[Federal Register Volume 61, Number 137 (Tuesday, July 16, 1996)]
[Rules and Regulations]
[Pages 37011-37015]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-17895]
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DEPARTMENT OF HEALTH AND HUMAN SERVICES
Health Care Financing Administration
42 CFR Part 413
[BPD-647-F]
RIN 0938-AH11
Medicare Program; Reporting of Interest From Zero Coupon Bonds
AGENCY: Health Care Financing Administration (HCFA), HHS.
ACTION: Final rule.
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SUMMARY: This final rule requires Medicare providers to report all
interest expense and interest income from zero coupon bonds in the cost
reporting period in which the interest was accrued. This final rule is
necessary to add provisions to the Medicare regulations that
specifically address the reporting by providers of interest expense and
income from zero coupon bonds.
EFFECTIVE DATE: This regulation is effective on August 15, 1996.
FOR FURTHER INFORMATION CONTACT: Ann Pash, (410) 786-4615.
SUPPLEMENTARY INFORMATION:
I. Background
Section 1861(v)(1)(A) of the Social Security Act (the Act) defines
reasonable cost for any service under Medicare as the cost actually
incurred, excluding any cost unnecessary in the efficient delivery of
needed health services. That section of the Act also provides that
reasonable costs must be determined in accordance with regulations that
establish the methods to be used and the items to be included for
purposes of determining which costs are allowable for various types or
classes of institutions, agencies, and services. In addition, section
1861(v)(1)(A) of the Act specifies that regulations implementing the
principles of reasonable cost payment may provide for the use of
different methods in different circumstances. This section of the Act
is implemented by regulations at 42 CFR part 413. In particular,
Sec. 413.24 establishes the methods to be used and the adequacy of data
needed to determine allowable costs for various types or classes of
institutions, agencies, and services.
[[Page 37012]]
Under Medicare, providers are paid for inpatient and outpatient
services that they furnish to beneficiaries under Part A (Hospital
Insurance) or Part B (Supplementary Medical Insurance). Currently, most
hospitals are paid for their hospital inpatient operating costs and
capital-related costs under the prospective payment systems in
accordance with sections 1886 (d) and (g) of the Act and regulations at
42 CFR part 412. Under these systems, Medicare payment is made at a
predetermined, specific rate for inpatient operating costs and
inpatient capital-related costs for each hospital discharge based on
the information contained in actual bills submitted. Section
1886(f)(1)(A) of the Act requires us to maintain a system for reporting
costs of hospitals paid under the prospective payment systems. This
provision is implemented by regulations at Sec. 412.52. Section 412.52
requires all prospective payment system hospitals to meet the cost
reporting requirements of Secs. 413.20 and 413.24, which include
submitting a cost report for each 12-month period.
Hospital outpatient units and hospitals and hospital units that are
excluded from the prospective payment systems, as well as most other
providers, are generally paid an amount based on the reasonable cost of
items and services furnished to beneficiaries, in accordance with
section 1861 (v)(1)(A) of the Act, the regulations at 42 CFR part 413,
and the Provider Reimbursement Manual. These cost-based providers are
subject to the same cost reporting requirements of Secs. 413.20 and
413.24 and thus must maintain financial records and statistical data
sufficient for the proper determination of costs payable under the
Medicare program and submit cost reports on an annual basis.
For cost-based providers (and for prospective payment hospitals
during the capital prospective payment system transition period),
interest expense on capital indebtedness such as loans for acquiring
facilities and equipment or for making capital improvements and on
current indebtedness is an allowable cost as set forth at
Secs. 413.130(a)(7) and 413.153. Interest must be necessary--that is,
incurred on a loan made to satisfy the financial need of a provider,
and for a purpose reasonably related to patient care. It must also be
proper--that is, incurred at a rate not in excess of that which a
prudent borrower would have to pay in the money market when the loan
was made.
One source of financing for providers is the sale of zero coupon
bonds. Similarly, one source of provider investment income is the
purchase of zero coupon bonds. The name ``zero coupon bond'' is derived
from the fact that there are no coupons issued with these bonds. Zero
coupon bonds are issued by government agencies, corporations (including
Medicare providers), and banks at a price substantially below the face
value of the bond. The difference between the purchase price of a zero
coupon bond and the face amount payable at maturity reflects the actual
amount of interest and is neither a discount nor an adjustment to the
interest rate as with most other bonds. All interest is actually paid
when the bond is presented for redemption, at face value, on the date
of maturity.
II. Policy Changes
A. Interim Policy
As discussed in detail in our December 13, 1993 proposed rule (58
FR 65150), on December 22, 1989, we issued a Regional Office memorandum
for distribution to all intermediaries that allowed providers to choose
which method they would use to report interest expense or income from
zero coupon bonds--either at maturity in a lump sum, or each year as
the interest accrues, as long as their treatment of interest expense is
consistent with their treatment of interest income.
We stated that this interim policy would apply to all zero coupon
bonds issued or purchased on or after December 22, 1989, as well as to
any zero coupon bond interest reported on cost reports that could be
amended or reopened as of December 22, 1989. Thus, a provider's options
under the interim policy are as follows:
Bonds Issued before December 22, 1989: For interest from
zero coupon bonds issued before December 22, 1989, that is reportable
on cost reports that could be amended or reopened as of December 22,
1989, a provider could request amendment or reopening and specify the
method to be used for reporting interest expense and income on zero
coupon bonds. Conversely, by not requesting an amendment or reopening,
a provider could choose to continue the method already in use.
Bonds Issued on or after December 22, 1989, and before
February 22, 1991: For all zero coupon bonds issued on or after
December 22, 1989, but before February 22, 1991, a provider could
choose the method it would use to report interest expense or income, as
discussed above. Therefore, in cases where a provider's cost reports
are not amended, or cost report determinations are not reopenable, on
or after December 22, 1989, the provider's preference would be
evidenced by the choice the provider exercises for the first zero
coupon bonds issued or purchased on or after December 22, 1989, but
before February 22, 1991. In either case, once the provider has
exercised its choice, the method of reporting interest accrued on all
zero coupon bonds issued or purchased from that date through February
21, 1991, should be consistent with that choice.
B. Current Policy (Applicable to Bonds Issued on or after February 22,
1991)
We revised the Medicare Provider Reimbursement Manual (Transmittal
No. 358) in February 1991 to establish our current policy. In
developing the manual issuance, we concluded that it was not
appropriate to continue to permit the provider to report accrued
interest in a lump sum at maturity because the interest accrues during
the life of the bond. We now require that, for zero coupon bonds issued
or purchased by providers on or after February 22, 1991, all interest
expense and income must be reported in the cost reporting period in
which the interest accrues.
Neither the policy enunciated in our December 22, 1989, Regional
Office memorandum nor the one in the Provider Reimbursement Manual has
been set forth in regulation.
III. Provisions of the Proposed Rule
On December 13, 1993, we published in the Federal Register (58 FR
65150) a proposed rule to add to the Medicare regulations at 42 CFR
413.153 provisions that specifically address the reporting by providers
of interest expense and interest income from zero coupon bonds. We also
proposed to add the definition of ``zero coupon bond'' to the
regulations.
Under our proposal, for zero coupon bonds issued on or after the
effective date of a final regulation, interest expense incurred to
finance capital-related costs would be an allowable expense, and
interest income earned for investment purposes would be an allowable
offset, in the cost reporting period in which the interest accrues. We
proposed that earned interest from zero coupon bonds must be offset
against all allowable interest expense as set forth in
Sec. 413.130(g)(2). In addition, interest expense must meet the
definition of ``necessary'' in Sec. 413.153(b)(2)(iii).
For cost reporting purposes, we proposed to require the use of the
effective interest method rather than the straight line method. Under
the straight line method, the interest for a computation period is
computed by dividing the total interest payable (the
[[Page 37013]]
value at maturity less the amount paid) by the number of compensation
periods. This method recognizes the average interest expense or income
for each compensation period.
Under the effective interest method, we indicated that in each
computation period (as specified by the bond instrument) we would apply
the interest rate to the sum of the face amount and the accrued
interest from prior periods. If the interest computation period
involves portions of more than one cost reporting period, the amount of
interest for that computation period would be apportioned to each cost
reporting period. This method recognizes the actual accrual of interest
expense or income for each interest computation period (as specified by
the bond instrument) throughout the life of the bond to maturity. A
constant effective yield rate is determined and applied to the book
value (outstanding loan balance including prior accrued interest) of
the bond at the beginning of each period to determine the total
interest for the period. We also proposed to set forth in the
regulations under proposed Sec. 413.153(f)(3)(iv) an example of the
computation of interest using the effective interest method.
IV. Analysis of and Responses to Public Comments
We received two letters of comment on the December 22, 1993
proposed rule. These comments and our responses are discussed below.
Comment: One commenter questioned whether the effective date of the
final regulation would be the February 22, 1991, effective date of the
manual provisions. The commenter also wanted us to explain the current
applicability of the interim policies in the Regional Office memorandum
dated December 22, 1989, and in the Provider Reimbursement Manual for
the interim period before the effective date of this final rule. The
commenter stated that if the final rule has an effective date other
than February 22, 1991, the manual provisions would be inconsistent
with the regulation.
Response: This final rule is effective on August 15, 1996 and
applies to bonds issued on and after that date. This date is not
inconsistent with the effective dates of HCFA's prior policies
addressing reimbursement for zero coupon bond interest. The
reimbursement policies in existence before the effective date of this
final rule apply to cost reporting periods that precede the
promulgation of this final rule, and the policies continue in force
only with respect to bonds issued before August 15, 1996. The December
22, 1989 memorandum provided that for interest from zero coupon bonds
issued before December 22, 1989 (that is reportable on a cost report
that can be reopened on or after December 22, 1989), a provider could
request amendment or reopening to specify the method of reporting the
interest expense and income on the zero coupon bonds.
The memorandum did not establish a time limitation on these
requests. However, in order to effectuate an orderly implementation of
this rule, we are requiring providers to submit requests for reopening
or amendment within 60 days of publication of this final rule, that is
by September 16, 1996. Any request received after that date will not be
considered timely and will not be honored.
The provisions of this final rule supersede any agency policy that
is inconsistent with the regulation's terms.
Comment: One commenter stated that while the preamble and the
regulation text of the proposed rule referred to interest expense
incurred to finance capital-related costs, section 213(A) of the
Provider Reimbursement Manual refers to ``issuing zero coupon bonds for
a purpose related to patient care.'' The commenter asked for consistent
use of language as the Manual wording implies that interest expense for
operating purposes, such as working capital, is also an allowable cost.
Response: The language in section 213(A) of the Manual is correct.
Zero coupon bonds may be used to provide funds for either capital-
related costs or operating costs, as long as the costs are for a
purpose related to patient care. We have revised Sec. 413.153(f)(1) to
clarify that interest expense incurred to provide funds for ``patient
care-related costs'' is an allowable expense.
Comment: One commenter suggested that in the final rule we
reference a specific exception to our general policy on the liquidation
of liabilities, established at section 2305 of the Provider
Reimbursement Manual, since the actual payment of interest expense will
not be made until the bonds mature.
Response: Section 2305 of the Manual requires that short-term
liabilities be liquidated within 1 year of the end of the cost
reporting period in which the liability is incurred, subject to certain
specified exceptions. With zero coupon bonds, the interest accrues
during the life of the bond but is not payable until maturity or
redemption of the bond. Since there are no specified interest payments
due during the life of the bond, the liability for payment does not
occur until the bond matures or is redeemed. There is no short-term
liability. We note, in section 2305, that it does not apply to zero
coupon bonds until they mature or are redeemed.
Comment: One commenter objected to the language in
Sec. 413.153(f)(2), which specified that earned interest from zero
coupon bonds must be offset against all allowable interest expense. The
commenter's concern was that in the case of a bond defeasance (an
advance refunding of debt) there are specific guidelines regarding the
treatment of costs associated with advance refunding and with the
allocation of investment income. These guidelines are laid out in the
Provider Reimbursement Manual in sections 2806.G.1, 233, and 213. The
commenter believed that the proposed regulations are in conflict with
specific instructions for bond defeasance.
Response: The commenter is correct. In an advance refunding of debt
(which includes bond defeasance), the investment income is offset
against the interest expense of both the refunded debt and the
refunding debt and is included in determining the gain or loss on the
advanced refunding rather than included with other investment income
and prorated under Sec. 413.130(g)(2). We agree that some changes in
the language of the regulations are needed to better reflect the
treatment of investment income in an advance refunding. We have removed
the reference to ``all'' in Sec. 413.153(f)(2) and revised the section
to indicate that if zero coupon bonds are purchased with the proceeds
of an advance refunding, offset of the investment income is required
under Sec. 413.153(b)(2)(iii), but the investment income is not
prorated under Sec. 413.130(g)(2).
Comment: One commenter raised a question about the current
applicability of the section of the memorandum dated December 22, 1989,
that allowed a provider, under certain circumstances, to reopen or
amend a cost report to specify the method to be used for reporting
interest expense and income on zero coupon bonds issued before December
22, 1989.
Response: The memorandum dated December 22, 1989, provided that for
interest from zero coupon bonds issued before December 22, 1989, that
is reportable on a cost report that can be reopened on or after
December 22, 1989, a provider could request amendment or reopening to
specify the method of reporting the interest expense and income on the
zero coupon bonds. The memorandum did not contain a time limitation on
the requests. However, in order to effectuate an orderly implementation
of these provisions, we are requiring providers to submit request for
reopenings or amendments
[[Page 37014]]
within 60 days of publication of this final rule. Any request received
after that date will be considered not timely filed and will not be
honored.
V. Provision of the Final Regulations
This final rule adopts the provisions of the proposed rule as
final, with the following minor revisions:
In Sec. 413.153(f)(1), we have changed the phrases
``capital-related cost'' to ``patient care-related cost'' and to
``provide funds'' rather than ``finance''.
In Sec. 413.153(f)(2), we deleted the word ``all'',
rewrote part of the section for clarity, and added an appropriate
cross-reference provision for handling zero coupon bonds purchased with
the proceeds of an advance refunding of debt.
VI. Regulatory Impact
We generally prepare a regulatory flexibility analysis that is
consistent with the Regulatory Flexibility Act (RFA) (5. U.S.C. 601
through 612) unless we certify that a final rule will not have a
significant economic impact on a substantial number of small entities.
For purposes of the RFA, we consider providers to be small entities.
Also, section 1102(b) of the Act requires us to prepare a
regulatory impact analysis for any final rule that will have a
significant impact on the operations of a substantial number of small
rural hospitals. Such an analysis must conform to the provisions of
section 603 of the RFA. For purposes of section 1102(b) of the Act, we
define a small rural hospital as a hospital with fewer than 50 beds
located outside a metropolitan statistical area.
In the December 22, 1993 proposed rule, we concluded that the
proposed rule changes would not have a significant economic impact on a
substantial number of small entities, and would not have a significant
impact on the operations of a substantial number of small rural
hospitals. As discussed above, we received two letters of comments on
the proposed rule, neither of which objected to our conclusion that
these changes will not have a significant impact. This final rule
adopts the provisions at the proposed rule with only minor technical
changes. Therefore, we have determined, and certify, that this final
rule will not have a significant economic impact on a substantial
number of small entities. Also, this final rule will not have a
significant impact on the operations of a substantial number of small
rural hospitals. Therefore, we have not prepared a regulatory
flexibility analysis or a rural hospital impact analysis.
In accordance with the provisions of Executive Order 12866, this
final regulation was not reviewed by the Office of Management and
Budget.
Under the provisions of Public Law 104-121, we have determined that
this final rule is not a major rule.
VII. Collection of Information Requirements
Under the Paperwork Reduction Act of 1995, agencies are required to
provide 60-day notice in the Federal Register and solicit public
comment before a collection of information requirement is submitted to
the Office of Management and Budget (OMB) for review and approval. In
order to fairly evaluate whether an information collection should be
approved by OMB, section 3506(c)(2)(A) of the Paperwork Reduction Act
of 1995 requires that we solicit comment on the following issues:
Whether the information collection is necessary and useful
to carry out the proper functions of the agency;
The accuracy of the agency's estimate of the information
collection burden;
The quality, utility, and clarity of the information to be
collected; and
Recommendations to minimize the collection burden on the
affected public, including automated collection techniques.
The overall recordkeeping and information collection burden
associated with filing the provider cost report has been approved by
OMB through August 31, 1996 under OMB No. 0938-0050.
In the December 13, 1993, proposed rule (58 FR 65150), we indicated
that there would be no additional reporting burden on those providers
who have zero coupon bonds and solicited comments. No comments were
received.
Section 413.153 defines when interest expense is an allowable cost
and how interest income is treated. The changes to this section
represent a clarification of the current policy on interest expense and
income as it applies to zero coupon bonds. It does not change the
information collection and recordkeeping requirements. The information
and recordkeeping required is that which is already required to file a
cost report and approved by OMB as indicated above.
List of Subjects in 42 CFR Part 413
Health facilities, Kidney diseases, Medicare, Puerto Rico,
Reporting and recordkeeping requirements.
42 CFR chapter IV, part 413, is amended as follows:
PART 413--PRINCIPLES OF REASONABLE COST REIMBURSEMENT; PAYMENT FOR
END-STAGE RENAL DISEASE SERVICES; OPTIONAL PROSPECTIVELY DETERMINED
PAYMENT RATES FOR SKILLED NURSING FACILITIES
A. The authority citation for part 413 is revised to read as
follows:
Authority: Secs. 1102, 1861(v)(1)(A), and 1871 of the Social
Security Act (42 U.S.C. 1302, 1395x(v)(1)(A), and 1395hh).
Subpart G--Capital-Related Costs
B. Section 413.153 is amended by adding paragraphs (b)(4) and (f)
to read as follows:
Sec. 413.153 Interest expense.
* * * * *
(b) Definitions--* * *
(4) Zero coupon bonds. Zero coupon bonds are issued by government
agencies, corporations, and banks at a price substantially below the
face value. The difference between the purchase price and the face
value reflects the actual amount of interest and is neither a discount
nor an adjustment to the interest rate as with other bonds. Interest is
paid at maturity when the bond is redeemed at face value.
* * * * *
(f) Zero coupon bonds--(1) Interest on bonds issued on or after
August 15, 1996. For zero coupon bonds issued on or after August 15,
1996, interest expense incurred to provide funds for patient care-
related costs is an allowable expense, and interest income earned for
investment purposes is an allowable offset, in the cost reporting
period in which the interest accrues.
(2) Interest income offset. Interest income from zero coupon bonds
must be offset against allowable interest expense as prescribed in
paragraph (b)(2) of this section and in Sec. 413.130(g)(2). If zero
coupon bonds are purchased with the proceeds of an advanced refunding
of debt, offset of the investment income is required under
Sec. 413.153(b)(2)(iii), but the investment income is not prorated
under Sec. 413.130(g)(2).
(3) Use of effective interest method. (i) Interest expense and
interest income from zero coupon bonds that are reported as they accrue
must be amortized using the effective interest method. This method
recognizes the actual accrual of interest expense or income for each
interest computation period (as specified by the bond instrument)
throughout the life of the bond.
[[Page 37015]]
(ii) A constant effective yield rate is determined and applied to
the book value (outstanding loan balance including prior accrued
interest) of the bond at the beginning of each period to determine the
total interest for the period.
(iii) If the interest computation period involves portions of more
than one cost reporting period, the amount of interest for that
computation period shall be apportioned to each cost reporting period.
(iv) An example of the computation of interest using the effective
interest method follows:
Facts
Life of zero coupon bond: 15 years.
Value at maturity: $50,000.
Bondholder pays $6,996 for the bond.
Annual interest rate is 13.5506% compounded semi-annually.
From the table below, interest for the first year would be $980.11
($474.00 plus $506.11).
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Col. 4
Col 2 Book value
Book value Col. 3 end of
Col 1 Six-month periods beginning Effective period
of period interest* (columns 2
+ 3)
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1 $6,996.00 $474.00 $7,470.00
2 7,470.00 506.11 7,976.11
3 7,976.11 540.40 8,516.51
4 8,516.51 577.02 9,093.53
29 43,855.94 2,971.37 46,827.31
30 46,827.31 3,172.69 50,000.00
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*Computed by multiplying the book value at the beginning of each period
(Column 2) by 6.7753% (the annual interest rate of 13.5506% 2 =
6.7753%).
(Catalog of Federal Domestic Assistance Program No. 93.773,
Medicare--Hospital Insurance; and Program No. 93.774, Medicare--
Supplementary Medical Insurance Program)
Dated: February 23, 1996.
Bruce C. Vladeck,
Administrator, Health Care Financing Administration.
[FR Doc. 96-17895 Filed 7-15-96; 8:45 am]
BILLING CODE 4120-01-P
