Introduction of the diagnosis-related group (DRG)-based Medicare Prospective Payment System is one of a series of major innovations that has occurred in the payment and delivery of health care over the past ten years. Changes such as the increased prevalence of health maintenance organizations, preferred provider organizations, third-party utilization review programs, and the peer review organizations for Medicare patients have all altered the way health care is financed and delivered. The DRG-based Medicare Prospective Payment System is the most visible of these changes, given its breadth of application and its radical departure from the previous retrospective reimbursement for hospital care. The Medicare Prospective Payment System has been in effect since October, 1983. As we approach the fifth anniversary of this program, it is a good time to review its history and to make some judgments as to its future.