Health Affairs, 25, no. 1 (2006): 70-80 doi: 10.1377/hlthaff.25.1.70 © 2006 by Project HOPE	New Online   Senate Health Reform Bill   Rewarding Providers   Public Option Policy Brief   Health Reform & Abortion   Delivery System Reform

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Pricing & Payment

The Future Of Medicare Hospital Payment

Abstract

 
The combination of health care cost growth exceeding general inflation and the swelling of beneficiary rolls with baby boomers will create fiscal pressure for Medicare. Despite dramatic declines in the growth of hospital costs following the introduction of Medicare’s prospective payment system (PPS), the growth in Medicare hospital spending per beneficiary has been close to three times the overall rate of inflation since 2000. This paper examines issues related to Medicare’s using its pricing policies to more aggressively pursue hospital cost containment. I discuss the need to calibrate payments to reflect expected necessary costs to reduce potential effects on beneficiaries’ access, quality of care, or technological improvements.

As the largest single purchaser of health care, traditional or fee-for-service (FFS) Medicare has much latitude in establishing prices and securing desired access for its beneficiaries. Yet it must remain conscious of the externalities created for the health sector by its influential position. Medicare affects the supply and nature of services through both its direct purchases and the fact that other payers and providers use its policies as guideposts for their own decisions. Medicare’s ability to manage these conflicting pressures is uncertain. It is clear, however, that taking advantage of opportunities to become a more effective and efficient purchaser will be essential to any success.

An efficient purchaser pays the minimum necessary to secure an adequate supply of services. An efficient purchaser is also cognizant of differences in the benefit or value of services and reflects those differences in the prices it pays, as well as in the decision whether to purchase a service. No one would dispute that Medicare has always had the objective of being an efficient purchaser and that the program has indeed gotten better at it; consider the replacement of "reasonable" cost reimbursement policies with prospective payment for hospitals and other providers. At the same time, concern that its payment policies might negatively affect beneficiaries’ access or compromise the quality of services, particularly the development and diffusion of new technology, has made Medicare a somewhat conservative purchaser. Some might believe that these accommodations have been too conservative, accommodating not only necessary but also unnecessary and undesired spending. One might support this view by looking internationally and considering what the United States obtains for its much higher health spending.² What Medicare pays for a service is only one area of potential concern. The program has also been reluctant to question the value of services and whether some should be purchased at all, a reflection, perhaps, of its historical mandate "not to interfere in the practice of medicine."

The question for the future is whether Medicare can more aggressively pursue being an efficient purchaser without sacrificing the program’s primary objective and without untoward effects on the health care sector. In this paper I explore this question with regard to payments for hospital care. Specifically, I consider some steps that Medicare might take to better assure that it spends only what is necessary to secure access to acceptable services. I do not discuss an equally important aspect of being an efficient purchaser: appropriately rewarding and encouraging better-quality services. Although the current interest in pay-for-performance is strong, its short-term potential for containing program spending is likely limited. The discussion here is not visionary in the sense of suggesting sweeping structural changes to current payment methods. The experience of the past twenty-three years suggests strongly that Medicare payment policies change at best incrementally and that this will remain the case for the foreseeable future.³ Concerns about potential impacts of change, stemming initially from providers but effectively communicated to policymakers, have been and likely will remain strong and effective restraints.

Medicare Payment—A Bit Of History

Top Medicare Payment-A Bit Of... Hospitals’ Place In The... Medicare Payments In An... Concluding Remarks NOTES

 
Medicare’s current hospital payment method, the prospective payment system (PPS), was transformative when it was implemented in 1983. Its predecessor, retrospective cost reimbursement, created clear incentives to increase the costs of care. This would be true even if other payers purchased efficiently and were willing to pay only the minimum required to gain access to services of desired quality. Other payers, however, added to inflationary pressures by paying either costs as Medicare had or charges that exceeded costs. For hospitals, a dollar spent was essentially a dollar earned. The PPS ended that situation by severing the direct link between a hospital’s spending and its Medicare revenue. It transformed the calculus of spending decisions, as marginal expenditures could no longer be justified on the basis of virtually automatic increases in revenue.

The rate of hospital cost growth shifted dramatically post-PPS. Averaging about 14 percent per year in the ten years before 1983, the growth in the cost of a Medicare hospital day declined one-third during the following decade, even as the number of days used by Medicare beneficiaries fell about one-fifth.⁴ As a result, growth in Medicare spending on inpatient hospital care slowed considerably.⁵

Medicare’s ability to continue to moderate inpatient care spending was subsequently aided by the actions of private purchasers. Starting in the early 1990s, managed care plans and other private payers began aggressively seeking lower payments or lower increases in payments from hospitals. Hospitals responded with discounts, concerned about being excluded from insurers’ networks. In fact, between 1994 and 1998, spending on hospitals was essentially flat; it initially declined and then recovered. Concerns about being excluded from networks and the willingness to grant discounts abated as consumers demanded more choice of providers in their health plans and as many hospitals increased their bargaining power by forming systems and consolidating in other ways. At the end of the decade, private payments began to grow more rapidly. Growth in spending on hospitals has reemerged as a more serious challenge. Since 2000 it has exceeded overall inflation, growing almost three times faster than the Consumer Price Index (CPI) and more than twice the increase in GDP.

Hospitals’ Place In The Health Care System

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Given Medicare’s size and the potential impacts of its policies, one must acknowledge the unique position or role of the hospital before considering how to modify those policies to address the program’s fiscal challenges. Hospitals are the providers of last resort. Ideally, they have the capacity to deliver essential treatment whenever necessary—managing individual emergencies as well as major catastrophes.

Hospitals also have aspects of being a social good, providing benefits to current users directly and, by their presence, to all others who are potential users. The challenge is how to ensure that hospitals receive adequate, but not excessive, compensation so that sufficient capacity is present when demanded. This challenge is intensified when pressures for cost control increase.

The need for hospital capacity has been underscored in recent years by concerns about bioterrorism and naturally occurring epidemics such as severe acute respiratory syndrome (SARS) or possibly avian flu.⁶ In surveying hospitals to assess the prevalence of emergency room crowding and the capacity to deal with infectious disease outbreaks, the U.S. Government Accountability Office (GAO) found such capacity to be very limited in many metropolitan areas.⁷ The principal cause of the limited capacity, in the words of some hospital executives, was their responsiveness to changes in the marketplace. They had "right-sized," eliminating excess beds and curtailing other services, in response to payers’ demands for discounts and lower per unit costs.

Hospitals provide other social goods. Some of these, such as uncompensated care or medical education costs, are fairly easy to measure. Others, such as the costs of innovation and technology diffusion, are more difficult to quantify. Like emergency capacity, it is hard to specify how much is sufficient and desirable.

Historically, payments for the social goods associated with hospital services have largely been an implicit part of the payments for direct services.⁸ When, prior to the PPS, Medicare and other payers were virtually passive about paying the costs that hospitals incurred, hospitals effectively determined how much was available to finance these functions. As Medicare and other payers became more concerned about controlling costs, the question of whether service payments were adequate to fund these activities became important. As long as the political choice is not to finance these social goods through direct appropriations, a challenge for Medicare in determining future service payments is to strike a balance that ensures and preserves the desired capacity and other social benefits without providing hospitals with excessive compensation that crowds out more valued private or public activities.⁹ This challenge is compounded by the difficulty in measuring the array of social benefits.

Medicare Payments In An Era Of Fiscal Challenge

Top Medicare Payment-A Bit Of... Hospitals’ Place In The... Medicare Payments In An... Concluding Remarks NOTES

 
Accepting the premise that radical changes in Medicare payments are not going to occur in the immediate future, what are the options for starting to address the fiscal challenge facing the program, fulfilling its objective, and avoiding harmful effects on the health care sector? Operating within the context of the current PPS, the principal actions would seem to be as follows: (1) increase the incentives for cost containment by restraining the growth in payments over time; and (2) simultaneously improve the calibration of payments to reflect the necessary costs of delivering services to avoid influencing treatment decisions for Medicare beneficiaries or unduly affecting the supply of services more generally.

Exercising restraint. In the context of the current PPS, the principal mechanism for effecting cost control will be the update factor: the congressionally specified annual increase in payments. One of the roles assigned to the Medicare Payment Advisory Commission (MedPAC) is to provide Congress with recommendations for updating Medicare payments. In making those recommendations, MedPAC considers two factors: first is the adequacy of current payments, and second is how much the costs of an efficient provider are expected to rise in the following year.¹⁰ Both involve multiple elements. Payment adequacy is assessed in terms of beneficiaries’ access to care, changes in the volume of services or quality of care, hospitals’ access to capital, and the relationship of Medicare payments and costs (the Medicare margin). Expected cost increases involve the projected change in the prices of hospital inputs, measured by the Centers for Medicare and Medicaid Services (CMS) hospital market basket and changes in productivity.

Medicare margins. Public and congressional attention tends to focus most on the Medicare margins and the hospital market basket, perhaps because they are the most readily quantifiable elements considered. The question becomes what is happening to margins and what the update should be relative to the market basket. Not surprisingly, the update factor and Medicare margins have exhibited a strong negative correlation over the years. This historical pattern of larger payment increases when margins are lower becomes an issue as the identified need for fiscal constraint coincides with the declining margins of recent years and a forecast of negative Medicare margins for 2005.¹¹

Hospital efficiency. Underlying the attention given Medicare margins is the implicit assumption that hospitals’ reported costs are necessary for the delivery of their services and on average represent the cost of efficient operations. It is true that the PPS does create a strong incentive to be efficient. Yet there are conceptual and empirical grounds to question whether reported costs measure only necessary costs or, even if necessary, whether those costs involve only the delivery of desired services.

Fiscal pressure from payers. MedPAC in its March 2005 report to Congress noted the apparent responsiveness of hospital cost growth to the fiscal pressure being exerted by payers.¹² In the 1990s, private payers, as noted previously, sought and obtained large discounts from providers as a prerequisite for inclusion in their networks. During this period of constraints on private revenues, hospital costs grew very slowly. But as the decade ended, many providers took actions to strengthen their bargaining positions with insurers and succeeded in getting large increases in private fees.¹³ Simultaneously, hospital cost growth accelerated rapidly, with Medicare costs per discharge increasing much faster than changes in input prices measured by the market basket.

Do revenues generate costs? The issue is what this recent experience signifies. Was the upsurge in costs an aberration, or did it reflect an apparent reality of the health care sector—the availability of revenues generates costs? Some might be comfortable with the idea of this being an aberration, a catch-up period of recovery and reinvestment following the years of reduced spending growth. There could be some truth to that perspective. The growth in costs did decline somewhat in 2003 but remain at a level still much higher than the change in the market basket index.¹⁴ In thinking about the longer term, one has to be concerned that the "revenues generate costs" interpretation of these shifts might contain kernels of truth for the health sector in general and for hospitals in particular.

It should be remembered that about three-quarters of hospitals operate as nonprofits. They might operate efficiently, but the value of any savings from being efficient is the ability to invest those monies in other activities related to the hospital missions. A minimal margin in such an institution might result from funds’ being quickly used to serve its mission and reflect successful management, not a distress signal. The challenge for a powerful payer such as Medicare is knowing the difference. The reality of current cost accounting and information systems is that disentangling the costs of various activities within a hospital or assessing their value with any precision is not feasible.

Dealing with imperfect information. Although these uncertainties need to be taken into account, the fiscal challenge facing Medicare and health care purchasers more globally suggests that imperfect information cannot preclude efforts to restrain costs. Given the uncertainties that are present, policies need to be moderated to reduce risks, and investments in information gathering and monitoring to understand impacts must be intensified. In considering how Medicare payments should change in the future, greater emphasis should be given to what is happening with respect to access to and quality of hospital care and to the expected increases in input costs (the market basket). Less attention should be paid to how payments relate to current costs (margins), because those costs might be too much of a reflection of hospitals’ expectations regarding future revenues.

Finding new efficiencies. Ideally, the pressures of purchasers’ fiscal restraint would serve as an impetus for finding new efficiencies or savings from eliminating services or aspects of services that provide minimal benefits. Those pressures would be akin to the discipline coming from the customer side of the market that fosters innovation and price savings in other industries. Peter Drucker has observed that an important trait of successful companies is often their ability to employ "price-led costing"—that is, to recognize what customers are willing to pay and design a product that can be profitably produced and deliver sufficient benefits to attract buyers. The contrasting behavior is "cost-led pricing"—a perception that current costs are absolutely necessary and the product cannot be produced for less.¹⁵ In an ordinary market, sometimes that price reduces demand so much that the product is not viable.

Discussions of constraining cost growth in health care, not even proposing an actual cut in costs, seem to inevitably evoke predictions about extreme changes in what care can be provided. In part, this may reflect the reality that health care providers are not used to the type of competition Drucker envisions. Cost-saving innovation is perhaps more prevalent in other markets because it is a necessary condition of survival. Health care, for many good reasons, lacks the fluid entry and exit of providers that drive price and quality competition in other markets. The threat of extinction might not be the same strong motivating force in health care, but that does not mean that payers exercising more constraint on payments won’t have a positive effect. Cost-saving innovations seem possible through process redesign, effective use of information technology (IT), or elimination of duplicative or unnecessary service components.¹⁶ Finding new efficiencies and other savings frees revenues for other purposes.

Risks of exercising restraint. At the same time, the risks and potential consequences of Medicare or other payers exercising more restraint need to be acknowledged and addressed. The fiscal pressure coming primarily from private purchasers in the 1990s would seem to have been an important factor in the "right-sizing" mentioned earlier, with the concomitant increase in emergency room crowding and diversion and possibly reduced capacity to handle catastrophes. Understanding these consequences allows an informed decision as to whether the trade-off of more resources for alternative uses by spending less on health care is acceptable.

Targeting payments more precisely. It is essential that restraining the growth of Medicare payments be accompanied by careful attention to how those payments are targeted. Payments need to be calibrated as precisely as possible to reflect the necessary costs of appropriate care to minimize the potential for negative consequences.

The PPS is designed to avoid interference with access or treatment decisions by varying payment for patients based on their reason for admission and to encourage efficiency by making payments independent of an individual hospital’s costs. Hospitals keeping costs below payment levels earn profits, and those with costs in excess of payments must bear the losses. So that profits and losses reward efficiency and penalize inefficiency, payments are varied to reflect factors likely to influence costs that are beyond a hospital’s control. Thus, there are adjustments for patient case-mix, local labor-market wage levels, volume, teaching status, and the extent of care to the poor.¹⁷ A recent MedPAC analysis of the diagnosis-related group (DRG) adjustments for case-mix underscores the need to improve the PPS adjustments.¹⁸

Greater neutrality in patient selection and treatment. To avoid creating incentives that might affect either patient selection or treatment, PPS payments are adjusted for the expected costliness of a patient’s stay. These adjustments involve the assignment of a hospital stay to a DRG based on the principal diagnosis triggering an admission and, in some instances, the type of treatment and patient characteristics. From the outset, it was recognized that the DRG classification system did not explain all of the variation in costliness of individual stays. In fact, DRGs explained only about 30 percent of this variation. The DRG adjustments were initially deemed adequate, in that hospitals were expected to admit patients with above- and below-average costs both within a DRG and across DRGs. The net result would be that overall payments to hospitals would be appropriate.

Payment equity versus adequacy. When the PPS was first implemented, the shortcomings of the DRG adjustments might have resulted more in questions of payment equity for various hospitals rather than of adequacy. Hospitals with sicker-than-expected patients, as measured by their DRGs, would likely still receive sufficient payments to serve their patients. Payments, after all, were based on the prior cost experience under inflationary retrospective cost reimbursement. Nevertheless, the need to refine the DRG adjustments has long been recognized. In 1995 the Prospective Payment Assessment Commission (ProPAC, a predecessor of MedPAC) recommended (1) that DRGs be modified to make more distinctions among patient stays by taking account of specific secondary diagnoses that usually affect the cost of care and (2) that payments better account for differences in hospitals’ charging practices.¹⁹

The analysis conducted by MedPAC in 2005 as part of its study of specialty hospitals reached similar conclusions. It indicated a wide range in the potential profitability of stays both within and across DRGs. The variation in profitability across DRGs tended to favor those involving surgical rather than medical treatments for similar types of conditions—that is, cardiac or orthopedic care. The variation within a DRG, most importantly, was not random but was systematically related to readily identifiable information: namely, patients’ secondary diagnoses. This analysis resulted in MedPAC recommendations to improve the fit between hospitals’ actual and predicted case-mix costs by refining the current DRGs to more fully capture differences in patients’ severity of illness.²⁰

Barriers to DRG refinement. The current discussion of specialty hospitals’ role and potential impact on community hospitals might provide a new impetus for refinement of DRGs. The importance of "leveling the playing field" might be more apparent to stakeholders, and the willingness to take on the technical difficulties and live with the distributional consequences might be greater. However, the technical issues are not trivial.²¹ Refinement introduces more complexity into the DRG classification, creating the need for more information about stays and creating the risk that inaccurate information could result in inappropriate payments.

Distributional consequences of modifying the DRGs have also been an issue to consider. The ProPAC analysis revealed that refining the DRGs would generally increase payments to larger and teaching hospitals and reduce payments to smaller and rural hospitals. As the latter hospitals tended to fare less well under the PPS already, the idea of further curtailing their revenues through refined DRGs had limited appeal.

Two changes since ProPAC’s original recommendation might make the distributional consequences more palatable today. First, a volume adjustor has been added to the PPS. One of the reasons that small hospitals were more likely than others to fare poorly under the PPS was that they had higher per unit costs because their lower volumes reduced their ability to spread their fixed costs. The second new reality is that most small hospitals are no longer paid under the PPS. Approximately 1,100 of these hospitals have become "critical-access hospitals." This category, created by the Balanced Budget Act (BBA) of 1997, receives cost-based reimbursement instead of PPS rates.

The CMS has indicated an intention to explore the types of adjustments that MedPAC has recommended.²² What changes the agency ultimately chooses to propose and adopt and how far it goes to make PPS payments neutral regarding patient selection is not known at the moment. It will be a function in part of what burden it places on hospitals in requiring more information and what burden the agency places on itself in terms of assuring that the supplied information is accurate and is used to appropriately pay claims and recalculate future weights.

It is important to recognize that more fundamental refinement of DRGs likely needs to be an ongoing process. Beyond adding a few new DRGs and annually recalibrating the weights, the cost variation within and across DRGs needs to be systematically reviewed to assess the effects of new treatment modalities as well as to identify additional factors that explain cost variation to improve classification of stays.

Assuring that rewards are for efficiency, not just lower costs. Besides the adjustment for case-mix, the PPS includes other adjustments to reflect cost influences outside of hospital administrators’ control. The principal adjustment of this type takes account of the variation in local wage levels, while others acknowledge the higher costs that teaching commitment, care to the poor, or small size might add.

Even with these adjustments, there has been persistent wide variation in hospitals’ Medicare margins. In 2003 the gap between the margins for all Medicare services of the twenty-fifth- and seventy-fifth-percentile hospitals was twenty-four percentage points, ranging from –11.5 percent to 12.5 percent. This variation raises the question of whether refining current adjustments or taking account of additional factors would be appropriate. The Medicare Prescription Drug, Improvement, and Modernization Act (MMA) of 2003 requested that the GAO examine the PPS to determine if such structural changes might be appropriate.²³

Prior reviews have raised questions about the need for refined or additional payment adjustments. In 2003 MedPAC found that the DRG and wage-index adjustments in the current PPS appeared to disproportionately benefit hospitals with more complex cases, as measured by the DRGs, or located in areas with high average wages.²⁴ Earlier reviews by ProPAC (1993) and the GAO (2002) also identified problems with the precision of the wage adjustment attributable to the defined labor markets’ involvement of large heterogeneous areas.²⁵ Each agency recommended changes that have not been adopted.

Greater attention to fiscal restraint needs to be accompanied by greater attention to the adequacy of the existing adjustments and the need for additional adjustments. More importantly, there needs to be an increased willingness to take action when information about needed changes is developed. A variety of objections to change often get raised. One factor that should not be a barrier is a lack of information to assess the need for and to design changes. Considering the billions of dollars involved in paying for services, the incremental investment in data collection and analysis to improve how those dollars are spent is extremely small.

Concluding Remarks

Top Medicare Payment-A Bit Of... Hospitals’ Place In The... Medicare Payments In An... Concluding Remarks NOTES

 
When portrayed against the projected growth in Medicare spending, the modest proposals discussed here for payment policy changes are woefully inadequate. Yet the difficulty and importance of taking even such modest steps should not be underestimated. Given history, one might question whether even modest efforts to contain spending of the type considered here will occur and be sustained. That health care costs are growing faster than the economy, consuming larger shares of individuals’ incomes and creating greater burdens for the public sector, is hardly news. Neither is it novel to suggest that these trends will only get worse in the future and there will or should be a response that attempts to contain those costs. Prior attempts to restrain costs have occurred—witness managed care or the BBA in the 1990s—but these have been short-lived.

There is the view that health care costs could reach some threshold where the public might tolerate serious and sustained efforts that limit spending. But what might that threshold be? The Technical Review Panel on the Medicare Trustees Reports in 2000 found that the projection of health care consuming 38 percent of GDP in 2075 was not implausible.²⁶ The panel noted that total GDP would have grown so much that the remaining 62 percent would still allow increased real spending on other goods and services.

It would be a dramatic step for Medicare to become a more aggressive purchaser today. The movement from cost reimbursement to prospective payment starting in 1983 was easier because cost reimbursement’s inherent incentive to raise costs was widely recognized. With the perception that the incentives of the PPS strongly encourage efficiency, the idea that encouraging reductions in the costs of the average provider might be necessary and appropriate will face strong resistance. Fear of the trade-off between such cost containment and access to and quality of care will be an extremely powerful deterrent. Understanding what the trade-off truly would involve, not what it is purported to be, is essential. A tradeoff is occurring now between health care and other goods. Being well informed about both trade-offs is key to rational choices regarding the future.

Editor's Notes

 
Bill Scanlon (wscanlon{at}hprd.net) is senior policy adviser at Health Policy R&D and a consultant to the National Health Policy Forum, both in Washington, D.C.

This paper was prepared for "Future Hospital Care: How Will We Pay the Bill?," a hospital payment symposium convened by the Federation of American Hospitals in Washington, D.C., 15 July 2005. The author acknowledges the helpful comments of Laura Dummit, A. Bruce Steinwald, and several anonymous reviewers on an earlier version of this paper.

NOTES

Top Medicare Payment-A Bit Of... Hospitals’ Place In The... Medicare Payments In An... Concluding Remarks NOTES

 

1. 2005 Annual Report of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds (Washington: U.S. Department of Health and Human Services, March 2005).
2. U.E. Reinhardt, P.S. Hussey, and G.F. Anderson, "U.S. Health Care Spending in an International Context," Health Affairs 23, no. 3 (2004): 10–25.[Abstract/Free Full Text]
3. Some might perceive traditional Medicare payment policies as quite dynamic, given all of the prospective payment systems (PPSs) for different services and the physician fee schedules that have been introduced during the past two decades. The alternative view is that the nonviability of the older payment methods was recognized in 1982 when the hospital PPS was adopted, and it took almost twenty years to change payment methods for other services.
4. Calculations using data from Health Care Financing Review, Medicare and Medicaid Statistical Supplement, 2003, Table 23, http://www.cms.hhs.gov/review/supp/2003 (accessed 21 October 2005).
5. The shifting of services from the inpatient setting to hospital outpatient or other ambulatory settings plus the increased use of postacute services contributed greatly to this change.
6. U.S. Government Accountability Office, Hospital Preparedness: Most Urban Hospitals Have Emergency Plans, but Lack Certain Capacities for Bioterrorism Response, Pub. no. GAO-03-924 (Washington: GAO, 6 August 2003).
7. Ibid.
8. In most cases, the financing comes from the payment for a service exceeding its marginal cost. There are explicit add-ons to Medicare service payments for uncompensated care and medical education.
9. An alternative model would provide separate funding for social goods as specifically targeted appropriations. Past discussions of this approach have not advanced greatly. Concerns about the future availability of appropriated funds and satisfaction with the funding embedded in service payments likely helped maintain the status quo.
10. Medicare Payment Advisory Commission, Report to the Congress: Medicare Payment Policy (Washington: Med-PAC, March 2005), 44.
11. Ibid., 51.
12. Ibid., 55.
13. L.M. Nichols et al., "Are Market Forces Strong Enough to Deliver Efficient Health Care Systems? Confidence Is Waning," Health Affairs 23, no. 2 (2004): 8–21.[Abstract/Free Full Text]
14. MedPAC, A Data Book: Healthcare Spending and the Medicare Program (Washington: MedPAC, June 2005), 102.
15. P.F. Drucker, The Essential Drucker (New York: Harper Collins, 2001), 102.
16. Institute for Healthcare Improvement, "Going Lean in Health Care," White Paper, 2005, http://www.ihi.org/IHI/Products/WhitePapers/GoingLeaninHealthCare.htm (accessed 22 October 2005).
17. The teaching and disproportionate-share hospital (DSH) adjustments involve two components. The first reflects the impact on the cost of the hospital’s services from its engagement in these activities (for example, in the teaching adjustment case, the additional indirect costs associated with residents and interns providing care). The second is an add-on payment to directly subsidize teaching or care to the poor because of the social benefits these activities provide.
18. MedPAC, Report to the Congress: Physician-Owned Specialty Hospitals (Washington: MedPAC, March 2005).
19. Payments were not aligned with the expected costs of patients’ stays, for two reasons. First, individual DRG groupings included patients with too much variation in their needs for care. Second, the weights used to vary payments did not reflect relative differences in costs of stays across DRGs. The weights were based on the estimated charges for stays within each DRG. Although the original DRG weights had been computed using estimated costs per stay, they had been updated annually using charges as a readily available proxy for costs. Hospitals’ charging practices resulted in a divergence over time between charges and costs, which makes charges a problematic choice for a cost proxy. Prospective Payment Assessment Commission, Report and Recommendations to the Congress (Washington: ProPAC, 1995).
20. MedPAC, Report to the Congress: Physician-Owned Specialty Hospitals.
21. Julian Pettingill, in testimony before MedPAC, indicated the CMS’s concerns about DRG refinement, including a large increase in the number of diagnostic categories, the potential for small numbers of cases in selected categories, the risk of unstable weights for categories with limited numbers of cases, the potential for upcoding, the timeliness of cost data to compute category weights, and incentives that might reward avoidable complications. MedPAC transcript, 9 December 2004.
22. Federal Register 70, no. 85 (4 May 2005): 23454–23456.
23. The GAO’s report was expected in December 2005.
24. MedPAC, Report to the Congress: Variation and Innovation in Medicare (Washington: MedPAC, June 2003).
25. ProPAC, Report and Recommendations to the Congress (Washington: ProPAC, March 1993); and GAO, Medicare Hospital Payments: Refinements Needed to Better Account for Geographic Differences in Wages, Pub. no. GAO-02-963 (Washington: GAO, September 2002).
26. Technical Review Panel on the Medicare Trustees Reports, Review of Assumptions and Methods of the Medicare Trustees’ Financial Projections, December 2000, http://www.cms.hhs.gov/publications/technicalpanelreport/toc.asp (accessed 7 November 2005).

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