Fact Sheets

IMPROVING MEDICARE'S HOSPITAL INPATIENT PROSPECTIVE PAYMENT SYSTEM TO BETTER RECOGNIZE THE COSTS OF CARE

IMPROVING MEDICARE'S HOSPITAL INPATIENT PROSPECTIVE PAYMENT SYSTEM TO BETTER RECOGNIZE THE COSTS OF CARE

On April 13, 2007, the Centers for Medicare & Medicaid Services (CMS) issued a proposed rule to update the hospital inpatient prospective payment system (IPPS) for fiscal year (FY) 2008.  This proposed rule builds on the framework established over the last few years to implement the most significant revision of Medicare’s inpatient hospital rates since 1983.

These reforms are measured steps to improve the accuracy of Medicare’s payment for inpatient stays to better account for the severity of the patient’s condition. 

• They continue changes begun last year to improve the accuracy of Medicare’s inpatient hospital payments by using hospital costs rather than charges to set rates.  

• They adjust payment under the IPPS to better recognize severity of illness and the cost of treating Medicare patients by increasing payment for some services and decreasing payment for others. 

• They will help to eliminate biases in the current system that have provided incentives for physician-owned specialty hospitals to treat the healthiest and most profitable cases leaving the sickest and least profitable patients to general acute care hospitals. 

Background

In its March 2005 Report to Congress on Physician-Owned Specialty Hospitals, the Medicare Payment Advisory Commission (MedPAC) recommended that the Secretary improve payment accuracy in the hospital inpatient prospective payment system (IPPS) by:

• Refining the current diagnosis-related groups (DRGs) to more fully capture differences in severity of illness among patients,
• Basing the DRG relative weights on the estimated cost of providing care rather than on charges,
• Basing the weights on the national average of hospitals' relative values in each DRG,
• Adjusting the DRG relative weights to account for differences in the prevalence of high cost outliers cases, and
• Implementing the case-mix measurement and outlier policies over a transitional period.

Key Actions Taken by CMS in the FY 2006 Final Rule

In the proposed rule to update the IPPS for FY 2006, CMS performed an extensive review of the cardiovascular DRGs in MDC 5 (Diseases and Disorders of the Circulatory System), particularly those DRGs that are commonly billed by specialty hospitals.  In doing so, CMS identified conditions that would lead to a more complicated patient stay requiring greater resource use.  These conditions are called Major Cardiovascular Conditions (MCV).  Using the MCV approach, CMS found a sound analytical basis for revising 9 cardiovascular DRGs that account for nearly 700,000 cases.  CMS replaced these 9 DRGs that are commonly billed by specialty hospitals with 12 new DRGs that better recognize severity of illness.

Changes to the cardiac DRGs addressed a portion of the disproportionately higher payments that are accruing to specialty hospitals under the current DRG system.  CMS has analyzed a sample of specialty hospitals and found that by linking DRG assignment to case severity, the DRG changes will help to ensure that payments more accurately reflect the resources necessary to care for patients.

Key Actions Taken by CMS in the FY 2007 IPPS Rule

• Improving the Accuracy of Payments by Adopting Cost-Based Weights—

Basing DRG relative weights on costs instead of charges,  improves the accuracy of payments, leading to better incentives for hospital quality and efficiency and ensuring that payment rates relate more closely to patient resource needs.   More specifically, these changes are expected to reduce incentives for hospitals to cross-subsidize underpaid cases by having to treat the most profitable patients. 

Improvement to the Relative Weights.

• In response to comments, CMS addressed a number of technical issues (including statistical trims, weighting etc.) by revising the methodology.  The changes reduced the magnitude of the payment impacts, up or down, relative to the proposed rule.

• More specifically, in the final rule, CMS did not use a “hospital-specific” methodology in response to public concern about distortions in the relative weights due to charge compression—the practice of applying a lower percentage markup to higher cost services and a higher percentage markup to lower cost services.  This decision further mitigated the payment impacts.

• Finally, CMS implemented the cost weights over a 3-year transition period from FY 2007 to FY 2009 period.

• As a result of these changes to the relative weights, between FY 2006 and FY 2009, payments to cardiac specialty hospitals are projected to decline by over 5 percent.

Further Improvements for FY 2008.  Shortly after the final rule was published, CMS engaged RTI International to further study charge compression and whether the cost methodology can be further refined to address the issue.

• Revising the Payment System to Better Account for Severity— 

Improvements to the DRGs.  CMS identified 20 new DRGs involving 13 different clinical areas that would significantly improve the CMS DRG system’s recognition of severity of illness.  The final rule modified 32 DRGs to better capture differences in severity.  The new and revised DRGs were selected from 40 current DRGs which contain 1,666,476 cases and represent a number of body systems.  In creating these 20 new DRGs, CMS deleted 8 and modified 32 existing DRGs. 

Further Improvements for FY 2008.  Shortly after the final rule, CMS contracted with RAND Corporation to conduct an evaluation of alternative severity DRG systems.  Further, CMS indicated our plans to update our own prior research, to achieve further improvements in payment accuracy by FY 2008.

Key Actions Taken by CMS in the FY 2008 IPPS Proposed Rule

• Revising the Payment System to Better Account for Severity.  In the FY 2008 proposed rule, CMS updated an analysis of a severity DRG system that we considered adopting in the mid-1990s.  Based on that analysis, this rule proposes to adopt Medicare-Severity DRGs (MS-DRGs).

The MS-DRGS better recognize severity of illness than the current CMS DRGs.  Cases are more evenly distributed among the different severity of illness levels under the MS-DRGs than the CMS DRGs and they have a better ability to explain patient differences in cost.  As a result, payments to cardiac specialty hospitals for treating less severely ill patients will decline.  Cardiac specialty hospitals generally treat the healthiest and least costly patients and their payments are projected to decline by 4 percent from the MS-DRGs.  This reduction is in addition to reductions of over 5 percent that we estimated last year. 

In addition, the MS-DRGs are responsive to public comments received in response to the FY 2007 final rule in the following ways:

• The MS-DRGs are not based on a proprietary system.  As a result, they would continue to be available to the public in the same way as the current CMS DRGs.

• The MS-DRGs would retain many of the improvements that we have made to the DRGs over the years.

• The MS-DRGs would redistribute payments within DRGs and not across DRGs.

Although the proposed MS-DRGs do not redistribute payments across DRGs, they will increase and decrease payments to hospitals depending on the types of cases they treat.  The MS-DRGs, like all of the severity DRG systems being evaluated by RAND, can be expected to increase payment to urban hospitals and decrease payments to rural hospitals.  This impact occurs because patients treated in urban hospitals are generally more severely ill than patients in rural hospitals.  Although adoption of a severity DRG system can be expected to reduce payments to rural hospitals in FY 2008, cost weights are estimated to increase payments to rural hospitals.  The cost weights are being phased-in from FY 2007 to FY 2009.  Therefore, CMS estimates that there will be further increase in payments to rural hospitals in FY 2009 if we continue with the current schedule for adopting cost weights. 

Evaluating Alternative DRG Systems.  CMS is using the FY 2008 proposed rule to update the public on the progress of the RAND Corporation evaluation of five DRG products.  Further, the proposed rule indicates that CMS has asked RAND to evaluate the proposed MS-DRGs.

DRG Relative Weights.  RTI has completed a preliminary report on charge compression.  Its analysis suggests CMS could expand from 13 to 19 hospital departments to improve payment accuracy.  However, these changes are very complex and could not be modeled for the FY 2008 proposed rule.  CMS is asking for public comments on whether to adopt these changes in the final rule.