Hospital Upcoding of Short Stay and Outpatient Encounters as DRG Inpatient Claims

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As early as 1989 the Health and Human Services Office of the Inspector General (OIG) issued a warning on the Related Groups (DRG) Prospective Payment System.  The OIG warned that prospective payments:

…might induce physicians and hospitals to admit patients who do not need acute hospital care, in order to obtain payment for treatment that could have been given on an out-patient basis.  

The financial incentives proposed at that time still apply. For example, Medicare payments for short inpatient stays are 290 % higher than for the identical services and beneficiary burden of illness under observation (outpatient) level of care (CY 2012). Subsequent years are similar.

Further evidence for the financial incentive underlying the use of DRG billing over short-stay/observation was highlighted with a 2012 analysis from the Medicare Payment Advisory Commission.

Inpatient stays of 1 to 3 days, billed under the DRG system, resulted in hospital payments between 110 and 155 % greater than the hospital costs for managing these patients.  Furthermore, these “short stays” comprised 48 % of hospital discharges (2012).  This short-stay billing opportunity has resulted in a financial windfall to Part A facilities.  

Observation, outpatient services may be provided in any unit of an acute care hospital, including traditional inpatient units with intensive monitoring capability.   “Observation” is a term which may be misleading:  the services rendered are not passive, watchful waiting, but may incorporate diagnostic and/or therapeutic procedures for a broad range of patient medical need, in any hospital care unit, which are typically concluded in 48 hours or less.

As outlined in the Medicare Claims Processing Manual,

Observation care is a well-defined set of specific, clinically-appropriate services, which include ongoing, short-term treatment, assessment, and re-assessment, that are furnished while a decision is being made regarding whether patients will require further treatment as hospital inpatients or if they are able to be discharged from the hospital.  Observation services are commonly ordered for patients who present to the emergency department and who then require a significant period of treatment or monitoring in order to make a decision concerning their admission or discharge.

Part A facilities may adopt coding and billing practices to induce favorable inpatient claim adjudication over observation level of care, even though the latter may be both safe and appropriate for a given beneficiary’s medical need. The Medicare Program Integrity Manual is clear in assessing the appropriate complexity and intensity of services provided to beneficiaries:

Contractors shall consider a service to be reasonable and necessary if the contractor determines that the service is:

  • Safe and effective;
  • Not experimental or investigational;
  • Appropriate, given the duration and frequency;
  1. Furnished in accordance with accepted medical practice;
  2. Furnished in a setting appropriate to the patient’s medical need;
  3. Ordered and furnished by qualified personnel;
  4. One that meets but does not exceed the patient’s medical need;
  5. At least as beneficial as an existing and available medically appropriate alternative.


Part A facilities are positioned to engage in Medicare fraud. The question is, which ones will cross that line?