Medicare observation status has remained controversial since its introduction as an administrative payment category dating back to at least 1983. Much of the debate revolves around beneficiary billing and the 3-day rule, which requires that beneficiaries spend 3 consecutive days as an inpatient in order to receive coverage for postacute skilled nursing facility (SNF) care. Evolving with our health care system and recent legal challenges, this policy challenge has only been magnified by the COVID-19 pandemic. We briefly review the history of Medicare observation stays, recent policy changes, and legal challenges and propose that Congress permanently amend the 3-day rule to include observation stays.
Established in 1967 as part of Medicare’s extended care benefit, the 3-day rule was implemented by policy makers at a time when the average hospital length of stay (LOS) for those aged 65 years and older was 13.8 days and observation status did not exist.1 In contrast, in 2018, Medicare beneficiary hospitalizations averaged 5.54 days, whereas observation stays, increasingly common, numbered 1 896 598 compared with 10 791 977 total inpatient stays.
An inpatient and observation stay differ in both expected LOS and Medicare payment structure. Patients are expected to be under observation for fewer than 2 midnights, after which inpatient admission is deemed more appropriate. Medicare Part A covers inpatient stays, which fall under the inpatient prospective payment system. These payments are based on diagnosis-related groups coupled with case severity. In contrast, an observation stay falls under Medicare Part B. It is covered under the outpatient prospective payment system, a fee-for-service model with beneficiary cost sharing, and can help hospitals avoid readmission penalties.
Beneficiary financial liability also differs. For inpatient care, beneficiaries face a $1408 annual Part A deductible and no coinsurance for the first 60 days of hospital care, noting that 81% of beneficiaries have supplemental coverage. For observation stays, there is a $198 Part B deductible and 20% coinsurance. Consequently, short inpatient stays are likely to be more costly to the beneficiary and to Medicare. For example, Medicare pays over $2000 more for a short inpatient stay for chest pain (the most common observation stay diagnosis) than for an observation stay of similar length.
During the COVID-19 crisis, the Centers for Medicare and Medicaid Services (CMS) has temporarily suspended the 3-day rule. With the spread of COVID-19 expected to continue into the next year, postponed elective procedures will eventually surge, and demand for hospital beds and SNF services will remain high. CMS Administrator Seema Verma reported that these blanket waivers would not increase total payments made under the Medicare program nor change the essential acute-care nature of the Medicare SNF benefit. CMS and the Medicare Payment Advisory Committee should collect data and analyze SNF use under its emergency waivers to verify this and drive further policy improvements around beneficiary needs.
Meanwhile, after almost a decade of litigation, a federal judge recently ruled in favor of the plaintiff in the case Alexander v Azar. Nancy Niemi, an 84-year-old Medicare beneficiary, found herself ineligible for a postacute SNF stay after hospitalization for weeks under observation status. Her case was the basis of a 2011 lawsuit, which achieved class action status in 2017. The March 2020 ruling established that Medicare beneficiaries who were originally classified as inpatients but changed to observation status have the right to appeal their decisions. Previously, Medicare beneficiaries were unable to appeal their observation status.
The COVID-19 pandemic is not the first time the 3-day rule has been suspended. Both legislative history and the Medicare Advantage marketplace provide examples for current policy makers. Between January 1, 1989, and January 1, 1990, the Medicare Catastrophic Coverage Act (since repealed) eliminated the 3-day rule, reduced cost-sharing, and increased covered SNF days. Medicare payments to SNFs more than tripled,2 along with a 16% increase in Medicare-covered SNF admissions and 13% increase in LOS.
Medicare Advantage, a publicly funded, privately administered managed competition model for Medicare beneficiaries, provides a more recent example. Some health plans chose to increase benefits by waiving the 3-day requirement. In a 2015 study that compared plans that eliminated the 3-day requirement with other plans that retained this requirement, the former group had a net decline in hospital LOS without an increase in hospital or SNF admissions or a longer SNF LOS.3
Some have argued that the 3-day rule was implemented to ensure appropriate use of SNF services and that eliminating it would lower standards for receiving postacute care.4 However, we agree with other stakeholders in calling for immediate, permanent change. We believe the CMS should count observation stays toward the 3-day rule while simultaneously researching and subsequently replacing an arbitrary LOS with specific functional criteria for SNF care to determine eligibility.
Both changes would require new authority from Congress as SNF care eligibility is statutorily tied to inpatient status. Continued advocacy by stakeholders has led to legislative efforts to amend the 3-day rule, including legislation in both the Senate and House dating back to 2013. A Congressional bill proposed in 2017 would have required time spent in observation to be counted toward the 3-day prior hospitalization.
Estimates of costs of vary. The Office of Inspector General notes that CMS payments already do not follow the 3-day rule, suggesting that the costs of this proposed change are small. At the same time, the Office of Inspector General cited CMS projections that such a change would increase SNF admissions by 20%, costing $56 billion from 2014 to 2023, less than 1% of Medicare’s annual budget. Still, further evidence from Medicare Advantage3 suggests that postacute care costs may remain unchanged.
Although the true cost of waiving the 3-day rule is difficult to ascertain given multiple variables, the consequences of uncovered postacute care or unexpected cost shifting loom large for beneficiaries. Although the number of affected stays remains small—estimated between 75005 and 24 000 observation stays—these costs are real to vulnerable Medicare beneficiaries.
Corresponding Author: Brian J. Miller, MD, MBA, MPH, 300 Kenan Center Drive, Chapel Hill, NC, 27599 (firstname.lastname@example.org).
Conflict of Interest Disclosures: Dr Miller reported serving as a member of the Centers for Medicare and Medicaid Services Medicare Evidence Development and Coverage Advisory Committee, serving as a consultant to the Federal Trade Commission, and receiving fees for clinical work at MedStar Georgetown University Hospital. No other disclosures were reported.
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