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of all providers, consumers and Government and other third-party payers. Therefore, as we seek to bring the increase in health care costs in line with the growth of the general economy, it is essential that the actions taken be constructive to this end, and it must be recognized that this objective cannot be accomplished in a relatively short time. What is forgotten is the fact that these 6,000 hospitals are governed by 100,000 community-oriented trustees who are very, very concerned, just as you are in the Congress and as other people are, about the rate of increase in cost. Sometimes, the allegations of what is going on in hospitals overlook the dedicated service of these trustees, many of whom both of you Senators know from your own States and your own communities. Hospitals are ready and willing to reduce costs, but not at the expense of reducing quality or turning away patients.

It is essential that the actions taken be constructed with all the ends in mind and it must be recognized that cost reduction objectives cannot be accomplished in a short timespan.

Hospital cost increases result from a variety of factors. On page 2 of our statement we have set forth, as we see it, the difference in impact of inflation on the economy as a whole versus that on the hospitals' market basket and the services that lead to the increase in cost.

We know that you recognize the unique characteristics of the health care delivery system, Mr. Chairman, and our analysis indicates that S. 1470 reflects an understanding and consideration of its complexities. S. 1470, in revising the method of payment to hospitals, establishes a system of incentives and disincentives based on target rates for groups of essentially similar hospitals. We strongly support the provisions allowing State rate review programs to serve as an alternative method for control over medicare and medicaid payments. In addition, we support your efforts not only to make improvements in the medicare reimbursement system, but also your efforts to improve the current medicaid program.

The approach of your bill, Mr. Chairman, which considers the operational differences between institutions, is a reasonable and equitable one that deals rationally with cost problems, unlike the inequitable and harmful approach proposed by the administration's bill, S. 1391. In your introductory remarks on S. 1470, you expressed several concerns about the administration's proposal which we share. We have concluded that S. 1391 is inequitable in design, wrong in concept, and impossible to administer.

If the committee would like, we can expand on that later on.

On pages 4 to 6, Mr. Chairman, we have noted some of the present hospital controls as well as hospital activities designed to reduce the rate of increase. We have touched upon the importance of planning and on the existence of capital controls and we have suggested the use of incentives to eliminate unneeded facilities. We are pleased with the provisions of your bill dealing with this matter. I will have more to say about that later.

Even unneeded facilities, Mr. Chairman, we must recognize, are depended on by some people. It is one of the reasons why it is difficult to say that there are a lot of excess beds or unneeded facilities, when the elimination of those would mean that some people would then have to go without.

We have touched on utilization, review, and medical audit. We have spoken favorably about the anti-fraud and abuse provisions which you began and which are now moving forward in the Congress.

We have talked about the impact of State rate review. We have noted the excessive regulation problems. We have suggested greater public disclosure of costs and charges. We have commented on the problem of patient demand, how the encouragement of better health practices could be a contributor to lower rates of increase in hospitals, as well as health care costs.

We have touched upon the individual hospital efforts. We have noted that we would certainly support reasonable efforts to go further, as we did in the testimony on your bill last year, and as we hope to do today.

The balance of the testimony, Mr. Chairman, deals with S. 1470. It is basically supportive with a few suggestions which, we believe, would improve the workability of the approach. We began the discussion of that on page 7.

We believe that the provisions, Mr. Chairman, of section 2 would result in significant improvement of the existing methodology of section 223 of the 1972 amendments, which it is intended to replace, and we strongly support the provision in the bill that permits State rate review programs as an option to the bill's federally administered controls. We are pleased with the addition of those provisions which we take as responsive to our suggestions last year. However, the proposal we think—and we noted this, Mr. Chairman, on page 7-is a narrow delegation to the States because of the requirements that delegation would be only to those States where hospital payments would be less than would be paid under the Federal program, are perhaps too re strictive.

Governors would have difficulty in determining whether or not they could meet that challenge. We think probably, with the present situation of the rate review programs, broader opportunity for delegation would be advisable, and we noted that.

On page 8, we have commented favorably on the proposal for uniform functional costs reporting systems without the requirement of a uniform functional accounting system. We think that uniform reporting will deal with the problem. Of course, a problem basic to the workability of the classification system is the need to get uniformity of reporting.

Toward the bottom of page 8 we begin noting the number of recommendations which we believe, as I said earlier, would make the provisions of the bill more workable and I would like to highlight several of them.

In the middle of page 9, under item 3, we noted that the proposed system of classification continues to be based on bed size and type of facility. We suggest a consideration of other variables, such as case mix and length of stay which would provide more flexibility.

On page 11. under point 7, we suggested a somewhat broader exception process because the assessment of intensity and complexity of care, as we noted on the bottom of the page, in addition to patient mix, would add a needed flexibility and would give opportunity to expand on the evaluation of the workability and classification system.

On page 12, we expressed a concern about the possibility that, over time, the incentive formula, the average per-diem cost within a group of comparable institutions which may have a ratchet effect. We suggested a 2-year review.

We might also, and will discuss this further with the staff, Mr. Chairman, consider the use of the median rather than average to make the system more workable.

We have suggested, at the bottom of page 12, two important issues,. the first being a provision for charity care and bad debts incurred by hospitals. Some attention might be given to that-medicare and medicaid might share in the ocst of treating all unsponsored patients.

We have suggested at the bottom the need to provide for the financing of necessary replacement of hospital plant. The problem of surplus revenues, or an operating margin, Mr. Chairman, is not understood as the testimony of the Secretary yesterday seems to indicate. Section 46 addresses another question, and we must provide for the effect of inflation on working capital and provide the equity needed for the improvement of plant or replacement of wornout facilities. Mr. Chairman, hospitals, as a whole, do not have a surplus, an operating surplus-hospitals as a whole, across the field-we have tracked this for a number of years, the field operates at an operating loss. What does bring about excess of revenues over expenditures are nonoperating revenues, donations, and so on, that make it possible for expansion; and this is an absolutely necessary part of hospital operations.

Finally, Mr. Chairman, from pages 13 through 17, we have offered comments on other sections. We were particularly pleased with several sections, such as section 3, to encourage the closing and conversion of unneeded facilities, and section 24, the conversion of unneeded acute beds in small institutions.

We made a minor suggestion or so on that. We are not quite sure, I will say, Mr. Chairman, that we completely understand the new sections 12, 15 and 40, although we do see improvement over the earlier version and will be pleased to work with the committee staff on needed clarification.

Finally, Mr. Chairman, as I noted in the concluding remarks on page 17, we believe that your bill includes many constructive and important reforms in administration and reimbursement for services. under medicare and medicaid programs. We support them and have suggested some modifications, and we do appreciate the opportunity to continue to work with you and your staff and in participating in this hearing.

I would be glad to respond to questions.

Senator TALMADGE. Thank you very much, Mr. McMahon, for your very helpful testimony.

On page 12, you express concern over a possible ratchet effect on average hospital costs under the reimbursement plan in the bill. Do you believe that that would occur because the average cost would be reduced as above average high cost hospitals brought their costs down? That, of course, would tend to lower the average when it was next calculated. I agree that we should avoid forcing the average down to unfair and inequitable levels, but Secretary Califano testified yes

terday that the proposal would not have much of a moderating effect on hospital costs.

I gather that your stand is just the opposite, that we might moderate hospital costs too much. Is that what you are saying?

Mr. MCMAHON. We are concerned-well, it really goes to the workability, Mr. Chairman, of the incentive activity. If you take an average and then give the incentive for the hospitals to come below the average through an award, we are not sure on what the effect of that on the average as well as the effect through the elimination or the reduction of rate of increase of the high costs will have. That is the reason that we have suggested the possibility of the use of a median which would avoid what I am talking about.

It might be useful-why we suggested what we did in the testimony, the reevaluation very 2 years might be useful. We are concerned. We know it is going to have a very positive effect, Mr. Chairman, in focusing on and giving notice to the institutions who are above, substantially above, the average to bring themselves in line.

I think this is a very useful concept, because it zeroes in on those where savings are possible and we are convinced that that program will have a beneficial effect.

Dr. GEHRIG. May I add to that?

As Mr. McMahon has stated, I think this is going to have a very positive effect. I think it is important to note that the plan in the bill would provide, prior to initiation, data for hospitals to look at. I believe its effect will occur before, in fact, it becomes fully in force, because it would have provided fuller data to hospitals in which those costs are high. They can begin to make management changes prior to the effective date of this bill and adjust accordingly. It will have a real effect in moderating costs. It will occur early.

Senator TALMADGE. We are concerned with the need for accurate measures and methods for hospital wage levels in geographical areas. Both you and the Department of Health, Education, and Welfare, say that such methods are not now available.

HEW says, however, that they can be developed in a reasonable period of time. If these methods are not now available, what yardsticks do you people use who say that hospital wages are too high, too low, or average?

Mr. MCMAHON. Mr. Chairman, we have always thought that the issue there is one to be determined by the institution itself. Again, asI say, governed by those community-oriented trustees who are very much concerned, both about the rates of increasing costs and about the ability to obtain and retain qualified people.

We have had some experience and tracked very closely, Mr. Chairman, some of the impact of section 223, and we know that hospitals in a specific community are influenced by activities outside of that community.

For example, you may have a State institution in a relatively moderate wage-level community, but it is tied to its own State wage programs and cannot really be measured by that community wage level. There are other problems as well.

When the need comes to recruit nurses out of that community, we have always been very careful to try to measure or make comparisons

about the wage level from institution to institution, because we know what the problems are.

We pointed out in the testimony, as you note, there are some problems with that concept. We have no solution at this stage. We would certainly be pleased to work with you and the staff to see what we might be able to do.

Senator TALMADGE. Thank you for that suggestion.

Should the wages of nonprofessional hospital employees be in a class by themselves, or is it reasonable to relate them to general wage levels in a given geographical area, or similar areas?

That is, are there not broad types of employment related to the work which janitors, electricians, orderlies, and administrative and clerical personnel do in hospitals?

Mr. MANZANO. We do not have specific data on a national basis on what those wage comparisons are, but there are indications, when you are talking about classifications of employees that are representative of the general employment market, that is a market in which hospitals must compete, their wages are generally comparable.

Senator TALMADGE. Is it not reasonable to use those as benchmarks? Mr. MANZANO. In the case of classifications of employees that are represented in the general wage market, it would be, yes, Mr. Chairman.

Senator TALMADGE. Senator Dole?

Senator DOLE. Thank you, Mr. Chairman.

I think Mr. McMahon touched on the administration proposal. We are not having a hearing on that as such, but you might briefly tell us, at this point, what you think the principal defects are in that approach, the approach that Secretary Califano discussed briefly yesterday and also your comments or suggestions, if any, on having the Comptroller General take a look at what they are attempting to do in reorganization.

I might say GAO is already starting that investigation. They are going to start at 2 o'clock this afternoon with a meeting with the Finance Committee Health Staff. Your comments might be helpful. Mr. MCMAHON. All right. Let us take those, Senator Dole, one at a time.

When one from the hospital field tries to pick a beginning point to analyze the administration's proposal, one is at a complete disadvantage, because it is all bad. Whether you are talking about the use of a specific percentage or whether you are talking about this extremely complex system that the bill sets forth, the whole thing is based upon a series of misunderstandings and miscomprehensions of the ways hospitals work.

For example, the Secretary said that 20 percent of the hospitals are already below 9 percent and he does not see why the others cannot do so. When you look at it, hospitals vary so greatly that those who are in a steady state, you might say, operating at about the same occupancy, providing the same services, ought to be under 9 percent. An institution, as you know, that I am familiar with, will operate at less than a 9-percent increase next year, but it will not the following year, when some new services come into play.

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