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

For convenience, Table 1 summarizes the basic findings of the literature concerning the effects of PPS on hospital finances. The literature is in general agreement on a few central descriptive results. Specifically, there were: * Initial windfalls in the first year of PPS (PPS 1) as a

result of higher-than-planned PPS payments. * Modest annual increases in payments after PPS 1,

caused by small updates and increases in the case-mix

index (CMI). * Initial large cost reductions in PPS 1 because of

reductions in length of stay, followed by a return to

nearly double-digit inflation thereafter. * High initial profits on Medicare cases that declined

over time, as Medicare costs grew faster than Medicare

payments. * Steady hospital profits in PPS 4 and after, even as PPS

profits have continued to fall. * Higher rates of closures and mergers in the years

following the introduction of PPS.

The most important issues in the literature on hospital finances under PPS concern the causes and implications of this agreed pattern of basic results.

[TABULAR DATA OMITTED]

Expenditures in hospitals

Russell (1989) notes that Part A trust fund payments have been growing at a slower rate since the start of PPS, with savings cumulating to around 20 percent by 1990 (or a saving of slightly less than 3 percentage points on the rate of increase).(2) But for PPS to be successful in the longer run, not only must Medicare payments be reduced, but inflation in hospital expenses must be slowed. All but one early study suggest that expenses grew at a slower rate under PPS. (The exception is Sloan, Morrisey, and Valvona [1988b], who find that volume reductions explain all reductions in expenses, with no net efficiency effects.) Studies of expenditures in hospitals during the first year or two of PPS found significant reductions in cost per admission for hospitals that were pressured,(3,4) and for the aggregate of all hospitals under PPS.(5) The measured effects in these studies are quite large, though consistent with the initial large reductions in LOS. Adding to the apparent validity of these large initial effects is the fact that the three Urban Institute/Georgetown studies (Feder, Hadley, and Zuckerman, 1987; Hadley, Zuckerman, and Feder, 1989; Hadley and Swartz, 1989) use entirely unique data sets and methods, but still yield consistent findings for the first year of PPS. The large declines in admission volumes appear to have contributed, but in a minor way, to total expenditure reductions, making expenditure reductions somewhat larger than the efficiency gains alone.(6)

Most of the research on expenditures is consistent as to sources of the effect, but most studies observe only the first year two of PPS - a period when sharp LOS reductions occurred and little financial pressure was applied. During the first years of PPS, inflation in hospital expenses per adjusted discharge (and Medicare operating expenses per discharge) were reduced about 5-7 percentage points from pre-PPS, double-digit levels (Prospective Payment Assessment Commission, 1991a; Cromwell and Puskin, 1989.(7) Cromwell and Puskin (1989) attribute this decline to: * A slowdown in the rate of increase in wages per hour