The Centers for Medicare & Medicaid Services (CMS) has issued a proposed rule that takes significant steps to improve the accuracy of Medicare's payment under the acute care hospital inpatient prospective payment system (IPPS), while providing additional incentives for hospitals to engage in quality improvement efforts.

The payment reforms include a proposal to restructure the inpatient diagnosis related groups (DRGs) to account more fully for the severity of the patient's condition. In addition, the proposed rule includes provisions to ensure that Medicare no longer pays hospitals for their additional costs of hospital-acquired conditions (including infections), and includes an expanded list of publicly reported quality measures. The proposed rule would also reduce payment for a DRG involving the implantation of a device, when a hospital replaces a device and the replacement is supplied to the hospital at no or reduced cost.

Medicare's inpatient rates for operating expenses will increase by 3.3 percent in FY 2008 for those hospitals that report quality data to CMS. Overall, the proposed rule is estimated to increase payments to more than 3,500 acute care hospitals by $3.3 billion.
"The payment reforms included in this proposed rule would continue a process for the third consecutive year to ensure that Medicare payments for inpatient services are more accurate and better reflect the severity of the patient's condition," said CMS Acting Administrator Leslie V. Norwalk, Esq. "The proposed rule also represents yet another major step forward in Medicare's efforts to foster higher quality care in inpatient settings."

Expanding on the work of the previous two years, the proposed rule would create 745 new severity-adjusted diagnosis related groups (DRGs) (Medicare Severity DRGs or MS-DRGs) to replace the current 538 DRGs. Projected aggregate spending from the reforms will not change. However, payments would increase for hospitals serving more severely ill patients and decrease for serving patients who are less severely ill. Consistent with public interest expressed on last year's changes, CMS is proposing to revise the current DRGs so that the system will continue to be based upon a non-proprietary case mix system making it available to the public.

The changes reflect recommendations from the Medicare Payment Advisory Commission (MedPAC). CMS took its initial steps toward implementing the new system when it created new DRGs for cardiac procedures performed in FY 2006. An additional set of DRGs reflecting severity of illness was introduced for discharges in FY 2007. By more accurately recognizing the costs of caring for a patient, the new MS-DRGs will further reduce incentives for hospitals to "cherry pick," the practice of treating only the healthiest and most profitable patients. They also address concerns that specialty hospitals -- hospitals that provide a limited range of services and typically are owned in whole or in significant part by physicians who serve as referral sources -- may selectively provide such profitable services. For example, concerns about inappropriate payments for specialty hospitals involved payments for certain elective cardiac admissions. Last year, we estimated that payment reforms for 2006 and 2007 reduced payments to cardiac specialty hospitals by over 5 percent. The reforms for FY 2008 are estimated to reduce payments an additional 4 percent.

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