Under the DRG reimbursement system, prior to 2008, hospitals treating more severely ill patients in certain DRGs than those of the average hospital often did not receive payment levels commensurate with the costs of treating such patients. Accordingly, CMS adopted the Medicare Severity Diagnosis Related Groups (MS-DRGs) in 2008 to better align payment levels with a DRG that more adequately considers differences in patient severity of illness.

Under what was then the new MS-DRG payment system, the budgetary goal under Medicare was zero change to overall Medicare payments by paying less for less severely ill patients and more for more severely ill patients who, prior to MS-DRGs were paid the same rate. Severity payment rates were put into place and hospitals were paid based upon these rates, but these severity rates were flawed and resulted in billions of dollars in overpayments.

Now understand, these are not undocumented or unsupported overpayments like those being chased by the RACs. When CMS implemented MS-DRGs in 2008 hospitals recognized the financial incentives for improving medical record documentation and diagnosis coding to more fully account for the patient’s severity of illness. And while the Documentation and Coding Improvements (DCI) greatly helped hospitals measure patient severity more accurately, they increased payments without a real increase in patient severity or the resources hospitals used to furnish care to these patients.

Figure 1. Percent of cases with major complications jumped in 2008 and 2009

Source: MedPAC analysis of Medicare fee-for-service claims from IPPS hospitals in proposed rule MedPAR files (December updates) for fiscal years 2006 – 2009 from CMS.

Overpayment Could Top $19 Billion

In a letter from Medicare Payment Advisory Commission (MedPAC) to the Centers for Medicare and Medicaid Services (CMS), dated May 27, 2010, MedPAC confirms that the ongoing efforts of CMS to administer and improve the payment systems for acute inpatient hospital services and long-term care hospital services has resulted in overpayments of $6.9 billion over 2008 and 2009. Plus, they expect an additional $4.8 billion in overpayments in 2010 and overpayments will continue until CMS puts into place a prospective offsetting adjustment to the IPPS payment rates. MedPAC estimates that overpayments could reach $19 billion in total for 2008 through 2012. Cumulative overpayments are increasing at a rate of about 3.9 percent per year this year (2010) and will likely increase 1 percent in 2011 after CMS’s planned recovery adjustment, according to MedPAC. MedPAC calculates the 3.9 percent increase in 2009 represents about $4.5 billion. This means that the “reductions in payment rates that CMS has proposed to offset the effects of coding changes do not represent payment cuts, but rather offset unintended overpayments to hospitals.” MedPAC stated.

So, with a requirement by law for CMS to stay budget neutral for changes in DRGs and relative weights – that is, they do not increase or decrease aggregate IPPS payments to hospitals compared with the payments that would have been made without the changes, CMS needs to implement a way to recoup the current and future overpayments. Plus, section 7 of the Transitional Medical Assistance, Abstinence Education, and Quality Improvement Act of 2007, limits the prospective adjustments that CMS could apply to offset increases due to DCI in 2008 and 2009. But if overpayments occurred because actual DCI exceeded those adjustments, CMS is required to recover the overpayments plus interest and further reduce IPPS payment rates to fully prevent overpayments from continuing to occur.

Possible Solutions

CMS analysis of 2008 and 2009 hospital inpatient claims shows that DCI increased case mix by 2.5 percent in 2008 and 5.4 percent in 2009. This resulted in IPPS overpayments of 1.9 percent in 2008 and 3.9 percent in 2009. MedPAC confirms these numbers and estimates additional overpayments equal to 3.9 percent of annual IPPS payments will continue through 2010, 2011 and all future years until CMS makes prospective offsetting adjustments to the IPPS payment rates.