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Hospital case managers and the hospital industry have joined the chorus of those opposed to observation status – a designation that renders a beneficiary ineligible for Medicare-covered skilled nursing facility (SNF) care.  This Alert discusses a recent survey by the American Case Management Association and an amicus brief filed by the American Hospital Association in the Center for Medicare Advocacy's lawsuit challenging observation status, Bagnall v. Sebelius.[1]  It also sets out the policy of the Centers for Medicare & Medicaid Services (CMS) that determinations of medical necessity for inpatient care must use clinical judgment and consider all relevant factors, not just a proprietary screening tool.


As readers of the Center's Alerts know, observation status is an increasing obstacle to Medicare coverage of care in a skilled nursing facility (SNF).[2]  Observation status means that a patient in an acute care hospital is classified as an outpatient, even though, just like an inpatient, the person is placed in a bed in the hospital, stays overnight, and receives nursing, medical care, diagnostic tests, treatments, therapy, prescription and over-the-counter medications, and food.  However, the patient's classification as an outpatient makes him or her ineligible for Medicare coverage of subsequent SNF care.  The Medicare statute requires three days of inpatient status (not counting the day of discharge) as a precondition to Medicare coverage of care in a SNF.[3]

Bipartisan legislation pending in Congress – H.R. 1543 in the House and S. 818 in the Senate, the "Improving Access to Medicare Coverage Act of 2011," – would count all time in the hospital toward meeting the three-day qualifying hospital stay.  A Congressional briefing on the legislation in October 2011 was co-sponsored by the Center for Medicare Advocacy with physician groups (the American Medical Association and the American Medical Directors Association), nursing home trade associations (the American Health Care Association, LeadingAge), and advocacy organizations (AARP, the National Committee to Preserve Medicare and Social Security, and the Alzheimer's Association). 

The American Case Management Association Survey

The American Case Management Association (ACMA) is a national, non-profit professional membership association whose members represent nearly 40% of all U.S. hospitals, including most of the largest medical centers and most academic medical centers.  ACMA recognizes that both observation status and the three-day inpatient hospital stay requirement adversely affect both patients and hospitals and create barriers that prevent hospital case managers from providing patients with appropriate care in the hospital and in transitions to post-acute care and settings.  ACMA has called for the abolition of both observation status and the three-day requirement.

In April 2012, ACMA conducted a survey of its members about observation status.  Its key findings are that:

  • Nearly three-quarters of respondents (71%) have added staff specifically to determine medical necessity on admission status (i.e., whether patients should be classified as inpatients or as outpatients on observation status). 
  • Nearly one-third of respondents (32%) have spent more than $150,000 for staff to determine medical necessity and admission status.
  • More than two-thirds of respondents (68%) use an outside secondary reviewer to help them with medical necessity decisions.  These outside reviewers represent an additional financial burden on hospitals.
  • More than three-quarters of respondents (79%) report that patients are spending more time in observation (i.e., lengths of stay in observation status are increasing).
  • More than two-thirds of respondents (67%) report that patients in observation status do not know that their status will result in extra expenses for them.

The American Hospital Association's Brief in Bagnall v. Sebelius

In April, the American Hospital Association (AHA) filed a friend-of-the-court (amicus) brief in Bagnall.  Although the brief was filed "in support of neither party," AHA presents to the court "the difficult situation hospitals find themselves in with respect to observation status."  AHA Brief, page 3. 

AHA argues that a treating physician should be recognized as the person who makes decisions about whether a patient should be classified as an inpatient or an outpatient.  However, it contends, various categories of federal auditors (Recovery Audit Contractors,[4] Medicare Administrative Contractors,[5] and Zone Program Integrity Contractors[6]) and federal prosecutors (using the False Claims Act) frequently question treating physicians' decisions after the fact, substituting their medical judgment for the decision of the treating physician.  The AHA suggests that "misguided fraud prevention efforts may be encouraging the overuse of observation status."  AHA Brief, page 11.

The CMS Position about Proprietary Screening Tools

Some respondents to the ACMA survey express concern about proprietary screening tools that hospitals and CMS auditors use to determine patients' classification as inpatients or outpatients.  The RAC auditors discussed in the AHA brief use the proprietary screening tool Interqual of the McKesson Corporation.[7]  CMS has spoken clearly on this issue of the appropriate use of screening tools.

Originally in a 2008 transmittal, and later, as a revision to the Medicare Program Integrity Manual, CMS has explicitly stated that proprietary screening tools should not be used alone to determine a patient's designation as an inpatient or an outpatient.  CMS states, in full, in the Medicare Program Integrity Manual:

The review shall use a screening tool as part of their medical review of acute IPPS [inpatient prospective payment system] and LTCH [long-term care hospital] claims.  CMS does not require that you use a specific criteria set.  In all cases, in addition to screening instruments, the reviewer applies his/her own clinical judgment to make a medical review determination based on the documentation in the medical record [underlining provided].  The following shall be utilized as applicable, for each case:

            Admission criteria;
            Invasive procedure criteria;
            CMS coverage guidelines;
            Published CMS criteria;
            DRG validation guidelines
            Coding guidelines; and
            Other screens, criteria, and guidelines (e.g., practice guidelines that are well accepted by the medical community

Contractors shall consult with physician or other specialists if necessary to make an informed medical review determination. [8]


Opposition to observation status is mounting as hospital discharge planners and hospitals join advocates, the medical community, and the nursing home industry.  Hopefully this harmful policy will soon be ended.


[1]  No. 3:11-cv-1703 (D. Conn., filed Nov. 3, 2011).
[2] See “Brown University Confirms Observation Continues to Replace Hospital Admission Status,” (June 7, 2012), ; “Extended Observation Stays in Acute Care Hospitals: Criticism, Legislation and Discussion,”; “When Is a Hospital Stay Not a Hospital Stay? When the Patient Is in Observation” (Dec. 11, 2008).
[3] 42 C.F.R. §409.30(a)(1).
[4]  Recovery Audit Contractors (RACs), originally a demonstration program under §302 of the Tax Relief and Health Care Act of 2006 and later made permanent, are responsible for identifying overpayments and underpayments in the Medicare program.  Four RACs cover the country.
[5] Under §911 of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA), Medicare Administrative Contractors replaced Fiscal Intermediaries and Carriers.
[6] Zone Program Integrity Contractors, formerly Program Safeguard Contractors, perform program integrity functions for Medicare Parts A, B, Durable Medical Equipment, Prosthetics, Orthotics, and Supplies, Home Health and Hospice, and Medicare-Medicaid Data Matching.  (Program integrity functions for Parts C and D are handled by the Medicare Drug Integrity Contractor.)  MLN Matters SE 1204 Revised, The Office of Inspector General just issued a report about ZPICs.  OIG, “Conflicts and Financial Relationships Among Potential Zone Program Integrity Contractors,” OEI-03-10-00300 (July 2012),
[7] McKesson, “Two Medicare Recovery Audit Contractors Select McKesson’s InterQual Clinical Guidelines,” (Press Release, Nov. 10, 2010),,
[8] Medicare Program Integrity Manual, CMS Pub. No. 100-08, Chapter 6, section 6.5.1, (scroll down to page 35).  CMS initially issued this guidance as Transmittal 264 (Aug. 7, 2008), also MedLearn, “Guidance on Hospital Inpatient Admission Decisions,” SE1037,


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