News & Analysis

Medicare (Dis)Advantage: DRG Downgrades

Portrait of Dawn Carter

Dawn Carter

A down arrow in pink neon against a black background illustrates the idea of DRG downgrades. Photo by Ussama Azam on Unsplash.

When Ballad Health reported quarterly results for the period ending September 2023, the four-state, nonprofit system sounded all the typical warning notes about rising expenses, ambiguous surgery trends, and a growing loss on operations. Nothing in the financials looked particularly alarming, but one item in the commentary practically jumped off the page.

Ballad said that “level of care changes” are affecting up to 10% of inpatient discharges as Medicare Advantage plans impose “reductions in reimbursement either through the imposition of lower DRGs or conversion of patients to outpatient observation status, even if the admission was prior-authorized by the payer.”

These level of care changes – also known as downgrades – are one of the dirty little secrets of Medicare Advantage. Every provider can cite a long list of anecdotal evidence, but we don’t often see public data to quantify the extent of the problem. Based on AHA’s figure of 34 million admissions annually, hospitals may be hit with more than 3 million downgrade cases each year, if Ballad’s experience is at all typical.

As we’ll explain at the end of this article, we expect to see even more downgrades starting next year, so the trend is too urgent for any hospital to ignore. We’ll start here with the issue of Diagnosis Related Groups and discuss observation downgrades in the next installment of our Medicare (Dis)Advantage series.

How MA Is Downgrading Diagnoses

DRG downgrades are separate from the issue of denials, which already affect about 11% of submitted claims. Outright denials are coming under greater scrutiny by regulators, while DRG downgrades fly largely under the radar because: a) they’re poorly understood; and b) they’re framed as a challenge to coding standards, not clinical judgment.

Regardless of the framing, downgraded DRGs can have significant financial impact. For instance, if a physician determines that a patient has pneumonia with sepsis, the DRG would indicate a major complication or comorbidity (MCC), resulting in the highest level of reimbursement. But if an MA plan decides in an audit that the sepsis diagnosis was unsupported by proper notes or coding, then the medical complexity of the case gets downgraded to simple pneumonia, and the hospital’s payment is cut by $5,316.

That immediate payment cut is bad enough, but the actual cost goes much further, because a hospital’s case mix index (CMI) is based on the relative DRG weight of all inpatient discharges. CMI is one factor used in setting prospective payments, so repeated DRG downgrades can reduce reimbursement levels for years to come. A lower CMI also indicates to regulators that a hospital is serving a population with less risk and less complexity. If that’s not true – if the CMI has been artificially lowered by external DRG downgrades – that can negatively skew quality reporting and further reduce reimbursement levels in the future.

There’s a huge irony in all of this: While MA plans are using DRG downgrades to make hospitals’ patients look healthier, they are allegedly using coding tricks and provider incentives to make their own members look sicker. According to the Justice Department, four large MA plans representing 40% of all enrollees committed fraud by falsifying medical records in order to collect larger payouts based on inaccurate health data. A New York Times investigation put it this way:

"Each of the strategies — which were described by the Justice Department in lawsuits against the companies — led to diagnoses of serious diseases that might have never existed. But the diagnoses had a lucrative side effect: They let the insurers collect more money from the federal government’s Medicare Advantage program."

The DOJ isn’t the only one making such an argument. Whistleblower lawsuits and inspector general audits have now alleged similar overbilling schemes from nine of the ten largest MA plans. The total cost to taxpayers: $12 to $25 billion, per the NYT.

How to Mitigate DRG Downgrades

As a strategy and planning firm, Ascendient doesn’t delve into the intricacies of revenue cycle management, but we do think broadly about the business decisions that make healthcare more sustainable. From that vantage point, here are three proactive steps you can take to fight back against Medicare Advantage DRG downgrades:

First, get a handle on your data. Track your DRG downgrades by payer, and look for patterns. Sepsis, acute respiratory failure, acute kidney failure, and severe malnutrition are a few of the diagnoses known to trigger DRG reviews. Use your PEPPER report to gauge the validity of a payer’s concerns. In traditional Medicare, CMS will suggest interventions if your coding falls above the 80th percentile or below the 20th percentile. On the flip side, if your hospital is billing and coding for complex DRGs within a normal range, you wouldn’t expect a high rate of downgrades. Percentile data in the PEPPER report tells you where to focus your training efforts internally and signals when DRG downgrades may be getting out of hand.

Importantly, even an “outlier” datapoint can be justified if your patient population is statistically sicker than the norm, and your Hierarchical Condition Category score (or HCC) can help make the case. Medicare calculates HCC scores based on demographics (age, race, dual-eligible, etc.) and 16 chronic conditions including diabetes, kidney disease, and COPD. A higher score indicates a higher-risk population, and the national average is 1.986. A quick check in North Carolina shows that 40 out of 86 hospitals have a risk score above the national average. Those hospitals, in theory, could defend higher weighted DRGs, especially when they correlate highly with reported chronic conditions. (Note that HCC scores are calculated after all claim adjustments have been resolved, so CMS essentially is vouching for your billing.)

Second, use contract negotiations to reduce future DRG downgrades. Many hospitals and health systems focus their contract renewals on payment rates, but every aspect of the MA relationship is fair game. If your data show a pattern of repeated, unfounded DRG downgrades from a particular payer, ask your contracting team to negotiate for better guardrails. For instance, you might agree to a timetable for chart requests, a limit on the number of charts, or a threshold for action – for instance, no downgrades in PEPPER target areas where your hospital ranks between the 30th and 70th percentiles.

Finally, start thinking about artificial intelligence. The surest way to limit DRG downgrades is to have airtight charting and coding processes – two areas where AI is hugely promising. For instance, emerging technology allows an AI assistant to listen to physician interactions with a patient, translate the conversation into notes for the EHR, generate relevant codes for the billing team, and flag items that may trigger a downgrade based on past data with specific payers. The technology isn’t cheap, but when a single downgrade can cost $3,000 to $5,000 or more, the payoff might come sooner than you think. If you are properly tracking your downgrade data, the cost/benefit analysis should be fairly straightforward.


DRG downgrades are expensive and exasperating for hospitals, but the issue has been largely overshadowed by headlines about denials and prior authorizations. Some of the more blatant abuses may get reined in next year under new CMS rules that increase oversight of Medicare Advantage plans and bring medical necessity audits more in alignment with traditional Medicare. Those changes will likely cost MA plans billions of dollars in lost revenue – money that insurance companies won’t give up easily.

Already, per the AHA, Medicare Advantage organizations are claiming that “DRG audits are not medical necessity audits,” which would put them outside the purview of the new rules. Given this regulatory gray area, we think MA plans will step up their use of DRG downgrades starting in 2024, so the time is now for hospitals and health systems to get their strategies in place.

This is Part 3 in our series on Medicare (Dis)Advantage. Please click below to read additional installments: