Why observation care ‘just doesn't make sense’

An expert suggested eliminating ward-based observation by creating payments that blend inpatient and outpatient rates to alleviate burdens on patients and clinicians.


Working as a hospitalist in 2010, Ann M. Sheehy, MD, MS, observed firsthand the costly consequences of observation care.

One patient with a new diagnosis of cancer spent three days on her service. She had undergone her first round of chemotherapy, was dehydrated, had acute kidney injury, and was struggling with living on her own, so Dr. Sheehy's physical therapist colleague recommended skilled nursing facility placement.

But the case manager had bad news: The patient couldn't go due to a longstanding Medicare policy, which the agency had recently begun to more strictly enforce, stating that patients who were hospitalized weren't necessarily admitted as inpatients. This patient was under observation care.

“What this meant for my patient was that she had paid into the Medicare program her entire life, and when she needed the postacute skilled nursing facility benefit the most, she wasn't eligible for it,” said Dr. Sheehy, who is an associate professor of medicine and heads the division of hospital medicine at the University of Wisconsin School of Medicine and Public Health in Madison.

Medicare patients hospitalized under observation are covered by Medicare Part B, which has no skilled nursing benefit and a $1,340 deductible limit per service, compared to inpatients, who are covered by Medicare Part A and have skilled nursing coverage after three consecutive inpatient midnights, as well as a $1,340 deductible per benefit period.

“I think it's a real illustration of why policymakers need us as physicians or advanced practice providers to tell the story of our patients and the problems that we're seeing on the wards,” Dr. Sheehy said.

During her talk on Thursday, “Outpatient (Observation) Care for the Inpatient Attending,” which focused on original fee-for-service Medicare policy, she explained the fundamental flaws of observation care and outlined potential solutions.

Observation care poses difficulties for clinicians, patients, and hospitals, according to Dr. Sheehy.

Outpatient observation status is a billing distinction that's not necessarily linked to clinical care, but physicians are still burdened by it, she said. “When outpatient means hospitalization … and when ICU stays or time of day of admission can impact this status, it just doesn't make sense,” Dr. Sheehy said.

In practice, writing orders to specify why a patient needs to stay two midnights to meet CMS’ rule for determining inpatient hospital status “seems to be a waste of time on documentation that has little to do with patient care,” she said.

Plus, it's difficult to explain to patients how they can stay overnight and not be admitted, and “Sometimes we're left holding the bag with that message,” said Dr. Sheehy.

She said patients incur two main problems with observation care: 1) the lack of postacute skilled nursing facility coverage for those who need it, and 2) the out-of-pocket cost of hospitalization, specifically the lack of a cap on their financial risk. “This is huge stakes for our patients,” she said.

Finally, Dr. Sheehy said while hospitals have financial incentives to get inpatient billing for their patients, some may opt for observation care to save resources.

For instance, she said hospitals may favor observation care in order to avoid Medicare's Part A auditing and appeals process, which requires time and trained staff—about 5.1 full-time equivalents, according to her three-center study published in 2015 by the Journal of Hospital Medicine. “This is a huge amount of personnel that each hospital has to commit, just to manage this billing distinction,” said Dr. Sheehy.

While ED doctors were the first users of observation, the majority of observation care is now given to Medicare patients by hospitalists (59%), traditional inpatient/outpatient practitioners (21%), and cardiologists (10%), said Dr. Sheehy, quoting estimates from the Society of Hospital Medicine. “Largely, I think this represents the expansion of observation care to wards,” she said.

Observation care is a billing distinction unrelated to a physical location in the hospital, but observation units may be part of the solution, said Dr. Sheehy. “I'm a fan of observation units. We have one at our hospital, and I think it's served a certain subset of patients well,” she said.

However, “Only about a third of [hospitals] have observation units or clinical decision units,” said Dr. Sheehy, adding that observation units can be part of the solution but cannot solve the entire problem under current policy.

When thinking about policy reform, Dr. Sheehy said that “You can't fix a fundamentally flawed policy by tweaking it.” In 2017, she took part in publishing a Society of Hospital Medicine policy paper, which outlined two options to improve current policies and three options for comprehensive observation reform.

“I think medicine today is so different than when the Medicare program rolled out that we really need reform of this issue,” Dr. Sheehy said.

Her favorite reform option? Eliminating ward-based observation by creating payments that blend inpatient and outpatient rates. “So decreasing the inpatient payment rate to a degree and increasing the observation payment rate to meet in the middle in a budget-neutral way such that all patients would be considered inpatients” while leaving open the possibility of short-stay observation units, she said.

Dr. Sheehy ended her talk by encouraging internists to write letters on the issue to their government representatives, which can actually make an impact and generate responses. To speak in person to representatives about this and other issues, interested ACP members can join other ACP members and leaders on May 22-23 at ACP Leadership Day in Washington, D.C. Registration is open.