The furore over the substantial increase in health insurance premiums last year (2025) was followed by governmental announcements about the implementation of the Diagnosis-Related Groups (DRGs) payment model for treatment in hospitals, starting with minor illnesses.
Many people have asked about DRGs.
The explanations provided to my patients, colleagues and friends about the DRG payment model is summed up in this column and the next one (online April 28, 2026).
Fee for service
Private hospital bills comprise two components: doctors’ professional fees and hospital charges.
The former is regulated by Schedule 13 of the Private Healthcare Facilities and Services Act (PHFSA), which was last amended in 2013, while the latter are unregulated.
Doctors’ fees comprise, at most, 20-30% of the total bill, while hospital charges make up the rest.
Hospital charges include fees for laboratory/imaging services; medicines; consumable items; use of specialised facilities like the operating theatre, labour room, intensive care unit (ICU) and/or coronary care unit (CCU); and other services.
The payment model for private hospital bills is fee for service (FFA).
While section 106(1) of the PHFSA states: “The Minister may make regulations prescribing a fee schedule for any or all private healthcare facilities or services or health-related facilities or services”, various ministers have, over the years, claimed that they do not have the authority to regulate hospital charges.
Grouping similar cases
Every hospital has its own individual patient profiles – one hospital’s patients may not be exactly the same as another hospital’s down the road.
Similarly, the health profiles of one insurance company’s policyholders are different from that of another insurance company’s.
This case mix complexity refers to an interrelated, but distinct, set of patient attributes that includes severity of illness, prognosis, treatment difficulty, need for intervention and resource intensity.
According to the World Health Organization (WHO): “A case-based groups (CBG) system is a patient classification system that groups patient cases, including services received, into standardised case groups according to diagnosis and treatment or procedure received.
“It combines a clinical logic with an economic logic.
“A CBG system can be used to collect more detailed and/or standardised information about the services provided to patients, as well as in addition as a provider payment method.”
CBG systems usually have the following common features:
- Each case group contains cases with similar patterns of resource use.
- Cases within a group share common features from a clinical perspective.
- Each case can be classified into one group, i.e. the classification is exhaustive.
- The use of variables to define a group and to assign a case is based on information collected routinely in medical records.
A patent classification system based on the WHO’s International Classification of Diseases (ICD) with no other variables would usually comprise 25–27 groups.
However, additional classification factors are usually added to reflect relevant cost drivers to ensure that groups are economically more homogenous, with a meaningful average treatment cost allocated to each case group.
This leads to an increase in the patient classification groups.
The beginning of DRGs
DRGs are a complex and specific form of the CBG system.
DRGs were started in the late 1960s at Yale University in Connecticut, United States.
The initial objective for developing DRGs was to develop a framework for monitoring quality of care and utilisation of services in a hospital setting.
The team took 10,000 ICD9 codes (the current ICD11 has about 17,000 codes) and grouped them into 25 major diagnostic groups (MDC).
DRGs were first used on a large scale in New Jersey in the late 1970s when the American state used DRGs as the basis of a prospective payment system in which hospitals were paid a fixed specific amount for each patient treated.
Until then, hospitals had been reimbursed on a FFS model.
In 1982, the US Congress modified Section 223 of Medicare hospital reimbursement limits to include a case mix adjustment based on DRGs.
Medicare is an American government health insurance programme for people aged 65 years or more, and younger people with disabilities.
In 1983, the US Congress amended the US Social Security Act to include a national DRG-based hospital prospective payment system for all Medicare patients.
Since then, DRGs – including modified or adapted versions – have been used in various countries such as Australia, Thailand, Germany and Sweden.
As of this year (2026), the US has a total of 772 DRGs, Australia 800, Thailand 1,543, Germany about 1,200, and Sweden 1,983.
Defining DRGs
The Centres for Medicare and Medicaid Services (CMS), a US government agency that administers the nation’s major healthcare programmes, shared its experience in the publication Design and development of the diagnostic related group (DRG) in October 2020.
The basic characteristics of the US CMS’ DRG scheme are:
- “The patient characteristics used in the definition of the DRGs should be limited to information routinely collected on hospital abstract systems.
- “There should be a manageable number of DRGs which encompass all patients seen on an in-patient basis.
- “Each DRG should contain patients with a similar pattern of resource intensity.
- “Each DRG should contain patients who are similar from a clinical perspective (i.e. each class should be clinically coherent).”
The process taken by the US CMS in the formation of DRGs is summarised below (also, see graphic):
- All possible principal diagnoses were divided into 23 mutually exclusive principal diagnosis areas referred to as Major Diagnostic Categories (MDC).
Two new MDCs were created in the eighth version of the DRGs.
- MDCs were formed by physician panels as the first step toward ensuring that the DRGs would be clinically coherent.
The diagnoses in each MDC correspond to a single organ system or aetiology, and are usually associated with a particular medical speciality.
- Each MDC was evaluated to identify additional patient characteristics that would have a consistent effect on the consumption of hospital resources.
Since a surgical procedure would have a significant effect on resources, most MDCs were divided into surgical or medical groups.
- The surgical patients were further defined based on the precise surgical procedure performed, while the medical patients were further defined based on the precise principal diagnosis for admission to hospital.
- Since a patient can have multiple procedures related to their principal diagnosis during a particular hospital stay, and a patient can be assigned to only one surgical class, the surgical classes in each MDC were defined in a hierarchical order.
Patients with multiple procedures would be assigned to the surgical class highest in the hierarchy.
- Specific groups were defined for medical patients.
This usually includes a class for neoplasms (i.e. tumours), symptoms and specific conditions relating to the organ system involved.
- In each MDC there is usually a medical and a surgical class referred to as “other medical diseases” and “other surgical procedures” respectively.
The “other” medical classes would include diagnoses or procedures that were infrequently encountered or not well defined clinically.
The “other” surgical category contains surgical procedures that, while infrequent, could still be reasonably expected to be performed for a patient in the particular MDC.
- The process of defining the surgical and medical classes in an MDC required that each surgical or medical class be based on some organising principle.
Examples of organising principles are anatomy, surgical approach, diagnostic approach, pathology, aetiology or treatment process.
In order for a diagnosis or surgical procedure to be assigned to a particular class, it would be required to correspond to the particular organising principle for that class.
- Once the medical and surgical classes for an MDC were formed, each class was evaluated to determine if complications, comorbidities (associated illnesses), the patient’s age or discharge status consistently affected the consumption of hospital resources.
Physician panels classified each diagnosis code based on whether the diagnosis, when present as a secondary condition, would be considered a substantial complication or comorbidity.
- The final variable used in the definition of the DRGs was the patient discharge status.
Payment calculations
The calculation of DRG payment involves two distinct processes, i.e. assigning the patient to a specific group and then calculating the payment.
The assignment uses a hierarchical logic (grouper), i.e. MDC, surgical vs medical, and refinement (i.e. non-CC [complication and comorbidities], CC or MCC [major complication and comorbidities], which would have the highest resource use).
The final payment formula is: (Base rate x DRG weight) + Adjustments
For example, the DRGs for a caesarean section (CS) are:
- 786: CS without sterilisation with MCC
- 787: CS without sterilisation with CC
- 788: CS without sterilisation without CC or MCC.
An average case has a weight of 1.0.
DRG 788 has a weight of 2.7, while a caesarean hysterectomy (classified as DRG 786) has a weight of 3.3, meaning that the costs are 2.7 and 3.3 times more than the average case respectively.
On the other hand, a minor skin procedure might have a weight of 0.5.
Adjustments are made for items like local labour costs; outliers, e.g. the patient’s hospital stay is exceptionally long or expensive; and other factors.
It is obvious that the formation of DRGs and the associated payments are not a simple process.
The pros and cons, and implementation, of DRGs will be addressed in the next column.
Dr Milton Lum is a past president of the Federation of Private Medical Practitioners Associations and the Malaysian Medical Association. For more information, email starhealth@thestar.com.my. The views expressed do not represent that of organisations that the writer is associated with. The information provided is for educational and communication purposes only, and it should not be construed as personal medical advice. Information published in this article is not intended to replace, supplant or augment a consultation with a health professional regarding the reader’s own medical care. The Star disclaims all responsibility for any losses, damage to property or personal injury suffered directly or indirectly from reliance on such information.
