Exploring Episode-Based Approaches for Medicare Performance Measurement, Accountability and Payment Final Report. 2. Medicare Payment Policy

02/01/2009

Medicare uses separate payment mechanisms for each of its FFS provider settings and Medicare Advantage plans. Our review finds that these payments are currently not aligned in ways that stimulate coordination, shared accountabilities, and delivery of high quality care.  

We summarized the current Medicare payment systems for each provider or supplier type and benefit category.

  • hospital inpatient,
  • hospital outpatient,
  • physician,
  • skilled nursing (SNF),
  • long-term-care hospitals (LTCH),
  • inpatient rehabilitation facilities (IRF),
  • home health (HHA),
  • ambulatory surgical centers (ASC),
  • outpatient laboratories,
  • durable medical equipment (DME),
  • dialysis (ESRD),
  • hospice,
  • prescription drugs (Rx), and
  • Medicare Advantage (MA) plans.

The purpose of this discussion is to understand whether and how current payment policies create incentives for providers across a patient's continuum of care, as a starting point for any types of applications or reforms that would involve using episodes of care in the context of provider payments to better align financial incentives in various settings.  

In Table 1, we summarize the payment mechanism used by provider type and setting. The format used in this table mirrors a table presented in the MedPAC 2003 Report to Congress, however the content has been updated utilizing the October 2007 MedPAC Payment Basics reports, information on the CMS website and Federal Register. We report the fiscal year (FY) the payment method began, basis of payment, method used to determine payments, source of the base payment amount and any provider-specific adjustments made to the amount, and method to update payments, reporting incentives and other related policies. 

Medicare predominantly uses prospective rate systems for paying providers, through which providers agree to accept as payment in full a predetermined amount for each separately billable Medicare covered product, service, admission or set of services. Cost-based payment continues for Critical Access Hospitals (CAHs) and selected other categories of service or patients.

CMS developed and implemented prospective payment systems separately for each of the other FFS settings, beginning with acute hospital inpatient care in 1984 and, most recently, with ambulatory surgical centers in 2008.  Payments to providers are based on a unit of service, which varies by type of provider. These units of service may be per-discharge (hospital-based care), per-diem (SNF, hospice), per-episode (HHA), per-treatment (dialysis) or on a fee schedule (hospital outpatient, physician, outpatient therapy, outpatient labs, durable medical equipment). Typically, base payments are adjusted for patient characteristics, geographic factors, and in the case of physician payments, for practice expenses and professional liability costs.  Payment rates for most settings are updated annually to account for changes in market conditions, technology or practice patterns. 

FFS payments create incentives for providers to increase the number of reimbursable units provided (e.g. the number of discharges for hospitals, unique services for physicians) to maximize reimbursement. When the reimbursable unit encompasses a bundle of services, which occurs under DRG payments for hospitals, there are incentives created that encourage the provider to be more efficient in the use of services in order to maximize profits.  This has been evidenced by hospitals reducing lengths of stay in response to prospective payments, in contrast to cost based payment subject to limits.

In contrast to the payment per unit of service for most Medicare FFS providers, the Medicare Advantage program and the Part D prescription drug program make monthly capitated payments to private health plans or drug plans. In the case of the Medicare Advantage program, Medicare pays a base payment rate that is the lesser of the plan's bid and the local or regional benchmark, which is then risk-adjusted based on enrolled beneficiary characteristics.  Health plans participating in the Part D program receive payments based on their annual bids during a competitive bidding process.  Under the capitation arrangement, plans face incentives to limit resource use and to keep members healthier to maximize profits,

While the payment systems described above create incentives for provider behavior, often to provide more services, with only one exception do they specifically reward providers for delivering high quality, efficient care.  The exception is CMS' recent policy change, implemented in FY 2008, where the Medicare program no longer reimburses hospitals for the additional costs (i.e., a higher MS-DRG payment) associated with eight preventable complications, including three “never events,” unless the condition was documented as being present on admission (CMS, 2007c).  The final rule for hospital inpatient services for FY 2009 includes an additional seven conditions.

Due to the lack of differentiation in payment based on quality and efficiency and calls from many policy leaders to align payments with the delivery of high quality, efficient care, CMS has instituted value-based purchasing (VBP) initiatives for several settings as a means of better aligning payment and performance.  Currently, several Medicare FFS provider settings are provided a financial incentive for the reporting of quality data to CMS as the first step toward the longer term goal of differentiating payment based on performance or “pay for performance.” Currently, the hospital inpatient, hospital outpatient and home health settings have pay-for-reporting programs in place through which providers must report on a set of measures in order to receive their full payment updates. In contrast, the Physician Quality Reporting Initiative (PQRI) provides a bonus to physicians who report on a minimum of three measures during the reporting period.  

In the future, some or all of these programs could potentially transition to pay for performance (i.e., financial incentive linked directly to actual performance on measures rather than the reporting of measures).  In November 2007, the Secretary of Health and Human Services submitted a Report to Congress detailing a plan to implement a hospital value-based purchasing program for Medicare services as mandated by the 2005 Deficit Reduction Act1 (DRA). The Medicare Improvements for Patients and Providers Act of 20082 (MIPPA) requires the Secretary of Health and Human Services submit no later than May 2010 a plan to transition to value based purchasing  for physicians and other practitioners. Furthermore, MIPPA calls for the establishment of a P4P program for ESRD providers effective January 1, 2012.  Additionally, CMS has pay-for-performance (P4P) demonstration projects in process for hospitals, physician group practices, and home health agencies and is developing plans for P4P demonstrations in other settings.

Performance reporting initiatives are not the only value-based purchasing activities in which CMS is engaged. CMS is also exploring competitive bidding as a mechanism to contain costs and potentially ensure quality. A competitive bidding program was planned to start in 2008 for select durable medical equipment (DME) in 10 MSAs with a planned expansion to 80 MSAs in 2009; in addition, a competitive bidding demonstration was planned for clinical laboratories starting in 2008. However, MIPPA delays until after 2011 full implementation of the DME competitive acquisition program, and repeals the competitive bidding demonstration for clinical laboratory services.

CMS will test the use of gainsharing between hospitals and physicians as a mechanism to improve the quality and efficiency of care delivered to beneficiaries through two demonstrations (CMS, 2006): the Hospital Gainsharing Demonstration, which was authorized by section 5007 of the DRA and started in October 2008 and the Physician Hospital Collaboration Demonstration, which was authorized by section 646 of the MMSA and is targeted to start in spring 2009. In May of 2008, CMS announced its plans for the Acute Care Episode demonstration through which it will provide a single bundled payment for both Part A and Part B Medicare services provided during an inpatient stay for a select set of cardiac and orthopedic surgical procedures.

Table 1. Medicare's Payment Systems by Setting (as of 11/2008)

Payment System Description  Acute Inpatient Care Ambulatory Care
Acute care hospitals Critical access hospitals (CAH) Psychiatric hospitals Physicians Hospital outpatient departments Ambulatory surgical centers (ASC) Outpatient laboratories
Fiscal Year Began 1984 1997 2005 2000 2000 2008 1984
Basis of Payment Prospective Cost-based Prospective Prospective Prospective Prospective Prospective
Product Definition Method of Payment The labor portion of the base payment is adjusted by the hospital wage index and added to the non labor portion.  The total is multiplied by the MS-DRG3 weight. The adjusted base payment is further adjusted for  indirect medical education, share of low income patients, transfers and high cost  outliers  Medicare pays each CAH 101% of its reported costs for outpatient, inpatient, laboratory, and therapy services, as well as SNF level post-hospital extended care- in the hospital's swing beds The labor portion of the per-diem base rate is adjusted by the hospital wage index and added to the non-labor portion.  The total is adjusted for facility and patient characteristics through the PPS4adjustment factor.  The base rate is  then further modified by the per diem adjustor, the presence of an emergency department, ECT7  treatments and high cost outliers The 3 RVUs5(work, practice expense, and professional liability insurance) are each adjusted for complexity of service/expenses and geographic factors then are added together and multiplied by the conversion factor.  Payment modifiers are then applied to arrive at the adjusted fee schedule payment rate.  That rate is then adjusted for provider type (decrease) or geographic area(increase). For most services, Medicare pays the provider 80% of the fee schedule amount, and the beneficiary is liable for the 20% coinsurance   The labor portion of the conversion factor is adjusted by the hospital wage index and added to the non-labor portion.  The adjusted conversion factor is then multiplied by the APC6 relative weight.  The payment amount may be further adjusted for rural status, hold harmless payments and high cost outliers. The labor portion of the ASC conversion factor is adjusted by the hospital wage index and added to the non-labor portion.  The adjusted conversion factor is then multiplied by the APC relative weight.  Payment for the lab service is the lesser of the provider's charge, the carrier fee schedule amount and the National Limitation Amount (NLA)
Unit of payment Discharge Service Day Service Service Procedure Test
Classification system 743 MS-DRGs None 15 DRGs ~6700 HCPCS8 codes HCPCS grouped in APCs 3300 procedures grouped in APCs 1100+ HCPCS codes
Policies defining boundaries 72 hour rule short stay transfers; high cost outliers None High cost outliers Differentials by setting; multiple or atypical services High-cost outliers; multiple services discount Multiple services discount None
Product Relative Values (RV) Components of RV Single value for each MS  DRG NA- Captured in costs DRGs Physician work; practice expenses; liability insurance Single value for each APC Single value for each APC Combined with base amount
Source of RV Hospitals' billed charges None Billed charges Expert judgment; practice expense data; premium survey Median of estimated service costs Median of estimated service costs None
Base payment rate/conversion factor Components of base amt Labor-related; nonlabor; capital NA Labor-related; nonlabor; capital Single conversion factor (for sum of relative values) Labor-related; non-labor Labor-related; non-labor Carrier specific rates with limit
Source of base amt Updated providers' 1982 costs NA Updated providers' 2002 costs Projected spending under preceding method 1996 outpatient department charges adjusted to costs 1986 Survey of ASCs Updated 1983 lab charges
Adjustments for local market conditions Labor input prices Hospital wage index NA Hospital wage index Separate Geographic Practice Cost Indexes (work, practice expense, liability insurance) Hospital wage index Hospital Wage Index None
Other input prices COLA (Alaska, Hawaii) NA COLA (Alaska, Hawaii) None None None None
Other payment adjustments Low-income patients (DSH)9;GME10 None Patient characteristics; facility characteristics (teaching, rural, emergency dept); additional payment for ECT treatment Reduced rates for non-physician practitioners None   None
Payment update method Hospital market basket index NA Hospital market basket index Relative weights updated at least every 5 years; HCPCS codes updated annually, conversion factor updated annually according to SGR11system Hospital market index; Expert review of APC and relative weights annually Annual review of APCs and relative weights; conversion factor updated annually based on CPI starting 2010 Congress specifies update factors
Reporting incentives Reporting Hospital Quality Data for Annual Payment Update

(RHQDAPU) Withhold of  2 percentage points of APU12 for failure to report on quality measures plus public reporting

None None Physician Quality Reporting Initiative (PQRI) 2.0 % bonus for reporting on quality measures for FYs 2009 and 2010 Hospital Outpatient Quality Data Reporting Program (HOP QDRP) Withhold of 2 percentage points APU for failure to report on quality measures beginning 2008 None None
Payments for capital costs Separate prospective rates Included in payment rate Included in payment rate Included in payment rate Included in payment rate Included in payment rate Included in payment rate
Other policies Higher rates in large urban areas; new technology payments; reimbursement for bad debts; no reimbursement for preventable complications starting 2008 SNF, psychiatric, and rehab units and home health agencies are paid through prospective systems. The adjusted rate is higher for earlier days of a patient's stay and declines through the 22nd day. 10% addition for health professional shortage areas New technology pass-through; transitional corridors; hold harmless for cancer, children's and rural hospitals Full payment is only given for the procedure with the highest payment rate. Payments for other procedures performed on the same day are reduced to half their usual rates. NLA=74% of median fee schedule amounts set by 56 carriers.
Table 1. Medicare's Payment Systems by Setting (as of 11/2008) cont.
Other Services
Payment System Description Post Acute Care Services for Special Populations  
Skilled nursing facilities (SNF) Home health agencies Inpatient rehab facilities Long term care hospitals Outpatient dialysis care Hospice services
Fiscal Year Began 1998 2000 2002 2003 1982 1983
Basis of Payment Prospective Prospective Prospective Prospective Prospective Prospective
Product Definition Method of Payment The labor portion of the SNF base rate is adjusted by the pre-floor and pre reclassified hospital wage index then added to the non-labor portion. The adjusted base rate is then multiplied by the RUG13weight to arrive at the payment amount. The labor portion of the base rate is adjusted by the pre-floor and pre reclassified hospital wage index then added to the non-labor portion. The adjusted base rate is then multiplied by the HHRG14weight and adjusted for short stay or high cost outliers The labor portion of the base rate is adjusted by the hospital wage index and added to the non-labor portion.  The adjusted base rate is then multiplied by the CMG15weight and adjusted for rural location, share of low income patients, teaching facility and short stay or high cost outliers The labor portion of the base rate is adjusted by the hospital wage index and added to the non-labor portion. The adjusted base rate is multiplied by the MS-LTC-DRG16weight and adjusted for short stay or high cost outliers The labor portion of the freestanding base composite rate or the hospital-based composite rate is adjusted by the hospital wage index and added to the non-labor portion and to a drug add-on payment. This amount is then multiplied by a case-mix neutrality factor The labor portion of the four categories of base payments (routine home care, continuous home care, inpatient respite, general inpatient) is adjusted by the hospital wage index and added to the non-labor related portion.
Unit of payment Day 60-Day episode Discharge Discharge Dialysis Treatment Day
Classification system 53 RUGs 153 HHRGs 92 CMGs (87 have 4 tiers with separate payment rates =353 separate rates ) MS LTC DRGs None 4 care type groups
Policies defining boundaries None Short stay outlier (fewer than 5 visits, high-cost outliers Short stay outliers/deaths; transfers; high-cost outliers Short-stay outliers; high-cost outliers; interrupted stays None Beneficiary gives up curative treatment
Product Relative Values (RV) Components of RV Nursing care; therapy services Single value for each HHRG Single value for each CMG/tier Single value for each MS LTC DRG None Combined with base amounts
Source of RV Staff-time studies Estimated mean cost per HHRG Hospitals' billed charges Hospitals' billed charges None None
Base payment rate/conversion factor Components of base amt

Labor-related; other

Labor-related; other Labor-related; other Labor-related; other Labor-related; other Labor-related; other
Source of base amt Amount received in 1995, updated for inflation Spending in preceding system Projected spending under preceding method Projected spending under preceding method 1977-1979 cost reports Cost data from Medicare demonstration
Adjustments for local market  conditions Labor input prices Pre-floor and pre reclassified hospital wage index Pre-floor and pre reclassified hospital wage index Pre-floor and pre reclassified hospital wage index Hospital wage index Hospital wage index Hospice wage index
Other input prices None None None COLA (Alaska,Hawaii) None None
Other payment adjustments None Non-routine medical supplies; proportional episode payment adjustment for beneficiary elected transfers Low income patients; teaching facility None Higher rates for hospital-based facilities; adjusted for patient characteristics (age, BMI, body surface area; drug add-on payment None
Payment update method SNF market basket index Home health market basket index RPL17market basket index No legislative mandate to update payments. CMS updates based on RPL market basket index Annual updates of add-on payment based on growth in drug expenditures Hospital market basket index
Reporting incentives Public reporting As part of the Home Health Quality Initiative (HHQI), HHAs must report quality measures; otherwise 2 percentage points market basket update is withheld plus public reporting None None Public reporting None
Payments for capital costs Included in payment rate Included in payment rate Included in payment rate Included in payment rate Included in payment rate Included in payment rate
Other policies 128% increase in per-diem for SNF patients with AIDS   Higher rates in rural areas None Medicare caps payments to facilities at 3 sessions per week Annual payment per beneficiary capped
Table 1. Medicare's Payment Systems by Setting (as of 11/2008) cont.
Other Services
Payment System Description Durable medical equipment (DME) Medicare Advantage (MA) plans Part D plans
Fiscal Year Began 1986 1998 (M+C) 2006 (MA) 2006
Basis of Payment Prospective Prospective-Capitation Prospective-Capitation
Product Definition Method of Payment Payment is the lesser of the provider's charge or the state fee schedule amount All-inclusive A/B capitation rate is determined by multiplying the base rate (which is either the plan's bid or the benchmark) by the enrollee's risk measure, also known as the CMS-HCC18 weight. Capitation rate is determined by multiplying the plan's bid by the enrollee's risk measure, also known as the RxHCC19; adjusting for other factors; subtracting the enrollee premium; and adding the additional low income subsidy, reinsurance and risk corridor payments
Unit of payment Item Month Month
Classification system HCPCS within 5 equipment categories CMS-HCCs are based on beneficiaries' diagnosis, age, gender, working age status; Medicaid status and disabled status RxHCCs are based on beneficiaries' diagnosis, age, gender and disability status
Policies defining boundaries None Payment floors for base rate (national and urban). Separate CMS-HCC risk models for aged, disabled, ESRD, new enrollees, and institutionalized.  Additional frailty adjustment factor reflecting the average level of functional impairment. Additional adjustments are made for low income status, and institutionalized status

Separate RxHCC model for new enrollees

Product Relative Values (RV) Components of RV Combined with base amount One value for each HCC based on diagnosis, age, gender, working age status, Medicaid status, and disabled status. One value for each RxHCC based on age, gender and disabled status
Source of RV None The CMS-HCC risk adjustment model includes approximately 70 disease groups comprised of ICD-9 codes that are clinically related and have similar cost complications

CMS uses demographic and diagnostic information from original Medicare and MA organizations to determine beneficiaries' risk scores

The CMS RxHCC risk adjustment model includes approximately 70 disease groups comprised of  ICD-9 codes that are clinically related and have similar cost complications

 CMS uses demographic and diagnostic information from original Medicare and MA organizations to determine beneficiaries' risk scores

Base payment rate/conversion factor Components of base amt Single amount Local/regional benchmarks Plan bids
Source of base amt Allowed charges in 1986-1987 with exceptions for customized equipment, medications used in conjunction with DME, and home oxygen County-level payment rates used to pay MA plans before 2006 (based on historical FFS rates, subject to payment floors and minimum updates) Expected costs for a Medicare beneficiary of average health
Adjustments for local market  conditions Labor input prices NA Included in bid Included in bid
Other input prices Geographic differences reflected in separate fee schedule for each state None None
Other payment adjustments State fee schedules subject to national floor and ceiling. Fees for prosthetics and orthotics subject to regional limits. Rebates to plans for difference between benchmark and bid rate (if below the benchmark) that can be used to provide additional benefits or reduce premiums)

Enrollees must pay an additional premium for plans with bids above the benchmark

Adjustment for beneficiaries utilization of VA and DOD military facilities

Risk corridor payments for regional MA plans

Enrollees must pay a base premium plus any difference between their plan's bid and the nationwide average bid

Beneficiaries may also be subject to a late enrollment penalty

In addition to direct subsidy payments for drug coverage, plans also receive low income subsidy payments; individual reinsurance payments; and risk corridor payments

Payment update method CPI-U20 Plans' bids updated annually

Rise in national growth rate in per capita Medicare spending is used to update the benchmarks each year, subject to a minimum percentage increase

MA FFS capitation rates are rebased at lease once every 3 years based on more recent FFS claims data

Coefficients in the Part C CMS-HCC Risk Adjustment Model, and frailty adjustment factors are also periodically updated using more recent data

Parameters for the standard Part D benefit are updated each year based on the estimated annual change in per capita drug spending and the annual percentage increase in the CPI

Coefficients in the Part D RxHCC risk adjustment model were originally developed based on drug expenditure data from FEHB21 and MSIS22and will be updated based on actual Part D utilization

Reporting incentives None None None
Payments for capital costs Included in payment rate Included in payment rate Included in payment rate
Other policies      

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