When a patient arrives at the hospital, the classification of whether they are an inpatient or an outpatient is a source of significant confusion regarding hospital billing and coverage. Many people assume that occupying a hospital bed, eating hospital food, and receiving round-the-clock care means they are admitted as an inpatient. This assumption often proves incorrect, as the patient’s classification hinges on specific administrative rules that have vast financial and practical consequences. Understanding the distinction between observation status and formal inpatient admission is essential for anyone receiving hospital care today.
Defining Observation Status
Observation status is a technical designation legally and administratively classified as an outpatient service, regardless of the physical location or intensity of care provided. This classification is used when a physician needs a short-term period to assess a patient’s condition. The goal is to determine if the patient requires a full inpatient admission or if they can be safely discharged. Observation services include clinically appropriate treatments, ongoing short-term assessment, and reassessment.
This status is utilized for patients presenting with symptoms like chest pain, fainting spells, or minor infections where the diagnosis is not immediately clear or stability needs close monitoring. The assessment period is intended to be temporary, typically lasting less than 48 hours, though some stays can extend longer. Even if the patient stays overnight in a hospital bed, they remain an outpatient until a formal physician’s order admits them as an inpatient.
In some cases, a patient may initially be admitted as an inpatient, but a subsequent review by the hospital’s Utilization Review (UR) committee determines the stay does not meet the criteria for inpatient care. If this change is made before discharge, the hospital uses Condition Code 44 to officially change the status of the entire encounter from inpatient to outpatient observation. Medicare beneficiaries who receive observation services for more than 24 hours must be given a written notice, called the Medicare Outpatient Observation Notice (MOON), informing them of their outpatient status.
The Critical Distinction: How Status is Determined
The primary mechanism governing classification is the “Two-Midnight Rule,” a regulation established by the Centers for Medicare and Medicaid Services (CMS). This rule establishes that inpatient admission is appropriate only if the treating physician expects the patient to require medically necessary hospital care spanning at least two midnights. If the physician expects the necessary hospital care will last for less than two midnights, the patient is typically placed under observation status, even if the stay crosses one midnight.
The physician must document their clinical judgment and the expectation for a two-midnight stay in the patient’s medical record. This decision must be based on the complexity of the patient’s condition, the severity of signs and symptoms, and the risk of adverse events. This documentation is subject to review by the hospital’s Utilization Review team and potentially by external auditors to ensure compliance with Medicare guidelines. The key is the physician’s initial expectation at the time of the order, not the patient’s actual length of stay.
Hospitals face significant financial risk if they misclassify a patient, as inappropriate stays can lead to payment denials and audits. For example, if a patient is admitted as an inpatient but discharged before crossing two midnights, the hospital must document the initial expectation that a two-midnight stay was medically necessary. This rigorous documentation and review process drives the complex administrative logistics behind the choice between observation and inpatient status.
Patient Impact: Why the Classification Matters
The classification as outpatient observation versus inpatient directly affects the patient’s financial liability and eligibility for subsequent care under Medicare. For patients with traditional Medicare, an inpatient stay is covered under Medicare Part A and involves a single, fixed deductible for the entire stay. Observation status, being an outpatient service, is covered under Medicare Part B.
Under Part B, the patient may be responsible for a separate co-payment for each individual service received (e.g., blood tests, X-rays, or equipment), often amounting to a 20% coinsurance. Furthermore, drugs a patient self-administers are not covered under Part B, leading to out-of-pocket costs that Part A would typically cover. While a short observation stay may sometimes cost less than the inpatient deductible, multiple observation stays can accrue cumulative costs that exceed the single inpatient deductible.
A significant consequence of observation status involves eligibility for Medicare coverage of a Skilled Nursing Facility (SNF) stay for rehabilitation after hospitalization. Traditional Medicare requires the patient to have a qualifying stay of at least three consecutive calendar days as a formally admitted inpatient for the SNF stay to be covered. Time spent under outpatient observation status does not count toward this three-day inpatient minimum. Patients who require post-hospital rehabilitation but were never formally admitted may face paying for the entire SNF stay out-of-pocket.