Medicare's prospective payment system: a critical appraisal - Cost-Containment Issues, Methods, and Experiences

Health Care Financing Review, Annual, 1991 by Robert F. Coulam, Gary L. Gaumer

Introduction

The implementation of the prospective payment system (PPS) has produced major changes in the hospital industry and in the way hospital services are used by physicians and their patients. Hundreds or researchers and policy analyst have written about the consequences of PPS and commented on the principles of health care policy that PPS embodies. Our purpose here is to review this large body of work as it contributes to our understanding of: * The effectiveness of programs of administered pricing

in controlling spending and maintenance equity across

the hospital industry. * The relative importance of payment stringency,

payment incentives, and the regulation of admissions in

the pattern of effects seen to date. * The extent to which payment controls have resulted in

improved operational efficiency - or if not, whether

hospital finances or patient care have been

compromised.

As a policy for hospital cost containment, PPS represents a bundle of ratesetting principles that are fairly well understood but are certainly not universally admired. The components include administered prices rather than market forces, national base rates rather than hospital specific rate (i.e., a policy of equalizing rates rather than equalizing pressure), and a per case payment unit rather than payment per day, per service, or per procedure.

When PPS was implemented, there were strongly held expectations among promoters and skeptics. Promoters of the policy hoped that payment reduction would be matched by lower levels of spending through reduced lengths of stay (LOS), reduced intensity of care, and more efficient hospital operations. Promoters presumed this could occur without financial collapse or compromises in patient care, as large volumes of "slack" were used up (unproductive resources reallocated, unnecessary ancillaries and days eliminated, and so on). So long as hospitals had been reimbursed their costs, they faced few incentives to provide efficient care. PPS gave hospitals new incentives to operate economically.

But there were also skeptics. If hospitals faced new incentives for efficiency, there were serious questions as to whether they faced just the right incentives. An additional test or day of hospital care became costly under PPS, whether medically justified or not, and the narrow financial incentive was the same in either case to eliminate the added cost. Although hospitals would not necessarily strike the wrong balance between patient well-being and their income statements, there was nothing intrinsic to the PPS structure to guarantee that the right balance would be struck.(1) While PPS assumed that hospitals and physicians practiced inefficiently, it also assumed that hospitals and physicians would successfully mediate between conflicting pressures to enhance patient well-being and to contain costs. However, there necessarily were fears that the changes in practice patterns induced by PPS would be harmful - that changes in practice patterns would harm patients or, to the extent that hospitals resisted purely financial incentives and maintained quality care, that hospitals would suffer financially. Without pre-existing slack, PPS might well force a choice between survival of the institution and quality of patient care. Indeed, this choice is at the core of any system of incentive payment for hospitals: the "carrot" of being able to keep surpluses and the "stick" of failing to survive.

This issue of tradeoffs was of most concern to those worried about the phase-in to national rates. National rates would create a large number of losing hospitals - hospitals with high costs relative to the payment rates. If insufficient slack were available to these hospitals, they might either fail (which could reduce access) or cause quality of care to suffer.

The literature on PPS is as large and diffuse as we had anticipated in an earlier article (Gaumer, Glazier, and Cowen, 1987). Most of it is descriptive of trends, and most of it utilizes the same common national data sources (e.g., Medicare Cost Reports, American Hospital Association [AHA] annual survey data, Commission on Professional and Hospital Activities [CPHA] discharge abstracts, and Medicare Provider Analysis and Review Files [MEDPAR]. Only small portions of the literature use research approaches other than pre/post designs or test hypotheses about particular population groups or hospital types. For practical reasons, we will limit ourselves in this review to a discussion of the published literature, with occasional reference to unpublished material with which we are familiar.

The literature is more impressive for its size than for its value in understanding how PPS works and the patterns of its effects. There are a number of reasons that must be kept in mind as to why our understanding of PPS and its effectiveness as a cost-containment device is limited. These caveats are common in the literature we review but need to be restated. The most important qualification of the literature stems from the fact that PPS was implemented as a national program rather than as an experiment or a demonstration. Unlike the prior research on prospective payment, which dealt with the impact of State hospital ratesetting programs, PPS implementation offered analytical leverage only through pre/post-implementation comparisons, and comparisons with four waivered States (Maryland, Massachusetts, New Jersey, and New York). The pre/post comparisons that pervade the literature we review offer substantial threats of temporal confounding to factors that include, among others: the widespread adoption of surgical and other invasive technologies that end to favor outpatient care; the widespread implementation of managed-care programs in the private sector; and the liberalization of home care, nursing home, and hospice benefits for Medicare in the early 1980s. The number of years available for study has also been limited, largely because of delays in the availability of the most popular forms of administrative records. As we begin the ninth year of PPS, the bulk of the published literature on PPS effects is based on no more than the first 3 or 4 years of PPS experience. This short history limits our ability to observe the consequences of behavioral change among administrators, beneficiaries, and physician. In particular, we would like to understand how persistent controls on payment affect patterns of spending, clinical practice, and management that we observed in State ratesetting programs (Coelen, Mennemeyer, and Kidder, 1986). But given the short period of time covered by most of the PPS literature, the one-time, initial effects of implementing PPS are more readily observable in this literature than are the consequences of persistent stringency in payment rates.