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History of Medicine |

After the Revolution: DRGs at Age 30

Kevin Quinn, MA
[+] Article, Author, and Disclosure Information

From Xerox Corporation, Helena, Montana.

Acknowledgment: The author thanks Robert Coulam, Julian Pettengill, and Norbert Goldfield for valuable advice.

Potential Conflicts of Interest: Disclosures can be viewed at www.acponline.org/authors/icmje/ConflictOfInterestForms.do?msNum=M13-2115.

Requests for Single Reprints: Kevin Quinn, MA, Xerox Corporation, 34 North Last Chance Gulch, Helena, MT 59601; e-mail, kevin.quinn@xerox.com.

Author Contributions: Conception and design: K. Quinn.

Analysis and interpretation of the data: K. Quinn.

Drafting of the article: K. Quinn.

Critical revision of the article for important intellectual content: K. Quinn.

Final approval of the article: K. Quinn.

Administrative, technical, or logistic support: K. Quinn.

Collection and assembly of data: K. Quinn.

Ann Intern Med. 2014;160(6):426-429. doi:10.7326/M13-2115
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1 October 2013 marked 30 years since Medicare began paying hospitals by diagnosis-related group (DRG), arguably the most influential innovation in the history of health care financing. Initially developed as a tool for hospital management, DRGs became the basis of the inpatient prospective payment system that Medicare implemented in 1983. The strong incentives were revolutionary in their impact. Medicare spending growth slowed sharply, and, more remarkable, hospitals posted record profits. After the link between cost and payment was broken, hospitals moved quickly to cut costs. Nevertheless, a literature survey concluded that none of the worst fears about adverse effects on patients were realized. Diagnosis-related groups have also come to define “the product of a hospital” for purposes of benchmarking and risk adjustment. The acceptance of DRG algorithms owes much to their categorical approach, clinical focus, and transparency. The 2 most commonly used algorithms, Medicare DRGs and All Patient Refined (APR) DRGs, typically explain more than 40% of cost variance in inpatient stays, although with considerable range by care category. Because Medicare DRGs are unsuitable for obstetrics, pediatrics, and neonatology, some payers prefer APR DRGs. Diagnosis-related groups have proven to be a suitable basis for payment, as evidenced by widespread use. Common issues include mitigation of adverse incentives, appropriate payment for extremely costly stays, applicability to certain hospitals and care categories, and growing complexity. The DRG experience offers lessons about the effectiveness of financial incentives, the likelihood of adverse effects, the usefulness of case-mix measures, the risks of growing complexity, and the example that sensible policy need not be the domain of any one political party or other entity.





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Posted on July 14, 2014
Joseph Morris
Conflict of Interest: None Declared
Kevin Quinn's reflection on DRGs at 30 (18 March 2014) presents a concise history of how Medicare’s PPS incorporated DRGs. Regrettably it glosses over the multi-year effort in New Jersey that was critical to adapting DRGs into a payment mechanism. Under "History and Development" a single sentence states that NJ incorporated DRGs into its payment demonstration in 1980. Absent is any mention of the 4 year "experimental" phase of the NJ DRG project (1976 to 1980) and the first issuance of prospective DRG rates between 1980 and 1982. Understanding the entirety of the effort involved in the development of the case mix payment system is perhaps the most illustrative lesson for policy makers to learn.
To implement something so significant required an enormous effort by many people unified by a shared vision. Between 76 and mid 80s such collaboration existed in NJ. Might today’s national debate on health care reform be more fruitful by employing such an effort?

Employing DRGs as a payment tool was championed by Joanne E. Finley, MD, MPH, who served as NJ Health Commissioner, (June 1974 - March 1982). Prior to NJ she served as New Haven Health Commissioner and, as an Adjunct Professor at Yale, she learned of Fetter & Thompson's DRG work, which, at the time, was a tool to improve utilization review process. In classic Finley style, she saw DRGs as a payment device imbedded in a clinical tool. NJ’s project effort included clinicians, experienced in delivery of care, hospital administrators, and researchers. With input from industry partners, including, an active and ever questioning, Physicians Advisory Committee , the project devoted 4 years to formulate a viable system; and getting it right. The real lessons helpful to health policy makers in considering new payment approaches occurred in this period.

The project challenged NJ’s health care industry to design a payment approach that recognized a patient’s clinical characteristics and provided an incentive for cost effective care. The experimental rates included hospital specific variance reports by cost center (nursing, OR, ancillaries, dietary, etc.) to identify improvement opportunities compared to peer hospitals. Participating hospitals, physicians, payers, and state hospital association staff identified what worked and what required further development/refinement. A key study question was if hospitals, armed with specific clinical data and peer cost comparisons, could respond positively to payment incentives. Simply stated the successful implementation of a new hospital payment approach required enormous political effort and partnership between a lot of, heretofore, strange bedfellows.

Importantly there was a keen political and policy understanding by senior DOH executives. A critical moment was appointment of Bruce C. Vladeck as Assistant Commissioner in March 1979 a scant nine (9) months before projected implementation of NJ’s 1978 law authorizing DOH to set rates for all payers. The system had to be finalized, regulations needed to be promulgated, and NJ needed to secure a HCFA waiver for Medicare participation. A tall order for a new Assistant Health Commissioner who, not yet 30 years old, proved he was up to the challenge.

Under Vladeck's leadership, the project staff and the existing hospital rate setting staff merged, and, as a team, successfully issued and defended the rates in January 1980 for 26 hospitals (the remaining hospitals were phased onto system over the next 2 years). Collaboration, strong policy/political sense, consensus, and team work between hospitals, physicians, payers, and regulators as equal partners was the project’s mantra: Success hinged on some unique elements:
• Effort was devoid of arrogance - it was uncharted waters, we didn't have the answers, and the project was open to trial and error (and more importantly learning from the errors).
• Able assistance of subcontractor advisers including Deloitte and Puter Associates.
• At the same time, all of healthcare braced for implementation of the ICD-9 CM diagnosis coding system. ICD-9 codes would require development of a whole new set of DRGs! Here again, NJ played a role as it empanelled physician teams that reviewed each and every DRG definition and provide valuable input to the national review team.
• Incorporation of new "financial" payment elements included: inflation adjusted equipment and plant replacement funds, an inflation factor to project changes in hospital input costs, and most importantly, uncompensated care payments for the care of uninsured population.
In addition to grant funding for the project HHS approved the participation of both Medicare and NJ Medicaid under a HCFA demonstration waiver based on demonstrated efficacy made possible through the efforts of an entire NJ health care community.

DRGs proved to be an effective method to pay hospitals but today’s challenge is to devise an effective and unified way to pay for all components of health care delivery system for the entire population.
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