Outpatient procedures fall into an area that often is not included in the utilization review process. There can be several reasons why this is the case, with lack of resources being the most common. What defines “observation” and how it is utilized in the outpatient setting long has been a point of controversy and confusion in both the public and clinical arenas. 

There have been a number of notable articles in national publications highlighting the confusion surrounding these issues.  In the case of Bagnall vs. Sebelius[i], the Center for Medicare Advocacy filed a class-action lawsuit on behalf of seven plaintiffs for what is termed an “improper classification of observation status,” which allegedly deprives Medicare beneficiaries  of their Medicare Part A coverage for hospital care and aftercare.

“Inpatient,” “outpatient,” “observation,” “extended recovery” and “outpatient in a bed” are terms that frequently are used to distinguish between levels of care given to patients in hospitals, but inpatient and outpatient are the only two status determinations recognized by Medicare. Quick question: Outpatient services can be billed with CC44 for appropriately documented observation hours, right?  Observation Services, restated in Transmittal 1760[ii], are “a specific set of services provided to an outpatient in a hospital bed.” “Extended recovery” and “outpatient in a bed” are not Medicare terms; they are terms developed by hospitals to distinguish between certain outpatient areas or ways to classify patients for billing purposes.

The Centers for Medicare & Medicaid Services (CMS) Medicare Inpatient-Only List is a critical and very helpful resource for all hospitals when it comes to determining whether an outpatient or inpatient designation should be used. This list is a set of the procedures recognized by CMS to be performed safely in an inpatient setting only. In this document, CMS notes “that our designation of a service as ‘inpatient only’ does not necessarily preclude the procedure from being furnished in a hospital outpatient setting, but only means that Medicare will not make payment for that service were it to be provided to a Medicare beneficiary in that setting. This unfortunately leaves the beneficiary responsible for the payment.” (65 Federal Register 18434 at 18443[iii]) Basically, this guidance has been interpreted as Medicare’s position that these procedures should be performed in the inpatient setting. However, procedures that fall into the Inpatient Only List aren’t necessarily immune to denials – meaning if the physician documentation does not support the inpatient level of care, RACs and MACs still may deny the claim.

Many times, observation will be ordered after an outpatient procedure even though almost no indication for observation as a level of care is recorded after that procedure. There are some varying views among CMS contractors regarding this topic, but Medicare makes it very clear that observation hours cannot be counted if they already are bundled into another payment. Furthermore, CMS has made it clear that routine observation following an uncomplicated outpatient procedure is part of the normal recovery time following that procedure, and separate billing for observation hours during such time is not permitted. The Ambulatory Payment Classification (APC) for OP surgery includes not only the surgery, but also routine post-operative care. 

Again, “extended recovery” and “outpatient in a bed” are terms hospitals use, but they are not considered tantamount to outpatient status by Medicare. The Medicare Benefit Policy Manual, Chapter 1, Section 10[iv] states: “When patients with known diagnoses enter a hospital for a specific minor surgical procedure or other treatment that is expected to keep them in the hospital for only a few hours (i.e., less than 24 hours), they are considered outpatients for coverage purposes regardless of the hour they came to the hospital, whether they used a bed and whether they remained in the hospital past midnight.

Because of advances in technology and surgical technique, many surgeries now are completed as outpatient services, but patients still routinely are kept in the hospital overnight post-op (ICDs are a great example of this). So even though there is an overnight stay in such cases, the procedure still can be classified as an outpatient service. The APC for the surgery technically should cover all of that routine post-op care, not just care received in the recovery room. 

Remember, observation is a very specific level of care. Observation services are those services furnished by a hospital on the hospital’s premises – including use of a bed and at least periodic monitoring by nursing or other staff – that are deemed reasonable and necessary to evaluate an outpatient’s condition or to determine the need for a possible admission to the hospital as an inpatient. Such services are covered only when provided at the order of a physician (or another individual authorized by state licensure law and hospital staff bylaws) to admit patients to the hospital or to order outpatient tests.

Coverage of Outpatient Observation Services

When a physician orders that a patient be placed under observation, the patient’s status is outpatient. The purpose of observation is to determine the need for further treatment or inpatient admission. Thus, a patient in observation may improve and be released, or be admitted as an inpatient (CMS Medicare Benefit Policy Manual, Chapter 6, section 20.6).


With this in mind, the following best practices can help in making the proper determination:

  • First, make sure that no routine pre-op or post-op orders for observation have been written. Remember, OBS hours require a specific purpose in order to evaluate the possible need for further treatment or to decide on inpatient admission.
  • Any patient who occupies a bed overnight should be seen by case management, with strict admission criteria applied to these cases and review documented in an auditable format.
  • All cases that do not pass criteria, regardless of admission order status, should be referred to a physician advisor who is an expert in utilization standards and CMS rules and regulations.
  • The physician advisor then should review the case, speak with the admitting physician when needed and render a final recommendation based on UR Standards. The decision then should be documented in an auditable format on the chart or in the UR documentation.
  • After the physician advisor recommendation is made, the attending physician can make changes to the order as appropriate.
  • It is crucial that this process remain in place seven days a week, 365 days a year.

About the Author

Dr. Zelem currently serves as an executive medical director in client relations and education for Executive Health Resources (EHR). In this role, Dr. Zelem regularly visits EHR’s client hospitals to provide medical executives and staff members with ongoing education on a variety of topics, including Medicare and Medicaid compliance and regulations, medical necessity, Recovery Audit Contractors, utilization review, denials management and length of stay.

Contact the Author


To comment on this article please go to editor@racmonitor.com

Share This Article