BACKGROUND: In 2008, North Carolina Medicaid changed the way it classified neonatal care by adopting the Centers for Medicare & Medicaid Services Medicare Severity Diagnosis Related Group (MS-DRG) classification system. By changing the classification system, NC Medicaid merged two very different neonatal populations into one reimbursement class with implications both on hospital reimbursements and the regionalization of neonatal care in the state. METHOD: We analyzed North Carolina Medicaid data to determine DRG weights and associated lengths of stay. RESULTS: Following the adoption of the MS-DRG classification system, NC Medicaid reduced its reimbursement for extremely low birth weight (ELBW) infants but increased its reimbursement for infants with respiratory distress syndrome (RDS). CONCLUSIONS: Large tertiary care NICUs in North Carolina are being poorly reimbursed for the costliest ELBW infants for which they shoulder the greatest responsibility. Meanwhile community special care nurseries are potentially being over compensated for less sick infants. This has led to not only the financial instability of large safety net NICUs which provide care for the sickest and costliest infants, but may also have promoted the decrease in the quality of care for sick neonates. By reducing financial support for the State's sickest infants and most vulnerable citizens, Medicaid may have inadvertently widened the disparity of care as safety net hospitals re-examine their abilities to renovate, let alone expand, neonatal services.