Diagnosis-related groups (DRGs) were first used to pay hospitals in 1983 under the Medicare Program in the United States. This development was born out of a need to move away from an approach to hospital financing based on fee-for-service payments, which was seen as inherently inefficient and increasingly expensive. Since then, DRG-based hospital payment has been widely adopted internationally with the explicit objective of improving efficiency, principally because of its three overarching strengths, summarized here:
1. DRG-based hospital payment offers
greater transparency in the financing
of health care.
2. Payments are based on patient
characteristics. Fundamental to effective DRG-based
hospital payment is an accurate description
of the type of patients treated
(casemix).
3. DRG-based hospital payment is a form
of ‘yard stick competition’, designed to encourage greater efficiency in the absence of market competition.
‘Efficiency’
is a widely used term that can have various meanings. Economists make
distinctions between technical, cost- and allocative efficiency.
Technical efficiency is defined as maximizing output for
given input levels or, in this context, treating as many patients as possible
given the resources available. Hospitals are cost-efficient when they minimize costs for any given output level.
Allocative efficiency can be defined
for both outputs and inputs. The optimal output mix depends on the value of
each output, which requires judgments to be made on the relative values of an
appendectomy operation, a heart bypass, and all other health care
interventions. The optimal mix of inputs
depends on the relative price of each input type, such as the salaries of
doctors and nurses. Alongside these economic terms, reference is often made to
things thought to be indicative of efficient behavior, which – in the hospital
sector – might include the number and type of patients treated, unit costs, and
length of stay, for example. The extent to which DRGs contribute to achieving
these forms of efficiency depends on how they are used for payment purposes.
Yard stick
competition is designed to encourage providers to reduce their costs in
contexts in which they face limited competitive pressure. Yard stick
competition is effective when regulated prices are virtually independent of an
individual provider’s costs. Ideally, prices should reflect the supply costs of
efficient providers, determined across all providers within the same industry.
The role of DRG-based hospital payment, we
compare the three main forms of provider payment models used in hospital
financing:
1. cost-based reimbursement (also known as fee-for-service payment),
2. the global budget model,
3. DRG-based payment.
With cost-based
reimbursement, payments to hospitals are based on the cost incurred by each
patient. The main method of cost control is to specify a price list that details the unit payment for each ‘item
of service’ (for example, medication, X-ray, procedure). Hospitals must
therefore provide itemized bills for every patient treated, but there is no
incentive to limit what treatments they provide per insured patient.
Cost control is one of the key advantages of global budget arrangements, which have
been used in many European health care systems, at least if the budget
constraint is credible and binding, and separation exists between a payer.
This division has traditionally been present in social health insurance systems
and, since the 1990s, increasingly also in tax-funded systems. A fixed payment is agreed in advance for a target level of
activity – often specified at the specialty
level.
There are two key features of DRG-based
hospital payment. (1) Activity is
described using DRGs rather than by specialty. (2) The
reimbursement per DRG is to a large extent fixed in advance, as patient characteristics (especially the main
diagnosis) determine the DRG category with its fixed ‘price’.
The three models offer different incentives for
achieving objectives relating to activity levels, expenditure control, quality
of care, and the three types of efficiency.
DRG-based hospital payment performs better than
cost-based reimbursement regarding expenditure control, but not as well as
global budgets. The potential for
quality improvement under a DRG-based hospital payment system may be
dependent on whether payments are
adjusted for quality of care.
Where DRG-based hospital payment provides a fixed price per unit of activity,
hospitals are incentivized to increase activity and minimize cost and,
therefore, to improve technical
efficiency. While cost-based reimbursement also encourages increased
activity, there is no motivation to minimize inputs/costs. DRG-based hospital
payment may offer incentives to improve
allocative and cost-efficiency by encouraging providers to consider the
prices and amount of inputs they use. It may also promote an efficient
allocation of outputs if prices reflect their relative value but, in practice, most jurisdictions still base prices on costs. Nevertheless,
overall, DRG-based hospital payment is likely to provide stronger incentives
for efficiency compared to either of the alternatives.
DRG-based hospital payment systems have the
potential to enhance efficiency in
the delivery of hospital services, more so than other hospital payment models. This
is because there are clear incentives for hospitals to work harder. After all,
they are paid according to the number
of patients they treat, as well as to control their costs
because the prices they
face are set independently of their
costs. These payment characteristics encourage providers to
improve their technical and cost-efficiency and to seek allocative efficiency
in their choice of input mix. In theory, DRG-based hospital payment can be used
to support allocative efficiency in the overall mix of outputs produced by the
hospital sector as a whole. This requires the price attached to each DRG to
reflect its societal value. In practice, though, DRG prices are based on costs
in almost all countries, so the pursuit of allocative efficiency in this sense
has not been a feature of DRG-based hospital payment policy.
Empirical evidence is mixed in terms of the
extent to which DRG-based hospital payment has improved efficiency. This is
partly because of cross-country heterogeneity in how DRG-based hospital payment
systems are operated.
It is generally agreed that DRG-based hospital
payment affects indicators of
efficiency, such as activity and length
of stay, although the same caveats apply. Unintended consequences may include skimping (on quality),
cost-shifting, patient selection, or up-coding to higher-priced DRGs.
Quality of care is a multidimensional concept,
covering effectiveness, safety, accessibility, and responsiveness of care but
there is no agreement on how these should be measured. A useful and widely used
approach is the one conceptualized by Donabedian, that describes quality
measures as being either structure-, process- or outcome-oriented in nature. Structural measures – such as
qualification of medical staff or equipment levels – may represent conditions for
the delivery of a given quality of health care, but they are not sufficient to
ensure an appropriate care process. Process
measures should be based on clinical evidence of the effectiveness of the
process concerned and consistent with current professional knowledge. Thus,
process indicators may be more vulnerable to ‘gaming’ than outcome or structure
measures.
The way prices are set will have a significant
impact on the cost-efficiency effort of providers and, consequently, on
quality.
It appears that in most countries in which a
DRG-based hospital payment system is introduced, the monitoring and reporting of care quality remain inadequate.
Unintended adverse effects of DRG-based hospital payment systems on care quality could potentially be avoided by modifying the incentives of the payment system. If the payer/purchaser wants to improve the quality of care, payments need to be adjusted in a way that rewards hospitals for the additional costs/effort involved in raising quality. Furthermore, that the form of the payment contract should take into account the type of provider. Different options exist for adjusting DRG-based hospital payment systems based on the quality of care. Simplified, there are three options:
1. the hospital level,
2. the level of a DRG-or all DRGs for one condition,
3. the individual patient level.
Under the first option, total hospital income
could be adjusted based on hospital-level
quality indicators.
Under the second option, when patient-level data are available on
outcomes and/or treatment process(es), payments
can be adjusted for certain DRGs
based on the quality of all patients treated within that DRG. The aim is to
encourage a medical practice that is considered to be ‘good quality’ by moving
away from pricing simply based on average observed costs per episode.
The third option is to adjust payments for individual patients based on the quality of
their treatment, independent of the DRG to which they are allocated. This
requires reliable indicators of patient outcomes. Developing such indicators is
not always straightforward, as attributing a certain patient outcome to
provider behavior can be controversial. Indicators for bad (or good) quality,
on which such penalties (or rewards) are based, will thus need to be very
robust and subject to as little controversy as possible.
Of course, it is also possible to have a system that combines different approaches,
for example, quality adjustments at the patient level with a global
payment/adjustment for quality at the hospital level. However, an essential
prerequisite for any quality-based payment adjustments to the hospital payment
system is the availability of
information on the quality of care.
DRG-based payment systems may represent risks for the quality of care, but may
also provide opportunities for quality improvements. The introduction of DRGs has increased transparency and has
facilitated the comparison and
standardization of care. The pressure for efficiency introduced by
DRG-based payment systems might help to improve the organization of care,
accelerate the adoption of technology, and hence improve quality. Nevertheless,
hospitals can also skimp on quality as a way of saving costs by manipulating
the services/care provided to patients. Technology adoption rates may
decelerate if new technologies do not induce cost savings. At the same time,
these potential adverse effects are not inevitable consequences of DRG-based
hospital payment and can be addressed by carefully designing the payment
scheme.
Despite the widespread introduction of
DRG-based hospital payment systems since the early 2000s, the available
research evaluating the systems’ impact on care quality and patient outcomes is
too limited to draw any firm conclusions. The limited evidence so far does not
suggest that the introduction of DRG- based hospital payment had a
significant impact on patient outcomes.
DRG-based hospital payment provides an
opportunity to better measure the quality of care in hospitals. Thus, it
becomes possible to improve quality by providing explicit incentives for higher
quality procedures/treatments, penalizing ‘poor-quality care’, or granting
funds for improving patient outcomes. This requires continuous refinement of
data and indicators for monitoring the quality of care. In many countries,
information on patient outcomes and process quality is not routinely collected.
However, if financing arrangements become more sophisticated, the demand for
and supply of information regarding the quality of health care will surely
increase.