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Two-Midnight and Observation Rule

What you and your patients need to know about inpatient hospitalizations By Mirza Baig and Elizabeth Sidney

The two-midnight rule, which technically went into effect last Oct. 1, unleashed a storm of controversy. For hospitals and large health care systems, the rule can severely impact reimbursement. The rule also adds to the documentation burden of physicians while hitting unsuspecting patients in the wallet for services they assume were covered. Now, after strenuous pushback, the Centers for Medicare and Medicaid Services (CMS) is reportedly exploring an alternative payment methodology for short-term inpatient stays.

The federal CMS has twice delayed the deadline for Recovery Auditing Contractors (RACs) to begin reviewing compliance with the rule. The new deadline is March 31, 2015. However, Medicare Administrator Contractors (MACs) can continue auditing a limited number of short-stay claims.

The policy sets out a procedure for admitting physicians to predict how long a patient will need to be admitted. Inpatient stays of two midnights or more are generally covered under Medicare Part A. But if a stay does not span at least two midnights, the patient is assigned to observation status, even if the patient spends the night in the hospital. Under this category, services are reimbursed under Part B, regardless of the hour the patient came to the hospital or if the patient used a bed.

Patients may sleep in hospital beds and have tests taken on-site but they are not classified as inpatients. Patients who come to the ER with chest pains or fainting spells often end up as outpatients under observation. These observation stays also are being used by hospitals as a tool to avoid RAC visits and readmission penalties for sending patients home too early. RACs and MACs who review admissions can dispute any decision after the fact. Inpatient acute care hospitals, long-term care hospitals, and critical access hospitals are all subject to the two-midnight rule.

Complexity, Confusion and Stress

The two-midnight policy poses financial burdens for patients, who, as outpatients under observation, are hit with 20% copays plus the cost of self-administered drugs. Observation stays are not counted toward Medicare’s three-day eligibility requirement for skilled nursing facility coverage. When informed of their out-of-pocket obligations, angry patients have walked out of hospitals, foregoing diagnostic studies and medications, according to some reports. These unintended consequences pose safety and quality concerns.

In situations where a patient spends one midnight in observation, and the physician thinks the patient needs at least another midnight in the hospital, but as an inpatient, Medicare will allow the patient to be admitted despite the fact it is a one-night inpatient stay, according to When a patient is admitted as an inpatient, but ends up not staying two midnights, Medicare requires documentation supporting the order and initial expectation that two midnights were necessary.

More Documentation for Physicians

Physicians can expect increasing pressure from hospitals to meet rigorous documentation requirements. Admitting physicians must document the medical necessity for a two-night stay in the hospital, along with providing an assessment and care plan. Only physicians with admitting privileges can determine inpatient status, but the hospitalization does not necessarily have to be ordered by the attending physician. Inpatient stays begin only after a physician signs off on the order for admission, which means that the time a patient spends in observation will not be counted toward the length of stay requirement.

The medical record must contain the physician’s certification to support a two-night inpatient stay. This documentation can be included in the H&P, progress notes, and discharge summary. Clinical documentation must also contain the patient history and comorbidities; severity of signs and symptoms; risk of adverse events; and current medical needs requiring inpatient care.

Long-stay observation cases grew from 3% to 8% of all cases between 2006 and 2011. The two-midnight rule aims to curtail the growth of observation stays longer than 48 hours. And according to Moody’s Investor Services, the new rule has the potential to reduce reimbursement per case by $3,000 to $4,000.

Long-term Trends and Consequences

Some experts maintain the two-midnight rule is unlikely to achieve CMS’ goal of trimming observation days. According to the Center for Medicare Advocacy, researchers at the University of Wisconsin School of Medicine and Public Health applied the policy retrospectively to all observation and inpatient cases seen at the University of Wisconsin Hospital and Clinics between Jan. 1, 2012, to Feb. 28, 2013. They found the rule did in fact increase the number of observation status patients; if the rule had been in effect, 7.4% of inpatient encounters would have been assigned to outpatient status.

The study also showed that patient status was influenced by the time and day of the week. Patients admitted after 4:00 p.m. were admitted as inpatients 31% of the time, while patients who arrived before 8:00 a.m. were admitted as inpatients only 13.6% of the time. As for the day of the week, patients who came to the hospital on weekends were deemed inpatients 26.5% of the time. In contrast, patients who came on weekdays were admitted as inpatients only 22.6% of the time.

Interestingly, the researchers found little overlap in the diagnosis codes for short-stay inpatients and observation patients. They concluded that inpatients staying less than two midnights were clinically different from observation patients. This finding contradicts the OIG claim that short-term inpatients and observation patients are clinically the same. Researchers argued against reclassifying patients who stay less than two midnights as observation patients based solely on their length of stay.

The team concluded that hospitals would change their admission practices to compensate for the loss of revenue from fewer inpatient stays. Among the unintended consequences of the new rule: longer hospital stays, reduced efficiency and increased overall costs of care, the researchers surmised.

Mirz Baig is a student at John Marshall Law School who has an MBA with a concentration in health care administration. His goal is to be a health law attorney after graduation.

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