In-patient vs. Observation Care: the “2 Midnight Rule”
The Center for Medicare and Medicaid Services (CMS), members of Congress, and Medicare beneficiaries have raised concerns over the past few years about the length of time that Medicare beneficiaries spend as hospital outpatients receiving observation services. In 2011, The Center for Medicare Advocacy filed a class-action lawsuit against CMS alleging that the rapid increase in hospital use of observation status was financially harming Medicare patients. Observation services are paid under Part B, unlike inpatient services which are paid under Part A. Medicare patients who receive observation services pay 20% Part B copayments, the cost of self-administered drugs that are not covered under Part B, and the cost of post-hospital skilled-care nursing care (SNF). Medicare will not pay for SNF services unless the patient receives inpatient services for three consecutive days.
The Office of Inspector General released a memorandum report this summer describing hospitals’ use of observation stays and short inpatient stays (one night or shorter) in 2012 which found the following:
1. Hospitals provided observation services to Medicare beneficiaries in 1,511,875 stays. During these observation stays, hospitals provided short-term treatments and assessments and determined that the beneficiaries did not need to be admitted as inpatients.
2. For another 601,880 stays, hospitals provided observation services to beneficiaries who were then admitted to the hospital as inpatients.
3. Seventy-eight percent of observation stays began with beneficiaries being treated in the emergency department, while another nine percent began with the beneficiary having an operating room procedure.
4. In 92 percent of observation stays, beneficiaries spent at least 1 night (2 calendar days) in the hospital.
5. In total, Medicare paid $5.9 billion for short inpatient stays, an average of $5,142 per stay.
6. In contrast, it paid $2.6 billion for observation stays, an average of $1,741 per stay. For each of the most common reasons for the stays, the average payment was always higher for short inpatient stays than for observation stays.
7. Beneficiaries also paid more for short inpatient stays than for observation stays. Beneficiaries paid a total of $831 million for short inpatient stays, an average of $725 per stay. In contrast, they paid a total of $606 million for observation stays, an average of $401 per stay. This included what they paid for inpatient stays when they were treated for the same reason as the observation stay.
The study pointed out that a Medicare patient’s chances of being admitted or kept for observation depends on which hospital they go to, even when the symptoms are the same. Some hospitals billed short inpatient stays (one night or less) for less than 10 percent of their stays while others billed them for over 70 percent. It was also found that a patient in the hospital for three nights could have their claim coded several ways: all observation care, some part observation and some inpatient care or all three nights as inpatient care, depending on the hospital. These coding differences result in different payments to the hospital and different payments by the patient. Clearly more clarification is needed to distinguish the difference between an inpatient stay and an observation stay.
In order to address these concerns, on August 10, CMS made changes to this year’s IPPS’ (Hospital Inpatient Prospective Payment Systems for Acute Hospitals and Long Term Care) and effective October 1 final rule, CMS attempted to clarify the difference between inpatient and observation services because CMS recognizes that:
- Beneficiaries pay more as outpatients than if they were admitted as inpatients
- CMS may make improper payments for short inpatients stays when the beneficiaries should have been treated as outpatients.
CMS believes their existing inpatient admission criteria are valid (medical necessity, patient risk of an adverse event, etc.), but to clarify the time frames as requested by stakeholders, in their final rule effective October 1, CMS issued this new inpatient definition:
“We are specifying that for those hospital stays in which the physician expects the beneficiary to require care that crosses two midnights and admits the beneficiary based upon that expectation, Medicare Part A payment is generally appropriate.” “Conversely, we are specifying that hospital stays in which the physician expects the patient to require care less than two midnights, payment under Medicare Part A is generally inappropriate.”
CMS expects this policy change to reduce the number of observation stays lasting 2 nights or longer and to reduce the number of short inpatient stays. Overall they expect a net shift from outpatient to inpatient stays, increasing Medicare reimbursement to hospitals for inpatient stays by $220 million annually. To offset the costs of additional inpatient stays, CMS proposed implementing an across-the-board reduction in Medicare payments for all inpatient stays.
This rule has caused a small firestorm of complaints from hospitals and others which led CMS to announce on September 26 that RAC auditors will not be reviewing these criteria for 90 days while providers get training and other procedures in place.
In addition, many are concerned that the new rule does not deal with the variance in qualifying for SNF services. “The OIG report is just one more argument in favor of changing these arcane laws and speeding care to thousands of seniors trapped in this no man’s land of health care,” stated Mark Parkinson, president and CEO of the American Health Care Association/National Center for Assisted Living, the nation’s largest provider advocacy group.
One option to assist beneficiaries is certainly to allow nights spent in the hospital receiving outpatient/observation care to count toward the three-night minimum needed for SNF coverage, but such a change is likely to require new legislation. In March 2013, The Improving Access to Medicare Coverage Act of 2013 was proposed that would make this change, although the bill has not been taken up by Congress since then. Of course, estimates will be needed about how much it would cost Medicare to pay for the increased SNF services that would result from adding observation time to the three-night rule.
CMS must also set up better controls for distinguishing between inpatient and observation services and implement their “two night” rule when processing claims, as Medicare inappropriately reimbursed skilled-nursing facilities $255 million last year for beneficiaries who had not met the then three-day requirement. Conversely, hospitals have overcharged the agency by admitting patients who should have received less expensive observation or outpatient care, resulting in returning those funds to CMS. One Boston hospital had to repay $5.3 million to settle charges that it overcharged the agency. 
 Mullaney, Tim, “Federal Watchdog Agency Joins Chorus for Observation Stay Reform, Reports on Scope of the Problem,” McKnights, July 31, 2013
 Jaffe, Susan, “HHS Inspector General Scrutinizes Medicare Observation Care Policy,” Kaiser Health News, July 30, 2013.