• Needed: Medicare historian

    I guess I need a lot of help today. Here’s my second request for information of the day.

    Once upon a time, Medicare paid hospitals their reported costs plus 2%. It was a sure way to explode federal health spending and it did. This cost+2% system ended, but I don’t know when any more precisely than before 1980. I’ve been e-mailing experts on Medicare and so far those who have returned my e-mail don’t know either. But surely somebody does.

    If you know when and how Medicare cost+2% hospital reimbursement ceased, or know where I can look, please tell me. Anyone who can provide a cite-able reference gets the grand prize: two free round-trip journeys to a place of mental tranquility of your choosing, redeemable by cathartic bellowing into a stiff wind.

    • I don’t claim to be a Medicare historian but, if I remember correctly, the cost-plus method originated with Blue Cross. When Medicare went into operation in 1966, they adopted the Blue Cross approach. However, since Medicare reimbursed not-for-profit hospitals only for costs, I think the 2% you refer to is the Return on Equity payment to for-profit hospitals. That ended in 1984 (or began phasing out at that point) as a result of the Social Security Reform act in 1983 that established the PPS..

      • @Rob – Thanks. I just spent another half hour trying to track this down, adding “return on equity” to the search strings I’ve been trying. No luck. Somebody must know the answer but it is awfully hard to find it.

    • TEFRA replaced the cost-based system with the beginnings of a episode based payment method and that became PPS. I think “Pricing the Priceless” by Joe Newhouse discusses this

    • From “Hospital Reimbursement under Medicare” by Judith R. Lave (Spring 1984, Milbank Memorial Fund Quarterly):
      In 1982 the Congress passed TEFRA, which profoundly changed
      Medicare’s hospital reimbursement methods in a number of ways.
      First, the basis of reimbursement was shifted from an implicit per
      diem system to an explicit per case system; second, case-mix was incorporated into the payment system; and third, a limit was placed
      on the rate of allowable increase in costs per case. Although the
      language of the statute continued to use the term “reasonable costs,” the concept was radically changed. Costs per case higher than 120 percent of the average (adjusted for wage and case-mix) for comparable hospitals, or which increased more than the target rate over the base year, were no longer considered reasonable. TEFRA also required that the secretary of the Department of Health and Human Services develop a prospective payment system. The secretary reported to the Congress in December 1982, and by April 1983 prospective payment was embedded in law.

    • Austin:

      Serendipitously, I found the following which might have what you want.

      It’s a case in which a for-profit chain sued HHS over how their ROE payment had been calculated. In particular, footnote #3 states: “Congress has recently authorized the phasing out of return-on-equity payments between fiscal year 1987 and fiscal year 1990.”

      The timing suggests to me that the ROE phase out was part of the process of folding the capital reimbursement payment into the DRG rate — which makes sense.

      • @Rob – Thanks. Boy, I’m in a tight spot. What I’m trying to do is respond to a comment on a paper. Both the comment and experts I’ve exchanged e-mail with suggest there’s something about this that ended prior to 1980. I don’t think I can or want to debate that. It isn’t even critical to the paper so one solution is to drop it. But I need not do that if I can find an answer before the revision is due. So maybe they’re talking about something else. Maybe there was a +2% payment that was not related to “return on equity.”

    • Austin:

      I think they might be referring to Blue Cross.

      As I understand things, Medicare’s position was that they only reimbursed costs incurred by Medicare beneficiaries (thus, no allowance for a share of uncompensated care & that sort of thing).

      The logic behind the ROE payment seems to be related to the cost of capital. The idea being that not-for-profit status confers access to lower cost sources of capital. Doug Conrad has an interesting paper about this (“Returns on Equity to Not-For-Profit Hospitals”, Health Services Research, 1984, 19:1, p.41).

    • Looks like you found some answers. You could also try this: Medicare Begins Prospective Payment of Hospitals John K. Iglehart
      N Engl J Med 1983; 308:1428-1432June 9, 1983

    • Austin:

      It looks to me like the 2% add-on relates to capital costs. A 1984 article in Health Affairs, “Medicare Payment and Hospital Capital: The Evolution of Policy” describes this in some detail and is at:


      Apparently, when Medicare designed the initial formula, it included an additional 2% of allowable costs as reimbursement for capital improvements — in effect a return on capital payment. The for-profits received an additional ROE payment.

      It looks like the 2% rate was reduced to 1.5% in the 1983 legislation and phased-out in the late 1980s as mentioned in an earlier post.

      I wonder if the commenter meant to say “prior to 1990” rather than “1980”?