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The objective of this audit was to determine whether outpatient observation services billed by Presbyterian Hospital of Dallas (Hospital) met Medicare reimbursement requirements. Our review covered service dates between October 1, 1996 and September 30, 1999. The Hospital billed Medicare for observation services that did not meet Medicare criteria, resulting in an estimated overpayment of $361,832. We audited a statistical sample of 100 claims that contained observation services and determined that 35 percent of the observation services did not meet Medicare requirements. These observation services were primarily unallowable because medical records contained standing orders for observation, physicians’ orders were not documented in the medical records, and medical records documented that there were no complications following an outpatient procedure. The Hospital developed an action plan in 1999 to address the problems with observation service billings. We recommended that the fiscal intermediary recover the overpayment amount of $361,832, and review future observation claims to ensure the hospital’s action plan continues to reduce unallowable observation billing. The fiscal intermediary concurred with our recommendations.