In the Balanced Budget Act of 1997, there are provisions for HCFA to implement a prospective payment system under Medicare for hospital outpatient services, certain Part B services furnished to hospital inpatients who do not have Part A coverage, and partial hospitalization services furnished by community mental health centers. All services paid under the new prospective payment system are classified into groups called Ambulatory Payment Classes, or APCs. There are 346 APCs grouped into four status types, and they will include all hospital outpatient services. The following shows what services are included and which services are specifically excluded in this new payment methodology.


  • Surgical procedures
  • Radiology
  • Clinic and ER department visits
  • Diagnostic service and tests
  • Partial hospital for the mentally ill
  • Surgical pathology
  • Cancer chemotherapy
  • Services provided to SNF patient that the SNF cannot provide, such as ambulatory surgery, CT scans, and MRIs
  • Certain preventive services
  • Antigens
  • Splints and casts
  • Pneumococcal vaccine, influenza vaccine, and hepatitis B vaccine


  • Services paid under a fee schedule, such as ambulance, laboratory, chronic dialysis, orthotics/prosthetics, physical therapy, occupational therapy, and screening mammography
  • Services covered by SNF prospective payment system

In the managed care marketplace, there are a handful of organizations that have picked up on this change and identified it as a major force in their long-term strategy planning over the next year. Others seem to be relying upon the fact that implementation of the APC system, which was supposed to go into effect January 1, 1999, was postponed by HCFA due to Y2K computer system concerns, so it is not on the immediate horizon. The literature is inconsistent with some articles stating that it will be implemented in January 1, 2000, and others follow HCFA's indications that it will be in effect July 1, 2000. HCFA states on its website,, "We will implement the PPS as soon as possible after January 1, 2000, and we will publish notice of the anticipated implementation date in the Federal Register at least 90 days in advance of the implementation."

It is time for hospitals to begin thinking about what internal operational changes they will need to make in order to use APCs as a payment methodology with 90 days notice. Hospitals and PHOs must see this change as imminent to their Medicare business.

Why is the federal government instituting yet another payment change? According to DeMarco & Associates, a healthcare consulting firm specializing in physician-driven integration including physician-hospital joint venture strategies, there is a drive for the federal government to work toward a national fee schedule for Medicare. A first step in this is to tie together DRGs with payments for outpatient services through a prospective payment methodology, such as APCs. Another reason is that in some cases, the DRG system does not create the intended savings or has been gamed by hospitals on the outpatient side. The federal government wants simplified billing and a level playing field. For example, in the APC system, DRGs will receive the same payment for a post-surgical observation for a particular procedure whether it was performed in the emergency room or in an outpatient setting. In addition, the federal government wants to level payments between outpatient DRGs and the ambulatory surgery center fee schedule, and the next step with APCs is to apply them to ambulatory surgery centers.

For hospitals, the implementation of APCs means that they will need to assess their internal operations, including billing, coding, and information systems. Physicians cannot look to the hospital to manage this change for them. Hospitals and physicians will need to cooperate at the office level to make sure that medical records and coding accurately reflect diagnosis that can be attached to the new APC payment categories. Hospitals will also need to look to their accounting department to conduct activity-based costing so time spent on a procedure, labor, supplies, pharmaceuticals, equipment, and anesthetics can all be tied to a particular case so that hospital can begin to track their costs and manage them efficiently. Moving toward the mindset of accepting a case rate from the federal government and then managing those dollars inside the hospital will be the long-term challenge for hospitals in the new millennium.

How will APCs compare with payment methodologies that have preceded them? The following is a profile of APCs and a comparison of APCs to DRGs and APGs (Ambulatory Patient Groups). APCs are a derivative of APGs, which are the result of Congress mandating the development of outpatient prospective payment system in 1986. In early 1983, inpatient prospective payment went into effect for Medicare, and over the next 10 years, Medicare outpatient expenditures rose from $2.7 billion to $9.9 billion. In 1988, HCFA awarded 3M Health Information Systems a grant to develop ambulatory patient groups. By the mid-1990s, 3M had completed two versions of the APGs and submitted implementation reported and recommendations to Congress.





Services Covered Outpatient except fee schedules Full range of ambulatory settings, including same-day surgery units, hospital emergency rooms, and outpatient clinics Inpatient 
Classification Unit Visit Visit Discharge 
Classification Variable Procedure Procedure Diagnosis 
Number and Type of Procedures 


  •  Significant     
  •  Surgical    
  • Medical Visits    
  • Ancillary tests and procedures 
  • Significant    
  • Ancillary tests and procedures    
  • Incidental 
Number of Classification Groups 346 290 497 
Number of assigned groups One or more One or more One 
Coding requirements CPT-4 procedures 

HCPCS codes 

ICD-9-CM diagnoses 

CPT-4 procedures 

HCPCS codes 

ICD-9 diagnoses 

ICD-9 procedures 

Age, sex factors 

Payment Weight per APC 

Rate per facility 

Discount factor 

Uniform ancillary packaging 

Multiple APG discounting 

Weight per DRG 

Rate per facility 

With the advent of APCs, also known as "Another Payment Change," one might expect all of the healthcare literature and conference agendas to highlight it and place under the microscope the impact that it will have on managed care. HCFA projects that when this system is in place, total payment to hospitals for Medicare allowed outpatient service will be reduced by an average of 3.8 percent. Payments to hospital for inpatient and outpatient Medicare services combined are projected to be reduced by 0.4 percent. Cancer hospitals and children's hospitals are expected to be hit the hardest, with revenue for Medicare outpatient expected to drop by 29.2 percent and 34.8 percent, respectively.

There are associations and organizations that are taking the lead on education in this area, showing managed care professionals how the APC payment methodology will impact long-term strategy of hospitals, as well as managed care enterprises overall. One such association is HFMA. Along with articles in its magazine and newsletters, HFMA state chapters have held workshops on the topic. On October 13, there was an audioteleconference, "Ambulatory Payment Classification: Tracking the System Issues," available through HFMA.

As the federal government attaches prospective payment methodology to the outpatient side of a hospital's business, the next link to build will be to the RBRVS payment methodology to have the inpatient and outpatient payments under one roof; a national unified fee schedule is born. With the federal government as the largest payer, managed care plans and employers will follow the APC methodology. "Many relationships between hospitals and physicians may be reconsidered in light of this payment methodology change," says Jennifer Marx, MBA, consulting analyst for DeMarco & Associates. "Hospitals will find all current single specialty joint ventures between hospitals and physicians may see a reduction in income as the hospital's billing will be attached to APCs for reduced payments."

There will be pressure for groups to innovate and be able to operate with payments below the APC methodology at some point in time. William DeMarco, president and CEO of DeMarco & Associates, states that the dawn of this prospective payment methodology brings to the healthcare system one of the biggest changes since the passage of the HMO Act. "APCs bring forward the necessity for hospitals to work with physicians to prepare for these changes. Hospitals with affiliations but no true 'management arrangement' with distant hospitals or clinics will not be able to bill for these distant outposts under APCs. There will be opportunities for physicians and hospitals to begin to innovate as Medicare links outpatient and inpatient care through one payment system."

You can contact Jennifer Marx at DeMarco & Associates at 815-877-8781 or send an e-mail to:

Reprinted by the PFS Forum with permission from DeMarco & Associates.

Publication Date: Wednesday, March 08, 2006