How a DRG Determines How Much a Hospital Gets Paid

Black woman doctor talking to patient in hospital
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Medicare and certain private health insurance companies pay for hospitalizations of their beneficiaries using a DRG payment system. When you've been admitted as an inpatient to a hospital, that hospital assigns a DRG when you're discharged, based on the care you needed during your hospital stay. The hospital gets paid a fixed amount for that DRG, regardless of how much money it actually spends treating you. If a hospital can effectively treat you for less money than Medicare pays it for your DRG, then the hospital makes money on that hospitalization. If the hospital spends more money caring for you than Medicare gives it for your DRG, then the hospital loses money on that hospitalization.

What Does DRG Mean?

DRG stands for "Diagnosis-Related Group." Medicare's DRG system is called the Medicare Severity Diagnosis Related Group, or MS-DRG, which is used to determine hospital payments under the inpatient prospective payment system, or IPPS. It's the system used to classify various diagnoses for inpatient hospital stays into groups and subgroups so that Medicare can accurately pay the hospital bill. The idea behind DRGs is to ensure that Medicare reimbursements adequately reflect "the fundamental role which a hospital’s case mix [ie, the type of patients the hospitals treats, and the severity of their medical issues] plays in determining its costs" and the amount of resources that the hospital needs to treat its patients.

As of October 2015, the diagnoses that are used to determine the DRG are based on ICD-10 codes.

DRGs have historically been used for inpatient care, but the 21st Century Cures Act, enacted in late 2016, required the Centers for Medicare and Medicaid Services to develop some DRGs that apply to outpatient surgeries, which are required to be as similar as possible to the DRGs that would apply to the same surgery performed on an inpatient basis.

Medicare and private insurers are also piloting new payment systems that are similar to the current DRG system, but with some key differences, including an approach that combines inpatient and outpatient services into one payment bundle. In general, the idea is that bundled payments are more efficient and result in better patient outcomes than fee-for-service payments (with the provider being paid based on each service that's performed)

Learn more about this in “DRG 101: What Is a DRG & How Does It Work?” and in this summary of DRGs, published by CMS.

Figuring Out How Much Money a Hospital Gets Paid for a Given DRG

In order to figure out how much a hospital gets paid for any particular hospitalization, you must first know what DRG was assigned for that hospitalization. In addition, you must know the hospital’s base payment rate, which is also described as the "payment rate per case." Call the hospital’s billing, accounting, or case management department and ask what its Medicare base payment rate is.

Each DRG is assigned a relative weight based on the average amount of resources it takes to care for a patient assigned to that DRG. You can look up the relative weight for your particular DRG by downloading a chart provided by the Centers for Medicare and Medicaid Services following these instructions:

  1. Go to this web page on the CMS website.
  2. Scroll down to the bottom of the page. Locate the area entitled “Downloads.”
  3. Download table 5 (final rule and correction notice; this is for Fiscal Year 2018).
  4. Open the file that displays the information as an Excel spreadsheet (the file that ends with “.xlsx”.)
  5. The column labeled “weights” shows the relative weight for each DRG.

The average relative weight is 1.0. DRGs with a relative weight of less than 1.0 are less resource-intensive to treat and are generally less costly to treat. DRG’s with a relative weight of more than 1.0 generally require more resources to treat and are more expensive to treat. The higher the relative weight, the more resources are required to treat a patient with that DRG. This is why very serious medical situations, such as organ transplants, have the highest DRG weight.

To figure out how much money your hospital got paid for your hospitalization, you must multiply your DRG’s relative weight by your hospital’s base payment rate. Here’s an example with a hospital that has a base payment rate of $6,000 when your DRG’s relative weight is 1.3:

$6,000 X 1.3 = $7,800. Your hospital got paid $7,800 for your hospitalization.

How Does a Hospital’s Base Payment Rate Work?

The base payment rate is broken down into a labor portion and a non-labor portion. The labor portion is adjusted in each area based on the wage index. The non-labor portion varies for Alaska and Hawaii, according to a cost-of-living adjustment.

Since health care resource costs and labor vary across the country and even from hospital to hospital, Medicare assigns a different base payment rate to each and every hospital that accepts Medicare. For example, a hospital in Manhattan, New York City probably has higher labor costs, higher costs to maintain its facility, and higher resource costs than a hospital in Knoxville, Tennessee. The Manhattan hospital probably has a higher base payment rate than the Knoxville hospital.

Other things that Medicare factors into your hospital’s blended rate determination include whether or not it’s a teaching hospital with residents and interns, whether or not it’s in a rural area, and whether or not it cares for a disproportionate share of the poor and uninsured population. Each of these things tends to increase a hospital’s base payment rate.

Each October, Medicare assigns every hospital a new base payment rate. In this way, Medicare can tweak how much it pays any given hospital, based not just on nationwide trends like inflation, but also on regional trends. For example, as a geographic area becomes more developed, a hospital within that area may lose its rural designation.

Are Hospitals Making or Losing Money?

After the MS-DRG system was implemented in 2008, Medicare determined that hospitals' based payment rates had increased by 5.4 percent as a result of improved coding (ie, not as a result of anything having to do with the severity of patients' medical issues). So Medicare reduced the base payments rates to account for this. But hospital groups contend that the increase due to improved coding was actually only 3.5 percent, and that their base rates have been reduced by too much, resulting in $41.3 billion in lost revenue from 2013 to 2028.

Hospitals in rural areas are increasingly struggling, with hospital closures in rural areas becoming more common in recent years. There are also indications that even well-established, heavily trafficked hospitals are losing money in some areas, but that's due in part to an overabundance of high-priced technology, replicated in multiple hospitals in the same geographic location, and hospital spending on facility and infrastructure expansions.

The largest nonprofit hospitals, however, earned $21 billion in investment income in 2017, and are certainly not struggling financially. The challenge is how to ensure that some hospitals aren't operating in the red under the same payment systems that put other hospitals well into the profitable realm. That's a complex task, though, involving more than just DRG-based payment systems, and it promises to continue to be a challenge for the foreseeable future.

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