Ruminations on Observation

by Cozen O'Connor

On July 29, 2013, the Office of Inspector General of the U.S. Department of Health and Human Services (OIG) released a memorandum report finding that Medicare paid more on average for short inpatient stays than for observation stays in 2012. The report, Hospitals' Use of Observation Stays and Short Inpatient Stays for Medicare Beneficiaries,1 touches on the hot button issue of observation versus inpatient status, which has led to at least one class action lawsuit.2


Medicare beneficiaries receiving care at a hospital are classified as either inpatients or observation patients. Observation patients are outpatients who receive treatments and assessments to determine whether they require further treatment as inpatients or can be discharged. The Centers for Medicare & Medicaid Services’ (CMS) policy provides that observation services are usually needed for 24 hours or less.

Although the care that observation patients receive may be identical to the care received by inpatients, the consequences for beneficiaries who are not admitted as inpatients can be significant. First, they may have more out-of-pocket costs than if they were admitted as inpatients. Second, and most significantly, they may not qualify for skilled nursing facility (SNF) services if such services are needed following discharge from the hospital because Medicare will not pay for SNF services under Part A unless the beneficiary has been classified as an inpatient for at least three consecutive days, not counting the day of discharge.

According to the report, CMS, members of Congress and others have raised concerns about hospitals’ use of observation stays and short inpatient stays (i.e., stays that last less than two nights). In short, they are concerned that beneficiaries may be spending long periods of time in observation without being admitted as inpatients, which would make them ineligible for post-discharge SNF services, and that Medicare may be improperly paying for short inpatient stays where the beneficiaries should have been treated as outpatients.

The OIG’s Analysis of 2012 Medicare Data

In its report, the OIG classifies hospital stays into three categories: observation, long outpatient and short inpatient. In 2012, 72 percent of hospital stays were observation or long outpatient stays and 28 percent were short inpatient stays. Medicare beneficiaries had 1.5 million observation stays and 1.1 million short inpatient stays in 2012, which were often for the same reason as observation stays. The OIG found that Medicare paid an average of $1,741 for an observation stay, compared with $5,142 on average for a short inpatient stay.

Beneficiaries also paid more on average for short inpatient stays. In 2012, beneficiaries paid an average of $401 for an observation stay, while a short inpatient stay cost an average of $725 per short inpatient stay, a difference of $324. According to the report, even when patients were being treated for the same reasons, short inpatient stays were typically more costly than observation stays.

Most importantly, Medicare beneficiaries had 617,702 observation and long outpatient stays that lasted more than three nights, but that did not qualify them for SNF services. In some of these stays, beneficiaries were first classified as outpatients and then subsequently admitted as inpatients.

Additionally, the report identified the high amount of variability between hospitals as an issue — i.e., some hospitals were more likely to use short inpatient stays, whereas others were more likely to use observation or long outpatient stays. As a result, beneficiary liability was often a function of the admitting hospital’s observation policy rather than the standard Medicare coverage structure.

In its conclusion, the OIG recommends that CMS ensure that beneficiaries with similar post-discharge needs have the same access to and cost-sharing for SNF services. It also suggests that the ability to count outpatient nights towards the qualifying three-day inpatient stay may reduce the number of observation and long outpatient stays, but notes that such a policy change would likely require action by Congress. The OIG further recommends that CMS ensure that Medicare does not inappropriately pay when beneficiaries do not qualify for SNF services. Despite this recommendation, the OIG plans to identify SNFs that received Medicare payments for patients who did not have a qualifying inpatient stay so that CMS can look into recoupment.

Changes to Payment Policies for Inpatient and Outpatient Stays

In the report, the OIG describes two sets of proposed rules issued by CMS that would address some of these concerns by modifying how hospitals bill for observation and short inpatient stays. The first set of proposed rules would permit hospitals to rebill Medicare Part B if the hospital or a contractor decided that an inpatient admission under Part A was not medically necessary.3 The second set would create a time-based presumption that hospital stays lasting two nights or more would be presumed reasonable and necessary.4 According to the report, this proposed policy would reduce the number of short inpatient stays but not the number of observation or long outpatient stays.

Just days after the release of the OIG’s report, CMS adopted both proposals in a final rule although they do not solve the problem of observation status for beneficiaries.5 CMS clarified that the outpatient time would not be considered inpatient time, but may be considered during the medical review process for the sole purpose of determining whether the two night benchmark was met. In addition, CMS provides that outpatient time may not be retroactively included as inpatient time for SNF eligibility or other benefit purposes.

Observations about the Future of Observation and Inpatient Status

It is important to note that there are bills pending in Congress (H.R. 1179 and S. 569) that seek to amend the Social Security Act to permit the counting of outpatient nights towards the qualifying three-day inpatient stay for SNF coverage by Medicare. Despite bipartisan support, it remains to be seen how quickly these bills will move through the legislative process.

Interestingly, the OIG’s report and CMS’s focus on observation services and short stays coincides with the Pennsylvania Department of Public Welfare’s (DPW) consideration of comments on a new proposal to cover and fund observation services under the Medical Assistance (MA) program.6 In a recently published Pennsylvania Bulletin, DPW indicated that it is considering the establishment of an observation rate for hospital cases in which an inpatient admission is not medically necessary but observation of the patient is required.7 It intends to set a comprehensive rate to cover observation services determined to be compensable under the MA program.

If you have any questions about this report or wish to discuss how it applies to your particular circumstance, please feel free to contact Judy Wang Mayer, Mark Gallant or any member of the Health Law Group.

The OIG Report is available here.

2 In Bagnall v. Sebelius, No. 11-01703 (D. Conn.), a group of Medicare beneficiaries who had been hospitalized and then later discharged to nursing homes only to discover that their nursing home stays were not covered by Medicare because they were considered to be under observation, as opposed to admitted, by the hospital, filed a class action lawsuit over Part B coinsurance and nursing home costs they incurred.

3 78 Fed. Reg. 16632 (March 18, 2013).

4 78 Fed. Reg. 27486, at 27645-49 (May 10, 2013).

5 The final rule is available here. It is scheduled to be published in the August 19, 2013 Federal Register.

6 43 Pa. B. 3582 (June 29, 2013).

7 Note that DPW indicated the same intent in a 2010 Pennsylvania Bulletin. See 40 Pa. B. 3620 (June 26, 2010).


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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