5.2 IPPS and MS-DRGs

The Inpatient Prospective Payment System

The Inpatient Prospective Payment System (IPPS) pays acute-care hospitals a predetermined fixed amount per inpatient discharge rather than reimbursing itemized charges. The amount is set by the Medicare Severity Diagnosis Related Group (MS-DRG) assigned to the stay. Because payment is fixed in advance, accurate diagnosis and procedure capture directly drives hospital revenue — a hospital that treats a patient for less than the DRG payment keeps the difference; one that spends more absorbs the loss. Inpatient claims travel on the UB-04 (CMS-1450) institutional form, not the CMS-1500.

How an MS-DRG Is Assigned

MS-DRGs group hospital stays that are clinically similar and consume similar resources. Assignment depends on:

• Principal diagnosis — the condition, established after study, chiefly responsible for the admission.
• Secondary diagnoses — conditions that coexist on admission or develop during the stay.
• Procedures performed (ICD-10-PCS), patient discharge status, and sometimes age or sex.

Many MS-DRG families split into severity tiers based on secondary diagnoses:

A CC (Complication or Comorbidity) increases resource use; an MCC (Major Complication or Comorbidity) increases it substantially (e.g., acute respiratory failure, sepsis). Capturing one valid MCC can shift a stay two tiers and raise payment by thousands of dollars. There are over 760 MS-DRGs in the current grouper, organized into Major Diagnostic Categories (MDCs) by body system. The GROUPER software reads the coded claim and returns exactly one MS-DRG per discharge — no inpatient stay receives more than one MS-DRG, which is the key structural difference from OPPS, where one claim can return many APCs.

Why the Principal Diagnosis Selection Drives Everything

Because the principal diagnosis steers the claim into a MDC and then a base DRG, sequencing errors are the single most expensive coding mistake on an inpatient claim. If a patient is admitted for chest pain that is found after study to be an acute myocardial infarction, the MI — not the chest pain — is the principal diagnosis. Choosing the symptom over the confirmed condition can drop the stay into a far lower-weighted DRG. Billers do not assign the DRG, but they must recognize when a remittance reflects a DRG that seems inconsistent with the documented stay and route it back for coder review.

The Base Payment Calculation

Each MS-DRG carries a relative weight reflecting its average resource intensity, where 1.0000 is an average-cost case. Base payment is:

IPPS Base Payment = MS-DRG Relative Weight x Hospital Base Payment Rate

The hospital base rate combines a labor-related portion (adjusted by the area wage index) and a non-labor portion. So two hospitals with the same DRG can receive different dollars because their wage indexes differ.

Add-On Payments and Adjustments

• Outlier payments — extra payment for cases whose costs exceed the DRG payment plus a fixed-loss cost threshold.
• Disproportionate Share Hospital (DSH) — added payment for hospitals serving a high share of low-income patients.
• Indirect Medical Education (IME) — added payment for teaching hospitals to offset resident-training costs.
• New Technology Add-On Payments (NTAP) — temporary extra payment for qualifying new technologies.

Present-on-Admission Indicators

Each diagnosis on an inpatient claim carries a Present-on-Admission (POA) indicator (Y, N, U, W, or exempt). Conditions that were NOT present on admission — notably certain Hospital-Acquired Conditions (HACs) such as a Stage III/IV pressure ulcer or a catheter-associated UTI — are excluded from MCC/CC severity grouping, so a hospital cannot earn a higher MS-DRG for a complication it caused.

Quality Programs That Reduce IPPS Payment

• Hospital Readmissions Reduction Program (HRRP) — reduces payments up to 3% for hospitals with excess 30-day readmissions for targeted conditions (heart failure, pneumonia, COPD, AMI, CABG, elective hip/knee).
• Hospital Value-Based Purchasing (VBP) — withholds about 2% of base operating DRG payments and redistributes it on quality and efficiency performance.
• HAC Reduction Program — penalizes the worst-performing quartile 1% on hospital-acquired conditions.

Billers should expect these as claim-level adjustments on the remittance advice, not as denials. A reduced IPPS payment under VBP or HRRP is a correctly adjudicated claim, not a billing error — appealing it is wasted effort.

Putting the Numbers Together

Worked example: a stay groups to an MS-DRG with a relative weight of 1.8000 at a hospital whose blended base rate is $7,000. The base operating payment is 1.8000 x $7,000 = $12,600 before any add-ons or quality adjustments. If the hospital qualifies for IME and DSH, those add to the $12,600; if it is in the worst HAC quartile, a 1% reduction is subtracted. If the case is extraordinarily costly, an outlier payment may be layered on top once costs exceed the DRG payment plus the fixed-loss threshold.

The exam frequently presents this multiply-then-adjust sequence and asks which factor raises versus lowers the final payment — remember that DSH, IME, NTAP, and outliers add money, while HRRP, VBP withholds, and the HAC program can subtract it.