Inpatient Prospective Payment System (IPPS)

Key facts

Legal basis

Section 1886(d) of the Social Security Act; regulations at 42 CFR Part 412

In use since

Hospital cost reporting periods beginning on or after October 1, 1983

Classification

Medicare Severity DRGs (MS-DRGs), in use since fiscal year 2008

Update cycle

Federal fiscal year starting October 1; proposed rule in spring, final by August

Paid outside IPPS

Critical access, psychiatric, rehabilitation, long-term care and cancer hospitals

What is the Inpatient Prospective Payment System?

Before 1983, Medicare paid hospitals based on their reported costs. The IPPS replaced that with prospective payment: each inpatient discharge is assigned to a Medicare Severity Diagnosis-Related Group (MS-DRG), and the hospital receives a set amount for that group whether the patient stays three days or eight.

The system covers most general acute care hospitals, with notable exceptions. Critical access hospitals are paid based on cost, several specialty hospital types such as children's and psychiatric hospitals are paid under other systems, and Maryland hospitals operate under a separate state arrangement with CMS.

How IPPS payment is calculated

The core payment is the MS-DRG relative weight multiplied by a standardized base rate, whose labor-related share is adjusted by the local wage index. Hospitals can then receive add-ons or reductions:

• Indirect medical education (IME) adjustments for teaching hospitals.
• Disproportionate share hospital (DSH) and uncompensated care payments for hospitals serving many low-income patients.
• Outlier payments for unusually costly cases.
• New technology add-on payments (NTAP) for qualifying new drugs and devices.
• Quality program adjustments, including the Hospital Readmissions Reduction Program, Hospital Value-Based Purchasing and the Hospital-Acquired Condition Reduction Program.

Why the IPPS matters

DRG assignment is driven by coded diagnoses and procedures (ICD-10-CM and ICD-10-PCS), so documentation and coding directly affect hospital revenue. Because payment is fixed, a drug, device or extra day used during the stay is a cost to the hospital rather than a separately paid item, which is why makers of new inpatient technologies seek new technology add-on payments or new MS-DRG assignments.

The annual IPPS final rule sets payment updates for thousands of hospitals and publishes files such as DRG weights and wage indexes. Paired with Medicare inpatient utilization data by DRG, it shows which hospitals and service lines generate the most Medicare inpatient revenue.