There is an ongoing controversy between hospitals and government regulators (The Centers for Medicare and Medicaid Services, or “CMS”)—with Medicare beneficiaries caught in the middle. Although the issue seems technical and bureaucratic, it raises some significant issues for those covered by Medicare.

What is Going On?
Hospitals can label a stay as an “admission” to the hospital—or as a stay for “observation.” In recent years the use of observation status has skyrocketed; as noted by the Kaiser News Network, the use of observation status rose 88% between 2006 and 2012 and the number of observation stays lasting more than 48 hours increased five-fold in the same period.

This use of observation status can add to the cost Medicare—and to the amounts paid by Medicare beneficiaries. Here is what is going on—and why it matters:

  • Medicare reimburses hospitals differently for services provided on an in-patient basis and services provided on an outpatient basis. In-patient care generates significantly higher fees for hospitals. For comparable diagnoses an inpatient admission costs Medicare $3,160 more than treatment on an outpatient basis. As a result, government auditors have focused on short hospital stays where the diagnosis does not clearly justify hospitalization. Hospitals do not like this focus; the process of having claims questioned – or even disallowed –can be costly and is something hospitals seek to avoid.
  • CMS uses hospital readmission as one of its measures of quality of care—and a hospital with excessive readmissions can be lose up to 2% of total Medicare reimbursements. Needless to say, this is real money. This gives hospitals yet anther incentive to treat certain situations as “observations” and not admissions.

In response to these factors hospitals have been holding patients for “observation”—a medical form of limbo, where a patient may spend one (or more) nights in a hospital, but is not admitted on an in-patient basis. Over the past few years the increased use of “observation” status has been a source of frustration to Medicare beneficiaries.

Why does this matter?
Medicare is a series of silos—one silo (Part A) covers hospitalization, while other silos cover outpatient care (Part B) and prescription drugs (Part D). Confusingly, there are many differences between these coverages that affect people caught in observation status

    • Part A has a deductible ($1,260 per “benefit period”), but does not have a copayment. By contrast, Part B has a modest annual deductible ($147/year) but a 20% copayment (with no out-of-pocket maximum). So, the decision to keep someone in the hospital under observation status can result in a copay liability of 20% of the hospital bill—adding to the beneficiary’s costs that are not protected by an out-of-pocket maximum.
    • Part A also covers prescription drugs administered during a hospitalization. Part B (generally) does not cover prescription drugs and prescription drugs are covered (under Part D) only if an individual purchases prescription drug coverage from a private insurance company. So, observation status can also trigger higher costs for any prescription drugs administered in the hospital.
    • Medicare Part A covers skilled nursing care (with no deductible or copayment for the first 20 days of care) only after an inpatient hospital stay of 3 consecutive days or more, measured from the day the hospital admits you as an inpatient. This 3-day period does not include any period of observational status or the day of discharge from the hospital.

So, you can see how observation status can easily develop into an acute case of financial shock.

What’s Next?
There have been a number of different proposals to change how Medicare treats observations and short-term admissions. More on that in our next blog. However, what is lost in this controversy is the underlying problem—Medicare is a 50-year old design, reflecting the “base plus major medical” design found in the 1950s. This approach simply does not reflect medical advances that allow for shorter—or no—hospitalizations and for use of alternative settings for the delivery of care.

The controversy over observation status versus hospital admissions is not the illness; it is the symptom. Medicine has moved on since 1965; so should Medicare.