capacity so that all persons in the area will have the option to

voluntarily join an HMO.

Otherwise the objectives of the HMO Act

of 1973 can be subverted.

Second, $1513(e) should be amended so that HSAs are limited

to review and comment authority over grants, contracts, loans and loan guarantees under the HMO Act, rather than review and approval authority. The implementation of the HMO Act has a high national priority. HSAS should not be permitted to thwart this priority by disapproving HMO development or expansion projects which HEW determines are in the national interest.

These changes P. L. 93-641 are essential to development of new HMOs and rapid expansion of existing HMOs. This is a stated goal of Congress and the Administration.

It should not be frustrated

by a planning act which is designed to impose rationality upon the fee

for-service delivery system.

HMOs already plan rationally because

they have internal incentives to do so.

Sound public policy requires that regulatory systems be carefully designed to address specific problems. They should not be applied to organizations which are not creating the problem or in a manner which inhibits organizations which have great potential to assist in solving the problem.

Therefore, we conclude that the soundest approach is to exclude HMOs and their facilities and equipment from certificate of

need programs and not permit states to cover them.

This is especially the case where competition from HMOs and other health plans ensures that individual HMOs maintain close control over The possible exceptions would be where HMO com

their expenditures.

petition does not exist or where external subsidies offset the effect

of such expenditures on premiums. However, in general, there is little evidence that there is anything to be saved by implementing controls over HMO outpatient facility construction and equipment purchases, especially in light of the cost of implementing these controls and the risk of limiting the long-term useful effects of HMO competiton.

c. HMO Hospital Construction. We found that several large HMOS have sought to build or purchase their own hospitals when their enrollments reached high levels. Hospital ownership appears to produce significant savings over the continued use of non-HMO facilities and allows HMOs to improve the quality of inpatient care to their members. In addition, hospital ownership ensures that beds are available when needed, that HMO physicians can obtain staff privileges and that HMOS do not indirectly subsidize other health plans. In order to evaluate the desirability of HMO construction of hospitals, we estimate the impact of HMO hospital construction on community costs. We assumed that an HMO's acquisition of its own hospital produced net savings from all sources of 10 percent in average HMO costs. Although there is little evidence on the actual savings available from HMO hospital ownership alone, HMO administrators indicate that a ten percent savings seems attainable. This savings is consistent with the HMO cost comparisons cited in Chapter III. Using this assumption and our

HMO cost model, we examined the annual community costs (savings) per

member under two cases: the first, where community beds are not needed; the second, where they are needed. In addition, we examined the impact of alternative HMO enrollments over the likely range of values where hospital construction might be effective. Table II-9 summarizes these re

sults.

Table II-9

Annual Community Costs (Savings) Per Member (In Dollars)
Under Alternative Enrollments (In Thousands)

We found that where community beds are needed, HMO development and HMO hospital construction both produce substantial savings. HMO hospital ownership clearly enhances the savings made possible by encouraging HMO development. Where beds are not needed, HMO hospital ownership still produces community savings, but is less attractive than the continued use of existing hospitals. The best alternative in this situation is the purchase of an existing hospital by the HMO. Specifically, our analysis suggests

that:

⚫ where additional community beds are needed, community costs can be reduced the most by permitting an HMO to purchase or build its own hospital facilities; HMOs can reduce community costs as long as hospital ownership permits HMOs to reduce their hospitalization costs;

• where additional community beds are not needed, community costs can be reduced the most by requiring an HMO to acquire an existing community hospital in lieu of building a new one, if an appropriate existing hospital is available at a reasonable price;

• when existing community hospitals are not suited to HMO needs or unwilling to sell at a reasonable price, community costs are reduced the most by delaying all new construction until additional beds are needed in the area and by giving the HMO first priority on construction when need appears. However, if the HMO, as a result of such delay, is likely to lose enrollment or otherwise not expand its enrollment, then community costs are reduced the most by permitting the HMO to build. In addition, reducing the need for fee-for-service beds by appropriate amounts enhances the savings still further; and,

where new beds are needed within the next 3-5 years (the lead time for construction of a new hospital), where the HMO has an enrollment in excess of 80 thousand members, and where the HMO has demonstrated an inability to purchase an existing facility under reasonable terms, community costs are reduced the most in the long run by permitting the HMO to build new beds. Community savings in the short run are sufficient to justify the construction of the hospital prior to an explicit need for more community beds.

We did not examine these factors for networks and IPAS because their en

rollments typically have not been high enough to justify hospital construcHowever, this characteristic may change in the future and may war

tion.

rant closer examination.

d. Recommendations.

Based upon our findings above, we developed

recommendations affecting health planners' major activities, including health plan development, project review and health plan implementation. Our findings strongly indicate that HMO development is consistent with the long run health planning priority of cost control even though there may be