A risk-based prospective payment system that integrates patient, hospital and national costs

We suggest that a desirable form for prospective payment for inpatient care is hospital average cost plus a linear combination of individual patient and national average cost. When the coefficients are chosen to minimize mean squared error loss between payment and costs, the payment has efficiency and access incentives. The coefficient multiplying patient costs is a hospital specific measure of financial risk of the patient. Access is promoted since providers receive higher reimbursements for risky, high cost patients. Historical cost data can be used to obtain estimates of payment parameters. The method is applied to Medicare data on psychiatric inpatients.