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"Observation Status: Why a Medicare Loophole is Harming Beneficiaries, and How it Can Be Fixed" by Sarah Duval

Observation Status: Why a Medicare Loophole is Harming Beneficiaries, and How it Can Be Fixed.

by Sarah Duval

I Introduction: The Observation Loophole

There is a loophole in the hospital admissions system harming elderly Americans and their families. Observation status was designed for cases where further assessment is necessary before either choosing to admit or discharge a patient. There are cases where observation status is in both the hospital and patient's best interests. This assessment was not designed as a way for hospitals to supervise and treat patients without admitting them as inpatients, cutting down on admission rate and readmission rates. However, more hospitals are using it for that purpose because of recent tightening of Medicare inpatient admission criteria and a surge in the False Claims Act.

This improper use of observation status has severely burdened Medicare beneficiaries across the country as they are left with nursing home bills totaling thousands of dollars, simply because hospitals abused observation status and did not admit them as inpatients.

II What is Observation Status, and how is it Different from Inpatient Admission?

The Medicare program first established observation as a level of care in the early 1990s. See John George, Hospital Payments Downgraded, PHILADELPHIA BUSINESS JOURNAL, Feb. 18, 2011. The Medicare statue does not define observation status. (In the July 2009 quarterly updates, CMS revised portions of both the Claims Processing Manual and Benefit Policy Manual related to observation, switching from "observation status" to "observation services." For the purposes of this paper, the term "observation status" will be used). It is defined in the Center for Medicare and Medicaid Services (CMS) policy manual as:

"[A] well-defined set of specific, clinically appropriate services, which include ongoing short term treatment, assessment, and reassessment, that are furnished while a decision is being made regarding whether patients will require further treatment as hospital inpatients or if they are able to be discharged from the hospital. "

Medicare Benefit Policy Manual, CMS Pub. 100-02, Chapter 6, §20.6; same language in Medicare Claims Processing Manual, CMS Pub. 100-04, Chapter 4, §290.1

Observation status is designed as a time window hospitals may use to determine if the patient's symptoms warrant inpatient admission, or if treatment and discharge is a more appropriate approach. Further guidance from Emergency Department Coding guidelines, not CMS, explains these services include "bed care and periodic monitoring by nursing or other staff to evaluate the patient's condition and/or determine the need for a possible admission to the hospital as an inpatient." Caral Edelberg, ED Coding Update: Medicare sees increase in observation payments, 2009 WLNR 20549028. For Medicare purposes, "observation" is not an official patient status as opposed to inpatient, outpatient, or non-patient. Id. There is no official limit on the length of time a beneficiary can be kept in observation status, although CMS manuals do offer guidance that in most cases it should be limited to 24 or 48 hours. MEDICARE BENEFIT POLICY MANUAL, CMS Pub. 100-02, Chapter 6, §20.6; same language in MEDICARE CLAIMS PROCESSING MANUAL, CMS Pub. 100-04, Chapter 4, §290.1. Still, this is only advisory, and is not a strict cap on the hours that a beneficiary can spend in assessment.

In 2008, Medicare expanded the criteria for observation status by tightening the criteria for inpatient admissions. John George, Hospital Payments Downgraded, PHILADELPHIA BUSINESS JOURNAL, Feb. 8, 2011. The newly-tightened criteria for inpatient status are found in InterQual, a 260-page manual that has served as CMS's guidelines for everything from patient admission to clinical criteria for the past 12 years. See Press Release, CMS to Use McKesson's InterQual® Criteria to Support Medicare Initiatives for Twelfth Consecutive Year, MCKESSON HEALTHCARE, Sept. 29, 2011. When a patient arrives at the hospital they are assigned a case manager, a specially trained nurse who reviews each admission and compares the information to the criteria in the InterQual manual to see whether the patient qualifies as inpatient or observation status. See Pamela Tronetti, Case managers determine patients' hospital status, FLORIDA TODAY, Oct. 2010. The illness and the treatment must comply with a certain level of severity and intensity for the patient to qualify as an inpatient. See id.

It is difficult to draw a clear line between what the medical requirements of immediate inpatient admission and when observation status is the more appropriate approach. However, for a Medicare beneficiary, that vague difference can mean thousands of dollars. Under Medicare, Part A covers inpatient hospital admissions and Part B covers outpatient treatment, and includes observation services. When a beneficiary enters a hospital with symptoms severe enough that they will need rehabilitation at a skilled nursing facility after discharge, it is in their best financial interests to be admitted as an inpatient and covered under Part A.

Part A is a hospital insurance program, and applies when a beneficiary is admitted as an inpatient to a hospital. See 42 U.S.C. §§1395c (stating Part A "provides basic protection against the costs of hospital, related post-hospital, home health services, and hospice care"). The entitlements under Part A include a post-hospital stay at a skilled nursing facility. Id. at 1391x(h)(defining extended care services as "services furnished to an inpatient of a skilled nursing facility"). The Part A deductible for a hospital visit, $1,156 per benefit period in 2012, includes 20 days at a skilled nursing facility, and co-pays for day 21-100 at $144.50 per day. While Part A covers all inpatient stays by beneficiaries, in order to qualify for the post-hospital stay at a skilled nursing facility a beneficiary must have been an inpatient for not less than 3 consecutive days prior to the discharge. See 42 U.S.C. §§1395x(i)(extended care services furnished an individual after transfer from a hospital in which he was an inpatient for not less than three consecutive days before his discharge from the hospital in connection with such transfer). If this requirement is not met then the subsequent care must be paid for out of the beneficiary's pocket, a severe financial burden.

If a beneficiary is not admitted as an inpatient and instead are kept under observation status, they are considered by Medicare for billing purposes to be an outpatient. Outpatient services are covered by Part B, and include observation services. Unlike Part A, beneficiaries are responsible for a co-pay and generally pay 20% off the Medicare-approved amount for the doctor's services. For all other services, patients are charged a co-payment for each individual service. See CMS, Your Medicare Benefits, at 34. The idea behind observation was it would be applied for those patients who needed further evaluation to determine whether they needed to be admitted. Therefore, using the outpatient prospective payment system (OPPS), observation services are billed on a per-hour basis. See Tronetti. The longer the time spent in observation, the higher the bill for the beneficiary.

III Hospital Reimbursement Rates for Inpatient vs. Observation Status

For hospitals, there is a significant financial difference in reimbursement rates between inpatient and observation status, with the former being the more profitable. Under Part A, reimbursements are determined by the prospective payment system, PPS. Created in 1982 per a congressional mandate, PPS was designed to control costs by dividing inpatient admission cases into diagnosis-related groups, or DRGs. See Diers Thompson, Nursing resources, in DRDGs: THEIR DESIGN AND DEVELOPMENT 121 (R. Fetter ed., 1991), in OFFICE OF INSPECTOR GENERAL, REGION IX, MEDICARE HOSPITAL PROSPECTIVE PAYMENT SYSTEM: HOW DRG RATES ARE CALCULATED AND UPDATED 1 (Aug. 2001). Medicare reimburses hospitals at a flat rate for each DRG, regardless of the length of the hospital stay per patient. Id. This rewards particularly efficient hospitals, who get to keep the difference between the expected hospital stay and the actual stay; at the same time, it penalizes those which are inefficient. Ironically, this rate of efficiency - while profitable for hospitals - can be financially detrimental to beneficiaries who may fall short of the required three day inpatient stay. The average amount of time that patients spend as inpatients has declined by over 50% from 1972 to 2002, from 12.1 days to 5.9 days. See Landers v. Leavitt, 2005 WL 4113405 (D.Conn.). This is believed to be due in part to increased efficiency, as well as to the use of observation status. Id.

The payment rate for an observation case is well below the rate for an admitted patient, and is considered an outpatient level of care. Billing for observation services is done under Part B, with clients responsible for a significant amount of the co-pays. Part B is reimbursed on a fee for service schedule, rather than the flat rate DRG for Part A. See 42 U.S.C.A. § 1395w-4. For hospitals, admitting someone as an inpatient and receiving payment through the PPS is more profitable than Part B's fee for service schedule.

When a patient enters a hospital presenting with symptoms warranting more than outpatient treatment, hospitals are presented are two options: admit them immediately as an inpatient, or treat them under observation and wait to see if inpatient admission is necessary. With inpatient the more profitable choice, it comes as no surprise that some hospitals abused the system, admitting beneficiaries as inpatients even when the more appropriate category was observation. This practice resulted in significant over-billing of Medicare. In the recent years hospitals have felt the repercussions of those actions and many have increased the use of observation status, often improperly. This blowback is negatively impacting beneficiaries.

IV Blowback: Observation Status on the Rise

It is surprising how much impact legislation passed during the Civil War has on Medicare. Despite a century between the end of the Civil War and the enactment of the Medicare Statute, the False Claims Act touches almost everyone in the health care system. The False Claims Act prohibits the knowing submission of false or fraudulent claims to the federal government. 31 U.S.C. §§ 3729-3733 (1994). In 1986 a series of amendments modernized the False Claims Act, making it a powerful tool in their arsenal against problems like defense procurement and Medicare. GAO/HEHS-98-195 Application of the False Claims Act to Hospital Billing Practices at 3 (July 1998). Violation of the act comes at a high price: penalties of $5,500 to $11,000 per claim plus three times the government's damages. See 31 U.S.C. § 3730(b)-(c), (d)(1)-(3).

In addition, because the government itself cannot have eyes on everyone at all times, the False Claims Act allows for private citizens known as "whistleblower" to bring suit on the government's behalf. This is known as qui tam. The incentive for being whistleblower comes in part from the payback - whistleblowers get 10%-30% of the proceeds from each government case. Id. The financial figures associated with the False Claims Act are staggering. In 2010 the Federal government won or negotiated approximately $2.5 billion in health care fraud judgments and settlements. Id. Hospitals have a lot to lose.

As the False Claims Act has expanded its power, and Medicare tightened the criteria for inpatient admission, hospitals have increased their use of observation status. Now, if a hospital gives inpatient status to a Medicare patient who should only be under observation, the hospital is overcharging Medicare and can be required to refund some of the money the government paid and could face a suit brought under the False Claims Act. The increased enforcement began as a three-year pilot project in six states where Medicare recovery audit contractors (RACs), who received commissions based on overcharges they uncovered, forced hospitals and other health-care providers to return $1 billion in improper payments. Susan Jaffee, Growing Number of Patients Find Hospital Stays Does Not Mean they are Admitted, KAISER HEALTH NEWS, Sept. 2010. The program was expanded to every state in 2009. If a hospital is found to be in severe violation, it may be cut off from participation in Medicare altogether.

In addition to the False Claims Act, hospitals have to navigate a new deterrent to inpatient admissions found in the Affordable Care Act. The Affordable Care Act, in an effort to cut down on readmission rates and ensure appropriate treatment the first time, includes penalties for hospitals that have unusually high rates of re-admissions. See 42 USCA § 18031 (the implementation of activities to prevent hospital re-admissions through a comprehensive program for hospital discharge that includes patient-centered education and counseling, comprehensive discharge planning, and post discharge reinforcement by an appropriate health care professional). The provision, which goes into effect on October 1, 2012, aims to save about $7 billion during a 10-year period from hospitals that readmit (1) patients of all ages with certain diseases, and (2) all Medicare discharges - not just the certain diseases. See id., see also John H. Ferman, Use of Observation Days Is on the Rise, HEALTH POLICY ALTERNATIVES, INC., 2011 WLNR 854277. Because observation status does not count as an admission, it does not impact the hospital's potential readmission rate. This has resulted in concern that improper use of observation will increase further when that provision is enacted. Id.

The False Claims Act, re-admissions under the Affordable Care Act, and litigation have combined incentivize observation status as a "better safe than sorry" option - and the proof is in the numbers. Observation status claims rose from 828,000 in 2006 to more than 1.1 million in 2009. See Patients Sue over Hospital 'Observation Status', THE ADVISORY BOARD COMPANY, Nov. 1, 2010. Not only is observation status being used more frequently, it is for longer periods of time. CMS data indicate that claims for observation stays lasting more than 48 hours increased by nearly 300% from 26,176 to 83,183 across that period. Id.

It is dizzying to look at observation on such a macro level; that seemingly small decision made when a beneficiary enters a hospital whether to admit them as an inpatient or keep them on observation has an enormous ripple effect. However, it is important to also look at the impact on an individual level; what happens when a beneficiary who should have been admitted as an inpatient is instead kept on observation?

V The Personal Cost of the Observation Status Loophole

For an individual who is improperly kept in observation status and discharged to a nursing home without meeting the 3-day inpatient requirement, the cost is high. And, although advocates are working to raise awareness, the vast majority of beneficiaries are in the dark about how being in observation, rather than inpatient, can affect them. Families of beneficiaries also feel the impact.

For example, in 2009, Lawrence Barrows spent seven days at Dempsey Hospital in Connecticut. See Bagnall v. Sebelius, No. 3:11-cv-01703, D. Conn. While he was admitted as an inpatient at some point in the stay, it was not long enough to meet the 3 day consecutive inpatient requirement. After rehabbing in a skilled nursing facility, Barrows received a $36,000 bill. Id. Mr. Barrows has since passed away, leaving his widow, Lee Barrows, responsible for the bill. Now, Lee Barrows is one of seven lead plaintiffs in a class action lawsuit, Bagnall v. Sebelius. The suit was filed by the Center for Medicare Advocacy on November 3, 2011 and is challenging observation status. It claims that the use of observation status violates the Medicare Act, the Freedom of Information Act, the Administrative Procedure Act, and the Due Process Clause of the Fifth Amendment to the Constitution. See id.

VI Conclusion: Why Medicare Needs to Close the Observation Status Loophole

While observation status can seem complex, there is a clear solution: Medicare must set a firm cap on the length of time a beneficiary can spend in observation status. Preferably, this cap would be set at 24 hours, and certainly should be set at no more than 48 hours.

This cap is a simple adjustment that would solve several problems. First, it would still force hospitals to use observation for its appropriate purpose, not as a tool to avoid claims under the fraudulent claims act or falsely reduce readmission rates. The current structure does not encourage excellence in hospital care; it encourages improper use of observation. Second, it would remove observation stats as a litigation tactic. Third, it would protect beneficiaries from becoming victims of the observation status loophole and being forced to pay thousands of dollars out of pocket for services that should be covered by Medicare Part A. The cap is the best solution to the problems created by improper use of observation status, and would close the observation loophole.

Sarah Duval is a third-year student at the University at Buffalo Law School, State University of New York, and a candidate to earn her J.D. in May 2012. Sarah has interned at Legal Services for the Elderly and Disabled in Buffalo, N.Y., and the Center for Medicare Advocacy in Washington, D.C. She would like to thank Professor Anthony Szczygiel and the staff attorneys at LSED and the CMA for helping her understand the complex world of Medicare.

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This page contains a single entry from the blog posted on February 17, 2012 4:05 PM.

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