We find it difficult to comprehend the validity of a regulation which causes loss of Medicare-Medicaid certification for an institution solely because of medical staff refusal to perform U. R. functions while at the same time imposing no program sanctions on the involved physicians. Such a regulation can destroy an institution's effectiveness by destroying its relations with physicians.

We know of several hospital administrators who want to comply with the U.R. regulations but who cannot persuade eligible staff physicians to perform the required duties. Some staff physicians have indicated they would purchase a single share of stock in a hospital company in order to disqualify themselves from U.R. functions. Hospital administrators understandably feel the regulations are driving a wedge between hospital administrative personnel and physicians by not providing an alternative means of compliance or waiver until a PSRO can perform the review functions.

ECONOMIC COST

As we noted earlier in our statement we believe the controversy over the several regulations selected for discussion today stems from the broader administrative policy of the Medicare program that bases hospital reimbursement on reasonable "accounting" costs. Once limited to cost reimbursement in the accounting sense hospitals must look to non-Medicare patients to pay higher charges in order to average out all reimbursement at a level which equals the institution's economic cost or total financial requirements, including a margin for working capital and to establish a sound equity base. No facility, non-profit or for-profit can operate effectively without an adequate surplus.

Understanding the difference between accounting cost and economic costs can help us find the underlying cause of inflation and the key to long range cost containment in the health field. For this reason we are attaching to our statement a copy of an article entitled "Reimbursement based on 'Economic Cost': What Other Choice is There?" This excellent article was written by Robert S. Lemer, Partner; Marion D. Davis, Partner; and Gary W. Reicherzer, Supervisor, Ernst & Ernst, Houston, Texas and appeared in the February/March 1975 issues of the INVESTOR-OWNED HOSPITAL REVIEW.

We hope the article will be helpful to the Subcommittee in understanding the inflationary impact of the selected regulations under consideration today as well as the broader reimbursement policy of the Medicare program.

Our specific recommendations on the regulations under review at these hearings have been suggestions for temporary relief and equity. Only by changing the broader policy of cost reimbursement can we prevent future inequity among those who pay for health services. That reform should be mandated by Congress as soon as possible and we pledge our efforts to help develop a more equitable system to pay for health care services.

[From the Review, February/March 1975]

MEDICARE TECHNICIAN'S FORUM

REIMBURSEMENT BASED ON "ECONOMIC COST': WHAT OTHER CHOICE IS THERE? (By Robert S. Lemer, Partner; Marion D. Davis, Partner; Gary W. Reicherzer, Supervisor, Ernst & Ernst, Houston, Tex.)

The need to control the rapidly escalating "cost" of health care is frequently cited as a reason for placing the entire health care industry under one payment system (a third-party reimbursement system in the form of National Health Insurance.)

The escalating "cost" criterion frequently referred to is not really cost in an accounting sense, but rather charges to full-pay patients (more appropriatelycost in an economic sense). It is ironic that the escalation of rates to full charge paying patients is being fueled by cost reimbursers (Medicare, Medicaid and, to an extent, some insurance plans) through their (1) basic non-recognition of economic cost; (2) more restrictive interpretations of "allowable" accounting cost, and (3) ever-expanding coverage of the U.S. population.

A full understanding on the part of all third-party reimbursers and providers of the distinction between "cost" in the economic and accounting senses is vital in order to abate this accelerating pressure on the self-pay patient. This understanding will also be critical in arriving at proper rates under any reimbursement system evolving under National Health Insurance. It is a financial fact of life that our health care system cannot remain financially viable unless the providers' economic cost (i.e., total financial requirements) is the basis for rates.

Cost in the accounting sense includes salaries and wages, supplies, historical cost depreciation, interest and other operating expenses, as more fully defined in the AHA Chart of Accounts for Hospitals and the AICPA Hospital Audit Guide. However, cost in the economic sense comprises much more than that. Economic cost also includes such items as charity allowances and bad debts, as well as "Profit element."

As with any other economic entity, "profit" is an absolute financial necessity for all health care providers.

How else can a provider furnish the down payment or equity position demanded by lenders relative to the acquisition of new technology and services or expansion?

LEGEND TO EXHIBITS A THROUGH F

Profit (financial needs for working capital, new technology, expansion, price level depreciation increment, etc.)

Bad

debts and charity

allowances

Costs - in the accounting sense

*These amounts were arbitrarily selected as a beginning point for illustrative purposes and do not necessarily bear a correlation to actual experienced amounts.

54-804 0-753

Where else but from "profit" can a provider obtain funds necessary to cover working capital needs created by inflation, expansion of services and the significant timing lag inherent in collecting for health care services after they are rendered? What avenue other than "profit" is available to cover the inflationary additional cost (price level depreciation increment) when replacing plant and equipment? All of these needs for profit are widely recognized when discussing business entities in other sectors of the economy but are substantially disregarded by third-party reimbursers and others in the health care industry.

The difference between "accounting cost" and "economic cost" is perhaps more graphic in Exhibit A. It is not possible to pursue in this article a detailed discussion of the definition and conceptual differences.

Detailed discussions can be found in such publications as the AHA Statement on the Financial Requirements of Health Care Institutions and Services and the Aspen System Corporation's Winter 1974 edition of Topics in Health Care Financing relative to rate setting. Writings such as these are not in total agreement in all respects, but there is certainly a common conclusion among them that cost in the accounting sense, even though preferable for financial reporting purposes, would eventually be a bankrupt approach if uniformly applied to provider reimbursement from all sources.

Exhibits B and C portray the differences in charge levels to self-pay patients and third-party payers (1) where everyone pays their fair share of economic cost (Exhibit B) and (2) where third-party payers pay only their share of accounting cost (Exhibit C).

Exhibits B and C are presented in a situation wherein cost reimbursers cover only one-third of total services rendered by the provider.

Exhibit D shows the dramatic impact upon self-pay patients when the thirdparty cost reimbursers extend their coverage (to two-thirds in the Exhibit D example) and pay only their share of accounting cost.

It is difficult to understand why cost in the economic sense is not the reimbursement approach being advocated by those persons sincerely interested in the ongoing financial viability of our health care system.

Even when cost in the accounting sense is considered by itself, the inadequacy of the "cost" rates now paid to providers by the Medicare and Medicaid Programs would eventually bankrupt providers except for the presence of full-charge payers (self-pay patients). This is due to certain items not being included in the Programs' definition of "allowable cost" in the accounting sense.