Medicare Inpatient DRG Payment: How Admission, Coding and Charges Change the Payment

Medicare prices an acute inpatient stay using adjusted base rates, the patient’s diagnosis group and additional payments or reductions. The hospital supplies much of what goes into that calculation. An admission decision selects the payment system, a secondary diagnosis can raise payment for the entire stay, and a charge increase can produce extra money without extra care. If you work in utilization review, coding or finance, the decision behind the higher payment may be the part of the claim only you can explain.

That is why hospital billing fraud reaches beyond the diagnosis list. The admission decision chooses a payment system. Coding determines the group within it. Finance supplies figures that can raise payment again.

How Does a DRG Determine How Much a Hospital Gets Paid?

The Medicare inpatient DRG payment calculation multiplies the hospital’s adjusted base payment by the relative weight of the patient’s diagnosis group, then applies other adjustments. The weight reflects the resources expected for that type of stay. Under this prospective payment system, Medicare sets rates in advance for each discharge.

Coding sets the severity tier within the inpatient system: one added complication or comorbidity, or a major one, can move a stay between the tiers of a Medicare Severity Diagnosis Related Group and raise the payment for the whole admission, the opening that unsupported codes exploit in DRG upcoding.

For fee-for-service Medicare’s acute inpatient system, the core operating calculation is:

Operating base rate × (labor share × wage index + nonlabor share) × DRG weight.

The operating rate pays toward labor and supplies. A separate capital payment covers property costs such as depreciation and rent. The wage index adjusts the labor portion for local wages. Alaska and Hawaii also receive a cost-of-living adjustment to the nonlabor portion.

Under the Centers for Medicare & Medicaid Services’ fiscal 2027 inpatient payment rule, the labor share is 66% where the wage index exceeds one and 62% where it is one or lower. The hospital’s location therefore matters before its patients’ diagnoses enter the calculation.

The formula is the starting point for an acute hospital payment. Sole community hospitals can receive a hospital-specific rate instead, and critical access hospitals use cost-based payment.

Add-On Payments Depend on the Hospital, Too

Indirect medical education and disproportionate share adjustments add percentages to the wage- and DRG-adjusted base payment. The teaching adjustment depends on residents per bed, and the low-income adjustment depends on patient days. Capital payment uses the same DRG weight and has its own teaching and low-income adjustments. Eligible hospitals also receive uncompensated care payments, while unusually expensive stays can qualify for outlier payments.

Short stays ending in a transfer can receive a daily payment instead of the full DRG amount. Medicare calculates that daily rate by dividing the full payment by the DRG’s geometric mean length of stay. It generally pays twice that rate for the first day and the daily rate for each subsequent day, capped at the full DRG payment. Discharge destination and length of stay therefore affect the bill alongside diagnoses.

Do Hospitals Get Penalized for Readmissions?

Medicare’s Hospital Readmissions Reduction Program reduces payments to hospitals with excess readmissions under its measures. Separate programs adjust payments for hospital-acquired conditions and redistribute money according to performance on quality measures.

Admission Status Chooses the Payment System

Inpatient status puts a covered acute hospital stay under Medicare Part A and its payment by diagnosis group. Observation uses Part B and outpatient payment rules. The choice reaches the money before a coder selects the severity tier.

In its December 2016 analysis of fiscal 2014, the Inspector General found that Medicare paid, on average, three times as much for short inpatient stays as for short outpatient stays. For digestive disorders, the historical averages were $4,572 and $789, respectively. The reason for the visit could be similar while the payment was very different.

The report describes the two-midnight benchmark: inpatient payment generally follows a physician’s reasonable expectation that hospital care will last at least two midnights. It also describes documented, case-specific exceptions. The physician’s expectation and the admission record matter, as does any corporate instruction that pushed the decision.

Inpatient admission fraud exploits the payment difference by seeking inpatient reimbursement for care that belongs in an outpatient or observation setting. In its 2014 settlement with the hospital chain, the Justice Department alleged that Community Health Systems used a corporate scheme to increase unnecessary admissions at 119 hospitals. The allegation concerned a company policy reaching emergency department decisions across the chain.

What Is the 72 Hour Rule for Hospitals?

For acute inpatient billing, the 72 hour rule refers to Medicare’s three-day payment window. The inpatient payment rule includes related outpatient services delivered in the three days before admission in the inpatient payment. The hospital cannot bill those included services separately.

This preadmission payment window concerns which services the inpatient payment covers. The two-midnight admission benchmark concerns whether the patient qualifies for inpatient payment. An encounter can therefore raise both a status question and a question about services billed separately before admission.

Outlier Payments Turn Charges Into Estimated Costs

Medicare outlier payments cover part of the cost of unusually expensive stays above a threshold. The calculation estimates costs from the hospital’s charges using a cost-to-charge ratio drawn from an earlier cost report.

For fiscal 2027, the national fixed-loss amount is $49,346, added to the applicable payment and adjustments to determine the outlier threshold. It is not the total charge that automatically triggers an extra payment. Medicare generally pays 80% of costs above the threshold, or 90% for burn stays.

Outlier payments are financed through reductions in base rates across the system. Honest hospitals help fund inflated outlier payments through those same reductions.

The use of an older cost-to-charge ratio creates the opening. When a hospital sharply raises charges, the earlier ratio can turn the higher prices into higher estimated health care costs before the financial reports catch up. That is how a change made in finance can generate an extra payment on care delivered at the bedside.

St. Vincent Hospital agreed to pay approximately $1,784,000 in 2022 after receiving outlier payments it admitted it was not entitled to. According to the Justice Department’s settlement announcement, the hospital admitted raising all inpatient charges once by 18% and twice more by 15% during 2018 and 2019. Those increases produced extra payments even in cases without unforeseen complications or extended stays that would explain unusually high costs.

The annual cost report contains utilization, costs and charges by cost center, Medicare settlement information and financial statements. Those accounting records help explain the payment alongside the patient chart. St. Vincent also made a voluntary repayment before settling, but the Justice Department said it did not fully reimburse Medicare for the affected cardiac procedures.

The Decision Behind the Higher Claim

A utilization reviewer may know why the inpatient order changed. A clinical documentation specialist may know why a physician received a particular query. Finance may know when charges changed and which cost-to-charge ratio still applied. Each sees a different part of the same healthcare fraud case.

The useful connection is between the instruction and the bill it produced: an admission policy and the affected stays, a query and the diagnosis submitted, a charge increase and the outlier payments that followed. Internal objections and the response to them can explain why the hospital kept supplying an unsupported input. A payment calculation measures the effect. An insider can explain the decision.

In its February 2021 report, the Inspector General found that 54% of stays billed at the highest severity level in fiscal 2019 reached it on a single diagnosis, and that highest-severity stays rose almost 20% from fiscal 2014 through fiscal 2019 while total inpatient stays fell 5%, the pattern behind its call for targeted medical-record reviews.

RAND’s 2024 review of 39 upcoding studies shows why the patient record matters: just three tested coding against a gold standard, and most examined aggregate patterns rather than individual admissions. A claims pattern can identify where to look. The chart, the query and the internal instruction can show what happened there. That is what someone inside the hospital adds to the statistics.

A whistleblower case under the False Claims Act can pay 15% to 30% of what the government recovers.

You Know Why the Input Changed

The payment formula cannot tell an outsider who insisted on the admission, pushed the diagnosis or approved the charge increase. If you know that part of the story, speak with our whistleblower experts about the decision that raised Medicare’s payment. We build your strongest hospital billing whistleblower case around what you witnessed, stay with you through it, and bring in whistleblower lawyers who know Medicare billing cases.