced an average increase in Medicare inpatient and outpatient payments that exceeded $500,000, in fiscal year 2000 inflation adjusted dollars. While Medicare payments increased by 36%, Medicare patient days declined by 8%.

Prior to January 1, 2004, a hospital had to have 15 or fewer acute care beds and 25 or fewer total beds including swing beds to be eligible for CAH conversion. For this reason, the program has primarily attracted hospitals with a low average daily census. These small hospitals frequently had high costs per discharge and often suffered operating losses prior to conversion. In fact, over half of the hospitals that converted to CAH status in either FY 1999 or 2000 were losing money prior to conversion. CAH status dramatically changed the financial status of converting hospitals. Hospitals that converted in 1999 saw their total profit margins rise from –2.5% to an average of 2.3% one year after conversion and 3.7% two years after conversion. Most of the FY 1999 converters can now afford capital improvements, and the data indicate that capital expenditures started to grow significantly two years after conversion. Profit margins for fiscal year 2000 converters increased from a mean of 0% to 2% following conversion, and we expect those margins to grow further as CAHs adjust their operations to maximize their profitability given their new Medicare payment structure.

The CAH program has contributed significantly to the financial viability of small rural hospitals. This is likely due to a one-time shift to cost-based reimbursement as well as behavioral changes induced by higher payment rates. After conversion, CAHs expanded their outpatient and swing bed services and reduced their home health and SNF operations. However, it is important to emphasize that conversion to CAH status was not responsible for all of the financial changes experienced by CAHs. Approximately half of the increase in inflation-adjusted facility revenue was due to increases in non-Medicare sources. Future analysis of the financial viability of CAHs will need to address the impact of the rural-oriented provisions of the recent Medicare Prescription Drug Improvement, and Modernization Act which include the expansion of the bed limit for CAHs and the establishment of distinct part rehabilitation and psychiatric units in CAHs.