HA415 Unit 3 Observation Stay Cost Analysis Example

Thirty Hours, Two Labels, Three Payers: A Cost Analysis of One Composite Chest Pain Stay at a Community Hospital, Pricing It From the Hospital's Side and Setting the Cost Beside an Observation Payment and an Inpatient Payment

[Student Name]

Purdue University Global

HA415: Health Care Policy and Economics

Unit 3 Cost Analysis

[Instructor Name]

[Date]

The hospital, the patient and every cost and payment figure are composite and bracketed; actual Medicare amounts change each year and should be taken from current program data.

The Stay

A composite [74]-year-old woman arrives at 1600 with chest pain. Her first troponin is normal. She is placed on a telemetry bed, has two more troponin tests, an echocardiogram and an exercise stress test the next morning, all normal, and goes home at 2200 the next day, about thirty hours after arrival.

The Hospital's Cost

Costs are taken from the hospital's cost accounting system. Direct costs are traced to the patient; indirect costs are allocated from overhead departments using the finance department's step-down method, with patient days as the base for nursing units. Direct costs:

1. Telemetry bed nursing time, [30] hours at [$58] an hour of nursing cost: [$1,740]

2. Laboratory, including three troponin tests: [$165]

3. Echocardiogram: [$310]

4. Exercise stress test: [$420]

5. Medications and supplies: [$95]

Direct total: [$2,730] Indirect allocation (facilities, administration, information systems): [$1,140] Total cost: [$3,870] Of this, about [$2,600] is fixed in the short run, the bed, the monitor and the salaried staff, and would be incurred whether or not she was there; about [$1,270] is variable. The fixed share matters because it is the part of the cost the hospital pays whether the bed is filled or empty.

Why the Allocation Base Matters

If the finance department allocated overhead by charges rather than patient days, the indirect share would rise to about [$1,500], because diagnostic tests carry high charges. The method changes the answer, so the base is named here.

Two Labels

Medicare's two-midnight benchmark treats a stay as suited to inpatient status when, at admission, the physician reasonably expects care to cross two midnights (42 C.F.R. § 412.3, 2024). A stay expected to be shorter is usually billed as outpatient observation. This patient's stay spanned one midnight, so observation is the expected label.

Payment Under Observation

Medicare pays the hospital under the outpatient prospective payment system, most likely a single comprehensive payment for observation with the tests packaged into it: about [$2,900]. The patient pays Part B coinsurance on outpatient services, about [$600] here, plus the cost of any of her usual pills given by the hospital, which Part B generally does not cover. Total hospital revenue: about [$3,500]. Hospital margin against full cost: about minus [$370]; against variable cost: about plus [$2,230].

Payment Under Inpatient Admission

If the stay had been an inpatient admission, Medicare would pay a single amount for the diagnosis-related group for chest pain: about [$5,400]. The patient would owe the Part A deductible, about [$1,700] in a recent year, which she might already have met if hospitalized earlier in the benefit period. Total hospital revenue: about [$5,400], plus the deductible collected. Margin against full cost: about plus [$1,500].

Who Bears What

1. Hospital: under observation, it covers its variable costs and part of its fixed costs; under admission, it earns a margin.

2. Medicare: pays about [$2,500] less under observation.

3. Patient: under observation, pays coinsurance and self-administered drugs, often less than the inpatient deductible in a short stay, but she would have no inpatient days counted toward the three inpatient days that must precede Medicare coverage of a nursing home stay for rehabilitation.

What the Administrator Should Watch

Three numbers matter more than any single stay. The first is the share of short stays billed as observation, because a rising share lowers revenue per bed. The second is the length of observation stays: an observation stay that runs past [48] hours uses a bed for two days at a payment designed for one. The third is the share of observation patients who later need a nursing facility, since those patients and their families face costs they did not expect and may complain to the hospital. A monthly report on all three would let finance and case management see the effect of the two labels across the whole hospital.

Trends and Evidence

Observation stays among Medicare beneficiaries rose sharply during the 2000s while inpatient admissions fell, raising concerns about costs to patients and their eligibility for skilled nursing coverage (Feng et al., 2012). A study at one academic medical center found that patients in observation status were often similar to inpatients, with long stays and many different diagnoses, and that the hospital lost money on observation care (Sheehy et al., 2013).

Limits

Costs and payments are composite; real payments depend on location, the hospital's wage index and the exact services. Cost accounting systems differ, and the fixed and variable split is an estimate.

Conclusion

For this stay the label, not the care, decides who pays. Observation saves Medicare money, costs the hospital its full-cost margin and changes the patient's costs in ways she may not expect. Hospitals should explain observation status to patients early, as federal notice rules require, and administrators should know the cost behind each payment before judging which label is better for the hospital.

References

42 C.F.R. § 412.3 (2024). https://www.ecfr.gov/current/title-42/section-412.3

Feng, Z., Wright, B., & Mor, V. (2012). Sharp rise in Medicare enrollees being held in hospitals for observation raises concerns about causes and consequences. Health Affairs, 31(6), 1251-1259. https://doi.org/10.1377/hlthaff.2012.0129

Sheehy, A. M., Graf, B., Gangireddy, S., Hoffman, R., Ehlenbach, M., Heidke, C., Fields, S., Liegel, B., & Jacobs, E. A. (2013). Hospitalized but not admitted: Characteristics of patients with "observation status" at an academic medical center. JAMA Internal Medicine, 173(21), 1991-1998. https://doi.org/10.1001/jamainternmed.2013.8185