Step 1 - Hospitals submit a bill for each Medicare patient they treat to their Medicare fiscal intermediary (a private insurance company that contracts with Medicare to carry out the operational functions of the Medicare program). Based on the information provided on the bill, the case is categorized into a diagnosis related group (DRG), which determines how much payment the hospital receives.

Step 2 - The base payment rate is comprised of a standardized amount, which is divided into a labor-related and nonlabor share. The labor-related share is adjusted by the wage index applicable to the area where the hospital is located and if the hospital is located in Alaska or Hawaii, the nonlabor share is adjusted by a cost of living adjustment factor. This base payment rate is multiplied by the DRG relative weight.

Step 3- If the hospital is recognized as serving a disproportionate share of low-income patients, it receives a percentage add-on for each case paid through the PPS. This percentage varies depending on several factors, including the percentage of low-income patients served. It is applied to the DRG-adjusted base payment rate, plus any outlier payments received.

Step 4- If the hospital is an approved teaching hospital it receives a percentage add-on payment for each case paid through the PPS. This percentage varies depending on the ratio of residents-to-beds.

Step 5- Next, the costs incurred by the hospital for the case are evaluated to determine whether it is eligible for additional payments as an outlier case. This additional payment is designed to protect the hospital from large financial losses due to unusually expensive cases. Any outlier payment due is added onto the DRG-adjusted base payment rate.

COSTS NOT INCLUDED IN PPS PAYMENTS

The direct costs of medical education for interns and residents is paid based on a per resident payment amount.

The following costs continue to be paid on a reasonable cost basis:

• Hospital bad debts attributable to nonpayment of the Medicare deductible and coinsurance.
• Heart, liver, lung and kidney acquisition costs incurred by an approved transplant facility.

CORE ELEMENTS OF A PPS PAYMENT

• The standardized amounts, which are the basic payment amounts.
• A wage index to account for differences in hospital labor costs.
• The DRG relative weights, which account for differences in the mix of patients treated across hospitals.
• An add-on payment for hospitals that serve a disproportionate share of low-income patients.
• An add-on payment for hospitals that incur indirect costs of medical education.
• An additional payment for cases that are unusually costly, called outliers.

PPS STANDARDIZED AMOUNTS

The standardized amounts are based on 1981 hospital costs per Medicare discharge that have been adjusted to account for differences in certain hospital costs, such as case-mix, wage rates and any additional payment received for disproportionate share status and indirect medical education. The base year costs are increased by an update factor for every year since 1981. These update factors are set by Congress, and are intended to account for annual inflation while maintaining incentives for hospitals to be efficient. The standardized amounts are composed of two parts: a labor-related share and a nonlabor-related share.

There are currently two separate standardized amounts, one for hospitals in large urban areas, the other for all other hospitals. A large urban area is an area with a population of more than 1 million. These standardized amounts serve as the basis of payment for every fee for service Medicare discharge from an acute care hospital. The standardization process is intended to "nationalize" the costs of an individual hospital.

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Page Last Modified: 12/14/2005 12:00:00 AM
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