What the Inpatient Prospective Payment System is and how it affects your bill

The Inpatient Prospective Payment System (IPPS) is the method Medicare uses to pay hospitals for inpatient care. Instead of paying hospitals for each test, procedure, or day you stay, Medicare assigns a fixed payment amount based on your diagnosis. The hospital receives that amount whether your stay costs them more or less to deliver.

This system has been in place since 1983 and shapes how much you will owe for a hospital admission. If you are on Medicare, your bill is determined by your diagnosis code, not by how many CT scans you had or how many nights you spent in a bed. Private insurers often follow similar logic, though they may use different payment amounts.

The payment amount is called a Diagnosis-Related Group (DRG) rate. Medicare assigns every inpatient hospital stay to a DRG based on your primary diagnosis, secondary conditions, and any procedures performed. A DRG for a routine appendectomy pays differently than a DRG for a hip replacement with complications. The hospital knows the payment before you are discharged.

Key Takeaways

  • Medicare pays hospitals a fixed amount per admission based on diagnosis code, not on the actual length of stay or services used.
  • The payment amount is determined by your Diagnosis-Related Group (DRG), which combines your primary diagnosis, secondary conditions, and procedures.
  • Hospitals keep any payment surplus if costs run low, but absorb losses if costs run high, which is why they manage length of stay closely.
  • Your out-of-pocket cost (copay, coinsurance, deductible) is separate from what Medicare pays the hospital and depends on your coverage type.
  • Non-Medicare patients may see bills calculated differently, though many private insurers now use DRG-based or similar bundled payment models.

How Medicare calculates the DRG payment amount

Medicare starts with a base payment rate that varies by geographic location and hospital type. A rural hospital in Montana receives a different base rate than an urban teaching hospital in New York. This reflects differences in local wages and operating costs.

From that base, Medicare applies a DRG weight—a multiplier that reflects the average cost and complexity of your diagnosis. A DRG for uncomplicated pneumonia has a lower weight than a DRG for pneumonia with sepsis. The weight is recalculated annually based on national hospital cost data from the previous year.

The formula is: Base Rate × DRG Weight = Hospital Payment. If the base rate in your area is $5,000 and your DRG weight is 1.5, the hospital receives $7,500 for your admission, regardless of whether you stay three days or ten days.

Medicare also makes adjustments for teaching hospitals, safety-net hospitals serving low-income patients, and hospitals that treat a disproportionate share of uninsured people. These adjustments can increase the payment by 10 to 20 percent.

What happens when hospital costs are higher or lower than the payment

If the hospital's actual costs for your care fall below the DRG payment, the hospital keeps the difference. If costs exceed the payment, the hospital absorbs the loss. This financial risk is why hospitals closely manage length of stay and resource use—they have an incentive to discharge you efficiently without compromising care.

A hospital cannot bill you for the difference if costs run over. The DRG payment is the final payment from Medicare for that admission. However, you may still owe your share of the bill: your Medicare deductible (currently $1,676 for the first 60 days of an inpatient stay in 2024, though this amount changes yearly), coinsurance, or copayments depending on your coverage.

If the hospital's costs are unusually high due to complications or extended treatment, the hospital may request a case review or outlier payment from Medicare. Outlier payments are made when a case is exceptionally expensive—typically when costs exceed the DRG payment by a large margin. These are rare and require documentation of the extraordinary circumstances.

How your out-of-pocket cost is determined under IPPS

Your personal bill is separate from what Medicare pays the hospital. You are responsible for your Part A deductible, which applies once per benefit period (typically a calendar year or 60-day period). For 2024, this deductible is $1,676 for days 1 through 60 of an inpatient stay.

After you meet the deductible, you owe coinsurance for days 61 through 90 of the same benefit period. For 2024, coinsurance is $419 per day. If you stay longer than 90 days, you enter your lifetime reserve days, and coinsurance rises to $838 per day. These amounts are set by Medicare and change annually.

If you have a Medigap or Medicare Advantage plan, that plan may cover some or all of these costs. Medigap Plan F and Plan G, for example, cover the Part A deductible and coinsurance. Medicare Advantage plans have their own cost-sharing rules and may cap your out-of-pocket maximum.

The hospital bills your insurance first, then sends you a bill for your remaining balance. You do not pay the DRG amount directly—you pay only your share of the costs Medicare covers.

Why hospitals use DRG codes and how coding affects payment

Accurate coding is critical because the DRG assigned to your case determines the entire payment. A coder reviews your medical record after discharge and selects diagnosis and procedure codes from the ICD-10-CM (International Classification of Diseases, 10th Revision, Clinical Modification) system. These codes feed into a grouper software that assigns your DRG.

If your secondary diagnoses are coded correctly, you may be assigned to a higher-paying DRG. For example, if you are admitted for a hip fracture and also have diabetes, the diabetes code may move you to a DRG that pays more because your case is more complex. Hospitals employ coding specialists to ensure all relevant conditions are captured.

This is not fraud—it is accurate documentation. However, hospitals do have an incentive to code thoroughly, which is why they invest in coding departments. Medicare audits hospital coding through programs like the Recovery Audit Contractor (RAC) program, which reviews claims for accuracy and can reclaim overpayments.

How IPPS differs from other payment models

Before IPPS, Medicare paid hospitals based on cost-plus reimbursement: the hospital submitted its actual costs and received payment for those costs plus a margin. This created little incentive to control spending, and hospital costs rose rapidly.

IPPS shifted financial risk to hospitals by paying a fixed amount per admission. This encouraged hospitals to manage resources and discharge patients promptly. Over time, private insurers adopted similar models, though they may use different payment amounts or DRG weights.

Some hospitals now participate in bundled payment programs or accountable care organizations (ACOs), where payment is tied to quality outcomes or total cost of care across multiple providers. These are extensions of the prospective payment concept but go beyond the basic IPPS model.

Outpatient hospital services, physician services, and skilled nursing facilities use different payment systems. IPPS applies only to inpatient hospital stays of one or more days.

What to do if you receive a hospital bill you don't understand

Request an Explanation of Benefits (EOB) from Medicare and your supplemental insurance if you have it. The EOB shows what Medicare paid, what you owe, and the DRG code assigned to your stay. You can also call Medicare at 1-800-MEDICARE to ask about your specific claim.

If you believe the DRG assignment is wrong, you have the right to request a review. Contact the hospital's billing department and ask for the DRG code and the reason for the assignment. If you disagree, you can file an appeal with Medicare's Quality Improvement Organization (QIO) within 120 days of receiving the bill.

Check your hospital bill line by line for duplicate charges or services you did not receive. Hospitals make billing errors, and catching them early is easier than disputing them later. If you find an error, contact the hospital's patient advocate or billing department in writing and keep copies of all correspondence.

Frequently Asked Questions

Can a hospital charge me more than the DRG payment if my stay is expensive?

No. The hospital cannot bill you for the difference between the DRG payment and their actual costs. You owe only your Medicare deductible, coinsurance, and copayments as defined by Medicare. The hospital absorbs any loss if costs exceed the DRG payment.

Does the DRG payment change if I stay longer in the hospital?

No. The DRG payment is fixed per admission, not per day. A longer stay does not increase the hospital's payment from Medicare, which is why hospitals have an incentive to discharge you as soon as medically appropriate. Your coinsurance may increase if you stay beyond 90 days, but that is your cost, not the hospital's payment.

What if I am not on Medicare—does IPPS still apply to my bill?

IPPS applies only to Medicare patients. Private insurers use their own payment models, though many now use DRG-based or bundled payment systems similar to IPPS. Your bill will depend on your insurance plan's contract with the hospital. Ask your insurer how they calculate payment for inpatient stays.

Can I appeal if I think my DRG code is wrong?

Yes. You can request a review from Medicare's Quality Improvement Organization within 120 days of receiving your bill. Contact the hospital's billing department first to understand why the code was assigned, then file an appeal if you believe it is incorrect. Include documentation from your medical record that supports your position.

How do I find out what DRG code was assigned to my hospital stay?

Your hospital bill or Explanation of Benefits should list the DRG code. If it does not, call the hospital's billing department or Medicare at 1-800-MEDICARE and provide your claim number. Medicare can tell you the DRG, the payment amount, and the diagnosis codes used to assign it.