gation to pay a fair rate for services rendered. There will, therefore, be no federal budgetary savings in the initial periods of experimentation with prospective rates. There should, however, be an immediate impact on inflation rates in charges to non-government patients as well as long range cost containment for the Medicare program.

The concept of a predetermined rate for specific treatments on a per diem or per admission basis by diagnosis is one example of the type of prospective rate system we believe should be developed and tested. Other examples include a negotiated rate; a negotiated discount from billed charges with a negotiated inflation rate for subsequent years; and a rate review process limited to facilities whose rates exceed a percentile of group charges or costs.

RATE OF RETURN

We urge the Committee to amend the Medicare law to create a mechanism for the annual determination of a reasonable rate of return on investment. The Medicare rate of return should be equal to investments of comparable risk in other industries.

An adequate rate of return is necessary for a number of reasons, most importantly to: (1) protect the hospital's financial integrity and maintain its credit; (2) to reward investors at a level commensurate with the risk assumed in making their investment; and (3) to attract new capital for maintenance and needed expansion.

In no other industry are income taxes not recognized as an operating expense for purposes of cost based reimbursement or rate of return. By eliminating income taxes as a reimbursable cost, the Department of HEW has effectively reduced the return on equity for investor-owned hospitals to approximately 10% on a pre-tax basis or an after-tax return of approximately 5%.

Investor-owned hospitals must make a fair return on investment in order to be viable, and if the federal government refuses to pay its fair share, this increases the return needed from the private patients, in order to make the overall return acceptable. This is, in effect, an indirect subsidy to the federal government at the expense to private patients needing hospitalization. Such cross-subsidization represents not only a direct violation of the Medicare law, but is major cause of inflation in the private sector of the health industry.

Last year, in a case filed in the U.S. District Court for the District of Columbia, Humana of South Carolina, Inc. v. Mathews, Civil Action No. 75-0302, the court ruled that the Secretary of HEW must establish new guidelines for the determination of an appropriate rate of return on equity capital for investor-owned hospitals participating in the Medicare program. Humana contended that the current formula of one and one-half times the trust fund yield does not reimburse the reasonable cost of providing services insofar as a return on equity capital is such a cost and therefore, hospitals are forced to raise their charges to private paying patients. The court held that such cross-subsidization directly violates 42 U.S.C. § 1395x (v) (1) (A), the law governing the Medicare program. The court directed the Secretary of HEW to make "a detailed study of the various factors affecting the economics of the proprietary hospital industry” in order to enable the Secretary to determine the actual level of return needed to provide a reasonable return on equity and avoid cross-subsidization.

The Federal Power Commission, the Civil Aeronautics Board, the Federal Maritime Commission, the Interstate Commerce Commission and the Federal Communications Commission all recognize that federal income taxes represent a proper service cost in determining a just and reasonable rate of return.

Although S. 1470 attempts to correct this inequity by raising the allowable return to twice the rate on current hospital insurance trust fund investments until 1981 when it returns to the current 11⁄2 times, we believe that this is still insufficient. Section 46 would in effect increase the rate of return from 5% after taxes to 7% after taxes. That proposed increase would still fail to make the rate of return equal to investment of comparable risk.

The Federation recently contracted with ICF, Inc., a Washington based consulting firm, for an in-depth study of rates of return on equity in industries comparable to the investor-owned hospital industry. The study has just been completed and copies will be furnished to the Committee Members and staff.

The summary of findings by ICF includes the following conclusions:

1. For comparable risk industries, the estimated range of an after tax return on equity was between 11.0% and 16.0%.

2. For investor-owned hospitals, this range implies a multiplier of 3.7 of the Hospital Insurance Trust Fund rate, rather than the 2.0 in the proposed legislation.

3. Depending upon the level of Medicare cost adjustments which represent necessary costs of doing business but unallowable by Medicare, the multiplier required to achieve reasonable returns for investors would be between 5.2 and 8.6.

We urge you to consider these alternative approaches to improve the current Medicare rate of return on investment:

(1) Provide for an annual determination by the Secretary of a return equal to rates of return on investments in industries of comparable risk;

(2) Recognize income taxes as an allowable cost of doing business, reimbursable under Title XVIII; or

(3) Increase the current formula to at least 3.7 times the trust fund yield.

CAPITAL EXPENDITURES

Section 4 of S. 1470 provides that Medicare and Medicaid reimbursement of both capital and direct operating costs would be prohibited when a capital expenditure has not met with specific approval. We support this as a valid means of strengthening the health planning law in a manner which will effectively restrain increasing costs. We believe that it should be up to individual HSAS, working to meet the needs of the communities they oversee, to decide what new capital expenditures are justified. This is in marked contrast to the Administration's proposed dollar ceiling on capital expenditures on a state wide basis according to population, coupled with a fixed ratio of four beds per 1,000 individuals or occupancy of 80%

We do not, however, support the provision in S. 1470 which requires unanimous approval of a proposed capital expenditure when it involves an SMSA which crosses state boundaries. Although the other jurisdictions should certainly be actively consulted, the decision regarding approval should ultimately be left to the state in which the proposed expenditure will actually be made. That HSA should be equipped with sufficient data to accurately gauge the need-based on current and projected utilization trends-of the proposed project. It would be too cumbersome a process for approval to be secured from secondary jurisdictions and political stalemates could jeopardize needed health expenditures.

Finally we recommend an amendment requiring certificate of need agencies to solicit competitive applications for needed services, equipment, and facilities to stimulate competition and lower costs.

CONVERSION ALLOWANCE

The Federation supports that provision of the bill which encourages closing or converting underutilized beds or services by including in the hospital reasonable cost payment, reimbursement for costs associated with closure or conversion. However, in the case of for-profit hospitals, only increased operating costs would be recognized; capital costs would be disallowed.

We believe that regardless of ownership, hospitals should have both their capital and increased operating costs associated with closure or conversion recognized. To differentiate on the basis of ownership raises serious constitutional questions. If there are two hospitals located in a community-one a non-profit the other investor-owned-and the community believes that the investor-owned facility should be closed or converted to another use, the provision as presently stated provides no incentive for the investor-owned hospital to acquiesce. After all, no facility can be expected to shut down and retire its debt without benefit of patient income. The question should be "What is best for the community?" Then all costs connected with closing or converting the facility-regardless of ownership should be recognized.

This provision is essentially experimental, limiting transitional allowances to only fifty hospitals per year for the first two years of operation. The Secretary would review all recommendations forwarded by the Hospital Transitional Allowance Board; however, there would be no appeal to the Secretary's final decision. We recommend that when the program becomes more than experimental, these decisions become subject to judicial review.

In addition, we recommend that total hospital closures be given priority under this voluntary program. Little or no dollar savings will be realized from closing some beds within an institution, but significant savings can be realized if an eutire facility is purchased for fair value and closed.

HOSPITAL BASED PHYSICIAN REIMBURSEMENT

Insofar as control of physician reimbursement is concerned, we can understand the desire to discourage potential abuse or excessive payments by limiting the reimbursement for certain hospital based physicians. However, we believe that the actual method of payment-be it fixed fee, or percentage, lease, or direct billing arrangements-should be left to the discretion of hospital management. By restricting payments to a fixed fee, many rural areas might be unable to attract the services of these specialists.

We would not, however, be opposed to screens being applied to the final result of the hospital physician negotiations using a technique similar to the 75th percentile of the prevailing payment levels in the area.

Finally, there should be a "grandfather" clause covering all contracts made prior to enactment of S. 1470 between hospitals and hospital based physicians.

HOSPITAL CONTRACTS

We are pleased to note that Section 40 has been modified substantially, deleting last year's requirement that all contracts of $10,000 or more be approved in advance by the Secretary. This modification reflects an awareness of the chaos that such a provision would have caused in the daily administration of a facility.

However, Section 40 still provides that no cost or charge will be considered reasonable for purposes of reimbursement under Titles XVIII or XIX if it represents a commission or finder's fee or an amount payable under rental or lease arrangement where payment is based on a percentage arrangement. The Federation objects to this provision which covers consulting and management contracts for the same reasons it rejects the restrictions imposed on contracts with hospital based physicians. We believe that these are matters properly left to the discretion of the hospital's administrator and Board of Trustees.

Section 2 of the bill precludes the need for the kind of line-by-line budget examination proposed in Section 40. Under the proposed target rate, the concern is properly with the total costs, not with all the individual components that go into that final figure. Hospitals are given incentives to come in under the target rate, or at the very least make sure that their per diem routine operating costs do not exceed 120% of the average rate determined for their category. This factor in itself serves to prohibit the negotiation of contracts that are excessive. We, therefore, recommend that Section 40 be deleted altogether from S. 1470.

HOSPITAL PROVIDERS OF LONG-TERM CARE SERVICES

We believe that the stated purpose of Section 20 of S. 1470-to make better and more flexible use of underutilized hospital beds in rural areas by permitting their conversion to long-term care beds with appropriate reimbursement-is an excellent one. We would suggest, however, that this provision be amended to delete the requirement that limits the section to hospitals with less than fifty beds. Since a certificate of need would be required prior to conversion, planning authorities would not be faced with a surplus of long-term care beds. Therefore, we do not think that the potential success of this provision should be blunted by the currently suggested fifty bed limitation.

ADMINISTRATIVE REFORMS

Turning lastly to the area of administrative reforms, the Federation shares Senator Talmadge's concern that the new Health Care Financing Administration may be guilty of furthering, rather than alleviating, the bureaucratic superstructure controlling the health sector.

We would suggest that in re-examining the purpose and proposed organization of such an Administration under Section 30 of S. 1470, that consideration be given to placing it under the direct supervision of the Assistant Secretary for Health or creating an Under Secretary for Health, rather than an Assistant Secretary for Health Care Financing. With the exception of the Secretary himself, the Assistant Secretary-or Under Secretary-for Health, should be the top spokesman and policy maker for departmental health policy. The position of Assistant Secretary for Health Care Financing could serve to undermine this authority.

In addition to weakening the basic powers of the Assistant Secretary for Health, establishment of an Assistant Secretary for Health Care Fiancing separates cost and quality issues, and places even more authority in the hands of health economists. We, too, support cost-consciousness, but we are concerned by the increasing preoccupation with budget that has come to characterize departmental thinking and regulation. Issues of cost and quality of care are appropriately addressed jointly. For this reason, we believe that the Assistant Secretary for Health should have jurisdiction over the new agency.

SIXTY DAY COMMENT PERIOD

With few exceptions, a thirty day comment period is presently provided for public comment on proposed regulations. In order to assure that regulations affecting health care are representative of sound public policy, it is mandatory that the public and the health sector as a whole be given the time to respond with comments and constructive recommendations. However, as matters now stand, by the time that the proposed regulations reach our hospitals, particularly those in western regions, we are left with considerably less than thirty days in which to evaluate regulations that are often complex and lengthy. There is often not sufficient time available to study the regulations, gather information on their possible and probable effect, and then formulate and forward a response to the Department of Health, Education, and Welfare officials. Therefore, we strongly support the provision to extend the period for public comment on proposed regulations to sixty days except in those cases where the urgent nature of the regulations demands otherwise.

HEALTH INSURANCE BENEFITS ADVISORY COUNCIL

The effective administration of Title XVIII depends in part on the cooperation-not confrontation-between government and the health industry. HIBAC was created by Congress when Medicare was first passed as a means for affirming Congressional intent that industry advice and cooperation be sought by the department. Instead of abolishing HIBAC, as proposed in S. 1470, we recommend that the Council's role in the regulatory process be clarified and where appropriate, broadened.

We recommend that HIBAC be reconstituted as a ten member advisory body, broadly representative of health providers, consumers, and third party payors, a more workable size than the present nineteen members. HIBAC should be an advisory body of the legislative as well as the executive branch. It should meet more frequently and all proposed regulations under Title XVIII should be submitted to HIBAC thirty days prior to initial publication in the FEDERAL REGISTER. Any regulation which HIBAC determines to be contrary to the public interest or inconsistent with sound administration of the Medicare program, should be reconsidered by the Secretary prior to initial publication.

These recommendations, if adopted, would help restore confidence and trust in the system by assuring a real dialogue between the payor nd provider of program benefits.

CONCLUSION

S. 1470 is the result of a great deal of well thought out labor on the part of the Subcommittee Chairman, the Members, and the Committee staff. On its own it may be considered a bill with a great deal of merit; compared to arbitrary cost control schemes, it is particularly commendable.

These attempts to place arbitrary limits on hospital revenues ignore the causes of rising health costs, and fail to provide incentives to counter this trend.

The impact of 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 rising at a slower pace.

For this reason, together with our opposition to any government price controls over a single industry, we urge you to limit application of S. 1470 to government programs.

With regard to non-government patients, we recommend use of the President's general economic policy of jawboning to hospital rate increases in excess of an

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agreed upon percentage. The threat of adverse publicity from findings of local insurers and the President's Council on Wage-Price Stability would certainly create a climate in which most hospitals would attempt to hold down spending increases.

For example, all hospitals seeking charge increases in excess of 80% of the hospital service charge component of the CPI could be required to disclose and justify their budgets to their local Blue Cross plan and commercial insurance companies.

A national guideline for hospital price increases could be established with review of increases above that level by the President's Council on Wage-Price Stability, utilizing publicity as a disincentive to unrestrained price increases. We commend the Committee for taking the lead in revitalzing and reforming Titles XVIII and XIX of the Social Security Act, and thank you for this opportunity to present our views.

Senator TALMADGE. Our next witness is Mr. John F. Horty, president, National Council of Community Hospitals.

You may insert your statement in full in the record and summarize it in 10 minutes, if you will.

STATEMENT OF JOHN F. HORTY, PRESIDENT, NATIONAL COUNCIL OF COMMUNITY HOSPITALS, ACCOMPANIED BY JOHN HUFF, COUNSEL

Mr. HORTY. Thank you, Mr. Chairman, for the opportunity to appear here this morning. I have with me Mr. John Huff, legal counsel for the National Council of Community Hospitals. I will not read our statement to you, but rather attempt to summarize what we have said in our prepared statement, which we ask to be inserted in the record.

We have taken the position that the approach taken by this committee is a very constructive approach in an attempt to enact and formulate long-term reform in the health care system and we would welcome working with the committee in this effort. We do, however, urge the committee to consider postponement of the enactment of this kind of long-term reform because of our feeling that the present situation with respect to hospital costs is one which requires drastic action and also one which requires us to examine not merely the inequities in the present system, but also the possibility of total reform of the entire concept of the way in which hospitals are paid for their services. Not only the way in which hospitals are paid, but the way in which all sectors of the health care field are paid, physicians, and others.

In fact, it is our belief that the philosophy of reasonable cost reimbursement as such no longer provides the kind of incentives that this field needs, and therefore that the very excellently conceived and stated reforms of this bill would find the reasonable cost reimbursement systems do not get at the root problems of the entire industry at this point in time.

We therefore, in a sense, join with the administration in their concern with the immediate cost problem in the hospital field. However, as other witnesses have stated, we do not believe that the vehicle that the administration has adopted is a satisfactory vehicle. We have stated so in our testimony in detail. I will not go back over the litany of reasons that other witnesses have provided and which the committee already understands.