used, the Association has recommended the exclusion of specific components of routine operating costs which will help ensure that variations in the remaining costs are not due to the nature of the product produced or to characteristics of the production process. Therefore, the Association believes that the exciusion of capital costs; direct personnel and supply costs of hospital education and training programs; costs of interns, residents, and medical personnel; and energy costs associated with heating or cooling the hospital plant is a step in the proper direction.

Following a rather complicated calculation, S. 3205 establishes the ceiling. for routine service costs at 120 percent of each classification group's average. As we have stated earlier, the present Medicare reporting system does not permit identification of costs to be excluded in computing routine service costs. Therefore, no one knows what the actual distribution of hospital costs by group will look like. The Association believes that a 120 percent ceiling should not be established by statute without knowledge of these distributions. It is recommended that the bill provide the agencies with some flexibility in determining the ceiling and that the Committee Report clearly state Congressional intent as guidance for Executive Branch action.

The Association recommends that two additional components of routine operating costs be excluded. S. 3205 does propose removing "energy costs associated with heating or cooling the hospital plant." This is appropriate and desirable; however, it ignores the energy costs associated with lighting and operating the hospital facility. Prices for these energy costs, like those for heating and cooling, are beyond the hospital's control. Therefore, the Association. requests that energy costs for lighting and facility operations also be excluded from routine operating costs which are contained in the proposal. It has been our understanding that there was every intention of excluding malpractice premiums, although the proposed statute has omitted it. The exclusion of the additional energy costs and malpractice insurance premiums will help to ensure the remaining costs are comparable between facilities.

In determining routine operating cost, the proposed legislation includes a provision allowing for initial consideration of hospital wage levels, if available, for the local or state area where they are higher than the general wage levels. in the area. Following this initial first year adjustment, future hospital increases would be controlled by increases for all wages in the area in which the hospital is located. While we do recognize some technical problems with these index computations, the Association believes that the general principal is one which should be supported.

A further consideration in the wage level methodology, however, relates to the particular nature of the tertiary care/teaching hospital staffing patterns. The type and array of skilled personnel utilized in academic medical centers is frequently drawn from a regional or national labor pool. For example, the University of Virginia Medical Center in Charlottesville is located in a rural area of the state and outside of an SMSA. It must, however, compete with medical centers in Richmond, Virginia, Washington, D.C., and Baltimore, Maryland for skilled personnel. Because many medical centers must recruit personnel outside of the immediate area and across state lines, the Association recommends that the legislation include a provision which recognizes the skilled labor requirements of large academic medical centers.

Sections 223 of Public Law 92-603 permitted a provider, with appropriate public notice as determined by the Secretary to charge the patient for “. services which are expensive than the items or services determined to be necessary in the efficient delivery of needed health services . . ." S. 3205 in replacing Section 223 does not contain this or a similar provision. Providing that consumers and medical practitioners are appropriately appraised of additional charges prior to the use of services, the Association recommends that hospitals be permitted to charge the patient above the established cost ceiling for more expensive services directly requested or authorized by the patient.

S. 3205 will allow those institutions with routine operating costs below the ceiling for their group to share in the "surplus". One concern we must raise is the manner in which hospitals will be required to handle this "surplus". Although the Association believes it may very well be inappropriate to stipulate in legislation the specific ways this money must be utilized. Congress is encouraged to provide some guidance while assuring that the institutions have flexibility in determining institutional priorities.

The Association strongly supports the case mix provision provided in S. 3205. Tertiary care/referral hospitals serve the more severely ill patients and referral of such patients from other hospitals tends to increase in times of adverse economic conditions. Recognition of these facts in the legislation should help to ensure the economic integrity of tertiary/referral centers.

Experience gained since the development and initial operation of Section 223 of the 1972 Medicare amendments has demonstrated the urgent need for a viable and timely exception and appeal process. Such an effective and equitable process has not functioned under the present Section 223 cost limitations. Therefore, the Association recommends this legislation include provisions for an exception and appeal process which provides (1) that information describing the specific methodology and data utilized to derive exceptions be made available to all institutions; (2) that the identity of "comparable" hospitals located in each group be made available; (3) that the basis on which exceptions are granted be publicly disclosed in each circumstance, widely disseminated and easily accessible to all interested parties; and (4) that the exceptions process permit the use of "per-admission cost" determinations recognizing that compressing the length of stay often results in an increase in the hospital's routine per diem operating costs but no change or reduction in the per-admission costs.

The present bill provides for the Secretary to notify the hospital of its adjusted per diem payment rate for routine operating costs no later than April first of a given year. A hospital finding that its projected costs exceed the ceiling will presumably attempt to lower its costs. To lower its costs, the hospital may have to reduce its labor force or terminate existing contracts. Employee reductions and contract alterations not only require careful planning, they frequently require significant advance notification. Because many hospitals have fiscal year and reporting periods beginning on July first, S. 3205 would provide only a 90 day notice on the ceilings. The Association recommends that the bill be changed to require at least a 120 day notification by requiring the Secretary to notify the hospitals of their routine operating cost ceiling no later than March first of a given year.

Section 10(e) provides that "nothing in this section shall be construed as otherwise limiting the authority of the Secretary to continue otherwise authorized efforts toward development of improved systems of reimbursement . . ." The Association recommends that this subsection be modified to strongly and positively encourage the Secretary to continue and, where appropriate, expand efforts to develop improved systems of reimbursement.

Assuring Medicare beneficiaries needed health care services, encouraging efficiency in the provision of health care and paying the full and fair costs of health care providers should be the guiding principals of any reimbursement system. The compatibility of the goals can be maintained under a system which accounts for the many legitimate service and case-mix differences found between hospitals. When this is done, illegitimate costs arising from inefficiency or extravagance can be isolated. However, if care is not taken to identify the costs of inefficiency, legitimate reimbursement may be threatened and consequently the hospitals' ability to provide needed health services will be reduced.

In this regard, one has to be impressed with the thought and effort that went into the provider reimbursement portion of this proposal. One is also impressed with the real complexity of implementing the proposal on a national scale. While the Association finds the proposal, with suggested amendments, worthy of support, the Association recommends that we move forward cautiously and under the review and supervision of the above recommended Technical Advisory Board. Practitioner reimbursement reforms

The apparent purpose of Section 22(c) is to eliminate Medicare and Medicaid recognition of remuneration arrangements between physicians and hospitals in which the physician's fee-based income rate in his professional medical service practice is used as a basis for computing his compensation for Part A reimbursable services. In place of such arrangements, the subsection proposes recognition of ". . . an amount equal to the salary which would have reasonable been paid for such services . . ."

While this objective seems clear in principle, it is clouded with ambiguities in practical application. The bill includes no indication of the basis on which "... an amount equal to the salary which would have reasonably been paid . . ." is to be determined. Certainly the Association realizes and appreciates the

desire of the Congress to permit those developing regulations to have some flexibility in implementing this amendment; however, in recruiting and negotiating with the medical staff, the hospital chief executive officer and/or medical school dean must be able to determine the amount of compensation that Medicare and Medicaid will recognize. Therefore, the Association requests that Congress either modify the proposed amendment to incorporate some specific guidelines for regulations or so specify its intent in hearings and Congressional Reports that those preparing the regulations have a clear and consistent direction for determining a reasonable salary for physicians in employment situations.

Percentage contracts

MISCELLANEOUS REFORMS

Section 20, as the Association understands it, is designed, in part, to eliminate as reasonable charges Medicare and Medicaid recognition of expenses for services or facilities which are determined as a percentage of health service revenues. However, our discussions with many groups of individuals have indicated that there are varying interpretations for this subsection. Therefore, the Association requests that the Subcommittee clearly state the objective of this subsection in its report on this legislation.

Overhead cost controls

Section 40 will require the Secretary to establish regulations for determining the reasonable cost or charges of direct and indirect overhead expenses. This approach is one means of controlling costs; however, it seems to be in direct conflict with the philosophy and purpose underlying the cost ceilings imposed in Section 10. The direct and indirect overhead expense controls specified in this subsection are based on itemizing and controlling individual, rather than aggregate, expenses. The Association believes that simultaneous controls of individual overhead expenses and aggregate cost ceilings places management in an untenable position. To provide efficient and effective services within the cost ceilings, the hospital director needs the administrative flexibility which the overhead controls would diminish. In its consideration of changes, the Assocation strongly recommends that the Subcommittee adopt exclusively a cost control philosophy of cost ceilings rather than a philosophy of both ceiling and line-item controls.

Contract approval

This provision directs the Secretary to establish a program for review and advance approval of "consulting, management, and service contracts" with an annual cost of $10,000 or more. The Association believes this subsection contains several deficiencies. First, as with the overhead controls program, this contract approval amendment is an individual service control rather than an aggregate ceiling control. Once again, the hospital director must try to live within a ceiling at the same time his operational flexibility to do so is reduced. Second, by requiring advance approval of virtually all types of hospital contracts, this amendment shifts operational management authority from the hospital director to the HEW staff. The hospital director and governing board could propose and implement but not decide on courses of action. In effect, DHEW will be managing by contract review significant aspects of the nation's hospitals. Third, by requiring all contracts with an annual payment of $10,000 or more to be approved, the amendment guarantees that DHEW will have to undertake a significant bureaucratic expansion. This $10,000 threshold is so low that the number of contracts requiring approval will be significant. Bureaucracy will mushroom and the resultant costs will be an additional burden on the nation's health expenditures. Fourth, the legislation requires a procedure to determine if the services may appropriately be furnished by contract. Even if government authorities could judge the reasonableness of a contract price and could evaluate the contractor's likely ability to perform the services, the governing board of the institution should retain the right to determine whether it wants a function performed by "in-house" or contract personnel.

If this segment of the proposed Section 40 is intended to ensure that Medicare and Medicaid do not subsidize contracts of questionable value or contracts undertaken with nearly fraudulent intentions, the present provisions do not discriminate between those contracts likely to be undesirable and those which are characteristic of routine hospital operations. Therefore, the Association recommends that this section be re-written to direct the Secretary to control

-only those irregular, nearly fraudulent and self-dealing contracts which may be sources of abuse.

Conclusion

In conclusion, the Association expresses its appreciation to the Committee for this opportunity to testify on S. 3205. The Association shares the Committee's objective of improving the Medicare and Medicaid programs, and the Association has offered this testimony on the legislation as a sincere effort to refine and improve the proposed amendments.

Senator TALMADGE. Our next witness is Mr. John Alexander McMahon, president, American Hospital Association, accompanied by Leo J. Gehrig, M.D., senior vice president.

Without objection, your entire statement will be inserted in the record and you may summarize.

STATEMENT

OF JOHN ALEXANDER MCMAHON, PRESIDENT, AMERICAN HOSPITAL ASSOCIATION, ACCOMPANIED BY LEO J. GEHRIG, M.D., SENIOR VICE PRESIDENT

Mr. MCMAHON. Thank you, Mr. Chairman. We will be very brief. Mr. Chairman, as your introduction indicated, I am John Alexander McMahon, president of the American Hospital Association, representing more than 7,000 member institutions and 21,000 personal members.

As you indicated, Dr. Leo Gehrig, senior vice president of the Washington office, is here along with Allen J. Manzano, vice president of the association, on my right and Mr. Irwin Wolkstein, associate director of the Washington office, on my far left.

We appreciate the opportunity to present our views and recommendations and appreciate the inclusion of the entire statement in the record.

Your bill, Mr. Chairman, identifies and addresses a number of important areas, many of which provide for positive reform in the administration of medicare and medicaid. We also appreciate your understanding of the shortcomings of simplistic solutions-like arbritrary caps that have been suggested by others. The full statement indicates that there are certain sections of the bill which we support as they stand. In other areas, while we support the intent, we think that certain changes would be helpful. We have made in our full statement a number of constructive suggestions in response to your invitation for refinement and modification.

Mr. Chairman, on pages 2 to 5 of our full statement we have offered an explanation for the factors in rising health costs, including inflation, the difference in the hospitals' market basket, the effect of malpractice insurance premiums, increases in costs of food and energy in hospitals and the growing population and expanding benefits of the medicaid and medicare programs along with the statutory and regulatory requirements which often add to costs without raising benefits to patients. The statement also indicates that this system is not really out of control, as people suggest, because there are a number of controls Congress has already put in place, like the planning act and like the PSRO's, which this committee had a substantial hand in developing.

Mr. Chairman, on pages 5 and 6 we have touched on several current proposals to limit hospital reimbursement like the administration's 7-percent limit on increases and the budget resolution's reduction in the medicare and medicaid budget of $100 million. I would say we appreciate your efforts, Mr. Chairman, and those of Senator Long to restore those reductions during consideration of the budget resolution and we believe the bill that is the subject of these hearings offers a better and fairer approach to the problem.

Now, Mr. Chairman, let me address, if I may, section 10, perhaps the single most important section to hospitals, and I am going to read a paragraph at the bottom of page 6 of the full statement.

Section 10 of your bill proposes significant changes in the Federal reimbursement mechanisms for hospitals, and we have carefully studied these changes. We believe them to be a significant improvement over the existing methodology of section 223 of Public Law 92603, which section 10 is intended to replace. Any system to classify institutions for the purpose of reimbursement on a comparative basis has its difficulties, and we certainly applaud your proposal to remove from the comparison procedure for routine per diem hospital costs a number of elements which are beyond the control of institutions. Clearly, any classification system should be sufficiently sophisticated to separate efficient from inefficient institutions, and our suggestions for modifications of section 10 are designed to protect the efficient ones while motivating the others to increase their effectiveness. We offer the following suggestions which have been set forth in detail on pages 7 to 12 which we believe are necessary to make your proposed incentive system more effective, equitable, and workable, assuring you that we stand ready to participate in further refinements toward the ends that both your committee and we seek.

I will be glad to answer any questions about the specifices in time but let me only say we think the phasein principle is most important. We hope the exception process could be broadened and we hope the bill can be amended to assure adequate payment for medicaid services.

I would like now to turn, Mr. Chairman and Senator Dole, to page 12. We have an additional, and major, change to offer to section 10. We urge that section 10 be amended to provide that where a State rate review program has been established, either by statute as in Maryland and Connecticut, or voluntarily as in Indiana, which applies to all purchasers of care other than medicare and medicaid, and which is designed to meet the full financial requirements of the hospitals covered by the program, then medicare and medicaid should be required to pay the rates so established.

I have noted at the top of page 13, Mr. Chairman, our reasons for urging this amendment. We believe they are quite simple. If State rate review programs cover all patients but medicare and medicaid beneficiaries, and the latter pay according to a different formula, it is very likely that some hospital costs will not be met. Moreover, the application of two sets of formulas to two sets of patients may well result in one set of patients subsidizing the care of the other, contrary to the long established principle of Public Law 89-97, which set up medicare. and medicaid, which specifically prohibits such subsidization.