Inpatient vs. Observation Status: Finally Some Hope for Medicare Patients

A recent decision by the U.S. District Court for the District of Connecticut offers hope to Medicare beneficiaries caught up in the confusing and oft-times conflicting web of government reimbursement regulations impacting the decision whether a patient should be admitted to the hospital as an “inpatient” or placed on “observation” (i.e., outpatient) status during the patient’s hospital stay.

In Alexander v. Azar, No. 3:11-cv-1703 (D. Conn. Mar. 27, 2019), the court refused to dismiss a nationwide class action originally brought by seven Medicare beneficiaries on behalf of themselves and all Medicare beneficiaries placed on observation status during their hospital stay, rather than being admitted as inpatients. In denying a motion for summary judgment by the defendant, the Secretary of the U.S. Department of Health and Human Services (“DHS”), the court held that the plaintiffs had submitted sufficient evidence from which a reasonable fact finder could conclude that the “Two Midnight Rule” (or the “Rule”),[1] first issued in 2013 by the Centers for Medicare and Medicaid Services (“CMS”), established fixed criteria that, as applied, effectively dictate inpatient admission decisions, notwithstanding language in the regulation stating that the decision is based on the physician’s discretion, thus creating a property interest in being admitted as an inpatient when the requirements of the Rule are met. The court further held that the failure to admit a patient as an inpatient in such cases would result in the government’s deprivation of that property interest, without the patient having any right to a hearing or other administrative review to challenge that decision, in violation of the Due Process Clause of the Fifth Amendment.[2]

A. Background

  1. Medicare Part A vs. Part B Reimbursement

The determination of whether a Medicare beneficiary will be admitted to the hospital as an inpatient or placed on observation status can have severe financial ramifications for the patient. CMS pays hospitals for inpatient care under Medicare Part A, and for outpatient services, including observation services provided in a hospital setting, under Medicare Part B. For inpatient hospital stays under Part A, beneficiaries pay an annual deductible ($1,340 in 2019) and a daily coinsurance amount after the first 60 days (Medicare pays in full for the first 60 days). For observation services under Part B, covered beneficiaries pay 20% of a bundled payment rate for most facility charges (diagnostic imaging, stress testing, infusions, etc.), and 20% of professional fees. Beneficiaries under observation may also be responsible for the cost of self-administered medications taken at the hospital, and the full amount of any Part B services not covered by the bundled rate. If the patient is not enrolled in Medicare Part B, there is no coverage.

  1. SNF Coverage Requirement

In addition to implications for hospital coverage, if the patient requires care at a skilled nursing facility (“SNF”) after discharge, Medicare will pay for those services under Part A, but only if the patient has been an “inpatient” in the hospital for at least three consecutive days immediately prior to transfer to the SNF. Time spent on observation status does not count toward the three inpatient day requirement (e.g., if a patient is placed on observation status for one day, and then admitted as an inpatient for two days, Medicare will not pay for the SNF care at all).[3] The observation vs. inpatient admission decision can therefore have a far reaching impact on a patient’s financial obligations for hospital and SNF care, and hence his or her property interest.

  1. Disincentives to Admission Decision

The decision whether to formally admit a patient to the hospital has been further complicated by the fact that, while the determination has usually been regarded as a medical decision within the discretion of the patient’s treating physician, in reality that decision may be subsequently overturned, even retroactively, either internally, e.g., by the hospital’s utilization review (“UR”) committee, or externally, e.g., by a Quality Improvement Organization (“QIO”), a Recovery Audit Contractor (“RAC”) or by other authorized Medicare contractors (collectively, “Medicare Contractors”). (RAC audits are now only authorized upon referral by a QIO for a provider exhibiting “persistent noncompliance with Medicare payment policies”.)[4] If the admitting physician’s determination is subsequently overturned by the hospital’s UR committee prior to discharge, the patient’s status may be changed from inpatient to outpatient, and the hospital may bill under Part B for inpatient services that would have been reasonable and necessary had the hospital treated the beneficiary as an outpatient from the date of admission, provided that the criteria set forth in CMS’s Condition Code 44 are met.[5] If a Medicare Contractor reverses a hospital’s claim for payment under Part A after the patient has been discharged, the hospital may submit a claim for payment under Part B as long as it is filed within the Medicare time limit, which is one year from the date of service.[6] Unfortunately, in most cases, Medicare Contractor determinations are not made until long after the Medicare filing period has expired and the hospitals are left with no Medicare reimbursement for that stay at all. Hospitals have the right to appeal reversals by Medicare Contractors, but patients do not. Also, while Part A claims are subject to review by Medicare Contractors, Part B claims generally are not. Consequently, possibly out of fear of receiving no Medicare reimbursement for a hospital admission (especially a short stay), the risk of a lengthy and costly appeals process, or to avoid Part A review by various Medicare Contractors, hospitals are increasingly opting to have Medicare patients placed on observation status initially to ensure that it can bill for at least the Part B services. In fact, the ratio of observation stays to inpatient admissions has grown significantly in recent years.[7]

  1. The NOTICE Act

Recognizing that a growing number of patients were unaware of their status in the hospital or the financial liability they would be assuming for observation services, on August 6, 2015 Congress enacted the Notice of Observation Treatment and Implication for Care Eligibility (“NOTICE”) Act[8], which requires hospitals to provide oral and written notice to patients who receive observation services on an outpatient basis for more than 24 hours. The notice is to be given within 36 hours after the patient begins to receive observation services, and must explain, among other things, the reason(s) the patient was placed on observation, the implications of that status on the services furnished (including those furnished as an inpatient), and the implications for cost-sharing requirements and subsequent coverage eligibility for services furnished by a skilled nursing facility. In fact, CMS has created a standardized form – the Medicare Outpatient Observation Notice (the “Moon” notice) to be given to Medicare patients for this purpose. While it is laudable that patients must now receive notice of being placed on observation status, it is debatable how effective that notice will be in reality since most of these patients will be either elderly or disabled, or both, and usually first seen in the Emergency Department where they will often be under considerable stress. Most importantly, however, these patients do not have a right to appeal or otherwise challenge the observation status determination, notwithstanding this notice.

B. The Two Midnight Rule

The Two-Midnight Rule was originally adopted by CMS on October 1, 2013 (FY 2014) as part of the Medicare Benefit Policy Manual to establish a “bright line test” to clarify when a patient should be admitted as an inpatient or placed on observation status.[9] Under this Rule, an inpatient admission is generally appropriate for payment under Medicare Part A if the admitting physician expects the patient to require hospital care that “crosses at least two midnights”. Otherwise, observation / outpatient status is generally appropriate.

In arguing to the court that the Two-Midnight Rule does not grant a property interest in Medicare beneficiaries, the Secretary of DHS pointed to the specific language in the Rule which states that the admission decision is “discretionary” based on the physician’s review of “complex medical factors.” However, the court noted that the inclusion of discretion in a legal standard does not necessarily prevent the standard from creating an interest protected by the Due Process Clause. According to the court, it is well established that a recipient of government benefits, including Medicare benefits, may possess a property interest protected by the Due Process Clause, and that a legitimate claim to entitlement to those benefits exists when a regulatory or statutory scheme places “substantive limitations” on official discretion or “meaningfully channels” that discretion by mandating a defined outcome. The court further stated that it is a close question whether the language of the Two-Midnight Rule, considered alone, creates a property interest. However, the court found that there was sufficient evidence in the record for a fact finder to conclude that, in practice, the Rule is less discretionary than its language might suggest. That evidence included, among other things:

  • Evidence that applying the Rule is “a billing decision divorced from physician judgment;”
  • CMS guidance regarding when an inpatient admission is appropriate and payable under Part A, suggesting that the Rule should be applied in a rigid, formulaic manner;
  • CMS’s development of a “2 Midnight Rule Claim Review Guideline” for QIOs consisting of an “algorithm” or decision tree to review the admission decision;
  • CMS’s authorization to QIOs to rely on “commercially available screening tools” for their review of medical necessity admissions;
  • CMS’s steps to ensure that hospitals implement the Two Midnight Rule in accordance with its instructions (including requiring development of a utilization review plan and review of all inpatient admission orders); and
  • Evidence that a number of hospitals have developed internal policies treating the Rule as non-discretionary and requiring an inpatient admission where the requirements of the Rule are satisfied.

The court therefore concluded that plaintiffs had presented sufficient evidence for a trier of fact to conclude that a physician’s decision to admit a beneficiary as an inpatient “is meaningfully constrained by fixed criteria” and that CMS “meaningfully channels” physician discretion under the Two Midnight Rule, either directly or through its control of hospital reimbursement, effectively mandating inpatient admission when the standards of the Rule are met. The court further stated that if the fact-finder were to so conclude, the plaintiffs would have a protected property interest in being admitted as inpatients, and the failure to admit them as such, without affording those Medicare beneficiaries a hearing or other right to administrative review, would be in violation of the Due Process Clause of the Fifth Amendment. The court therefore ordered that the case proceed to trial promptly.

If the plaintiffs are successful at trial (and on appeal), the potential damages awarded in this nationwide class action could be staggering, which alone would send a loud message to CMS and to Congress that the system must change. If the plaintiffs are not successful, this decision has nonetheless highlighted the need for comprehensive reform of a system that is clearly broken.

C. Conclusion

The continued use of observation status as currently structured is a confusing, time consuming and costly problem for physicians, hospitals and patients alike. A more sensible and compassionate approach would be for CMS to: (i) eliminate all reimbursement-related incentives and disincentives to the observations vs. inpatient decision, including the Two Midnight Rule, and return the use of observation status to the treating physicians, consistent with its original intent; and (ii) eliminate the three day inpatient requirement for SNF coverage post discharge, or at least count time spent on observation toward that calculation.

In addition, Congress should step in and enact legislation that, at a minimum, provides all Medicare beneficiaries with a statutory right to challenge the denial of an inpatient admission, and, if CMS does not take the action recommended above, Congress should enact further legislation that does so.

To read a copy of the Alexander v. Azar click here.

To read a copy of the Two Midnight Rule click here.

[1] See:  42 C.F.R. §412.3(d)(1).
[2] DHS subsequently submitted a motion for reconsideration which was denied by the court in a Memorandum of Decision, dated June 4, 2019.  See: Alexander v. Azar, No. 3:11-cv-1703 (D. Conn. June 4, 2019)
[3] Legislation was introduced in both Houses of Congress in 2017 to remedy the issue with respect to follow-up SNF care.  The Improving Access to Medicare Coverage Act of 2017 would have required that time spent on observation status would count toward meeting the three-day prior inpatient stay requirement.  However, that legislation has not been enacted.
[4] See:  CMS Guidance: Reviewing Short Stay Hospital Claims for Patient Status: Admissions On or After January 1, 2016, dated December 31, 2015.
[5] Condition Code 44 was first introduced by CMS on September 10, 2004 in Transmittal 299, Change Request 3444.  Condition Code 44 requires, among other things, that the process be completed, including written notification to the patient, before the patient is formally discharged from the hospital; the decision to use Condition Code 44 must come from a member of the UR Committee who must be a physician (or other practitioner) on the medical staff; the attending physician must agree with the change, with that concurrence documented in the chart; if the attending does not agree, he or she can be overruled by two members of the UR Committee, but that admission would remain inpatient and require self-denial by the hospital.
[6] See:  42 C.F.R. § 424.44(a).
[7] The Hospital Observation Care Problem, Perspectives and Solutions from the Society of Hospital Medicine, by the Society of Hospital Medicine, Public Policy Committee, September 2017.
[8] Public Law 114-42, 42 U.S.C. §1395cc(a)(1)(Y).  The NOTICE Act was effective on March 20, 2017.
[9] Prior to the Two Midnight Rule, the Medicare Benefit Policy Manual provided that physicians should use a 24-hour period as a benchmark, i.e., they should order inpatient admission for patients who are expected to need hospital care for 24 hours or more.