Hospital readmission, generally defined as an unplanned return to a hospital within 30 days of discharge, represents a significant financial liability for healthcare providers. High rates of these rapid returns are viewed by major payers, most notably the federal government, as an indication of poor care coordination or substandard quality of initial care. This perception has led to policy changes that directly link a hospital’s readmission performance to its financial reimbursement, transforming a quality metric into a powerful financial incentive.
The Hospital Readmissions Reduction Program
The primary mechanism linking readmission rates to hospital finances is the Hospital Readmissions Reduction Program (HRRP), a federal policy established to encourage better post-discharge care. Mandated by the Affordable Care Act (ACA) and administered by the Centers for Medicare & Medicaid Services (CMS), HRRP specifically targets payments made under the Medicare Inpatient Prospective Payment System (IPPS).
The program’s goal is to incentivize hospitals to reduce avoidable readmissions by improving communication and care coordination for Medicare beneficiaries. When the program began in 2012, it initially tracked three conditions, but the list has since expanded to include six conditions:
- Heart failure
- Acute myocardial infarction (heart attack)
- Pneumonia
- Chronic obstructive pulmonary disease (COPD)
- Coronary artery bypass graft (CABG) surgery
- Elective total hip and total knee arthroplasty (joint replacement)
Hospitals with a high volume of Medicare patients face the greatest financial risk under this program, compelling them to invest in robust discharge planning and follow-up care.
Methodology for Calculating Payment Adjustments
The financial penalty under the HRRP is calculated using the Excess Readmission Ratio (ERR), which compares a hospital’s actual performance to a national standard. The ERR is a risk-adjusted ratio that divides a hospital’s predicted readmission rate by the expected rate for a similar patient population. A ratio greater than 1.0 indicates the hospital has more readmissions than expected, signaling poorer performance relative to the national benchmark.
CMS calculates a separate ERR for each tracked medical condition and procedure. These individual ratios are combined into a single hospital-specific payment adjustment factor. This factor determines the percentage reduction applied to the hospital’s total Medicare operating payments for all IPPS discharges during the fiscal year, not just those related to the penalized conditions.
The maximum payment reduction a hospital can incur is capped at 3% of its total Medicare reimbursement. This penalty is applied to the hospital’s base operating rate, lowering the reimbursement received for every Medicare patient discharge throughout the year. Although the average penalty is often less than the 3% maximum, the loss is sustained across all Medicare payments, creating a substantial financial burden for hospitals with consistently high ERR scores.
Indirect Financial and Operational Impacts
Beyond the direct payment cuts imposed by the HRRP, high readmission rates generate several indirect financial and operational challenges. The financial strain includes significant uncompensated care costs and wasted resources, as the hospital must dedicate staff and capacity to treat patients whose return could have been avoided. The overall cost of unplanned readmissions for Medicare beneficiaries alone is estimated to be in the tens of billions of dollars annually.
A hospital’s readmission performance also influences its standing in other quality-based payment programs, such as the Value-Based Purchasing (VBP) program. Readmission measures are a component of the overall quality score used in VBP, meaning poor performance can trigger additional penalties or prevent a hospital from earning incentive payments. A hospital’s published readmission rates can also negatively affect its reputation, leading to challenges in negotiating favorable rates with private insurance payers who use publicly reported quality metrics to inform contracting decisions.