Department of Health and Human Services 

OFFICE OF 

INSPECTOR GENERAL 

JANET REHNQUIST 

INSPECTOR GENERAL 

NOVEMBER 2002 

OEI-12-02-00170 

OVERSIGHT OF MEDICARE 

PPS-EXEMPT HOSPITAL SERVICES 
OFFICE OF INSPECTOR GENERAL


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 OIG’s 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. 
EXECUTIVE SUMMA RY 

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-forService 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. 

Oversight of Medicare PPS-Exempt Hospital Services i 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. 

Oversight of Medicare PPS-Exempt Hospital Services ii OEI-12-02-00170 
TA BLE OF CONTENTS 

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


Oversight of Medicare PPS-Exempt Hospital Services iii OEI-12-02-00170 
INTRODUC TION 

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. 

Oversight of Medicare PPS-Exempt Hospital Services 1 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 President’s Council on Integrity and Efficiency. 

Oversight of Medicare PPS-Exempt Hospital Services 2 OEI-12-02-00170 
FINDINGS 

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. It’s 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. 

Oversight of Medicare PPS-Exempt Hospital Services 3 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. 

Oversight of Medicare PPS-Exempt Hospital Services 4 OEI-12-02-00170 
Table 1


Medicare Payments to PPS-Exempt Hospitals and Units


Type of PPS-exempt unit or 

hospital 

Number of billing 

facilities in 2000* 

Payments in 2000* 

Rehab U nits in PP S Hospitals 

Psychiatric U nits in PP S Hospitals 

Long-Term Care Acu te Hospitals 

Rehab Specialty Ho spitals 

Psychiatric S pecialty Ho spitals 

Critical Access Ho spitals 

968 

1,468 

258 

204 

505 

318 

$2.685 billion 

$2.168 billion 

$1.706 billion 

$1.388 billion 

$0.637 billion 

$0.128 billion 

Totals 3,721 hospitals 

and units 

$8.712 billion 

* 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 feefor-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). 

Oversight of Medicare PPS-Exempt Hospital Services 5 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 

Necessity Issues 

$8.5 billion $5.1 billion 

Portion of Error Attributed to Medical 

Necessity Issues in PPS Hospital Inpatient 

Services 

$3.3 billion $1.8 billion 

Portion of Error Attributed to Medical 

Necessity Issues in PPS-Exempt Inpatient 

Services 

$0.6 billion $0.8 billion 

Oversight of Medicare PPS-Exempt Hospital Services 6 OEI-12-02-00170 
C O N C L U S I O N 

Our review identified a gap in Medicare’s 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. 

RECOMMEN DA TION 

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 

Oversight of Medicare PPS-Exempt Hospital Services 7 OEI-12-02-00170 
Comprehensive Error Rate Testing program become available. Appendix B contains the 

full text of CMS’ comments. 

Oversight of Medicare PPS-Exempt Hospital Services 8 OEI-12-02-00170 
APPENDIX A 

Oversight of Medicare PPS-Exempt Hospital Services 9 OEI-12-02-00170 
Oversight of Medicare PPS-Exempt Hospital Services 10 OEI-12-02-00170 
APPENDIX B 

Oversight of Medicare PPS-Exempt Hospital Services 11 OEI-12-02-00170 
ACKNOWLEDGMENTS 

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 

Oversight of Medicare PPS-Exempt Hospital Services 12 OEI-12-02-00170