CMS FACT SHEET 8 1 06
FY 2007 INPATIENT PROSPECTIVE PAYMENT SYSTEM FINAL RULE
GRADUAL IMPLEMENTATION OF IMPROVED ACCURACY IN DIAGNOSIS-RELATED
GROUP PAYMENTS
On August 1, 2006, the Centers for Medicare & Medicaid Services (CMS) issued the hospital
inpatient prospective payment system (IPPS) final rule for fiscal year (FY) 2007. In this rule,
CMS identified the goals of:
o making meaningful first steps in diagnosis-related group (DRG) reform in FY 2007,
while having further plans to continue reforms in FY 2008;
o taking needed steps toward more accurate payments, without disrupting hospital
payments;
o ensuring that Medicare does not overpay for some services while underpaying for more
severely ill patients and those with complex illnesses; and
o correcting inappropriate hospital incentives for treating certain types of patients and
providing certain types of services, by re-directing a portion of the payments from cases
that are currently overpaid to those that are underpaid.
Key Policies for FY 2007 Final Rule:
Implement the first year of a three year transition for cost weights, including significant technical
improvements to the payment methods based on public comments, and assess potential for
further improvements for FY 2008 based on a contractor analysis of issues raised in public
comments.
Make meaningful refinements to the current CMS classification system to increase recognition of
severity of illness, including 20 specific DRG changes; and
Conduct an evaluation with public comments of alternative severity adjustment systems for
implementation in FY 2008.
Main Impacts:
There will be limited hospital payment impact because of the simultaneous implementation of
incremental reforms for cost-based and severity-adjusted payments.
More specifically, payment to all hospitals will increase by an average 3.5 percent in FY 2007 or
by more than $3.4 billion.
Only 2 percent of hospitals have a projected reduction in payment as a result of the overall rule,
and factors other than the DRG changes (particularly certain wage index changes) account for
these reductions.
There will be a limited impact on payments in specific DRGs.
No DRG weight will decrease more than 5.4 percent in FY 2007. DRG weight reductions are
less than in the proposed rule because of methodological changes suggested by commenters.
Nineteen DRGs weights increase by more than 5 percent as compared to the current weight
methodology in the first year.
Changes to improve the IPPS are widely-supported because they will help assure that all
beneficiaries have access to appropriate, high-quality care.
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The Medicare Payment Advisory Commission (MedPAC), an independent body that advises the
Congress on Medicare payment policy, supports these reforms.
The types of payment changes being implemented were described as “promising” in a recently
released Government Accountability Office (GAO) report.
The final rule represents a meaningful step towards DRG reforms that are needed to assure that
all beneficiaries have access to quality care, while minimizing disruptions through a multiyear
transition and the simultaneous implementation of severity and cost-based payment changes, as
suggested by many who commented on the rule.
Background: Importance of Inpatient Payment Reforms for FY 2007 and FY 2008 for
Providing High-Quality Care for All Medicare Beneficiaries
This final rule begins to implement the most significant revision of Medicare’s inpatient hospital
rates since 1983. These reforms are measured steps to improve the accuracy of Medicare’s
payment for inpatient stays by better reflecting costs rather than charges and by adjusting
payment to better account for the severity of the patient’s condition. The changes will better
align payment with the cost of care, by increasing payments for some services and decreasing
payment for others in a way that adds up to only limited impacts at the hospital level, but
significantly more accurate payment for each patient treated by the hospital. The reforms will
eliminate biases in the current system arising from the hospital practice of charging much higher
than their costs for some services. These biases have led to the development of specialty
hospitals and general acute care hospitals to specialize in the most profitable and overpaid
services at the expense of other needed but poorly paid cases. As a result, some patients may
have more difficulty getting high-quality care, while other better-paid services may be provided
excessively. The reforms address concerns that specialty hospitals and other hospitals may focus
on certain services and patients because of the relatively favorable reimbursement.
Payments Based on Costs Instead of Charges
CMS proposed to base the relative weights on hospital-specific costs rather than on charges. The
limitations of charges as a measure of resource use are well known, among them the fact that
hospitals markup charges over costs in many different ways that bear little relation to cost.
Hospitals tend to cross-subsidize various departmental services, frequently applying a lower
markup to routine and special care services than they do to ancillary services. This approach not
only impairs transparency in hospital payments; it also creates potential problems in access to
needed services by beneficiaries in the low-markup, underpaid DRGs. Earlier this year, CMS
proposed to address these payment inaccuracies by adopting cost-based DRG payments based on
accounting for the differential mark-ups between costs and charges for 10 individual hospital
departments.
While this methodology addresses the effects of cross-subsidization, CMS noted in the proposed
rule that it expected to refine the cost-based payment methods to address a range of issues based
on public comments, and the final rule includes such refinements. For instance, CMS applied
less stringent statistical trimming criteria to include more high cost hospitals in the calculation of
national average cost to charge ratios. We also weighted these calculations to account for
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hospital size. One refinement involves addressing potential bias in cost-based weights due to
charge compression, the practice of applying a lower percentage markup to higher cost services
and a higher percentage markup to lower cost services. The public comments provided evidence
that the hospital-specific relative weight methodology exacerbates the effect of charge
compression on the final relative weights and results in payment for technology intensive DRGs
that is inappropriately low. CMS is not using a “hospital-specific” methodology in part for this
reason. In addition, CMS has engaged a contractor to further study charge compression,
including a suggestion in the public comments for how to adjust for it and steps to develop more
transparent information on device costs. CMS will use the results from the contractor’s research
to determine whether further steps are needed as the cost-based methodology continues to be
phased in during FY 2008.
Comments also suggested that the cost report data used in the cost methodology is outdated, not
consistent across hospitals, and does not account for the costs of newer technology. However,
the relationship between costs and charges (not costs alone) is the important variable in setting
Medicare’s payment under this new system. Older cost reports also do not include the hospital’s
higher charges for these same devices, and so the need to adjust for newer cost or charge
information exists under all payment methods. CMS expects to continue to use add-on payments
for new technologies to assure more timely adjustments for important but costly new
technologies. The use of average rather than hospital-specific cost to charge ratios, addresses
variations in hospital cost reporting. CMS is also using FY 2004 cost reports to calculate
national average cost to charge ratios for the final rule instead of the FY 2003 cost reports we
used for the proposed rule.
MedPAC recommended separately distinguishing anesthesia, labor and delivery, and inhalation
therapy because of the significant variation between the ratio of costs and charges for these areas
compared to the departments where they were included in the proposed rule. In the final rule, to
further improve accuracy and in response to the comment from MedPAC, CMS expanded the
number of hospital departments to 13.
The changes to the statistical trimming, the weighting of national cost-to-charge ratios, and
removing the hospital-specific portion from the weighting methodology will result in smaller
changes in payment, up or down than the proposed rule. Further, CMS is implementing the
cost-based weighting methodology gradually, by blending the cost and charge weights over a
three-year transition period. As a result, not only are ultimate payment impacts considerably
more moderated compared to the proposed rule, the gradual implementation also helps minimize
any disruptions and ensure smooth adoption.
Payments Based on Better Accounting for Severity of Illness
Earlier this year, CMS proposed to adopt refinements in accounting for patient disease severity,
in order to prevent underpayments for caring for the most severely ill patients. The proposed
options included adopting CS-DRGs that would replace the current system of 526 DRGs with
861 refined DRGs, as well as other options for timing and content of a refined severity adjusted
system. This included asking for public comments on whether alternatives to the proposed CSDRGs should be evaluated before a full refined severity adjusted system is adopted. In addition,
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CMS raised the possibility of making revisions to the current DRG system to better recognize
severity of illness for FY 2007. In response to the public comments, CMS is taking the
following actions to improve the DRG system’s recognition of severity of illness:
FY 2007 DRG Changes to Improve Recognition of Severity of Illness. CMS identified 20
new DRGs involving 13 different clinical areas that would significantly improve the CMS DRG
system’s recognition of severity of illness. The final rule also modifies 32 DRGs to better
capture differences in severity. The new and revised DRGs were selected from 40 current DRGs
which contain 1,666,476 cases and represent a number of body systems. In creating these 20
new DRGs, CMS is deleting 8 and modifying 32 existing DRGs. CMS is taking these interim
steps in FY 2007 as a prelude to making more comprehensive changes to better account for
severity in the DRG system by FY 2008.
Further Improvements Planned for FY 2008. Through a research contractor, CMS will
conduct an evaluation of alternative DRG severity systems, with opportunity for public input.
Based on this evaluation, CMS expects to implement one of these systems, or potentially a
system that CMS develops based on its own prior research, to achieve further improvements in
payment accuracy by FY 2008. The contract to evaluate severity-adjusted DRG systems will be
awarded by September 1, 2006. An interim report comparing severity-adjusted DRG systems
will be completed by the end of 2006 and will be released for public comment. A Technical
Advisory Panel to consider the interim report would then be convened in January 2007. Results
of the evaluation research contract would then be available to inform deliberations about the
IPPS rule for FY 2008.
Specialty Hospitals
These proposed revisions will improve the accuracy of payments, leading to better incentives for
hospital quality and efficiency and ensure that payment rates relate more closely to patient
resource needs. More specifically, these changes are expected to reduce incentives for hospitals
to cross-subsidize underpaid cases by having to treat the most profitable patients. In FY 2006,
CMS made significant changes to the cardiovascular DRGs that are commonly billed by
specialty hospitals to better recognize severity of illness. The FY 2007 changes take this
initiative further. As a result of the DRG payment reforms to improve accuracy, between FY
2006 and FY 2009, payment to cardiac specialty hospitals are projected to decline by over 5
percent due to the changes to the relative weights.
Details on Hospital and DRG Impacts
Medicare payment to 98 percent of hospitals will increase in FY 2007. The reduction in
payment to the remaining 2 percent of hospitals is occurring as result of factors other than the
changes CMS is making to improve the accuracy of the IPPS (generally updates to the wage
index data etc…). No hospital is projected to experience an estimated decrease in payment in
FY 2007 from the change to adopt cost weights after including the market basket update
# of Hospitals
4
Changes in total estimated payments
FY 2006 to FY 2007
Percent Gains/Losses in Specific Ranges
Final
Rule
Market Basket
and
Proposed DRG
Rule
Changes
More than -10%
14
0
Between -5 and -10 % 31
0
Between -1 and -5 % 140
0
Between -1 and 0
106
0
Between 0 and +1 % 144
1
Between 1% and 5% 831
3016
Between 5% and 10% 1733
545
More than +10%
523
33
Final
Rule
All
Factors
3
4
41
30
98
2711
609
99
The changes in the DRG relative weights are budget neutral. Therefore, some will go up and
others will go down from the changes we are making. As suggested earlier, the changes we are
adopting in this final rule result in few changes, up or down, relative to our proposed rule as
illustrated below.
# of DRGs
Changes in the Relative Weights
Percent Gains/Losses in Specific Ranges
Proposed
Rule
Final Rule
More than -10%
32
0
Between -5 and -10 % 42
1
Between -1 and -5 % 49
78
Between -1 and +1 % 42
308
Between 1% and 5% 111
130
Between 5% and 10% 97
12
More than +10%
153
7
5