NCPA - National Center for Policy Analysis

Hospital Audits and the "Two Midnight" Rule

December 20, 2013

Medicare needs to develop a better hospital billing system that makes clear which patients qualify for inpatient or outpatient status, says Emily Egan of the American Action Forum.

The Recovery Audit Contracting (RAC) program was established to detect Medicare fraud. The program was launched nationwide in 2009, and RACs audit Medicare claims to look for improper billing practices. Auditors receive a percentage of the money that they recover through the audits as payment.

The status of hospital patients (which directly impacts proper billing) is confusing, however.

  • If a patient is considered inpatient, Medicare Part A covers his claims, while an outpatient patient is covered by Medicare Part B.
  • Patients who are under "observation status" -- even if they are staying in the hospital -- are considered outpatient.

The status of the visit (inpatient or outpatient) determines copays, whether drugs are covered, and whether the patient qualifies for post-acute care under Medicare (which is only covered if a patient has a three-day inpatient stay). The RAC audits look into these billing complexities.

Because of the immense confusion with classifying observation stays, the Centers for Medicare and Medicaid Services (CMS) issued the "Two Midnight" rule: any patients on observation status will only be considered inpatient if they stay for two midnights or longer.

  • Hospitals have reacted negatively to the rule, insisting that it just creates incentives to discharge patients after midnight instead of when it is appropriate.
  • Patients could see unnecessarily long hospital stays. Moreover, two patients could come into the hospital for the same issue, stay in the hospital for the same amount of time, receive the same care, but one stay could be labeled inpatient while the other is labeled outpatient (based on the Two Midnight rule). The two stays would be billed entirely differently.
  • Moreover, hospitals will face RAC audits if they predict a longer stay but the patient leaves before two midnights.

Because of the complexity and confusion with the new rule, CMS instituted a grace period from the audits that runs through March. The American Action Forum estimates a loss of up to $408 million for the Medicare Trust Fund during the six month grace period.

Source: Emily Egan, "Primer: Recovery Audit Contractor Program and the 'Two Midnight' Rule," American Action Forum, December 11, 2013.


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