Since the advent of Medicare's prospective payment system, beneficial but cost-increasing medical advances have been systematically assigned to existing diagnosis-related groups (DRGs) that do not cover the costs of the new technology. Recent evidence suggests that such underpayment reduces the rate at which hospitals adopt that technology. Safeguards designed to offset the negative incentives of underpayment, including the recalibration of DRG values, update factors, and the allowance of Medicare profits, appear not to have worked. We studied the case of cochlear implantation. Years after Food and Drug Administration approval and a favorable decision about Medicare coverage, payment for the device remains well below its average cost, and many hospitals ration the availability of the device to Medicare patients because of the financial losses involved. Eventually, so few patients received the implant that the original manufacturer discontinued its production. Under the DRG system, negative payment incentives compete with clinical considerations when hospitals and physicians decide whether to adopt specific cost-increasing new forms of technology of proved value. Other payment mechanisms that do not insert arbitrary financial considerations into specific treatment decisions should be considered instead.