The Evolution of Diagnosis-Related Groups (DRGs)

Policymakers are searching for ways to control health care costs and improve quality. Diagnosis-related groups (DRGs) are by far the most important cost control and quality improvement tool that governments and private payers have implemented. This article reviews why DRGs have had this singular success both in the hospital sector and, over the past 10 years, in ambulatory and managed care settings. Last, the author reviews current trends in the development and implementation of tools that have the key ingredients of DRG success: categorical clinical model, separation of the clinical model from payment weights, separate payment adjustments for nonclinical factors, and outlier payments. Virtually all current tools used to manage health care costs and improve quality do not have these characteristics. This failure explains a key reason for the failure, for example, of the Medicare Advantage program to control health care costs. This article concludes with a discussion of future developments for DRG-type models outside the hospital sector.