Excluded facility financial status and options for payment system modification - Hospital Payment: Beyond the Prospective Payment System

Health Care Financing Review, Winter, 1993 by John E. Schneider, Jerry Cromwell, Thomas P. McGuire

Three Alternatives for Target Amounts

We simulated three approaches to setting target amounts on rebased costs, always maintaining budget neutrality, in the sense that Medicare outlays in the rebased year are unchanged.

Proportional Targets

In this simulation, the target amount is a constant proportion of facility average cost in the (rebased) base year. To assure budget neutrality with respect to HCFA outlays, target amounts are less than average cost in the rebased year because facility cost inflation exceeded target updates. The constant proportional (P) reduction used to set target amounts must be iteratively determined depending on the cost-sharing rule chosen. Proportional targets are evenhanded in the sense that all average costs are regarded as equally legitimate and then reduced proportionally.

Blended Targets

In this simulation, the target amount is a blend of rebased facility and national average costs. As with proportional targets, blended target amounts must be discounted to assure budget neutrality. A weighted average (50/50; 75/25) of each facility's rebased costs and the national average was constructed. Own-facility costs, in turn, were based on a 2-year average (1987-88) to minimize random year-to-year changes in base period costs. National average costs were also adjusted for each facility's area labor costs, using HCFA's 1988 hospital wage index file. The proportion of labor-related costs (.807) was based on the sum of wages, employee benefits, professional fees, business and computer services, etc., for TEFRA facilities (Federal Register, 1990). Blended targets allow a target amount well above rebased costs for low-cost facilities and below rebased costs for high-cost facilities.

Maximum Targets

In this simulation, the target amount is facility-rebased average cost subject to an upper limit. Each facility's target amount is set equal to its own average cost in the rebased year until it exceeds a uniform maximum target amount chosen iteratively to ensure budget neutrality. Establishing maximum targets is most beneficial for facilities in the middle range of costs, permitting recovery of full re-based costs until costs exceed a maximum.

Each approach to rescaling a facility's target after rebasing has its advantages and disadvantages. Proportional targets consider all costs as legitimate with each facility sharing equally percentage-wise in any redistributions. Blended targets reject the notion that low-cost facilities should share equally with high-cost facilities in any redistributions. By blending in a national rate with their own rate, then scaling targets to achieve payment neutrality, lower-cost facilities are less affected. One could argue that this is fairer in that they have better controlled their costs over time. Setting a maximum target on rebased costs is even more stringent on high-cost facilities. It assumes that all costs above the maximum are illegitimate. No one knows, of course, how much of a facility's costs are legitimate, or how efficient it is. These three approaches to setting targets, we believe, give policymakers options ranging from a very generous to a very strict interpretation of the legitimacy of high-cost outliers.