By Toni Cesta, PhD, RN, FAAN

Changes in healthcare reimbursement have occurred with lightning speed over the last two decades. Earlier, reimbursement had been stagnant for many years and functioned on a “no questions asked” basis. Providers billed for services rendered and were reimbursed — with no checks, balances, or control over costs of care. Case management, as a care delivery model, followed a similar course. It was a community-based model dating to the 1920s. But as reimbursement changed, so did case management. This month we will begin our discussion of reimbursement, including the changes to case management as it evolved with reimbursement.

Reimbursement Inspired Change in Healthcare

Evolution in reimbursement motivated change in healthcare delivery, moving case management into the limelight in the mid-1980s. Before the 1980s, most reimbursement schemes were fee-for-service (FFS), with little concern for length of stay or cost of care. Overuse was common — the more that was spent, the greater the reimbursement. This could be viewed as an overuse reward system. With no checks and balances on the system, costs continued to increase. At the same time, the costs of pharmaceuticals, radiology, and supplies escalated with minimal management. It became apparent to hospitals and healthcare systems that greater accountability was needed.

Forces driving the move toward case management:

  • 1970s: Escalating healthcare costs;
  • 1980s: Prospective payment system in acute care settings;
  • 1990s: Managed care infiltration;
  • 2000s: Prospectivfve payment in home care, outpatient care, rehabilitation services, and long-term care;
  • 2010: Healthcare reform.

Eventually, these spiraling and unchecked costs brought pushback from patients and third-party payers. No longer were they willing to pay these high costs. It also was becoming apparent that healthcare quality was not keeping pace with the increased expenditures. Were these higher costs necessary or were they simply a result of an unchecked healthcare system? Some patients were concerned they were paying more and getting less. This concern was not unfounded. Care quality did not improve simply by throwing more resources into the process. In fact, in some instances, resource misuse and overtreatment exacerbated the problem.

By the mid-1980s, many pilot projects were underway to develop changes in delivery that might reduce costs while improving care quality. Since value in healthcare is the equation that reduces costs and improves patient outcomes, these changes were a serious value proposition. The federal government under the Medicare and Medicaid programs introduced the prospective payment system (PPS) and the development of the diagnosis-related groups (DRGs). The idea was to move hospitals and healthcare systems to fixed-rate payments applied, regardless of the resources consumed.

Almost simultaneously, employers — the largest purchasers of healthcare insurance — began looking for alternatives to indemnity plans as healthcare costs continued to rise.

Early efforts were focused on cost-cutting, particularly in many of the early managed care plans. The tighter the controls on the expenditures, the lower the cost of care. Lower costs meant premiums could be kept as low as possible, attracting more companies to these plans.

It was not long before hospitals and healthcare systems realized the best way to control costs was to understand care quality. A different approach to measuring outcomes was born. While financial indicators were obvious, there were bigger challenges in measuring quality within managed care as well as under the PPS. Many hospitals introduced and adopted quality tools that focused on continuous quality improvement (CQI). CQI was one of the first concepts to gain popularity. The other was case management. In time, these techniques provided the framework for future delivery models and outcomes management.

The PPS and DRGs were the major drivers that moved case management from a community-based model to one that would be used in hospitals and other acute care settings. Under the earlier FFS models, there were no financial incentives for hospitals to reduce cost or shorten length of stay.

In the 1980s, healthcare policy began to shift to quality and cost of care as well as fiscal responsibility. The PPS was intended to control hospital costs by providing a price-per-case reimbursement. The provider, including the physician, became responsible for controlling the direct costs of care associated with treating each patient. The DRGs would set the price for the care provided during a hospital stay. By controlling the reimbursement, physicians, nurses, ancillary departments, and administrators could work to provide more efficient and cost-effective care. Also, the PPS would facilitate a reduction in variation, lead to standardization of care, and improve the efficiency of the care process. Unfortunately, although the PPS controlled the payment rate the hospital was to receive, it did not control the cost of care. This required changes in behavior, particularly from physicians who ordered the healthcare resources. Therefore, hospital costs continued to rise. This led to the opportunity for managed care to provider a greater influence in healthcare reimbursement.

Under the PPS, appropriate reimbursement is directly linked to the documentation in the medical record. How well a hospital fares under PPS was dynamically linked to accurate, legible, and timely documentation coding accuracy. Some hospitals introduced a new position that used either medical coders or registered nurses to monitor and audit medical record documentation. The most commonly used title for these positions is documentation specialist, although other titles are used. This person ensures the documentation reflects the care delivered, increasing the likelihood the hospital will be paid under the most accurate DRG assignment.

DRGs were codified in 1982 under the Tax Equity and Fiscal Responsibility Act (TEFRA). This was initially created to set limits for Medicare reimbursement. Developing this methodology was complex and laborious. The first DRGs were based on ICD-8 and HICDA-2 diagnostic codes. The I-8 was a four-digit system that measured the incidence of disease, injury, or illness. The five-digit I-9 was more specific in terms of location and precision of reporting clinical conditions. Specific measures would require more specificity in physician documentation.


DRG is a patient classification reimbursement system that groups similar patients. They are considered alike if they demonstrate similar cost and length of stay. Costs include services and resources used to directly care for a patient, including diagnostic and therapeutic interventions. Personnel costs include nursing hours per patient, among other criteria.

DRGs are subdivided into major diagnostic categories (MDCs). Examples of MDCs include diseases of the central nervous system, bone and cartilage, and diseases and disorders of the kidneys and urinary tract. MDCs are medical or surgical. The amount of DRGs in each MDC can vary from 1 to 20 or more.

Relative Weights and Case Mix Index

Each DRG is assigned a relative weight. These weights are relative to the number 1 and are based on average lengths of stay and costs of care. DRGs assigned 1 use an average amount of resources. DRGs weighted above 1 include greater case mix complexity and use more resources. These types of patients are reimbursed at higher amounts. DRGs weighted under 1 require fewer resources, are less complex, and are paid at lower amounts.

DRG weights correlate to the case mix index (CMI) of the hospital. The CMI is the sum of all DRG weights divided by the number of patients cared for over time, usually one calendar year. The higher the CMI, the higher the assumed case mix complexity of the hospital. Case mix is affected by:

  • severity;
  • prognosis;
  • treatment complexity;
  • interventional needs;
  • intensity of resource use;
  • presence of complications and comorbidities.

The Centers for Medicare & Medicaid Services (CMS) assigns each hospital a base rate for reimbursement. The base rate is determined by the type of hospital (teaching, academic, community), location, patient population, local cost of living, and services provided. Reimbursement is calculated by multiplying the DRG’s relative weight by the hospital’s base rate. CMS reviews DRGs and base rates annually. Adjustments are made as needed based on the previous year’s performance for all hospitals in the United States.

Measuring the Elements in Case Mix

Illness severity includes clinical indicators that reflect the need for hospitalization. Prognosis is the patient’s likelihood of recovering. The case mix reflects hospital costs. The types of patients and their use or resources, not the number of patients, affects hospital costs. Assignment of a DRG is based on the documentation in the medical record.

The DRG is assigned after discharge based on medical record coding. Once it is assigned, the hospital receives a lump-sum payment based on the relative weight of the assigned DRG. Some DRGs are weighted higher based on the complications and comorbidities associated with that DRG.

Assigning the DRG

Severity of Illness Criteria

  • Clinical findings: chief complaints and working diagnosis identified on physical examination, direct observation, and patient interview;
  • Vital signs: temperature, pulse, respiratory rate, and blood pressure;
  • Imaging: diagnostic radiology, ultrasound, MRI, and nuclear medicine results;
  • ECG;
  • Hematology, chemistry, and microbiology results;
  • Other (clinical parameters not identified already).

Intensity of Service Criteria

  • Physician evaluation;
  • Monitoring;
  • Treatments/medications;
  • Scheduled procedures;
  • Presence of comorbidities.


Patients with atypical short or long lengths of stay are defined as outliers. All other patients are defined as inliers. Classifying a patient as an outlier depends on the trim points for the DRG. Each DRG has a high length-of-stay trim, while some also have a short length-of-stay trim. Trim points represent the lowest and highest average lengths of stay for the DRG.

Patients also can be categorized as cost outliers. These patients are in appropriate length of stay but have used a higher-than-normal amount of resources. This is determined by using a flat amount or if the charges exceed the rate by at least 50%.

In 1985, the PPS was advanced beyond Medicare to allow some states to designate reimbursement rates for Medicaid and third-party payers such as managed care plans. Strong incentives were in place aimed at controlling hospital resources. The hospital would still be reimbursed a fixed amount of money based on the coded DRG, regardless of the cost.

During the early years of DRGs, hospitals realized RNs could play a vital role in managing these dwindling healthcare dollars. These early roles mainy focused on utilization review and discharge planning:

  • timely admissions;
  • confirmation of physician orders;
  • coordination of tests, treatments, and procedures;
  • accurate documentation;
  • patient and family education;
  • timely discharges.

Before these changes, there were few financial incentives in place to control healthcare processes. In fact, there were many disincentives. The fee-for-service environment meant more revenue and financial success for hospitals when patients stayed longer and used more resources. The PPS changed that. It became important to maximize the patient’s hospital stay by coordinating the flow of patient care activities, including tests, treatments, and procedures so delays could be avoided. Additional tactics included confirming physician orders and/or questioning of their appropriateness. These changes necessitated the movement of case management into the acute care setting and used RNs to drive the case management processes.

These are the steps of the DRG reimbursement process:

  1. The DRG is assigned after discharge.
  2. Once the DRG is assigned, the hospital is paid.
  3. One lump-sum payment is made for:
  • DRGs with complications or comorbidities;
  • Cost outlier payments.


The payment system for the acute care setting is complicated, and we have only begun to review the CMS system. Next month, we will continue to discuss this system and how it applies to the roles of case management professionals.