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This report examines the formulas that the Health Care Financing Administration (HCFA) uses to pay for the extra expenses incurred by unusual hospital cases (outliers) and recommends changes in these formulas. Outlier payments are those made in addition to the regular diagnosis-related-group payment and are designed to reduce hospitals' financial risks and their financial incentives to refuse to serve, or to underserve, exceptionally costly cases. There are two kinds of outliers — day outliers (cases that remain in the hospital beyond a certain number of days) and cost outliers (cases whose standardized charges exceed a cost threshold). The authors describe how the average cost of day outlier cases increases as a function of length of stay. They also consider the forms of the day outlier per diem and the cost outlier threshold, which determines which cases will be paid as outliers and the amount of the payment. The authors find a large percentage of day outlier payments go to profitable cases, which is contrary to policy intent. They recommend a reduction in the day outlier per diem to the level that would provide the same coinsurance to day and cost outliers. They suggest replacing the current formula for the cost outlier threshold with a fixed loss cost outlier threshold.

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