Mid-Sized Rural Hospitals

Prospective Payment System (PPS)

In 1965, Congress amended the Social Security Act to authorize the Medicare and Medicaid programs.  The initial reimbursement guidelines applied to all hospitals (urban and rural) and were based on the cost for providing services to Medicare and Medicaid patients. Then in the early 80s, the Reagan Administration concluded that this cost-based payment system was wasteful and encouraged hospitals to operate inefficiently. To fix the problem, the decision was made to replace the old cost-based system with a new payment system based on fixed prices or fees. This led to the establishment of the Prospective Payment System (PPS) which was implemented by CMS in 1983. Under this system, all hospitals regardless of size and location were paid for Medicare and Medicaid services based on predetermined prices under a coding system using diagnosis-related service groups.


This approach did much to address the problem of waste and inefficiency by creating strong incentives for hospitals to maintain efficient operations and tight cost controls; and it worked fine for urban hospitals and some large rural hospitals that had adequate patient volumes and a reasonable Medicare payer mix. But it proved to be a financial disaster for most small rural hospitals which typically have low patient volumes and higher percentages of Medicare patients. Finally, after the closure of literally hundreds of small rural hospitals, Congress stemmed the tide by passing the Critical Access Hospital (CAH) program under the Balanced Budget Act of 1997.


The CAH program is in recognition of the unique fiscal challenges facing these hospitals due to their small size (i.e. 25 beds or less), limited workforce, and dependency on government programs such as Medicare and Medicaid, and it has proven to be a major national initiative to strengthen rural healthcare by again offering cost-based reimbursement to smaller rural hospitals.

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