The Centers for Medicare & Medicaid Services (CMS) has released the Fiscal Year (FY) 2025 final rule for the Hospital Inpatient Prospective Payment System (IPPS) and the Long-Term Care Hospital Prospective Payment System, bringing critical updates to Medicare payment policies and rates. For hospitals and healthcare administrators navigating the complexities of Medicare reimbursements, understanding the nuances of Diagnosis Related Group Reimbursement is paramount. This rule outlines the framework for how hospitals will be financially compensated for inpatient services provided to Medicare beneficiaries. Notably, the COVID-19 Public Health Emergency (PHE) declarations concluded on May 11, 2023, which has implications for certain DRG payment adjustments that were in place during the PHE.
The bedrock of Medicare’s inpatient payment system, as mandated by Section 1886(d) of the Social Security Act, is the Inpatient Prospective Payment System (IPPS). This system governs how acute care hospitals are reimbursed for operating costs under Medicare Part A. At the heart of IPPS lies the concept of diagnosis-related groups (DRGs). Each inpatient case is categorized into a specific DRG, a classification system designed to group together clinically similar patients who are expected to consume similar hospital resources.
Every DRG is assigned a payment weight. This weight reflects the average resources required to treat Medicare patients within that specific DRG. It serves as the foundation for calculating hospital reimbursement. The higher the weight, generally, the more complex and resource-intensive the condition, and consequently, the higher the reimbursement.
The calculation of diagnosis related group reimbursement involves a base payment rate, which is segmented into labor-related and non-labor portions. The labor-related share is adjusted based on the wage index specific to the geographic area where the hospital is located, accounting for variations in labor costs across the country. For hospitals in Alaska and Hawaii, a further adjustment is applied to the non-labor share to reflect the cost of living differences. This adjusted base payment rate is then multiplied by the DRG relative weight to determine the core payment for a given case.
Beyond the base DRG payment, hospitals may qualify for additional payments based on specific criteria. One such adjustment is the Disproportionate Share Hospital (DSH) adjustment. Hospitals that treat a significant proportion of low-income patients are eligible for a percentage add-on payment. This DSH adjustment is designed to financially support hospitals that serve vulnerable populations and is calculated using statutory formulas to identify qualifying institutions.
Teaching hospitals also receive an additional payment known as the Indirect Medical Education (IME) adjustment. This add-on recognizes the indirect costs associated with medical education programs, such as the supervision and training of residents. The IME adjustment varies based on the ratio of residents to beds for operating costs and residents to average daily census for capital costs, acknowledging the financial impact of teaching programs on hospital operations.
Finally, the IPPS incorporates outlier payments to protect hospitals from substantial financial losses due to extraordinarily expensive cases. Cases deemed “outlier cases” due to their unusually high costs are eligible for additional payment. This outlier payment is added to the DRG-adjusted base payment rate, along with any applicable DSH or IME adjustments, providing a safety net for hospitals encountering exceptionally resource-intensive patient care.
For hospitals seeking comprehensive information and resources related to Medicare Fee-for-Service (FFS) programs, the CMS Hospital Center serves as a valuable online hub. It offers a centralized point of access to information pertinent to hospital administration and Medicare compliance.
