A fundamental assumption of categorical payment systems such as Medicare's diagnosis related groups (DRGs) is that one can identify characteristics of patients (eg, diagnosis) and of hospitals (eg, location) that predict costs, and, thereby, one can construct reasonable payment categories. However, the current DRGs for psychiatry are poor predictors of cost. If widely implemented, they would differentially jeopardize some hospitals and invite provider responses that would jeopardize needier patients. These dangers may be lessened by creative manipulation of the rules by which payments are determined and of the design of payment systems, which are configured so that the service providers themselves are motivated to provide adequate care.
In the early 1980s, Medicare's trust fund was going broke at an alarming rate. To avert bankruptcy, a radical shift in payment methodology was instituted. Since 1983, Medicare's Prospective Payment System (PPS) has reimbursed hospitals a fixed amount per hospital discharge