The Medicare IPPS: 40 years later

March 27, 2023 / By Richard Averill, MS, Ron Mills, PhD

Facing the imminent insolvency of the Medicare Part A hospital insurance trust fund, Congress passed legislation in 1983 that implemented the Medicare Inpatient Prospective Payment System (IPPS). The IPPS was designed to provide hospitals with the financial incentive to control costs. There were no new taxes and no reduction in payment levels to hospitals. Implemented as a budget neutral system, IPPS reformed how hospitals were paid. As a direct result of IPPS, Medicare annual expenditures for hospital care in 1990 were $18 billion lower ($37 billion in today’s dollars) than originally projected at the time of IPPS implementation, representing a 20 percent decrease in projected annual hospital Medicare expenditures. These expenditure reductions were achieved without a negative impact on patient outcomes.

The 1983 implementation of the Medicare Inpatient Prospective Payment System (IPPS) was successful in controlling Medicare inpatient costs because it was designed as a clinically credible management tool that facilitated real behavior change and performance improvement. The next phase of IPPS should expand the inpatient payment bundle to a hospital episode-of-care performance bundle that explicitly links episode cost and quality. A uniform, comparable and transparent episode performance bundle that highlights the tradeoffs between episode cost and quality can expand the incentives to control costs and provide hospitals the management information to improve performance.

As the 40-year anniversary of IPPS approaches, the Medicare Part A hospital insurance trust fund is once again approaching insolvency. What are the lessons learned from the implementation of IPPS and can those lessons be used to expand the scope of IPPS? Review the intent and assumptions of the original IPPS research, analyze the reasons for the success of IPPS and see what the next phase in the evolution of IPPS could be so that it can provide hospitals with expanded incentives to control costs and improve performance while helping to safeguard the Medicare trust fund.

Read the full text research paper in The Journal of Ambulatory Care Management.

Richard Averill, is a principal at The Hesperium Group. He was formerly the senior vice president for Clinical and Economic Research at 3M Health Information Systems and continues to serve as senior health care policy advisor to the company.

Ron Mills, former software developer for Clinical and Economic Research at 3M Health Information Systems.