5.2 Prospective Payment Systems

PPS vs. Fee-for-Service

A prospective payment system (PPS) sets the payment amount in advance based on how the case is classified, not on the line-item charges. This shifts financial risk to the provider: if care costs more than the predetermined rate, the provider absorbs the loss, creating an incentive for efficiency. Fee-for-service (FFS), by contrast, pays a separate amount for each itemized service, rewarding volume.

Medicare runs a distinct PPS for almost every care setting:

IPPS and MS-DRGs

The Inpatient Prospective Payment System (IPPS) pays acute-care hospitals a fixed amount per discharge based on the Medicare Severity Diagnosis-Related Group (MS-DRG). For FY 2026 there are roughly 770 MS-DRGs. Each MS-DRG carries a relative weight that reflects the average resource intensity of that group relative to the national average (weight 1.0 = average case).

Payment ≈ MS-DRG relative weight × hospital base rate (the base rate combines a labor and non-labor portion, adjusted by the area wage index; add-ons exist for indirect medical education, disproportionate share, and outliers).

How a MS-DRG is assigned

1. The principal diagnosis (the condition chiefly responsible for admission, per UHDDS) places the case into a Major Diagnostic Category and a base DRG.
2. Significant procedures (ICD-10-PCS) can move the case to a surgical DRG.
3. The grouper checks secondary diagnoses for a CC (complication/comorbidity) or MCC (major CC). Many DRGs come in 2- or 3-tier severity splits (e.g., "with MCC," "with CC," "without CC/MCC"), and an MCC raises the weight — and payment — the most.

Trap: Only diagnoses present on admission or arising during the stay that are documented and coded affect the CC/MCC tier — this is exactly why Clinical Documentation Integrity matters to reimbursement.

OPPS, RBRVS, and Post-Acute PPS

The Outpatient Prospective Payment System (OPPS) pays hospital outpatient services using Ambulatory Payment Classifications (APCs). Each APC groups clinically similar, resource-similar services; CPT/HCPCS codes drive APC assignment, and status indicators tell the system how an item pays (separately paid, packaged/bundled, etc.). Multiple APCs can be paid on one outpatient claim.

RBRVS (Resource-Based Relative Value Scale), implemented through the Medicare Physician Fee Schedule, pays physicians per service. Payment = (work RVU + practice-expense RVU + malpractice RVU), each adjusted by a geographic practice cost index, multiplied by the conversion factor (a national dollar amount).

Post-acute systems use patient-assessment instruments:

• SNF PPS → Patient-Driven Payment Model (PDPM), driven by the MDS (Minimum Data Set).
• IRF PPS → Case-Mix Groups from the IRF-PAI.
• HH PPS → Patient-Driven Groupings Model (PDGM), 30-day periods, driven by OASIS.

Key distinction: IPPS classifies by MS-DRG per discharge; OPPS classifies by APC per service/encounter — a frequent RHIT exam contrast.

Why PPS Was Created and How Hospitals Respond

Before IPPS launched in 1983, Medicare paid hospitals on a cost-reimbursement basis — the more a hospital spent, the more it was paid, which drove costs upward with no efficiency incentive. The shift to prospective, per-case payment reversed that incentive: under a fixed DRG rate, the hospital keeps the difference if it treats the patient for less than the rate and absorbs the loss if it spends more. PPS therefore rewards efficient, well-documented care and penalizes waste.

This is also why documentation specificity became financially central. The same admission can group to a higher- or lower-weighted MS-DRG depending entirely on whether a complication or comorbidity is documented and coded. Two patients who receive identical care can yield very different payments based on the record alone — the engine behind the entire CDI discipline.

Outliers, transfers, and the three-day window

• Cost outliers: an extraordinarily expensive case can earn an add-on payment above the DRG rate once costs exceed a fixed-loss threshold.
• Transfer rule: when a patient is transferred to another acute hospital (or, for certain DRGs, discharged to post-acute care), payment may be reduced to a per-diem amount rather than the full DRG.
• Three-day payment window: outpatient diagnostic and related services in the 72 hours before an inpatient admission are bundled into the inpatient DRG and may not be billed separately.

Reading a Relative Weight

The relative weight is a multiplier, not a dollar figure. A DRG with a weight of 2.0 consumes roughly twice the resources of the average case (weight 1.0) and pays about twice the base rate. Summing and averaging these weights across all discharges yields the case-mix index, covered in 5.5, which is why DRG assignment and the CMI are inseparable concepts on the exam.

A worked example: if a hospital's base rate is $6,000 and a patient groups to a DRG with a relative weight of 1.5, the base operating payment is roughly $9,000 (before wage-index and add-on adjustments). Move that same patient into the "with MCC" tier at a weight of 2.4, and the payment rises to about $14,400 — a $5,400 swing driven entirely by one documented and coded major complication. This single comparison captures why CDI and accurate coding are framed as revenue functions, not just compliance ones.