Insurance Aspects of DRG Outlier Payments

As part of Medicare's prospective payment system, the government pays "outlier" payments for especially long or expensive cases. These payments can be viewed as insurance for the hospital against excessive losses, and mitigate problems of access and underprovision of care for the sickest patients and problems of fairness for the hospitals that take care of them. This Note characterizes the outlier payment formulas that minimize risk for hospitals under any fixed constraints on the sum of outlier payments and minimum hospital coinsurance rate. The authors then simulate per-case payments for a policy that did not include any outlier payments, the current outlier policy, and several other policies that minimize risk subject to different coinsurance constraints. The current outlier policy achieves each of its goals to at least some extent, but more insurance could be provided without lessening attainment of the other goals. The Note also discusses some problems with the implementation of the current policy, such as its reliance on day outliers.