Final answer:
Hospital reimbursement prior to the Prospective Payment System (PPS) was based on a fee-for-service system, where providers were paid according to the cost of services provided. This created incentives for unnecessary services and higher costs. Modern payment systems like PPS and DRG aim to standardize and control such expenditures.
Step-by-step explanation:
Before the inception of the Prospective Payment System (PPS), hospitals used to get reimbursed through a fee-for-service system. This system involved medical care providers receiving compensation corresponding to the cost of the services they provided. Alternatively, Health Maintenance Organizations (HMOs) represent a different health care organizational structure in which providers are paid based on the number of patients they manage, rather than for each service they perform. Adverse selection is a critical concern in insurance markets because it occurs when insurance buyers possess more knowledge about their health risks than the insurers, leading to potential financial imbalances for the insurance providers.
Under the fee-for-service model, there was no limit on the daily charges and this gave an incentive to increase the quantity of services, potentially leading to unnecessary medical spending. Now, the Diagnosis-Related Group (DRG) system is commonly used in conjunction with PPS to determine hospital payments for Medicare patients, where each DRG represents a category of diagnoses that are expected to consume similar healthcare resources. Hence, the hospital reimbursement was previously generated on a fee-for-service basis, representing an incentive structure that the modern PPS and DRG models aimed to improve upon.