Observation Status: The New Treatment, Payment Paradigm

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With Medicare’s new MOON initiative, it’s more important than ever for emergency physicians to understand the nuances of observation care.

In the past several years, there has been a dramatic increase in the use of observation services in emergency departments (ED) and hospitals. The topic of “observation” tends to elicit a variety of reactions among emergency physicians. This ranges from the relief of finding a useful disposition for patients caught between a clear-cut inpatient admission and a discharge home to frustration over a nebulous administrative concept. Some perceive observation with outright disdain as a barrier to delivering care.

However, observation as a care delivery model has been around for more than 50 years, first appearing in the literature as early as the formation of the specialty of emergency medicine in the 1960s [1]. Since that time, decades of policy changes have made one thing clear: payers see observation as a less costly substitute for inpatient admission for short hospitalizations. And this is already happening: from 2010-2014 Medicare observation visits increased 8% per year while inpatient stays decreased by 3% per year [2].


About Observation Care
Observation in its most basic form is simply an outpatient visit (e.g., Medicare Part B visit) that can occur anywhere in a hospital. The Centers for Medicare and Medicaid Services (CMS) defines observation as a “well-defined set of specific, clinically appropriate services, which include ongoing short term treatment, assessment, and reassessment before a decision can be made regarding whether patients will require further treatment as hospital inpatients or if they are able to be discharged from the hospital . . . usually in less than 24 hours. In only rare and exceptional cases do reasonable and necessary outpatient observation services span more than 48 hours” [3].  This was clarified in 2013 with the “two midnight rule”: Medicare expects patients requiring less than two midnights of hospital care (with very few exceptions) to be classified as observation status and billed accordingly [4].

Perhaps the most straightforward clinical case for observation care is the chest pain patient requiring serial troponin and stress testing with a reassuring initial ED workup. Only about 20% of observation patients will require subsequent inpatient care [5]. The remainder are sent home after further diagnostics or treatments have established a pathway for safe discharge home. A significant body of research literature has emerged over the past several decades, showing that well-crafted care protocols for chest pain and other conditions can cut the hospital length of stay nearly in half without jeopardizing quality across dozens of conditions (Table 1 below) [6-10].


What observation means to patients and their bills
From the perspective of an emergency physician, the presence of a dedicated observation unit can also influence disposition decisions, specifically by expanding the options. However, care delivered in a dedicated ED observation unit is actually where the minority of observation care is delivered today in the United States. Most occurs in a distributed model, where care (e.g., setting, treating team) more closely resembles an inpatient hospitalization [14]. This creates understandable confusion among patients, their advocates, and even their health care providers. It is sometimes unclear to patients or even their medical team whether the patient is admitted to the hospital or not. To complicate the issue, keeping abreast of policy changes for providers and hospital is cumbersome. Furthermore, the policies themselves can sometimes be obtuse. For example, the “clock” for two midnights in Medicare patients starts when care in initiated in the ED. As a result, Medicare considers the patient who arrives to ED at 11:45pm differently than the one who arrives at 12:30am [4]. For clinicians, these are equivalent presentations, yet Medicare allows for an entire additional day of hospitalization when considering whether the latter patient should be considered observation or inpatient.

Misinformation often contributes to the fear and frustration with the concept of observation. The media has prominently featured patients telling frightening stories of exorbitantly high out-of-pocket expenses caused by an observation visit and has advocated for patients to protest [15-17]. Some stories are horrific—patients facing bills of tens of thousands of dollars, losing their house or retirement savings for a hospital visit they thought was covered by their inpatient Medicare benefit [15,17]. They later find that it was classified as outpatient observation status, which made their subsequent prolonged Skilled Nursing Facility (SNF) stay ineligible for coverage. However, when the Office of the Inspector General actually looked at out-of-pocket expenses in 2014, they found something surprising: 94% of Medicare patients with observation stays had a lower out-of-pocket expense than short-stay inpatient counterparts [18]. In 2016, Medicare also started bundling outpatient facility payments for observation visits, effectively capping out-of-pocket expenses well below the patient cost for an inpatient hospital admission [19]. By contrast, the 2017 Part A deductible for inpatient care is $1,316 per illness, a recurring expense that can occur multiple times in a calendar year. Yet problems with observation billing do remain, such as the loss of SNF eligibility for patients converted from observation to inpatient who fall short of the three-day minimum inpatient stay and others who pay for their home medications out of pocket, often at a premium [20,21].

Nevertheless, the influence of the media has a real impact. Many emergency physicians can recall at least one episode of a patient or family member voicing concern when the word “observation” is used to describe their disposition plan. Some patients in this scenario have even left against medical advice. Emergency physicians should have a basic understanding of the issues and also access to staff with additional expertise (e.g., case managers, financial councilors). Ideally, there should be resources available in the ED to closely examine the specifics of a patient’s insurance coverage and give a more detailed explanation when needed. While emergency physicians cannot be expected to know every nuance of payer policy around observation, there should be an accurate understanding of the major elements of Medicare related to observation. At a minimum, emergency physicians should be expected to be able to reduce inaccurate perceptions around the topic. In hospitals without a dedicated observation unit, a simplified explanation may be appropriate, i.e., as the emergency physician, you believe the patient requires further hospitalization. Since billing logistics of that hospitalization are dictated by the insurance company, the inpatient versus observation determination is based upon their guidance to hospital physicians and case managers.

Medicare Outpatient Observation Notice (MOON)
Medicare recently attempted to improve communication around observation care by mandating completion of a document called the Medicare Outpatient Observation Notice (MOON). Hospital staff present this form to the patient and obtain their signature as they approach 24 hours in observation status [22]. Medicare used nursing costs to estimate the costs of delivering the MOON, but any hospital staff member can perform this function. However, in some institutions administrators are delegating this work to physicians, sometimes even emergency physicians. Emergency physicians placed in this situation need to push back. The MOON is well-intentioned, yet it can be implemented inappropriately (i.e., requiring an emergency physician to administer it at the beginning of a hospital stay to patients outside of an emergency medicine-run observation unit). In a well-run observation unit with a nursing-administered MOON, emergency physicians would rarely be expected to play a role. It also may facilitate timely discussions around the plan of care and help assuage patient concerns. As a new initiative, time will tell if this notification requirement will prove to be merely burdensome or actually helpful.


As the healthcare system evolves, stakeholders will increasingly demand better outcomes at a lower cost. As emergency physicians, the decision to hospitalize a patient is our most expensive decision, which will no doubt face increasing scrutiny from payers and hospital administrators [23]. Observation offers a “safe space” where care can be continued without the same time pressures of the ED or thresholds for acuity in the inpatient services [24]. Ideally, this observation care should occur in a dedicated unit using condition-specific protocols of care. In this setting, the emergency physician can feel confident that they are not exposing patients to unreasonable out-of-pocket expenses while also giving them a good chance for a safe next-day discharge to home. In hospitals without a dedicated observation unit, emergency physicians are making a more straightforward “home vs. hospital” disposition decision—hopefully without sending patients home too soon or working too hard to “sell” them for admission. Once hospitalized, patients in this scenario are likely to be subject to the workflows of inpatient teams, later classified as an observation visit. The emergency physician has no control over this subsequent care, and messaging around observation versus inpatient status can be safely delegated to the admitting team.

Observation care is like an outpatient visit. It’s not inherently good or bad, but it is wrapped in a long and often confusing history as well as evolving policies and variable public perception. Emergency physicians should understand how to use this tool and advocate for best practices (e.g., a dedicated unit with dedicated protocols). Emergency physicians should also understand and communicate basic principles of how observation care may impact a patient’s out-of-pocket expenses versus alternatives, and know when to call in help from experts. Finally, emergency physicians should work to close loopholes and further protect patients, recognizing that observation is unlikely to go away and there is always room to make it better.


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  3. Medicare Advisory Payment Committee, A Data Book: Healthcare Spending and the Medicare Program, 2011, (Report):112. http://www.medpac.gov/documents/Jun11DataBookEntireReport.pdf
  4. Centers for Medicare and Medicaid Services, Frequently Asked Questions: 2 Midnight Inpatient Admission Guidance & Patient Status Reviews for Admissions, 2013, 2014(Web Page). http://www.cms.gov/Research-Statistics-Data-and-Systems/Monitoring-Programs/Medical-Review/Downloads/QAsforWebsitePosting_110413-v2-CLEAN.pdf
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  13. W. W. Decker, P. A. Smars, L. Vaidyanathan, D. G. Goyal, E. T. Boie, L. G. Stead and et al., A prospective, randomized trial of an emergency department observation unit for acute onset atrial fibrillation, Annals of Emergency Medicine, 2008, 52(4):322-328.
  14. M. A. Ross, J. M. Hockenberry, R. Mutter, M. Barrett, M. Wheatley and S. R. Pitts, Protocol-Driven Emergency Department Observation Units Offer Savings, Shorter Stays, And Reduced Admissions, Health Aff., 2013, 32(12):2149-2156.
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  16. H. Gleckman, AARP’s New Evidence That Medicare’s Hospital Observation Rules Are a Mess, Forbes Online, 2015. https://www.forbes.com/sites/howardgleckman/2015/04/20/aarps-new-evidence-that-medicares-hospital-observation-rules-are-a-mess/#715f56975f87
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  18. Office of the Inspector General, Hospitals’ Use of Observation Stays and Short Inpatient Stays for Medicare Beneficiaries, OEI-02-12-00040, 2013. https://www.oig.hhs.gov/oei/reports/oei-02-12-00040.pdf
  19. Centers for Medicare and Medicaid Services, 2016 Medicare OPPS Final Rule, 2015, 2015(Web Page). https://www.cms.gov/Medicare/Medicare-Fee-for-Service-Payment/HospitalOutpatientPPS/Hospital-Outpatient-Regulations-and-Notices-Items/CMS-1633-FC.html?DLPage=1&DLEntries=10&DLSort=2&DLSortDir=descending
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Dr. Baugh is a practicing emergency physician and Medical Director of Emergency Department Operations and Observation Medicine in the Department of Emergency Medicine at Brigham and Women's Hospital in Boston, MA.

HEALTH POLICY SECTION EDITOR Dr. Pines is a practicing emergency physician and a Professor of Emergency Medicine and Health Policy at the George Washington University.

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