Renee Leary
Dean Farley

The most important changes in the Medicare inpatient prospective payment system in nearly 25 years are here. Are you ready?

At a Glance
To prepare for the full impact of MS-DRG implementation, providers should:

  • Educate and communicate
  • Ensure coding accuracy and thoroughness
  • Assess productivity
  • Analyze and evaluate
  • Reassess current procedures
  • Stay current

The year 2008 promises to be a challenging year for hospitals as the Centers for Medicare and Medicaid Services (CMS) takes steps to strengthen the long-term financial security of the Medicare program and to ensure that Medicare payments under the inpatient prospective payment system (IPPS) are appropriate. Major changes to the IPPS were published in the Federal Register of Aug. 22, 2007, and include the adoption of severity-adjusted diagnosis-related groups (DRGs), a payment reduction to offset anticipated improvements in hospital coding, continuing efforts to reward good-quality hospitals financially, and substantial changes to capital payments. Also on the horizon is reduced payment for hospital-acquired conditions that lead to the assignment of a higher-paying DRG. It is important for hospitals to understand the implications of these IPPS changes so they can plan accordingly and focus their limited resources. How these Medicare changes will affect commercial DRG contracts is another matter to be closely watched.

Tackling Medicare Severity

In October 2007, CMS began paying for inpatient hospital services using the CMS-developed Medicare severity DRGs (MS-DRGs). Unlike the severity system proposed in spring 2006, MS-DRGs are transparent, are publicly available, and build on the DRG logic that CMS has used since 1983. DRG refinements and enhancements introduced over the past 20 years, including improvements to recognize new technologies and service complexity, are generally preserved. Initial findings by the RAND Corporation, hired by CMS to evaluate alternative severity systems, show that MS-DRGs are a significant improvement over current DRGs in explaining cost variation. In addition, because RAND has not identified any severity system as clearly superior or inferior, CMS believes that MS-DRGs will be permanently adopted.

Using its own severity DRG research from 1994 as a model, CMS tackled the following tasks in developing the MS-DRGs.

Complication and comorbidity review and stratification. The MS-DRGs continue to recognize "sicker" patients through a diagnosis-based complication and comorbidity (CC) list, which was reanalyzed and updated for the first time since the early 1980s. As appropriate, diagnosis codes were added and deleted from this list, and a subset of more severe or major CCs (MCCs) was identified. Previously, there were 3,326 diagnosis codes on the CC list, and approximately 77 percent of all cases had at least one CC-thus the CC list had lost the ability to differentiate patients who were truly sicker. Under MS-DRGs, only 37 percent of cases have at least one CC and 22 percent have at least one MCC. CMS believes that as a result of these and other refinements, the CC/MCC lists are better able to differentiate severely ill patients.

DRG consolidation. CMS started with the 538 Version 24 DRGs (effective during FY07) and eliminated pediatric (age <18), CC, and other diagnosis-driven complexity splits. Low-volume DRGs and other clinically similar DRGs were also combined, resulting in a total of 334 "base" DRGs. Specifically tailored to the Medicare population, these base DRGs may not be suitable for other populations. The appropriateness of using MS-DRGs for Medicaid and commercial populations, like the applicability of the CC and MCC list, requires further study.

Division into severity subclasses. Each base DRG was evaluated and, based on volume and charge statistics, either was not further subdivided or was subdivided into two or more severity subclasses. Severity subclass is determined by the most significant secondary diagnosis code (e.g., MCC versus CC), and there is no credit for multiple CC or MCC conditions. New CC/MCC severity adjustments have been introduced into all major diagnostic categories (MDCs) applicable to the Medicare population.

In summary, MS-DRGs represent the most significant change to the coding and reimbursement of Medicare inpatient services since DRGs were adopted in 1983. The number of final DRG categories is expanding from 538 to 745, and the CC list has been completely rethought. MS-DRGs continue to be represented by a three-digit number, ranging from 001 to 999 with gaps throughout. (There is no relationship between the numbering of the MS-DRGs and CMS DRGs. For example, CMS DRG 470 [Ungroupable] is now MS-DRG 999.)

During FY08, Medicare is assigning all cases to an MS-DRG. Payment, however, is a 50 percent blend of weights derived using the Version 24 CMS DRGs and the Version 25 MS-DRG weights. The full impact of MS-DRG-based reimbursement will not be felt until October 2008.

Coding Adjustment

CMS anticipates that hospital documentation and coding practices will change in response to the MS-DRGs, especially the new CC and MCC lists. In fact, it estimates that documentation and coding changes will lead to an estimated 4.8 percent increase in reported case mix. To ensure that Medicare does not overpay because of changes in coding and documentation, rather than real case mix changes, Medicare planned to implement a 1.2 percent coding adjustment in FY08 and a 1.8 percent coding adjustment in both FY09 and FY10. More recently, CMS reduced the FY08 coding adjustment to 0.6 percent as a result of congressional action.

CMS has reduced the standardized payment amounts by this coding adjustment. As soon as claims data are available, CMS will compare projections with actual case mix increases due to improved coding and adjust the standardized amount for differences between the forecast and the actual case mix increase.

This means that hospitals that do not become familiar with CC/MCC changes and other nuances of the proposed MS-DRGs, and do not improve their documentation and coding procedures accordingly, will experience a double hit. For one thing, their cases will be assigned to less complex MS-DRGs. Also, the reimbursement within these DRGs will be reduced by the applicable coding adjustment (0.6 percent for FY08).

Hospital Quality Reporting

Inpatient operating rates are reduced by 2 percent for hospitals that do not report data for a set of CMS-established quality measures. To receive the full payment update for FY08, hospitals were required to report data on a set of 27 quality measures during CY07, including 24 process measures related to the care of heart attacks (acute myocardial infarction), heart failure, pneumonia, and surgical improvement; two calculated mortality measures; and the Hospital Consumer Assessment of Healthcare Providers and Systems patient satisfaction survey. For FY09 payment rate determination, CMS is adding one new quality measure: pneumonia 30-day mortality for Medicare patients, which is calculated using Medicare claims data from between July 2006 and June 2007. CMS is also adding two new process measures:

  • Surgical care improvement project (SCIP) Infection 4: Cardiac surgery patients with controlled 6AM postoperative serum glucose
  • SCIP Infection 6: Surgery patients with appropriate hair removal

The pneumonia quality measure was approved in the FY08 final rule; the two process measures, which were pending National Quality Forum (NQF) endorsement, were approved in the outpatient PPS final rule published Nov. 27, 2007. Data on the two SCIP measures, which require additional abstracting, are due by Aug. 15, 2008, for the first quarter of CY08. Also under consideration, though not implemented at this time, are two additional process measures that are pending NQF approval: SCIP Infection 7, Colorectal patients with immediate postoperative normothermia; and SCIP Cardiovascular 2, Surgery patients on a beta-blocker prior to arrival who received a beta-blocker during the perioperative period.

Hospitals are generally concerned that the number of quality measures requiring additional data collection efforts is increasing each year. CMS notes that procedures for collecting data should be incorporated into care processes and should be a consequence of care, not an afterthought. The primary intent of collecting these data quality measures is to foster facilitywide changes in the institution. That said, CMS is working with-and encourages hospitals to work with-vendors to identify electronic solutions for collecting this information. CMS also plans to add, whenever possible, quality measures that do not require chart abstraction, such as claims-based mortality indicators.

Hospital-Acquired Conditions

The Deficit Reduction Act of 2005 requires CMS to select at least two preventable, hospital-acquired conditions that are high cost and/or high volume, lead to the assignment of a higher-paying DRG (are a CC or MCC), and can be identified through unique ICD-9-CM codes. Beginning Oct. 1, 2008 (FY09), if one of the selected conditions develops during the patient's hospital stay, the MS-DRG will be assigned as if the condition was not coded. Conditions that develop while the patient is hospitalized will be identified using the new present-on-admission (POA) indicator, which is required for all diagnoses submitted on inpatient claims for discharges on or after Jan. 1, 2008 (Maryland waiver, critical access, long-term care, cancer, psychiatric, inpatient rehabilitation, and children's hospitals are exempt from this requirement).

Beginning in October 2008, CMS will reduce payment for cases where one of the following CCs or MCCs developed during the patient's hospital stay-that is, it was not present on admission:

  • Catheter-associated urinary tract infections
  • Pressure ulcers (decubitus ulcers)
  • Serious preventable event-object left in during surgery
  • Serious preventable event-air embolism
  • Serious preventable event-blood incompatibility
  • Vascular catheter-associated infections
  • Surgical site infection-Mediastinitis after coronary artery bypass graft (CABG)
  • Hospital-acquired injuries-fractures, dislocations, intracranial injury, crushing injury, burns, and other unspecified effects of external causes 

The payment reduction will represent the difference between reimbursement calculated with the hospital-acquired CC or MCC on the case and that calculated without the CC or MCC present.

The difference between the higher costs associated with cases that have a hospital-acquired CC or MCC and the lower Medicare payment will be treated as cost savings by the Medicare program. This provision will apply only when the hospital-acquired condition is the only CC or MCC present on the claim. If any other CC or MCC, not subject to the hospital-acquired infection provision, is present, the case will be assigned to the higher-paying MS-DRG.

Hospitals should make sure that physicians, coders, and billing staff are working collaboratively to ensure complete and accurate documentation, code assignment, and reporting of diagnoses and procedures. Particular attention should be paid to automated systems that resequence diagnoses prior to claims submission; these tools should resequence POA indicators as well. Implementation of the POA indicator will require changes to the DRG grouping software to accept POA as a new input field and then logic changes to use this field accordingly. If this change was not included in the October 2007 MS-DRG software update, appropriate revisions should be in place before Jan. 1, 2008. 

Significant Pricing Changes and Trends

In addition to the "coding reduction" factor discussed earlier, CMS is making significant changes to the capital PPS. CMS has found that for the period between FY96 and FY04, every type of hospital and geographic grouping of hospitals realized positive aggregate margins from capital PPS payments (though the margin for rural hospitals [3.4 percent] lagged considerably behind that for urban hospitals [9.9 percent]). As a result of these findings, the 3 percent capital add-on for large urban hospitals has been eliminated and the capital adjustment for indirect medical education (IME) is being phased out over three years and will be completely gone in FY10. Because of the positive capital margins for all categories of hospitals, the capital standard federal rate will not be increased to account for these policy changes.

CMS is in year two of the transition to cost-based weights. FY08 MS-DRG weights will be based on a blend of one-third charge-based weights (weight methodology prior to FY07) and two-thirds cost-based weights. In addition, as discussed, weights are a 50/50 blend of the CMS DRG weight applicable to the case and the MS-DRG weight. Both CMS DRG weights and MS-DRG weights were calculated using the one-third charge and two-thirds cost blend.

The fixed loss outlier threshold for FY08 is decreasing from the current $24,485 to $22,185. This decrease is principally due to the fact that many cases currently paid as outliers will be assigned instead to higher-severity MS-DRGs.

CMS is also reducing the Medicare payment for cases in which an implanted device is replaced at reduced or no cost to the hospital. This policy will apply to MS-DRGs only where the implanted device determines the base DRG assignment and where the hospital is credited for more than 50 percent of the device's cost. Two new condition codes have been established to support this policy change:

  • Condition code 49-product replacement within product life cycle
  • Condition code 50-product replacement for known recall of a product

Provider Strategies for Succeeding and Winning Under MS-DRGs

CMS is assuming that all hospitals will improve their coding and that these improvements will lead to an aggregate 4.8 percent increase in reported case mix. In addition, urban hospitals are especially at risk through capital and IME reductions. Further reductions in IME and disproportionate share hospital (DSH) payments may be on the horizon, especially if MS-DRGs adjust for some of the unmeasured severity differences that the IME and DSH adjustments were designed to correct.

Providers should consider the following steps to prepare for the full impact of MS-DRG implementation.

Educate and communicate. Everyone in the facility who touches Medicare coding and billing or uses Medicare DRGs for analysis, reporting, and forecasting needs to understand that MS-DRGs are not just another grouper. If your facility is using one of the commercially available severity adjustment methodologies, such as All-Patient Refined (APR) DRGs® or All-Payer Severity-Adjusted (APS) DRGs®, then education on the differences between MS-DRGs and those methodologies would also be helpful.

Ensure coding accuracy and thoroughness. The keys to success under the MS-DRGs or any severity-adjusted DRG system are complete and accurate documentation and coding. Accurate data coded to the highest level of specificity drive severity assignment and are more important than ever. Device coding, in particular, can lead to the assignment of a higher-weighted MS-DRG, and CMS is considering developing a list of major devices to be used as a proxy for MCCs.

To evaluate coding thoroughness and accuracy, select charts at random or with a specific focus. Ask yourself: What isn't being coded that might be? Are we getting credit for the level of care we deliver? Audit to ensure that all codes are making it to the bill.

Assess productivity. MS-DRGs have most likely had a negative impact on coder productivity as staff learn the new system and become comfortable with its nuances. Because success with MS-DRGs or any severity system means coding completely and to the highest level of specificity, the entire medical record needs to be read and the volume of physician queries has most likely increased. Review current operational procedures and look for ways to prevent or recover from downturns in coder productivity and billing delays. Reassess staffing levels and needs, and take steps to retain your current coding staff. Evaluate your current approach to obtaining physician documentation, and look for ways to streamline this effort. Also, recognize that POA requirements will require additional physician queries.

Analyze and evaluate. Most hospitals prepared for MS-DRG implementation by using historical data and information in the proposed and final rules to determine how MS-DRGs would affect their case mix index and Medicare reimbursement. Now that MS-DRGs are a reality, it is important to monitor your actual performance against these projections. If things aren't what you expected, find out why. Note that weights in the proposed rule are based on a full implementation of MS-DRGs, whereas weights in the final rule are a phase-in blend based on 50 percent of the Version 24 CMS DRG methodology and 50 percent of MS-DRGs. Use both sets of weights to determine the short- and long-range impact of MS-DRGs. Ensure that your expected reimbursement is consistent with your actual cost experience. If not, you may need to reassess current operations.

Reassess current procedures. Any guidelines or procedures that were based on the CMS DRGs or the old CC list, including manual or automated screening processes, need to be reworked. Anything that was DRG driven should be identified and updated for MS-DRGs. Not only were the DRG logic and CC list completely revamped, but also DRGs were renumbered. For example, cases currently assigned to error DRG 470 (Ungroupable) will now be assigned to MS-DRG 999, so all internal and vendor systems that edit for and report on DRG errors need to be updated to search for MS-DRG 999. Management decision support systems should also have been modified properly to incorporate MS-DRGs.

Stay current. Monitor MS-DRG regulations, corrections, and transmittals; summarize changes; highlight areas of concern; and distribute both the information and analysis of potential impact to the appropriate departments within your facility. Besides the CMS web site, use your software vendors, who need to update their products as a result of these regulations, as another source for up-to-date information. Read the final rule carefully; it not only describes changes for this fiscal year but also gives insight into CMS's thinking and future plans.

Be heard. Be an active and vocal participant in the transition to severity-adjusted DRGs. Working through trade organizations such as HFMA, the American Hospital Association, and the American Health Information Management Association, make your opinion heard.

Don't stop. Now that you have been using severity-adjusted DRGs for a while, be sure to measure where you stand. Evaluate whether implemented changes have had the desired results. Don't treat MS-DRGs as a "one-time" deliverable; changing market forces and regulatory requirements make periodic education and reassessments critical.

As a final point, providers should evaluate how the MS-DRGs will affect their contracts with non-Medicare payers. At a minimum, all DRG-based contracts need to be reviewed, with particular attention to required annual updates based on regulatory changes and termination provisions.

Are these payers ready for MS-DRGs? If not, how will the payer keep the "obsolete" CMS DRGs updated to recognize ICD-9-CM code changes? Determine how areas carved out under current DRGs will need to be updated under MS-DRGs. Commercial and other non-Medicare payers, such as state Medicaid plans, may adopt other severity systems, which have been developed with an all-payer population in mind, so be prepared to support multiple severity systems.

Finally, be prepared for non-Medicare payers to seek adjustments for changes in coding practices and for hospital-acquired infections. Expect contracting language that allows for rate adjustments based on actual case mix index changes. Also expect present-on-admission reporting and policies that reduce reimbursement for conditions that develop while the patient is hospitalized and could have been prevented. 

More Changes Likely to Come

MS-DRGs are intended explicitly to move Medicare dollars from hospitals that previously had relatively low unmeasured case severity and to help hospitals that have been treating more serious patients without adequate compensation. However, despite these policy objectives, all hospitals face new risks and challenges from the FY08 final rule.

Because of the changes that CMS has made in anticipation of coding enhancements, hospitals now need to improve documentation and coding just to stay in place. At the same time, the expanded emphasis on reporting of quality information and new requirements for POA coding suggest that more changes are on the way as CMS looks for ways to reimburse hospitals based on results rather than efforts.

As you work through these changes, recognize that the situation is extremely fluid. MS-DRGs are going to have unintended consequences. They will eventually create problems and opportunities for the Medicare program and CMS will have to respond. At the same time, the response of non-Medicare payers may eventually be even more problematic for hospitals. Will other payers adopt MS-DRGs, even though MS-DRGs incorporate a number of changes, such as the elimination of pediatric age splits, that make them less attractive for non-Medicare populations? Will other payers adopt variations on MS-DRGs based on their own policy preferences? Will we see a proliferation of prospective payment methods, or will Medicaid programs, other public payers, and commercial health plans settle on a strategy that is reasonably consistent across non-Medicare payers? Only time will tell, but we can be fairly certain more changes are coming. 

Stay Current!

The CMS web site's IPPS area ( and the Medicare Learning Network are good sources for up-to-date information on regulations and changes.

Renee Leary is director, Vineyard Point Associates, LLC, Guilford, Conn. (

Dean Farley, PhD, is vice president, the Lewin Group, Falls Church, Va. (

Publication Date: Saturday, December 01, 2007

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