Medicare DRG Pricing Explained: 2025 Costs and How Diagnostic-Related Groups Work

Hospitals bill Medicare based on your Diagnostic-Related Group (DRG) classification, charging a bundled rate for your care instead of billing for each individual service separately. This system streamlines billing and aims to promote efficient, quality care.

Originating at Yale University in the 1960s, the DRG system was designed to monitor hospital care and control costs by categorizing patients with similar clinical conditions and treatment needs. Before DRGs, hospitals often reported higher expenses without a standardized way to define complex cases.

The first major implementation of DRGs occurred in New Jersey in the late 1970s, with nationwide adoption for Medicare reimbursement starting in 1983.

It's important to note that your DRG impacts the amount Medicare pays the hospital, but it does not directly affect your personal out-of-pocket costs.

Understanding How DRGs Function

DRGs group hospital services into bundled payments to discourage unnecessary procedures that can occur when billing is done per individual service. Medicare assigns your DRG based on your primary diagnosis and up to 25 related conditions. This classification places you in a tier with patients who have similar clinical profiles and expected treatment costs.

Factors such as specific procedures performed, your age, and sex can also influence your DRG assignment, reflecting the unique aspects of your care.

Medicare calculates DRG payment rates by analyzing average treatment costs for patients within each group, adjusting for regional differences like cost of living and healthcare wages. These calculations are reviewed and updated annually.

Additionally, Medicare considers "case-mix complexity," which accounts for illness severity, prognosis, treatment challenges, and potential complications, ensuring payments align with the complexity of your care.

The Three Main DRG Categories

The DRG system includes three types: basic DRGs, All-Patient DRGs (AP-DRGs), and All-Patient Refined DRGs (APR-DRGs). Basic DRGs are primarily used for Medicare, AP-DRGs cover a broader patient population including pediatrics, and APR-DRGs incorporate illness severity for a more detailed classification.

Within basic DRGs, there are two subcategories: Medicare Severity DRGs (MS-DRGs) for Original Medicare (Parts A and B), and Medicare Severity Long-Term Care DRGs (MS-LTC-DRGs) for long-term acute care settings.

DRG Example

For instance, if you have surgery and a systemic infectious disease simultaneously, you might be classified under MS-DRG 853.

What You Pay Out of Pocket for Hospital Care Under DRGs in 2025

Your DRG affects Medicare’s payment to the hospital but not your personal costs directly. If you have Original Medicare Part A, which covers hospital stays, you are responsible for a deductible of $1,676 in 2025.

Part A generally covers inpatient hospital stays for up to 60 days and skilled nursing facility care for up to 20 days without additional cost. Beyond these periods, daily coinsurance fees apply, and extended stays may incur full charges.

Most beneficiaries do not pay a monthly premium for Part A. Those who do pay between $285 and $518 monthly in 2025, depending on their work history.

If you have a Medicare Advantage plan, coverage is similar but managed by private insurers who may use their own DRG systems. Regardless, your out-of-pocket expenses usually include premiums, deductibles, and any applicable copays.

Potential Drawbacks of the DRG System

While DRGs aim to improve payment efficiency and reduce unnecessary care, research shows mixed results. A 2020 review of 36 studies indicated that DRGs can sometimes increase costs for complex conditions and specialized treatments.

Other challenges include possible early patient discharges leading to readmissions, reduced service availability, and lower hospital admissions.

Moreover, hospitals in resource-limited areas may struggle to collect social determinant data, potentially disadvantaging marginalized patient groups.

Summary

Medicare uses Diagnostic-Related Groups to determine hospital payments based on your medical condition, billing a bundled amount rather than individual services. This system affects what Medicare pays the hospital but generally does not increase your out-of-pocket expenses.

Understanding DRGs helps you navigate hospital billing and anticipate your financial responsibilities under Medicare in 2025.

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