From 1965 until 1998, nursing home facilities were paid on a cost-based reimbursement system by combining cost reports with the number of patient days. In 1998 payment was switched to Prospective Payment system, which is more of an acuity based system. Facilities perform a full assessment on each resident and compile the data using the Minimum Data Set (MDS). The needs of the residents, as determined by the MDS, is then converted to a Resource Utilization Group (RUG) score. Facilities are then paid Medicare funds based on this RUG score for the Medicare eligible residents. Medicaid funding is more of a cost-based payment system with partial adjustments made on acuity, but the states determine the bulk of the per diem rates.
The higher reimbursement for residents with a higher RUG score is supposed to be used for the increased staffing needs for more nursing and therapy services. This actually is what "Resource Utilization" means: that the facility will have to utilize more resources for the more acute residents. This isn't supposed to be an "acuity lottery" where a facility gets an increase in pay without a corresponding increase in staffing. For example, a facility can get paid $15,000 or more a month for a new Medicare patient. The facility can't just smile at their luck of getting a new partially paralyzed resident with multiple health conditions and pocket the extra money. In fact, if the nursing homes don't increase staffing for such patients they will begin to neglect their existing patients as they just can't take care of them all.
The federal government didn't just pull the RUG reimbursement rates amounts out of a hat. In 2006, the number of RUG categories was increased from forty-four to fifty-three to provide greater variety of scores and especially provide scores that were higher to accommodate the increased acuity level of residents. The trend is for patients to be discharged from hospitals earlier and moved into skilled facilities. Skilled facilities then get paid these higher RUG scores for traditional hospital provided care such as respiratory care, IV therapies, etc. The expense of such services exceeded what was expected by Medicare. So, the government decided to revamp the RUG system with a new version, RUG-IV and MDS 3.0. In order to develop RUG-IV, a large study was designed to re-evaluate staffing needs based on the scores.