July 23, 2015
Medicare, Observation Care, and the Two-Midnight Rule
Medicare cost sharing and posthospital coverage can
outpatient services, which are covered under Medicare Part
depend on whether a beneficiary was admitted to the
B, typically pay 20% of the Medicare reimbursement
hospital and received treatment as an inpatient or received
amount for outpatient items and services after paying the
treatment as an outpatient. Some beneficiaries are surprised
annual Part B deductible ($147 in CY2015). According to a
to learn that despite having received treatment overnight in
2013 HHS OIG report, beneficiaries often incurred greater
a hospital bed during their hospital stay they were never
cost sharing for short inpatient stays than for observation
formally admitted but instead were under observation as an
stays when they received treatment for the same reason.
outpatient. The Two-Midnight Rule implemented by the
Centers for Medicare & Medicaid Services (CMS) is
Whether a patient was admitted also can affect Medicare’s
intended to clarify when an inpatient admission is
coverage for post-acute care following the hospital stay.
considered medically necessary.
Medicare provides coverage for 100 days of skilled nursing
facility (SNF) care per spell of illness. To receive SNF
Observation Care
coverage, a Medicare beneficiary must have had a three-day
inpatient hospital stay within 30 days of admission to the
Observation care typically is characterized as a component
SNF, among other requirements. Time spent as a hospital
of emergency medicine that allows hospitals to triage
outpatient does not count toward satisfying the three-day
patients who do not immediately require an inpatient
inpatient requirement for SNF coverage.
admission but are too sick to discharge immediately. Under
observation, the hospital provides assessment, ongoing
Reviews of Short Inpatient Stays
short-term treatment, and reassessment before determining
whether the patient should be admitted as an inpatient for
Some researchers have suggested that the increased use of
additional treatment or is well enough to be discharged.
observation care might be in response to increased scrutiny
However, there is some ambiguity with respect to which
of short hospital inpatient stays from Medicare and private
patients should be under observation and the duration of
payers. For instance, Medicare’s Recovery Audit Program,
their observation stay. For example, according to a 2013
which was implemented nationally in 2010, provides an
report by the Department of Health and Human Services’
increased level of scrutiny on short hospital inpatient stays.
(HHS’s) Office of Inspector General (OIG), chest pain was
This oversight is conducted due to the incentives that exist
the most common reason for an observation stay in 2012
within Medicare’s inpatient prospective payment system
and the most common reason for a short hospital inpatient
(IPPS) for hospital inpatient care. Medicare’s IPPS payment
stay (less than two nights). Additionally, while 63% of
for inpatient care is provided to the hospital on a per
observation stays were for one night or less, 11% of
discharge basis (typically not adjusted for length of hospital
beneficiaries’ observation stays were for three nights or
stay) for each inpatient admission. Thus, under the IPPS,
more in 2012.
shorter hospital inpatient stays generally are more profitable
for hospitals than longer inpatient stays. In contrast,
Observation care is provided on an outpatient basis but may
Medicare’s reimbursement for outpatient observation care
be provided within a hospital in a hospital ward, an
is provided on a per diem basis and often at a lower rate.
observation unit, or both. Dedicated observation units have
grown in popularity among U.S. hospitals. According to a
Under Medicare’s Recovery Audit Program, recovery audit
2011 academic study using National Hospital Ambulatory
contractors (RACs) conduct post-payment reviews of
Medical Care Survey data, 36% of emergency departments
Medicare claims to identify and correct improper payments.
had an observation unit in 2007, up from 19% in 2003.
One type of post-payment review is a patient status review,
Similarly, a 2012 academic study of observation stay use
which is an audit of a health care claim paid for a hospital
relative to inpatient admissions among Medicare
inpatient admission to determine if the patient could have
beneficiaries based on claims data showed an increase from
been safely and effectively treated as an outpatient (based
86.9 observation stays per 1,000 inpatient admissions in
on the available medical documentation). Patient status
2007 to 116.6 observation stays per 1,000 inpatient
reviews can act as a safeguard against the incentives to
admissions in 2009.
admit patients for short inpatient stays rather than providing
outpatient care.
Implications of Hospital Status
Under the RAC program, following a patient status review,
Whether a beneficiary is admitted to the hospital or treated
an RAC notifies the applicable Medicare administrative
as an outpatient can impact the beneficiary’s cost-sharing
contractor (MAC; an entity that processes Medicare claims)
liabilities. Under Medicare Part A, which provides inpatient
when it identifies a Medicare hospital inpatient stay in
hospital coverage, beneficiaries are required to pay an
which the patient could have been safely and effectively
inpatient deductible ($1,260 in CY2015) if they are
treated in an outpatient setting. Hospitals may appeal RAC
admitted to the hospital. Beneficiaries who receive hospital
decisions of medically unnecessary hospital inpatient
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Medicare, Observation Care, and the Two-Midnight Rule
admissions. Additionally, a hospital that returns its inpatient
period to assess hospitals’ understanding of the rule and to
reimbursement is able to rebill Medicare Part B for items
assist hospitals in compliance with it. Additionally, CMS
and services that would have been payable under Part B had
prohibited RACs from conducting patient status reviews on
the beneficiary originally been treated as an outpatient
hospital inpatient admissions of less than two midnights
rather than an inpatient (if the dates of services occurred in
between October 1, 2013, and October 1, 2014. The
the last 12 months). Certain services cannot be rebilled to
Protecting Access to Medicare Act (PAMA; P.L. 113-93)
Part B because they specifically require an outpatient status
permitted CMS to extend the probe and educate period and
on the date of service (e.g., observation services, emergency
to extend the moratorium on RAC patient status reviews of
department visits). Beneficiaries may be refunded if cost
hospital inpatient admissions through March 31, 2015.
sharing is less under Part B, or they may be liable for
Recently, the Medicare Access and CHIP Reauthorization
additional cost sharing if their liability under Part B is
Act of 2015 (MACRA; P.L. 114-10) permitted CMS to
greater.
further extend the probe and educate period and to continue
the PAMA moratorium on RAC patient status reviews
Two-Midnight Rule
through September 30, 2015.
In response to concerns over long observation stays and
Recent Changes to the Two-
RAC determinations of medically unnecessary short
Midnight Rule
hospital inpatient admissions, CMS finalized the Two-
Midnight Rule on August 19, 2013. This rule was intended
On July 1, 2015, CMS released proposed changes to the
to provide clarification on when hospital inpatient
Two-Midnight Rule under the Hospital Outpatient
admissions and hospital outpatient services generally are
Prospective Payment and Ambulatory Surgical Center
appropriate. Under the Two-Midnight Rule, if the admitting
Payment Systems proposed rule (see 80 Federal Register
physician expects a beneficiary’s treatment will require a
39200). In the proposed rule, CMS stated it would continue
stay in the hospital that crosses two midnights, or if the
to use the two-midnight benchmark for a medically
treatment includes a procedure that is specified by CMS as
necessary inpatient admission. However, CMS would
inpatient only, it generally is to be deemed appropriate and
provide added flexibility to this rule on a case-by-case basis
medically necessary under Medicare regulations for the
for hospital inpatient stays of less than two midnights if the
physician to admit the beneficiary to the hospital as an
admitting physician determines that an inpatient stay is
inpatient and for the hospital to receive reimbursement
expected to be less than two midnights but documentation
under Medicare Part A. Such a decision to admit a
in the medical record supports the physician’s judgment
beneficiary can come after the beneficiary has spent one
that an inpatient admission is necessary. Additionally, Part
midnight under observation or has received other hospital
A payment would continue to be made for an inpatient stay
outpatient services. Hospital stays that are expected to be
of less than two midnights if the procedure is specified as
less than two midnights generally will be considered
inpatient only or for a case identified under the rare and
outpatient stays, unless they are a “rare and unusual”
unusual exception.
exception, of which only one has been identified (certain
cases that involve newly initiated mechanical ventilation).
No later than October 1, 2015, Quality Improvement
Organizations (QIOs)—groups of regional and national
Additionally, with the implementation of this rule, CMS
health quality experts, clinicians, and consumers under
would instruct RACs to no longer conduct patient status
contract from CMS—in replacement of MACs, would
reviews on inpatient stays of two midnights or more. For
review inpatient stays of less than two midnights. For short
inpatient stays of less than two midnights, RACs could
inpatient stays that do not fall under the inpatient-only
continue to conduct patient status reviews to determine if
procedure list or the cases identified as rare and unusual
the inpatient stay could have been safely provided on an
exceptions, Part A reimbursement would be subject to the
outpatient basis.
clinical judgment of the QIO medical reviewer based on
information contained in the medical record. QIOs would
Hospital-advocacy groups contend that the Two-Midnight
refer claim denials to the MAC for payment adjustment.
Rule is overly complicated, administratively burdensome,
QIOs also would educate hospitals about claims denied
and undermines a physician’s medical judgment. Hospital
under the Two-Midnight Rule and collaborate with such
groups filed a lawsuit in U.S. District Court for the District
hospitals to improve organizations’ processes and/or
of Columbia contending that the Two-Midnight Rule and
systems. Hospitals that consistently fail to adhere to the rule
related policies burden hospitals with arbitrary standards
or fail to improve their performance after QIO educational
and documentation requirements and deprive hospitals of
intervention would be referred to RACs for further payment
Medicare reimbursement to which they are entitled. CMS
audit. CMS is accepting public comments on all sections of
has stated that the Two-Midnight Rule does not override the
the proposed rule through August 31, 2015. Absent
clinical judgment of a physician but provides a benchmark
additional administrative or congressional action, such
for physician expectation of a medically necessary inpatient
payment audits can begin on October 1, 2015.
admission and consistent application of Medicare’s Part A
benefit.
Scott R. Talaga, stalaga@crs.loc.gov, 7-5956

CMS implemented the Two-Midnight Rule and instructed
MACs to implement a “probe and educate” medical review
IF10264
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