Observation Medicine: The Good, The Bad, and The Ugly

Observation medicine in 2017 has proved no less a hot topic than it has been recent years. Institutions continue to develop observation units and processes to determine the correct level of care for when a patient requires hospitalization. This has not been a smooth transition from the days when a patient requiring admission as an inpatient was a fairly simple and straightforward process.

Clearly, there have been advantages to managing lower acuity patients in a more efficient and cost-effective format, but there have been some downsides as well. So, let’s start with the Good.

The Good

Observation level of care has resulted in institutions developing more efficient care delivery processes for lower level-of-care patients. This has reduced costs and Length of Stay (LOS) for hospitals. The less time the patient remains in the hospital, the fewer medications, lab tests, EKGs, radiographs and consults are performed. A lower LOS means less direct costs for nursing and providers, and additional capacity for the hospital. The extra capacity can be used for acute care inpatients awaiting a bed, or for growth needs, or result in a reduced hospital bed footprint with overall savings.

The new bundled reimbursement for Medicare Fee for Service patients (C-APC 8011) pays a flat rate of around $2,300 for care delivery to observation patients. This means the hospitals now share the risk for inefficient management of Observation patients.

Managing the units well can provide a range of positives impacts:

  • Reduce the risk of missing a serious diagnosis.
  • Reducing Left Without Treatment (LWOTs) rates
  • Improving door to doc times
  • Reducing LOS for admitted patients
  • Reducing boarder volume

Finally, when patients are dispositioned in a more rapid fashion, it typically results in improved patient satisfaction scores.

At US Acute Care Solutions, our observation medicine units have captured much of this good. Our average Length of Stay for observation patients is less than 20 hours, and our hospital partners which have instituted closed observation units have seen significant improvements in important hospital metrics.

The Bad

So, with all the good how could there possibly be anything bad about observation medicine? Let’s start with the Emergency Department. With the advent of observation services, some organizations have seen an increase in ED patients requiring hospitalization. This may be secondary to observation level of care being used as a mechanism to speed disposition. Many times, emergency physicians are incentivized to make disposition decisions in a timelier fashion. CMS core measures look at total Length of Stay for admitted patients in the ED, LWOTs, and treat and release times, and therefore providers’ paychecks may be linked to more rapid disposition. The days of holding patients for significant periods and sending them home from the ED have faded.

Providers in the ED often have little training in determining who is or isn’t an observation patient, and mainly focus on who can go home or who requires hospitalization. This lack of training has resulted in the need for additional resources to screen patients for appropriate level of care. This is why provider training is such an important part of observation unit implementation. Without it, additional resources are needed in the form of care management, or an expensive third party to screen patients.

Meanwhile, if the hospital is using “virtual” space for its observation patients, increases in observation volume may lead to unavailable inpatient beds for acute care patients, letting them languish in the ED for hours on end. This is one reason why I always advise a closed observation care unit with its own, dedicated space.

Insurers, for their part, are focused more than ever on reducing the number of inpatients and broadening the scope of observation care. Yet there is little direction for hospitals to determine specifically who is or isn’t observation level of care. Many organizations use Interqual or Millmans as guides, but they are by no means all-encompassing. Criteria change yearly and it seems more and more difficult for patients to meet the infamous “observation level of care” requirements. Patients in grey zones can be left in observation care for days—even with the new 2-Midnight Rule.

Hospitals must review observation level of care patients daily to determine if the patient’s status has changed. If so, updates may need to be provided to insurers to “approve” the change in status, which by no means is a guarantee of payment.

Hospitals now have to extract out the time patients spend off an observation unit for procedures or stress testing. This can prove an extremely difficult challenge.

There is a lot of confusion for providers on what this all means: observation level of care, acute care, extended recovery care, code 44s, denials of payment, mismatched professional and facility fees, and multiple interactions with utilization management or physician advisors surrounding optimal documentation to support level of care.

The Ugly

All this change in definitions and regulation have had significant impacts on both patients and hospitals. Both the government and commercial insurers have mandated the use of observation medicine without providing a rulebook for what observation level of care really means.

Additionally, patients usually face significant financial impacts when they are categorized as observation level. Co-pays and responsibility for drugs can be very expensive. Hospitals whose primary mission is to provide acute medical care are now directed to inform patients what their level of care is and the potential financial consequences of observation level of care, even though hospitals have little to do with the financial impact. Shouldn’t private and public insurers be the responsible parties to educate their own customers?

Medicare has decided that a patient’s stay in observation does not count toward eligibility for rehab or nursing home stays. Medicare has also developed relationships with third-party contractors to review patients with short length of “inpatient” stays to determine if the patient should have been in observation.

These RAC audits are incentivized to the tune of 9-12% of whatever penalty is gleaned from the hospital. The cost to the hospital to develop the infrastructure to appeal these denials of payment can be overwhelming.  Medicare instituted pre-payment audits in which short stay inpatient admissions are denied payment at all. If an appeal is lost, there is again significant financial impact. Commercial insurers have taken to pretty much denying any inpatient stay less than 48 hours.

The consequences of this tangle are pretty ugly for everyone involved.


We still have a lot to learn around observation medicine. Yes, it has forced hospitals to start to examine how they care for patients. If done right, observation care can dramatically improve hospital capacity management, with good follow-on effects for patient care, patient satisfaction, and the financial performance of the hospital.

Observation has helped move hospitals away from the fee-for-service model they have lived on for years. Most hospitals now understand that value, not volume, will be the future of healthcare. But we clearly need to continue to improve this process for the patient, the hospital and healthcare in general.

Keep the good, refine the bad, and eliminate the ugly.