Question

Medicare payments to providers are heavily based on DRGs and APCs today. Explain how DRGs and APCs work, and discuss how they impact hospitals in particular

Answer 1

How DRGs and APCs work:

Ambulatory payment classifications (APCs) are a classification system for outpatient services. APCs are similar to DRGs. Both APCs and DRGs cover only the hospital fees, and not the professional fees, associated with a hospital outpatient visit or inpatient stay.

DRGs have 497 groups, and APCs have 346 groups. APCs use only ICD-9-CM diagnoses and CPT-4 procedures. Payments for both are based on a weight for each DRG/APC and a rate for the facility.

The unit of classification for DRGs is an admission while APCs utilize a visit. The initial variable used in the classification process is the diagnosis for DRGs and the procedure for APCs. Only one DRG is assigned per admission, while APCs assign one or more APCs per visit.

The DRG payment calculation multiplies the facility rate times the DRG weight, while the payment calculation for each APC multiplies the facility rate times the APC weight times a discount factor (if multiple surgical APCs are performed during the same visit). Total payment for the visit is the sum of the payments for all APCs.

Medicare's outpatient prospective payment system (PPS) includes hospital outpatient services designated by the secretary of Health and Human Services. This includes most outpatient services, hospital outpatient department services not part of the consolidated billing for skilled nursing facility (SNF) residents, supplies also on the durable medical equipment point of series fee schedule, certain preventative services, Medicare Part B covered inpatient services if Part A coverage is exhausted, and partial hospitalization services in Community Mental Health Centers.

Medicare's PPS excludes services provided by critical access hospitals and prospectively paid services including ambulance; clinical laboratory; physical, occupational, and speech therapy; end-stage renal disease; and screening mammography services as well as durable medical equipment, orthotics, and prosthetics. Also excluded are outpatient services covered by the SNF prospective payment system, and services that require inpatient hospitalization.

The APC classification system is designed to explain the amount and type of resources utilized in an outpatient visit. Each APC consists of patients with similar clinical characteristics and resource usage. APCs include only the facility component of the visit; medical professionals will continue to be paid from a fee schedule based on CPT-4 procedure codes and modifiers. The system encompasses all provider-based ambulatory settings including same day surgery centers (ASCs), emergency departments (ED), and clinics, but excludes home visits, nursing home or inpatient admissions. APCs were based on Version 2.0 of the Ambulatory Patient Groups (APGs). APCs added more groups for procedures performed in freestanding ASCs, which will utilize a subset of the APCs.

Impact of DRGs and APCs on Hospitals:

Since the 1980s most U.S. hospitals have been paid by Medicare through diagnosis-related groups (DRGs). The introduction of DRGs shifted payment from a “cost plus profit” structure to a fixed case rate structure. Under a case rate reimbursement, the hospital is not paid more for a patient with a longer length of stay, or with days in higher intensity units, or receiving more services. The diagnostic categorization of the patient determines the reimbursement rate. Thus, if all other things are equal, if a patient has a shorter stay in a lower intensity bed with fewer procedures and tests, the costs to the hospital will be lower and the revenue will be unchanged, thus the contribution margin (revenue minus variable costs) will be improved. Of course, these tradeoffs will need to also result in neutral or improved quality, or the improvement will be illusory.

Under this design, in place for more than 25 years, hospitals are not at risk for costs of care outside of their doors and in fact may profit from a cycle of hospitalizations followed by extensive use of specialists and outpatient facilities (particularly affiliated outpatient surgery centers, testing and diagnostic centers, and cancer care). Costs that drive up cost per admission such as entry through the emergency department (ED), use of ICU beds, and delays in care or delays in discharge have a direct negative impact to the hospital.

All hospitals are not paid on DRGs; a small but important subset such as Veterans Administration hospitals, critical access hospitals, or “DRG exempt” hospitals have different contractual arrangements that will affect their financial case for palliative care. It is therefore important to verify how a hospital is paid based on case rates before significant financial modeling. Even in the other cases, compelling approaches may exist and many of the suggestions included in this chapter will apply, but these will need to be crafted with clarity about hospital priorities and realities.