What Are Medical Necessity Denials? A Comprehensive Guide for Hospital RCM Administrators

Nearly three in four healthcare providers report that insurance claim denials have increased between 2022 and 2024, with approximately 38% of survey respondents indicating that at least one in ten claims are denied (Experian Health, 2024). Among these denials, those based on medical necessity represent a significant and persistent challenge for healthcare organizations, adding administrative burden and threatening financial stability.

Understanding Medical Necessity Denials

Medical necessity denials occur when an insurance provider determines that a service, procedure, or treatment isn't medically required according to their specific criteria. The term "medically necessary" generally refers to healthcare services or supplies needed to diagnose or treat an illness, injury, condition, disease, or its symptoms that meet accepted standards of medicine.

While this definition sounds straightforward, interpretation varies significantly between providers and payers, creating a common source of friction in the reimbursement process. According to KFF's analysis of HealthCare.gov marketplace insurers, only about 6% of in-network claim denials were based on medical necessity in 2023 (KFF, 2025). However, these denials often involve high-dollar services that significantly impact a provider's bottom line.

The Financial Impact of Medical Necessity Denials

Medical necessity denials can have substantial financial implications for healthcare providers. While not always an "all or nothing" scenario, these denials frequently result in:

• Complete loss of expected revenue for certain procedures or services

• Partial reimbursement in some cases, particularly when alternative treatment codes can be applied

• Additional administrative costs for appeals and resubmissions, estimated at $25-$118 per claim (HFMA, 2022)

• Delayed cash flow as denied claims move through the appeals process

The industry standard benchmark for medical necessity denial rates is approximately 5%, but many organizations experience higher rates, particularly for certain high-risk procedures and services (MD Clarity, 2025). Each percentage point above this benchmark represents significant lost revenue opportunity.

Where Medical Necessity Denials Occur in the Revenue Cycle

Medical necessity denials can occur at multiple points throughout the revenue cycle, though they most commonly manifest at these critical junctures:

Pre-Service/Front-End

• Eligibility verification: When insurance verification fails to identify medical necessity requirements for certain procedures

• Prior authorization: When insurers reject authorization requests due to perceived lack of medical necessity

• Patient registration: When incomplete or inaccurate documentation doesn't support the medical necessity of the planned service

According to Change Healthcare, the front end of the revenue cycle sees the highest concentration of denial triggers, with nearly 27% of denials stemming from registration and eligibility issues (MGMA, 2024).

Mid-Revenue Cycle

• Clinical documentation: When documentation isn't sufficient to establish medical necessity

• Coding: When diagnostic or procedural codes don't align with medical necessity requirements

• Charge capture: When charges don't match documented medical necessity criteria

This phase is particularly vulnerable as patient documentation must translate into appropriate codes that justify the medical necessity of services rendered.

Back-End/Post-Service

• Claim submission: When claims lack proper documentation or coding to support medical necessity

• Claim adjudication: When payers review claims and determine services weren't medically necessary

• Payment posting: When partial payments are received due to medical necessity determinations

Even after a denial occurs, the revenue cycle continues with the appeals process, creating additional work for already strained staff resources.

Most Commonly Denied Procedures for Medical Necessity

Certain clinical areas and procedures face higher rates of medical necessity denials. Understanding these high-risk services can help organizations focus their prevention efforts:

Diagnostic Imaging

Advanced imaging studies are frequently targeted for medical necessity denials, including:

• MRI scans: Particularly for musculoskeletal conditions without prior conservative treatment

• CT scans: Especially when ordered for screening purposes rather than based on specific symptoms

• PET scans: Often require extensive documentation to justify medical necessity, especially for cancer staging

Insurance carriers typically require clinical documentation showing that the imaging is necessary based on symptoms, prior treatment failures, or specific diagnostic criteria. For example, Medicare and commercial payers often require documentation of failed conservative therapy before approving MRIs for joint pain (Diagnostic Imaging, 2024).

Cancer Treatments

Cancer-related claims face unique challenges with medical necessity denials:

• Newer therapies and medications: Often denied as "experimental" despite oncologist recommendations

• Off-label use of approved medications for rare cancer types

• PET scans for treatment monitoring: Frequently challenged based on frequency

• Genetic testing: May be denied if not directly tied to treatment decisions

As new cancer treatments emerge, payers may be slow to update their medical necessity criteria, leading to denials for treatments that oncologists consider standard of care (American Cancer Society, 2024).

Orthopedic Procedures

Joint replacements and other orthopedic procedures face intense scrutiny:

• Total joint replacements: Require extensive documentation of joint disease, failed conservative treatments, and functional limitations

• Arthroscopic procedures: Often denied without evidence of specific structural abnormalities

• Spinal procedures: High denial rates without documentation of neurological deficits or failed conservative care

For joint replacements specifically, many payers require documentation of end-stage joint disease, distinct structural abnormalities, and evidence showing the procedure's benefits outweigh the risks (Coronis Health, 2016). Medicare guidelines outlined in the CMS Major Joint Replacement booklet emphasize the need for detailed documentation of the patient's medical history, failed conservative treatments, and objective findings to support medical necessity (RACmonitor, 2022).

How Medical Necessity Denials Differ from Level of Care Denials and DRG Downgrades

While related, these three types of denials impact providers differently and require distinct management approaches. Understanding these differences is critical, as they each present different financial implications:

Medical Necessity Denials

Medical necessity denials occur when a payer determines that a service, procedure, or treatment wasn't clinically justified for the patient's condition. These denials focus on whether the care itself was required, regardless of the setting or intensity.

Key characteristics:

• Focus on whether the service should have been provided at all

• Can apply to any healthcare service, from diagnostic tests to surgeries

• Often require clinical evidence to demonstrate the service was needed for the patient's condition

• May be based on payer-specific criteria that differ from standard clinical guidelines

• Can result in partial or complete financial loss depending on the specific denial and payer policies

Level of Care Denials

Level of care denials focus specifically on the setting where care was provided, not whether the care itself was necessary. These denials occur when payers believe a service could have been provided in a less intensive (and less expensive) setting.

Key characteristics:

• Focus on where care was provided (e.g., inpatient vs. observation)

• Often involve disputes about admission status

• Usually apply to hospital stays and transitions between care settings

• May be triggered by documentation that doesn't justify the higher level of care

For example, a payer might agree that a patient needed treatment but deny an inpatient claim because they believe the patient could have been treated in an observation status. According to the American Hospital Association, these types of denials have increased significantly in recent years, particularly among Medicare Advantage plans.

DRG Downgrades

Diagnosis-Related Group (DRG) downgrades differ from outright denials in that the payer doesn't refuse payment entirely but instead reclassifies the patient's stay into a lower-paying DRG category, resulting in reduced reimbursement.

Key characteristics:

• Payment is reduced rather than denied completely

• Focus on the classification of the patient's condition and treatment

• Often target high-weighted DRGs that can be dropped to lower-weighted categories

• Directly impact a hospital's case mix index and future reimbursement rates

According to Sound Physicians, DRG downgrades may cost hospitals as much or more than medical necessity denials (Sound Physicians, 2024). When a payer downgrades a DRG—for example, from pneumonia with sepsis to simple pneumonia—the financial impact can be substantial, with reductions of several thousand dollars per case.

Denial Formats and Communication Methods

Medical necessity denials can arrive in several formats, each requiring a different approach to interpretation and response:

Electronic Remittance Advice (ERA)

The most common format for denials is through the Electronic Remittance Advice, which contains standardized codes indicating the reason for denial:

• Claim Adjustment Reason Codes (CARCs): These codes explain why a claim was adjusted or denied, with specific codes for medical necessity issues.

• Remittance Advice Remark Codes (RARCs): These provide additional information about the denial, often citing specific payer policies or documentation requirements.

For example, CARC 50 is commonly used to indicate "These are non-covered services because this is not deemed a medical necessity by the payer." The X12 organization maintains the official list of these standardized codes used throughout the healthcare industry.

Payer-Specific Denial Letters

Many payers send formal denial letters that provide more detailed explanations of why services weren't considered medically necessary. These letters typically include:

• Patient and claim identification information

• Specific denial reasons

• References to payer policies or clinical guidelines used in the determination

• Instructions for appeal rights and processes

• Timeframes for submitting appeals

Payer Portal Notifications

Increasingly, payers are communicating denials through their provider portals, where additional information may be available:

• Real-time denial notifications

• Searchable databases of denied claims

• Documentation upload capabilities for appeals

• Tracking features for denial status

Explanation of Benefits (EOB)

Patients receive Explanations of Benefits that indicate when services have been denied, often prompting them to contact the provider about the denial. These documents typically show:

• The service that was denied

• The reason for denial, often in simplified language for patients

• The patient's financial responsibility

Understanding these various formats is crucial for effective denial management, as each format may contain different levels of detail and require different response mechanisms.

Key Metrics to Monitor

When tracking medical necessity denials, hospital administrators should monitor these essential metrics:

1. Denial rate by payer: Track the percentage of claims denied by each payer to identify problematic relationships.

2. Denial rate by service type: Determine which services trigger the most denials.

3. Appeal success rate: Measure the percentage of successfully overturned appeals.

4. Time to appeal resolution: Monitor how long denials take to resolve.

5. Financial impact: Calculate the dollar value of denied claims and potential revenue at risk.

   
   

Root Cause Analysis Techniques

Successfully addressing medical necessity denials requires a thorough understanding of why they occur. Implement these root cause analysis strategies:

Conduct Regular Denial Pattern Analysis

Establish a standardized process to analyze denial trends weekly or monthly. Look for patterns related to:

• Specific procedures or service lines

• Individual providers or coders

• Particular payers or health plans

• Common documentation gaps

Create visualizations of this data to make patterns more easily identifiable. For example, a heat map showing denial rates by service line and payer can quickly identify problematic areas.

Implement Clinical Documentation Reviews

Perform targeted audits of documentation for frequently denied services. Compare documentation practices between providers with high and low denial rates to identify best practices. Focus especially on:

• Clarity of medical decision-making

• Documentation of necessity criteria

• Alignment with payer-specific requirements

• Consistency between different parts of the medical record

Evaluate Pre-Service Authorization Processes

Examine how your organization handles prior authorizations, focusing on:

• Accuracy of diagnosis and procedure codes

• Completeness of clinical information

• Timeliness of submission

• Communication of authorization requirements to clinical teams

Team Structure Optimization

Effective denial management requires the right organizational structure with clearly defined roles and responsibilities.

Create a Cross-Functional Denial Management Team

Establish a dedicated team representing multiple departments, including:

• Clinical staff (physicians, nurse reviewers)

• Coding specialists

• Revenue cycle managers

• Payer relations representatives

• Legal/compliance personnel

This team should meet regularly to review denial trends, develop prevention strategies, and coordinate appeals efforts.

Define Clear Roles and Responsibilities

Establish specific ownership for each step of the denial management process:

• Initial denial review and triage

• Medical record review and appeal development

• Appeal submission and tracking

• Payer follow-up

• Reporting and analytics

Document these responsibilities in standard operating procedures to ensure consistency and accountability.

Implement Case Management Approach

For complex or high-dollar denials, assign a case manager to coordinate the appeal process from start to finish. This approach ensures continuity and prevents appeals from falling through the cracks.

Technology Integration Strategies

Leveraging technology is essential for efficiently managing and preventing medical necessity denials.

Implement Automated Denial Prevention Tools

Utilize claim scrubbing software that can:

• Identify missing or contradictory information before submission

• Flag services that typically require prior authorization

• Apply payer-specific medical necessity rules

• Check for appropriate diagnosis-procedure code pairs

These tools can significantly reduce preventable denials by catching issues before claims are submitted.

Leverage Predictive Analytics

Implement systems that can analyze historical denial data to predict which claims are at high risk for denial. This allows for proactive intervention, such as:

• Enhanced documentation before submission

• Gathering additional clinical evidence

• Preemptive peer-to-peer discussions

Integrate EHR with Revenue Cycle Systems

Ensure seamless information flow between clinical and billing systems to:

• Automatically transfer clinical data to support medical necessity

• Flag documentation gaps in real-time

• Alert providers when additional documentation is needed

• Facilitate easier access to medical records during appeals

Staff Training Approaches

Effective training is critical to reducing medical necessity denials and improving appeal success rates.

Develop Specialty-Specific Documentation Guidelines

Create specialty-specific documentation templates and guidance that:

• Highlight the specific elements required to establish medical necessity

• Incorporate payer-specific requirements

• Include examples of strong vs. weak documentation

• Address common denial reasons for each specialty

Implement Regular Provider Education

Conduct ongoing education for clinical staff on:

• Current payer medical necessity criteria

• Documentation best practices

• Common denial reasons and how to address them

• The financial impact of denials on the organization

Make this education practical and data-driven by sharing real examples from your organization.

Train Dedicated Appeal Specialists

Develop expertise in medical necessity appeals by:

• Training staff on payer-specific appeal processes

• Teaching effective appeal letter writing techniques

• Educating on how to identify and present strong clinical evidence

• Developing skills in navigating peer-to-peer discussions

Performance Measurement Frameworks

Implementing robust metrics is essential to track progress and identify opportunities for improvement.

Establish Key Performance Indicators (KPIs)

Develop a dashboard that tracks:

• Overall denial rate and trend over time

• Denial rate by reason, payer, service line, and provider

• Appeal success rate and financial recovery

• Average time to appeal resolution

• Financial impact of denials and appeals

Review these metrics regularly with leadership and share relevant data with clinical departments.

Implement Financial Impact Analysis

Calculate the true cost of denials by measuring:

• Direct revenue loss from unrecovered claims

• Administrative costs of appeal processing

• Opportunity costs of delayed payment

• Staff time dedicated to denial management

This analysis can help justify investments in prevention and management strategies.

Track Provider-Specific Metrics

Create provider scorecards that show:

• Individual denial rates compared to peers

• Common denial reasons for each provider

• Documentation improvement opportunities

• Financial impact of denials on their practice

This data can drive more targeted education and improvement efforts.

Current Industry Trends in Medical Necessity Denial Management

Increasing Payer Scrutiny of Level of Care Determinations

Medicare Advantage plans denied 3.4 million prior authorization requests for health care services in 2022, with a denial rate of about 7%, a share that has increased over recent years (KFF, 2025). This trend extends to medical necessity determinations after services are rendered, with particular focus on inpatient vs. observation status decisions.

Rising Complexity of Payer Requirements

The complexity of payer requirements for medical necessity continues to rise. Between March 2020 and March 2022, there were more than 100,000 payer policy coding and reimbursement changes (HFMA, 2024). This complexity makes it increasingly difficult for providers to keep up with requirements across multiple payers.

Shift Toward AI-Driven Denials Management

The healthcare industry is seeing a decline in the use of automation for claims management, with only 31% of providers currently using some form of automation or AI in 2024, down from 62% in 2022 (Experian Health, 2024). This surprising decrease may be related to decreased confidence in how these technologies work, as only 28% feel confident in their understanding of automation and AI, compared to 68% in 2022.

Growing Spotlight on Payer Denial Practices

Recent events have increased public scrutiny of health insurer claims practices. A 2023 KFF survey found that 17% of respondents reported an insurer had denied coverage of care recommended by a doctor, with more than half saying neither they nor their doctor challenged the denial (U.S. News, 2024). This heightened attention may lead to regulatory changes and increased pressure on payers to justify denial decisions.

Increasing Financial Vulnerability of Healthcare Providers

With rising denial rates and the variable financial impact of medical necessity denials, healthcare organizations are facing unprecedented financial vulnerability. According to a 2023 study by the American Hospital Association, a majority of hospitals report having claims that remain unpaid for extended periods, with some claims still unresolved after several years, compounding the financial impact of denials.

How Cofactor AI Helps Resolve Medical Necessity Denials

Facing the growing challenge of medical necessity denials, healthcare organizations need powerful, innovative solutions. Cofactor AI addresses this need with a comprehensive approach designed specifically for complex denials management.

Reduce Administrative Load with Automated Appeal Generation

Cofactor AI's denials management platform transforms the time-intensive appeals process by automatically generating comprehensive appeal letters that incorporate the strongest evidence from the medical record, appropriate guidelines, and payer policies. This automation turns what traditionally takes 1-4 hours per appeal into a process requiring just 10-15 minutes of staff time, allowing your team to focus on strategic initiatives rather than administrative paperwork.

Streamline Workflows with Intelligent Prioritization

Our platform's sophisticated prioritization engine evaluates each denial based on financial impact, appeal deadline, and likelihood of overturn. This proprietary algorithm ensures your team focuses efforts where they'll have the greatest impact, maximizing revenue recovery with existing resources. The system becomes increasingly precise as it processes more of your organization's denial data, continuously improving its recommendations.

Improve Documentation with AI-Powered Analysis

Cofactor's AI analyzes medical documentation, payer policies, clinical guidelines, and coding standards to identify the strongest evidence to support your appeals. This thorough analysis helps identify documentation gaps and patterns that can inform clinician education, ultimately reducing future denials through improved documentation practices.

Deliver Concrete ROI Through Increased Appeal Volume and Success

By automating the most time-intensive components of the appeals process, Cofactor enables facilities to appeal a significantly higher percentage of denials without adding staff. Our AI-generated appeals incorporate comprehensive clinical evidence, relevant coding guidelines, and payer-specific requirements, potentially improving overturn rates. Even modest improvements in success rates translate to significant additional revenue recovery.

Medical necessity denials present a significant challenge for healthcare organizations, but with the right strategies and technology partners like Cofactor AI, you can transform this challenge into an opportunity for improved financial performance and operational efficiency. By implementing the approaches outlined in this guide and leveraging Cofactor's innovative AI-powered solutions, your organization can reduce denial rates, streamline appeals, and maximize revenue recovery.

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