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What Is the Purpose of Medicare's PPS?

The purpose of Medicare's prospective payment system (PPS) is to better control health care costs by giving hospitals incentives to promote more cost-effective delivery of health care to patients. The prospective payment system helped restructure the U.S. health care system in the 20th century.

  1. History

    • Between 1965 and 1983, Medicare used a "retrospective cost-based reimbursement" system to pay hospitals that treated Medicare patients. Under this system, Medicare would determine hospitals rates of reimbursement at the end of the fiscal year, which provided little incentive for hospitals to control costs. In 1982, Congress created the PPS to provide a reward to hospitals that were more cost-efficient.

    Features

    • Under PPS, hospitals are reimbursed by Medicare under a flat rate based on the types of inpatient care provided to the patient. Cases are divided into diagnosis-related groups (DRGs) and each DRG pays the same amount, regardless of the level of services provided or the amount of time a patient stays in the hospital. In effect, hospitals can lose money if costs exceed the Medicare payment, and retain the balance when a payment exceeds their costs.

    Benefits

    • A 2006 study by the RAND Corporation and the University of California at Los Angeles found that while the PPS was effective in controlling the growth of Medicare costs, there was no overall decline in the quality of health care to Medicare patients.

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