title: Insurance principles and the design of prospective payment systems.
abstract: This paper applies insurance principles to the issues of optimal outlier payments and designation of peer groups in Medicare's case-based prospective payment system for hospital care. Arrow's principle that full insurance after a deductible is optimal implies that, to minimize hospital risk, outlier payments should be based on hospital average loss per case rather than, as at present, based on individual case-level losses. The principle of experience rating implies defining more homogenous peer groups for the purpose of figuring average cost. The empirical significance of these results is examined using a sample of 470,568 discharges from 469 hospitals.
mesh_terms: D003365:Costs and Cost Analysis; D003625:Data Collection; D003669:Deductibles and Coinsurance; D003953:Diagnosis-Related Groups / Q000191:economics*; D004469:Economics, Hospital / Q000706:statistics & numerical data*; D007350:Insurance, Hospitalization / Q000706:statistics & numerical data*; D006278:Medicare; D011445:Prospective Payment System / Q000458:organization & administration*; D012307:Risk Factors; D014481:United States