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The use of “Observation Status” – treating certain hospitalized Medicare patients as outpatients when their care is indistinguishable from that of formally admitted inpatients – continues to garner considerable public and Congressional attention. It remains an unresolved problem that has serious financial consequences for Medicare patients and their families.[1]  

On July 30, 2014, the Senate Special Committee on Aging held the first Congressional hearing that focused on the impact of Observation Status on patients.  The same day, the Society for Hospital Medicine, the professional association of hospitalists, released a White Paper about the impact of Observation Status on patients and physicians.  The witnesses and White Paper confirm the problems that Observation Status creates for patients and hospitals and skilled nursing facilities (SNFs).  Meanwhile, an ongoing series of audits by the Office of Inspector General continues to request repayments by hospitals for overpayments, primarily for labeling their patients inpatients instead of outpatients, and the U.S. Department of Justice announced settlement for $98 million of litigation against a Tennessee-based hospital chain for misclassifying patients as inpatients.

Senate Special Committee on Aging

The Senate hearing, “Admitted or Not? The Impact of Medicare Observation Status on Seniors,”[2] began with testimony by Sylvia C. Engler, a Massachusetts woman whose 90-year old husband Harold had double hernia surgery and spent 10 days in the hospital in 2013.  Mr. Engler spent five days in the hospital, returned home for fewer than two days, and then returned to the hospital for an additional five days.[3] 

Mr. Engler’s subsequent six-week recovery in the skilled nursing facility (SNF) was not covered by Medicare Part A because he had been in “medical observation” – an outpatient status – at the hospital for all 10 days.  The Englers paid the SNF $7,859 the day that he was discharged.  If they had not paid that discounted amount at the time of his discharge, the SNF told them that it would put the full amount due for his six-week stay, $15,000, into collection.  Mrs. Engler testified that she later learned that the hospital in which her husband had been on Observation Status had repaid Medicare millions of dollars because it had classified patients as inpatients instead of as outpatients.

Testifying on behalf of the Society for Hospital Medicine, Ann M. Sheehy, MD, MS, of the University of Wisconsin School of Medicine and Public Health, described observation care as “often distinguishable from inpatient care.”[4]  As a physician seeing a patient for the first time in the hospital, she testified that she is not able to tell whether the patient is an inpatient or an outpatient.  Dr. Sheehy testified that the new two-midnight rule,[5] which directs physicians to admit a patient to inpatient status if they anticipate that the patient will remain in the hospital for at least two midnights, “is not a fix for the observation problem.”  She described the difficulty for a physician of guessing whether a patient will need to stay in the hospital for two midnights before having a diagnosis or treatment plan for the patient. 

Dr. Sheehy’s research also shows that the time of day a person arrives at the hospital is a key factor that determines whether the person will be admitted as an inpatient.  In a retrospective application of the two-midnight rule at her hospital, she found that 31.2% of patients arriving after 4:00 p.m. would have been classified as inpatients, compared to only 13.6% of patients who were hospitalized before 8:00 a.m.[6] 

The Society for Hospital Medicine’s White Paper, “The Observation Status Problem: Impact and Recommendations for Change,” surveyed hospitalists, who reported that in one of six cases, they are asked to change the status of their patients.[7]  Most hospitalists reported having case managers and external consultants help make admission decisions.

Finally, Dr. Sheehy reported that the Recovery Audit Contractor (RAC) program “is fraught with problems that negatively impact Medicare beneficiaries.”  RACs are paid on a contingency basis, creating financial incentives for auditors to question physicians’ judgment.[8]

Marna Borgstrom, President and Chief Executive Officer of Yale-New Haven Health System, testified that the two-midnight rule causes confusion and huge bills for patients, strains the doctor-patient relationship, and penalizes hospitals that “provide innovative, efficient care,” especially academic medical centers and safety-net hospitals.[9]  On behalf of the Association of American Medical College’s Council of Teaching Hospitals and Health Systems, she recommended that CMS defer to physicians’ clinical judgment for hospital stays lasting less than two midnights and that Congress eliminate the (statutory) three-day inpatient stay requirement for coverage of care in a SNF.

Bob Armstrong, Vice President of Elder Care Services for St. Mary’s Health System, Lewiston, Maine, described a patient whose care at the SNF was not covered because his five-day hospital stay was classified as observation.[10]  He supported enactment of the Improving Access to Medicare Coverage Act of 201, S. 569/H.R. 1179.[11]

Senators attending the hearing – Chairman Bill Nelson (D – FL), Ranking Minority Susan Collins (R – ME), Elizabeth Warren (D – MA), Richard Blumenthal (D -CT), Tammy Baldwin (D – WI), and Sheldon Whitehouse (D – RI) – expressed concern about the problem of Observation Status.  All of them are cosponsors of S. 569.

In a written statement for the record, the HHS Office of Inspector General (OIG) discussed its 2013 report on Observation Status and the need for a careful evaluation of the new two-midnight rule.[12]  The OIG’s 2013 report evaluated hospitals’ use of observation, long outpatient stays, and short inpatient stays.[13]  It described 618,000 hospital stays in 2012 that crossed three midnights or more but would not qualify the patient for Part A coverage of the subsequent SNF stay because one or more of the midnights was not inpatient.  OIG reiterated in its 2014 statement, “It is important to ensure that beneficiaries with similar post-hospital care needs have the same access to and cost-sharing for SNF services.”

Audits by the Office of Inspector General, HHS

Despite its work expressing concern about Observation Status, the OIG, through its audit division, is conducting an ongoing series of audits, called Medicare compliance reviews, at acute care hospitals to determine whether the hospitals are appropriately reimbursed by Medicare.  The first area evaluated in the inpatient portion of OIG’s reviews is short inpatient stays, an area that OIG’s work has identified as “at risk for noncompliance.” 

A representative audit was conducted at the University of Cincinnati Medical Center and reported in June 2014.[14]  The audit covered $22,811,691 in Medicare payments made to the Medical Center for calendar years 2010 and 2011.  The OIG reviewed a stratified random sample of 228 inpatient and outpatient claims for which Medicare made payments of $3,259,968; 169 of the 228 claims were inpatient claims. 

Of these 169 inpatient claims, the OIG identified 56 claims, with Medicare payments of $570,102 that had been billed as inpatient that it found should have been billed as outpatient.  Five other categories of inpatient errors (40 claims) totaled $29,764 in overpayments in the inpatient claims category.[15]  

OIG estimated that the Medical Center received net overpayments of at least $9,818,296 for the two-year period and it recommended that the Medical Center refund the full amount to Medicare.[16]

The Medical Center described steps it has taken “to strengthen its existing internal controls related to” the Observation Status issue – requiring all RN case managers to attend a training provided by McKesson, routine audits of the case managers by the UCC Care Management Department, and adding a Medical Director to support the case management process.[17]  The Medical Center disagreed with 50 of the cases identified by the OIG and indicated its intention to appeal.[18]  It also noted that two cases involved procedures that are on CMS’s inpatient-only list and may not be billed as outpatient services.[19]

U.S. Department of Justice

On August 4, 2014, the U.S. Department of Justice announced a $98.15 million settlement with Community Health Systems, Inc. (CHS), resolving allegations made in seven separate lawsuits under the False Claims Act that the hospital company knowingly billed Medicare and other government health care programs for inpatient services that should have been billed as outpatient or observation services.”[20]  The News Release issued by the Department of Justice described the federal government’s allegations that “from 2005 through 2010, CHS engaged in a deliberate corporate-driven scheme to increase inpatient admissions” although “inpatient admission of these beneficiaries was not medically necessary.”  CHS’s News Release indicates that the settlement resolves allegations involving short stay admissions at 119 of its hospitals. [21]  The company denies any wrongdoing.  CHS is the largest operator of acute care hospitals in the United States, with 206 hospitals, and 31,000 licensed beds, in 29 states.[22] 


Observation Status and outpatient status harm Medicare patients, especially those who need to continue their recovery in a SNF.  Broad policy issues involve how to classify hospital stays, the proper role of the Recovery Audit program, and how to update criteria for Medicare coverage of SNF care.  As these issues are reviewed and debated, Medicare patients simply want all of their time in the hospital to be counted for purposes of satisfying the three day inpatient stay requirement.  Congress or CMS should act now to solve this problem.


T. Edelman, August14, 2014

[1] See the Center for Medicare Advocacy’s information on Observation Status, with links to prior Weekly Alerts, at

[5] 78 Fed. Reg. 50495, 50906-954 (Aug. 19, 2013), discussed in CMA, “Observation Status: New Final Rules from CMS Do Not Help Medicare Beneficiaries” (Weekly Alert, Aug. 29, 2013),
[6] Sheehy A, Graf B, Gangiredd S, et al, “Observation status for hospitalized patients: implications of a proposed Medicare rule change,” JAMA Intern Med. 2013; 173 (21): 2004-2006, discussed in CMA, “New Study: CMS’s 2-Midnight Rule Increases Hospital’s Use of Observation Status” (Weekly Alert, Feb. 20, 2014),
[7] Available at
[8] The Senate Special Committee on Aging held a Roundtable discussion on the Recovery Audit Program on July 9, 2014. Committee Staff Report, “Improving Audits: How We Can Strengthen the Medicare Program for Future Generations,” /doc/Improving%20Audits%20-%20Improper%20Payments%20Report%20-%20FINAL.pdf
[11] H.R. 1179 is sponsored by Congressman Joe Courtney (D, Ct) and has 158 co-sponsors, as of August 12, 2014; S. 569 is sponsored by Sherrod Brown (D, OH) and has 26 cosponsors, as of August 12, 2014. The bills would count all time in the hospital for purposes of satisfying the requirement for a three day inpatient hospital stay. 42 U.S.C §1395x(i).
[12] OIG, Statement for the Hearing Record” (July 30, 2014),
[13] OIG, Use of Observation Stays and Short Inpatient Stays for Medicare Beneficiaries, OEI-02-12-00040 (July 2013),, discussed in CMA, “Observation Status: OIG Provides an Analysis and CMS Issues Final Regulations” (Weekly Alert, Aug. 8, 2013),
[14] OIG, Medicare Compliance Review of University of Cincinnati Medical Center for Calendar Years 2010 and 2011, A-05-12-00080 (June 2014),
[15] Id. page 4, Figure 1.
[16] Id. 10.
[17] Id. 23, Appendix E, University of Cincinnati Medical Center Comments, letter dated Dec. 20, 2013 from Lee Ann Liska, Chief Executive Officer, to Regional Inspector General for Audit Services.
[18] Id.
[19] Id.  CMS discusses the inpatient-only list in the Medicare Claims Processing Manual, Chapter 4, §180.7,  The CPT Codes that are inpatient only are published as Addendum E to the Outpatient Prospective Payment System rules.  Go to  Click on 2015 OPPS NPRM Addenda; then click on Addendum E.  See for the CPT codes for the inpatient only list for 2014.
[20] Department of Justice, “Community Health Systems Inc. to Pay $98.15 Million to Resolve False Claims Act Allegations” (News Release, Aug. 4, 2014),





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