How Payers Are Improperly Underpaying Inpatient Services As Observation Services

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Health plans and their delegated IPAs are using a number of different tactics to deny payment for inpatient services by improperly classifying inpatient claims as observation or other types of outpatient status. Payers are denying or underpaying inpatient claims in this way using at least 3 different methods: (1) improperly applying the Medicare Two-Midnight Rule to commercial and Managed Medicaid claims to deny short-stay inpatient claims; (2) failing to apply the Medicare Two-Midnight Rule to commercial claims when they are required by the contract to do so; or (3) failing to admit patients who require inpatient care and instead ordering services to occur in an observation setting, in many cases for two or more nights. The Two-Midnight Rule is a Medicare rule whereby CMS will not reimburse a hospital for an inpatient admission unless the admitting physician expected the patient to require a hospital stay that crosses two midnights and the medical record supported that reasonable expectation. There are a couple of exceptions to this rule, including the list of services identified as “inpatient only,” see 42 C.F.R. §419.22(n), but otherwise the rule is widely applied by Medicare.

1. Silent Application of the Two-Midnight Rule in Denying Inpatient Admissions

Some payers are denying or underpaying hospital claims for short-stay inpatient admissions (1 or 2 nights) by applying the Medicare Two-Midnight Rule to commercial and Managed Medicaid claims without notifying the hospitals that the payers are using this standard in their claims review. In many cases, the hospitals’ commercial contracts with the payers do not contain provisions expressly incorporating either Medicare payment guidelines, in general, or the Two Midnight Rule, in particular, to adjudication of the claims. Some commercial payers—such as Anthem Blue Cross, United, and Blue Shield—sometimes are denying the inpatient claims entirely. Other payers, like Aetna, sometimes unilaterally downgrade the claims from an inpatient to an observation rate, or only pay the emergency services and certain ancillary charges.

Moreover, for Medi-Cal managed care claims, guidance from the Department of Health Care Services indicates that it is improper for payers to downgrade inpatient or observation claims to outpatient status. “Medi-Cal has never recognized outpatient observation as a legitimate status within the hospital. Therefore a patient ordered to ‘observation status’ by Medi-Cal providers is determined to be admitted as ‘inpatient status’ by Medi-Cal for purposes of reimbursement.” Medi-Cal Update, Bulletin 426, March 2011.

2. Failure to Apply the Two-Midnight Rule to Inpatient Admissions

In some cases, the commercial contracts between a hospital and a payer expressly require application of Medicare rules, in general, or the Two-Midnight Rule, in particular, to adjudication of patient claims. Nonetheless, a number of payers are denying or underpaying longer inpatient hospital stays (over two or more nights) as not qualifying for reimbursement as inpatient admissions. Instead, the payers are asserting that the inpatient admission was not medically necessary, and are either denying payment in total or downgrading the patient to outpatient or observation rates.

3. Failure to Admit Patients Who Require Inpatient Care

We have learned that a medical group with financial risk for paying claims may be purposefully not admitting patients who require inpatient care, and instead keeping the patient in observation status for many nights. This type of conduct not only would undercut payment obligations but also interferes with medically necessary patient care.

4. What are Hospitals’ Options Vis-à-Vis the Payers

Hospitals are best served if they appeal inappropriate denials or underpayments. We have found that some payers are willing to apply the correct inpatient rates on appeal. Alternatively if the hospital determines on review that the services were indeed only appropriate for an observation level of care, then the hospital could decide to re-bill the claim as an outpatient observation claim. Some hospitals have been reluctant to rebill inpatient claims as observation claims because they do not want to be accused of submitting a bill that is not supported by the medical records. To avoid this concern, we are working with some payers to determine if they will agree to pay the claims as outpatient or observation without requiring providers to re-bill the claim. Third, hospitals should consider challenging the health plans’ practices. These denials or downgrades of claims can add up to a significant amount of lost revenue for hospitals over a fairly short period of time. Moreover, the longer the hospitals wait in challenging the practice, the more expensive and difficult it can become to challenge the plan’s improper denials and downgrades.

When negotiating your contracts with payers, we recommend that you consider striking any language that would expressly allow a payer to deny or reduce reimbursement based on undisclosed policies or protocols. There are potential ways to challenge payer practices that are based on such policies, but it is easier to address at the contracting stage than later at the claims stage. An even better solution is to implement more specific language in the contract itself specifying what services will qualify as inpatient, observation or outpatient.

We also recommend that hospitals educate their admitting physicians, nurses, and billing staff on the Two-Midnight Rule, how commercial and Managed Medicaid payers are applying that rule to deny or reduce payments, and how to better document the medical records to reflect the medical necessity of inpatient admissions.

5. A Challenge to the Constitutionality of the Two-Midnight Rule

As previously discussed in King & Spalding’s Health Headlines, there is a pending case against the United States Department of Health and Human Services (“HHS”), Alexander v. Azar, No. 3:11-cv-1703, in which the Two-Midnight Rule is being challenged as unconstitutional. The case involves an 84-year-old woman who was hospitalized for 39 days after being treated in the emergency room. It took weeks to stabilize her blood pressure, and she experienced serious complications. Nonetheless, the patient was categorized as an outpatient on “observation status” for her entire hospitalization, and she therefore lacked the three-day inpatient stay Medicare requires for coverage of her subsequent, very expensive care at a nursing home. She attempted to challenge her lengthy placement on observation status, but Medicare does not allow beneficiaries to appeal this issue. As a result, she still owes thousands of dollars to the nursing facility.

The court certified a class action composed of all Medicare beneficiaries who, since January 1, 2009, have received or will be placed in “observation services” as an outpatient during a hospitalization. Class members are likely to number in the hundreds of thousands. The court cited a 2012 study by researchers at Brown University that identified 918,180 Medicare beneficiaries who experienced observation stays in 2009 alone. The plaintiffs are alleging due process violations resulting from their inability to appeal hospitals’ decisions to provide outpatient observation care rather than admit them as inpatients. Plaintiffs allege that they incur higher out-of-pocket costs when placed in observation because they have co-payment responsibilities under Part B that they would not incur if they were admitted as inpatients. (Inpatient care is covered by Part A.) Although Medicare inpatients may have deductible responsibilities, Part B co-payments and charges for non-covered services, like self-administered drugs, can sometimes be higher than a patient’s Part A financial responsibility. Plaintiffs are seeking an injunction requiring HHS to establish administrative review procedures to appeal a hospital’s decision to place a Medicare beneficiary on observation status.

In March, the court denied HHS’s motion to dismiss, motion for summary judgment and motion to decertify the class, stating that “[a]fter eight years of litigation, this case will finally proceed to trial.” At the time of publication of this newsletter, trial was set for August 12, 2019. If the plaintiff is successful, it is unclear what action CMS may take at conclusion of the lawsuit, but it is possible that the agency would make changes to the Two Midnight Rule. Any changes to the Two-Midnight Rule could have a spillover effect into how commercial payers and Medicaid managed care plans review one- and two-day inpatient claims. Additionally, any appellate review process CMS establishes for patients to challenge reversal of inpatient admission on grounds of Two-Midnight Rule may be useful in appealing parallel decisions by commercial payers and Managed Medicaid managed care plans. Regardless of the result of the trial, the case is likely to be appealed to the Second Circuit Court of Appeals.

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