Diagnosis Related Groups (DRGs)

An Estimate of Annual DRG Maintenance Expenses in the US

By:

Sabine Moravi-Bottoli

December 2000

Kommission zur Vergabe von Stipendien zum Zweck einer

Public Health-Ausbildung

pA. Förderungsstelle des Bundes für Erwachsenenbildung für die Steiermark

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Table of Contents

I. INTRODUCTION 3

II. DIFFERENT DRG SYSTEMS 5

1. MEDICARE DRGS 5 2. REFINED DRGS (RDRGS) 8 3. ALL PATIENT DRGS (AP-DRGS) 8 4. SEVERITY DRGS (SDRGS) 10 5. ALL PATIENT REFINED DRGS (APR-DRGS) 10 6. COMPARISON OF THE STRUCTURE OF THE DRG SYSTEMS 13 7. INTERNATIONAL REFINED-DRGS (IR-DRGS) 14

III. INSTITUTIONS 17

1. DEPARTMENT OF HEALTH AND HUMAN SERVICES 17 2. HEALTH CARE FINANCING ADMINISTRATION 18 3. MEDICARE PAYMENT ADVISORY COMMISSION 19 4. THE UNITED STATES GENERAL ACCOUNTING OFFICE 19

IV. HCFA FINANCIAL REPORT 20

1. INTRODUCTION 20 2. MEDICARE 21 3. HCFA’S COMBINED STATEMENTS OF FINANCIAL POSIT IONS 23 4. COMBINED STATEMENTS OF OPERATIONS 24 5. EXPENSES BY OBJECT CLASS 26 6. ADMINISTRATIVE EXPENSES 27 7. REPORT OF INDEPENDENT AUDITORS ON INTERNAL CONTROL 28

V. ESTIMATED ANNUAL DRG MAINTENANCE EXPENSES IN THE US 30

1. HEALTH CARE FINANCING ADMINISTRATION 30 2. 3M HIS 30 3. MEDICARE PAYMENT ADVISORY COMMISSION 31 4. THE UNITED STATES GENERAL ACCOUNTING OFFICE 31 5. SUMMARY 31

VII . REFERENCES 32

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I. Introduction

The Diagnosis Related Groups (DRGs) are a patient classification scheme that was originally

developed as a means of relating the type of patients a hospital treats (i.e., its casemix) to the

costs incurred by hospitals. The design and the development of the DRGs began in the late

sixties at Yale University (Fetter, et al, 1980). In 1983, US Congress enacted a DRG based

prospective payment system (PPS) for all Medicare patients. After the enactment of the

Medicare PPS, a number of states and large payors implemented DRG based hospital PPS for

non-Medicare patients. In addition, DRGs have been used as the basis of global budget

allocation and payment in several countries in Europe as well as Australia. (Averill, et al, 1998).

The original purpose of DRGs was to relate the casemix of a hospital to the resource demands

and associated costs experienced by the hospital. DRGs focused exclusively on resource

intensity. With the changes in the US health care system, there has been increased demand

for a patient classification system for applications beyond resource use, cost and payment:

• Compare facilities across a wide range of resource and outcome measures

• Evaluate differences in inpatient mortality rates

• Implement and support critical pathways

• Facilitate continuous quality improvement projects

• Support internal management and planning systems

• Manage capitated payment arrangements. (Averill, et al, 1998)

With the implementation of the Medicare prospective payment system in October 1983, the

responsibility for the maintenance and modification of the DRG definitions became the

responsibility of the Health Care Financing Administration (HCFA). HCFA updates the

Medicare DRGs on an annual basis. HCFA is one of the operating divisions of the Department

of Health and Human Services (DHHS), the United States government's principal agency for

protecting the health of all Americans and providing essential human services.

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This project is about estimated annual DRG maintenance expenses in the US. Project

methodologies included research of papers, analysis of financial statements, and interviews

with key stakeholders.

Chapter II describes and compares different DRG systems that have been developed in the

US including Medicare DRGs, Refined DRGs, All Patient DRGs, Severity DRGs, All Patient

Refined DRGs, and International Refined DRGs. Chapter III portrays the Department of Health

and Human Services, the Health Care Financing Administration, the Medicare Payment

Advisory Commission, and the United States General Accounting Office. In chapter IV HCFA’s

financial statements are analyzed. Chapter V discusses estimated annual DRG maintenance

expenses in the US and provides a conclusion.

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II. Different DRG Systems

DRG technology has experienced an evolutionary development process. The later

generations of DRG systems have incorporated the improvements made by earlier

generations. DRG systems that have been developed in the US include:

• Medicare DRGs

• Refined DRGs (RDRGs)

• All Patient DRGs (AP-DRGs)

• Severity DRGs (SDRGs)

• All Patient Refined DRGs (APR-DRGs)

• International-Refined DRGs (IR-DRGs)

Each of these DRG systems were created to address specific limitations in the original DRGs.

1. Medicare DRGs

The initial DRG definitions developed at Yale intended to describe all types of patients seen in

an acute care hospital. The DRGs encompassed both the elderly patient populations as well

as the newborn, pediatric and adult populations. However, with the implementation of the

Medicare prospective payment system in October 1983, the responsibility for the

maintenance and modification of the DRG definitions became the responsibility of the

Health Care Financing Administration. HCFA updates the Medicare DRGs on an annual

basis. The focus of all DRG modifications instituted by HCFA after 1983 has been on

problems relating primarily to the elderly population. (Averill, et al, 1998)

Section 1886 (d) of the Social Security Act (the Act) sets forth a system of payment for the

operating costs of acute care hospital inpatient stays under Medicare Part A (Hospital

Insurance) based on prospective set rates. Section 1886 (g) of the Act requires the Secretary

to pay for the capital-related costs of hospital inpatient stays under a prospective payment

system. Under these prospective payment systems, Medicare payment for hospital inpatient

operating and capital-related costs is made at predetermined, specific rates for each hospital

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discharge. Discharges are classified according to a list of diagnosis-related groups. (Federal

Register, 1999)

Certain specialty hospitals are excluded from the prospective payment systems. Under section

1886(d)(1)(B) of the Act, the following hospitals and hospital units are excluded from the

prospective payment systems: psychiatric hospitals or units, rehabilitation hospitals or units,

children’s hospitals, long-term care hospitals, and cancer hospitals. For these hospitals and

units, Medicare payment for operating costs is based on reasonable costs subject to a hospital-

specific annual limit. (Federal Register, 1999)

HCFA administers the PPS and issues all rules and changes concerning DRGs. Changes to

the hospital inpatient prospective payment systems and fiscal year 2000 rates included

revisions for operating costs and capital related costs to implement changes arising from

HCFAs continuing experience with the systems, changes in the amounts and factors

necessary to determine rates for Medicare hospital inpatient services for operating costs and

capital-related costs, rate-of-increase limits as well as policy changes for hospital and hospital

units excluded from the prospective payment systems. (Federal Register, 1999)

DRGs classify patients into clinically cohesive groups that demonstrate similar consumption of

hospital resources and length-of-stay-patterns. Besides reimbursement, DRGs have two major

functions. The first is to evaluate the quality of care. Since all cases in a DRG are clinically

similar, analysis of treatment protocols, related conditions or demographic distribution can be

done. Critical pathways are designed around DRGs. Benchmarking and outcome analysis

can be launched using the DRG clinical framework. Quality reviews can be performed to

access coding practices and physician documentation. Ongoing education of physicians,

coders, nurses and utilization review personnel can be guided to the results of DRG analysis.

(Schultz, 1998):

Secondly, DRGs assist in evaluating the utilization of services. Each DRG represents the

average resources needed to treat patients grouped to that DRG relative to the national

average of resources used to treat all Medicare patients. The DRG assigned to each hospital

inpatient stay relates to the hospital casemix (i.e. the types of patient the hospital treats). The

casemix index is determined by averaging the DRG relative weights for all hospital inpatients.

Medicare computes the casemix adjustment for each fiscal year based upon the casemix data

received. The casemix index is then used to adjust the hospital base rate, which is a factor in

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computing the total hospital payment under the prospective payment system. The formula for

computing the hospital payment for each DRG is as follows:

DRG Relative Weight x Hospital Base Rate = Hospital Payment

The hospital casemix complexity includes the following patient attributes:

• Severity of illness

• Prognosis

• Treatment difficulty

• Need for intervention

• Resource intensity

However, the purpose of the DRG is to relate casemix to resource utilization only.

Reimbursement is adjusted to reflect the resource utilization and does not take into

consideration severity of illness, prognosis, treatment difficulty or need for intervention.

(Schultz, 1998)

DRGs are assigned using the principal diagnosis, up to eight additional diagnoses, the principal

procedure and up to five additional procedure codes, and age, sex and discharge status. One

DRG is assigned for each inpatient stay.

DRG assignment is based upon the following considerations:

• Principal and secondary diagnosis and procedure codes

• Sex

• Age

• Discharge status

• Presence or absence of complications and comorbidities (CCs)

• Birth weight for neonates.

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HCFA has developed a standard list of diagnoses that are recognized as complications and

comorbidities for the DRGs. When these CCs are present as secondary diagnoses, they

would be considered as a complication or comorbidity that may impact DRG assignment.

(Schultz, 1998)

2. Refined DRGs (RDRGs)

During the mid 1980s the Health Care Financing Administration funded a project at Yale

University to revise the use of complications and comorbidities in the Medicare DRGs

(Freeman, et al, 1995). In the Medicare DRGs a secondary diagnosis is considered a CC if it

causes a significant increase in the hospital resource use. For certain types of patients, a

different Medicare DRG is assigned depending on whether or not a CC is present. The Yale

project mapped all secondary diagnoses that were considered a CC in the Medicare DRGs into

136 secondary diagnosis groups each of that was assigned a CC complexity level. For

surgical patients each secondary diagnosis group was assigned to one of four CC complexity

levels, (non CC, moderate CC, major CC, and catastrophic CC). For medical patients each

secondary diagnosis group was assigned to one of three CC complexity levels (non-CC,

moderate or major CC and catastrophic CC). All age splits and CC splits in the Medicare

DRGs were eliminated and replaced by the four subgroups for surgical patients, or the three

subgroups for medical patients. The DRG system developed by the Yale project is referred to

as Refined DRGs or RDRGs.

3. All Patient DRGs (AP-DRGs)

In 1987, the state of New York passed legislation instituting DRG-based prospective payment

system for all non-Medicare patients. The legislation included a requirement that the New York

State Department of Health (NYDH) evaluate the applicability of the Medicare DRGs to a non-

Medicare population. The legislation required that the DRGs be evaluated with respect to

neonates and patients with Human Immunodeficiency Virus (HIV) infections. The evaluation

concluded that the Medicare DRGs were not adequate for a non-Medicare population. NYDH

entered into an agreement with 3M Health Information Systems (3M HIS) to research and

develop all necessary DRG modifications. The DRG definitions developed by NYDH and 3M

HIS are referred to as the All Patient DRGs or AP-DRGs.

During the mid 1980's extensive research had been performed independently by the National

Association of Children's Hospitals and Related Institutions (NACHRI) on alternative

approaches to improve the DRG categories for neonates and other pediatric patients. The

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system developed by NACHRI was called the Pediatric Modified Diagnosis Related Groups or

PM-DRGs. The PM-DRGs created many additional DRGs specifically for neonatal and

pediatric patients. As part of the New York DRG evaluation effort, NYDH and 3M HIS

examined the NACHRI neonatal definitions and adopted a modified version of them.

In addition to the changes for the neonatal AP-DRGs, MDC 24 was created for HIV infection

patients. Assignment to MDC 24, it is based on a principal diagnosis of an HIV infection, or a

principal diagnosis of an HIV related complication combined with a secondary diagnosis of an

HIV infection.

Subsequent updates have made additional enhancements to the AP-DRGs. For example, as

demonstrated by the RDRGs some CCs have a greater impact on hospital resource use than

others. The AP-DRGs designate a subset of the CCs as major CCs. These major CCs are

similar to the catastrophic CCs in the RDRGs. In order to avoid significantly increasing the

number of DRGs, major CC AP-DRGs for surgical patients within an MDC and major CC AP-

DRGs for medical patients within an MDC were formed for some MDCs. In total, 60 major CC

AP-DRGs were created. As part of the development of the major CC AP-DRGs, a limited

reevaluation of the CC list was performed.

The AP-DRGs introduced many additional changes to the Medicare DRGs. Some of these

primarily affect pediatric patients while others affect patients of all ages. The pediatric

modifications include some of the recommendations originally developed by NACHRI as well

as other significant modifications. MDC 25 was added for patients with multiple traumas. In

addition, significant modifications have been made for transplants, long term mechanical

ventilation patients, cystic fibrosis, nutritional disorders, high-risk obstetric care, acute leukemia,

hemophilia, and sickle cell anemia.

Some of the DRG modifications, originally developed in the AP-DRGs, have subsequently

been adopted in the Medicare DRGs. For example, in Version 8.0 of the Medicare DRGs, an

HIV infection MDC was added. However, the Medicare HIV infection MDC consists of three

DRGs and does not discriminate among HIV infection patients at the level of detail contained in

the AP-DRGs.

The AP-DRGs have been updated in January of every year since 1988. (Averill, et al, 1998)

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4. Severity DRGs (SDRGs)

In 1993, HCFA initiated a re-evaluation of the use of complications and comorbidities within the

Medicare DRGs (Federal Register, 1994). The DRG system developed is referred to as the

severity DRGs of SDRGs (sometimes also referred to as Severity Refined DRGs) or SR-

DRGs. The re-evaluation excluded the DRGs associated with pregnancy, newborns and

pediatric patients. The major CC list from the AP-DRGs was used to identify an initial list of

major CCs. Using Medicare data the categorization of each secondary diagnoses as a non-

CC , non-major CC or a major CC was re-evaluated. The end result was that 111 diagnoses

that were non-CCs in the Medicare DRGs were made a CC, 220 diagnoses that were a CC

were made a non-CC and 395 CCs were considered a major CC. This evaluation differed

from the RDRGs in that both non-CCs and CCs were evaluated and the evaluation was

performed independently for each individual diagnosis as opposed to aggregate secondary

diagnosis groups.

All CC splits in the Medicare DRGs were eliminated plus an additional 24 Medicare DRGs

were merged together. The resulting base DRGs were then subdivided into three, two or no

subgroups based on an analysis of Medicare data. The result was 84 DRGs with no

subgroups, 124 with two subgroups and 85 with three subgroups. This plus the 63 DRGs not

evaluated resulted in a total of 652 SDRGs.

In SDRGs, a patient is assigned to a subgroup corresponding to the highest level secondary

diagnosis. Like RDRGs, multiple secondary diagnoses at a one level do not cause a patient to

be assigned to a higher subgroup. The categorization of a diagnosis as non-CC, non major

CC or major CC is uniform across the SDRGs and there are no modifications for specific

SDRGs. HCFA published the SDRGs in 1994, but did not establish an implementation date.

They have not been updated by HCFA since the original 1994 release. (Averill, et al, 1998)

5. All Patient Refined DRGs (APR-DRGs)

The All Patient Refined DRGs (APR-DRGs) further refine the basic AP-DRG structure by

adding four subgroups. In contrast to the SDRGs and RDRGs, the initial version of the APR-

DRGS used the AP-DRGs as the base DRGs instead of the Medicare DRGs. The only

exception was the neonatal MDC for which an entirely new set of base DRGs was developed.

In subsequent updates of the APR-DRGs, the base AP-DRGs have been substantially

modified. All age, CC and major CC distinctions in the AP-DRGs were eliminated and replaced

by two sets of four subgroups. One set of subgroups addresses patient differences relating to

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severity of illness and the second set addresses the risk of mortality. Severity of illness is

defined as the extent of organ system loss of function or physiologic de-compensation, while

risk of mortality is the likelihood of dying. Since severity of illness and risk of mortality are

distinct patient attributes, separate subgroups are assigned to a patient for severity of illness

and risk of mortality. Thus, in the APR-DRG system a patient is assigned three distinct

descriptors:

• The base APR-DRG

• The severity of illness subgroup

• The risk of mortality subgroup

The four severity-of-illness subgroups and the four risk-of-mortality subgroups represent minor,

moderate, major or extreme severity of illness or risk of mortality. The assignment of a patient

to one of these four subgroups takes into consideration not only the specific secondary

diagnoses but also the interaction between secondary diagnoses, age, principal diagnoses,

and the presence of certain non-OR procedures. The assignment of a patient to a subgroup

for each APR-DRG is performed separately for severity of illness and risk of mortality.

The creation of the four levels created the opportunity for a complete revaluation of the

diagnoses categorized as a complication or comorbidity. With the expansion to four

subclasses, many non-CC diagnoses could be assigned to at least a level of moderate

whereas previously there was not sufficient justification to include them with the heterogeneous

set of diagnoses previously categorized as a CC. Because of this re-evaluation, there were

1693 diagnoses that are considered a non-CC in the AP-DRGs and Medicare DRGs that were

assigned to the moderate, major, or extreme level in the APR-DRGs. Conversely, 418

secondary diagnoses that are considered a CC were moved to the non-CC (minor) level in the

APR-DRGs.

In the AP-DRGs, the assessment of the severity of illness or risk of mortality of a patient is

specific to the APR-DRG to which a patient is assigned. The determination of the severity of

illness and risk of mortality is disease specific. The significance attributed to a secondary

diagnosis is dependent on the underlying problem. In APR-DRGs the severity or risk of

mortality level of a secondary diagnosis is assigned separately for each base APR-DRG.

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The most important component of determining the final patient subgroup is the recognition of

the impact of interactions among secondary diagnoses. In APR-DRGs, high severity of illness

and risk of mortality are primarily determined by the interactions of multiple diseases. Patients

with multiple diseases involving multiple organ systems constitute the patients with a more

extensive disease process who are difficult to treat and who have poor outcomes. In APR-

DRGs specific combinations of secondary diagnoses interact causing the severity of risk of

mortality subgroup to be increased.

The combination of the base APR-DRG and the final patient severity of illness and risk of

mortality subgroup constitute the complete APR-DRG description of the patient. For

applications such as evaluating resource-use or establishing patient care guidelines, the APR-

DRGs in conjunction with the severity of illness subgroup is used. For evaluating patient

mortality, the APR-DRG in conjunction with the risk of mortality subgroup is used.

The subdivision of the 382 base APR-DRGs into the four severity subgroups, combined with

the two error APR-DRGs (i.e., 469, 470), results in 1530 APR-DRGS. The APR-DRGs were a

joint development of 3M HIS and NACHRI. The APR-DRGs encompass all the DRG

modification developed for the original PM-DRGs plus subsequent NACHRI research. APR-

DRGs are updated every two years. (Averill, et al, 1998)

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6. Comparison of the Structure of the DRG Systems

Medicare

DRGs

version 12.0

SDRGs RDRGs

version 10.0

AP-DRGs

version 12.0

APR-DRGs

version 12.0

Number of base DRG

categories

338 316 367 NA 384

Number of DRGs 492 652 1170 641 1350

Multiple Trauma MDC limited limited limited complete complete

HIV infection MDC limited limited limited complete complete

Newborn birth-weight

used

no no limited complete complete

NACHRI pediatric

changes

no no no limited complete

Major (extreme) CCs no yes yes yes yes

Death used in

definition

yes yes yes yes no

LOS used in definition no no yes newborn

only

no

CC list reevaluated no substantial no limited complete

Multiple CCs

recognized

no no no no yes

Number of CC

subgroups

2 3 3 med., 4

surg.

3 4

CC subgroup structure variable variable relatively

uniform

variable uniform

Risk of mortality

subgroup

no no no no yes

Base DRGs used - Medicare Medicare Medicare AP-DRGs

except

neonates

Table: Comparison of the Structure of the DRG Systems (Averill, et al, 1998)

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7. International Refined-DRGs (IR-DRGs)

The clinical researchers at 3M Health Information Systems recognized that countries have the

following conflicting needs:

• A DRG system that is unique to the country

• The ability to compare one country to another

• Conformity to multiple coding systems

In response, a new classification system was developed. Building on twenty years of

experience in developing classification systems, 3M has designed the new IR-DRGs to provide

the same results in classifying patients regardless of the coding system in use. The new

system allows a particular country to localize IR-DRGs using its own diagnosis and procedure

codes. Furthermore, the IR-DRGs use the concept of severity adjustment (refinement) to

better describe the relative resource demand based on individual patient characteristics.

(Mullin, et al, 2000)

A statistically valid and clinically coherent system must be employed in order to aggregate

patient treatment episodes that are similar in their resource consumption and to explain

variations in resource use. Classification systems developed for the United States, including

the HCFA-DRGs, can be difficult to adapt where the coding systems vary from ICD-9-CM.

Limits on their capacities to fully meet the needs of other countries have recently emerged.

Because of a variety of countries have adapted existing coding and classification systems to

meet their specific requirements, numerous coding and classification systems are used

worldwide. Many countries have adopted or modified World Health Organization’s

International Classification of Diseases 10th revision (WHO ICD-10) for diagnosis coding in an

effort to meet their own specific needs. Some countries have also developed or modified

existing procedure coding systems for use in their countries to more accurately describe their

medical practices.

Ideally, a classification system specifically designed for use with these various coding systems

would solve these problems. As countries continue to shift from ICD-9 to ICD-10, the ideal

classification system would also group a patient into the same DRG category regardless of the

coding system used. This would make the process of change much easier for hospital

managers.

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IR-DRGs build upon key design advancements of both the AP-DRGs and APR-DRGs. The

IR-DRGs are designed not only for use as part of a funding system, but also for outcomes

analysis. This would include managing all the data needed for direct and indirect patient care

to compare resource usage across facilities and regions and support local and national health

system management. The system incorporates the concept of “refinement” through the use of

multiple levels of CCs applied to all individual severity-of-illness subgroups. (Mullin, et al, 2000)

The IR-DRGs consist of 330 base DRGs, each of which will contain three subclass severity

levels, plus two error IR-DRGs for a total of 992 DRGs. Several base categories that were

eliminated from the United States’ versions of DRGs (because these procedures were being

conducted in ambulatory care facilities rather than acute care hospitals), were returned to the

IR-DRGs. For example, Carpal Tunnel Release, not included in the current U.S. based

systems, was incorporated into IR-DRGs because this procedure is so frequently documented

as an inpatient procedure in international electronic patient records.

A major advantage of the IR-DRG system is the ability to update the classification within the IR-

DRGs. In addition, an International Advisory Panel will discuss periodic updates of the IR-DRG

grouper, making recommendations and overseeing implementation of updates.

International standards for statistical reporting of computer-based patient data, represented in a

coded form, have many useful applications, including:

• Decision-making for direct patient care

• Statistical reporting

• Funding calculations

• Automated decision support

• Profiling

• Benchmarking

• Clinical research

Standards must be developed to support all of these functions. While past systems were

insufficient for application without customized coding schemes to suit some countries’ and

system operators’ particular needs, the comprehensive IR-DRG system should be put forward

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as a possible standard. Further research on the remaining impediments to acceptance of

standards and the efforts to overcome them should be undertaken. (Mullin, et al, 2000)

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III. Institutions

To estimate annual DRG maintenance expenses in the US, interviews were performed with

representatives of selected institutions. The following paragraphs provide a brief summary of

these institutions i.e. the Department of Health and Human Services, its operating arm, the

Health Care Financing Administration, the Medicare Payment Advisory Commission, and the

United States General Accounting Office.

1. Department of Health and Human Services

The Department of Health and Human Services is the United States government's principal

agency for protecting the health of all Americans and providing essential human services,

especially for those who are least able to help themselves. DHHS’ budget for the fiscal year

2000 is US $395 billion; the Department has 61,654 employees.

The Department includes more than 300 programs, covering a wide spectrum of activities.

Some highlights include:

• Medical and social science research

• Preventing outbreak of infectious disease, including immunization services

• Assuring food and drug safety

• Medicare (health insurance for elderly and disabled Americans) and Medicaid (health

insurance for low-income people)

• Financial assistance for low-income families

DHHS is the largest grant-making agency in the federal government, providing some 60,000

grants per year. DHHS' Medicare program is the nation's largest health insurer, handling more

than 900 million claims per year.

The Department's programs are administered by eleven Health and Human Services operating

divisions:

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• Health Care Financing Administration (Employees: 4,363, FY 2000 Budget: US $325.4

billion)

• National Institutes of Health (Employees: 16,673, FY 2000 Budget: US $17.8 billion)

• Food and Drug Administration (Employees: 9,009, FY 2000 Budget: US $1.1 billion)

• Centers for Disease Control and Prevention (Employees: 7,511, FY 2000 Budget: US $3.0

billion)

• Agency for Toxic Substances and Disease Registry (Employees: 412, FY 2000 Budget: US

$70 million)

• Indian Health Service (Employees: 14,673, FY 2000 Budget: US $2.4 billion)

• Health Resources and Services Administration (Employees: 2,152, FY 2000 Budget: US

$4.8 billion)

• Substance Abuse and Mental Health Services Administration (Employees: 686, FY 2000

Budget: US $2.7 billion)

• Agency for Healthcare Research and Quality (Employees: 285, FY 2000 Budget: US $205

million)

• Administration for Children and Families (Employees: 1,500, FY 2000 Budget: US $36.1

billion)

• Administration on Aging (Employees: 147, FY 2000 Budget: US $933 million)

(www.hhs.gov)

2. Health Care Financing Administration

The Health Care Financing Administration, an operating division of the DHHS provides health

insurance for over 74 million Americans through Medicare, Medicaid and the State Children’s

Health Insurance Program (SCHIP). Medicare, the nation's largest health insurance program,

covers approximately 39 million Americans. Medicare provides health insurance to people age

65 and over and those who have permanent kidney failure and certain people with disabilities.

Medicaid is a jointly funded, Federal-State health insurance program for certain low-income

and needy people. It covers approximately 36 million individuals including children, the aged,

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blind, and/or disabled, and people who are eligible to receive federally assisted income

maintenance payments. (www.hcfa.gov)

3. Medicare Payment Advisory Commission

The Medicare Payment Advisory Commission (MedPAC) is an independent federal body that

advises the U.S. Congress on issues affecting the Medicare program. It was established by

the Balanced Budget Act of 1997 (P.L. 105-33), which merged the Prospective Payment

Assessment Commission (ProPAC) and the Physician Payment Review Commission (PPRC).

The Commission has 17 members who bring a wide range of expertise in the financing and

delivery of health care services. The Commission is supported by a full-time Executive Director

and a staff of about 30 analysts. Analysts typically have backgrounds in economics, health

policy, public health, or medicine.

The primary outlet for the Commission’s recommendations are two reports, required by statute

to be issued on March and June of each year. In addition to these reports, MedPAC advises

the Congress through other avenues, including comments on reports to the Congress by the

Secretary of the Department of Health and Human Services, testimony, formal comments on

proposed regulations, briefings for Congressional staff and (forthcoming) a series of short issue

briefs. (www.medpac.gov)

4. The United States General Accounting Office

The General Accounting Office (GAO) is the investigative arm of Congress. GAO exists to

support the Congress in meeting its Constitutional responsibilities and to help improve the

performance and accountability of the federal government for the American people. GAO

examines the use of public funds, evaluates federal programs and activities, and provides

analyses, options, recommendations, and other assistance to help the Congress make

effective oversight, policy, and funding decisions. In this context, GAO works to continuously

improve the economy, efficiency, and effectiveness of the federal government through financial

audits, program reviews and evaluations, analyses, legal opinions, investigations, and other

services. GAO's activities are designed to ensure the executive branch's accountability to the

Congress under the Constitution and the government's accountability to the American people.

GAO is dedicated to good government through its commitment to the values of accountability,

integrity, and reliability. (www.gao.gov)

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IV. HCFA Financial Report

HCFA’s financials were analyzed to provide an estimate for annual DRG maintenance

expenses. HCFA’s 1997 Financial Report was analyzed since more current financials were

not electronically available at the time this project was written.

1. Introduction

HCFA is the largest purchaser of health care in the world. Medicare and Medicaid outlays1,

including State funding, represent 33.9 cents of every dollar spent on health care in the United

States -- 59.2 cents of every dollar spent on nursing homes, 47.7 cents of every dollar received

by U.S. hospitals, and 28.5 cents of every dollar spent on physician services. (U.S. Department

of Health and Human Services, 1997)

In addition to establishing rules for eligibility and benefit payments, paying 853 million Medicare

benefits claims, and providing States with matching funds for Medicaid benefits, HCFA carries

out many other important activities i.e. safeguarding the fiscal integrity of the Medicare and

Medicaid programs, assuring the safety of medical facilities, and maintaining the Nation’s

largest collection of health care data. (U.S. Department of Health and Human Services, 1997)

1 Outlays are used in the discussions of HCFA’s financial activity only when comparable expense data are not available. They refer to the issuance of checks, disbursement of cash, or electronic transfers of funds made to liquidate an axpense regardless of the fiscal year the service was provided or the expense was incurred.

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2. Medicare

Title XVIII of the Social Security Act was established by the Social Security Amendments of

1965. Legislated as a complement to Social Security retirement, survivors, and disability

benefits, Medicare originally covered people aged 65 and over. In 1972, the program was

broadened to cover the disabled, people with end-stage renal disease, and certain others who

elect to purchase Medicare coverage.

Since 1967, Medicare enrollment has increased from 19.5 million to 38.6 million beneficiaries,

a 98 percent increase. The percentage of beneficiaries aged 85 and over has grown from 6.2

percent in 1966 to 11.6 percent in 1995.

Medicare is a combination of two programs, each with its own enrollment, coverage, and

financing--Hospital Insurance and Supplementary Medical Insurance. The Balanced Budget

Act of 1997 (BBA) created a third program called Medicare+Choice that restructures the

Medicare managed care program and, through user fees, provides funding for better consumer

information.

In the Hospital Insurance (HI) Trust Fund, Medicare contractors are paid by HCFA to

process Medicare claims for hospital inpatient services, hospice, and certain skilled nursing

and home health services. Benefit payments made by the Medicare contractors for these

services, as well as administrative costs, are charged to the HI Trust Fund. The financial

statements include HI Trust Fund activities administered by the Department of the Treasury

(Treasury).

In the Supplementary Medical Insurance (SMI) Trust Fund, Medicare contractors are paid by

HCFA to process Medicare claims for physicians, medical suppliers, hospital outpatient

22

services and rehabilitation, end stage renal disease (ESRD), rural health clinics, and certain

skilled nursing and home health services. Benefit payments made by the Medicare contractors

for these services, as well as administrative costs, are charged to the SMI Trust Fund. The

financial statements include SMI Trust Fund activities administered by Treasury. (U.S.

Department of Health and Human Services, 1997)

23

3. HCFA’s combined statements of financial positions

Source: U.S. Department of Health and Human Services, 1997

24

4. Combined Statements of Operations

25

Source: U.S. Department of Health and Human Services, 1997

In 1997, HCFA's expenses total US $309 billion. Administrative expenses of US $3 billion are

less than one percent of the total. HCFA has approximately 4,000 Federal employees, but

carries out many important operational activities through third parties: (1) 22,000 employees at

65 Medicare contractors have primary responsibility for processing Medicare claims, providing

technical assistance to providers and servicing beneficiaries needs, including responding to

inquiries; (2) 34,000 State employees have primary responsibility for administering Medicaid;

(3) 6,000 State employees have primary responsibility for inspecting hospitals, nursing homes,

and other facilities to ensure that health and safety standards are met; and (4) 1,600

employees at 53 Peer Review Organizations conduct a wide variety of quality improvement

programs to ensure quality of care provided to Medicare beneficiaries. The Social Security

Administration (SSA), the Railroad Board, and other Federal agencies also provide thousands

of other staff, either full or part time, who support Medicare and/or Medicaid operations.

Of HCFA's approximately 4,000 Federal employees, about 1,380 work in 10 regional offices

around the country providing direct services to Medicare contractors, State agencies,

providers, beneficiaries, and the general public. Approximately 2,620 of HCFA's employees

work in Baltimore and Washington, D.C., providing funds to Medicare contractors; writing

policies and regulations; developing more efficient operating systems; setting payment rates;

26

managing programs to fight fraud, waste, and abuse; monitoring contractor performance;

developing and implementing customer service improvements; and assisting States and

Territories with Medicaid and other issues. (U.S. Department of Health and Human Services,

1997)

5. Expenses by Object Class

Source: U.S. Department of Health and Human Services, 1997

27

6. Administrative Expenses

Note 14: Administrative Expenses (Dollars in Millions)

Source: U.S. Department of Health and Human Services, 1997

For purposes of financial statement presentation, administrative costs are considered

expenses to the Medicare trust funds when outlayed by Treasury although some funds may

have been used to pay for assets such as property and equipment. In this regard, SSA

reported US $49.5 million of Property and Equipment, (Net) attributable to the Medicare

program as of September 30, 1997. This amount is not included in HCFA's Combined

Statement of Financial Position as assets related to the Medicare program. However, funds

withdrawn from the trust funds by SSA during FY 1997 to pay for this activity are included in

this section as an administrative expense to the Medicare program. The SSA administrative

costs are reported to HCFA by Treasury. These expenses are also reported by SSA on their

FY 1997 Annual Financial Statement. . (U.S. Department of Health and Human Services,

1997)

28

HCFA's administrative costs have been allocated to the Medicare and Medicaid

programs based on the HCFA cost allocation system. Administrative costs allocated to the

Medicare program include US $1.2 billion paid to Medicare contractors to carry out their

responsibilities as HCFA's agents in the administration of the Medicare program.

HCFA's administrative costs are less than one percent of total expenditures. In the past, HCFA

has been placed in a difficult position because the agency's resources have been straight-lined

(in constant dollars) while the scope and magnitude of the programs it administers increased.

This was caused by the budget scoring rules which totally separated mandatory and

discretionary spending, with Medicare and Medicaid benefit dollars being on the mandatory

side, while the money used to administer these programs was on the discretionary side. Thus,

while the benefit payments were growing, the dollars available to administer them were not.

Actions to remedy this situation have resulted in a variety of funding mechanisms. Most of

HCFA's claims payment and management oversight operations are funded through an annual

appropriation; certain quality control functions, primarily the Peer Review Organizations and the

Medicare Integrity Programs, are funded through direct trust fund draws; and numerous other

activities are funded through a variety of user fees. In 1997, administrative expenses were US

$2,899 million.

User fees are currently collected to fund the activities related to the survey and certification of

laboratories under Clinical Laboratory Improvement Amendments (CLIA), sales of data from

HCFA's numerous data bases, and sales of Freedom of Information Act (FOIA) material.

Unless set by statute, these fees are set to cover the costs of doing business and are

reassessed at least every two years. Income received from user fees in 1997 ranged from

slightly under US $200,000 for FOIA to more than US $30 million for CLIA. Beginning in 1998,

comparative information developed to enhance beneficiary choices will be disseminated under

the Managed Care plus Choice provision. This will be funded from a legislatively mandated

user fee collected monthly from each managed care organization. (U.S. Department of Health

and Human Services, 1997)

7. Report of Independent Auditors on Internal Control

The report of Independent Auditors on Internal Control at HCFA includes information related to

the financial management systems that were found not to comply with the requirements

(Brown, 1997):

29

• The HCFA does not have an integrated accounting system to capture expenditures at the

Medicare contractor level.

• The HCFA’s process for preparing annual financial statements is manually intensive,

involving a series of spreadsheets that incorporate general ledger data as well as Treasury

information, contractor information, and adjustments determined by HCFA.

30

V. Estimated Annual DRG Maintenance Expenses in the US

This project is about annual DRG maintenance expenses in the US. With the implementation

of the Medicare prospective payment system in October 1983, the responsibility for the

maintenance and modification of the DRG definitions became responsibility of the Health Care

Financing Administration. DRGs are being used to reimburse for operating costs of acute care

hospital inpatient stays under Medicare Part A (Hospital Insurance). 3M HIS updates the DRG

system on an annual basis on behalf of HCFA. Annual maintenance expenses not only exist

for HCFA but also for hospitals and health plans. This report focuses only on the HCFA side

since hospital and health plan expenses were not captured in the past and therefore, cannot be

estimated.

In 1997, total Medicare Trust Fund Administrative Expenses were US$ 2.8 billion. HCFA’s

administrative costs are less than one percent of total expenditures of US $308 billion. Total

hospital insurance administrative expenses were US $1.3 billion in 1997.

Due to a lack of available data on annual DRG maintenance expenses, interviews with

representatives of HCFA, 3M HIS, MedPac, and GAO were conducted on the requested

subject.

1. Health Care Financing Administration

A representative of HCFA stated “we don’t have that level of detail”. HCFA would not be able

to break out financials to a level that was necessary to report annual DRG maintenance

expenses. HCFA’s activity-based costing would not allow that level of detail. It was pointed

out that annual expenses to maintain the DRG system could account for a small fraction

(approximately 10-20%) of the total hospital insurance administrative expenses of US $1.3

billion. Based on that conversation, estimated annual DRG maintenance expenses could be

anywhere between US $130 and 260 million.

2. 3M HIS

A representative of 3M HIS indicated that approximately 12 persons from 3M HIS are

constantly working on the maintenance of the DRG system on behalf of HCFA. Maintenance

includes an ongoing process to capture comments from hospitals, to ensure clinical

appropriateness, and statistical appropriateness. Also, underlying coding systems (ICD-9-CM

31

in the US) and policy changes needed to be considered when discussing DRG maintenance

expenses. The representative was not familiar with the contractual specifics between HCFA

and 3M HIS regarding HCFA’s expenses for services provided by 3M.

Overall, it was estimated that annual DRG maintenance expenses could be up to US $1.3

billion. This estimate might be overstated but would include everything that goes into DRGs

i.e. coding systems, DRG maintenance provided by 3M, policy changes, etc.

3. Medicare Payment Advisory Commission

A representative from MedPac pointed out that reimbursement under Medicare Part A not only

included hospitals compensated with DRGs but also hospitals that were excluded from a PPS,

skilled nursing facilities (SNF), and home health. Reimbursement with DRGs could account for

65% of Medicare Part A.

Therefore, annual DRG maintenance expenses could be up to 65% of the total hospital

insurance administrative expenses of US $ 1.3 billion. The amount could be US $ 845 million.

4. The United States General Accounting Office

A representative from GAO indicated that she would not be aware of any studies that had been

done on annual DRG maintenance expenses in the US. She believed that those expenses

could be up to US $ 1.3 billion.

5. Summary

Interviews with representatives of HCFA, 3M HIS, MedPac, and GAO were conducted on

annual estimated DRG maintenance expenses in the US. Based on these interviews, these

expenses could be in a range of US $130 million and 1.3 billion.

32

VII . References

Averill, R, Muldoon, J, Vertrees, J, Goldfield, N, Mullin, R, Fineran, E, Zhang, M, Steinbeck, B,

Grant, T, "The Evolution of Casemix Measurement Using Diagnosis Related Groups (DRGs),

HIS Research Report, 5-98, 1998, pp. 1-40.

Brown, J, “Inspector General’s Report on the HCFA Financial Statements for FY 1997”, pp. 34-

36

Federal Register, Vol. 16, No. 106, June 2, 1995, Pg. 29209

Federal Register, Vol. 64, No. 146, July 30, 1999, pp. 41490-41491

Fetter, R, Shin, Y, Freeman,J, Averill, R, Thompson, J, "Case Mix Definition by Diagnosis-

Related Groups", Medical Care,, Vol. 18, No.2, pp. 1-53.

Freeman, J, Fetter, R, Hayong, P, Schneider, K, Lichenstein, Hughes, J, Bauman, W, Duncan,

C, Freeman, D, Palmer, G, "Diagnosis Related Group Refinement with Diagnosis- and

Procedure-Specific Comorbidities and Complications", Medical Care, Vol. 33, No. 8, pp. 806-

827.

Mullin, R, Vertrees, J, Freedman, R, Castoni, R, Mann, K, “Case-Mix Analysis Across Patient

Populations and Boundaries: A Refined Classification System Designed Specifically for

International Use”, Working Paper 15/09/00, 3M Health Information Systems, 2000, pp. 1-8

Schultz, D, “1999 St. Anthony’s DRG Guidebook”, 1999, pp. intro-3 – intro-8

U.S. Department of Health and Human Services, Health Care Financing Administration,

“Financial Report Fiscal Year 1997”, pp. 1-127

Internet Sources:

www.dhhs.gov: U.S. Department of Health and Human Services

www.gao.gov: United States General Accounting Office

33

www.hcfa.gov: Health Care Financing Administration

www.medpac.gov: The Medicare Payment Advisory Commission