What Is Hospital Observation Status?

When a patient is put into the hospital, they’re assigned a status. Inpatient status and observation status—which is technically an outpatient designation—are the two most common.

When you're admitted to the hospital, it's not always easy to figure out if you've been admitted as an inpatient, or considered an outpatient under hospital observation status.

This article will help you understand how and when observation status is used, and what the implications might be in terms of your health coverage.

The Difference Between Inpatient Status and Observation Status

Inpatient status is what we typically think of as someone being admitted to the hospital. Observation status is a type of outpatient status. However, someone in hospital observation status can spend multiple days and nights actually inside the hospital, even though they're technically an outpatient. In fact, they might be in the very same type of hospital bed, right next door to someone who is considered an inpatient. 

Observation used to be a way to keep someone in the hospital for a short time while healthcare providers tried to decide if they were sick enough to need inpatient treatment.

Now, observation patients can sometimes be kept in the hospital for multiple days on observation status. It's easy to see how this can be confusing for patients since we don't tend to think of "outpatient" as involving an overnight stay in the hospital.

Why Does Inpatient vs. Observation Matter?

If you're sleeping in the same hospital ward and getting the medical treatment you need, why should you care whether you're on inpatient status or observation status? It's because the difference could result in different out-of-pocket costs and different coverage for post-hospital care, depending on your health coverage.

For people on Medicare, the distinction between inpatient and observation status is crucial in terms of the out-of-pocket costs for that care, but also for the coverage of care in a skilled nursing facility after the hospital stay. This is described in more detail below.

Your health insurance company or Medicare won’t pay for your hospital stay as an observation patient in the same manner it would have paid as an inpatient. Instead, they’ll pay for your hospital stay using the outpatient services part of your health insurance benefit.

With a private insurance plan (individual/family or employer-sponsored), you might not notice much of a difference, especially if you have a plan that counts both inpatient and outpatient care toward your deductible.

But if you're enrolled in Original Medicare (Part A and Part B), the difference could be very significant. That's because Part A (inpatient services) and Part B (outpatient and physician services) have different benefit structures and cost-sharing rules.

Although complex and confusing, there are rules, or at least guidelines, your healthcare provider and hospital follow when deciding whether to assign you hospital observation status or inpatient status.

Example

Say Mr. Smith comes to the emergency room with chest pain. Unable to tell for sure whether or not Mr. Smith is having a heart attack, the cardiologist, Dr. Jones, puts Mr. Smith in the hospital on observation status.

Mr. Smith spends the night in a hospital room attached to a heart monitor. Throughout the night, nurses check on him regularly. He gets oxygen and has blood tests drawn every few hours. Dr. Jones may even have ordered more extensive tests to determine the condition of Mr. Smith's heart.

Late the next evening, after two days and one night in the hospital, Dr. Jones has enough information to determine that Mr. Smith didn't have a heart attack. Mr. Smith is sent home.

Mr. Smith's health insurance company pays for part of his hospital stay charges under Mr. Smith's outpatient services benefit coverage. (If Mr. Smith has Medicare, Medicare Part B will cover 80% of the Medicare-approved cost of the services Mr. Smith received during his observation stay, assuming he's already paid his Part B deductible for the year.)

In this case, let's say that Mr. Smith's health insurance policy has a 25% coinsurance for outpatient services. So Mr. Smith pays for 25% of the charge for every blood test and X-ray. He also pays 25% of the charge for oxygen, heart monitoring, and the hospital's hourly charges for outpatient observation services. (If he has Medicare Part B, the coinsurance rate is 20%.)

If Mr. Smith had received the same exact services as an inpatient rather than on observation status, depending on the type of coverage he has, he may have owed a single hospitalization copayment and his health insurance would have covered the rest of the charges.

But it's also common for health insurance plans to count hospitalization towards the plan's deductible, and then begin assessing coinsurance charges. In that case, the total amount that Mr. Smith owed may have ended up roughly similar either way.

Under Original Medicare, in 2024, Mr. Smith would pay $1,632 for his hospital stay if he were considered an inpatient, plus Part B costs for physician services that he received during his time in the hospital (that's a $240 annual deductible, plus 20% of the Medicare-approved amount of the physician services).

But if he's considered an outpatient and his stay is classified as an observation stay, he'll owe the $240 Part B deductible (assuming he hasn't already met it earlier in the year) plus 20% of all Medicare-approved costs associated with his stay.

So his costs under observation would depend on how much care was provided to him, and how many tests were run.

(Most Medicare enrollees also have supplemental coverage, in the form of Medigap coverage, Medicaid, or coverage from a current or former employer, which pick up some or all of the out-of-pocket costs under Medicare. And enrollees with Medicare Advantage pay different cost-sharing that varies from one plan to another.)

Inpatient vs. Observation and Medicare Coverage of Skilled Nursing Facility Care

Patients are sometimes well enough to leave the hospital, but not yet well enough to return home. Skilled nursing facilities can be used to fill this gap. A patient who has a knee replacement, for example, might only need a few days in the hospital, but may still need a stepped-down level of care at a skilled nursing facility before being able to return home.

Original Medicare only pays for care in a skilled nursing facility if it's preceded by at least a three-day inpatient hospital stay. (Medicare Advantage plans can waive this requirement, as can Medicare Accountable Care Organizations.)

This is one of the reasons patients and their families need to understand whether inpatient or observational status is being used. This three-day inpatient requirement can be confusing for patients, especially if they don't understand how a stay in the hospital can still be classified as outpatient care.

Consumer advocates, lawmakers, and even the head of the Centers for Medicare and Medicaid Services have indicated that addressing this issue is a priority, so it remains to be seen whether the three-day rule will continue to apply in the future.

But for the time being, it's still important for patients, especially if they have Medicare, to understand whether their hospital stay is classified as inpatient or observation.

There is an appeals process available, however, for patients with Medicare whose hospital stay was classified as observation, and a subsequent skilled nursing facility stay was not covered. This stems from a court ruling that was issued in 2020, and it applies to medical care dating back to 2009 (the lawsuit took several years to make its way through the court system).

Summary

When a person is kept overnight in the hospital, they are likely considered an inpatient. But that's not always the case. Depending on the circumstances, they might be kept in the hospital under observation, which is an outpatient status. This can affect how the patient's health insurance covers the cost, and whether or not Medicare will pay for skilled nursing facility care after the patient leaves the hospital.

There are guidelines that doctors follow when determining whether a patient should be classified as inpatient or observation status, so this doesn't tend to be something that a doctor can change based on a patient's request. But the more you understand about this, the better you'll be able to prepare for how your health plan will cover the treatment.

If you or your loved one is covered by Medicare and it appears that skilled nursing facility care will be necessary before returning home, it's wise to discuss this in advance with the doctor at the hospital, as well as the billing office at the skilled nursing facility.