United States: Proposed Changes to Medicare Hospital DRGs Most Radical Since 1983

Executive Summary

Proposed rules published by CMS on April 25, 2006 would make the most significant changes to Medicare inpatient diagnostic related group (DRG) payments since DRGs were initiated in 1983. Many of the changes implement provisions of the Deficit Reduction Act of 2005 (DRA), with some to be effective October 1, 2006, and others on October 1, 2007, or later.

CMS has proposed fundamental changes in the calculation of DRG weights, by changing the classification system and recalibrating weights, and would substantially change DRG payments to many hospitals. Although the effect on DRG payments is intended to be budget-neutral nationwide, many individual hospitals will experience material increases or decreases. Some hospitals may see an increase or decrease in the federal fiscal year beginning October 1, 2006 (FY 2007), only to experience the opposite result in the next year.

A hospital can determine the full impact of the changes only by modeling on a DRG-specific basis. Attached as Exhibit A is a table from the Federal Register that identifies DRGs with the largest reductions and increases. Generally, the largest reductions are for cardiovascular, device-dependent and surgical DRGs; the largest increases are for medical DRGs.

The proposed rules state that improving payment accuracy should reduce the opportunity for specialty hospitals to focus on DRGs that produce a high profit margin. The current weights, in place since 1983, are viewed by CMS as presenting "opportunities for providers to specialize in cases they believe to have higher margins."

The proposed rules are expected to increase, substantially, the percent of DRGs with payment to cost ratios between 0.95 and 1.05, thereby reducing "the incentives that Medicare payments may provide for the further development of specialty hospitals."

Different changes will have different effective dates. The case mix index (CMI) changes, i.e., the use of hospital specific relative weights (HSRVs) and a modified version of cost-based weights instead of weights based on charges, will be effective for FY 2007.

CMS is also proposing to modify DRGs to account for patient acuity, effective for FY 2008 or earlier. No definition is provided for the meaning of "or earlier."

Many hospitals are proposing a delay in implementation of the changes to allow further time for study and to propose a new methodology. Others are proposing a transition period from the current system to the new system. Some hospitals are studying the legality of the proposed rules.

In Bellevue Hospital Center v. Leavitt, the United States Court of Appeals for the Second Circuit ordered CMS on April 3, 2006, to apply the OMA to 100% of the wage index effective for FY 2007. The court required CMS to "immediately . . . collect data that are sufficiently robust to permit full application of the occupational mix adjustment."

On May 17, CMS published proposed rules that would modify a hospital’s wage index calculation, effective FY 2007. The proposed rules replace the OMA information that was included in the April 25 proposed rules. Under the new proposal, 100% of the OMA would be included in the wage index, thereby increasing the complexity and options available to hospitals for modification of their wage index. Under current rules, only 10% of the wage index is adjusted for occupational mix.

The proposed rules "clarify" CMS policy for indirect medical education (IME) and direct graduate medical education (GME) payments. For purposes of the IME full-time equivalent (FTE) count, time spent by residents in activities that do not involve the care and treatment of particular patients, such as educational conferences, journal clubs, seminars and other didactic or scholarly activities, may not be counted.

For GME purposes, time for such nonpatient activities may not be counted if it is in a non-hospital site, but such time may be counted if it is in the hospital or in hospital-based providers and subproviders.

Because these proposed rules are referred to as "clarifications," CMS and fiscal intermediaries may attempt to apply these rules retroactively.

However, CMS acknowledged that, "Although the agency appears to have made a conflicting statement in a letter directed to a particular individual implying that didactic time spent in nonhospital settings could be counted for direct GME and IME, that statement was inaccurate," and as a result may have a difficult time applying this "clarification" retroactively.

The proposed rules request comments on a variety of proposals to require hospitals to provide information to the public regarding their charges and Medicare payments.

The proposed rules also seek comments on value-based purchasing, commonly referred to as pay-for-performance, which plan is required to be implemented in FY 2009 by the DRA. Hospitals should consider commenting on the need to include incentives that align hospitals and physicians, since physician cooperation is crucial in obtaining improvements in performance. Hospitals should also urge modifications to the Anti-kickback Statute and Stark Statute and applicable regulations, in order to permit hospitals and physicians to implement financial incentives designed to satisfy the requirements of value-based purchasing.

CMS is also soliciting comments on steps to encourage the adoption and use of HIT, the role of HIT in a valuebased purchasing program, and the possible development of mandatory standards for HIT by the Secretary of Health and Human Services.

CMS is contemplating reducing payments to hospitals for cases where the patient is treated for a condition that was not present on admission.

The proposed rules request comments on how CMS should implement the DRA requirement that CMS identify at least two preventable conditions that categorize a patient as a complication or comorbidity DRG. Many hospitals are concerned this proposal could reduce payments based on conditions beyond their control.

The proposed rules contain a number of other changes affecting the following provisions, among others: outlier threshold; capital payment rate; new technology payments; GME payments; skilled nursing facility bad debt; long term care hospitals; Emergency Medical Treatment and Active Labor Act (EMTALA); critical access hospitals; sole community hospitals; Medicare- dependent hospitals; and rural referral centers.

To view Exhibit A, a table from the Federal Register that identifies DRGs with the largest reductions and increases, please Click here

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