Financing the hospitals and their accounting

DRGs and cost accounting: Which is driving which?

In the past, cost accounting has not been of high priority to hospitals in conventional payment systems. However, costs were, if at all, likely to be registered in decentralized and mutually incompatible information systems. Global budgets used to be the common funding model in most European health care systems. With the aim of improving the efficiency of hospital care, DRG-based hospital payment systems have been introduced in many European countries since 1983. This development fundamentally changed hospital services from being sources of incremental revenue to being sources of incremental costs. Regulatory authorities throughout Europe very soon came to realize that DRGs could not serve as payment rate-setting mechanisms without a functioning cost-accounting system. Thanks to that, DRG helped to increase an awareness of the importance of cost accounting in hospitals.


There are three steps involved in allocating hospital costs:

1. overhead cost allocation: allocation of hospital overhead costs to medical departments – including heating etc. - these costs can be allocated by various ways diferring between countries

2. indirect cost allocation: allocation of department overhead costs to patients – including general personal costs and costs of medical departments

3. direct cost allocation: allocation of department direct costs to patients – including material, medicines etc. – allocating directly from patients expenses. There are four types of approaches – „bottom-up“ method taking into account individual situation of patient, „top-down“ method allocating budget according to average costs, „micro-costing“ taking into account more detailed information and „macro-costing“ regarding only basic procedures. The most common is bottom-up micro-costing combination.


Nearly every European country has a unique approach to collecting cost data in order to further develop their DRG-based system. Most countries allow their hospitals to use a cost-accounting system which best fulfils their own needs, but some countries require their hospitals to have mandatory cost-accounting systems. Some countries have their own national costing guidelines for cost accounting.


The relative importance of any DRG-based hospital payment system is determined by the share of hospital costs that are covered by DRG-based payments. For example, inpatient care funding through DRGs represents 75–85 per cent of hospital costs in Germany and Portugal. However, most countries exclude some (medical)

specialties and/or hospital services due to:

• the usual incentive set by the DRG system to shorten the patient’s length of stay, which is considered harmful in these specialties

• coding problems in hospital services for which DRG prices cannot be reliably calculated because they are rarely provided

• circumstances involving specialties in which a diagnosis seems to be a bad predictor for costs (for example, psychiatric care)


Conclusions: Which is driving which?

One may argue that cost accounting is driving the further development of DRGs. Cost-accounting data made it possible to validate cost homogeneities and to detect cost-outliers in the patient population. This led to revisions and refinements of the existing DRG systems. However, one could also argue that DRGs are driving cost accounting. The introduction of comprehensive and standardized cost-accounting systems was encouraged by the need to collect data for calculating DRG weights as well as supporting hospital management and auditing. In conclusions, these systems really help each other, and it is important that they are taken as separate systems so they can evaluate each other’s credibility.


DRG-based hospital payment: Intended and unintended consequences

The fact that DRG-based hospital payment system can strongly affect a budget that the hospital will get can change a hospitals’ behavior and strategies. Every country has a unique system and that’s why these consequences differ. Most countries calculate DRG relative weights from the average costs of the groups or they adapted them from the other countries. These weights often differ also among regions of one country or among different groups of hospitals in the country. Based on these weights, after some adjustments, it is later created a budget for a hospital. Some countries are using DRG-based case payment systems, whereby hospitals receive payment for each patient determined by the weight of the DRG. The other way is using DRG-based budget allocation system, whereby hospitals will get a budget based on past years and what are their expected costs next year. Every country has specific guidelines what should hospitals do in case of reaching less or more expenses than expected. That is affecting hospitals behavior in a good or a bad way.

In general, there are three main incentives attributed to DRG-based hospital payment systems. Hospitals are incentivized to reduce costs per treated patient, to increase revenues per patient, and to increase the number of patients. Reducing costs per patient is possible by reducing the length of stay, reducing the intensity of the services provided, or selecting patients for whom hospitals can provide care at costs that are below the DRG payment rate. This can have some positive effect and can influence efficiency and quality of services but can also have some negative effects.


Fortunately, there are ways how to prevent negative affects and support positive affects of these incentives. On the one hand, reducing the length of stay can lead to higher efficiency and intensity of services in hospitals. On the other hand, this could lead to inappropriately early discharges that could lead to lower quality and negative consequences on the patient’s health. That is why every country has some way to identify the standard length of stay for every DRG and the payments for outliers are affected. The other way – selecting patients for whom they have a competitive advantage – can lead to positive effect of higher specialization of hospitals and becoming more professional in some fields, but a negative effect is lower hospital care for patients with other diagnosis.

Another incentive can be changing coding practices and reclassifying patients into a different DRG with an associated higher payment rate. That is a very unfair way, and it is of course illegal. That’s why there are various controls on a national level. Also, there are some special treatments for patients that are quite expensive and aren’t necessary for every patient from a DRG group. To raise homogeneity of these DRG, these special treatments are financed separately and not based on DRG group.

Increasing the number of patients is also a good way how to positively affect hospitals budget. That can be a good reason for improving quality and efficiency. On the other hand, if activity is increased by admitting patients for services that could be provided in outpatient settings, efficiency is reduced.

For more fair financing of hospitals the DRG is still improving, the DRG classification is still more detailed, the national guidelines are regularly updated.


There are many positive effects of using DRG in hospitals and there are also some negative ones. But the important thing is that DRG system is still improving, and it is important to implement it carefully, gradually and with controlling mechanism.