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risk, and Medicare paid a substantially smaller share for equity costs than other hospital patients (see Table 2 on page 7). This share was even below the ROES earned in low risk regulated industries such as electric utilities. Thus, non-Medicare patients subsidized the use of hospital services by Medicare patients to the extent of the difference.

3. Under the Medicare ROE formula, return on equity payments should have been based upon a 3.7 Hospital Trust Fund multiplier rather than the current 1.5 multiplier.—A multiplier equal to 3.7 would have yielded IOH rates of return on equity which were commensurate with their risk during each year of the 1969-75 period. If Medicare recognized taxes as an allowable cost, then the corresponding appropriate Trust Fund multiplier should have been 2.0. In 1976, the use of a multiplier of 3.7 would have increased total Medicare costs (net of taxes) by about $28 million or less than 0.3 percent of total Medicare program costs.

4. Medicare disallowances of certain unavoidable hospital expenses or investments can produce effective Medicare ROEs which are below the appropriate nominal rates identified above.-Consequently, higher Hospital Trust Fund multipliers might be needed to ensure that effective ROES are commensurate with the ROES in similar risk industries. Such unavoidable costs disallowed by Medicare include income taxes, routine SEC registration costs, and other stock maintenance costs. If such disallowances represent three percent of total costs attributable to Medicare, then a Trust Fund multiplier equal to 5.1 rather than 3.7 would have been required to provide the appropriate average ROEs during 1969–75. Medicare equity disallowances include denial of fair market value assessments of IOH land used for hospital expansion and of hospitals acquired through the exchange of stock. When three percent of the value of such investments is disallowed by Medicare, then the Trust Fund multiplier needed to provide appropriate ROES during 1969-75 would have been 3.8.

5. Medicare ROE payments in the indicated range would allow IOH8 to reduce non-Medicare patient charges by at least two percent, or reduce the amount of debt capital employed by some 10Hs.-By eliminating the current subsidy of Medicare patient expenses by other payors, hospital charges could be reduced on average by about two percent without reducing overall IOH profits. In areas where third-party cost-reimbursement covers a larger than average proportion of all patients, non-Medicare charges could be reduced even more. Alternatively, these ROE payments could permit IOHS to raise additional equity and thereby reduce some of the risk created by the use of large amounts of debt. The higher Medicare ROES might thus tend to be offset by the lower interest rates and payments which result from a less risky capital structure. Under certain circumstances, this return to a more balanced capital structure would produce lower total capital costs.

6. Under alternative Medicare reimbursement systems, IOHs should still receive ROEs which on average are consistent with the 11 to 16 percent returns.— Although our analysis focussed specifically on changes under the present Medicare cost-reimbursement system, most experts agree that Medicare reimbursement should be reformed to promote greater efficiency among hospitals. If a different reimbursement approach is adopted through legislation or changes in DHEW policy, then the new approach should still provide a target average industry ROE of at least 11 to 16 percent, because the IOH industry continues to face the same business and financial risks as before. Indeed, a new reimbursement system could actually increase industry risk. This seems to have occurred in other regulated industries that are naturally competitive, such as airlines and nursing homes.

7. Future analysis should focus upon three key factors which affect the determination of appropriate ROEs for investor-owned hospitals.-Specifically, future work should focus upon :

The degree to which certain unallowable costs and investments are simply unavoidable in IOH operations and thus may unreasonably reduce the effective return on equity:

The potential impact on return on equity and capital structure of alternative Medicare reimbursement proposals: and,

The degree to which full payment of IOH debt costs and partial payment of equity costs affects total costs of capital and the resulting capital structure.

These factors are important in the establishment of an appropriate regulatory policy for hospital reimbursement and were simply beyond the scope of this study.

TABLE 1.-COMPARISON OF RISK IN THE IOH INDUSTRY WITH RISK IN 24 OTHER CONSUMER PRODUCT AND SERV

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TABLE 2.-ICF ESTIMATES OF APPROPRIATE ROE'S FOR INVESTOR-OWNED HOSPITALS, 1969-75

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1 Sales-weighted average of 10 major hospital management companies. Source: Tables 3 and 4 in ch. II.

Mr. BROMBERG. That study finds that the aftertax return on equity in comparable industries was 11 to 16 percent. The law has been interpreted to make our return on equity a pretax return. Under present law, we would only get 5 percent after taxes. As the bill is written, under section 46, that would be increased to 7 percent after tax.

We think the study will document the need for higher return.

I would like to make a comment on the administrative reforms of the bill. On page 22 of our testimony, in addition to the concerns that the chairman and others have expressed we have another one, and that is, that the quality of care may be subordinated to budgetary problems unless this new Health Care Financing Administration is either placed under the Assistant Secretary for Health or under a new Under Secretary for Health.

We do not think it is really possible to separate quality and cost issues. We are afraid that having one agency concerned with costs separated from the top position in the Department of HEW that those issues will not be properly addressed.

Finally, at the end of our testimony, starting at page 25, we make the following conclusions. This bill is a result of a great deal of wellthought-out labor on the part of the subcommittee chairman, the mem

bers, and the committee staff. On its own, it may be considered to be a bill with a great deal of merit; compared to arbitrary cost control schemes, it is particularly commendable.

The impact of this bill, S. 1470, on reducing the rate of inflation in cost reimbursement under medicare and medicaid should automatically impact non-Government program costs. Charges to private patients, for example, should rise less sharply because actual costs will be moderated and will be rising at a much slower pace as a result of your bill. For this reason, together with our opposition to any Government price controls over one industry, we urge you to limit application of your bill to medicare and medicaid. We will be very much willing to work with the staff to see how the bill can be applied to ancillaries. We would like to see the concept limited first to medicare and medicaid and with respect to other patients to make sure that there is no shifting of costs.

We would recommend use of a general jawboning policy particularly emphasizing public disclosure, rate review, and public finance. It seems to us that there is not enough disclosure in the hospital field. Not only do consumers not pay at the time they get the service, they make payments, but do not pay at the time they get it, but also they are not aware of what the competitive charges are.

It seems that the first step to stimulate the competition would be disclosure.

Second, the threat of adverse publicity, for example, from findings of local insurers or the President's Council on Wage-Price Stability in the cases of unjustifiably high rate increases, the threat of adverse publicity in itself would create a problem which most hospitals would attempt to hold down climate increases.

A national guideline for hospital price increases could be established, with review of such increases by the President's Council, utilizing publicity.

We commend the committee for taking the lead in changing the medicare and medicaid programs, and thank you for this opportunity to present our views.

Senator TALMADGE. Thank you, Mr. Bromberg, for your constructive testimony.

Do you have any questions, Senator Dole?

Senator DOLE. Just briefly. It is an excellent statement.

I asked the previous witness why does not the free market operate in the medical care arena and I just noted that you were sort of nodding your head. I could not get that in the record. I thought I would ask you the same question.

Mr. BROMBERG. Let me take a shot at it, Senator. I think, Senator, it has not worked because nobody has let it work. I think this bill, S. 1470, is the first effort I have really seen in the Congress to inject competition. I think competition can play a role.

I agree that hospitals are not like automobile companies, but there are certain analogies. We do not, for example, say that there should be a 9-percent limit on automobiles or food or housing, although people spend almost as much on food and housing as they do on health.

We do say if you want to buy a Cadillac instead of a Chevrolet you have that right. We are not going to take that away from you and

say that all cars should be no higher in quality than Chevrolet, but because the patient does not have that choice under the administration bill-it would just put a flat cap on that-that eliminates competition. By classifying hospitals by size and looking at the average costs, that is the classic way of stimulating competition: by rewarding efficiency. Until we have more public disclosure, until we have more patient cost sharing, we cannot have true competition in that sense.

Senator DOLE. That is the point I wanted to make. Only 10 percent of the costs now are paid by the patient, is that correct?

Mr. BROMBERG. Yes; that is correct. Third party payers not only pay them, but the patient never even knows about it. Although he pays the premium, he pays that premium at the beginning of the month. He does not pay it when he sees the doctor or goes to the hospital. That is another problem, paying at the time that the service is received.

We realize that there are people who cannot afford it, that to the medicaid patient, the first dollar coverage may be catastrophic. To the vast number of other Americans, that is not true. It does not have to be applied that way.

Senator DOLE. I do not know how the insurance companies work. Maybe I can find out. It seems like they should be exercising a costconscious discipline when they decide what rates to pay and what premiums to charge. Maybe they do, but it must not be very tough.

Mr. SAMSEL. They should be considering what benefits should be offered to the public as well-what benefits, possibly that the beneficiary should be paying the first dollar.

Senator DOLE. One way to bring about efficiency, when I start paying more, I take a closer look at it.

Mr. BROMBERG. When you have cost reimbursement, we will pay you whatever you spend. There is no way you can stimulate competition or efficiency. The more you spend, the more you get.

The other point I would like to make, you asked the question of a prior witness as to whether there were any fat hospitals in their association. Under the administration bill, the fat hospitals would get fatter.

The problem is even more compounded.

Senator DOLE. I suggested it would be the survival of the fattest. I guess that would fit the administration's program.

Finally, there has been a consensus or a feeling among those who testified that perhaps the bill introduced by the chairman and others should be expanded to cover all payors.

You do not feel that this would be satisfactory, or workable, or necessary?

Mr. SAMSEL. I do not feel it should be extended at this time. The extension to other fields, such as the third party payors, direct payment, robs the management again of his essential management techniques at arriving at the appropriate price levels he should be charging for services.

We do not believe that the outside bureaucratic influences can really come to the appropriate price levels. They should be charged for an individual hospital. We are talking about very complex organizations. Many things have to be taken into account. We are utilizing very good management techniques to arrive at those various areas

that are necessary to address in setting rates. We do not believe that they can be ascertained from outside the hospital itself. I do not think Government establishing the price level is only a temporary measure and it really takes away from the manager his abilty to be efficient in the long run.

Mr. BROMBERG. Taking it across the board would, in effect, do to the hospitals what the Health Security Act does to the whole health system. It places in the hands of the Federal Government total control over an industry, in this case, part of an industry, hospitals.

I think it is that objection to price controls, as well as the fact that until we see how it works under medicare and medicaid, we would be making a dramatic jump, that leads us to that conclusion.

Mr. SAMSEL. You would be greatly surprised what incentives would do for the efficient management of hospitals.

Senator DOLE. I am certain they are significant. Are the investorowned operations costs less?

Mr. BROMBERG. Last year we paid $50 million in property taxes and $150 million in income taxes, so we are a taxpaying industry as well. We like to think our rates are very competitive.

One other point-it came up yesterday, and I would like to address it briefly. Secretary Califano has made several comments over the past 2 weeks about one example of the fact that hospitals could cut is the $1 billion in profits that exist. I would like to point out for the record, as I have to him in a letter last night, $1 billion surplus from 7,000 hospitals, 6,000 of which are nonprofit, $1 billion surplus on $55 billion in revenues is less than a 2-percent margin which I think is not only low, but dangerously low.

Our particular industry is a for-profit industry. We had $250 million profits on $5 billion in revenue, or 5 percent. When compared to any other sector or any other industry, any other sector of the health field, certainly when compared to hospital supply companies, that is dramatically low. If the quality of just existing plant and services is to be maintained, I think a 2-percent reserve should not be used as an example of where costs need to be cut. It shows a misunderstanding, I think.

Senator DOLE. Thank you.

Senator TALMADGE. Thank you very much, gentlemen, for your very constructive and very helpful testimony.

[The prepared statement of Mr. Bromberg follows:]

STATEMENT OF MICHAEL D. BROMRERG, DIRECTOR, NATIONAL OFFICES, AND ROBERT J. SAMSEL, PRESIDENT, FEDERATION OF AMERICAN HOSPITALS

On behalf of the members of the Federation of American Hospitals, we would like to thank the Committee for this opportunity to present our views on proposed reforms of the Medicare and Medicaid programs.

I am Michael D. Bromberg, Director. National Offices of the Federation. Accompanying me is Robert J. Samsel, President of our organization and Vice President of American Medical International, Inc., one of the world's largest hospital management companies.

The Federation of American Hospitals is the national association of investorowned hospitals, an industry with 1,050 hospitals in the United States and over 111,000 beds. In addition, our member hospital management companies now manage under contract over 165 additional hospitals, including teaching institutions, public, religious and other community non-profit hospitals.

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