Patient Observation Status: A Struggle between Hospitals and Medicare Funding

Recently, some seniors on Medicare think that there was a mistake. Others may be stunned when they find that after being in a hospital for days, doesn’t always mean that they were actually admitted. If you’re on Medicare and you’re in the hospital for a few days, you may think you’re an inpatient. Increasingly, hospitals are placing older patients on “observation status.” They may be there for days, but technically as outpatients.

A recent government investigation found that observation patients often have the same or similar health problems as those who are admitted. The observation designation means that they can have higher out-of-pocket expenses and fewer Medicare benefits.

This trend has grown significantly over the past five years, rising 69% over that period, to 1.6 million Medicare beneficiaries entering hospitals as observation patients in 2011. At the same time, Medicare hospital admissions have slightly declined. Further exacerbating those figures, the study found that last year more than 600,000 Medicare patients were in the hospital for at least three days, but still couldn’t qualify for coverage of nursing home care.

The Center for Medicare Advocacy is now suing the Department of Health and Human Services. “Our lawsuit challenges the use of observation status,” says Toby Edelman, a senior attorney with the organization who argues that long observation stays are not authorized by the Medicare statute.

The question that you are probably asking yourself now is, “Why are more Medicare patients receiving observation care instead of being admitted?” The answer: Medicare has a strict set of criteria for hospital admissions and usually won’t pay anything for admitted patients who should have been observation patients. In response to these rules, in recent years, hospitals have increased their numbers of observation patients.

Under recently revised Medicare rules and through a program called RAC (Recovery Audit Contractors), the auditors will then go through old hospital records and decide if the hospital should have classified an individual as an inpatient or outpatient. Hospitals that were denied reimbursement because a patient should not have been admitted must now resubmit a bill to Medicare for a payment based on observation status within one year. The American Hospital Association has argued that this is not an adequate amount of time and is suing Medicare to end the policy.

Joanna Hiatt Kim, vice president for payment policy at the American Hospital Association, explains that if the RACs conclude that an inpatient should have been an outpatient, the hospitals are required to return the funding that they had received years before, and they then frequently get little or no reimbursement, “even though there’s no dispute whatsoever that the care [the patient] received was reasonable and necessary.” So hospitals increasingly use observation status to make sure Medicare compensates them something that they won’t have to give back.

Hospitals have one additional incentive for keeping patients in observation status: If patients return within 30 days, they do not count as readmissions (as they weren’t admissions in the first place). Medicare withholds a percentage of payment from hospitals with high readmission rates.

HHS has issued new rules designed improve issues for patients and hospitals. Yet, critics say it’s not enough. Fixing this problem at the source would require an act of Congress, says Rep. Joe Courtney, D-Conn. “It was not really an issue that could be resolved easily by Medicare through an administrative change,” he explained.

So Courtney has proposed legislation, with more than 90 co-sponsors, including 20 Republicans,  that would require Medicare to pay for follow-up treatment in a nursing home for any patient who had been in the hospital for at least three days, no matter if they’re an inpatient, outpatient, or on observation status. “This is an issue that has a life of its own,” he says. “It is not an issue that […] falls into traditional partisan playbooks.”