The federal government may be overpaying hospitals an estimated $5 billion as a result of the 18-month moratorium on enforcing a controversial rule that tells hospitals when patients should be admitted, an independent Medicare auditing company told a congressional panel Tuesday.

Last September, Medicare officials announced that patients whose doctors expect them to stay in the hospital through two midnights or longer should be admitted, while those expected to stay for less time should be kept for observation.

But then Medicare announced a moratorium on penalizing hospitals that violate the rules. Congress has extended the moratorium through March 2015.

Dr. Ellen Evans, medical director for the auditing company, Health Data Insights, told the panel that postponing enforcement means that hospital claims for short patient visits during this time period “will never be subject to review.”

The American Hospital Association later claimed that the $5 billion figure was inflated.

The hearing before the House Committee on Ways and Means Subcommittee on Health was the first congressional inquiry examining the consequences of the two-midnight rule.

The rule followed strong criticism from seniors and hospitals that Medicare regulations were leading to increasing numbers of seniors being classified as observation patients. Many seniors in a regular hospital room don’t know they’re in observation care because hospitals aren’t required to tell them.

Yet, the distinction between observation care and being admitted is important for seniors. If they have not been admitted to the hospital for at least three consecutive days, they are not eligible for follow-up nursing home coverage and may have higher out-of-pocket expenses while in the hospital.

Hospitals, meanwhile, complained that the two-midnight rule was confusing since observation and admitted patients often receive similar treatment for similar health problems. Yet hospitals are paid more by Medicare for admitted patients. If Medicare auditors later decide a hospital should have billed Medicare for observation care, not for an admission, the hospital can end up with no payment at all.

“Hospitals are not doing anything wrong,” said Rep. Kevin Brady, R-Texas, the subcommittee’s chairman. “No matter if a service is inpatient or outpatient, a hospital still uses the same equipment and the same medical staff to deliver care.”

Sean Cavanaugh, a newly appointed deputy administrator at the Centers for Medicare & Medicaid Services, defended the two-midnight rule, telling the committee that the agency intended to balance several principles: the need for clear admissions criteria that “are consistent with sound clinical practice, reflect the beneficiaries’ medical needs, respect a physician’s judgment, and are consistent with the efficient delivery of care to protect” Medicare’s fiscal health.

Cavanaugh said that the agency is seeking public input on how to define short hospital stays and how to design a more appropriate payment.

As the federal government continues to grapple with the problem, the number of Medicare observation patients has shot up 88 percent over the past six years, to 1.8 million in 2012, according to the Medicare Payment Advisory Commission, an independent agency.

Asked by Rep. Bill Pascrell, D-N.J., to explain the sharp increase, Cavanaugh said he has heard anecdotal reports from hospital associations and individual hospitals that patients have been placed in observation, as a precaution, to minimize the hospitals’ risk of losing their Medicare payments if they are audited.

Pascrell also asked Cavanaugh if anything can be done to remove Medicare’s three-day hospitalization requirement for nursing home coverage. Cavanaugh said the Affordable Care Act allows the agency to waive it, which it has done in some experimental payment programs. “We will evaluate the results closely,” Cavanaugh said.

Instead of reducing the number of observation patients as Medicare officials hoped, the rule has had the opposite effect, Amy Deutschendorf, senior director of clinical resource management at the Johns Hopkins Medical System in Baltimore, told the committee.

“Since Oct. 1, 2013, we have seen a three-fold increase in the number of patients our physicians cautiously predicted would only stay only one midnight, and thus began as outpatients, but later had to admit for longer stays, demonstrating the complexity of anticipating length of stay based on a patient’s initial presenting symptoms,” she said.

And if patients improve after receiving extensive treatment for less than two midnights, she said they are considered observation patients, and hospitals are penalized for doing a good job by earning a lower payment from Medicare than for admitted patients.

“We call it the Cinderella rule,” Deutschendorf said after the hearing. “It’s confusing to hospitals as well as patients, who haven’t been informed that their Medicare Part A hospital benefit doesn’t cover stays less than two-midnights.”

Contact Susan Jaffe at Jaffe.KHN@gmail.com

This article was produced by Kaiser Health News with support from The SCAN Foundation.