Linear programming models for cost reimbursement

Tamura, Lauer, and Sanborn (1985) reported a multiple regression approach to the problem of determining a cost reimbursement (rate-setting) formula for facilities providing long-term care (nursing homes). In this article we propose an alternative approach to this problem, using an absolute-error criterion instead of the least-squares criterion used in regression, with a variety of side constraints incorporated in the derivation of the formula. The mathematical tool for implementation of this approach is linear programming (LP). The article begins with a discussion of the desirable characteristics of a rate-setting formula. The development of a formula with these properties can be easily achieved, in terms of modeling as well as computation, using LP. Specifically, LP provides an efficient computational algorithm to minimize absolute error deviation, thus protecting rates from the effects of unusual observations in the data base. LP also offers modeling flexibility to impose a variety of policy controls. These features are not readily available if a least-squares criterion is used. Examples based on actual data are used to illustrate alternative LP models for rate setting.