In 1983, Medicare replaced cost based reimbursement with the Prospective Payment System (PPS), where hospitals would be paid for inpatient care based on a specified payment based on the illness of the patient and the resources that were required to treat them.
Patients were assigned to categories, known as Diagnosis Related Groups, or DRGs, based why they were admitted to the hospital. The DRG system was developed at Harvard University in the 1970s, and Medicare adapted the system in order to incentivize hospitals to reduce cost. If the hospital would only receive a fixed payment, it was in their interest to keep costs as low as possible in order to make as much profit as they could.
Originally, there were 470 DRGs, and every patient could be categorized into one of them, based on three main criteria:
- The illness that caused their admission.
- Any complicating factors
- Any surgical or other procedure that occurred during the stay
Each DRG had a different weight, or intensity factor. For instance, DRG 127 Heart Failure and Shock had a lower weight than DRG 209 Total Joint Replacement. This was to recognize that the costs of the surgical procedure like a total knee replacement were much higher than a medical admission caused by congestive heart failure.
Calculating the DRG Payment
The DRG weight was then multiplied by the Medicare Base Rate in order to determine what the hospital would be paid. It was then up to the hospital to treat the patient as inexpensively as possible. If they could treat the patient for less than the payment, they kept the difference. If they couldn’t they lost money, and many hospitals did close in the first several years of Prospective Payment.
The system included an additional payment for outliers, those patients that had unusually long lengths of stay or cost, generally related to an abnormal complication. Payment for the hospitals’ cost of buildings and equipment (capital) was paid as a pass-through, as were payments for medical education.
Many hospitals did profit from the new system, as hospital length of stays plummeted, and procedures were shifted to an outpatient setting. Medicare made changes to the system and the DRG weights every year.
Hospitals became better versed at finding complications which increased the apparent severity of the patient’s illness. Medicare termed this increase in the hospital overall case index as DRG creep. It was Medicare’s contention that the patients were not actually sicker, just that the better coding of illnesses made it appear so. As a result, the overall DRG weights were reduced every year.
The Prospective Payment System continues to this day. DRGs have been replaced by MS-DRGs, which break down illnesses into more refined groups, but the basic structure of reimbursement is unchanged. Hospitals and Medicare are still at work refining the system, so that payment for patients under the Medicare program is fair and costs are contained as much as possible, ensuring the continued viability of Medicare.
