Medicare, Observation Care, and the Two-Midnight Rule
Updated November 18, 2015
Medicare, Observation Care, and the Two-Midnight Rule
Medicare cost sharing and posthospital coverage can
amount for outpatient items and services after paying the
depend on whether a beneficiary was admitted to the
annual Part B deductible ($147 in CY2015). According to a
hospital and received treatment as an inpatient or received
2013 HHS OIG report, beneficiaries often incurred greater
treatment as an outpatient. Some beneficiaries have been
cost sharing for short inpatient stays than for observation
surprised to learn that despite having received treatment
stays when they received treatment for the same reason.
overnight in a hospital bed during their hospital stay, they
were never formally admitted but instead were under
Whether a patient was admitted also can affect Medicare’s
observation as an outpatient. The Two-Midnight Rule
coverage for post-acute care following the hospital stay.
implemented by the Centers for Medicare & Medicaid
Medicare provides coverage for 100 days of skilled nursing
Services (CMS) is intended to clarify to hospitals when an
facility (SNF) care per spell of illness. To receive SNF
inpatient admission is considered medically necessary.
coverage, a Medicare beneficiary must have had a three-day
inpatient hospital stay within 30 days of admission to the
Observation Care
SNF, among other requirements. Time spent as a hospital
Observation care typically is characterized as a component
outpatient does not count toward satisfying the three-day
of emergency medicine that allows hospitals to triage
inpatient requirement for SNF coverage. P.L. 114-42 (The
patients who do not immediately require an inpatient
NOTICE Act), signed into law on August 6, 2015, requires
admission but are too sick to discharge immediately. Under
hospitals to notify a beneficiary if he or she has been under
observation, the hospital provides assessment, ongoing
observation for more than 24 hours and communicate the
short-term treatment, and reassessment before determining
implications of such status.
whether the patient should be admitted as an inpatient for
additional treatment or is well enough to be discharged.
Reviews of Short Inpatient Stays
However, there is some ambiguity with respect to which
Some researchers have suggested that the increased use of
patients should be under observation and the duration of
observation care might be in response to increased scrutiny
their observation stay. For example, according to a 2013
of short hospital inpatient stays from Medicare and private
report by the Department of Health and Human Services’
payers. For instance, Medicare’s Recovery Audit Program,
(HHS’s) Office of Inspector General (OIG), chest pain was
which was implemented nationally in 2010, provides an
the most common reason for an observation stay in 2012
increased level of scrutiny on short hospital inpatient stays.
and the most common reason for a short hospital inpatient
This oversight is conducted due to the incentives that exist
stay (less than two nights). Additionally, while 63% of
within Medicare’s inpatient prospective payment system
observation stays were for one night or less, 11% of
(IPPS) for hospital inpatient care. Medicare’s IPPS payment
beneficiaries’ observation stays were for three nights or
for inpatient care is provided to the hospital on a per
more in 2012.
discharge basis (typically not adjusted for length of hospital
stay) for each inpatient admission. Thus, under the IPPS,
Observation care is provided on an outpatient basis but may
shorter hospital inpatient stays generally are more profitable
be provided within a hospital ward, an observation unit, or
for hospitals than longer inpatient stays. In contrast,
both. Dedicated observation units have grown in popularity
Medicare’s reimbursement for outpatient observation care
among U.S. hospitals. According to a 2011 academic study
is provided on a per diem basis and often at a lower rate.
using National Hospital Ambulatory Medical Care Survey
data, 36% of emergency departments had an observation
Under Medicare’s Recovery Audit Program, recovery audit
unit in 2007, up from 19% in 2003. Similarly, a 2012
contractors (RACs) conduct post-payment reviews of
academic study of observation stay use relative to inpatient
Medicare claims to identify and correct improper payments.
admissions among Medicare beneficiaries based on claims
One type of post-payment review is a patient status review,
data showed an increase from 86.9 observation stays per
which is an audit of a health care claim paid for a hospital
1,000 inpatient admissions in 2007 to 116.6 observation
inpatient admission to determine if the patient could have
stays per 1,000 inpatient admissions in 2009.
been safely and effectively treated as an outpatient (based
on the available medical documentation). Patient status
Implications of Hospital Status
reviews can act as a safeguard against the incentives to
Whether a beneficiary is admitted to the hospital or treated
admit patients for short inpatient stays rather than providing
as an outpatient can impact the beneficiary’s cost-sharing
outpatient care.
liabilities. Under Medicare Part A, which provides inpatient
hospital coverage, beneficiaries are required to pay an
Under the RAC program, following a patient status review,
inpatient deductible ($1,260 in CY2015) if they are
an RAC notifies the applicable Medicare administrative
admitted to the hospital. Beneficiaries who receive hospital
contractor (MAC; an entity that processes Medicare claims)
outpatient services, which are covered under Medicare Part
when it identifies a Medicare hospital inpatient stay in
B, typically pay 20% of the Medicare reimbursement
which the patient could have been safely and effectively
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Medicare, Observation Care, and the Two-Midnight Rule
treated in an outpatient setting. Hospitals may appeal RAC
period to assess hospitals’ understanding of the rule and to
decisions of medically unnecessary hospital inpatient
assist hospitals in compliance with it. Additionally, CMS
admissions. Additionally, a hospital that returns its inpatient
prohibited RACs from conducting patient status reviews on
reimbursement is able to rebill Medicare Part B for items
hospital inpatient admissions of less than two midnights
and services that would have been payable under Part B had
between October 1, 2013, and October 1, 2014. The
the beneficiary originally been treated as an outpatient
Protecting Access to Medicare Act (PAMA; P.L. 113-93)
rather than an inpatient (if the dates of services occurred in
permitted CMS to extend the probe and educate period and
the last 12 months). Certain services cannot be rebilled to
to extend the moratorium on RAC patient status reviews of
Part B because they specifically require an outpatient status
hospital inpatient admissions through March 31, 2015.
on the date of service (e.g., observation services).
Recently, the Medicare Access and CHIP Reauthorization
Act of 2015 (MACRA; P.L. 114-10) permitted CMS to
Two-Midnight Rule
further extend the probe and educate period and to continue
In response to concerns over long observation stays and
the PAMA moratorium on RAC patient status reviews
RAC determinations of medically unnecessary short
through September 30, 2015.
hospital inpatient admissions, CMS finalized the Two-
Midnight Rule on August 19, 2013. This rule was intended
Recent Changes to the Two-
to provide clarification on when hospital inpatient
Midnight Rule
admissions and hospital outpatient services generally are
On November 13, 2015, CMS released changes to the Two-
appropriate. Under the Two-Midnight Rule, if the admitting
Midnight Rule under the Hospital Outpatient Prospective
physician expects a beneficiary’s treatment will require a
Payment and Ambulatory Surgical Center Payment Systems
stay in the hospital that crosses two midnights, or if the
final rule (see 80 Federal Register 70298). In the final rule,
treatment includes a procedure that is specified by CMS as
CMS stated it would continue to use the two-midnight
inpatient only, it generally is to be deemed appropriate and
benchmark for a medically necessary inpatient admission.
medically necessary under Medicare regulations for the
However, CMS would provide added flexibility to this rule
physician to admit the beneficiary to the hospital as an
on a case-by-case basis for hospital inpatient stays of less
inpatient and receive reimbursement under Medicare Part
than two midnights if the admitting physician determines
A. Such a decision to admit a beneficiary can come after the
that an inpatient stay is expected to be less than two
beneficiary has spent one midnight under observation or has
midnights but documentation in the medical record supports
received other hospital outpatient services. Hospital stays
the physician’s judgment that an inpatient admission is
that are expected to be less than two midnights generally
necessary. Additionally, Part A payment would continue to
will be considered outpatient stays, unless such stays are a
be made for an inpatient stay of less than two midnights if
“rare and unusual” exception, of which only one has been
the procedure is specified as inpatient only or for a case
identified (certain cases that involve newly initiated
identified under the rare and unusual exception.
mechanical ventilation).
Beginning January 1, 2016, Quality Improvement
Additionally, with the implementation of this rule, CMS
Organizations (QIOs)—groups of regional and national
would instruct RACs to no longer conduct patient status
health quality experts, clinicians, and consumers under
reviews on inpatient stays of two midnights or more. For
contract from CMS—in replacement of MACs, would
inpatient stays of less than two midnights, RACs could
determine the appropriateness of payment for inpatient
continue to conduct patient status reviews to determine if
stays of less than two midnights. For short inpatient stays
the inpatient stay could have been safely provided on an
that do not fall under the inpatient-only procedure list or the
outpatient basis.
cases identified as rare and unusual exceptions, Part A
reimbursement would be subject to the clinical judgment of
Hospital-advocacy groups contend that the Two-Midnight
the QIO medical reviewer based on information contained
Rule is overly complicated, administratively burdensome,
in the medical record. QIOs would refer claim denials to the
and undermines a physician’s medical judgment. Hospital
MAC for payment adjustment. QIOs also would educate
groups filed a lawsuit in U.S. District Court for the District
hospitals about claims denied under the Two-Midnight Rule
of Columbia contending that the Two-Midnight Rule and
and collaborate with such hospitals to improve
related policies burden hospitals with arbitrary standards
organizations’ processes and/or systems. Upon referral
and documentation requirements and deprive hospitals of
from QIOs, RACs could conduct payment audits of
Medicare reimbursement to which they are entitled. CMS
hospitals that consistently fail to adhere to the rule or fail to
has stated that the Two-Midnight Rule does not override the
improve their performance after QIO educational
clinical judgment of a physician but provides a benchmark
intervention beginning January 1, 2016.
for physician expectation of a medically necessary inpatient
admission and consistent application of Medicare’s Part A
Marco A. Villagrana, Analyst in Health Care Financing
benefit.
IF10264
CMS implemented the Two-Midnight Rule and instructed
MACs to implement a “probe and educate” medical review
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Medicare, Observation Care, and the Two-Midnight Rule
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