Statement for the Hearing Record:  
 
 
Office of Inspector General 
U.S. Department of Health and Human Services 
 
 
 
Hearing Title: 
Admitted or Not? The Impact of Medicare  
Observation Status on Seniors 
 
United States Senate  
Special Committee on Aging 
 
July 30, 2014 
216 Hart Senate Office Building 
2:15 PM 
 
 
 
 
 
 
 
 
 
 
 
 
  Statement for the Hearing Record: 
 
Office of Inspector General 
U.S. Department of Health and Human Services 
Hearing Title: Admitted or Not? The Impact of Medicare Observation Status on Seniors 
United States Senate 
Special Committee on Aging 
 
 
Good morning, Chairman Nelson, Ranking Member Collins, and other distinguished Members of 
the Committee.  Thank you for inviting the U.S. Department of Health and Human Services (the 
Department) Office of Inspector General (OIG) to submit a statement for the hearing record 
about our work in an important area of hospital policy that affects beneficiaries, providers, and 
taxpayers.   
 
In July 2013, we published a report about hospital observation and short inpatient stays.  The 
Centers for Medicare & Medicaid Services (CMS) subsequently implemented the two-midnight 
hospital policy.  The key takeaways today are:  1) significant issues existed with observation and 
short inpatient stays in 2012, 2) policymakers must ensure that beneficiaries with similar 
post-hospital care needs have the same access to and cost-sharing for skilled nursing facility 
(SNF) services, and 3) careful evaluation of the two-midnight policy and possible alternatives is 
essential. 
 
Many Had Expressed Concerns About Observation and Short Inpatient Stays 
 
When Medicare beneficiaries enter the hospital, hospital physicians often need to decide whether 
to admit them as inpatients or to provide observation services.  Observation services are 
short-term treatments and assessments provided to outpatients to determine whether beneficiaries 
require further treatment as inpatients or can be discharged. 
 
CMS, Members of Congress, industry groups and the public raised concerns about hospitals use 
of observation stays and short inpatient stays.  They were concerned about beneficiaries spending 
long periods in observation stays without being admitted as inpatients.  In particular, they were 
concerned that beneficiaries may pay more as outpatients than if they were admitted as 
inpatients.  Moreover, beneficiaries who were not admitted as inpatients may not qualify under 
Medicare for needed SNF services following discharge from the hospital.  Beneficiaries who did 
not qualify for SNF services under Medicare may have independently chosen to receive them, 
but were then responsible for all SNF charges.  In addition, CMS was concerned about improper 
payments for short inpatient hospital stays when the beneficiaries should have been treated as 
outpatients.   
 
Some of these issues may have arisen because Medicare pays for inpatient and outpatient stays 
very differently.  Inpatient hospital stays are paid under Medicare Part A according to the 
Inpatient Prospective Payment System (IPPS).  The IPPS is designed to reflect the cost of caring 
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  for an average beneficiary, so payments to hospitals generally do not depend on the number of 
services provided or the beneficiarys length of stay.   
 
Observation and other outpatient stays are paid under Medicare Part B according to the 
Outpatient Prospective Payment System (OPPS).  The OPPS is a hybrid of a prospective 
payment system and a fee schedule, so payments to hospitals tend to increase as the number of 
services provided increases. 
 
Significant Issues Existed With Observation and Short Inpatient Stays Prior to the 
Two-Midnight Hospital Policy 
 
OIG evaluated hospitals use of observation stays and short inpatient stays in 2012, before the 
implementation of CMSs new hospital policy.1  Our findings highlight important issues that 
require continued attention.  They are summarized below. 
  
Beneficiaries in observation stays commonly spent 1 night or more in the hospital 
 
Beneficiaries had 1.5 million observation stays in 2012.  Beneficiaries in these stays were most 
often treated for chest pain, and the majority of these stays began in the emergency department.  
In 92 percent of observation stays, beneficiaries spent at least 1 night in the hospital.  In 
26 percent of stays, beneficiaries spent 2 nights; in 11 percent of stays, beneficiaries spent at 
least 3 nights. 
 
Short inpatient stays were often for the same reason as observation stays, but Medicare paid 
nearly three times more for a short inpatient stay than for an observation stay, on average  
 
Beneficiaries had 1.1 million short inpatient stays in 2012.  Similar to beneficiaries in 
observation stays, those in short inpatient stays were most commonly treated for chest pain.  
Additionally, 6 of the 10 most common reasons for short inpatient stays were among the 10 most 
common reasons for observation stays.  The areas of overlap were chest pain, digestive 
disorders, fainting, nutritional disorders, irregular heartbeat, and circulatory disorders. 
 
However, short inpatient stays were far more costly to Medicare than observation stays.  
Medicare paid an average of $5,142 per short inpatient stay, but it paid an average of $1,741 per 
observation stay.  For each of the most common reasons a beneficiary was in the hospital, the 
average Medicare payment was always higher for short inpatient stays than for observation stays.   
 
Beneficiaries also paid far more for short inpatient stays than for observation stays, on average 
 
Beneficiaries paid almost two times more for short inpatient stays than for observation stays on 
averagethat is, $725 per short inpatient stay compared to $401 per observation stay.  For all 
                                                           
1 Hospitals Use of Observation Stays and Short Inpatient Stays for Medicare Beneficiaries, OEI-02-12-00040, July 
2013, available at http://oig.hhs.gov/oei/reports/oei-02-12-00040.asp.  Short inpatient stays are inpatient stays that 
lasted 1 night or less. 
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  but two of the most common reasons for treatment, beneficiaries paid more, on average, for short 
inpatient stays than for observation stays.  The two exceptions were stays for circulatory 
disorders and for coronary stent insertions.  In addition, 6 percent of beneficiaries in observation 
stays paid more than they would have paid had they been in an inpatient stay.  
 
Hospitals varied widely in their use of short inpatient and observation stays 
  
Some hospitals were far more likely to use short inpatient stays while others were far more likely 
to use observation stays.2  Nationally, just over one-quarter of these stays were short inpatient 
stays.  However, some hospitals used short inpatient stays for less than 10 percent of their stays, 
while others used them for over 70 percent of their stays. 
 
A clearer policy was needed 
 
Our report showed that though observation and short inpatient stays were for similar reasons, 
reimbursement was very different.  The variation in the use of these stays across hospitals 
suggested that the policy in place at the time was not being implemented consistently.  Given 
that the inpatient-versus-outpatient decision affects how much Medicare pays and how much the 
beneficiary pays, a clearer policy was needed. 
 
Beneficiaries with Similar Post-Hospital Care Needs Should Have the Same Access To and 
Cost-sharing for SNF Services 
 
We also found that beneficiaries had almost 618,000 hospital stays that lasted 3 nights or more, 
but did not include 3 inpatient nights.  Because their stays did not include 3 inpatient nights, 
these beneficiaries did not qualify for SNF services under Medicare.  For about 25,000 of the 
618,000 hospital stays, beneficiaries received SNF services following discharge from the 
hospital.  Medicare nearly always paid (inappropriately) for these SNF services.  However, for 
about 2,000 of the hospital stays, Medicare did not pay for the SNF services, and the beneficiary 
was charged an average of about $11,000. 
 
This result raised concerns about SNF services for beneficiaries.  It is important to ensure that 
beneficiaries with similar post-hospital care needs have the same access to and cost-sharing for 
SNF services.  Allowing nights spent as an outpatient to count toward the 3 nights needed to 
qualify for SNF services may require additional statutory authority. 
 
Careful Evaluation of the Two-Midnight Policy and Possible Alternatives is Essential  
 
In response to ongoing concerns, CMS implemented a hospital policyknown as the 
two-midnight policyin October 2013 to address the issues with observation and short inpatient 
stays.  The new policy provides guidelines for when hospitals should bill for inpatient stays and 
                                                           
2 This analysis includes outpatient stays that lasted at least 1 night, but were not coded as observation stays.  For 
some of these stays, hospitals may have provided observation services without coding the claims as observation 
stays.  Hospitals are not always paid a separate amount for coding claims as observation stays. 
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  when they should bill for outpatient services, such as observation.  Specifically, the rule states 
that a hospital stay is appropriately inpatient when the physician admits a beneficiary with the 
expectation of the stay lasting at least two midnights.  CMS expects this policy to reduce the 
numbers of short inpatient stays and of observation stays lasting 2 nights or longer.   
 
However, the policy has not been evaluated to ensure that it is working effectively.  This policy 
will affect hospitals use of observation stays and short inpatient stays, which in turn will affect 
Medicare and beneficiary payments to hospitals.  The new policy may also affect beneficiaries 
access to SNF services.  Because providers have been vocal in their opposition to the two-
midnight policy and because CMS and Congress are considering alternatives, a careful 
evaluation of the two-midnight policy and possible alternatives is essential.  
 
As policymakers move forward, the issues that we highlighted in our prior report continue to be 
relevant.  Information about the impact of the new policy is needed to ensure that policymakers 
take these issues into account as they move forward.   
 
Further Action Is Needed To Ensure that Hospital Payment Policies Are Efficient and 
Effective 
 
Ensuring that Medicares hospital payment policies are effective and efficient for beneficiaries, 
providers, and taxpayers is of paramount importance.  A number of factors must be carefully 
considered, including clear guidelines for hospitals and contractors; similar payments for similar 
care; and the overall impact on Medicare payments, hospitals, and beneficiaries.  This will 
continue to require a concerted effort by a number of key players, including CMS, CMSs 
contractors, providers, OIG, and Congress.  Such actions are essential for fighting fraud, waste, 
and abuse and for protecting Medicare beneficiaries and the Medicare Trust Fund. 
 
New and changing Department programs, including hospital payment policy, offer opportunities 
to prevent waste and fraud and increase the value realized from prudent Federal investments. 
They also raise challenges for efficient and effective implementation; therefore, close oversight 
is essential.  Full funding of OIGs fiscal year 2015 budget request would enable us to continue 
and enhance our focus on hospital payment policy, as well as the Departments other public 
health and human service programs, the marketplaces, and Medicare.3   
 
Thank you for your leadership and interest in these important issues and for the opportunity to 
discuss some of our work.   
 
                                                           
3 For more details on OIGs impact, the essential work we have planned, and the resources needed to fulfill these 
mission-critical activities, see OIGs fiscal year 2015 Congressional budget justification, available online at 
http://oig.hhs.gov/reports-and-publications/index.asp. 
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