Prospective Payment: Medicare’s Secret Success Story

Abstract

Despite its rich intellectual foundations, the health services research field often seems blind to history and naively susceptible to faith-based conventional wisdom. In their new study of Medicare prospective payment, Rick Mayes and Bob Berenson throw off both of these limitations, with illuminating results. Although managed care is widely regarded in policy circles as a noble victory for employers and insurers in the struggle for control of health spending, Mayes and Berenson contend that “the private sector neither initiated this battle nor provided the critical innovation that transformed health care in the United States.” This slender volume offers value on several dimensions. First, it is an explication of recent history that connects the dots from prospective payment to Medicare-based deficit reduction to cost shifting to managed care. By the same token, the story here serves as a bracing corrective to the mythology of market-based reform and the assumption that government’s role in health is inescapably a negative one. Further, policy scholars will relish the intimately detailed examination of the process by which research and ideas are translated into practice, amid all of the unpredictability of politics and circumstance. It is also a readable saga of the life and times of a generation of thinkers and actors who are still among us and who are still riding the train of events set in motion by enactment of the prospective payment system (PPS) in 1983. Text and notes are loaded with colorful recollections and ruminations of former whiz kids who grew older and wiser as the fruits of their labor ripened. Finally, the PPS story is a sobering object lesson in how sharply policy making by disinterested professionals may contrast with the kind of politically and ideologically driven strategy and legislation that is characteristic of the current era. The backstory here, it will be remembered, is that analysts and policymakers recognized in the early 1980s that cost-based provider reimbursement, which Medicare had cloned from the traditional Blue plans, was fueling runaway inflation in health care. Researchers had been tinkering with diagnosis-based reimbursement schemes for years at this point, and notwithstanding the fact that such “administered prices” were anathema to conservative economists, diagnosis-related groups (DRGs) looked like the right fix to officials in Congress and the Reagan administration. “We just pulled them off the shelf,” said Don Moran, then in the Office of Management and Budget. In the heat of the moment, debate was minimal, and details were left to the experts. First-order effects were resoundingly successful. Medicare hospital payment growth dropped from 16.2 percent a year in 1980–83 to 6.5 percent in 1984–87, while hospitals’ financial health improved with increases in efficiency, and patient outcomes showed no discernible damage. Mayes and Berenson explore a panoply of more-nuanced effects, but the mother of unintended consequences in their history is Congress’s eventual discovery that the annual DRG update factor could be a very