Coding for Inpatient or Observation Status: More Than Just the Two-Midnight Rule

Hint: Look at physician’s order, not services provided

Incorrectly coding a patient’s hospital status could cost your physicians significantly, even years down the road. The Centers for Medicare & Medicaid Services (CMS) has been aggressively reviewing inpatient and observation claims to reduce the amount of improper payments. When you’re under such scrutiny, thorough documentation is the best solution for correct billing and avoidance of audit findings.

Knowing what to look for in the documentation when billing will make you a vital asset to your practice, says medical compliance consultant Duane Abbey in his live audio conference with AudioEducator. During his presentation on inpatient and observation services billing, Abbey takes you through real-life examples so you can make the best coding decision in  each scenario.

Misidentifying Could Cost You Thousands

At first sight, it seems that differentiating between inpatient and observation should be obvious, so why isn’t it?

Essentially, says Toby Edelman, senior policy attorney at the Center for Medicare Advocacy, it’s because “the difference between observation and inpatient care is basically indistinguishable,” unless patients are in an actual observation wing of the hospital. In fact, in hospitals without designated observation wings, a patient under observation could be in a bed right next to an inpatient. And yet, observation care is defined as outpatient care, meaning that billing and reimbursement will be very different from that for inpatient care.

How different reimbursement is all boils down to the fact that inpatient services are paid for under Medicare Part A, which covers hospital services and 80% of doctor services up to a period of 60 days (after the deductible is met). In contrast, outpatient care (and thereby observation services) is paid for under Medicare Part B, which covers only 80% of all charges after the annual deductible is met.

The Complex Truth: Although it may seem like a technicality, correctly identifying a patient’s hospital status on your claims can make or break your practice’s reimbursement, so ensure you have all the documentation you need to make a clear call.

Use the Two-Midnight Rule as a Base

Traditionally, physicians will use the “Two-Midnight Rule” to determine hospital status, and thereby reimbursement. That is, if the admitting physician initially estimates that the patient will require care for 48 hours or less before they can go home or receive care in a doctor’s office, they will place the patient under observation. If, in contrast, the patient is presenting symptoms requiring a stay for more than 48 hours, the physician should order inpatient care.

Both inpatients and patients under observation can therefore stay overnight and receive the same treatments, making it hard to say which status is which, especially when outpatients require monitoring for more than 48 hours to observe the progression of their symptoms. When determining which services to bill for, the first and most important item to focus on is the wording of the physician’s order in the documentation.

Physician’s Order Determines a Patient’s Status

The admitting physician’s order should state explicitly if the patient is being sent to observation or inpatient care. This order should be written, dated (with time), and signed by the billing physician (or other qualified individual if the billing physician cannot be present). For inpatient services, documentation must also include why the patient is being admitted, in addition to estimated length of stay.

For documentation with an order for observation, make sure the following is included:

  • History, examination and medical decision making (MDM)
  • Time spent in observation (with initial/end dates)
  • A statement by the physician that the patient is not stable enough to return home or to receive treatment in a doctor’s office.


Go Heavy on the Details: The more details provided, the better case you will have to stand up to an auditor’s questioning. For inpatients, a note explicitly stating that a stay of more than 24 hours is anticipated could save hours of headaches with auditors trying to justify an inpatient status.

As a coder, you’re the last line of defense for properly recording inpatient or observation services coding. Knowing how to search the documentation to determine status for billing can save you from having thousands of dollars revoked in a future audit finding, says Abbey.

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