Cost Estimates for Cost Outlier Cases Under Medicare's Prospective Payment System

The authors studied the ratio of costs to charges (RCC) used to estimate the cost of Medicare hospital cases in the formula which sets cost outlier payments. The authors estimate that, under current payment policy, the cost of the average cost outlier case is overestimated by 23 percent. The causes of this overestimate are a secular decline in RCC of between 2 and 3 percent a year and the fact that cost outlier cases typically receive a higher percentage of ancillary charges that have a very low actual RCC. The inaccurate estimate of the cost of cost outlier cases contravenes current policy intent in two important ways. First, it changes the fraction of the excess costs that are insured from the intended 75 percent to 92 percent. Secondly, cases face different cost outlier thresholds, and therefore receive different payment amounts, depending on the mix of ancillary and accommodation services required by the patient. It would be possible to improve the measurement of the cost of cost outlier cases by using separate RCCs for ancillary and accommodation charges. The outcomes of alternative policies are estimated in the report.