En español | Jean Arnau spent five days in the hospital with a fractured spine — lying in a hospital bed, wearing a hospital gown and ID bracelet, eating hospital food and receiving regular nursing care.

But when she was discharged and needed to transfer to a skilled nursing facility for rehabilitation, her family learned that she had never been formally admitted as an inpatient to the hospital at all. Instead, she'd been classified as an outpatient under "observation" — a status that would cost her thousands of dollars.

Sign up for the AARP Health Newsletter.

Being classified as an outpatient under "observation" can spike your hospital costs. — Photo by Flickr/Getty Images

Most patients would regard as meaningless the seemingly slight distinction between the two labels — after all, they're getting exactly the same kind of care. But it can have costly consequences.

Under the rules, Medicare picks up the whole tab for the first 20 days in an approved skilled nursing facility for rehab or other care, but only if someone has spent at least three full days in the hospital as an admitted patient. If instead a patient has been under observation — for all or part of that time — he or she is responsible for the entire cost of rehab.

[Note that this situation applies only to Medicare coverage in skilled nursing facilities — which are usually nursing homes — and not to rehabilitation hospitals or inpatient rehabilitation facilities. Such places have different rules to qualify for Medicare coverage, but coverage is not affected by previous observation status while in a regular hospital.]

Arnau, an 84-year-old widow from Narragansett, R.I., got hit with a large bill. The skilled nursing facility she went to charged her $3,900 for a two-week stay. And although she had a Medigap supplemental policy, this insurance does not pay the out-of-pocket costs of services that Medicare does not cover.

Unwelcome news

Her family only learned about the problem the day Arnau left the hospital, says her daughter Mimi Auer, who is considering appealing the decision. At first she thought it was a mistake. But staff at the nursing facility told her they'd had four cases like her mother's just the previous week. "Four cases of the same situation, [in which Medicare patients] had to pay for the nursing home because they'd been on observation in the hospital," Auer protests. "What's going on here?"

Over the past several years, hospitals throughout the country have increasingly classified Medicare beneficiaries as observation patients instead of admitting them, according to researchers at Brown University, who recently published a nationwide analysis of Medicare claims in the journal Health Affairs. The results showed that in just three years, 2007 through 2009, the ratio of Medicare observation patients to those admitted as inpatients rose by 34 percent.

Medicare tells hospitals that the decision to admit or discharge a patient who is under observation can most often be made in less than 24 hours. "In only rare and exceptional cases do reasonable and necessary outpatient observation services span more than 48 hours," says the Medicare Benefit Policy Manual (PDF), the agency's coverage bible.

But the Brown University study found that more than 10 percent of patients in observation were kept there for more than 48 hours. And it identified more than 44,800 who were kept in observation for 72 hours or longer in 2009 — an increase of 88 percent since 2007.

This research confirms the longtime concerns of consumer advocates. Two years ago, for example, the federal Medicare agency held a "listening session" (PDF) at which more than 2,200 hospital administrators, physicians, patient advocates and others called in — far more than any other such sessions had ever attracted — to discuss the topic of observation status.

"Almost everyone who spoke felt the practice was harmful and should be ended," says Judith Stein, founder and executive director of the Center for Medicare Advocacy. But nothing came of it, and so last year the center filed a class action lawsuit (PDF) against the federal government in an attempt to force change.

Next: More out-of-pocket costs. »