This article evaluates the potential efficacy of implementing a prospective payment system based on case mix in the nursing home industry. The analysis of structural differences between the nursing home and hospital industries suggests that the mechanism of compensating long-term care facilities should be based on functional health status rather than on diagnosis and that incentives to improve quality and access should be strengthened. The article assesses several systems of classifying patients that have been proposed as the basis for implementing a prospective payment system in the nursing home industry. The article concludes with a discussion of policy issues related to the appropriate unit of payment and the scope of regulatory authority.

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