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benefit of the entire amount of the differential between their prior cost and the average cost of the class. They might find these improved services preferable to keeping only part of the differential, which would pay for only a smaller amount of new service.

Fourth, because the proposed system is tied to average routine operating costs per patient day, the Bill introduces incentives to lengthen stays and to increase admissions-factors which can only increase the total health care cost, although lowering it on a unit basis.

Finally, the Bill entails tremendously complex calculations for each hospital and for the Government. The Bill would require determination of the classifications, determination of index rates for the "area" in which each hospital is located, and determination of the increase in the cost of each hospital's mix of goods and services. These calculations cannot be taken out of a reference book. The Bill would require resolution of a number of additional questions: e.g., did the hospital “manipulate” its patient mix or flow; does it provide less than the "normal" range of patient services; do its patients require “a substantially greater intensity of care"; what portion of its routine operating costs are "attributable to the greater intensity”; etc. These are no simple questions. They will have to be resolved by the thousands. Doing so will be expensive.

In addition, the Bill introduces uncontrollable uncertainties, which can only further complicate the problems hospital management must deal with. How, for instance, can a hospital whose fiscal year begins in January budget when it will not be informed of HEW's calculation of its adjusted per diem payment rate until April 1: These complexities can only increase hospital costs and the costs of Medicare Medicaid administration. 2. S. 1470 does not embody structural reforms

In introducing S. 1470, the Chairman of this Subcommittee referred to the Bill as a long-term solution to the cost containment problem. NCCH is pleased that the Chairman recognizes the need for long-range reform. But we must respectfully note that S. 1470 does not present fundamental long-range reform. S. 1470 makes highly complex adjustments in the present reasonable cost reimbursement system, but it does not change the basic system.

As my statement last year on S. 3205 discussed, there is widespread dissatisfaction, on the part of both the Government and the hospitals, with the reasonable cost reimbursement system. The reasonable cost system contains a number of inherent difficulties :

“Reasonable cost" represents the ultimate in conflict of interest. It permits HEW to determine what is reasonable cost for the services it is purchasing. Not surprisingly, we have observed in the past few years numerous occasions on which HEW has restricted what is “reasonable,” not because a service was unreasonable or unnecessary or because the cost of the service actually was unreasonable as a financial matter, but only because the Government sought ways to reduce Federal expenditures for health care. The Government has transformed a system that was intended and designed to prevent hospitals from overcharging the Government into a mechanism for underreimbursing them.

Reasonable cost entails a vast army of Federally employed and Federally activated accountants whose sole mandate is to save the Federal dollar without consideration of the effect on the provision or quality of care. Reasonable cost requires expensive and time-consuming audit of the thousands of participating hospitals.

Reasonable cost makes no allowance for the fact that even not-for-profit hospitals need a “profit” to provide them with working capital and discretionary funds.

Reasonable cost subjects hospitals to a process of review and second-guessing years after the services have been performed, and after the reimbursement has been approved and paid by the Government itself.

As a result of these and other pro ems with the reasonable cost system of reimbursement, NCCH determined to develop a more effective and fairer method of reimbursement. It soon recognized that the reimbursement system cannot be changed without changing the structure of the delivery system.

S. 1470 does not approach those needed changes. Classifying hospitals, pegging reimbursement to certain arbitrability selected levels, and indexing costs represent fine tunings of the reasonable cost system. They do not address the problems inherent in any system of reimbursement based on reasonable costs, and they do not point the way to a new delivery system. Indeed, a larger number of functionaries, both in hospitals and the Government, would be required to administer the pro

posed system. As discussed above, the Bill introduces a host of complex calcula. tions and determinations. The inevitable result will be additional phalanxes of accounts, economists, statisticians, systems analysts, lawyers, and associated personnel.

Nor does S. 1470 prevent the Government from continuing to cut back on what it is willing to recognize as a reasonable cost. Indeed, S. 1470 would make those unwarranted determinations applicable to all hospitals (by reducing the average). And S. 1470 would give the Government yet another tool to assert its selfinterest: reimbursement pegged at the average of a class and limited to 120% of the average could always be lowered by changing those arbitrary standards.

We also note that S. 1470 would exacerbate the reasonable cost system in another way. At the present time, hospitals that are not reimbursed by MedicareMedicaid for the full and fair cost of caring for these Federal beneficiaries are forced to transfer these costs to private patients. S. 1470 (Section 2(f) (1)) would prohibit such a transfer. This can only result in impairing the financial stability of hospitals or forcing them to eliminate the services they are now providing Federal beneficiaries for which they are not fully reimbursed. We would think a more just provision would be one that required the Federal Government to pay the full cost of hospital services its beneficiaries receive.

S. 1470 does not do anything for a not-for-profit hospital's need for a “profit." The incentive payment in the Bill is not a profit. As I mentioned above, hospitals could well decide they would be in a better position by increasing their expenditures to the permitted average than by keeping a small percentage of what they can save. Also, the money made available by this provision would go to the hospital offering the least services (and whose routine operating costs, therefore, are below the average)—while the more active, more innovative hospital is deprived of discretionary funds. All hospitals need an operating margin. 3. 8. 1470 will in fact impede necessary structural reforms.

NCCH believes that long-range structural reforms must contain at least the following elements: financial incentives for providers to restrain health care costs; management discretion, including the opportunity to benefit from success and the obligation to bear the burdens of failure; mechanisms that require both health care providers and patients to consider the cost as well as the benefit of any particular health service; increased control by health care institutions of the source of their "business”; increased competition among health care institutions to serve patients with better quality of care at lower cost; recognition of the benefits of diversity among health care providers; and greatly reduced Government control over the management of a health care institution except in the area of quality assurance.

I believe these principles will find widespread acceptance by the health care field, the Government, the medical profession, and patients. We believe that there is sufficient consensus as to the outlines of structural reform that we should be certain that no measures are implemented which would be inconsistent with these reforms or make their implementation more difficult. It is our confidence that reform is possible that made us propose the 24-month freeze.

S. 1470, NCCH believes, would hold back long-range reforms. There are three major premises of the Bill that we believe are inconsistent with true structural reform.

a. Hospitals should not and cannot be classified but 8. 1470 would promote

their arbitrary classification A basic premise of S. 1470, I fear, is that diversity among hospitals should be discouraged, and if possible, eliminated. The Bill would force hospitals into grossly determined classifications, and set their reimbursement on the basis of the costs of other hospitals who happen to be in the same classification. This approach totally ignores the ways in which hospitals of the same "type" and "size" (the two criteria employed by Section 2) may be different.

We do not believe that it is possible to categorize hospitals. They are far too diverse to permit classification, except by a complex of matrixes that is so sophisticated that it is yet to be developed. HEW's efforts in this direction, pursuant to Section 1861 (v) (1) (A) of the Act, have been grossly simplistic and have unfairly lumped disparate hospitals together. We have no reason to believe that classifications made under Section 2 would be any different.

We doubt that classification of hospitals would work even with the most sophisticated system and we believe it is a false way of handling reimbursement. No two people are alike. Hospitals are nothing but aggregates of the interaction of many individuals (including those who shaped the institution in prior years) and to classify hospitals is even more impossible than classifying individuals.

Even if, after spending millions of dollars, some sufficiently sophisticated classification system were developed, moreover, it would be outmoded the next day, for institutions are and should be perpetually changing. They cannotand should not-be fast-frozen. Classification, in short, is impossible for living things.

The safety valve in Section 2 by which the payment rate would be readjusted for any hospital which the Secretary determined provided “substantially greater intensity of care” is not workable. Experience has shown that the Secretary is reluctant to make such determinations (which result in additional Federal payments) and that even if he does, they are made years after the event. In any event, how does the Secretary determine what is substantially greater intensity of care? There are, moreover, a vast number of variables among hospitals in addition to intensity that affect cost. Every hospital is different from every other. The unusual is commonplace.

The effort by S. 1470 to squeeze every hospital into categories is, if I may mention two legends, akin to the endeavors of King Canute and Procrustes combined. Diversity should be welcomed and promoted. It is a threat only to those who wish to exert centralized Governmental control. S. 1470, therefore, is inconsistent with the directions in which NCCH and others believe structural reform and the best and most efficient health care system lie.

b. Although bureaucracy in this field should be reduced, S. 1470 would add

yet another layer of bureaucratic control NCCH does not believe the structural reform of the health care delivery system is advanced by a system under which the Federal Government would set reimbursement for all hospitals on the basis of arbitrary percentages of artificially created categories of hospitals. There is no reason to believe that a hospital which exceeds the average cost of the hospitals in the category in which the Secretary has placed it is by virtue of that statistic alone inefficient. That hospital may provide additional (or different) services. A vibrant, innovative health care system is not promoted where the Government sets reimbursement on a totally arbitrary basis and reserves for itself the right to set some other arbitrary rate when it so chooses.

In addition, s. 1470 would, as discussed above, increase the complexity of an already overwhelmingly complex system and require a new army of accountants, economists, statisticians, bureaucrats, lawyers, and the like. This growth of the bureaucracy is harmful by itself. It calcifies the entire system. The more complex the reimbursement system, the more innovation and risk-taking are discouraged. Management must focus on working within a complex set of rules ; Government must strive to assert the primacy of its rules and protect their efficacy. The more entrenched such a system is, the more difficult it becomes to reverse the trend and develop a health care system that can function without the daily and minute control of the Governmental dead hand.

c. Managerial innovation and ercellence is essential to the future strength

of this field, but S. 1470 impedes hospitals' efforts to exert managerial

control An essential component of any structural reform must be enhancement of a hospital's ability to manage its own business.” Hospitals are the only institution I know of that have virtually no control over their "sales force" (primarily physicians), little control over their "production department" (physicians, and even a hospital's own employees), and no direct connection with their "customers”. (patients). Until hospitals can determine what patients they serve, what services are provided, and when, it will be possible for them to introduce financial considerations into the provision of health care or to control their own expenditures. To increase the efficiency of the system, to widen access, and to introduce financial incentives, hospitals will have to develop different and more meaningful ties with their patients and be more directly responsible for the provision of health care.

In his speech before the Hospital Association of Pennsylvania last October, Senator Talmadge recognized that hospitals do not have the legal authority or the power to make the decisions that largely determine the cost of care because the medical staff decides admissions and length of stay, what tests are performed, and so on. Senator Talmadge continued by saying that we cannot continue to accept that reality as an ercuse forerer."

We agree with Senator Talmadge as to hospitals' inability to make those deci. sions, but we teliere that the reality cannot be ignored or brushed aside. Ways must be fourd to change this reality so that hospitals can control costs. This is a prime element of the reforms needed in the health care delivery system. But S. 1470 does nothing to increase hospitals' ability to control their own costs; the Bill actually impedes efforts by hospitals to work out more ežective relati nships with their physicians.

I reier, of course, to Section 12, which effectively precludes any arrangement (other than a salaried employee relationship between a hospital and any physician for the physician to perform medical services at the hospital. We understand and share the current disquietude over the amounts of money Le physicians receive. But eren if it is wise as a matter of public policy for the ijovernment to be in the position of imposing compensation limitations on one small sement of society. Section 12 is not an efective mechanism for doing so. Putting hospital-associated pişsicians on a fee-for-service basis is no garantee that the total amount of their compensation will be any less than it was under the hospital arrangemect. It is likely to be more, and it certainly will be more difficuit for anyone to know what the phşsieian's total compensation is. Except to the extent ignorance of the outcome can be masked as a solution, then, Section 12 is unlikely to be effective.

At the same time, and of more importance for long-range reform, Section 12 will destroy hospitals' efforts to tie physicians more closels to the institution. By its terms, Section 121c) would limit the physician's compensation under any arrangement to the amount he would receive if he had been on a salary. I imagine it may be rather difficult to calculate what a physician would have received if he had been on salary.

But the provision would have far more harmful results than merely enharcing the complexity of the system. As applied by the bureaucracy, the provision certainly will limit physicians' compensation to less than what thes will receive under fee-for-service. This, plus the “ethical” arguments that will be raised in favor of fee-for-service will effectively prevent any warrangement" between community hospitals and their physicians. Hospital associated physicians would be given an overwhelming incentive to refuse any arrangement with the hospital and go to fee-for-service.

As a consequence, most of the ties that these arrangements generate between a hospital and their physicians would be broken. It is an elemental fact that a person who is paid by the hospital feels more loyalty to the institution and is more willing to cooperate with hospital management in cost and quality control than is one who receives no funds from the hospital, but only uses it as a workplace. Furthermore, arrangements between hospitals and physicians gire the hospitals leverage to obtain beiter service. To ensure around-the-clock coverage by a radiology group, for instance, a hospital may offer the group a contract. The existence of a contract gives the hospital a vehicle for enforcing quality, for ensuring that the contracting physicians mesh their operations with other hospital services, for obtaining administrative and educational services from them, et cetera. If hospitals are prevented from entering into such arrange ments with physicians, they will be deprived of their main bargaining counter. How will the community hospital provide radiology around the clock, 24 hours a day, if it has nothing to give the radiologist in exchange for his agreement to provide such services? A physician on fee for service will tend to work at the hours when there is the most amount of potential “business." Section 12, therefore, will impede hospitals' efforts to provide quality care in the short term, and it will set back efforts to tighten the relationship between hospitals and physicians and thus discourage long-range reform efforts.

I recognize that Sertion 12(e) was spurred by a suspicion of percentage contracts. But the effect is orerkill. The Bill is not limited to those arrangements. And even if it were. NCCH would oppose the provision. Percentage contracts are abused by some physicians. But that does not justify prohibiting the arrange ment. The fault is not in percentage contracts themselves. Such contracts are in many instances an effective and fair way for the hospital to obtain specialty services. A hospital should be left free to use whatever arrangement it deems best. To the extent there are "abuses" of percentage contracts, thes are a result

of poor negotiating or of the hospital's lack of bargaining power. In such a market, the physician will be able to collect comparably high compensation no matter what arrangement (including fee-for-service) is used. The problem can best be faced by changing the market pressures, and the hospital's leverage, not by futilely trying to reverse the consequences of those pressures and reducing the hospital's leverage.

An increasing number of physicians are being produced. It is possible that within four or five years, the market will swing into a more realistic balance. Hospitals will then be able to negotiate more advantageous arrangements with physicians who wish to use their facilities. But Section 12 would prevent them from doing so (except to the extent they are able to obtain salaried physicians). Section 12 leaves no room for the hospitals to develop innovative arrangements with doctors in the broad area between fee-for-service on one extreme and physician employees on the other. Structural reform of the system requires the development of such arrangements, but Section 12 would deter that effort.


For these reasons, NCCH must respectfully oppose S. 1470 at this time. We urge consideration of our proposal for a short-term freeze, designed to contain cost increases immediately and to force a wide-ranging consideration of what kind of health care delivery system the American people desire. The ideas developed in S. 1470 could play an important part in formulating structural reform, although, as my testimony has indicated, NCCH believes the health care delivery system needs changes that go beyond those proposed by S. 1470.

I appreciate the opportunity to appear before you today.

Senator TALMADGE. The next witness is Dr. Charles E. Phillips, president, American Protestant Hospital Association. I understand he is not present. His statement will be inserted in the record.

[The prepared statement of Dr. Phillips follows:)


HOSPITAL ASSOCIATION Mr. Chairman, I am Charles D. Phillips, President of the American Protestant Hospital Association, representing some 300 hospitals, homes for the aging and other health care agencies throughout the country, as well as some 2,000 personal members who are engaged in the delivery of health care services. The Association membership is dedicated to providing quality health care to patients within a Christian reference and to ensuring the strength and viability of our voluntary, pluralistic health care delivery system. With me is Michael S. Cassedy, the Director of our Government Affairs Department.

We greatly appreciate the opportunity to present the position of APHA on S. 1470. Mr. Chairman, let me say at the outset that the members of APHA appreciate your concern about the rising costs of the Medicare and Medicaid programs to the taxpayers of this nation. We are grateful for your commitment to the development of reforms which will prevent the cutting and slashing of payments to hospitals and physicians indiscriminately and inequitably and the imposing of arbitrary controls and indiscriminate limits on payments to hospitals such as the Administration's proposed ceiling on hospital cost increases.

We are concerned, however, that the reforms which are proposed as solutions to the problem of escalating costs of hospital services under Medicare and Medicaid be based on an awareness of the factors which are responsible for such increases, and that the retorms address those factors rather than taking a simplistic approach of limiting reimbursement. We believe that this bill demonstrates your awareness of the enormity of the problems faced both by the federal government and the health care institutions of this nation and that it is a step in the direction of addressing needed reform.

Mr. Chairman, we will comment on only certain sections of this bill which ire feel are of more crucial significance to our members. Sec. 2. Criteria for determining reasonable cost of hospital services

APHA is confused over the intent of the provision whereby the Secretary shall establish an “accounting and uniform functional reporting systeni" to

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