Why You May Pay More if You Are Hospitalized for Observation

Medicare, health insurance companies, and hospitals are always looking for ways to save money. Assigning you to observation status rather than inpatient care is one way to do so, but might end up costing you more.

When you are hospitalized, knowing whether you’ve been admitted as an inpatient or put on observation status is important to you financially. Here’s why, and what you can do if faced with unexpected costs.

Doctors examining patient in hospital room
Caiaimage / Robert Daly / Getty Images

What Is Observation Status?

When you are put in the hospital, you’re assigned either inpatient or observation status. These classifications are broadly described as follows:

  • Inpatient status means that if you have serious medical problems that require highly technical skilled care.
  • Observation status means that have a condition that doctors want to monitor to see if you require inpatient admission.

You may be assigned to observation status when your doctors aren’t sure how sick you actually are. In such cases, the doctors can observe you and make you an inpatient if you become sicker, or let you go home if you get better.

From an insurance standpoint, observation patients are classified as a type of outpatient. The classification determines which portion of your policy (outpatient benefits vs. hospitalization benefits) will pay for the hospital stay.

It is often difficult to know which status you have been assigned unless the hospital or your doctor tells you. The room you are assigned may not help. Some hospitals will have a special area or wing devoted solely to observational patients. Others will put their observation patients in the same rooms as their inpatients.

Because of this, patients may assume that they are inpatients simply because they are in a regular hospital room.

People may also assume they are inpatients because they've been admitted for more than a few days. Generally speaking, observation status is limited to 48 hours, but this is not always the case. Some hospitals may keep you on observation status well past this period if they believe it is warranted.

How Observation Status Is Assigned

Hospitals don’t assign you to one status or another because they feel like it or because one status offers them better financial gains. Instead, there are guidelines published in the Medicare Benefit Policy Manual that direct who is assigned to inpatient status and who is assigned to observation status.

The guidelines are complex and change every year. While many parts of the guidelines are detailed and clearly spelled out, others are vague and open to interpretation. Because of this, most hospitals and insurance companies will hire a third-party service to review the guidelines and establishes internal policies by which inpatient or observational status is assigned.

These policies are largely standardized to ensure that hospitals and insurance companies see eye-to-eye. These include InterQual or Milliman guidelines commonly used in the healthcare industry.

From a broad perspective, the assignment of an inpatient or observation status is based on two criteria:

  1. Are you sick enough to need inpatient admission?
  2. Is the treatment you need intense enough or difficult enough that a hospital is the only place you can safely receive the treatment?

Based on the admission guidelines of the hospital, there will be a system in place to review each case by either a hospital case manager or utilization review nurse.

The staff member will assess your diagnosis, your doctor’s findings, the results of your lab and imaging studies, and the prescribed treatment to see if your case meets the criteria for inpatient or observational status.

How Observation Status Affects Insurance

It is important to note that a hospital's internal policies don't always align with those of your health insurer. Just because your hospital considers you to be an inpatient doesn't mean your insurer will.

For example, if you’re an inpatient but your health insurance company determines that you should have been assigned observation status, it can refuse to pay for the entire hospital stay. In some cases, you might not discover this until you receive a letter stating that the claim has been denied.

In fact, the Centers for Medicare and Medicaid Services (CMS) contracts companies to search hospitalization records to find inpatient admissions that could have been handled in observation status. This can happen months after you've been released, by which time Medicare may have taken back all the money paid to the hospital.

If this occurs, you will also likely be billed.

What Happens If a Claim Is Denied

If a claim is denied due to an inappropriate patient classification, the hospital will usually fight the denial by demonstrating that they met InterQual or Milliman guidelines for the status you were assigned. If the hospital doesn’t follow the guidelines closely, it risks such denials.

If the hospital fails to appeal the denial, you may be faced with additional bills. Although it is unlikely your insurer will deny the entire claim, you may still take a financial hit.

If you have private insurance, your share of the cost will depend on the specifics of your plan. But if you have Original Medicare, you could end up paying a larger portion of the bill. Here's why:

  • Since observation patients are a type of outpatient, their bills are covered under Medicare Part B (the outpatient services part of the policy) rather than Medicare Part A (the hospitalization part of the policy).
  • Medicare Part A covers inpatient stays of up to 60 days with one flat-rate fee, whereas Medicare Part B has a 20% coinsurance without any cap on out-of-pocket costs.

In other words, if the claim is denied based on the patient assignment, you may end up paying 20% of the Medicare-approved charges, with no cap on how high the bills can be.

Medicare beneficiaries can avoid unlimited out-of-pocket exposure by enrolling in a Medigap plan or Medicare Advantage or having additional coverage under an employer-sponsored plan.

Denials for Skilled Nursing Care

If you're on Medicare, observation status may also cost you more if you need to go to a skilled nursing facility after your hospital stay.

Medicare usually pays for services like physical therapy in a skilled nursing facility for a short period of time. But, you only qualify for this benefit if you've been an inpatient for three days prior to moving to the skilled nursing facility. If you’re in observation status for three days, you won’t qualify for this benefit, meaning that you’ll have to pay the entire bill yourself unless you have secondary coverage.

In recent years, the CMS has indicated that they are open to changing this rule. There are already waivers from the three-day rule available for care organizations that participate in Medicare's Shared Savings Program. Similarly, Medicare Advantage plans have the option to waive the three-day inpatient rule for skilled nursing facility coverage.

It's possible that the rule could be changed or eliminated altogether in the future, depending on the approach that CMS takes.

In April 2020, a judge ruled that Medicare beneficiaries have the right to appeal hospital stays assigned as observation status if they believe it should have been classified as inpatient. Prior to 2020, this was not something you could do.

The Two-Midnight Rule

In 2013, the CMS issued guidance called the "two-midnight rule" which directs which patients should be admitted as inpatients and covered under Medicare Part A (hospitalization). The rule states that if the admitting doctor expects the patient to be in the hospital for a period spanning at least two midnights, the care can be billed under Medicare Part A.

In 2015, the CMS updated the two-midnight rule, providing some wiggle room for doctors if they believe inpatient treatment is needed even if the stay does not span two midnights. Under certain circumstances, Medical Part A benefits can still be applied.

Should I Fight or Settle?

If assigned an observation status that you think is incorrect, your first instinct may be to fight if there is a risk of a claim denial. Even so, the reassignment of your status is not always the solution.

Having yourself reassigned as an inpatient may seem like it could save you money if your coinsurance costs are higher for observational (outpatient) care. It may also help if you're on Medicare and you're going to need a skilled nursing facility after hospitalization.

But, remember, your health insurer may refuse to pay the hospital bill if it determines you were incorrectly assigned to inpatient status. If this happens, neither you nor the hospital will likely succeed in fighting the denial.

As such, it is important for you to understand how the assignment was made and what that may or may not cost you. To do so:

  • Ask what specific guidelines were used to assign your observation status.
  • Ask what types of treatments, test results, or symptoms would have qualified you for inpatient status with the same diagnosis.
  • Speak with someone from the billing office who can estimate your out-of-pocket costs whether you’re in observation or inpatient status.

If you’re too sick to do this yourself, a trusted friend, family member, or patient advocate to do so on your behalf.

If a denial is received as a result of the hospital assignment, remember that you have a right to appeal under the law. The hospital will often have a dedicated insurance or financial aid officer to assist you with this. The assigning doctor will also need to participate.

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Article Sources
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