One of the main parts of the health sector is university hospitals, as providers of highly professional tertiary health care services as well as knowledge transfer system for any level of health service providers. Creation of a fair and effective system offinancing of in-patient care is a significant part of health financing policy reform and the payment model has a direct impact on health services delivery. Starting in 2014 Latvia introduced equalized payments by diagnosis-related groups (DRGs) to pay a flat rate for average costs. This created cost shifting and other negative provider behaviours included misclassification of treatment without clinical justification. This leads to the necessity for the government to monitor and evaluate activity against baselines and regulate complianceto achieve the policy intent of the payment system. In terms of managing risk, there is a need to define national-level financing policy, to establish an effective overall cost-control mechanism. The purpose of this article is to identify the main determinants of the university hospital behaviour and based on international experience propose payment system model taking into consideration Latvian university ‘tertiary’ hospital needs.