On January 25, 2022, the U.S. Court of Appeals for the Second Circuit affirmed a lower court ruling that the Secretary of HHS violated the due process rights of Medicare beneficiaries by failing to provide an administrative review process when a hospital’s utilization review committee (URC), acting pursuant to CMS’s regulations, reclassified beneficiaries’ status from “inpatient” to “observation.” The Second Circuit’s decision in Barrows v. Becerra finds that a URC’s determination to reclassify a patient who was initially admitted as an inpatient to an outpatient receiving observation services is a “state action” and, thus, must be afforded due process under the Fifth Amendment.

URCs are the internal hospital committees responsible for reviewing inpatient status determinations under CMS regulations. The Medicare statute requires hospitals to have a URC, and URCs must include at least two physician members. URCs have the authority to reclassify an admission from inpatient to outpatient (observation) if the URC determines that a patient should not have been admitted for inpatient services. The URC’s decision can have significant financial impact on Medicare beneficiaries. Inpatient admissions are covered under Part A, and patient cost sharing does not apply once the inpatient deductible has been met. Observation services are outpatient services covered under Part B and may include copayment obligations that are higher than what a beneficiary would incur if they had remained as an inpatient.

The Second Circuit noted that CMS’s standards for when a patient should be classified as an “inpatient” have varied over the years. Prior to 2013, CMS directed physicians to use a 24-hour period as a benchmark. In other words, a physician should consider a number of factors, including the patient’s medical history and medical needs, to determine whether the patient would be expected to need hospital care for 24 hours or more. In 2013, CMS promulgated its so-called “Two Midnight Rule,” which allowed payment under Medicare Part A when a physician reasonably expects a patient to require medically necessary hospital care that will span two midnights after the patient arrives at the hospital. Claims that do not meet the Two Midnight Rule may be billed as outpatient observation services under Medicare Part B.

Medicare has historically reimbursed hospitals at a higher average rate for Part A inpatient claims than for Part B observation claims. In general, the Secretary utilizes his contractors to ensure that Part A inpatient claims are supported and payable under Medicare guidelines through audits and post-payment reviews. Additionally, hospitals’ inpatient claims can be investigated by the OIG or the DOJ. Under these scenarios, formal appeal procedures are readily available for providers to challenge a finding that a hospital’s Part A inpatient claims were improperly submitted. No such appeal rights, however, exist for beneficiaries when a URC reclassifies a patient’s status from “inpatient” to “observation” before submitting the claim to the Medicare contractor for payment.
The central question in Barrows v. Becerra is whether hospital URCs, are “state” actors for purposes of constitutional due process. In other words, are URCs acting for CMS when they implement Medicare coverage standards even though these committees are typically employed and staffed by the hospitals.

The Court provided reasons in support of its finding that the URCs are considered “state” actors, including:

• The Medicare statute expressly requires hospitals to form and utilize URCs in admission decisions and that the URC decision-making process is governed largely by statute and regulation.

• By engaging in audits and post-payment reviews, CMS pressures URCs to adhere closely to those regulations so that hospitals only submit claims for reimbursement that the regulations direct are appropriate for payment by Medicare. As the Court put it, “[b]ecause a hospital faces a risk that it will not be reimbursed for services it already provided to a patient if it improperly classifies that patient as an inpatient, URCs are strongly incentivized to make decisions that conform to CMS guidance.”

• URC members and utilization review staff may use the same commercial screening tools utilized by Medicare contractors.

As a result, the Court affirmed that the Secretary of HHS violates due process rights when URCs reclassify inpatient admissions to observation status without providing a mechanism to appeal that decision. Because the Second Circuit’s decision applies only to providers in New York, Connecticut, and Vermont, the Secretary of HHS is only bound by the decision in those areas. Further, it is unclear what steps a hospital may need to take to provide the necessary due process if a Medicare beneficiary disagrees with the URC’s reclassification decision. These steps may place an additional administrative burden on the hospital and offset reimbursement gains realized by hospitals being able to bill those claims under Medicare Part A.

The Barrows v. Becerra opinion is available here.