By more accurately recognizing the costs of caring for a patient, the new MS-DRGs should help reduce the potential for abusive practices. Under the old DRG system (with payments based on broad averages) incentives could lead hospitals to "cherry pick" - the practice of treating only the healthiest and most profitable patients. The new MS-DRGs help address the concerns that certain 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. Finally, by paying more accurately for inpatient services, MS-DRG's will minimize the cost shifting hospitals now say they have to make to account for variation in payment among Medicare inpatient procedures.

In addition to the base payment for the DRGs, the law requires Medicare to make a supplemental payment to a hospital if its costs for treating a particular case exceed the usual Medicare payment for that case by a set threshold. Medicare sets the threshold for high cost cases at an amount that is projected to make total "outlier payments" equal to 5.1 percent of total inpatient payments. For FY 2008, CMS is adopting a high cost outlier threshold of $22,650, down from $24,485 in FY 2007. By better recognizing severity of illness in the DRG reforms that are part of this final rule, fewer cases would be paid as outliers if CMS did not reduce the fixed loss amount. Reducing the fixed loss amount will help assure that hospitals that do treat these extremely costly cases will have an easier time qualifying for outlier payments.


The rule also changes the way Medicare pays for hospital capital-related costs based on an analysis that showed substantial positive margins experienced by some hospitals. In response to comments from MedPAC and other parties, the rule does not finalize the proposal to provide a zero payment update for urban hospitals and instead provides a full update for all hospitals. However, the final rule does eliminate the large urban add-on payment, and adopts a policy of discontinuing the teaching adjustments to capital payments over a three-year period.

The rule implements a provision of the Deficit Reduction Act of 2005 (DRA) that takes the first steps toward preventing Medicare from giving hospitals higher payment for the additional costs of treating a patient who acquires a condition (including an infection) during a hospital stay. Already the feature of many state health care programs, the DRA requires hospitals to begin reporting secondary diagnoses that are present on the admission of patients, beginning with discharges on or after October 1, 2007. Beginning in FY 2009, cases with these conditions would not be paid at a higher rate unless they were present on admission. In order to improve the reliability of care in the nation's hospitals, the rule identifies eight conditions, including three serious preventable events (sometimes called "never events") that meet the statutory criteria. CMS will work to add an additional 3 conditions to the list next year.

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