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On July 30, 2012, as part of proposed rulemaking on the outpatient prospective payment system, the Centers for Medicare & Medicaid Services (CMS) asked for public comment on potential policy options related to "observation status."[1]

What is Observation Status?

Observation status refers to the classification of a patient in an acute care hospital as an outpatient, even though the person is placed in a bed in the hospital, stays overnight (or, often, many nights), and receives medically necessary nursing and medical care, diagnostic tests, treatments, therapy, prescription and over-the-counter medications, and food.  Although outpatients may be intermingled with, and indistinguishable from, inpatients, the distinction between inpatient and outpatient status is significant.  Inpatients pay a large deductible ($1156 in 2012), after which Medicare Part A covers all care and services received in the hospital.  They are eligible for Medicare coverage of their subsequent stay in a skilled nursing facility (SNF) if they have three days of inpatient status in the hospital (not counting the day of discharge).[2]  Outpatients, on the other hand, pay co-payments for each hospital service billed under Medicare Part B, pay for medications, and, if they should need subsequent care in a SNF, Medicare will not pay for it. 

Final Rules Published November 15, 2012

In final rules published November 15, 2012, CMS declines to make any changes to observation status at this time, promising that "[w]e will take all of the public comments that we received into consideration as we consider future actions that we could potentially undertake to provide more clarity and consensus regarding patient status for purposes of Medicare payment."[3]

CMS' response is disappointing both because hospitals' use of observation status is increasing and adversely affecting tens of thousands of Medicare beneficiaries nationwide[4] and because CMS previously solicited public comment on observation status in 2005 and decided, at that time, that it wanted to consider the issue further.[5]

Despite refusing to address the observation status issues in regulations at present, CMS reported that the number of hospital patients in observation for more than 48 hours increased from 3% of hospital claims in 2006 to 7.5% in 2010 and that the financial consequences for patients may be significant – Part B copayments and drug costs for outpatients in observation may exceed the Part A inpatient deductible, and subsequent care in a SNF may not be covered by Medicare.[6]

CMS summarized the 350 comments it received on various options to revise its observation status policy, but provided no responses in the final rule to the comments that it received.  CMS' rationale for not providing responses is that while it requested comment, it did not propose any specific changes.[7]

Policy Options Discussed by CMS

  • Clarifying current admission instructions or establishing specified clinical criteria for inpatient status.  Commenters expressed concerns about the need to give primacy to the clinical judgment of the treating physician and about the use of proprietary screening tools to make decisions about a patient's status as inpatient or outpatient  (some commenters supported their use, others opposed them);
  • Using hospital utilization review procedure for making appropriate decision about inpatient-outpatient status.  Some commenters supported requiring hospitals to maintain utilization review staff 24 hours per day, seven days per week; others supported eliminating utilization review entirely.
  • Using a prior authorization process for inpatient admission.  Some commenters supported prior authorization; others saw it as a barrier to urgently needed care.
  • Using time-based criteria for inpatient admission, such as strictly limiting outpatient observation to 24 or 48 hours.
  • Aligning payment to match payment rates more closely to resources spent by a hospital for a patient in outpatient status.
  • Public comments received on other topics, such as establishing rules for the external review of inpatient claims (many commenters expressed concerns that external reviewers' criteria are not the same as Medicare's and that external reviewers making medical necessity decisions may not be physicians), improving beneficiary protections (such as clarifying and strengthening rules when patients' status is changed from inpatient to outpatient),  and revising the qualifying criteria for SNF coverage (such as counting all time in the hospital toward meeting the qualifying inpatient requirement for SNF coverage).

The proposed and final rules also describe the Medicare Part A to Part B Rebilling Demonstration, which allows hospitals to receive 90% of the allowable Part B payment when payment under Part A is denied.  Hospitals voluntarily participating in the Demonstration must waive their appeal rights and do not receive any reimbursement for "observation hours," which they could have billed to Medicare if they had originally described the patient's status as "outpatient."[8]  This month, the American Hospital Association (AHA) sued the Department of Health and Human Services over a related issue – CMS's practice of disallowing any Medicare reimbursement to hospitals whose decision to admit a patient to inpatient status is later overturned by a Recovery Audit Contractor, even when the patient received medically necessary services in the hospital as an "outpatient."[9]


Observation status remains a significant issue for Medicare beneficiaries across the country.  The Center for Medicare Advocacy is pursuing litigation[10] challenging the practice and wants to hear from you.  The Center also hopes that  legislation now pending in Congress – the "Improving Access to Medicare Coverage Act of 2011," H.R. 1543 (introduced by Congressman Joe Courtney, D, CT,  and 37 co-sponsors) and S.818 (introduced by Senator John Kerry, D, MA, and six co-sponsors) – will be reintroduced in the next Congress.  The identically worded bipartisan bills would count all time in the hospital, whether called inpatient or outpatient, toward meeting the three-day qualifying hospital stay.


[1] 77 Fed. Reg. 45,061, at 45,155 (July 30, 2012).  See Center for Medicare Advocacy, “CMS Invites Public Comment on Observation Status” (Weekly Alert, Aug. 9, 2012),
[2] 42 C.F.R. §409.30(a)(1).
[3] 77 Fed. Reg. 68,209, at 68,433 (Nov. 15, 2012).
[4] See Center for Medicare Advocacy, “Brown University Confirms Observation Continues to Replace Hospital Admission Status,” (June 7, 2012),  (discussing study confirming increases in the number and length of outpatient observation stays).
[5] In proposed rules updating prospective payment rates for skilled nursing facilities under Medicare published in 2005, CMS asked if observation time should be counted towards meeting the three-day qualifying hospital stay requirement for subsequent Medicare coverage of care in a SNF.  70 Fed. Reg. 29,069, at 29,098 (May 19, 2005).  In the final rules, while acknowledging that most commenters supported such a change, CMS declined to change its policy, saying it was “continuing to review this policy.”  70 Fed. Reg. 45,025, at 45,050 (Aug. 4, 2005).
[6] 77 Fed. Reg., at 68,427.
[7] 77 Fed. Reg., at 68,428.
[8] 77 Fed. Reg. 45,061, at 45,155 (July 30, 2012); 77 Fed. Reg. 68,209, at 68,428-429 (Nov. 15, 2012).
[9] The American Hospital Association v.Sebelius, Case No. 1:12-cv-1770 (D.D.C. filed Nov. 1, 2012),
[10] Bagnall v. Sebelius, No. 11-1703 (D. Conn., filed Nov. 3, 2011),




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