Cost Containment Through Drgs

Title: Cost Containment through DRGs

The Retrospective Payment System

At the inception of Medicare in 1965 Congress adopted the private health insurance sector's retrospective cost-based reimbursement system to pay for hospital services. Under this system, Medicare made interim payments to hospitals throughout the hospital's fiscal year for itemized billed services and expenditures.1 Policy makers soon saw an immense problem with this reimbursement method as they observed inflationary costs increase at an alarming rate from 4.7 billion dollars in 1967 to 72.3 billion in 1985. 2 Two factors were blamed for the rapid growth in outflows, first; payment methodologies that paid providers based on their charges for providing services consequently created an incentive to provide more services, and second; large increases in medical technology increased the demand and cost for related services.1

Introduction of the Prospective Payment System

In response to payment growth, in 1982, Congress mandated the creation of a prospective payment system (PPS) to control costs. This system is a per-case reimbursement mechanism under which inpatient admission cases are divided into related groups called diagnoses-related groups (DRGs). Originally, DRGs were developed to facilitate hospital management and financing by providing a system for classifying acute-care patients that would allow hospital performance to be measured and evaluated, however the system was later further advanced as a basis for payment to hospitals through Medicare's PPS. 3

Diagnosis-Related Groups

The DRG system classifies all human diseases according to the affected organ system, surgical procedures performed on patients, morbidity, and sex of the patient. The classification also accounts for up to eight diagnoses in addition to the primary diagnosis, and up to six procedures performed during the day. Assigning a DRG code to a discharged patient covered by Medicare determines the Medicare payment.1 They are described by the Health Care Financing Administration as "a manageable, clinically coherent set of patient classifications that provide a means of relating the types of patients a hospital treats (i.e., its case mix) to the costs a hospital incurs. Although there is some variation among patients within a DRG, there should be an overall similarity in resources required to treat patients in the same DRG. The DRG system should therefore, in theory, provide equitable payments in that comparable resource consumption is comparably compensated."4 In other words, Medicare pays hospitals a flat rate per case for inpatient hospital care so that theoretically, efficient hospitals are rewarded for their efficiency and inefficient hospitals have an incentive to become more efficient.

Effects of DRG Implementation

One of the largest indicators of efficacy in hospitals is a patient's Average Length of Stay. Prior to PPS, the ALOS of Medicare beneficiaries was declining slowly, expectantly, the introduction of PPS drastically decreased LOS, after which it stabilized to continually show a consistent decreased LOS.5 As indicated by Figure 1, average length of stay decreased from a little over 7 patients days per 1,000 discharges to about 5 patient days per 1,000 discharges from 1980 to 1999 respectively.9 The fact that nominal length of stay was stable in later years implies that LOS most likely continued to decline for comparable patients, because complexity of the average Medicare care increased over time.5

The vast amount of literature available generally agrees on few very significant results regarding the effects of PPS and DRGs on hospital finances. First, there were initially very large cost reductions in the first year of PPS because of the reductions in length of stay and a higher than necessary PPS reimbursement. However, the initial profits of Medicare cases declined over time as Medicare costs grew faster than Medicare payments. Though profits through PPS reimbursement have slightly decreased, overall profits have remained steady, potentially indicating the intended positive workings of PPS. However, one must also consider that there have been much higher rates of closures, particularly in small facilities, and mergers, suggesting that those who do not have other means of earning profits are being forced to close their doors.6

As hospitals saw a decrease in the profits they could earn through inpatient services there was a natural shift to having many tests, medical treatments, and surgeries performed in outpatient settings. A drastic change is seen, in particular to physician services, away from the inpatient setting to the outpatient setting as indicated by the change in the place of physician rendered from 1983 through 1986. In 1983, approximately 61 percent of Medicare physician dollars were for services delivered in the hospital; by 1986, the percentage had decreased to 47 percent. In his article, The Impact of the Prospective Payment System on Physician Charges Under Medicare, C. Fisher describes how allowed charges for physicians and suppliers for inpatient surgical services totaled more almost $4.6 billion by 1986, but showed only