A DRG, or Diagnosis-Related Group, is a classification system that sorts hospital stays into categories based on what’s wrong with the patient and what treatment they received. Each category carries a preset payment amount, which determines how much a hospital gets paid for that stay. Medicare introduced the system in 1983 to replace the old approach of simply reimbursing hospitals for whatever they charged, and it remains the foundation of how hospitals are paid for inpatient care in the United States.
Why the DRG System Exists
Before DRGs, Medicare paid hospitals on a cost-plus basis: whatever the hospital spent treating a patient, Medicare covered it, plus a margin. This created little incentive to control costs. Hospitals with higher price tags often argued they treated sicker patients, but there was no standardized way to measure whether that was actually true.
The DRG system solved this by creating the first practical method for defining and measuring the complexity of patients a hospital treats. Instead of taking hospitals at their word, Medicare could now compare the actual mix of conditions and procedures across facilities. Congress amended the Social Security Act in 1983 to launch a national DRG-based prospective payment system for all Medicare patients, meaning hospitals would know in advance what they’d be paid for a given type of case rather than billing after the fact.
How a DRG Gets Assigned
When you’re discharged from the hospital, your medical record gets run through a software tool called a grouper. The grouper looks at several pieces of information to land on a single DRG code: your principal diagnosis (the main reason you were admitted), any procedures performed during your stay, your age, sex, discharge status (whether you went home, transferred to another facility, or something else), and any secondary diagnoses that complicated your care.
Those secondary diagnoses matter a lot. The system classifies them as either a CC (complication or comorbidity) or an MCC (major complication or comorbidity). A patient admitted for pneumonia who also has diabetes and kidney failure will land in a higher-paying DRG than a patient admitted for pneumonia alone, because those additional conditions make the hospital stay more resource-intensive. This severity layering is how the system tries to account for the reality that not all cases of the same condition cost the same to treat.
How DRG Payments Are Calculated
Every DRG carries a number called a relative weight, which reflects how expensive that type of case is compared to the national average. A routine hospitalization might have a weight below 1.0, while a complex heart surgery might carry a weight of 5.0 or higher. The hospital multiplies that weight by a base payment rate (set annually by Medicare) to determine the dollar amount for that stay.
The base rate itself isn’t uniform everywhere. It gets adjusted for local wage levels, since labor is the biggest hospital expense. Hospitals in Alaska and Hawaii receive a cost-of-living adjustment. Teaching hospitals and those serving a disproportionate share of low-income patients receive additional add-on payments. But the core math stays the same: relative weight times base rate equals payment.
This means the hospital receives the same payment whether you stay three days or seven, whether the surgeon uses expensive supplies or cheaper ones. The financial incentive flips: instead of being rewarded for doing more, hospitals are rewarded for being efficient.
What Happens When Costs Exceed the Payment
Some cases are genuinely more expensive than any standard payment can cover. A patient who develops serious complications, requires multiple surgeries, or spends weeks in intensive care can rack up costs far beyond the DRG payment. For these situations, Medicare has an outlier payment system.
If a hospital’s combined operating and capital costs for a case exceed the DRG payment by more than a set dollar threshold (published annually by CMS), the hospital qualifies for additional reimbursement. The extra payment covers 80% of costs above that threshold, or 90% for burn cases. This safety valve prevents the DRG system from financially punishing hospitals that take on the most critically ill patients.
MS-DRGs vs. APR-DRGs
The version Medicare uses is called MS-DRGs (Medicare Severity Diagnosis-Related Groups). It adjusts payments based on whether a patient has a CC, an MCC, or neither. This gives each base DRG up to three severity tiers.
A more granular version called APR-DRGs (All-Patient Refined Diagnosis-Related Groups) is used by many state Medicaid programs and private insurers. APR-DRGs sort patients into four severity-of-illness levels (minor, moderate, major, extreme) and four risk-of-mortality levels using the same categories. The key difference is that APR-DRGs account for the interaction between multiple secondary diagnoses, not just the single most severe one. A patient with three moderate complications might be grouped higher than a patient with one major complication, which better reflects true clinical complexity.
How DRGs Affect Your Hospital Stay
The DRG system directly shapes the care experience for patients, even though most people never hear the term during their hospitalization. Because hospitals receive a flat payment per case, there’s a strong incentive to discharge patients as soon as they’re medically stable. Research from public hospitals in Hong Kong found that introducing DRG-based resource allocation was associated with a 1.77% decrease in average length of stay and a 2.9% increase in the number of patients admitted. When the DRG scheme was later discontinued at some facilities, lengths of stay crept back up and admissions dropped.
This efficiency pressure has real benefits: shorter stays reduce your exposure to hospital-acquired infections and get you back to your normal life faster. But it also creates tension. Hospitals have to balance the financial incentive to discharge quickly against the clinical need to keep patients who aren’t ready to leave. Discharge planning, follow-up appointments, and post-acute care referrals have all become more important in a DRG world because the system shifts some of the recovery burden outside the hospital walls.
Case Mix Index: Measuring Hospital Complexity
DRGs also give hospitals and regulators a way to compare facilities. A hospital’s Case Mix Index, or CMI, is calculated by adding up the DRG relative weights for all Medicare discharges and dividing by the total number of discharges. A hospital with a CMI of 2.0 treats cases that are, on average, twice as resource-intensive as the national baseline.
CMI matters because it influences how much total revenue a hospital receives from Medicare and serves as a rough indicator of the complexity of care a facility provides. Academic medical centers and trauma hospitals typically have higher CMIs than community hospitals, reflecting the more severe cases they handle. It’s also closely watched by hospital administrators because even small shifts in CMI, driven by changes in coding accuracy or patient population, can translate into millions of dollars in revenue.