Understanding The 2023 Medicare Hospital Readmission Penalty

Every year, the Centers for Medicare & Medicaid Services (CMS) penalizes hospitals with excessively high readmission rates. The monetary penalty for every U.S. hospital in 2023 was recently released by CMS. In theory, a higher penalty should indicate lower quality and vice-versa. However, the methodology used in calculating the penalties is complex and nuanced with the result that the readmission penalty may not be entirely reflective of a hospital’s overall quality of care.

 

Background

One of the provisions of the Affordable Care Act of 2010 (aka “Obamacare”) was to direct CMS to penalize hospitals with high rates of patients requiring readmission to a hospital within 30 days of an inpatient hospital stay. The first penalties were assessed in 2013; this is the 11th year of the penalty program. The calculations are only made for a few specific diagnoses and are based on data during 3 previous years. CMS calculates the amount of every hospital’s penalty in October or November each year and then that penalty is applied to the following year’s Medicare payments. The maximum penalty is 3%, meaning that for a hospital receiving the maximum penalty, CMS will reduce the amount that it pays that hospital for all of the Medicare services the hospital charges by 3% the next calendar year. Because many hospitals operate on razor-thin margins, even a relatively small reduction in what it gets paid by Medicare can be financially devastating. This is especially true for hospitals that operate on a July to June fiscal year, such as most academic medical centers, that can find themselves with an reduction in Medicare payments in the middle of the fiscal year. This can make it very difficult for these hospitals to accurately forecast their annual budgets since they do not know what they will get paid from Medicare services during the second half of their fiscal year.

You can look up every U.S. hospital’s readmission penalty for 2023 here. CMS uses a 4-step process to determine the amount of each hospital’s penalty.

The actual equation that CMS uses to calculate each hospital’s penalty is complex with the result that even most hospital administrators do not fully understand it:

Lurking behind the equation are a lot of subtleties that affect how the public should interpret the readmission penalty.

COVID affected the calculations

Normally, CMS looks at historical readmission data from between 2 and 5 years in the past. Thus, normally, CMS would base the 2023 readmission penalty on data from July 2018 to June 2021. This has always been a source of criticism since the penalty is based on what a hospital did 5 years ago rather than what it has done more recently in the past 2 years. Consequently, a hospital with poor readmission performance 5 years ago could have a large readmission penalty even if its readmission performance was stellar during the past 2 years.

The first 6 months of the COVID pandemic was a trying time for most hospitals. Many exceeded their maximum inpatient capacity. To care for inpatients, many had to recruit doctors and nurses who did not normally provide inpatient care. Because of this, CMS excluded all data from January 2020 to July 2020. As a result, rather than being based on 3 years of historical readmission data, this year’s penalty is based on 2.5 year of data.

A second effect of COVID was on the diagnoses used for penalty determination. Normally, CMS looks at readmission rates only for patients with one of six diagnoses: acute myocardial infarction, heart failure, pneumonia, COPD, coronary artery bypass surgery, and hip & knee replacement surgery. COVID disproportionately affected patients coded with pneumonia. As a result, CMS dropped pneumonia as one of the diagnoses used for readmission calculations. Therefore, the penalties were based on 5 diagnoses this year rather than 6.

A third effect of COVID on the readmission penalty calculation was that any patient with COVID as a primary or secondary admission diagnosis was eliminated from the hospital’s readmission calculation. Thus, a patient admitted with an acute myocardial infarction who was found to also have COVID on admission was excluded from the hospital’s data.

A fourth effect of COVID was on comorbidity determination. CMS adjusts every individual patient for that particular patient’s medical co-morbidities. So, for example, a patient with an admission for COPD who requires mechanical ventilation is expected to have a higher readmission rate than a COPD patient who does not require mechanical ventilation. Similarly, a patient undergoing knee replacement who is over age 65 and has diabetes is expected to have a higher readmission rate than a knee replacement patient who is younger than age 65 and not diabetic. This year, CMS added history of COVID within the past year as one of the co-morbidities used in the readmission calculation for all five of the readmission diagnoses. Thus, a patient admitted with COPD who had a COVID infection 8 months previously would be expected to have a higher 30-day readmission rate than a COPD patient who had never had COVID in the past.

Not all hospitals are included

CMS excludes about 40% of U.S. hospitals from the readmission penalty program. These include pediatric hospitals, Veterans Administration hospitals, psychiatric hospitals, rehabilitation hospitals, long-term acute care hospitals, and critical access hospitals. In addition, a hospital must have had more than 25 eligible patients for each of the 5 diagnoses. Thus, a hospital that only performed 24 coronary artery bypass surgeries during the 2.5 year period would not be subject for readmission penalties for CABG surgeries. CMS also excludes all hospitals in Maryland from readmission penalties because of an agreement between CMS and Maryland.

It is impossible for hospitals to monitor their readmission rates

Every autumn, hospitals await the CMS report on their readmission data with no advance knowledge of what the hospital’s readmission rate will be. These are sent to the hospital as a “Hospital Specific Report”. For most other quality metrics, hospitals can continuously monitor their performance internally. For example, any hospital should be able to determine on any given day what their mortality rate, C. difficile incidence, and emergency department wait times are. But readmission rates are unique. Medicare looks at admission to any hospital within 30 days of an inpatient discharge, not just the the hospital that the patient was originally admitted to. The original hospital will know if a patient gets admitted again to that hospital but has no way of knowing if a patient gets admitted to some other hospital. For example, if a patient is discharged from the Ohio State University Medical Center, OSU can track any readmissions to an OSU hospital. However, if that patient gets admitted to a non-OSU hospital in Cincinnati, OSU will not know about it. On the other hand, Medicare gets billed by every hospital that a patient is admitted to so Medicare will know whenever a patient is admitted to any hospital in the United States. This phenomenon has little impact on small, rural or community hospitals since a patient admitted to that hospital will likely return to that same hospital given that it is the only hospital in the region. But for tertiary care or referral hospitals, patients often live hundreds of miles away and readmissions are more likely to occur at their local community hospital rather than at the tertiary care hospital. Thus a tertiary care hospital will have no idea what its readmission rate performance is until CMS sends out the Hospital Specific Reports.

Hospitals normally institute a continuous quality improvement process for quality metrics. This requires real-time monitoring of that quality metric so that the hospital can continuously change its procedures and policies to make their quality outcomes better. This turns out to be difficult for reducing 30-day readmissions because the readmission data that Medicare gets is 2-5 years old. To make an analogy, imagine how difficult it would be for a coach to improve his or her basketball team if the coach did not know the outcome of each game until 5 years after it was played.

All hospitals are not treated the same

One of the main criticisms of the initial formula that CMS used in the first years of the readmission penalty was that hospitals that cared for a large number of poor people were disproportionately penalized compared to hospitals caring for a largely affluent patient population. Poor individuals are less likely to have insurance, less likely to be able to afford medications, less likely to have transportation for doctor office visits, and less likely to have a primary care physician. All of these factors contribute to higher hospital readmission rates but these are factors that are largely not under the hospital’s control. In response to this criticism, several years ago, CMS changed the methodology used in readmission calculation to adjust for the percentage of poor and underserved patients that each hospital cares for. The current methodology uses the percentage of “dual-proportion” patients. This is based on the percentage of Medicare patients that also have full Medicaid benefits. Medicaid is used as a marker for low-income patients. CMS divides U.S. hospitals into one of five quintiles based on the percentage of a hospital’s dual proportion patients. Quintile #1 includes hospitals with fewer than 14% of its Medicare patients having dual coverage with Medicaid. Quintile #5 includes hospitals with more than 31% of its Medicare patients having dual coverage with Medicaid.  The breakdown of hospitals based on their percentage of dual proportion is seen in the graph below:

All hospital stays are not treated the same

Medicare classifies each patient’s hospital stay as either an “inpatient” stay or an “observation” stay. The rules for how to classify any given patient are complicated but in general, a patient who is expected at the time of arrival to the hospital to be in the hospital for less than 2 midnights is considered to be in observation status. Overall in the U.S., about 84% of hospital stays are designated as inpatient and about 16% are designated as observation. The financial difference in the two types of hospital stays is very significant, both for the hospital and for the patient. An observation stay is considered an outpatient visit and is thus subject to Medicare Part B billing rather than Medicare Part A billing. This means that the patient in observation status is responsible for all medication charges and is responsible for a 20% co-pay of the cost of the hospital stay. CMS pays the hospital much less for an observation stay than for a regular inpatient stay. Observation stays are less expensive for Medicare because much of the healthcare costs are passed on to the patient.

Because observation stays are considered outpatient visits from a Medicare perspective, these hospital stays are not included in the hospital readmission calculation. For a readmission to count, both the initial hospital stay must be an inpatient stay and the second hospital stay within 30 days must also be an inpatient stay. This is also the same when CMS calculates a hospital’s mortality rate – only inpatient stays are included and deaths occurring when a patient is in observation status do not count against the hospital’s mortality rate.

Hospitals can “game the system” by putting certain patients in observation status in order to improve their readmission data and their mortality data. For example, take a patient who is admitted for a COPD exacerbation on February 1st. That patient then comes back to the hospital on February 20th after having a cardiopulmonary arrest following a drug overdose. The patient is intubated, receives mechanical ventilation, and placed in the ICU but it is clear that the patient has had severe brain and heart damage and is not expected to live beyond 24 hours. The person overseeing the hospital’s quality data will advise the ICU physician to admit the patient as an observation stay so that the hospital stay does not count as a readmission and so that the death does not count as an inpatient mortality. On the other hand, the person overseeing the hospital’s finances will advise the ICU physician to admit the patient as an inpatient stay so that the hospital gets paid more from Medicare. Whichever of the two hospital administrators is most persuasive (or most vocal) will usually win out. The result is that hospitals that more liberally designate patients as being in observation status can lower their CMS readmission penalty. The goal of Medicare auditors is to pay hospitals as little as possible so they will penalize hospitals who put patients in inpatient status who should really be in observation status. However, those auditors do not care if a hospital puts patients in observation status who should really be in inpatient status since it saves Medicare money.

This can also be an effective strategy for hospitals that have a low volume of patients with one of the five diagnoses used in the readmission calculation. For example, if a hospital has 24 heart failure inpatient admissions over a 3-year period, then putting the next heart failure patient in observation status ensures that the hospital will not have any heart failure readmission penalty since there would still be fewer than 25 heart failure inpatient admissions during that 3-year period. The cost to the hospital is that they might get paid $4,000 less by putting that patient in observation status rather in inpatient status. But by avoiding a 0.2% readmission penalty for all medicare charges for the next year, that hospital might avoid a total $80,000 penalty. That is a $76,000 net return on investment for putting that one patient in observation status rather than inpatient status!

For some hospitals, it is cheaper to pay the penalty

In the United States, the average hospital has 19.8% of revenue from Medicare, 13.1% from Medicaid, and 68.4% from private commercial insurance. The hospital with the highest annual net patient revenue in the U.S. is New York Presbyterian Hospital at $5.7 billion. However, the average U.S. hospital’s total annual patient revenue is much lower at about $200 million. Thus, the average hospital has annual Medicare revenue of about $40 million ($200 million x 19.8%). A maximum Medicare readmission penalty of 3% would therefore be about $1.2 million for that average hospital. Only 17 hospitals were fined the full 3% for 2023 and only 231 hospitals will pay more than 1% penalty. 25% of hospitals will pay no penalty at all. The average hospital penalty is 0.43%.

Given that the average hospital has $40 million in annual Medicare revenue and that the average hospital has a 0.43% Medicare penalty in 2023, that average hospital will have a $172,000 penalty. Implementing a readmission reduction program in a hospital can be very costly. It requires hiring data analysts to monitor readmissions, instituting costly discharge transition clinics, and increasing the percentage of patients in observation status. For many hospitals, the total cost to reduce readmissions sufficiently to avoid a CMS penalty can be considerably more than the expense of the penalty. In general, the larger the hospital and the higher the percentage of Medicare patients in a hospital’s payer mix, the more likely it will make financial sense for a hospital to devote a lot of money into a readmission reduction program. Furthermore, because the readmission penalty is based on the hospital’s performance between 2-5 years previously, it will take 5 years before money spent today on a readmission reduction program will fully affect the annual CMS penalty. And it is likely that CMS will continue to revise the readmission penalty formula so that the formula will look considerably different over the next 5 years.

How can the process be improved?

Medical care in the United States is more expensive than anywhere else in the world and it is essential for our economy that we reign in healthcare costs. Because hospitalizations are expensive, reducing unnecessary hospital admissions is central to controlling those healthcare costs. Readmissions to the hospital within 30 days of hospital discharge are frequently avoidable if processes are in place to ensure that patients get appropriate outpatient care. This includes filling medication prescriptions, keeping office appointments with medical providers after discharge, access to outpatient physical & occupational therapy, etc. Penalizing hospitals for excessive readmissions is one way to reduce costs by incentivizing hospitals to institute processes that reduce hospital readmissions. However, after eleven years of the CMS Hospital Readmissions Reduction Program, it is clear that the program can do better. Some specific improvements include:

1. Provide hospitals with real-time readmission data. This is probably the single most important change that CMS can make and it really should not be terribly difficult. Ideally, hospitals should know what their current readmission rates are every month so that the hospital can employ continuous improvement processes to reduce those readmissions. The current model of basing the penalty on a hospital’s readmission rates from 2-5 years in the past makes improving readmissions very difficult. Ideally, CMS should provide every hospital with its current rolling 3-year average readmission rate and this should be updated monthly.
2. Eliminate observation status hospital stays. Currently, hospitals spend an enormous amount of money to determine whether any given patient should be in observation status or inpatient status. Medicare loves observation status because CMS does not have to pay as much to hospitals for patients in observation status as opposed to inpatient status. Instead, those additional costs are passed on to the individual patient. So, the net overall cost to the country as a whole is the same, regardless of whether a patient is in observation or inpatient status. When the overhead expense of monitoring and policing observation stays is included, the overall cost of having observation status actually increases the country’s overall healthcare costs. When it comes to readmission rates, some hospitals game the system by preferentially putting readmitted patients in observation status instead of inpatient status. It is time to eliminate observation status and simply pay hospitals for patient stays, regardless of whether or not the patient’s hospital stay crosses two midnights.
3. Base the penalty on the overall readmission rate rather readmission rates for only 6 diagnoses. Every hospital is different. Not all hospitals perform coronary artery bypass graft surgery and not all hospitals perform knee & hip replacement surgery. Currently, hospitals focus their readmission rate reduction strategies on just the 6 conditions that CMS penalizes them on. Savvy hospitalists know that they can readmit patients who have had a stroke, diverticulitis, or a drug overdose every week without having to worry about any penalty. By using overall readmission rates (for all diagnoses), the quality process will be simpler for hospitals and will benefit all patients and not just those patients who have one of the 6 conditions that CMS currently uses in readmission penalty determination. However, CMS would need to determine a different method of risk-adjustment for comorbidity since the current method is by using specific comorbidities for each of the 6 eligible diagnoses.
4. Eliminate hospital exceptions. Currently, about 40% of U.S. hospitals are not subject to readmission penalties. This is understandable for pediatric hospitals (few, if any, Medicare patients) and Veterans Administration hospitals (funded by the VA and not by CMS). Psychiatric hospitals are excluded because they do not normally admit patients with the 6 conditions that CMS bases the readmission penalty on. Long-term acute care hospitals, rehabilitation hospitals, and critical access hospitals are also excluded. Ideally, CMS should use data for both Medicare and Medicaid patients since it can track readmissions for both groups. By focusing on total readmission rates rather than the 6 currently used diagnoses, many of the currently exempted hospitals can be included in the readmission reduction program. However, there may need to be different readmission rate benchmarks for psychiatric hospitals, long-term acute care hospitals, etc.

January 4, 2023