Examining Medical Necessity Compliance in Medicare Part A 

By Cheryl Ericson, RN, MS, CCDS, CDIP 

The Program for Evaluating Payment Patterns Electronic Report (PEPPER) was on hiatus for over a year, but it is finally available again to short-term acute care (STACs) hospitals. Versions for other facility types are expected to be released in the coming months.  PEPPER is a comparative report that summarizes paid Medicare Fee-for-Service (FFS) claims by Medicare fiscal year (FY) quarter that may be at-risk for improper payment.  

Medicare Billing Compliance:

General Guidance 

Medicare has a couple of different Medicare FFS compliance tools. The Comprehensive Error Rate Testing (CERT), a program implemented in 1996 to estimate the national Medicare FFS improper payment rate, establishes target areas for all other Medicare FFS audit programs  (e.g., Medicare contractors such as Medicare Administrative Contractors and Recovery auditors). It is the only program in which Medicare contractors may randomly select claims for audit. Audited STAC claims are classified as a hospital outpatient (Part B), Part A (excluding hospital inpatient prospective payment system – IPPS), and Part A (hospital IPPS). CERT findings are published annually.  

To determine the improper payment rate for Medicare Part A in 2025, 18,041 claims were sampled, and 8,750 were reviewed, resulting in an improper payment rate of 3.1% (Table A1). Currently, Medicare Part A has the lowest improper payment rate of all claim types audited by CERT. Medical necessity errors accounted for the largest share of improper Part A payments at $2.9 billion (Table A5). As expected, the improper payment rate is higher for shorter inpatient admissions stays (zero to one day) with a rate of 17.8% of claims billed to Medicare Part A. This is somewhat surprising since the Medicare Two-Midnight Rule has been in use since 2013 with limited modifications since that time.  

Medical necessity denials can have a greater impact on revenue than coding errors. When an inpatient claim is denied payment under Medicare Part A, how quickly the organization corrects the patient’s status determines the extent of the revenue leakage. If patient status is corrected quickly, the hospital may be able to bill observation services in addition to separately billable Medicare Part B services, if an order is placed and at least eight hours of observation care is provided.  

Unfortunately, due to limited utilization review (UR) staffing, antiquated UR workflows, lack of Physician Advisor support and other factors, medical necessity errors usually are not caught until the patient has been discharged, preventing the hospital from the ability to bill observation services.  

Medicare Billing Compliance:

Hospital Specific Guidance 

Where CERT provides general information for all hospitals, PEPPER provides hospital-specific information. The format and structure of PEPPER allow a hospital to easily identify specific MS-DRGs that may be vulnerable to improper payment due to medical necessity errors.   

PEPPER Methodology: 

PEPPER is designed to highlight specific target areas that are vulnerable to medical necessity or coding errors that can contribute to improper Medicare payments.  In this blog, the focus is on medical necessity target areas, but there is overlap between these areas as some are the result of both medical necessity and coding errors. These include: 

• Percutaneous cardiovascular (CV) procedures 
• Knee Replacement
• Syncope
• Digestive System Diagnoses
• Medical Back
• Spinal Fusion
• 3-Day Skilled Nursing Facility (SNF)
• 2-Day Medical MS-DRGs
• 2-Day Surgical MS-DRGs
• 1-Day Medical MS-DRGs
• 1-Day Surgical MS-DRGs

What sets PEPPER apart from other Medicare audit tools is that hospitals are compared against their peers at the state, jurisdiction, and national level. This comparison allows Medicare to identify hospitals that are outliers, defined as those in the top or bottom 20 percentiles within each comparison group. Medicare recommends that hospitals are outliers confirm that their revenue cycle practices are compliant with Medicare billing requirements.  

Compare target reports (Table 2) can be extremely helpful for hospital leadership to understand the relationship between medical necessity denials and hospital revenue. This table includes a column for the sum of payments. In the sample ST-PEPPER 2025 Q3 report available on the PEPPER website, the dummy data reveals the hospital as a high outlier for the target areas of Percutaneous CV procedures and medical back.  

Specifically, the hospital had 23 Medicare Part A claims that generated $349,280 in payments. Because this is a quarterly report when multiplied by four, this provides an estimate of annual dollars at risk within this one target area: $1,397,120. It is unlikely that all these claims will be denied. Still, even if a fraction of them could have a detrimental impact on hospital finances, especially if the hospital has a low or negative operating margin.  

Conclusion 

Far too often, hospital leadership views UR as a cost center and is reluctant to invest in resources to optimize accurate Medicare billing, including the use of external vendors. In a healthcare environment where payer denials are increasing year-over-year, it is not only the payments at risk, but the cost associated with appealing denials that must be considered. American Hospital Association Report found, “administrative costs now account for more than 40% of total expenses hospital incur in delivering care to patients.” Furthermore, they argue, “hospital staff must expend valuable time and resources to overturn inappropriate denials, adding unnecessary cost and burden to the health system.”