JAMA Forum: The Unintended Consequences of the “Observation Status” Policy

Diana Mason, PhD, RN

Diana Mason, PhD, RN

Imagine you’re 78 years old and covered by Medicare, and one afternoon sudden chest pain sends you to the emergency department (ED). There, after a physical examination and some diagnostic tests, the ED physician says she wants to hospitalize you to monitor your condition. After a week of hospitalization, experiencing fluctuating symptoms, you are transferred to a skilled-nursing facility (SNF); on the second day there, you are told Medicare won’t pay for your care at the SNF because you weren’t a hospital inpatient for a minimum of 3 nights.

What you didn’t know—and what even the hospital unit physicians and nurses may not have known—is that you were hospitalized as an outpatient on what is called “observation status.” Even though you were on a unit with others admitted as inpatients, and even though all of you received care from the same staff, you were initially admitted so that your health status could be observed and evaluated. But during your week-long hospital stay, your status was never changed from outpatient (observation status) to inpatient.

Medicare’s observation status rule causes so much confusion that advocates such as AARP and the Center for Medicare Advocacy have taken on the issue, and the Centers for Medicare and Medicaid Services (CMS) has been deliberating on how to refine the rule. There were an estimated 1.5 million observation stays among Medicare beneficiaries in 2012. The number increased 100% from 2001 to 2009, likely because of financial pressure on hospitals to reduce potentially preventable readmissions of inpatients within 30 days. Patients who are on observation status are considered outpatients, and so the Medicare readmission rules (and penalties) don’t kick in if they are readmitted within a month.

Why the Difference?

Why differentiate between regular hospitalizations and observation status admissions? The Medicare policy arose from the realization that patients who only need to be observed shouldn’t cost payers as much as those who need more care. Indeed, Medicare now pays much less for the observation admissions. In 2012, there were 1.1 million “short inpatient” hospitalizations of less than 2 nights that cost Medicare almost 3 times the amount it would have paid for an observation stay of the same length.

But there have been several unintended consequences of the observation status policy:

  1. Consequences for patients without Medicare Part B coverage. Medicare Part A pays for inpatient stays, including medications. But observation status is not considered an inpatient stay. If you are hospitalized on observation status, payment by Medicare is under Part B, which covers physician and outpatient services. But an estimated 3.9 million Medicare beneficiaries have opted out of Part B coverage, and if Medicare won’t pay, it’s often the patient who’s left with the bill.
  2. Consequences for the hospital. A year after an inpatient hospitalization, Medicare auditors could determine that the patient should have been admitted on observation status and that the hospital should refund Medicare for the stay. In 2013, CMS authorized payment under Medicare Part B for all reasonable and necessary outpatient-type services provided to patients who auditors found did not qualify for inpatient hospitalization, rather than not cover anything. This presumes the patient has opted in for Part B coverage.
  3. Consequences for skilled nursing care. Perhaps most significantly, an observation status admission precludes Medicare coverage of a subsequent SNF stay, even if the patient has met the longstanding rule of spending at least 3 consecutive midnights in a hospital. In 2012, 11% of Medicare patients on observation status had hospitalizations of 3 or more nights. In some cases, physicians will reclassify people as inpatients when more than observation is needed. Observation status was intended for short stays: 48 hours or less. Medicare patients who are not reclassified as inpatients will have to either forgo SNF care or pay for it themselves, regardless of the length of their hospitalization.

Reducing the Unintended Consequences

Those concerned about the unintended consequences of the observation status rule under Medicare highlight 4 possible improvements:

  1. Require that patients be informed in writing when they are admitted on observation status and the implications of that designation. CMS has revised its definition of “inpatient” as requiring at least 2 nights of hospitalization and encourages physicians to write inpatient-admission orders reflecting this definition. If 2 nights are not expected, the patient should be admitted on observation status. Right now, the only way for patients to know for sure whether they are on observation status is to ask.
  2. Limit the amount a patient would have to pay for an observation stay. AARP has proposed that the cap be the amount of the patient’s inpatient deductible.
  3. Eliminate or reduce the 3-night hospital stay rule for covering SNF care or include observation days in the count. The 3-night rule was developed when hospital stays were much longer. But changing this policy will require legislation, not just a rule change. In testimony before the House Ways and Means Subcommittee on Health, the Center for Medicare Advocacy’s senior policy attorney, Toby Edelman, called for legislation eliminating the 3-night rule.
  4. Set aside dedicated observation units in hospitals. A study conducted in 2012 estimated that such units could lessen confusion about observation status and decrease costs to patients, hospitals, and Medicare by up to $3.1 billion a year. Although some hospitals have such units, most do not.

Edelman closed her testimony on May 20, 2014, with a quote from Robert Wachter’s 2013 commentary in JAMA Internal Medicine:

…if one was charged with coming up with a policy whose purpose was to confuse and enrage physicians and nearly everyone else, one could hardly have done better than Observation Status.

Whether through legislation or rule-making or actions by hospitals, it’s time to clean up the unintended consequences of this policy.


About the author: Diana J. Mason, PhD, RN, is the Rudin Professor of Nursing and Codirector of the Center for Health, Media, and Policy at the Hunter College; Professor at the City University of New York; and President of the American Academy of Nursing.

About The JAMA Forum: JAMA has assembled a team of leading scholars, including health economists, health policy experts, and legal scholars, to provide expert commentary and insight into news that involves the intersection of health policy and politics, economics, and the law. Each JAMA Forum entry expresses the opinions of the author but does not necessarily reflect the views or opinions of JAMA, the editorial staff, or the American Medical Association. More information is available here and here.


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