The Financial Risk to Hospitals Inherent in DRG, Per Diem, and Capitation Reimbursement Methodologies

EXECUTIVE SUMMARY This study uses Monte Carlo simulation to assess the short-term financial risk to hospitals inherent in three reimbursement methodologies. The results are quite consistent across a wide variety of assumptions concerning utilization and costs. The primary conclusions are as follows: DRG and per diem contracts have similar risk. If the health status of the population is correctly assessed, capitation contracts have less short-term risk than DRG or per diem contracts for fixed cost structures above 70 percent. When hospital managers are unable to assess health status correctly, capitation contracts are significantly riskier than DRG or per diem reimbursement methodologies. Small populations increase the risk of capitation contracts relative to DRG and per diem contracts. Although the simulation analysis assessed only short-term risk, it is clear that capitation contracts have long-term risks that are not inherent in DRG and per diem contracts. The results have significant implications for hospital managers regarding both information needs and managerial responses to managed care plan contracts.