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Medicare Part A covers inpatient hospital and critical access hospital (CAH) care, post-hospital skilled nursing facility (SNF) care, some home health services and hospice care.

Federal funding for Part A services is derived solely from the Hospital Insurance (HI) Trust Fund. That fund is largely created from payroll taxes. Beneficiaries also contribute out-of-pocket to the cost of their own medical care under Part A through the payment of deductibles and coinsurance.

Excerpt from Barry D. Alexander and James F. Flynn, Fundamentals of Medicare: Intro, Fundamentals of Health Law (American Health Lawyers Association Nov. 2011).


Medicare reimbursement is primarily operated under a Prospective Payment System (PPS) methodology, first implemented in 1983. Today, prospective payment systems figure prominently in Part A reimbursement. Generally, a prospective payment system is a “method of reimbursement in which Medicare payment is made based on a predetermined, fixed amount. The payment amount for a particular service is derived based on the classification system of that service (for example, diagnosis-related groups (“DRGs”) for inpatient hospital services).” CMS Glossary at

The majority of hospitals are paid by Medicare under the inpatient PPS methodology originally developed in 1983 and continually refined from year to year. Largely following the model used for inpatient hospital reimbursement, PPS methodologies have since been developed for each of the other major parts of Part A coverage as follows:

Skilled Nursing Facilities – phased in over 3 years beginning July 1, 1998

Home Health – on or after October 1, 2000

Inpatient rehabilitation facilities – on or after January 1, 2002

Long term care hospitals – on or after October 1, 2002

Inpatient psychiatric facilities – on or after January 1, 2005

Special payment provisions apply to hospitals identified as isolated or essential hospitals primarily located in rural areas. Such entities include sole community hospitals (SCHs), critical access hospitals (CAHs), rural referral centers (RRCs), and Medicare-dependent hospitals (MDHs).

Common Areas of Concern

Certain hospital types are excluded from PPS primarily because the government has been unable to devise a workable PPS methodology for these hospitals. These include children’s hospitals, cancer hospitals, and religious non-medical health care institutions. Medicare traditionally reimburses PPS-exempt hospitals for “reasonable costs” subject to a certain cost limit (known as the “TEFRA limit”). In Medicare parlance, these hospitals are frequently referred to as “TEFRA hospitals.” PPS-excluded hospitals receive a per diem interim payment for the cost of inpatient care that is subject to a final cost report settlement. Medicare uses the hospital’s net cost amount (i.e., exclusive of capital-related and medical education costs) to determine whether such costs exceed the program’s targeted cost threshold (the “TEFRA target amount”). Medicare imposes a “penalty payment” on hospitals that exceed the TEFRA target amount as only a portion of the excess cost will be reimbursed to the hospital. Similarly, hospitals will receive an “incentive payment” from Medicare if their final reimbursable costs fall below the TEFRA limit. Tax Equity and Fiscal Responsibility Act of 1982. Pub. L. No. 97-248, 96 Stat. 324. TEFRA hospitals are paid a target rate for their operating costs. The “cost with TEFRA limit” reimbursement scenario is set forth in 42 U.S.C.A. § 1395x(v), which defines “reasonable cost,” and at 42 C.F.R. §§ 412.22, 413.40.

Excerpt from James F. Flynn, Medicare Part A, Fundamentals of Health Law (American Health Lawyers Association Nov. 2011).