Bank Negara Malaysia’s (BNM) White Paper states that a phased transition from the existing billing-based treatment to a standardised diagnosis-based billing (DRGs) can help to reduce inpatient treatment costs once implemented in private hospitals.
This is the third component of the BNM strategy, in addition to copayments and deductibles (CPD), as outlined in the White Paper, aimed at increasing premiums charged by commercial assurers. Diagnosis-Related Groups (DRGs) have been hailed as the magic pill that will curb rising hospital expenditure. Policymakers and payors assumed that if hospitals received a fixed payment per case rather than fee-for-service billing, insurance claims would reduce.
While the rationale appears intuitive, such an assumption reflects a fundamental “misdiagnosis”. DRG is a fundamentally a diagnosis-based costing classification and not a cost-reduction tool. While it enhances efficiency and compels hospitals to improve resource management, it does not directly reduce the real cost of delivering care or health insurance premiums.
Understanding this distinction is critical to avoid unrealistic expectations and policy disappointment as BNM moves forward in addressing rising premiums.
This statement is evident in the United States’ Medicare system, where DRG was implemented in 1983, and insurance premiums continue to rise despite CPD mechanisms. Evidence from the US Medicare programme (where DRGs have been in place since 1983) indicates that health care expenditures and insurance premiums have continued to increase despite the presence of DRG reimbursement and CPD measures.
About DRG
DRG groups inpatient cases into clinically similar diagnostic categories based on ICD (International Classification of Diseases) codes. A software application uses a patient’s ICD-10-CM (diagnoses) and ICD-10-PCS (procedures) codes, along with age, sex, and discharge status, to classify the patient into a specific DRG cost matrix.
Hospitals are then paid based on a fixed amount calculated from a base rate, with adjustments for certain treatment variables. The cost would include tests, drugs, and procedures. Private hospitals would know the cost of treatment in advance based on the clinical assessment done by doctors.
In essence, DRG changes only the methodology for determining treatment costs and the manner in which hospitals are paid. The payment reflects, to a certain degree, an average of charges among patients with the same diagnosis. DRG does not eliminate underlying cost drivers.
The ‘Misdiagnosis’
Several factors explain why DRG is often mistaken for a cost-cutting instrument.
First, there is confusion between DRG payment limits and real costs. When a payor sets a fixed reimbursement based on DRG, spending appears to be controlled. However, hospitals may still face the same or higher expenses. If payments are less than the actual costs, hospitals absorb the loss. The underlying cost drivers play a big role in determining the true cost. This includes operational expenses, hospital capital expenditure, and their financing cost.
Second, early DRG adopters sometimes reported slower growth in hospital spending. These outcomes were often attributed entirely to DRG. In reality, those reforms typically coincided with better management practices, clinical protocols, and tighter utilisation control. DRG provided the structure, but operational changes produced the savings.
Third, reform narratives are often simplified. Saying “DRG reduces costs” is politically attractive and easy to explain from a PR perspective. In reality, DRG creates incentives for efficiency if properly implemented. Oversimplification of statements feeds unrealistic public expectations of premium reduction or stability.
Benefits Of DRG
Rather than directly reducing costs, DRG influences the behavior of the hospital’s board, management, and doctors. Because payment is fixed through DRG matrices, hospitals are incentivised to manage resources more carefully. They may be compelled to avoid unnecessary investigations, and doctors must rely solely on clinical judgment before ordering any test.
Hospital lengths of stay are shortened, and any extension must be supported by strong justifications. In this sense, DRG encourages efficiency, not austerity.
DRG also enhances cost transparency. By grouping cases and assigning standardized payments, hospitals and regulators can compare performance across institutions. Inefficient practices become more visible, enabling targeted improvement.
Additionally, DRG enhances budget predictability. Payors can forecast spending more accurately because payment amounts are known in advance. Predictability, however, should not be mistaken for lower costs.
Regulators need to acknowledge that certain structural realities limit DRG’s ability to reduce inpatient spending on its own.
First, DRG cost is based on a provider-agreed market benchmark. In the Malaysian context, the benchmarking can be done by assurers or the MOH. It is more efficient, faster, and more beneficial for assurers to lead the benchmarking process based on their purchasing power.
They have the right resources to negotiate and do data analytics. However, this is not happening (yet) in Malaysia. MOH has a team looking into this, and they are likely to negotiate with hospital providers. How low can they bring down the cost?
Will the new cost be at the 25th, 50th, or 75th percentile of their original cost? We can only infer, but we know that government decisions usually will look beyond true cost. It needs to consider stakeholders’ interests (e.g., Khazanah, Royal Families, other influential shareholders), government tax revenue, unemployment, compensation packages, and the overall impact on the health care supply chain. We predict that the cost reduction would be minimal and will not happen in 2027 as planned.
Second, based on global data, it is observed that hospital costs reimbursed through DRG payments range from 70 per cent to 90 per cent, depending on country practices. Generally, surgical treatment is identified, readily determined, and classified under DRG.
Non-surgical treatment, cancer therapy, and highly specialised, experimental, or treatment with extremely high-cost outliers are usually charged based on existing methodology. This would affect overall insurance claims expenses.
Third, with an aging population and an increased risk of chronic diseases, heart disease, and cancers, coupled with patients’ expectations of more advanced treatment, demand for inpatient care is expected to rise. Total spending may still increase if more patients require hospitalization. DRG does not reduce demand for care.
There is also a care quality risk that needs to be contended with. Early discharges, under medicated or limited care, may lead to complications and readmissions, ultimately increasing overall spending. Any cost control, without quality safeguards, is counterproductive.
Fourth, modern medicine relies on specialised staff and expensive technology. These factors raise the real cost of treatment. DRG cannot change the clinical complexity of cases. Can doctors deny patient treatment?
Fifth, hospitals facing financial pressure may shift costs rather than eliminate them. They might move services to outpatient settings, bill separately for excluded items, or code cases into higher-paying groups to protect their revenue. Doctors and hospitals may justify billing outside the DRG framework. These approaches do not improve efficiency.
Sixth, DRG driven cost are not set in stone. It needs to be reviewed periodically as the cost of doing business rises annually. There are simply many cost factors that does not remain static.
Reframing Expectations Holistically
A more realistic view of DRG is to look at it as an enabling tool that aligns incentives. In theory, it encourages hospitals to prioritise value over volume. Without regulation and board control, this may never have happened.
Without leadership, data, and process improvement, the system will not deliver meaningful savings. DRG works best when paired with strong governance and collaboration between clinicians and administrators. When doctors understand that DRG is a payment framework rather than a clinical restriction, resistance declines, and improvements become possible.
Conclusion
In conclusion, DRG should be understood not as a direct cost-containment solution, but as a payment and classification framework that reshapes incentives within hospital financing.
While DRGs can improve transparency, standardisation, and operational discipline, they do not eliminate the fundamental drivers of health care costs, including medical inflation, technological advancement, demographic change, and rising demand for complex care.
International experience shows that expenditures and premiums may continue to grow even after DRG adoption, underscoring that payment reform alone is insufficient. Sustainable cost control requires complementary measures, including robust benchmarking, prudent purchasing, clinical governance, and coordinated utilisation management.
In Malaysia, the success of DRG will depend less on reimbursement mechanisms and more on leadership, data analytics, and stakeholder alignment. By reframing expectations and treating DRG as an enabling tool rather than a “magic pill”, policymakers can pursue realistic reforms that balance efficiency, quality, and affordability.
Dr Mohamed Rafick Khan is a trained physician with 12 years of experience in military medical services and over 22 years of experience in the assurance industry. He retired as the CEO of a multinational reinsurance company in 2019 and remains active as an independent international assurance industry consultant.
- This is the personal opinion of the writer or publication and does not necessarily represent the views of CodeBlue.
