On April 29, the Centers for Medicare and Medicaid Services (CMS) issued final rules and a methodology on Medicare “value-based purchasing” for acute inpatient hospital services, as required by section 3001 of the Affordable Care Act (ACA), arguably the most far-reaching reform in Medicare hospital payments since introduction of DRGs in 1983. The final rules follow proposed rules on January 13 and a 60 day public comment period. The final rules govern Medicare DRG payments for 3,500 acute care hospitals for discharges on or after October 1, 2012. Hospitals will face a 1.0 percent ($850 million in the aggregate) reduction in base operating Medicare DRG payments for 10/1/12-9/30/13. The reduction percentages will grow each subsequent year, reaching 2.0 percent for 10/1/16-9/30/17. The savings will be reallocated to underwrite an incentive pool for each year. Each hospital will have an opportunity to earn incentive payments from the pool that will be tied to statistical measures of patient safety, efficiency, and quality of care. Incentive payments will be based on an annual, composite score for each hospital. Hospital performance will be measured using data that hospitals have been reporting to CMS since 2004 under the Hospital Inpatient Quality Reporting Program (HIQRP) which are posted to the CMS “Hospital Compare” website. Composite scores will be calculated for each hospital for the year beginning 10/1/12 based on 12 clinical process of care measures (70 percent of the composite score), such as correct administration of preventive antibiotics within an hour before surgical incisions and proper administration of beta blockers for coronary care patients; and 8 “patient experience of care” measures (30 percent of the composite score), such as pain management, physician communication with congestive heart failure patients about medication use after discharge, etc. Patient experience of care will be measured through statistically representative surveys of recently discharged patients. Hospitals will be scored on their own performance compared to their peers as well as their improvement as compared with baseline periods, usually getting credit based on the higher of the two. Composite scores will be calculated differently for each hospital for the year beginning 10/1/13, using an expanded data set including outcome measures such as hospital-acquired condition measures (infections, accidents, etc.), patient mortality measures, and additional patient safety and quality measures. The final rules include revisions to Medicare regulations governing the collection and use of hospital data by Quality Improvement Organizations (QIOs) and detailed explanations of the algorithms that CMS will use to calculate incentive payments for each hospital. CMS incorporated significant changes based on valuable public comments from hospitals, physicians, state agencies and other Medicare/Medicaid stakeholders. CMS’ approach remains reasonably fluid (within ACA parameters) and will continue to evolve through sub-regulatory issuances. State Medicaid agencies that are independently pursuing pay-for-performance, quality improvement, and cost reduction strategies should continue to share their expertise with CMS, analyze CMS statistical methods and assumptions that may affect the financial performance of key hospitals in their states, and align their payment strategies with Medicare where consistent with state objectives. The final rules are scheduled for official publication in the Federal Register on May 6.