OBJECTIVES: Patients with pneumonia and respiratory failure usually require intensive care unit (ICU) admission. Because of high acuity and the need for expensive interventions, concern exists over the ability of DRG reimbursement to cover inpatient costs. This study evaluated the costs and DRG reimbursement associated with the care of pneumonia and concurrent respiratory failure. METHODS: Forty-six consecutive patients with complete data sets enrolled in the VALID study, a phase III multicenter study evaluating recombinant SP-C-based surfactant treatment (Venticute®, ALTANA, Konstanz, Germany) in patients with pneumonia and respiratory failure, in 9/2006 were included. Total costs (ICU/non-ICU) were assessed, assumed daily costs were $1,238 (US$) for ICU without ventilation, $2760 with ventilation, $1004 for stepdown, and $770 for ward. FY07 reimbursement was determined by multiplying the relative weight for each DRG code by a base rate of US$6000. For outlier payment calculations, the threshold for FY2006 of $23,300.00 was used. Costs above regular reimbursement plus this threshold were reimbursed at 80%. RESULTS: Mean age was 53.2+16.3 (mean + SD), with a mean APACHE II score of 17.4+6.4. Mean hospital LOS = 29 days, with mean ICU, stepdown, and ward LOS of 22, 2 and 5 days respectively. Mean duration of ventilation was 17 days (range 2–49). Total costs averaged $58,242, with 46.1% of all costs accounting for ICU care (excluding ventilation), 44.0% for ventilation, and 103.5% and 6.4% for stepdown and ward respectively. Across all DRGs, the average shortfall (cost minus reimbursement) equaled $20,897 with a loss occurring in 36/47 (76.6%) patients. CONCLUSION: This preliminary analysis suggests that DRGs fail to cover costs associated with pneumonia and respiratory failure. This potentially places hospitals that care for these patients at significant financial risk and suggests the needs for revision in reimbursement schemes to insure a more equitable payment relative to expected resource consumption.