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The CMS Hospital Quality Incentive and Penalty Programs: Where Do They Stand?

Tawnya Bosko, DHA, MS, MHA, MSHL
Vice President,
The Camden Group, El Segundo, CA

On the heels of the release of the Centers for Medicare and Medicaid Services (CMS) Inpatient Prospective Payment System (IPPS) fiscal year (FY) 2016 final rule, it seems fitting to review the CMS hospital quality incentive and penalty programs, given that by 2017 they will collectively make up to six percent of hospital Medicare payments at risk. The three programs are the Value-Based Purchasing (VBP) program, the Hospital Readmissions Reduction Program (HRRP) and the Hospital Acquired Conditions (HAC) program. As part of healthcare reform, these programs are designed to transition hospitals to more value-based reimbursement by incentivizing or penalizing providers based on their performance on certain quality metrics. The broad questions of whether the programs are designed correctly and whether Medicare has chosen the most appropriate metrics underscore the complexity of reimbursing providers based on quality, but overall these three programs provide a fundamental change in how Medicare reimburses hospitals for services and in how hospitals manage and monitor quality performance.


The VBP program is largely a payment redistribution program where each eligible hospital contributes a set percentage of base operating payments to a VBP payment pool, 1.5 percent for FY 2015, 1.75 percent for FY 2016 and 2 percent of base operating payments when fully phased in (2017). This VBP payment pool is used to bonus hospitals for performance on the VBP criteria which are separated into domains including process of care, outcomes, patient experience and efficiency and weighted as indicated in Graph 1. If a hospital receives less than the set percentage contribution to the pool (i.e., 1.75 percent for FY 2016), then it is essentially penalized for VBP because its bonus is less than its contribution. Likewise, if its performance warrants a VBP payment greater than the set percentage contribution, it is essentially receiving a bonus or upward payment adjustment for VBP. For FY 2015, 55 percent of eligible hospitals received a bonus under the VBP program. However, only about 800 of those hospitals still profited after considering CMS’ other quality incentive and penalty program performance.1

The VBP is the only one of the three CMS quality programs that offers bonuses, though it is on a budget neutral basis. Further, it is also the only program that takes into account a hospital’s improvement even if the hospital’s performance is still subpar.2

CMS has indicated its emphasis on the efficiency and outcomes measures as shown in Graph 2. The increased weights from FY 2015 to FY 2016 in each of these domains and a lesser focus on process of care measures, which will represent only 10 percent of VBP for FY 2016, signifies a gradation moving from performing certain processes to showing quality outcomes and efficiency.


The HRRP is strictly a penalty program applied to those hospitals that have excessive preventable readmissions for certain conditions as shown in Table 1. The HRRP was phased in beginning in FY 2013 with a one percent penalty maximum for that year and reached its overall maximum penalty of three percent of hospital base operating payments in FY 2015. As shown, the HRRP performance data period is a three year rolling timeframe. For its first year in FY 2013, results were based on performance from July 1, 2008 – June 30, 2011. The rolling three year data period has continued, which means, for example,the data period has already ended for the new measure coronary artery bypass graft (CABG) that will be included for FY 2017.

For FY 2016, only 799 of 3,414 (23 percent) of all eligible hospitals will avoid a penalty for excess avoidable readmissions, meaning 77 percent of all eligible hospitals will be penalized. However, the majority of hospitals penalized have a penalty in the range of .01 - .5 percent as shown in Graph 3; and the number of hospitals penalized as well as the average penalty fell from FY 2015.1 In FY 2015, 10 percent of hospitals accounted for approximately 50 percent of total penalties; while most other penalized hospitals had a modest impact.2 Since the readmissions penalties were enacted, readmissions have dropped, but still, approximately one in five patients admitted to the hospital are readmitted within 30 days of discharge.3

For FY 2016, there are 38 hospitals that fell in the worst performing category, meaning they will received the maximum penalty of three percent for avoidable readmissions for FY 2016. Of those “worst performing,” 13 (34 percent) are surgical specialty hospitals that were not subject to readmission penalties until FY 2015 when hip and knee replacements were added as a metric. Thus, the HRRP program is somewhat new to these facilities. Another five (13 percent) of the worst performers are part of the Appalachian Regional Healthcare system based in Kentucky, which contributes to Kentucky’s having the highest average HRRP penalty for FY 2016.4

HRRP penalties are estimated to be $420 million for FY 216. Additionally, the 2016 IPPS Final Rule expanded the pneumonia measure to include patients with a principal discharge diagnosis of pneumonia or aspiration pneumonia and with a principal diagnosis of sepsis with a secondary diagnosis of pneumonia beginning in FY 2017.5 CABG is also being added to the measures included for readmissions for FY 2017 as shown in Table 1. The program is often criticized for lack of adjustment for socioeconomic factors, which has been recommended by MedPAC.  


The HAC program, or one percent penalty applied to the worst performing quartile of hospitals with regard to conditions that patients acquire while receiving treatment for another condition in an acute care setting is the newest of the CMS quality-related programs, having been made effective for FY 2015. Unlike the VBP and HRRP, the HAC penalty is not limited to just the hospital base operating payment, but rather it includes add-on payments such as outliers, disproportionate share hospital (DSH), uncompensated care and indirect medical education (IME) making its impact more pronounced. The HAC penalty, ifapplicable, is applied after these add-on payments and any other quality program (VBP and HRRP) adjustments. A report by the Agency for Healthcare Research and Quality (AHRQ) showed that the number of medical errors decreased by 17 percent between 2010 and 2013. However, the same study showed that even with the decrease, one in eight hospital admissions included a patient injury in 2013,6 highlighting the need to focus on HACs.

As shown in Graph 4, there is considerable overlap of the HAC measures between domains within HAC and with those in other quality-based programs such as the VBP. For example, the National Healthcare Safety Network (NHSN) central line associated infections measure is also represented in the Agency for Healthcare Research and Quality (AHRQ) PSI 90 composite; and both also appear in the VBP program, making their impact more significant. Further, CMS calculates the HAC measures using different periods of time and for different lengths of time than that used in the VBP program for the same measures. While additional measures are planned and the weighting of domains changing, the total penalty is currently fixed at one percent.

FY 2015 penalties were estimated at $373 million for the 721 hospitals penalized.7 And, in FY 2015 urban teaching hospitals made up nearly half (45 percent) of the hospitals that were penalized for HAC,8 which is a main reason that the HAC program draws criticism. Also, the statute requires that the worst performing quartile of hospitals be penalized regardless of whether they have shown improvement and regardless of how different the worst performing hospitals’ performance is from that of other hospitals.2 

While each of these programs has flaws that should be assessed and corrected, CMS has made it clear that the hospital reimbursement structure is changing to incentivize value, efficiency and outcomes. While the metrics, weights and data periods may change, value-based reimbursement will continue to have an impact in redesigning the healthcare delivery system. As shown in Graph 5, the current value-based programs will have an increasing share of hospital payment at risk over the coming years. Properly designing and aligning financial incentives to drive effective behavior change is imperative to the success of our healthcare system. In this transition period, hospitals should understand the current metrics and take steps to proactively analyze their performance, institute performance improvement programs and increase the overall value of care delivered within their system. While performance on the current programs directly impacts hospitals’ bottom lines, increased access to information on hospitals’ performance through transparency initiatives such as Yelp partnering with ProPublica to incorporate hospital performance data9 into their reviews and other initiatives could ultimately impact consumer choice, increasing the importance of performance on quality metrics. There are legitimate reasons to criticize the current programs. However, hospitals should use these metrics as a starting point to improve internal processes, assess external relationships and provide more effective care.

1Kaiser Health News (2015) http://khn.org/news/1700-hospitals-win-quality-bonuses-from-medicare-but-most-will-never-collect/
2 Kahn, C., Ault, T., Potetz, L., Walke, T., Chambers, J. and Burch, S. (2015) Assessing Medicare’s Hospital Pay-For-Performance Programs And Whether They Are Achieving Their Goals. Health Affairs, 8:1281-1288.
3 Kaiser Health News (2015) http://khn.org/news/half-of-nations-hospitals-fail-again-to-escape-medicares-readmission-penalties/
4 Becker’s Hospital Review (2015) http://www.beckershospitalreview.com/quality/the-38-hospitals-facing-highest-medicare-penalties-for-readmissions.html
5 The Center for Medicare and Medicaid Services (2015) https://www.cms.gov/Newsroom/MediaReleaseDatabase/Fact-sheets/2015-Fact-sheets-items/2015-07-31-4.html
6 The Agency for Healthcare Research and Quality (2014) http://www.ahrq.gov/professionals/quality-patient-safety/pfp/%20interimhacrate2013.html
7 Kaiser Family Foundation (2014) http://khn.org/news/medicare-cuts-payments-to-721-hospitals-with-highest-rates-of-infections-injuries/
8 Health Affairs (2015) Medicare’s Hospital Acquired Condition Reduction Program. Health Policy Brief.
9 The Washington Post (2015) http://www.washingtonpost.com/news/to-your-health/wp/2015/08/05/coming-to-yelp-a-bigger-dose-of-data-on-health-care-facilities/

Tawnya Bosko, DHA, MS, MHA, MSHL, is a Vice President with The Camden Group with over 20 years of experience in healthcare management and strategy specializing in healthcare economic analysis and strategy formulation, optimization and efficiency studies, healthcare costs, quality and prices and reimbursement and incentive model methodologies. Dr. Bosko holds a doctoral degree in health administration from the Medical University of South Carolina, a master’s degree in healthcare administration from the University of North Carolina at Chapel Hill, a master's degree in applied economics from Georgia Southern University, a master's degree in health law from Nova Southeastern University, Florida and a bachelor’s degree from Kent State University, Ohio. She can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..


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