Medicare prospective payment without separate urban and rural rates

Health Care Financing Review, Winter, 1992 by Sheila M. O'Dougherty, Philip G. Cotterill, Steven Phillips, Elizabeth Richter, Nancy De Lew, Barbara Wynn, Thomas Ault

By their nature, the DRG refinement and outlier payment changes shift payments to hospitals with higher proportions of relatively expensive cases. The wage-index change (dividing each State rural area into counties with populations greater than 25,000 and those with less than 25,000) has a similar effect. Together, these changes would be expected to move the payment-to-cost ratios in the desired directions, because rural hospitals tend to have less costly cases than hospitals in large urban areas. Indeed, the combination of case-level refinements did achieve parity among the payment-to-cost ratios of the broad urban and rural hospital categories.

However, some striking disparities are also evident. For example, the payment-to-cost ratio of the major teaching hospitals increased markedly, and it was already the highest among the groups examined under the simple single-rate system. To address this problem, the payment adjustments for indirect medical education (IME) and DSH costs were re-evaluated. Regression analysis was used to estimate the relationship between Medicare cost per case and the IME and DSH variables. The basis for the IME and DSH adjustments was solely their relationship to hospital costs. This approach, which embodies the policy judgment that Medicare should only pay for hospital costs related to the delivery of care to Medicare beneficiaries, differs from ProPAC's current position. ProPAC's approach involves estimating the IME adjustment without controlling for DSH effects and then determining the DSH adjustment as a policy decision independent of Medicare cost. The DSH payment is viewed as a Medicare subsidy to assist hospitals in ensuring access to quality care for low-income Medicare beneficiaries (Prospective Payment Assessment Commission, 1992).

In our analysis, the resident-to-average-daily-census ratio replaces the resident-to-bed ratio as the IME measure of teaching intensity. An analysis of these alternative measures of teaching activity and reasons for the choice of the resident-to-average-daily-census ratio appear in a separate article in this issue of the Review (Phillips, 1992).

Our analysis found a significant DSH effect only for urban hospitals of 100 beds or more, and this effect existed for hospitals in both large-urban and other-urban areas. Furthermore, there were independent effects of DSH and urban location, which suggests that greater payment equity could be achieved by adjusting for both factors separately. Cost regression estimates were used jointly with simulations to evaluate alternative add-on payments for hospitals in large-urban areas.

Our estimated IME and DSH adjustments improved the parity of the payment-to-cost ratios of teaching and DSH hospitals relative to other hospital groups. However, urban hospitals not receiving the IME and/or DSH adjustments still had lower payment-to-cost ratios than hospitals receiving those adjustments. It proved difficult to maintain parity among the broad urban and rural hospital groups while simultaneously balancing the ratios of subgroups within urban and rural areas. The best approach to emerge from our analyses was to combine re-estimated IME and DSH adjustments with a small add-on of about 3 percent for all hospitals in large urban areas.