Effective October 1, 1983, Medicare implemented a prospective payment system (PPS) for reimbursing inpatient hospital operating costs. This system replaced the existing retrospective cost reimbursement system whereby interim rates were paid on each bill and end of year adjustments were made based on information contained in hospital cost reports. Most hospitals are now paid a fixed amount, determined in advance, for the operating costs of each case according to one of nearly 500 Diagnosis Related Groups (DRGs). A discharge is assigned to a DRG based on diagnosis, surgery, patient age, discharge destination and sex. Each DRG has a weight established for it based primarily on Medicare billing and cost data. Each weight reflects the relative cost, across all hospitals, of treating cases classified in that DRG. The short stay hospital files include PPS exempt units (rehabilitation and psychiatric) and waiver state (Maryland) hospitals not paid under the PPS.
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