Diagnosis-Related Group Payment System

A Diagnosis-Related Group (DRG) system classifies hospital cases into groups expected to have similar clinical characteristics and resource needs. The hospital receives a predetermined case-based payment for the patient’s group, rather than separate payment for every test, procedure or day of care. If treatment costs less than the payment, the hospital retains the saving; if it costs more, the hospital bears the additional cost.

Change from fee-for-service

Under fee-for-service, hospital revenue generally rises with the number and intensity of billable services. Under DRG payment, revenue is largely fixed for a classified episode, shifting financial risk for resource use from the purchaser to the hospital.

• Fee-for-service can encourage additional tests, procedures and longer stays because each service generates revenue.
• DRG payment encourages hospitals to manage the total cost of the admission rather than maximise individual billable inputs.

Resulting hospital incentives

The hospital gains from cost-effective treatment within the fixed payment, which can promote standardised care pathways, shorter lengths of stay, better procurement and substitution away from unnecessary inputs. However, payment per admission may still encourage more admissions unless purchasing and referral arrangements control volume.

• Hospitals have stronger incentives to improve operational efficiency and coordinate services within an admission.
• DRGs reduce incentives for excessive service intensity, but do not automatically reward better health outcomes or post-discharge continuity.

Risks and safeguards

Case-based payment can create incentives for upcoding, whereby a case is assigned to a higher-paying group. Hospitals may also avoid costly patients, provide insufficient care, discharge patients prematurely or divide treatment across multiple admissions.

• Accurate clinical coding, audits and penalties are needed to limit gaming.
• Severity adjustment and outlier payments can protect hospitals treating unusually complex or expensive cases.
• Quality indicators, readmission monitoring and outcome-based purchasing are needed to prevent savings from being achieved through under-treatment.