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It is my strong belief that S. 3205 is certainly consistent with the resolution of the Governors' Conference. I look forward to the testimony this morning of the able and distinguished Governor of my own State, Governor Busbee, who will speak on behalf of our Nation's Governors. The National Association of Counties, from whom we will also hear today, has called for immediate wage and price controls on hospitals to avoid bankrupting costs.

But there is an overriding need to get a handle on medicare and medicaid costs apart from the Federal, State, and local budget effects. There is no question that the way we pay for care under our programs serves to inflate health care costs for all Americans. That situation needs correction now.

There is an absolute need for the Federal and State governments to effectively manage the existing health care programs. It is difficult, if not foolhardy, to extend health insurance coverage to other segments of the population until we are satisfied that we can manage what we've got now.

I believe we have a representative list of witnesses this week. It is my hope that these hearings will provide the basis for timely congressional action on necessary changes in the way Government conducts medicare and medicaid.

As I have stated repeatedly, none of the provisions in S. 3205 are locked in concrete. Hopefully, constructive changes and improvements will be a product of these hearings.

But, while improvements can and should be made, no one should mistake a willingness to make changes as a sign of weakness. With many billions of public tax dollars at stake, there will of course be those who presently profit from waste, inefficiency, fraud and abuse, and outdated methods of payment who will not want any changes made. Often these are the same people who in forums and cocktail parties constantly decry "big wasteful government." Nevertheless, they will come here to try to preserve their own share of that big government and those wasteful expenditures. It's always the other guy they're talking about. Well, they can't have it both ways and they won't have it both ways if we do our job.

I want to assure those people that the limits of tolerance have been reached. What has been glossed over, ignored, or sidestepped in the past will now be faced headon. We owe that much to the American people.

Now it is with a great deal of pleasure that we welcome the distinguished Secretary of Health, Education, and Welfare, the Honorable David Mathews.

Mr. Secretary, you may proceed as you see fit, sir.

STATEMENT OF HON. DAVID MATHEWS, SECRETARY, DEPARTMENT OF HEALTH, EDUCATION, AND WELFARE; ACCOMPANIED BY THEODORE COOPER, ASSISTANT SECRETARY FOR HEALTH; STUART ALTMAN, DEPUTY ASSISTANT SECRETARY FOR PLANNING AND EVALUATION/HEALTH; J. BRUCE CARDWELL, COMMISSIONER OF SOCIAL SECURITY; THOMAS TIERNEY, DIRECTOR, BUREAU OF HEALTH INSURANCE, SOCIAL SECURITY ADMINISTRATION; AND M. KEITH WEIKEL, COMMISSIONER, MEDICAL SERVICES ADMINISTRATION, SOCIAL AND REHABILITATION SERVICE

Secretary MATHEWS. Thank you very much, Mr. Chairman.

I might say before I commence my formal remarks that we prepared this testimony in recognition that is indeed a major national problem, one in which we join you in concern.

The underlying structural characteristics of the health care industry, the prevalence of public and private insurance coverage and the reimbursement practices of these third parties have resulted in chronic inflation in health care costs and tremendous increases in public and private outlays. For example, hospitals which are, for the most part, non-profit institutions are generally reimbursed for all reasonable. costs associated with patient care. This reimbursement method is inherently inflationary since there is little formal incentive to keep the hospital's costs down. Similarly, it is generally the physician, who is reimbursed on the basis of his billed charge, who decides on the amount and type of services to be provided. Thus, the higher the billings and the more services provided, the higher the physician's income. The inflationary effects of these reimbursement methods are clearly exaggerated by the virtual guarantee of payment by a public or private insurer and the dependence of the consumer on the medical care provider. In fiscal year 1975, 92 percent of all hospital expenses and 65 percent of all physician expenses were paid for by a public or private insurance program. In fiscal year 1975, $103 billion was spent in the United States for personal health care services. Almost 70 percent of these expenditures were paid for by public and private insurance programs.

The two major Federal financing programs, medicare and medicaid, spent $22 billion of Federal funds in fiscal year 1975. The States for their share of medicaid spent an additional $5.6 billion. Many of the current problems in these programs that this bill is designed to address stem from their original design. When these two programs were established by Congress in 1965, they were designed not to interfere with and to rely to the maximum extent possible on the existing private health care delivery system and reimbursement arrangements. Thus, cost-based reimbursement for hospitals and fee-for-service reimbursement of physicians were adopted; the medicare program relied on private insurance companies to administer program reimbursements; and State medicaid programs were given great flexibility with respect to reimbursement practices, scope of benefits, and program administration.

The cumulative effect of these organizational, administrative, and reimbursement arrangements, coupled with the growth of private health insurance coverage has been chaotic. Over the past 10 years, hospital costs and physician fees have increased over 50 percent faster than the overall cost of living. Health care expenditures have increased from 5.9 percent of gross national product in 1966 to 8.3 percent in 1975. Over the last 2 years, Federal medicare and medicaid outlays have increased 40 percent and now exceed 80 percent of the entire HEW health budget. Many State medicaid programs are in severe financial difficulties. Private health insurance premiums increased this year on the order of 30 to 60 percent. Medicare beneficiaries are facing increased out-of-pocket costs and medicaid beneficiaries in many States face great difficulties in getting access to care.

To help alleviate these problems the Federal Government has proposed several major legislative and program initiatives. We believe that a comprehensive approach to financing health care involving Federal and State governments and the private sector is potentially the most effective from both a health delivery and cost containment perspective. This administration is working to effect improvements in the existing Federal health care programs and to strengthen the capacity of State governments and the private sector to meet these problems. The medicare improvements of 1976 was designed to provide protection against the catastrophic costs of illness for medicare beneficiaries and to control rising health care costs.

The Department is vigorously attempting to control costs in the Federal programs through its hospital cost and physician fee limitation authorities obtained through the 1972 Social Security Amendments. The President also proposed a $10 billion consolidation program, the Financial Assistance for Health Care Act, which would combine 15 categorical health service programs and the medicaid program and provide States with increased flexibility and funds to meet their health needs.

The PSRO program is becoming fully operational and should result in better quality and more appropriate levels of care for medicare and medicaid beneficiaries. The Health Planning and Resources and Development Act of 1974 establishes a network of health planning and resource development agencies at the regional level to improve the development and allocation of resources, as do the more limited end stage renal disease and emergency medical services. programs.

We are supporting demonstrations of how to accomplish redirection of the delivery system toward ambulatory and preventive care through our support of health maintenance organizations and manpower development programs. Our preventive and health education efforts also include immunizations, fluoridation, rehabilitation, regulation of foods, drugs, cosmetics, protection of workers from occupational hazards, as well as the early and periodic screening, detection and treatment program for all eligible children up to age 21.

S. 3205 must be viewed in light of these initiatives and the current institutional structure of the health care industry. Some of its provisions would make major structural changes in these programs and cause major organizational changes within HEW. Others would

effectuate minor changes in the benefit packages, reimbursement or administration of medicare and medicaid.

While I believe that some of the proposed solutions have considerable merit, I am not totally confident that the bill, as a whole, would be as effective as intended. My concern is with any measure that is aimed only at governmental health financing programs. Nevertheless, I see this bill as addressing the widest range of medicare and medicaid program issues since the 1972 Social Security Amendments.

We are currently in the process of analyzing the 27 different provisions of this bill as well as other proposals affecting our health financing programs and will submit our legislative recommendations as part of the next budget/legislative cycle. Nevertheless, I would at this time like to share with you my preliminary views on the bill.

It seems to me that as we engage together in an analysis of ways to remedy current problems, we should agree on the criteria against which to test the proposed remedies. Among the chief criteria I would apply are the effects on the overall health care delivery system as well as on the medicare and medicaid programs.

In particular, each provision must be evaluated for its effects on program beneficiaries, program costs, overall health care costs, accessibility of resources, medical care providers' behavior and private health insurance coverage.

In assessing the individual provisions of this bill, two fundamental and interrelated issues must be addressed. First, does the particular provision address a real programmatic problem? Second, is the proposed legislative solution likely to be effective or are there alternative solution that would more effectively solve the specific problem? Furthermore, in attempting to deal with the problems in the medicare and medicaid programs, we must guard against creating additional problems on the private side of the health care delivery system.

The major reimbursement reforms in S. 3205 address very real problems. The Department agrees with the general direction suggested in section 10 to change medicare and medicaid hospital reimbursement from a retrospective cost basis to a prospective budget related approach. However, while we fully recognize the problems of cost reimbursement for hospitals, we have some concerns about the particular solution offered.

First, by excluding all teaching, energy, and capital costs from the routine cost limits, only about 35 percent of the hospital's costs would be subject to the prospective limits. This would likely result in hospitals shifting costs internally or raising their charges to nonmedicare-medicaid patients the result being no change in overall hospital costs. In fact, because of the noninclusive definition of routine costs, this proposed system could be less effective than the current prospective routine cost limits established under section 223 of the 1972 social security amendments, which apply to about 50 percent of a hospital's costs.

We are also concerned about the proposed hospital classification system. As you know, developing an appropriate system to group hospitals for reimbursement purposes is very difficult. While we appreciate the simplicity of the system developed in section 10, we are quite concerned about the lack of an appropriate local wage index to adjust personnel costs among hospitals.

The Department, in cooperation with several States, is experimenting, demonstrating and evaluating a variety of prospective reimbursement systems using authorities obtained in section 222 of the 1972 Social Security Amendments and section 1526 of the planning title in the PHS Act. We are also continually refining the section 223 classification system and cost limits. These efforts should provide the information necessary to develop an effective and equitable hospital prospective reimbursement system.

We are also supportive of the intent of the physician reimbursement provisions, sections 20 through 23. Current reimbursement differentials between urban and rural areas reflect differences in physicians' customary charges. This reimbursement system was not intended to address the shortages of physicians in rural areas but some narrowing in these differentials might be useful in addressing this problem. Nevertheless, I would express some reservations about the possible effectiveness of the mechanism proposed in section 20. The problem of physician location is much more complicated than a medicare-medicaid reimbursement issue. We see a need for a broader approach. The Department is actively developing both manpower and reimbursement policies designed to encourage physicians to locate in rural areas. The Department is also analyzing alternative policies and incentive mechanisms to encourage physicians to accept assignment. We support the intent of the participating and non-participating physician concepts developed in section 21. We do, however, question both the potential effectiveness of the proposed incentives to encourage acceptance of assignment and the impact of "always" or "never" alternatives. In addition, we are quite concerned about the administrative costs to both the physician and the medicare program of adopting these incentives. The Department supports efforts to develop a more appropriate reimbursement method for hospital-based physicians. We support the effects in section 22 to tie reimbursement to the actual services performed.

We share the concern of S. 3205 that medicaid physician reimbursement levels in some States do not provide the accessibility to care for medicaid beneficiaries that is available to more affluent persons. Nevertheless, there are several major issues which must be considered, including whether these rates should be raised. First, many States medicaid programs are experiencing cutbacks in eligibility, benefits and/or provider reimbursement as a result of State budgetary difficulties. Second, since there is nothing sacrosanct about medicare reimbursement rates, there is no way to know at what "appropriate" level to set the medicaid reimbursement rates.

Sections 2 and 3 of the bill would result in a major administrative reorganization of health programs within HEW. This is an area of particular interest to me. However, the issues involved in establishing an Assistant Secretary for Health Care Financing and an Inspector General for Health as well as merging the Bureau of Health Insurance, the Medical Services Administration, the Bureau of Quality Assurance and the Office of Nursing Home Affairs are extremely complicated. Organizational changes do not necessarily solve problems.

On the one hand, combining these programs organizationally is way to increase standardization and coordination. It could lead to

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