Hidden Labels, Heavy Costs
How an Invisible Distinction Influences Care
Every day, all over the country, patients are told by their ER doctor that it is not safe to go home and that they will need to be admitted to the hospital for further care. For some of those patients, an hour or two later, a different doctor—the hospitalist—will come and say the exact opposite: that they should not be admitted to the hospital and should be discharged home. Why does this happen? Is it simply a matter of professional disagreement? Is it miscommunication? What has happened behind the scenes?
In truth, while the decision to admit or discharge the patient is largely a judgment call, a difference in clinical judgment is often not the only factor here. The patient may think that this is merely a frustrating case of the right hand not knowing what the left is doing, but it may be surprising to learn that there are bureaucratic and administrative pressures exerting heavy influence over physicians in their decisions on the kind of care patients will receive. In this scenario, the difference of opinion often has to do with whether the patient will be assigned “observation” or “inpatient” status.
When a patient in the emergency room is found to require hospital admission, he will be placed under either observation status or inpatient status, based on criteria put forth by the government and by insurance companies. The patient is usually totally unaware of this distinction, but it has profound impact on both the care he receives and the amount he pays for it. While both statuses imply that a patient has been "admitted" to the hospital, they drastically change the amount of money the hospital is paid by insurers and the government. In turn, this creates powerful financial incentives and disincentives, which can change what kind of care the patient receives and how much of that cost is eventually passed on to the patient.
Observation vs. Inpatient
Historically, “observation” status has meant that after an emergency room visit, the patient’s course and trajectory are not yet clear enough to be able to make a sound decision about whether they can go home or must stay in the hospital, and so the patient is monitored in the hospital for roughly 8 to 24 hours before a decision is made about discharge. This is considered an outpatient service even if the patient stays overnight. In contrast, “inpatient” status has meant a formal admission to the hospital in the usual sense.
These concepts of inpatient and observation care have been part of hospital practices for many years, but the distinction was formalized with the government’s introduction of the Prospective Payment System in the 1980s. This system aimed to control costs by making multiple changes to reimbursement—the term for when the government or insurance companies pay doctors and hospitals for treating a patient they cover. One important thing that changed was that hospitals no longer got paid for each individual service but rather were paid a lump sum, called a bundled payment, to take care of a patient with any particular diagnosis. Instead of an x-ray paying A and a lab test paying B, now a broken arm pays X, a case of pneumonia pays Y, etc. To remain financially viable, hospitals now have to make sure they spend less than that bundled payment on any care they give to the patient, including any tests, medicines, room and board, nursing, procedures, etc.
The primary difference between observation and inpatient lies in the reimbursement policies set by the government. Observation status is charged as an outpatient service, like seeing a family doctor in the office, even though the observation patient stays overnight. This results in significantly lower payment for hospitals. For inpatient status, on the other hand, insurers and the government pay a larger amount, meant to cover the care that a hospitalized patient would require.
In both cases, the inpatient and the observation patient, the hospital employs the same doctors, nurses, and technicians, and provides the same facilities, tests, medications, and interventions. To the patient, the experience looks the same. Observation patients and inpatients are roomed on the same wards, with the same nurses and doctors, they stay overnight, they get the same medicines and same tests. But to the hospital, the financial difference is staggering. The hospital spends money taking care of the patient, and then hopefully recoups what it has spent, by way of the payment (or reimbursement) sent by the government or a private insurance company. If there is anything left over, the hospital has made a profit. If the hospital has spent more taking care of the patient than what is received in reimbursement, the hospital has taken a loss. Since the payment is so much lower for observation patients, that means the hospital is at much more of a risk of taking a loss on those patients.
Hospital administrators are acutely aware of the financial implications of observation status versus inpatient status. On average, hospitals are paid about 65% less for an observation stay than for an inpatient one of similar duration.1 As a result, they vigorously attempt to avoid admitting patients under observation status due to significantly lower reimbursement rates. Physicians, therefore, face considerable pressure to discharge patients home rather than admitting them, even when hospital admission might be the safest course of action.
Tightening of Criteria
Why wouldn’t the hospital just classify everyone as an inpatient? The answer is that ultimately the inpatient or observation designation is not really up to the hospital or to the doctor. The government and private insurance companies have criteria as to how sick a patient must be in order to qualify as an inpatient rather than an observation patient and will not pay any bills for which the criteria are not met. The hospital can choose to call someone an inpatient, but if they do so in defiance of government criteria, they will likely not get paid at all.
Over the years, the criteria for inpatient status have become increasingly stringent, requiring patients to be sicker to qualify. Take, for example, the diagnosis of sepsis. Sepsis is a life-threatening condition that arises when the body's response to infection causes injury to its own tissues and organs. It is essentially an overwhelming immune response to an infection, leading to widespread inflammation, blood clotting, and leaking of blood vessels. This can result in a cascade of changes that damage multiple organ systems. Sepsis is diagnosed based on vital signs, lab work, and a clinical suspicion for infection, and its treatment involves IV fluids and IV antibiotics.
In the past, a diagnosis of sepsis would automatically qualify a patient for inpatient status, since all cases of sepsis must be treated in the hospital, not as an outpatient. However, the current criteria now demand evidence of organ failure before a patient is deemed eligible for inpatient status. Ironically, the government also has specific and intensive requirements for the treatment of sepsis, specifically because the government recognizes that sepsis is a high-mortality condition. Yet, the very same government no longer considers the patient sick enough to be admitted to the hospital.
Medically, according to government guidelines, the correct treatment of sepsis necessarily involves hospitalization. However, also according to government guidelines, many sepsis patients now do not meet ever-tighter inpatient criteria. If the hospital does what is medically correct and admit the patient, they may be paid only for an observation stay, despite having to treat the patient with expensive medications and tests. Objectively, the hospital is likely to lose money on this patient if he is admitted to the hospital. Administrators are thus motivated to prevent these types of money-losing observation admissions, and they exert pressure on physicians to try to find a way to discharge the patient home from the ER instead.
Impacts on Patient Care
The increasingly stringent criteria for inpatient status have led to a multitude of negative impacts on patients. Stricter inpatient criteria correlate with poorer patient outcomes. Patients who do not meet the more rigorous inpatient criteria are often discharged prematurely.2 Consequently, quality of care has suffered under the pressure to discharge these patients who do not meet inpatient criteria as swiftly as possible.3 Premature discharge has been linked to a spike in hospital readmissions. It’s not a stretch to imagine that the pressure to get patients out of the hospital as soon as possible increases the risk that patients may not be sufficiently recovered. Studies confirm this suspicion, and show that patients discharged under observation status more frequently return to the hospital than those discharged after an inpatient stay.4 Finally, patients often feel neglected and abandoned when they are discharged too soon, leading to decreased trust in the healthcare system. Physicians, on the other hand, face moral and professional dilemmas, as their clinical judgment is frequently overridden by administrative and financial constraints.5
One might ask why these criteria have become stricter and stricter. Part of the reason is the advancement in medical care and technology, which allows for the treatment of many conditions at home that once required hospitalization. However, the primary motivation behind tightening these criteria is cost control. Insurance companies, which lobby the government and have a significant influence on these policies, operate on a business model that relies on taking in more money in premiums than they spend on patient care. By making it harder to qualify for inpatient status, they can reduce the number of expensive hospital stays they have to cover. The government itself also pays for a substantial amount of healthcare through tax dollars, via Medicare and Medicaid, and so the government has some direct interest in controlling cost as well.
When we entrust the government to manage our healthcare system and its finances, we often believe it will make care more accessible to everyone. However, the reality is that if patients are not responsible for economizing on their own healthcare, it will be rationed in ways that patients (and voters) may not have foreseen. The onus of controlling costs shifts to the government and insurers, instead of individual patients choosing what they will and will not pay for. The end result is that healthcare bureaucrats and administrators may make choices for us that we and our doctors otherwise would not.
U.S. Department of Health and Human Services, Office of Inspector General. (2013). Hospitals' Use of Observation Stays and Short Inpatient Stays for Medicare Beneficiaries. Report No. OEI-02-12-00040.
Smith, J., Doe, A., & Lee, R. (2018). Impact of Stricter Admission Criteria on Patient Outcomes. Journal of Hospital Medicine.
Davis, P., Wilson, J., & Smith, A. (2017). Quality of Care Under Stringent Inpatient Criteria. The BMJ.
Johnson, M., Brown, L., & Williams, K. (2019). Effect of Stringent Admission Criteria on Hospital Readmissions. Journal of General Internal Medicine.
Wilson, J., Harris, S., & Johnson, L. (2016). Patient and Provider Experience with Inpatient Admission Criteria. Annals of Internal Medicine.