Focus on Observation

Observation impact must balance revenue and cost

Lower-cost services still bring profit

The impact of the new observation codes on hospitals hinges on issues of revenue vs. cost.

"The way payment systems operate today, hospitals can't maximize revenue by admitting patients who would be better off transferred to observation," says Louis Graff, MD, director of emergency medicine at New Britain (CT) Hospital. "They must operate cost-effectively." If a hospital provides a lower-cost service and gets less from payers, it can still show a profitable bottom line.

"It wouldn't be good for hospitals if they kept getting paid less and less and their true costs stayed the same, but facilities are restructuring and learning how to do things more cost-effectively," says Graff. "For example, 70% of our surgery is moving to the outpatient setting. Fifteen years ago, hardly any outpatient surgery was done." It's when institutions stagnate and try to preserve their traditional systems that they lose money on their Medicare patients and their capitated contracts.

Failure to diagnose may lead to malpractice

When physicians use traditional methods for patients with critical presentations - admission or discharge - diagnostic accuracy comes into question. Failure to diagnose is a significant source of malpractice actions. With observation programs, clinical performance improves and fewer serious diagnoses are missed. Five percent of chest pain patients with acute myocardial infarction (AMI) and 12% to 44% of abdominal pain patients with acute appendicitis are not identified on initial emergency department evaluation.

Critical diagnostic syndromes such as chest and abdominal pain can be evaluated more accurately and cost-effectively in an observation unit than in traditional venues, says Graff.

Typically, after an observation period of eight to 10 hours, 80% of patients can be discharged.1 Serious disease that requires hospitalization can be identified In the remaining 20%. Observation beds are more than 50% cheaper than inpatient beds when both are used for evaluation.

Studies have shown that the true cost of doing a rule-out-AMI in an observation unit is half of what it is in the hospital. The hospital is paid less, but the hospital's costs are lower as well. If you put a chest pain patient in the hospital, it takes an average of three days to do a DRG 143, and half the patients admitted with chest pain are found to have nothing wrong with them. Charges run about $5,000 to $6,000, and true costs run about $3,000. The DRG might be $2,000, so the hospital loses money on those admitted cases.

A recent study out of Chicago's Cook County Hospital tested the hypothesis that selected asthma patients could avoid an inpatient stay by undergoing an intensive treatment protocol of up to 12 hours in an "emergency diagnostic and treatment" or observation unit.2 Two hundred patients who failed to respond to therapy in the emergency department were either placed in observation or admitted. Those placed in observation had clinical outcomes equivalent to those of the inpatients. Overall costs were lower, there was greater patient satisfaction, and the quality of life improved. The mean cost per patient in the observation group was $1,203; that of the admitted group was $2,247.


1. Graff LG. Observation units in the emergency department. Critical Decisions in Emergency Medicine 1995; 10:7-10.

2. McDermott MF, Murphy DG, Zalenski RJ, et al. A comparison between emergency diagnostic and treatment unit and inpatient care in the management of acute asthma. Arch Intern Med 1997; 157:2,055-2,062.