Cost-Based Reimbursement

Cost-based reimbursement is a retrospective payment system in which the payer agrees to reimburse the provider for allowable costs incurred while providing health care services to the covered population. Allowable costs are generally defined as all costs related to the health care services provided. Cost-based reimbursement is based on how much a medical service costs rather than on how much the provider charges for the service.

This system of payments resulted in increasing medical expenditures, because a cost-based reimbursement system encouraged health care spending rather than limited it. The payer assumed all the financial risk for providing health services, because the provider was assured of reimbursement for all costs incurred in providing care. Consequently, this system of reimbursement contributed to excessive use of medical services and overinvestment in capital assets.

Medicare payments to hospitals were under this form of payment beginning in 1965 when the Medicare program was signed into law. Cost-based reimbursement for most hospitals ended in 1983 and ended for the physician/provider population in 1992 as prospective payment systems were implemented. In the Medicare program, costbased reimbursement was replaced by a prospective payment system implementing diagnosis-related groups (DRGs) for payment of hospital inpatient services, and ambulatory payment classifications (APCs) for hospital outpatient services.