What Observation vs. Inpatient Decisions Are Really Costing Hospitals

One of the most consequential decisions in a hospital can happen before a patient reaches the floor: whether the stay should be classified as observation or inpatient. This observation vs. inpatient decision can change reimbursement by thousands of dollars, even when the clinical care looks much the same. As health plans scrutinize hospitalizations more closely, observation versus inpatient status has become a growing concern for hospital revenue integrity.

Adam Milne, Senior Vice President of Strategic Advisory Services at CorroHealth, has seen the pressure intensify since the pandemic, as payers have become increasingly sophisticated in how they scrutinize hospitalization status. Across CorroHealth’s client portfolio, he reports that Medicare Advantage denials rates were approximately 17% in 2020; in some markets, they now exceed 30%. These are portfolio observations rather than a national benchmark, but they illustrate how quickly the environment has changed. Inpatient hospitalization is one of the largest expenses health plans manage, and Milne says payers have become more strategic in how denials manifest. “Providers and health plans are finding this to be a zero-sum game,” he explains.

A Low Denials Rate Can Hide a Bigger Problem

A hospital with relatively few denials may appear to have its status decisions under control. Yet the denials rate captures only claims a payer has formally challenged. It says less about cases classified conservatively from the outset or documentation that never fully supported the care delivered.

Observation vs. Inpatient Changes That Never Show Up as Denials

Consider an illustrative scenario: a patient whose condition warrants an inpatient admission under applicable rules and contract terms, but whose status is changed to observation because the team expects a payer dispute. The hospital may avoid denials while accepting reimbursement below what the clinical circumstances supported. Multiply that choice across a service line, and the lost revenue could be substantial without showing up in a denials report. Even the panelists found it hard to size: Devault said she is unable to quantify how much denied revenue traces back to status or documentation decisions. Observation vs. inpatient decisions can leave this potential revenue loss hidden in cases that were never formally denied.

When Mid-Stay Denials Force a Change to Hospital Observation Status

Kathy Devault, System Director of Health Information Management at Bozeman Health, described the practical difficulty of a Medicare Advantage payer denying a stay while the patient was still admitted. The hospital changed the patient to observation, leaving a prolonged observation stay and a difficult retrospective discussion. Her example reflects the tension between resolving an immediate payer challenge and making the appropriate status determination in time. Questions about hospital observation status can arise when a payer challenges a stay before discharge.

Everyone Touches the Decision, but Who Owns the Outcome?

Observation and inpatient decisions travel through several hands. Emergency department clinicians assess the patient, utilization management reviews medical necessity, clinical documentation integrity (CDI) teams clarify the record, and coding and denials teams confront the consequences later. Each group sees a different part of the case, often through separate work queues and performance measures.

Why Separate Work Queues Leave Accountability Gaps

When teams manage separate parts of the process, gaps in accountability can follow. Denials may be tracked as a coding problem even when the underlying issue began with an admission order or missing documentation. By the time the pattern becomes visible, the patient is long discharged and the best opportunity to intervene has passed.

Moving the Observation vs. Inpatient Decision Closer to Admission

At Premier Health, Dr. Pradeep Kadambi, vice president and chief medical officer of Upper Valley Medical Center, described an early effort to bring physicians, case management, and utilization review closer to the admission decision, with a goal of establishing accurate status in near real time. The approach recognizes that later appeals can only do so much when early choices have already shaped the claim. “The goal isn’t assigning ownership of the denial because we all own it, but it’s actually owning the outcome,” he said.

Align the Revenue Cycle on Patient Status

Milne argues that hospitals need a clear position on when inpatient care is justified, grounded in clinical evidence, regulations, and payer contracts. “An organization that has taken a provider-driven strategy and ensured that it’s in line with the regulations, in line with the contracts… that is where we find revenue integrity to be the best,” he says.

What Each Team Must Do to Support Hospital Revenue Integrity

That strategy should guide the entire revenue cycle and support hospital revenue integrity. Physicians need to understand what the documentation must convey about the patient’s condition and expected care. Utilization management needs a consistent escalation pathway for difficult cases. And CDI and coding teams need to apply the same underlying rationale, while denials specialists should feed recurring payer objections back into the process.

The shared goal is accurate, compliant reimbursement. Success cannot rest solely on whether a claim avoids rejection but should also reflect whether the hospital captured the payment supported by the care provided.

Make Status Review a Continuous Process

The most useful interventions occur while clinicians can still clarify their thinking and document the patient’s course. Instead of relying mainly on retrospective denials committees, hospitals can create checkpoints around admission and during the stay, with physician advisors available when a decision needs another look.

Placing Physician Advisors and Liaisons in the ED

Patricia Plair, Chief Financial Officer of the Jackson Memorial Campus at Jackson Health System, described embedding physician advisors and an observation liaison in the emergency department. Her organization also reviews observation cases after 24 hours, when additional tests may clarify medical necessity, and revisits status at roughly 36 hours during multidisciplinary rounds.

Why Observation Status in the Hospital Should Be Revisited as Care

These checkpoints provide a practical model: revisit status as clinical circumstances evolve, document the reasoning, and escalate concerns before discharge. Reviewing observation status in the hospital at these points helps teams respond to changing clinical circumstances. Retrospective findings are still important, but their greatest value is in improving the next decision.

Use Analytics to Find Revenue That Never Became a Denial

Payers can analyze large volumes of claims to identify where status decisions are vulnerable. Hospitals need an equally detailed view of their own patterns. Denials rates by themselves cannot reveal how frequently a service line defaults to observation, how often cases change status, or whether payment falls short of what clinical and contractual criteria support.

Sizing Under-Realized Reimbursement in Cases Never Denied

Milne says it is “really key to ensure that the root causes can be identified, the appropriate steps and interventions can be applied,” and that this depends on “accessible, actionable analytics.” A useful view connects payer behavior with diagnosis-related groups (DRGs), service lines, admission decisions and appeal outcomes. It can also estimate under-realized reimbursement in cases that were never formally denied, including cases involving hospital observation status.

Deciding Which Gaps to Fix and Which to Dispute

Those findings help leaders distinguish fixable documentation gaps from disputes worth pursuing with a payer. They can also show where a change in workflow would have more impact than simply adding appeals staff. The objective is to give teams evidence they can act on, rather than another dashboard that does little to guide daily decisions.

Technology Helps When the Process Is Clear

Artificial intelligence can help flag complex cases and surface relevant documentation, while directing reviewers toward the decisions most likely to need attention. That is especially valuable when case managers and clinicians are already managing extensive payer requirements and repeated queries.

Why Medical Necessity and Billing Definitions Don’t Always Match

Clear definitions of observation status in the hospital and inpatient admission help technology support, rather than distort, clinical judgement. Dr. Eric Shelov, a pediatric hospitalist and informatics leader at Children’s Hospital of Philadelphia, noted that pediatric observation units can hold children who “would be in an ICU in another hospital,” and that intensive clinical observation does not always resemble the interventions billing definitions associate with inpatient status. A tool must be able to reflect the clinical nuance and the applicable billing rules, rather than treating a diagnosis or code as the whole story.

Poorly designed prompts can add to documentation fatigue or encourage inconsistent choices. Before introducing automated recommendations, leaders should agree on escalation rules, reviewer responsibilities and what constitutes sufficient clinical support. The best technology makes appropriate decisions easier within the existing clinical workflow, while leaving the final judgment with qualified professionals.

Examples of Prompts Hospitals Are Testing

Panelists offered concrete examples. Plair said Jackson Health System is working toward prompts that flag a patient with one of its top 10 denials diagnoses and suggest documentation considerations for physicians. Shelov described language-based nudges built into templates, without pop-up windows, and warned that adopting technology before people, process and definitions are settled “runs the risk of just turbocharging confusion.” Dr. Pradeep Kadambi added that AI should complement staff, not replace them.

Hold Payers Accountable, Too

Fixing internal process is only half the answer. Milne said the most successful systems also have a strategy for holding health plans accountable, because some denials are inappropriate. He cited HHS Office of Inspector General reports and a recent Kaiser Family Foundation finding that a significant share of authorization denials are made inappropriately, and said providers and patients win the majority of the cases they pursue.

Measure Revenue Earned, Not Just Denials Avoided

Hospitals can begin by examining where observation and inpatient decisions have the greatest financial and clinical consequences. Pair denials trends with estimated under-realized revenue by payer, DRG, and service line. Review how frequently status changes after admission and whether the documentation supports those decisions. Then assign enterprise-level ownership for acting on the findings.

The work requires a consistent strategy across admitting, utilization management, CDI, coding and denials. Milne’s central point is that status decisions must be managed across the full revenue cycle, with technology and analytics supporting the people responsible for them.

For hospital leaders, the strongest measure of progress is whether patients are placed in the appropriate status and the organization receives the reimbursement the care legitimately supports. Getting those decisions right from the start can help hospitals protect revenue and avoid costly disputes down the line.