Section 306 of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (MMA) directed the Centers for Medicare & Medicaid Services (CMS) to create a demonstration project aimed at ensuring that correct payments were being made to Medicare providers. This project examined the cost of using private contractors, known as Recovery Audit Contractors (RACs), who were paid on a contingency fee basis to carry out this function.

The demonstration project lasted three years (2005-2007). It originally focused on the three states with the largest Medicare utilization: California, Florida and New York. Combined, these three states account for 25 percent of Medicare spending. Arizona, Massachusetts, and South Carolina were added to the project in 2007.

As part of the demonstration project, the RACs were prohibited from reviewing claims in the following circumstances:

  • Incorrect level of physician evaluation and management (E/M) code
  • Hospice and home health services
  • Claims previously reviewed by another Medicare contractor
  • Claims involved in a potential fraud investigation
  • Payments made to providers under another CMS-conducted demonstration project

All other claims, both Part A and Part B, were open for RAC review. The contractors were permitted to review claims paid up to four years before the date of review, but not claims paid during the fiscal year in which the review was conducted.

According to the final CMS report on the demonstration project, 96 percent of improper payments identified by RACs were overpayments, while 4 percent were underpayments. Most overpayments (85 percent) were collected from inpatient hospital providers, 6 percent from inpatient rehabilitation facilities, and 4 percent came from outpatient hospital providers. Given the contingency fee payment methodology, it was not surprising when CMS reports on the program indicated that a majority of recovered funds resulted from audits of hospitals and other Part A entities. Hospitals tend to bill for higher dollar-value claims than practices do. Thus, the RACs could be paid more for less work if they focused on Part A claims than if they focused on Part B claims.

Medicaid RAC program

Under the Patient Protection and Affordable Care Act of 2009 (ACA), the RAC program was expanded to include Medicaid. While CMS has specified some of the requirements for the Medicaid RAC program, many of the details are left to each state to determine. For more information about your state’s Medicaid RAC program, contact your state Medicaid agency.