The Chapter 83 System (System) was developed in New Jersey in the mid-1970s and implemented beginning in 1980. It changed the reimbursement system from a “Hotel Model” payment based on length of stay (LOS) to a “Per Case Model” based on illness primarily as defined by specific ICD-9 diagnosis and procedure codes.  The clinical information was merged with other information, including, patient demographic data, to be “grouped” into the applicable Diagnosis Related Group  (DRG) . The theory was that in the Hotel Model hospitals were be incentivized to keep the patient in the hospital longer whereas reimbursement under a Per Case Model, based on an average LOS, would incentivize a hospital to discharge the patient as soon as medically proper.




The Chapter 83 System was funded through a grant of $4m from the federal government. NJ also received a waiver from Medicare payment principles during this time and therefore was able to create an “All-Payer System”. All patients were covered under the Chapter 83 reimbursement system, even those unable or unwilling to pay.


Unique Features of the System


Working Cash Infusion (WCI): Hospitals entering the System could qualify for a WCI if their balance sheet was not up to certain financial standards. The new System was designed to reward efficiency and punish inefficiency.  However, if a hospital entered the system in poor financial condition, it would put them in a difficult position to compete. Thus, the WCI component.


Capital Costs:  The hospitals had a choice of choosing to be reimbursed on principle & interest or depreciation & interest for their building and fixed equipment costs. Initially, this was a choice made annually but this was quickly recognized as a flaw and was corrected, requiring hospitals to choose a single method and live with that choice going forward.


Capitalized Interest:  As an experiment within an experiment, three (3) hospitals were paid for their capitalized interest as it was incurred. The theory was that if the interest was paid while it was incurred , it would be less costly in the long run as this interest would not be compounded. This experiment was discontinued after the three hospitals received it, as it was found to be too costly.


Uncompensated Care:  Charity care patients (patients who could not afford to pay) and Bad Debts (people who refused to pay) were included as a cost to paying patients and third party payers. The System started out by adding the individual percentage of uncompensated care to the individual hospital rates but found that this put those hospitals with high uncompensated care percentages at an unfair competitive disadvantage. Later an uncompensated care fund was created and all hospitals had a uniform add-on to their rates. Hospitals with actual uncompensated care rates higher than the average would receive money from the fund and hospitals with actual uncompensated care percentages lower than the average would pay into the fund.


Uniform Bill (UB):  A uniform bill was created to be used by all payers. This was not only used for billing purposes but the corresponding data was used to set and cost-out the base year rates. Cost-to-charge ratios were created and applied to the bills. Each bill that was costed-out was then averaged within each DRG and that average was used to create the standard.


Trim Points:  The purpose of utilizing LOS trim points was to pay for “outliers” in a different manner than inliers. Inliers were patients that fell within the average length of stay and therefore could be reimbursed  based on a standard average rate. Outliers were patients within a DRG that, for whatever reason, were treated in a very unusually short or long period of time. The trim points were based on standard deviations and set for each DRG. Inliers were paid for by a standard rate, low outliers were paid for on a low per diem rate and high outliers received the inlier rate plus the high per diem.


Length of Stay (LOS) Adjustment:  As hospitals began to treat patients in a shorter time frame (less inpatient days), what were once high outliers came to be reimbursed as inliers under the original trim points. However the cost of treating the patient was not going down as fast as the reimbursement. This ended up penalizing some of the more efficient hospitals. The LOS adjustment was introduced to incorporate a methodology to shift the rate year cases back to the allocation of inliers and outliers based on the base year.


Teaching Costs:  Over time regression analysis was done so that teaching costs could be removed from the standards. The regression analysis highlighted the fact that the concentration of residents within specialties were a large contributing factor of costs incurred in treating the patients.




Hospital Rate Setting Commission (HRSC):  The Commission was established to set rates and hear appeals. It consisted of representatives from the hospital industry, Department of Insurance, Department of Health and the general public.


Rebasing:  The purpose of rebasing was to continually adjust rates as hospitals treatment patterns changed, including treating patients in less time since the treatment should then be less costly. Ultimately, the base years that were used were 1978,1979,1982 and 1988. Each year had a different rationale for being used. 1978 was used for the first 26 hospitals entering the system in 1980. In 1980 there were over 100 acute care facilities in NJ. 1979 was used for the hospitals that were not able to produce good UB data in 1978. 1982 was used as that was the first year all acute care facilities were on the Chapter 83 System. 1988 was used to capture the effects of the nursing shortage4 that was occurred in the mid 80s.


Extraordinary Appeals:  Hospitals which had large deficits under the Chapter 83 System were allowed to appeal for extraordinary relief.


Why Did the System Fail?


Hospitals were not incentivized to lower uncompensated care costs so they spent their scarce dollars in areas that were being under-reimbursed. Other reasons for the system failing include the following:


Uncompensated Care:  Uncompensated care costs continued to rise over the years. Grants that were previously given to hospitals from governmental agencies were no longer provided because uncompensated care was a pass-through and paid for under the Chapter 83 System. Also,

Loss of Medicare Waiver:  The Medicare waiver was given based on the premise that Chapter 83 would result in lower costs for Medicare patients than would be incurred under the federal PPS system. The waiver was lost in 1989 and therefore the shortfall had to be made up from the remaining payers.


Appeal Process:  The process was time consuming, not timely and allowed for appeals of almost any issue imaginable


Length of Stay Adjustment:  The whole premise of the Chapter 83 System was to lower the overall patient length of stay and therefore decrease costs. By putting in the Length of Stay Adjustment it, in effect, transferred the shorter length of stay patients back to the length of stays occurred in the base year.


ERISA:  The ERISA plans sued based on the premise that they could not, and should not, pay for services (uncompensated care add-on) not incurred by their subscribers. ERISA won the preliminary case but lost on appeal.


Political Football:  The Chapter 83 system had mixed reviews from the politicians and the ERISA lawsuit provided the detractors a reason to dump the system.


Possible Solutions


Although a lot of the errors made in the earlier years were corrected (i.e. options on paying for buildings and fixed equipment and capitalized interest), Chapter 83 ended before all the mistakes could be corrected.


The Medicare PPS system should have been appealed by the NJ hospitals and the Chapter 83 System itself should have encouraged such action by incentivizing the hospitals. For example, amounts won on appeal could have been shared as profits to the hospital and also used to lower the Chapter 83 rates. After the Chapter 83 system ended, hundreds of millions of dollars were won by NJ hospitals appealing the PPS rates. Therefore it is very unlikely that Chapter 83 actually paid more than the PPS rates, at least not in 1989 when the waiver was lost.


The Length of Stay Adjustment should have been replaced by a more frequent rebasing including adjustments to the trim points.




The appeal process should have been streamlined to disallow all but the most significant issues and appeals should have been heard by the HRSC in a more timely manner.


When it came to Uncompensated Care, bad debts needed to be dealt with more aggressively. Charity care had to be addressed as a social issue and not as an add-on to rates. After the Medicare waiver was lost, Chapter 83 rates were increased approximately 20 percent to paying patients to account for the non-paying patients.


About the Author


Phil A. Besler, CPA, FHFMA, brings 35 years of experience in healthcare finance to the job that includes analyzing and implementing federal and statewide reimbursement laws, monitoring of federal and statewide reimbursement systems, assisting hospitals and other healthcare providers in the management of both regulated and non-regulated reimbursement systems, and representation on many healthcare committees. Since founding Besler Consulting, Phil has been responsible for meeting the financial consulting needs of over 100 healthcare clients. One of his most significant contributions to date was the forefront position he assumed in the Jersey Shore 1992 PRRB appeal case, which led to Program Memorandum 99-62, the inclusion of Charity Care and General Assistance days in the hospital DSH calculation. This effort resulted in over $300 million of additional revenue for New Jersey hospitals alone. Prior to becoming President of Besler Consulting, Phil was a Senior Manager at Ernst & Young and earlier served the State of New Jersey Department of Health as Chief of Rate Setting. He is a licensed Certified Public Accountant and is a member of both the American Institute of Certified Public Accountants. He holds a Bachelor of Science Degree in Accounting and is a graduate of Wilkes University in Pennsylvania.


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