Health Information Management

Clear up confusion surrounding observation services

JustCoding News: Outpatient, August 8, 2012

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Observation services can generate so much confusion that CMS actually asked for comments on observation and inpatient status as part of the 2013 OPPS proposed rule.

Coders need to remember that observation is a service and not a status, says Kimberly Anderwood Hoy, JD, CPC, director of Medicare and compliance for HCPro, Inc. Patients are admitted as inpatients or outpatients. Outpatients can receive observation services, but they are not classified as observation status.

That distinction can become tricky when a physician writes an order to admit a patient to observation. To make matters even more confusing, patients who receive observation services often use the same beds as inpatients. However, the patient’s physical location does not determine the patient’s status as inpatient or outpatient, Hoy says. The physician’s orders dictate the patient’s status.

The patient’s underlying clinical condition will determine whether he or she needs to be admitted as an inpatient or should be placed in observation, says Deborah K. Hale, CCS, CCDS, president and CEO of Administrative Consultant Service, LLC, in Shawnee, Okla.

CMS requires hospitals to base inpatient admissions on certain medical necessity criteria, Hale says. Hospitals can choose from several different sets of criteria, but CMS does not endorse any specific criteria.

The difference between a patient admitted as an inpatient and one referred to observation is usually a combination of initial presentation and any underlying secondary diagnoses, Hale says.

Defining inpatient vs. observation
The Medicare Benefit Policy Manual describes an inpatient as a person admitted to a hospital for bed occupancy to receive inpatient hospital services. A patient is generally an inpatient when formally admitted as such with the expectation that he or she will remain at least overnight, says Hoy.

“It is irrelevant whether the patient is transferred, discharged, or even dies, thereby not actually using the bed overnight,” Hoy says. And the fact that a patient remains at the hospital overnight does not automatically make him or her an inpatient, she adds. He or she may be an outpatient who requires extended recovery from a procedure or requires observation services overnight.

Medicare defines observation as a service provided while the decision to admit or discharge home is being made. Observation consists of specific, clinically appropriate services, including:

  • Ongoing short-term treatment
  • Assessment
  • Reassessment

The Medicare Benefit Policy Manual further notes that observation is common for patients who present to the ED and require a significant period of treatment or monitoring before physicians can decide whether to admit or discharge them. Typically patients need more than eight hours of care, but less than 24 hours, Hale says.

"Observation services are intended for patients who are expected to respond very quickly to treatment, usually within 24 hours,” says Hale. Commonly, patients with conditions such as mild dehydration or asthma without any underlying chronic lung disease are placed in observation. The patient could also have a condition that is expected to resolve quickly, but requires treatment that can only be provided in the hospital setting.

Observation is really a time for decision-making: is the patient well enough to be discharged or should the patient be admitted?

Any physician with privileges at a facility can order observation for a patient at that facility, Hale says. However, Medicare will only cover the services if they are reasonable and necessary.

Observation is not just a parking place for patients, Hale adds. Rather, the patient must be under the care of a physician during the period of observation. The way coders and auditors see that is through the progress notes that are timed, written, and signed by the physician. “If a physician thinks [he or she] won’t have as much documentation for an observation patient, that physician has misinterpreted what CMS’ expectations are,” Hale says.

Coding observation
Facilities receive payment for observation services under two composite APCs:

  • APC 8002, Level 1 Extended Assessment and Management. Payment is made when a patient is referred directly to the hospital from a provider-based clinic or comes from another physician’s office or urgent care center.
  • APC 8003, Level 2 Extended Assessment and Management. This is more common, Hale says. Payment is made when a patient comes in from a Type A ED with an E/M level 4-5 visit (CPT® codes 99284–99285); Type B ED with an E/M Level 5 visit (HCPCS code G0384); critical care 99291–99292, G0390) or trauma.

Medicare reimburses for observation services as long as the above guidelines are met, regardless of the patient’s diagnosis, Hale says. Medicare does not require certain laboratory tests be performed.

However, Medicare will not pay for observation services if the patient has a procedure with status indicator T (significant procedure, multiple reduction applies) on the claim.

For example, a patient comes in with abdominal pain and is placed in observation. The physician determines the patient needs an appendectomy, takes the patient to surgery, removed the appendix, and returns the patient to the post-operative recovery room. In this case, the appendectomy has a status indicator T, so the facility will only be paid for the surgery and the ED visit, not the observation.

Coders report observation services by the hour using HCPCS code G0378 (observation services, per hour) says Hale. In order for the facility to qualify for the composite payment for observation services, the patient must spend at least eight hours in observation.

Counting observation hours
Observation services cannot start before the signed and timed physician order, but coders should also review the nurses’ notes to determine when the observation actually began, Hale says. The observation time ends when all of the medically necessary services have been completed. As a result, observation may end well before discharge.

Do not count hours a patient might spend in a custodial setting, for example, when the patient is waiting for a ride home, Hoy says. CMS will not pay for observation services provided for a patient’s convenience or for the family’s convenience, she adds.

Many hospitals struggle to capture the start and stop times for observation services because staff must document the times manually, Hale says.

Coders also need to carve out observation time when a patient receives a therapeutic service that requires active monitoring. The facility receives payment for the active monitoring as part of the code for the procedure; therefore, that time cannot be included in the observation hours, Hoy says.

Facilities should develop a policy to describe:

  • Services that will require carve-out hours to be carved out (active monitoring)
  • List of drugs that require “active monitoring”
  • How much time to carve out for these services (actual time vs. average time)

CMS also does not pay for observation that is a routine part of another Part B service, such as recovery time following minor surgery.

Changing status
Sometimes a physician fails to write an inpatient admit order for a patient who should be admitted. CMS has been very clear that facilities cannot make an order retroactive to the beginning of the encounter, Hale says. However, if an outpatient is receiving observation services and the physician decides to admit the patient, the physician can write an admit order at that point. The time and date when the physician writes the inpatient order become the date and time of the admission.

“This is very important because it drives so many factors in the coding and billing process,” Hale says.
In other cases, the facility’s utilization review committee may determine that a patient does not meet medical necessity to be an inpatient. Under certain conditions, the patient’s status can be changed from inpatient to observation using condition code 44. In order to report condition code 44, the following four conditions must be met:

  • The change in patient status from inpatient to outpatient is made prior to discharge or release, while the beneficiary is still a patient of the hospital
  • The hospital has not submitted a claim to Medicare for the inpatient admission
  • The practitioner responsible for the care of the patient and the UR committee concur with the decision
  • The concurrence of the practitioner responsible for the care of the patient and the UR committee is documented in the patient’s medical record

When the patient’s status is changed using condition code 44, providers may bill for all medically necessary Part B services that were ordered and furnished, Hale says, including:

  • Surgical procedures
  • Implants/devices
  • Injections and infusion therapy
  • Rehabilitation therapy (PT, OT, speech)
  • ED services
  • Surgical dressings

Note, however, that observation is missing from the list, Hale says. Even when the facility appropriately changes a patient’s status from inpatient to outpatient with observation, the facility cannot go back and bill observation for the time the patient was considered an inpatient.

E-mail your questions to Senior Managing Editor Michelle A. Leppert, CPC, at

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