Diagnosis-Related Groups (DRGs) are a foundational concept in modern healthcare finance that fundamentally changed how hospitals are paid for inpatient services. Introduced primarily to manage escalating costs, this system provides a standardized method for classifying the diverse array of patient cases treated in a hospital setting. DRGs group similar clinical events together for administrative and financial management, allowing payers, particularly government programs, to move toward a predictable payment model for hospital care.
Defining Diagnosis-Related Groups
DRGs classify hospital inpatient cases into categories that are clinically comparable and require similar levels of hospital resources. The system aims for standardization by creating a manageable number of patient classes that reflect a hospital’s unique patient mix, known as its case mix. This approach focuses on the expected cost of an entire episode of care, rather than listing every service provided. The two main criteria for grouping patients are similar clinical attributes and comparable resource intensity.
The process begins by sorting all hospital cases into Major Diagnostic Categories (MDCs), which represent broad groups corresponding to major organ systems or medical specialties. A patient’s principal diagnosis determines which of the approximately 25 MDCs they are initially placed into. Within each MDC, cases are further refined into a specific DRG based on whether a major surgical procedure was performed and other clinical variables. The current system used by Medicare, the Medicare Severity DRG (MS-DRG) system, contains over 750 distinct groups.
How Patient Data Determines the DRG
Assigning a patient to a specific DRG relies on comprehensive and accurate documentation of the hospital stay. The core input is the patient’s principal diagnosis, the condition established after study to be chiefly responsible for the admission. This information, along with all secondary diagnoses, is translated into standardized codes using the International Classification of Diseases (ICD) coding system. Secondary diagnoses often include complications and comorbidities (CCs or MCCs) that significantly increase the severity of illness and complexity of care.
Additional factors influencing the final DRG assignment include any surgical procedures performed, which are also assigned ICD procedure codes. Patient demographics, such as age and sex, and the patient’s discharge status are necessary inputs. These variables can affect the typical duration and expense of treatment. All of these coded inputs are fed into a specialized software program known as a “grouper,” which assigns the single, most appropriate DRG for that hospital stay.
The Role of DRGs in Hospital Reimbursement
The DRG system establishes the framework for the Prospective Payment System (PPS), which determines hospital reimbursement for inpatient care. Under PPS, the hospital receives a single, fixed payment based on the assigned DRG, regardless of the actual costs incurred during the stay. This fixed payment structure replaced the older fee-for-service model, which reimbursed hospitals for every service provided retrospectively. Medicare, the largest payer for inpatient services, began using this system in 1983.
The fixed payment is calculated by multiplying the DRG’s “relative weight” by a hospital-specific base rate. A higher relative weight, such as for a complex organ transplant, indicates greater resource intensity and results in a higher payment. This mechanism shifts the risk of cost overruns from the payer to the hospital, creating a powerful incentive for efficiency. If a hospital treats the patient for less than the fixed payment, it retains the difference; if costs exceed the payment, the hospital absorbs the loss.
Effects on Hospital Operations
The implementation of the DRG system altered hospital management and patient care delivery by prioritizing efficiency and documentation. The financial incentives inherent in the prospective payment model pressure hospitals to manage resource utilization meticulously. Since the payment is fixed, hospitals must ensure that the costs associated with care do not exceed the reimbursement amount.
A direct operational consequence is the focus on accurate and thorough clinical documentation. Because the correct DRG assignment, and therefore the correct payment, depends entirely on the coded patient data, physicians and coders must capture every relevant diagnosis, procedure, and complication. The system also incentivizes hospitals to minimize the patient’s Length of Stay (LOS), as a shorter stay generally means lower overhead and greater financial gain. This drive for efficiency requires careful management to ensure that patients are not discharged prematurely or that quality of care is not compromised.