Inpatient Prospective Payment System (IPPS)

How It Works

IPPS was introduced in 1983 to control rising hospital costs. Instead of paying whatever hospitals charged (the prior retrospective system), Medicare prospectively determines what each DRG should cost and pays accordingly. The base payment rate is adjusted by several factors: the hospital's area wage index (higher in expensive labor markets), whether the hospital is a teaching hospital (indirect medical education adjustment), whether it treats a disproportionate share of low-income patients (DSH adjustment), and whether the case involves new technologies. IPPS created financial incentives for hospitals to be efficient — they keep the savings if they treat a patient for less than the DRG payment, and absorb the loss if they spend more.

Related Terms

• Diagnosis Related Group (DRG) — A classification system that groups hospital inpatient stays into categories based on diagnosis, procedures, and patient complexity — used by Medicare to determine how much a hospital gets paid.
• Case Mix Index (CMI) — A measure of the average complexity and resource intensity of a hospital's patients — higher CMI means the hospital treats sicker, more complex patients.
• Centers for Medicare & Medicaid Services (CMS) — The federal agency that administers Medicare, Medicaid, and the ACA marketplace — setting hospital payment rates, quality standards, and the data that HospitalCostData uses.