The lawsuit filed by the Department of Health and Human Services and Department of Defense accuses the rehabilitation hospital in Baltimore of falsely manipulating its computerized billing system so that it looked like patients had a severe form of malnutrition called kwashiorkor.
Hospitals are compensated more for a patient who has a more severe and complex diagnosis.
A spokeswoman for the University of Maryland Medical System, which owns Kernan, said in a statement that the hospital had not yet been served with the lawsuit, but pulled a copy from court records. She said the medical system doesn't agree with the government's findings.
Mary Lynn Carver, senior vice president of communications for the system, said the organization had been in discussion for a while with the U.S. attorney's office regarding how it coded patients with malnutrition.
"There are a variety of reasons why patients at Kernan may be classified with malnutrition," Carver said. "This diagnosis is used both for low weight as well as for nutritional deficiencies including protein malnutrition that are determined by blood work. The hospital conducted an evaluation of all our malnutrition cases which resulted in a substantially different conclusion than the U.S attorney's office."
Federal health officials said in the lawsuit that Kernan put in place a computer system that recognized the words "protein malnutrition" as "kwashiorkor" and then put pressure on clinicians to write protein malnutrition in a patient's chart. The disease was usually described as a secondary disease.
The lawsuit said that in many instances the medical evidence didn't support diagnosis of the disease or the evidence was contradictory or incomplete.
Secondary diagnosis of kwashiorkor at Kernan rose from zero cases in 2004 to 287 cases in 2007, the lawsuit said. Lesser degrees of malnutrition coded as secondary diagnoses also increased.
"Through this false and fraudulent scheme, Kernan hospital inflated its compensation," the government wrote in its lawsuit.
The military's Tricare health benefit program, along with others, were inappropriately charged, according to the lawsuit.
The Maryland Health Services Cost Review Commission, which sets the state's hospital rates, found that Kernan had been inappropriately paid $1.6 million in Medicare, Medicaid and other reimbursements. Under the false claims act the federal government can seek damages beyond that.
Carver said the medical system hopes to resolve the issue.
"We look forward to working constructively with the U.S. attorney's office to resolve this case," she said.