Observation Status

The Medicare statute and regulations authorize payment for skilled nursing facility (SNF) care for a beneficiary who, among other requirements, was a hospital inpatient for at least three days before the admission to the SNF. The Center for Medicare Advocacy has written before about difficulties in calculating hospital time for purposes of using Medicare's post-acute SNF benefit. In the past, the Center's primary focus was how time in observation status and in the emergency room was not counted by the Medicare program when that time was followed by a beneficiary's formal admission to the hospital as an inpatient.[1] In recent months, however, a related issue has arisen.

The Center has heard repeatedly about beneficiaries throughout the country whose entire stay in a hospital, including stays as long as 14 days, is classified by the hospital as outpatient observation. In some instances, the beneficiaries' physicians order their admission, but the hospital retroactively reverses the decision. As a consequence of the classification of a hospital stay as outpatient observation (or of the reclassification of a hospital stay from inpatient care, covered by Medicare Part A, to outpatient care, covered by Medicare Part B), beneficiaries are charged for various services they received in the acute care hospital, including their prescription medications. They are also charged for their entire subsequent SNF stay, having never satisfied the statutory three-day hospital stay requirement.

Centers for Medicare & Medicaid Services (CMS) Definition of Observation Services

Neither the Medicare statute nor the Medicare regulations define observation services. The only definition appears in various CMS manuals, where observation services are defined as:

a well-defined set of specific, clinically appropriate services, which include ongoing short term treatment, assessment, and reassessment, that are furnished while a decision is being made regarding whether patients will require further treatment as hospital inpatients or if they are able to be discharged from the hospital.[2]

In most cases, the Manuals provide, a beneficiary may not remain in observation status for more than 24 or 48 hours.[3]

Even if a physician orders that a beneficiary be admitted to a hospital as an inpatient, since 2004 CMS has authorized hospital utilization review (UR) committees to change patients' status from inpatient to outpatient. Such a retroactive change may be made, however, only if (1) the change is made while the patient is in the hospital; (2) the hospital has not submitted a claim to Medicare for the inpatient admission; (3) a physician concurs with the UR committee's decision; and (4) the physician's concurrence is documented in the patient's medical record.[4] CMS explains that retroactive reclassifications should occur infrequently, "such as a late-night weekend admission when no case manager is on duty to offer guidance."[5] Although CMS anticipated in 2004 that reclassifications would be used less frequently over time,[6] the Center has heard about this practice only recently.

When a beneficiary is placed in observation status by the attending physician, a hospital may be required to give the patient an Advance Beneficiary Notice (ABN) of noncoverage in order to shift liability to the beneficiary. A critical issue for CMS is whether the service meets the requirements of a Part B-covered service. If the service is a Part B service, but it "falls outside of a timeframe for receipt of a particular benefit,"[7] then the hospital must give the beneficiary an ABN. If the service is not a Part B service, an ABN is not required to shift liability to the beneficiary; the hospital may voluntarily give the patient such notice. Although the precise application of these principles to observation services has not been addressed in any administrative or court decision, the Center believes that placement of a beneficiary in observation status for more than 24 or 48 hours should lead to the requirement that the hospital give the patient an ABN.

Under the Medicare Act, when a determination is made that a service was not medically necessary and that Medicare will not pay for it, payment will nevertheless be made if the beneficiary did not know, and could not reasonably be expected to know, that payment would not be made.[8] A beneficiary is presumed not to know "that services are not covered unless the evidence indicates that written notice was given to the beneficiary [bold font in original]."[9] A provider must inform a beneficiary when services are not medically necessary; its failure to do so will relieve the beneficiary of responsibility of paying for the service.[10]

If a hospital UR committee determines that a patient's inpatient stay is not medically necessary and should be reclassified as outpatient observation, CMS explicitly requires that the beneficiary be notified promptly in writing.[11] The notice is necessary so that the beneficiary "is fully informed about the change in status and its impact on the co-insurance and deductible for which the beneficiary would be responsible."[12]

SNFs that believe that Medicare coverage will be denied because of a technical reason, such as a lack of the three-day qualifying hospital stay, may give the resident a Notice of Exclusion of Medicare Benefits (NEMB).[13] Use of the notice by SNFs is optional.

The NEMB-SNF informs the beneficiary that, in the SNF's view, Medicare will not pay for the resident's care. The form offers the beneficiary three options:

In the Center's experience, hospitals and SNFs are not giving beneficiaries notice of non-coverage. Hospitals are not complying with the notice requirements and are not giving patients an ABN when beneficiaries are assigned to observation status in the hospital for time periods exceeding 24 or 48 hours.

The Center anticipates that more beneficiaries may be placed in observation status next year as the Recovery Audit Contractor (RAC) program moves from demonstration status to a permanent, nationwide program.[14] RAC was authorized by §306 of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (MMA) to detect and correct improper payments in the traditional Medicare program, both overpayments and underpayments. The review of the three-year demonstration program found that RAC contractors, who were paid on a contingency basis, identified $1.03 billion in improper payments -- $992.7 million (96%) in overpayments and $37.8 million (4%) in underpayments. Most of the overpayments (85%) were collected from inpatient hospitals. The review also reported that only 14% of providers appealed and only 4.6% of RAC overpayment determinations were overturned on appeal.[15]

The Center would like to hear your experiences as we work on solutions to these issues. In the meantime, the Center suggests that:

[1] Litigation challenging CMS’s method of calculating hospital time was unsuccessful. Estate of Landers v. Leavitt, 545 F.3d 98 (2d Cir. 2008).

[2] Medicare Benefit Policy Manual, CMS Pub. 100-02, Chapter 6, §20.6; same language in Medicare Claims Processing Manual, CMS Pub. 100-04, Chapter 4, §290.1.

[3] Id.

[4] Medicare Claims Processing Manual, CMS Pub. No. 100-04, Chapter 1, §50.3, originally issued as CMS, “Use of Condition Code 44, ‘Inpatient Admission Changed to Outpatient,’” Transmittal 299, Change Request 3444 (Sep. 10, 2004).

[5] CMS, “Clarification of Medicare Payment Policy When Inpatient Admission Is Determined Not To Be Medically Necessary, Including the Use of Condition Code 44: ‘Inpatient Admission Changed to Outpatient,’” MedLearn Matters (Sep. 10, 2004).

Use of Condition Code 44 is not intended to serve as a substitute for adequate staffing of utilization management personnel or for continued education of physicians and hospital staff about each hospital’s existing policies and admission protocols. As education and staffing efforts continue to progress, the need for hospitals to correct inappropriate admissions and to report condition code 44 should become increasingly rare.

Question and Answer 3.

[6] Id.

[7] Medicare Benefit Policy Manual, CMS Pub. 100-02, Chapter 6, §20.6.C.

[8] 42 U.S.C. §1395pp, 1879 of the Social Security Act.

[9] Medicare Claims Processing Manual, CMS Pub. 100-04, Chapter 30, §30.1.

[10] Hospital ABNs are discussed in CMS, “Preliminary Instructions: Expedited Determinations/Reviews for Original Medicare,” Transmittal 594, Change Request 3903 (June 24, 2005), which will be put in the Medicare Claims Processing Manual, Chapter 30, at §80. This Transmittal includes 10 different forms for Hospital –Issued Notices of Noncoverage (HINNs), none of which addresses observation status.

[11] CMS, “Clarification of Medicare Payment Policy When Inpatient Admission Is Determined Not To Be Medically Necessary, Including the Use of Condition Code 44: ‘Inpatient Admission Changed to Outpatient,’” MedLearn Matters (Sep. 10, 2004).

[12] CMS, “Clarification of Medicare Payment Policy When Inpatient Admission Is Determined Not To Be Medically Necessary, Including the Use of Condition Code 44: ‘Inpatient Admission Changed to Outpatient,’” Question 8, MedLearn Matters (Sep. 10, 2004).

[13] Medicare Claims Processing Manual, CMS Pub. No. 100-04, Chapter 30, §90. The NEMB-SNF form is at http://www.cms.gov/BNI/Downloads/CMS20014.pdf.

[14] http://www.cms.gov/RAC/02_ExpansionStrategy.asp.

[15] The Medicare Recovery Audit Contractor (RAC) Program: An Evaluation of the 3-Year Demonstration, page 2 (June 2008), http://www.cms.gov/RAC/Downloads/RAC%20Evaluation%20Report.pdf.