Using hospital-specific costs to improve the fairness of prospective reimbursement

Pope, G. (1990). Using hospital-specific costs to improve the fairness of prospective reimbursement. Journal of Health Economics, 9(3), 237-251. DOI: 10.1016/0167-6296(90)90045-5

Payment rates in Medicare's Prospective Payment System (PPS) are based on averages of historical hospital costs. Compared to reimbursing each hospital's own costs, pricing at the average of costs implies a massive redistribution of payments among hospitals. Because not all sources of hospital costs are accounted for in the PPS, some of this redistribution is ‘unfair’. Information in hospital-specific costs on unmeasured patient severity and input prices can be exploited to reduce payment inequities. However, fully hospital-specific rates are not optimal because costs also reflect treatment intensity and efficiency differences among hospitals.