Traditional Medicare Provider Payment—Hospitals

Medicare pays for hospital inpatient and outpatient services using a prospective payment system (PPS). As a rule, the PPS provides a single payment for a group of related services. For example., hospitalization for a specific condition or care related to an outpatient procedure. In addition to paying for beneficiary services, Medicare subsidizes teaching hospitals and covers uncompensated care costs of facilities that serve a disproportionate share of individuals with low incomes or those who are uninsured. Medicare also subsidizes certain rural hospitals, such as Critical Access Hospitals and certain comprehensive cancer hospitals that are not paid under the PPS. Subsidies for graduate medical education were designed to help pay for the cost of educating medical residents and create incentives for teaching hospitals to treat Medicare beneficiaries.

In its March 2016 report to Congress, MedPAC noted that most beneficiaries had no problem obtaining hospital services, in part because most hospitals have low occupancy rates. But large reductions in Medicare hospital payments could lead to cuts in hospital staffing and closure of some hospitals, particularly those with low operating margins (e.g., rural hospitals, inner-city teaching hospitals, and public hospitals). Staffing cuts and closures would affect all patients who use these hospitals, not just Medicare beneficiaries.

Under the Affordable Care Act, Congress has slowed Medicare payments to hospitals. It has reduced PPS payment updates to account for expected gains in productivity and lower future “disproportionate share hospital” payments. The latter reflect lower uncompensated care costs due to expected gains in the number of insured patients.

As part of efforts to control Medicare costs and improve quality and patient safety, The Centers for Medicare & Medicaid Services aims to reduce avoidable hospital readmissions. Hospitals with high readmission rates for certain conditions can now receive lowered reimbursement rates. In 2009, the all-cause 30-day hospital readmission rate for Medicare patients was almost 19 percent. Many of these readmissions were avoidable. In fiscal year (FY) 2013, as an incentive to reduce readmissions and improve transitional care, Medicare payments were cut by 1 percent for hospitals with high rates of avoidable readmission within 30 days for cases of heart attack, heart failure, and pneumonia. Cuts increased to 3 percent in FY 2015. Since 2013, additional conditions have been added to the list of avoidable readmissions, including hip and knee replacements, chronic lung disease, and coronary artery bypass graft surgery.

Hospital-specific readmission rates are published on Medicare’s Hospital Compare website (medicare.gov/hospital compare). From 2011 through the end of 2013, Medicare hospital readmission rates dropped 1.5 percentage points, from 19 percent to 17.5 percent (representing a reduction of about 7.9 percent). This drop amounted to 150,000 fewer preventable readmissions, leading to Medicare savings of $4.1 billion. Patients who visit the emergency room or receive observation services without being admitted are not categorized as discharged or readmitted for purposes of this initiative. They are both considered outpatient services. It is not clear whether hospitals are using observation services to reduce the number of readmissions that are potentially categorized as avoidable or whether this practice will compromise the quality of care.