Two-Midnight Rule War's Payment Cut Battle May be its Last

CMS says a 0.2% Medicare payment cut for hospitals is needed to offset the estimated costs of implementing the two-midnight rule. Hospitals contend it is "an arbitrary standard." But an analysis of the financial impact of the rule will likely take years and another round in federal court.

The three-year-long struggle over Medicare's two-midnight rule for hospital admissions could be over as soon as next month.

Under the rule, which the Centers for Medicare & Medicaid Services launched in 2013, a hospital stay that spans less than two midnights is generally not considered appropriate for designation as an inpatient admission. The two-midnight rule has financial implications for hospitals because inpatient cases are reimbursed at Medicare A reimbursement rates, which are significantly higher than Medicare B rates for outpatient care.

Hospitals have been vocal critics of the two-midnight rule since its inception. "CMS has developed an arbitrary standard," Lawrence Hughes, assistant general counsel of the Chicago-based American Hospital Association, told me last week.

In January, CMS enacted a pair of two-midnight rule concessions, including a revision that allows an attending physician to designate anyone for inpatient care based on medical necessity as supported by the medical record.

But a financial sticking point linked to the rule still divides CMS and hospitals: a 0.2% payment cut that CMS imposed on hospitals in the federal fiscal year that began in October 2013 (FY 2014).

"It really added insult to injury," says Joanna Hiatt Kim, AHA's vice president of payment policy. CMS estimates the cut will total $220 million for FY 2014. "It was an arbitrary rule with an arbitrary payment cut... CMS needs to get it out of there."

In September, US District Court Judge Randolph Moss cast doubt on the legality of the 0.2% payment cut, and ordered federal officials to justify the reimbursement reduction and to subject their justification to public comment.

According to the court ruling, Medicare actuaries calculated that implementing the two-midnight rule would result in a net annual shift of 40,000 patient encounters from outpatient status to inpatient status, which would increase Medicare spending by $220 million in FY 2014. The 0.2% across-the-board Medicare payment cut to hospitals was designed to offset that increased cost, the court ruling states.

The payment cut was remanded back to CMS for justification in part because the agency had omitted critical material on which it relied to determine the reimbursement reduction and deprived the public of its right to participate in rulemaking, Moss ruled.

In December, CMS officials filed their justification for the 0.2% payment cut in the Federal Register. In the 32-page document, the federal agency says it is still examining claims data from FY 2014 to gain a firm understanding of the financial impact of the two-midnight rule. But even without a determination of the rule's impact on hospitals that is based on empirical data, CMS is standing its ground on the 0.2% payment cut.

CMS made a good-faith effort to estimate the financial impact of the rule, according to the federal agency's justification document: "The task of modeling the impact of the 2-midnight policy on hospital payments begins with a recognition that some cases that were previously outpatient cases will become inpatient cases and vice versa. Therefore, our actuaries were required to develop a model that determined the net effect of the number of cases that would move in each direction."

In addition, CMS asserts that the methodology used to predict an annual shift of 40,000 patient encounters from outpatient status to inpatient status may have been based on "an overly conservative definition of observation services," resulting in an underestimation of the cost to the Medicare program.

Hospital officials have been skeptical of the logic behind the 0.2% payment cut since it was first proposed, Hughes says. "We never thought the estimate of the impact was realistic in the first place."

The data that hospitals have collected to gauge the financial impact of the two-midnight rule indicates that CMS grossly overestimated the cost to Medicare, Hiatt Kim says. "If anything, we think there was a net decrease in inpatient volume. They can argue for whatever they want, but it doesn't mean it's grounded in reality."

Members of the public had until Feb. 2 to submit comments on the CMS justification document for the 0.2% Medicare payment cut. CMS is expected to take a final stand on the payment cut by March 18. As of Friday, the public comments had not been posted online for viewing.

In the AHA's public comment letter, which was submitted Feb. 2, the hospital association assails the calculations that CMS used to set the 0.2% payment cut, arguing that more accurate methodologies would have found the reimbursement reduction unjustifiable.

"Had CMS's actuaries properly accounted for the portion of observation stays that were not continuous, the net change in the number of cases shifting from outpatient to inpatient would have been zero, or even a small net decrease in inpatient stays," the AHA comment letter states. It makes "only a few minor corrections to CMS's actuaries' assumptions would entirely negate the net increase in inpatient stays predicted by CMS."

CMS is likely facing an avalanche of criticism in the public comment letters about the agency's justification for the 0.2% payment cut, but federal officials are unlikely to budge on the reimbursement reduction, says Colleen Hall, a senior manager for the Chicago-based healthcare consultancy Crowe Horwath. "I do not believe the comments alone will make CMS overturn their ruling on the payment cut… It will go back to the courts."

If the payment cut controversy lands back in US District Court, the case could take a couple of more years to resolve, she says.

"It's all going to come down to the validity of the calculation. As time goes on, we can see real analysis at the provider level. Only then will there be clear and irrefutable evidence for the court to overturn CMS," Hall says.

Data to conduct that level of analysis on the financial impact of the two-midnight rule will not be available until next year, she says. Implementation of the rule was delayed in 2014 and 2015 and "A full year of good data will not be available until FY 2017."

Even if CMS and hospitals can resolve their differences over the two-midnight rule, friction between the parties over drawing the line between inpatient and outpatient care, and the associated financial impacts, will be hard to eliminate. "Medicare officials will never define inpatient medical necessity, and that's the challenge," Hall says.