Healthcare Policy


Now that we’ve discussed the method Medicare uses to pay physicians, it’s time to learn about how Medicare pays hospitals! The method is another complicated process called Diagnosis-Related Groups, or DRG’S, and it is boring, too. 

I went into practice in 1974. At that time, it was the policy of hospitals to bill Medicare and insurance companies for every service provided and every item used to treat the patient. Payers were billed a long list of itemized services that included a daily hospital charge plus every item used in treating the patient—oral drugs, injectables, IV fluids, IV administration sets, lab tests, therapy, supplies, operating room, etc. It was a clerical nightmare for hospitals. There was no incentive to cut costs and save money so hospital costs grew and grew, and Medicare resources were strained. Prices of items were sometimes inflated and hospitals had no urgency to discharge patients. The longer the patient was hospitalized, the more the hospital was paid. Most physicians, myself included, admitted patients to the hospital just “for tests.” This method was unsustainable so an alternative system had to be found.

Design and development of DRG’S began in the late 1960’s at Yale University. The “purpose [of DRG’s] was to monitor the quality of care and the utilization of services in a hospital setting.” In 1982, TEFRA, the Tax Equity and Fiscal Responsibility Act, changed Medicare reimbursement limits to be based on diagnosis. In 1983, Congress amended the Social Security Act to make DRG’S the basis for hospital payments for all Medicare patients. Thus, the DRG System was adopted.

“Rather than pay the hospital for each specific service it provides, Medicare pay[s] a predetermined amount based on your Diagnostic Related Group, DRG.” That means that hospitals get paid according to the diagnosis for which a patient is hospitalized. Medicare, in its bureaucratic wisdom and ingenuity, adopted a system whereby a hospital receives a set payment based on the patient’s reason for hospitalization, the diagnosis. Age, sex, and necessary medical procedures are factored in, too. Through complicated calculations, Medicare allocates a value, a fixed dollar amount, for every conceivable diagnosis that might land you in the hospital.  

This system has so many fudge-factors and loopholes it would take forever to explain, but the bottom line is both good and bad for hospitals. If the cost of treating the patient is less than the DRG payment, the hospital earns a profit. If the patient’s cost of treatment exceeds the DRG payment, the hospital takes a loss. Getting a patient treated and out of the hospital becomes a priority because shortening the length of stay improves profits. This has led to an increased emphasis on outpatient services, and is part of the reason patients are sent home, or to rehab, 4 days after heart surgery, or your total knee replacement was done as an outpatient. Hospitals learn to be more efficient and are less prone to over-treat you.

Hospital billing departments have coding experts who comb through patients’ charts after discharge to be certain the treating physician has chosen the right diagnosis to maximize reimbursement. This becomes a game hospitals play with physicians and Medicare. We are questioned about details of the case to make certain some important diagnosis is not omitted. I remember being told the diagnosis “Diabetes out-of-control” had a better-paying DRG than “Diabetes” alone. I was unaware of that fact, but it was true, the patient’s diabetes WAS out of control, thus I added that to the list of diagnoses. 

Hospitals are penalized if a patient is re-admitted within 30 days after release. “This is meant to discourage early discharge, a practice often used to increase bed occupancy turnover rate.” At times it’s very hard to know if your patient is stable or unstable. Just when you think they’re medically stable, they take a sudden, unforeseen turn for the worse. This can be a tough situation, and readmissions are unavoidable. Since our practice employed the hospitalist physicians for St. Francis Hospital, medical records placed a nurse in our office to evaluate all re-admissions. Her job was to identify the circumstances and the doctors involved in re-admissions hoping to correct the problem. She had a difficult job that required a great deal of tact, but she was a very capable evaluator. It’s interesting, though, that hospitals have had to hire extra people to audit charts, at considerable expense, to protect themselves from punitive fines. These fines come about because hospital reimbursement is so abysmally low, and every extra day a patient languishes in a bed is lost money for the hospital. 

The DRG system has been in effect for nearly 40 years. Had you ever heard of it? It has changed how medical services are provided, and has impacted hospitals financially. When it was first implemented I heard predictions of its demise in 3-5 years. That didn’t happen. Rural hospitals struggle financially with this payment system and many have closed. A few “well-established, heavily-trafficked hospitals are losing money in some areas…” The “largest non-profit hospitals, however, earned $21 billion in investment income in 2017, and are certainly not struggling financially.”

In summary: DRG’S, or Diagnosis Related Groups, are the way hospitals are paid for Medicare-related services. The patient’s diagnosis “decided after evaluation and treatment” is the determinant of the payment the hospital receives. Each DRG has a pre-determined dollar value that is paid to the hospital after discharge regardless of how much is spent treating the person. It is incumbent upon the physician to carefully and accurately word the final diagnoses to maximize reimbursement. 

References: Gluckman TJ, et al. Trends in diagnosis related groups for inpatient admissions and associated changes from 2012 to 2016. JAMA Network Open 2020 Dec 1;3(12).

“History of the Development of the Diagnosis Related Groups (DRG’S)”

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