Medicare Advantage Two-Midnight Rule Contributing To Higher Outpatient Revenues

The expansion of the two-midnight rule by the Centers for Medicare and Medicaid Services (CMS) to include Medicare Advantage plans has led to increased inpatient volumes and revenue growth in the first quarter of the year, according to a report by Strata Decision Technology.

This rule impacts inpatient care, which has higher reimbursement rates compared to outpatient services. Initially, the two-midnight rule applied only to traditional Medicare. It mandates that if a clinician determines a patient needs hospital care for more than two midnights, the patient must be admitted as an inpatient rather than being held under observation status as an outpatient.

In April 2023, CMS published the final rule, extending the two-midnight rule to Medicare Advantage plans for the first time. This expansion affects over 30 million people across the country enrolled in these managed care plans.

The report indicates that over 20% of Medicare Advantage patients could be impacted by this rule. An analysis of Medicare Advantage encounters from 2023—before the rule's expansion—showed that 22.3% of these patients were held in observation status for two days or more. In comparison, 8.7% of traditional Medicare patients and 11.3% of patients with commercial insurance plans had observation stays of two days or more in 2023.

How Will It Impact?

In an analysis of Q1 hospital financial data, Strata Decision Technology highlighted the early impact of the two-midnight rule on Medicare Advantage (MA) plans.

Data from 2023, prior to the rule's incorporation, showed that 22.3% of MA patients were held in observation status for at least two days. This rate was significantly higher than for Medicare Fee-For-Service (FFS) patients (8.7%) and those with commercial insurance (11.3%).

After the rule's expansion in 2024, hospitals experienced a 3.9% year-over-year (YOY) increase in inpatient admissions for March, while outpatient volumes dropped by 5.1%. The YOY increase in inpatient revenue (3.7%) also surpassed the growth in outpatient revenue (2.4%) for the first time since November 2021, during the COVID-19 public health emergency.

Steve Wasson, Chief Data and Intelligence Officer at Strata, noted that this shift helped some organizations receive appropriate reimbursement for their services. However, he suggested that these Q1 results might not indicate a long-term shift away from outpatient care but rather a temporary correction in inpatient admissions.

A subsequent Strata report for April showed a higher YOY rise in outpatient visits (12.9%) compared to inpatient admissions (9.7%). Similarly, outpatient revenue increased by 15.3%, outpacing the 11.7% rise in inpatient revenue. Both figures, however, indicated robust growth.

Hospitals Outlook

Leading for-profit health systems are optimistic about the expansion of the two-midnight rule, as inpatient care typically receives higher reimbursement rates compared to other settings.

Hospital operating margins demonstrated strong performance in the first quarter. The median year-to-date operating margin was 4.7% in March, slightly down from 5.2% in January but a substantial increase from less than 1% in early 2023.

Despite the overall increase, the median change in operating margin remained nearly flat both year-over-year and month-over-month. From March 2023 to March 2024, the median operating margin decreased by 0.1 percentage points and was down 0.3 percentage points compared to February 2024. Additionally, the median change in operating EBITDA margin declined by 0.4% year-over-year and 0.5% from the previous month.

The two-midnight Rule for Medicare was introduced in 2013 by CMS, and its main objective was to provide the necessary care to patients seamlessly. The expansion of the two-midnight rule to Medicare Advantage plans has significantly impacted hospital finances, contributing to increased inpatient volumes and higher revenues in the first quarter of 2024. This rule mandates that patients needing hospital care for more than two midnights be admitted as inpatients, leading to greater reimbursement rates. The initial data showed a notable rise in inpatient admissions and revenue, with inpatient revenue growth surpassing outpatient for the first time since the COVID-19 public health emergency. Despite this shift, overall outpatient visits and revenue also saw substantial increases, suggesting a robust but balanced growth in hospital operations.