Medicare’s Big Changes

Moving to a payment system tied to the severity of illness and refusing to pay for hospital-acquired conditions may encourage private payers to do the same

Martin Sipkoff
Contributing Editor

On Oct. 1, the Centers for Medicare & Medicaid Services is to initiate a notably altered way to pay hospitals. Its new system, Medicare Severity DRG (MS-DRG), is weighted by the severity of diagnosis, paying more for sicker patients. Some hospitals, such as those in urban areas treating a sicker-than-average population, will see an increase in Medicare payments. Others will see a drop.

Most significantly, payment is now tied to the quality of care. Last year, CMS said it will no longer pay for eight conditions if they were not present on admission. On April 14, CMS proposed an expansion of that list, including nine more conditions, for final adoption later this year.

Health plans are looking hard at all this. Starting this spring and summer, several are refusing to pay for hospital errors. Aetna and WellPoint, for example, are banning payments for care resulting from serious avoidable errors, such as operating on the wrong limb or giving a patient incompatible blood.

“This value-based purchasing has been coming for some time,” says Fred Pane, senior director of pharmacy affairs at Premier, a hospital group-purchasing organization. “It is an important change that could affect all health care reimbursement over time.”

Reform to address this flaw in the prospective system of payment began with the Deficit Reduction Act of 2005, which was a federal product of the marriage of quality and cost control that began in the early 1990s.

The act’s stated purpose was to reduce overall hospital costs by improving care: Congress ordered CMS to select at least two conditions that the agency considered costly or too frequent, that resulted in the assignment of patients to a higher-paying DRG when they have that condition as a secondary diagnosis after admission, and that could have been prevented through adherence to evidence-based guidelines.

In March 2007, Rand Health produced a detailed evaluation of the current system and the changes proposed by CMS to meet the demands of the Deficit Reduction Act.

It said that the purpose of what it called refinements in the CMS payment system is “to improve payment accuracy and equity so that hospitals do not avoid treating expensive cases” or have the advantage of treating less costly conditions. “The refinements would reduce payments for less expensive cases and increase payments for more expensive cases.”

In a November 2007 report to Congress, the Department of Health and Human Services moved that idea a step further by stating that “value-based purchasing, which links payment to performance, is a key policy mechanism that CMS is proposing to transform Medicare from a passive payer of claims to an active purchaser of care.”

Starts in October

“Accountability is always highly effective,” says Babette Apland, senior vice president and health care manager for HealthPartners, a Minnesota health plan. “In our experience, providers agree with that idea.”

The changes apply to more than 3,500 hospitals paid under the Inpatient Prospective Payment System (IPPS). It is effective for discharges on or after Oct. 1, 2008. “The rule continues the transformation of the Medicare program to a prudent purchaser of services by proposing a number of payment policies that are more accurate and by strengthening incentives for hospitals to improve the quality of care they furnish to beneficiaries,” says CMS spokeswoman Ellen Griffith-Cohen.

Aetna has taken the position that MS-DRG can improve care and lower costs. The company, the third-largest by enrollment, has begun stipulating in hospital contracts that it will no longer pay nor let patients be billed for the National Quality Forum’s 28 “never events,” incidents so egregious they should never occur.

The overall effect of MS-DRG goes beyond what CMS won’t pay for — it changes the manner in which payments are evaluated and weighed. MS-DRG has 25 major disease categories, 745 diagnosis-related groups, and three subclasses of complications and comorbidities. That is the same number of major disease categories as the original system, adopted in 1983, but there are 207 additional DRGs and the new subclass designation “major complication or comorbidity,” an example of which is severe sepsis.

“It is a far less passive system,” says Meredith Rosenthal, PhD, an associate professor of health economics and policy at the Harvard School of Public Health.

The actuarial consulting company Milliman Inc. recently published a study of the effect of the changes on health plans and hospitals. Calling MS-DRG “the most significant revision to Medicare inpatient payment methods” in more than a quarter century,” the report states that the financial effect on health plans and hospitals will result from the degree of change in the “related weights” used as a basis for payment: “Although the overall effect on the Medicare program is intended to be cost-neutral, the substantial changes in payment levels for individual cases will result in significant changes to the total amount of Medicare inpatient payments received.... It would be a mistake to assume that the changes will average out.”

According to the Milliman analysis, under this new system, payment for some individual admissions will increase by as much as 20 percent. The report states that a few hospitals, such as acute-care facilities treating the sickest patients, including some specialty hospitals, may see their Medicare payments double.

The original payment DRG system, known as CMS-DRG, was adopted in 1983 as a prospective system. Payments to hospitals were made based on admission diagnosis. But that system was “never completely prospective,” says Rosenthal.

In an article in the October 2007 issue of the New England Journal of Medicine, Rosenthal points out that CMS-DRG payments were adjusted for patients who developed complications after admission, and CMS made “outlier payments that partially compensated hospitals for additional expenses incurred.”

Perverse incentive

“With regard to preventable complications, these retrospective features of the DRG payment system have harbored a perverse incentive: Hospitals that improved patient safety and ameliorated problems such as nosocomial infections saw their Medicare revenues — and sometimes their profits — reduced,” wrote Rosenthal.

Reform to address this flaw in the prospective system of payment began with the Deficit Reduction Act of 2005, which was the federal product of the marriage of quality and cost control that began in the early 1990s.

The act’s stated purpose was to reduce overall hospital costs by improving care: Congress ordered CMS to select at least two conditions that the agency considered costly or too frequent, that resulted in the assignment of patients to a higher-paying DRG when they have that condition as a secondary diagnosis after admission, and that could have been prevented through adherence to evidence-based guidelines.

Bigger changes ahead

The total financial effect of MS-DRG on each health system will depend on total patient mix. “Our initial estimates suggest that the net change in total Medicare payments will be 5 percent or less for most hospitals,” the report says. That’s the good news, but as always the devil is in the details.

According to the report, the bottom line is that about 60 percent of hospitals will see a drop in Medicare payments — and some could lose as much as 30 percent of their Medicare payment.

The effect of the shift in how CMS weighs its Medicare payments — and the attendant adjustment in software and procedural codes — is dwarfed by a much bigger change.

For discharges occurring on or after Oct. 1, Medicare will no longer pay the additional costs incurred by hospitals when certain hospital-acquired infections develop or when certain medical errors occur.

Specifically, hospitals “will not receive additional payment for cases in which one of the selected conditions was not present at admission,” according to the new CMS rules. “That is, the case would be paid as though the secondary diagnosis [were] not present.”

Health plans are following Medicare. In addition to Aetna, WellPoint, the largest plan by enrollment, is doing the same thing in Virginia with four errors from the NQF never-events list, including leaving a sponge or other object in a patient after a procedure or performing the wrong procedure. The company says it will extend the policy to its plans in New England, New York, and Georgia.

UnitedHealth Group and Cigna said they will be following suit sometime this year. The Blue Cross Blue Shield Association publicly says that all 39 members are looking at similar measures.

The amount of money saved by the plans may be minimal, however. In Minnesota, where hospitals are required by law to report such errors, only 154 NQF never events were reported last year out of 9 million hospital admissions, according to recent reports.

Challenge to health plans

The big savings will come if health plans stop paying for all hospital-acquired conditions, not just never events.

The Centers for Disease Control & Prevention estimates that patients develop 1.7 million infections in hospitals a year, causing or contributing to as many as 99,000 deaths a year.

On average, urinary-tract infections and hospital-acquired pneumonia can add more than $10,000 to a patient’s hospital bill.

A serious antibiotic-resistant bloodstream infection can result in more than $100,000 in extra costs. Such common problems total more than $4.5 billion in additional health spending a year, according to the CDC.

MS-DRGs — with the emphasis on hospital-acquired and preventable infections in addition to a few never events — are expected to save the federal government $20 million in fiscal year 2009, according to a CMS statement, and health plans may well expand their contract stipulations to include the kind of hospital-acquired infections CMS will no longer pay for.

“It’s not going to be just CMS,” Craig Becker, president of the Tennessee Hospital Association, said recently. “It’s going to be everybody.”

Public comment will be accepted through June 13 on the additional nine conditions that CMS no longer wants to pay for. The final rule will be issued on or before Aug. 1.

Quality reporting measures

There is one more significant change happening under the new rules associated with MS-DRG: Hospitals now report 27 quality-related measures to CMS in order to receive the full annual update to Medicare’s payment rates.

CMS also announced on April 14 that it proposes to add 43 new quality measures to the 30 measures now listed in its voluntary reporting of standardized quality measures.

These are measures that are publicly reported on Hospital Compare, the CMS public Web site for comparing hospital quality reports (

The agency must receive data about these measures for a hospital to receive its full inflation update for fiscal year 2010. The additional measures, if adopted in the final rule following a public comment period, will take effect Oct. 1, 2008, for fiscal year 2009.

The move to severity-based payments and especially the refusal of CMS to pay for treatments for conditions not present on admission is a sign that the times are indeed changing.

“Tying payment to the quality of care represents the future of health care,” says Premier’s Pane. “It was inevitable.”

Changes in Medicare payments linked to quality of care

Beginning Oct. 1, Medicare will no longer pay for eight hospital-acquired medical conditions, five of which are “serious reportable adverse events” as determined by the National Quality Forum. Here is a list of those HACs, their frequency and cost in 2007, and where evidence-based guidelines are available addressing their prevention.

CMS will not pay for these hospital-acquired conditions

Selected hospital acquired condition (HAC)
Selected evidence-based guidelines
Number of cases in FY2007 Cost per hospital stay in FY2007
Foreign object retained after surgery
750 $63,631
Air embolism
57 $71,636
Blood Incompatibility
24 $50,455
Stage III & IV pressure ulcers
257,412 $43,180
Falls and trauma:
  • Fractures
  • Dislocations
  • Intracranial injuries
  • Crushing injuries
  • Burns
  • Electric shock
193,566 $33,894
Catheter-associated urinary tract infection (UTI)
12,185 $44,043
Vascular catheter-associated infection
29,536 $103,027
Surgical site infection — Mediastinitis after coronary artery bypass graft (CABG)
69 $299,237
Source: Centers for Medicare & Medicaid Services

Nine more conditions proposed for payment exclusion

On April 14, CMS announced an expansion of the conditions listed on the chart above. The following conditions are now proposed. Following a public comment period, they could also be adopted for implementation by this October.

Proposed hospital-acquired conditions ineligible for payment
HAC candidate
Selected evidence-based guidelines
Number of cases in FY2007 Cost per hospital stay in FY2007
Surgical site infections following elective procedures:
  • Total knee replacement
  • Laparoscopic gastric bypass and gastroenterostomy
  • Ligation and stripping of varicose veins


Legionnaires’ Disease
351 $86,014
Glycemic control:
  • Diabetic ketoacidosis
  • Nonketotic hyperosmolar coma
  • Diabetic coma
  • Hypoglycemic coma
Iatrogenic Pneumothorax
22,665 $75,089
480 $23,290
Ventilator-associated pneumonia (VAP)
30,867 $135,795
Deep vein thrombosis (DVT)/pulmonary embolism (PE)
140,010 $50,937
Staphylococcus aureus septicemia  (Intravascular catheter-associated Staphylococcus aureus  septicemia only)
27,737 $84,976
Clostridium difficile-associated disease (CDAD)
96,336 $59,153
Source: Centers for Medicare & Medicaid Services

More information about MS-DRG is available at the CMS Web site. Fact sheets for all the proposed changes, and the current final changes, are at The 1,047-page description of MS-DRG in the Federal Register, which includes information on review process, may be found at or .

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