viders and government in the provision of health care services. Central among these issues is the rapidly increasing cost of health care services. Hospitals are concerned and are working actively to restrain health care cost increases within› their control. Health care cost increases are a complex problem; to address the issue requires the combined efforts of all providers, consumers, and government and other third-party payers. Therefore, as we seek to bring the increase in health care costs more 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 recog-nized that this objective cannot be accomplished in a relatively short time.

Hospital cost increases result from a variety of factors. These include infla-tion in the general economy, the intensification and improvement of services, modernization and maintenance of service capacity, expansion of manpower resources, increased demand for services, and compliance with government regulations. Although the Consumer Price Index (CPI) reflects inflation in the general economy, it is inappropriate as an index of the impact of inflation on the goods and services that hospitals must buy. Moreover, the CPI does not reflect the impact of increased intensity of hospital services. The hospital market basket includes many items that have risen much faster than the CPI. The AHA, therefore, has developed a hospital cost index (HCI) and a hospital intensity index (HII) which are based on the price and utilization of 37 serviceelements which are common in the delivery of care to patients. These more typically reflect the hospital market basket. Using these indices, we have found that of the 15 percent rise in hospital costs last year, 10 percent was purely the result of inflation. The remaining 5 percent resulted from incerased intensity and' improvement in patient care.

We know that you recognize the unique characteristics of the health care. delivery system, Mr. Chairman, and our analysis 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 con-cept, and impossible to administer.

S. 1391 would require use of uniform percentage limits on increases in revenues, without regard to individual hospital situations. Such an approach would! exert the heaviest pressures where they are the least appropriate on the most efficient hospitals. An efficient hospital would be forced to curtail essential services and sacrifice the quality of care in order to survive within the formula constraints set forth in S. 1391. It is our belief that such a cap is arbitrary in natureand could have the unintended effect of rewarding hospitals for past inefficiencies or preventing many hospitals from making essential improvements in their services. Additionally, S. 1391, as a "short-term expedient," would create distortions in the financing and administration of hospital services which would have serious and long-term adverse impact on the delivery of health care.

Payment reform is only one part of an array of government and private programs under development or in existence that deal with the problems of health care costs. The American Hospital Association is committed to the pursuit of a reasonable solution to this problem which promotes efficiency and does not jeopardize access to delivery of quality health care. While we have stated the opposition of the AHA to the Administration's hospital cost containment bill, we are by no means negativistic with regard to viable alternatives for the containment of health care costs. Neither do we feel any less committed to seeking solutions to the nation's problems of health care costs than is the federal government.

COST CONTAINMENT APPROACHES

Our Association has consistently supported a variety of programs aimed at conserving the nation's health care resources, some of which are in place, some

in developmental stages, and others yet in the process of formulation through legislative and administrative initiatives, state and federal. Among them are the following:

1. AHA vigorously supports comprehensive health planning and the development of local community planning. Our Association has urged and continues to urge the development of strong certificate of need laws at the state level to avoid the development of duplicative or unneeded health resources and to coordinate the allocation of available resources. Planning efforts must be continued and broadened. We are pleased to note that S. 1470 recognizes that success with eliminating unneeded capacity requires that account be taken of the costs associated with conversion or closure of beds. This bill has taken a positive approach to making possible the correction of maldistribution of resources.

2. AHA supports the development of improved utilization review and medical audit. We have worked for the development of cost effective, institutional quality assurance programs as part of Professional Standards Review activities, which can be important in the identification and analysis of areas of high hospital utilization. Where such utilization patterns are inappropriate, corrective action should be taken and can have a beneficial impact on health care expenditures.

3. AHA fully supports anti-fraud and abuse legislation to strengthen the capability of the government to detect, prosecute, and punish fraudulent activities under the Medicare and Medicaid programs, as embodied in your bill, S. 143 (also in H.R. 3).

4. The AHA believes that an effective state rate review system can assure the public that hospital costs and rates are reasonable and appropriate. Such state systems can provide for individualized hospital review, consideration of community characteristics and coordination with local planning decisions. Such rate review programs must include the participation of all payers and recognize the legitimate financial requirements of hospitals necessary for the provision of services to their communities. Furthermore, such state-based review systems permit the development and testing of alternative payment methods and the evaluation of their effectiveness.

5. AHA believes that the government has an obligation to analyze the cost benefits of regulations it imposes on hospitals. As we have stated in the past, government regulations have significantly contributed to the cost of hospital care-for example the continual revision of the Life Safety Code. These and other regulations often have been imposed with significant cost impact but without commensurate improvement in health care or safety.

6. We understand and accept the need for greater public disclosure of hospital cost data. We support collection and disclosure of such information in order to enable the public to make more informed choices in the use of health care services, as well as to better understand the nature of hospital costs.

7. Another factor that has contributed to the increase in health expenditures is patient demand, often unrestrained because of a lack of direct financial involvement. We support exploration of the restructuring of copayments and deductibles to stimulate greater consumer cost consciousness in decisions to utilize health care services. Such restructuring must be carefully designated in order not to impose inappropriate financial barriers to care upon those with limited

resources.

In addition to all such cost containment approaches, the American Hospital Association and its member hospitals have sought and continue to seek ways of conserving health care resources. Many hospitals across the country, in addition to their usual management activities, have developed special cost containment efforts. While the Association does not at this time have a complete picture of these activities, our information from many sources points out savings through projects which will have continuing long-term benefits, as well as projects that result in one-time savings. These efforts include a wide variety of approaches such as the conversion or closure of underutilized resources; the development of shared services with other institutions; changes in the methods of providing hospital support services; and cost savings changes in hospital staffing patterns.

MEDICARE/MEDICAID ADMINISTRATIVE AND REIMBURSEMENT REFORM ACT, S. 1470 Criteria for determining reasonable cost of hospital services

We have carefully reviewed the hospital reimbursement changes outlined in Section 2 of your bill. When a classification system is used for the purposes of

reimbursement on a comparative basis, it must be sufficiently sophisticated to permit differentiation of efficient and inefficient hospitals. We believe that the provisions of Section 2 would result in significant improvement over the existing methodology of Section 223 of P.L. 92–603, which it is intended to replace.

We appreciate your recognition that certain hospital costs must be excluded in order to assure comparability. Your bill eliminates, for purposes of cost comparison, the costs of capital, education, energy, and malpractice insurance.

While the bill provides for the exclusion of malpractice insurance expense from the determination of routine operating costs, a significant problem remains in the application of this exclusion. Commercial insurance companies insure hospitals against malpractice under a single policy which includes coverage for both professional and comprehensive general liability. Because it will not be feasible to identify the specific costs of malpractice insurance alone, we strongly recommend that this exclusion include the total cost of such policies.

Mr. Chairman, we strongly support the provision of your bill which permits state rate review programs as an option to the bill's federally administered controls. However, the proposal would permit delegation only to state programs which are legislatively mandated, and we urge that you amend this provision to recognize voluntary programs which meet other established criteria.

One of the conditions for state delegation requires that the estimated aggregate annual Medicare and Medicaid payments by the state to hospitals be less than would otherwise be paid under the federal programs. We are extremely concerned about this requirement. Many state rate review programs are still in the developmental stage, and it would not be unusual for such programs, in coping with overall costs in their early years, to permit an annual payment higher than would be allowed by the federal programs. We believe that similar constraints in Sections 222 of P.L. 92-603 and 1526 of P.L. 93-641 are important reasons for the very limited development of and experience with these alternative payment systems. In a similar manner, S. 1470 provides that the delegation of rate review authority to a state be revoked if it is determined that in any one-year period, except in extraordinary circumstances, the state program results in payments greater than would otherwise have been made by the federal programs. We believe that such rigid requirements for delegation to states, or revocation of delegation, will have the effect of stifling the development of state rate review programs, which, over time, can achieve the goal we all seek. We recommend that this section be modified to allow the Secretary more flexibility in permitting the state rate review options, taking into account longer-term results of such delegation.

We commend you for proposing a uniform, functional cost reporting system without the requirement that there be established a uniform functional accounting system. We agree with the need to identify "like" costs of institutions. Such a reporting requirement is a prerequisite in your classification system and is used in the determination of inpatient per diem target rates. The position of the American Hospital Association has been and remains that a uniform functional cost reporting system will accomplish this objective. Last year, S. 3205 would have required "a uniform system of accounts . . ." and in our testimony on that bill, we pointed out the problem that such a requirement would create. Because of the differences in the nature and operation of various kinds of hospitalsurban and rural, large and small, teaching and non-teaching-the requirement for a uniform functional accounting system would have required each of these institutions to adopt a singular method for recording all transactions that would be burdensome, extremely costly and unnecessary.

We offer the following recommendations that we believe will improve the provisions of Section 2 of your bill and we are ready to participate in further discussions toward that end:

1. In defining routine operating costs, the bill eliminates several items that are, in fact, beyond the control of an institution and have, in the past, created difficulties in using a classification scheme. The objective in excluding these costs is to remove from the determination of routine operating costs major "cost elements beyond the control of the hospital" which vary widely among institutions in a way which is unrelated to the efficiency of the institutions. We agree with this. However, at some future date other cost elements meeting the same criteria may appear and should be similarly excluded. Therefore, we strongly recommend that this provision be modified to permit the Secretary to deal with such circumstances as they arise.

2. Among the costs to be excluded from routine operating costs are "energy costs associated with heating and cooling the hospital plant." We believe all energy costs must be excluded for two reasons: (1) there is a significant variability in types of energy sources used by hospitals and their costs in various regions of the country; and (2) differentiation of the cost of energy by type and use is very difficult, if not impossible. For example, electricity, which is used for environmental control, particularly cooling, is also used for the operation of diagnostic and therapeutic equipment, as well as lighting.

3. The proposed system of classification continues to be based on bed size and type of facility. While these variables can account for certain aspects of hospital routine operations, others such as case mix and length of stay, are necessary to truly classify "like" hospitals.

We recognize the inherent problems of developing and utilizing such data in any classification system. Further, the state of the art of determining and comparing these extremely important variables, as they relate to cost, requires further development. It is essential that evaluative procedures for analysis of the effectiveness of the payment method be carried out on a continuing basis. Such activity will be important to ensure that the basic classification and exceptions processes cover all appropriate factors and that the entire procedure can be improved.

4. The bill provides that the personnel component of average per diem routine costs be adjusted through the use of a wage index based on general wage levels prevailing in the areas where the hospitals are located. As expressed last year, our concern is that this index refers to wage levels in the general economy rather than the segment of the labor force from which hospitals recruit their employees. It must be pointed out that the correlation between these wage levels is not even approximate because in any hospital, employees' wage levels are not representative of wage levels in a cross section of the general economy. Moreover, to the best of our knowledge, wage data of nonmetropolitan areas are not available on a periodic basis, and it is in these areas that approximately 50 percent of all hospitals are located.

Although a hospital with higher wage levels than those prevailing in the general economy of its area would have a on-year reprieve under the bill, it would be subjected to controls thereafter that fail to recognize that those higher levels of cost may be fixed, for example, by virtue of prior contractual arrangements, or may well be maintained by state or local law, as in the case of public institutions. Again, we recommend that a new hospital wage index be developed and maintained based on that segment of the labor market from which hospitals must recruit.

5. Section 2 provides that ". . . at the end of the fiscal year retrospective adjustments will be made in the amount paid a hospital to reflect the lesser of the cost increases incurred by the hospital or the cost increase in practice which occurred in goods and services used. . .". The problem with this provision is that a hospital could be told at the beginning of the fiscal year that it would be reimbursed at a certain dollar level per patient day for its routine services, and budget accordingly. But, if at the end of the year the government determines that the forecasted price increase was in error, and, therefore, that the hospital should be paid at a level lower than that previously set, the institution would subsequently incur a deficit. We do not believe that hospitals should be placed at such risk. The system should not permit a retrospective denial of reimbursement of incurred costs on the basis of erroneous economic forecasts.

6. We concur with the use of a uniform data base period, i.e., Fiscal year 1979, in establishing the target rate for Fiscal 1981. As you know, in projecting payment rates it is essential that the base data be as accurate and as reflective as possible of actual situations. However, the proposal is silent concerning adjustments to base data in recognition of institutions' varying fiscal years. We believe that this is not your intent, and we recommend that a varying inflation adjustment be incorporated in the proposal that would reflect the inflation factor during an institution's actual fiscal year.

7. Section 2 provides an exceptions process based on two criteria. The first exception is for an underutilized hospital in a medically underserved area. The second exception is for increased intensity of care or unusual patient case mix. One of the problems faced by hospitals with unusual case mixes and high levels of intensity of care, is that they do not have the necessary comparative data to justify their costs. We have observed that hospitals seeking exceptions from

the limitations imposed under Section 223 of P.L. 92-603 for this same purpose experience this difficulty. They must attempt to justify atypical costs without knowledge of the amount or nature of such costs for other hospitals in their peer grouping. We recommend that the bill provide that the HEW Secretary make such comparative data available to all hospitals within a classification group.

Furthermore, the assessment of the intensity and complexity of care provided by the institutions include, in addition to patient mix, such variables as length of stay. Hospitals with high patient turnover and shorter lengths of stay are usually characterized by higher intensity and per diem routine costs, and we strongly recommend that these factors be included as justification for exception.

8. We continue to be greatly concerned about the provisions that would tie the incentive reimbursement formula to average per diem costs within a group of comparable institutions without provisions for evaluating and altering an unwarranted "ratchet" effect. If, as intended, the results of the incentive formula would be that each year average per diem costs would potentially be reduced, additional hospitals not previously found to have high costs would be so identified and penalized. This would be the inevitable consequence each fiscal year of cost reductions in hospitals classified in the highest category. Unless provision is made to deal with this effect, the eventual result would be that costs related to the provision of needed, complicated and, therefore, costly health services would no longer be recognized. Thus, the delivery of such services would no longer be feasible in many health care institutions. We recommend that legislative language be included to ensure that this matter be reviewed every two years after the system is applied, so that the system may be evaluated and modified accordingly..

9. Two important issues are not addressed in Section 2 of the bill. The first is the provision of charity care and the bad debts incurred by hospitals. Unsponsored patients are a serious problem to hospitals because of the increasing stringency of state programs and because of the decline in the ability of local governments to finance the care of their medically needy patients. This problem is critical, and a solution must be found. We believe the time has come for both Medicare and Medicaid to acknowledge and share in the costs of treating all unsponsored patients.

The second issue not addressed is the need to provide for the financing of the necessary replacement of hospital plant as it wears out and for needed improvements. Paying hospitals only their operating costs will not be sufficient to provide them needed capital funds or permit them to secure debt financing at realistic interest rates, if needed, they can qualify for loans at all. We are anxious to work with the Committee to devise methods for addressing these issues.

Payments to promote closing and conversion of underutilized facilities

We support, Mr. Chairman, the need to provide special reimbursement provisions to encourage hospital efforts to close or convert underutilized facilities. AHA strongly endorses the experimental approach in Section 3 of the bill. Federal participation in hospital capital expenditures

Section 4 of the bill amends Sections 1122 and 1861 of the Social Security Act, relating to the health planning process. Under P.L. 93-641, most, if not all, states will have a certificate-of-need program in place by 1980. We support the provision in the bill that would strengthen the health planning process by expanding the reimbursement penalties applied to providers who proceed with capital expenditures without planning approval. We do believe, however, that the application of the certificate-of-need requirement should be broadened to include capital expenditures at any site when such expenditures are made for equipment or services customarily provided in a hospital setting.

We understand the purposes of the provision in this section that requires designated planning agencies to jointly review and approve a proposed capital expenditure in a standard metropolitan statistical area (SMSA) which encompasses an interstate area. However, we are also concerned that this provision may block needed action in these areas because it may involve in the review process a designated planning agency which is primarily interested in supporting improvements only in its own area. In view of the fact that P.L. 93-641