CMS plans to soften but keep the controversial "two-midnight" rule governing short hospital stays in spite of aggressive calls from providers and policy experts to abandon the policy.

In a proposed payment rule posted Wednesday, the Obama administration said it plans to allow physicians to exercise judgment to admit patients for short hospital stays on a case-by-case basis. The CMS also said it would remove oversight of those decisions from its administrative contractors and instead ask quality improvement organizations to enforce the policy. Recovery audit contractors, meanwhile, would be directed to focus only on hospitals with unusually high rates of denied claims.

The proposed changes are outlined in the 2016 Hospital Outpatient Prospective Payment System and Ambulatory Surgical Center Payment System proposed payment rule (PDF).

Under the two-midnight rule, the CMS directs its payment contractors to assume a hospital admission was appropriate if a patient's stay spanned two midnights and otherwise should have been billed as an outpatient observation visit.

The rule was conceived to address a spike in observation stays attributed to hospitals' fear that Medicare audit contractors would challenge their admissions. Many patients, as a result, found themselves ineligible for skilled nursing after spending days in the hospital because their stay had been billed as observation.

Providers, however, complain that the agency's attempt to clarify Medicare admissions policies undermines clinical decision making.

Under the new policy, physicians who admit patients for what are expected to be short stays must document factors that support the decision, such as severity of symptoms and the risk of an adverse medical event occurring during the hospitalization.

The CMS said it still supports the underlying policy, which went into effect in October 2013 although the Obama administration and Congress have delayed enforcement of it. The agency said in the proposed rule that Medicare has benefited when hospitals have adopted the policy.

Last month, Medicare Payment Advisory Commission, which advises Congress on Medicare spending, suggested that lawmakers push for the repeal of the two-midnight rule in its entirety.

MedPAC did not, however, recommend an alternative short-stay payment policy. The CMS said Tuesday that it didn't receive any viable alternative to the rule despite requesting suggestions through public comment on three different occasions. “The public comment process has not produced any consensus on a recommended payment policy proposal to address this issue,” the agency said.

Meanwhile, the policy appears to be working the CMS said. The number of observation visits lasting more than two days was down 11% in fiscal 2014 compared with fiscal 2013.

“I think what they did is a good first step,” said Linda Fishman, senior vice president of public policy analysis and development at the American Hospital Association. Fishman said the proposed changes are in line with modifications the hospital industry requested.

The AHA would still like to see the CMS scrap the 0.2% reduction to hospital payments that was adopted to balance the expected increase in higher-paying inpatient stays. The association also wants the CMS to wait until the start of 2016 to enforce the policy.