stringent moratorium, the freeze would be temporary. At the same time, the freeze would force the American public ot consider what kind of health care delivery system it wishes to implement when the freeze expires. The freeze would give state and local planning agencies the time necessary to develop the various health plans required by the Planning Act.

It is ironic that hospitals should suggest a freeze, but this is an indication of how absurd the current system is and how great is hospitals' need to be given the tools to maintain and contain costs and how strongly held in their belief that fundamental changes in the health care delivery system must be made changes which will be considered and instituted only if there is strong impetus to do so.

We have received gratifying support from hospitals and other concerned groups for our proposal. We commend it to your attention. We believe NCCH's proposal warrants your approval, and that it is not inconsistent with the careful consideration of S. 1470 as part of long-range reform.

Our criticisms of S. 1470, set out below, are therefore meant to be constructive and to be considered along with other proposals for reforming the health care delivery system during the 24 months' life of our proposed freeze. Thus, while we cannot endorse S. 1470 in its present form, we believe that your purposes and ours are fundamentally the same. The philosophical difference is that S. 1470 is an effort to reform the existing reimbursement system. We believe it is time to stop, take stock, and evaluate the possibilities of truly radical reform, of developing a new system, rather than reforming the present system. Consideration of S. 3205 last year helped develop NCCH's realization that fundamental reforms are needed. I hope we can persuade you of the need for reforms that go beyond what S. 1470 envisions.

1. S. 1470 is not an effective cost containment measure

S. 1470 is not an immediate cost containment measure. The reimbursement changes proposed by Section 2 of the Bill apparently would not be effective (according to the terms of subsection (d)) until fiscal year 1981-and given the awesome administrative burdens the Bill would entail, we do not believe they could be implemented any more rapidly. The cost of health care is rising too rapidly and is too important a problem to defer cost containment measures for three more years.

More importantly, however, it is difficult to perceive how S. 1470 will be a strong cost-containment measure, whenever it is implemented. The Bill assumes that the cost problem arises from some high-cost and therefore presumptively inefficient hospitals. It is our belief, however, that the real problem is the basic system under which hospitals are forced to operate-which the Bill does, as I discuss below, nothing to rectify.

We do not believe the Bill would effectively save significant amounts of money, for a number of reasons.

First, of course, the Bill applies only to routine operating costs, which account for approximately 50% of a hospital's total costs.

I will discuss later the inappropriateness of attempting to classify hospitals and the irrelevance of pegging reimbursement to the average cost. But even setting those difficulties aside, the mechanism proposed by Section 2 would do little to prevent even routine operating costs from rising. The Bill does not address the fact that the average is a floating average and that it will inevitably float higher because system pressure, not inefficiencies of individual hospitals, cause higher costs. The Bill does not discourage hospitals-regardless of utilization and "profitability" factors--from purchasing expensive new equipment, which can increase routine operating costs. Experience to date has shown that planning cannot be counted upon to stop this expensive proliferation. Nor does the Bill prevent doctors from ordering additional tests or providing new services which may require longer stays and increase routine operating costs. Third, the Bill might encourage some hospitals to raise their costs. Hospitals at the average cost will be encouraged to raise their costs to take advantage of the 120% range offered by the Bill. Those below the average will be encouraged to rise to the average (and from there to 120% of the average). The Bill offers the so-called incentive of permitting hospitals whose routine operating costs are below the average to retain a percentage of that differential. But we can foresee hospitals who would prefer to retain 100% of the differential, rather than a percentage of it, and will offer a sufficient number of improved services so that operating costs rise to the average. By doing so, the hospitals would have the

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 problems 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 calculations 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. S. 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 S. 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 excellence 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 excuse forever.”

We agree with Senator Talmadge as to hospitals' inability to make those decisions, but we believe that the reality cannot be ignored or brushed aside. Ways must be found 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 effective relationships with their physicians.

I refer, 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 Some physicians receive. But even if it is wise as a matter of public policy for the Government to be in the position of imposing compensation limitations on one small segment of society, Section 12 is not an efective mechanism for doing so. Putting hospital-associated physicians on a fee-for-service basis is no guarantee that the total amount of their compensation will be any less than it was under the hospital arrangement. It is likely to be more, and it certainly will be more difficult for anyone to know what the physician'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 closely to the institution. By its terms, Section 12(e) 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 enhancing the complexity of the system. As applied by the bureaucracy, the provision certainly will limit physicians' compensation to less than what they 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 "arrangement" 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 give the hospitals leverage to obtain better 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 arrangements 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 disconrage long-range reform efforts.

I recognize that Section 12(e) was spurred by a suspicion of percentage contracts. But the effect is overkill. 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 arrangement. 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, they are a result