Do Hospitals Respond to Changing Incentive Structures? Evidence from Medicare's 2007 DRG Methodology Change

In 2007, the Centers for Medicare and Medicaid (CMS) significantly restructured the diagnosis related group (DRG) system by moving from the CMS DRG to the Medicaid Severity (MS) DRG. The MS DRGs expanded the number of illness categories, explicitly recognizing the variation of complications present within certain conditions, and allowing for differential reimbursement depending on the severity of the case. Each DRG has a weights which reflect the average service intensity for patient with that illness. Payments are proportional to weights. After the implementation of the MS-DRG system, hospitals may choose from up to three new DRGs depending upon the severity of the diagnosis reported including either complication/co-morbidity (CC) or no complication/co-morbidity (non-CC) or major complication/comorbidity (MCC). Each of these new DRGs has a different reimbursement weight with the more complicated cases receiving higher weights and more reimbursement, the less complicated cases receive a lower weight and lower reimbursement.

We explore whether hospitals, given a diagnosis, systematically code patients into the higher severity MS DRG to increase their reimbursements. In the economics literature, this is known as upcoding (e.g. Dafny 2005, Silverman and Skinner, 2004).

Using the National Inpatient Survey (NIS) data from 2005-2008 and MS DRG weights from CMS, we first compare the average DRG weights using the MS DRGs to the counterfactual calculation of the average DRG weights using the old CMS DRGs. Our preliminary results indicate that patients have an increase in average DRG weight of .048 to .071. This indicates that patients are recorded as 4-6 percent sicker, under the MS-DRG methodology.

However, this is only suggestive of upcoding because the distribution of severity of illness within a CMS DRG may have changed such that patients needed more services and the higher weights were appropriate. We use a look back approach applying the counterfactual calculation to data for the three years before the policy change to determine the extent to which aggregate weights persist over time.

For a more formal test of upcoding, we estimate the equation below for those DRGs where we observe three categories post 2007. Weight refers to the weight associated with the assigned DRG for patient i in hospital h. Spread refers to the difference in the weights between different severity levels in MS-DRG group and γh are hospital fixed effects (Dafney, 2005 and Barros and Braun 2017 employ a similar method).

2008Weight_igh=β0+ β1Spread_2-1,g+ β2Spread_3-2,g + β32007Weight_igh + γh +ε_igh (1)

Table 1 (not shown) presents estimates of equation 1 stratified by hospital type. The positive and significant coefficients on the spread variables are indicative of upcoding.

Another concern is technological change, which may increase the service intensity of the illness, and increase the weight of the DRG. However, this would only be a threat to identification if the technological change were newly implemented in 2008 and were within the MS DRGs which had seen expansion in the policy change. To address this, we will examine DRG groups with high frequency (common ailments) and investigate technological change in these groups.

See more of: Incentives and Risk in Medicare Reimbursement
See more of: Hospital Reimbursement and Behavior

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