Medicare's Observation Status Rule

It affects how services are billed, what a beneficiary pays out of pocket and whether Medicare will cover follow-up care after discharge.

Problems often stem from Medicare's observation status policy, which hospitals use when monitoring patients who may not yet require a full inpatient admission.

According to the Centers for Medicare & Medicaid Services, observation services allow physicians time to evaluate a patient's condition and determine whether inpatient care is necessary or if the patient can be safely discharged.

Understanding how Medicare classifies hospital stays can help beneficiaries avoid unexpected costs and better plan for care after leaving the hospital.

The Question

Why was my hospital stay billed as outpatient instead of inpatient under Medicare?

The Answer

Medicare uses guidance known as the two-midnight rule to help determine whether a hospital stay should be classified as inpatient or outpatient.

Under CMS policy, physicians must assess whether a patient is expected to require medically necessary hospital care that spans at least two midnights.

◆ If the physician expects the patient will need care crossing two midnights, the stay is generally considered an inpatient admission and covered under Medicare Part A.

◆ If the expected stay is shorter, the patient may be placed under observation status, which is classified as outpatient care and billed under Medicare Part B.

CMS says the decision is based on the physician's clinical judgment at the time of admission.

The two-midnight rule is a benchmark, not an absolute requirement, and, in some cases, a shorter stay may still qualify as inpatient if medically appropriate.

Observation Status

Observation status is used when physicians need additional time to monitor a patient before deciding on full inpatient admission.

Patients under observation may receive many of the same services as inpatients, including:

◆ Diagnostic testing.

◆ Medications.

◆ Overnight hospital stays.

◆ Monitoring by hospital staff.

Because of this, many beneficiaries assume they've been formally admitted.

However, observation status is considered outpatient care, even if the patient stays overnight in a hospital room.

The Impact

The difference between inpatient admission and observation status can directly affect both costs and coverage.

Here are some details on the distinction.

Inpatient (Medicare Part A)

◆ Covered under a single hospital deductible per benefit period.

◆ Most hospital services are included.

◆ Counts toward eligibility for skilled nursing facility care.

Observation Status (Medicare Part B)

◆ Typically requires 20% coinsurance for many services.

◆ Services may be billed separately.

◆ Some medications, particularly self-administered drugs, may not be fully covered under Part B.

Because of this structure, outpatient observation stays can sometimes result in higher out-of-pocket costs than expected.

The classification also carries important consequences after discharge, particularly when a beneficiary needs follow-up care in a skilled nursing facility.

The Skilled Nursing Facility Rule

Observation status can affect coverage for care after discharge.

Under Original Medicare, beneficiaries must have an inpatient hospital stay of at least three consecutive days for Medicare to cover care in a skilled nursing facility.

◆ Observation days don't count toward this requirement.

◆ A patient who spends multiple days under observation may not qualify for SNF coverage.

Some Medicare Advantage plans may waive this requirement, but, in general, it still applies under Original Medicare.

To help patients understand this distinction, Medicare requires hospitals to provide formal notice when a stay is classified as observation care.

Medicare Outpatient Observation Notice

To reduce confusion, hospitals are required to notify patients receiving observation services.

Medicare beneficiaries who receive observation care for more than 24 hours must be given a written notice called the Medicare outpatient observation notice, or MOON.

The notice explains:

◆ That the patient is considered an outpatient.

◆ How the classification affects Medicare coverage.

◆ Potential cost implications.

Hospitals must provide this notice within 36 hours after observation services begin.

Understanding The Rule Matters

Hospital care is one of the most significant expenses for Medicare beneficiaries.

Knowing whether a stay is classified as inpatient or outpatient can help prevent unexpected bills and coverage gaps.

Beneficiaries may consider:

◆ Asking hospital staff whether they've been formally admitted.

◆ Confirming their status during the stay.

◆ Reviewing their Medicare summary notice after discharge.

For agents and advisors, helping clients understand observation status can reduce confusion and support better planning for follow-up care.

What to Do

To review, here are some key characteristics of hospital stays to remember.

◆ Observation status is outpatient care, even if the patient stays overnight.

◆ The two-midnight rule guides, but doesn't strictly determine, admission decisions.

◆ Costs may be higher under Part B due to coinsurance and separate billing.

◆ Observation stays don't count toward the three-day requirement for skilled nursing facility coverage.

◆ Patients should confirm their hospital status early to avoid surprises.

Observation status can be an unexpected and costly distinction for Medicare beneficiaries, particularly when a hospital stay looks and feels like an inpatient admission.

Because the classification affects not only what a patient may owe during the stay, but also whether Medicare will cover follow-up care in a skilled nursing facility, it's important for beneficiaries to understand how the rule works.

Asking whether a stay has been classified as inpatient or outpatient, reviewing notices provided by the hospital and checking Medicare billing statements afterward can help prevent confusion and reduce the risk of unexpected expenses.

Tricia Blazier is director of Healthcare Insurance Services at Allsup.