Department of Health and Human Services 
OFFICE OF 
INSPECTOR GENERAL 
OVERSIGHT OF MEDICARE 
PPS-EXEMPT HOSPITAL SERVICES 
JANET REHNQUIST 
INSPECTOR GENERAL 
NOVEMBER 2002 
OEI-12-02-00170  O I G
FFICE OF  NSPECTOR  ENERAL

http://www.oig.hhs.gov/ 
The mission of the Office of Inspector General (OIG), as mandated by Public Law 95-452, as amended, 
is to protect the integrity of the Department of Health and Human Services (HHS) programs, as well as 
the health and welfare of beneficiaries served by those programs.  This statutory mission is carried out 
through a nationwide network of audits, investigations, and inspections conducted by the following 
operating components: 
Office of Audit Services 
The OIG's Office of Audit Services (OAS) provides all auditing services for HHS, either by conducting 
audits with its own audit resources or by overseeing audit work done by others.  Audits examine the 
performance of HHS programs and/or its grantees and contractors in carrying out their respective 
responsibilities and are intended to provide independent assessments of HHS programs and operations 
in order to reduce waste, abuse, and mismanagement and to promote economy and efficiency 
throughout the Department. 
Office of Evaluation and Inspections 
The OIG's Office of Evaluation and Inspections (OEI) conducts short-term management and program 
evaluations (called inspections) that focus on issues of concern to the Department, the Congress, and 
the public.  The findings and recommendations contained in the inspections reports generate rapid, 
accurate, and up-to-date information on the efficiency, vulnerability, and effectiveness of departmental 
programs. 
Office of Investigations 
The OIG's Office of Investigations (OI) conducts criminal, civil, and administrative investigations of 
allegations of wrongdoing in HHS programs or to HHS beneficiaries and of unjust enrichment by 
providers.  The investigative efforts of OI lead to criminal convictions, administrative sanctions, or 
civil monetary penalties.  The OI also oversees State Medicaid fraud control units which investigate and 
prosecute fraud and patient abuse in the Medicaid program. 
Office of Counsel to the Inspector General 
The Office of Counsel to the Inspector General (OCIG) provides general legal services to OIG, rendering 
advice and opinions on HHS programs and operations and providing all legal support in OIGs internal 
operations. The OCIG imposes program exclusions and civil monetary penalties on health care providers 
and litigates those actions within the Department. The OCIG also represents OIG in the global 
settlement of cases arising under the Civil False Claims Act, develops and monitors corporate integrity 
agreements, develops model compliance plans, renders advisory opinions on OIG sanctions to the health 
care community, and issues fraud alerts and other industry guidance.  E X E C U T I V E   S U M M A R  Y  
PURPOSE 
To examine the extent of routine review of Prospective Payment System (PPS)-exempt 
inpatient services for medical necessity and reasonableness. 
BACKGROUND 
Forty million beneficiaries have coverage for hospital services through Part A of 
Medicare.  In addition to acute care hospitals, Part A covers inpatient care in psychiatric, 
rehabilitation, critical access, and long-term care hospitals. Each of these specialty 
hospitals is exempt from the PPS established for acute care hospitals in 1983. 
During our annual work planning process, we determined that these providers were not 
being routinely reviewed. The Peer Review Organization (PRO) program, whose 
contractors have recently been renamed as Quality Improvement Organizations (QIOs), 
has eliminated routine medical review of PPS-exempt inpatient services from its 
contracts. Fiscal intermediaries, who reviewed claims prior to the PPS, ceased routine 
review with the establishment of the PRO program. Payment safeguard contractors, 
operating under the relatively new Medicare Integrity Program (MIP), have not received 
task orders dedicated to analysis and review of these providers either. 
To determine the potential impact of this lapse in oversight, we reviewed data from the 
HCFA Customer Information System (HCIS) for the number of billing providers and an 
estimate of Medicare payments. We took information regarding improper payments 
attributed to PPS-exempt facilities from Improper Fiscal Year 2000 Medicare Fee-for-
Service Payments," report number A-17-00-02000. We reviewed requests for proposals 
for both the sixth and seventh PRO contract cycles, the Medicare Program Integrity 
Manual, Medicare regulations, and the Social Security Act.  The PPS-exempt hospitals 
received approximately $8.7 billion from Medicare in the year 2000 and accounted for 
$800 million of the estimated year 2000 Medicare payment error rate. 
i 
Oversight of Medicare PPS-Exempt Hospital Services  OEI-12-02-00170  FINDINGS 
Medical Review of PPS-Exempt Hospitals and Units Has Not Been 
Routinely Performed 
The QIOs, fiscal intermediaries, and MIP contractors could all potentially perform routine 
statistical analysis and medical review of PPS-exempt hospitals; however, for a variety of 
reasons, none were tasked to do so. On February 28, 2002, after our exit conference with 
CMS, fiscal intermediaries were notified that they may include PPS-exempt hospitals in 
their reviews; however, no additional funding was provided for this expansion of review 
responsibility. 
Medicare Payments and Error Rate Estimates for PPS-Exempt 
Inpatient Services Are Significant 
Medicare paid approximately $8.7 billion to PPS-exempt hospitals in 2000 for inpatient 
claims by over 3,700 different PPS-exempt hospitals and units.  Our audit report 
Improper Fiscal Year 2000 Medicare Fee-for-Service Payments," attributed $800 million 
of improper payments as being due to issues of medical necessity in PPS-exempt 
facilities. 
RECOMMENDATION 
The CMS should ensure that oversight of PPS-exempt hospital services is performed. 
AGENCY COMMENTS 
The CMS concurred with our recommendation, referencing Transmittal 21. Given the 
lack of funding for this additional work, it is not clear to what extent fiscal intermediaries 
will conduct systematic oversight, including medical review, nor is it clear to what extent 
this may hamper oversight of other Part A provider types by drawing off resources. The 
CMS should be able to assess the effects of this program memorandum as the results of 
its Comprehensive Error Rate Testing program become available. Appendix B contains 
the full text of CMS comments. 
ii 
Oversight of Medicare PPS-Exempt Hospital Services  OEI-12-02-00170  T A B  L E   O F   C O N T E N T S  
EXECUTIVE SUMMARY ...................................................... i

INTRODUCTION .............................................................1

FINDINGS  ..................................................................3

Medical Review .........................................................3

Medicare Payments and Error Rates  .........................................4

CONCLUSION  . . . . . . . . . . . . . .. . . . . . . . . . . . . .. . . . . . . . . . . . . .. . . . . . . . . . . . .  7

RECOMMENDATION . . . . . . . . . . . . . .. . . . . . . . . . . . . .. . . . . . . . . . . . . .. . . . . . . .  7

APPENDICES ...............................................................9

Appendix A: Transmittal 21 ...............................................9

Appendix B:  Agency Comments . . . . . . . . . . . . . .. . . . . . . . . . . . . .. . . . . . . . .  11

ACKNOWLEDGMENTS . . . . . . . . . . . . . .. . . . . . . . . . . . . .. . . . . . . . . . . . . .. . . . .  12

iii 
Oversight of Medicare PPS-Exempt Hospital Services  OEI-12-02-00170  I N T R O D U C T  I O N  
PURPOSE 
To examine the extent of routine review of Prospective Payment System (PPS)-exempt 
inpatient services for medical necessity and reasonableness. 
BACKGROUND 
The Centers for Medicare & Medicaid Services (CMS) is the federal agency responsible 
for administrating the Medicare program, a health insurance program for certain 
Americans who are disabled, have end stage renal disease, or are over the age of 65. Part 
A of Medicare is hospital insurance, covering hospital care, skilled nursing, home health, 
and hospice for 40 million beneficiaries. 
Section 1816 of the Social Security Act originally established fiscal intermediaries as the 
entities that pay claims to hospitals and other Part A providers. Among their duties, fiscal 
intermediaries were charged to ...make such audits of the records of providers as may be 
necessary to insure that proper payments are made... [ 1816(a)(2)(B)]. Until the mid 
1980s, these were the sole CMS contractors who assured program integrity of hospital 
services. 
The Peer Review Improvement Act of 1982 established PROs to review health care 
services provided to Medicare beneficiaries to determine: whether services were 
reasonable and medically necessary; whether they met professionally recognized 
standards of care; and, for inpatient services, whether they could have been more 
economically provided in an outpatient setting or an inpatient facility of a different type. 
PROs conducted a substantial number of random medical reviews of hospital claims, 
replacing fiscal intermediaries as the primary source of inpatient medical review. 
The Health Insurance Portability and Accountability Act of 1996 created a third group of 
CMS contractors with the potential to conduct medical review of PPS-exempt inpatient 
services. In addition to QIOs and fiscal intermediaries, the Medicare Integrity Program 
currently uses 12 payment safeguard contractors to carry out specific task orders to 
conduct reviews, audit cost reports, make payment determinations, and educate providers 
and beneficiaries. 
1 
Oversight of Medicare PPS-Exempt Hospital Services  OEI-12-02-00170  Methodology 
Much of the data collection for this inspection occurred during routine work planning. 
The HCFA Customer Information System provided data on Medicare payments and the 
number of billing providers. Estimates of improper payments were taken from a current 
OIG report entitled Improper Fiscal Year 2000 Medicare Fee-for-Service Payments," 
report number A-17-00-02000. The CMS documents were reviewed, including the 
requests for proposals for both the sixth and seventh (current) PRO contract cycles, the 
Medicare Program Integrity Manual, Medicare regulations, and the Social Security Act. 
We conducted this study in accordance with the Quality Standards for Inspections issued 
by the Presidents Council on Integrity and Efficiency. 
2 
Oversight of Medicare PPS-Exempt Hospital Services  OEI-12-02-00170  F I N D I N G S  
The PPS-exempt hospital inpatient services have not been routinely reviewed for medical 
necessity since the PRO program eliminated routine medical review from its contracts in 
1995. Fiscal intermediaries, who reviewed claims prior to the PPS, ceased routine review 
with the establishment of the PRO program. The PPS-exempt hospitals received 
approximately $8.7 billion from Medicare in the year 2000 and $800 million of the 
estimated year 2000 Medicare payment error rate was attributed to PPS-exempt facilities. 
The number of providers, the amount of Medicare reimbursement going to them, and the 
sizable payment error rate associated with PPS-exempt inpatient services makes it critical 
that systematic oversight occur. On February 28, 2002, CMS released a transmittal 
making fiscal intermediaries accountable for this oversight; however, no additional 
funding has been dedicated to PPS-exempt hospital medical review. 
Medical Review of PPS-Exempt Hospitals Has Not Been Routinely 
Performed 
While QIOs, fiscal intermediaries, and Medicare Integrity Program contractors all have 
authority to conduct medical review in hospitals, none were conducting routine review 
prior to February of 2002. 
Quality Improvement Organizations. Through four contract cycles, CMS directed QIOs, 
then referred to as PROs, to carry out medical review of inpatient services. In the early 
1990s, CMS began refocusing the PRO program on quality improvement. This involved 
voluntary collaborations between PROs and hospitals to improve the overall quality of 
care, rather than focusing on specific cases of substandard or unnecessary care. Random 
medical review by PROs was phased out in 1995, with few program integrity projects in 
the remainder of that contract or the subsequent 3-year contract cycle. 
In response to hospital payment errors, CMS introduced the Payment Error Prevention 
Program into the sixth PRO contract, beginning in 1999. Its purpose was to reduce the 
occurrence of payment errors; however, the contract explicitly limited it to inpatient PPS 
services. The CMS determined a state-specific error rate through medical review of 
inpatient PPS claims and PRO performance was evaluated based on reductions in that 
rate. A draft seventh cycle contract posted on the CMS Internet site on December 3, 2001 
indicated that this limitation in PRO oversight would continue through the next 3-year 
contract cycle. Although medical reviews are still being conducted to measure state error 
rates, the Payment Error Prevention Program has been eliminated from the contract. 
3 
Oversight of Medicare PPS-Exempt Hospital Services  OEI-12-02-00170  Medicare Integrity Program Contractors.  Payment safeguard contractors have broad 
authority to conduct program integrity activities including data analysis and medical 
review. The Medicare Integrity Program offers the opportunity to create a single, 
specialized contractor to conduct hospital reviews, potentially improving review 
consistency and operational efficiency. To date, however, none of the task orders 
awarded specifically addresses oversight of PPS-exempt hospital claims. 
Fiscal Intermediaries.  Fiscal intermediaries have the authority to conduct reviews for 
reasonableness and medical necessity within their jurisdictions. Fiscal intermediaries did 
not conduct medical review of inpatient services on a routine basis once the PRO program 
began operations. 
On February 5, 2002, a draft copy of this report was presented to CMS in an exit 
conference.  On February 28, 2002, Transmittal 21 notified fiscal intermediaries that they 
may include PPS-exempt hospitals in their reviews; however, no additional funding was 
provided for this effort.  The full text of the transmittal is in Appendix A. 
Medicare Payments and Error Rate Estimates for PPS-Exempt 
Inpatient Services Are Significant 
Medicare paid approximately $8.7 billion to PPS-exempt hospitals and units in 
2000 for inpatient care 
Table 1 summarizes Medicare payments to PPS-exempt hospitals and units in 2000. 
While psychiatric and rehabilitation care comprise the largest components of PPS-exempt 
payment, long-term care hospitals have experienced nearly a seven-fold increase in 
payment since 1992. Many long-term care hospitals are located on the campus of an 
acute PPS hospital, either as a hospital-within-a-hospital or as a satellite unit, facilitating 
discharges from the host hospital into a long-term care hospital without the patient 
being fully aware that discharge to a different provider has occurred. 
Critical access hospitals, while accounting for a small portion of dollars ($128 million), 
consist of a significant number of hospitals, with many more still in the application 
process. The beneficiaries who depend on these facilities have few choices for urgent 
care. Medical review for medically unnecessary or unreasonable services in these settings 
is a beneficiary protection issue as much as it is program integrity. 
4 
Oversight of Medicare PPS-Exempt Hospital Services  OEI-12-02-00170  Table 1

Medicare Payments to PPS-Exempt Hospitals and Units

Type of PPS-exempt unit or  Number of billing  Payments in 2000* 
hospital  facilities in 2000* 
Rehab U nits in PP S Hospitals  968  $2.685 billion 
Psychiatric U nits in PP S Hospitals  1,468  $2.168 billion 
Long-Term Care Acu te Hospitals  258  $1.706 billion 
Rehab Specialty Ho spitals  204  $1.388 billion 
Psychiatric S pecialty Ho spitals  505  $0.637 billion 
Critical Access Ho spitals  318  $0.128 billion 
Totals  3,721 hospitals  $8.712 billion 
and units 
* Data taken from HCIS, the HCFA Customer Information System.  Run Date 01/28/2002. 
An estimated $800 million was paid in error due to issues of medical necessity 
For the past 5 years, the OIG has conducted annual reviews to estimate the extent of fee-
for-service payments that do not comply with Medicare requirements. In Fiscal Year 
1996, $23 billion of Medicare payments were estimated to be improper due to problems 
with documentation, coding, medical necessity, coverage, and other issues. 
By the year 2000 review, payment errors due to medical necessity issues had declined to 
$5.1 billion (from $8.5 billion in the 1996 review).  Medicare has been successful in 
lowering the overall payment error rate through a combination of education and 
enforcement activities. Errors in hospital inpatient services due to medical necessity 
issues were reduced to $1.8 billion for PPS hospitals, but an additional $800 million was 
attributed to PPS-exempt hospitals.  Although not statistically significant, this is slightly 
higher than the $624 million paid in error in 1996. 
A comparison of error rates for fiscal year measurements in 1996 and 2000 are listed 
below in Table 2. These data were previously published in our audit report Improper 
Fiscal Year 2000 Medicare Fee-for-Service Payments," (A-17-00-02000). 
5 
Oversight of Medicare PPS-Exempt Hospital Services  OEI-12-02-00170  Table 2

Improper Medicare Fee-For-Service Payments

Estimate of Improper Payments  FY1996  FY2000 
Total Medicare Payments in Error  $23.2 billion  $11.9 billion 
Portion of Error Attributed to Medical  $8.5 billion  $5.1 billion 
Necessity Issues 
Portion of Error Attributed to Medical  $3.3 billion  $1.8 billion 
Necessity Issues in PPS Hospital Inpatient 
Services 
Portion of Error Attributed to Medical  $0.6 billion  $0.8 billion 
Necessity Issues in PPS-Exempt Inpatient 
Services 
6 
Oversight of Medicare PPS-Exempt Hospital Services  OEI-12-02-00170  C O N C L U S I O N 
Our review identified a gap in Medicares program integrity controls and strategy. The 
PPS-exempt hospital inpatient services have not been routinely reviewed for medical 
necessity since the PRO program eliminated routine medical review from its contracts in 
1995.  Fiscal intermediaries, who reviewed claims prior to the PPS, ceased review with 
the establishment of the PRO program. The PPS-exempt hospitals received 
approximately $8.7 billion from Medicare in the year 2000 and $800 million of the 
projected year 2000 Medicare payment error rate was attributed to PPS-exempt facilities. 
The number of providers, the amount of Medicare reimbursement going to them, and the 
sizable payment error rate associated with PPS-exempt inpatient services makes it critical 
that systematic oversight occur. During the course of this inspection, CMS published 
Transmittal 21, directing fiscal intermediaries to include PPS-exempt inpatient services in 
their medical review functions, within their current operating budget. While we applaud 
CMS action, we remain concerned since additional funds were not awarded in support of 
this additional responsibility. 
R E C O M M E N D  A T  I O N  
CMS should ensure that oversight of PPS-exempt hospital services is 
performed 
Over 3,700 acute and post-acute providers have been free from any systematic review 
since 1995.  While the potential for review now exists, there is still no dedicated funding, 
nor is there an explicit level of effort or performance goal for PPS-exempt inpatient 
review. To the extent that fiscal intermediaries elect to conduct review of PPS-exempt 
hospitals, the resources must be taken from review of other Part A providers, such as 
skilled nursing facilities and home health agencies. 
Agency comments 
The CMS agreed with our recommendation, referencing Transmittal 21. Given the lack 
of funding for this additional work, it is not clear to what extent fiscal intermediaries will 
conduct systematic oversight, including medical review, nor is it clear to what extent this 
may hamper oversight of other Part A provider types by drawing off resources. The CMS 
should be able to assess the effects of this program memorandum as the results of its 
7 
Oversight of Medicare PPS-Exempt Hospital Services  OEI-12-02-00170  Comprehensive Error Rate Testing program become available. Appendix B contains the 
full text of CMS comments. 
8 
Oversight of Medicare PPS-Exempt Hospital Services  OEI-12-02-00170  APPENDIX A 
9 
Oversight of Medicare PPS-Exempt Hospital Services  OEI-12-02-00170  10 
Oversight of Medicare PPS-Exempt Hospital Services  OEI-12-02-00170  APPENDIX B 
11 
Oversight of Medicare PPS-Exempt Hospital Services  OEI-12-02-00170  A C K N O W L E D G M E N T S  
This report was prepared under the direction of Stuart Wright, Director, Medicare and Medicaid 
Branch. Other principal Office of Evaluation and Inspections staff who contributed include: 
Bambi Straw, Program Specialist 
Linda Moscoe, Technical Support Staff 
12 
Oversight of Medicare PPS-Exempt Hospital Services  OEI-12-02-00170