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Evaluating Financial Risk in the Medicare Prospective Payment System

Krannert School of Management, Purdue University, West Lafayette, Indiana 47907-1310
Department of Epidemiology and Public Health, Yale University School of Medicine, New Haven, Connecticut 06520-8034

The Medicare Prospective Payment System (PPS) is analogous to an insurance scheme in which financial risk is mitigated through experience rating. In addition, risk is also mitigated through reinsurance provisions. Although a provider may not want this reinsurance, participation is mandatory. We develop a framework for evaluating financial risk under the PPS. We use this framework to examine optional reinsurance as an alternative risk mitigation mechanism. We illustrate an application of optional reinsurance using data for Medicare psychiatric inpatient services. Our analysis indicates that viable schemes exist for implementing optional reinsurance as a prospective payment option.

Key Words: health care; hospitals; medicare; pricing; psychiatric services