How recalibration method, pricing, and coding affect DRG weights - diagnosis-related group

Health Care Financing Review, Winter, 1992 by Grace M. Carter, Jeannette A. Rogowski

Introduction

In this study, we addressed the issue of how to best control for the variation across hospitals in resource use and pricing policy during calculation of DRG relative weights. DRG weights are used for prospective payment of Medicare hospital operating costs and, starting with fiscal year (FY) 1992, for prospective payment of capital costs.

The DRG payment that each hospital receives for a case is proportional to the DRG weights. Ideally, the weights should reflect the relative cost of providing care in each DRG in an efficient hospital. If so, when a hospital's cost structure differs from its payments, it has an incentive to either become more efficient or to reduce its frequency of care for the DRGS for which its costs exceed payment. Therefore if payments are set at efficient costs, hospitals have the maximum incentives for efficiency. However, because the efficient cost structure is unknown, the DRG weights have been based on estimates of the average cost structure.

Considerations of beneficiary access and provider equity also imply weights should be proportional to costs. If the prospective payment system (PPS) paid so that average payment equaled average cost (or less than cost) and weights were not proportional to costs, then hospitals might refuse to provide care in those DRGs that were undervalued, thus seriously limiting access to needed care. Finally, inaccurate weights would cause inequity among providers, based on each hospital's DRG distribution. The equity issue is important because the case-mix index (CMI) (or average DRG weight) is the largest PPS payment adjustment and has a substantial effect on the distribution of PPS payments.

It is not easy to measure the cost of care for cases in each DRG, however. Information about per diem costs and departmental costs and charges from the hospital's cost report can be used to transform charges into an estimate of the cost of each case. These cost estimates can then be standardized and averaged in the same way as in the usual method to produce cost-based weights. Although these cost-based weights account for consistent variations across hospitals and across departments within hospitals in percentage markup, they do not account for within-department variation in markups or for any variations across hospitals in cost. In addition, the cost reports take longer to acquire than charge data and so cost-based weights would be based on older data than the standard-method weights. Costbased weights were used in the first 2 years of PPS.

Since 1986, the DRG weights have been calculated using charges standardized by the factors used to pay operating costs associated with teaching, disproportionate share, and input prices. The payment factors capture only a small part of the variation across hospitals in charges for any specific DRG. In addition, hospitals mark up each service differentially using inconsistent allocations of fixed costs and unknown pricing rules, thus possibly introducing further errors in the standard method.

Another method that would account for more of the cross-hospital variation in charges than the standard method is the HSRV methodology. This method would also account for cross-hospital variation in costs. The HSRV methodology differs from the current method in that hospital charges are not standardized using fixed-payment adjustments, but instead are standardized at the hospital level using hospital-specific charges and the hospital's CMI. If, within each hospital, charges were set in proportion to costs, then the HSRV method would be superior to the standard method in the extent to which it produces weights that reflect relative costs. However, because pricing rules vary and are unknown, there is no guarantee that the HSRV method will yield relative weights closer to relative costs.

The most important criterion for choosing among methods should be the extent to which the method produces weights that reflect the relative costs of care across DRGs. Because only charges can be directly observed, however, it is not possible to measure the true relative costs of care across DRGs. For example, it is widely believed that relative weights used in the first PPS years were compressed (i.e., the resources needed by DRGs with high relative weights were underestimated and those with low relative weights were overestimated). Because we cannot measure relative costs precisely, we must fall back on secondary criteria.

One of the most important of these secondary criteria is the correspondence, at the hospital level, between average Medicare inpatient cost per case and the Medicare CMI. If the DRG weights are compressed, then the CMI for hospitals with a high CMI will be biased downward, the CMI for hospitals with a low CMI will be biased upward, and cost will not be in strict proportion to the CMI. Such CMI compression may be caused by factors in addition to DRG compression. CMI compression could also be caused by a correlation between the CMI and the likelihood that a hospital would receive cases that require greater than average resources for that DRG, or by a correlation between the CMI and a tendency to provide more resources to similar cases.