For Now, Medicare Beneficiaries Win Right to Challenge Certain Outpatient Observation Placement Orders

On March 24, 2020, the U.S. District Court for the District of Connecticut granted a class of Medicare beneficiaries the right to challenge their designation in hospitals as outpatients receiving observation services rather than as inpatients. In the case, Alexander v. Azar, the court ruled that the Department of Health and Human Services (HHS) violated the beneficiaries’ due process rights when they were initially admitted to the hospital as inpatients but had their statuses later changed to outpatient. Specifically, the court determined that HHS deprived the beneficiaries of their property interest in Part A coverage for the hospital services rendered to them without proper procedural protections in place. The court ordered HHS to establish a procedure to allow beneficiaries to challenge the decisions of hospitals to change their statuses from inpatient to outpatient. Note that the court did not grant patients originally placed in outpatient status receiving observation services the same opportunity. While this decision is groundbreaking and worthy of significant attention, note that the Government filed a Notice of Appeal on May 22, 2020. Time will tell whether the relief ordered by the District Court will withstand appellate scrutiny.


By way of background, Medicare provides every American, 65 years or older, access to health insurance to meet hospital, medical and other health costs. Medicare Part A covers inpatient hospital services, skilled nursing facility (SNF) care, home health and hospice care. Medicare Part B covers medical and other health services that are not covered by Part A, including outpatient observation services. Typically, Part A benefits are covered via payroll taxes. However, beneficiaries are required to enroll and pay applicable premiums to obtain Part B benefits. Applicable law, regulations and guidance broadly define the term “inpatient hospital services” to encompass services furnished to hospital inpatients. Statutory, regulatory and sub-regulatory guidance instructs hospitals not to differentiate between the “level of care” of services rendered to inpatients and outpatients.

By contrast, CMS defines outpatient observations services as a well-defined set of specific, clinically appropriate services (e.g., short term treatment, assessment, and reassessment whether patients will require further treatment as hospital inpatients).  Many Medicare beneficiaries would argue that outpatient observation services are anything but “well-defined.” In fact, Alexander v. Azar was initiated by a nationwide class of patients that had received hospital care as outpatients receiving observation services, many of whom had received such services for many days, and some of whom may have been unaware of their status as outpatients.


Medicare Hospital Conditions of Participation require hospitals to implement a utilization review plan to review inpatient admissions and the duration of hospital stays for medical necessity. Such a plan should include at least two (2) physicians and hospital care managers as part of the utilization review committee (URC) to perform patient reviews. The court in Alexander v. Azar found that the following URC review process was utilized for inpatient admissions: upon admission, a case manager (or other URC member) reviews the admission for compliance with Medicare regulations and policy. The first level review would be completed by a nurse case manager using a commercial screening tool (e.g., InterQual or MCG). If the criteria are not met, a second level review is conducted by a physician member of the URC. If the physician finds the inpatient admission was not medically necessary, the treating physician is contacted to enter an order for outpatient observation services. The court determined this process to be highly persuasive to the admitting physician.


There can be significant repercussions to designating a patient as a hospital outpatient receiving observation services, rather than as a hospital inpatient (e.g., denial of coverage of necessary SNF care following hospitalization). To receive coverage for post-hospital SNF care, federal regulations require, a beneficiary to have been hospitalized for medically necessary inpatient hospital care for at least three consecutive calendar days. Patients not qualifying for SNF coverage must cover their SNF care (which was found to average around $10,000) or forego SNF care altogether.

Additionally, beneficiaries designated as outpatients receiving observation services may be responsible for hospital costs. Not all individuals eligible for Part B benefits choose to obtain them. If a patient opts not to enroll in Medicare Part B, and the patient is not formally admitted to the hospital as an inpatient (or the patient’s status is changed to outpatient with observation services), the patient could be responsible for the entire cost of the hospital stay.


The Medicare beneficiaries in Alexander v. Azar won their case under a due process claim. To succeed on a due process claim, the plaintiff must show that (1) state action (2) deprived him/her of liberty or property (3) without due process of law. The court determined that HHS violated the beneficiaries’ due process rights by depriving them of their property interest in Medicare Part A coverage for hospital services rendered to them without sufficient procedural safeguards in place.

The court found that URC’s patient status determinations were significantly influenced by the government’s actions to reduce overpayments (e.g., aggressive auditing activity, providing “education” of audit findings to URC members). On this basis, the court found that URC’s patient status determinations essentially constituted state action.

Additionally, upon considering the Two-Midnight Rule (i.e., physicians order inpatient admission for beneficiaries they expect to require hospital care that crosses two midnights), CMS sub-regulatory guidance, and CMS enforcement practices, the court found that beneficiaries “have a protected property interest in Part A coverage for a hospital stay that satisfies inpatient admission criteria.” The court determined that the Two Midnight Rule is mandatory, guaranteeing Part A coverage when its requirements are met. As patients re-designated as outpatients receiving observation services were deprived of this coverage, the second element was met.

The court also found that there was a significant risk of error in the URC’s decisions to change a beneficiary’s status from inpatient to outpatient receiving observation services. The court found that URC determinations often mirror those of Medicare contractors. Significantly, hospital appeals from determinations made by Medicare contractors enjoy a significant overturn rate in the Medicare appeals process, demonstrating such determinations are frequently erroneous. As URC decisions often follow the same process as Medicare Contractors, the court found it follows that URC decisions would also be frequently erroneous. As there are no procedural safeguards in place to protect the beneficiaries’ interests from such an erroneous decision, the final element of the due process claim was met.


Due to the high risk of erroneous deprivation of a beneficiaries’ property interest, the court determined that additional procedural safeguards would be valuable. To this end, the court held that Medicare beneficiaries, on or after January 1, 2009, are entitled to appeal the denial of their Part A coverage that:

  • Have been/will be formally admitted as a hospital inpatient;
  • Have been/will be subsequently reclassified as an outpatient receiving observation services;
  • Have received/will receive an initial determination or Medicare Outpatient Observation Notice, indicating the observation services are not covered under Medicare Part A; and
  • The beneficiary either:
    • Was not enrolled in Part B coverage at the time of their hospitalization; or
    • Stayed at the hospital for three or more consecutive days but was designated as an inpatient for fewer than three days, unless more than 30 days has passed after the hospital stay without the beneficiary being admitted to a SNF.


Hospitals are well advised to follow the Alexander v. Azar decision. Should the decision stand, the beneficiaries specified in Section V must be given the opportunity to appeal re-designation decisions from inpatient to outpatient receiving observation services.

For a more comprehensive review of this decision, please see:

For any questions regarding the U.S. District Court’s decision in Alexander v. Azar, please contact Jessica L. Gustafson, Esq. at, Abby Pendleton Esq. at, or your regular HLP attorney, or call (248) 996-8510.

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