During the past 10 years, the RACs (Recovery Audit Contractors) have been able to recoup billions of dollars over the single issue of inappropriate or medically unnecessary inpatient admissions. For the most part, while these admissions may not have been medically necessary, some form of service (namely outpatient or observation) was fully justified. The RACs and hospitals constantly disagree relative to the propriety of inpatient admissions.

Two key factors in the appeals of RAC denials of inpatient admissions include:

  1. Auditors are looking at cases well after the fact (that is, retrospectively) and

  2. The Medicare program has not adopted national standards for inpatient admissions.

First is the issue of retrospective auditing. Physicians and hospitals must make decisions prospectively based on current information and assessment performed at the point in time in which patient status must be determined. After the fact, there may be more information available that could eliminate the need for an inpatient admission. Also, in looking at each case, the overall outcome can be assessed. In theory, Condition Code 44 can assist in these cases. Unfortunately, the Centers for Medicare & Medicaid Services (CMS) does not honor the official National Uniform Billing Committee (NUBC) definition for the use of Condition Code 44. For Medicare, the patient must not have been discharged and utilization review must be involved.

For any sort of auditing, there must be well-established guidelines. Auditors can use these guidelines to determine whether a given hospital admission met the relevant criteria. At least with guidelines, disagreements will be directed to specific criteria. Unfortunately for the Medicare program, no national standards have been adopted. The individual RACs are free to adopt national standards.

CMS recently changed the rules to allow Inpatient Part B billing to take place under certain circumstances. If a hospital determines through self-audit that an inpatient admission was not appropriate, for example, presuming the patient has been discharged, the hospital can bill for the services provided except for any services that require outpatient status. The one-year timely filing guideline also must be met. For RAC audits that occur two and three years after the initial hospital admission, if the inpatient status was not appropriate, the hospital has no recourse.

Assessing Complex Systematic Issues

When we have problems of this magnitude and complexity, it is best to turn to the general areas of the systems approach. One of the main tenets of the systems approach involves identifying the problem, not just the symptoms or associated conditions. Root cause analysis and similar techniques are part of the general areas of process improvement and organizational optimization, which often fall under the general methods of Six Sigma.

Now, for our case, the relevant questions include:

  • Are these denials due to lack of medical necessity?

  • Are these denials due to lack of documentation?

  • Are these denials due to lack of inpatient admission guidelines?

  • Are these denials really due to clinical issues?

All four of these questions and other similar questions are certainly worth consideration. The battles that are fought in this area typically center on clinical issues and sufficient documentation. However, there may be a more fundamental issue in play.

The RACs are incentivized by money. The more money they recoup, the greater the RACs’ payments – and they have found a gold mine with the inpatient admission question. Why is this the case? The reason is that, for a service that legitimately can be provided as either inpatient or outpatient, there is a significant payment difference. Does this make sense?

The general consensus answer to this question is “no.” There should be no financial incentive for a physician or hospital to provide services at a given site under a specific payment system. In other words, when there are crossover services (that is, services than can be provided in different settings), the payments should be about the same. This means that the payment systems involved should smoothly interface for these services.

Note that this issue of interfacing payment systems emerges with some regularity. One example involves provider-based clinics and the increased payment that can be generated relative to equivalent freestanding clinic services. Another example involves surgeries that can be performed at an ambulatory surgical center versus in outpatient status at a hospital.


DRGs and APCs

Let us consider the DRG and APC payment systems interface. Consider the following simple case:

Two elderly patients present to the ER complaining of chest pains. The first patient is placed in observation status and taken to a bed on the medical/surgical floor. For the second patient, the physician determines that there should be an inpatient admission. The two patients are in beds in rooms next to each other. Assume that services, tests, and pharmaceuticals are all exactly the same. Both patients are discharged after 36 hours.

Let us consider the approximate payments for APCs and DRGs. Obviously, to determine a precise payment would require significantly more detail. For APCs, the payments that will accrue in this scenario come from the ER encounter, observation, and any ancillary services (injections, infusions, tests, etc.). For illustrative purposes we will consider payments of $1,500. On the other side, it would be difficult to obtain a DRG with a conversion factor of that is much less than 0.6650. If we take $4,200 as the payment rate, then the DRG payment would be about $2,700.

Thus, there is a $1,200 difference for this simple case, and an 80 percent difference between the two cases (i.e., $1,200/$1,500). If the two payments were more equalized, the payment difference would not be pronounced. For instance, if the APC payment was $2,000 and the DRG payment was $2,200, there would be a $200 difference, or a 10 percent increase.

With a 10 percent difference in payment, would the RAC auditors really be interested in short-stay inpatient admissions? While there are many variables surrounding this question, if the potential recoupment was $200, then the payment to the RAC would only be in the neighborhood of $20.1 Considering that a complex review is necessary, this type of payment level would not be attractive.

Thus, if the two payment systems, OPPS and IPPS, were more equalized for services that can be provided in either setting, there would be no significant economic motive to provide the service in a particular setting. This means that we could all get back to having the decision as to whether an inpatient admission versus observation services should be provided be a clinical decision – which is what it should be. The payment systems involved should not offer any motivation for either the provider or the payor.

Bottom Line

For any given case, again, the decision as to whether outpatient observation or inpatient status is appropriate should be purely clinical in nature. The payment or payment systems involved should have no bearing on this decision. If the two payment systems are properly interfaced and payments for similar services are generally equalized, then:

  1. There will be no economic incentive to choose the site of service based on payment; and

  2. The payor, in this case Medicare, would have no financial incentive for questioning the medical decision-making.

CMS should be encouraged to make certain that, for payment systems for which there is an interface or intersection, there should be no significant payment differential.


This same issue is also present with provider-based clinics. The two payment systems involved in this case are the OPPS and the MPFS. There is a rather complicated interface using different RVUs (relative value units) for facility versus non-facility services on the physician side. Note that both the U.S. Department of Health and Human Services (HHS) Office of Inspector General (OIG) and MedPAC (the Medicare Payment Advisory Commission) have made recommendations that this payment differential be eliminated or partially eliminated. In the Dec. 10, 2013 Federal Registers for both OPPS and MPFS, CMS indicated that data gathering will commence in 2015 relative to provider-based clinics. Thus, in the coming years, this payment differential may be changed and crossover services will be paid similarly.

About the Author

Duane C. Abbey, Ph.D., CFP, is an educator, author and management consultant working in the healthcare field. He is President of Abbey & Abbey Consultants, Inc., which specializes in healthcare consulting and related areas. His firm is based in Ames, Iowa. Dr. Abbey earned his graduate degrees at the University of Notre Dame and Iowa State University.

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1 This amount presumes that the inpatient payment would be offset by the outpatient payment.


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