HERC: Estimating Medicare Payments
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Estimating Medicare Payments


Medicare Basics

Determining the Relative Value of Outpatient Services

To find the cost of outpatient services, we recommend that Medicare reimbursement rates developed by CMS be used. Medicare regulations report a relative value for CPT codes for physician, anesthesiology, and laboratory procedures. A conversion factor translates these relative values into a reimbursement amount. This relative value is converted to a reimbursement rate by multiplying the relative value by a conversion factor. As an example, for the year 2009, Medicare paid physician and laboratory providers about $36.07 for each unit of relative value; anesthesiologists were reimbursed about $20.92 per unit.

Medicare Relative Values

Medicare has adopted the Resource Based Relative Value System to reimburse providers for services provided to Medicare patients. Care is characterized by a CPT code. Each CPT code has an associate set of relative values (RVUs), consisting of Facility, Physician Work, and Malpractice RVUs.

  • Global Fees
    The RVUs for some procedures reflect a global fee that reimburses the providers for the procedure, for visits that occur immediately before the procedure, and for visits after the procedure was performed. For each procedure, CMS indicates the length of the follow-up period that the global fee covers. Global fees give providers an incentive to be efficient, and use the minimal number of visits. The cost analyst has a different concern, wishing to adopt a method in which the cost estimate reflects the number of visits that occur before and after the procedure. For this reason, we recommend that the analyst not apply global fees, but whenever possible, apply separate RVUs for the procedure and the pre-procedure and post-procedure visits.
  • Facility vs. non-facility RVUs
    CMS has created two sets of RVUs for the practice expense component of care. The standard payment is for office-based provider services. If the service is provided in a setting that meets the CMS definition of a "facility" (hospitals, ambulatory surgery centers, etc.) then the facility is eligible for a separate facility payment and this reduces the practice expenses component of many procedures. The difference is these two sets of RVUs is generally small, but it can be substantial for certain procedures. The relative values for each CPT code may be downloaded from the CMS web site. The analyst should apply the facility weights for care at VA medical centers. It is uncertain whether the office setting should be applied for care provided by VA satellite clinics, or whether VA databases provide sufficient information to determine where care is actually delivered.

    When the facility weights are used for the provider payment, the facility payment should also be included in the pseudo-bill. When including facility payments, one must be careful to not double count payments, especially for images and non-surgical procedures such as cardiac tests.

Services Not Reimbursed by Medicare

Many of the CPT codes used by VA do not appear on the list of services that are reimbursable by Medicare. There are several reasons for this, including the following:

  • Medicare does not pay for the service,
  • the VA code is not specific,
  • the VA code is out of date,
  • the VA code is not a valid CPT code.

In general, we believe that a cost should be assigned to all services, even if they are not reimbursable by Medicare. It is the challenge of the analyst to make as few assumptions as possible in assigning the RVU (and thus estimate the cost). We consider each of these problems in turn.

  • Gap Codes
    There are some services which Medicare does not pay for. These services have a CPT code, but HCFA has not assigned them a relative value unit. These CPT codes are known as "gap codes." Relative values for these procedures are developed by private firms such as Optum, and are generally available for a fee.
  • Unspecified Procedures
    CPT codes for unspecified procedures, typically ending with the digits "99", do not have a Relative Value Unit assigned to them. Among the top 30 CPT codes used by VA are the following unspecified codes for laboratory tests:

    85999 - Unlisted hematology and coagulation procedure
    84999 - Unlisted chemistry procedure
    83999 - Unlisted miscellaneous pathology test


The analyst can assign an RVU by assuming that the unlisted code represents a typical procedure of its type. Thus the RVU would be the weighted mean RVU of the procedures of that type, with the weight the relative frequency the procedure is used by VA. Using this method we would assign an RVU to 85999 "Unlisted hematology and coagulation procedures", based on the VA weighted mean RVU for hematology and coagulation procedures, that is, all procedures reported in the range of CPT codes 85002-85810.

Estimating What Medicare Would Have Paid for a VA Inpatient Hospital Stay

VA cannot bill Medicare for care provided to Veterans. However, calculation of a hypothetical Medicare reimbursement is useful to cost analysts who are interested in estimating the resources used to provide VA inpatient care. Medicare reimburses both hospitals and providers for the cost of inpatient stays.

Hospital payment

Medicare reimburses hospitals based on the Diagnosis Related Group (DRG) that is assigned to the hospital stay. Medicare determines the national average charge for each DRG and expresses them as relative values; these are known as DRG weights. A schedule of DRG weights is published annually by Medicare; these are available from the Federal Register and from the Centers for Medicare & Medicaid Services (CMS) website.

Medicare pays a standard amount for each unit of DRG weight. Medicare makes additional payments to hospitals for capital, to compensate them for outlier cases, for the indirect and direct costs of medical education, and to assist hospitals that have a disproportionate share of indigent and Medicaid patients.

Here is one method of estimating the Medicare reimbursement. This method assumes that the additional payments for capital, outliers, medical education, and disproportionate share, should be assigned to stays in proportion to their DRG weight. This assumption will result in a estimate that is likely to mean very near the national average Medicare payment for that DRG. This assumption means that the cost estimate won't reflect the effect of the hospital's own medical education or wage costs, which do influence Medicare reimbursement.

This example uses data from 1996. The sources of information used to calculate these payments included:

  • Federal Register / Vol. 60, No. 170 / Friday, September 1, 1995 / Rules and Regulations, "Medicare Program; Changes to the Hospital Inpatient Prospective Payment Systems and Fiscal Year 1996 Rates; Final Rule".
  • Medicare and the American healthcare System: Report to the Congress. Prospective Payment Assessment Commission, June 1997

It was determined that the average Medicare payment per DRG weight in 1996 was $5,267. The table lists the components that entered this payment calculation.

Components that entered this payment calculation
Payment Per DRG Weight Type of Payment
$3808.00 Standard Payment
$194.22 Outlier Payments
$512.15 Capital Payments
$298.43 Indirect Medical Education
$291.94 Disproportionate Share Provider Payments
$162.19 Direct Medical Education
$5,266.93 Total Payment

Standard payment rate
There are separate standard payment rates for large urban and other areas. The value of $3,808 is an average of the values published in the Federal Register. The average was weighted by the DRG relative value units produced by hospitals in large urban areas and hospitals in other areas. The estimate of DRG relative value units was from the ProPAC report.

Additional payments
Outlier payments were expected to be 5.1% of the DRG payments according to the regulation. This was $194.22 per DRG weight. The regulation projected that 1996 capital payments would be $727.26 per discharge. Since there was an average of 1.42 DRG weights per discharge in FY96, capital payments would be $512.15 per DRG weight. The Indirect Medical Education (IME) Payments were 7.84%, or $298.43. The Disproportionate Share Provider (DSH) payments were 7.67%, or $291.94. Direct Graduate Medical Education (GME) payments were 4.26% or $162.19.

These additional payment rates were calculated from the 1997 projected data published by ProPAC. Total amount paid on the basis of standard payments was estimated by taking "operating payments" and subtracting outlier, IME, and DSH payments. Capital and direct GME were assumed not to be operating payments.

Alternate calculation methods. Using the $8 billion capital estimate in the ProPAC report gives a 13.63% capital cost, or $519.00 per DRG weight. Using the 5.28% outlier payments implied in the ProPAC report suggests a $201.11 outlier payment cost. Using this method, the total Medicare payment per DRG weight in FY 1996 is $5,281.

The CMS web site reports $87.5 billion in payments to acute hospitals for inpatient care in FY95, and that inpatient costs grew at an annual rate of 5.2% during the period 1990-1996. Also reported is the number of discharges by DRG in the Medpars data, and the schedule of DRG weight per discharge. These were used to determine that Medicare paid for 11.7 million discharges; these had an average DRG weight of 1.422, yielding a total of 16.7 million DRG weights. These data suggest an average payment of $5,509 per DRG weight in FY96. Since some discharges are excluded from the report (to avoid disclosing patient data) this figure represents an upper bound of the cost.

Estimating A Medicare Outpatient Facility Payment

Medicare reimburses providers and facilities separately. Outpatient facility payments cover the costs pertaining to outpatient care, such as the use of operating and recovery rooms for ambulatory surgery. The payments are limited to certain types of care and to specific types of facilities. Facilities eligible for Medicare facility payments include the following:

  • hospital-based clinics
  • emergency rooms
  • freestanding ambulatory surgical centers
  • federally qualified health centers
  • skilled nursing facilities
  • rural health clinics
  • comprehensive outpatient rehabilitation facilities
  • home health agencies
  • hospices

How do I get data on outpatient facility payments?

The one readily available data source for outpatient facility payments is the Medicare Outpatient Prospective Payment System. In August 2000, Medicare switched from fee-for-service reimbursement to a prospective payment system. Under prospective payment, Medicare assigns each current procedural terminology (CPT) code on the patient record to an Ambulatory Payment Classification (APC) group. Medicare bases the reimbursement rates on studies of the number, type, and cost of services provided. The method for applying APCs and the Medicare payment rates is available on the CMS website. Documentation for the HERC Outpatient Average Cost Datasets provides a more detailed discussion.

Last updated: April 12, 2023