Are PPS payments adequate? Issues for updating and assessing rates - prospective payment system

Health Care Financing Review,  Winter, 1992  by Steven H. Sheingold,  Elizabeth Richter

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Correction for market basket forecast

The FY 1991 estimated market basket percentage increase used to update the payment rates was 5.2 percent. DHHS' most recent data indicate the actual FY 1991 increase was 4.3 percent, reflecting that the increase in wages was lower than projected. The resulting error in the projected FY 1991 market basket rate of increase forecast was -0.9 percentage points. DHHS' policy has been to make a forecast error correction if their estimate is off by 0.25 percentage points or more; it would continue to make corrections for forecast errors under the proposed framework, and would therefore include a forecast error adjustment of - 0.9 percentage points in setting PPS rates for FY 1993.

Policy adjustment factors

Although the productivity recommendation of -0.8 to -1.0 in the proposed framework is comparable to the -1.0 factor used each year in the current framework, the intensity recommendation differs considerably from the current counterparts. Using the existing framework would lead to a recommendation in a range of -1.8 to 0 for practice patterns and 0.3 to 0.5 for science and technology. Thus, the total policy adjustment target (including productivity) is -2.5 to -0.5 under the existing framework compared with 0.0 to 0.3 in the proposed framework.

Assessing the adequacy of rates

Currently, one of the most usable and controversial measures associated with the PPS is financial margins. They have been used to judge the adequacy of PPS rates, although they have not been scrutinized carefully as to their appropriateness for that purpose. In this section, we present trends in margins, consider their validity for judging adequacy of the rates, and discuss alternative methods.

Table 3 shows the changes in Medicare and total margins, revenues, and costs from 1985 through 1990. PPS margins have declined during this time, from 13.7 percent in 1985 to -3.4 percent in 1990. Examination of the increases in costs and revenues per discharge shows that Medicare operating costs per case have increased 55.1 percent from FY 1986 through FY 1990, whereas Medicare payments have increased 29.1 percent during the same period, a little more than one-half as much as the increase in Medicare costs.

[TABULAR DATA OMITTED]

Total margins, on the other hand, decreased in the first years of PPS, but have leveled off in recent years. Total operating cost per case has increased 66.1 percent, while total operating revenues per case have increased 60.1 percent. Medicare costs have increased somewhat more slowly than total hospital costs, but the main difference in the movement of Medicare and total margins over time is due to the difference in Medicare and total revenue growth. These results amplify the concern over the adequacy of increases in Medicare payments: Are the declining margins caused by inadequate updates, or rather by hospitals' inability to control costs?

The trends in PPS margins and the associated controversy highlight the need to develop methods for systematically evaluating the PPS. Any system based on pre-set rates requires not only an update process, but also a periodic assessment of the rate structure and its impacts on providers and beneficiaries. One aspect of this process is assessing the rates relative to the goals and objectives engendered in the system. In the current climate, an important first step is addressing whether the current rates are too low or whether they are adequate to satisfy the system's policy goals. That is, has the update process appropriately recognized changes in the delivery of care, patient characteristics, technology, and other factors that have affected the cost of care?