Diagnosis Related Groups (DRGs) are a system used in healthcare to classify hospital cases into groups that are expected to require similar levels of hospital resources. Originating with Medicare, this classification system has been widely adopted by private insurers to manage costs and standardize payment for inpatient stays. The primary function of the DRG system is to establish a predictable method for hospital reimbursement by categorizing complex services into financially comparable units.
How Patient Data Is Grouped
The process of assigning a patient’s stay to a single DRG is driven by a software application known as the “Grouper.” This mechanism uses clinical data captured during the hospitalization to determine the correct category. The most significant factor is the patient’s principal diagnosis, the condition chiefly responsible for the admission to the hospital.
Beyond the principal diagnosis, the system considers any major surgical procedures performed during the stay. The Grouper also evaluates secondary diagnoses, specifically looking for comorbidities and complications (CCs and MCCs). These secondary conditions reflect greater severity of illness and result in a higher-weighted DRG, correlating to greater expected resource consumption.
Medical coding translates clinical information into a standardized language. Coders use the International Classification of Diseases (ICD) system to report diagnoses (ICD-10-CM) and inpatient procedures (ICD-10-PCS). These standardized codes are the primary input for the DRG Grouper, allowing the software to accurately categorize the patient into one of the approximately 750 available DRG classifications.
The Prospective Payment Model
The DRG system is the foundation for the Prospective Payment System (PPS), which fundamentally changed how hospitals are reimbursed for inpatient care. Before DRGs, hospitals operated under a fee-for-service model, reimbursed for actual costs incurred, including every supply and test. This older method provided little incentive for hospitals to control costs.
The PPS operates by paying a single, fixed payment for each assigned DRG. This lump sum is established before the patient is discharged, based on the historical average cost of treating patients within that specific DRG. Hospitals receive this fixed amount regardless of the actual length of stay or the total number of services rendered.
This model shifts the financial risk from the payer to the hospital, creating a powerful incentive for efficiency. The fixed payment rate is calculated using a relative weight assigned to the DRG, which reflects the expected resource intensity compared to all other DRGs. For cases with exceptionally high costs that far exceed the fixed payment threshold, known as “outliers,” the PPS includes a provision for additional reimbursement to protect hospitals from financial losses.
The Effect on Hospital Efficiency
The shift to the Prospective Payment System necessitated a change in hospital administrative and clinical behavior. Since the hospital’s payment is fixed, any cost incurred above that predetermined amount results in a financial loss. Conversely, if the hospital provides care for less than the fixed payment while maintaining quality, it retains the difference.
This financial structure drives modern hospital efficiency initiatives, collectively termed “cost containment.” Hospitals are incentivized to streamline care pathways, reduce unnecessary testing, and manage resources judiciously. The system encourages a reduction in the average length of stay, since keeping a patient for an extra day reduces the hospital’s margin without increasing the fixed payment.
The DRG structure moves the focus from maximizing services—the goal of the older fee-for-service model—to minimizing the cost of necessary care. This requirement pushes hospitals toward developing standardized clinical protocols and robust utilization review programs. The goal is to ensure every resource used is medically necessary and contributes to the patient’s timely recovery and discharge.
Ensuring Proper Code Assignment
The financial integrity of the DRG system depends on the accuracy of the medical record documentation and the resulting code assignment. If documentation is incomplete or ambiguous, the hospital risks assigning an incorrect DRG, potentially leading to underpayment. For example, failing to document a major complication means the hospital receives the lower fixed rate for a less complex case.
To mitigate this risk, most hospitals have established Clinical Documentation Improvement (CDI) programs. These programs work with clinicians to ensure the medical record accurately reflects the patient’s severity of illness and the intensity of services delivered. CDI specialists query providers in real-time to clarify documentation, ensuring the final DRG assignment is appropriate and fully supported by clinical facts.
Payers, including Medicare, employ extensive auditing mechanisms to verify that the final DRG assigned matches the documented services. Organizations like Recovery Audit Contractors (RACs) review hospital records to identify improper payments, resulting from either over-coding for higher reimbursement or under-coding due to poor documentation. This external scrutiny ensures the system’s accuracy and integrity are maintained.