Under the IPPS, hospitals are not paid separately for each item or service they provide. Rather, payment is based on the DRG to which the entire inpatient stay is assigned. Each of the 538 DRGs has a classification, that is, an assigned combination of any of the approximately 17,000 diagnoses and procedures codes. When codes for these diagnoses and/or procedures appear together on a claim, the inpatient stay is assigned to the appropriate DRG and paid accordingly. In addition, CMS determines if the inpatient stay is eligible for an outlier payment beyond the DRG payment. Hospitals can receive outlier payments for individual inpatient stays determined to be extremely costly if a hospital can demonstrate that the estimated cost of an individual inpatient stay exceeds a cost threshold established by CMS. Medicare law requires CMS to revise the DRG classifications and payment weights at least annually to reflect changes in treatment patterns, new medical services and technologies, and other factors that may change the relative costliness of an inpatient stay. To accomplish this, CMS assembles a MEDPAR file from inpatient claims for a fiscal year, so that the file contains one record for each inpatient stay provided during that year. A MEDPAR record includes the admission and discharge dates, patient and hospital identifiers, and codes that identify the diagnosis and the procedures delivered during the inpatient stay. The record also contains the hospital’s total charge for the inpatient stay. The total charge represents the charges for all services—including any new technology, drugs, or supplies—provided during the inpatient stay. The total payment to the hospital is also included in the MEDPAR record. MEDPAR records do not indicate the hospital’s actual cost for the inpatient stay or the cost of individual procedures, which are not recorded on claims by hospitals. CMS uses data from the MEDPAR file to revise the DRGs for the coming fiscal year. It revises the DRGs in a two-step process: reclassification of DRGs and calculation of DRG payment weights. First, CMS incorporates new codes into the IPPS that represent new diagnoses or procedures by assigning them to the same DRGs as existing codes for clinically similar diagnoses or procedures. Using data from the MEDPAR file, CMS may reclassify the DRG assignment of inpatient stays with a particular procedure or diagnosis code if it determines the inpatient stays are more similar in their clinical characteristics and costliness to a DRG other than the DRG to which those stays were previously assigned. CMS will create a new DRG if it determines that the inpatient stays involving newly identified diagnoses and procedures cannot be described by any of the existing DRGs. The classification of most DRGs does not change from year to year. The second step in revising the DRGs involves calculating weights across all DRGs, so that the DRGs reflect the expected relative differences in costliness of inpatient stays for the upcoming fiscal year. Prior to fiscal year 2007, CMS annually derived each DRG’s weight by dividing the average charge per inpatient stay for that DRG by the average charge per inpatient stay across all DRGs for a fiscal year. Effective fiscal year 2007, CMS uses charge data from the MEDPAR file and hospitals’ cost-to-charge ratios from Medicare cost reports to estimate the costs per inpatient stay. CMS then uses these average estimated costs to measure the relative costliness of inpatient stays that will be assigned to each DRG. In reclassifying and weighting DRGs, CMS generally requires that the data meet three criteria: (1) the data must be representative of the Medicare population; (2) the data must be timely—that is, they should be the most recent data available; and (3) the data must be complete—meaning that CMS needs total charges or other measure of costliness for all services provided during an inpatient stay. Charge data collected at the inpatient- stay level allow CMS to appropriately measure relative costliness across the DRGs. The DRG classifications and payment weights for any given fiscal year are based on data from the MEDPAR file for inpatient services provided 2 fiscal years prior, and therefore, do not reflect the cost of the most recently used technologies. For example, during the summer of 2006, when CMS was finalizing the DRGs for fiscal year 2007, the most recent data pertained to inpatient services provided through the end of fiscal year 2005, and did not reflect the cost of technologies first adopted by hospitals in fiscal year 2006. The time lag in the data that are used to set DRG classifications and weights is primarily due to two factors in combination: the time it takes to annually finalize the DRGs, and the time it takes for CMS to process each inpatient claim into a MEDPAR record. First, Medicare law requires that DRG classifications and weights be revised annually and published in the Federal Register on or before the August 1 before each fiscal year. Fiscal years begin October 1 and end the following September 30. In order to obtain public input, CMS generally publishes its proposed DRGs for the coming fiscal year in the Federal Register each April and accepts comments for 60 days before publishing the final DRGs by August. The second factor that affects the incorporation of the cost of new technologies into the MEDPAR file involves the time it takes for CMS to process each inpatient claim into a MEDPAR record. Before a record for an inpatient stay can be added to the MEDPAR file, the hospital must submit the claim, a private contractor must process and pay the claim, and CMS must create a MEDPAR record using information on the claim. It takes about 6 months from the time of the inpatient stay to the time the MEDPAR record for that inpatient stay is created. In addition, the MEDPAR record may not be added to the MEDPAR file until as much as 3 months later, since the MEDPAR file is updated quarterly—in December, March, June, and September. This means that MEDPAR records are not available to CMS until 6 to 9 months after the inpatient stay has occurred. (See fig. 1.) Because DRG payments for a given fiscal year are based on claims for inpatient services provided 2 fiscal years prior, Medicare can provide hospitals with add-on payments, in addition to the DRG-based payments, for inpatient stays involving certain new technologies. CMS designates technologies for add-on payments if they meet specified criteria for being new, costly, and a substantial clinical improvement over existing technologies. CMS considers a technology new if no more than 2 to 3 years have passed between the date when the technology was first introduced on the market, as identified by CMS, and the payment year. At the end of this period, CMS assumes the costs for the technology to be fully reflected in the most recent MEDPAR file and supplemental add-on payments are no longer necessary. CMS considers a new technology costly if the average amount charged by hospitals for all inpatient stays involving the technology exceeds a charge threshold or a predetermined amount. CMS considers a new technology a substantial clinical improvement over existing technologies if the technology has one or more unique clinical advantages—for example, the technology diagnoses a medical condition in a patient population where that condition was previously undetectable. Every year, CMS accepts applications from technology manufacturers, hospitals, and other stakeholders, in which they present evidence that certain technologies meet the criteria for add-on payments in the coming fiscal year. When CMS publishes its final DRG classifications and weights, it summarizes each application, and explains why the particular technology was approved or rejected for add-on payments. For fiscal year 2007, CMS approved one new application and continued add-on payments for two technologies approved for fiscal year 2006. As a result, hospitals receive an add-on payment, in addition to a DRG payment, when they submit a claim to Medicare that includes the code for a procedure involving one of those three technologies. The amount of the add-on payment is determined on a claim-by-claim basis; the hospital receives up to half the estimated cost of the technology, depending on the amount by which the total cost of the inpatient stay is estimated by CMS to exceed the DRG-based payment. CMS has used external data for two purposes: to inform DRG reclassification and to evaluate new technology add-on payment applications. To inform DRG reclassification, CMS accepts the submission of external data that are intended to demonstrate that inpatient stays involving a new technology are costlier on average than the other inpatient stays in the same DRG. CMS uses data from the MEDPAR file to validate the external data submitted. Generally, CMS will not make a reclassification decision for a DRG involving a new technology if the technology is so new that it does not appear in the MEDPAR file. To evaluate new technology add-on payment applications, CMS has generally used external data in conjunction with data from the MEDPAR file to evaluate whether a new technology meets one of three eligibility criteria, specifically, the criterion related to cost. CMS officials told us they have used external data to inform the DRG reclassification process. External data are submitted by stakeholders as part of a request to reclassify—from one DRG to another—certain procedure codes involving particular new technologies. Although CMS will accept the submission of external data, it has used data from the MEDPAR file to validate the external data submitted. Specifically, when external data are submitted for a proposed DRG reclassification for a procedure or new technology, CMS’s policy is to find the same or similar evidence in the MEDPAR file. CMS encourages stakeholders to submit their external data for DRG reclassification purposes by the December before the issuance of the proposed rule the following April. Although there is no formal application process to request a DRG reclassification, CMS explained its policy for accepting external data submissions in its July 30, 1999, notice of final rulemaking. It stated that external data submissions must be sufficiently detailed—include applicable hospital and beneficiary identifiers, procedure and diagnosis codes, admission and discharge dates, and total charges for each inpatient stay involving the codes—so that CMS can validate whether the same, or similar, inpatient stays appear in the MEDPAR file.