What the Inpatient Prospective Payment System Does

The Inpatient Prospective Payment System (IPPS) is how Medicare pays hospitals for inpatient care. Instead of paying hospitals whatever they bill, Medicare assigns a fixed price to each hospital stay based on the patient's diagnosis and the procedures performed. The hospital receives that amount regardless of how much the actual care costs—if treatment runs cheaper, the hospital keeps the difference; if it runs over, the hospital absorbs the loss.

This system has shaped how hospitals operate since 1983. Before IPPS, Medicare paid hospitals their actual costs plus a percentage markup, which gave hospitals little reason to control spending. IPPS flipped that incentive: hospitals now profit by treating patients efficiently and lose money if they overspend. For patients, IPPS means your bill depends on your diagnosis code, not on how many days you stay or how many tests you receive.

Key Takeaways

  • Medicare assigns a fixed price to your hospital stay based on your diagnosis and procedures, called a Diagnosis-Related Group or DRG.
  • The hospital receives that fixed amount from Medicare no matter what the actual care costs, creating an incentive to treat you efficiently.
  • Your out-of-pocket costs (copay, coinsurance, deductible) are calculated from that fixed price, not from the hospital's actual bill.
  • IPPS applies only to inpatient hospital stays covered by Medicare; it does not cover outpatient services, skilled nursing, or non-Medicare patients.
  • The Centers for Medicare & Medicaid Services updates IPPS payment rates and DRG definitions every October.

How Diagnosis-Related Groups Determine Your Payment Amount

When you are admitted to a hospital, the medical records team assigns your stay a Diagnosis-Related Group (DRG) code. This code combines your primary diagnosis, any secondary diagnoses, the procedures performed, your age, sex, and whether you had complications. The DRG code is a number—for example, DRG 470 is "major joint replacement or reattachment of lower extremity without MCC" (MCC means major complication or comorbidity).

Each DRG has a fixed payment amount set by the Centers for Medicare & Medicaid Services (CMS). That amount varies by hospital location and hospital type. A teaching hospital in New York receives a different payment for the same DRG than a rural hospital in Nebraska. CMS publishes these rates in the Federal Register every August for the fiscal year beginning October 1.

The DRG code is assigned before or shortly after discharge, based on the codes the hospital's coders extract from your medical record. If the coder misses a complication or secondary diagnosis, the DRG may be lower than it should be, and the hospital receives less payment. If the coder adds codes that do not match the medical record, the hospital may face audits and repayment demands. This is why accurate coding matters to both the hospital's revenue and the accuracy of the payment system.

What IPPS Covers and What It Does Not

IPPS covers only inpatient hospital stays—the nights you spend in a hospital bed under a hospital's care. It covers the room, nursing, medications, imaging, lab work, and operating room time during that stay. Once you are discharged, IPPS stops explore.

IPPS does not cover outpatient services, even if they happen at the same hospital. A surgery performed in an outpatient center, an emergency room visit that does not lead to admission, or a chemotherapy infusion in a hospital cancer center all use different payment systems. Skilled nursing facilities, rehabilitation hospitals, and long-term acute care hospitals have their own separate payment systems. Home health, hospice, and dialysis centers are paid under different rules entirely.

IPPS applies only to Medicare patients. Patients with private insurance, Medicaid, or no insurance are not covered by IPPS, though some private insurers have adopted similar fixed-price models. A hospital may use IPPS rates as a reference point when negotiating with private insurers, but the actual payment to the hospital comes from the insurance contract, not from CMS.

How Your Out-of-Pocket Costs Are Calculated Under IPPS

Your Medicare copay or coinsurance for an inpatient stay is based on the IPPS payment amount, not on the hospital's actual charges. Medicare Part A covers inpatient hospital care after you meet your deductible. For 2024, the Part A deductible is $1,632 per benefit period. Once you meet the deductible, you pay coinsurance—a fixed daily amount—for days 1 through 60, a higher daily amount for days 61 through 90, and an even higher amount for lifetime reserve days beyond that.

The coinsurance amounts are set by law and do not change based on your diagnosis or the hospital's actual bill. What changes is the length of stay. A patient with a straightforward diagnosis might stay three days and pay three days of coinsurance. A patient with complications might stay ten days and pay ten days of coinsurance. The hospital's incentive under IPPS is to discharge you as soon as medically safe, because every extra day costs the hospital money (the fixed DRG payment does not increase, but staffing and supply costs do).

If you have a Medigap or Medicare Advantage plan, your out-of-pocket costs may be lower because those plans cover some or all of your coinsurance. The IPPS payment amount itself does not change—it goes to the hospital—but your personal cost depends on your supplemental coverage.

Why Hospitals Changed How They Operate Under IPPS

Before 1983, hospitals had no financial reason to discharge patients quickly or avoid unnecessary tests. Medicare paid them for every day and every service. Hospital stays were longer, and costs rose faster than inflation. IPPS created the opposite incentive: a hospital that keeps you longer than necessary loses money on your case.

This shift led hospitals to invest in efficiency—better scheduling, faster diagnostic protocols, and earlier discharge planning. It also created pressure to code diagnoses aggressively, because a higher-paying DRG means more revenue for the same work. Some hospitals hired more coders; others faced audits for coding that CMS deemed inflated. The system works as intended when coding is accurate, but the financial incentive to code higher has been a persistent source of tension.

IPPS also changed which patients hospitals admit. A patient with a low-paying DRG and complex social needs (homelessness, substance use, poor follow-up care) is financially risky under IPPS. Some hospitals developed social work and discharge planning teams to manage these cases; others located in areas with fewer such patients. This is one reason why IPPS is sometimes criticized for creating incentives that do not always align with patient welfare.

How IPPS Rates Are Updated and Who Sets Them

The Centers for Medicare & Medicaid Services updates IPPS payment rates every fiscal year, effective October 1. CMS publishes a proposed rule in the Federal Register in spring, takes public comment for 60 days, and publishes the final rule in August. The final rule includes the new DRG definitions, the payment rates for each DRG, and adjustments for hospital location, teaching status, and other factors.

Payment rates are adjusted for inflation using a formula set by Congress. CMS also adjusts rates based on hospital quality measures—hospitals that score well on readmission rates, mortality rates, and patient safety metrics receive a small bonus; those that score poorly may receive a small penalty. These adjustments are typically 1 to 2 percent of the base payment.

Congress can change IPPS rules through legislation. For example, Congress has periodically adjusted the payment formula, changed which hospitals may have access to for rural or teaching adjustments, and created temporary add-on payments for new technologies or high-cost drugs. These changes are not made by CMS alone; they require an act of Congress.

IPPS and Your Hospital Bill After Discharge

After discharge, you will receive a bill from the hospital. That bill shows the hospital's charges for your stay—the list prices for the room, each test, each medication, each procedure. These charges are often much higher than the IPPS payment the hospital actually received from Medicare. This can be confusing: your bill might show $50,000 in charges, but Medicare paid the hospital $12,000 under IPPS.

The difference between charges and payment is called the contractual adjustment. You are not responsible for this difference. You owe only your deductible and coinsurance, which are calculated from the IPPS payment amount, not from the hospital's charges. If you have a Medigap plan, it may cover your coinsurance, and you owe nothing. If you have a Medicare Advantage plan, you owe whatever your plan's cost-sharing rules specify.

If you receive a bill for more than your deductible and coinsurance, contact the hospital's billing department. The bill may be incorrect, or the hospital may be trying to collect a debt from a previous stay. Do not ignore it—hospitals can place accounts in collections, which affects your credit. But you should not pay more than your Medicare cost-sharing obligation.

Frequently Asked Questions

Does IPPS explore to my hospital stay if I have private insurance?

No. IPPS applies only to Medicare patients. If you have private insurance, your hospital bill is determined by your insurance contract, not by IPPS. Your insurer may negotiate a rate with the hospital that is higher or lower than the IPPS rate, but IPPS does not directly affect your bill.

Can a hospital refuse to admit me because my DRG pays too little?

No. Hospitals cannot legally refuse admission based on payment. However, hospitals may locate in areas with higher-paying DRGs, or they may invest more in services that attract higher-paying patients. This is an indirect effect of IPPS, not a direct refusal.

What happens if I stay longer than the average for my DRG?

The hospital still receives the same IPPS payment. Your out-of-pocket coinsurance increases for each extra day, but the hospital's payment does not. This is why hospitals have an incentive to discharge you as soon as medically appropriate. If your doctor believes you need to stay longer, they can document medical necessity, and Medicare will cover the extra days under your coinsurance rules.

How do I know what DRG code was assigned to my stay?

Your hospital bill or Explanation of Benefits from Medicare should list your DRG code. If it does not, contact the hospital's medical records department and ask for your discharge summary. The summary includes the DRG code and the diagnoses and procedures that determined it. You can also view your Medicare claims on the Medicare.gov website under "My Medicare".

Can the DRG code assigned to my stay be wrong?

Yes. If the hospital's coder missed a diagnosis or procedure, the DRG may be lower than it should be. If you believe your code is incorrect, you can request a medical records review. Contact the hospital's billing or medical records department and ask them to review the coding. If you disagree with their response, you can file an appeal with Medicare.