Medicare and 35 State Medicaid programs use prospective systems based on case mix for NH reimbursement. This approach provides a fixed amount, typically set at the average cost for each patient group considered to be clinically homogenous. State Medicaid programs may also include other features in attempting to align payment and costs. Features include add-ons for certain types of residents, cost ceilings and floors on specific cost centers, and incentives for direct care spending (Schlenker 1986
; Feng et al. 2006
; Rudder, Mollot, and Mathuria 2009
;). NHs with managed care contracts use a variety of reimbursement methods, including case mix reimbursement.
The Medicare payment system pays a fixed amount for predefined patient groups. With this approach, payment needs to be well aligned with the cost of caring for patients in these groups. If payment rates for each patient group are not aligned appropriately with the cost of each group, perverse incentives arise, leading to both access and quality issues. Some patients may be less profitable than others and some may represent net losses. These patients may face difficulty gaining access to NH care because they are financially less attractive. For those that represent net losses, once admitted, facilities may have difficulty meeting their clinical needs.
Medicare pays only for postacute, skilled care NH patients defined as those having had at least a 3-day hospital stay for medically necessary inpatient hospital care, and who require daily skilled care or rehabilitation services (Centers for Medicare and Medicaid [CMS] 2008
). The daily rate depends on the care needs of the patient as measured by the Resource Utilization Groups (RUGs), a case mix index (CMI) for NHs, that is expected to cover operating and capital costs (MedPAC 2009b
). A person is classified into a RUG based on expected minutes of therapy, activities of daily living, need for special services, and certain clinical conditions. There were 44 RUGs during the 1998–2005 period, which were expanded to 53 categories in 2006. Each RUGs category has a nursing and a rehabilitation weight that was derived from NH staff time studies performed during the 1990s. There is an “other” component that covers room and board and capital costs. The minimum data set (MDS) assessment is used to determine the RUG for each patient. The increase in the number of groups used for Medicare from 44 to 53 was an attempt to better capture the variation in nontherapy ancillary (NTA) service costs (such as drugs, laboratory expenses, and respiratory services) of patients classified into high therapy and extensive services groups (CMS 2005
). A new RUGs, RUG-IV, being proposed for FY2011, would make adjustments to the groupings based on more recent time and motion studies and would increase the number of groups to 66 and expand the number of rehabilitation, special care, and complex care groups (CMS 2009
The RUGs classification system has been criticized for having a number of inadequacies. Analyses of the explanatory power of the 44 categories RUGs shows that it explains about 40–55 percent of staff time costs for all NH residents, with the higher estimate when NTA costs are not included (Fries et al. 1994
; White, Pizer, and White 2002
;). The MedPAC criticizes the RUGs classification because it was developed from staff time studies, and it argues that the 53 category index still does not reflect much of the additional costs of NTAs because these are not strongly related to staff time. MedPAC suggests ways to improve diagnostic information using information to classify patients from the prior hospitalization, to improve reimbursement accuracy by developing a new method for reimbursing NTAs and therapies that would use patient and NH stay characteristics that reflect cost differences, and to implement an outlier payment system for high NTA and therapy costs (MedPAC 2008
Analysis of NH cost reports can provide insights into how well the RUGs classification system explains the variation in NH costs. The annual costs of care at the facility level depends primarily on the case mix of its residents, the number of days of care provided, and the wages that the NH pays to provide that care. NHs that admit a greater percentage of postacute patients will generally have a higher overall case mix because postacute patients require more complex medical care and services. To the extent that the RUGs reflect the true cost burden of postacute care, the costs of NHs that provide a higher percentage of postacute care will be appropriately reimbursed. However, if the RUGs do not sufficiently capture the costs for all types of postacute care, then the percentage of postacute care provided by the facility will also explain some of the costs.
In this paper, we analyze whether the RUGs CMI sufficiently capture the cost burden of postacute patients. We estimate cost functions that include in addition to the RUGs CMI, inpatient days, ownership, and wage index, the percent of days due to Medicare skilled care days (%SKILLED). If costs are higher when facilities have a higher %SKILLED, even when controlling for RUGs (using the 53 RUGS CMI), then this suggests that the current RUGs do not sufficiently capture differences in costs of postacute patients. In addition to the impact on total costs, we also estimate the impact on the two cost categories that are expected to be affected, as argued by MedPAC—rehabilitation and NTAs.