Sorry guys...I wrote an absolute thesis on the subject of Medicare, Medicaid, and private health insurance reimbursement, but it overwhelmed this Mayo blog and wouldn't upload. So I am trying again in a more brief post.
I offered the entire history of Diagnostic Related Groups (DRG's) that came out of a Federal government study at a hospital in New Jersey in 1976 that resulted in 476 Diagnostic Groups for each disease known, each with its own amount of reimbursement, that is known to hospitals and physicians from the moment the patient is admitted to the hospital. This happened because within a very short time after introducing Medicare and Medicaid in 1965, less than 10years later, the Federal government was spending way more on Medicare healthcare and Medicaid (indigent care) than they thought they would (surprise, surprise). They had to reign in the expenditures, so they did the study with the hospital in New Jersey, and came up with 476 disease specific codes with known average length of hospital stays and costs incurred. So...
Simply put: Say a man is admitted for a radical prostatectomy, and the hospital will receive, say, $25,000 for that surgery and admission. If the patient stays in the hospital too long, they have "overstayed their financial welcome." The physician and/or care team did not do a good job of caring for the patient, and they spent more than the $25,000 they knew they'd receive for that admission. So now they have lost money. On the other hand, if they get the patient out of the hospital a day earlier than planned, they make a profit because they still get the $25,000. This form or "prospective payment" came from the results of that New Jersey study in 1976. Prospective payment was phased in over four years: Year #1 75% traditional "fee for service" reimbursement (spend a dollar, get reimbursed a dollar) and 25% DRG payment. Year #2 50% traditional "fee for service" and 50% DRG payment. Year #3 25% "fee for service", and 75% DRG, and finally Year #4 and thereafter, it was 100% DRG payment. The DRG payment was lower than traditional "fee for service" payment, and that is why it was phased in so hospitals could change levels of care, and cut back operational costs that would keep them from being profitable.
Hospitals had difficulty with this, so back in the mid-1980's they started "cost shifting"...increasing their billings to private insurance companies for patients with such insurance, to make up for their Medicare DRG losses. The private insurance companies quickly learned what was going on, and said "no more." That is when "captitated" payment through health plans started to take shape. If a health plan had a certain number of patient enrollees, then each contracted hospital or physician group got a flat amount of money per patient..."per capita." Health plans incentivized physician groups with bonus money to not over-utilize services and care, which quickly became motivation not to do certain types of care, procedures/treatments, and pharmaceuticals. The physicians then got to share in the bonus money if they achieved their goals of managing and under-utilizing their billable patient procedures. Many physicians hated this because it was an unethical temptation and means to provide substandard care for the sake of money from the health plans. It still goes on today no matter the form of health coverage (HMO, PPO, EPO, and group health plans, etc.). Hospitals have physicians and teams of nurses that review patient charts for compliance with "Standards of Care" that each hospital develops to manage the utilization of services for each type of diagnosis. The care for every patient admitted for a certain diagnosis must follow the Standards of Care protocols. Physicians who over utilize services that costs the hospital too much money are reprimanded. BTW...each DRG could be adjusted as follows: That same man admitted for a radical prostatectomy, might also have had high blood pressure, Type II Diabetes, and Crohn's disease of the bowel. Each of these has its own DRG, but they were additive for the admission because that RP patient had to have their high blood pressure, Type II Diabetes and Crohn's disease "managed"/cared-for while in the hospital for the RP. Also, there was/is adjustments for geographic location in the paid DGR amount. Due to cost of living, wages, costs of supplies, etc., it costs more to treat a patient in, say, metropolitan Los Angles, Chicago, New York, or Boston, than it does in Des Moines, Casper, Tulsa, or Jefferson City, etc. So, Medicare reimburses more for such patients in those metropolitan areas. Hope this clears things up.