Improving Medicare's Policy for Payment of Unusual Hospital Cases

In FY 1989, the Health Care Financing Agency (HCFA) changed the amount it would pay for extremely long or costly Medicare hospital stays called outliers. Based on a 20% sample of Medicare hospitalizations as recorded in the Medicare Provider Analysis and Review (MEDPAR) file, the authors compared the distribution of outlier payments under the FY 1989 policy with the FY 1988 distribution under the previous policy; described the extent to which each policy provided reimbursement to the most costly cases and examined the distribution of outlier payments among other patient groups and among hospital groups; and estimated the effect of outlier payments on hospitals' financial risk using the methodology developed in Keeler et al. (1988). The authors examined three characteristics of stays that hospitals might have changed in response to the incentives inherent in outlier policy: (1) the resources provided to long-staying patients, (2) the discharge rate near the old outlier threshold, and (3) the concentration of very expensive cases in public hospitals in large urban areas. The outlier policy appears to have accomplished several goals. In particular, the new policy succeeded in: concentrating outlier funds on the costliest cases; providing more funds to hospitals with cases that are more costly than average for their Diagnosis Related Group (DRG); and decreasing risk by 5% from what it would have been if the policy had not changed. The study also identified two problems with existing outlier policy: (1) day outlier payments frequently exceed the cost of the services delivered; and (2) the formula for setting cost outlier thresholds produces less than optimum protection from risk. Although the changes were not large, the authors found some evidence that hospitals responded to the outlier policy change both by increasing length of stay and increasing the services delivered to the most costly patients. They judge that this analysis increases the strength of the argument for using case-based rather than hospital-based outlier payments.