After five days in the hospital with a fractured spine, Jean Arnau was discharged and needed to transfer to a skilled nursing facility for rehabilitation. Only then did her family find out that she had never been formally admitted as an inpatient to the hospital.

While the care the 84-year-old Rhode Island woman got was exactly the same, she had been classified as an outpatient under “observation” – a status that cost her thousands of dollars more than she would have paid if she had been admitted as an inpatient.

The same thing happened to Lois Frarie, a 93-year-old retired teacher. She spent four days at a local hospital in California while being treated for a broken elbow and pelvis. Then she went to a nearby nursing home to build up her strength.

But her family was stunned to find out that they would have to pay thousands of dollars up front since two of the days she spent in the hospital were considered "observation care." She wasn't an admitted patient for at least three consecutive days and therefore she didn’t qualify under federal law for Medicare’s nursing home coverage. “I assumed I was under the hospital’s care,” Frarie told Kaiser Health News/USA Today.

Earlier this month, a federal judge heard arguments in a lawsuit over the “observation” practice. While Arnau and Frarie are not part of the lawsuit, their situations are similar to what happened to Richard Bagnall and the others who are contesting the practice of people spending more than three days in the hospital but still not be considered “inpatients.”

This observation status prevents them from getting Medicare coverage of post-acute care. Beneficiaries who are placed under observation – which is considered outpatient care – cannot qualify for nursing home coverage, even if they are in the hospital for three days. They also face higher out-of-pocket costs, including higher copayments and charges for drugs that are not covered for outpatient stays.

The reason for the increased charges are that as an outpatient, the person’s Medicare coverage comes not under Part A (hospital insurance) but Part B (which normally covers doctors' services and outpatient care). For some patients, this can also mean paying more out of pocket — especially if they need prescription drugs, which would be covered under Part B and not under Part A or even the Medicare Part D drug benefit.

The two women are hardly alone with this problem. More and more seniors are finding themselves in the same financial jam. The number of beneficiaries under observation has increased by 69% in the past five years, reaching 1.6 million in 2011, according to the most recent federal statistics. In addition, the number of such visits that last more than 24 hours has doubled to more than 744,000, according to government statistics.

The concept of observational care is intended to help medical folks and patients save time and money. It addresses several of health care’s thorniest challenges by helping reduce hospital readmission rates, can help reduce crowding and speed issues in the emergency room, saves patients an extended hospital admission (not to mention re-admission) and most importantly, improves patient outcome, emergency room professionals argue.

But the policy has also caused financial havoc and added stress for patients with extra costs. In Bagnall v. Sebelius, the plaintiffs are asking a federal judge in Connecticut to eliminate observation status, or to at least require written notification when a patient is placed on observation.

Government lawyers are asking the judge to dismiss the case, saying the plaintiffs did not go through the lengthy multi-step Medicare appeals process before filing suit. But federal records and interviews with patients and advocates show that many observation patients who call Medicare about the billing problem find out there is nothing that Medicare can do to help. “People are often told there is nothing to appeal,” Judith Stein, executive director of the Center for Medicare Advocacy, which is representing 14 seniors in the lawsuit told Kaiser Health News recently.

Once patients leave the hospital and then find out they were receiving observation services, when their bill arrives, it’s often too late. That’s because hospitals and physicians are prohibited from reclassifying observation patients as inpatients once they've been discharged, according to Medicare rules.

Few people realize they are admitted as observation patients, not as an inpatient. The great surprise here is that under current law, hospitals are not required to tell patients their status. Under Medicare’s rules, Medicare picks up the whole tab for the first 20 days in an approved skilled nursing for rehab or other care, but only if someone has spent at least three full days in the hospital as an admitted patient. If you are admitted under “observation” – for all or part of that time, you are responsible for the entire cost of your rehab in a skilled nursing facility. If you are doing rehab in a rehab hospital or an inpatient rehab facility, different rules apply under Medicare, so your stay is covered.

Two years ago, Medicare held a “listening session” at which more than 2,200 hospital administrators, physicians, patient advocates and others called in to discuss “observation status.” “Almost everyone who spoke felt the practice was harmful and should be ended,” Stein, founder and executive director of the Center for Medicare Advocacy, told AARP last fall. But nothing came of the discussion, so the center filed the lawsuit against the federal government to force a change.

To address this, Medicare recently proposed some changes on its own, aimed at helping more beneficiaries become eligible for nursing home care after a hospital stay by requiring patients to be admitted as inpatient if a physician expects the individual to be in the hospital for more than three days. The proposed admission changes are part of a 1,400-page annual hospital payment update released recently. If adopted, Medicare estimates it will result in 40,000 more inpatient hospital stays.

A big trend among hospitals has been moving some people from their emergency rooms into observation units where they can undergo further monitoring or testing before doctors decide whether they should be released or admitted.

The idea makes a lot of sense. The problem is that many hospitals and insurers haven’t set up their clinical or billing systems or their insurance contracts with these patients in mind. That has resulted in longer hospital stays for some patients but often it means larger bills for consumers. It also leads to patient confusion when observation patients are not separated from other inpatients.

Where there has been true success with observation units are when they are completely separated and operated with separate staff and clearly defined protocols. In those cases, it has often helped catch the patients who might fall between the cracks – those who need more than an emergency department visit but don’t need long hospital stays.

Rather than send a patient home who is at high risk for a heart attack following an emergency department visit because of chest pain, for example, staff might refer him to an observation unit for repeat blood tests, EKGs and a stress test. By monitoring and treating patients intensively up front, observation unit staff can forestall problems and help people get better faster.

A new twist is about to make the need for observation units even greater. In an effort to rein in spiraling costs, Medicare is now taking a tougher line with hospitals, sending auditors to investigate not only fraud but also cases in which the agency thinks that "medically unnecessary" hospitalizations have occurred.

Also, as part of the new health care reform legislation, and to improve the quality of care, Medicare will soon start penalizing hospitals that readmit patients in less than 30 days — raising the question of whether hospitals might label people as observation patients so that they cannot be counted as a readmission if they happen to return.

The Centers for Medicare and Medicaid Services, which runs Medicare, and private insurers are monitoring hospital admissions closely and have been retroactively denying payment if they determine an admission wasn’t warranted.

The health law will probably prompt hospitals to use the observation designation with more patients, even if they don’t receive special care, say experts. Unfortunately, the “complexity of this fragmented, loophole-ridden payment system has taken one of the best ideas in medicine and made it confusing to patients and doctors,” Kellermann says. “It could undermine what is one of the best ideas in health care.”

So What Options Do You Have?

Patients or their families will need to press the hospital for information about their inpatient or observation status. Remember – your status can be changed daily or at any time.

Patient advocates also recommend you discuss observational status with doctors and to make sure you talk with the hospital billing people before you leave the hospital.

If you need rehab or any other continuing care after you are discharged but learn that Medicare won’t cover your stay, ask your doctor whether you qualify for similar care at home through Medicare’s home health benefit or for Medicare-covered care in a rehabilitation hospital.

There is also an appeals process through Medicare if you go to a skilled nursing facility and have to pay for it yourself, but it is a long and difficult process.

Contributing to this story were: AARP Bulletin, Kaiser Health News, USA Today and the Washington Post.

Alan Schlein runs DeadlineOnline.com, an internet training and consulting firm. He is the author of the bestselling “Find It Online” books.

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