Lack of Medical Necessity: The Next Compliance Wave

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Just when it started to look like smooth sailing for health care providers after years of intense regulatory scrutiny, the next compliance wave has crashed onto the scene. On October 30, 2002, forty FBI and other federal agents raided and searched a hospital located in Redding, California and owned by Tenet Healthcare and the offices of two non-employed physicians, a cardiologist and cardiothoracic surgeon. Newspaper reports included the obligatory picture of dark-suited agents confiscating boxes of seized records, much like the picture associated with the Columbia/HCA investigation five years earlier. Alleged lack of medical necessity for invasive coronary procedures provides the motive for this new probe.

Unnecessary Procedures

The investigation, which also involves the Office of Inspector General (OIG), focuses on the activities of Dr. Chae Hyun Moon, the hospital’s director of cardiology, and Dr. Fidel Realyvasquez Jr., the hospital’s chairman of cardiac surgery. One patient alleges Dr. Moon recommended bypass surgery that two surgeons and four cardiologists later evaluated as unnecessary. The patient met with the hospital’s chief executive in late June 2002 to express his concerns about Dr. Moon, but the executive allegedly supported Dr. Moon. One medical professional told federal authorities in an affidavit that many physicians and administrators at Redding were aware of “this pattern of unnecessary procedures,” but that the doctors were extremely powerful because of the revenue they generated. The affidavit also noted that the doctors in question are the highest Medicare cardiology billers in Northern California.

Within two weeks of the raid, Tenet’s stock plunged more than 50% and its chief operating and financial officers resigned. A Tenet spokesman admitted to the New York Times: “We don’t have an independent means to judge medical necessity.” On November 4, 2002, Tenet announced the hiring of the national medical audit practice of The Mercer Consulting Group to assist in reviewing treatments performed by the two doctors under investigation at Redding. Mercer will, in turn, hire independent, expert cardiologists to review patient records and internal documents regarding the cases. Mercer also will be responsible for concurrent review of any future cases the two Redding physicians intend to perform at the hospital.

Leading Cause for Improper Medicare Payments

The OIG foretold its concern about lack of medical necessity in its annual reports on improper Medicare fee-for-service payments. Since 1996, the OIG has conducted detailed medical and audit reviews on a limited sample of Medicare claims. In 2001, the OIG reviewed only 6,594 fee-for-service claims, out of approximately 1 billion Medicare claims annually. The OIG reviewed actual medical records to identify any improper payments in the sample and then extrapolated the sample error rate over the entire Medicare claim population. For fiscal year 1996, the sample error rate was 13.8% and the extrapolated estimate of total improper Medicare payments was $23.2 billion. The fiscal year 2001 sample error rate had declined to 6.3% and the extrapolated estimate of total improper payments fell to $12.1 billion.

As the error rate declined, the primary offending type of improper payments has shifted from documentation to medical necessity. In fiscal year 1996, documentation errors (insufficient or no documentation) were the leading cause of improper payments. Hospitals responded to OIG’s first report highlighting improper payments and to the Columbia/HCA investigations by adopting documentation and coding compliance programs to ensure all Medicare claims were supported by documentary evidence that the products and services were actually provided as claimed. Documentation errors declined as a result of these compliance efforts, leaving medically unnecessary services as the leading cause for improper payments for each of the last two fiscal years. In order for the OIG to further shrink in the error rate, it must reduce the number of improper payments attributable to medically unnecessary services.

Legal Developments

The Health Insurance Portability and Accountability Act of 1996 introduced civil monetary sanctions focusing on lack of medical necessity. Penalties up to $10,000 per claim now apply if any person knowingly presents a claim that is “for a pattern of medical or other items or services that a person knows or should know are not medically necessary.” 42 U.S.C. § 1320a-7a(a)(E). Furthermore, the Balanced Budget Act of 1997 required ordering physicians to provide diagnostic or other medical information when ordering a service from another entity. 42 U.S.C. § 1395u(p)(4). Such diagnostic or other medical information provides a means for Medicare contractors to review and edit claims for medical necessity.

Federal law imposes obligations on all health care practitioners (including hospitals or other health care facilities) to assure that services or items ordered or provided such practitioner:


  • will be provided economically and only when, and to the extent, medically necessary;
  • will be of a quality which meets professionally recognized standards of health care; and
  • will be supported by evidence of medical necessity and quality in such form and fashion as may be required by peer review organizations.


Each utilization and quality control peer review organization must use its authority and influence to assure that each practitioner complies with these obligations. 42 U.S.C. § 1320c-5.

Review of Medical Necessity

The Tenet case highlights the problem for hospitals to obtain effective review of medical necessity decisions by its medical staff. Federal law outlines a utilization review plan of a hospital that is considered sufficient. 42 U.S.C. § 1395x(k). The plan must include the following four elements:

  1. Review, on a sample or other basis, of admissions to the institution, the duration of stays therein, and the professional services (including drugs and biologicals) furnished (A) with respect to the medical necessity of the services, and (B) for the purpose of promoting the most efficient use of available health facilities and services.
  2. Review to be made by a committee composed of two or more physicians, with or without participation of other professional personnel.
  3. Review, in each case of inpatient hospital services or extended care services furnished to such an individual during a continuous period of extended duration, as may be specified in regulations.
  4. Prompt notification to the institution, the individual, and his attending physician of any finding (made after opportunity for consultation to such attending physician) by the physician members of such committee or group that any further stay in the institution is not medically necessary.

Federal regulations expand upon the statute in several significant respects. The regulations stipulate that any individual who has a direct financial interest (for example, an ownership interest) in that hospital or was professionally involved in the care of the patient whose case is being reviewed may not participate in utilization review of such case. 42 C.F.R. § 482.30(b)(3). If, because of the small size of the institution, it is impracticable to have a properly functioning staff committee within the institution, the committee must be a group outside the institution. 42 C.F.R. § 482.30(b)(2). The regulations also specify that reviews may be conducted on a sample basis, except that the utilization review committee must review all cases reasonably assumed by the hospital to be outlier cases because the extended length of stay exceeds the threshold criteria for the diagnosis. 42 C.F.R. § 482.30(c) and (e).

Outlier Payments

Outlier payments are supplemental Medicare reimbursements intended to reimburse hospitals that elect to perform especially complicated procedures on very ill patients. The outlier payment kicks in when a hospital’s charges surpass a certain level, as determined by a complex formula, beyond the average charges for a particular Diagnostic Related Group (DRG).

Tenet’s outlier payments far exceed other large private hospital systems, according to research by the California Nurses Association and the Institute for Health and Socio-Economic Policy. In the two years following full implementation of the Balanced Budget Act of 1997, in which Medicare payments to hospitals were reduced, Tenet’s percentage of all Medicare reimbursements for outlier payments jumped from 4.56% to 7.16% to 10.04%, years in which the national average rose only slightly from 3.24% to 3.48% to 3.5%. Tenet’s percentage of outlier payments was nearly double the average for HCA (formerly Columbia HCA) in the most recent year of the study (fiscal year 1999-2000).

Compliance Burdens for Medical Necessity

To comply with federal regulations establishing Medicare’s conditions of participation, Tenet’s utilization review committees should have reviewed every outlier case and a sampling of all other cases. Each review should have been conducted independent of any physician professionally involved in the care of the patient whose case is being reviewed. At this stage it is unclear whether Tenet has documentation to evidence its compliance with these burdens.

Hospitals cannot assume medical necessity is the sole responsibility of the attending physicians. Medical necessity is now the number one reason for improper payments in the Medicare system according to the OIG. The law imposes specific and extensive obligations on all providers (including hospitals) for assuring that services are medically necessary and supported by evidence of medical necessity. Providers should take a fresh look at their business processes needed to satisfy these compliance burdens associated with medical necessity. Lack of medical necessity is the next compliance wave in the health care industry.