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Payments for outliers under medicare's prospective payment system
Journal of Health Economics 7 (1988) 291-296. North-Holland
EDITORIAL Payments for Outliers under Medicare’s Prospective Payment System Bruce STEINWALD and Diane MURDOCK Prospective Payment Assessment Commission, Washington, DC 20024, USA
Final version received June 1988
Medicare’s Prospective Payment System (PPS) uses Diagnosis-Related Groups (DRGs), a patient classification system, to establish fixed prices for payment for services delivered to hospitalized Medicare beneficiaries. The payment amount for an individual case depends primarily on the DRG in which the patient is classified, and is unrelated to the resources actually used in the care of that case. Because hospitals can keep the difference between payments and their costs, they have an incentive (subject to both ethical and formal controls) to economize. In principle, collective hospital economizing permits the Medicare program to purchase hospital services for its beneliciaries with relatively modest periodic increases in DRG payments over time. This payment system is based on the resource homogeneity of cases grouped within the same DRG. Within DRGs, cases that require relatively long stays and many resources for treatment are counterbalanced by cases that stay a relatively short time and consume few resources compared to the average for the DRG. But many DRGs are not homogeneous by any standard, and both random and systematic elements in the distribution of cases may result in financial hardship for some hospitals. Outlier payment policy was instituted as part of PPS to ameliorate this problem. It also reduces the likelihood of discrimination against Medicare beneficiaries who can be identified in advance as resource-intensive patients compared to the average for their DRGs. The outlier payment system originally designed for PPS relies heavily on the relationship between length of stay for a case compared to the average stay for all cases in the same DRG. Charge data from patient bills are also used to identify cases thaQ are abnormally costly, after adjusting charges to estimate the costs of services delivered. Thresholds in the distributions of 0167-6296/88/o
1988, Elsevier Science Publishers B.V. (North-Holland)
B. Steinwald and D. Murdock, Editorial
292
Table 1 Simulated outlier payments as a percentage of total PPS payments, by hospital type. Hospital type
Total outiiers
cost outliers
Day-only outiiers
Dual outliers
All New England Middle Atlantic South Atlantic East North Central East South Central West North Central West South Central Mountain Pacific Urban Rural Major teaching Other teaching _ Non-teaching
5.7% 9.0 11.0 5.8 4.3 4.2 3.3 3.5 3.2 3.7 6.1 3.5 8.8 6.5 4.3
0.4% 0.1 0.2 0.7 0.3 0.6 0.4 0.6 0.8 0.7 0.5 0.5 0.2 0.3 0.6
2.6% 5.5 6.8 1.9 I.7 1.5 1.3 1.1 0.7 ::
2.6% 3.4 4.1 3.2 2.4 2.2 1.7 1.8 1.7 1.9 2.8 1.4 4.1 3.1 1.9
1.6 4.5 3.1 1.9
pSourc~ Estimates based on fiscal year 1986 Medpar patient billing data and fiscal year 1988 outlier payment rules, reported in Prospective Payment Assessment Commission ( 1988b).
stays and costs, and a f&mula for additional payment, were established so that outlier payments would amount to approximately five percent of total PPS payments. Cases that qualify both on the basis of length of stay (day outliers) and cost (cost outliers) are termed dual outliers and are paid using the day outlier methodology. The design of outlier payment policy resulted from a mixture of practicality and ideology. Days are an unambiguous measure of resource use and easily used as a criterion for defining outlier cases. In contrast, costs are not measured at the individual patient level, and must be derived from charge information. In addition, system designers were determined to break the link between costs and payments as much as possible, which accounts, in part, for the relative unimportance of cost estimates in determining outlier payments and for the relatively low percentage of total payments set aside for the outlier payment pool. Apart from these considerations, very little theory or information on expected outcomes was used to set specific features of the outlier payment system. As indicated in table 1, outlier payments are unevenly distributed across hospital types and geographic areas. Urban hospitals and teaching hospitals tend to have a higher proportion of outlier payments than rural hospitals and non-teaching hospitals. The relatively low proportion of outlier payments received by rural hospitals is matched by a lower contribution to the outlier set-aside than that required of urban hospitals. All other variations in
B. Steinwaldand D. Murdock, Editorial
293
Table 2 Summary statistics by outlier type, derived from simulations.’ All Percent of PPS cases Mean charge Mean cost Average total paymentb Average outlier payment Average loss Mean length of stay Mean special care days
3.6% $26620 $18250 $11130 $5480 -%7120 36 6
Cost
0.5% S34790 $19200 $9670 $3110 - $9550 20 10
Day-oW
2.2”/, $15910 $12858 $9250 $4160 - $3578 34 2
Dtlald
O-Y% Wz220 $30880 $16480 $9860 -%14400 49 12
‘Source: ProPAC estimates derived by applying fiscal year 1988 outlier payment rules to the fiscal year 1986 Medpar data, as reported in Prospective Payment Assessment Commission (1988b). bThe average payment for outlier cases, including the inlier portion of the payment. ‘The current law definition of length of stay outliers includes both day-only and dual outliers. dDual outliers are paid as day outliers.
the payment distribution, unless they are simply a reflection of proportions of rural hospitals, indicate some degree of subsidization of high-outlier hospitals by low-outlier hospitals. New England and Middle Atlantic hospitals have a higher percentage of outlier payments than hospitals in other regions. New York State is distinctively unique in the amount of outlier payments it receives. New York accounts for six percent of PPS discharges and receives approximately 25 percent of total outlier payments [Prospective Payment Assessment Commission (ProPAC) (1988c)]. This may be attributed to long average lengths of stay in New York hospitals combined with the current emphasis on length of stay as the principal criterion for identifying outlier cases. Table 1 also indicates that the distribution of outlier types also varies by hospital type and geography. All outliers, by design, lose money, but the amount of loss varies considerably by outlier type. Table 2 shows that average losses are greatest for dual outliers (cases that meet both length of stay and cost criteria) and smallest for day-only outliers. Day outlier cases, on average, consume considerably fewer hospital resources than cost outlier cases. The average loss for dual outlier cases is four times as great as the average loss for day-only crstliers. Analyses by Ellis and McGuire (1988) and by Keeler et al. (1988) in this Journal add to the growing body of knowledge [Guterman (1986), Pettengill et al. (198?), ProPAC (1988b,c)] that current outlier payment policy is suboptimal. In particular, both articles demonstrate that costs are a more appropriate criterion than days to evaluate risk. This consensus view led the Prospective Payment Assessment Commission (ProPAC) (198&a) to recommend changing outlier payments by moving away from a day-oriented policy
294
B. Steinwuld and D. Murdock,
Editorial
toward a policy based more heavily on costs and losses. In its recent Notice of Proposed Rulemaking to change PPS in fiscal 1989, the Health Care Financing Administration (HCFA) presented plans consistent with ProPAC’s recommendation [U.S. Department of Health and Human Services (1988)]. Both ProPAC and HCFA acknowledge that further improvements in outlier payment policy need to be investigated. Therefore, there is ample potential for scholarly work like the above articles, suitably digested and filtered for consumption by the policy making apparatus, to further influence policy in this area. Both Ellis and McGuire and Keeler et al. use insurance principles to examine existing outlier policy and develop proposed improvements. This approach has two advantages. First, it provides a body of theoretical and empirical literature from which to draw inferences about the likely outcomes of potential changes in payment policy based on insurance principles. Second, application of insurance concepts helps make complex issues more easily understood by policymakers. The terms ‘premium’, ‘deductible’, and ‘coinsurance’ are readily comprehended through personal experience. The insurance analogy therefore provides an assist to the advancement of rational payment policy that might otherwise be impeded by the need for policymakers to be educated about unfamiliar concepts. Both Ellis and McGuire and Keeler et al. demonstrate persuasively that a more rational outler policy would use loss, that is, payments minus costs, as the appropriate criterion variable for outlier payment. Both clearly relate loss to the insurance concepts used to examine current and potentially improved payment policy. Where they part company is that the former would define loss at the hospital level and the latter would continue with the present caselevel orientation. As long as PPS exists, it is very unlikely that outlier policy would ever be changed from a case-based system to a hospital experience-rated system. First, outlier policy has always been linked to the inadequacies of case-mix measurement. That is, a principal reason for having outliers at all is to make up for imperfections in the DRGs in measuring case-level severity. Second, a hospital-level adjustment would not address the problem of potential discrimination against resource-intensive patients. Although this problem has anever been documented to be serious, it would be inappropriate to do away entirely with this case-level safeguard. Reeler et al.‘s development of the stop-loss principle has definite potential for application in future improvements to ontlier payment policy. The current changes to outlier policy that will be implemented in fiscal 1989 are seen both by ProPAC and HCFA as interim measures, and the policy climate for further improvements is favorable. It is likely that such further improvements will make extensive use of the insurance analogy. Despite our view that the Keeler et al. approach is the more likely outlier
B. Steinwald and D. Murdock, Editorial
295
approach to be pursued, Ellis and McGuire have performed worthwhile research that contributes meaningfully to our understanding of the distributions of costs and payments under PPS. In particular, Ellis and McGuire’s research shows that outlier policy is an ineficient means of addressing the problem of systematic occurrence of relatively costly cases within DRGs. Consistent with this finding, research by ProPAC has led to a similar conclusion that interhospital payment equity is more readily achieved by hospital-level payment adjustments rather than by feasible improvements in DRG classifications and weights [Steinwald and Price (198811. Others in the past have argued that PPS payments should be based, in part, on individual hospital’s costs. Some components of inpatient care, notably capital and the direct costs of medical education, continue to be paid on the basis of actual costs. The system was phased in to pay, in decreasing proportion, on the basis of hospitals’ historical costs per case. The American Hospital Association once proposed that the system should pay indefinitely on the basis of DRG prices that were a blend of national and hospitalspecific rates. More recently, Feder et al. (1987) have argued that payment equity requires an element of hospital-specific costs factored into the DRG payments. These proposals are conceptual allies to Ellis and McGuire and respond in large part to the same perceived problems with the current structure of PPS. They differ in that only Ellis and McGuire have proposed to introduce the hospital-specific component through outlier payments. Nevertheless, there is precedent in PPS for improving payment equity through hospital-level adjustments. The indirect teaching adjustment was originally instituted in large part to correct for the inability of DRGs to measure costs associated with severity variations within DRGs. After PPS was implemented, the disproportionate share adjustment was added to pay for unmeasured costs associated with service to the poor. As reasons for cost variations are identified through further research, these adjustments may be modified or supplemented to better accommodate systematic variations in costs of treatment that are not measured by the DRGs. Such improvements might be identified and implemented in tandem with further refinements to case-based outlier payment policy. References Ellis, Randall P. and Thomas G. McGuire, 1988, Insurance principles and the design of prospective payment systems, Boston University, Jan. 14. Feder, Judith, Jack Hadley and Stephen Zuckerman, 1987, How did Medicare’s prospective payment system affect hospitals?, New England Journal of Medicine 317, Oct. 1, 126129. Guterman, Stuart, 1986, A descriptive analysis of the PPS outlier payment policy, presented at the Third Annual Meeting, Association for Health Services Research, June 24. Keeler, Emmett B., Grace M. Carter and Sally Trude, 1988, Insurance aspects of DRG outlier payments (The RAND Corporation, Santa Monica, CA) May.
296
B. Steinwald and D. Murdock, Editorial
Pettengill, Julian, Michael G’Grady and Richard Rimkunas, 1987, Medicare’s prospective payment system: An analysis of the financial risk of outlier cases, Report to Congress, The Congressional Research Service, Library of Congress, Nov. 5. Prospective Payment Assessment Commission, 1988a, Report and recommendations to the Secretary, U.S. Department of Health and Human Services, Washington, DC, The Commission, March 1. Prospective Payment Assessment Commission, 1988b, Technical appendixes to the report and recommendations to the Secretary, U.S. Department of Health and Human Services, Washington, DC, The Commission, March 1. Prospective Payment Assessment Commission, 1988c, Medicare prospective payment and the American health care system: Report to the Congress, Washington, DC, The Commission, June. Steinwald, Bruce and Kurt F. Price, 1988, DRGs and health care cost containment in the U.S., prepared for a symposium, Controlling costs while maintaining health: The experience of Canada, the United States of America, and the Federal Republic of Germany with alternative cost containment strategies, Bonn, June 27-28. U.S. Department of Health and Human Services, 1988, Federal Register 53, May 27, 1951349517.
EDITORIAL Payments for Outliers under Medicare’s Prospective Payment System Bruce STEINWALD and Diane MURDOCK Prospective Payment Assessment Commission, Washington, DC 20024, USA
Final version received June 1988
Medicare’s Prospective Payment System (PPS) uses Diagnosis-Related Groups (DRGs), a patient classification system, to establish fixed prices for payment for services delivered to hospitalized Medicare beneficiaries. The payment amount for an individual case depends primarily on the DRG in which the patient is classified, and is unrelated to the resources actually used in the care of that case. Because hospitals can keep the difference between payments and their costs, they have an incentive (subject to both ethical and formal controls) to economize. In principle, collective hospital economizing permits the Medicare program to purchase hospital services for its beneliciaries with relatively modest periodic increases in DRG payments over time. This payment system is based on the resource homogeneity of cases grouped within the same DRG. Within DRGs, cases that require relatively long stays and many resources for treatment are counterbalanced by cases that stay a relatively short time and consume few resources compared to the average for the DRG. But many DRGs are not homogeneous by any standard, and both random and systematic elements in the distribution of cases may result in financial hardship for some hospitals. Outlier payment policy was instituted as part of PPS to ameliorate this problem. It also reduces the likelihood of discrimination against Medicare beneficiaries who can be identified in advance as resource-intensive patients compared to the average for their DRGs. The outlier payment system originally designed for PPS relies heavily on the relationship between length of stay for a case compared to the average stay for all cases in the same DRG. Charge data from patient bills are also used to identify cases thaQ are abnormally costly, after adjusting charges to estimate the costs of services delivered. Thresholds in the distributions of 0167-6296/88/o
1988, Elsevier Science Publishers B.V. (North-Holland)
B. Steinwald and D. Murdock, Editorial
292
Table 1 Simulated outlier payments as a percentage of total PPS payments, by hospital type. Hospital type
Total outiiers
cost outliers
Day-only outiiers
Dual outliers
All New England Middle Atlantic South Atlantic East North Central East South Central West North Central West South Central Mountain Pacific Urban Rural Major teaching Other teaching _ Non-teaching
5.7% 9.0 11.0 5.8 4.3 4.2 3.3 3.5 3.2 3.7 6.1 3.5 8.8 6.5 4.3
0.4% 0.1 0.2 0.7 0.3 0.6 0.4 0.6 0.8 0.7 0.5 0.5 0.2 0.3 0.6
2.6% 5.5 6.8 1.9 I.7 1.5 1.3 1.1 0.7 ::
2.6% 3.4 4.1 3.2 2.4 2.2 1.7 1.8 1.7 1.9 2.8 1.4 4.1 3.1 1.9
1.6 4.5 3.1 1.9
pSourc~ Estimates based on fiscal year 1986 Medpar patient billing data and fiscal year 1988 outlier payment rules, reported in Prospective Payment Assessment Commission ( 1988b).
stays and costs, and a f&mula for additional payment, were established so that outlier payments would amount to approximately five percent of total PPS payments. Cases that qualify both on the basis of length of stay (day outliers) and cost (cost outliers) are termed dual outliers and are paid using the day outlier methodology. The design of outlier payment policy resulted from a mixture of practicality and ideology. Days are an unambiguous measure of resource use and easily used as a criterion for defining outlier cases. In contrast, costs are not measured at the individual patient level, and must be derived from charge information. In addition, system designers were determined to break the link between costs and payments as much as possible, which accounts, in part, for the relative unimportance of cost estimates in determining outlier payments and for the relatively low percentage of total payments set aside for the outlier payment pool. Apart from these considerations, very little theory or information on expected outcomes was used to set specific features of the outlier payment system. As indicated in table 1, outlier payments are unevenly distributed across hospital types and geographic areas. Urban hospitals and teaching hospitals tend to have a higher proportion of outlier payments than rural hospitals and non-teaching hospitals. The relatively low proportion of outlier payments received by rural hospitals is matched by a lower contribution to the outlier set-aside than that required of urban hospitals. All other variations in
B. Steinwaldand D. Murdock, Editorial
293
Table 2 Summary statistics by outlier type, derived from simulations.’ All Percent of PPS cases Mean charge Mean cost Average total paymentb Average outlier payment Average loss Mean length of stay Mean special care days
3.6% $26620 $18250 $11130 $5480 -%7120 36 6
Cost
0.5% S34790 $19200 $9670 $3110 - $9550 20 10
Day-oW
2.2”/, $15910 $12858 $9250 $4160 - $3578 34 2
Dtlald
O-Y% Wz220 $30880 $16480 $9860 -%14400 49 12
‘Source: ProPAC estimates derived by applying fiscal year 1988 outlier payment rules to the fiscal year 1986 Medpar data, as reported in Prospective Payment Assessment Commission (1988b). bThe average payment for outlier cases, including the inlier portion of the payment. ‘The current law definition of length of stay outliers includes both day-only and dual outliers. dDual outliers are paid as day outliers.
the payment distribution, unless they are simply a reflection of proportions of rural hospitals, indicate some degree of subsidization of high-outlier hospitals by low-outlier hospitals. New England and Middle Atlantic hospitals have a higher percentage of outlier payments than hospitals in other regions. New York State is distinctively unique in the amount of outlier payments it receives. New York accounts for six percent of PPS discharges and receives approximately 25 percent of total outlier payments [Prospective Payment Assessment Commission (ProPAC) (1988c)]. This may be attributed to long average lengths of stay in New York hospitals combined with the current emphasis on length of stay as the principal criterion for identifying outlier cases. Table 1 also indicates that the distribution of outlier types also varies by hospital type and geography. All outliers, by design, lose money, but the amount of loss varies considerably by outlier type. Table 2 shows that average losses are greatest for dual outliers (cases that meet both length of stay and cost criteria) and smallest for day-only outliers. Day outlier cases, on average, consume considerably fewer hospital resources than cost outlier cases. The average loss for dual outlier cases is four times as great as the average loss for day-only crstliers. Analyses by Ellis and McGuire (1988) and by Keeler et al. (1988) in this Journal add to the growing body of knowledge [Guterman (1986), Pettengill et al. (198?), ProPAC (1988b,c)] that current outlier payment policy is suboptimal. In particular, both articles demonstrate that costs are a more appropriate criterion than days to evaluate risk. This consensus view led the Prospective Payment Assessment Commission (ProPAC) (198&a) to recommend changing outlier payments by moving away from a day-oriented policy
294
B. Steinwuld and D. Murdock,
Editorial
toward a policy based more heavily on costs and losses. In its recent Notice of Proposed Rulemaking to change PPS in fiscal 1989, the Health Care Financing Administration (HCFA) presented plans consistent with ProPAC’s recommendation [U.S. Department of Health and Human Services (1988)]. Both ProPAC and HCFA acknowledge that further improvements in outlier payment policy need to be investigated. Therefore, there is ample potential for scholarly work like the above articles, suitably digested and filtered for consumption by the policy making apparatus, to further influence policy in this area. Both Ellis and McGuire and Keeler et al. use insurance principles to examine existing outlier policy and develop proposed improvements. This approach has two advantages. First, it provides a body of theoretical and empirical literature from which to draw inferences about the likely outcomes of potential changes in payment policy based on insurance principles. Second, application of insurance concepts helps make complex issues more easily understood by policymakers. The terms ‘premium’, ‘deductible’, and ‘coinsurance’ are readily comprehended through personal experience. The insurance analogy therefore provides an assist to the advancement of rational payment policy that might otherwise be impeded by the need for policymakers to be educated about unfamiliar concepts. Both Ellis and McGuire and Keeler et al. demonstrate persuasively that a more rational outler policy would use loss, that is, payments minus costs, as the appropriate criterion variable for outlier payment. Both clearly relate loss to the insurance concepts used to examine current and potentially improved payment policy. Where they part company is that the former would define loss at the hospital level and the latter would continue with the present caselevel orientation. As long as PPS exists, it is very unlikely that outlier policy would ever be changed from a case-based system to a hospital experience-rated system. First, outlier policy has always been linked to the inadequacies of case-mix measurement. That is, a principal reason for having outliers at all is to make up for imperfections in the DRGs in measuring case-level severity. Second, a hospital-level adjustment would not address the problem of potential discrimination against resource-intensive patients. Although this problem has anever been documented to be serious, it would be inappropriate to do away entirely with this case-level safeguard. Reeler et al.‘s development of the stop-loss principle has definite potential for application in future improvements to ontlier payment policy. The current changes to outlier policy that will be implemented in fiscal 1989 are seen both by ProPAC and HCFA as interim measures, and the policy climate for further improvements is favorable. It is likely that such further improvements will make extensive use of the insurance analogy. Despite our view that the Keeler et al. approach is the more likely outlier
B. Steinwald and D. Murdock, Editorial
295
approach to be pursued, Ellis and McGuire have performed worthwhile research that contributes meaningfully to our understanding of the distributions of costs and payments under PPS. In particular, Ellis and McGuire’s research shows that outlier policy is an ineficient means of addressing the problem of systematic occurrence of relatively costly cases within DRGs. Consistent with this finding, research by ProPAC has led to a similar conclusion that interhospital payment equity is more readily achieved by hospital-level payment adjustments rather than by feasible improvements in DRG classifications and weights [Steinwald and Price (198811. Others in the past have argued that PPS payments should be based, in part, on individual hospital’s costs. Some components of inpatient care, notably capital and the direct costs of medical education, continue to be paid on the basis of actual costs. The system was phased in to pay, in decreasing proportion, on the basis of hospitals’ historical costs per case. The American Hospital Association once proposed that the system should pay indefinitely on the basis of DRG prices that were a blend of national and hospitalspecific rates. More recently, Feder et al. (1987) have argued that payment equity requires an element of hospital-specific costs factored into the DRG payments. These proposals are conceptual allies to Ellis and McGuire and respond in large part to the same perceived problems with the current structure of PPS. They differ in that only Ellis and McGuire have proposed to introduce the hospital-specific component through outlier payments. Nevertheless, there is precedent in PPS for improving payment equity through hospital-level adjustments. The indirect teaching adjustment was originally instituted in large part to correct for the inability of DRGs to measure costs associated with severity variations within DRGs. After PPS was implemented, the disproportionate share adjustment was added to pay for unmeasured costs associated with service to the poor. As reasons for cost variations are identified through further research, these adjustments may be modified or supplemented to better accommodate systematic variations in costs of treatment that are not measured by the DRGs. Such improvements might be identified and implemented in tandem with further refinements to case-based outlier payment policy. References Ellis, Randall P. and Thomas G. McGuire, 1988, Insurance principles and the design of prospective payment systems, Boston University, Jan. 14. Feder, Judith, Jack Hadley and Stephen Zuckerman, 1987, How did Medicare’s prospective payment system affect hospitals?, New England Journal of Medicine 317, Oct. 1, 126129. Guterman, Stuart, 1986, A descriptive analysis of the PPS outlier payment policy, presented at the Third Annual Meeting, Association for Health Services Research, June 24. Keeler, Emmett B., Grace M. Carter and Sally Trude, 1988, Insurance aspects of DRG outlier payments (The RAND Corporation, Santa Monica, CA) May.
296
B. Steinwald and D. Murdock, Editorial
Pettengill, Julian, Michael G’Grady and Richard Rimkunas, 1987, Medicare’s prospective payment system: An analysis of the financial risk of outlier cases, Report to Congress, The Congressional Research Service, Library of Congress, Nov. 5. Prospective Payment Assessment Commission, 1988a, Report and recommendations to the Secretary, U.S. Department of Health and Human Services, Washington, DC, The Commission, March 1. Prospective Payment Assessment Commission, 1988b, Technical appendixes to the report and recommendations to the Secretary, U.S. Department of Health and Human Services, Washington, DC, The Commission, March 1. Prospective Payment Assessment Commission, 1988c, Medicare prospective payment and the American health care system: Report to the Congress, Washington, DC, The Commission, June. Steinwald, Bruce and Kurt F. Price, 1988, DRGs and health care cost containment in the U.S., prepared for a symposium, Controlling costs while maintaining health: The experience of Canada, the United States of America, and the Federal Republic of Germany with alternative cost containment strategies, Bonn, June 27-28. U.S. Department of Health and Human Services, 1988, Federal Register 53, May 27, 1951349517.