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Observation Status – hospital patients’ classification as outpatients, which makes them ineligible for Medicare Part A coverage of their subsequent stay in a skilled nursing facility (SNF) when they do not have “inpatient” status for at least three consecutive midnights – is an ongoing issue that the Center for Medicare Advocacy has discussed many times.[1]  This Alert is an update of current activities.

I. Medicare Payment Advisory Commission

At its April 2, 2015 public meeting, the Medicare Payment Advisory Commission (MedPAC), the independent government entity that advises Congress on Medicare policy, voted unanimously to support a package of recommendations for hospital short inpatient stays.[2]  MedPAC had discussed many of these issues in four prior public meetings.

One recommendation allows Observation Status time to be counted toward the qualifying inpatient hospital stay requirement, but only if the patient has at least one inpatient day in the hospital.[3]  The Commissioners approved this recommendation along with other recommendations in the package, but they did not discuss the issue at the April meeting. 

At the prior public meeting on January 16, 2015, MedPAC staff explained that the Observation Status recommendation, then in its proposed form, would continue to recognize the SNF benefit as a post-hospital benefit, and would protect “the financial interests” of the Medicare program.[4] The recommendation would affect approximately 50,000 of the 100,000 patients who were hospitalized for at least three midnights but did not meet the three-day inpatient requirement.

At the April meeting, staff explained the potential impact of the recommendation:

The Commission anticipates that this policy will increase program spending for the beneficiaries who will now qualify for SNF coverage.  The overall impact of this policy on spending is dependent on the behavioral response of beneficiaries and providers.  For example, a lower threshold for Medicare SNF coverage could provide a greater incentive for nursing facilities to send beneficiaries to the hospital in order to requalify for the SNF benefit.[5]

MedPAC’s reasoning on the issue of Observation Status is flawed.  Counting all time in the hospital would not expand the Medicare SNF benefit.  Since its enactment, the Medicare program has required that a patient be hospitalized for at least three days before Part A will pay for post-acute care in a SNF (assuming all other requirements are also satisfied).  What has changed is that many hospitalized patients are now called outpatients and are not formally admitted as inpatients, even though the care they receive as outpatients is indistinguishable from the care they would receive if they were formally admitted as inpatients;[6] the distinction between inpatient and outpatient status does not make clinical sense.[7] 

Commissioners also overstate concerns about SNFs’ sending patients to hospitals in order to qualify them for new Medicare benefit periods.  Qualifying for a new benefit period requires more than rehospitalization.  A SNF resident is not eligible to begin a new benefit period unless the resident has not been in either a hospital or a SNF receiving Medicare-covered care for at least 60 consecutive days, and then the resident must be hospitalized for at least three consecutive days, be admitted to the SNF within 30 days of discharge from the hospital, and meet all other requirements for Part A coverage.[8]

At the April meeting, Commissioners approved two additional beneficiary protections.  They recommended that Congress:

(1) Require hospitals to give patients timely notice of their Observation Status[9] and
(2) include self-administered drugs in the reimbursement to hospitals for patients’ outpatient stays, instead of allowing hospitals to bill patients for these drugs.[10]

MedPAC recognizes that the primary cause of hospitals’ increased classification of patients as outpatients is the Recovery Audit program (still known by its former name, Recovery Audit Contractor [RAC]).  When RACs determine that hospitals improperly classified patients as inpatients instead of as outpatients, hospitals are required to return all Medicare reimbursement they received, even when there is no dispute that the care the hospitals provided was medically necessary and appropriate. 

MedPAC’s package of suggested changes includes recommendations for the RACs:

(1) The Secretary of Health and Human Services should consider establishing a penalty system for hospitals that have excessive rates of short inpatient stays.  Such a penalty system would replace RAC review, either in whole or in part.[11]
(2) The three-year look-back period for RAC review and the hospital one-year period for rebilling Medicare Part B should be aligned, so that hospitals have sufficient time to rebill Medicare under Part B if Part A claims are denied.

As part of the RAC reforms, MedPAC also recommends that the Secretary withdraw the two-midnight rule.[12]  Most of the Commissioners’ discussion in April focused on this rule.

The two-midnight rule, which CMS promulgated in 2013,[13] creates time-based presumptions for determining whether patients are inpatients or outpatients.  Under the two-midnight presumption, a physician should order inpatient status when he or she “expects the patient to require a stay that crosses at least 2 midnights.”[14]  If the physician is unsure or believes the patient is likely to remain hospitalized for fewer than two midnights, the patient should be classified as an outpatient.  A two-midnight benchmark directs RACs not to audit hospitals for patients who were hospitalized for two midnights.  (The 2013 rules also authorize hospitals to rebill Medicare Part B for services provided to hospitalized outpatients, but hospitals must submit the new bills within one year of providing the services.[15]  As noted above, MedPAC wants to align the times for hospital rebilling and RAC review.)

CMS has repeatedly delayed RAC enforcement of the two-midnight rule,[16] which has been controversial.  At the April meeting, some Commissioners described the two-midnight rule as a safe harbor for hospitals.  Nevertheless, they support its withdrawal, seeing the rule as a barrier to the continued reduction in patients’ length of stay in hospitals. 

II. Congress

The Medicare Access and CHIP Reauthorization Act of 2015, Pub. Law 114-10, delays enforcement of the two-midnight rule.

The Improve Access to Medicare Coverage Act of 2015, legislation to count all time in the acute-care hospital for purposes of satisfying the three-day hospitalization requirement for Part A coverage of care in a SNF, has been reintroduced in the 114th Congress as H.R. 1571 and S.843.[17]

III. AARP Report

A new report by AARP’s Public Policy Institute, Observation Status: Financial Implications for Medicare Beneficiaries,[18] finds that hospitalized patients who spent at least three days in Observation Status and later went to a SNF that was not covered by Medicare, owed, on average, $12,970 for their SNF care.  This cost was more than five times the amount these patients would have owed the SNF if they had had a qualifying inpatient stay in the hospital.

IV. Litigation

The Second Circuit Court of Appeals reversed and remanded Bagnall v. Sebelius, now known as Barrows v. Burwell, No. 13-4179-cv (2nd Cir., Jan. 22, 2015), holding that Medicare beneficiaries placed in Observation Status may have a Constitutionally-protected interest in challenging their outpatient classification.[19]  The case is now proceeding in the discovery phase.


Observation Status is a problem affecting hundreds of thousands of Medicare beneficiaries and their families.  It is past time for this problem to be resolved, whether by legislation, administrative action,[20] or litigation.

T. Edelman – April 2015

[1] See
[2] The Issue Brief is at; the PowerPoint presentation, at; the transcript, at
[3] See transcript,, at 17.
[4] See, slide 10.  See CMA, “Observation Status and the Medicare Payment Advisory Commission,” (Weekly Alert, Jan. 22, 2015),
[5] See transcript,, at 17.
[6] See testimony of Ann Sheehy, M.D., testifying at the Senate Special Committee on Aging’s hearing, “Admitted or Note: The Impact of Medicare Observation Status on Seniors,” on July 30, 2014, page 4,
[7] See testimony of Ann Sheehy, M.D., testifying at the Ways and Means Committee’s Health Subcommittee hearing, “Current Hospital Issues in the Medicare Program,” on May 20, 2014, page 2,
[8] 42 U.S.C. §1395x(a); 42 C.F.R. §409.60.
[9] 18-19.
[10] 20.
[11] 9.
[12] 9.
[13] 78 Fed. Reg. 50495, 50906-954 (Aug. 19, 2013). See CMA, “Observation Status: New Final Rules from CMS Do Not Help Medicare Beneficiaries,” (Weekly Alert, Aug. 29, 2013),
[14] 42 C.F.R. §412.3(e)(1).
[15] 42 C.F.R. §414.5.
[16] Most recently, on April 1, 2015, CMS again delayed enforcement of the two-midnight rule, in light of Congress’ consideration of H.R. 2, the Medicare Access and CHIP Reauthorization Act of 2015.
[17] See CMA, “Observation Status Bills Reintroduced in Both the House and Senate (H.R.1571/S.843),” (Weekly Alert Mar. 26, 2015),
[19] See CMA, “Appeals Court Allows Hospital Patients in ‘Observation Status’ to Continue Court Case,” (Weekly Alert, Jan. 29, 2015),  The Second Circuit decision is at
[20] The Center for Medicare Advocacy believes that the Secretary has authority to promulgate rules counting all time in the hospital, including observation time, for purposes of the three-day qualifying hospital requirements. See

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